CAFR FYE 6/30/15 (a.k.a. “The 2015 Metro Audit Is Out”)

On December 8, 2015, the Department of Finance released the Consolidated Annual Financial Report for the year ended June 30, 2015. In accounting-ese, that’s the CAFR FYE 6/30/15. For the rest of us, that means Metro’s latest audited financial statements are out. You can find the full CAFR document here.

There was also a Metro Nashville Audit Committee meeting on December 8, 2015. The newly-released CAFR was on the agenda and Metro’s external auditors, Crosslin & Associates, were there to answer questions.

I am writing this post to help me remember some of what was discussed, and to share information with the public. The entire CAFR is more than 300 pages long. I am not trying to cover everything – just some of the things I found most important.

IF YOU DON’T WANT TO READ THE WHOLE THING…

Financial statements are boring.  Talking about financial statements is boring.  If you don’t want to read all of this, you should know that because of changes to accounting rules, all of Metro’s pension liability is included in the 2015 financial statements.  The result is that Metro’s liabilities for its core government operations are $323 million more than its assets.  In 2017 and 2018, further accounting rules changes will require Metro to include its enormous unfunded retirement insurance benefit obligations on its financial statements.  This will dramatically increase the amount of red ink on Metro’s balance sheet.

The amount of these pension and retirement benefit obligations hasn’t changed overnight, but the new accounting rules are forcing some very large liabilities onto Metro’s financial statements.  As we go forward over the next few years, we will need to pay attention to what real world consequences there will be from showing this much red ink.

SOME LINGO FIRST

The most interesting things in the CAFR are being driven by the Governmental Accounting Standards Board, or GASB, which is the independent organization that establishes standards of accounting and financial reporting for U.S. state and local governments. GASB issues statements about how governments like Metro must present financial information. GASB typically issues new statements several years in advance in order to give the accounting profession and governments time to adjust to the new standards.

Fiscal year 2015 is the first time financial statements are required to comply with GASB Statement No. 68, which is designed to improve the financial reporting for pension obligations. Basically, instead of discussing long-term pension liability in the written notes at the end of the financial statements, this year Metro was required to show its pension liability directly on its financial statements.

In fiscal years 2017 and 2018, GASB Statement Nos. 74 and 75 will require Metro’s Other Post-Employment Benefit, or OPEB, liability also to be added to the financial statements. The OBEP liability is the amount that Metro is obligated to pay for health, dental, and life insurance for retirees. Also, in 2017, GASB Statement No. 77 will require Metro to include additional information about tax abatements.

I will also mention a “Statement of Net Position.” This is the balance sheet for a government. Private sector companies have balance sheets that balance – this means that the company’s assets always equal its liabilities plus how much equity the owners have. It always balances, by definition. A government doesn’t have owners. Instead of a balance sheet, a government has a statement of net position – this means the assets minus the liabilities equals the “net position.” You hope your government has more assets than liabilities, and therefore a positive net position.

The last bit of lingo is to mention “going concern” disclosures. With private sector companies, if auditors make a “going concern” disclosure, it means that there is legitimate doubt about whether the company will continue to exist for the next year. I am admittedly not well-versed with the exact implication of a “going concern” disclosure in a government setting. But, for auditors, where there is severe financial distress, their guidelines require them to insist upon a specific “going concern” disclosure. More about that later.

PENSION

I mentioned that 2015 is the first year where GASB 68 is mandatory. To comply, Metro has added its long-term pension liability to its financial statements. Adding this large obligation to its financial statements means that Metro’s net position has decreased compared to previous years.

There are two parts of this to look at. First, in order to provide accurate year-over-year comparisons, last year’s CAFR numbers had to be restated to reflect what they would have looked like if the pension liability had been on the financials last year. If you look at the 2014 CAFR, it showed a net position for Metro due to governmental activities of $87,113,535. After last year’s liabilities were restated to include the pension liability, Metro’s net position went down to a negative $241,742,450. (You can see this restatement at Note 2, at page B-47 of the CAFR.)Then, what happened this year? The net position for governmental activities slid another $80,929,233 to the negative. (CAFR, B-5) And so Metro’s net position (that’s assets minus liabilities) as of June 30, 2015, was in the red by $322,671,683.

I want to be clear. Nothing about Metro’s cash flow changed. Nothing about Metro’s pension obligation changed. Nothing here changes the fact that everyone seems to agree that Metro’s pension obligations are pretty well funded. The only thing that happened was that Metro’s long-term pension obligations were promoted, if you will, from the written-in-words fine print in the Notes up to the actual financial statements with the rest of the numbers. That said, a large negative net position is striking, and it is new for Metro.

If you want to see all of the detail on how the pension liability numbers add up, look at Note 7, at pages B-75 to 94 of the CAFR.OPEBFor the 2015 CAFR, the OPEB obligations are still in the written-in-words fine print in the Notes. In 2017 and 2018, these obligations will get moved up to the financial statements with the rest of the numbers.

To find the fine print on the OPEB obligations, look for Note 8, which is at pages B-95 to 97 of the CAFR. You will see that the actuarial accrued liability for Metro retirees’ OPEB benefits is $2.16 billion, and there is an additional $473 million liability for MNPS retirees, for a total of $2.633 billion. This means that the expected cost to Metro to fully honor its post-retirement health, dental, and life insurance promises to retirees is $2.633 billion. This is funded at 0% -- Metro has no money set aside for this obligation.

The current GASB rules do require Metro to include a portion of this liability on its financial statements. The 2015 statements include a liability equal to the payment that would be required this year in order to get the OPEB obligations fully funded in 30 years. (Think about it this way – if you had a baby in 2015 and you wanted to have tuition money in 18 years – how much would the first year of an 18 year savings plan cost you?) The amount Metro would need to pay this year to have the OPEB fully funded in 30 years is $1.192 billion. Since Metro is NOT making that payment, the $1.192 billion shows up as a liability on the financial statements. You can see that number on page B-8 of the CAFR. And this means that the financials already show a billion dollar chunk of the OBEP obligation.

I can’t figure out all the math, or predict where things will stand in a few years, but it is clear that Metro should expect its “net position” to get pushed much, much farther into the red once the unfunded OPEB liability is placed entirely on the financial statements in a few years.

Finally, because the plan is unfunded, Metro makes all payments due for retiree OPEB benefits as they become due. You can see on page B-95 that Metro paid about $72 million this fiscal year to honor obligations for Metro and MNPS employee insurance benefits. This number has been climbing steadily over the years. You get the logic – people live longer, insurance costs more, there are more retirees, and none of it is pre-funded – so of course, the annual cost increases over time.

TAX ABATEMENTS

The external auditors, Crosslin, shared with the audit committee that GASB 77 will require some additional disclosures about tax abatements no later than 2017. Crosslin said that Metro probably will not have to make many changes to implement this rule. The audit committee will need to learn more about this over the next few years.

GOING CONCERN?

In addition to describing the finances of the core Metro government, the CAFR also includes a compilation of the finances of Metro’s “component units.” The “component units” are eleven separate organizations in Metro like MTA, MDHA, and the Convention Center Authority. These units have separate audits that are not individually included in the CAFR. Typically, you would need to go to each of the units to obtain a copy of its full individual audit. You can see a list of these units at B-39 and 40.

One of the units, the Hospital Authority, has a “going concern” note in its audit. According to page 2 of Crosslin’s opinion in the CAFR, financial conditions related to General Hospital and Bordeaux Long Term Care “raise substantial doubt about the Hospital Authority’s ability to continue as a going concern.” I guess this probably isn’t a surprise?

But, going back to the 2017/18 requirements to add the full OPEB liability to Metro’s financial statements, the audit committee asked Crosslin if that will create a risk of Metro requiring a “going concern” disclosure. The basic answer was that Crosslin would have to assess the situation at the time. After further questioning, my sense was that there are several things that could make a difference. First, Metro might take steps to limit, or change, or fund, its OPEB obligations between now and 2018. Second, the accounting industry may change or update its thinking about what circumstances warrant a going concern note for a government. Third, investment market conditions can make a dramatic impact (positive or negative) on how long-term OPEB obligations are calculated. These factors could influence whether adding the full OPEB obligations to the financials will create the risk of a going concern disclosure

For me, the important takeaway was that they didn’t say “no – don’t worry about it.” Instead, they said that it depends. In my day job as a lawyer, where I sometimes help companies deal with financial distress, when auditors say that a going concern note is a possibility, it is a sign that something important and fundamental needs to be addressed.

WRAP UP

I would like to compliment Metro’s finance department and Metro’s departments, commissions, and agencies who help put the audited financials together. I know it is a significant group effort to get the financial statements together and compiled for the CAFR. Thanks to everyone involved.

If anyone has questions or comments about any of this, please feel free to email me at bob.mendes@nashville.gov