Tuesday, May 30, 2006 | When the City Council’s independent budget analyst finds a few extra bucks of revenue, she doesn’t recommend they get funneled into San Diego’s famously underfunded pension system. She wants the new cash plugged into the city’s depleted reserves.
Indeed, with all the focus of the city’s financial crisis bearing down on the pension system, the emergency reserves took a discreet beating this year, a fact that has the city’s top finance officials concerned. Its legal fund parched, the city repeatedly turned to its emergency reserves in fiscal year 2006 in order to cover a number of unforeseen expenses for lawsuits and consultants working to put the city’s legal and financial mess in order.
The city kicked off fiscal year 2006 with reserves of 3.9 percent of its operating budget, considered by rating agencies to be adequate, though on the low side, but a breadth of unplanned expenses has sapped the reserve dangerously low – about 2 percent – as the final month of the fiscal year approaches.
That’s why, despite the pension crisis, mountains of deferred repairs needed for city infrastructure, and persistent complaints about police and fire protection, Independent Budget Analyst Andrea Tevlin places emergency reserve funding at the top of her priority list. Tevlin has called the city’s current situation “very, very serious.”
“It’s one of the key indicators of financial stability,” Tevlin said of reserves.
Emergency reserves are significant, though they rarely grab much attention. Credit rating agencies use them to measure a city’s health, looking at reserves as a bellwether of how a city will survive temporary cash-flow shortages and natural disasters such as earthquakes or wildfires.
“Unexpected things come up in life. If you have reserves, you can deal with them. If you do not have reserves, it will throw your entire municipality into turmoil,” said April Boling, who studied the city’s reserves as a member of the 2001 Blue Ribbon Committee on City Finances.
Credit rating agencies consider reserves of 5 percent average, the blue ribbon committee recommended reserves of 7 percent to 10 percent, and the city’s new chief financial officer wants to get to 8 percent soon. So soon, in fact, he crafted a creative borrowing plan for the pension system that, if enacted, would divert into general fund reserves $25 million that would have otherwise gone into the moribund pension system in fiscal year 2007.
Even if the City Council, as is recommended, ekes $7.2 million out of its tight budget in the coming fiscal year to slide into reserves, Tevlin forecasts that its reserves will bump up only to 2.15 percent. Additionally, administrators hope tax revenues come in higher than expected when this fiscal year ends June 30, allowing them to pump $10 million into reserves. Those two infusions would take the city back up to a general fund reserve of 3.5 percent.
For nearly two years, the city has been focused on restoring a credit rating that was suspended in 2004 by Standard and Poor’s, one of the three major credit rating agencies. The dried-up reserves, coupled with the city’s pension problems and other budget difficulties, then led to the question: How good will the city’s credit rating be when it is finally restored?
The consensus: Probably not too good, though it could slowly get better with time and a new management team. The lower the credit rating, the higher the costs of issuing debt – something the city will likely be doing a lot of when it returns to Wall Street’s good graces. It has been unable to borrow money for nearly two years to complete vital public works projects and enact a pension borrowing plan, and could conceivably seek more than $1 billion in loans within the first year it returns to capital markets.
“The city has a new team and it looks like they’re doing some good things, but it takes time to prove it all out,” said Amy Doppelt, managing director for credit rating firm Fitch Ratings. Doppelt said she was still confident, though, in the strength of the region’s economy and the city’s revenue streams.
And, with two pending lawsuit judgments in which the city could be forced to cough up more than $100 million a piece, the situation makes the city’s ability to manage its potential liabilities even more precarious.
Officials blame the well-documented struggle with lawsuits and consultants for the reserve’s dwindled state. In the early part of fiscal year 2006, the city burned quickly through its $6.2 million public liability fund, the account that normally covers unforeseen legal costs. The city’s burdens in the legal and consultant arena are many, with its employees snared in federal investigations, its legal docket crammed with pension and other lawsuits, and its gnarled affairs necessitating the help of a band of high-priced consultants. Consultants working to regain the city’s credit rating have run through upwards of $30 million alone.
So, with that fund dry and the city struggling to fulfill its basic services, city administrators turned to the emergency reserves to cover their mounting bills.
The emergency account totaled $33.9 million on July 1, the start of fiscal year 2006, but has slowly dropped to $18.4 million.
A lawsuit by the Police Officers Association against the city cost the fund $500,000. A stormwater claim cost $1.5 million. Bills for the audit committee, a group of accountants and attorneys preparing an investigation into allegations of wrongdoing, and outside auditors sucked out another $1.7 million. A ruling against the city in a condemnation case against a developer in the building of State Route 56 cost the fund another $10.4 million, though the city is appealing that case.
Legal fees for the ongoing Roque de la Fuente case scheduled to be approved Tuesday would sap another $1.5 million from the fund.
Moody’s Investor Services cited the sliding reserve levels in its last downgrading of the city’s credit rating in August, as the situation leaves the city little room for error in its budgeting forecasts and its day-to-day operations. That means that if disaster strikes, there’s more of a chance the city could be unable to pay its bills and default on its obligations – a scary sign for investors the usually stable world of municipal bonds.
In February, Moody’s followed with this statement:
“Fundamentally, the city’s general fund finances remain extremely narrow, with a tightly balanced budget and a weak balance sheet, both in terms of reserves and liquidity.”
Jay Goldstone, the city’s chief financial officer, called the fund’s current state “very concerning, there is absolutely no doubt about that.” With revenues forecasted to come in higher than expected by the end of the fiscal year on June 30, Goldstone hopes to put another $10 million back into reserves in short time.
He remains optimistic. The fact that the city has been able to absorb the mountain of legal and consulting costs and maintain any reserve fund, Goldstone said, is a sign of the strong local economy and the city’s revenue streams.
But with a seemingly endless brigade of consultants, accountants and attorneys locked in a number of protracted audits, investigations and lawsuits over the city’s fiscal and legal demise, the city again in fiscal year 2007 could continue to see a steady flow of bills from outside professionals.
It would take $72 million this year to boost the city up to Goldstone’s goal of 8 percent for reserves, though that won’t happen in the coming year. He plans to slowly build up the fund, calling it a high priority.
Indeed, the pension borrowing plan Goldstone put together for Mayor Jerry Sanders is testament to that. Past administrators envisioned a plan close to that of Goldstone’s: borrowing about $600 million to plug into the troubled pension fund. Pension hawks have said that every extra dollar the city has for years must be pushed into the pension system in order to keep it afloat.
However, Goldstone has proposed a borrowing plan that uses chunks of the borrowed money to replace the city’s annual payment into the pension system. The practical effect: the city would pay less into the troubled pension fund than under previous plans. Instead, the general fund and other reserves would get a quick boost of $50 million in fiscal year 2007 and $22 million in fiscal year 2008.
Goldstone’s task is to rebuild city finances so that, among many other goals, the reserves are only tapped for true emergencies.
“I would hope that once you really establish these reserves they are really for catastrophes – though maybe somebody would say that’s what we’ve been in the last few years,” he said.
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