Facility Refinancing Guide to Underwriting | Local Initiatives Support Corporation

The underwriting due diligence process can be an intense and time-intensive one. It involves a lender’s detailed examination of the school’s organization—its management team, educational model, student achievement, and financial performance. The lender will also make an assessment of the school’s ability to repay its loan from cash flow as well as the value of the collateral provided should it fail to make payments and default on the loan. Several of the tabs included in the toolkit are items that lenders will request from schools. Others are analyses lenders typically use to assess a school’s credit strengths and weaknesses.

Due Diligence Checklist
At times it can seem like the list of items lenders request is never ending, but the more responsive schools are, the more they strengthen the underwriter’s ability to obtain approval for their financing through the organization’s credit approval procedures or marketing process. Tab 5 provides the more detailed due diligence checklist of items lenders typically require during underwriting so that schools can get a jump start on compiling them. Ensuring that someone on the school’s team is tasked with responsibility for timely responses to requests for these documents and information is important to expediting loan approval.

Pro Forma Budget Templates
These tabs provide detailed and summary templates schools can use to develop and present the multiyear pro forma budgets all lenders will require, usually for at least a five-year projection period. Schools can use the detailed template to project enrollment, state per pupil funding, local and federal revenue, any facilities assistance funding, as well as any private funding. Schools will also be able to itemize expenses, breaking down instructional expenses, facility debt service, other occupancy expenses, student services, and general and administrative expenses.

The detailed template is designed to capture all operating revenues and expenses with minimal inputs on the school’s part. In keeping with underwriting convention, revenues are generally escalated at 2% and expenses at 3%. This convention is meant to be conservative in that expenses are growing more rapidly than revenues. However, these escalation factors can be customized to reflect each school’s funding environment. In the current period of COVID-19 uncertainty, it will be important to reflect actual per pupil revenue and any one-time revenue sources, such as Paycheck Protection Program funding, for the current fiscal year. Underwriters may also require an assumed 5% to 10% reduction in per pupil revenues for the next fiscal year or two. They will likely perform sensitivity analysis to determine how much per pupil revenue can be cut and still allow a school to break even, with no operating losses.

The detailed Tab 6 is linked to a summary version of the pro formas in Tab 7, which might be more appropriate for certain audiences. Both versions calculate a number of ratios lenders review based on the results of inputs, including net income margin, debt service coverage, debt burden percentage, and facility burden percentage, among others. These calculations will provide insight into a lender’s underwriting analysis and how a school’s metrics compare to the benchmarks discussed in the Refinancing Options section of the guide.

Cash Flow Projections Template
In addition to annual pro forma budget projections, lenders will request a monthly cash flow projection, typically for a 24-month period. Lenders will use this projection to assess whether operating cash flow is sufficient to cover operating expenses and sustain adverse events, such as per pupil funding deferrals or reductions, loss of students, or unanticipated expenditure increases. Like the pro forma budgets, this template includes the major revenue and expense line items used by charter schools and automatically calculates cash balances on a monthly basis.

Borrower Financial Tables
Underwriters typically analyze audited financial results for the most recent three-year period to assess a school’s financial strength and historic operating performance. Schools can customize this tab to input their most recent audited financials, and the tool will calculate several financial performance metrics lenders use, including: net income margin, current ratio, quick ratio, days cash on hand, total debt/net assets, total liabilities/ net assets and total debt/total assets. The “Minimum Benchmark” column shares ratios generally required by the most flexible CDFIs or mission-driven lenders. Schools can compare results to these minimum benchmarks and to the requirements for other sources discussed in the Refinancing Options section of this guide.

Loan Amortization Schedule Template
Tab 10 allows schools to calculate amortization schedules by inputting the loan amount, annual interest rate, amortization period (in months) and term (in months). Monthly and annual debt service payments will be automatically calculated based on these inputs. This tool also calculates the balloon amount due at maturity if the loan term is shorter than the amortization period. The balloon amount is the amount of principal outstanding at maturity of the loan that will need to be refinanced.

For bond refinancing options, schools should request a debt service schedule with principal and interest payments based on the underwriter’s recommended bond structure. Bond offerings are generally structured to achieve level annual debt service over the life of the bond. If the borrower has existing debt for other schools or other projects, the individual bond’s debt service can also be structured to achieve level annual debt service for the borrowing entity as a whole. For example, if a school has existing debt with level annual payments, it could structure minimal principal repayment on the new bond issue in the early years, when existing debt is outstanding, in order to achieve level debt service over a longer period. The underwriter should also provide the all-in cost associated with various structuring scenarios, as discussed further in the Bond Market option in the Refinancing Options section.

Refinancing Sensitivity Analysis
If a school’s refinancing option is not fully amortizing, as is the case for short-term and mini-permanent, or medium-term, financing, it will have a principal balloon amount to refinance at maturity. Lenders will perform sensitivity analyses to assess the magnitude of refinancing risk associated with this balloon payment, since it affects their repayment. The balloon amount in this tab is linked to the balloon calculation in Tab 10, Loan Amortization Schedule, but schools can input the number directly in this tab as well. The other key school input is annual net operating income in the year refinancing debt matures.

The table calculates debt service coverage ratios for the next round of permanent, or takeout, financing that will refinance the principal balloon, depending on a range of amortization periods and interest rates. If this table indicates low debt service coverage ratios based on the balloon amount, the lender may request a shorter amortization period on its loan in order to reduce the amount and the corresponding risk. On the other hand, healthy debt service coverage ratios well above 1.2x in this table—with more conservative assumptions of short amortization periods and high interest rates—will give a lender comfort that the refinancing risk is low.

Related Articles in Undertsanding your Needs:

Related link in Essential Resources:

Legal Disclaimer:

Nothing in this material should be construed as investment, financial, brokerage, or legal advice. Moreover, the facts and circumstances relating to your particular project may result in material changes in the processes, outcomes, and expenses described herein. Consult with your own professional advisors, including your financial advisors, accountants, and attorneys, before attempting to consummate any transaction described in this material.