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San Jose Retirement at 50 Threatens Solvency: Muni Credit

Police officers and firefighters in San Jose, California, can retire at age 50 with 90 percent of their pay. The deal has left Silicon Valley’s capital so short of cash that a library and community center has stood unused since its completion two years ago.

The predicament of the 10th-biggest U.S. city reflects the painful choices that rising public-worker pension and health costs are inflicting on municipalities. In San Jose, the burden has become a $2.7 billion unfunded liability, costing the city its AAA bond rating. Next month, voters will decide on a measure that would trim the city’s payments for its two pensions.

“Our police officers and firefighters will probably make more money in retirement than they did while they were working,” Mayor Chuck Reed, 63, said in an interview last week in his City Hall office. “We’re seeing the impacts of that on our ability to provide services.”

From California to Rhode Island, local governments are trying to curb retirement costs that are straining budgets almost three years after the end of the longest recession since the 1930s. Illinois Governor Pat Quinn proposed last month that public employees pay more for pensions. Forty-one states have reduced benefits or raised contributions, according to the National Association of State Budget Officers.

Technology Hometown

San Jose, hometown of Cisco Systems Inc. (CSCO), the biggest maker of computer-networking equipment, is looking to cut pension and retiree-health benefits approved during more robust economic times. The city of about 960,000 has two plans, one for safety personnel and one for civilians, covering about 4,700 retirees.

Police and fire personnel can retire and tap pension benefits at age 50 with 25 years of service, or at any age if they’ve worked 30 years, earning a maximum of 90 percent of final compensation, according to the city auditor. The median retirement age was 54 as of June 2009. Police and firefighters who retired since 2006 receive an average pension of about $103,000, including cost-of-living increases, according to the city.

Reed, a lawyer who served in the Air Force, attributes the benefits growth to a combination of confidence among lawmakers that stocks would appreciate, friendly relations between union leaders and City Council members and unions seeking changes granted to other cities.

“We’re competing” with other pension plans, Reed said. “It’s a leapfrog, and the unions used that very effectively in arguing for increased benefits.”

Benefit Boost

When San Jose’s pension benefits were established in 1961, police and firefighters could retire at 55 and, with 20 years of service, receive a pension of half of final compensation, according to the city auditor. In 1984, the City Council agreed to give employees and their families health care for life after 15 years of service.

The region’s economy flourished during the dot-com boom, and in 1998 the benefit was raised from 75 percent to 80 percent of final pay.

In 2002, police and fire retirees got a guaranteed annual increase and a so-called 13th paycheck when plan earnings beat expectations. Civilian employees got the extra payment in 1986 and the yearly boost in 2006.

Jim Spence, president of the Association of Retired San Jose Police Officers & Firefighters, said the pay and benefit levels are needed to recruit employees.

“They did a dangerous job and the reward for that job is they would get a decent pension,” Spence said in a telephone interview.

“I’m not going to apologize for the fact that I have a good retirement benefit because that’s something that we negotiated for,” he said. “That’s something we worked for.”

Costs Triple

Reed, who moved to San Jose in 1978, ran for mayor in 2006 after six years as a council member with the goal of fixing the city’s budget deficit and curbing spending.

Retirement costs have climbed to $245 million this fiscal year from $73 million a decade ago. In the same period, the workforce dropped 28 percent to 5,400, according to the mayor.

Reed said he began to view pension costs as a threat when he saw a chart projecting obligations would escalate to $400 million in 2016.

“We started realizing we have to cut pay, we have to cut benefits, we can’t continue on this,” he said.

Last year, Reed floated the idea of declaring a fiscal emergency, which he said would have allowed him to require concessions from employees. The same move was tried for three straight years in Stockton, California, an agricultural center about an hour’s drive away.

Stockton’s Mediation

Stockton defaulted this year on $2 million in bond payments and entered mediation with creditors. A new state law requires the talks before a municipality can seek Chapter 9 bankruptcy protection.

California has already been home to two of the largest U.S. municipal bankruptcies: Orange County, which filed in 1994 after losing $1.7 billion on investments; and Vallejo, in 2008, after failing to win union concessions.

Other California cities may be financially vulnerable, according to Matt Fabian, managing director of Concord, Massachusetts-based Municipal Market Advisors, and Karol Denniston, a Los Angeles lawyer who helped write California’s municipal bankruptcy law.

Mammoth Lakes, a ski resort community of 8,200 near Yosemite National Park, lost a lawsuit with a developer and faces a judgment more than twice the size of its annual operating budget. Hercules, a town of 24,000 near San Francisco, is saddled with debt from the state’s elimination of redevelopment agencies, as are Milpitas with about 67,000 people, and Poway, with about 48,000.

Boom and Bust

Lincoln, a Sacramento suburb of 43,000, and Chowchilla, a town of close to 19,000, saw their populations soar in the housing boom before real-estate taxes evaporated in the bust.

“We’re struggling to live within our means,” said Anna Jatczak, assistant city manager of Lincoln, where the 2011-2012 budget is 65 percent lower than four years earlier. “Everyone in California is dealing with this in one way or another.”

In March, San Jose’s City Council voted to place a measure on the June ballot that would require new hires to contribute 50 percent toward their retirement plan.

The city expects a $9 million surplus in fiscal 2013 and a $22 million deficit the following year, Jennifer Maguire, the budget director, said in an April 25 interview.

Since March 2011, Fitch Ratings, Moody’s Investors Service and Standard & Poor’s have cut the city’s general-obligation ratings to the second-highest grade.

‘Arduous Barriers’

The city’s leadership is “being significantly challenged to manage retirement costs and faces arduous barriers to reduce the impact of those obligations,” Moody’s said in a statement announcing the March downgrade.

Investors in San Jose debt are unfazed by the fiscal strains, in part because a dearth of sales by California issuers has bolstered demand.

A tax-exempt San Jose general-obligation bond maturing in September 2022 traded with an average yield of 1.14 percent on April 26, or 0.77 percentage point below a BVAL benchmark of top-rated debt. In December, the bond traded with an average yield as high as 2.84 percent, almost a percentage point above the AAA bond.

San Jose’s 40,000-square-foot Bascom Library and Community Center, empty since 2010, was paid for out of proceeds of a $212 million bond voters approved in 2000. Three other libraries and a police substation, all newly built, are also unused.

Fiscal Emergency

On top of trimming pension costs, the mayor’s plan would also give the City Council authority to temporarily suspend annual pension increases during a fiscal emergency. It eliminates the extra paycheck and voters would approve any future benefit increase.

“We are already in a position where services are substandard,” Reed said. If the measure fails, the city will be a year away from a “service-level insolvency,” meaning it will have money to pay its bills only by cutting services, he said.

Reed, whose term expires in 2014, said the pension issue will define his tenure as mayor.

“Failure is not an option, because it will result in really bad things happening to the people of San Jose,” he said. “My job is to avoid that, to look ahead to the future and to take the steps necessary to avoid a disaster.”

Following are pending deals:

OHIO HIGHER EDUCATIONAL FACILITY COMMISSION is set to issue $175 million of revenue bonds as soon as tomorrow on behalf of the University Hospitals Health System. Banc of America Merrill Lynch is the underwriter. Moody’s rates the deal A2, sixth- highest. (Added May 1)

DISTRICT OF COLUMBIA plans to sell $329 million in revenue bonds as soon as this week. The debt, backed by the district’s income taxes, will be used for refunding, according to data compiled by Bloomberg. S&P rates the bonds AAA, its top grade. (Added April 30)

LOS ANGELES plans to issue $300 million in wastewater revenue bonds as soon as this week, according to an offering document. The debt will be used for refunding and divided between senior lien bonds and subordinate bonds. (Added April 30)

To contact the reporters on this story: Alison Vekshin in San Francisco at avekshin@bloomberg.net; James Nash in Los Angeles at jnash24@bloomberg.net

To contact the editor responsible for this story: Stephen Merelman at smerelman@bloomberg.net

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