Fitch Ratings has assigned a rating of 'BB+' to the following series of revenue bonds issued by the Florida Development Finance Corporation (FDFC) on behalf of Renaissance Charter School, Inc. (RCS):
--$85.1 million education facilities revenue bonds (RCS projects), series 2011A;
--$3.3 million taxable education facilities revenue bonds (RCS projects), series 2011B.
The fixed-rate series 2011A and 2011B bonds (the bonds) are expected to price via a negotiated sale on or about June 15, 2011. Proceeds will be used to finance construction and renovation of facilities to be used for seven charter schools at four locations; fund a portion of the interest expense over the first 30 months through capitalized interest; a debt service reserve equal to the lesser of the legally defined maximum annual debt service, 125% of average annual debt service, or 10% of the par amount of the bonds; and pay costs of issuance.
The Rating Outlook is Stable.
RATING RATIONALE:
--The 'BB+' rating primarily reflects the significant credit risks presented by RCS' current capital plan, which involves the opening of three startup schools on two campuses, and is heavily reliant on substantial enrollment growth over multiple years to pay pro forma debt service.
--Additional concerns include management agreements with Charter Schools USA (CSUSA) that are not coterminous with final maturity of the bonds; extremely limited projected liquidity of the seven schools involved in this transaction (the financed schools); a very high debt burden; and industry-standard charter-renewal risk.
--Offsetting credit strengths include strong security and contractual provisions, including a favorable flow of funds, subordination of CSUSA's management fees, and the use of various risk mitigants in the construction contracts; CSUSA's record of financial and operational success as a charter management organization (CMO); and healthy demand for CSUSA-managed schools, including the financed schools.
KEY RATING DRIVERS:
--Continued strong performance of CSUSA as a CMO, thereby ensuring high levels of student demand;
--Regular renewals of the CSUSA management contracts for the financed schools;
--Achievement of projected enrollment growth within anticipated timelines, and proactive action on the part of CSUSA to ensure financial stability during the ramp-up phase for the financed schools.
SECURITY:
The bonds are secured by a gross pledge of various revenues of the financed schools. Pledged revenues consist primarily of per full-time equivalent (FTE) funding from the state of Florida (general obligation bonds rated 'AAA' with a Negative Outlook by Fitch). Further security is provided through a debt service reserve fund (DSRF); a first lien on three of the financed facilities and a leasehold interest in the fourth; and capitalized interest during the enrollment ramp-up period.
CREDIT SUMMARY:
Reflective of the speculative-grade rating, the financing plan (base case) for the series 2011 bonds relies on significant enrollment growth over multiple years. Three of the seven financed schools will open for their first semester next fall and a fourth school is just nearing the end of its inaugural year. Base case projections indicate funded FTE enrollment supporting the series 2011 bonds more than doubling from 1,259 in the current 2010-11 school year to 2,958 in the 2011-12 school year (beginning in fall 2011). Given that in the absence of such substantial growth RCS would likely be unable to cover debt service by 1.0 times(x) and would be in violation of multiple covenants under the transaction documents, the risk to bondholders of failed growth is high.
Fitch believes several key factors mitigate this risk, but are insufficient to warrant an investment grade rating. First, demand for CSUSA schools, and specifically the financed schools, is high. CSUSA typically retains over 90% of eligible students at its managed schools, and new applications routinely exceed the number of available slots. Preliminary fall 2011 data for all of the financed schools indicates similar trends. Through May 16, the combination of recommitted current students and new applicants exceeds fall 2011 enrollment targets by over 60% on a combined basis. Only a single grade at one school is currently under-enrolled, and CSUSA expects to fully enroll that grade this summer. While recommitted students and applicants are not guaranteed to attend in the fall, Fitch believes the significant oversubscription makes it probable that the initial enrollment target will be achieved or exceeded. Pro forma base case projections anticipate continued substantial enrollment growth beyond fall 2011. Fitch requested sensitivity analyses to assess (1) the financed schools' ability to withstand enrollment shortfalls or (2) weakened state per-FTE funding. In the first case, the financed schools would be unable to cover debt service without achieving nearly all of the enrollment growth contemplated in the base case. Under the second scenario (state funding reductions), the financed schools would be able to continue covering debt service by implementing cost containment measures, including deferring CSUSA management fees. Fitch notes that CSUSA decreased operating expenses at the existing financed schools in fiscal 2009 and 2010 during a period of volatility in state funding.
A second key offset to the substantial enrollment growth risk is CSUSA's track record of successfully opening and operating charter schools since 1998. CSUSA schools consistently outperform their district public school competitors academically; in fiscal 2010, 15 of 20 CSUSA-managed schools achieved an 'A', the highest possible academic grade from the state's Department of Education. Impressively, CSUSA recently became the first and only CMO in the nation accredited on a company-wide basis by the Southern Association of Colleges and Schools Council on Accreditation and School Improvement (SACS/CASI). CSUSA's internal process for opening new schools includes careful assessment of demand and potential school locations, and intensive marketing and recruitment practices. Fitch notes that all three of the startup schools in the series 2011 transaction are in markets with existing CSUSA-managed schools, providing additional brand recognition, and familiarity with local demand dynamics. Because of CSUSA's integral role in managing the schools, Fitch believes the renewal of CSUSA's management agreements for the financed schools, which is anticipated, is essential to rating stability.
Current management agreements for the financed schools will have an initial term of the greater of five years or the expiration of the related charter. Any unanticipated change in CSUSA's role in managing the financed schools could lead to negative rating pressure.
Due to the startup nature of three of the financed schools, the projected available funds (cash and investments that are not restricted) are extremely light while the debt burden will be very high. Coverage of projected fiscal 2012 (the first full year of operations for the financed schools) operating expenses from available funds is anticipated to be approximately 6%-7%, and coverage of total pro forma debt is projected at 1%-2%. Pro forma legal maximum annual debt service (as defined in the bond documents) is expected to consume a very high 35%-36% of projected fiscal 2012 revenues.
Characteristic of the sector, RCS faces the possibility of charter non-renewal for each of the financed schools, although several have been successfully renewed. CSUSA's history of success with charter renewals throughout the state, as well as its record of academic and financial stability helps mitigate this concern. In addition, state laws governing charter schools explicitly define the valid reasons for charter termination or non-renewal, and provide a clear appeals process.
Bondholders benefit from structural aspects of the transaction. The trust indenture requires RCS to divert pledged revenues of all of the financed schools to the trustee on a monthly basis for initial allocation to debt service and replenishment of any DSRF deficiencies. While not a true intercept of state aid, this structure functions in much the same way and preserves the priority of bondholders over the schools' operating expenses and CSUSA's management fees. The debt service allocations are done on a combined basis and are non school-specific. Additional protections include construction risk mitigation measures such as guaranteed maximum price contracts for all four facilities, with provisions to withhold payment or assess contractor penalties for late completion on three of the contracts. Construction at three of the four facilities is currently underway and CSUSA reports they are all on schedule to open this summer. The fourth project will begin this summer and is scheduled to open before fall 2012.
Additional information is available at 'www.fitchratings.com'
In addition to the sources of information identified in the Revenue-Supported Rating Criteria, this action was additionally informed by information from the underwriter.
Related Research and Applicable Criteria:
'Renaissance Charter School, Inc.' dated 02 Sept. 2010.
'Revenue-Supported Rating Criteria', dated 08 Oct 2010.
'Criteria for Rating Charter Schools', dated 23 Jan 2007.
For information on Build America Bonds, visit www.fitchratings.com/BABs.
Applicable Criteria and Related Research:
Renaissance Charter School, Inc. (Florida Development Finance Corporation)
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=551705
Revenue-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=564565
Criteria for Rating Charter Schools
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=311604
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