City Pension Woes Called 'Significant'

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City Pension Woes Called 'Significant'

By Philip J. LaVelle, Union-Tribune

February 4, 2004

As San Diego Mayor Dick Murphy was making positive public remarks about the city pension system and city finances, top officials were telling a darker story to Wall Street – one of accounting errors and ballooning debts likely to force tax increases, service cuts or both.

The picture painted in financial disclosure reports, filed Jan. 27 and quietly distributed to City Council offices, led a major Wall Street credit-rating agency Monday to signal that its confidence in San Diego's financial management – something mayors here have crowed about for years – is now "diminished."

Moody's Investor Service lowered the city's fiscal outlook from "stable" to "negative," citing intentional underfunding of the pension fund and accounting errors disclosed last week to agencies that collect data on municipal debt. It also cited the possible loss of $9.5 million in property tax revenue to Gov. Arnold Schwarzenegger's fiscal 2005 budget.

The clear signal to bond investors: Moody's believes San Diego has financial problems, amplified by a troubled pension system, and unless city officials take action, a downgrade in the city's bond rating is likely. That would make it tougher to issue new bonds for a variety of city projects, while adding untold millions of dollars to the city's annual interest costs on existing bonds.

"They're going to have to somehow figure out how to raise revenues or cut expenses or both in order to balance their budget and address their problems, and I imagine it's not going to be easy," said Dari Barzel, vice president and senior credit officer at Moody's.

"The city is facing significant challenges, and we'll be watching to see how they address those in the coming months," Barzel said.

City officials have intentionally underfunded the San Diego City Employees Retirement System since 1996 and used the money – more than $100 million to date – to balance tight annual city budgets, a practice done on a scale unique among California's large cities.

The damage to the pension system was hidden by soaring investment returns, which boosted fund balances, in the late 1990s. But ensuing market declines revealed the broader damage to the system, which has been hammered not only by investment losses, but by benefit increases and continued underfunding.

In November 2002, despite warnings from pension trustee Diann Shipione, Murphy voted to continue the underfunding through 2009.

Today the fund has a $1.1 billion deficit, more than $1 billion in health care costs with no identified funding source, and tens of millions of dollars owed because of a court settlement with retirees. It faces further losses if retirees – who allege that the underfunding is illegal – win a pending court case.
For months, Murphy attributed the deficit largely to investment losses and said the situation is similar to that in other large California cities.

Moody's disagreed, saying San Diego faces greater challenges than other California cities because of the pension underfunding and the system's relatively low reserves.

Faced with the Moody's report, Murphy on Monday amended his take on the pension system, adding "10 years of city underfunding" to his assessment of its troubles. His Pension Reform Committee is studying the issue.

Murphy could not be reached for comment.

Initially, the city told Wall Street little about its pension troubles. In September, the city published a "preliminary official statement," which discloses the city's financial condition, as an initial move toward selling $505 million in sewer bonds.

The pension system merited only four paragraphs in that document, which mentioned the deficit but not the underfunding. The deficit's recent spike "resulted primarily from less-than-anticipated investment returns," the report said.

But pension system trustee Shipione, in letters sent to Murphy, council members, top city officials and the city's pension underwriters, warned of errors and omissions in these financial statements.
Underwriters, in turn, asked city officials for explanations.

City officials pulled back their sewer-bond effort, and on Jan. 27 disclosured a series of accounting errors. These reports also revealed that by 2011, the city may have to pump $306 million into the pension system, up from the $85 million required this year. But this would not improve the system's liabilities versus its assets, and by then the deficit could be $2.4 billion, the city said.

These reports also said that without new revenue or cuts in pension benefits, the projected bill "may become difficult for the city to fund without reductions in other services."

Shipione said the accounting errors falsely improved the city's financial condition. "These disclosures are the city putting the best possible face on it," she said. "It shows an intentional cooking of the books, to misstate and hide the real condition of the pension system."

Moody's did not give an opinion on whether the errors were mistakes or something worse. If misconduct were found, it would probably lead to a major credit-rating downgrade.

For now, Moody's action is a warning for investors, alerting them that a fiscal situation long depicted as sunny by city officials is cloudier than previously thought.

In the past, Moody's has noted concerns with the city's low reserves, but has said this has been offset by the city's "careful financial management."
But "this confidence has been diminished by concerns raised by the city's decision to effectively give itself budget relief by underfunding its retirement system as well as recent revelations of errors," Moody's said Monday.

The fallout could be significant. Murphy hopes to use bonds to help build his new library system, and bonds could play key roles in improving the city's neglected infrastructure, including upgrading police and fire facilities.
Additionally, the pension's troubles are likely to complicate the city's efforts to refinance the Padres ballpark bonds.

All this comes at a troublesome time for Murphy – the March 2 primary is a month away – while handing fresh ammunition to his re-election opponents, county Supervisor Ron Roberts, Port Commissioner Peter Q. Davis and environmental designer Jim Bell.
San Diego's financial prestige is also on the line.

"There's almost certainly going to be a cloud over the city, based on the actions of the municipal leaders," said Raphael Bostic, a professor at the University of Southern California's School of Policy, Planning and Development. "At some point, they're going to have to clean this up."

"This is not good news," said Fred Siegel, president of The Siegel Group Inc., a New Orleans-based firm that manages $1.1 billion in assets worldwide. "They've either got to raise taxes or cut something or both, or they're going to be paying a lot more interest for the bonds because they'll be looking at a downgrade."

Murphy has yet to call for tax increases or service cuts, and his public pronouncements have been relatively upbeat. Friday, three days after the Jan. 27 disclosures, he told a television interviewer the city has top credit ratings, "so we're fiscally strong."