Fitch Rates Indiana Finance Authority's $96MM State Appropriation Bonds 'AA '; Outlook Stable
The bonds, which will fund various improvements to the Indianapolis Motor Speedway, are expected to sell via negotiation the week of June 29, 2015.
In addition, Fitch affirms the 'AAA' implied general obligation (GO) rating on the state of Indiana and affirms the 'AA+' rating 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.
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.
SECURITY
The bonds are limited obligations of the IFA, paid from biennial state legislative appropriations made to the Indiana Motorsports Commission (IMC) which is a legislatively-created entity.
KEY RATING DRIVERS
APPROPRIATION SECURITY: Bond payment relies ultimately on biennial legislative appropriations, although appropriation risk is mitigated by the state's reliance on appropriation debt to fund its capital program and the requirement of legislative approval for projects and financings. General obligation debt is constitutionally prohibited.
LOW DEBT BURDEN: Indiana's low debt burden is one of the key credit strengths underlying its high rating. Most of the state's net tax-supported debt burden covers transportation needs, including those funded through public-private partnerships. Indiana expects a portion of the public-private partnership obligations to be self-supporting from toll revenues.
HIGH RESERVE LEVELS: Indiana's budget management is strong and the state prudently used the recovery from the recession to build up and maintain solid reserves. Revenue forecasts have been revised downwards this year, but Fitch anticipates the state will manage to a stable fiscal profile.
MANUFACTURING-HEAVY ECONOMY: An economy that remains considerably concentrated in manufacturing, particularly transportation equipment, exposes the state to economic downturns and emphasizes the importance of Indiana's reserve balances.
RATING SENSITIVITIES
FUNDAMENTAL CREDIT CHARACTERISTICS: The implied GO rating is sensitive to shifts in fundamental credit characteristics including the state's commitment to strong financial management practices and its low long-term liabilities burden.
APPROPRIATION RATING LINKED TO GO: The rating on the bonds and other appropriation-backed debt is sensitive to shifts in the state's implied GO rating of 'AAA', to which this rating is linked.
CREDIT PROFILE
The series 2015C bonds will fund a series of improvements at the Indianapolis Motor Speedway, home to the Indianapolis 500 race. Indianapolis Motor Speedway, LLC (IMS; owner of the speedway) will lease a portion of the speedway (including the planned improvements) to the IFA. IFA will lease the leased premises to the IMC, which will lease them back to IMS. The legislature established the IMC in 2013 as an instrumentality of the state essentially to finance improvements at the speedway.
Given that the bonds are payable from biennial state appropriations, the 'AA+' rating rests on the credit quality of the state. The IFA and the IMC both covenant to seek a total of \\$7 million in annual state appropriations for debt service for 20 years (totaling \\$140 million). Per the indenture, the fixed-rate bonds will be sized for annual debt service at or below \\$7 million with a 20-year maturity. The indenture does not authorize variable-rate bonds.
In Fitch's view, the fact that the transaction directly benefits a private entity (IMS) rather than a state entity as with other Indiana appropriation-backed debt does not warrant a rating distinction. IFA has strong incentive to seek appropriations for this project given the demonstrated state commitment. In three consecutive legislative sessions the general assembly approved legislation for this transaction. Each of the legislated changes enhanced protections for bondholders and deepened the state's commitment to the project. The state uses appropriation-backed bonds as its primary means of capital markets access and the IFA covenants for the series 2015C bonds parallel those in other IFA state appropriation-backed transactions.
Additionally for this transaction, IFA is required under statute and the trust indenture to seek sufficient appropriations even if the funded project (the speedway improvements) is not available for use. This differs from other Indiana appropriation-backed debt which requires project availability to compel appropriation requests by the lessees of IFA bond financed facilities.
The state's legislature and budget committee recently authorized \\$14 million in biennial appropriations for debt service, even though construction is ongoing. IMS expects all improvements to be completed by June 30, 2017.
The 'AAA' implied GO reflects Indiana's historical pattern of low debt, balanced financial operations, and a commitment to funding reserves to provide a cushion in times of economic and revenue decline. These strengths are offset by an economy that, despite ongoing diversification, remains heavily concentrated in the cyclical manufacturing industry.
DEDICATED REVENUES COULD OFFSET NEED FOR APPROPRIATIONS
Indiana anticipates receiving revenues to offset the \\$140 million in aggregate general fund appropriations for debt service, but Fitch's rating does not rely on performance of those revenues. Per a sublease agreement and statute, IMS will pay \\$2 million annually to IMC for 20 years. The state will also credit certain taxes and fees collected from activities within an improvement district encompassing the speedway and surrounding area against the \\$140 million in appropriations. After 30 years, IMS' parent company (Hulman and Company) guarantees to cover any shortfall between \\$140 million and the sum of the annual IMS fee plus the credited taxes and fees.
LIMITED LONG-TERM LIABILITY DEMANDS
Low debt is a principal credit strength for Indiana. The state's net tax-supported debt (NTSD) of \\$2.4 billion equates to a modest 1% of personal income. Indiana's constitution prohibits general obligation debt. The state meets the bulk of its capital needs through debt issuance by the IFA secured by biennial state lease-rental appropriations. Fitch's NTSD calculation excludes bonds issued by IFA to support construction of a convention center and football stadium which have a demonstrated record of more than three years of self-support from local taxes.
Fitch's NTSD calculation for Indiana includes availability and milestone payment (AP and MP) commitments for public-private partnership transportation projects (P3) which Fitch views as long-term state obligations. Under terms of the AP and MP agreements and related contracts, Indiana pays private operators fees based on the successful completion and continued operation of the projects. The state anticipates a portion of the P3 projects will be self-supporting from toll revenues but, subject to terms of the various agreements for the projects, Indiana remains committed even if such revenues are insufficient.
Indiana's unfunded pension obligations are modest, with the largest liability for a closed plan that has a significant reserve fund set aside to mitigate annual contribution growth pressure. Per Fitch's May 2014 state pensions update, combined state debt and Fitch-adjusted pension liabilities of represented 5.6% of 2013 personal income, below the 6.1% median for U.S. states.
As of June 30, 2014, the state's aggregated unfunded pension liabilities for its Public Employees Retirement Fund (for state employees) and Teachers Retirement Fund (TRF, pre and post 1996) totaled \\$14.1 billion.
The vast majority (\\$11 billion) of the unfunded pension liability is for the closed pre-1996 TRF plan. The TRF plan is a defined benefit plan intended to be funded on a pay-as-you-go basis and beginning in 1995 the state established a Pension Stabilization Fund (PSF) to provide additional resources to manage the annual contributions.
As of June 30, 2014 the PSF held approximately \\$2.9 billion and was expected to allow the state to cap annual increases in general fund appropriations for the pre-1996 TRF to 3% over the next 12 years. Thereafter, the state projects general fund appropriations begin declining steadily.
WELL-MANAGED FISCAL POSITION
Indiana's budgeting has been strong, with a focus on structural solutions to close budget gaps. 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. The state utilized those controls during fiscal 2014 when revenues trended lower than budgeted. Given the timely and responsive action, Indiana managed to another operating surplus and kept reserves well-funded despite the modest and unanticipated decline in general fund revenues.
The state maintained budget balance and a solid reserve position despite significant economic and revenue weakening in the recession. Since 2012, the state's combined fund balances have essentially been at statutory maximums for reserve levels (12.5% of operating revenues at the end of each biennium).
For fiscal 2015, the state estimates ending the year with fully funded reserves of approximately \\$2 billion, providing a substantial financial cushion. The bulk of the combined fund balance is in the form of general fund balance with smaller portions in a Medicaid reserve, the rainy day fund, and a tuition reserve for K-12 education.
MANAGEABLE REVENUE WEAKNESS
For fiscal 2014, Indiana's general fund revenues declined 0.4% year-over-year (yoy), a trend the state noted early on in the fiscal year and addressed quickly. The governor imposed a 3% spending reversion on agencies at the start of the fiscal year. In December 2013 he implemented an additional set of reversions as revenue reports indicated underperformance. Following these expense actions, Indiana ended the year with a \\$106.8 million operating surplus.
The April 2015 revenue forecast calls for modest general fund revenue growth in fiscal 2015 of 1.5% to \\$14.6 billion. The 2013 legislature enacted a personal income tax cut package with the initial phase effective Jan. 1, 2015. In 2014, the legislature enacted an additional set of modest tax cuts. The state estimates that the cumulative tax cuts will reduce general fund revenues by approximately \\$500 million once fully implemented over the next several years. Given its continued prudent budget management, including ongoing spending reversions, Fitch expects the state should end the current year in structural balance with stable reserves.
Revenue through May is ahead of the April forecast by 1.6%, or \\$211 million after robust personal income tax collections in April. Revenues are now essentially in line with the enacted budget, just 0.8% below. Personal income tax revenues through May are up 6.9% (\\$305.1 million) yoy and 3.3% (\\$150 million) ahead of the April forecast. Sales and use tax revenues, the state's largest general fund revenue source at approximately 50%, are just 0.2% below the forecast.
Indiana forecasts general fund revenues will increase 2.4% yoy in fiscal 2016 and accelerate modestly to 3.4% in fiscal 2017. The recently enacted fiscal 2016-2017 biennial budget continues the state's practice of maintaining structural balance and solid reserve levels. K-12 spending increases approximately 4%, or \\$480 million, while most executive branch agencies saw 3% budget reductions. Indiana anticipates using \\$100 million of its general fund balance each year to support key transportation projects through transfers to its Major Moves 2020 Construction Fund. Reserve levels should remain robust at \\$1.8 billion through the biennium, still covering well over 10% of estimated general fund revenues.
MANUFACTURING-DEPENDENT ECONOMY
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 U.S. As a result, the state is prone to large swings in conjunction with national business cycles. 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. The state's unemployment rate rose as high as 10.8% in June 2009.
Indiana's economic rebound from the recession has been solid. Through May 2015 the state's payrolls increased 10.3% since its recessionary trough in July 2009, versus 9.3% growth for the U.S. since its trough in February 2010. The state's yoy employment growth trends are slightly below the nation. As of May 2015, the state recorded 1.9% yoy growth in the three-month moving average for non-seasonally adjusted payrolls, versus 2.2% for the U.S. The May 2015 unemployment rate dipped to 5.1%, below matched the national rate at 5.5%. After spiking during the worst of the recession, Indiana's unemployment rate has moved generally in line with the national rate. The state's wealth levels remain below average for a U.S. state, with per capita personal income of \\$39,433, or 86% of the national level.
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