Sector View: Negative
While there are several factors that could influence credit quality over the next year, revenue pressures caused by cuts, delays, or deferrals to per-pupil funding have the most potential to bring on credit deterioration. We do not expect all credits will weaken in 2021 and beyond, but in the current environment we still expect downgrades to outpace upgrades. Any major policy changes negatively affecting school choice could also cause disruption. Schools with relatively stronger enrollment trends and greater financial reserves are likely to fare better, while lower rated schools in challenged states will have less operating flexibility.
For the most part, charter schools experienced healthy demand and stable-to-growing enrollments across our rated universe in fall 2020, whether classes were offered in person, online, or under a hybrid model. Despite challenges, charter schools had a better transition to remote learning in the spring than many traditional local schools, and the receipt of federal stimulus funds helped schools offset pandemic-related expenses and maintain financial flexibility. In addition, the federal relief bill passed in December includes $54.3 billion in funding for K-12 (about four times as much as the $13.5 billion provided under the CARES Act), as well as $4.1 billion for governors to distribute to schools based on need. While these one-time funds provide material support, the bill does not provide any additional funding for state and local governments, which affects our view of the longer-term funding outlook for charter schools. As expenses continue to rise, we believe the charter school sector will face operating pressure in 2021 and beyond due to likely decreases in state funding of K-12 education. The ability of schools' management to react proactively and manage expenses accordingly will be critical to maintaining credit quality.
The charter school sector is inherently volatile, relative to other public finance sectors, as charter contracts are required to operate, and nonrenewal or revocations due to failure to meet authorizer standards can affect credit quality swiftly. Indicative of these intrinsic risks, 14% of S&P Global Ratings' ratings in the sector carried negative outlooks as of Dec. 31, 2020, higher than the 7% of U.S. public finance ratings with a negative outlook as of the same date. While our rated universe increasingly reflects more-established charter schools that have completed several successful charter renewals, maintain steady academics, and experience less credit volatility than newer schools, our view on 2021 highlights key questions that matter for the stability of charter school credit quality.
Questions That Matter
1. Why is the charter school sector view negative?
Charter schools are highly dependent on state and local funding sources to support operations. 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. Lack of federal funding for state and local governments in the December federal aid bill did not help. While the impacts from slower economic growth will vary greatly by state, for many it has already resulted in, or will cause, reductions in per-pupil funding for charter schools. Fundraising and grants will likely be down too.
How this will shape 2021
Uneven economic recovery will continue. States have been affected by the virus in different waves and measures taken to control the spread have also varied. Similarly, the post-virus economic recovery will vary by locale.
More budget stabilizing actions to come. As economies reopen, significant budget gaps remain for many states and cuts will be necessary to bring revenues in line with expenditures, even if more federal support were to appear. Mid-year reductions or delays in per-pupil funding are possible, and fiscal 2022 cuts are likely looming.
What we think and why
Per-pupil funding cuts, deferrals, and delays are magnified for charter schools. Like traditional school districts, charter schools are public schools that are publicly funded and do not charge tuition. But unlike school districts, charter schools do not have authority to levy taxes and are therefore much more dependent on state funding. They also generally receive less funding per pupil than district schools. As a result, when per-pupil revenue cuts materialize, the impacts are greater for charter schools than for district schools and could result in more negative rating actions.
Proactive management and contingency planning will be key to creditworthiness. The ability of schools to forecast, react, and manage expenses accordingly is critical. We expect that management teams are planning for possible cuts or deferrals and we understand that some of our rated schools have already incorporated salary freezes, cuts in non-essential expenses, or delays in capital projects into current budgets. Schools with relatively stronger reserves will fare better. We believe lower rated schools in pressured states will have less flexibility to absorb steep cuts.
In times of financial stress, the authorizer relationship can become more strained. In many cases, charter schools are authorized by the school district; relationships vary greatly, with some that are supportive and some severely restrictive or antagonistic. Given the inherent conflict of interest with school district authorizers that compete for the same students and the related per-pupil revenue, there could be heightened tension. The pandemic has exacerbated this pressure in certain respects.
Federal support for school choice could change. While President-elect Joe Biden's platform includes a range of policy initiatives that are generally supportive of K-12 and higher education, the direction of school choice under a Biden administration will bear watching from a charter school perspective. Given the considerable disruption to education last year due to the pandemic, and the likely long-term consequences, the new secretary of education will play a critical role.
What could change the trajectory
Rapid coordinated vaccinations. Should vaccinations enable economies to recover and revenues to stabilize, per-pupil funding for charter schools could benefit, as could in-person enrollment.
Additional federal stimulus money for state and local governments. Similar to traditional K-12 schools, charter schools received Coronavirus Aid, Recovery, and Economic Security (CARES) Act funding to offset COVID-19 related expenses. Additionally, about 25% of our rated charter schools were approved for loans under the Paycheck Protection Program (PPP) with an average loan size ranging from $500,000 to $1 million. Both these sources of liquidity were key in supporting schools' operations and providing financial flexibility for the near term. The recently passed relief bill will help as well, although without funding for state and local governments, the additional support could be offset by state cuts to per-pupil funding.
Upside economic recovery. According to S&P Global's economists, the U.S. economy could rebound in 2021 if re-openings occur sooner than had been anticipated amid promising treatment and vaccine news, with the government providing additional federal support in some form of direct revenue replacement.
2. How will regional economic and demographic differences affect charter school credits?
Social distancing, health measures, and many other economic influences have varied by state and county, and there is significant disparity across the 25 states in which we hold charter school ratings.
How this will shape 2021
Not all states are created equal. Expectations differ materially by state for fiscal 2021 and beyond, but there are several states in which we hold numerous charter school ratings that are already facing per-pupil funding cuts (Colorado) and deferrals (California). Across our rated universe, we believe mid-year cuts or changes in funding plans are possible in certain areas, and expect fiscal 2022 will bring more reductions in funding .
State politics are critical for charter schools. While federal support is important, major decisions affecting charter schools--from authorization to funding mechanisms--are determined at the state level, and political changes can have material effectss. Should charter law and policy changes of significant impact occur in areas where we hold a large number of ratings, then a greater number of our rated charter schools could face more credit stress.
What we think and why
More charter schools could engage in short-term cash flow borrowing to offset liquidity pressures. For example, in California, instead of imposing funding cuts, the state's fiscal 2021 budget relies on apportionment deferrals totaling approximately $12.5 billion (about 36% of fiscal 2021 Prop. 98 funding). The school aid deferrals represent a cut in payments made during the fiscal year, but the deferrals would be phased back in to schools in future years to the extent that general fund revenue grows, or additional federal aid is received. While the recently passed bill provides some liquidity cushion, given the magnitude of the deferral, in our view, charter schools in California will need to more closely monitor cash if the state deferral is not reversed.
|Rating/Outlook||Rated charter schools||State revenues per student, FY2019 ($)||Median DCOH, FY2019||Median lease-adjusted MADS coverage, FY2019||Median dependency on state revenues (%)||FY2021 per-pupil funding||Avg charter term|
|California||AA-/Stable||37||9,769||127||1.3||73||Base per-pupil funding was flat but apportionment deferrals total approximately $12.5 bil. The state budget allowed that in the event additional federal stimulus funding was enacted, the state could offset these deferrals, so we could see changes.||5 years|
|Colorado||AA/Stable||28||7,313||161||1.5||75||Decrease in funding of about 5%.||5 years|
|Texas||AAA/Stable||34||8,898||105||1.5||86||Biennium budget, expected to continue unabated for FY2021 and FY2022.||Initial term of charter is 5 years; charters are renewed for 10-year terms.|
|Utah||AAA/Stable||29||7,054||155||1.6||88||Increase in funding of about 2%.||Evergreen charter|
|Michigan||AA/Negative||28||7,826||54||1.2||78||Flat base aid funding for as well as a one-time increase averaging approximately $65 per pupil for schools.||Varies, one to seven years|
|Minnesota||AAA/Negative||25||7,770||82||1.1||67||Biennium budget includes a 2% education increase; in the past, MN had holdbacks of around 10%, there is a possibility the state may raise the holdback percentage, but unlikely.||Maximum 5 years|
|Arizona||AA/Stable||24||7,397||68||1.2||84||Flat to modest increases.||Initial term of charter is 15 years; maximum length of renewal contracts is 20 years.|
|Pennsylvania||A+/Negative||18||13,419||125||1.5||87||Flat to increasing funding.||5 years|
|Florida||AAA/Stable||11||7,014||169||1.3||86||Increase in funding of about 2%.||Initital term of charter is 5 years; maximum length of renewal contracts is 15 years.|
|Nevada||AA+/Negative||10||7,131||81||1.2||91||Flat base per-pupil funding.||6 years|
|New York||AA+/Negative||10||14,895||206||1.6||95||Flat funding, but state budget shortfall of about $14.9 bil. could mean cuts for K-12.||5 years|
|DCOH--days' cash on hand. Table includes states with 10 or more charter school ratings.|
Cash is king. In other key states, even if fiscal 2021 funding holds, there could be impacts for fiscal 2022 and beyond. Federal funding was helpful (especially PPP loans) but given the slim 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. Any changes in the timing of state aid payments could challenge local liquidity.
Competition and demographics increase social risk. While demand for charter schools continues to grow, changing demographics intensify competition in certain regions. In some areas with limited growth expectations, the struggle for students is more palpable. Because enrollment is a key factor in our analysis, any material changes can affect financial operations and impede credit quality.
Increasing risk of unionization. Given the growing focus on teacher health and safety, benefits, and working conditions due to the pandemic, and especially in regions where teacher shortages are creating pressures, we think that unionization efforts could gain further traction, which could limit flexibility at a time when operating budgets could be squeezed. This risk differs by state, given varying unionization laws.
What could change the trajectory
Rapid state revenue recovery. If budget gaps dissipate for states as economies reopen, or direct revenue replacement comes in the form of additional federal aid, making cuts in per-pupil funding unnecessary, charter schools' greatest risk will be mitigated.
3. Does strong demand for charter schools create opportunities?
Several reports this year found that, on average, when compared to traditional school districts, charter schools had a better transition to virtual learning and more flexibility on reopening plans for fall 2020. Exemplifying this, many charter schools in our rated universe experienced increased demand and larger wait lists for fall 2020 – although we believe there is potential for enrollment fluctuations, given the uncertainty surrounding school re-opening plans through the rest of this school year and into fall 2021. While academic testing was waived in 2020, with uncertainty around testing for 2021, it is possible that charter schools overall will experience less learning loss for students, given the flexibility around in-person instruction or greater support for students, which could continue to fuel increased demand. We expect this will vary based on a charter school's current academic profile, demographics, and available resources to support such investments in academic programming.
How this will shape 2021
The charter school sector continues to mature as an option for school choice. As the charter school sector has grown, expanding capital markets access and financing options have made funding more readily available for schools. Investments have been made in school facilities and programs, making charter schools a more competitive option for parents and students compared to ten or fifteen years ago.
Disparity grows between higher and lower rated schools. For charter schools already facing operational, academic, and financial challenges before the pandemic, we believe COVID-19 has exacerbated these pressures. At the same time, successful charter schools continue to experience strong demand and growth and we continue to see high performing charter schools expanding as their schools reach capacity and waitlists grow.
What we think and why
Charter schools' access to capital will continue to expand. Charter school issuance volume has grown each year since 2011, outside of the one-year decline during 2018 (experienced across the public finance sectors). At the same time, charter schools' opportunities and options have expanded, interest rates remain very low, and there continues to be strong demand for high yield municipal debt. We have seen a few recent transactions with longer bond terms of 35 years as the market continues to mature. While bond financing can still provide significantly lower rates than many other forms of capital financing for charter schools, there continues to be increasing financing options for charter schools beyond rated debt. As such, several schools moved forward with expansion plans in 2020 despite the pandemic.
Creditworthy schools can access their state's credit enhancement program, resulting in higher enhanced ratings and lower interest costs. Notably, Idaho recently created a charter school facilities program fund, which S&P Global Ratings rated 'A+' in November 2020, three notches lower than the state's ICR (AA+), reflecting our assessment of the state's moral obligation pledge (see our report published Nov. 12, 2020, on RatingsDirect, on the first bonds rated under the program). Similar programs in Texas, Arizona, Colorado, and Utah continue to aid charter schools that qualify in these states.
Pooled funds gain traction for charter schools. In 2020, Equitable Facilities Fund (EFF, the sole member of ESRF) successfully completed its second tranche for the Equitable School Revolving Fund, Del.'s (ESRF) series 2020A and B bonds (see our analysis published June 12, 2020), continuing to broaden the financing options available to charter schools at a lower cost of capital. S&P Global Ratings assigned its 'A' rating to this loan program, under our municipal pool rating methodology.
What could change the trajectory
Disruption to the municipal market or material weakness for banks could threaten access to capital. Given that most rated charter schools reside on the line between investment grade and non-investment grade, if it became hard to gain access to capital, schools could experience a liquidity crisis.
ESG factors like cybersecurity will continue to test the sector. Beyond the many credit risks inherent in the sector, a growing number of risks continue to arise from less-traditional areas--such as governance scandals, school shootings, weather, unionization or strikes, or cybersecurity issues. Given this, we believe management teams will need to address increasing questions regarding transparency and sufficient and timely disclosure, as well as enterprise risk management.
Disproportionate funding cuts to charter schools from state or federal funds. Charter schools benefited from federal PPP funding, which was not available to traditional public schools. Should school districts decide to reconcile or equalize federal monies, as has been discussed in Denver, charter schools could see less additional support.
Ratings Distribution And Performance
As of Dec. 31, 2020, S&P Global Ratings had 298 public ratings on charter schools in 25 states. Certain states such as California and Texas have large charter school networks with multiple schools supporting a single rating. The charts below reflect the number of obligated groups issuing rated debt, and not the number of schools or networks. While 85% of the ratings currently carry a stable outlook, negative outlooks (41) outpace positive ones (3), highlighting the inherent pressures facing individual schools within the sector. During 2020, we downgraded 18 ratings, compared to 21 in 2019. We think that we could see a meaningful change in financial metrics to the extent there are material per-pupil funding cuts or notable changes in charter law across a multitude of states, affecting a critical number of rated charter schools. In 2020, we assigned 24 new public ratings, compared to 17 in 2019.
While the majority of rated issuers, which continue to mature, are stable, the charter school sector is susceptible to some unexpected credit profile changes, which could relate to failure to meet authorizer standards, charter nonrenewal due to academics, or enrollment shortfalls. During the past year, we continued to see examples of these credit risks particular to the charter school sector, but we did not see any payment defaults (failure to make payment of principal and interest as scheduled, per S&P Global Ratings' definition) within our rated universe. We did see three payment defaults in 2019, caused by prolonged enrollment pressures leading to financial issues, weak academics, management turnover, and charter contract issues, among others. While these types of events aren't uncommon in the sector, we believe these examples represent individual situations and are not indicative of any sector-wide trends. Prior to 2019, within our rated universe we have only seen four other payment defaults. We do expect that COPPA, which ceased operations in June 2020 and is currently rated CC/Negative, will default in 2021. According to Municipal Market Analytics, 70 charter schools (rated and unrated) have defaulted since 2010; 10% of these were rated.
|Rated Charter Schools Defaults|
|Obligor||State||Default date||Rating prior to default||Initial rating||Current status|
|North Star Charter School||ID||6/2/2014||C||BB||NR|
|Charter School of Boynton Beach||FL||8/18/2015||CC||BBB-||NR|
|Stride Academy of Minnesota||MN||4/1/2019||CC||BB-||NR|
|ASPIRA of Florida Inc||FL||7/31/2019||B||BB||NR|
|Plymouth Educational Center Charter School of Michigan||MI||11/1/2019||D||BBB-||D|
- Bang For The Buck: How U.S. Fiscal Stimulus Could Benefit The Recovery, Dec. 15, 2020
- Outlook For U.S. States: Symptoms Persist, But A Shot In The Arm Could Lead To Growth, Jan. 5, 2021
- Outlook For U.S. Local Governments: Revenue Pressures Mount And Choices Get Harder, Jan. 6, 2021
- U.S. Charter School Ratings And Outlooks: Current List, April 30, 2020
- U.S. Charter School Medians In 2019 Were Stable Pre-COVID-19, But Disparity Grows Between Higher And Lower Rated Schools, Dec. 14, 2020
- Through The ESG Lens 2.0: A Deeper Dive Into U.S. Public Finance Credit Factors, April 28, 2020
- Credit FAQ: How COVID-19 And The Recession Could Affect Credit Quality For U.S. K-14 Schools, Sept. 3, 2020
This report does not constitute a rating action.
|Primary Credit Analyst:||Jessica L Wood, Chicago + 1 (312) 233 7004;|
|Secondary Contacts:||Peter V Murphy, New York + 1 (212) 438 2065;|
|Avani K Parikh, New York + 1 (212) 438 1133;|
|Shivani Singh, New York + 1 (212) 438 3120;|
|Research Contributors:||Aditi Jain, CRISIL Global Analytical Center, an S&P affiliate, Mumbai|
|Arpita Ray, CRISIL Global Analytical Center, an S&P affiliate, Mumbai|
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