Fitch Rates Indiana Finance Authority’s $134MM State Appropriation Bonds ‘AA+’; Outlook Stable
By Business Wire News
By Business Wire News
Fitch Ratings has assigned an ‘AA+’ rating to Indiana Finance Authority’s (IFA) $134.415 million facilities revenue bonds, series 2016A.
The bonds, which will finance construction of a new public mental health care facility, are expected to sell via negotiation on or about June 7, 2016.
In addition, Fitch has affirmed Indiana’s ‘AAA’ Issuer Default Rating (IDR) and ‘AA+’ ratings on outstanding Indiana appropriation-backed debt issued by the Indiana Finance Authority (IFA), the Indiana State Office Building Commission, and the Indiana Transportation Finance Authority. Fitch has also affirmed at ‘AA+’ the rating on the IFA’s TIFIA loan with the U.S. Department of Transportation (USDOT) for the East End Crossing Project.
The IFA was established in 2005. The state’s debt structure formerly was diffuse with state appropriation-backed debt issued through several commissions and authorities. The IFA is the successor agency to the former agencies.
The Rating Outlook is Stable.
The bonds are limited obligations of the IFA, paid from biennial state legislative appropriations made to the Department of Administration and then to IFA.
KEY RATING DRIVERS
The ‘AAA’ IDR reflects Indiana’s low long-term liability burden and strong operating profile including a commitment to ongoing structural budget balance and rapid restoration of fiscal flexibility in times of economic expansion. Cyclical declines can be challenging for the state, with an above-average susceptibility of state revenues to weakness during recessions.
Economic Resource Base
Despite ongoing diversification, Indiana’s economy remains highly dependent on manufacturing, which makes up about 17% of employment and 22% of earnings in the state compared to 9% and 10%, respectively, for the nation. As a result, the state is prone to large swings in conjunction with national business cycles and is also likely to see slower overall growth than the nation. The state’s seasonally adjusted monthly non-farm payroll employment declined 8.6% from its pre-recession peak to recessionary trough, versus a 6.3% decline for the nation. Despite this concentration, Indiana’s overall economic profile is solid with jobs growth slightly ahead of the national trend since the Great Recession and education and health services becoming nearly as important as manufacturing.
Revenue Framework: ‘aa’ factor assessment
Fitch expects Indiana’s revenues, primarily income and sales taxes, will continue to reflect the depth and breadth of the economy, but also its slower pace of growth. The state has complete legal control over its revenues.
Expenditure Framework: ‘aaa’ factor assessment
The state maintains ample expenditure flexibility with a low burden of carrying costs for liabilities, and the broad expense-cutting ability common to most U.S. states. Also, as with most states, Medicaid remains a key expense driver but one that Fitch expects to remain manageable.
Long-Term Liability Burden: ‘aaa’ factor assessment
Indiana’s long-term liability burden is just below the median for states and is well managed. Since establishment of the IFA in 2005, debt issuance and management has been centralized. The state issues debt infrequently, has been active in the public private partnership (PPP) market, and also relies on pay-go capital funding. The burden of unfunded pensions is higher than the debt burden, but manageable. The closed Teacher’s pre-1996 account utilizes a dedicated Pension Stabilization Fund to manage growth of annual contributions for the plan.
Operating Performance: ‘aaa’ factor assessment
Indiana remains extremely well-positioned to deal with economic downturns, with very strong gap-closing capacity in the form of ample budgetary reserves, the state’s control over revenues and spending and a demonstrated willingness to take timely budgetary action. The state tends to rely on its significant expenditure control to deal with budgetary stress. As revenues recover, Indiana restores many of those cuts and focuses on reserve restoration.
FUNDAMENTAL CREDIT CHARACTERISTICS: The state’s ratings are sensitive to shifts in fundamental credit characteristics, including Indiana’s manufacturing-centered economic profile, proactive and conservative financial management, and very manageable long-term liabilities.
APPROPRIATION-BACKED BONDS; TIFIA LOAN: The ratings for Indiana’s appropriation-backed debt are sensitive to changes in the state’s ‘AAA’ IDR, to which they are linked.
Indiana primarily relies on its sales and use tax and individual income tax for general operating revenues. Together, they account for 80%-90% of general fund revenues. The sales and use tax has gradually become more important and this trend will likely continue given personal income tax reductions enacted into law several years ago that are being phased in.
Historical revenue growth, adjusted for the estimated impact of policy changes, has been essentially flat on a real basis over the last 10 years. Sharp declines during the recession offset strong gains in the years leading into it. Since then, revenue growth has generally been slow. Fitch anticipates the long-term trend for revenue growth will be in line with historical performance.
Indiana has no legal limitations on its independent ability to raise revenues through base broadenings, rate increases, or the assessment of new taxes or fees.
Education is the dominant spending item for Indiana given that the state essentially fully funds basic education costs for K-12. Local education aid consumes roughly half of general fund expenditures annually. Medicaid is the next largest area of spending for the state, and the most rapidly growing one. Between 2009 and 2015, Medicaid spending grew between 8% and 9% on an average annual basis while overall general fund expenditures increased at a 2.6% average annual rate.
Spending growth, absent policy actions, will likely be slightly ahead of revenue growth driven primarily by Medicaid, requiring regular budget measures to ensure ongoing balance. The fiscal challenge of Medicaid is common to all U.S. states and the nature of the program as well as federal government rules limit the states’ options in managing the pace of spending growth. In other major areas of spending such as education, Indiana is more able to adjust the trajectory of growth since it does not retain responsibility for direct service delivery. This is true even for education spending as the state appropriates money to local school districts rather than operating any schools itself.
Indiana retains ample expenditure flexibility. While Medicaid costs are somewhat beyond the state’s ability to materially change given federal requirements for the program, the state’s carrying costs for liabilities are minimal. Like most states, Indiana’s operating budget (outside of Medicaid) goes largely towards funding of services rather than direct service delivery allowing the state to shift costs to lower levels of government in times of fiscal stress.
Long-Term Liability Burden
Indiana maintains a modest long-term liability burden that should remain very manageable. Per Fitch’s October 2015 State Pension Update report, the state’s total net tax-supported debt and unfunded pension liabilities of $15 billion made up just 5.71% of 2014 personal income compared to the 50-state median of 5.8%.
Debt is limited to capital needs and the state is not a regular issuer. GO bonds are prohibited under state law so Indiana has a long history of using appropriation-backed bonds to meet its capital borrowing demands. The state has been a leader in utilizing PPPs, particularly for transportation needs. The largest of these projects use an availability-payment structure with payments derived from state appropriations. Fitch incorporates estimates for the outstanding related project debt on these PPPs in its assessment of long-term liabilities. While the total amounts are substantial and account for approximately one-third of total net tax-supported debt, overall debt levels remain very modest.
The state maintains close control over its pension system, with all but one small system under the oversight of the Indiana Public Retirement System (INPRS). The Public Employees’ Retirement Fund (PERF) and the Indiana Teachers’ Retirement Funds (TRF) are the state’s primary retirement systems. The TRF includes a pay-go pre-1996 account (closed to new members) that is supported by a substantial reserve fund (Pension Stabilization Fund) meant to smooth annual growth in state contributions to support benefits.
Indiana’s ability to respond to cyclical downturns rests with its superior budget flexibility. Conservative fiscal practices and a somewhat concentrated, but still diverse, economy provide sufficient resources to the state to gradually restore fiscal flexibility once utilized. Indiana typically responds to budgetary stress with spending restraint and use of budgetary reserves. After a budget is enacted, the budget agency has significant statutory authority to administer the budget and scale back spending as needed, allowing the state to be responsive to changing conditions.
As revenues recover in economic expansions, the state works toward restoring prior year cuts and rebuilding reserves. By fiscal 2012, the state had essentially reached its statutory cap for budgetary reserves (12.5% of operating revenues in the final year of each biennium); since then, excess funds have been refunded to taxpayers, directed towards pay-go capital needs, or used to defease debt. The bulk of the reserves is in the form of unrestricted general fund balance with smaller portions in a Medicaid reserve, the rainy day fund, and a tuition reserve for K-12 education. Education funding has also been increased in recent budgets, particularly in the current fiscal 2015-2017 biennial budget, after recessionary cutbacks.
Indiana ended fiscal 2015 with another reported operating surplus (a modest $210.4 million, or 1.4% of operating revenues), even as general fund revenues fell just short of the forecast. The state, as it regularly does, utilized spending reversions to bring down expenditures mid-year as revenue collections showed signs of modest weakness relative to the forecast. Based on the December 2015 revenue forecast technical committee projection, the state forecasts fiscal 2016 operating revenues will be essentially flat versus the prior year ($68 million, or 0.4%, increase). Earlier in the fiscal year, the governor implemented a 3% executive agency spending reversion (excluding higher education) to ensure budgetary balance in light of the tepid growth expectations. Given its continued prudent budget management Fitch expects the state will end the current year in structural balance with stable reserves. Revenue through April is in line with the December forecast with slight over-performance in individual and corporate income tax collections offsetting sales and use tax weakness.
Additional information is available at ‘www.fitchratings.com‘.
In addition to the sources of information identified in the applicable criteria specified below, this action was informed by information from Lumesis and InvestorTools.
U.S. Tax-Supported Rating Criteria (pub. 18 Apr 2016)
Dodd-Frank Rating Information Disclosure Form
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Fitch Ratings, Inc.
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