CHICAGO — Detroit Public Schools, which is under state receivership, plans to come to market later this year with a $200 million deficit borrowing to erase two-thirds of the red ink in its fiscal 2012 budget.
The district’s new emergency manager, Roy Roberts, released a proposed $1.2 billion spending plan Friday that counts on the deficit financing.
Roberts announced the borrowing plan the same day that Michigan Gov. Rick Snyder unveiled a plan to create a new authority that will take over the district’s, and eventually the state’s, worst schools.
In addition to the budget, DPS administration this week is expected to submit a five-year deficit elimination plan to the state that outlines how the system will erase the remainder of the deficit not dealt with through the proposed borrowing.
The cash-strapped district faces a $327 million deficit, representing 65% of its general fund.
The deficit has mounted despite the district being under state-controlled emergency management since early 2009. Long-time manager Robert Bobb recently left the job, and Snyder in mid-May appointed Roberts, a former General Motors executive.
Information about the proposed bond sale is tentative. DPS officials and its finance team declined to comment. But sources provided some early details on the borrowing.
The district is tentatively expected to enter the market with the fiscal stabilization bonds in October. A source said the finance team, which DPS selected without issuing a request for proposals, will be led by Siebert Brandford Shank & Co. in the role of senior manager and JPMorgan as co-senior, with Lewis & Munday PC as bond counsel.
Public Financial Management Inc. has served as the district’s financial adviser in the past, though it is unclear whether the firm is working on this issue.
DPS is expected to use a bond structure modeled after its $200 million deficit financing in 2005, which converted short-term notes issued for cash-flow purposes into longer-term bonds backed by the state aid intercept program, sources said.
The bonds are also expected to use as models recent borrowings by other fiscally stressed local Michigan issuers that needed to reassure bondholders they won’t lose their investment if the issuer enters bankruptcy.
DPS officials are in the midst of trying to gain state legislative support for a bill that would effectively insulate from bankruptcy school district debt that’s issued as cash-flow borrowing through the state aid intercept program. The bill targets DPS’ 2005 bonds, and presumably the upcoming financing.
For DPS, winning passage of the legislation is important. The 2005 bonds are insured by Assured Guaranty Ltd., which has warned it will require the district to accelerate repayment of the bonds next year unless the law passes.
The city of Ecorse, which is also under emergency management, earlier this month sold $9.3 million of fiscal stabilization bonds that featured an intercept structure.
That borrowing also required passage of a new law, allowing Ecorse to hire a third-party servicer to intercept and distribute its property tax revenue pledged to pay the debt.
Detroit last year issued fiscal stabilization bonds that relied on a similar intercept feature. In the city’s case — as would be the case with DPS — the pledged revenue came from state aid, not property taxes.
Intercept structures can strengthen troubled credits, according to Tom Kozlik, director and municipal credit analyst at Janney Capital Markets. “These types of structures are usually a credit positive,” said Kozlik, who recently wrote a report, “Structure Matters for Distressed Michigan City,” on Ecorse’s deal.
“The issuer and finance team are trying to come up with something a little more specialized structure, with a higher level of credit,” he said.
For one investor, however, DPS’ upcoming deficit bond sale will “certainly be a pass,” though the bonds may draw buyers looking for higher yields.
“There are plenty of credits that are better investments for individuals and for our client base,” said Michael Pietronico, the chief operating officer of Miller Tabak Asset Management. “From our perspective, a deal structure like this would be more geared toward institutions that are looking to add more yield than they can find in the primary market.”
“But considering the state of financial affairs of Detroit, one can expect a deal like this, even if attractively priced in terms of yield, to trade quite poorly should liquidity be needed in the secondary market,” he added.
The district’s 2005 borrowing totaled $213 million and converted one-year state aid notes into 15-year bonds that mature in 2020. DPS paid 1.55% interest on the notes when originally issued in 2004. They were due to mature in August 2005.
“The district has determined that it has other pressing needs for the funds, which would otherwise be used to redeem the 2004 district note, making it unable to redeem its 2004 district note within 12 months after the date on which it was issued,” according to bond documents on the 2005 conversion.
DPS officials held their first public budget hearing Monday night. The spending plan must be approved by Thursday to take effect by the start of the district’s fiscal year Friday.
The budget relies on the $200 million bond sale to cut the $327.3 million deficit to $127 million. It trims an additional $231 million in spending, in part by reducing the district’s workforce to 9,269 from 10,122, including laying off 4,400 teachers.
Revenues for the total operating budget totals $1.24 billion and operating expenses total $1.04 billion. Personnel costs make up $670 million — down from $1 billion in fiscal 2009.
The general fund budget totals $682.3 million. Of that, state aid makes up $363 million and property tax revenue makes up $81.6 million, according to DPS budget documents.
Debt service in the new budget would increase to $41.7 million in 2012, or $628 per student. That’s down from $55.7 million in fiscal 2011 but up from $24.7 million in 2009.
“We must create and maintain an organization that totally accepts its responsibility for making this the top-rate school district that it can be,” Roberts said in budget documents released last Friday. “That begins with this budget. The budget that is being submitted is fiscally sound and balanced.”
