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San Diego Ready for Its Return

SAN FRANCISCO - San Diego will be back in the municipal bond market next month for the first time in four years.

California's second-biggest city hopes a handful upgrades and four years of financial reforms will convince investors that the city has recovered from a pension scandal that pushed it out of the public municipal bond market for four years.

The city published a preliminary official statement before Christmas and plans to sell $64 million of water revenue bonds through the San Diego Public Facilities Financing Authority during the second week in January. The debt will refinance a $57 million private placement sold in 2007.

The city has to refinance now - despite recent market turmoil - because the private placement is maturing. The surge in long-term rates forced the city to delay a $245 million economic refunding until the market improves. Officials may still add that into the deal if the market makes a quick recovery in the New Year.

"The timing isn't the best," said chief operating officer Jay Goldstone, who was brought in after the scandal to oversee the rebuilding of the city's financial operations. "But at least it's small enough that I have every expectation that there will be a market for it and that we will get this deal done."

Just getting a deal done would be a major milestone for San Diego. The Securities and Exchange Commission sanctioned the city for securities fraud in 2006 for failing to disclose the extent of its unfunded pension liabilities. The scandal cost the mayor, city manager, and most top financial officials their jobs. The city has spent the past four years with limited access to capital through private placements.

The road back to the bond market has included a long series of reforms, including creation of new positions for an independent budget analyst office and a chief financial officer and the formation of an independent audit committee and a disclosure practices working group.

The DPWG vets San Diego's bond documents in minute detail. The City Council spent hours trying to make sure the city's POS was as accurate as humanly possible. Director of debt managment Lakshmi Kommi and the city's financing team footnoted every single statement in the document.

They mercifully left the footnotes out of the published document, but Kommi and disclosure counsel John McNally, of Hawkins, Delafield & Wood LLP, showed during City Council hearings in November that they can cite them chapter and verse.

San Diego's reforms have convinced the rating agencies that the city is ready to be trusted again. It has gotten upgrades from all three major rating agencies this year. Fitch Ratings and Moody's Investors Service upgraded the city's general obligation, lease revenue, and water system bonds earlier this month. The upcoming senior-lien water deal is rated AA-minus by Standard & Poor's and Fitch and A1 by Moody's.

"The upgrades reflect Fitch's recognition of the city's significant management, structural, and procedural changes, many implemented in response to the city's pension funding and disclosure turmoil and a widespread study commissioned by the city," Fitch analysts Amy Doppelt and Alan Gibson said in a report.

The agency said the city is suffering a "severe dislocation" in the housing market and continues to face high pension costs. The city actuary said San Diego's accrued unfunded pension liability was $2.7 billion as of Oct. 31.

Fitch said the city had "acted quickly" to address a shortfall in revenues this year and came into the year with good fund balances.

The water system, which serves 1.3 million people and has about $790 million of outstanding debt, expects to fund about 80% of its five-year, $724 million capital plan with debt.

Moody's said the system has "significantly improved" its financial performance in recent years. The water system is increasing rates by 6.5% a year to help fund the increased capital spending. Its debt service coverage ratio rose to 1.99 in 2007 from 1.02 in 2004.

"Despite the anticipated increase in debt, rate increases already in place through 2011 will continue to provide strong debt service coverage, and with the planned capital improvements, the system will have met most of its long-term capital needs for the foreseeable future," Moody's analyst Kevork Khrimian said in a report.

The upcoming water deal will be sold by a syndicate led by Morgan Stanley. JPMorgan is co-senior manager. Fullbright & Jaworski LLP is bond counsel.

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