Chart 1

Overview

As of April 23, 2024, S&P Global Ratings maintains six public ratings on North Carolina charter schools. North Carolina began allowing charter schools to operate after passing the Charter Schools Act of 1996. As of the 2023-2024 school year, North Carolina is home to 211 charter schools serving approximately 145,000 students, representing around 9% of all public school students in the state.

Although our six rated North Carolina charter schools represent a small sample size, we believe growing charter school enrollment, compared with that of traditional district schools, reflects increasing demand for charter school options in the state.

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The credit profiles for our rated charter schools in North Carolina are generally stronger than those of the rest of the sector. About 70% of our North Carolina charter school ratings are investment-grade, compared with approximately 45% for the sector, as noted in our 2024 sector outlook for charter schools, published Jan. 17, 2024, on RatingsDirect. We attribute the stronger ratings distribution to healthy demand for rated charter schools in the state, particularly those in the highest-growth urban areas. This demand contributes to strong enrollment growth and, in turn, revenue base growth.

Authorizer Framework

• The North Carolina Department of Public Instruction (NC DPI) is the only state authorizer for charter schools. The North Carolina Office of Charter Schools is housed within the NC DPI and provides recommendations on whether to grant, renew, amend, or terminate a charter school application. The Office of Charter Schools sends recommendations and supporting information about each charter school to the Charter School Review Board, which provides the final decision.
• In our view, the authorizer's process for authorization, renewal, and revocation is clear and transparent with details published on its website. The authorizer monitors charter schools at least annually and creates a report card for each school based on relevant benchmarks. Charter schools facing nonrenewal or revocation are allowed to appeal the decision to the North Carolina State Board of Education (SBE), but information is limited on how the appeals process works.
• The NC DPI has no vested interest in the outcome of the authorization process given that it is independent and does not compete with charter schools for students or funding, which we view positively. However, since there are no alternate options, charter schools across the state are limited in their options, which could pose a challenge if any conflicts arise.
• North Carolina charter schools are authorized for an initial five-year charter term with a maximum term length of 10 years.

Credit Fundamentals

North Carolina charter schools are mostly single-site operators with only two out of six of our rated universe having more than two school sites. Half of these schools operate in or near the Charlotte metro area in Mecklenburg County, where the school-aged population base is robust (with a 5.1% increase in kindergarten through 12th grade projected over the next five years), explaining stronger demand relative to sector medians.

Table 1

Financial resources of our rated North Carolina charter schools have, on average, remained lower than those of rated peers. Days' cash on hand fell to 133 in fiscal 2023 from 146 the year prior, remaining moderate compared with our rated universe medians. Median revenue increased to $18,238 from $16,440 on account of the increased demand profile in the North Carolina region as well as positive per pupil funding trends over the past several years.

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Median demand metrics have improved in fiscal 2023, and we attribute this to favorable state school-aged population growth trends and generally high academic achievement among our rated schools in the state. Across North Carolina, enrollment in charter schools grew each year over the past decade, compared with flat-to-declining enrollment across district schools (see chart 2). In fiscal 2023, median enrollment within our rated universe grew with the largest growth in the 'BBB-' rating category. Enrollment for one speculative-grade credit saw a slight decline in fall 2022 but has since rebounded, and as of fall 2023 the school projects enrollment growth well above that of previous years.

What We're Watching

Student enrollment trends.   North Carolina's kindergarten through 12th-grade elementary and secondary school enrollment has grown as a result of favorable demographic factors, including positive birth rates and in-migration. The charter school market has become increasingly saturated in larger areas such as Wake County and the Charlotte metro area. Demand has grown in more rural areas of the state, where school choice options are limited and exposure to charter schools is relatively new. Although charter school enrollment has continued to grow and outpace district school enrollment, enrollment trends across the state have been mixed depending on the age and reputation of the charter school. In general, more established charter schools with solid academic reputations have continued to see increasing growth and substantial waitlists. Conversely, relatively newer schools have generally faced enrollment challenges as a result of high startup and operational costs. We expect similar enrollment trends hereafter with the highest enrollment growth anticipated around the Charlotte metro area as well as in rural regions across the state as options become available.

Funding trends.   Charter schools in North Carolina receive the majority of their funding from the state, with about 25% of revenue coming from local sources. Recent funding trends have been positive with single-digit growth annually for charter schools in our rated universe in addition to an expectation for continued per pupil funding growth in the mid-single-digit area through fiscal 2025. In March 2024, the North Carolina SBE voted to approve a new funding policy that will begin in fall 2024 (fiscal 2025). Under this new policy, the state will follow a "hold harmless" funding level in which a school, whether district or charter, will be funded based on a calculation including its prior-year average daily membership (ADM) and projected ADM for the budgeted year. The main purpose of this policy change is to provide schools with the appropriate time to plan and adjust to fluctuations in student demand, and we believe that this will benefit any charter school that faces unexpected enrollment declines in the near future.

Capacity and expansion allowances.  Under House Bill 219, the state authorizer updated enrollment policies with regard to charter school expansion. A non-low-performing school (one that has received a performance grade of 'A', 'B', or 'C') can increase maximum authorized enrollment once per year if it is in at least its second year of operations, and can expand to offer one grade higher or lower, without approval, if it has been in operations for three years and has been in financial compliance as required by SBE's adopted rules. For a low-performing school (one that has received a school performance grade of 'D' or 'F'), any expansion plan is subject to approval by the Charter School Review Board. We expect an increase in charter school enrollment over the next few years, including expansion plans, given an increased ability for non-low-performing charter schools to grow with minimal formal approval processes needed.

Increased potential for capital funding.  With the recent legislation, counties can now use property taxes to directly appropriate capital funds to charter schools. These funds may be used to acquire property, construct or renovate facilities, and furnish or purchase equipment. While we have not observed the receival of county funds for capital purposes to charter schools in our rated universe, the change in legislation allows for potential additional capital support that may benefit charter schools and capital project financing.

School choice vouchers.   North Carolina students have access to two types of school choice vouchers, the Opportunity Scholarship program and the Personal Education Savings Account (ESA). The Opportunity Scholarship program was launched in the 2014-2015 school year, and under it all students across kindergarten to 12th grade are eligible to receive a voucher for as much as $7,468 for the 2024-2025 school year, depending on household income. The ESA program, which was launched in the 2022-2023 school year, requires that a student be defined as having a disability per the Individuals with Disabilities Education Act to receive funding. Under both voucher programs, funds can be used for tuition, transportation, equipment, and other necessary private school expenses. As of the 2022-2023 school year, roughly 2% of the total student age population statewide participated in at least one of the state's school choice voucher programs. While the population of students using vouchers is relatively small in the State of North Carolina, we believe the expansion of school choice heightens competition for students across all types of schools, including charter schools, but we have observed no material enrollment pressures to charter schools within our rated universe.

Pension funding levels.   We view credit risks related to pension and other postemployment benefits (OPEB) as somewhat elevated across our rated universe in North Carolina. Charter schools participate in the North Carolina Teachers and State Employees Retirement System defined benefit pension plan and in the North Carolina Retiree Health Benefit Fund defined benefit OPEB plan. While we view the former as adequately funded with a funded ratio of about 83% as of fiscal 2023, the latter is significantly underfunded with a funding ratio of only 10.7%. In addition, when pension and OPEB obligations are combined, several schools in our rated universe have an elevated exposure within their budgets with at least 10% or more of their annual expense base allocated to pension and OPEB funding. We expect pension and OPEB liabilities will continue to pressure some charter schools in our rated universe given the size of recent contributions as a percentage of annual expenses as well as the OPEB plan's low funded rate, which has only slightly improved over the past several fiscal years.

Testing and learning loss.   Academic performance has varied across the state with charter schools in our rated universe receiving state assessments in the 'A', 'B', and 'C' categories for the 2022-2023 school year. Within our rated universe, the highest-rated schools have the strongest academic results and tend to be among the top performers in their respective areas. While 2022-2023 school year assessments across the state are still lower than pre-pandemic levels, they have improved over the past three years with expectations for the next accountability assessments to show continued performance improvement. The SBE has also been piloting adaptive testing with an idea to have the difficulty of an assessment fluctuate based on the number of questions answered correctly or incorrectly in previous sections. Adaptive testing has not been formally rolled out, but we believe the potential use of differentiated testing structures could benefit students with varying academic needs.

Long term use of one-time funds.  Elementary and Secondary School Emergency Relief (ESSER) funds have provided significant operating revenue to both district and charter schools over the past several years. Many schools have used ESSER funds to provide additional support systems for students following the pandemic, including part-time or full-time staff and other resources focused on academics and well-being. As most of the schools' federal relief funds are expected to be spent by the close of fiscal 2024, schools that have relied on these funds will have to reallocate budgetary resources accordingly. The NC DPI has rolled out full-day trainings to prepare schools for the expiration of ESSER funds, so many schools have been relatively prepared for fiscal 2025 and beyond. However, some schools may be unable to manage expenses as quickly and could face a fiscal cliff with material operating pressures and the challenge of affording certain recurring expenses.

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