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 equipment lease revenue refunding bonds (subject to annual appropriation):
--$5.485 million tax-exempt series 2016A;
--$6.2 million federally taxable series 2016B.
The bonds are expected to sell via negotiation on or about April 13, 2016.
In addition, Fitch affirms the following ratings:
--$122.1 million in general obligation (GO) bonds issued by the state at 'AA+';
--$1 billion appropriation-backed debt of the state issued by the Oklahoma Capital Improvement Authority at 'AA';
--$953.8 million appropriation-backed debt of the state issued by the ODFA at 'AA'.
The Rating Outlook has been revised to Negative from 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 is annual allocations to the state
Board of Regents for higher education on behalf of certain
Oklahoma
colleges and universities.
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.
FISCAL CHALLENGES DRIVE THE NEGATIVE OUTLOOK: Revenue collections in fiscal 2016 are far below the state's expectations, largely driven by significant softening in the oil and natural gas industries, and requiring sizable appropriation cuts and draws from the state's rainy day fund (RDF) to balance. A sharp, almost 19% drop in total available revenue for the operating budget is forecast for fiscal 2017 as commodity prices and production are expected to remain subdued, while the full-year impact of a recent personal income tax (PIT) cut is also incorporated. Fitch believes sustainably balanced fiscal operations in 2017 and beyond will be challenging, particularly as revenue measures require a super majority of the legislature or a voter referendum to enact.
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 February 2016 are trending higher year over year (yoy) as the natural resources slowdown continues to be incorporated, while remaining below national averages.
CONSERVATIVE FINANCIAL MECHANISMS: The state's financial operations benefit from the maintenance of a separate RDF (the constitutional reserve), 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.
LOW LIABILITY BURDEN: Debt levels are low, and tax-supported debt is amortized relatively quickly. Several rounds of pension reform have improved the state's overall long-term liability position bringing it to the state average of 5.8% of personal income.
RATING SENSITIVITIES
The rating on the state's appropriation-backed bonds is sensitive to shifts in the state's GO rating to which it is linked.
The Negative Outlook reflects Fitch's concern that the state may be challenged in achieving structurally sustainable solutions over the medium term given its fiscal and economic challenges.
CREDIT PROFILE
The state's 'AA+' GO bond rating reflects 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 policies have helped to date to buffer fiscal 2016 financial operations that have been strained by an 8.9% year-to-date underperformance in state revenue sources caused by the low natural resource prices.
The state appropriated a portion of the RDF when enacting the fiscal 2016 budget in addition to other one-time actions to achieve balance. Mid-year underperformance in state revenue sources caused by low natural resource prices necessitated two rounds of expenditure reductions to bring the state back within the 5% revenue cushion. To offset cuts to secondary education and corrections, the state recently appropriated an additional $78.5 million from the RDF to these agencies, weakening the state's financial profile. With this appropriation, the RDF is expected to approximate a still sufficient 5.9% of currently expected revenue in fiscal 2016.
The state is forecasting a $1.3 billion total operating funds budget gap in fiscal 2017 (equal to 19% of appropriations in fiscal 2016) as a result of continued low natural resource prices and weak economic forecast as well as a previously enacted PIT rate cut. The governor's executive budget proposes several revenue initiatives to balance the budget in addition to expenditure reductions. However, tax rate adjustments are limited by a supermajority requirement of the legislature or voter referendum to raise tax revenues, making passage of the initiatives uncertain.
ECONOMIC BASE SAPPED BY LOW COMMODITY PRICES
After consistently outperforming national growth trends coming out of the last recession, the state's recent employment trends show yoy employment declines over the past four months through February 2016, as the slumping natural resources sector has led to shuttered rigs, production declines, and layoffs. The state recorded modest 0.7% yoy employment growth in 2015 as compared to more robust national employment growth of 2.1%; the state's recovery of jobs from the trough of the last recession stands at 162% as of February 2016 as compared to a national average of 159%.
February 2016 yoy employment declined by 0.5% as compared with 1.9% yoy growth for the nation, incorporating a substantial 21.8% yoy three-month moving average decline in natural resources and mining employment, which constitutes 3% of state employment. Manufacturing also continues to trend downward, with a 7.1% three-month moving average yoy decline. Faintly positive trends continued in most other state employment sectors through February.
Positively,
Oklahoma's
4.2% unemployment rate in February remains below the national 4.9% rate. The rate has moved closer to that of the nation (80% in 2015 compared to 65% in 2012) as the state's annual employment growth has slowed. The low rate highlights the state's progress in diversifying its economy beyond natural resource development in recent years, which nonetheless has not spared the state from the effects of the current energy sector contraction.
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, reports an average of 76 rotary rigs in the state in February 2016, down from a peak average of 214 in September 2014, incorporating actions by domestic oil companies to pull back on well drilling and production 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 59% yoy for the first eight months of fiscal 2016 and 67% 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 February 2016 revenue forecast lowered expectations for severance tax revenue by 64.4% 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 2% in fiscal 2016.
LARGELY CONSERVATIVE FINANCIAL MECHANISMS
Financial operations are supported by largely conservative fiscal 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 GRF, including in the current and two most recent fiscal year ended on June 30, 2014 and 2015. However, a supermajority requirement on tax rate increases limits the state's fiscal flexibility.
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, a divergence 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 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 prior three fiscal years. Severance taxes from oil production were forecast to decline by 22% from fiscal 2015.
Year-to-date through February 2016, GRF revenues are below the original budget forecast by 8.9% and down 9.7% 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. To date, sales tax collections are 11.3% below expectations (incorporating a decline in mining-related equipment purchases), gross production tax collections are 67% below forecast, and motor vehicle tax collections are 13.2% below forecast. Recognizing the revenue trend, the BOE lowered the fiscal 2016 and 2017 revenue forecasts in both December 2015 and February 2016.
The February forecast projects a decline of 9.6% in fiscal 2016 GRF revenues from fiscal 2015. The forecast revisions accompanied two rounds of state certifications of revenue failures for fiscal 2016, requiring state action to reduce the budget by a total of $552 million (7.7% of budgeted appropriations), as state law requires the budget to be balanced.
For fiscal 2017, the BOE's February forecast further updated revenue expectations, certifying $766.2 million less revenue available for GRF appropriations, a decline of 13.3% as compared to the enacted budget for fiscal 2016. The negative revision includes both the softened oil and natural gas price expectations as well as a full year loss from the PIT rate cut. 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; Fitch believes it is unlikely to be triggered in the near term.
The Negative Outlook incorporates Fitch's expectation that enacting a sustainably balanced budget for fiscal 2017, while possible, will be challenging in the context of the suppressed natural resource price environment. Fitch is currently forecasting an oil price per barrel (bbl) of $35 in 2016 and $45 in 2017; the state's forecast incorporates price expectations of $39.67/bbl in fiscal 2016 and $40.29/bbl in fiscal 2017.
CONSERVATIVE DEBT MANAGEMENT
The state's debt management is conservative and net tax-supported debt of almost $2 billion is equal to a very manageable 1.1% of 2015 personal income. Debt amortization is rapid, with 73.4% of outstanding principal repaid in 10 years; current GO debt, which totals only $122 million, is fully repaid in three years. The state has a manageable capital plan with a significant pay-go component, although it has indicated additional debt issuance for capital projects may be considered. Fitch expects tax-supported debt to remain low.
Oklahoma's
combined burden of debt and unfunded pension obligations, adjusted by Fitch to reflect a 7% return assumption, at 5.7%, approximates the median for
U.S.
states. The state took significant steps to address weakened pensions in recent years, which had been a credit issue; solutions included contributions in excess of actuarial requirements. Several reform measures were enacted in the 2011 through 2014 legislative sessions, including closing OPERS' (the state's largest pension system) defined benefit system to most new participants as of Nov. 1, 2015.
OPERS funded ratio has risen to a reported 93.6% in fiscal 2015 from 81.6% in fiscal 2013. TRS' (teachers) funded ratio improved to 66.6% in fiscal 2015, from 57.2% in fiscal 2013. A lawsuit challenging the passage of OPERS reforms on several grounds, including procedural violations remains unresolved. Fitch will monitor the outcome, which the state believes would have a minimal impact 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.
CURRENT OFFERING
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 current offering will refund a portion of the ODFA's outstanding 2006A bonds for debt service savings.
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 is currently $907 million, following two successive rounds of cuts since the fiscal year began, totaling $56 million. Despite the appropriation reductions, Fitch believes the state retains sufficient financial resources to fund debt service requirements for higher education debt obligations.
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 beginning of the second 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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Fitch Ratings
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Marcy Block
Senior Director
+1-212-908-0239
Fitch Ratings, Inc.
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New York, NY
10004
or
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or
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or
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