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Fitch Ratings - New York - 08 Mar 2022: Fitch Ratings has assigned a rating of 'AA-' to the Oklahoma Capitol Improvement Authority's (OCIA) $46.595 million of state facilities revenue bonds, federally taxable series 2022B (subject to annual appropriation).
The Rating Outlook is Stable.
The bonds will be sold by negotiation on March 23, 2022. Proceeds will be used to finance construction of the Oklahoma National Guard Museum, which will be located in Oklahoma City, OK. The museum will be constructed and operated under the authority of the Oklahoma Military Department (OMD).
The bonds are lease revenue bonds secured by and payable from payments to be received by the OCIA from the OMD pursuant to the terms of a lease agreement for use and occupancy (the 'agreement') entered into between the OCIA and the OMD. Payments under the agreement are payable from all legally available funds including, but not limited to, annual budgetary appropriations made by the Oklahoma legislature and allocated to the OMD for the purpose of funding its annual operating budget.
The 'AA-' rating on this OCIA issue, one notch below Oklahoma's 'AA' Issuer Default Rating (IDR), reflects the optionality inherent in the expected repayment of the bonds from annual budgetary appropriations made by the state of Oklahoma to the Oklahoma Military Department.
Oklahoma's 'AA' IDR reflects conservative budgeting practices, including timely actions to address budget shortfalls and its practice of budgeting only 95% of projected operating fund revenue, and a low liability position. These factors are critical to the rating given the sizable economic concentration in natural resource development, which limits long-term revenue growth prospects and increases revenue volatility. The state's reserves have historically been strongly affected by economic cycles.
Oklahoma's economy is broad, but with high concentration in natural resources given the state's role as a major producer of crude oil and natural gas. One-fourth of state GDP is directly tied to natural resource development and multiplier effects boost this concentration still further. Excluding federal offshore areas, Oklahoma was the fourth-largest crude oil producing state in 2020 and third-largest natural gas producer. The economic base is nevertheless diverse and includes notable health care, higher education, trade & transportation, and state and federal government components.
Revenue Framework: 'aa'
Fitch expects Oklahoma's revenues, which are supported by broad-based sources, to continue to reflect economic volatility tied to its extensive natural resources sector. While the state legislature has an unlimited independent legal ability to raise operating revenues, tax rate increases require either a legislative supermajority vote or direct voter approval, limiting practical revenue-raising flexibility.
Expenditure Framework: 'aa'
The state maintains ample expenditure flexibility with a low burden of carrying costs for liabilities and the broad expense-cutting ability common to most U.S. states. As with most states, Medicaid remains a key expense driver but one that Fitch expects the state will continue to actively manage to prevent fundamentally impairing other functions.
Long-Term Liability Burden: 'aaa'
On a combined basis, the state's debt and net pension liability are well below the median for U.S. states as a percentage of personal income and a low burden on resources. Other post-employment benefit (OPEB) obligations are minimal compared with the debt and net pension liability burden, accounting for 0.1% of personal income versus 3.1% for debt and pensions, or less than 3% of total liabilities.
Operating Performance: 'aa'
A policy of appropriating only 95% of expected general revenue fund revenues provides a cushion for revenue variability, as does the state's proactive management of financial operations. The state rapidly rebuilds reserves during periods of economic growth, but regular drawdowns and other non-recurring actions during periods of low crude oil and natural gas prices have tended to limit the prospects for sustained financial resilience, to date.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
--Revenues showing evidence of less volatility and/or growth at a faster and more sustainable pace, ahead of Fitch's long-term expectations for national inflation;
--A sustained increase in reserves to levels in excess of historical norms that provides an enhanced cushion against the state's high economic volatility and revenue cyclicality;
--Diversification of the state's economy to the extent that natural resource market volatility is less consequential for operating performance.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
--An inability to restore reserves to levels that can cushion revenue volatility, roughly commensurate with pre-pandemic levels, as the economic recovery takes hold after the crisis has passed;
--State revenue growth that falls below the level of Fitch's expectations for long-term U.S. inflation over an extended period of time.
International scale credit ratings of Sovereigns, Public Finance and Infrastructure issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of three notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.
Federal Relief Provides Critical Support
Federal aid measures enacted starting in 2020 have provided direct fiscal support and boosted economic activity in Oklahoma and throughout the country during the pandemic. Under the American Rescue Plan Act (ARPA), Oklahoma's state and municipal governments have been allocated $3.19 billion in direct aid from the Coronavirus State and Local Recovery Fund. The state's portion is $1.87 billion. Oklahoma received its entire ARPA allocation in 2021.
The governor and legislature created a collaborative process for determining how to utilize the federal moneys. A legislative joint committee on pandemic relief funding is working with the governor to issue project recommendations. The committee approved several project awards in November 2021, but none of the ARPA funds have yet been formally allocated.
Fitch expects the combination of direct aid and significant federal stimulus will positively affect Oklahoma's state economy and tax revenues over the near term. However, Fitch also believes that recent and ongoing stimulus is unlikely to alter Oklahoma's underlying credit fundamentals.
Oklahoma Economic Update
Oklahoma's 2020 employment declines were not as steep as those of the nation, but its employment recovery has lagged that of the U.S. Non-farm payrolls shrank 10% on a seasonally-adjusted basis from February through April 2020 versus a 15% contraction nationally. Through December 2021, the state recovered 71% of jobs lost compared with 84% nationally.
The weaker jobs recovery is related to a slow rebound in energy employment. The recovery in spot oil prices has spurred some hiring, but considerable supplies of stored crude, more efficient extraction techniques and energy producers' desire to limit capital spending will limit the short-term upside.
Monthly unemployment data from the U.S. Bureau of Labor Statistics (BLS) shows the state well-positioned with a 2.3% unemployment rate for December, compared with a 4.2% rate for the nation. Oklahoma's Fitch-adjusted unemployment rate (which incorporates labor force exits) was also 2.3% versus the 5.5% state median. Oklahoma is one of few states whose labor force has grown since 2020.
Fiscal 2021 Results Reflect Tight Spending Coupled with Revenue Overperformance
Fiscal 2021 actuals beat projections by $282 million (4.2%) and exceeded the prior fiscal year by $735 million (11.7%). The entire $282 million surplus, plus $30 million of excess income taxes, was deposited into the constitutional reserve fund (CRF), raising its balance to $371 million. Together, the CRF and the budget stabilization fund (BSF) held $541.9 million at the start of fiscal 2022, equal to 7.7% of fiscal 2021 GRF revenues. This compares with $1.2 billion, or 17.6% of revenues at the start of fiscal 2020.
GRF tax revenues' fiscal 2021 performance was supported by solid growth in personal and corporate income taxes (PIT and CIT), which were $400 million, or 13.6%, above estimate. Sales and use tax (SUT) growth was less robust, finishing (1.5%) above estimate, but above prior-year levels. Gross production taxes (GPT) ended at $419 million versus $577 million forecast -- 27% below budget.
Fiscal 2022 Budget Focuses on Reserve Augmentation, Medicaid Expansion
The fiscal 2022 budget included appropriations of $9.07 billion, up 4.4% annually, reflecting a return to the practice of appropriating 95% of certified revenues. The budget used $200 million of cash reserves for core operations and $884 million of unspent 2021 receipts as free cash to appropriate as needed. The budget also allocated $251 million to fund two years of supplemental pension contributions, restoring a pre-pandemic practice that improved the public pension systems' asset-to-liability ratios.
Related to Oklahoma's Medicaid expansion, which became effective Oct. 1, 2021, the budget included a $164 million deposit to cover the state's first-year share of Medicaid expansion costs. The state is covering its long-term share of expansion costs by raising its medical provider fee from 2.5% to 4.0% of hospital net patient revenues over three years.
The fiscal 2022 budget also included $330 million of tax cuts that affect two state funds: the GRF and education reform revolving fund. The top CIT rate was reduced to 4% from 6%, resulting in a $54 million revenue loss in fiscal 2022 and $110 million annually thereafter. The budget also reduced all PIT rate brackets by 0.25% (e.g. the top PIT rate was cut to 4.75% from 5%) for an $83 million GRF revenue loss in fiscal 2022 followed by $237 million annually thereafter. Fitch believes the tax cuts will likely have a modest effect on Oklahoma's pace of revenue formation. This is reflected in Fitch's Stable Outlook.
Oklahoma Fiscal 2022 Revenue Update
GRF tax collections performed above estimates through January 2022. GRF revenues totaled $4.6 billion, nearly $809 million or 21% above budget estimates. All major tax revenues are outperforming budget and the state's December 2021 BOE estimate, with income taxes tracking $284 million, or 16%, above estimate, sales taxes $211 million (17%) above estimate, and gross production taxes (GPT) on oil & gas extraction $268 million (117%) above estimate.
The recovery in oil and gas prices is driving half the fiscal 2022 revenue surge with GPT up by a staggering $406 million (441%) yoy through January. A broader recovery in consumer spending is also spurring the expansions of PIT, CIT and SUT. If revenue growth stays near current levels, the state will be required to make an $809 million deposit to the CRF at fiscal YE. This would bring the CRF balance close to $1.2 billion, or about 18% of revenues and above its 15% of revenues constitutional cap, not counting funds in the BSF and cash flow reserve funds and also slightly above pre-pandemic levels.
Fiscal 2023 Executive Budget Proposal Targets Higher Reserve Levels
On Feb. 8, the governor presented his executive budget proposal for fiscal 2023. The governor's proposal holds budget appropriations in key spending areas essentially flat to current-year levels despite an expansion of all major revenues (see below) that is projected to continue into 2023. The proposed all-funds budget of $8.9 billion represents a $204 million (2.3%) spending decrease compared with fiscal 2022, with virtually the entire difference relating to a drop in non-recurring expenditures. Spending on education, public safety, and health & human services would remain flat.
The governor's proposal argues that it would be prudent to boost Oklahoma's statutory reserves further in light of continued economic and energy market volatility stemming from both the ongoing pandemic and from uncertain commodity prices connected to heightened geopolitical risks. The state's consensus revenue forecasting unit, the Board of Equalization (BOE), estimates that solid economic growth will raise general revenues by over $1 billion in fiscal 2023. The governor's stated aim is to utilize virtually all new resources to bolster reserves and liquidity, to insulate the state against future economic shocks.
The rating on the OCIA bonds, secured by annual appropriations from the state's general fund, is one notch below Oklahoma's 'AA' IDR, reflecting the state's general credit standing. The rating also reflects the sound lease structure and statutory authorization for these types of bonds in the State of Oklahoma. OCIA is one of the principal financing agencies of the state and the bonds are secured by lease rental payments made by the OMD that are derived from the state's general fund revenues.
Both the state constitution and enabling statutes provide for appropriation of lease payments, and this type of leasing structure and bond issuance has been validated by Oklahoma's Supreme Court. The term of the lease extends for the 20-year life of the bonds. The lease payments are not abatable.
Under the statute that authorized the OCIA to issue that bonds (Oklahoma Title 73, as amended, or the Act), the Oklahoma legislature expresses its intention to provide funds sufficient to pay debt service due on the bonds each year as part of its lump-sum appropriation for the OMD. Under the terms of the agreement, the OMD pledges to include the debt service amount coming due in the next fiscal year in its annual budget requests to the legislature until final maturity.
For additional information on the state of Oklahoma, please see "Fitch Affirms Oklahoma's 'AA' IDR and 'AA-' Lease Revenue Ratings; Outlook Stable," published on Feb. 3, 2022.
02 February 2022
In addition to the sources of information identified in Fitch's applicable criteria specified below, this action was informed by information from Lumesis.
The principal sources of information used in the analysis are described in the Applicable Criteria.
Oklahoma, State of (OK) [General Government] has an ESG Relevance Score of '4' for Biodiversity and Natural Resource Management due to the impact of natural resources management on its economy and governmental operations which, in combination with other factors has a negative impact on the state's credit profile and is relevant to the rating in conjunction with other factors.
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.