NEW YORK--()--Fitch Ratings downgrades to 'BB' from 'BBB-' and removes from Rating Watch Negative approximately $8.885 million of outstanding public school academy limited obligation revenue bonds issued by the Michigan Finance Authority. The bonds were issued on behalf of Hope Academy (Hope).
The Rating Outlook is Stable.
Pledged revenues consisting of up to 20% of total state allocated per pupil foundation allowance (PPFA), and all other legally available, unrestricted funds secure the bonds. On a monthly basis, the trustee intercepts the pledged revenues for the payment of bond debt service prior to remitting excess funds to Hope. In addition to the intercept mechanism, bondholders benefit from a property mortgage and a cash-funded debt service reserve equal to maximum annual debt service (MADS).
KEY RATING DRIVERS
FINANCIAL METRICS DRIVE DOWNGRADE: Hope's operating performance, balance sheet resources and debt burden are considered speculative grade under Fitch's recently updated charter school rating criteria. While the demonstrated manageability of the debt burden provides some comfort, the overall financial profile primarily exhibits speculative grade characteristics more consistent with the 'BB' rating.
ACADEMIC PERFORMANCE FALLS SHORT: Hope has failed to achieve adequate yearly progress (AYP) requirements for two years in a row, in part as a result of its sizeable special education population. Given the significant focus on academic performance in the charter renewal process, Fitch views the charter school risk common among charter schools to be heightened in this case.
STRONG ENROLLMENT: Hopehas continued to grow its enrollment despite the AYP issues; in fall 2012, Hope exceeded its growth projections in the kindergarten through eighth grade population. This core strength lends stability to the rating.
CAPABLE MANAGEMENT TEAM: The management team exhibits a combination of academic expertise, fiscal conservatism and dedication to the local community to manage the challenges that Hopefaces.
ALTERNATIVE HIGH SCHOOL IMPACT: In fall 2012, a separately managed, alternative high school program under Hope's existing charter opened in its current facility. While the operational linkages are intended to be temporary, any failure to protect the traditional academy from the academic or financial stresses associated with the new academic program could negatively impact the rating.
STANDARD SECTOR CONCERNS: A limited financial cushion; substantial reliance on enrollment-driven, per pupil funding; and charter renewal risk are credit concerns common among all charter school transactions that, if pressured, could negatively impact the rating over time.
LIMITED FINANCIAL FLEXIBILITY
The 'BB' rating primarily indicates an overall financial profile that Fitch considers to be inconsistent with an investment grade rating. Hope's operating margin averaged -0.8% from fiscal 2007 to fiscal 2011. These narrow annual results underscore Hope's limited ability to absorb unanticipated revenue or expense fluctuations. In fiscal 2012, certain expense overruns associated with Hope's new facility resulted in a 9.5% operating deficit ($561,000). This demonstrates the potential for volatility that the lack of flexibility allows.
While these overages were one-time in nature, Fitch anticipates Hopeto generate a break-even to positive margin in fiscal 2013. That said, Hope's already very limited balance sheet was negatively impacted by the deficit. Available funds, defined as cash and investments not permanently restricted, reached $231,000 at their highest level in fiscal 2011. Following the fiscal 2012 operating deficit, available funds dropped to just $97,000 . This represents a negligible 1.6% of annual operating expenses ($5.9 million) and 1.1% of total outstanding debt ($9.2 million).
The Stable Outlook indicates Fitch's expectation that Hope's anticipated fiscal 2013 operating surplus will help resurrect available funds to a level more consistent with the 'BB' rating. At present, Hope expects to generate as much as a $580k cash flow surplus, which would materially augment Hope's financial cushion.
AYP UNDERPERFORMANCE POSES RISK
In each of the last two academic years (2010-11 and 2011-12), Hope has failed to achieve federally mandated AYP targets toward a national goal of 100% proficiency by 2014. Fitch notes that Hopemaintains a sizeable special education population (11.4% of total enrollment), whose performance has lagged the traditional population and contributed to the missed targets. Michigan received a waiver from the United States Department of Education that will allow it to establish its own educational objectives. The waiver also grants the state 10 years to achieve 85% proficiency. The 2011-12 academic data will serve as a benchmark for creating these state-specific standards.
These state level factors mitigate the impact of Hope's failure to comply with existing federal academic performance guidelines. Nonetheless, academic performance is a key consideration in Hope's pending charter renewal. Eastern Michigan University (EMU), Hope's authorizer, noted that academic performance is weighted heavily in the renewal considerations (60%). EMU indicated that Hope's performance is trending in the right direction. However, its two consecutive years of underperformance will likely result in a three-year charter renewal rather than the standard five-year term.
Given the substantial changes to the academic performance review process in the state, Fitch views Hope's prospects of achieving compliance in the near term favorably. Importantly, enrollment has not suffered as a result of Hope's academic shortfalls. In fall 2011, Hope enrolled 674 students in kindergarten through eighth grades - surpassing its projected level of 658 by 2.4%. However, until Hope's performance comes into alignment with prevailing standards, Fitch will continue to view the renewal risk as heightened.
ALTERNATIVE HIGH SCHOOL PROGRAMMING
In fall 2012, Hope Academy Schools of the Future (HASF) enrolled 104 ninth grade students in a separately managed alternative high school program targeting at-risk students. HASF is currently operating in the same facility as Hope's K-8 program and under the academy's existing charter. The joint operations are not intended to be permanent. Additionally, Hope's administration anticipates HASF receiving its own charter and a separate facility within the next two years.
Certain risks are associated with HASF that could negatively impact the credit quality of Hopeover time. First, HASF's focus on an at-risk student population could elevate concerns regarding Hope's existing problems with academic performance. Fitch notes that EMU recognizes the distinction between the two programs, and plans to evaluate them separately. This somewhat mitigates concerns in this area. However, absent any precedent on this issue, Fitch views this as a potentially adverse credit factor.
The financial impact of HASF is mixed. As long as HASF operates under Hope's charter, PPFA for its students will be included in the security pledge for the series 2011 bonds. As the additional student population will increase the revenue base, the debt burden statistics (a high 14.9% in fiscal 2012) will likely lessen. However, the temporary nature of the combined operations makes any positive impact muted from a long-term credit perspective.
Fitch notes positively that HASF maintains a fully distinct and balanced budget. The schools will be required to post consolidated financial statements as long as they operate jointly, but the discrete operations are separately managed. HASF is managed by Black Family Development, Inc. (BDFI) with academic support provided by the national Schools of the Future program. Hope does utilize an out-sourced chief financial officer (CFO), who serves as the CFO of BDFI. Hope's in-house management team has not experienced any changes, which Fitch notes positively.
Hope Academy is a charter school located near the historic district of Detroit, MI (the city), and serves students living in the city and the surrounding suburbs. Hopehas been in operation since 1998. Additonally, its charter has been renewed twice (both for five-year terms) during that period. The renewal process is currently underway and Hopeanticipates receiving confirmation of its third renewal in April 2013.
Fitch's actions are part of its completed industry-wide review, which commenced September of last year when Fitch placed all of its rated charter schools on Rating Watch Negative. Fitch will release an overview of its rating actions in a separate press release later today.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research
--'Charter School Rating Criteria' (Sept. 19, 2012);
--'Revenue-Supported Rating Criteria (June 12, 2012);
--'Fitch Places all Charter School Bonds on Rating Watch Negative (Sept. 19, 2012).
Applicable Criteria and Related Research
Charter School Rating Criteria
Revenue-Supported Rating Criteria