In late August, the California State Auditor released its annual Local Government High Risk Ranking Dashboard (https://www.auditor.ca.gov/local_high_risk/overview). This tool uses information and data gathered from cities’ Annual Comprehensive Financial Reports (ACFR) across California to identify potential high-risk financial practices. For the most recent report, the data used is from cities’ ACFRs from Fiscal Year 2020.
The online dashboard ranks more than 470 California cities. It is used by the State Auditor as part of their process for determining whether a city is at risk of fiscal distress. Various financial indicators are used to assess the fiscal health of cities, including:
- Financial reserves
- Debt burden
- Cash availability (liquidity)
- Revenue trends
- Retirement obligations
Points are assigned to financial indicators and then added to determine a city’s ranking on the dashboard. Risk designation is given to various indicators based upon the scoring system below:
- High Risk: 0 to 41.76 points
- Moderate Risk: 41.77 to 71.23 points
- Low Risk: 71.24 to 100 points
The lower the number a city receives for its overall ranking on the State Auditor’s dashboard, the more a city’s fiscal health is considered at “risk.”
How Does Modesto Rank?
The City of Modesto was identified as High Risk and ranked 10th among all cities in California by the State Auditor in the most recent annual report. The City received 40.79 points out of 100 and therefore is considered High Risk based on the point system. For context, the City of Gardena, which ranked 13th and received a rank of Moderate Risk, scored 42.23 points out of 100.
Our Response to the State Auditor’s Ranking
When this ranking was received from the State Auditor, City staff began to analyze the findings. The Finance Director, Accounting Manager, and Budget Manager reviewed the State Auditor’s results against the City’s Fiscal Year 2020 Annual Comprehensive Financial Report (ACFR).
Staff also contacted the City’s external auditor, Hudson Henderson & Company, Inc., for their professional opinion regarding the following indicators used by the State Auditor:
- Cash availability (liquidity)
- Other Post-Employment Benefits (OPEB) Liability
Hudson Henderson & Company expressed similar concerns held by City staff about the liquidity ratio used by the State Auditor and its value in showing a government agency’s true liquidity. They agreed that a meeting with the State Auditor to discuss these areas should be the next step. City staff was able to hold a meeting with the State Auditor on September 14, 2021 to address concerns about the rankings for liquidity, in particular, the liquidity calculation and the OPEB Funding ranking that the City had received.
How is Liquidity (Cash Availability) Calculated?
After discussions with the State Auditor’s staff, we understand that a significant factor in the City’s ranking is the State Auditor’s calculation of the City’s liquidity numbers did not consider all current assets that the City holds in the General Fund; using only cash and investment balances in their calculation. For the City, this misrepresents the liquidity ratio due to the way reimbursements flow from the General Fund for large projects at the end of each fiscal year.
As shown above, the cash availability (liquidity) ratio using the current formula, which uses all assets in the calculation, offers a more favorable liquidity rating for the City. The cash-only methodology used by the State Auditor is much less favorable for Modesto. Our current method of reimbursement is an accepted practice, however, for purposes of this ranking, it does not accurately reflect the City’s position.
If the liquidity ratio was changed and the current ratio was used, as shown above, the City’s ranking would change from High Risk to Low Risk for this category as the calculation would then go from less than 100% to greater than 150%. By making this change, it would also change the City’s overall ranking from High Risk to Moderate Risk.
Other Post-Employment Benefits (OPEB)
When discussing the Other Post-Employment Benefits (OPEB) Funding ranking that the City received, staff from the State Auditor’s Office explained the ranking measures the extent to which a city has set aside assets to pay for the City’s OPEB liability, such as health and dental benefits, earned by its employees. If a city does not have sufficient assets set aside for these expenses, it will likely have to make higher OPEB contributions to those plans in the future, potentially impacting other spending priorities.
In particular, cities that have trusts in place to hold assets for future use will receive a more favorable rating. The City does not have a trust in place but does hold sufficient cash with an adequate reserve level in the Employee Benefits Fund to pay for these expenses. However, those assets were not considered in the ranking and contributed to a lower score.
How we Intend to Improve our Ranking in the Future
To address the cash liquidity issue, City staff has identified a more optimal way to account for the reimbursements at fiscal year-end that will not impact the cash balances of the General Fund. This approach will be used starting in Fiscal Year 2021-22. The City believes this change will significantly impact our placement in future rankings on the State Auditor’s Fiscal Health of California Cities dashboard with respect to liquidity.
For the OPEB ranking, the City has been exploring the idea of creating trusts for both OPEB and pension costs for many years. In fact, the City released a Request for Proposal several months ago and an item will be coming to Council for approval in the near future. This is a critical first step in supporting both pension and OPEB trust funds as the City works on ways to create ongoing contributions to fund these future liabilities.
While the City’s ranking on the State Auditor’s dashboard for the Fiscal Health of California Cities can be alarming, please be assured that City staff from the Finance Department and Budget Division, the external auditors from Hudson Henderson & Company, and myself are constantly monitoring the fiscal health of the City to ensure that Modesto can continue to pay its bills both in the short and long term.
While the State Auditor’s dashboard does provide valuable information, it does reaffirm some important findings, such as the need for the City to work towards funding pension and OPEB obligations with a specific funding plan. This will bring value and potential savings to future liability costs.
We take opportunities like these to identify areas where we can improve, and the State Auditor’s report highlighted some of these areas. While we may not necessarily agree that our City is at high risk of financial collapse, we have always acknowledged that the City’s current revenue is not keeping paces with our expenses. However, our commitment has remained the same, we will continue to provide high quality services to our community and be innovative in our service delivery with the resources we do have.