OFICINA DEL COMISIONADO DE ASUNTOS MUNICIPALES ÁREA DE ASESORAMIENTO, REGLAMENTACIÓN E INTERVENCIÓN FISCAL ÁREA DE ARCHIVO DIGITAL

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1 OFICINA DEL COMISIONADO DE ASUNTOS MUNICIPALES ÁREA DE ASESORAMIENTO, REGLAMENTACIÓN E INTERVENCIÓN FISCAL ÁREA DE ARCHIVO DIGITAL MUNICIPIO DE CATAÑO AUDITORÍA DE JUNIO DE 2016

2 BASIC FINANCIAL STATEMENTS, REQUIRED SUPPLEMENTARY INFORMATION AND INDEPENDENT AUDITORS REPORT (WITH ADDITIONAL REPORTS REQUIRED BY THE SINGLE AUDIT ACT) YEAR ENDED JUNE 30, 2016 Municipality of Cataño P.O. Box 428 Cataño, P.R

3 BASIC FINANCIAL STATEMENTS WITH ADDITIONAL REPORTS AND INFORMATION REQUIRED BY THE SINGLE AUDIT ACT CONTENTS BASIC FINANCIAL STATEMENTS Page Independent Auditors Report 1-5 Required Supplementary Information (Part 1) Management s Discussion and Analysis 6-15 Government-Wide Financial Statements: Statement of Net Position 16 Statement of Activities 17 Fund Financial Statements: Governmental Funds: Balance Sheet 18 Statement of Revenues, Expenditures and Changes in Fund Balances 19 Reconciliation of the Balance Sheet- Governmental Funds to Statement of Net Position 20 Reconciliation of the Statement of Revenues, Expenditures, and Changes in Fund Balances to the Statement of Activities 21 Notes to Basic Financial Statements SUPPLEMENTARY INFORMATION Required Supplementary Information (Part II): Budgetary Comparison Schedule-General Fund 65 Notes to Budgetary Comparison Schedule-General Fund 66 Schedule of Expenditures of Federal Awards 67 Notes to the Schedule of Expenditures Federal Awards 68

4 BASIC FINANCIAL STATEMENTS WITH ADDITIONAL REPORTS AND INFORMATION REQUIRED BY THE SINGLE AUDIT ACT CONTENTS INTERNAL CONTROL AND COMPLIANCE WITH LAWS AND REGULATIONS Page Independent Auditors Report on internal control over financial reporting and on compliance and other matters based on an audit of financial statements performed in accordance with Government Auditing Standards Independent Auditors Report on compliance for each major program and on internal control over compliance required by the Uniform Guidance FINDINGS AND QUESTIONED COSTS Schedule of Findings and Questioned Costs Corrective Action Plan Summary Schedule of Prior Years Audit Findings

5 INDEPENDENT AUDITORS REPORT To the Honorable Mayor and the Municipal Legislature Municipality of Cataño Cataño, Puerto Rico Report on the Financial Statements We have audited the accompanying financial statements of the governmental activities, each major fund, and the aggregate remaining fund information of the Municipality of Cataño, Puerto Rico (Municipality), as of and for the year ended June 30, 2016, and the related notes to the financial statements, which collectively comprise the Municipality s basic financial statements, as listed in the table of contents. Management s Responsibility for the Financial Statements Management is responsible for the preparation and fair presentation of these financial statements in accordance with accounting principles generally accepted in the United State of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error. Auditor s Responsibility Our responsibility is to express opinions on these financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America and the standards applicable to financial audits contained in Government Auditing Standards, issued by the Comptroller General of the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor s judgment, including the assessment of risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity s preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity s internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinions. Summary of Opinions Opinion Unit Governmental Activities General Fund Debt Service Fund Capital Projects Fund Aggregate Remaining Fund Information Type of Opinion Adverse Unmodified Adverse Adverse Qualified 1

6 Basis for Adverse Opinion on Governmental Activities INDEPENDENT AUDITORS REPORT (CONTINUED) Noncompliance with GASB No. 68 Accounting and Financial Reporting for Pensions an amendment of GASB Statement No. 27 The Municipality s pension plan administrator has not provided the audited actuarial and financial information necessary for the proper recognition and reporting of its net pension liability as of June 30, As a result, management has not complied with the accounting and financial reporting requirements for pensions that are provided to the employees of state and local governmental employers through pension plans trusts that comply with the criteria set forth in the GASB Statement No. 68. Accounting principles generally accepted in the United States of America require that governmental employers whose employees are provided with defined benefit pensions through cost-sharing multiple-employer pension plans recognize a liability and pension expense and report deferred outflows of resources and deferred inflows of resources related to pensions for its proportionate share of the collective net pension liability, pension expense, deferred outflows of resources and deferred inflows of resources reported by the pension plan trust. The amount by which this departure would affect the assets, deferred outflows of resources, liabilities, deferred inflows of resources and net position of the Municipality s governmental activities has not been determined. In addition, the Municipality s financial statements do not disclose the descriptive information about the pension plans through which the pensions are provided required by the GASB Statement No. 68 for cost-sharing employers. In our opinion, disclosure of this information is required by accounting principles generally accepted in the United States of America. Impairment loss on deposits with fiscal agent On October 18, 2016, the Puerto Rico Department of Treasury issued Circular Letter No Impairment Loss on Deposits with the Governmental Development Bank of Puerto Rico. This Circular Letter instructs the public corporations and municipalities of the Commonwealth to recognize an impairment loss on the deposits maintained with the Governmental Development Bank (GDB). The deposits with the GDB are not insured nor collateralized with investments; therefore, these deposits are exposed to a significant custodial credit risk: the risk that another party to a deposit or investment transaction (counterparty) will not fulfill its obligations; for example, the issuer of a debt instrument may not redeem the instrument at maturity. Due to the financial and fiscal crisis faced by the Commonwealth and certain public entities, they have been unable to repay their loans and lines of credit with the GDB, seriously affecting the bank s liquidity and ability to repay its own debts. As a result, the GDB was unavailable to pay on May 1, 2016 the principal due on its bonds and notes and the interest payments due thereafter. In April 2016, the Governor of Puerto Rico declared the GDB in a state of emergency and issued a moratorium on the payments of its debts. Also, the GDB has not issued its financial statements for the fiscal years ended on June 30, 2015 and As a result of these events, the management of the GDB believes that a substantial doubt exists as to the bank s ability to continue as a going concern. However, the management of the Municipality has not complied with the accounting and financial reporting requirements for the recognition of an impairment loss on deposits with a significant custodial credit risk. Accounting principles generally accepted in the United States of America require that nonparticipating interest-earning investment contracts, such as nonnegotiable certificates of deposit with redemption terms that do not consider market rates, should be reported using a cost-based measure, provided that the fair value of those contracts is not significantly affected by the impairment of the credit standing of the issuer or other factors. The amounts by which this departure would affect the assets and fund balance of the Municipality s Debt Service and Capital Projects Fund are $8,521,428 and $4,296,179 respectively. 2

7 INDEPENDENT AUDITORS REPORT (CONTINUED) Adverse Opinion In our opinion, because of the significance of the matter discusses in the Basis for Adverse Opinion on Governmental Activities paragraph, the financial statements referred to above do not present fairly the financial position of the governmental activities of the Municipality of Cataño, as of June 30, 2016, or the changes in financial position thereof for the year then ended in accordance with accounting principles generally accepted in the United States of America. Basis for Adverse Opinion on Debt Service and Capital Projects Fund Impairment loss on deposits with fiscal agent As previously explained in the Basis for Adverse Opinion on Governmental Activities paragraph, management of the Municipality has not complied with the accounting and financial reporting requirements for the recognition of an impairment loss on deposits with a significant custodial credit risk. Accounting principles generally accepted in the United States of America require that nonparticipating interest-earning investment contracts, such as nonnegotiable certificates of deposit with redemption terms that do not consider market rates, should be reported using a cost-based measure, provided that the fair value of those contracts is not significantly affected by the impairment of the credit standing of the issuer or other factors. The amounts by which this departure would affect the assets and fund balance of the Municipality s Debt Service and Capital Projects Fund are $8,521,428 and $4,296,179 respectively. Adverse Opinion In our opinion, because of the significance of the matter discusses in the Basis for Adverse Opinion on Debt Service and Capital Projects Fund paragraph, the financial statements referred to above do not present fairly the financial position of the Municipality of Cataño, as of June 30, 2016, or the changes in financial position thereof for the year then ended in accordance with accounting principles generally accepted in the United States of America. Basis for Qualified Opinion on Aggregate Remaining Fund Information As previously explained in the Basis for Adverse Opinion on Governmental Activities paragraph, the management of the Municipality has not complied with the accounting and financial reporting requirements for the recognition of an impairment loss on deposits with a significant custodial credit risk. Accounting principles generally accepted in the United States of America require that nonparticipating interest-earning investment contracts, such as nonnegotiable certificates of deposit with redemption terms that do not consider market rates, should be reported using a cost-based measure, provided that the fair value of those contracts is not significantly affected by the impairment of the credit standing of the issuer or other factors. The amount by which this departure would affect the assets and fund balance of the Municipality s Aggregate Remaining Fund Information is $99,045. Qualified Opinion In our opinion, except for the effects of the matter described in the Basis for Qualified Opinion on Aggregate Remaining Fund Information paragraph, the financial statements referred to above present fairly, in all material respects, the financial position of the Aggregate Remaining Fund Information of the Municipality of Cataño, Puerto Rico, as of June 30, 2016, and the changes in financial position thereof for the year then ended in accordance with accounting principles generally accepted in the United States of America. 3

8 MANAGEMENT DISCUSSION AND ANALYSIS For the fiscal year ended June 30, 2016 INDEPENDENT AUDITORS REPORT (CONTINUED) Unmodified Opinions In our opinion, the financial statements referred to above present fairly, in all material respects, the respective financial position of General Fund of the Municipality of Cataño, Puerto Rico, as of June 30, 2016, and the respective changes in financial position for the year then ended in accordance with accounting principles generally accepted in the United States of America. Other Matters Required Supplementary Information Accounting principles generally accepted in the United States of America require that the Management s Discussion and Analysis on pages 6 through 15 and Budgetary Comparison information on pages 65 through 66, be presented to supplement the basic financial statements. Such information, although not a part of the basic financial statements, is required by the Governmental Accounting Standards Board, who considers it to be an essential part of financial reporting for placing the basic financial statements in an appropriate operational, economic, or historical context. We have applied certain limited procedures to the required supplementary information in accordance with auditing standards generally accepted in the United States of America, which consisted of inquiries of management about the methods of preparing the information and comparing the information for consistency with management s responses to our inquiries, the basic financial statements, and other knowledge we obtained during our audit of the basic financial statements. We do not express an opinion or provide any assurance on the information because the limited procedures do not provide us with sufficient evidence to express an opinion or provide any assurance. Management has omitted historical pension information, as stated in GASB Statement No. 68, that accounting principles generally accepted in the United States of America require to be presented to supplement the basic financial statements. Such missing information, although not a part of the basic financial statements, is required by the Governmental Accounting Standards Board, who considers it to be an essential part of financial reporting for placing the basic financial statements in an appropriate operational, economic, or historical context. Our opinion on the basic financial statements is not affected by this missing information. Other Information Our audit was conducted for the purpose of forming opinions on the financial statements that collectively comprise the Municipality s basic financial statements. The accompanying supplementary information Schedule of Expenditures of Federal Awards is presented for purposes of additional analysis as required by Title 2 U.S. Code of Federal Regulations Part 200, Uniform Administrative Requirements, Cost Principles, and Audit Requirements for Federal Awards, and is also not a required part of the basic financial statements. The Schedule of Expenditures of Federal Awards are the responsibility of management and were derived from and relate directly to the underlying accounting and other records used to prepare the basic financial statements. Such information has been subjected to the auditing procedures applied in the audit of the basic financial statements and certain additional procedures, including comparing and reconciling such information directly to the underlying accounting and other records used to prepare the basic financial statements or to the basic financial statements themselves, and other additional procedures in accordance with auditing standards generally accepted in the United States of America. In our opinion, the Schedule of Expenditures of Federal Awards are fairly stated in all material respects in relation to the basic financial statements as a whole. INDEPENDENT AUDITORS REPORT (CONTINUED) 4

9 MANAGEMENT DISCUSSION AND ANALYSIS For the fiscal year ended June 30, 2016 INDEPENDENT AUDITORS REPORT (CONTINUED) Other Reporting Required by Government Auditing Standards In accordance with Government Auditing Standards, we have also issued our report dated March 21,2017 on our consideration of the Municipality s internal control over financial reporting and on our tests of its compliance with certain provisions of laws, regulations, contracts, and grant agreements and other matters. The purpose of that report is to describe the scope of our testing of internal control over financial reporting and compliance and the results of that testing, and not to provide an opinion on internal control over financial reporting or on compliance. That report is an integral part of an audit performed in accordance with Government Auditing Standards in considering Municipality s internal control over financial reporting and compliance. LOPEZ-VEGA, CPA, PSC San Juan, Puerto Rico March 21, 2017 Stamp No of the Puerto Rico Society of Certified Public Accountants was affixed to the record copy of this report. 5

10 MANAGEMENT DISCUSSION AND ANALYSIS For the fiscal year ended June 30, 2016 This discussion and analysis of the Municipality of Cataño (the Municipality) financial performance provides an overview of the Municipality s financial activities for the fiscal year ended on June 30, This Management Discussion and Analysis (MD&A) should be read in conjunction with the accompanying basic financial statements and the accompanying notes to those financial statements. Besides, this document includes comparative data with prior year as this information was available for the prior fiscal year ended on June 30, This MD&A is prepared in order to comply with such pronouncement and, among other purposes, to provide the financial statements users with the following major information: 1. a broader basis in focusing important issues; 2. acknowledgement of an overview of the Municipality s financial activities; 3. provides for an evaluation of its financial condition as of the end of fiscal year compared with prior year results; 4. identification of uses of funds in the financing of the Municipality s variety of activities and; 5. assess management s ability to handle budgetary functions. FINANCIAL HIGHLIGHTS The following comments about the financial condition and results of operations as reflected in the financial statements prepared for fiscal year 2016 deserve special mention: 1. Total assets of the Municipality amounted to $147,466,718 which represents a decrease of 3% compared to prior fiscal year. 2. At the end of fiscal year 2016, total liabilities amounted to $70,670,497. Out of said amount, $48,724,478 corresponded to long-term liabilities of which $35,316,00 represented the outstanding balance of bonds and notes issued. The Municipality continued to meet all debt service requirements, most of which was paid from self-generated revenues. 3. Total net position of the Municipality amounted to $76,796,221 which represents an increase of 4% compared to prior fiscal year. 4. Total revenues available for the financing of activities as reflected in the Statement of Activities amounted to $51,440,771, derived from the following sources: $1,768,975 from charges for services; $1,067,329 from operating grants and contributions; $2,966,777 from capital grants and contributions, and $45,637,690 from general revenues. 5. Total expenses incurred to afford the cost of all functions and programs as reflected in the Statement of Activities amounted to $48,462, As reflected in the Statement of Activities, the current fiscal year operations contributed to an increase in the net position figure by $2,977, As of the close of the current fiscal year, the Municipality s Governmental Funds reported combined ending fund balance of $10,095,841. 6

11 MANAGEMENT DISCUSSION AND ANALYSIS For the fiscal year ended June 30, 2016 FINANCIAL HIGHLIGHTS (CONTINUED) 8. In the fund financial statements, the governmental activities revenue increased $1,295,439, (or 3%), and the governmental activities expenditures decreased $2,554,934 (or 6%); as compared to the prior year operation. 9. At the end of the current fiscal year, the Municipality s general fund deficit amounted to $(7,353,736) compared to prior year fund deficit of $(9,150,189). 10. The actual General Fund budgetary activities resulted in a favorable balance of $3,114,796. FUNDAMENTALS OF FINANCIAL STATEMENTS PRESENTATION The new approach used in the presentation of the financial statements of the Municipality is based on a governmentwide view of such statements as well as a presentation of individual funds behavior during fiscal year The combination of these two perspectives provide the user the opportunity to address significant questions concerning the content of said financial statements, and provide the basis for a comparable analysis of future years performance. The comparative analysis is a meaningful and useful management tool for municipal management in the decision making process. Under the aforementioned approach, assets and liabilities are recognized using the accrual basis of accounting which is similar to the method used by most private enterprises. This means that current year s revenues and expenses are accounted for regardless of when cash is received or paid. FINANCIAL STATEMENTS COMPONENTS The basic financial statements consist of the government wide financial statements, the major funds financial statements and the notes to the financial statements which provide details, disclosure and description of the most important items included in said statements. The Statement of Net Position reflects information of the Municipality as a whole on a consolidated basis and provides relevant information about its financial strength as reflected at the end of the fiscal year. Such financial level is measured as the difference between total assets and liabilities, with the difference between both items reported as net position. It is important to note that although municipalities as governmental public entities were not created to operate under a profit motive framework, the return on assets performance plays an important role in their financial operations. The higher the increments achieved in net revenues, the higher the capacity to increase the net position figure either through additional borrowings or through internally generated funds. This in turn will benefit the welfare of the Municipality of Cataño constituents. The Statement of Activities is focused on both gross and net cost of the various activities of the Municipality. It presents information which shows the changes in the Municipality s net position at the most recent fiscal year. Based on the use of the accrual basis of accounting, changes are reported as soon as the underlying event occurs, regardless of the timing of the related cash flows. Under said approach, revenues and expenses are reported in the Statement of Activities based on the theory that it will result in cash flows to be realized in future periods. A brief review of the Statements of Activities of the Municipality at June 30, 2016, shows total expenses incurred to afford the cost of all functions and programs amounted to $48,462,825. Upon examining the sources of revenues for the 7

12 MANAGEMENT DISCUSSION AND ANALYSIS For the fiscal year ended June 30, 2016 FINANCIAL STATEMENTS COMPONENTS (CONTINUED) financing of said programs, the Statement reflects that $5,803,081 was derived from the following sources: $1,768,975 charges for services; $1,067,329 from operating grants and contributions; and $2,966,777 from capital grants and contributions obtained from other sources. General revenues for the year amounted to $45,637,690. When such figure is added to the $5,803,081 previously mentioned, total revenues available for the financing of activities amounted to $51,440,771. There was a excess of revenues over expenses in the amount of $2,977,946 which contributed to a decrease in the figure of net position attained at the end of the fiscal year. The Fund Financial Statements are another important component of the Municipality s financial statements. A fund is a grouping of related accounts that are used to maintain accountability and controls over economic resources of the Municipality that have been segregated for specific activities. The municipal fund type of accounting is used to demonstrate compliance with related legal requirements. Information offered through this Statement is limited to the Municipality s most significant funds and is particularly related to the local government only, instead of the government as a whole. Government funds are used to account for essentially the same functions as those reported as governmental activities. The funds are reported using an accounting basis known as modified-accrual, which measures cash and all other financial assets that can be readily converted into cash. The fund statement approach gives the user a short-term view of the Municipality s government operations and the basic services it provides. Since the focus of government funds is narrower than that of the financial statements as a whole, it also helps the user with comparable information presented in the governmental activities report. By doing so, readers of the basic financial statements may understand better the long-term effect of the Municipality s short-term financial decisions. Because the focus of governmental funds is narrower than that of the government-wide financial statements, it is useful to compare the information presented for governmental funds with similar information presented for governmental activities in the government-wide financial statements. By doing so, users of the basic financial statements may be better understand the long-term impact of the Municipality s near term financial decisions. The Government Fund Balance Sheet and the Governmental Fund Statement of Revenues, Expenditures and Changes in Fund Balances provide a reconciliation to facilitate this comparison between governmental funds and governmental activities. INFRASTRUCTURE ASSETS Historically, a government s largest group of assets (infrastructure-roads, bridges, underground pipes [unless associated with an utility], etc.) have not been reported nor depreciated in government financial statements. GASB 34 requires that these assets be valued and reported within the Governmental column of the Government-Wide Statements. Additionally, the government must elect to either (a) depreciate these assets over their estimated useful life or (b) develop a system of asset management designed to maintain the service delivery potential to near perpetuity. If the government develops the asset management system (the modified approach) which periodically (at least every third year), by category, measures and demonstrated its maintenance of locally established levels of service standards, the government may record its cost of maintenance in lieu of depreciation. The information about the condition and maintenance of condition of the government infrastructure assets should assist financial statement users in evaluating a local government and its performance over time. According to the requirements of GASB 34, the government must elect to either (a) depreciate the aforementioned assets over their estimated useful life or (b) develop a system of asset management designed to maintain the service delivery to near perpetuity. If the government develops the asset management system, (the modified approach) which periodically (at least every three years), by category, measures and demonstrate its maintenance of locally established levels of service standards, the government may record its cost of maintenance in lieu of depreciation. In this particular respect, the Municipality has elected the use of recognizing depreciation under the useful life method and it contemplates to continue this treatment on said basis. 8

13 MANAGEMENT DISCUSSION AND ANALYSIS For the fiscal year ended June 30, 2016 FINANCIAL ANALYSIS OF THE MUNICIPALITY AS A WHOLE, Net Position The Statement of Net Position serves as an important indicator of the Municipality s financial position at the end of the fiscal year. In the case of the Municipality of Cataño, primary government assets exceeded total liabilities by $76,796,221 at the end of 2016, as compared with $73,818,275 which reflect an increase of $2,977,946 over previous fiscal year. The following condensed Statement of Net Position of the Primary Government shows on a comparative basis the most important components of the $2,977,946 increase reflected in the Net Position figure. Summary Statement of Net Position Increase (Decrease) % Current and other assets $ 30,469,681 $ - $7,325,803 32% 23,143,878 Capital assets 116,997, ,680,553 (2,683,516) (2%) Total assets 147,466, ,824,431 4,642,287 3% Current and other liabilities 21,946,019 21,780, ,292 1% Long-term liabilities 48,724,478 47,225,429 1,499,049 3% Total liabilities 70,670,497 69,006,156 1,664,341 2% Invested in capital assets, net of related debt 96,037,037 95,795, , % Restricted 18,716,592 12,374,434 6,342,158 51% Unrestricted (37,957,408) (34,351,713) (3,605,695) 10% Total net position $ 76,796,221 $ 73,818,275 $2,977,946 4% $150,000,000 $147,466,718 $142,824,431 $100,000,000 $73,818,275 $69,006,156 $50,000,000 $- Total Assets $70,670,497 Total Liabilities $76,796,221 Net Position

14 MANAGEMENT DISCUSSION AND ANALYSIS For the fiscal year ended June 30, 2016 FINANCIAL ANALYSIS OF THE MUNICIPALITY AS A WHOLE (CONTINUED) Changes in Net Position The Municipality s net position increased by $2,977,946. Approximately 84% of the Municipality s total revenue came from taxes, while 12% resulted from grants and contributions, including federal aid. Charges for Services, Interest and Investment earnings and miscellaneous provided 4% of total revenues. The Municipality s largest expenses included items such as general government, health and welfare services, public works, culture and recreation and public safety. The following table and graphic presentation includes in absolute and relative terms, the composition of revenues and expenses for the fiscal years ended on June 30, 2016 and Such analysis helps the reader to evaluate the Municipal administration performance in the administration of its current financial operations. Condensed Statement of Activities Increase (Decrease) % Program revenues: Charges for services $ 1,768,975 $ 192,270 $ 1,576, % Operating grants and contributions 1,067,329 2,177,572 (1,110,243) (51%) Capital grants and contributions 2,966, ,280 2,297, % General revenues: Property taxes 27,122,910 26,784, ,260 1% Municipal license tax 10,789,863 10,933,488 (143,625) (1%) Municipal sales and use tax 5,214,379 4,004,881 1,209,498 30% Construction excise taxes Grants and contributions not restricted 2,333,382 3,814,950 (1,481,568) to specific programs (39%) Interest and investments earnings 95, ,386 (28,890) (23%) Miscellaneous 638, ,544 (210,281) (25%) Loss on impairment of deposits with fiscal agent (556,603) - (556,603) 100% Total revenues 51,440,771 49,550,021 1,890,750 4% Expenses: General government 26,449,732 12,723,086 13,726, % Public safety 2,668,025 2,726,785 (58,760) (2%) Public works 7,846,889 11,162,040 (3,315,151) (30%) Health and welfare 5,222,131 18,789,659 (13,567,528) (72%) Culture and recreation 2,333,622 2,588,173 (254,551) (10%) Community development 195, ,436 (267,215) (58%) Education 588, ,203 (37,299) (6%) Urban and economic development 1,371,039-1,371, % Interest on long-term debt 1,787,262 1,944,766 (157,504) (8%) Total expenses 48,462,825 51,023,148 (2,560,323) (5%) Change in net position 2,977,946 (1,473,127) 4,451, % Net position, beginning of year 73,818,275 75,291,402 (1,473,127)) (2%) Net position, end year $ 76,796,221 $ 73,818,275 $ 2,977,946 4% 10

15 MANAGEMENT DISCUSSION AND ANALYSIS For the fiscal year ended June 30, 2016 FINANCIAL ANALYSIS OF THE MUNICIPALITY AS A WHOLE (CONTINUED) 3.69% 0.40%1.20% 2.83% 4.82% 10.78% 16.19% Expenses % General government Public safety Public works Health and welfare Culture and recreation Community development Education 5.51% Urban and economic development Interest on long-term debt 11

16 MANAGEMENT DISCUSSION AND ANALYSIS For the fiscal year ended June 30, 2016 FINANCIAL ANALYSIS OF THE MUNICIPALITY S INDIVIDUAL FUNDS As noted earlier, the Municipality uses fund accounting to ensure and demonstrate compliance with finance related legal requirements. Governmental Funds The focus of the Municipality s governmental funds is to provide information on near-term inflows, outflows, and balances of spendable resources. Such information is useful in assessing the Municipality s financing requirements. In particular, unreserved fund balance may serve as a useful measure of a government s net resources available for spending at the end of the fiscal year. As of the end of the current fiscal year, the Municipality s governmental funds reported combined ending fund balance of $10,095,841 an increase of $6,354,589 in comparison with the prior year. The combined fund balances include restricted fund balance amounting to $18,781,596. This is the portion of fund balance that reflects resources that are subject to externally enforceable legal restrictions 1) to pay for specific program purposes $1,566,046; 2) to pay for capital projects $7,139,266; and 3) to pay debt services $10,076,284. Within the governmental funds, it is included the general fund which is the chief operating fund of the Municipality. As of June 30, 2016, the general fund has an unassigned fund deficit of $(7,478,736). GENERAL FUND BUDGETARY HIGHLIGHTS During fiscal year , the Municipal Legislature approved revisions to the operational budget that was prepared in accordance to the analysis of previous year s results. Despite of the balance budget, the expected amounts of revenues were not collected, as reflected in exhibit, Budgetary Comparison Schedule-General Fund attached here to. The Municipality of Cataño current year operation had an excess of revenues over expenses of $3,114,796. CAPITAL ASSETS AND DEBT ADMINISTRATION Capital Assets The Municipality s investment in capital assets as of June 30, 2016, amounted to $202,358,110 which upon deduction of accumulated depreciation in the amount of $85,361,073 produced a net book value attributable to capital assets in the amount of $116,997,037. Said investment includes land, construction in progress, buildings, improvements, equipment, infrastructure, furnishing, computers and vehicles. Infrastructure assets are composed of items such as roads, bridges, streets and sidewalks, drainage systems, lighting systems, and similar items. The total increase in the Municipality s investment in capital assets for the current fiscal year represented five percent (5%) of net book value. Depreciation charges for the year totaled $5,285,222. Debt Administration The Puerto Rico Legislative Assembly has established a limitation for the issuance of general obligation municipal bonds and notes for the payment of which the good faith, credit and taxing power of each municipality may be pledged. The applicable law also requires that in order for a Municipality to be able to issue additional general obligation bonds and notes, such Municipality must have sufficient payment capacity as defined in Act No. 64. Such Act requires a Municipality must has sufficient payment capacity to incur additional general obligation debt if its deposits in the Redemption Fund and the annual amounts collected with respect to such Municipality s Special Additional Tax (as defined below), as projected by GDB, is sufficient to service to maturity the Municipality s outstanding general obligation debt and the additional proposed general obligation debt. 12

17 MANAGEMENT DISCUSSION AND ANALYSIS For the fiscal year ended June 30, 2016 CAPITAL ASSETS AND DEBT ADMINISTRATION (CONTINUED) The Municipality is required under prevailing applicable law to levy a Special Additional Tax in such amounts as shall be required for the payment of its general obligation municipal bonds and notes. In addition, principal of and interest on all general obligation municipal bonds and notes and on all municipal notes issued in anticipation of the issuance of general obligation bonds issued by the Municipality constitute a first lien on the Municipality s Basic Tax revenues. Accordingly, the Municipality s Basic Tax revenues would be available to make debt service payments on general obligation municipal bonds and notes to the extent that the Special Additional Tax levied by the Municipality, together with moneys on deposit in the Municipality s Redemption Fund, are not sufficient to cover such debt service. In the particular case of the Municipality of Cataño, it has never been necessary to apply Basic Taxes to pay debt service on general obligation debt of the Municipality. ECONOMIC FACTORS AND NEXT YEAR S BUDGETS AND RATES The Municipality relies primarily on property and municipal taxes as well as federal and state grants to carry out the governmental activities. Historically, property and municipal taxes have been very predictable with increases of approximately five percent. Federal and State grant revenues may vary if new grants are available, but the revenue can be also predictable. Those factors were considered when preparing the Municipality s budget for the fiscal year The Commonwealth of Puerto Rico and its instrumentalities are currently facing a severe fiscal and liquidity crisis. For the past four years, credit rating agencies have downgraded their rating on the Commonwealth debt obligations based on, among other problems, years of deficit financing, pension underfunding, budgetary imbalance and a prolonged economic recession. These downgrades have severely limited the access to markets and the issuance of new debt by the Commonwealth and its instrumentalities (including municipalities), thus worsening the financial and economic conditions for the current and subsequent fiscal years. On April 6, 2016 the Commonwealth approved Act known as the Puerto Rico Emergency Moratorium and Financial Rehabilitation Act ( Act No. 21 ) (as amended) to declare a moratorium on debt service payments and to stay related creditor remedies for a temporary period for the Commonwealth and certain of its instrumentalities. On April 8, 2016 the Commonwealth s Governor signed Executive Order No ( EO No ) declaring the Bank in state of emergency pursuant to Act No. 21. EO No implemented a regulatory framework governing GDB s operations and liquidity by prohibiting loan disbursements by GDB and establishing a procedure with respect to withdrawals, payments and transfer requests with respect of funds held on deposits at GDB by the Commonwealth and its instrumentalities, including the Municipalities. The withdrawal, payment and transfer of funds held on deposit at GDB are restricted to those reasonable and necessary to ensure the provision of essential services and the GDB is authorized to establish weekly limits on the aggregate amount of such disbursements. These measures have significantly decreased the ability of the Municipalities to fulfil their debt obligations with contractors, since the majority of the construction projects are financed through the issuance of bonds and notes whose proceeds are deposited in escrow accounts administered by the GDB. In order to avoid prolonged delays in their construction projects due to nonpayment, many Municipalities have resorted to using their own operating cash balances to pay the contractors and subsequently requesting reimbursement to the GDB. However, this practice has further hindered the liquidity of these Municipalities, affecting the payments of their operational obligations. The Municipality is a participating employer in a retirement plan administered by the Employee s Retirement System of the Government of Puerto Rico and its Instrumentalities (ERS). The ERS is a mature retirement system with a significant retiree population. In order to improve the liquidity and solvency problems of the ERS caused by years of significant underfunding, the Commonwealth approved Act No. 3 of 2013 and Act No. 32 of 2013 which amend the provisions of the different plan structures under the ERS. Among the most significant changes brought upon by these Acts were increases in the employer 13

18 MANAGEMENT DISCUSSION AND ANALYSIS For the fiscal year ended June 30, 2016 ECONOMIC FACTORS AND NEXT YEAR S BUDGETS AND RATES (CONTINUED) and employee contribution rates; a supplemental contribution of $2,000 per pensioner to finance the Special Laws and Additional Benefits Program; and the imposition of an Additional Uniform Contribution (AUC) whose amount will be annually determined based on the ERS funding requirements. These additional contributions have significantly increased the pension costs for the Municipalities, which are paid with operational funds, thus aggravating the liquidity crisis faced by the majority of the Municipalities. Even with these measures, there is a high probability that the ERS will become insolvent by fiscal year 2018 causing the Agency to operate on a pay-as-you-go basis. When the benefits to be paid surpass the contributions received, the resulting deficiency will be subsidized by the Commonwealth and its instrumentalities, including the Municipalities. On June 30, 2016, the U.S. President signed the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA), which grants the Commonwealth and its component units access to an orderly mechanism to restructure their debts in exchange for significant federal oversight over the Commonwealth s finances. In general, PROMESA seeks to provide Puerto Rico with fiscal and economic discipline through the creation of a control board, relief from creditor lawsuits through the enactment of a temporary stay on litigation, and two alternative methods to adjust unsustainable debt. First, to ensure fiscal and economic discipline, PROMESA creates a federally appointed oversight board that has plenary authority over Puerto Rico s finances. The board s primary function is to provide fiscal oversight through the development and approval of fiscal plans and budgets, and to enforce compliance with those plans and budgets through broad-based powers such as reducing non-debt expenditures and instituting certain hiring freezes. The board also has oversight over legislative processes because PROMESA requires the board to review new laws and deny their enforcement if they are inconsistent with the approved fiscal plans and budgets. The board also has authority to review contracts to ensure compliance with the fiscal plan, and to prevent the execution or enforcement of a contract, rule, executive order or regulation to the extent that it is inconsistent with the approved fiscal plan. Second, the enactment of PROMESA also operates as a broad-based stay on litigation, applicable to all entities, with respect to claims related Puerto Rico s financial debt, as well as on enforcement of provisions in contracts that allow for termination and the exercise of remedies based on non-payment of financial obligations, among other conditions. Finally, PROMESA contains two methods to adjust Puerto Rico s debts. The first method is a streamlined process to achieve modifications of financial indebtedness with the consent of a supermajority of affected financial creditors. This method has benefits such as potential speed relative to a traditional restructuring through a formal in-court process. The second method is a court-supervised debt-adjustment process, which is modeled on Chapter 9 of the U.S. Bankruptcy Code. This process includes the so-called cram-down power, which may provide Puerto Rico with flexibility in debt adjustment, but it also gives the oversight board total control over the adjustment process and includes certain provisions designed to protect creditor interests. The Commonwealth expects that its ability to finance future budget deficits will be severely limited even if it achieves a comprehensive debt restructuring, and, therefore, that it will be required to, among other measures reduce the amount of resources that fund important governmental programs and services in order to balance its budget. There is no assurance, however, that budgetary balance will be achieved and, if achieved, that such budgetary balance will be based on recurring revenue or expense reductions or that the revenue or expense measures undertaken to balance the budget will be sustainable on a long term basis. Moreover, the measures to achieve budgetary balance through austerity may adversely affect the performance of the Commonwealth s economy, which, in turn, may adversely affect governmental revenues. While the Fiscal and Economic Growth Plan that was released on September 9, 2015 and updated on January 18, 2016 and the proposed comprehensive debt restructuring seek to address these recurring budgetary imbalances and to make debt service payments sustainable, it is at present uncertain that such a restructuring will be consummated or that it will 14

19 MANAGEMENT DISCUSSION AND ANALYSIS For the fiscal year ended June 30, 2016 ECONOMIC FACTORS AND NEXT YEAR S BUDGETS AND RATES (CONTINUED) achieve the goals of recurring budgetary balance and debt sustainability. Furthermore, the restructuring proposals presented by the Commonwealth depend on one hundred percent participation, which can only be achieved practically through a mechanism to bind holdout creditors. While PROMESA provides the Commonwealth tools to bind such holdouts and adjust its debts in an orderly manner, PROMESA gives the oversight board total control over such adjustment process and includes certain provisions designed to protect creditor interests, which are untested. There is thus no assurance that the federally appointed oversight board of PROMESA will be successful in achieving budgetary and fiscal balance through a debt restructuring or otherwise. FINAL COMMENTS The Municipality is a governmental entity whose powers and authority vested on its Executive and Legislative Branches are specifically established in the Municipal Autonomous Act approved in August By virtue of such powers, it provides a wide range of services to its constituents which includes, among others, public works, education, public safety, public housing, health, community development, recreation, waste disposal, welfare and others. The Municipality s principal sources of revenues are derived from property taxes, municipal license taxes, subsidies from the Commonwealth of Puerto Rico s General Fund and contributions from the Traditional and Electronic Lottery sponsored by said Government. The Municipality s management is committed to a continued improvement in the confection of a budget that will response to the needs of the public and private sectors in accordance with its permissible revenues levels. It further contemplates to maintain or improve its current levels of Net Position as indicative of a strong financial position which has been identified as one of the main short and long-term objectives of the Municipality. FINANCIAL CONTACT The Municipality s financial statements are designed to present users (citizens, taxpayer, customers, investors and creditors) with a general overview of the Municipality s finances and to demonstrate the Municipality s accountability. If you have questions about the report or need additional financial information, contact the Municipality s Chief Financial Officer. 15

20 STATEMENT OF NET POSITION JUNE 30, 2016 Assets Current assets: Governmental Activities Cash and cash equivalents $ 9,989,004 Cash with fiscal agent 18,643,646 Due from: Commonwealth Government 1,592,730 Federal Government 119,301 Inventories and other assets 125,000 Total current assets 30,469,681 Noncurrent assets: Capital assets, net of depreciation 116,997,037 Total noncurrent assets 116,997,037 Total assets $ 147,466,718 Liabilities Current liabilities: Accounts payable and accrued liabilities 2,624,602 Due to other governmental entities 3,207,794 Unearned revenues: Municipal license tax 8,573,187 Intergovernmental 238,825 Matured interest due and payable 897,095 Current portion of long-term obligations 6,404,516 Total current liabilities 21,946,019 Noncurrent liabilities (excluding current portion): Bonds payable 30,940,000 Notes payable 4,376,000 Compensated absences 5,766,618 Claims and judgments 6,009,855 Christmas bonus 319,480 Due to other governmetal entities 7,717,041 Less: Amount reported as current portion (6,404,516) Total noncurrent liabilities 48,724,478 Total liabilities 70,670,497 Net position Invested in capital assets, net of related debt 96,037,037 Restricted for: Capital projects 7,074,262 Debt service 10,076,284 Federal and state funded programs 1,566,046 Unrestricted (deficit) (37,957,408) Total net position $ 76,796,221 The notes to the financial statements are an integral part of this statement. 16