DALLAS - On the heels of a downgrade, accounting mismanagement, a lawsuit, and questions about its leadership, the Dallas Independent School District this week plans to issue $400 million of general obligation debt in the teeth of a credit crisis.
Despite all those problems, the bonds carry triple-A ratings thanks to their backing by the nearly exhausted Texas Permanent School Fund, which should reassure risk-averse buyers, investment experts say.
"Overall, it's kind of a good name that might be somewhat damaged by the bad news that's coming out," Jeffrey Timlin, portfolio manager at Sage Advisory Services, said of DISD. "The mismanagement of the school district is probably going to play into people's concerns, and that will affect the long end of the curve rather than the short end."
This week's negotiated deal is co-managed by RBC Capital Markets, Citi, and Siebert Brandford Shank & Co., with First Southwest Co. and Estrada Hinojosa & Co. as co-financial advisers to the district. Vinson & Elkins LLP and West & Associates LLP are co-bond counsel.
DISD received downgrades from Fitch Ratings and Standard & Poor's last week as officials readied the first slice of a $1.35 billion authorization approved by voters in May.
Both agencies lowered the underlying rating to AA-minus from AA while maintaining negative outlooks. Moody's Investors Service affirmed its Aa3 rating but lowered the outlook to negative.
"Our negative outlook assignment is predicated upon our ongoing concerns regarding the reduction in financial flexibility that is a product of structurally unbalanced budgets, as well as the district's financial reporting shortcomings," wrote Moody's analysts Douglas Benton and Dwight Burns.
Standard & Poor's, which also has a negative outlook on DISD, said the "drastic and unanticipated" reduction in the district's general fund reserve led to the downgrade.
The fiscal 2008 general fund balance of $62.4 million is roughly half the previous year's $120.1 million, and officials expect a further decline to about $38 million next year. The drop is due to DISD's "ongoing internal control and reporting problems, including an underestimation of payroll-related expenditures," according to analysts.
"Not surprisingly, staffing changes have accompanied the deteriorating financial position of the district," Fitch analysts said.
Timlin said the bonds are likely to price at about 30 basis points over triple-A benchmarks, with spreads of 50 basis points likely at the long end. "That's susceptible to further spreading," he said. Municipal Market Data Wednesday said insured triple-A bonds were yielding 5.96% at 30 years.
The district recently named Larry Throm executive chief financial officer, overseeing financial services, information technology, and human development. Earlier this year, DISD fired the former CFO and budget director while it "formally launched a strategy to transform its financial operations."
A four-person team led by chief operating officer Eric Anderson has been tasked with transforming the district's financial reporting by implementing strict controls and improving efficiencies while attempting to develop a comprehensive five-year plan.
Several trustees have called for a no-confidence vote on superintendent Michael Hinojosa, who has said he has no plans to resign.
As the state's second-largest school district, DISD continues to grow and is in urgent need of new buildings at many of its aging schools.
Hinojosa and the board once set a goal of being recognized as "the best urban school district in the United States" by 2010. However, the district's finances have been so roiled by mismanagement and flawed accounting that key officials did not even know how much money individual departments had actually spent in the previous year.
That led to discovery this year that the district was actually running a $64 million deficit, unbeknownst to the top management or the board. That in turn led to a series of painful layoffs of teachers, followed by some rehirings when officials discovered they did not need to cut as deeply into the teaching ranks as they had.
Last month, the board of trustees said they had narrowed the deficit to about $52 million for this year and $75 million for fiscal 2009, following job cuts and the termination of several programs. Officials said the reduction in staff narrowed the deficit by about $26 million.
The district's audit was delayed by accounting problems this year, threatening to prevent it from issuing any of its new bonds on the public market.
Auditors at Deloitte & Touche said that officials "did not routinely compare actual expenses to budgeted amounts, a weakness that 'could lead to overspending,' " according to the Report to Management that accompanied the audit for fiscal 2007.
The revolving door of top administrators over the past few years allowed the problems to persist and all but go unnoticed, the auditors said.
Issuance from the bond referendum had also been delayed since July, when a group of black parents and community leaders filed a federal civil-rights lawsuit alleging DISD failed to use proceeds from debt authorized by voters in 2002 as laid out in that bond referendum. The suit contends the district failed to deliver promised projects in the city's predominately minority southern sector.
In October, a district court judge ruled in favor of the school system, granting an "expedited declaratory judgment" that validates the election and the bonds.
Just before the lawsuit was filed, the district applied to the Texas Education Agency to receive the backing of the state's triple-A rated Permanent School Fund and has until Dec. 12 to issue the debt with the credit enhancement.
The PSF has lost 30% of its value in the deepening national recession. The fund - which backs school debt at a fraction of the cost of traditional bond insurance - now stands at about $17.5 billion, down from $25 billion a year ago.
TEA officials were concerned the fund would reach its capacity for enhancing bonds, but through continual defeasance of debt that gets refunded and the slight uptick in the market over the past few days, the fund continues to have enough capacity to back debt.
Cassie Huggins of the TEA's state funding division said the level of applications has remained steady and officials move as quickly as they can to address each issue.
The TEA recently sent districts a new list of obligations needed to meet the requirements of the PSF, which included keep the state agency abreast of the exact timing of sales.
Steve Korby, DISD's executive director of financial services, said the district has contacted the TEA twice to reaffirm its application and plans to do so once more, as per the new mandate.
"The fund was very shaken by the hits it took as the market continued its downward trend, but things appear to have stabilized for now - well, at least, where the fund is concerned - and we still have the PSF guarantee," Korby said.