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Different Kinds of Loans
Charter schools can borrow money in one of two primary ways. The first is through a traditional loan and the second is through bond financing.* In both instances, without governmental or other intervention, financing costs for charter schools can be relatively high. A third, less common method charter schools have been able to use to obtain loans for their facilities is through a publicly funded loan program. This section discusses how some jurisdictions are attempting to make financing more affordable for charter schools.
Allowing Charter Schools to Indirectly Issue Bonds
Most states and Washington, D.C., attempt to make bond financing as affordable as possible for charter schools by allowing them to utilize public bonding authority, giving them the ability to directly or indirectly issue tax-exempt bonds (usually limited obligation or revenue, not general obligation, bonds). As public entities with taxing authority, local school districts have long had access to this low-cost financing mechanism. Those jurisdictions wishing to give the same opportunity to charter schools have done so by making it clear in statute that local government and other public finance authorities are empowered to issue tax-exempt bonds on behalf of charter schools. These are known as conduit issuers. In some instances, lawmakers have given this authority to existing governmental entities, such as public finance authorities; in others, they have created a new entity vested with the authority to issue bonds on behalf of charter schools. Either way, explicitly authorizing conduit issuers has been the most prevalent strategy thus far for allowing charter schools to borrow at a relatively affordable cost.
According to a 2007 study by Local Initiatives Support Corporation (LISC), a nonprofit community-based development organization, about two-thirds of the states with charter school legislation, plus the District, have made charter schools eligible to access tax-exempt bonds through conduit issuers. Seventeen states have a statewide (or, in the case of the District, districtwide) conduit issuer that has issued tax-exempt municipal bonds to finance charter facilities.28 The ability of these organizations to issue tax-exempt bonds on behalf of charter schools lowers borrowing costs for the schools.
All conduit issuers charge fees for their services, although the services included and the mechanisms for calculating the fees vary. Their fees vary, too: Some conduits charge a fixed onetime amount, some charge annual fees that vary based on the size of the principal, some charge variable one-time fees, and still others charge both an initial fee and subsequent annual fees. These fees generally come on top of additional charges associated with any bond issuance (e.g., those from the underwriter with whom a conduit works to issue the bonds or from a legal or financial advisor [or, in some cases, both] who might be involved in the process). However, some conduits provide some of these services. A charter school seeking to finance its facilities through bonds also must be prepared to pay whatever interest rate lenders require. This rate is not set by the conduit issuer, but by the market, and is influenced by the school's creditworthiness.
Table 3 on page 21 lists state-authorized conduit issuers in four states—Colorado, Massachusetts, Michigan, and Texas—and a district-authorized conduit in Washington, D.C., which are among the most active nationwide in issuing tax-exempt bonds for charter schools. In some of these jurisdictions, charter schools also have access to local-level or countywide conduit issuers. But, based on the high level of tax-exempt bond offerings that these five conduits have issued on behalf of charter schools, each seems to be a predominant issuer in its jurisdiction. The role that each of these conduit issuers has played in the charter bond market in its respective area is discussed below.
Colorado. In 1998, Colorado became one of the first states to grant charter schools the ability to issue tax-exempt bonds through a public authority when the state legislature gave an existing conduit issuer, the Colorado Educational and Cultural Facilities Authority (CECFA), the ability to issue bonds on behalf of charter schools.29 CECFA began issuing bonds for charters in 1999.
According to Jim Griffin, president of the Colorado League of Charter Schools (League), his members consider CECFA to be "a very capable, active, and helpful conduit financier." Although CECFA's fees were relatively high to begin with, he says, once it started doing a significant volume in charter bonds, it reduced its fees, and the costs to charter schools became reasonable. In recent years, the governing board of CECFA has voted to reduce its annual fees by 50 to 75 percent.
Bill Dougherty, a financial advisor to CECFA, says that, prior to expansion of the conduit's scope, the financing environment for charter facilities had been "predatory in nature." In the early- to mid-1990s, after the first Colorado charter school bill passed, new schools were forming without any established way for them to borrow capital. Dougherty characterizes it as a time when the "very few providers" (i.e., lenders, investors, and underwriters) were demanding "very high interest rates at onerous terms" on such financing options as commercial mortgage loans and taxable bonds. When charter schools started to push for less expensive ways to finance the capital they needed for facilities, the logical step was to give them access to CECFA and, through it, to tax-exempt bonds.
Gradually, according to both Dougherty and Jo Ann Soker, CECFA's executive director, as the charter school bond market has developed through the work of this conduit issuer, so, too, has the financial acumen of charter school operators in the state. One result is that some charter school operators secured investment-grade ratings for their bonds due to their school's strong fiscal operations. Because higher ratings allow schools to realize lower interest rates on their bonds, these schools can achieve lower ongoing financing costs.
Massachusetts. The Massachusetts Development Finance Agency (MassDevelopment) is the Commonwealth's finance and development authority, legislated into existence for the purpose of providing businesses and local officials in distressed communities with financial and real estate tools and expertise to stimulate economic growth in the state. Helping to finance charter school facilities in these communities is intended to spur the state's economic growth by creating jobs (e.g., from building construction or renovation), as well as by supporting education. One of MassDevelopment's roles is acting as a conduit to issue tax-exempt bonds for charter schools. Once a charter school decides to seek bond funding for its facility, MassDevelopment guides the school through the process. In addition, its staff may advise school operators on related issues, such as real estate and building renovation, areas of expertise for the organization derived from its overall economic development charge. Marc Kenen, executive director of the Massachusetts Charter Public School Association, says that, given the inherent complexity of issuing charter school bonds, having MassDevelopment facilitate the process is almost as important as its ability to issue the tax-exempt bonds. He adds that the charter community considers the agency to be especially helpful in pre-project planning; instances of this include guiding operators through the basic components involved in renovating a building (e.g., role of an appraiser, state requirements, environmental regulations) and helping school operators explore alternative financing, such as federally funded loans, for their projects.
Michigan. A major role of the Michigan Public Educational Facilities Authority (MPEFA or Authority), created in 2002, has been helping charter schools—known in Michigan as public school academies—to acquire tax-exempt bond financing. Since 2003, MPEFA has been an active conduit issuer for charter schools (see table 3 on p. 21) and, as of July 2008, it was working on an additional $88 million in bond deals for nine schools.
MPEFA financial manager Kathleen O'Keefe notes that this conduit issuer provides some benefits that commercial financiers cannot offer. For example, as will be detailed later in this section, MPEFA can intercept a charter school's per-pupil funding from the state, diverting it to pay bondholders directly, a service that makes the bonds more appealing to buyers because it decreases the risk that schools will pay their lenders late or not at all. In the same vein, she says, the Authority's close relationship with the Michigan Department of Education allows it to productively and quickly deal with "any hiccups in state aid payments" that otherwise might interfere with charter schools making timely payment on bond debt.*.
According to Dan Quisenberry, president of the Michigan Association of Public School Academies (MAPSA), one important aspect of MPEFA's work is that, by creating a "healthy infrastructure" for charter schools to seek bond funding, it has fueled the development of a bond-financing market in Michigan for charter schools. This has come about in part, Quisenberry says, because the conduit issuer's oversight on bond deals has given investors more comfort in buying charter school bonds.
Texas. In 2003, the Texas Public Finance Authority (TPFA)—a state agency that since 1984 has provided capital financing for state agencies and certain public institutions of higher education—established the Charter School Finance Corporation (CSFC) as a nonprofit corporation under Chapter 53 of the Texas Education Code.30 An amendment to the Texas Education Code enabled the authority to create the CSFC to issue bonds specifically for the acquisition, construction, repair, or renovation of facilities for open-enrollment charter schools.31 Other local conduit issuers in Texas also are able to issue bonds on behalf of charter schools and began doing so in 1999, with the first bond issue closing in early 2000.
Kim Edwards, executive director of the TPFA at the time this guide was researched, notes that in Texas school finance is decentralized. Among other things, this means that under state statute, there is no geographic restriction on local conduit issuers; so, for example, a school in Houston can have bonds issued by a conduit issuer located in Dallas. Thus, the state's charter schools can choose to work with any one of a variety of municipal conduits in addition to the TPFA. As of June 2008, TPFA had issued over $130 million in bonds for six schools, which constituted over 40 percent of the dollar amount of the state's bond issuances to date for charter school facilities. The bond issues handled by the TPFA have tended to be larger than those handled by local conduits; for example, there was a $35 million issue for KIPP (Knowledge Is Power Program) in Houston and a $37 million issue for IDEA Public Schools in various locations in the state. Edwards attributes these larger bond deals, in part, to the fact that the schools for which TPFA has issued bonds have tended to be larger and more established than others in the state, making them relatively more appealing investments.
Washington, D.C. The District of Columbia Home Rule Act authorizes the District to issue tax-exempt bonds for the acquisition, construction, and renovation of eligible capital projects that are owned by nonprofits, including charter schools.32 The District created the Revenue Bond Program, which is administered under the Office of the Deputy Mayor for Planning and Economic Development. According to program director William A. Liggins, to qualify for the program, charter schools must receive tax approval and planning approval, if needed (e.g., zoning variance) from various agencies, as well as a memorandum of understanding from the District's charter school board. In addition to the relatively high volume of bond transactions the District had completed for charter schools as of December 2008 (as shown in table 3), five additional revenue bond issues worth $103.2 million were pending. Because the bonds issued through the program are tax-exempt, says Liggins, the longer-term bonds tend to have interest rates that are 2 to 3 percentage points lower than those on taxable bonds with the same term. In addition, he notes, his office has made an effort to expedite the issuing process; applications are generally reviewed, sent to various agencies for their approval, and voted on by the city council within 90 days—a relatively short time span, as it is not uncommon within the charter school bond world for it to take up to a year to structure and close charter school bond deals. Even when glitches come up, such as tax or zoning problems, Liggins says, they are usually resolved quickly and the deals are approved within 120 days.
Allowing Charter Schools to Directly Issue Bonds
Another way for state policymakers to provide charter schools with tax benefits aimed at alleviating the burden of facilities costs is to establish the legal framework for the schools to issue tax-exempt debt directly. By giving charter schools the power to issue bonds on their own behalf, rather than rely on conduit issuers, legislators could help schools further reduce their bond transaction costs.
Thus far, this policy alternative remains primarily a theoretical option. A recent development in Michigan, however, has opened the door to giving charter schools authority to directly issue their own tax-exempt bonds. Michigan's Revised School Code, Act 451 of 1976, provides the state's charter schools, known as public school academies, with statutory authority to issue bonds, as do traditional public schools. For many years, however, it was unclear whether the obligations of such schools could be issued directly on a tax-exempt basis.33
As part of its audit of Summit Academy North charter school in Romulus, Mich., the Internal Revenue Service (IRS) confirmed in a 2006 technical advice memorandum (TAM) that "a public school academy [i.e., charter school] is permitted to borrow money and issue taxexempt bonds." 34 An attorney commenting in the Bond Buyer about this IRS memorandum speculated that the ruling could be a helpful for charter schools across the country, given that many states have similar laws establishing that charter schools are public schools and, further, that they have the authority to issue bonds. 35
The IRS became interested in these issues because of a legal opinion accompanying a lease-purchase agreement that Summit Academy North entered into with Ohio-based Park National Bank in 1998. The opinion, written by the law firm counseling the academy, indicated that interest payments on the debt were tax-exempt because the academy was a "political subdivision" of the state.36 While the TAM concluded that the academy was not a political subdivision of the state, it also concluded that, as a public school and as structured under its particular charter agreement (which was granted by a Michigan university), the academy was carrying out governmental functions as an extension of the state and, therefore, should be able to issue tax-exempt bonds.37
Since this 2006 IRS decision, the state of Michigan has not tracked how many other charter schools have taken advantage of the ability to issue tax-exempt debt directly. Nor is it clear how broadly applicable the TAM might be beyond the particular facts and circumstances of this case. MAPSA's Quisenberry says his impression is that a few other charter school operators have issued debt in this fashion and that, among charter school operators, it is considered a welcome alternative but probably not a far-reaching solution to the facilities-funding challenge. Simply because charter schools have the legal right to issue tax-exempt debt themselves, he says, does not mean that the market will allow all schools to do so. He suggests that for charter schools that are considered a high risk, such as those in the start-up phase, issuing through a conduit may give potential investors an added layer of security.
Compensating Investors With Tax Credits in Lieu of Interest
As an incentive to invest in charter schools, state policymakers can make federal tax breaks available to investors. This option is intended to accomplish the same policy objective as taxexempt financing by creating opportunities for charter schools to obtain more favorable financing terms.39 Several states have moved to make charter schools eligible to participate in their state's allocation of Qualified Zone Academy Bond (QZAB) tax credits.40
The federally sponsored QZAB program allows public schools (including charter schools) to issue the tax-credit bonds if the school is located in an empowerment zone or enterprise community or is serving a population in which 35 percent or more of its students are qualified to receive free or reduced-price lunch. In addition, to qualify for QZAB allocations, a school or district is required to raise a contribution from private business equal to at least 10 percent of the proceeds from the bond issue. Proceeds from QZABs may not be used for construction of new facilities, but can be used for a variety of other school-related needs, including rehabilitation or repair of facilities. Investors earn tax credits, which make them willing to accept lower interest payments, thus reducing the cost of borrowing for charter schools.
Congress has authorized $400 million for the QZAB program each year since 1998, parceling out allocations of QZAB tax credits to states and territories based on the percentage of their population living below the poverty line.41 States have the authority to determine whether to allocate some portion of their QZAB allocation to charter schools, as well as to determine the amount of that allocation, if any.42
The QZAB program was conceived largely as a way of subsidizing school renovations in low-income communities by allowing schools to shift the interest payments on their financing from the borrower (i.e., the school) to the federal government. QZABs differ from tax-exempt bonds, for which the borrower pays interest, albeit at a relatively lower rate, since the investor does not have to pay tax on QZAB earnings. The U.S. Department of Treasury is supposed to set a tax credit rate on QZABs so that, on average, school districts that use the program will pay no interest. For example, investors might need to receive tax credits at the same rate they receive interest on corporate bonds with an "A" rating (e.g., 8 percent) in order for the investors to require no interest. Under this scenario, the Treasury would use the interest rate of A-rated corporate bonds as the rate at which it would provide tax credits on QZABs. For every dollar investors held in QZABs, therefore, they would receive 8 cents a year in tax credits until the bond matured. As a general rule, QZABs cut the cost of financing by half, according to an estimate in a 2004 Education Evolving report.43
According to a 2007 study by Local Initiatives Support Corporation (LISC), which provides a catalog of financing options available for charter school facilities nationally, only 24 of the 41 jurisdictions with charter legislation expressly make charter schools eligible to participate in their QZAB programs, with four more having no explicit prohibition against charter schools' participation.44 The LISC report also found that, as of 2007, charter schools in several jurisdictions (Arizona, California, Massachusetts, Michigan, Wisconsin, and the District) had issued QZABs. Among the jurisdictions featured in this guide, five have issued QZABs to charter schools—Arizona, California, Massachusetts, Michigan, and the District. These five jurisdictions are among the most active nationwide in allocating QZAB credits to charter schools.
As of August 2008, approximately $3.5 million in QZAB credits had been allocated to Arizona charter schools according to Steven Race, chief financial officer at the Arizona Department of Education, which administers the state's allocation of QZAB credits. All public schools, including traditional and charter schools, that meet the federal eligibility criteria may apply to participate in the state's QZAB program. Arizona's QZAB credits are allocated to eligible applicants on a first-come, first-served basis.
California charter schools may apply to participate in the state's QZAB program either directly or through their authorizing districts.45 California Department of Education (CDE) staff are charged with reviewing and awarding QZAB applications. They score project proposals based on the clarity and strength of required application elements (e.g., descriptions of the pledged contributions from private business). The application process and eligibility requirements are the same for charter schools as they are for traditional public school districts, except that a charter school applying separately from its authorizing district must inform and solicit support from its authorizer. According to Shannon Farrell-Hart, education fiscal services consultant in the CDE's School Facilities Planning Division, as of August 2008, the state had allocated $14 million in QZAB credits for charter schools, with another $2.5 million pending and expected to close later in the year.
Qualified public schools in Massachusetts, including charters, are eligible to participate in the state's QZAB program on a first-come, firstserved basis, according to Cliff Chuang, coordinator of Charter School Research and Finance at the Massachusetts Department of Elementary and Secondary Education, which helps administer the program and allocate the state's QZAB credits. Chuang reports that since 1998 $33.6 million, representing 83 percent of the state's total QZAB allocations, has been issued on behalf of seven charter schools, with MassDevelopment serving as the conduit issuer for most of the QZAB deals.
However, there has never been an over-demand for QZAB allocations in the state because they entail complicated financial transactions and strict eligibility requirements, says Chuang, adding, "You can't go into this without sophisticated financial expertise. Then you need to have a consultant who really knows what he or she is doing, somebody who has studied [QZABs]." The need for this level of technical expertise means that schools must hire private consultants, resulting in higher transaction costs. Charter schools that have applied for QZABs have tended to be the state's larger, more established operators, according to the Massachusetts Charter Public School Association's Marc Kenen.
In Michigan, as of August 2008, the state had allocated about $3.7 million in QZAB credits for charter schools (or "public school academies" as they are known in the state), according to Andy DeYoung, an analyst in the Office of Grants Coordination and School Support at the Michigan Department of Education, which administers the state's QZAB program. As in Arizona and Massachusetts, all public schools in Michigan that meet the federal qualifications, including charter schools, are eligible to receive QZAB allocations on a first-come, first-served basis.
Charter schools are eligible to participate in the District's QZAB program as well. As of August 2008, the District had allocated $4.9 million in QZAB credits for charter schools, according to Liggins from the District's Office of the Deputy Mayor for Planning and Economic Development. Staff of this office are responsible for reviewing QZAB applications in the District and determining which of these will be presented to the city council for approval. Criteria used to evaluate applications include many considerations, such as the specific school improvements proposed, the level of need for physical improvements at each school applying, and the level of economic development in the area where the school is located. In addition, approval of QZAB applications submitted by charter schools takes into account whether the schools are in good standing with their chartering authorizers. Echoing Chuang's concerns about the difficulty of accessing QZAB funds, Liggins also notes that because of the complexity of the QZAB rules and regulations, it is challenging for charter schools to satisfy all of the associated credit requirements.
Additionally, Congress adopted the Tax Relief and Health Care Act of 2006, imposing restrictions on QZABs. This statute subjects QZAB issuers to the same arbitrage regulations as those that apply to tax-exempt bonds.46 In this context, arbitrage is profiting by borrowing at one interest rate, then investing the borrowed funds to earn a higher interest rate. While some say that investor interest in QZABs has declined in recent years due to overall market conditions, respondents from California, Massachusetts, and Washington, D.C., report that the new requirements have lessened the appeal of QZABs for investors and issuers alike.
In fact, Liggins suggests that by adding tax constraints that reduce the total amount of money that can be issued to schools, the new restrictions are at odds with the overall goal of the QZAB program, which is to give significantly lower-cost financing to qualifying schools. Whatever the reason, fewer QZAB deals have been packaged in the District recently, and Liggins anticipates that there will probably be an even greater slowdown in the future. Likewise, Rebecca Sullivan of MassDevelopment says her state has not used many QZAB allocations since these changes took effect. Chuang quantifies that observation, noting that prior to the arbitrage rule change Massachusetts used "every penny" of its QZAB allocations, but that as of spring 2008 the state had yet to give away over $13 million, the full amount of the state's 2006 and 2007 allocations. These allocations are due to expire in 2008 and 2009, respectively; meanwhile a $10-million deal for a Boston charter school is pending and expected to close before the end of 2008. Farrell-Hart of CDE makes a similar point to Chuang, stating that the arbitrage changes mean that QZABs are no longer "as good a deal for investors." She adds that, as of summer 2008, California had $48.6 million remaining from the $98 million awarded to the state in QZAB allocations for 2006 and 2007; as in Massachusetts, these allocations also are set to expire in 2008 and 2009.
Enabling Direct Loans for Charter School Facilities
As discussed above, the relatively low-cost finance options that states and Washington, D.C., have made available for charter school facilities has tended to relate to some form of bond financing. Another option for helping charter schools cover their capital expenses is to offer direct loans of public funds for this purpose. The District is the only jurisdiction interviewed for this project that has a dedicated loan fund for charter school facilities support. Established in 2003, the District's Direct Loan Fund for Public Charter School Improvement program provides flexible loan funds for the purchase, renovation, construction, and maintenance of charter school facilities, whether a school chooses to lease or own its site. As of the close of 2007, the District had obligated over $14 million in these direct loan funds, with approximately $12 million more available. According to Liggins from the District's Office of the Deputy Mayor for Planning and Economic Development, schools can receive up to $2 million in these loan funds at a relatively low interest rate (ranging from 2 to 4 percent over the life of the program thus far).
*Readers who are unfamiliar with the fundamentals of bond financing can find a very basic overview in the box on p.19 entitled, "Basic Bond Concepts and Terminology."