DALLAS – Despite the blow from Hurricane Harvey in 2017, long-term growth prospects for municipal utility districts in Texas are holding up well, according to the latest reports.

“Fund balances largely remained strong, but weakened in lower rating categories,” according to a Feb. 2 report on sector medians led by Moody’s analysts Roy Ousley and Gera McGuire. “Strong fund balances will help to mitigate the future fiscal effects of Hurricane Harvey-affected districts.”

“Of the nine counties most populated with MUDs, five of them were impacted by Harvey, affecting about 75% of our rated MUDs,” Moody’s wrote. “While we expect assessed value trends to continue, certain regions, particularly those affected by Hurricane Harvey, may have a one- to two-year delay in value growth if not some tax base loss.”

While MUDs are found statewide and districts that perform similar functions exist elsewhere in the nation, the counties of southeast Texas that were swamped by Harvey in August have far more than any other part of the state. Most Texas MUDs are in suburban Houston, which includes Harris, Fort Bend and Montgomery counties.

Harris County, which includes Houston, has 341 MUDs, which is more than double the county with the second most.

MUDs are political subdivisions of the state that provide water, sewage, drainage and other utility-related services within specific boundaries. MUDs promote rapid population growth by providing utility infrastructure for residential and commercial developments in extraterritorial jurisdictions of cities and sometimes within city boundaries. Once built in anticipation of annexation by neighboring cities, most MUDs in recent years have continued to operate independently.

Typically, a developer covers the upfront costs for infrastructure and is reimbursed with bonds when the tax base develops. Master districts that get the projects off the ground issue project revenue bonds. Once established, individual MUDs issue general obligation bonds.

In 2017, bond volume for special districts in Texas fell 29% from 2016 to $15.7 billion, according to Thomson Reuters. The number of deals dropped to 808 from 999.

MUDs have relatively small tax bases and high debt burdens compared to other general obligation issuers. However, they have limited operating expenses given the limited-scope of operations. MUDs typically hire service providers under contract, eliminating high labor costs and pension obligations that have dogged Houston and other cities.

Ronald Welch, an economist and real estate agent who tracks developments in 669 MUDs in the Houston area and serves on the board of one, noted that about 75% of bonds issued for MUDs in the Houston area carry bond insurance.

The silhouette of a truck is seen submerged in water at a trailer park flooded by Hurricane Harvey in Rose City, Texas, U.S., on Wednesday, Sept. 6, 2017
Flooding in the aftermath of Hurricane Harvey in Rose City, Texas. Despite the damage, municipal utility districts in the Houston area retained their ratings strength. Bloomberg News

The active districts that Welch covers have a total taxable value of $206.4 billion as of the 2015 assessments, with outstanding debt of $9.29 billion. That translates to a debt-to-value ratio of 4.5%. With 2.7 million people living in the MUDs, the per-capita debt comes to $3,433.

The districts typically receive funding from a combination of property taxes and other sources although taxes typically make up a majority of revenues.

The median fixed cost as a percentage of operating revenue is 36% for all of the MUDs that Moody’s rates, about double the fixed costs of other local governments.

“While counterintuitive, Baa MUDs have the lowest fixed costs,” the report noted. “This is driven by the slow principal payout of these MUDs as they begin to issue debt on small tax bases with limited revenue streams.”

As MUDs mature and move from the Baa category to the A category, revenue streams become more diverse as MUDs collect more revenue from water and wastewater charges and payout of debt increases, analysts said.

Texas leaders were relieved last week when Congress passed a budget that included $90 billion in federal aid for disaster relief. The funding will cover parts of Texas affected by Hurricane Harvey.

Texas Comptroller Glenn Hegar expects an economic loss of $3.8 billion in the first year after Harvey but an $800 million gain after three years.

“While the initial impact of Harvey was severe, the Texas economy has already absorbed much of the damage from this record-breaking storm and should avoid long-term losses,” Hegar said in the Feb. 8 edition of his office’s “Fiscal Notes” on the state’s economy.

Harvey’s total costs have been estimated at about $125 billion, according to the National Oceanic and Atmospheric Administration. As of Nov. 30, 2017, the Texas Division of Emergency Management estimated Harvey had damaged or destroyed more than 178,000 Texas homes and inflicted about $670 million in damage to public property such as government buildings, roads, bridges, water facilities and electric utilities. The storm also caused more than $200 million in Texas crop and livestock losses, and flooding may have ruined more than 250,000 vehicles.

Shortly after Harvey’s landfall, S&P Global Ratings assessed 364 MUDs, or 84% of its total MUD portfolio, within the disaster-declared area.

Only 14 of S&P’s negative outlook revisions were due to the potential for a material deterioration in MUDs' tax bases following Hurricane Harvey. Long term, analysts are watching to see how key credit factors such as level of reserves and direct property taxes for debt and operations will be affected.

“According to our analysis, fewer than 10% of the MUDs within the Houston MSA experienced various degrees of street or home flooding and only 3% of the MUDs expect what we consider a substantial assessed valuation loss,” S&P said. “In addition, most of these MUDs did not authorize a reappraisal of damaged properties, making the potential negative impact of AV loss in the current year less likely. Any damage or decline will likely show up in fiscal 2019, giving the districts time to adjust the tax rate as needed.”

The aftermath of Harvey generated controversy after the U.S. Army Corps of Engineers made the decision to flood districts downstream from the Barker Reservoir. The reservoir exceeded capacity after record rainfall of more than 50 inches of rain hit the Houston area.

Investors who bought bonds for the Cinco Ranch area were not told about the danger of flooding from a release of water from the reservoir, according to a survey of bond documents by the Houston Chronicle.

Attorneys and others involved in the bonds defended the failure to disclose the risk to the municipal utility districts downstream from the dam.

The Chronicle reported that 10 districts that serve subdivisions along the southwestern fringe of Barker Reservoir sold bonds 74 times since 1991, borrowing a total of $297 million. Only one of the 74 official statements disclosed the risk that the reservoir could inundate nearby subdivisions, the Chronicle found.

Moody’s senior analyst Adebola Kushimo is scheduled to appear on a Tuesday panel at The Bond Buyer’s Texas Public Finance Conference in Austin where the hurricane’s impact on MUDs will be discussed, as is S&P senior director Kate Boatwright.

Hegar, the state comptroller, gives a keynote address Wednesday morning.

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