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Rating Update:

MOODY'S PLACES ON WATCHLIST FOR POSSIBLE DOWNGRADE HARRIS COUNTY'S (TX) Aaa RATED GO BONDS AND HARRIS COUNTY FLOOD CONTROL DISTRICT G.O. AND CONTRACT REVENUE BONDS

23 Jun 2011

AFFECTS $3B OF OUTSTANIDNG DEBT

County
TX

Opinion

NEW YORK, Jun 23, 2011 -- Moody's Investors Service has placed Harris County's (TX) Aaa rating on review for possible downgrade, affecting $1.3 billion of general obligation unlimited tax and $1.1 billion of general obligation limited tax debt. Concurrently, we have placed on review for possible downgrade the Aaa ratings on the Harris County Flood Control District's $413 million of Contract Tax Revenue Bonds and $103 million in Unlimited Tax Debt.

RATING RATIONALE

The Aaa reflects the county's sizable tax and economic base, which benefits from above average growth both in terms of jobs and employment and which is expected to recover at a somewhat faster pace than the nation as a whole from the current recession. Substantial non-General Fund liquidity, ample tax raising margin, well funded pension, the flexibility afforded by the absence of collective bargaining and a modest debt burden are also important credit characteristics.

The review for downgrade reflects the county's narrowed financial position following a deficit in 2010 that is projected to have grown in 2011, exacerbated by a change in accounting treatment of mobility related funding that has further constrained financial flexibility. Our review, which we expect to complete within 90 days, will incorporate an assessment of audited fiscal 2011 results and fiscal 2012 operations, including the impact of decisions made at the county's mid-year budget review.

CREDIT STRENGTHS:

"Positive economic trends, with continuing diversification beyond Oil and Gas through growth in Medical and Trade sectors

"Strong demographic trends

"Ample taxing margin

"Well funded pension position

CREDIT CHALLENGES:

"Trend of operating short-falls in General Fund subfund

"Limited long range financial or capital planning

"Exposure to volatile oil and gas industry

FINANCIAL POSITION IMPACTED BY STRUCTURAL IMBALANCE; EXTENT OF NARROWED FLEXIBILITY MADE EVIDENT THROUGH CHANGE IN ACCOUNTING PRACTICE

Fiscal year end 2010 audited financial results reflect a $26 million deficit bringing General Fund balance to $342 million or 22% of revenues on an audit basis. Net of $118 million for debt service and an illiquid receivable, available fund balance at year end was 14%. We believe a 2010 change in accounting practice brings to light limitations on the financial flexibility as represented by General Fund balance. Prior to 2010, the $120 million annual transfer from the Harris County Toll Road Authority, use of which is limited to mobility related expenses (as defined in Texas Transportation Code: design, construction, maintenance and operation of roads, streets and other related facilities), were not segregated within the General Fund nor designated at year end. At year end 2010, $92 million, or just under 1/3 of the county's total fund balance (net of the debt service designation and an illiquid receivable) in unspent mobility funds were designated for mobility projects in the audited financials-on a day to day basis, these funds are now in a distinct account. This designation, taken with the General Fund operating loss of $23 million, resulted in an available General Fund balance (inclusive of Public Improvement Contingency Fund (PICF) designated fund balance) of $102 million or a more modest 7% of General Fund revenues.

The fiscal 2010 operating loss reflects appropriation of reserves as a revenue source and departure from recent history wherein positive revenue and expenditure variance facilitated replenishment of reserves. The county annually adopts a budget in February at which time only preliminary taxable values are available. In August of each year, taxable values are available and the county sets the tax rate for collection in December based upon these values. Commissioners Court thus has the ability to adjust the tax rate (from which 71% of General Fund receipts are derived) --or the budget- 6 months into the fiscal year to ensure structural balance. In fiscal 2010, the County worked to offset appropriated fund balance through a hiring freeze and other modest budget control measures. While the aggregate General Fund fiscal 2010 reduction in reserves was modest relative to revenues (1.5%), taken with the designation of funds for mobility the change in unreserved, undesignated fund balance was dramatic, falling from $166 million in 2009 to $59 million (figures are inclusive of PICF designation of reserves).

UNAUDITED RESULTS REFLECT CONTINUED NARROWING OF GENERAL FUND SUBFUND IN 2011

The fiscal 2011 budget included the appropriation of $273.6 million of reserves-of which $95.4 million is from designated mobility funds and the remaining $168 represents appropriation of available reserves (including $35 million from the PICF). Positive variance was driven by actual property tax receipts in excess of budget ($28 million) and the county's continuing hiring freeze, which resulted in an 8% reduction in headcount between fiscal year end 2010 and 2011. Fiscal 2011 results, however, are expected to reflect a consecutive General Fund deficit, which is forecast to approximate $30 million based upon cash basis numbers. Audited results are expected in August. The county has not provided estimates on an accrual basis and Moody's notes the impact of accruals could be significant. Restriction of mobility fund reserves will cause a substantial further reduction of unrestricted fund balance. Cash basis results reflect a decline net of mobility funds in excess of $100 million bringing year end unresererved, unrestricted cash balances (net of PICF) to a reported $45.6 million-down from $153 million in fiscal 2010.

2012 EXPECTED TO RESULT IN STABILIZATION OF FINANCIAL OPERATIONS, HOWEVER, STRUCTURAL IMBALANCE MAY PERSIST

The county's adopted 2012 budget includes continued appropriation of reserves as a revenue source. Taxable values were forecast at budget to decline 2.6%, which taken with declining revenues available to be appropriated, required significant budget reduction. Departments were required to make 10% cuts on average, resulting in layoffs and a continued hiring freeze. The county's largest operating expenditure is public safety, including the county jail (which is run by an independently elected Sheriff). This department was not subject to a 10% cut, however, reductions were made, particularly in the overtime budget and management reports more stringent levels of centralized oversight are expected to prevent overspending within this function. To date, property tax receipts in excess of budget ($28 million) as well as a number of one time transfers ($46 million), including $35 million from the mobility subfund to the general fund subfund to reimburse for mobility work undertaken by the general fund subfund, is forecast to replenish appropriated fund balance and begin the rebuilding of reserves-an important consideration in today's rating action.

Despite narrowed reserves, the county retains strong liquidity for unforeseen events. Management reports the General Fund subfund routinely supports mobility fund eligible projects ($20-40 million), facilitating future reimbursements from the mobility subfund (i.e. release of designated fund balance). Cash from mobility is available for the county's day to day liquidity needs as well. The county's highly liquid Toll Road Authority could legally advance cash on an interim basis-although these amounts would need to be repaid-as was the case following Hurricane Ike as the county sought to facilitate clean up in advance of FEMA reimbursement.

AMPLE TAXING MARGIN; COUNTY SETS TAX RATE FOR MULTIPLE ENTITIES

The County has ample taxing margin for operations and limited tax debt -- the cap is $8/$1,000 and the current rate is $3.70. The Flood Control District similarly has ample margin with a cap of $3/$1,000 and a current rate of $0.29. The County additionally sets the property tax rate for the Harris County Hospital District (HCHD), a county component unit, as well as The Port of Houston, a legally distinct entity for which the County appoints two of the seven Port commissioners, and with the City of Houston jointly appoints the chairman. While HCHD has legal taxing authority of $7.50/$1,000 for district operations (now at $1.92) and the Port issues GO debt with an unlimited tax rate, Commissioners Court strives for a flat tax rate across the various taxing jurisdictions. Moody's notes that this practice has the potential to pressure county operations especially to the extent that property values continue to decline and/or HCHD or Port requirements increase absent a departure from this practice

COUNTY IMPACTED BY NATIONAL ECONOMIC CONDITIONS; DEMOGRAPHIC TRENDS SUPPORT RETURN TO TAXBASE GROWTH

Harris County, the third most populous in the U.S., encompasses the City of Houston (Aa2 general obligation rating), serving as the center of the country's energy sector. Moody's Economy.com reports the MSA's economic diversity index has improved markedly since the oil bust of the 1980's approaching 60% of the national average, as compared to the 30% range exhibited prior to 1990. The county's dependence on the volatile energy sector remains but has decreased somewhat over time given growth in medical services/research (Texas Medical Center with 42 institutions and over 73,500 jobs), transportation and distribution sectors (Continental Airlines, rated B2, and Port of Houston). Oil prices in excess of $100 a barrel and the expectation of continued permitting for deep water drilling have positively impacted both oil drilling activity and the locally based oil and gas supply manufacturing business, which has a world-wide reach. The de-funding of the NASA Constellation program could impact the bay area centered aerospace base - specifically the estimated 6,000 contractor jobs with a substantial economic multiplier. The Continental Airlines (16,000 jobs) merger is not expected to have a dramatic impact on Harris County, despite 1,500 former headquarters job losses given the City is expected to remain a significant hub for the combined airline.

The 2010 census reflects 20% growth over the last decade for the county, bringing population to 4.09 million, of which 38% resides in unincorporated Harris County. The county's assessed valuation (AV) declined 4.6% in fiscal 2011 (values as of 1/1/2010) to $273 billion and are forecast to stabilize in 2012 - with 0.29% growth currently forecast (final values expected in August). The county's top ten taxpayers comprise a modest 6.0% of assessed value with no single payer contributing more than 1.1%. Employment data for Harris County showed improvement April 2010 to April 2011, which resulted in improved unemployment levels (8.0% in April) as compared to 7.7% and 8.7% for the state and nation respectively for the same time period. County wealth indices exceed state averages (PCI is 109% of state average) but are slightly below the national average.

DEBT LEVELS EXCEED MEDIANS BUT ARE EXPECTED TO REMAIN MANAGEABLE

The county's debt burden is 1.0% on a direct basis, as compared to the nationwide median for Aaa counties of 0.5%. On an overall basis, debt burden is substantially above the national average for Aaa rated counties at 8.1%, reflective of substantial overlapping debt from school and municipal utility districts. The direct debt burden incorporates the county's general obligation debt outstanding, with $1.76 billion in limited tax debt (including flood control contract revenue and g.o. bonds) and $684 million of unlimited tax debt. Approximately $558 million in outstanding toll road general obligation unlimited tax bonds has been excluded as these bonds are fully supported by net revenues of the County's toll road system. Also included in the county's debt burden is $357.2 million of tax supported commercial paper. The rate of principal retirement on the county's debt is below average with 44% amortized in ten years. While the county does not maintain a formal CIP, future borrowing is guided by authorized, un-issued debt (of which there is currently $442 million) and the county's goal of maintaining a level debt service tax rate. Infrastructure needs will continue as growth continues in the unincorporated portions of the county-where substantial land remains for future development. Debt burdens are projected to remain manageable given Moody's expectation of renewed tax base growth in the medium term.

The county's existing debt is largely fixed rate but includes the $177 million 2004B put bonds (mandatory tender in 2012). In the event the county is unable to remarket these bonds in 2012, the put feature is "soft", the county is not obligated to repurchase the bonds but rather would continue to pay bondholders at the penalty rate (8%). The county's general obligation commercial paper program ($800 million maximum authorized) represents additional variable rate exposure. External liquidity for the county's CP programs in provided by Bank of America ($300 million, Series B and C, rated Aa3 Watchlist for downgrade); JP Morgan Chase ($100 million, Series D, rated Aa3/negative outlook), State Street Bank ($200 million, Series A1, rated Aa3/negative outlook), and Helaba ($200 million, Series F rated Aa2/stable outlook). The Helaba agreement expires August 1, 2012 while the remainder expire August 20, 2013. The county's only General Government swap was cancelled in 2011, netting the county a modest revenue to its HOT fund.

What could change this rating up: (removal from watchlist)

"2011 audited results better than currently forecast

"Significant improvement in fiscal 2012 operations and/or augmentation of available reserves

What could change this rating down:

"Audited 2011 results substantially limit available reserves

"Fiscal 2012 operations significantly weaker than currently forecast

"Failure to restore structural balance in medium term

"Significant additional taxbase declines absent actions to augment recurring revenues or reduce recurring expenditures

KEY STATISTICS:

2010 Population: 4,092,459 (+20% since 1990)

Fiscal 2011 Taxable Full Value: 272.8 billion

Full value per capita: $66,675

1990 Per Capita Income as % of state/US: 109.3%/99.3%

April 2011 Unemployment: 8.0% vs state at 7.7% and nation at 8.7%

Fiscal 2010 Available General Fund balance (adjusted for debt service reserve and illiquid receivable): $194 million (14% of revenues)

Fiscal 2010 Unreserved General Fund balance (includes PICF designation): $59 million (3.8%)

Outstanding General Obligation Debt (includes Flood Control GO and Contract Revenue bonds, excludes outstanding CP): $2.8 billion

The principal methodology used in this rating was General Obligation Bonds Issued by U.S. Local Governments published in October 2009.

REGULATORY DISCLOSURES

Information sources used to prepare the credit rating are the following: parties involved in the ratings, parties not involved in the ratings, public information and confidential and proprietary Moody's Analytics information.

Moody's Investors Service considers the quality of information available on the credit satisfactory for the purposes of maintaining a credit rating.

Moody's adopts all necessary measures so that the information it uses in assigning a credit rating is of sufficient quality and from sources Moody's considers to be reliable including, when appropriate, independent third-party sources. However, Moody's is not an auditor and cannot in every instance independently verify or validate information received in the rating process.

Please see ratings tab on the issuer/entity page on Moodys.com for the last rating action and the rating history.

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Please see the Credit Policy page on Moodys.com for the methodologies used in determining ratings, further information on the meaning of each rating category and the definition of default and recovery.

Analysts

Robyn Rosenblatt
Analyst
Public Finance Group
Moody's Investors Service

Kristin Button
Backup Analyst
Public Finance Group
Moody's Investors Service

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MOODY'S PLACES ON WATCHLIST FOR POSSIBLE DOWNGRADE HARRIS COUNTY'S (TX) Aaa RATED GO BONDS AND HARRIS COUNTY FLOOD CONTROL DISTRICT G.O. AND CONTRACT REVENUE BONDS
No Related Data.
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