CHICAGO — Moody’s Investors Service downgraded Detroit Public Schools, now in its fifth year of state oversight, citing operational problems and falling enrollment.

The rating agency late Wednesday also cut its rating on the Pontiac City School District, located outside Detroit, which defaulted on a May debt-service payment. The bond insurer covered the payment, and the district has not yet repaid the insurer, according to Moody’s.

Moody’s dropped its issuer rating on Detroit Public Schools to B2 from B1 and maintained its negative outlook.

Analysts said the district’s finances improved in 2012 but mainly due to the issuance of deficit bonds, which led to “material growth” in the district’s direct debt burden.

“In addition, as operating revenue continues to decline, the share of resources dedicated to debt service has grown and will likely increase further in the coming years,” analyst Matthew Butler wrote in the downgrade report.

Falling enrollment will continue to pressure the district, as it means a drop in state aid and will require more budget cuts. The drop in revenue will also mean that debt service will eat up more of the general fund, Moody’s said.

On the positive side, the district’s management, led by emergency manager Roy Roberts, has been willing to make cuts, according to analysts. State oversight and the EM’s broad powers are also strengths.

“The maintenance of a negative outlook reflects the pressure that continued enrollment loss will likely exert on the district’s operations,” Butler wrote.

DPS could win an upgrade if its general fund operations improve or the regional economy strengthens.

In nearby Pontiac, the school district faces its own set of challenges. Moody’s downgraded the district’s issuer rating  to B3 from B1 and the general obligation limited tax debt rating to Caa1 from B2 after the district missed a May 1 debt payment. The rating remains on review for further downgrade, Moody’s said.
Pontiac schools have $14.8 million of outstanding debt.

The district faces a potential state takeover and Treasury officials announced Thursday after a preliminary review law that the district is under “probable financial stress.” The next step is appointment of an independent financial review team.

The district failed to make a May 1 $1.4 million debt payment on GO limited-tax bonds issued in 2006. The bonds are insured by Syncora, which was unaware of the missed payment until the paying agent notified it on May 21, according to Moody’s.

The insurer paid the bondholders, but as of Wednesday the district had not yet repaid Syncora.

The missed payment comes after the state denied the district permission to issue tax anticipation cash-flow notes in April, which it typically does every year. The state also withheld its March and April state aid payments due to the lack of a deficit elimination plan, according to Moody’s.

The school district has a June 15 debt payment coming up for GO unlimited-tax bonds, but that payment is expected to come from the state school loan revolving fund.

The Pontiac district is located in the city of Pontiac, which has had an emergency manager for years. “The rating is under review for downgrade given the uncertainty regarding the amount and timing of recovery on the missed May 1 debt-service payment, the high probability that the district will need to borrow for its upcoming debt-service payments, and the continued deterioration of the district’s cash flows,” Moody’s said.

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