Michigan’s unemployment insurance bonds

January 2, 2012

Michigan called on Citibank to help repay about $3 billion the state owed to the federal government for expenses racked up during the deepest part of the recession. Like many states, Michigan had to manage soaring unemployment insurance costs and borrowed from the feds to help workers who had lost their jobs. Washington had given these loans on very advantageous terms, but like a teaser rate for a credit card, those are expiring and interest costs will soon jump for borrowers. So Michigan, like Texas and Idaho, has refinanced these payments.

Michigan’s new UI bonds, underwritten by Citibank, use some of muniland’s favorite structures with a few twists. The bonds are “variable rate demand revenue” bonds, which are cousin to the the more commonly known “variable rate demand obligation” bonds (VRDO).

The “variable rate” part of  “variable rate demand revenue” bonds refers to the interest rate which is reset weekly through a remarketing process. Although these UI bonds are issued for a two-year maturity the weekly resetting allows the borrower to a pay much lower interest rate. The structure also allows the bond’s owner to put the bond back to the “remarketing agent” at the weekly auction.

VRDO bonds are unsecured obligations of the issuer and rely on the willingness and ability of an issuer to raise sufficient taxes to service the debt. Repayment of VRDO bonds usually comes from the issuer’s general fund, which also pays for the salaries, pensions and other costs of a running a government.

In contrast the cash flow to pay off variable rate demand revenue bonds (the Michigan UI type) comes from a dedicated stream of revenues from a specific municipal operation like a hospital or sewer plant.  These bonds are secured and their cash flows cannot be diverted to another purpose. Investors have preferred this flavor of bonds in the past year amidst fiscal and economic uncertainties. The trading activity for the Michigan UI bonds looks like institutions snapped them up in trades that were bigger than $1 million.

In the case of the Michigan UI bonds the revenue stream is secured by the Michigan Finance Authority, an autonomous public body, who in turn will collect unemployment insurance payments from employers in the state. Standing behind the MFA is a letter of credit issued by Citibank insuring repayment to bondholders. This shows the might of Citibank that they can pledge their assets to backstop an agency of the state of Michigan.

Muniland is full of odd bond structures but bonds to repay the federal government for unemployment expenses are uncommon. Michigan has done an interesting and big deal with Citibank. Let’s keep our eye on this one.


The Official Statement for the offering

S&P rating report

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