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In This List

Credit FAQ: How COVID-19 And The Recession Could Affect Credit Quality For U.S. K-14 Schools


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Credit FAQ: How COVID-19 And The Recession Could Affect Credit Quality For U.S. K-14 Schools

Since the onset of the COVID-19 pandemic the U.S. educational landscape has changed markedly, and it may never go back to the way it was. This means that schools--from local districts to charter schools to independent schools and community colleges--will transform their operations to respond to a situation that may last no longer than a year. While this is daunting enough considering the number of students enrolled in these schools, for many there is the added pressure of possible funding cuts stemming from tighter state budgets. The blow could be cushioned a bit for some districts after they ended the 2019-2020 school year with lower-than-budgeted expenditures following several months of savings from not having students in their buildings. However, while it may provide a little extra cushion, we don't expect this to solve all the problems facing schools in 2020-2021.

We held a "back-to-school" webcast in August covering this wide range of K-14 education operators. (For more on higher education, also covered in our webcast, see "Not-For-Profit Higher Education Mid-Year Sector View: Fall 2020 Enrollments Will Drive Credit," published Aug. 15 on RatingsDirect). While each type of educational environment has its unique challenges, there are two common themes: revenue uncertainty and enrollment fluctuation. This FAQ details where schools stand to date during the pandemic, some key issues facing credit quality in this uncertain environment, and what we will be watching for as schools ramp up across the country this fall.


What We're Watching

Much of the funding for public education comes from state revenues, so any kind of state budget pressure presents a possibility for per pupil revenue cuts. In this COVID-19-induced recession, states have seen lower revenues, particularly from sales and other user taxes. According to the Urban Institute, about half of states are seeing revenues down 4% or more year over year, and given balanced budget requirements, that doesn't bode well for recipients of state aid. There are things that could change this trajectory, such as a healthy amount of stimulus money from the federal government, but the amount and timing of another federal aid package remains uncertain.

While there are many factors that will influence credit quality over the next year, there are several that we view as having the most potential to bring on deterioration. Many of the factors are common among both traditional K-12 schools and charter schools (chart 1), while some are more specific to charter schools (chart 2).

What We're Watching For Schools

Chart 1


What We're Also Watching For Charter Schools

Chart 2


Rating Distribution

S&P Global Ratings maintains more than 6,200 local school district ratings and 286 charter school ratings. More than half of our charter school ratings are 'BBB-' and 'BB+' compared to an average between 'A+' and 'A' for local school districts. The differential reflects some of the inherent risks of the charter school sector as charter schools cannot levy taxes, per-pupil revenues are often lower, and reserves are generally weaker. In addition, charter school contracts can face non-renewal or revocation risk and bond maturities typically exceed the length of charter terms. Across our universe of rated school districts and charter schools, the majority of rating actions since the onset of COVID-19 have been outlook revisions, not rating changes.

Chart 3


Local Schools: All Eyes On State Aid Cuts And Enrollment Changes

What will happen if states cut aid to local school districts? Are districts prepared to handle sizable revenue reductions? What role does enrollment play?

There is never a good time for school aid to be cut, but some times are worse than others. Cuts made in advance of the school's fiscal year can often be addressed through a combination of budget adjustments and use of reserves, but mid-year cuts are more difficult to absorb. In our 2020 local government sector report in January ("U.S. Local Government 2020 Sector Outlook: A Precarious Balance Of Stability And Uncertainty"), we talked about the preparedness of schools and local governments for a recession. We looked at the growth in reserve levels since 2011 and saw that average reserves have steadily been climbing over this period, to 16.1% in 2018 from 18.6% in 2011. However, it was also clear that even with growing reserves, school districts on average have much less set aside for a rainy day than local governments, making it even more important for any significant changes in revenues or expenditures to be met with budget adjustments promptly, to avoid risking the possibility of liquidity pressures and credit deterioration.

Along with reserves, enrollment trend is another very important part of schools' readiness to absorb unexpected cuts. Most states include enrollment as a factor in their revenue distribution and so an upward trend--or at least stable enrollment--can be a very important factor in maintaining operational balance. However, in the 2020-2021 school year enrollment may be another wild card for districts already struggling to reopen safely in the midst of a pandemic. For example, in many districts where charter schools operate, the charter schools are offering in-person schooling, an important factor for some parents who are snapping up the seats. While this is good for charter schools, any student loss for traditional schools--particularly unexpected--can have a notable impact on revenues. Shifts to private and parochial schools have a similar impact, as does an increase in home-schooling and cyber-charter attendance. On the whole, a multitude of choices is advantageous, but can leave the home district with enrollment shifts which may, or may not, end up being temporary.

States have slightly different ways of funding school operations. How do they compare in terms of operating flexibility for schools? What do you do when a state aid cut is announced?

About 40% of U.S. public school students are enrolled in schools in six states: California, Texas, New York, Illinois, Michigan, and Pennsylvania. All six states have some reliance on enrollment for state aid apportionment. As shown in chart 4, there are other kinds of limitations in some states that can hinder the ability of districts to respond to aid cuts, and all of these states also have a history of making adjustments to school aid over the past decade.

When we hear of a state aid cut, we stress our portfolio by the cut amount (it could be per-pupil, an across-the-board percentage, or specific dollar amount) and assess the impact on the district's reserves and liquidity. Should the cut be material enough to pressure ratings or if there is sufficient market interest, we may publish a state-specific commentary to address these credit pressures. When we determine that a specific rating could be pressured, we reach out to management and ask about the impact of the announced state-aid reductions on the district's current and upcoming budget. What, if any, expenditure reductions can they make to maintain structural balance, or what is their plan to return to balance? We also focus on cash flow and if they plan to borrow for liquidity purposes. As we assess the particulars of any district's situation, we also consider it from the lens of what kinds of operating limitations or flexibility can be found in their home state.

Chart 4


Charter Schools: Liquidity And Operating Flexibility Are Front and Center

How has the charter school sector been affected by COVID-19?

Charter schools are public schools that are publicly funded and so do not charge tuition. But unlike school districts, charter schools do not have the authority to levy taxes and are therefore much more dependent on state funding. They also generally receive less funding per pupil, so as state budget cuts materialize, the impacts could be magnified for charter schools and result in more rating actions going forward.

Overall, charter schools had a better transition to virtual learning than traditional local schools, and with more flexibility on reopening plans all of this is translating to increased demand for the upcoming school year. In addition, fiscal 2020 funding was not broadly affected, and expenses to support distance learning were largely offset by supplemental funding or other savings, helping to balance out any immediate impact to the sector's credit quality.

However, we are very closely watching fiscal 2021 state budgets and potential funding pressures. There is the potential for mid-year cuts and even if fiscal 2021 funding holds in our key states, there could be impacts for fiscal 2022 and beyond. The ability of schools to react proactively and manage expenses accordingly is key. We have been asking management teams about stress testing or scenario planning efforts and understand that some of our rated schools are looking at salary freezes, non-essential expense cuts, or delaying capital projects. We believe those schools with stronger enrollment trends and financial cushion are likely to fare better, while lower rated schools in pressured states will have less flexibility to absorb steep cuts.

What were some of the supplemental funding sources available to charter schools to address COVID-19 pressures?

Similar to traditional K-12 schools, charter schools were eligible for Coronavirus Aid, Recovery, and Economic Security (CARES) Act funding which does not have to be repaid and is allocated typically to offset increased COVID-19 related expenses. Some charter schools were also approved for loans under the Paycheck Protection Program (PPP). Based on data from the Small Business Association, about a third of our rated charter schools were approved for these loans, with the typical loan size reported in the range of $350,000 to $1 million. Both these sources of liquidity were key in supporting schools and providing flexibility in the near term.

Charter schools are facing a lot of the same pressures as traditional public schools, but also have unique challenges. Beyond funding levels what are you watching more specifically for charter schools?

Generally lower reserve levels:  We expect more charter schools could engage in short-term cash flow borrowing to offset liquidity pressures. Given the coverage metrics across the sector, especially for our lower rated schools, we are closely monitoring potential pressures that could result in violation of financial covenants or lack of ability to meet debt service

Upcoming charter renewals may look different:  We're watching how authorizers will address the process given academic testing was waived in the spring and this school year will continue down an uncharted path. In some states, local school districts serve as charter authorizers, and especially during times of financial stress, tension could be heightened.

The impact of increased unionization efforts in recent years:  Currently about only 11% of charter schools nationwide are unionized but if efforts gain further traction, this could limit flexibility at a time when operating budgets could be squeezed.

The upcoming election:  We're watching for legislative shifts or any changes that could affect state charter frameworks.

Enrollment growth:  On a positive note, growing demand and continued enrollment growth for high performing charter schools and networks could offset some of the funding or cost pressures.

Funding differentiations in mode of instruction:  Based on our conversations with management teams, we understand funding to charter schools would not be differentiated based on mode of instruction.


Favorable Demand Continues At The Top Tier While Affordability And Economic Uncertainties Persist

We have public ratings on 43 K-12 independent schools; these are private schools, typically smaller than public schools, and are not state, federal, or property tax supported. These schools depend heavily on tuition revenues, and have both day and boarding components. We rate some of the strongest, top-ranked schools in the country, with excellent demand, diverse revenues, robust balance sheets, and significant endowments bolstered by healthy fundraising.

Chart 5


Chart 6


How is COVID-19 affecting K-12 independent schools? Given social distancing, do you expect demand to be affected?

Demand at many of our rated independent schools, particularly those with a favorable market position, appears to be steady to growing. So far, the majority of our rated schools are planning for in-person instruction in fall 2020. Despite disruptions caused by school closures through spring and summer 2020, and risks of dampened student demand, to date, fall 2020 enrollment, even at boarding schools, is generally holding up well. Nationally, there appears to be an uptick in private school demand given that many public schools plan to remain online for fall 2020. This is despite these schools' high tuition, with continued increases planned for fall 2020.

Our rated independent schools with stronger demand profiles are commanding stable-to-higher enrollment, while comparatively weaker schools continue to face pressure. Many of our rated schools have large campuses and comparatively smaller student populations that enable easier social distancing. Many schools planning for in-person instruction have engaged in extensive space analysis to determine social distancing for students on campus, and are also prudently planning for various scenarios should a shift in local health conditions prompt a return to online learning.

Federal measures have also affected independent schools directly. How have limits on international student visas and the availability of PPP loans affected the sector?

About 15% of our rated schools enroll 20% or more international students. These students often pay full-tuition, receive minimal tuition discounts, and meaningful drops in this population could weaken school finances. Given recent federal visa pronouncements, new international students at schools entirely online in fall 2020 will not be able to enter the U.S. Schools that are more selective potentially could withstand declines in new international students by pivoting to enrolling more domestic students. Given a desire by parents to keep their kids enrolled at these prestigious, selective schools, many families of students that cannot come to campus are committed to enrolling for the upcoming school year via distance learning. Some schools are differentiating tuition levels for students unable to travel and study on campus.

About 25% of our rated independent schools were approved for federal PPP loans administered by the SBA, with most loans below $5 million. Assuming stipulated conditions for loan forgiveness are met, these funds could offset increased expenses, revenue losses, and bolster liquidity.

What We're Watching

Softer fundraising and volatile market conditions could limit endowment growth:  Overall fundraising efforts and endowment returns have been healthy in recent years, supporting good balance sheet growth for our rated schools. Recessionary conditions could inhibit fundraising success in fiscal 2021 following a solid fundraising year in fiscal 2020. Despite a recovery in stock market returns since March, potential market volatility through the remainder of 2020 could cause investment losses, weaken endowments, and consequently impact endowment draws.

Affordability and pricing pressures will remain focal points:  Despite generally favorable demand in the face of flat-to-rising tuition levels during these recessionary times, we think affordability, tuition discounting levels, and long-term financial sustainability concerns will, longer-term, remain important to enrollment decisions.

Enrollment growth:  There appears to be growing demand for a private school education despite the high price tag, largely as parents seek in-person instructions for their kids and many public schools remain online. Independent schools with stronger enrollment trends and financial cushion are likely to fare better, while lower rated schools will continue to face pressure, intensifying the gap between stronger and weaker schools. A persistent loss of international students due to visa or other considerations could stress operating budgets.

More room for virtual learning?  We have recently seen an effort to expand existing business models or pursue unique programming to further diversify school operations, including pursuing home-school or virtual school curriculums. A quick, relatively seamless transition reported by schools to virtual education delivery in the current pandemic presents new opportunities for educational providers to connect with students in alternative ways.


Potential Enrollment Surge For Fall In The Midst Of State Funding Uncertainties

We rate around 220 non-profit community colleges; these are public, two-year, open-access, low-cost schools that widely cater to non-traditional students. The majority of these are tax-supported, while also dependent on state and student revenues. Almost 65% of our ratings are in the two highest rating categories; ratings have generally been steady over time, and outlooks are predominantly stable despite an overall negative sector outlook. This inherent ratings stability stems from these colleges' steady property tax revenues, a key revenue source, compared with state and tuition revenues which can/do fluctuate depending on state budgets and enrollment trends. Also, these colleges have material expense flexibility to accommodate revenue shortfalls.

Chart 7


Chart 8


What are you seeing in terms of enrollment at community colleges? Will the historical countercyclical relationship (where community college enrollment goes up when unemployment goes up) hold?

The last two recessions resulted in double-digit enrollment gains at community colleges, evidence that the sector is countercyclical to local economic conditions, to a greater degree than four-year higher education institutions. Since the Great Recession, enrollment has suffered in the face of record national unemployment, with students deferring college for relatively well-paying jobs. For our rated universe, the majority of colleges have reported a seamless transition to remote learning for spring, and a bump in summer 2020 enrollment versus the previous year. Given the nature of their student body, which comprises many non-traditional, adult learners, flexible program offerings have generally included remote learning options. This has aided these institutions' need to abruptly shift to virtual instruction in the latter half of spring 2020 given the pandemic.

So far, some of our rated colleges are reporting enrollment increases for the fall, while others are preparing for losses. Factors aiding enrollment include students opting to enroll at their local, low-cost community colleges given prolonged fall 2020 online classes, disruption of athletics, and on-campus living at four-year higher education institutions. Conversely, reduced programs, and students opting for a gap year for health, personal, or financial reasons could stunt enrollment growth. We note many students apply and enroll at community colleges closer to semester start dates, and thereafter. Therefore, enrollment numbers are fluid and definitive trends are unlikely to emerge until the last quarter of 2020.

Given their affordability, how much do community colleges stand to lose--or gain--from COVID and economy-related recessionary changes,? Is there a concern about state revenue cuts for community colleges, too?

An enrollment surge for fall 2020 is likely to augment student revenues at our rated community colleges. Given their relative affordability, most colleges are planning for modest tuition increases this fall, which will increase revenues. Unlike many four-year institutions, these colleges have few international students and on-campus housing, and are buffered from the impact of recent federal visa changes on foreign student enrollment, and a need for housing refunds. Lastly, our rated colleges report minimal tuition and fee refunds to date.

Most of our rated community colleges are planning for continued remote learning or hybrid instructional modes for the fall. Colleges are likely to continue curtailing expenses, such as travel and utilities, and other non-essential expenses. Hiring freezes and furloughs have also been instituted at certain institutions. Management teams indicate federal CARES Act funds have partly offset increased pandemic-related expenses. Given state funding uncertainties, many of our rated colleges are preparing for funding cuts or deferrals. On average, state funding comprises approximately 25% of our rated institutions' operating revenues. Therefore, significant funding cuts, absent commensurate expense adjustments, could impair operating performance and fund balances.

What We're Watching

State funding could dip, but we expect resilient property tax revenues, and careful expense management:  Given reduced revenues and large budgetary shortfalls across several states, cuts to higher education funding, including community colleges, are likely in fiscal 2021--the magnitude of which will differ state by state. Community colleges' typical lack of faculty tenure, use of part-time adjuncts, and overall expense flexibility is expected to partly offset state revenue drops, while other revenue streams (student and property tax revenues) could rally. However, tough budgeting decisions may need to be made given scarce resources, which could affect academic programs and services, while amplifying the financial burden on students if there are increased tuition and fees.

Possibility of an enrollment surge for fall 2020?  While our rated colleges are reporting mixed results to date, admissions cycles are far from complete, even though figures from the previous two recessions have demonstrated robust enrollment growth in uncertain economic times. However, this recession is unlike any other due to health and safety concerns that could thwart growth.

Impact of remote learning on student outcomes:  Given the nature of community college students--many of whom are low-income and lack access to reliable technology--online learning may not be an optimal learning platform. Generally, this sector has demonstrated weaker student outcomes measured by retention, persistence, and graduation rates. A longer period of virtual learning could lead to students disengaging, withdrawing, or dropping out of enrolled courses. While colleges appear committed to addressing these gaps, we will monitor whether these effects are pronounced for the sector.

Related Research

This report does not constitute a rating action.

Primary Credit Analysts:Jane H Ridley, Centennial (1) 303-721-4487;
Avani K Parikh, New York (1) 212-438-1133;
Shivani Singh, New York (1) 212-438-3120;
Secondary Contacts:Jessica L Wood, Chicago (1) 312-233-7004;
Blake E Yocom, Chicago (1) 312-233-7056;

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