Harlem Children’s Zone The Promise Academy charter schools run by Harlem Children’s Zone in New York City provide an extended school day and school year to help ensure academic achievement.

Elise Balboni, Project Director, Local Initiatives Support Corporation (LISC), and Ann Margaret Galiatsos, Management and Program Analyst, U.S. Department of Education

Overview

Despite charter schools’ benefits for many communities and their success in improving student achievement (see "Why Charter Schools?"), there continues to be a mismatch in the market between the perception and reality of their creditworthiness for financing purposes. The actual repayment performance of charter schools that have borrowed to date is impressive. In its "2010 Charter School Facility Finance Landscape," the Local Initiatives Support Corporation reviews this performance and the impact that the federal credit enhancement program administered by the U.S. Department of Education has had in stimulating development of the sector.

Facilities Hurdle

Charter reform allowed for the creation of independent public charter schools but did not provide public facilities or public funding for facilities. Unlike traditional school districts, charter schools do not have taxing authority and must rely on their operating revenues and limited public capital funds to pay for their facilities. Of the 41 jurisdictions with a charter law, only 11 provide additional per-pupil funding specifically for facilities, with only three providing more than $1,000 on a per-pupil basis. As a result, facilities have been a major challenge for most charter school operators. Some school districts in major cities, such as New York City and Denver, have made district facilities available for some charters, but generally, charter operators have to find, develop, and finance their own buildings. Only about a third of the 5,000 charter schools operating in the United States are in their permanent facilities.

Charter School Funding

Charters receive public operating funding, known as per-pupil revenue, based on their enrollments. This revenue varies by state, both in terms of the absolute dollar amount and in the percentage a charter receives compared with a traditional district school in the same jurisdiction. Charters essentially finance both their academic programs and their buildings through this operating revenue stream.

A May 2010 report by Ball State University, "Charter School Funding: Inequity Persists," analyzed charter funding in 24 states and the District of Columbia, which account for 93 percent of the nation’s charter school enrollment, to determine the magnitude of the funding discrepancy between charters and other public schools. It found that there was an average charter per-pupil funding gap of 19 percent, or $2,247, when compared with traditional public schools in the same jurisdiction during the 2006-2007 school year. The gap was even larger—28 percent, or $3,727 per pupil—in 40 urban areas, where almost half of the charter schools in the study were located. The report further found that lack of access to local funding and facilities capital funding were the primary sources of the funding disparity.

Early Market Development

The charter school facility financing sector was developed in its early phases by nonprofit community development organizations with support from the philanthropic community and the U.S. Department of Education. Traditional commercial lenders were reluctant to lend to start-up schools that generally had charter terms limited to between three and seven years, faced significant political opposition, and had no proven track record in the areas of academic achievement, student recruitment and retention, or financial management.

Faced with this major financing challenge, charter schools turned to nonprofit community development organizations (community development financial institutions and community foundations) serving their neighborhoods. As financial institutions with a mission of providing capital and technical assistance for low-income communities and residents, these organizations worked in the urban communities where charters tend to be located and had experience with underwriting riskier borrowers underserved by traditional lending sources.

Several nonprofit community development organizations made their first grants and loans to charter schools in the mid-1990s. Over time, they developed an expertise in underwriting early-stage loans to charter schools, and charter financing became an integral part of their loan portfolios.

U.S. Department of Education Credit Enhancement Program

While the community development financing organizations were the first to respond to charter financing needs, it was not until the creation of an innovative federal program that the sector began to develop in earnest. In 2001, Congress appropriated $25 million for a pilot credit enhancement program, the Charter School Facilities Financing Demonstration Grant Program. Its successor, the Credit Enhancement for Charter School Facilities Program (CE Program), was authorized under the No Child Left Behind Act and since 2003 has received annual funding ranging from $8 million to $37 million.

Designed to stimulate private-sector financing for charter schools, the CE Program provides grant funds on a competitive basis to public and nonprofit entities to develop innovative credit enhancement models that leverage capital from the private sector. Program funds may not be used for the direct purchase, lease, renovation, or construction of facilities; they may be employed only to attract other financing for such purposes. To date, the CE Program (including its pilot form) has made 30 awards to 19 public and nonprofit entities totaling $222 million and leveraging $1.9 billion (see table 2).

Data on the charter facilities sector indicate that loan volume increased significantly with the establishment of the CE Program. As of September 30, 2009, the $222 million awarded to grantees had helped leverage $1.9 billion in financing for 335 distinct charter schools (some of which benefited from multiple financings). As can be seen in table 2, because of the program’s structure, the financing leveraged does not necessarily occur in the year in which the award is made. Thus, loan volume continues to expand, although appropriation levels have been flat or declining, with loan volume in 2009 roughly 11 times greater than in 2003.

Of the 335 charter schools that have received credit enhancement through the CE program, as of September 30, 2009, only two had defaulted in a manner that resulted in an actual loss of grant funds. These two losses totaled $335,000, which was 0.15 percent of the $222 million in grant funds awarded and 0.02 percent of the $1.9 billion in financing leveraged. This low percentage of loss is contrary to the perception of charters as risky borrowers.

Current Market and Track Record

LISC’s 2010 "Landscape" identified 29 private nonprofit organizations that provide financing for charter school facilities. As of the end of 2009, these organizations had provided $1.1 billion in direct financial support (loans, grants, and guarantees) and another $369 million in New Markets Tax Credit (NMTC) allocations for charter school facilities. Of the $1.1 billion financing total, $343 million, or 31 percent, has been repaid in full.

Because of their role in helping develop the market, these nonprofit organizations have tended to serve the "riskier" schools—those earlier in the charter school life cycle or those with little surplus cash flow or limited collateral. Despite this higher-risk profile, the default rate for charter school financing provided by these organizations is 1 percent measured as a percentage of originated financing, with realized losses of only 0.3 percent.

Private capital from traditional lenders and the tax-exempt bond market also has become more available. Several national financial institutions have invested significantly in the sector, including Prudential, Bank of America, Citigroup, and, most recently, JPMorgan Chase. Other regional commercial lenders have, on a smaller scale, financed schools in their geographic markets. This increased investment by traditional lenders was the result of the availability of enhancements to mitigate risks, incentives for investing in NMTCs, and potential eligibility for positive consideration under the Community Reinvestment Act (see "Charter Schools Benefit From New Markets Tax Credit Financing").

In addition, older charter schools and schools with larger enrollments have been able to access the tax-exempt bond market. According to the 2010 "Landscape," between 1999 and 2009, $2.4 billion in rated tax-exempt debt was issued to finance charter school facilities. As would be expected with the higher credit quality necessary for the tax-exempt market, the default rate for this debt is lower than that of the nonprofit financing organizations. The default rate is 0.1 percent in terms of defaults that affected bondholders and 0.4 percent when taking into account additional cases where the charter school missed debt service payments, but bondholders were kept whole due to credit enhancement built into the issuance.

Challenges Ahead

Until charter schools receive equitable public provision of facilities, they will continue to look to the private sector for financing. Despite the schools’ strong track record of performance, progress in gaining access to such financing was slowed with the global credit crisis beginning in 2008. The downturn in the economy and tightening of credit as a result of the subprime mortgage crisis affected every private source of charter school facility financing. Many commercial lenders scaled back their community development lending, access to the tax-exempt bond market stalled with the collapse of the municipal insurers, and many of the nonprofit community development lenders slowed their loan origination across all program areas, including charter schools.

While private financing sources rebounded in 2009 and 2010, they are still inadequate to meet the needs of this burgeoning sector. The universe of investors well-versed in charter underwriting remains too small for the growing number of charter schools, with misconceptions about the riskiness of charter loans more reflective of concerns relevant at the beginning of the movement two decades ago than of the actual repayment performance of schools that have borrowed. With bond insurance no longer an option and declining appropriations for the federal CE Program, there are fewer sources of credit enhancement available to bridge the perceived "credit gap" for charter schools. Certain philanthropies have stepped in with other forms of enhancement, but the need to expand the number of lenders and investors remains. Nonprofit community development organizations can continue to play an innovative role in structuring charter school facility financings, but they are limited in the amount of capital they can deploy. They need partners with larger capital resources willing to invest in this high-performing sector that plays such an important role in our nation’s education reform efforts.

Elise Balboni can be reached at (917) 698-9960 or elisebalboni@gmail.com; Ann Margaret Galiatsos can be reached at (202) 205-9765 or ann.galiatsos@ed.gov.