Fitch Affirms Alliance for College-Ready Public Schools, CA's Rev Bonds at 'BBB-'; Outlook Stable

Fitch Ratings affirms its 'BBB-' rating on approximately $22 million of outstanding California Statewide Communities Development Authority school facility revenue bonds, series 2011A issued on behalf of Alliance for College-Ready Public Schools (Alliance).

The Rating Outlook is Stable.

SECURITY

The bonds are payable from lease payments made by three Alliance-managed charter schools (Ouchi High School, Skirball Middle School and O'Donovan Middle Academy) and secured by an assignment of rents and deed of trust over the school facilities. Lease payments constitute a joint and several obligation payable from the schools' gross revenues. Additional bondholder protections include a debt service reserve cash-funded to MADS and a capital maintenance and operating fund.

KEY RATING DRIVERS

SOUND FINANCIAL PERFORMANCE: The three obligated charter schools' (the schools) track record of operating surpluses; sound coverage of pro forma MADS from current operations; and a manageable, albeit high, debt burden, underpin the 'BBB-' rating. Financial performance is tempered by a balance sheet cushion that is limited, yet acceptable for the rating category.

STABLE DEMAND: The schools maintain full and stable enrollments, bolstered by strong programmatic and fiscal management provided by Alliance, a well-established charter management organization (CMO) that manages a successful network of 22 Los Angeles area based charter schools.

LIMITED OPERATING HISTORY: Counterbalancing the above credit strengths are the schools' relatively limited operating histories, including at or just over five years of audited operating history.

CHARTER RENEWAL SUCCESS: While their operating histories are limited, the schools now have three charter renewals among them, with the youngest of the three schools having recently been merged into the oldest of the three to form a continuous grade 6-12 program under a single, recently renewed five-year charter.

RATING SENSITIVITIES

MANAGEMENT INTERRUPTION: Any adverse change or interruption to the existing CMO relationship between Alliance and the schools, while unlikely, would strongly influence the rating.

CHARTER RELATED CONCERNS: A limited financial cushion; substantial reliance on enrollment-driven, per pupil funding; and charter renewal risk are credit risks common among all charter school transactions that, if pressured, could negatively impact the rating over time.

CREDIT PROFILE

The schools' financial performance remains sound, with each having generated operating surpluses since inception, albeit based on relatively small revenue bases. Operating margins ranged between a healthy 12.9% and 21% for fiscal 2013, driven largely by prudent budgeting and administrative efficiencies derived through the Alliance network. The schools continue to benefit from the strong financial oversight and budgetary guidance provided by Alliance and stable enrollments which support consistent operating performance. Characteristic of charter schools, revenue diversity is limited with state aid comprising the majority (two-thirds) of funding and federal aid representing another 12%-17%.

Following significant cuts to state funding of public K-12 education from fiscal years 2009-2012, funding levels were held flat for fiscal 2013 and improved for fiscal 2014, primarily due to voter passage of the governor's tax increase initiative, Proposition 30, in November 2012. Fitch rates California's general obligation bonds 'A' with a Stable Outlook. Proposition 30 also led to a revision of the state's funding formula, which benefits Alliance's schools due to the mostly low income demographic they serve. Alliance anticipates another positive operating result for the schools in fiscal 2014, which Fitch considers realistic based on enrollment stability, improved state funding, and management's conservative budgeting and operating track record.

On a combined basis, the schools' debt burden is high but manageable. Total pro forma MADS ($1.7 million) represented 12% of the schools' combined fiscal 2013 operating revenues of $14.4 million. The schools' positive operations enabled them to generate sufficient coverage of between 1-2.5 times (x) pro forma MADS for the past five fiscal years (2.5x in fiscal 2013). Debt to net income available for debt service was also a moderate 5.1x. In addition, Alliance's management fee, which totaled $1 million for the schools in fiscal 2013, is subordinate to debt service, providing an added layer of flexibility in the event operations weaken.

While joint and several, Fitch notes favorably that on an individual basis, coverage of the schools' internally allotted share of debt service was about 2.5x, 2.2x and 3.2x for Ouchi, Skirball, and O'Donovan, respectively, in fiscal 2013. Fitch considers a track record of over 1x MADS coverage and a debt burden under 15% investment grade credit attributes.

Typical of charter schools, the schools' balance sheet resources are limited, though improved slightly in fiscal 2013. On a combined basis, available funds (cash and investments not permanently restricted) totaled $3.5 million as of June 30, 2013, covering fiscal 2013 operating expenses ($11.9 million) and debt ($22 million) by 29.4% and 16%, respectively. While these liquidity metrics are considered low, they provide the schools a modest financial cushion to manage any unexpected funding declines and/or expenditure increases.

Enrollment at the schools remains stable. Combined enrollment at the three schools is currently 1,465, up slightly from 1,450 the prior year. Ouchi enrolled 575 students in grades 9-12, while Skirball and O'Donovan enrolled 440 and 450 students in grades 6-8, respectively. Given Alliance's goal of maintaining small schools, each school remains at or near its desired capacity and enrollment is not anticipated to vary significantly from current levels. This is viewed favorably by Fitch as no material enrollment growth is planned or needed to meet the schools' financial obligations. In total, Alliance presently manages 22 schools in Los Angeles, serving nearly 10,000 students in grades 6-12.

In general, Alliance-managed schools continue to outperform their district peers academically as measured by California's academic performance index (API). While the schools' API scores are solid, O'Donovan Middle Academy was highlighted as needing improvement and was placed on the district's program improvement list in 2012. The district expressed concern over O'Donovan's academic record, but remains confident in Alliance's track record and its programmatic leadership of its schools.

While the schools continue to mature, Fitch still considers their operating histories as limited. Ouchi, Skirball and O'Donovan have seven, six and five years of audited financial statements, respectively, which is at or just over Fitch's minimum (five-year) expectation for investment grade charter schools. However, Fitch notes that the schools now have three charter renewals among them. Ouchi recently received its second five-year renewal, while Skirball's second renewal will come up in June 2016. The schools' renewal success to date is viewed favorably by Fitch, but still reflects their limited histories.

O'Donovan is the youngest school, having just completed its fifth year of audited financial statements in fiscal 2013 and not undergoing a renewal on its own. However, Alliance merged this school into Ouchi commencing with the current 2013-2014 academic year to form a continuous 6-12 program on the two schools' shared campus. As such, O'Donovan's existing charter was collapsed and Ouchi's charter was revised to incorporate both schools and simultaneously renewed for a further five-year term effective June 2014 to June 2019.

Fitch continues to take comfort in Alliance's broader reputation and positive working relationship with its schools' authorizer (Los Angeles Unified School District-the district), which partially mitigates renewal risk. The district continues to view Alliance as a strong charter operator and a partner within the district; the second largest in the country. This was evident in its recent renewal of Ouchi's revised charter. It also cited no issues at present that would result in nonrenewal of Skirball's charter in 2016.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Charter School Rating Criteria' (Sept. 19, 2012);

--'Fitch Downgrades Alliance for College-Ready Public Schools (CA) to 'BBB-'' (March 8, 2013).

Applicable Criteria and Related Research:

Charter School Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=688957

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=818138

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