CHICAGO--(BUSINESS WIRE)--Fitch Ratings has affirmed the 'BB+' rating on approximately $9.395 million education revenue bonds, series 2011A&B, issued by the Beasley Higher Education Finance Corporation on behalf of FOCUS Learning Academy, TX (Academy, FOCUS).
Fitch has removed the ratings from Rating Watch Negative and assigned the bonds a Negative Outlook.
The revenue bonds are secured by a pledge of FOCUS' gross revenues, a cash-funded debt service reserve and a mortgage on property and facilities.
KEY RATING DRIVERS
CHARTER RENEWAL APPROVED: The removal from Rating Watch Negative reflects FOCUS' charter renewal from the Texas Education Agency in April 2014 for the maximum allowable10 years, through July 1, 2023. The Academy's charter had expired in June 2013 and renewal had been pending during Fitch's last rating review.
WEAK FINANCIAL METRICS: The Negative Outlook reflects the Academy's speculative grade financial metrics, failure to meet the 1.1x debt service coverage covenant in fiscal 2013, and expected resolution of covenant violations in the fiscal year ending Aug. 31, 2014. This covenant violation is technically an event of default, and as such 25% of bondholders could have required FOCUS to hire a consultant but did not choose to do so. These credit characteristics remain speculative grade attributes.
ENROLLMENT CHALLENGES IMPACT MARGINS: The Academy's enrollment fell short of expectations in both fiscal years 2013 and 2014. Expenses were adjusted, and at this time fiscal 2014 interim results indicate a small operating surplus that achieves financial covenants. Enrollment for fall 2014 (fiscal 2015) is not finalized, but preliminary results indicate some growth.
GOVERNANCE LACKS INDEPENDENCE: While demonstrating effective management, overlap between FOCUS' board of directors and day to day administration team weakens the independent oversight mechanism that Fitch's criteria expect to be present in an investment grade charter school.
IMPROVED OPERATIONS AND COVERAGE: The Academy's inability to return to break-even to positive operating margins and achieve covenant compliance could cause a rating downgrade.
STANDARD SECTOR CONCERNS: A modest financial cushion, substantial reliance on state per pupil funding, and charter renewal risk are credit concerns common in all charter school transactions that, if pressured, could impact the rating over time.
STABILIZED ENROLLMENT: Stabilized or modestly growing enrollment, in conjunction with conservative operating budgets and consistently balanced operating results, are needed to maintain the 'BB+' rating long-term.
Located in Dallas, TX FOCUS is a K-12 charter school that received its first charter in 1998 and started with an initial enrollment of 177 students in grades K-6. The Academy's instructional program includes a multi-sensory approach to education, which results in specialized curricula for 'learning different' students. This cohort currently makes up approximately 20% of the student body. The Academy ended fiscal 2014 with 844 students, down from an end-of-year high of 884 in fiscal 2012. Management reports it has facility capacity for 1,175 students.
ENROLLMENT TARGETS ADJUSTED
FOCUS's fiscal 2014 budget reflected the initial enrollment of 871 students. In past years, the Academy used overly optimistic budget and enrollment assumptions. When enrollment growth flattened in fiscal 2013 and declined slightly in fiscal 2014, expenses were not implemented in a timely fashion. The Academy's ability to budget more conservatively is expected going forward.
OPERATIONS EXPECTED TO IMPROVE IN FISCAL 2014
FOCUS's operating revenues are largely reliant on state per pupil funding. While fiscal 2014 results are expected to reflect another modest decline in enrollment, this is partially offset by slight state funding improvement, expense containments, and the positive effect of federal grant revenue, which grant is expected to be completely spent during fiscal 2015. Fiscal year end is Aug. 31, therefore 2014 results are not final; however, based on unaudited nine-month interim statements and the Academy's estimates, the margin is expected to be modestly positive. Maintenance of this level is also anticipated in fiscal 2015. FOCUS's operating margins were a slim 0.4% in fiscal 2012 and negative 4.7% in fiscal 2013.
Management reports a 3% increase in per-pupil state funding for fiscal 2015, but also notes that employer pension contributions rose to 1.5%, from zero previously. Further state-mandated increases in charter school pension contribution requirements beyond fiscal 2015 could create additional budget pressure, which Fitch will monitor.
WEAK LIQUIDITY AND COVERAGE VIOLATION
Available funds declined to $1.7 million or a weak 10.7% of fiscal 2013 operating expenses ($9.9 million) and 10.8% of outstanding debt ($9.9 million at that time). Fitch views this financial cushion as low. Net income available for debt service weakened for FY13 and the covenant requirement of 1.1x coverage of transaction maximum annual debt service ($817,000), was not achieved (it was 0.8x). Under the bond documents, violation of the liquidity covenant (which did not happen) requires FOCUS to hire an independent consultant; violation of the coverage covenant gives bondholders an option to require an independent consultant (they did not require that of FOCUS).
Fitch's ratio of long term debt to net income available, which measures years of debt-financed cash flow, weakened to 14x in fiscal 2013 from 8.7x in FY12, further reflecting operational weakness. The Academy's debt burden (MADS as a percent of operating revenue) of 8.9% is moderately high, but stronger than most Fitch rated charters. Annual debt service obligations are approximately level through final maturity in 2041.
The Academy has long-term plans for facility expansion, assuming enrollment growth. Fitch is concerned that additional debt plans would further pressure Focus' balance sheet resources. Issuance of additional debt or loans, without a return to operating surpluses and growth in balance sheet resources, would be viewed negatively.
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 16, 2014);
--'Fitch Places FOCUS Learning Academy on Rating Watch Negative', March 6, 2014.
Applicable Criteria and Related Research:
Charter School Rating Criteria
Revenue-Supported Rating Criteria