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Fixed-Income Insights

Here’s a look at the factors informing our view of this growing category within the high-yield muni market.

[Note: This article is from the upcoming edition of The Muni Quarterly.]

Charter school enrollment in the United States has grown significantly over the past several years, increasing from 1.2 million students in 2007 to 3.1 million in 2017. As a result, municipal-bond issuance for charter schools also has increased, from $1.0 billion in 2007 to $3.5 billion in 2017, according to the Local Initiatives Support Corp. (a nonprofit community development financial institution).1 Given the growing presence of charter schools in the high-yield municipal bond market, we thought it would be valuable to provide an overview of the sector—and the basic investment parameters for evaluating the securities therein.

 

U.S. Charter School Enrollment Has More Than Doubled in the Past Decade
National enrollment in charter public schools, 2006/07–2016/17

Source: National Alliance for Public Charter Schools. Data for 2006–07 through 2014–15 are from the U.S. Department of Education, National Center for Education Statistics, Common Core of Data (CCD), Public Elementary/Secondary School Universe Survey. Data for 2016–17 are estimated from prior-year data and calculated average growth rates.

 

Charter schools are authorized under state legislation that is specific to each of the 44 states in which they operate. The laws that apply to these institutions vary, but generally they cover basic shared characteristics, such as charter authorization, approval, monitoring, renewal, funding, and accountability. One of the key risks for charter schools is nonrenewal of the charter by a charter authorizer (often local school boards), which can result in closure of the school.

The most significant source of funding for charter schools is state aid, which typically is based on a student per capita-funding formula. State aid per student during the 2016–17 school year, for example, ranged from a low of $6,843 in Utah to a high of $21,605 in New York, according to the National Education Association. Charter schools receive the same basic state aid per student as do public schools, but often are not allocated the capital funding or other additional monies sometimes provided to traditional public schools.

Financial Factors
Charter schools are able to operate on lower budgets than traditional public schools, because they typically do not have unions or offer pensions, and they generally hire younger teachers. In some states, legislatures have begun to level the playing field, enabling charter schools to access additional funding, which is a positive factor in terms of credit quality.

Given that charter schools often may be required to have a school facility in place prior to receiving approval for the charter, different financing vehicles have emerged to meet this need. There are nonprofit entities and for-profit firms that will offer start-up financing to build a school on spec. Alternatively, schools may enter into a lease to occupy an existing building.  Charter schools typically will issue bonds to finance the purchase of a leased asset or to take a buy-out option on a financed building. These institutions typically will have at least one year of operating experience, with a minimum of five grade levels, prior to issuing bonds

Charter schools may be either a single-site or multi-site charter. Single-site charters often are mission driven—reflecting a founder’s vision of a community’s educational need—and are managed by educators or community-based organizations. Charter schools also may be managed by a nonprofit charter management organization or a for-profit education management organization. As such, we evaluate all management teams on similar criteria, regardless of organizational structure.

Grading the Schools
In addition to reviewing managerial structure, we evaluate academic success, competitive landscape, and financial performance. The academic performance of charter schools is analyzed on the same basis—an annual state grade—as are traditional public schools. As charter schools become increasingly prevalent, they face increased scrutiny on academic performance. In some areas, charter schools are now competing not only with public schools but also other new charter schools opening in the region.

In analyzing financial performance, we review operating results, liquidity, and debt metrics. Compared with public schools, though, charter schools typically exhibit weaker financials, such as lower operating margins, narrower liquidity, and higher debt.

Although the sector exposes investors to some risks, these can be mitigated, and attractive opportunities can be identified with diligent credit analysis. For example, we have a favorable view of IDEA Public Schools, a not-for-profit corporation operating a multi-site system in Texas. IDEA has 61 schools, and a 15-year operating history, including two charter renewals, a sizeable wait list, strong academic performance, and healthy debt-service coverage. IDEA also has limited liquidity and high debt.  

In addition, we have a positive view of single-site charters, such as Charter School of Educational Excellence (CSEE). This school, located in Yonkers, New York, has a 13-year operating history, good academic performance, a wait list equal to almost 60% of enrollment, very healthy debt-service coverage, moderate leverage, and adequate liquidity. CSEE, however, is small in size and historically has experienced some delays in payments from the Yonkers Public School District.  

Overall, our investment view on the charter school sector is positive, based on continued growth in enrollment, improving equality in state funding, strong federal support for school choice, and an industry that is emerging from small-scale “cottage style” management to increasingly professional organizations.

 

1Charter school bonds and other types of private-activity bonds (PABs) saw a large increase in issuance in late 2017. According to a Bloomberg report, issuers accelerated their offerings to avoid potential changes from the U.S. tax-reform bill.

 

About The Author

RELATED FUND
The Lord Abbett High Yield Municipal Bond mutual fund seeks to deliver income exempt from federal income tax by investing in lower-rated municipal bonds.

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