Most Common Trigger of Charter School Bond Defaults – Disclosure Failures

School Improvement Partnership is highlighting the causes or triggers of defaults on municipal high-yield charter school bonds in a weekly series entitled THE TOP TEN TRIGGERS OF CHARTER SCHOOL BOND DEFAULTS. In case you missed it, Risk # 10 was School Safety; Risk # 9, Construction Risk; Risk # 8, Shifting State Support for Charter Schools; Risk # 7, School Leadership; Risk # 6: Poor Management; Risk #5: Student Retention; Risk #4: Authorizer Relations; Risk #3: Poor Academic Performance; and Risk #2, Financial Issues.

The Most Common Trigger: Disclosure Failures

As has been detailed in analyzing nine of the “Top Ten Triggers of Charter School Bond Defaults”, there are many issues that can damage the performance of a charter school – and ultimately the value of its bonds. Compounding the problem is that in 2018, a record 75% of charter school bonds were unrated, so the periodic analysis from the rating agencies is absent from EMMA, the electronic bulletin board set up by the Municipal Securities Rulemaking Board (the “MSRB”) for information on charter school bonds and all municipal bonds.

Given the number of factors to track, and the rarity of ratings in the sector, it should come as no surprise that the #1 leading indicator of charter school bond defaults is disclosure failures. Disclosure failures indicating a default take one of three forms. First, information that the market may deem material may be omitted from EMMA disclosure filings. A second alarming trend: information filed may be misleading,  or worse,  never filed. The third common form of disclosure failure: the failure to appoint a party knowledgeable about what the bond market is expecting.  What exactly is a Days Cash on Hand? How do you measure student retention? Having a continuing disclosure expert to ask questions regarding the data being submitted can mean the difference between an accurate continuing disclosure filing and a misleading one.

Disclosure Omissions. As the high-yield charter school market has grown to over $3 billion annually, the market’s expectation of the information to be included in continuing disclosure filings has evolved far beyond the 16 material events required under SEC Rule 15c2-12. Has there been any communications from the charter authorizer? Has the school experienced leadership changes? Are students returning? These issues are among The Top Ten Triggers, and without this data, an investor can have a misleading idea of the value of their charter school bonds. It was the failure to file audited financial statements and notice of draws from the debt service reserve fund that led to a $1.6 million fine by the Securities Exchange Commission against a trustee bank with continuing disclosure reporting obligations for a non-profit’s high-yield bonds.[1] Omitting important data can cause an investor to over-value its bond and be hampered in taking early action when performance is lagging.  For the 40 charter schools for which School Improvement Partnership serves as continuing disclosure agent, all of this information is routinely included in its reports, as is the value of the debt service reserve fund and other trustee-held funds.

Misleading Disclosures. When a charter school makes a misleading filing on EMMA, bond valuation and pricing decisions are being made on inaccurate information. A North Carolina charter school kept reporting the same enrollment every quarter, despite the fact that enrollment kept dropping. Since the State Department of Education measures enrollment once annually and provides 60% of school revenue, the school thought it was complying with its continuing disclosure obligations. Unfortunately, 40% of school revenue comes from local school districts which pay according to monthly enrollment. Misleading disclosure can come from the most well-intentioned of charter schools.

Communicating with Bondholders. Why can’t charter schools file continuing disclosure information with the same accuracy and alacrity as they do report cards for their young students? Ask the bondholders for Knowledge Academies in Tennessee. The school was unable to file its 2018 audit on time and had to post on EMMA the following notice: “Our auditors are in the process of seeking clarification regarding the calculation as defined in the Master Indenture for ‘debt service coverage’ and ‘days cash on hand’.” Unfortunately, the bonds went into payment default shortly thereafter. Charter schools rarely have additional staff trained to make continuing disclosure filings. And auditors are familiar with GAAP, not the MSRB. How does a school calculate its Debt Service Coverage Ratio if it rents its building? How do you measure the graduation rate?  As it prepares quarterly and annual reports in collaboration with its charter school clients, School Improvement Partnership has answered these questions and more. There is no substitute for having a professional with the requisite expertise and experience to help ensure charter school administrators communicate with the bond market accurately and on a timely basis.

Why Disclosure Failures Matter. Disclosure failures are a leading indicator that trouble could be on the horizon for a charter school. Such failures short-circuit the ability of the charter school and the charter school bond investor to spot issues before they mature into problems or covenant defaults. Good continuing disclosure serves as a type of bond insurance for investors: if an issue ever arises at the charter school, investors will receive notice early enough to put remedies in place to address it. Otherwise, charter school bond investors are left to buy 30-year charter school bonds and just hope nothing ever changes from the day they purchase them at par.

 

[1] In the Matter of BOKF, NASEC Administrative Proceeding File No. 3-17533, September 9, 2016.