DALLAS – Hearings begin Thursday on Michigan legislation that paves the way for Gov. Rick Snyder's restructuring plan for the debt-laden Detroit Public Schools.
The discussion about the troubled district will come in the wake of Tuesday's resignation of the district's state appointed emergency manager.
Senate Bills 710 and 711, sponsored by state Sen. Goeff Hansen, R-Hart, would split Detroit Public Schools into two entities.
The bills, introduced last month, would also change the legal structure of the district's outstanding debt, creating a lockbox to ensure that investors get paid in full, and on time.
Under the plan, the existing Detroit Public Schools entity would remain intact only for the purpose of collecting tax revenue until its outstanding debt is retired.
A new entity, Detroit Community District, would operate schools.
Wendy Berry, a director in New Oak Capital's fundamental credit group, said the restructuring proposal should send a positive sign to bondholders that Michigan wants to avoid a DPS bankruptcy. The district has been under state oversight for the last seven years.
The district's debts include $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. It's unclear if all would stay with the old DPS entity.
Snyder's plan relies on $715 million of state help: $515 million to eliminate DPS' structural operating deficit and help with overdue pension payments and unpaid bills, and another $200 million of start-up funding for the new operating entity.
The Snyder administration says without action, the district will be "virtually insolvent" by April.
The Hansen bills provide $250 million from the state's general fund for the start-up costs but don't address the operating deficits.
Hearings before the Senate's government operations committee are expected to continue for two weeks, according to Hansen's chief of staff, Peter Wills.
Hansen said the legislation is a first step toward a long-term solution.
"Detroit is on the rebound, with a sound financial footing, improving economy and a rising population, but numerous efforts to improve K-12 education there have not worked," he said in a statement.
The hearings get underway with the district's monthly expenses slated this month to rise by $26 million to begin repaying cash flow notes issued to paper over operations.
That amount is equal to about one-third of the district's monthly expenses, Moody's Investors Service said.
The emergency manager, Darnell Earley, has warned that the system will exhaust cash to maintain operations by April due to its debt load.
The hearings mark the first steps toward advancing a plan that failed to gain much traction since Snyder first unveiled a general outline last spring. Snyder will supply additional details on the funding scheme when he unveils his fiscal 2017 budget recommendation on Feb. 10, according to budget office spokesman Kurt Weiss. The Detroit schools will compete for legislative and budgetary attention amid the water contamination crisis in Flint and efforts to improve state pension funding.
Moody's says the district's split-up would be a credit positive and some believe it's likely to be welcomed by bondholders.
"All the money that comes in gets scooped up by the old DPS entity and every dollar of whatever is due gets taken out fist, what is left over goes to the new entity," Berry said.
The bills would allow the new entity in charge of educating students to continue to borrow and issue bonds for operating purposes on a longer-term basis.
Instead of the typical ten-year term, borrowing terms would be stretched out to 25 years.
"It is a long time particularly when you consider that most entities, if they are in a distress situation, can typically only borrow on a short-term basis," Berry said.
DPS' operating deficits ballooned over the last four years to an expected $335 million at the end of 2016 from $83 million in 2012 an enrollment plummeted, according to the Citizens Research Council of Michigan, a nonpartisan public affairs research organization.
The district began the current school year with legacy debts totaling almost $440 million. Adding to the district's more recent fiscal deficit challenges is its heavy reliance on short-term notes to help with cash flow throughout the fiscal year.
In 2016, debt service payment obligations will nearly triple to $2,982 per student from $1,105 in 2015 mainly because the district pushed its 2015, $83 million cash-flow note repayment onto the current school year's budget.
The way the district is set up today, debt service obligations compete directly with the resources that would otherwise go to classrooms to fund educational services.
"It significantly reduces the amount of resources that are available for the district to operate – last year DPS has about $4,700, this year they gave only about $3,000," said Craig Thiel, a senior research associate at the CRCM.
Declining enrollment has already hurt the district's balance sheet and Moody's warns the district could lose even more students as it is forced to divert funds from the classroom.
Ten years ago, it had more than 127,000 students. This year, it has an enrollment of 46,306, down 38% from fiscal 2011.
That's driven its general fund revenues down to $667 million this year from $1.13 billion in fiscal 2011.
The payment mechanism under the restructuring proposal supported by Snyder is basically the same mechanism used in other debt-laden districts of the state, which include Highland Park, Inkster and Buena Vista.
In those cases the state allowed for the local 18-mill school operating tax to be repurposed and instead of using it to fund the per pupil allowance, the dollars were diverted to debt repayment. Currently the tax generates around $71 million per year.
"The city of Detroit is a property poor community; it takes fairly significant millage to raise resources to improve capital vis-a-vis other communities in the state where the property tax and property base is much wealthier," said Thiel.
Alternatives are being proposed for debt service payments under the restructuring.
Sen. Hoon-Yung Hopgood, D-Taylor, is expected to soon introduce a bill that takes a percentage of funding from Michigan's tobacco tax revenue, the equivalent of the $71 million DPS needs per year, and redirects it through Michigan's School Aid Fund for the new operating district, said Wills.
Tobacco tax revenue totaled $940.3 million in fiscal year 2014 with 38.2% of collections earmarked to the School Aid Fund. It is unclear if Hopgood will propose taking a larger slice of tobacco tax revenue. The senator did not immediately return a call to elaborate on his proposal.
Wills said the Hansen bills propose to take the school aid fund "as a vehicle to filter any other revenue and we are hopeful that this tobacco tax revenue will be supported." He said that some other ideas for funding involve use of the state's tobacco settlement money to support DPS' debt service repayments.
Unlike the city of Detroit, which emerged from Chapter 9 in 2014, nearly all of DPS's debt is backed by state under Michigan's Qualified School Bond and Loan Program. That means that the state could ultimately be on the hook for a good portion of DPS's operating debt in a Chapter 9, although the bankruptcy court would have the final word.
"Michigan would much prefer to restructure the school district so that it would be able to pay most if not all of its municipal obligations," said Berry.
The fate of the restructuring plan faces political hurdles.
"Right now it is just standalone Senate bills," said Wills. "I know that our House colleagues have other ideas and may be producing their own package at some point or if we are able to send the Senate bills to the House, they will certainly be amended."
Michigan State Rep. Sherry Gay-Dagnogo, D-Detroit, a former DPS teacher, said that the House is mobilizing a committee to hear the bills once they come to the House. But she said that the DPS problem "is much bigger than just dividing the district into two," and that the bills don't address larger governance issues or the district's academic challenges.
Gay-Dagnogo takes issue with language in the Senate bills that put the new district temporarily under a nine-member school board appointed by Gov. Snyder and Detroit Mayor Mike Duggan. This means DPS, which is already on its fourth state-appointed emergency manager since 2009, would be the only Michigan district without a local, elected representative government.
"The proposal continues to penalize people locally and not give them a voice in their public schools," she said.
Instead of a state appointed board proposed under the Senate Bills, Gay-Dagnogo wants the state to use its bonding powers to take control of the district's debt and restore a local school board.
DPS carries an underlying junk-level Caa1 rating with a negative outlook from Moody's. Standard & Poor's on Sept. 8 downgraded the district's 2011 and 2012 state-aid backed bonds one notch to A and A-minus respectively amid falling enrollment.
Under Hansen's bills, the new Detroit Community District would shift in 2017 to an elected board. Responsibility for the district's $1.5 billion of unfunded pension liabilities would lay with the new district. The City of Detroit's Financial Review Commission would have responsibility for overseeing the new district's finances.
Earley, who has come under criticism for decisions made during his tenure as EM in Flint, notably the use of Flint River water for the city's water system that is blamed for a surge in childhood lead poisoning, has served in the Detroit schools post since January 2015 and his term was to end in June. Recent teacher "sick-outs" over poor school conditions have also heightened scrutiny of his current tenure.
"Darnell has done a very good job under some very difficult circumstances. I want to thank him for his professionalism and his service to the people of Michigan," Snyder said. "He restructured a heavily bureaucratic central office, set in place operating and cost-containment measures, and has taken steps to stabilize enrollment. These factors should all set the course for a sustainable, new Detroit Community Schools, as I have proposed."
Snyder said he would appoint a transition leader before the end of the month to set in place his plan to restructure DPS to address the district's academics and finances.