Role of the Public Sector
To address the stubbornness of the traditional financial markets in responding to the needs of charter schools, Congress appropriated $25 million in 2001 to create a credit-enhancement demonstration program. After a successful first year, the CECSF program was authorized under the No Child Left Behind Act and funded at approximately $36 million annually thereafter. As of 2007, over $160 million in grants have been awarded to sixteen organizations; CDFIs have received $133 million, or thirteen awards.
The purpose of the demonstration was to find innovative, market-based solutions to the facilities financing problem. The program is proving to be an effective impetus for attracting traditional capital to charter schools. For example, TRF and NCB Capital Impact collaborated to create the Charter School Capital Access Program (CCAP) Fund. TRF and NCB Capital Impact used a $6.4 million CECSF grant as a first loss reserve to create a $45 million lending pool capitalized by leading national and international banks such as Citibank, JPMorgan Chase, Washington Mutual, and Bank of America. For many of the participants in the fund, CCAP was their first foray into charter school lending. Part of the goal for TRF and NCB Capital Impact was to demonstrate that charter loans could be prudent investments.
The request to participate in CCAP was easier for financial institutions to consider than a direct loan to a charter school. First, banks did not have to make the loans themselves and therefore did not have to understand the industry in as much depth. TRF and NCB Capital Impact each had at least five years' experience in the market, a collective portfolio at the time of nearly $40 million, and no loan losses to date. The two organizations had underwriting criteria that was consistent and time tested. Second, the first loss reserve protected investors fully for the first $6.4 million of loan loss. Third, TRF and NCB Capital Impact each invested $5 million into CCAP in a subordinate position to further protect the senior lenders. Under such a scenario, it became highly unlikely that investors would suffer losses. Transaction efficiency also improved. To date, the CCAP Fund has performed well. There have been very few delinquencies, no defaults, and no losses.
Since the creation of CCAP, banks in the program have continued to lend to charter schools, mostly through CDFIs. The Charter School Facility Finance Landscape (LISC 2007) reports that Bank of America and Citigroup have each invested between $100 million and $150 million in the market to date. The statutory requirement limiting CECSF program eligibility to nonprofit and public agencies has created an important advantage for CDFIs in designing and implementing approaches that leverage capital from traditional financial institutions.
CECSF spawned many other innovative programs and products. NCB Capital Impact created the Enhancement Fund with $40 million from a single pension fund investor, the first such institutional investor to enter the charter market. Because the pension fund is a “buy and hold” investor, NCB Capital Impact was able to create twenty-five-year fully amortizing loans. On an "all-in" basis, pricing is competitive with tax-exempt bonds and in many cases beats the tax-exempt market. The IFF is using the program to enhance tax-exempt bonds for charter schools in Chicago. Most charter bond transactions have credit enhancements, usually in the form of bond insurance or letters of credit from banks. Through its Illinois Charter Capital
Program (ICCP), created with an $8 million grant from the CECSF, IFF facilitated bond issuances in 2006 for two charter operators by funding loss reserves that reduced the cost of bond insurance. Transactions totaling $18.7 million created four new campuses serving 1,873 children, approximately 90 percent of whom qualify for subsidized meals through the U.S. Department of Agricultures School Lunch Program. The bonds are twenty-five-year fully amortizing notes. One is priced all-in at 5.9 percent, the other at 6.2 percent.
TRF is creating a unique partnership with PNC Bank and a local Philadelphia tax-exempt bond issuer to credit-enhance bond transactions. For more mature charter schools, especially those that have gone through at least one renewal of their charter by the authorizing body, access to capital is beginning to broaden. Local banks are offering more favorably priced, longer-term loans, and investment bankers are structuring bond transactions. TRF will accelerate this market momentum by purchasing participations from PNC in letters of credit that back the bonds. By taking the highest risk, TRF will facilitate bond transactions for schools that could not otherwise qualify. In addition to getting cheaper capital, borrowers will pay lower transaction costs because the bonds will be placed in a pool and cost will be shared.
These are but a few examples of the ways in which CDFIs have made use of the CECSF program to create innovative programs and products. Without the credit enhancement, CDFIs would not have achieved the level of scale and innovation they have attained, and fewer charter schools would have been able to start up and grow. Today, the market is recognizing charter schools as creditworthy. The top echelon of financially viable schools is now reaching the tax-exempt bond market where they can get the best rates and terms available to them. There have been roughly seventy rated bond issuances totaling nearly $1 billion (LISC 2007). As a matter of parity, many feel that charter schools, as public schools, should be able to access the bond market under the same conditions as traditional public schools. Because they are stand-alone organizations without taxing authority, they are not treated in the same manner as public schools by the capital markets. This is not likely to change for the foreseeable future. Charter schools will have to earn their way into the capital markets through their own financial performance. However, as momentum builds toward greater access to capital, it is wise to question the future role for CDFIs.
As the market evolves, CDFIs should not give up their role as leaders and innovators. There is much more work to be done. The job of CDFIs is now to move “down market” where there are still plenty of schools struggling to develop and finance their facilities. CDFIs should find a way to add value as players in tax- exempt bond transactions. Of the four thousand charter schools in operation, less than 2 percent have accessed the bond market. More charter schools need access to tax-exempt bonds. CDFIs can secure their position in the charter school market by collaborating with each other to facilitate access to the tax-exempt bonds for schools that are not otherwise able reach this market. As the data show, CDFIs are collectively originating enough loan volume annually to be significant to the capital markets. Their task is to find ways to standardize products, consolidate infrastructure, and achieve more efficient transaction executions.