Lower Merion Citizens for Responsible Budgeting (CRB)
Letter to Editor Re: LM Taxes, Reserve Balance and Credit Rating
May 29, 2007
During the recent budget discussions, Lower Merion Township’s (LMT) minimum reserve fund balance policy, current reserve level, and double AAA-rating were discussed extensively. In the Main Line Life on Wednesday Jan. 17, 2007, Board President Bruce Reed raised the subject again. Speaking for Citizens For Responsible Budgeting (CRB), I hope to clarify and further advance the discussion.
Many Commissioners continue to misunderstand the relationship between Aaa/AAA credit ratings and reserve levels. In his letter, President Reed stated: “the rating agencies have advocated that a much more substantial reserve [more than 12%] should be maintained.” Moody’s (rating agency), in its recently issued credit report on LMT, reaffirmed LMT’s Aaa-rating and noted its strong reserve level, however, no specific percentage was advocated. In fact, credit rating agencies do not, and will not, advocate for a specific reserve level. Citing no evidence, President Reed then declared, in his letter, that “the minimum would appear to be in the 17 percent to 18 percent range, or higher.” President Reed assures us that the Board will re-examine the reserve policy and, while re-examination is welcome, it should have occurred before the majority of Commissioners abandoned it, and reserve levels were then used by those Commissioners as justification to raise taxes.
What is LMT’s minimum reserve fund policy? LMT properly maintains a rainy day fund to guard against unplanned reductions in service, or raising taxes and fees, because of temporary revenue shortfalls or emergencies. The minimum reserve fund policy requires a minimum rainy day fund of 12% of the three-year average of LMT’s general fund balance. Currently, that translates to an approximately $5.2 million minimum rainy day fund. The actual rainy day fund is closer to $11 million. Under the policy, action to raise reserves is mandated if the rainy day fund falls below the 12% minimum. The reserve policy does not require Commissioners, however, to return money to the taxpayers if reserves exceed 12%, or any level for that matter.
What is a Aaa/AAA credit rating? From time to time, LMT issues General Obligation Bonds to finance capital improvements. Credit ratings define a municipality’s creditworthiness in the context of the bonds it issues. Moody’s and Standard & Poor’s (S&P) are the two most common rating agencies. Aaa is the highest rating Moody’s will assign and AAA is the highest S&P will assign. Aaa/AAA credit ratings allow LMT to pay a lower coupon, or interest rate, on bonds it issues. Lower interest payments save the taxpayer money, but such savings are offset when taxes are raised to over-fund reserves, under the mistaken assumption that an over-funded reserve is needed to maintain the AAA-rating.
How do Moody’s and S&P approach the rating of municipalities, and are reserve levels determinative? Many factors are considered, including the economy, finances, debt and administrative/management strategies. “The most useful tool for evaluating credit risk is through examining the way [these] four key areas interact” (The Determinants of Municipal Credit Quality Government Finance Review, December 1999). A Moody’s representative recently confirmed that the 1999 article still reflects Moody’s methodology. The level of reserve is only one financial statistic used to evaluate the finances of a municipality and financial factors are only one of the four key areas considered. Therefore, a fixation on the level of reserves can be misleading, and most certainly did mislead a majority of Commissioners in the 2007 Budget discussion. In fact, Moody’s reports that reserves of its Aaa-rated municipalities across the country range from 0.5% to 147%. With a range that broad, reserve levels cannot be determinative, as President Reed appears to believe.
What are LMT’s true reserve needs? The Government Finance Officers Association (GFOA), a professional association dedicated to the sound management of government financial resources, recommends maintaining 6-8% in reserves. Moody’s analysts write that reserves “should be sufficient to address normal contingencies, which, as a general guideline, is typically at least 5 to 10% of annual revenues” (Government Finance Review, December, 1999). A February, 2002 Special Comment by Moody’s entitled Your General Fund Balance- One Size Does Not Fit All !, again affirmed “a minimum [reserve] level of between 5% to 10%”. In November 2006, Township Manager, Doug Cleland, wrote in LMT’s Civic Express, that a possible 2007 budget deficit “would be addressed by the minor, planned use of our excess (emphasis added) fund balance level.” The evidence agrees with Manager Cleland’s assessment that LMT has an excessive fund balance, and additionally, LMT’s reserve needs are met by current policy or by adhering to GFOA and Moody’s guidelines.
Reserves should only meet true rainy day needs, and revenue requirements should be discussed and debated within the context of the budget being considered. Anything else calls into question whether revenue is being raised to spend on an agenda not actually in the budget, and therefore not publicly disclosed. Absent new information or significant changes, existing policy should be followed, not unilaterally declared archaic. LMT is fortunate to have strong management, steady revenue, reasonable debt levels and a solid economy. Unless President Reed is aware of significant pending changes or new information, such as LMT’s future debt level in excess of what was disclosed to the Rating Agencies, then the current policy should guide our rainy day fund level and revenue should be raised accordingly. If President Reed is aware of new information, he should share it with the public.
Scott Masaitis
Citizens for Responsible Budgeting