Ambitious Texas Charter Spurs Growth With Unrated Bond Deal

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DALLAS - In their early years, charter schools started out small, leasing space in churches or vacant buildings to stretch their meager funding for facilities.

Some newer Texas charter schools have started out big, creating entire districts and issuing bonds to finance construction or to buy high quality buildings. Among the largest are Harmony Public Schools, KIPP Inc., and Life School of Dallas, all with multiple campuses in the state.

Charter operators cite favorable Texas laws that permit multiple schools under a single charter and the recent addition of a triple-A state guarantee program for a limited number of bonds that carry investment-grade ratings.

Harmony has more than $110 million of bonds with the Texas Permanent School Fund guarantee, while KIPP has the wrap on nearly $95 million of bonds. The PSF backs more than $90 million issued on behalf of Life School, according to the Texas Education Agency.

One of the newest entrants in the Texas charter school movement decided not to wait for the PSF guarantee before issuing $111 million of unrated bonds to buy six campuses in three cities. The August deal was one of the largest for a Texas charter school operator to date.

Known as International Leadership Texas, the nonprofit chose to take advantage of low interest rates now rather than wait for a rating and application for the PSF guarantee.

"We initially thought the market would not be interested in us unless we had PSF backing," said IL Texas founder Eddie Conger, a retired Marine Corps major and former principal in the Dallas Independent School District. "But because we started so large, it was enough of a short history that financials could prove out to the bond market."

The IL Texas district began with 2,500 students in August 2013, an enrollment that grew to 5,176 students in its third year.

"The thing that catches everybody's eye is that it's so big and it's only after two years of operating history," said Drew Masterson, managing director at First Southwest Co. and financial advisor on the deal. "It was the largest first-year charter in the country when it opened."

As evidence of demand for its international curriculum that emphasizes English, Spanish and Mandarin, the district claims a waiting list of more than 6,000 students.

The district now operates schools in the Dallas-Fort Worth region, with campuses in Garland, Arlington and Fort Worth.

Within the next year, IL Texas plans six groundbreaking ceremonies for its new campuses opening in Arlington and Keller near Fort Worth, and Katy in the suburbs of Houston.

"What makes this bond sale so very important to me is that it helps us lower our costs, which allows us to return some of that savings back to our teachers who serve our most important people, the students and their families," Conger said. "It reduces our annual expense to the tune of about $800,000, and it gives us stability. We don't have to deal with a 2.5% increase in rent ever again."

The deal allows IL Texas to buy the buildings that it had already been using under a lease arrangement.

"The cost savings from the low-interest-rate market we're in now compared to the lease payments were more compelling than waiting for PSF," Masterson said. "It was really just a cash flow comparison that drove the decision."

The bonds were issued through the Clifton Higher Education Finance Corp. and underwritten by BB&T Capital Markets. Fourteen institutional investors, including insurance companies and a hedge fund, acquired the bonds. The all-in interest cost came to 5.84%, Conger said.

Paula Permenter, managing director at BB&T, said that some of the buyers were first-time investors in charter schools.

"Charter school revenue bonds are story credits," said Permenter, whose firm specializes in the sector. "The school did an excellent job of articulating their history and growth plans and answering all investor inquiries."

Last year BB&T underwrote 16 charter school transactions totaling $223.2 million, Permenter said.

While a rating broadens the market for charter school bonds, Permenter said that tax-exempt funds, private money managers and insurance companies are becoming more receptive to unrated credits that show promise.

The bonds came to market as investors were digesting Puerto Rico's default, Chicago area credit downgrades, and several months of consistent municipal bond fund outflows, Permenter noted.

"Therefore, a lot of the investors that typically participate in charter school financings did not participate in this deal simply because they were sitting on the sidelines based on these market events," she said. "What we found most interesting is that we had two investors who participated that had never bought charter school bonds in the past."

With the early milestones achieved, IL Texas envisions an investment-grade credit in its future and the possibility of refunding its debt with a PSF guarantee.

"Investors see this (the PSF guarantee) as an indication of political support in the state," Permenter said. "International Leadership has not been in operation long enough to apply, but they are aware of the credit metrics required to secure an investment grade rating and it is their goal to qualify for the PSF guaranty as soon as possible."

The Texas Legislature authorized the PSF backing for charter schools in 2013 under House Bill 885.

The Texas Education Agency issued the first charter school bond guarantees in March 2014 and has now guaranteed 16 bonds for nine charter districts. In total, the PSF has guaranteed $447 million in charter school debt, split between $266 million in new money and $181 million in refunding issues.

Texas has 550 open-enrollment, public charter schools that receive no state funding for facilities, which puts them at a financial disadvantage against traditional public schools.

Conger said one of his top goals is to close an $11,000 gap in teacher pay between his district and those of traditional public schools. Reducing facilities cost should help provide more money for teachers, he said.

In a major school finance lawsuit now before the state Supreme Court, charter schools are a party to the claim that public school funding is inadequate. Charter operators argue that because they receive no money for facilities, they are shortchanged about $1,000 per student.

"We're very hopeful that the Texas Supreme Court will put more money into education, and that will have a positive impact on our operations," Conger said.



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