CHICAGO — The Michigan Finance Authority will sell $92 million of one-year state aid revenue notes for the Detroit Public Schools next week in the first market offering to carry the Detroit name since the city's bankruptcy filing last month.
The notes are being issued to smooth out cash flow for the school district, which is a separate unit of government that is not under city authority. Like the city, Detroit Public Schools are under emergency management oversight.
The notes mature on Aug. 20, 2014. They are being issued under a junior subordinated lien with a third priority behind a $211 million 2011 issue that matures in 2021 and a $126 million 2012 issue that matures in 2020.
JPMorgan and Loop Capital Markets LLC are underwriting the sale and Public Financial Management Inc. is advisor to the district. The notes are secured by state aid received by the district beginning in fiscal 2014, and the district's limited tax general obligation pledge.
Investors benefit from an intercept mechanism that sends funds needed to repay the notes directly from the state treasurer to the trustee before any disbursements to the district. The notes carry a short-term rating of SP-1 from Standard & Poor's.
Despite strong repayment safeguards and the issue's short maturity that limits long-term risk, the notes face a skeptical market audience given the Detroit name and the district's own financial stress, market participants said.
One New York trader said the deal would find buyers "unless something happens in the courts between now and next week" involving Detroit's bankruptcy, but it's unclear how steep a yield penalty the district might face. Another trader said a call from a state issuer recently to ask if it would be bidding an upcoming competitive sale illustrates the struggle for state borrowers, because the firm never bids on Michigan deals.
The district and PFM did not return calls to discuss the transaction.
The offering statement informs potential investors that the emergency manager has no intention of asking Michigan Gov. Rick Snyder for authority to file Chapter 9 bankruptcy. Such a request is permissible in the absence of a reasonable alternative to rectify the district's financial emergency. The document still warns of the potential pitfalls such a filing could have on the value of the notes.
In bold print, the offering statement notifies investors that despite the authority's lien on state aid being one that is built into statutes "the enforceability of this lien in the event of a Chapter 9 bankruptcy case of the district under the U.S. Bankruptcy Code is uncertain."
Such a filing could subject note holders to "the exercise of judicial discretion" and could have a "material adverse effect on the district and its ability" to pay the notes and borrow in the future.
The liens on the distributable state aid for the notes and bonds are "perfected," a status that affords them strong protection even in legal proceedings, because they were issued pursuant to the State School Aid Act, meaning the aid is exempt from being taken, sequestered, or applied to other debts or liabilities other than for payment of the obligations to which the lien applies.
"As such, we believe that, in the absence of intentional negotiation with bondholders, the notes and bonds will continue to be paid, even in the occurrence of bankruptcy," Standard & Poor's wrote.
Detroit's EM Kevyn Orr took the city into its historic Chapter 9 bankruptcy July 18 and his attempts to treat the city's GO debt as unsecured have rattled the municipal market especially in Michigan. Three issuers slated to bring negotiated deals to market have pulled or postponed them as investors demanded too steep a premium.
Municipal Market Advisors in its weekly report said it doesn't expect postponements to become a norm because Michigan local governments will come to terms with higher borrowing costs due in part to the uncertainty posed by the Detroit EM's aggressive stand against repaying much of the city's debt.
MMA said it expects higher spreads for Michigan municipalities at least until the treatment of Detroit's unsecured creditors is decided.
Snyder recently named Detroit chief financial officer Jack Martin as the new emergency manager of Detroit Public Schools to replace Roy Roberts. The state has controlled DPS, which is plagued by falling enrollment and chronic deficits, since early 2009.
The short term rating reflects the pledge of all state aid appropriated to the district beginning in fiscal 2014, analysts' view of limited risks in aid payments, and the intercept of all state aid for payment on the notes, Standard & Poor's said.
The credit also benefits from the ability of the Michigan state treasurer to advance any state aid that has been appropriated by the state to the district, regardless of when the aid is due. Standard & Poor's said it anticipates that enrollment could decline by as much as 33% and state aid would still be sufficient to cover debt service by at least 1 times.
Fiscal 2014 aid is expected to provide 1.1 times coverage of the repayment obligations including the 2011 and 2012 debt. The district receives about $31.8 million monthly in state aid. No debt senior to the notes can be issued as long as the notes are outstanding.
The credit's challenges include the risk that state aid could be reduced beyond district projections, and ongoing fiscal stress. The district is required to provide monthly updates regarding the ratio of monthly school aid receipts and the repayment of set-aside requirements.
School aid is generally disbursed on a per-pupil basis, along with additional aid for special programs and needs. The district's enrollment has suffered and most recently dropped year over year by 250 students but it remains the state's largest district with 51,070 students.
Fiscal 2013 ended with a $6 million deficit but a $6 million surplus is anticipated this year due to savings from school closures and possible budget cuts. Management believes the district is on track to cure the district's structural imbalance by the end of fiscal 2016.
Taylor Riggs contributed to this story