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11 Oct 2016
New York, October 11, 2016 -- Issue: Lease Revenue Refunding Bonds (Oklahoma Department of Corrections Union City Facility Project) Series 2016A; Rating: Aa2; Rating Type: Underlying LT; Sale Amount: $2,595,000; Expected Sale Date: 10/13/2016; Rating Description: Lease Rental: Appropriation;
Summary Rating Rationale
Moody's Investors Service has assigned a rating of Aa2 to the Oklahoma Development Finance Authority's Lease Revenue Refunding Bonds (Oklahoma Department of Corrections Union City Facility Project) Series 2016A. The Aa2 rating is the same as that of the State of Oklahoma (Aa2, negative). The bonds are payable from annually appropriated lease payments, like the majority of the Oklahoma's outstanding debt. However, a constitutionally based guarantee applicable to these bonds, through the Credit Enhancement Reserve Fund (or CERF), creates a credit that is significantly stronger than the state's non-guaranteed lease debt, which is rated Aa3.
The negative outlook reflects the ongoing fiscal effects of a severe two-year decline in production and employment levels in the state's oil and gas sector and our expectations of a prolonged, muted recovery in oil prices and continued declines in production and ongoing sector volatility. We expect the state's financial reserves to continue to decline into fiscal 2018, as the state seeks to offset lower revenue and maintain adequate levels of spending. Contraction in the energy resources sector will continue to pressure employment levels.
Factors that Could Lead to an Upgrade
Rapid recovery in the oil and gas sector leading to sustained economic and revenue outperformance
Increase in financial reserves
Significant economic diversification beyond the oil and gas sector
Factors that Could Lead to a Downgrade
Exhaustion of CERF's claims reserve account
Depletion of state's financial reserves
Continued use of one-time revenues to address future budget gaps
Steeper-than-expected decline in energy production
The ODFA has guaranteed payment on the Series 2016A bonds under the state's constitutionally authorized Credit Enhancement Reserve Fund (CERF) program. The ODFA acts as insurer against nonpayment with trustee as beneficiary. The guaranty policy stipulates that in the event of nonpayment of debt service, the ODFA irrecovably guarantees payment of principal and accrued interest on the Series 2016 bonds. In practice, the state expects to have sufficient advance warning of nonpayment given that budgets are finalized in May and debt service payments are on July 1 and December 1, with the July appropriation made in the prior fiscal year. As specified by the transaction documents, in the event of nonpayment and subsequent notification by the bond trustee, the ODFA would first draw on the Claims Reserve Account of the CERF program, which currently contains $1.2 million and consists of premiums paid by other borrowers under the program. If the reserve is insufficient to cure the nonpayment, the ODFA would then issue previously authorized state general obligation bonds. The CERF program is constitutionally authorized with $100 million in general obligation bonds having been previously authorized by a vote of the people in 1988. Currently, there are $30 million of bonds outstanding that were issued under the program, and several million more are contemplated in the coming weeks. A 91-day claims period between trustee notification and general obligation bond issuance incorporates a review by the state's attorney general and a 30-day incontestability waiting period after notification by the trustee.
Although rated the same as the state's general obligation debt, lease-appropriation bonds that benefit from this additional enhancement are not themselves general obligation bonds. They carry additional risks, such as the risk that a market will not exist for general obligation bonds when the guarantee is triggered. Given the lack of nonpayment history on CERF bonds, the process has never been tested.
The CERF bonds are also distinct from general obligation bonds in that a 30-day incontestability waiting period must elapse between the state attorney general's issuance of a certificate that the forms and procedures for bond issuance have been followed and the actual bond issuance. The CERF guarantee makes the credit of these bonds stronger than that of traditional lease-appropriation debt. The CERF guarantee mitigates the risk of non-appropriation since such an action would trigger the issuance of general obligation bonds. It is also clear that the voter intent and constitutional language call for issuance of general obligation bonds in the event of nonpayment.
The Series 2016A bonds are secured by rental payments made by the Oklahoma Department of Corrections (DOC) to the ODFA. The department's obligation to make payments under a facilities lease and operation agreement with the authority is subject to the availability of funds through legislative appropriation. Moody's views the risk of non-appropriation as slight, given Oklahoma's record of timely payment on appropriation-backed securities in the past and the state's reliance on this kind of borrowing for a broad range of purposes. Most of the state's net tax-supported debt requires annual appropriation for payment of interest and principal. Oklahoma's need for continued market acceptance of these securities provides a strong incentive for future legislatures to make timely appropriations for debt service. The essential function performed by the department's facilities also suggests only a minimal risk of non-appropriation.
The lease agreement provides that the department's obligation to make payments from appropriated funds will be absolute and unconditional. The agreement requires the department to make annual requests for legislative appropriations sufficient to cover the bonds' debt service, to pay lease rentals on a monthly basis to the bond trustee, and to insure the facility and its operations. There is no debt-service reserve associated with the issue. Risk of default from late budget adoption is mitigated by the requirement that lease payments be made monthly, to provide in advance for upcoming bond interest and principal requirements.
Use of Proceeds
The Series 2016A bonds will refinance outstanding Series 2006 bonds, which were issued to finance the DOC's purchase of a prison in Union City, Oklahoma from a private operator.
Oklahoma is the 28th-largest state, with a population of 3.9 million. It had a gross domestic product of $169 billion in the first quarter of 2016, which ranks 29th in the US.
The principal methodology used in this rating was Lease, Appropriation, Moral Obligation and Comparable Debt of US State and Local Governments published in July 2016. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.
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