WASHINGTON — Most cities' "bottom lines" are positive and have bounced back from the financial crisis, though many are still in negative territory and are vulnerable to becoming distressed if they aren't already, according to a report from Merritt Research Services.
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Analysts and observers have tended to focus on governments' general funds when discussing financial conditions. But while it's important to analyze those funds, they don't encompass all of the money governments have at their disposal that could effectively provide relief for special services or debt service. Also general funds don't take into account long-term debt liabilities such as large pension debts, according to the report.
Under the Governmental Accounting Standards Board's statements, state and local governments report a net position (also called net assets), which is what they have left over after they deal with liabilities. The liabilities are viewed broadly and include pension and other post-employment benefit liabilities in addition to debt, Ciccarone said.
The amount of the net position that is most relevant as a "bottom line figure" is the unrestricted net assets portion, which excludes the portion of the net position that's restricted and not available for public discretionary purposes, according to Ciccarone.
"This amount is what the government has under its control, free and clear of all debts and restrictions," he wrote in the report. He told The Bond Buyer that the amount is a sign of what available resources a government has "that will directly or indirectly cushion taxpayers and investors."
Looking at the ratio of cities' unrestricted net assets to their governmental activities expenditures places the unrestricted net assets into the context of a jurisdiction's scale of financial responsibilities, according to the report.
"The vast majority of cities are in positive bottom line territory with their available assets outnumbering liabilities," Ciccarone wrote. The median ratio of cities' unrestricted net assets to governmental expenditures fell to 20% in 2011 from 29% in 2007, with the decline largely related to a burst of pension and other post-employment benefit unfunded liability adjustments coming onto cities' balance sheets. But in the past two years, most cities have seen their unrestricted net assets ratios bounce back, with median ratios of about 22% in each of fiscal 2013 and 2014, according to the report.
If cities have negative unrestricted net position numbers, it's not necessarily the case that they are insolvent, Ciccarone said. "However, a negative net asset position, especially one that is worsening, is frequently a sign that a government has taken on debt and liabilities that strain its ability to cover them," he wrote. "Besides debt and pensions, it also covers unpaid bills, promises for worker benefits that have been accrued but not yet paid and the implicit write-off of infrastructure that may still be in use but is no longer carried on the books of a city as a viable asset."
Cities that are distressed or have considered or filed for bankruptcy can have negative unrestricted net asset ratios. For example, Detroit's ratio was -5.6% in fiscal 2003 and worsened for each of the next ten years before the city filed for bankruptcy.
But rating agencies don't appear to heavily weight cities' unrestricted net position ratios into the metrics on which they base their ratings, according to the report. For example, in 2014 about 90% of the 34 largest cities had ratings in the double-A or triple-A categories, even though very few of them came close to the median unrestricted net assets ratio for AA-rated cities in that fiscal year.
Larger cities are more likely to have negative unrestricted net asset ratios, since they tend to have more unionized work forces with legacy defined benefit programs that continue to be a burden even after the cities' populations decline. The median ratios of net unrestricted assets to government expenditures for cities over 500,000 fell to -19.6% in fiscal 2014 from 3.5% in fiscal 2007, according to the report.
The big cities with the worst unrestricted net asset ratios in fiscal 2014 were New York City, Portland, Ore., Chicago, Houston and Milwaukee. A major reason why New York's ratio is negative is because it aggressively reports its OPEB liabilities and pension responsibilities and was an early adopter of the new GASB standards. Those standards require state and local governments to account for the full extent of their unfunded pension liabilities, according to the report.
Ciccarone expects the unrestricted net asset ratios of most cities that have their own retirement and health care benefit plans to decrease in the coming years, since new standards from GASB will cause more unfunded pension liabilities to appear on governments' balance sheets.
The report was the final installment in a five-part series on the credit quality of U.S. cities. "Finding the right mix of numbers and measures to identify city problems early will help empower stakeholders to better address their problems well before they become a crisis," Ciccarone wrote. "By the same token, governments doing all the right things to run a tight ship and steer a course within their own means should be rewarded for their good stewardship."
