OREANDA-NEWS. Fitch Ratings downgrades to 'B+' from 'BB+' approximately \$16.9 million in civic facility revenue bonds, series 2007A, issued by the City of Albany Industrial Development Agency, NY on behalf of the Brighter Choice Charter School for Boys and Brighter Choice Charter School for Girls (BCCS). In addition, Fitch places the bonds on Rating Watch Negative.

SECURITY
The bonds are a general obligation of BCCS and are payable from gross revenues comprised mainly of state mandated school district per-pupil aid payments. Bondholders benefit from a cash funded reserve equal to maximum annual debt service (MADS), other reserve funds under the indenture and a first mortgage lien on the two school facilities.

KEY RATING DRIVERS

WEAK FINANCIALS DRIVE DOWNGRADE: Weaker than expected financial results drive the downgrade. Operations were expected to improve in fiscal 2014 but the operating margin declined to -3%, worse than the -1.2% margin in fiscal 2013. Annual debt service coverage fell below 1x as a result of weaker operations. The schools have very narrow financial flexibility based on minimal balance sheet resources and very limited capacity to raise per pupil revenues by increasing enrollment.

TECHNICAL DEFAULT DRIVES WATCH: The Negative Watch reflects Fitch's view that coverage below 1x in fiscal 2014 constitutes an event of default under the bond documents, as well as continuing to violate the 1.1x covenant. No notice of an event of default has been posted on EMMA. Fitch considers acceleration or foreclosure unlikely, but exercise of those remedies could cause an immediate payment default or impair the schools' ability to pay debt service in full.

ACADEMICS IMPROVE: Academic results based on state test scores improved in the 2013-2014 academic year, which was the second year of state testing to Common Cores standards. Fitch notes positively that the schools outperformed the Albany district overall, which should help support its application for a full five-year charter renewal when the current charter expires in June 2015.

RATING SENSITIVITIES

SUFFICIENT DEBT SERVICE COVERAGE: Generation of at least 1x debt service coverage from improved fiscal 2015 operations is necessary to maintain the current rating level. Failure to meet debt service obligations from operations is not sustainable due to the schools' limited financial cushion and would result in further negative rating action.

RATING WATCH CONCERNS: Fitch would expect to remove the Rating Watch in the event of a formal waiver of fiscal 2014 violations by bondholders or evidence of debt service coverage above 1x in fiscal 2015. Alternatively, exercise of remedies such as acceleration or foreclosure would cause further negative rating action.

CHARTER SCHOOL SECTOR RISKS: 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 affect the rating.

CREDIT PROFILE

BCCS opened in 2002 with a stated mission to provide a public school alternative for students from economically disadvantaged families. The schools, which are authorized by the New York State Board of Regents, have received two renewals after the initial charter. BCCS continues to benefit from a strong relationship with the Albany Charter School Network (network), which is increasing its level of academic support and financial oversight over the schools. The schools remain fully enrolled, slightly above their chartered enrollment of 270 students each.

WEAKER FINANCIALS; COVERAGE DECLINES
BCCS' operating margin declined to -3% in fiscal 2014 from -1.2% in fiscal 2013. Weaker operating results fell well short of management's and Fitch's expectations of a small operating surplus. Slightly lower enrollment in the Boys school and expense pressures related to compensation drove the worse performance, exacerbated by lacking expense monitoring procedures.

Coverage of debt service declined to 0.9x as a result. Fitch considers failure to cover debt service obligations from operations to be unsustainable in light of the school's limited balance sheet resources.

Available funds (cash and investments less restricted net assets) of \$265,000 as of June 30, 2014 are very low relative to operating expenses (2.9%) and debt (1.6%), providing minimal cushion to cover debt service, operating losses, or unanticipated expenses.

Management expects improvement in fiscal 2015 based on slightly higher enrollment, which should generate additional per-pupil revenues; budgeted expenditure reductions; and enhanced financial and operational oversight from the network. The schools are following the recommendations of a consultant, as required by bond documents due to 1x debt service coverage in fiscal 2013, in violation of the 1.1x covenant. As of Sept. 30, 2014, fiscal 2015 operations remained on track to achieve a budgeted surplus and coverage in excess of the 1.1x covenant.

TECHNICAL DEFAULT INCREASES RISK
Fitch is concerned that fiscal 2014 debt service coverage below 1x constitutes an event of default under the bond documents. While fiscal 2013 debt service coverage did not meet the covenanted 1.1x, there was no event of default because the schools retained and followed the recommendations of a consultant. In Fitch's view, the documents state that debt service coverage below 1x constitutes an event of default despite retaining a consultant.

Fitch estimates fiscal 2014 coverage at 0.9x based on audited financial statements, as no covenant calculations have been provided. An event of default under the documents could entitle bondholders to pursue acceleration, foreclosure, or other remedies which could cause an immediate payment default or impair the schools' ability to pay debt service in full. Fitch considers acceleration unlikely, but in Fitch's opinion the magnitude of the downside risk warrants the Rating Watch. A waiver or evidence of sufficient (at least 1x) coverage in fiscal 2015 would alleviate Fitch's immediate concerns reflected in the Watch. Exercise of bondholder remedies would lead to negative rating action.

IMPROVED ACADEMICS
Academic results for both schools in the 2013-2014 school year improved based on state test results. In addition, scores exceeded district averages by notable margins in both ELA in mathematics. Fitch notes this development positively given mild concern about results in 2012-2013, the first year of state tests aligned to Common Core standards. Fitch believes improved academic results and favorable performance versus the district will help the schools' bids for renewal. The schools have applied for full five-year renewals when their charters expire in June 2015.

The Brighter Choice Middle Schools (bonds rated 'B+' on Rating Watch Negative by Fitch) are currently engaged in the renewal process and may face challenges based on academic performance. The middle schools and BCCS are both affiliated with the network but maintain separate charters and finances. It is unclear what impact nonrenewal would have on BCCS.