Impairments hit 15-year high, MMA says

Municipal Market Analytics said municipal bond impairments from January through April were the highest since they began tracking in 2009, with the charter school sector totaling most impairments.

MMA recorded 63 impairments this calendar year, with 59 of them coming in January to April, according to Wednesday’s issue of Default Trends. The four-month total was the largest number since 2009.

MMA Managing Director Lisa Washburn told The Bond Buyer, “The spenddown of federal aid provided during the pandemic likely staved off problems that would have materialized earlier if not for the cash buffer provided.

“Borrowers in many sectors are faced with a meaningfully higher cost basis post-pandemic, related to inflation and the labor market shortage, which has negatively impacted operating margins,” Washburn said. “Those that have constraints on their revenue-raising capabilities (e.g., charter schools, retirement, and hospitals, to a lesser extent) are likely to be having a more challenging situation addressing the higher costs without margin erosion. For example, charter school revenues come predominantly from state K-12 funding, retirement facilities with skilled nursing and/or assisted living are likely to have a portion of their revenues coming from Medicaid and/or Medicare, and nonprofit hospitals’ payor mix is, on average, 40-50% governmental payors.” 

To explain the elevated level of impairments, Washburn also mentioned climate change and cyber risk costs, the decline of college student enrollment, which affects higher education, and a higher interest rate environment that reduces distressed issuers’ ability to refinance or borrow.

One-third of this year’s MMA impairments were from charter schools, which had never been so high.

There are a record 67 ongoing charter school impairments in the MMA database, now the sector with the most impairments over the last 12 months, MMA said.

Washburn told The Bond Buyer the causes of charter school problems were, “the loss of (or almost fully spent) pandemic aid, higher costs (for teachers and operations), revenue constraints, enrollment underperformance (for some, especially in areas in which there are declining K-12 populations), charter renewal issues (for some), and construction-related issues (for a few).”

Over the last six years MMA has found 20% to 25% of charter school technical defaults transition to payment defaults within a few years.

MuniCredit News Publisher Joseph Krist said, “we know that the pandemic did and continues to do damage to [charter school] attendance. Charters are tightly constructed credits anyway so changes to the basic revenue block — attendance-based government funding — is going to be a problem.”

S&P Global Ratings Managing Director Jessica Wood said, “S&P expects continued rising costs and labor shortages to create greater operating challenges for those schools with less financial flexibility in 2024.”

Salaries and academic support costs have been particular problems. “One-time emergency federal funds, which buoyed fiscal 2023 results and liquidity and offset some of the rising costs, have mostly been spent, and enrollment challenges continue to some schools.”

In its outlook, S&P “projected that significant operating pressures at smaller schools with lean management oversight, coupled with enrollment declines, could lead to technical covenant violations, such as a breach of a debt service coverage covenant,” Wood continued. 

“Charter schools require a lot of due diligence since, by definition, failure to maintain financial and academic standards could result in revocation of the charter,” said Howard Cure, Evercore director of municipal bond research.

“Other risks for charter schools stem from often a small scale and start-up aspect for this sector,” Cure said. “Other factors to consider are the differences in how charter schools operate depending on state legislation including the number of schools allowed/any volume caps, formulas for funding versus traditional public schools and the number and type of charter authorizers.”

Those investing in the area should look for larger, more established schools, with high academic standards, in states that provide consistent aid, Cure said.