Kapolei, Hawaii:  Six months ago, Island Pacific Academy was like many start-up independent schools. Even though it had enrolled 650 students PK-11 in four years of existence, it struggled to meet the debt service on a $20 million bond issue amidst rising costs and the stagnant enrollment of the current recession.  Today, the School has cash reserves and completed the purchase of its property. The debt remains, but the debt service is more manageable, given the school’s comparatively low tuition and enrollment.  How did they do it?

“Bond math 101″, says Nick Prassas, financial advisor to the School.  “Two years ago, the School sold a bond issue at par, at a low fixed interest rate.  When the credit crisis hit, interest rates spiked higher.  Higher interest rates, lower bond prices.  The School was able to negotiate the repurchase of its bond issue from bond holders at a substantial discount.”

Of course, the School still needed a source of funds to buy back their discounted bonds.  That source:  federal stimulus dollars from the United States Department of Agriculture.

“We were at the right place at the right time,” says Stuart Hirstein, Associate Headmaster and Chief Operating Officer.   “The USDA, which provides rural community facilities financing, became one of the conduits for disbursing federal stimulus funds. The agency, having guaranteed a loan for the School several years ago, was already familiar with our financial profile.  We made our request just as stimulus funds were being allocated.”

The USDA funds came in the form of a direct loan, and a loan guarantee.   The direct loan carries an interest rate of 4.5%, repayable over forty years, instead of the customary thirty.

“It sounds straightforward, now that we’ve closed the transaction,” says Dan White, Headmaster of the School. “The USDA program is designed to support new community initiatives.  Fortunately, IPA had received a five-year grant from the Hawaii Community Foundation in their Schools of the Future program. The Schools of the Future process will, in fact, transform our school and represent a genuinely new initiative. Putting the deal together, though, required long hours and hard work by several knowledgeable people.”

The notion of a school capitalizing on the USDA stimulus program to buy back their own bonds at a discount, just one year after selling them, is novel.

“Obviously the recession provided fertile ground for thinking outside the norms of independent school finance,” added Prassas. “Everything we hear, though, about independent schools in the post-recession world would suggest that the old norms are not likely to return.”

“The schools of the future—15 to 20 years down the road—might well look very different than today.  Why wouldn’t school financing evolve in a similar fashion?” asked White.“We still need to make enrollment targets,” continued White. “The debt service is still a huge chunk each month.  We continue to be frugal; we have to be. But we have a huge asset—our land—that we did not have before, and there is great security for the school in that fact.”

As a small, unrated, first-time borrowing, the financing accomplished important objectives that were simply not possible with other alternatives:

•    Immediate funding to lock-in escalating construction costs.

•    Thirty-year fixed rate financing, eliminating future interest rate refinancing risk and simplifying the budget process.  Commercial banks and other conventional sources offered only 7-10 year fixed rate financing.

•    Tax-exempt borrowing rate of 5.50% is significantly lower than conventional lending sources.

•    A tax-exempt private placement (negotiated and placed directly with one mutual fund) avoided substantial underwriting, credit enhancement, and legal fees, achieving an all-in bond rate about 100 basis points lower than a traditionally underwritten bond issue.

*Prassas Capital acted solely as a financial advisor to this transaction.

For more information, please contact us.

Today’s Bloomberg:   The Reading, Pennsylvania school district must pay $230,000 to Deutsche Bank because it is on the losing side of a wager on long-term interest rates.

Excerpts from the article:
“It was all done in a real hurry,” said Keith Stamm, the only member of the board to vote against the deal. “The whole board is so desperate to try to find a way to raise money, they see this floated in front of them as a big-time amount of money and they want to go forward with it.”

William Cinfici, another board member and a registrar for the state’s division of vital records, said Concord (the school’s financial advisor) didn’t provide enough financial information to evaluate the transaction.

`Nobody Questioned It’

“It was arcane, nobody questioned it,” Cinfici said. “Everything was presented to us at the last minute. I said, `Well, I’ll trust in the guys’ judgment.”’

While Reading’s taxpayers are liable for the loss, bankers and advisers already have pocketed $1 million in fees for arranging the swap.

The Internal Revenue Service has probed whether the mispricing of municipal swaps has allowed advisers and banks to make excessive fees, depriving the federal government of earnings from the investment of tax-exempt bond proceeds. The U.S. Justice Department and SEC have asked for information on swaps as part of an antitrust investigation into alleged bid- rigging in the $2.3 trillion municipal market.

Local governments from Augusta, Georgia, to Oakland, California, are being lured by similar opportunities to speculate with derivatives created by the world’s biggest banks. Most of the $400 billion of private agreements sold to municipalities escape taxpayers’ notice and are little understood by the public officials and administrators who approve them.

The article can be read in its entirety here