OREANDA-NEWS. Houston, TX mayor Sylvester Turner's pension reform proposal contains several positive elements while also introducing some level of risk. The proposal, which the mayor outlined in broad terms in a speech on Sept. 14, includes reforms to benefits and contribution practices that could improve the sustainability of the city's pensions. Reforms include benefit changes in the municipal, police and fire plans that reportedly could reduce the combined unfunded liability of the programs by 1/3; implementation of a closed 30-year amortization period; a reduction in the discount rate to 7% from rates currently ranging from 7.08% to 8.50%, and a requirement that the city make the actuarially required contribution annually. Fitch cautions that achieving even a 7% return assumption carries risk given recent market performance and the low interest rate environment.

The proposal also includes the issuance of $1 billion of pension obligation bonds (POBs). Fitch views POBs as a neutral to negative credit consideration, noting the possible impact to overall financial flexibility and additional investment risks associated with their use. A key consideration is the use of proceeds from a POB borrowing: if proceeds are used to boost a system's assets, they essentially replace one long-term liability with another. It is Fitch's understanding that Houston's POB proceeds would be used in this manner, rather than replacing contributions, and thus Fitch does not consider this deficit financing. POB use does entail interest rate risk, as investment returns on POB proceeds must exceed the cost of borrowing for the strategy to be considered a financial success.

POBs are typically used for plans that are poorly funded and with questionable long-term sustainability, and Houston's pension programs fit into this category. Use of POBs alone typically is insufficient to correct underlying sustainability concerns and provides only temporary relief in the absence of broader reforms. However, POB use in conjunction with reforms to benefits and contribution practices increases the odds of strengthening funding positions and improving long-term sustainability.

Fitch's evaluation of a local government's long-term liability burden measures overall debt totals and net pension liabilities as a percentage of the economic base (as measured by total personal income). Houston's burden currently is moderate at roughly 14%. Fitch will conduct a thorough analysis of Houston's pension reform program once agreements between all parties are executed and any necessary legislative approval is obtained.