You’re Chopped! Detroit Public Schools Falls Below Investment Grade

Detroit Public Schools’ (DPS) bond rating was recently cut to non-investment grade. The situation is both in flux and complex. SNWAM does not hold any DPS bonds.

Detroit Public Schools (DPS) limited tax general obligation bonds, secured by state aid, saw their credit rating chopped three notches to BB from BBB by S&P. The bonds remain on credit watch negative by S&P because of the potential for untimely redemption, refunding or defeasance–in other words, less than full payment to bondholders. We should mention that, unlike the City of Detroit, DPS did not default. DPS and the City of Detroit are two legally separate entities that share a coterminous boundary and therefore the same property tax base. That being said, under legislation promulgated in July, DPS was divided in two. One district is called the Detroit Public Schools Community District (new co.), and it will take over all educational operations and continue to receive state school aid. The other district, or DPS (old co.), will persist as a special purpose vehicle to collect tax millage and service outstanding debt. As a result of the legislation, DPS will no longer be eligible for state school aid. State aid can only flow to school districts that have students, and DPS now has no students. Michigan starts a new fiscal year on Oct 1st, and at that time the DPS bondholders will only have the limited tax general obligation pledge securing their holdings going forward. Without the state aid intercept, the bonds’ value will be diminished. Due to the complexity and timeline of the situation, S&P estimates a 50% chance of another downgrade over the next two months.

Source: S&P Ratings and SNWAM Research