Fitch Rates Michigan State Building Authority’s $990MM Bonds ‘AA-‘; Outlook Stable
By Business Wire News
By Business Wire News
Fitch Ratings assigns a ‘AA-‘ rating to the following State of Michigan State Building Authority (SBA) bonds:
— 2015 revenue and revenue refunding bonds, series I (facilities program).
The bonds are expected to sell via negotiation on or about July 30th.
In addition, Fitch affirms the ‘AA-‘ ratings on outstanding Michigan SBA revenue bonds, the ‘AA’ rating on State of Michigan GO bonds, and other debt linked to the state’s GO rating, as detailed at the end of this release.
The Rating Outlook is Stable.
The bonds are limited obligations of the SBA payable from and secured by a pledge of and first lien on state lease payments for the respective facilities, subject to annual legislative appropriation. The legislature is contractually obligated to appropriate lease payments on an annual basis.
KEY RATING DRIVERS
RATING LINKED TO STATE: The ‘AA-‘ rating on SBA revenue bonds, one notch below Michigan’s general obligation (GO) rating, reflects the appropriation required for debt service payment.
ECONOMIC AND FISCAL STABILITY: Michigan’s GO rating, to which the SBA ratings are linked, reflects the state’s improved economic and fiscal performance, with structurally balanced budgeting, growing reserves and higher liquidity.
MANUFACTURING DOMINANCE: The state’s economy is dominated by manufacturing. Although the competitive posture of its large automotive sector has improved since its restructuring in recent years, the state is likely to remain exposed to the economic and fiscal impacts of manufacturing cyclicality over the long term.
MANAGEABLE LIABILITIES: Net tax-supported debt is low given the state’s infrequent debt issuance. Obligations for retiree pensions and health care are manageable given state reforms and the state continues to pursue additional savings.
LINK TO STATE RATING: The rating on SBA revenue bonds is sensitive to changes in the credit quality of the state of Michigan, to which it is linked.
STATE ECONOMIC OUTLOOK: Michigan’s GO rating is sensitive to changes in the state’s economic outlook, particularly from the manufacturing sector. Exposure to manufacturing-related concentration and cyclicality is a limiting credit factor. The Stable Outlook assumes the continuation of conservative fiscal management and an ongoing commitment to replenishing and sustaining reserve balances that has marked recent years.
The ‘AA-‘ rating on the SBA’s revenue bonds reflects the state of Michigan’s general creditworthiness, solid legal provisions in the underlying lease obligations of the state, and the SBA’s integral role in funding state facilities. Lease features include a provision that contractually obligates the state legislature to appropriate annually to pay monthly rental payments to the SBA for the life of each facility lease, corresponding to the term of the bonds.
Created by a 1964 Act, the SBA provides financing for state projects, mostly at the state’s universities and community colleges. The SBA plays a key role in the state’s overall capital financing, with approximately $3.2 billion in bonds and CP notes outstanding as of Sept. 30, 2014.
The current bonds are being issued under the SBA’s 2003 master indenture for new projects and for refunding purposes, including refunding certain remaining series under a separate, 2005 master indenture. Simultaneously with this sale, the SBA will convert the final series outstanding under the 2005 master indenture, 2011 series II-A and II-B, to the 2003 master indenture under existing provisions of both indentures. Fitch confirms that, based on the information provided to Fitch, the conversion of the remaining 2005 master indenture bonds to the 2003 master indenture will not result in a withdrawal or downgrade on the ratings assigned to SBA revenue bonds.
GENERAL OBLIGATION CREDIT QUALITY
Michigan’s GO bond rating, to which the SBA revenue bonds’ credit quality is linked, reflects the state’s solid economic and fiscal recovery over the last several years and conservative approach to state fiscal management. After a decade of persistent economic weakness, the result of manufacturing cyclicality and the near-collapse of the domestic auto sector, the state’s economy is growing again and structural changes in the automotive sector have improved its longer-term viability. Fitch assumes that Michigan’s automotive manufacturing sector will remain a sizable and cyclical component of the economy even as services grow in size and importance to the state’s economic profile.
Michigan has used the economic and revenue momentum of recent years to stabilize state finances, with structurally balanced budgets, annual surpluses, higher liquidity and annual deposits to the budget stabilization fund (BSF), the state’s rainy day fund. Despite a one-time BSF draw during fiscal 2014 of $194.8 million for the state’s contribution to the Detroit bankruptcy settlement, continued BSF deposits remain a priority, with annual appropriations in both fiscal 2015 and 2016 as well as funds deposited to repay the draw for the Detroit settlement. The state’s ‘AA’ GO bond rating assumes that the state’s financial exposure to distressed local governments and school districts will remain within manageable parameters in the future.
The state’s longstanding conservative fiscal management, combined with the actions taken in recent years, leaves it better positioned to address future economic and revenue uncertainty, in Fitch’s opinion. Tax-supported debt has been falling gradually and state’s exposure to retiree obligations is manageable, in part given recent benefit reforms.
Michigan’s economy lost jobs on an annual basis between 2001 and 2010, with the 2009 decline particularly steep at 7% year-over-year reflecting the combined impact of the national recession and the domestic automotive sector’s weakness and associated restructuring. Employment turned around thereafter, with employment rising 2.3% in 2011, 2.1% in 2012, and 1.9% in 2013, faster than the national rate in each year.
Despite recent improvement, automotive retrenchment has been difficult for the state, with roughly two-thirds of automotive manufacturing and parts employment lost over a decade. Both sectors have logged sizable gains since 2010, although Fitch notes that production has rebounded faster than employment reflecting productivity improvements. Manufacturing jobs represent 13.8% of total jobs in Michigan as of May 2015, well ahead of the 8.6% U.S. level, exposing the state to future cyclicality. However, the economy also benefits from a diverse and growing service sector, which has seen particularly strong gains in professional and business services, education and health, and leisure and hospitality.
The unemployment rate has historically been higher than the national average, although has declined steadily since peaking at 13.7% in 2009 (147% of the nation.) The 5.5% unemployment rate in May 2015 was only 104% of the nation’s 5.3% level. The state’s May 2015 consensus forecast assumes an unemployment rate at 5.8% during 2015, falling to 5.4% by 2017.
Consistent with the state’s significant employment losses, personal income growth consistently lagged the nation’s throughout the last decade through 2013. Michigan’s personal income in 2014 grew faster than the nation’s, up 4% vs. 3.9% nationwide. Measured by per capita personal income, Michigan ranked 36th among the states in 2014, at 88% of the national average. The May 2015 consensus forecast assumes solid personal income growth going forward, ranging from 4.6% in 2015 to 4.2% in 2017.
Michigan has long taken a conservative approach to fiscal management, although a decade of economic and revenue weakness starting with the 2001 recession eroded the state’s financial standing. During that time, the state took repeated remedial action to maintain budgetary balance, including revenue increases, spending austerity and the use of one-time resources. The latter included debt restructuring, depletion of the BSF, and reliance on federal stimulus funding. Economic improvement beginning in 2010 was matched by revenue stabilization, with higher liquidity and sizable surplus balances. Improved liquidity has meant the state has not borrowed for cash flow purposes since fiscal 2011.
With fiscal stabilization the state has made replenishing its BSF a priority. Beginning with a $363 million deposit in fiscal 2012, the BSF has benefitted from annual sizable deposits. The balance has grown rapidly as a result, with the exception of fiscal 2014, when the state withdrew $195 million under one provision of a nine-bill package related to Detroit’s Chapter 9 bankruptcy settlement. The package also directs $17.5 million to the BSF from the state’s receipt of tobacco settlement revenues annually for 21 years; the deposits are expected to total $368 million.
FISCAL 2015 BALANCED DESPITE TAX CREDITS
The fiscal 2015 adopted budget was based on the May 2014 consensus revenue forecast and projected revenues increasing by 4.1% ($864 million) from fiscal 2014; general fund-general purpose (GF/GP) revenue was forecast to increase 5.4% and school aid fund (SAF) revenue is projected to increase 3.1%. The budget included a $285 million shift of GF/GP resources for transportation, reflecting the state’s increasing focus on making additional resources available for transportation capital and maintenance. A package of tax and fee changes that would have raised revenues and shifted resources for transportation needs failed in a May 2015 voter referendum.
The fiscal 2015 outlook was affected mid-year by much higher than forecast business tax credit payments granted as part of past economic development packages. The January 2015 consensus forecast lowered fiscal 2015 and 2016 GF/GP revenues by $325 million and $532 million, respectively. Corrective action was taken immediately to return to forecast balance, with community college spending shifted to the SAF from the GF/GP, recognition of lower Medicaid caseload, and a range of spending cuts.
Beyond the challenge posed by the tax credits, the state’s overall performance has been steady. Year-to-date through May, GF/GP revenues are up 5.5% ($313 million), with SAF revenues up 8.1% ($602 million). At present, the fiscal agency for the state’s House of Representatives forecasts the year to end with a GF/GP balance of $170 million. Following the tobacco deposit and a general fund appropriation of $94 million in fiscal 2015, the BSF balance is forecast to be $499 million as of Sept. 30, 2015, the state’s fiscal year-end.
FISCAL 2016 CONTINUES RESERVE DEPOSITS
The fiscal 2016 adopted budget reflects the May 2015 consensus forecast, which assumes net GF/GP revenues rising 1.6% ($157 million), and net SAF revenues rising 3% ($360 million). The plan continues to prioritize BSF deposits, with $95 million appropriated in addition to the tobacco settlement funds deposit noted earlier. The state has also allocated $400 million in GF/GP resources for transportation purposes, of which $143 million is intended to be ongoing. Although the state’s budget for fiscal 2016 has been settled, deliberations in the legislature continue regarding options for providing more sustainable funding for transportation. Fitch will monitor legislative actions to assess their potential impact on the state’s ability to maintain structural balance going forward.
DEBT AND RETIREE OBLIGATIONS
The state’s debt and retiree obligations are manageable. As of Fitch’s 2014 state pension report, net tax-supported debt and unfunded pensions attributable to the state measured 4.3% of personal income, below the 6.1% median for the states.
Net tax-supported debt, at $7.6 billion as of Sept. 30, 2014 (the most recent reporting date), represents a low 1.9% of 2014 personal income. GO debt amortization is rapid with 80% to be retired over the next 10 years. Other sizable tax-supported programs include the SBA bonds issued for higher education and state facilities and several transportation revenue supported bond programs. The state’s debt level has fallen gradually in recent years given limited new issuance.
Retiree obligations are manageable. In 1997 the Michigan State Employees’ Retirement System (MSERS) converted to a defined contribution plan for newly-hired employees, and a similar change recently has been implemented for new hires in the Michigan Public School Employees’ Retirement System (MPSERS), a system managed by the state but for which the state carries no obligations.
The state has enacted various changes to state-administered retiree pension and health benefits in recent years to limit the growth of obligations, although some changes have been subject to litigation. Legislation passed in recent years also eliminated other post-employment benefits for new hires and lowered the state’s unfunded liability. For MPSERS, recent reforms include the state supplementing school funding to cover schools’ contributions over a certain share of payroll.
The systems’ funded ratios have been affected by past investment losses. As of Sept. 30, 2013, the most recent actuarial valuation date, the reported funded ratios of MSERS and MPSERS were 60.3% and 59.6%, respectively. Using Fitch’s more conservative 7% discount rate assumption (compared to the systems’ 8% level), the funded ratios would drop to 54.3% and 53.7%, respectively. Under GASB 67, the systems’ Sept. 30, 2014 ratios of assets to liabilities are 68.1% and 66.1%, respectively, reflecting in part the recognition of recent market gains that have yet to be smoothed in to the earlier actuarial figures.
RELATED BOND RATINGS AFFIRMED WITH THIS RATING ASSIGNMENT
In conjunction with the assignment of the ‘AA-‘ rating to the SBA’s 2015 revenue and revenue refunding bonds, series I (facilities program), Fitch has affirmed the following ratings that are directly linked to the state’s general obligation credit quality:
— State of Michigan general obligation bonds at ‘AA’;
— Michigan State School Bond Loan Fund program rating at ‘AA’;
— Outstanding Michigan SBA revenue bonds at ‘AA-‘.
The Rating Outlook is Stable.
Additional information is available at ‘www.fitchratings.com‘.
Rating Guidelines for State Credit Enhancement Programs (pub. 18 Apr 2013)
Tax-Supported Rating Criteria (pub. 14 Aug 2012)
U.S. State Government Tax-Supported Rating Criteria (pub. 14 Aug 2012)
Dodd-Frank Rating Information Disclosure Form
Fitch Ratings, Inc.
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