Fitch Affirms Harris County, TX's IDR at 'AAA'; Outlook Stable
--Issuer Default Rating (IDR);
--$814.9 million unlimited tax bonds;
--$329.1 million unlimited tax and subordinate lien revenue bonds;
--$898.7 million limited tax bonds;
--$184.1 million limited tax and subordinate lien revenue bonds.
The Rating Outlook is Stable.
The unlimited tax bonds are payable from an unlimited annual property tax levy. Certain unlimited tax bonds are additionally payable from a subordinate lien on the net revenues of the county's toll road system. The limited tax bonds are payable from an annual property tax levy limited to $0.80 per $100 assessed valuation (AV) for operations and debt service. Certain limited tax bonds are additionally payable from a subordinate lien on the net revenues of the county's toll road system.
KEY RATING DRIVERS
The 'AAA' IDR and general obligation (GO) ratings reflect the county's strong gap-closing capacity in the form of budget controls supplemented by reserve funding, a modest liability burden, and the solid economic base and growth prospects. Management's prudent budgeting of its expansive resource base benefits the county's prospects for maintaining structural balance through economic cycles.
Economic Resource Base
Harris County is the largest county in Texas and the third largest in the nation, encompassing all but a small portion of the city of Houston, with a population totaling 4.6 million. The county features a large, diverse economy that remains exposed to the energy sector. Expansion of the healthcare, biomedical research, aerospace, port, and petrochemical industries over the past several decades has reduced the historically strong reliance on the energy exploration sector.
Revenue Framework: 'aaa' factor assessment
A healthy pace of revenue growth is likely to continue as cyclical contraction within the energy sector is balanced against continued expansion of the county's diverse economy. Property tax revenue flexibility remains ample.
Expenditure Framework: 'aa' factor assessment
The pace of expenditure growth is expected to generally track revenue gains. The county's expenditure flexibility is aided by prudent budgeting, pay-go capital spending, and lack of collective bargaining agreements with any of its personnel.
Long-Term Liability Burden: 'aaa' factor assessment
The long-term liability burden is modest relative to personal income and driven primarily by overlapping debt. The county consistently funds its pension at actuarially determined levels and the unfunded pension liability is modest relative to the resource base.
Operating Performance: 'aaa' factor assessment
The combination of the county's expenditure flexibility and revenue-raising authority, as well as its record of very large reserve funding, should enable maintenance of a high level of financial flexibility during cyclical downturns.
Shift in Fundamentals: The IDR and GO ratings are sensitive to material change in the county's strong revenue-raising and expenditure flexibility and solid financial position, which Fitch expects the county to maintain throughout economic cycles.
Stalled Economic Recovery: An extended deviation from the county's historical ability to rebound from energy sector downturns may lead to negative rating pressure.
Houston's regional economy decelerated in 2015 and 2016 due to the significant contraction of the energy exploration sector that was triggered by plunging oil prices in late 2014. The Houston MSA 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, many of which have cut operating costs via layoffs.
Due to substantial diversification of the economy, Fitch expects current cyclical pressures will not be as pronounced as those experienced in previous oil busts. Considerable growth in non-energy sectors has enabled year-over-year employment trends to remain positive albeit modest leading to an uptick in the MSA's unemployment rate. The significant presence of downstream users of oil and natural gas, such as petrochemical refineries, also provides some protection from shifts in volatile energy prices. An estimated $50 billion worth of petrochemical projects are underway in the MSA, whose construction payrolls and direct employment have helped counter losses in the mining and manufacturing sectors.
IHS projects the MSA's total employment will rebound beginning in 2017 as oil prices trend higher, leading to 2% annual employment gains through 2021, led by professional and business services. Trade and transportation is projected to benefit from additional activity at the Port of Houston due to the recent expansion of the Panama Canal. The port is ranked first in the U. S. in foreign waterborne commerce and second in total tonnage.
The county experienced a large 12% population gain in 2010-2015, the majority of which occurred in the unincorporated areas. Fitch expects the MSA's strong population growth trend to continue. Continued population gains have helped stabilize the MSA's housing market, allowing median home prices to remain stable despite the energy sector downturn. AV growth for the county is expected to moderate somewhat after posting double-digit growth over the last two fiscal years. Preliminary AV estimates for fiscal 2017 point to a still solid 7.5% increase although Fitch expects near-term AV growth to be more modest.
Property taxes account for about 80% of general fund revenues. Favorable revenue trends have been aided by steady tax base gains and the county's goal to maintain a level O&M tax rate even during periods of AV growth.
Historical revenue growth has exceeded the level of inflation and U. S. GDP growth, aided by steady AV growth. Fitch expects the county's revenues to moderate somewhat in the near term due to cyclical pressure but rebound quickly. AV increased by 11.7% in fiscal 2016 and, as noted above, the preliminary AV for fiscal 2017 points to a 7.5% gain. The fiscal 2017 budget conservatively assumed a 5.8% gain.
At $0.39 in fiscal 2015, ample taxing margin remains under the $0.80 per $100 AV cap for operations and limited tax debt service. If a proposed tax rate results in an 8% year-over-year levy increase (based on the prior year's values), the rate increase may be subject to election if petitioned by voters.
Public safety spending accounts for 55% of general fund spending and is projected to grow at a manageable pace given remaining moderate capacity within the county jail, eliminating a potential source of significant spending pressure.
The pace of spending growth absent policy actions is likely to be generally in line with revenue growth but pressured by an expanding population and growing service delivery needs in the unincorporated portions of the county, requiring ongoing budget management.
The county's fixed cost burden is elevated but still within the moderate range, with carrying costs for debt, pension, and OPEB equaling 18.6% of governmental spending in fiscal 2016. Expenditure flexibility is aided by the county's lack of collective bargaining agreements with any of its personnel.
Long-Term Liability Burden
The long-term liability burden, direct and overlapping debt and unfunded pension liabilities, is modest at about 10% of personal income. About 85% of the total liability burden is in the form of overlapping debt. The 10-year principal amortization rate for all direct debt is slightly above average at 60%.
Overall debt levels have risen mostly from substantial debt issuances by the county's 350 overlapping jurisdictions. Continued overlapping debt issuance is likely to be accompanied by steady gains in personal income, leading Fitch to expect the county's long-term liability burden to remain modest relative to the resource base.
Including a $784 million GO authorization approved by voters in 2015, the county's remaining bond authorization totals $991 million. This amount is equal to about 39% of net direct debt (including the Harris County Flood Control District's contract revenue bonds that are paid by the county's limited tax). The county plans to issue its remaining authorization over a seven to 10 year period. Capital needs, while extensive, appear to be manageable given the county's history of a measured pace of debt issuance and its goal to maintain a level tax rate.
County employees participate in the Texas County and District Retirement System, a cost-sharing multiple-employer plan. The county consistently funds its pension at the actuarially determined level and the unfunded pension liability is modest, equal to 0.5% of personal income based on Fitch's adjusted 7% rate of return.
Fitch believes the county's ample revenue-raising capacity, solid expenditure control, and moderate carrying costs make it exceptionally well-positioned to manage through an economic downturn. Based on historical results, Fitch would expect a moderate economic downturn to result in a modest decline in revenues in the first year of a downturn, followed by a prompt rebound, and would expect the county's financial position to remain solid throughout the economic cycle.
During the last downturn, significant right-sizing via the elimination of about 1,000 positions (5% of total personnel), with no deferrals of annual pension contributions, led to steady and sustainable additions to financial reserves. Moderate annual pay-go funding also provided additional expenditure flexibility. The accumulation of substantial reserves allowed the county to forego its annual TAN borrowing for interim cash-flow purposes in fiscal 2017.
A large $313 million (15.2% of spending) general fund operating surplus was posted in the fiscal 2016 audit, resulting in a very high unrestricted fund balance of $810 million or 39% of spending. Relative to general operating expenditures (net of limited tax debt service), the cushion is equivalent to an even higher 49% of spending, well above its 15% fund balance policy. Additional reserves are available in the mobility fund, part of the general fund group, which totaled $302 million and can serve as a source of short-term borrowing, requiring only commissioners' court approval. Mid-year results lead Fitch to expect another large operating surplus for fiscal 2017.