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Philly schools: Why it costs extra to be poor

The district paid nearly 2.4 percent on its most recent major bond issue, compared with a little over 1.3 percent for Lower Merion.

Superintendent William R. Hite Jr.
Superintendent William R. Hite Jr.Read moreDAVID MAIALETTI / Staff Photographer

Money: The worse you need it, the more it costs.

The Philadelphia School District pays a lot more interest when it borrows money than wealthier and more-solvent suburban districts do.

At current prices, "Philly pays a penalty" of 1 percentage point above what top-rated suburban districts like Lower Merion have to pay to persuade bondholders to lend it money for building projects and other expenses, says Eric Kazatsky, municipal credit strategist for Bloomberg Intelligence, a Princeton bond firm associated with Bloomberg LP.

With $1.4 billion in fixed-rate debt financing school repairs and other long-term projects, Philadelphia pays nearly 2.4 percent on its most recent major bond issue, compared with a little more than 1.3 percent for Lower Merion. Counting both recent bond sales and older bonds that might be refunded at cheaper rates, the higher price costs city taxpayers more than $14 million a year, compared with what they'd pay if Philadelphia could borrow at Lower Merion rates. And that's not counting the spreads on $1.4 billion in floating-rate debt, which is tougher to calculate.

In all, the district expects to spend $272 million on bond payments this year, 9 percent of its total budget.

Why do city schools pay extra? Reviewing tax collections and spending, the Standard & Poor's agency gives wealthy suburbs like Lower Merion AAA, its top rating — a strong sign of faith that investors will get their money back with interest. Philadelphia gets a lower Ba3 rating, a "speculative grade" or junk-bond level where borrowers are considered less likely to pay.

Yet Philadelphia schools have regularly paid what they owed since before the state declared the district "distressed" and strengthened financial oversight in 2001. The district has eliminated its deficit and shows a small surplus for the current budget year, thanks to improved cash management and higher property and retail-sales tax collections, even as new union contracts and a continued loss of students to charter schools could cost 1,300 district workers their jobs in the next few years, Kazatsky notes.

Also, buyers of Philadelphia bonds enjoy extra guarantees they'll get paid: Under state law covering "distressed" municipalities, bondholders are guaranteed to collect interest in case of financial trouble, even if it means cutting off state aid to keep classrooms open. And city tax collectors set aside money for interest payments in special accounts every day, months in advance of bond payments, Kazatsky notes.

"They have really good financial controls," he told me. In a report to clients Friday, Kazatsky noted that Philadelphia school bonds are a higher-yielding alternative to lower-interest notes issued by schools in larger communities such as Los Angeles, the Las Vegas area, and Broward County, Fla.

Why doesn't the city get more credit for its bond guarantees? "For people who know the city, it's a renaissance story. But to outside investors who don't understand and don't care, it's just another crappy urban school district" they can force to pay extra when it sells bonds, Kazatsky told me. "It's more about perception than the fundamentals."

"No one understands it," said Uri Monson, the School District's finance director, whose job includes implementing the recent fiscal improvements. Last fall, he says, he met with bond buyers at the yearly Institutional Investor magazine muni-bond conference in Boston to explain the state protections that Philadelphia school bond buyers enjoy. "Once they see it, they like it," he added.

But bonds are bought by many buyers, large and small. It's tough to convince distant investors that tax collector controls and state guarantees have a lot of meaning. That's especially true in a state like Pennsylvania, where the latest in a string of annual state budget delays in Harrisburg once again threatens faith in the school subsidies that Philadelphia and other school districts rely on, Kazatsky told investors.

Staff writer Kristen A. Graham contributed to this column.