OREANDA-NEWS. Fitch Ratings assigns an 'AA' rating to \$7.485 million state of Oklahoma, Oklahoma Development Finance Authority (ODFA) Oklahoma state system of higher education, master equipment lease revenue bonds, series 2015A (subject to annual appropriation).

The bonds are expected to sell via negotiation on or about April 21, 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 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. 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: The state's commodity-based economy, based on oil and gas production as well as various agricultural products, has exhibited solid growth since the recession with unemployment rates well below the national average. Differing from the post-recession trends, Fitch expects the current low oil prices, if they continue long term, to have a negative impact on employment in this sector. Reduced production would also reduce severance taxes collected from this sector.

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

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. 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 East Central University under a 19-year lease, and for Rogers State University under a five-year lease.

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 2015 operating fund appropriation for the State Regents is \$988.5 million, identical to the budget appropriation for fiscal 2014, and the governor has proposed maintaining the same level of appropriation for the regents in fiscal 2016.

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 and cash reserve funds. The state has demonstrated a willingness and ability to address fiscal challenges including revenue underperformance through the 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 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 164% as of February 2015 as compared to a national average of almost 132%.

Slower employment growth is continuing in 2015 as the state's three-month moving average for employment growth as of February 2015 shows yoy growth of 1.6% as compared with 2.3% yoy for the nation. Positive trends are seen in most state employment sectors with some weakness in non-durable goods manufacturing, down 1.6% yoy, and the information sector, down 1.1% yoy. Oklahoma's unemployment rate continues to be well below the nation; February's rate was a modest 3.9%, inclusive of 1.3% growth in the state's labor force, compared to 5.5% for the nation.

The state's economy has 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, reported on April 10, 2015, that the number of rotary rigs in the state has dropped by over 35% yoy, from 192 to 124, 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 steady through February 2015, Fitch expects those trends to begin to show some weakening 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 March 21, 2015, that are up 22% yoy compared to the same period in 2014 and a continued claims four-week moving average that is up 8.2% yoy as of March 21, 2015.

The price declines have also contributed to yoy declines in the state's collection of severance tax revenue, down 8.1% yoy in March 2015 and 10.4% 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. These results have contributed to the state's forecast revenue gap in fiscal 2016, now estimated at \$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 remains key to the state maintaining its 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 both severance and corporate income tax receipts to the general revenue fund (GRF), including in the recent fiscal year ended on June 30, 2014.

The enacted \$6.8 billion fiscal 2013 operating budget (GRF and special revenue funds, not inclusive of federal aid) was a 5% increase from fiscal 2012 appropriations. The state legislature appropriated \$45 million from the \$578 million 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 was still equal to almost 10% of GRF revenues. The state also maintains a cash flow reserve fund (CFRF) that is derived from any revenues in excess of the 95% appropriated and capped at 10% of GRF appropriations.

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 remained at \$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; although 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 CFRF available from fiscal 2014 receipts that can be used for expenditures in fiscal 2015.
The forecast for the GRF alone in fiscal 2015 of \$5.86 billion factored in solid 4% growth from actual collections in fiscal 2014, including 4.9% growth in the PIT (36% of GRF revenues), 3.8% growth in sales tax collections (35% of GRF revenues), and 22.4% growth in the volatile CIT (6.4% of GRF revenues), offset by a 2.9% expected decline in severance tax revenue (5.5% of GRF revenues). Through March 2015, GRF revenue collections are 2% ahead of the estimate for the fiscal year and are demonstrating 5.6% yoy growth from March 2014 despite the noted deviation in severance tax revenue. In particular, the PIT is exhibiting 10% yoy growth from March 2014; 12.1% ahead of the estimate at the time the budget was enacted, and sales tax collections through March 2015 were up 5.3% yoy and were 1.3% ahead of forecast, incorporating consumer purchases that the state attributes to relief from previously high gasoline prices.

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, lowering expected oil production tax revenue by \$9 million (6.3%) while gas production tax revenue was also forecast at a lower level; down by \$27.2 million (19%). 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; 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 personal income tax (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 legislature is currently considering the governor's \$7.2 billion budget proposal for fiscal 2016 that was premised on the lower \$298 million budget gap and included \$300 million in various fund sweeps to fund operations. The proposal also contained targeted reductions to the departments of education, human services, health care, mental health, and department of corrections. Fitch expects additional budget reductions to be made by the legislature and consideration given to applying funds from the RDF in response to the increased revenue shortfall forecast. Fitch expects the state to undertake the actions required to maintain budgetary balance while ensuring that the RDF is maintained at a level that provides cushion for variability in its revenue sources.

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, were 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. 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. These reforms resulted in OPERS improving its funded ratio under the prior GASB standards to a reported 88.6% in fiscal 2014 from 81.6% in fiscal 2013, while 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.