Resilience, credit fundamentals cited in Michigan upgrade

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CHICAGO — Michigan’s progress in rebuilding reserves and trimming debt, chipping away at its pension burden, tax structure reforms, and structurally balanced budgets helped win the state an upgrade Monday from S&P Global Ratings.

S&P raised the state’s general obligation bonds one level to AA from AA-minus and assigned a stable outlook, with its appropriation-backed debt rising in tandem to AA-minus from A-plus. The review comes ahead of a $142 million sale of GO-backed environmental program bonds.

"The upgrade reflects Michigan's demonstrated resilience following the Great Recession and improved credit fundamentals that we believe will persist through economic cycles," said analyst Carol Spain.

"In our view, diversification of the state's economy, revitalization of distressed communities, structural budget alignment, stronger reserves, and reforms to address its sizable pension and other postemployment benefit liabilities will better position it for the next downturn," Spain said.

The state has structurally balanced its general fund and school fund accounts for the last seven years, paid down some debt early and funded infrastructure with cash with surplus revenues.

The state bolstered reserves to $1 billion this year, up from $710 million in fiscal 2017. Reserves hit a peak of $1.3 billion in 2000 and then were drained by 2011 to deal with past recessions. Total tax-supported debt dropped to $7.1 billion in fiscal 2017 — including $1.55 billion of GO paper and $3.55 billion of general fund-secured appropriation debt — from $8.3 billion in 2015.

The state expects to end fiscal 2018 Sept. 30 with more than $300 million in surplus revenue and S&P labeled the $56.8 billion fiscal 2019 budget approved last month “structurally balanced.”

The state’s pension funds are at a 64% funded ratio. The state adopted various reforms in 2017 and has reduced assumed rate of returns, adopted new morality tables and altered payroll assumptions that should result in faster funding progress.

Gov. Rick Snyder touted the upgrade as a result of his fiscal policy efforts taking hold.

“For the past eight years, our state has undergone a reinvention leading to eight back-to-back balanced budgets and more than $1 billion in our rainy day fund,” Snyder said in a statement. A new governor will be elected this year. Snyder could not run due to term limits. The state is rated AA by Fitch Ratings and Aa1 by Moody’s Investors Service.

Despite its progress, the state faces “potential headwinds that could lead us to lower the rating” including federal trade policy changes that S&P warns “could have an outsized effect on Michigan's economy and revenue performance.”

S&P also said it still expects the state to experience downturns more deeply than others, but structural changes in the auto industry and the state's overall economic make-up should lessen their severity. Overall manufacturing employment has decreased to about 14% in 2017.

"The stable outlook reflects that despite slower projections, Michigan will continue to demonstrate positive economic performance over the two-year outlook horizon, and our expectation that the state will continue to build its budget stabilization fund balances," Spain said.

The outlook is also predicated on the state’s limited support for distressed local governments. The state provided some assistance for Detroit to emerge from its Chapter 9 bankruptcy in 2016, for a bailout for Detroit’s public school system, and has earmarked a total of $300 million to deal with Flint’s water contamination crisis.

The state reported last month that for the first time in 18 years, no district or municipality was under an emergency manager’s control. The program has come under fire for EM decisions made in Flint that led to the water crisis, but investors and analysts support such intervention as a positive for local government credits. Snyder and his administration also came under fire for decisions that contributed to the ongoing water crisis.

Stabilization of Detroit and its schools indicate that “at least in the near term, we do not anticipate that the state will need to provide additional extraordinary financial support,” S&P said, adding that no new local governments have been identified for intervention since 2014 and the state has “represented that outstanding exposure to lawsuits is limited” on Flint.

Other looming credit risks include a slowdown in revenue growth and rising Medicaid costs, coupled with potential federal changes to Medicaid funding, but the worries are offset by the state’s “track record” of structurally aligning its budgets.

The upgrade will have a ripple effect in raising the credit quality of various state enhancement and intercept programs that benefit schools and local governments.

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