Loan Categories

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There are three main categories of loans for facilities: conventional loans, tax-exempt bond financing, and New Markets Tax Credits (NMTC) financing. It is important for your school to understand the major characteristics of each category before you approach a financial institution.

Conventional Financing

Conventional financing generally comes from regional and national commercial banks, community banks, and community development financial institutions (CDFIs). There are also private finance companies offering conventional loans. However, they may charge a premium, so be sure you examine terms carefully.

Tax-Exempt Bond Financing

Tax-exempt bonds are a good alternative to conventional financing for strong charter schools with solid credit and a clear ability to service debt over a long period of time. Tax-exempt bonds may offer lower interest rates and provide longer terms than conventional financing. These bonds are a form of long-term debt financing used for the construction of institutional facilities such as charter schools. Typically, they are authorized by federal, state, or municipal law and issued by a qualified agency such as a local school district or state agency. Private and corporate investors that are seeking tax-exempt income then purchase the bonds through a registered securities broker or dealer.  

Tax-exempt bonds can also require significant reporting requirements and restrictive covenants. Completing a bond transaction requires multiple parties. Due to additional legal and consultant fees, and loan reserves funded up front, transaction costs (all paid for by the borrower) are higher. Therefore, bond financings are recommended for projects over $5 million.

Tax-exempt bonds may be rated by one of the three major credit rating agencies — Moody’s, Standard & Poor’s, or Fitch. The rating quality will determine the bond’s price and other factors that affect the terms of the ultimate sale to the investor community. Bonds without a rating will pay a premium via a higher interest rate.

Unless the charter school is established and very strong, the tax-exempt bonds will have to be issued on a credit-enhanced basis. In other words, the bondholders may require that the bonds have an additional source of security by a third-party source of credit support, such as a letter of credit. Credit enhancement can add additional costs to the transaction.

If you are interested in bond financing, you need to hire a broker who will walk you through the process of rating, attracting investors, and issuing the bonds. They will work with a bond underwriter who prepares a package to demonstrate ability to support the tax-exempt debt.


Typical Parties to a Tax-Exempt Bond Transaction

  • Borrower: Charter school
  • Borrower’s Legal Counsel: The borrower’s legal counsel protects the interests of the charter school during negotiation and provides certain legal opinions required at bond closing.
  • Issuing Authority: Tax-exempt bonds are issued by a state, local government unit, government agency, or public authority on behalf of the borrower. The issuing authority serves as a “conduit” for the bonds to the borrower.
  • Issuer’s Legal Counsel: The issuer’s legal counsel represents the interests of the issuing authority at bond closing, performing duties such as preparing the bond purchase agreement, reviewing and preparing the official statement, reviewing various legal opinions from other parties, and qualifying the bonds for sale under the particular state’s securities laws.
  • Underwriter: The underwriter structures the financing, negotiates the business terms, prepares the offering statement (to be circulated to potential buyers of the bonds), arranges the credit enhancement (if needed), organizes and manages the marketing and selling of the bonds, negotiates the terms of the bond sales, and arranges for the delivery of the bonds and payment of the purchase prices at bond closing.
  • Underwriter’s Legal Counsel: The underwriter’s counsel represents the underwriter’s interests during and at the close of the transaction.
  • Credit Enhancer (Bank, Bond Insurer, or CDFIs): A commercial bank or a bond insurance company that provides a credit enhancement (such as a letter of credit) to the bond.
  • Credit Enhancer’s Legal Counsel: Represents the interests of the bank or bond insurance agency.
  • Bond Trustee: The trustee holds, invests, and administers the bond funds for the particular bond issue. The trustee also serves as bond registrar, transfer agent, and paying agent for the bonds, and acts on behalf of the bondholders to ensure that the borrower meets the terms of the covenants contained in the bond documents. In the event of a bond default, the trustee pursues all legal remedies permitted in the bond documents.
  • Bond Legal Counsel: The bond’s legal counsel writes the majority of the financing documents and provides opinions on the legality and tax-exempt nature of the bond issue, as well as the underlying security (collateral) for the issue.
  • Financial Auditor: The auditor prepares a summary of the charter school’s historical audits to include in the offering statements. The auditor also typically prepares comparative year-to-date statements for the charter school. In addition, the auditor provides a “comfort letter” at the time of the bond sale (and subsequent closing) that addresses the financial information provided in the official statement.

New Markets Tax Credits

New Markets Tax Credits (NMTC) are another attractive type of financing for charter schools. NMTC is a federal tax credit program created to stimulate increased investment and economic growth in low-income communities. It attracts private capital to low-income communities by providing investors with a federal tax credit for investments made in businesses or economic development projects located in some of the nation’s most distressed communities.

To be eligible for NMTC financing, the school facility must be located in a qualifying low-income census tract, as measured by poverty rate or median family income. Before you finalize your site location, you can contact your CDFI partner and ask them to check NMTC eligibility for you. There are very specific federal guidelines that your project needs to stay within, and you will have to issue annual compliance certificates and social impact data reports.

The benefit for a charter school is that a portion of the investments from private investors (approximately 20 to 25% of total project costs) will turn into “free” equity for the school at the end of the seven-year NMTC compliance period. In addition, NMTC financings generally require interest-only payments (no principal payments), reducing the annual loan payments for the school. The loans have a seven-year term and have to be refinanced at that time by the school.

NMTC financings are better for projects over $5 million due to the complexity of the structure, and the transaction costs tend to be high given the number of parties involved. A consultant expert in NMTC financing may help you manage the process and ultimately save costs. The process to obtain NMTC financing is similar to bond and conventional financing. The organizations who receive NMTC allocations, called “CDE” as defined below, are affiliates of larger financial institutions, states, municipalities, real estate development firms, and nonprofit organizations. CDFIs receive NMTC allocations and have historically invested in charter school projects that demonstrate strong impact. They will help find the other parties involved in the NMTC financing. To get started, contact an organization that received an NMTC allocation. Lists of CDEs can be found at the CDFI Fund. See the CDFI website for more information, www.cdfifund.gov.

Typical Parties to NMTC Financing

  • Borrower/QALICB (Qualified Active Loan Income Community Business): Charter school or special-purpose entity affiliated with the school that will own the real estate property and lease it back to the school. This entity will have to comply with NMTC regulations during the seven-year compliance period.
  • CDE (Community Development Entity): Eligible organization that applies for and receives allocations of tax credits from the Treasury Department. They will provide the tax credits to equity investors in exchange for their investments into the project. The CDEs will use these investments to make qualified low-income community investments (QLICI) to businesses and projects located in eligible low-income communities (LCI).
  • Equity Investor: A for-profit private corporation (usually large commercial banks) that will purchase tax credits in exchange for an investment in the project. Investments typically represent 20 to 25% of total project costs.
  • Leverage Lender: A financial institution (bank or CDFI) that will make a loan to the investment fund, representing approximately 75% of total project costs, unless the school has grants or equity it can leverage through the NMTC structure. This is called the “leverage NMTC structure” and is the most commonly used structure for charter school projects.
  • Investment Fund: Special-purpose entity created for the transaction, usually managed by the equity investor, which pulls funding from the equity investor and the leverage lenders to make qualified equity investments (QEI) in the CDEs.
  • NMTC Accountant: Accounting and consulting firm that will advise the parties on underlying tax, structuring, and business issues of the NMTC program. The firm will develop an extensive model of the transaction that includes project budget and financial forecasts, as well as various tests to confirm compliance with the NMTC program.
  • Attorneys: Each of the QALICBs, CDEs, equity investors, and leverage lenders will hire legal counsel that represents their interest during the closing of the financing. They will prepare legal and tax opinions and draft or review loan documentation.

Related link in Essential Resources: Analysis of Loan Types

Related link in Essential Resources: Who Are the Lenders?

Legal Disclaimer:

Nothing in this material should be construed as investment, financial, brokerage, or legal advice. Moreover, the facts and circumstances relating to your particular project may result in material changes in the processes, outcomes, and expenses described herein. Consult with your own professional advisors, including your financial advisors, accountants, and attorneys, before attempting to consummate any transaction described in this material.