The Free Press, Mankato, MN

June 16, 2013

N. Kato study: Unpaid assessments spawned debt

Fund transfers were only short-term solution

By Dan Linehan

---- — NORTH MANKATO — A new study of North Mankato's debt shows the city relied on transfers of millions of dollars between funds to make up for unpaid special assessments.

In the next few years, the city will have to find ways to pay back that debt, currently at $3.2 million, and collect those assessments without relying on fund transfers.

Northland Security's 96-page debt study suggests the property tax levy will need to rise by $357,000 between 2014 and 2017. That's equivalent to a 7 percent increase in the levy, but Mayor Mark Dehen said North Mankatoans' taxes may not necessarily rise.

“Is it simply property tax increases? No. We will look at what our options are,” he said. “Will we look at reducing some services? Possibly.”

In March, Moody's Investors Service reduced the city's credit rating from Aa3 to A3 and placed it under review for possible further changes.

That review was apparently finished by last Wednesday, when Moody's said the city wouldn't be downgraded again at that time. However, the outlook for the city was revised to negative.

The agency's explanation for the “negative” outlook provides a more simply-worded explanation than the debt study.

“The negative outlook reflects the city's historic unwillingness to increase the property tax levy to meet high fixed debt service expenditures, expected flat levy for fiscal 2014, and somewhat aggressive special assessment assumptions potentially leading to further narrowing of operating reserves.”

The review, dated Wednesday, seems to make a reference to the debt study, listing this as a strength: “New management has produced a comprehensive plan to address high annual debt service requirements.”

Dehen said the core of the city's problem are unpaid special assessments for infrastructure improvements the city incurred when it built roads and pipes for new housing developments. The city had planned on being paid back when the lots sold, but many were sent into foreclosure due to the recession and housing crisis. So the city was left with debt for these improvements but with no money to pay it back.

The debt report refers to these uncollected special assessments with the only two lines in the report that are underlined for emphasis: “If the city were able to collect all of the outstanding special assessments, as originally anticipated, it would have enough cash to pay debt service and repay the internal loans. The financial planning challenge rests with the timing and certainty of the collection of the special assessments.”

An assumption in the report is that the city will collect 10 percent of its delinquent special assessments, now at a total of $721,000, annually beginning in 2013.

But the report also envisions the city relying less on special assessments to pay back its debt, and more on property taxes.

The city's original plan to pay back its $35 million in total debt called for 21 percent to be paid with property taxes and 29 percent with special assessments.

The new plan, at least as suggested by this study, calls for 37 percent to be repaid from property taxes and only 9 percent from special assessments. It also plans on paying 5 percent of debt with cash, while the original plan didn't include cash at all.

The city's original plan for paying back these special assessments involved “borrowing” the money from various city funds that had excess balances.

This is “not what you're supposed to be doing,” Freyberg said.

Moody's seemed to frown on the practice, too, warning that an “increase in interfund loans to the debt service fund” could make its credit rating go down.

The debt study includes a plan to pay off those loans by 2017.

Dehen said the council was aware of these loans to some extent, but former City Administrator Wendell Sande “carried it all in his head.”

“Not all of that is apparent to us,” he said.

Dehen said the city was a victim of a “perfect storm” of financial misfortune in the past few years — the recession and the retirements of Finance Director Steve Mork and Sande.

“I don't think there was a mistake made,” Dehen said. … “There's no malice in any of this, no obfuscating.”

Councilman Bob Freyberg, though, said the city's finances have been mishandled, calling it “frankly kind of appalling.”

“For the last two budget sessions, I have harped about the amount of debt we have and the GO (general obligation) debt,” he said.

Even so, Freyberg said he's “very happy” that this study was done, so the city can learn from its mistakes. He also called it a “good reflection” on City Administrator John Harrenstein.

The study did not examine the health of the utility funds, which disappointed Freyberg, who said the city will likely have to raise residents' drinking water bills by about 5 percent next year.

A consultant from Northland is scheduled to discuss the report with the City Council at 8:30 p.m. Monday, during the regular meeting at City Hall.

Freyberg plans to bring past audit letters to show how past warnings weren't heeded.And the council will have to decided whether to delay, as city staff recommend, a $500,000 infrastructure project at Cliff Court.

Dehen said the city also has growth prospects on the horizon that will help it pay back the debt. Thirty-five new houses are being built, which will add to the tax base.

And the city will be receiving $200,000 more in local government aid in 2014.

“I think we're going to come out of this just fine,” Dehen said. ... “It's going to cramp our style for awhile, but it's not going to stop us from doing business.”