Audit raises red flags on Flint's finances, but mayor says city can recover

A new audit shows pension debt in Flint is in worse condition than what Detroit faced when it entered bankruptcy, but new Flint Mayor Sheldon Neeley said he’s confident the cash-strapped city can right its financial course.

Flint has more than $370 million in pension legacy costs that remain unfunded — a 30% funding rate that is worse than the 65% rate that a consultant for Detroit's emergency manager calculated in 2013 for Detroit's General Retirement employees.

The Flint audit also uncovered a dozen material findings — significant errors and financial risks — questioning accounting practices under former Mayor Karen Weaver's administration that led to several errors, including miscalculated balances and a lack of internal controls over purchasing cards. But the city's current budget isn't running a deficit, so it isn't eligible to file for bankruptcy, experts said.

On Jan. 2, the state of Michigan notified Flint that it had 30 days to submit a corrective action plan to address the audit problems and, on Jan. 3, the state told the city that it was delinquent in submitting a separate report detailing its 2019 funding levels for pension and retiree health care.

Neeley, a former city councilman and legislator who won his seat in October, plans to comply with the state's requests and remains optimistic there’s a way out of Flint’s financial malaise that avoids the specters of bankruptcy or emergency management that have hung over Flint in recent years.

"We are changing the trajectory of the city as it relates to our finances and looking at pathways around those two options,” Neeley told The Detroit News.

The city's pension debt — regardless of how large — is one of several financial stresses facing Flint and is arguably less important than the city and state's policy response to the challenge, said Matt Fabian, a partner at Municipal Market Analytics Inc., a Concord, Massachusetts-based group focused on the municipal bond market and distressed municipalities.

"Pensions make the medium- and long-term budget situation worse," Fabian said. "It complicates other issues that are almost always the cause for bankruptcy.

"Ultimately, the pension is a long-term cost that needs to be covered and it's going to consume tax increases and budget cuts and state aid.”

While mismanagement in part may be to blame for some of Flint's financial stress, so are more than a decade of population loss, taxable value decreases and dips in state revenue sharing with little room to raise taxes, said Mitch Bean, former House Fiscal Agency director and a principal at Great Lakes Economic Consulting.

"It’s the constraints that were put upon them, and then the state to a certain extent is balancing its budget on the backs of communities and schools," Bean said.

Flint’s financial path

Flint was under state emergency management from late 2011 to 2015, when the state began the process of returning local control. Local control wasn’t completely restored until April 2018.

The city was under emergency management when Flint switched its water sources from a Detroit area system to the Flint River, prompting the city to add more chemicals to its water without proper corrosion controls.

The chemicals leached lead from the lines on its way to people’s faucets, spurring the Flint water crisis.

The contaminated water "only compounded Flint's existing financial issues," said Senate Minority Leader Jim Ananich, D-Flint. And the problems that have plagued the city could take years to resolve, despite some revitalization in the downtown, he said.

"The city's population has declined, drastically shrinking its tax base, so there will continue to be some financial hurt until we have recovered from the crisis and the economy has adapted to the new environment," Ananich said.

Flint's population shrank from 111,475 in 2010 to an estimate of nearly 96,000 in 2018, state revenue sharing dipped from $18.9 million in 2014 to $14.1 million in 2018, and taxable value plummeted 40% from 2008 to 2012, according to data in "Michigan's Great Disinvestment," a report on which Bean collaborated.

"Places like Flint have a really, really small tax base,” Bean said. "It's much lower than what you need to provide services.”

The city has received hundreds of millions of state and federal dollars since the lead contamination came to light and is more than halfway through replacing its lead service lines. But much of the aid was limited to water infrastructure while the city’s budget struggled.

State aid — short of state oversight — could be essential to Flint's future recovery efforts and in its standing with lenders, Fabian said. After Detroit's bankruptcy, he said, lenders are increasingly noting a municipality's relationship with the state perhaps more than the debt pressures squeezing a community's budget.

"What’s the relationship with the state and is the state going to be a partner or an adversary in the future of the city?" Fabian said.

When Neeley took over in November, his new hires included new advisers in finances, including economist Eric Scorsone, who came in as a member of Neeley’s transition team.

Scorsone, the former deputy state treasurer and chief economist for the state Senate, is an associate professor and director of the Center for Local Government Finance and Policy at Michigan State University.

The state Department of Treasury volunteered to help as Neeley transitioned into his role as mayor and plans to help the city assess and improve its pension funding.

“We’re aware of the city of Flint’s finances and underfunded retirement benefits,” said Cary Vaughn, audit manager for the Michigan Treasury Department. “We plan to work with the city as they create their Corrective Action Plan.”

That relationship with the state may be challenging. City councilman and finance chair Eric Mays told The News Monday his job was "to keep the state out" of Flint — a reference to the state's past emergency management.

He also had harsh words for Neeley. Mays said he was "ecstatically excited" the city ended its fiscal year with a $24 million fund balance.

"This mayor campaigned we were on the verge of bankruptcy," Mays said during a Monday council meeting. "You give me $24 million, and me and my son and my grandkids, we are going to live good.”

Mounting debt

Flint has more than $620 million in unfunded pension and retiree health care costs.

At the end of 2018, 31% of the city’s promised pension was funded — down from 36% at the end of 2017 — amounting to $372.9 million in unfunded liability, according to the city's most recent audit. The city’s liability for retiree benefits such as health care, which is not pre-funded, amounts to $249.8 million, the audit report said.

The city contributed $23.5 million to its pension plan in 2018, but $50.9 million was paid to retirees, the audit said.

The projected $17.9 million Flint had to pay in 2018-19 retiree health care costs “is nearly insurmountable for a city in the fragile financial state in which Flint finds itself,” according to the city audit.

Yet the city will need to increase its contributions to the retirement fund so it reaches funding levels acceptable to the state. The state deems a pension system “underfunded” if it falls below 60% funded.

At the end of 2018, Flint had 1,773 retirees and beneficiaries receiving benefits supported by 443 active employees working to earn their own benefits, according to the audit report.

“Because we have so many retirees to current employees, we know we’re going to have address some of the city’s contribution levels,” Scorsone said. “We do expect some substantial increases in the city’s contribution levels going forward to try and make up the difference.”

Mays said he hopes to contribute more to the fund in the next few years, after building up the general fund balance, which he argued are similar to challenges other cities are facing.

"We’re a city just like other cities," he told The News. "There are some legacy costs dealing with pension and retiree costs."

Other debts include several emergency loans or fiscal stabilization bonds issued under emergency managers, Scorsone said.

The city also has a liability of $100 million in bonds for the Karegnondi Water System, which is offset by about $97 million of monthly credits through its water contract with the Detroit area's Great Lakes Water Authority.

The audit noted marginal increases in Flint's income tax revenue and property value. The city ended the 2018-19 fiscal year in late June with a positive balance of $720,000 after spending $52.5 million, the audit said.

Income tax revenue in fiscal year 2018-19 was $16 million, up from $15.5 million in 2017-18. The city's taxable value of property was $734 million in 2018 compared with $714 million in 2017, according to the audit.

The increase in tax revenue is still well below where the city was 10 years ago, Scorsone said, but stressed Flint’s financial situation is not impossible.

“We should be very clear on this,” Scorsone said. “The city of Flint, given its current cash position, would not be eligible for bankruptcy. You pretty much have to be out of cash completely, as Detroit was, to even enter into a bankruptcy conversation.”

Audit highlights issues

The audit of Flint’s finances from July 1, 2018 through June 30, 2019 found 12 material conditions within the city, most zeroing in on a lack of financial controls within the city.

“I’m very concerned about the outcomes and what the audit revealed,” Neeley said. “We’re taking action currently trying to move us beyond the position we are in now."

The audit itself was barely completed before a Dec. 31 state deadline. Mays and fellow council member Monica Galloway asked for it to be released exclusively to them when it was complete Dec. 27, Neeley said in a statement, and it was only released to the public after Neeley became aware of its availability.

Mays countered that a draft had been given to Neeley before it was given to the council and, upon realizing as much, Mays demanded the final draft be given to himself and Galloway.

"It’s the purview of the Flint City Council in this case," Mays said. "We conduct it. We pay for it, and we try to get it done on time.”

Other council members expressed serious concerns about the audit. Council member Kate Fields said Monday the city had "never had a worse audit."

Flint council member Eva Worthing said she was ready to work with the administration and auditors, who are expected to make a formal presentation on the audit Wednesday to the City Council.

"We must work with the administration to fix some of these errors," Worthing said. "It's not an opinion. This is what the auditor said.”

Among those conditions highlighted in the report were insufficient number of accounting employees, inadequate controls over employee use of purchase cards, numerous incorrect balances and adjustments, and incomplete payroll data.

In one instance, “an employee had a pay increase and documentation of approval of this increase was not available and did not agree to the city’s compensation schedule,” the report said.

The city’s handling of cash in the treasurer’s office also lacked proper processes or a secure way to transfer cash to a safe throughout the day.

In the Department of Public Works, vendors started work without purchase order approvals or a contract, contracts were undated, and about $11.5 million in expenditures did not have associated purchase orders.

“Additionally, we examined a city council resolution for a fire truck purchase that had signatures form another document taped over it and copied,” the report said. “we were unable to find an original signed copy of the final resolution.”

The mayor characterized the problems identified as a failure to follow procedure and inadequate governing. He said his administration has made changes in the roughly two months since he took office, including the revocation of some purchase cards.

eleblanc@detroitnews.com