Fitch Rates Oklahoma's $6MM ODFA Bonds 'AA'; Outlook Stable

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

--$6.075 million Oklahoma Development Finance Authority (ODFA) Oklahoma state system of higher education master equipment lease revenue bonds, series 2014B (subject to annual appropriation).

The bonds are expected to sell via negotiation on Aug. 13, 2014.

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

--$177.53 million Oklahoma general obligation (GO) bonds at 'AA+';

--$1.15 billion appropriation-backed debt of the state issued by the Oklahoma Capital Improvement Authority at 'AA';

--$736 million appropriation-backed debt of the state issued by the ODFA at 'AA'.

The Rating Outlook is Stable.

SECURITY

The bonds are limited special obligations of the ODFA secured by annual appropriations of the state of Oklahoma. The intended source of repayment on the bonds is the state board of regents for higher education on behalf of certain Oklahoma colleges and universities from their annual budget allocations.

KEY RATING DRIVERS

APPROPRIATION MECHANISM: The rating on the ODFA 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 (RDF). 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 ODFA bonds currently offered are secured by lease rental payments by the State Regents from state general fund revenues, subject to annual legislative appropriation. ODFA is one of the principal financing agencies of the state. Both the state constitution and enabling statutes provide for appropriation of lease payments in support of the master equipment program, and the master leasing structure on behalf of the State Regents has been validated by the Oklahoma state supreme court. The terms of the leases extend through the life of the bonds, with a maximum term of 20 years; lease payments are not abatable. The current offering will provide for equipment purchases by two higher education institutions within the state.

All higher education appropriations to the State Regents are consolidated, with the State Regents authorized to allocate funds first to payment of lease rentals of each participating institution. The State Regents covenant to include a budget request for lease payments sufficient to pay debt service for program bonds. The fiscal 2015 operating fund appropriation for the State Regents is $988.5 million, identical to the budget appropriation for fiscal 2014. The stable appropriation is a positive for the State Regents as most other state agencies' appropriations were decreased by 5.5% in fiscal 2015, incorporating a reduced level of expected revenues for that year.

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 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 1.2% yoy employment growth in calendar year (CY) 2013 as compared to a more robust national employment growth rate of 1.7%. June 2014 yoy state employment growth improved to 2.2%, slightly more robust than the 1.9% yoy growth for the nation. The improved growth rate encompassed fairly widespread sector growth, including 5.8% yoy growth in leisure and hospitality, 3.3% yoy growth in trade, transportation, and utilities, and 3.7% yoy growth in manufacturing employment. Offsetting the growth was a modest 0.7% decline in yoy mining and natural resources employment and a 3.2% decline in information sector employment. Oklahoma's unemployment rate has historically been well below the nation's; June 2014's rate at 4.5%, below the 6.1% rate for the nation, continues this trend.

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 in 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 both severance and corporate income tax receipts to the general fund, including in the recent fiscal year that ended on June 30, 2014.

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 (RDF) at fiscal year-end, bringing the RDF 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 although the final estimated total revenue growth in the general revenue fund (GRF) was a more modest 0.9% 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 was still equal to almost 10% of GRF revenues. The state also maintains a cash flow reserve fund (CFRF) that is derived from any revenues in excess of the 95% appropriated and capped at 10% of GRF appropriations.

The enacted $7.1 billion operating budget for fiscal 2014 (not inclusive of federal funds) was a 4.1% increase from fiscal 2013. Notable expenditure increases included an additional $90.9 million to the department of education, $33.9 million increase to higher education, and $108.1 million to health and human services 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. The state estimates revenue collections in the GRF in fiscal 2014 totaled $5.6 billion, which was just $1.5 million (0.3%) above collections in fiscal 2013 and $283.8 million (4.8%) below the official estimate upon which the fiscal 2014 budget was based.

Notable deviations from forecast occurred with the sales tax (short of forecast by 3.5% but 3.1% growth yoy) and the corporate income tax (CIT; short of forecast by 36.4% and 32.1% below collections in fiscal 2013). The personal income tax (PIT) missed the forecast by a modest 0.9% while declining 1.4% yoy from fiscal 2013. The difference from the PIT forecast is notable as the forecast benefited from the addition of $51.4 million from the state's inability to undertake dedicated renovations to the state capitol (which were to have been drawn from PIT collections before deposit to the general and education funds). The legislation permitting this capital expense 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. These lower than expected results were somewhat offset by strong 50.4% yoy growth in severance tax receipts that were 22.7% improved from forecast. As the lower, total revenue collection was within the state's required 95% appropriation requirement, no budgetary adjustments were required to maintain balance. The RDF balance remained at $535 million, equal to 9.6% of fiscal 2014 expenditures.

The enacted $7.1 billion operating fund budget for fiscal 2015 is a 1.4% decrease from the fiscal 2014 budget, incorporating $188 million less certified revenue than in fiscal 2014. Offsetting the decline in the enacted budget, the 2015 budget agreement provided for the use of $292.7 million in fund balances in various state funds, including $101 million from the CFRF available from fiscal 2014 receipts, that can be used for expenditures in fiscal 2015. A component of the certified revenue forecast, the $5.86 billion GRF revenue forecast factors in solid 4.5% growth from actual collections in fiscal 2014, including 2.1% growth in the PIT, 3.8% growth in sales tax collections, 22.4% growth in the volatile CIT, offset by a 2.9% expected decline in severance tax revenue.

A PIT rate reduction for the state's highest taxpayers from 5.25% to 5%, contingent on increases in GRF tax revenue compensating for the foregone PIT revenue, was enacted in the 2014 legislative session, but does not take effect until Jan. 1, 2016 and therefore does not impact the revenue forecast for fiscal 2015. A second tax cut, to 4.85%, is scheduled to take effect on Jan. 1, 2017 under the same guidelines. When fully enacted, the full-year impact of the two rate cuts is estimated to be approximately $200 million.

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 1.3% of 2013 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 an expected $120 million bond for capitol building repairs that was approved by the 2014 legislature, 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 were 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 (teachers') 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 unfunded pension liabilities as a percentage of personal income at 7% is slightly above the median for U.S. states of 6.1%.

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. State Government Tax-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686033

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=843375

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Contacts

Fitch Ratings
Primary Analyst
Marcy Block
Senior Director
+1-212-908-0239
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

Sharing

Contacts

Fitch Ratings
Primary Analyst
Marcy Block
Senior Director
+1-212-908-0239
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