The Downgrade Controversy, How Did It Happen
By: David Taylor
One of the Big Three credit rating agencies for commercial and governmental entities has lowered the credit worthiness of the City of Houston for the second time in less than a year. Moody’s Investors Service last Wednesday announced it was downgrading the City of Houston's general obligation limited tax rating to Aa3 from Aa2, affecting approximately $3 billion in previously issued bonds.
Concurrently, Moody's assigns an Aa3 to the City of Houston $600 million Public Improvement Refunding Bonds, Series 2016A. The caveat this time comes with the epithet, “The outlook remains negative.”
The report cited the weakening economic and financial performance driven by prolonged decreases in oil prices. It also reflects the city's high fixed costs, large unfunded pension liabilities (among the highest in the nation), as well as property tax caps.
“This is the result of some factors that are pretty much out of our control in that the oil markets have had a more prolonged downturn than previous recoveries,” said City Controller Chris Brown. “This one seems to be longer than others.”
Brown said, in his mind, this only underscores the urgent need for council and the mayor to address the structural challenges, unfunded pension liabilities and unbalanced budget and the revenue cap.
“Those are some of the areas, at least from a managerial standpoint, that we have some control over,” he said.
Brown said he saw the report as a warning shot.
“I hope that it helps to urge all stakeholders and elected officials to work toward solving some of these problems we’ve had for many years,” he said.
HOW DID IT HAPPEN
The Texas Legislature controls pension benefits for cities. In 2001, the legislature dramatically increased Plan A benefits by raising the 25-year pension from 80 percent to 90 percent of salaries.
City employees typically earn approximately a third less than their counterparts in the private sector and with politics at the center of their pay raises, they are lucky to see a pay raise if one at all, every three or four years. In order to compensate, cities and the state have tried to compensate by offering better pension packages to their employees.
SOME CHANGES HAVE BEEN MADE
The City has a ‘Meet and Confer’ agreement with the Houston Municipal Employees Pension System (HMEPS) and the Houston Police Officers Pension System (HPOPS) that went into effect July 1, 2011 that gave the City a limited ability to make some changes.
“New hires, for example, have a much more reduced benefits structure than current employees or retirees,” Brown said.
The Houston Firefighter’s Relief and Retirement Fund (HFRRF) is negotiated through collective bargaining which will require the state legislature to act to make any kind of change to their plan.
“The mayor (Turner) has been in discussion with all three pension plans and asking for what he calls a ‘shared sacrifice’ from them and asked all of them to come to the table with ideas that we can bridge that unfunded liability,” Brown explained.
He says that there is hope that a plan can be reached and taken to the state legislature and get a bill passed that would offer some type of reform.
The number is staggering, some $5.6 billion, up from about $3.4 billion from the audited financials from the previous year.
“A large portion of that is because of the new and more strict reporting requirements that force us to lower the discount rate at which we come to arrive at the unfunded liabilities through the three different pension plans. It also forces us to disclose the annual payment but the total deferred payment and the total unfunded liability,” Brown said.
The Governmental Accounting Standards Board (GASB) Statement No. 68 only exacerbated the problem for the city and now leaders must face the music and at a fast tempo.
UNCAPPING THE CAP
Brown said the revenue cap was put into place back in 2004 with a referendum supported by citizens who were worried that the city wasn’t efficiently managing its money and concerned growing pension liability would be forced onto taxpayers to pay.
According to Brown, this fiscal year, approximately $100 million in property tax revenue was returned back to the taxpayer in the form of a reduced tax rate.
“We’ve actually reduced the city’s tax rate from 63.875 cents per $100 assessed valuation down to 60.11 cents.
That’s revenue the city no longer has in its coffers,” Brown said.
It becomes added pressure, he said, because revenues are capped.
“In an aggregate basis, if you compare it with the amount of growth we’re experiencing in the city versus the amount of growth allowed under the revenue cap, you essentially cap that extra growth,” the controller said.
Brown said they could go to the voters and ask for an increase in the cap for a specific thing such as additional police on the street.
Another alternative would be a referendum to ask voters to remove the cap completely, something Brown said he didn’t believe voters would approve if City Hall didn’t first do some form of internal reforms with pensions and budget.
Some blame the predicament the city finds itself in on the pension board’s actuarial firm, Towers-Perrin, for underestimating the number of employees who might switch from their Plan B that allowed employees to contribute nothing, but only receive about 51 percent after 25 years to change their plan to Plan A if they paid back their years of service contribution plus 6 percent interest.
“It was almost a 250 percent increase in cost to service pensions over a 15-year period and that is a huge portion and reason why we are having the challenges. The revenue cap only exacerbates the problem,” Brown said.
HOPE ON THE HORIZON
Brown said despite some naysayers, we’re not headed to being another Detroit.
“We have a long way to go but we have the ability with the pensions to devise a mutually agreed upon shared sacrifice. The mayor is working on a plan now and I think if we can get something passed in this next legislative session, we can drastically reduce that unfunded liability,” he said.
Based on some preliminary numbers and reports, Brown was confident that the number could be almost cut in half overnight.“That would add a huge amount of liquidity to the ledger,” he said.
Work on the revenue cap would also bring some favor from Moody’s and then finally, stop underfunding those pension obligations.
“If we do that, it’s like homework, we pay it like we’re supposed to for the next 30 years or so and we can take care of it,” he said.
TIMELINE TO REPAIR
Many of the proposals could be addressed in the coming weeks or months, but the biggest hurdle to tackle, according to Brown, would be the pension and it won’t be touched until the legislature is back in session. That would be the next biennium, around this time next year.
Brown was confident that the city would be able to balance the $130 million shortfall within the next three months or so.
“It’s not magic, but the mayor is driving that effort. He’s been very pro-active about fixing what we can do now,” he said.
The budget, which would be adopted in late June, Brown said the mayor is taking the initiative to get that done in order to focus on other city problems, including the pensions.
While there was some talk about a ballot issue with the revenue cap, Brown didn’t foresee it happening in the fall.