Standard & Poor's Ratings Services said it lowered its issuer credit rating (ICR) on the state of North Dakota to AA-plus from AAA.
At the same time, it lowered the ratings on the state's appropriation debt to AA from AA-plus and the ratings on the state's moral obligation-backed debt two notches to A-plus from AA. The outlook on all ratings is stable.
"The downgrade reflects our view of increased volatility in the state's economy that has translated into a projected $1.074 billion, or 22%, general fund revenue shortfall for the 2015-2017 biennium," said Standard & Poor's credit analyst Carol Spain.
High oil prices and the introduction of horizontal drilling with hydraulic fracturing dramatically have increased North Dakota's oil production in the Bakken Shale formation over the past 10 years, earning it the position as the nation's second-largest oil-producing state and, correspondingly, growing both state revenues and reserves.
Sharp declines in oil prices since December 2014 have resulted in slowing economic activity, and, although directly oil-related revenues comprise a minimal share of the general fund budget, an actual shortfall of 17.3% compared with budgeted revenues over the first six months of fiscal 2016 illustrates the state budget's susceptibility to a downturn in the oil industry, the rating agency said.
It has previously cited North Dakota's very strong reserves as a credit strength, mitigating its vulnerability to oil sector declines. However, as a result of its updated revenue forecast, officials plan to make budget cuts of $244.9 million (4.05%) and expect to draw down the entire general fund balance of $331.7 million, and $497.6 million of its budget stabilization reserve fund, leaving combined reserve balances at $74.9 million, or just 3.1% of annualized ongoing expenditures.
While North Dakota would still have significant balances in its other reserve funds, in S&P's view, drawdowns of such magnitude are not commensurate with more highly rated peers.
"The stable outlook reflects our view of the state's structural balance over the 2015-2017 biennium, as one-time capital costs equal the size of revenue shortfalls," added Spain. It also reflects the state's ample reserves in the legacy fund, which it views as providing flexibility in the case of shortfalls in the following biennium. The outlook additionally reflects S&P's view that state officials will continue to update revenue projections and take further budgetary actions if necessary to offset any further potential revenue shortfalls over the two-year horizon.
The rating could be lowered further if economic indicators decline further or revenues fall considerably below current estimates. Also, evidence of structural imbalance over time could pressure the rating. Conversely, given the cyclicality of the state's revenue base, upward rating potential over the near term is limited, in the rating agency's view. However, it would likely view further diversification of the tax base or maintenance of very strong reserves to offset volatile revenues as favorable.
