November 3, 2016 - 4:26 PM EDT
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Fitch Rates $3MM Oklahoma ODFA Bonds 'AA'; Outlook Negative

Fitch Ratings has assigned an 'AA' rating to the following state of Oklahoma, Oklahoma Development Finance Authority (ODFA) state system of higher education bonds:

--$2.06 million master equipment lease revenue refunding bonds, tax-exempt series 2016C (subject to annual appropriation);

--$930,000 master equipment lease revenue bonds, federally taxable series 2016D.

The bonds are expected to sell via negotiation on or about Nov. 15, 2016.

The Rating Outlook is Negative.

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 annual allocations to the state Board of Regents for higher education on behalf of certain Oklahoma colleges and universities.

KEY RATING DRIVERS

State Appropriation: The rating on the bonds, secured by annual appropriations from the state's general fund, is one notch below Oklahoma's 'AA+' Issuer Default Rating (IDR), reflecting the state's general credit standing, sound lease structure, and statutory authorization for these types of bonds. The Negative Outlook reflects the state's challenge in achieving structurally sustainable solutions over the medium term given the sizable economic concentration in natural resource development and subdued growth prospects for revenues.

Economic Resource Base

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. After consistently outperforming national growth trends coming out of the last recession, the state's economy has weakened and employment has shown recent, steady declines as the slumping natural resources sector has led to shuttered rigs, production declines, and layoffs. The unemployment rate moved closer to the national average (80% in 2015 compared to 65% in 2012) while the continuing drag in 2016 has boosted the rate above that of the U.S. Population growth continues above the national pace.

Revenue Framework: 'aa' factor assessment

Fitch expects Oklahoma's revenues, which are supported by broad-based sources, to continue to reflect economic volatility tied to the extensive natural resources sector. The current economic slowdown is expected to extend over the medium term and will continue to challenge revenue growth. The state has complete control over its revenues, with an unlimited independent legal ability to raise operating revenues as needed, although a supermajority vote of the legislature or voter approval for tax rate increases limits flexibility.

Expenditure Framework: 'aaa' factor assessment

The state maintains ample expenditure flexibility with a low burden of carrying costs for liabilities and the broad expense-cutting ability common to most U.S. states. A policy of appropriating only 95% of expected revenues provides a cushion for revenue variability. As with most states, Medicaid remains a key expense driver but one that Fitch expects to remain manageable.

Long-Term Liability Burden: 'aaa' factor assessment

Debt levels are low. On a combined basis, the state's net tax-supported debt and unfunded pension obligations is at the median for U.S. states as a percentage of personal income and a low burden on resources. Other post-employment benefit (OPEB) obligations are small.

Operating Performance: 'aa' factor assessment

The state's strong management of its financial operations has historically offset volatility in its revenue sources; however, the state has been especially challenged by the current economic slowdown and prolonged period of low natural resource prices. The state's financial operations benefit from the maintenance of a separate rainy day fund (RDF; the constitutional reserve) and cash flow reserve funds although the state drew on its reserves to cover gaps in fiscal 2016 and further applied reserves in the enacted budget for fiscal 2017. There is a consistent history of rebuilding reserves as the economy strengthens; however, a likely prolonged low oil price environment will continue to subdue the economy over the medium term and rebuilding of reserves may prove difficult.

RATING SENSITIVITIES

The rating on the state's appropriation-backed bonds is sensitive to shifts in the state's IDR to which it is linked.

The Negative Outlook on the IDR reflects Fitch's concern that the state will be challenged in providing a durable response to its current economic and financial challenges, diluting its future financial flexibility.

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. Additionally, the master leasing structure on behalf of the State Regents has been validated by the Oklahoma's 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 equipment lease program is 20 years and lease payments are not abatable. The series 2016C bonds will refund outstanding bonds for debt service savings and the series 2016D bonds will finance the acquisition of equipment for Oklahoma State University.

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 2017 operating fund appropriation for the State Regents is $810 million; this is a reduction of almost 16% from the enacted fiscal 2016 budget and down 7.7% from the revised fiscal 2016 budget following two rounds of mid-year cuts. Despite the appropriation reductions, Fitch believes the state retains ample financial resources to fund debt service requirements for higher education debt obligations, particularly as the majority of debt service is funded by student tuition and campus fees. The bonds are rated one notch below the state's IDR, reflecting the slightly higher degree of optionality associated with payment of appropriation debt.

Oklahoma's 'AA+' IDR reflects the state's strong control over revenues and spending, conservative budgeting practices and low liability position. These factors are critical to the 'AA+' rating given the sizable economic concentration in natural resource development and subdued growth prospects for revenue. Continuing recent trends, early fiscal 2017 sales tax collections are running below expectations by 6.5%; however, the underperformance has been offset by solid personal income tax (PIT) and severance tax collections. Through September, total General Revenue Fund revenue collections are running 1.4% ahead of forecast although 9.5% below the same period from one year earlier, reflecting the PIT rate cut and the softened economic profile. Overall, Fitch expects the state to maintain balanced financial operations in fiscal 2017.

For additional information on the state of Oklahoma, please see 'Fitch Rates $18MM Oklahoma ODFA Bonds 'AA'; Outlook Negative' dated Oct. 10, 2016 and available at www.fitchratings.com.

Date of Relevant Rating Committee: May 13, 2016

Additional information is available at 'www.fitchratings.com'.

In addition to the sources of information identified in the applicable criteria specified below, this action was informed by information from Lumesis and InvestorTools.

Applicable Criteria

U.S. Tax-Supported Rating Criteria (pub. 18 Apr 2016)

https://www.fitchratings.com/site/re/879478

Additional Disclosures

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1014301

Endorsement Policy

https://www.fitchratings.com/regulatory

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Source: Business Wire (November 3, 2016 - 4:26 PM EDT)

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