NEW YORK--(BUSINESS WIRE)--Fitch Ratings has assigned an 'AA' rating to the following state of Oklahoma, Oklahoma Development Finance Authority (ODFA), Oklahoma state system of higher education, master real property lease revenue bonds (subject to annual appropriation):
--$16.34 million series 2016A.
The bonds are expected to sell via negotiation on or about Jan. 26, 2016.
In addition, Fitch affirms the following ratings:
--$152.3 million in general obligation (GO) bonds issued by the state at 'AA+';
--$1.1 billion appropriation-backed debt of the state issued by the Oklahoma Capital Improvement Authority at 'AA';
--$957.3 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 obligations 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+' general obligation (GO) bond rating. This reflects the state's general credit standing, sound lease structure, and statutory authorization for this type of bond.
CONCENTRATED AND WEAKENED ECONOMIC BASE: The state's commodity-based economy, based on oil and natural gas production as well as various agricultural products, has weakened as a result of sharply lower prices for oil and natural gas. Unemployment rates through November 2015 are trending higher year over year (yoy) as the natural resources slowdown continues to be incorporated, while remaining below national averages.
COMMODITY PRICES UNDERMINING THE REVENUE OUTLOOK: Year to date revenue collections have not met the state's expectations and the revenue outlook for fiscal years 2016 and 2017 was severely trimmed at a recent meeting of the state's forecasting board. Actions to solve for the fiscal 2016 gap have been authorized; however, Fitch believes more stringent budget balancing solutions will be required in enacting a fiscal 2017 budget, as a budget gap approximating 13% of expenditures has been identified.
CONSERVATIVE FINANCIAL MECHANISMS: The state's financial operations benefit from the maintenance of separate rainy day fund (RDF; the constitutional reserve) and cash flow reserve funds and a policy of appropriating only 95% of expected revenues. The limited appropriation of revenues provides a cushion for the variability in the state's revenue sources, particularly the cyclical severance tax revenue.
MANAGEABLE LIABILITY POSITION: Debt levels are low, and tax-supported debt is amortized relatively quickly. Most new debt issuance is in the form of lease revenue bonds. Several rounds of pension reform have improved the state's long-term liability position.
RATING SENSITIVITIES
The rating on the state's appropriation-backed bonds is sensitive to shifts in the state's GO rating to which they are linked.
The Stable Outlook on the GO bonds reflects Fitch's expectation that the state will effectively respond to its current severe fiscal challenges while maintaining adequate financial reserves and a conservative liability profile. Absent structurally sustainable actions that recognize a prolonged low oil price environment, Fitch expects negative pressure on the state's rating.
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 real property program. Additionally, 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; the maximum lease term permitted by the ODFA under the master real property lease program is 30 years and lease payments are not abatable. The current offering will provide funding to Langston University to acquire student housing facilities from the Langston Economic Development Authority, the entity that constructed the student housing.
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 all bonds. The enacted fiscal 2016 operating fund appropriation for the State Regents was $963.4 million; a 3.5% reduction from the fiscal 2015 appropriation, enacted as part of state's plan to close a projected $611 million revenue shortfall in that fiscal year. As part of recent, across-the-board state actions to close a mid-year, fiscal 2016 budget gap, the State Regents appropriation was lowered by 3% to $939 million. Despite the appropriation reduction, Fitch believes the state retains sufficient financial resources to fund debt service requirements for higher education debt obligations.
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 RDF and cash flow reserve funds (CFRF). These disciplined policies have helped to date to buffer fiscal 2016 financial operations that have been strained by an underperformance in state revenue sources caused by the low natural resource prices that are sapping the state's economy.
The state appropriated a portion of the RDF when enacting the fiscal 2016 budget in addition to other one-time actions to achieve balance. Recent budgetary actions necessitated by the lower revenue forecast for fiscal 2016 were geared to bring the state back within the 5% revenue cushion and did not include an additional appropriation from the RDF to balance. However, the state could consider an additional appropriation from the RDF during the 2016 legislative session should the budget fall further out of balance; an action that could weaken the state's financial profile in the absence of concurrently enacting structural solutions in the fiscal 2017 budget. The state is facing a $900 million budget gap in fiscal 2017 as a result of the low natural resource prices as well as a previously enacted personal income tax (PIT) rate cut. Tax rate adjustments are limited by a supermajority requirement of the legislature or voter referendum to raise tax rates.
CONCENTRATED ECONOMIC BASE SAPPED BY LOW COMMODITY PRICES
After consecutively outperforming national growth trends coming out of the last recession, the state's yoy employment growth has slowed considerably as the slumping natural resources sector is incorporated. The state recorded 1.1% yoy employment growth in 2014 as compared to more robust national employment growth of 1.9%; however, the state's recovery of jobs from the trough of the recession stands at 156% as of November 2015 as compared to a national average of 152%.
Slow employment growth continued through most of 2015 although November 2015 yoy employment declined by 0.1% as compared with 1.9% yoy growth for the nation, incorporating a substantial 18.8% yoy decline in natural resources and mining employment (accounting for over 3% of state employment). Manufacturing also continued to trend downward, with a 5.9% yoy decline. Positive trends continued in most other state employment sectors through November, including 5.7% yoy growth in construction.
Positively, Oklahoma's 4.2% unemployment rate in November continues to be well below the national 5% rate, inclusive of strong 3.7% growth in the state's labor force, although the rate has moved up from 4% in November 2014. The low rate highlights the state's success in diversifying its economy beyond natural resource development. Fitch believes further erosion is likely given escalating initial and continuing unemployment insurance claims.
One-third of the state's gross state product is attributable to the drilling, production, and economic multiplier effects of the oil and natural gas sectors. Baker Hughes, a large oilfield service company, has reported average rotary rigs in the state were more than halved yoy as of December 2015, from 209 to 86, incorporating actions by domestic oil companies to pull back on new well drilling and reduce their workforces as profit margins have shrunk.
The price declines have also contributed to falloffs in the state's collection of severance tax revenue, down 31.9% yoy for the first five months of fiscal 2016 and 61.1% below forecast. The less-than-robust results are attributable to both below-forecast prices for natural gas and crude oil although the general fund does not receive severance taxes on crude oil production until $150 million has first been allocated for education and other specified programs. The December 2015 revenue forecast lowered expectations for severance tax revenue by 64.5% from the forecast used to enact the fiscal 2016 budget. Severance tax revenue accounted for 5.9% of fiscal 2014 GRF revenue; that figure is expected to decline to 1.9% in fiscal 2016.
CONSERVATIVE FINANCIAL MECHANISMS; WEAK FINANCIAL PERFORMANCE
Financial operations are supported by conservative financial policies, including a provision in the state constitution that limits appropriations to 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 revenue fund (GRF), including in the current and two most recent fiscal year ended on June 30, 2014 and 2015.
GRF revenue growth in fiscal 2015 was a modest 1.8%; 2.2% below forecast, but as the shortfall was within the state's required 95% appropriation limit, no budgetary adjustments were required to maintain balance. The RDF balance totaled $535 million, equal to 9.3% of fiscal 2015 GRF revenues, with additional revenue cushion provided by a CFRF of $275 million.
The state enacted a $7.18 billion total operating funds budget for fiscal 2016 (0.5% lower than expenditures in fiscal 2015) that solved for an identified $611 million budget gap through a mix of expenditure reductions, $225 million in various fund sweeps, a $121 million application of monies from the CFRF, and $150 million from the RDF. This was the second consecutive year in which the state applied one-time fund sweeps to solve for its revenue shortfalls, diverging from its more typical conservative practices.
In support of the enacted budget, the state Board of Equalization's (BOE) June 2015 revenue forecast projected GRF revenue in fiscal 2016 to total $5.7 billion. The forecast assumed a modest 0.3% increase from fiscal 2015 partly due to the implementation of lower PIT rates for the state's highest taxpayers, from 5.25% to 5%, pursuant to previously enacted tax reduction legislation. The lower rates contributed to an expected 6.4% decline in the PIT from fiscal 2015, while lower severance tax revenues were forecast from the natural resources softening, and the CIT was projected to decline by 17.7%. The declines were expected to be offset by an almost doubling in natural gas severance tax revenue from the completion of deferred tax rebate payments to producers that reduced revenue the past three fiscal years. Severance taxes from oil production were forecast to decline by 22% from fiscal 2015.
Year-to-date through November 2015, GRF revenues are below forecast by 4.6% and down 4.4% yoy, with better than expected results in the PIT and CIT unable to compensate for weak collections in sales, gross production, and motor vehicle taxes. Recognizing the current revenue trend, the BOE's December 2015 revenue forecast now projects fiscal 2016 GRF revenues to decline 7.4% from fiscal 2015; compared to the earlier 0.3% forecast gain. The forecast revision led to the state certifying a revenue failure for fiscal 2016, requiring state action to reduce the budget by at least $157 million, as state law requires the budget to be balanced.
Following the forecast revision, the state implemented 3% across-the-board reductions to GRF appropriations, reducing appropriations by $176.9 million to bring the operating funds budget back within the 5% certified revenue cushion. The state does not currently anticipate an additional appropriation from the RDF in fiscal 2016; however, the legislature may appropriate up to $150 million in additional RDF monies if warranted. The RDF balance of $385 million equals 6.7% of GRF revenue in fiscal 2016, excluding this potential draw.
The BOE's December forecast also updated revenue expectations for fiscal 2017, certifying $900.8 million less revenue available for appropriations (12.9%) as compared to the enacted budget for fiscal 2016. The negative revenue forecast revision includes both the softened oil and natural gas price expectations as well as a full year loss from the PIT rate cut. Fitch believes the state will be challenged to enact a budget for fiscal 2017 that solves for this gap without far more extensive actions than taken to date. The current rating assumes structurally balanced solutions that recognize a natural resource price environment that is expected to be suppressed over at least the next two years. Fitch is currently forecasting an oil price per barrel (bbl) of $45 in 2016 and $55 in 2017; the state's forecast incorporates price expectations of $42.83/bbl in fiscal 2016 and $53.77/bbl in fiscal 2017. Under current statute, a second PIT tax cut, to 4.85%, will take effect no earlier than two years after the enactment of the first rate cut under the established trigger guidelines.
CONSERVATIVE DEBT MANAGEMENT
The state's debt management is conservative and net tax-supported debt of $2.1 billion is equal to a very manageable 1.2% of 2014 personal income. Debt amortization is relatively rapid, with 65.6% of outstanding principal repaid in 10 years; current GO debt, which totals only $152 million, is fully repaid in five years. The state has a manageable capital improvement plan although it has indicated additional debt issuance for capital projects may be considered. Fitch expects tax-supported debt to remain manageable.
Oklahoma's combined burden of debt and unfunded pension obligations, adjusted by Fitch to reflect a 7% return assumption, is equal to the 5.8% median for U.S. states. The state has taken significant steps to address weakening pensions, which had been a credit issue; solutions included overfunding its required contributions in recent years. Several reform measures were enacted in the 2011 through 2014 legislative sessions to address funding gaps, including HB 2630 in 2014 that closed OPERS' (the state's largest pension system) defined benefit system to most new participants as of Nov. 1, 2015, with new employees eligible for a new defined contribution pension plan as of that effective date.
HB 2630 contributed to OPERS improving its funded ratio to a reported 88.6% in fiscal 2014 from 81.6% in fiscal 2013. TRS' (teachers) funded ratio improved from 57.2% in fiscal 2013 to 63.2% in fiscal 2014. A lawsuit was filed in October 2014 regarding the closure of the defined benefit plan, challenging the passage of HB 2630 on several grounds, including procedural violations in its passage. Fitch will monitor the progress of this lawsuit, which the state believes would have a minimal impact on OPERS and the state should the state not prevail.
Beginning in fiscal 2014, the state's pension systems issued financial statements under new GASB statement 67 reporting standards. Based on the new standards, OPERS reports assets equaling 96% of liabilities for fiscal 2015, while TRS reports the same figure at 72.4% in fiscal 2014 (fiscal 2015 not yet available); the higher ratios under the new standards primarily reflect the full recognition of solid asset gains in recent years.
Additional information is available at 'www.fitchratings.com'.
Fitch recently published an exposure draft of state and local government tax-supported criteria (Exposure Draft: U.S. Tax-Supported Rating Criteria, dated Sept. 10, 2015). The draft includes a number of proposed revisions to existing criteria. If applied in the proposed form, Fitch estimates the revised criteria would result in changes to less than 10% of existing tax-supported ratings. Fitch expects that final criteria will be approved and published by the end of the first quarter of 2016. Once approved, the criteria will be applied immediately to any new issue and surveillance rating review. Fitch anticipates the criteria to be applied to all ratings that fall under the criteria within a 12-month period from the final approval date.
Applicable Criteria
Exposure Draft: U.S. Tax-Supported Rating Criteria (pub. 10 Sep 2015)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869942
Tax-Supported Rating Criteria (pub. 14 Aug 2012)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686015
U.S. State Government Tax-Supported Rating Criteria (pub. 14 Aug 2012)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686033
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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=997881
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