Fitch Affirms Hope Academy (MI) Revs at 'BB'; Outlook Stable
CHICAGO--(BUSINESS WIRE)--Fitch Ratings affirms the 'BB' rating on approximately $8.885 million of outstanding public school academy limited obligation revenue bonds, series 2011, issued by the Michigan Finance Authority on behalf of Hope Academy (Hope, Academy).
The Rating Outlook is Stable.
Pledged revenues consist of up to 20% of state allocated per pupil foundation allowance (PPFA), and all other legally available, unrestricted funds. The trustee intercepts the pledged revenues from the State of Michigan monthly, for bond debt service, prior to remitting excess funds to Hope. In addition to the intercept, bondholders benefit from a property mortgage and a cash-funded debt service reserve equal to maximum annual debt service (MADS). There is a debt service annual coverage (DSC) covenant of at least 1.1x.
KEY RATING DRIVERS
WEAK BALANCE SHEET AND OPERATIONAL VOLATILITY: Hope's operating performance, balance sheet resources and debt burden metrics have fluctuated downward due to moving into a new building (fiscal 2012) and upward when hosting an alternative high school year (fiscal 2013). The balance sheet remains slim for the rating category.
ACADEMIC PERFORMANCE FALLS SHORT: Hope has demonstrated low academic performance in the last three years, in part due to a sizeable special education population. Given significant weight placed on academic performance in the charter renewal process, Hope remains susceptible to non-renewal risk, even though its charter was renewed in June 2013 for a three-year term. This term was shorter than its prior three five-year charter terms.
STRONG ENROLLMENT: Hope has grown enrollment in recent years as a result of adding 7th and 8th grade classes. This growth has met or exceeded projections despite academic issues, and lends stability to the rating.
CAPABLE MANAGEMENT TEAM: The management team exhibits academic expertise, fiscal conservatism and dedication to the local community. However, implementation of academic initiatives could further stress already limited financial flexibility.
ACADEMIC PERFORMANCE: Failure to improve academic performance generally, and under the state-required academic transformation plan, could heighten renewal risk.
FINANCIAL PERFORMANCE: Maintaining balanced operating performance, generating positive debt service coverage, building reserves, and meeting bond covenants are important to maintaining Hope's current rating.
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.
Hope Academy is a K-8 charter school located near the historic district of Detroit, MI (the city), and serves students living in the city and surrounding suburbs. Hope has operated since 1998, having received an initial five-year charter and two subsequent five-year renewals (through June, 2013). Eastern Michigan University (EMU) reauthorized Hope's current charter for only three years, effective through June 2016, due in part to academic performance. Most students are considered low income and qualify for free or reduced lunch assistance.
Proceeds of the series 2011 bonds funded the purchase of a facility (formerly a Detroit Public School building) with a capacity of about 700 students. This allowed Hope to add seventh and eighth grades. As of the 2012/2013 academic year, Hope was fully moved into the new space, and serves K-8 as planned. Management continues to study adding on grades 9-12. Enrollment for fall 2013 was 705 students, but by mid-year had dipped to around 656.
A separate alternative high school shared Hope's facility - and its charter authorization - on a temporary basis for the 2012/2013 academic year only. Only Hope occupies the facility in 2013/2014. Hope uses an out-sourced chief financial officer (CFO), who also serves as the CFO of Black Family Development, Inc. Hope's in-house management team has not changed, which Fitch notes positively.
SLIM OPERATING PERFORMANCE
Hope's operating margin has fluctuated widely in recent years. It was modestly negative in four out of the last six years, was negative 9.5% in 2012, and returned to positive 1.5% in fiscal 2013. The negative margin in fiscal 2012 was in large part due to delays in moving into the new building and related non-recurring expenses. The stronger fiscal 2013 results include financial operations of an alternative high school (grade 9 only) which is no longer part of Hope and will not be included in its 2014 audit results.
In Fitch's view, the variable financial results underscore Hope's limited ability to absorb unanticipated revenue or expense fluctuations. For the current fiscal 2014 budget, the school budgeted a modest surplus. Interim financial reports for the first two quarters of the year indicate operations are balanced. However, Fitch will monitor the financial impact of the mid-year enrollment decline once the fiscal 2014 audit becomes available.
GENERALLY SUFFICIENT DEBT SERVICE COVERAGE
Positively, Hope has achieved at least 1.0x current coverage in all but one of the last six years. Fiscal 2013 MADS coverage, reflecting the series 2011 bonds, was 1.5x. An exception was fiscal 2012, in which non-recurring expenses related to the new facility resulted in a $561,000 operating deficit and only 0.4X MADS coverage.
LIMITED BALANCE SHEET
Hope has a very limited balance sheet. Available funds, defined as cash and investments not permanently restricted, declined to $145,000 at June 30, 2013. This represented a very modest 1.9% of annual operating expenses ($7.8 million) and 1.6% of outstanding debt ($8.9 million). Fitch considers this slim liquidity level low for the 'BB' rating category.
In addition, the school utilizes a bank line ($300,000) and a state aid anticipation note ($650,000) to smooth cash-flow during the academic year. The Stable Outlook indicates Fitch's expectation that Hope's positive 2013 operating results and positive debt service coverage will continue. This should, over time, grow available funds to a level more consistent with the 'BB' rating, and reduce reliance on short-term note and bank line borrowing for working cash.
In each of the last three academic years (fiscal 2011, 2012 and 2013), Hope has failed to achieve federally mandated AYP (annual yearly progress) targets. Starting in academic year 2012/2013, Michigan received a U.S. Department of Education waiver from AYP/no child left behind requirement standards, and was thus allowed to set its own standards. However, Hope continues to be an under-performing institution, and Michigan ranked it as a 'Priority' school in 2013, one with academic growth and achievement among the lowest 5% in the state. As such, it has filed an academic transformation plan with the state, and is working to improve academic indicators and testing results. Like other schools in Michigan and the U.S., Hope is also preparing for Common Core academic standards, for which the first year is expected to be 2014/2015.
Hope's charter authorizer noted that a single statistic determines 'priority' status, which for Hope is the academic performance between its highest and lowest performing students, ranked state-wide. Hope maintains a sizeable special education population, about 13% of enrollment, whose performance typically lags the traditional population and contributed to the academic status.
RECENT CHARTER RENEWAL
EMU, Hope's authorizer, noted that academic performance is weighted heavily in the renewal considerations. EMU renewed Hope's charter effective June 2013, but for a three-year period instead of the standard (and former) five-year period. This change was due in part to Hope's academic performance.
There are substantial changes to the academic performance review process in the state, which Fitch will monitor. Importantly, enrollment at Hope Academy has not suffered as a result of the academic ranking. However, Fitch continues to view Hope's charter renewal risk as heightened.
ALTERNATIVE HIGH SCHOOL
In fall 2012 (fiscal 2013), Hope Academy Schools of the Future (HASF) enrolled about 104 ninth grade students in a separately managed alternative high school program targeting at-risk students. The program had a strong technology component. HASF shared Hope's facility and was authorized under Hope's charter for one year, and HASF operations were incorporated in the fiscal 2013 audit. As of the 2013/2014 academic year, HASF does not operate in Hope's facility or within Hope's charter contract. No HASF operations are included in the fiscal 2014 or future financial statements.
Additional information is available at 'www.fitchratings.com'
Applicable Criteria and Related Research
--'Charter School Rating Criteria' (Sept. 19, 2012);
--'Revenue-Supported Rating Criteria (June, 2013);
--'Fitch Downgrades Hope Academy (MI) to 'BB'' (March 8, 2013).
Applicable Criteria and Related Research:
Charter School Rating Criteria
Revenue-Supported Rating Criteria