NEW YORK--()--Fitch Ratings downgrades to 'BB' from 'BBB' and removes from Rating Watch Negative the rating on $76.915 million in bonds issued by the Pima County Industrial Development Authority, Arizona (PCIDA). The bonds were issued on behalf of the American Charter Schools Foundation (ACSF).
The Rating Outlook is Stable.
The bonds are secured by a joint and several pledge of the revenues of the ten ACSF schools (collectively, the schools), which primarily consist of state aid based on enrollment.
KEY RATING DRIVERS
WEAK FINANCIAL PROFILE: The downgrade to 'BB' primarily reflects a history of break-even to slightly negative operations and a very limited financial cushion. The downgrade also reflects a high debt burden and adequate, albeit limited, coverage of transaction maximum annual debt service (TMADS). Under Fitch's updated charter school rating rriteria, ACSF's financial profile demonstrates characteristics consistent with a speculative grade rating.
ENROLLMENT ISSUES PERSIST: Aggregate enrollment at the schools rebounded in fall 2012 following three consecutive years of declines. However, enrollment declines persisted at several schools. The inability to correct these issues over a total of four enrollment cycles is an additional credit concern.
STRUCTURAL BONDHOLDER PROVISIONS: Legal and structural security measures include a trustee intercept of state aid. This provides for payment of debt service before any pro-rata distribution of revenues to the schools, and contractual subordination of the charter management organization's (CMO) fee.
MARGIN DETERIORATION: Should ACSF's operating margin deteriorate for any reason, causing TMADS coverage to fall below 1x or a depletion of current balance sheet resources, further negative rating pressure is likely to result.
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 under its updated charter school rating criteria. ACSF's operating margin averaged -0.4% from fiscal 2007 to fiscal 2011. In fiscal 2012, certain accounting changes artificially inflated operating results to a solid surplus level (+4.8%). After adjusting for these one-time revenue inclusions, the margin dipped below the historical average, to -1.3%.
The CMO (the Leona Group) noted that certain unanticipated costs and demand changes resulted in the operating deficit in fiscal 2012, despite the expectation for break-even results as of the end of the third quarter of fiscal 2012. The primary cost overruns related to unexpected repairs on modular facilities at one school (West Phoenix High School). Further, management made a decision to honor agreed upon bonus payments at certain schools based on enrollment improvements in fall 2012 despite the fact that the enrollment levels eroded during the course of the year. This resulted in weaker than anticipated financial performance.
Fiscal 2012 demonstrates the material lack of operating flexibility that ACSF maintains relative to revenue or expense fluctuations that may occur during the normal course of business. The narrowed operations compound existing issues related to ACSF's already limited balance sheet cushion. Available funds, defined as cash and investments not permanently restricted, declined to $1.4 million as a result of the fiscal 2012 deficit. In fiscal 2012, available funds represented just 4% of operating expenses ($34.1 million) and 1.8% of outstanding debt ($76.9 million).
HIGH DEBT BURDEN
ACSF's minimal operating and financial flexibility exacerbate concerns about the foundation's high debt burden. TMADS of $5.6 million represented 16.6% of fiscal 2012 operating revenues, consistent with the historical average of 16.4%. Fitch's criteria considers a debt burden exceeding 15% a speculative grade attribute. While operations continue to provide adequate coverage of the TMADS burden, fiscal 2012 coverage was just 1.1x, providing a limited offset to concerns related to affordability.
ENROLLMENT ISSUES LIMIT BUDGET IMPROVEMENT
In fall 2012, the CMO successfully increased aggregate enrollment across the schools by 257 students, or 6.3%. Fitch views this turnaround positively given that the aggregate student population has declined in each of the prior three enrollment cycles (fall 2009, 2010 and 2011). However, three schools continued to experience enrollment losses.
Leona has noted that two of the schools may require significant programmatic change to meet the needs of the current service area demographics, which have changed significantly in the last five years. Fitch considers the potential costs associated with these changes as a further risk to ACSF's ability to generated balanced annual financial performance going forward. The persisting enrollment issues are incorporated in the downgrade to 'BB'.
ACSF is comprised of 10 schools, nine of which operate in the Phoenix metropolitan area. The tenth school operates in the Tucson area. The schools maintain independent charters from the Arizona State Board of Charter Schools. Each charter has a fifteen-year term, and expires in 2017 or 2018, depending on the school. The ACSF schools each maintain management agreements with Leona, one of the largest CMOs in the state of Arizona. Leona manages charter schools nationwide, and maintains its headquarters in Michigan.
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'
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