Fiscal 2023 was not without its challenges as most U.S. community colleges had exhausted emergency federal money and enrollment was still recovering from previous declines. However, higher levels of state support fueled by improved state credit quality helped management teams as they returned to an operating structure more in line with pre-pandemic models.

S&P Global Ratings had 199 public ratings on community colleges as of Aug. 15, 2024. These ratings range from 'AAA' to 'BBB', with more than 60% of institutions rated in the 'AA' category and almost 30% in the 'A' category, along with only 14 colleges in the 'AAA' category and three colleges in the 'BBB' category. Therefore, changes in median metrics for these rating categories might represent the variability associated with a small sample size, rather than wholesale differences in credit quality. There are currently no non-investment-grade ratings for U.S. community colleges.

Most of our rated community colleges have a stable outlook (195 of 199), three have a negative outlook, and one has a positive outlook.

Chart 1

All data and ratings included in this report are as of Aug. 15, 2024. We excluded the financial data for three institutions that had not yet published fiscal 2023 audits as of this date. All of our rated community colleges follow Governmental Accounting Standards Board standards. Although we rate other types of debt for community colleges, such as off-balance sheet housing debt, the data in this report reflects the underlying credit characteristics of publicly rated community colleges, community college districts, or systems. S&P Global Ratings publishes these medians as general benchmarks to observe broader sector trends. The credit analysis for any institution involves an assessment of qualitative factors that are beyond the scope of this article. Therefore, these medians should not be considered thresholds to achieve a particular rating.

Table 1

Table 2

Enrollment And Demand Medians

Enrollment is showing signs of recovery

Fall 2022 saw an uptick in enrollment across most rating categories, indicating an enrollment recovery from the initial impact of the pandemic and amid persisting demographic pressures across the country. Despite these pressures, community colleges we rate 'AAA' experienced stable enrollment, and those we rate 'AA+' and 'AA' experienced an increase in enrollment of 2.0% and 3.5%, respectively. This represents the solid demand for these schools and their ability to draw from a wider student population, compared with the more narrow demand profile of some lower-rated institutions. Community colleges we rate 'AA-' and 'A+' experienced a 6% and 2% drop, respectively. These declines are mostly tied to more intense demographic challenges compared with those of peers across the rating distribution. Community colleges we rate 'A' and 'A-' remained essentially flat, while those we rated 'BBB+' and 'BBB' saw an increase of 6.4% and 6.7%, respectively. Given that we only rate three colleges in the 'BBB' category, it's difficult to draw definitive conclusions about the improvement. Fall 2023 enrollment data indicate that enrollment was up by over 3% and continues to recover, and preliminary fall 24 enrollment data show more of the same.

Chart 2

Financial Medians

Relatively consistent margins despite exhaustion of pandemic relief as major revenue sources increase

Most community colleges entered fiscal 2023 expecting softer financial performance given that most federal relief funds were already spent, and expenses were increasing due to inflation. Still, most community colleges fared similarly to previous years because they experienced increases in state aid funding, student-generated revenues, and property taxes. In most states, community colleges levy a property tax millage to support operating revenues, and the portion of the budget composed of property tax revenues can vary from less than 5% to over 30%, with a median reliance across our rated sector of 30%. We view property tax base support as a stabilizing credit factor, particularly the larger the proportionate share of the budget, because it limits the portion of revenues subject to fluctuations in enrollment and tuition revenues. Still, smaller community colleges will still require tight expense controls in parts of the U.S. with unfavorable demographic trends.

Chart 3

Regional Breakout And Medians For Top Three States

Nearly two-thirds of our rated community colleges are located in three states: California (34%), Texas (18%), and Illinois (11%). Below, we've highlighted some key credit characteristics for these states given that they make up the majority of our rated universe in this sector.

California

California is the largest community college district system of higher education in the U.S., serving more than 2 million students at 116 colleges. We currently rate 67 California community colleges, which is the highest number in our rated universe. The 'AA' median rating for these California schools is supported by generally large and healthy multicity tax bases, strong state support, and high wealth and income metrics, offset by relatively higher debt metrics compared with the rest of the U.S.

We continue to watch for the impact of enrollment recovery, which has started to show signs of rebounding after several years of declines. However, the state's declining demographic trends will become an increasing challenge, with recent enrollment projections by the California Department of Education indicating that statewide kindergarten to grade 12 enrollment is expected to drop by about 12% through fiscal 2034. In addition, we continue to monitor the full implementation of the student-centered funding formula, which is a more multi-faceted and equity-focused approach to funding. To ease the transition, the original legislation included a hold harmless provision. Beginning in 2025-2026, a district's funding floor will be equal to its 2024-2025 hold harmless funding level or its student-centered funding formula-generated funding level, whichever is higher. This new funding floor is not set to expire, but it is also not adjusted for inflation. Beyond fiscal 2025, a district's funding floor could decrease in real terms as the costs of delivering services rise with inflation. Ultimately, this could lead to budgetary pressure if a district has not planned carefully, and adjusted expenditures given enrollment declines.

Despite California facing a large operating deficit in its fiscal 2025 budget, it was able to shield community colleges from funding cuts through Proposition 98 rainy-day fund reserve withdrawals, deferrals, and funding shifts, delays and borrowings. As a whole, California community colleges have built up their reserves and liquidity positions to levels stronger than that of past recessionary environments, which we believe is important given the state's volatile revenues.

Texas

Texas is home to the second-highest number of community colleges in our rated universe at 35. Their median rating of 'AA-' is supported by tenured and experienced management teams and material property tax support, coupled with steady state funding in recent years. Through House Bill 8 (HB 8), the Texas Legislature recently passed legislation redefining how state appropriations are awarded, putting a greater emphasis on workforce development programs. We believe that HB 8 allows community colleges to work more effectively and efficiently with local employers, universities, and other community partners to connect students with learning tract outcomes that position them to join the workforce or continue their education. Before HB 8, community colleges did not receive state funding for contact hour credits tied exclusively to workforce development programs. Following HB 8, community colleges across Texas will, on average, receive more in state appropriations for programs that align with student career interests, as well as the local development effort of municipalities and employers' desire for a trained workforce across multiple disciplines. These synergies should allow for continued enrollment stabilization if not modest increases in the near term as community colleges receive funding to educate and train students in expanding disciplines such as artificial intelligence, cyber security, health care-related fields, and trades. We will continue to monitor how community college management teams across Texas incorporate additional state funding into their respective strategic plans.

Illinois

With 22 ratings, Illinois has the third-largest number of community colleges we rate. Revenue composition is similar to overall medians, with student dependence at 19%, state funding at 22%, and higher property-tax revenue dependence at 35%. Local tax bases for Illinois districts tend to be stable-to-modestly growing and diverse, providing steady support to budgets. Illinois' credit quality has improved in recent years, as illustrated by the upward movement of the state rating to 'A-' with a stable outlook (in February 2023), from 'BBB-' with a negative outlook (in April 2020). We view this positively for Illinois community colleges because state funding typically makes up approximately 22% of total revenues (ranging from 10%-37% depending on the school), and there is now more state revenue stability than in the past when Illinois experienced a budget impasse. In addition, reserve levels for Illinois districts are typically above average for the sector, which provides stronger financial flexibility. For example, the median ratios for Illinois districts for financial resources to expenses and debt are 118% and 262%, respectively, compared with the overall median ratios of 100% and 125%, respectively. Illinois community college districts participate in the State Universities Retirement System, a pension plan that has weaker actuarial assumptions and a poor funded status, but the state makes substantially all required contributions on behalf of community colleges, limiting exposure to pension obligations. For more information, see our "Pension Spotlight: Illinois," published June 26, 2023, on RatingsDirect.

Table 3

What We're Watching

Enrollment trends:   While community college enrollment has historically been counter cyclical to the economy, with higher demand seen in recessions, this was not apparent during the economic pressures in recent years. However, many community colleges have now begun to see a rebound in demand from the recent low points and are projecting continued growth over the next few years returning to historical levels. We note that, similar to four-year institutions, demand trends remain bifurcated, with larger community colleges benefiting from a broader reach and beneficial corporate and/or higher education partnerships. The National Student Clearinghouse, which tracks community college enrollment across the U.S., has indicated that undergraduate enrollment at community colleges grew 4.7% in spring 2023. Furthermore, community colleges in areas with weakening demographics, such as declining high school population trends, will continue to face heightened enrollment challenges.

State support:  State support remains a major revenue driver for community colleges. According to the State Higher Education Executive Officers Association's annual Grapevine survey, state support (excluding federal relief) for higher education hit $126.5 billion in fiscal 2024, up 10% from fiscal 2023. For fiscal 2024, 41 states reported year-over-year increases in combined state and federal stimulus funding, with 20 states boosting support by more than 10%. We expect that state governments will continue to support public higher education institutions as they navigate tough demand conditions through fiscal 2025. With most of our rated community colleges located in California and Texas, we will continue to monitor closely state funding decisions in these two states and across the country, as well as their impact on community college budgets. We will also continue to monitor how the adoption of state funding models that center more on performance and success factors affects community college operations. For more information, see "With Fiscal 2025 Budget Deadline In Sight, U.S. States Navigate A New Revenue Environment," published June 25, 2024.

Evolving risk management:  Community colleges face risks similar to those of public universities, such as aligning programmatic offerings based on labor market and student demand, the heightening of demographic pressures in certain regions of the country, evolving physical risk primarily tied to geographic location, and rising cyber-security risks. In addition, material turnover among senior management is present across the sector. We will continue to monitor community college enrollment strategies and their effect on enrollment trends, leadership responses, and any potential credit impact related to these risks.

Pension and other postemployment benefit (OPEB) funding:  Fiscal 2023 and fiscal 2024 year-to-date investment returns have generally been favorable compared with fiscal 2022. As a result, we expect improvement in U.S. public pension funded ratios for fiscal 2024. However, conditions are less visible for fiscal 2025, given uncertainty about monetary policy and the upcoming U.S. presidential election. We will continue to monitor the impact pension and OPEB costs have on community college budgets and senior leadership's ability to execute strategic initiatives to mitigate this risk. For more information on U.S. public pension and OPEB credit characteristics, see " Pension Brief: U.S. Public Pension Funded Ratios Continue Improvement In 2024," July 25, 2024.

Capital investments:   As community colleges implement strategic plans, they grapple with prioritizing deferred maintenance versus new construction. In all cases, senior leadership officials face high construction costs and still higher-than-historical interest rates as they move to implement measures aimed at attracting and retaining students. In addition to traditional classroom needs, we are seeing more recent examples of community colleges considering building or expanding on-campus residence hall options, as housing affordability becomes a broader concern in certain areas. Community colleges able to effectively execute facility improvement strategies will be better positioned to maintain potential positive enrollment momentum than their counterparts that cannot navigate project cost barriers. We believe a combination of prudent liquidity policies and practices, coupled with an ability to secure grants or special gifts, will be key characteristics of community colleges that are successful in this challenging construction environment.

Property tax revenue support:  Community colleges continue to receive a material portion of their total revenues from property taxes at nearly 30% across the sector. Property values have demonstrated resilience in previous economic cycles, with the exception of those community college district service areas that were more concentrated in traditionally volatile sectors. S&P Global Ratings will continue to monitor trends related to property values as well as legislative changes that could potentially affect how community colleges collect property taxes, given they make up a significant portion of the revenue basis for community colleges and any major changes could affect budgets.

Table 4

Related Research

• Pension Brief: U.S. Public Pension Funded Ratios Continue Improvement In 2024, July 25, 2024
• With Fiscal 2025 Budget Deadline In Sight, U.S. States Navigate A New Revenue Environment, June 25, 2024
• Pension Spotlight: Illinois, June 26, 2023