DALLAS – Uncertainty over how bondholders will be repaid once Detroit Public Schools is split into two entities has put the district's bond ratings at risk of slipping into junk territory.
On Thursday S&P Global Ratings downgraded DPS' series 2011 and 2012 bonds by three notches. The 2011 bonds were downgraded to BBB from A and the 2012 bonds were downgraded to BBB-minus from A-minus.
The ratings are on CreditWatch with negative implications, where they were placed March 10, 2016. The principal amount of the 2011 and 2012 bonds is approximately $214 million.
At the same time S&P affirmed the short-term notes SP-3 rating on the series 2015-E notes that are similarly secured by state aid. The ratings agency also removed the rating from credit watch.
S&P based Thursday's rating action on the lack of information on how bond repayments will work under the school district's restructuring. The rating on each series is based on the district's pledge of state aid.
"It is our understanding that under the new legislation, the state aid bonds will have to be redeemed, refunded, or defeased because state aid can only flow to school districts that have students, and the Old Co will not have any students," said S&P. "If the actions taken through this [restructuring] process provide bondholders with anything less than the full promise of the original bonds, it is likely to be considered a distressed exchange and therefore a default under our criteria."
The rating agency said there is a 50 percent chance that it will lower the ratings again over the next three months if it views the redemption as providing less than the original promise. S&P said the rating could sink to D territory.
"The plan is to refund, defease or otherwise restructure the bonds without any reduction in principal before October 20, 2016," said Jeremy Sampson, a spokesman for Michigan's Department of Treasury.
On June 21 Michigan Gov. Rick Snyder signed a $617 million legislative package that outlines a restructuring of DPS. The school district, which has been under state emergency management oversight for the last seven years, risked not being able to open doors in the fall and defaulting on debt payments. Without legislative action, the district was headed toward bankruptcy with the state likely on the hook for much of the district's bonded debt.
Under the rescue plan, the state will pay off $467 million of accumulated DPS operating debt. A new, debt-free school system will be established with an additional $150 million provided to cover transitional operating costs.
DPS's debt includes $1.5 billion of unlimited-tax general obligation bonds, $199 million in borrowing from the state's School Loan Revolving Fund, and $259 million in limited-tax GO debt paid by district operating revenues, rather than a dedicated debt service levy.
The new Detroit Community District will own assets and operate the schools. DPS (the Old Co) survives solely to collect tax millage and service debt outstanding. The Old Co will no longer be eligible to receive distributable state aid.
State aid will remain pledged to the existing bonds and 2015-E notes until Oct. 1. According to S&P, DPS has been making set aside payments to repay the 2015-E notes in full at their August 2016 maturity.
However the rating agency said it remains unclear on how DPS will repay bondholders once state aid flow stops. "Under the new legislation, once the restructuring is effectuated, the series 2011 and 2012 bonds would no longer be supported by a pledge of distributable state aid and the only remaining pledge backing the bonds would be the limited tax general obligation pledge."
