Charter Schools Capture Window of Opportunity in Q2 to Tap Municipal Market; Headwinds Persists on Both Operating and Macro Levels

The recent reprieve from volatility in the capital markets has presented a window of opportunity for charter schools to finance their projects – resulting in some of the largest deals that the municipal market has seen from the sector, according to market participants.

But clusters of distress still imperil the industry, where lower-rated credits chronically struggle with enrollment growth and management turnover. Macro patterns, such as declining student population and waning pandemic relief funds, dampen medium- and long-term outlooks.

There is a silver lining on the regulatory front, however. Amid myriad proposed program cuts across the board within the Department of Education, charter schools are the sole programs projected to receive an increase in funding, of $60 million, bringing the total budget allocated to expanding high-quality charter schools to $500 million.

Although market participants continue to monitor federal funding proposals, the surge in supply seen in the latter part of the second quarter was primarily due to abnormally large deals capitalizing on a stabilizing period amid the administration shift in Washington, said sources who specialize in charter school bonds.

Accessing Capital

At $490 million, International Leadership of Texas, or ILTexas, was the largest charter school deal in history to come to market, according to Drew Masterson, CEO of Masterson Advisors, a Houston-based financial consulting firm that advised ILTexas ahead of pricing in June. ILTexas was an anomaly in the sector in terms of deal size, which is typically about $20 million to $40 million, including unrated deals.

Masterson Advisors also advised IDEA Public Schools, a charter school system of 145 schools across Texas, Louisiana, Florida and Ohio, which came to market in mid-June with a $287 million offering to refund its Series 2014 and Series 2015 bonds. Both the ILTexas and IDEA offerings are backed by the Texas Permanent School Fund, or PSF, meaning they received insured AAA ratings from S&P Global Ratings.

Texas charters pay a “substantial fee” to participate in the PSF program, which is equivalent to 20 bps to 30 bps, said Garrett Hall, assistant vice president at Masterson Advisors.

“The PSF fee goes to fund a charter reserve fund to protect the corpus of the PSF,” Hall added. As of Feb. 28, the balance of the fund was $126 million, and there has never been a draw on the reserve fund or the PSF itself.

The PSF-backed deals were able to price at an auspicious time, although the majority of the deals were refinancings, with some new-money components, according to a source. “They were waiting till the market stabilized […] and the market was really choppy in the first quarter,” they said.

The year-to-date yield average for a PSF-backed, AAA rated 10-year bond is 3.806%, with an average spread of 51 bps, compared with a 5.893% yield and a 260-bps spread for a nonrated bond, according to Hall.

Within the credit spectrum, year-to-date average spreads for the 10-year paper are 81 bps for an AA credit, 116 bps for a BBB- credit, and 142 bps for a BB+ credit. Meanwhile, average spreads for a 30-year bond are slightly tighter, coming at 68 bps, 101 bps and 134 bps, respectively, Hall said.

A chart outlining spread ranges per credit rating, according to data from Masterson Advisors, is shown below:
 

Offerings from smaller charter schools – namely, Acadiana Renaissance Charter School and Lafayette Renaissance Academy Project – were business as usual. Proceeds from the two deals totaling $251.6 million, issued via the Louisiana Public Facilities Authority, are being used to acquire a number of buildings that the schools had already occupied, noted Bridget Young, senior credit analyst of the First Eagle municipal credit team.

When schools are starting out, they usually have a developer that builds the schools, then the schools lease the buildings from the developer through a lease lasting roughly 10 years, Young explained. These leases may entail “pretty egregious rent escalations around 5% a year,” which are costly to the schools, meaning the schools would want to seize any opportunity that arises for a buyout to give them some relief on their budget, she added.

Last week, Wake Preparatory Academy, BridgePrep Academy and Imagine School at North Port sold an aggregate of $385 million in unrated and sub-investment-grade charter school bonds at spreads up to 206 bps. “The super-high-quality charters are pricing very tight while the nonrated charter schools are pricing very attractively,” Young said. “It’s a barbell almost – you’re able to pick up yields by getting comfortable with those nonrated deals.”

A chart outlining final yields on the aforementioned primary deals is shown below:
 

Keeping a Pulse on Adverse Patterns

Slow population growth and a sluggish funding environment are among macro factors that affect a charter school’s performance, sources tell Octus. Edkey Inc. in Mesa, Ariz., and Acero Charter Schools Inc. in Chicago are two examples of active distressed situations under Octus’ coverage, which showcase how the demographic and legislative backdrops are essential to charter school performance.

Edkey, for instance, recently reported that it missed its bond covenants for the fiscal year ended June 30, 2024, because of net operating deficits and decreased enrollment. Meanwhile, Acero announced last October that it would close seven out of its 15 schools by the end of this school year in June but later entered into an agreement with Chicago Public Schools, or CPS, to continue operating through June 2026 five out of the seven schools targeted for closure.

Since Acero shares the geography and funding environment with the CPS system, it experiences a lot of similar budget and personnel pressures, Young said. CPS recently laid off 161 employees and closed another 209 vacant positions as part of an effort to alleviate a budget gap of $734 million for fiscal year 2026, as reported.

Apart from ongoing financial challenges, Chicago’s declining population also poses obstacles to maintaining healthy demand for charter school enrollment, Young added. Charter schools would thrive in areas where there is population growth – “otherwise, you have to capture a bigger market share of a shrinking population,” she said. According to the 2020 U.S. Census, Chicago’s population was 2.7 million, roughly what it was in the 1920s, after the city experienced decades of decline since the 1960s.

In Texas, charter schools have been facing compounded demographic pressures as they must compete with both the public school system and homeschooling programs, Masterson said. “Since Covid it’s just not been the same. You have much more homeschooling, probably out of the community that would have chosen a charter school,” he explained, adding that the number of homeschooled students in the state is about equal to the number of students in charter schools, which is estimated to be in the 400,000 to 500,000 range.

The competitive landscape has made assessing demand based on the geography even more integral to charter school operations, Masterson said. “Really great programs are struggling to fill their schools in certain areas,” such as inner-city San Antonio and Houston reporting flat, if not declining, enrollment, he added.

Declining enrollment, however, is not the only factor contributing to operational distress and eventual closures. Management and teacher turnover also plays a crucial role, said Anand Kesavan, CEO of Equitable Facilities Fund, or EFF, a nonprofit social impact fund that has originated over $1.7 billion of loans to over 80 different school obligors spanning 229 campuses in 50 cities nationwide.

“Leaders transitioning job markets are a tough issue now, and teachers are moving, which makes running schools harder,” Kesavan said. In terms of academic performance, test scores post-pandemic haven’t recovered, especially in low-income communities, he added, saying that there should be extra due diligence done to make sure the schools are managing their enrollment and finances well.

When a days cash on hand or debt service coverage ratio covenant violation occurs, the damage may have already been far along, sources said. “It’s not difficult to look at past results and projections to determine if a school is meeting its budget,” Kesavan said. Some analysts, such as Young, would even go as far back as the original offering memorandum to see how a school’s performance compares with historical estimates.

On the bankruptcy front, Charter School Capital, or CSC, a Beaverton, Ore.-based company offering development and financing services for charter schools, filed for chapter 11 protection on June 9 in the Bankruptcy Court for the District of Delaware. The filing was triggered by a reduction in activity in its “Money To Run Your School” business, macroeconomic challenges, disruptions in the municipal bond market and recent litigation with a preferred shareholder, as reported. At its peak, CSC had financed about $300 million in receivables per year but in 2024 financed only $32.6 million due to a pandemic-induced decrease in demand for ongoing receivables financing.

Another active coverage name, Wonderful Foundations, whose direct servicer Charter School Realty Co. is owned by CSC, does not expect any impact from the chapter 11 filing because the former is not included in the bankruptcy petition, as reported.

“From a business standpoint, this is a classic case of finding the schools and giving them the best deals, versus finding schools that don’t have any other options and take whatever deal you give them,” according to a source familiar with CSC. “The reality is that [CSC] was lending to the bottom quartile schools…so I’m not surprised [about the bankruptcy],” the source said.

Focusing on Quality

Charter schools are inherently mission-focused, so they tend to spend the money that they make, sources told Octus. But a high-quality school would have good liquidity, good debt service coverage ratio and a reasonable real estate package, among other operating strengths.

Quality educators and an experienced management team are also part of a strong charter school credit, Young said. “The board should be diversified […] Typically, you’d want someone with a finance background, someone with an education background, others in human resources and safety and security, which are not always represented,” she explained.

For new issue deals in particular, Young would look for ways the school could mitigate construction risks, including whether all permits are in place, zoning is appropriate, construction has enough time for completion and there are alternative plans to house students in case construction is behind schedule. “There’s a whole realm of things to look for when you have a construction project versus when you’re doing modest renovations,” she said.

Investors have also been “flocking to bigger, high-quality school systems like IDEA, which is backed by the state of Texas,” Kesavan said, underscoring the attractiveness of a large, well-oiled system that’s been around for a long time.

Given more stable market conditions, market participants anticipate that inflows into the sector will sustain through year-end, albeit mostly with small- and medium-size deals ranging from $25 million to $100 million.

“Overall I’m pretty bullish on the market given more quality authorization, more quality metrics and post-Covid stability, all of which are tailwinds for the sector but it makes it harder to open a school,” said Kesavan. “In a way, that’s better for investors because the barriers to open a school are now higher,” he said.