Seattle sells bonds despite havoc in the credit market

Seattle went to a dangerous place — Wall Street — seeking money last week: $216 million for lids on reservoirs and other water-system improvements.

It was a big leap amid the credit markets' collapse earlier this fall.

From the city's perspective, the bond sale went well. But it almost didn't happen, Finance Director Dwight Dively says.

Nervous city money managers decided to proceed less than 48 hours before the sale was held.

The anxiety the sale generated for Seattle, a city with one of the highest bond ratings in the nation, is a sign of the havoc the nation's financial mess has wreaked among state and local governments.

The crisis has slammed not only their operating budgets, but also their investment portfolios and their ability to sell bonds — which is how they borrow money — for big-ticket projects.

"They're getting hit just like businesses are," says Rich Yukubousky, executive director of the Municipal Research and Services Center of Washington, a local-government information clearinghouse.

Public-employee retirement funds managed by the Washington State Investment Board have lost more than 20 percent of their value since last fall. Some big short-term government-investment accounts are earning less than half what they did a year ago.

Local governments with good — but not great — bond ratings are having more trouble finding investors to finance capital projects. Some have delayed scheduled bond sales, hoping the market will improve next year.

Some who expect to go to market soon fear they may end up paying higher interest rates, which could result in higher taxes or utility rates to pay off the bonds.

But Seattle's sale this week suggests that the bond market, while still tight, is healthier now than in late September, when it essentially shut down.

In Washington state, governments' short-term investments have relatively little exposure to the troubled instruments that have defaulted and caused big problems elsewhere.

"There are no disasters here," says attorney Hugh Spitzer, a public-finance specialist.

And, despite shrinking portfolios, the state's pension funds still generate plenty of cash to pay current retirees' benefits, says Joe Dear, executive director of the state Investment Board.

The State Investment Board manages investments for 38 funds. By far the largest are the 17 retirement funds for state and local government workers, teachers, police officers, firefighters and other public employees.

On Sept. 30, 2007 — before the crash — those funds held assets valued at $65 billion. By Oct. 17 of this year, the last date for which an estimate is available, the combined portfolio was worth about $52 billion, Dear says.

But the board has no plans to alter its investment strategy, which calls for a diversified portfolio of stocks, private equity, real estate and fixed-income assets.

"The important thing to remember is, these are cycles," Dear says. "Because of the nature of our work, we have the longest time horizon of anybody."

The retirement funds lost 1.2 percent of their value in fiscal 2008, which ended June 30, and could lose more in 2009. But those losses come after four years of double-digit gains, topped by 21 percent growth in 2007.

The board aims for an 8 percent annual return over the long term. Because of the cushion from past years, a rate of return of 2 percent or more in fiscal 2009 would keep the funds on course, says State Actuary Matthew Smith.

If returns fall short, the Legislature could raise contribution rates for employers and employees, he says — but any increases wouldn't take effect until 2011.

The State Investment Board also manages investments for the state's GET college-tuition savings program and funds that benefit injured workers. Because Treasurys and other fixed-income investments account for a larger share of their assets, those funds have suffered less than retirement funds, Dear says.

On the debt front, the turmoil in the credit markets has kept many municipal borrowers away from Wall Street this fall. Across the nation, governments are delaying projects because they can't borrow money to finance them.

In October, Washington governments sold $157 million in long-term fixed-rate bonds — down from $400 million in October 2007, says Dick Schober, managing director for public finance at Seattle-Northwest Securities, one of the region's largest underwriters.

Small to mid-sized cities, school districts and other jurisdictions with bond ratings that are good, but not top-notch, are having an especially difficult time getting capital, he says.

Tactic no longer worked

Before the crisis, they effectively could have bought a higher rating — and a lower interest rate — by purchasing bond insurance. But those insurers are in financial trouble themselves, so that tactic no longer works, Schober and other observers say.

There are fewer prospective investors — many may have fled to the safety of Treasurys — and those that remain "are being very selective," Schober says.

The Port of Seattle last month delayed until next year a planned bond sale to finance purchase of the Eastside rail line from BNSF. Spokeswoman Charla Skaggs says Port officials were concerned that the bonds would have sold now at an unreasonably high interest rate — if they sold at all.

Longview plans to sell bonds next spring for water- and sewer-system improvements. City Manager Bob Gregory says the interest rate buyers demand could be 1 to 2 percentage points higher than the city had anticipated.

That could translate into a 10 percent increase in city utility bills. If the market doesn't improve, Longview may have to reconsider, Gregory says.

Seattle sold its water bonds last week to Merrill Lynch, the lowest of five bidders, for a total interest cost of 4.99 percent. Dively says he's pleased.

But several weeks ago investors — if there were any — would have demanded 6 percent or more, he says. And an increase of one percentage point in the interest rate could have meant a 2 percent increase in water rates.

The state plans to sell up to $864 million in bonds in January, its first offering since the crisis hit. Many will finance transportation projects.

State Treasurer Mike Murphy says the State Finance Committee, which he chairs, will review the sale Dec. 3. He expects it will proceed. The state's bond rating is high, he says, and the market is improving.

"There's plenty of money out there, but there's been a whole lot of uncertainty," he says.

Eric Pryne: 206-464-2231 or epryne@seattletimes.com