DALLAS -- Michigan is prepping its first general obligation bond issue of 2016 amid growing uncertainty about the long-term impacts on the state's credit from Flint's water contamination crisis and the financial plight of the Detroit Public Schools.
"For Michigan these are issues that will eat into its reserves," said Howard Cure, director of municipal research at Evercore Wealth Management. "I'm not sure how much more aggressive the state can be on lowering taxes when they have these issues and what happens to the state during the next recession as far as taking care of these communities? These are a lot of issues and I think investors are definitely thinking about it."
The state will take competitive bids March 29 on $82 million of tax-exempt GOs, offered with maturities between 2021 to 2024.
Robert W. Baird & Co, Inc. is the financial advisor. Bond counsel is Dickinson Wright PLLC and issuer and disclosure counsel is Dykema Gossett PLLC.
Proceeds will fund grants to local municipalities under the Michigan Department of Environmental Quality's Storm Water, Asset Management and Wastewater Program, according to Terry Stanton, a spokesperson for the Michigan Treasury department.
In 2002, Michigan voters approved Proposal 2, creating the Great Lakes Water Quality Bond Fund and dedicating $1 billion to help prevent sewage overflows. Most of the bond dollars are used by the State Revolving Fund to provide loans to local units of government to improve sewer and storm water infrastructure. Approximately $303 million in grants have been awarded since 2002.
Moody's Investors Service and Standard & Poor's affirmed the state's ratings of Aa1 and AA-minus respectively.
S&P revised its outlook on Michigan down to stable from positive ahead of the deal, saying that spiraling costs of fixing Flint's water system and rescuing DPS could eat away at Michigan's healthy surplus.
"Michigan currently has the wherewithal to support projected additional costs and maintain the current rating," said Standard & Poor's credit analyst Carol Spain. "But if costs related to the Flint water crisis or distressed local credits escalate, there could be credit pressure." The revised outlook also applies to Michigan's A-plus appropriation-backed debt rating.
Moody's kept its outlook at stable.
"The Aa1 rating incorporates the state's solid financial position and liquidity, a strong tax revenue trend driven by robust economic growth, and moderate debt and pension burdens," said Moody's, which raised the state's rating one notch last summer. "The rating also recognizes our expectation that the state will continue to oversee local government distress with manageable direct state financial exposure."
Michigan's current credit strength lies in part in its healthy reserves and liquidity. Michigan has a $600 million surplus and an over $380 million emergency fund, but the burden of Flint and the Detroit schools is expected to halt the state's positive momentum in building reserves, which had fueled positive credit momentum.
Over the past decade the state has experienced both economic and fiscal improvements. Unemployment, for example, dropped to below the national rate in September after climbing to more than 4 percentage points above the U.S. rate in 2009.
The state's consensus revenue estimate reflects incremental operating fund tax revenue growth of about 3.3%, or $725 million, but most of it would be allocated to incremental spending increases in Flint, DPS and to boost transportation funding.
Market participants have worries.
Investors are looking at Flint for potential costs that could be drawn out for years, Cure said.
Cure believes the strains stemming from Detroit's schools and Flint are somewhat related, in that both are very poor communities that are struggling and the state "doesn't want the electorate to think that all these poor people are being neglected."
Cost estimates for the Flint water crisis range from $700 million to $1.5 billion.
Snyder has requested a total $232 million from state lawmakers to tackle both the short-term health and long-term safety concerns of Flint residents in the wake of the city's water contamination crisis.
Snyder said in a release on March 16 that the Federal Emergency Management Agency rejected his request for funding through emergency protective measures and Individuals and Households programs. They would have covered costs of food, water and other needs, as well as help repair water systems.
In the March 3 letter to the Federal Management Emergency Agency, Snyder specifically requested funding from the Category B program for emergency protective measures and the Individuals and Households Program.
"I don't have access to what the state is looking at, but it is optimistic to assume that the state or any other party understands the full dollar cost of the Flint disaster," said Matt Fabian, a partner at Municipal Market Analytics. "It is open-ended and, ultimately will be born in part by the state budget. Because this is Michigan, overages are more likely to be paid to the detriment of other spending, most likely local aid."
DPS' bailout so far carries a price tag of $715 million.
The school district, which has been under emergency management since 2009, has seen operating deficits balloon over the last four years to a projected $335 million at the end of 2016 from $83 million in 2012 an enrollment plummeted, according to the Citizens Research Council of Michigan, a nonpartisan public affairs research organization.
The district's fourth emergency manager, Darnell Earley, who departed at the end of February, was coincidentally the emergency manager of Flint when the city made the ill-fated decision to switch from Detroit Water and Sewerage System to obtain water from the Flint River in 2014.
The river water was not properly treated, causing lead contamination in the water pipes that remained even after the city shifted back to Detroit water.
Snyder is asking lawmakers to use tobacco settlement proceeds at the rate of $72 million a year for 10 years to eliminate the school district's $515 million deficit and wants to provide another $200 million to invest in the schools.
To address DPS' more immediate and dire cash flow crisis and keep its door open past April, Snyder has proposed using $50 million in supplemental funding from the state's general fund. The funding has cleared the House and is awaiting a Senate vote.
His fiscal 2017 executive budget also identifies education, health care, job creation, and infrastructure investment as key priorities. It calls for an overall 0.8%, or $438 million, increase in spending over fiscal 2016, with a 1.5%, or $145 million, increase in general fund spending.
Spending on transportation incorporates a tax package enacted in 2015 effective Jan. 1, 2017, that includes a 7.3-cent gas tax increase which would raise $236 million, an 11.3-cent diesel fuel increase expected to raise $69 million, and a 20% increase in vehicle registration fees which would generate $155 million.
In the near term, it eases general fund support for transportation by $390 million, but long-term transportation funding phases back to general fund support in fiscal 2019, which S&P said "could pressure the general fund in future years."