Bloomberg News

Texas Gives Charter Schools Momentum in Financing: Muni Credit

July 08, 2011

July 8 (Bloomberg) -- Texas will join Colorado in providing state backing for charter-school bond offerings, a move that may spur debt sales while reducing some issuers’ borrowing costs in a growing part of the municipal market.

U.S. charter schools raised more than $5 billion in about 480 bond issues from 1999 through December, typically paying 2 percentage points more in yield than top-rated municipal borrowers, according to Local Initiative Support Corp., a New York-based nonprofit focused on community development.

“Texas is really helping the movement go forward,” said Russ Caldwell, a senior vice president at D.A. Davidson & Co. The Great Falls, Montana-based investment bank has underwritten 19 percent of all charter-school debt, more than any other firm, according to a Local Initiative study.

Under a measure awaiting Governor Rick Perry’s signature, qualifying Texas charter schools can sell debt backed by the state’s $25 billion Permanent School Fund, a AAA rated endowment. About 120,000 students attended 520 institutions that may benefit this year, and about 56,000 are on waiting lists, according to the Texas Charter School Association in Austin.

The change may lead to about $350 million in borrowing in the next three years, said David Dunn, the charter group’s executive director. He said bonds supported by the fund can only be used for new construction, not to refinance existing debt.

Rating Qualification

Perry has until July 19 to sign or veto the measure. To qualify for the endowment’s backing, schools must obtain investment-grade credit ratings.

In the broader municipal-debt market yesterday, yields on top-rated 10-year bonds rose to a two-month high of about 2.79 percent, according to a Bloomberg Valuation index.

Nationwide, about 1.7 million children attend 5,300 charter schools, according to the Local Initiative report released last month. Yet fewer than 400 have borrowed through the tax-exempt debt market. The institutions typically serve the public under contract with a city or district and operate largely outside the municipal bureaucracy and rules.

Bonds totaling $429 million have been sold by 31 Colorado charter schools since 2003 through a program that requires the state to cover debt service when necessary, said Jo Ann Soker, executive director of the Colorado Educational and Cultural Facilities Authority in Denver.

Rising enrollment and more schools will fuel growth in debt issued by the institutions around the U.S., Standard & Poor’s said in an April report. The rating company in New York graded $1.8 billion of “unenhanced debt” from 123 schools through April 10, up from $590.7 million five years earlier.

None Above BBB+

Investment-grade ratings were given to 81 percent of the debt, while none got better than a BBB+, eighth lowest, David G. Hitchcock, an S&P analyst in New York, said in the report. The rest fell below investment quality, mostly at BB+.

Charter-school bondholders face an “inherent risk” of contract loss, which would “likely result in a default of its bonds as public funds would no longer be available for debt service,” Hitchcock said in the report.

Defaults have occurred in 14 issues out of 251 unrated debt sales by charter institutions since 1998, according to the Local Initiatives report. That’s a rate of about 5.6 percent.

That’s “an eye-catching number and it’s higher than I thought it was going to be,” Elise Balboni, a co-author of the study, said in a telephone interview.

1-in-229 Default

By comparison, just one of 229 charter-school debt issues graded by Fitch Ratings, Moody’s Investors Service or S&P went into default, according to Balboni’s study.

Texas charter schools that borrow using the endowment fund’s backing must escrow 10 percent of the resulting savings to cover any defaults by other program participants.

Opponents including the Texas School Board Association fought the new law, saying it would drain endowment financing capacity while public-school enrollment is rising by about 80,000 students a year. Lawmakers last month balanced the two- year Texas budget partly by holding public-school funding $4 billion below mandated levels.

The endowment has a 13 percent return in 2010 and assets rose to $25 billion, the Texas Education Agency said in February. The fund’s backing may cut the yield on charter-school debt issues by as much as 3 percentage points, Balboni said.

“We need to equalize capital spending so we don’t create different classes of students,” Davidson’s Caldwell said.

Investors buying the debt have included Allianz SE’s Pacific Investment Management Co., T. Rowe Price Group Inc. and Madison Dearborn Partners LLC’s Nuveen Investments Inc., Caldwell said.

About 4.82 million students enrolled in Texas schools through the 12th grade last year, state figures show. Charter institutions accounted for about 2.5 percent of the total, said Josie Duckett, a spokeswoman for the industry group in Austin.

Following is a description of pending sales of U.S. municipal debt:

MICHIGAN, where the population of Detroit has fallen to the lowest level since 1910, will issue about $646 million in debt through the State Building Authority as soon as next week. The sale includes $634.4 million of tax-exempt bonds, including $46 million with a variable rate, and a $12 million taxable portion. The securities will finance building renovation and construction, including a new $52 million state police headquarters in Lansing. JPMorgan Chase & Co. will lead underwriters in the sale. (Added July 8)

--With assistance from Sarah Frier in New York. Editors: Ted Bunker, Walid el-Gabry.

To contact the reporter on this story: David Mildenberg in Austin, Texas, at dmildenberg@bloomberg.net

To contact the editor responsible for this story: Mark Tannenbaum at mtannen@bloomberg.net


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