Fitch Rates Michigan's GOs 'AA'; Outlook Stable

NEW YORK--()--Fitch Ratings assigns an 'AA' rating to the following State of Michigan general obligation (GO) bonds:

--$78 million GO environmental program bonds, series 2014A (tax-exempt);

--$20 million GO environmental program bonds, series 2014B (taxable).

The bonds are expected to be offered via negotiated sale on June 24, 2014.

In addition, Fitch affirms the following:

--The rating on approximately $2 billion in outstanding GO debt at 'AA';

--The rating on Michigan State Building Authority (MSBA) lease obligations at 'AA-';

--The rating on Michigan Municipal Bond Authority (MMBA) school loan revenue bonds at 'AA-';

--The rating on MMBA local government loan program revenue bonds at 'AA-'.

The Rating Outlook is Stable.

SECURITY

General obligations of the state, with full faith and credit pledged.

The MSBA and MMBA bonds are secured by annual state appropriations, resulting in a rating one notch below the state GO.

KEY RATING DRIVERS

ECONOMIC AND FISCAL IMPROVEMENT: Michigan's GO rating reflects the state's improved economic and fiscal performance, with structurally balanced budgeting, increased 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.

BELOW AVERAGE LIABILITY BURDEN: Net tax-supported debt is expected to remain in the low-to-moderate range. Obligations for retiree pensions and health care are manageable and the state continues to pursue additional savings. On a combined basis, Michigan's debt and pension liability is well below the median for a U.S. state.

RATING SENSITIVITIES

CONSERVATIVE FISCAL MANAGEMENT: The Stable Outlook assumes that the state will continue to act to preserve its improved fiscal position, including through a continued commitment to reserve funding.

ECONOMIC OUTLOOK: The rating is also sensitive to material changes in expectations for the state's economic performance. The state economy's exposure to manufacturing-related concentration and cyclicality is a limiting credit factor.

CREDIT PROFILE

Michigan's GO bond rating reflects its solid economic and fiscal recovery over the last several years. 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, albeit slowly, and structural changes in the automotive sector have improved its longer-term viability. Fitch assumes that Michigan's manufacturing sector will remain a sizable and cyclical component of the state's economy.

Michigan has used recent economic and revenue momentum to stabilize state finances, with structurally balanced budgets, annual surpluses, higher liquidity and sizable deposits to the budget stabilization fund (BSF), the state's rainy day fund. The state's contribution of $195 million from the BSF in the current fiscal 2014 towards the proposed Detroit bankruptcy settlement agreement includes guidelines for a restoration of the funds, and the legislatively-approved budget for fiscal 2015 includes an additional deposit to the BSF. Fitch's 'AA' rating on Michigan's GO bonds assumes that the state will continue to preserve its improved fiscal position in any future support of Detroit or other stressed local governments in the state.

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 and retiree obligations are manageable, in part given the benefit reforms that the state continues to pursue to contain the growth of liabilities.

ECONOMY

Michigan's economy lost jobs on an annual basis between 2001 and 2010, with the decline in 2009 particularly steep at 7% year-over-year (yoy) reflecting the combined impact of the national recession and the domestic automotive sector's weakness and associated restructuring. Employment turned around thereafter, rising 2.3% in 2011, 2.1% in 2012, and 1.8% in 2013, ahead of 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 during the course of the last decade. Both sectors have logged sizable gains since 2010 although automotive manufacturing employment slipped by almost 1% yoy from April 2013 to April 2014. Motor vehicle parts manufacturing employment was up by 0.6% yoy over this same time frame. Manufacturing jobs represent 13.6% of total jobs in Michigan as of April 2014, well ahead of the 8.7% U.S. level, exposing the state to future cyclicality.

The unemployment rate has exhibited fairly steady declines since peaking at 13.4% in 2009 (145% of the nation.) Although it remains over U.S. levels, the 7.4% unemployment rate in April 2014 was 117% of the nation's at 6.3%. The state's May 2014 consensus economic forecast estimates slower wage and salary employment growth of 0.7% in 2014 and a stronger 1.2% in 2015.

Consistent with the state's significant employment losses, personal income growth lagged the nation throughout the last decade, and the decline in 2009 was more than 1% deeper than that of the nation. The state has enjoyed a strong rebound since then, rising 5.5% in 2011, 3.5% in 2012, and 2.5% in 2013; U.S. personal income rose 6.1%, 4.2%, and 2.6%, respectively, over these same periods. As of May 2014, the state forecasts 2% growth in 2014 and 2.6% in 2015. By 2013 per capita personal income the state ranks 35th among the states at 88% of the national level.

FINANCES

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 budgetary reserves, and reliance on federal stimulus funding.

Economic improvement beginning in 2010 was matched by revenue stabilization, with higher liquidity and sizable surplus balances in fiscal years 2011 through 2013 in both the general and school aid funds. Improved liquidity has meant the state has not needed to borrow for cash flow purposes since fiscal 2011. The state's reserve position has also improved over this period through deposits in fiscal years 2012 and 2013. At the end of fiscal 2013, the BSF reached $505.6 million and the state's general fund unassigned balance was $1.2 billion.

The enacted fiscal 2014 budget appropriated $75 million into the BSF but the state has appropriated $195 million from the BSF to a segregated fund for the benefit of Detroit pensioners as part of the city's bankruptcy. This action is expected to reduce the BSF from an estimated $581.2 million to $386.4 million (4.4% of general fund [GF] revenue), although the balance may be bolstered by a deposit of one-third of anticipated fiscal 2014 GF budgetary lapses, currently believed by the state to approximate $30 million. A modest, approximate $10 million would be deposited to the BSF under this agreement.

To restore the money to the BSF for the Detroit payment, the legislature passed House Bill (HB) 5573, as part of a nine-bill package related to Detroit's Chapter 9 filing, that directs $17.5 million to be deposited on an annual basis from the state's receipt of tobacco settlement revenue for 21 years, until approximately fiscal 2035. The deposits are expected to total $367.5 million.

The fiscal 2014 budget as adopted anticipated the beginning cash balance to be reduced from $1.2 billion to $283.6 million at year-end; however, revenues have been softer in fiscal 2014 compared to fiscal 2013, partly due to personal income tax (PIT) collections that are down yoy related to the acceleration of capital gains into fiscal 2013. The reduced PIT collections contributed to the May 2014 consensus forecast that lowered the revenue outlook by $317 million from the January 2014 consensus forecast. Overall, the May 2014 consensus forecast projects combined GF/general purpose (GP) and school aid fund (SAF) revenue to be down by 0.1% ($16.8 million) from fiscal 2013.

The legislatively-approved operating budget for fiscal 2015, which begins Oct. 1, incorporates the May 2014 revenue forecast and projects revenues increasing by $863.7 million (4.1%) from fiscal 2014. GF/GP revenue is forecast to increase by 5.4% and SAF revenue is projected to increase by 3.1% from fiscal 2014. As part of the enacted budget, the legislature has appropriated $94 million into the BSF. Estimated expenditures are expected to rise 4.1% in the general fund and K-12 education expense is expected to increase by 4%. Other notable areas of budget growth include $112 million for higher education. Increased spending related to Medicaid is expected to be offset by $243.4 million in additional federal aid related to the state's Medicaid program expansion. The governor is currently reviewing the legislatively-approved budget bills and spending provisions before signing the fiscal 2015 appropriations into law.

DEBT AND RETIREE OBLIGATIONS

The state's debt and retiree obligations are manageable. Net tax-supported debt, at $8 billion as of Sept. 30, 2013 (the most recent reporting date), represents 2.1% of 2013 personal income. GO debt amortization is rapid with 47% to be retired over the next five years and 82% to be retired over the next 10 years.

Retiree obligations are limited. 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).

The state has enacted various changes to state-administered retiree pension and health benefits in recent years to limit the growth of obligations to existing employees, although in some cases the changes remain 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 assuming direct responsibility for contributions over a certain share of payroll.

The systems' funded ratios have been affected by past investment losses. As of Sept. 30, 2012, the most recent actuarial valuation date, the reported funded ratios of MSERS and MPSERS were 60.3% and 61.3%, respectively. Using Fitch's more conservative 7% discount rate assumption (compared to the systems' 8% level), the funded ratios would drop to 54.4% and 55.2%, respectively. Nonetheless, on a combined basis, net tax-supported debt and the total pension liability attributable to the state are at 4.3% of 2013 personal income, a level well below the 6.1% median for U.S. states.

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

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686015

U.S. State Government Tax-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686033

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=835057

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Contacts

Fitch Ratings
Primary Analyst
Marcy Block
Senior Director
+1-212-908-0239
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Douglas Offerman
Senior Director
+1-212-908-0889
or
Committee Chairperson
Laura Porter
Managing Director
+1-212-908-0575
or
Media Relations:
Elizabeth Fogerty, +1-212-908-0526 (New York
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Marcy Block
Senior Director
+1-212-908-0239
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Douglas Offerman
Senior Director
+1-212-908-0889
or
Committee Chairperson
Laura Porter
Managing Director
+1-212-908-0575
or
Media Relations:
Elizabeth Fogerty, +1-212-908-0526 (New York
elizabeth.fogerty@fitchratings.com