Financing Solutions for the Not-For-Profit Education Sector

Banks bring schools' dreams to life

The nonprofit sector plays a vital social and economic role in the United States. According to the IRS there are almost 2 million nonprofits operating in the U.S. and a little over 1.5 million of those entities – or 75% – were tax exempt 501(c)(3) organizations. These are broadly described as “charitable and religious organizations” and are the most common type of nonprofit. New England alone is home to more than 80,000 501(c)(3) organizations. These entities aren’t just doing good – meeting our communities’ education, health, religious, charitable and human service needs – they’re also contributing to regional economies by creating employment opportunities and boosting the use of local goods and services.

Education is a key not-for profit (NFP) sub-sector and consists of charter schools, private/religious schools and colleges/universities. Despite playing a critical societal role, the sector faces a number of challenges, the most prominent of which is declining enrollment, exacerbated by rising tuition costs and an ongoing need for campus refurbishment. While many of these educational institutions are funded with a variety of revenue sources, including donations, endowments, state/federal funding and tuition payments, when a large capital project becomes necessary, they often need to turn to a bank for help through financing vehicles such as bonds. And that’s where a knowledgeable lender who is well-versed in tax-exempt lending can make a real difference, delivering interest expense savings of well over $1 million during the life of the bond.  

Headwinds for higher education

Although maintaining enrollment is always a challenge for charter and private/religious schools, it’s particularly problematic in the college/university space. Not only is the high school graduating pool shrinking as the current generation of parents opts to have fewer children than previous generations, but youth are also choosing to explore options other than college/university, like attending community college or technical school, or heading straight into the workforce. This creates a problem for smaller schools that really depend on steady enrollment numbers to stay afloat. In addition, ballooning tuition rates are leading to a higher debt load for students when they graduate – another deterrent to enrollment. As a result, the term “demographic cliff” – defined as a one-time 15% drop in prospective students – has become a reality for schools looking for students. 

How can a school attract prospective students? 

Although the oft-quoted phrase “If you build It, they will come” is related to a sports movie, it is also applicable to the NFP education sector. Large capital projects like the campus refurbishments mentioned above help recruit students to the school and strengthen enrollment. These projects usually range from $5 to $30 million and may consist of a new dormitory, an athletic center, a student center, a new cafeteria or renovations to existing buildings. Another large capital project, typically for charter schools, is finding a “forever” home which involves buying a building and then rehabbing it to make it more like a school since these schools tend to lease space at the start of their mission.

Financing to help schools' dreams become reality

When they’re undertaking these types of large capital projects – like purchasing a permanent space or renovating their current facilities – educational institutions that fall under the 501(c)(3) tax exemption category, including charter schools, private schools and colleges/universities, often require help securing financing; operations simply cannot cover such significant expenses all at once. 

Tax-exempt bond financing is a great way to spread that cost over 30 years. Under this model, the bank purchases the bond directly from the issuer – in this case, the educational institution – and receives mortgage-style interest and principal payments until the bond matures. In effect, the bank is providing a loan to the educational institution. In a recent example, a bank purchased approximately $30 million in bonds issued by a college in New England. The college used the funds for two purposes: first, to refinance its existing $20 million debt, and second, to help finance the construction of new facilities for one of its professional programs. 

Thanks to the organization’s tax-exempt status, the interest income earned by the bank in these situations isn’t taxed and the bank passes that exemption on to the customer by discounting their rate by 79% (100% less 21% corporate tax rate). As a result, the organization benefits from paying a reduced rate on the bonds and the ensuing lower debt service can be paid from operations over the duration of the 30-year bond. That 2% interest rate difference on a significant project can really help the organization reduce their interest expense over the life of the bond – for instance, 2% on a $20 million project results in $400,000 in savings in the first year alone. 

Why banks should finance NFPs: Great for the community

A great bank partner is dedicated to working collaboratively with nonprofit leaders and organizations to understand and meet the needs of their residents by providing expert guidance and assistance that will result in educational opportunity, pathways for economic mobility and sustained economic growth. Banks consider that work to be not only an obligation, but a privilege, and are pleased that their efforts are recognized through the Community Reinvestment Act performance evaluations carried out by the Federal Deposit Insurance Corporation (FDIC). Look for a bank that has an overall “Outstanding” rating – the highest possible rating. According to FDIC data, only 10% of all banks nationally receive an “Outstanding” rating, and even fewer achieve that recognition in all three categories of the examination. These rankings are a true testament to a bank’s work ethic and a high rating reflects their customer-centric, relationship-driven focus. That bank will have a lasting impact in the areas that need the help the most. 

If you’re looking for advice about developing financing solutions for your school, contact: