Overview
CHARTER SCHOOLS IN 34 STATES AND THE DISTRICT OF COLUMBIA have accessed the tax-exempt bond market to finance their facilities. Texas is the most active state based on historical par amount issued, with over $7.6 billion in aggregate issuance, representing nearly one fifth of national charter school bond issuance since 1998. As of December 31, 2022, Arizona, Florida, Colorado, and California are the next most active states respectively based on par issuance, representing a combined 38% of total historical issuance. These five states—Texas, Arizona, Florida, Colorado, and California—account for approximately 57% of aggregate charter school bond issuance since 1998.
Of the 15 states with the most historical par issuance, all but Michigan issued more par in the eight-year period between 2015 and 2022 than in the prior 17 years.
In terms of number of transactions, Colorado and Arizona account for the largest share of charter school bond offerings, with 276 and 258 transactions, respectively. Five other states have executed more than 100 transactions, including Michigan (168), California (170), Florida (172), Utah (118), and Minnesota (112). Eleven states with a charter law had not yet executed a charter school bond transaction as of year-end 2022.12
Among the 10 most active states in terms of total par issuance since inception, 7 states have issued a larger proportion of rated par compared to unrated par. Except for outliers Texas (81% rated) and North Carolina (25% rated), most of the larger states are concentrated in the range of 40-60% rated par to total par. In certain states, the relative composition of rated and unrated par—and the distribution of ratings within rated par—have changed over time, in many cases driven by the availability of state bond credit enhancement.
Average transaction size varies by state, ranging from $6 million (Rhode Island) to more than $37 million (Texas) based on total issuance since 1998, with a median of $15 million. Transaction size is influenced by a range of factors including the relative cost of real estate acquisition and construction, typical or average school enrollment and/or grade span (i.e., K–8 schools with larger enrollments), the number of networks (also known as charter management organizations, or CMOs) issuing debt for multiple campuses, and debt capacity/affordability based on per-pupil revenue.13
Please refer to the State Dashboards section for summary statistics on charter school bond issuance in each state, including annual issuance from 2015 to 2022, average par amount, and a summary of the composition of rated and unrated transactions in each state.
State Bond Credit Enhancement Programs
In order to achieve higher credit ratings and lower interest rates, many charter schools have utilized credit enhancement to further secure their bond offerings. Credit enhancement can involve the substitution of a stronger third party’s credit, other full or partial guarantees of repayment, or funding of specific collateral pledged for repayment, such as additional reserves.14 For the reasons explored below, this study focuses specifically on bond credit enhancement programs that leverage a state’s moral obligation pledge or other state-pledged collateral (such as a funded debt service reserve) to increase the rating on a bond compared to what the charter school obligor would otherwise have achieved in the absence of state credit enhancement.
CHARTER SCHOOL BOND CREDIT ENHANCEMENT BEFORE THE CREDIT CRISIS
Prior to the 2008 credit crisis, the primary source of credit enhancement for charter school bonds was bond insurance and bank letters of credit, which together accounted for more than 70% of total enhanced issuance. One state, Colorado, offered access to bond credit enhancement through the Colorado Charter School Moral Obligation Program, the first program in which a state statutorily allowed the use of a “moral obligation” pledge in connection with charter school bonds (see definition and further explanation of moral obligation terminology below). Due to the credit market dislocation that took place from 2008 to 2010, most of the active bond insurers either were downgraded, limited their enhancement to higher-quality borrowers, or exited the market entirely. The lack of viable enhancement options meant that nearly all charter schools had to access the market on an unenhanced basis—i.e., based on the strength of their underlying rating or, if unrated, underlying credit fundamentals. Spreads on charter school bonds widened considerably, translating into higher interest rates for schools.
The landscape of credit enhancement options for charter school bonds has shifted dramatically since the credit crisis from private sources of credit enhancement such as bond insurance to primarily public sources. Over the past decade, state bond credit enhancement programs, including “moral obligation” and other programs that substitute (or attach) a state’s stronger credit rating for the “underlying” rating of the charter school borrower (i.e., the rating the bond would have received without credit enhancement), have become the predominant source of credit enhancement for the sector.
This study focuses specifically on a subset of state bond credit enhancement programs that—through a variety of structures and funding mechanisms—employ the state’s stronger credit rating (or the credit rating of the specific pledged collateral, i.e. the debt service reserve fund) to increase the rating from what the charter school would otherwise have achieved on a standalone basis, resulting in a lower interest rate for the charter school borrower. We elected this approach with the specific goal of measuring the impact of these programs on access, ratings, and pricing of charter school bonds. By comparing the cost of capital of “enhanced” offerings to prevailing interest rates for bond offerings without credit enhancement, we can estimate the savings in interest expense of each bond and the program in the aggregate.
At the time of publication, five states15,16 offer bond credit enhancement programs that result in a higher rating on charter school bonds through the presence of some additional security provided by the state: Colorado (enacted in 2002 and first accessed in 2003), Utah (2012), Texas (opened to charter schools in 2011 and first accessed in 2014), Arizona (2017), and most recently Idaho (enacted in 2019 and accessed in 2020). These programs vary in structure, eligibility requirements, and source of funding, but can be broadly described as debt service reserve fund replenishment programs. A brief description of each program and updated statistics on enhanced bond issuance in each state is provided below. For each program, we estimate the total dollar amount of savings achieved through the substitution of the state’s stronger credit rating (or, in the case of Texas, the rating of the Permanent School Fund). We examine the impact of each program on the rating distribution within each state in a series of graphs following the program descriptions.
OTHER CHARTER SCHOOL CREDIT ENHANCEMENT PROGRAMS
There are several other credit enhancement programs that have been utilized in conjunction with tax-exempt bond issues. The U.S. Department of Education Credit Enhancement for Charter School Facilities Program (CEP) provides grants to state entities and nonprofit organizations to enhance charter school debt, including tax-exempt bonds.
These credit enhancement vehicles are used strictly as credit enhancement rather than credit substitution; in other words, their presence does not typically change the rating on the bond, but may reduce overall borrowing costs through a lower interest rate or the substitution of a guarantee for the 12-month debt service reserve that is otherwise typically added to the par amount of the bond.
The federal CEP and other state credit enhancement programs are an important source of bond credit enhancement that can reduce overall borrowing costs for schools.
MORAL OBLIGATION PROGRAMS
One common form of state bond credit enhancement is the use of a “moral obligation” pledge. The term “moral obligation” is used to describe a promise, or pledge—but not a legally binding obligation—to replenish a debt service reserve fund when it has been tapped due to a borrower’s inability to meet its scheduled debt service payment. In a moral obligation pledge, the executive branch of a state or municipality agrees to seek legislative approval to appropriate funds to replenish the reserve. In bond documents, the moral obligation pledge is typically referred to as a “debt service reserve fund deficiency makeup provision”. The additional security provided by the state’s pledge typically results in a rating one notch below the state’s credit rating.
The Municipal Securities Rulemaking Board defines a moral obligation bond as follows: “A bond that, in addition to its primary source of security, is also secured by a non-binding covenant that any amount necessary to make up any deficiency in debt service will be included in the budget recommendation made to the governing body, which may appropriate funds to make up the shortfall. The governing body, however, is not legally obligated to make such an appropriation.”
COLORADO
Colorado pioneered the use of a state moral obligation pledge for charter school bonds in 2002. Colorado’s Charter School Moral Obligation Program allows Colorado charter schools issuing bonds through the Colorado Educational and Cultural Facilities Authority that carry an investment-grade rating to attach the state’s moral obligation pledge to their bond offering. Under the program, the state agrees to pay debt service from a dedicated reserve fund, and seek an appropriation to replenish that fund as needed, when and if a charter school defaults on bonds covered by the program, thus providing significant additional security to bondholders. Use of the state’s moral obligation pledge raises the expected rating on the bond from the low triple-B investment-grade category to the single-A or double-A mid-to-high investment-grade category, depending on the rating agency and other factors.
The initial 2002 statute limited the total amount of bonds outstanding under the program to $200 million and appropriated $1 million for a reserve fund to cover potential defaults. The cap on total par amount outstanding under the program was increased from $200 million to $400 million in 2016, from $400 million to $500 million in 2014, and most recently from $500 million to $750 million in 2021.17 Total state appropriations increased from $1 million in 2002, representing 50% of the maximum outstanding balance on bonds enhanced through the program. By 2021, the figure had risen to $7.5 million, which accounted for 10% of the maximum outstanding balance of moral obligation-guaranteed bonds. Notably, this increase apparently did not impact the rating bump.
Colorado established a mechanism for participating schools to contribute to the fund in order to increase liquidity and insulate the state from the likelihood of needing to appropriate funds to cover a debt service shortfall. Schools that use the moral obligation pledge are required to place a portion of their debt service savings from the lower interest rate due to this credit enhancement— of 0.10% (10 basis points) of the outstanding par amount of the bond annually—into a common reserve fund, which provides liquidity to protect against defaults and mitigate risk to the state. As of February 28, 2023, the available balance in the debt service reserve fund is over $16 million, comprised of $7.5 million in state-appropriated reserve funds, $8.1 million in the interest savings account capitalized by participating schools, and $1.0 million in earned interest.18 According to the Colorado Department of the Treasury, there have been no defaults on guaranteed bonds and there has never been a draw on the debt service reserve fund.19
Since 2003, 77 Colorado charter school transactions representing $1.07 billion of par issuance have been credit enhanced by the state’s moral obligation pledge. Based on our cost savings methodology, we estimate that Colorado’s moral obligation program has saved participating schools more than $130 million in debt service expense—a savings of more than 12%.
CREDIT ENHANCEMENT COST SAVINGS METHODOLOGY
Each state has a method of measuring the cost savings to schools from participating in its respective bond credit enhancement program. Some states and issuers report and periodically update information about the number of schools that have accessed the program, the par amount of bonds issued, and the estimated cost savings (see, for example, https://ucsfa.utah.gov/about-ucsfa/). LISC reviewed these methodologies and those used by other researchers in the sector. Our goal was to define a simple method that could be applied across states to measure the impact of distinct programs and potentially inform future research and policy.
In this study, we compare the median spread to MMD for all transactions, issued in a particular year, that meet the minimum rating required for eligibility to participate in the state program (typically, triple-B), to the median spread to MMD for each state’s enhanced transactions issued in the same year. It's important to note that in many of these comparisons, the sample size of enhanced transactions is limited. Due to the variation in the spread between different rating categories over time, caused by market conditions, we opted to utilize the average difference in spread between enhanced and comparable unenhanced offerings for each year between 2015 and 2022. We then apply the difference (measured in basis points of annual yield) to the total par amount of enhanced issuance and multiply by 30 years to arrive at the estimated savings over the life of the bonds. For example, Colorado’s estimated savings of $133.07 million is calculated as follows:
It is possible to quantify the impact of state credit enhancement more accurately at the individual transaction level by comparing the yield on an enhanced offering to the yield on an unenhanced offering with the same underlying credit rating priced on the same day. In some cases, an enhanced series can be compared to an unenhanced series within the same bond issue. More precise analysis, whether transaction-level or sector-wide, would require comparing the spread to MMD of each enhanced issue to the spread to MMD on either a single or a subset of unenhanced charter school bond offerings with similar characteristics (rating, potentially state of issue, potentially transaction size, etc.), issued on the same day or within a specific date range. It would also need to consider program participation fees, deposits to the state debt service reserve fund, legal fees and other costs of issuance specific to the program that offset the interest rate savings. It should also be noted that not all bonds remain outstanding for their full term, so the full estimated savings may not be achieved.
- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -
UTAH
Charter school participation in Utah’s moral obligation bond credit enhancement program began in late 2012. Utah’s Charter School Credit Enhancement Program allows qualified investment-grade rated20 charter schools to obtain more favorable financing terms by adding an additional layer of security from the state. Specifically, the state commits a moral obligation pledge to draw on its general fund if sufficient funds are not available from the school-funded dedicated reserve fund, or—notably—to issue general obligation bonds, if necessary, to cure a debt service shortfall of a participating school.21 Like other moral obligation programs, this promise is a moral rather than a legal pledge (and therefore not a liability to the state22), insofar as any requests from the governor to replenish the Charter School Reserve Account must be appropriated by the legislature at its discretion.23 Because the State of Utah has the highest possible triple-A credit rating from each of the three major rating agencies, Utah’s moral obligation-backed bonds are rated in the high investment-grade double-A category. The program is administered by the Utah Charter School Finance Authority.
An initial appropriation of $3 million was earmarked for the Charter School Reserve Account upon its inception in 2012. Building on Colorado’s model, Utah’s program requires that charter school borrowers accessing the state’s moral obligation pledge deposit into the Charter School Reserve Account a one-time fee equal to 1.5% of the par amount of the bond issue and an annual fee of 0.20% (20 basis points) of the principal amount outstanding on the bond. According to unaudited figures published by the Utah State Legislature, the Charter School Reserve Account has increased from the initial state appropriation of $3 million to more than $16 million as of year-end 2022. There have been no draws on the debt service reserve fund since the program was established.24
As of December 31, 2022, 31 charter school bond offerings have utilized Utah’s moral obligation pledge as additional security for more than $525 million in par issuance. Based on our estimated savings methodology, Utah’s moral obligation program has saved participating schools more than $100 million in debt service expense—an estimated savings of 20%.
- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -
TEXAS
Charter schools in Texas began to access the Texas Permanent School Fund (PSF) in 2014.25 The PSF was established in the Texas Constitution of 1876 to help finance public schools, including guaranteeing bonds issued by school districts. Bonds backed by the PSF are rated at the highest triple-A level by all three major rating agencies. Charter schools must achieve an underlying investment-grade rating to be eligible for the PSF guarantee. Unlike bonds backed by a state moral obligation pledge, the PSF has its own credit rating, i.e. a rating independent of the state’s, and bonds issued with the PSF guarantee are assigned this rating without the one-notch downgrade from the state’s rating as is typical in a moral obligation pledge. Bonds guaranteed through the program (the “School District Bond Guarantee Program”) are guaranteed by the corpus of the PSF; there is no appropriation or payment risk as is common in state moral obligation programs. The Texas Commissioner of Education administers the PSF.
The guarantee capacity of the PSF fluctuates based on several factors: a) the value of fund reserves, b) the reserve requirement set by the state, and c) the outstanding amount of debt guaranteed by the fund. This capacity is subject to, and restricted by, a federal cap of approximately $220 billion as of August 31, 2023, known as the "State Capacity Limit".26 Charter schools may access the available capacity of the PSF in proportion to the number of students enrolled in charter schools, which was approximately 8% as of 2022.27 Charter schools are required to contribute a portion of the savings achieved from participation in the program into a ”Charter District Bond Guarantee Reserve Fund”. This fund, managed by the Texas Education Agency, serves as a first loss reserve for charter school bond defaults, insulating the corpus of the PSF from potential loss.
More than $4 billion in par issuance (71 distinct issues) has been enhanced through the PSF since the first PSF-guaranteed offering in 2014. This represents a remarkable 63% of total Texas charter school bond issuance since charter schools first accessed the PSF 2014. Based on our estimated savings methodology, the Texas PSF has saved participating charter schools more than $770 million in debt service expense—an estimated savings of 19%. There have been no defaults (by a school district or charter school) in the history of the program.28
- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -
IDAHO29
Enacted in 2019, Idaho’s moral obligation program is modeled in part after the Colorado and Utah programs. Bonds issued with the state’s moral obligation pledge are typically rated one notch below the state’s double-A rating. The Public Charter School Facilities Program is administered by the Idaho Housing and Finance Association.
To reduce the likelihood of needing a future appropriation, Idaho’s bond credit enhancement legislation established a fund within the state treasury, which is funded from grants, gifts, appropriations, and required fees from schools that borrow through the program. At bond closing, schools are required to deposit a one-time fee equal to 0.5% of the par amount of the bond and an ongoing annual fee equal to 0.075% (7.5 basis points) on the bond’s outstanding principal balance into a restricted debt service reserve fund. This backstop fund will be used, as available, to replenish any draws on the debt service reserve fund without the need for state appropriation. Idaho’s program also requires use of an intercept mechanism, whereby the Idaho Department of Education pays all school revenues directly to the bond trustee, which sets aside funds for bond payment first and then transfers the balance to the participating school. As in Colorado, the intercept mechanism mitigates default risk and therefore appropriation risk to the state by creating a layer of reserves that can be tapped without legislative approval.
In contrast to other state programs, Idaho’s moral obligation program does not limit eligibility to investment-grade rated schools. Schools are required to obtain an underlying borrower rating and meet other criteria, but there is no threshold rating for participation in the program. Therefore the credit support and resulting savings for schools can be significant, as the spread between unrated and investment-grade rated schools is historically wider than the spread between categories within the investment-grade rated universe.
As of December 31, 2022, ten transactions totaling approximately $93 million benefitted from enhancement through Idaho’s moral obligation bond credit enhancement program. The enhanced rating on these bonds was in the single- or double-A category in each case. These transactions represented the first enhanced offerings in the state since prior to the 2008 credit crisis. Based on our estimated cost savings methodology, in its short history, Idaho’s moral obligation program has already saved participating charter schools a projected $24 million in interest expense—a savings of 26% on the estimated interest cost of comparable unenhanced bonds. Notably, Idaho’s program generates the highest projected cost savings on a percentage basis (26% compared to 12-20% for other state bond credit enhancement programs). This may be attributable to the broader eligibility criteria for Idaho’s credit enhancement program, which is the only program to date that does not require an investment-grade rating to qualify for enhancement.
There are no known defaults on bonds enhanced through Idaho’s Public Charter School Facilities Program.
- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -
ARIZONA
The Arizona Public School Credit Enhancement Program was established to reduce borrowing costs for public schools through a repayment guarantee. To be eligible for the guarantee, charter schools must be admitted as a member school in the Achievement District, a group of schools that meet certain academic, enrollment, and financial criteria.30 In addition, at least 75% of the debt guaranteed must have a minimum underlying rating of double-B. This is a lower rating threshold than peer programs in Colorado, Texas and Utah, which require an underlying investment-grade rating.
Arizona’s bond credit enhancement program is overseen by the Credit Enhancement Eligibility Board, which is made up of the governor, the state treasurer, and the director of the Arizona Department of Administration. Based on total funding of $100 million and a maximum leverage ratio of 3.5:1, the program’s guarantee capacity is $350 million.31 Schools benefiting from the enhancement are required to pay 25 basis points of the outstanding principal amount of guaranteed bonds annually to grow the reserve fund.
Since charter schools first accessed the program in 2017, Arizona charter schools or networks have executed 12 transactions totaling approximately $275 million in original par issuance. This represents approximately 12% of total issuance between 2017 when the program was first accessed and year-end 2022. Based on our estimated cost savings methodology, Arizona has saved participating charter schools a projected $39 million in interest expense—a savings of 14%.
There are no known defaults on bonds enhanced through Arizona Public School Credit Enhancement Program.
Rating Distribution Charts for States with Bond Credit Enhancement Programs
State Dashboards
11. In this section, transactions are organized by the location of the charter school obligor (as opposed to the state where the conduit issuer is located).
12. These states are: Alabama, Alaska, Iowa, Kansas, Kentucky (charter school law passed in 2022), Maine, Mississippi, New Hampshire, Virginia, West Virginia, and Wyoming.
13. The standard benchmark in charter school facility financing is that schools should spend no more than 15% of total recurring public revenue on facilities debt service. See Balboni, E. (2020). Charter school facility refinancing guide and toolkit. Charter School Facility Center, National Alliance for Public Charter Schools. https://facilitycenter.publiccharters.org/resource/charter-school-facility-refinancing-guide-and-toolkit.
14. Balboni, E., & Berenbach, S. (2014). Fixed income securities. In L.M. Salamon (ed.), New Frontiers of Philanthropy: A Guide to the New Tools and New Actors that Are Reshaping Global Philanthropy and Social Investing (pp. 341-65). New York: Oxford University Press.
15. Indiana was one of the earlier states to statutorily allow use of the State of Indiana’s and the City of Indianapolis’s moral obligation pledge for charter schools; however, the statute has not been actively implemented on behalf of the state’s charter schools.
16. The Arkansas Development Finance Authority operates the Bond Guaranty Program, which guarantees debt service from a dedicated reserve account for bonds issued by nonprofit organizations, including charter schools. Three charter schools in Arkansas accessed the state program, one per year in 2010, 2012, and 2015, for total enhanced par issuance of approximately $14 million. Each bond was assigned a single-A rating. The program reached capacity and has not been accessed by a charter school since 2015; therefore, it is not included in this report.
17. See SB21-157, General Assembly, 2021 Reg. Sess. (Colorado 2021). https://leg.colorado.gov/bills/sb21-157.
18. Colorado Department of the Treasury. (2023). Charter school intercept and moral obligation. https://treasury.colorado.gov/charter-school-intercept-and-moral-obligation.
19. Charter School Facility Center, National Alliance for Public Charter Schools. (n.d.). Moral obligation—a state credit enhancement program. https://facilitycenter.publiccharters.org/resource/moral-obligation.
20. Utah also offers an alternative set of requirements for schools that are not investment-grade rated (10 years in operation, strong enrollment and waitlist metrics, strong absolute and comparative academic performance). These are considered relatively stringent and in line with underlying metrics for low investment-grade rated schools.
21. Utah Charter School Finance Authority. (n.d.). Credit Enhancement Program. https://ucsfa.utah.gov/credit-enhancement-program/.
22. Charter School Facility Center, National Alliance for Public Charter Schools. (n.d.). Moral obligation—a state credit enhancement program. https://facilitycenter.publiccharters.org/resource/moral-obligation.
23. Utah Charter School Finance Authority. (n.d.). Credit Enhancement Program. https://tinyurl.com/m7tra3zr.
24. Utah State Legislature. (n.d.). Charter School Reserve Account. https://cobi.utah.gov/fund/2475.
25. LISC. (2014). 2014 Charter school facility finance landscape. https://www.lisc.org/media/filer_public/59/38/5938b90b-07cc-411c-845f-431f50a4682e/2014csflandscape.pdf.
26. Texas Education Agency. (2023). Texas Permanent School Fund Bond Guarantee Program summary (pg. 1). https://tea.texas.gov/sites/default/files/PSF_BGP_Summary.pdf.
27. Texas Education Agency. (2022). Enrollment in Texas public schools 2021-22 (pg. 4). https://tea.texas.gov/sites/default/files/enroll-2021-22.pdf.
28. See Pierog, K. (2023, April 4). Texas school bond guarantee program capacity rebounds to $5.4 billion. The Bond Buyer. https://tinyurl.com/2k3bsded; and 2022 Texas Permanent School Fund Annual Comprehensive Financial Report (pg. 99). https://texaspsf.org/reports/.
29. Information on Idaho’s program is compiled from and attributed to Balboni, E. (2020). Charter school facility refinancing guide and toolkit. Charter School Facility Center, National Alliance for Public Charter Schools (pp. 24-25). https://facilitycenter.publiccharters.org/resource/charter-school-facility-refinancing-guide-and-toolkit.
30. LISC. (n.d.). Arizona state financing map. SchoolBuild. https://www.lisc.org/charter-schools/funding-options/state/arizona/.
31. Ibid.