NEW YORK--()--Fitch Ratings has downgraded to 'BBB' from 'A' and removed from Rating Watch Negative the rating on approximately $12.7 million of series 2010 (Pinnacle Charter School, Inc. High School Project) charter school revenue bonds for the Colorado Educational and Cultural Facilities Authority. The bonds were issued on behalf of Pinnacle Charter School (Pinnacle).
Fitch has withdrawn its ratings on the following bond due to pre-refunding activity:
--Colorado Educational & Cultural Facilities Authority (CO) (Pinnacle Charter School, Inc. Project) charter school revenue refunding & improvement bonds, series 2003 (all maturities).
The Rating Outlook is Negative.
The series 2010 bonds are payable from annual lease payments made by Pinnacle, subject to annual appropriation by the school, and secured by a first mortgage over the financed facilities. The bonds are not on parity with Pinnacle's series 2013 bonds (not rated by Fitch).
KEY RATING DRIVERS
STATE MORAL OBLIGATION: The 'BBB' rating is based on Pinnacle's inclusion in the state of Colorado's charter school moral obligation program (the program), which provides a mechanism for the state to restore draws on the school's debt service reserve fund.
REVISED RATING METHODOLOGY: The downgrade primarily reflects Fitch's assessment of Pinnacle's underlying credit attributes in the context of revised rating criteria for charter schools, namely with regard to Pinnacle's high leverage position, limited financial cushion, and pressured academic performance.
NEGATIVE OUTLOOK REFLECTS UNCERTAINTY: The negative outlook reflects uncertainty related to management's ability to address certain academic challenges, particularly in relation to a second consecutive year of declining aggregate student proficiency levels.
SOUND OPERATING PROFILE: Counterbalancing the aforementioned concerns are Pinnacle's long operating history, which includes multiple charter renewals, steady and growing enrollment trends, and a track-record of favorable financial performance.
STRUCTURAL and LEGAL PROTECTIONS: Structural and legal provisions providing bondholder protection include the state's debt service intercept program and various reserve funds, reflecting a favorable statutory environment for charter schools.
STANDARD SECTOR CONCERNS: A modest 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.
PRESSURED ACADEMIC PERFORMANCE: An inability to generate consistently satisfactory academic outcomes could yield downward rating pressure.
STATE MORAL OBLIGATION PROGRAM
Under the program, if a charter school draws on its debt service reserve fund and fails to replenish it immediately, the authority shall submit a certificate to the Governor certifying the amount necessary to restore the reserve fund to its requirement. The Governor shall then submit a request for appropriations to the legislature in an amount sufficient to restore the reserve fund.
The general assembly then, at its discretion, may appropriate to restore the reserve fund. In order to qualify for the program, a school must merit an investment grade credit profile at the time of bond issuance, and participate in the Colorado Charter School Intercept Program. Under the intercept program, the state Treasurer pays a portion of the school's monthly per pupil revenue distribution directly to the trustee in amounts sufficient to pay debt service requirements.
The rating builds upon Fitch's view of the underlying credit quality of the charter school (bottom-up analytic approach). Moral obligation program bonds are secured separately by each school, and Fitch views each bond as project-specific. The state is actively engaged in debt issuances under the moral obligation program, and the statute provides clear mechanisms to trigger the state's moral obligation. In addition to the moral obligation, the statute also provide an additional backstop (the state charter school debt service reserve fund, or CSDSRF) so that an additional appropriation due to a debt service reserve draw down is less likely to be necessary.
HIGH LEVERAGE POSITION
Following the recent refinancing of its series 2003 bonds, pro-forma maximum annual debt service (MADS) of around $2.24 million represented a high 15.2% of fiscal 2012 operating revenue, which is viewed as a high speculative-grade credit attribute based on Fitch's revised charter school criteria. Further, Pinnacle's pro-forma debt to net income available for debt service metric was 10.3x in fiscal 2012, which is also viewed unfavorably. Some comfort is provided by the school's ability to generate at least 1.3x MADS coverage in each of the past three fiscal years (2010-2012) and the absence of near-term debt plans.
DEMAND SUPPORTS ANNUAL OPERATING PERFORMANCE
Established in 1997, Pinnacle's K-8 enrollment remained at near capacity for the 2012-2013 academic school year. Demand for the new high school stayed healthy as well, as evidenced by a total headcount growth of 13% above the prior year, to 507. Management anticipates the continuation of modest, organic growth at the high school, as the students in lower grades cycle through the school and contribute toward the targeted goal of 580.
Given recent enrollment patterns and demand to date, Fitch believes Pinnacle's enrollment goal is reasonable. Importantly. Pinnacle's academic performance is generally weaker than district and statewide performance. That said, it is generally on par with or modestly greater than other schools in close geographic proximity, which supports student demand and enrollment trends.
Favorable enrollment trends have enabled the school to generate an operating surplus in each of the past five fiscal years, including a 3.6% operating margin in fiscal 2012. Fitch interprets these results as evidence of management's ability to effectively plan for and (when necessary) implement budgetary adjustments to deliver healthy financial results.
Pinnacle's ability to deliver operating surpluses partially offsets concern related to the school's limited financial cushion. As of June 30, 2012, available funds, defined by Fitch as cash and investments not permanently restricted, totaled approximately $4.3 million. This covered fiscal 2012 operating expenses ($14.3 million) and debt ($29.9 million) by 30% and 14.3%, respectively.
PRESSURED ACADEMIC PERFORMANCE
Aggregate proficiency attained on state standardized exams in reading, writing, and math at Pinnacle trended downward for a second consecutive year in 2011-2012. Performance in math remained a priority performance challenge, as aggregate student proficiency levels in the subject decreased from around 50% in prior years to 39.2% in academic year 2011-2012, and elementary school students were categorized by the state as no longer meeting proficiency standards in the most recent year.
Further, Fitch notes that similar to other public schools in the state, Pinnacle is assigned State accreditation points based on several key performance indicators related to student proficiency, which also showed a downward trend, although points assigned are satisfactory in most cases. Of particular concern, Pinnacle's middle school program scored in just the 11th percentile of schools in the state in 2011, before rising modestly in 2012. The elementary school's ranking also declined, although Fitch notes that elementary school exams in the fifth grade were mis-administered in 2012, which may have substantially affected the outcome.
Pinnacle's pressured academic performance can be partially attributed to changes in the student composition of the school, with newer students scoring significantly lower than returning students. New elementary school students, which represented 20% of the student body in academic year 2011-2012, accounted for a significant amount of score variation.
Other variables were also significant, as middle school students with learning challenges produced significantly lower math scores than their classmates in 2012. Therefore, measures of student growth are important to assess the prospects for improvement in student exam scores. While student growth in reading and writing is generally acceptable, student growth in math in 2012 is characterized by the state as not on track for elementary school and middle school students. This raises concern about future academic performance and contributes to Fitch's Negative Outlook.
As part of its review, Fitch spoke with Pinnacle's authorizer who noted that present levels of academic performance are perceived to be satisfactory, although further declines might warrant some concern. As a result, Fitch does not believe that Pinnacle's charter application is currently at risk for non-renewal. Furthermore, Pinnacle's authorizer noted the remaining areas used for charter evaluation purposes - financial and organizational performance - remain sound. Given the importance of academic performance in the authorizer's overall evaluation of Pinnacle's charter standing, Fitch will continue to actively monitor this aspect of the credit.
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);
--'Rating Guidelines for Moral Obligations' (April 20, 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
Rating Guidelines for Moral Obligations