Private Schools Tap New Source: Tax-Exempt Bonds

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Like many private schools, Albuquerque Academy in New Mexico has taken on several big expansion projects over the past 10 years. It added a middle school to its campus in 1985, and half a decade later it built a new library and science facility.

To finance those improvements, which totaled $30 million, the 1,000-student school chose an option that has grown in popularity in recent years: tax-exempt bonds.

An increasing number of private schools are issuing such bonds to finance their capital needs, according to a report released last month by Moody's Investors Service, a New York-based credit-rating company.

While public schools and some private colleges and universities traditionally have relied on tax-exempt bonds to build, upgrade, and repair facilities, private elementary and secondary schools are relative newcomers to the public-finance market.

"I think it's a level of sophistication that the schools are reaching to really become creative in their funding," said Joyce G. McCray, the executive director of the Council for American Private Education.

Tough Eligibility

James T. Kaull, the director of business and development services for the National Association of Independent Schools, estimates that at least 50 independent schools have taken advantage of the public-finance market--primarily because it cuts costs.

Tax-exempt debt can undercut private-industry interest rates by more than a third, and translate into substantial savings on multi-million-dollar loans.

Traditionally, private schools have turned to several options to finance large-scale projects, said Richard Elkins, the chief business officer of Albuquerque Academy. Often, schools borrow money through bank or insurance-company loans, take money out of their endowments, or raise funds through their constituencies.

While the federal government has long made tax-exempt bonds available to nonprofit private schools as well as public ones, entering the public-bond market is a complicated process with a long list of eligibility requirements.

Private school officials say that schools attempting this route face many hurdles: completing a substantial amount of paperwork, networking with bond and rating agencies, securing a government sponsor, and paying start-up costs that typically are around 2 percent of the bond amount, depending on the state. Moreover, to sell itself as a worthy investment, a school usually must have a long-standing reputation, healthy endowment, and demonstrated market power, among other assets.

'More Fiscally Responsible'

But as private schools struggle to meet increasing financial-aid needs, repair deteriorating facilities, and keep up with technology, borrowing in the public-finance market may offer the smartest solution to overburdened budgets, said John Eldert, the business manager of Choate Rosemary Hall in Wallingford, Conn.

The school issued a $25 million bond last month to renovate its aging dormitories. Over the next three decades, the 1,000-student boarding and day school, which serves grades 9-12, will use the funds to replace roofs, boilers, piping, and wiring and to meet new building codes.

Mr. Eldert estimated the tax-exempt bond, which the school issued at a 7 percent interest rate, will save approximately $1 million a year over the 30-year period, compared with other loan options.

Another possibility--tapping a school's endowment--could be the most shortsighted way to finance expansion or deferred maintenance, Mr. Eldert said.

Most schools entering the public-finance market have endowments that well exceed their debt. But an endowment "is not there to spend, it's there to hold, to collect interest forever," Mr. Eldert said.

A school can also try to raise funds with a capital campaign, he added, but such money is better off going into the endowment and generating income for future generations.

"The day you build a building, it starts to cost you money. There are costs to operate it and costs to replace it piece by piece to maintain it, over 30, 60, 100 years," Mr. Eldert said. "So schools who borrow are being far more fiscally responsible by keeping money in their endowment." Such institutions, he said, unlike other private and public schools, become self-sustaining.

Those private schools that have chosen to enter the public-bond market tend to be favorably received by investors.

Moody's recent report, "Perspective on Higher Education," says "the credit strengths and weaknesses of independent schools are similar to those of private liberal-arts colleges." The report identifies 10 independent schools the service has rated, all of which received high credit ratings of Aaa to A.

Vol. 14, Issue 17

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