by Richard A. Ciccarone
Despite serious jawboning by market participants and a spotlight on a spate of municipal credit problems since 2010, Merritt Research Services’ latest and most expansive study to date, using financial reports from 2014, continues to show that municipal bond audits substantially lag the regulated corporate securities market when it comes to completion time and their availability for market and public use.
Involving nearly 10,000 municipal bond related audits for 2014 and over 70,000 over the past eight years, the study found that audit times take close to six months to get done while revenue bond borrowers generally finish the task closer to four months. That’s a long way from the 60 to 90 day standard used in the corporate bond world. While a fair share of municipal enterprise type and not-for-profit issuers reach the 120 day mark for completing their books, only about 5% of all states and counties and 10% of all cities finish their audits within 120 days, a target encouraged by the SEC and others. That’s about the same share of audits reaching the 120 day timing mark in 2011.
While there are a meaningful number of municipal bond borrowers that finish much faster than the norm, there are also a significant percentage of governmental municipal bond borrowers that take closer to a year to ready their audited books for public dissemination.
The lack of progress over time solidifies the legitimacy and importance of the message that more has to be done to improve the time it takes to make municipal bond audits public.
When it comes to improving accountability to stakeholders, access to timely audited reporting is critical to evaluate financial condition and adherence to appropriate fiscal standards. For municipal bondholders, late or stale audits inhibit the market’s ability to assign accurate pricing relative to the risk associated with the borrower, as well as the public’s ability to influence outcomes.
The Scope of the Study
In this latest study, Merritt Research Services examined a total of 73,586 audits released by municipal bond borrowers over the seven year period of 2008 to 2014. During that time span, the number of annual audited reports included in a single year ranged from a low of 8,256 in 2008 to as high as 11,870 in 2012, to 9,866 in 2014, the most recent of the years audits included in the study among the 16 primary municipal bond credit sectors that were the focus of the analysis, the largest number of documents for the 2014 year belonged to local school districts with 2,448 audits, followed by 1,539 cities and 1,364 water & sewer borrowers. Other municipal bond sectors that were represented in our primary group included borrowers related to airports, counties, community colleges, dedicated tax entities, hospitals, private and public higher education, public power (retail and wholesale), special districts, states & territories, tollways, and other revenue supported borrowers. Various other minor municipal bond types, representing about 10% of the overall borrowers included in the study, were also counted in the overall tabulation of audit times but were not broken out. They included borrowers such as charter and private primary & secondary schools, life care retirement centers, and land districts.
To calculate audit timing, Merritt examined all audits collected in its database as of September 25, 2015 to identify the time period that begins with the fiscal year ending date to the date in which the audit letter was signed. The span between those two dates resulted in the “Audit Time” used as the measure for this analysis. An audit may not be made publicly available for weeks after the audit letter is signed if, for instance, a governing board approval is required before its release.
While the analysis does not cover every borrower in the municipal market, we believe that the vast number of audits counted in the totals presents a sound case that the median tallies used in the study are statistically significant for each credit sector as well as for all municipal bond borrowers applying to each year.
Among the 16 major municipal credit sectors focused on in our analysis, the slowest median audit completion times were attributed to governmental units, replicating a pattern consistent in past annual studies. States and counties reported at the slowest pace, tied at 175 days, followed closely by cities, with a median time of 169 days. On the other side of the scale, wholesale public power issuers repeated for the seventh straight year as the fastest reporting sector, with a median completion time at 100 days. Not-for-profit hospitals and private universities, both historically among the fastest sectors to report, had medians of 112 and 113 days, respectively.
There was a dose of good news in that the median number of days for all municipal bond issuers fell by 6 days in 2014 versus the previous year, improving from 149 to 143 days. Several municipal credit sectors saw better median times, beating their 2013 medians by at least five days or more; they included: airports, public higher education, retail electric, school districts, and water & sewer enterprises. Additionally, 11 out of the 13 primary sectors in the study, as well as the total collection of 2014 borrowers, experienced median reporting times below their seven year average. Perhaps this is an indication that the trend is moving in the right direction, albeit, at a baby steps pace.
In stark contrast to regulated corporate borrowers, municipal bond issuers would fall far short of the 60-90 days required public reporting times mandated by the SEC dependent on the company’s size, if the reporting rules would also apply to them.
In stark contrast to regulated corporate borrowers, municipal bond issuers would fall far short of the 60-90 days required public reporting times mandated by the SEC dependent on the company’s size, if the reporting rules would also apply to them. Hypothetically, if a 90 day requirement was the standard for munis, only 2% of cities, counties and states would pass that test if 2014 reporting times applied to them. Among other governmental units, 9% of school districts and 8% of special districts would qualify. The pass rate for municipal bond market revenue type borrowers is a bit better, but still a far cry from corporates. Thirty six percent of public power wholesale electric issuers make the grade, followed next in line by not-for-profit hospitals at 29%, and toll roads at 21%.
The results look better if a 120 day standard were to be in force. Under these criteria, there are some positive sector stand outs: 71% of all hospital bond issuers would make the mark, followed by wholesale electric at 69%, and private higher education with 67% reporting in 120 days. The bad news is that most governmental entities struggle to make this goal. Only 5% of all counties, 10% of cities, and 6% of states complete their audit in 120 days.
No regulatory or standards board for municipal bond issuers has set forth a requirement determining a specific time frame between the end of an entity’s fiscal year and the filing of its annual audit. The Municipal Securities Rulemaking Board (MSRB), which administers the Electronic Municipal Market Access (EMMA) database of municipal disclosure documents, does not have the authority to mandate when or how municipal issuers file their financial information. The Government Finance Officers Association (GFOA) rewards entities that file financial documents within six months of the fiscal year end with its ‘Certificate of Achievement for Excellence in Financial Reporting.’ The Government Accounting Standards Board (GASB), which establishes financial reporting standards for governmental bodies, uses the six-month parameter as its unofficial minimum guideline.
Fast and slow municipal bond reporting entities can be found among large and complex cities and organizations, as well as small and simple ones. Although that finding could apply to all sectors, the cities sector showed one of the most interesting contrasts between the quickest and slowest reporters.
Among the top three finishers, Blue Mound, TX (pop. 2,463) clocked the fastest audit time of all cities by signing its report in a mere 31 days after the close of the fiscal year; albeit, it took an exception to generally accepted accounting principles (GAAP), by not including a management discussion & analysis section. Tied for second fastest were the cities of Heath, TX (pop. 7,752) and the town of Eastchester, NY (pop. 33,030) at 49 days; both of these cities conformed to GAAP principles.
Just to show that big cities can produce timely audits, it is worth recognizing two cities: Columbus, Ohio and New York, New York. These cities stand out from the crowd for their consistency in overcoming the added complexity related to their size and structure within the context of the Governmental Accounting Standards Boards (GASB) rules for generally accepted accounting principles. The city of Columbus, Ohio (pop. 835,957) finished its GAAP compliant report in just 83 days, the fastest amidst all big cities. This is the fourth time out of the last five years that Columbus got the job done in 90 days or less. Much of the credit should go to Hugh Dorrian, the city’s Auditor since 1969, who has a long record of accomplishment as a leader among his peer group for disclosure. New York City also deserves commendation. While it has one of the most multifaceted auditing challenges, it was able to sign its audit in 121 days, close to the 120 mark, which it has done every year since 2002, the year we started keeping track of its audit time.
At the low end of the list, the village of Freeport, NY (pop. 43,255) dawdled in with its signed FY 2014 report in 482 days. Two other smaller Massachusetts cities took 400 and 396 days to complete their books and round out our three worst times among cities, based on all records received in our database by September 25, 2015.
Detroit, MI, coming out of its landmark bankruptcy, took the longest audit time among big cities (352 days after the close of its 2014 fiscal year). Subsequent to our deadline for inclusion into our audit time records, Richmond, VA signed its report on October 5, 2015. Had it been counted, it would have been the second slowest audit time recorded among all cities (462 days). Among large cities, Baltimore, MD has still not reported its audited financials for the June 30, 2014 fiscal year.
Some state and local governments have complained that generally accepted accounting principles formulated and made effective by GASB Statement 34 more than 10 years ago have slowed the audit process…we looked at the medians for local governments in New Jersey, which use a simpler, modified accrual fund accounting approach, and not the GASB 34 rules. We found that NJ cities and counties don’t complete their audits any faster than their counterparts in other states which use GASB 34.
Some state and local governments have complained that generally accepted accounting principles formulated and made effective by GASB Statement 34 more than 10 years ago have slowed the audit process. Under the GASB rules, governments are required to present their books both on a traditional modified accrual fund accounting basis, as well as an entity-wide accrual based presentation. However, it is worth mentioning that we looked at the medians for local governments in New Jersey, which use a simpler, modified accrual fund accounting approach, and not the GASB 34 rules. We found that NJ cities and counties don’t complete their audits any faster than their counterparts in other states which use GASB 34. Cities in New Jersey had a FY 2014 median audit time of 176 days, compared to the lower national-city median of 169. New Jersey counties had a median of 170 days vs. the national-county median of 175.
The state with the fastest reporting median for its cities was North Carolina at 118 days, and the slowest state median for its cities was found in Massachusetts, at 214 days.
Revenue bond sectors, by and large, continued their trend in 2014 that showed faster median turnaround times for audits than state and local governments. There was no significant change in sector results from past years. No revenue bond sector medians fell within a 90 day audit time reporting, but three sectors were able to show a median time within 120 days: Wholesale Electric (Public Power) at 100 days, Hospitals at 112, and Private Higher Education at 113. Tollways just missed the mark, with its median of 127 days.
Higher rated municipal bond borrowers generally have better audit reporting times. The analysis took a look at whether credit ratings show any correlation with audit times. Looking at medians for each sector based on the lowest of either Moody’s or S&P ratings, we found that the highest rated (AAA or AA) credits normally had the fastest median audit times. This was true for Airports, Cities, Counties, Hospitals, Public Higher Education, School Districts, States, and Water & Sewer credits. Syracuse University, a perennial standout for fast reporting for revenue bond issuers, completed its audit in a remarkable 30 days. The sixth straight year in which Syracuse finished its books in 31 days or less.
Richard A. Ciccarone is a Co-Publisher of MuniNet Guide. He is also President and Chief Executive Officer of Merritt Research Services, a municipal bond credit database and research company that primarily serves institutional investors, investment dealers and bankers. Mr. Ciccarone has over 35 years of investment management and research experience, specializing in municipal bonds.
A complete statistical compilation of the report is available upon request to Richard.Ciccarone@Merrittresearch.com
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Seasoned investors and the general public have common cause to desire more timely municipal bond audits. When a municipality fails to make their bond audits publicly available, it affects investors’ abilities to accurately match price and risk. Furthermore, the public does not have the information required to exercise their input and influence. Merritt Research’s latest study shows there is more to criticize than celebrate.