Overview

As of Oct. 15, 2023, S&P Global Ratings maintained 23 ratings on Arizona charter schools. In 1994, Arizona became the 11th state in the nation to enact a charter school law, and today there are about 550 charter schools in the state serving more than 230,000 students. According to the National Alliance for Public Charter Schools, approximately 21% of the state's K-12 public school students attend charter schools, which means Arizona has the nation's second-highest percentage of charter school enrollment, behind Washington, DC.

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Current Arizona charter school ratings span from 'BB-' to 'BBB' and represent everything from large networks to single-site schools. Only 22% of our ratings on Arizona charter schools are investment grade, which is modest when compared with about 45% for the sector. While many of our rated Arizona charter schools have experienced recent robust enrollment growth, their median financial metrics, though improving, have historically lagged the sector, resulting in lower ratings. We believe this is primarily due to many schools undertaking expansions, resulting in lighter financial operations and higher debt loads. In addition, Arizona's funding levels have historically trailed the nation despite increases in recent years.

In 2018, Arizona created a state public school credit enhancement program, allowing qualifying schools to obtain favorable financing at a lower cost of capital for guaranteed bonds carrying a 'AA-' rating. For more information, please see "Arizona Public School Credit Enhancement Program" published March 9, 2021, on RatingsDirect. In 2021, the program reached its total enhancement capacity of $350 million, with 16 loans made to nine charter school borrowers, with underlying ratings maintained on seven of these schools. We understand there is no additional capacity planned for the enhancement program but will monitor for changes.

Authorizer Framework

• There are three authorizing options for charter schools in Arizona: the state board of education, the Arizona State Board for Charter Schools (ASBCS), or higher education institutions--such as a university under the jurisdiction of the Arizona board of regents or a community college district. The ASBCS is the state's largest independent authorizer and oversees more than 550 public charter schools. Currently, the state board of education has a self-imposed moratorium on charter authorizing, so the ASBCS oversees all schools approved by both state boards.
• The ASBCS was created through legislation in 1994 to grant charter status to qualifying applicants and to oversee public charter schools. All of our rated charter schools in Arizona are authorized by the ASBCS.
• Arizona charter schools are authorized for longer terms than other states, with an initial 15-year charter term, and a maximum renewal length of 20 years. The state board of education may approve any charter school's transferring of charter to a different authorizer, which we view favorably, as it provides flexibility. Authorizers are still required to review schools at five-year intervals.
• Arizona charter law provides general guidance on the process for authorization, renewal, revocation, and appeals. The law requires charter sponsors to review a charter school at five-year intervals using performance framework adopted by the sponsor. This includes an academic performance expectation, operational performance expectation, and financial performance expectation set forth in the performance framework.
• The ASBCS financial framework focuses on various financial metrics, including days' cash on hand, adjusted net income, average daily membership, lease-adjusted debt service coverage, and a review of audit disclosures. Schools are evaluated on each measure, which then roll up to an overall performance rating. The ASBCS was granted authority to close schools based on financial performance through legislation passed in 2018. A charter school that falls below standard on any of the measures is subject to a financial intervention process, which provides the board the authority to revoke or terminate contracts if the school does not demonstrate improved performance.

Credit Fundamentals

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Median financial metrics have improved during the past few years, which we believe can be attributed to increased state funding as well as the recent substantial level of federal stimulus funds schools and the continued maturation of operating profiles.

More than half of our rated schools are networks with multiple campuses, while the rest are stand-alone operators. Given the favorable population trends, many of the charter schools we rate are rapidly expanding and have incurred substantial debt to finance this growth. There are five higher-rated Arizona charter school ratings at the 'BBB-' and 'BBB' ratings. Despite the state's average financial metrics that have been weaker compared to the national medians, these higher rated schools stand out, primarily given their longer operating histories and consistent track record of sound financial performance.

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We view Arizona as a charter friendly state, given its above-average charter authorization length, lack of a cap on charter school growth, and rising enrollment trends that are among the strongest in the nation. Enrollment levels for our rated schools in the state, particularly for the large networks undertaking expansions, have been generally solid, supported by healthy demographic and population trends. Approximately 87% of our rated charter schools and networks are in Maricopa County, where the school-age population base is healthy, with a 1.7% increase projected over the next five years. As shown in chart 3, the state's charter school enrollment has grown during the past decade, while traditional school district enrollment has softened.

What We're Watching

Empowerment Scholarship Accounts (ESAs).   While ESAs were originally created in 2011, legislation expanded the program in 2022. This now universal "voucher" program allows qualified students to use state funds (estimated at $7,000 per student) toward education expenses that can include private school tuition, educational supplies, home education, and more. This program remains a hot topic due to the growing number of students participating and its potential costs. The state's current governor has been a critic of the expanded voucher program due to its potential fiscal implications and has called for more transparency and accountability for both the program and charter schools. We believe this expansion of school choice further heightens competition for students among all schools, including charters, but we have not observed significant enrollment pressure to charter schools within our rated universe.

Steady state funding.   Unlike Arizona's traditional public schools, charter schools are not funded by local property taxes. Instead, base funding is calculated according to formula similar to the one used to calculate traditional public school funding, but charters also receive 'additional assistance' on a per-pupil basis. Charter schools are eligible for supplemental results-based funding if a school provides at least 200 days of instruction and/or if standardized test scores place a school in the top 10% of the state. Overall, funding has increased steadily in recent years, with base-level funding growing 2.9% in fiscal 2024, following increases of more than 8% in fiscal 2023, and 2% in fiscal 2022.

Healthy demographics.   The state's population continues to grow due to net migration from other states, given its increased job prospects and affordable housing prices (particularly when compared to California). For more information, please see "State Brief: Arizona," published March 28, 2023, on RatingsDirect. Maricopa County led the nation in population increases from 2021 to 2022 and is the among the 10 most populous counties in the nation, with continued projected growth in the minor/school-age population. We expect favorable demographics will support enrollment at rated charter schools with solid student demand, although we believe there is heightened competition for students, given the many educational options available. In addition, with greater work-from-home options post-pandemic, schools have reported some enrollment shifts as parents who may have commuted are opting for closer schools. We will monitor enrollment trends at our rated schools and the state.

Teacher shortages.   The state has long experienced teacher shortages, a challenge that was exacerbated by the pandemic. In our view, a shortage of skilled teachers could impair academic outcomes for schools in our rated universe, as there are a high level of vacancies and unfilled positions. While there have been recent efforts to stem the losses by increasing teacher pay across the state, many continue to leave the profession. We will monitor both the trend of a shrinking number of teachers and increasing salaries on school budgets and operating performance.

Long-term use of one-time funds.   Charter school operating budgets have been cushioned in recent years by the substantial level of federal stimulus funding allocated through the Elementary and Secondary School Emergency Relief fund. Many schools have used these funds to offset various expenses to address learning loss, hire additional staff, or certain eligible capital expenses, such as HVAC upgrades. When use of these funds expires in September 2024 (fiscal 2025), schools could face budgetary challenges if they used these federal funds to support recurring operating expenses.

ASBCS financial framework.   The Arizona Attorney General's office recently completed an audit on the ASBCS and issued a recommendation that it update its financial framework to better account for student enrollment changes that can lead to financial challenges. The report also recommended that the board track financial health over multiple years. We will monitor any updates to the board's framework and how this might improve transparency, oversight, and accountability of charter schools.

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