Mayor: Borrow $674M for Pension

Monday, April 10, 2006 | The city of San Diego would borrow $674 million to inject into its deficit-laden pension system in the next two and a half years, according to a plan Mayor Jerry Sanders is scheduled to unveil Monday.

The proposal marks the first significant detail the new administration has given as part of its plan to fix a pension deficit that is estimated to be at least $1.4 billion and threatens to consume city budgets for years to come. It also provides an early glimpse of how the mayor will attempt to manage the pension deficit: through creative loans that spread the burden of the debt out for several decades.

The move wouldn’t eliminate the debt, but rather move a chunk of it over from the retirement system to the city’s books, while at the same time raising hundreds of millions of dollars to stabilize a pension fund with assets of $3 billion and liabilities of $4.4 billion.

Supporters argue that such financing gives the pension fund a large, upfront cash infusion to invest and earn money, while detractors say it only shifts debt and doesn’t fundamentally address the financial inequity presented by the pension deficit – that tomorrow’s taxpayers will be paying for the services and employees of today.

“What we want to do is begin addressing in a true and meaningful manner the unfunded liability,” said Jay Goldstone, chief financial officer.

Through four different bonding plans and its annual contribution, the new administration hopes to inject a total of $856.1 million into the pension fund in the next two fiscal years. Such an infusion would lift the pension system’s funding ratio, a measure of its assets versus liabilities, from 68 percent to 84 percent.

The administration wants to boost the plan’s funding level to 85 percent, a goal that would likely require further actions such as more loans or land sales, as the deficit is projected to potentially dip back down below 80 percent in three years despite the proposed round of loans. A system below 80 percent is considered unhealthy in the industry.

The pension funding plan resembles others that have come forward from such outfits as the former City Manager’s Office and Mayor Dick Murphy’s Pension Reform Commission.

But it differs in one essential – and potentially troublesome – manner. The other plans envisioned putting the hundreds of millions in loans into the system on top of the city’s annual payment, while Sanders’ plan uses the loans to supplant about half of city’s annual pension contribution.

As such, the mayor’s plan actually frees up extra cash in the super-tight city budget, money that he plans to divert to other daily expenses such as filling potholes and to replenish its diminished emergency reserve funds.

The remainder of the annual pension payment, a creeping expenditure that has for the last two years caused sizable cuts in city jobs and services, will then be used to pay off a portion of the annual pension costs and the annual payments on $300 million in pension obligation bonds to be issued in fiscal year 2007 and $200 million for 2008.

Under previous plans, the annual repayments on the loans were to come directly from the city’s annual budget, not its annual pension payment. The move in Sanders’ plan is essentially an admission that the city cannot wholly manage its pension deficit without ignoring the basic pillars of its budget.

April Boling, former chairwoman of the Pension Reform Commission, said that overall, she believes the plan is solid. However, she wasn’t convinced the city could use the bond proceeds to avoid making its full annual pension contribution.

“I question the legality of that maneuver,” Boling said in an e-mail.

Officials in the Mayor’s Office said bond counsel and the City Attorney’s Office have blessed the proposal.

The plan is scheduled to be introduced Monday in harmony with the unveiling of the mayor’s first budget Friday. Together, the budget and financial recovery plan are being touted by the Mayor’s Office as a comprehensive reform package that will stabilize the city’s tattered finances this coming fiscal year and solve its issues by the end of Sanders’ three-year term.

“The bleeding will stop,” said spokesman Fred Sainz. “That’s all we’re saying now because it is manageable. We’re still a city in crisis.”

The Details

Normally, the city would make a $163 million cash payment into the pension system.

But the new mayor’s plan essentially cuts that payment into a number of pieces and puts $85.8 million of cash into the system in order to cover the year’s costs, known as the “normal cost.”

Then, the administration would use $30 million of the $163 million to begin making payments on a $300 million loan that would be injected directly into the pension system in fiscal year 2007. A year later, the administration would use another $20 million of that pie in order to issue a $200 million pension obligation bond.

For fiscal year 2007, the proposal frees up about $50 million in the city budget and diverts cash that would have gone into the pension system to other daily expenses such as filling potholes and to replenish the diminished emergency reserve fund.

Under the terms of contracts with one of its labor unions, the city must inject $600 million into the pension system by fiscal year 2008 – something that this plan would do if successful.

As part of those contracts, the city must also annually use $17.3 million freed up by employee wage and benefit concessions to borrow money for the pension fund, which has suffered as the result of deals in 1996 and 2002 that allowed the city to annually underfund the system while at the same time boosting employee benefits.

Sanders has proposed issuing an additional $174 million in bonds as well, using the funds freed up by employee concessions to make the annual payments on the loan. Part of that proposal has hit a snag, as employee unions have questioned whether Sanders’ plan to borrow against the city’s tobacco settlement revenues complies with labor contracts.

In total, Sanders would borrow $674 million by fiscal year 2008. To repay those loans, the city will be forced to set aside $67.3 million annually for at least the next two decades in addition to its annual pension contribution. The pension obligation bonds will be repaid over a 20-year period.

Pat Shea, a structured finance attorney and former candidate for mayor, said the proposal has little practical impact on the city’s debts, as it merely reconfigures the burdens.

He said the only way to deal with the deficit is to adjust down the debt, something City Attorney Mike Aguirre is attempting to do with lawsuits challenging the legality of the benefit increases, or to bring in more revenue by raising taxes.

“This doesn’t do either one of those two things,” Shea said. “It’s not like it’s going away. There’s nothing vaporizing here.”

The mayor has supported Aguirre’s attempts to roll back previous benefit increases in the courtroom, but has ruled out tax increases.

Boling said the plan needs council’s absolute commitment in order to be successful.

“It is a long-term plan and will be a failure if it is not implemented in its entirety. If adopted this year, the Mayor absolutely must find a way to lock the entire plan into place so that the Council does not attempt to deviate from it in the future if it becomes difficult to live with,” Boling said in an e-mail.

The council would have to approve Sanders’ budget and any bond deals, though a majority has signaled support for pension obligation bonds in the past.

The City’s Fiscal Credibility

The city has been stuck with lowered and suspended credit ratings since early 2004 and has been unable to borrow money competitively in public financial markets for two years, a situation that has complicated or doomed scores of basic and vital infrastructure projects.

Credit rating agencies are awaiting an audit of the city’s fiscal year 2003, 2004 and 2005 financial statements. The certification has been long stalled as outside auditors have demanded the completion of an independent investigation into allegations of wrongdoing.

Two such investigations have been completed at a cost of $6 million, but the law firm that conducted them was determined to lack the proper independence from city officials. A third investigation has been under way for more than a year at a cost of $16.2 million but has constantly been delayed by technical and other problems.

The consulting firm conducting the investigation last said publicly that it expects the investigation to be complete by May.

Goldstone, the CFO, said the mayor’s plan expects the city to return to the fiscal markets by the end of the calendar year, but did say that backup plans were being contemplated should it remain stranded from financial markets.

Sanders’ plan is similar to a strategy former City Manager Lamont Ewell and the council began charting last June with the intentions of boosting the retirement plan’s funding level above 80 percent. Ewell’s plan was to round up $600 million by issuing pension bonds, borrowing and selling public land, and pour the proceeds into the pension fund by the end of the 2008 fiscal year.

Consultants verified that the retirement fund would reach 80 percent by 2008 if it received a $600 million infusion, but determined the fund would drop below that benchmark within two years.

Sanders’ proposal doesn’t include selling city-owned real estate, although he has mentioned it as an option in the past.

The mayor’s pension funding plan is part of a financial recovery package the mayor hopes to carry out during the remaining three years of his term. The package includes eventually establishing a trust fund to pay down the nearly $1 billion retiree health care liability the city has incurred; increasing the city’s emergency reserves from 3.7 percent of the budget this year to 6.6 percent in 2008; “reengineering” the business practices of one-third of the city departments every year; and dedicated at least $20 million this year to complete basic infrastructure projects that are currently backlogged.

The financial plan also includes goals the mayor hopes to finish by the end of the year, Goldstone said. These goals include creating a new pension system for future employees; and the successful passage of Sanders’ ballot proposition to allow private companies to compete for city contracts with municipal workers.

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