Friday, May 16, 2008 | The city of San Diego’s banishment from Wall Street, a grueling slog that cost tens of millions of dollars and took nearly four years, ended Thursday with Standard & Poor’s restoration of the city’s credit rating.
The rating agency suspended San Diego’s credit rating in fall 2004 as the city’s financial crisis unfolded and the veracity of its financial disclosures to potential investors came under scrutiny from auditors and federal regulators.
The lifting of the suspension now opens the door for the city to return to public borrowing markets, where money for basic infrastructure projects and other endeavors can be attained with more favorable interest rates, and provides Mayor Jerry Sanders’ reelection campaign with an important boost weeks away from the June 3 primary.
With its credit rating sunken and suspended, the city has for nearly four years been forced to postpone basic projects, such as the construction of fire stations and water and wastewater projects, or seek financing in the more costly private markets. The credit troubles also foiled a number of plans to borrow hundreds of millions of dollars to plug into the employee pension plan.
Standard & Poor’s said the city’s completion of a series of long-delayed financial statements detailing its economic health spurred the upgrade. The city’s 2003 audit of its financial statements wasn’t completed until March 2007, and the three following years’ audits trickled in during the last year.
“We had suspended the rating because of lack of information,” said Standard & Poor’s credit analyst Sussan Corson, “so we feel we have enough information to reinstate.”
In an 11-page report on the city’s financial status, the agency said its positive outlook “reflects the expectation that recent improvements in city management practices have begun to address the city’s long-term financial challenges.”
While the reinstatement doesn’t automatically guarantee entrance to Wall Street, the city’s chief operating officer, Jay Goldstone, said he’d spoken with investors and was confident that the city would be ready to go by the time the ink dries on its borrowing paperwork.
The city’s credit ratings still come in below the levels they were at before its financial meltdown. For example, Standard & Poor’s gave San Diego’s general obligation bonds an AA rating before its fiscal meltdown. On Thursday, the agency rated San Diego’s general obligation bonds at an A. The higher the credit rating, the better the interest rates.
The A rating leaves the city below average for cities with populations greater than 150,000. Of the cities analyzed by Standard & Poor’s, a large majority, 71, received AA ratings, according to the agency’s 2007 report. Twenty-one cities achieved AAA ratings, while 32 cities received A ratings.
Fitch Ratings, another of the three major credit rating agencies, upgraded the city’s credit outlook from negative to positive in March. Fitch assigned San Diego’s general obligation bonds a AAA rating before its 2004 meltdown; it currently gives San Diego a BBB+.
Sanders campaigned in 2005 on a pledge to return the city to Wall Street and admittedly never expected to still be dogged by the problem as his reelection campaign neared.
With his opponent, businessman Steve Francis, plowing millions of dollars into a constant stream of television ads, Sanders has had difficulty fending off his opponents’ criticism. The mayor now avoids having to go into Election Day without having accomplished a key goal of his administration.
“This is the most significant day in the city of San Diego in the past four years,” Sanders said. “The city once again has access to the bond market.”
Sanders said from today forward just about all city borrowing will be cheaper, and taxpayers can expect millions in savings this year on water and wastewater system bonds.
Sanders took the opportunity to congratulate himself and his administration, and take a jab at his critics. “For those who say the city has not made progress,” Sanders said. “Standard & Poor’s has sent a very strong message to the contrary.”
Francis said it’s good news for the city. But, he added, the ability of San Diego to borrow money does not eliminate the need for stronger fiscal reforms, fiscal restraint and better management of city finances.
“Unfortunately our fiscal crisis is much deeper than one improved credit rating can solve,” Francis said.
Renewed access to the public bond market means the city will save about $2.5 million annually in borrowing costs, Goldstone said. He said it was a conservative estimate calculated by assuming that the city will borrow $200 million in new money for water and sewer projects this year, and refinance around $500 million in existing debt.
The existing debt includes $150 million for water and sewer the city had to borrow privately earlier this year and hundreds of millions of dollars in higher interest bonds from the 1990s that it could not refinance while suspended from the bond market.
Goldstone said the city will likely lump both the new and old debt into one big offering.
He added that by being able to lock in rates now, when they are low, the city makes itself less vulnerable to unexpected changes in the economy that could increase borrowing costs. “If we had to wait another year, who knows where rates will go and who knows what the economy will do or where construction costs are going?” Goldstone said.
Goldstone said the city will be able to essentially boost its rating even further by purchasing bond insurance, which will set the city back a one-time payment of around $1 million.
The four-year credit freeze, and the city’s long and labored attempts to break it, cost the city of San Diego dearly. In seeking financing from private banks, rather than the public markets, the city paid a premium.
For example, when the city refinanced the Petco Park bonds last year it was estimated that the $3.3 million package cost an additional $400,000 because it was done privately. While the city had to do a series of these private packages, officials said it benefited from low interest rates and therefore wasn’t hurt too badly. Still, officials chose to use this option sparingly, instead waiting out their stay in financial purgatory to undertake many of their plans.
In 2004, city officials said the return to Wall Street was imminent. But as time wore on, it became apparent that San Diego was in for a protracted battle to regain its credibility.
Constant delays and ballooning consultant bills consistently frustrated the process along the way. The city’s outside auditor, KPMG, refused to certify the city’s 2003 financial statement until the city completed an independent investigation into whether city officials intentionally misled investors by failing to disclose the true depths of its financial crisis.
The city hired law firm Vinson & Elkins to complete that report, which was also demanded by the Securities and Exchange Commission, which had launched an investigation into securities fraud. Ultimately, the law firm bowed out after collecting more than $6 million and completing two reports that were dismissed by KMPG and the SEC for their lack of independence from city officials.
Vinson & Elkins’ failings led to the hiring of a group of high-powered consultants from Kroll Inc. headed by former SEC Chairman Arthur Levitt. The group said it would be in and out in three months. However, the delays that beset the auditors and Vinson & Elkins also bogged down Kroll. In the end, its investigation took 18 months and cost $20.3 million.
KMPG eventually gave its blessing to the 2003 financial statement in March 2007. The statements contained more than $1 billion in changes from the original statements. The city has since finished its 2004, 2005 and 2006 statements.
In total, the city spent more than $30 million on outside attorneys, auditors and consultants in the effort.
Then the federal government struck. The SEC sanctioned the city for securities fraud in a 2006 settlement and last month filed civil securities fraud charges against five former top city officials for their alleged roles in allowing the misleading information to be released.
Analysts at Standard & Poor’s and Fitch said the lifting of the rating suspension doesn’t guarantee San Diego’s immediate return to Wall Street. Whether or not they are welcomed back will depend entirely on the investors.
Amy Doppelt, a Fitch analyst, said some investors might be ready to snap up the city’s bonds, but others might want to wait until the city puts out its 2007 audited financial statement, which Goldstone expects to be out in July or August.
“The only real true test would be when they’re ready to go the market,” she said.
Goldstone said he has had conversations about whether people would buy San Diego bonds with some of the big mutual funds like Vanguard and Fidelity. “I’ve talked to some who say they would need to see the city’s 2007 financial reports before making a decision, and others have said ‘No problem,’” Goldstone said.
Standard & Poor’s said San Diego’s fiscal outlook is buoyed by a diverse regional economy; strong wealth and income indicators; good reserve levels and recent management improvements; and a moderate overall debt burden.
It tempered those strengths by noting the region’s housing bust; weaknesses in the city’s internal financial controls; its limited revenue-raising options; and its long-term debts such as deferred maintenance and pension and retiree health care obligations.
Goldstone said he expects Fitch and Moody’s, the other credit rating agency, to “fall in line relatively quickly” and upgrade their ratings of the city’s creditworthiness.
“I do believe that this signals a new beginning,” he said.