LOS ANGELES — The struggles of some charter school operators, and a recent across-the-board Fitch Ratings action targeting the sector, may raise questions about the viability of charter school bonds.
But charter school experts and supporters say such concerns are overblown, and the fundamental equations of charter school credit remain unchanged.
“There are credit issues that have long been understood about the sector that continue to exist,” said Eugene Clark-Herrera, a San Francisco-based public finance partner at Orrick, Herrington & Sutcliffe.
The primary issue for charter bonds remains that the school renewals run from five to 15 years, while long-term bonds have 20- to 30-year maturities, he said.
“That has always been the primary issue: Will the charter be renewed, so the school can remain in existence until bond maturity?” said Clark-Herrera, co-author of the Orrick publication “Public Charter Schools: Borrowing With Tax-Exempt Bonds.”
One California charter school issuer did a financial high-wire dance this summer
The American Heritage Education Foundation, operator of two Escondido charter schools, narrowly avoided having to repay $24 million in outstanding bond debt after it went into technical default.
The bonds were issued through the conduit California Municpal Finance Authority.
Although the school operators are current on bond payments, it violated the bond covenant by failing to maintain the debt-service coverage ratio for fiscal 2011, according to disclosure documents posted on the Municipal Securities Rulemaking Board’s EMMA website. Under the agreement, if the bonds drop below the prescribed ratio, bondholders can accelerate payments.
According to filings, the school’s leaders asked bondholders for a waiver on the technical default and for modifications to the covenant so that acceleration upon technical default would be an optional provision, not mandatory. Bondholders have not approved the amendment.
On Oct. 5, the U.S. Bank National Association, trustee for American Heritage’s bonds, posted a disclosure filing notifying bondholders that it will not accelerate repayment of the bonds as a result of the technical default. Over 91.4% of bondholders either voted to waive the default or instructed the trustee not to accelerate amounts owing on the bonds, according to the disclosure.
If bondholders had not waived the covenant requiring accelerated payments when Heritage failed to maintain its debt-service coverage level, Heritage would have been required to immediately pay the full amount of the bonds and accrued interest, according to disclosure documents.
Standard & Poor’s downgraded Heritage’s bonds to speculative-grade on June 19, reducing the rating to BB-plus from BBB-minus.
The credit rating agency further downgraded the credit to BB-minus on Sept. 19
On Sept. 18 Fitch put all of the charter school bonds it rates on negative watch.
The rating agency made the announcement that it would alter its criteria to include more stringent requirements for school finances and place more emphasis on political and regulatory factors after some individual issuers faced financial setbacks.
Clark-Herrera said he found Fitch’s decision to put the bonds on negative watch reactionary.
“I don’t think Fitch was misunderstanding charter schools before they did the downgrade,” he said. “I think their criteria is thorough and complete in terms of the characteristics they look at.”
The $5.4 billion charter school bond sector has a low default rate, according to Elise Balboni, project director for the study “Charter School Bond Issuance: A Complete History” produced by the Local Initiatives Support Corp., a nonprofit community development corporation.
According to Balboni, bonds in the charter sector have a 3% default rate as only 22 have defaulted out of almost 600 issuances.
Of that number, there were no defaults on investment-grade-rated charter school bonds, one default on non-investment rated and 21 defaults on unrated issuances, she said.
Just prior to Fitch’s announcement, it had three multi-notch downgrades of charter schools across the country. Among schools that took hits was the Fulton Science Academy in Georgia. The State Board of Education denied its request for a charter renewal within six months after it issued bonds.
Fitch downgraded the bonds to CC from B and withdrew its ratings.
Clark-Herrera said he doesn’t think there have been any new developments in state charter laws to give investors any reason for new concerns.
Aside from the duration and renewal of a charter, the other fundamental issue for a charter issuer is whether the academic program is successful enough to continue to attract students, because if parents take their kids out of school, it loses funding, he said.
Balboni said the 15-year-old sector could become as big as health care, but she said there needs to be more uniformity in underwriting standards.
Although Standard & Poor’s considers academic success an important criteria in determining credit strength, some underwriters do not include much information about academics in disclosure documents, Balboni said.
“We need to find measures everyone can agree upon about what makes a good charter school,” she said.
One change in rating criteria that made sense to Clark-Herrera would be to require the school have at least one charter renewal in order for a rating to reach investment grade.
That was one of the changes proposed by Fitch.
The agency plans to give speculative-grade ratings to all schools until they have at least five years of audited history and have had their charter renewed.
“Nothing has changed in terms of the law or the funding of schools,” Clark-Herrera said. “It is a matter of the rating agency evolving its rating criteria.”
The school leaders at Heritage might beg to differ when it comes to school funding changes.
School leaders said they have experienced significant changes.
According to a letter that Dennis Snyder, president of Heritage, wrote to the bond trustee, California eliminated facilities funding for students who fell under its individualized learning program, causing its funding shortfall in fiscal 2011.
The school has since been able to return its debt coverage ratio to prescribed levels by increasing enrollment and through employee attrition, according to disclosure documents.
While the cuts Heritage received because of its large individualized learning program are likely an issue specific to them, the state’s charter schools have been facing other hardships, according to Vicky Waters, a spokeswoman with the California Charter School Association.
All public schools have experienced budget cuts, but the situation is exacerbated for charter schools because of continued deferrals, funding inequity, and lack of facilities provided by districts, Waters said.
The state has released expected funding to public schools, both traditional and charter, months late.
The number of charter schools in California has grown from 809 schools enrolling 341,000 students in fiscal 2009 to 982 schools teaching 412,000 students in fiscal 2011, Waters said.