Finger-pointing on California's late CAFR as investors shrug
The late release of California's financial statements and a related spat between two offices responsible for it haven’t risen to become a point of concern among municipal market investors and analysts.
The California State Auditor gave the state’s comprehensive annual financial report an unqualified opinion, but in a separate 33-page report says if state financial officers don't change their ways there may be material misstatements in future years.
California released the CAFR in June, eleven months after the end of the fiscal 2018. The state’s internal goal is March 31, though the Government Finance Officers Association recommends it be released within six months of the end of the fiscal year.
The audited financials were not available when it sold billions of bonds during its spring sales.
Though investors asked about the tardy CAFR, it never became an issue, said Deputy Treasurer Tim Schaefer.
The amount of financial information that California makes available to investors on a monthly basis helps.
“Generally speaking, it’s safe to say that investors understand that California is a large issuer and we also make significant regular and rhythmic data points available to our investors throughout the year,” Schaefer said.
It took California 333 days past the end of its fiscal year to release its CAFR this year, compared to a median 174 days for states, said Richard Ciccarone, president and chief executive officer of Merritt Research Services LLC. Every state had to adopt new OPEB standards, and most still published their CAFR on time, Ciccarone said.
California was the second-slowest after Illinois, which has yet to release its CAFR. Next slowest is New Jersey, which took 304 days.
The late CAFR isn’t weighing on California’s double-A-minus ratings.
“We do prefer an earlier or on time CAFR to a later one,” said David Hitchcock, an S&P Global Ratings senior director.
But S&P tends to look more to forward-looking financial information like the information contained in the fiscal 2020 budget, Hitchcock said.
The state produces and releases a lot of information on a timely basis, Hitchcock said.
“In terms of the significance to the rating, it would not have an impact on the rating unless it was much later than it was,” Hitchcock said.
A late CAFR becomes more of a ratings issue if an issuer is chronically late or unable to produce a timely CAFR, said Karen Krop, a Fitch Ratings senior director.
“California is generally on time with the CAFR,” Krop said. “I don’t see this one late CAFR as an issue; and they do put out robust financial data throughout the year. They put out revenue performance information, which we track. And, they disclose with their bond disclosure all types of information.”
She added the first-time implementation of Governmental Accounting Standards Board Statement No. 75 was a big deal for all of the states, so when finance officers say it slowed them down, Fitch doesn’t question it.
“The state is in good shape,” Krop said. “They have done what they needed to do during the expansionary period to build reserves. They paid back and handled budgetary borrowing, which prepares them for the next downturn.”
The state auditor took the state controller to task in the July 18 audit report for the late delivery of the CAFR. The controller countered with several examples arguing that the state auditor contributed to the tardiness.
Michael Tilden, deputy state auditor, also criticized State Controller Betty Yee’s office for the way it handled the new accounting standards that took effect for fiscal 2018, calling the state controller’s method for allocating other post-employment benefit liability "flawed," adding that if it’s not corrected it could lead to material misstatements in future CAFRs.
“The state controller’s method of allocating OPEB liabilities to state funds does not align with the state’s primary method of paying for OPEB benefits,” Tilden wrote. “Currently, the state pays for these benefits as they become due using the pay-as-you-go method.”
Yee had warned in March that California’s CAFR would be late, because changes to FI$CAL, an electronic accounting system, were putting departments behind on submitting financial documents to the controller’s office.
Despite concerns raised in Tilden’s report, the state auditor’s office gave the state’s fiscal 2018 CAFR an “unqualified” opinion, which generally means the auditor concludes the financial statements present fairly the results of the organization's operations and its financial position according to generally accepted accounting principles.
The controller’s allocation methodology is based on the state’s recent efforts to prefund its OPEB liability by making financial contributions to OPEB based on pensionable compensation, but these contributions cannot be used to pay benefits until July 2046 at the earliest, or when the OPEB plan is fully funded, Tilden wrote.
"The state controller’s method of allocation did not result in a material misstatement” but the risk remains for future years if it does not change its methodology to better align with the state’s method of paying for OPEB benefits," Tilden wrote.
Tilden’s report also said that the controller’s office employed unrealistic timelines and faulty project management protocols that resulted in the CAFR coming out late. The auditor also expressed concern that a policy adopted by the Department of Finance in consultation with the controller’s office allowed departments that have implemented FI$CAL to submit estimated financial reports if they were unable to prepare actual reports using FI$CAL.
“According to the state controller’s records 17 departments submitted estimated financial reports that were included in the CAFR,” Tilden wrote.
The California Community Colleges chancellor’s office submitted estimates that posed a material risk to the state’s fiscal year 2017-18 CAFR, he wrote.
The chancellor’s office still has not completed and finalized its year-end reconciliations and financial reports, in spite of the fact that the state controller has already published the state’s CAFR for fiscal 2018, Tilden wrote.
Yee responded in the report that her office met regularly with the state auditor’s office from October 2018 through May 2019 about numerous issues related to the delay, not just the new OPEB standards.
Yee cited several examples of late audits by the state auditor’s office of various departments that resulted in the controller’s office receiving information needed for the CAFR late. She also cited the auditor’s non-responsiveness when the controller’s office sought feedback about how they planned to handle the more extensive reporting on OPEB liability required through GASB 75.
“The average turnaround time for feedback on information that SCO formally provided to CSA was over 75 days,” Yee wrote.
Tilden countered that the state controller “refuses to accept responsibility for not implementing a major new accounting and financial reporting standard for OPEB in a timely manner and instead seeks to blame us."
Tilden’s report suggested the controller’s office did not begin working to incorporate the more comprehensive accounting for OPEB liability until late last year.
Though Tilden said that identifying material weaknesses and weighing in on internal controls was not an objective of the audit, he writes that the auditors found “three deficiencies in internal control over financial reporting that we consider to be material weaknesses, and one other deficiency that we consider to be significant.”
Yee countered that “ultimately, SCO’s approach did not cause a material misstatement of the OPEB liability and related amounts of state funds. Furthermore, none of the externally audited agencies received a modified opinion pertaining to SCO’s allocation of OPEB.”
Neither the state auditor’s office nor the controller’s office returned calls seeking additional comment about the report.
If a state is going to issue a late CAFR and wants to hit the bond markets without being penalized, this year is the year.
“When you have spreads as narrow as they are today, even credit call spreads don’t show up to the degree they should,” Ciccarone said.
Weaker credits tend to have slower audits, but the market hasn’t penalized issuers for slow audits, Ciccarone said.
“I think the market has reflected that even in government there is too much emphasis on cash accounting,” he said. “That can hide too many things that need to be revealed.”
The danger with allowing late audits is that “you can’t govern well if you have to wait too long to see that things are not the way it’s supposed to be.”