Noteware: What Does the CAFR Say? – “When You’re in a Hole, Quit Digging”

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Late in the afternoon of December 26, 2014 — a post-Christmas Friday holiday for many — the City of Houston released its Comprehensive Annual Financial Report (CAFR) for fiscal year 2014, just meeting the legal deadline. Release of this year’s CAFR was accompanied by and greeted by…silence. Neither the City administration nor the media had any comments whatsoever.  To my knowledge, this article, written roughly one month after the release, represents the first public media analysis of the CAFR!

Before we discuss what this year’s CAFR tells us, it is first necessary to note a couple of technical items. First, the City of Houston conducts its financial operations from two sets of funds: “government funds” (which includes the “general fund” and related “debt service fund”) and “enterprise funds” (which perform “business type activities”). The “government funds” account for collection of taxes and the expenses to deliver most public services (police, fire, road construction/maintenance, etc), and also issue and service general obligation debt. The “enterprise funds” account for fees charged to users of their services, and issue debt related to those fees; in Houston, the three major “enterprise funds” are: the Combined Utility System (the “CUS” — water and sewer operations), the Airport System, and the Convention and Visitors Bureau.  The structure of the City’s funds is shown on the accompanying chart.

This structure is roughly analogous to two partners who keep their financial affairs separate (checking accounts, credit agreements, etc.) but co-mingle their affairs in managing their household.  The general fund is supported by various other funds (the CUS and Dedicated Drainage and Street Renewal Fund, received from “the rain tax”), and as in the analogous household, the financial and operational linkages between the general fund and the enterprise funds are critically important to understanding the City’s overall fiscal condition.

The second consideration is that the CAFR, like the City’s operations, is large and very complex – nearly 300 pages of numbers, with little verbal explanation. Although the CAFR is prepared in strict accordance with the Governmental Accounting Standards Board, few people seem to understand the CAFR, and city leaders do not appear to use it for management or policy purposes. That’s unfortunate, because the CAFR is the one place where most relevant numbers are presented comprehensively and, presumably, accurately. The CAFR also uses accrual accounting, the importance of which we discussed previously, and is comparable to a 10-K for a corporation.

So, what does the 2014 CAFR say?  First, its presentation of the City’s financial results is consistent with prior years: the City received record revenues from record property and sales tax collections, and general fund expenses again exceeded these revenues (page 10).  The City underfunded its employees’ pension funds by $110 million (page 93), effectively borrowing the deferred amounts from the funds. The City stated that it issued $119 million of general obligation bonds and total debt increased by $453 million (page 12), but it appears (pages 78-79) that it reduced overall long term bonded debt by about $138 million, including a decrease in general obligation bonded debt of $57 million.  This is good news, but somewhat confusing, since the two sets of numbers seem inconsistent.

And, upon first glance, the long string of annual deficits appeared to end in 2014, as the City showed a $153 million increase in Net Position (page 207). Closer examination reveals the “turnaround” to be illusory, a result of “profit” from “business activities” – mostly, collection of more water and sewer revenues than expended for operations and repairs (which might explain continual water main breaks) and interest earning in restricted fund balances. While this may sound like accounting gobbledy gook, the main takeaway is that the general fund’s unrestricted operations were again negative. And, as in past years, the Unrestricted Deficit of “Governmental Activities” widened, from $(2.458 billion) to $(2.651 billion).

As is customary, Controller Ronald Greene wrote a transmittal letter summarizing the results. Two of his observations are startling. First, his table documenting the aging of the City’s workforce (page xii) indicates that in 2014, there were just 1.2 active workers for every retired worker in the City’s Municipal Employees union; in 2005, that ratio was 3.2. These numbers have clear implications for future pension obligations.   (I wish Mr. Greene had articulated these implications.)

Second, the statistical section (page 231) of the controller’s letter documents the decline in the City’s population. In 2010, according to the US Census bureau, 2,275,926 people lived in the City of Houston. By 2014, the population had fallen to 2,099,451, a decline of 158,475 people, or 7%. The same table presented the City’s unemployment rate at 9.0%! As noted previously, the region may be booming, but people (and jobs) are fleeing the City.

In summary, the most recent CAFR clearly demonstrates that the City is in financial trouble that it will only get worse in the next few years. The information confirms the conclusions I have presented in this series of articles. Nevertheless, as the City continues along its dangerous path, the posture of the Administration and the watchdogs we all rely on, including the general media, is… silence.

If you are alarmed by these conclusions — and the silence of our leaders — then you will be even more alarmed by the next article: What the CAFR does NOT say.

A version of this article appeared in the Houston Business Journal on February 5, 2015.

About Jim Noteware 18 Articles
Jim Noteware is a Houston-based real estate developer, focusing on suburban master-planned and urban infill communities. He also specializes in the turnaround of distressed properties, portfolios and organizations. He has served two big-city mayors, in Houston and Washington, D.C., working to improve the performance of large troubled public agencies.