By Matthew Dolan

A leading credit rating agency dialed back its outlook on the State of Michigan, citing increasing costs associated with the City of Flint's water crisis and the financially distressed Detroit Public Schools.

"It was based on our understanding that the state was planning on building up its rainy-day fund, but due to some of these other priorities, they are not going to be able to build up their reserves in the same way" over the next two fiscal years, Standard & Poor's credit analyst Carol Spain said in an interview Friday.

The rating agency said it believes in building reserves during good economic times. That's especially important to Michigan's credit quality because of the state's cyclical, auto-driven economy, according to S&P.

Despite more money for the state's reserves fund in Gov. Rick Snyder's proposed budget, "we still view balances as being at only adequate levels," according to the S&P report issued Thursday.

The revised outlook from Standard & Poor's Ratings Services affects two kinds of state debt: state general obligation bonds and appropriation-backed debt. The forecast moves to stable from positive, meaning it's less likely the state will see a rating boost over the next 24 months.

The move does not affect the state's credit ratings with the agency.

Instead, the outlook is generally used to provide some guidance about what action S&P may take next in the next two years. A stable rating essentially means the rating agency is neutral on a move to increase or decrease the rating, according to company officials.

Michigan Treasurer Nick Khouri said in an interview Friday that the state would not expect to see any immediate impact as a result of the modification of S&P's outlook on the state.

"I am disappointed and it's unfortunate to reduce the outlook," Khouri said. But he said that the Snyder administration has introduced financially responsible measures to restructure the financially strapped Detroit school district with $715 million drawn, in large measure, from the state's tobacco settlement fund. Michigan's House of Representatives approved a $48.7-million appropriation to ensure the school district won't run out of cash next month.

Khouri added that the administration has also included nearly $200 million for restoring safe drinking water to Flint and aiding those contaminated by its lead-laced water supply. But the state treasurer said that any future legal liability against the state from ongoing lawsuits connected to the water crisis remains uncertain.

In the same announcement this week, S&P affirmed its AA-rating on the state's general obligation debt and its A+ rating on the state's appropriation-backed debt. The rating agency also assigned an AA-rating to Michigan's series 2016A GO bonds.The series 2016A GO bonds will be used to finance the Great Lakes Water Quality Bond Fund.

There have been two rating upgrades from Moody's and Fitch Ratings during the Snyder administration, but no downgrades, according to the state's Treasury office. Outlooks on the state by rating agencies have been revised five times, but they all happened without a rating change either up or down, state officials said.

In her report on Michigan, Spain wrote that "although many of the governor's budget proposals are pending legislative approval, in our view, there is significant political pressure for the state to contribute funds toward both Flint and DPS. It is likely that costs related to the Flint water crisis over the next two years will surpass the executive budget's projections."

"Michigan currently has the wherewithal to support projected additional costs and maintain the current rating," Spain said. "But if costs related to the Flint water crisis or distressed local credits escalate, there could be credit pressure."

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