SAN FRANCISCO - In a state plagued by budget deficits, the bad news from California's pension fund for municipal employees in November was like rubbing salt in a wound.

The California Public Employees Retirement System notified public officials throughout the state that because of investment losses it might have to impose an increase of as much as 5% in their required contributions to the fund, a hit that would be the roughest for public employers since the dot-com bust. That estimate was based on a worst-case scenario in which the fund's investment returns for the 2008-09 fiscal year declined by 20%.

Although the exact figures won't be known until the end of the current fiscal year, finance directors have already started to prepare for the worst, cutting costs by freezing compensation, leaving positions unfilled, and even considering some service cuts.

While rating analysts don't expect the credit quality of California cities to suffer significantly, they note that the specter of a Calpers cost increase only exacerbates the budgetary pressures municipalities already face.

"Calpers' increased contributions are just going to be another contributor to the general credit stress that we anticipate," said Eric Hoffman, an analyst with Moody's Investors Service. "By itself it's not likely to cause us to change any municipality's rating, but it is a negative credit pressure, there's no question."

Cities across California and the nation are suffering from reduced sales tax revenue as the recession curbs economic activity, as well as declining property tax receipts resulting from shrinking home values. San Diego, which doesn't even participate in Calpers, is facing a $45 million budget shortfall next year. Sacramento is looking at a $50 million deficit.

The fact that Calpers' $181 billion portfolio lost about a quarter of its value in the fiscal year that began July 1 - and could increase required contributions from employers - only sharpens the pain. Calpers expects to report a paper loss of as much as 103% on its housing investments this year.

On a positive note, any Calpers contribution changes reported at the end of this fiscal year wouldn't affect California municipalities until fiscal 2011-12.

Cities contacted for this story all said they don't expect their credit ratings to suffer as a result of the squeeze from Calpers, but most are adjusting budgets with the worst-case scenario in mind.

"The increase we're projecting based on the preliminary PERS guidance indicates about a $5 million impact to our general fund, which is less than 2% of the total revenues that are projected for the year," said Santa Monica finance director Carol Swindell, whose city has a general fund budget of roughly $250 million and an all-funds budget of just under $550 million. "The city also has a strong reserve and fund balance position, which helps us to manage how we deal with the future challenges."

Swindell said Santa Monica has already set aside a reserve fund to deal with rising Calpers costs. She added that she's planning to ask the City Council at a meeting scheduled for the last week in January to establish an "economic uncertainty fund" to help Santa Monica deal with general economic pressures.

Torrance, in Los Angeles County, already has a reserve fund for economic anomalies that totals between $12 million and $14 million, according to finance director Eric Tsao. The city would only draw from that fund if it couldn't find other ways to balance the budget, which it's already working on doing, he said, by cutting staff through attrition, trimming spending growth, and restraining wage increases.

On top of a revenue decline of as much as $3 million, mainly from falling sales tax income, the city is anticipating losses of as much as 33 % in its Calpers portfolio, which at its height was valued at more than $900 million, according to Tsao.

Although the city expected that Calpers would be hit by the economic downturn, the magnitude of its decline was much larger than expected. "We expect our rates to jump in the ballpark of $4 million to $4.5 million in the 2011-12 fiscal year" to make up for the roughly $300 million loss the city expects, Tso said.

In Roseville, a suburb of Sacramento, officials have already implemented measures to restrain costs, including cutting raises, eliminating positions through attrition, and offering early retirement to city workers. Travel budgets have been trimmed, and spending on materials, supplies, and services has been slashed by 20%.

The city is also considering asking employees to pay their share of contributions to the Calpers plan; currently the city pays the employee portion as well as the employer portion of the required contribution from Calpers, according to finance director Russell Branson. "We have so many other pressures on our revenues that it's difficult to absorb increased costs right now," he said.

Sunnyvale, in Silicon Valley, in 2007 had already projected that the economy would begin to slump in 2008, although "naturally, we did not project the end of the world as we know it," said finance director Mary Bradley.

But because the city works on a 20-year budgeting cycle, it's in better shape than many municipalities, she said. Out of an overall budget of roughly $300 million, the city's annual Calpers contributions are likely to rise only $3.5 million under a worst-case scenario - though that doesn't mean the city won't be slicing expenses, she said.

Sunnyvale is now anticipating a $12 million decline in revenues from what it had previously projected, and could experience a $3.5 million increase in contributions to Calpers, using the worst-case scenario.

"Right now we're looking at all operational activities to see how much we can do to tighten and save with the least impact," said Bradley, who waxed philosophical about the city's current budgetary pressures.

"As economic fortunes decline, costs sometimes go up," she said. "It's just a matter of weathering this particular storm."

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