Fitch Affirms Patterson Park Public Charter School (MD) at 'BB+'

Fitch Ratings affirms the 'BB+' rating on $12.6 million outstanding series 2010A and B bonds issued by the Maryland Health and Higher Educational Facilities Authority (MHHEFA) on behalf of the Patterson Park Public Charter School (PPPCS).

The Rating Outlook is Stable.

SECURITY

The bonds are a general obligation of PPPCS, secured by a first mortgage on the school's facilities. A cash-funded debt service reserve (DSR) provides further security.

KEY RATING DRIVERS

FINANCIAL METRICS DRIVE RATING: Operating and liquidity metrics for PPPCS are considered speculative grade per Fitch's charter school rating criteria. PPPCS' operating results are typically below or close to break-even on a GAAP basis.

EXPECTED ADEQUATE DEBT SERVICE COVERAGE: PPPCS has demonstrated consistent coverage of transaction maximum annual debt service (TMADS) at or above the covenanted 1.1x. Fiscal 2014 coverage was 1.2x. PPPCS benefits from strong demand and stable enrollment, which supports the school's primary revenue-driver, per pupil funding.

LIMITED BALANCE SHEET FLEXIBILITY: PPPCS has weak balance sheet ratios, consistent with the rating category and typical of the sector, that limit flexibility to manage budget fluctuations. An additional factor is union contracts for its teachers. Though operations may allow for modest growth in PPPCS' balance sheet metrics, flexibility will likely remain narrow.

RATING SENSITIVITIES

MARGIN DETERIORATION: A decline in PPPCS' operating margin that causes TMADS coverage to fall below 1.1x, or causes significant depletion of available funds (defined by Fitch as cash and investments not permanently restricted), would result in a negative rating action.

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 that, if pressured, could negatively impact the rating.

CREDIT PROFILE

PPPCS opened in 2005 in a former Catholic school located just north of Patterson Park in Baltimore, MD. PPPCS expanded its facilities in fall 2011. Since receiving an initial three-year charter in 2005, PPPCS has received two five-year charter renewals from Baltimore City Public Schools (BCPS). The most recent five-year renewal was February 2013, which extends the charter to June, 2018. Enrollment in this PreK-8 charter school for fall 2014 was 682 students, slightly up from 673 in fall 2013. About 20% of students were K or Pre-K. The school is located in southeastern Baltimore and has a curriculum that emphasizes diversity and a thematic, experiential learning approach. Fitch notes positively that the school remains in good standing under its charter and has a positive working relationship with the authorizer, BCPS.

SPECULATIVE GRADE OPERATIONS AND BALANCE SHEET METRICS

The 'BB+' rating reflects weak balance sheet ratios, which are consistent with the rating category. Available funds (AF), defined by Fitch as cash and investments not permanently restricted, was $1.46 million at June 30, 2014, an increase from $1.1 million in fiscal 2013 and fiscal 2012. This resource level represented only 17% of fiscal 2014 operating expenses and 12% of outstanding debt ($12.6 million). While AF provides some budgetary cushion, it is inadequate to fund debt service for any length of time.

Operating margins on a full accrual basis have been break-even or slightly negative in recent years. The fiscal 2014 net operating deficit was $208,000, an operating margin of negative 2.5%. After averaging a positive 9.8% between fiscal 2008 and fiscal 2011, PPPCS' operating margin in fiscal 2013 was ($26,000), essentially at break-even (negative 0.3%), and in fiscal 2012 was ($240,000), or negative 3.1%. The primary driver of the weaker operating performance was increased depreciation and interest expense associated with the series 2010 bond-financed facility expansion.

The school reports that the fiscal 2015 budget is balanced, and operating results should be comparable to fiscal 2014. Management does not fully budget for depreciation expense, but does budget to meet the 1.1x coverage covenant. As a result, performance is expected to remain below break-even for the near term. Fitch notes that PPPCS has limited control on increases in operating expenses (mainly salaries and benefits), which are mandated by BCPS union contracts.

ADEQUATE DEBT SERVICE COVERAGE

PPPCS' budgets typically generate adequate coverage of the school's TMADS obligation. TMADS is MADS excluding a planned double payment in the final amortization year ($941,000 for the series 2010 bonds). The fixed rate debt service structure is level. PPPCS generated 1.2x TMADS coverage in fiscal 2014, lower than the 1.37x coverage in fiscal 2013, and more comparable to 1.1x in fiscal 2012. Management reports that coverage increased in fiscal 2013 due to program and expense reductions and higher than budgeted per-pupil funding. The TMADS obligation represented a high 11.5% of fiscal 2014 operating revenues.

Bond covenants include a 1.1x minimum MADS coverage ratio and a requirement for cash and investments to be at least 7% of total operating expenses. Per the school's fiscal 2013 and 2014 disclosure, both of these covenants were met. Bond documents also require quarterly funding of a renewal and replacement fund up to $200,000 over time; at June 30, 2014, the R&R fund held $86,000.

SOLID ENROLLMENT

Like most charter schools, PPPCS is heavily reliant on per pupil funding to support its annual operating budget. In fiscal 2014, student-generated revenues provided about 92% of operating revenues. Given the concentrated revenue stream, maintaining stable enrollment and balance sheet reserves over time are important credit factors.

PPPCS has gradually increased enrollment in recent years, well past the originally anticipated 585 students. Enrollment was 682 in fall 2014, up from 673 in fall 2013 and 622 in fall 2011. Management indicates that about 39 additional K-8 students could be added under the existing charter cap, which allows enrollment of up to 675 K-8 students. This gap provides some demand and budget flexibility, as the school has no facility constraints. School management has no plans to request a higher enrollment cap from its authorizer.

BUDGET CONSTRAINTS

Per pupil funding (PPF) is the school's largest revenue source. Actual PPF for fiscal 2014 was $9,450, an approximate 2.8% increase from $9,192 per student in fiscal 2013. For the current fiscal 2015, there was no increase. The fiscal 2016 funding level is not yet available. Fitch notes that over time PPF tends to be flat or increase modestly.

Fitch notes that PPPCS' operational flexibility is more limited than many charter schools because its instructional faculty, employed by BCPS, is unionized. PPPCS does not have teacher pension expense (that is a liability and expense of the city), but it must fund any Baltimore City Public School union contract increases. Management reports that a new three-year contract was negotiated effective for fiscal 2014 that included annual teacher bonus, wage increases and step increases that effectively result in a 4% annual benefits increase. As salaries and benefits typically comprise the majority of operating expenses, Fitch views this as a significant limitation. Additionally, Baltimore charter schools, including PPPCS, are required to pay a portion of BCPS debt service, even if they are not located in BCPS facilities. For PPPCS, who has its own facility, management reports this is about $200,000 per year.

PPPCS' relative budgetary stability benefits from strong demand. For fall 2014, PPPCS received 180 applications for 46 pre-kindergarten openings (expanded from 21 slots in fall 2012) and 162 applications for 92 kindergarten openings. Management reports that attrition was about 5% for the 2013/2014 academic year, and is expected to be similar for the current 2014/2015 year. The school does not carry or draw from wait lists during the academic year. Fitch views high retention favorably as it indicates satisfaction with the academic program and limits reliance on a potentially seasonal wait list.

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

Applicable Criteria and Related Research

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

-- 'Revenue-Supported Rating Criteria (June 2014);

-- 'Fitch Affirms Patterson Park Public Charter School (MD) at 'BB+' (Jan. 27, 2014).

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=750012

Additional Disclosure

Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=978455

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