Tuesday, February 07, 2006 | The City Council approved in concept Monday a creative financing plan to borrow $100 million to inject into its struggling pension system, a move that supporters hailed as an important step in curing San Diego’s pension ills but that opponents said would have a negligible impact on a stifling deficit.
The proposal, brought forward by Mayor Jerry Sanders, sells investors the rights to a maximum of $10.3 million of the city’s annual tobacco settlement funds for the next 16 to 22 years in exchange for $100 million upfront to plug into a pension system with a deficit that’s estimated to be approaching $2 billion. In total, officials project the city will spend $170 million including interest and fees over the life of the loan in order to access the $100 million immediately.
Officials plan to use money freed up through last year’s labor negotiations to supplant the $10.3 million that will annually be lost from the city’s operating budget as a result of the securitization plan.
“This is a small first step, but it’s a first step,” said Councilman Jim Madaffer.
The lending program is more expensive than standard borrowing plans because the city’s financial situation has left it barred from traditional financing markets. A number of opponents said they weren’t convinced the deal made sense in the long term, and the city’s chief financial officer said there was no definitive answer when asked if it would have a positive impact on the pension deficit.
“Is it really worth tying up these funds? We don’t know,” said Councilman Tony Young.
The mayor was forced to move quickly on the complex financing because of a unique set of circumstances.
In negotiations last year led by former Mayor Dick Murphy, labor unions agreed to contribute more annually into the pension system or take pay cuts, thereby freeing up an estimated $17.6 million. The city agreed to leverage the freed funds to issue bonds and inject the proceeds into the pension system.
Contracts with three of the five labor unions expire at the end of this fiscal year, therefore officials said they have to leverage the money opened up by labor concessions by June 30 or a chunk of it would’ve returned to employees’ pockets.
The city has not accessed the public-finance market since 2003 because of questions surrounding the honesty and accuracy of its financial reporting. It remains stuck with a suspended credit rating pending the release of its long-delayed fiscal year 2003, 2004 and 2005 audited financial statements.
That left city officials with few viable options to seek public loans. Tobacco securitization bonds provided that opportunity, as the bonds’ creditworthiness is tied to tobacco companies’ revenues, not the city’s financial health. These types of bonds have been issued by states and municipalities across the country and allow governments a chance to cash out on the annual funds they receive from tobacco companies as a result of a 1998 settlement with 46 states related to damages caused by smoking.
Each year, California receives a percentage of the top four tobacco companies’ revenues, and San Diego receives a slice of the state’s share.
City officials currently project the city will repay the loan in 16 years. However, if the city’s tobacco revenues dip below $10.3 million a year, the loan will take longer to pay off. The city’s tobacco revenues have sunk from $12.1 last year, but CFO Jay Goldstone estimated that those revenues will increase in the coming years.
He called the transaction “a viable first step in improving the funding of the San Diego City Employees’ Retirement System.”
The council approved the plan in concept by a vote of 5-to-2. Young and Councilwoman Donna Frye voted against the proposal, saying that they weren’t convinced that the deal made sense. A detailed financing plan will have to return to the council for final approval before any bonds are issued.
Council President Scott Peters recused himself from the vote because he owns investments in two of the firms handling the transaction. Peters said he holds $129,000 and $300,000 in stocks in Citigroup and Lehman Brothers, respectively.
City Attorney Mike Aguirre called the action “a major, major move by the city,” although he had opposed a larger but similar financing plan passed by the City Council in September.
“He is doing the best he can do with what he has to honor the commitment that was made by someone before him,” Aguirre said of Sanders.
Frye and Young said they needed to see the long-term impacts the $100 million injection would have on the pension fund.
In the long-term, the city is bound by the labor contracts to inject a total of $600 million into the system by 2008. A blueprint passed by the City Council in September to deal with the pension deficit contemplated this tobacco securitization plan and called for the additional $500 million to be pumped in by 2008 through another $400 million in bonds and $100 million in land sales.
That injection would lift the pension system’s funding to an 80-percent funded ratio, a measure of assets versus liabilities that is generally considered sound. However, even with the $600-million injection of loans and land, the system’s funding would again dip below the perilous 80-percent level by 2010, according to the September report.
“We really need a much bigger influx of money on an annual basis if we’re really going to get out of this,” Young said.
If the city were able to stave off the June 30 deadline and wait to offer bonds until it had traditional access to capital markets, it could reduce its annual interest from about 6.45 percent to between an estimated 5 percent and 5.5 percent.
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