How Charter School Debt Issuers Can Ace Rating Agency Interviews

As the charter school sector continues to grow and mature, municipal bond ratings from Wall Street’s big credit rating agencies including S&P Global Ratings, Moody’s, and Fitch Ratings are increasingly within reach. Charter schools are still unlikely to achieve the high ratings typical of bonds issued by essential public service entities and enterprises such as local governments, public school districts, and water utilities — rating agencies and investors still consider the charter sector largely a “high yield” sector, meaning that most schools are generally non-investment grade credits (1). However, established charter schools and charter management organizations (CMOs) with strong demand, good management, high academic standards, stable financial performance, and at least one charter renewal under their belts are increasingly able to achieve low investment grade (‘BBB’ category) or high speculative grade (‘BB’) ratings. These organizations often find that the credibility of an independent credit rating results in strong investor demand and a lower cost of capital than other financing sources.

While a lower cost of capital is great news, coming face-to-face with credit rating agencies is a stressful and intimidating experience. Here’s the good news: whether you are a new charter school debt issuer dealing with a rating agency for the first time, or you have long-standing established relationships with rating agencies, there are a few simple ways you can maximize your interactions with them, reduce the anxiety of the rating process, and maybe even nab a higher rating. Here are our top 10 suggestions:

10. It’s not all about you. Ratings can feel like an intensely personal reflection on your school and its leadership. The strength of management is an explicit factor in nearly every rating methodology. But there are many rating factors over which you have little to no influence. For example, charter schools face a host of industry risks over which they have little direct control, including legislative and policy risks, local demographics, and funding risk. These risks play a large role in the rating process. Do your best to control the things you can, such as sharing quality information and delivering a strong presentation, and don’t worry about the rest.

9. Understand the bigger context. Credit rating agencies assess creditworthiness in many asset classes and geographies. When they assess your credit risk, they have an eye on how your organization and your sector compares to many other organizations and sectors across the globe. They call this “rating comparability”. It’s the idea that a ‘BBB’ rated charter school in Indiana should have relatively comparable credit risk to a ‘BBB’ rated mortgage pool in Sweden or a ‘BBB’ rated oil company in Canada. Understanding that rating methodologies have this bigger context will help you understand their approach to risk assessment and the rationale behind some of their questions.

8. Keep in mind that fixed income has asymmetric risk. Fixed income investing is inherently asymmetric. Unlike stockholders, who participate in the upside potential of a company’s strategies, a bondholder who buys your debt will at best get her money back plus interest (ignoring potential secondary market trading gains), while on the downside, she risks everything. This is why credit analysts seem to be inherently negative, or don’t seem to be giving you enough “credit” for all your great strategies. It’s not that they don’t see the upside potential, it’s just that downside risk is more important when assessing creditworthiness.

7. Educate your board. Rating meetings typically include one or more members of the board or governing body to present your organization’s governance structure and practices. It’s important for board members to demonstrate pride in all the wonderful work your school does for students and the community, but the rating agencies also want to know if your board is capable of providing the oversight and effective challenge of management that is needed for success. Make sure your board is highly educated about what rating agencies do, what kind of questions they ask, and how credit analysts look at risks in the charter school sector. Your board members should be able to provide specific examples of their oversight of management — replacing a CEO or a key official, challenging a strategy, ordering an internal assessment of certain risks or internal controls, etc. They should be able to demonstrate their understanding of industry risks and how they use that knowledge to oversee management. As a bonus, an educated, effective, and proactive governing body is not just good for rating agency relations, it’s good for the organization.

6. Be prepared to discuss hot button issues. All rating agencies publish their methodologies, and their ratings must be determined through application of one or more published methodologies. So naturally your rating presentation materials will focus on the factors relevant in the methodologies. But rating agencies can catch you off-guard with questions that are topical and relevant, but not mentioned in the methodology, such as how you are managing cyber risk. Go beyond the rating methodologies, learn the current hot button issues, and be prepared to answer questions about them. Rating agencies signal these hot button issues through regular commentaries and public speaking.

5. Don’t ghost them. Ever. Rating agency relationships are long-term committed, if not always monogamous, partnerships. There is an expectation, and in some cases a contractual promise, to provide relevant information to them so they can maintain credit ratings that are reflective of current developments. If things start to go badly, such as a governance or management scandal, a high-profile teacher or student safety event, or enrollments are significantly below expected, don’t try to hide it or try to fix the problem completely before talking to the rating agencies. Be proactive: be transparent about the issue, convey your seriousness about resolving it, talk to them about what you have done so far and what you still plan to do. But ducking them is likely to backfire in more than one way. First, once they know there’s a problem, they must reflect that information in their rating. If you refuse to talk to them, they will use whatever information they can get, such as news articles, which may lack the full context that talking with you can provide. If they have to make assumptions about events or issues, they are likely to be very conservative, and they may downgrade the rating. They may even decide that they have insufficient information to maintain the rating, which could result in a rating withdrawal.

4. Don’t be shy — ask for that upgrade! Credit rating agencies maintain continuous surveillance of their ratings. You might reasonably assume that if your school warrants a higher rating, an upgrade will just happen in the normal course of the rating agency’s work. However, human nature being what it is, it doesn’t always work that way. Ratings are not particularly granular and there isn’t a bright line between ratings that can be calculated mathematically. There’s “wiggle room” around every rating (although rating agencies prefer the phrase “analytic judgement” to “wiggle room”). For a charter school that’s doing well, sometimes the rating agency could reasonably justify affirming the rating or upgrading. The big rating agencies are keeping track of tens of thousands of municipal ratings. They have resource constraints like any other organization. So, advocate for yourself. Point out your strengths and tie those strength into their methodologies. Point to comparable charter schools that have higher ratings. Ask them to specifically address your points. Sometimes, it works. But if you don’t get the upgrade, you’ll at least get detailed feedback on why you aren’t being upgraded, and what it would take to get there.

3. Embrace Environmental, Social and Governance (ESG) leadership. Virtually unknown several years ago, the three-letter acronym ESG is now front and center in the lexicon of credit raters, investors, and employers. ESG is a dominant theme at investor conferences. Rating agencies publish frequently about the importance of ESG factors in credit ratings, with some even publishing formal ESG-themed scores. ESG factors are now cited by S&P as causing about a third of all rating changes for US public finance debt issuers (2). This increased ESG scrutiny raises the imperative for debt issuers to understand ESG’s expanding role in credit ratings and access to capital, track the metrics that credit raters and investors are following, and align presentation materials and disclosure accordingly. The explosive growth of interest in ESG analysis signals that credit raters and investors believe traditional credit metrics are inadequate to measure creditworthiness in an interconnected world where long-term success is increasingly tied to an organization’s behaviors towards its environment, employees, vendors, customers, the local community, and even its role in global phenomena such as climate change.

For charter schools, growth in ESG analysis is great news. As nonprofits, charter schools have always thought broadly about their role in the local community and the many stakeholders they serve, espousing values of social and environmental stewardship that their corporate brethren have only more recently begun to embrace. Charter schools are emerging as great candidates for social impact investors who often use ESG as a framework for analyzing factors that go beyond traditional credit metrics. Learning about ESG metrics and including them in your presentation materials will enhance your discussions with rating agencies and increase access to a wider base of potential investors.

2. Think like an analyst. A good way to prepare for a rating agency meeting is to put yourself in their shoes. If you were an analyst, what would you be asking? For example, a small number of charter schools suffer a charter revocation, raising the risk of bond default. You should demonstrate your understanding of recent charter revocations and why your school isn’t facing a similar risk, how you manage charter renewal exposure, and what contingency plans you have in place. Another example: analysts spend a lot of time looking at historic and projected statistics. They may even create their own financial models and forecasts. They try to understand changes in the numbers because it helps to tell the story of your organization and informs their view of your future performance. You can do the same thing by looking at all reported statistics with an analyst’s perspective. Any significant deviation from historic trends in revenue, expenses, balance sheet ratios, per pupil funding, or enrollment statistics will generate a question from analysts. If you anticipate those questions and come prepared with responses, you’ll not only impress the analysts, you’ll make their jobs easier, and yours, by reducing the amount of follow-up work to be done later. Which leads us to tip #1:

1. Give them what they want! Many charter school issuers find the rating process too long and too iterative (“every time I give them one piece of information, they ask me for something else”). This can be frustrating, whether you are trying to get to market with a new bond sale or just get through this year’s rating surveillance process. It’s frustrating for the rating agencies, too. While you can’t control what rating analysts will ask for, and sometimes the answer to one question spawns other questions, you can reduce the back-and-forth significantly by ensuring that the materials you provide, including rating presentations, continuing disclosure, quarterly financials, budgets, and other information, are tailored to meet their information needs. Comb through the rating agency’s charter school methodology, look at every factor they assess, every ratio they calculate, and ask yourself where they will get that data. If it isn’t in your presentation, audited financial statements or other disclosure documents, they are going to ask you for it. By aligning your materials with rating agency needs, not only will you reduce turnaround time and frustration on both sides, you’ll also create a favorable impression. Who knows, maybe you’ll get a better management score and finally get that long-coveted upgrade!

1. The terms “non-investment grade”, “speculative-grade”, “junk”, and “high-yield” are generally used for bonds with credit quality of ‘BB+’ or lower from S&P or Fitch, and ‘Ba1’ or lower from Moody’s. Where public credit ratings are not available, the terms refer to estimated credit quality or the internal credit rating scales of institutional investors, which are proprietary.

2. “When Public Finance Ratings Change, ESG Factors Are Often the Reason”, S&P Global Ratings, March 28, 2019”

The author is President of Nutshell Associates LLC, a municipal advisory and consulting firm, and a faculty member of the McDonough School of Business at Georgetown University.