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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 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
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
Related link in Essential Resources: Analysis of Loan Types
Related link in Essential Resources: Who Are the Lenders?
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.