Overview

As of May 24, 2022, S&P Global Ratings maintains 29 public ratings on Michigan charter schools. Michigan has the third-highest number of rated charter schools, after California and Texas. Michigan enacted its charter school law in January 1994, and the first schools opened just a few months later, in fall 1994; by 1997, 100 charter schools had opened across the state. Today, there are almost 300 charter schools in the state serving over 150,000 students, or a little more than 10% of all public-school students statewide.

Chart 1

Only 21% of our Michigan charter school ratings are investment-grade, compared with 44% for the sector as a whole. While our Michigan charter school ratings constitute roughly 10% of our rated universe, they represent 45% of our 'B' rated category schools. We believe the weaker ratings distribution for charter schools in the state stems from years of economic and funding pressures, enrollment instability, academic concerns, and slim operating margins, combined with the timing of per-pupil funding payments, which has historically led some schools to be increasingly reliant on short-term cash flow borrowing. The majority of our rated Michigan charter schools are located in Wayne County, which includes Detroit.

The state originally limited the number of charter schools to a 150-school cap, which was reached in 1999, meaning new schools could only open after an existing school closed. In 2011, Michigan voted to remove this cap and the number of charter schools increased. However, according to the Michigan Department of Education, more than 210 charter schools have closed in the state since 1995, for a myriad of reasons and with varying lengths of operating history. In our view, this reflects some of the volatility of the sector, but also a fairly active oversight process within the state, which includes a law that requires charter revocation for any school operating for at least four years in the lowest achieving 5% of all public schools. We expect to monitor how pandemic-related effects on testing and academic outcomes will be incorporated over time.

Authorizer Framework

• School boards, intermediate school boards (also known as educational service agencies), and public universities and community colleges can serve as authorizers. About two-thirds of Michigan charter schools are authorized by public universities and community colleges, while local school districts and intermediate school districts make up the balance. There are currently 43 active authorizing entities in the state.
• All of our rated schools are authorized by either a public university or community college, or will be as of fiscal 2022. In our view, the prevalence of non-school-district authorizers eliminates the inherent conflict of interest that is typical when local school districts serve as authorizers and are competing for students and funding. Most of our rated schools report a good working relationship with their respective authorizers and benefit from some authorizer support in the form of trainings, leadership development, and the sharing of best practices. Additionally, as required by state law, an authorizer must approve the charter school's board. This is fairly unique in the sector and has the potential to affect the independence of charter boards, though in practice we have not found that authorizers interfere in board member composition.
• The Michigan Department of Education provides clear guidance on the process for authorization, renewal, revocation, and appeals, which we view positively. Michigan law does not dictate the length of renewal contracts, but in most cases charter schools are authorized for a maximum term of five years. Within our rated universe, we have seen charter contract terms ranging from one to seven years.
• At any time, a charter school is allowed to apply to transfer or receive a new contract from an alternative authorizer, which we view favorably, as it provides flexibility for schools. However, if a school is in the bottom 5% academically, or the previous charter was revoked or not renewed due to just cause, typically a new authorizer is not likely to grant the request, given the focus on educational outcomes. The decision to revoke a charter contract is at the discretion of the authorizer and is generally not subject to review by a court or state agency.

Credit Fundamentals

Table 1

The Michigan student retention rate has improved modestly, to 88% in fiscal 2021, from 84% in fiscal 2018. The maximum annual debt service (MADS) coverage metric has also improved, to 1.9x, from 1.2x in fiscal 2018. Notably, the median days' cash on hand has improved over the past few years, to 91 days in fiscal 2021 from 60 days in fiscal 2018, mainly due to funding received from the Elementary and Secondary School Emergency Relief (ESSER) Act and significant state funding increases.

Chart 2

Generally, Michigan charter schools do not operate large systems, though many contract with management organizations to provide a full range of support services. All of our rated schools are single-site operators, which results in median enrollment levels and operating budgets that are significantly smaller when compared with medians for the entire sector. Generally, median ratios for our rated Michigan charter schools lag those of schools in other states and across the sector, given some of the pressures already described, which somewhat limits financial flexibility.

Since S&P Global Ratings started rating charter school bonds, we have experienced a total of eight defaults in our rated universe. Three of those defaults were Michigan charter schools. Most recently, Plymouth Educational Center in Detroit was rated 'D', reflecting Plymouth's missed bond principal payment on Nov. 1, 2021, as permitted under its extended forbearance agreement between the school and U.S. Bank N.A., as trustee. During summer 2021, Plymouth's forbearance agreement was extended by three years from July 1, 2021, to June 30, 2024. The agreement permits Plymouth to miss bond principal payments during this time frame; we understand the school continues to make interest payments. Under our criteria, we consider the nonpayment of principal and interest in a timely and full manner as equivalent to default.

The two other Michigan defaults occurred in 2013 (Bradford Academy) and 2017 (Allen Academy). Bradford Academy defaulted on its bonds, though the school entered into a forbearance agreement with bondholders and continues to operate. Allen Academy defaulted following the school's closure due to charter nonrenewal. Given our ratings distribution and modest financial profiles for many of our rated Michigan schools, we actively monitor any sharp declines in enrollment, academic outcomes, or financial results, and how these may affect the charter relationship.

In Michigan, bondholders are provided protection through a state aid pledge agreement. The authorizing body intercepts pledged state aid revenues and sends them directly to the trustee for debt service. The remaining funds, less the 3% charged by the authorizer, are then sent to the charter school for operations. Per-pupil funding is distributed by the state in equal installments each month from October through August. The gap in funding has historically led to certain schools engaging in short-term cash flow borrowing from the state through state aid anticipation notes. State statute limits the use of state per-pupil state aid for debt service to no more than 20% of that appropriated. In our view, this can limit flexibility in the event of enrollment declines, but builds an inherent cap on a school's debt burden and is intended to ensure that Michigan charter schools continue to spend the majority of revenues on educational support. With the influx of federal dollars in fiscal years 2020 and 2021, short-term borrowing has been less common among our rated schools.

What We're Watching

Stagnant population growth.   Michigan has the second-slowest rate of population growth in the country. In Wayne County, where 17 of our 29 rated charter schools are located, the school-age population is projected to decline by more than 7% in the next five years, which could continue to pressure enrollment for both charter schools and traditional public schools in the medium term. We have assessed the economic fundamentals for schools in Wayne County and Genesee County (Flint, where we have two rated schools) as highly vulnerable.

Increased funding.   In fiscal 2022, Michigan Governor Whitmer signed the largest (K-12) budget in the state's history, $17.1 billion, which closed the state's per-pupil funding gap. The proposed state budget for fiscal 2023, which is currently under consideration by the legislature, proposes $18.4 billion in funding, with a $435 per-pupil increase in the state aid foundation allowance, to $9,135 per pupil. This would represent a 5% increase, which we would view favorably.

Equalization.   With the passing of the fiscal 2022 state budget, the K-12 per-pupil funding gap between charter schools and school districts was closed. The gap had been in place for 27 years, since the state last overhauled the financing of public education, and closing the gap was a priority for Michigan charter schools. Districts and charter schools now all receive $8,692 in base per-student aid from the state, closing the previous gap of $418 between lower- and higher-funded schools. For more information on S&P Global Ratings' Michigan school district ratings, see our latest credit brief.

Midterm elections.   The governor, lieutenant governor, secretary of state, and other state representatives will be up for re-election in November of this year. It is expected to be a competitive race, and we will continue to monitor the outcome of the election and what the potential effects could be for charter schools, especially if the governor's office (Dem.) or the legislature (Rep.) switches parties.

Increased regulations.   Recently, Democrats in both the Michigan House and Senate introduced the School Freedom, Accountability, Choice, and Transparency (FACT) Act, which would require authorizing organizations that oversee charter schools and the education management organizations that run them to comply with a series of new regulations, including: producing financial audits, posting recruitment costs annually, and holding monthly board meetings, among other requirements. As of this writing, the bill has been referred to the Education Committee, with no further action. If the Democrats gain control of the legislature, this bill is more likely to move forward; we will be closely monitoring this situation.

Long-term use of one-time funds.   ESSER funds have provided a significant amount of operating revenue to traditional public and charter schools. Many schools have 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 either ensure that current spending is sustainable or be willing to make cuts down the road.

Teacher shortage.   Michigan's teacher shortage has been growing and is expected to worsen; eight years ago (2013-2014), there were 23,000 individuals in teacher prep programs in the state, while now there are only about 9,000. Over that same period, the number of individuals completing teacher education programs has dropped from 4,720 to 2,258. In response, the Michigan Department of Education has requested $300 million to $500 million to spend on teacher recruitment over the next five years.

Labor relations.   As most Michigan charter schools are not unionized and employ teaching staff through a third-party management organization, they are not required to participate in the state's retirement plan. Of our rated schools, only four schools participate in the Michigan Public Schools Employees Retirement System. Our remaining rated schools typically offer a 401k defined-contribution plan, some with a matching component. In our view, the employment of teachers through third-party management organizations can provide cost flexibility, but can also present risk if a sudden change in management structure were to result in significant shifts in teacher retention, potentially affecting enrollment or academic outcomes.

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Related Research

• Through The ESG Lens 3.0: The Intersection Of ESG Credit Factors And U.S. Public Finance Credit Factors, March 2, 2022