Fitch Rates Oklahoma's $1.7MM ODFA Bonds 'AA'; Outlook Stable
--$1.745 million series 2015C.
The bonds are expected to sell via negotiation on or about Nov. 17, 2015.
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 this type of bond.
CONSERVATIVE FINANCIAL MECHANISMS: The state's financial operations benefit from the maintenance of separate rainy day fund (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 current low prices for oil and natural gas. Unemployment rates through September 2015 are trending higher year over year (yoy) as the natural resources slowdown has been incorporated, yet they remain just below national averages.
MANAGEABLE LIABILITY POSITION: Debt levels are low, and tax-supported debt is amortized relatively quickly. Most new debt issuance is in the form of lease revenue bonds. Several rounds of pension reform have improved the state's long-term liability position.
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 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 under the equipment lease program is 20 years and lease payments are not abatable. The current offering will provide funding for equipment purchases at four state colleges: Murray State College, Northeastern Oklahoma Agricultural and Mechanical College; Rose State College, and Southeastern Oklahoma State University.
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 fiscal 2016 operating fund appropriation for the State Regents is $963.4 million; this is a 3.5% reduction from the fiscal 2015 appropriation, enacted as part of state's plan to close a projected $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 flow reserve funds (CFRF). These disciplined policies are important given the potential for wide fluctuations in state revenue sources, particularly severance and corporate incomes taxes.
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 be sound. 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 COMMODITY PRICES
After consecutively outperforming national growth trends coming out of the recession, the state's yoy employment growth has slowed considerably. The state recorded 1.1% yoy employment growth in 2014 as compared to more robust national employment growth of 1.9%; however, the state's recovery of jobs from the trough of the recession stands at 152% as of September 2015 as compared to a national average of 146%.
Slow employment growth is continuing in 2015 with September 2015 yoy employment growth at 0.1% as compared with 2% yoy for the nation. Positive trends continued in most state employment sectors through September although the state's important mining sector recorded a 16.7% yoy decline reflecting employment losses tied to low prices for both crude oil and natural gas. Manufacturing also continues to trend downward, with a 5.8% yoy decline in September.
Positively, Oklahoma's 4.4% unemployment rate in September continues to be well below the national 5.1% rate, inclusive of strong 3.2% growth in the state's labor force. The low rate highlights the state's success in diversifying its economy beyond natural resource development. However, Fitch believes the state's economy has weakened from the natural resources slowdown, reflected in the state's September revenue sources, which were both under the state's expectations and lower than one year prior.
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 average rotary rigs in the state were more than halved yoy in October, from 208 to 90, incorporating actions by domestic oil companies to pull back on new well drilling and reduce their workforces as profit margins have shrunk.
The price declines have also contributed to falloffs in the state's collection of severance tax revenue, down 20.7% yoy for the first three months of fiscal 2016 and 61.5% below forecast. The less-than-robust results are attributable to below-forecast prices for natural gas as the general fund does not receive severance taxes on crude oil production until $150 million has first been allocated for education and other specified programs.
CONSERVATIVE FINANCIAL MECHANISMS
Financial operations are supported by conservative financial policies, including a provision in the state constitution that limits appropriations to 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, 2015 as well as in fiscal 2014.
GRF revenue growth in fiscal 2015 was a modest 1.8%, largely due to corporate income taxes (CIT) that came in 19.1% below forecast and severance tax revenue that was 34% below forecast. The personal income tax (PIT) exhibited 6.4% yoy growth from fiscal 2014; 4.1% 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. Overall, the state's GRF revenues were 2.2% below forecast but as the shortfall was within the state's required 95% appropriation limit, no budgetary adjustments were required to maintain balance. The RDF balance remained at $535 million, equal to 9.3% of fiscal 2015 GRF revenues.
The state enacted a $7.18 billion total budget for fiscal 2016 (0.5% lower than expenditures in fiscal 2015) that solved for an identified $611 million 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. Fitch does not currently expect the RDF to be tapped in fiscal 2017.
In support of the enacted budget, the state Board of Equalization's (BOE) June 2015 revenue forecast projected GRF revenue in fiscal 2016 to total $5.7 billion. This would be a modest 0.3% increase from fiscal 2015 partly due to the implementation of lower PIT rates for the state's highest taxpayers, from 5.25% to 5%, pursuant to previously enacted tax reduction legislation. The lower rates contribute to an expected 6.4% decline in the PIT from fiscal 2015, while lower severance tax revenues are forecast from the natural resources softening, and the CIT is projected to decline by 17.7%. The declines were expected to be offset by an almost doubling in natural gas severance tax revenue from the completion of deferred tax rebate payments to producers that reduced revenue the past three fiscal years. Severance taxes from oil production were forecast to decline by 22% from fiscal 2015.
Year-to-date through September 2015, GRF revenues are below forecast by 0.3%, with better than expected results in the PIT and CIT offsetting weak collections in sales, gross production, and motor vehicle taxes. Through September, GRF revenues are down 0.9% yoy but within the state's 5% cushion for budgeting purposes for this fiscal year. The governor has noted the negative trend in a recent executive order that directed state agencies to submit written plans by Dec. 1 to reduce nonessential expenses by 10% for both the remainder of fiscal 2016 and for fiscal 2017, in advance of an expected update to the forecast by the BOE in December. Based on the current revenue trend, Fitch expects the BOE to reduce the revenue forecast for fiscal 2016 and provide a weak revenue outlook for fiscal 2017. The director of the Office of Management and Enterprise Services (OMES), who also serves as the state's director of finance, can reduce appropriations at any time during the fiscal year if OMES believes the state's revenue sources will fall below the 95% projected level.
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. The state estimates the revenue loss from the fiscal 2016, 0.25% rate cut to be approximately $57 million in fiscal 2016 (partial-year impact) while the revenue loss in fiscal 2017 is estimated at $147 million.
CONSERVATIVE DEBT MANAGEMENT
The state's debt management is conservative and net tax-supported debt of $2.1 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 $152 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, is equal to the 5.8% median for U.S. states. 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. Several reform measures were enacted in the 2011 through 2014 legislative sessions to address funding gaps, including HB 2630 in 2014 that 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.
HB 2630 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. A lawsuit was filed in October 2014 regarding the closure of the defined benefit plan, challenging the passage of HB 2630 on several grounds, including procedural violations in its passage. Fitch will monitor the progress of this lawsuit, which the state believes would have a minimal impact on OPERS and the state should it not prevail.
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.
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