One way to look at the California State Auditor ranking Modesto among the dozen California cities at high risk for financial distress is to think of the city as a person who is living paycheck to paycheck.

That may be an extreme view, but the auditor’s assessment found Modesto is not saving enough for a rainy day, has too much debt and is not setting aside enough money for its long-term obligations.

City officials admit Modesto has its financial challenges but said the auditor’s assessment is too bleak. They also said because of changes the city will make to how it accounts for some of its funding, Modesto expects to rank better in future assessments.

“It’s not as bad as the auditor says, but we do acknowledge that we have a significant need to generate additional revenues for city operations,” Deputy City Manager Caluha Barnes said.

The state auditor in August released its annual assessment of California’s cities. This most recent assessment was for 423 cities and their audited financial statements for the 2019-20 fiscal year, which ended June 2020 and is the most recent year that audited statements were available.

The state auditor looked at 10 indicators to assess a city’s ability to pay its bills in the short and long term. Cities were graded on a scale from zero to 100 points: The higher the score the better a city’s fiscal health.

Modesto earned 40.79 points and was ranked 10th worst and among the dozen cities ranked high risk for financial distress. The other rankings are moderate and low risk.

Even if the accounting change Modesto will make were in effect for the most recent assessment, Modesto could have expected to have been ranked at best 31st among the 423 cities. That would have moved Modesto into the moderate risk category.

Stanislaus County’s other cities were ranked moderate or low risk. But Riverbank was not assessed because it was among the roughly 60 California cities that had not yet published audited financial statements.

This is the state auditor’s fourth annual assessment. Modesto has ranked worse each year, and this is the first year it was among the high-risk cities.

Modesto was the 40th worst city in the 2016-17 fiscal year. It was 23rd in 2017-18 and then 13th in 2018-19. The city was ranked as a moderate risk in each of those years.

Modesto officials have talked repeatedly over the years about their struggle each year in balancing the city budget. Their focus is on the general fund, which makes up about a third of the annual operating budget.

The general fund is the fund that city officials have the most discretion over in how it is spent; the fund is closely tied to the local economy because it is based on sales, property and other taxes; and the fund primarily pays for public safety.

This year’s general fund is about $153 million.

“We know we have an issue where (general fund) expenses exceed revenue growth and the challenge to put away extra money (in reserves),” Modesto Budget Manager Steven Christensen said.

Christensen and Barnes spoke to The Bee on Friday about the state auditor’s assessment.

Modesto also has a cushion because of the federal government’s pandemic relief efforts. Modesto is getting about $46 million from the American Rescue Plan Act to help it and the community with the pandemic’s economic fallout.

Modesto has received half of the ARPA funding and will receive the balance next year. But this is one-time money with restrictions on how it can be used, and no one knows when the pandemic and its economic affects will end. The city is using about $4 million of this funding to help balance its current budget.

Here is a look at the 10 factors and how Modesto fared in each of them:

GENERAL FUND RESERVES: This is the most critical factor in determining a city’s financial health. Out of the 100 points a city can earn among the 10 factors, the state auditor assigns a maximum of 30 points for this. Modesto earned 5.27 points and was ranked high risk.

The state auditor found the city had reserves equal to 15% of its general fund. The recommended bare minimum is 17%, according to the California State Auditor.

Here is what the auditor’s assessment says: “This city may have insufficient reserves to cover its expenses in the event of a fiscal emergency, such as an economic recession. It has saved enough funds to cover about 2 months of expenses, and its reserves have been declining, on average, by 1 percent annually.”

A city would need at least six months to be low risk for its reserves.

DEBT BURDEN: This was another high risk category for Modesto, with the city earning 7.41 out of a possible 15 points. This is not a city’s pension obligations, but what a city borrows for such projects as upgrading its wastewater plant.

This is what the state auditor’s website says about Modesto: “This city’s long-term debts equate to 111 percent of the city’s total government revenues, which may be too high for the city to pay back its debts without significant financial strain.”

But Modesto has shown improvement in this category. While it has been high risk in all four assessments, the percentage of debt to revenue has fallen each year, from a high of 145% in the first assessment to 111% in the current one. Modesto would move to moderate risk if its debt percentage falls below 100%.

LIQUIDITY: Another high-risk category for Modesto. The city earned 1.05 out of a possible 10 points. According to the state auditor, this is the readily available money a city has in its general fund at the end of its fiscal year to pay bills that are due over the next 12 months.

This is like someone using their checking account to pay their rent. It’s not that they don’t have other money but it may be in a retirement account. Modesto had readily available money to cover 21% of its bills.

The trend line has not been good for Modesto. It was ranked low risk for liquidity in the first two annual assessments and moderate risk in the third year before falling to high risk.

But this is where Modesto is getting unfairly dinged, according to Barnes, the deputy city manager, and Christensen, the city’s budget manager.

They said for about the last couple of years Modesto has been using its general fund to advance money for the project to upgrade a section of Highway 132. They said the state reimburses the general fund for the advance, but because of a timing issue that is not reflected in the state auditor’s most recent assessment.

Christensen said Modesto’s general fund has just as much liquidity as it had when the city was ranked low risk in this category. He said Modesto will be making an accounting change to better reflect its true liquidity and expects to be low risk in future assessments that reflect the accounting change.

But assuming Modesto had earned the full 10 points for liquidity in this assessment it would have scored 49.74 points and been ranked 31st out of the 423 cities.

Christensen said Modesto spoke with California State Auditor officials Sept. 14 about this and changes the city may enact to lesson the impact of its pension and retiree benefit costs. Christensen said the officials were helpful but would not change how they calculated the city’s liquidity in this assessment.

REVENUE TRENDS: Modesto was at moderate risk, earning 3.25 out of 5 possible points. Its general fund revenues increased on average by 6% from the 2017-18 to 2019-20 budget years. Modesto officials have said general fund revenues have continued to grow but not as fast as expenses.

PENSION OBLIGATIONS: Modesto also was at moderate risk, earning 5.68 out of 10 possible points. This compares a city’s unfunded pension obligations against its annual citywide revenues. Modesto’s unfunded pension obligations were $341.8 million versus citywide revenues of $434.6 million in its 2019-20 budget year. According to the auditor’s website: “This city’s unfunded pension obligations are substantial compared to its total government revenues.”

PENSION FUNDING: This was a high risk category for the city. The city earned 3.4 out of 5 points. It had $1.15 billion in pension obligations and had $787 million to pay those obligations. This includes what current workers have earned when they retire as well as future payments to retirees. Modesto had enough assets to pay 68% of its pension costs, according to the auditor’s website. Cities with assets equal to at least 80% of their pension obligations are low risk. (Modesto is one of the many local agencies throughout the state that belong to the California Public Employees’ Retirement System.)

PENSION COSTS: This is a city’s annual payment for its pensions. Modesto was at moderate risk in 2019-20, earning 3.06 out of 5 possible points. The city had a pension payment of $30.8 million, which was 7% of its citywide revenues. Cities at 5% or lower are low risk.

FUTURE PENSION COSTS: Modesto was high risk, with 1.67 out of 5 possible points. The auditor says the city’s annual payment to CalPERS is expected to be $50.9 million in its 2027-28 budget year. City officials have talked in recent years about the strain this will put on the city’s budget and have looked at how to lessen the impact.

City officials are expected to bring to the City Council in a few months a proposal to set up a trust that sets aside funding to pay some of this steep increase, according to Christensen, Modesto’s budget manager. The trust could be funded by the city and its labor groups.

OTHER POST-EMPLOYMENT BENEFITS OBLIGATIONS: This is for retiree health, dental and vision insurance. Modesto was rated low risk because its unfunded obligations were $26.5 million or 6% of its citywide revenues. These obligations are what Modesto owes in the future, according to the state auditor’s office. Modesto earned 10 out of 10 possible points for this factor.

OTHER POST-EMPLOYMENT BENEFITS FUNDING: This is how much a city is putting away to cover those future obligations. Modesto was ranked high risk. Modesto is doing what many cities do in that it is paying its annual costs but not setting aside money to pay future costs, according to the state auditor’s office. Modesto earned 0 out of 5 points. Modesto also is looking at a trust to set aside money to pay future costs. Christensen said a proposal would come to the council the same time as the proposal for the trust for pension costs.