NEW YORK--(BUSINESS WIRE)--Fitch Ratings has downgraded to 'BB-' from 'BB+' and removed from Rating Watch Negative the rating on $8.4 million charter school revenue bonds, series 2010, issued by the Industrial Development Authority of the County of Pima, Arizona. The bonds were issued on behalf of Cambridge Academy East (CAE).
The Rating Outlook is Stable
SECURITY
The bonds are a general obligation of CAE and secured by a first mortgage on the financed facilities. The trustee receives payments directly from the state to cover debt service.
KEY RATING DRIVERS
WEAK FINANCIAL METRICS: The downgrade is a result of CAE's operating performance, balance sheet resources and debt burden. Fitch considers these attributes low speculative grade under its recently updated charter school rating criteria. While academic performance and enrollment growth counter-balance some concerns, the overall financial profile primarily exhibits speculative grade characteristics more consistent with the 'BB-' rating.
IMPROVEMENT FOR FISCAL 2013: The Stable Outlook indicates an expectation of break-even operations for fiscal 2013 and operating surpluses thereafter as a result of enrollment growth.
GOVERNANCE LACKS INDEPENDENCE: While demonstrating effective management, a majority of CAE's board maintains inter-related business and familial ties with the management team. Fitch's revised investment grade criterion looks for a fully independent board.
HIGH DEBT, LOW COVERAGE: Transaction maximum annual debt service (TMADS) consumes a high 19.2% of operating revenues and current net income from operations is unable to cover debt adequately; TMADS coverage was 0.7x for fiscal 2012.
RATING SENSITIVITIES
CONTINUED FISCAL IMBALANCE: A continued trend of negative margins and inability to service debt with income from operations would negatively pressure the rating.
STANDARD CHARTER RISKS: 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.
CREDIT PROFILE
CAE's financial profile indicates the characteristics of a speculative grade rating. CAE's operations have generated two consecutive years of deeply negative margins. Fitch expects the -12.1% operating deficit for fiscal 2012 (weaker than the previous years' negative 9%%) to improve markedly to near break-even for the current fiscal year (2013) as the CAE streamlines costs and improves monthly cash flow.
Operating stress was driven by state aid cuts in 2011 (down 8% from the prior year) and high depreciation expense reflecting capital improvements to the campus financed by the 2010 bond issuance. In addition, net income available for debt service for the past two years has been insufficient to provide at least 1x coverage of TMADS (approximately $660,000). That said, Fitch expects coverage to improve going forward.
Fitch also expects that over time, CAE's operations will reflect enrollment at full capacity and operating revenues that are in excess of recurring expenditures. Nonetheless, CAE will likely remain at its current rating level until operations stabilize and breakeven to slightly positive margins are derived on a consistent basis.
CAE's new financial manager has helped to improve operating performance. Additionally, strategic shifting of key positions has enabled CAE to create a position for an administrator who is tasked with securing previously untapped governmental revenue sources. However, certain close ties maintained by the board to senior management, as well as the control maintained by the founding family of CAE, make for a governance structure that is not considered consistent with the strength and independence implied by an investment grade rating by Fitch.
Enrollment growth resulted from adding the seventh and eighth grades in school year 2011 and 2012, respectively. The headcount for fall 2012 was 616 students, 12% higher than the student count in 2011 (548 students). Maximum capacity for CAE is 760 students. Fitch expects CAE to reach this capacity in time as the school matches student growth, effective instructional capability and operational sufficiency. CAE competes for students with neighboring charter schools and has invested in extracurricular programs to retain and attract incoming students. Despite competition from other charter schools in the area, CAE has effectively grown and sustained enrollment throughout its operating history.
CAE's limited balance sheet, negatively impacted by fiscal 2012's operating deficit, poses a challenge. Available funds, totaling $361,000 in fiscal 2012 constituted a meager 9.4% of annual operating expenses ($3.9 million) and 4.3% of total outstanding debt ($8.4 million). Fitch notes that charter schools typically have low levels of financial flexibility. Additionally, the ability to grow unrestricted cash on hand is constrained due to thin margins.
CAE is an educational establishment serving grades K-8, founded by a family of educators. Originally chartered in 2002, CAE is in year 11 of its 15-year charter. CAE began operations in 1999 and currently operates two campuses situated in Maricopa County, AZ. An intercept mechanism for state fund disbursements to the school diverts funds first to the trustee for debt service before releasing monies for operations.
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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