OREANDA-NEWS. February 12, 2016. Fitch Ratings has affirmed the 'BBB' rating on the approximately \\$12.1 million of series 2010 bonds (Pinnacle Charter School, Inc. High School Project) issued by the Colorado Educational and Cultural Facilities Authority on behalf of Pinnacle Charter School (Pinnacle).

The Rating Outlook is Stable.

SECURITY

The series 2010 bonds are payable from annual lease payments made by Pinnacle, subject to annual appropriation by the school, and secured by a first mortgage over the financed facilities related to the high school. The bonds are not on parity with Pinnacle's series 2013 bonds (not rated by Fitch).

KEY RATING DRIVERS

STATE MORAL OBLIGATION: The 'BBB' rating is based on Pinnacle's inclusion in the state of Colorado's charter school moral obligation program (the program), which provides a mechanism for the state to restore draws on the school's debt service reserve fund.

SOUND OPERATING PROFILE: Pinnacle's credit profile reflects a long 18-year operating history, with multiple charter renewals and steady demand. It also shows a track-record of positive GAAP-based operating performance and historically healthy debt service coverage, albeit narrowing, which partially offsets a high debt burden; and an adequate level of unencumbered reserves to help counter short-term financial difficulties.

ACADEMICS CHALLENGES: Overall student proficiency across the elementary, middle, and high schools is mixed, with the high school designated as a high performing school. The middle and elementary schools' achievement results are below district and state averages on most recent state assessments. The state rating system is on hold for one year. The elementary school's proficiency declined in school year 2013-14, placing it on priority improvement status, which is still in place for 2014-2015.

ABBREVIATED CHARTER TERM: Operating under one charter, the academic performance of the elementary and middle schools affected the term of the charter renewal for Pinnacle as a whole. The charter was recently renewed for a three-year term to June 2019, plus a two-year auto-renewal subject to meeting prescribed academic performance benchmarks; the standard term in Colorado is five years.

STRUCTURAL and LEGAL PROTECTIONS: Structural and legal provisions providing bondholder protections include the state's debt service intercept program and various reserve funds, reflecting a favorable statutory environment for charter schools.

RATING SENSITIVITIES

ACADEMIC PERFORMANCE: Pinnacle has sufficient operating history; however, a continuation of the elementary and middle schools' substandard academic performance could influence the term of future charter renewals. Failure to improve academic performance over the next two years could hinder auto-renewal of the charter in 2019 and result in downward rating pressure.

STANDARD SECTOR CONCERNS: A modest 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

Pinnacle, which is located in Federal Heights (10 miles north of Denver), received its initial charter from Adams County School District in No. 12 in 1997 and underwent a successful renewal in 2000. In 2006, Pinnacle left the district to join the Colorado Charter School Institute, a statewide charter granting agency. The school's charter is subject to renewal every five years. The charter was successfully renewed in June 2011 and was recently approved for a three-year renewal effective June 2016, plus a provisional two-year auto-renewal. The elementary, middle and high schools all operate under a single charter. While the series 2010 bonds are solely secured by the operations of the high school facility, Fitch's analysis incorporates the operational and financial health of Pinnacle's K-8 facility given the strong operational linkage across all three schools and the single charter.

STATE MORAL OBLIGATION PROGRAM

Under the program, if a charter school draws on its debt service reserve fund and fails to replenish it immediately, the authority shall submit a certificate to the Governor certifying the amount necessary to restore the reserve fund to its requirement. The Governor shall then submit a request for appropriations to the legislature in an amount sufficient to restore the reserve fund. The general assembly then, at its discretion, may appropriate to restore the reserve fund.

In order to qualify for the program, a school must merit an investment-grade credit profile at the time of bond issuance, and participate in the Colorado Charter School Intercept Program. Under the intercept program, the state Treasurer pays a portion of the school's monthly per pupil revenue distribution directly to the trustee in amounts sufficient to pay debt service requirements.

The rating builds upon Fitch's view of the underlying credit quality of the charter school (bottom-up analytic approach). Moral obligation program bonds are secured separately by each school, and Fitch views each bond as project-specific. The state is actively engaged in debt issuances under the moral obligation program, and the statute provides clear mechanisms to trigger the state's moral obligation. In addition to the moral obligation, the statute also provides an additional backstop (the state charter school debt service reserve fund, or CSDSRF) so that an additional appropriation due to a debt service reserve drawdown is less likely to be necessary.

PRESSURED ACADEMIC PERFORMANCE

All Colorado schools, including charter schools, transitioned to common core academic standards and testing in the 2014/2015 academic year. This transition means that 2014/2015 academic test results are not comparable to those of prior years, and the state is still developing a rating scale for Colorado schools. As such, the Colorado Department of Education (CDE) school performance framework indicators, used to evaluate academic performance relative to state expectations, for the 2013/2014 school year are being held over for one school year.

In 2013/2014, student proficiency at the high school level exceeded performance framework indicators, while proficiency at the middle and elementary school was rated as not meeting performance indicators the same year. The CDE will defer to a district rating for the school, in this case the authorizer Charter School Institute (CSI). Based on CDE framework and student performance trend data, CSI classified the middle and the elementary school as improvement, and priority improvement schools, respectively, and the high school as a performance school based on student performance trend data. As a priority improvement-level school, the elementary school was previously required to submit a unified improvement plan (UIP) for the 2014/2015 school year and is currently expected to show improvement in student performance based on benchmarks in the recent charter renewal.

The school's performance will be reviewed by CSI, CDE and members of the state review panel, who are appointed by the state commissioner of education and deemed as experts on improvement by the state. A decision on whether or not to keep a school open is up to the authorizer, CSI.

Pinnacle's pressured academic performance as a whole can be attributed to changes in the student composition of the school over the last several years. Newer students continue to score below returning students indicating Pinnacle has a positive impact on continuously enrolled students. Pinnacle continues to underperform both the district and state on new test assessments administered in 2014-2015, except at the high school level.

ABBREVIATED CHARTER RENEWAL TERM

With respect to the most recent charter renewal approved in December 2015, two of the three main areas used for charter evaluation purposes - financial and compliance - remain sound; however, the 2013/2014 levels of academic performance of Pinnacle as a whole were used by CSI for the basis of the abbreviated charter term (effective June 2016) to three years with a two-year auto-renewal subject to meeting prescribed academic performance benchmarks; the standard term in Colorado is five years. Fitch does not believe that Pinnacle's charter is currently at risk for revocation; however, given the importance of academic performance in the authorizer's overall evaluation of Pinnacle's charter standing, there is uncertainty in the 2019 renewal process. Fitch will continue to closely monitor this aspect of the credit.

DEMAND SUPPORTS ANNUAL OPERATING PERFORMANCE
Favorable enrollment trends have enabled the school to generate a GAAP-based operating surplus in each of the past five fiscal years (fiscal 2011-2015) averaging 3.8%, though reduced enrollment (planned to reduce class size) and increased costs related to health care benefits and pension contributions narrowed the margin to a slim but positive 0.7% in fiscal 2015. Fitch interprets historically positive results as evidence of management's ability to effectively plan for and (when necessary) implement budgetary adjustments to deliver positive financial results.

As is typical of charter schools, Pinnacle's primary funding source is per pupil revenue (PPR; 82% of fiscal 2015 operating revenues). Following several years of either cuts or flat funding, PPR rates increased by approximately 3.3%, 6.12% and 3.9% (estimated) for fiscal 2014, 2015 and 2016, respectively. After an 8.4% increase in total PPR in fiscal 2015 to \\$14.8 million, estimates for fiscal 2016 are flat based on the lower estimated PPR rate and decline in FTE. According to management, the increase in PPR for FY2017 is expected to be closer to 1.4%; however, Pinnacle has some flexibility to increase class size under its charter, if necessary, to offset the decrease in funding.

LIMITED LIQUIDITY AND HIGH DEBT BURDEN
Pinnacle's balance sheet resources provide only a limited financial cushion. As of June 30, 2015, available funds, defined by Fitch as cash and investments not permanently restricted, totaled \\$6.95 million, representing 38% and 23% of operating expenses and total debt, respectively. These ratios are low, although above many other Fitch rated charter schools.

Pro forma maximum annual debt service of about \\$2.24 million represented a high 12.3% of fiscal 2015 operating revenues of about \\$18.11 million. The high burden is partially offset by Pinnacle's ability to cover transaction maximum annual debt service (TMADS) from operations. Coverage has ranged from 1.0x-1.5x over the past five years (2011-2015); coverage narrowed but remained adequate at 1.0x in FY15.

Typical of many charter school financings, Pinnacle's debt amortization schedule includes a large final-year bullet maturity for both the series 2010 and series 2013 bonds, which the school intends to partially pay with the debt service reserve funds.