2018 Charter School Credit Ratings for Nine States, with a Focus on California and Michigan

There are situations in which B is a grade to be avoided.

Let us consider some 2018 charter school credit ratings as reported in Standard & Poor’s.

First, some background on “rated debt,” compliments of Zacks:

Just like stocks, debt instruments, specifically bonds, can be traded in public exchanges. Since corporate bonds can be a great deal more complicated than stocks, they sometimes come with ratings to help investors understand the potential risks and rewards. …

In finance, the word “rating” refers to a letter grade assigned to a corporation or its debt instruments by a rating agency. These ratings are based on the rating agency’s prediction of the default probability. In simpler terms, the better the rating, the more likely the firm will be able to make good on its promise to pay periodic interest and repay the principal. …

Next, a word about “investment grade” bonds from Investopedia:

An investment grade is a rating that indicates that a municipal or corporate bond has a relatively low risk of default. Bond rating firms, such as Standard & Poor’s and Moody’s, use different designations consisting of upper- and lower-case letters ‘A’ and ‘B’ to identify a bond’s credit quality rating. ‘AAA’ and ‘AA’ (high credit quality) and ‘A’ and ‘BBB’ (medium credit quality) are considered investment grade. Credit ratings for bonds below these designations (‘BB’, ‘B’, ‘CCC’, etc.) are considered low credit quality, and are commonly referred to as “junk bonds.”

And now, about those charter schools:

According to S&P’s U.S. Charter Schools 2019 Sector Outlook, the following ratings capture virtually all of its 281 rated charter schools across 25 states for 2018:

• BBB: An obligation rated ‘BBB’ exhibits adequate protection parameters. However, adverse economic conditions or changing circumstances are more likely to weaken the obligor’s capacity to meet its financial commitments on the obligation.
• BB: An obligation rated ‘BB’ is less vulnerable to nonpayment than other speculative issues. However, it faces major ongoing uncertainties or exposure to adverse business, financial, or economic conditions that could lead to the obligor’s inadequate capacity to meet its financial commitments on the obligation.
• B: An obligation rated ‘B’ is more vulnerable to nonpayment than obligations rated ‘BB’, but the obligor currently has the capacity to meet its financial commitments on the obligation. Adverse business, financial, or economic conditions will likely impair the obligor’s capacity or willingness to meet its financial commitments on the obligation.
• *Ratings from ‘AA’ to ‘CCC’ may be modified by the addition of a plus (+) or minus (-) sign to show relative standing within the rating categories.

BBB is considered “investment grade,” while BB and B are considered “junk” and “junkier,” respectively. The ratings can go higher and lower, with the A-grades as stellar and C-grades edging nearer to default, and D, arriving at default.

For the nine states with 10 or more charter schools holding rated debt in 2018 (Texas, California, Colorado, Utah, Michigan, Minnesota, Arizona, Pennsylvania, and Florida), the S&P breakdown of each state’s debt by rating, S&P illustrates as follows:

The light blue bars represent “investment grade.” The dark blue and yellow bars represent “junk,” with the yellow being “junkier.”

In five of the nine states, “junk” is the dominant rating. Only Utah has no “junkier” B’s, while Michigan has the most– which made me curious for more of the state-level details.

As of this writing, S&P offers detailed reports regarding five of the states: Texas, California, Colorado, Michigan, and Pennsylvania.

Let us more closely consider S&P info for California and Michigan.

California

California has been in the news of late for legislative efforts to regulate charter school expansion (see here also) as well as the election of traditional public school proponent and charter school critic, Jackie Goldberg, to the Los Angeles Unified School Board (LAUSD). Too, California governor Gavin Newsom is focused on charter school accountability, including “tighter rules on charter school enrollment.”

Below is what S&P has to report about California’s 2018 charter school bond ratings, including the potential effect of both increasing charter school accountability and curbing expansion of California’s charter school sector on future ratings:

As of March 7, 2019, S&P Global Ratings maintains 32 public ratings on bonds secured by California charter schools. In 1992, California became the second state in the U.S. to enact a charter school law. Today, the state is home to over 1,200 charter schools that serve roughly a 10th of the state’s kindergarten through 12th-grade (K-12) students. In California, there are many charter networks and 15 of our 32 ratings are for schools that are part of a charter network with more than five campuses. Overall, 31% of California charter school ratings are investment grade compared with 44% for the sector as a whole. We believe this stems from more charter issues on average due to the prevalence of district authorized schools, challenges for independent study schools, and other case by case factors.

Since the 2018 midterm elections, Democrats have a supermajority in both legislative houses. Democratic Gov. Gavin Newsom supports increasing accountability and transparency of charter schools and Superintendent of Public Instruction Tony Thurman has indicated support for a hiatus on new charter schools. Combined, we view these factors as neutral to negative for the sector’s growth and expansion. For S&P Global Ratings’ existing rated universe, the curbing of charter growth in already tight or competitive markets could be a positive factor for demand, and may improve credit quality. Generally, we view increased reporting and accountability positively as it increases information available for evaluation of financial and academic outcomes. We note that in terms of financial flexibility, better transparency could prevent incidences of fraud or mismanagement that result in costly outcomes for schools, but onerous regulations could strain finances by necessitating additional administrative service and increasing reporting expenses.

Any regulation can be seen as “onerous” if one must forfeit accustomed freedom. But the charter school dysfunction in California is complicated, as journalist Anna Phillips illustrates in this detailed, March 29, 2019, Los Angeles Times article, which begins and ends as follows:

California is home to about one out of every five charter schools in the United States, but state oversight of them is far from a national model.

Since the Charter Schools Act of 1992 was passed more than a quarter-century ago, a political standoff in Sacramento has made it almost impossible to repair even the parts of the charter law that no one disputes are broken. …

California lawmakers could, of course, remain paralyzed, trapped between opposing sides, fearful of incurring either the unions’ or the charter backers’ wrath.

The system could default to doing what it has done in the past: addressing peripheral issues and leaving the core problems in the charter law unresolved.

Last summer, former Superintendent of Public Instruction Tom Torlakson convened a panel of experts to consider ways to improve the law. The group disbanded without agreeing on a set of recommendations.

Newsom has requested a new task force to study the fiscal impact of charter schools on school districts. It’s supposed to report back in July.

As for S&P’s charter school rating actions for the first quarter of 2019: Three California charter schools have had their ratings lowered (John Adams Academies, Inc., from BB+ to BB) or “placed on CreditWatch” (Partnerships to Uplift Communities: 2012 and 2014 Obligated Groups, rated BB and BB-, respectively.)

Michigan

Concerning Michigan: Of course, it is the home state of school choice ideologue and decades-long public-ed destructive force, Betsy DeVos (see here also), deep and inconvenient ties to whom Democratic presidential hopeful and former Newark, New Jersey mayor, Cory Booker, likely wishes could be erased. Detroit is also currently in the news because one of its charter schools is facing eviction by its hedge-fund landlord.

Michigan is also noteworthy for weaker charter school credit ratings, as S&P reports in its 2018 state brief:

As of May 17, 2019, S&P Global Ratings maintains 28 public ratings on Michigan charter schools. Michigan enacted its charter school law in 1993, with the first schools opening in 1994. Today there are about 300 charter schools in the state serving just under 150,000 students, or approximately 10% of the state’s kindergarten through 12th grade (K-12) population. Only 21% of our Michigan charter school ratings are investment grade compared with 44% for the sector as a whole. Further, while our Michigan charter school ratings constitute roughly 10% of our rated universe, they represent 30% of our ‘B’ category schools. We believe the weaker ratings distribution 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 Detroit.

In 2011, Michigan voted to remove its cap on the number of charter schools in the state, with the cap fully phased out by 2015. Since then, however, despite new schools opening, the number of charter schools in the state has leveled off at about 300 as schools continue to close at a similar pace. According to the Michigan Department of Education, 140 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, with a law that requires charter revocation for any school operating for at least four years in the lowest achieving 5% of all public schools.

Michigan charter schools are engaged in the “churn” that disruptive, market-based ed reform insists is good. And still, Michigan charter schools are “tops” at “B”-level credit ratings (as in lower-rated than BB-junk-rated). (Recall the yellow bars on the chart above and that Michigan wins the junkier-junk-rated contest.)

Regarding S&P’s charter school rating actions for the first quarter of 2019: Three Michigan charter schools have had their ratings lowered (Hanley International Academy, from BB+ to BB) or affirmed as negative outlook (Flint International Academy and Old Redford Academy, BB and BB-, respectively).

Maybe that churn (and those BB and B ratings) should come with a warning sign.

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Schneider is a southern Louisiana native, career teacher, trained researcher, and author of two other books: A Chronicle of Echoes: Who’s Who In the Implosion of American Public Education and Common Core Dilemma: Who Owns Our Schools?. You should buy these books. They’re great. No, really.

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