From: "Art" <artsti@comcast.net>

To: <MPierzchala@rockvillemd.gov>

Cc: <josjordan@verizon.net>; <mayorcouncil@rockvillemd.gov>; <BHall@rockvillemd.gov>; <GCohen@rockvillemd.gov>

Subject: Re: Questions for RedGate Advisory Committee

Date: Monday, September 06, 2010 8:52 PM

Mark,

Regarding your first question, the City will have to recognize the financial impact of the $2.4 million of cumulative deficits that RedGate will have incurred by the end of FY 2011 as well as the cost of any future uses of the land.  Going forward, the question is how large are the relative costs of different options for RedGate?  Staff will have to provide those estimates.  Whatever the costs, they will be new costs in the General Fund budget, and Mayor and Council will have to find a way to pay for them in an extremely tight fiscal environment.

You asked also asked if we shouldn't already be charging RedGate's deficit against the General Fund reserve?  The simple answer is yes, a fiscally prudent government would recognize the impact of RedGate's deficits on the General Fund reserve.  In fact, as I explain below, I don't think Mayor and Council will have a choice about this.  I think your auditor will require it.

Because Rockville budgets for RedGate in a separate fund, the connection between RedGate and the General Fund reserve is not obvious.  Here's the linkage.  When fees from golfers are insufficient to cover RedGate's expenses, the City pays the bills by tapping the General Fund.  This leaves less cash in the General Fund reserve to cover unexpected General Fund shortfalls.

You might be asking yourself, "If this is true, why don't we see this in the budget?"

Welcome to the magic of accrual accounting.  When the General Fund is tapped to cover RedGate's cash shortfalls, the transaction is booked as a liability (an IOU) of RedGate and as an asset (a receivable) of the General Fund.  From an accounting perspective, the General Fund trades cash for an IOU of equal value, with no net change in the General Fund's total assets.  Since the reserve is calculated as assets minus liabilities, this does not change the calculated reserve.

Here's the problem with this accounting.  Treating RedGate's IOU as a General Fund asset is reasonable only for as long as it is reasonable to expect RedGate to begin operating in the black and have sufficient cash to repay the General Fund.  This was a plausible assumption for the first couple of years of the five-year business plan for RedGate that Mayor and Council approved in 2006.  Now the plan has clearly failed.  The current expectation is that RedGate will run large and growing deficits in perpetuity.  It will never generate sufficient cash to pay all expenses and repay the General Fund.  At this point, the General Fund is holding worthless IOUs from RedGate. 

This should give you heartburn.  It means that, in reality, the General Fund has a smaller cash reserve than the $10.8 million figure printed in the FY 2011 budget.  The $10.8 million figure includes $890,291 owed by RedGate at the end of FY 2009, plus the additional General Fund cash used in FY 2010 and FY 2011 to cover RedGate's cash shortfall.  Staff would have to tell you the precise amounts, but given the size of RedGate's deficits, it's at least another $800,000, raising the total value of the IOU to at least $1.7 million.  Because RedGate can never repay this debt, the $1.7 million paper asset should be written down to zero, leaving the General Fund with a real cash reserve of just $9.2 million.

Hence, the real General Fund reserve - the amount that can be converted to cash and used to cover a shortfall - is just 14.7 percent of revenue, not the 17.5 percent shown in the Budget document. 

Also, if RedGate continues on its current course and incurs an additional $3.5 million of deficits by the end of FY 2015, 40 percent or more of the General Fund reserve would be worthless IOUs from RedGate, even though the published reserve balance might be higher than the 15 percent target.

One final point.  When Gavin Cohen discussed this issue at your June 21 meeting, it was in the context of a question about the financial impact of consolidating RedGate into the General Fund.  It would be easy to come away from that meeting thinking you could avoid impairing the General Fund reserve by leaving RedGate in a separate enterprise fund.  Nothing could be further from the truth.  At some point - probably sooner rather than later - Rockville's auditor will require you to write down this debt to zero as a condition for getting a clean audit. 

I understand the politics that have made it hard to deal with RedGate's deficits.  Unfortunately, by failing to deal with this problem, Mayor and Council have dug a deep hole for taxpayers, and the hole is getting deeper by larger amounts each year.  It would be smart to deal with this now, before your auditor gives you some really bad news, and you have to explain to taxpayers why taxes have to be raised to replace a sudden, large loss in the General Fund reserve.

Regards,

Art Stigile