News Column

Fitch Rates Oklahoma's $16MM ODFA Bonds 'AA'; Outlook Stable

June 20, 2014

NEW YORK--(BUSINESS WIRE)-- Fitch Ratings assigns an 'AA' rating to the following issue of the state of Oklahoma:

--$15.825 millionOklahoma Development Finance Authority (ODFA) Oklahoma state system of higher education master real property lease revenue bonds, series 2014D (subject to annual appropriation).

The bonds are expected to sell via negotiation the week of July 9, 2014.

In addition, Fitch affirms the ratings on the following outstanding debt:

--$177.53 millionOklahoma general obligation (GO) bonds at 'AA+';

--$1.161 billion appropriation-backed debt of the state issued by the Oklahoma Capital Improvement Authority at 'AA';

--$749.8 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 bonds 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+' GO bond rating. This reflects the state's general credit standing, sound lease structure, and statutory authorization for these types of bonds.

CONSERVATIVE FINANCIAL OPERATIONS: The state's financial operations are conservatively managed, including maintenance of separate rainy day (the constitutional reserve) and cash flow reserve funds and a policy of appropriating only 95% of expected revenues. Growth in personal and corporate income taxes as well as sales tax revenues has bolstered financial operations and allowed for consecutive deposits to the rainy day fund. This has in turn offset the cyclical collections of severance tax revenue.

CONCENTRATED ECONOMIC BASE: The state's commodity-based economy, based on oil and gas production as well as various agricultural products, strongly rebounded from the recession although recent economic growth has been more subdued.

MANAGEABLE DEBT POSITION: Debt levels are low, and tax-supported debt is amortized relatively quickly. Most new issuance is in the form of lease revenue bonds. The unfunded pension liability for state employees has improved following significant pension reform.

RATING SENSITIVITIES

The rating is sensitive to shifts in the state's GO rating to which it is linked.

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, and the master leasing structure on behalf of the State Regents was recently validated by the Oklahoma state supreme court. The terms of the leases extend through the life of the bonds, with a maximum term of 30 years; lease payments are not abatable. The current offering will be applied to construction or renovation of student housing facilities for two higher education institutions within the state.

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 program bonds. The fiscal 2014 operating fund appropriation for the State Regents is $988.5 million, which is an increase in appropriation of 3.5% from fiscal 2013. The enacted budget for fiscal 2015 provides for a flat budget appropriation from fiscal 2014. The stable appropriation is a positive for the State Regents as most other state agencies' appropriations were decreased by 5.5% in fiscal 2015, incorporating a reduced level of expected revenues for that year.

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 rainy day (the constitutional reserve fund) and cash reserves. The state has demonstrated a willingness and ability to address fiscal challenges including revenue underperformance through the recent recession. Tax rate adjustments are limited by a supermajority requirement of the legislature or voter referendum to raise tax rates.

SLOW GROWTH IN STATE'S CONCENTRATED ECONOMIC BASE

After consecutively outperforming national growth trends coming out of the recent recession, the state's year-over-year (YOY) employment growth slowed in 2013. The state recorded 1.2% YOY employment growth in calendar year (CY) 2013 as compared to a more robust national employment growth rate of 1.7%. April 2014 YOY state employment growth improved to 1.7%, equal to 1.7% YOY growth for the nation. The improved growth rate encompassed a meaningful 4% YOY growth in construction, 5.2% YOY growth in leisure and hospitality, and 2.6% YOY growth in trade, transportation, and utilities employment. Offsetting the growth was a modest 1.5% decline in YOY mining and natural resources employment and a 0.3% decline in government employment. Oklahoma's unemployment rate has historically been well below the nation's; April 2014's rate at 4.6%, below the 6.3% rate for the nation, continues this trend.

The economy continues to be supported by the state's large natural resources base; an analysis conducted by the Oklahoma City University found that one in six jobs in the state is related to the oil and gas industry. Additionally, one-third of the state's gross state product is attributable to the drilling, production, and economic multiplier effects of this sector. The state remains focused on diversifying its economic base and recent expansions in aerospace manufacturing, as well as professional and business services, point to some success in this endeavor. Growth in other economic sectors remains key to the state maintaining overall economic stability.

CONSERVATIVELY MANAGED FINANCIAL OPERATIONS

Financial operations are conservatively managed with the state permitted to enact appropriations for only 95% of anticipated revenues in the forthcoming fiscal year. This conservative budgeting is important given wide fluctuations in severance tax receipts to the general fund.

Positive economic momentum coming out of the recession translated into strong receipts for the fiscal year ending June 30, 2012, particularly in income, sales, and oil severance taxes, resulting in the state depositing $328 million to the constitutional reserve fund (rainy day fund or RDF) at fiscal year-end, bringing the reserve to $577.5 million, the second highest balance on record.

The enacted $6.8 billion fiscal 2013 operating budget (not inclusive of federal aid) was a 5.1% increase from fiscal 2012 appropriations. A decline in severance tax receipts in fiscal 2013, down 48.5% from fiscal 2012, incorporated the impact of temporary tax reductions and rebates for producers and offset gains in other tax revenue sources and contributed to the modest 0.9% estimated total revenue growth in the general revenue fund (GRF) between the fiscal years.

The state legislature appropriated $45 million from the RDF prior to the close of fiscal 2013 to finance costs associated with the severe weather events in the Oklahoma City area in May 2013. The draw lowered the RDF balance to $535 million, which is still equal to almost 10% of GRF revenues. The cash flow reserve, derived from any revenues in excess of the 95% appropriated and maintained at 10% of general fund appropriations, received a $27.4 million addition in fiscal 2013. This brings the balance to $559.5 million; combined, both reserves were equal to 19.5% of GRF revenues in fiscal 2013.

The enacted $7.1 billion operating budget for fiscal 2014 (inclusive of federal funds) was a 5.1% increase from fiscal 2013. Notable expenditure increases included an additional $31.6 million to the department of education, $70.1 million increase to higher education, and $145.2 million to health and human services to cover the cost of currently eligible Medicaid enrollees joining the system with the implementation of federal health care reform requirements and increases to human services agency funding.

A companion bill to the operating budget included a two-step lowering of the top personal income tax (PIT) rate. However, following the passage of the bill, the legislation was ruled by the state Supreme Court to be unconstitutional, due to the prohibition on multiple subjects being included in a single piece of legislation. The rate reduction from 5.25% to 5% was to be effective Jan. 1, 2015, and a further reduction was scheduled to be effective Jan. 1, 2016, if total revenue growth met or exceeded the fiscal impact from the second planned tax reduction. The combined loss in PIT revenues was estimated at $237 million per year. The second piece of the disallowed legislation appropriated $60 million in PIT revenue for repairs to the state capitol building in fiscal 2014 from current revenue collections; that dedication was prohibited by the court ruling.

The June 2013 estimate from the State Board of Equalization (SBE) forecast fiscal 2014 GRF sources to grow by 5.1% to almost $5.9 billion from the estimated ending fiscal 2013 revenues. A decline in the PIT was forecast at 0.5% while the corporate income tax (CIT) was expected to grow by a robust 6.7% from fiscal 2013. Other major revenue sources, such as the sales tax, were forecast to grow 6.8% and severance tax receipts were expected to show renewed growth of 22.5% from fiscal 2013.

The forecast was officially updated in December 2013 and expected revenues in the GRF were lowered by 2.3% to $5.75 billion. Adjustments included an addition of $51.4 million to the PIT forecast from the inability to undertake the dedicated renovations to the state capitol (which were to have been drawn from collections before deposit to the general and education funds) offset by year-to-date declines in collections. This provided for a 0.9% ($19.3 million) positive revision in the PIT, a net increase of 17% ($46.4 million) in production tax revenue, a negative revision to the sales tax of 3.7% ($75.9 million), and a 22.1% ($106.3 million) negative revision to the CIT.

The SBE forecast was again updated in February 2014 and expected GRF revenue in fiscal 2014 was again lowered (to $5.71 billion). Notable adjustments from the December 2013 forecast included a $68 million decrease in expected CIT revenue offset by a $20.1 million increase in production tax revenue. Year to date through May 2014, GRF revenue is running 0.2% below collections through May 2013 and is 4.8% below forecast. As the lower revenue collection continues to provide cushion within the state's required 95% appropriation requirement, the state is not recommending budgetary adjustments at this time.

Through May 2014, collections from the volatile CIT are down 35.5% YOY and are running 38% below the original budget forecast. PIT revenue is 1.6% below forecast and down 3% YOY largely due to greater than expected refunds and the use of outstanding PIT credits in May 2014. Sales tax receipts have exhibited 3% YOY growth, but are 3.5% below forecast. Somewhat offsetting these disappointing results are severance tax receipts, which are up over 54.9% from fiscal 2013 and are 18.9% above the budget forecast. The state anticipates fairly stable revenue receipts through the close of the fiscal year on June 30 and the RDF is expected to remain at the current level.

The enacted $7.1 billion operating budget for fiscal 2015 is a 1.4% decrease from the fiscal 2014 budget, incorporating $188 million less revenue than in fiscal 2014. Notable measures in the budget include $150 million in additional spending for seven state agencies while 52 state agencies experienced a 5.5% appropriation reduction. The legislature also authorized a $120 million bond issue for renovations to the state capitol building; the bond will be issued as a state lease obligation. A PIT rate reduction for the state's highest taxpayers from 5.25% to 5%, contingent on increases in GRF tax revenue compensating for the foregone PIT revenue, that was enacted earlier in the legislative session does not take effect until Jan. 1, 2016 and therefore does not impact the revenue forecast for fiscal 2015. A second tax cut, to 4.85%, is scheduled to take effect on Jan. 1, 2017 under the same guidelines. When fully enacted, the full-year impact of the two rate cuts is estimated to be approximately $200 million.

CONSERVATIVE DEBT MANAGEMENT

The state's debt management is conservative and net tax-supported debt of $1.9 billion is equal to a very manageable 1.3% of 2013 personal income. Debt amortization is relatively rapid, with 65.6% of outstanding principal repaid in 10 years; current GO debt is fully repaid in five years. Aside from the expected $120 million bond for capitol building repairs, there are fairly limited plans for additional borrowing and the state has a manageable capital improvement plan.

The state has taken significant steps to address pension underfunding, which had been a credit issue. Several reform measures were adopted in the fiscal 2011 legislative session to address funding gaps. Unfunded cost of living adjustments were eliminated, reducing all seven state systems' unfunded liabilities by a combined one third; the minimum age for retirement was raised for all new employees; a portion of all future surplus revenue and one-time funds was dedicated to the fiscal restoration of the systems; employer and employee contribution rates are now set to meet the annual actuarially calculated required contribution (ARC); and other actions were taken to restore system integrity.

For fiscal 2013 on a reported basis, OPERS' (state's largest system) funded ratio was a solid 81.6% and TRF's (teacher's) funded ratio was a weaker 57.2%. Using Fitch's more conservative 7% discount rate assumption (instead of the 7.5% rate assumed by OPERS and 8% for TRF), the funded ratio for OPERS would be 77.3%, while for TRF it would be 51.6%. The state overfunded its required contribution to the systems in fiscal years 2012 and 2013. On a combined basis, the state's debt and unfunded pension liabilities as a percentage of personal income at 7% is slightly above the median for U.S. states of 6.1%.

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

In addition to the sources of information identified in Fitch's report 'Tax-Supported Rating Criteria', this action was additionally informed by information from IHS Global Insight.

Applicable Criteria and Related Research:

--'Tax-Supported Rating Criteria' (Aug. 14, 2012);

--'U.S. State Government Tax-Supported Rating Criteria' (Aug. 14, 2012).

Applicable Criteria and Related Research:

Tax-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686015

U.S. Local Government Tax-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=685314

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=835719

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Fitch Ratings

Primary Analyst

Marcy Block

Senior Director

+1-212-908-0239

Fitch Ratings, Inc.

33 Whitehall Street

New York, NY 10004

or

Secondary Analyst

Karen Krop

Senior Director

+1-212-908-0661

or

Committee Chairperson

Douglas Offerman

Senior Director

+1-212-908-0889

or

Media Relations

Elizabeth Fogerty, +1-212-908-0526

elizabeth.fogerty@fitchratings.com


Source: Fitch Ratings


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