DALLAS — North Dakota lost its Standard & Poor's triple-A rating because of the impact of oil price volatility on the state's economy.
S&P lowered the state's issuer credit rating one notch to AA-plus late Thursday. The rating agency also lowered the state's appropriation debt rating one level to AA from AA-plus, and the state's moral obligation-backed debt rating by two notches to A-plus from AA. The outlook on all the ratings is stable at the lower level.
"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 analyst Carol Spain.
North Dakota's economic health of recent years and flush reserves in its Budget Stabilization Fund can be traced to the development of shale oil fields that benefitted from high oil prices, but recent extended price declines have negatively affected sales tax and other revenue collections.
"We were dismayed that S&P downgraded North Dakota's AAA rating, especially because the state has planned for possible downturns by building up our reserve funds and protecting the structural balance of our budget by focusing on one-time infrastructure investments verses ongoing operations," said Office of Management and Budget director Pam Sharp. "We believe the financial condition of the state is still very solid."
This month North Dakota dipped into its $572 million budget reserve to the tune of $497 million to help cover a $1 billion shortfall in revenue for the 2015-2017 biennium triggered by falling crude oil prices. The budget forecast assumes West Texas Intermediate crude oil prices of $30 per barrel as of January 2016 that gradually transition to $43 per barrel by June 30, 2017.
The state had already implemented across-the-board budget cuts of 4.05% to make up for the shortfall in a $6 billion general fund budget for the current two-year cycle that began in July 2015. Another $75 million remains in the reserve fund, which is earmarked to provide further relief if the economy hasn't turned around by the state's next revenue forecast, which is scheduled for the summer.
S&P had previously cited North Dakota's strong reserves as a credit strength mitigating its vulnerability to oil sector decline. However the February drawdown on reserves increases the state's susceptibility to a downturn in the oil industry.
"In our view, drawdowns of such magnitude are not commensurate with more highly rated peers," said S&P. "We recognize that it is still early in the biennium and that actual revenues could outperform projections or the state legislature could enact additional budget cuts to reduce expected drawdowns. However, in our view, the proven vulnerability of the state's economy and general fund budget to the cyclical oil industry warrants a rating action."
The revised budget forecast projects $2.5 billion of gross production and extraction taxes, down 28% from the 2015 legislative forecast. North Dakota has two different oil taxes: a 5.0% oil and gas production tax and an oil extraction tax, which was reduced from 6.5%, effective Jan. 1, in attempt to mitigate swings in oil prices.
S&P gives North Dakota's rating a stable outlook because of its ample reserves in the legacy fund, which give it flexibility in the case of shortfalls in the following biennium.
As of December 2015, the state reported a $651.6 million balance in its foundation aid stabilization fund, although the state plans to make $71.8 million transfer to the Department of Public Instruction. Although the fund is meant to support education, it provides the general fund with flexibility to reduce education spending.
The state's strategic investment and improvements fund had an unassigned balance of $101.4 million, which has historically been used to finance capital improvements but could also be tapped to fund operations. The state's legacy fund had a balance of $3.6 billion, but it can't be used until 2017, and then only 15% of the principal may be spent, once each biennium, and only after a two-thirds majority vote of the legislature.
North Dakota also limits the amount of oil tax revenue that flows through to the general fund at $300 million per biennium. For the current biennium that runs through until June 30, 2017, the state has already reached two-thirds of that limit through December 2016, or the first 6 months of the 24-month period.
North Dakota primarily issues appropriation-backed debt through the North Dakota Building Authority. The debt burden is low and cannot exceed 10% of the sales use and motor vehicle tax revenues which is currently forecasted to total $230.7 million during the 2015-17 biennium. A portion of the North Dakota Public Finance Authority debt also carries the state's moral obligation pledge, with that debt going to fund projects across the state. The state's tax supported debt totals $290.8 million including moral obligation bonds and $67 million without the moral obligation.