Tuesday, Oct. 20, 2009 | Few people would find $1.7 billion in debt cause for celebration.
Try telling that to the city of San Diego.
This January marked the city’s first time on the public bond market since September 2004 when a dour Dick Murphy announced the stripping of San Diego’s credit rating and then his mayoral resignation seven months later. Fighting for a restored rating cost tens of millions of dollars, delayed numerous capital projects and forced the city to take out private loans at higher interest rates.
San Diego has taken advantage of its credit resurrection. The city has issued $1.7 billion in five bond deals this year. That total does not count a $14 million offering by the city’s Redevelopment Agency or $125 million in short-term loans to ensure regular cash flows.
The deals answer the most pressing question the city faced when it announced its return to the market 18 months ago: Would investors buy the city’s bonds in spite of its financial history?
“Certainly that they were able to issue the amount they did signifies an amount of investor confidence,” said Amy Doppelt, a managing director at Fitch Ratings.
Last month, the Bond Buyer trade newspaper reported that San Diego was “among the busiest issuers” this year. (The newspaper also reported that the city had issued $2.5 billion in debt this year, a figure city Director of Debt Management Lakshmi Kommi said was “overstated.”)
San Diego’s strategy for its reentrance into the market has long been to refund debt incurred in short-term private loans designed to tide the city over until its public market return and to refinance older public debt issued in the 1990s.
More than 70 percent of the debt the city issued this year, or $1.2 billion, was used to repay earlier loans.
The total has made San Diego by far the single largest issuer of debt used to refund prior bonds in the state, according to data from the California Debt and Investment Advisory Commission. The statistic is a consequence of the years of missing out on the lower interest rates that come with access to the public market, analysts said.
“That’s what happens, I guess. The capital and bonding needs don’t go away,” said Gabe Petek, an analyst with Standard & Poor’s. “When they went back to replace that (private debt) with publicly owned debt, it makes sense that that is a big number.”
The bulk of this year’s financing focused on the city’s water and wastewater systems. The city had to repay short-term private loans and upgrade water and wastewater facilities to maintain federal and state environmental standards, Kommi said. The water and wastewater systems added nearly $300 million in debt for these upgrades in 2009.
The city also refinanced older public debt in the water and wastewater systems. The refinancing saved the city $44.1 million in today’s dollars, according to reports made to City Council for each bond issue.
It didn’t hurt that the three credit rating agencies, Fitch, Standard & Poor’s and Moody’s, rated San Diego’s water and wastewater systems around a grade higher than the city’s general fund. Higher ratings mean lower interest rates, and less the city must pay to borrow.
San Diego’s lower general fund ratings stemmed from structural budget problems that limit the city’s cash flow options, analysts said. Problems include a high level of fixed costs from pension or other post-employment benefits. A budget deficit, such as the $179 million one San Diego faces this year, exacerbates those difficulties.
“When you have higher fixed costs there’s less room to cut,” said Petek, the Standard & Poor’s analyst. “Cities like San Francisco and Los Angeles have deficits too, but maybe they don’t have the kind of fixed costs San Diego has so maybe they have more flexibility on the expense side.”
Such considerations will be more important for the city moving forward. The city plans to refund a $103 million private bond it issued last year for deferred maintenance including street repair. The five-year financial forecast released last month anticipates two more public issues for deferred maintenance in fiscal years 2011 and 2013. These bonds are backed by the general fund.
Further, the city will be looking at refinancing other bonds that are backed by the general fund, such as those for past Balboa and Mission Bay Park improvements, Kommi said.
Should the city expand its Convention Center or build a new City Hall, bonds for those projects likely would add to the general fund’s debt load, even if they are financed through a third party.
As the city continues to issue new bonds, Petek said his agency would be monitoring its debt levels.
“Probably the larger credit point is that their larger debt pressures are on the rise, and that is something we’re looking at going forward,” he said.
One area the agencies have seen dramatic improvement is in the city’s disclosure practices. Each bond offering the city issued this year includes two pages disclosing the city’s past financial problems amid other disclosures throughout the official statements. It was the city’s failure to disclose its pension underfunding that landed the city as an entity and city officials in hot water with the federal Securities and Exchange Commission.
“They are signaling to the marketplace that they want to be crystal clear about their financial situation to investors,” Alan Gibson, an analyst with Fitch.
The city’s primary previous failing in the bond market, Goldstone said, was not its financial gymnastics related to pension underfunding, but rather the city not disclosing what it was doing.
“The city’s problem was a lack of disclosure,” Goldstone said. “If anything, now we’re going to the other extreme.”
Discussions between the city and rating agencies about fixed costs and disclosures are a long ways from the conversations the city had with agencies a couple years ago. Then questions were more likely to focus on elementary problems, such as the city’s lack of audited financial statements.
There are no ongoing penalties from their perspective, analysts said, to the city’s past problems.
“The important point is that once we got back to issuing them a public rating that’s it,” Petek said. “We’re not holding on to that other residue.”