U.S.

PUBLIC FINANCE

ISSUER IN-DEPTH
3 June 2020
Michigan (State of)
State bond plan will revive stalled highway and bridge
projects
Michigan's (Aa1 stable) plan to borrow $3.5 billion for road and bridge improvements
will substantially increase the state's transportation infrastructure investment, which has
Contacts stagnated in recent years. The debt program will let Michigan, which ranks near the bottom
of states in terms of capital outlays, complete important road projects despite projected
Ted Hampton +1.212.553.2741
VP-Sr Credit Officer transportation revenue losses from the coronavirus. This should in turn limit the burden from
ted.hampton@moodys.com construction cost growth, a credit positive. But the financings will only cover some of the
Chandra Ghosal +1.212.553.1095 state's backlog of transportation investment needs for a few years (see Exhibit 1). The state
VP-Senior Analyst/Manager therefore will remain in search of recurring transportation resources to restore its roads.
chandra.ghosal@moodys.com
» Borrowing will improve infrastructure funding capacity, despite a coronavirus-
Nicholas Samuels +1.212.553.7121
VP-Sr Credit Officer induced revenue decline. The state has lowered its projection for revenue dedicated to
nicholas.samuels@moodys.com highway purposes by 8.4% for current year (ending September 30). Bonds backed by this
Emily Raimes +1.212.553.7203 revenue will still have strong debt service coverage.
VP-Sr Credit Officer/Manager
emily.raimes@moodys.com » Lagging infrastructure investment exposes Michigan to rising costs and reduced
Timothy Blake, CFA +1.212.553.4524
economic competitiveness. Michigan has ranked near the bottom of the 50 states
MD-Public Finance based on infrastructure spending as a share of total state and local expenditures, and
timothy.blake@moodys.com state financial statements show a decline in capital assets relative to the state's GDP.

CLIENT SERVICES » Technological advances pose a risk to transportation funding, even with fuel tax
indexing set to begin in 2022. Fuel-efficient and electric vehicles have reduced gas tax
Americas 1-212-553-1653
revenue, a primary funding source. Funding infrastructure likely will require less reliance
Asia Pacific 852-3551-3077
on fuel tax revenue in the future.
Japan 81-3-5408-4100
EMEA 44-20-7772-5454 Exhibit 1
Bond proceeds will almost double infrastructure investment capacity through fiscal year 2024
Prior planned investment Incremental funding Approximate annual funding need
$3.0

$2.5

$2.0
$ billions

$1.5

$1.0

$0.5

$-
2020 2021 2022 2023 2024

Approximate annual funding need is based on the amount of annual incremental funding estimated under the “Fixing Michigan
Roads Plan,” a 2019 proposal that the state did not implement.
Source: Michigan State Transportation Commission, “Rebuilding Michigan,” January 30, 2020 presentation

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 MOODY'S INVESTORS SERVICE U.S. PUBLIC FINANCE

Borrowing will improve infrastructure funding capacity, despite coronavirus-induced revenue decline
The proceeds of a $3.5 billion bond plan will benefit the state by increasing its ability to invest in infrastructure, offsetting expected
declines in the motor fuel tax and registration fee revenue that Michigan relies on to fund such investment. The coronavirus pandemic,
which disrupted economic activity and drove the state's unemployment rate to a preliminary 22.7% in April from 4.3% in March, will
weigh on the pledged revenue. Since February, the state has lowered its forecast for motor fuel taxes and motor vehicle registration
fees by 8.4% for the current fiscal year (ending September 30) and by 5.0% for the next fiscal year.

The bond plan will not cover the state's estimated annual funding needs (about $2.5 billion, as indicated in Exhibit 1), and it will only
provide additional resources for about five years. Because the plan lacks funding for roads overseen by local entities, it does not address
more than a quarter of the state's total transportation infrastructure funding needs. Michigan's local roads show greater signs of neglect
overall than the state's, with 54% listed as being in “poor” condition last year.1 Given these local infrastructure needs, legislators
and other policymakers are likely to revisit transportation infrastructure funding once the state makes strides in recovering from the
coronavirus pandemic.

Michigan's ample capacity to issue the new bonds, under the existing State Trunk Line bond (Aa2 stable) program, reflects the quantity
of pledged revenue, largely from motor vehicle registration fees and motor fuel taxes (see Exhibit 2) and the amortization of substantial
Trunk Line bond principal since the last new borrowing, in 2011 (see Exhibit 3).
Exhibit 2 Exhibit 3
Pledged revenue is derived from vehicle registration fees and fuel Outstanding debt has declined since 2010; tax increase in 2017
taxes spurred revenue growth
By fiscal year
$400
Miscellaneous Oustanding debt Future MADS Revenue
fees $1,600
2% $200
$1,400

$- $1,200
2010 2011
$1,000
$ millions

Registration $800
Motor fuel taxes
taxes 51%
47% $600

$400

$200

$-
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

Reflects fiscal year 2019 constitutionally restricted Michigan Transportation Fund revenue.
Source: Disclosure document for Michigan State Trunk Line Fund bonds for fiscal year 2019,
including data from Michigan Department of Transportation and Michigan State Budget
Office
Reflects fiscal years ending September 30. MADS stands for maximum annual debt
service.
Source: Disclosure documents for Michigan State Trunk Line Fund bonds for fiscal years 2010
through 2018, including data from Michigan Department of Transportation and Michigan
State Budget Office

Even if pledged revenue declines 10% this year compared with 2019, the state will retain substantial debt capacity under the
Transportation Commission's policy of maintaining 4.0x coverage of maximum annual debt service.2 After a 10% decline, resulting
pledged revenue would provide 4.0x coverage on debt service equal to $210 million. The Trunk Line program's debt service on
outstanding bonds drops off rapidly (to $73.9 million in fiscal 2023 and $8.1 million in 2026) from $113.5 million in fiscal 2022.

The initial issuance in the $3.5 billion program is currently estimated at between $300 million and $400 million and is anticipated by
September 30. Through the end of fiscal 2024, Michigan plans to increase its infrastructure investment capacity as shown in Exhibit 1
compared with the state's prior plan (which excluded borrowing). That would mean about $350 million more this year and almost $1.2
billion more in both fiscal 2021 and 2022. Towards the end of fiscal 2024, when the state anticipates having completed the borrowing
program, it will have invested $7.39 billion, compared with the $3.86 billion the state anticipated without the debt. The state will add

This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on
www.moodys.com for the most updated credit rating action information and rating history.

2 3 June 2020 Michigan (State of): State bond plan will revive stalled highway and bridge projects

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26 projects, with an aggregate cost of $1.57 billion, to its work list during the period. It will also shift another 23 projects costing an
estimated $2.16 billion to debt from pay-go financing.

The $3.5 billion of State Trunk Line Fund bonds are a substitute for a more far-reaching infrastructure plan with a hefty gasoline tax
increase that Gov. Gretchen Whitmer unsuccessfully advocated for last year, which would have provided substantial funding for both
state and local roads. The more ambitious funding plan would have imposed a 45 cents-a-gallon increase on top of the state's 26.3-
cent gasoline tax. About 27% of the first-year revenue (or $569 million) from the governor's 2019 proposed tax increase would have
gone to local roads. The Whitmer administration argued that substantial new revenue — $2.5 billion a year — was needed to get roads
and bridges to 90% “good” or “fair” condition in 10 years. Without new funding, the state projected that the portion of roads in “poor”
condition would double, to 44%, in five years. Legislators' resistance reflected both the magnitude of the proposed tax hike and the
fact that the state had raised its motor fuels tax only two years earlier.

Lagging infrastructure investment exposes Michigan to rising costs and reduced economic
competitiveness
Continuing failure to provide funds needed to keep roads and bridges from falling into disrepair will limit Michigan's economic
competitiveness and ultimately increase costs to restore infrastructure. To the extent Michigan's roads, bridges and other
transportation elements deteriorate, unmet infrastructure funding needs will increasingly compete with other state spending priorities,
such as pensions, education and healthcare.

Expenses associated with road and bridge repair and construction tend to rise at a faster pace than general spending. In other words,
the longer infrastructure work is deferred, the larger the share of available funding resources it will require, assuming no revenue
increases are enacted.3 The state estimates that the amount it needs to invest just in its Trunk Line infrastructure (interestates and
other major highways overseen by the state's Department of Transportation) is about $1.5 billion a year, a sum that grows by about
12% (or $180 million) each year it is deferred.

Michigan's audited financial statements show that the value of its capital assets (including transportation, as well as other
infrastructure) increased, but at a pace that lagged economic growth, during the past decade (see Exhibit 4). Over the period shown,
the value of the state's capital assets increased 24%, half as much as state GDP, driving the ratio of assets to GDP lower by 1.1
percentage points, to 5.3% from 6.4%. The decline in Michigan's capital asset to GDP ratio was somewhat more than the average
for the 10 largest states ranked by GDP. 4 Most of the capital assets included in the state's financial reports are transportation
infrastructure elements, such as roads and bridges, which account for almost all of the value in both the “infrastructure” and
“construction in progress” categories (see Exhibit 5). Other types of state capital assets reported include state buildings and state-
owned land.
Exhibit 4 Exhibit 5
Growth in the state's capital assets has lagged the economy Transportation accounts for most of the state's ”infrastructure”
By fiscal year and “construction in progress” assets
84%
Capital
Capital
assets
assets
(left
(left
axis)
axis) Capital
Capital
assets
assets
to GDP
to GDP
(right(right
axis)axis) Construction in
$35 7% progress Other
82% (infrastructure) 4%
7%
$30 6%
80%
$25 5%
Buildings
78%
20%
$ billions

$20 4%

76%
$15 3%
Infrastructure
55%
$10 74% 2%

$5 1%
72% Land and
improvements
$0 0% 14%
70% 2010
2009 2009 2011 2012 2013
2010 2014 2015 2016
20112017 2018 20192012

Source: State of Michigan Comprehensive Annual Financial Reports for fiscal years 2009 to
2018; US Bureau of Economic Analysis Source: State of Michigan Comprehensive Annual Financial Report for fiscal 2019.

3 3 June 2020 Michigan (State of): State bond plan will revive stalled highway and bridge projects

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 MOODY'S INVESTORS SERVICE U.S. PUBLIC FINANCE

Michigan's low investment in transportation infrastructure compared with other states is captured in the US Census Bureau's state
and local finances data. Its investment in infrastructure (by both the state and local government units) as a share of direct general
expenditure ranks near the bottom of the 50 states. As shown in Exhibit 6, Michigan was 49th on that basis in 2017, the most recent
year for which these statistics are available. It should be noted, however, that these data do not reflect the full-year impact of
Michigan's most recent transportation revenue-raising effort, which took effect in 2017. The state and its local governments allocated
7.0% of total direct general expenditures to capital outlay, compared with 10.1% in the nation as a whole. In view of the declines in
the state's capital asset to GDP ratio in the past decade, Michigan's 2017 capital investment figures represent continuation of a longer
trend. In 2008, the share of the state's capital outlays for infrastructure was 8.5%, compared with 12.8% for the nation as a whole.

Exhibit 6
Michigan ranks near the bottom of states by capital outlay as a share of direct general expenditure

25%

20%

15%

10%

5%

0%
Alabama
Tennessee

New Mexico

Nevada
South Carolina
New Hampshire

Arizona

New York

Montana

Kansas

North Dakota
Oregon

Mississippi

Ohio

Iowa
Illinois

Utah

Wyoming
Vermont

Kentucky

Colorado
Missouri

Pennsylvania

Virginia
Michigan

Maryland

North Carolina

Florida

Wisconsin
Rhode Island

Georgia

Minnesota

Texas
Oklahoma
Connecticut
Louisiana

Nebraska

Alaska
Maine

New Jersey

Idaho
California

Indiana

Arkansas

Hawaii

Delaware

Washington

South Dakota
Massachusetts

US total
West Virginia

Source: US Census Bureau 2017 Census of Governments: Finance

The May 2020 failures of the Edenville and Sanford dams in Michigan, resulting in the forced evacuation of thousands of residents
from Gladwin, Midland and Saginaw (Aa2) counties, show the potentially severe risk of deferring infrastructure investment in general,
beyond roads and bridges. While the dams in question are privately owned, their collapse underscores that governments can face
unexpected costs if they don’t ensure such facilities are maintained to offset aging and address stress imposed by climate conditions or
other changing circumstances.

Technological advances may hamper state's transportation funding, even with fuel tax indexing set to
begin in 2022
Addressing transportation infrastructure deficiencies will likely require more substantial revenue growth, even though existing law
provides for inflation indexing (using the consumer price index) of the state's motor fuel tax levy starting in fiscal 2022. Technologies
such as fuel-efficient and electric vehicles will only increase the challenge. As shown in Exhibit 7, growth in motor fuel tax collections
has been anemic except for the 2017 effects of the state's last motor fuel tax increase. Motor fuel taxes currently account for about half
of the constitutionally restricted sources from which Michigan derives revenue for the Trunk Line program.

Consideration of new sources to invest in roads and bridges is likely once the immediate economic and fiscal consequences of the
coronavirus pandemic have eased. Such measures could include imposing a vehicle miles traveled (VMT) charge. This approach
ultimately would allow for improved durability of long-term revenue, given that technological innovations (electrification of vehicles

4 3 June 2020 Michigan (State of): State bond plan will revive stalled highway and bridge projects

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 MOODY'S INVESTORS SERVICE U.S. PUBLIC FINANCE

and simply more fuel-efficient cars) eventually will reduce gasoline demand. Legislation introduced last year would have initiated a 6-
cents-per-mile VMT, but only for trucks weighing at least 26,000 pounds.

Like other state highway revenue bond programs in general, Michigan's can weather an economic downturn, given the Trunk Line
program's strong debt service coverage and initial indications that motor fuel demand is starting to rebound as people adjust to the
economic turmoil from the pandemic.5

Exhibit 7
Motor fuel tax revenue is stagnant (excluding effect of 2017 rate increase)
“Rate in effect” refers to the motor fuel tax; exhibit uses fiscal years

Revenue (left axis) Rate in effect (right axis)

$1,600 $0.30

$1,400
$0.25
$1,200
$0.20
$1,000

Rate in effect
$ millions

$800 $0.15

$600
$0.10
$400
$0.05
$200

$- $-
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 (April
(Prelim) Est)

Includes revenue from tax on gasoline, diesel and alternative fuels such as liquefied natural gas.
Source: Michigan Department of Transportation bond documents and annual disclosures

5 3 June 2020 Michigan (State of): State bond plan will revive stalled highway and bridge projects

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 MOODY'S INVESTORS SERVICE U.S. PUBLIC FINANCE

How does Michigan assess the quality of its roads?

Pavement conditions, one of the most basic aspects of transportation infrastructure quality, have deteriorated, based on the assessment
of the Michigan Transportation Asset Management Council. The proportion of major roads designated “poor” increased to 40.5% in 2018
from 29.6% in 2008, as shown in Exhibit 8. During this period, “good” or “fair” roads fell to just under 60% in 2018 from 70.5% in 2008. The
assessment applies to federal aid rated roads, a broader category that includes the state's “Trunk Line” roads.

Exhibit 8
More of the state's roads have slipped into the “poor” quality category in recent years
Poor Fair Good
100%

90%

80%

70%

60%

50%

40%

30%

20%

10%

0%
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Source: Michigan Transportation Asset Management Council

Another important measure is what the state uses to assess the state of its roads for accounting purposes. Under accounting guidelines, the
state does not need to depreciate highway assets if it keeps the roads designated in “poor” condition from exceeding 30%. In 2018, the most
recent year for which data are available, the state reported that 27% of roads were in poor condition, up from about 18% in 2008, as shown
in Exhibit 9. In the same year, the state increased spending to maintain the condition of its roads by 29%, taking advantage of increased
motor fuel tax collections. The state's percentage of structurally deficient bridges has increased to 6.3% in 2019 from 5.5% in 2018. While
states use varying measurement approaches, data from Ohio highlight the severity of Michigan's road problems. Ohio, an adjacent state using
the same accounting approach for infrastructure, reported that the percentage of roads in “poor” condition was only 3.1% for its “priority
subsystem)” (including interstate highways) and 1.4% for its “general subsystem,” including two-lane routes outside of cities.

Exhibit 9
Road quality (pavement assessment) deteriorated during a period when maintenance spending largely stagnated
Pavement assessment (left axis) Maintenance spending (right axis)
84% $1,200

82%
$1,000
80%
$800
78%
$ millions

76% $600

74%
$400
72%
$200
70%

68% $-
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Pavement assessment bar shows percentage of Michigan's highway assets in “good,” rather than “poor,” condition. These assessments are made on a calendar-year basis.
Source: State of Michigan Comprehensive Annual Financial Reports

6 3 June 2020 Michigan (State of): State bond plan will revive stalled highway and bridge projects

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 MOODY'S INVESTORS SERVICE U.S. PUBLIC FINANCE

Moody’s related publications

Sector Comment

» State highway revenue bonds will benefit as gasoline demand rebounds from coronavirus low, April 29, 2020

Sector Profile

» Capital asset growth uneven among states with the largest economies, November 21, 2019

To access any of these reports, click on the entry above. Note that these references are current as of the date of publication of this
report and that more recent reports may be available. All research may not be available to all clients.

Endnotes
1 Source: Michigan Transit Asset Management Council
2 The legal additional bonds test requires that future maximum annual debt service following a new issue be no more than half the actual pledged revenue
in the most recent fiscal year (i.e., a 2.0x coverage test). Compliance with these tests is based on the transportation revenue (primarily motor fuels taxes
and registration fees), which are allocated by statute to the Trunk Line program.
3 In fact, the state's tax revenue grew about half as fast on average as highway construction costs over the period from 2004 through 2018, according to
federal data.
4 Using this measure, Michigan's decline in infrastructure value relative to GDP mirrors, but is more pronounced, than the trend seen among the 10 states
with the largest economies, reflecting strong economic growth and somewhat muted infrastructure investment trends. From 2009 through 2018, the
most recent period for which all data for the 10 states with the largest economies are available, Michigan's capital asset to GDP ratio fell 1 percentage
point to 5.4%, a larger drop than all but two of the 10 largest states. The average change among those states was a decline of 0.3%, and the average ratio
at the end of the period was 8%.
5 The US Energy Information Administration on April 29 reported a 15.7% rebound in gasoline supplied during the fourth week of April from the low point
reached earlier in the month.

7 3 June 2020 Michigan (State of): State bond plan will revive stalled highway and bridge projects

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8 3 June 2020 Michigan (State of): State bond plan will revive stalled highway and bridge projects

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