OREANDA-NEWS. Fitch Ratings has assigned an 'F1+' rating to the City of Houston, Texas' (the city) \$220 million tax and revenue anticipation notes (TRANs), series 2015.

The notes are scheduled for a competitive sale on June 17. Proceeds will finance general operating expenditures during fiscal 2016 in anticipation of tax and revenue collection.

In addition, Fitch affirms the following ratings:

--\$1.36 billion public improvement bonds (PIBs) at 'AA';
--\$9.7 million certificates of obligation (COs) at 'AA';
--\$184.7 million pension obligation bonds (POBs) at 'AA'.

(Fitch does not rate the city's outstanding PIBs, series 2008A, 2009A, taxable 2009B, 2011A, taxable 2011B, and 2014A. Fitch also does not rate the city's taxable POBs, series 2008A and 2008B).

The Rating Outlook is Stable.

SECURITY
The TRANs are payable from ad valorem taxes, sales and use taxes, franchise charges and fees, and certain other general revenues (remaining after legally required deductions of amounts for payment of bonded indebtedness and other obligations of the city, or payment to any special fund or special trust fund).

PIBs, notes and POBs are secured by a limited ad valorem tax levied against all taxable property in the city. COs are secured further by a subordinate lien against certain city revenues.

KEY RATING DRIVERS

NOTE RATING REFLECTS LONG-TERM CREDIT QUALITY: The 'F1+' rating assigned to the TRANs corresponds to the long-term rating on the city's limited tax bonds.

BUDGET PRESSURES TO CONTINUE: Financial challenges remain, led by increases in benefit and public safety outlays. Voter approved property tax limitations restrict revenue and budget flexibility but operating reserves remain sound. Fitch assumes in its rating and Stable Outlook that management will take appropriate action to address these challenges.

LARGE BENEFIT LIABILITIES: Debt levels are manageable and the pace of amortization is above average; however, when other long-term liabilities (pension, retiree health benefits) are included, the overall burden is large. Annual payments to both the municipal and police plans have been less than actuarially-determined annual required contributions (ARC), even using an aggressive investment return rate assumption.

LARGE, DIVERSE REGIONAL ECONOMY: The expansive regional economy has continued to show solid gains in recent months, although the recent plunge in oil prices is expected to slow the pace of growth over the near term

RATING SENSITIVITIES

PRESSURED FINANCES, LARGE OBLIGATIONS: A material reversal of recent operating gains and corresponding declines in reserves, or continued erosion of pension funding levels, would be a negative credit consideration and could lead to downward pressure on the rating.

CREDIT PROFILE

ANNUAL TRAN BORROWING FINANCES CASH FLOW NEEDS

TRAN proceeds will be used to finance a portion of general operating expenditures for fiscal 2016 in anticipation of the collection of taxes and revenues. The TRAN's pledged revenue base is broad, representing the majority of general fund revenues. Coverage of the note repayment is healthy.
Projected pledged revenues total \$1.92 billion, a modest 1% increase from projected fiscal 2015 levels. These revenues represent 9.6 times (x) the TRAN principal, and the projected June 30, 2016 cash balance (plus TRAN proceeds) provides a satisfactory 1.5x coverage.

The city is authorized to borrow additional amounts for cash flow needs throughout the year, subject to a \$300 million limitation in the aggregate for such purposes, although no additional borrowing is planned. The city's practice is to set aside funds for TRAN repayment in three generally equal installments in April, May and June of the fiscal year.

The projected beginning cash balance for fiscal 2016 is estimated to be roughly \$207 million, approximately \$16 million larger than the beginning balance for fiscal 2015. This increase in cash balance is due to the net surplus projected for fiscal 2015 financial operations, as detailed below.

ECONOMIC PERFORMANCE BOOSTING REVENUES; PRESSURES CONTINUE

Both sales and property tax revenues recorded impressive gains over the past three fiscal years, with sales tax receipts posting a cumulative 15% increase and property taxes climbing 13% over this timeframe. These two sources combine to produce roughly three-quarters of general fund revenues. However, property tax revenue growth will become constrained next fiscal year. Voters in 2004 approved Proposition 1 that restricts property tax revenue growth to the lesser of CPI plus population growth or 4.5%. Proposition H approved by voters in 2006 amended the cap to allow \$90 million in additional revenue for use on public safety.

Financial performance has been somewhat variable but generally positive in recent years due to aggressive cost cutting and favorable revenue variances. At fiscal 2013 year-end, the unrestricted general fund balance totaled \$197.8 million or 9.6% of spending and transfers out, up \$50 million from fiscal 2011.

Operating results turned negative in fiscal 2014, as continued wage and benefit pressures boosted general fund spending up 9% over the prior year. Although revenues posted a solid gain of nearly 7%, the increased spending and larger debt service transfer contributed to a net deficit after transfers of \$14 million. At \$204 million, the year-end unrestricted general fund balance was a satisfactory 9% of spending. General fund liquidity remained sound, with fiscal 2014 year-end cash and investments at \$248 million or roughly 48 days of spending.

The fiscal 2015 budget reflects continued spending pressures, led by a more than 20% increase in pension contributions and pay increases for police and municipal workers. General fund spending is slated for a 7.4% increase from the prior year budget. Revenues were budgeted for a similar 8.5% gain, with property and sales taxes projected to climb more than 12% and 5%, respectively. The adopted budget included an operating gap of \$48.5 million, but better than forecast revenue, aggressive staffing controls, and \$23.5 million in land sales are expected to increase the unassigned fund balance by \$17 million (0.9% of spending), increasing reserves to 12% of spending.

Management has expressed its commitment to maintaining the unassigned general fund balance at its 7.5% of spending policy target as it faces additional benefit and personnel cost pressures. In addition, due to the revenue cap discussed above, the city will forego \$53 million (2.3% of general fund revenues) in property taxes in fiscal 2016. The budget is further pressured from rising debt service costs (\$31 million) and a one-time \$25.5 million repayment of deferred contributions to the police pension plan.

The resulting fiscal 2016 imbalance, if realized, would reduce reserves by \$86 million (3.6% of spending) to the 7.5% fund balance policy level (plus a 1% budget stabilization fund). Net of the one-time repayment of the pension deferral, the gap between recurring revenues and expenditures is moderately smaller at \$49 million (2.1% of spending). The imbalance is premised on slower sales tax growth of 1.8% that reflects management's anticipation of flat employment levels due to expected contraction in Houston's energy sector.

The city's five-year forecast includes continued structural imbalances based on the 3% property tax revenue growth allowed under the revenue cap, moderate sales tax growth (2.5% - 4.4%), and police pension adjustments of \$50 million in each of fiscal 2017 and 2018. These additional city contributions are required per contract in order to keep the police pension plan funded at a minimum of 80%. The fiscal 2015 budget also included such a payment, but it was not needed upon the update to the actuarial valuation.

LONG-TERM LIABILITIES SIZABLE

Fitch considers Houston's overall debt levels above average at roughly \$4,880 per capita but more moderate when measured against the tax base at 4.4% of market value. The pace of tax-supported debt retirement is above average, with two-thirds retired in 10 years. The city also maintains multiple GO commercial paper programs to provide interim capital financing. The total authorized amount is \$875 million, and the amount outstanding at March 31, 2015 was \$111.9 million. The city's five-year general government capital improvement plan is up moderately from prior plans, with streets and drainage the largest components. The city anticipates that the majority of tax supported components of the plan will be debt funded. Due to the aggressive pace of debt amortization, future debt is not expected to materially impact the debt burden.

The city has three single employer defined benefit pension programs -- for municipal, police and fire employees. Fitch considers the large unfunded liabilities in the municipal and police plans and the pressures associated with improving and maintaining funding levels for all programs significant credit concerns.

The city's efforts in recent years to address the pension funding issue have included negotiated benefit adjustments, contribution increases, pension obligation borrowings, and in-kind contributions. In 2011 the city and the municipal employee association agreed to a multi-year agreement that included increased city contributions to the pension plan. The current police pension funding agreement expires in 2023 and also calls for increased contributions from both the city and police employees.

The firefighter pension plan is governed by state statute, which defines both benefits and the amount of required contributions. The city recently sued the firefighter pension plan, challenging the governing statute as unconstitutional. The trial judge ruled against the city, and the city has appealed this decision.

City contributions to the municipal and police plans have met the contractual requirements, but the payments have fallen short of the actuarially-determined ARCs. The city's expectation is that as the combination of benefit adjustments and increasing contributions take effect, the assets of these two systems will be sufficient to meet obligations as they come due. The city's investment return assumption of 8.5% is aggressive, making the prospect to achieve progress (absent strong market performance) more challenging. An inability to make measurable progress in closing these funding gaps would not be consistent with the current rating and likely would result in negative rating action.

The funding level for the municipal plan, when adjusted for a more conservative 7% investment return assumption, is estimated at a low 50%; the police and fire plans are in somewhat better shape at roughly 70% and 74% funded, respectively (assuming a 7% return). Other post-employment benefits (retiree healthcare) also represent a sizable liability, but recent program changes have shaved the total liability by one-third from \$3.1 billion to \$2 billion, which equals less than 1% of fiscal 2015 market value.

Additional pension outlays likely will continue to pressure the city's operations. Evidence of this pressure is found in the high fiscal 2014 carrying cost (combined debt service, pension ARC and OPEB payment) of 25.7% of governmental spending.

OIL PRICE COLLAPSE CLOUDS OTHERWISE STRONG ECONOMIC PICTURE

The post-recession recovery of Houston's regional economy has outpaced that of many other large U.S. cities, as a robust energy sector, the Port of Houston and healthcare all contributed to recent population and employment gains. Regional employment continued to register moderate gains, posting a 1.3% increase in the 12-month period ending in March 2015; the city's unemployment rate of 3.9% for the month was down from 5% in the same period last year and is below the state (4.2%) and U.S. rate (5.4%). The metro population continues to expand at an annual rate of roughly 2%, in line with state growth trends and double the U.S. average. The city's population has increased more slowly due to its land-locked boundaries.

The recent plunge in oil prices will materially affect the pace of economic growth in the city over the near term. Houston is home to several thousand energy companies, ranging from large multi-national concerns to numerous mid-sized to smaller exploration, construction, engineering and service companies. While growth in other sectors (e.g. shipping, healthcare) has reduced dependence on the energy sector over the past several decades, direct employment in the sector was 4% of the 2014 regional total. Estimates of the oil and gas contribution to Houston's 2014 GDP range from 15-20%, and when associated industries are included the share of GDP increases to 35-40%.

A number of energy companies have announced layoffs in recent weeks, including Schlumberger, Halliburton and Baker Hughes. Total job loss estimates vary, but projections for 2015 Houston employment gains are sharply lower than the 100,000 annual increases in jobs the city has experienced recently.