California City and County Fiscal Strength Index – 2017 Update

Relative to earlier years and their peers in other states, most California city and county governments were in good financial condition at the end of fiscal year 2015. California Policy Center’s study of audited financial statements and socioeconomic indicators show widespread fiscal strength, but a few trouble spots as well.

Our analysis extends a fiscal strength study published in The Fiscal Times in January. That study assigned fiscal scores to 116 US cities with population greater than 200,000. The six highest scoring large cities in The Fiscal Times review were all located in California. Here, we extend the study universe to include every California city and county that has published audited financial statements in 2014 or 2015 (we used 2015 statements when available, but relied on 2014 statements in a few cases in which 2015 statements could not be obtained).

Of the 511 cities and counties we analyzed, over 60% scored 90 or higher. But fiscal health was not universal: eight cities had scores below 50. Several of these cities appeared on a distressed municipality list published by California Policy Center in November 2014. The earlier CPC analysis used a different scoring system, but relied upon similar variables.

You can see all the scores with links to the financial statements we used here:

Excluded from the study were 28 local governments for which audited financial statements could not be found. These are mostly smaller towns and cities. In 2015, the federal government required public agencies receiving $500,000 or more in federal grant funds to file audited financials (this threshold has since been raised to $750,000), while financial regulations normally require governments borrowing on the municipal bond market to file these statements. So, if a municipality received less than $500,000 in federal funds and did not have outstanding municipal bonds in 2015, it did not need to prepare audited financials.

The scoring system is described in a new working paper which will be published by the Haas Institute at UC Berkeley in the next few weeks. It is based on empirical research that associates local government fiscal distress with weak revenue performance, high debt burdens and low or negative general fund balances.

While the first two factors are straightforward, the third may require more explanation. A government’s general fund is roughly analogous to an individual’s checkbook, and a negative general fund balance is like an overdraft. A government or an individual may have other assets available to pay day-to-day bills, but it may be difficult to get access to these assets when needed. The City of Vallejo went bankrupt in 2008, citing exhaustion of its general fund balance, even though it had $100 million of cash elsewhere. Stockton and Sen Bernardino also had low or negative general fund balances at the time of their 2012 bankruptcy filings.

The score is based on the following five factors:

1. the ratio of a city’s general fund balance to its expenditures (40 percent weighting)

2. the ratio of its long-term obligations (including the current portion and Other Post-Employment Benefits but excluding pensions) to total government-wide revenues (30 percent weighting)

3. the ratio of actuarially determined pension contributions to total government-wide revenues (10 percent weighting)

4. change in local unemployment rate (10 percent weighting)

5. change in property values (10 percent weighting)

Changes in the unemployment rate and home prices provide an indication of future revenue trends. The long-term obligation and pension contribution ratios provide insight into the government’s debt burden – including the debt that arise from making unfunded commitments to retired and retiring employees.

Data for the first three factors were obtained from audited financial statements, unemployment rates were obtained from the Bureau of Labor Statistics and home prices were gathered from Zillow. For some smaller entities, unemployment rates and/or home prices were unavailable. In these cases, data from a nearby city or county was used.

To receive a perfect 100 score, a city or county must have had all of the following five characteristics in 2015:

1. General fund balance equal to 32% or more of general fund expenditures
2. Long term liabilities no greater than 40% of total revenues
3. Actuarially determined pension contributions no greater than 10% of total revenues
4. Flat or declining unemployment rate
5. Property value increase of 3% or more

It is not necessary to have a perfect score to be regarded as fiscally healthy. I consider a score of 71 or higher to be roughly equivalent to a rating of AAA, but it may be appropriate to make adjustments to the score before using it as a rating proxy. Analysts may wish to deduct points for a recent bankruptcy, late filing of audited financial statements or qualified audit opinions.

All 511 scores and supporting data are in an associated Google Sheet. The balance of this paper profiles the eight cities that scored lower than 50 (no county scored in this range).

Several of these low scoring cities were cited in our November 2014 study. Among the cities identified as highly stressed in the earlier analysis, three have significantly improved their financial position: Firebaugh, Huron and Sutter Creek. Ione is no longer required to file audited financial statements. Blythe, Calipatria, King City, Ridgecrest and San Fernando remain near the bottom of our rankings, with scores of between 51 and 60.

Atwater

Atwater, a city located just north of Merced in the Central Valley, has the lowest score in our survey. Like many inland cities, Atwater suffered a steep decline in revenues in the wake of the Great Recession. General fund revenues fell from $11.7 million in 2008 to $9.1 million in 2012. City officials were slow to cut spending in response, wiping out a large general fund balance. In 2008, Atwater reported a general fund balance of $4 million, which was 32% of that year’s expenditures. By 2012, the city’s general fund balance was negative $3.9 million.

Since then conditions have improved slowly, but Atwater’s general fund balance remained deep in negative territory. Most general fund revenue is spent on public safety, which has proved difficult to cut given the city’s high crime rate.

In 2013, voters overwhelmingly approved Measure H, a ½ cent sales tax increase to maintain public safety services. The additional revenue from this tax has been placed in a special fund overseen by a citizen’s oversight board. But the management of Measure H revenue has come under question. According to Merced County TV News, almost $900,000 of Measure H revenue was spent on a new 100-foot ladder fire truck despite the fact that the city has no building taller than 35 feet.

A large portion of Atwater’s public safety expenditures are attributable to pension contributions and retiree healthcare costs. According to CalPERS data, Atwater had 50 retired public safety employees in 2015 – double the number still employed by the city. These retirees benefited from the city’s generous 3% at Age 50 formula, so their annual benefits are large for a city of modest means. Required safety pension contributions are rising from $1.1 million in 2014 to over $1.8 million in 2018. Citywide retiree healthcare costs were $600,000 in 2015 and the city has an unfunded OPEB obligation of $5 million.

Aside from pension and OPEB obligations, Atwater is also carrying a heavy load of bonded debt which includes $79 million in outstanding sewer bonds. To the city’s credit, it is trying to keep residents informed of its financial difficulties. Atwater’s home page prominently links to a slide presentation that explains the situation.

Coalinga

Coalinga is located central California’s Pleasant Valley. Its main industries are agriculture, oil and incarceration. Total revenue declines from $30 million in 2009 to $18 million in 2014. The city was hit hard by Governor Brown’s decision to shut the Claremont Custody Center in 2011, and the more recent decline in oil prices.

In 2014, Coalinga had general fund revenues of $5.7 million and expenditures of $8.6 million. Some of the deficit was offset by transfers from other funds, but the city’s general fund balance deteriorated from negative $2.0 million to negative $3.4 million. Management attributed part of the deficit to difficulties arising from the termination of its 401a defined contribution plan. Coalinga expected to receive a termination payment from the plan sponsor, the International City and County Management Association (ICMA), but didn’t. Issues surrounding the plan termination are now being litigated in Fresno County Superior Court (Case Number 16CECG000082), with the city seeking damages from ICMA, Strategic Retirement Advisors (a firm that provides advice to public agencies on their retirement systems) and Verisight (a third-party plan administrator).

Coalinga’s 2015 audited financial statements are not available. The city’s financial director informed CPC that the long delay in the release of these statements was attributable to staff turnover and that they were expected to be released by the end of March. The city’s most recent budget showed a 2015 general fund surplus of $900,000.

More recently, Coalinga had some positive fiscal news. In July 2016, the city sold its vacant prison building to Ocean Grown Extracts, which will use the facility to grow marijuana and produce cannabis oil. The $4.1 million purchase price should eliminate Coalinga’s negative general fund balance. The new business will also generate incremental tax revenue for the City.

Compton

In our 2014 report, we named Compton as the state’s most fiscally distressed city. Our updated scoring system places the city further down the list, but its fiscal and management problems remain largely unresolved. Since our previous report, the city council has fired two city managers. After G. Harold Duffey vacated the position in December 2014, assistant city manager Jonny Ford stepped into the role. In October 2015, Compton hired former Lynwood city manager Roger Haley to permanently fill the position, but then removed him in July 2016. According to the Compton Herald, Haley was terminated because he spent a large amount of city funds to promote a sales tax increase on the June ballot and for failing to keep the Council properly informed about fiscal conditions. In January, Compton named Cecil Rhambo as its new City Manager.

The minutes of a March 2016 Council Meeting support the belief that Haley misinformed elected officials. At that meeting, a financial advisor is quoted as saying that the city was about to have its credit ratings restored and that the city has not been distressed since late 2012. Since that meeting, the city has sold two bond issues, neither of which carried a rating. Further, a review of Moody’s and Standard and Poor’s web sites show that the city remains unrated.

One reason that the ratings were withdrawn was that Compton could not produce audited financial statements on a timely basis. Normally, local governments must provide audited financial statements within nine months of their fiscal year end. According to a disclosure filed with the Municipal Securities Rulemaking Board, the city failed to file audited financial statements for its 2011 fiscal year, filed its 2012 statements 16 months late and filed its 2013 statements 21 months late.

The city’s audited financial statements for the fiscal year ended June 30, 2014 are dated November 17, 2016, which is 19-1/2 months after the March 30, 2016 filing deadline. The continual filing delays makes a rating restoration unlikely. Moreover, the city’s 2014 audit is qualified – which means that the independent auditor could not fully verify the amounts reported by the city.

The auditor’s letter notes that “the City could not provide documentation to support $6.3 million in additions to capital assets.” The auditor could also not determine whether the city had earned $2.9 million in federal grant revenues, raising the possibility that the grant money was not spent for the intended purpose.

According to the city’s unaudited 2015 financial report. Compton’s general fund revenues were $1.4 million greater than expenditures. However, the city general fund balance was negative $33.5 million, which is the equivalent of a huge overdraft on an individual’s checking account. Compton has other funds, some of which have positive balances, but its aggregate fund balances totaled negative $20.9 million – rendering the city essentially insolvent. (According to an email message I received from Compton’s financial manager, the general fund balance improved in 2016 and the recently approved sales tax will accelerate this trend.)

Compton can continue operating because it issues annual revenue anticipation notes. The most recent offering floated last July has a term of 11 months and carries an interest rate of 2%. This is quite a low borrowing cost for an unrated city with known financial problems. It is only possible because the revenue required to repay the bonds never passes through the city’s hands. Instead, property tax and vehicle license fee revenue collected by Los Angeles County on behalf of Compton is transferred directly to a bond trustee, who then pays bond investors.

While 2% may seem a small price to pay to keep the city going, Compton also has to pay underwriting, legal and financial advisor fees when issuing these bonds. For the June 2016 offering, these costs of issuance totaled 2.21% of principal according to the State Treasurer’s Debt Watch site, so the city’s overall borrowing cost was closer to 4%.

Aside from this short-term debt, Compton has other bond and loan obligations, as well as pension and OPEB liabilities. But as a proportion of city revenues, these obligations are in line with many other cities in California and across the country. Also, the city has had a special property tax dedicated to paying retirement obligations since 1947.

Compton also experienced lower unemployment and increasing property values in 2015, suggesting a positive revenue trend. Recent commercial developments including a new Amazon shipment/cargo center and a new Walmart should also brighten the city’s revenue picture.

Under the circumstances, it is likely that Compton can struggling along – rolling over and whittling down its short-term bond debt – as long as we don’t have another economic downturn. If a regional or national recession strikes however, the city will once again be at risk of bankruptcy.

Marysville

As a small, lower middle class city with few jobs outside of service and retail, Marysville fits the profile of many struggling cities in America. But unlike some other cities in our survey, Marysville’s revenue decline in the aftermath of the Great Recession was modest: total revenues fell from roughly $12 million in 2007 to $11 million in 2015. However, the city is burdened by a large amount of debt in relation to its limited revenue and small economic base. Marysville has a population of 12,216 and its median household income is only about $35,000 a year.

The city’s 2015 financial statements show a general fund balance of negative $10.5 million but most of this red ink is due to an incorrect accounting treatment. Marysville accounted for its $9 million Net Pension Liability in its general fund, but this amount is only supposed to appear in the Government-Wide financial statements. Removing the pension liability still leaves a significant amount of red ink: a negative $1.5 million balance.

Marysville is burdened with $32 million of long-term debts apart from its pension obligations, including sewer bonds and Certificates of Participation (COPs) – which are primarily serviced from tax revenues.  On the plus side, only one city employee and his spouse are eligible for retiree healthcare benefits.

In 2014, city leaders proposed Measure W, which would have authorized a 1% sales tax for ten years with revenues directed to the general fund. However, voters narrowly defeated the new tax. In September 2015, Moody’s Investors Service downgraded the city’s issuer rating to Baa3, and 2011 Taxable Refunding Certificates of Participation (COPs) to B2, reflecting the risk that tax revenues would be insufficient to service the COPs and fund public safety. A rating of B2 is five notches below Moody’s lowest investment grade rating, and is thus deep into “junk bond” territory.

In June 2016, voters were asked to approve a similar 1% sales tax hike under Measure C. This tax increase passed with a 55% majority. Moody’s responded by upgrading Marysville to Baa2 again.  The rating agency also upgraded the city’s COPs to Ba2, which is still two notches below investment grade. If the additional sales tax revenue reaches the forecast level of $1.6 million annually, and the new funds are not spent on new initiatives, the City should be able to reverse its negative general fund balance in the near future.

Maywood

Like its southeast Los Angeles County neighbor, the City of Bell, Maywood is a small municipality that has experienced chronic management problems. In 2015, the State Auditor identified Maywood as one of six high risk cities requiring special monitoring. The Auditor since deferred actions on four of the six cities, focusing on Hemet and Maywood. Although Hemet scored well in our model, Maywood was among the ten worst general purpose governments we evaluated in 2014 and again in our new survey.

After its review, the State Auditor concluded that “Maywood’s city council has failed to properly oversee the city’s operations and has allowed numerous financial and administrative problems to remain uncorrected, such as the city’s failure to maximize revenue and lack of the most rudimentary internal controls. Further, it has accepted flawed budgets and frequently ignored its municipal code when it approved non-competitively bid contracts.”

According to the auditor’s report, Maywood’s fiscal problems date back several years. In 2010, the city lost its general liability and workers compensation insurance, triggering the layoff of all municipal employees and the disbanding of its police force. Although Maywood no longer had employees, it was still obligated to fund pensions for its former workforce, but failed to pay the bills it received from CalPERS. Maywood has also suffered substantial turnover among mayors and City managers. It is also facing an investigation by the Los Angeles District Attorney for failing to abide by the Brown Act, a state law that sets standards of transparency for City Council meetings.

Maywood’s 2015 CAFR contains a going concern opinion from the city’s auditor reflecting doubts that the city could continue to operate as an independent entity. Triggering this opinion was the city’s negative $1 million general fund balance and its government-wide net unrestricted position of negative $27 million. On the plus side, the city only has $3 million in bonded debt.

Soledad

Located south of Salinas in Monterey County, Soledad’s economy is largely dependent on agriculture and two state prisons. While the city has a positive general fund balance, it received a low score due to a high ratio of debt to revenues. Most of the city’s debt takes the form of an interest-free loan from the state of California to finance the construction of a new sewer plant. Through 2010 Soledad borrowed $46 million, which it was supposed to pay in 20 annual installments. The city later negotiated an extension of the loan to 30 years reducing annual payments to $1.5 million.

This debt service burden is relatively large for a city that collected only $18 million of revenue in 2015. Soledad’s total revenues had exceeded $23 million before the recession in 2008. The city has already published its 2016 financial statements, which show higher revenue and lower debt – due to principal repayments. It should thus receive a higher score on our next survey.

Vernon

Vernon, located south of downtown Los Angeles, has only 210 residents but also plays host to 1800 mostly industrial businesses employing over 50,000 workers. In a previous report, we found that municipal employees outnumber residents and are paid, on average, $107,848 per year.

The city reported revenues of $249 million in 2015, mostly from power, light and water bills collected by municipal utilities. The general fund had $39 million in revenue and $53 million in expenditures. Its negative balance improved from negative $23 million to negative $16 million as a result of transfers from the utilities and the sale of property.

While city utilities were profitable, they are heavily encumbered by debt. As of June 30, 2015, the utilities had $383 million in outstanding bonds.

Victorville

Due to a depressed economy, Victorville has suffered poor revenue performance in the wake of the Great Recession. After peaking in 2008 at $130 million, governmental fund revenues cratered – falling to $70 million by 2013 – and have only recovered slightly thereafter, reaching $76 million in 2015. Total government revenues of $173 million are well below the $236 million recorded in 2008. With a shrinking to stagnant revenue base, the city will be challenged to service its large debt burden which includes over $300 million in bonds issued between 2005 and 2008 (however, as discussed below, city management considers much of this debt to not be the city’s responsibility). The city’s bonded debt dwarfs its $36 million net pension liability and $18 million OPEB liability.

Weak revenues have also been draining the city of cash. In fiscal year 2015, Victorville’s general fund balance declined from $4.8 million to $3.4 million – enough to cover only about 6% of annual spending. According to City Manager, Doug Robertson, the city’s general fund balance climbed back to nearly $4 million in fiscal year 2016.

Victorville has also been struggling with bonds issued by the Southern California Logistics Airport Authority (SCLAA). Because SCLAA is separate legal entity, Robertson disputes the inclusion of its debt in our calculations, however city officials have administrative control over this entity and its debt is consolidated with that of the city for financial reporting purposes.

The Authority has been defaulting on bond payments since 2011. The most recent default affected interest and principal payments on subordinated bonds due December 1, 2016, with some bondholders receiving as little as 12% of their promised payments.

In April 2013, the Securities and Exchange Commission sued Victorville, a city official, SCLAA and the bond underwriter for fraud in connection with the sale of the defaulted bonds. The SEC complaint alleges that the defendants inflated the value of an airport hangar used as collateral for the bonds and that they misappropriated a portion of the bond proceeds. The defendants tried unsuccessfully to have the case dismissed, but it has yet to come to trial – almost four years after the initial filing. (the case number is EDCV13-0776, US District Court, Central District of California).

Although the case does not relate to bonds issued by Victorville, officials claim that payments to lawyers and the costs of complying with SEC subpoenas have weighed on the city finances.