Fitch Rates Oklahoma’s $15MM ODFA Bonds ‘AA’; Outlook Stable

Fitch Ratings assigns an 'AA' rating to the following issue of the state of Oklahoma:

--$15.34 millionOklahoma Development Finance Authority (ODFA) Oklahoma state system of higher education master real property lease revenue bonds, series 2014B (subject to annual appropriation).

The bonds are expected to sell via negotiation the week of March 4.

In addition, Fitch affirms the following ratings:

--$177.53 million in outstanding State of Oklahoma general obligation (GO) bonds at 'AA+';

--$1.174 billion in outstanding appropriation-backed debt of the state issued by the Oklahoma Capital Improvement Authority at 'AA';

--$698.7 million in outstanding 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, reflecting 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 percent 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, offsetting 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 on the real property leases; lease payments are not abatable. The current offering will be applied to refunding outstanding bonds for debt service savings 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 percent from fiscal 2013. The governor's proposed budget for fiscal 2015 recommends a decreased appropriation of $939.1 million for a reduction of 5 percent from fiscal 2014. The decrease is comparable to those recommended for most other state agencies 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, including an appropriation limit of 95 percent 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 THE 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 1.1 percent YOY employment growth in December 2013 as compared to a more robust national employment growth rate of 1.6 percent. The modest growth largely encompassed a meaningful 4.2 percent YOY decline in mining and natural resources employment, which is a continuation of a descending trend begun in February 2013, as all other sectors, aside from a 1.3 percent decline in construction, recorded positive YOY growth. Offsetting this decline was 2.7 percent YOY growth in leisure and hospitality, 4.7 percent YOY growth in professional services, and 1.6 percent YOY growth in manufacturing. Oklahoma's unemployment rate has historically been well below the nation's, with December 2013 at 5.4 percent, up from 5.1 percent in December 2012, yet still below the 6.7 percent rate for the nation.

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, and 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 with 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 percent 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 fiscal 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 and 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 percent increase from fiscal 2012 appropriations. A decline in severance tax receipts in fiscal 2013; down 48.5 percent 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 percent 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 percent of GRF revenues. The cash flow reserve, derived from any revenues in excess of the 95 percent appropriated and maintained at 10 percent of general fund appropriations, received a $27.4 million addition in fiscal 2013, bringing the balance to $559.5 million; combined, both reserves were equal to 19.5 percent of GRF revenues in fiscal 2013.

The enacted $7.1 billion operating budget for fiscal 2014, inclusive of federal funds, was a 5.1 percent increase from fiscal 2013. Notable expenditure increases include 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 service 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 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 percent to 5 percent 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 percent to almost $5.9 billion from the estimated ending fiscal 2013 revenues. A decline in the PIT was forecast at 0.5 percent while the CIT was expected to grow by a robust 6.7 percent from fiscal 2013. Other major revenue sources, such as the sales tax, were forecast at a growth rate of 6.8 percent and severance tax receipts were expected to show renewed growth of 22.5 percent from fiscal 2013.

The forecast was officially updated in December 2013 and expected revenues in the GRF were lowered by 2.3 percent 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 percent ($19.3 million) positive revision in the PIT, a net increase of 17 percent ($46.4 million) in production tax revenue, a negative revision to the sales tax of 3.7 percent ($75.9 million), and a 22.1 percent ($106.3 million) negative revision to the CIT. As the lowered revenue expectation continues to provide cushion within the state's required 95 percent appropriation requirement, the state is not recommending budgetary adjustments at this time. The state does retain the ability to enact across the board expenditure reductions should revenues fall below 95 percent of the annual certified estimate.

Year to date through December 2013, GRF results were notably below expectations but a boost in PIT collections in January 2014 have moved actual, seven-months' receipts to 4.5 percent below expectations from the prior 6.7 percent below forecast results in December. January PIT receipts included the addition of $17.1 million from the disallowed state capitol improvement funding; however, overall receipts from the PIT in January 2014 remain down 4.3 percent YOY and are running below the budget forecast by 1.7 percent. Collections from the volatile CIT are down 34.6 percent YOY and are running 37 percent below forecast. Sales tax receipts have exhibited 1.7 percent YOY growth, but are 3.9 percent below forecast. Somewhat offsetting these disappointing results are severance tax receipts, which are up over 147 percent from fiscal 2013 and are 10.2 percent above the budget forecast although the amount of overage has lessened since December (then up 545 percent YOY and 15 percent above forecast). Overall GRF revenues are 0.2 percent lower YOY but still remain within the state's 5 percent revenue cushion on appropriations.

The governor's proposed $7 billion operating budget for fiscal 2015 incorporates a 2.4 percent reduction of recurring revenues in support of the budget, an $83 million transfer from non-restricted agency revolving funds to the GRF, and an increase of $43.2 million in the education reform revolving fund's spending authority. Other than certain strategic initiatives, the budget includes a 5 percent reduction to most state agencies as a result of the lower revenue forecast. The budget also factors in the governor's proposed successor bill to the 2014 PIT rate reduction legislation, with a recommended PIT rate reduction for the state's highest taxpayers from 5.25 percent to 5 percent, effective Jan. 1, 2015. If enacted, the rate reduction is estimated to reduce fiscal 2015 revenue by $47.4 million and fiscal 2016 revenue by $71.1 million.

CONSERVATIVE DEBT MANAGEMENT

The state's debt management is conservative and net tax supported debt of $1.9 billion is equal to a manageable 1.2 percent of 2012 personal income. Debt amortization is relatively rapid, with 65.6 percent of outstanding principal repaid in 10 years; current GO debt is fully repaid in five years. Aside from the governor's current proposal to issue a $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 percent and TRF's (teacher's) funded ratio was a weaker 57.2 percent. Using Fitch's more conservative 7 percent discount rate assumption (instead of the 7.5 percent rate assumed by OPERS and 8 percent for TRF), the funded ratio for OPERS would be 77.3 percent, while for TRF it would be 51.6 percent. The state overfunded its required contribution to the systems in fiscal years 2012 and 2013. On a combined basis, the state's debt and pension liabilities are about average for U.S. states rated by Fitch at 6.5 percent, below the median of Fitch- rated states.

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

Additional information is available at 'fitchratings.com'.

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