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Converting Permanent Financing

For most charter schools who have already gone through the facility development process and associated financing or are getting ready to exit the lease period with a turnkey developer, the next major facilities hurdle is often the conversion to permanent financing.  Typically, charter schools have sought out tax-exempt bond financing for a variety of reasons including cost, term, and amount of capital required.  Additionally, because of the ability for bond financing to cover up to 100% project value or project cost, bond financing can often provide charter schools the opportunity to roll additional capital improvements or another phase of construction into the bond issuance transaction.  Over the last few years, the bond market has been characterized as a borrower’s market with ample liquidity and a ton of investors willing to buy both rated and unrated bonds at competitive rates.  This has been a tremendous permanent financing resource for charter schools.

Flash forward to the COVID-19 pandemic and the ongoing economic fallout, and capital market experts note that we’re starting to see a transition back to an investor’s market.  Specifically, since early March 2020, investors pulled more than $40B out of municipal bond funds, driving down new bond issuance by more than 40%.[1]  The decrease in liquidity has been observed in the fluctuation of a number of indices, including the Thomson Reuters Municipal Market Data (MMD) Index.[2]  Fluctuation in this index which is used as a basis for the pricing of tax-exempt bonds, has led to an increase in interest rates to the borrower, anywhere from 100 to 200 basis points[3] more relative to where a comparable deal might have been done pre-COVID-19.

So, what does this mean for your school if you were going to be exploring the tax-exempt bond market during COVID-19?  In the short-term, keep in mind and build into your planning and analysis the following:

Expect there to be some meaningful increase in the interest rate due to prevailing market conditions.  Whereas you or your financial team might have previously run permanent financing scenarios at an effective interest rate of 5.00% or 5.50%, it is more likely you will see an effective interest rate closer to 6.00% and higher, particularly if it is an unrated bond issuance.

More often than not, either a portion or all of a debt service reserve requirement gets rolled into the amount being borrowed through a bond issuance.  As the cost of debt increases, the size of the required debt reserve will also increase, which means the overall principal being borrowed increases as well.  The increased borrowing, in turn, can drive up issuance-related costs, which can also drive up the overall principal being borrowed as well.  As you plan for a bond issuance, make sure your financial plan can robustly account for the interconnectedness of these factors and update accordingly.

Expect the underwriting process to take longer and to be more in depth with greater scrutiny on the longer-term financial prospects of your school.  Similar to charter schools looking for their initial round of financing, it is critical to invest in rigorous financial planning.

On April 1, 2020, S&P Global Ratings (S&P), one of the three credit rating agencies for charter schools and the agency that has issued the most charter school ratings, announced that outlooks for all U.S. public finance sectors were now negative, with the outlook of the charter school sector overall shifting from stable to negative.[4]With regards to the charter school sector, S&P’s outlook revision to negative was primarily done in the context of charter schools’ reliance on per-pupil state funding and a number of states facing or likely facing meaningful budget shortfalls or deficits for the 2020 and 2021 budget years.Additionally, S&P analysts noted there may be a budgetary drag associated with the investment and implementation of technology and remote education.S&P also flagged that charter schools with a lower rating were likely to be more vulnerable to state funding developments and face greater risk when it came to debt service coverage and covenant pressure, liquidity and fundraising.

All this means that hyper-optimized financial pro forma that leaves little room for error may present challenges for a successful underwriting, or delay bond issuance.  What may have passed muster a couple of months ago may not necessarily do so now and in the months ahead.  If you’re not clear on what good financial benchmarks and indicators might be for a bond issuance, in 2017 S&P also updated its extensive methodology for assigning ratings and related credit products to charter schools, found here, and you can see what earns high and low marks across different areas of assessment.  If you still plan to pursue tax exempt bond financing and you have some lead time, consider pursuing an actual rating.  Rated charter schools and bond issuances will see a lower effective interest rate than unrated charter schools and bond issuances.

As you track developments in the capital markets or as your own plans shake out further, perhaps you recognize that there may be a need to wait on pursuing bond financing.  Other options include but are not limited to requesting a loan term extension, identifying a new commercial lender, or identifying a CDFI lender.

As a borrower, you may not have known requesting a loan term extension from your current lender was a possibility.  Depending on the relationship, amount outstanding, type of rate, other debt, length of the extension being requested, and rationale, a loan extension for up to a year can be straightforward with a nominal fee anywhere from 1% to 3% of the outstanding principal.  We do recommend broaching this topic with your lender early enough so that they have time to process the request before the loan matures.  Lenders may require an updated financial analysis and some refreshed underwriting to ensure that your operations can afford to continue paying on the loan.

Should you identify a new commercial lender, the caveat here is interest rates will not likely be lower than bond financing and they may be higher than your initial financing interest rates depending on market conditions.  Additionally, most commercial loans are still going to be limited to anywhere between a 5 and 15-year term, and any amortization greater than the term will mean either a balloon payment at the end or the proverbial kicking the can down the road on permanent refinancing.  Most commercial loans are also going to be limited to 80% loan-to-value, which limits some of the ability to roll any new capital projects or construction into the refinancing without some equity contribution or meaningful asset appreciation.

Identifying a CDFI lender is another alternative that comes with its considerations.  CDFIs have been incredible partners to charter schools and in some cases have been the lender when other lending institutions have said no.  A CDFI may in fact have been the lender for your facility’s initial financing.  While CDFIs are usually not positioned to serve as a new long-term lender, they may be able to provide bridge financing, similar to a commercial lender, until you are ready to issue a bond.

Concluding Thoughts

COVID-19 is presenting a host of challenges for charter schools, and its total impact is to be determined.  Facilities development will see its fair share of those challenges, some familiar and some new.  With a focus on robust financial analysis, thoughtful planning around timelines and contingencies, and the tapping of key subject matter expertise, charter schools will be able to meet these challenges head on. 

SchoolPrint is a free service to charter schools who need assistance in identifying and working with quality construction service providers, or general assistance in navigating the facilities process. We provide the blueprint schools need to successfully complete their facility projects. If your current facility situation has been further exacerbated by COVID-19 and you need expertadvice, please feel free to email us at SchoolPrint@lisc.org. 

[1] Charter School Facilities Center (2020, April 30). Charter Schools and the Capital Markets During a Pandemic.

[2] The MMD is a proprietary yield curve that provides the offer-side of “AAA” rated state general obligation bonds, as determined by the MMD analyst team.  For further reading, please consult:  Municipal Securities Rulemaking Board (2017, August).  “Understanding Municipal Market Indices, Yield Curves And Benchmarks.”

[3] Ibid.

[4] S&P Global Ratings (2020, April 1). All U.S. Public Finance Sector Outlooks Are Now Negative.