What's Behind Our Sector View?

Our sector view is stable, in part due to states' strong fiscal position   U.S. charter schools start the year benefitting from continued higher per-pupil revenue in most states and a financial cushion provided by federal stimulus money. Demand remains healthy, although competition for students has intensified, attendance nationwide is a concern, and not all charter schools have been able to maintain or increase enrollment. Financial tailwinds from federal emergency relief funds, which remain available for use through September 2024, provide operating flexibility for some schools, although it varies across the sector as many have exhausted all this money already. In our view, once all federal support is depleted, the budgetary transition should be relatively smooth for schools that have been using these funds for one-time needs only, but those that have been relying on emergency money for regular and recurring expenses could face a "fiscal cliff" with significant operating pressures. At the same time, despite moderating inflation, general expense pressures tied to salaries, benefits, utilities, and supplies, coupled with labor shortages, will continue to present a budgetary challenge for most schools. Still, we don't anticipate that operations will be materially stressed sectorwide unless states meaningfully cut per-pupil funding--which we don't anticipate this year, given states' strong reserves entering 2024 despite certain expected budget deficits. (For more, see "U.S. States 2024 Outlook: Credit Stability Endures In Unstable Times," published Jan. 4, 2024, on RatingsDirect.)

Although our sector view is stable, the charter school sector still faces inherent risks because charter schools require a charter contract to operate, and nonrenewal or revocation can swiftly affect credit quality. S&P Global Ratings continues to closely monitor all rated schools' charter contracts, as state testing requirements have resumed fully and academics are a key driver of charter renewals. States, authorizers, and schools continue to navigate how best to evaluate academic outcomes and benchmarks, and most schools we rate report a collaborative approach following the unprecedented learning loss caused by the pandemic; however, in our opinion, this is something to watch.

Outlooks and rating actions point to stability in credit quality.  As of Jan. 1, 2024, ratings on 23 schools (about 7%) have positive outlooks and an almost equal number (22, also about 7%) have negative outlooks. During 2023, we saw general stability in distribution of stable outlooks (86% as of Dec. 31, 2023, the same as a year ago) across the rated charter school sector. We also made an almost equal number of upgrades (11) and downgrades (12) as K-12 demographics and demand for charter schools have not affected enrollment uniformly across the sector. We expect this trend will continue in 2024, as some charter schools are expanding, while others have reported falling enrollment amid heightened competition for students.

Expectations for 2024.  Based on our conversations with management teams, we expect fiscal 2024 financial performance will see some compression from fiscal 2023 operating margins, given increasing costs of investments in salaries and academic support. Revenues remain high and one-time emergency federal funds, which buoyed fiscal 2023 results and liquidity, are still available for some schools to spend through September 2024, offsetting some of the rising costs. Although we expect slowing economic growth in 2024, we anticipate steady creditworthiness for those schools with uninterrupted demand, good operations, and healthy cash flow, which in our opinion have cushion at the current ratings to withstand a moderate degree of financial pressure and mitigate credit risks.

Sector Top Trends

Slower economic growth could translate to funding cuts, but for now, states remain in strong fiscal condition.   S&P Global Ratings' chief U.S. economist has forecast that U.S. GDP growth will likely come in at 1.5% and 1.4% in 2024 and 2025, respectively, down from over 2.0% in 2023. Rising consumer prices and interest rates are whittling discretionary income, which could continue to affect affordability and school choices. For charter schools, per-pupil funding has been rising, but history shows that, should state budgets be squeezed in 2025 or beyond, reductions to K-12 funding could follow. Per-pupil funding levels differ by state; however, in most states where we rate charter schools, per-pupil funding growth remains healthy. Although federal sources have provided meaningful flexibility, state funding growth remains critical for charter schools, given their high reliance on these revenues.

Table 1

Political momentum for charter schools remains strong.   In 2023, charter school advocates continued to make legislative gains in statehouses across the country, demonstrating that bipartisan support for charter schools continues. In May, Montana became the 46th state to enact a charter school law, and charter school supporters made progress in Colorado, Indiana, Ohio, Wisconsin, and Wyoming. Of note, in 2023, new types of authorizers were added in several states, including Montana (new state authorizer), Nevada (cities and counties), North Carolina (new state authorizer), Oklahoma (new state authorizer, more types of universities, and accredited private institutions of higher learning), Utah (private institutions of higher education), and Wyoming (new state authorizer), which we view positively.

Emergency federal support is still providing financial flexibility, but not for long.  K-12 schools received significant emergency stimulus funds, which generally offset rising costs during the past few years. The amount of funding, coupled with the flexibility in timing and usage of the last round of federal funds, has bolstered rated schools' unrestricted liquidity and operating margins, which we expect will continue into 2024, given the funds' September 2024 usage deadline. Across our rated universe, the median unrestricted days' cash on hand increased 34% in five years to 146 days in fiscal 2022 from 109 days in fiscal 2017, spurred not only by federal support but also stronger operations from growing enrollment and favorable state funding. In the next year, liquidity strength will continue to play a key role in credit stability. However, once the extraordinary federal money runs out, it will be critical for schools to plan accordingly to avoid any sharp drops in services and staffing.

Rising costs create greater operating pressure in 2024.  Inflation has eased, but higher expenses and labor shortages will continue to hamper school budgets in 2024, creating greater operating difficulties for those schools with less financial flexibility. Significant operating pressures at smaller schools with lean management oversight, coupled with enrollment declines, could lead to technical covenant violations, such as a breach of a debt service coverage covenant; we believe this could occur more frequently in the year ahead. During 2023, several of the schools we rate reported a breach in financial covenant resulting in a technical event of default; most implemented corrective action plans to avoid covenant breaches. While we could see more covenant violations, particularly at smaller schools and those experiencing leadership transitions and enrollment challenges, we believe networks and other large operators are better positioned due to greater oversight from management teams and other benefits that come from scale.

Demand is healthy.  Demand has increased across the charter school sector, with enrollment up by 9.0% between fall 2019 and fall 2022, while traditional public school enrollment dropped by 3.5% over the same period, indicating charter schools have maintained enrollment gains while enrollment losses at traditional public schools have continued. For the majority of charter schools we rate, enrollment stabilized or increased in fall 2023, continuing this trend--but some are facing enrollment declines with significant variance across the country and by state and region. Enrollment remains a leading credit indicator; and we expect general enrollment momentum will continue, although greater competition from homeschooling, online--or private schools, given growing school choice voucher programs--remains a risk. In addition, as attendance nationally has fallen since the onset of the pandemic, this remains an area we are monitoring, especially for charter schools in states where funding is based on daily attendance.

Chart 1

Demographic trends vary across markets.   The disparity in population trends across states is striking and will continue to affect the competitive landscape for charter schools. Many states, such as California, Illinois, Michigan, Minnesota, and New York, are experiencing general school-age population declines due to falling birth rates and outmigration. Charter school operators in these states will need to keep gaining market share to hold enrollment steady as they compete for a shrinking number of students. We believe these markets are also likelier to experience additional strain between the traditional school districts (which often act as authorizers) and charter school operators as competition becomes more intense, which might hamper legislative environments and authorizer frameworks in future years. Markets in other states, such as Arizona, Florida, Idaho, Nevada, and Texas, enjoy more favorable population trends, with expected student-age population growth largely attributable to multiplying job prospects and more affordable housing. We expect favorable demographics will support enrollment at rated charter schools in these areas of the country, despite heightened competition.

Voucher programs expand across the country, with mixed impacts on charter schools.   In the U.S., place of residence typically determines where children go to school. School choice enables parents to send their children to the learning environment that works best for them, whether that's public school, private school, or homeschooling. There are many different types of school choice programs, such as Education Savings Accounts (ESAs), vouchers, and tax-credit scholarship programs. The popularity of school choice voucher programs continues to rise across the country, with more states passing bills in 2023 that provide state funds to students being homeschooled or attending private schools. In our opinion, over time, these programs could affect demand for public schools depending on the local competitive landscape and how many students move to homeschool or parochial school options; however, we do not expect to see a mass exodus of charter school students to expensive private independent schools, given the limited nominal value of vouchers compared to private school tuition costs. Voucher programs have proven to be controversial, as illustrated in several states, including Georgia and Texas, that failed to pass programs in 2023; and in Arkansas and Nebraska, public school advocates are working to collect signatures for referendums that would ask voters in the 2024 election to reject newly passed private school choice programs.

During 2023, we saw increases in the number of states that implemented or expanded into a "universal" program, where all students in the state can access the program, regardless of family income--although most are tiered to prioritize students with lower household incomes. Many other states have school choice programs, but they have income requirements or other prerequisites.

Table 2

Academic performance has improved overall, though significant learning gaps remain.   A recent study conducted by the Education Recovery Scorecard project using Northwest Evaluation Assn. data showed that while K-12 learning growth has regained momentum, recovery has been mixed across socioeconomic groups, leading to widening of learning gaps compared with before the pandemic. In addition, state academic accountability measures, which can affect charter renewal or revocation risk, have fully resumed--placing greater emphasis, in our opinion, on accelerating learning gains in schools. This is occurring as many states are revisiting measures of student success and testing requirements as schools look to recover from learning loss; while changes could be positive in the long run, they also create more near-term uncertainty. Anecdotally, several charter schools we rate have reported shorter-than-maximum charter extensions due to recent academic performance. In our view, if this becomes a widespread trend, it could create renewal concerns. We continue to watch for impacts to academic performance, state accountability, and charter standing as many schools might need to reallocate budgets to sustain programming aimed at tackling learning loss.

Labor shortages continue.   Attracting and retaining qualified teaching staff remains a key challenge and priority for the entire K-12 education sector, but especially for charter schools, which typically receive less funding and as such, pay teachers less. Although vacancy rates for teachers and staff have improved for many schools since the height of the pandemic, this remains a pronounced issue for others. To address this, schools have hired full-time substitutes to float between classrooms and have implemented certification programs for paraprofessionals to build a pipeline of teachers. Compensation for teaching staff at charter schools has historically lagged that at traditional district schools; however, schools are making a concerted effort to boost salaries, benefits, and work environments to remain competitive. For some rated schools, even with pay that tops the local district's, teacher retention remains a critical problem and added responsibilities have contributed to teachers deciding to leave the profession or seek other education-related jobs. Implications for schools that are not able to remain fully staffed are significant; not only does this impair academic outcomes for students, but in some cases, it has limited enrollment levels.

During 2023, lawmakers in at least 26 states introduced bills to raise teacher pay according to FutureEd, a Georgetown University think tank that tracks education policy; some of those bills have been signed into law in Arkansas, Florida, Idaho, Maryland, Montana, Oklahoma, Tennessee, Utah, and Washington. These bills often have bipartisan support, signaling that teacher pay will remain a priority in 2024, and we believe compensation will remain a key expense pressure in the near term, squeezing operating margins.

Potential for increased unionization pressures.   Although only about 11% of charter schools nationwide are unionized, we saw an uptick in the number of rated charter schools participating in collective bargaining agreements with teachers' unions in 2023. In addition, the number of strikes increased in the nation's largest school systems, especially in California. We continue to see an increased focus on teacher wages, benefits and working conditions, with schools raising teachers' salaries and bonuses to meet the rising cost of living. Although inflation is cooling, we believe this trend of higher wages and expenses for schools will likely persist and potential strikes and unionization activity could continue, leading to greater operating difficulties for those schools with less financial flexibility.

Table 3

2024 elections and education policies.   In 2024, the presidential election, congressional elections, and 11 gubernatorial elections could swing governmental budget and policy priorities around K-12 education. During 2023, politicians and lawmakers set the course for 2024, which we expect will include education policy debates around school choice, raising teacher pay measures, standardized testing, and improving mental health, among other things. As a result, 2024 could bring legislative changes that will affect charter schools, depending on how things shake out.

Management response is key to disruptions caused by event risk.  Beyond charter nonrenewal or revocation, additional event risks continue to affect the sector. We expect 2024 will see an increasing focus on teacher wages and working environments, especially in regions where teacher shortages are creating pressures. In addition, cyber breaches, significant management turnover, governance scandals, or weather events can also constrain schools' operating flexibility. While some schools have broad tools to address environmental, social, and governance risks, smaller or less-sophisticated management teams can lack the financial resources or expertise to implement comprehensive risk management strategies to insulate operations from these evolving risks. We expect the focus on management's planning around these risks will heighten further in 2024.

Charter schools are a widening playground for cyber criminals.   The Cybersecurity and Infrastructure Security Agency states that K-12 traditional school districts and charter schools tend to be a target of cyber crime for two primary reasons: They are "target rich and cyber poor." As discussed in "U.S. K-12 Schools Are A Playground For Cyber Criminals," published Oct. 24, 2023, charter schools maintain highly sensitive data and typically have more limited financial and resource allocation to data security, such as in-house cyber security expertise, putting them at high risk for cyber attacks. To date, for those rated schools that have faced cyber incidents, we have not observed long-term operational or material financial impacts to credit quality due to cyber risk mitigation plans, including cyber insurance, but we will continue to monitor these situations.

Rating Performance

As of Dec. 31, 2023, S&P Global Ratings had 346 public ratings on charter schools in 26 states and the District of Columbia. Certain states such as California and Texas have large charter school networks with multiple schools supporting a single rating; therefore, our rated universe covers approximately 1,400 schools. Charts 2 and 3 reflect the number of obligated groups issuing rated debt, and not the number of schools or networks. In 2023, we assigned 16 new public ratings, compared with 27 in 2022 and 28 in 2021.

Chart 2

Chart 3

Chart 4

Chart 5

Our rated universe increasingly reflects more-established charter schools, which generally have completed several successful charter renewals, uphold steady academic performance, and experience less credit volatility than newer schools. However, the charter school sector inherently remains susceptible to potential unexpected credit profile changes, including failure to meet authorizer standards, or academic or enrollment shortfalls. We expect there could be credit stress among lower-rated issuers, especially for schools that start 2024 weaker from an enrollment, academic, or financial standpoint. For some, operating stress could mount as staffing pressures heat up throughout the year, which could cause liquidity and bond covenant problems, particularly if breached covenants lead to collateral postings or acceleration of debt.

During 2023, two payment defaults (failure to make payment of principal and interest as scheduled, per S&P Global Ratings' definition) occurred within our rated universe. As of Jan. 1, 2024, 12 ratings (about 3.5%) are at 'B+' or lower, indicating a higher level of vulnerability to nonpayment.

Table 4