CHICAGO - Catholic elementary and high schools are increasingly turning to the tax-exempt debt market to finance their capital projects, according to bankers at Ziegler Capital Markets, which recently closed a deal for the National Shrine of the Little Flower in Royal Oak, Mich.
"It's starting a trend for diocese schools to access the tax-exempt market instead of depleting their internal funds," said Lynn Daly, a senior vice president in Ziegler's church and school group. "We're very careful with any faith-based financing to make sure that we understand what we're financing, and that it's not exclusively a project for prayer. It takes a little bit more attention than with a university."
Religious universities have benefited for years from tax-exempt borrowing, but using tax-exempt bonds for K-12 schools with religious affiliations has been relatively rare. The subject has been debated for years, though many market participants have become more comfortable with the practice since a 2002 Sixth Circuit U.S. Court of Appeals decision ruling that bond-funded loans to such schools do not violate the First Amendment's establishment clause separating church and state.
But the issue remains somewhat open to debate as projects need to pass the court's "pervasively secular" rule for both the projects being financed and the secular extent of the school's programs. The test is easier for most universities to pass as they have broader non-secular programs than faith-based high schools. And while federal laws seem to endorse tax-exempt issuance for schools with religious affiliations, state laws can be stricter.
In the case of the Shrine of the Little Flower, a high school, proceeds will finance construction of a new athletic field house and various renovations.
Like other issuers, faith-based organizations are attracted to the relatively low cost of borrowing in the tax-exempt market.
"It's an extremely cost-efficient way to borrow for faith-based organizations," said Scott Rolfs, Ziegler's managing director of the church and school group. "The law was a bit unclear for kindergarten through 12th grade, but a lot of clarity was brought to the top with the 2002 court decision. It's still a state-by-state analysis, as some are more permissive than others. But it's a concept that works quite well and it does give them some opportunities if they want to conserve endowment dollars."
On Oct. 9, Ziegler sold $4.1 million of tax-exempt variable-rate demand revenue bonds, backed by a letter of credit from Charter One Bank, for the National Shrine of the Little Flower high school in Royal Oak. Unlike other similar deals, the bonds are backed only by the revenues of the school, not a guarantee from the archdiocese, Daly said.
"The archdiocese is not on the hook for the payments, it's all resting on the shrine," she said. "It's something that the archdiocese would love to see more of, but it's always tended to be easier to put their guarantee on it."
The transaction was buffeted by turbulence in the credit markets over the last several weeks. First the variable-rate debt market froze in mid-September just as the finance team planned to sell the bonds. After waiting three weeks, rating agencies downgraded Charter One's parent company, Royal Bank of Scotland PLC, three days before the team entered the market.
Deciding to move ahead despite the LOC's downgrade, the bonds managed to sell for an interest rate below the Securities Industry and Financial Markets Association weekly swap index, Daly said.
"It was another hurdle, another hitch thrown our way," she said. "It made us hold our breath to make sure the buyer was still on board."
Over a five-week period, the bonds have remarketed at roughly 5.6 basis points below SIFMA, said Daly.
Robert Schwartz from Michigan-based Butzel Long acted as bond counsel on the deal.