Oct. 3 (Bloomberg) -- Texas public charter schools, the fastest-growing part of the state’s education system, are poised to see their bonds go to top grade from near junk as a $33 billion fund backed by oil revenue prepares to guarantee the securities for the first time.
The Texas Permanent School Fund, created in 1876, insures $59 billion of bonds sold by the state’s districts, helping issuers lower interest costs for projects from classrooms to football stadiums. A plan extending the pledge to investment-grade charter schools won Internal Revenue Service approval in September.
The charter institutions, which have borrowed more than $800 million since 2000, say the backing may lure more borrowers and investors. The difference in financing costs was evident in sales last month. Buyers demanded 10 times more in extra yield on 10-year debt offered for charter operator IDEA Public Schools, rated two steps above junk, than on top-rated bonds from Lubbock’s school district.
“I wouldn’t touch charter schools with a 10-foot pole, but now with Permanent School Fund backing, it’s a whole different story,” said David Jaderlund of Jaderlund Investments LLC, a Santa Fe, New Mexico, firm that manages $500 million in bonds. “You don’t even have to look at the numbers because it doesn’t matter if the school is in the poorest section of Texas or Highland Park,” a wealthy Dallas suburb.
U.S. charter schools, which are privately run with public funding, are already selling the most municipal debt in at least six years, led by issuers in Arizona and Texas.
Nationwide, the schools have sold about $890 million this year, the most since at least 2007, data compiled by Bloomberg show. About 80 percent of the debt has a credit rating. The trend defies an issuance slowdown this year, as borrowing has dropped 13 percent across the $3.7 trillion municipal market.
While the institutions enroll about 4 percent of the nation’s public schoolchildren, they are gaining popularity as parents seek alternatives without paying private-school tuition. In Texas, charter schools educate about 200,000 students, out of about 5 million in the public system. Republican Governor Rick Perry told the state Board of Education in February that the number of the institutions permitted in Texas should be increased.
The nation’s biggest oil producer, Texas is among a handful of states that insure school bonds approved by the education commissioner in case of a default. The fund’s assets have risen 76 percent since 2003, after payments to schools, because of investment gains and royalties on oil and gas receipts from drilling on state-owned land.
Real estate and mineral rights, including oil and natural gas, make up about 14 percent of the fund’s assets, with the balance invested in areas such as stocks and bonds.
Without the fund’s backing, Weslaco, Texas-based charter operator IDEA, rated BBB by Standard & Poor’s, borrowed $63 million last month through the Clifton Higher Education Finance Corp. The sale included 10-year bonds priced to yield 4.5 percent, or about 1.5 percentage points more than benchmark debt, data compiled by Bloomberg show.
The same week, Lubbock Independent School District borrowed $31.9 million through tax-exempt debt, including a 10-year portion for which the yield spread was about 0.13 percentage point. The bonds are insured by the fund, giving them a AAA rating.
With IDEA planning to double enrollment within five years to 30,000, “the PSF couldn’t come at a better time for us,” said Chief Executive Officer Tom Torkelson.
“We’ll be sending less money to bond buyers and investing more money in our schools” if IDEA receives the state’s support when it next borrows, he said.
Cosmos Foundation Inc., a Houston charter firm that operates as Harmony Public Schools and has sold $250 million in bonds since 2007, expects to cut its interest payout by a full percentage point with support from the fund, said Soner Tarim, Harmony’s chief executive officer. The company is the largest charter firm in Texas, with 26,000 students in 40 sites. It expects to enroll as many as 40,000 within five years.
The default rate of charter schools underscores the risk to investors without the fund’s backing.
About 2.8 percent of the $7.7 billion issued by U.S. charter schools since 1998 has defaulted, said Wendy Berry, a consultant for the Local Initiatives Support Corp., a nonprofit New York community development organization. Five schools failed in the year ending June 30.
That compares with a total default rate of local general obligations of 0.01 percent from 1970 to 2012, according to a Moody’s study.
“There are going to be a few screwups if knuckleheads are running some schools,” said Richard Rickey, chief executive officer of Orenda Education, a Georgetown, Texas, charter operator that is in the market to sell about $10.5 million in bonds. The school expects to pay an interest rate of about 7.65 percent, then in a few years seek state backing to refinance at about 5 percent, Rickey said.
“We’re throwing away millions of dollars on interest costs that we can put in the classroom,” he said. Money from the current issue would expand its Georgetown building, replacing modular classrooms used by its 1,000 students.
As much as $900 million in guarantees will be available to Texas charter schools, according to their share of total public school enrollment, said Tom Sage, a Houston attorney who specializes in school finance at Andrews Kurth LLP.
“Some investors will miss the extra yield,” said Brian Colon, a Denver-based managing director of Robert W. Baird & Co., which underwrites school bonds. “But this is a unique and positive development for charter schools.”
Interest rates in the municipal market were little changed as the partial shutdown of the nation’s government extended to a second day.
Top-rated 10-year munis yield about 2.72 percent, compared with 2.62 percent for similar-maturity Treasuries.
The ratio of the yields, a measure of relative value, is about 104 percent, compared with an average of 93 percent since 2001. The higher the figure, the cheaper munis are compared with federal securities.
Following is a pending sale:
Florida’s Broward County plans to offer about $434 million in airport-system revenue bonds next week to finance work at Fort Lauderdale-Hollywood International Airport, including the expansion of terminals and a runway. The bonds are backed by liens on airport revenue such as from carrier fees, car rentals and parking. The issue will add to the county’s existing airport debt of about $1.1 billion, sale documents show.
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