CHICAGO - The Michigan Municipal Bond Authority abandoned plans to issue $200 million of revenue bonds this week in favor of a $150 million note issue in a bid to generate cash for the state's clean water revolving fund without getting stung by ongoing market turmoil.

Officials hope to return to a more stable long-term market in six months to convert the notes to longer-term debt.

The authority plans to sell Wednesday the $150 million note issue on behalf of its triple-A rated clean water revolving fund program. Proceeds will be used to provide low-interest loans to local governments for clean water and sewer projects.

It is the first time in the program's 10-year history that the state will issue notes instead of bonds, said Tom Letavis, executive director of the MMBA.

"Given the market, it didn't make sense to do a long-term structure," he said. "This [short-term structure] will better fund our program, and we're hopeful that in six months things will settle down in the market. If it doesn't, we'll have to come up with a different long-term strategy."

The notes are set to mature July 15, 2009.

JPMorgan is the senior book-running manager on the deal and Citi is co-senior. Michigan-based Stauder, Barch & Associates Inc. is financial adviser on the deal. Miller, Canfield, Paddock and Stone PLC and Dickinson Wright PLLC are co-bond counsel.

Guiding the state's decision to issue notes instead of bonds is the program's reserve fund. Funded with a combination of federal capitalization funds, state match funds, and other money, the reserves are currently invested in guaranteed investment contracts with seven providers.

Under the reserve fund's investment rules, all GIC providers must be rated double-A or higher, or the provider must post at least 103% collateral in the form of Treasuries or other obligations of the federal government. With the bankruptcy of Lehman Brothers - a large provider of guaranteed investment contracts, though not one of Michigan's providers - and the downgrade of other firms, the state's finance team "no longer felt secure" in investing with those institutions, Letavis said.

The reserves now have to be invested in either Treasuries or other federal government obligations, and those currently generate insufficient yields, according to Letavis.

"We need to get a certain rate to help subsidize the loans to local communities, and if we did it now, that would reduce the amount of the loans that we could make," he said.

As it is, one of the reserve's seven GIC providers - Depfa Bank Plc - was recently downgraded to below double-A, though it continues to meet requirements by posting 105% collateral with a third-party custodian, according to rating analysts.

"The credit strength of the investment agreement is important because the earnings are a critical component of the revenues used to pay debt service," Moody's Investors Service analyst Baye B. Larsen noted in a report.

Michigan's clean water revolving fund has $1.4 billion of outstanding program bonds, according to Fitch Ratings. All three major rating agencies maintain triple-A ratings on the state's combined clean water and drinking water funds, and officials said they expect the highest short-term rating for the note deal.

The triple-A ratings come from the strong reserve fund and the security provided by the large and diverse pool of fund borrowers, analysts said.

Of the 196 borrowers that make up the combined clean water and drinking water programs, Detroit is the largest, making up 23% of the outstanding loans, and is expected to remain the largest borrower as it embarks on a future sewer overflow project.

"Concerns about Detroit's pool concentration are mitigated, to some extent, by MMBA's ability to limit a borrower's participation to 30% of available funds in any given year," said Fitch analyst Adrienne M. Booker.

No borrower has defaulted on the program, and most loans are backed by general obligation limited-tax pledges, analysts said.

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