San Diego Business Journal

Pension Problem Limits S.D.'s Ability To Issue New Bonds

BY MIKE ALLEN

Once one of the most fiscally well run municipalities in California, the city of San Diego is looking like just the opposite, forced to deal with the grim realities of its severely underfunded employee pension plan, and apparently unable to borrow by issuing municipal bonds.

The latter problem is a direct result of the former, and compounded by a dual investigation by the U.S. Attorney's Office and the Securities and Exchange Commission into the city's financial matters.

The federal probes were launched in February after the city revealed it made errors in its financial reports for the past two fiscal years regarding its pension plan and its sewer fund.

Following the disclosures, the city's credit rating was downgraded by bond rating agencies Standard & Poor's and Fitch, while Moody's put the city on a credit watch. All this, combined with the federal probe, caused the city to back off from plans to refinance higher interest debt, including Petco Park bonds.

With a probable hike in interest rates coming later this year, the city may have lost its chance to refinance debt at the lower rates, according to some investment professionals.

'Difficult' To Sell Bonds Now

"Knowing the interest rates were going up, it would have been probably better to pay the higher premiums," said John Chalker, managing director for LM Capital Management, a San Diego-based bond investment firm. "It would be difficult to sell the bonds now."

Answers to a series of written questions by the San Diego Business Journal posed to the city's finance director, Deputy City Manager Patricia Frazier, shed little light on the problem.

"We do not know the timetable for completion of the investigations by the SEC and U.S. Attorney, nor do we know how they may conclude their investigation," Frazier said.

San Diego had planned to refinance at least three different bond issues, including $169 million for bonds issued in 2002 for Petco Park at 7.66 percent, a higher than market rate required because of pending litigation on the project. The ballpark lawsuits have since been resolved.

The city's disclosure documents released in January and March contain arcane language concerning various errors, but following each detailed explanation, a statement follows: "This did not affect the actual financial statements as such."

Frazier said the sentence means the city's "internal and external auditors did not believe the errors, individually or in the aggregate, to be material in relation to the financial statements taken as a whole."

Asked to provide some total dollar amount to the size of the errors, Frazier wrote: "There is no way to indicate the aggregate impact of the errors, as they relate to a variety of issues, not all of which are comparable."

One Problem Supersedes All

While the city grapples with a variety of financial constraints and begins making severe cuts to its 2005 fiscal year budget, one issue supersedes all others: a $1.1 billion under funding of the city employees retirement fund.

Diann Shipione, one of 13 trustees on the City Employees Retirement System, read the disclosure statements provided to Wall Street analysts and was blunt in her assessment of what the reports mean.

"The disclosure statements confirm the city is cooking the books," she said.

Last September, Shipione sent a memo to Larry Grissom, the administrator of the city's $3 billion pension system, asking clarification regarding funding for the pension plan. The information contained in disclosure statements issued in advance of a planned refinancing of some $500 million in sewer revenue bonds didn't make sense, she said.

The memo was copied and sent to San Diego Mayor Dick Murphy. In September, Murphy appointed a pension reform committee to investigate the pension issue and come up with a solution.

Because of the city's decision to contribute less to the employee pension fund, done in agreement with the employees' labor unions since 1996, the accumulated deficit as of June 2003 is in excess of $1.1 billion, or 67 percent of what it should be, according to city disclosure statements.

Unaddressed, but perhaps even more critical, is whether the city is also on the hook for paying health benefits to all its retirees, which would boost the unfounded liability by another $1 billion, Shipione said.

"There is no relation to what the city promises to pay (retirees) and what it can afford to pay," Shipione said.

San Diego's finance woes have been exacerbated by those of the state, yet even California has been able to tap into the public markets to obtain some $7 billion in economic recovery bonds earlier this month.

Bill Holland, business editor for KFMB-AM, said the state's bonds were a success because of all the "sweeteners," built into the bonds, including obligating part of the sales tax as well as the state's general fund for repayment.

Obligating different revenue streams and paying above market interest rates may be the only way the city can return to the public markets, Holland said.

"Right now, the city can go out and (issue new bonds) anytime they want to, but they'd have to pay through the nose because of (the rating downgrades and investigations)," he said.

New Bond Issue Unlikely

Yet given the cloud of a federal probe, it's unlikely the city would move ahead with any bond issue, he said.

Should the city be found liable for purposely deceiving the public about its financial health, the city's credit ratings might be downgraded to below investment grade or junk bond status. That would cause most institutional investors to automatically sell San Diego's bonds because of rules prohibiting funds from holding such risky debt.

"If you start lying to the system, you're dead meat," Holland said.

San Diego City Councilwoman Donna Frye said she is frustrated by the lack of information concerning the city's financial problems, and what city staffers are doing to resolve matters. The city is now considering using a private placement entity to issue short-term debt called tax anticipation notes, but Frye said she isn't certain what this will ultimately cost.

"As best I can understand it, when you're in a bad financial situation, in litigation, and in an adverse situation, you have to do things another way," Frye said. "This would possibly be through a private placement (similar to how the city issued its ballpark bonds) and will mean higher interest rates."