Despite Funding And Regulatory

Hurdles, The U.S. Charter School

Sector Continues To Grow
Primary Credit Analyst:
Sharon A Gigante, New York (1) 212-438-2008; sharon_gigante@standardandpoors.com
Secondary Contact:
Avani Parikh, New York (1) 212-438-1133; avani_parikh@standardandpoors.com
Table Of Contents
A Dynamic Evolution
Academic Performance Drives Demand
Management Is Becoming More Sophisticated
State Funding Is Declining
More Debt Issuance Is Likely
Related Research
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Despite Funding And Regulatory Hurdles, The
U.S. Charter School Sector Continues To Grow
Since the first one opened in Minnesota in 1992, charter schools have emerged as one of the leading tools for
education reform across much of the U.S. Yet while the charter school sector continues to grow and evolve, it faces
challenges arising from funding shortfalls, legislative oversight, and conforming with new academic standards. As of
Aug. 1, 2012, Standard & Poor's Ratings Services rated 150 charter schools across 22 states and the District of
Columbia.
The Center for Education Reform estimates that during the 2011-2012 academic year, 5,714 charter schools served
more than 1.9 million students in 39 states and the District of Columbia. Other charter school experts estimate that
another 400,000 or more children are on charter school waitlists. Considering that 2011-2012 charter school
enrollment grew by 13% from the prior year, we believe enrollment could surpass the 2 million mark at the start of the
new 2012-2013 school year.
Overview
The U.S. charter school sector continues to grow and evolve but faces challenges arising from funding
shortfalls, legislative oversight, and conforming with new academic standards.
New IRS rules could prohibit public charter school educators from participating in state retirement plans,
which would affect an estimated 95,000 public charter school employees nationwide.
Some states are making it easier for charter schools to succeed by equalizing per-pupil funding with that of
traditional public schools , lifting charter school enrollment caps, and making it easier for schools to acquire
facilities.
Continuing financial stress and performance challenges could pressure debt ratings well into 2013.
Despite the growing popularity of charter schools, the start of the 2013 school year will bring many of the same
challenges that they've been facing since their inception, including state per-pupil funding levels that can be 30% or
more lower than for traditional public schools; continually evolving legislation that dictates the general operating
environment, such as caps on enrollment levels; and new academic performance standards that will likely make it
more difficult for underperforming charter schools to stay open. In addition, we understand that new proposed IRS
regulations could force states to prohibit public charter school educators from participating in state retirement plans.
The proposed regulations, released in November 2011, would affect an estimated 95,000 public charter school
employees nationwide potentially forcing more than 93% of the nation's charter school workforce to either leave
their public charter schools or lose their state pensions, according to the National Alliance for Public Charter Schools.
The news is not all bad, however. Some states are actually changing their laws to make it easier for charter schools to
succeed by equalizing per-pupil funding with that of traditional public schools, lifting charter school enrollment caps,
and making it easier for schools to acquire facilities. According to a January 2012 report by the Center on Reinventing
Public Education, over the past three years, many more states have expanded the allowable number of charter schools
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or students enrolled in charter schools, compared to those that have restricted them. During the 2010-2011 school
year, for every charter school that closed, nearly 3.5 new ones opened.
A Dynamic Evolution
The charter school sector continues to evolve, and its development varies widely from state to state. As state
legislators continue to lift or modify limits on the establishment of charter schools, we expect to see competition for
students intensify in some markets since the number of schools is likely to grow. Rather than opening new, unproven,
start-up schools, many charter school advocates are hoping to replicate existing charter schools that have already
proven to be highly successful in educating students to expand enrollment. This is particularly true in urban areas,
where charter school replication models continue to proliferate in response to federal policy initiatives and
private-sector influences. Because enrollments at these schools are typically large and well-diversified across several
campuses, the schools are often able to withstand greater fluctuations in student demand. A falling headcount at one
location is frequently offset by rising enrollment at another. This is generally not the case for newer, smaller schools.
Without a clearly differentiated market presence, or the means with which to expand, many small schools in certain
markets will likely face operating challenges due to enrollment losses to large and growing competitors.
Academic Performance Drives Demand
A key indicator of a charter school's success is the academic performance and success of its students, which creates
ongoing demand for the school's program. Charter schools with the strongest waiting lists are often those that offer a
rigorous and highly regarded curriculum that outperforms the local traditional public schools. In addition, the charter
authorizer closely monitors a school's academic performance, and continued underperformance can lead to charter
revocation. As a result, we're seeing a continued emphasis on curriculum development and redefining educational
programming to best meet students' needs. As education reform continues to evolve and a growing number of states
have adopted the Common Core Standards (currently 45 states, according to www.corestandards.org), we are seeing
charter schools aligning their curricula with these standards. (The Common Core State Standards Initiative is a
state-led effort coordinated by the National Governors Association Center for Best Practices (NGA Center) and the
Council of Chief State School Officers (CCSSO). The standards were developed in collaboration with teachers, school
administrators, and experts to provide a clear and consistent framework to prepare children for college and the
workforce. For more information, please see www.corestandards.org.)
When the No Child Left Behind Act was signed into law in 2002, proponents expected that every child would test at
grade level in reading and math by 2013-2014. According to the act, adequate yearly progress in test scores was the
key indicator of a school's academic success. With this key milestone approaching, more than half the states have
sought waivers from the Department of Education. The DOE required states that received waivers to demonstrate
detailed plans for preparing all students for college and careers, target federal aid to the students most in need, and
create better support of teachers and principals.
Many states, as well as the District of Columbia, that received waivers have created their own academic standards and
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Despite Funding And Regulatory Hurdles, The U.S. Charter School Sector Continues To Grow
are emphasizing student growth and progress using new measures of success. For example, the District of Columbia
Public Charter School Board's Performance Management Framework is now in place to measure a charter school's
success or failure. According to its guidelines, the framework measures both academic performance related to student
outcomes, particularly performance growth, and nonacademic elements of school performance, such as financial
health and compliance with its charter. Charter schools in D.C. that are designated as low-performing schools under
the guidelines may be candidates for charter revocation, which underscores the importance of performing under these
measures.
This increased focus on academic accountability, which is at the root of educational reform, may also put pressure on
a school's operations and ratings in some instances. Schools with lagging academic performance could face charter
revocation and ultimately the loss of state funding. Without alternative revenue streams, which is a structural limitation
of the sector, a payment default on outstanding debt would be imminent. While charter revocation remains a
significant credit risk, most persistently low-performing schools undergo some form of remediation, which often
includes a significant restructuring of teaching staff, management, and even grade-level offerings, before the charter is
withdrawn. Although such restructurings have presented minimal operating interruptions in some cases, in others,
enrollments have declined and operating performance has weakened. Therefore, restructuring activity has become a
growing factor in deteriorating credit quality for some schools during the past calendar year. We are also seeing a
trend of charter schools and school districts forming partnerships to improve low-performing schools throughout their
communities. And some public school districts may also begin to experiment with converting their own public schools
into charter schools.
Management Is Becoming More Sophisticated
We view a strong and diverse management team as a key component to a charter school's success, and as the sector
continues to evolve, we believe charter school management teams and boards of directors are becoming more
sophisticated. Many charter schools that we rate began with strong, dynamic founders who ran almost all aspects of
the organization. And while a dynamic founder can be key to growth in the early years of a charter school, over time
many boards and founders found it necessary to bring in a professional management team with expertise in specific
functions. On the other hand, many other charter schools started out with educational or financial management
organizations in place to help manage the administrative, academic, fiscal, or other specialized services of a school.
After a few years, some schools decided that these management contracts were costly or restricted curriculum
flexibility and instead opted to pursue self-management or other more cost-effective vendors. This often resulted in an
increase in operating funds that schools could use to educate the students. We've also seen some schools begin to
contract with outside providers to explore the effectiveness and economics of distance or online learning, particularly
against the backdrop of state funding constraints. Charter schools view online learning as a good source of additional
revenue, as these students do not require additional, costly, classroom space.
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Despite Funding And Regulatory Hurdles, The U.S. Charter School Sector Continues To Grow
State Funding Is Declining
As funding levels from state sources have fallen over the past few years, many schools that had historically coped by
expanding enrollment are actively seeking approval to increase the enrollment limits under their charters, while others
are now near physical capacity. Since most charter schools derive 70% to 90% of their revenues from state sources,
flat-to-declining state appropriations represent significant operating challenges for the sector. Most have also taken
significant steps to contain costs in response to previous funding reductions. As a result, we believe the sector's
operating flexibility has already taken a hit. While state support for kindergarten through 12th-grade education appears
to be stabilizing in many areas of the country for fiscal 2013, additional reductions in some states, along with continued
funding at reduced rates or payment deferrals in others, could place significant operating strain on a number of
schools, making liquidity an important factor in meeting their ongoing payment obligations. Complicating many
schools' limited ability to respond to tighter funding are their already weak fundamental financial profiles, which
underlie the largely speculative-grade credit quality of the sector. [] These factors could put pressure on some schools'
ratings and could lead to downgrades in the face of reduced operating flexibility. Growing competitive pressure and
escalating academic accountability demands could also add to operating difficulty, although these credit factors will
not likely affect all charter schools equally.
More Debt Issuance Is Likely
We believe charter school growth will continue to be strong throughout the U.S., particularly in urban areas, where
charter schools have shown a lot of success in educating minority and low-income students. Successful charter schools
are proving that school choice can work by greatly improving standardized test scores and graduation rates in some of
the most challenging areas of the U.S., where academic success has been lagging. And we believe more states than not
are going to change their laws to allow for more school choice options, including offering vouchers to students and
lifting caps on charter school enrollment growth. Standard & Poor's thus expects more and more charter schools to
enter the bond markets as newer schools continue to grow and schools that have operated for a number of years begin
to exceed their original capacity and look for ways to expand.
Related Research
Special Report: In Tough Economic Times, Is Higher Education Still Worth The Price?, Aug. 28, 2012
U.S. Charter Schools Continue to Grow But The Sector Outlook Remains Mixed, June 11, 2012
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Despite Funding And Regulatory Hurdles, The U.S. Charter School Sector Continues To Grow
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