Thu 21 Apr, 2022 - 4:34 PM ET
Fitch Ratings - New York - 21 Apr 2022: Fitch Ratings has assigned a 'AA-' rating to the Oklahoma Capitol Improvement Authority's (OCIA) $41.547 million Transportation Infrastructure Finance and Innovation Act (TIFIA) loan obligation series 2022-1 (subject to annual appropriation). In addition, Fitch has affirmed the ratings of the following securities issued by the state:
--the state's long-term Issuer Default Rating (IDR) at 'AA';
--$1.3 billion of lease revenue bonds issued by the Oklahoma Capitol Improvement Authority at 'AA-';
--$512.5 million of lease revenue bonds issued by the Oklahoma Development Finance Authority at
The Rating Outlook is Stable.
The TIFIA loan is a limited special obligation of the OCIA for the benefit of the Oklahoma Department of Transportation (ODOT) to be paid from annual state budgetary appropriations to the ODOT. The TIFIA loan is being issued and secured pursuant to a lease and use agreement between the OCIA and ODOT, and by a separate loan agreement being entered into between the ODOT and the U.S. Dept. of Transportation (U.S. DOT).
Under the terms of its lease and use agreement with the OCIA, ODOT is obligated, and pledges to use, moneys included in annual appropriations it receives from the state to make lease rental payments equal to debt service on the TIFIA loan to OCIA, which will use said funds, along with legislative apportionments and any other legally available funds, to pay TIFIA loan debt service.
The 'AA-' rating assigned to the loan made by TIFIA (a division within U.S. DOT) to the OCIA for the benefit of ODOT reflects the annual appropriation security for loan repayments codified in the lease and use agreement entered into by OCIA and ODOT, which is an instrumentality of Oklahoma, the ultimate obligor. The 'AA-' rating, one notch below the state's 'AA' Long-Term Issuer Default Rating (IDR), reflects the slightly elevated risk of non-appropriation of moneys sufficient to pay loan debt service.
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 also 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, will continue to reflect above-average economic volatility tied to the natural resource sector. While the state legislature has 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 fundamental impairment of other functions.
Long-Term Liability Burden: 'aaa'
On a combined basis, the state's debt and net pension liabilities are well below the median for U.S. states as a percentage of personal income, and are a low burden on resources. Other post-employment benefit (OPEB) obligations are minimal compared to debt and net pension liabilities, accounting for 0.1% of personal income versus 2.9% for debt and pensions, or less than 3% of total liabilities.
Operating Performance: 'aa'
A constitutional provision limiting appropriations to only 95% of expected General Revenue Fund revenues provides a cushion for revenue variability, while the state's proactive management of financial operations has historically offset volatility. 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 to date tended to limit the prospects for sustained financial resilience.
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 continues;
--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. 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 US. Non-farm payrolls shrank 10% on a seasonally-adjusted basis from February through April 2020 versus a 15% contraction nationally. Through February 2022, the state recovered 79% of jobs lost compared to 90% nationally. Oklahoma's weaker recovery is related to an initially slow rebound in energy industry employment. Considerable stored crude supplies, more efficient extraction and energy producers' desire to limit capital spending from mid-2020 through late 2021 served as a drag on hiring for more than a year.
Monthly unemployment data from the U.S. Bureau of Labor Statistics (BLS) shows the state well-positioned with a 2.6% unemployment rate for February 2022, compared to a 3.8% rate for the nation. Oklahoma's Fitch-adjusted unemployment rate (which incorporates labor force exits) was 2.7% versus the 4.8% state median. Oklahoma is one of few states whose labor force has grown since 2020.
Fiscal 2021 Results Reflected Tight Spending Coupled with Revenue Outperformance
Fiscal 2021 actuals outperformed 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. The CRF, along with the budget stabilization fund (BSF), held $541.9 million at the start of the 2022 fiscal year, equal to 7.7% of GRF revenues. This compares to $1.2 billion, or 17.6% of revenues at the start of fiscal 2020.
Fiscal 2021 tax revenue 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 only 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 Focused on Reserve Augmentation, Medicaid Expansion and Tax Cuts
Oklahoma's adopted fiscal 2022 budget included appropriations of $9.07 billion, up 4.4%, and reflecting a return to the practice of appropriating 95% of certified revenues. The budget uses $200 million of cash for core operations and $884 million of unspent 2021 collections as free cash to appropriate as needed. The fiscal 2022 budget also allocated $251 million of dedicated revenues for supplemental pension contributions, restoring a pre-pandemic practice that improved the asset-to-liability ratios of Oklahoma's public pension systems.
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 over three years.
The fiscal 2022 budget also included $330 million of tax cuts. 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 its Stable Outlook.
Oklahoma Fiscal 2022 Revenue Update
GRF tax collections performed above estimates through March 2022. GRF revenues YTD have totaled over $5.7 billion, nearly $1.1 billion, or 23% above budget estimates. All major tax revenues are outperforming budget and the state's December 2021 BOE estimate, with income taxes tracking $446 million, or 23% above estimate, sales taxes $255 million (16% above estimate), and GPT on oil & gas extraction $337 million (92% above estimate).
The recovery in oil and gas prices is driving half the fiscal 2022 revenue surge with GPT up $511 million or 269% yoy through March. A recovery in consumer spending is spurring the expansion of PIT, CIT and SUT. If revenue growth stays near current levels, the state will be required to make a $1.08 billion deposit to the CRF at fiscal YE. This would bring the CRF balance close to $1.6 billion, or about 20% of revenues, above its 15% of revenues constitutional cap, not counting additional moneys in the BSF and cash flow reserve.
Fiscal 2023 Executive Budget Proposal Targets Higher Reserve Levels
On February 8, the governor presented his executive budget proposal for fiscal 2023. The governor's proposal holds budget appropriations in key spending areas essentially flat at current-year levels despite an expansion of all major revenues that is projected to continue into 2023. The proposed $8.9 billion all-funds budget represents a $204 million (2.3%) drop in spending from fiscal 2022, with virtually the entire difference relating to lower 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 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.
Oklahoma's economy is closely linked with the fortunes of the energy industry, but the presence of large health care, higher education, trade & transportation and government components add diversity. Five U.S. military installations that employ 69,100 active duty personnel account for the large federal presence, as does the U.S. Postal Service and U.S. Dept. of Veterans affairs, both among the state's top 10 employers.
Other major employers include Wal-Mart, Amazon Inc., Integris Health, Oklahoma State University and Hobby Lobby. Wealth and educational attainment levels are below the U.S. average. Unemployment tends to be low.
The Oklahoma Board of Equalization's (BOE) June 2021 West Texas Intermediate (WTI) forecast was for a $47/bbl average for fiscal 2022. The state averaged only 27 active oil rigs in June 2021 versus over 100 rigs in 2019. By April 14, 2022, however, that number climbed to 51 as crude oil and natural gas prices rose. WWTI spot oil prices reached $94/bbl as of April 11, 2022 - double the forecast. The recovery in crude oil prices has boosted Oklahoma's oil and gas tax collections in 2021 and 2022 YTD. Collections are expected to remain strong through 2022.
SUT and PIT provide almost equal support to the GRF, accounting for more than 70% of fiscal 2021 general revenues on a cash basis, with significant additional revenue flowing from corporate income and severance taxes in most years.
Historical growth in revenues, after adjusting for the estimated effect of tax policy changes, was slightly above the pace of U.S. inflation over the 10 years through 2020, even when incorporating the deep natural resource downturn of 2015 through 2017. A multi-year slump in commodity prices combined with a PIT rate cut required significant action to close budget gaps in fiscals 2016 through 2018, including extensive use of one-time actions.
Over the long-term, Fitch expects GRF revenues to expand at the rate of inflation--assuming that the boom and bust cycles common to the natural resource industry largely cancel each other out and result in a slow annualized pace of revenue growth. Fitch believes elevated revenue volatility will remain part of Oklahoma's financial profile given its dependence on natural resource-related taxes and income tax.
Fitch would regard a faster pace of revenue formation accompanied by lessening economic volatility as positive for the rating. Increased economic diversification could contribute to such a trend.
The state has unlimited legal ability to raise revenues, although rate increases require either a supermajority vote of the legislature or a majority vote of the people. An additional constitutional restriction that prohibits enacting new revenue measures during the final week of the legislative session is also a limiting factor on the state's revenue-raising flexibility.
As in most states, education and health and human services spending are Oklahoma's largest operating expenses. Education is the larger item, as the state provides significant funding for local school districts and public higher education. Health and human services account for the second largest spending area, with Medicaid the main driver. The fiscal challenge of Medicaid is common to all U.S. states. The nature of the program and federal rules limit states' options for managing spending growth. As with all federal initiatives, Medicaid remains subject to regulatory changes that could affect aspects of the program.
Fitch expects spending growth, absent policy actions, will be marginally ahead of natural revenue growth, driven primarily by Medicaid, and will require regular budget adjustments to ensure ongoing balance. Baseline spending growth grew significantly in fiscal years 2019 and 2020 as the state raised teacher and state employee salaries and increased K-12 education funding. The state also restored funds to other budget areas that were cut during the 2015-16 downturn. Fiscal 2022 budgeted spending rose by 4.4%, led by K-12 education.
Oklahoma retains ample ability to adjust expenditures to meet changing fiscal circumstances. Medicaid remains a notable cost pressure, but spending on debt service, pension contributions and OPEB are low; carrying costs are less than 4% of expenditures.
Pension contributions in recent years have been significantly above the actuarially determined contributions (ADCs) because by Oklahoma statutorily dedicates 5% of SUT, PIT, CIT and net lottery proceeds, and 1% of cigarette taxes, to support the ADCs for several state pension systems. These include plans for firefighters, law enforcement, police and teachers. Other revenues dedicated for ADCs include insurance premium taxes, driver's license taxes and motor vehicle inspection fees.
Although the state is a frequent borrower, overall debt levels are modest. There are no general obligation bonds currently outstanding. Outstanding debt consists of $1.85 billion of lease revenue bond obligations supported by annual legislative appropriations divided between OCIA for state agency projects and ODFA mainly for higher education system projects. The latter are supported, to a significant extent, by student tuition and campus fees.
As of Fitch's 2021 State Liability Report, Oklahoma's combined liability burden was 2.8% of 2020 personal income when applying Fitch's standard 6% discount rate assumption for U.S. state and local government pension plans. This is well below the 50-state median of 4.7% as calculated by Fitch. Using updated data from the state's fiscal 2021 audited financial statements and 2021 state personal income data, Fitch calculates combined liability burden of 2.9% of personal income for the state.
The funded status of the major pension systems, covering state employees (PERS), teachers (TRS) and other retirees, has improved since 2012 due partly to overfunding of annual ADCs using allocations of specific tax receipts, as noted above. Fitch views Oklahoma's commitment to over-funding its pension ADCs as noteworthy. Pension ADCs are a small percentage of overall spending.
PERS reported a 112.5% ratio of assets to liabilities as of fiscal 2021 while TRS reported an 80.8% ratio. Using Fitch's standard 6% discount rate for U.S. state and local government pension systems (versus the 6.5% and 7.0% rates used by the systems) would lower the systems' asset-to-liability ratios to 106.7% and 72%, respectively. These levels are improved from 82% and 56% in 2015. Sharp asset value growth in 2021 pushed the ratio of assets to liabilities higher for Oklahoma's pensions, like other pensions nationally. Improvement in Oklahoma's plan ratios over time also reflects a consistent practice of making contributions higher than the ADCs, including through dedicating portions of state tax revenues.
Oklahoma's ability to respond to cyclical downturns rests upon a combination of strong budgetary flexibility and maintenance of a healthy fiscal reserve cushion. The state's reliance on spending cuts and one-time actions to close budget gaps, supplemented by reserve draws when structural balance cannot be achieved, partly reflects the restrictions noted above that limit the state's practical ability to raise recurring revenues.
Fitch's Analytical Stress Test (FAST) scenario analysis tool relates historical revenue volatility to GDP to support the assessment of operating performance under Fitch's criteria. FAST is not a forecast, but represents Fitch's estimate of possible revenue behavior in a downturn based on historical revenue performance. FAST provides a relative sense of a particular state's risk exposure compared to its peers.
Oklahoma's FAST results show a 7% revenue decline in year one of the scenario in response to a standard 1% GDP contraction, well above the 3% median year-one decline for U.S. states. Oklahoma's revenues decline by a cumulative 7% over the three-year scenario versus essentially flat revenues for the U.S. state median. Above-average revenue volatility is reflected in Fitch's 'aa' financial resilience assessment. Fitch anticipates the state will rely on its strong budgetary flexibility to absorb the effects of downturns, but use all or most of its reserves. The state acts to rebuild resilience during recoveries, but its profile is more consistent with 'aa' than with 'aaa'.
Oklahoma's actions over the past decade reflect a pattern of drawing down reserves almost completely during recessions and replenishing them when the economy rebounds. The state's post-Great Recession recovery was tied to vibrant growth in the natural resource industry. Oklahoma replenished the CRF to $806 million (12% of revenues) in 2019, assisted by higher oil prices and faster GDP growth.
The state then reduced the CRF balance to $302 million and RSF balance to $333 million on a cash basis by FYE 2020. The budgeted use of reserves in fiscal 2021 lowered combined balances to $229 million at June 30, 2021 (equal to 3.4% of GRF revenues). Solid fiscal 2021 revenue performance resulted in a $282 million surplus deposited directly to the CRF, raising its balance to $370 million in July 2021 and boosting total reserves to $542 million, equal to 7.7% of fiscal 2021 GRF revenues.
The state is examining options to enhance reserve funding, as a consensus exists in state government that Oklahoma's reserve practices have not spared it from the negative impacts of repeated, energy-related downturns. Maintaining adequate reserves is critical to Oklahoma's ability to weather the 'boom and bust' cycles inherent to the energy industry. A sustained boost to reserve funding could have positive rating implications.
Oklahoma's financial operations are supported by conservative fiscal policies, including a provision in the state constitution that limits appropriations to 95% of anticipated operating fund revenues as certified by the BOE for the next fiscal year. Revenues exceeding 100% of the BOE-certified amount flow are deposited into the CRF up to a constitutional cap of 15% of the prior fiscal year's GRF revenues.
Monthly revenue monitoring by the Office of Management and Enterprise Services (OMES) and three BOE revenue forecasts annually are used to help maintain structural balance. State agency spending is overseen by OMES' director, who has legal authority to cut spending when revenues fall below forecast.
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 due to the impact of natural resources management on its economy and governmental operations, which has a negative impact on the credit profile, and is relevant to the ratings 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