NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the 'B' rating on the Industrial Development Authority of the County of Pima's education revenue refunding bonds (Carden Traditional Schools project) series 2012.
Fitch removes the Rating Watch Negative and assigns the bonds a Negative Outlook.
Absolute and unconditional obligation of the borrower (Calibre, or CTS) and the guarantor (E-Institute Charter School, Inc. or EICS), payable from all legally available revenues, and secured by a first lien on facilities owned by the borrower. Gross revenues of both the borrower and guarantor will flow directly from the state treasurer to the trustee for debt service.
KEY RATING DRIVERS
NEGATIVE OUTLOOK: Removal of the Rating Watch Negative reflects Calibre's compliance with the debt service coverage requirement in fiscal 2013 and lack of immediate concerns of covenant violations. The Negative Outlook reflects Calibre's deteriorated financial position and expectation that the institution's going concern status will be resolved upon the receipt of the fiscal 2014 audit, in December of this year. Meanwhile, Fitch is concerned about the school's declining margins both on an individual and consolidated (with EICS) basis and potential challenges in meeting coverage requirements for escalating debt service (DS).
SPECULATIVE-GRADE CHARACTERISTICS: The 'B' rating reflects Calibre's extremely tenuous financial position which includes a high debt burden, expense growth historically outpacing revenues, lower than anticipated enrollment levels and coverage of DS only with substantial, albeit planned, EICS support.
ENROLLMENT SHORTFALL: Actual enrollment at Calibre and EICS' campuses is significantly below the school's base case projections. Fitch notes that initial headcount projections were aggressive; however, Calibre's ability to adjust expenditures for a lower headcount could alleviate operating pressure and possibly stabilize performance.
MANAGEMENT RESPONSIVENESS TO IMPROVE: Calibre's previous CFO left the institution in spring of 2013 and was replaced in August 2013. This gap in the position caused marked challenges in procuring information during previous reviews. While communication with the school has increased marginally with the new CFO, Fitch expects Calibre's future responsiveness levels to improve enough to be comparable with other rated schools in the portfolio.
FAILURE OF FY2014 COVERAGE TEST: The inability to meet the transaction maximum annual debt service (TMADS) coverage test of one times (x) for the combined entity (Calibre and EICS) in fiscal 2014 may constitute an event of default. Fitch may downgrade the bonds in this case to reflect the increased volatility due to remedies that include an accelerated timeline for bond redemption.
PROTRACTED FISCAL IMBALANCE: A persistent negative trend for Calibre operating margins resulting in the continuance of a going concern note from the auditor for another year, in Fitch's view, indicates an intrinsic lack of fiscal stability and would likely result in ratings pressure.
RELIANCE ON EICS PERFORMANCE: Improvement for EICS operations is essential to the current rating assuming Calibre's continued weak margins. However, consolidated improvement can only be effectuated by EICS operations equating to or eclipsing the relative size of Calibre's student enrollment.
STANDARD CHARTER RENEWAL RISK: Like all Fitch-rated charter schools, Calibre and EICS are subject to charter renewal risk, which Fitch views as a substantial credit concern. Also, balance sheet resources are very limited, providing virtually no offset in the event of continued financial volatility.
TRANSACTION PARTICIPANT OVERVIEW
Calibre serves grades K-8 and includes two campuses, one in Glendale and another in Surprise, AZ. EICS, the financial guarantor for the rated debt of CA, maintains six physical campuses. The financial statements and charter agreements for both schools each include a fully-online campus managed by the schools' education management organization (EMO), Learning Matters Educational Group, Inc. (LMEG). Both Calibre and EICS are authorized by Arizona State Board for Charter Schools (ASBCS, the authorizer) with 15-year terms that expire in 2015. LMEG serves as EMO for both schools and maintains a working relationship with the ASBCS.
NEGATIVE OUTLOOK REFLECTS UNCERTAINTY
Fitch previously noted that Calibre's credit profile is indicative of a low speculative grade rating. Fitch removes Calibre from a Rating Watch Negative as the school posted TMADS coverage of over 1x in fiscal 2013 complying with a DS coverage covenant requiring at least 1x coverage of DS. The Negative Outlook reflects Fitch's longer term concern that Calibre and EICS as a consolidated entity continue to post weak results and could encounter problems in achieving DS coverage specified under bond covenants, especially considering the escalating schedule of DS.
The covenant compares combined net income available for debt service of Calibre and EICS to maximum annual debt service, excluding the final year of maturity TMADS. Coverage below 1.0x could be declared an event of default under terms of the loan agreement by the trustee. The trustee's remedies for events of default include acceleration, receivership, foreclosure, or a suit for judgment. While the declaration is subject to certain loan agreement provisions allowing Calibre and EICS to develop a remedy plan within specified timeframes, in the event of acceleration, Fitch views Calibre and EICS as highly unlikely to be able to meet full and immediate payment on the bonds without defaulting.
ENROLLMENT BELOW PROJECTIONS
Calibre and EICS enrolled fewer students in fall of 2013 than originally projected when the bonds were issued. While average daily membership (ADM) improved from 752 to 820 for Calibre and 557 to 698 for EICS, the original fall 2013 expectations of 1,050 and 895 for Calibre and EICS, respectively, grossly overshot actual enrollment trends. Originally, Fitch noted strong waitlists for Calibre and EICS. However, fall 2013 information relating to waitlists did not record such pent up demand. Therefore, the foregoing expectation for both Calibre and EICS is incremental enrollment growth but this information cannot be verified as no waitlist information was provided for fall 2013 enrollment.
Fitch favorably notes that academic performance for both Calibre campuses are adequate and are comparable to peers. Additionally, EICS was able to re-classify all of its campuses as alternative, thereby reducing the benchmarks used to evaluate performance and more accurately reflect its at-risk population. Calibre and EICS were noted as generally meeting academic requirements by the Arizona State Board for Charter Schools (ASBCS, the authorizer).
OPERATING MARGINS CONTINUE TO DECLINE
Consolidated fiscal 2013 margins declined to 6.3% from 7.4% in fiscal 2012. While EICS' individual performance improved markedly, from 3.8% to 15.3%, Calibre generated a negative 24.8% margin, further weakened from fiscal 2012's 18.5% margin. Fitch notes that Calibre's expense growth has outpaced revenue increases for the past two years. Unless there is a reversal of this trend, financial wherewithal and debt service coverage will continue to hinge substantially on EICS for the long term.
During fiscal 2013, LMEG, as the management company (EMO) implemented several measures to align expenses with revenues including salary freezes, layoffs, and various downward adjustments to facility and technology-related costs. Fiscal 2013 results are not indicative of overall improvement as these improvements were enacted mid-year and Fitch expects these changes may be evidenced in fiscal 2014 results. FY2014 budgeted figures indicate revenue growth based on enrollment and stable state funding. Fitch, acknowledging the auditor's expressed concern about Calibre's ongoing viability in both the fiscal 2012 and 2013 audit, expects rating pressure if this concern is unmitigated for the fiscal 2014.
LIQUIDITY AND DEBT SERVICE COVERAGE IMPROVE
Available funds for Calibre and EICS, on a consolidated basis, covered just 12.2% and 7.2% of operating expenses and debt, respectively. While improved from fiscal 2012, these levels remain very light, which is typical of most charter schools reviewed by Fitch.
Combined TMADS coverage (EICS and Calibre) improved from a very weak 0.3x to 0.9x in fiscal 2013. Adjusting for management fees which are subordinate to DS payment, coverage improved to 1.8x in fiscal 2013, up from 1.4x in 2012. Notwithstanding this improvement, Calibre, individually can only support roughly one-third of required TMADS and is expected to remain at this level for the foreseeable future. Fitch notes positively that EICS, as the guarantor of the bonds, will continue to support Calibre operations until the bonds are entirely paid off.
Additional information is available at 'www.fitchratings.com'.
In addition to the sources of information identified in the 'Revenue-Supported Rating Criteria' and 'Charter School Rating Criteria', this action was informed by information from the Arizona Department of Education website (http://www.azed.gov/).
Applicable Criteria and Related Research:
--'Revenue Supported Rating Criteria', dated June 3, 2013;
--'Charter School Rating Criteria', dated Sept. 19, 2012;
--'Fitch Maintains The Rating Watch Negative on Calibre Academy (AZ) Revenue Bonds', dated Nov. 4, 2013;
--'Fitch Downgrades Carden Traditional Schools (AZ) To 'B'; Still On Watch Negative', dated March 8, 2013.
Applicable Criteria and Related Research:
Revenue-Supported Rating Criteria
Charter School Rating Criteria