Fitch strips Indianapolis of prized AAA bond rating

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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