OREANDA-NEWS. Fitch Ratings assigns an 'AA' rating to \$9.6 million of state of Oklahoma, Oklahoma Development Finance Authority (ODFA) Oklahoma state system of higher education, master equipment lease revenue bonds, series 2015B (subject to annual appropriation).

The bonds are expected to sell via negotiation on or about June 16 and 17, 2015.

In addition, Fitch affirms the following ratings:

--\$177.53 million in general obligation (GO) bonds issued by the state at 'AA+';
--\$1.097 billion appropriation-backed debt of the state issued by the Oklahoma Capital Improvement Authority at 'AA';
--\$784 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 obligations 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+' general obligation (GO) bond rating. This reflects the state's general credit standing, sound lease structure, and statutory authorization for these types of bonds.

CONSERVATIVE FINANCIAL MECHANISMS: The state's financial operations benefit from the maintenance of separate rainy day (RDF; the constitutional reserve) and 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 collections of severance tax revenue.

CONCENTRATED ECONOMIC BASE: Growth in the state's commodity-based economy, based on oil and natural gas production as well as various agricultural products, has slowed as a result of the current low oil price environment. While unemployment rates through April 2015 remained low and below national averages, initial and continuing unemployment claims have escalated and this trend is impacting the state's key tax sources: personal income (PIT), sales, and motor vehicle.

MANAGEABLE LIABILITY POSITION: Debt levels are low, and tax-supported debt is amortized relatively quickly. Several rounds of pension reform have improved the state's long-term liability position, with the combined burden of debt and pensions slightly above the state median. Most new debt issuance is in the form of lease revenue bonds.

RATING SENSITIVITIES
For the ODFA and OCIA bonds: The ratings are sensitive to shifts in the state's GO rating to which they are linked.

For the GO bonds: The 'AA+' rating is sensitive to changes in the fundamental characteristics of the state, which include its concentrated economy, conservatively managed financial operations, and its debt and liability positions.

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 equipment program. Additionally, the master leasing structure on behalf of the State Regents has been validated by the Oklahoma state supreme court.

The terms of the leases extend through the life of the bonds; the maximum lease term permitted by the ODFA is 20 years and lease payments are not abatable. The current offering will provide funding for equipment purchases at Tulsa Community College and refund three outstanding leases issued for higher education institutions in 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 these bonds. The fiscal 2016 operating fund appropriation for the State Regents is \$963.4 million, a 3.5% reduction from the fiscal 2015 appropriation, enacted as part of state's plan to close an identified \$611 million revenue shortfall in that fiscal year. Despite the appropriation reduction, Fitch believes the state remains committed to funding its higher education institutions.

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 RDF and cash reserve funds. The state expects to use a portion of the RDF to fund budgetary expenditures in fiscal 2016 in addition to other one-time actions, including fund sweeps. Despite these actions, Fitch believes financial operations continue to benefit from disciplined financial policies. Tax rate adjustments are limited by a supermajority requirement of the legislature or voter referendum to raise tax rates.

CONCENTRATED ECONOMIC BASE AFFECTED BY LOW OIL PRICES
After consecutively outperforming national growth trends coming out of the recession, the state's year-over-year (yoy) employment growth slowed in 2013 and 2014. The state recorded 1.3% and 1.1% yoy employment growth in those respective years as compared to more robust national employment growth of 1.7% and 1.9%, respectively, although the state's recovery of jobs from the trough of the recession stands at a robust 156% as of April 2015 as compared to a national average of 134%.

Slower employment growth is continuing in 2015 as April 2015 yoy employment growth was 1.4% as compared with 2.2% yoy for the nation. Positive trends were seen in most state employment sectors through April with noted weakness in mining, down 6.6% yoy. Fitch expects employment figures in May and June to show some softening as the mining sector layoffs are incorporated. Oklahoma's unemployment rate continues to be well below the nation; April's rate was 4.1%, inclusive of 3.9% growth in the state's labor force, compared to a 5.4% unemployment rate for the nation that has had much slower labor force growth.

The state's economy and financial operations have recently been hampered by the weakness in crude oil prices as 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, has reported May 2015 average rotary rigs in the state have dropped by over 46% yoy, from 194 to 105, incorporating actions by domestic oil companies to pull back on new well drilling and reduce their workforces as profit margins have shrunk. While the state's monthly employment and unemployment rate trends held relatively steady through April 2015, Fitch expects those trends to weaken as the slowdown in the state's natural resource industry is incorporated. Fitch believes the labor impacts of the slowdown are captured in initial unemployment claims for the first week in January 2015 through May 23, 2015 that are up 27% yoy compared to the same period in 2014.

The price declines have also contributed to yoy declines in the state's collection of severance tax revenue, down 19.1% yoy in April 2015 and 20.6% below forecast. The yoy decline is largely attributable to a fall in oil production tax revenue while the below-forecast results are largely stemming from lower than expected natural gas prices. Fitch expects revenue collections for May and June 2015 to show softening in several revenue sources, such as sales and motor vehicle taxes. These results have contributed to the state's forecast revenue gap in fiscal 2016 of \$611 million.

The state remains focused on diversifying its economic base, and recent expansions in aerospace manufacturing, as well as in professional and business services, point to some success. Fitch believes that growth in other economic sectors will help to support the state's overall economic stability.

CONSERVATIVE FINANCIAL MECHANISMS
Financial operations are supported by conservative financial policies 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 both severance and corporate income tax receipts to the general revenue fund (GRF), including in the most recent fiscal year ended on June 30, 2014.

The enacted \$7.1 billion operating budget for fiscal 2014 (not inclusive of federal funds) was a 4.2% increase from fiscal 2013. Revenue collections in the GRF alone in fiscal 2014 totaled \$5.6 billion, essentially flat to collections in fiscal 2013 and \$283.8 million (4.8%) below the official estimate on which the fiscal 2014 budget was based. As the lower, total revenue collection was within the state's required 95% appropriation limitation, no budgetary adjustments were required to maintain balance. The RDF balance was \$535 million, equal to 9.5% of fiscal 2014 GRF revenues.

The enacted \$7.1 billion operating fund budget for fiscal 2015 was a 1.4% decrease from the enacted fiscal 2014 budget, incorporating \$188 million less certified revenue for operating fund expenditures than in fiscal 2014 but a 0.1% increase from actual fiscal 2014 appropriations. Offsetting the decline in the forecast revenues, the 2015 budget agreement provided for the use of \$292.7 million in fund balances in various state funds, including \$101 million from the state's cash flow reserve fund (CFRF) available from fiscal 2014 receipts that could be used for expenditures in fiscal 2015.

The forecast for the GRF alone in fiscal 2015 of \$5.86 billion factored in solid 4% expected growth from actual collections in fiscal 2014. Through April 2015, GRF revenue collections demonstrated 4.3% yoy growth while running 0.1% below the estimate for the fiscal year, largely due to corporate income taxes (CIT) that are 30.6% below forecast and severance tax revenue that is 20.6% below forecast. The PIT exhibited 10.4% yoy growth from April 2014, which is 8.8% ahead of the estimate at the time the budget was enacted, although the state believes some of the growth can be attributed to separation payments to dismissed oil industry workers. Sales tax collections through April 2015 were up 4.8% yoy and were meeting forecast, incorporating consumer purchases that the state attributes to relief from previously high gasoline prices, although the state reports that revenue collections were not as favorable in May 2015.

In February 2015, the state's board of equalization's (BOE) updated its revenue forecast for fiscal 2015 and its revenue estimate for fiscal 2016 upon which the enacted budget will be based. For fiscal 2015, the BOE lowered its GRF revenue expectation to \$5.79 billion, a 1.8% decrease from its December 2014 forecast. The forecast revision incorporated a decrease in expected price per barrel (bbl) for crude oil; from \$76.32/bbl to \$71.89/bbl for the year. Overall, severance tax revenue is expected to be 25% lower than receipts in fiscal 2014. The BOE also dropped its expectation for PIT growth from fiscal 2014 to 9.2% from an 11.9% expectation in December 2014, and the sales tax is now expected to grow by 5.6%. In total, the BOE's revised forecast for fiscal 2015 revenues is 1.1% lower than that forecast with the enacted budget although growth remains expected at 2.9% above fiscal 2014 revenue performance.

As part of the trigger mechanism that was included in 2014 legislation that lowered PIT rates for the state's highest taxpayers from 5.25% to 5%, the BOE determined in December 2014 that expected revenue growth in fiscal 2016 was sufficient for the implementation of a PIT rate reduction, effective Jan. 1, 2016, contributing to a then-forecast budget gap of \$298 million.

The February 2015 GRF revenue forecast for fiscal 2016 lowered expected GRF revenues to \$5.65 billion; this is down from \$5.96 billion estimated in December 2014, incorporating a lower forecast price of oil/bbl of \$57.55, down from \$59.97/bbl forecast in December. The lower oil price forecast is expected to trigger further declines in severance tax receipts as well as lower expected revenues from the PIT and sales tax from spillover economic effects. Severance tax receipts are expected to increase by 16.2% but the growth reflects the falloff of prior payouts for gas development incentives, increasing the tax rate, as oil severance tax revenue is expected to continue to decline. The PIT is expected to decline by a sizable 9.4% from fiscal 2015, incorporating the rate cut as well as the softer economic forecast, while the sales tax is expected to grow by 2.7%. Overall, total GRF revenue is expected to decline by 2.3%, contributing to a forecast budget gap for fiscal 2016 of \$611 million.

The state recently enacted a \$7.18 billion budget (0.5% lower than expected expenditures in fiscal 2015) for fiscal 2016 that solves for the identified 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. The budget includes targeted reductions to the departments of education, general government, transportation, natural resources and judiciary. This is the second consecutive year in which the state has applied one-time fund sweeps to solve for its revenue shortfalls, diverging from its more typical conservative practices. Fitch believes the RDF, expected to equal 6.8% of revenue in fiscal 2016, continues to be maintained at a level that provides cushion for variability in the state's revenue sources and we believe the state has incorporated the lower natural resources' prices into its forecast. Fitch does not currently expect the RDF to be tapped in fiscal 2017.

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 same trigger guidelines. The state estimates the revenue loss from the 0.25% rate cut to be approximately \$57 million in fiscal 2016 and \$147 million in fiscal 2017.

CONSERVATIVE DEBT MANAGEMENT
The state's debt management is conservative and net tax-supported debt of \$2 billion is equal to a very manageable 1.2% of 2014 personal income. Debt amortization is relatively rapid, with 65.6% of outstanding principal repaid in 10 years; current GO debt, which totals only \$178 million, is fully repaid in five years. There are fairly limited plans for additional borrowing and the state has a manageable capital improvement plan.

Oklahoma's combined burden of debt and unfunded pension obligations, adjusted by Fitch to reflect a 7% return assumption, was slightly above the 6.1% median for U.S. states as of 2013. The state has taken significant steps to address pension underfunding, which had been a credit issue, including overfunding its required contributions to the systems in recent years. As 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 were set to meet the annual actuarially calculated required contribution (ARC); and other actions were taken to restore system integrity.

Passed in the 2014 legislative session, HB 2630 closed OPERS' (the state's largest pension system) defined benefit system to most new participants as of Nov. 1, 2015, with new employees able to enroll in a new defined contribution pension plan as of that effective date. This reform contributed to OPERS improving its funded ratio under the prior GASB standards to a reported 88.6% in fiscal 2014 from 81.6% in fiscal 2013. TRS' (teachers) funded ratio improved from 57.2% in fiscal 2013 to 63.2% in fiscal 2014. 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 97.9% of liabilities, while TRS reports the same figure at 72.4%; the higher ratios under the new standards primarily reflect the full recognition of solid asset gains in recent years.