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 refunding
bonds (subject to annual appropriation):
--$18.66 million tax-exempt series 2016B;
--$10.985 million federally taxable series 2016C.
The bonds are expected to sell via negotiation on or about June 1, 2016.
In addition, Fitch affirms the following ratings the state of Oklahoma:
--Issuer Default Rating (IDR) at 'AA+';
--$122.1 million state general obligation (GO) bonds 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 remains 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
Oklahoma's 'AA+' rating reflects the state's strong control over
revenues and spending, conservative budgeting practices, and low
liability position. These factors are critical to the rating given the
sizable economic concentration in natural resource development and
subdued growth prospects for revenue. The Negative Outlook reflects
Fitch's concern that the state may be challenged in achieving
structurally sustainable solutions over the medium term given its
current fiscal and economic challenges.
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 the 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 for a U.S. state. 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, Fitch
believes enacting sustainably balanced fiscal operations in 2017 and
beyond will be challenging, given the current economic slowdown and
expectation for a 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 has drawn on its reserves to cover gaps in
fiscal 2016. 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
additional draws on the RDF are currently anticipated.
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 refund a portion of the ODFA's outstanding 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.
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 are 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 ten 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 is the primary
contributor to the 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
expenses 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, however, as 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 Dec. 31, 2015, the state's debt burden at 1.1% of 2015 personal
income is very modest and remains a manageable burden on resources. Per
Fitch's October 2015 State Pension Update report, the state's total net
tax-supported debt and unfunded pension liabilities (UAAL) represented a
manageable 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 ARC payment in fiscal 2015.
The state is a very modest although frequent issuer of debt; most debt
issuance is backed by annual appropriations from the state legislature.
As of Dec. 31, 2015, there was $122 million in outstanding general
obligation debt out of a total of $2 billion outstanding. The remainder
of obligations is fairly evenly split between the Development Finance
Authority, largely for projects related to the state's system of higher
education, and the Capital Improvement Authority, for capital projects
related to various state agencies. Fitch expects the state to continue
to be a very modest issuer of debt in future years although noting the
potential for some increased borrowing in 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 the state's current efforts to close
the recent, significant budget gaps created by the extensive softening
in the oil and natural gas industries and the PIT rate cut. The state
relies on spending cuts and reserve draw-downs to achieve balance in
downturns; the requirement of a supermajority vote of the legislature or
an affirmative vote of the electorate for revenue expansions 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 as the
volatile natural resource industry has an oversized impact on the
state's economy and finances and operations also respond quickly to
national economic trends.
Current Developments of Interest
Fiscal 2016 financial operations have been strained by an 8%
year-to-date underperformance in state revenue sources caused by
significant softening in the oil and natural gas industries. The state's
recent employment trends show year-over-year (yoy) employment declines
over the past five months through March 2016, as the slumping natural
resources sector has led to shuttered rigs, production declines, and
layoffs. Baker Hughes, a large oilfield service company, reports an
average of 62 rotary rigs in the state in April 2016, down from a peak
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. 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 $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.
This economic weakness and the PIT rate cut have led to total GRF
revenues that are down 9.4% 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. To date, sales tax collections are
6.9% below expectations (incorporating a decline in mining-related
equipment purchases), gross production tax collections are 67% below
forecast, and motor vehicle tax collections are 11.8% below forecast.
The fiscal 2016 underperformance has required two rounds of sizable
appropriation cuts and draws from the state's RDF 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. 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 the previously enacted PIT rate cut. The state is
working to achieve concurrence on expenditure and revenue measures to
balance the budget while also considering an additional appropriation
from the RDF. 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.
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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