Financial Analysis of Battle Creek, Michigan

John Maxwell Sarah Overmyer Kevin Paris Andrew Phifer

Executive Summary After completing a top-level analysis of the City of Battle Creek, Michigan, we have determined that the city is in a fair financial state. The group completed the 10-Point Test (10PT) and the Financial Trend Monitoring System (FTMS). On the whole, when scoring the city with 10PT, the city comes out ranked about average with a total score of 3. These are relative scores of course, but given the macroeconomic climate of the state of Michigan, this ratio seems to indicate that the financial managers of Battle Creek are doing their job very well. Some ratios of interest are Ratio 7 and Ratio 9. Ratio 7 is scored with a -1. By ranking into the worst quartile for this metric, shows that Battle Creek is having a cash flow problem and may have trouble meeting short-term obligations. The score is 0.535 where the top end of the lowest quartile is 0.622. These cash crunch issues bear out in the last few years where the city has had to reach into the unreserved fund balance to meet the shortfall. In 2008 and 2009, the city drew ~$3.6M and ~$5.0M, respectively, from the rainy day fund. In 2010, there was some stabilization and there was a net surplus of ~$0.2M. The city must be vigilant in shoring up its spending side to cut down on possibility of dipping into the fund balance too often. Ratio 9 is interesting because the population of the city has been declining. There must be active management of the citys long-term debt because the city does not have a growing population to meet the demands of the debt. The city has made some effort to this effect as they decreased total debt outstanding by 9.1% during FY 2010. At the same time there are certain items in the statements that could cause some concerns to lenders. The ratings agencies have not punished Battle Creek in the past three years. All three have stayed constant placed the general obligation bonds and wastewater revenue bonds in the upper medium grade category. The city is on a good footing, but a misstep in managing the debt or meeting short-term cash needs could be very painful to solve.

Financial Trend Monitoring System, Introduction to the Methodology: The Financial Trend Monitoring System, developed by Sanford M. Groves of , uses long-term financial data for local governments to assess its financial health and plan for its financial future. The system uses a set of twelve factors to assess the financial condition of a local government. The twelve factors fall under three categories: Environmental Factors, Organizational Factors, and Financial Factors. Due to the limited scope of this report, we used 10 indicators to study the financial condition of Battle Creek, Michigan. Of these, three indicators fall under Environmental Factors: percent change in property value, per capita personal income, and population. The remaining seven factors fall under the Financial Factors Category. [i] Analysis of Findings (*Note: All tables referenced appear in the Appendix): After considering the data provided in the 2010 CAFR for Battle Creek, the city appears in a positive financial position, although it does face concerns of a declining population. As Table 2 shows, from 2002-2009, the citys expenditures exceeded its revenues. However, in 2010, the city closed this gap and revenues slightly exceeded expenditures. After 2003, the city lowered both its long-term debt to assessed value ratio and its per capita long-term debt(Tables 6 and 7). Altogether, over the entire period from 2001-2010, its debt-service ratio inched up slightly, though it has total debtservice ratio has basically hovered around 5% of total revenue for all government funds (Table 8). During this time, Battle Creek has substantially improved its property tax performance. Property tax revenue has climbed steadily since 2004, and Battle Creek has succeeded greatly in collecting property taxes, failing to collect only 0.3% of property taxes levied in 2010 (Tables 3 and 4). This has occurred despite a seemingly volatile local real estate market that has fluctuated significantly in the period 2001-2010 (Table 5). Despite its apparently sound financial management, Battle Creek faces significant environmental challenges. After facing declining per capita income from 20032006, incomes in the city began to rise past their 2003 levels. However, per capita income fell sharply from 2009 to 2010, likely due to the dismal economy nationwide (Table 9). Most

significantly, population has declined sharply from 2002 onward, falling from 53,311 to 51,843 in 2010 (Table 10). The population decline appears to present the most significant challenge to Battle Creek in the years to come. Recommendations: In the future, city leaders will have to account for the decline in population, possibly with cuts to existing service. However, the city must continue to provide a high level of service to a smaller population. The city must thus demonstrate its friendliness to businesses and citizens. Since much of its revenues rely on property taxes (as well as income taxes), the city must work to retain high property values by maintaining its quality of life in areas such as education, crime prevention, and recreational opportunities. These qualities may also help attract new businesses to the area. The ability of the city to attract new business will greatly influence its ability to maintain a sound fiscal position, since unemployment has increased significantly since 2001.(2010 CAFR pg. 138) 10-Point Test, Introduction to the Methodology: Because an in depth financial analysis for a city can be time consuming, costly and difficult to convey, Ken W. Browns landmark 10-Point Test (10PT) offers financial managers a snapshot of a citys fiscal health that avoids these disadvantages. The test develops ten ratios for a city broken down into four categories: Revenues, Expenditures, Operating Position and Debt Structure. Each ratio is compared to an index of quartile ranges of cities with similar population in order score them from -1 (worst) to 2 (best). Because the 10PT is a cursory view of a city, a negative outlook may only mean that a more in depth analysis is needed.[ii] Analysis of Findings (Note: Full 10-Point Test results found in appendix): By looking at Browns ten key ratios and comparing them to cities of similar population, Battle Creek receives a 10PT score of 3. This means that Battle Creeks financial health is average even during these difficult economic times. By breaking the findings down by category, the city is doing well on the revenue side (ratios 1-3). The city gets its largest positive score of 2 from ratio 1 because a large

amount of revenue is being generated in comparison to the relatively small population. This analysis is counter to what Brown suggests because he believes that a lower ratio leaves room for more revenue. However, were assuming that a healthy revenue from taxation is beneficial for the city and its finances. By looking at expenditures (ratio 4), the city is labeled as average, but that it is on the cusp of falling into the worst quartile. The operating expenditure is just shy of the total expenditure. By looking at the operating position (ratios 5-7), one can see that this is where there is perhaps cause for concern. The city earns its lowest score of negative 1 on ratio 7 because there seems to be insufficient cash to meet its short-term liabilities. This ratio reflects on short-term solvency and it appears that the city is either relying on receivables or intergovernmental funds to meet its obligations. By looking at debt structure (ratios 8-10), the city is once again average by being able to pay off its short-term and long-term debt obligations in addition to its debt servicing. However, ratio 9 is dependent on population and property tax revenues so a stable tax base is critical to maintaining the average rating on this ratio.[iii] Recommendations: Because the 10PT is only a snapshot of current financial stability and Battle Creek received an average overall rating, the city should invest in a more in depth financial analysis especially since some of the ratios were on the cusp of falling into a worse quartile. The analysis should particularly focus on problem ratio 7 which highlighted a cash flow issue. The city needs to manage their spending while they are in fair condition before this issue creates a larger problem. Evaluation of Methodologies for Financial Analysis:The greatest benefit of using the 10point test for financial analysis is that it is a quick and easy way to look at a small citys financial health. It is a simple and inexpensive analysis tool that can be updated easily in for to look at a citys standing on a continuous basis. Revenues and expenditure are shown clearly, as well the proportion of revenue that comes from outside the city. The 10-point test also shows long-term debt.

Disadvantages are that all 10 ratios carry the same weight, which may not show particular strengths and weaknesses of a city. For example, it is normal for capital to vary widely in small cities because capital projects and expenditures can be irregular and large compared to total expenditure. Also, the interpretation of the score can only be compared to other cities 10-point test. It provides no absolute estimate of how a city is doing, only a comparison to other cities of similar size. Finally, the 10-point test does not address where resources for the community are coming from specifically, which may be very helpful in looking at long term financial security. It only provides information on whether or not funds are coming from within the city or outside it. In the case of Battle Creek, the current population is so close to 50,000 that it may make sense to look at different limits for the 10-point test. In this analysis, the 10-point test for cities with population 50,000 to 100,000 was used, but different results would have been attained had the 30,000 to 50,000 inhabitant rubric been used. The largest advantage over the 10-point test that the Financial Trend Monitoring System (FTMS) holds is that it is much more detailed and in depth. The FTMS looks at each factor over time, much more clearly showing changes and trends, such as population and property values. In looking at things over a longer period of time, financial analysts have a better view of how actions, such as delaying payments, may affect the future. The FTMS shows a more human side of a city, as opposed to the 10-point test, because population is looked at over time and per capita income is included in the analysis. Though the richness of information provided by the FTMS can help to paint a broader picture of the financial health of a city, the FTMS is much more complicated and takes much more time to prepare than the 10-point test. It does not provide as simple an outlook as the 10-point test and therefore may be difficult to prepare for someone who is not a financial specialist. Its detailed analysis does not provide a single reference number, which can quickly be used to compare relative financial health to other years or other cities, as the 10-point test does.

Analysis: From 2002 through 2009, the City of Battle Creek has run a shortage of revenues against expenditures in the general fund. The CPU adjusted average during that time period was ~$2.5M. The most significant deficit was in 2003, when the deficit in the general fund was was $6,737,023. Since that time period, the City has had to reach into the unreserved balance of the general fund to meet the balanced budget requirements. Property taxes in the state of Michigan are limited by the Headlee Amendment which limits the annual increase in the State Equalized Value of real property. In addition, Proposal A limits the increase in taxable property value to 5% or the rate of inflation whichever is less. In 2009, there was a 3% increase in the assessed value of property. From what information that was found in the 2009 CAFR, the gain was due to an appreciation in the real property values in the city. Although this increase was in the middle of a recession, the cereal industry is somewhat recession-proof good and this may have led to the ability for the values of the factories to rise even as the residential values decreased. In 2006, there was a 1.476% raise in the total direct tax rate, which increased the total revenues from property tax as the total assessed value also increased.

[i] Groves, Sanford M, "An Introduction to Evaluating Financial Condition," Evaluating Local Government Financial Condition, handbook 1, International City/County Management Association, Washington D.C., 1980, pp. 1-26. [ii] Ken W. Brown, The 10-Point Test of Financial Condition: Toward an Easy-to-Use Assessment Tool for Smaller Cities, Government Finance Review, December 1993: 21-26. [iii] Battle Creek CAFR 2010