Charter School Financing: Understanding Bonds

Editor’s Note: We understand that navigating charter school facility financing options can be a daunting and dizzying task for charter leaders. For this CHARTER EDtalk, we wanted to help break down some details around bond funding for charter school facilities. We were honored to be joined by John “Tiny” McLaughlin, Sr. Vice President at Ziegler, Scott Rolfs, Managing Director at Ziegler, and Charter School Capital’s Jon Dahlberg, Vice President of Business Development and Facilities and our Chief Marketing Officer, Janet Johnson.
We think it’s vital to keep tabs on the pulse of all things related to charter schools, including informational resources,  and how to support charter school growth. We hope you find this—and any other blog post we write—both interesting and valuable. Below you will find the video and the transcript. Please read on to learn more about using bonds for charter school facility financing.

Janet Johnson: Hi everybody, I’m Janet Johnson with Charter School Capital. We’d like to welcome you to our charter and talk today about facilities financing. We’re honored today to have Scott Rolfs, who heads up the Charter School practice at Ziegler and Tiny McLaughlin, who is the SVP at Ziegler, and Jon Dahlberg who heads up our origination for facilities financing at Charter School Capital. Welcome gentlemen and thank you so much for joining us today.
Tiny McLaughlin (TM): Thanks so much for having us.

Why do you love charter schools?

Scott Rolfs (SR):  Ziegler, the company that we work with, was founded back in 1902 and our founder, Ben Ziegler, started this as an insurance agency. And then he reached out to the community, and the community needed infrastructure: hospitals, churches, schools. And he really turned that insurance agency into a bond underwriting firm specifically focused on infrastructure needs and community needs. And so, from that, the Ziegler Company has evolved over the years to where we are really one of the premier financiers for non-profit community-based organizations, and we’ve done that through bond-financing both taxable and tax-exempt. We’ve got a great history of it. And with our financing for Charter Schools, which we’ve done for quite a while, we added to the team a number of years ago, John Tiny McLaughlin, who’s been a great addition and Tiny will tell you a little bit about his unique background. I come at it from a finance and legal perspective, I was in legal for 25 years, and Tiny, you add a whole new dimension to it with your background as well.
TM: Yeah, I was very fortunate. I was approached by Ziegler a number of years ago and I never even considered going to finance or banking, and in fact, when our CEO said, “I’d like you to join the firm”, I said,”And do what?” He said, “We’ll make you a banker” and I said, “You’re kidding”, he said, “Well, you’d only have to work with Charter Schools”, I said, “Let’s talk.” And so, my background was one of leadership (I’m a formal naval officer) and I was brought into a Charter School on the West side of Chicago. I’ve been very active in education reform and love to really help turn around a failing school. Loved it, worked there for a number of years and remained on the board for more than a decade. I view charter schools as the most promising reform in terms of the ability to close the achievement gap that exists in this country. And that’s why I love charter schools.
JD: That’s awesome. So, we’ve had several talks about financing options, right. You talk about the need for change. There are 3.1 million kids that are going to charter schools and another 1.1 that need a seat, right? There’s a huge waiting list. We spend a lot of time talking about the financing options, and you guys are bond experts. So, let’s focus on bonds. How do you know when a school is exhibiting the indicators that it’s ready to explore bond financing to finance their school?

When to choose a bond for charter school facility financing

SR: Well I think one of the things that we’ve heard you reference are some of the talks you’ve done in the past is that really, loan size is the first part to start with. So, getting out into the bond market, it can be a very, very attractive and very long-term capital solution. But there is a size where it starts to make sense, there’s a size where it doesn’t, and that really is dollar-wise. So, what we look at is about five million dollars and higher is where we think it makes sense to consult with an underwriter like at Ziegler to learn more about the bond market options. If you’re looking at something less than five million dollars in need, then it’s probably better to look at some other options, lease purchase, a bank loan,etc., or whatever else that might be.
JD: Okay, so, what does the bond market look for in criteria other than size, right. So, if you’re a five-million-dollar school or if you have a five-million-dollar project, what else should they be focusing on?

How do we qualify to get a bond?

SR: So, one of the things with a bond market finance that’s really important is being able to allow us to tell a story to investors about success with your school or the model of your school. And so that can come up with either proof of enrollment or track record in that regard. It can also come up with perhaps cash reserves that you’ve been able to build up, but it’s important to know, though, that even if you’re looking at a newer project, if you’re part of a system, a CMO (or the like) that has a proven track record, we can get you into the bond market – in some cases right away – for a new school, which wasn’t the case say, three, five, seven years ago. I think the bond market is maturing. Investors in the bond market have matured to where they really understand what makes a successful school—and as a result, the access has expanded.
TM: And I’ll add to that. In the past, there was sort of a de facto rule that you really had to have gone through a renewal in order to get through the bond market. It’s really changed now, and whether you can, or you can’t get to the bond market really depends on your relationship with your authorizer. If they show great confidence in you, even if you’re a school that’s only been around for two and a half, three years, there are times where you’ve demonstrated to them you’re going to be around for the long haul. You’re making an impact in this community, you’re showing gains that are greater than the schools around you and that we really want to see. And so, in our diligence process, we connect with your authorizer and make sure that you’re in good standing with them, and that’s a very important part of this.
JD: You have a long track record in the bond market, without getting into a macroeconomic discussion, the money moved up and down, right?  We’re coming out of an environment where historically, money was very cheap and the fed is increasing the cost of rate. Does that change what a school needs to do or how they need to behave as we move to a slightly rising rate environment?

Interest rates, inflation, flexibility, and timing

SR: Well actually, we would say talk to us now—accelerate the project. If we were to share with you an interest rate perhaps showing just market interest rate or the US economy over the last hundred years, you would see that the last eight to ten years have been an incredible time to borrow – very, very low rates. They’ve gone up a bit, but they still exist. We’re still probably three or four points below historical 50-year loans on things like a ten-year Treasury bond. So, to your point Jon, there’s a lot of discussion on the news, federal reserve inflation pressures are coming, building costs are going down.
JD: Double-digit inflation, we’re hearing double-digit inflation in construction costs.
TM: Certainly, in a lot of markets.
JD: Exactly, not all markets. Some markets are definitely, definitely seeing the pressure.
SR: So, I think one thing is, we’ve encouraged people to move a little bit sooner if they can. The second thing is with bond financing that we don’t necessarily highlight enough is that bond financing allows for growth in the way of phased financing. So, let’s say your school has a 10-million-dollar project, we can go out today, get that charter school facility financing for you, lock in a 30 or 35-year fixed interest rate. Now, you’re growing, you’re succeeding, you want to replicate and do another campus five miles down the road say, three years from now. With bond financing, you can stack these, and so we can lock in today’s rates 30, 35 years of project one, and come back and finance project two for you. Now the rates on the project two loan are probably if interest rates are higher in the market, going to be a bit higher, but we don’t need to refinance project one.
JD: You do all the work now and you add money to the project.
SR: You add the money to the project, it allows you to lock-in, really. You keep the first phase at those low rates which are going to be below market at that point, years down the road.
TM: I think it’s important that a lot of financing sources, particularly in traditional bank debt, when you borrow you will be told you can’t take on any additional debt without getting our permission. What we’re really talking about here is that provided you’re making your payments, and provided you’re meeting all the terms of your bond agreement, you’re allowed to go back in the market without asking anyone provided you hit certain coverage requirements that you pre-negotiate.
SR: Yes, Tiny, I think that’s a key point to note. There’s a bit more flexibility in the bond market for growth. A little bit more objectivity and the ability to borrow funds for future phases for growth than you might not have in a conventional bank market perhaps.

Understanding the bond process and planning

JD: Two-part question, let’s talk about the process of what a school needs to know about getting a bond. And related to that, can you compare and contrast what a rating is and how a rating impacts set process? Are they two tracks, are they connected? Talk a little bit about rating and process if you would, please.
SR: Sure. The first thing on the process is really, we ask you to reach out to an underwriter (like a Ziegler) very early on in the whole process if your board is deciding, “Maybe we need to expand.” Because, where we can help you is, we have a lot of historical metrics that we’ve compiled – statistics over the years – on what is a safe debt-load for a school. We want to help you achieve your vision and get that school building, but at the same time, we don’t want to put you in such a debt-load that all of the sudden six months after than loan closes you’re saying, “My Gosh, how are we going to pay this back? How are we going to attract 500 new students to cover the mortgage?” So, we love for the schools to reach out to us early on, so we can get you some ideas, some sort of guard rails on borrowing capacity before you go out perhaps and approach a contractor or an architect and start to really run dollar cost. I think that’s a key one.
TM: Yes, we too often see in the market where a school will have a vision for a project and they’ll go out and they’ll design something without having any idea of what their real capacity for finance is, and that ultimately leads to disappointment. The real disappointment is when they’ve designed what they think is their perfect school, but their model supports going up to 800 students and the financing for that would need to be at 1600 students. So, it’s very important to know what you can afford before you can start designing.
SR: And specifics on the process, John, is working with an underwriter like Ziegler. Once you’re ready, every building plan is ready to go, it’s about a 60 to 90-day process to work through the bond offering process it. What we do is we learn everything we can about your school and we prepare a story that then we take out to our investors – who we have relationships with – and are really interested in Charter School bonds, and we tell that story. We communicate that effectively to them to be able to not only retain the capital and close the financing but drive down the interest rate to the lowest possible levels that we can for you. And so, on the 60 to 90-day process, there are some attorneys involved because we need to work with some type of state issuing authority that is able to sort of bless the bonds, for lack of a better term, to give them their tax-exempt designation. But that’s part of that whole timeline. So, there’s going to be a few attorneys we’ll introduce you to who we manage, and we always try to make this as turnkey as possible for the borrower.
TM: I think one of the things that is really important as well is that in order to go to the bond market, you need to be, what we like to call “show ready”. Because investors are providing you 30-year money, because you go to the market once for this, what they don’t want to find out is that, “Oh by the way, I didn’t get my zoning approved on this” or, “By the way, I was unable to secure permits” or, “Yeah, we didn’t really get a really solid bid from the contractor and it’s going to be 40% more.” That’s exactly what investors don’t want to hear so we really want to make sure that essentially, the day that you close the bond if you’re going to be building your school facility, that’s the day you’re going to start. You’ve got to just put the shovel in the ground.
SR: Costs are locked in, that’s the big thing.

Understanding ratings

JD: And how does rating fit into that?
SR: So, for those not familiar with what a rating is, a rating is where a third-party entity is going to assess…
JD: Not you?
SR: Not us. It’s going to be a third-party entity, names that people would be familiar with such as Standard & Poor’s or Moody’s. They’re called national rating agencies. That third-party entity is going to take a look at your school’s finances and they’re going to assign a letter grade. I mean, everyone enlisted in this is involved in the education world, it’s just like getting their grade on that paper.
JD: It’s not pass-fail?
SR: Well it’s not pass-fail, but they’re looking at the creditworthiness – what they might see as the creditworthiness of your school to borrow this amount of money. Then they’ll assign a letter grade and just as with the classroom, B’s and A’s are better and that’s what we want to head to. Now, specifically on whether or not you should get a rating, we would say what’s interesting (in the bond market today for Charter Schools) a majority of the financings now are being done at what’s called a non-rated basis, so the schools are not going out to a Standard & Poor’s or Moody’s and necessarily getting a rating. There are some advantages for really super-credit worthy schools (who have a great deal of cash on a balance sheet) to get those ratings. That’s where we come in as underwriters and help provide advice as to what makes sense. But investors in the Charter bond world have become very sophisticated in analyzing the borrowings of different schools and they actually are not necessarily placing a lot of stock in ratings. So, what we’re able to do, is save the cost of a rating in certain cases, probably six out of ten are non-rated right now.
TM: And you know, Ziegler has a significant number of analytical tools, so when we go into this process we’ll help you say, “If we were to go to a rating agency, this is the likely rating you would receive”, and we do encourage people to go through the rating process if we think it’s going to lower their overall cost of capital. If we don’t think it will do that then we have a discussion. Obviously, it’s the school’s decision, but in particular, in the rating world, there’s a term ‘investment grade’ and ‘non-investment grade.’
The investment grade world is BBB minus or better or sometimes BAA3 or better. If you’re able to achieve those, a couple of good things can happen. One, the universe of investors who are allowed to invest in you goes up—more competition for your bonds equals the lowest rates. The second is, there are at least four states in the country right now that have what we call credit enhancement programs where the state either puts a pool of capital behind it in case there’s a default or it puts what is called its moral obligation behind it, and that can dramatically reduce your cost of capital into the high threes and fours in today’s world for 30, 35 years. So, if you’re in one of those states or if you can achieve that investment grade, it’s very significant and very important to do it.
JD: So, then the first move for a school might be contacting you and then work together on a rating, not start with the rating?
SR: Exactly, don’t start with the rating.
JD: We counsel our schools to stay on mission, right? It’s going to take, as I understand you, it is going to take you time and money, which is going to take the focus away from the classroom, to do a rating.
SR: It will.
JD: Is it expensive?
SR: Rates can cost between say, 30 to maybe 70 thousand dollars depending on the size of the financing. If you’re borrowing ten million dollars, twenty million dollars, you know, your network is borrowing 40, 50 million dollars. And so that’s where we’ll do the analysis for you, we’ll say, “This is where we think the cost of capital will be with the rating” including the cost of the rating, we’ll build that factor in and then we’ll say, “This is where the cost will be without a rating.” And then we’ll let the borrower make an informed decision as to which direction they want to go.

The pros and cons of bonds

JD: So, given your experience, the hundreds of bonds that you have done for charter schools over the last decade plus, can you share some of the pros and the cons? You’re good at the pros right, but what are some of the cons that schools really should be mindful of when you do an honest assessment of the plus and minus?
SR: Well I think you have to look at what your other alternatives are. For a number of charter schools, the bond market can present to you the lowest cost of capital and provide a true 30 or 35-year fixed interest rate. So that you can focus on your educational mission once the bond financing is closed because you’re not always worried about the lease that’s coming up or this bank notes that’s only five years, the interest rates are going to reset. I’m a little concerned about that. But, I think it comes back, John, to the size of the financing is really one of the big things. Is you have to weigh out the pros and cons. You know, before we came over, Tiny, you were talking a little relating to the availability of facilities and costs in some markets.
TM: Absolutely. There are a lot of places where even if you wanted to purchase a facility, you can’t. Just the real estate doesn’t exist. Landlords are unwilling to sell.
I fall back also on your academic readiness, as well. I mean, you know, like everything else, there’s no point in having a charter school unless you’re going to do something better for kids than what’s available. And you have to have demonstrated that in order to go the bonding market. And, I would also say you have to have a demonstrated history of success. You’re not going to be able to go if you’re a brand new school right out of the gate and you’re not a replication. So, you have to have a track record of both, academic, leadership, and financial success. So, that’s what I’d say.

Partnering with your association and local leaders

JD: Well, that’s very helpful. Thank you. The one last question. You know, we’re at the National Alliance, the conference right now. And we’re spending a lot of time talking about advocacy. From your perspective, if you could give a school some advice about how they can partner with their association.
SR: Let me take this one, Tiny. Because I was just in a session that was talking about the political landscape in 2018. It was a great session. One of the speakers there noted that the most effective thing schools can do to ensure that the charter movement continues to prosper in the future is to have your local politicians and representatives at your school constantly. And what they said was politicians are always looking for an opportunity to speak to voters. They said so many times maybe a state legislature might pass a favorable bill for the charter movement and school choice movement. But then the people in the schools, the grassroots people, forget that. Now invite those legislators back who are keys to your success. Have them come to speak to your kids. Have them visit for a day. Have them there for the ribbon cutting. Because now you’ve brought them on board as partners. And those folks are going to stay long-term partners hopefully with you within your state framework.
TM: Scott, you took the words right out of my mouth. I tell every single school that, I’ve yet to meet a politician out there who doesn’t want their picture taken doing something positive for kids. And so, you’re asking them to come. They’re more than willing to come. They’re looking for that photo op. And it doesn’t have to be a big thing. It doesn’t have to be the ribbon cutting of the new school. You can have somebody come in do your kindergarten reading program. What politician doesn’t want that picture taken? So, those are great opportunities out there. That and just remind your local politicians that you vote and you’re active in your election cycle.
JJ: Gentleman, this has been really interesting. And we really appreciate your time today. People can get a hold of you at …
SR: Ziegler.com. Visit our website. We got a lot of resources out there for charter schools, webinars, pieces, statistics, everything that can help. Give us a call.
JJ: Thank you so much.
TM: Thank you very much for having us.

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