Unrated Texas deal will be largest for charter schools
DALLAS — A Texas charter school operator plans to price what industry participants say will be the largest-ever deal for charter schools on Tuesday.
International Leadership Texas will use the proceeds of the $346 million in unrated bonds to buy 13 campuses across the state. The deal, expected to close Dec. 21, follows a $55 million private bond sale in September to purchase campuses in Grand Prairie and Katy, Texas, and a previous $111 million deal to acquire its original four campuses in 2015. The school district issues public debt through the Clifton Higher Education Finance Corp.
The 30-year bonds, coming in two series, include $14.5 million of taxable debt.
“The main motivation for issuing such a large bond issue is to purchase facilities that are currently owned by developers with lease structures with annual payments and acquisition prices escalating 2.5% annually,” said financial advisor Drew Masterson, managing director of Masterson Advisors.
“Texas is an excellent state for charter management organizations to grow,” Masterson said. “With a single charter, CMO’s can add additional campuses with Texas Education Agency approval. This allows for significant economies of scale operationally. Additionally, once scale is achieved the existing schools help support the financings for new schools.”
Without ratings, the bonds will test the muni market’s appetite for high-yield debt and come amid volatility in the equity markets.
The deal also comes after IL Texas declared a technical default Nov. 7 on its 2015 bonds for failing to maintain operating reserves equal to at least 40 days of operating expenses for the fiscal year ended June 30. In the prior year, the district was flagged for dropping below the debt service coverage ratio in its bond covenant.
School officials say they are encouraged after investor outreach meetings.
“We’ve met with 10 large institutions in Boston and Chicago and a similar number in New York,” said Alan Seay, chief executive of IL Texas.
“We had many great questions with really constructive feedback,” he said.
“There is no substitute for personal interaction with our investors and potential investors,” said Eddie Conger, a retired Marine officer and former public school principal who became the district’s first superintendent. “I love telling the story of our strong academics that you just can’t get from a document.”
Masterson left Hilltop Securities to launch his own firm and specialize in charter schools after Hilltop dropped charters in favor of traditional school districts. Jonathan Church, vice president at Masterson, is also working on the deal.
The underwriting team at BB&T Capital Markets is led by managing director Rob Nickell.
The deal is expected to appeal to institutional investors. Although these bonds do not qualify for the Texas Permanent School Fund guarantee, the call features are designed to allow a refunding with PSF debt when IL Texas becomes eligible.
“We are considering serial bonds in the early years and term bonds in the intermediate and longer-term maturities,” Masterson said.
In the wake of the technical default, a consultant’s report found that the material event could have been avoided and recommended a series of corrective practices.
“The new and proposed future debt is structured to improve future cash flows and liquidity,” the consultant Dynamic Support Solutions wrote. “These transactions by themselves, exchanging monthly lease payments for semi-annual debt payments, will bring additional liquidity to IL Texas and is expected to bring the company into compliance with the liquidity requirement.”
Since opening in 2013, IL Texas has contracted with property developers to build its facilities. The developers fronted all the costs of site purchase, site development, and campus construction. Then they leased the campuses back to the charter school using leases that provided financial incentives to the school to purchase the buildings two to five years after construction.
The 2015 bond transaction represented the first of the purchase options. The two bond transactions in 2018 continue the strategy and will result in IL Texas being the sole owner of all its campuses, officials said.
“Our growth between 2016 and 2017 is what is moving this transaction into the unprecedented territory,” said Seay. “This is a good deal for the school in that, ultimately, we will realize significant savings paying back the bonds versus continuing to pay for the leases.”
IL Texas has promised to maintain a debt service coverage ratio of 110% on the new bonds.
Unlike traditional public school districts that have taxing power for buildings and facilities, charter schools have leased facilities or have purchased and adapted existing properties such as churches, office buildings and other types of structures.
In recent years large charter operators in Texas have teamed with developers to build more attractive facilities. The transactions start with lease-to-own agreements, with rental converted to ownership through bond transactions.
The nonprofit International American Education Federation Inc. received a five-year Texas Education Agency charter for IL Texas in March 2013. The charter was renewed this year for 10 years and will be up for renewal every 10 years thereafter.
IL Texas, which focuses on foreign languages, leadership and physical fitness, enrolled a record 2,500 students at its first campus built by Athlos Academies in the Dallas-Fort Worth area. Since 2013, Athlos has built 11 IL Texas campuses in the Dallas-Fort Worth area and five in the Houston metro area. Another school in College Station near Houston was built by Hawkins Companies. All the schools bear similar traditional architectural designs.
School officials plan to achieve investment-grade ratings in the process of expanding their reach across Texas.
This week's deal comes 20 years after the first charter school bond issue.
“I think to date, this is the largest single transaction that’s been issued,” said Brian Colon, manager at R.W. Baird & Co. “With scale comes larger capital needs. And with larger capital needs comes larger issues.”
Baird is the top underwriter for charter school bonds but is not involved in the IL Texas deal.
"As long as public education remains underfunded and charter schools continue to be in demand (there are 140,000 names on charter school waiting lists across the state), we expect overall volume will continue to increase," said Katherine Bathgate, spokeswoman for the Texas Charter School Association.
The previous largest single charter school issue of $192 million came from American Leadership Academy Inc. in Arizona in 2017 through the Pima County Industrial Development Authority.
The third largest came from Idea Public Schools, the largest charter operator in Texas. The $176.6 million issue, underwritten by Baird last year, financed improvements at Idea’s existing educational facilities, to acquire land for future schools and other school expansions and to advance refund some of IDEA’s bonds issued in 2009 and 2010. The refinancing provided more than $13 million of total interest cost savings to Idea, officials said.
About 140 publicly offered charter school bonds were issued in 24 states, totaling over $3.5 billion, according to Baird. Arizona issued the most bonds in 2017 with more than $882 million, beating out Texas' more than $531 million.
Texas’ second-largest charter school chain, Harmony Public Schools, received an underlying rating of Baa2 from Moody’s Investors Service for a $37.8 million issue of revenue and refunding bonds through the Arlington Higher Education Finance Corp. in April 2017. The investment-grade rating qualified Harmony for the PSF’s triple-A guarantee.
By refunding $11.9 million of Series 2011A bonds with bonds guaranteed by the PSF, Harmony was able to use $5 million from its debt service reserve fund for the refunding. That allowed Harmony to enhance net present value savings without extending debt service.
To date, the PSF has guaranteed nearly $1.7 billion of charter school bonds, a fraction of the bond volume guaranteed for traditional public schools. Charter schools have been eligible for PSF backing since 2014.