S.D. Cautious on ‘Lucrative’ Bonds

It’s a bold, innovative and potentially lucrative way for cities to raise funds. It could also be risky.

Which is why San Diego officials say they’re proceeding oh-so-cautiously with their tentative plans to issue up to $400 million in taxable bonds under a relatively new “guaranteed investment contract.”

City officials Monday interviewed five underwriting companies that survived the cut from 18 applicants and plan to make their recommendations to the San Diego City Council next month.

The plan works like this: The city issues as much as $400 million in AAA-rated, 10-year bonds that carry, say, 8.5% interest. The city turns around and, through an underwriter, invests nearly all of the proceeds, say $390 million, in a guaranteed investment contract, or GIC, of one or more insurance companies.

The insurance firm then assumes responsibility for meeting the debt service on the original $400 million, but will sell the bonds, at a profit of course, to private companies.

The city ends up pocketing, in this example, $10 million, the insurance company turns around and sells the bonds to private companies for a profit at a higher interest rate, and the private companies borrow money at a lower interest rate than they could secure through a bank or savings and loan.

In addition, the insurance company avoids filing regulatory documents that would be required if the bond offering were done privately.

If the insurance company should default on the bond payments, the city would not be liable, according to Jack Farris, an economist with the city’s Financial Management Department.

The risk is that the city’s name would be on the bonds, and that could negatively affect future efforts by city officials to finance projects.

The applications for would-be underwriters emphasizes the city’s concerns about that risk.

“How would the city’s bond rating be affected by a default of a GIC provider,” the proposal reads. “There is a concern that (the bonds) may have a negative impact on the marketability of future city general obligation . . . financings of such projects as a new Central Library, Balboa Park and Mission Bay improvements, and an office building for city employees.”

Several other similarly skeptical questions are contained in the proposal request.

No other California city has yet issued bonds under a GIC, so the San Diego proposal may be breaking new ground, officials said. Only a couple of other cities have tried it, including Memphis, Tenn., which was the focus of a recent Forbes magazine story.

The potential risk is remote, maintained Hal Kuykendall, a local financial consultant who is representing a joint venture that is among the five finalists to underwrite the bond issue. (The identity of the other finalists hasn’t been disclosed.)

“We’re proposing (that) only the highest-rated life insurance companies be used,” he said.

Kuykendall, a former finance director for the San Diego Housing Commission, said he first broached the taxable bond issue with city officials a couple of months ago.

“They’re proceeding cautiously (and will) evaluate the risk and decide,” he said. “I think the city should be cautious. If they thought it would affect their rating, we all should back away from it and . . . not do it.”