NEW YORK--()--Fitch Ratings downgrades to 'B-' from 'BBB' approximately $35.2 million in outstanding charter school revenue bonds for the Colorado Educational and Cultural Facilities Authority. The bonds were issued on behalf of The Academy.
The bonds remain on Rating Watch Negative by Fitch.
The bonds are essentially a general obligation of the school, with each series secured by first liens on their respectively financed facilities.
KEY RATING DRIVERS
MANAGEMENT TURNOVER AND FINANCIAL CHALLENGES: A number of significant changes have occurred since Fitch's last review, including the release of audited financial statements that raised material management concerns. A new executive director is on board and the school has a remediation plan in place. However, the absence of a multi-year track-record of stabilization under the new senior management team coupled with The Academy's unfavorable financial and debt credit attributes drive the rating downgrade.
UNRESOLVED TECHNICAL DEFAULT RISK: The Rating Watch Negative reflects the fact that the violation of certain debt covenants could trigger an event of default. Management is currently in the process of pursuing a waiver, the outcome of which is presently unknown. Fitch expects to resolve the rating watch based on the outcome of this process.
SOUND DEMAND AND ENROLLMENT TRENDS: Despite the aforementioned challenges, The Academy's demand profile remains sound. Steady and growing enrollment trends are supported by healthy school-wide retention rates, favorable academic performance relative to district- and state-wide averages, and an established reputation given its 19-year operating history.
DEBT MANAGEABILITY CONCERNS: The Academy's considerable debt burden, weak debt service coverage from net operating income, and elevated pro-forma debt to net income available for debt service metric are negative rating factors.
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.
INABILITY TO OBTAIN WAIVER: As the school appears to have triggered a technical event of default under the bond documents, failure to receive a waiver for the covenant violations may lead to the acceleration of bond payments, the result of which would likely adversely impact the rating.
INADEQUATE OVERSIGHT CONTRIBUTED TO RESERVE VIOLATIONS
The fiscal 2011 audit (not available during Fitch's previous review of The Academy) documented, among other things, a number of deficiencies in internal controls that contributed to the violation of various reserve requirements. Both the new management team and the school's authorizer, The Academy's home district, indicated to Fitch that violating the reserve requirements did not directly result in any material negative ramifications; however, Fitch believes it is a significant negative credit factor.
Following its discovery of the reserve violations in first quarter-2012, the Board hired external assistance to formulate and implement revised policies and procedures related to fiscal oversight and governance. The Board also conducted a search for a new executive director who was hired in June 2012. As the school's fiscal year ends on June 30, the Board and new executive director had limited opportunity to address the findings in the fiscal 2011 audit. This resulted in the persistence of same concerns cited by the auditor in the fiscal 2012 audit.
Importantly, Fitch notes that a violation of the reserve requirements appears to represent a technical event of default, which underpins the retention of a rating watch negative. Fitch is presently waiting for the bond trustee's final determination on the matter.
NEW MANAGEMENT TEAM INSTITUTES RECOVERY PLAN
Fitch notes that The Academy has made some measurable progress in addressing institutional weaknesses. Among their steps to address weaknesses include the establishment of a Board Finance committee comprised of members with financial experience, instituting quarterly internal audits and monthly budgetary variance reports, and creating a business manager position tasked to ensure financial compliance. Management's stated plan aims to generate sufficient financial performance to restore full compliance with various reserve requirements by fiscal year-end 2014.
Preliminary information suggests some success with expense management as prescribed in the recovery plan. That said, Fitch believes the school's history of financial underperformance warrants some caution. The Academy's operating margin on a full accrual basis averaged a negative 8.1% between fiscal years 2008-2012.
SOUND DEMAND AND ENROLLMENT TRENDS
Despite recent challenges, The Academy's demand profile remains sound. K-12 enrollment grew by approximately 4% over the preceding year, to 1,752 in academic year 2012-2013. Management plans to revise the schedule associated with the high school grades in academic year 2013-2014 to support a modest increase in enrollment, closer to the school's physical capacity of around 1800.
The new senior management team revised the school's waiting list policy to have the list refreshed on an annual basis beginning in academic year 2013-2014, which is viewed favorably by Fitch The list for that year presently includes 2,074 applicants, which bodes well for enrollment in fiscal 2014. Driving strong demand for the school are favorable academic performance outcomes, which generally exceed district- and state-wide averages across various subjects and grade levels.
DEBT MANAGEABILITY CONCERNS
The Academy's leverage profile remains an area of concern. Transaction maximum annual debt service (TMADS) of around $2.6 million (fiscal 2036) consumed a very high 20.8% of fiscal 2012 operating revenues. The Academy's ability to cover TMADS from net operating income has ranged from just 0.5x to 0.8x over the past three fiscal years, which Fitch views as a negative credit factor. Further, The Academy's pro-forma debt to net income available for debt service metric was 16.8x in fiscal 2012, which underscores Fitch's concern regarding debt manageability.
Fitch's actions are the result of its completed charter school industry-wide review, which commenced September of last year when Fitch placed all of its rated 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. 29, 2012).
Applicable Criteria and Related Research
Charter School Rating Criteria
Revenue-Supported Rating Criteria