Texas Legislators Forward Comments on Proposed Arbitrage Bond Guidance

We are writing to bring your attention to a regulatory issue of great importance to Texas' open-enrollment public charter schools.

During the 2011 session of the Texas Legislature, we authored legislation granting access to the Texas Permanent School Fund (PSF) bond guarantee to qualifying open-enrollment public charter schools. In October 2011, the Texas Education Agency (TEA) requested an amendment to Treasury Regulation Section 1.148-11(d)(1) to facilitate the implementation of this new law. A copy of a letter sent to the Internal Revenue Service and the U.S. Department of the Treasury is enclosed for your reference.

We would like to respectfully urge you to move forward in amending Treasury Regulation Section 1.148-11(d)(1), or taking any similar actions to allow Texas' qualifying public charter schools access to the PSF bond guarantee, as soon as possible. Open-enrollment public charter schools currently serve 155,000 students, and 101,000 more are on admission waitlists. Full implementation of Texas law guaranteeing these public schools access to the PSF bond guarantee would have a positive impact on their ability to grow and serve the needs of current and future public charter school students.

Please keep us apprised of your progress as you consider this matter.

I am writing on behalf of the Texas Education Agency (the "Agency") to provide comments on Notice 2010-5, which indicated the intention of the Internal Revenue Service (the "Service") to amend Treasury Regulation Section 1.148-11(d)(1) (the "Regulation") when the arbitrage regulations are next modified. The changes to the Regulation proposed by Notice 2010-5 were requested by the Agency to facilitate the Agency's administration of the Texas Permanent School Fund, a perpetual trust fund created by the Texas constitution to support public, free schools in Texas (the "Fund"); and the Agency greatly appreciates the efforts by personnel of the Treasury Department and the Service to accommodate the Agency's requests.

In June 2011, the Texas Legislature enacted new legislation authorizing the Agency to write regulations to permit the Fund to guarantee obligations issued for the benefit of open-enrollment charter schools created under Texas law ("Charter Schools"), in addition to the obligations of independent school districts, which are political subdivisions with general taxing powers ("Districts"). Under Texas law a charter for a Charter School can be issued either to a political subdivision or a nonprofit corporation which has received a determination letter that it is described in Section 501(c)(3) of the Internal Revenue Code of 1986, as amended ("Code"). Accordingly, the Agency respectfully requests that the Regulation be revised as follows (attached is the Regulation as we propose it be revised):

Under Texas law, a Charter School is part of the public school system of Texas and provides instruction to students at one or more elementary or secondary grade levels as provided in its charter. It must accept students on an open-enrollment basis (admitting students either by lottery or in the order in which applications are received) without charging tuition. A Charter School is entitled to receive a portion of the periodic distributions from the Fund to all public schools in Texas based on the number of pupils attending the Charter School.

A Charter School is a local government and political subdivision for many purposes under the laws of Texas, whether or not the charter holder possesses any of the powers enumerated in the Estate of Shamberg. A Charter School is required to comply with many of the same laws as a District, including the following:

• minimum curriculum requirements (i.e. grade level objectives, subjects, textbooks)

• high school graduation requirements

• bilingual education requirements

• special education program

• awarding contracts for construction and professional services

• investment of public funds

• conflicts of interest

• open meetings

• open records

• sovereign immunity

Under Texas law, a charter for a Charter School can be granted to a governmental entity, a public senior college or university, a public junior college, a public technical institute, a public state college, a medical or dental unit or other agency of higher education, or a nonprofit corporation with a determination letter from the Service that it is described in Section 501(c)(3) of the Code. Thus, all of the potential recipients of an open-enrollment charter are either a political subdivision possessing more than an insubstantial amount of the powers enumerated Estate of Shamberg, or a nonprofit corporation with a determination letter that it is described in Section 501(c)(3) of the Code. However, many of the political subdivisions, including public senior colleges or universities, public state colleges, and medical or dental units, lack the power of taxation. Accordingly, we have requested the deletion of the words "with general taxing powers" in paragraph (d)(1)(ii) and "general" in paragraph (d)(1)(iv) of the Regulation.

B. As a result of the credit crisis, there is only one monoline bond insurance company currently issuing new insurance policies in the municipal market, reduced from 8 only four years ago. The remaining monoline insurer is no longer rated Aaa or AAA by any nationally recognized rating agency. Moody's Investors Service, a nationally recognized rating agency, has indicated that it does not expect to see any "healthy bond insurers" in the municipal market for at least two to three years. The Bond Buyer, September 28, 2011.

In this unsettled credit environment, a perpetual trust fund like the Fund can provide meaningful interest rate savings for bonds issued for the benefit of a Charter School. The statutory framework adopted by the Legislature requires that, in order for a Charter School to have its bonds guaranteed by the Fund, the bonds to be guaranteed must have an investment grade rating by a nationally recognized rating firm without the guarantee. The lowest investment grade rating is Baa (Moody's) or BBB (S&P). Historically, bonds guaranteed by the Fund have been rated Aaa/AAA by all nationally recognized rating agencies.

As a result of the credit crisis and continuing unsettled conditions of the credit market, the "spreads," or difference in interest rates between bonds of the same maturity, have widened considerably between bonds rated Aaa/AAA and those rated Baa/BBB. On July 6, 2007, the spread between Aaa/AAA and Baa/BBB credits was approximately 50 to 60 basis points throughout the yield curve, according to The Bond Buyer. As of October 14, 2011, the spreads between Aaa/AAA and Baa/BBB credits ranged from 140 to 190 basis points. Even with the overall decline in interest rates due to the accommodative policies by the Federal Reserve, the cost of borrowing for a Baa/BBB credit in 2011 is somewhat higher than it was in 2007, since lower interest rates in maturities of up to 10 years are offset by interest rates 50-95 basis points higher in maturities 15 years and longer.

Thus, permitting the Fund to guarantee bonds issued for the benefit of a Charter School can result in significant interest savings for the Charter School. Since Charter Schools generally lack the power of taxation, they rely primarily on state funding and charitable donations. Interest rate savings of 140 to 190 basis points, or 1.40% to 1.90%, can meaningfully increase the amount of Charter School revenue that can be devoted to costs of instruction.

C. The requested amendments to the Regulation are consistent with the unique status of qualified 501(c)(3) bonds. Under the Internal Revenue Code of 1954, as amended to October 22, 1986 (the "1954 Code"), funds issued for the benefit of organizations described in Section 501(c)(3) of the Code had the same status as bonds issued for the benefit of political subdivisions. Section 103(b)(3) of the 1954 Code defined the term "exempt person" to mean

While the Act did apply the public approval requirement of Section 147(f) and limit on bond-financed issuance costs of Section 147(g) to qualified 501(c)(3) bonds, such bonds continued to be exempt from the state volume limitations of Section 146, and many of the other rules set forth in Section 147 of the Code, as provided in Section 147(h)(2). In addition, the small issuer exception of Section 265(b)(3) applies to qualified 501(c)(3) bonds to the same extent it applies to governmental bonds.

Modifying the Regulation to include qualified 501(c)(3) bonds within the scope of the exception is entirely consistent with the Congressional intent expressed in the General Explanation and reflected in the Code. Charter Schools are carrying out the essential governmental function of providing public, free education to students of Texas.

For the foregoing reasons, the Agency respectfully requests that the language of the Regulation be modified as set forth above and on the attachment to permit the Fund to guarantee obligations issued for the benefit of Charter Schools. The Agency greatly appreciates the efforts of the Treasury Department and the Service in making prior modifications to the Regulation and in considering this further request. If the Agency or I can provide any further information or analysis to assist the Treasury Department in its deliberations, please feel free to call me at 713-220-4479 or e-mail me at the address above.

Thank you very much for your consideration.