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Moody's Downgrades Houston's Credit but Mayor Turner Has a Plan. Sort Of.

There's a reason Houston Mayor Sylvester Turner has been talking about Houston's budget and money issues from pretty much the moment he was sworn into office in January: Houston's finances are not doing so hot, and we now have a downgraded credit rating to make that even more apparent.

Considering the steady stream of bad news we've had recently about the state of Houston's finances — the $160 million budget shortfall that's expected to keep growing and the looming city layoffs and department budget cuts — this latest development shouldn't come as a surprise. Turner certainly seemed to take it in stride.

"Since entering office in January of this year, I have devoted my full attention to addressing an anticipated budget shortfall and many of the concerns that Moody's listed," Turner stated in a release issued Friday morning about the downgrade. "Addressing the City's fiscal challenges is my number one priority! We will get it done!" 

After all, Moody's Investor Service placed the city of Houston on a negative outlook last summer, a move that indicated the famed bond credit rating business wasn't feeling particularly sanguine about the city's financial prospects. And then Moody's took the next logical step and downgraded the city's general obligated tax rating from Aa2 to Aa3 in a report issued Wednesday. This downgrade affects $3 billion in previously issued bonds. 

"The outlook remains negative," the Moody's report dryly concludes.

So why is Moody's long-faced about Houston's financial setup? Well, there are plenty of reasons, but really, much of it comes down to oil.

Despite the city's much-vaunted economic diversification (the Texas Medical Center and all of that aerospace stuff) in recent decades, the current oil bust has been rough on city finances. Houston has been hit hard with both sales tax revenues and a general economic punch to the gut caused by widespread energy company layoffs and their sharp decline in capital investments ever since oil prices started dropping back in July 2014. 

Still, Turner has remained unclear about how exactly he's going to handle all of this. The city's revenues from both crude oil production royalties and sales taxes have plummeted in recent months, creating a looming hole in the city's finances that Turner has to fill before he can even put a fiscal budget for 2017 in place. (That has to be done by the start of July.) To cover that budget gap, Turner has already said repeatedly that the city budget is going to be shrunk by more than $160 million, with layoffs and budget cuts expected from every corner of city government except the Houston Police Department, as we've recently reported. 

Now, with this downgrade to deal with on top of everything else, Turner is spinning the Moody's report as if it's something he planned for, noting that he already has a plan for balancing the 2017 budget — though, of course he has a plan, since the city can't sign off on a budget if it isn't balanced — and has met with 13 of the 16 city council members to discuss some details of the impending budget cuts. 

But the Moody's report points out that the city is probably going to have to draw on "an already somewhat limited reserve position compared to peers" to deal with the looming 2017 budget shortfall, even with every city department (sans HPD) on the budgetary chopping block. 

Despite Turner's effort to draw a happy face on this situation, Moody's was pretty clear that it's going to take a lot for the city to bounce back to a more rosy rating, including coming up with a sustainable plan to manage the pension liabilities without threatening the city's financial health and fattening up the city's reserve position and increasing liquidity, i.e., the amount of cash on hand. Moody's calls for a "structurally balanced operation with full pension contribution" to help improve the city's standing. 

Steadily increasing pensions payments are bleeding the city dry. Unfunded and growing pension costs, if unaddressed, will only exacerbate existing problems the city is scrambling to fix – like dilapidated streets and sidewalks. Just recently, Turner announced that all city jobs, except for police, are now on the chopping block with an estimated budget shortfall that's grown to $160 million. Factor in the $350 million the city is expected to pay out in pension benefits this year alone (more than double what the city spends on parks, libraries and trash pickup), and, as Moody's points out, the city's financial outlook seems all the more gloomy.

It's not exactly clear yet what Turner plans to do on the pension front. In the mayor's race last year, Turner's opponent, Bill King, espoused the more controversial yet detailed plan of the two – issue bonds to cover the city's current pension hole (which is huge; the city has underfunded pension obligations to the tune of $3.2 billion) while switching new city employees to a 401k-style defined-contribution plan, which the unions most certainly would have fought.

Turner, whose campaign was endorsed by the city's police and fire unions, offered the somewhat more vague plan of working with the unions to resolve the issue while removing the voter-imposed revenue cap to, among other things, pay down some municipal debt. In its outlook published this week, Moody's lists removing the revenue cap as one among several steps that could lead to a credit-rating upgrade in the future.

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That revenue cap, voted into existence in 2004, limits the increase in the city's annual property tax collections to the combined rates of inflation and population growth, or 4.5 percent, whichever is lower. Last year it kicked in for the first time, causing the city's biggest tax cut since 1987, according to the Houston Chronicle. Moody's says ditching that cap would help the city's financial outlook.

When it comes down to it, however, much of this is still about oil. If the market truly recovers, bringing oil prices out of the toilet — and as of Friday morning, oil was going for $40 a barrel again, so all hope is not lost — then the city's finances will likely recover in kind. 

But if the oil industry doesn't turn things around — and as we've previously reported, there are many factors outside of U.S. control that are keeping the world oil market just sloshing over with excess crude oil — the odds are good that Houston's fortunes will also stay mired in a mucky financial mess. 

We've come a long way as a city, but we're still an oil town at heart. And when oil prices are low enough long enough, that always shows up in the place it hurts the most — the city's finances. 

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