NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed its 'BB' rating on approximately $16.1 million of educational revenue bonds, series 2012 issued by the Industrial Development Authority of the City of Phoenix on behalf of Great Hearts Academies (Veritas Project).
The Rating Outlook is revised to Positive from Stable.
SECURITY
The bonds are a joint and several obligation of two charter schools, Veritas Preparatory Academy (VPA) and Archway Classical Veritas (ACV) (together, the schools) and are payable from all legally available revenues. The bonds are further secured by a first mortgage lien over the facility in which the schools are co-located, and a cash-funded debt service reserve.
KEY RATING DRIVERS
POSITIVE OUTLOOK: The Outlook revision reflects Fitch's expectation that the credit profile of the schools combined will continue to improve in fiscal 2016 (particularly with inclusion of ACV which will have completed five-years of operating history), driving improved coverage on the series 2012 bonds.
STABLE OPERATIONS: The 'BB' rating is supported by VPA's successful 13-year operating history, favorable demand trends evidenced by a track record of enrollment growth and robust waiting lists at both schools, and trend of positive operating results on a combined basis. Offsetting factors include thin balance sheet resources, which are typical of the charter school sector and provide little financial flexibility.
LIMITED HISTORY OF ACV: Per Fitch's charter school rating criteria, the calculation of debt service coverage excludes ACV based on limited four-year operating history. Maximum annual debt service (MADS) coverage on the series 2012 bonds from VPA operations alone increased to 1.0x in fiscal 2015, from 0.9% in fiscal 2014. MADS coverage on a combined basis also has a limited history (three-years) of consistent coverage of over 1.0x, though coverage rises to 2.0x in fiscal 2015.
HIGH DEBT BURDEN: The schools' combined financial leverage remains high as measured by a MADS burden at about 11% on a combined basis in fiscal 2015. Debt to net income available for debt service is high but reduced to 7x, down from 8x in the prior year.
STRONG MANAGEMENT OVERSIGHT: The schools benefit from the strong programmatic leadership of Great Hearts Academies (GHA), whose reputation for academic excellence drives consistently strong student demand among its network of 22 charter schools located throughout the Phoenix metropolitan area. This strong leadership is expected to continue though GHA continues to reorganize its Arizona operations.
RATING SENSITIVITIES
ACHIEVEMENT OF FINANCIAL METRICS: Veritas Preparatory Academy's achievement of certain financial metrics based on its own operations, principally achieving consistent MADS coverage of at least 1.0x, together with Archway Classical Veritas' long-term consistency in operations after five years is expected to yield upward rating momentum of Great Hearts Academies' long-term 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 Great Hearts Academies' rating.
CREDIT PROFILE
GHA continues to reorganize its Arizona operations. The founding CEO of GHA will now run GHA's Texas operations effective March 2015. GHA recently appointed an interim CEO and new President to run it Arizona operations focusing on the business side and academic side, respectively. The revised leadership structure is in line with GHA's effort for state and national expansion.
DEMAND SUPPORTED BY STRONG ACADEMICS
The schools continue to benefit from favorable student demand trends, resulting from the strong academic performance among GHA's network of schools. VPA's 13-year operating history continues to be viewed as a credit positive, with growing enrollment and strong academic achievement. While only in its fifth academic year, ACV has also demonstrated enrollment growth and solid academic performance, underscoring the demand for GHA's program offerings and brand recognition throughout the Phoenix metropolitan area.
The schools' academic quality is also evidenced by their high Arizona Department of Education rankings. All schools in the GHA network, including VPA and ACV, continue to outperform state averages on Arizona's standardized testing.
The schools maintain a positive working relationship with their authorizer, the Arizona State Board of Charter Schools (ASBCS). While both schools are still operating under their initial charters, they are for terms of 15 years. ASBCS performs both annual and five-year reviews for charter schools with 15-year contracts. Fitch views the schools' charter terms and their positive working relationship with ASBCS as a credit positive, indicating a more favorable charter environment.
VPA enrolled a total of 708 students in grades 6-12 as of November 2015, which is up from 690 in November 2014 and exceeded budgeted expectations. Management expects some incremental growth but does not intend to grow too much beyond the current level to preserve its academic mission, which is achievable due to current demand and wait lists. Enrollment is capped at 750 students per its charter providing some operating flexibility.
Demand continues to be strong for ACV as well, with 539 students enrolled in grades K-5 as of November 2015, also exceeding budget. ACV's charter caps enrollment at 600. Combined enrollment of 1,247 is slightly higher than the prior year and remains ahead of the initial projection provided to Fitch of 1,140 for fall 2015. The schools maintain robust and actively managed wait lists (136 for VPA and 1,249 for ACV). Fitch views the schools' nearly full enrollments and sizeable wait lists as reflective of the solid demand for GHA's programs, which center on a rigorous classical liberal arts curriculum.
ADEQUATE MARGINS
Typical of most charter schools, revenue diversity is very limited. The schools are highly reliant on state per pupil funding (PPF), which represented 79% and 69% of VPA and ACV's fiscal 2015 operating revenues, respectively. Following relatively flat funding during fiscal years 2010-2012, PPF has steadily increased for the fourth consecutive year in fiscal 2016.
The schools' fiscal 2015 combined operating margin was a solid 7.4%, up from 5.6% the prior fiscal year. VPA's margin has fluctuated, averaging 2.6% (2011-2015), and was positive 6.6% in fiscal 2015, compared to 5.2% in the prior year. Despite only four years of audited operating history, for the last two years ACV has generated a solid 8.8% and 6% operating margin (fiscal years 2015 and 2014, respectively) boosting aggregated performance.
Fitch views continued enrollment stability and positive operations critical as the schools' combined balance sheet resources provide little financial flexibility. On a combined basis, available funds (cash and investments not restricted) totaled $2 million as of June 30, 2015. Available funds covered fiscal 2015 combined operating expenses and debt by a low 20.4% and 12.6%, respectively, but reflect marked improvement over the prior year and meets Fitch's expectations for the ratings category.
MODERATING DEBT BURDEN; IMPROVED COVERAGE
The schools' financial leverage remains high as measured by pro forma MADS coverage and burden. Debt service coverage, as calculated by Fitch, remains weak but improved. Despite VPA's track record of enrollment growth, strong academic performance and recently positive operating results in the last two fiscal years, VPA still cannot fully cover the carrying charges on the series 2012 bonds from current operations without the benefit of revenues derived from ACV.
VPA's fiscal 2015 net income available for debt service totaled just $1.16 million, covering MADS ($1.18 million) by 0.98x. Fitch views MADS coverage of at or under 1x as a speculative grade credit attributes. Fitch believes there is potential for upward rating momentum based on improving coverage levels for VPA and ACV's completion of its fifth year of operations in fiscal 2016.
Under Fitch's charter school rating criteria, a school having less than five years of audited operating history is excluded from this calculation in pooled transactions. While ACV has experienced strong demand to date and benefits from its affiliation with VPA and the GHA network, it has only completed four full academic years (2012/13-2014/15). When incorporating ACV into the debt service calculation, MADS coverage improves to an adequate 2.0x for fiscal 2015, up from 1.7x in fiscal 2014.
The schools' debt burden remains high, although leverage metrics improved slightly from fiscal 2014 to fiscal 2015. MADS consumed a high 11.1% of the schools' combined fiscal 2015 operating revenues. Total debt outstanding of about $16.1 million also represented a high 7.0x of combined net income available for debt service. High leverage ratios are characteristic of the charter school sector.
While the broader GHA network will likely continue to grow and expand, VPA and ACV have no more material capital or borrowing needs. The current campus constructed in 2012 is relatively new. Moreover, based on the improved state funding environment, modest enrollment growth, and lack of capital plans, Fitch believes the school's debt burden should moderate over time.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria
Charter School Rating Criteria (pub. 05 Nov 2015)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=872774
Revenue-Supported Rating Criteria (pub. 16 Jun 2014)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012
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