NEW YORK--(BUSINESS WIRE)--Fitch Ratings affirms its 'AAA' long-term rating on outstanding Michigan Finance Authority (MFA) unemployment obligation assessment revenue bonds, as follows:
-- $1.25 billion, series 2012A;
-- $1.2 billion, series 2012B;
-- $41 million, series 2012C (variable rate demand bonds).
The Rating Outlook is Stable.
Special revenue obligations of MFA secured by a pledge of and lien on obligation assessments required to be levied on all contributing employers in the state of Michigan while bonds are outstanding at a level sufficient to ensure 1.5x debt service, plus amounts necessary for administrative costs and to replenish the liquidity reserve fund, if necessary.
KEY RATING DRIVERS
PLEDGED TAX IS BROAD AND UNLIMITED: The source of bond repayment is obligation assessments levied on all contributing Michigan employers. There are no restrictions on the rate or amount, nor the treasurer's ability to reset the rate, if needed, and revenues are only available for the bonds.
ANNUAL RATE SETTING PROVIDES STRONG COVERAGE: The treasurer covenants to set the rate at a level which provides 1.5x coverage of debt service in the following year, as well as administrative costs.
LIQUIDITY PROTECTIONS: A liquidity reserve funded at $75 million from proceeds provides bondholder protection in the unlikely event that pledged taxes underperform well beyond historical experience. Given the highly seasonal nature of unemployment tax collections, the indenture provides that a minimum of $35 million is retained through the second half of the year, rather than used for early bond repayment, providing additional protection.
STRONG COLLECTIONS AND ENFORCEMENT: The state's unemployment tax collection mechanisms are well-established, with a collection rate of approximately 98%. The pledged obligation assessment is collected in the same manner, and subject to the same penalties, as other unemployment taxes.
CLOSED LIEN: The lien is closed, with no additional bonds possible except for refunding purposes. The bonds were issued as part of broader unemployment system reforms to improve its sustainability.
MANUFACTURING DOMINANCE: The state's economic performance has stabilized in recent years following a decade-long economic slump driven by automotive sector weakness. The economy is growing although it remains dominated by the cyclical manufacturing sector. Although the competitive posture of the automotive sector has improved, the state is likely to remain exposed to the economic and fiscal impacts of manufacturing cyclicality over the long term.
SIGNIFICANT CHANGE IN CREDIT STRENGTHS: The rating is sensitive to severe, unexpected changes in short-term economic and pledged revenue performance.
The 'AAA' rating reflects the security provided by the obligation assessment, a legislatively authorized tax payable by contributing Michigan employers exclusively for bond repayment. The treasurer covenants to levy the tax at a rate sufficient to provide 1.5x coverage of the following year's debt service. The obligation assessment rate is unlimited and may be adjusted at any time but must be set at least annually. Excess collections are directed to early redemption after transfers for debt service. Since $2.9 billion in bonds was issued in June 2012, more than $200 million in excess collections has been directed to early retirements.
Given the highly seasonal nature of the assessment, with most collections received early in the year, the indenture requires that a minimum of $35 million be retained through the latter half of the year, when collections are lowest, to augment coverage. A liquidity reserve of $75 million is also available in the event that revenues are insufficient.
Obligation assessment bonds were issued to refund variable rate demand obligations issued in December 2011 to repay an advance taken by the state from the federal government to cover a deficit in the state's unemployment trust fund. The lien is closed and no additional bonding is possible except for refunding purposes.
The obligation assessment is a separate levy authorized by the state legislature solely for the purpose of repaying the bonds and charged to contributing Michigan employers at the same time and in the same manner as the state's other, longstanding unemployment assessments. The MFA must provide the treasurer an estimate of the following year's debt service, administrative expenses, and amounts to replenish the liquidity reserve by October 20.
The treasurer as a matter of policy will set the rate by November 20, but covenants set the rate no later than the following February 1, at a level expected to provide 1.5x coverage of debt service, administrative costs and liquidity reserve replenishment. The rate is composed of fixed and variable components which together range from 0.68% to 2.25% in 2014, levied on the first $9,500 of taxable wages. The assessment generated $287.4 million in 2012 and $466.7 million in 2013 and is expected to generate similar amounts annually through the bonds' final maturity.
The obligation assessment remains segregated from the state's other unemployment taxes, which are not pledged to bondholders. All unemployment taxes are payable by contributing Michigan employers on a quarterly basis and due by the 25th of the month after the end of a quarter. Approximately 67% of collections arrive in the first half of the year, the vast majority of which reflect workers' January-March wages. The collections are deposited to a separate obligation trust fund held in the state treasury. Deposits are then transferred to the trustee on a monthly basis.
The bonds' structure takes into account the seasonality of collections. Principal and interest are due on July 1 and January 1, with two-thirds of scheduled debt service paid on the July 1 date. The indenture directs that excess collections after semiannual debt service be applied to early redemption. However, before the transfer for July 1 debt service has been made, the indenture requires that $35 million in excess collections be retained to augment projected coverage of debt service on the following January 1. Should projected coverage fall short of the required 1.5x level, additional amounts must be retained. The retention mechanism would ensure sufficient revenues for debt service in the event of taxable wage decline well beyond the level experienced by the state in the last downturn. The retention requirement is not operative in the first half of the year, when the most revenues are collected.
A separate liquidity reserve fund, sized at a minimum of $75 million, is available if revenues are insufficient to cover debt service requirements. In the event of a draw, the liquidity reserve fund receives obligation assessment revenues following transfers for debt service. The tax rate established by the treasurer must likewise take into account amounts necessary to replenish the fund.
The obligation assessment bonds benefit from the well-established nature of the state's unemployment assessment system. Contributing Michigan employers pay several levies to the state's unemployment trust fund, from which state benefits are paid, with components based on their benefit experience, the status of the state fund, and whether the state has federal advances outstanding. Historical collection experience is very strong, with almost 98% of taxes due being collected since 2006. The system has been in operation for decades, with the legislature making periodic adjustments to benefits, the taxable wage base, and other factors. None of the other levies are available to bondholders.
The use of bonds to repay federal advances was part of a broader reform to improve the sustainability of the state's unemployment benefit system. The state borrowed a cumulative total of nearly $3.3 billion as of December 2011 from the federal unemployment trust fund to cover state unemployment benefits, resulting in interest charges to the state and higher federal tax rates on the state's contributing employers. Among other changes, the state reduced the number of weeks of benefits for which laid off workers are eligible, to 20 weeks from 26, and raised the wage base subject to taxation, to $9,500 from $9,000, until the state's unemployment trust fund is replenished to a level of $2.5 billion. The state's trust fund balance was $1.5 billion as of Dec. 31, 2013.
Michigan's economy has returned to growth following a decade of weakness that culminated in severe losses during the last recession. Employment in 2010 was 17.4% below the level of 2000. Much of the weakness was tied to the state's large, though now much diminished, manufacturing sector, including its globally significant automotive sector. After considerable restructuring, the automotive sector has stabilized and the broader state economy has returned to growth. Job growth has been strong, with employment rising 2.3% and 2.1% in 2011 and 2012. Employment rose 1.8% in 2013, just ahead of the nation's 1.7% rate. Job growth continues in 2014 but at a slower pace, with April 2014 up 0.6% in Michigan, below the 1.7% national rate. Unemployment continues to decline, with April 2014 at 7.4%, compared to 8.8% one year earlier; the state's rate remains higher than the 6.3% national rate. The state forecasts continued slow job growth going forward, with wage and salary increases of 0.7% in 2014, 1.2% in 2015 and 1.3% in 2015. The risk to the bonds of state economic underperformance is offset by annual rate setting and the liquidity protections.
Additional information is available at 'www.fitchratings.com'
In addition to the sources of information identified in the Tax-Supported Rating Criteria, this action was additionally informed by information from IHS Global Insight.
Applicable Criteria and Related Research:
-- 'Tax-Supported Rating Criteria' (Aug. 14, 2012).
-- 'U.S. State Government Tax-Supported Rating Criteria' (Aug. 14, 2012).
Applicable Criteria and Related Research:
Tax-Supported Rating Criteria
U.S. State Government Tax-Supported Rating Criteria