CHICAGO — A Detroit charter school defaulted on its Oct. 1 debt payment despite carrying a pledge of state aid, an intercept feature, and other protections designed to enhance bondholder security.

The Detroit Academy of Arts and Sciences made only a partial Oct. 1 payment on bonds originally issued in 2001. A payment of $600,000 was made out of $1.7 million due. It's the first default for the school, which opened in 1997.

The missed payment marks the third Michigan public school to default so far this year, though the other two schools were traditional public school districts.

Schools across Michigan face near-record levels of fiscal stress, and lawmakers are considering several bills to help address their problems. In Detroit, the landscape is aggravated by intense competition between charter and traditional public schools fighting for a shrinking student population.

Detroit has one of the highest concentrations of charter schools in the country, with more than 40% of students attending a charter school, according to Moody's Investors Service analyst Matthew Butler.

"The city itself has been losing population, and therefore the total student population is declining, while there a growing number of schools are opening to serve the population," Butler said. "Those two forces really increase the competitive nature in the environment and result in significant changes in enrollment for any individual entity."

In the case of the Detroit Academy of Arts and Sciences, the school saw a sharp enrollment drop after it closed its high school. That meant a big drop in state aid.

Moody's on Tuesday downgraded the academy to Ca from Caa2 with the expectation that bondholders will not recover more than 65% of the net present value of the remaining debt service payments in the school. The outlook remains negative at the lower rating.

When the bonds were first issued in 2001, they came with a handful of protections designed to enhance bondholder security. That included a pledge of state aid as well as intercept feature, which placed the aid directly with a bond trustee.

The borrower also pledged to set up a reserve fund, and bondholders were given a first mortgage lien on school facilities. But the pledges failed to prevent the recent default. The state aid pledge is insufficient because Michigan law requires that no more than 20% of state aid be used for debt service. Another mechanism in the financing that allowed the district to ask for the state to accelerate its monthly aid payments may be helpful but does not address the fundamental aid shortfall.

"The state aid advance kind of helps on a cash flow basis, but the amount falls well short of the amount needed for annual debt service," Butler said.

The debt service reserve account has more than $2 million, but none of the funds were transferred to the bond trustee to make the October payment.

Bondholders also have a first mortgage lien on the school buildings. The high school building was sold in August but for only $100,000, a "modest sum" compared to the $26.2 million outstanding principal, Butler noted.

The $31 million of revenue bonds were issued in May 2001 featuring Ba1 ratings from Moody's. JPMorgan was the underwriter.

The bonds mature in 2031.

School officials did not return calls for comment by press time.

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