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Providence Financial









MONTHLY NEWSLETTER:  DECEMBER 2006 ISSUE

WHAT ARE THEY TALKING ABOUT?
BY BRENT VAN ALFEN, PROVIDENCE FINANCIAL COMPANY, INC.


As in most specialized industries, investment bankers use jargon that sometimes leaves others wondering what those guys are talking about. In this article, I will try to explain some of the terms that relate to the basic types of bond issues that may be relevant to many charter schools.

Taxable and Tax-Exempt Bonds
The coupon rate (interest rate) on a bond is either subject to taxation or not subject to taxation for the investor who buys the bonds. The rate on a taxable bond can therefore be expected to be higher than a rate on a comparable tax exempt bond. It is interesting that this is not always the case as in todayís market for charter school bonds. For instance, I know an underwriting firm that will do a taxable bond issue at around 6% to 6.25% in todayís market while many tax-exempt bonds are going out at a higher rate. There are at least two reasons for this apparent anomaly.

First, the underwriter that has the ability to sell bonds at this rate has a very strong retail sales force that caters to individual investors who buy bonds for their retirement accounts. As long as these investors can get around 1% above a certificate of deposit rate, they will be interested.

Second, the underwriting standards and credit requirements are higher for these bonds than many tax-exempt bonds. The requirement that affects most charter schools is loan-to-value ratio. This taxable bond program requires that the school cannot borrow more than 80% to 85% of the appraised value of the property while tax-exempt bond programs routinely lend up to 100% or more of the value of the property.

In other words, the tax-exempt bond market investors are willing to take a higher perceived risk on the bonds they buy in order to get a rate of return that is really exceptional in their market.

Another area where there is a rather large difference between the costs of taxable and tax-exempt bonds is in the costs of issuance. It will generally cost a school about three to five times more in legal costs to get a tax-exempt bond issue as compared to a taxable bond issue.

Enhanced and Un-enhanced Bonds
There are situations where an enhancement can be applied to a bond issue that significantly reduces the risk to the investor and makes the bonds more marketable. As a result, the rate on an enhanced bond is almost always considerably lower than a comparable bond issue that is not enhanced. An enhancement usually takes the form of a letter of credit guarantee from a large bank that has an investment grade rating. With the letter of credit, investors buy the bond based on the strength of the bank providing the letter of credit. There is not enough space here to fully explain this type of bond issue, but the net result to the school is a rate that is considerably lower than the same bonds would be if they were not enhanced. This type of bond issue is not very often used because the credit parameters of the letter of credit bank must be adhered to. Again, the loan-to-value ratio is usually what separates the schools that use this type of bond issue from the ones that donít. Banks will only go up to 80% to 85% of the appraised value of the property being financed. Just recently, we got a rate of 4.3% for this type of bond issue; so the savings can be pretty dramatic. One caution, though, is that this type of rate floats. Although it floats with a very stable bond index rate, it is subject to change over time.

The vast majority of municipalities hire a financial advisor to assist them in their financing efforts, and charter schools, in almost all cases, should do the same.

Rated and Un-rated Bonds
Bonds may be rated by major credit rating agencies such as Standard and Poor, Moody, and Fitch. These rating agencies thoroughly examine and monitor the credit strength of a bond issue and its underlying borrower. There are not many charter schools that are large enough or strong enough to make it worth the cost and time required to get them rated. In cases where it is cost efficient to get a school rated, the resulting coupon rate is very attractive. For example, a school I worked with that we got rated achieved a 5.25% rate fixed for thirty years.

The vast majority of municipalities hire a financial advisor to assist them in their financing efforts; and charter schools, in almost all cases, should do the same. The first thing the advisor should do is assist the school in determining the best type of financing to pursue. Should it be one of the alternatives described above or something entirely different? Without an experienced advisor, a school may not know about an option that could save thousands of dollars. It is also important to understand that any given underwriter does not offer all of the types of bond programs available. Once a financing strategy is in place, then a financial advisor should go shopping to find you the best possible underwriter for that job. Please give me a call if I can help you.

Brent Van Alfen, President, Providence Financial Co., Inc.
Phone: 801-299-8555, Email: brent@providencefinancialco.com