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Tuesday, April 11, 2006 | Pinned against the wall by the demands of labor contracts and a skin-tight budget, Mayor Jerry Sanders has chosen a complex borrowing plan to combat San Diego’s pension ills that relies on a bouquet of assumptions, many of which are out of his hands.
The new mayor, having opposed tax increases and apparently brushed aside the option of bankruptcy to manage the city’s debts, instead continued down a path for fiscal recovery laid down by his predecessors Monday by formally announcing a plan to borrow $674 million and inject it into the pension system by fiscal year 2008.
The viability of the plan hinges on a number factors. For starters, in order to borrow $574 million of that $674 sum, the city must again win the access to Wall Street that it lost two years ago following the release of inaccurate financial statements. City officials past and present have maintained for nearly all of those two years that they were tantalizingly close to returning to the financial markets to release pension obligation bonds, only to have those hopes dashed by consistent delays in investigations and audits.
The Mayor’s Office expects the city to rejoin the capital markets by the end of the calendar year, and the mayor said Monday that the long-delayed investigations into alleged wrongdoing at City Hall are now forecasted to wrap up by June instead of May.
Upon reaching the financial markets, the mayor must also hope that he can issue the bonds at favorable interest rates, something officials said they believe they can do right now.
“As we know, interest rates are rising and we are keeping an eye on that,” said CFO Jay Goldstone, who crafted the mayor’s financing plan.
The attraction of pension obligation bonds is that they stabilize bleeding pension funds by providing them a large, borrowed cash infusion to invest. The borrowing project will prove successful if the city is able to earn more on its borrowed money than it pays in annual interest costs. If not, it would be a money loser.
Pension obligation bonds once fetched interest rates in the 5-percent range; for example, the county issued pension obligation bonds in 2004 at 5.29 percent interest.
It is assumed the city could get a 6-percent interest rate if it entered the market today, a rate that city officials would be content with, as the pension system assumes an 8 percent returns on its investments. Goldstone said he would support the financing package until interest rates began approaching the 7-percent range.
To be sure, Sanders touted the bonding plan Monday as one part of a 10-point plan that he said will holistically begin to address the city’s financial problems this year, but take the full three years of his term to complete. He said that when combined with a streamlining of the city organization, a balanced budget and other financial reforms, the cash infusions will bring about fundamental fiscal reform.
The pension system deficit, estimated to be at least $1.4 billion, is central to the city’s fiscal woes, as the city’s annual pension payment is expected to chew up ever-growing chunks of its annual day-to-day budget and has caused deep cuts in jobs and basic services in recent years.
A number of Sanders’ budget reforms are new to the city and he said Monday that his streamlining process will trim 500 positions from the city budget in fiscal year 2007. But the massive bonding project is similar to plans contemplated by former Mayor Dick Murphy’s Pension Reform Commission and former City Manager Lamont Ewell.
“What makes ours different is that we’ll actually get it done,” Sanders said.
Under labor contracts negotiated last year by Murphy, the city is obligated to inject $600 million into the pension system by 2008 or lose funds that were freed up by employee salary cuts.
Previous proposals envisioned dumping the $600 million into the system on top of the annual bill, while the mayor’s new proposal has the city paying only about half of its pension bill with its own cash and covering the other half with part of the borrowed money.
The remainder of the annual pension payment, expected to be between $160 million and $170 million in the upcoming fiscal year 2007, would be diverted to cover annual payments on the bonds. The rest, about $50 million, would go to cover everyday expenses and replenish the city’s depleted emergency reserve funds.
The move frees up some breathing room in the already tight city budget and funnels money into long-neglected but important funds, although the legality of the maneuver has been questioned, as some officials have wondered whether the city can use bond proceeds to actually supplant part of its annual pension bill.
In order to release the bonds, the mayor will need the signature of City Attorney Mike Aguirre.
Officials with the Mayor’s Office originally said over the weekend that the City Attorney’s Office and bond counsel had determined that the move was legally sound. Aguirre cast doubt on that assumption Monday, saying his office hadn’t completed a full review of the plan.
“Obviously, we need the attorney’s office to opine on that,” Goldstone said Monday.
Much of Sanders’ plan appears to be geared towards impressing the credit rating agencies that have downgraded or suspended San Diego’s credit rating in the last two years and led to its suspension from Wall Street.
The mayor’s plan gives a significant boost in the next two years to the city’s emergency reserve funds, something credit rating agencies have expressed concerns about. And the mayor said his short-term goal is to get the pension fund up to an 85-percent funding ratio, something he said credit rating agencies favor. (The funding ratio is a measure of a fund’s assets versus its liabilities.)
It’s possible that the $674 million cash infusion contemplated in the mayor’s borrowing plan would be followed by further borrowing or land-sale proposals in the future in order to maintain the mayor’s stated funding goal.
Although the mayor’s plan doesn’t include such projections, the plan put forward by the former city manager last year forecasted the practical impacts of putting $600 million into the system by fiscal year 2008 on top of paying the full bill presented by the pension system.
Even with such an infusion of funds now, consultants determined that the pension fund could again dip below the 80-percent threshold within three years. That could force the city to have to evaluate land sales or further borrowing projects to boost the fund back up to Sanders’ stated goal of 85 percent.
“Needless to say what we are going to do is try to put a plan together that is going to target the 85-percent level, and how we maintain that – we will make the decision as we are going forward,” he said.
The mayor’s plan does afford some budget flexibility in fiscal year 2007 and 2008, but that is only short-term relief. After 2008, the city’s annual pension expenses – the cause of much distress on recent city budgets – will increase significantly again absent similar loans.
The issuing of bonds in 2007 and 2008 frees up at least $80 million a year in the city budget under Sanders’ plan. In 2008, for example, the city uses $50 million of the $80 million to make the annual payments on the 20-year bonds and puts the rest back into the budget.
However, in 2009 the city won’t have the bond proceeds cover half of its pension bill absent more bonds. Instead, it would have to fund the previous bonds by taking $50 million out of its regular budget. And it will have to make a full annual pension payment that’s forecasted to be $183.8 million.
The city only pays about $85 million in straight cash into the pension system in 2007 under Sanders’ plan. That figure will shoot up to $233.8 million in 2009 when the $50 million in bond payments and the annual pension bill are added together. (The increase in the 2009 payment is partially reflective of a 2004 voter decision to tighten the city’s payment schedule, forcing it to pay off its pension debt over a shorter timeframe.)
April Boling, the former chairwoman of the Pension Reform Commission, said the plan is solid and is similar to the plan the commission put forward in 2004 to manage the pension deficit on a long-term basis with bonds or land sales and increased pension contributions.
But others were more skeptical of the city’s ability to finance the project.
“I think it’s going to be remarkable if they get into the capital markets this fiscal year but if they do, I think it would be even more remarkable if they can get these pension obligations bonds worked out,” said pension whistleblower Diann Shipione.