Archbishop Charles Chaput in his column last week on called the Archdiocese of Philadelphia’s new financial report “very serious – and that’s an understatement.”

True to his word, a 37-page report released today shows an operating deficit of $39.1 million for the fiscal year spanning July 1, 2011 to June 30, 2012.

An accompanying supplemental document to the report, audited by the firm Grant Thornton, put the deficit in the context of new accounting procedures and one-time expenses and revenues during the period.

Those “non-recurring” items included revenues of $15.8 million from the sale of Cardinal Dougherty and Northeast Catholic high schools (closed in 2010) and expenses totaling $21.2 million. Considering those one-time adjustments, the “core” operating deficit for the year was $17.4 million.

Notable components of those expenses were a $13 million increase in the self-insurance reserve needed to pay insurance claims against the Archdiocese in areas such as workman’s compensation, liability and automobile insurance; and legal and professional fees of $11.9 million.

Those fees stemmed from some of the unprecedented events that made 2011-2012 a very mean year.

The supplemental report indicates $534,000 was spent investigating the fraudulent actions of former archdiocesan CEO Anita Guzzardi, convicted in 2012 and currently serving a two-to-seven year sentence; $4.6 million spent on an investigation related to scores of archdiocesan priests placed on administrative leave from their duties as a result of the second Philadelphia Grand Jury on clergy sexual abuse; and $6.7 million spent on the criminal trial of a priest, and an independent legal and financial review of archdiocesan operations.

A final item that the document refers to as an “interest rate swap loss” cost a one-time fee of $8.9 million.

Those adjustments to the operating deficit and many other items in the report make it a complex read that shows the financial state of the Philadelphia Archdiocese in more detail than it has ever before made public.

Many factors opened the chasm between expenses ($138.2 million) and revenues ($99.1 million).

But the underlying cause was what Archbishop Chaput last week termed in his weekly column “chronic patterns of behavior” flowing from “well-intentioned but poor management decisions … over nearly two decades at every level of archdiocesan and parish leadership; a crippling habit of trying to hang on to the past and keep unsustainable ministries, schools and parishes afloat, despite great changes in our demographic and financial realities.”

For the Archdiocese’s Chief Financial Officer Timothy O’Shaughnessy, “to me what that means is we probably kept certain things (going) beyond a period of time where we could really afford them,” he said during an interview with a day before the financial report was released.

“And given our financial situation right now, we can’t do that any longer. We’ve got to be responsible in how we manage that operating budget,” he said.

Welcome to Philadelphia, Archbishop
The reality of operating deficits that had been building for years became apparent to Archbishop Chaput when he was installed as Archbishop of Philadelphia in September 2011, only two months after the start of the 2011-2012 fiscal year. Only then did he begin to see how dire was the financial condition of his archdiocese.

And he was without a chief financial officer to grapple with the mounting deficits, as the previous top financial adviser had been removed for suspicions of fraud the previous summer. By spring 2012, O’Shaughnessy and new controller began to assess how bad the financial health of the Archdiocese was, and to put in place tactical solutions to address the problem.

One of these was to eliminate external debt by bringing it “in house” and applying the debt to the appropriate internal balance sheet. In other words, a decision was made to pay off outside creditors such as banks and bond holders by using the funds of internal church entities, which would become the creditors to another indebted archdiocesan entity.

The report shows how the Office of Financial Services (OFS) – the office that manages the financial matters of the Archdiocese’s central administration – held a high amount of debt from the construction of the two newest Catholic high schools, Pope John Paul II in Royersford (completed in 2010) and Bishop Shanahan High School in Downingtown (1998).

The report revealed bonds of more than $47 million with Montgomery County for Pope John Paul II and $50 million with Chester County for Bishop Shanahan.

The external bonds were “retired” or paid off to the counties in the amount of more than $97.7 million, plus the aforementioned interest rate swap (an interest-payment funding mechanism).

“Even if we hadn’t paid off the debt we would have experienced that loss of $8.9 million,” O’Shaughnessy said. “But we’ve eliminated any (future) exposure on that swap because we paid off or liquidated the debt.”

The money to do so came from  “participating archdiocesan entities,” the report said.

Those entities and the amounts they are owed by the archdiocesan Office for Catholic Education for the now internal obligations include Catholic Health Care Services ($48.6 million), Catholic Social Services ($22.6 million), and Office for Financial Services and the Catholic Cemeteries Office each at just under $3 million.

The boards of directors for each organization agreed to the arrangements, O’Shaughnessy said.

“We technically refinanced OCE’s portion of that primarily by way of borrowing from CHCS and CSS,” he explained. “So that debt is now off this balance sheet but it is on OCE’s balance sheet,” adding that the debt is “secured with mortgages.”

In addition, OCE took two loans from OFS in June 2012 for $3.4 million and $3 million. No payments on the principal of the loans was due in 2013, but the agreement requires payments of a little more than $50,000 in each of the next two years, plus a “balloon payment” of $2.8 million in 2015.

A lifeline from the cemeteries
The contribution by Catholic Cemeteries was not the first time that office had recently come to the aid of lagging archdiocesan finances. The report indicates in 2003, OFS took a loan from Cemeteries for an unspecified amount. By September 2010 the agreement was altered to require payments of $100,000 each year culminating in a balloon payment of 8.5 million in 2020.

As of June 30, 2012, the outstanding amount of the loan was $9.2 million.

It may seem  ironic that a financial lifeline was provided the Archdiocese by its Cemeteries Office, but it is not the only irregular practice in the financial circumstances of the church prior to 2012.

Accounting irregularities resulted in failures to record in the OFS balance sheet a $43.3 million depreciation of long-lived assets — and a diocese more than 200 years old naturally has many such assets.

Another major consideration was failure to account for the reality that some parishes and church entities may not be able or willing to pay past obligations to the Archdiocese. That “doubtful accounts” allowance alone represents a $26.4 million liability.

More than $43 million in assets also were not included in the OFS accounting, including $22.3 million in collections from Catholic Life 2000 projects.

These adjustments in the current report turned what was referred to as net assets of $34.4 million in the 2011 financial report to a nearly $3 million liability in the 2012 report.

The long-term headaches
Although both the 2012 operational deficit and prior-period adjustments from previous management concern O’Shaughnessy, he was most concerned with four larger matters that will impact the Archdiocese’s future.

First is the Trust and Loan Fund. The long-established fund works in the manner of a bank, in which parishes deposit money and earn interest, and the money is then loaned to other parishes for new building construction or other capital needs.

Before the end of the 2012 fiscal year, the fund was short $82 million. Over the years it had, plainly, become a different kind of bank in which its reserves were tapped to fund those long-running archdiocesan operating deficits.

O’Shaughnessy described the cause of the fund’s depletion as a combination of “some investment losses,” the use of some fund reserves “for parish loans that we were not sure we were going to fully collect” – i.e., questionable loans — and borrowing from the fund “historically to provide cash for the operating deficits of the archdiocese.”

But the fund’s deficit was addressed by the Archdiocese writing a promissory note of $78.9 million in May 2012, and increasing it to $82 million after June 30, 2012. The note pledges a host of archdiocesan properties for sale (some of which are included in a coming auction). Proceeds from the transactions, when complete, will go toward replenishing the fund completely.

“We’ve stepped forward and signed a promissory note to cover the entire shortfall,” O’Shaughnessy said. “Not just the shortfall associated with borrowing but investment losses and loan reserves. We’re going to make up the entire balance.”

The Archdiocese of Philadelphia is a “self-insurer” in that it covers its losses from insurance claims. As of June 30, 2012, however, the self-insurance reserve used to pay claims was experiencing a $30 million shortfall.

Two other fund shortfalls concern employee pensions. The lay employees’ plan has a liability of $629.8 million; that is the amount expected to be required to meet lay employee retirees’ benefits. The fund has only $478 million in assets, or a shortfall of almost $152 million.

The picture for archdiocesan priests is much darker. For the pension liability of $90.4 million, only $500,000 existed in the fund as of 2012. While $4 million was moved into the fund last January and the annual per-priest contribution to the fund was increased to $9,300, the monies remain woefully short.

The contribution does not even cover the needs of current retired priests, which O’Shaughnessy said should be $11,850 per priest annually.

“Even the current charge is less than it needs to be,” he said. “When we’re putting money away for the pension plan, it really needs to be longer. It’s not just for next year’s bills for the current retired priests . We need to start putting money away for the current active priests as well.

“So we’re very much on a pay-as-you-go basis. But the amount we’re collecting isn’t even sufficient enough to cover that.”

Looking forward, a new hope
Despite the Archdiocese’s gloomy bottom line and the short and long-term factors contributing to it, the chief financial officer pointed to glimmers of hope toward a more sound financial footing.

He had estimated about a $17 million deficit entering the 2012-2013 fiscal year last year, which was accurately borne out by the new financial report.

To close the gap, dramatic measures were taken last June including the layoffs of 45 archdiocesan employees and subsequent sale of the retired priests’ home in Ventnor, N.J., and the archbishop’s residence, both of which netted more than $14 million.

Between the salary and benefit reductions, property sales and other adjustments detailed in the report, O’Shaughnessey estimates the current “core deficit” to be below $5 million.

“We’ve taken very significant steps to get that core number down from that $17 million range to sub-$5 million in really less than 18 months, but as time goes by we’re going to have to get that real close to zero,” he said.

He did not say whether that would entail deeper cuts in expenses at the end of the fiscal year next June but added, “Realistically we’re going to have to take one more big step to zero.”

O’Shaughnessy was enthusiastic about the revenue side of the equation. Parish assessments are coming in above expectations, even if not at 100 percent levels. (An assessment is a type of “tax” which a parish, using a formula of 10.5 percent of an average of three years’ offertory collections, pays to the Archdiocese to sustain its centralized operations and ministries. The median annual assessment for parishes is $76,500.)

“In terms of current-year assessments … we’ve collected 88 percent of what we’ve billed. I think that’s terrific,” he said. “It exceeds what we budgeted for. It has a lot to do with the fact we’ve probably had more communication in the last 12 to 18 months with the parishes with our financial situation.”