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San Diego Ready to Bond

SAN FRANCISCO - Is San Diego ready for its close up?

"Yes, we are ready to get back in the public bond market," chief operating officer Jay Goldstone said this week, after the Securities and Exchange Commission charged five former top city administrators with securities fraud for failing to disclose the city's unfunded pension liabilities to investors.

California's second biggest city - locked out of the market since a pension and municipal disclosure scandal broke in 2004 - has cleaned up its act, according to Goldstone and his boss, Mayor Jerry Sanders.

Sanders, who took office in a special election after predecessor Dick Murphy resigned at the height of the pension scandal, has trumpeted San Diego's "tough" financial reforms in his reelection campaign and his pitch to Wall Street.

Goldstone said the city has replaced most key financial personnel, consolidated budgeting, treasury, and debt management under a new chief financial officer, formed a disclosure practices working group with members from inside and outside the mayor's administration, replaced its external auditors, and proposed a charter amendment that would make the internal auditor independent of the administration.

San Diego has now implemented three-quarters of the financial controls recommended by the risk-management consultancy Kroll Inc. during an investigation led by former SEC chairman Arthur Levitt. The city continues to work under the watch of a muni market disclosure consultant imposed by the SEC when regulators sanctioned San Diego for its disclosure practices in November 2006.

"The city has put some very tight procedures in place that have cleaned up the problems of the past," said Goldstone, who was hired by Sanders as the city's first chief financial officer after the pension scandal. He's since been promoted to chief operating officer.

Fitch Ratings last month revised its outlook to positive from negative on its BBB-plus rating, suggesting the city may be on the verge of a comeback. It rated the credit AAA before the pension scandal.

Top city officials, including the mayor, will travel to San Francisco next week to meet with analysts at Standard & Poor's, which withdrew its AA-minus rating on the city in September of 2004 because San Diego couldn't provide updated financial statements.

The city released four long-delayed certified annual financial reports in the past year, catching up with its 2006 report last month. It plans to issue its 2007 CAFR in June or July.

Standard & Poor's would not comment on San Diego specifically. Analyst Gabe Petek said the agency takes a close look at both financial results and internal controls before reinstating any withdrawn rating.

"To reinstate a rating, it entails a full review of the entity's financial performance - based on thorough review of all necessary financial reporting documents such as audits, CAFRs, budgets, pension and OPEB actuarial valuation reports, etc. - and financial management practices, which includes financial controls," Petek said.

"We have no commitment, but it's my hope that they'll go to their credit committee following that meeting," Goldstone said. "We think we deserve to have our credit rating reinstated" because city officials have made strides in "cleaning up the problems that we inherited."

Sanders and Goldstone have also requested meetings to make their case for higher ratings at Fitch and Moody's Investors Service. Moody's, which had rated San Diego Aa1, currently rates the city A3.

The city has about $1.7 billion of long-term bonds outstanding. It has sold short-term debt in private placements since 2004 and plans to borrow another $103 million in a private placement to Bank of AmericaNA, pending city council approval.

The city's exile from the public bond market has cost taxpayers, both in additional interest costs of as much as $2 million since 2004 and in delayed infrastructure projects, according to Goldstone. "We have big needs," he added, citing $1.4 billion in needed water and sewer projects.

Goldstone said the city's plan is to regain its Standard & Poor's rating, to publish its 2007 CAFR, and then bring a "plain-vanilla" wastewater bond deal to the public market in the second half of the year. It may have to sell this first round of story bonds via negotiation, but it will issue them competitively if possible.

Not so fast, says San Diego city attorney Michael Aguirre.

"The pension system continues to spiral out of control," he said. "We haven't raised any new money, and we haven't gotten rid of any benefits yet."

Goldstone acknowledges that the city still faces a $1.2 billion unfunded pension liability, but he said the city is now fully acknowledging and addressing the problem. It now pays new obligations as they accrue, and it will offer smaller pensions to new workers beginning in 2009. The city also has considered issuing pension obligations bonds.

"The city attorney has been fighting the pension benefits and lost at the trial level, and he's trying to figure out other things he can do to roll back benefits," Goldstone said. "If he's successful, great. It would improve our financial situation, but the mayor does not have the authority to unilaterally roll back pension benefits that have been granted."

In the meantime, the city has cut the amortization period for its unfunded pension liability to 20 years from 28 years to more quickly pay down the debt. It is no longer accepting new employees into the retirement health plan. It is still only paying about half the annual required contribution on the plan's $880 million unfunded liability, but the mayor is increasing payments annually and plans to fully fund the required contribution within five years.

Aguirre said that's not good enough, calling the mayor's financial reforms "cosmetic." He said the city still employs financial officials who worked under the now disgraced former administration.

The mayor, chief operating officer, chief financial officer, budget director, controller, and internal auditor are all new, Goldstone said. Only debt manager Lakshmi Kommi remains, and she has a reputation for both competence and trustworthiness, he said.

That means it's time for the city to start addressing pressing capital needs. The city's fiscal 2009 budget, which will be presented to the City Council Monday, calls for $574 million of capital spending, with about three-quarters of it debt-financed, Goldstone said.

The mayor announced Tuesday that he will introduce a $3.2 billion all-funds budget that will be balanced, as required by law.

San Diego's tax and fee revenues are forecast to be "fairly flat" with growth of just 1% to 2%, as the economy continues to suffer from the housing market slowdown, Goldstone said. But the budget would cut 127 positions and benefits from an increase in state transportation aid to fund a 7.4% increase in general fund expenditures.

"We have financial challenges - who doesn't?" Goldstone said. "But San Diego's biggest problem was disclosure. The fundamentals are fairly strong. We've strengthened our controls and put safeguards in place. And that's why I say we are ready to go back into the market."

 

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