July 19 - Fitch Ratings has published an exposure draft of the charter
school criteria outlining the agency's changes to the way it analyzes charter
schools. The draft includes a number of proposed amendments to existing
criteria. If applied in the proposed form, the exposure draft would trigger a
substantial number of downgrades to existing charter school ratings.
Recent events in the charter school sector led Fitch to re-evaluate its
assessment of the financial and operational downside risks facing these
entities. Fundamentally, Fitch views charter schools as inherently
non-investment grade because of their typically high leverage and lack of
operational and financial flexibility. Those schools with significant credit
strengths could reach investment grade, but will be capped in the 'BBB' rating
Fitch invites feedback on the exposure draft during a four-week comment period
ending Aug. 20, 2012. Please submit comments to firstname.lastname@example.org. The
agency will continue to apply its current criteria until the finalization of the
revised criteria, which Fitch expects to publish in September 2012, following
the review of comments received during the comment period.
The main proposals upon which feedback will be sought are:
-- Increased Emphasis on External Risk Factors
Fitch believes the operating model for charter schools exposes these entities to
substantial external risks that are often outside of the direct control of
management. These include political risk, regulatory risk, and competitive risk.
Fitch proposes to place greater emphasis on these qualitative factors in
assigning charter school credit ratings.
-- School District Cap on Certain Charter School Ratings
Fitch has observed at least one instance where a financially pressured school
district withheld per-pupil funds legally due to a charter school, thereby
significantly pressuring the school's financial position. State intervention
failed to solve the problem. In light of this risk, Fitch proposes to cap a
school's rating at the level of the school district that either authorizes it or
serves as a pass-through for per pupil funding.
-- Operating History and Renewal Threshold
Charter renewal has always been a fundamental credit concern for the sector.
Recent issues faced by rated schools highlighted the inherent risks of having
basic operating authority controlled by an external party. Fitch proposes to
rate as non-investment grade any schools that have less than five years of
audited operating history and no charter renewals. This standard will also apply
to transactions with multiple charter schools (pooled transactions) such that
only those schools that meet the threshold will be included in Fitch's
assessment of historical pro forma maximum annual debt service (MADS) coverage
(see below for more details). The only possible exceptions to this requirement
will be when initial charter terms exceed five years and Fitch can sufficiently
assess a school's likelihood of renewal.
-- Historical Financial Performance Expectations
Most charter schools lack the history of audited financial performance to
support an investment grade rating. The exposure draft identifies a set of
baseline financial attributes Fitch would expect in order to consider a charter
school for investment grade. They include sum sufficient pro forma MADS
coverage, pro forma MADS burden (as a percentage of operating revenues) of 15%
or less, and net debt-to-net income available for debt service of 10 times or
less. Very few rated schools exhibit all of these attributes from audited
financials, and this could be a primary driver of downgrades for existing
ratings under the new criteria.
-- Ratings Effect
Fitch expects the proposed changes will affect ratings on nearly all charter
schools. The agency currently rates 22 charter school transactions investment
grade and expects most, if not all, of these ratings would be downgraded to
non-investment grade under the proposed criteria. The five transactions
currently rated non-investment grade could move one to two notches lower. This
assessment is based on a preliminary review of Fitch's charter school ratings.
Further analysis will be performed when any final criteria are applied to all
ratings, which could lead to a higher or lower number of rating actions.
After the comment period and upon the publication of the new criteria, Fitch
expects to place on Rating Watch Negative those schools it views at risk of
downgrades, which could include all charter school ratings. Fitch would then
conduct full rating reviews for those schools over the following six months,
utilizing the new criteria.
Fitch has also re-published its current charter school rating criteria alongside
the exposure draft. The current charter school rating criteria remains
unchanged, and in effect, with the exception of a specification that the
criteria are currently under review and subject to comment.
Feedback on the exposure draft should be sent to email@example.com by
Aug. 20, 2012.