NEW YORK--()--Fitch Ratings has downgraded to 'BBB-' from 'BBB' and removed from Rating Watch Negative the rating on approximately $22 million of outstanding school facility revenue bonds, series 2011A, for the California Statewide Communities Development Authority. The bonds are issued on behalf of Alliance for College-Ready Public Schools (Alliance).
The Rating Outlook is Stable.
The bonds are payable from lease payments made by three Alliance-managed charter schools and secured by an assignment of rents and deed of trust over the school facilities. Lease payments constitute a joint and several obligation payable from the schools' gross revenues. Additional bondholder protections include a debt service reserve cash-funded to MADS, a capital maintenance and operating fund, and subordination of Alliance's management fee.
KEY RATING DRIVERS
LIMITED OPERATING HISTORY: The downgrade primarily reflects the relatively limited operating histories of the three obligated charter schools (the schools). This includes one school with less than five years of audited operating history, and no track record of multiple charter renewals. Under Fitch's revised charter school rating criteria, these factors are considered high speculative grade attributes, which in this case are offset by other credit strengths.
STABLE DEMAND: Counterbalancing the above concerns are the full and stable enrollment levels at the schools, bolstered by strong programmatic and fiscal management provided by Alliance, a well-established charter management organization (CMO) that manages a successful network of 21 Los Angeles area based charter schools.
SOUND FINANCIAL PERFORMANCE: The investment grade rating is further supported by the schools' track record of operating surpluses; sound coverage of pro forma MADS from current operations; and a manageable, though moderately high, debt burden. Financial performance is tempered by a limited balance sheet cushion. However, liquidity metrics are acceptable for the rating category.
MANAGEMENT INTERRUPTION: Any adverse change or interruption to the existing CMO relationship between Alliance and the schools, while unlikely, would strongly influence the rating.
CHARTER RELATED 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.
The rating downgrade centers on the limited operating histories of the schools, Ouchi High School, Skirball Middle School, and O'Donovan Middle Academy. Ouchi and Skirball have six and five years of audited financial statements, respectively. This is just over Fitch's minimum expectation for investment grade charter schools. Additionally, they each have only one charter renewal, which is viewed favorably, but still reflects their limited histories.
Their five-year charters expire in June 2014 and June 2016, respectively. O'Donovan is the youngest school, having only four years of audited financial statements. It has yet to undergo a charter renewal, with its initial five-year charter expiring in June 2013. Fitch notes that charter renewal risk is partially mitigated by Alliance's broader reputation and its positive working relationship with its schools' authorizer, Los Angeles Unified School District (the district).
Offsetting the schools' limited operating histories are their stable enrollment trends. Combined enrollment at the three schools was 1,438 as of the October 2012 student count. Ouchi enrolled 545 students in grades 9-12, while Skirball and O'Donovan enrolled 442 and 451 students in grades 6-8, respectively. Given Alliance's goal of maintaining small schools, each school remains at or near its desired capacity. Additionally, enrollment is not anticipated to vary significantly from current levels. This is viewed favorably by Fitch as no material enrollment growth is planned or needed to meet the schools' financial obligations. In total, Alliance manages 21 schools in Los Angeles, serving more than 9,400 students in grades 6-12.
In general, Alliance-managed schools continue to outperform their district peers academically. That said, there has been some volatility in academic performance among the schools. In 2012, two of the three schools in this transaction did not meet adequate yearly progress (AYP) under the No Child Left Behind Act. However, the authorizer stated that the district places more emphasis on California's academic performance index (API).
While the schools' API scores continue to improve, O'Donovan Middle Academy was highlighted as needing improvement and recently placed on the authorizer's program improvement list. The authorizer expressed concern over O'Donovan's academic record. That said, the record was not cited as a factor that would, on its own, result in non-renewal of the school's charter come June 2013. Fitch will continue to monitor the schools' academic performance, but continues to take comfort in Alliance's positive authorizer relationship and strong programmatic leadership of its schools.
Financial performance remains sound, with each school having generated operating surpluses since inception. Operating margins ranged between a healthy 9% and 20% for fiscal 2012 and are driven largely by prudent budgeting and administrative efficiencies derived through the Alliance network. Operating performance was similar to the fiscal 2011 results. The schools continue to benefit from the strong financial oversight and budgetary guidance provided by Alliance, which supports consistent operating performance. Characteristic of charter schools, revenue diversity is limited with state aid comprising the majority (two-thirds) of funding and federal aid representing about 12%-17%.
Following significant cuts to state funding for public K-12 education over the past four fiscal years (2009-2012), funding levels remained fairly flat in fiscal 2013 (state of California general obligation bonds rated 'A-' with a Positive Outlook by Fitch). This was a result of voter passage of the governor's tax increase initiative (Proposition 30) in November 2012, which spared the schools further funding cuts. However, as the schools' prudently prepared for further cuts in their 2013 operating budgets, they expect to end the fiscal year with healthy operating surpluses. Based on passage of Proposition 30 and year-to-date results as of Dec. 31, 2012, Fitch views management's assumptions as realistic.
The schools' debt burden, while moderately high, is manageable. Total pro forma MADS ($1.73 million) represented 13.3% of the schools' combined fiscal 2012 operating revenues of $13 million. Moreover, on a consolidated basis, the schools' positive operations enabled them to generate sufficient coverage of between 1.0-2.2 times (x) pro forma MADS for the past four fiscal years (2.2x in fiscal 2012).
When excluding O'Donovan Middle Academy from the coverage calculation due to its less than five-year audited operating history (per Fitch's charter school rating criteria), coverage falls to a still acceptable 1.5x. While joint and several, Fitch notes favorably that on an individual basis, coverage of the schools' internally allotted share of debt service was 2.5x, 1.8x and 2.5x for Ouchi, Skirball, and O'Donovan, respectively, in fiscal 2012. Fitch considers a track record of over 1x MADS coverage and a debt burden under 15% investment grade credit attributes.
Typical of charter schools, the schools' balance sheet resources are limited, though improved slightly in fiscal 2012. On a combined basis, available funds (cash and investments not permanently restricted) totaled $3.19 million as of June 30, 2012. Available funds covered fiscal 2012 operating expenses ($11 million) and debt (approximately $22.3 million) by 29% and 14.3%, respectively. While these liquidity metrics are generally considered low, they provide the schools a modest financial cushion to manage any unexpected funding declines and/or expenditure increases.
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
Revenue-Supported Rating Criteria
Charter School Rating Criteria