NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the 'BB-' rating on the $7.2 million outstanding charter school revenue bonds, series 2010, issued by the Industrial Development Authority of the County of Pima, Arizona on behalf of Cambridge Academy East (CAE).
The Rating Outlook is revised to Negative from Stable.
SECURITY
The bonds are a general obligation of CAE, secured by a first mortgage on the financed facilities and a cash-funded debt service reserve sized to transaction maximum annual debt service (TMADS). There is an intercept mechanism in place directing state funding disbursements to the trustee to cover debt service on the bonds before monies are released to the school for operations. The Fitch rating does not incorporate the intercept mechanism.
KEY RATING DRIVERS
PERSISTENT DECLINE IN ENROLLMENT: The Outlook revision to Negative is based on a continuing trend of declining enrollment, mostly at CAE's Queen Creek campus, which is resulting in significant budgetary pressure for fiscal 2017. Enrollment declined an overall 26.9% in fall 2016, as a result of past administrative issues, as well as increased competition from neighboring charter schools.
VOLATILE FINANCIAL PERFORMANCE: CAE's operating margin improved to 3.2% in fiscal 2016 from a small deficit (-2.2% margin) in fiscal 2015. Management attributes improved performance to increases in state per pupil funding and managed expense growth. CAE is budgeting breakeven operating performance for fiscal 2017; however, enrollment that is currently under-budget adds operating pressure.
WEAK FINANCIAL CUSHION: CAE's balance sheet resources remain limited on both a nominal and ratio basis, providing minimal cushion relative to operating expenses and debt.
HIGH DEBT BURDEN: CAE's debt burden remains high; TMADS was 20.5% of fiscal 2016 operating revenue. The school has been able to cover TMADS from operations for the past four fiscal years, although debt manageability could be stressed going forward if enrollment declines persist.
RATING SENSITIVITIES
ABILITY TO STABILIZE ENROLLMENT: Cambridge Academy East's inability to stabilize enrollment and sustain breakeven operations would stress coverage ratios and cause negative rating pressure.
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 schools that, if pressured, could negatively impact the rating. Favorably, CAE's charter was renewed in 2016 for a 20-year term.
CREDIT PROFILE
Founded by a family of educators, CAE is a charter school serving grades K-8. Originally chartered in 2002, ASBCS renewed CAE's charter for a 20-year term in 2016. The school began operations in 1999 and currently operates two campuses, Mesa, serving grades K-6, and Queen Creek, serving grades K-8, both situated in Maricopa County, AZ.
Fitch continues to view CAE's highly interconnected board and administrative structure as less than ideal. Close ties maintained between the board, senior management, and the founding family constitutes a governance structure inconsistent with the independence typically expected by Fitch. Nevertheless, CAE's management team remains committed and effective.
VOLATILE OPERATING RESULTS
Operating results remain volatile, though margins did improve to 3.2% in fiscal 2016 from -2.2% in fiscal 2015. Management attributes improved performance mainly to increases in state per pupil funding and managed expenses.
CAE has a small revenue base, contributing to operating volatility, with just $3.2 million in operating revenue for fiscal 2016. Typical of most charter schools, revenue flexibility is very limited with about 89% of CAE's operating revenues derived from state per-pupil funding.
Favorably, the funding environment has improved in Arizona from previous years. In May 2016, state voters passed Proposition 123 (Prop 123), which raised the base level of per pupil funding to $3,600 for fiscal 2016 from $3,426.74, an increase of 5%. The new legislation ties future increases in base level funding to the rate of inflation, and generates additional revenues of $3.5 billion for all Arizona public schools, including charter schools, over the next 10 years from the State Land Trust, with $50 million having been paid out in fiscal 2016.
CAE's fiscal 2017 budget is stressed by declines in enrollment and related revenues are down approximately 16% from fiscal 2016, despite the improved funding environment. Most of the enrollment declines are at the Queen Creek campus. Management has a history of matching expenses to revenue and enrollment, and CAE expects breakeven operations for fiscal 2017. However, there is significant budgetary pressure due an overall 26.9% enrollment decline in fall 2016.
CONTINUED ENROLLMENT DECLINES
The Queen Creek campus experienced a significant 25% enrollment decline in the 2016-2017 academic year, following declines in each of the last three fiscal years. Management attributes the declines to competition from several new charter schools in the area. Additionally, the campus has been plagued by administrative issues leading to several teacher resignations.
Average daily membership (ADM), which determines state per pupil funding, fell in fiscal 2017 to 318 as of the 40-day count, compared to 425 in fiscal 2016, 438 in fiscal 2015 and 544 in fiscal 2014. For the 2016-2017 school year, 335 students are presently enrolled at CAE's two campuses; 210 at Mesa and 125 at Queen Creek, compared to 458 for the 2015-2016 school year. Enrollment at the Mesa campus remained largely stable, declining by only 10 students, while enrollment at Queen Creek declined by 113 students.
For 2014 (the most recently available data), the Mesa campus retained its state accountability grade of 'A'. The Queen Creek campus was upgraded to 'A' from 'B' following implementation of a turnaround plan. Both campuses met their annual measurable objectives, which the Arizona State Board of Charter Schools uses to measure school performance. State academic performance measures are currently being revised so grades remain on hiatus until 2017 at the earliest. When available, the scores will not be comparable to 2014.
CAE has made administrative changes at the Queen Creek campus, including hiring a new principal, which management reports are gradually repairing damaged community relationships and recapturing enrollment. However, area competition remains a concern.
Given its high reliance on enrollment-driven per pupil funding, rating stability will depend on CAE's ability to stabilize enrollment and sustain both breakeven operating performance and sum sufficient debt service coverage.
WEAK LIQUIDITY AND HIGH DEBT BURDEN
CAE's balance sheet remains limited and provides a very thin financial cushion relative to operating expenses and debt. Available funds (AF), or cash and cash equivalents not permanently restricted, increased to $508,000 as of June 30, 2016 from $394,000 as of June 30, 2015, but still only covered fiscal 2016 operating expenses ($3.1 million) and outstanding debt ($7.3 million) by a low 7.0% and 16.4%, respectively.
The series 2010 bonds and a small capital lease (approximately $37,000) are the school's only debt. Its debt burden remains very high with TMADS of about $660,000 representing 20.5% of fiscal 2016 operating revenues. Coverage of TMADS improved to 1.2x in 2016 from 1.0x in 2015 and the school has maintained sum sufficient coverage over the past four fiscal years. However, debt manageability could be stressed going forward if enrollment declines persist.
Pro forma debt to net available income was high at 9.0x in fiscal 2016, though improved from 10.7x in fiscal 2015, due to the improved operating performance. CAE reports no material capital needs or additional borrowing plans for either campus. Fitch views CAE as having no additional debt capacity at its current rating level.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria
Charter School Rating Criteria (pub. 04 Nov 2016)
https://www.fitchratings.com/site/re/889812
Revenue-Supported Rating Criteria (pub. 16 Jun 2014)
https://www.fitchratings.com/site/re/750012
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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1016484
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