Top Ten Triggers of Charter School Bond Default: #6 Poor Management

High-yield municipal bonds for charter schools have a 5% default rate. School Improvement Partnership is reviewing the causes or triggers for such defaults in a series entitled THE TOP TEN TRIGGERS OF CHARTER SCHOOL BOND DEFAULTS. We are exploring one trigger per week over the ten weeks, leading up to the most common cause of charter school bond defaults. In case you missed it, Risk Number 10 was School Safety; Risk Number 9: Construction Risk; Risk Number 8: Shifting State Support for Charter Schools; Risk Number 7: School Leadership. Which brings us to:

RISK #6: Poor Management

Introduction: In our review of the 52 high yield charter school bonds which have defaulted through December 31, 2016, poor management arises in three separate contexts. First, when charter schools and CMSs have for-profit managers, concern for management fees can outweigh concern for the school’s long-term success. Second, when a Board of Directors and management team does not support the founder in a way that helps implement his or her vision with an eye toward accountability and transparency, problems arise. And finally, poor management can flow from a conflict of interest where the interests of an individual (or individuals) are put above those of the students and their families. Our analysis relies heavily on the excellent study by our friend Wendy Berry, “New Oak 2017 Charter School Default Study”.

 For-Profit Managers: There are many examples of public entities successfully enlisting the private sector to further public policy goals with an eye toward efficiency; public education is not exempt from this trend. Professional development and financial back office are two functions often privatized by charter schools and CMOs to efficiently access best practices. However, privatizing management of an entire charter school or CMO has led to problems for charter school investors, especially in Michigan where more than half of charters are run by for-profit managers. A key challenge is producing revenues sufficient to pay the management fee, which generally includes a minimum 10% return to the management company’s investors. While management fees are often subordinated (in whole or in part) to debt service, the result can be a large accrued and unpaid balance, which prevents the school leadership from investing in other necessary priorities. This was the situation at Bradford Academy, a Michigan charter school which defaulted on more than $15 million of bonds. When the initial for-profit manager left with its management fees unpaid, administrators and key staff soon followed. Some states – California among them – have taken the step of prohibiting for-profit managers. Privatizing certain functions is essential to smooth operations, but problems can arise when for-profit mangers are allowed to put their interest ahead of the school’s interests.

“Foundertitis”: Charter school founders are a unique combination of visionary, courageous leader and talented multi-tasker. The charter school movement would not exist without them. Unfortunately, “Founderitis” can break out when a charter school founder leaves, should leave or doesn’t leave when it is time. There are common symptoms of founderitis that a charter school investor should be on the lookout for. Among them is a Board of Directors made up of “founder friends” who lack the requisite expertise and independence required to operate a charter school. This was the case for Harambee Institute of Science and Technology in Philadelphia, an Afro-centric charter school when the charismatic founder suddenly died, leaving the Board to sort out how to move forward. With few scalable systems in place and no experienced educators on the Board to assist in the transition, thee school faltered. The school ultimately accessed the high yield bond market, but only after all family members of the founder were removed from leadership.

Conflicts of Interest: How a conflict of interest can lead to poor management and trouble for charter school investors? One need look no further than UNO Charter School Network Inc., which borrowed $37.5 million in bonds to build three charter schools in Chicago in 2011. The Securities and Exchange Commission  uncovered the fact that the COO awarded multi-million dollar construction contracts to his two brothers, including an $11 million contract to one for windows.  Now they may have been outstanding contractors. However, failure to disclose these details and take steps to ensure that they were the best contractors for the job ultimately did the school in.

Conclusion: What is a charter school bond investor to do to avoid poor management, the sixth most common cause of charter school bond defaults? First, make sure the Board of Directors is independent of the founder and the for-profit manager (if any), and that all members have the requisite skillsets and experience to provide to execute their governance function in an informed manner. It is equally important that the founder of the CMO or charter school has systems in place that will allow for adequate school operations should he or she leave the organization. Above all, charter school investors should regularly review operational, financial and academic progress of the school in order to catch any warning signs that management may be faltering – or existence of conflicts of interest. School Improvement Partnership supports this best practice by providing such reports on a quarterly and annual basis for schools in its clients’ portfolios, enhancing transparency and accountability for the charter school bond market.

Wonder what number 5 is? See you next week!