A recent segment on the long-running CBS show 60 Minutes featured an episode on the precarious financial health of state governments titled “The Day of Reckoning.” While much of the focus was on State governments, those being interviewed and in-the-know discussed how the dire financial situation of state governments is likely to rapidly trickle down to local municipalities, counties, and schools if something isn’t done soon. Meredith Whitney, a financial analyst on Wall Street who accurately predicted the banking crisis was quoted as saying, “The most alarming thing is the level of complacency…” when discussing what she believes is the single largest threat to our economy—a potential financial meltdown of state and local governments.
Whether you are a finance officer, a member of a governing body, auditor, or involved in some other financial responsibility of government finance, you likely have a keen awareness of the reliance your government probably has upon funding from state and federal governments. While some form of tax revenue usually makes up the majority of revenue sources, intergovernmental revenues are almost always the second most important source of funding for local governments. Perhaps never in recent history have the questions begged to be asked as they are now: Where does my local government sit financially? How able are we to weather an economic crisis if state or federal funding is not present as it is now?
One of the most commonly asked questions I receive when presenting annual financial statements to governing bodies is: How much fund balance should we have in our General Fund? While my response is always, “it depends”, there is guidance available which can assist you in developing a fund balance policy for your government, if you do not already have one. The Government Finance Officers Association has a recommended policy suggesting unreserved fund balance in the General Fund to be no less than two months of operating expenditures. Rating agencies look for similar percentages.
If your government does not have a fund balance policy, you should consider developing one. Doing so will accomplish several items, including a resulting discussion with the decision makers on what your government considers adequate. It also establishes an understanding with future policy makers that this is a policy that has been established with well thought out consideration for the long-term stability of your government’s primary operations. It allows for consistency and sets parameters that can be utilized as part of the budgeting process. It also should result in favorable results from rating agencies, such as Standards & Poor and Moody’s.
The appropriate fund balance level as determined in the policy will be dependent upon a variety of factors. These may include potential fluctuations in revenue sources, anticipated expansion or contraction of services, the availability of temporary financing, as well as the overall comfort level, history, and financial culture of management and the governing body. State and Local Government Industry Insights
You should evaluate your revenue sources for your governmental funds and determine what kind of impact decreases or stoppage of state and/or federal revenues have had and will have on operations. If you budget unreliable intergovernmental revenues for ongoing operations, you may be putting yourself at risk. These types of intergovernmental revenues may be more appropriately budgeted for capital or discretionary areas. Track the percentage of revenue sources such as taxes, charges for services, intergovernmental, etc. for the last five to ten years and compare them across revenue sources. If your reliance upon intergovernmental revenues is significant or increasing, this may be cause to make changes to fees, investment strategies, or look for alternative sources of funding.
Recent years have seen favorable rates being offered on debt for governments. This has resulted in an attractive means of financing and a resulting increase in local government debt load. But how much debt is too much debt? There are some commonly-used indicators to determine this. One is your government’s debt capacity. For many Midwestern states, municipalities are limited to issuing general obligation debt of no more than a statutorily determined percentage of their equalized value. The actual percentage your government is at may not be nearly as important as how it has trended over the last five to ten years. If your government has seen a steady increase in this percentage, this could have future implications on your government’s ability to meet its long-range capital financing needs and potentially staying within statutory limitations. If your government has revenue bonds outstanding that were issued by a community development or redevelopment agency, this debt is often not included in determining your debt capacity. However, it should not be ignored and is an important factor in determining your government’s debt load. Many governments will track the debt capacity both with, and without these types of revenue bonds. Just because they do not legally need to be included in the calculation does not hide the fact that they are most likely going to be repaid by future tax revenue, just like general-obligation debt.
Another good measurement of your government’s debt burden is how much principal and interest is being paid each year when compared to total, non-capital governmental expenditures. Calculating this involves taking total principal and interest paid in a year, divided by governmental (non-proprietary) non-capital expenditures. If this percentage is in excess of 20%, as noted by some bond rating agencies, your government may be spending a disproportionate share of resources on debt retirement.
In addition to the above, a determination of your debt per capita over the last five to ten years is a good indicator or your government’s reliance upon debt issuance. If this number has been trending upwards, you should ask why. It may make sense given recent development projects or other capital needs, but a comparatively high number when evaluated against similar entities, or a consistently increasing number over recent years should be noted and openly discussed as to long-term implications.
If your municipality has Tax Increment Districts (TID), you should be performing annual projections to determine the long-term viability of those districts being able to pay off any outstanding debts, whether this is in the form of bonds, notes, or advances from other funds. If these projections forecast an inability to pay off the debt during the life of the district, you should begin evaluating options now for how that debt is going to be repaid. This could impact future tax levies or significant transfers from your General, or other funds. Not being proactive in making this determination could have a significant impact on future operations of your government.
Several other financial tools exist such as multi-year financial and capital forecasts, but the above indicators should provide you and your government some useful measurements to assess financial vulnerabilities. Most of us involved in government finance realize the general public pays very little attention to the finances of their local government. Many don’t even realize annual financial statements exist for their city, county, school, etc. However, almost all of the above noted indicators are available from annual financial statements. The key is understanding the statements, focusing on the major indicators, and having a resulting open dialogue about where your government is, and should be going forward. This process can only help if there ever is an actual day of reckoning. Because we all know that the public will want answers under that scenario.
For more information on this topic, or to learn how Baker Tilly specialists can help, contact our team.