Mayor and Members of the City Council:
City staff learned yesterday that Moody's Investors Service has downgraded the City of Richmond’s issuer rating to Ba1 from Baa1, its 1999 Taxable Limited Obligation Pension Bonds (POBs) to Ba2 from Baa2, and its Series 2006 A Wastewater Revenue Bonds to Baa2 from A2. No outlook was assigned. This action concludes a review, the first step of which was the rating action taken by Moody’s on May 13, 2015, as described in its published report of that date (the “May Report”). At that time, Moody’s downgraded the City of Richmond’s issuer rating (implied GO) to Baa1 from A1 and its pension obligation bonds (POBs) rating to Baa2 from A2, and indicated that the ratings remained under review for possible downgrade. Click her for a copy of the report.
When I informed you about the prior Moody’s downgrade this past May, I stated that the downgrade did not come as a surprise; in fact, I had expected that this could have happened several years ago. Moody’s May Report described what I believed to be a good summary of measures that should be taken by the City to address its financial issues.
I normally find the rating agencies’ analytical approach in reviewing a city’s finances to be helpful, and believe that their credit reports can provide a good financial management road map. I also do not want to discount the importance of sound financial management as a top priority for the City.
However, I believe that this action by Moody’s to further downgrade the City’s credit is completely unwarranted. The conclusions contained in their August 4, 2015 report (attached) (the “August Report”) are filled with inaccuracies, unsupported statements, and pure conjecture concerning Richmond’s credit risks that do not reflect the City’s debt management history.
I have described below some of the numerous flaws in the August Report. In doing so, however, my intent is not in any way to minimize the financial challenges that the City is still facing. Even though “Richmond’s long-term economic prospects are positive” (as stated in the August Report), it will be important to continue to adopt sustainable budgets and improve the City’s cash position, just as the City Council began to do in adopting the FY 2015-16 budget, in order for this potential to be realized.
I have organized my comments below by first providing a verbatim excerpt from the May and August Reports, as appropriate, in blue text, followed by my comments.
First, I believe that it is important to reflect on what Moody’s reported in its May Report when they previously downgraded the City. Their report included the following summary for rating factors:
May Report:
WHAT COULD MAKE THE RATING GO DOWN
· Further deterioration of financial position and liquidity through continued deficit spending
· Decline in the tax base
Comment:
Between May and August of this year, the City Council passed a balanced budget (i.e., no deficit spending) that increases liquidity by adding to General Fund cash reserves. Moreover, as noted in the August Report, “The City’s tax base is large and growing, with an estimated 8.9% increase from its FY 2015 total assessed valuation (AV) of $11.8 billion to $12.9 billion for FY 2016.” In fact, the August Report cites as a strength the City’s “(l)arge tax base with recent healthy growth rates and improving economic conditions.” The August Report also states that “The City's unemployment rate has declined, falling from a peak of 17.9% in 2010 to the current rate of 5.4% in April 2015. By comparison, the unemployment rate for April 2015 was 6.3% in California and 5.4% nationally. New employment opportunities include over 1,000 jobs from businesses locating in Richmond in the last five years, with the majority in the last year.”
In sum, neither of the factors that Moody’s previously cited in its May Report as possibly leading to a credit downgrade manifested themselves, and, in fact, there were significant improvements in the City’s financial position and a significant increase in the tax base between May and August of this year.
In summarizing the City’s credit risk in its August Report associated with the recent downgrade, Moody’s stated:
August Report:
WHAT COULD MAKE THE ISSUER AND POB RATINGS GO DOWN
· Further deterioration of financial position
· Decline in the tax base
Comment:
These statements are axiomatic, and not unique to Richmond. Deterioration of financial position and a decline in the tax base are credit risks associated with any municipal debt issuer. Yet, when applied to Richmond, the statements are completely inconsistent with recent events showing improvements to the City’s financial position (thus, misapplication of the term “further”), and an expansion of the City’s tax base, as described above.
August Report:
WHAT COULD MAKE THE WASTEWATER REVENUE BOND RATING GO DOWN
· Significant depletion of cash reserves
· Decline in debt service coverage levels
Comment:
These statements are likewise axiomatic, completely contrary to fact, and contrary to other statements that Moody’s makes elsewhere in its report. In identifying the City’s financial strengths, the August Report cites “(v)ery healthy wastewater enterprise reserves,” and “(m)oderately strong wastewater enterprise rate-setting record, including a recently approved program of 6.8% annual increases for five years.” Cash and liquidity in the wastewater enterprise are not only strong, but they are getting stronger.
In addition, it is important to note that City has never breached its debt service coverage levels.
August Report (Economy and Tax Base):
Positively, as part of the permitting processing for this project, Chevron agreed to a community benefits agreement with the City providing $80 million in funding over 10
years for a wide range of benefits to Richmond residents. Of this amount, $3.8 million will fund City planning efforts that would have likely required the City to use the General Fund or secure other funding sources.
Comment:
The second sentence relating to the use of $3.8 million is simply wrong. The planning activities associated with the use of the Chevron ECIA funds are for a climate action plan and zoning ordinance amendments – for far less than $3.8 million. This error was pointed out to Moody’s during a review of their draft report, and they did not correct it or otherwise respond.
August Report (Financial Operations and Reserves):
We anticipate that despite subsequent revenue increases, this already weak financial position will deteriorate without strong cost-cutting measures in the very near term (emphasis added).
Comment:
This statement that “we anticipate” is speculative and without foundational support. It ignores the fact that significant budget reductions have been made that led to an operating surplus (preliminary, unaudited) in FY 2014-15 and a balanced budget for FY 2015-16.
August Report (Financial Operations and Reserves):
Outside the General Fund, the City reported large accumulated deficits expected to be eliminated by future revenues. However, many of these funds receive revenue from other City funds or from sources that are limited, in some cases by law.
Comment:
The referenced deficits were, in virtually all cases, accumulated ten years ago or prior. The important fact is, not that they exist, but that these deficits are not growing. Any shortfall in a non-General operating fund is balanced through a budgeted operating transfer from the General Fund or other source. This is routine, and sound, financial management practice. The General Fund is balanced with these transfers taken into account.
A number of “cost recovery” operating departments cannot be completely self-sufficient through fees for service. As an example, the Planning and Engineering Departments will each be performing services for which there is not a paying “client” (e.g. advanced planning, and traffic engineering, respectively). This is why they receive a General Fund transfer in.
August Report (Financial Operations and Reserves):
Operating revenues are projected to increase by $15 million in FY 2016, but the City's adopted budget yields a $1.9 million operating deficit, which is the result of expenditure of restricted fund balances.
Comment:
We spent a great deal of time with Moody’s discussing their statement, which we believe to be factually inaccurate. The restricted fund balances that they assert lead to a structural deficit reflect timing in restricted revenues and debt service expenditures which span two fiscal years. The operating budget is balanced.
August Report (Financial Operations and Reserves):
The City is also expending about $1.1 million annually for project management of remaining successor agency projects, for which it has been reimbursed by placing staff costs on its Recognized Obligation Payment Schedule (ROPS), which is considered semi-annually by the California Department of Finance (DOF). DOF reserves the right to reconsider items on future ROPS regardless of their approval or disapproval on a prior ROPS, which poses a risk to the City that if any future project management costs are denied by DOF, they would become a General Fund liability.
Comment:
Calling this practice a “risk” is nearly incomprehensible. State law specifically allows for staff costs to be reimbursed for direct project costs through the ROPS process. (Health and Safety Code Sec 34171(b).) Inclusion of staff costs for reimbursement on projects is sound financial management. Moreover, the State has never denied this reimbursement to Richmond’s successor agency on a project that is a recognized obligation. Finally, the denial of such costs would trigger the loss of future tax increment – not current cash. Such costs would not become a General Fund liability.
August Report (Debt Structure):
Since their original placement in 2005, growth in annual debt service has outpaced the growth in the pledged pension override tax levy. While revenues from the pension
override currently exceed the combined debt service on the 1999 and 2005 POBs, the City relies on the additional pension override revenue to fund its annual pension costs, which far exceed the remaining override tax revenue.
Comment:
It is unclear why the report implies that use of pension override tax levy to pay a portion of annual pension costs is a credit risk. This has been (sound) financial practice since the 2005 validation action regarding use of these funds. In fact, the existence of the pension override tax is a major credit positive for the City.
August Report (Wastewater Management and Governance):
Given the City's demonstrated history of large, long-term inter-fund loans between governmental and enterprise funds, the City's extremely narrow liquidity poses a significant risk of to the wastewater enterprise's cash reserves.
Comment:
This statement is completely unsupported by facts and is, at best, twisted logic. The report cites on numerous occasions the cash position of the wastewater enterprise as a credit strength and then hoists the City on this petard. An inter-fund loan not repaid during the same fiscal year between the wastewater enterprise and the City would violate the California Constitution, and has, to the best of any recollection, never been done by the City within the last thirty years, and possibly longer. To say that abundance of cash in the wastewater enterprise represents a significant risk, while also citing it as a credit strength, is circular reasoning at best.
* * * * *
I have attempted herein to describe only some of what I believe to be significant problems with the August Report. To reiterate, sound financial management must be a top priority for the City, and my intent in preparing this memorandum is not in any way to minimize the financial challenges that the City is still facing.
Needless to say, I am disappointed in the downgrade, and there is much work to be done; however, I am also disappointed by the analysis that purports to support that downgrade, and believe that Moody’s reached an erroneous conclusion in their most recent credit decision related to Richmond.
Please feel free to contact me if you have any questions or require any additional information.
Sincerely,
Bill Lindsay
City Manager
Bill Lindsay
City Manager
City of Richmond
450 Civic Center Plaza
Richmond, California 94804
(510) 620-6512
Bill_lindsay@ci.richmond.ca.us
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