[March 08, 2013]

Fitch Downgrades Great Hearts Academies' (AZ) Veritas Project to 'BB'

Fitch Ratings has downgraded to 'BB' from 'BBB' and removed from Rating Watch Negative its rating on approximately $16 million of educational revenue bonds, series 2012 issued by the Industrial Development Authority of the City of Phoenix. The bonds are issued on behalf of Great Hearts Academies (Veritas Project).

The Rating Outlook is Stable.

SECURITY

The bonds are a joint and several obligation of two charter schools, Veritas Preparatory Academy (VPA) and Archway Classical Veritas (ACV) (together, the schools) and are payable from all legally available revenues. The bonds are further secured by a first mortgage lien over the facility in which the schools are co-located, and a cash-funded debt service reserve.

KEY RATING DRIVERS

LIMITED HISTORY OF ACV; WEAK COVERAGE: The downgrade reflects the fact that ACV opened in 2011 and consistent with Fitch's revised criteria, schools with limited operating histories present substantial credit risk and are not included when calculating debt service coverage in pooled transactions. VPA alone is unable to fully cover transaction maximum annual debt service (TMADS) for the series 2012 bonds.

HIGH LEVERAGE METRICS: The downgrade further reflects the schools' high leverage position, evidenced by a high pro forma debt to net income available ratio and a high pro-forma TMADS burden.

STABLE OPERATIONS: VPA's 10-year operating history; track record of enrollment growth, coupled with strong demand for ACV to date; and recent trend of positive to breakeven operating results, partially offset the aforementioned concerns and underpin the 'BB' rating.

STRONG MANAGEMENT OVERSIGHT: The schools benefit from the strong programmatic leadership of Great Hearts Academies (GHA), whose reputation for academic excellence drives consistently strong student demand among its network of schools.

IMPROVING FUNDING ENVIRONMENT: State per student funding increased modestly (about 1%) for fiscal 2013 following several years of relatively flat state support. This coupled with enrollment growth, should result in stable fiscal 2013 operating results.

RATING SENSITIVITIES

ACHIEVEMENT OF FINANCIAL METRICS: VPA's achievement of certain financial metrics on its own merit, principally TMADS coverage; or on a combined basis once ACV reaches five years of audited operating history in fiscal 2016, could result in upward rating movement.

CHARTER RELATED 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

Debt service coverage is the primary weakness present in this credit. Despite VPA's track record of enrollment growth, strong academic performance and breakeven to positive operating results, it cannot cover the carrying charges on the series 2012 bonds with current financial resources. The school's fiscal 2012 net income available for debt service totaled just $217,000, covering TMADS ($1.18 million) by only 0.2 times (x).

Under Fitch's charter school rating criteria, a school having less than five years of audited operating history is excluded from this calculation in pooled transactions. While ACV has experienced stong demand to date and benefits from its affiliation with VPA and the GHA network, it has only completed one full academic year thus far (2011-2012). Even when incorporating ACV into the debt service calculation, TMADS coverage improved to only 0.8x for fiscal 2012.

The schools' high debt burden is another credit weakness. TMADS consumes a high 15.2% of the schools' combined fiscal 2012 operating revenues ($7.75 million). Total debt outstanding of approximately $16.4 million also represents a high 17.2x of combined net income available for debt service ($954,000). While high leverage ratios are not uncommon for the charter school sector, Fitch views a debt burden between 15%-20% and TMADS coverage of under 1x as speculative grade credit attributes.

VPA's 10-year operating history is a credit positive, with solid demand trends and strong academic performance. The schools maintain a positive working relationship with their authorizer, the Arizona State Board of Charter Schools (ASBCS). While both schools are still operating under their initial charters, they are for terms of 15-years. ASBCS performs five-year reviews for charter schools with 15-year contracts. VPA was last reviewed in 2008, with its next review later this year.

Fitch views the schools' 15-year charter terms and their positive working relationship with ASBCS as a credit positive and partially mitigating charter renewal risk. The schools' academic quality is evidenced by their high state Department of Education rankings of A (or excelling) for VPA and B (or above-average) for ACV. All schools in the GHA network, including VPA and ACV, continue to outperform state averages on Arizona's standardized testing.

VPA enrolled a total of 629 students in grades 6-12 as of Oct. 2012. Fitch views management's expectation to reach 700 students next year as reasonable given current demand and wait lists. Enrollment is capped at 750 per its charter. Demand has been strong to date for ACV as well, with 510 students enrolled in grades K-5 as of October 2012. The schools' combined enrolment of 1,139 is up from 982 students as of October 2011 and is just ahead of the schools' initial projection provided to Fitch of 1,091 for fall 2012. The schools maintain robust and actively managed wait lists (457 for VPA and 1,200 for ACV). Fitch views the schools' nearly full enrollments and sizeable wait lists as reflective of the solid demand for its programs, which center on a rigorous classical liberal arts curriculum.

VPA generated a positive to breakeven operating margin for the past three fiscal years (2010-2012), averaging 3.5%. ACV, somewhat atypical for start-up schools, generated a solid 7.8% margin in fiscal 2012, raising the schools' combined margin to a solid 3.8%. Management expects the schools to end fiscal 2013 with modest surpluses. Fitch believes this projection is attainable based upon continued enrolment growth and the slightly improved state funding level.

Fitch views continued enrollment stability and breakeven to positive operations critical as the schools' balance sheet resources provide little financial flexibility. On a combined basis, available funds (cash and investments not restricted) totaled just $708,000 as of June 30, 2012, covering fiscal 2012 combined operating expenses ($7.46 million) and debt ($16.4 million) by a very low 9.5% and 4.3%, respectively. Following acquisition and construction of the new campus in 2012, the schools have no more material capital or borrowing needs. As a whole, GHA typically funds routine capital expenditures through operating cash flow.

Fitch's actions are the result of its completed charter school industry-wide review, which commenced September of last year when Fitch placed all of its rated schools on Rating Watch Negative. Fitch will release an overview of its rating actions in a separate press release later today.

Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.

Applicable Criteria and Related Research:

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

--'Revenue-Supported Rating Criteria' (June 12, 2012);

--'Fitch Places All Charter School Bonds on Rating Watch Negative' (Sept. 29, 2012).

Applicable Criteria and Related Research

Revenue-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm rpt_id=681015

Charter School Rating Criteria

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

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