Detroit's schools weigh a vast capital gap

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Detroit Public Schools Community District, looking to tackle ballooning capital needs, may opt to get its own bond rating or seek private funding if it can’t get help from the state.

The school district released a facilities report this summer saying it would cost $500 million to get its school buildings up to standards. Finding that money is challenging because of a state law that prohibits the district from issuing debt under the state’s school bond qualification and loan program.

Moody’s Investors Service warned in a November report that the district’s capital needs could top $1.5 billion by 2023 if not addressed.

“We could expect a unique innovative solution to this issue,” Andrew Van Dyck Dobos, the lead Moody’s analyst on Detroit Public Schools, said in a phone interview. “The state has shown an ability to come up with innovative solutions in past for Detroit, including DPS’ bailout of 2016. They took unique approach to it and could be that they get creative in trying to come up with a solution to this issue. I think it will be imperative for them to get a sense of urgency because the costs will start to escalate with deferred maintenance.”

The district has budgeted just $9 million for capital expenses out of a budget of roughly $760 million.

Michigan has not historically offered capital support for schools, in contrast with other states that provide matching grants or funding for capital. What the state has done historically is allowed for districts to issue bonds enhanced by the state’s credit quality.

The Michigan Legislature’s $617 million bailout of the District’s operating ledger blocks the school district from accumulating any new capital debt until 2040, with the system’s existing 13 mill tax rate for capital improvements dedicated to paying $1.63 billion in old debt from eight capital municipal bond issues between 1998 and 2010.

Under the plan the district was split into two organizations. The new Detroit Public Schools Community District provides education while Detroit Public Schools retained responsibility for the vast majority of outstanding liabilities.

The split allowed DPSCD to begin with a clean balance sheet, in part by shedding approximately $53 million in annual debt service expenditures beginning in fiscal 2017. This relief, along with a one-time transfer of $45.2 million from DPS, enabled DPSCD to post a positive general fund balance in fiscal 2017.

However the bailout package basically says Detroit Public Schools has maxed out on its ability to have state-enhanced debt and under the current law the new district cannot reach back into that program, because they have the same tax base.

With the road to state-enhanced debt blocked the district must consider other ways to pay for its capital needs.

One option is to access the bond market on its own credit quality that, without a rating, could result in prohibitive costs for interest on that borrowing, said Van Dyck Dobos. Moody’s rates Detroit Public Schools B2 with a stable outlook but does not rate the new DPSCD because it has no outstanding debt.

The school district has said it may be interested in getting a standalone rating that is independent from outstanding Detroit public school’s rating and old legacy debt. DPSCD Superintendent Nikolai Vitti believes that would move the district closer to a rating similar to the city of Detroit. The city is rated Ba3 by Moody’s Investors Service and B-plus by S&P Global Ratings. The outlook for both is stable.

Vitti said that the district has focused on what it can control: creating which was the creation of stronger policies, systems and processes to improve the district’s financial condition to support students.

“The improvement in rating speaks to an improvement in responsible stewardship with an elected, empowered school board,” he said in a written statement to The Bond Buyer. “We aligned our budget to a strategic plan through zero-based budgeting. This has created a balanced budget, 10% rainy-day fund, and strong fund balance. We look forward to a rating that separates DPS and DPSCD.”

Van Dyck Dobos said Moody’s has not been engaged to rate DPSCD nor has it internally initiated the process of rating the district because it has no debt. He said that to get a rating, DPSCD would first have to get into position to reenter the market under their own credit and for that to occur the district would likely need either voter approval or some kind of legislative change to get them the authority and the capacity to take on debt.

“If they were to be given authority to borrow and we were asked to rate it, that would be a very interesting conversation with them,” Van Dyck Dobos said. “While their outstanding debt would lay against the credit quality, they have legal separation between the new co. — DPSCD — and old co. — DPS — that would offer new dynamics for us to go through and determine what the rating level would be.”

Ron Leix, a Michigan Treasury spokesman, said that the state has ongoing discussions with all school districts, including DPSCD, regarding capital improvements.

“The school district has options provided under state law or by voter approval. This includes voter approval to leverage a millage to issue debt or for a sinking fund.” A voter-approved sinking fund millage could generate up to $20 million in annual revenue, according to Moody’s.

Another solution could be for the state to use its monthly school aid payments as backstop to a DPSCD debt offering, said Craig Thiel, research director for the Citizens Research Council of Michigan, a not-for-profit public affairs research organization.

“A state securitization backstop of the monthly school aid payments could maybe make the debt more attractive to lenders,” Thiel said.

“You have a whole new leadership in House and Senate and change of leadership in the executive branch in January and they may want to revisit this and look at these options,” Thiel said.

Democrat Gretchen Whitmer will take over the governor's office from term-limited Republican Rick Snyder. Republicans remain in control of the legislature.

Van Dyck Dobos said that because of the bailout the school district is receiving roughly $70 million per year in additional funding that it would not otherwise received, though much of it goes to cure the legacy district's debt. “That money is restricting the state’s ability to push that to other needs,” he said. “The question would be would the state be in a position to offer this one school district additional money going forward.”

Snyder spokesman Ari Adler said there is no plan at this time to request any more money for the Detroit district before Snyder leaves office at year's end.

"As the district looks to make improvements in the future, it would need to work with the leaders in the governor’s office and the state legislature at that time to determine the best course of action at all levels to achieve additional success for Detroit’s schools," Adler said.

Van Dyck Dobos said it might be the case that the state would prefer there be a local solution to the issue but the city of Detroit has not stepped forward with any financial support directly at this time. The city of Detroit and the school district are two legally separate entities.

“They don’t have real ownership of the district and they don’t really have the resources right now accumulated to support something of the magnitude of DPSCD’s capital needs,” Van Dyck Dobos said of the city.

Outside of state funding, private money is essentially the only option for the district, said Sarah Reckhow, an associate professor of political science at Michigan State University.

The district has already raised $2.4 million in private funds to cover the cost of hydration stations across the city schools after drinking water was turned off in schools in August in response to excessive lead and copper levels in 57 schools.

“Several philanthropies and corporate funders have supported the district in various ways and most recently to provide drinking water stations in school,” said Reckhow. “But the size of the anticipated facilities costs seems too large for private funding to realistically cover. Not to mention, it’s a short term remedy for a structural issue, because Michigan provides no state grants for districts for school facilities.”

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