Deal In Focus

Houston Conversion

DALLAS — With the year-end deadline approaching, Houston this week will refund $94 million of private-activity bonds for its airport system with variable-rate debt to gain exemption from federal alternative-minimum tax provisions.

The negotiated deal with Citi comes as the AMT exemption for private-activity bonds nears its end. Congress failed to extend the exemption beyond 2010, though there is talk that lawmakers might renew it in 2011, along with the Build America Bond program that has given municipal bond issuers access to the taxable market.

First Southwest Co. and Kipling Jones & Co. serve as co-financial advisers on the deal, with Vinson & Elkins and Bates & Coleman as co-bond counsel. Fulbright & Jaworski and Escamilla, Poneck & Cruz serve as co-underwriter's counsel.

The new bonds will carry a two-year letter of credit from Barclays Bank, which results in enhanced ratings of AAA from Standard & Poor's and Aa3 from Moody's Investors Service. Underlying ratings are A from Standard & Poor's and A2 from Moody's.

"We believe specific rating strengths include the airport system's dominant market position in a large, growing, and diversifying service area, high liquidity, with audited unrestricted cash and investments of $1 billion in 2010, affording more than 1,500 days' cash," wrote Standard & Poor's analysts Adam Torres and Todd Spence.

Rates for the new bonds will reset weekly, but can be shifted to a daily rate, according to the preliminary official statement.

After this issue, Houston will have about $450 million in bonds outstanding under the senior lien with fixed rates and $2.04 billion at the subordinate lien. Of those, $1.6 billion is fixed rate, $323 million is auction rate, and $93 million is variable rate.

There are no swaps in effect. Houston also has a $150 million commercial paper program at the senior-lien level, with no amounts currently outstanding.

"After the current sale, variable-rate debt not including auction-rate securities will make up a very manageable 3.97% of the system's total debt," according to Moody's analyst Laura Barrientos.

Traffic at the city's two major air facilities — Hobby Airport and George Bush Intercontinental — turned positive in 2010, growing by 2.1% to 24.5 million. Areas of strong growth include international travel, which increased 5.7%, and Hobby Airport with a 5.6% growth spurt.

The current capital-improvement plan totals $695 million through fiscal 2015, of which $160 million is in spending from existing carryover projects and the remainder in new projects.

The city has indicated that additional bond issues are likely, but officials have not decided how much to issue in 2011. Future projects are geared toward renovation and rehabilitation.

The Houston Airport System includes three facilities within the city: George Bush Intercontinental Airport, William P. Hobby Airport and Ellington Airport. Bush is by far the system's largest airport and provides domestic and international service.

Hobby serves the domestic market, and Ellington is operated as a joint military-civilian airfield and has no commercial passenger traffic.

Continental Airlines at Bush Intercontinental and Southwest Airlines at Hobby each account for more than 85% of passenger boardings at those airports. With the merger of United Airlines and Continental, Houston loses its home-based carrier Continental but becomes United's largest hub. The combination of the two airlines, which should be complete by the end of 2011, is not expected to have a negative effect on traffic at Bush, analysts say.

"The stable outlook reflects our expectation that during the next two years, the airport's capital improvement plan and associated debt needs will prove manageable in terms of financial resources," Standard & Poor's Torres wrote.

"However, given the uncertainty regarding the additional debt plans, we do not expect to raise the ratings. We could lower the ratings if additional debt plans significantly affect [debt-service coverage] and liquidity ratios."

As the fourth largest city in the country, with a population of 2.14 million and 5.9 million in the 10-county area, Houston will remain one of the major airline markets in the world. Its metro area continues to grow, even though the economy has weakened in the past year.

"It is Moody's expectation that the city will return to being an above-average performer over the medium to long term," Barrientos noted.

While Houston was spared the worst effects of the recession, the city and county governments are coping with the after-effects in terms of falling revenues and a declining tax base.

Houston Mayor Annise Parker last week announced mandatory furloughs designed to close a $30 million budget gap. City employees are expected to take six unpaid days off during the coming calendar year.

The Houston Organization of Public Employees, which represents an estimated 13,000 workers, said employees who make $10.60 an hour or less will be exempted from the plan.

"While the city has been able to withstand the current economic crisis longer than most, we are now faced with budget challenges that force us to make tough fiscal choices," Parker said. "I sincerely appreciate HOPE's willingness to offer suggestions that will help the city as it works to find fiscally responsible solutions for dealing with our ongoing budget situation."

The city is also selling land and increasing fees to bring in more revenue.

While the immediate problems are severe, officials consider funding problems in Houston's three pension systems as the larger threat. Within three years, the pension for firefighters will require the city to contribute 45% of its payroll costs for that retirement plan, according to an actuarial study.

The police and municipal employee pensions are underfunded by $2.1 billion — comparable to what Houston spends for public safety and general operations each year.

Parker also parted ways this month with finance director Michelle Mitchell "by mutual consent." Mitchell, a former Goldman, Sachs & Co. executive and Merrill Lynch analyst, said she is returning to the private sector.



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