Monday, November 14, 2005 | A special relationship with the Bank of America has kept the city of San Diego’s financial paralysis from turning into one of the largest municipal bankruptcies in U.S. history but the cost of that friendship is increasing faster than city staff anticipated.

Tied to a continually fluctuating interest rate set in London, a loan the city received in July is growing costlier than expected as the world’s interest rates continue to rise.

The loan – a so-called Tax Anticipation Note – carries with it a floating interest rate set to the London Inter-Bank Offering Rate, or LIBOR. In other words, as the LIBOR changes, so does the interest rate charged to the city. City staff, led by Deputy City Manager Lisa Irvine and acting-Treasurer Charles Mueller, told the City Council in June that the interest rate for that loan was estimated to be between 2.6 and 3.5 percent.

Mueller said then that the rate was comparable to what the city could have expected to receive by issuing regular Tax Anticipation Notes to a broader array of municipal bond buyers – as had been the city’s practice for decades before a much-delayed audit caused the city to lose its credit on Wall Street.

Yet as of Friday the three-month LIBOR – the rate Mueller said was the one to which the city’s interest rate was pegged – has already increased to 4.3 percent.

Had the city been able to bond as it would in a normal year, the interest rate on the $185 million loan would have been fixed at 2.99 percent. The increasing rate is yet another cost of the seemingly unending delay of the city’s fiscal year 2003 and 2004 audits, without which San Diego has been unable to ingratiate itself again with Wall Street investors.

Asked about the way the privately financed loans compare to the city’s historical practice of issuing bonds to multiple investors, Irvine provided a written response.

“As a general rule, publicly placed debt is less costly to the borrower than privately placed debt. This is because the private placement market is usually accessed by borrowers whose circumstances … present higher than usual degrees of risk,” Irvine said.

Those circumstances include the city’s inability to account for the money it spent, collected and owed over the last three years. Yet Bank of America does not blindly give the city money.

To help Bank of America decide whether to float the city the loans, Irvine said city staff has given the bank information about the city’s current financial situation that is unavailable to anyone else.

“The financial information shared with the financial institutions is in a draft, unaudited form,” Irvine said. “It is shared with the understanding that the draft information transmitted is subject to change, will be returned to the city upon review and will not be shared with any other entities.”

The Tax Anticipation Notes financed by Bank of America in both fiscal years 2004 and 2005 have provided the city much-needed revenue at a time when financial institutions consider the city a higher risk than it was only a couple years earlier. In fact, the city has been forced to appeal to Bank of America four times over the last two years to replace the flow of cash that normally would have come from multiple municipal investors.

Without help from the Bank of America, or another willing and able investor, the city would have been unable to proceed with vital infrastructure projects.

Last month, the City Council preliminarily approved a $152 million restructuring of an earlier deal it had made with the Bank of America. The city was forced to essentially refinance the loan because it had only been paying the interest on the loan and a massive balloon payment was approaching.

The cost would have left the city unable financially to replace any of the dilapidated sewer lines along its 3,000-mile wastewater system. On a normal year, the city would hope to replace 45 miles of the system. This loan, like the Tax Anticipation Note, is also set to a variable interest rate that is growing along with the LIBOR index.

And the city may have to continue with those loans for more than a year if it is to keep itself solvent.

An outside audit committee – a firm known as Kroll Inc. – was brought in to help the city finish and consolidate multiple investigations into past practices of city staff accused of wrongdoing. But Kroll partners recently announced they would have to delay their work for months because of technical problems.

Until that is done, the city’s independent auditor KPMG will not sign off on the needed fiscal year 2003 audit. Nor will the fiscal year 2004 audit proceed.

And even when those are complete, City Attorney Mike Aguirre said it may take up to a year for the city to find itself in a position where it could legally proceed with public issuances of bonds.

“Right now private financing is our only option and it will be for some time,” said Aguirre, who has not objected to the city’s relationship with Bank of America. The city attorney has even gone so far as to suggest the city back off its agreements with the multitude of city consultants attempting to produce the needed audits. If that were to happen, private loans like the one from Bank of America may be the city’s only option for the indefinite future.

Mayor-elect Jerry Sanders said during the campaign that one of his main priorities was to get the audits completed to allow the city to re-enter the public bond market “to protect the city from high interest rates.”

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