Wednesday, March 11, 2009 | As the city of San Diego city considers whether to issue pension obligation bonds in the next year or two, it can draw few hard conclusions from the experiences with pension bonds of San Diego County and the city of Chula Vista.

Officials from both the county and Chula Vista believe the pension bonds they’ve issued will pay off. Whether they’re right depends largely on how the markets behave in the next few years. And, as evidenced by the recent financial meltdown, markets can behave very badly.

In Chula Vista, the interest rate that the city is paying on its bonds hovers around the return that the pension fund has been earning since 1994, which suggests the city may be breaking even on its bonds. And to come out ahead, it needs a strong market between now and 2011, when nearly half of its bonds are set to mature.

The experiences of the county and Chula Vista are important to the city of San Diego because city officials have proposed borrowing to bulk up the pension system in the past and may consider pension bonds again in the next year.

Pension obligation bonds work like this: A government agency issues bonds and invests the borrowed money, often in its regular pension fund. The idea is that a government will earn more on the invested money than it pays in interest on the bonds. That difference is used to shrink the pension deficit.

That’s if everything works out as planned. The bonds carry the risk that the earnings on the borrowed money will be less than the interest rate, thus losing taxpayers’ money.

Neither the county nor Chula Vista have done a study of their bonds to figure out if they paid off for taxpayers. Yet officials from both municipalities believe they have saved money. The county’s chief financial officer, Don Steuer, noted that until this year, the county’s pension fund — where the county’s pension bonds are invested — has been boasting double-digit investment returns.

“It’s been a substantial savings for the county,” Steuer said of the pension obligation bonds.

But double-digit returns can quickly turn into losses, as shown by the $2.5 billion in losses that the county’s fund has suffered in recent months. Making things more complex is that the governments have issued bonds at different times and at different interest rates. So getting the timing right is important.

Since 1994, the county has issued more than $1.6 billion in pension obligation bonds to shore up its pension fund. Those bonds have carried a broad range of interest rates, including ever-changing variable rates.

Chula Vista issued nearly $17 million in pension bonds in 1994 at fairly high interest rates, between 6.1 percent and 8.3 percent. On average, the city has paid a 7.89 percent interest rate over the life of its bonds, the last of which will be paid off in August 2011. When the bonds were issued in 1994, the money was sunk into the California Public Employees’ Retirement System, or Calpers, which manages Chula Vista’s pensions.

It’s hard to tell what the bonds have earned because they’re put into the regular Calpers fund, not in separate investments. Also, the dates Calpers uses to measure its annual returns don’t match exactly with the dates that bond proceeds were invested.

But from January 1994 through December 2008, Calpers’ annual investment return averaged 7.91 percent. That’s awfully close to the annual interest rate the city is paying on its bonds and suggests the next two years could be crucial in determining whether the city saves money on its bonds.

April Boling, a former San Diego City Council candidate who served as chairwoman of the city’s Pension Reform Committee, said governments should secure bond interest rates that are significantly lower than the expected rate of return to avoid a tight spread like Chula Vista is dealing with.

“If all you’re talking about is a quarter percent that’s dicey in my view,” Boling said.

Chula Vista’s finance director, Maria Kachadoorian, said on the whole, she believes the pension bonds will “play out in favor of the city.”

Working in the city’s favor is the fact that it paid off more than half of its bonds before the recent market crash. Judging by Calpers’ average return from 1994 to 2007, the city likely made money on those bonds. But working against the city is the fact that the remaining debt carries an 8.15 percent interest rate, and the city must count on the market turning around in the next two years to turn a profit on those bonds.

Scott Barnett, president of, said financial officials’ projections that the bonds will pay off should be viewed with skepticism.

“Obviously, they’re in a tight situation there,” he said. But the city finance staff of Chula Vista for quite a number of years has been overly sanguine in their financial prospects.”

Barnett said city officials were reluctant in 2006 to accept the then-looming financial crisis, despite the warnings he spelled out in a report.

These days, Kachadoorian said she would be wary of issuing new pension bonds even if the city ends up making money on its current bonds. She said the current market is “very different” from when Chula Vista first issued its bonds.

“You’re basically banking that Calpers is going to earn more than what you’re paying in debt service,” she said.

Kachadoorian, who wasn’t finance director in 1994, didn’t know why the bonds were issued or why they held such high interest rates. If the city did issue pension bonds again, Kachadoorian said she would want a larger spread between the interest rate the city was paying on the bonds and the rate that Calpers assumes it will earn on its investments.

When the bonds were issued, Calpers assumed it would earn 8.25 percent a year on its investments. That rate has since been lowered to 7.75 percent, less than the average interest rate the city pays on the bonds.

It’s even more difficult to gauge the performance of San Diego County’s pension bonds. The county has issued more than $1.6 billion in debt since 1994, including some bond issues that repriced more expensive debt. Last year, the county refinanced more than $400 million in debt, mostly bonds with variable interest rates that had surged in yield when the securities markets tumbled in early 2008.

The interest rates on the county’s pension bonds now range from less than 3 percent to just over 6 percent. The bonds are slated to be paid off by 2028.

In gauging whether to issue bonds, Steuer said the county compares the interest rate to the 8.25 percent rate of return assumed by the county’s pension fund, the San Diego County Employees’ Retirement Association.

For the decade ending June 30, the county’s pension fund earned 8.1 percent. That doesn’t include significant investment losses that have occurred since then and any potential fallout from the collapse of a hedge fund that had managed $78 million of the county’s money.

Steuer said that despite annual ups and downs, the pension fund’s assumed rate is unlikely to be lowered below the rate the county is paying on its pension bonds.

“Is it conceivable? Yes,” he said. “Is it probable? No.”

Please contact Rani Gupta directly at with your thoughts, ideas, personal stories or tips. Or set the tone of the debate with a letter to the editor.

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