Michigan Refunding $368M of GOs; $1.42B of Notes on Tap

CHICAGO -- Michigan today will enter the market with $368 million of general obligation refunding bonds and is expected to soon price a $1.42 billion note issue that is currently on the day-to-day calendar.

The $1.42 billion of notes is the state's largest such deal to date and represents its seventh since 2003. Proceeds will cover operating deficits in the state's general fund and school aid fund until tax revenues flow into state coffers.

Today's $368 million school refunding bond transaction is divided into two series, including a $222 million federally taxable piece. The GOs will refund debt originally issued in 1998 and 2005, most of which is variable rate and backed by standby bond purchase agreements from recently downgraded Depfa Bank PLC. The transaction is expected to cut nearly in half the state's floating-rate debt, bringing the total down to $351 million in an overall debt portfolio of roughly $1.5 billion.

Merrill Lynch & Co. is the senior book-running manager on the GO refunding deal, leading six additional underwriters. Robert W. Baird & Co. is the state's financial adviser, and Dickinson Wright PLLC, and Miller, Canfield, Paddock and Stone PLC are co-bond counsel. Merrill took retail orders on the bonds yesterday.

Fitch Ratings assigned a AA-minus rating with a negative outlook to the transaction. Standard & Poor's assigned a AA-minus with a stable outlook, and Moody's Investors Service affirmed its Aa3 with a stable outlook.

The notes mature Sept. 30, 2009, the last day of Michigan's fiscal year, and carry the state's full faith and credit pledge. Unlike the last two note issues, this issue will not be backed by a letter of credit. The deal, in which state officials are ready to price any day depending on market conditions, marks the seventh year in a row that Michigan has issued short-term debt in order to cover expected operating deficits.

Regular cash-flow borrowing can affect a state's credit rating, analysts said.

"Michigan's repeated issuance of cash-flow notes in recent years underscores the weakening of the state's financial position caused by the economic stress it has experienced in recent years," Moody's analyst Ted Hampton wrote in a report on the note transaction.

Moody's downgraded the state several times since it began issuing cash-flow notes in 2003. Moody's assigned a MIG-1 rating to the note issue - the highest-quality note rating - based on Michigan's GO pledge, its strong liquidity outside the general and schools funds, and good fiscal management. Fitch assigned an F1-plus rating to the transaction, and Standard & Poor's assigned an SP-1-plus rating.

Goldman, Sachs & Co. will be the book-running senior manager with a syndicate of 10 additional underwriters.

Without proceeds of the note issue, the state's general fund and school aid fund would experience deficits beginning in December, and face a $2.48 billion deficit by August 2009, according to Moody's. The state faces deficits throughout the year even with the note borrowing and expects to turn to internal borrowing to cover those shortfalls

Michigan's weak economy, plagued by a declining automobile industry, remains its greatest credit challenge and one of its biggest challenges to future cash flow, Hampton said.

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