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

Fitch Ratings affirms the 'BB+' rating for $13.5 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 anticipated to remain below or close to break-even on a GAAP basis going forward.

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 2013 coverage was stronger at 1.37x. PPPCS benefits from strong demand and stable enrollment, which supports the school's primary revenue-driver, per pupil funding. Importantly, enrollment growth is not required to achieve sufficiency coverage of the TMADS obligation.

LIMITED BALANCE SHEET FLEXIBILITY: PPPCS has low balance sheet ratios, which are consistent with the rating category. These limit flexibility to manage budget fluctuations, including union contracts for its instructional faculty. Though operations are expected to 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 over time.

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. 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 2013 was 673 students, up 4.2% from fall 2012 primarily due to a second Pre-K class. About 20% of students were K or PreK. The school is located in southeastern Baltimore and has a curriculum that emphasizes diversity and a thematic, experiential learning approach.

SPECULATIVE GRADE OPERATIONS AND BALANCE SHEET METRICS
The 'BB+' rating reflects slim balance sheet ratios, which are consistent with the rating category. Available funds (AF), defined by Fitch as cash and investments not permanently restricted, was $1.09 million at June 30, 2013, about the same nominal amount as in fiscal 2012. This represented a slim 13.9% of fiscal 2013 operating expenses and 8% of outstanding debt ($13.7 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. After averaging 9.8% between fiscal 2008 and fiscal 2011, PPPCS' operating margin was essentially at break-even in fiscal 2013 (negative 0.3%), compared to negative 3.1% in fiscal 2012. The primary driver of the weaker operating performance was increased depreciation and interest expense beginning in fiscal 2012, associated with the series 2010 bond-financed facility expansion. The school reports that the fiscal 2014 budget is balanced, and budget results could be stronger than expected. 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.

ADEQUATE DEBT SERVICE COVERAGE
Importantly, 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.) TMADS for the series 2010 bonds is $941,000. The fixed rate debt service structure is level. PPPCS has generated average coverage of 1.1x over the past five fiscal years. Coverage increased to 1.37x in fiscal 2013, a budget year that management reports incorporated some program and expense reductions and higher than budgeted per-pupil funding. Fiscal 2012 TMADS coverage was lower at 1.1x.

DEBT BURDEN: The TMADS obligation represented a high 12% of fiscal 2013 operating revenues. However, it remains more moderate than the 15% that Fitch considers to be the limit for investment grade charter schools.

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 disclosure, both of these covenants were met. Bond documents also require funding a renewal and replacement fund up to $200,000 over time; at June 30, 2013, the R&R fund held $116,000.

SOLID ENROLLMENT
Like most charter schools, PPPCS is heavily reliant on per pupil funding to support its annual operating budget. In fiscal 2013, 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 673 in fall 2013, up from 622 in fall 2011. Management indicates that about 44 additional K-8 students could be added under the existing charter cap. It allows enrollment of up to 675 K-8 students; PPPCS currently has 631 such students, providing some demand and budget flexibility.

BUDGET CONSTRAINTS
Actual per pupil funding for fiscal 2013 was higher than budgeted (approximately $9,192 per student versus $9,007). For the current fiscal 2014, funding increased 2.8% to $9,450. The fiscal 2015 funding level is not yet available.

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 contract was still under negotiation at the end of calendar 2013, and the school will budget to incorporate the results. As salaries and benefits typically comprise the majority of operating expenses, Fitch views this as a significant limitation.

PPPCS' budgetary stability has historically benefited from strong demand. For fall 2013, PPPCS received 175 applications for 42 pre-kindergarten openings (expanded from 21 slots previously) and 218 applications for 93 kindergarten openings. Management reports that attrition was below 7% for the 2012/2013 academic year, and is expected to be similar for the current 2013/2014 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 2013);
--'Fitch Downgrades Patterson Park Public Charter School (MD) to 'BB+' (March 8, 2013).

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=709499

Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=817375
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