Municipal Finance: Varied approaches, but still get the job done

(from Maine Townsman, January 2005)
By Lee Burnett, Freelance Writer

Imagine running a restaurant that receives almost all its food in a single annual delivery and dishes it out on demand whether the dinner hour brings a single lady’s bridge group or a battalion of National Guardsmen.

Managing a town’s finances is kind of like running this hypothetical restaurant. The tax money comes in all at once and must be immediately salted away in timed investments that mature in staggered intervals coinciding with the due date of an irregular flow of bills, big and small. The twin roller coasters of income and outflow must be perfectly synchronized, or else checks bounce and ultimately default looms.

But building up too large a financial cushion to cover bumps in the road is a sure way to arouse taxpayer anger. And municipal money managers must fight the temptation to earn top dollar on investments for the first commandment of municipal finance is to safeguard taxpayer’s money. Adding to the complexity are brand new accounting requirements borrowed from corporate America.

Suffice it to say, the sleepy days of municipal finance are fast disappearing. Even small towns are rethinking long established structures and habits.

QUALIFIED PERSONNEL

The small York County town of Alfred (population 2,500 with an annual municipal budget of less than $1 million) is the latest town to consider abandoning the election of part-time officials to handle municipal finance; instead, the town would hire professionally trained people to handle positions of treasurer, town clerk and tax collector.

“We just really can’t afford to have people who are not skilled,” said Selectman John Sylvester. “Well-intentioned, smart people are not good enough anymore.” Alfred voters defeated the proposed change at a November special town meeting, but will be asked again in March, according to Sylvester.

Alfred is not alone. All over Maine, municipal officials are grappling with the demands of GASB 34, a corporate-style accounting system that requires all assets to be depreciated like a piece of machinery. To keep up with the changes, municipal money managers are being sent to more training sessions than ever before. The day is probably not far off that even small towns will feel it necessary to hire professional finance directors, according to the predictions of some. The hiring of skilled financial expertise could even be shared with a neighboring town to reduce the overall cost.

STATE REGULATIONS

Maine is unique in New England in allowing towns to run their own financial affairs within parameters set by the state, according to John Quartararo, a senior vice president in Banknorth’s government banking division who also has extensive experience in municipal finance. Maine requires all towns and cities to have an annual audit and publishes a list of allowable municipal investment options, but otherwise keeps out of municipal finance. By contrast, Massachusetts and New Hampshire are so involved that they actually set municipal tax rates. More laissez-faire Vermont has no municipal finance law beyond requiring towns to follow the “prudent investment rule.”

Quartararo said he believes Maine’s audit requirement is a good safeguard. against “the kind of financial mismanagement we’ve seen across the river” in New Hampshire. He points to the recent embezzlement conviction of a treasurer at a private school in Northwood, New Hampshire ($242,000 over a seven-year period). “The state is involved, but people steal,” said Quartararo. “If you don’t require an annual audit, there is no independent review.” While conceding that Maine is not immune from municipal embezzlement, Quartararo believes the incidence is lower than elsewhere.

FINANCIAL MANAGEMENT STRUCTURES

A variety of structures have evolved for handling municipal finance. Small towns traditionally split the functions of the tax collector and treasurer, often relying on separate part-time elected officials in each position. As more towns hired managers and administrative assistants, the two positions and functions were often combined as part of the administrator’s overall responsibility. Larger communities often employ full-time finance directors to oversee tax collections and purchasing, to plan investments and to maintain credibility with lenders.

A slew of other arrangements exist. Some communities employ bookkeepers and even in-house auditors.

The structures for handling municipal finance are as varied as the towns in Maine, says Greg Chabot, a partner in Runyon, Kersteen Ouellette, Maine’s largest municipal auditor.

“Some are very hands on, others rely on administrative assistants. There are a lot of variations,” said Chabot, who works with towns of all sizes.

Some small towns “might have no one who has formal bookkeeping training,” said Chabot. “That’s where you find the auditor plays a role in bookkeeping.”

Small towns often struggle with separate accounting requirements for scholarship trust funds and capital projects, while larger communities often wrestle with separate accounting systems for the schools and municipal services. “Auburn brought everything in-house and that made it easier to reconcile things,” says Chabot.

Chabot passes no judgments on whether Maine towns have outgrown small town structures. “It’s tough to make a general statement. The structure works well for small towns. A lot can’t afford to hire a financial director.”

In general, he said, towns are growing more sophisticated in their investments. “In the past, most have kept a lot in checking accounts; they didn’t have many options. Now, there many more investment options. Most of them have some type of investment vehicle. Most do pretty good.”

GETTING MORE PROFESSIONAL

Like many small towns, Alfred struggles with old structures and misconceptions, which Selectman Sylvester sums up this way: “Most people think municipal government is a bunch of dolts, that you don’t need any special qualifications, you don’t have a hell of a lot of responsibility and we sit around, drink coffee and trade gossip, but if you spend a little time in it you realize it’s a very demanding profession.”

The small town of Alfred has some big-city responsibilities these days. Town officials regularly apply for grants; the local planning board manages an escrow account; town officials bid out tax anticipation notes to cover operating expenses in the lean months before taxes come rolling in; and two years ago, the town went to the bond market for the very first time borrowing $850,000 to finance construction of a transfer station.

Sylvester said Alfred is “blessed with a treasurer who is knowledgeable and skilled.” But Treasurer Pat Smith also learned many of those skills on the job during the past decade. Smith came to the job with skills learned in college accounting classes and while working in computer jobs in the insurance and banking industries. Smith confessed that early in her career, “I was calling MMA every time I turned around.”

Smith doubts she could handle the job if she started today with the same training she came into the job with ten years ago. “It’s not adequate,” she said.

The growing demand of the job is a big reason why Smith won’t seek re-election this year. “If I were to stay in the job, I’d have to go back to school,” she said, citing a growth in both the volume and complexity of the work. The position pays $21,730. “I’ve told them in no uncertain terms they should be paying $28,000, $30,000, $32,000. It won’t be long before it’s full-time,” she said.

“When I took over, it was three nights a week,” explained Smith. “I’m now working close to 30 hours (on average) and I don’t have time to get it all done.” The weekly warrant has expanded from one page to five pages and the number of town employees, full-time, part-time and once-per-year has expanded from about 30 to 150. There are separate accounts for capital planning, planning board escrow, bond issue, and community development block grant. “Now I have a half dozen accounts,” she said.

GASB 34 ADDS COMPLEXITY

A good example of the newfound complexity is an accounting change known as GASB (gaz-bee) 34, which stands for Government Accounting Standards Board’s Statement 34. It requires all municipal governments — on a phased schedule of implementation depending on community size — to inventory all town-owned assets (roads, sewers, streetlights, etc.) in order to set a monetary value on them and begin depreciating them. “It’s the single largest, radical change government accounting has ever seen,” said Lisa Parker, finance director in Saco.

The purpose is to make it more difficult for municipalities to hide a backlog of deferred maintenance.

“I always took the approach you can’t maintain something you don’t measure,” said Parker. Saco was one of the first communities in Maine to implement GASB 34 in 2001 and it led to a $1.5 million investment in road improvements over three years. “We went from having 39 percent of the roads falling below acceptable standards to now we have only two percent,” said Parker. The investment will pay off in the long term, she said. “If we stay on top of things, roads will never get where they need huge outlays to totally reconstruct them.”

GASB 34 is making it more difficult for the City of Augusta to avoid looking at its $12 million in unfunded pension liability, according to Finance Director Ralph St. Pierre.

“We’re not unique. Portland’s unfunded liability is up in the $90 to $100 million range. Some communities have a surplus. In our case, it happens to be a negative. We’d always reported it as a footnote in our financial statement and it was being paid down.”

St. Pierre said he doesn’t consider the accounting change that big a deal. “ It doesn’t mean anything, it just makes us more aware of it, having it sit on our balance sheet.” Eventually, carrying an unfunded liability for a long time could hurt the city’s double A minus bond rating, he said.

STICK TO FUNDAMENTALS

Quartararo has seen a lot of changes in municipal finances during his 25-year tenure. Not long ago, it was common for towns and cities to rely on outside auditors to fix their accounting shortcomings, a practice now frowned upon.

“When I first began working in Bangor in 1990, they were still working on the 1989 audit. They were a year behind and relied heavily on their auditor to fix accounting problems,” he said.

“If I’m supposed to be looking over your shoulder, and I do the work for you, then I’m not reviewing your work,” said Quartararo.

He said the practice has been curtailed in the wake of the Enron scandal, which toughened accounting standards across the board — not just in corporate America, but in government accounting as well. Quartararo said he’s not sure whether the practice has been entirely abandoned, but he said “it should be.”

Towns may also be getting more careful with their investments.

It’s been 10 years since the largest municipal bankruptcy ever in Orange County, California put a scare into municipal money managers about the dangers of investments in high-risk derivatives. In Maine, Auburn lost millions in derivatives investments.

To guard against future embarrassments, the Maine Legislature adopted a practice of publishing a list of allowable municipal investments. But, says John Quartararo, “just because it’s allowed by law, doesn’t mean do it.” He is reminded of the enticements he received while finance director in Bangor to invest in a particular Texas bank that seemed like a good thing, but was eventually driven out of business by lawsuits from misled investors.

“Why take money and put it in a product you don’t understand, in a company you don’t know anything about?” asks Quartararo.

The first rule of municipal finance, he said, is to safeguard taxpayers' money, a rule that seemingly needs to be learned again and again. Quartararo cautions against the lure of sending municipal funds to banks in Nevada, which are currently advertising attractive rates.

“They’re taking money out of their market (Maine) and those funds are available to grow the economy in Nevada, so they (municipal finance directors in Maine) can turn around and look great because of the returns. But there are banks in Nevada going out of business.”

Quartararo underscores his point: “Are funds insured or collateralized if (the investment company) goes out of business? Are taxpayers protected?”

Increasingly, local elected officials are being urged to develop investment policies to provide guidance to finance directors and treasurers.

“I would never in my fiduciary capacity make an investment unless I had in writing an investment policy,” says Joseph Cuetara, municipal bond counsel at Moors & Cabot in Boston. He cautions against ever setting a high rate of return as a goal, Cuetara said.

“A municipality is not a mutual fund,” he said.

Another wise practice being pushed with increasing frequency is to build up the amount of cash on hand — the undesignated fund balance. A healthy undesignated fund balance makes it possible to operate during lean months without having to borrow. Quartararo recommends building up the fund balance to one month’s worth of revenue, plus accounts payable at the end of the year.

“To the extent you build up cash position and investment performance, that’s better for you,” said Quartararo. “It doesn’t mean that if you have to borrow (in anticipation of taxes) that shows poor financial management.”

Building up the undesignated fund balance is easier said than done in some towns. In Alfred, Selectman Sylvester said he’d face the wrath of taxpayers if he tried to build up the undesignated fund balance. He measures the trade-off this way: the town could spend $1,500 or $2,000 in interest costs to borrow money in anticipation of taxes during lean months or it could raise taxes $2 to $3 per thousand, so it doesn’t have to borrow.

“People won’t stand for it,” said Sylvester. Others suggest reducing the sticker shock by building up the undesignated fund balance over a number of years.

As municipal finance continues to grow in complexity, one change that small towns should consider is banding together to hire the services of a finance director, say Cuetara and others. Already, South Portland and Westbrook currently share the services of an in-house professional assessor. It may become more attractive as tax pressures and calls for regionalizing services grow.

Augusta's Ralph St. Pierre concurs. “The complexity of government and accounting rules (has increased) basically to be able to interact with banking changes.” Online banking, for example, promises efficiences, “but you need a certain amount of training to understand the technology and make it work for you,” says St. Pierre. “You need economies of scale to make it cost-effective. Sometimes, if you’re small, if you aggregate, you can get the economies of scale.”

MAINE HAS GOOD REPUTATION

For all the growing complexity of municipal finance, Maine cities and towns can be proud of their reputation among lenders as prudent money managers, said Cuetara He quotes with pride a particular analyst at Standard & Poors as being “awestruck” by the rapid amortization of debt and reluctance to borrow in Maine. Cuetara cites a $2.5 million town hall expansion in Falmouth and a new town hall in Kittery that were built without borrowing a cent. New sewer lines in Ellsworth with a 70-year life expectancy “easily could have been bonded over 20 years. but they paid it off in ten years.”

Cuetara salutes this frugal impulse. “It’s not an inbred aversion to borrowing. It’s an inbred aversion to paying interest,” he said. “This is why I deal with Maine. It’s an honor for me. It’s kind of like getting a job at Gucci’s. It has cachet. Their names sell in the marketplace. They pay their bills.”