Fitch Assigns 'AAA' Implied GO to Indiana & Affirms Outstanding Bonds at 'AA+'; Outlook Stable

NEW YORK--()--Fitch Ratings assigns an 'AAA' implied GO rating to 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, secured by biennial state legislative appropriations. The 'AAA' implied GO rating reflects the general credit quality of the state of Indiana. Indiana is constitutionally prohibited from issuing GO debt.

KEY RATING DRIVERS

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 for 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, 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.

APPROPRIATION SECURITY: Bond payment relies 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.

RATING SENSITIVITIES

The rating is sensitive to shifts in fundamental credit characteristics including the state's low long-term liabilities burden and its commitment to strong financial management practices.

CREDIT PROFILE

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.

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. The state's aggregated unfunded pension liabilities totaled $12.7 billion as of June 30, 2013. Combined debt and pension liabilities represent 5.9% of 2013 personal income, below the median for U.S. states. The vast majority ($11.2 billion) of the unfunded pension liability is for the closed pre-1996 Teachers Retirement Fund (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, 2013 the PSF held approximately $2.6 billion and was expected to allow the state to cap annual increases in general fund appropriations for the pre-1996 TRF to 3% through fiscal 2018. Thereafter, the state projects the PSF will allow smaller yoy increases in general fund appropriations before appropriations begin declining steadily in fiscal 2037.

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 a 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. Combined fund balances dropped from $1.4 billion at the end of fiscal 2009 (about 11% of operating revenues) to a still meaningful $831 million at the end of fiscal 2010. By the end of fiscal 2012, the state reported an increase in balances to $2.16 billion, or 15% of operating revenues. Since then, the state's combined fund balances have been at or near this level, declining to meet statutory maximums for reserve levels in odd years (12.5% of operating revenues) which are the end of each biennial budget. At the end of fiscal 2014, the state reported $2 billion in combined fund balances providing a substantial financial cushion for the state of 13.9% of operating revenues. 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.

Fitch views recent revenue weakness as a temporary and manageable event. For fiscal 2014, Indiana's general fund revenues declined 0.4% yoy, which 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. Indiana also adopted a new revenue forecast in December, incorporating the weaker revenue trends. The state attributes a portion of the revenue decline to a falloff in personal income tax revenues (which declined 1.6% yoy) due to one-time income acceleration in the prior year because of federal tax changes. Fitch notes multiple states reported personal income tax weakening in fiscal 2014, attributed largely to the same reason. Prior to fiscal 2014, the state had seen three consecutive years of yoy operating revenues growth. Personal income and sales tax comprise approximately 80% of general fund revenues.

In the second half of the biennium, Fitch anticipates Indiana will maintain fiscal constraint through spending reversions. The December 2013 revenue forecast calls for revenue growth in fiscal 2015, but reflecting the fiscal 2014 revenue weakness, the growth projection for fiscal 2015 is from a lower fiscal 2014 base than had originally been budgeted. The 2013 legislature enacted a personal income tax cut package with the initial phase effective January 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. Fitch anticipates the state will demonstrate continued prudent budget management and should end the year in structural balance with stable reserves.

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 with 8.5% growth in payrolls since its recessionary trough in July 2009 versus 7.3% growth for the U.S. since its trough in February 2010. The state's yoy employment growth trends are ahead of the nation. As of August 2014, the state recorded 2.5% yoy growth in the three-month moving average for non-seasonally adjusted payrolls, versus 1.9% for the U.S. The August 2014 unemployment rate was 5.8%, just below the national rate of 6.1%. 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 modest, with per capita personal income of $38,622, or 86% of the national level.

Additional information is available at 'www.fitchratings.com'.

In addition to the sources of information identified in Fitch's report 'U.S. State Government Tax-Supported Rating Criteria', this action was additionally informed by information from IHS.

Applicable Criteria and Related Research:

--'U.S. State Government Tax-Supported Rating Criteria', Aug. 14, 2012.

Applicable Criteria and Related Research:

Tax-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686015

Additional Disclosure

Solicitation Status

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Contacts

Fitch Ratings
Primary Analyst
Eric Kim
Director
+1-212-908-0241
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Karen Krop
Senior Director
+1-212-908-0661
or
Committee Chairperson
Douglas Offerman
Senior Director
+1-212-908-0889
or
Media Relations
Elizabeth Fogerty, New York, +1 212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Eric Kim
Director
+1-212-908-0241
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Karen Krop
Senior Director
+1-212-908-0661
or
Committee Chairperson
Douglas Offerman
Senior Director
+1-212-908-0889
or
Media Relations
Elizabeth Fogerty, New York, +1 212-908-0526
elizabeth.fogerty@fitchratings.com