Finishing his first year in office, Philadelphia Mayor Michael Nutter can take credit for shedding new light on the city's fiscal operations and for a reduction in crime.

Fiscal stability and ethics reform have been at the forefront of the mayor's agenda, yet the city's revenues have been hard hit by the national recession, prompting cuts to programs and employee layoffs.

Those same economic forces will present challenges to the city in coming years. Like other municipalities, Philadelphia faces higher borrowing costs given current conditions in the troubled credit markets. And that will complicate efforts to deal with severely underfunded pension liabilities and other fiscal issues.

Following a recent meeting in Manhattan with New York City Mayor Michael Bloomberg to talk about budgets and the faltering economy, Nutter spoke with The Bond Buyer about these problems and his goals for the city.

Addressing a $108 million shortfall in the current budget and an estimated $1 billion deficit over the next five years required Nutter to revise Philadelphia's $4 billion fiscal 2009 budget with spending reductions and a postponement of corporate-tax reductions. That $220 million initiative could have helped spark business activity and job creation in the private sector. While the city tightens its belt, Nutter's focus is to keep pertinent public services intact.

"Our absolute, iron-clad method is that we will have a balanced budget and that we will take the necessary actions - quickly and swiftly and reasonably as possible - to ensure that we are preserving our core services and to be mindful of the impact on the most vulnerable populations, children and senior citizens," Nutter said. "And that we are particularly careful to figure out the long-term implications of the decisions and actions that we take today. Those are the three guiding principals around how we dealt with this financial crisis."

The city in mid-December was able to capture a financing opportunity - although at higher current interest rates - on $186 million of new-money general obligation bonds. Original plans called for Morgan Stanley to hold a retail pricing on Dec. 15 and institutional bidding the following day. After selling more than $100 million in retail, officials decided to increase the deal size and open the sale to long-term buyers, selling the debt in one day.

The bonds, insured by Assured Guaranty Corp., will mature from 2009 through 2018 with term bonds in 2023, 2028, and 2038. Yields range from 3.50% with a 4% coupon in 2009 to 7.25% with a 7.125% coupon in 2038.

Moody's Investors Service and Standard & Poor's assign Philadelphia underlying ratings of Baa1 and BBB, respectively. Fitch Ratings assigns its BBB-plus rating to the city.

"I think that the schedule was light so we were one of the only, if not the only, new-issue pricing [Monday]," said city Treasurer Rebecca Rhynhart. "We also heard investors liked the coupons close to the yield or being equal to the yield in a lot of maturities."

While retail demand is high, Matt Fabian, managing director at Municipal Market Advisors, said Philadelphia's GO deal could be a sign of higher borrowing costs for issuers.

"It's an indicator of where deals have to be priced," Fabian said. "Seven percent could well be a very common level going forward. I mean, this could be helping to set a new level - seven percents could be the new six percents."

Along with Morgan Stanley, Merrill Lynch & Co. and Siebert Brandford Shank & Co. served as co-senior managers on the deal. City officials opted to sell the deal via negotiation rather than competitive bid due to difficult market conditions, according to city finance director Rob Dubow.

"We still want to do competitive as much as we can," Dubow said. "But given how turbulent the market was, we thought we really needed to go negotiated. But, we've established systems where for every time we're going to select a bond professional, we get a committee together and we go through all the proposals. We have a score sheet, we score them all and whoever scores the highest is who we wind up picking."

Philadelphia would like to issue debt through open bidding to make for greater transparency, especially in light of corruption and cronyism scandals in 2002 through 2004. The city's former treasurer, Corey Kemp, currently is serving a 10-year sentence for allowing the late Ronald White, a prominent local bond lawyer, to pick and choose investment banking firms. Prosecutors said White allocated underwriting business to his clients.

Cleaning up city government was one of Nutter's top priorities when he took office in early January and he appointed two former U.S. attorneys to help bring back transparency and openness. Over the past year, city inspector general Amy Kurland and Philadelphia's first chief integrity officer Joan Markman have been working with city officials to help maintain ethical standards.

"It helps in my cabinet as they interact with all the deputy mayors and commissioners and other cabinet officers on a regular basis to provide guidance and training and leadership for them as well," Nutter said. "So it's a good group, and I think when you have that constant reminder it does help keep it in the forefront of your mind as opposed to way in the back."

Along with ethics reform, Nutter is focused on decreasing Philadelphia's pension and health care costs, which currently take up 21% of the city's budget.

The city's pension payments will only increase, as the roughly $3.8 billion fund's value dropped 12% in the month of October, with the pension's funding level now below 50%, Nutter said.

The city would like to issue $3.5 billion of pension bonds to help boost the fund and keep pension payments level, yet market conditions are such that the taxable transaction is on hold. Postponing the sale requires the city to take on $300 million in additional pension costs over the next five years. Once Philadelphia is able to issue the debt, net savings will be roughly $35 million per year and won't begin until fiscal 2011.

Yet a prior pension bond sale did not help the city over the long run. Philadelphia sold $1.3 billion of POBs in 1999, and nearly 10 years later, the city's pension fund challenges continue. Nutter, who worked on the municipal desk at Pryor, Counts & Co. before his 15-year career in the City Council, said his finance team is evaluating how to avoid prior POB financing errors.

"We did a big borrowing in the late '90s and from a pure timing standpoint I think everyone's pretty much in agreement that it came about at one of the worst times in the marketplace," Nutter said. "The city took all the money in, and out of all this our folks have done a lot of research, a lot of analysis. But we've also learned a lot of lessons on what to do, what not to do. The financing and even the need for the dollars was all played out in the way to avoid many of the danger areas that the city found itself in in the late '90s and to not make those mistakes again."

For more structural changes, the city formed a joint labor management health care evaluation committee comprised of union leaders and city officials to help draft reform proposals to reduce costs. In addition, Nutter is pushing for restructuring Philadelphia's government by potentially merging different departments in an effort to reduce the city's expenses.

"Our general belief here is that we're not going to be able to cut our way out of this financial situation and we can't just sit around waiting and hoping that things are going to get better."

Fitch Ratings has praised Philadelphia's recent fiscal management.

"With regard to Philadelphia, the management team and the mayor have been extremely pro-active in revising their budget assumptions," said Fitch analyst Chris Hessenthaler. "They've implemented several measures which were probably difficult, to a degree, to implement. They've delayed some business and wage tax cuts, which is huge, and they've implemented layoffs, which I'm sure was difficult. They've done a number of things that have been very hard [in order] to adjust to the economic downturn and I think that management is a credit here. They've been very proactive."

Many in Philadelphia's business community support the mayor's decision to postpone reductions in the net income portion and the gross receipts portion of the business privilege tax because Nutter has included business leaders in civic planning discussions and has pledged to decrease those taxes when the city's economy returns, according to Mark Schweiker, president of the Greater Philadelphia Chamber of Commerce.

"Because of the confidence in Mayor Nutter and the economic downturn, the prudent course was to accept the thinking with the understanding that two pursuits would be considered," Schweiker said. "One, that as soon as economic conditions improve the business tax reductions would continue again, and the second was that in the interim, the business leadership of the city and this organization would have the opportunity to help pursue efficiencies and participate actively in the task force that the mayor has put to work on this."

Nutter and other officials wanted to lower corporate taxes to help bring more business development and corporate expansions into Philadelphia to help create jobs and expand the city's tax base. Getting the word out to prospective businesses is one of Nutter's tasks. He stressed the city's proximity to New York City and Washington, D.C., the many port facilities in the greater Philadelphia area, the 15% drop in crime over the last year, and the city's cultural history.

"I think Philly has some great strategic assets and advantages so I'm always thinking about how to better promote who we are and what we're about," Nutter said.

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