The Morning Report
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Monday, Jan. 5, 2009 | With a new city attorney at the helm, San Diego city officials hope they can move forward on backlogged infrastructure improvements halted when ex-City Attorney Mike Aguirre refused to sign off on a complex plan to borrow more than $100 million.
Signing off on the financing plan could be a key early decision for Aguirre’s successor, Jan Goldsmith. Mayor Jerry Sanders has long touted the need to make long-delayed fixes to city streets and other facilities. The infrastructure bond marked one of many clashes between Aguirre and the mayor, who supported Goldsmith in the recent election.
Goldsmith said he has yet to fully analyze the proposal, in which the city would essentially pay rent on its own properties to raise money without a public vote. But echoing statements made during the campaign, Goldsmith said he would give greater weight to the opinion of the city’s outside bond counsel, which has opined that the borrowing arrangement is legal.
“What I said is we had legitimate opinions based on legitimate securities experts and bond experts,” Goldsmith said. “I would tend to defer to them unless they were flat-out wrong.”
City officials say the arrangement used to fund the bond is a common one that will fund much-needed repairs to the city’s streets and buildings. But the transactions have been criticized as a way to issue debt without voter approval, and experts say such borrowing must be carefully scrutinized to ensure public agencies get a good deal.
Last spring, City Council members agreed to issue up to $108 million in bonds through an arrangement known as a lease-leaseback. The city would lease five city-owned buildings — the police headquarters, the Rose Canyon operations station and three branch libraries — to a city-controlled financing authority for $1 a year. Using those assets as collateral, the financing authority would issue bonds, the proceeds of which would finance repairs to buildings, streets, sidewalks and storm drains.
The city, meanwhile, would pay the financing authority rent to use the police station and the other properties. That money, which comes from the city’s day-to-day budget, would be used to pay back the bondholders.
The arrangement would allow the city to fund its improvements with tax-free bonds without having to seek voter approval because the bonds are backed by the assets, not direct city funds.
Aguirre refused to sign off on the measure, saying it was a gimmick meant to thwart the will of the electorate by sidestepping state constitutional provisions requiring voters to sign off on debt. He said Sanders should instead ask voters to approve a general obligation bond, in which an agency issues long-term securities backed by the “full faith and credit” of the agency.
In his refusal, Aguirre noted that there were no legal cases on point. The courts have upheld several lease-leasebacks. But in those cases, the building being leveraged was the one that would be improved. In this case, the properties leveraged have nothing to do with the improvement plans.
There is no authoritative ruling on a situation where one building was being leased to make improvements to other facilities, according to an opinion by the city’s hired bond counsel, the law firm Hawkins Delafield & Wood. But that firm found that the borrowing arrangement was legal.
Goldsmith said that advice fit with other experts’ opinions that such arrangements are lawful.
Such arrangements have been common in the state for decades. They’ve even been used in San Diego, with the Torrey Pines Golf Course being leveraged to fund improvements to Balboa and Mission Bay parks. But Aguirre is not alone in his dislike of the transactions.
“Obviously, this lease-revenue nonsense is just a way to issue bonds without a public vote,” said Richard Rider, who heads San Diego Tax Fighters.
For Rider, the key issue is that though the voters didn’t approve the bonds, they are still on the hook for them — even though that’s not explicitly stated.
“No city’s going to renege on the bonds,” Rider said, “and who pays the bonds? The people who should be voting on it don’t have a say.”
The courts, however, haven’t agreed with him. Rider has filed suit over lease-leaseback deals for improvements to Qualcomm Stadium and the expansion of the Convention Center. Both times, the courts found that the arrangements were legal.
“The fact that it’s widespread or technically construed by the courts as legal does not mean that it’s prudent, wise, moral, or otherwise a wise policy,” Rider said.
City officials say the bonds aren’t an attempt to avoid the electorate but a common way for California public agencies to raise money for capital expenses without hiking taxes.
“These are very, very common and very easy to put together and structure,” said Jay Goldstone, the city’s chief operating officer. “Typically, the only time I’ve experienced doing a (general obligation) bond is asking voters if they will increase their tax burden to cover the debt service. We’re not asking for added revenues from the taxpayer to pay this.”
The idea of leasing assets to borrow money was taken from the private sector, said Lori Raineri, president of Governmental Finance Strategies, a Sacramento firm that advises public agencies.
She doesn’t find the concept problematic, but said cities have to be careful to ensure they are getting good terms on a complicated deal by looking at factors such as administrative costs and the terms of the loan.
“I’m not sure about this one in particular, but it’s not unusual for public agencies to not know the cost of the financing,” said Raineri, who isn’t involved with San Diego’s proposal. “On the other hand, there are public agencies that are real experts in this. It varies a lot, and it’s hard to tell.”
The city of Oxnard has been criticized for its extensive use of the lease-leaseback arrangements. The Los Angeles Times recently detailed how the city sold its streets to a private company to raise money for street repairs after voters refused to approve a bond measure and the city had already leveraged almost all of its property.
And though defaults are believed to be extremely rare, they’re not unheard of: A Bay Area school district defaulted on $10 million it borrowed in the 1980s through a lease-leaseback. That case was unusual because the district was using the money not for one-time capital costs, but for ongoing operating expenses.
San Diego’s plan calls for a 10-year loan in which the city would only pay interest for the first two years. City officials plan to refinance the loan with a 20- or 30-year term after the first two years, before the higher payments kick in, a plan that Goldstone said would make the borrowing more affordable by limiting the annual payment.
The payment for the first two years was estimated in April at $3.5 million a year, though Goldstone said the numbers have probably increased since that time. If the city could not refinance after two years, officials have estimated the city would spend $15.5 million annually over the next eight years to pay off the bonds.
Councilwoman Donna Frye cited the terms as the reason she voted against the bond last year. Aguirre has likened the deal to a “subprime mortgage with a teaser rate.”
The city had originally planned to borrow the money from Bank of America because it was cut off from the public bond market at the time. Now that the city’s credit rating has been restored, the city is considering whether to sell the bonds as a public offering, which typically have a lower interest rate.
During the years the city couldn’t access the public bond market, Goldstone said it paid a premium of a quarter percentage point to nearly a full percentage point over public bond rates to borrow money privately.
But Goldstone said the city still may choose to go the private route, in which the bank typically holds the notes until maturity.
“In today’s environment, because the public bond market has dried up quite a bit, we may not have the same kind of access to the money as we would have maybe a year ago,” he said. “That may drive the decision to do this as a private placement.”
Goldstone also said the interest rates for a private financing have likely increased since the City Council approved the borrowing last spring. But he noted that construction costs are “way down.”
“While we may pay a little more interest,” he said, “we may save on the cost of construction, so it would potentially make sense to move the financing forward.”
Voter-approved general obligation bonds, incidentally, are typically issued at a slightly lower rate than the public bond offering the city is contemplating because they are backed by the full faith and credit of the city, rather than by specific assets. Goldstone said the difference is not huge — usually one notch, or the difference between a AA and a AA- rating.
If the city were to issue public bonds instead of private borrowing, it would have to seek approval from the City Council, which has four newly elected members.
Goldstone said city officials plan to ask Goldsmith, the city attorney, to review the offering in the next few weeks and hope to complete the transaction by late January or early February.
Goldsmith said his office will re-review the opinions issued by Aguirre and by the outside bond counsel. Key to the analysis, he said, will be hiring a securities lawyer to fill a position that has been vacant since the spring.
“When I get an opinion from an outside expert, I like to ask questions, which I will do,” Goldsmith said. He added that he will take advantage of the bond counsel’s knowledge.
“I do understand it is common practice to retain experts and use that expertise,” he said.