Fitch Ratings has assigned a '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):
--$16.705 million series 2016F.
The bonds are expected to sell via negotiation on or about Aug. 30, 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 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. Oklahoma's unemployment rate remains below the national
rate although it has moved closer to that of the nation (80% in 2015
compared to 65% in 2012 and continuing to rise this year). 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. 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 GO rating 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
real property 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 real property
lease program is 30 years and lease payments are not abatable. The
current offering will fund construction of student housing on three
separate college campuses.
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. The remainder of this release addresses factors
related to the state's 'AA+' IDR.
Revenue Framework
Sales taxes and personal income taxes (PIT) provide almost equal support
of the General Revenue Fund (GRF), totaling about 75% of fiscal 2016
revenues, with additional revenue flowing from corporate income and
severance taxes. The state is directed by state statute to deposit
portions of tax revenues to several of its pension systems for funding
of the actuarially required contribution (ARC). Dedicated revenues
include insurance premium taxes, driver's license taxes, and motor
vehicle inspection fees; a sizable 5% of revenues from sales and use
taxes, PIT, corporate income taxes, and lottery proceeds is dedicated to
funding the annual contribution to the teachers' pension system.
Historical growth in the state's revenues, after adjusting for the
estimated impact of tax policy changes, was slightly below the pace of
national GDP growth over the 10 years through 2014, with solid growth in
most years more than compensating for recessionary declines. A key input
to the solid growth trend has been natural resource development;
however, the current slump in these commodities required state action to
close a sizable forecast budget gap in fiscal 2017. Fitch expects this
slow revenue trend will continue over the medium term as crude oil and
natural gas prices are expected to remain subdued.
Expenditure Framework
As in most states, education and health and human services spending are
Oklahoma's largest operating expenses. Education is the larger line
item, as the state provides significant funding for local school
districts and the public university and college system. Health and human
services spending is the second largest area of spending, with Medicaid
being the primary driver.
Fitch expects that spending growth, absent policy actions, will be ahead
of natural revenue growth, driven primarily by Medicaid, and require
regular budget adjustments to ensure ongoing balance. The fiscal
challenge of Medicaid is common to all U.S. states and the nature of the
program as well as federal government rules limit the states' options in
managing the pace of spending growth. In other major areas of spending
such as education, Oklahoma is able to more easily adjust the trajectory
of growth.
Overall, Oklahoma retains ample ability to adjust expenditures to meet
changing fiscal circumstances. While Medicaid remains a notable cost
pressure, spending requirements for debt service, pension, and OPEB are
manageable; carrying costs accounted for 8% of expenditures in fiscal
2015. Pension contributions over the past several years have been
significantly above the ARC as the state dedicates certain portions of
various taxes to pension liabilities and these contributions benefited
from the robust revenue growth coming out of the national recession
prior to fiscal 2015. Fitch does not expect this ratio to change
significantly; but, commensurate declines in both dedicated revenues and
operating expenditures are expected as the state tackles its current
financial difficulties.
Long-Term Liability Burden
As of June 15, 2016, the state's debt burden at 0.8% of 2015 personal
income is very modest and remains a low burden on resources. Per Fitch's
October 2015 State Pension Update report, the state's total net
tax-supported debt and unfunded pension liabilities represented a low
5.8% of 2014 personal income, equal to the 50-state median. The state
has consistently overfunded its ARC for the pension systems in recent
years due to robust revenue growth, and Fitch expects annual
contributions in upcoming years to move closer to the ARC due to the
constrained revenue situation. The state's OPEB obligations are modest,
and the state made 63% of the actuarially calculated ARC payment for
OPEB in fiscal 2015.
The state is a very modest although frequent issuer of debt; most debt
is backed by annual appropriations from the state legislature. As of
June 15, 2016, there was $122 million in outstanding general obligation
debt out of a total of $2.1 billion outstanding. The remainder fairly
evenly split between the Development Finance Authority, largely for
projects related to the state's system of higher education with a large
proportion self-supported by tuition and campus fees, and the Capital
Improvement Authority, for capital projects related to various state
agencies. The state reports limited future debt issuance plans although
a $200 million bond issue for transportation projects is expected during
fiscal 2017.
Operating Performance
Oklahoma's ability to respond to cyclical downturns rests with its
superior budget flexibility. While the state fared better than the
nation through the most recent recession, operating revenues
nevertheless experienced two years of significant declines. To achieve
budgetary balance, the state reduced expenditures and applied balances
in its RDF, a similar approach to that taken by the state in closing the
recent significant budget gaps created by the extensive softening in the
oil and natural gas industries and the PIT rate cut enacted prior to the
fall in resource prices. The state's reliance on spending cuts and
reserve draw-downs to achieve balance in downturns partially reflects
the requirement of a supermajority vote of the legislature or an
affirmative vote of the electorate for revenue expansions, which limits
the state's practical ability to use this tool.
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. The state closely tracks revenue collections during the year and
forecasts are updated three times each fiscal year.
The state's monthly revenue monitoring and forecast updates are an
important tool that the state applies to ensure budgetary balance.
Additionally, state agency spending is overseen by the state's secretary
of finance and administration who is granted the authority to enact
across-the-board agency reductions should revenues fall below
expectations. These practices are critical to maintaining balance, since
the volatile natural resource industry has an oversized impact on the
state's economy, and finances and operations respond quickly to national
economic trends.
The state's steady recovery following the most recent recession, largely
tied to vibrant growth in the oil and natural gas industries, allowed
the state to rebuild its RDF to 9.3% of GRF revenues in fiscal 2015. The
enactment of a two-step PIT rate cut in 2014, with the first reduction
taking effect in 2016, did not consider the potential for a significant
retraction in this sector that would slash the state's operating
revenues. The rate cut contributed to a very large structural budget gap
identified for fiscal 2017, leading to the allocation of $65.8 million
from the RDF. The appropriation from the RDF for fiscal 2017 follows
total appropriations from the fund of $228.6 million in fiscal 2016,
bringing the expected RDF balance at the close of fiscal 2017 to $240.8
million or 4.6% of GRF revenues. Fitch believes the continued
appropriations from the RDF highlight the difficulty in achieving
structural solutions to the currently underperforming revenue sources
and have reduced the state's financial flexibility.
Current Developments of Interest
Fiscal 2016 financial operations were strained by the underperformance
in state revenue sources caused by significant softening in the oil and
natural gas industries; revenue performance for fiscal 2016 is estimated
at 9.4% below the expectations on which the enacted budget was based.
While PIT collections were about 1.3% less than forecast, sales tax
collections were over 11% below (incorporating a decline in
mining-related equipment purchases), gross production tax collections
were 67% below forecast, and motor vehicle tax collections were 6% below
forecast.
For fiscal 2016, the state instituted a 7% mandatory midyear funding cut
to balance the budget following the declaration of a revenue failure.
Final revenue collections were an improvement on expectations, allowing
the state to identify $140.8 million that can now be allocated toward
expenditures in fiscal 2017. The governor is considering calling a
special legislative session to direct the $140.8 million to teacher pay
increases. Without a special session, the moneys would be distributed
equally among all agencies receiving GRF allocations. The $140.8 million
is not eligible to be deposited in the RDF as the funds are not
considered surplus funds under state statute.
Fitch believes financial operations will continue to be challenged in
the context of the suppressed natural resource price environment. Fitch
is currently forecasting an oil price per barrel (bbl) of $42 in 2016
and $45 in 2017; the state's forecast incorporates a price expectation
of $40.29/bbl in fiscal 2017.
The enacted $6.8 billion operating budget for fiscal 2017, not inclusive
of the $78.6 million supplemental appropriation for fiscal 2016 from the
RDF, closed an anticipated $1.3 billion budget gap (equal to 19% of
appropriations in fiscal 2016) that resulted from continued low natural
resource prices, a weak economic forecast, and the previously enacted
PIT rate cut. State actions to address the gap included various fund
transfers and sweeps, additional allocations from the cash flow reserve
fund, reforms to the PIT, a shift to bonding for transportation capital
projects rather than pay-go funding, and a further appropriation from
the RDF. Fitch believes the sizable number of one-time measures to close
the gap leaves the state exposed to further potential budgetary
imbalance with a reduced reserve position and is reflected in the
Negative Outlook. Further, 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; however,
Fitch believes it is unlikely to be triggered in the near term.
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/creditdesk/reports/report_frame.cfm?rpt_id=879478
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