S&P Global Ratings saw some strengthening in median metrics across its 297 rated charter schools in fiscal 2020, despite a slight uptick in the proportion of speculative-grade ratings overall. These improvements among key financial median metrics reflect a maturing sector supported by a stable-to-growing per-pupil funding environment. Following COVID-19 closures toward the end of fiscal 2020, drastic per-pupil funding cuts largely did not materialize as originally feared. At the same time, some of our rated entities reported expense savings as a result of the transition to remote learning in spring 2020. However, we believe most of the growth across our charter medians remains organic.

Generally, enrollment seemed to rise among many of our rated schools in fall 2020 as the pandemic fueled greater demand for charter schools with flexibility on hybrid or in-person learning approaches. Nevertheless, home school or private options did hamper enrollment growth for some charter schools, particularly in the lower grades. We expect one-time revenues and expenses related to the pandemic, along with varied enrollment stories, to flow through schools' financial statements in fiscal 2021, which may have a material impact on fiscal 2021 median results.

In our view, charter schools will benefit in the short term from substantial federal funding. While these funds are one-time in nature, we believe they will afford most schools the financial flexibility to manage any revenue shortfalls and recoup additional expenses related to the pandemic. We will continue to monitor how management teams across the sector use these funds to support their respective organizations. For more information related to our view of how economic conditions and federal stimulus affect the charter sector, please see our commentary, "State, Local Government, School District, And Charter School Sector Views Revised Back to Stable," published March 24, 2021, on RatingsDirect.

Rated Charter School Universe Continues To Expand

Charter school ratings currently range from 'A-' to 'D' (see Chart 1). The proportion of investment-grade ratings in 2021 decreased marginally compared with 2020, to 42.4% from 43.8%. This trend is consistent with previous years. However, the composition of issuers in our portfolio continues to grow and change (see Table 1). Notably, our number of charter school ratings increased by 12% from 2015 to 2020, as more charter schools have gained access to capital markets.

Chart 1

The nature of the charter school sector lends itself to inherent risk and volatility, where charter nonrenewal or revocations can affect credit quality swiftly. We continue to closely monitor all our rated schools' charter contracts and understand that all of our rated schools up for renewal in 2021 have successfully been renewed, with the exception of one credit currently awaiting news from its authorizer.

As many charter schools' enrollment pictures stabilize and federal relief begins to bolster balance sheets, our charter school outlook distribution looks somewhat rosier than this time last year. In May 2020, 14% of charter schools were on negative outlook and none were on positive outlook. As of June 30, 2021, 12% of our rated universe is on negative outlook, with 2% on positive outlook (see Chart 2). Ten positive rating actions occurred in the second quarter of 2021 alone, pointing to the start of a post-pandemic recovery.

Chart 2

The Methodology Behind Our Median Calculations

S&P Global Ratings produced these medians from fiscal 2020 audited results for charter schools with public ratings based on its charter schools criteria. For organizations where our group rating methodology criteria applies, we have included financials of either the obligated group or the consolidated group, depending on which we believe are more meaningful to the rating outcome based on the relationship between the obligated group and consolidated group.

These medians are not requirements for any particular rating, but rather reflect the sector's general credit trends at the specified levels. As economic conditions and the number of rated schools change, so will the reported medians. We view financial ratio analysis as important in our assessment of a charter school's credit quality. However, it is just one of many factors we assess. Our ratings encompass a variety of enterprise profile and other qualitative factors (demand and competition, academic performance, management and governance, growth plans, local area demographics, state legislatures, and charter structure) that are all key to our analysis. We publish these medians as general benchmarks and measures to observe broader industry trends. Credit analysis involves an assessment of many qualitative factors that are beyond the scope of this article. Therefore, these medians should not be considered thresholds to achieve a particular rating.

How medians have changed

While sectorwide medians for fiscal 2020 remained similar to previous years'results (see Table 1), several key metrics improved. Schools' demand profiles strengthened somewhat, as evidenced by enrollment growth and steady waitlist and retention ratios. Operationally, schools overall saw stronger margins and lease-adjusted maximum annual debt service (MADS) coverage. Balance sheets grew and most debt ratios improved, except for debt per student. These medians also reflect changes in our rating universe as issuers move in or out of the universe.

Anecdotally, many of our rated charter schools experienced increased demand amid the pandemic. Charter schools overall responded nimbly to the crisis last spring and were able to swiftly adopt the technology necessary for virtual learning. Enrollment growth and federal relief from ESSER I, II, and III, along with stable-to-growing state budgets, will likely support schools' operations and liquidity positions in fiscal 2021 and beyond. Thus, we may see inflated medians metrics in the coming fiscal years, and we will consider how to adjust for one-time funding, though schools' long-term growth will be most influenced by continued economic stability and demographic shifts.

Table 1

Financial medians continue to improve across rating levels

As in past years, several financial medians generally tended to improve with credit quality in fiscal 2020 (see Table 2). Notable exceptions to this trend are state revenue per student and total expense per student, which do not appear to be correlated with rating level and are more likely tied to state funding or regional cost-of-living factors, which ultimately incorporate key demographic characteristics unique to each region.

While entities rated 'BBB' and higher tend to have a size advantage by serving significantly more students, the medians for 'BBB-' and 'BB+' enrollment levels are about the same. Size alone does not determine a rating, but we believe that more modest operations, particularly those below 400 students, are riskier creditwise, given that they have less financial flexibility and are more susceptible to demand profile fluctuations. Most financial metrics also improve higher up the rating scale, which is in line with our expectations and consistent with previous trends.

Table 2

We continue to see that the variability in financial metric trends remain at the lower rating medians ('BB-' rating and the 'B' category). This is due to the significantly smaller sample size within these categories and the many factors behind the rating at this level stemming from structural or strained financial operations, or challenges related to the enterprise profile, which could incorporate a poor authorizer relationship.

While enrollment levels were up this year compared with last year, schools continue to maintain a lower waitlist as a percentage of total enrollment for the third consecutive year. This could be a factor of more schools in our rated universe maturing, which generally leads to softer waitlists due to fewer available seats for potential new students.

Enrollment and state funding remain key factors underlying state medians

Our coverage of charter school public ratings spans 25 states and the District of Columbia (D.C.; see Chart 3). California and Texas continue to have the largest number of publicly rated charter schools. Also, some states have large charter school networks, with multiple schools supporting a single rating. This results in higher enrollment, operating bases, and total revenue medians. Chart 3 reflects the number of obligated groups supporting rated debt, and not the number of schools or networks.

Chart 3

Table 3 provides medians for the states where we have at least 10 ratings.

• New York, Pennsylvania, California, and Minnesota have the highest costs per student and Utah has the lowest. Supported by plentiful facilities funding from the state's lease aid, Minnesota has the highest debt per student, followed by Pennsylvania, which directly relates to these states' greater expenses.
• Utah and Colorado schools continue to have the lowest expenses per student, partially due to lower costs of financing through their state credit enhancement programs and relatively higher excess margins, lease-adjusted MADS coverage, and unrestricted cash ratios. New York's unrestricted cash and excess margins medians are inflated by one school with six years' liquidity, with plans to spend down 70% of cash toward the purchase a new facility.
• Texas and Arizona schools also have pooled credit enhancement programs that lower their costs of financing and exhibit relatively lower expense per student, supporting relatively higher enrollment levels compared with other states, except for California and Florida.
• California, Pennsylvania, Texas, and Utah generally continue to exhibit higher financial metrics and, not surprisingly, higher median ratings compared with state peers.
• Michigan schools continue to exhibit the lowest median ratings, tied to relatively low medians for unrestricted cash levels, lease-adjusted MADS coverage, waitlists (generally nonexistent), and excess margins compared with those from other states. Additionally, Michigan statute limits the use of per-pupil funding on debt service to 20%, and many charter schools in the state are relatively small, in our opinion, serving high-needs students in low socioeconomic areas with declining demographic trends, primarily population.

Table 3

For further state-specific information, please see our most recent charter brief reports on New Jersey, New York, and California.

Medians by authorizer type show largely consistent metrics

Table 4 includes a breakout of medians by authorizer type. Based on the medians, charter schools with a state or local agency authorizer and school district authorizer have more favorable key financial metrics, like coverage and days' unrestricted cash, than those authorized by other authorizer types. We believe that this is primarily enrollment-driven, as these authorizers generally operate in areas with larger enrollment, in states like Arizona, Colorado, Texas, California and Utah, which helps improve these medians. Larger enrollment generally leads to more funding availability based on per-pupil funding appropriated by each state and potentially better margins and potentially healthier liquidity as schools grow materially higher than break-even enrollment levels. We view stable relationships between charter schools and authorizers as a key credit factor, since they help support an environment that allows charter schools to improve their financial operations while supporting the instructional needs of growing populations. Conversely, we view unfavorable relationships as negative credit factors, as they can materially limit a charter school's ability to successfully operate and could even lead to closure of the charter organization if the charter is not renewed. We see this potential conflict in areas where demographic trends demonstrate declining enrollment trends and relatively scarce financial resources as compared with regions with positive demographic trends, as they are a major factor in determining per-pupil funding. Poor academic performance, lack of internal controls, limited governance, and weak financials are other factors that could lead to an adverse charter/authorizer relationship.

Table 4

Size still has its advantages (large networks vs. single-site schools)

Table 5 provides median metrics of all large network charter schools with 10 or more campuses as well as the same metrics of all smaller, single-site schools with fewer than 500 students enrolled in our portfolio. While enterprise profiles by way of enrollment size and waiting lists are meaningfully stronger for large networks, financial metrics show mixed results. Despite the median rating of 'BB' for the single-site schools and a whole category higher rating median of 'BBB-' for the larger networks, margins, lease-adjusted MADS coverage, days' cash on hand, and unrestricted net assets as a percentage of expenses actually have stronger median figures for the single-sites. Financially, we believe this demonstrates how the larger networks can afford to operate at softer margins and lower coverage levels, and with less cash on hand on a relative basis, given that the sizable absolute values of their financial metrics provide financial flexibility and stability. Many of the challenges that charter schools face manifest in the enterprise profile, namely charter renewal risk, which may not be reflected in financial metrics. A larger network may be better equipped to mitigate these enterprise risks through multiple campuses, and even multiple charters and a more robust management team scaled to meet the demands of a larger organization.

Table 5

What We're Watching

We believe that COVID-19 federal relief monies will support schools' operations in the coming fiscal years, though since these are one-time funds, we will be watching how wisely schools deploy these resources in a sustainable way. We also believe that schools have the opportunity to successfully leverage federal support through strategic spending to better position themselves to meet organizational goals as the economy continues to recover. We expect most of our rated charter schools' enrollments will rebound from any pandemic-induced declines in fall 2020, though increased competition from home-schooling, online, or traditional options remains a risk. We also believe there remains some uncertainty regarding fall 2021 enrollment and mode of instruction relative to the pandemic recovery and vaccination rollout. We will continue to monitor potential risks across the sector, such as evolving legislation, increasing competition for students amid changing demographics, shifts in labor relations, teacher shortages heading into fiscal 2022, potential changes to per-pupil state aid allocations, and rising pension expenses.

Table 6

Table 7