CHICAGO--(BUSINESS WIRE)--Fitch Ratings has downgraded to 'BB-' from 'BB+' approximately $9.19 million of education revenue bonds, series 2011A&B issued by the Beasley Higher Education Finance Corporation on behalf of FOCUS Learning Academy, TX (Focus).
Fitch has also placed the bonds on Rating Watch Negative.
SECURITY
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
PRESSURED ACADEMIC PERFORMANCE: The Rating Watch Negative is driven by Focus' two consecutive years of academic designations from the state of 'Improvement Required (IR)'. Under state law, the state has no option but to revoke a charter if the IR designation is made for three consecutive years. The academy is appealing the 2014/2015 academic year designation.
GROWING BUT CHALLENGED ENROLLMENT: The rating downgrade to 'BB-' is driven by the challenges of maintaining the increased fall 2015 enrollment and academic performance risk. While Focus' enrollment grew in fiscal 2015, and to date in fiscal 2016, that growth challenged facility capacity. Importantly, new charter students that were not included in the 2014-2015 state accountability rating will be included in the 2015/2016 state rating, increasing the challenge to improve Focus' academic performance.
FINANCIAL METRICS IMPROVE: Fiscal 2014 financial operations generated a modest operating surplus, resulting in 1.8x vs. the prior year's debt service coverage violation. Based on nine-month interims and management estimates, operations for the fiscal year ending Aug. 31, 2015 are expected to be slimmer but again meet bond covenants. Balance sheet metrics remain slim, which is typical of Fitch's charter school rating portfolio.
GOVERNANCE LACKS INDEPENDENCE: There is overlap between Focus' board of directors and day to day administration, thereby weakening the independent oversight mechanism.
RATING SENSITIVITIES
STRESSED ACADEMIC PERFORMANCE: Should Focus Learning Academy not improve academic performance, thereby triggering charter revocation by the state, the rating will be downgraded to reflect the increased risk of default.
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 enrollment, strong expense management focused on academic achievement, conservative operating budgets, and consistently balanced operating results are needed to maintain the 'BB-' rating long-term.
DEBT CAPACITY: Fitch views Focus as having no additional debt capacity at this time.
CREDIT PROFILE
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.
Focus ended fiscal 2015 with 941 students, up from 844 at the end of fiscal 2014. Much of this increase came from mid-year transfers (about 57 high school students) from an area charter school that closed. However, management reports that these transfers resulted in significant administrative and academic stress during the 2014-2015 academic year. Preliminary enrollment for fall 2015 is about 1,150 students, another increase, which brings Focus closer to its reported facility capacity of 1,175 students. Enrollment stabilization at the fall 2015 enrollment level will be required to support debt and lease obligations
Due to fall 2015 enrollment increases, Focus entered into an $830,000 capital lease in June 2015 to provide 12 classrooms with three modular/temporary buildings. Those buildings are not expected to be completed until early 2016, and Focus management has temporarily converted its athletic center to an instructional Center.
ACADEMIC PERFORMANCE
The Texas Education Agency assigned Focus an 'improvement required (IR)' accountability rating for two consecutive years, academic year 2013/2014, and 2014/2015. Under state law, the state must revoke a charter if the IR designation is made for three consecutive years.
The academy is appealing the 2014/2015 academic year designation, which outcome is uncertain; results of the appeal should be known in calendar 2015. Given state law regarding academic performance and charter status, academic performance issues, unless rapidly improved, will likely drive the rating.
Management reported that it had expected to meet state performance targets in 2014-2015 but did not due to acceptance of mid-year transfer students. New students were not included in the prior accountability rating, but will for the 2015-2016 academic year.
BUDGETED ENROLLMENT TARGETS
Focus' fiscal 2015 budget reflects the initial enrollment of about 1,150 students (up from 871 students budgeted in fall 2014). At this time, the fiscal 2016 budget assumptions appear to match actual enrollment, and the preliminary budget is balanced; enrollment assumptions also matched actuals in fiscal years 2015 and 2014. In previous years, Focus used less conservative budget and enrollment assumptions, which resulted in failure to meet debt service covenants in fiscal 2013. Fitch views the academy's ability to monitor and manage operating expenses during the fiscal year as critical to achieving operating balance.
OPERATIONS IMPROVED
Focus' operating revenues remain highly reliant on state per-pupil funding, as is the case with most charter schools. State funding was 82% of operating revenue in fiscal 2014. Positively, in recent years there have been slight annual improvements in state per-pupil funding.
Academy operations improved significantly for the fiscal year ended Aug. 31, 2014, primarily due to expense controls. An operating surplus of $366,000 (4% operating margin) resulted in 1.8x debt service coverage, which met bond covenants (at least 1.1x is required). For fiscal 2015, based on unaudited nine-month interim statements and management estimates, the margin is expected to be somewhat slimmer, but still meet bond covenants. Focus' operating margins were a slim 0.4% in fiscal 2012 and negative 4.7% in fiscal 2013.
WEAK LIQUIDITY
Available funds improved slightly to $1.2 million at fiscal year-end 2014, still a weak 13.7% of operating expenses ($8.7 million) and 12.4% of outstanding debt ($9.7 million at that time). The pro forma debt ratio, including the recent $830,000 capital lease, weakens slightly to about 11.7%. Fitch views these financial cushion ratios as low.
Focus' ratio of long-term debt to net income available, which measures years of debt-financed cash flow, improved slightly to 6.6x in FY14 from 14.7x in FY13, although still reflecting operational weakness.
Focus' FY14 debt burden (MADS as a percent of operating revenue) of 8.9% is moderately high but more favorable than most Fitch rated charter schools. On a pro forma basis, including capital lease debt service, the debt burden increases only moderately to 10.4% based on fiscal 2014 revenue. Annual bond debt service obligations are approximately level through final maturity in 2041; the capital lease structure is level with a 10-year term.
NO ADDITIONAL DEBT CAPACITY
Focus has long-term plans for facility expansion, assuming enrollment growth. Fitch views the recent capital lease as manageable, but has significant concerns regarding any additional debt until academic rankings are stabilized, as well as enrollment. At this time Fitch views Focus as having no new debt capacity.
Additional information is available at 'www.fitchratings.com'
Related Research
--'Fitch Affirms FOCUS Learning Academy (TX) Educational Revs at 'BB+); Outlook Negative, dated Aug. 24, 2014.
Applicable Criteria
Charter School Rating Criteria (pub. 19 Sep 2012)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=688957
Revenue-Supported Rating Criteria (pub. 16 Jun 2014)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012
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