Texas Guarantee Could Raise Risk for Prior Charter School Debt: S&P
DALLAS — Now that Texas has provided its first Permanent School Fund guarantee for a charter school bond issue, Standard & Poor's is warning of a potential downside for holders of charter school debt without a PSF wrap.
The risk comes from a provision in state law that allows the Texas Education Commissioner to reduce state funds for a charter school that draws on state-provided reserves for its debt service.
Withholding or reducing regular state funding for a charter school could impair its ability to meet debt service on bonds issued before the PSF guarantee became available, said S&P analyst Karl Propst in a bulletin issued May 20.
"We believe, however, that a draw from and reimbursement to the PSF program are likely to occur only in a distress situation," Propst said. "We therefore do not believe that potential PSF reimbursement impacts the rating on non-PSF bonds while the underlying charter school is investment grade, or, in our view, otherwise not at risk of becoming delinquent on debt service payments."
The charter schools must carry an investment-grade rating to qualify for the PSF guarantee, but once the bonds are issued, the schools do not lose their PSF insurance if their issuer rating falls below investment grade, Propst said.
However, a junk-bond underlying credit would reflect some form of financial decline.
"I would think bondholders would have ample warning because they would see the deterioration of the school's finances," Propst said.
The underlying ratings for most charter schools already stand on the lowest rung of investment grade or slightly higher in the triple-B category.
In Texas, fewer than 20 of the more than 200 charter schools enjoy investment-grade ratings, and most of those carry only one rating.
So far, the scenario in which the Texas Education Agency might withhold state funding to cover draws on debt-service reserves is hypothetical, Propst said.
"How realistic is this? I don't know," he said. "The program is new and we've just started having requests for PSF ratings on these charter schools."
Bond attorney Thomas Sage, a partner at Andrews Kurth in Houston, disagreed with the idea that a school's non-PSF debt would be more at risk than the PSF debt under S&P's scenario.
In the event state funding were withheld from a school to repay a draw on PSF reserves, all of that school's parity debt would be affected equally, with or without the state guarantee, Sage said.
"The shortfall in revenue applies equally to all bonds," said Sage, who has worked as bond counsel on two PSF-backed charter school deals and is preparing for a third in June. "All the bonds suffer equally."
Texas has approved up to $727.4 million of charter school financing guarantees after passage of legislation allowing the credit wrap in the 2013 Texas Legislature. The refunding enhancement total is capped at 50% of the new-money charter school bonds with PSF coverage. Refunding issues must provide present value savings and cannot extend the maturities of the refunded debt.
The S&P bulletin was prompted by an increasing number of charter school bond issues carrying the PSF guarantee after the Life School of Dallas entered the market with the first triple-A wrap on April 30.
The Life School sale included $85.6 million of tax-exempt fixed-rate bonds maturing serially through 2044 with the PSF guarantee and $6.5 million of taxable Qualified School Construction Bonds. The bonds were sold at a combined interest rate of 3.8%, net of the federal tax credit for the QSCBs. Bonds with 4% coupons maturing in 2044 earned yields of 4.13%, a spread of 82 basis points against Municipal Market Data's triple-A, 30-year Texas bonds.
With a muni market hungry for new issues, the pioneering deal came at an opportune time, Sage said.
"It was five times oversubscribed," said Sage, who served as bond counsel. "There weren't a lot of PSF deals in the market, so it got a lot of attention."
The Life School debt included a $37.5 million refunding of bonds that were issued before the PSF guarantee was available. With the PSF guarantee, the deal provided present-value savings of 23% or $9 million, Sage said.
On May 22, the second PSF charter school deal came to market on behalf of Riverwalk Education Foundation Inc., which operates the School of Science and Technology in San Antonio.
A refunding of $6.3 million of Riverwalk's Series 2007 bonds with PSF-backed bonds produced present value savings of nearly 20%, or $1.4 million, Sage said.
Those bonds carried underlying ratings of BBB-minus from S&P with a stable outlook. The PSF guarantee provides triple-A coverage.
One of the better-known names among charter schools, KIPP Inc., is coming to market in early June with $48.8 million of PSF-backed refunding revenue bonds and $5.2 million of taxable qualified school construction bonds. The refunding bonds will take out $32.5 million of debt issued in 2006. Other proceeds will go toward a new campus.
After this deal, KIPP will have about $172 million of bonds outstanding, with debt service of about $12 million in fiscal year 2015, according to S&P.
Before applying the triple-A PSF rating to KIPP's upcoming deal through the La Vernia Higher Education Finance Corp., S&P lowered its outlook on the charter operator's BBB underlying rating.
"The negative outlook reflects our view of KIPP Houston's increased leverage our anticipation that growth may not catch up with the increased debt service for several years," analyst Carlotta Mills wrote with Propst as secondary analyst.
Despite that caveat, "we're extremely hopeful that KIPP will enjoy the benefit of the permanent school fund as these others have," Sage said.
Douglas Benton, senior municipal credit manager for Cavanal Hill Investment Management in Richardson, Texas, said that "all things being equal," his firm would prefer to own bonds from traditional school districts with higher underlying ratings.
"While speaking disparagingly of the Texas-PSF can be considered almost unpatriotic, I would note that this is a fact pattern whereby an untested process is being awarded a gilt-edge credit rating by the rating agencies," said Benton, a former analyst for Moody's Investors Service.
"Charter schools contain a noteworthy level of risk as the state does not have the same paternalistic financial assistance perspective as they have exhibited for the public schools," he added.