The education landscape: The road ahead for Texas' growing population

The discussion will provide an overview of the education sector, namely higher education institutions as well as K-12 and charter schools. Our panelists will also discuss the impact of key issues facing the sector like inflation and what, if any, policies and statutes are getting traction as to state appropriations for all school levels.  Among the topics of discussion will be:

• Latest on the Permanent School Fund ceiling and impact on K-12 and charter schools
• Will voucher program gain traction?
• Higher ed status of enrolment: is the dip seen during the pandemic persisting?
• Impact of merger/consolidation of higher ed institutions  

Transcript:

Announcer (00:09):

All right, in line with the developments in Texas with the growing population here we have the education landscape panel. It is my pleasure to introduce the next panelist, the road ahead for Texas' growing population and I am actually going to leave it to Juarez to introduce the panelist if you do not mind. Thank you.

Orlando Juarez (00:32):

Thank you.

(00:37)Good afternoon everybody. My name is Juarez Orlando. I am an attorney with the law firm of McCall Parkerson Horton and it is my pleasure to be moderating this panel today with a very diverse panel. We have Eduardo Ramos from Austin ISD. We have Nicole Conley, managing director with Seabert Williams and S Shank. We have Jonathan Church, senior vice president with Masters and Advisors, and we have Doug Kilcommons managing director with Coral Bond Rating Agency. And so with this panel, we are hoping to have a very interesting perspectives on the education landscape here in Texas today. And with that, before opening up the discussion, I would just like to provide a brief opportunity for each of the panelists to kind of introduce themselves and provide any disclaimers or introductory notes they would like to make. So starting with Ed.

Eduardo Ramos (01:28):

So my name is Eduardo Ramos. I am the current CFO for Austin. ISD come with 27 years of experience in school finance. So I actually was born in into school finance. I graduated on a Saturday from St. Edwards University and that Monday started work at Pflugerville isd. So I have been in school finance ever since. I can say to this day I still love what I do. It is all about the students for me, so any decision that I make and my leadership team makes, I know that I impacts the students of our district and so it is a great opportunity for me. Great job. It is very stressful lately and so I am still going strong.

Orlando Juarez (02:07):

Okay, Nicole!

Nicole Conley (02:09):

Thank you. Good afternoon. I am Nicole Conley. I always say I greased the skids for ED. I was the former CFO CEO of Austin Issd as well. I sort of worked on in central Texas passing sort of the first billion bond election here. I was an appointee by Speaker Strauss on the School of Finance Commission and working to working on historic legislation from HB three, fundamentally changing school finance laws that had not been meaningfully updated for years, 30 years I think since the eighties. I come by. Do not let the baby face fool you. I have been working in urban large school districts for over 25 years, starting out my career in New York City Department of Education and DC Public Schools before coming to Austin for the last 10 to 12 years. Having the local district experience but also sort of statewide experience and sort of working on legislative issues. Thank you. Good afternoon.

Orlando Juarez (03:04):

Thank you.

Jonathan Church (03:05):

Hi, good afternoon everyone. Jonathan Church. I am a senior vice president with Masters and Advisors. We are a financial advisor based in Texas. We represent everyone from large issuers like Harris County, city of Houston, down to a lot of specialized districts or muds as we affectionately call them. I am very much involved in between those two extremes with the charter school practice represent about 20 or so charter schools, primarily based in the state of Texas. So looking forward to bringing a little bit of that perspective to today's conversation.

Doug Kilcommons (03:33):

Great. I am not going to be insulted that the rating agency person is last here, so that is my slater, but all joking is aside. Good afternoon. My name is Doug Kilcommons. I am a managing director at Crow Bond Rating Agency. We are one of the major bond raiders in the municipal space. My background has been in credit for the majority of my career, both on the rating agency side and banking side. A lot of time spent here in Texas, so I am happy to be here today and also a lot of time spent in the education and nonprofit space, so look forward to today's discussion.

Orlando Juarez (04:06):

All right, thank you guys. And Ed, I guess I will ask you and Nicole to both kind of kick us off with a very broad question of what do you all think some of the most challenging areas of concern facing ISDs like Austin ISD in particular, and then Nicole, maybe if you could speak to K through 12 on a broader scale today in today's environment. All right.

Eduardo Ramos (04:28):

So I think our number one concern right now as far as school districts are concerned is teachers leaving the profession. And so they have been faced with a lot of challenges, additional workloads have been placed on them and then of course pay has been a concern for many years with our teachers. And so It is becoming more and more difficult to really pay our teaching staff a livable wage, a competitive wage based on what they do. And so one of the things that we know with regards to state funding is that we are currently funded at $6,160 per student. We also know that back in 2019 with the passage of House Bill three, since that time to you, fast forward to 2023, inflation has increased 14.5%. So in order for the legislature to keep up with inflation, they would have to raise the basic allotment by $900 and that would come at a cost of 12.6 billion to the state of Texas.

(05:31)We do know with current legislation that they have preliminarily invested 5 billion dollars in public ed, which is still a significant amount, but you can still see that the huge gap that we face as school districts with regards to competing with inflation and what we are able to pay our teachers. And so we have to come up with creative ways to retain our teachers. One of the areas that we are focusing on specifically with the public funding realm is as far as Austin isd, and you have seen school districts do this throughout the state, You are starting to see teacher housing being placed on bonds. You are starting to see workforce housing being discussed by school districts where before that was not even a topic. And so I can not say in Austin ISD we are looking at workforce housing as a huge retention piece for our district. We are one of the most expensive places to live in central Texas.

(06:28)And so what can we do to retain our teachers and have them live where they work? And so we are moving forward with a project that includes workforce housing. So we are looking at forming a public facility corporation in order to do that. And so that would enable us to really target not only teachers but our staff throughout the district and give them an opportunity to live in an area where they actually work. Also, we have looked at and you hear about property tax relief being talked about at the legislative level. And so when you talk about the state looking at, depending on which house bill you look at, if It is either house on the house bill side or the Senate side, they are looking at investing between 16 to 17 billion in property tax relief. And so that is a reality that we face for school districts that does not translate to additional funding.

(07:24)So we receive zero additional dollars from property tax relief, but one of the things that we do know is It is a huge benefit to our homeowners. And so with additional property tax relief that translates to school districts reducing their tax rate. And so when You are a homeowner and the biggest portion of your property tax bill is from a school district, that is a significant benefit to our taxpayers. So right now, based on the current legislation that is being discussed, there is two different versions. House Bill has a specific version with property tax relief. The Senate has a different version. And so with the house bill version, that one concentrates on putting a cap on appraisals. One of the more concerning pieces with the house bill version is it puts a cap on real property. The former legislation put a cap on homesteads. And so once you talk about putting a cap on real property, that is 90% of a school district is taxable base.

(08:26)And so that is going to have a huge impact on the ability of school districts to tax specifically on the debt service side. So what that would mean for any school district in the state of Texas if the house version were to move forward is that it would drastically minimize the bonding capacity that is available to a school district. And so school districts would be able to construct much less than what they are anticipating. And so we are watching that bill very closely on the Senate. The focus is on the homestead exemption. And so that was increased from 25,000 homestead exemption to 40,000 with house Bill three. Now they are looking at increasing that to $70,000 and so that would have a significant benefit to our tax payers. Also, they are looking at tax rate compression and so depending on what bill, you look at tax rates and bringing those tax rates down, that could translate to a tax rate reduction of between 7 cents to 15 cents for any given school district depending on the value of your property. And so that would have a significant benefit to our taxpayers. But again, it comes at a huge investment by the legislature. They did and are looking at a 33 billion surplus. So the majority of that surplus would be eaten up through property tax relief also. And then I am going to transfer it over to Nicole if she has anything to add.

Nicole Conley (10:02):

Oh, you are doing younger.!

Eduardo Ramos (10:04):

Alright!

Nicole Conley (10:05):

This is it.

Eduardo Ramos (10:06):

This is it.

Nicole Conley (10:07):

So Ed sort of teed me up for a lot of the things that I have, my experience. And so I have worked as an issuer and now I am working on the other side of the transaction and really trying to support my former colleagues in new ways in understanding debt and issuance and impacts and really how to distinguish themselves in front of a new investor base that is becoming highly more competitive, more and more competitive each day. Property taxes have a huge concern in the state of Texas. We have the three-legged stool. We do not have an income tax. We are highly reliant on property taxes. They are not going anywhere. Ed already said half the bill is the school tax. I would say half of that bill is the state equalization process. We know that. And thank you Austin taxpayers for being so generous. You are one of the biggest contributors to the equalization system that ensures that all kids across the state have some level of education, but with compression and compressing in the tax rates, there is concerns about the growing sustainability and the cost of property tax compression and what that means and what that pressure It is going to put on the available dollars towards education, towards educating students.

(11:19)And already, I mean school funding formulas are 30 years old. They do not keep pace with inflation. So school districts automatically have to cut to absorb that. So property taxes of are keen concern. Obviously if their revenue goes down on the INS side and it constrains debt capacity, it will make it harder to pass bond elections. And we have got about 26 billion on the ballot coming. This may record bond elections for school districts that says to me that school districts have mounting needs. These needs have been mounting over times. The pressures from covid. We realize that we have to put create educational spaces that serve all modalities of learning for all of our students if we really believe in equity. And that equity is another one that is, there is some misalignment with what We are seeing on the political forefront. And politics obviously have great relevance. Relevance at every level in education.

(12:14)So property taxes have a great concern. I know school districts are concerned about tech meeting technology, safety needs, mental health needs, equity chapter three 13. So I have heard the governor talk about we, he is won the governor cup for the last 10 years. We have got three cities in the top 10 across the nation in terms of growth, that is really an enormous coup for Texas, mean, Texas economic prowess is always one of note. However, we are leaving a lot on the table with the disservice that we are doing with students that do not go on and have post-secondary success. When I was on the school finance commission, we quantified it. It was like a million dollars in lifetime earnings, almost $25,000 in annual tax payments that we were losing because we could not educate kids to have success after they graduate high school. So it became of keen concern to K-12.

(13:10)So you have got the need to educate more students. Well you have got the need to educate all students. You might be losing revenue as a result of the demographic and student shifts. You have got issues with regards to S for dollars going away, but how do you create sustainability over time? But at the same time really get some improvements in the property tax systems because ED takes the calls from taxpayers paying their bills, whereas other entities may miss those points of challenges from taxpayers. So all of these needs are mount in this legislative session. You have got the chapter three 13, which is really important to local economic development and school board. There is this whole thing about corporate subsidizing corporations that is sort of taken on its own fervor in this session. So all of this really just when we look at school bond elections. It is harder to pass.

(14:03)Back in 2018 we had a 90% over a 90% pass rate for school bond elections. Now we have dropped down to under 70% pass rate. And when you think about again, the impact to some of these legislative bills on the property taxation system, how school districts and K-12 might fare in the future of really passing these elections, which are greatly needed. I mean the old schools are usually on an average age of 50 years old. There is poor technology. We all agree that we need to invest in technology. Those referendums are passing. Before it was really difficult to get technology and sort of bond proposition bills and get them to pass. You always had to explain to taxpayers why that was included or not. And so I do think that with all of these different issues in terms of transparency, uniform election dates, I think the first panel, the panel sort of denoted some of these things, all of that will impact on the capacity that school districts have to really change the physical environments and the technological access for students across the state.

(15:12)So those are front of minds for many of the districts. I will, I will start a discussion about inflation and our asset. When we built out our bond program in the first billion dollar, we use escalating factors of around 5%. We all know what has happened with inflation, the cost of construction, all the supplier issues that we have seen sort of challenge systems and It is costing more and more. I have school districts cannot honor their commitments that they've made previously to voters. So they have to get back out there to honor those projects coupled with the fact that they have all these new mounting needs. And so the inflation is something that is really rocking the world of many school districts both on the MNS, MNO and the INS side.

Eduardo Ramos (15:59):

So in our most recent bond of the 2.4 billion bond that passed with a 73% approval rating, we did include escalation costs in our estimates. And so those range between 12 and 15%. So when Nicole talks about during the 2017 bomb program, they built a 5% inflation factor in there. Now we are talking about 12 to 15%. So these are real numbers that school districts face with regards to construction costs.

Nicole Conley (16:27):

And so obviously the lack of available revenue to satisfy bond programs is greatly going to constrain the growth and the need to build out to ensure that all kids have what they have. And that is something that is really, we are leaving opportunities on the table for most of our in Texas as a GDP I think. I think we quantify the billions of dollars at one point in time that we lost in GDP and our own eco what we are the feather in our cat about, about being economic powerhouses because we cannot ensure that we have an educated and stable workforce. I do. So do you want to go into PSF.

Orlando Juarez (17:09):

Yeah, let us go into PSF. Back in February, the state board of education voted to revise APSF on guaranteed program rules to reduce that required capacity from 5%. The program reserves, I am sorry, from 5% to quarter percent. Ed back when we priced your bond transaction on the first tranche of your voted authorization, you all move forward without the PSF guarantee. Can you kind of talk about your experience, what you experienced during that time, some considerations you made, timing and otherwise?

Eduardo Ramos (17:43):

So one of the things that we wanted to consider if the bond passed, which it did in November, is to enter the market pretty quickly specifically because we knew that the permanent school fund and the bond guarantee program were nearing capacity. And so we actually applied for the bond guarantee two days after our bond election passed. We were denied that bond guarantee. And so we still decided to move forward in January with our bonta. We sold 600 million in the month of January. And so for us it was important to move forward at that time period. One because we wanted to start our construction projects as quickly as possible, but there is a large amount of investor cash flow available during the month of January. And one of the things that we saw was that not having the bond guarantee did impact our overall interest costs.

(18:37)And so in looking at the ultimate final numbers from our sell, we did have a strong true interest cost of 3.67%. But also we do know that that same day Dallas SD was watching our transaction, we had such a good day that morning that they decided to enter the market that afternoon as soon as ours was done. So we entered the market without the bond guarantee with two AAA bond ratings from both Moody's and Crow Dallas, ISD entered the market with a bond guarantee. Their bond rating was not aaa, but they received a three point 57 true inches cost. And so that did affect us. We know for a fact by 10 basis points. So for school districts not having that bond guarantee is going to affect their bond capacity and the cost that they face in the market.

Nicole Conley (19:33):

And on the transactional side. So at Siebert we had the opportunity to participate in support and lead both PSF and non PSF transactions. And when I look back at that first quarter, ED talked about 10 basis points, but I saw anywhere from a spread of anywhere from five to 22 basis point depending on the maturity. And when you extrapolate, we have record bond elections happening in May 26 over 26 billion and you extrapolate over that. You are talking about anywhere from 155 million to almost 682 million worth of taxpayer costs that could be saved as a result of having that PSF guarantee. So It is keenly important, but in absence of it, I do not think that that is going to be resolved anytime soon. And speaking with congress, Congressman DGAs office who, Congressman Doggett's office who has been biting at this for many a couple years at a minimum, IRS has not meaningfully updated these caps since 2008 and then there is not a lot, there is trepidation in really taking on this issue.

(20:40)It is tied to a tax bill and in Congress we know that It is hard to get tax bills to move. The only remedy at this point is maybe an administrative remedy, but you have got to get the IRS, treasury TA and everyone to sort of come together and agree upon that. And that spirit of participation has not been met, at least as I understand it on the IRS side. So my thinking is that the non P S F is probably going to be here to stay. I know that the state board of ed took action to reduce the reserve levels freeing up 6 billion. But when you think about it, 6 billion, when you got 26 billion of potential new authorization on top of what is out there, that is a drop in the bucket. So non PSF issuances are probably going to happen more, it's going to be likely.

(21:27)So as a K-12 issuer, you have to distinguish yourself in the market and we have been helping districts do that. We have been able to try to work on ways on expanding the investor base, getting some of that crossover attention, those high grade investors, some that may have not participated in PSF enhancements because of their own internal limitations and how do we draw them to these transactions and how do we support the increased competition amongst the 1100 school districts who are now going out there courting in some similar investors. So we have been working with them to distinguish themselves through roadshow talking about the profiles of their districts, the credit quality. Many of our districts are growing the needs of mounted and they know that they are going to be doing these bond at least school bond elections on a more routine basis. How do they build up their standings across investors?

(22:18)How do investors know about the local profile, some of the economic goals of the K-12 issuers and many times the K-12 issuers are the largest employers in their area. So We are talking about economic activity for the entire locality if not region. And so it really is going to be more and more important for K-12 to distinguish themselves among, amongst investors partnering with those who can walk them through complex market environments. We are probably going to see more and more resulting from the Silicon Valley bank fallout just everyone is talking about dollars in China. I mean it does not seem like We are going to have market clarity anytime soon. So I think K-12 is going to have to ratchet up standing and sort of being a player in the investment market to lure the right investors. They are going to have to really partner with and have expertise in some of these debt areas and many times do not. The pipelines for CFO have all been sort of constrained to find a good CFO is difficult, but there are opportunities to really, really tell the story of K-12 in a new and novel way and hopefully still have the tools and capacity to meet some of the bond and the debt needs through some kind of consensus or agreement at the legislative level, which we can not really see today.

Orlando Juarez (23:45):

Thank you guys. Before we lateral over to the charter school discussion, I wanted to touch on vouchers a little bit. It looks like that program's been faced with some resistance lately. Just kind of want to get your thoughts on whether or not you all think the program has any possibility of passing.

Eduardo Ramos (24:02):

I will start. I know that is one of the legislative priorities from both the governor and the lieutenant governor. The vouchers or what are they call, they are calling them education savings accounts. They are facing huge opposition at the house. And so there has been an amendment actually filed that would prevent legislative dollars from actually being used in voucher programs. So currently that is a debate that actually was as recent as this week at the legislative level, but it is going to face a huge opposition once it gets to the house.

Nicole Conley (24:35):

And I would just add that thank goodness for the rural school districts, those rural communities that are out there fighting alongside some of the urban communities, obviously worried about the siphoning of public dollars and sustainability, right? Because you already can not meet inflationary costs. You have got school systems where enrollment is slightly decline, statewide enrollment is declined, but a lot of urbans are seeing those declines as well because as people choices schooling becomes where it happens has dramatically changed. So I do think that, I do not know that the governor and the lieutenant governor can do a lot of things. Could vouchers, are vouchers off the Could they happen? Absolutely, yes. I mean there is a lot of commitment towards it and too in my mind, I do not know where It is going to happen. I know that there is a strong desire and commitment to do that in the state of Texas. I have seen them do things that I didn't think that they would be able to do here. So I do not necessarily think the voucher issue is off the table, but thank goodness for the rural districts who really have joined forces with the urbans to really sort of beat back some of that.

Jonathan Church (25:48):

And I would just add I was very early in the process and all the charter leaders that We are talking to are very much attuned to the possibility that it could pass. And I think charter schools wanting to be competitive. I think the mantra has been bring it on. I have heard from more than one charter school leader. They like the competition and they welcome it and of course the devil will be in the details on whatever sort of compromise might come out of that, but definitely something to watch for.

Orlando Juarez (26:17):

Awesome, thank you Jonathan. And while you were speaking on topics, I guess let us jump into the charter school discussion and we will start off with that same broad question that I posed to Ed and Nicole, what do you think the biggest issues facing charter schools in particular today are?

Jonathan Church (26:35):

Sure, and just as a reminder, we work with charter schools in the sector. We work with the largest charter management networks, the idea of public harmony, public schools that are vast regional presences. And we also work with the Soul New Charter School out of the last session, academy of Visual Performing Arts out of Fort Worth. So very different issues depending on where you are in your growth cycle, but kind of just broadly speaking, maybe bring it back to that PSF discussion. For our charter schools, I think It is a very acute problem for charter schools not having that PSF access. As a reminder, the very strongest charter school credits are triple B. This is not double A triple A world, they are triple B. There is one A minus with a negative outlook out there, but these are schools that if they were to go to the market, unenhanced would be looking at spreads of up to 75 basis points potentially with the triple B unenhanced rating out there, plus being triple B credits, unless my rider friends want to tell me differently.

(27:40)Usually in this market It is a full debt service reserve fund required. So very inefficient, very expensive to go to the market. And just to share some numbers, I ran earlier on that 25 million or so will get you maybe a year ago in nice new school building for most of our charter schools, 4% type of rates. PSF market today You are looking at about 1.5 million into annual debt service. So 1.5 million for that 4% rate for our strongest schools. If they go unenhanced in the market about 4.75%, triple B minus full debt services are fun. It is about 1.7 million. So You are talking about $200,000 per year in additional expense to the school. With a 10 year call kind of being back in vogue, You are basically locking in 2 million of extra cost onto one school project. So It is very impactful and something, yeah, We are very much watching as the at the IRS level and hoping for a fix here in the near term.

Orlando Juarez (28:39):

All right. What about other state funding issues that might be applicable to charter schools, the end of supplemental Esser funding and any funding expectations after the current legislative session?

Jonathan Church (28:50):

Sure, and certainly the so-called esser cliff is something a lot of our schools are looking at Esser funding designed for again to plug learning loss due to covid. A lot of historically underserved populations that charter schools focus on, these are the hardest hit communities from covid Learning Loss folks that did not have access to high quality education five days a week during the pandemic. These folks are coming back. We have used charter schools, have used those esser funds to plug programs, ad programming like afterschool tutoring, afterschool programming, additional tutoring, interventionalists, the full suite of services that are out there they have used with those additional revenues from the federal government and those are going away after 2024. So I think a lot of hard decisions are going to have to be made on things like that. In addition to that, I think we have not really touched on it yet, but just a drop in average daily attendance continues to be a major issue and the TA came through last year with a fix to plug some of that to allow schools to raise that overall 88 percentage.

(29:58)But we are seeing again, average daily attendance. I think a lot of charter school leaders we have talked to have spoken about a fundamental covenant with families being disrupted because of covid, all of a sudden that incentive to put your kid in school five days a week may not be that same pressing need. And so We are seeing average daily attendance historically for most of our schools, 96, 97% maybe up 98%. We are seeing that number 92, 94% these days. And so major budget impacts and without a quick fix for that, I think that might very well be here to stay for the next few years. So something to watch. All

Orlando Juarez (30:34):

Right, thank you. And we heard Ed and Nicole talk about the impact of inflation on the ISD K through 12. Can you talk a little bit about how that is impacted charter schools, if there is anything distinct there for you?

Jonathan Church (30:46):

Sure, and I just got off I think a couple calls this morning before this and VE is our favorite phrase these days, value engineering, we talk about it on every single finance call I am on as projects. The cost as they are minor charter schools, they are funding these projects directly from student revenues and so there is no access to the I ns type funds. And so any sort of increase in costs, these 10, 20% costs we have seen in addition to just land costs very impactful for these schools. In addition to that, We are talking about some of the investment grade charter schools. The overwhelming majority of charter schools are non-investment grade. They are double B if they choose to go get a rating, a lot of non-rated debt out there for those schools. You are still seeing rates, even with MMD movement, You are still seeing rates stubbornly of the 6% rate plus 6% range plus on that, which is expensive and It is creeping up from there. So very expensive borrowing costs for schools. We have seen some philanthropic lenders like Equitable Facilities Fund is one we work with quite a bit. It has been very active in the Texas market offering below market rates. But for those that do not qualify for those, they have very strong stipulations around academics and historically underserved populations and that sort of thing. But if you do not qualify for that very, very expensive debt and it is daily conversation with our clients about facility affordability.

Orlando Juarez (32:11):

All right. And are you all seeing the same teacher staffing challenges that the ISDs are seeing?

Jonathan Church (32:16):

I think so, and I think I am just taking it from a slightly different perspective. I think yes, same exact challenges. You are seeing schools having to go ahead and be proactive with things like salary raises before anything's flushed out in the session, which as a financial advisor, a little scary when We are looking at projection models, but they need to do what they need to do to retain teachers and to attract teachers. But We are also, what is interesting about charter schools is even during the pandemic they still had a 12% overall growth rate. That enrollment growth is there. There is a wait list of over 66,000 students, charter school wait lists across the state of Texas. And so I think that demand is going to continue to be there. And so these same exact teacher challenges, retention at recruiting new teachers and staff is going to be a major challenge for these schools as they continue to grow out into the state here.

Orlando Juarez (33:04):

All right. Thank you. Doug, can we drag you into the conversation here? Ready? So I'd like to ask about any significant factors that Kroll takes into consideration when rating charter schools in particular.

Doug Kilcommons (33:17):

Yeah, so to echo Jonathan's point, the sector by what it is is inve non-investment grade. So if you looked across the market, you see a very small sliver that gets rated. The rated schools tend, as Jonathan said, to get into the triple B category, most triple B minus some that have been operating for a while and have had the benefit of being able to build up liquidity start to creep up in the triple B category. Some get to triple B flat, others approach triple B plus. There are schools that have enhancement which bumps them into the A category, but outside of, again, with some enhancement that does not burn off it, It is really a triple B ish sector and It is a very small rated universe. So the predominance of credits are non-investment grade. Our methodology for looking at charter schools really focuses on flexibility that a school has and part of flexibility is, as Jonathan mentioned, when you do a bond deal and You are structuring how debt service gets paid, thinking about how that debt service profile looks over time, many schools build to accommodate growth that has not yet shown up the build it and they will come approach, as we all know is a risky proposition.

(34:36)So those automatically enter their rate, their rated life at a lower level than a school that may be looking to buy the building it had been leasing for 10 years. They have got to establish enrollment base, they do not need to grow. They are the school that everybody wants to go to in that market. And so that is a little bit more of a less risky proposition out of the box from a rating perspective, but It is really about flexibility. I would say that one of the things, and Jonathan hit on this and It is absolutely true, you have to know what You are getting when you pick up a charter school transaction. You are not going to see, you would see for a college or university tons of liquidity. You are not going to see an endowment, You are often not going to see fundraising, although that depends on the location, but that is usually not part of it.

(35:24)It is really going to depend upon the per pupil funding model. It is going to depend upon the consistency of enrollment. It is going to depend upon if you are really looking to become a different player in your market and therefore are growing and have not really had the evidence that growth will come, these are things that you have to manage and we looking to as part of an engagement. The one last thing I will say, the role of the state in charter school financing cannot be underestimated. We actually look at a few up at the northeast where the state has special designations for certain schools and that state involvement, that state role really provides what we would consider to be a rating floor because they are actually there in the event that the local funds do not show up. And so that is something that we consider in our analysis and It is not present in every market and It is not present in every state, but where it is present, it does play a pretty significant role in our view of the credit.

Orlando Juarez (36:24):

Thank you, Doug. Well we have heard about the challenges facing ISDs and charter schools. Can you help us out with explaining some of the challenges You are seeing faced by higher education institutions?

Doug Kilcommons (36:39):

Sure. So I will just start out by saying a couple of just general comments on the sector. Unlike charter schools, higher education is a predominantly investment grade space, oftentimes a category and better. And so yes, there is a large unrated universe in higher ed as well, but there is a very large rated universe. And if you look at rating spreads and rating movement over time, it is a solidly investment grade sector and that is also picking up both private universities and public. So that is a common abroad across the industry. One of the things I will say on top of that, it is a very resilient industry and if you think about all of the crisis that have taken place in the last 20 plus years, you can go back to 9/11, you can think about the great recession, you can think about covid. All of these institutions learned from the past challenges and tend to institutionalize what they have learned, which has again led to stability among many of these credits within the sector.

(37:44)At KBRA, we look at higher ed under a four prong approach or four rating determinants that basically guide our rating. Number one, and probably the most important is management and long range planning management is the number one reason ratings do not change in this space. And I can not tell you over the years how many conversations I had before going into a meeting thinking, wow, this is really going to be in danger of even being moved down or having the outlook changed only to find out that the plan that management talked to us about during the good days they are actually putting into place now that they need it and really are doing so to protect credit quality. So again, management is one of the keys. The other three institutional profile market position and value proposition really means something in this space, especially for private universities.

(38:33)So we look at that and then obviously the big two, finances and debt round out our approach, we use a mix of both qualitative and quantitative variables. We do not use scorecards, we do not use prescribed waitings. So we have the ability when we look at an individual institution, we balance the four determinants I just mentioned in light of the situation that is in front of us. And so that is how we approach the sector and it allows for a very informed approach and really one that when we have a unique institution in front of us, we can really figure out the exact quality of it. In terms of challenges, so basically not unlike what we heard earlier today from my fellow panelists, inflation is one that We are looking at. Inflation is impacting everything at universities from salaries and benefits. It is impacting capital improvement programs. Even situations where you had a very project that was well planned with cost locked in, there have been challenges around getting labor for an extended period of time.

(39:31)Labor costs are up across the board, locking in materials costs that while inflation is starting to come down, there are still lots of pressure points with regards to these very large capital programs, especially if You are building for very specific uses. And so again, a high tech lab at a research university that is going to come at a cost. The other interesting thing that You are seeing now, and this is fresh and top of mind for me, coming from the Northeast Rutgers University, they have experienced their first strike ever among non-faculty members looking for higher wages, better benefits, better work life balance. This is something that was unheard of just a year ago and now it is showing up and I think there are other institutions like Rutgers that will be facing this. So this is something that we look at and has certainly been a pressure point.

(40:27)I will say that one of the things that you often hear about higher ed and why is it so expensive and what can be done, one of the biggest problems in this sector when you look at expenses upwards of 70% of an institution's expenses are tied up in salaries and benefits. If you as an institution go to attack that expense base, you could potentially lose faculty and therefore potentially lose grant funding, potentially lose students and really lose your competitive position. So it is a very difficult thing to balance. Some institutions have done this and they have been able to really bring down costs, but with 70% really tied up in your faculty and the compensation, It is really becomes hard to trim away at that expense base. So inflation obviously is contributing to that and exacerbating it. Staffing levels, especially among the academic medical centers, which we all know the challenges in not-for-profit healthcare at this point, nursing and some of the ancillary services that support nursing, it is still a challenge to recruit and retain employees.

(41:38)It is an unfortunate out outcome of covid one of many. But the, I will say that the recent trends have been stabilizing in nursing and acute care nurses. Long-term care seems to be the spot where the challenges are still very acute. So there is some been some positive developments there. And then last but not least on the enrollment front, obviously during covid enrollments across the country were impacted by the shutdown of local economies, institutions sending students home and going fully virtual. And then there was a reopening obviously in different phases based on the state you were in. And again, many schools did not get back to their full on-campus enrollment until the fall of last year. So again, two plus year ordeal. One of the things you'll continue to see despite the covid situation, enrollments will remain very variable. So the schools that have a very strong market position and brand schools that have, were able to pivot to fully in person, fully remote and then somewhere in between generally fared very well.

(42:46)And so you see this now, certainly as you look at public universities are a great example where public universities, their enrollments stayed very strong if not bumped up a bit. But what you did see was auxiliary revenues during the depths of the pandemic really take a hit and now they have started to come back. In some cases in record levels. Several of the institutions we look at, the recovery in auxiliary has been in the 20 to 30% range fiscal year over the fiscal year, which is incredible. The one thing that you as an institution need to embrace on the enrollment piece will always be around the delivery model. The online or hybrid approach is not going away. It will always be there in some form complimenting the on-campus experience. And that also is not going away. I remember reading articles at the depths of 2020 around that no one will ever want to go on college campuses again.

(43:37)We all know that that is not true and the numbers bear that out today so that that is also not going away. But you as an institution need to be flexible. You need to consider exactly what the market wants. And then for full online delivery, pro models and full online programs, colleges and universities that have managed those lines of business as true lines of business with a strategy and an approach and really manage them as profit centers have fared very, very well. And you see now more and more of the large publics actually providing full degree programs through their online platform and those degrees come with the brand of the university. That has been a very compelling argument for many, many students, many non-traditional students. And that is something that we have seen as an offset to let us say the traditional population potentially in certain states. So that is been a positive, but clearly something that as an institution you need to think about in terms of your mission. And if you have not yet come up with a good approach to that online delivery method, that is something definitely that will help in terms of enrollment management.

Orlando Juarez (44:49):

Thanks, Doug. I guess before we open up the floor to the audience for any questions, I would like to ask each of you all if you have any wrap up items that you would like to address. We will start just going down the line here. No, let us do it reverse so Doug does not feel like he is being left, left, left or last as the rating analyst.

Doug Kilcommons (45:10):

Thank you Juarez. Yeah, so interesting. So last thing, comments. The one thing I will say, because this is a question that often comes up, do we have a bias in terms of kind of credit when you look at a public institution, ver versus a private, and is there more risk in one versus the other? And I would just say that it, and again, and I apologize for the rating analyst answer of it depends, but it really does depend. But I would say that inherently none either of those sectors is not more or less risky for a public. You benefit from the backdrop of the state, you were formed by the state you were serving the state's population, there is an inherent protection there. That protection often comes with additional restrictions. Sometimes cumbersome procurement processes, a longer lead time to get debt issued. So there is a balance there.

(46:03)And so while you do have that protection, you also have some additional hoops to jump through in a lot of what you do. Privates on the other hand, while they really operate as the market would like them to, and if you cannot carve out your niche in a very crowded market, you often are not in business. Privates benefit from tremendous autonomy. They can fundraise and many are prolific fundraisers, they can issue debt when the market is ripe. They do not have to go through lengthy procurement and various state processes that potentially they may miss a favorable market window. They also have the ability to remake themselves more easily and that allows schools to really adjust to what is going on in the market and what the market really wants. So I would say again, the last thing, my last comment would be, it really is going to depend on the specific credit in front of you. You have to approach it with the understanding of how each of those sub-sectors within higher ed operates. But again, there is really no one is better than the other or one is more protected than the other.

Orlando Juarez (47:08):

Thank you Doug. Jonathan?

Jonathan Church (47:10):

Yeah, no, I just think again, the titles, the Road for the Road ahead for Texas growing population. I think charter schools have been a part of the state since 1995 initially passed. And so providing programs that have unique opportunities for families, college prep, stem arts focus, all these different programs are there so likely continue to be part of the solution for that growing population going forward.

Orlando Juarez (47:35):

Thank you.

Nicole Conley (47:35):

I just keep my comments brief. Just sort of the conflict between local control and what We are seeing in terms of state legislative issues and how that sort of changes what school districts are able to do to serve not only sort of build on compensation programs like workforce housing, but how that impacts on programming. And It is the higher ed level, you know, talked about strategic abandonment and branding. K-12 really have those opportunities. I mean people involuntarily pay into a system and everyone thinks they own education. And so politics, the relevance of politics is something that is mounting and It is going to be difficult when schools are beacons of our communities. But you have that contrast between local control.

Eduardo Ramos (48:20):

And there is a lot of conversations going on at the legislative level for public schools. The ultimate fix for us is an increase to the basic allotment with an inflationary factor built into the formula that would allow us to retain our valuable teachers and our valuable employees in the districts.

Orlando Juarez (48:38):

Thank you guys. We have about four minutes. If anybody has any questions they would like to ask the panel. If not, then there is nothing else. Guys, thank you all for your time for coming and you all enjoy lunch.