S&P Global Ratings' median financial metrics for rated charter schools strengthened in fiscal 2021, as anticipated, following sizable amounts of pandemic relief, increased per pupil funding in most states, and overall steady demand trends. The third and largest round of Elementary and Secondary School Emergency Relief (ESSER) for public K-12 schools extends through September 2024, so we expect debt service coverage and liquidity metrics for charter schools will remain buoyed by this support in the near term, depending on broader economic conditions.

In fiscal 2021, median financial metrics improved as per pupil funding trends fared better than schools originally expected, with 18 of 20 states with three or more rated schools experiencing stable-to-increasing per pupil funding compared with the previous year. ESSER I, II, and III emergency money has provided, on average, significant reimbursements for COVID-19-related expenses and the allowable overlap often helped schools displace some existing expenses. Only 25% of rated issuers applied for and received Paycheck Protection Program (PPP) loans, so the improvement in median financial metrics is predominately due to the aforementioned factors. We have included both PPP and ESSER funds in our medians calculations based on audited presentations. However, we stress-test schools' financials as part of our credit analysis, adjusting out one-time funds to assess schools' underlying performance. We are monitoring management teams' budgeting practices and expense sustainability for when these one-time funds expire. Most schools indicate these funds are being used for one-time academic intervention and support programs for students, along with bonuses for teachers and capital projects.

Fall 2020 (fiscal 2021) median enrollment and demand metrics remained mostly stable from the previous year, which was not surprising given what we had been hearing anecdotally from rated schools throughout the pandemic. Even with the transition to virtual or hybrid learning for many schools across the country in fall 2020, median enrollment across all rated charter schools fell by less than 1%. Waitlists shrank slightly, spurred, in part, by families choosing to delay pre-school and kindergarten applications. Generally, student retention held strong, demonstrating the reluctance to switch schools during a tumultuous academic year. Building on these trends, our initial fall 2021 demand data (fiscal 2022) show overall median enrollment growth, providing evidence of rated charter schools' nimbleness through the pandemic and their ability to attract new students with the return of in-person instruction.

Rated Charter School Universe Expands While Outlooks Stabilize

In the past year, the number of public charter school ratings rose by 5%, reflecting a maturing sector, low interest-rate environment, and charter schools' increasing access to capital markets. Ratings range from 'A-' to 'D' (see chart 1). The share of speculative-grade ratings remained comparable with last year at about 57%. The greatest number of ratings are 'BBB-'; this rating level rose to a four-year high at 101 ratings, reflecting some self-selection in schools accessing the public debt markets.

Chart 1

Since last summer, upgrades have outpaced downgrades two to one, following stable-to-increasing enrollment, significant cushion provided by federal stimulus, and higher per pupil revenue in most states. At the height of the pandemic, in May 2020, 14% of charter school ratings had a negative outlook, and none had a positive outlook, reflecting the uncertainty of state funding at the time and the substantial uptick of one-time expenses from the transition to distance learning. As of June 2022, only 7% of ratings have a negative outlook and 6% have a positive outlook (see chart two). In the past year, 81% of outlook revisions were either a return to a stable or a positive outlook. Overall, we believe these outlook changes are captured in the stable outlook we have for the sector (see "Outlook For Charter Schools: While Growing Demand And Stimulus Funds Provide Flexibility, Risks Persist," published Jan. 11, 2022).

Despite these positive trends, the charter school sector has inherent risks, in that charter schools require a charter contract to operate, and nonrenewal or revocations can affect credit quality swiftly. We closely monitor all rated schools' charter contracts and understand that almost all the schools that were up for renewal in 2022 were successfully renewed. The few renewals remaining are in the process of presenting at June board meetings, and we do not anticipate any non-renewals. No rated schools faced revocation in the past year.

Chart 2

The Methodology Behind Our Median Calculations

We produced these medians from fiscal 2021 audited results for charter schools with public ratings based on our charter schools criteria. For organizations where our group rating methodology 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 can the reported medians change over time. 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 charter frameworks, 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.

Median Finances Improve Amid A Healthy Funding Environment

While some of the fiscal 2021 median metrics remain consistent with those of previous years, many key financial metrics improved (see table 1). Median excess margins doubled, boosted predominately by emergency ESSER funds that addressed one-time expenses but also offset some reoccurring expenses. As a result, maximum annual debt service (MADS) coverage strengthened too. This change reflects improved margins combined with slightly lower median MADS, as many schools used the low-interest-rate environment to refinance existing debt. Balance sheets also improved. In fiscal 2021, median days' cash on hand jumped by almost 12% from the year before, compared with just a 7% increase between fiscal 2020 and fiscal 2019. PPP loans hit only 25% of rated schools' balance sheets in fiscal 2020 and contributed to only two days' cash on hand, highlighting other factors, such as generally stable enrollment, state per pupil funding growth, and ESSER funds as the main drivers for rosier reserves across the fiscal 2021 medians.

Most schools will receive ESSER reimbursements in the coming two-to-three fiscal years. According to a recent study conducted by the U.S. Department of Education, as published in the Wall Street Journal, public K-12 schools across the country cumulatively have about 93% of their ESSER III money left to spend through September 2024. Thus, we expect our medians will continue to strengthen in fiscal 2022 due to these additional federal dollars. However, inflationary pressures remain top of mind, especially as they relate to rising teacher compensation and staff wage growth to attract and retain talent. Economic conditions, demographic shifts, and increased competition for students amid a variety of new learning options will continue to influence the sector and our median metrics. Schools' receipt of ESSER dollars may also cause noise in the upcoming medians if expenditures and corresponding reimbursements cross two different fiscal years.

Table 1

Lower-Rated Schools Benefited More From Pandemic Relief

Our financial medians continued to strengthen across rating categories in fiscal 2021 (see table 2). We anticipated this due to the infusion of substantial pandemic-relief and cost savings associated with many rated schools operating in a virtual or hybrid learning mode for at least some portion of the fiscal year. These nonrecurring revenues had a more significantly positive effect on lower-rated entities. Specifically, excess income margins in the 'B' category improved by a much greater extent relative to fiscal 2020 when compared with all other rating categories. Similarly, balance-sheet metrics for the 'B' and 'BB' categories strengthened materially whereas investment-grade ratings saw a more muted impact on average. This is generally because lower-rated schools tend to have a smaller operating base and less financial flexibility than higher-rated peers, so additional one-time money can have a greater impact.

Table 2

Fall 2020's demand metrics were more mixed across rating categories as some schools posted year-over-year gains in median enrollment while others saw a decrease, with no meaningful correlation to credit quality. There was a consistent trend of stable-to-improved student retention across all rating categories, with more pronounced improvement at the lower end of the rating spectrum. Although generally lower enrollment and generally higher retention may at first seem contradictory, they can be explained in part by a materially lower number of pre-school and kindergarten entrants. As a result, at many schools with a larger number of students enrolled in the lowest grade levels, enrollment fell.

Fiscal Growth Varied Widely By State

Chart 3

In the past year, the number of states with public charter school ratings expanded by one with the addition of the first rated school in Oklahoma. We now rate charter schools in 26 states plus D.C. (see chart 3). California tops the list with the most (38) publicly rated charter schools. Arizona, Colorado, Michigan, Minnesota, and Texas all have at least 25 rated schools. Florida and New York had the most activity in terms of new ratings; we rated three new schools in each state in the past year.

Some states have large charter school networks, with multiple schools supporting a single rating, which can result in higher median enrollment and total revenues. Chart 3 reflects the number of obligated groups supporting rated debt, and not the number of schools or networks. Table 3 lists medians for states with at least 10 public ratings on charter schools.

Table 3

Issuers in Colorado, Florida, Texas, and Utah have the highest median ratings, with common characteristics supporting the relatively higher credit quality: strong balance-sheet and liquidity metrics with correspondingly low-to-moderate debt metrics. Furthermore, all these states, except Florida, have state credit enhancement programs, which provide lower costs of financing and, in some cases, require certain minimum underlying credit characteristics to qualify for the enhancement.

Michigan schools continue to have the lowest median ratings, supported by comparatively low medians for enrollment and waitlists, limited unrestricted cash, and high debt per student. Somewhat offsetting these weaknesses, Michigan statute limits the use of per pupil funding for debt service to 20%, which somewhat curbs the impact of debt service on the operating budget. While many of the charter schools in the state are relatively small, in our opinion, they serve high-need students in low socioeconomic areas with dwindling school-age populations.

Although median enrollment fell modestly in fall 2020, it rose in most states from fall 2019 to fall 2020. Charter schools in D.C., Nevada, New Jersey, New York, and Tennessee all had significant enrollment growth (greater than 5%), reflecting, in part, the presence of networks in these states with growth plans that preceded the pandemic. In North Carolina and Texas schools, enrollment growth was slower in fall 2020 but grew further the following year, posting notable gains from fall 2019 to fall 2021 (see map). Meanwhile, Colorado, Idaho, and Utah schools' median enrollment changes were slightly negative, which anecdotally is explained by competitive home-school and online options in these states. Michigan schools' median enrollment decline was the most pronounced at almost 4%, although losses slowed in fall 2021 with the return of in-person instruction.

Our data suggest that charter schools in certain states felt a greater impact from federal pandemic relief than others. Notably, median excess margins in Florida, Michigan, and Minnesota schools rose considerably in fiscal 2021 whereas in Arizona and Colorado they improved by just 5%. Days' cash on hand improved the most in Michigan, Minnesota, Pennsylvania, and Texas, but it weakened on average in Arizona, Colorado, and New York. However, the drop in New York schools' median cash position is largely caused by one school's purchase of a facility, distorting the year-over-year comparison with other state medians. Arizona, operating under a pre-pandemic state statute, funded full-time virtual students at 95% of the state's base per pupil funding level for fiscal 2021, and Colorado's per pupil funding fell by about 5%, which helps explain the weaker margins and reserves in those states. Minnesota was the only state with a more notable difference in liquidity when adjusting out PPP loans, with a 21-day difference in days' cash on hand. Other state medians saw a negligible difference from PPP loans.

Flexibility Tends To Favor Larger Networks

Large charter school networks continued to benefit from their economies of scale achieved by their size compared with their small single-site counterparts amid the pandemic. Table 4 compares charter school networks with 10 or more campuses alongside single-site schools with fewer than 500 students. Demand metrics indicate a stark contrast between the two groups, with large networks boasting not only higher median enrollment but also meaningfully stronger waitlists. In terms of relative performance in fiscal 2021, enrollment increased at large networks by 6% on average in fall 2020 from fall 2019 while at small single-site schools it dropped 1%, reflecting networks' expansion plans that often preceded the pandemic. Similarly, waitlist as a percentage of enrollment improved nearly 36% at large networks while single-site waitlists weakened nearly 52%.

Table 4

Large networks' financial growth outperformed small single-site medians in fiscal 2021 as well. With substantial enrollment bases, larger networks benefitted more from per pupil funding hikes, and they also often received more federal relief than smaller schools, depending on the demographic they serve, as well as greater fundraising and grant opportunities. Excess margins for networks improved 175% in fiscal 2021 from fiscal 2020, versus 48% for small stand-alone schools. MADS coverage at networks also improved at a higher rate. Liquidity growth was more pronounced too, with a 24% jump in days' cash from the year prior, compared with a 2.5% drop at single-site schools. Notably, none of the rated large networks applied for PPP loans and only three small schools applied, so the changes in metrics were not due to these funds. Overall, the financial medians converged across the two subgroups, such that there is now little difference in many of their key performance metrics. This highlights how networks can often operate with thinner margins and less cash on hand at any given time, since the sizable absolute values of their financial metrics provide financial flexibility and stability, which proves important during a crisis.

What We're Watching

Fall 2022 enrollment trends.   Although initial fall 2021 median enrollment indicates a rebound from previous years, the recovery is uneven. In 14 states with five or more rated issuers, enrollment in nine states increased in fall 2021 from fall 2019 (see map). However, the pandemic and demographic shifts have pressured enrollment in states like California and Michigan. We will monitor enrollment trends in fall 2022 and whether states like Colorado, Florida, and Utah, with solid school-aged populations, are able to recapture enrollment losses as more students return to classrooms, or if saturation in these markets and longer-term shifts in student preferences are more to blame for median enrollment declines.

Recessionary pressures.   S&P Global Economics' U.S. real-time economic trackers continue to show that high prices and interest rates have softened economic activity in early June, and inflation is at a nearly 40-year high. Although per pupil funding trends in most states remain positive for fiscal years 2022 and 2023, a recession when pandemic relief is winding down could affect funding levels to schools. How management teams navigate budget planning and expense management during a possible downturn will be critical.

Teacher shortages and labor relations.   Teacher burnout, evidenced by lower-than-historical teacher retention rates, is a problem across the entire education sector. Labor shortages in other areas such as transportation, lunch services, and substitute teaching have also presented many operational difficulties. The seemingly fragile state of labor relations in the education sector was perhaps most evident in March 2022, when members of the Minneapolis Federation of Teachers went on a three-week strike. And days before that, members of the St. Paul Federation of Educators struck a deal with St. Paul Public Schools less than an hour before the deadline to strike. Based on historical data, only about 10% of charter schools nationally are unionized, but we are monitoring any uptick in unionization efforts across the sector following two stressful years for teachers. We will also be watching the impacts of the competitive labor market, from a staffing and budgetary standpoint, should it place unsustainable upward pressure on labor costs for schools.

Midterm elections and proposed federal regulations.   This November, 36 states will hold gubernatorial elections including Arizona, California, Colorado, Michigan, Minnesota, and Texas, which each have more than 25 rated issuers. D.C. will also hold its mayoral election (six rated schools). State leaders play a key role in education policy and there could be implications for charter schools, either favorable or unfavorable, which we will monitor. We will continue to watch federal legislation, such as the current proposed changes to the federal Charter Schools Program grants that would, among other things, require a community impact analysis that might curtail access to federal start-up funding for charter schools in highly competitive markets or in areas with dwindling student demographics.

Return of academic testing and changing state accountability metrics.   In the past two years, state accountability scores were on hold, given the unprecedented learning environments for students across the country. Almost all the schools we rate have seen some academic slippage during the pandemic. We will keep an eye on whether states and authorizers continue to take a relative approach to these academic shortfalls or if, with the return of academic testing in spring 2022, schools will be held to a pre-pandemic standard, potentially affecting charter contracts. We have also heard of states and authorizers proposing new measures such as the social and emotional growth of students, so we will see if these new metrics are adopted in the medium term, perhaps providing some uplift to charter schools' state scores over time.

Pensions.   Although many state plans have, or will likely see, improved funded ratios for fiscal 2021 because of robust market returns, we believe current market volatility may impair fiscal 2022 funded statuses and contribute to increased contributions. Rising pension contributions can be burdensome for smaller charter schools with less operating flexibility. We will are monitoring funded ratios in California, Colorado, Illinois, Michigan, Minnesota, and New Jersey, where ratios have historically been low or volatile.

Table 6

Table 7