The COVID-19 pandemic may hit Michigan especially hard, given its high concentration in the service and manufacturing sectors, and its recovery could lag other states, S&P Global Ratings said in moving its outlook on the AA rating to negative.
"Our negative outlook also reflects difficult fiscal decisions ahead for Michigan as it deliberates the fiscal 2021 budget and beyond," said S&P analyst Ladunni Okolo in the report published Tuesday.
S&P praises the state for using the latest period of expansion to build reserves so it’s “well positioned” with a strong cushion in the form of a $1.15 billion reserve. The state also benefits from strong liquidity, including $6.7 billion in pooled cash.
But a protracted recovery could lead to budget gaps that end up draining much of those funds and that could drive a downgrade. “Repeated or significant draws on reserves could indicate near-term pressure on the state's credit quality and lead to a downgrade,” Okolo said. “If, in our view, the state demonstrates diminished capacity to make cuts, raise revenues, or tap reserves to address likely shortfalls beyond the next fiscal year, we would likely lower the rating.”
The state’s position left Fitch Ratings comfortable enough to earlier this month affirm its AA rating and stable outlook.
“The state has managed the risk of revenue cyclicality by gradually strengthening its financial flexibility, including successful efforts to rebuild its budget stabilization fund,” Fitch said, adding, “the state is currently well-positioned to address the fiscal challenges associated with the coronavirus pandemic and resulting economic downturn.”
Michigan continues to maintain its credit rating among all three rating agencies during the COVID-19 pandemic.
State finance officials highlighted the affirmation of both ratings in a statement.
“The COVID-19 pandemic is a crisis unlike any we have seen before in modern times,” Department of Treasury spokesman Ron Leix said. “The outlook change is not unique to Michigan — it appears S&P is treating all public entities similarly due to the COVID-19 pandemic, taking immediate action based on projections, while other agencies are taking a wait-and-see approach based on actual data.”
“It is still very early in the COVID crisis and there are a considerable amount of unknowns that have the potential to significantly impact the state’s financial picture, such as the potential for additional federal aid,” Leix said.
Michigan’s unemployment numbers exceed national averages as the economic shutdown significantly impacted the manufacturing sector that is a solid driver of the state’s economy. “Akin to prior recessions, we expect Michigan will experience slower productivity and employment growth, which translates into stagnant revenue growth, and could lead to considerable budget challenges for the state over the next few years,” S&P said.
The negative outlook reflects an at least a one-in-three chance of a downgrade. Any action on the general obligation rating would also impact AA-minus ratings on appropriation-backed bonds, and AA-minus and AA-plus ratings on various Michigan State Building Authority credits and priority lien related entities, such as the Michigan comprehensive transportation gas tax bonds rated AA-plus and the Detroit Convention Facility Authority's AA-rated debt.
State and legislative budget officials released revised estimates in May, cutting revenues by $3.2 billion in the current fiscal year that runs through September, and another $3 billion in fiscal 2021. A budget for 2021 has not yet been adopted and the revenue estimating conference will offer fresh numbers in August.
After whittling down this year’s gap to $2 billion, Gov. Gretchen Whitmer and legislative leaders announced a deal last month to close the shortfall through various measures. The state is drawing $350 million from reserves. The state will be reimbursed for $490 million of costs, with some public safety expenses covered by federal relief dollars as well as $340 million in health-related expenses that qualify for Medicaid reimbursement or relief dollars.
The plan pushes some of the state's budget pain to downstream governments through $256 million in cuts in funding for kindergarten through 12th grade, $200 million for higher education, and $97 million for local governments. It would freeze hiring and cut some positions to save another $490 million.
But it also frees relief that state officials say will help compensate for cuts. The deal provides federal Coronavirus Aid, Relief, and Economic Security Act funding to schools and local governments.
“Michigan appears reasonably well-positioned to address the projected fiscal 2021 revenue shortfall by relying on remaining federal coronavirus relief funds to cover eligible costs, delays to ongoing and planned capital projects, extensions to fiscal 2020's discretionary spending and hiring freezes, potential reductions in state funding for Michigan's local government units … and, if necessary, a portion of the state's $1.2 billion rainy day fund balance,” Fitch said.
