Bloomberg News

Michigan Poised for Upgrade After Seizing Detroit: Muni Credit

April 09, 2013

Michigan’s resurgent economy has it poised for the best credit rating in eight years and is pushing borrowing costs to a record low, showing investors are distinguishing the state’s finances from those of its biggest city.

Moody’s Investors Service and Standard & Poor’s revised their outlooks on the eighth-most-populous state to positive in the past two weeks, citing increased financial reserves. A one- level upgrade by Moody’s to Aa1, second-best, would bring the rating to the highest since 2005.

The improved prospects show the state is overcoming the fiscal woes of Detroit, graded seven levels below investment grade by Moody’s. It is among six Michigan cities under emergency managers. While yields on taxable city debt due in April 2018 exceed 9 percent, the interest rate on similar state bonds fell to a historic low before a bond sale set for today, data compiled by Bloomberg show.

“It’s not just Detroit, it’s not just Flint, there’s a lot more to the state,” said Bill Ahern, who oversees $100 million of Michigan funds at Eaton Vance Management in Boston. “Throughout the entire economic downturn, they managed to keep their debt levels relatively low compared to some other states. That goes to good financial management.”

Auto Driver

General Motors Co. (GM:US) and Chrysler Group LLC went through bankruptcy four years ago. Along with Ford Motor Co. (F:US), they rebounded to earn a combined $13.5 billion in 2012, helping create a 34 percent jump in auto jobs since January 2009. Michigan’s jobless rate is 8.8 percent, the lowest since 2008, down from a 26-year high of 14.2 percent in 2009.

From the end of the recession, in June 2009, through 2012, Michigan’s economic health was the nation’s second-strongest, trailing only North Dakota, according to the Bloomberg Economic Evaluation of States index.

“Michigan is the comeback state and our progress is being recognized,” Republican Governor Rick Snyder said in an April 2 statement.

The state is selling $200 million of taxable general- obligation school-loan bonds today via auction, its biggest issue in a year.

Record Low

Similar debt is trading with record-low yields. Taxable Michigan general-obligation bonds maturing in November 2018 traded April 5 at an average yield of 1.58 percent, the lowest since they were sold in October 2010, Bloomberg data show. Similar-maturity Treasuries yield about 0.8 percent.

The extra yield that muni investors demand to own debt from Michigan issuers rather than AAA securities is 0.71 percentage point, compared with an average of 0.86 percentage point since June 2009, Bloomberg data show.

The narrowing spread in Michigan, which is tied with New Jersey carrying S&P’s third-lowest state grade, “may be investors trying to get extra yield,” Ahern said.

Michigan is selling under its school-bond qualification and loan program, which provides a credit enhancement and loan mechanism for school-district debt. The bonds must be used for capital projects and have to be approved by Treasurer Andy Dillon. The three major rating companies grade the bonds the same as other state borrowings.

Cost Benefit

Terry Stanton, a Dillon spokesman, said via e-mail that the state expects better interest rates as a result of the rating changes.

Meanwhile in Detroit, Kevyn Orr, a 54-year-old lawyer who worked on Chrysler’s 2009 bankruptcy, has said he’ll try to persuade city bondholders to reduce a debt of about $8.6 billion.

A scenario in which investors take a loss is a “taboo subject” that may scare some away, Ahern said.

Emergency managers in Michigan got an expanded toolkit last month. Under the system, while elected mayors and councils remain, the state-appointed fiscal overseers have authority to operate and restructure, sell assets and alter union contracts. No Michigan city has declared bankruptcy.

Union officials, school board and council members in managed cities including Benton Harbor and Flint claimed in a lawsuit that the law violates citizens’ due process rights under the U.S. Constitution.

Penalty Avoided

The state’s intervention helps explain why Michigan localities haven’t been penalized by Detroit’s fiscal distress, said Matt Fabian, a managing director at Concord, Massachusetts- based Municipal Market Advisors. After Jefferson County, Alabama, in November 2011 filed the biggest municipal bankruptcy, some issuers across the state paid an additional 0.25 percentage point to borrow.

“Michigan is seen as more of a benefactor -- they’re taking an active role to avert a payment default or bankruptcy by Detroit,” Fabian said. “The whole architecture for intervention and curing problems at the local level” gives investors confidence, he said.

The state is issuing amid the biggest wave of muni sales in 10 months. Localities are poised to sell about $10 billion this week, the most this year, Bloomberg data show.

The wave isn’t deterring munis from rallying to the strongest in more than a month as selling related to tax season wanes.

At 1.83 percent, yields on 10-year benchmark munis are the lowest since March 6, Bloomberg data show. They have also rebounded relative to Treasuries. Benchmark 10-year federal debt yields about 1.75 percent.

The ratio between the two interest rates, at about 105 percent, has dropped from a seven-month high set this month. The lower the percentage, the more expensive local debt is by comparison.

To contact the reporter on this story: Brian Chappatta in New York at bchappatta1@bloomberg.net

To contact the editor responsible for this story: Stephen Merelman at smerelman@bloomberg.net


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