That charter schools struggle to find and finance adequate building space is a problem that has received well-deserved attention lately, but few reporters and analysts have documented the challenges charters face in entering the multi-trillion-dollar municipal bond market.

So a hat-tip goes to longtime charter and reform leader Nelson Smith for drawing attention to a worthwhile report from the Local Initiatives Support Corporation (LISC), which found a lack of consensus among underwriters and investors as to what drives credit strength in the charter sector.

As they expand, more charters are turning to municipal bond markets to finance their building projects. When schools issue bonds, an investor essentially loans them money in return for regular interest payments until the bond “matures,” at which point the school repays the principal. School districts and other government entities issue bonds all the time, but many lenders continue to see charters as risky investments.

That perception has consequences for charters, which end up paying higher rates than schools districts, if they can find investors at all. And it’s a perception that seems to be based on a faulty picture of what makes a charter school viable for the life of a bond, which can last up to thirty years.

The overall financial condition of the charter school sector is sound, LISC analysts Elise Balboni and Wendy Berry report. The notion of credit risk often is fueled by high-profile defaults or potential defaults that imply that schools can lose their students or charters with little or no notice. “That simply is not the case,” Balboni and Berry write. “Like any other borrower, charter schools do not transform from being a strong credit to a weak one from one day to the next.”

In fact, most schools that have defaulted on their bonds suffered from subpar academics, which many lenders did not consider—or did not consider thoroughly enough. In 393 underwritings that LISC examined, sixty-four contained no information on academic performance. Those that did examine student outcomes generally looked to results on state assessments and school grades. In just six instances did underwriters consult authorizer reports, which LISC correctly notes may contain valuable information about a school’s ongoing academic performance and ability to meet key benchmarks.

That’s a problem because these academic markers are perhaps the most important factors in determining a school’s long-term viability, as Balboni and Berry write:

It is time to place increased emphasis on academic performance as a fundamental credit factor in charter school underwriting. Academic quality speaks to a school’s long-term ability to attract and retain students and the per-pupil funding that accompanies them. It is also the best predictor of charter renewal. It is difficult for an authorizer to close a high-quality charter school even if the relationship between the school and its authorizer is strained or contentious.

With hope, this recommendation may soon become standard practice for some investors. Nelson Smith, who today is a senior advisor to the National Association for Charter School Authorizers, said that NACSA is assembling a working group of lenders and authorizers who will try to develop a common language for evaluating the viability of charter schools. “We’re hoping to marry the keen financial/operational analyses of underwriters with the performance frameworks NACSA develops for authorizers—and we just might come up with some tools both camps can use,” Smith said.

Let’s hope they succeed. Absent a major political shift that sends more public dollars to charter school buildings, the bond market may be the catalyst that enables quality charters to scale up.

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