As of March 10, 2020, S&P Global Ratings maintains 25 public ratings on charter schools in the State of Minnesota, which was the first state to enact charter school law in 1991. The first charter school opened its doors in 1992. Today, there are about 170 charter schools in the state serving about 60,000 students, or approximately 7% of the state's kindergarten through grade 12 population.
Only a quarter (25%) of our Minnesota charter school ratings are investment-grade, compared with 44% for the sector as a whole. Less than 60% are rated 'BB+' or 'BB', and five of our Minnesota charter school ratings are 'BB-' or lower; this ratio of non-investment-grade ratings is slightly higher than S&P's Charter sector as a whole. While the state's economy continues to thrive and the population in the Twin Cities--where the majority (over 90%) of our rated charter schools are located--continues to grow, median enrollment levels at Minnesota charter schools tend to be smaller than our sector averages, waitlists are more vulnerable in size, and state funding increases have been minimal. We believe the lower ratings distribution stems from slim operating results that have resulted in weaker coverage ratios compared to the overall sector. Also, all of our rated Minnesota charter schools are considered stand-alone operators (not large systems) and have a median enrollment of 730 students. As a result, median enrollment levels and operating budgets are significantly smaller when compared with medians for the entire sector. Currently, five ratings carry a negative outlook, and none have a positive outlook, indicative of current credit pressures in the state and possibly further deterioration of Minnesota charter school ratings.
Although recently there has been some political pressure to limit charter school growth, the authorizing legislation does not, at present, cap the number of charter schools that can open, nor do authorizers have the ability to set enrollment capacity within a charter. As a result, the number of charter schools (and students) has been increasing year-over-year, with 17 new charters approved for fall 2020 operations. At the same time, according to the Minnesota Association of Charter Schools, 25% of chartered schools have closed, or never opened, because they did not demonstrate results or fulfill agreements outlined in their charter contracts. Reflecting the volatility of the sector, the Minnesota Association of Charter Schools also reports that one to two charter schools operating in the state close annually due to poor performance, governance decisions, or financial troubles. In our view, this demonstrates the importance of authorizer accountability and oversight.
Authorizer Framework
- In Minnesota, an authorizer may be a local school district, a non-sectarian non-profit organization, a college or university, or a new nonprofit created for the sole purpose of authorizing schools (known as single-purpose authorizers). The role of the authorizer is to ensure that the schools it authorizes fulfill the purposes for public schools and the agreed upon terms of the charter contract, through ongoing oversight and evaluation of academic, operational, and financial performance.
- Charter contracts in the state typically extend for up to five years, and benchmarks are evaluated annually. Failure to meet charter requirements or acceptable fiscal management standards, violations of law, and failure to meet academic performance standards could lead to charter revocation or non-renewal. Given the number of possible authorizers throughout the state, we believe that a charter school facing revocation or non-renewal could seek another authorizer, but that has been rare.
- There are 10 discrete authorizers among our rated universe of 25 Minnesota charter schools, and none are competing local school districts. In our view, due to the absence of local school district authorizers among our rated charter schools, the inherent conflict of interest that could arise when local school districts serve as authorizers and are competing for students and funding has been avoided among those charter schools.
- In accordance with state statutes, authorizers must also demonstrate to the Minnesota Department of Education their capacity and ability to serve as an authorizer, and are evaluated at least every five years. As part of that review, the law requires the state department of education to comment on each authorizer's evaluation process for providing formal written evaluation of the school's performance before renewal of a charter contract.
- Most of our rated schools report good working relationships with their authorizer, and benefit from some authorizer support, in the form of training, oversight, and facilitation of advisory sessions with other charter schools.
Credit Fundamentals
Fiscal 2018 Minnesota Charter School Medians | ||||
---|---|---|---|---|
BBB- | BB+ | BB/BB- | B/B- | |
Enrollment (no.) | 739 | 1,077 | 532 | 533 |
Waiting list as % of enrollment | 46.3 | 14.9 | 4.2 | 0.0 |
Student retention rate (%) | 93.5 | 90.5 | 79.0 | 80.4 |
Lease adjusted maximum annual debt service (MADS) coverage (x) | 1.3 | 1.4 | 1.2 | 1.0 |
Lease adjusted MADS burden (% total revenues) | 13.2 | 12.9 | 11.6 | 11.0 |
Days" unrestricted cash on hand | 131.9 | 101.2 | 85.8 | 94.2 |
Total revenues ($000s) | 9,583 | 11,374 | 8,036 | 8,021 |
All of our rated Minnesota charter schools are considered stand-alone operators and median enrollment levels and operating budgets are significantly smaller when compared with medians for the entire sector. Given the overall size of these schools, we generally see limited operating flexibility, which has led to weaker-than-average lease-adjusted maximum annual debt service coverage ratios than national averages, alongside noticeably smaller reserves relative to operations. These considerations likely explain why the majority of our ratings on Minnesota charter schools fall into the speculative-grade category, despite the longevity of charter school operations within the state.
We also note that, with two exceptions, all of our Minnesota charter schools are in the Minneapolis-St. Paul-Bloomington metropolitan statistical area (MSA). The Twin Cities are growing, but most of the projected school-age population growth can be found in suburban areas. Hennepin, Sherburne, and Wright counties are projected to see some growth in their school age populations, but all other counties in the MSA (Anoka, Carver, Ramsey, and Washington counties) depict flat-to-negative student age growth trends. Of our 25-charter school universe, 14 schools are located in these counties with weaker demographic projections, and the state's education funding formula is heavily weighted on per pupil funding, or average daily membership. Therefore, any declines to enrollment size at schools could also pressure operating budgets and ultimately their credit ratings, especially those schools that have limited capacity to cut operating costs.
In addition, state law prohibits charter schools from owning their own buildings, and only after a charter school has been in operation for six continuous years can it form an affiliated building corporation to purchase a facility through a lease-purchase agreement. In our opinion, this prohibition presents a challenge for start-up charters in obtaining suitable space to operate a school, since owners of retail or commercial space are less likely to reconfigure their properties for school use for an organization that might not succeed over the long term. Furthermore, former parochial schools facilities are becoming more scarce as real estate costs in the Minneapolis-St. Paul MSA continue to increase. While these barriers to entry might be beneficial for existing charter schools by restricting competition from new entrants, the limited availability of new space could also constrain total enrollment and financial flexibility at existing sites. Since all of our rated Minnesota charter schools issue debt using related limited liability corporations, which can affect the availability and comparability of financial reporting, please refer to our criteria guidance, "U.S. Public Finance Charter Schools," published Dec. 20, 2019. The guidance describes S&P Global Ratings' general approach to calculating lease-adjusted maximum annual debt service coverage under some of the most commonly seen structures and reporting presentations.
What We're Watching
Demographics. About 70% of the state's 5.5 million residents live in the Minneapolis-St. Paul MSA, which is a significant employment center and home to several headquarters for major corporations. As a result, we believe the state will continue to attract residents, which in turn should help provide stable funding and opportunities for student growth. Minnesota's population growth has come in line or begun to just slightly exceed the U.S. rate in recent years due to both a favorable birth rate and improvement in net domestic in-migration. Most of the population growth, however, is occurring within the MSA's western counties. Charter schools located in St. Paul and its eastern boarders are faced with declining school aged populations, which may trigger enrollment pressures in the future. The Twin Cities are also home to the world's largest urban Hmong population, which continues to grow and serve as a niche sector for several of our rated charter schools in the state. Of the five schools on negative outlook, one is located in St. Paul facing enrollment declines, and the other is a Hmong school that is groping with enrollment pressures from competing schools.
State funding. State per-pupil funding has steadily increased by 2%-3% annually over the past five years. We do not foresee any funding cuts to education over the next year, and expect continued funding increases of 2%-3% annually given ongoing economic growth and recent annual funding increases. Minnesota is currently rated 'AAA/Stable' and has a history of strong financial results and healthy reserves, which supports our view of further funding increases. However, since the majority of charter school funding comes from state aid, any economic downturn could affect state education allocations in future years.
Pensions. Charter school employees are required to participate in cost-sharing, multiple-employer pension plans, including the General Employees Retirement Fund and the Teacher's Retirement Association. While required pension contributions are determined by state statute, statutory contribution rates have historically not kept pace with the actuarially determined contribution (ADC). In 2018, state lawmakers made some pension reforms that increased both employer and employee contributions, which should bring rates closer to the ADC. While this will lead to increased fixed costs for charter schools, we generally believe that pension costs are manageable, and are typically less than 10% of operating expenditures. However, in the future, if pension contributions absorb a larger share of charter schools' budgets, our view of a school's debt and liabilities profile could weaken.
Disparity in funding. Minnesota charter schools receive state funding based on the average state per pupil revenue and funding based on a statewide average property tax amount that is meant to offset the lack of access to local revenues. This calculation, however, does not factor in voter-approved local excess levy referendums that enable district schools to raise additional local revenue through property taxes that are not shared with charters. Although not eligible for the levy funds, charter schools in the state are eligible to receive lease aid (since Minnesota charter schools are prohibited from purchasing land or buildings with state funds). Under state statute, chartered schools are eligible to receive either 90% of the approved rent cost or an amount equal to the number of students multiplied by about $1,300, whichever is less. Despite additional funds for capital use, we believe there still exists opportunities for funding equalization between charter schools and local districts. In our opinion, the state's charter school portfolio could strengthen if the funding gap narrowed because additional resources could strengthen a school's overall market position while providing additional financial resources.
Charter caps. There has been a growing campaign from public officials in Minnesota to limit charter school growth, especially in the state's core urban areas where traditional school districts are coping with enrollment declines and budget imbalances. If this initiative gains momentum and legislative support, Minnesota charter school growth could be stifled.
Teacher shortage. Similar to other states across the country, Minnesota is facing a teacher shortage. While the state is looking into options to attract and retain teachers, such as allowing schools to apply for grants to help retain quality teachers and creation of a program designed to provide student loan debt relief in the form or repayment awards, we believe the shortage could lead to higher operating costs as charter schools look to retain teachers. A teacher shortage could also limit growth prospects at charter schools and weaken academic quality, which could pressure both the enterprise and financial profiles of charter schools in the state.
Labor relations. Minnesota law provides that a charter school's teachers are "at will" employees and could organize for collective bargaining similar to teachers in other districts. However, collective bargaining agreements among charter schools in Minnesota are rare. Despite the limited number of organized unions among Minnesota charter schools, one of the state's largest school districts, St. Paul Public Schools, has been on the brink of strike in recent years. Should staffing strikes occur and spill over to charter schools, we believe there could be a credit risk to operations and financial flexibility. While we do not expect any disruptions at present, we will continue to monitor for any.
This report does not constitute a rating action.
Primary Credit Analyst: | Ann M Richardson, Farmers Branch + 1 (214) 765 5878; ann.richardson@spglobal.com |
Secondary Contacts: | Jessica L Wood, Chicago (1) 312-233-7004; jessica.wood@spglobal.com |
Peter V Murphy, New York (1) 212-438-2065; peter.murphy@spglobal.com | |
Research Assistants: | Arpita Ray, Mumbai |
Aditi Jain, Pune |
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