CHICAGO – Indiana is awaiting word from S&P Global Ratings to see if legislation designed to strengthen the state’s AA-plus rated school intercept program resolves concerns that prompted a CreditWatch review.

Lawmakers unanimously approved Senate Bill 196, designed to address flaws that S&P warned could drive a downgrade to the AA-plus rated program. Gov. Eric Holcomb signed the bill Tuesday.

S&P put the Indiana School Corp.’s AA-plus rating – notched one level off the state’s AAA credit – on CreditWatch with negative implications citing uncertainty over whether the intercept program’s timeline for making school payments could effectively avert a default.

Any negative action would impact the ratings on bond obligations issued by 42 school corporations that benefit from the state program.

Eric Holcomb
Indiana Gov. Eric Holcomb signed a bill to clarify the way the state's school bond intercept program works. Bloomberg

S&P took the action after learning in a routine portfolio review that the program’s administration, overseen by the state treasurer, worked differently from the way the agency had understood.

"On that basis … we believe there is uncertainty that intercept payments will always be made available to ensure timely payment of debt service in full,” analysts said. "If we are going to rate it on par with the state appropriation rating we want to see the program provide a full and timely debt payment as was our previous understanding and our current understanding is that it may not.”

S&P warned that a multiple notch hit could occur without program revisions. The program does not serve as state guarantee of school bonds. Its strengths lie in the intercept mechanism that gives debt service a priority position above other costs which may be paid out of a school corporation's general fund.

The concerns stemmed from the reporting timeline between a district’s default on lease payments needed to cover debt service and how quickly the treasurer would act to avert an actual bond default. A second concern stemmed from the allocation of intercepted state aid funds and whether they could sufficiently cure a looming default.

With the goal of shoring up the program’s rating, Indiana Treasurer Kelly Mitchell’s office worked on the legislation with the assistance of its counsel Barnes & Thornburg LLP.

“The Treasurer was pleased to see SB 196 signed into law by Gov. Holcomb this week as a result of the good working relationship with all parties involved,” said treasurer's spokeswoman Catherine Seat.

To meet S&P’s criteria, the legislation puts into statute the timeframe by which the treasurer will pay -- within five days upon being notified of a school corporation's failure to pay debt service obligations when due -- the unpaid debt service obligations from state funds.

The legislation also expands the pools of funds that can be drawn from to fully cover an obligation. Previously, the state could draw only the amount that the district was set to receive under its monthly allocation, which is tied to an enrollment-based formula. That amount could fall short of what was needed to cover the obligation, allowing a default to occur. Ongoing monthly aid payments would then go to cover the default until cured.

Under the legislation, the treasurer will still first turn to a district’s appropriated funds. If insufficient, the office can draw from any surplus funds appropriated by the general assembly for distribution for tuition support in each state fiscal year. If still insufficient and a budget is in place for next fiscal year appropriating school aid payments, the treasurer can use state funds to fully cover a debt service obligation.

The state would recover those funds from future distributions earmarked for the district.

The state operates on a biennial budget so appropriation risk – which drives the current rating level – would remain in a situation where the intercept is triggered during the second year of the budget cycle before a new budget is approved and the first pots of funds fall short.

“I think the legislation addresses S&P’s issues because it puts in a much more explicit process to address, in advance of a payment default, the shortfall with state revenues, which was always the intent,” said an Indiana public finance source familiar with the legislation.

S&P continues to the review the legislation. It last issued a comment in late March when the legislation was pending, saying it was aware of proposal that may better define the process of administering an intercept and expand on the source and availability of revenues that could be intercepted.

“If a bill is enacted into law that revises the procedures for intercepting state aid or the source and availability of revenues to be intercepted, we will review the new law and, following a thorough examination, make any updates to the rating that we consider appropriate,” analysts said in March.

After S&P’s credit watch placement, Gurtin Fixed Income highlighted its concerns, first outlined in a 2015 report that found “the controlling statute is fraught with ambiguity, because the enhancement does not require the state to act within any set period of time to cure a default.”

The report questioned S&P’s continued rating of the program so highly.

In other state news, Holcomb on Thursday signed into law the state’s next biennial budget and transportation package, both of which were approved by lawmakers late last week before they adjourned.

“Indiana lawmakers passed an infrastructure plan of historic proportions, putting our state in a strong position to finish what we started, maintain what we have and build for future growth,” Holcomb said in a statement. “We did this all while maintaining a balanced budget and responsible reserves that will continue to diversify and grow our economy.”

Under the transportation legislation, Indiana can seek permission from federal regulators to toll its interstate highways. The bill raises the state’s gasoline and diesel taxes by 10 cents per gallon, raises other taxes and fees and phases out the diversion of the state sales tax on transportation related taxes which combined should generate $1.2 billion in new annual spending for transportation by 2024.

The $32.3 billion two-year state budget funds key provisions in Holcomb’s agenda including increased direct flights at Hoosier airports, freeing up some funds in a $500 million trust to foster entrepreneurship and regional economic development efforts, and providing $9 million for pre-kindergarten education.

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