MAY 1, 2014

U.S. PUBLIC FINANCE

CREDIT FOCUS

Boston Well-Positioned to Maintain Superior Credit Quality with Strong Tax Base and Specialized Employment Sectors
Summary
Aaa Stable

RATINGS
Boston (City of) MA
General Obligation

KEY INDICATORS
2011 2012 2013

As the economic center of New England, Boston (Aaa stable) is well-positioned to maintain its strong credit profile with a growing tax base and durable sectors such as government and higher education. The city has also proven it can successfully address fiscal challenges and manage elevated liabilities related to retirement benefits. Key factors in the citys stability are: Consistent property tax growth. The tax base has grown in eight of the last 10 years, resulting in a steady increase in tax revenue under Proposition 2 1/2, driven by thriving real estate development. Strong presence of higher education, state and local government, and health care sectors. Large and stable institutions contribute to lower unemployment, spur infrastructure investment and support high-tech and start-up firms. Conservative and responsive fiscal oversight. The city has produced annual operating surpluses since 2001, with exceptions in only two years. The city has also maintained strong reserve levels (averaging 30.1% of revenues from 2008-13) that strengthens its ability to manage declining state aid and higher union-related expenses. Proactive management of large pension and other post-employment benefits (OPEB) liabilities. The city plans an aggressive funding schedule to pay down its entire unfunded pension liability by 2025, 15 years before a state-imposed deadline and far sooner than many local government peers. Management has reduced OPEB liabilities through plan changes and increased payments into a trust.

Assessed Value $86.8 $88.5 $92.2 ($billions) Available Fund 27.1% 27.3% 28.1% Balance as % of Revenue Adjusted Net Pension $5.2 $5.2 $5.9 Liability ($billions) 3-Year Ave. ANPL as 4.92% 4.97% 5.70% % of Equalized Value

Analyst Contacts:
BOSTON +1.212.553.1653

Nicholas Lehman +1.617.371.2940 Analyst nicholas.lehman@moodys.com NEW YORK +1.212.553.1653

Geordie Thompson +1.212.553.0321 Vice President -Senior Credit Officer/Manager geordie.thompson@moodys.com Naomi Richman +1.212.553.0014 Managing Director - Public Finance naomi.richman@moodys.com

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Consistent increase in property tax revenue driven by strong new growth

The roots of Bostons steady property tax revenue growth are threefold: increasing assessed values, the ability under state law to increase the tax levy regardless of valuation declines, and a surge in new growth even during the recession and recovery. The citys assessed values continue to grow year over year. In the last 10 years, Boston has only experienced two years of declines, in 2010 and 2011, when values fell 3.5% and 0.5%, respectively. In 2014, the assessed value increased by a sound 8.3%. The five-year average (2010-2014) is a more modest 1.7% due to the two down years, but it remains reflective of a steady growth trend. Secondly, despite operating under the long-established tax levy limitation of Proposition 2 1/2, Boston and other Massachusetts local governments benefit from the mechanics of the cap, which limits the levy, not the tax rate. Therefore, even in those years that values fall, the city is able to raise the levy by 2.5% over the previous year. The 2.5% annual increase allows for consistent revenue growth (see Exhibit 1) and provides realistic budget projections.
EXHIBIT 1

Fiscal Year Property Tax Levy Growth Provides Steady Revenue increase
Prop. 2 1/2 Growth $100 $90 $80 $70 ($ millions) $60 $50 $40 $30 $20 $10 $0 2003 Source: City of Boston 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 New Growth

Lastly, new development projects continue to add to the tax rolls in the form of new growth, which provides additional tax revenue above the 2.5% limit each year (see Exhibit 1). Even through the recession and weak national recovery, the city benefited from annual new growth close to the $32 million 10-year average. In fiscal 2014, the city is poised to benefit from $53.1 million of new growth, one of the largest increases in over 10 years. The current increase is attributable to some large projects coming on line and increased revenue due to expiring 121A tax reduction agreements. Development and redevelopment efforts remain strong throughout the citys neighborhoods, with the Boston Redevelopment Authoritys current pipeline of 244 projects, covering over 59 million square feet, valued at $23 billion. There is approximately 4 million square feet under construction, including the former Filenes building in the Downtown Crossing district and the New Balance headquarters in Brighton. In addition, multifamily housing will be a key driver over the near term with permit levels at a six-year high when measured on a 12-month moving average. Ground has been broken on the $630 million Millennium Tower and the $175 million AVA Theater District apartment complex, which highlight the rise in construction payroll through 2016.

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MAY 1, 2014

CREDIT FOCUS: BOSTON WELL-POSITIONED TO MAINTAIN SUPERIOR CREDIT QUALITY WITH STRONG TAX BASE AND SPECIALIZED EMPLOYMENT SECTORS

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Dampening the expansion trend is Bostons high business and living costs, which could limit new growth figures in the future. Below-average population growth will cause the city to underperform in some economic statistics.

Economy bolstered by strong higher education, state and local government, and healthcare sectors
Boston remains a center for life sciences, finance, business and professional services, with a concentration of hospital and higher education facilities that continue to act as an economic stimulus. Seven of the top 10 employers are in the healthcare sector; Massachusetts General Hospital is the citys largest single employer.
EXHIBIT 2

Employment base anchored by health care and higher education

Top 10 largest employers # of employees

Massachusetts General Hospital Brigham & Women's Hospital Boston University Children's Hospital Boston Beth Isreal Deaconess Medical Center Fidelity Investments Liberty Mutual Holding Co. Inc. State Street Bank and Trust Co. Boston Medical Center Tufts Medical Center
Source: City of Boston

23,983 15,043 9,783 9,424 8,765 7,600 7,125 5,600 5,598 5,266

In Massachusetts, the healthcare sector employs 21% of the states highly educated workforce. Despite our overall negative outlook for the sector, it will continue to provide stability to Bostons employment base given the strengths of the particular institutions in the city. In December 2013, the citys unemployment rate of 6.2% was below the state and US jobless rates. Also bolstering the economy is the presence of some of the most widely-recognized higher education institutions in the world. There are 35 universities and colleges in the city, with more than 152,000 students, representing over 23% of the citys 2012 population. The institutions are regularly investing in infrastructure, such as Northeastern Universitys new $80 million dormitory and the recent groundbreaking on a $225 million science and engineering building. The environment also supports high-tech and startup firms that benefit from access to large venture capital opportunities. As the state capital, Boston also benefits from multiple government institutions, which employ over 77,000 federal, state and municipal workers.

Conservative and responsive fiscal management provides proactive management of budget pressures
For over 10 years, the city has shown a commitment to maintaining structurally balanced operations and healthy reserve levels to address fiscal challenges and promote a healthy financial profile. The city has produced annual operating surpluses in 11 out of the last 13 years (see Exhibit 3). The two operating deficits in fiscal 2010 and 2011 were due in part to recessionary pressures not uncommon across the state and nation.
3 MAY 1, 2014 CREDIT FOCUS: BOSTON WELL-POSITIONED TO MAINTAIN SUPERIOR CREDIT QUALITY WITH STRONG TAX BASE AND SPECIALIZED EMPLOYMENT SECTORS

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EXHIBIT 3

Boston Consistently Delivers Surpluses

Revenues $2,750,000 Expenditures

$2,500,000

$2,250,000

$2,000,000

$1,750,000

$1,500,000 2001 Source: City of Boston

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

The historic operating performance reflects moderate, but consistent surpluses year over year, a challenge to a large city where education, public safety and employee benefits represent the majority of expenditures. Boston has effectively managed a $134 million decline since 2008 in net state aid (see Exhibit 4), the citys second-largest revenue source accounting for 19% of 2013 revenues. To help offset unforeseen challenges, the city has maintained sufficient available reserve levels averaging $721 million, or 30.1% of revenues, over the last six years (2008-2013), compared to the median of 20% of revenues for Massachusetts local governments rated Aaa by Moodys and 28% for Aaa-rated cities nationwide.
EXHIBIT 4

Fiscal Year State Assessments have Decreased Net State Aid by $134M since 2008
Net State Aid - *FY14 budget and FY15/16 projections 400 350 300 250

Millions

200 150 100 50 0 2008 2009 2010 2011 2012 2013 2014* 2015* 2016*

Source: City of Boston

Given its past prudent management, the city is well-positioned to overcome future challenges in maintaining structural balance. Chief among these are state assessments, employee wages, health benefits and pension costs. An increase in state assessments reflects ongoing budget pressure from charter school tuition costs, which continue to rise and reduce the net state aid the city receives each year. Going forward, the citys budget projections include additional declines in state aid given the state legislatures recent increase to the cap on charter school enrollment.

MAY 1, 2014

CREDIT FOCUS: BOSTON WELL-POSITIONED TO MAINTAIN SUPERIOR CREDIT QUALITY WITH STRONG TAX BASE AND SPECIALIZED EMPLOYMENT SECTORS

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Additional near-term challenges loom as well. In December 2013, the city council approved an arbitrators ruling that the Boston Police Patrolmens Association receive a contract that contains increases totaling 25.4% ($88 million), covering 2010-16. Last month the Boston Police Superior Officers Federation and Boston Police Superior Detectives came to similar terms as the Patrolmens contract. In addition, a recently announced pending contract with firefighters includes an 18.8% ($92.4 million) pay increase covering 2011-17. Collective bargaining reserves from prior years will cover the retroactive pay, but the fiscal 2015 and 2016 budgets will be pressured by the above average salary increases. In a positive development, the combination of the arbitration award and other voluntary contract and pending settlements will place over 98% (over 16,000 employees) of the citys unionized workforce under contract through 2016, providing city management with stable costs over the near term. The city has managed union settlements similar to the ones with the police and fire associations throughout the citys history. The city also successfully negotiated a four-year agreement beginning in fiscal 2012 with all city unions, stabilizing many of the health insurance cost drivers, including co-pay changes, premium shifts and the implementation of mandatory Medicare for all eligible retirees. However, the cost of health insurance over the medium to long term will remain a challenge to the citys financial position. Budget pressure from annual pensions costs will continue as the city budgets for double digit increases to meet an aggressive funding schedule that is discussed in detail in the following section. A two-year budget forecast from March of this year identified gaps of $10 million in 2015 and $50 million in 2016. Since then, a balanced budget for 2015 was submitted to the city council on April 9, 2014. The remaining 2016 budget gap is manageable, representing less than 2% of revenues, and management has an established history of balancing current year operating budgets by maintaining tight expenditure control measures on all departments.

Continued active management is key to addressing large long-term liabilities

Bostons unfunded liabilities for pension and other post-employment benefits (OPEB) are substantial and will continue to be a drag on its high quality credit position. The city is actively managing these liabilities on both an annual and long-term basis. The city contributes to the State-Boston Retirement System (SBRS), a cost-sharing multi-employer pension plan. As reported on January 1, 2012, the plan had an Unfunded Actuarial Accrued Liability (UAAL) of $2.8 billion. Using a more conservative discount rate, we calculate an adjusted net pension liability (ANPL) of $5.9 billion. Bostons ANPL is significant on a nominal basis and relative to the citys operating budget. In 2013, the citys ANPL was 2.64 times greater than the citys general fund revenues and equal to 5.7% of equalized value. The state requires the city to fully fund its share of the pension plans annual required contribution (ARC), which the city projects to increase by an annual average of 11.9% through 2016. The rapidly increasing payments are attributable to an aggressive funding schedule: the city expects to pay down the entire unfunded liability by 2025, 15 years before the maximum funding deadline of 2040 allowed by the state. In fiscal 2013, the citys pension contribution was 5.3% of its budget. Given the citys aggressive commitment to reaching the full funding date, the annual rise in pension costs will be a key budget challenge, although the city estimates it will save a total of $1.6 billion in retirement contributions relative to the extended 2040 funding date (see Exhibit 5 and 6). The city plans to manage escalating pension costs through conservative budgeting of departmental expenditures as well as improving local revenue receipts.

MAY 1, 2014

CREDIT FOCUS: BOSTON WELL-POSITIONED TO MAINTAIN SUPERIOR CREDIT QUALITY WITH STRONG TAX BASE AND SPECIALIZED EMPLOYMENT SECTORS

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EXHIBIT 5

Funding Schedule up to 2040 State Deadline

UAAL $500 $450 $400 $350 $ in Millions $300 $250 $200 $150 $100 $50 $0 2015 2017 2030 2016 2031 2038 2034 2019 2020 2035 2013 2032 2028 2024 2036 2037 2021 2040 2025 2039 2018 2022 2033 2026 2027 2029 2023 2041 2014 Employer Contributions $2,000 $1,800 $1,600 $1,400 $1,000 $800 $600 $400 $200 $0 Millions $1,200

Source: Pension plan actuarial valuations

EXHIBIT 6

Bostons Current Funding Schedule

UAAL $600 $500 $ in Millions $400 $300 $200 $100 $0 2035 2032 2036 2037 2040 2025 2039 2018 2022 2033 2026 2027 2041 2014 2015 2030 2038 2034 2042 2017 2029 2023 2016 2019 2031 2043 2013 2020 2021 2028 2024 Employer Contributions $2,000 $1,800 $1,600 $1,400 $1,000 $800 $600 $400 $200 $0 Millions $1,200

Source: Pension plan actuarial valuations

In addition, Boston has substantially reduced its OPEB liability through plan changes and increased payments into an established OPEB trust. The city implemented health plan design changes in 2012 that helped reduce its OPEB UAAL to $2.1 billion in 2013, a substantial decline from $5.6 billion in 2007. The city plans to continue making annual pay-as-you-go contributions, which represented 81% of the $187 million ARC in 2013. It also plans annual deposits of $40 million from either recurring revenues or reserves (based on operating budget performance) into the OPEB trust, which has a current balance of $272 million. The 2013 combined fixed costs of pension, OPEB and debt service represented $441 million, or 17% of expenditures, a level that has remained stable over the past three years. Despite the large unfunded liabilities, the citys proactive approach to addressing the liabilities (notably, the aggressive pension funding date) represents the sound fiscal management of a highly-rated government. The ability to maintain a balanced operating budget with the rising costs will be a key factor in the citys rating in the future.

MAY 1, 2014

CREDIT FOCUS: BOSTON WELL-POSITIONED TO MAINTAIN SUPERIOR CREDIT QUALITY WITH STRONG TAX BASE AND SPECIALIZED EMPLOYMENT SECTORS

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Moodys Related Research

Rating Update:

Moodys assigns Aaa to Boston, MAs GO Bonds, outlook stable, March 2014 US Local Governments The new stable will be an era of constrained resources, but the worst is over, December 2013 (160299) US Higher Education, Not-for-Profits and Independent Schools, November 2013 (160659) US Not-for-Profit Hospitals Revenue growth will decline; Margins to contract on physician and IT investments, November 2013 (160569) US Local Government General Obligation Debt, January 2014 (162757)

2014 Outlooks:

Rating Methodologies:

To access any of these reports, click on the entry above. Note that these references are current as of the date of publication of this report and that more recent reports may be available. All research may not be available to all clients.

MAY 1, 2014

CREDIT FOCUS: BOSTON WELL-POSITIONED TO MAINTAIN SUPERIOR CREDIT QUALITY WITH STRONG TAX BASE AND SPECIALIZED EMPLOYMENT SECTORS

U.S. PUBLIC FINANCE

Report Number: 169935

Author Nicholas Lehman

Production Specialist Cassina Brooks

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MAY 1, 2014

CREDIT FOCUS: BOSTON WELL-POSITIONED TO MAINTAIN SUPERIOR CREDIT QUALITY WITH STRONG TAX BASE AND SPECIALIZED EMPLOYMENT SECTORS