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Fitch strips Indianapolis of prized AAA bond rating

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Fitch Ratings this month stripped Indianapolis of its prized AAA bond rating, a move that stems in part from concern that property-tax caps will further squeeze the city’s already tight finances.

For now, the downgrade is unlikely to have a big effect on the interest rates the city pays, since two other agencies—Standard & Poor’s and Moody’s—left their ratings unchanged.

But officials with all three agencies say the city’s financial outlook is growing stormier, despite signs the recession is coming to an end. The biggest looming challenge is the caps kicking in next year that permanently restrict property taxes—local government’s largest income source.

A host of other issues will intensify the squeeze. For example, current property taxes are being paid based on pre-recession, 2007 assessments—figures likely to fall when the decline in the values of commercial and residential properties are factored in.

The recent reassessment also has added to the pressure, since it has led to delays in issuing bills and collecting taxes, thereby pinching cash flow. And then there’s the expectation that the economic recovery will be anemic, slowing the growth in income tax collections—the second-biggest source of revenue.

Together, these factors place Indianapolis in a financial vise.

“It’s [all] going to continue to put financial pressure on them, at least until the cycle normalizes,” said Melanie Shaker, Fitch’s director of Midwest public finance. “Hopefully, that will happen in 2010. But it’s going to take some time to shake out.”

The Fitch downgrade came as a shock to Mayor Greg Ballard’s administration, which has prided itself on living within its means. For the last two years, Ballard, a Republican, has cut all local government spending 5 percent annually, except public safety. He’s proposed another 5-percent cut to next year’s budget to keep it balanced.

City Controller David Reynolds called the downgrade unwarranted.

“I just think they overreacted,” he said.

But City-County Councilor Joanne Sanders, the Democratic minority leader, worries it’s the tip of a looming iceberg.

“It’s probably one of the first dominoes to fall in the saga of property-tax caps. There will be worse in the future,” she said, noting that recession-induced local home foreclosures and business bankruptcies also will reduce property taxes for at least the next few years. “Whenever you get a decrease in your rating, it does not bode well.”

The Indiana General Assembly passed the caps in 2008 amid an uproar from homeowners over soaring property tax bills. The so-called circuit breakers will limit property taxes to 1 percent of the assessed value of a home, 2 percent of a rental property, and 3 percent of a business.

Indianapolis is sensitive to interest rate changes because they can have a big impact on annual interest expense. Ballard has budgeted $166 million for debt service next year. That’s 12 percent of his $1.2 billion total budget.

Fitch assigned the lower rating to bonds the city plans to float to refinance $167 million in debt stemming from construction of Circle Centre mall. The bonds are supported by property taxes generated within a downtown tax-increment financing district.

In 2002, the administration of then-Mayor Bart Peterson restructured the debt, hoping to save money with a variable interest rate.

But the international credit crunch caused variable rates to soar, and voided bond insurance that reduced the risk to buyers of the debt. Because that insurance now isn’t available at a reasonable rate, Indianapolis is setting aside cash instead.

Ballard’s new bond issue is expected to build up cash reserves and lower interest costs from their current variable 9 percent to a fixed 6 percent, saving the city several million dollars over the next 10 years.

Both Standard and Poor’s and Moody’s Investors Service left their debt ratings unchanged. S&P designated the bonds AA with a stable outlook, two notches below the top, while Moody’s pegged them at Aa3, three steps below its best investment grade, also with a stable outlook.

Fitch, however, rated the new bonds AA-, a three steps below its former top rating. The agency also moved its rating for outstanding Indianapolis debt down a notch, from AAA to AA+. And while its outlook for the new bonds is stable, Fitch placed all future bond bank issues in its rating watch negative category, pending further review.

Fitch’s Shaker said that while Indianapolis’ diverse economy helps blunt the impact of the recession, the city is not immune from it. Further, she said, the tax caps will contract tax collections for years to come.

“I don’t see it as cataclysmic at all. I see them able to manage within it,” Shaker said. “But it’s certainly weaker.”

Falling property values

The Fitch report has a silver lining in that it notes Ballard’s stringent budget management, said Bill Waltz, the Indiana Chamber of Commerce’s vice president of taxation and public finance.

Still, he acknowledged depreciating property values are worrisome. According to the Metropolitan Indianapolis Board of Realtors, the average sale price of a Marion County home in June was $106,307, down 20 percent from the $133,138 recorded in June 2006.

“[Declining real estate values are] something we should be paying very close attention to, and have good reason to be concerned about,” Waltz said. “Because it’s no doubt going to exacerbate the situation a little bit, if not a lot.”

Marion County Treasurer Mike Rodman, a Democrat, said the caps will shift more of the property-tax load to businesses—a burden that could knock some firms out of business, further pinching tax collections. About two-thirds of property taxes now are paid by homeowners.

“The mom-and-pop businesses, this could put some of them in troubled waters, it really could,” he said.

He added: “If we’ve got lower assessments and the caps, that’s going to put a lot of pressure on David Reynolds.”

‘Under promise, over deliver’

Reynolds, the city controller, is unfazed. He said he’s built extremely conservative assumptions into his projections for this year and the next few after that.

Next year’s $1.2 billion budget, for example, is in the black by just $400,000, but it sets aside $16 million in a rainy day fund. Reynolds assumes local government will lose $30 million annually in future years due to the tax caps. Next year, Indianapolis expects to collect $324 million in property taxes.

“What’s the saying? Under-promise, over-deliver,” Reynolds said. “You want to protect yourself so you can deliver.”

Ballard’s proposed 2010 budget shows he has slashed nearly $80 million in spending from Peterson’s last budget. Next year’s budget would cut almost $40 million more in spending outside public safety, criminal justice or debt service.

But Reynolds said city services haven’t suffered as a result. Instead, he said, new efficiencies are yielding better results for less money.

For example, he noted Ballard inherited six separate human resources departments. He’s consolidated the functions for the Indianapolis Metropolitan Police Department and Indianapolis Fire Department, but other agencies like the Sheriff’s Department and the Marion County Prosecutor’s Office still maintain separate HR.

Within the Controller’s Office, Reynolds pointed to the hire of a Six Sigma black belt, who’s spearheading efficiency efforts for half a dozen major projects. That kind of thinking permeates Ballard’s administration, Reynolds said.

“Service is still being provided,” he said. “It’s the same services at a lower cost.”

Sanders, the Democratic City-County Council leader, sees a different picture, in which local government service cuts are leading to backlogs in all sorts of basic areas, like sidewalk repair or weed control on public parcels.

“I think we’re going to start seeing more and more,” she said.

Shaker, the Fitch analyst, will be watching closely to make sure the city does not overextend itself.

“What policy decisions they make to live within their means are not my bailiwick,” she said. “But what is important to me is they are able to withstand the effects of the circuit breaker and potential income tax growth leveling off.”•

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