NEW YORK--(BUSINESS WIRE)--Fitch Ratings has downgraded the rating on the Industrial Development Authority of the County of Pima's education revenue refunding bonds (Carden Traditional Schools project) series 2012 to 'B' from 'BBB-'.
The bonds remain on Rating Watch Negative by Fitch.
SECURITY
Absolute and unconditional obligation of the borrower (Carden Traditional Schools, or CTS) and the guarantor (E-Institute Charter School, Inc. or EICS) payable from all legally available revenues, and secured by a first position 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 allocation, first to debt service.
KEY RATING DRIVERS
LOW SPECULATIVE-GRADE CHARACTERISTICS: The 'B' rating primarily reflects the extremely tenuous fiscal position of Calibre Academy (Calibre, the new name for CTS), and the narrowed financial performance of EICS.
LACK OF FINANCIAL FLEXIBILITY DRIVES WATCH: Calibre's fiscal 2012 audit included a going concern note. Calibre's financial position has deteriorated rapidly in the past year. Fitch views substantial near-term improvement as unlikely. EICS, facing its own challenges, is not capable of supporting Calibre's operations indefinitely.
ENROLLMENT FALLS SHORT: Actual enrollment at Calibre and EICS' campuses is significantly below the school's base case projections. The shortfalls, and the inability to adjust the expenditure base accordingly, are the primary driver of weakened financial performance.
RATING SENSITIVITIES:
FAILURE OF COVERAGE TEST: The loan agreement for the bonds states that less than sum-sufficient TMADS coverage from the combined entity (Calibre and EICS), beginning in fiscal 2013 (which started on June 30, 2012), may constitute an event of default. In such a scenario, Fitch would likely downgrade the bonds to at least 'CCC' and keep the bonds on Rating Watch Negative. According to terms of the loan agreement and indenture for the bonds, the trustee could implement accelerated redemption provisions.
INADEQUATE PROGRESS TOWARDS FISCAL BALANCE: Calibre's management organization has begun implementing various expense reduction measures. While Fitch does not anticipate breakeven operations in fiscal 2013, a lack of meaningful fiscal improvement could make default a real possibility.
LACK OF IMPROVEMENT AT EICS: As guarantor, fiscal improvement at EICS could mitigate risks associated with Calibre's operating deficit and bolster the credit quality of the bonds. Conversely, another year with only a modestly positive margin in fiscal 2013 could exert negative rating pressure.
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.
CREDIT PROFILE
POSSIBILITY OF COVERAGE COVENANT FAILURE
The loan agreement requires Calibre to post on EMMA results of a combined debt service coverage test within 30 days of audit completion. The test compares combined net income available for debt service of Calibre and EICS, to maximum annual debt service, excluding the final year of maturity (transaction maximum annual debt service, or TMADS).
State law requires audits to be submitted to the state department of education by Nov. 15. Beginning in fiscal 2013, coverage below 1.0x can be declared an event of default under terms of the loan agreement by the trustee. The declaration is subject to certain loan agreement provisions allowing Calibre and EICS to develop a remedy plan within specified timeframes. Fitch believes failure of the test is possible given Calibre and EICS' weakened financial positions as discussed below.
The trustee's remedies for events of default under the loan agreement and trust indenture for the bonds, include acceleration, receivership, foreclosure, or a suit for judgment. In the event of acceleration, Fitch views Calibre and EICS as highly unlikely to be able to meet demands for full and immediate payment on the bonds without a payment default. This includes full use of the trustee-held cash-funded debt service reserve fund, equivalent to TMADS of approximately $1.4 million. No event of default has been declared to date and management has begun implementing expense reduction measures that could allow Calibre and EICS to meet the debt service coverage test for fiscal 2013.
FINANCIAL POSITION SEVERELY WEAKENED
Both Calibre and EICS performed well below both historical trends and Fitch's expectations in fiscal 2012. Calibre generated a negative 18.5% margin while EICS' margin narrowed considerably to 3.8%. Fitch calculated a consolidated margin of negative 7.1%. This was much weaker than the 6.8% and 8.7% margin in fiscal 2010 and 2011, respectively. Combined TMADS coverage fell to a very weak 0.3 times, and the TMADS burden remained high at 14.5% of consolidated revenues.
ENROLLMENT FAR BELOW PROJECTIONS
Calibre and EICS enrolled far fewer students than originally projected by the schools' education management organization (EMO), Learning Matters Educational Group, Inc. (LMEG) when the bonds were issued. On a consolidated basis, the schools reported average daily membership (ADM, used in state funding formulas) of 1,422 on Dec. 5, vs. fiscal 2012 ADM of 1,329 and a fiscal 2013 base case projection of 2,100.
LMEG attributed part of the shortfall to construction delays for the bond-financed addition to Calibre's Surprise campus. Management believes the delays caused uncertainty for parents and students and dampened demand.
Management did not offer a detailed explanation for the slow growth at EICS. LMEG replaced principals at three of the six EICS campuses before the start of the current school year. The EMO indicated the changes were performance-based. Fitch will closely monitor how this significant turnover affects school performance and enrollment.
MANAGEMENT SLOW TO RESPOND
Fitch expresses concern over management's seemingly delayed response to fiscal 2012 enrollment shortfalls compared to projections. This despite growth on a consolidated basis. Calibre and EICS increased consolidated revenues 1.6%, but also increased expenses 19.1%. Fitch believes this mismatch is unsustainable and reflects negatively on governance.
LMEG, as EMO, implemented several measures over the past several months to better align expenses with revenues including salary freezes, layoffs, and various downward adjustments to facility and technology-related cost. LMEG estimates the total annual and recurring savings at approximately $1.3 million. Fitch will evaluate Calibre and EICS' ability to demonstrate the significant projected savings.
LMEG expects Calibre's enrollment will increase significantly next year following a full year of successful operations in the expanded Surprise campus. That said, Fitch is skeptical of Calibre's ability to meet growth projections given the recent track record.
Balance sheet resources for both schools remain very light. Combined available funds at the end of fiscal 2012 provided minimal coverage of just 10.5% and 5.9% of operating expenses and debt.
TRANSACTION PARTICIPANT OVERVIEW
CTS changed its name to Calibre Academy in spring 2012. LMEG made the name change to distinguish itself from schools directly affiliated with the Carden Educational Foundation. Calibre includes a Glendale and newly-expanded Surprise campus, with fall 2013 ADM of 148 and 698, respectively. EICS maintains six physical campuses with a combined fall 2013 ADM of approximately 688.
The financial statements and charter agreements for both schools each include a fully-online campus managed by LMEG. Taylion Virtual Academy of Arizona serving grades K-8 with fall 2013 ADM of 26 is part of Calibre'e reporting. Taylion Virtual High School of Arizona with a fall 2013 ADM of 97 is reported under EICS.
Both Calibre and EICS are authorized by the Arizona State Board for Charter Schools (ASBCS), with 15-year terms that began in 2000. Fitch spoke with the authorizer and believes the schools and LMEG, which serves as EMO for both schools, maintain positive working relationship with the ASBCS.
Fitch's actions are part of its completed industry-wide review, which commenced September of last year when Fitch placed all of its rated charter schools on Rating Watch Negative. Fitch will release an overview of its rating actions in a separate press release later today.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--'Charter School Rating Criteria' (Sept. 19, 2012);
--'Revenue-Supported Rating Criteria' (June 12, 2012);
--'Fitch Places all Charter School Bonds on Rating Watch Negative' (Sept. 19, 2012).
Applicable Criteria and Related Research
Charter School Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=688957
Revenue-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=681015
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