Houston Undaunted by Downgrades Ahead of $600M Deal
By: Richard Williamson
Houston officials still expect strong demand for $600 million of general obligation bonds this week despite two downgrades ahead of the deal. “It will have an effect,” Controller Chris Brown acknowledged after Moody’s Investors Service dropped the city’s GO rating one notch to Aa3 Wednesday and retained a negative outlook. “Despite the downgrade, we believe we’ll continue to have a good pricing,” added Brown, who won election as controller in a 2015 runoff that focused heavily on the Bayou City’s long-term debt profile.
The Tuesday deal includes $107 million of new money and an anticipated $493 million of refunding, which could vary based on market conditions.
“Rates are still relatively low,” Brown said. “I look for a good reception. The timing is good for us.”
Standard & Poor’s followed the Moody’s downgrade Friday by lowering the nation’s fourth-most populous city to AA from AA-plus.
The ratings downgrades could cost the city anywhere from $1 million to $1.5 million in net present value savings, Brown estimated. Nonetheless, he expects about $48 million on NPV savings over the life of the bonds.
One immediate benefit of the refunding should be a reduction in debt service in fiscal years 2017 and 2018, Brown said. That is part of the city’s plan to trim the budget amid a reduction in sales tax revenue and weaker growth in property tax revenue.
“The refinancing will still yield considerable savings,” Mayor Sylvester Turner told The Bond Buyer after the Moody’s downgrade. “I remain confident that the steps we are taking today will create fiscal stability for the city tomorrow."
Standard & Poor’s also shifted its outlook to negative when it downgraded Houston last week.
“The negative outlook reflects our view that there is at least a one-in-three probability that we could lower the rating again within the next two years if Houston is unable to develop and implement a credible plan that lowers its unfunded pension liability or if continued softness in oil prices leads to ongoing contractions in tax revenue," Standard & Poor's analyst Omar Tabani wrote.
"The downgrade reflects our opinion of the city's large unfunded pension liability that has been exacerbated by what we consider optimistic rate of return assumptions and a history of lower-than-actuarially determined contributions, which the current administration is seeking to correct," Tabani said.
Standard & Poor’s had upgraded Houston in February 2014. Its rating remains a notch above Moody’s.
The ratings actions come as Brown and Turner are preparing for the annual Houston Investor Conference April 11-12.
Officials from the city, Harris County, the Port of Houston, the city’s airports, the Harris County Metro Transit Authority and the Harris County Houston Sports Authority made presentations at last year’s conference, when Brown’s department was represented by then-Controller Ronald Green, who was term-limited out of office last year.
Brown was deputy controller under Green.
The Sports Authority will play a prominent role this year as Houston prepares to host the National Football League’s 2017 Super Bowl. For investors the authority can also do some bragging about restoring its investment-grade credit ratings on outstanding bonds after restructuring its debt and resolving litigation with bond insurer National Financial Guarantee Corp., formerly MBIA Insurance Co., in 2015.
Until then, all eyes are on the price of oil, which has an outsized impact not only in Houston but in other energy-centric cities and states.
“We’re getting hit from all sides here right now,” Brown said. “The fact is that we can’t control the economy.
“If the oil prices come back, Houston will be a very prosperous city,” Brown said. “We’re already starting to see a rebound from the $26. We just broke $40, as we speak.”
The futures price of West Texas Intermediate Crude broke the $40 barrier on Thursday, falling back slightly to close at $39.35 at week’s end.
For budgeting purposes, Houston assumed that oil prices could fall below $20 by the end of the fiscal year, leaving a sizable cushion if prices go the other way. The city’s oil and gas revenues come indirectly through sales taxes and property taxes, including those levied on the oil and gas companies with sizable operations in Houston.
Three of the city’s top five taxpayers are energy companies. However, the word most often heard among public officials is diversification.
Dramatic growth in the medical and high-tech industries since the historic energy bust of 1986 has done a lot to ease the impact of falling oil and gas prices. Even after the downgrade, S&P acknowledged that the Houston economy remained strong.
“While currently low oil prices create some uncertainty over near-term employment levels in the oil industry, we believe the local economy is broad and diversified enough to withstand ongoing slowdowns in oil-related activity as long as they are not too protracted,” Tabani wrote.
“Although it has not yet occurred, a prolonged slowdown could result in muted property tax base growth over the next few years,” he added. “However, the city continues to see a boom in downstream petrochemical activity and continues to maintain a large medical presence, both of which are expected to help mitigate the impact of low oil prices.”
When discussing Houston’s role as the nation’s energy hub, economists distinguish the impact of low oil prices on the so-called “upstream” and “downstream” sectors.
The west side of the metro area, including Fort Bend County, is generally identified with the upstream sector, which includes exploration, drilling and production companies.
The east side of the city and its suburb of Baytown are heavily represented by downstream industries, including refining, chemical production and related businesses. The transportation sector, which includes pipelines, is known as the midstream sector.
“The current drilling downturn — the worst since the 1980’s – has hit Houston’s West Side particularly hard,” according to University of Houston professor Bill Gilmer.
“Meanwhile, largely neglected compared to its upstream sibling, the downstream refining and chemical plants in East Houston are enjoying a massive and unprecedented $50 billion construction boom.”
“A combination of strong U.S. economic growth and this downstream construction may be just enough to keep the Houston economy out of recession,” Gilmer added.
Loop Capital Markets managing director Curtis Flowers is lead banker on Tuesday’s negotiated deal, with five underwriters as co-managers. First Southwest Co. managing director Trey Cash and senior vice president Tina Peterman are financial advisors.