Fitch Downgrades Hope Academy (MI) Revs to 'B'; Outlook Remains Negative
OREANDA-NEWS. Fitch Ratings has downgraded the rating on approximately $8.6 million of public school academy limited obligation revenue bonds, series 2011, issued by the Michigan Finance Authority on behalf of Hope Academy to 'B' from 'BB-'.
The Rating Outlook is Negative.
Pledged revenues consist of up to 20% of state allocated per-pupil foundation allowance (PPFA), and all other legally available, unrestricted funds. The trustee intercepts the pledged revenues from the state of Michigan monthly for bond debt service, prior to remitting excess funds to Hope. In addition to the intercept, bondholders benefit from a property mortgage and a cash-funded debt service reserve equal to maximum annual debt service (MADS). There is an annual debt service coverage (DSC) covenant of at least 1.1x.
KEY RATING DRIVERS
MULTIPLE FACTORS DRIVE DOWNGRADE: Hope's negative fiscal 2015 operating performance, in conjunction with two years of enrollment declines, weak balance sheet, high debt burden, and weak academic ranking, all drive the rating downgrade.
WEAK BALANCE SHEET: Hope's balance sheet provides limited flexibility to manage operating or enrollment fluctuations. Fiscal 2015 available funds ratios, as calculated by Fitch, were only 1.6% of operating expenses and 1.1% of debt.
LOW ACADEMIC PERFORMANCE: Hope has demonstrated low academic performance in recent years. State-wide academic rankings are frozen for the current 2015/2016 academic year due to adoption of Common Core standards, and as such Hope remains a state-designated 'Priority School'. This is the weakest academic ranking relative to all Michigan schools. Hope's charter authorizer does report academic improvement.
ENROLLMENT AND POPULATION DECLINES: Enrollment fell 15% in fall 2015 and 13% in fall 2014. Hope had previously realized several years of growth. The recent enrollment trend is partly due to Detroit area population losses and resulting higher competition.
DSC NOT ACHIEVED: Hope did not meet fiscal 2015 MADS coverage per Fitch calculations (0.9x on a consolidated basis). Previously, Fitch calculated coverage had met or slightly exceeded DSC of 1.1x in six out of the last seven fiscal years. Operations remain highly stressed due to further enrollment declines in fiscal 2016.
ACADEMIC PERFORMANCE: Failure of Hope Academy (MI) to improve academic performance and receive a charter renewal in 2016 would cause another rating downgrade.
ENROLLMENT AND FINANCIAL PERFORMANCE: Failure to reverse enrollment losses, strengthen operating performance, and achieve debt service coverage and bond covenant compliance would result in another downgrade.
STANDARD SECTOR CONCERNS: 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 which, if pressured, could negatively impact the rating.
Hope Academy is a K-8 charter school located near the historic district of Detroit, MI (the city), and serves students living in the city and surrounding suburbs. Hope has operated since 1998, having received three five-year charters, with the most recent renewal a three-year charter through June 2016. The shorter charter term was due partly to poor academic performance. Most students qualify for free or reduced lunch assistance, and about 10% receive special education services.
A separate alternative high school shared both Hope's facility and its charter authorization for only the 2012/2013 academic year; that arrangement has ended.
Hope operates in a former public school building with capacity of about 700 students, which the charter authorizer characterizes as attractive and well maintained. Enrollment declines are a significant concern. Enrollment for fall 2015 declined 15% to 520 students, following a 13% decline in fall 2014 to 615. This followed six years of enrollment growth, from 441 students in fall 2017 to 705 in fall 2013.
Management reports that lower enrollment is due to population declines in the Detroit metro area, which has an excess of both public and charter school seats. Additionally, management reports that area demographics are changing, with fewer families with school-aged children. Hope does not provide student transportation, which can be a competitive issue. Management adjusted its fiscal 2016 budget to reflect actual enrollment, including several lay-offs.
Hope made significant management changes to lower expenses in fiscal 2015, continuing into fiscal 2016. These include changing to a management-company structure with BFDI Educational Services (BES) as manager and employer of all staff, hiring a new school leader, cutting expenses, and laying off some non-teaching staff to focus on academics. Effective fiscal 2015, Hope/BES employees are no longer part of the state retirement system. Hope's board composition remains stable with five members.
A new school superintendent started in the 2014/2015 academic year, and an acting principal position was made permanent in 2015/2016. The school has an active working relationship with its authorizer, Eastern Michigan University (EMU).
EMU, Hope's authorizer, noted that academic performance is weighted heavily (as much as 60%) by renewal considerations. EMU renewed Hope's charter in 2013, for a three-year period instead of the standard (and former) five-year period. This change was due in part to Hope's academic performance. Fitch views Hope's charter renewal risk as heightened; however, the authorizer indicates academic progress.
WEAK OPERATING PERFORMANCE
Audited fiscal 2015 results were weaker than recent years at negative $316,000 (negative 5.6% margin); operations reflected a 13% enrollment decline. This compared to fiscal 2014 results which were close to break-even at negative 0.2%. Hope's GAAP operating margin tends to fluctuate; on a full accrual basis between fiscal 2008 and 2014 it has been modestly negative in four out of the last seven years.
For the current fiscal 2016 budget year, management reports operations remain very tight, but are on track for balanced results and achieving the covenanted 1.1x coverage. However, weakening operating performance due to enrollment declines drives Fitch's downgrade to 'B'. Failure in fiscal 2016 to improve operations in general and meet coverage covenants would trigger further negative rating actions by Fitch. Hope's weak balance sheet reserves further limit the school's ability to absorb significant enrollment or state funding fluctuations.
Fitch measures debt service coverage on a consolidated basis (which appears to be different from bond covenants). Hope achieved at least 1.0x current coverage in all but two of the last seven years in Fitch's analysis. However, fiscal 2015 MADS coverage (which is the same as transactional MADS coverage due to level debt service) was only 0.9x. In contrast, fiscal 2014 MADS coverage was 1.3x, and fiscal 2013 coverage was 1.5x.
Management reports that it met fiscal 2015 coverage covenants, which it measures using only general fund operations. The school's 2015 audit is silent regarding meeting - or not meeting - bond covenants. However, the weak fiscal 2015 MADS coverage calculated by Fitch indicates strained operating results. Given further enrollment declines in fall 2015, Fitch does not expect significant improvement in fiscal 2016. Hope has no new debt capacity at this time; management reports no debt plans.
WEAK BALANCE SHEET
Hope has a weak balance sheet relative to the rating category. Available funds (AF) is defined as cash and investments not permanently restricted. For fiscal 2015, this was $81,000, only 1.6% of annual operating expenses ($5.7 million) and 1.1% of outstanding debt ($8.6 million). Fitch's AF calculation does not reflect $3.5 million of non-cash accounting adjustments for GASB 68 pension liabilities.
The school has a 2016 state aid note for $950,000 (the same amount as in 2015 and in 2014) to smooth cash-flow during the academic year. The note is secured by state per-pupil funding and was about 16% of fiscal 2015 revenue. Hope reports that state payments are consistently made on time.
In recent years Hope has failed to achieve state academic targets. In both fiscal 2013 and 2014, and continuing into 2015, the state classified Hope as a 'Priority School', an under-performing institution with academic achievement among the lowest 5% of all Michigan schools. State-wide, academic classifications were frozen in the 2015/2015 academic year due to transition to new common core testing. As such, Hope's academic classification did not change for the current 2015/2016 academic year. However, EMU, the authorizer, reports academic progress.
Hope is in the second of a three-year, state-mandated, academic plan. Like other schools in Michigan and many in the U.S., academic year 2014/2015 testing results are not yet available, and are not comparable to prior testing results. Michigan adopted a hybrid of its previous achievement test with some Common Core components, first administered in the spring of 2015.