OFFICIAL STATEMENT DATED AS OF MARCH 8, 2006

NEW ISSUES— BOOK-ENTRY ONLY

RATINGS: See “RATINGS” herein

The City has taken no action to cause any interest on the Taxable Bonds to be excludable from gross income for the purposes of federal income taxation and therefore it is assumed that interest on the Taxable Bonds is not excludable from gross income for federal tax purposes under existing law. See “TAX MATTERS—TAXABLE BONDS.” In the opinion of Co-Bond Counsel, interest on the Tax Exempt Obligations is excludable from gross income for federal income tax purposes under existing law, subject to the matters described herein under “TAX MATTERS—TAX EXEMPT OBLIGATIONS,” and is not includable in the alternative minimum taxable income of individuals. See “TAX MATTERS—TAX EXEMPT OBLIGATIONS” for a discussion of the opinions of CoBond Counsel, including the alternative minimum tax on corporations.

$91,060,000 CITY OF HOUSTON, TEXAS
$63,740,000 TAXABLE PENSION OBLIGATION BONDS, SERIES 2006A Interest Accrual Date: Date of Delivery $24,005,000 PUBLIC IMPROVEMENT REFUNDING BONDS, SERIES 2006B $3,315,000 CERTIFICATES OF OBLIGATION, SERIES 2006C Due: March 1, as shown inside

CUSIP Prefix: 442331 (Series 2006 Obligations)

ISIN Prefix: US442331 (Series 2006A Bonds)

This Official Statement is provided to furnish information in connection with the offering by the City of Houston, Texas (the “City”) of its Taxable Pension Obligation Bonds, Series 2006A (the “Series 2006A Bonds” or the “Taxable Bonds”), Public Improvement Refunding Bonds, Series 2006B (the “Series 2006B Bonds” or the “Tax-Exempt Bonds”), and Certificates of Obligation, Series 2006C (the “Series 2006C Certificates” or the “Tax Exempt Certificates,” and together with the Series 2006B Bonds, the “Tax-Exempt Obligations”). Collectively, the Series 2006A Bonds, Series 2006B Bonds and Series 2006C Certificates are referred to herein as the “Series 2006 Obligations.” The Series 2006 Obligations are direct obligations of the City, secured by and payable from the receipts of an annual ad valorem tax levied, within legal limits, on taxable property within the City. See “THE OBLIGATIONS — Source of Payment.” The Series 2006 Obligations are authorized pursuant to the laws of the State of Texas, the City’s Charter and separate ordinances adopted by the City Council of the City authorizing the issuance of each respective series of Series 2006 Obligations. See “INTRODUCTION” for a detailed discussion of the laws authorizing the issuance of the Series 2006 Obligations. Proceeds of the sale of the Series 2006A Bonds will be used to fund part of the unfunded liabilities of the pension systems for municipal employees and classified police officers of the City and to pay costs of issuance relating to the Series 2006A Bonds. Proceeds of the sale of the Series 2006B Bonds will be used to fund the final installment of a legal settlement currently outstanding against the City and pay costs of issuance relating to the Series 2006B Bonds. Proceeds of the Series 2006C Certificates will be used to fund the demolition of dangerous buildings within the City and pay costs of issuance relating to the Series 2006C Certificates. See “PURPOSE AND PLAN OF FINANCING” and “THE CITY— Employee Pension Funds.” Interest on the Series 2006 Obligations will accrue from their respective dates of delivery and will be payable on each March 1 and September 1, commencing September 1, 2006, until maturity or earlier redemption, and will be calculated on the basis of a 360-day year consisting of twelve 30-day months. Deutsche Bank Trust Company Americas is the initial paying agent/registrar for the Series 2006 Obligations (the “Paying Agent/Registrar”). The Series 2006 Obligations are being issued in fully registered form and, when issued, will be registered in the name of Cede & Co., as registered owner and nominee for The Depository Trust Company, New York, New York (“DTC”), which will act as securities depository for the Series 2006 Obligations. Individual purchases will initially be made in book-entry form only in denominations of $5,000 principal amount or any integral multiple thereof. No physical delivery of the Series 2006 Obligations will be made to the owners thereof. See “APPENDIX E” which describes DTC and also discusses the global securities clearance procedures of the Euroclear System and Clearstream. The Series 2006A Bonds are subject to optional and mandatory redemption prior to maturity, as described herein, and the Series 2006B Bonds are subject to optional redemption prior to maturity, as described herein. The Series 2006C Certificates are not subject to redemption prior to maturity. See “THE OBLIGATIONS—Optional Redemption” and “THE OBLIGATIONS—Mandatory Redemption.” Payment of the principal of and interest on the Series 2006B Bonds and Series 2006C Certificates when due will be insured by a financial guaranty insurance policy to be issued by Ambac Assurance Corporation simultaneously with the delivery of the Series 2006B Bonds and Series 2006C Certificates. The Series 2006A Bonds will not be insured. SEE INSIDE COVER PAGE FOR MATURITY AND PRICING SCHEDULE This cover page is not intended to be a summary of the terms of, or the security for, the Series 2006 Obligations. Investors are advised to read the Official Statement in its entirety to obtain information essential to the making of an informed investment decision. The Series 2006 Obligations are offered when, as and if issued by the City, subject to the approving opinions of the Attorney General of the State of Texas and the opinions of Vinson & Elkins L.L.P., Houston, Texas, and Law Offices of Francisco G. Medina, Co-Bond Counsel for the City, as to the validity of the issuance of the Series 2006 Obligations under the Constitution and laws of the State of Texas. Certain legal matters will be passed upon for the City by its Special Disclosure Co-Counsel Andrews Kurth LLP, Houston, Texas, and Bates & Coleman, P.C. Certain legal matters will be passed upon for the Underwriters by Greenberg Traurig, LLP, Houston, Texas, Counsel to the Underwriters. The Series 2006A Bonds are expected to be available for delivery on or about March 29, 2006, and the Series 2006B Bonds and the Series 2006C Certificates are expected to be available for delivery on or about April 19, 2006, through the facilities of DTC in New York, New York, and through the Euroclear System and Clearstream in Luxembourg in Europe, as appropriate.

MORGAN STANLEY JPMORGAN
APEX PRYOR SECURITIES
(a division of Rice Financial Products)

LEHMAN BROTHERS
RAMIREZ & CO., INC. SIEBERT BRANDFORD SHANK & CO., INC.

MATURITY AND PRICING SCHEDULE

$91,060,000 CITY OF HOUSTON, TEXAS

$63,740,000 TAXABLE PENSION OBLIGATION BONDS, SERIES 2006A $63,740,000 5.508% Term Bonds due March 1, 2036 Price: 100% CUSIP No.: 442331HW7(1) ISIN No.: US442331HW74(1)

$24,005,000 PUBLIC IMPROVEMENT REFUNDING BONDS, SERIES 2006B(2) Maturity (March 1) 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 Principal Amount $ 1,425,000 1,480,000 1,540,000 1,600,000 1,665,000 1,735,000 1,810,000 1,885,000 1,965,000 2,065,000 2,170,000 2,275,000 2,390,000 CUSIP No. (1) 442331HX5 442331HY3 442331HZ0 442331JA3 442331JB1 442331JC9 442331JD7 442331JE5 442331JF2 442331JG0 442331JH8 442331JJ4 442331JK1

Interest Rate 4.00% 4.00 4.00 4.00 4.20 4.25 4.25 4.25 5.00 5.00 5.00 5.00 5.00

Initial Yield 3.91% 3.98 4.05 4.15 4.25 4.32 4.38 4.44 4.32(3) 4.34(3) 4.36(3) 4.37(3) 4.40(3)

$3,315,000 CERTIFICATES OF OBLIGATION, SERIES 2006C(2) Maturity (March 1) 2013 Principal Amount $ 3,315,000 CUSIP No. (1) 442331JL9

Interest Rate 5.00%

Initial Yield 3.820%

__________________
(1)

(2) (3)

Copyright 2005, American Bankers Association. CUSIP numbers for the Series 2006 Obligations and ISIN numbers for the Series 2006A Bonds have been assigned by Standard & Poor’s CUSIP Service Bureau, a Division of The McGraw-Hill Companies, Inc. and are included solely for the convenience of the owners of the Series 2006 Obligations. This data is not intended to create a database and does not serve in any way as a substitute for the CUSIP and ISIN Service. Neither the City, the Co-Financial Advisors nor the Underwriters are responsible for the selection or correctness of the CUSIP or ISIN numbers set forth herein. Insured by Ambac Assurance Corporation. Reflects yield to first optional call date. See "THE OBLIGATIONS—Optional Redemption—Series 2006B Bonds."

City of Houston, Texas
ELECTED OFFICIALS Bill White, Mayor Annise D. Parker, City Controller CITY COUNCIL Council Member, District A........................................ Toni Lawrence Council Member, District B ......................................... Jarvis Johnson Council Member, District C .................................... Anne Clutterbuck Council Member, District D........................................... Ada Edwards Council Member, District E ....................................... Addie Wiseman Council Member, District F ....................................... M.J. Khan, P.E. Council Member, District G................................................Pam Holm Council Member, District H................................................Adrian Garcia Council Member, District I ...............................................Carol Alvarado Council Member, At-Large Position 1.................................................. Peter Brown Council Member, At-Large Position 2..................................................... Sue Lovell Council Member, At-Large Position 3..........................Shelley Sekula-Gibbs, M.D. Council Member, At-Large Position 4............................................Ronald C. Green Council Member, At-Large Position 5............................................... Michael Berry

APPOINTED OFFICIALS Chief Administrative Officer................................................................................................................................ Anthony W. Hall, Jr. City Attorney..............................................................................................................................................................Arturo G. Michel Director, Department of Finance and Administration ............................................................................................. Judy Gray Johnson City Secretary................................................................................................................................................................... Anna Russell ADVISORS AND CONSULTANTS Co-Financial Advisors.................................................................................................................................. First Southwest Company
Estrada Hinojosa & Company, Inc.

Co-Bond Counsel ............................................................................................................................................. Vinson & Elkins L.L.P.
Law Offices of Francisco G. Medina

Special Disclosure Co-Counsel ............................................................................................................................. Andrews Kurth LLP
Bates & Coleman, P.C.

FINANCING WORKING GROUP Office of the City Attorney .......................................................................................................................................... Susan T. Taylor Gary L. Wood Department of Finance & Administration .......................................................................................................................Mel Trammell Michael Shannon Asha Patnaik Office of the City Controller .......................................................................................................................................... James Moncur Sue Bailey Shawnell Holman-Smith

i

No broker, dealer, sales representative or any other person has been authorized by the City or the Underwriters to give any information or to make any representation other than as contained in this Official Statement in connection with the offering described in it and, if given or made, such other information or representation must not be relied upon as having been authorized by any of the foregoing. This Official Statement does not constitute an offer to sell or the solicitation of any offer to buy any securities other than those described on the cover page, nor shall there be any offer to sell, solicitation of any offer to buy or sale of such securities by any persons in any jurisdiction in which it is unlawful for such person to make such offer, solicitation or sale. THE SERIES 2006 OBLIGATIONS HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, IN RELIANCE UPON EXEMPTIONS CONTAINED IN SUCH ACT. ANY REGISTRATION OR QUALIFICATION OF THE SERIES 2006 OBLIGATIONS IN ACCORDANCE WITH APPLICABLE PROVISIONS OF SECURITIES LAW OF THE STATES IN WHICH THE SERIES 2006 OBLIGATIONS MAY HAVE BEEN REGISTERED OR QUALIFIED AND ANY EXEMPTION FROM REGISTRATION OR QUALIFICATION IN OTHER STATES CANNOT BE REGARDED AS A RECOMMENDATION THEREOF. IN MAKING AN INVESTMENT DECISION, INVESTORS MUST RELY ON THEIR OWN EXAMINATION OF THE TERMS OF THIS OFFERING, INCLUDING THE MERITS AND RISKS INVOLVED. THE SERIES 2006 OBLIGATIONS HAVE NOT BEEN RECOMMENDED BY ANY FEDERAL OR STATE SECURITIES COMMISSION OR REGULATORY AUTHORITY. FURTHERMORE, THE FOREGOING AUTHORITIES HAVE NOT CONFIRMED THE ACCURACY OR DETERMINED THE ADEQUACY OF THIS OFFICIAL STATEMENT. ANY REPRESENTATION TO THE CONTRARY MAY BE A CRIMINAL OFFENSE. The information set forth herein has been furnished by the City and includes information obtained from other sources which are believed to be reliable, but is not guaranteed as to accuracy or completeness, and is not to be construed as a representation, by the Co-Financial Advisors. The information and expressions of opinion contained herein are subject to change without notice, and neither the delivery of this Official Statement nor any sale made hereunder shall, under any circumstances, create any implication that there has been no change in the affairs of the City or the other matters described herein since the date hereof. Certain statements in this Official Statement, which may be identified by the use of such terms as “plan,” “project,” “expect,” “estimate,” “budget” or other similar words, constitute forward-looking statements. Such forward-looking statements refer to the achievement of certain results or other expectation or performance which involve known and unknown risks, uncertainties and other factors. These risks, uncertainties and other factors may cause actual results, performance or achievements to be materially different from any projected results, performance or achievements described or implied by such forward-looking statements. The City does not plan to issue updates or revisions to such forward-looking statements if or when its expectations, or events, conditions or circumstances on which such statements are based, occur, or if actual results, performance or achievements are materially different from any results, performance or achievements described or implied by such forward-looking statements. The Underwriters have provided the following sentence for inclusion in this Official Statement. The Underwriters have reviewed the information in this Official Statement in accordance with, and as part of, their respective responsibilities to investors under the federal securities laws as applied to the facts and circumstances of this transaction, but the Underwriters do not guarantee the accuracy or completeness of such information. This Official Statement includes descriptions and summaries of certain events, matters and documents. Such descriptions and summaries do not purport to be complete, and all such descriptions, summaries and references thereto are qualified in their entirety by reference to this Official Statement in its entirety and to each such document, copies of which may be obtained from the City or from the Co-Financial Advisors to the City for this issuance. Any statements made in this Official Statement or the appendices hereto involving matters of opinion or estimates, whether or not so expressly stated, are set forth as such and not as representations of fact, and no representation is made that any of such opinions or estimates will be realized. This Official Statement is delivered in connection with the sale of securities referred to herein and may not be produced or used, in whole or in part, for any other purposes. This Official Statement does not constitute an offer to sell or the solicitation of an offer to buy, nor shall there be any sale of the Series 2006 Obligations in any jurisdiction in which it is unlawful to make such offer, solicitation or sale. No dealer, salesman or other person has been authorized by the City to give any information or to make any representation other than those contained herein, and, if given or made, such other information or representation must not be relied upon as having been authorized by the City or any other person. The information and expressions of opinion herein are subject to change without notice, and neither the delivery of this Official Statement nor any sale made hereunder shall, under any circumstances, create the implication that there has been no change in the matters described herein since the date hereof. The prices and other terms respecting the offering and sale of the Series 2006 Obligations may be changed from time to time by the Underwriters after the Series 2006 Obligations are released for sale, and the Series 2006 Obligations may be offered and sold at prices other than the initial offering prices, including sales to dealers who may sell the Series 2006 Obligations into investment accounts. IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT TRANSACTIONS THAT STABILIZE OR MAINTAIN THE MARKET PRICES OF THE SERIES 2006 OBLIGATIONS AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN MARKET. SUCH STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME.

ii

TABLE OF CONTENTS
INTRODUCTION........................................................................................................................................................................................................... 1 PURPOSE AND PLAN OF FINANCING..................................................................................................................................................................... 2 Series 2006A Bonds............................................................................................................................................................................................... 2 Series 2006B Bonds ............................................................................................................................................................................................... 2 Series 2006C Certificates....................................................................................................................................................................................... 2 SOURCES AND USES OF FUNDS.............................................................................................................................................................................. 3 THE OBLIGATIONS ..................................................................................................................................................................................................... 3 Source of Payment ................................................................................................................................................................................................. 3 Description ............................................................................................................................................................................................................. 4 Ownership .............................................................................................................................................................................................................. 4 Special Record Date............................................................................................................................................................................................... 4 Transfers and Exchanges ....................................................................................................................................................................................... 5 Optional Redemption ............................................................................................................................................................................................. 5 Mandatory Redemption.......................................................................................................................................................................................... 6 Notice of Redemption of the Series 2006 Obligations .......................................................................................................................................... 7 Additional Obligations........................................................................................................................................................................................... 7 PROPERTY TAXES ...................................................................................................................................................................................................... 7 Property Subject to Taxation by the City............................................................................................................................................................... 7 Constitutional and Statutory Tax Rate Limitations ............................................................................................................................................... 8 City Charter Tax and Revenue Limitations ........................................................................................................................................................... 8 Taxing Procedures................................................................................................................................................................................................ 10 Tax Rolls .............................................................................................................................................................................................................. 12 SCHEDULE 1: TAX ROLLS...................................................................................................................................................................................... 12 Ad Valorem Tax Levies and Collections............................................................................................................................................................. 13 SCHEDULE 2: AD VALOREM TAX LEVIES AND COLLECTIONS .................................................................................................................. 13 Principal Taxpayers.............................................................................................................................................................................................. 14 SCHEDULE 3: PRINCIPAL TAXPAYERS .............................................................................................................................................................. 14 AD VALOREM TAX OBLIGATIONS OF THE CITY ............................................................................................................................................. 14 Authority to Issue Bonds and Other Obligations................................................................................................................................................. 14 Obligations of the City......................................................................................................................................................................................... 15 SCHEDULE 4: OUTSTANDING DEBT ................................................................................................................................................................... 16 Ad Valorem Tax Obligation Percentages ............................................................................................................................................................ 17 SCHEDULE 5: AD VALOREM TAX OBLIGATION PERCENTAGES ................................................................................................................ 17 Principal and Interest Payable from Ad Valorem Taxes ..................................................................................................................................... 18 SCHEDULE 6: PRINCIPAL AND INTEREST PAYABLE FROM AD VALOREM TAXES (EXCLUDING OUTSTANDING COMMERCIAL PAPER NOTES)...................................................................................................................................................................... 18 COMPUTATION OF DIRECT AND OVERLAPPING DEBT.................................................................................................................................. 19 SCHEDULE 7: DIRECT AND OVERLAPPING DEBT ........................................................................................................................................... 20 CAPITAL IMPROVEMENT PLAN............................................................................................................................................................................ 21 SCHEDULE 8: CAPITAL IMPROVEMENT PLAN (NON-ENTERPRISE FUND)............................................................................................... 21 SCHEDULE 9: VOTER-AUTHORIZED OBLIGATIONS....................................................................................................................................... 22 GENERAL OBLIGATION COMMERCIAL PAPER PROGRAMS ......................................................................................................................... 22 THE CITY..................................................................................................................................................................................................................... 23 Governmental Structure ....................................................................................................................................................................................... 23 Home-Rule Charter .............................................................................................................................................................................................. 23 Redistricting ......................................................................................................................................................................................................... 23 Services Provided by the City.............................................................................................................................................................................. 23 City Response to Hurricane Katrina .................................................................................................................................................................... 24 Employees ............................................................................................................................................................................................................ 25 SCHEDULE 10: CITY EMPLOYEES........................................................................................................................................................................ 25 SCHEDULE 11: COMPENSATED ABSENCE LIABILITY AND LONG-TERM DISABILITY FUND ............................................................. 26 SCHEDULE 11A: COMPENSATED ABSENCE LIABILITY................................................................................................................................. 26 SCHEDULE 11B: LONG-TERM DISABILITY FUND............................................................................................................................................ 26 Health Benefits Fund, Medical Plan, Dental Plan and Life Insurance Plans ...................................................................................................... 26 Health Care Benefits for Retired Employees....................................................................................................................................................... 27 Employee Pension Funds ..................................................................................................................................................................................... 27 SCHEDULE 12: ACTUARIALLY DETERMINED CONTRIBUTION AMOUNTS AND CHANGES IN PENSION PLAN ASSETS ............. 30 Municipal System Overview and Agreement...................................................................................................................................................... 31 SCHEDULE 12A: MUNICIPAL SYSTEM PENSION PLAN ASSETS, LIABILITIES AND UNFUNDED ACTUARIAL ACCRUED LIABILITY...................................................................................................................................................................................... 33 Police System Overview and Agreement ............................................................................................................................................................ 33 SCHEDULE 12B: POLICE SYSTEM PENSION PLAN ASSETS, LIABILITIES AND UNFUNDED ACTUARIAL ACCRUED LIABILITY .......................................................................................................................................................................................................... 35 Firefighter Fund Overview................................................................................................................................................................................... 35 SCHEDULE 12C: FIREFIGHTER FUND PENSION PLAN ASSETS, LIABILITIES AND UNFUNDED ACTUARIAL ACCRUED LIABILITY .......................................................................................................................................................................................................... 36 State Legislation................................................................................................................................................................................................... 36 ANNEXATION PROGRAM AND “IN-CITY” DISTRICTS..................................................................................................................................... 36 Annexation Program ............................................................................................................................................................................................ 36 In-City Districts.................................................................................................................................................................................................... 38

iii

ACCOUNTING AND BUDGETING PROCEDURES AND GENERAL FUND REVENUES ............................................................................... 38 Financial Accounting ........................................................................................................................................................................................... 38 Budgeting Procedures .......................................................................................................................................................................................... 39 Financial Policies ................................................................................................................................................................................................. 39 City Investment Policy......................................................................................................................................................................................... 40 City Interest Rate Swap Policy ............................................................................................................................................................................ 40 General Fund and General Debt Service Fund Budgets for Fiscal Year 2006 ................................................................................................... 40 SCHEDULE 13: GENERAL FUND BUDGET FOR FISCAL YEAR 2006............................................................................................................. 41 SCHEDULE 14: DEBT SERVICE FUND BUDGET ................................................................................................................................................ 42 SCHEDULE 14A: TAX BOND DEBT SERVICE FUND BUDGET FOR FISCAL YEAR 2006 .......................................................................... 42 SCHEDULE 14B: TAX CERTIFICATE DEBT SERVICE FUND BUDGET FOR FISCAL YEAR 2006 ............................................................ 42 Summary of General Fund Revenues, Expenditures, Transfers and Changes in Fund Balance ........................................................................ 43 SCHEDULE 15: SUMMARY OF GENERAL FUND ............................................................................................................................................... 43 SCHEDULE 16: GENERAL FUND UNRESERVED AND UNDESIGNATED FUND BALANCES................................................................... 44 Sales and Use Tax and Franchise Charges and Fees ........................................................................................................................................... 44 SCHEDULE 17: SALES AND USE TAX AND FRANCHISE CHARGES AND FEES......................................................................................... 44 Charges to Other City Funds................................................................................................................................................................................ 44 SCHEDULE 18: DISCRETIONARY DEBT SERVICE TRANSFERS BY COMBINED UTILITY SYSTEM TO THE DEBT SERVICE FUND ................................................................................................................................................................................................. 45 SCHEDULE 19: GENERAL FUND INDIRECT CHARGES TO OTHER CITY FUNDS...................................................................................... 45 SCHEDULE 20: GENERAL FUND DIRECT CHARGES TO OTHER CITY FUNDS .......................................................................................... 45 Industrial District Contracts ................................................................................................................................................................................. 45 SCHEDULE 21: INDUSTRIAL DISTRICT CONTRACTS ..................................................................................................................................... 46 Tax Abatement ..................................................................................................................................................................................................... 46 Short-Term Financing .......................................................................................................................................................................................... 46 Special Revenue Funds ........................................................................................................................................................................................ 46 ENTERPRISE SYSTEMS OF THE CITY .................................................................................................................................................................. 46 Enterprise Funds: Summary of Revenues, Expenses and Changes in Net Fund Assets..................................................................................... 47 SCHEDULE 22: ENTERPRISE FUNDS.................................................................................................................................................................... 47 LITIGATION AND REGULATION ........................................................................................................................................................................... 48 General Litigation and Claims ............................................................................................................................................................................. 48 Environmental Regulation ................................................................................................................................................................................... 48 Other Environmental Measures ........................................................................................................................................................................... 48 Periodic Flooding ................................................................................................................................................................................................. 49 REMEDIES ................................................................................................................................................................................................................... 49 LEGAL INVESTMENTS AND ELIGIBILITY TO SECURE PUBLIC FUNDS IN TEXAS................................................................................... 50 BOND INSURANCE.................................................................................................................................................................................................... 50 Payment Pursuant to Financial Guaranty Insurance Policy................................................................................................................................. 50 Ambac Assurance Corporation ............................................................................................................................................................................ 51 Available Information .......................................................................................................................................................................................... 51 Incorporation of Certain Documents by Reference ............................................................................................................................................. 51 RATINGS...................................................................................................................................................................................................................... 52 TAX MATTERS—TAXABLE BONDS ..................................................................................................................................................................... 52 In General ............................................................................................................................................................................................................. 52 Payments of Interest............................................................................................................................................................................................. 53 Disposition or Retirement .................................................................................................................................................................................... 53 Information Reporting and Backup Withholding ................................................................................................................................................ 53 Treasury Circular 230 Disclosure ........................................................................................................................................................................ 53 TAX MATTERS—TAX-EXEMPT OBLIGATIONS ................................................................................................................................................. 54 Tax Exemption ..................................................................................................................................................................................................... 54 Additional Federal Income Tax Considerations .................................................................................................................................................. 54 LEGAL PROCEEDINGS ............................................................................................................................................................................................. 56 CO-FINANCIAL ADVISORS ..................................................................................................................................................................................... 56 FINANCIAL STATEMENTS ...................................................................................................................................................................................... 56 UNDERWRITING........................................................................................................................................................................................................ 56 FORWARD LOOKING STATEMENTS .................................................................................................................................................................... 56 REGISTRATION, SALE AND DISTRIBUTION....................................................................................................................................................... 57 CONTINUING DISCLOSURE OF INFORMATION ................................................................................................................................................ 57 Annual Reports..................................................................................................................................................................................................... 57 Material Event Notices......................................................................................................................................................................................... 57 Availability of Information from NRMSIRs and SID......................................................................................................................................... 58 Limitations and Amendments .............................................................................................................................................................................. 58 Compliance with Prior Undertakings .................................................................................................................................................................. 58 GENERAL INFORMATION ....................................................................................................................................................................................... 58 APPENDICES APPENDIX A – APPENDIX B – APPENDIX C – APPENDIX D – APPENDIX E – APPENDIX F – AUDITED BASIC FINANCIAL STATEMENTS OF THE CITY .........................................................A-1 ECONOMIC AND DEMOGRAPHIC CHARACTERISTICS............................................. B-1 FORMS OF CO-BOND COUNSEL OPINIONS ..... C-1 CONTINUING DISCLOSURE SCHEDULES ..........D-1 SECURITIES DEPOSITORY ..................................... E-1 SPECIMEN OF BOND INSURANCE POLICY.........F-1

iv

OFFICIAL STATEMENT
$91,060,000 CITY OF HOUSTON, TEXAS
$63,740,000 TAXABLE PENSION OBLIGATION BONDS, SERIES 2006A $24,005,000 PUBLIC IMPROVEMENT REFUNDING BONDS, SERIES 2006B $3,315,000 CERTIFICATES OF OBLIGATION, SERIES 2006C

INTRODUCTION This Official Statement is provided to furnish information in connection with the offering by the City of Houston, Texas (the “City”) of its Taxable Pension Obligation Bonds, Series 2006A (the “Series 2006A Bonds” or the “Taxable Bonds”), Public Improvement Refunding Bonds, Series 2006B (the “Series 2006B Bonds” or the “Tax-Exempt Bonds”) and Certificates of Obligation, Series 2006C (the “Series 2006C Certificates” or the “Tax-Exempt Certificates,” and together with the Tax-Exempt Bonds, the “Tax-Exempt Obligations”). Collectively, the Series 2006A Bonds, the Series 2006B Bonds and the Series 2006C Certificates are referred to herein as the “Series 2006 Obligations.” The Series 2006 Obligations are direct obligations of the City, secured by and payable from the receipts of an annual ad valorem tax levied, within legal limits, on taxable property within the City. See “THE OBLIGATIONS—Source of Payment.” The Series 2006A Bonds are authorized pursuant to the general laws of the State of Texas, particularly Chapter 107, Texas Local Government Code, as amended, Chapter 1201, Texas Government Code, as amended, the City’s Charter and a separate ordinance adopted by the City Council of the City (the “Series 2006A Bond Ordinance”). The Series 2006B Bonds are authorized pursuant to the general laws of the State of Texas, particularly Chapters 1201 and 1207, Texas Government Code, as amended, the City’s Charter and a separate ordinance adopted by the City Council of the City (the “Series 2006B Bond Ordinance”). The Series 2006C Certificates are authorized pursuant to the general laws of the State of Texas, particularly Section 271.041 et. seq., Texas Local Government Code, as amended, the City’s Charter and a separate ordinance adopted by the City Council of the City (the “Series 2006C Certificate Ordinance,” and together with the Series 2006A Bond Ordinance and the Series 2006B Bond Ordinance, the “Ordinances” and each an “Ordinance, as appropriate”). The City’s audited basic financial statements for the Fiscal Year ended June 30, 2005 (the “Financial Statements”) are attached to this Official Statement as APPENDIX A. Attached as APPENDIX B is certain economic and demographic information about the City. Attached as APPENDIX C are the respective forms of opinion of Co-Bond Counsel for each respective series of Series 2006 Obligations. Attached as APPENDIX D is a listing of continuing disclosure schedules included in this Official Statement. Attached as APPENDIX E is information relating to the securities clearance procedures applicable to the Series 2006 Obligations, including a description of The Depository Trust Company (“DTC”) and the global securities clearance procedures of the Euroclear System and Clearstream. Attached as APPENDIX F is a specimen policy with respect to the financial guaranty insurance obtained by the City for the Series 2006B Bonds and Series 2006C Certificates. The Financial Statements present information on the general financial condition of the City at the dates and for the periods described therein. The Series 2006 Obligations are secured by and payable from the receipts of an annual ad valorem tax levied, within legal limits, on taxable property within the City. See “THE OBLIGATIONS—Source of Payment” and “PROPERTY TAXES.” The inclusion of the Financial Statements, which are part of the City Controller’s Comprehensive Annual Financial Report, for the Fiscal Year ended June 30, 2005 (the “Controller’s Report”), and other financial information in this Official Statement is not intended to imply that any other tax receipts, revenues or moneys of the City are pledged to pay the principal of or interest on the Series 2006 Obligations. As used herein, the term “Fiscal Year,” unless otherwise indicated, means the City’s Fiscal Year, which currently is the twelve-month period beginning on July 1 of a calendar year and ending on June 30 of the next succeeding calendar year. Each such period may be designated with the number of the calendar year in which such period ends. The City is the fourth largest city in the nation and the largest city in Texas. In January 2005, according to the Texas State Data Center, the City’s population was approximately 2.05 million, and in December, 2005, according to the University of Houston Center for Public Policy, the population of its primary metropolitan statistical area was approximately 4.50 million, which is the ninth largest in the United States. Located on the coastal plain in Southeast Texas, approximately 50 miles from the Gulf of Mexico, the City is a major corporate and international financial center. Leading industries include energy, engineering and construction, real estate, aerospace and space, commerce, medicine and health care, transportation, biotechnology and computer technology. For additional information about the City, see “APPENDIX B—Economic and Demographic Characteristics.” See “THE CITY— City Response to Hurricane Katrina” for information relating to the impact on the City of Hurricanes Katrina and Rita.

PURPOSE AND PLAN OF FINANCING Series 2006A Bonds The Houston Municipal Employees Pension System (“HMEPS” or the “Municipal System”) and Houston Police Officers Pension System (“HPOPS” or the “Police System”) operate under certain statutory authority for the benefit of certain municipal employees and classified police officers, respectively, of the City. HMEPS and HPOPS qualify as public pension funds within the meaning of state law, and in accordance with Chapter 107, Texas Local Government Code, each respective pension system has entered into an agreement with the City providing, among other things, the amount of the unfunded liability of each respective pension system, and, therefore, the City is authorized by Chapter 107, Texas Local Government Code, and other applicable Texas law to issue pension obligation bonds for the purpose of funding all or a portion of such unfunded liability of each respective pension system. For further information regarding the City and the pension systems, see the sections captioned “THE CITY— Employee Pension Funds; —Municipal System Overview and Agreement; and —Police System Overview and Agreement.” The Series 2006A Bonds are being issued to fund a part of the unfunded liability of HMEPS and HPOPS, respectively. Proceeds of the Series 2006A Bonds will also be used to pay costs relating to the issuance of the Series 2006A Bonds. Series 2006B Bonds In 1995 and 1999 certain employees of the City’s Fire Department filed suit against the City in federal district court seeking payment of compensation allegedly owed to such employees for overtime work under federal and state law. In July 2004, the federal district court issued an opinion on partial summary judgment ordering that, in addition to compensation for unpaid overtime work, the City also pay liquidated damages in an amount equal to the amount of actual damages (i.e. unpaid overtime compensation). Following the release of such opinion, a settlement agreement was reached among the parties and a final judgment was entered on November 19, 2004 (the “Final Judgment”). The Final Judgment required the City to pay the settlement in three installments. The City paid the first two installments in December 2004 and July 2005, respectively, with proceeds of certain bonds issued by the City. The third and final installment is required to be paid on or before July 15, 2006, and the Series 2006B Bonds are being issued to fund the third and final installment. Proceeds of the sale of the Series 2006B Bonds will also be used to pay costs relating to the issuance of the Series 2006B Bonds. Series 2006C Certificates The Series 2006C Certificates are being issued to fund the demolition of dangerous buildings within the City. Proceeds of the sale of the Series 2006C Certificates will also be used to pay costs relating to the issuance of the Series 2006C Certificates.

[Remainder of Page Intentionally Left Blank]

2

SOURCES AND USES OF FUNDS The proceeds from the sale of the Series 2006 Obligations will be applied as follows:

Series 2006A Bonds Sources of Funds: Principal Amount of the Series 2006A Bonds ............................................................................................. $63,740,000.00 Total Sources of Funds.......................................................................................................................... 63,740,000.00 Uses of Funds: Deposit to HMEPS...................................................................................................................................... $33,000,000.00 Deposit to HPOPS....................................................................................................................................... 30,000,000.00 Underwriters’ Discount............................................................................................................................... 296,925.58 Issuance Expenses(1) ................................................................................................................................... 443,074.42 Total Uses of Funds .............................................................................................................................. 63,740,000.00 Series 2006B Bonds Sources of Funds: Principal Amount of the Series 2006B Bonds ............................................................................................. $24,005,000.00 Original Issue Premium ............................................................................................................................... 452,946.30 Total Sources of Funds.......................................................................................................................... $24,457,946.30 Uses of Funds: Deposit to Judgment Bond Fund ................................................................................................................. $24,075,000.00 Underwriters’ Discount............................................................................................................................... 128,273.33 Issuance Expenses(1) ................................................................................................................................... 254,672.97 Total Uses of Funds .............................................................................................................................. $24,457,946.30 Series 2006C Certificates Sources of Funds: Principal Amount of the Series 2006C Certificates ..................................................................................... Original Issue Premium............................................................................................................................... Total Sources of Funds.......................................................................................................................... Uses of Funds: Deposit to 2006 Demolition Fund ............................................................................................................... Underwriters’ Discount ............................................................................................................................... Issuance Expenses(1) ..................................................................................................................................... Total Uses of Funds .............................................................................................................................. _______________
(1)

$3,315,000.00 234,138.45 $3,549,138.45

$3,500,000.00 14,613.80 34,524.65 $3,549,138.45

Includes certain legal fees, fees of the Paying Agent/Registrar, premium for financial guaranty insurance policy (in the case of the Series 2006B Bonds and Series 2006C Certificates), contingency and other costs of issuance.

THE OBLIGATIONS Source of Payment The Series 2006 Obligations are secured by and payable from the receipts of an annual ad valorem tax levied, within legal limits, on taxable property within the City. The City has covenanted to assess, levy and collect an ad valorem tax in each calendar year (“Tax Year”), within the applicable limitations described below, sufficient to pay the principal of and interest on the Series 2006 Obligations. Except for certain exemptions described herein, all property in the City is subject to the ad valorem tax. See “PROPERTY TAXES.” Under the terms of the Ordinances, prior ordinances, and applicable Texas law, the City is obligated to assess, levy and collect in each Tax Year ad valorem taxes sufficient to pay the principal of and the interest on all outstanding obligations payable in such Tax Year from ad valorem tax proceeds. Such obligations (referred to herein collectively as the “Tax Obligations”) include the following: (i) Certain obligations to fund the City’s unfunded actuarially accrued liability (“UAAL”) to the City’s pension programs, which to date the City has issued for HMEPS and HPOPS (collectively, the “Pension Obligations”), all as more fully described herein. The Series 2006A Bonds are being issued as Pension Obligations, the proceeds of which will be used to fund a portion of the unfunded liabilities of HMEPS and HPOPS. Series 2006A Bond proceeds will not be used to fund a portion of the

3

unfunded liability of the Houston Firefighters Relief and Retirement Fund (“HFRRF” or “Firefighter Fund”), although the City may issue additional Pension Obligations at a later date for such purpose; (ii) Bonds (“Tax Bonds”) and notes (“Tax Notes”) payable from ad valorem taxes, including Tax Bonds, such as the Series 2006B Bonds, to refund obligations of the City, including non-appealable judgments and legal settlements against the City; (iii) (iv) (v) Certificates of obligation (“Tax Certificates”), such as the Series 2006C Certificates; General obligation commercial paper notes (“Commercial Paper Notes”); and Certain assumed bonds of special districts annexed by the City (“Assumed Bonds”).

In addition, the City is authorized to enter into tax-supported interest rate swap agreements. The City has entered into one tax-supported interest rate swap agreement (as described herein) and may enter into additional interest rate swap agreements that may be payable in whole or in part from ad valorem taxes if payments become due under any such swap agreements. See “ACCOUNTING AND BUDGETING PROCEDURES AND GENERAL FUND REVENUES—City Interest Rate Swap Policy.” As of January 31, 2006 the outstanding principal amount of Tax Obligations, adjusted to include the Series 2006 Obligations, was $2,754,926,000. See “AD VALOREM TAX OBLIGATIONS OF THE CITY—Authority to Issue Bonds and Other Obligations; —Obligations of the City,” “SCHEDULE 4: OUTSTANDING DEBT” and “PROPERTY TAXES —City Charter Tax and Revenue Limitations.” Description The Series 2006 Obligations will mature in the aggregate principal amounts and on the dates indicated on the inside cover page of this Official Statement. The Series 2006 Obligations will be dated as set forth in the respective Ordinance for each series of Series 2006 Obligations and will accrue interest from the dates of delivery for each respective series, which are expected to be as follows: March 29, 2006, in the case of the Series 2006A Bonds, and April 19, 2006, in the case of the Series 2006B Bonds and Series 2006C Certificates. The Series 2006 Obligations will be payable each March 1 and September 1, commencing September 1, 2006, until maturity or earlier redemption. Deutsche Bank Trust Company Americas is the initial paying agent/registrar (the “Paying Agent/Registrar”) for the Series 2006 Obligations. The Series 2006 Obligations will be issued in fully registered form in denominations of $5,000 or any integral multiple thereof. Principal of the Series 2006 Obligations is payable upon presentation and surrender thereof at the principal payment office of the Paying Agent/Registrar, which is currently located in New York, New York. Interest on the Series 2006 Obligations will be payable to the registered owner whose name appears in the registration books for the Series 2006 Obligations (the “Register”) maintained by the Paying Agent/Registrar at the close of business on the 15th day of the calendar month immediately preceding the applicable interest payment date (the “Record Date”) and shall be payable by the Paying Agent/Registrar (i) by check sent by United States Mail, first class postage prepaid, to the address of the registered owner recorded in the Register or (ii) by such other method, acceptable to the Paying Agent/Registrar, requested by, and at the risk and expense of, the registered owner. Accrued interest payable at maturity of the Series 2006 Obligations will be paid upon presentation and surrender of such Series 2006 Obligations at the principal payment office of the Paying Agent/Registrar. All references in this Official Statement to the Series 2006 Obligations are subject to the specific provisions of the Series 2006A Bond Ordinance, the Series 2006B Bond Ordinance or the Series 2006C Certificate Ordinance, as appropriate. Ownership The City, the Paying Agent/Registrar, and any other person may treat the person in whose name any Series 2006 Obligation is registered (the “Registered Owner”) as the absolute owner of such Series 2006 Obligation for the purpose of making and receiving payment of the principal thereof and the interest thereon and for all other purposes, whether or not such Series 2006 Obligation is overdue. Neither the City nor the Paying Agent/Registrar will be bound by any notice or knowledge to the contrary. All payments made to the person deemed to be the Registered Owner of any Series 2006 Obligation in accordance with the Series 2006A Bond Ordinance, the Series 2006B Bond Ordinance or the Series 2006C Certificate Ordinance, as appropriate, will be valid and effectual and will discharge the liability of the City and the Paying Agent/Registrar for such Series 2006 Obligation to the extent of the sums paid. With respect to the Series 2006B Bonds and the Series 2006C Certificates, so long as the Bond Insurer shall not have defaulted in its payment obligations under the bond insurance policy insuring the Series 2006B Bonds and Series 2006C Certificates, it shall have all rights granted to the Owners of such Series 2006B Bonds and Series 2006C Certificates in the applicable Ordinance. Special Record Date If interest on any Series 2006 Obligation is not paid on an interest payment date and continues unpaid for thirty (30) days thereafter, the Paying Agent/Registrar will establish a new record date for the payment of such interest, to be known as a “Special Record Date.” The Paying Agent/Registrar will establish a Special Record Date when funds to make such interest 4

payment are received from or on behalf of the City. Such Special Record Date will be fifteen (15) days prior to the date fixed for payment of such past due interest, and notice of the date of payment and the Special Record Date will be sent by United States mail, first class postage prepaid, not later than five (5) days prior to the Special Record Date, to each affected Registered Owner of record as of the close of business on the day prior to the mailing of such notice. Transfers and Exchanges Beneficial ownership of Series 2006 Obligations registered in the name of The Depository Trust Company, New York, New York (“DTC”) will be initially transferred as described under “APPENDIX E — SECURITIES DEPOSITORY— Depository Trust Company.” With respect to the Series 2006A Bonds, APPENDIX E also describes the global clearance procedures of the Euroclear and Clearstream systems. So long as any Series 2006 Obligations remain outstanding, the Paying Agent/Registrar shall keep the Register at its principal payment office in which, subject to such reasonable regulations as it may prescribe, the Paying Agent/Registrar shall provide for the registration and transfer of the Series 2006 Obligations in accordance with the terms of the applicable Ordinance. The Series 2006 Obligations shall be transferable only upon the presentation and surrender thereof by Cede & Co., as DTC’s nominee or any subsequent Registered Owner, at the principal payment office of the Paying Agent/Registrar, duly endorsed for transfer, or accompanied by an assignment duly executed by Cede & Co., as DTC’s nominee, or any subsequent Registered Owner or the authorized representative thereof in a form satisfactory to the Paying Agent/Registrar. Upon due presentation and surrender of a Series 2006 Obligation for transfer, the Paying Agent/Registrar is required to authenticate and deliver in exchange therefor, in a timely fashion after such presentation and surrender, a new Series 2006 Obligation or Series 2006 Obligations, registered in the name of Cede & Co., as DTC’s nominee, or such other transferee, in authorized denominations, of the same series, maturity and interest rate, in the same aggregate principal amount as the Series 2006 Obligation or Series 2006 Obligations so presented and surrendered. In the event the Series 2006 Obligations are not held in a book-entry registration system, all Series 2006 Obligations shall be exchangeable upon the presentation and surrender thereof at the designated office of the Paying Agent/Registrar, initially in New York, New York, for a Series 2006 Obligation or Series 2006 Obligations of the same series, maturity and interest rate, in any authorized denomination and in an aggregate principal amount equal to the Series 2006 Obligation or Series 2006 Obligations presented for exchange. Series 2006 Obligations issued in exchange for other Series 2006 Obligations shall be entitled to the benefits and security of the applicable Ordinance to the same extent as the Series 2006 Obligation or Series 2006 Obligations in lieu of which such Series 2006 Obligation is delivered. The City or the Paying Agent/Registrar may require DTC or any subsequent Registered Owner of any Series 2006 Obligation to pay a sum sufficient to cover any tax, fee, or other governmental charge that may be imposed in connection with the transfer or exchange of such Series 2006 Obligation. Any fee or charge of the Paying Agent/Registrar for such transfer or exchange shall be paid by the City. The Paying Agent/Registrar shall not be required to transfer or exchange any Series 2006 Obligation called for redemption during any period beginning 15 calendar days prior to, and ending on the mailing date of, the mailing of any notice of redemption, nor shall the Paying Agent/Registrar be required to transfer or exchange any Series 2006 Obligation selected for redemption, in whole or in part, when such redemption date is scheduled to occur within 30 calendar days; provided, however, that such restriction shall not apply to the transfer or exchange by Cede & Co. as DTC’s nominee or any subsequent Registered Owner of the unredeemed portion of a Series 2006 Obligation called for redemption in part. Optional Redemption Series 2006A Bonds. The Series 2006A Bonds are subject to optional redemption prior to their maturity at the option of the City, in whole or in part (and, if in part, on a Pro Rata basis as described below in “—Mandatory Redemption—Series 2006A Bonds”) on any date, at a redemption price equal to the greater of: (a) (b) 100 percent of the principal amount of the Series 2006A Bonds to be redeemed; or the sum of the present values of the remaining scheduled payments of principal of and interest on the Series 2006A Bonds to be redeemed (exclusive of interest accrued to the date fixed for redemption) discounted to the date of redemption on a semiannual basis (assuming a 360-day year consisting of twelve 30-day months) at the Treasury Rate plus 12.5 basis points;

plus, in each case, accrued and unpaid interest on the Series 2006A Bonds being redeemed to the date fixed for redemption. For the purposes of determining the Treasury Rate, the following definitions shall apply: “Comparable Treasury Issue” means, with respect to any redemption date for a particular Series 2006A Bond, the United States Treasury security or securities selected by the Designated Investment Banker which has an actual or interpolated 5

maturity comparable to the remaining average life of the applicable Series 2006A Bonds to be redeemed, and that would be utilized in accordance with customary financial practice in pricing new issues of debt securities of comparable maturity to the remaining average life of the applicable Series 2006A Bonds to be redeemed. “Comparable Treasury Price” means, with respect to any redemption date for a particular Series 2006A Bond, (1) the average of the Reference Treasury Dealer Quotations for such redemption date, after excluding the highest and lowest Reference Treasury Dealer Quotations, or (2) if the Designated Investment Banker obtains fewer than four such Reference Treasury Dealer Quotations, the average of all such quotations. “Designated Investment Banker” means one of the Reference Treasury Dealers appointed by the City. “Reference Treasury Dealer” means Morgan Stanley & Co. Incorporated and its successors and three other firms, specified by the City from time to time, that are primary U.S. Government securities dealers in the City of New York, New York (each a “Primary Treasury Dealer”); provided, however, that if any of them ceases to be a Primary Treasury Dealer, the City shall substitute another Primary Treasury Dealer. “Reference Treasury Dealer Quotations” means, with respect to each Reference Treasury Dealer and any redemption date for a particular Bond, the average, as determined by the Designated Investment Banker, of the bid and asked prices for the Comparable Treasury Issue (expressed in each case as a percentage of its principal amount) quoted in writing to the Designated Investment Banker by such Reference Treasury Dealer at 3:30 p.m., New York City time, on the third business day preceding such redemption date. “Treasury Rate” means, with respect to any redemption date for a particular Series 2006A Bond, the rate per annum, expressed as a percentage of the principal amount, equal to the semiannual equivalent yield to maturity or interpolated maturity of the Comparable Treasury Issue, assuming that the Comparable Treasury Issue is purchased on the redemption date for a price equal to the Comparable Treasury Price, as calculated by the Designated Investment Banker. If less than all of the Series 2006A Bonds are to be redeemed pursuant to an optional redemption, the City shall determine the maturity or maturities and the amounts thereof to be redeemed, and if less than the entire maturity is redeemed, the City shall direct the Paying Agent/Registrar to redeem the Series 2006A Bonds of such maturity on a Pro Rata (as defined below) basis to each Owner in whose name such Series 2006A Bonds are registered on the Record Date immediately preceding the redemption date. Series 2006B Bonds. The Series 2006B Bonds maturing on and after March 1, 2017, are subject to optional redemption prior to maturity, in whole or in part, on March 1, 2016, or any date thereafter, at 100% of the principal amount thereof, plus accrued interest to the redemption date. Series 2006C Certificates. The Series 2006C Certificates are not subject to optional redemption prior to maturity. Mandatory Redemption Series 2006A Bonds. The Series 2006A Bonds are being issued as term bonds, maturing on March 1, 2036 (the “Series 2006A Term Bonds”), and are subject to mandatory sinking fund redemption, prior to their scheduled maturity, and will be redeemed by the City at a redemption price equal to the principal amount thereof, plus interest accrued thereon to the date of redemption, on the dates and in the principal amounts shown in the following schedule: $63,740,000 Term Bond due March 1, 2036 Mandatory Sinking Fund Mandatory Sinking Fund Redemption Date (March 1) Redemption Amount 2031 $ 11,415,000 2032 12,045,000 2033 12,710,000 *** *** 13,415,000 2035 2036 (maturity) 14,155,000 Mandatory redemptions of the Series 2006A Term Bonds will be made on a Pro Rata (as defined in below) basis to each Owner in whose name the Series 2006A Term Bonds are registered on the Record Date immediately preceding the mandatory sinking fund redemption date. If less than all of the Outstanding Series 2006A Term Bonds of a maturity are optionally redeemed as provided above, then following the Pro Rata reduction of the redeemed bonds among the bondholders, the City shall direct the Paying Agent/Registrar to proportionately reduce the principal amount of each of the remaining mandatory sinking amounts for such mandatory sinking fund redemption dates. 6

Pro Rata is determined in connection with any partial optional redemption or mandatory redemption of Series 2006A Bonds by multiplying the principal amount of such maturity to be redeemed on the applicable redemption date by a fraction, the numerator of which is equal to the principal amount of such maturity owned by an Owner, and the denominator of which is equal to the amount of such maturity then Outstanding immediately prior to such redemption date, and then rounding the product down to the next lower integral of $5,000, provided that the portions being redeemed are required to be in multiples of $5,000, and all Series 2006A Bonds of a maturity to remain outstanding following any redemption are required to be in multiples of $5,000. Series 2006B Bonds The Series 2006B Bonds are not subject to mandatory redemption prior to maturity. Series 2006C Certificates The Series 2006C Certificates are not subject to mandatory redemption prior to maturity. Notice of Redemption of the Series 2006 Obligations At least thirty (30) days prior to the date fixed for any such redemption, a written notice of such redemption shall be given to the Registered Owners of the Series 2006A Bonds or Series 2006B Bonds, as applicable, or portions thereof being called for redemption by depositing such notice in the United States mail, first-class, postage prepaid, addressed to each such Registered Owner at their address shown on the registration books of the Paying Agent/Registrar; provided, however, that so long as DTC is the securities depository for the Series 2006A Bonds and Series 2006B Bonds, as applicable, such notice shall be given only to DTC. The failure to send, mail or receive any notice of redemption shall not affect the validity or effectiveness of the proceedings for the redemption of any Series 2006A Bonds or Series 2006B Bonds, as applicable. By the date fixed for any such redemption, due provision shall be made with the Paying Agent/Registrar for the payment of the required redemption price for the Series 2006A Bonds or Series 2006B Bonds, as applicable, or the portions thereof which are to be so redeemed, plus accrued interest to the date fixed for redemption. If a portion of any such Series 2006A Bonds or Series 2006B Bonds, as applicable, shall be redeemed, a substitute Series 2006A Bond or Series 2006B Bond having the same maturity date, bearing interest at the same rate, and in an aggregate principal amount equal to the unredeemed portion thereof, will be issued to the Registered Owner upon the surrender of the Series 2006A Bonds or Series 2006B Bonds, as applicable, being redeemed, all as provided for in the Series 2006A Ordinance or the Series 2006B Ordinance, as applicable. Additional Obligations The City expects to issue additional Tax Obligations payable (in whole or in part) from ad valorem taxes. Such Tax Obligations may be issued as Pension Obligations, Tax Bonds, Tax Notes, Tax Certificates or Commercial Paper Notes and/or Assumed Bonds, all of which may be payable at such time or times and under such other terms, conditions and details as determined and approved by City Council. For additional information about possible future issuances of Pension Obligations, see “THE CITY — Employee Pension Funds.” See also “SCHEDULE 4: OUTSTANDING DEBT.” As part of the City’s debt management program, the City has entered into a tax-supported interest rate swap agreement (as described herein), and may enter into additional interest rate swap agreements which may be payable in whole or in part from ad valorem taxes if payments by the City become due under any such swap agreements. See “AD VALOREM TAX OBLIGATIONS OF THE CITY—Interest Rate Swaps.” The City may also annex additional districts and thereby create additional Assumed Bonds. See “ANNEXATION PROGRAM AND “IN-CITY” DISTRICTS — Annexation Program” and “SCHEDULE 9: VOTER-AUTHORIZED OBLIGATIONS.” PROPERTY TAXES Property Subject to Taxation by the City Except for certain exemptions provided by federal law and the Texas Tax Code (the “Tax Code”), all property in the City is subject to ad valorem taxation from which the City’s general purpose expenditures and debt service expenditures on Tax Obligations are paid. Categories of exemptions applicable to the City include: (i) property used for public purposes and owned by the State or political subdivisions thereof; (ii) property exempted from ad valorem taxation by federal law; (iii) certain household goods, family supplies and personal effects; (iv) farm products owned by producers; (v) certain property affiliated with charitable organizations, youth development associations, religious organizations and qualified schools; (vi) designated historical sites; (vii) solar and wind powered energy devices; and (viii) most individually owned automobiles. For information relating to certain tax and revenue limitations applicable to the City, see “—Constitutional and Statutory Tax Rate Limitations” and “—City Charter Tax and Revenue Limitations.” See also “AD VALOREM TAX OBLIGATIONS OF THE CITY—Authority to Issue Bonds and Other Obligations.” Taxable property in the City is required to be valued for tax purposes at 100% of the market value (with certain limited exceptions) as of January 1 of each calendar year (“Tax Year”). Pursuant to the Tax Code, which authorizes residential homestead exemptions of up to 20% of the appraised value, City Council has authorized the full amount of such residential 7

homestead exemptions since Tax Year 1988 and thereafter. The residential homestead exemption can be rescinded or changed by the City Council at any time. City Council also authorized a senior citizen exemption and a disabled citizen exemption (“Additional Exemptions”) in an amount up to $53,240 of appraised value per household. A household may claim one but not both Additional Exemptions. In Tax Year 2005, approximately 93,900 households claimed one of the Additional Exemptions, with an average Additional Exemption claim of $46,587 for each such household. On November 2, 2004, the voters of the City approved a charter amendment that provides for a minimum annual exemption increase of 10% for Tax Year 2005 through Tax Year 2008 for such persons. See “—City Charter Tax and Revenue Limitations—Proposition 1.” In addition, the Tax Code provides for an exemption of up to $12,000 for real or personal property of disabled veterans or the surviving spouse or children of a deceased veteran who died while on active duty in the armed forces. The Tax Code also gives the City the authority to place a cap on the ad valorem tax imposed on the residence homesteads of disabled persons and persons 65 years of age or older. If the City were to provide for such a cap, the City would be prohibited from increasing the total ad valorem tax on the residence homestead of such persons above the amount of tax imposed in the year such residence first qualified for an exemption based on the age or disability status of the owner. The freeze on ad valorem taxes on the homesteads of such persons is also transferable to a different residence homestead. As of December 16, 2005, exemptions totaling $30,714,135,810 of appraised value have been claimed by taxpayers and subtracted from the total appraised value for Tax Year 2005 of $143,240,222,415, resulting in a net appraised value of $112,208,628,252. Compared to previous years, the exemptions are substantially higher but such increase is attributable to a change in the method of reporting governmental, religious and charitable properties. Because these values are added to the tax rolls and then deducted as exemptions the effect of this change is neutral. Since Texas law allows taxpayers one year from the earlier of payment or delinquency date to claim residential homestead exemptions, the City estimates that approximately $317,458,353 in additional residential homestead exemptions might be claimed, approved and subtracted from the final tax roll for Tax Year 2005. See “—Tax Rolls.” Constitutional and Statutory Tax Rate Limitations The Constitution of the State of Texas (the “State” or “Texas”) limits the maximum ad valorem tax rate to $2.50 (per $100 of assessed valuation) for home-rule cities such as the City. However, as discussed below, the City Charter has tax rate limitations that are more restrictive than those imposed under the Texas Constitution. See “—City Charter Tax and Revenue Limitations.” The City’s tax rate for Tax Year 2004 (Fiscal Year 2005) was $0.650 (per $100 assessed valuation), which consisted of $0.46573 for general purposes and $0.18427 for debt service. See “SCHEDULE 2: AD VALOREM TAX LEVIES AND COLLECTIONS.” The City has adopted a tax rate for Tax Year 2005 (Fiscal Year 2006) of $0.6475 (per $100 assessed valuation), which consists of $0.46359 for general purposes and $0.18391 for debt service. The City Charter provides that, in preparing the City’s budget, provision shall first be made for the payment of debt service on the City’s outstanding bond indebtedness, with the remaining revenues to be apportioned among the City’s respective departments. See “ACCOUNTING AND BUDGETING PROCEDURES AND GENERAL FUND REVENUES— Budgeting Procedures.” As described below, in future Fiscal Years the amount of the tax levy allocated to debt service may need to be increased, reducing the amount allocable for the delivery of essential governmental services if there is no corresponding increase in the overall tax levy. The Tax Code provides certain limitations on annual tax rate increases based on a complex formula. These limitations are not applicable to tax levy increases to pay debt service on specified debt, including Tax Obligations. Generally, these limitations require two public hearings if the proposed annual increase exceeds the lower of the “effective tax rate” or the “rollback tax rate” as such terms are defined in the Tax Code, and an election (upon petition of 7% of the qualified voters of the City) to limit to 8% any proposed increase which would otherwise exceed 8%. In addition, before City Council can adopt a tax rate that produces tax revenues that exceed the previous year’s tax revenues, it must first conduct public hearings on the proposed tax rate. City Charter Tax and Revenue Limitations In 2004, voters approved initiatives proposing to reduce, cap or otherwise limit ad valorem tax revenues or other revenues of the City. One initiative (“Proposition 1”) was placed on the ballot by City Council in response to a citizen initiative (“Proposition 2”) that was placed on the ballot as a result of a petition submitted by voters of the City to the City Secretary. In an election held in November 2004, a majority of the voters voted for both Proposition 1 and Proposition 2, but Proposition 1 received more favorable votes than Proposition 2. Below there is a discussion of a lawsuit that was filed relating to Proposition 2 (the “Proposition 2 Lawsuit”). For a discussion of the ongoing litigation regarding Proposition 2, see “—Proposition Litigation,” below. Proposition 1. Proposition 1 took effect in Fiscal Year 2006 and amended the City Charter by placing a limitation on increases in revenues received by the City. In particular, Proposition 1 limits increases in (i) the City’s ad valorem tax revenues by requiring voter approval for increases in ad valorem taxes in future years above a limit equal to the lesser of the actual revenues in the preceding Fiscal Year, plus 4.5%, or the revenues received in the preceding Fiscal Year, plus the cumulative combined rates of inflation and the City’s population growth (based on the published estimates of the U.S. Census Bureau for the most recently available 12 month period), but not less than zero, excluding ad valorem tax revenues required by state law to be deposited into a tax increment fund and adding ad valorem tax revenue attributable to each annexation occurring after July 1, 8

2005, for the first year after such annexation; and (ii) water and sewer rates by limiting increases to the combined increases in the rates of inflation and population growth, excluding rate increases required by certain bond covenants and rates established by contract, unless approved by the voters. For certain historic demographic information about the City, see “APPENDIX B — Economic and Demographic Characteristics.” Not yet reflected in the demographic information included as APPENDIX B is the large influx of displaced residents from Louisiana, Mississippi and Alabama as a result of Hurricane Katrina, estimated at 135,000 to 150,000 residents. See “THE CITY—City Response to Hurricane Katrina.” Proposition 1 also provides for minimum annual increases of 10% in the disabled and senior exemption for all residents who are 65 or older or who qualify for the disability exemption in Tax Years 2005 through 2008, and provides that the exemption in Tax Year 2008 shall thereafter be maintained unless increased by City Council. See “—Constitutional and Statutory Tax Rate Limitations” for a discussion of the effect of Proposition 1 on Tax Year 2005 (Fiscal Year 2006) tax rates. Proposition 1 further provides that City Council has full authority to assess and collect all revenues of the City without limitation, except as to ad valorem taxes and water and sewer rates. Proposition 2. Proposition 2 would limit increases in the City’s “combined revenues.” The term “combined revenues” as defined in Proposition 2 includes all revenues of the City, including the general fund, special revenue funds and enterprise funds, excluding only grant monies and revenues from other governmental entities. (Proposition 1 applies only to ad valorem tax revenues and water and sewer rate increases and not to “combined revenues.”) Proposition 2 provides that it takes effect in Fiscal Year 2006 and requires a 60% vote at a regular election to increase combined revenues over the amounts for the immediately preceding Fiscal Year, adjusted for the rate of change in the consumer price index (the “CPI”) for the Houston area and the City’s population. For certain historic demographic information about the City, see “APPENDIX B — Economic and Demographic Characteristics.” As noted above, not yet reflected in the demographic information included as APPENDIX B is the large influx of displaced residents from Louisiana, Mississippi and Alabama as a result of Hurricane Katrina. See “THE CITY—City Response to Hurricane Katrina.” If the actual increase in the amount of revenue for any given Fiscal Year is less than the allowable increase, then such reduced amount of revenue received by the City would be the baseline for the next Fiscal Year. Proposition 2 sets the allowable revenues in Fiscal Year 2006 as the “combined revenues” derived from the City’s Fiscal Year 2001 Comprehensive Annual Financial Report, increased by (i) the percentage by which the City’s estimated population at the last reportable date prior to the beginning of Fiscal Year 2006 (as obtained from the Texas State Data Center) has increased above the official 2000 Census population numbers, and (ii) the percentage by which the CPI for the City’s Primary Metropolitan Statistical Area (“PMSA”) at the end of calendar year 2004 exceeds the CPI for the City’s PMSA at the end of calendar year 1999. If in any year the City’s revenues exceed the amount allowed by Proposition 2, then the City is required to deposit such excess in a taxpayer relief fund. If the balance in the taxpayer relief fund reaches $10 million, such amount is required to be refunded to taxpayers. Proposition 2 includes a provision that states that the City shall always honor its covenants with bondholders and that shortfalls in debt coverage, among other covenants, shall be made up from reductions in other expenditures. See “ACCOUNTING AND BUDGETING PROCEDURES AND GENERAL FUND REVENUES—Budgeting Procedures” for the current charter provision regarding budgeting for the payment of debt service. Proposition Litigation. Proposition 1 was approved with language stating that if another proposed charter amendment relating to limitations on increases in City revenues, such as Proposition 2, is approved at the same election and Proposition 1 receives the higher number of favorable votes, then Proposition 1 would prevail and the other proposed charter amendment shall not become effective (the “supremacy provision”). Additionally, the City Charter provides that if inconsistent measures are approved by the voters at the same election, the one receiving the highest number of votes will prevail (the “Charter inconsistency provision”). In 2005 the City Attorney issued an opinion to the effect that the provisions of Proposition 1 are inconsistent with the provisions of Proposition 2, and that Proposition 1, having received the higher number of favorable votes, prevails and is legally binding and that Proposition 2 is not legally binding. In December 2004, certain supporters of Proposition 2 filed the Proposition 2 Lawsuit in State district court to enforce the provisions of Proposition 2. In the petition, the plaintiffs allege that there is no factual or legal inconsistency between Proposition 1 and Proposition 2 and that both propositions should be declared to be valid as a matter of law or, in the alternative, that the propositions should be harmonized. On November 1, 2005, the district court denied the City’s motion for summary judgment in the plaintiffs’ declaratory judgment action. On January 9, 2006, the district court granted the plaintiffs’ motion for summary judgment as to the declaratory judgment action, but did so without stating any legal or factual basis for such ruling. Texas law provides that, because the district court did not state the basis for its decision, it must be assumed in the City’s appeal that the district court found for the plaintiffs on every argument presented in their motion. Therefore, in order to overturn the trial court’s ruling, each ground for summary judgment must be defeated. There is not currently a final appealable judgment, but the City has indicated that it will pursue an appeal of the ruling once a final order has been entered. Once this case is before the Court of Appeals, it could conclude any of the following: • • The plaintiffs did not have standing to bring the suit; Proposition 1 and Proposition 2 are consistent, and, therefore, both are in effect, in full as written;

9

• • • •

The supremacy provision dictates that only Proposition 1 is in effect; Proposition 1 and Proposition 2 are inconsistent but can be reconciled; therefore both propositions are in effect, and the City (or some court) must harmonize them; Proposition 1 and Proposition 2 are inconsistent, and the Charter inconsistency provision dictates that only Proposition 1 is in effect; or Proposition 1 and Proposition 2 are inconsistent, but the supremacy provision and the Charter inconsistency provision do not apply; therefore both propositions are in effect despite the inconsistencies.

A ruling from the Court of Appeals is unlikely to be issued prior to City Council’s adoption of the City’s budget for Fiscal Year 2007. Vinson & Elkins L.L.P. is one of the law firms representing the City in regard to this matter. Effects of Proposition 1 and Proposition 2. It is difficult to determine with any certainty the impact on City finances and operations if the Court of Appeals were to hold that Proposition 1 and Proposition 2 should both be given effect. By its own terms, if Proposition 2 were held to be effective, the City could experience long-term adverse consequences, which may be substantial, with regard to its ability to fund essential governmental operations, as explained below. Proposition 2 does not differentiate between general fund revenues, which fund essential services, and enterprise fund revenues, such as landing fees and concession revenues attributable to the Houston Airport System, which fund operations of a particular enterprise system. As a general matter, enterprise fund revenues can only be spent on costs of the enterprise system. Accordingly, any increase in revenues attributable to an enterprise fund could force reductions in essential services, such as police, fire, parks and libraries, in order to comply with the Proposition 2 revenue limitations. In addition, because of the manner in which Proposition 2 provides for a reduction in the revenue baseline if the actual increase in the amount of revenue for any given Fiscal Year is less than the allowable increase, Proposition 2 could create a “ratcheting down effect” with the result being that spending on essential services may not keep pace with population growth and inflation. Dramatic or continual reductions in the revenues available to fund essential governmental operations could have an eventual negative impact on the City’s bond ratings, resulting in a higher cost of borrowing. The City Controller has certified that the City’s Fiscal Year 2006 budget complies with both Proposition 1 and Proposition 2. While the City does not believe that it would be required to comply with the provisions of Proposition 2 during the pendency of any appeal, it is anticipated that the City Controller will certify whether the Fiscal Year 2007 budget complies with both Proposition 1 and Proposition 2. Taxing Procedures The Harris County Appraisal District (the “Appraisal District”), a county-wide agency created under the Tax Code, is responsible for appraising property in the City. The Appraisal District Review Board (the “Review Board”), which is appointed by the Appraisal District and various taxing entities, is responsible for reviewing the values established by the Appraisal District. The Appraisal District is governed by a six-member board of directors. Voting for membership on the board of directors of the Appraisal District is cumulative, based on total taxes levied by taxing entities within the Appraisal District. The City, Harris County (the county in which the City primarily lies), and the Houston Independent School District are the major taxing entities in the Appraisal District and, by using the right of cumulative voting, each entity can appoint one board member. The Tax Code requires the Appraisal District to implement a plan for periodic re-appraisal of property at least once every three years. Taxpayers may protest appraisals. In certain cases, the Review Board determines whether the appraisals are substantially uniform and in compliance with Texas law. The City also has the right to challenge certain Appraisal District determinations, but not the appraised value of an individual taxpayer’s property. Orders of the Review Board are subject to appeal to a Texas district court. The City’s tax roll is certified for the City by the Appraisal District’s chief appraiser and the tax rate established by the City Council is applied to the values set by the Appraisal District, as reduced by exemptions granted by the City Council. The City’s voters can require the Appraisal District, Harris County’s Tax Assessor-Collector or a specified taxing entity within the Appraisal District to collect such taxes on behalf of the City by approving an appropriate proposition at an election held for that purpose. Such an election can be called by petition of 10,000 qualified voters in the City or Harris County. Currently, the City’s taxes are collected by Harris County’s Tax Assessor Collector pursuant to a contract. Harris County will continue to bill and collect current taxes. The City contracts with a law firm to enforce the collection of delinquent taxes. Before September 1 of each year, or as soon thereafter as practicable, the rate of taxation is set by the City based upon the valuation of property within the City as of the preceding January 1 as well as the amount of funds required to be raised for general operations, debt service and authorized contractual obligations. Tax statements are required to be mailed by October 1 or as soon thereafter as practicable. Taxes are due upon receipt of a tax bill and become delinquent on February 1 of the following year. If tax statements are mailed after January 10, the 10

delinquency date is postponed to the first day of the next month that will provide a period of at least 21 days between the date the statements are mailed and the date taxes become delinquent. Delinquent taxes incur a penalty of 6% of the amount of the tax for the first calendar month of delinquency plus 1% for each month or portion of a month of delinquency until July 1, when the penalty becomes 12%. Interest on delinquent taxes accrues at the rate of 1% per month until the taxes are paid. To secure the payment of all taxes, and penalty and interest on delinquent taxes, the City has a statutory lien on taxable property, which is on a parity with the lien of other taxing entities. The taxpayer is personally liable for payment of the tax, and property of the taxpayer is subject to seizure and sale to satisfy delinquent taxes. The City also may sue to foreclose on real or personal property to satisfy its tax lien or to enforce personal liability, or both. If a judgment is obtained to foreclose a tax lien, the court may order the property sold to satisfy the tax lien. See “— Ad Valorem Tax Levies And Collections.” The City’s ability to collect delinquent taxes by foreclosure may be adversely affected by the amount of taxes owed to other taxing units, the foreclosure sale price attributable to market conditions, the taxpayer’s right to redeem the property, or by bankruptcy proceedings that restrain the collection of a taxpayer’s debts.

[Remainder of Page Intentionally Left Blank]

11

Tax Rolls Set forth in the schedule below are the City’s tax rolls for Tax Years 2001 through 2005, as provided by the Appraisal District. The tax rolls represent the total appraised value of property, after subtracting all exemptions, and reflect all adjustments made by the Appraisal District. All figures are as of June 30 of each Fiscal Year, except for Tax Year 2005, which are based upon tax rolls as of December 31, 2005. SCHEDULE 1: TAX ROLLS Tax Year 2001 2002 2003 2004 2005 ____________________
(a)

Fiscal Year 2002 2003 2004 2005 2006

Real Property (in thousands) $ 75,855,543 79,404,007 83,728,939 86,756,312 92,187,577 (c)

Personal Property (in thousands) $ 19,607,584 19,901,369 19,428,663 19,124,913 19,438,507 (c)

Total Tax Rolls(a)(b) (in thousands) $ 95,463,127 99,305,376 103,157,602 105,881,225 111,627,084(c)

(b)

(c)

As of February 14, 2006, the Harris County Appraisal District Litigation Tracking System indicated that 1,420 active lawsuits have been filed which, in the aggregate, challenge the valuation placed on approximately $7,008,164,991 of the total appraised tax rolls for the Tax Years 2001-2005 and all prior Tax Years. No prediction can be made as to how the tax rolls may be affected by these lawsuits. As of December 31, 2005, the City has entered into 34 active abatement agreements to stimulate economic development. Property owners receiving these abatements agree to construct certain real property and/or personal property improvements in consideration of the abatement of ad valorem taxes on such improvements for a specified period of time, with a minimum investment exceeding $1 million and the creation or retention of twentyfive (or more) full-time jobs. Ad valorem taxes are paid on all other property. These abatement projects currently represent investments of approximately $726 million with the value of abatable improvements totaling approximately $372 million. These amounts reflect an estimate of taxable valuations based on tax rolls available as of December 31, 2005. See “—Property Subject to Taxation by the City.”

[Remainder of Page Intentionally Left Blank]

12

Ad Valorem Tax Levies and Collections The following schedule sets forth for Fiscal Years 2001 through 2005 the tax rate in each year, the net amount of ad valorem taxes levied by the City, the amount of each year’s levy that was collected through the end of each respective Fiscal Year, the amount of prior years’ delinquent taxes collected in each year and the percentage of the net levy represented by such total collections. All figures are as of June 30 of each Fiscal Year and do not include refunds, penalties and interest collections. SCHEDULE 2: AD VALOREM TAX LEVIES AND COLLECTIONS

Tax Rate(a) Fiscal Year 2001 2002 2003 2004 2005
(a)

General Purposes $0.46682 0.47601 0.47459 0.49452 0.46573

Debt Service $0.18818 0.17899 0.18041 0.16048 0.18427

Total $0.65500 0.65500 0.65500 0.65500 0.65000
(e)

Net Current Year Tax Levy(b) (in thousands) $574,325 625,283 650,450 675,682 688,228

Current Collections Prior to End of Fiscal (c) (d) Year (in thousands) $558,193 608,337 632,588 657,988 669,659

Prior Years’ Delinquent Collections(d) (in thousands) $17,315 18,950 23,285 25,599 27,722

Total Collections(c) (d) (in thousands) $575,508 627,287 655,873 683,587 697,381

Total Collections Percentage of Net Levy 100.2% 100.3 100.8 101.2 101.3

______________________
(b)

(c)

(d)

(e)

The Texas Constitution limits the maximum ad valorem tax rate to $2.50 (per $100 of assessed valuation) for home rule cities such as the City; however, for a discussion of the more restrictive City Charter limitations see “PROPERTY TAXES —City Charter Tax and Revenue Limitations.” The figures represent net adjusted levies including the late certification and correction rolls from the Appraisal District for the current Tax Years through June 30 of each Fiscal Year. These amounts do not include revenues from various types of Industrial District Contracts (as defined herein) entered into by the City with industrial property owners outside of the City’s corporate limits. Such Industrial District Contracts have a term of fifteen years and allow property owners to make payments to the City in lieu of paying ad valorem taxes. See “ACCOUNTING AND BUDGETING PROCEDURES AND GENERAL FUND REVENUES — Industrial District Contracts.” Includes all ad valorem tax receipts received by the City, although such receipts include revenues (“Tax Increments”) designated for various tax increment reinvestment zones, such revenues are deposited into separate funds maintained by the City for its 22 tax increment reinvestment zones. For Fiscal Year 2005, the City transferred approximately $25.65 million of Tax Increments into these funds as required by Texas law. The City anticipates transferring approximately $31.25 million of Tax Increments into these funds in Fiscal Year 2006; however, the Texas Legislature recently passed a law authorizing the City to use a portion of such Tax Increments to reimburse the City for police, fire and other related public safety general fund expenditures attributable to population growth in such zones. By virtue of contracts among the City, the tax increment reinvestment zones and the local government corporations that manage the zones, the Tax Increments are transferred to the respective local government corporation and are available for use on authorized projects in the zone and to be pledged to obligations issued by the local government corporation on behalf of the zone. Bonds and other obligations issued by the local government corporation do not represent debt of the City. See “ANNEXATION PROGRAM AND ‘IN-CITY’ DISTRICTS — In-City Districts.” The City has adopted a tax rate for Tax Year 2005 (Fiscal Year 2006) of $0.6475 (per $100 assessed valuation). See “—Constitutional and Statutory Tax Rate Limitations.” The City Charter provides that, in preparing the City’s budget, provision shall first be made for the payment of debt service on the City’s outstanding bond indebtedness, with the remaining revenues to be apportioned among the City’s respective departments. See “ACCOUNTING AND BUDGETING PROCEDURES AND GENERAL FUND REVENUES— Budgeting Procedures.” In future Fiscal Years the amount of the tax levy allocated to debt service may need to be increased, reducing the amount allocable for the delivery of essential governmental services, if there is no corresponding increase in the overall tax levy.

[Remainder of Page Intentionally Left Blank]

13

Principal Taxpayers The top ten taxpayers for Tax Year 2005 by taxable valuations as provided by the Appraisal District and the percentage of the total taxable valuation attributable to each such taxpayer were as follows: SCHEDULE 3: PRINCIPAL TAXPAYERS Rank 1 2 3 4 5 6 7 8 9 10 Name CenterPoint Energy Inc. (HL&P and Entex) Crescent Real Estate Hines Interests Ltd. Partnership Southwestern Bell Tel Co. L.P. Anheuser Busch Inc. Trizec Hahn Allen Center LP Chevron USA Inc. Lyondell-Citgo Refining Co. Continental Airlines Inc. HG Shopping Center LP Taxable Valuation $1,527,791,411 868,962,243 851,876,092 689,506,802 473,881,489 415,503,465 307,237,666 305,047,927 302,383,604 266,442,640 $6,008,633,339 % of Tax Roll(a)(b) 1.37% 0.78 0.76 0.62 0.42 0.37 0.28 0.27 0.27 0.24

TOTAL __________________
(a) (b)

Based on Tax Year 2005’s total taxable value of $111,627,084,000 as of December 31, 2005. The percentage of the total taxable valuation attributable to the top ten taxpayers is approximately 5.38%.

AD VALOREM TAX OBLIGATIONS OF THE CITY Authority to Issue Bonds and Other Obligations Statutory Limitation. Texas law authorizes the City to incur total bonded indebtedness through the issuance of Tax Obligations in an amount not to exceed 10% of the total assessed valuation of property in the City. As of December 16, 2005, the statutory limitation on such Tax Obligations would be approximately $14.3 billion based on an assessed valuation of approximately $143.2 billion. See “— Ad Valorem Tax Obligation Percentages.” Revenue bonds, tax and revenue anticipation notes, and other contracts are not included in the bonded indebtedness total to which the statutory limitation of 10% applies. See “— SCHEDULE 4: OUTSTANDING DEBT.” The City has covenanted to assess, levy and collect an ad valorem tax in each Tax Year sufficient to pay debt service on outstanding Tax Obligations, subject to the requirements of the City Charter. See “ACCOUNTING AND BUDGETING PROCEDURES AND GENERAL FUND REVENUES—Budgeting Procedures;” “PROPERTY TAXES—City Charter Tax and Revenue Limitations.” Tax Bonds and Commercial Paper Notes. Voter-authorized ad valorem Tax Obligations may be issued as Tax Bonds, Commercial Paper Notes, or as bond anticipation notes. A favorable vote by a majority of those voting in an election held for the purpose of approving Tax Bonds is required to authorize the issuance of Tax Bonds (other than the $100,000 permanent improvement bonds authorized by the City Charter which may be issued annually by the City without an election). The City may issue Tax Bonds without an election to refund previously issued and outstanding Tax Obligations of the City, whether or not originally voter-authorized. Although the City has never exercised such authority, Texas law allows the issuance of Tax Bonds without an election to refund revenue bonds of the City. The City may also issue Tax Bonds, such as the Series 2006B Bonds, without an election to refund any general or special obligation of the City, including final, unappealable judgments resulting from lawsuits or legal settlements against the City. Pension Obligations. The City may also issue Pension Obligations, such as the Series 2006A Bonds, the issuance of which does not require voter approval. Pension Obligations may be payable from and secured by ad valorem taxes or revenues or both to fund the UAAL associated with the City’s employee pension funds. See “THE CITY—Employee Pension Funds— Pension Obligation Bonds.” In addition to the Series 2006A Bonds, the City issued as Pension Obligations a $300 million collateralized note and deferred interest certificates in November 2004, and a series of bonds in March 2005, in the approximate amount of $57 million. For information about the collateralized note and deferred interest certificates, see “THE CITY— Municipal System Overview and Agreement—Agreement—City Funding Commitment.” Tax Certificates and Other Obligations. The City may also issue Tax Certificates, such as the Series 2006C Certificates, payable from ad valorem taxes and, in some cases, a pledge of certain City revenues (e.g. mixed beverage taxes) for the purpose of paying any contractual obligations to be incurred in the construction of any public work or for the purchase of materials, supplies, equipment, machinery, buildings, land and rights-of-way, for the demolition of dangerous structures, and other professional services. The City also is authorized to issue tax anticipation notes and time warrants payable from ad valorem taxes for general purposes. The issuance of Tax Certificates, certain Commercial Paper Notes, tax and revenue anticipation notes

14

and time warrants does not require voter approval unless the applicable law allows a qualifying referendum petition to be filed with the City within a specified time limit. Assumed Bonds. The City may add to its tax-supported bonded indebtedness by assuming outstanding bonds (“Assumed Bonds”) of water districts that have been annexed by the City or water districts within the City that have been abolished. The City also may, at any time following the dissolution of an annexed water district or the abolition of an in-City water district, issue those bonds authorized by the voters of such water districts prior to their annexation or dissolution, or refund the obligations of the annexed or abolished water districts. The proceeds of such bonds must be used only for financing authorized improvements in the annexed or dissolved water district. Texas law authorizes the City to incur or assume obligations (through annexation) that are substantially equivalent to Tax Bonds, through the pledge of ad valorem tax receipts for the payment of contracts for water and sewer services with other political subdivisions or non-profit corporations. See “ANNEXATION PROGRAM AND ‘IN-CITY’ DISTRICTS.” Interest Rate Swaps. As part of its debt management program and consistent with the guidelines set forth in its interest rate swap policy adopted in 2003, the City considers and reviews various interest rate swap proposals, including tax supported interest rate swaps. The City’s interest rate swap policy does not impose any quantitative limits on the amount of rate, credit or other risks that the City could assume under interest rate swap agreements. See “ACCOUNTING AND BUDGETING PROCEDURES AND GENERAL FUND REVENUES – City Interest Rate Swap Policy.” With respect to certain outstanding Tax Bonds, the City entered into a tax supported interest rate swap agreement (the “Swap Agreement”) with Rice Financial Products Corp. LLC (the “Counterparty”). Under the Swap Agreement, the Counterparty effectively pays a variable interest rate based on a LIBOR rate plus a fixed spread, and the City pays a variable interest rate, based on a tax exempt BMA rate times a notional principal amount equal to $200 million. The initial payment date was March 1, 2005, and thereafter payments continue every September 1 and March 1 through the maturity on March 1, 2025. Through March 1, 2007 the City will be a net recipient under the Swap Agreement. While the City expects to remain a net recipient of payments under the Swap Agreement, it could be required to make semiannual payments under the Swap Agreement, and the payments could be substantial, if short-term interest rates increase substantially and/or the historic relationship between short-term taxable and tax-exempt interest rates narrows. Both the City’s and the unrated Counterparty’s obligations under the Swap Agreement are guaranteed through surety bonds issued by AMBAC Assurance Corporation (the “Swap Insurer”). The City and the Counterparty (with the consent of the Swap Insurer), or the Swap Insurer, could each terminate the Swap Agreement if the other party (or the Swap Insurer) fails to maintain a specified credit rating, commits an event of default or certain acts of insolvency, may not legally perform its obligations under the Swap Agreement, or merges or otherwise combines with or transfers substantially all of its assets to a materially less creditworthy entity. For further details, see Note 8.C.4 to the City’s audited financial statements for Fiscal Year 2005 presented in APPENDIX A. For information on interest rate swaps relating to the City’s Combined Utility System Revenue Bonds, see footnote (d) of “SCHEDULE 4: OUTSTANDING DEBT.” Enterprise System Debt. The City also is authorized to issue revenue bonds and notes without voter approval to finance improvements to its Combined Utility System, Convention and Entertainment Facilities, Airport System, parks and certain other revenue-producing enterprises. Such revenue bonds and notes are payable solely from the revenues derived from the operation of the related enterprise system. Texas law also authorizes the City to issue revenue anticipation notes which are repaid during the Fiscal Year of issuance. Obligations of the City The following schedule sets forth, as of January 31, 2006, the outstanding principal amounts of obligations of the City payable from ad valorem taxes and other revenue sources, adjusted to include the Series 2006 Obligations.

[Remainder of Page Intentionally Left Blank]

15

SCHEDULE 4: OUTSTANDING DEBT

Amount
Payable from Ad Valorem Taxes Tax Bonds(a) .................................................................................................................................... Pension Obligations(b) ..................................................................................................................... General Obligation Commercial Paper Notes(c) .............................................................................. Tax Certificates .............................................................................................................................. Assumed Bonds(a) ............................................................................................................................ Subtotal................................................................................................................................... Payable from Sources Other Than Ad Valorem Taxes Combined Utility System Revenue Bonds(d) ................................................................................... Combined Utility System Commercial Paper Notes(e) .................................................................... Water and Sewer System Revenue Bonds(f) .................................................................................... Contract Revenue Obligations — CWA, HAWC, TRA(g)............................................................... Airport System Senior Lien Commercial Paper Notes(h) ................................................................. Airport System Subordinate Lien Revenue Bonds(i) ....................................................................... Airport System Inferior Lien Revenue Obligations(j) (k) ................................................................... Airport Special Facilities Revenue Bonds(k) .................................................................................... Hotel Occupancy Tax and Civic Parking Facilities Revenue Bonds(l) ........................................... Hotel Occupancy Tax Revenue Commercial Paper(m) ..................................................................... Subtotal................................................................................................................................... Total Debt Payable by the City (n)............................................................................................................
_______________________
(a)

$

(in thousands) 1,774,290 437,608 446,800 85,048 11,180 2,754,926 3,424,940 115,000 799,832 357,765 48,500 2,148,055 56,810 592,845 594,050 22,500 8,160,297 10,915,223

$

(b)

(c) (d)

(e) (f)

(g)

(h) (i)

(j)

(k)

(l)

(m)

(n)

A portion of the debt service for Tax Bonds and Assumed Bonds is paid by transfers of certain revenues of the City’s Combined Utility System. See “SCHEDULE 18: DISCRETIONARY DEBT SERVICE TRANSFERS BY COMBINED UTILITY SYSTEM TO THE DEBT SERVICE FUND.” The City has entered into an ad valorem tax-supported basis swap with a notional principal value of $200 million. The underlying bonds for such swap consist of various maturities of Tax Bonds issued between 1998 and 2002. See “—Interest Rate Swaps.” For additional information see Note 8.C.4. of the City’s audited financial statements for Fiscal Year presented in APPENDIX A. A portion of the debt service for the Pension Obligations is paid by the City’s Combined Utility System, Airport System and Convention and Entertainment Facilities Department. See “THE CITY — Employee Pension Funds – Municipal System Overview and Agreement—City Funding Commitment;” and “— Police System Overview and Agreement—City Funding Commitment” The City has five general obligation commercial paper programs with total authorization of $1,008.5 million. Of this amount, $1,376,950,000 of Combined Utility System Revenue Bonds, Series 2004B and Series 2004C, were issued as auction rate securities. The City has entered into a revenue supported interest rate swap agreement with a notional amount of $653,325,000, which is equal to the original principal amount of the Series 2004B Bonds, in order to synthetically convert the variable rate on such bonds to a fixed rate. The City has entered into another revenue supported interest rate swap agreement, effective December 3, 2007, with a notional amount of $249,075,000, which relates to a portion of the original principal amount of the Series 2004C Bonds, in order to hedge against rising interest rates by locking in a historically low long-term interest rate on a synthetic basis. This latter transaction was undertaken in anticipation of the City issuing fixed rate bonds to refund certain variable rate debt in 2007. See “—Authority to Issue Bonds and Other Obligations” and Note 8.C.16 and Note 17.H of the City’s audited financial statements for Fiscal Year 2005 presented in APPENDIX A. The City has authorized $900 million of Combined Utility System Commercial Paper Notes, Series A. This amount represents outstanding Water and Sewer System Revenue Bonds issued prior to the City’s creation of the Combined Utility System in 2004. The Water and Sewer System is now a component of the Combined Utility System. Contract Revenue Obligations consist of obligations under certain contracts between the City and the Trinity River Authority (Livingston Project), Coastal Water Authority, and the Houston Area Water Corporation, which are payable, as to both principal and interest, as operating expenses of the City’s Combined Utility System. The City has authorized a $150 million Airport System Senior Lien Commercial Paper Program. Of this amount, $348,475,000 of the Airport System Revenue Bonds were issued as auction rate securities, and $92,900,000 were issued as variable rate demand obligations. The City has subleased the automated people mover located at the George Bush Intercontinental Airport. The automated people mover was financed with proceeds of certain Series 1997A Special Facilities Revenue Bonds with a current principal balance of $56,810,000. Under the sublease, the City agreed to make sublease payments a portion of which relates to debt service on the Series 1997A Bonds. Such payments are payable from Airport System Net Revenues on the same priority as Houston Airport System Inferior Lien Revenue Obligations. The Series 1997A Bonds remain outstanding as Special Facilities Revenue Bonds; however, for purposes of the foregoing schedule, the Series 1997A Bonds are listed as “Inferior Lien Revenue Obligations” rather than “Special Facilities Revenue Bonds.” In addition, the City has created a $150 million Airport System Inferior Lien Commercial Paper Program, which the City uses for appropriation purposes for the Airport System. There is no commercial paper outstanding under such program. All Special Facilities Revenue Bonds are secured solely from Special Facilities Lease Revenues. This amount does not include $56,810,000 in current principal amount of Series 1997A Special Facilities Revenue Bonds which are included in the foregoing schedule as Houston Airport System Inferior Lien Obligations. See footnote (j) above. Of this amount, $150 million of the Hotel Occupancy Tax and Special Revenue Bonds were issued as auction rate securities. Additionally, approximately $310 million of this amount was used to finance the costs of a 1,200 room convention center hotel and an adjoining parking garage, which amount was loaned to the Houston Convention Center Hotel Corporation to be repaid from revenues of the hotel. The Harris County–Houston Sports Authority (“Sports Authority”), which has also issued hotel occupancy tax supported debt, is a venue district created jointly by the City and Harris County and exists as a political subdivision separate and apart from the City. Sports Authority debt is not included in the foregoing schedule. The City has authorized a $75 million Hotel Occupancy Tax Revenue Commercial Paper Program to fund certain capital improvements of the Convention and Entertainment Facilities Department. This amount does not include certain operating leases of the City, which totaled $57.6 million, at June 30, 2005. See Note 9 to the City’s audited financial statements for Fiscal Year 2005 presented in APPENDIX A.

16

Ad Valorem Tax Obligation Percentages The following schedule shows (i) tax-supported debt, (ii) tax rolls as of June 30 of each Fiscal Year, except for Tax Year 2005, the figures for which are based on tax rolls as of December 31, 2005, (iii) tax-supported debt as a percentage of the City’s tax rolls, (iv) tax-supported debt per capita, and (v) debt service requirements payable from taxes at the end of Tax Years 2001 through 2005. For purposes of this schedule, ad valorem tax obligations consist of outstanding Tax Bonds, Tax Certificates, Tax Notes, Commercial Paper Notes, Pension Obligations and Assumed Bonds as of the dates shown. SCHEDULE 5: AD VALOREM TAX OBLIGATION PERCENTAGES Tax-Supported Debt as a Percentage of Tax Roll 2.03% 2.04 2.01 2.30 2.37 Debt Service Requirement Payable from Taxes(c)(d) (in thousands) $ 205,352 219,673 219,788 233,354 248,105

Tax Year

Fiscal Year

Tax-Supported Debt at December 31 (in thousands) $ 1,934,789 2,025,330 2,073,359 2,432,724 2,644,366

Tax Roll(a) (in thousands) $ 95,463,127 99,305,376 103,157,602 105,881,225 111,627,084

TaxSupported Per Capita Debt(b) $ 981 1,022 1,024 1,196 1,289

2001 2002 2002 2003 2003 2004 2004 2005 2005 2006 _____________________
(a)

(b)

(c)

(d)

The tax roll represents the total appraised value of property, after subtracting all exemptions, and reflect all adjustments made by the Appraisal District as of June 30 of each Fiscal Year. As of December 16, 2005, the total assessed value for Tax Year 2005 (including exempt property values) was $143 billion, which is the appraised value used to determine the statutory limitation of approximately $14.3 billion relating to total bond indebtedness. Per capita figures are based on population estimates according to the Texas State Data Center. See “APPENDIX B—Economic and Demographic Characteristics” for additional population information and other economic and demographic information. These amounts have not been reduced by the combined ending fund balances in the General Debt Service Fund, which were as follows for the Fiscal Years indicated: Fiscal Year 2002 – $102,176,000, Fiscal Year 2003 – $99,534,000, Fiscal Year 2004 - $91,774,000 and Fiscal Year 2005- $106,864,000. The projected combined ending fund balance for Fiscal Year 2006 is $110,160,000. These amounts include principal and interest payments for Tax Bonds, Tax Notes, Pension Obligations and Tax Certificates, and interest only for Commercial Paper Notes at an assumed rate appropriate for each Fiscal Year.

[Remainder of Page Intentionally Left Blank]

17

Principal and Interest Payable from Ad Valorem Taxes The following schedule presents the City’s annual principal and interest requirements for Fiscal Years 2006 through 2035 for the outstanding Tax Bonds, Pension Obligations, Tax Certificates and Assumed Bonds as of January 31, 2006, adjusted to include the Series 2006 Obligations. The following schedule also does not include an interest rate swap agreement entered into by the City in connection with certain Tax Obligations. See “AD VALOREM TAX OBLIGATIONS OF THE CITY—Interest Rate Swaps.” Debt service on Commercial Paper Notes is not reflected in the following schedule, but see footnote (a) below. As of January 31, 2006, the principal amount of Commercial Paper Notes outstanding is $446.8 million. SCHEDULE 6: PRINCIPAL AND INTEREST PAYABLE FROM AD VALOREM TAXES (EXCLUDING OUTSTANDING COMMERCIAL PAPER NOTES)(a) Fiscal Year Pension Assumed Total Debt Tax Bonds Ended June 30 Obligations(b) Tax Certificates Bonds Service(c)(d) 2006 $ 202,277,577 $ 9,535,794 $ 5,419,415 $ 1,374,559 $ 218,607,345 2007 210,264,016 17,493,262 4,625,693 1,376,736 233,759,695 2008 211,770,634 19,160,027 5,809,793 1,372,351 238,112,804 2009 203,611,446 20,553,729 8,662,468 1,303,821 234,131,464 2010 194,206,336 21,947,432 9,694,768 1,323,000 227,171,536 2011 179,254,005 23,887,637 13,755,130 1,221,963 218,118,735 2012 166,387,768 26,364,334 5,515,120 1,041,503 199,308,724 2013 146,798,643 28,831,018 8,829,380 928,236 185,387,277 2014 131,679,649 31,297,702 5,348,085 1,007,070 169,332,506 2015 122,996,330 47,428,868 5,351,805 1,180,763 176,957,766 2016 121,237,699 50,717,684 5,351,985 1,182,795 178,490,162 2017 116,651,399 51,790,665 5,354,415 1,182,298 174,978,777 2018 112,816,374 52,863,647 5,353,565 591,480 171,625,066 2019 78,497,000 53,936,628 5,354,115 28,600 137,816,343 2020 71,817,350 54,542,665 5,355,495 184,200 131,899,710 2021 67,595,863 53,355,852 5,352,150 189,988 126,493,852 2022 66,484,738 50,866,151 5,353,750 190,088 122,894,726 2023 66,485,463 48,399,466 4,333,500 119,218,429 2024 40,102,713 45,932,782 4,333,750 90,369,245 2025 23,118,963 43,466,098 4,335,500 70,920,561 2026 2,907,713 40,999,414 4,338,250 48,245,377 2027 398,213 38,532,730 4,336,500 43,267,443 2028 398,213 36,066,046 36,464,259 2029 398,213 41,939,362 42,337,575 2030 398,213 40,543,286 40,941,499 2031 398,213 51,802,189 52,200,401 2032 2,858,213 51,802,276 54,660,488 2033 2,862,138 51,801,643 54,663,780 2034 139,400 331,842,036 331,981,436 2035 2,859,400 26,307,036 29,166,436 2036 14,934,657 14,934,657 $ 2,547,671,875 $1,478,942,119 $ 132,164,630 $ 15,679,449 $ 4,174,458,072 __________________________
(a)

(b)

(c)

(d)

Each Fiscal Year the City budgets for Commercial Paper Notes debt service and related reserve funds based on a calculation that assumes a certain amount of Commercial Paper Notes is expected to be issued during that Fiscal Year at an assumed rate of interest. See “CAPITAL IMPROVEMENT PLAN — General Obligation Commercial Paper Programs.” See “THE CITY — Employee Pension Funds;” “—Municipal System Overview and Agreement — City Funding Commitment;” and “— Police Pension System Overview and Agreement — City Funding Commitment.” The figures above include debt service on a $300 million secured promissory note issued by the City to HMEPS at an assumed interest rate of 8.5% (the “Secured Note”). The interest rate on the Secured Note is at a variable rate, and the actual rate could be higher than the assumed rate above. The figures further assume that 73.5% of the interest on the Secured Note is deferred in Fiscal Year 2006 and 64.3% is deferred in each subsequent fiscal year through Fiscal Year 2015 up to a maximum deferral of $150 million, with such interest being satisfied with unsecured notes bearing interest at 8.5% (the “Unsecured Notes”). The figures above assume that the Unsecured Notes will be repaid from Fiscal Year 2011 through Fiscal Year 2030. A portion of the debt service for the Pension Obligations is paid by the City’s Combined Utility System, Airport System and Convention and Entertainment Facilities Department. See “THE CITY — Employee Pension Funds – Municipal System Overview and Agreement — City Funding Commitment;” and “– Police System Overview and Agreement – City Funding Commitment.” Total debt service does not include payments related to various leases for office space and equipment, which are not considered debt under Texas law. The terms and conditions of such leases and agreements vary. See Note 9 to the City’s audited financial statements for Fiscal Year 2005 presented in APPENDIX A. Totals may reflect a variance due to rounding.

18

COMPUTATION OF DIRECT AND OVERLAPPING DEBT Other governmental entities whose boundaries overlap the City have outstanding bonds or other obligations payable from ad valorem taxes. The information contained in SCHEDULE 7 under the heading “Net Direct Debt,” other than for the City, has been obtained from the Municipal Advisory Council of Texas and from the individual governmental entities. The information contained in SCHEDULE 7 under the heading “City Share of Debt” has been obtained from the Municipal Advisory Council of Texas. Net Direct Debt is equal to the outstanding principal amount less sinking fund balances. The City has not independently verified the accuracy or completeness of such information, and no person is entitled to rely upon such information as being accurate or complete. Furthermore, some entities listed below may have issued additional bonds or other obligations since the dates shown on this table and may have programs requiring the issuance of substantial amounts of additional bonds or other obligations, the amount of which cannot be determined.

[Remainder of Page Intentionally Left Blank]

19

SCHEDULE 7: DIRECT AND OVERLAPPING DEBT
Net Direct Debt(a) Amount (in thousands) As of City City of Houston-direct debt(c) Counties Fort Bend County Harris County (including Toll Road Bonds) Harris County Flood Control Montgomery County School Districts Aldine I.S.D. Alief I.S.D. Clear Creek I.S.D. Conroe I.S.D. Crosby I.S.D. Cypress-Fairbanks I.S.D. Deer Park I.S.D. Fort Bend I.S.D. Galena Park I.S.D. Goose Creek Consolidated I.S.D. Houston I.S.D. Huffman I.S.D. Humble I.S.D. Katy I.S.D. Klein I.S.D. New Caney I.S.D. North Forest I.S.D. Pasadena ISD Sheldon I.S.D. Spring I.S.D. Spring Branch I.S.D. Municipal Utility Districts Harris County MUD No. 355 Harris County MUD No. 359 Harris County MUD No. 366 Harris County MUD No. 390 Northwood Municipal Utility District No. 1 Other Jurisdictions Clear Lake City Water Authority Fort Bend Parkway Road District Harris County Dept. of Education Houston Community College Lee College District N. Harris–Montgomery Community College Dct Port of Houston Authority San Jacinto Jr. College District Total overlapping debt Total direct and overlapping debt $ 66,438 688 6,795 144,555 18,354 214,899 293,726 67,774 11,650,276 14,314,142 $ 09/30/04 07/01/05 06/30/05 07/26/05 06/30/05 06/30/05 06/30/05 06/30/05 47.39% 12.58% 56.87% 97.70% 0.92% 19.49% 56.87% 12.97% 31,485 87 3,864 140,839 169 41,884 167,042 8,790 5,092,244 7,756,110 8,289 9,740 2,835 1,911 2,158 06/30/05 06/30/05 06/30/05 06/30/05 06/30/05 100.00% 100.00% 100.00% 100.00% 100.00% 8,289 9,740 2,835 1,911 2,158 213,261 261,038 505,080 432,244 73,091 943,432 96,848 534,110 210,353 191,518 1,946,777 39,445 321,939 764,663 147,450 100,288 74,190 238,325 65,185 433,747 372,396 06/30/05 08/31/04 506/30/04 08/31/04 08/31/04 06/30/05 08/31/04 06/30/05 08/31/04 06/08/05 06/30/05 06/30/05 06/30/05 08/31/04 06/30/05 06/30/05 08/31/04 08/31/04 06/30/05 06/30/05 06/30/05 52.67% 79.27% 27.31% 0.08% 0.37% 15.40% 0.14% 1.00% 15.65% 0.92% 94.33% 30.99% 3.50% 24.60% 2.49% 0.37% 79.24% 41.21% 0.12% 2.61% 82.18% 112,325 206,925 137,937 346 270 145,289 136 5,341 32,920 1,762 1,836,395 12,224 11,268 188,107 3,672 371 58,788 98,214 78 11,321 306,035 67,365 2,252,769 385,230 141,770 06/30/05 06/30/05 06/30/05 06/30/05 4.62% 56.87% 56.87% 0.06% 3,112 1,281,150 219,080 85 $ 2,663,866 01/31/06 100.00% $ 2,663,866 % of Debt Applicable to City(b) City Share of Debt (in thousands)

________________________ (a) The net direct debt amounts, except for the amount relating to the City, were provided by the individual government entities. Net Direct Debt is equal to the outstanding principal amount less sinking fund balances, except for City debt. (b) Overlapping percentage represents the estimated percentage of the total taxable values of the particular entity covered by the City, according to the Municipal Advisory Council of Texas. (c) This amount includes Tax Obligations as of the date shown, and has not been reduced by balances in the sinking funds. The amount does not include debt of certain reinvestment zones and public improvement districts created within the City.

20

CAPITAL IMPROVEMENT PLAN A 1983 resolution adopted by the City Council requires the Mayor to develop and submit annually to the City Council for approval a continuous five-year Capital Improvement Plan (the “CIP”). In each year, the Mayor must review the CIP, revise it as necessary and prepare a capital budget for approval and adoption by the City Council. The annual update of the CIP provides, upon approval by the City Council, a continuous five-year plan. In addition, the process of developing the CIP provides for significant public participation, as well as input from other governmental entities for joint projects. An example of such coordination is the joint effort between the City and the Metropolitan Transit Authority of Harris County, Texas (“METRO”) to repair streets and overpasses in order to improve the transportation system and general mobility. The 2006-2010 CIP consists of the projects and facilities described in the following chart. (The 2006-2010 CIP also includes proposed improvements for the Combined Utility System, Airport System and Convention and Entertainment Facilities, which are financed primarily with revenues of those enterprise systems and, therefore, are not included in the table below). SCHEDULE 8: CAPITAL IMPROVEMENT PLAN (NON-ENTERPRISE FUND) Amount (in thousands) Streets, Bridges and Traffic Control .......................................................... Storm Sewers and Drainage....................................................................... Parks and Recreation ................................................................................. Police Department ..................................................................................... Fire Department ......................................................................................... General Government.................................................................................. Public Library ............................................................................................ Public Health ............................................................................................. Solid Waste Management .......................................................................... Low Income Housing ................................................................................ Total.................................................................................................. $ 952,672 260,962 96,108 103,965 53,686 43,215 61,645 16,489 18,061 46,578 $1,653,381(a)

____________________ (a) The tax-supported component (approximately $428 million) of the 2006-2010 CIP addresses a full range of capital facility and infrastructure improvements. The voter authorized improvements are expected to be initially financed with Commercial Paper Notes. The remaining amount is expected to be funded by grants, funds from agencies participating in joint capital improvement projects with the City and various other sources.

[Remainder of Page Intentionally Left Blank]

21

The following schedule sets forth the categories of bond authorization approved by the voters in elections held in November of 1997 (the “1997 Election”) and November of 2001 (the “2001 Election”) and the amount of each such authorization approved by City Council for issuance as Commercial Paper Notes. SCHEDULE 9: VOTER-AUTHORIZED OBLIGATIONS

(in thousands) 1997 Election
Approved by City Council for Issuance as Commercial Paper Notes

Purposes Streets, Bridges, Traffic Control, Storm Sewers and Drainage Parks and Recreation Police Department Fire Department Permanent & General Imp.(b) Low Income Housing Total

Voter Authorized

Commercial Paper Issued(a)

Commercial Paper Notes Approved by City Council but Unissued

$

350,000 30,000 23,450 29,710 91,840 20,000

$

350,000
30,000 23,450 29,710 91,840 20,000

$

350,000
30,000 10,232 29,710 80,058 20,000 520,000

$

$

545,000

$

545,000

$

$

0 0 13,218 0 11,782 0 25,000

2001 Election
Approved by City Council for Issuance as Commercial Paper Notes

Purposes Streets, Bridges, Traffic Control, Storm Sewers and Drainage Parks and Recreation Police and Fire Departments Permanent & General Imp.(c) Public Libraries Low Income Housing Total Combined Total (1997 Election and 2001 Election)
________________________________ (a) (b) (c)

Voter Authorized

Commercial Paper Issued(a)

Commercial Paper Notes Approved by City Council but Unissued

$

$ $

474,000 80,000 82,000 80,000 40,000 20,000 776,000 1,321,000

$

$ $

324,400 62,500 40,500 41,000 17,000 14,600 500,000 1,045,000

$

$ $

156,817 32,868 20,541 4,774 0 0 215,000 735,000

$

$ $

167,583 29,632 19,959 36,226 17,000 14,600 285,000 310,000

As of December 31, 2005. Includes certain buildings relating to Public Libraries, Public Health, and Solid Waste Management. Includes certain buildings relating to Public Health and Solid Waste Management.

GENERAL OBLIGATION COMMERCIAL PAPER PROGRAMS The City authorized a Series A General Obligation Commercial Paper Program (“Series A Notes”), with a current total available authorization of $118.2 million, which includes voter authorization from the 1997 Election. The liquidity providers for the Series A Notes are Landesbank Hessen-Thuringen Girozentrale and Dexia Credit Local. As of January 31, 2006, $116.5 million of the Series A Notes was outstanding. The City authorized a Series B General Obligation Commercial Paper Program (“Series B Notes”), with a current total available authorization of $25.8 million, which includes voter authorization from the 1997 Election. The liquidity provider for the Series B Notes is JPMorgan Chase Bank, National Association. As of January 31, 2006, $7.0 million of the Series B Notes was outstanding. Upon issuance of the current available authorizations for the Series A Notes and the Series B Notes, the City’s voted authorizations under the 1997 Elections will be exhausted. The City’s Series C General Obligation Commercial Paper Program expired in July 2004 in accordance with the terms of the ordinance creating such program. The City authorized a Series D General Obligation Commercial Paper Program (“Series D Notes”) with a current total available authorization of $500 million, which includes voter authorization from the 2001 Election. The liquidity provider for the Series D Notes is DEPFA Bank plc, acting through its New York Branch. As of January 31, 2006, $215.0 million of the Series D Notes was outstanding.

22

The City authorized a Series E General Obligation Commercial Paper Program (“Series E Notes”) with a current total available authorization of $225 million under Chapter 1431, Texas Government Code, as amended (voter authorization not required). The liquidity provider for the Series E Notes is Bank of America, N.A. As of January 31, 2006, $83.5 million of the Series E Notes was outstanding. The City authorized a Series F General Obligation Commercial Paper Program (the “Series F Notes”) with a total available authorization of $139.5 million under Chapter 1431, Texas Government Code, as amended (voter authorization not required) to fund certain capital improvements related to drainage. The liquidity provider for the Series F Notes is DEPFA Bank plc, acting through its New York Branch. As of January 31, 2006, $24.8 million of the Series F Notes was outstanding. With regard to all general obligation commercial paper programs, Commercial Paper Notes may be issued for a period not to exceed 270 days and will bear interest based upon the specified term of the Commercial Paper Notes, but not to exceed 10%. The principal and interest on the Commercial Paper Notes is payable from ad valorem taxes and other funds that may be provided under their respective lines of credit. The Commercial Paper Notes are offered for sale by commercial paper dealers. THE CITY Governmental Structure The City has a mayor-council form of government in which the Mayor and the fourteen-member City Council serve as the legislative body. Nine council members are elected by district and five council members are elected at-large. The Mayor, all members of the City Council and the City Controller are elected for two-year terms. The present term of office for all elected officials expires in January 2008. The City Charter limits the terms of office for all elected City officials to three two-year terms. The Mayor is the City’s chief executive officer. The Mayor exercises administrative control over the City’s government; presides over City Council meetings; establishes the City Council agenda; and appoints the heads of the various departments of the City, subject to confirmation by the City Council. The Mayor also is responsible for preparing and submitting the City’s annual budget proposals to the City Council for adoption. The City Controller is the City’s chief financial officer. The Office of the City Controller superintends, supervises, manages and conducts the fiscal affairs of the City; maintains the books of accounts; prepares financial statements; conducts the sales of City obligations; certifies the availability of funds before the City incurs any financial obligation; and, along with the Mayor, countersigns all warrants, contracts or orders for payment of any money by the City. Home-Rule Charter Voters of the City adopted the City Charter under the home-rule provision of the Texas Constitution. Under the Texas Constitution, the City Charter may be amended not more than once every two years at an election held for that purpose, which may be called by the City Council or upon petition of 20,000 of the City’s registered voters. The last City Charter amendments were adopted on November 2, 2004. In addition, the City Charter allows the City’s voters to exercise the powers of initiative and referendum. To enact an initiative ordinance, a petition signed by voters equal in number to at least 15% of the greater total vote cast for Mayor in any general election in the preceding three years must be submitted to the City. Thereafter, the City Council may enact the ordinance or call an election on the question of its adoption. In order to exercise the referendum power, a petition signed by voters equal in number to at least 10% of the greater total vote cast for Mayor in any general election in the preceding three years must be submitted to the City. City Council may repeal the ordinance that is the subject of the referendum petition or submit the issue to the electorate. See “PROPERTY TAXES—City Charter Tax and Revenue Limitations.” Redistricting Whenever the City determines that a material imbalance in population exists due to recent annexations or the realignment of county voting precinct boundaries, the City Council adopts a revised redistricting plan to balance the population among the City Council districts and to bring such City Council districts into compliance with state and federal law. Each time that the City redistricts it must submit the redistricting plan to the United States Department of Justice for preclearance under the Voting Rights Act of 1965. Further, the City Charter provides that whenever the City’s population exceeds 2.1 million, two additional City Council districts must be added. According to Texas State Data Center January, 2005 figures, the City’s population was approximately 2.050 million. This figure does not include any increases in population that may be attributable to the relocation of residents from Louisiana, Mississippi and Alabama as a result of Hurricane Katrina. See “—City Response to Hurricanes Katrina.” Services Provided by the City The City provides law enforcement and fire protection services, emergency medical services, water, sanitary sewer and solid waste disposal services, storm drainage, bridge and street facility maintenance, library and park services, building inspection and civil defense services. In addition to these services, the City also provides preventive health services through

23

numerous health facilities within the City and certain housing services to low income and homeless families and operates convention, cultural, sports and airport facilities. The City does not operate public hospitals, schools, transit services or a higher education system, nor does it expend City funds for public assistance programs. Public hospitals and schools within the City’s boundaries are administered by the State or special districts or other governmental entities with independent taxing authority. METRO operates the transit system and is financed by a separate 1% sales and use tax, federal and State grants and fare receipts. City Response to Hurricane Katrina On August 29, 2005, Hurricane Katrina struck the coasts of Louisiana, Mississippi and Alabama. The destruction caused by the hurricane led to a significant number of displaced residents of the affected states seeking refuge in the City. As of the date of this Official Statement the City estimates that between 135,000 and 150,000 displaced residents of the affected states remain in the City. In response to the influx of evacuees, the City worked with Harris County and various State and federal agencies and nonprofit organizations to coordinate needed resources to assist the evacuees. As part of its response, the City offered temporary housing to thousands of evacuees in shelters in the days immediately following Hurricane Katrina. In addition to providing shelters, the City provided equipment, food, medical supplies, facilities, and City emergency and civilian personnel. The City, in conjunction with other public and private entities, is providing temporary housing and other support to the evacuees for a period of between six and twelve months based upon eligibility provided by FEMA. Available housing is near capacity, and the City is no longer initiating new leases for evacuees per FEMA’s concurrence and approval. The City will also work with public and private entities, including the Texas Workforce Commission, to facilitate the integration of Hurricane Katrina evacuees into the workforce. Due to the unprecedented nature of this situation, the scope of the City’s response may change significantly in that it may incur additional disaster related costs or may determine that certain of the programs initiated as part of the response should be reduced or eliminated. Following Hurricane Katrina, the President of the United States issued a declaration of emergency for the State of Texas, which resulted in federal assistance becoming immediately available to the City for 100% of eligible costs incurred in providing shelter and care to victims of Hurricane Katrina. Eligible costs include those costs associated with providing shortterm sheltering, interim sheltering for a period of up to one year, medical costs, transportation costs and costs associated with temporary increases in the provision of governmental services such as public safety, education and judicial expenditures. The total cost of the City’s response is estimated to be approximately $165 million through February 28, 2006, but such costs are expected, as of the date hereof, to be paid from sources other than the City’s general fund. If FEMA approves an extension of the temporary housing program beyond February 28, total lifetime costs could exceed $350 million, with FEMA providing the funding for this cost. Approximately 85% of the estimated costs are associated with the temporary housing program. To date the City has received an advance of approximately $125.3 million from FEMA to cover eligible disaster related expenses, and FEMA has approved another $20 million in funding to be advanced to the City when needed. Additionally, the City has received more than $1 million in private donations for disaster-related expenses, but does not expect to receive any additional significant donations. The City has created the Hurricane Katrina Aid and Recovery Fund to track and record all expenses related to the relief effort, and City Council has authorized $10 million to be transferred to such fund as an initial deposit for the recovery effort. The City anticipates, as of the date hereof, that FEMA advances and reimbursements will be sufficient to cover substantially all of the costs associated with the City’s relief efforts, including the reimbursement of the $10 million transferred to the Hurricane Katrina Aid and Recovery Fund. Notwithstanding such expectation, the City cannot predict whether any advances, reimbursements or other approvals from FEMA will be made in a timely manner, whether all or substantially all of the City's expenses will be approved by FEMA, or whether FEMA, due to other unforeseen circumstances, may change, reduce or redirect certain resources dedicated to Hurricane Katrina relief efforts to another effort instead. However, to the extent that FEMA advances or reimbursements are not sufficient to cover all costs associated with the City’s efforts, the City may decide to authorize other available funds of the City or seek monies from other sources to fund any shortfall.

24

Employees The following schedule shows the total number of City employees at the end of Fiscal Years 2002 through 2005 and Fiscal Year 2006 figures through December 31, 2005: SCHEDULE 10: CITY EMPLOYEES Fiscal Year Police (classified)(a) Fire (classified) Other Municipal Total
________________________________ (a)

2002 5,420 3,309 13,683 22,412

2003 5,415 3,431 13,246 22,092

2004 5,244 3,655 12,722 21,621

2005 4,880(a) 3,888 12,922 21,690

2006 4,819 3,938 12,301 21,058

In 2001, the City and HPOPS entered into a “meet and confer” agreement that enhanced the retirement benefits of police officers. These benefit changes were codified by the State legislature in 2003. The City believes that many police officers delayed retirement in order to take advantage of the enhanced benefits expected under the “meet and confer” agreement. See “—Employee Pension Funds – Police System Overview and Agreement.” The City has budgeted funding for new cadet classes which the City believes will produce approximately 240 new police officers in the current Fiscal Year.

Bargaining with Police and Firefighters. Texas law prohibits municipal employees from engaging in strikes. Accordingly, classified police officers and firefighters may not strike if they feel aggrieved of any terms or conditions of their employment in Texas. They may, however, elect bargaining agents. The bargaining agents for police officers “meet and confer” upon specific terms and conditions of employment, including wages, in a negotiated fashion with the Mayor and/or his representatives. The bargaining agents for firefighters negotiate with the City pursuant to Subchapter C of Chapter 174 of the Texas Local Government Code (“Chapter 174”) and engage in collective bargaining. The City and the firefighters’ union recently approved a collective bargaining agreement relating to matters including wages, staffing and other benefits. The City projects that the collective bargaining agreement will result in an increase in the City’s payments for firefighter compensation and benefits, including pension contributions, of approximately $17.7 million in Fiscal Year 2006 as compared with the City’s payments in Fiscal Year 2005, with additional increases in such payments of approximately $18.0 million in Fiscal Year 2007 and approximately $14.3 million in Fiscal Year 2008. The City’s Fiscal Year 2006 Budget anticipated the possibility of a collective bargaining agreement and includes an amount sufficient to fund the increased payments for firefighter compensation and benefits in Fiscal Year 2006. See “THE CITY – Employee Pension Funds – Firefighter Fund Overview.” The initial term of the agreement expires on December 31, 2008, at which time the agreement will remain in effect until replaced by a successor agreement or until terminated by mutual agreement. This collective bargaining agreement supersedes Texas law. See also “—Health Care Benefits for Retired Employees.” Bargaining with Other Municipal Employees. The Texas Legislature recently enacted Chapter 146 of the Local Government Code (“Chapter 146”), which extended to municipal employees of the City, other than department heads, firefighters and police officers, the right to appoint bargaining agents to “meet and confer” with representatives of the City or any agency, board, commission or political subdivision that is required to establish wages, salaries, rates of pay, hours, working conditions or other terms and conditions of employment regarding such issues. Chapter 146 prohibits municipal employees from engaging in strikes and specifically prohibits the bargaining agent and the City from entering into agreements regarding pension-related matters governed by Article 6243g, Vernon’s Texas Civil Statutes, or a successor statute (now Article 6243h, Vernon’s Texas Civil Statutes). See “—Employee Pension Funds.” However, any agreement affecting the salaries of municipal employees will likely have an effect on the City’s pension liabilities. In order to invoke the provisions of Chapter 146, a majority of the municipal employees must submit a petition requesting the recognition of a particular employee association as the sole and exclusive bargaining agent for all covered employees before the City may begin negotiations with the employee association. After receiving such a petition, the City may (i) grant recognition of the association as requested in the petition and meet and confer under Chapter 146 without an election by the voters of the City, (ii) order an election to determine whether a public employer may meet and confer under Chapter 146, or (iii) order a certification election to determine whether the employee association represents a majority of the covered employees. See also “—Health Care Benefits for Retired Employees.” Accumulated Vacation, Sick Leave and Compensatory Time. Until November 2003, City employees accrued from 10 to 22 days of vacation annually, depending upon the duration of their employment and could accumulate up to 90 days of paid vacation time. Effective November 2003, the annual accruals range from 10 to 25 days, and generally employees hired as of January 1, 2000 or later are able to accumulate up to 45 days of paid vacation time. Under a compensable sick leave plan, employees accrue 2.5 hours of sick leave per two-week pay period with a matching feature for hours accrued but unused at the end of the benefit year. Leave accrued beyond 1,040 hours is payable upon termination or retirement. As of June 30, 2005, the amount of accumulated vacation, sick leave and compensatory time was approximately $375 million. Of this total amount, $116 million was expected to be paid within 12 months from governmental funds, and $235 25

million was recorded as a long-term liability of the governmental funds. A short-term liability of $8 million and a long- term liability of $16 million were recorded in the enterprise funds. Additionally, the City provides in its annual budget for each Fiscal Year an amount reasonably calculated to provide funding for the payment of accumulated sick leave and vacation benefits for City employees whose employment terminates during that year. In Fiscal Years 2004 and 2005, the City paid out approximately $24 million and $10 million, respectively, relating to these benefits for civilian employees, and approximately $18 million and $6 million, respectively, relating to these benefits for classified employees. The City is subject to federal and State laws regarding the terms, conditions and extent of financial benefits it must provide to its employees. The additional cost to the City of future changes in the benefits afforded by such laws cannot be predicted but may substantially increase the City’s personnel costs. The following schedules provide the compensated absence liability and long-term disability obligation as of June 30, 2005. See also “—Health Care Benefits for Retired Employees.” SCHEDULE 11: COMPENSATED ABSENCE LIABILITY AND LONG-TERM DISABILITY FUND SCHEDULE 11A: COMPENSATED ABSENCE LIABILITY June 30, 2005 (in thousands) General Fund Short Term Liability ........................................................................... Other Governmental Short Term Liability ................................................................ Enterprise Funds Liability ......................................................................................... Internal Service Funds Liability ................................................................................ Governmental Funds Long-Term Liability................................................................ Total .......................................................................................................................... SCHEDULE 11B: LONG-TERM DISABILITY FUND June 30, 2005 (in thousands) Assets Available for Future Long-Term Disability Obligations ................................ Less: Claims Payable on Long-Term Disability Obligations.................................... Net Assets.................................................................................................................. $ $ 6,402 (6,385) 17 $ $ 3,038 112,658 23,759 98 234,992 374,545

Health Benefits Fund, Medical Plan, Dental Plan and Life Insurance Plans The Health Benefits Fund (the "Health Benefits Fund") is an Internal Service Fund administered by the Human Resources department of the City. The Health Benefits Fund was established to centralize the financial transactions for the City's employee benefit plans, which include medical, dental and life insurance programs. The medical plan offered to employees and retirees ("Subscribers") offers two options: (i) an insured health maintenance organization (HMO) or (ii) a self-insured Preferred Provider Organization (PPO). Both the HMO and PPO are supported by contributions from the City and Subscribers. The HMO plan emphasizes managed care through the routing of most treatment through a primary care physician. The PPO includes some managed care features, but has a larger network of physicians across the country in comparison with the HMO. Both plans are administered by the same vendor. The City's contract provides for the imposition of significant financial penalties for noncompliance by the vendor with the performance standards established by the medical plan. The City, in conjunction with Subscriber contributions, pays the HMO, which covers 96% of the participants, a fixed premium each plan year. Fluctuations in the medical plan's cost are limited by a risk-sharing arrangement that provides a stop-loss feature to provide an upper limit on costs. The contract for the current medical plan expires on April 30, 2006 and a new contract will take effect on May 1, 2006. Similar to the current contract, the new contract will have an escalation clause for each year, which is capped at a certain amount each year. For Fiscal Year 2006, the medical plan has been funded 78% by the City and 22% by the Subscribers. During Fiscal Year 2007, when the new contract is in effect, it is expected that the medical plan will be funded 77% by the City and 23% by the Subscribers. The City's portion of medical plan expenses (total expenses less the total received from Subscribers) increased by approximately 8.0% from Fiscal Year 2004 to Fiscal Year 2005, is expected to increase by 6% from Fiscal Year 2005 to Fiscal Year 2006, and is expected to continue to increase by single digit percentage rates for the new contract starting May 1, 2006.

26

The dental plan offered to employees consists of a managed care dental agreement and a group indemnity agreement, both of which are fully insured. City employees may choose between these two alternative plans for dental services. Employees pay 100% of the costs associated with these dental plans. The life insurance plans offered to employees provide basic life insurance coverage for active employees through a commercially insured policy. Basic life insurance coverage is one times salary of the employee. Basic life insurance coverage premiums for retirees are paid by retiree contributions. Basic life insurance coverage premiums for retirees are paid by retiree contributions. In addition to basic life insurance, participants may purchase additional life insurance coverage at their own expense. Health Care Benefits for Retired Employees The City provides certain health care benefits for its retired employees, their spouses and survivors. Employees on long-term disability and their spouses can also qualify for retiree health care benefits. It is expected that substantially all of the City's employees that reach normal retirement age while working for the City will become eligible for such benefits. Beginning with the Fiscal Year that commences on July 1, 2007, the City must implement GASB 45, Accounting by Employers for Other Postemployment Benefits (OPEB), which will require the City to report the actuarially accrued cost of post-employment benefits, other than pensions, such as health and life insurance for current and future retirees. GASB 45 will require that such benefits be recognized as current costs over the working lifetime of employees, and to the extent such costs are not prefunded, GASB 45 will require the reporting of such costs as a financial statement liability. Under GASB 45, the City will be required to commission an actuarial valuation of its OPEB costs every two or three years depending on the number of benefit plan participants. City contributions to OPEB costs that are less than an actuarially determined annual required contribution will result in a net OPEB cost, which under GASB 45 will be required to be recorded as a liability in the City’s financial statements. The City expects that such liability will be significant in the future. The annual required contribution for such benefits reported in compliance with GASB 45 is expected to substantially exceed the annual amounts that the City has paid in the past. Similar to many issuers, the City’s current practice has been to fund the cost of OPEB on an annual pay-as-you-go basis, with OPEB costs accounted for as a current operating expense in the City’s financial statements in the Fiscal Year in which the OPEB cost is paid. According to the City’s audited financial statements, OPEB costs incurred by the City in Fiscal Year 2005 were $28.997 million for health care costs for retired employees. See the table captioned “Statement of Revenues, Expenditures and Changes in Fund Balances in Governmental Funds” on page A-20 of the City’s audited financial statements for Fiscal Year 2005 presented in APPENDIX A. To date, the City has not accumulated assets to offset future benefit costs. The City recognizes the importance of assessing the impact of any unfunded OPEB liabilities resulting from the implementation of this new accounting rule, including possible impacts on current and future finances, so that efforts can be made to address and mitigate any such liabilities. The City is working on an implementation plan and has commissioned, as a preliminary planning tool, an actuarial study in order to help the City in estimating the actuarial costs of other post-employment benefits. This study has not been finalized, and the City expects that prior to the adoption and implementation of GASB 45 an actuarial valuation will be prepared that takes into consideration certain additional factors not under consideration by the ongoing study, including factors relating to actuarial assumptions, possible OPEB funding options, revised enrollment assumptions, possible benefit design changes and other factors that the City may consider in addressing OPEB issues. Options available to any issuer such as the City to offset or reduce the future costs of OPEB that will be required to be reported by GASB 45 include the following: • • • • Reduction of benefits for active employees and/or retirees; Increase of required contributions from active employees and/or retirees; Change in the OPEB plan from a “defined benefit” plan to a “defined contribution” plan; and Contributing assets or pre-funding with real property, a dedicated revenue stream or other taxes or City assets not yet identified.

See also Note 11 of the City’s audited financial statements for Fiscal Year 2005 presented in APPENDIX A which includes information relating to retiree health care premiums paid by the City in Fiscal Year 2005, as well as information relating to health and long-term disability benefits. Employee Pension Funds General Overview. Pension Systems. The City has three pension programs, which cover virtually all City employees: the Houston Municipal Employees Pension System (“HMEPS” or the “Municipal System”) for municipal employees; the Houston Police Officers’ Pension System (“HPOPS” or the “Police System”) for classified police officers; and the Houston Firefighters’ Relief and Retirement Fund (“HFRRF” or the “Firefighter Fund”) for classified firefighters (collectively, the “Pension Systems”). The Pension Systems were established in accordance with State law, with the Municipal System established pursuant to Article 6243h of Vernon’s Texas Civil Statutes, as amended, (the “HMEPS Statute”), the Police System established pursuant to Article 6243g4, as amended, (the “HPOPS Statute”) and the Firefighter Fund established pursuant to Article 6243e.2(1), as amended (the “HFRRF Statute, ” and collectively with the HMEPS Statute and the HPOPS Statute, the “Pension Statutes”).

27

The Pension Statutes establish the governance structure of each Pension System, City and employee contribution levels and the method for the determination of benefits payable to retirees under the Pension Systems; provided, however, the HMEPS Statute and the HPOPS Statute establish local “meet and confer” processes through which the City and the Boards of Trustees of the Municipal System and Police System, respectively, may reach binding agreements regarding City and employee contribution levels and the determination of benefits payable to retirees that differ from those provided in the Pension Statutes. For additional information on the “meet and confer” process and “meet and confer” agreements between the City and the Boards of Trustees of the Municipal System and the Police System, respectively, see “—‘Meet and Confer’ Process;” “—Municipal System Overview and Agreement;” and “—Police System Overview and Agreement.” For information relating to the Firefighter Fund, see “— Firefighter Fund Overview.” Governance. The governance structure for each Pension System is established by the applicable Pension Statute. Each Pension System is overseen by a Board of Trustees on which representatives of the City comprise a minority of the membership, with the majority of the members being active or retired members of the respective Pension Systems and their appointees. The majority of the members of the Board of Trustees of each Pension System have a personal interest in the pension plan administered by the Board of Trustees. All trustees of each Pension System take an oath to “diligently and honestly administer” such Pension System, and each trustee is counseled on his/her fiduciary responsibilities. Trustees appointed by the City are counseled that their fiduciary duties to the Pension System take precedence over the interests of the agency or official that appointed them to the board. No legal challenges have arisen as a result of potential conflicts of interest. “Meet and Confer” Process. The respective boards of the Municipal System and the Police System are vested with the authority to reach binding agreements on City and employee contribution rates, the determination of benefits payable to retirees and other matters under the “meet and confer” process. Authority with respect to such matters on behalf of the City is vested with the City Council in the case of the Municipal System and the Mayor in the case of the Police System. The HFRRF Statute does not contain comparable statutory language authorizing comprehensive agreements on such issues through the “meet and confer” process. While the Pension Statutes require each Pension System to undergo periodic actuarial valuations, there is no statutory requirement that the funding plan determined through “meet and confer” negotiations be actuarially based or subject to independent actuarial evaluation. Accordingly, there can be no assurance that the funding plan arrived at through the “meet and confer” process will address the UAAL and attendant future actuarially determined contributions that currently exist within the Pension Systems. Funding Status. The Pension Systems have experienced rapid increases in UAAL and attendant increases in future actuarially determined contributions. Such increases resulted from a number of factors, including benefit increases, lower than expected investment returns, contributions below the actuarially determined amounts and actual experiences that differed from actuarial assumptions. To address this problem, the City has taken a number of actions, including (i) conducting a successful election to opt-out of an amendment to the Texas Constitution, which prohibits (unless the jurisdiction “opts out”) a reduction in or other impairment of the retirement or death benefits provided by the public retirement systems of political subdivisions that a member of such a system has “accrued,” and (ii) concluding “meet and confer” negotiations with HMEPS and HPOPS. For additional discussion of the funding status of the Pension Systems and the steps being taken by the City and the Pension Systems to address the increases in UAAL and attendant future actuarially determined contributions of the individual Pension Systems, see “—Municipal System Overview and Agreement;” “—Police System Overview and Agreement;” and “—Firefighter Fund Overview.” The City has historically funded the Pension Systems in amounts (1) agreed upon by the City and the respective boards of the Pension Systems as part of jointly sponsored changes in State law or (2) agreed upon in negotiations with the Municipal System’s and Police System’s respective boards through the “meet and confer” process. The City budgets for its contributions by allocating the cost between its General Fund and Enterprise Funds based upon the nature of the employment of the covered employees. For Fiscal Year 2005, the General Fund was responsible for approximately 53% ($35 million) of the City’s $66.0 million contribution to the Municipal System, a portion of which was paid with the proceeds of Pension Obligations. The General Fund covers substantially all of the City’s contributions to the Police System and the Firefighter Fund. For further discussion of the City’s funding commitment to each Pension System, see “—Municipal System Overview and Agreement;” “— Police System Overview and Agreement;” and “— Firefighter Fund Overview.” During Fiscal Year 2005, “meet and confer” negotiations were ratified in which the boards of the Municipal System and the Police System agreed to certain present and future contribution levels required by the City. The agreed-to contribution levels for the next few years for the Municipal System are less than the actuarially determined contributions and are expected to result in an increased UAAL and an attendant increase in future actuarially determined contributions. See “—Municipal System Overview and Agreement.” Accordingly, the Municipal System “meet and confer” negotiations should be recognized as only an intermediate step toward addressing the financial challenges of the Municipal System. The agreed-to contribution levels for the Police System are less than the actuarially determined contribution levels for a number of years and are expected to result in an increased UAAL and attendant future actuarially determined contributions, but agreed-to scheduled increases in the City’s future contribution levels and benefits changes for new members of the Police System are expected to result in a reduction of the UAAL over the long term as new members of the Police System replace existing members. See “—Police System Overview and Agreement.” Accordingly, the City views the Police System “meet and confer”

28

negotiations as part of a long term plan by the City and the Police System Board of Trustees to address the financial challenges of the Police System. For information relating to the Firefighter Fund, see “—Firefighter Fund Overview.” The City has adopted its Fiscal Year 2006 Budget. As described in more detail below, the amount of the Fiscal Year 2006 contribution to the Municipal System, through cash contributions and a portion of the proceeds derived from the issuance of the Series 2006A Bonds as Pension Obligations, has been established by the “meet and confer” negotiations. See “—Municipal System Overview and Agreement.” The City’s Fiscal Year 2006 contribution to the Police System has been established as a percentage of payroll through “meet and confer” negotiations, with such contribution being made from a combination of cash and a portion of the proceeds derived from the issuance of the Series 2006A Bonds as Pension Obligations. See “— Police System Overview and Agreement.” The City’s required contribution to the Firefighter Fund for Fiscal Year 2006 has been set pursuant to the HFRRF Statute to be the actuarially determined contribution rate adopted in the July, 2002 actuarial valuation report. See “—Firefighter Fund Overview.” The total amount of the City’s contribution to the three Pension Systems for Fiscal Year 2006 is expected to be approximately $165 million, which would be an increase over the Fiscal Year 2005 contribution of approximately $135 million. The City expects to fund its required contribution to the Firefighter Fund in cash, through the issuance of Pension Obligations, or a combination of the foregoing. A number of factors influence the amount of the City’s pension benefit liability, including, without limitation, the results of “meet and confer” negotiations, legislative changes to the Pension Statutes, changes in the levels of benefits provided or in the contribution rates of the City, increases or decreases in the number of covered employees, changes in actuarial assumptions or methods, differences between actual and anticipated investment experience of the Pension Systems and general economic conditions, including inflationary factors, any of which could give rise to additional liability of the City to the Pension Systems and which could result in the City being obligated to make additional payments to the Pension Systems. It is expected that the UAAL of the Municipal System, the Police System and the Firefighter Fund will continue to increase, perhaps substantially, if the City continues to make contributions that are less than the actuarially determined amounts. To the extent that benefits are not reduced further, the increasing UAAL and attendant future actuarially determined contributions can be expected to place substantial additional financial burdens on the General Fund and the Enterprise Funds of the City, either directly through the respective operating budgets or through increased debt service payments. Prospective investors are cautioned that any projections or forecasts in this section and the sections that follow, including projections of the amount of the UAAL and the amounts of required contributions by the City, constitute “forward looking” information that reflects the judgment of the City, the boards of the Pension Systems and the actuaries as to the amount of assets that will be required to be accumulated for the funding of future benefits over the lives of the currently active employees, vested terminated employees and existing retired employees. Such judgments are based on a variety of assumptions concerning future events and circumstances, one or more of which could prove to be inaccurate or be changed in the future. The assumptions underlying the projections are material to the development of the projections, and variations in the assumptions may produce substantially different results. Actual results may vary, and such variations may be material. Historical Funding Status and Changes in Pension Plan Assets. Part 1 of the following table sets forth for each of the Fiscal Years 2001 through 2005 the amount of the annual pension cost to the City and the percentage contribution made by the City to each of the Pension Systems. Part 2 of the following table sets forth for each of the Fiscal Years 2001 through 2005, actuarially determined amounts and actual City pension contribution amounts as a percentage of payroll. Part 3 of the following table sets forth certain information from the most recently published financial reports for the Municipal System, the Police System and the Firefighter Fund, which are dated as of the end of Fiscal Year 2005 (June 30, 2005). Each part of the following tables should be read in context with the respective sections that follow that describe in more detail the Municipal System, Police System and Firefighter Fund, respectively, including the results of the “meet and confer” negotiations with the Municipal System and Police System, as well as the agreed to or expected changes in contribution and benefit levels of the Pension Systems.

[Remainder of Page Intentionally Left Blank]

29

SCHEDULE 12: ACTUARIALLY DETERMINED CONTRIBUTION AMOUNTS AND CHANGES IN PENSION PLAN ASSETS

Part 1: Annual Pension Costs and Contributions Made (a) (in millions)
Municipal System
Fiscal Year ended June 30 Annual Pension Cost City Contrib.
(b)

Police System
Annual Pension Cost City Contrib.
(b)

Firefighter Fund
Percent Contrib. Annual Pension Cost City Contrib.
(b)

Percent Contrib.

Percent Contrib.

2001 2002 2003 2004 2005
(a)

$ 45.3 43.3 76.7 133.5 129.4

$41.3 40.8 40.6 58.1 66.0

94% 95 53 44 51

$ 42.2 30.0 57.1 73.9 105.9

$30.6 32.6 34.7 36.6 36.6

76% 109 61 50 35

$15.6 15.0 22.7 36.3 52.2

$24.0 28.5 28.0 28.3 32.7

157% 184 121 78 63

_______________________________________

(b)

For further details, see the City’s financial statements for Fiscal Year 2005 presented in APPENDIX A, including particularly Note 10 and the section in APPENDIX A captioned “Required Pension System Supplementary Information.” Contributions made by the City in compliance with binding “meet and confer” agreements or the Pension Statutes, as applicable.

Part 2: Actuarially Determined Amount and Actual City Contribution as a Percentage of Payroll(a)
Municipal System(b)
Fiscal Year ended June 30

Police System(b)

Firefighter Fund(b)

Actuarial

Actual

Actuarial

Actual

Actuarial

Actual

2001 2002 2003 2004 2005
(a)

9.50% 9.50 17.70 31.80 29.40(c)

10.00% 10.00 10.00 14.70 16.90(d)

16.30% 11.30 20.50 24.40 31.20

11.60% 12.29 12.37 12.40 11.30(d)

11.00% 9.90 14.90 23.80 31.10

15.40% 15.40 15.40 16.40 18.00

_______________________________________

(b)

(c)

(d)

For further details, see the City’s financial statements for Fiscal Year 2005 presented in APPENDIX A, including particularly Note 10 and the section in APPENDIX A captioned “Required Pension System Supplementary Information.” Sources: Adopted actuarial reports for the respective Pension System for actuarially determined percentages and internal City figures for actual contribution percentages. See “—Police System Overview and Agreement” and “—Firefighter Fund Overview.” This figure represents the actuarial amount set forth in the July 1, 2004 actuarial valuation report and is based on plan design changes as a result of “meet and confer” negotiations described below for the Municipal System. See “— Municipal System Overview and Agreement.” Actual contribution percentages take into account the City’s contribution of proceeds obtained from the issuance of Pension Obligations.

Part 3: Changes in Pension Plan Assets(a) (in millions)
Fiscal Year 2005 Additions
(b) ............................................................................ (c) ........................................................................

Municipal $ 588.4 182.3 406.1 $

Police 387.0 158.5 228.5 $

Fire 398.0 92.9 305.1 $

Total 1,373.4 433.7 939.7

Deductions

Net Increase

.......................................................................

City’s Total Contribution ..........................................
_______________________________________ (a)

$

363.2

$

37.1

$

32.7

$

433.0

(b) (c)

For further details, see the City’s financial statements for Fiscal Year 2005 presented in APPENDIX A, including particularly Note 10 and the section in APPENDIX A captioned “Required Pension System Supplementary Information.” Includes contributions by the employees and the City, net increase in the fair value of investments, income from investments, and other income. Includes benefits paid to members, refunds to members, and other costs, including professional services and administrative expenses.

30

Municipal System Overview and Agreement General. The Municipal System provides benefits to most municipal employees other than classified police officers and firefighters. It is structured as a contributory defined benefits pension program for employees hired since 1999 (“Plan A”). Employees hired prior to 1999 had a choice between a contributory plan (“Plan A”) and a non-contributory plan (“Plan B”). The 2001 Texas Legislature increased benefit levels for both Plan A and Plan B, primarily by increasing the benefit accrual levels and the maximum pension amount. These benefit changes were supported jointly by the City and representatives of the Municipal System based on an actuarial cost analysis performed by the board’s actuary, which showed that the City contribution to the Municipal System as a percentage of payroll could be expected to rise to approximately 14.7% as a result of the changes. In the years following the 2001 benefits increase, the Municipal System has experienced an increase in UAAL and attendant future actuarially determined contributions in an amount that greatly exceeds the actuarial projection made at the time of the benefit increases as described below. Funding Status. As shown in “Part 2—Schedule 12: Actuarially Determined Contribution Amounts and Changes in Pension Plan Assets,” since Fiscal Year 2003, the City has not made contributions to the Municipal Systems in the actuarially determined amounts (although such contributions have been legally sufficient under the HMEPS Statute or “meet and confer” agreements). See “—Schedule 12A: Municipal System Pension Plan Assets, Liabilities and Unfunded Actuarial Accrued Liability” for additional results and trends. In addition to the benefit increases adopted in 2001, substantial differences between actual experiences and actuarial assumptions regarding the City’s municipal workforce largely contributed to the rapid rise in the City’s actuarially determined pension contribution. In particular, the unexpected exercise of optional conversions of service from the non-contributory group (Plan B) to the contributory group (Plan A) with higher benefit levels, the utilization of the Deferred Retirement Option Plan (“DROP”) and, to a lesser extent, investment performance that was less than the actuarially assumed return affected the plan’s actuarial condition. Agreement. On August 18, 2004, the Board of Trustees of the Municipal System approved, and on September 1, 2004, City Council ratified, the funding plan and benefit changes discussed below (the “HMEPS Agreement”). The HMEPS Agreement was effective as of September 15, 2004, and will remain in effect for a period of five years from January 1, 2005. The HMEPS Agreement has three elements: (1) a funding commitment by the City for Fiscal Years 2005, 2006 and 2007, to include cash, the issuance of Pension Obligations and the contribution of certain City assets; (2) a required increase in the employee’s contribution; and (3) benefit level reductions. Notwithstanding the changes effected by the HMEPS Agreement, the City’s funding commitment, while substantially greater than normal cost, is less than the City’s current projection of actuarially determined contributions. Under the terms of the HMEPS Agreement, the City’s funding commitment for Fiscal Years 2006 and 2007 is approximately $141 million in the aggregate, and the amount of actuarially determined contributions for Fiscal Years 2006 and 2007 is approximately $219 million. Unless offset by investment performance or other factors, this funding deficiency is will result in an increased UAAL with attendant increases in future actuarially determined contributions until additional steps are taken to increase funding levels or modify benefits. The following is a summary of certain terms of the HMEPS Agreement, including changes in the City’s funding commitment, employee contributions and benefit levels: City Funding Commitment. Under the HMEPS Agreement, the City agreed to make budgeted contributions of $33 million, $36 million, and $39 million for Fiscal Years 2005, 2006, and 2007, respectively, and to issue Pension Obligations in each of those three Fiscal Years such that the net proceeds of each such issue is equal to $33 million, for a total three-year funding commitment by the City from these sources of $207 million. The issuance of Pension Obligations in lieu of using cash will result in an increase in the City’s tax-supported bond indebtedness in order to achieve a reduction in UAAL. The first series of Pension Obligations were delivered on March 30, 2005 and a payment of $33 million was delivered to HMEPS to satisfy the Fiscal Year 2005 contribution. See “SCHEDULE 4: OUTSTANDING DEBT.” A portion of the proceeds of the Series 2006A Bonds will be used to satisfy the Fiscal Year 2006 contribution. In addition to the above contributions, in the HMEPS Agreement the City agreed to deliver to the Municipal System a collateralized note in the amount of $300 million maturing on December 1, 2033 (the “Collateralized Note”). The Collateralized Note contains interest deferral provisions and was issued in conjunction with two deferred interest certificates, (1) a collateralized deferred interest certificate and (2) an uncollateralized deferred interest certificate, which provide the City some budgetary flexibility. The Collateralized Note and its related deferred interest certificates were issued pursuant to Chapter 107, Texas Local Government Code, and constitute general obligations of the City. See “SCHEDULE 4: OUTSTANDING DEBT.” The Collateralized Note was delivered by the City to the Municipal System on November 10, 2004, and is now considered an asset of the Municipal System for actuarial valuation purposes. In addition to the City’s ad valorem tax pledge, the Collateralized Note is additionally secured by a (i) a first lien deed of trust in the hotel constructed adjacent to the George R. Brown Convention Center (the “Convention Center Hotel”) and (ii) a first lien security interest in the City’s interest in the existing note from the Houston Convention 31

Center Hotel Corporation in the original principal amount of $310,550,000, which is secured by the City’s deed of trust in the Convention Center Hotel and the adjacent parking garage. The City may, at its sole option, defer interest payments on the Collateralized Note or the deferred interest certificates and allocate such deferred interest to the deferred interest certificates. Any deferred interest will first be allocated to the uncollateralized deferred interest certificate for so long as such allocations do not cause the balance on the uncollateralized deferred interest certificate to exceed $150 million. Thereafter, the City may allocate deferred interest to the collateralized deferred interest certificate to the extent increases in the appraised value of the Convention Center Hotel will support such deferrals. All or a portion of the deferred interest due under the uncollateralized deferred interest certificate may, under certain circumstances, be converted to assignable certificates, which may then be assigned by the Municipal System to a third party. The Collateralized Note and the deferred interest certificates are not transferable by the Municipal System, and the Collateralized Note and its deferred interest certificates may be pre-paid in whole or in part without penalty at the option of the City at any time during their term. The Collateralized Note and the deferred interest certificates will bear interest at an annual rate determined each April 1 to be the greater of (a) 8.5% or (b) the yield on the determination date for the Treasury obligation maturing closest to December 1, 2033, plus a predefined rate adjustment. The Collateralized Note and deferred interest certificates will be payable annually on October 1, beginning in 2005 and each subsequent year through 2033. The HMEPS Agreement calls for periodic appraisals of the Convention Center Hotel by an independent appraiser beginning in 2014 and requires the City to post sufficient additional collateral to the extent that the value of the Convention Center Hotel is less than amounts then owing under the Collaterized Note. Employee Contribution. Beginning January 1, 2005, and continuing throughout the term of the HMEPS Agreement, City employees participating in the contributory groups contribute 5%, rather than the prior 4%, of base salary. Benefit Changes. The most significant benefit changes in the revised benefit schedule effected by the HMEPS Agreement are summarized below:

• • • •

Normal retirement eligibility, which is a combination of age and years of service, was increased from 70 to 75 points with a minimum age of 50. The accrual percentages used to calculate the retirement benefit for employees are reduced for service after January 1, 2005. The cost of living adjustment (COLA) for retirees is changed to 3% per year from the present 4%. New hires after January 1, 2005 will have an annual COLA of 2% when they become eligible. Restrictions are imposed on an employee’s ability to purchase prior service, to convert from the noncontributory plan to the contributory plan and to utilize the Deferred Retirement Option Program (“DROP”).

Amendment to the HMEPS Agreement. City Council and the HMEPS Board of Trustees approved an amendment to the HMEPS Agreement, which increases the size of the HMEPS Board of Trustees from nine members to eleven members. As amended, the HMEPS Agreement became effective on July 1, 2005, with the agreement providing for four members of the HMEPS board as City appointees, rather than two, with the Mayor and the City Controller each having appointment authority for one trustee and City Council having appointment authority for the other two trustees. Under the amendment, each of the four City appointees will be required to have expertise in financial matters and none of the City appointees may be members of the Municipal System. The City funding commitment, increased employee contributions and reduced benefits provided for in the HMEPS Agreement are estimated to have had the effect of lowering the UAAL from approximately $1.8 billion as of July 1, 2003 to approximately $948 million as of July 1, 2005. The HMEPS Agreement should be recognized only as a step toward addressing the financial challenges to the Municipal System. It is likely that additional increases in City or employee contributions and/or additional benefit decreases will become necessary upon the expiration of the HMEPS Agreement, but the types and degree of such changes will depend on investment performance and other factors. It is expected that HMEPS’s UAAL and attendant actuarially determined contributions will continue to increase, perhaps substantially, if the City’s actual contributions are less than the actuarially determined contributions.

32

SCHEDULE 12A: MUNICIPAL SYSTEM PENSION PLAN ASSETS, LIABILITIES AND UNFUNDED ACTUARIAL ACCRUED LIABILITY (in millions) As of July 1(a) 2001 2002 2003 2004 2005

Actuarial Accrued Liability ........................ Actuarial Value of Plan Assets ................
(b)

$ $ $

1,956 1,490 466 76%

$ $ $

2,515 1,520 996 60%

$ $ $

3,278 1,510 1,768 46%

$ $ $

2,634 1,501 1,133 57%

$ $ $

2,725 1,778 948 65%

Unfunded Actuarial Accrued Liability ....... Funded Ratio ..............................................
_______________________________________
(a)

(b)

For further details, see the City’s financial statements for Fiscal Year 2005 presented in APPENDIX A, including particularly Note 10 and the section in APPENDIX A captioned “Required Pension System Supplementary Information.” The actuarial value of plan assets is determined by the actuary for the Municipal System. The value represents a generally accepted method of recognizing market gains and losses (relative to the assumed rate of return) over a five year period. During periods in which market results have been unfavorable (such as the five year period prior to the most recent valuations), the actuarial value of plan assets will be larger than the market value of assets. As of the date of the most recent actuarial valuations, the actuarial value of plan assets, as determined by the system actuary, overstated the market value by approximately 6.4%.

Police System Overview and Agreement General. The Police System provides benefits to the City’s classified police officers and is structured as a contributory defined benefits pension program. In 2001, the Police System and the City entered into a “meet and confer” agreement that included significant benefit increases to members of the Police System and changed the City’s contribution rate. These changes were made pursuant to a cost analysis by the Police System’s actuary that indicated that the benefits would have the effect of raising the City’s required contribution to approximately 16% of payroll. These changes were legally binding at the time of the “meet and confer” agreement, but were subsequently codified as part of the HPOPS Statute by the Texas Legislature in 2003. The Police System has experienced a rapid increase in UAAL and an attendant increase in actuarially determined contributions, generally beginning after the benefit increases were granted. Funding Status. As shown in “Part 2—Schedule 12: Actuarially Determined Contribution Amounts and Actual City Contributions as a Percentage of Payroll,” the City made the actuarially determined contribution in Fiscal Year 2002, but in Fiscal Years 2001, 2003, 2004 and 2005, the City’s contributions to the Police System were substantially lower than the actuarially determined amounts (although such contributions have been legally sufficient under the HPOPS Statute or “meet and confer” agreements). See “—Schedule 12B: Police System Pension Plan Assets, Liabilities and Unfunded Actuarial Accrued Liability” for additional results and trends. Agreement. On September 22, 2004 the Board of Trustees of the Police System approved, and on September 29, 2004 City Council ratified, a “meet and confer” agreement (the “HPOPS Agreement”), which contains the funding plan and benefit changes discussed below. The HPOPS Agreement became effective on October 9, 2004 and terminates on June 30, 2017. The HPOPS Agreement has three elements: (1) a funding commitment by the City from any available source, including budgeted contributions and net proceeds of Pension Obligations; (2) a required increase in the employee’s contribution; and (3) benefit level reductions initiated primarily for future employees (as further defined below, “New Members”). Following the execution of the HPOPS Agreement, the City issued Pension Obligations and delivered the net proceeds of such Pension Obligations to the Police System to satisfy a portion of its Fiscal Year 2005 funding commitment. See “SCHEDULE 4: OUTSTANDING DEBT.” A portion of the proceeds of the Series 2006A Bonds will be used to satisfy a portion of the City’s Fiscal Year 2006 funding commitment. Notwithstanding the changes effected by the HPOPS Agreement, the City’s funding commitment, while greater than normal costs beginning in Fiscal Year 2006, is substantially less than the actuarial forecast included in the actuarial valuation report as of July 1, 2004. Under the terms of the HPOPS Agreement, the City’s funding commitment for Fiscal Years 2006, 2007 and 2008 is estimated to be approximately $177 million in the aggregate, and the amount of the actuarial forecast is approximately $337 million in the aggregate.

33

The following is a summary of certain terms of the HPOPS Agreement, including changes in the City’s funding commitment, employee contributions and benefit levels: City Funding Commitment. The HPOPS Agreement includes the City’s commitment to make contributions from any available source, including cash contributions from budgeted amounts, and net proceeds from Pension Obligations, as follows: Fiscal Year End June 30 2005 2006
(a)

Payment Amount $36,645,000 16% of total member compensation, but not less than $53,000,000(b) $5,000,000 increase over prior year’s payment $5,000,000 increase over prior year’s payment $5,000,000 increase over prior year’s payment $5,000,000 increase over prior year’s payment $5,000,000 increase over prior year’s payment $5,000,000 increase over prior year’s payment

(a)

2007 2008 2009 2010 2011 2012

______________________ (a) The City funded the portion of the Fiscal Year 2005 payment amount that was not budgeted ($22.9 million) through the issuance of the Pension Obligations. A portion of the proceeds of the Series 2006A Bonds will be used to fund $30 million of the City’s Fiscal Year 2006 contribution. The use of Pension Obligations in subsequent Fiscal Years will depend on budgetary constraints at the time of each Fiscal Year’s budget preparation. (b) Based upon the Fiscal Year 2006 Budget, the City estimates this amount to be approximately $53 million.

Beginning in Fiscal Year 2013 and continuing until the Funded Ratio (as defined below) equals 100%, the City’s payment amount will increase by $5 million over the prior year’s payment amount, unless the amount of such increased payment would be less than the actuarially required contribution. If $5 million is less than the actuarially required contribution, the annual payment will increase by $10 million over the prior year’s payment amount. The Funded Ratio means the ratio or percentage derived by dividing the Police System’s actuarial value of assets by its actuarial accrued liability. Once the Funded Ratio reaches 100%, the City’s payment amount in each Fiscal Year will be the greater of (a) 16% of covered payroll or (b) the actuarially required amount. In addition, beginning in Fiscal Year 2013, once the Funded Ratio reaches 75%, the City must make contributions if needed to restore the Funded Ratio to 75%. An additional floor is established once the Funded Ratio reaches 80% such that the City must make contributions if needed to restore the Funded Ratio at or above 80%. Member Contributions. Beginning October 9, 2004, then current active members began contributing 9%, rather than the former 8.75%, of pay (as defined by the HPOPS Agreement). In addition, persons who become active members after October 9, 2004 (“New Members”), will contribute 10.25% of pay. Benefit Changes. The most significant aspects of the Police System Plan are summarized below:

• • • •

Normal retirement age for any New Member or prior members who are reemployed after October 9, 2004, is 55. The DROP is no longer available to New Members. The rate of earnings credited to a current member’s DROP account will not be less than 3% nor more than 7%. The cost of living adjustment (COLA) for retirees is 80% of the increase in the Consumer Price Index for all Urban Consumers for the preceding year, with a minimum increase of 2.4% and a maximum increase of 8%. No thirteenth benefit payment will be available to New Members. Current members will not be entitled to a thirteenth benefit payment for any year in which the Funded Ratio is less than 120%. For New Members, the benefit formula on which the benefits are based is reduced to 2.25% of Final Average Pay for the first 20 years of service plus 2% of Final Average Pay for service in excess of 20 years, subject to a cap of 80% of Final Average Pay. The definition of “pay” on which the benefit formula is based is modified for New Members and current members, although a transition formula is utilized for those current members who are within 36 months of retirement. 34

• •

Prior to the adoption of the benefit changes described above, it was estimated that the UAAL would experience increases resulting from estimated liability losses that were generally related to provisions of the plan that are being phased out over the 36 months that began with the adoption of the new plan. Specifically, the old plan determined an individual’s retirement benefit based on a formula that was heavily influenced by the highest single pay period during the last year before retirement, while the new plan replaces this provision with a benefit calculation based on the average pay over a 36-month period. Under the old plan, certain voluntary work assignments by police officers in their last year before retirement had the effect of increasing the liabilities of the Police System above previously estimated amounts. Based on the July 1, 2004 actuarial valuation, the City funding commitment, increased employee contributions and reduced benefits are estimated to have had the effect of lowering the UAAL as of July 1, 2004, from approximately $873 million to approximately $699 million. The July 1, 2004 actuarial valuation for the Police System predicts that the UAAL will rise each year notwithstanding the required additional City contribution included in the HPOPS Agreement, and will reach approximately $1.46 billion in Fiscal Year 2014. The funded percentage is predicted to drop each year until it reaches 71% in Fiscal Year 2014. The City expects that over the longer term increased City contributions and benefits changes for New Members will ultimately result in a decrease in the UAAL and an increase in the funded percentage as New Members replace existing members of the Police System. While the results of the “meet and confer” negotiations with the Police System were intended to provide a long-term solution to the funding problem, it is possible that additional increases in City or employee contributions and/or additional benefit decreases may become necessary upon the expiration of the HPOPS Agreement depending on investment performance and other factors. SCHEDULE 12B: POLICE SYSTEM PENSION PLAN ASSETS, LIABILITIES AND UNFUNDED ACTUARIAL ACCRUED LIABILITY (a)

(in millions)
As of July 1 2002 2003 $ 2,594 $ 2,337 $ 257 90% $ 2,875 $ 2,395 $ 480 83%

2001 Actuarial Accrued Liability ................................... Actuarial Value of Plan Assets(b) ............................ Unfunded Actuarial Accrued Liability................... Funded Ratio..........................................................
_______________________________________ (a)

2004 $ 3,339 $ 2,466 $ 873 74%

$ 2,306 $ 2,226 $ 80 97%

(b)

For further details, see the City’s financial statements for Fiscal Year 2005 presented in APPENDIX A, including particularly Note 10 and the section in APPENDIX A captioned “Required Pension System Supplementary Information.” The actuarial value of plan assets is determined by the actuary for the Police System. Such value represents a generally accepted method of recognizing market gains and losses (relative to the assumed rate of return) over a five year period. During periods in which market results have been unfavorable (such as the five year period prior to the most recent valuations), the actuarial value of plan assets will be larger than the market value of assets. As of the date of the most recent actuarial valuations, the actuarial value of plan assets, as determined by the system actuary, overstated the market value by 1.0%.

Firefighter Fund Overview General. The Firefighter Fund provides benefits to the City’s classified firefighters and is structured as a contributory defined benefits pension program. As of July 1, 2004, each fund member in active service must make contributions to the fund in an amount equal to 9% of the member’s salary at the time of the contribution. The City’s contribution rate to the Firefighter Fund is an amount equal to the program’s normal costs plus an actuarially determined percentage of salary required to amortize the UAAL of the fund over a constant (or rolling) period of 30 years, subject to a statutorily mandated minimum contribution rate set by the State Legislature in 2003. Funding Status. As shown in “Part 2—Schedule 12: Actuarially Determined Contribution Amounts and Actual City Contributions as a Percentage of Payroll,” in Fiscal Years 2001, 2002 and 2003, the City’s contributions to the Firefighter Fund exceeded the actuarially determined amounts, and in Fiscal Years 2004 and 2005, the City’s contribution was 69% and 58% respectively of the actuarially determined amount. State law provides that the City contribution to the Firefighter Fund be the greater of two times the firefighter’s contribution or an actuarially determined rate established at least once every three years. Employees of the Fire Department currently contribute 9% of their pay to the Firefighter Fund, and the City’s contribution in Fiscal Year 2005 was 18% of payroll, or $32.7 million. This rate was lower than the actuarially determined rate at that time, but equal to the statutory minimum. See “Part 2—Schedule 12: Actuarially Determined Contribution Requirements and Changes in Pension Plan Assets.” See also “—Schedule 12C: Firefighter Fund Pension Plan Assets, Liabilities and Unfunded Actuarial Accrued Liability” for additional results and trends.

35

An actuarial valuation of the Firefighter Fund as of July 2004 indicates that the UAAL was approximately $267 million and the funded ratio was 88%. The HFRRF Board of Trustees adopted an actuarial report that set the City’s Fiscal Year 2006 contribution rate at approximately 23.8% of payroll. The 23.8% contribution rate is less than the range of possible actuarially determined contribution rates for Fiscal Year 2006. The actuarially determined contribution rate in the July 2004 actuarial valuation was 31.1% of payroll. The City and the firefighters’ union recently approved a collective bargaining agreement relating to matters including wages, staffing and other benefits. Pension contributions are not part of the collective bargaining agreement. It should be noted, however, that the collective bargaining agreement will have an impact on the classified payroll, which will in turn impact the amount to be contributed by the City to the Firefighter Fund in Fiscal Year 2006 and in subsequent years. The City projects that the collective bargaining agreement will result in an increase of approximately $4.2 million in the City’s contribution to the Firefighter Fund in Fiscal Year 2006, which amount was included in the Fiscal Year 2006 Budget, and additional increases of approximately $3.0 million and $2.2 million in Fiscal Year 2007 and Fiscal Year 2008, respectively. SCHEDULE 12C: FIREFIGHTER FUND PENSION PLAN ASSETS, LIABILITIES AND UNFUNDED ACTUARIAL ACCRUED LIABILITY (in millions) As of July 1(a) 2002 $ 1,970 $ 1,922 $ 48 98%

2001 Actuarial Accrued Liability .................................................... Actuarial Value of Plan Assets ............................................
(b)

2004(c) $ 2,267 $ 2,000 $ 267 88%

$ 1,651 $ 1,863 $ (212) 113%

Unfunded Actuarial Accrued Liability (Surplus).................... Funded Ratio ..........................................................................
_______________________________________ (a)

(b)

(c)

For further details, see the City’s financial statements for Fiscal Year 2005 presented in APPENDIX A, including particularly Note 10 and the section in APPENDIX A captioned “Required Pension System Supplementary Information.” (For the actuarial valuations shown in this schedule for Fiscal Years 2001 and 2002, the UAAL was amortized over a constant 40 year period, the methodology utilized from 1983 to 2002. For Fiscal Year 2004, the UAAL was amortized using a constant (or rolling) period of 30 years). As of the date of this Official Statement an actuarial report as of July 1, 2005, for the Firefighter Fund is in draft form and has not been finalized. The actuarial value of plan assets is determined by the actuary for the Firefighter Fund. Such value represents a generally accepted method of recognizing market gains and losses (relative to the assumed rate of return) over a five year period. During periods in which market results have been unfavorable (such as the five year period prior to the most recent valuations), the actuarial value of plan assets will be larger than the market value of assets. As of the date of the most recent actuarial valuations, the actuarial value of plan assets, as determined by the system actuary, overstated the market value by 0.1%. No actuarial study was required or conducted in 2003.

State Legislation Although the City is a home-rule city under the Texas Constitution, it may not adopt ordinances or charter provisions inconsistent with Texas law. The Texas Legislature may enact legislation that (i) materially increases the costs and expenditures of the City or (ii ) reduces the ability of the City to collect ad valorem taxes or other revenues described herein. Under the Texas and United States Constitutions, the Texas Legislature may not, however, enact legislation that impairs the City’s ability to pay principal of and interest on its indebtedness. The most recent regular session of the Texas Legislature concluded on May 30, 2005, with the next regular session scheduled to convene January 9, 2007. However, because the State’s school finance system has been held unconstitutional by the Texas Supreme Court, it is expected that the Governor will call one or more special legislative sessions to address the State system of taxation and the deficiencies noted by the Texas Supreme Court. Such special sessions may include consideration of bills relating to ad valorem tax revenue limitations, ad valorem tax caps, limitations on increases in assessed valuations and other issues relating to the State system of taxation, which may have an effect on the City, its finances and operations. ANNEXATION PROGRAM AND “IN-CITY” DISTRICTS Annexation Program General. Chapter 42, Texas Local Government Code, as amended, provides that, within the limits described therein, the unincorporated area contiguous to the corporate limits of any city constitutes that city’s extraterritorial jurisdiction. The extent of a city’s extraterritorial jurisdiction depends in part on the city’s population. For the City, the extraterritorial jurisdiction consists of all the contiguous unincorporated areas, not a part of any other city, within five (5) miles of the corporate limits of the City. With certain exceptions, a city may annex territory only within the confines of its extraterritorial jurisdiction. When a city annexes additional territory, the city’s extraterritorial jurisdiction expands in conformity with such annexation. Under Chapter 43, Texas Local Government Code, as amended, when a city annexes additional territory, the city’s extraterritorial

36

jurisdiction expands in conformity with such annexation; however, since 1999, there are significant additional procedures and requirements governing annexation, including the requirement that the City adopt a three year annexation plan, discussed below, as well a service plan for each area to be annexed. Each service plan must include certain municipal services as well as the construction or acquisition of any needed capital improvements by certain dates. A failure by the City to provide the required services or improvements for a particular area on a timely basis may result in a petition for disannexation of the area and its subsequent disannexation. The sections that follow discuss water districts, full purpose annexations (the method prior to 1999 by which the City historically expanded its boundaries) and limited purpose annexations and strategic partnerships (which have resulted from the 1999 changes in Texas law). Water Districts. Water districts are political subdivisions of the State of Texas empowered to issue bonds and to own and operate water, sanitary sewer and drainage systems. Water district bonds are usually payable from the receipts of ad valorem taxes levied by the water district and, in some cases, are further payable from the net revenues, if any, derived from the operation of its water and sanitary sewer systems. Full Purpose Annexations. Historically, the City expanded its geographic boundaries and tax base through the full purpose annexation of contiguous unincorporated areas. These annexations included properties served by a large number of water districts. However, as previously noted, in 1999 full purpose annexations became procedurally more difficult to undertake and as a result are not frequent. Since 1999, the City has completed only one full-purpose annexation limited to road rights-of-way. For water districts subject to full purpose annexation by the City, State law generally requires that the City (i) take over all assets of the water district, (ii) assume all debts, liabilities and obligations of the water district and (iii) perform all functions and services of the water district. State law also requires that the City assume the water district’s functions within 90 days following the annexation. When the City assumes water district bonds or other obligations payable in whole or in part from ad valorem taxes, State law requires the City to levy and collect ad valorem taxes on all taxable property within the City in amounts sufficient to pay the principal of and interest on such assumed bonds and obligations. The City may issue voterauthorized but unissued bonds of annexed water districts, but the proceeds must be used for the voted purposes within the annexed water district. Under existing law, neither the annexation of water districts nor the assumption of their outstanding bonds or other obligations requires voter authorization. Limited Purpose Annexations and Strategic Partnership Agreements. Since the change in Texas law described above, the City is required to adopt a three-year annexation plan and, with certain exceptions, only those areas identified in such plan are eligible for annexation. The City has adopted three-year plans every December since 1999. Those plans do not identify any territory for annexation, and the City currently has no plans to annex additional territory. If the City were to decide to annex territory during the three year period of the plan, such annexation generally would be of territory that is not required to be identified in the plan or territory annexed as the result of an agreement between the City and either property owner or a water district board. The primary exceptions to that requirement would be small tracts of land. A water district included in an annexation plan may, by written request, require the City to negotiate and enter into a strategic partnership agreement, which may delay or serve as an alternative to annexation of the district. A strategic partnership agreement must be of benefit to both parties. Should the City and any such district be unable to reach an agreement on the terms of the strategic partnership agreement, either party may seek binding arbitration. During the pendency of the arbitration proceeding or during the appeal of an arbitration decision, the City may not annex the district. Texas law also gives the City the option of entering into strategic partnership agreements with municipal utility districts by mutual consent without proposing the annexation of the districts. Strategic partnership agreements may provide for limited-purpose annexation for a period of time, during which the City may impose a sales and use tax within the boundaries of the part of the district that is annexed for limited purposes. Strategic partnership agreements may provide that at the completion of the agreed duration of the limited purpose annexation, full-purpose annexation may occur either on an agreed full-purpose annexation date without the need for further action by the City, or by City action at that time. The qualified voters of an area annexed for limited purposes are entitled to vote in municipal elections for members of the governing body or for amendments to the municipal charter. Such voters may not vote in a bond election. The City has completed 84 limited-purpose annexations by mutual consent with water districts, which continue to exist. The City expects to enter into similar agreements with other districts in the future. Generally, the limited-purpose annexations have applied only to non-residential property, and the City is authorized to, and does impose, its sales tax in each of the areas annexed for limited purposes. In most cases the City and a district divide the sales tax evenly. The City is not authorized to levy an ad valorem tax on property annexed for limited purposes, and the district continues to levy and collect ad valorem taxes. The strategic partnership agreements entered into so far by the City defer the time for full-purpose annexation by City action for periods of up to 30 years or, in some cases, until the district utility system is developed or some other event occurs. The City does not assume the debts of a district until such time as the district is annexed for full purposes, at which time all of the sales taxes collected within the district will be retained by the City, the annexed area will become subject to City ad valorem tax levy and collection, the district will be dissolved and the debt will be assumed by the City. In some cases, the City agrees to provide police or health inspection services to the district, if the cost of providing such services is marginal to the 37

City. Generally, in two cases where land was disannexed by the City and reannexed for limited purposes, the City agrees to provide fire, police and emergency medical services to the district. In-City Districts Texas law authorizes the creation of certain types of “in-city” districts with independent taxing authority. The City has authorized by resolution the creation of water districts within its corporate limits, 14 of which have been created (one of which, Harris County Municipal Utility District No. 361, was disannexed and then re-annexed for limited purposes pursuant to a strategic partnership agreement) and one additional water district which has been consented to by the City but not yet created. See “— Limited Purpose Annexations and Strategic Partnership Agreements” above. In order to encourage development within the City, the City has entered into agreements with “in-city” districts whereby the district will provide the water, wastewater and stormwater drainage infrastructure in the district and convey such facilities to the City, although in some instances, the district has retained ownership and operation of its facilities. In exchange, the City agrees to maintain the facilities and rebate to the district, the portion of City ad valorem taxes collected within the district and attributable to drainage. The City agrees to collect water and wastewater charges at standard City retail rates and remit to the district for deposit in the debt service fund of the district, the difference between City retail rates and wholesale rates. The City’s obligations under these agreements are payable only from revenues from within the district, can never exceed annually the annual debt service of the district and expire upon maturity of the district’s bonds. In addition, 14 active municipal management districts created by the Texas Legislature also exist within the corporate limits of the City and have independent authority to impose assessments on certain property owners to support and enhance specific residential or business corridors within the City. Municipal management districts may issue bonds secured by assessments or taxes levied on property within the district pursuant to a vote in such district approving the bonds. Under State law, the City also can create public improvement districts both within the corporate limits of the City and within its extraterritorial jurisdiction. The City has created six such public improvement districts. The City is authorized to issue bonds secured by assessments on property within a public improvement district or other debt obligations to finance certain public improvements or administrative costs. The City has also created certain entities to enhance and encourage redevelopment activities within the City. As of the date of this Official Statement, 22 reinvestment zones exist within the City to provide a mechanism to fund certain public improvements and related redevelopment costs, in addition to providing administrative support for these projects. In many cases, in order to move effectively and efficiently manage the tax increment reinvestment zones, the City has created local government corporations, which are not for profit local government corporations created under Chapter 431 of the Texas Transportation Code, as amended. Such redevelopment authorities are created to aid, assist and act on behalf of the City in the performance of certain of the City’s governmental and proprietary functions, including acting as a financing vehicle for the reinvestment zones. Tax increment revenues for each such reinvestment zone are initially deposited in separate tax increment funds maintained by the City and then a local government corporation if a local government corporation has been created to manage such reinvestment zone. Projects financed on behalf of tax increment reinvestment zones are typically accomplished through the issuance of bonds by local government corporations which pledge tax increment revenues received from the City by virtue of a contract between the respective local government corporation, the tax increment reinvestment, and the City. See footnote (d) of “SCHEDULE 2: AD VALOREM TAX LEVIES AND COLLECTIONS” for a discussion of the transfer of tax increment revenues into tax increment funds. ACCOUNTING AND BUDGETING PROCEDURES AND GENERAL FUND REVENUES Financial Accounting The accounts of the City are organized on the basis of funds, each of which constitutes a separate entity for accounting purposes. The most significant of these funds is the General Fund, which accounts for all revenues and expenditures of the City not accounted for in the various enterprise funds or the other funds maintained by the City (the “General Fund”). Other than ad valorem taxes, the primary sources of General Fund revenues include sales and use taxes, franchise charges and fees, charges to other City funds, industrial district contract revenues and miscellaneous revenue sources such as fines, penalties, licenses, fees, interest income from investments and other taxes. There are three major enterprise funds: the Combined Utility System Fund, the Airport System Fund, and the Convention and Entertainment Facilities Fund (collectively, the “Enterprise Funds”). The methods of accruing revenues and expenditures differ between the General Fund and Enterprise Funds. For a description of the accrual methods and the reporting entity definition, see Note 1 to the Financial Statements for Fiscal Year 2005 as presented in APPENDIX A. Other major governmental funds maintained by the City include the Debt Service Fund, Capital Projects Fund, and Grants Fund. Other funds include Nonmajor Special Revenue Funds, Internal Service Funds, and Fiduciary Funds, including Pension Trust Funds and certain agency funds. 38

Budgeting Procedures State law and the City Charter require that the Mayor annually prepare and submit to the City Council a balanced budget consisting of an estimate of the revenues and expenditures in the budget period. The proposed expenditures in each budget period may not exceed the estimated available resources in such period. According to the City Charter, the estimate of available resources is based on the amount of available surplus, if any, carried forward from the preceding period, the estimated revenues of the City derived from ad valorem taxes, based on the total valuation of the property for taxation for the preceding period, and such other contingent revenues of the City as may probably accrue. The City Charter further provides that, in preparing the budget, provision shall first be made for the payment of debt service on the City’s outstanding bond indebtedness, with the remaining revenues to be apportioned among the City’s respective departments. After a budget has been approved by the City Council, the Mayor may, under certain limited circumstances, submit a revised budget to the City Council for approval. The City Council appropriates funds both in support of the budget and for specific purposes. The City Charter also provides that no appropriation or obligation of City funds may be made unless the City Controller first certifies that funds are available for payment of such obligation or that such funds will be available before the maturity of such obligation. The City Charter prohibits the execution of any warrant, contract or order for payment unless signed by the Mayor and countersigned by the City Controller, each of whom is an independently elected official. The City Controller’s responsibility not to certify the availability of funds in the event of a shortfall in revenues in a Fiscal Year can serve to assure that expenditures do not exceed resources during such Fiscal Year. If a budget is not adopted prior to the beginning of a Fiscal Year, the City Council historically has adopted an ordinance which appropriates funds to authorize an interim spending plan for City operations. Financial Policies The City Council has adopted an ordinance establishing financial policies for the City (the “Financial Policies Ordinance”). The Financial Policies Ordinance divides these policies into three categories: Operating Programs, Capital and Debt Management, and Accounting, Auditing and Financial Planning. The Financial Policies Ordinance may be amended or rescinded by the City Council as it deems appropriate. Under the heading of Operating Programs, the Financial Policies Ordinance states that current revenues will be sufficient to support current expenditures. All retirement and employee benefit systems will be financed in a manner systematically to fund liabilities. The City will assure that sufficient funds are provided to pay current service plus interest on unfunded liabilities plus amortization of the unfunded liabilities over a programmed period. Each Enterprise Fund of the City will maintain revenues which support the full (direct and indirect) cost of the service provided. An annual review of all fees and charges will be conducted to determine the extent to which the full cost of associated services is being recovered by revenues. The General Fund undesignated fund balance shall be maintained at a level sufficient to provide for temporary financing of unforeseen needs of an emergency nature and to permit orderly adjustment to changes resulting from termination of revenue sources. In addition to the General Fund Undesignated Fund Balance, the City will maintain a Rainy Day Fund in an amount not less than $20 million with funds available to respond in the event of an emergency; and to provide for unanticipated or unforeseen extraordinary needs. The City will allocate sufficient funds during the subsequent two fiscal years to replenish any use of Rainy Day funds in the previous year. The Financial Policies Ordinance also provides that the level of the General Fund balance will be a minimum of 5% of total expenses less debt service. To the extent that funds in the General Fund exceed 7.5% of total expenses less debt service, the excess funds are available upon appropriation for non-recurring expenses. See “SCHEDULE 16: GENERAL FUND UNDESIGNATED FUND BALANCES.” Under the heading of Capital and Debt Management, the Financial Policies Ordinance provides that any capital project financed through the issuance of bonds or other obligations shall be financed for a period not to exceed the expected life of the project. Average (weighted) general obligation bond (or other obligations) maturities shall be kept at or below 12 years. The Financial Policies Ordinance also provides that annual contributions to the Debt Service Fund from the General Fund shall not exceed 20% of the total General Fund revenues, excluding state and federal grants. The City’s Financial Policies Ordinance requires that an annual audit be performed by an independent public accounting firm in accordance with generally accepted accounting principles. The June 30, 2005 City Controller’s audited Comprehensive Annual Financial Report of the City of Houston, Texas (defined herein as the “Controller’s Report”), and additional financial information are available for public inspection, or copies may be obtained by written request, to the extent permitted by law, addressed to the Office of the City Controller. See “GENERAL INFORMATION.” City Investment Policy The City maintains an investment strategy that emphasizes, in order of priority, safety, liquidity and return on investment, as embodied in its investment policy (the “Investment Policy”). The City does not invest in inverse floaters or interest-only or principal-only mortgage-backed securities. The Investment Policy provides, among other things, that (i) the 39

Investment Manager (as defined in the Investment Policy) shall submit quarterly investment reports to City Council and (ii) the Investment Policy shall be reviewed annually by City Council. For a further discussion of the Investment Policy and a description of the status of the City’s investments as of June 30, 2005, see Note 1.E.1. and Note 3.B. to the Financial Statements for Fiscal Year 2005 as set forth in APPENDIX A. Standard & Poor’s Rating Services has assigned an “AAAf” credit quality rating, and an “S1” volatility rating to the City’s General Investment Portfolio. The ratings reflect the view of Standard & Poor’s Rating Services, from whom an explanation of the significance of such ratings may be obtained. City Interest Rate Swap Policy On November 25, 2003, the City adopted a master swap policy (the “Swap Policy”), to provide guidance for the City in its use of swaps, caps, floors, collars, options and other derivative financial products (collectively, “Swaps”) in conjunction with the City’s management of its assets and liabilities. The Swap Policy describes the circumstances and methods by which Swaps will be used, the guidelines to be employed when Swaps are used, and who is responsible for carrying out these policies. The City may enter into Swaps as authorized by the City Council and approved by the Attorney General of the State of Texas in connection with the issuance or payment of certain debt obligations, before, concurrently with, or after the actual issuance of the debt. As a general rule, the City will enter into transactions only with counterparties whose obligations are rated in the double-A category or better from at least one nationally recognized rating agency. In addition, if a counterparty’s credit rating is downgraded below the double-A rating category, the City may require that its exposure to the counterparty be collateralized or may exercise its right to terminate the transaction prior to its scheduled termination date. In order to limit the City’s counterparty risk, the City will seek to avoid excessive concentration of exposure to a single counterparty or guarantor. The Swap Policy provides that the City may choose counterparties for entering into Swap contracts on either a negotiated or competitive basis. To provide safeguards on negotiated transactions, the Swap Policy provides that the City may secure outside professional advice to assist in the process of structuring, documenting and pricing the transaction, and to verify that a fair price was obtained. In any negotiated transactions, the counterparty will be required to disclose all payments to third parties (including lobbyists, consultants and attorneys) who had any involvement in assisting the counterparty in doing business with the City. The City will track and regularly report on the financial implications of its Swaps. A quarterly report will be prepared for the City Council including: (i) a summary of key terms of the agreements, including notional amounts, interest rates, maturity and method of procurement, including any changes to Swap agreements since the last reporting period; (ii) the mark-to-market value (termination value) of its Swaps, as measured by the economic cost or benefit of terminating outstanding contracts at specified intervals; (iii) the amount of exposure that the City has to each specific counterparty, as measured by aggregate markto-market value, netted for offsetting transactions; (iv) the credit ratings of each counterparty (or guarantor, if applicable) and any changes in the credit rating since the last reporting period; and (v) any collateral posting as a result of Swap agreement requirements. In addition, the City will perform such monitoring and reporting as is required by the rating agencies or for compliance with GASB requirements. General Fund and General Debt Service Fund Budgets for Fiscal Year 2006 The City adopted its Fiscal Year 2006 Budget on July 22, 2005. State law provides that no budget may be adopted when budgeted expenditures exceed budgeted resources, and the City Charter provides that no appropriation or obligation of City funds may be made unless the City Controller first certifies that funds are or will be available for payment of such obligations before maturity. In the Fiscal Year 2006 Budget, $1.57 billion is budgeted for expenditures and transfers and $1.69 billion is budgeted for total available resources, which would result in a General Fund ending balance of approximately $122 million, which consists of approximately $100 million in undesignated funds, $20 million for the “Rainy Day” Fund and $2 million designated for sign abatements. The Fiscal Year 2006 Budget provides for transfers of $195 million from the General Fund to the Debt Service Fund. The budgeted tax rate for Tax Year 2005 (Fiscal Year 2006) is $0.650 (per $100 assessed valuation). See “PROPERTY TAXES—Constitutional and Statutory Tax Rate Limitations;” however, the City has adopted a tax rate of $0.6475 (per $100 assessed valuation) for Tax Year 2005. The City Council may modify or amend the adopted Fiscal Year 2006 Budget as it deems appropriate. The following schedules set forth a summary of the adopted General Fund Budget (excluding grant programs) and the adopted Debt Service Fund Budget for Fiscal Year 2006.

40

SCHEDULE 13: GENERAL FUND BUDGET FOR FISCAL YEAR 2006 Adopted Fiscal Year 2006 (in thousands) BUDGETED RESOURCES Ad Valorem Taxes (current and delinquent) .......................................................................... Sales and Use Tax.................................................................................................................. Franchise Fees........................................................................................................................ Municipal Court Fines and Forfeits ....................................................................................... Miscellaneous ........................................................................................................................ TOTAL CURRENT REVENUES(a) ............................................................................... Other Financing Sources(b)...................................................................................................... Beginning Fund Balance as of July 1(c)................................................................................... TOTAL BUDGETED RESOURCES(a) .......................................................................... BUDGETED EXPENDITURES Administrative Services and Public Finance.......................................................................... Public Safety .......................................................................................................................... Development and Maintenance Services ............................................................................... Human and Cultural Services................................................................................................. General Government .............................................................................................................. Transfer to Debt Service Fund ............................................................................................... TOTAL BUDGETED EXPENDITURES(a) ................................................................... Designated “Sign Abatement” Amount ................................................................................. Designated “Rainy Day” Amount .......................................................................................... Budgeted Ending Fund Balance – undesignated .................................................................... ENDING FUND BALANCE as of June 30 ................................................................... TOTAL BUDGETED EXPENDITURES AND ENDING FUND BALANCE(a) .......................................................................................................
____________________________________________________________ (a) (b) (c)

$

$

$

690,246 395,845 171,627 47,806 194,087 1,499,614 71,000 122,954 1,693,568

$

$

62,122 886,945 175,145 128,035 123,367 195,000 1,570,614 2,119 20,000 100,835 122,954

$

$

1,693,568

Totals may reflect a slight variance due to rounding. This amount represents proceeds from the sale of Pension Obligations. The amount represents an estimate of the beginning fund balance which was used in preparing the budget. The actual beginning Unreserved Fund Balance for Fiscal Year 2006 is $142,695,000. The beginning Unreserved and Undesignated Fund Balance is $120,625,000.

[Remainder of Page Intentionally Left Blank]

41

SCHEDULE 14: DEBT SERVICE FUND BUDGET SCHEDULE 14A: TAX BOND DEBT SERVICE FUND BUDGET FOR FISCAL YEAR 2006(a) Adopted Fiscal Year 2006 (in thousands) BUDGETED RESOURCES Interest Earnings on Debt Reserves and Bond Funds.......................................................................... Transfers in from: General Fund............................................................................................................................. Water and Sewer Operating Fund ............................................................................................. Other Sources............................................................................................................................ Third Party Reimbursements..................................................................................................... TOTAL CURRENT REVENUES(b) .......................................................................................... Beginning Fund Balance Estimate as of July 1 ................................................................................... TOTAL BUDGETED RESOURCES(b) ..................................................................................... BUDGETED EXPENDITURES Debt Service Requirements Tax Bonds ................................................................................................................................. Assumed Bonds......................................................................................................................... Commercial Paper Paid Off from Third Party........................................................................... Miscellaneous ........................................................................................................................... TOTAL BUDGETED EXPENDITURES(b) ........................................................................... Budgeted Ending Fund Balance as of June 30 .................................................................................... TOTAL BUDGETED EXPENDITURES AND ENDING FUND BALANCE(b) ............................................................................................................
_________________ (a) This fund includes the debt service for the City’s Tax Bonds, Assumed Bonds, Pension Obligations and Commercial Paper Notes. (b) Totals may reflect a variance due to rounding.

$

2,743

190,000 26,282 9,479 20,000 248,504 94,676 $ 343,180

$ 223,525 1,375 20,000 600 245,500 97,680 $ 343,180

SCHEDULE 14B: TAX CERTIFICATE DEBT SERVICE FUND BUDGET FOR FISCAL YEAR 2006 Adopted Fiscal Year 2006 (in thousands) BUDGETED RESOURCES Interest Earnings on Debt Reserves...................................................................................................... Transfers from General Fund ............................................................................................................... TOTAL CURRENT REVENUES(a) ............................................................................................. Beginning Fund Balance Estimate as of July 1 .................................................................................... TOTAL BUDGETED RESOURCES(a) ........................................................................................ BUDGETED EXPENDITURES Debt Service Requirements.................................................................................................................. TOTAL BUDGETED EXPENDITURES(a) .................................................................................. Budgeted Ending Fund Balance as of June 30 ..................................................................................... TOTAL BUDGETED EXPENDITURES AND ENDING FUND BALANCE(a) .....................................................................................................................
_________________ (a) Totals may reflect a variance due to rounding.

$

$

0 5,000 5,000 1,527 6,527

$

4,698 4,698 1,829 6,527

$

42

Summary of General Fund Revenues, Expenditures, Transfers and Changes in Fund Balance The following schedule sets forth the actual revenues, expenditures, and transfers for Fiscal Years 2005 and 2004. Fund balances in this summary differ from budgeted fund balances due primarily to the inclusion of certain reserves. See footnote (b) below. The Fiscal Year 2005 and Fiscal Year 2004 amounts are taken from the audited basic financial statements included in the City Controller’s Comprehensive Annual Financial Report of the City of Houston, Texas for the years ended June 30, 2005 and June 30, 2004, respectively. For additional information concerning the City’s basic financial statements for the General Fund for Fiscal Year 2005, see APPENDIX A. SCHEDULE 15: SUMMARY OF GENERAL FUND Fiscal Year 2005 (in thousands) REVENUES Taxes and Assessments ...................................................................... Licenses and Permits.......................................................................... Charges for Services(a) ....................................................................... Intergovernmental-grants ................................................................... Fines and Forfeits............................................................................... Contributions...................................................................................... Investment Income ............................................................................. Other .................................................................................................. Total Revenues............................................................................. EXPENDITURES General Government .......................................................................... Public Safety ...................................................................................... Public Works...................................................................................... Health................................................................................................. Parks and Recreation.......................................................................... Library ............................................................................................... Retiree Benefits.................................................................................. Capital Outlay .................................................................................... Debt service principal ........................................................................ Debt service interest........................................................................... Total Expenditures ....................................................................... OTHER FINANCING SOURCES (USES) Proceeds from Issuance of Debt and Tax Notes................................. Transfers in ........................................................................................ Transfers out ...................................................................................... Total other financing sources (uses)................................................... Changes in Fund Balance................................................................... FUND BALANCE, beginning of year...................................................... FUND BALANCE, end of year(b).............................................................. $1,227,388 17,692 120,181 19,993 51,251 1,780 6,541 15,938 $1,460,764 105,091 835,130 196,413 50,311 47,592 33,222 28,997 37,163 1,090 6,443 $1,341,452 111,205 1,029 (197,127) (84,893) 34,419 135,725 $ 170,144 Fiscal Year 2004 (in thousands) $1,193,874 15,271 132,771 11,826 47,135 2,433 4,520 15,900 $1,423,730 118,411 776,226 198,088 51,121 43,198 32,456 26,581 32,116 1,028 3,311 $1,282,536 26,693 6,800 (174,998) (141,505) (311) 136,036 $ 135,725

_______________________ (a) This category includes ambulance service, library fees, parking fees, charges for direct and indirect services performed for other funds, rents and royalties, and other fees and charges. (b) This amount includes various reserves totaling $27,449,000 for Fiscal Year 2005 and $24,947,000 for Fiscal Year 2004.

[Remainder of Page Intentionally Left Blank]

43

The following schedule sets forth the unreserved and undesignated fund balances for the General Fund for the periods designated below, except for Fiscal Year 2006 which shows the amount projected: SCHEDULE 16: GENERAL FUND UNRESERVED AND UNDESIGNATED FUND BALANCES Unreserved and Undesignated General Fund Balance (in thousands) $ 78,209 83,027 88,186 120,042 137,274(a)

Fiscal Year 2002 ........................................................... 2003 ........................................................... 2004 ........................................................... 2005 ........................................................... 2006 (projected)......................................... ____________________
(a)

As of December 31, 2005.

Sales and Use Tax and Franchise Charges and Fees A 1% sales and use tax is collected for the City by the State. Sales and use tax revenues accounted for approximately 25% of Fiscal Year 2003 General Fund revenues, approximately 26% of Fiscal Year 2004 General Fund revenues and approximately 25% of Fiscal Year 2005 General Fund revenues. Sales and use taxes are projected to be approximately 26% of the Fiscal Year 2006 General Fund revenues. The sales and use tax is collected by the retailer from the consumer or purchaser and remitted by the retailer to the Comptroller of Public Accounts of the State which then remits a portion of the collected amount to the City on a monthly basis. The City also collects franchise fees on utilities, including electric, telephone and gas companies, and other parties such as cable television companies, that have obtained franchises from the City. The fees generally vary from 1% to 5% of the gross revenues collected by the franchise holder within the City, although this varies. For example, some franchise fees are a designated amount spelled out in the franchise agreement, adjusted annually by an inflation or growth factor. This is true of electric franchise fees and fiber optic franchises. Other fees, such as those for the use of the right-of-way by telecommunications companies, are a function of the number of access lines in the municipality’s right-of-way. Franchise charges and fees accounted for approximately 12% of Fiscal Year 2003 General Fund revenues and 12% of Fiscal Year 2004 General Fund Revenues. Franchise charges and fees accounted for approximately 11% of Fiscal Year 2005 General Fund revenues and are projected to constitute 11% of the budgeted General Fund revenues in Fiscal Year 2006. City Council recently adopted an ordinance that dedicates all of the City’s franchise fee revenue above a base amount (equal to the franchise fee revenue actually collected in Fiscal Year 2005) to public safety expenditures. Set forth below is a schedule that shows the amount of revenues obtained by the City from the sales and use tax and from franchise charges and fees for Fiscal Years 2002 to 2005 and for Fiscal Year 2006 the amount projected: SCHEDULE 17: SALES AND USE TAX AND FRANCHISE CHARGES AND FEES Sales and Use Tax (in thousands) $ 341,952 322,538 347,982 370,583 400,308 Franchise Charges And Fees (in thousands) $ 175,359 160,673(a) 161,379 162,263 173,876(b) (c)

Fiscal Year 2002 ................................................................. 2003 ................................................................. 2004 ................................................................. 2005 ................................................................. 2006 (projected) ............................................... ____________________
(a) (b)

(c)

The amount of franchise charges and fees was reduced from the previous year due to the effect of electric deregulation. The projected increase in franchise charges and fees in Fiscal Year 2006 is the result of the renegotiation of the City’s franchise agreement with CenterPoint Energy, Inc. and an increase in the price of natural gas. As of December 31, 2005.

Charges to Other City Funds The City’s Combined Utility System is charged each year to compensate the Debt Service Fund for the cost of paying debt service (“Discretionary Debt Service”) on certain Assumed Bonds issued to pay the cost of water and sewer improvements. The Combined Utility System is also charged for debt service payments on certain Tax Bonds issued for sewer purposes. See “ENTERPRISE SYSTEMS OF THE CITY.” Payments to the Debt Service Fund of Discretionary Debt Service and debt service on such Assumed Bonds and Tax Bonds for Fiscal Years 2002-2005 and the amount projected for Fiscal Year 2006 are shown below:

44

SCHEDULE 18: DISCRETIONARY DEBT SERVICE TRANSFERS BY COMBINED UTILITY SYSTEM TO THE DEBT SERVICE FUND Fiscal Year 2002................................................................................................................. 2003................................................................................................................. 2004................................................................................................................. 2005................................................................................................................. 2006 (projected)............................................................................................... Amount (in thousands) $ 36,479 23,811(a) 29,572 28,200 31,798(b)

_______________________
(a) (b)

The Fiscal Year 2003 transfer does not include $10 million that was transferred to the General Fund rather than the Debt Service Fund. As of December 31, 2005.

Indirect Charges. A charge is made by the General Fund to the Combined Utility System, Airport System, and Convention and Entertainment Facilities funds, and to certain grant and special revenue funds for indirect charges incurred by the General Fund on behalf of such funds. The total amounts of these charges for Fiscal Years 2002-2005 and the amount projected for Fiscal Year 2006 are shown below: SCHEDULE 19: GENERAL FUND INDIRECT CHARGES TO OTHER CITY FUNDS Indirect Charges (in thousands) $ 15,095 15,859 14,647 11,031(a) 14,887(b) (c)

Fiscal Year 2002 ................................................................................................................ 2003 ................................................................................................................ 2004 ................................................................................................................ 2005 ................................................................................................................ 2006 (projected) ..............................................................................................

____________________ (a) The decrease in the indirect charges for Fiscal Year projection is primarily the result of changes in the methodology used to calculate such charges, as well as recognition of a direct transfer from an Enterprise Fund in lieu of an indirect transfer. (b) The increase is due to the inclusion of charges from interfund engineering, construction and real estate services that were recovered from capital improvement plan projects. In previous years, such amounts were categorized as direct interfund transfers. See “SCHEDULE 20: GENERAL FUND DIRECT CHARGES TO OTHER CITY FUNDS.” (c) As of December 31, 2005.

Direct Charges. An additional charge is made by the General Fund to the Combined Utility System, Airport System, and Convention and Entertainment Facilities funds, the Capital Projects Fund and certain other funds of the City for specific services provided to such funds by the General Fund. The total amounts of these charges for Fiscal Years 2002-2005 and the amount projected for Fiscal Year 2006 are shown below: SCHEDULE 20: GENERAL FUND DIRECT CHARGES TO OTHER CITY FUNDS Charges for Specific Services (in thousands) $ 62,590 62,099 57,056 61,233 44,345(a) (b)

Fiscal Year 2002 ................................................................................................................. 2003 ................................................................................................................. 2004 ................................................................................................................. 2005 ................................................................................................................. 2006 (projected)...............................................................................................

__________________________
(a)

(b)

The decrease from Fiscal Year 2005 to Fiscal Year 2006 is due to the exclusion of charges for engineering, construction and real estate services that are now recovered from capital improvement plan projects and are now categorized as indirect charges. See “SCHEDULE 19: GENERAL FUND INDIRECT CHARGES TO OTHER CITY FUNDS.” As of December 31, 2005.

Industrial District Contracts The City annexed certain land adjacent to the Houston Ship Channel for the limited purpose of navigation and wharfage. No ad valorem taxes are collected from these industrial property owners. Historically, the City has entered into contracts (the “Industrial District Contracts”) with owners of a portion of that land. Under these Industrial District Contracts,

45

industrial property owners agree to make payments to the City in lieu of taxes in return for the City’s agreement to refrain from annexing their properties. These Industrial District Contracts are for terms of fifteen years and have payments based on the following factors: (i) the City’s tax rate during each year of the contracts, (ii) 100% of the assessed valuation of land within the affected area, (iii) 73.4% of personal property in the affected area and (iv) with respect to improvements to land, certain percentages of assessed valuations. Specifically, for improvements completed after January 1, 1997, the percentage is 40% for the first three Tax Years, 45% for the fourth and fifth Tax Years, 50% for the sixth and seventh Tax Years and 73.4% thereafter during the term of the contracts. The following schedule shows the amount of the City’s Industrial District Contracts revenues for Fiscal Years 2002 through 2005 and the amount projected for Fiscal Year 2006: SCHEDULE 21: INDUSTRIAL DISTRICT CONTRACTS Contract Amount (in thousands) $ 15,642 15,014 15,153 14,635 13,830(a)

Fiscal Year 2002................................................................................................................. 2003................................................................................................................. 2004................................................................................................................. 2005................................................................................................................. 2006 (projected)............................................................................................... ____________________
(a)

As of December 31, 2005.

Tax Abatement The City has entered into various economic development tax abatement agreements and redevelopment tax abatement agreements for certain projects. See footnote (b) under “SCHEDULE 1: TAX ROLLS.” Short-Term Financing The City’s General Fund revenue collections are not evenly distributed throughout a Fiscal Year. The principal revenue source is ad valorem taxes, which are largely collected shortly before the tax delinquency date, which ordinarily is February 1 of each year. Prior to these collections, the City finances current operations by the expenditure of the beginning fund balance, collections from other revenues sources and the City’s tax and revenue anticipation notes which, by Texas law, must be repaid by the end of the Fiscal Year in which they are incurred. It is the normal business practice of the City to issue tax and revenue anticipation notes each Fiscal Year which are repaid before the close of each such Fiscal Year. On July 6, 2005, the City issued its $180,000,000 Tax and Revenue Anticipation Notes, Series 2005, to fund general operating expenditures for Fiscal Year 2006 in anticipation of the collection of taxes and revenues, a significant portion of which will be collected in the latter half of Fiscal Year 2006. The City does not expect to issue any additional tax and revenue anticipation notes during Fiscal Year 2006, but does expect to issue tax and revenue anticipation notes to fund general operating expenditures for Fiscal Year 2007. For further information regarding tax and revenue anticipation notes, see Note 7 to the Financial Statements in APPENDIX A. Special Revenue Funds The City maintains various special revenue funds, which are budgeted and accounted for outside the City’s General Fund. Revenues of such funds are not considered available revenues and are dedicated to specific City projects. For further information regarding the special revenue funds, see Note 1.C. to the Financial Statements in APPENDIX A. ENTERPRISE SYSTEMS OF THE CITY The City’s Enterprise Funds account for the activities of the City that render service on a user charge basis to the general public. Enterprise Funds are assessed charges by various City departments for services performed on their behalf. See “ACCOUNTING AND BUDGETING PROCEDURES AND GENERAL FUND REVENUES— Charges to Other City Funds.” Revenues of the Enterprise Funds are not pledged to the payment of Pension Obligations (including the Series 2006A Bonds), Tax Bonds (including the Series 2006B Bonds), Tax Certificates (including the Series 2006C Certificates), Commercial Paper Notes or Assumed Bonds.

46

Enterprise Funds: Summary of Revenues, Expenses and Changes in Net Fund Assets Below is a summary of the revenues, expenses, and changes in net fund assets of the City’s Enterprise Funds for Fiscal Year 2005. SCHEDULE 22: ENTERPRISE FUNDS (in thousands) Fiscal Year 2005 Combined Utility System $598,874

Airport System Operating revenues: Total operating revenues Operating expenses Administrative costs Maintenance and operating Depreciation and amortization Total operating expenses Operating income (loss) Nonoperating revenues (expenses) Investment income Hotel occupancy tax Other revenues Loss on disposal of assets Other expenses Interest on long-term debt Contributions in Contributions out Arbitrage Expense Recovery Total nonoperating revenues (expenses) Income (loss) before contributions and transfers Capital Contributions Transfers in Transfers out Total transfers Change in net assets Liability from internal service funds undercharging proprietary funds Net Change Total net assets, July 1 Total net assets, June 30 $353,641

Convention & Entertainment Facilities $19,175

Houston Area Water Corp. $ --

Total $971,690

-223,972 105,891 329,863 23,778

-32,797 10,372 43,169 (23,994)

-332,800 224,074 556,874 42,000

77 --77 (77)

77 589,569 340,337 929,983 41,707

14,968 -4,295 (549) -(79,496) --1,137 (56,645) (32,867) 63,989 ---31,122

15,926 42,266 --(19,614) (29,468) 4,106 (41,371) -(28,155) (52,149) 231 2,942 (709) 2,233 (49,685)

12,972 -24,707 (4,193) -(201,142) ---(167,656) (125,656) 42,495 -(87,414) (87,414) (170,575)

-----(92) 191 --99 22 -26,567 -26,567 26,589

43,866 42,266 29,002 (4,742) (19,614) (307,198) 4,297 (41,371) 1,137 (252,357) (210,650) 106,715 29,509 (88,123) (58,614) (162,549)

1,037,797 $1,068,919

186,598 $136,913

620,135 $449,560

6,117 $32,706

(1) (162,550) 1,850,647 $1,688,097 (711) $1,687,386

Cumulative liability resulting from internal service funds undercharging proprietary funds Total net assets business-type activities

[Remainder of Page Intentionally Left Blank]

47

LITIGATION AND REGULATION General Litigation and Claims The City is a defendant in various lawsuits and is aware of pending claims arising in the ordinary course of its municipal and enterprise activities, certain of which seek substantial damages. That litigation includes lawsuits claiming damages that allege that the City caused personal injuries and wrongful deaths; class actions and other lawsuits and claims alleging discriminatory hiring and promotion practices and certain civil rights violations arising under the Federal Voting Rights Act; claims regarding overtime compensation to City employees; various claims from contractors for additional amounts under construction contracts; and claims involving ad valorem tax assessments and various other liability claims. The status of such litigation ranges from an early discovery stage to various levels of appeal of judgments both for and against the City. The amount of damages is limited in certain cases under the Texas Tort Claims Act and is subject to appeal. The City intends to defend itself vigorously against the suits; however, no prediction can be made, as of the date hereof, with respect to the liability of the City for such claims or the final outcome of such suits. The City typically utilizes its General Fund to liquidate claims and judgments; however, the City may, at its option, issue Tax Bonds to pay any final, unappealable judgments and settlements resulting from lawsuits against the City. See Note 13 to the Financial Statements in APPENDIX A. See also the section captioned “PROPERTY TAXES—City Charter Tax and Revenue Limitations.” The City is also aware that various claims for inverse condemnation may be asserted against the City in connection with operations of the City’s Combined Utility System, the amounts of which are unknown. The City intends to defend itself vigorously against these claims; however, the City’s liability with respect to these claims cannot be predicted. Environmental Regulation The City is subject to the environmental regulations of the State and the United States. These laws and regulations are subject to change, and the City may be required to expend substantial funds to meet the requirements of such regulatory authorities. Failure to comply with these laws and regulations may result in the imposition of administrative, civil and criminal penalties. Other Environmental Measures Air quality control measures required by the United States Environmental Protection Agency (the “EPA”) and the Texas Commission on Environmental Quality (“TCEQ”) may curtail new industrial, commercial and residential development in Houston and adjacent areas. Under the Clean Air Act Amendments of 1990, the eight county Houston-Galveston Consolidated Metropolitan Statistical Area (“CMSA”) has been designated by the EPA as an ozone non-attainment area. Such areas are required to demonstrate progress in reducing ozone concentrations each year until compliance with EPA’s ozone standards is achieved. The Houston-Galveston CMSA initially was designated as a severe ozone non-attainment area under EPA’s 1-hour ozone standard. As part of an overall program to achieve compliance with the 1-hour ozone standard, the EPA and TCEQ imposed a series of increasingly stringent limitations on emissions of “highly reactive” volatile organic compounds and nitrogen oxides (“NOx”) from existing stationary sources of air emissions in the Houston-Galveston CMSA. Although these limitations were successful in reducing ozone concentrations, they were not sufficient for the Houston-Galveston CMSA to achieve compliance with the 1-hour ozone standard. In April 2004, EPA introduced a new national ambient air quality standard for ozone, the 8-hour standard, which is considered to be somewhat more stringent than the previous 1-hour standard. EPA formally designated the Houston-Galveston CMSA as a moderate ozone non-attainment area under the new 8-hour standard and has required the Houston-Galveston CMSA to achieve compliance with the 8-hour standard by 2010. EPA is transitioning from the older, 1-hour standard to the new, 8-hour standard and, accordingly, revoked the 1-hour standard effective June 15, 2005. Although the 1-hour standard is no longer in effect, non-attainment areas such as the Houston-Galveston CMSA are not allowed to “back-slide” or lose progress already made towards attaining the 1-hour ozone standard. As a result, the specific emission control measures established in an effort to achieve compliance with the 1-hour standard must stay in place until the Houston-Galveston CMSA attains the 8-hour standard. In addition to the emissions reductions previously required for the Houston-Galveston CMSA to achieve compliance with the 1-hour ozone standard, further emissions reductions will be required in order to achieve compliance with the new 8-hour ozone standard. In addition, any new source of significant air emissions, such as a new industrial plant, must provide for a net reduction of air emissions by arranging for other industries to reduce their emissions by 1.15 times the amount of pollutants proposed to be emitted by the new source. Due to the shortage of economically reasonable control options, it is possible that such emission reduction requirements could have a negative impact on the area’s economic growth and development. If the Houston-Galveston CMSA fails to demonstrate progress in reducing ozone concentrations or fails to meet the 8-hour ozone standard by 2010, EPA may impose a moratorium on the awarding of federal highway construction grants and other federal grants for certain public works construction projects, as well as severe emissions offset requirements on new major sources for which construction has not already commenced.

48

Other constraints on economic growth and development include lawsuits filed under the Clean Air Act by plaintiffs seeking to require emission reduction measures that are even more stringent than those adopted by TCEQ and approved by EPA. From time to time, various plaintiff environmental organizations have filed lawsuits against TCEQ and EPA seeking to compel the early adoption of additional emission reduction measures, many of which could make it more difficult for businesses to construct or expand industrial facilities or which could result in travel restrictions or other limitations on the actions of businesses, governmental entities and private citizens. Any successful court challenge to the currently effective air emissions control plan could result in the imposition of even more stringent air emission controls that could threaten continued growth and development in the Houston-Galveston CMSA. In addition, TCEQ has announced enforcement initiatives addressed to sources of NOx and HRVOCs in the Houston area. TCEQ announced that it is dedicating additional enforcement resources to perform in-depth, on-site inspections of industrial facilities that have unauthorized emissions of significant amounts of HRVOCs in the past year. TCEQ also announced a diesel engine initiative, pursuant to which TCEQ will be investigating the regulatory compliance of stationary diesel engines at facilities along the Houston Ship Channel. Moreover, while the City continues to have the ability to inspect industrial facilities to determine whether they are complying with TCEQ-imposed air emissions limits, the City no longer is authorized by the State to bring direct enforcement actions against alleged violators; rather the City must refer its investigation results to the TCEQ for action. The City previously obtained the ability to pursue direct enforcement against violators on December 29, 2004, following amendment of a contract between the City and TCEQ that allowed the City to conduct investigations of industrial facilities. However, this contract, and the funding provided by TCEQ to assure its implementation, expired on September 1, 2005. The discontinuance of this contractual arrangement with the TCEQ and the loss of the associated funding is likely to diminish the City’s role in performing facility investigations, and could have a limiting effect on the City’s ability to help the HoustonGalveston CMSA attain compliance with EPA’s ozone standards. It remains to be seen exactly what steps will ultimately be required to meet federal air quality standards, how the EPA may respond to developments as they occur, and what impact such steps and any EPA responses may have upon the economy and the business and residential communities in the Houston-Galveston CMSA. For additional information see Note 17 to the Financial Statements in Appendix A. Periodic Flooding Owing in part to its relatively flat topography and moist climate, certain areas in the City are subject to periodic flooding and associated severe property damage as a result of storm events and hurricanes. The City and Harris County each participate in the National Flood Insurance Program, which is administered by the Federal Emergency Management Agency (“FEMA”). Communities participating in the National Flood Insurance Program are required by FEMA to adopt restrictions on development in designated flood prone areas. In exchange, the National Flood Insurance Program makes federally backed flood insurance available to homeowners, renters, and business owners located in the participating communities. In connection with its administration of the National Flood Insurance Program, FEMA will from time to time introduce revisions to Flood Insurance Rate Maps, which serve to classify the relative flooding potential of geographic areas. Flood Insurance Rate Maps exist for the Greater Houston area as well as unincorporated Harris County. However, revised digital Flood Insurance Rate Maps for the City and surrounding areas have recently been developed and released by FEMA for public review and comment. The new Flood Insurance Rate Maps have been developed with an advanced laser mapping technology, called LiDAR, that is believed to provide a more precise understanding of flood risks on the ground. One consequence of the new digital Flood Insurance Rate Maps that FEMA is now in the process of adopting is that some homes and businesses within the City and the surrounding area that were outside of the 100-year flood plain (those areas that are determined to have a greater than 1% chance of flooding in any given year) under the existing Flood Insurance Rate Maps will be included in the 100-year flood plain if the new maps are adopted as proposed. Residential, commercial, and industrial properties in Houston that are reclassified as being within the 100-year flood plain could experience a diminution in value, the extent of which cannot yet be determined. REMEDIES The Ordinances do not specifically provide any remedies to a Registered Owner if the City defaults on the payment of the principal of or interest on any Series 2006 Obligations, nor does it provide for the appointment of a trustee to protect and enforce the interest of the Registered Owners upon the occurrence of such a default. If a Registered Owner of a Series 2006 Obligation does not receive payment of principal or interest when due, the Registered Owner may seek a writ of mandamus from a court of competent jurisdiction requiring the City to levy and collect taxes. Such Registered Owner also may seek a judgment against the City. The mandamus remedy, however, may be impractical and difficult to enforce. There is no provision for the acceleration of maturity of principal of a Series 2006 Obligation in the event of a default. A judgment against the City could not be effectively enforced by a direct levy and execution against property owned by the City or any City funds. The enforcement of a claim for the payment of a Series 2006 Obligation also would be subject to the applicable provisions of the Federal bankruptcy laws and to any other statutes affecting the rights of creditors of political subdivisions and may be limited by general principles of equity.

49

LEGAL INVESTMENTS AND ELIGIBILITY TO SECURE PUBLIC FUNDS IN TEXAS Under Texas law, the Series 2006 Obligations are legal and authorized investments for banks, savings banks, trust companies, building and loan associations, savings and loan associations, insurance companies, fiduciaries and trustees. The Series 2006 Obligations are also legal and authorized investments for the sinking funds of cities, towns, villages, school districts and other political subdivisions or public agencies of the State of Texas and are eligible to secure deposits of public funds of the State of Texas or any political subdivision or agency thereof and are lawful and sufficient security for the deposits to the extent of their market value. The City has not made any investigation of any other laws, rules, regulations or investment criteria that affect the suitability of the Series 2006 Obligations for any of the above purposes or limit the authority of any of the above persons or entities to purchase or invest in the Series 2006 Obligations. BOND INSURANCE Payment of the principal of and interest on the Series 2006B Bonds and Series 2006C Certificates when due will be insured by a financial guaranty insurance policy to be issued for the Series 2006B Bonds and Series 2006C Certificates by Ambac Assurance Corporation simultaneously with the delivery of the Series 2006B Bonds and Series 2006C Certificates. Reference is made to APPENDIX F for a specimen of the Bond Insurer’s policy. See also “RATINGS” herein. The following information has been furnished by Ambac Assurance Corporation (“Ambac Assurance” or the “Bond Insurer”) for use in this Official Statement. Payment Pursuant to Financial Guaranty Insurance Policy Ambac Assurance has made a commitment to issue a financial guaranty insurance policy (the “Financial Guaranty Insurance Policy”) relating to the Series 2006B Bonds and Series 2006C Certificates, effective as of the date of issuance of the Series 2006B Bonds and Series 2006C Certificates. Under the terms of the Financial Guaranty Insurance Policy, Ambac Assurance will pay to The Bank of New York, New York, New York or any successor thereto (the “Insurance Trustee”) that portion of the principal of and interest on the Series 2006B Bonds and Series 2006C Certificates which shall become Due for Payment but shall be unpaid by reason of Nonpayment by the Obligor (as such terms are defined in the Financial Guaranty Insurance Policy). Ambac Assurance will make such payments to the Insurance Trustee on the later of the date on which such principal and interest becomes Due for Payment or within one business day following the date on which Ambac Assurance shall have received notice of Nonpayment from the Paying Agent/Registrar. The insurance will extend for the term of the Series 2006B Bonds and Series 2006C Certificates and, once issued, cannot be canceled by Ambac Assurance. The Financial Guaranty Insurance Policy will insure payment only on stated maturity dates and on mandatory sinking fund installment dates, in the case of principal, and on stated dates for payment, in the case of interest. If the Series 2006B Bonds and Series 2006C Certificates become subject to mandatory redemption and insufficient funds are available for redemption of all outstanding Series 2006B Bonds and Series 2006C Certificates, Ambac Assurance will remain obligated to pay principal of and interest on outstanding Series 2006B Bonds and Series 2006C Certificates on the originally scheduled interest and principal payment dates including mandatory sinking fund redemption dates. In the event of any acceleration of the principal of the Series 2006B Bonds and Series 2006C Certificates, the insured payments will be made at such times and in such amounts as would have been made had there not been an acceleration. In the event the Paying Agent/Registrar has notice that any payment of principal of or interest on a Series 2006B Bond or Series 2006C Certificate, as applicable, which has become Due for Payment and which is made to a Holder by or on behalf of the Obligor has been deemed a preferential transfer and theretofore recovered from its registered owner pursuant to the United States Bankruptcy Code in accordance with a final, nonappealable order of a court of competent jurisdiction, such registered owner will be entitled to payment from Ambac Assurance to the extent of such recovery if sufficient funds are not otherwise available. The Financial Guaranty Insurance Policy does not insure any risk other than Nonpayment, as defined in the Policy. Specifically, the Financial Guaranty Insurance Policy does not cover: 1. payment on acceleration, as a result of a call for redemption (other than mandatory sinking fund redemption) or as a result of any other advancement of maturity. 2. payment of any redemption, prepayment or acceleration premium. 3. nonpayment of principal or interest caused by the insolvency or negligence of any Trustee, Paying Agent or Bond Registrar, if any. If it becomes necessary to call upon the Financial Guaranty Insurance Policy, payment of principal requires surrender of Series 2006B Bonds or Series 2006C Certificates, as applicable, to the Insurance Trustee together with an appropriate instrument of assignment so as to permit ownership of such Series 2006B Bonds or Series 2006C Certificates, as applicable, to be 50

registered in the name of Ambac Assurance to the extent of the payment under the Financial Guaranty Insurance Policy. Payment of interest pursuant to the Financial Guaranty Insurance Policy requires proof of Holder entitlement to interest payments and an appropriate assignment of the Holder’s right to payment to Ambac Assurance. Upon payment of the insurance benefits, Ambac Assurance will become the owner of the Series 2006B Bonds or Series 2006C Certificates, as applicable, appurtenant coupon, if any, or right to payment of principal or interest on such Series 2006B Bonds or Series 2006C Certificates, as applicable, and will be fully subrogated to the surrendering Holder’s rights to payment. Ambac Assurance Corporation Ambac Assurance Corporation (“Ambac Assurance”) is a Wisconsin-domiciled stock insurance corporation regulated by the Office of the Commissioner of Insurance of the State of Wisconsin and licensed to do business in 50 states, the District of Columbia, the Territory of Guam, the Commonwealth of Puerto Rico and the U.S. Virgin Islands, with admitted assets of approximately $8,994,000,000 (unaudited) and statutory capital of $5,649,000,000 (unaudited) as of December 31, 2005. Statutory capital consists of Ambac Assurance’s policyholders’ surplus and statutory contingency reserve. Standard & Poor’s Credit Markets Services, a Division of The McGraw-Hill Companies, Moody’s Investors Service and Fitch Ratings have each assigned a triple-A financial strength rating to Ambac Assurance. Ambac Assurance has obtained a ruling from the Internal Revenue Service to the effect that the insuring of an obligation by Ambac Assurance will not affect the treatment for federal income tax purposes of interest on such obligation and that insurance proceeds representing maturing interest paid by Ambac Assurance under policy provisions substantially identical to those contained in its Financial Guaranty insurance policy shall be treated for federal income tax purposes in the same manner as if such payments were made by the Obligor of the Series 2006B Bonds or Series 2006C Certificates, as applicable. Ambac Assurance makes no representation regarding the Series 2006B Bonds and Series 2006C Certificates, or the advisability of investing in the Series 2006B Bonds or Series 2006C Certificates and makes no representation regarding, nor has it participated in the preparation of, the Official Statement other than the information supplied by Ambac Assurance and presented under the heading “BOND INSURANCE”. Available Information The parent company of Ambac Assurance, Ambac Financial Group, Inc. (the “Company”), is subject to the informational requirements of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and in accordance therewith files reports, proxy statements and other information with the Securities and Exchange Commission (the “SEC”). These reports, proxy statements and other information can be read and copied at the SEC’s public reference room at 100 F Street, N.E., Room 1580, Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further information on the public reference room. The SEC maintains an internet site at http://www.sec.gov that contains reports, proxy and information statements and other information regarding companies that file electronically with the SEC, including the Company. These reports, proxy statements and other information can also be read at the offices of the New York Stock Exchange, Inc. (the “NYSE”), 20 Broad Street, New York, New York 10005. Copies of Ambac Assurance’s financial statements prepared in accordance with statutory accounting standards are available from Ambac Assurance. The address of Ambac Assurance’s administrative offices and its telephone number are One State Street Plaza, 19th Floor, New York, New York, 10004 and (212) 668-0340. Incorporation of Certain Documents by Reference The following document filed by the Company with the SEC (File No. 1-10777) is incorporated by reference in this Official Statement: 1. The Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2004 and filed on March 15, 2005; 2. The Company’s Current Report on Form 8-K dated April 5, 2005 and filed on April 11, 2005; 3. The Company’s Current Report on Form 8-K dated and filed on April 20, 2005; 4. The Company’s Current Report on Form 8-K dated on May 3, 2005 and filed May 5, 2005; 5. The Company’s Quarterly Report on Form 10-Q for the fiscal quarterly period ended March 31, 2005 and filed on May 10, 2005; 6. The Company’s Current Report on Form 8-K dated and filed on July 20, 2005; 7. The Company’s Current Report on Form 8-K dated July 28, 2005 and filed on August 2, 2005; and

51

8. The Company’s Current Report on Form 10-Q for the fiscal quarterly period ended June 30, 2005 and filed on August 9, 2005. 9. The information furnished and deemed to be filed under Item 2.02 contained in the Company’s Current Report on Form 8-K dated and filed on October 19, 2005; 10. The Company’s Quarterly Report on Form 10-Q for the fiscal quarterly period ended September 30, 2005 and filed on November 9, 2005; 11. The Company’s Current Report on Form 8-K dated November 29, 2005 and filed on December 5, 2005; 12. The Company’s Current Report on Form 8-K dated and filed on January 25, 2006; and 13. The Company’s Current Report on Form 8-K dated January 23, 2006 and filed on January 27, 2006. All documents subsequently filed by the Company pursuant to the requirements of the Exchange Act after the date of this Official Statement will be available for inspection in the same manner as described above in “Available Information”. RATINGS The Series 2006A Bonds are rated “AA-,” “Aa3” and “AA-” by Fitch Ratings (“Fitch”), Moody’s Investors Service (“Moody’s”) and Standard & Poor’s Ratings Services (“Standard & Poor’s”), respectively. The Series 2006B Bonds and Series 2006C Certificates are expected to be rated “AAA,” “Aaa” and “AAA” by Fitch, Moody’s and Standard & Poor’s, respectively, based upon the financial guaranty insurance policy to be issued for the Series 2006B Bonds and Series 2006C Certificates by the Bond Insurer. See “BOND INSURANCE” herein. Fitch, Moody’s and Standard & Poor’s have assigned underlying ratings of “AA-,” “Aa3” and “AA-,” to the Series 2006B Bonds and Series 2006C Certificates. Ratings reflect only the views of the rating agencies, from whom an explanation of the significance of such ratings may be obtained. There is no assurance that ratings will continue for any given period of time or that they will not be revised downward or withdrawn entirely if, in the judgment of the rating agency, circumstances so warrant. Any such downward revision or withdrawal could have an adverse effect on the market price of the Series 2006 Obligations. The City and the Co-Financial Advisors will undertake no responsibility to oppose any revision or withdrawal of such ratings. TAX MATTERS—TAXABLE BONDS The following discussion describes the principal U.S. federal tax treatment of U.S. persons that are beneficial owners (“Owners”) of the Series 2006A Bonds (the “Taxable Bonds”). This summary is based on the Internal Revenue Code of 1986, as amended to the date hereof (the “Code”), published revenue rulings, judicial decisions and existing and proposed Treasury regulations, changes to any of which subsequent to the date of this official statement may affect the tax consequences described herein. This summary discusses only Taxable Bonds held as capital assets within the meaning of section 1221 of the Code. It does not discuss all of the tax consequences that may be relevant to an Owner in light of its particular circumstances or to Owners subject to special rules, such as certain financial institutions, insurance companies, tax-exempt organizations, foreign taxpayers, taxpayers who may be subject to the alternative minimum tax or personal holding company provisions of the Code, dealers in securities or foreign currencies, or Owners whose functional currency (as defined in section 985 of the Code) is not the U.S. dollar, or to an Owner that might have purchased the Taxable Bonds in circumstances that would give rise to original interest discount, acquisition premium, market discount or amortizable premium. Except as stated herein, this summary describes no federal, state or local tax consequences resulting from the ownership of, receipt of interest on, or disposition of, the Taxable Bonds. Investors who are subject to special provisions of the Code should consult their own tax advisors regarding the tax consequences to them of purchasing, holding, owning and disposing of the Taxable Bonds, including the advisability of making any of the elections described below, before determining whether to purchase the Taxable Bonds. For purposes of this discussion, a “U.S. person” means an individual who, for U.S. federal income tax purposes, is a citizen or resident of the United States, or a corporation, partnership or other entity created or organized in or under the laws of the United States or any political subdivision thereof, or an estate or trust the income of which is subject to U.S. federal income taxation regardless of its source of income. The term also includes nonresident alien individuals, foreign corporations, foreign partnerships, and foreign estates and trusts to the extent that their ownership of the Taxable Bonds is effectively connected with the conduct of a trade or business within the United States, as well as certain former citizens and residents of the United States who, under certain circumstances, are taxed on income from U.S. sources as if they were citizens or residents. In General The City has taken no action to cause any interest on the Taxable Bonds to be excludable from gross income for the purposes of federal income taxation, and therefore it is assumed for the purposes of this “TAX MATTERS—TAX BONDS”

52

section that income derived from a Taxable Bond by an Owner is subject to U.S. federal income taxation and that a Taxable Bond held by an individual who, at the time of death, is a U.S. person is subject to U.S. federal estate tax. Payments of Interest Stated interest paid on each Taxable Bond will generally be taxable in each tax year held by an Owner as ordinary interest income without regard to the time it otherwise accrues or is received in accordance with the Owner’s method of accounting for federal income tax purposes. Disposition or Retirement Upon the sale, exchange or other disposition of a Taxable Bond, or upon the retirement of a Taxable Bond (including by redemption), an Owner will recognize gain or loss equal to the difference, if any, between the amount realized upon the disposition or retirement and the Owner’s basis in the Taxable Bond. An Owner’s tax basis for determining gain or loss on the disposition or retirement of a Taxable Bond will be the cost of such Taxable Bond to such Owner, increased by the amount of original issue discount and any market discount includible in such Owner’s gross income with respect to such Taxable Bond, and decreased by the amount of any payments under the Taxable Bond that are part of its stated redemption price at maturity (i.e., all stated interest payments with respect to the Taxable Bonds previously paid) and by the portion of any premium applied to reduce interest payments as described above. Such gain or loss will be capital gain or loss (except to the extent the gain represents accrued original issue discount or market discount on the Taxable Bond not previously included in gross income, to which extent such gain would be treated as ordinary income). Any capital gain or loss will be long-term capital gain or loss if at the time of disposition or retirement the Taxable Bond has been held for more than one year. Information Reporting and Backup Withholding The City is required to report to the IRS payments of interest and accruals of original issue discount (if any) on Taxable Bonds held of record by U.S. persons other than corporations and other exempt holders. Such information will be filed each year with the IRS on Form 1099 which will reflect the name, address, and taxpayer identification number of the registered Owner. A copy of Form 1099 will be sent to each registered Owner of a Taxable Bond for federal income tax reporting purposes. Interest paid to an Owner of a Taxable Bond ordinarily will not be subject to withholding of federal income tax if such Owner is a U.S. person. Backup withholding of federal income tax at a rate of 28 percent may apply, however, to payments made in respect of the Taxable Bonds, as well as payments of proceeds from the sale of Taxable Bonds, to registered holders or Owners that are not “exempt recipients” and that fail to provide certain identifying information. This withholding generally applies if the Owner of a Taxable Bond (who is not an exempt recipient) (i) fails to furnish to the City such Owner’s social security number or other taxpayer identification number (“TIN”), (ii) furnishes the City an incorrect TIN, (iii) fails to properly report interest, dividends or other “reportable payments” as defined in the Code, or (iv) under certain circumstances, fails to provide the City or such Owner’s broker with a certified statement, signed under penalty of perjury, that the TIN provided to the City is correct and that such Owner is not subject to backup withholding. Individuals generally are not exempt recipients, whereas corporations and certain other entities generally are exempt recipients. To prevent backup withholding, each prospective holder will be requested to complete an appropriate form. Any amounts withheld under the backup withholding rules from a payment to a person would be allowed as a refund or a credit against such person’s U.S. federal income tax, provided that the required information is furnished to the IRS. Furthermore, certain penalties may be imposed by the IRS on a holder or Owner who is required to supply information but who does not do so in the proper manner. Treasury Circular 230 Disclosure The tax discussion set forth above was written to support the marketing of the Taxable Bonds and is not intended or written by Co-Bond Counsel to be used, and it cannot be used, by any taxpayer for the purpose of avoiding any penalties that may be imposed on a taxpayer by the Internal Revenue Service in respect of federal income taxes. No limitation has been imposed by Co-Bond Counsel on disclosure of the tax treatment or tax structure of the Taxable Bonds. Co-Bond Counsel will receive a non-refundable fee contingent upon the successful marketing of the Taxable Bonds, but not contingent on any taxpayer’s realization of tax benefits from the Taxable Bonds. All taxpayers should seek advice based on such taxpayer’s particular circumstances from an independent tax advisor. This disclosure is provided to comply with Treasury Circular 230. IN ADDITION, THE FEDERAL TAX DISCUSSION SET FORTH ABOVE IS INCLUDED FOR GENERAL INFORMATION ONLY AND MAY NOT BE APPLICABLE DEPENDING UPON AN OWNER’S PARTICULAR SITUATION. INVESTORS SHOULD CONSULT THEIR OWN TAX ADVISORS CONCERNING THE TAX IMPLICATIONS OF HOLDING AND DISPOSING OF THE TAXABLE BONDS UNDER APPLICABLE STATE OR LOCAL LAWS. FOREIGN INVESTORS SHOULD ALSO CONSULT THEIR OWN TAX ADVISORS REGARDING THE TAX CONSEQUENCES UNIQUE TO INVESTORS WHO ARE NOT U.S. PERSONS. 53

TAX MATTERS—TAX-EXEMPT OBLIGATIONS Tax Exemption In the opinion of Vinson & Elkins L.L.P. and Law Offices of Francisco G. Medina, Co-Bond Counsel, (i) interest on the Series 2006B Bonds and the Series 2006C Certificates (the “Tax-Exempt Obligations”) is excludable from gross income for federal income tax purposes under existing law and (ii) interest on the Tax-Exempt Obligations is not subject to the alternative minimum tax on individuals and corporations, except as described below in the discussion regarding the adjusted current earnings adjustment for corporations. The Internal Revenue Code of 1986, as amended (the “Code”), imposes a number of requirements that must be satisfied for interest on state or local obligations, such as the Tax-Exempt Obligations, to be excludable from gross income for federal income tax purposes. These requirements include limitations on the use of bond proceeds and the source of repayment of bonds, limitations on the investment of bond proceeds prior to expenditure, a requirement that excess arbitrage earned on the investment of bond proceeds be paid periodically to the United States and a requirement that the issuer file an information report with the Internal Revenue Service. The City has covenanted in the Series 2006B Bond Ordinance and the Series 2006C Certificate Ordinance that it will comply with these requirements. Co-Bond Counsel’s opinion will assume continuing compliance with the covenants of the Series 2006B Bond Ordinance and the Series 2006C Certificate Ordinance pertaining to those sections of the Code that affect the exclusion from gross income of interest on the Tax-Exempt Obligations for federal income tax purposes and, in addition, will rely on representations by the City, the City’s Co-Financial Advisors and the Underwriters with respect to matters solely within the knowledge of the City, the City’s Co-Financial Advisors and the Underwriters, respectively, which Co-Bond Counsel has not independently verified. If the City should fail to comply with the covenants in the Series 2006B Bond Ordinance or the Series 2006C Certificate Ordinance or if the foregoing representations should be determined to be inaccurate or incomplete, interest on the Tax-Exempt Obligations could become taxable from the date of delivery of the Tax-Exempt Obligations, regardless of the date on which the event causing such taxability occurs. The Code also imposes a 20% alternative minimum tax on the “alternative minimum taxable income” of a corporation if the amount of such alternative minimum tax is greater than the amount of the corporation’s regular income tax. Generally, the alternative minimum taxable income of a corporation (other than any S corporation, regulated investment company, REIT, REMIC or FASIT), includes 75% of the amount by which its “adjusted current earnings” exceeds its other “alternative minimum taxable income.” Because interest on tax exempt obligations, such as the Tax-Exempt Obligations, is included in a corporation’s “adjusted current earnings,” ownership of the Tax-Exempt Obligations could subject a corporation to alternative minimum tax consequences. Except as stated above, Co-Bond Counsel will express no opinion as to any federal, state or local tax consequences resulting from the receipt or accrual of interest on, or acquisition, ownership or disposition of, the Tax-Exempt Obligations. Co-Bond Counsel’s opinions are based on existing law, which is subject to change. Such opinions are further based on Co-Bond Counsel’s knowledge of facts as of the date thereof. Co-Bond Counsel assumes no duty to update or supplement its opinions to reflect any facts or circumstances that may thereafter come to Co-Bond Counsel’s attention or to reflect any changes in any law that may thereafter occur or become effective. Moreover, Co-Bond Counsel’s opinions are not a guarantee of result and are not binding on the Internal Revenue Service (the “Service”); rather, such opinions represent Co-Bond Counsel’s legal judgment based upon its review of existing law and in reliance upon the representations and covenants referenced above that it deems relevant to such opinions. The Service has an ongoing audit program to determine compliance with rules that relate to whether interest on state or local obligations is includable in gross income for federal income tax purposes. No assurance can be given whether or not the Service will commence an audit of the Tax-Exempt Obligations. If an audit is commenced, in accordance with its current published procedures the Service is likely to treat the City as the taxpayer and the Owners may not have a right to participate in such audit. Public awareness of any future audit of the Tax-Exempt Obligations could adversely affect the value and liquidity of the Tax-Exempt Obligations during the pendency of the audit regardless of the ultimate outcome of the audit. Additional Federal Income Tax Considerations Collateral Tax Consequences. Prospective purchasers of the Tax-Exempt Obligations should be aware that the ownership of tax exempt obligations may result in collateral federal income tax consequences to financial institutions, life insurance and property and casualty insurance companies, certain S corporations with Subchapter C earnings and profits, individual recipients of Social Security or Railroad Retirement benefits, taxpayers who may be deemed to have incurred or continued indebtedness to purchase or carry tax exempt obligations, taxpayers owning an interest in a FASIT that holds taxexempt obligations and individuals otherwise qualifying for the earned income credit. In addition, certain foreign corporations doing business in the United States may be subject to the “branch profits tax” on their effectively connected earnings and profits, including tax exempt interest such as interest on the Tax-Exempt Obligations. These categories of prospective purchasers should consult their own tax advisors as to the applicability of these consequences. Prospective purchasers of the Tax-Exempt

54

Obligations should also be aware that, under the Code, taxpayers are required to report on their returns the amount of tax-exempt interest, such as interest on the Tax-Exempt Obligations, received or accrued during the year. Tax Accounting Treatment of Original Issue Premium. The issue price of all or a portion of the Tax-Exempt Obligations may exceed the stated redemption price payable at maturity of such Tax-Exempt Obligations. Such Tax-Exempt Obligations (the “Premium Bonds”) are considered for federal income tax purposes to have “bond premium” equal to the amount of such excess. The basis of a Premium Bond in the hands of an initial owner is reduced by the amount of such excess that is amortized during the period such initial owner holds such Premium Bond in determining gain or loss for federal income tax purposes. This reduction in basis will increase the amount of any gain or decrease the amount of any loss recognized for federal income tax purposes on the sale or other taxable disposition of a Premium Bond by the initial owner. No corresponding deduction is allowed for federal income tax purposes for the reduction in basis resulting from amortizable bond premium. The amount of bond premium on a Premium Bond that is amortizable each year (or shorter period in the event of a sale or disposition of a Premium Bond) is determined using the yield to maturity on the Premium Bond based on the initial offering price of such bond. The federal income tax consequences of the purchase, ownership and redemption, sale or other disposition of Premium Bonds that are not purchased in the initial offering at the initial offering price may be determined according to rules that differ from those described above. All owners of Premium Bonds should consult their own tax advisors with respect to the determination for federal, state, and local income tax purposes of amortized bond premium upon the redemption, sale or other disposition of a Premium Bond and with respect to the federal, state, local, and foreign tax consequences of the purchase, ownership, and sale, redemption or other disposition of such Premium Bonds. Tax Accounting Treatment of Original Issue Discount Bonds. The issue price of all or a portion of the Tax-Exempt Obligations may be less than the stated redemption price payable at maturity of such Tax-Exempt Obligations (the “Original Issue Discount Bonds”). In such case, the difference between (i) the amount payable at the maturity of each Original Issue Discount Bond, and (ii) the initial offering price to the public of such Original Issue Discount Bond constitutes original issue discount with respect to such Original Issue Discount Bond in the hands of any owner who has purchased such Original Issue Discount Bond in the initial public offering of the Tax-Exempt Obligations. Generally, such initial owner is entitled to exclude from gross income (as defined in Section 61 of the Code) an amount of income with respect to such Original Issue Discount Bond equal to that portion of the amount of such original issue discount allocable to the period that such Original Issue Discount Bond continues to be owned by such owner. Because original issue discount is treated as interest for federal income tax purposes, the discussions regarding interest on the Tax-Exempt Obligations under the captions “—Tax Exemption” and “— Additional Federal Income Tax Considerations—Collateral Tax Consequences” generally applies, and should be considered in connection with the discussion in this portion of the Official Statement. In the event of the redemption, sale or other taxable disposition of such Original Issue Discount Bond prior to stated maturity, however, the amount realized by such owner in excess of the basis of such Original Issue Discount Bond in the hands of such owner (adjusted upward by the portion of the original issue discount allocable to the period for which such Original Issue Discount Bond was held by such initial owner) is includable in gross income. The foregoing discussion assumes that (a) the Underwriter has purchased the Tax-Exempt Obligations for contemporaneous sale to the public and (b) all of the Original Issue Discount Bonds have been initially offered, and a substantial amount of each maturity thereof has been sold, to the general public in arm’s-length transactions for a price (and with no other consideration being included) not more than the initial offering prices thereof stated on the cover page of this Official Statement. Neither the City nor Co-Bond Counsel has made any investigation or offers any comfort that the Original Issue Discount Bonds will be offered and sold in accordance with such assumptions. Under existing law, the original issue discount on each Original Issue Discount Bond is accrued daily to the stated maturity thereof (in amounts calculated as described below for each six-month period ending on the date before the semiannual anniversary dates of the date of the Tax-Exempt Obligations and ratably within each such six-month period) and the accrued amount is added to an initial owner’s basis for such Original Issue Discount Bond for purposes of determining the amount of gain or loss recognized by such owner upon the redemption, sale or other disposition thereof. The amount to be added to basis for each accrual period is equal to (a) the sum of the issue price and the amount of original issue discount accrued in prior periods multiplied by the yield to stated maturity (determined on the basis of compounding at the close of each accrual period and properly adjusted for the length of the accrual period) less (b) the amounts payable as current interest during such accrual period on such Tax-Exempt Obligation. The federal income tax consequences of the purchase, ownership, and redemption, sale or other disposition of Original Issue Discount Bonds which are not purchased in the initial offering at the initial offering price may be determined according to rules which differ from those described above. All owners of Original Issue Discount Bonds should consult their own tax advisors with respect to the determination for federal, state, and local income tax purposes of interest accrued upon redemption, sale or other disposition of such Original Issue Discount Bonds and with respect to the federal, state, local and foreign tax consequences of the purchase, ownership, redemption, sale or other disposition of such Original Issue Discount Bonds.

55

LEGAL PROCEEDINGS The delivery of the Series 2006 Obligations is subject to receipt of the approving opinions of the Attorney General of the State of Texas and the opinions of Co-Bond Counsel, Vinson & Elkins L.L.P., Houston, Texas, and Law Offices of Francisco G. Medina, Houston, Texas, as to the validity of the issuance of the Series 2006 Obligations under the Constitution and laws of the State. The opinions of Co-Bond Counsel will be based upon an examination of transcripts of certain proceedings taken by the City incident to the issuance and authorization of the Series 2006 Obligations. Copies of the proposed opinions of Co-Bond Counsel to be issued in connection with the issuance of the Series 2006 Obligations are included in APPENDIX C to this Official Statement. Certain matters will be passed on for the City by its Special Disclosure Co-Counsel, Andrews Kurth LLP, Houston, Texas and Bates & Coleman, P.C., Houston, Texas. Certain other legal matters will be passed on for the Underwriters by Counsel to the Underwriters, Greenberg Traurig, L.L.P., Houston, Texas. The fees of Co-Bond Counsel, Special Disclosure Co-Counsel, and Underwriters’ Counsel for their services with respect to the Series 2006 Obligations are contingent upon the sale and delivery of the Series 2006 Obligations. CO-FINANCIAL ADVISORS First Southwest Company and Estrada Hinojosa & Company, Inc. (the “Co-Financial Advisors”) have been retained by the City as co-financial advisors in connection with the issuance of the Series 2006 Obligations and, in such capacity, have assisted the City in the preparation of documents. The fee for the Co-Financial Advisors for services rendered with respect to the sale of the Series 2006 Obligations is not contingent upon the issuance and delivery of the Series 2006 Obligations. Although the Co-Financial Advisors have read and participated in the preparation of this Official Statement, the CoFinancial Advisors have not independently verified any of the information set forth herein. The information contained in this Official Statement has been obtained primarily from the City’s records and from other sources which are believed to be reliable, including financial records of the City and other entities which may be subject to interpretation. No guarantee is made as to the accuracy or completeness of any such information. No person, therefore, is entitled to rely upon the participation of the CoFinancial Advisors as an implicit or explicit expression of opinion as to the completeness and accuracy of the information contained in this Official Statement. FINANCIAL STATEMENTS The basic financial statements of the City for the year ended June 30, 2005, included in this Official Statement in APPENDIX A, have been audited by Deloitte & Touche LLP. The City has not requested Deloitte & Touche LLP to reissue its report related to the basic financial statements, and Deloitte & Touche LLP has not performed any procedures in connection with this Official Statement. UNDERWRITING The Series 2006 Obligations are being purchased pursuant to one purchase contract (the “Purchase Contract”) between the City and Morgan Stanley & Co. Incorporated, as representative (the “Representative”) of the several underwriters named on the cover page (collectively, the “Underwriters”). The Purchase Contract provides that the Underwriters will purchase all of the Series 2006 Obligations, if any are purchased, the obligation to make such purchase being subject to certain terms and conditions set forth in the Purchase Contract, the approval of certain legal matters by counsel and certain other conditions. The Underwriters may offer and sell the Series 2006 Obligations to certain dealers and others at prices lower than the offering prices stated on the inside cover page. The offering prices may be changed from time to time by the Underwriters. The Underwriters have agreed, subject to certain conditions, to purchase the Series 2006A Bonds at a price of $63,443,074.42 (which consists of the principal amount of the Series 2006A Bonds, less an Underwriters’ discount of $296,925.58). The Underwriters have agreed, subject to certain conditions, to purchase the Series 2006B Bonds at a price of $24,329,672.97 (which consists of the principal amount of the Series 2006B Bonds, less an Underwriters’ discount of $128,273.33, plus a net original issue premium of $452,946.30). The Underwriters have agreed, subject to certain conditions, to purchase the Series 2006C Certificates at a price of $3,534,524.65 (which consists of the principal amount of the Series 2006C Certificates, less an Underwriters’ discount of $14,613.80, plus a net original issue premium of $234,138.45). FORWARD LOOKING STATEMENTS The statements contained in this Official Statement, and in any other information provided by the City, that are not purely historical are forward looking statements, including statements regarding the City’s expectations, hopes, intentions, or strategies regarding the future. Readers should not place undue reliance on forward looking statements. All forward looking statements in this Official Statement are based on information available to the City on the date hereof, and the City assumes no

56

obligation to update any such forward looking statements. It is important to note that the City’s actual results could differ materially from those in such forward looking statements. The forward looking statements herein are necessarily based on various assumptions and estimates and are inherently subject to various risks and uncertainties, including risks and uncertainties relating to the possible invalidity of the underlying assumptions and estimates and possible changes or development in social, economic, business, industry, market, legal and regulatory circumstances and conditions and actions taken or omitted to be taken by third parties, including customers, suppliers, business partners and competitors, and legislative, judicial and other governmental authorities and officials. Assumptions related to the foregoing involve judgments with respect to, among other things, future economic, competitive, and market conditions and future business decisions, all of which are difficult or impossible to predict accurately and many of which are beyond the control of the City. Any of such assumptions could be inaccurate and, therefore, there can be no assurance that the forward looking statements included in this official statement would prove to be accurate. REGISTRATION, SALE AND DISTRIBUTION The Series 2006 Obligations have not been registered under the federal Securities Act of 1933, as amended (in reliance upon an exemption therefrom), or the blue sky laws of any jurisdiction. The Ordinances have not been qualified under the federal Trust Indenture Act of 1939, as amended (in reliance upon an exemption therefrom). CONTINUING DISCLOSURE OF INFORMATION In the Ordinances, the City has made the following agreement for the benefit of the holders and beneficial owners of the Series 2006 Obligations. The City is required to observe this agreement for as long as it remains obligated to advance funds to pay the Series 2006 Obligations. Under the Ordinances, the City will be obligated annually to provide certain updated financial information and operating data and timely notice of specified material events, to certain information vendors. This information is available to securities brokers and others who subscribe to receive information from the vendors. Annual Reports The City will provide certain updated financial information and operating data to certain informational vendors annually. The information to be updated includes all quantitative financial information and operating data of the general type included in this Official Statement under APPENDIX A and the schedules listed in APPENDIX D. The City will update and provide this information within six months after the end of each fiscal year. The City will provide updated information to each nationally recognized municipal securities information repository (“NRMSIR”) and any state information depository (“SID”) designated for the State and approved by the staff of the United States Securities and Exchange Commission (the “SEC”). See APPENDIX D relating to the City’s obligation to update Schedules 12 (Part 2), 12A, 12B, and 12C, which contain actuarial information relating to the Pension Systems. The City may provide updated information in full text or in such other form consistent with the agreement, as permitted by the SEC Rule 15c2-12 (the “Rule”). The updated information will include audited financial statements, if the City commissions an audit and if the audit is completed by the required time. If audited financial statements are not provided by that time, the City will provide unaudited financial statements by the required time and audited financial statements if and when they become available. Any such financial statements will be prepared in accordance with the accounting principles described in APPENDIX A or such other accounting principles as the City may be required to employ from time to time pursuant to state law or regulation. Currently, the City’s fiscal year-end is June 30. Accordingly, the City must provide the updated information by December 31 in each calendar year, unless the City changes its fiscal year. If the City changes its fiscal year, it will notify each NRMSIR and any SID of the change. Material Event Notices The City also will provide timely notices of certain events to certain information vendors. The City will provide notice of any of the following events with respect to the Series 2006 Obligations, if such event is material to a decision to purchase or sell Series 2006 Obligations: (1) principal and interest payment delinquencies; (2) non-payment related defaults; (3) unscheduled draws on debt service reserves reflecting financial difficulties; (4) unscheduled draws on credit enhancements reflecting financial difficulties; (5) substitution of credit or liquidity providers, or their failure to perform; (6) adverse tax opinions or events affecting the tax-exempt status of the Series 2006 Obligations; (7) modifications to rights of holders of the Series 2006 Obligations; (8) Series 2006 Obligation calls; (9) defeasances; (10) release, substitution, or sale of property securing repayment of the Series 2006 Obligations; and (11) rating changes. Neither the Series 2006 Obligations nor the Ordinances make any provision for debt service reserves, credit enhancement (with the exception of bond insurance), or liquidity enhancement. In addition, the City will provide timely notice of any failure by the City to provide financial information or operating data in accordance with its agreement described above under “CONTINUING DISCLOSURE OF INFORMATION — Annual Reports.” The City will provide each notice described in this paragraph to any SID and to either each NRMSIR or the Municipal Securities Rulemaking Board (the “MSRB”). 57

Availability of Information from NRMSIRs and SID The City has agreed to provide the foregoing information only to NRMSIRs and any SID. The information will be available to holders of and beneficial owners of the Series 2006 Obligations only if the holders comply with the procedures and pay the charges established by such NRMSIRs or SID or obtain the information through securities brokers who have done so. The Municipal Advisory Council of Texas (the “MACT”) has been designated by the State as a SID, and the SEC has determined that it is a qualified SID. Any filing under this Official Statement may be made solely by transmitting such filing to the MACT as provided at http://www.disclosureusa.org unless the SEC has withdrawn the interpretive advice in its letter to the MACT dated September 7, 2004. The address of the MACT is 600 West 8th Street, P.O. Box 2177, Austin, Texas 78768-2177, and its telephone number is (512) 476-6947. Limitations and Amendments The City has agreed to update information and to provide notices of material events only as described above. The City has not agreed to provide other information that may be relevant or material to a complete presentation of its financial results of operations, condition, or prospects or agreed to update any information that has been provided, except as described above. The City makes no representation or warranty concerning such information or concerning its usefulness to a decision to invest in or sell Series 2006 Obligations at any future date. The City disclaims any contractual or tort liability for damages resulting in whole or in part from any breach of its continuing disclosure agreement or from any statement made pursuant to its agreement, although holders of Series 2006 Obligations may seek a writ of mandamus to compel the City to comply with its agreement. The City may amend its continuing disclosure agreement to adapt to changed circumstances that arise from a change in legal requirements, a change in law, or a change in the identity, nature, status, or type of operations of the City, if the agreement, as amended, would have permitted an underwriter to purchase or sell Series 2006 Obligations in the offering described herein in compliance with the Rule, and either the holders of a majority in aggregate principal amount of the outstanding Series 2006 Obligations to which the agreement relates or any person unaffiliated with the City (such as nationally recognized bond counsel) determines that the amendment will not materially impair the interests of the beneficial owners of such Series 2006 Obligations. The City may also amend or repeal the agreement if the SEC amends or repeals the applicable provisions of the Rule or a court of final jurisdiction determines that such provisions are invalid, and the City may amend the agreement in its discretion in any other circumstance or manner, but in either case only to the extent that its right to do so would not prevent the Underwriters from purchasing the Series 2006 Obligations in the offering described herein in compliance with the Rule. If the City amends its agreement, it must include with the next financial information and operating data provided in accordance with its agreement described above under “CONTINUING DISCLOSURE OF INFORMATION — Annual Reports” an explanation, in narrative form, of the reasons for the amendment and of the impact of any change in the type of information and operating data provided. See “APPENDIX D — SUMMARY OF SCHEDULES RELATED TO CONTINUING DISCLOSURE OF INFORMATION.” Compliance with Prior Undertakings The City has complied in all material respects with all continuing disclosure agreements made by it in accordance with the Rule. GENERAL INFORMATION The description herein of the Series 2006 Obligations and the Ordinances do not purport to be complete, and all such descriptions or references thereto are qualified in their entirety by reference to the complete forms of the Ordinances. Statements made herein involving estimates or projections, whether or not expressly identified as such, should not be construed to be statements of fact or as representations that such estimates or projections will ever be attained or will approximate actual results. Any summaries or excerpts of constitutional provisions, statutes, ordinances or other documents do not purport to be complete statements of same and are made subject to all of the provisions thereof. Reference should be made to such original sources in all respects. This Official Statement is not to be construed as a contract with the Underwriters or the holders of any of the Series 2006 Obligations. For additional information with respect to the financial condition of the City, a copy of the June 30, 2005 Comprehensive Annual Financial Report of the City of Houston, Texas is available upon written request addressed to the City Controller, P.O. Box 1562, Houston, Texas 77251-1562. A copy of the most recent quarterly investment report is also available upon request from the City Controller. Copies of the Ordinances may be obtained from Anna Russell, City Secretary, City Hall Annex, 900 Bagby, Level P, Room P-101, Houston, Texas, or by mail, P.O. Box 1562, Houston, Texas 77251-1562.

__________________________________________________
This document has been approved by the City Council of the City of Houston.

58

APPENDIX A AUDITED BASIC FINANCIAL STATEMENTS OF THE CITY

[THIS PAGE INTENTIONALLY LEFT BLANK]

A-1

A-2

City of Houston, Texas
Management’s Discussion and Analysis (Unaudited) June 30, 2005 As management of the City of Houston, we offer readers of the City of Houston’s financial statements this narrative overview and analysis of the financial activities of the City of Houston for the fiscal year ended June 30, 2005. Please read this information in conjunction with the basic financial statements that follow this section. The discussion and analysis includes comparative data for 2004. All amounts, unless otherwise indicated, are expressed in millions of dollars. Financial Highlights Some of the City’s financial highlights for the fiscal year ending June 30, 2005 include: • • • • • The assets of the City of Houston exceeded its liabilities at the close of the most recent fiscal year by $4.5 billion. The City’s total net assets decreased during the year by $532 million. Unrestricted assets are a deficit of $775 million. The City of Houston’s total expenses were $3.435 billion. Program revenues of $1.512 billion reduced the net cost of the City’s functions to be financed from the City’s general revenues to $1.923 billion.

Overview of the Financial Statements This discussion and analysis is intended to serve as an introduction to the City of Houston’s basic financial statements. The City of Houston’s basic financial statements are comprised of three components: (1) government-wide financial statements, (2) fund financial statements, and (3) notes to the financial statements. Government-wide financial statements. The government-wide financial statements are designed to provide readers with a broad overview of the City of Houston’s finances, in a manner similar to a privatesector business. The statement of net assets presents information on all of the City of Houston’s assets and liabilities, with the difference between the assets and liabilities reported as net assets. Over time, increases and decreases in net assets may serve as a useful indicator of whether the financial position of the City of Houston is improving or deteriorating. The statement of activities presents information showing how the government’s net assets changed during the most recent fiscal year. All changes in net assets are reported as soon as the underlying event giving rise to the change occurs, regardless of the timing of related cash flows. Thus, revenues and expenses are reported in this statement for some items that will not result in cash flows until future fiscal periods (e.g., uncollected taxes and earned but unused vacation leave). Both of the government-wide financial statements distinguish between functions of the City of Houston that are principally supported by taxes and intergovernmental revenues (governmental activities) from other functions that are intended to recover all or a significant portion of their costs through user fees and charges (business-type activities). The governmental activities of the City of Houston include general government, public safety, public works, health, housing and community development, parks and recreation, and library. The business-type activities of the City of Houston include the airport system, water & sewer system and convention & entertainment facilities.

A-3

The government-wide financial statements include not only the City of Houston itself (known as the primary government), but also legally separate component units for which the City of Houston is financially accountable. With the exception of the Houston Area Water Corporation and the three pension systems, financial information for the component units is reported separately from the financial information presented for the primary government itself. The Houston Area Water Corporation and the pension systems, although also legally separate, function for all practical purposes as departments of the City of Houston, and therefore have been included as an integral part of the primary government. Fund financial statements. A fund is a group of related accounts that is used to maintain control over resources that have been segregated for specific activities or objectives. The City of Houston, like other state and local governments, uses fund accounting to ensure and demonstrate compliance with financerelated legal requirements. All of the funds of the City of Houston can be divided into three categories: governmental funds, proprietary funds, and fiduciary funds. Governmental funds. Governmental funds are used to account for essentially the same functions reported as governmental activities in the government-wide financial statements. However, unlike the governmentwide statements, fund financial statements focus on near-term inflows and outflows of spendable resources, as well as on balances of spendable resources available at the end of the fiscal year. Such information may be useful in evaluating a government’s near-term financing requirements. Because the focus of governmental funds is narrower than that of the government-wide financial statements, it is useful to compare the information presented for governmental funds with similar information presented for governmental activities in the government-wide financial statements. By doing so, readers may better understand the long-term impact of the government’s near-term financing decisions. The governmental fund balance sheet (see pgs. 18-19) displays a reconciliation to facilitate this comparison between governmental funds. The reconciliation between the governmental fund statement of revenues, expenditures, and changes in fund balances and governmental activities is provided on a separate schedule (see page 22). The City of Houston maintains nine individual governmental funds for financial reporting purposes. Information is presented separately in the governmental fund balance sheet (see page 18) and in the governmental fund statement of revenues, expenditures, and changes in fund balances (see page 20) for the general fund, the debt service fund, the capital projects fund and the grants fund, all of which are considered to be major funds. Data from the other funds is combined in the column labeled “Nonmajor Governmental Funds” on both of these statements (see also the separate tab labeled “Governmental Funds” for more information on these funds). Proprietary funds. The City of Houston maintains two different types of proprietary funds (see statements beginning on page 24): Enterprise funds (see also separate tab of same name) and internal service funds (see also separate tab of same name). Enterprise funds are used to report the same functions presented as business-type activities in the government-wide financial statements. The City of Houston uses enterprise funds to account for its aviation system, combined utility system (formerly called the water and sewer system), and the convention and entertainment facilities. The City also includes the Houston Area Water Corporation as a nonmajor proprietary fund. Internal service funds are an accounting device used to accumulate and allocate costs internally among the City of Houston’s various functions. The City of Houston uses internal service funds to account for health and benefits and long-term disability activities. Because both of these services predominantly benefit governmental rather than business-type functions, they have been included within governmental activities in the government-wide financial statements. Proprietary funds provide the same type of information as the government-wide financial statements, only in more detail. The proprietary fund financial statements provide separate information for the aviation system combined utility system and convention and entertainment facilities, all of which are considered to be major funds for the City of Houston. Conversely, both internal service funds are combined into a single, aggregated presentation in the proprietary fund financial statements.

A-4

Fiduciary funds. Fiduciary funds (see separate tab of same name) are used to account for resources held for the benefit of parties outside the government. Fiduciary funds are not reflected in the governmentwide financial statements because the resources of those funds are not available to support the City of Houston’s own programs. The accounting used for fiduciary funds is much like that used for proprietary funds. Notes to the financial statements. The notes (see separate tab of same name) provide additional information that is essential to a full understanding of the data provided in the government-wide and fund financial statements. Other information. In addition to the basic financial statements and accompanying notes, this report also presents certain required supplementary information concerning: General fund – budget vs. actual (pgs. 112-115); general budget policies (pg. 117); and the City of Houston’s progress in funding its obligation to provide pension benefits to its employees (pg. 118). Government-wide Financial Analysis As noted earlier, net assets may serve over time as a useful indicator of a government’s financial position. In the case of the City of Houston, on a government-wide basis, assets exceeded liabilities by $4.5 billion at the close of the most recent fiscal year.

Net Assets June 30, 2005 (W comparative totals for 2004) ith (in millions) Governm ental Activities 2005 2004 Current and other assets Capital assets Total assets Long-termliabilities Other liabilities Total liabilities Net assets Invested in capital assets, net of related debt Restricted Unrestricted (deficit) Total net assets $ 787 5,558 6,345 2,995 511 3,506 3,532 169 (862) 2,839 $ $ 750 5,500 6,250 2,597 445 3,042 3,388 206 (386) 3,208 $ $ Business-type Activities 2005 2004 1,991 7,850 9,841 7,668 486 8,154 1,138 462 87 1,687 $ 1,905 7,536 9,441 7,202 389 7,591 1,361 502 (13) 1,850 $ $

Total 2005 2,778 13,408 16,186 10,663 997 11,660 4,670 631 (775) 4,526 $ $ 2004 2,655 13,036 15,691 9,799 834 10,633 4,749 708 (399) 5,058

$

$

.

A-5

By far the largest portion of the City of Houston’s net assets (103.2%) reflects its investment in capital assets (e.g., land, building, machinery, equipment and infrastructure), less any related debt used to acquire those assets that is still outstanding. The City of Houston uses these capital assets to provide services to citizens; consequently, these assets are not available for future spending. Although the City of Houston’s investment in its capital assets is reported net of related debt, it should be noted that the resources needed to repay this debt must be provided from other sources, since the capital assets themselves cannot be used to liquidate these liabilities. An additional portion of the City of Houston’s net assets (13.9%) represents resources that are subject to external restrictions on how they may be used.

Change in Net Assets June 30, 2005 (With comparative totals for 2004) (in millions)

Governmental Activities 2005 2004 Program Revenues: Charges for services Operating grants and contributions Capital grants and contributions General revenues: Property taxes Sales taxes Other taxes Other Total revenues Expenses: General government Public safety Public works Health Housing and community development Parks and recreation Library Retiree benefits Interest on Long-term Debt Depreciation and amortization Airport System Convention & Entertainment Facilities Combined Utility System Total expenses Change in net assets before contributions, special items and transfers Contributions Special items Transfers Change in net assets Net assets July 1 Net assets June 30 $ 229 162 38 665 371 186 41 1,692 $ 219 144 46 646 348 185 37 1,625 $

Business-type Activities 2005 2004 972 4 106 42 74 1,198 $ 819 22 42 47 57 987 $

Total 2005 1,201 166 144 665 371 228 115 2,890 $ 2004 1,038 166 88 646 348 232 94 2,612

144 1,128 283 124 79 84 49 29 116 96 2,132 (440) 11 2 58 (369) 3,208 2,839

234 903 251 105 63 63 38 27 96 86 1,866 (241) 40 3 39 (159) 3,367 3,208

407 134 762 1,303 (105) (58) (163) 1,850 1,687

316 92 681 1,089 (102) (13) (39) (154) 2,004 1,850

144 1,128 283 124 79 84 49 29 116 96 407 134 762 3,435 (545) 11 2 (532) 5,058 4,526

234 903 251 105 63 63 38 27 96 86 316 92 681 2,955 (343) 40 (10) (313) 5,371 5,058

$

$

$

$

$

$

A-6

Governmental activities. Governmental activities decreased the City of Houston’s net assets by $369 million. Key elements of this change are as follows: • • • • Sales tax revenue continued to show improvements during fiscal year 2005 providing a 7% increase for the year, from $348 million to $371 million. The City’s property tax rate was lowered by $.005 to $0.65 per $100 assessed value. Property tax revenue increased by $19 million because of the City’s rising property values and continued effort in the collection of delinquent taxes. The largest increase in expenses was in the area of public safety - $225 million. This was offset by a decrease in General Government expenses - $90 million. Retiree benefits were up 7% from $27 million to $29 million, reflecting the overall issue of increased health care costs.

Revenue by Source - Governmental Activities

Other 2% Charges for services 14% Operating grants and contributions 10% Capital grants and contributions 2%

Other taxes 11%

Sales taxes 22%

Property taxes 39%

A-7

Program Revenue and Expense Governmental

$1,200 $1,000 $800
Expense

$600 $400 $200 $0
opm en t nt rm D eb t ants lth a ry s s a fet y Publ ic w orks ation nme H ea Libr nefit l - gr rtiza tion

Revenue

re c re

gove r

Publ ic

deve l

e be

es t o n Lo ng-te Inter

G en e ra l

mmu nity

rnm enta

Reti re

an d

Park s

gove

Business-type activities. Business-type activities decreased the City of Houston’s net assets by $163 million. Key elements of this change are as follows: • • Airport systems operating expenses were up by 28%, from $257 million to $330 million. Operating revenues for these facilities were up by 31%, from $270 million to $354 million. Investment income increased by 150% from $6 million to $15 million. Convention & Entertainment operating expenses were relatively the same at $43 million. Operating revenues increased by 12% from $17 million to $19 million. Hotel occupancy taxes decreased by 11%, from $47 million to $42 million. Contributions out reflect a donation of $41.4 million of land to the Houston Downtown Park Corporation for the purpose of building a park across the street from the George R. Brown Convention Center. The Convention and Entertainment Fund had purchased the property over a two-year period for this purpose. The Combined Utility System operating expenses increased by 17% from $476 million to $557 million. Operating revenues increased by 13% from $531 million to $599 million. Investment income was up by 86%, from $7 million to $13 million and interest expense was down by 2%, from $205 million to $201 million. Also, contributions were up 91%, from $22 million to $42 million.

Hou sing a

A-8

D ep re c i a tion

nd c o

Inter

and

amo

Revenue by Source Business-type
Capital grants and contributions 9% Other taxes 4% Operating grants and contributions 0%

Other 6%

Charges for services 81%

ProgramRevenue & Expense Business-type
$700

$600

$500

$400

Revenue
Operating expense

$300

Nonoperating expense
Interest expense

$200

$100

$0 Airport System Convention & Entertainment Combined Utility

A-9

Financial Analysis of the Government’s Funds As noted earlier, the City of Houston uses fund accounting to ensure and demonstrate compliance with finance-related legal requirements. Governmental funds (see pgs.18-21 and separate tab of same name). The focus of the City of Houston’s governmental funds is to provide information on near-term inflows, outflows, and balances of spendable resources. Such information is useful in assessing the City of Houston’s financing requirements. In particular, unreserved fund balance may serve as a useful measure of a government’s net resources available for spending at the end of the fiscal year. As of the end of the current fiscal year, the City of Houston’s governmental funds reported combined ending fund balances of $438 million. Approximately 48% of this total amount ($210 million) constitutes unreserved fund balance, which is available for spending at the government’s discretion. The remainder of fund balance is reserved to indicate that it is not available for new spending because it has already been committed (1) for capital expenditures ($97 million), (2) to pay debt service ($109 million), or (3) a variety of other restricted purposes ($21.5 million). The general fund is the chief operating fund of the City of Houston. At the end of the current fiscal year, unreserved fund balance of the general fund was $142.7 million, while the total fund balance reached $170 million. As a measure of the general fund’s liquidity, it may be useful to compare both unreserved fund balance and total fund balance to total fund expenditures. Unreserved fund balance represents 10.6% of total general fund expenditures, while total fund balance represents 12.7% of that same amount. Key differences between last year’s general fund activity and this year’s include: • • • • • • $37 million increase in total revenues $59 million increase in expenditures $84.5 million increase in proceeds for issuance of debt $5.8 million decrease in transfers from other funds $3.1 million increase in interest expenditures $22 million increase in transfers to other funds

The debt service fund has a total fund balance of $107 million, all of which is reserved for the payment of debt service. The net increase in fund balance during the current fiscal year in the debt service fund was $15 million. Interest expenditures decreased by $9 million. The capital projects fund, which is used for the acquisition and/or construction of capital facilities by the City (except those financed by Enterprise Funds), has a fund balance of $90.5 million. The net increase in fund balance during the current fiscal year was $15 million. The grants fund is used to account for grant resources received from various local, state and national agencies and organizations. The grants fund has a reserved fund balance of $3 million.

Proprietary funds (see pgs.24-33 and tabs labeled “Enterprise Funds” and “Internal Services Funds”). The City of Houston proprietary funds provide the same type of information found in the governmentwide financial statements, but in more detail. At the end of the year, unrestricted net assets were $0 for the Airport System, $19.2 million for Convention and Entertainment, $68 million for the Combined Utility System and $75 thousand for the Houston Area Water Corporation. The total increase in net assets for the Airport System and the Houston Area Water Corporation funds were $31 million and $27 million, respectively. The Combined Utility System and the Convention and Entertainment funds experienced decreases of $171 million and $50 A-10

million, respectively. Other factors concerning the finances of these funds have already been addressed in the discussion of the City of Houston’s business-type activities.

General Fund Budgetary Highlights Total revenues were below of budget (pgs. 112-115), by $1 million. The details of the more significant variances are detailed below: • • • • • • • • $2 million increase in franchise taxes $2 million increase in license and permits $5 million decrease in direct services for other funds $1 million increase in municipal courts fines and forfeits $2 million decrease in other fines and forfeits $1 million increase in interest $1 million decrease in ambulance fees $4 million increase in other revenues

Total expenditures for the General Fund were $36 million below the final expenditure budget. The details of the more significant variances are detailed below: • • • $3 million decrease in total general government expenditures $28 million decrease in public safety expenditures $1 million decrease in debt service interest

Capital Asset and Debt Administration Capital assets (see Note 6, Capital Assets, pages 71–72). The City of Houston’s investment in capital assets for its governmental and business-type activities as of June 30, 2005, amounts to $13 billion (net of accumulated depreciation). This investment in capital assets includes land, buildings and improvements, machinery, equipment, storm drainage, streets and bridges. The total increase in the City of Houston’s net investment in capital assets for the current fiscal year was 3% (a 1% increase for governmental activities and a 4% increase for business-type activities).

Capital Assets June 30, 2005 (With comparative totals for 2004) (net of depreciation in millions)

Governmental Activities 2005 Land Buildings, improvements and equipment Plants, lines and rights Construction in progress Infrastructure Assets Total $ 362 554 354 4,288 $ 5,558 $ $ 2004 355 528 326 4,291 5,500 $ $

Business-type Activities 2005 394 2,618 3,585 1,253 7,850 $ $ 2004 400 2,160 3,554 1,422 7,536 $ 2005 756 3,172 3,585 1,607 4,288 $ 13,408

Total 2004 $ 755 2,688 3,554 1,748 4,291 $ 13,036

A-11

Major capital asset events during the current fiscal year included the following: • • • • Governmental and Business-type activities construction in process balance reflects a $141 million decrease. Governmental and Business-type activities land balance reflects a $1 million increase. Business-type activities buildings, improvements and equipment balance reflect a $458 million increase. Business-type activities plants, lines and rights balance reflects a $31 million increase.

More detailed information about the City’s capital assets is presented in Note 6 to the financial statements. Long-term debt (Note 8, pages 73–90). At the end of the current fiscal year, the City of Houston had total bonded debt outstanding of $10.2 billion. The two largest portions of this total are made up of $2.4 billion comprising debt backed by the full faith and credit of the government and $7.0 billion comprising various enterprise fund revenue bonds which are payable from future revenues of the various operations of those enterprise funds. The City issued $357 million in pension bonds during the fiscal year to reduce the unfunded liability of the Houston Municipal Employees Pension System and the Houston Police Officers Pension System. The remainder of the City of Houston’s debt represents various long-term contracts and capital leases.
Outstanding Debt June 30, 2005 (With comparative totals for 2004) (in millions) Governmental Activities 2005 General obligation bonds and commercial paper Pension notes Inferior lien contract Capital lease Revenue bonds Other borrowings Total 2004 Business-type Activities 2005 2004 2005

Total 2004

$

2,155 262 51 23 2,491

$

2,072 52 25 2,149

$

251 95 60 6,996 267 7,669

$

6,873 246 7,119

$

2,406 357 60 51 6,996 290

$

2,072 52 6,873 271 9,268

$

$

$

$

$ 10,160

$

The City’s total debt increased by $892 million or 9.6% during the current fiscal year. During the current fiscal year, the City issued the following debt: • • • • $357 million of pension obligations to reduce unfunded accrued actuarial liability. $178 million of general obligation debt to refund commercial paper and to fund a judgment. $181 million of combined utility system revenue bonds to improve the system and refund commercial paper. $93 million of airport system revenue bonds to refund prior debt to provide present value savings.

A-12

Standard & Poor’s, Moody’s and Fitch’s underlying ratings of the City’s obligations are as follows:

General Obligation Water & Sewer System Junior Lien Combined Utility System First Lien Houston Airport System Convention & Entertainment

Std & Poor's AAA+ A+ A A-

Moody's Aa3 A1 A2 A1 A3

Fitch's AAA+ A A+ n/r

State statutes limit the amount of general obligation debt a governmental entity may issue to 10% of its total assessed valuation. The current debt limitation for the City of Houston is $12.2 billion, which is significantly in excess of the City of Houston’s outstanding general obligation debt.

Next Year’s Budget and Rates Highlights of the FY06 budget are as follows: • • Decreased the property tax rate by ¼ cent to 64.75 cents per $100 of valuation and increased the homestead exemption for seniors. Increased the public safety budget by $48 million, primarily due to Firefighter raises, two new fire stations and three new police academy classes.

A-13

CITY OF HOUSTON, TEXAS STATEMENT OF NET ASSETS June 30, 2005 (amounts expressed in thousands)

Governmental Activities Assets Equity in pooled cash and investments Receivables, net of allowances Accounts receivable Hotel occupancy tax receivable Property taxes receivable Sales taxes receivable Mixed beverage taxes receivable Franchise taxes receivable Special assessments receivable Accrued Interest and other Due from component units Internal balances Due from other governments Inventory Prepaid items Deferred charges for issuance cost Restricted assets Investments Assessments receivable Accrued interest receivable Amounts held by other government Receivable and deposits Other assets Water rights, net of amortization Other long-term receivables Garage rights, net of amortization Fire fighter's pension trust asset Capital Assets Land Buildings, improvements and equipment Plants, lines and rights Construction in progress Infrastructure assets Less accumulated depreciation Buildings, improvements and equipment Plants, lines and rights Infrastructure assets Total assets $ 453,344 63,152 59,371 64,464 2,224 34,238 9,823 5,355 (6,617) 39,244 19,839 1,570 10,998 29,742 362,162 1,126,470 353,578 6,169,653 (572,821) (1,881,237) 6,344,552

Business-type Activities $ 1,181,915 100,904 12,902 97 1,651 314,115 6,617 17,342 10,045 1,839 54,203 39,563 225,450 12,266 12,611 393,818 3,807,175 6,910,094 1,252,820 (1,188,823) (3,324,975) 9,841,629 $

Total 1,635,259 164,056 12,902 59,371 64,464 2,224 34,238 9,920 1,651 319,470 56,586 29,884 3,409 65,201 39,563 225,450 12,266 12,611 29,742 755,980 4,933,645 6,910,094 1,606,398 6,169,653 (1,761,644) (3,324,975) (1,881,237) 16,186,181

Component Units Governmental Business-type $ 109,740 39,388 1,100 24 1,016 6,417 103 4,898 2,981 8,960 78,508 14,400 218 (6,186) 261,567 $ 36,215 16,292 122 1,401 363 1,752 3,811 2,880 510 22,957 3,949 4,316 11,488 293,874 2,525 (22,982) 379,473 (Continued)

$

$

$

$

$

* The notes to the basic financial statements are an integral part of this statement * A-14

CITY OF HOUSTON, TEXAS STATEMENT OF NET ASSETS June 30, 2005 (amounts expressed in thousands)

Governmental Activities Liabilities Accounts payable and accrued expenditures Accrued payroll liabilities Accrued interest payable Contracts and retainages payable Due to component units Due to other governments Advances and deposits Other liabilities Unearned revenue Noncurrent liabilities Due within one year Capital lease Notes payable Revenue bonds payable Claims and judgments Compensated absences Contracts payable Arbitrage rebate Bonds payable Inferior lien contracts Other liabilities Due in more than one year Capital lease due in more than one year Notes payable Revenue bonds payable Claims and judgments Compensated absences Contracts payable Bonds payable Inferior lien contracts Commercial paper Arbitrage rebate Other long-term liabilities Collateralized note payable Due to City of Houston Municipal pension trust liability Police officers' pension trust liability Pension obligation bonds payable Total liabilities Net assets Invested in capital assets, net of related debt Restricted net assets Restricted for debt service Restricted for renewal and replacement Restricted for maintenance and operations Restricted for capital improvements Other restricted Unrestricted (deficit) Total net assets (deficit) $ 64,302 101,532 2,969 (861,603) 2,838,964 $ 70,999 28,449 42,951 24,397 11,001 10,818 307 25,999

Business-type Activities $ 26,513 2,561 82,483 98,160 23,518 770 29,558 125,072 $

Total 97,512 31,010 125,434 122,557 23,518 11,771 40,376 307 151,071

Component Units Governmental Business-type $ 9,629 2 3,309 10,821 211 5,296 3,012 2,030 $ 9,733 893 3,565 742 6,750 17,978

1,156 56,645 115,696 74 120,585 1,515 50,097 99,786 234,992 1,587,815 445,700 12 21,880 210,300 167,081 125,745 51,588 3,505,588

64,066 3,728 8,105 18,505 3,255 6,931,654 4,149 15,654 248,294 56,810 251,000 1,048 89,700 64,063 5,577 8,154,243

1,156 64,066 60,373 123,801 18,505 74 120,585 3,255 1,515 50,097 6,931,654 103,935 250,646 248,294 1,587,815 56,810 696,700 1,060 21,880 300,000 231,144 125,745 57,165 11,659,831

10,846 2,835 8 24,703 110,215 5,709 10,552 5,355 204,533

1,320 2,625 337 308,127 352,070

3,531,764

1,138,154 47,728 12,852 106,557 292,416 2,185 $ 87,494 1,687,386 $

4,669,918 112,030 12,852 106,557 393,948 5,154 (774,109) 4,526,350 $

78,956 18,732 5,145 7,154 21,443 (74,396) 57,034 $

(12,723) 6,719 10,459 22,948 27,403

* The notes to the basic financial statements are an integral part of this statement * A-15

CITY OF HOUSTON, TEXAS STATEMENT OF ACTIVITIES For the Fiscal Year Ended June 30, 2005 (amounts expressed in thousands)

Functions/Programs Primary Government Governmental activities General government Public safety Public works Health Housing and community development Parks and recreation Library Retiree benefits Interest on long-term debt Unallocated Depreciation Total governmental activities Business-type activities Airport System Convention & Entertainment facilities Combined Utility System Houston Area Water Corporation Total business-type activities Total primary government Component Units Governmental Business-type Total component units activities $

Expenses

Charges for Services

Program Revenue Operating Grants and Contributions

Capital Grants and Contributions

$

143,477 1,127,663 282,767 124,267 78,867 83,945 49,084 28,997 116,180 96,355 2,131,602

$

25,074 139,814 43,652 13,624 6,009 1,187 229,360

$

4,914 20,031 19,261 55,446 54,186 5,554 2,918 162,310

$

37,591 37,591

406,908 133,622 762,209 169 1,302,908 3,434,510 $

353,641 19,175 598,874 971,690 1,201,050 $

4,106 191 4,297 166,607 $

63,989 42,495 106,484 144,075

$

67,930 101,262 169,192

$

2,452 74,925 77,377

$

59,599 12,152 71,751

$

41,386 41,386

General Revenues: Taxes Property taxes levied for general purposes/tax increments Property taxes levied for debt service Industrial assessments tax Sales tax Franchise tax Mixed beverage tax Bingo tax Hotel occupancy tax Investment earnings Other Contributions Special Items - gain (loss) on sale of assets Transfers Total general revenues, special items, and transfers Change in net assets Net assets (deficit) beginning Net assets (deficit) ending

(Continued)

* The notes to the basic financial statements are an integral part of this statement * A-16

Net (Expense) Revenue and Changes in Net Assets Primary Government Governmental Business-type Activities Activities

Total

Component Units Governmental Business-type

$

(113,489) (967,818) (182,263) (55,197) (24,681) (72,382) (44,979) (28,997) (116,180) (96,355) (1,702,341)

$

-

$

(113,489) (967,818) (182,263) (55,197) (24,681) (72,382) (44,979) (28,997) (116,180) (96,355) (1,702,341)

$

-

$

-

(1,702,341)

10,722 (110,341) (120,840) 22 (220,437) (220,437)

10,722 (110,341) (120,840) 22 (220,437) (1,922,778)

-

-

-

-

-

35,507 35,507

(14,185) (14,185)

$

476,831 188,000 14,635 370,583 162,263 8,343 270 13,179 27,652 11,216 2,071 58,383 1,333,426 (368,915) 3,207,879 2,838,964

$

42,266 43,866 30,138 (58,383) 57,887 (162,550) 1,849,936 1,687,386

$

476,831 188,000 14,635 370,583 162,263 8,343 270 42,266 57,045 57,790 11,216 2,071 1,391,313 (531,465) 5,057,815 4,526,350

$

39,109 3,032 2,923 60 45,124 80,631 (23,597) 57,034

$

750 2,101 9,239 12,090 (2,095) 29,498 27,403

* The notes to the basic financial statements are an integral part of this statement * A-17

CITY OF HOUSTON, TEXAS BALANCE SHEET — GOVERNMENTAL FUNDS June 30, 2005 amounts expressed in thousands

General Assets Equity in pooled cash and investments Receivables, net of allowances Accounts receivable Property taxes receivable Sales taxes receivable Mixed beverage taxes receivable Franchise taxes receivable Special assessments receivable Due from component units Due from other funds Due from other governments Inventory Prepaid items Total assets Liabilities and fund balance Liabilities Accounts payable Accrued payroll liabilities Contracts and retainages payable Due to other funds Due to other governments Advances and deposits Claims and judgments Compensated absences Other liabilities Unearned revenue Total liabilities Fund balance Reserved for imprest cash and prepaids Reserved for equipment acquisitions and other capital outlay Reserved for inventory Reserved for debt service Unreserved Total fund balance Total liabilities and fund balance $ 1,691 6,615 19,143 142,695 170,144 343,557 $ $ 111,743 31,332 59,371 64,464 2,224 34,238 9,823 6,352 3,297 19,143 1,570 343,557 $

Debt Service

Capital Projects

108,008 5,355 113,363

$

112,233 1,298 2,403 10,060 125,994

$

$

$

24,758 26,539 217 12,526 10,990 5,282 2,084 3,038 87,979 173,413

755 389 5,355 6,499

1,462 22,147 834 19 10,993 35,455

106,864 106,864 113,363 $

90,539 90,539 125,994

Capital assets used in governmental activities are not financial resources and, therefore, are not reported in the funds. Assets not available to pay for current-period expenditures are deferred in the funds. Internal service funds are used by management to charge the cost of health, benefits and workers' compensation to individual funds. The assets and liabilities of the internal service funds are included in the governmental activities in the statement of net assets. Liabilities, including bonds payable, not due and payable in the current period are not reported in the funds. Net assets of governmental activities (Continued)

* The notes to the basic financial statements are an integral part of this statement * A-18

Grants

Nonmajor Governmental Funds

Total

$

770 13,491 126 24,795 693 39,875

74,453 1,495 2,722 1,092 3 79,765

$

407,207 47,616 59,371 64,464 2,224 34,238 9,823 5,355 11,603 39,244 19,839 1,570 702,554

$

$

$

5,251 1,312 1,558 2,533 144 186 25,923 36,907

4,191 573 475 2,650 12 3,377 7 121 665 12,071

36,417 28,424 24,397 18,932 11,002 8,678 2,084 3,189 307 130,915 264,345

693 2,275 2,968 $ 39,875 $

3 67,691 67,694 79,765

1,691 97,154 19,839 109,139 210,386 438,209

5,557,805 131,856

2,006 (3,290,912) $ 2,838,964

* The notes to the basic financial statements are an integral part of this statement * A-19

CITY OF HOUSTON, TEXAS STATEMENT OF REVENUES, EXPENDITURES and CHANGES in FUND BALANCES— GOVERNMENTAL FUNDS For the Fiscal Year Ended June 30, 2005 amounts expressed in thousands

General Revenues Taxes and assessments Licenses and permits Charges for services Intergovernmental - grants Fines and forfeits Contributions Investment income Other Total revenues Expenditures Current Expenditures General government Public safety Public works Health Housing and Community Development Parks and recreation Library Retiree benefits Capital outlay Debt Service Debt service principal Debt service interest Debt service fiscal agent & fees Total expenditures Other financing sources (uses) Proceeds from issuance of debt Proceeds from refunded debt Bond premium Transfers in Transfers out Payment to escrow agent for refunded bonds Total other financing sources (uses) Changes in fund balance Fund balances, July 1 Fund balances, June 30 $ $ 1,227,388 17,692 120,181 19,993 51,251 1,780 6,541 15,938 1,460,764 $

Debt Service 2,458 1,203 3,661 $

Capital Projects 20,095 2,063 1,421 23,579

105,091 835,130 196,413 50,311 47,592 33,222 28,997 37,163 1,090 6,443 1,341,452

138,517 87,745 3,316 229,578

49,697 24,803 64,915 12,105 3,143 154,663

111,205 1,029 (197,127) (84,893) 34,419 135,725 170,144 $

1,837 173,062 10,546 239,128 (183,566) 241,007 15,090 91,774 106,864 $

160,000 352 (13,984) 146,368 15,284 75,255 90,539 (Continued)

* The notes to the basic financial statements are an integral part of this statement * A-20

Grants 142,960 400 143,360 $

Nonmajor Governmental Funds 22,548 36,109 4,324 2,213 1,717 11,883 78,794 $

Total 1,227,388 40,240 156,290 187,372 53,464 1,780 13,179 30,445 1,710,158

18,332 2,771 53,642 55,773 5,259 2,908 138,685

8,950 28,936 52,329 436 1,303 5,764 2,233 99,951

163,738 907,201 316,428 104,389 57,076 70,720 39,273 28,997 39,396 139,607 94,188 3,316 1,964,329

575 (6,502) (5,927) (1,252) 4,220 $ 2,968 $

1,679 37,659 (6,250) 33,088 11,931 55,763 67,694 $

274,721 173,062 10,546 278,743 (223,863) (183,566) 329,643 75,472 362,737 438,209

* The notes to the basic financial statements are an integral part of this statement * A-21

CITY OF HOUSTON, TEXAS Reconciliation of the Statement of Revenues, Expenditures, and Changes in Fund Balance of Governmental Funds to the Statement of Activities For the Fiscal Year Ended June 30, 2005 (amounts expressed in thousands)

Net change in fund balances - total governmental funds Amounts reported for governmental activities in the statement of activities are different because:

$

75,472

Governmental funds report capital outlays as expenditures. However, in the statement of activities the cost of those assets is allocated over their estimated useful lives and reported as depreciation expense. This is the amount by which the depreciation ($150,382) was less than the increase in capital assets ($208,109) in the current period. Revenue in the statement of activities that do not provide current financial resources are deferred as revenues in the funds. Generally, governmental funds report revenue when cash is actually received , or is expected 60 days after the close of the fiscal year. Cash received during the period relates to prior periods.

57,727

97,463

(88,845)

The issuance of long-term debt provides current financial resources to governmental funds, while the repayment of the principal of long-term debt consumes the current financial resources of governmental funds. Neither transaction, however, has any effect on net assets. Also, governmental funds report, as expenditures, the effect of issuance costs, premiums, discounts, and similar items when debt is first issued, whereas these amounts are deferred and amortized in the statement of activities. This amount is the net effect of these differences in the treatment of long-term debt and related items. Some expenses reported in the statement of activities do not require the use of current financial resources and therefore are not reported as expenditures in governmental funds. Governmental funds report payments as expenditures in the period of disbursement. The liquidation of long-term liabilities previously accrued should not be reported in the statement of activities.

(341,867)

(169,461)

Internal service funds are used by management to change the costs of certain activities, such as the cost of health benefits, to individual funds. The net revenue (expense) of the internal service fund is reported with governmental activities.

596

Change in net assets of governmental activities

$

(368,915)

* The notes to the basic financial statements are an integral part of this statement * A-22

CITY OF HOUSTON, TEXAS

This page is left blank intentionally

A-23

CITY OF HOUSTON, TEXAS PROPRIETARY FUNDS Statement of Net Assets June 30, 2005 amounts expressed in thousands

Business-type Activities - Enterprise Funds

Airport System
Assets Current Assets Cash and Cash Equivalents Equity in pooled cash and investments Receivables, net of allowances Accounts receivable Hotel occupancy tax receivable Special assessments receivable Accrued interest and other Due from component units Due from other funds Due from other governments Inventory Prepaid items Restricted assets Investments Total current assets Noncurrent Assets Deferred charges for issuance cost Other assets Water rights, net of amortization Other long-term receivables Garage rights, net of amortization Total other assets Capital assets Land Buildings, improvements and equipment Plants, lines and rights Construction in progress Less accumulated depreciation Buildings, improvements and equipment Plants, lines and rights Net capital assets Total noncurrent assets Total assets $

Convention & Entertainment

Combined Utility

$

46,753 547,450 30,456 1,651 5,032 10,967 3,441 1,400 6,696 653,846

$

28,009 36,049 755 12,902 314,115 447 439 21,774 414,490

$

188,093 335,485 69,693 97 5,489 6,375 6,604 3,765 615,601

1,960 193,210 3,150,188 437,613 (948,142) 2,832,869 2,834,829 3,488,675 $

4,337 12,611 12,611 99,757 431,495 20,866 (122,775) 429,343 446,291 860,781 $

46,281 225,450 12,266 237,716 100,851 225,492 6,910,094 637,389 (117,906) (3,324,975) 4,430,945 4,714,942 5,330,543 (Continued)

* The notes to the basic financial statements are an integral part of this statement * A-24

Business-type Activities-Enterprise Funds

Nonmajor

Total

Governmental Activities Internal Service Funds

$

76 5,941 7,328 13,345

$

262,855 $ 919,060 100,904 12,902 97 1,651 314,115 16,909 17,342 10,045 1,839 39,563 1,697,282

46,137 1 2 46,140

1,625 156,952 156,952 158,577 $ 171,922 $

54,203 225,450 12,266 12,611 250,327 393,818 3,807,175 6,910,094 1,252,820 (1,188,823) (3,324,975) 7,850,109 8,154,639 9,851,921 $

46,140 (Continued)

* The notes to the basic financial statements are an integral part of this statement * A-25

CITY OF HOUSTON, TEXAS PROPRIETARY FUNDS Statement of Net Assets June 30, 2005 amounts expressed in thousands

Business-type Activities - Enterprise Funds

Airport System
Liabilities Current Liabilities Accounts payable Accrued payroll liabilities Accrued interest payable Contracts and retainages payable Due to other funds Due to component units Due to other governments Advances and deposits Inferior lien contracts Claims and judgments Compensated absences Revenue bonds payable Unearned revenue Total Current Liabilities Noncurrent liabilities Revenue bonds payable Claims and judgments Compensated absences Contracts payable Inferior lien contracts Commercial paper Arbitrage rebate Pension note payable Municipal pension trust liability Unearned revenue Pension obligation bonds payable Total noncurrent liabilities Total liabilities Net assets Invested in capital assets, net of related debt Restricted net assets Restricted for debt service Restricted for renewal and replacement Restricted for maintenance and operations Restricted for capital improvements Other restricted Unrestricted (deficit) Total net assets

Convention & Entertainment

Combined Utility

$

8,086 765 49,667 43,860 2,863 2,960 3,255 1,043 2,893 27,665 143,057

$

2,921 81 6,313 3,211 37 23,518 4 467 58 335 13,680 396 51,021

$

10,933 1,715 24,267 66,629 6,680 766 26,131 2,627 4,877 20,356 1,287 166,268

2,106,407 1,625 3,807 56,810 48,500 160 34,800 22,584 2,006 2,276,699 2,419,756

631,425 54 308 22,500 888 3,300 2,412 11,771 189 672,847 723,868

4,066,745 2,470 11,539 248,294 180,000 51,600 39,067 111,618 3,382 4,714,715 4,880,983

695,039 32,267 12,852 34,160 292,416 2,185 1,068,919

87,801 15,461 14,407 19,244 136,913

322,683 58,702 68,175 449,560

$

$

$

Cumulative liability resulting from internal service funds' undercharging proprietary funds Net assets of business-type activities (Continued)

* The notes to the basic financial statements are an integral part of this statement * A-26

Business-type Activities-Enterprise Funds

Nonmajor

Total

Governmental Activities Internal Service Funds

$

4,573 2,236 2,965 2,365 12,139

$

26,513 $ 2,561 82,483 116,665 9,580 23,518 770 29,558 3,255 3,728 8,105 64,066 1,683 372,485

34,582 25 2 2,140 7,566 98 406 44,819

127,077 127,077 139,216

6,931,654 4,149 15,654 248,294 56,810 251,000 1,048 89,700 64,063 123,389 5,577 7,791,338 8,163,823

27 27 44,846

32,631 75 32,706

1,138,154 47,728 12,852 107,269 292,416 2,185 87,494 $ (712) $ 1,687,386

1,294 1,294

$

* The notes to the basic financial statements are an integral part of this statement * A-27

CITY OF HOUSTON, TEXAS PROPRIETARY FUNDS Statement of Revenues, Expenses and Changes in Fund Net Assets For the Fiscal Year Ended June 30, 2005 amounts expressed in thousands

Business-type Activities - Enterprise Funds

Airport System Operating Revenues Landing area fees Terminal space rentals Other building and grounds area Parking Concession Other Rental Water/Sewer Billing Health benefit premiums Total operating revenue Operating Expenses Administrative costs Claims Costs Maintenance and operating Depreciation and amortization Bad debt expense Total operating expenses Operating income (loss) Nonoperating revenue (expenses) Investment income Hotel occupancy tax Other revenue Loss on disposal of assets Other expenses Interest on long-term debt Arbitrage expense recovery Contributions in Contributions out Total nonoperating revenues (expenses) Income (loss) before contributions and transfers Capital contributions Transfers in Transfers out Total transfers

Convention & Entertainment

Combined Utility

$

102,072 151,417 55,444 41,842 2,866 353,641

$

8,882 3,373 6,920 19,175

$

598,874 598,874

223,972 105,891 329,863 23,778

32,797 10,372 43,169 (23,994)

332,800 224,074 556,874 42,000

14,968 4,295 (549) (76,496) 1,137 (56,645) (32,867) 63,989 -

15,926 42,266 (19,614) (29,468) 4,106 (41,371) (28,155) (52,149) 231 2,942 (709) 2,233

12,972 24,707 (4,193) (201,142) (167,656) (125,656) 42,495 (87,414) (87,414)

Change in net assets Liability resulting from internal service fund's undercharging proprietary funds Net change Total net assets (deficit), July 1 Total net assets, June 30 $

31,122

(49,685)

(170,575)

1,037,797 1,068,919 $

186,598 136,913 $

620,135 449,560

Cumulative liability resulting from internal service funds' undercharging proprietary funds Total net assets business-type activities

(Continued)

* The notes to the basic financial statement are an integral part of this statement *

A-28

Business-type Activities Enterprise Funds Non-Major Houston Area Water Corp.

Total

Governmental Activities Internal Service Funds

$

-

$

102,072 151,417 64,326 45,215 2,866 6,920 598,874 971,690

$

215,374 215,374

77 77 (77)

77 589,569 340,337 929,983 41,707

4,044 211,338 215,382 (8)

(92) 191 99 22 26,567 26,567

43,866 42,266 29,002 (4,742) (19,614) (307,198) 1,137 4,297 (41,371) (252,357) (210,650) 106,715 29,509 (88,123) (58,614)

602 2 604 596 -

26,589

(162,549) (1) (162,550) 1,850,647 1,688,097 (711) $ 1,687,386 $

596

6,117 $ 32,706

698 1,294

* The notes to the basic financial statement are an integral part of this statement *

A-29

CITY OF HOUSTON, TEXAS PROPRIETARY FUNDS Statement of Cash Flows For the Fiscal Year Ended June 30, 2005 amounts expressed in thousands

Business-type Activities - Enterprise Funds Airport System Cash flows from operating activities Receipts from customers Payments to employees Payments to suppliers Internal activity-payments to other funds Claims paid Due from other governments Other revenues Other expenses Net cash provided by (used in) operating activities Cash flows from investing activities Interest income on investments Purchase of investments Proceeds from sale of investments Net cash provided by (used in) investing activities Convention & Entertainment

$

337,583 (72,384) (69,114) (39,629) (5,447) 4,295 155,304

$

20,054 (6,657) (23,499) (1,483) (51) 1 (4,085) (15,720)

14,531 (389,187) 559,931 185,275

15,940 (55,074) 66,951 27,817

Cash flows from capital and related financing activities Retirement of revenue bonds Proceeds from inferior lien contract Proceeds from issuance of revenue bonds Proceeds from issuance of commercial paper Interest expense on debt Advances and deposits on construction Contributed capital Acquisition of property, plant and equipment, net Net cash provided by (used in) capital and related financing activities

(19,740) 6,681 702 28,500 (106,636) 7 54,242 (279,548) (315,792)

(6,590) (22,715) (6,141) (35,446) (Continued)

* The notes to the basic financial statements are an integral part of this statement *

A-30

Business-type Activities - Enterprise Funds Combined Utility

Nonmajor

Total

Governmental Activities Internal Service Funds

$

601,984 (115,020) (148,849) (8,010) (2,787) 25,742 353,060

$

(81) (81)

$

959,621 (194,061) (241,462) (49,122) (8,285) 1 30,037 (4,166) 492,563

$

215,374 (1,956) 36,165 (34) (213,097) 36,452

13,504 (380,478) 281,534 (85,440)

241 6,122 6,363

44,216 (824,739) 914,538 134,015

602 602

(71,947) 208,722 180,000 (189,042) 14,854 (267,634) (125,047)

(5,033) 19,139 (20,388) (6,282)

(98,277) 6,681 209,424 208,500 (323,426) 19,146 69,096 (573,711) (482,567)

(Continued)

* The notes to the basic financial statements are an integral part of this statement *

A-31

CITY OF HOUSTON, TEXAS PROPRIETARY FUNDS Statement of Cash Flows For the Fiscal Year Ended June 30, 2005 amounts expressed in thousands

Business-type Activities - Enterprise Funds Airport System Cash flows from noncapital financing activities Promotional contract paid from hotel occupancy tax revenues to component units Proceeds from pension bonds Transfers Other revenues Payments to Hotel Corporation Hotel occupancy tax revenue Transfers to debt service fund Transfers to other funds Net cash provided by (used in) noncapital financing activities Net increase (decrease) in cash and cash equivalents Cash and cash equivalents, July 1 Cash and cash equivalents, June 30 Non cash transactions Amortization expense Pension note Unrealized gain (loss) on investments Inferior lien contract Contributions of capital assets Capitalized interest expense Gain (loss) on disposal of assets Total non cash transactions Reconciliation of operating income (loss) to net cash provided (used) by operating activities Operating income (loss) Adjustments to reconcile operating income (loss) to net cash provided (used) by operating activities Depreciation and amortization Other revenues Due to other fund non-cash transfer Changes in assets and liabilities Accounts receivable and prepaids Due from other funds Due from other governments Inventory and prepaid insurance Accounts payable Accrued payroll liabilities Due to other funds Due to other governments Advances and deposits Claims and judgments-workers' compensation Compensated absences Pension note Pension Obligation payable Deferred revenue Other long-term liabilities Net cash provided by (used in) operating activities $ 1,962 1,962 26,749 20,004 46,753 $ Convention & Entertainment (18,064) 189 2,233 (5,598) 42,985 21,745 (1,604) 29,613 28,009

$

34,800 437 51,756 32,634 549 120,176

$

3,300 15 37,262 1,068 41,645

$

23,778

$

(23,994)

105,891 4,295 (15,007) (3,208) (123) 2,709 (1,891) 1,958 (1,065) (4,404) 235 34,800 7,336 155,304

10,372 (4,085) (22) (257) 61 (2,271) (185) (571) 1 (18) 97 29 3,300 919 904 (15,720) (Continued)

$

$

* The notes to the basic financial statements are an integral part of this statement *

A-32

Business-type Activities - Enterprise Funds Combined Utility 3,382 (27,822) (56,567) (81,007) 61,566 126,527 $ 188,093 $

Nonmajor $

Total (18,064) 5,533 2,233 (5,598) 42,985 (27,822) (56,567) (57,300) 86,711 176,144 262,855 $

Governmental Activities Internal Service Funds 2 2 37,056 9,081 46,137

$

51,600 533 6,660 25,048 4,193 88,034

$

92 6,469 6,561

$

92 89,700 985 51,756 43,922 65,219 4,742 256,416

-

$

$

42,000

$

(77)

$

41,707

$

(8)

224,072 25,741 (10,451) (5,446) (254) (910) 1,526 (3,162) 4,240 3,652 306 (665) 51,600 10,901 9,910 353,060

(4) (81)

340,335 30,036 (4,085) (25,480) (8,911) (254) (972) 1,960 (5,238) 5,627 1 2,569 (4,001) (401) 89,700 18,237 10,829 904 492,563

223 36,641 (68) (13) (370) (3) 50 36,452

$

$

$

$

* The notes to the basic financial statements are an integral part of this statement *

A-33

CITY OF HOUSTON, TEXAS STATEMENT OF FIDUCIARY NET ASSETS FIDUCIARY FUNDS June 30, 2005 amounts expressed in thousands

Pension Trust Assets Cash Equity in pooled cash and investments Investments U.S. government and agency securities Corporate bonds Other fixed income securities Commingled equity funds Common and preferred stock Real estate and partnerships Short-term investment funds Invested securities lending collateral Receivables, net of allowances Accounts receivable Contributions Accrued interest and other Other Assets Land Building Total assets

Agency Funds

$

4,061 62,840 73,687 1,161,249 420,920 2,968,819 793,993 656,369 1,174,652 30,275 3,809 417,565 56,350 541 7,784 7,832,914

$

45,149 120 45,269

Liabilities Accounts payable Advances and deposits Security lending collateral Foreign funds contracts payable Other liabilities Total liabilities Net assets Held in trust for pension benefits and other purposes

66,982 925,986 73,824 4,058 1,070,850 $

45,139 130 45,269

$

6,762,064

* The notes to the basic financial statements are an integral part of this statement *

A-34

CITY OF HOUSTON, TEXAS STATEMENT OF CHANGES IN FIDUCIARY NET ASSETS FIDUCIARY FUNDS PENSION TRUST FUNDS For the Years Ended June 30, 2005 amounts expressed in thousands

2005 Additions Contributions: City of Houston Plan members Total Contributions Investment earnings Interest and dividends Net increase in the fair value of investments Total investment earnings Less investment expense Net investment earnings Total additions Deductions Benefits Refund of contributions Administrative expense Total deductions Change in net assets Total net assets, July 1 Total net assets, June 30

$

433,061 68,253 501,314 241,762 678,942 920,704 (48,686) 872,018 1,373,332

415,198 2,264 16,202 433,664 939,668 5,822,396 6,762,064

$

* The notes to the basic financial statements are an integral part of this statement *

A-35

CITY OF HOUSTON, TEXAS

A-36

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005

Note 1: Note 2: Note 3: Note 4: Note 5: Note 6: Note 7: Note 8: Note 9: Note 10: Note 11: Note 12: Note 13: Note 14: Note 15: Note 16: Note 17:

Summary of Significant Accounting Policies ...................................................................................A-38 Reconciliation of Government –Wide and Fund Financial Statements ............................................A-49 Deposits and Investments..................................................................................................................A-52 Allowance for Doubtful Accounts ....................................................................................................A-70 Property Tax .....................................................................................................................................A-70 Capital Assets ...................................................................................................................................A-71 Short -Term Debt –Tax and Revenue Anticipation Notes ................................................................A-73 Long -Term Liabilities ......................................................................................................................A-73 Leases................................................................................................................................................A-91 Pension Plans ....................................................................................................................................A-92 Other Employee Benefits ..................................................................................................................A-96 Interfund Transactions ......................................................................................................................A-97 Commitments and Contingencies ...................................................................................................A-100 Related Organization Transactions .................................................................................................A-101 Conduit Debt Obligations ..............................................................................................................A-101 Major Discretely Presented Component Units................................................................................A-102 Subsequent Events ..........................................................................................................................A-110

A-37

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005

Note 1: Summary of Significant Accounting Policies The City of Houston, Texas ("City") was incorporated under the laws of the Republic of Texas in 1837 and again under the laws of the State of Texas in 1905. The City operates under a Home Rule Charter with a Mayor-Council form of government and provides the following services as authorized or required by its charter: public safety (police and fire), highways and streets, sanitation, water, airports, health services, culture-recreation, storm drainage, solid waste disposal, planning and inspection, civil defense, public improvements, and general administrative services, including pension and other benefits for its employees. The financial statements presented in this report conform to the reporting requirements of the Governmental Accounting Standards Board ("GASB"), which establishes combined statements as the required reporting level for governmental entities that present financial statements in accordance with generally accepted accounting principles. The significant accounting policies of the City are as follows: A. Principles Used in Determining the Reporting Entity for Financial Reporting Purposes The accompanying financial statements include financial statements for related organizations in accordance with GASB Statement No.14, The Financial Reporting Entity and GASB Statement No. 39, Determining Whether Certain Organizations are Component Units. Organizations are included if they are financially accountable to the City, or the nature and significance of their relationship with the City are such that exclusion would cause the financial statements to be misleading or incomplete. Inclusion is determined on the basis of the City’s ability to exercise significant influence. Significant influence or accountability is based primarily on its operational or financial relationship with the City (as distinct from legal relationship). The City is financially accountable if it appoints a voting majority of an organization’s governing body and is able to impose its will on that organization, or there is a potential for the organization to provide specific financial benefits to or impose specific financial burdens on the City. Blended component units (although legally separate entities) are, in substance, part of the City’s operations. Blended component units provide services exclusively or almost exclusively for the City. Both governmental and business-type discretely presented component units are reported in separate columns in the government-wide financial statements to emphasize their legal separateness from the City. B. Basis of Presentation - Financial Reporting Entity 1. Component Units Most component units of the City issue separately audited financial statements. Component units are reported in the City’s Comprehensive Annual Financial Report (“CAFR”) as shown in the following tables. Additional information is available from the addresses shown. Following are the City’s blended component units: Blended Component Units Reported with the Primary Government Houston Area Water Corporation 611 Walker, Suite 2100 Houston, TX 77002

Brief Description of Activities, Relationship to the City and Key Inclusion Criteria The Corporation is organized for the purpose of: providing treated, potable water to the City of Houston for sale to customers located wholly or partially in Area Three of the Harris-Galveston Coastal Subsidence District, and; aiding and assisting the City of Houston in performing its obligations with respect to a regional groundwater reduction plan by, among other things, constructing, improving, equipping, repairing, operating and maintaining water treatment and distribution facilities and purchasing and selling water in connection therewith. Reporting Fund: Business Type, Non-Major

Houston Firefighters’ Relief & Retirement Fund 4225 Interwood North Parkway Houston, TX 77032

Responsible for administration, management, and operation of the pension system solely for active and retired City of Houston firefighters. One member of the Board is either the Mayor or an appointed representative, five members are elected by active firefighters, one member is elected by retired firefighters, two members are citizen representatives, and one member is the City Treasurer. Reporting Fund: Houston Firefighters’ Relief and Retirement Pension Trust Fund.

A-38

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005

Blended Component Units Reported with the Primary Government Houston Municipal Employee’s Pension System 1111 Bagby, Suite 2450 Houston, TX 77002

Brief Description of Activities, Relationship to the City and Key Inclusion Criteria Responsible for administration, management, and operation of the pension system solely for active and retired municipal (non-classified) employees of the City. One member of the Board is appointed by the Mayor, four are elected by active employees, two are elected by retirees, one is appointed by the elected trustees and one is the City Treasurer. Reporting Fund: Houston Municipal Employee’s Pension Trust Fund.

Houston Police Officer’s Pension System 602 Sawyer, Suite 300 Houston, TX 77007

Responsible for administration, management, and operation of the pension system solely for active and retired police officers of the City. One member of the Board is appointed by the Mayor, three are elected by employees, two are elected by retirees, and one is the City Treasurer. Reporting Fund: Police Officer’s Pension Trust Fund.

Following are the City’s discretely presented business type component units: Discretely Reported Component Units Houston Convention Center Hotel Corporation (“HCCHC”) c/o George R. Brown Avenida De Las Americas Houston, TX 77010 Houston Housing Finance Corporation (“HHFC”) 9545 Katy Freeway, Suite 105. Houston, TX 77024 Brief Description of Activities, Relationship to City, and Key Inclusion Criteria Local government corporation created by the City in accordance with the Texas Transportation Corporation Act and Chapter 394 of the Texas Local Government Code authorized to construct, improve, enlarge, equip, repair, operate and maintain a hotel in downtown Houston within one thousand feet of the George R. Brown Convention Center. Board members are appointed by the Mayor and confirmed by City Council. Non-profit corporation incorporated by the City in accordance with the Texas Housing Finance Corporation Act to finance residential mortgage loans to low or moderateincome persons through the sale of revenue bonds collateralized by the mortgage loans. The Board is nominated by the Mayor and confirmed by City Council. The City has financial accountability because it appoints a voting majority of the Board and the City can impose its will. Houston Zoo, Inc. (HZI) is a 501 (c)(3) corporation and has a contract with Houston Zoo Development Corp to operate the Zoo. The Mayor may appoint up to 20% of the Board of Directors of HZI. Houston Zoo Development Corporation (HZDC) is a local government corporation that leases the zoo from the City. The lease provides for the City to make payments in support of capital and operating expenses over the lease term, which it makes available to HZI.

Houston Zoo, Inc. 1513 N. MacGregor Houston, TX 77030

Following are the City’s discretely presented governmental fund component units. Discretely Reported Component Units City Park Redevelopment Authority c/o Hawes Hill Calderon LLP P.O. Box 22167 Houston, Texas 77227 Brief Description of Activities, Relationship to City, and Key Inclusion Criteria Local government corporation created by the City in accordance with Chapter 431 of the Texas Transportation Corporation Act to assist the City Park Tax Increment Reinvestment Zone Board in the redevelopment of a neighborhood northwest of Downtown Houston. The City has financial accountability because the voting majority of the board members are nominated by the City Council and the operations provide financial benefit to the City.

A-39

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005
Discretely Reported Component Units Cultural Arts Council of Houston (“CACH”)/Harris County 3201 Allen Parkway, Suite 250 Houston, TX 77019 East Downtown Redevelopment Authority c/o Hawes Hill Calderon LLP P.O. Box 22167 Houston, Texas 77227 Brief Description of Activities, Relationship to City, and Key Inclusion Criteria Non-profit organization that is the officially designated arts agency of the City. The City does not appoint a voting majority, but is financially accountable because CACH is fiscally dependent on the revenues provided from a portion of hotel occupancy tax, which is levied by the City. Local government corporation created by the City in accordance with Chapter 431 of the Texas Transportation Corporation Act to assist the East Downtown Tax Increment Zone Board in the redevelopment of a blighted neighborhood east of Downtown Houston. The City has financial accountability because the voting majority of the board members are nominated by City Council and the operations provide financial benefits to the City. Local government corporation created by the City in accordance with Chapter 431 of the Texas Transportation Corporation Act to assist the Fourth Ward Tax Increment Reinvestment Zone Board in the redevelopment of a blighted neighborhood adjacent to Downtown Houston. The City has financial accountability because the voting majority of the board members are nominated by City Council, the operations provide financial benefits to the City, the City has investment authority for the Zone’s assets, and the City maintains the books and records. Local government corporation created by the City in accordance with Chapter 431 of the Texas Transportation Corporation Act to assist the Greater Greenspoint Tax Increment Reinvestment Zone Board in the redevelopment of the Greenspoint Mall and blighted adjacent neighborhood in North Houston. The City has financial accountability because the voting majority of the board members are nominated by City Council and the operations provide financial benefits to the City. A non-profit organization established in 1963 and funded by both private sector memberships and a portion of the hotel bed tax. Their mission is to improve the economy of Greater Houston by attracting conventions, tourists, film projects and international government officials to the area through sales and marketing efforts. Local government corporation created by the City in accordance with Chapter 431 of the Texas Transportation Corporation Act to assist the Gulfgate Tax Increment Reinvestment Zone Board in the redevelopment of the Gulfgate Mall and blighted adjacent neighborhood southeast of Downtown Houston. The City has financial accountability because the voting majority of the board members are nominated by City Council and the operations provide financial benefits to the City. Provides review and guidance to the operation, funding and development of the Houston Area Library Automated Network, which provides library services to Houston and surrounding communities. Three members are appointed by City Council, two by the County, and one elected by the smaller libraries. The City does not appoint a voting majority, but is financially accountable for this organization because HALAN is fiscally dependent on the City for all revenues and the City can impose its will. A non-profit organization established by the City of Houston in 1986, providing loans and management counseling to small and emerging businesses, and encouraging the expansion of commercial and industrial enterprises. The City has financial accountability because the voting majority of the board members is appointed by City Council and the operations provide financial benefits to the City. Local government corporation created by the City in 2004 in accordance with Chapter 431 of the Texas Transportation Corporation Act to aid and act on behalf of the City to accomplish the City’s governmental purpose of providing for the acquisition, development, operation, and maintenance of a new public park, open space and related amenities and facilities to provide recreational, educational and tourism opportunities within, and beautification of the Central Business District of the City.

Fourth Ward Redevelopment Authority c/o Zinetta Burney, General Counsel Burney & Foreman 5445 Almeda Suite 400 Houston, Texas 77004

Greater Greenspoint Redevelopment Authority 16945 Northchase Dr, Suite 1900 Houston, Texas 77060

Greater Houston Convention and Visitors Bureau 901 Bagby, Suite 1005 Houston, Texas 77002 Gulfgate Redevelopment Authority c/o Knudson & Associates 8588 Katy Freeway, Suite 441 Houston, Texas 77024

HALAN - Houston Area Library Automated Network Board Houston Central Library 500 McKinney Houston, TX 77002 Houston Business Development Corp. 5330 Griggs Road Houston, Texas 77021 Houston Downtown Park Corporation 2217 Welch Houston, TX 77019

A-40

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005
Discretely Reported Component Units Houston Library Board Houston Central Library 500 McKinney Houston, TX 77002 Houston Parks Board 2001 Kirby Dr., Suite 814 Houston, Texas 77019 Lamar Terrace Public Improvement District City of Houston Box 1562 Houston, Texas 77251 Main Street Market Square Redevelopment Authority 909 Fannin St., Suite 1650 Houston, Texas 77002 Memorial City Redevelopment Authority c/o Knudson & Associates 8588 Katy Freeway, Suite 441 Houston, Texas 77024 Brief Description of Activities, Relationship to City, and Key Inclusion Criteria Solicits and manages funds raised privately for library improvements. Advises the Mayor and City Council on additions and improvements to the library system that provide a direct benefit to the City. Board members are nominated by the Mayor and confirmed by City Council. Solicits and manages funds raised privately for park acquisitions and advises the Mayor and City Council on park acquisitions and improvements, which provide a direct benefit to the City. Board members are nominated by the Mayor and confirmed by City Council. Special district organized under state statute to redevelop a blighted neighborhood in Southwest Houston. The City has financial accountability because the voting majority of the board members are nominated by City Council and the operations provide financial benefits to the City. Local government corporation created by the City in accordance with Chapter 431 of the Texas Transportation Corporation Act to assist the Main St./Market Square Tax Increment Reinvestment Zone Board in the redevelopment of Downtown Houston. The City has financial accountability because the voting majority of the board members are nominated by City Council and the operations provide financial benefits to the City. Local government corporation created by the City in accordance with Chapter 431 of the Texas Transportation Corporation Act to assist the Memorial City Tax Increment Reinvestment Zone Board in the redevelopment of the Memorial City Mall and Town & Country Mall areas, west of Downtown Houston. The City has financial accountability because the voting majority of the board members are nominated by City Council and the operations provide financial benefits to the City. Local government corporation created by the City in accordance with Chapter 431 of the Texas Transportation Corporation Act to assist the Memorial Heights Tax Increment Reinvestment Zone Board in the redevelopment of a blighted neighborhood adjacent to Downtown Houston. The City has financial accountability because the voting majority of the board members are nominated by City Council and the operations provide financial benefits to the City. Local government corporation created by the City in accordance with Chapter 431 of the Texas Transportation Corporation Act to assist the Midtown Tax Increment Reinvestment Zone Board in the redevelopment of a blighted neighborhood south of Downtown Houston. The City has financial accountability because the voting majority of the board members are nominated by City Council and the operations provide financial benefits to the City. Local government corporation created by the City in accordance with Chapter 431 of the Texas Transportation Corporation Act to assist the Old Sixth Ward Tax Increment Reinvestment Zone Board in the redevelopment of a neighborhood adjacent to Downtown Houston. The City has financial accountability because the voting majority of the board members are nominated by City Council, the operations provide financial benefits to the City, the City has investment authority for the Zone’s assets, and the City maintains the books and records. Local government corporation created by the City in accordance with Chapter 431 of the Texas Transportation Corporation Act to assist the OST/Almeda Corridors Tax Increment Reinvestment Zone Board in the redevelopment of a blighted neighborhood south of Downtown Houston. The City has financial accountability because the voting majority of the board members are nominated by City Council and the operations provide financial benefits to the City.

Memorial-Heights Redevelopment Authority c/o Knudson & Associates 12 Greenway Plaza, Suite 1500 Houston, Texas 77046-1287 Midtown Redevelopment Authority 3401 Louisiana, Suite 355 Bienville Building Houston, Texas 77002

Old Sixth Ward Redevelopment Authority c/o Parke Patterson Consultants, Inc. P.O. Box 994 Sugar Land, Texas 77487

OST/Almeda Corridors Redevelopment Authority 5445 Almeda Suite 502 Houston, Texas 77004

A-41

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005
Discretely Reported Component Units Saint George Place Redevelopment Authority c/o Hawes Hill Calderon LLP P.O. Box 22167 Houston, Texas 77227-2167 Brief Description of Activities, Relationship to City, and Key Inclusion Criteria Local government corporation created by the City in accordance with Chapter 431 of the Texas Transportation Corporation Act to assist the St. George Place Tax Increment Reinvestment Zone Board in the redevelopment of a blighted neighborhood in southwest Houston. The City has financial accountability because the voting majority of the board members are nominated by City Council, the operations provide financial benefits to the City, the City has investment authority for the Zone’s assets, and the City maintains the books and records. Local government corporation created by the City in accordance with Chapter 431 of the Texas Transportation Corporation Act to manage and administer the Sharpstown Public Improvement District (the “PID”), created under Chapter 372 of the Local Government Code. Board members are appointed by the Mayor and approved by City Council. Local government corporation created by the City in accordance with Chapter 431 of the Texas Transportation Corporation Act to assist the South Post Oak Tax Increment Reinvestment Zone Board in the development of an affordable housing project in Southwest Houston. The City has financial accountability because the voting majority of the board members are nominated by City Council and the operations provide financial benefits to the City. Local government corporation created by the City in accordance with Chapter 431 of the Texas Transportation Corporation Act to assist the Southwest Houston Tax Increment Reinvestment Zone Board in the redevelopment of the Sharpstown Mall and adjacent neighborhoods southwest of Downtown Houston. The City has financial accountability because the voting majority of the board members are nominated by City Council and the operations provide financial benefits to the City. Local government corporation created by the City in accordance with Chapter 431 of the Texas Transportation Corporation Act to assist the Upper Kirby Tax Increment Reinvestment Zone Board in the redevelopment of a neighborhood west of Downtown Houston. The City has financial accountability because the voting majority of the board members are nominated by City Council and the operations provide financial benefits to the City. Local government corporation created by the City in accordance with Chapter 431 of the Texas Transportation Corporation Act to assist the Uptown Tax Increment Reinvestment Zone Board in the redevelopment of the Galleria Mall area, west of Downtown Houston. The City has financial accountability because the voting majority of the board members are nominated by City Council and the operations provide financial benefits to the City.

Sharpstown Economic Development Authority c/o Hawes, Hill & Associates P.O. Box 22167 Houston, Texas 77227-2167 South Post Oak Redevelopment Authority c/o Knudson & Associates 8588 Katy Frwy. Houston, Texas 77024

Southwest Houston Redevelopment Authority c/o Hawes Hill Calderon LLP P.O. Box 22167 Houston, Texas 77227-2167 Upper Kirby Redevelopment Authority 3015 Richmond Avenue, Suite 200, Houston, Texas 77098-3114

Uptown Development Authority 1980 Post Oak Blvd., Suite 1580 Houston, Texas 77056

2. Related Organizations The following entities are related organizations to which the City appoints board members but for which the City has no significant financial accountability. Some of these organizations are Access Houston Cable Corporation, Coastal Water Authority, Employees Deferred Compensation Plan, Harris County–Houston Sports Authority, Metropolitan Transit Authority of Harris County, Houston Clean City Commission, and the Miller Theater Advisory Council. All transactions with these related organizations are conducted in the ordinary course of business. Further financial information is available from the respective organizations. C. Basis of Presentation – Government-wide and Fund Financial Statements The government-wide financial statements (i.e., the statement of net assets and the statement of changes in net assets) report information on all of the nonfiduciary activities of the primary government and its component units. For the most part, the effect of interfund activity has been removed from these statements. Governmental activities, which normally are supported by taxes and intergovernmental revenues, are reported separately from business-type activities, which rely to a significant extent on fees and charges for support. Likewise, the primary government is reported separately from certain legally separate component units for which the primary government is financially accountable.

A-42

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005

The statement of activities demonstrates the degree to which the direct expenses of a given function or segment are offset by program revenues. Direct expenses are those that are clearly identifiable with a specific function or segment. Program revenues include 1) charges to customers or applicants who purchase, use, or directly benefit from goods, services, or privileges provided by a given function or segment and 2) grants and contributions that are restricted to meeting the operational or capital requirements of a particular function or segment. Taxes and other items not properly included among program revenues are reported instead as general revenues. Separate financial statements are provided for governmental funds, proprietary funds, and fiduciary funds, even though the latter are excluded from the government-wide financial statements. Major individual governmental funds and major individual enterprise funds are reported as separate columns in the fund financial statements. The accounts of the City are organized on the basis of funds, each of which is accounted for with a separate set of self-balancing accounts that comprise its assets, liabilities, fund balance/retained earnings, revenues, and expenditures/expenses. Government resources are allocated to and accounted for in individual funds for the purpose of carrying on specific activities in accordance with special regulations, restrictions, or limitations. The type and purpose of funds is described below. Fund Accounting 1. The City reports the following major governmental funds: (a) General Fund - is the principal operating fund of the City and is used to account for all financial resources except those required to be accounted for in another fund. (b) Debt Service Fund - is used to account for the accumulation of resources for, and the payment of principal, interest, and related costs of tax supported debt. (c) Capital Projects Fund - is used to account for financial resources to be used for the acquisition or construction of major capital facilities (other than those financed by proprietary funds and trust funds). Such resources are derived principally from proceeds of public improvement bonds and from special assessments. (d) Grants Fund - The Grants Fund is used to account for grant resources received from various local, state and national agencies and organizations. The use of these resources is restricted to a particular function of the City by each grantor. 2. The City reports the following major enterprise funds: (a) Airport System Fund - is used to account for the operations of the City’s Airport System. The system is comprised of George Bush Intercontinental Airport, William P. Hobby Airport, and Ellington Field. (b) Convention and Entertainment Facilities Fund - is used to account for the operations of the City’s major entertainment facilities, outdoor venues, and parking garages and surface lots. These assets include, but are not limited to, the following: George R. Brown Convention Center, Gus S. Wortham Center, Jesse H. Jones Hall, Houston Center for the Arts, Talento Bilingue de Houston, Jones Plaza, and Theater District parking garages. (c) Combined Utility System Fund – is used to account for the production and transmission of water and the treatment of wastewater for City residents and businesses as well as for other governmental entities located in the Houston area. 3. The City reports the following fund types: (a) Nonmajor Special Revenue Funds - are used to account for the proceeds of specific revenue sources (other than major capital projects) that are legally restricted to expenditures for specific purposes. (b) Internal Service Funds - are used to account for the financing of goods or services provided by one department to other departments of the City on a cost-reimbursement basis. (c) Fiduciary Fund Types - Trust and Agency Funds are used to account for assets held by the City in a trustee capacity or as an agent for individuals, private organizations, other governmental units and other funds. These include the following: (1) Pension Trust Funds - are used to account for the assets held in trust for the members and beneficiaries of the City’s three defined benefit pension plans. (2) Agency Funds - are custodial in nature and do not involve measurement of results of operations.

A-43

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005
D. Measurement Focus and Basis of Accounting The government-wide financial statements display information about the City of Houston as a whole. Government-wide statements exclude both fiduciary funds and fiduciary component units. The statement of net assets and the statement of activities are prepared using the economic resources measurement focus and the accrual basis of accounting. Revenues, expenses, gains, losses, assets, and liabilities resulting from exchange and exchange-like transactions are recognized when the exchange takes place, regardless of the timing of related cash flows. Revenues, expenses, gains, losses, assets and liabilities resulting from non-exchange transactions are recognized in accordance with Statement of Government Accounting Standards No. 33, Accounting and Financial Reporting for Nonexchange Transactions. Program revenues include (1) amounts received from those who purchase, use, or directly benefit from a program, (2) amounts received from parties outside the City of Houston’s citizenry that are restricted to one or more specific programs and (3) earnings on investments that are legally restricted for a specific program. Program revenue is divided into three categories: (1) charges for services, (2) operating grants and contributions and (3) capital grants and contributions. All governmental funds are accounted for using the current financial resources measurement focus. This means that only current assets and current liabilities are generally included on their balance sheets. Their reported fund balances (net current assets) are considered a measure of "available spendable resources." Governmental fund operating statements present increases (revenues and other financing sources) and decreases (expenditures and other financing uses) in net current assets. Accordingly, they are said to present a summary of sources and uses of "available spendable resources" during a period. Non-current portions of certain long-term receivables, primarily property taxes and special assessments, are reported on the balance sheets of governmental funds in spite of their spending measurement focus. Special reporting treatments are used to indicate that they should not be considered "available spendable resources," since they do not represent net current assets. Recognition of governmental fund revenues represented by noncurrent receivables is deferred until they become current receivables. Because of their spending measurement focus, expenditure recognition for governmental fund types is limited to exclude amounts represented by non-current liabilities. Since they do not affect net current assets, such long-term amounts are not recognized as governmental fund type expenditures or fund liabilities. Proprietary funds and pension trust funds of the primary government and blended Component Units are accounted for on a cost of services or "economic resources" measurement focus. This means that all assets and all liabilities (whether current or noncurrent) associated with their activity are included on their balance sheets. In accordance with GASB Statement No. 20, the City has elected to follow all Financial Accounting Standards Board (FASB) pronouncements issued prior to November 30, 1989, unless those pronouncements conflict with or contradict GASB pronouncements. The City has elected not to follow FASB pronouncements issued subsequent to that date. All proprietary funds define operating revenues consistent with the precepts of Statement of Government Accounting Standards No. 9 paragraphs 16 – 19 and 31: cash receipts from customers, cash receipts from interfund services provided and used with other funds and other operating cash receipts. All other revenue recognized is non-operating. Basis of accounting refers to when revenues and expenditures or expenses are recognized in the accounts and reported in the financial statements, regardless of the measurement focus applied. All governmental funds use the modified accrual basis of accounting. Under the modified accrual basis of accounting, revenues are recorded when susceptible to accrual; i.e., both measurable and available. Available means collectible within the current period or soon enough thereafter to pay current liabilities. The City considers receivables collected within sixty days after year-end to be available and recognizes them as revenues of the current period. Expenditures are generally recognized under the modified accrual basis of accounting in the accounting period in which the fund liability is incurred, if measurable. Claims, judgments and compensated absences are recognized when matured. The following types of revenues are susceptible to accrual under the modified accrual basis of accounting: delinquent property taxes (including penalty and interest); services billed to other funds; sales tax; mixed beverage tax; franchise fees; fines and forfeits; ambulance receipts; and investment earnings. Intergovernmental revenue from reimbursable grants and capital projects is recognized when the related expenditure is incurred. All proprietary and pension trust funds use the full accrual basis of accounting. Their revenues are recognized when they are earned, and their expenses and related liabilities, including claims, judgments, and compensated absences, are recognized when they are incurred. When restricted and unrestricted resources are available to cover expenses, unrestricted resources are first applied. Administrative overhead charges are included in direct program expenses.

A-44

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005
E. Assets, Liabilities, and Fund Equity 1. Deposits and Investments The City’s investment policy requires all deposits to be fully collateralized with depository insurance; obligations of the United States of America or its agencies and instrumentalities (excluding those mortgage backed securities prohibited by the Public Funds Investment Act); or in any other manner and amount provided by law for the deposits of the City. At all times, such securities are to have a fair value of not less than 102% of the amount of the deposits collateralized thereby, adjusted by the amount of applicable depository insurance. Substantially all cash, except for imprest accounts, is deposited with financial institutions in interest bearing accounts or is invested. The majority of the City's cash and investments are administered using a pooled concept, which combines the monies of various funds for investment purposes. Interest earnings of the pool are apportioned to each fund, unless otherwise required by bond covenants, based on the fund’s relative share of the investment pool. Amounts on deposit in interest bearing accounts and other investments are displayed on the statement of net assets as "Equity in pooled cash and investments" and in accordance with GASB Statement No. 31 Accounting and Financial Reporting for Certain Investments and for External Investment Pools, are carried at fair value. The blended and discretely presented component units separately invest their funds and report investments pursuant to their respective investment policies described in their separately audited financial statements at their fair values. Investments authorized by the City’s investment policy, which is guided by state laws and city ordinances, generally include: obligations of the United States of America or its agencies and instrumentalities; fully-collateralized Certificates of Deposit from City Council-approved public depositories; direct obligations of the State of Texas or its agencies and instrumentalities; other obligations, the principal and interest of which are unconditionally guaranteed or insured by, or backed by the full faith and credit of, the State of Texas or the United States or their respective agencies and instrumentalities; obligations of states, agencies, counties, cities, and other political subdivisions; no-load money market mutual funds registered and regulated by the Securities and Exchange Commission; corporate commercial paper; fully collateralized repurchase agreements; and reverse repurchase agreements within specific terms. Investments are carried at fair value based on quoted market prices. 2. Inventories of Materials and Supplies With the exception of fuel, inventories are carried at the average cost in government-wide, proprietary and governmental funds. Inventories are presented under the consumption method. These inventories include: automobile parts, chemical and medical supplies, uniforms and their accessories, vaccines and office supplies. Fuel is carried based on the first-in, first-out inventory method. 3. Capital Assets a. Governmental Funds - Property, Plant, Equipment, and Infrastructure Asset valuation is based on historical costs or estimated historical costs, if original costs are not available. Capital assets are not capitalized in the funds used to acquire or construct them. Instead, capital acquisition and construction are reflected as expenditures in governmental funds. Capital Assets, which include land; building and improvements; improvements other than buildings, machinery and equipment; construction in progress; and infrastructure (e.g. storm drainage, streets and bridges), are reported in the applicable governmental and business-type activities columns in the government-wide financial statements. These capital assets include the estimated historical cost of infrastructure acquired prior to fiscal year 1981. Capital assets are defined by the government as assets with an initial cost of more than $5,000 (amount not rounded) and an estimated useful life in excess of four years. Such assets are recorded at historical cost or estimated historical if purchased or constructed. Donated capital assets are recorded at estimated fair market value at the date of donation. The cost of normal maintenance and repairs that do not add to the value of the asset or materially extend assets lives are not capitalized.

A-45

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005
Major outlays for capital assets and improvements are capitalized as projects are constructed. Interest incurred during the construction phase of capital assets of business-type activities is included as a part of the capitalized value of the assets constructed. Buildings and improvements (improvements other than buildings, machinery and equipment and infrastructure) are depreciated using the straight-line method over the following estimated useful lives: Assets Buildings and improvements Improvements other than buildings Machinery Equipment Storm drainage Streets Bridges b. Enterprise Funds – Property, Plant and Equipment Property, plant, and equipment owned by the Enterprise Funds are stated at cost or estimated historical cost if original cost is not available. Construction costs (excluding land and equipment) are added to construction work-in-progress until the assets are substantially complete. At that point, the project is moved to the appropriate asset category and depreciation begins. Depreciation on equipment begins in the year of acquisition. Land and equipment costs are added to the capital asset base in the year of acquisition. Interest costs on funds borrowed to finance the construction of property, plant and equipment of the enterprise funds are capitalized when the costs materially exceed interest earnings on related revenue bond proceeds. For fiscal year 2005, the capitalized interest cost for the Airport System Facilities was $32.6 million, Combined Utility System Fund was $25.0 million and Convention & Entertainment Facilities Fund was $1.07 million. Depreciation is computed using the straight-line method on the composite asset base over the estimated useful lives as follows: Assets Airport System Facilities Convention & Entertainment Facilities Combined Utility System Facilities Years 4-45 4-45 5-50 Useful Life Range from 15 to 45 years Range from 15 to 30 years Range from 4 to 30 years Range from 4 to 15 years 50 years Range from 6 to 50 years Range from 20 to 50 years

Water rights and conveyance system rights of the Combined Utility System Fund are amortized over the life of the related contracts. These rights are reported as other assets. 4. Bond Discounts and Issuance Costs Bond discounts and issuance costs in Enterprise Funds are amortized over the term of the bonds using the effective interest method. Gains or losses on Enterprise Fund refundings are amortized over the term of the lesser of the new bonds or the refunded bonds using the effective interest method. 5. Fund Balance a. Reserve - Indicates that portion of a fund balance that has been legally segregated (e.g., by bond ordinance) for specific purposes. Designated Fund Balance - Indicates that portion of a fund balance for which the City has made tentative plans. Undesignated Fund Balance - Indicates that portion of a fund balance that is available for appropriation in future periods.

b. c.

F. Transfers, Revenues, Expenditures and Expenses 1. Interfund Transactions A description of the four basic types of interfund transactions and the related accounting policies are as follows: a. b. Loans are reported as receivables and payables as appropriate. Charges for services are reported as revenues for the performing fund and expenditures of the requesting fund.

A-46

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005
c. Transactions to reimburse a fund for expenditures made by it for the benefit of another fund are recorded as expenditures or expenses in the reimbursing fund and as a reduction of expenditures or expenses in the fund that is reimbursed.

d. All other interfund transfers, such as legally authorized transfers from a fund receiving revenue to the fund through which the resources are to be expended, are transfers. Transfers are classified as other financing sources or uses (or transfers for proprietary funds) in the Statement of Revenues, Expenditures (or expenses) and Changes in Fund Balances (or net assets). For reporting at the government-wide statements level, the City of Houston eliminates direct interfund charges for services and the balances created within the same fund categories (i.e. governmental vs. business-type). This process ensures neither business-type nor governmental funds report direct internal revenue/expenditures. Interfund activity and balances resulting from transactions with the fiduciary funds are not eliminated. Instead the fiduciary interfund activity and balances are treated as transactions with an external party. Interfund activity with discretely presented component units are handled in the same manner as fiduciary interfund activity/ balances. However, the discretely presented balances are reported on a separate line of the Statement of Net Assets. The Internal Service Fund is essentially a clearing account for income, expenses, assets and liabilities of the City’s health benefits and long-term disability programs. 2. Compensated Absences Full-time civilian employees of the City are eligible for 10 days of vacation leave per year. After five years, employees receive 15 days. The amount of vacation time gradually increases after that, reaching a maximum of 25 days per year after 18 years of service. Employees may accumulate up to 90 days of vacation leave (45 days for employees hired after December 31, 1999). Upon termination or retirement, employees are paid for unused vacation leave based on the average rate of pay during the employee’s highest paid 60 days of employment. Part-time employees (those working less than 30 hours per week) are not eligible for vacation leave benefits. Firefighters accrue 15 to 22 days of vacation annually, based upon years of service. Police officers participate in a paid time off program that combines sick and vacation leave. Officers enter the program upon completion of their probationary period and then accrue 15 to 40 days annually, based upon years of service. The majority of full-time civilian employees and firefighters are covered under the compensatory sick leave plan and receive a leave time allowance of 2.5 hours per payroll period (bi-weekly) up to a maximum of 65 hours per year. Employees who use fewer than 65 hours during the benefit year will receive a match of additional hours equal to the number of hours accrued minus the number of hours used. Once an employee’s balance has reached 1,040 hours, no additional match for unused hours is given. Upon termination, all unused sick leave time allowances in excess of 1,040 hours are payable to the employee at the employee’s rate of pay at the time of termination. An employee who uses less than 16 hours of sick leave in any benefit year receives up to three days of personal leave in the next year. Personal leave may be used in place of vacation leave, but will not accumulate and will not be paid out at termination. The balance of full time civilian employees and firefighters are covered by a sick plan that was closed to employees in 1985. That plan accumulates a cash value for every sick day not used, which is payable upon resignation or retirement. As noted above, classified police officers are covered by a paid time off plan. The City also has adopted policies of compensatory time to comply with the Fair Labor Standards Act as amended in 1985. These policies provide limits to the accumulation of compensatory time and also provide that time not used will be paid in cash. Only classified employees and civilian employees in certain pay grades routinely earn compensatory time. To the extent that the City’s obligation is attributable to employees’ services already rendered and it is probable that the City will compensate the employees for the benefits through paid time off or some other means, vacation and compensatory time benefits are accrued as liabilities (on a government-wide basis) as employees earn the benefits. On a fund financial statement basis for the governmental funds, only matured liabilities and liabilities expected to be liquidated with current assets are accrued. Sick leave benefits are accrued as a liability as employees earn the benefits, but only to the extent that it is probable that the City will compensate the employees through cash payments conditioned on the employees’ termination or retirement. A compensated absence is liquidated in the fund where the employee’s salary was paid at termination, with all compensated absences liquidated in the general fund that are associated with employees’ salaries paid from governmental funds. G. Statement of Cash Flows ⎯ Cash and Cash Equivalents The City considers cash and cash equivalents to be equity in pooled cash and investments which consist of cash on hand, demand deposits and all highly liquid investments which can be deposited or withdrawn without notice or penalty for the proprietary operating funds. H. Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect certain reported amounts and disclosures. Accordingly, actual results could differ from those estimates.

A-47

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005
I. Internal Service Funds The Internal Service Funds’ purpose is to measure the full cost of providing health benefits and long- term disability to City employees and dependants for the purpose of fully recovering that cost through fees or charges – employee payroll deductions and expenditures in departmental personnel budgets. Any profit (loss) during a period is credited (charged) back to participating programs. All assets and liabilities are reported in the governmental activities column of the Statement of Net Assets. J. New Accounting Pronouncements In November 2003, the GASB issued Statement No. 42, “Accounting and Financial Reporting for Impairment of Capital Assets and for Insurance Recoveries.” This statement will, among other things, establish accounting and financial reporting standards for the impairment of capital assets. Under this standard, a capital asset is considered impaired when its service utility has declined significantly and unexpectedly. The City has not determined the impact, if any, upon its financial position, results of operations or cash flows upon adoption, which is required on or before the City’s fiscal year ending June 30, 2006. In May 2004, the GASB issued Statement No. 43, “Financial Reporting for Other Postemployment Benefit Plans Other Than Pension Plans” and in June 2004, the GASB issued Statement No. 45, “ Accounting and Financial Reporting by Employers for Postemployment Benefit Other Than Pension Plans.” Statement No. 43 establishes accounting and financial reporting standards for healthcare and other nonpension benefits provided to employees as part of their compensation for services. The statement will be implemented in the City’s fiscal year ending June 30, 2006 to meet GASB requirements. Statement No. 45 establishes standards for the measurement, recognition, and display of other postemployment benefits expenses and related liabilities and assets, and other related disclosure requirements. This statement will be implemented on or before the fiscal year ending June 30, 2007 to meet GASB requirements. The City has not determined the impact, if any, upon its financial position, results of operations or cash flows upon adoption of these two Statements. In May 2004, the GASB issued Statement No. 44, “Economic Condition Reporting: The Statistical Section – an amendment of NCGA Statement 1.” This statement clarifies various issues relative to the presentation of the statistical section of the CAFR. The statement has been implemented in the City’s fiscal year ending June 30, 2005 to meet GASB requirements. In December 2004, the GASB issued Statement No. 46, “Net Assets Restricted by Legislation – an amendment of GASB Statement No. 34.” Statement No. 46 enhances the usefulness and comparability of net asset information reported by state and local governments by clarifying the meaning of the phrase ‘legally enforceable’ as it applies to restrictions imposed on net asset use by enabling legislation and by specifying the accounting and financial reporting requirements for those restricted net assets. The requirements of this Statement are effective for financial statements for periods beginning after June 15, 2005. The City has not determined the impact, if any, upon its financial position, results of operations or cash flows upon adoption. In July 2004, the GASB issued Statement No. 47, “Accounting for Termination Benefits.” Statement No. 47 requires employers to disclose a description of the termination benefit arrangement, the cost of the termination benefits (required in the period in which the employer becomes obligated if that information is not otherwise identifiable from information displayed on the face of the financial statements), and significant methods and assumptions used to determine termination benefit liabilities. For termination benefits provided through an existing defined benefit OPEB plan, the provisions of this Statement should be implemented simultaneously with the requirements of Statement 45. For all other termination benefits, this Statement is effective for financial statements for periods beginning after June 15, 2005. The City has not determined the impact, if any, upon its financial position, results of operations or cash flows upon adoption.

A-48

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005
Note 2: Reconciliation of Government-wide and Fund Financial Statements A. Explanation of Certain Differences between the Governmental Fund Balance Sheet and the Statement of Net Assets Long-term liabilities applicable to the City's governmental activities are not due and payable in the current period and accordingly are not reported as fund liabilities in the governmental fund statements. Interest on long-term debt is not accrued in governmental funds, but rather is recognized as an expenditure when due. All liabilities - both current and long-term - are reported in the government-wide statement of net assets. Also, during the year the City refunded some of its existing debt. The amount borrowed is received in the governmental funds and increases fund balance. The amount that was sent to the paying agent to be escrowed for payment of the old debt as it comes due is paid out of governmental funds and reduces fund balance. The difference between those amounts will be amortized as an adjustment to interest expense in the government-wide statement of activities over the remaining life of the refunded bonds. Balances at June 30, 2005, were (in thousands):

Unamortized bond issuance cost Section 108 receivable Deferred revenue

$

$ Internal Service Fund total assets Internal Service Fund liabilities Cumulative asset resulting from undercharging the enterprise funds $ Bonds, notes, and capital lease payable Arbitrage rebate payable Accrued interest Compensated absences not reported at the fund level Claims and judgments not reported at the fund level Net pension obligation (liabilities less assets) $

10,998 23,395 97,463 131,856 46,140 (44,846) 712 2,006 (2,490,636) (86) (42,951) (347,374) (146,781) (263,084) (3,290,912)

$

A-49

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005
B. Explanation of Certain Differences between the Governmental Fund Statement of Revenues, Expenditures, and Changes in Fund Balances and the Government-wide Statement of Activities Bond proceeds are reported as financing sources in governmental funds and thus contribute to the change in fund balance. In the government-wide statement of net assets, however, issuing debt increases long-term liabilities and does not affect the governmentwide statement of activities. Similarly, repayment of principal is an expenditure in the governmental funds, but reduces the liability in the government-wide statement of net assets. Balances at June 30, 2005 were (in thousands):

Debt issued: Public Improvement Bonds Pension Obligations Commercial paper Premium on bonds Capital appreciation bonds accretion Capital appreciation bonds retired

$

178,295 284,788 195,000 10,546 354 (155) 668,828

Repayments: Refunded commercial paper Refunded pension obligations Principal payments

(160,900) (22,900) (141,077) (324,877)

Amortization of: Deferred gain Premium Net adjustment

$

1,978 (4,062) 341,867

A-50

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005
Under the modified accrual basis of accounting used in the governmental funds, expenditures are not recognized for transactions that are not normally paid with expendable available financial resources. In the government-wide statement of activities, however, which is presented on the accrual basis, expenses and liabilities are reported regardless of when financial resources are available. In addition, interest on long-term debt is not recognized under the modified accrual basis of accounting until due, rather than as it accrues. The adjustment is a combination of the following items (in thousands):

Property taxes earned but not available Ambulance fees earned but not available Fines and forfeits earned but not available Other (primarily assessments) earned but not available Total revenue not reported at fund level Property taxes for prior periods Ambulance fees for prior periods Fines and forfeits for prior periods Other (primarily assessments) for prior periods Total revenue for prior period transactions Interest on long-term debt Municipal Employees pension Police Officers' pension Firefighters' pension Claims and judgments Debt issuance costs Amortization of debt issuance costs Compensated absences Other liabilities Total differences in accrued expenses

$

46,794 5,408 14,991 30,270 97,463 (53,257) (7,186) (11,701) (16,701) (88,845) (20,840) (44,403) (69,248) (19,523) 9,311 1,915 (648) (26,080) 55 (169,461)

$ $

$ $

$

A-51

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005
Note 3: Deposits and Investments

A. Deposits At June 30, 2005 the carrying amount of the City's deposits was $13,806,903. The City's bank balance is the sum of three accounts which total $39,665,521. The three accounts that comprise this balance are described by the following:
Accounts Conc. 00103333903 Sec 108 00103336856 JPM MM Account Subtotal Bank 15,375,568 372,544 23,917,409 39,665,521 Collected 10,000,000 372,544 23,917,409 34,289,953

Mkt Value Collateral

14,178,302

14,178,302

The first account is a demand deposit account with JP Morgan Chase bank that as of June 30, 2005 had a ledger balance of $15,375,568 and a collected balance of $10,000,000. The difference between the ledger and collected balance of $5,375,568 represents checks deposited in this bank account for which the collection of available funds had not been obtained as of June 30, 2005. A Depository Pledge Agreement is in effect by which collateral is pledged by JP Morgan Chase to the City to cover collected balances. The collateral is in the form of high quality fixed income securities, are held by a third party, and as of June 30, 2005 had a market value of $14,178,302. According to the terms of the pledge agreement the City is granted a security interest in the pledged securities. In the event of a default by JP Morgan Chase, the City may sell the pledged securities to satisfy any indebtedness owed to the City by JP Morgan Chase, provided at least 3 business days written notice and opportunity to cure the default is given. The second account is a demand deposit account with JP Morgan Chase Bank for the City's Housing and Urban Development section 108 account, which had a collected and ledger balance as of June 30, 2005 of $372,544. This balance was collateralized by the same Depository Pledge Agreement described above. The third account is an SEC registered money market fund. The City has an agreement with JP Morgan Chase that any collected balances in its concentration bank account at the end of a day over $10,000,000 will automatically be swept into this money market fund. The balance in the money market fund as of June 30, 2005 was $23,917,409. There is no custodial risk associated with this money market fund. The carrying amount of the pension trust fund component unit deposits was $4,061,000 and the bank balance was $4,115,978. The carrying amount of the discretely presented component unit deposits was $49,299,006 with a bank balance of $46,463,798 of which $1,595,025 was uncollateralized.
B. Investments and Risk Disclosures

The following describes the investment positions of the City's operating funds as of June 30, 2005. As of that date, the City had approximately $1.7 billion in fixed income investments in four separate investment pools, each serving a specific purpose as described below. All investments are governed by Texas state law and the City's Investment Policy, which dictates the following objectives, in order of priority:
1. Safety 2. Liquidity 3. Return on Investment 4. Legal Requirements The City’s investment policy does not address concentration of credit risk.

A-52

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005
These funds are managed internally by City personnel.

I. General Investment Pool 960 The General Investment Pool consists of all working capital, construction and debt service funds which are not subject to yield restriction under IRS arbitrage regulations. The funds of the City's enterprise systems, as well as the general fund are commingled in this pool in order to gain operational efficiency. Approximately 98% of the City's total investable funds are contained in this portfolio.
City of Houston Investments As of June 30, 2005 U.S. Treasury Notes Credit Quality Ratings(1)(2) n/a Market Value 18,412,665 WAM ( yrs ) 0.776

$

Housing & Urban Development Dept (“HUD”) Government National Mortgage Association Certificate of Deposits (less than $100,000 each) Commercial Paper Agency Notes (4) Agency Notes (3) (4) Collateralized Mortgage Obligations (3) (4) Mortgaged Backed Securities (3) (4) Municipal Bonds

n/a AAA FDIC Insured A-1+ AAA not rated not rated not rated AAA AA SP-1+

6,338,434 4,535,262 298,569 134,561,895 1,008,046,103 282,624,501 7,049,171 89,009,031 52,028,602 12,430,838 41,193,047
$ 1,656,528,118

0.771 9.572 0.153 0.008 1.227 0.395 7.305 11.918 1.552 2.125 0.923
1.604

Total Investments

(1) Standard and Poor’s Rating Services has assigned an AAAf credit quality rating and S1 volatility rating to the City’s General Investment Pool. The AAAf signifies the highest level of credit protection, and the S1 rating signifies volatility consistent with a portfolio of government securities maturing from one to three years. (2) All credit ratings shown are either actual S&P ratings, or if an S&P credit rating is not available, the equivalent S&P credit rating is shown to represent the actual Moody’s or Fitch credit rating. (3) These securities are not individually rated by the rating agencies. The issuers of these securities, which includes the Federal Home Loan Mortgage Corporation (“Freddie Mac”) and the Federal National Mortgage Corporation (“Fannie Mae”), are rated AAA by the rating agencies. Federal Agricultural Mortgage Corporation (“Farmer Mac”), which comprises 1.3% of this portfolio, is not rated by the credit rating agencies as to the individual securities or as an issuer. Farmer Mac is a government sponsored enterprise and is a permitted investment under state law and City investment policy. (4) These are securities issued by government sponsored enterprises, including the Federal Home Loan Bank, Freddie Mac, Fannie Mae, Farmer Mac, and Federal Farm Credit Bank System. Risk Disclosures: Interest Rate Risk. In order to ensure the ability of the City to meet obligations and to minimize potential fair value losses arising from rising interest rate environments, the City's investment policy limits this investment portfolio’s dollar-weighted average stated maturity to 2.5 years maximum. As of June 30, 2005, this investment portfolio dollar-weighted average stated maturity is 1.6 years. Modified duration for the same period is 1.074. Modified duration can be used as a multiplier to determine the percent change in price of a bond portfolio for every 100 basis point (1%) change in yield. For example, a portfolio with a modified duration of 1.074 would experience approximately a 1.074% change in market price for every 100 basis point change in yield.

A-53

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005 Credit Risk: The US Treasury Notes and securities issued by HUD and the Government National Mortgage Association. are direct obligations of the United States government. The Certificates of Deposit are for amounts less than $100,000 and guaranteed by the FDIC, an arm of the US Government. The Commercial Paper, which is limited by law to maturities of 270 days or less, has the highest short-term rating of A-1+. The Agency Notes, Collateralized Mortgage Obligations and Mortgage Backed Securities are issued by government sponsored enterprises but are not direct obligations of the US Government. The Municipal Securities that were issued as long-term securities are rated AAA or AA. The Municipal Securities that were considered short-term securities as time of issue, and thus were not given a long-term credit rating, have the highest short-term credit rating of MIG-1. Custodial Credit Risk. The custodial credit risk for investments is the risk that, in the event of the failure of the counterparty, the City of Houston will not be able to recover the value of its investment or collateral securities that are in the possession of an outside party. Investment securities are exposed to custodial credit risk if the securities are not registered in the name of the City, and are held by either the counterparty or the counterparty's trust department or agent but not in the City's name. As of June 30, 2005 none of the City's investments in the General Investment Pool 960 were subject to custodial credit risk. II. Tax Exempt Pool 971 The Tax Exempt Pool consists of those funds which are subject to yield restrictions and arbitrage regulation under the1986 Tax Reform Act.
City of Houston Investments As of June 30, 2005 Fidelity Tax-Exempt Money Market Mutual Fund Risk Disclosures: Credit Quality Ratings SEC 2a-7 fund (unrated) Market Value 5,302,384 WAM 1-Day

Interest Rate Risk. In order to ensure the ability of the City to meet obligations and to minimize potential fair value losses arising from rising interest rate environments, the City's investment policy limits this investment portfolio dollar-weighted average stated maturity to 1.0 years maximum. As of June 30, 2005, this investment portfolio’s dollar-weighted average stated maturity is 1 day. Modified duration for the same period is 0.003 year. Credit Risk. Due to the nature of municipal bonds (more risk, less liquidity), the City investment policy limit its investments in the Tax-Exempt Pool with high quality, short maturity securities (generally less than 1 year) and a minimum rating of A, if the yield is reasonably higher than that of tax-exempt money market mutual funds. Otherwise, funds in this pool will be invested in one or more tax-exempt money market mutual funds that are SEC registered and regulated under rule 2a-7. In sum, rule 2a-7 requires that the fund have a weighted average maturity of less than 90 days to maturity, individual securities cannot be more than 397 days to maturity and must have a rating by nationally recognized rating agencies in one of the two highest short-term rating categories. Custodial Credit Risk. The custodial credit risk for investments is the risk that, in the event of the failure of the counterparty, the City of Houston will not be able to recover the value of its investment or collateral securities that are in the possession of an outside party. Investment securities are exposed to custodial credit risk if the securities are not registered in the name of the City, and are held by either the counterparty or the counterparty's trust department or agent but not in the City's name. As of June 30, 2005 none of the City's investments in the Tax Exempt Pool 971 were subject to custodial credit risk. III. Housing Department Section 108 Pool 974 The Housing Department Pool was created to comply with rules of the US Department of Housing and Urban Development (“HUD”), which requires that funds provided by HUD must be held in a separate custodial account for HUD's benefit. The primary goal of this fund is to meet the cash and investment needs of the City's Housing and Community Development HUD program cash flows.
City of Houston Investments As of June 30, 2005 U.S. Treasury Bills Risk Disclosures: Credit Quality Ratings AAA Market Value 1,040,901 WAM 14-Day

Interest Rate Risk. In order to ensure the ability of the City to meet obligations and to minimize potential fair value losses arising from rising interest rate environments, the City's investment policy limits this investment portfolio’s dollar-weighted average stated maturity to 6.0 months maximum. As of June 30, 2005, this investment portfolio dollar-weighted average stated maturity is 14 days. Modified duration for the same period is 0.036 year.
A-54

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005

Credit Risk. Pool 974 only consists of U.S. Treasury Bills with maturities less than 6 months. HUD requires that investment of their funds must be in direct obligations of the United States Government. Custodial Credit Risk. The custodial credit risk for investments is the risk that, in the event of the failure of the counterparty, the City of Houston will not be able to recover the value of its investment or collateral securities that are in the possession of an outside party. Investment securities are exposed to custodial credit risk if the securities are not registered in the name of the City, and are held by either the counterparty or the counterparty's trust department or agent but not in the City's name. As of June 30, 2005 none of the City's investments in the Housing Dept. 974 Pool were subject to custodial credit risk. IV. Convention Center and Hotel Reserve Fund Pool 979 The Convention Center and Hotel Reserve Fund Pool consists of proceeds from the 2001 Series A, B and C Hotel Occupancy Tax and Special Revenue Bond issues designated as reserve funds.
City of Houston Investments As of June 30, 2005 MBIA Flex Repo Risk Disclosures: Credit Quality Ratings not rated Market Value 22,207,693 WAM ( yrs ) 6.175

Interest Rate Risk. This is a 5.64% fixed rate investment provided by MBIA Inc. The market value of this investment is held at a constant value because it is collateralized for 105% of its par value (see credit risk below). Credit Risk. This investment is collateralized with fixed income government securities that are held by a third party. The market value of that collateral is maintained at least 105% of the par value of this investment, and is monitored monthly. Custodial Credit Risk. The custodial credit risk for investments is the risk that, in the event of the failure of the counterparty, the City of Houston will not be able to recover the value of its investment or collateral securities that are in the possession of an outside party. Investment securities are exposed to custodial credit risk if the securities are not registered in the name of the City, and are held by either the counterparty or the counterparty's trust department or agent but not in the City's name. As of June 30, 2005, the City's investments that were subject to custodial credit risk were the collateral securities for the MBIA Flex Repo, held by an independent third party custodian (Wells Fargo) with whom the City has a current custodian agreement. V. Miscellaneous Money Market Account
The City maintains several separate money market account balances for various purposes described below:
City of Houston Investments As of June 30, 2005 JP Morgan US Government Money Market Fund: Airport System Special Facilities Revenue Bonds Series 1997A Reserve Fund. Credit Quality Ratings Market Value WAM ( yrs )

AAA

$

6,681,455

< 90 days

JP Morgan US Government Money Market Fund: Balances held for auction rate debt service. JP Morgan US Treasury Plus Money Market Fund: TNRCC Trust Fund for held for utility projects. First American Treasury Obligation Money Market Fund: Balances held for commercial paper debt service. Total Miscellaneous Money Market Funds

AAA

293,816

< 90 days

AAA

3,833,373

< 90 days

AAA

277,995 $ 11,086,639

< 90 days

Risk Disclosures: Interest Rate Risk. These money market funds maintain an average maturity of less than 90 days and seek to maintain a stable net asset value of $1.00. These funds are redeemable on a same day notice. Credit Risk. These funds hold only US dollar denominated securities that present minimal credit risk. They have the highest credit ratings Standard & Poor's and Moody's of AAAm and Aaa respectively.

A-55

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005
Custodial Credit Risk. The custodial credit risk for investments is the risk that, in the event of the failure of the counterparty, the City of Houston will not be able to recover the value of its investment or collateral securities that are in the possession of an outside party. Investment securities are exposed to custodial credit risk if the securities are not registered in the name of the City, and are held by either the counterparty or the counterparty's trust department or agent but not in the City's name. As of June 30, 2005 none of the City's investments in the above noted money market funds were subject to custodial credit risk. VI. Houston Foundation

The Houston Foundation consists of two trusts, of which the Hill Trust is reported on this schedule. The Hill trust was established by will in the early 1900's as a general purpose charity trust. The foundation's board usually designates that the money be used for a specific purpose, such as the purchase of medical supplies or to fund Meals on Wheels, rather than for administrative or staff salaries. The City's Finance and Administration staff provides administrative support to the foundation and its board.
City of Houston Investments As of June 30, 2005 Cash and Equivalents Credit Quality Ratings not rated Market Value $ 53,895 WAM ( yrs ) > 90 days

Fixed Income Equities Total Assets

not rated n/a

1,212,681 1,328,446 $ 2,595,022

2.14 n/a

Risk Disclosures: Interest Rate Risk. The fixed income portion of this portfolio is invested in two mutual funds, about 80% of which is invested in a shortterm bond fund with a modified duration of 1.6. The remaining 20% is invested in an intermediate bond fund with a modified duration of about 4.3. Credit Risk. The allocation of assets among various asset classes are set by the board. The mutual funds containing the fixed income investments are not rated, but the average credit quality of the specific securities held by the mutual funds is Aa2. The equity assets are split among five mutual funds with their respective objectives as follows: International Value, Growth, Midcap Index, Smallcap Index, and Domestic Value. The fund's managers consider broad diversification as a measure of safety and balance in the investment of funds. Custodial Credit Risk. The custodial credit risk for investments is the risk that, in the event of the failure of the counterparty, the City of Houston will not be able to recover the value of its investment or collateral securities that are in the possession of an outside party. Investment securities are exposed to custodial credit risk if the securities are not registered in the name of the City, and are held by either the counterparty or the counterparty's trust department or agent but not in the City's name. As of June 30, 2005 all of the foundation's holdings in the above noted mutual funds were subject to custodial credit risk.

VII. Investments – Houston Area Water Corporation As of June 30, 2005, the Corporation had the following investments: Weighted Average Maturity 37 days 44 days 1.7 yrs.

Investment JP Morgan U.S. Government Money Market Fund JP Morgan Prime Money Market Funds Pool managed by the City of Houston

$

Fair value 75,458 3,050,712 4,277,210

Interest Rate Risk. The Corporation does not have a formal investment policy that limits investment maturities as a means of managing its exposure to fair value losses arising from increasing interest rates. Credit Risk. State law limits investments in commercial paper, corporate bonds, and mutual bond funds to the top two ratings issued by nationally recognized statistical rating organizations. The corporation has no investment policy that would further limit its investment choices. As of June 30, 2005, Standard & Poor’s Investment Services has assigned its AAAf credit rating and S1 volatility rating available from Standard & Poor’s and reflects the extremely strong protection that the Pool’s portfolio investments provide against losses from credit defaults or credit deterioration. The S1 volatility rating recognizes the Pool’s sensitivity to changing market conditions as a result of its low market risk profile and conservative investment policies. The corporation’s investment in the U.S. Government Money Market Fund was rated AAAm by S&P Rating and Aaa by Mood’s Rating. The corporation’s investment in the Prime Money Market Fund was rated AAAm by S&P Rating and Aaa by Moody’s Rating.

A-56

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005 VIII. Investments – Municipal Employees Pension System (the “System”) Portions of the System’s investments are classified as security investments. A security is a transferable financial instrument that evidences ownership or creditorship. Investments in commingled funds, limited partnerships, real estate trusts, and loans and mortgages are investments that are evidenced by contracts rather than securities. The fair values of the System’s investments at June 30, 2005 are presented by type, as follows:

United States government securities Corporate bonds Capital stocks Commingled funds Limited partnerships, real estate trust, and loans and mortgages Short-term investment funds (cost)

$

62,840,296 73,687,436 458,701,513 420,920,132 372,737,677 97,408,425

$

1,486,295,479

The System’s Board (Board), in accordance with the power and authority conferred under the Texas Statutes, employed State Street Bank and Trust Company (Custodian) as custodian of the assets of the System, and in said capacity, the Custodian shall be a fiduciary of the System’s assets with respect to its discretionary duties including safekeeping the System’s assets. The Custodian shall establish and maintain a custodial account to hold, or direct its agents to hold, for the account of the System all assets that the Board shall from time to time deposit with the Custodian. All right, title and interest in and to the System’s assets shall at all times be vested in the System’s Board. In holding all system assets, the Custodian shall act with the same care, skill, prudence and diligence under the prevailing circumstances that a prudent person acting in like capacity and familiar with matters of this type would use in the conduct of an enterprise with a like character and with like aims. Further, the Custodian shall hold, manage and administer the System’s assets for the exclusive purpose of providing the benefits to the members and the qualified survivors of the System.
The Board shall manage the investment program of the System in compliance with all applicable Federal and State statutes and regulations concerning the investment of pension assets. The Board has adopted a Statement of Investment Policies and Objectives (Investment Policy) to set forth the factors involved in the management of investment assets for the System and is made part of every investment management agreement.

Custodial credit risk. For an investment, custodial credit is the risk that, in the event of the failure of the counterparty, the System will not be able to recover the value of its investment or collateral securities that are in the possession of an outside party. Investment securities are exposed to custodial credit risk if the securities are uninsured, are not registered in the name of the System, and are held by either the counterparty or the counterparty’s trust department or agent but not in the System’s name. At June 30, 2005, the System’s investments that were not subject to custodial credit risk were the investments in U.S. government securities and corporate bonds as they are registered in the name of the System and held in possession of the Custodian. Concentration of credit risk. The allocation of assets among various asset classes are set by the Board. For major asset classes (e.g., U.S. equity, international equity, fixed income, real assets, and alternative investments), the System will further diversify by employing managers with demonstrated skills in complementary areas of expertise. The managers retained will utilize varied investment approaches, but, when combined will exhibit characteristics that are similar, but not identical, to the asset class proxy utilized in the strategic asset allocation plan. The Investment Policy of the System provides that no investment manager shall have more than 15% (at market value) of the System’s assets in one investment style offered by the firm, with the exception of passive management.

A-57

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005 Significant guidelines by type of investment are as follows: U.S. equity managers 1. A manager's portfolio shall contain a minimum of twenty-five issues. 2. No more than 5% of the manager's portfolio at market shall be invested in American Depository Receipts. 3. No individual holding in a manager's portfolio may constitute more than 5% of the outstanding shares of an issuer. 4. No individual holding may constitute more than 5% of a manager's portfolio at cost or 10% at market. 5. Short sales, purchases on margin, non-negotiable or otherwise restricted securities are prohibited, other than where expressly permitted.

6. While there are no restrictions on cash, a manager must notify the System if the cash position exceeds 10%. International equity managers 1. Not more than 5% at cost and 10% at market value of a manager's portfolio shall be invested in the securities of any one issuer. 2. Not more than 30% of the assets of a manager's portfolio (at market value) shall be invested in any one country with the exception of Japan. 3. 4. While there are no restrictions on cash, a manager must notify the System if the cash position exceeds 10%. Currency forwards and futures will be limited as follows: a. b. c. d. Limits on net forward and future sales of currencies will be addressed in each manager's respective Guidelines and Objectives, Forward and future exchange contracts of any currencies, other than Yen, Sterling and Euro shall be limited to the manager’s underlying equity position in the local market, Foreign exchange contracts with a maturity exceeding 12 months are prohibited, and Currency options may be entered into in lieu of or in conjunction with forward sales of currencies. The same effective limitations specified in (a) through (c) above will apply to currency options.

Fixed income managers 1. No more than 10% of a manager's portfolio at market shall be invested in the securities of any single issuer, with the exception of the U.S. government and its agencies. 2. No individual holding in a manager's portfolio shall constitute more than 10% of the market value of an issue. Global opportunistic fixed income/high yield managers 3. No more than 5% at cost and 10% at market value of a manager's portfolio shall be invested in the securities of any single issuer, with the exception of the U.S. government and its agencies. There is no security issued by a single issuer that is being held with market value over 5% of the System’s plan net assets as of June 30, 2005. Interest rate risk. The System invests in fixed income securities including, but not limited to, investments representing instruments with an obligated fixed rate of interest including public and private debentures, mortgages, investments in life insurance general accounts and guaranteed investment contracts, with maturities greater than one year, and options/futures. Instruments may have an investment grade or non-investment grade rating. Purchases and sales, investment selection and implementation of investment strategies are delegated to the discretion of the investment manager, subject to compliance with its management agreement and the Investment Policy. Interest rate risk is the risk that changes in interest rates will adversely affect the fair value of the investment. Duration is a measure of a debt investment’s exposure to fair value changes arising from changes in interest rates. It uses the present value of cash flows, weighted for those cash flows as a percentage of the investment’s full price.

A-58

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005 The greater the duration of a bond, or a portfolio of bonds, the greater its price volatility will be in response to a change in interest rates and vice-versa. Duration is the measure of a bond price’s sensitivity to a 100-basis point change in interest rates. The duration of the System’s debt securities are managed by the active managers. At June 30, 2005, the following table shows the System’s investments by type, amount and the effective duration rate calculated using the software Wilshire Axiom.
Effective Duration Collateralized mortgage obligations Convertible bonds Corporate bonds Corporate bonds (International) GNMA/FNMA/FHLMC Government issues Government issues (International) Misc. receivable (auto/credit card) Options-futures Other asset backed 3.99 3.25 6.89 2.25 2.28 4.59 6.30 0.99 3.54 4.80 Domestic $ 11,604,049 4,122,076 45,458,947 123,089 21,906,214 34,435,711 1,265,178 (233,658) 9,331,750 $ 128,013,356 International 94,240 1,689,463 1,422,355 Fair Value 11,698,289 5,811,539 45,458,947 1,545,444 21,906,214 34,435,711 4,797,481 1,265,178 (233,658) 9,842,587 136,527,732

4,797,481

510,837 8,514,376

Credit risk. The quality ratings of investments in fixed income securities are set forth in the Investment Policy as follows:

1.

All issues purchased must be of investment grade quality Baa (Moody's) or BBB (S&P) unless expressly authorized by the Board, in which case a minimum B rating shall apply, with a maximum limit of non-investment grade credits of 20% at market. For global opportunistic fixed income/high yield securities, more than 50% of a manager’s portfolio at market shall be invested in non-investment grade fixed income securities, i.e. those with ratings of BA1 (Moody’s), BB+ (Standard & Poor’s), or lower, or unrated bonds, including corporate bonds, convertible bonds, and preferred stocks.

2.

The quality ratings of investments in fixed income securities as described by nationally recognized statistical rating organizations at June 30, 2005 are as follows: Quality Rating AAA AA+ AAA AA+ BBB BBBBBB+ BB BB+ BBB B+ BCCC and below Not rated Rating not available Total credit risk debt securities U.S. government fixed income securities* Total fixed income securities Fair Value $ 26,746,361 182,910 557,981 1,170,123 953,692 1,432,390 3,014,419 4,208,705 2,143,098 5,887,768 6,715,068 1,881,936 4,937,965 5,814,350 7,943,678 4,549,622 3,179,075 5,173,004 86,492,145 50,035,587 $ 136,527,732 Percentage of Holdings 19.58 0.13 0.41 0.86 0.70 1.05 2.21 3.08 1.57 4.31 4.92 1.38 3.62 4.26 5.82 3.33 2.33 3.79 % % % % % % % % % % % % % % % % % %

63.35 % 36.65 % 100.00 %

*Obligations of the U.S. government or obligations explicitly guaranteed by the U.S. government are not considered to have credit risk and do not have purchase limitations.

A-59

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005
Foreign currency risk. International securities investment managers are expected to maintain diversified portfolios by sector and by issuer using the System’s Investment Policy.

Foreign currency risk is the risk that changes in exchange rates will adversely affect the fair value of an investment or a deposit. Each investment manager, through the purchase of units in a commingled investment trust fund or international equity mutual fund, establishes investments in international equities. The System has an indirect exposure to foreign currency fluctuation as of June 30, 2005 as follows: Percentage of Holdings 36 22 14 8 3 3 3 2 2 2 5 % % % % % % % % % % %

Fair Value EURO Currency Japanese Yen Pound Sterling Swiss Franc Norwegian Krone Canadian Dollar Hungarian Forint Singapore Dollar Hong Kong Dollar Australian Dollar Other foreign currencies Total securities subject to foreign currency risk $ 64,743,286 39,341,395 24,551,143 15,199,722 5,455,402 5,086,231 4,973,540 3,733,631 3,487,281 3,221,610 9,945,068 179,738,309

$

100 %

Securities Lending. State Statues allow the System to participate in securities lending transactions and the Board has authorized its custodian to lend the System’s securities to broker-dealers and banks pursuant to a form of loan agreement. During the year ended June 30, 2005, the System’s custodian lent, at the direction of the Board, the System’s securities and received cash, securities issued or guaranteed by the United States government, and irrevocable bank letters of credit as collateral. The custodian does not have the ability to pledge or sell securities delivered for collateral, absent a borrowers default. Borrowers were required to deliver collateral for each loan equal to: (i) in the case of loaned securities denominated in United States dollars or whose primary trading market was located in the United States or sovereign debt issued by foreign governments, 102% of the market value of the loaned securities; and (ii) in the case of loaned securities not denominated in United States dollars or whose primary trading market was not located in the United States, 105% of the market value of the loaned securities.

The Board did not impose any restrictions on the amounts of the loans that the System’s custodian made on its behalf. There were no failures by any borrowers to return loaned securities or pay distributions. Moreover, there were no losses during the year resulting from a default of the borrowers or the custodian. During the year ended June 30, 2005, the Board and the borrowers maintained the right to terminate all securities lending transactions on demand. The cash collateral received on each loan was invested together with the cash collateral of other qualified tax-exempt plan lenders, in a commingled investment pool. As of June 30, 2005, such investment pool had an average duration of 40 days and an average weighted maturity of 410 days, respectively. Because the loans were terminable at will, their duration did not generally match the duration of the investments made with cash collateral. On June 30, 2005, the System had no credit risk exposure to borrowers. The collateral held and the fair value of securities on loan as of June 30, 2005, was $96,629,097 and $92,807,489, respectively. The fair values of the underlying securities lent as of June 30, 2005 are as follows: 2005 $27,699,150 34,267,743 10,089,776 20,750,820 $92,807,489

U.S. government securities Domestic equity Domestic fixed income International equity

A- 60

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005
IX. Investments – Houston Firefighters’ Relief and Retirement (HFRRF) Fund

Statutes of the State of Texas authorize the HFRRF to invest surplus funds in the manner provided by the Government Code, Title 8, Subtitle A, Subchapter C. This subchapter provides for the investment of surplus assets in any investment or investments that are deemed “prudent” by the HFRRF Board. The investment policy of the HFRRF Board does not restrict the types of investments authorized to be made on behalf of the HFRRF; however, the Board seeks to produce a return on investments that is based on prudent and reasonable investment risk and the cash flow requirements of the HFRRF given prevailing capital market conditions. While the HFRRF Board recognizes the importance of the preservation of capital, it also adheres to the theory of capital market pricing which maintains that varying degrees of investment risk should be rewarded with incremental returns. Consequently, prudent risk-taking is justifiable. The HFRRF Board has employed Mellon Trust (HFRRF Custodian) as HFRRF Custodian of the assets of the HFRRF, and in said capacity, the HFRRF Custodian shall be a fiduciary of the HFRRF’s assets with respect to its discretionary duties including safekeeping the HFRRF’s assets. The HFRRF Custodian shall establish and maintain a custodial account to hold, or direct its agents to hold, for the account of the HFRRF all assets that the HFRRF Board shall from time to time deposit with the HFRRF Custodian. All right, title and interest in and to the HFRRF’s assets shall at all times be vested with the HFRRF’s Board. In holding all HFRRF assets, the HFRRF Custodian shall act with the same care, skill, prudence and diligence under the prevailing circumstances that a prudent person acting in like capacity and familiar with matters of this type would use in the conduct of an enterprise with a like character and with like aims. Further, the HFRRF Custodian shall hold, manage and administer the HFRRF ‘s assets for the exclusive purpose of providing the benefits to the members and the qualified survivors of the HFRRF Fund. The HFRRF Board shall manage the investment program of the HFRRF in compliance with all applicable Federal and State statutes and regulations concerning the investment of pension assets. The HFRRF Board has adopted an Investment Policies and Procedures (Investment Policy) to set forth the factors involved in the management of investment assets for the HFRRF. The HFRRF Board has established an Investment Committee to act on all matters related to investments. The fair values of the HFRRF’s investments as of June 30, 2005 by type, are as follows:

Short-term investment funds Fixed Income Common equity Preferred equity Alternative investments - partnerships Real Estate Total investments

$

116,398,655 737,221,349 975,558,275 7,122,422 299,765,798 121,489,048 2,257,555,547

$

Portions of the HFRRF’s investments are classified as security investments. A security is a transferable financial instrument that evidences ownership or creditorship. Investments in partnerships and real estate are investments that are evidenced by contracts rather than securities.
Custodial credit risk. For an investment, custodial credit is the risk that, in the event of the failure of the counterparty, the HFRRF will not be able to recover the value of its investment or collateral securities that are in the possession of an outside party. Investment securities are exposed to custodial credit risk if the securities are uninsured, are not registered in the name of the HFRRF, and are held by either the counterparty or the counterparty’s trust department or agent but not in the HFRRF’s name. At June 30, 2005, the HFRRF’s security investments that were not subject to custodial credit risk were the investments in fixed income and equity investments. Concentration of credit risk. The allocation of assets among various asset classes are set by the HFRRF Board with the objective of optimizing the investment return of the HFRRF within framework of acceptable risk and diversification. For major asset classes (e.g., domestic equities, international equities, fixed income, alternative investments, and real estate), the HFRRF will further diversify by employing investment managers who implement the strategies selected by the Investment Committee.

Significant guidelines are as follows:
Public market investments

1.

Specific guidelines will be developed cooperatively by the HFRRF’s investment staff, legal counsel, and investment manager and shall be incorporated into the Investment Management Services Contract executed by the Chair of the Investment Committee, Executive Director and the investment manager.

A-61

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005
2. In case of conflict between the specific manager guidelines and the general guidelines, the specific guidelines, as approved by the Investment Committee, shall supersede. The general guidelines are as follows: a. Manager investment philosophy, style, and strategy shall remain consistent and shall not change without the Investment Committee’s approval. The manager shall have discretion to manage the portfolio consistent with the style presented to the Investment Committee at the time of selection and further subject to the restrictions established by the policy herein. The following transactions are prohibited: short sales, selling on margin, put and call options, and the use of derivatives for speculation unless authorized by the Investment Committee. Transactions that involve a broker acting as a principal, where such broker is also affiliated with the manager who is making the transaction are prohibited, unless specifically approved by the Investment Committee. Transactions shall be executed at competitive costs, or within the parameters established for directed brokerage transactions by the Investment Committee. Managers shall maintain cash levels consistent with their style as presented to the Investment Committee at the time of selection. Any deviation shall be allowed only after notifying the Chief Investment Officer and Executive Director and should be related to unusual market conditions. The cash level held by each manager will be addressed in the Investment Management Services Contract.

b.

c.

d.

e.

3.

The Investment Committee with the assistance from the HFRRF staff shall monitor each investment manager’s performance and adherence to style, strategy, and manager specific guidelines. It is the Investment Committee’s discretion to take corrective action by replacing an investment manager if they deem it appropriate at any time.

Alternative and real estate investments

a.

The investment specific guidelines for each manager will be incorporated in a Limited Partnership Agreement, Limited Liability Company Agreement, or other binding agreement as is appropriate for the investment. The Chair of the Investment Committee and the manager execute this document. In case of conflict between the specific manager guidelines and the general guidelines, the specific guidelines, as approved by the Investment Committee, shall supersede. The general guidelines are as follows: 1. Manager investment philosophy, style, and strategy shall remain consistent and shall not change without the Investment Committee’s approval. The manager shall have discretion to manage the portfolio consistent with the style presented to the Investment Committee at the time of selection and further subject to the restrictions established by the policy herein. The Chair of the Investment Committee may execute amendments and consents if the resulting changes or allowances are provided for in the governing documents as previously accepted by the Investment Committee. Otherwise, such changes are to be approved by the Investment Committee. The Investment Committee will be notified on a quarterly basis of all executed amendments.

b.

2.

c.

The Investment Committee with assistance from the HFRRF staff shall monitor each Alternative and Real Estate manager’s performance and adherence to strategy and manager specific guidelines. It is the Investment Committee’s discretion to take corrective action by replacing an investment manager if they deem it feasible and appropriate at any time. Alternative and Real Estate investment manager retention is governed in most cases by Limited Partnership Agreements, Limited Liability Company Agreements, or other binding agreements. In these cases, the Investment Committee with assistance from the HFRRF staff shall identify available options as allowed by the governing documents and determine the impact and consequences of these options.

As of June 30, 2005, the HFRRF Fund’s investments of $119,666,229 in an individual U.S. Treasury Bond exceeded 5% of HFRRF net assets.
Interest rate risk. The Fund invests in fixed income securities including, but not limited to, investments representing instruments with an obligated fixed rate of interest including public and private debentures, mortgages, investments in life insurance general accounts and guaranteed investment contracts, with maturities greater than one year, and options/futures. Instruments may have an investment grade or non-investment grade rating. Purchases and sales, investment selection and implementation of investment strategies are delegated to the discretion of the investment manager, subject to compliance with its management agreement and the HFRRF’s Investment Policy.

A-62

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005
Interest rate risk is the risk that changes in interest rates will adversely affect the fair value of the investment. Interest rate risk is the greatest risk faced by an investor in the fixed income market. The price of a fixed income security typically moves in the opposite direction of the change in interest rates. The weighted average maturity expresses investment time horizons (when the investment come due and payable) in years, weighted to reflect the dollar size of individual investments within the investment type. The HFRRF does not have a formal investment policy that limits investment maturities as a means of managing its exposure to potential fair value losses arising from future changes in interest rates, but rather mandates such limits within the Investment Management Services Contract. At June 30, 2005, the following table shows the HFRRF’s investments by type, with weighted average maturity and fair value: Weighted Average Maturity U.S. government issues Corporate debt Non-U.S. government issues Asset backed securities General obligations U.S. private placements FHLMC/FNMA Revenue bonds Total fixed income securities 10.94 9.14 3.44 4.95 17.62 14.84 3.30 19.29 10.03 $

Fair Value 352,853,759 236,284,791 38,820,794 33,662,412 25,636,309 18,462,880 16,174,875 15,325,529 737,221,349

$

Credit risk. Credit risk is the risk that an issuer or other counterparty to an investment will not fulfill its obligations. The HFRRF does not have a formal policy limiting investment credit risk, but rather mandates such limits within the Investment Management Services Contract.

The HFRRF’s exposure to investment credit risk in fixed income securities as of June 30, 2005 is as follows: Percentage of Holdings 4.55 0.91 0.95 0.39 0.21 0.71 0.15 0.54 0.66 1.17 0.72 0.68 1.33 0.84 0.84 1.12 0.26 0.19 0.22 0.01 0.58 % % % % % % % % % % % % % % % % % % % % %

Quality Rating Aaa Aa1 Aa2 Aa3 A1 A2 A3 Baa1 Baa2 Baa3 Ba1 Ba2 Ba3 B1 B2 B3 Caa1 Caa2 Caa3 Ca Rating not available Total credit risk debt securities* $

Fair Value 102,629,555 20,633,205 21,502,751 8,916,013 4,677,978 16,076,632 3,438,580 12,160,835 14,855,742 26,495,592 16,148,864 15,382,990 30,060,416 18,876,577 18,996,109 25,265,596 5,791,107 4,365,818 4,913,523 114,100 13,065,607 384,367,590

$

17.03 %

*Obligations of the U.S. government or obligations explicitly guaranteed by the U.S. government are not considered to have credit risk and therefore, have not been included in this disclosure.

A-63

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005
Foreign currency risk. Foreign currency risk is the risk that changes in exchange rates will adversely affect the fair value of an investment or a deposit. International securities investment managers are expected to maintain diversified portfolios by sector and by issuer using the HFRRF’s Investment Policy. The HFRRF’s exposure to foreign currency fluctuation as of June 30, 2005 is as follows:

Fair Value EURO Currency British Pound Sterling Japanese Yen Canadian Dollar Swiss Franc Australian Dollar South Korean Won Singapore Dollar Mexican New Peso Hong Kong Dollar Norwegian Krone Brazil Real New Taiwan Dollar Thailand Baht New Zealand Dollar Swedish Krona Hungarian Forint South African Rand Czech Koruna Israeli Shekel Indonesian Rupian New Turkish Lira Danish Krone Total securities subject to foreign currency risk $ 111,242,262 93,786,763 57,408,173 44,885,887 31,252,035 27,962,587 21,283,947 14,553,404 14,316,690 13,646,305 13,378,602 12,777,475 11,565,215 9,509,435 8,922,327 6,473,212 6,431,204 4,522,012 3,258,751 1,410,356 1,408,732 1,382,067 10,563 511,388,004

Percentage of Holdings 4.93 % 4.15 % 2.54 % 1.99 % 1.38 % 1.24 % 0.94 % 0.64 % 0.63 % 0.60 % 0.59 % 0.57 % 0.51 % 0.42 % 0.40 % 0.29 % 0.28 % 0.20 % 0.14 % 0.06 % 0.06 % 0.06 % 0.00 % 22.62 %

$

Securities Lending Arrangement The HFRRF had the following securities on loan and held the following related cash collateral balances, at fair value, as of June 30, 2005: Securities Lent Collateral Held Fixed Income $ 466,887,790 $ 477,737,216 Common and preferred stocks 61,243,760 64,346,716 $ 528,131,550 $ 542,083,932

State statutes and Board policies permit the HFRRF to lend its securities to broker-dealers and other entities with a simultaneous agreement to return the collateral for the same securities in the future. The HFRRF’s Custodian lends securities of the type on loan for collateral in the form of cash or other securities of 101% to 109%, which varies based on the types of securities lent. The HFRRF has no credit risk exposure to borrowers because the amounts the HFRRF owes the borrowers exceed the amounts the borrowers owe the HFRRF as of June 30, 2005. The contract with the HFRRF’s Custodian requires it to indemnify the HFRRF if the borrowers fail to return the securities (and if the collateral is inadequate to replace the securities lent) or fail to pay the HFRRF for income distributions by the securities’ issuers while the securities are on loan. All security loans can be terminated on demand by either the HFRRF or the borrower. Cash collateral is invested in the lending agent’s collateral investment pool, which has a weighted-average maturity of approximately 31 days as of June 30, 2005. The risk associated with the HFRRF’s participation in the securities lending program is investment risk, which affects the yield spread on the investments within the loan investment pool. The HFRRF cannot pledge or sell collateral securities received unless the borrower defaults. At June 30, 2005, securities lending transactions were collateralized in cash.

A-64

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005

X. Investments – Houston Police Officers’ Pension (HPOP) Summary of Significant Accounting Policies Investments. Statutes of the State of Texas authorize the HPOP System to invest surplus funds in a manner provided by the Government Code, Title 8, Subtitle A, Subchapter C. Investments are reported at fair value. Securities traded on national or international exchanges are valued at the last reported sales price at current exchange rates. Investments that do not have an established market value are reported at estimated fair value. Dividend income is recorded on the ex-dividend date. Income from other investments is recorded when earned. Gains and losses on sales of securities are recognized on the trade date. The cost of investments sold is determined using the first-in, firstout cost flow method. Short-term investments include funds held in the Northern Trust Short Term Investment Fund (STIF) and commercial paper with maturities not exceeding one year. Fixed income investments include government securities such as Treasury securities, Federally sponsored agency issued discount notes, bonds, agency pass-through securities and collateralized mortgage obligations; US corporate bonds such as term bonds and asset backed securities; and foreign securities such as dollar denominated and non-dollar denominated issues of non-US governments and private corporations. Call options on fixed income securities give the holder the right but not the obligation to purchase US Treasury securities during the term of the option contract. The holder pays a premium for this right, which is carried as an asset of the System, subject to daily mark-to-market adjustments, during the contract term. The issuer of the option has an obligation to the holder to settle the option position in cash at the fair value of the underlying security in exchange for the price specified by the option, until the contract is exercised or expires. Equity securities consist of individual shares of equity securities plus units of commingled stock funds of both US and foreign entities. Alternative investments consist of investments in real estate and venture capital and private equity limited partnerships. The System's investments have been categorized to address deposit and investment risks related to custodial credit risk, credit risk, concentration of credit risk, interest rate risk, and foreign currency risk. Custodial Credit Risk. Custodial credit risk for deposits is the risk that in the event of a bank failure, the HPOP System’s deposits may not be returned to them. The HPOP System considers only demand deposits as cash. As of June 30, 2005, the HPOP System had a balance of $131 thousand on deposit at a financial institution. The Federal Depository Insurance Corporation covered cash on deposit up to $100 thousand at this financial institution. As of June 30, 2005, $31 thousand of the System’s bank balance of $131 thousand was exposed to custodial credit risk as it was uninsured and uncollateralized. In addition, at June 30, 2005, the System has approximately $811 thousand on deposit and an overdraft of approximately $976 thousand with other financial institutions, which is subject to custodial credit risk, as it is not covered by depository insurance and is uncollateralized. Credit Risk. Credit risk is the risk that the counterparty will not fulfill its obligations. As of June 30, 2005, the System’s fixed income assets that are not government guaranteed represented 99.9% of the System’s fixed income portfolio. The following tables summarize the System’s fixed income portfolio exposure levels and credit qualities.
Average Credit Quality and Exposure Levels of Non-U.S. Government Guaranteed Securities ($000’s) Weighted Percent of All Market Value Average Credit Fixed Income Fixed Income Security Type June 30, 2005 Quality Assets Corporate Bonds $ 207,280 40.9% B International Government Agencies 1,027 0.2% A Government Bonds 159,636 31.5% AA Mutual Bond Funds 138,445 27.3% Not Rated Total $ 506,388 99.9%

A-65

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005

Ratings Dispersion Detail ($000's) Credit Rating Level AAA AA A BBB BB B CCC C D SD Not Rated Total Corporate Bonds $ 486 1,084 44,194 129,164 17,106 772 544 100 13,830 $ 207,280 International Government Bonds $ 55,448 76,749 6,038 12,645 6,282 2,474 $ 159,636 Mutual Bond Funds International Government Agencies

$

1,027

$ $

138,445 138,445

$

1,027

The HPOP System’s investment policy allows Investment managers full discretion in adopting investment strategies to deal with these risks. Unless otherwise provided in the individual investment manager agreement, the average quality rating of each individual fixed income portfolio on a weighted value basis shall be A-rated or higher, and no issue should have a rating below investment grade (Baa or higher). Certain managers, such as high yield managers, may be exempted from these requirements as provided for in their contracts. Credit risk for derivative instruments held by the HPOP System results from counterparty risk, essentially that the counterparty will be unable to fulfill its obligations, assumed by the HPOP System. Information regarding the HPOP System’s credit risk related to derivatives is found under the derivatives disclosures. Policies regarding credit risk pertaining to credit risk associated with the HPOP System’s securities lending program are found under the securities lending disclosures.

Concentration of Credit Risk. Concentration of credit risk is the risk of loss attributable to the magnitude of the HPOP System’s investment in a single issue. The HPOP System’s operational guidelines for each specific portfolio limits investments in any one single domestic equity issue to 15% of each portfolio at market value and for any one single international equity issue to 5% of the HPOP System’s investments. For fixed income investments, the HPOP System’s policy limits, by each specific portfolio, investment in any one single fixed income security to 10% of each portfolio at market value. As of June 30, 2005, the HPOP System did not have any investments in any one organization which represented greater than 5% of plan net assets. Interest Rate Risk. Interest rate risk is the risk that changes in interest rates will adversely affect the fair values of the HPOP System’s financial instruments. This risk is managed within the portfolio using the modified duration methodology. It is widely used in the management of fixed income portfolios and estimates the sensitivity of a bond’s price to interest rate changes. All of the HPOP System’s fixed income portfolios are managed in accordance with guidelines that are specific as to the degree of interest rate risk taken. The reporting of modified duration found in the tables below quantifies the interest rate risk of the HPOP System’s fixed income investments. Interest rate risks associated with derivative instruments are found in the derivatives disclosures of these notes.

A-66

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005

Modified Duration of Fixed Income Assets by Security Type ($000's) % of All Fixed Income Assets 0.2% 40.9% 0.2% 31.4% 27.3% 100.0% Weighted Average Modified Duration (years) 0.1 4.9 5.5 4.8 7.0 5.9

Fixed Income Security Type US Treasuries Corporate Bonds International Government Agencies Government Bonds Mutual Bond Funds Total

Market Value June 30, 2005 $ 921 207,280 1,027 159,636 138,445 507,309

$

M odified Duration Analysis - Corporate and International Government Bonds ($000's) M arket Value June 30, 2005 $ 1,163 191,232 8,523 6,362 $ 207,280 Average M odified Duration 0.6 4.7 7.8 11.3 Contribution M odifed Duration 0.0 4.3 0.3 0.3 4.9 Contribution M odifed Duration 0.0 2.6 0.6

Corporate Bonds Less than 1 year to maturity 1 to 10 years maturities 10 to 20 years maturities Greater than 20 years maturities Total

International Government Bonds Less than 1 year to maturity 1 to 10 years maturities 10 to 20 years maturities

M arket Value June 30, 2005 $ 112,463 10,778

Average M odified Duration 0.0 4.7 11.3

Greater than 20 years maturities Total

$

36,395 159,636

12.7

2.2 5.4

Foreign Currency Risk. Foreign currency risk is the risk that changes in exchange rates will adversely impact the fair value of an investment. The books and records of the HPOP System are maintained in US dollars. Foreign currencies and non-dollar denominated investments are translated into US dollars at the bid prices of such currencies against US dollars at each balance sheet date. Realized and unrealized gains and losses on investments which result from changes in foreign currency exchange rates have been included in the net appreciation in fair value of investments. Net realized foreign currency gains and losses resulting from changes in exchange rates include foreign currency gains and losses between trade date and settlement date of investment securities transactions, foreign currency transactions and the difference between the amounts of interest and dividends recorded on the books of the HPOP System and the amount actually received.

A-67

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005

The HPOP System’s exposure to foreign currency risk in U.S. dollars as of June 30, 2005, is shown in the table below:
Foreign Currency Exposure by Asset Class ($000's)

Currency Australian dollar British pound sterling Canadian dollar Chinese yuan renminbi Czech koruna Danish krone Euro Hong Kong dollar Hungarian forint Japanese yen Mexican peso New Taiwan dollar New Zealand dollar Norwegian krone Polish zloty Singapore dollar South African rand South Korean won Swedish krona Swiss franc

Short Term Investments Equities $ 157 $ 2,055 227 82,602 (50) 4,517

Fixed Income $ 9,179 2,127

228

186,545 3,861 90,686

1,448 69,013

270

53,176

4,675 2,630 8,523 6,847 1,492 $ 168 1,000 $ 31,422 424,363 $ 136,435

Options on Foreign Currencies Total $ 41,232 $ 43,444 47,977 139,985 (16,859) (10,265) 38,864 38,864 1,658 1,658 (1,452) (4) (189,308) 66,478 3,861 1,036 1,036 21,741 165,873 6,740 6,740 2,339 2,339 (1,913) 2,762 2,630 1,663 1,663 8,523 2,112 2,112 4,519 11,366 7,652 9,144 21,446 53,036 $ (10,553) $ 551,245

Securities Lending Program –

Fair Value ($000’s)
June 30, 2005

Investments held by System’s agent in System’s name: Short-term investments Fixed income Equities Alternative investments Foreign currency contracts Securities lending collateral investment pool

$

168,342 424,028 1,527,437 267,806 2,694 288,266

$ Investments held by brokers under securities loans with cash collateral: Fixed income Equities

2,678,573

$ $

83,281 165,385 248,666

A-68

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005

The HPOP Board of Trustees’ policies permit the HPOP System to lend securities (domestic and international equities and fixed income) to securities firms on a temporary basis through its custodian bank. The HPOP System receives fees for all loans and retains the right to all interest and dividend payments while the securities are on loan. Cash, letters of credit or various government securities having market values equal to or exceeding 102 and 105 percent of the value of the loaned securities for domestic and international securities, respectively, collateralize all security loan agreements. Whenever market value of the securities on loan changes, the borrower must adjust the collateral accordingly. At June 30, 2005, the HPOP System had no credit risk exposure to borrowers because the amounts the HPOP System owes the borrowers exceed the amounts the borrowers owe the HPOP System. The HPOP System's bank pools all collateral received from securities lending transactions and invests any cash collateral. The HPOP System holds an undivided share of the collateral provided by the borrowers of the securities. At June 30, 2005 the weighted-average maturity of the collateral pool was 29 days. The relationship between the maturities of the collateral pool and the HPOP System's loans has not been determined. Cash collateral invested in the custodian bank collateral pool at June 30, 2005 and 2004, was $256,170 thousand and $305,144 thousand, respectively. The balance of the collateral at June 30, 2005 of $32,096 thousand consists of treasury securities and letters of credit. The HPOP System cannot sell or pledge the collateral unless the borrower fails to return the securities borrowed. The market value of securities on loan at June 30, 2005 was $279,405 thousand. Derivatives – The HPOP System's investment managers may invest in derivatives if permitted by the guidelines established by the HPOP System’s Board of Trustees. The HPOP System’s staff monitors guidelines and compliance. From time to time the HPOP System's investment managers will invest in foreign currency contracts, options, swaps, reverse repurchase agreements, index linked bonds, collateralized mortgage obligations and mortgage-backed securities. No derivatives are purchased with borrowed funds. These derivative instruments are subject to the following risks: • Credit Risk – The risk that the counterparty will not fulfill its obligations. The HPOP System’s investment managers seek to control this risk through counterparty credit evaluations and approvals, counterparty credit limits, and exposure monitoring procedures. Interest Rate Risk – The risk that changes in interest rates will adversely affect the fair values of the HPOP System’s financial instruments or cash flows. Basis Risk – The risk that arises when variable interest rates on a derivative and an associated bond or other interest-paying financial instrument are based on different indexes. Termination Risk – The risk that a derivative’s unscheduled end will adversely affect an investment manager’s strategy. Rollover Risk – The risk that a derivative associated with the HPOP System’s fixed income investments does not extend to the maturity of those investments.

• • • •

Foreign currency contracts are used to hedge against the currency risk in the HPOP System’s investments in foreign equity and fixed income securities and also as part of a total return strategy that seeks absolute returns from relative changes in the prices of foreign currencies. The other derivatives are used to enhance yields and provide incremental income. The HPOP System is invested in a total return strategy utilizing various foreign currency derivative instruments. The strategy is managed by a third party investment management firm in an account managed by a prime broker. At June 30, 2005, the HPOP System has approximately $13,000 thousand on deposit with the prime broker and this amount changes monthly as the HPOP System and the prime broker swap cash flows each month equal to the profit or loss in the account. This amount is subject to custodial credit risk, as it is not covered by depository insurance and is uncollateralized. At June 30, 2005, the HPOP System held units in this commingled fund that represent approximately $95,000 thousand in foreign currency exposure pursuant to this strategy. As the HPOP System holds units in this fund, the underlying foreign currency contracts are not reflected in the accompanying schedule of derivative instruments. Futures on investments are used to take advantage of mis-pricing opportunities. When a position is taken in a futures contract, a margin is posted and the contract is subject to daily mark-to-market adjustments. To liquidate the contract prior to expiration an offsetting position in the same contract must be taken. At expiration the holder of the futures contract accepts delivery of the underlying asset at the agreed-upon price.

A-69

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005

The average futures balance outstanding, not including foreign currency contracts, during the fiscal year ending June 30, 2005 was $284,442 thousand. Futures outstanding, not including foreign currency contracts at June 30, 2005 were $790,033 thousand. The contract or notional amounts of these instruments reflect the extent of the HPOP System’s involvement in each class of financial instrument as of June 30, 2005 as follows ($000’s):
Contracts 54 27 23 9 1,122 1,122 Notional Description Value Futures on Treasury Bills and Equivalents $ 684,323 Fixed Income Futures 97,225 Commodity Futures (16,284) Equity Futures 8,485 Long foreign currency contracts 679,832 Short foreign currency contracts (677,138) $ 776,443 Exposure $ – – – – (5,168 ) 7,863 $ 2,695

Note 4: Allowance for Doubtful Accounts

The following were the allowances for doubtful accounts receivable by fund as of June 30, 2005 (in thousands):
Fund General Uncollectible general property taxes Ambulance charges Fines and forfeits Demolition liens Others Grant revenue Airport System Convention and Entertainment Facilities Accounts receivable Hotel occupancy tax Combined Utility System Amount

$

44,600 209,218 163,754 28,120 3,092 74,272 891 653 180 82,269 607,049

$
Note 5: Property Tax

The City's annual ad valorem property tax is required to be levied by October 1, or as soon thereafter as practicable, on the assessed value listed as of the prior January 1 for all real and certain personal property. Taxes are due on January 31 of the year following the year of the levy. A tax lien attaches to all property on January 1 of each year to secure the payment of all taxes, penalties and interest that is ultimately imposed on the property. The tax rate established by the City Council for the 2004 tax year was $0.65 per $100 of assessed value with $0.46573 for operations and $0.18427 for debt service. The City Charter limits the property tax rate to $0.50 per $100 of assessed valuation excluding taxes levied for "debt service," as that term is defined in Section 1 of Article III of the City Charter. The Texas Property Tax Code ("Code"), with certain exceptions, exempts intangible personal property, household goods, and family-owned automobiles from taxation. In addition, the Code provides for countywide appraisal districts.

A-70

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005
Note 6: Capital Assets A. Governmental activities of the Primary Government

A summary of changes in capital assets for the year ended June 30, 2005 follows (in thousands):

Balance July 1, 2004 Primary Government Capital assets not being depreciated: Land Land associated with capital lease Right of way Construction Work in Progress Total capital assets not being depreciated Other capital assets: Buildings Buildings associated with capital lease Improvements and Equipment Streets, Storm Sewers, Bridges Total other capital assets Less accumulated depreciation for: Buildings Buildings associated with capital lease Improvements and Equipment Infrastructure Total accumulated depreciation Other capital assets, net Primary Government capital assets, net $ 351,744 3,200 1,565,119 325,708 2,245,771 416,704 50,179 597,430 4,513,803 5,578,116 (218,864) (3,684) (313,252) (1,788,009) (2,323,809) 3,254,307 $ 5,500,078 $

Additions 7,782 10 151,628 159,420 2,209 38,910 4,879 45,998 (18,206) (2,007) (33,814) (96,355) (150,382) (104,384) 55,036

Retirements $ (473) (473) (16,899) (3,573) (20,472) 17,006 3,127 20,133 (339) (812) $

Transfers (91) 91 (123,758) (123,758) 35,966 1,971 89,324 127,261 78,694 (78,694) 127,261 3,503 $

Balance June 30, 2005 358,962 3,200 1,565,220 353,578 2,280,960 454,879 50,179 621,412 4,604,433 5,730,903 (158,376) (5,691) (408,754) (1,881,237) (2,454,058) 3,276,845 $ 5,557,805

$

$

$

B. Business-type Activities
Balance July 1, 2004 Airport System Capital assets not being depreciated: Land Construction Work in Progress Total capital assets not being depreciated Other capital assets: Buildings, Improvements and Equipment Total other capital assets Less accumulated depreciation for: Buildings, Improvements and Equipment Total accumulated depreciation Other capital assets, net Airport System capital assets, net Convention and Entertainment Facilities Capital assets not being depreciated: Land Construction Work in Progress Total capital assets not being depreciated Other capital assets: Buildings, Improvements and Equipment Total other capital assets Less accumulated depreciation for: Buildings, Improvements and Equipment Total accumulated depreciation Other capital assets, net Convention and Entertainment Facilities capital assets, net Additions Retirements Transfers Balance June 30, 2005

$

170,087 703,073 873,160 2,579,150 2,579,150 (844,510) (844,510) 1,734,640 2,607,800

$

22,844 253,336 276,180 55,386 55,386 (106,127) (106,127) (50,741) 225,439

$

(2,865) (2,865) 2,495 2,495 (370) (370)

$

279 (518,796) (518,517) 518,517 518,517 518,517 -

$

193,210 437,613 630,823 3,150,188 3,150,188 (948,142) (948,142) 2,202,046 2,832,869

130,493 23,943 154,436 425,327 425,327 (112,779) (112,779) 312,548 466,984

7,974 4,935 12,909 1,334 1,334 (10,035) (10,035) (8,701) 4,208

(41,371) (41,371) (39) (39) 39 39 (41,371)

2,661 (8,012) (5,351) 4,873 4,873 4,873 (478)

99,757 20,866 120,623 431,495 431,495 (122,775) (122,775) 308,720 429,343

A-71

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005

Balance July 1, 2004 Combined Utility System Capital assets not being depreciated: Land Construction Work in Progress Total capital assets not being depreciated Other capital assets: Buildings, Improvements and Equipment Plants and Lines Total other capital assets Less accumulated depreciation for: Buildings, Improvements and Equipment Plants and Lines Total accumulated depreciation Other capital assets, net Combined Utility System capital assets, net Houston Area Water Corporation Capital assets not being depreciated: Construction Work in Progress Total capital assets not being depreciated Houston Area Water Corporation capital assets, net Business-type activities capital assets, net

Additions

Retirements

Transfers

Balance June 30, 2005

99,479 568,534 668,013 227,734 6,690,654 6,918,388 (115,377) (3,136,704) (3,252,081) 3,666,307 4,334,320

1,372 293,040 294,412 4,801 18,330 23,131 (10,094) (202,570) (212,664) (189,533) 104,879

(8,347) (18,745) (27,092) 7,565 14,299 21,864 (5,228) (5,228)

(224,185) (224,185) 1,304 219,855 221,159 221,159 (3,026)

100,851 637,389 738,240 225,492 6,910,094 7,135,586 (117,906) (3,324,975) (3,442,881) 3,692,705 4,430,945

126,406 126,406 126,406 $ 7,535,510 $

30,546 30,546 30,546 365,072 $

(46,969) $

(3,504)

156,952 156,952 156,952 $ 7,850,109

C.

Depreciation Expense Depreciation expense was charged to functions/ programs of the primary government as follows (in thousands):

Governmental activities General government Public safety Public works Health Parks and recreation Library Infrastructure Total depreciation expense - governmental activities Business-type activities Airport System Convention & Entertainment Facilities Combined Utility System Total depreciation expense - business-type activities

$

$ $

2,949 27,686 10,775 2,190 8,435 1,992 96,355 150,382 106,127 10,035 212,664 328,826

$

D. Pension Trust Funds In February 1998, the Firefighters’ Relief and Retirement Fund purchased land in the amount of $541,194 for use in the construction of a new office building for its operations and its members. In April of 2001, the construction of the new building was completed. The building cost of $9,086,063 is being depreciated over 30 years. The accumulated depreciation for the building as of June 30, 2005 amounted to $1,302,528.

A-72

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005
Note 7: Short-Term Debt – Tax and Revenue Anticipation Notes

The City issues tax and revenue anticipation notes (“TRANS”) in advance of property tax collections, depositing the proceeds in its general fund. These notes are necessary because the City’s operating expenses are spread over the entire fiscal year, and the collection of major revenue sources such as property and sales taxes does not coincide with these expenses. Short-term debt activity for the year ended June 30, 2005, was as follows (amounts in thousands):
Balance July 1, 2004 Tax and revenue Anticipation notes $ $ Issued 180,000 $ Redeemed 180,000 $ Balance June 30, 2005 -

On July 1, 2004, the City closed on the sale of $180,000,000 Tax and Revenue Anticipation Notes (“TRANS”), Series 2004. The proceeds of the TRANS were used to pay working capital expenditures until tax revenues were received. Stated interest rates were 3.00% to 4.50%, and the average yield was 1.59%. The notes matured on June 30, 2005. Note 8: Long-Term Liabilities
A. General Long-Term Liabilities

Changes in General Long-Term Liabilities for the year ended June 30, 2005 are summarized as follows (in thousands):
Amounts Due within One Year

Balance July 1, 2004 Governmental Activities Bonds and notes payable General tax obligation debt Accretions, net HUD Section 108 Loans Houston Emergency Center capital lease Plus premium on bonds Less deferred amount on refundings Total bonds and notes payable Other liabilities: Claims and judgments Compensated absences Arbitrage rebate Pension liability Total other liabilities Governmental Activities Long-Term Liabilities Discretely Presented Component Units: Notes payable Revenue bonds Discretely Presented Component Units Long-Term $

Additions

Retirements/ Transfers

Balance June 30, 2005

$

2,031,539 1,318 24,865 52,344 60,405 (21,702) 2,148,769 168,117 338,163 140 179,175 685,595

$

658,083 354 10,546 668,983 45,403 80,393 196,552 322,348

$

(322,316) (155) (1,470) (1,091) (4,062) 1,978 (327,116) (57,089) (67,868) (54) (82,901) (207,912)

$

2,367,306 1,517 23,395 51,253 66,889 (19,724) 2,490,636 156,431 350,688 86 292,826 800,031

$

120,585 1,515 1,156 123,256 56,645 115,696 74 172,415

$

2,834,364

$

991,331

$

(535,028)

$

3,290,667

$

295,671

34,324 126,615 160,939 $

1,225 1,225 $

(13,565) (13,565) $

35,549 113,050 148,599 $

10,846 2,835 13,681

(Continued)

A-73

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005

Balance July 1, 2004 Business-type activities Bonds and notes payable Airport System debt Convention and Entertainment debt Combined Utility System debt Houston Area Water Corporation Long-term contracts - Combined Utility Premiums, discounts and deferred amount on refundings Total bonds and notes payable Other liabilities: Claims and judgments Compensated absences Arbitrage rebate Pension liability Total other liabilities Business-type activities long-term liabilities Total Reporting Entity long-term liabilities

Additions

Retirements/ Transfers

Balance June 30, 2005

Amounts Due within One Year

$

2,211,380 636,820 3,933,580 130,260 246,250 (39,176) 7,119,114 11,878 24,159 2,151 45,103 83,291

$

221,371 3,489 416,072 40,385 57,594 738,911 3,728 10,061 38,710 52,499

$

(113,510) (6,590) (54,032) (17,547) 2,515 (189,164) (7,729) (10,461) (1,103) (19,750) (39,043)

$

2,319,241 633,719 4,295,620 130,260 269,088 20,933 7,668,861 7,877 23,759 1,048 64,063 96,747

$

30,920 13,680 20,356 2,365 18,596 85,917 3,728 8,105 11,833

$

7,202,405

$ $

791,410 1,783,967

$ $

(228,207) (776,800)

$

7,765,608

$ $

97,750 407,102

$ 10,197,708

$ 11,204,875

A-74

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005

This page is left blank intentionally

A-75

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005
B. Schedule of Changes in Bonds and Long-Term contracts (amounts expressed in thousands)
Face Value Outstanding 7/1/2004 $ 1,365 1,556,435 427,800 12,420 33,519 2,031,539 24,865 52,344 $ FY05 Issued/ Increased 178,295 284,788 195,000 658,083 -

Stated Interest Rate Range General Tax Obligation Debt General obligation bonds Public improvement bonds Pension obligations Commercial paper Annexed district bonds Tax and revenue certificates of obligation Total General Tax Obligation Debt HUD Section 108 Loans Houston Emergency Center Lease Revenue Bonded Debt Airport System Bonds Subordinate lien refunding revenue bonds Senior lien commercial paper Inferior lien contractual obligation Pension obligations Convention and Entertainment Facilities Senior lien hotel occupancy tax/parking facilities Hotel and parking revenue commercial paper Pension obligations Combined Utility System Combined Utility System first lien bonds Water and Sewer System junior lien revenue bond Combined Utility System commercial paper Pension obligations Houston Area Water Corporation Long-Term Contracts-Water and Sewer System Coastal Water Authority Trinity River Authority Other long term contracts Total Revenue Bonded Debt and Long-Term Contracts, Primary Government Total Bonds and Long-Term Contracts Payable, Primary Government 2.40 to 6.00 2.90 to 10.00 5.38 to 6.00 5.31 to 8.50 $ 5.95 to 6.40 5.40 2.00 to 7.00 5.31 to 8.5 2.72 to 10.0 3.90 to 8.25 3.00 to 6.00

$ $ $

$ $ $

2,191,380 20,000 2,211,380 614,320 22,500 636,820 3,029,170 864,410 40,000 3,933,580 130,260 214,085 8,000 24,165 246,250

$

92,900 28,500 63,165 36,806 221,371 3,489 3,489 181,090 180,000 54,982 416,072 40,385 40,385

2.41 to 5.75 3.02 to 10.00 5.31 to 8.50

2.55 to 5.25 0.25 to 7.00 2.94 to 10.00 5.31 to 8.5 3.75 to 5.50 2.00 to 7.50 5.75 to 6.75 3.22 to 5.87

$ $

7,158,290 9,267,038

$ $

681,317 1,339,400

(Continued)

1) Adjustments consist of unamortized bond premiums, discounts, deferred (gains) losses from bond refundings and capital appreciation bond accretions.

A-76

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005

FY05 Redeemed/Refunded $ 1,365 116,730 22,900 177,100 770 3,451 322,316 1,470 1,091 $

Face Value Outstanding 6/30/05 1,618,000 261,888 445,700 11,650 30,068 2,367,306 23,395 51,253 $ Adjustments
(1)

Net Outstanding 6/30/2005 $ 1,665,165 261,888 445,700 11,650 31,585 2,415,988 23,395 51,253

47,165 1,517

$ $ $

$ $ $

$ $ $

48,682 -

$ $ $

$

110,410 3,100 113,510 6,590 6,590 14,032 40,000 54,032 15,460 2,000 87 17,547

$

2,173,870 48,500 60,065 36,806 2,319,241 607,730 22,500 3,489 633,719 3,029,170 1,031,468 180,000 54,982 4,295,620 130,260 239,010 6,000 24,078 269,088

$

(39,798) (39,798) 37,375 37,375 (126,428) 152,891 26,463 (818) (2,289) (2,289)

$

2,134,072 48,500 60,065 36,806 2,279,443 645,105 22,500 3,489 671,094 2,902,742 1,184,359 180,000 54,982 4,322,083 129,442 236,721 6,000 24,078 266,799

$ $

191,679 516,556

$ $

7,647,928 10,089,882

$ $

20,933 69,615

$ $

7,668,861 10,159,497

A-77

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005
C. Terms of Long-Term Debt 1. General Obligation Bonds These bonds are payable from the general revenue of the City. No new General Obligation Bonds were issued this fiscal year. 2. Public Improvement Bonds The City has issued Public Improvement Bonds on numerous occasions. The bonds are payable from ad valorem tax revenues. The proceeds are used for street and bridge improvements, traffic signals, municipal buildings, parks, and other capital improvements. Interest is payable semi-annually; principal is payable in various amounts annually through March 1, 2025. 3. Pension Obligation Bonds The City issued General Obligation Taxable Pension Bonds and a Collateralized Pension Obligation Note in Fiscal Year 2005. The proceeds were used to reduce the unfunded actuarial accrued liability of the Houston Municipal Employees Pension System and the Houston Police Officers Pension System. Interest is payable semi-annually, and principal is payable in varying amounts through 2035. Although these obligations have an ad valorem tax pledge, a portion of the liabilities is recorded in the enterprise funds because the liabilities are directly related and expected to be paid from those funds based on percentages of payroll. 4. General Obligation Swap Agreements On February 20, 2004 the City entered into a basis swap referred to as a synthetic reduced variance coupon swap with RFPC, LLC (“RFPC”). Objective. The objective of the swap is for the City to reduce its fixed rate debt service costs through a swap structure that takes on basis risk. Terms. The notional principal value of the swap is $200,000,000, with the underlying bonds being various maturities of PIBS issued between 1998 and 2002. The City pays an amount equal to 5% plus the tax-exempt market standard BMA Index rate divided by .667 minus the taxable six-month US Dollar LIBOR rate minus a constant of 69 basis points, up to a maximum of 10%. The City receives a fixed rate of 5%. Because the two 5% fixed rates offset one another, the City is effectively making variable payments based on BMA and receiving variable payments based on LIBOR plus a fixed spread. The variable rate is fixed for each budget period. The agreement is effective from March 1, 2004 to March 1, 2025. Starting in fiscal year 2017, the notional value of the swap declines as the principal amount of the associated debt is repaid in varying amounts until the debt is retired in 2023. Payments will be received or made every six months based on the indexes for the prior budget period.

As of June 30, 2005 the swap created synthetic variable-rate exposure as follows:
Variable rate payment to counterparty TERMS Fixed Rate BMA/0.667 -LIBOR -Constant Fixed RATE (%) 5.000 3.622 (3.150) (0.690) 4.782 (5.000) (0.218) 5.190 4.972

Net payment to counterparty Receipt from counterparty Net interest rate swap (receipt) Fixed rate bond coupon payments Synthetic variable interest rate on bonds

Fair value. The fair value of the swap was negative $3,405,000 as of June 30, 2005. The value was calculated using the zero coupon method. This method calculates the future net settlement payments required by the swap, assuming that the current forward rates implied by the yield curve correctly anticipate future spot interest rates. These net payments are then discounted using the spot rates implied by the current yield curve for hypothetical zero-coupon bonds due on the date of each future net settlement on the swaps. Credit risk. As of June 30, 2005, the City was not exposed to credit risk because the swap had a negative fair value. However, if interest rates change and the fair value of the swap becomes positive, the City will be exposed to credit risk on the swap in the amount of its fair value. RFPC, swap counterparty, has not been rated by the rating agencies. To mitigate this potential credit risk for an unrated counterparty, the City required RFPC to purchase a surety bond from a AAA-rated insurance company. Under the

A-78

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005
surety bond, the insurance company is unconditionally and irrevocably obligated to guarantee all payments under the swap by the counterparty. The City’s obligations under the swap are also insured. Should the insurance company’s rating decline in the future, the RFPC will be required to post collateral for the City’s benefit. Interest rate risk. The City has an exposure to interest rate risk because it is paying a variable rate on the swap. However, this risk is mitigated because the payment formula has a BMA-based variable component that is offset by subtracting a LIBOR variable component. Basis risk. The City is exposed to basis risk based on changes in the relationship between the BMA Index and six-month US Dollar LIBOR. The City entered into the swap in anticipation of savings that would be produced based on the historical trading patterns of BMA and LIBOR in different interest rate, tax, and economic environments over the past two decades. If, however, future trading patterns prove to be significantly different than historical ones, the City’s anticipated savings could fail to materialize, and it could be exposed to additional costs. Among the factors that could cause this trading relationship to change would be a major reduction in marginal income tax rates, repeal of the tax-exemption on municipal bond interest, or other changes in federal policy that would reduce the benefit that municipal bonds currently enjoy in comparison to taxable investments. Termination risk. The City may terminate the swap for any reason. The RFPC may terminate the swap if both the City and the City’s insurer fails to perform under the terms of the contract. If the swap has a negative fair value at the time of termination, the City will be liable to the counterparty for that payment. The City’s termination risk is significantly mitigated by a provision in the swap agreement that allows the City to make the termination payment in equal annual installments from time of termination up to termination date of the agreement in 2025. Swap receipts and associated debt. As of June 30, 2005, the City expected to receive swap payments as reported in Note 8D, assuming current interest rates remain the same. As rates vary, variable rate bond interest payments and net swap payments will vary. Related debt service payments on the underlying Public Improvement Bonds are included in Note 8D with other City Public Improvement Bonds. 5. General Obligation Commercial Paper The City currently issues Commercial Paper Notes (“Notes”) under its $219,000,000 General Obligation Commercial Paper Program, Series A, its $25,800,000 General Obligation Commercial Paper Program, Series B, its $385,000,000 General Obligation Commercial Paper Program Series D, its $155,000,000 General Obligation Commercial Paper Program Series E, and its $139,500,000 General Obligation Commercial Paper Program Series F. The Notes may be issued for a period not to exceed 270 days and will bear interest based upon the specified term of the Notes, but not to exceed 10%. Principal on the Notes is payable from ad valorem tax revenue, the issuance of new commercial paper, bond proceeds and other funds provided under the line of credit. Interest is payable as the Notes mature from ad valorem tax revenue collected by the City. Proceeds from the Notes are used to finance various capital projects and public improvements for authorized City purposes. Upon maturity, the Notes will be remarketed by the commercial paper dealers or extinguished with long-term debt. During fiscal year 2005 the weighted average interest rate for the General Obligation Notes, including dealer and credit fees, was 2.094%. The average year-end rate, including fees, was 2.717%. The Credit Agreements expire on the following dates: Series A on June 9, 2007, Series B on March 30, 2007, the Series D on May 27, 2007, the Series E on November 21, 2006, and Series F on June 18, 2007. 6. Annexed District Bonds Assumed The City has assumed general tax obligation debt of annexed districts. The payment dates and maturities vary, but in general, interest is payable semi-annually and principal is payable annually. The final maturity date is October 1, 2021. 7. Certificates of Obligation Since 1988, the City has issued Certificates of Obligation each year to provide for the purchase of equipment utilized in general City operations including, without limitation, police vehicles, maintenance vehicles and equipment, computer equipment, and costs associated with demolishing dangerous structures. Each year the City is obligated to levy, assess, and collect ad valorem taxes sufficient to pay principal and interest on the certificates payable semi-annually until maturity. Generally, these certificates are not subject to redemption prior to final maturity on March 1, 2022. 8. Housing and Urban Development Section 108 Loan (HUD) The City’s Housing and Community Development Department has borrowed money from HUD and loaned it to the Houston Small Business Development Corporation (HSBDC). HSBDC in turn makes small business loans to under-served areas of the community. In fiscal year 2005 there were no new loans.

A-79

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005

9. Houston Emergency Center Lease The City has entered into a capital lease for equipment used in the Emergency Management Center. Repayment terms are laid out in Note 9: Leases. 10. Airport System Revenue Bonds These funds are paid solely from a lien on the airport system’s net revenues, which must total 110% of the debt service requirements for Subordinate Lien Bonds for such fiscal year. The bonds have a final maturity in the year 2032. Airport System Subordinate Lien Revenue Bonds, Series 2000P1 and 2001P2, 2002C, 2002D-1, and 2002D-2, have been issued as auction rate securities with current 7-day resets. Series 2005A has been issued as Variable Rate Demand Obligations with a 7-day reset. These bonds may all be converted to other modes including fixed rate bonds. The City has a liquidity facility in place for the Series 2005A bonds with a termination date of July 1, 2010. The maximum interest rate permitted under the ordinance is 10%. The City has purchased municipal debt service reserve fund policies that unconditionally guarantee the payment of principal and interest on all current outstanding airport system subordinate lien issues. The reserve policies terminate upon final maturities on various dates in the future. Each of the draws made against the reserve policy shall bear interest at the Prime Rate plus two percent, not to exceed a maximum interest rate of 12%. The repayment provisions require one-twelfth of the policy costs for each draw to be repaid monthly, beginning the first month following the date of each draw. 11. Airport System Commercial Paper Airport System Senior Lien Commercial Paper Notes Series A and B (the “Notes”) have been authorized for $150 million, and Airport System Inferior Lien Commercial Paper Notes Series C have been authorized for $150 million to establish, improve, enlarge, extend and repair the City’s Airport System, acquire land, and pay interest and cost of issuance of the Notes. As of June 30, 2005, $48.5 million in Airport Commercial Paper is outstanding. During fiscal year 2005 the weighted average interest rate for the General Obligation Notes, including dealer and credit fees, was 2.459%. The average year-end rate, including fees, was 2.899%. The Series A and B Notes are collateralized by revolving credit agreements convertible to direct pay letters of credit issued by a bank, and a lien on the net revenues of the Airport System. The Letter of Credit will terminate on January 4, 2008 for Series A and B. 12. Convention and Entertainment Facilities Bonds These bonds are special limited obligations of the City that are paid from a lien on the pledged receipts of the Hotel Occupancy Tax (HOT), revenues collected from seven City-owned parking facilities, and rebates of certain taxes derived from operation of the Convention Center Hotel and Parking Garage. The pledged HOT receipts are equal to 5.65% of the cost of substantially all hotel room rentals in the City, plus related penalties and interest for delinquent payments. As long as any of the Senior Lien Bonds remain outstanding, the City is required to levy a Hotel Occupancy Tax at a rate not less than 7%. The City currently levies a Hotel Occupancy Tax at the rate of 7%. Final maturity of the bonds is September 1, 2033. The City has obtained a debt service reserve insurance policy for the Senior Lien Hotel Occupancy Tax Revenue Bonds. The surety policy provides insurance sufficient to pay maximum annual debt service of the Bonds. The surety policy expires upon final maturity of all outstanding Bonds, September 1, 2033. The City of Houston Convention Center Revenue Bonds, Series 2001C-1 and 2002C-2, have been issued as 7-day auction rate securities and are subject to conversion at the option of the City and subject to certain restrictions, to bonds that bear interest at rates other than auction rates. The maximum interest rate permitted under the ordinance is 10%. 13. Convention and Entertainment Hotel and Parking Revenue Commercial Paper Hotel Occupancy Tax and Parking Revenue Commercial Paper Notes Series A have been authorized for $75 million to finance the costs of site acquisition, construction, and improvements for convention center facilities. The notes are issued as subordinate lien debt. The maturity of the Notes may not exceed 270 days and the maximum interest rate may not exceed 10%. Upon maturity, the Notes will be remarketed by the commercial paper dealer or extinguished with long-term debt. The Notes are collateralized by a Letter of Credit that expires on January 16, 2008. During fiscal year 2005 the weighted average interest rate for the Notes, including fees, was 2.400%. The average rate in effect at year-end was 3.021%.

A-80

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005
14. Combined Utility System First Lien Revenue Bonds City Council authorized creation of the Combined Utility System (“the System”) on September 3, 2003. The Combined Utility System currently consists of the City’s Water and Sewer System. In the future the City may elect to include other utility systems. Its bonds are special obligations of the City payable from Net Revenues of the System after payments for maintenance and operations and debt service on Water and Sewer Junior Lien bonds. Net Revenues must equal 110% of the First Lien Revenue Bonds debt service. The Combined Utility System Revenue Refunding Bonds, Series 2004B and 2004C, were initially issued as 7-day and 35-day Auction Rate Securities. The maximum rate allowed under ordinance is 10%. 15. Combined Utility System Commercial Paper The Combined Utility System Commercial Paper Notes Program Series A has been authorized for $900 million to finance costs of eligible projects for the City’s combined utility system, including acquisition or construction of improvements and additions or extension for the system, and costs of issuance. The notes are issued as third lien obligations. The maturity of the Notes may not exceed 270 days and the maximum interest rate may not exceed 10%. Principal on the Notes is payable from the issuance of new commercial paper, bond proceeds and other funds provided under the line of credit available through a revolving credit agreement with four banks. The agreement expires on June 8, 2007. Interest on the Notes is payable from net revenues of the System and loans under the credit agreement. During fiscal year 2005 the weighted average interest rate for the Notes, including credit and dealer fees, was 2.440%. The rate in effect at year-end was 2.944%. 16. Combined Utility System Swap Agreements Combined Utility System swaps. On June 10, 2004 the City entered into three identical pay-fixed, receive-variable rate swap agreements. The City pre-qualified six firms to submit competitive bids on the swap. The bidding took place on June 7, 2004. The three firms selected all matched the lowest fixed rate bid of 3.7784%. Objective. The objective of the swaps is to protect against the potential of rising interest rates in conjunction with the City’s Combined Utility System 2004B auction rate variable interest bonds (“2004B Bonds”) and to achieve a lower fixed rate than the market rate for traditional fixed rate debt at time of issuance of the 2004B Bonds. Terms. The notional amount of the swap agreements totals $653,325,000, the principal amount of the associated 2004B Bonds. The City’s swap agreements contain scheduled reductions to outstanding notional amounts that follow anticipated payments of principal of the 2004B Bonds in varying amounts during the years 2028 to 2034. Under the terms of the swaps, the City will pay a fixed rate of 3.7784% (lower than the rate for fixed rate debt at time of issuance) and receive a floating rate equal to 57.6% of One-Month US Dollar LIBOR plus 37 basis points. All agreements were effective June 10, 2004, the date of issuance of the 2004B Bonds. The termination date is May 15, 2034. At June 30, 2005, the effective rate on the bonds associated with the swap was computed as follows: RATE (%) Received (Paid) 1.8547 0.3700 2.2247 (3.7784) (1.5537) (2.2915) (0.2530) (4.0982)

TERMS Variable rate payment from counterparties Swap receipt Fixed rate paid to counterparties Net rate (paid)/received for swap Average variable rate paid on 2004B bonds Plus dealer and auction fees on 2004B bonds Effective rate of 2004B bonds LIBOR x 57.6% + Constant Fixed

In contrast, the fixed rate the City paid on its Combined Utility System Series 2004A fixed rate bonds, which have a comparable maturity, was 5.080%. Fair value. Because long-term interest rates have declined, the swaps had a negative fair value of $74,612,000 as of June 30, 2005. This value was calculated using the zero-coupon method. This method calculates the future net settlement payments required by the swap, assuming that the current forward rates implied by the yield curve correctly anticipate future spot interest rates. These net

A-81

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005
payments are then discounted using the spot rates implied by the current yield curve for hypothetical zero-coupon bonds due on the date of each future net settlement on the swaps. Credit risk. As of June 30, 2005, the City was not exposed to credit risk because the swaps had a negative fair value. However, should interest rates increase and the fair value of the swap become positive, the City would be exposed to credit risk on the swap in the amount of its fair value. The City’s swap policy generally requires that swap counterparties be rated double-A or better by at least one nationally recognized rating agency. As of June 30, 2005, the ratings of the three swap counterparties all met this standard (see below). Also, under the agreements, if a counterparty’s credit rating falls below double-A, collateral must be posted in varying amounts depending on the credit rating. No collateral has been required to date. Counterparty Credit Rating (Moody’s /S&P /Fitch) Aa3 /A+ /AAAaa/AAA/-Aa2 /AA+ /AA+

COUNTERPARTY Goldman Sachs Capital Markets Bear Stearns Financial Products UBS AG TOTAL

Notional Amount $353,325,000 150,000,000 150,000,000 $653,325,000

Fair Value ($40,350,000) (17,131,000) (17,131,000) ($74,612,000)

Basis risk. The City is exposed to basis risk on the swaps because the variable payment received is based on an index other than BMA. Should the relationship between LIBOR and BMA move to convergence (because of reductions in tax rates, for example), the expected cost savings may not be realized. The City has issued tax-exempt auction rate bonds with an average rate of 2.292% (not including dealer and auction agent fees) as of June 30, 2005, whereas the associated LIBOR-based rate of the swap was 2.225%. Termination risk. The City may terminate for any reason. A counterparty may terminate a swap if the City fails to perform under the terms of the contract. The City’s on-going payment obligations under the swap (and, to a limited extent, its termination payment obligations) are insured, and counterparties cannot terminate so long as the insurer does not fail to perform. If a swap should be terminated, the associated variable-rate bonds would no longer carry synthetic fixed interest rates. Also, if at the time of the termination the swap has a negative fair value, the City would be liable to the counterparty for a payment equal to the swap’s fair value. Swap payments and associated debt. As of June 30, 2005, debt service requirements for the swap agreements are reported in Note 8D, assuming current interest rates remain the same. As rates vary, variable rate bond interest payments and net swap payments will vary. Expected debt service payments on the associated Combined Utility System 2004B bonds are included with other Combined Utility System Bonds on Note 8D. 17. Water and Sewer System Junior Lien Revenue Bonds These bonds are paid solely from a lien on the net water and sewer system revenues, which must total 110% of the current debt service requirements on the junior lien bonds. As part of the restructuring to the new Combined Utility System, the City refunded a substantial portion of the outstanding junior lien bonds on June 10, 2004 and reissued bonds as Combined Utility System bonds. Debt service payments on remaining Water and Sewer Junior Lien Revenue Bonds will be made after payment of operating expenses and prior to any debt service payments on the Combined Utility System bonds. The final maturity date for the remaining junior lien bonds is December 1, 2028. 18. Coastal Water Authority (“CWA”) The contract payable relating to CWA represents the outstanding principal balance of $153,070,000 at June 30, 2005 of City of Houston Water Conveyance System Contract Certificates of Participation, Series 1993, representing contract payments owed by the City to pay debt service on bonds issued by CWA, plus $85,940,000 of CWA Revenue Refunding Bonds, Series 1999 and Series 2004, issued by CWA, a governmental agency of the State of Texas, to finance the construction of a water conveyance system. Pursuant to a series of exchange agreements with CWA, the City issued the Certificates and endorsed the bonds and is unconditionally obligated to pay from the gross operating revenues of the City’s water and sewer system all debt service payments on these Certificates and Bonds, as well as amounts necessary to restore deficiencies in funds required to be accumulated under the CWA bond resolutions. The bonds mature on December 15, 2034. 19. Trinity River Authority (“TRA”) The contract payable to TRA represents the outstanding principal balance at June 30, 2005 of certain revenue bonds issued by TRA, a governmental agency of the State of Texas, to finance construction of a dam and reservoir on the Trinity River near Livingston, Texas. Pursuant to a contract with TRA, the City has endorsed the bonds associated only with this project and is unconditionally obligated to pay from the gross operating revenues of the City’s water system maintenance and operating expense A-82

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005
of the reservoir and amounts necessary to restore any deficiencies in funds required to be accumulated under the TRA bond resolutions. As consideration for the above obligation, the City receives a perpetual 70% beneficial interest in these reservoir facilities and the use of 70% of the reservoir water. As consideration for the remaining 30% interest in the reservoir facilities and water, TRA is obligated to allow the City credits for water usage. Consequently, the cost of the City’s obligation of TRA has not been reflected in the City’s accounts as a receivable or as a reduction of the cost of the City’s 70% interest in the facilities. The final maturity date for the bonds is April 15, 2008. 20. Houston Area Water Corporation (“HAWC”) The HAWC Series 2002 Bonds are special obligations of the City that were issued to provide financing for the acquisition of rightsof-way and real property interests, and the design, construction and equipping of the Northeast Water Purification Plant and a water conveyance system. The Bonds are payable both as to principal and interest solely from pledged revenues, including pledged contract payments made by the City to HAWC under the Amended and Restated Treated Water Supply Contract dated May 1, 2002. Pursuant to the Contract the City has unconditionally agreed to pay to HAWC as maintenance and operation expenses from the gross revenues of the City’s Water and Sewer System such sums as required to pay operation and maintenance expenses incurred by HAWC with respect to the City Project, debt service on the Series 2002 Bonds, amounts required to establish, restore and maintain a debt service reserve fund, and all other debt service obligation expenses. Such payments are an unconditional obligation of the City, but payable solely from gross revenues of the City’s Water and Sewer System. 21. Other Contracts On June 20, 1967 the City, TRA, and Chambers-Liberty Counties Navigation District contracted with the United States of America to have the U.S. Army Corps of Engineers build a salinity control barrier and recreation facilities at Wallisville Lake. Because of legal actions, construction was blocked for a long period, and the project was not completed until April 2003. The City’s share of the project cost was $10,580,707, which will be paid to the U.S. government over 50 years at 3.222% interest with final payment due January 1, 2053. Payments will be made only after funding all maintenance and operation costs and debt service payments for the water and sewer system, including required reserves. In April 2000 the City, Brazos River Authority (“BRA”), and the Texas Water Development Board (“TWDB”) entered into an agreement to develop the Allen’s Creek water supply reservoir in Fort Bend County as a regional water supply. TWDB committed to provide up to $20,000,000, or up to 50% of funding, to provide for construction of the project. The City and BRA agreed to purchase TWDB’s ownership share in future years. In 2004 the TWDB paid $14 million for site acquisition for the project. The City will purchase TWDB’s share. Interest payments on the lease-purchase will begin in 2005 at an average rate of 5.85%. Interest costs over the first eight years will be partially deferred to later years. Principal payments will begin in 2022, and the final principal payment will be made in 2036.

A-83

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005

D. Schedule for Debt Service Requirements to Maturity (in thousands): 1. General Long-Term Tax Obligation Debt (adjusted for Capital Appreciation and Deferred Interest Bonds reclassification of principal & interest) (in thousands):

Public Improvement Bonds Year Ending June 30 2006 2007 2008 2009 2010 2011-2015 2016-2020 2021-2025 2026-2030 2031-2035 Total Principal 116,270 124,350 132,720 131,955 129,260 489,090 330,155 164,200 1,618,000 Interest 84,930 78,636 71,628 64,234 57,524 198,576 87,766 20,039 663,333

$

$

General Obligation Swap Agreements Payment Receipts $ (499) (436) (436) (436) (436) (2,180) (1,814) (435) (6,672)

Pension Obligation Bonds Principal 15,450 246,438 $ 261,888 $ Interest 18,458 20,615 20,615 20,615 20,615 103,074 103,074 103,074 102,674 79,920 $ 592,734 $

$

$

$

General Obligation Commercial Paper Year Ending June 30 2006 2007 2008 2009 2010 2011-2015 2016-2020 2021-2025 Total Principal 445,700 $ 445,700 Interest 12,110 10,299 $ 22,409

Annexed District Bonds Principal 815 860 900 875 940 4,060 2,840 360 $ 11,650 Interest 560 517 472 429 383 1,319 329 20 $ 4,029

Tax and Revenue Certificates of Obligation Principal 3,500 1,075 1,645 3,390 1,230 8,188 8,020 3,020 $ 30,068 Interest 1,131 987 944 874 755 6,735 2,073 200 $ 13,699

$

$

$

$

$

$

Year Ending June 30 2006 2007 2008 2009 2010 2011-2015 2016-2020 2021-2025 2026-2030 2031-2035

Principal $ 120,585 571,985 135,265 136,220 131,430 501,338 341,015 167,580 15,450 246,438 $ 2,367,306

Total Future Requirements Swaps Interest (Receipts) $ 117,189 $ (499) 111,054 (436) 93,659 (436) 86,152 (436) 79,277 (436) 309,704 (2,180) 193,242 (1,814) 123,333 (435) 102,674 79,920 $ 1,296,204 $ (6,672)

Total Future Requirements $ 237,275 682,603 228,488 221,936 210,271 808,862 532,443 290,478 118,124 326,358 $ 3,656,838

A-84

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005

2. HUD Section 108 Loans (in thousands):
Section 108 Loans Year Ending June 30 2006 2007 2008 2009 2010 2011-2015 2016-2020 2021-2024 $ Total Future Requirements $ 2,729 2,823 3,041 3,013 2,991 10,080 6,374 1,995 33,046

Principal 1,515 1,680 1,980 2,045 2,125 7,140 5,090 1,820 23,395 $

Interest 1,214 1,143 1,061 968 866 2,940 1,284 175 9,651

$

$

$

3. Business-Type Funds (adjusted for Capital Appreciation and Deferred Interest Bonds reclassification of principal & interest) (in thousands):

Airport System Revenue Bonds Year Ending June 30 2006 2007 2008 2009 2010 2011-2015 2016-2020 2021-2025 2026-2030 2031-2035 Principal 27,665 28,385 29,825 41,515 43,020 260,165 336,775 436,365 563,200 406,955 $ 2,173,870 $ Interest 103,416 101,630 100,199 98,368 96,262 445,348 371,825 278,236 161,164 29,484 $ 1,785,932 $

Airport System Commercial Paper Principal 48,500 $ 48,500 $ Interest 1,406 1,406 724 $ 3,536 $

Airport System Inferior Lien Contract Principal 3,255 3,450 3,660 3,880 4,085 23,975 17,760 $ 60,065 $ Interest 3,231 3,030 2,816 2,602 2,388 8,294 1,500 $ 23,861 $

Airport System Pension Obligations Year Ending June 30 2006 2007 2008 2009 2010 2011-2015 2016-2020 2021-2025 2026-2030 2031-2035 Principal 601 36,205 $ 36,806 $ Interest 2,735 3,065 3,065 3,065 3,065 15,322 15,322 15,322 15,307 12,536 $ 88,804 $

Airport System Total Future Requirements Total Future Principal Interest Requirements $ 30,920 $ 110,788 $ 141,708 31,835 109,131 140,966 81,985 106,804 188,789 45,395 104,035 149,430 47,105 101,715 148,820 284,140 468,964 753,104 354,535 388,647 743,182 436,365 293,558 729,923 563,801 176,471 740,272 443,160 42,020 485,180 $ 2,319,241 $ 1,902,133 $ 4,221,374

A-85

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005

Convention and Entertainment Facilities Revenue Bonds Year Ending June 30 2006 2007 2008 2009 2010 2011-2015 2016-2020 2021-2025 2026-2030 2031-2035 Principal 13,680 14,775 17,540 18,620 21,230 136,650 93,566 94,606 103,598 93,465 $ 607,730 Interest 21,495 20,766 19,921 18,954 17,954 69,013 85,293 105,895 123,261 104,540 $ 587,092

Convention and Entertainment Facilities Commercial Paper Principal 22,500 $ 22,500 Interest 680 680 372 $ 1,732

Convention and Entertainment Pension Obligations Principal 57 3,432 $ 3,489 Interest 259 291 291 291 291 1,452 1,452 1,452 1,451 1,189 $ 8,419

$

$

$

$

$

$

Year Ending June 30 2006 2007 2008 2009 2010 2011-2015 2016-2020 2021-2025 2026-2030 2031-2035

Convention and Entertainment Total Future Requirements Total Future Principal Interest Requirements $ 13,680 $ 22,434 $ 36,114 14,775 21,737 36,512 40,040 20,584 60,624 18,620 19,245 37,865 21,230 18,245 39,475 136,650 70,465 207,115 93,566 86,745 180,311 94,606 107,347 201,953 103,655 124,712 228,367 96,897 105,729 202,626 $ 633,719 $ 597,243 $ 1,230,962

Combined Utility System Revenue Bonds Year Ending June 30 2006 2007 2008 2009 2010 2011-2015 2016-2020 2021-2025 2026-2030 2031-2035 Principal 9,000 9,000 9,000 15,000 39,665 159,910 197,460 717,595 900,340 972,200 $ 3,029,170 $ Interest 128,641 127,632 128,136 127,317 126,348 608,787 568,301 459,512 256,842 73,592 $ 2,605,108 $

Combined Utility System Commercial Paper Principal 180,000 $ 180,000 $ Interest 5,299 4,980 $ 10,279 $

Combined Utility System Swap Agreements Net Swap Payment $ 9,949 9,949 9,908 9,949 9,949 49,704 49,663 49,704 48,287 17,859 $ 264,921

A-86

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005

Combined Utility System Pension Obligations Year Ending June 30 2006 2007 2008 2009 2010 2011-2015 2016-2020 2021-2025 2026-2030 2031-2035 Principal 1,013 53,969 $ 54,982 $ Interest 4,076 4,566 4,566 4,566 4,566 22,828 22,828 22,828 22,801 18,631 $ 132,256 $

Water and Sewer Jr. Lien Revenue Bonds Principal 11,356 16,563 16,363 21,028 25,757 299,957 510,415 104,726 25,303 $ 1,031,468 $ Interest 48,740 54,437 54,859 62,000 66,182 274,862 79,284 74,209 98,572 813,145

$

$

Year Ending June 30 2006 2007 2008 2009 2010 2011-2015 2016-2020 2021-2025 2026-2030 2031-2035

Principal $ 20,356 205,563 25,363 36,028 65,422 459,867 707,875 822,321 926,656 1,026,169 $ 4,295,620

Combined Utility System Total Future Requirements Net Swap Interest Payment $ 186,756 $ 9,949 191,615 9,949 187,561 9,908 193,883 9,949 197,096 9,949 906,477 49,704 670,413 49,663 556,549 49,704 378,215 48,287 92,223 17,859 $ 3,560,788 $ 264,921

Total Future Requirements $ 217,061 407,127 222,832 239,860 272,467 1,416,048 1,427,951 1,428,574 1,353,158 1,136,251 $ 8,121,329

4. Long-Term Contracts-Combined Utility System (in thousands):
Coastal Water Authority Year Ending June 30 2006 2007 2008 2009 2010 2011-2015 2016-2020 2021-2025 2026-2030 2031-2035 Principal 16,505 18,390 19,470 18,155 14,825 67,025 29,655 22,805 16,435 15,745 $ 239,010 Interest 13,366 12,263 11,076 9,948 8,991 32,051 16,158 10,772 5,423 1,939 $ 121,987 Trinity River Authority Principal 2,000 2,000 2,000 $ 6,000 Interest 346 221 97 $ 664 CWA/TRA Total Future Requirements Principal 18,505 20,390 21,470 18,155 14,825 67,025 29,655 22,805 16,435 15,745 $ 245,010 Interest 13,712 12,484 11,173 9,948 8,991 32,051 16,158 10,772 5,423 1,939 $ 122,651 Total 32,217 32,874 32,643 28,103 23,816 99,076 45,813 33,577 21,858 17,684 $ 367,661

$

$

$

$

$

$

$

A-87

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005

Year Ending June 30 2005 2006 2007 2008 2009 2010-2014 2015-2019 2020-2024 2025-2029 2030-2032

Houston Area Water Corporation Total Future Requirements Principal Interest $ 2,365 $ 6,710 $ 9,075 2,485 6,591 9,076 2,585 6,492 9,077 2,680 6,395 9,075 2,790 6,288 9,078 16,290 29,091 45,381 21,260 24,127 45,387 27,525 17,859 45,384 35,430 9,946 45,376 16,850 1,306 18,156 $ 130,260 $ 114,805 $ 245,065

Water & Sewer System Contracts U.S. Army Corps of Engineers Texas Water Development Board Year Ending June 30 2006 2007 2008 2009 2010 2011-2015 2016-2020 2021-2025 2026-2030 2031-2035 2036-2040 2041-2045 2046-2050 2051-2055 Principal 91 93 97 100 103 566 664 778 911 1,068 1,251 1,467 1,719 1,170 $ 10,078 $ Interest $ 325 322 319 316 316 1,510 1,413 1,299 1,165 1,009 825 610 358 76 9,863 $ Principal 1,935 4,055 5,385 2,625 14,000 Interest 164 164 246 327 450 3,724 7,484 5,341 3,086 1,756 233 $ 22,975 $

Other Contracts Total Future Requirements Principal $ 91 93 97 100 103 566 664 2,713 4,966 6,453 3,876 1,467 1,719 1,170 $ 24,078 Interest 489 486 565 643 766 5,234 8,897 6,640 4,251 2,765 1,058 610 358 76 $ 32,838 $ Total 580 579 662 743 869 5,800 9,561 9,353 9,217 9,218 4,934 2,077 2,077 1,246 $ 56,916 $

$

$

A-88

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005

E. Debt Issuances and Refundings Throughout its history, the City has issued refunding bonds from time to time when there has been an operational or economic gain for the City. These refundings have been structured as legal defeasances of the old debt as ruled by the Texas Attorney General, and such debt, including the debt balances refunded during fiscal 2005 described below, has been removed from the City’s books. Airport System Inferior Lien Contract. On July 1, 2004 the City and Continental Airlines, Inc. entered into a Sublease Agreement associated with the Special Facilities Lease for the Automated People Mover System and the City’s Airport System Special Facilities Revenue Bonds (Automated People Mover System) Series 1997A (“1997A Special Facilities Bonds”). As part of the Sublease, the City agreed to make sublease payments that include amounts equal to the debt service on the 1997A Special Facilities Bonds. The payments are payable from Airport system net revenues on the same priority as inferior lien bonds. Accordingly, the principal amount of the 1997A Special Facilities Bonds, $63,165,000 was recorded as an Inferior Lien Contract. See Note 15, Conduit Debt Obligations. Water and Sewer Junior Lien Revenue and Refunding Bonds, Series 2004A. On August 19, 2004 the City closed the sale of $181,090,000 in Water and Sewer Junior Lien Revenue and Refunding Bonds, Series 2004A, in a private placement to the Texas Water Development Board (“TWDB”). The bonds were issued at rates ranging from 0.75% to 4.00% with an average rate of 3.049%. The bonds are due in varying amounts from 2005 to final maturity on May 15, 2024. A portion of the proceeds were used to currently refund $40,000,000 outstanding Combined Utility System Commercial Paper Notes which were used to fund projects previously approved by the TWDB. The refunding was undertaken to lower variable interest rate exposure on the refunded Commercial Paper Notes rather than for savings. The remaining proceeds were designated to fund other TWDB approved water and sewer projects and to pay cost of issuance of the bonds. Coastal Water Authority Revenue Bonds, Series 2004. On October 20, 2004 Coastal Water Authority (“CWA”) closed the sale of $40,385,000 in Revenue Bonds, Series 2004. The bonds were issued at rates ranging from 2.00% to 5.00% with an average yield of 4.708%. The bonds are due in varying amounts from June 15, 2006 to final maturity on June 15, 2034. The proceeds will be used to fund the Authority’s Lynchburg and Trinity River Pump Station Expansion Projects and to pay the costs of issuance of the bonds. By the terms of a contract between the City and CWA, the City’s Water and Sewer System (“the System”) makes these debt service payments and records them as maintenance and operations expenses of the System. The bonds are recorded as a Long Term Contract Liability in the Combined Utility System. Collateralized Pension Obligation Note. On November 10, 2004 the City issued a $300,000,000 collateralized note (“The Collateralized Note”) to Houston Municipal Employees Pension System (“HMEPS”) as part of the meet and confer agreement with HMEPS to fund part of the unfunded accrued actuarial liability of its pension plan. The Collateralized Note bears interest at 8.5% per year unless the rate adjustment formula, based on U.S. Treasury securities maturing in 2033, calls for a higher interest rate. The promissory note from the Houston Hotel Corporation to the City, as well as the related Deed of Trust, have been pledged as collateral on the notes. Interest on the notes may be paid or deferred, at the City’s option, up to a maximum of $150,000,000 plus 75% of the amount by which the appraised value of the hotel exceeds $300,000,000. If the interest is deferred, the City will issue uncollateralized deferred interest certificates that may be converted to assignable certificates at the request of HMEPS, up to $150 million, or collateralized deferred interest certificates up to the limit based on the appraised value of the hotel. The Collateralized Note constitutes a general obligation of the City with an ad valorem tax pledge, but the City may look to other revenue sources available to pay the debt, including the collateral and its proceeds as well as interest deferrals and contributions from proprietary funds. Because the liability is directly related to and expected to be paid from the Airport System Fund, the Combined Utility Fund, and the Convention and Entertainment Fund, part of the liability for the Collateralized Note has been allocated among these funds based on percentage of payroll for HMEPS contributions. Pension Obligation Note, Series 2004. On December 10, 2004 the City issued a $22,900,000 Pension Obligation Note, Series 2004 (“the Note”) as part of a funding agreement with Houston Police Officers Pension System (“HPOPS”) to reduce the unfunded actuarial accrued liability of its pension plan. Maturity date was February 15, 2006. The Note bore interest at a rate equal to the onemonth Dollar LIBOR plus 45 basis points, which averaged 2.98% during the time the Note was outstanding. The Note, a general obligation of the City, was refunded with proceeds of the Taxable General Obligation Pension Bonds, Series 2005, on March 30, 2005. Public Improvement Refunding Bonds, Series 2004B. On December 21, 2004, the City issued $174,860,000 Public Improvement Refunding Bonds, Series 2004B. Stated interest rates for the bonds ranged from 5.0% to 5.5%, and the average yield was 4.40%. The bonds are due in varying amounts from years 2010 to 2024. Proceeds of the bonds were used 1) to currently refund all outstanding Series B General Obligation Commercial Paper Notes and part of Series A and Series E General Obligation Commercial Paper Notes, 2) to fund the first installment of the Vela Settlement Agreement, and 3) to pay costs of issuances on the bonds. The Commercial Paper refunding was undertaken to reduce the City’s exposure to variable interest rate exposure rather than for savings.

A-89

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005
Tax Notes, Series 2004C. On December 21, 2004, the City issued $3,435,000 Tax Notes Series 2004C. Stated interest rates for the notes, which mature in varying amounts from 2005 to 2010, ranged from 2.5% to 3.375%, and the yield was 2.92%. Proceeds of the certificates were used to purchase a TASER law enforcement weapon system, including related support equipment, and to pay costs of issuance of the Series 2004C Notes. Taxable General Obligation Pension Bonds, Series 2005. On March 30, 2005 the City issued $57,165,000 in Taxable General Obligation Pension Bonds, Series 2005. The bonds mature in varying amounts between 2029 and 2035. The stated interest rate and the yield is 5.31%. Proceeds were used 1) to fund a portion of the unfunded actuarial accrued liability of the Houston Municipal Employees Pension System (“HMEPS”); 2) to refund the City’s $22,900,000 Taxable Pension Obligation Note, Series 2004, which was issued to fund a portion of the unfunded actuarial accrued liability of the Houston Police Officers Pension System (“HPOPS”), and 3) to pay costs of issuance related to these bonds, including the cost of negotiating agreements with HMEPS and HPOPS. The refunding of the Note was undertaken to lower variable interest rate exposure rather than for savings. The City pledged to assess and collect property taxes sufficient to pay debt service on these bonds. Because the liability is directly related to and expected to be paid from the Airport System Fund, the Combined Utility Fund, and the Convention and Entertainment Fund, part of the liability for the Collateralized Note has been allocated among these funds based on percentage of payroll for HMEPS contributions. Airport Subordinate Lien Revenue Refunding Bonds, Series 2005. On June 2, 2005 the City issued $92,900,000 in Airport System Subordinate Lien Revenue Refunding Bonds, Series 2005. Proceeds of the bonds were used to currently refund a portion of Airport System Subordinate Lien Revenue Refunding Bonds, Series 2000A, and to pay costs of issuance. The bonds mature on July 1, 2030. The bonds were issued as variable rate demand obligations with a weekly interest reset. The initial interest rate was 2.70%. Using a certified average rate of 4.85% for similar fixed rate debt issued at the same time, the cash savings on future debt service was $16,842,000 and the net present value saving of the transaction was $9,632,000. The acquisition price of the new debt exceeded the carrying value of the old debt by $1,719,000. This amount is being amortized over the life of the refunded debt. F. Bond Compliance Requirements The revenue bond ordinances require that during the period in which the bonds are outstanding the City must create and maintain certain accounts or funds to receive the proceeds from the sale of the revenue bonds and to account for the revenues (as defined), which are pledged for payment of the bonds. The assets can be used only in accordance with the terms of the bond ordinance and for the specific purpose(s) designated therein. The City is generally required to make a monthly transfer to debt service funds equal to one-sixth of the next interest payment and one-twelfth of the next principal payment. Certain bond ordinances have additional requirements for the establishment of rates and the accumulation of principal and interest repayment amounts from surplus operating funds. Generally, the bonds may be redeemed prior to their maturities in accordance with the bond ordinances and at various premiums equal to or less than 2%. During fiscal year 2005 the City has complied with the requirements of all revenue bond ordinances and related bond restrictions. G. Voter Authorized Obligations On November 4, 2001, voters of the City authorized the issuance of $776,000,000 of Public Improvement Bonds. On June 18, 2002, City Council passed an ordinance stipulating that $165,000,000 of the $776,000,000 be issued as General Obligation Commercial Paper Series D. On October 8, 2003, City Council passed Ordinance 2003-0937 authorizing an additional $110,000,000 to be issued as General Obligation Commercial Paper Series D. On September 8, 2004, City Council passed Ordinance 2004-0944 authorizing an additional $110,000,000 to be issued as General Obligation Commercial Paper Series D for a total authorized issuance of $385,000,000. In addition, the City is authorized by the City Charter to issue $100,000 annually in general improvement bonds without voter approval. H. Legal Debt Margin At June 30, 2005, the City’s legal debt limit was 10% of assessed property valuation totaling $121,806,056,000. The City’s legal debt margin was $7,494,063,000.

A-90

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005
Note 9: Leases A. Operating Leases 1. City as Lessee The City has obtained office space, data processing and other equipment through long-term operating leases. The future minimum payments under these agreements are as follows (in thousands):
Year ended June 30 2006 2007 2008 2009 2010 2011-2015 2016-2020 2021-2025 2026-2030 2031-2035 2036-2040 2041-2045 2046-2050 2051-2055 2056-2060 2061-2065 2066-2070 2071-2075 2076-2080 Total Operating Lease Payments $ 9,565 5,081 3,070 2,866 1,359 3,337 2,439 2,539 2,381 2,000 2,000 2,250 2,250 2,500 2,500 2,750 2,750 3,000 3,000 $ 57,637

2. City as Lessor The Convention and Entertainment Facilities department is a lessor of four facilities. The Airport System is the lessor of approximately 10 percent of its land and substantially all of its buildings and improvements. These lease agreements are noncancelable operating leases with fixed minimum rentals and non-cancelable operating use and lease agreements with annually adjusted rates. Rental income is earned from leasing various parcels of land to airlines, fixed base operators and various corporations for hangars, aircraft maintenance facilities, flight kitchens and cargo buildings; to auto rental companies for their service facilities and storage lots; and to a variety of other entities for buildings and other permanent improvements. Minimum guaranteed income on such non-cancelable operating leases is as follows (in thousands):
Year Ended June 30 2006 2007 2008 2009 2010 2011-2015 2016-2020 2021-2025 2026-2030 2031-2035 2036-2040 2041-2043 Total Operating Leases Minimum Rental Income $ 31,219 30,527 29,621 28,340 26,775 112,836 96,147 89,599 46,222 10,643 10,751 5,998 $ 518,678

The contingent income associated with these non-cancelable operating leases was $7,128,638 in Fiscal Year 2005. In addition, income is earned from certain non-cancelable operating use and lease agreements for landing fees and terminal building rentals. Such income is adjusted annually based on a compensatory formula to recover certain operating and capital costs of the related facilities. Such income for fiscal year 2005 was $234,880,954. A-91

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005
B. Capital Leases 1. The City as Lessee The City entered into a capital lease for the Houston Emergency Center. The City’s annual payment is $4,338,700 and is shared by the City’s Police Department and the Fire Department. The assets acquired through the capital lease are as follows (in thousands):
Governmental Activities Asset: Land Building Total Assets Less: Accumulated Depreciation Net Total $ 3,200 50,179 53,379 (5,691) 47,688

$

The future minimum lease obligations and the net present value of these minimum lease payments as of June 30, 2004, were as follows (in thousands):
Year ended June 30 2006 2007 2008 2009 2010 2011-2015 2015-2020 2021-2025 2026-2027 Total minimum lease payments Less: Amount representing Interest Present value of minimum lease payments Capital Lease Payments $ 4,339 4,339 4,339 4,339 4,339 21,693 21,693 21,693 8,677 95,451 (44,198) $ 51,253

Note 10: Pension Plans A. Plan Descriptions The City has three single employer defined benefit pension plans (Firefighters' Relief and Retirement Fund, Municipal Employees’ Pension System, and the Police Officers’ Pension System), which cover substantially all of its employees. These pension plans were established under the authority of Texas statutes (Vernon's Texas Civil Statutes, Articles 6243.e2 (1), 6243g, 6243g-4, respectively), which establish the various benefit provisions. All plans provide for service-connected disability and death benefits to survivors, with no age or service eligibility requirements. Employer and employee obligations to contribute, as well as employee contribution rates, are included in the statutes, and for the Municipal Employees’ Pension System and the Houston Police Officers’ Pension System, some requirements are delineated in new (September ’04) meet and confer agreements. Additionally, these laws provide that employer funding be based on periodic actuarial valuations, statutorily approved amounts or, in the cases of the Municipal Employees’ Pension System and the Police Officers’ Pension System, amounts agreed to in meet and confer agreements. All pension plans provide service, disability, death, and vesting benefits. In addition, each pension plan recognizes participant and employer contributions as revenues in the period in which they are due pursuant to formal commitments and recognizes benefits and refunds when they are due and payable in accordance with the terms of the pension statutes. The specific summary plan description is available at the plan offices listed in footnote 1. On November 10, 2004 the City issued a $300,000,000 collateralized note (“The Collateralized Note”) to HMEPS as part of the meet and confer agreement with HMEPS to fund part of the unfunded accrued actuarial liability of its pension plan. The collateralized note bears interest at 8.5% per year unless the rate of adjustment formula based on U.S. Treasury securities maturing in 2003, calls for a higher interest rate. The promissory note from the Houston Hotel Corporation to the City, as well as the related Deed of trust, is pledged as collateral on the collateralized notes. Interest on the collateralized notes may be paid or deferred, at the City’s option, up to a maximum of $150,000,000 plus 75% of the amount by which the appraisal value of the hotel exceeds $300,000,000. If the interest is A-92

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005
deferred, the City will issue uncollateralized deferred interest certificates that may be converted to assignable certificates at the request of HMEPS up to $150 million, or collateralized deferred interest certificates up to the limit based on the appraisal value of the hotel. The Collateralized Note constitutes a general obligation of the City with an ad valorem tax pledge, but the City may look to other revenue sources available to pay the debt, including the collateral and its proceeds as well as interest deferrals. B. Actuarially Determined Contribution Requirements and Contributions Made Historically, the City's funding policies have provided for actuarially determined periodic contributions at rates such that, over time, they will remain level as a percent of payroll, except for the police officers pension system, which has had a statutorily limited level of employer contributions. The contribution rate for normal cost is determined using the entry age normal actuarial cost method. The firefighters’ and municipal pension plans use the level percentage of payroll method to amortize the unfunded actuarially accrued liability (or surplus) over 30 years from July 1, 2004 and the police pension uses the level percentage of payroll method to amortize the unfunded actuarially accrued liability over 30 years (constant). (See “Subsequent Events” note on page 109 for further pension information related to the municipal and police pension funds.) The reported contributions to the pension funds for the year ended June 30, 2005, were different from the actuarially determined requirements based on July 1, 2004 actuarial valuation for all three plans. Contributions are as follows:

Percentage of Payroll City of Houston normal cost Amortization of unfunded actuarial accrued liability (surplus) Required employer contribution rate Employer contribution made Employee contribution made Contribution Amounts (in thousands) Net contribution required Total city contribution Total employee contribution Total contribution

Firefighters 20.7% 10.4% 31.1% 18.0% 9.00%

Municipal 20.9% 8.5% 29.4% 16.9% 5.0%

Police 16.7% 14.5% 31.2% 11.3% 8.77%

$ $ $

69,293 32,699 16,355 49,054

$ $ $

150,419 66,006 23,488 89,494

$ $ $

133,106 36,645 28,410 65,055

C. Annual Pension Cost and Net Pension (Obligation) Asset The annual pension cost associated with the City’s three pension funds for the current year is as follows (in thousands): Houston Municipal Employees' Pension $ 126,932 14,261 (11,824) 129,369 66,006 (63,363) (167,781) (231,144) $ Houston Police Officers' Pension 104,696 4,802 (3,605) 105,893 36,645 (69,248) (56,497) (125,745)

Houston Firefighters' Pension Annual required contribution $ Interest on net pension obligation Adjustment to annual required contribution Annual pension cost Contribution made Change in net pension (obligation) asset Net pension (obligation) asset beginning Net pension (obligation) asset end of year 52,938 (4,188) 3,472 52,222 32,699 (19,523) 49,265 29,742

$

$

$

A-93

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005
D. Houston Firefighters’ Pension System

Schedule of Employer Contributions (in millions) Annual Required Contribution as a % of Base Pay 9.9% 14.9% 23.8% 31.1%

Year Ended June 30 2002 2003 2004 2005

Annual Pension Cost $15.0 $22.7 $36.3 $52.2

Percentage Contributed 184% 121% 78.1% 62.5%

Net Pension Asset $51.9 $57.2 $49.3 $29.7

The information presented in the required supplementary schedules was determined as part of the actuarial valuations at the dates indicated. Additional information as to the actuarial valuation used for purposes of the financial statements is as follows: Valuation date Actuarial cost method Amortization method Remaining amortization period Asset valuation method Actuarial assumptions: Investment rate of return Inflation rate Payroll growth rate Annual increase attributable to seniority/merit Cost of living adjustment July 1, 2004 Entry age Normal Cost Level percent of payroll over 30 years Rolling 30 year 5 year smoothed market 8.5%, net of expenses 4.0% 5.0% 3% to 10% 3% annually

E. Houston Municipal Pension System Information Schedule of Employer Contributions (in millions) Annual Required Contribution as a % of Base Pay 9.5% 17.7% 31.8% 29.4%

Year Ended June 30 2002 2003 2004 2005

Annual Pension Cost $43.3 $76.7 $133.5 $129.4

Percentage Contributed 95.0% 53.0% 43.6% 51.1%

Net Pension Obligation $56.3 $92.3 $167.8 $231.1

A-94

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005

The information presented in the required supplementary schedules was determined as part of the actuarial valuations at the dates indicated. Additional information as to the actuarial valuation used for purposes of the financial statements is as follows: Valuation date Actuarial cost method Amortization method Remaining amortization period Asset valuation method Actuarial assumptions: investment rate of return Payroll growth factor Projected individual salary increases General inflation rate F. Houston Police Officer’s Pension System Information Schedule of Employer Contributions (in millions) Annual Required Contribution as a % of Base Pay 11.3% 20.5% 24.4% 31.2% July 1, 2004 Entry age Level percentage closed Rolling 30 year period ending, June 30, 2035 5 year smoothed market 8.5%, net of expenses 3.0% Graded rates based on years of service 3.0%

Year Ended June 30 2002 2003 2004 2005

Annual Pension Cost $30.0 $57.1 $73.9 $105.9

Percentage Contributed 109.0% 61.0% 49.6% 34.6%

Net Pension Obligation $3.2 $19.2 $56.5 $125.8

The information presented in the required supplementary schedules was determined as part of the actuarial valuations at the dates indicated. Additional information as to the actuarial valuation used for purposes of the financial statements is as follows: Valuation date Actuarial cost method Amortization method Remaining amortization period Asset valuation method Actuarial assumptions: Investment rate of return Payroll growth rate, attributable entirely to inflation Annual increase attributable to seniority/merit Annual cost of living adjustment Projected salary increases July 1, 2004 Entry Age Normal Cost Level percent of payroll Amortized over 30 years 30 years 5 year smoothed market 8.5%, net of expenses 3.5 % 0.0% to 9.55% 3.0% Graded rates based on years of service

A-95

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005
Note 11: Other Employee Benefits A. Post-Retirement Health Insurance Benefits Pursuant to a City Ordinance, the City provides certain health care benefits for retired employees. Substantially all of the City's employees become eligible for these benefits if they reach normal retirement age while working for the City. Contributions are recognized in the year paid. The cost of retiree health care premiums incurred by the City amounted to approximately $49,891,440 for the year ended June 30, 2005. Retiree health care is accounted for in the Health Benefits Fund, an Internal Service Fund. At June 30, 2005, there were 8,125 retirees eligible to receive benefits. B. Health Benefits Internal Service Fund The City’s Health Benefits plan is currently administered by HMO Blue Texas. Employees and retirees are able to choose between an HMO Plan with all benefits covered by third party purchased insurance or a substantially self-insured with specific individual aggregate stop loss features Preferred Provider Organization Plan (PPO). Specific and aggregate stop loss insurance is provided for the PPO plan of $300,000 and approximately $8,000,000 based on enrollment, respectively. Premiums paid (employer and subscriber) for current employees to third party administrators totaled approximately $138,794,794 for the year ended June 30, 2005. Effective May 2004, the POS plan was replaced with self-insured Preferred Provider Organization (PPO). The City also provides one times salary of basic life insurance, with a minimum of $15,000, at no cost to the employee. The employee, at no cost to the City, may then obtain additional life insurance up to four times their annual salary. The current cost for active employees for both basic and voluntary life insurance totaled $5,187,088 for the year ended June 30, 2005.

PPO/POS and PPO/OOA Schedule of Changes in Liability (in thousands) June 30, 2005 Beginning actuarial estimate of claims liability, July 1 Incurred claims for fiscal year Payments on claims Actuarial adjustment Ending actuarial estimate of claims liability, June 30
C. Long-Term Disability Plan The long-term disability plan, accounted for as an internal service fund, is a part of the Income Protection Plan implemented effective September 1, 1985 (renamed the Compensable Sick Leave Plan (CSL) in October, 1996) and is provided at no cost to City employees who are members of CSL. Coverage is effective the later of September 1, 1985 or upon completion of two years of continuous service. When an employee cannot work because of injury or illness, the plan provides income equal to 50% of base pay plus longevity or 70% of base plus longevity when combined with income benefits available from other sources. Plan benefits may be payable after all CSL scheduled sick leave benefits, including frozen sick leave days, have been used, however, not before six months absence from work. The plan is administered by Disability Management Alternatives, Inc., which is reimbursed from the fund for claims as they are paid along with a fee for administrative services. Effective September 1, 2001 the Meet and Confer Agreement established Paid Time Off (PTO) for police classified officers. This replaces their participation in the LTD plan.

June 30, 2004 $ 809 7,513 (7,301) (10) 1,011

$

1,011 9,153 (9,959) 737 942

$

$

Schedule of Changes in Liability (in thousands) June 30, 2005 Beginning actuarial estimate of claims liability, July 1 Incurred claims for fiscal year Payments on claims Actuarial adjustment Ending actuarial estimate of claims liability, June 30 $ 5,799 1,890 (688) (650) 6,351 June 30, 2004 $ 5,262 1,085 (774) 226 5,799

$

$

A-96

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005
D. Deferred Compensation Plan The City offers its employees a deferred compensation plan (Plan), created in accordance with Internal Revenue Code Section 457 as a separately administered trust. The Plan, available to all City employees, permits employees to defer a portion of their salary until future years. The deferred compensation funds are not available until termination, retirement, death or unforeseeable emergency. However, the Plan now offers loans to participant employees. The maximum amount is the lesser of $50,000 or 50% of the total account balance, less any outstanding loans. The minimum loan amount is $1,000. Pursuant to tax law changes, the Plan’s assets are no longer subject to the City’s general creditors and are not included in these financial statements. E. Workers' Compensation Self-Insurance Plan The City has established a Workers' Compensation Self-Insurance Plan, accounted for within the various operating funds. The plan is administered by Cambridge Integrated Services Group, Inc. Funds are wire transferred to Cambridge as needed to pay claims. At June 30, 2005 the City has an accumulated liability in the amount of $62.3 million covering estimates for approved but unpaid claims and incurred but not reported claims (calculated on an actuarial basis) recorded in the Statement of Net Assets and Enterprise Funds. The amount of liability is based on the estimate of an independent actuary. ` Schedule of Changes in Liability (in thousands)
June 30, 2005 Beginning actuarial estimate of claims liability, July 1 Incurred claims for fiscal year Payments on claims Actuarial adjustment Ending actuarial estimate of claims liability, June 30 $ 56,095 16,202 (18,337) 8,347 62,307 June 30, 2004 $ 56,462 14,956 (21,065) 5,742 56,095

$

$

Note 12: Interfund Transactions A. Transfers Transfers during the year ended June 30, 2005, were as follows (in thousands):

Transferred to:
General Fund $ 1,029 709 3,025 $ 4,763 Nonmajor Governmental Funds $ 7,659 30,000 $ 37,659 Debt Service $ 188,674 6,502 2,721 13,409 27,822 $ 239,128 Capital Projects $ 352 $ 352 Grants Fund $ 575 $ 575 Convention & Entertainment Facilities $ 442 2,500 $ 2,942 Houston Area Water Corporation $ 26,567 $ 26,567 Total Transfers Out $ 197,127 6,502 6,250 13,984 709 87,414 $ 311,986

Transferred from:
General Fund Grants Fund Nonmajor Funds Capital Projects Convention & Entertainment Combined Utility System Total transfers in

Transfers are used to (1) move receipts restricted to debt service from the funds collecting the receipts to the debt service fund and (2) use unrestricted revenues collected in the general fund to finance various programs accounted for in other funds in accordance with budgetary authorizations, (3) use unrestricted revenues in the Combined Utility fund and special revenue fund to finance general fund programs. The Combined Utility System and Convention Entertainment Facilities transferred capital assets valued at $3.025 million and $709 thousand, respectively to the General Fund.

A-97

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005
B. Transfers to Component Units

Transfers to the Cultural Arts Council of Houston from the Convention and Entertainment Facilities during the year ended June 30, 2005 totaled $8,172,032.
C. Interfund Charges

The General Fund charges the Airport System, Convention and Entertainment Facilities, Combined Utility System, Capital Project, Sign Administration, Auto Dealer's and Cable Television Funds for services provided by the General Fund on behalf of these funds. Such charges totaled $80,248,000 for the year ended June 30, 2005, and are recorded as revenue in the General Fund and as expense, expenditure or capital assets in the funds assessed. Included in the Fiscal Year 2005 total are charges to the funds for direct and indirect expenses as shown below (in thousands):
Airport System Convention & Entertainment Facilities Combined Utility Sytem

Other Funds

Total

General Services Fire Services Police Services Engineering Services Fleet Maintenance Legal Other Total

$

$

2,389 10,087 18,704 264 467 31,911

$

$

442 14 35 67 558

$

$

1,236 11,025 726 14 4,606 17,607

$

$

6,964 7,916 7,838 426 7,028 30,172

$

$

11,031 10,087 18,704 18,955 8,863 440 12,168 80,248

A-98

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005
D. Schedule of Amounts Due To and Due From Other Funds

The interfund balances are primarily due to charges for services between funds during the fiscal year and settled shortly after year-end. The composition of interfund balances as of June 30, 2005 is as follows (in thousands):

Receivable Fund General Fund

Payable Fund Combined Utility System Grants revenue Nonmajor Governmental Funds Capital Projects Fund Health Benefits Fund Airport System Convention and Entertainment Facilities

Amount $ 739 1,197 934 834 2 2,609 37 6,352 2 2 126 126 1,100 1,303 2,403 3,336 1,696 5,032 438 1 8 447 5,087 1 12 389 5,489 5,941 5,941 2,437 253 32 2,722

$ Health Benefits General Fund $ $ $ $ $ $ Airport System General Fund Nonmajor Governmental Funds General Fund Airport System Nonmajor Governmental funds General Fund Grants revenue Nonmajor Governmental Funds Debt Service $ $ Convention and Entertainment Facilities $

Grants Revenue

General Fund

Capital Projects Fund

General Fund Grants revenue

$ Combined Utility System $

$ HAWC Combined Utility $ Nonmajor Governmental Funds General Fund Airport System Grants revenue $

$

A-99

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005
Note 13: Commitments and Contingencies A. Litigation and Claims

The City is a defendant in various lawsuits and is aware of pending claims arising in the ordinary course of its municipal and enterprise activities, certain of which seek substantial damages. That litigation includes lawsuits and claims alleging that the City caused personal injuries and wrongful deaths; class actions and other lawsuits and claims alleging discriminatory hiring and promotional practices and certain civil rights violations arising under the Federal Voting Rights Act; various claims from contractors for additional amounts under construction contracts; and claims involving property tax assessments and various other liability claims. Alleged damages in the lawsuits are approximately $161.8 million. The status of such litigation ranges from an early discovery stage to various levels of appeal of judgments both for and against the City. The amount of damages is limited in certain cases under the Texas Tort Claims Act and is subject to appeal. The City intends to defend itself vigorously against the suits. There is other threatened litigation for which an amount cannot be determined. The City typically utilizes the General Fund to liquidate claims and judgments. In the Statement of Net Assets, the City has recognized a liability of $76.3 million for potential litigation losses arising from various lawsuits. In 2004, Houston voters approved two ballot propositions limiting City revenue growth. Proposition 1 limits annual growth in property taxes to the lesser of the actual revenues in the preceding fiscal year, plus 4.5 percent, or the revenues received in the previous fiscal year, plus the cumulative combined rates of inflation and the city’s population growth. Proposition 2 caps growth in all City revenues, including the General Fund, Special Revenue Funds and Enterprise Funds. Under Proposition 2, any annual increase in total revenues above the consumer price index and population growth would require a 60 percent vote at a regular election. Although both propositions received a majority of votes in the 2004 election, it is the City’s position that only Proposition 1 prevails because it received a higher number of favorable votes. Supporters of Proposition 2 have sued in State District court to enforce the provisions of Proposition 2. The district court ruled in favor of the plaintiffs and ordered that both propositions be in effect. The City will appeal the ruling. According to an analysis conducted by the City Controller’s Office, the Fiscal Year 2006 budget complies with the requirements of both propositions. Included within the Claims and Judgments liability line item is an accrual of $55.7 million related to the settlement of litigation styled as Juan E. Vela v. City of Houston which was filed in 1995 with a settlement reached during fiscal year 2005. The settlement relates to Houston Fire Department paramedics lawsuit against the City for past due overtime pay and liquidated damages, and calls for the remaining liability to be paid during fiscal years 2006 and 2007.
B. Environmental Liabilities

The City is aware of various sites contaminated by asbestos or other hazardous materials. The City has recorded accrued liabilities of $16.1 million, to be used for: assessment and remediation of asbestos, lead and mold; Phase I and II environmental site assessments and remediation, and; remediation of radioactive material.
C. Commitments for Capital Facilities

At June 30, 2005, the City had appropriated but not yet spent from Capital Projects and Enterprise Funds approximately $1,265,856,000 for capital projects. The City leased a tract of land for 30 years with a 30-year renewal option for $100 per year to The Houston Music Hall Foundation. On this site, the Houston Music Hall Foundation constructed the new music hall named the Hobby Center for the Performing Arts. Substantial completion occurred by October 31, 2002, as required by the agreement. The grand opening was in May of 2003. The Music Hall was granted and conveyed to the City. The City is obligated to pay from parking revenues $1 million per year for 30 years beginning on the commencement of the lease. The City's annual obligation is secured by a pledge of the parking revenues from the Civic Center and Tranquility Park Parking Garages equal to $1,200,000 per year for 30 years.
D. Risk Management

The City is self-insured for claims pertaining to third party liability, unemployment and workers’ compensation. The City carries fidelity coverage to comply with City ordinance and purchases commercial property insurance with a per occurrence loss limit of $400 million. Such insurance provides deductibles as follows: $2.5 million per occurrence for all perils except for 2% of the damaged insured value for windstorm or hail from a named storm, subject to $2.5 million minimum and a $10 million maximum; and a $5 million deductible for a flood. Although no losses were sustained in excess of the $300 million per occurrence loss limit in the last 5 years, Tropical Storm Allison caused damages in excess of the $5 million sub-limit (in 2001) to locations in the 100-year flood plain (Flood Zone A). Insurance reimbursed the City $32.6 million for property damage. The current sub-limit for flood is $50 million, of which $35 million may apply to Flood Zone A. Emergency Management is working with the Finance and Administration Department to coordinate a claim to FEMA for the amount not covered by insurance. Self-insured claims are reported as liabilities in the accompanying financial statements when it is probable that a loss has occurred and the amount of that loss can be reasonably estimated. This determination is based on reported pending claims, estimates of claims incurred but not yet reported, actuarial reports and historical analysis. All claims are accounted for in the Government-wide Statement A-100

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005
of Net Assets. Claims that are expected to be paid with expendable, available financial resources are accounted for in the General Fund and the appropriate Enterprise Funds. Through its Health Benefit Plan, the City has consistently purchased commercial insurance up to certain limitations in the event of adverse loss experience. For unemployment claims, the City pays claims as they are settled. Unemployment claim activity is as follows:
Unemployment Claim Activity June 30, 2005 June 30, 2004 $112,223 $134,852 1,114,092 646,874 (1,110,804) (669,503) $115,511 $112,223

Unpaid claims, beginning of fiscal year Incurred claims (including IBNRs) Claim payments Unpaid claims, end of fiscal year

E. Federal and State

Amounts received or receivable from grantor agencies are subject to audit and adjustment by grantor agencies, principally the federal and state governments. Any disallowed claims, including amounts already collected, could be a liability of the City.
Note 14: Related Organization Transactions A. Metropolitan Transit Authority (“Metro”)

The City and Metro have an interlocal agreement under which Metro would fund up to $20 million of revenue for street maintenance and traffic control during the fiscal year ended June 30, 2005. The City received $16.695 million from Metro under this contract in FY05. The money is accounted for in the general fund.
B. Trinity River Authority (“TRA”)

As described in Note 8C, the City and TRA have a long-term contract under which the City is obligated to pay debt service for certain bonds as well as certain maintenance and operating expenses for a TRA dam and reservoir. During the fiscal year ended June 30, 2005 the City paid $2.5 million for debt service and $2.3 million for maintenance and operating expenses under the terms of the contract.
C. Coastal Water Authority (“CWA”)

The City has a long-term contract with Coastal Water Authority (CWA) for the acquisition of water. During the fiscal year ended June 30, 2005, the City paid CWA $29.1 million for debt service and $14.5 million for maintenance and operating expenses.
Note 15: Conduit Debt Obligations

To provide for the airport facilities, the City has issued eight series of Special Facility Revenue Bonds. These bonds are limited special obligations of the City, payable solely from and secured by a pledge of revenue to be received from agreements between the City and various third parties. The bonds do not constitute a debt or pledge of the faith and credit of the City and accordingly have not been reported in the accompanying financial statements, except for the City of Houston Special Facility Revenue Bonds (Automated People Mover System), Series 1997A, which are reported as an Inferior Lien Obligation because the City has contracted with Continental Airlines to operate certain facilities and pay related debt service. See Note 8D.

At June 30, 2005, the aggregate value of Special Facility Revenue Bonds outstanding was $654,630,000, which includes $60,065,000 of City of Houston Special Facility Revenue Bonds (Automated People Mover System), Series 1997A, bonds.

A-101

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005

Note 16: Major Discretely Presented Component Units

The following discretely presented component units represent major component units. For reporting purposes, the City considers a component unit to be major if assets, liabilities, revenues or expenses exceed 10% of that component unit’s class and exceed 5% of all component units combined.
Net Assets Major Component Units - Discretely Presented Governmental June 30, 2005 (in thousands)

Cultural Arts Council of Houston Cash, receivable and other current assets $ Noncurrent assets Capital assets, net of accumulated depreciation Total assets Current liabilities Long-term liabilities Total liabilities Net assets Invested in capital assets, net of related debt Restricted Unrestricted (deficit) Total net assets (deficit) 2,628 29 2,657 968 968 1,038 651 1,689

Greater Houston Convention & Visitor's Bureau $ 3,487 285 3,772 2,059 2,059 1,713 1,713

Houston Downtown Park Corporation $ 12,556 56,986 69,542 56,986 12,556 69,542

$

$

$

(Continued)

A-102

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005

Midtown Redevelopment Authority $ 28,673 1,471 6,759 36,903 3,020 38,690 41,710 2,933 11,517 (19,257) (4,807) $

Uptown Revelopment Authority' 11,609 1,352 1,800 14,761 6,196 38,630 44,826 1,800 4,830 (36,695) (30,065)

Nonmajor Component Units $ 101,816 11,035 21,081 133,932 35,756 79,214 114,970 17,237 35,089 (33,364) 18,962

2005 $ 160,769 13,858 86,940 261,567 47,999 156,534 204,533 78,956 52,474 (74,396) $ 57,034

$

$

$

A-103

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005

Change in Net Assets Major Component Units - Discretely Presented Governmental For the Year Ended June 30, 2005 (in thousands)

Component Units Cultural Arts Council of Houston/Harris County Greater Houston Convention & Visitors Bureau Houston Downtown Park Corporation Midtown Redevelopment Authority Uptown Development Authority Nonmajor Component Units Total component units General Revenues: Taxes Property taxes levied for general purposes Intergovermental - grants Contributions Unrestricted investment earnings Other Loss on sales of assets Transfers Total general revenues, special items and transfers Change in net assets Net assets beginning New component unit & restatement Net assets ending

Expenses $ 8,900 12,569 4,104 5,717 10,026 26,614 $ 67,930

Charges for Services $ 97 570 1,785 $ 2,452

Operating Grants and Contributions $ 9,130 11,514 32,274 815 5,866 $ 59,599

Capital Grants and Contributions $ 41,371 $ 15 41,386

Cultural Arts Council of Houston/Harris County $ 327 $ 327

64 64 391 1,298 $ 1,689

(Continued)

A-104

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005

Net (Expense) Revenue and Change In Net Assets

Greater Houston Convention & Visitors Bureau $ (485) $ (485)

Houston Downtown Park Corporation $ 69,541 $ 69,541

Midtown Redevelopment Authority $ (4,902) $ (4,902)

Uptown Redevelopment Authority $ (10,026) $ (10,026)

Nonmajor Component Units $ (18,948) $ (18,948)

Total Component Units $ 327 (485) 69,541 (4,902) (10,026) (18,948) $ 35,507

211 1,987 2,198 1,713 1,713

1 1 69,542 $ 69,542 $

6,943 297 146 7,386 2,484 (7,291) (4,807) $

7,137 128 7,265 (2,761) (27,304) (30,065) $

25,029 60 2,395 726 28,210 9,262 9,700 18,962

39,109 60 3,032 2,923 45,124 80,631 (23,597) 57,034

$

$

A-105

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005

Net Assets Major Component Units - Discretely Presented Business-type June 30, 2005 (in thousands)

Houston Convention Center Hotel Corp. Cash, receivable and investments Noncurrent assets Capital assets, net of accumulated depreciation Total assets Current liabilities Long-term liabilities Total liabilities Net assets Invested in capital assets, net of related debt Restricted Unrestricted (deficit) Total net assets (deficit) $ 24,527 26,768 272,146 323,441 19,789 325,368 345,157 (23,071) 5,440 (4,085) (21,716)

Houston Housing Finance Corp. $ 18,521 9,874 28,395 436 2,962 3,398 1,310 23,687 24,997

Houston Zoo Inc. $ 14,878 12,759 27,637 3,515 3,515 10,348 10,428 3,346 24,122 $

Total 57,926 36,642 284,905 379,473 23,740 328,330 352,070 (12,723) 17,178 22,948 27,403

$

$

$

$

A-106

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005

This page is left blank intentionally

A-107

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005

Change in Net Assets Major Component Units - Discretely Presented Business-type For the Year Ended June 30, 2005 (in thousands)

Component Units Houston Convention Center Hotel Corp. Houston Housing Finance Corp. Houston Zoo Inc. Totals

Expenses $ 77,312 5,469 18,481 $ 101,262

Charges for Services $ 57,669 843 16,413 $ 74,925

Operating Grants and Contributions $ 4,313 7,839 $ 12,152

General Revenues: Taxes Property taxes levied for debt service Unrestricted investment earnings Other Transfers Total general revenues, special items, and transfers Change in net assets Net assets (deficit) beginning Net assets (deficit) ending

A-108

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005

Net (Expense) Revenue and Change in Net Assets Houston Convention Center Hotel Corp. $ (19,643) $ (19,643) Houston Housing Finance Corp. $ (313) $ (313) Houston Zoo Inc.

$

$

5,771 5,771

$

Total (19,643) (313) 5,771 (14,185)

$

1,402 9,239 10,641 (9,002) (12,714) (21,716)

$

750 571 1,321 1,008 23,989 24,997

$

128 128 5,899 18,223 24,122

$

750 2,101 9,239 12,090 (2,095) 29,498 27,403

A-109

CITY OF HOUSTON, TEXAS NOTES TO THE BASIC FINANCIAL STATEMENTS June 30, 2005

Note 17. Subsequent Events A. Tax and Revenue Anticipation Notes On July 6, 2005, the City closed the sale of $180,000,000 Tax and Revenue Anticipation Notes (“TRANS”), Series 2005. The proceeds of the TRANS will be used to pay working capital expenditures until tax revenues are received in February 2005. Stated interest rates were 4.00% to 5.75%, and the average yield was 2.63%. The notes will mature on June 30, 2006. B. Public Improvement Refunding Bonds On July 7, 2005 the City closed the sale of $100,025,000 of Public Improvement Refunding Bonds, Series 2005A. Stated interest rates ranged from 4.0% to 5.125%, and the average yield was 4.19%. The bonds are due in varying amounts from March 1, 2014 to March 1, 2025. Proceeds were used to fund the second installment of a judgment against the City relating to firefighters overtime pay, to refund certain Public Improvement Bonds and Certificates of Obligation issued from 1999 to 2001, and to pay costs of issuance. The cash savings of the transaction was $3,860,000, and the net present value savings of the transaction was $3,384,000, or 4.43%. On November 15, 2005 the City closed the sale of $95,740,000 of Public Improvement Refunding Bonds, Series 2005E with a stated interest rate of 5.0%. The average yield was 4.54%. The bonds mature in varying amounts from 2013 to 2025. Proceeds were used to refund $100,000,000 of General Obligation Series A Commercial Paper Notes, and to pay costs of issuance. The Bonds were issued to lock in long term fixed rates rather than to achieve debt service savings. C. Taxable Public Improvement Refunding Bonds On July 7, 2005, the City closed the sale of $7,770,000 of Taxable Public Improvement Refunding Bonds, Series 2005B. The stated interest rate was 5.125%, and the yield was 5.237%. The bonds are due in varying amounts from March 1, 2032 to March 1, 2035. Proceeds were used to fund the pension costs related to firefighters overtime judgment and to pay costs of issuance. D. Certificates of Obligation On July 7, 2005 the City closed the sale of $3,310,000 of Certificates of Obligation, Series 2005C. The stated interest rate was 5.0%, and the yield was 3.2%. The bonds are due on March 1, 2010. Proceeds will be used to fund the demolition of dangerous buildings within the City and to pay costs of issuance. On November 15, 2005 the City closed the sale of $53,445,000 of Certificates of Obligation, Series 2005D. Stated interest rates ranged from 3.50% to 5.00%, and the average yield was 4.54%. The bonds are due in varying amounts from 2008 to 2027. The proceeds were used to pay the purchase option price of the Houston Emergency Center Lease and to pay costs of issuance of the Certificates and exercise of the purchase option. Cash savings over future lease payments will be $4,484,000, and the net present value savings will be $4,128,000, or 8.1%. E. Water Sewer Junior Lien Revenue Bonds On July 18, 2005 the City closed the sale on $1,965,000 in Water Sewer Junior Lien Revenue Bonds, Series 2002C2 in a private placement with the Texas Water Development Board (“TWDB”). The City had contracted with TWDB in June 2002 for a line of credit of $6,180,000 to be drawn when the City has completed certain work related to drinking water improvements. Previously the City drew $180,000 on this line, leaving $4,035,000 to be drawn in the future. Stated interest rates ranged from 2.0 to 3.05%, and the average yield was 2.78%. The bonds mature in varying amounts between 2006 and 2013. F. Combined Utility System Revenue Refunding Bonds On September 28, 2005 the City closed the sale on $250,855,000 in Combined Utility System First Lien Revenue Refunding Bonds, Series 2005. Stated interest rates ranged from 4.375 to 5.00%, and the average yield was 4.52%. The bonds are due in varying amounts from 2013 to 2035. The proceeds were used to currently refund Water and Sewer Jr. Lien Revenue Bonds Series, 1996C, to currently refund $200,000,000 of Combined Utility System Commercial Paper Notes, Series A, and to pay costs of issuance. Cash savings on bond debt service payments related to refunding the Water and Sewer Jr. Lien bonds will be $5,648,000, and the net present value savings will be $3,870,000, or 6.22%. The portion of bonds related to the Notes refund was issued to lock in long term fixed rates rather than to achieve debt service savings. On October 11, 2005 the City closed the sale on $144,915,000 in Combined Utility System First Lien Revenue Refunding Bonds, Series 2005A. Stated interest rates ranged from 5.0 to 5.25%, and the average yield was 3.84%. The bonds are due in varying amounts from 2011 to 2017. The proceeds were used to advance refund Water and Sewer Jr. Lien Revenue Bonds, Series 1996D, and to pay costs of issuance. Cash savings on bond debt service payments will be $10,556,000, and the net present value savings will be $6,854,000, or 4.3%.

A-110

G. Taxable Pension Deferred Interest Certificates On October 1, 2005 the City elected to defer $16,702,500 in interest payments on its $300,000,000 Collateralized Pension Obligation Note, and to allocate such deferred interest to the Uncollateralized Deferred Interest Certificate, as allowed by the ordinance authorizing issuance of the Note. (The City made a partial payment of $6,035,000 on the $22,737,500 interest incurred on the Note.) The Deferred Interest Certificate will bear interest at the greater of a) 8.5%, b) the yield on April 1 of each year for the Treasury obligation maturing closest to December 1, 2033, plus a predefined rate adjustment. Under the authorizing ordinance, the City is allowed to defer up to $150,000,000 in interest on the Note. The City will pay down the Certificate by December 1, 2033. H. Combined Utility System Forward Interest Rate Swap On November 1, 2005 the City entered into a forward interest rate swap transaction with RBC Dain Rauscher. The swap will begin on December 3, 2007. The transaction was conducted through a competitive bid process. It is intended to hedge the interest rate on a portion of the City’s variable rate Combined Utility System First Lien Revenue Bonds, Series 2004C. Under the terms of the contract, the City will pay a fixed rate of 3.761% on a par value of $249,075,000, and it will receive variable payments based on 70% of onemonth LIBOR. The City’s scheduled net swap payments are insured by Ambac Assurance Corporation. I. Pension System Updates – Houston Police Officer’s Pension System In August 2005, the Board approved a plan to alter the System’s asset allocation by decreasing exposure to the US and international public equity markets and adding or increasing exposure to inflation indexed securities, emerging market debt, commodities, real estate and a structured beta investment strategy. Assets allocated to US and international equity markets will be decreased from 58.0percent to 40.5 percent of plan assets. The System has interest in Refco Group Ltd, LLC, a subsidiary of Refco Inc., through the System’s investment in the Thomas H Lee V private equity partnership (the Partnership). In October 2005, Refco, Inc.’s chief executive officer was arrested for allegedly executing and concealing a fraud which led to a liquidity crisis for Refco, Inc. Subsequently Refco, Inc. and numerous subsidiaries including Refco Group Ltd, LLC, filed for Chapter 11 bankruptcy protection. Pursuant to these events the System intends to write down its investment in the Partnership, which has a preliminary valuation of $19.2 million, by approximately $3.7 million during the 2006 fiscal year. This write-down represents the System’s proportionate interest in Refco Group Ltd, LLC through the System’s investment in the Partnership. The Partnership is a named defendant in numerous class action filings that have been made pursuant to the situation, however, the System expects no further material loss as a result of Refco, Inc. and Refco Group Ltd, LLC bankruptcy or the attendant class action proceedings. J. City of Houston’s response to Hurricanes Katrina and Rita On August 29, 2005, Hurricane Katrina struck the coasts of Louisiana, Mississippi and Alabama. The destruction caused by the hurricane led to unprecedented numbers of evacuees seeking refuge in the City of Houston. The City mobilized its efforts with Harris County and various State and federal agencies and nonprofit organizations to coordinate needed resources to assist the evacuees. As part of its response, the City offered temporary housing to thousands of evacuees in shelters in the days immediately following the storm. The City provided equipment, food, medical supplies, facilities, and City Emergency and civilian personnel. The City is currently providing temporary housing to over 30,000 evacuees for periods of six to twelve months based on evacuees eligibility provided by FEMA. President Bush issued a declaration of emergency for the State of Texas which resulted in federal assistance becoming available to the City for 100% of eligible costs incurred in providing shelter and care to victims of the hurricane. The eligible costs include interim short term sheltering, interim sheltering for a period of up to one year, medical costs, transportation costs and temporary increases in the provision of governmental services such as public safety, education and judicial expenditures. The costs of the City’s effort to assist the evacuees are estimated to be $350 million. To date the City has received advances of approximately $145 million from FEMA and another $1 million in private donations to the City to help pay the costs of assisting the evacuees. The City expects to receive reimbursement for substantially all of its costs associated with sheltering and housing the evacuees from Hurricane Katrina. On September 24, 2005, Hurricane Rita caused extensive damage to the coastal regions of Texas and Louisiana. The City of Houston was included in a declaration of emergency that made the City eligible for federal assistance to reimburse the City 100% of the costs of debris removal and emergency protective measures taken by the City for a period of 34 days through and including October 27, 2005. Emergency protective measures include the costs of police overtime and emergency access and communication. The City believes that FEMA advances and reimbursements will be sufficient to cover substantially all of the costs associated with the City’s response to Hurricane Rita. K. Clean Water Act On August 19, 2005, the City executed an Agreed Order with the Texas Commission on Environmental Quality to resolve alleged violations of the Clean Water Act concerning Sanitary Sewer Overflows (SSOs) in the City’s collection basins. Under the terms of the Agreed Order, the City will implement a plan over the next 10 years to correct causes of SSOs. The City will structurally “renew” (i.e., replace or rehabilitate) its wastewater collection system. It will also increase preventative maintenance activities for lift stations and force mains, and improve management information systems. The value of the Capital Improvement Project is estimated to be $755.4 million over the next 10 years. Funding for this project will be provided by the Water and Sewer Fund.

A-111

Required Supplemental Information
CITY OF HOUSTON, TEXAS GENERAL OPERATING FUND Schedule of Budgeted and Actual Revenues and Expenditures For the Year Ended June 30, 2005 amounts expressed in thousands (unaudited) Variance with Final BudgetPos (Neg)

Budgeted Amounts Original Final Revenues
Taxes and assessments Property Taxes Industrial Assessments Sales Tax Franchise Tax Mixed Beverage Tax Bingo Tax Hotel Occupancy Tax Total taxes and assessments Licenses and permits General Health Permits Total licenses and permits Charges for services Ambulance service Library fees Parking Services performed for other funds Direct Indirect Rents and royalties Others Total charges for services Intergovernmental - grants Fines and forfeits Municipal Courts Others Total fines and forfeits Contributions Interest Other Sale of Property Other Total Other Total revenues Other financing sources (uses) Transfers in Transfers from primary government Other financing sources (uses) Total other financing sources (uses Total revenues and other financing source $ 671,553 14,406 371,548 160,399 8,200 275 1,226,381 8,735 6,620 15,355 24,175 4,047 65,961 10,419 1,010 12,302 117,914 22,189 47,601 4,540 52,141 1,680 5,000 2,649 7,610 10,259 1,450,919 3,500 3,500 $ 1,454,419 $ $ 671,553 14,406 371,548 160,399 8,200 275 1,226,381 8,735 6,620 15,355 24,175 4,047 65,961 10,419 1,010 12,302 117,914 22,189 47,601 4,540 52,141 1,680 5,000 2,649 7,610 10,259 1,450,919 3,500 3,500 1,454,419 $ $

Actual Budget Basis

671,294 14,635 370,583 162,263 8,343 270 1,227,388 11,584 6,108 17,692 22,740 3,223 61,234 11,031 1,005 12,964 112,197 18,881 48,827 2,424 51,251 1,780 6,414 3,091 11,382 14,473 1,450,076 1,029 48,600 49,629 1,499,705

$

(259)
229 (965)

1,864 143 (5) 1,007 2,849 (512) 2,337 (1,435) (824) (4,727) 612 (5) 662 (5,717) (3,308) 1,226 (2,116) (890) 100 1,414 442 3,772
4,214 (843) (2,471)

48,600
46,129 $ 45,286

* See note to Required Supplementary Information*

A-112

CITY OF HOUSTON, TEXAS GENERAL OPERATING FUND Schedule of Budgeted and Actual Revenues and Expenditures For the Year Ended June 30, 2005 amounts expressed in thousands (unaudited) Variance with Final BudgetPos (Neg)

Budgeted Amounts Original Final
General government Legislative and executive Personnel services Other current expenditures Total legislative - council Legislative - Mayor's Office Personnel services Other current expenditures Total executive - mayor's office Total legislative and executive Affirmative Action Personnel services Other current expenditures Total affirmative action Judicial Municipal Courts Judges Personnel services Other current expenditures Total municipal court judges Municipal Courts Administration Personnel services Other current expenditures Equipment acquisition Total municipal court administration Total judicial Elections Finance administration Controller Personnel services Other current expenditures Total controller Finance and Administration Personnel services Other current expenditures Equipment acquisition Total finance and administration Information Technology Personnel services Other current expenditures Total information technology Audits Bond and Legal Total finance administration Legal Personnel services Other current expenditures Total legal 9,693 1,105 10,798 9,978 1,279 11,257 10,164 2,230 12,394 608 2,262 41,218 10,699 2,153 12,852 608 2,262 42,308 18,272 1,845 20,117 18,633 1,811 20,444 4,912 925 5,837 5,217 925 6,142 14,438 1,777 2 16,217 20,209 1,000 14,411 2,077 10 16,498 20,773 1,000 3,720 272 3,992 4,003 272 4,275 1,535 97 1,632 1,582 152 1,734 1,655 149 1,804 6,007 1,779 148 1,927 6,341 3,999 204 4,203 4,148 266 4,414

Actual Budget Basis

4,036 230 4,266 1,748 101 1,849 6,115 1,576 138 1,714

112 36
148

31 47
78 226

6 14
20

3,948 265 4,213 14,310 2,030 10 16,350 20,563 1,334

55 7
62

101 47 148 210

(334)

5,067 892 5,959 17,748 1,682 19,430 10,209 2,069 12,278 890 2,282 40,839 9,634 1,041 10,675

150 33
183

885 129 1,014

490 84
574

(282) (20)
1,469

344 238
582

*See note to required Supplementary Information*

A-113

CITY OF HOUSTON, TEXAS GENERAL OPERATING FUND Schedule of Budgeted and Actual Revenues and Expenditures For the Year Ended June 30, 2005 amounts expressed in thousands (unaudited) Variance with Final BudgetPos (Neg)
529 97 626 6,465 630 60 7,155 2,014 203 2,217 91,238

Budgeted Amounts Original Final
City Secretary Personnel services Other current expenditures Total city secretary Planning and Development Personnel services Other current expenditures Equipment acquisition Total planning and development Human Resources Personnel services Other current expenditures Total human resources Total general government Public safety Police Personnel services Other current expenditures Equipment acquisition Total police Fire Personnel services Other current expenditures Equipment acquisition Total fire Total public safety Public Works Administration Personnel services Other current expenditures Equipment acquisition Total administration Building Services Personnel services Other current expenditures Equipment acquisition Total building services Solid Waste Personnel services Other current expenditures Equipment acquisition Total solid waste Total public works 25,311 35,819 61,130 172,743 26,021 40,975 45 67,041 181,072 8,448 14,493 22,941 9,631 15,051 63 24,745 46,189 42,483 88,672 42,484 46,764 38 89,286 275,325 17,599 18 292,942 808,945 273,421 19,630 191 293,242 817,088 490,715 25,138 150 516,003 493,454 30,189 203 523,846 2,056 231 2,287 97,314 2,180 237 2,417 94,129 10,482 2,974 13,456 6,831 686 60 7,577 619 88 707 634 88 722

Actual Budget Basis

105 (9)
96

366 56 422

166 34
200 2,891

470,877 26,784 206 497,867 272,077 19,089 186 291,352 789,219

22,577 3,405 (3)
25,979

1,344 541 5
1,890 27,869

42,341 46,461 38 88,840 9,515 15,054 63 24,632 26,262 40,682 45 66,989 180,461

143 303 446

116 (3) 113

(241) 293 52 611

*See note to required Supplementary Information*

A-114

CITY OF HOUSTON, TEXAS GENERAL OPERATING FUND Schedule of Budgeted and Actual Revenues and Expenditures For the Year Ended June 30, 2005 amounts expressed in thousands (unaudited) Variance with Final BudgetPos (Neg) 794 133 3
930

Budgeted Amounts Original Final
Health Personnel services Other current expenditures Equipment acquisition Total health Parks and Recreation Personnel services Other current expenditures Equipment acquisition Total parks and recreation Library Personnel services Other current expenditures Equipment acquisition Total library Retiree Benefits Hospital and life insurance Total retiree benefits Other current expenditures Tax appraisal fees Limited-purpose Annexation Districts Insurance Claims and judgments Membership dues Advertising and promotion Zoo Contract Consultants Miscellaneous support services Total other current expenditures Debt service Debt service principal Debt service interest Total debt service Total expenditures Other financing sources (uses) Transfers out Total other financing sources (uses) Total expenditures and other financing use $ 196,009 196,009 1,454,907 $ 196,629 196,629 1,502,371 $ 1,090 5,249 6,339 1,258,898 1,090 5,249 6,339 1,305,742 5,489 13,128 1,470 6,000 780 200 7,494 372 9,538 44,471 5,489 13,128 1,470 6,517 755 225 7,494 372 9,038 44,488 (191) (191) 29,609 29,609 22,178 6,560 4,153 32,891 22,843 6,623 4,133 33,599 34,188 12,768 46,956 34,503 13,320 353 48,176 37,886 11,544 49,430 37,672 13,295 275 51,242

Actual Budget Basis
36,878 13,162 272 50,312 34,598 12,640 354 47,592 22,638 6,452 4,132 33,222 28,997 28,997 5,003 12,654 1,153 5,813 656 278 7,494 335 8,184 41,570 1,090 6,443 7,533 1,270,144 197,073 197,073 1,467,217

(95) 680 (1)
584

205 171 1
377

612
612

486 474 317 704 99 (53) 37 854
2,918

(1,194)
(1,194) 35,598 (444) (444) $ 35,154

*See note to required Supplementary Information*

A-115

CITY OF HOUSTON, TEXAS REQUIRED RECONCILIATION FOR GENERAL FUND BUDGET vs. GAAP PRESENTATION For the Year Ended June 30, 2005 amounts expressed in thousands (unaudited) Revenues Actual amounts (budgetary basis) "revenues" from the budgetary comparison schedules Revenues of non-budgeted funds Equipment Acquisition Revolving Funds Rainy Day Grant Matching Fund Vendor Overpayment Houston Downtown Public Improvement District Planning and Development Special Projects Commercial Paper Dangerous buildings demolition programs Total revenues of non-budgeted funds Interest on pooled investments from non-budgeted revenues Total revenues as reported on the statement of revenues, expenditures, and changes in fund balances Expenditures Actual amounts (budgetary basis) "expenditures" from the budgetary comparison schedules Expenditures of non-budgeted funds Equipment Acquisition Dangerous building demolition programs Revolving Funds Firefighter’s Judgement Bond Planning and Development Special Projects Grant Matching Fund Vendor Overpayment Total expenditures of non-budgeted funds Total expenditures as reported on the statement of revenues, expenditures, and changes in fund balances Other financing sources (uses) Actual amounts (budgetary basis) "other financing sources and uses" from the budgetary comparison schedules Proceeds from Issuance of Debt Total other financing sources and uses as reported on the statement of revenues, expenditures, and changes in fund balances--governmental funds $ (84,893) $ 1,341,452 $ 1,460,764

$

1,450,076

88 8,711 526 1,124 709 4 3 175 54 11,394 (706)

$

1,270,144

35,253 1,892 8,785 24,075 18 505 780 71,308

$

(147,444) 62,551

*See note to Required Supplementary Information*

A-116

CITY OF HOUSTON, TEXAS REQUIRED NOTES TO THE SUPPLEMENTARY INFORMATION June 30, 2005 (Unaudited)

1.

General Budget Policies
During January of each year, the Mayor, with City Council input, establishes budget guidelines. All departments of the City submit requests for appropriations to the Mayor and the City’s Department of Finance and Administration so that a budget may be prepared. Typically during June, the City Controller certifies that funds are available for a continuing appropriation and the budget is proposed to City Council. City Council holds public hearings and a final budget is normally adopted by June 30th. A final appropriation ordinance is adopted later in the fiscal year and may include budget revisions or amendments. The legal level of budgetary control is the departmental level within each fund, even though the budget is prepared by fund, department, and expenditure category. The Mayor is authorized to transfer unlimited budgeted amounts within departments and amounts between departments, provided such transfers do not exceed 5% of an expenditure category. Expenditure categories are personnel services, other current expenditures and capital outlay. Appropriations related to funds with annual budgets lapse at yearend except for Capital Outlay appropriations, which cover multiple years. On March 16, 2005, City Council approved the Fiscal Year 2005 general appropriation ordinance in the amount of $1.503 billion for the General Fund. In addition, City Council amended the Fiscal Year 2005 Annual Budgets to reflect additional financing sources and additional expenditures related to the Houston Municipal Employee Pension System as well as a transfer from the General Fund to the Convention and Entertainment Fund of $438 thousand to be used for expenditures related to the Miller Outdoor Theatre. Annual operating budgets are adopted for the General Operating Fund, the Debt Service Fund, the Special Revenue Funds (except for the Grants Revenue Fund, Disaster Recovery, Health Special Fund and the Housing Special Fund) and the Proprietary Funds. The budgets are adopted on a basis consistent with generally accepted accounting principles for all governmental funds. Budgets for proprietary funds are prepared on the accrual basis, but focus on expenses relating to maintenance and operations, and equipment purchases and, accordingly, exclude depreciation and other allocations related to income determination. The following provides actual fiscal year 2005 results for both budgeted and non-budgeted Special Revenue Funds (in thousands):
Other Sources (Uses) $ 36,850 (2,500) (5,927) 2 (1,264) $ 27,161

Budgeted Special Revenue Funds Non-budgeted Disaster Recovery Fund Non-budgeted Grants Revenue Fund Non-budgeted Health and Housing Non-budgeted Other Funds Total Special Revenue Funds - Actual

Revenues $ 60,711 7,701 143,360 737 9,645 $ 222,154

Expenditures $ 92,457 486 138,685 1,811 5,197 $ 238,636

2.

General Fund Budgetary Highlights
While revenues were only $843 thousand below budget (pgs. 112-115), there were some significant differences between some of the budgeted and actual revenue numbers. Some of the increases/decreases from budget include: • • • • • • $1 million increase in taxes and assessments $2 million increase in licenses and permits $6 million decrease in charges for services $3 million decrease in intergovernmental grants $1 million increase in interest $4 million increase in other revenues

Budgeted expenditures increased by $47 million during the fiscal year. The most significant changes in the budget were: • • • • • $3 million decrease in general government $8 million increase for public safety $8 million increase for public works $4 million increase for health, parks and recreation and library $30 million increase in retirement benefits

Ultimately, total expenditures for the General Fund were $36 million below the final expenditure budget.

A-117

CITY OF HOUSTON, TEXAS REQUIRED PENSION SYSTEM SUPPLEMENTARY INFORMATION June 30, 2005 Houston Firefighters’ Pension System Supplementary Information (unaudited)
Schedule of Funding Progress (in millions) (unaudited) Actuarial Accrued Liability (AAL) Entry Age (b)

Actuarial Valuation Date

Actuarial Value of Plan Assets (a)

Unfunded AAL (Surplus UAAL) (b-a)

Funded Ratio (a/b) 104% 105% 106% 105% 109% 113% 98% 88%

Projected Annual Covered Payroll (c) $131.6 $142.0 $149.0 $159.0 $163.6 $164.3 $190.6 $181.5

UAAL as Percentage of Covered Payroll ((b-a)/c) (27%) (39%) (51%) (43%) (84%) (129%) 25% 147%

July 1, 1996 $1,024.5 $ 989.3 ($35.2) July 1, 1997 $1,183.8 $1,128.2 ($55.6) July 1, 1998 $1,347.4 $1,271.4 ($76.0) July 1, 1999 $1,538.5 $1,470.6 ($67.9) July 1, 2000 $1,726.3 $1,589.3 ($137.0) July 1, 2001 $1,863.1 $1,650.8 ($212.3) July 1, 2002* $1,922.4 $1,970.1 $47.8 July 1, 2004 $2,000.3 $2,266.8 $266.5 * No actuarial study was required or conducted for July 1, 2003.

Houston Municipal Pension System Supplementary Information ( unaudited)
Schedule of Funding Progress (millions) Actuarial Accrued Liability (AAL) Entry Age (b) $1,042.5 $1,240.1 $1,339.9 $1,509.4 $1,955.8 $2,515.2 $3,278.3 $2,633.8

Actuarial Valuation Date July 1, 1996 July 1, 1998 July 1, 1999 July 1, 2000 July 1, 2001 July 1, 2002 July 1, 2003 July 1, 2004

Actuarial Value of Plan Assets (a) $857.3 $1,095.6 $1,222.2 $1,376.0 $1,490.2 $1,519.7 $1,510.3 $1,501.2

Unfunded AAL (Surplus UAAL) (b-a) $185.2 $144.5 $117.7 $133.4 $465.6 $995.5 $1,768.0 $1,132.5

Funded Ratio (a/b) 82% 88% 91% 91% 76% 60% 46% 57%

Projected Annual Covered Payroll (c) $367.6 $397.7 $407.7 $432.6 $418.0 $399.8 $390.3 $366.1

UAAL as Percentage of Covered Payroll ((b-a)/c) 50% 36% 29% 31% 111% 249% 453% 309%

Houston Police Officer’s Pension System Supplementary Information (unaudited)
Schedule of Funding Progress (millions) Actuarial Accrued Liability (AAL) Entry Age (b) $1,258.2 $1,549.3 $1,773.8 $1,966.4 $2,306.4 $2,593.7 $2,874.7 $3,339.2
A-118

Actuarial Valuation Date July 1, 1997 July 1, 1998 July 1, 1999 July 1, 2000 July 1, 2001 July 1, 2002 July 1, 2003 July 1, 2004

Actuarial Value of Plan Assets (a) $1,329.6 $1,518.1 $1,746.3 $2,013.5 $2,226.3 $2,337.1 $2,394.4 $2,466.0

Unfunded AAL (Surplus UAAL) (b-a) ($71.4) $31.2 $27.5 ($47.1) $80.1 $256.6 $480.3 $873.1

Funded Ratio (a/b) 106% 98% 98% 102% 97% 90% 83% 74%

Projected Annual Covered Payroll (c) $187.1 $196.4 $246.6 $250.7 $264.2 $286.1 $300.4 $329.8

UAAL as Percentage of Covered Payroll ((b-a)/c) (38%) 16% 11% (19%) 30% 90% 160% 265%

APPENDIX B ECONOMIC AND DEMOGRAPHIC CHARACTERISTICS

[THIS PAGE INTENTIONALLY LEFT BLANK]

APPENDIX B ECONOMIC AND DEMOGRAPHIC CHARACTERISTICS
This Appendix contains a brief discussion of certain selected economic and demographic data on the City of Houston, Texas (the “City”) and surrounding areas. Information in this Appendix has been obtained from sources that are believed to be reliable; however, such information is subject to revision and adjustment, and no representation is made with respect to the accuracy or completeness of such information. The following data focuses primarily on four geographic areas, the Houston Primary Metropolitan Statistical Area (the “Houston PMSA”), the Consolidated Metropolitan Statistical Area (the “Houston CMSA”), the Greater Houston Area and Harris County, the county in which the City primarily lies. The Greater Houston Area includes all of Harris County and parts of six surrounding counties. The Houston PMSA consists of six counties: Chambers, Fort Bend, Harris, Liberty, Montgomery and Waller. The Houston CMSA consists of eight counties: Brazoria, Chambers, Fort Bend, Galveston, Harris, Liberty, Montgomery and Waller. IT SHOULD BE NOTED THAT THE FOUR GEOGRAPHIC AREAS DESCRIBED ABOVE ENCOMPASS POPULATIONS AND AREAS WHICH FAR EXCEED THE POPULATION AND AREA OF THE CITY, SO THAT THE FOLLOWING DATA MAY SET FORTH STATISTICS AND TRENDS WHICH DO NOT NECESSARILY REFLECT STATISTICS AND TRENDS APPLICABLE SOLELY TO THE CITY ITSELF. IN ADDITION, INVESTORS SHOULD NOTE THE DATA CONTAINED IN THIS APPENDIX MAY FLUCTUATE MORE OR LESS IN SUBSEQUENT YEARS THAN IN PRIOR YEARS AND SUCH FLUCTUATIONS MAY BE COUNTER TO THE TRENDS AND STATISTICS EXHIBITED IN THE FOLLOWING TABLES.

B-1

HOUSTON PMSA POPULATION ESTIMATES 1996-2005 Population Estimates (In Thousands) 4,499.4 4,414.8 4,376.6 4,340.9 4,268.1 4,177.6 4,057.8 3,964.9 3,829.3 3,692.9

Calendar Year 2005* .......................... 2004 ........................... 2003 ........................... 2002 ........................... 2001 ........................... 2000 ........................... 1999 ........................... 1998 ........................... 1997 ........................... 1996 ........................... _________________

Annual % Change 1.9 0.9 0.8 1.7 2.2 3.0 2.3 3.5 3.7 2.8

* Projected. Source: University of Houston, Center for Public Policy, Institute for Regional Forecasting, December 2005.

HOUSTON POPULATION ESTIMATES (WITHIN THE CITY LIMITS) 1996-2005 Population Estimates (In Thousands) 2,050.7 2,012.7 2,009.7 2,001.1 1,977.2 1,958.3 1,846.0 1,829.1 1,807.4 1,791.5

Calendar Year(a) 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 _________________

Annual % Change 1.88 0.2 0.4 1.2 1.0 6.1 0.9 1.2 0.9 0.7

Source: Population Estimates Program, Population Division, U.S. Census Bureau (1996-2004) and Texas State Data Center (2005).
(a)

Figures from 1996-2004 are as of July of each year and the 2005 Texas State Data Center figure is as of January, 2005, which does not include any population increases that may be attributable to the relocation of residents from Louisiana, Alabama and Mississippi as a result of Hurricane Katrina. See “THE CITY—City Response to Hurricane Katrina.”

B-2

HOUSTON CONSUMER PRICE INDEX ALL URBAN CONSUMERS 1995-2004 Average Index 169.5 163.7 159.2 158.8 154.2 148.7 146.8 145.4 142.7 139.8 Annual % Change 3.5 2.8 0.3 3.0 3.7 1.3 1.0 1.9 2.1 1.4

Calendar Year 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995
_______________ Source: University of Houston, Center for Public Policy, December 2005.

HOUSTON PMSA NON-AGRICULTURAL WAGE AND SALARY EMPLOYMENT (SEASONALLY ADJUSTED) AND AVERAGE NUMBER OF JOBS BY EMPLOYMENT SECTOR(a) (b)
(In Thousands)

2005* Annual Average NON-MANUFACTURING Mining........................................................ Construction............................................... Transportation & public utilities ................ Trade .......................................................... Finance, insurance & real estate................. Services...................................................... Government................................................ Total Non-Manufacturing .............................. MANUFACTURING..................................... WAGE AND SALARY – TOTAL ................ _________________

2004 Annual Average

2003 Annual Average

2002 Annual Average

2001 Annual Average

71.0 163.8 149.0 364.5 135.9 879.5 337.2 2,100.9 205.2 2,306.1

66.7 163.3 148.4 359.5 135.8 863.4 333.9 2,071.0 205.8 2,276.8

64.6 172.6 150.6 356.6 133.3 846.3 330.8 2,054.8 208.1 2,262.9

62.9 179.4 158.6 364.2 132.1 836.4 324.3 2,057.9 219.5 2,277.4

65.3 177.5 168.2 366.2 133.7 828.2 311.8 2,050.9 231.5 2,282.4

* Projected. (a) Average number of jobs estimated to exist in the Houston PMSA without reference to place of residence of worker. (b) Calendar Year. Source: University of Houston, Center for Public Policy, December 2005.

B-3

HOUSTON PMSA NON-AGRICULTURAL WAGE AND SALARY EMPLOYMENT AVERAGE NUMBER OF JOBS FOR ALL EMPLOYMENT SECTORS 1996-2005 Annual Average (In Thousands) Calendar Year 2005* .................................................................... 2004...................................................................... 2003...................................................................... 2002...................................................................... 2001...................................................................... 2000...................................................................... 1999...................................................................... 1998...................................................................... 1997...................................................................... 1996......................................................................
_________________ *Projected. Source: University of Houston, Center for Public Policy, December 2005.

2,306 2,277 2,263 2,277 2,283 2,243 2,191 2,156 2,054 1,972

HOUSTON PMSA UNEMPLOYMENT RATE (NOT SEASONALLY ADJUSTED) % UNEMPLOYED 1996-2005 Calendar Year 2005* .................................................................... 2004...................................................................... 2003...................................................................... 2002...................................................................... 2001...................................................................... 2000...................................................................... 1999...................................................................... 1998...................................................................... 1997...................................................................... 1996......................................................................
_________________ * Projected. Source: University of Houston, Center for Public Policy December 2005.

Annual Average 5.7% 6.3 6.9 6.0 4.7 4.4 4.8 4.4 5.3 5.6

B-4

PORT OF HOUSTON TONNAGE TOTAL CARGO 1995-2004 Calendar Year 2004.................................................................. 2003.................................................................. 2002.................................................................. 2001.................................................................. 2000.................................................................. 1999.................................................................. 1998.................................................................. 1997.................................................................. 1996.................................................................. 1995..................................................................
_________________ *Estimated. Source: Port of Houston Authority.

Short Tons 200,000,000* 190,923,145 177,560,718 185,050,168 186,567,246 158,828,203 169,070,334 165,456,278 148,182,876 135,231,322

HOUSTON CMSA ANNUAL HOUSING STARTS 1995-2004 Units Multi-Family 10,858 16,761 12,401 7,183 7,590 11,990 18,280 11,560 3,880 3,840

Calendar Year 2004* ...................................... 2003 ....................................... 2002 ....................................... 2001 ....................................... 2000 ....................................... 1999 ....................................... 1998 ....................................... 1997 ....................................... 1996 ....................................... 1995 .......................................
_________________ *Estimated. Source: CDS Research.

Single Family 45,039 41,995 34,640 34,311 31,120 27,270 29,030 22,880 20,500 17,230

Total 55,897 58,756 47,041 41,494 38,710 39,260 47,310 34,440 24,380 21,070

B-5

GREATER HOUSTON AREA APARTMENT OCCUPANCY RATES(a) 1996-2005 Calendar Year 2005................................................................ 2004................................................................ 2003................................................................ 2002................................................................ 2001................................................................ 2000................................................................ 1999................................................................ 1998................................................................ 1997................................................................ 1996................................................................ Occupancy Rate 90.6%(b) 85.8 87.1 89.7 91.5 90.7 89.4 90.5 91.1 90.0

_________________ (a) Physical occupancy based on calendar year. (b) The 2005 figure does not include any increases that may be attributable to the relocation of residents from Louisiana, Alabama and Mississippi as a result of Hurricane Katrina. See “THE CITY—City Response to Hurricane Katrina.” .Source: Apartment Data Services, Inc. (1995-1997) and CB Richard Ellis (1998-2005)

HOUSTON HOTEL OCCUPANCY RATES 1996-2005 Average Occupancy Rate 63.1%(a) 61.4 60.4 63.2 68.9 65.6 63.6 66.7 68.4 65.4

Calendar Year 2005................................................................ 2004................................................................ 2003................................................................ 2002................................................................ 2001................................................................ 2000................................................................ 1999................................................................ 1998................................................................ 1997................................................................ 1996................................................................
_________________ Source: The PKF Consulting/Hospitality Advisory Services.
(a)

The 2005 figure does not include any increases that may be attributable to the relocation of residents from Louisiana, Alabama and Mississippi as a result of Hurricane Katrina. See “THE CITY—City Response to Hurricane Katrina.”

B-6

CITY OF HOUSTON BUILDING PERMITS 1996-2005 New Non-Residential(a) Calendar Year 2005 ............................ 2004 ............................ 2003 ............................ 2002 ............................ 2001 ............................ 2000 ............................ 1999 ............................ 1998 ............................ 1997 ............................ 1996 ............................
_________________ (a) Privately owned. Source: City of Houston, Public Works and Engineering.

Number of Permits Issued 3,231 1,218 3,217 2,976 3,291 3,418 3,620 3,370 3,011 2,568

Dollar Value (In Thousands) $ 1,150,103 673,381 731,725 864,773 1,379,047 891,856 1,133,165 1,227,234 452,897 477,398

New Residential(a) Single Family Number of Permits Issued 7,296 5,958 5,140 4,152 4,320 4,655 4,064 3,940 3,523 2,766 2,446 Multi-Family Number of Permits Issued 274 440 472 696 308 339 323 912 488 148 130

Calendar Year 2005 .......................... 2004 .......................... 2003 .......................... 2002 .......................... 2001 .......................... 2000 .......................... 1999 .......................... 1998 .......................... 1997 .......................... 1996 .......................... 1995 ..........................
_________________ (a) Privately Owned. Source:

Dollar Value (In Thousands) $1,152,592 943,913 819,294 666,003 681,451 764,656 657,106 610,412 523,623 369,783 317,590

Dollar Value (In Thousands) $359,663 344,397 510,474 524,060 323,373 238,869 259,005 551,691 279,105 103,045 180,280

City of Houston, Public Works and Engineering.

B-7

HOUSTON PMSA GENERAL PURPOSE OFFICE SPACE ACTIVITY(a) 1996-2005 Net Rentable Area(b) 177.88 178.14 147.31 147.23 143.40 143.57 143.93 156.07 156.56 155.33 Leasing Net Activity(c) Absorption(d) (Millions of Square Feet) (f) 1.2 (f) 0.2 (f) 0.8 (f) 1.1 (f) 1.3 (f) 2.7 (f) 1.6 (f) 1.8 14.1 8.4 9.7 2.6 Annual Vacancy Rate 14.46% 16.35 16.44 16.55 13.20 13.89 13.00 10.26 11.13 15.89 Average Rents (Per Square Foot)(e) $17.78 17.81 21.01 20.66 22.81 18.81 17.58 18.04 14.30 12.19

Calendar Year 2005 ........................................ 2004 ........................................ 2003 ........................................ 2002 ........................................ 2001 ........................................ 2000 ........................................ 1999 ........................................ 1998 ........................................ 1997 ........................................ 1996 ........................................

_________________ (a) Based on buildings greater than 29,999 square feet. (Excludes single tenant government-owned and medical office buildings). (b) Decrease in 1999 due to change in the market base (37 single-tenant buildings). (c) Leasing activity shows the total number of square feet leased each year, excluding renewals of existing leases. (d) Millions of square feet net absorption is the difference between the total number of square feet that are leased (excluding renewals of leases) and the total number of square feet that have become vacant in the year. (e) Average asking rental rates are quoted on a gross basis. (f) This statistic was discontinued by CB Richard Ellis. Source: CB Richard Ellis, The Outlook Report.

CITY OF HOUSTON AVIATION PASSENGER AND AIR FREIGHT TRENDS 1996-2005 The following table presents total passenger arrivals and departures and air freight (in pounds) for George Bush Intercontinental Airport, William P. Hobby Airport, and Ellington Airport for the years indicated. Passenger Arrivals & Departures Domestic and International 47,955,718 44,857,749 42,091,086 42,025,521 43,406,128 44,430,766 42,013,112 39,870,793 37,065,879 34,941,925 Air Freight(a) Total Domestic And International 766,686,000 784,200,000 740,645,000 731,447,000 700,999,000 748,959,000 739,515,000 734,058,000 666,474,000 639,509,000

Calendar Year 2005(b)........................ 2004(b)........................ 2003.......................... 2002.......................... 2001.......................... 2000.......................... 1999.......................... 1998.......................... 1997.......................... 1996..........................
_________________ (a) Air Freight is in pounds and excludes airmail. (b) Preliminary numbers. Source:City of Houston, Airport System.

Domestic 41,049,989 38,472,652 36,471,415 36,357,296 37,824,235 38,777,484 36,955,352 35,317,196 33,218,323 31,573,933

International 6,905,729 6,385,097 5,620,391 5,668,225 5,581,893 5,653,282 5,057,760 4,553,597 3,847,556 3,367,992

B-8

APPENDIX C FORMS OF CO-BOND COUNSEL OPINIONS

[THIS PAGE INTENTIONALLY LEFT BLANK]

VINSON & ELKINS L.L.P.
2300 FIRST CITY TOWER 1001 FANNIN STREET H O U S T O N , T E X A S 7 7 0 0 2 -6 7 6 0

LAW OFFICES OF FRANCISCO G. MEDINA
1111 NORTH LOOP WEST; SUITE 820 HOUSTON, TEXAS 77008

March __, 2006 WE HAVE ACTED as co-bond counsel for the City of Houston, Texas (the "City"), in connection with an issue of bonds (the "Bonds") described as follows: CITY OF HOUSTON, TEXAS TAXABLE PENSION OBLIGATION BONDS, SERIES 2006A dated March __, 2006, in the principal amount of $63,740,000. The Bonds are issued, mature, bear interest, and are subject to redemption prior to maturity and may be transferred and exchanged as set out in the Bonds and the Ordinance adopted by the City Council of the City authorizing their issuance (the “Ordinance”). WE HAVE ACTED as co-bond counsel for the sole purpose of rendering an opinion with respect to the legality and validity of the Bonds under the Constitution and laws of the State of Texas, under which the City is acting as a home-rule city of the State of Texas. We have not investigated or verified original proceedings, records, data or other material, but have relied solely upon the transcript of certified proceedings described in the following paragraph. We have not assumed any responsibility with respect to the financial condition or capabilities of the City or the disclosure thereof in connection with the sale of the Bonds. Our role in connection with the City's Official Statement prepared for use in connection with the sale of the Bonds (the "Official Statement") has been limited as described therein. IN OUR CAPACITY as co-bond counsel, we have participated in the preparation of and have examined a transcript of certified proceedings pertaining to the authorization and issuance of the Bonds on which we have relied in giving our opinion. The transcript contains certified copies of certain proceedings of the City Council of the City, the Board of Trustees of the Houston Municipal Employees Pension System and the Board of Trustees of the Houston Police Officers’ Pension System, and customary certificates of officials, agents and representatives of the City, the Houston Municipal Employees Pension System and the Houston Police Officers’ Pension System and other public officials; and other certified showings relating to the authorization and issuance of the Bonds. We have also examined the initial Bond of this issue.

C-1

BASED ON SUCH EXAMINATION, IT IS OUR OPINION THAT: (1) The transcript of certified proceedings evidences complete legal authority for the issuance of the Bonds in full compliance with the Constitution and laws of the State of Texas presently in effect and, therefore, the Bonds are valid and legally binding obligations of the City; and (2) A continuing ad valorem tax on all taxable property within the City necessary to pay the principal and interest on the Bonds, has been levied and pledged irrevocably for such purposes, within the limits prescribed by law. THE RIGHTS OF THE OWNERS of the Bonds are subject to the applicable provisions of the federal bankruptcy laws and any other similar laws affecting the rights of creditors of political subdivisions generally, and may be limited by general principles of equity which permit the exercise of judicial discretion. INTEREST ON THE BONDS IS NOT EXCLUDABLE from gross income for federal income tax purposes under existing law. We express no opinion as to any other federal, state or local tax consequences resulting from the ownership of, receipt of interest on, or disposition of the Bonds.

C-2

VINSON & ELKINS L.L.P.
2300 FIRST CITY TOWER 1001 FANNIN STREET H O U S T O N , T E X A S 7 7 0 0 2 -6 7 6 0

LAW OFFICES OF FRANCISCO G. MEDINA
1111 NORTH LOOP WEST; SUITE 820 HOUSTON, TEXAS 77008

April __, 2006 WE HAVE ACTED as co-bond counsel for the City of Houston, Texas (the "City"), in connection with an issue of bonds (the "Bonds") described as follows: CITY OF HOUSTON, TEXAS, PUBLIC IMPROVEMENT REFUNDING BONDS, SERIES 2006B, dated April __, 2006, in the principal amount of $24,005,000. The Bonds are issued, mature, bear interest, and are subject to redemption prior to maturity and may be transferred and exchanged as set out in the Bonds and the Ordinance of the City authorizing their issuance (the “Ordinance”). WE HAVE ACTED as co-bond counsel for the sole purpose of rendering an opinion with respect to the legality and validity of the Bonds under the Constitution and laws of the State of Texas, under which the City is acting as a home-rule city of the State of Texas, and with respect to the exclusion of interest on the Bonds from gross income for federal income tax purposes. We have not investigated or verified original proceedings, records, data or other material, but have relied solely upon the transcript of certified proceedings described in the following paragraph. We have not assumed any responsibility with respect to the financial condition or capabilities of the City or the disclosure thereof in connection with the offer and sale of the Bonds. Our role in connection with the City's Official Statement prepared for use in connection with the sale of the Bonds (the "Official Statement") has been limited as described therein. IN OUR CAPACITY as co-bond counsel, we have participated in the preparation of and have examined a transcript of certified proceedings pertaining to the Bonds, which contains certified copies of certain proceedings of the City; customary certificates of officers, agents and representatives of the City, and other public officials; and other certified showings relating to the authorization and issuance of the Bonds. We have also examined the final judgment in the case Juan E. Vela et al. v. the City of Houston, Civil Action H-97-3471, U.S. District Court, Southern District of Texas. We have also examined the initial Bond of this issue. BASED ON SUCH EXAMINATION, IT IS OUR OPINION that the transcript of certified proceedings evidences complete legal authority for the issuance of the Bonds in full

C-3

compliance with the Constitution and laws of the State of Texas presently effective and that therefore the Bonds constitute valid and legally binding obligations of the City, and a continuing ad valorem tax on all taxable property within the City necessary to pay the principal and interest on the Bonds, has been levied and pledged irrevocably for such purposes, within the limits prescribed by law. THE RIGHTS OF THE OWNERS of the Bonds are subject to the applicable provisions of the federal bankruptcy laws and any other similar laws affecting the rights of creditors of political subdivisions generally, and may be limited by general principles of equity which permit the exercise of judicial discretion. IT IS OUR FURTHER OPINION that: (1) (2) Interest on the Bonds is excludable from gross income for federal income tax purposes under existing law. The Bonds are not "private activity bonds" within the meaning of the Internal Revenue Code of 1986, as amended (the "Code"), and interest on the Bonds is not subject to the alternative minimum tax on individuals and corporations, except that interest on the Bonds will be included in the "adjusted current earnings" of a corporation (other than any S corporation, regulated investment company, REIT, or REMIC or FASIT) for purposes of computing its alternative minimum tax.

In providing such opinions, we have relied on representations of the City, the City's financial advisor, and the Underwriters (as defined in the Ordinance), with respect to matters solely within the knowledge of the City, the City's financial advisor, and the Underwriters, respectively, which we have not independently verified, and have assumed continuing compliance with the covenants in the Ordinance pertaining to those sections of the Code which affect the exclusion from gross income of interest on the Bonds for federal income tax purposes. If such representations are determined to be inaccurate or incomplete or the City fails to comply with the foregoing provisions of the Ordinance, interest on the Bonds could become includable in gross income from the date of original delivery, regardless of the date on which the event causing such inclusion occurs. Except as stated above, we express no opinion as to any federal, state or local tax consequences resulting from the receipt or accrual of interest on, or acquisition, ownership, or disposition of the Bonds.

C-4

Owners of the Bonds should be aware that the ownership of tax-exempt obligations may result in collateral federal income tax consequences to financial institutions, life insurance and property and casualty insurance companies, S corporations with Subchapter C earnings and profits, individual recipients of Social Security or Railroad Retirement benefits, taxpayers who may be deemed to have incurred or continued indebtedness to purchase or carry tax-exempt obligations, taxpayers owning an interest in a FASIT that holds tax-exempt obligations, and individuals otherwise qualifying for the earned income credit. In addition, certain foreign corporations doing business in the United States may be subject to the "branch profits tax" on their effectively-connected earnings and profits (including tax-exempt interest such as interest on the Bonds). The opinions set forth above are based on existing law, which is subject to change. Such opinions are further based on our knowledge of facts as of the date hereof. We assume no duty to update or supplement these opinions to reflect any facts or circumstances that may hereafter come to our attention or to reflect any changes in any law that may hereafter occur or become effective. Moreover, our opinions are not a guarantee of result and are not binding on the Internal Revenue Service (the "Service"); rather, such opinions represent our legal judgment based upon our review of existing law and in reliance upon the representations and covenants referenced above that we deem relevant to such opinions. The Service has an ongoing audit program to determine compliance with rules that relate to whether interest on state or local obligations is includable in gross income for federal income tax purposes. No assurance can be given whether or not the Service will commence an audit of the Bonds. If an audit is commenced, in accordance with its current published procedures the Service is likely to treat the City as the taxpayer. We observe that the City has covenanted in the Ordinance not to take any action, or omit to take any action within its control, that if taken or omitted, respectively, may result in the treatment of interest on the Bonds as includable in gross income for federal income tax purposes.

C-5

[THIS PAGE INTENTIONALLY LEFT BLANK]

VINSON & ELKINS L.L.P.
2300 FIRST CITY TOWER 1001 FANNIN STREET H O U S T O N , T E X A S 7 7 0 0 2 -6 7 6 0

LAW OFFICES OF FRANCISCO G. MEDINA
1111 NORTH LOOP WEST; SUITE 820 HOUSTON, TEXAS 77008

April __, 2006 WE HAVE ACTED as co-bond counsel for the CITY OF HOUSTON, TEXAS (the “City”) in connection with an issue of certificates of obligation (the “Certificates”) described as follows: CITY OF HOUSTON, TEXAS, CERTIFICATES OF OBLIGATION, SERIES 2006C, dated April __, 2006, in the principal amount of $3,315,000; the Certificates mature, bear interest, and may be transferred and exchanged as set out in the Certificates and the Ordinance of the City authorizing their issuance (the “Ordinance”). WE HAVE ACTED as co-bond counsel for the sole purpose of rendering an opinion with respect to the legality and validity of the Certificates under the Constitution and laws of the State of Texas, under which the City is acting as a home-rule city of the State of Texas, and with respect to the exclusion of interest on the Bonds from gross income for federal income tax purposes. We have not investigated or verified original proceedings, records, data or other material, but have relied solely upon the transcript of certified proceedings described in the following paragraph. We have not assumed any responsibility with respect to the financial condition or capabilities of the City or the disclosure thereof in connection with the sale of the Certificates. Our role in connection with the City’s Official Statement prepared for use in connection with the offer and sale of the Certificates (the "Official Statement") has been limited as described therein. IN OUR CAPACITY as co-bond counsel, we have participated in the preparation of and have examined a transcript of certified proceedings pertaining to the authorization and issuance of the Certificates on which we have relied in giving our opinion. The transcript contains certified copies of certain proceedings of the City Council of the City and customary certificates of officials, agents and representatives of the City and other public officials; and other certified showings relating to the authorization and issuance of the Certificates. We have also examined a specimen of the form of registered certificate of this issue. BASED ON SUCH EXAMINATION, IT IS OUR OPINION that the transcript of certified proceedings evidences complete legal authority for the issuance of the Certificates in full compliance with the Constitution and laws of the State of Texas presently effective and that therefore the Certificates constitute valid and legally binding obligations of the City, and a continuing ad valorem tax on all taxable property within the City necessary to pay the principal and interest on the Certificates, has been levied and pledged irrevocably for such purposes, within the limits prescribed by law.

C-7

THE RIGHTS OF THE OWNERS of the Certificates are subject to the applicable provisions of the federal bankruptcy laws and any other similar laws affecting the rights of creditors of political subdivisions generally, and may be limited by general principles of equity which permit the exercise of judicial discretion. IT IS OUR FURTHER OPINION that: (1) (2) Interest on the Certificates is excludable from gross income for federal income tax purposes under existing law. The Certificates are not "private activity bonds" within the meaning of the Internal Revenue Code of 1986, as amended (the "Code"), and interest on the Certificates is not subject to the alternative minimum tax on individuals and corporations, except that interest on the Certificates will be included in the "adjusted current earnings" of a corporation (other than any S corporation, regulated investment company, REIT, or REMIC or FASIT) for purposes of computing its alternative minimum tax.

In providing such opinions, we have relied on representations of the City, the City’s financial advisor, and the Underwriters (as defined in the Ordinance), with respect to matters solely within the knowledge of the City, the City’s financial advisor, and the Underwriters, respectively, which we have not independently verified, and have assumed continuing compliance with the covenants in the Ordinance pertaining to those sections of the Code which affect the exclusion from gross income of interest on the Certificates for federal income tax purposes. If such representations are determined to be inaccurate or incomplete or the City fails to comply with the foregoing provisions of the Ordinance, interest on the Certificates could become includable in gross income from the date of original delivery, regardless of the date on which the event causing such inclusion occurs. Except as stated above, we express no opinion as to any federal, state or local tax consequences resulting from the receipt or accrual of interest on, or acquisition, ownership, or disposition of the Certificates. Owners of the Certificates should be aware that the ownership of tax-exempt obligations may result in collateral federal income tax consequences to financial institutions, life insurance and property and casualty insurance companies, S corporations with Subchapter C earnings and profits, individual recipients of Social Security or Railroad Retirement benefits, taxpayers who may be deemed to have incurred or continued indebtedness to purchase or carry tax-exempt obligations, taxpayers owning an interest in a FASIT that holds tax-exempt obligations, and individuals otherwise qualifying for the earned income credit. In addition, certain foreign corporations doing business in the United States may be subject to the "branch profits tax" on their effectively-connected earnings and profits (including tax-exempt interest such as interest on the Certificates).

C-8

The opinions set forth above are based on existing law, which is subject to change. Such opinions are further based on our knowledge of facts as of the date hereof. We assume no duty to update or supplement these opinions to reflect any facts or circumstances that may hereafter come to our attention or to reflect any changes in any law that may hereafter occur or become effective. Moreover, our opinions are not a guarantee of result and are not binding on the Internal Revenue Service (the "Service"); rather, such opinions represent our legal judgment based upon our review of existing law and in reliance upon the representations and covenants referenced above that we deem relevant to such opinions. The Service has an ongoing audit program to determine compliance with rules that relate to whether interest on state or local obligations is includable in gross income for federal income tax purposes. No assurance can be given whether or not the Service will commence an audit of the Certificates. If an audit is commenced, in accordance with its current published procedures the Service is likely to treat the City as the taxpayer. We observe that the City has covenanted in the Ordinance not to take any action, or omit to take any action within its control, that if taken or omitted, respectively, may result in the treatment of interest on the Certificates as includable in gross income for federal income tax purposes.

C-9

[THIS PAGE INTENTIONALLY LEFT BLANK]

APPENDIX D SUMMARY OF SCHEDULES RELATED TO CONTINUING DISCLOSURE OF INFORMATION

[THIS PAGE INTENTIONALLY LEFT BLANK]

APPENDIX D SUMMARY OF SCHEDULES RELATED TO CONTINUING DISCLOSURE OF INFORMATION

Schedule 1: Schedule 2: Schedule 3: Schedule 4: Schedule 5: Schedule 6: Schedule 7: Schedule 8: Schedule 9: Schedule 10: Schedule 11: Schedule 12:* Schedule 12A: * Schedule 12B: * Schedule 12C: * Schedule 13: Schedule 14: Schedule 15: Schedule 16: Schedule 17: Schedule 18: Schedule 19: Schedule 20: Schedule 21: Schedule 22:

Tax Rolls Ad Valorem Tax Levies And Collections Principal Taxpayers Outstanding Debt Ad Valorem Tax Obligation Percentages Principal and Interest Payable from Ad Valorem Taxes (Excluding Commercial Paper Notes) Direct and Overlapping Debt Capital Improvement Plan (Non-Enterprise Fund) Voter-Authorized Obligations City Employees Compensated Absence Liability And Long-Term Disability Fund Actuarially Determined Contribution Requirements and Changes in Pension Plan Assets Municipal System Pension Plan Assets, Liabilities and Unfunded Actuarial Accrued Liability Police System Pension Plan Assets, Liabilities and Unfunded Actuarial Accrued Liability Firefighter Fund Pension Plan Assets, Liabilities and Unfunded Actuarial Accrued Liability General Fund Budget for Fiscal Year 2006 Debt Service Fund Budget Summary of General Fund General Fund Undesignated Fund Balances Sales and Use Tax and Franchise Charges and Fees Discretionary Debt Service Transfers by Water and Sewer System to the Debt Service Fund General Fund Indirect Charges to Other City Funds General Fund Direct Charges to Other City Funds Industrial District Contracts Enterprise Funds

___________________
* The City agrees and is obligated to update Schedules 12 (Part 2), 12A, 12B and 12C only to the extent that the City receives updated actuarial reports from the boards of the Pension Systems. The City is not empowered to require the boards of the Pension Systems to obtain updated actuarial reports. The Pension Systems will periodically receive additional actuarial reports with regard to the City’s pension plans, to the extent required under State law or requested by the boards of the Pension Systems. Accordingly, updated Schedules 12 (Part 2), 12A, 12B and 12C may not be available in every annual continuing disclosure filing.

D-1

[THIS PAGE INTENTIONALLY LEFT BLANK]

APPENDIX E SECURITIES DEPOSITORY

[THIS PAGE INTENTIONALLY LEFT BLANK]

APPENDIX E SECURITIES DEPOSITORY

The Depository Trust Company The Depository Trust Company (“DTC”), New York, NY, will act as securities depository for the Series 2006 Obligations. The Series 2006 Obligations will be issued as fully-registered securities in the name of Cede & Co. (DTC’s partnership nominee) or such other name as may be requested by an authorized representative of DTC. One fully-registered certificate will be issued for each maturity of each series of the Series 2006 Obligations, in the aggregate principal amount of such series, and will be deposited with DTC. DTC, the world’s largest depository, is a limited-purpose trust company organized under the New York Banking Law, a “banking organization” within the meaning of the New York Banking Law, a member of the Federal Reserve System, a “clearing corporation” within the meaning of the New York Uniform Commercial Code, and a “clearing agency” registered pursuant to the provisions of Section 17A of the Securities Exchange Act of 1934. DTC holds and provides asset servicing for over 2 million issues of U.S. and non-U.S. equity issues, corporate and municipal debt issues, and money market instruments from over 85 countries that DTC’s participants (“Direct Participants”) deposit with DTC. DTC also facilitates the post-trade settlement among Direct Participants of sales and other securities transactions in deposited securities, through electronic computerized book-entry transfers and pledges between Direct Participants’ accounts. This eliminates the need for physical movement of securities certificates. Direct Participants include both U.S. and non-U.S. securities brokers and dealers, banks, trust companies, clearing corporations, and certain other organizations. DTC is a wholly-owned subsidiary of The Depository Trust & Clearing Corporation (“DTCC”). DTCC, in turn, is owned by a number of Direct Participants of DTC and Members of the National Securities Clearing Corporation, Government Securities Clearing Corporation, MBS Clearing Corporation, and Emerging Markets Clearing Corporation, (NSCC, GSCC, MBSCC, and EMCC, also subsidiaries of DTCC), as well as by the New York Stock Exchange, Inc., the American Stock Exchange LLC, and the National Association of Securities Dealers, Inc. Access to the DTC system is also available to others such as both U.S. and nonU.S. securities brokers and dealers, banks, trust companies, and clearing corporations that clear through or maintain a custodial relationship with a Direct Participant, either directly or indirectly (“Indirect Participants”). DTC has Standard & Poor’s Rating Services’ highest rating: AAA. The DTC Rules applicable to its Participants are on file with the Securities and Exchange Commission. More information about DTC can be found at www.dtcc.com. Purchases of Series 2006 Obligations under the DTC system must be made by or through Direct Participants, which will receive a credit for the Series 2006 Obligations on DTC’s records. The ownership interest of each actual purchaser of each Obligation (“Beneficial Owner”) is in turn to be recorded on the Direct and Indirect Participants’ records. Beneficial Owners will not receive written confirmation from DTC of their purchase. Beneficial Owners are, however, expected to receive written confirmations providing details of the transaction, as well as periodic statements of their holdings, from the Direct or Indirect Participant through which the Beneficial Owner entered into the transaction. Transfers of ownership interests in the Series 2006 Obligations are to be accomplished by entries made on the books of Direct and Indirect Participants acting on behalf of Beneficial Owners. Beneficial Owners will not receive certificates representing their ownership interests in Bonds, except in the event that use of the book-entry system for the Series 2006 Obligations is discontinued. To facilitate subsequent transfers, all Series 2006 Obligations deposited by Direct Participants with DTC are registered in the name of DTC’s partnership nominee, Cede & Co., or such other name as may be requested by an authorized representative of DTC. The deposit of Series 2006 Obligations with DTC and their registration in the name of Cede & Co. or such other DTC nominee do not effect any change in beneficial ownership. DTC has no knowledge of the actual Beneficial Owners of the Series 2006 Obligations; DTC’s records reflect only the identity of the Direct Participants to whose accounts such Series 2006 Obligations are credited, which may or may not be the Beneficial Owners. The Direct and Indirect Participants will remain responsible for keeping account of their holdings on behalf of their customers. Conveyance of notices and other communications by DTC to Direct Participants, by Direct Participants to Indirect Participants, and by Direct Participants and Indirect Participants to Beneficial Owners will be governed by arrangements among them, subject to any statutory or regulatory requirements as may be in effect from time to time. Redemption notices shall be sent to DTC. If less than all of the Series 2006 Obligations within an issue are being redeemed, DTC’s practice is to determine by lot the amount of the interest of each Direct Participant in such issue to be redeemed. Neither DTC nor Cede & Co. (nor any other DTC nominee) will consent or vote with respect to Bonds unless authorized by a Direct Participant in accordance with DTC’s Procedures. Under its usual procedures, DTC mails an Omnibus Proxy to the City as soon as possible after the record date. The Omnibus Proxy assigns Cede & Co.’s consenting or voting rights to those Direct Participants to whose accounts Bonds are credited on the record date (identified in a listing attached to the Omnibus Proxy). Redemption proceeds, distributions, and dividend payments on the Series 2006 Obligations will be made to Cede & Co., or such other nominee as may be requested by an authorized representative of DTC. DTC’s practice is to credit Direct Participants’ accounts upon DTC’s receipt of funds and corresponding detail information from the City or Paying Agent/Registrar, on payable date E-1

in accordance with their respective holdings shown on DTC’s records. Payments by Participants to Beneficial Owners will be governed by standing instructions and customary practices, as is the case with Series 2006 Obligations held for the accounts of customers in bearer form or registered in “street name,” and will be the responsibility of such Participant and not of DTC, Paying Agent/Registrar, or the City, subject to any statutory or regulatory requirements as may be in effect from time to time. Payment of redemption proceeds, distributions, and dividend payments to Cede & Co. (or such other nominee as may be requested by an authorized representative of DTC) is the responsibility of the City or Paying Agent/Registrar; disbursement of such payments to Direct Participants will be the responsibility of DTC; and reimbursement of such payments to the Beneficial Owners will be the responsibility of Direct and Indirect Participants. DTC may discontinue providing its services as depository with respect to the Series 2006 Obligations at any time by giving reasonable notice to the City or Paying Agent/Registrar. Under such circumstances, in the event that a successor depository is not obtained, certificates are required to be printed and delivered. The City may decide to discontinue use of the system of book-entry transfers through DTC (or a successor securities depository). In that event, certificates will be printed and delivered. The information in this section concerning DTC and DTC’s book-entry system has been obtained from sources that the City believes to be reliable, but the City takes no responsibility for the accuracy thereof. Global Clearance Procedures The information that follows is based solely on information obtained from Clearstream or Euroclear, as appropriate. No representation is made as to the completeness or the accuracy of such information or as to the absence of material adverse changes in such information subsequent to the date hereof. General. The Series 2006A Bonds initially will be registered in the name of Cede & Co. as registered owner and nominee for DTC, which will act as securities depository for the Series 2006A Bonds. Purchases of the Series 2006A Bonds will be in bookentry form only, as more fully described below. Clearstream and Euroclear may hold omnibus positions on behalf of their participants through customers’ securities accounts in Clearstream’s and/or Euroclear’s names on the books of their respective U.S. Depositories, which, in turn, hold such positions in customers’ securities accounts in the U.S. Depositories’ names on the books of DTC. Citibank, N.A. acts as the U.S. depository for Clearstream and JPMorgan Chase Bank acts as the U.S. Depository for Euroclear. The City cannot and does not give any assurances that DTC, Participants, Clearstream, Clearstream customers, Euroclear or Euroclear Participants will distribute to the Beneficial Owners of the Series 2006A Bonds: (i) payments of principal and interest payments (including redemption payments) with respect to the Series 2006A Bonds; (ii) confirmation of ownership interest in the Series 2006A Bonds; or (iii) notices sent to DTC or Cede & Co., its nominee, as the registered owner of the Series 2006A Bonds, or that they will do so on a timely basis, or that DTC, the Participants, Clearstream, Clearstream customers, Euroclear or Euroclear Participants will serve and act in the manner described in this Official Statement. The City will have no responsibility or obligations to DTC, the Participants, Euroclear, Euroclear Participants, Clearstream, Clearstream customers or the Beneficial Owners with respect to: (i) the accuracy of any records maintained by DTC or any DTC Participants, Clearstream, Clearstream customers, Euroclear or Euroclear Participants; (ii) the payment by DTC or any DTC Participants, Clearstream, Clearstream customers, Euroclear or Euroclear Participants of any amount due to any Beneficial Owner in respect of principal and interest payments (including redemption payments) on the Series 2006A Bonds; (iii) the delivery by DTC or any DTC Participants, Clearstream, Clearstream customers, Euroclear or Euroclear Participants of any notice to any Beneficial Owner that is required or permitted to be given to owners under the terms of the Series 2006A Bonds; or (iv) any consent given or other action taken by DTC as registered holder of the Series 2006A Bonds. The information concerning Clearstream and Euroclear has been derived from information obtained from Clearstream and Euroclear and other sources. Neither the City nor the Underwriters make any representation or warranty regarding the accuracy or completeness thereof. Clearstream. Clearstream Banking, société anonyme, 42 Avenue J.F. Kennedy, L-1855 Luxembourg (“Clearstream, Luxembourg”), was incorporated in 1970 as “Cedel S.A.”, a company with limited liability under Luxembourg law (a société anonyme). Cedel S.A. subsequently changed its name to Cedelbank. On 10 January 2000, Cedelbank’s parent company, Cedel International, société anonyme (“CI”) merged its clearing, settlement and custody business with that of Deutsche Börse AG (“DBAG”). The merger involved the transfer by CI of substantially all of its assets and liabilities (including its shares in Cedelbank), and the transfer by DBAG of its shares in Deutsche Börse Clearing (DBC), to a new Luxembourg company, which with effect 14 January 2000 was renamed Clearstream International, société anonyme, and was then 50% owned by CI and 50% owned by DBAG. Following this merger, the subsidiaries of Clearstream International were also renamed to give them a cohesive brand name. On 18 January 2000, Cedelbank was renamed “Clearstream Banking, société anonyme”, and Cedel Global Services was renamed “Clearstream Services, société anonyme”. On 17 January 2000, Deutsche Börse Clearing AG was renamed “Clearstream Banking AG”. E-2

Today Clearstream International is 100% owned by DBAG. The shareholders of DBAG are comprised of mainly banks, securities dealers and financial institutions. Clearstream, Luxembourg holds securities for its customers and facilitates the clearance and settlement of securities transactions between Clearstream, Luxembourg customers through electronic book-entry changes in accounts of Clearstream, Luxembourg customers, thereby eliminating the need for physical movement of certificates. Transactions may be settled by Clearstream, Luxembourg in any of 36 currencies, including United States Dollars. Clearstream, Luxembourg provides to its customers, among other things, services for safekeeping, administration, clearance and settlement of internationally traded securities and securities lending and borrowing. Clearstream, Luxembourg also deals with domestic securities markets in over 30 countries through established depository and custodial relationships. Clearstream, Luxembourg is registered as a bank in Luxembourg, and as such is subject to regulation by the Commission de Surveillance du Secteur Financier, “CSSF”, and the Banque Centrale du Luxembourg (“BCL”) which supervise and oversee the activities of Luxembourg banks. Clearstream, Luxembourg’s customers are world-wide financial institutions including underwriters, securities brokers and dealers, banks, trust companies and clearing corporations. Clearstream, Luxembourg’s U.S. customers are limited to securities brokers and dealers and banks. Currently, Clearstream, Luxembourg has approximately 2,000 customers located in over 80 countries, including all major European countries, Canada, and the United States. Indirect access to Clearstream, Luxembourg is available to other institutions that clear through or maintain a custodial relationship with an account holder of Clearstream, Luxembourg. Clearstream, Luxembourg has established an electronic bridge with Euroclear Bank S.A./N.V. as the Operator of the Euroclear System (the “Euroclear Operator”) in Brussels to facilitate settlement of trades between Clearstream, Luxembourg and the Euroclear Operator. Euroclear Bank. Euroclear Bank S.A./N.V. (“Euroclear Bank”) holds securities and book-entry interests in securities for participating organizations and facilitates the clearance and settlement of securities transactions between Euroclear Participants, and between Euroclear Participants and Participants of certain other securities intermediaries through electronic book-entry changes in accounts of such Participants or other securities intermediaries. Euroclear Bank provides Euroclear Participants, among other things, with safekeeping, administration, clearance and settlement, securities lending and borrowing, and related services. Euroclear Participants are investment banks, securities brokers and dealers, banks, central banks, supranationals, custodians, investment managers, corporations, trust companies and certain other organizations. Certain of the managers or underwriters for this offering, or other financial entities involved in this offering, may be Euroclear Participants. Non-Participants in the Euroclear System may hold and transfer book-entry interests in the Securities through accounts with a Participant in the Euroclear System or any other securities intermediary that holds a book-entry interest in the securities through one or more securities intermediaries standing between such other securities intermediary and Euroclear Bank. Clearance and Settlement. Although Euroclear Bank has agreed to the procedures provided below in order to facilitate transfers of securities among Participants in the Euroclear System, and between Euroclear Participants and Participants of other intermediaries, it is under no obligation to perform or continue to perform such procedures and such procedures may be modified or discontinued at any time. Initial Distribution. Investors electing to acquire Securities through an account with Euroclear Bank or some other securities intermediary must follow the settlement procedures of such an intermediary with respect to the settlement of new issues of securities. Securities to be acquired against payment through an account with Euroclear Bank will be credited to the securities clearance accounts of the respective Euroclear Participants in the securities processing cycle for the business day following the settlement date for value as of the settlement date, if against payment. Secondary Market. Investors electing to acquire, hold or transfer securities through an account with Euroclear Bank or some other securities intermediary must follow the settlement procedures of such an intermediary with respect to the settlement of secondary market transactions in securities. Please be aware that Euroclear Bank will not monitor or enforce any transfer restrictions with respect to the securities offered herein. Custody. Investors who are Participants in the Euroclear System may acquire, hold or transfer interests in the securities by book-entry to accounts with Euroclear Bank. Investors who are not Participants in the Euroclear System may acquire, hold or transfer interests in the securities by book-entry to accounts with a securities intermediary who holds a book-entry interest in the securities through accounts with Euroclear Bank. Custody Risk. Investors that acquire, hold and transfer interests in the securities by book-entry through accounts with Euroclear Bank or any other securities intermediary are subject to the laws and contractual provisions governing their relationship with their intermediary, as well as the laws and contractual provisions governing the relationship between such an intermediary and each other intermediary, if any, standing between themselves and the individual securities.

E-3

Euroclear Bank has advised as follows: Under Belgian law, investors that are credited with securities on the records of Euroclear Bank have a co-property right in the fungible pool of interests in securities on deposit with Euroclear Bank in an amount equal to the amount of interests in securities credited to their accounts. In the event of the insolvency of Euroclear Bank, Euroclear Participants would have a right under Belgian law to the return of the amount and type of interests in securities credited to their accounts with Euroclear Bank. If Euroclear Bank did not have a sufficient amount of interests in securities on deposit of a particular type to cover the claims of all Participants credited with such interests in securities on Euroclear Bank’s records, all Participants having an amount of interests in securities of such type credited to their accounts with Euroclear Bank would have the right under Belgian law to the return of their pro-rata share of the amount of interests in securities actually on deposit. Under Belgian law, Euroclear Bank is required to pass on the benefits of ownership in any interests in securities on deposit with it (such as dividends, voting rights and other entitlements) to any person credited with such interests in securities on its records. Initial Settlement; Distributions; Actions Upon Behalf of Owners. All of the Series 2006A Bonds will initially be registered in the name of Cede & Co., the nominee of DTC. Clearstream and Euroclear may hold omnibus positions on behalf of their participants through customers’ securities accounts in Clearstream’s and/or Euroclear’s names on the books of their respective U.S. Depository, which, in turn, holds such positions in customers’ securities accounts in its U.S. Depository’s name on the books of DTC. Citibank, N.A. acts as depository for Clearstream and JPMorgan Chase Bank acts as depository for Euroclear (the “U.S. Depositories”). Holders of the Series 2006A Bonds may hold their Series 2006A Bonds through DTC (in the United States) or Clearstream or Euroclear (in Europe) if they are participants of such systems, or directly through organizations that are participants in such systems. Investors electing to hold their Series 2006A Bonds through Euroclear or Clearstream accounts will follow the settlement procedures applicable to conventional EuroBonds in registered form. Securities will be credited to the securities custody accounts of Euroclear and Clearstream holders on the business day following the settlement date against payment for value on the settlement date. Distributions with respect to the Series 2006A Bonds held beneficially through Clearstream will be credited to the cash accounts of Clearstream customers in accordance with its rules and procedures, to the extent received by its U.S. Depository. Distributions with respect to the Series 2006A Bonds held beneficially through Euroclear will be credited to the cash accounts of Euroclear Participants in accordance with the Terms and Conditions, to the extent received by its U.S. Depository. Such distributions will be subject to tax reporting in accordance with relevant United States tax laws and regulations. Clearstream or the Euroclear Operator, as the case may be, will take any other action permitted to be taken by an owner of the Series 2006A Bonds on behalf of a Clearstream customer or Euroclear Participant only in accordance with the relevant rules and procedures and subject to the U.S. Depository’s ability to effect such actions on its behalf through DTC. Secondary Market Trading. Secondary market trading between Participants (other than U.S. Depositories) will be settled using the procedures applicable to U.S. corporate debt obligations in same-day funds. Secondary market trading between Euroclear Participants and/or Clearstream customers will be settled using the procedures applicable to conventional EuroBonds in same-day funds. When securities are to be transferred from the account of a Participant (other than U.S. Depositories) to the account of a Euroclear Participant or a Clearstream customer, the purchaser must send instructions to the applicable U.S. Depository one business day before the settlement date. Euroclear or Clearstream, as the case may be, will instruct its U.S. Depository to receive the securities against payment. Its U.S. Depository will then make payment to the Participant’s account against delivery of the securities. After settlement has been completed, the securities will be credited to the respective clearing system and by the clearing system, in accordance with its usual procedures, to the Euroclear participant’s or Clearstream customers’ accounts. Credit for the securities will appear on the next day (European time) and cash debit will be back-valued to, and the interest on the Series 2006A Bonds will accrue from the value date (which would be the preceding day when settlement occurs in New York). If settlement is not completed on the intended value date (i.e., the trade fails), the Euroclear or Clearstream cash debit will be valued instead as of the actual settlement date. Euroclear Participants and Clearstream customers will need to make available to the respective clearing systems the funds necessary to process same-day funds settlement. The most direct means of doing so is to pre-position funds for settlement, either from cash on hand or existing lines of credit, as they would for any settlement occurring within Euroclear or Clearstream. Under this approach, they may take on credit exposure to Euroclear or Clearstream until the securities are credited to their accounts one day later. As an alternative, if Euroclear or Clearstream has extended a line of credit to them, participants/customers can elect not to pre-position funds and allow that credit line to be drawn upon to finance settlement. Under this procedure, Euroclear Participants or E-4

Clearstream customers purchasing securities would incur overdraft charges for one day, assuming they cleared the overdraft when the securities were credited to their accounts. However, interest on the securities would accrue from the value date. Therefore, in many cases, the investment income on securities earned during that one day period may substantially reduce or offset the amount of such overdraft charges, although this result will depend on each Participant’s/customer’s particular cost of funds. Because the settlement is taking place during New York business hours, Participants can employ their usual procedures for sending securities to the applicable U.S. Depository for the benefit of Euroclear Participants or Clearstream customers. The sale proceeds will be available to the DTC seller on the settlement date. Thus, to the Participant, a cross-market transaction will settle no differently from a trade between two Participants. Due to time zone differences in their favor, Euroclear Participants and Clearstream customers may employ their customary procedure for transactions in which securities are to be transferred by the respective clearing system, through the applicable U.S. Depository to another Participant’s. In these cases, Euroclear will instruct its U.S. Depository to credit the securities to the Participant’s account against payment. The payment will then be reflected in the account of the Euroclear Participant or Clearstream customer the following business day, and receipt of the cash proceeds in the Euroclear Participants’ or Clearstream customers’ accounts will be back-valued to the value date (which would be the preceding day, when settlement occurs in New York). If the Euroclear Participant or Clearstream customer has-a line of credit with its respective clearing system and elects to draw on such line of credit in anticipation of receipt of the sale proceeds in its account, the back-valuation may substantially reduce or offset any overdraft charges incurred over that one-day period. If settlement is not completed on the intended value date (i.e., the trade fails), receipt of the cash proceeds in the Euroclear Participant’s or Clearstream customer’s accounts would instead be valued as of the actual settlement date. Procedures May Change. Although DTC, Clearstream and Euroclear have agreed to these procedures in order to facilitate transfers of securities among DTC and its Participants, Clearstream and Euroclear, they are under no obligation to perform or continue to perform these procedures and these procedures may be discontinued and may be changed at any time by any of them. THE CITY AND THE PAYING AGENT/REGISTRAR CANNOT AND DO NOT GIVE ANY ASSURANCES THAT DTC, DIRECT PARTICIPANTS OR INDIRECT PARTICIPANTS OF DTC, CLEARSTREAM, CLEARSTREAM PARTICIPANTS, EUROCLEAR OR EUROCLEAR PARTICIPANTS WILL DISTRIBUTE TO THE BENEFICIAL OWNERS OF THE SERIES 2006A BONDS (1) PAYMENTS OF PRINCIPAL OF, PREMIUM, IF ANY, OR INTEREST ON THE SERIES 2006A BONDS (2) CONFIRMATIONS OF THEIR OWNERSHIP INTERESTS IN THE SERIES 2006A BONDS OR (3) OTHER NOTICES SENT TO DTC OR CEDE & CO., ITS PARTNERSHIP NOMINEE, AS THE REGISTERED OWNER OF THE SERIES 2006A BONDS, OR THAT THEY WILL DO SO ON A TIMELY BASIS, OR THAT DTC, DIRECT PARTICIPANTS OR INDIRECT PARTICIPANTS, CLEARSTREAM, CLEARSTREAM PARTICIPANTS, EUROCLEAR OR EUROCLEAR PARTICIPANTS WILL SERVE AND ACT IN THE MANNER DESCRIBED IN THIS OFFICIAL STATEMENT. NEITHER THE CITY NOR THE PAYING AGENT/REGISTRAR WILL HAVE ANY RESPONSIBILITY OR OBLIGATIONS TO DTC, THE DIRECT PARTICIPANTS, THE INDIRECT PARTICIPANTS OF DTC, CLEARSTREAM, CLEARSTREAM PARTICIPANTS, EUROCLEAR, EUROCLEAR PARTICIPANTS OR THE BENEFICIAL OWNERS WITH RESPECT TO (1) THE ACCURACY OF ANY RECORDS MAINTAINED BY DTC OR ANY DIRECT PARTICIPANTS OR INDIRECT PARTICIPANTS OF DTC, CLEARSTREAM, CLEARSTREAM PARTICIPANTS, EUROCLEAR OR EUROCLEAR PARTICIPANTS; (2) THE PAYMENT BY DTC OR ANY DIRECT PARTICIPANTS OR INDIRECT PARTICIPANTS OF DTC, CLEARSTREAM, CLEARSTREAM PARTICIPANTS, EUROCLEAR OR EUROCLEAR PARTICIPANTS OF ANY AMOUNT DUE TO ANY BENEFICIAL OWNER IN RESPECT OF THE PRINCIPAL OF, PREMIUM, IF ANY, OR INTEREST ON SERIES 2006A BONDS; (3) THE DELIVERY BY DTC OR ANY DIRECT PARTICIPANTS OR INDIRECT PARTICIPANTS OF DTC, CLEARSTREAM, CLEARSTREAM PARTICIPANTS, EUROCLEAR OR EUROCLEAR PARTICIPANTS OF ANY NOTICE TO ANY BENEFICIAL OWNER THAT IS REQUIRED OR PERMITTED TO BE GIVEN TO OWNERS UNDER THE TERMS OF THE TRUST AGREEMENT; OR (4) ANY CONSENT GIVEN OR OTHER ACTION TAKEN BY DTC AS OWNER OF THE SERIES 2006A BONDS.

E-5

[THIS PAGE INTENTIONALLY LEFT BLANK]

APPENDIX F SPECIMEN OF FINANCIAL GUARANTY INSURANCE POLICY

[THIS PAGE INTENTIONALLY LEFT BLANK]

Financial Guaranty Insurance Policy
Obligor:

Ambac Assurance Corporation One State Street Plaza, 15th Floor New York, New York 10004 Telephone: (212) 668-0340
Policy Number:

Obligations:

Premium:

Ambac Assurance Corporation (Ambac), a Wisconsin stock insurance corporation, in consideration of the payment of the premium and subject to the terms of this Policy, hereby agrees to pay to The Bank of New York, as trustee, or its successor (the “Insurance Trustee”), for the benefit of the Holders, that portion of the principal of and interest on the above-described obligations (the “Obligations”) which shall become Due for Payment but shall be unpaid by reason of Nonpayment by the Obligor. Ambac will make such payments to the Insurance Trustee within one (1) business day following written notification to Ambac of Nonpayment. Upon a Holder’s presentation and surrender to the Insurance Trustee of such unpaid Obligations or related coupons, uncanceled and in bearer form and free of any adverse claim, the Insurance Trustee will disburse to the Holder the amount of principal and interest which is then Due for Payment but is unpaid. Upon such disbursement, Ambac shall become the owner of the surrendered Obligations and/or coupons and shall be fully subrogated to all of the Holder’s rights to payment thereon.

In cases where the Obligations are issued in registered form, the Insurance Trustee shall disburse principal to a Holder only upon presentation and surrender to the Insurance Trustee of the unpaid Obligation, uncanceled and free of any adverse claim, together with an instrument of assignment, in form satisfactory to Ambac and the Insurance Trustee duly executed by the Holder or such Holder’s duly authorized representative, so as to permit ownership of such Obligation to be registered in the name of Ambac or its nominee. The Insurance Trustee shall disburse interest to a Holder of a registered Obligation only upon presentation to the Insurance Trustee of proof that the claimant is the person entitled to the payment of interest on the Obligation and delivery to the Insurance Trustee of an instrument of assignment, in form satisfactory to Ambac and the Insurance Trustee, duly executed by the Holder or such Holder’s duly authorized representative, transferring to Ambac all rights under such Obligation to receive the interest in respect of which the insurance disbursement was made. Ambac shall be subrogated to all of the Holders’ rights to payment on registered Obligations to the extent of any insurance disbursements so made. In the event that a trustee or paying agent for the Obligations has notice that any payment of principal of or interest on an Obligation which has become Due for Payment and which is made to a Holder by or on behalf of the Obligor has been deemed a preferential transfer and theretofore recovered from the Holder pursuant to the United States Bankruptcy Code in accordance with a final, nonappealable order of a court of competent jurisdiction, such Holder will be entitled to payment from Ambac to the extent of such recovery if sufficient funds are not otherwise available. As used herein, the term “Holder” means any person other than (i) the Obligor or (ii) any person whose obligations constitute the underlying security or source of payment for the Obligations who, at the time of Nonpayment, is the owner of an Obligation or of a coupon relating to an Obligation. As used herein, “Due for Payment”, when referring to the principal of Obligations, is when the scheduled maturity date or mandatory redemption date for the application of a required sinking fund installment has been reached and does not refer to any earlier date on which payment is due by reason of call for redemption (other than by application of required sinking fund installments), acceleration or other advancement of maturity; and, when referring to interest on the Obligations, is when the scheduled date for payment of interest has been reached. As used herein, “Nonpayment” means the failure of the Obligor to have provided sufficient funds to the trustee or paying agent for payment in full of all principal of and interest on the Obligations which are Due for Payment. This Policy is noncancelable. The premium on this Policy is not refundable for any reason, including payment of the Obligations prior to maturity. This Policy does not insure against loss of any prepayment or other acceleration payment which at any time may become due in respect of any Obligation, other than at the sole option of Ambac, nor against any risk other than Nonpayment. In witness whereof, Ambac has caused this Policy to be affixed with a facsimile of its corporate seal and to be signed by its duly authorized officers in facsimile to become effective as its original seal and signatures and binding upon Ambac by virtue of the countersignature of its duly authorized representative.

P S

C E
A-

M I
Secretary

N E

President

Effective Date: THE BANK OF NEW YORK acknowledges that it has agreed to perform the duties of Insurance Trustee under this Policy.

Authorized Representative

Form No.: 2B-0012 (1/01)

Authorized Officer of Insurance Trustee

[THIS PAGE INTENTIONALLY LEFT BLANK]