MOORLACH UPDATE — Financial Restatements — August 29, 2011

CONGRATULATIONS OCEAN VIEW, HUNTINGTON BEACH LITTLE LEAGUE INTERNATIONAL WORLD SERIES CHAMPIONS!

The OC Register’s website has a collection of photos at http://www.ocvarsity.com/sections/article/gallery/?pic=1&id=27482&db=….

A week ago on Sunday, the OC Register had an in depth article on unfunded pension and health care (retiree medical) liabilities.  The reporters, Tony Saavedra and Jon Cassidy, were able to obtain market value pension liabilities for those cities in CalPERS and provided helpful graphs, like the one below.

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An interesting revelation comes from viewing the graphics:  South County has lower unfunded liabilities.  This is true for two reasons.  Firstly, because South County cities are newer, their retiree populations are lower than that of longer established cities like Anaheim and Santa Ana.  Secondly, these cities are contract cities.  While the majority of North County cities tend to be full service cities, with their own police and fire departments, South County cities contract police services from the Orange County Sheriff’s Department and fire services from the Orange County Fire Authority (OCFA).  As a result, it is the County and the OCFA that carry the unfunded pension liabilities for these public safety employees on their books, not the contract cities.  If the proportionate share were calculable and assignable, then the graphics may look a little different.

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The dirty little secret about the above unfunded liabilities is that they are not reported on the cities’ balance sheets in their Comprehensive Annual Financial Reports (CAFRs).  This is because it has never been required by the Government Accounting Standards Board (GASB).  Instead, they only require a mention of these liabilities in the footnotes to the audited financial statements.  Incredulous!

Can you imagine not reporting a major obligation on a loan application?

Most cities have their CAFRs posted online.  When you go to the Basic Financial Statements section of the CAFR, you get a quick snapshot of the assets, liabilities, and net asset details.

What if we were to take the unfunded liability amounts from the footnotes and add them to the balance sheet?  For many cities, the restated financial statements would be a nightmare!  Whatever little net positive unrestricted equity they have would be swallowed up by the amounts of the previously unreported debts owed.  And I mean really owe, because municipalities who do not make their pension contributions would be sued by defined benefit pension plan providers in a heartbeat for nonpayment.

Obtaining actuarial reports on the unfunded liabilities is another fun problem.  The footnotes for the year ended June 30, 2010 for Newport Beach and Irvine refer to the information provided by CalPERS for the prior fiscal year, June 30, 2009.  Consequently, the data you’re reading when you peruse the financials is not necessarily current.

It makes you wonder if an attorney without any financial training, now serving as a judge, would be confused when a county makes a big deal about an unfunded actuarial accrued liability (UAAL) when GASB does not.

I did a little exercise with the cities of Newport Beach, incorporated in 1906, and Irvine, which is newer and contracts with OCFA, using the information in their CAFRs.  Then I compared it to the data available from the June 30, 2010 CAFR for the County of Orange.  The results are not encouraging.

I would expect a major campaign against GASB’s efforts to require the reporting of UAALs on balance sheets by those who would prefer to keep this debt hidden.

The result was provided in Sunday’s OC Register’s Commentary section and is presented first below.  The read is a little like being in an accounting class, but if you wade through, you’ll see that the County is in dire fiscal shape.

As a result, antics like Sacramento taking $48 million in Vehicle License Fee revenues from us is a very, very big deal.  There is minimal wiggle room from a cash flow perspective for the County.  In the meantime, pass the duct tape and say a little prayer for the County when you have a chance.

Friday evening I participated in the annual West County Chambers of Commerce Legislative Mixer, an event I try to make every year.  The Orange County Breeze covers this area of the County and recently went online with their articles.  It’s the second article below.  (I did not understand the line “no one from the state level showed up” – as we had three Assemblymen present.)

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John Moorlach: O.C. again could face bankruptcy

The accounting profession has two rule-making bodies that provide generally accepted accounting principles and auditing standards for reporting financial statements. The Financial Accounting Standards Board (FASB) provides rules and promulgations for the private sector. Municipalities follow the rules established by the Government Accounting Standards Board (GASB).

FASB has required companies for 25 years to report unfunded liabilities for defined-benefit pension plans on balance sheets. GASB has not. However, GASB is finally addressing this oversight. Regrettably, it’s too late. The abuse of public employee defined-benefit plans has already been done, and the damage may be irreparable.

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GASB also requires that unfunded liabilities for retiree medical benefits be reported on balance sheets. Unfortunately, municipalities are only required to report the compounded amount of payments minus the annual required contributions. The employer should make 30 annual payments towards this debt, like a mortgage. It does not report the mortgage, only those payments that were less than the annual mortgage payments.

A balance sheet provides an entity’s assets, which are the things it owns, like cash, land and buildings. Also included are liabilities, such as loans that it owes, like mortgages. The difference is known as equity, retained earnings (deficit), or net assets.

GASB breaks apart municipalities’ net assets into three categories:

1) Investment in capital assets, net of any related debt. A city may own land and buildings, but it would not necessarily sell City Hall to pay off debts. Consequently, why overstate your net worth by including this equity? When you, as a private investor, compute your net worth, you wouldn’t include any equity in your residence as an investable asset. Municipalities shouldn’t either.

2) Restricted resources. This is any asset on the books that does not belong to the municipality, but belongs to another outside party.

3) Unrestricted net assets that are truly available to a city or county.

What will happen when GASB requires cities and counties to fully report unfunded pension and retiree medical liabilities on their balance sheets? You credit liabilities and debit unrestricted net assets. How will this look?

Let’s use the city of Irvine as an example. Its net assets are $2,082,629,000. It’s investment in capital assets are $1,488,021,000. The restricted resources by outside parties are $349,681,000. This leaves unrestricted net assets of $244,927,000. Irvine’s unfunded retiree medical costs, as of July 1, 2008, was $3,471,000. Its unfunded pension liabilities, as of June 30, 2009, were $91,995,000. Thus, the true net assets available are only $149,461,000.

Next door is the city of Newport Beach. Its net assets are $2,323,822,000. Its net investment in capital assets is $2,193,362,000. The amount of restricted resources is $34,237,000. This leaves unrestricted net assets of $96,223,000. The unfunded retiree medical liability as of June 30, 2008, is $40,230,000 and the unfunded pension liability, as of June 30, 2009, is $134,117,000. This results in true net assets available as a negative $78,124,000 (deficit).

What does this mean for Newport Beach? It has cash on its balance sheet of $175,001,580. The unfunded liabilities are $174,347,000. To pay off these debts today, it would exhaust the checking account for the city. It would also force the city to explain to outside parties where restricted resources amount of $34,237,000 went.

Folks, we are facing a major problem. Not having to report employee benefit liabilities has allowed public employee unions to abuse them. Had municipalities been required to report benefit increases that immediately generated unfunded liabilities, it’s highly unlikely that elected officials would have approved them.

I’ve used data from the Comprehensive Annual Financial Reports for June 30, 2010, for Irvine and Newport Beach. What happens when we take the same information for the county of Orange?

The county’s net assets are $4,794,221,000. The net investment in capital assets is $3,097,843,000. The restricted resources are $1,384,586,000, thanks to our relationships with the state and the federal governments. That leaves unrestricted net assets available to the county of $311,792,000, or just a little less than that of Irvine and Newport Beach combined. The county’s unfunded retiree medical liability is approximately $396,009,000, which wipes out the county’s unrestricted equity. The county’s defined-benefit pension plan’s unfunded actuarial accrued liability is $3,703,891,000. The county has an available equity of a negative $3,788,108,000. The net investment in capital assets doesn’t even cover this debt.

The county of Orange, which went bankrupt in 1994, is a bankruptcy candidate again.

The county has renegotiated its retiree medical in 2006 and 2007, reducing it by $1 billion. It also negotiated new pension tiers for new hires; increased withholdings for employees that, until recently, had the county paying their entire employee portion of the pension contribution; and froze pay raises for three years. The County’s voters approved Measure J, requiring voter approval before any future negotiated retirement benefit can become effective. The county even negotiated a voluntary opportunity for current employees to opt down to the lower pension formula offered to new hires and offers a defined-contribution plan as an incentive. Unfortunately, the Internal Revenue Service is obstructing this option.

What more can be done? The county could withhold more from its employees to pay a larger percentage of the annual cost. This will assist cash flow, but doesn’t do anything to the liability. The county could sell assets, but it doesn’t have enough of them. The county could negotiate a return to the old retirement formulas, but this has not been tested anywhere. The city of Vallejo filed for Chapter 9 bankruptcy, but did not allow the judge to rewrite bargaining unit agreements.

More cuts and benefit modifications can be pursued. Outsourcing should be expanded. The county’s public employee unions should negotiate to reduce pension benefit formulas for current employees, which is the best alternative. Otherwise, I don’t see any pay raises in the near future for county workers. If the county experiences an unforeseen financial calamity, then a bankruptcy judge may just have to approve a reorganization plan, again. This course of action is very expensive, but at least we’re familiar with it.

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Every year in August, a handful of Chambers of Commerce in northwest Orange County organize a joint “legislative networking mixer.”

Politicians from all levels of government are invited.

This year’s mixer was hosted by Orco Block Company, a family-run masonry business based in Stanton. The Stanton Chamber of Commerce took the lead in organizing the mixer, and Park Avenue Restaurant catered the food.

Familiar faces allowed time to speak from the podium included California Assemblymen Jim Silva (R-CA67), Chris Norby (R-CA72), Allan Mansoor (R-CA68) and Orange County Supervisor John Moorlach.

The common theme that ran through their talks was that the state and all its local entities will remain in bad shape until the state legislature and governor can regain control over the budget.

Mixing among the crowd were councilmembers and community leaders from La Palma, Cypress, Rossmoor, Seal Beach, Stanton and Los Alamitos.

Congressman Ed Royce (R-CA40) did not come nor did he send a field representative. He announced on August 15 that he would run for re-election in the new 39th District that includes Buena Park but not Cypress or Los Alamitos. The District straddles the Los Angeles – Orange County line, with Hacienda Heights, Rowland Heights, Walnut and Diamond Bar within its boundaries as well as Yorba Linda, Placentia and Fullerton.

Congressman Dana Rohrabacher (R-CA46) also did not attend and also did not send a representative. He is expected to run for re-election in the new 48th District that hugs the coast from Seal Beach to South Laguna.

Also running in that District will be John Campbell (R-CA48), the current incumbent.

To keep things entertaining, Irvine Mayor Sukhee Kang has declared his candidacy.

No one at the State Senate level showed up, unless you count Jim Silva, who will be out of a job next year. He has already announced his candidacy for the 34th State Senate District, which is next up for election in 2014.

California State Senator Tom Harman (R-CA35) is termed out. Lou Correa (R-CA34) represents neighboring District 34 and will inherit Cypress in new District 29.

OC Breeze’s coverage area will be split among new State Senate Districts 34 (El Dorado Park Estates, College Park east, Los Alamitos, JFTB and Rossmoor) and 29 (Cypress). The smaller cities in District 34 will likely be overshadowed by Santa Ana. In new Senate District 29, Fullerton may dominate. It’s currently represented by Republican Caucus Chairman Bob Huff.

Another border-straddling District is the 47th Congressional, which reaches across the county border from Long Beach to snag not just Rossmoor, Los Alamitos (and the JFTB) and Cypress but also Stanton, Westminster and Garden Grove.

That no doubt prompted the appearance of Gary DeLong (R), never seen before redistricting. DeLong is currently Long Beach Councilman for District 3, stretching from the county border on the east to as far west as Junipero Avenue in the west, zigzagging north to Atherton in the north and encompassing the southern shore line from Alamitos at 72nd through Bluff Park. His official Congressional campaign website is minimal, with a home page and two buttons, one to contribute and one to subscribe to a newsletter.

His likely opponent next year, Alan Lowenthal (D-CA27), did not attend. Lowenthal currently represents Long Beach in the California State Senate. He started out as a Long Beach City Councilman before stepping up to the State Assembly.

When Lowenthall announced his run for Congress prior to redistricting, the Long Beach Press Telegram foresaw a primary battle among Democratic candidates:

The move could set the stage for a three-way battle between Lowenthal and Reps. Laura Richardson and Linda Sanchez, whose current districts would be greatly affected by the proposed boundaries being drawn by the Citizens Redistricting Commission.

That lack of attention is exactly what gripes those in Orange County paying attention to redistricting — the strong likelihood that their concerns will be ignored by a Congressional representative turned towards Long Beach.

FIVE-YEAR LOOK BACKS

1996

August 29

Joe Bel Bruno of The Bond Buyer provided an update, “Orange County Officials Aim To Pay Off Some Debt Early,” that makes me pine for the opportunity to do it again, but now with our unfunded medical retiree and defined benefit pension plan liabilities (a debt which is now a crushing four times larger).

                In an effort to regain the faith of Wall Street and taxpayers, Orange County officials today are expected to adopt a plan to help the county pay off early some of the more than $880 million of bankruptcy recovery bonds it issued three months ago.

                County Treasurer John Moorlach says the plan is not aimed as much at impressing Wall Street as it is at winning back support from county residents still jaded from the debacle.

                “I don’t think this is going to restore faith on Wall Street, but it is doing something to restore faith on Main Street,” Moorlach said.

                “This is taking the attitude that we need to get this bankruptcy over as quick as possible, and put it behind us.  If we can pay down a mortgage sooner, the interest costs will go downstream and Wall Street understands that.”

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