Overview

As of May 15, 2023, S&P Global Ratings maintains five public ratings on Tennessee charter schools, with three of the organizations in Memphis and two in Nashville. Tennessee is the twentieth-largest school system in the U.S., serving more than 980,000 students across approximately 1,900 public schools for the 2022-2023 school year. As of fall 2022, Tennessee served about 45,000 charter school students representing 4.6% of all public school students in the state.

Although our five rated Tennessee charter schools represent a small sample size, we believe the comparatively higher rating distribution is linked to increasing demand for charter schools in the state.

Chart 1

Authorizer Framework

• Most Tennessee charter schools are authorized by Local Education Agencies (LEAs), typically the local school district. There are currently five LEAs authorizers within the state: Metro Nashville Public Schools, Shelby County Schools, Hamilton County Department of Education, Rutherford County Schools, and Knox County Schools.
• If an application for a new charter school is denied by the LEA or an existing contract is revoked or not renewed, the charter school can appeal the decision to the Tennessee Public Charter School Commission (TPCSC), which began governing the appeals process in January 2021. If a charter school receives a favorable ruling in the appeals process, the commission will serve as the authorizer. In 2022, TPCSC received 13 appeals from applicants whose initial charter application were denied by the LEA. Of these 13 appeals, three were approved, six denied, and four were withdrawn.
• The Achievement School District (ASD) will authorize charter schools that are on the state department's priority school list--those in the bottom 5% in the state. ASD works with schools primarily in Nashville and Memphis.
• Charter schools are monitored annually by a framework, which includes a review of the organization's annual audits, performance, and financial reports. A renewal evaluation report from the authorizer is provided one year prior to the expiration of a charter contract; we believe these reports provide good transparency regarding performance. Schools deemed a priority school (those evaluated in the lowest 5% of all public schools) can have their charter revoked unless authorized by the ASD. Other factors that could cause a charter school to be closed include serious violations of law, material and substantial violation of the charter contract, or fiscal mismanagement.

Credit Fundamentals

Of the five Tennessee charter schools that we rate, we consider two to be networks. The largest network, KIPP Nashville, serves close to 3,000 students accounting for about 7% of all charter school students in the state. Networks typically benefit from larger revenue streams, higher enrollment spread across schools, more depth to the management team, and steadier operations supporting underlying credit fundamentals. We view the diffusion of risks appreciated by larger operators as a credit strength.

Table 1

Our rated Tennessee charter schools generally have healthy operating margins and debt service coverage, strong reserves, and a manageable debt profile. Most Tennessee charter schools rely primarily on the state for per-pupil funding, which has increased modestly over the past three years. However, charter schools also receive additional funding from local sources, which can fluctuate based on the local economy. In recent years, Nashville's local economy has grown, and consequently funding for schools surrounding the city has accounted for more than one-third of the per-pupil allocation and it has led to more significant growth in operating revenues when compared with that of other state operators. This trend is expected to continue into fiscal 2024, although economic uncertainties persist beyond next year.

Chart 2

From fiscal 2016-2021, statewide charter school enrollment increased by more than 50% to approximately 45,000 from less than 30,000. Given the favorable political environment at the state level, we anticipate the sector will likely continue to grow its footprint over the next several years.

What We're Watching

Political environment.  Tennessee's governor favors school choice and has opposed federal restrictions limiting federal funding for charter schools. He also supported increasing the number of charter school operators in the state as well as providing additional facility funding for charter schools. However, the political environment in Nashville is considered less charter-friendly, with an increase in denied charter applications in recent years. Despite this, we believe the appeals process provides flexibility somewhat mitigating this concern.

New funding formula.  In 2022, the Tennessee Legislature passed the Tennessee Investment in Student Achievement funding formula representing the state's largest change in kindergarten through twelfth grade (K-12) school funding in more than 30 years. The new formula moves to a student-based approach providing more funds to economically disadvantaged students or those who have special needs, which we anticipate will benefit charter schools serving communities with the most need.

Facility funding.   After budget cuts were enacted during the pandemic resulting in no facility funds for charter schools, the state legislature approved a one-time $24 million allocation for charter school facility funding to be allocated in 2023, with $6 million in reoccurring funds for future years. Most of the funds are being distributed to charter schools through a competitive grant process. While we view the reoccurring portion of the facility funding as modest, the governor has expressed a desire to provide more than $30 million in facility funding for charter schools, which we believe provides an opportunity for further increases in future years.

K-12 population trends vary within the state.   The school-age population surrounding Nashville is projected to increase by about 3% over the next five years, which decreases the risk of oversaturation and will likely continue to fuel demand for charter schools. The school-age population projection surrounding Memphis is less favorable, reflecting a 3% decline over the next five years, which could create a more competitive environment for charter schools operating in the area.

Academic testing.   The Tennessee Comprehensive Assessment Program continues to be the state's testing program. Testing continued during the pandemic, but the state removed any consequences related to academic accountability for those schools that achieved a minimum of 80% participation. For 2022-2023, state-testing accountability frameworks returned to the typical pre-pandemic approach, we will monitor how authorizers analyze and assess new testing data.

Labor challenges.   We continue to monitor the influence of inflationary pressures on labor costs and labor shortages, which could pressure school faculty operations. Not all schools were affected by the teacher shortage equally, and we believe a charter school's ability to attract and retain talented faculty is key to the organization achieving its mission.

Long-term use of one-time funds.   Elementary and Secondary School Emergency Relief funds flooded traditional and charter schools with cash. Many schools used emergency funding to hire additional full- or part-time staff to address learning loss amid the pandemic. As the wave of federal relief expires in September 2024, schools will need to ensure that current spending is sustainable or prove willing to make cuts down the road.

Table 2