Fitch Affirms American Charter School Foundation's (MI) Revs at 'BBB'; Outlook Revised to Negative

NEW YORK--(BUSINESS WIRE)--Fitch Ratings affirms the 'BBB' rating on the following revenue bonds issued by the Pima County Industrial Development Authority (PCIDA), Arizona on behalf of American Charter Schools Foundation (ACSF), a non-profit based in Michigan:

--$80.5 million the PCIDA (ACSF) educational revenue bonds series 2007A.

The Rating Outlook is revised to Negative from Stable.

RATING RATIONALE:

--The Negative Outlook reflects persistent enrollment weakening across nearly all 10 ACSF schools in Arizona for the past three years, pressuring the schools' primary revenue stream of student-based state aid;

--Despite these substantial challenges, ACSF's overall financial metrics have been stable, warranting maintenance of the 'BBB' rating; the charter management organization (CMO) overseeing all 10 schools has sustained an essentially breakeven combined operating margin and preserved the very limited balance sheet cushion through aggressive expense management measures;

--Legal and structural provisions remain strong, including a trustee intercept of state aid which provides for payment of debt service before any pro-rata distribution of revenues to the schools, and contractual subordination of the CM0's fee;

--The CMO has taken various steps to stem enrollment declines, but their success is uncertain at this point as enrollment for the 2011-12 school year will not be finalized until later this summer;

WHAT COULD TRIGGER A DOWNGRADE?

--Failure to stabilize enrollment, which Fitch believes is likely to lead to negative operating performance and/or a reduction in core academic services that could further weaken demand;

--A sustained negative operating margin, threatening ACSF's very thin liquidity cushion.

SECURITY:

The bonds are secured by a joint and several pledge of the revenues of the 10 ACSF schools, which primarily consist of state aid based on enrollment.

CREDIT SUMMARY:

Between fiscal 2009 and fiscal 2011, state-funded enrollment declined at nine of ACSF's 10 schools, and 11.3% on a combined basis to 4,162. The Leona Group, the CMO, oversees day-to-day operations for the ACSF schools and attributes most of the decline to the weakened employment profile in school markets, and political changes in the state of Arizona that have led some Latino families to relocate or drop out of the public and charter school systems. English language learners (ELL) had been a key demographic for nearly all ACSF schools, making up 25% of enrollment in fiscal 2008. The ELL share declined sharply to just 8.6% in the current fiscal year, due mainly to the decline in local employment, and the fallout in the state from the debate around recently adopted immigration legislation. The CMO has been actively repositioning the schools to draw students from populations with a different demographic profile. Most of these changes are being implemented during the current fiscal year and their success will not be clear until fall 2011 enrollment numbers are more final in late summer.

Importantly, financial operations have remained relatively stable despite the enrollment declines. ACSF's schools generated a 0.1% combined operating margin in fiscal 2010, following a negative 0.7% margin in 2009. Per-student state aid typically accounts for approximately 90% of operating revenues (less in 2010 and 2011 because of the temporary shift towards federal ARRA funding) so enrollment declines can severely constrain fiscal flexibility. The CMO has been able to implement cost controls, especially in salaries which are its largest expense item. Instructional expense dropped 10.5% in fiscal 2009 and then increased just 1.1% in 2010. Budgetary data provided by the CMO indicates a 15% reduction in total salaries in the current year, with additional cuts planned for fiscal 2012 to absorb state funding reductions. Leona Group also deferred approximately one-fifth of its total management fee for the ACSF schools this fiscal year, and is contractually obligated to continue deferrals as long as they are needed to ensure all cash flow obligations of the schools, including debt service, are fully met. The fiscal 2012 ACSF school budgets include a similar deferral. Management fees have historically accounted for 10 -15% of overall operating expenses.

While Fitch views management's ability to maintain a stable margin positively, there is a risk that continued expense reductions could impact the quality of the core academic offerings of ACSF schools. Any weakening could lead to declining academic performance, thereby exacerbating the negative enrollment trends. Additionally, the ACSF schools maintain a very thin liquidity cushion with combined available funds at the end of fiscal 2010 covering just 3% of 2010 operating expenses and 1.4% of pro-forma debt (excluding the repair and replacement fund which had just over $1 million at the end of fiscal 2010, but whose use is restricted). Both ratios are down incrementally from 2009, but remain above 2008 levels. Fitch believes that without enrollment stabilization in fall 2011, ACSF may face substantial challenges in maintaining financial stability without damaging its core academic offerings.

ACSF has contracted with the CMO to manage its schools. Leona is the largest CMO in the state of Arizona serving approximately 6,433 students, and over 17,000 students in five states nationwide. The ACSF schools are chartered through the Arizona State Board of Charter Schools for a 15-year term expiring in 2017. Nine of the schools operate in the Phoenix metropolitan area, while one operates in the Tucson area.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Revenue-Supported Rating Criteria', dated 08 Oct 2010.

--'Criteria for Rating Charter Schools', dated 23 Jan 2007.

For information on Build America Bonds, visit www.fitchratings.com/BABs.

Applicable Criteria and Related Research:

Revenue-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=564565

Criteria for Rating Charter Schools

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=311604

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