The charter school bond market is back, and even a Securities and Exchange Commission action against Chicago-based UNO Charter School Network Inc. this month for defrauding bondholders is unlikely to slow that growth.
Charter schools nationally raised $1.3 billion in bond offerings last year, the most since they were first issued in 1998. Investors eager for higher yields are fueling the market, which is dominated by junk bonds.
UNO’s problems are “typical of some charter schools, of growing pains and getting the management house in order,” says Standard & Poor’s Financial Services LLC analyst Carlotta Mills, whose agency gave that network a low investment grade rating with a “stable outlook.”
The bond market for charter schools grew steadily in the decade leading up to 2007, with $1 billion raised that year, but the financial crisis halved offerings in 2008. Chicago charter schools have raised $215 million in the bond market since 1999.
Noble Network of Charter Schools, one of the city’s fastest-growing charter systems, tapped the bond market for $20 million last year. Before that, UNO’s troubled $37.5 million offering in 2011 was the most recent deal and that system’s largest.
Local critics complain that charter schools aren’t as transparent as traditional public schools, a criticism underscored by the UNO violation, in which a school executive handed $13 million in construction and window installation contracts to a relative.
The SEC action, its first bond case against a charter operator, required UNO to revamp its management and submit to monitoring to prevent conflicts of interest. UNO is “taking all necessary steps to move forward and continue providing quality public charter school education in Chicago,” it said in a June 6 statement.
S&P justified its relatively rosy December rating on UNO—an update on an earlier rating—by pointing to the school’s ability to win renewal of three charters, recovery from recent deficits, improved cash levels and waiting lists for its schools.
Since 2006, UNO has used about $60 million in bond financing to build 16 schools with about 7,500 elementary and high school students. In addition to UNO and Noble, Chicago International Charter School and Perspectives Charter Schools have issued bonds. Charters typically count on making future payments on the bonds with per-pupil funding they receive from the school board.
“The municipal bond market is clamoring for more charter school bonds, but the reality of the situation is that we would need a dramatic increase in facilities funding or large charitable donations to make new school buildings possible,” says Craig Henderson, a founding board member at the Chicago International Charter School and an investment manager who specializes in tax-free muni bonds.
The Chicago charter schools have ratings just above investment grade, mainly because they are large networks with waiting lists of students. They also qualify as tax-exempt investments, thanks to the Illinois Finance Authority, which issues the bonds, although the state does not back them.
Finance Authority Chairman Bill Brandt says the UNO violation caused “consternation,” but charter schools fit the agency’s mission to foster education, employment and economic development. “As long as the school continues to have a significant amount of folks that want to go there and waiting lists and continues to perform financially as well as they have been, the bonds aren’t implicated,” Mr. Brandt says.
Investors are blowing off a slew of risks to earn higher interest rates. S&P rates 210 charter school bonds, with nearly half of them below investment grade, says Ms. Mills, who is based in San Francisco. And that’s just a portion of the approximately 730 bonds ever issued because only half qualify for a rating.
Bondholder risks include schools failing to win renewal of their charters because of poor academic or financial performance, government cuts to education funding and inexperienced management. Defaults are more common than in municipal finance generally.
Still, the industry has a significant local presence. Milwaukee-based Robert W. Baird & Co., underwriter for UNO’s troubled offering, is the second-biggest underwriter for charter school bonds across the country. Chicago-based B.C. Ziegler & Co. is the 10th-largest issuer. Chicago-based Nuveen Investments Inc., recently purchased by New York-based TIAA-CREF, is a major investor in charter school bonds.
With the industry feeding a Chicago charter school appetite to expand, there are likely to be more growing pains in the future.
By Lynne Marek June 23, 2014