Fitch Rates Oklahoma's $221MM OCIA Bonds 'AA'; Outlook Stable

NEW YORK--()--Fitch Ratings assigns an 'AA' rating to the following issue of the state of Oklahoma:

--$221.36 million Oklahoma Capitol Improvement Authority (OCIA) state facilities refunding revenue bonds, series 2014A (subject to annual appropriation).

The bonds are expected to sell via negotiation the week of March 24, 2014.

In addition, Fitch affirms the following ratings on the outstanding debt listed below:

--$177.53 million State of Oklahoma general obligation (GO) bonds at 'AA+';
--$1.161 billion appropriation-backed debt of the state issued by the OCIA at 'AA';
--$714 million appropriation-backed debt of the state issued by the Oklahoma Development Finance Authority at 'AA'.

The Rating Outlook is Stable.

SECURITY

The bonds are limited special obligations of the OCIA secured by annual appropriations of the state of Oklahoma. The current issue refunds the outstanding series 2005 A-F bonds where the intended source of repayment on the bonds is from five separate state agencies from their budget allocations.

KEY RATING DRIVERS

APPROPRIATION MECHANISM: The rating on the OCIA bonds, backed by Oklahoma's annual legislative appropriation pledge, is one notch below the state's 'AA+' GO bond rating. This reflects the state's general credit standing, sound lease structure, and statutory authorization for these types of bonds.

CONSERVATIVE FINANCIAL OPERATIONS: The state's financial operations are conservatively managed, including maintenance of separate rainy day (the constitutional reserve) and cash flow reserve funds and a policy of appropriating only 95% of expected revenues. Growth in personal and corporate income taxes as well as sales tax revenues has bolstered financial operations and allowed for consecutive deposits to the rainy day fund. This has in turn offset the cyclical collections of severance tax revenue.

CONCENTRATED ECONOMIC BASE: The state's commodity-based economy, based on oil and gas production as well as various agricultural products, strongly rebounded from the recession although recent economic growth has been more subdued.

MANAGEABLE DEBT POSITION: Debt levels are low, and tax supported debt is amortized relatively quickly. Most new issuance is in the form of lease revenue bonds. The unfunded pension liability for state employees has improved following significant pension reform.

RATING SENSITIVITIES

The rating is sensitive to shifts in the state's GO rating to which it is linked.

CREDIT PROFILE

The OCIA bonds currently offered are secured by lease rental payments to OCIA from five separate state agencies (collectively, the agencies): the Oklahoma Military Department, the Oklahoma Attorney General, the Native American Cultural and Educational Authority, the Oklahoma State Bureau of Investigation, and the Oklahoma State Regents for Higher Education on behalf of certain Oklahoma colleges and universities from their annual budget allocations; subject to annual legislative appropriation.

The OCIA is one of the principal financing agencies of the state as the use of GO bonds is limited. The leases are renewable annually until the bonds are paid and the agencies covenant to include a budget request for lease payments sufficient to pay debt service for their respective obligations. Lease terms match amortization of the 2014 bonds and lease payments are not abatable. The current offering will be applied to refunding outstanding bonds for debt service savings.

The state's 'AA+' GO bond rating and Stable Outlook reflect low debt levels and disciplined financial policies. This includes an appropriation limit of 95% of certified general fund revenues, close monitoring of revenue results, and provisions to maintain separate rainy day (the constitutional reserve fund) and cash reserves. The state has demonstrated a willingness and ability to address fiscal challenges including revenue underperformance through the recent recession. Tax rate adjustments are limited by a supermajority requirement of the legislature or voter referendum to raise tax rates.

SLOW GROWTH IN THE STATE'S CONCENTRATED ECONOMIC BASE
After consecutively outperforming national growth trends coming out of the recent recession, the state's year-over-year (YOY) employment growth slowed in 2013. The state recorded 1.1% YOY employment growth in December 2013 as compared to a more robust national employment growth rate of 1.6%. The modest growth largely encompassed a meaningful 4.2% YOY decline in mining and natural resources employment. This is a continuation of a descending trend begun in February 2013, as all other sectors, aside from a 1.3% decline in construction, recorded positive YOY growth.

Offsetting this decline was 2.7% YOY growth in leisure and hospitality, 4.7% YOY growth in professional services, and 1.6% YOY growth in manufacturing. Oklahoma's unemployment rate has historically been well below the nation's, with December 2013 at 5.4%, up from 5.1% in December 2012, yet still below the 6.7% rate for the nation.

The economy continues to be supported by the state's large natural resources base; an analysis conducted by the Oklahoma City University found that one in six jobs in the state is related to the oil and gas industry. Additionally, one-third of the state's gross state product is attributable to the drilling, production, and economic multiplier effects of this sector. The state remains focused on diversifying its economic base and recent expansions in aerospace manufacturing, as well as professional and business services, point to some success with this endeavor. Growth in other economic sectors remains key to the state maintaining overall economic stability.

CONSERVATIVELY MANAGED FINANCIAL OPERATIONS

Financial operations are conservatively managed with the state permitted to enact appropriations for only 95% of anticipated revenues in the forthcoming fiscal year. This conservative budgeting is important given wide fluctuations in severance tax receipts to the general fund.

Positive economic momentum coming out of the recession translated into strong receipts for the fiscal year ending June 30, 2012, particularly in income, sales, and oil severance taxes, resulting in the state depositing $328 million to the constitutional reserve fund (rainy day fund or RDF) at fiscal year-end and bringing the reserve to $577.5 million, the second highest balance on record.

The enacted $6.8 billion fiscal 2013 operating budget (not inclusive of federal aid) was a 5.1% increase from fiscal 2012 appropriations. A decline in severance tax receipts in fiscal 2013; down 48.5% from fiscal 2012, incorporated the impact of temporary tax reductions and rebates for producers and offset gains in other tax revenue sources and contributed to the modest 0.9% estimated total revenue growth in the general revenue fund (GRF) between the fiscal years.

The state legislature appropriated $45 million from the RDF prior to the close of fiscal 2013 to finance costs associated with the severe weather events in the Oklahoma City area in May 2013. The draw lowered the RDF balance to $535 million, which is still equal to almost 10% of GRF revenues. The cash flow reserve, derived from any revenues in excess of the 95% appropriated and maintained at 10% of general fund appropriations, received a $27.4 million addition in fiscal 2013. This brings the balance to $559.5 million; combined, both reserves were equal to 19.5% of GRF revenues in fiscal 2013.

The enacted $7.1 billion operating budget for fiscal 2014 (inclusive of federal funds) was a 5.1% increase from fiscal 2013. Notable expenditure increases include an additional $31.6 million to the department of education, $70.1 million increase to higher education, and $145.2 million to health and human service to cover the cost of currently eligible Medicaid enrollees joining the system with the implementation of federal health care reform requirements and increases to human services agency funding.

A companion bill to the operating budget included a two-step lowering of the top PIT rate. However, following the passage of the bill, the legislation was ruled by the state Supreme Court to be unconstitutional, due to the prohibition on multiple subjects being included in a single piece of legislation. The rate reduction from 5.25% to 5% was to be effective Jan. 1, 2015, and a further reduction was scheduled to be effective Jan. 1, 2016, if total revenue growth met or exceeded the fiscal impact from the second planned tax reduction. The combined loss in PIT revenues was estimated at $237 million per year. The second piece of the disallowed legislation appropriated $60 million in PIT revenue for repairs to the state capitol building in fiscal 2014 from current revenue collections; that dedication was prohibited by the court ruling.

The June 2013 estimate from the State Board of Equalization (SBE) forecast fiscal 2014 GRF sources to grow by 5.1% to almost $5.9 billion from the estimated ending fiscal 2013 revenues. A decline in the PIT was forecast at 0.5% while the CIT was expected to grow by a robust 6.7% from fiscal 2013. Other major revenue sources, such as the sales tax, were forecast at a growth rate of 6.8% and severance tax receipts were expected to show renewed growth of 22.5% from fiscal 2013.

The forecast was officially updated in December 2013 and expected revenues in the GRF were lowered by 2.3% to $5.75 billion. Adjustments included an addition of $51.4 million to the PIT forecast from the inability to undertake the dedicated renovations to the state capitol (which were to have been drawn from collections before deposit to the general and education funds) offset by year to date declines in collections. This provided for a 0.9% ($19.3 million) positive revision in the PIT, a net increase of 17% ($46.4 million) in production tax revenue, a negative revision to the sales tax of 3.7% ($75.9 million), and a 22.1% ($106.3 million) negative revision to the CIT.

The SBE forecast was again updated in February 2014 and expected GRF revenue in fiscal 2014 was again lowered (to $5.71 billion). Notable adjustments from the December 2013 forecast included a $68 million decrease in expected CIT revenue offset by a $20.1 million increase in production tax revenue. As the lowered revenue expectation continues to provide cushion within the state's required 95% appropriation requirement, the state is not recommending budgetary adjustments at this time. The state does retain the ability to enact across the board expenditure reductions should revenues fall below 95% of the annual certified estimate.

The updated forecasts incorporate fiscal 2014 year to date GRF revenues that have been consistently below forecast, with results through February at 4.8% below expectations. PIT receipts through February include the aforementioned funds from the disallowed state capitol improvement funding; improving an otherwise below forecast PIT to essentially meeting forecast.

Collections from the volatile CIT are down 34.9% YOY and are running 39% below the original budget forecast. Sales tax receipts have exhibited 1.6% YOY growth, but are 4.2% below forecast. Somewhat offsetting these disappointing results are severance tax receipts, which are up over 84.7% from fiscal 2013 and are 6.5% above the budget forecast. However, the amount of overage continues to lessen since December (then up 545% YOY and 15% above forecast). Overall GRF revenues are 0.2% higher YOY.

The governor's proposed $7 billion operating budget for fiscal 2015 incorporates a 2.4% reduction of recurring revenues in support of the budget. This represents an $83 million transfer from non-restricted agency revolving funds to the GRF and an increase of $43.2 million in the education reform revolving fund's spending authority. Other than certain strategic initiatives, the budget includes a 5% reduction to most state agencies as a result of the lower revenue forecast.

The budget also factors in the governor's proposed successor bill to the 2014 PIT rate reduction legislation, with a recommended PIT rate reduction for the state's highest taxpayers from 5.25% to 5%, effective Jan. 1, 2015. If enacted, the rate reduction is estimated to reduce fiscal 2015 revenue by $47.4 million and fiscal 2016 revenue by $71.1 million.

The February 2014 SBE forecast lowered the state's discretionary expenditure authority for fiscal 2015 to $6.9 billion from the prior $7.1 billion; discretionary expenditures are a component of the governor's proposed budget for fiscal 2015. The revised estimate is $17.7 million less than the revenue base used for the governor's proposed budget.

CONSERVATIVE DEBT MANAGEMENT

The state's debt management is conservative and net tax supported debt of $1.9 billion is equal to a very manageable 1.2% of 2012 personal income. Debt amortization is relatively rapid, with 65.6% of outstanding principal repaid in 10 years; current GO debt is fully repaid in five years. Aside from the governor's current proposal to issue a $120 million bond for capitol building repairs, there are fairly limited plans for additional borrowing and the state has a manageable capital improvement plan.

The state has taken significant steps to address pension underfunding, which had been a credit issue. Several reform measures were adopted in the fiscal 2011 legislative session to address funding gaps. Unfunded cost of living adjustments were eliminated, reducing all seven state systems' unfunded liabilities by a combined one third; the minimum age for retirement was raised for all new employees; a portion of all future surplus revenue and one-time funds was dedicated to the fiscal restoration of the systems; employer and employee contribution rates are now set to meet the annual actuarially calculated required contribution (ARC); and other actions were taken to restore system integrity.

For fiscal 2013 on a reported basis, OPERS' (state's largest system) funded ratio was a solid 81.6% and TRF's (teacher's) funded ratio was a weaker 57.2%. Using Fitch's more conservative 7% discount rate assumption (instead of the 7.5% rate assumed by OPERS and 8% for TRF), the funded ratio for OPERS would be 77.3%, while for TRF it would be 51.6%. The state overfunded its required contribution to the systems in fiscal years 2012 and 2013. On a combined basis, the state's debt and pension liabilities are about average for U.S. states rated by Fitch at 6.5%.

Additional information is available at www.fitchratings.com.

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

Applicable Criteria and Related Research:
--'Tax-Supported Rating Criteria' (Aug. 14, 2012);
--'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
U.S. Local Government Tax-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=685314

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Contacts

Fitch Ratings
Primary Analyst:
Marcy Block, +1-212-908-0239
Senior Director
Fitch Ratings, Inc., One State Street Plaza, New York, NY 10004
or
Secondary Analyst:
Karen Krop, +1-212-908-0661
Senior Director
or
Committee Chairperson:
Douglas Offerman, +1-212-908-0889
Senior Director
or
Media Relations:
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com

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Contacts

Fitch Ratings
Primary Analyst:
Marcy Block, +1-212-908-0239
Senior Director
Fitch Ratings, Inc., One State Street Plaza, New York, NY 10004
or
Secondary Analyst:
Karen Krop, +1-212-908-0661
Senior Director
or
Committee Chairperson:
Douglas Offerman, +1-212-908-0889
Senior Director
or
Media Relations:
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com