Deal in Focus

Struggling Pontiac District Turns to Private Placement

CHICAGO — The Pontiac School District plans to privately place $16 million of tax anticipation notes this week, one of several Michigan school systems eying the increasingly popular alternative to a public offering.

Located near Detroit in triple-A rated Oakland County, the PSD faces severe financial challenges, including falling enrollment, a deep deficit, junk-bond ratings, and negative headlines tied to personnel scandals and financial missteps.

The Michigan Education Department this month warned that if the district continues to fail to meet the goals outlined in its deficit elimination plan, it will start cutting off state aid as soon as April.

If the district is unable to borrow, it could run out of money to make payroll by the end of this month, according to Moody’s Investors Service. 

The Pontiac district’s junk-bond ratings, along with the notes’ short maturity and a bond trustee intercept feature that protects the revenue backing the bonds, make the deal a prime candidate for a private placement.

While the troubled district has relied on private placements in recent years, other local schools that enjoy stronger fiscal positions are also increasingly considering the option -— and banks are seeking them out, especially to refund general obligation bonds that mature in less than 10 years, according to market participants.

“The banks just seem to have an appetite for these issues right now,” Paul Stauder of Stauder, Barch & Associates, a Michigan-based financial advisor, said in an email.

Stauder said many of the deals are technically done as private placements but are sold by competitive bid, and that nearly all of the deals are refundings.

“For small or short-term bond issues, sometimes it proves to be a lower cost option for issuers,” he said.

There have been 38 private placements in Michigan since last year, totaling $421 million in par value, according to Thomson Reuters.

The Pontiac School District has privately placed tax anticipation notes every year since 2009 to raise badly needed operating funds. This year it considered a public offering as well as a private placement, but ultimately opted for the direct loan structure.

“There’s the cost savings, and particularly this works for deals that are smaller with shorter maturities,” said Jim Crowley, a partner at Clark Hill PLC, bond counsel on the Pontiac deal. “We’ve seen it a lot this year.”

“A lot of the refunding opportunities we’ve been working on, a number of them have gone to private placements rather than underwriters — a lot of them,” he added.

The Municipal Securities Rulemaking Board has indicated concerns about issuers’ increasing use of bank loans that are not subject to municipal market disclosure requirements.

The board is expected to publish a notice encouraging issuers to voluntarily disclose information on the MSRB’s online EMMA system about their bank loans or direct placements of bonds.

The Pontiac School District serves three suburban municipalities, two of which are highly rated and one of which, Pontiac, has been taken over by the state. The city is now on its third emergency manager since the state takeover in March 2009.

Plagued by 10% enrollment declines every year over the last five years, the school district in 2011 reported a fund balance deficit of $24.5 million, or negative 33.4% of revenues, according to Moody’s.

While many Michigan districts issue state aid notes, the PSD issues tax anticipation notes because the bulk of its funding comes from property taxes, primarily from large nonresidential payers like General Motors Corp.

Added pressure comes from the State Department of Education, which has warned that if the district fails to meet the goals of its recently revised deficit-elimination plan, the state will start withholding aid payments as soon as next month.

The notes mature in less than a year and feature a so-called lockbox intercept that ensures the property tax revenue backing the debt will flow directly from the local treasurer to the note trustee.

The district has entered into an intercept agreement with Pontiac, the city of Auburn Hills, and triple-A rated Bloomfield Township, each of which has agreed to transfer the district’s portion of their property tax receipts directly to the note trustee, Huntington National Bank.

At the notes’ maturity or sooner — the district has paid them off early for the last few years — the trustee will transfer the funds from the lockbox to the investors.

The district has issued tax anticipation notes with a similar structure every year since 2009. Each year it has privately placed the debt with Fifth Third Bank. The bank this year opted not to purchase the notes, and the finance team expects to partner with KeyBank. 

“Our job is to pursue different options, and with Pontiac we decided to go both routes — a public offering or a private placement, because we weren’t sure what investors would want,” said Brian Lefler, a director at Robert W. Baird & Co.

The firm was hired to act either as the underwriter or the placement agent on the deal, depending on the final transaction.

“Given this issuer, these are story bonds,” Lefler said.

He asserted that the deal’s intercept structure, additional pledges, and coverage levels offset challenges facing the Pontiac School District and the city itself, although Moody’s raised concerns that the intercept is not a sure bet of debt repayment.

“The city of Pontiac has an emergency manager who is essentially appointed by the governor and the state treasurer — they’re going to turn over the money,” Lefler said. “It’s very simple. This is a school district tax levy and the money needs to be turned over.” 

The notes are being issued via the Michigan Finance Authority, which will act as conduit. In addition to the trustee intercept feature, the notes are secured by the district’s limited-tax general obligation pledge and Oakland County’s delinquent tax revolving fund, neither of which are subject to the intercept pledge.

Moody’s analysts gave the notes a speculative-grade credit rating, warning that the intercept feature and additional protections may not be enough to offset challenges.

The rating agency also placed the district’s Baa2 issuer rating and Ba3 limited-tax GO rating on review for possible downgrade ahead of the deal. Neither Standard & Poor’s nor Fitch Ratings rate the district.

Moody’s said if the borrowing fell through, the district would likely fail to make payroll and other expenses within the month.

The city of Pontiac’s precarious financial position is a burden for the district and poses a potential threat to repaying the notes, according to analysts. The ratings agency downgraded the city to Caa1 from B2 last May.

Pontiac collects 31% of the district’s taxes.

Moody’s noted that bond counsel’s opinion is that the property taxes collected on behalf of the PSD are the district’s property, but added that it is uncertain how those taxes would be treated if the city declared bankruptcy.

There is the possibility that the flow of funds to the bond trustee would be interrupted, according to Moody’s analyst David Levett in the report on the upcoming deal.

“In the potential scenario where the flow of funds from the city of Pontiac were completely disrupted due to a bankruptcy proceeding, very limited margin remains for further declines in valuation or collection rate,” Levett wrote.

“Assuming some additional stress to property valuations and collections rates, intercepted revenues could be insufficient to fulfill payment of the Dec. 1, 2012, maturity on time and in full,” he wrote.

Levett said the borrowing, if successful, should ease near-term pressure on the district. If the borrowing falls through, a downgrade is likely, he said.

The Pontiac School district has $7.2 million of outstanding unlimited-tax GO bonds and $15.7 million of outstanding limited-tax GOs.



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