Consider Selling Detroit Public Schools Debt: MMA

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Matt Fabian, managing director and senior analyst for Municipal Markets Advisors, speaks during the Bloomberg Link Insurance Portfolio Strategies conference in New York, U.S., on Wednesday, March 2, 2011. Insurers, which held about $23 trillion in assets globally at the end of 2009, are facing pressure on their investment results as low interest rates hurt returns and as planned new rules for the industry make equity and real-estate investments less attractive. Photographer: Stephen Yang/Bloomberg *** Local Caption *** Matt Fabian

CHICAGO -- Investors holding Detroit Public Schools debt should consider selling, investment advisory firm Municipal Market Analytics said Tuesday.

"[T]here is likely more to gain from selling than holding at this point," MMA says in a comment titled "Detroit Public Schools, Willingness, and Distress" in its April 28 weekly outlook report. "[A]ll Michigan local school bondholders are effectively long the risk that the governor of Michigan will not look to impair bondholders in a hypothetical DPS Chapter 9. That is not a good bet."

The report comes as Gov. Rick Snyder is set to release a plan Thursday to overhaul the troubled district, which has been under state control since 2009 and still faces a $160 million deficit. After months of work from local and state officials, Snyder is expected to send a legislative package to lawmakers this month.

The plan is expected to divide the troubled district into two entities, one that will shoulder legacy debt and one that will take over educational duties.

That proposal does not bode well for bondholders left with the 'old' or debt-holding district, MMA said.

"This structure, in theory, positions the emergency manager to recommend a Chapter 9 if no reasonable alternative exists to repair the existing financial emergency," the firm says.

And Snyder's demonstrated "contempt" for bondholders in Detroit's bankruptcy -- where unlimited-tax general obligation bonds were treated as unsecured -- is hardly reassuring, the firm adds.

While DPS' state-aid backed bonds are expected to survive a bankruptcy, it's uncertain whether the district's bonds that are part of the state enhancement program would survive intact.

The possible weakness of Michigan's Qualified School Bond and Loan Program was highlighted for the first time in a February 2015 official statement for the Detroit schools, MMA notes.

The official statement warns investors that because no Michigan school district has filed for Chapter 9, the fate of enhanced bonds under is uncertain:

"In the absence of a legal precedent addressing the obligation of the State Treasurer to make an Act 92 payment in the context of a Chapter 9 proceeding, no assurance can be given that if the school district were to become a debtor under a Chapter 9 proceeding, the obligation of the state Treasurer to pay principal and interest on the municipal obligations post-bankruptcy filing would not be impaired," the OS says.

MMA says that marks a "dramatic shift in interpretation of QSBLSF, which has represented the essence of a programmatic security in the municipal market. However, Michigan's recent actions vis-a-vis bondholders give us little reason not to assume the worst."

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