OREANDA-NEWS. Fitch Ratings has affirmed the 'BB+' rating on La Vernia Higher Education Finance Corporation, TX's \$65 million of education revenue bonds, series 2009A, issued on behalf of KIPP, Inc. (KIPP). Reference is made herein to KIPP's open enrollment charter school in the State of Texas.

The Rating Outlook is Stable.

SECURITY

The series 2009 bonds are effectively secured by a senior lien on KIPP's revenues and a lien on and security interest in certain real property on which KIPP's Houston area schools are located. Additional security features include a \$20 million debt service fund guaranty and debt service reserve fund.

The bonds rank on parity with \$47 million of outstanding City of Houston Higher Education Finance Corporation revenue bonds, series 2014A, not rated by Fitch. Both series of bonds are senior to approximately \$57 million of outstanding qualified zone academy bonds and qualified school construction bonds.

KEY RATING DRIVERS

LEADING POSITION SUPPORTS OPERATIONS: KIPP's reputation and long operating history support consistently healthy student demand and enrollment trends. Moreover, KIPP's students demonstrate favorable academic outcomes, as measured by standardized state assessments.

SIZEABLE FINANCIAL LEVERAGE: A highly leveraged balance sheet stems from capital investments in new facilities to accommodate strong enrollment growth. Fiscal 2014 available funds represented just 6.2% of long-term debt and 8.5% of unrestricted operating expenses. The ratios, both of which have trended downward in recent years, are about half that of similarly-rated charter schools by Fitch.

POSITIVE OPERATING MARGINS: Strong demand supports a history of positive operating margins. Nevertheless, significant unrestricted operating expense growth averaging 17% annually since fiscal 2010 causes some volatility in year-to-year results.

GOOD COVERAGE METRICS: Good debt service coverage ratios average 1.37x annually since fiscal 2010, including 1.7x in fiscal 2014. Weaker maximum annual debt service (MADS) coverage averages effectively 1x.

RATING SENSITIVITIES

INCREASED LEVERAGE: Financing its sizable growth plans with additional debt would likely impede the improvement in KIPP's balance sheet ratios, thereby limiting its upward rating potential. KIPP's balance sheet ratios are Fitch's foremost rating concern.

STANDARD SECTOR CONCERNS: In addition to KIPP's limited financial cushion, a substantial reliance on enrollment-driven funding and charter renewal risk are credit concerns common among all charter schools that, if pressured, could negatively impact the rating.

CREDIT PROFILE

Two teachers from Teach for America Corps founded The Knowledge is Power Program in Houston in 1994 as an inner-city public school program. KIPP began as one middle school and now operates 22 schools across multiple campuses. Two additional schools are planned for fall 2016.

Historically, KIPP held two charters authorized by the Texas Education Agency (TEA): KIPP Southeast Houston (SE), which covered five schools, and KIPP, Inc. Effective July 1, 2013, schools operating under the KIPP SE charter were transferred to the KIPP, Inc. charter; the former was eliminated. TEA extended KIPP's charter through July 1, 2023 in tandem with the charter consolidation and increased maximum enrollment to 23,300 from 19,000, recognizing its growth plans. KIPP's charter remains in good standing with TEA.

MARKET-LEADING POSITION SUPPORTS OPERATIONS

KIPP's strong reputation and demonstrated track-record of producing favorable academic outcomes supports consistently solid student demand. Total enrollment stood at 11,522 in January 2015, nearly double the 2011 figure. Moreover, KIPP's lottery held 9,728 names in January compared with 8,013 and 7,036 names in January 2014 and 2013, respectively, in a sign of the strong demand.

All but two of KIPP's schools achieved TEA's accountability ratings of 'met standard' in 2014. Several schools achieved a mark of distinction in at least one evaluation area. In addition, two KIPP schools received 2014 national Blue Ribbon honors reserved for higher performing schools. Plans are in place for the two schools scoring 'improvement required'.

KIPP alumni have a more than 50% college graduate rate compared with 18% for Harris County and 8% typical of KIPP's regional peer group, according to KIPP.

SB2 IS NOT EXPECTED TO ADVERSELY IMPACT KIPP

KIPP's nearly 20 year operating history reflects a clear competency in managing through varied regulatory landscapes. Consequently, Fitch does expect Senate Bill 2 (SB2), enacted in 2013, to adversely impact the school's operations. SB2 made significant changes in the state's charter school laws, including instituting mandatory charter expiration for schools that exhibit three years of academic or financial underperformance.

SIGNIFICANT FINANCIAL LEVERAGE

KIPP's weak balance sheet ratios are Fitch's principal rating concern. The ratios reflect significant debt-financed capital needs to accommodate robust growth. KIPP's leverage position highlights the importance of healthy demand and enrollment trends to support its financial performance.

The ratios of available funds to long-term debt and unrestricted operating expenses were a low 6.2% and 8.5%, respectively, in fiscal 2014. Pro-forma MADS of approximately \$12.3 million represented a high 11.2% of unrestricted operating revenues. MADS includes debt service on subordinated debt and excludes expected federal credit payments on those bonds.

KIPP refinanced outstanding series 2006 bonds in June 2014. The refinancing bonds are guaranteed by the Texas Permanent School Fund. Fitch does not rate the debt but includes it in KIPP's financial ratios. KIPP's long-term strategy may include additional debt financing, but such plans are presently undetermined.

POSITIVE OPERATING MARGINS

A track record of positive GAAP-based operating performance somewhat mitigates KIPP's limited financial cushion. However, year-to-year results have been uneven, in part, due to rapid growth. Moreover, a concentrated revenue source in state per pupil aid, as is typical of the sector, contributes to some degree of volatility.

The fiscal 2014 operating margin registered 1.1%, down from 1.5% in fiscal 2013. However, debt service coverage improved to 1.7x from 1.1x. The repayment of a \$5 million note in fiscal 2013 pressured coverage metrics that year. Interim fiscal 2015 results are trending ahead of budget, according to KIPP.

A \$6 million line of credit facility provides additional liquidity support.

DEBT SERVICE GUARANTY PROVIDES ADDITIONAL SUPPORT

A partial guaranty of the series 2009 bonds provides additional bondholder protections. PHILO Houston, LLC, a 501c3 created by PHILO Finance Corporation (PFC) for the KIPP transaction, provides the unconditional and irrevocable \$20 million guaranty. The guaranty is supported by three parties: PFC (\$9 million), the Local Initiatives Support Corporation (LISC) (\$1 million), and the Bill & Melinda Gates Foundation (\$10 million). The \$9 million PFC guaranty extends through the term of the bonds, while the LISC and Bill & Melinda Gates Foundation guaranties expire in 2019.