NEW YORK--(BUSINESS WIRE)--Fitch Ratings downgrades its rating on approximately $15.1 million of education facility revenue bonds issued by the Industrial Development Authority of the City of Phoenix, Arizona on behalf of Brighter Choice Charter Middle School for Boys and Brighter Choice Charter Middle School for Girls (BCCMS, the schools) to 'B+' from 'BB-'. In addition, Fitch places the bonds on Rating Watch Negative.
Education facility revenue bonds are a general obligation of BCCMS, with the Brighter Choice Foundation (BCF, the foundation) providing a guaranty for debt service. A custody agreement directs state of New York (general obligation bonds rated 'AA+' by Fitch) educational aid funding received by Albany City School District (the district) to the bond trustee for the payment of debt service. Other security provisions include a debt service reserve funded to maximum annual debt service (MADS) and a first mortgage lien on the campus.
KEY RATING DRIVERS
RENEWAL CONCERNS DRIVE DOWNGRADE: The downgrade to 'B+' reflects limited renewal prospects, as BCCMS is not expected to receive full five-year renewals when the initial provisional charters expire in January 2015. The schools have applied only for short-term, three-year renewals. The Negative Watch reflects Fitch's concern that academic results below authorizer expectations could adversely affect the renewal outcomes, which would warrant further negative rating action. BCCMS is authorized by the Charter School Institute (CSI) of the State University of New York (SUNY).
ACADEMICS REMAIN A CONCERN
Testing results below authorizer expectations drive Fitch's concerns about the charter renewal. Scores improved slightly in the 2013-14 academic year but remain below expectations based on certain comparative measures published by the authorizer. Additional improvement is required to establish long-term viability. Fitch notes positively that recent staff changes, curricular changes, and increasing academic support from the Albany Charter School Network should support academic growth over time.
OPERATIONS IMPROVE: BCCMS' operating margin improved to negative 2% in fiscal 2014 (unaudited) as the schools reached full enrollment by expanding into eighth grade. Fitch expects generally balanced operations going forward due to stable student demand and per-pupil revenues now in proportion to fixed costs. Fitch notes positively that MADS coverage exceeded 1x in fiscal 2014 (unaudited), as expected for the first year of full enrollment.
WEAK LIQUIDITY AND HIGH DEBT BURDEN: Liquid resources held by BCCMS provide minimal financial cushion against unforeseen expenses or changes in funding. Further, a small revenue base results in a high pro-forma debt burden.
CHARTER RENEWAL: Fitch expects the Negative Watch to be resolved by April 2015. Barring other significant changes, Fitch would expect to remove the obligor from the Negative Watch following a three-year renewal. The following authorizer outcomes, however, would lead to further negative rating action: three-year renewal with unrealistic conditions attached, renewal for a period of less than three years, or non-renewal.
ACADEMICS AND OPERATIONS: BCCMS' inability to maintain good coverage from balanced operations or to meaningfully improve academic performance could cause further negative rating pressure.
The schools are separate not-for-profit educational corporations, each running a single-gender middle school in adjacent facilities in Albany, NY. Each school received a provisional five-year charter on Jan. 12, 2010 from SUNY's CSI. The charters expire in January 2015. Both schools have applied for three-year renewals, short of the full five-year term allowed by the NY's charter law. The schools opened to 5th graders in fall 2010 and added one grade each year until reaching full authorized enrollment of roughly 440 students in grades 5-8 in the 2013-14 academic year. The schools' start-up costs and facilities were sponsored at inception by the foundation, which also guarantees debt service on the bonds. The bonds were issued in early 2012 to finance the schools' purchase of the facilities from the foundation.
Limited renewal prospects indicate a credit weakness and heighten the risk to bondholders. The schools have applied for renewal terms of only three years for both charters, short of the full five-year term allowed by state charter law. Fitch believes that academic results below the authorizer's published expectations could adversely affect the schools' renewal outcomes. Failure to obtain a three-year charter term would lead to further negative rating action. Fitch expects the charter renewal process to be resolved no later than April 2015.
ACADEMICS REMAIN A CONCERN
Weak academic scores relative to the authorizer's published guidelines are the main driver of Fitch's renewal concerns. The authorizer's renewal guidelines weigh academic performance above other factors; academic expectations are clearly defined. Positively, the schools achieved modest growth in student scores for the 2013-14 school year, and the schools slightly outperformed Albany district schools, which demonstrated low average scores. However, the schools underperformed on the authorizer's comparative measures of their achievement versus schools with similar proportions of economically disadvantaged students, and BCCMS students' growth was below statewide median growth.
Academic improvement is critical to the schools' viability. Fitch considers continued academic improvement necessary to maintain the rating level, even if the schools achieve three-year renewals. Fitch views current efforts to improve academic scores as favorable, but notes continued challenges. The schools have made staff changes and created a strategic academic plan, including curricular changes and regular intervention blocks throughout the school day, to improve outcomes. In addition, the schools should benefit over time from the foundation's strategic shift (through the closely affiliated Albany Charter School Network) toward greater academic and operational involvement in its schools.
MARGINS IMPROVE BUT STILL SLIGHTLY NEGATIVE
BCCMS' operating margin improved as expected in fiscal 2014 (unaudited) as the schools reached full enrollment. The rating incorporates Fitch's expectation that the schools will continue to operate with generally balanced operations on a GAAP basis and generate acceptable coverage of debt service obligations. The schools posted slightly negative margins of 2% in fiscal 2014 (unaudited). They had posted very negative results in fiscal 2013 partially due to recognition of interest expense (including non-cash amounts capitalized at issuance) and other fixed costs before reaching full enrollment and receiving associated per-pupil revenues.
STABLE DEMAND SUPPORTS OPERATIONS
Healthy student demand for the schools supports stable enrollment, resulting in predictable revenue from per-pupil funding and leading to balanced operations. Since reaching full enrollment in fall 2013 with the addition of the eighth grade, the schools have maintained enrollment at or near the authorized level of 440 (220 apiece). Barring non-renewal of their charters, Fitch expects demand for the schools to remain healthy based on marketing support through the network, affiliation with network elementary schools, and the recent closure of two other middle schools in area.
GOOD COVERAGE; HIGH DEBT BURDEN
Improved operations led to sound debt service coverage, but the schools' debt burden remains high. Coverage of MADS ($1.4 million including subordinate loan payments) from operations improved to 1.2x in fiscal 2014 (unaudited). Fitch anticipates MADS coverage will remain over 1x given the expectation of balanced operations going forward. However, the debt burden remains quite high, with MADS consuming 20% of fiscal 2014 operating revenues (unaudited). Fitch generally considers a debt burden over 15% to be a speculative-grade characteristic.
LIMITED OBLIGOR AND GUARANTOR RESOURCES
Liquid resources held by BCCMS provide minimal financial cushion. Combined available funds, defined by Fitch as cash and investments not permanently restricted, are very weak compared to both operations (3.5%) and total debt (1.6%). Limited liquid resources to absorb unanticipated operating pressures are a credit weakness and highlight the importance of maintaining balanced operations.
The guaranty of debt service payments by the foundation gives bondholders the clear expectation of support from foundation resources. However, Fitch does not believe the foundation guaranty provides material credit enhancement at this time and does not include potential BCF support as a rating factor. The foundations assets are also somewhat limited, with its available funds equal to an adequate 59.4% of its operating expenses but a weak 8.3% of its total debt. Fitch estimates that the debt service reserve fund and foundation resources are sufficient to support debt service payments for between one and approximately three years at the current resource levels. While the BCCMS bonds are currently the foundation's only guaranty, the foundation is not restricted from spending its resources to support other affiliated charter schools or from incurring additional liabilities.
Additional information is available at 'www.fitchratings.com'
Applicable Criteria and Related Research:
--'Charter School Rating Criteria' (Sept. 19, 2012);
--'Fitch Affirms Brighter Choice Charter Middle Schools (NY) at 'BB-'; Outlook Negative' (Dec. 23, 2013).
Applicable Criteria and Related Research:
Charter School Rating Criteria