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Since the early 1970s, moral obligation bonds have been used to finance housing, higher education facilities, hospitals, corrections facilities, and more. Some states are now using this tool to help charter schools save on borrowing costs.  

As more charter schools access the bond market to finance their facilities, the interest they pay is funded by a school’s operating costs (which are provided through taxpayer dollars), meaning every increase in interest represents fewer dollars available for textbooks, teacher salaries, and field trips. As states seek to use their education budgets more efficiently, moral obligation bonds are an attractive option to lower interest rates without overburdening the state’s balance sheet.

States have the opportunity to use this often overlooked financing tool, a Moral Obligation pledge, to help save charter schools millions of dollars in interest payments without costing the state much money. It allows the state to enhance the credit rating of any borrower by pledging the state will consider appropriating funds to cover any shortfalls should they materialize. This does not bond the state to make a payment and is therefore not a liability to the state. It does have the benefit of improving the borrower’s credit rating to one notch below the state’s rating. And it can be designed to not impact the state’s credit rating.

If your state is interested in learning more about this program:

  • Here’s a brief about the broader topic of state credit enhancements. See how moral obligation pledges are part of a bigger movement.
  • This isn’t just for charter schools. Read this report, Lowering the Cost of Capital for Public Charter Schools, which examines how and why some states are turning to moral obligation bonds to fund charter school facilities. This report also shows the widespread use of moral obligation pledges in other states for other types of community and economic development. 
  • To hear how Colorado went through the process of enacting their legislation, contact us. 
  • See the financial benefits of the program - Colorado has saved charter schools $100 million!  
  • Learn more about the experience of other states. The Moral Obligation and Charter School Financing report outlines Utah and Colorado’s active Moral Obligation programs for charter schools. 
  • Explore innovative ways to fund a moral obligation pledge: A state could apply for the federal credit enhancement program and use the grant proceeds to fund the state’s debt service reserve fund. Then this would not cost the state a dime. The next application for the federal award typically is announced in the winter. Contact us for more information.

Here are examples of state bills, statutes, and program descriptions:

FAQ’s on Moral Obligation

Does a moral obligation affect a state’s credit rating?

The adoption of a moral obligation program, in itself, has not impacted a state’s credit rating. Moral obligation debt that has not required any contribution to the debt service reserve fund from the morally obligated party is considered self-supporting, and therefore should not weaken a state’s debt metrics.

Would a borrower’s default affect a state’s credit rating?

If many borrowers were to default and the debt service reserve fund were not sufficient, necessitating a state to step in and contribute to the debt service reserve fund, then the amount the state is obligated to pay is considered as debt. If this is a significant number, it could weaken a state’s liability profile.

Has a moral obligation pledge ever defaulted?

We have not discovered any defaults on state moral obligations. Rhode Island’s Studio 38 almost defaulted, but never did. There are known cases of local government appropriation defaults (Vadnais Heights, MN and Platte County, Mo), but no known state defaults.

What if the state chose not to fund the debt service reserve fund?

If a state chose not to fund the moral obligation program, this would likely have a significant impact on a state’s GO rating. According to S&P’s “issue Credit Ratings Linked” criteria: “The failure of an obligor to honor these obligations in a timely manner would likely have a significant impact on the obligor's GO rating or ICR. Should that occur there could be an adverse effect on future debt issuances, as investors may become wary of the obligor's willingness to support their debt. For example, if a state chose to not pay these contingent obligations, we would likely cap the state's GO rating or ICR in the 'BB' category in accordance with "U.S. State Ratings Methodology", and similarly cap the linked issue credit rating in the 'B' category (see section H and table 2 for this and other possible rating caps and rating notches).”

For questions or more information, please contact us.

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