CHICAGO –The Detroit Public Schools’ debts are so burdensome that the $715 million price tag of a state restructuring proposal is more affordable than an eventual default or potential legal action, says Gov. Rick Snyder.
Snyder laid out more financial detail Monday on the controversial restructuring he first pitched in April.
Governance of the school system and the need for additional state funds drive much of the debate and opposition. Despite the political hurdles, legislation is being drafted and should be released in the next week. Snyder said he hopes for action before the end of the year so the changes can be put in place by June.
The cornerstone of Snyder’s proposal is to split the current district into two entities.
The new Detroit Community School District would manage education and operations and the old district, similar to a shell company, would be left intact to repay the district’s accumulated operating debt. Additional state help of $715 million over the next decade to make up for lost aid that would go to pay down existing debts and cover startup operating and capital costs of $200 million.
Market participants say they remain concerned over the long-term fate of much of the district’s $2 billion of bonds. The administration said the existing bonded debt would remain under the old entity with the existing millage repaying it.
“We are near the point where a solution needs to be developed given the size of the debt and the history of this financial environment,” Snyder said. If the district were to default or face some other legal action, “it would cost the citizens of Michigan and other school districts a lot more money. The Detroit school system has significant debts.”
Snyder argues the massive school restructuring is needed to compliment the city’s recovery following its exit from Chapter 9 bankruptcy and to allow a greater emphasis on academics.
The loss of nearly 100,000 students over the last decade has driven the district’s $500 million accumulated operating deficit, adding to the strains of repaying bonds and meeting pension obligations. State documents warn that the district is “at risk of collapsing financially.”
The legislation is expected to establish the new district with its students, teachers, employee benefit expenses, and assets such as school buildings falling under its purview.
The district, which serves 47,000 students, would be governed by a seven-member board appointed by the governor and Detroit mayor with an all-elected board in place by 2021. The current board would manage the old legacy school system remaining to repay debts. The new district would be prohibited from levying millages until the old debt is fully repaid.
The legislation would create a Detroit Education Commission, appointed by the mayor and governor, that would hire a chief education officer and hold sway over school openings and closures. One revision made since April calls for the existing Financial Review Commission that oversees Detroit’s finances to have fiscal oversight of the old and new districts instead of a creating a new oversight panel. There would be some tweaks to membership.
The district has operated under the state-mandated oversight of an emergency manager for six years.
Responsibility for the district’s $1.5 billion of unfunded pension liabilities would lay with the new district.
“We believe they can manage those costs,” Snyder said, citing the $1,100 in per pupil funding that would freed by eliminating the district’s deficit.
Snyder said the state’s School Aid Fund is healthy enough to bear the burden of the providing the additional $715 million over the next decade to make up for lost property tax millage that would remain with the old entity to retire debt.
“This does not have to come at the expense of any cut” to other districts, he said.
Snyder, a Republican, enjoys GOP majorities in the legislature but faces challenges to accomplishing the changes in time for the next school year. Detroit Mayor Mike Duggan and legislative Democrats prefer an elected school board and greater local control.
DPS Emergency Manger Darnell Earley expressed support in a statement.
“Gov. Snyder’s plan to reform the education landscape in Detroit, including a transformation of Detroit Public Schools into a more financially stable new district without the crushing burden of debt that exists today, represents the best way forward for the district and the children it serves,” Earley said.
Snyder said he was open to changes. “Let’s get the legislative process going,” he said.
Market participants who follow Detroit schools said they were still digesting the additional details released Monday but questions remain over the long-term status of much of the district’s $2.1 billion of bond debt. That includes $1.5 billion of capital bonds, which are structured as unlimited-tax general obligation bonds, and are paid for with a local millage approved by voters. Another $165 million is owed to the state's school loan revolving fund.
“There’s still a lack of clarity” on the fate of the district’s GO debt, said one muni buyside representative, who asked not to be named.
In Michigan “bondholders have to assume the worst,” said Matt Fabian, a partner at Municipal Market Analytics, citing the state’s position on Detroit’s Chapter 9 and doubts raised by Snyder over pending legislation that would attach a statutory lien and trust structure to local unlimited tax GOs.
The bulk of the ULTGOs are part of Michigan's Qualified School Bond and Loan Program. A February official document for a DPS bond sale warned that the fate of the enhanced bonds would be uncertain in a bankruptcy.
Snyder steered clear of warning that bankruptcy loomed for the district, but stressed action is needed soon to tackle the district’s fiscal strains.
“I wouldn’t say necessarily bankruptcy” looms “but you could have financial defaults,” he said. “I think it makes good financial sense” to act “because the state and other districts will pay more.”
Snyder also said he didn’t see a bankruptcy filing in the old school entity’s future given that a millage exists.
The district earlier this year issued $121 million of notes that featured a statutory lien on state aid. The district needed to issue the notes, sold through the Michigan Finance Authority, to cover its operating cash flow through next August.
DPS announced last spring that it did not have enough cash to pay off a 2014 note issue due in August that carried a 2.75% interest rate. In May, it borrowed $85 million in state-aid notes to cover the bulk of the $107 million note payment due in August, paying 4.85% on the notes.
The latest sale marked the fourth instance in which the district tapped its state aid - which is declining because of its downward enrollment spiral - to cover borrowings, underscoring the district’s precarious financial condition. The sale featured a fourth lien on the district's state aid, subordinate to state-aid debt with first, second and third liens on state aid issued in 2011, 2012 and 2015 and total $338 million.
They also may be subordinate to the district's late pension payments.
Bond documents also warned that the district was behind on its contributions to the state's teacher retirement system, and that could trump note payments. That's because the State's Office of Employment Retirement Systems also has the right to ask the treasurer to intercept state aid to pay off the district's pension payments.
There is also no certainty that the statutory lien on the state aid would remain solid in the event of a bankruptcy.
Standard & Poor's on Sept. 8 downgraded the 2011 and 2012 state-aid backed bonds one notch to A and A-minus respectively amid falling enrollment. Enrollment at DPS fell an average of 12.5% from fiscal 2007 to 2012, then dropped 23% in fiscal 2013, after the state created a new educational authority to take over failing schools. Enrollment fell 5.5% in fiscal 2014 and was down 2.8% in fiscal 2015.
