HomeMy WebLinkAboutStaff Report 1.A 04/08/2013 Ageinda'Item/w#1 .A
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DATE: April 8,2013
TO: Honorable Mayor and Members of the City Council through City Manager
FROM: William Mushallo, Finance Director
SUBJECT: General Fund Reserve.Policy and Funding Considerations
RECOMMENDATION
It is recommended that the City Council provide Staff with feedback to update the City's General
Fund reserve policy. It is also recommended that the City Council provide feedback regarding
recommendations for funding the reserves over the long term,and for distribution of new
revenues derived from Solid Waste franchise fees between funds.
BACKGROUND
On February 2, 2013, the,City Council developed goals'for 2013 and 2014. A significant priority
for the Council is the goal of Financial Stability. While;the goal has many components,
completing two of the deliverables as soon as possible support preparation of the FY14 budget.
It will also help establish a,key part of the basic,framework of the long term General Fund
financial plan. Those deliverables are:
1. Review/Establish Reserve Policies for the General Fund,Other Operating Funds, and
Intra-Governrrrental Service Funds
2. Develop a Long-Term Plan to Achieve the City Council's Designated General Fund
Reserve Policy
The main purpose of today's workshop is to address the first part of deliverable #1 listed above.
Once the General Fund Reserve Policy is formulated, we can begin-to address deliverable#2. In
conjunction with the FY14 budget process funds can be earmarked to begin building the desired
reserves over the next several years.
In addition to the deliverables mentioned above, among the other priorities included in the
Financial Stability goal is " Finance additional Street improvements using new revenue from
Solid Waste Franchise" and within that priority'.is the deliverable "Establish.Council-policy
regarding allocation of new franchise revenues between Streets and other uses". The further
purpose of this workshop is to also address that deliverable.
The City currently has in place a General Fund Reserve Policy stating"a minimum fund balance
reserve in the General Fund will be-maintained•at all times: The City's goal is to reach an
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optimal level for this reserve of 15% of the General Fund operating budget" It has, unfortunately,
been several years since that goal has been achieved. During the past several years General Fund
balances as a percent of actual expenditures(as opposed to budget estimates) were as follows:
FY 2003 19.3%
FY 2004 18.7%
FY 2005 21.6%
FY 2006 20.7%
FY 2007 17.4%
FY 2008 7.4%
FY 2009 5.5%
FY 2010 5.4%
FY 2011 1.4%
FY 2012 3.9%
General Fund balance began declining,in FY 2006 and was reduced to 1.4% of expenditures by
FY 2011. This amount was precariously low and equated to only 5 days of expenditures. As of
June 30, 2012, the fund balance was 3.9% of expenditures and remains extremely low; only
providing for about 14 days of expenditures.
DISCUSSION
In order to develop a recommendation for a fiscally prudent General Fund reserve policy,
significant research was conducted. Moody's Rating Service was consulted. The Government
Finance Officers Association was contacted and information from their best practices
publications was used. Finally, other cities were contacted to determine their respective reserve
policies. The table below shows reserve policies currently in effect in neighboring cities:
Redwood City Not less than 15%or not more than 20% of GF revenues
Mill Valley 15% GF contingency reserve and 10% unrestricted GF balance
Santa Rosa Between 15% and 17% of expenditures
Windsor 25% of operating expenditures
14ealdsburg 25% of revenues for a contingency reserve and $1.25 million for a
recession reserve
Napa Undesignated fund balance of 2%-5% of expenditures; emergency
reserves equal to 12% of expenditures; 1% contingency reserve
Rohnert Park General Fund reserve of 10% of operating expenses; 5% contingency
reserve, general fund endowment reserve
Novato Emergency and disaster response reserve fund =15% of GF budget
San Rafael 10%
The average of the above General.Fund reserve policies is approximately 18% of expenditures.
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The Government Finance Officers Association recommends that the adequacy of fund balance in
the General Fund be assessed based upon a government's own specific requirements. The
following factors should be considered:
• The predictability of its revenues and the volatility of its expenditures (i.e., higher levels
of unrestricted fund balance may be needed if significant revenue sources are subject to
unpredictable fluctuations or if operating expenditures are highly volatile)
• Its perceived exposure to significant one-time outlays (e.g., disasters, immediate capital
needs, state budget cuts,etc.)
• The potential drain upon general fund resources from other funds as well as the
availability of resources in other funds (i.e., deficits in other funds may require that a
higher level of unrestricted fund balance be maintained in the general fund,just as, the
availability of resources in other funds may reduce the amount of unrestricted fund
balance needed in the general fund)
• Liquidity (i.e., a disparity between when financial resources actually become available to
make payments and the average maturity of related liabilities may require that a higher
level of resources be maintained)
• Commitments and assignments (i.e., governments may wish to maintain higher levels of
unrestricted fund balance to compensate for any portion of unrestricted fund balance
already committed or assigned by the government for a specific purpose)
After considering the above mentioned factors, the GFOA recommends, at a minimum, that
general-purpose governments, regardless of size, maintain unrestricted fund balances in their
General Fund of no less than two months of operating revenues or operating expenditures. This
calculates out to approximately 17%.
As mentioned earlier in this report, Moody's was contacted to see if they had any recommended
reserve policy criteria. While they didn't have specific criteria available, they provided me with
the following table:
';4 aft sp 1-Financial1Data 3F nanncctaIStatissttics_&:
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Years Total General Available General
General Fund GF Fund Net Cash
Fund Balance Balance as % of
Revenues as %of as °!o of General
($000) Revenues Revenue Revenues
nA:1Median', ° 2011 7,723 32 27 28.5
2011 5,198 23.8 16.8 20.5
:'A33fNe'dian ' 2011 8,738 12.5 9.2 9.9
The table shows actual nation-wide medians for A-rated General Obligation ratings. The third
column that shows General Fund Balance as a percent of revenues is the one we will use for
comparisons. Organizations with an Al rating have 32% of revenues in fund balance; those with
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an A2 rating have 23.8%, and those with an A3 rating have a median of 12.5% of revenues in
fund balance. Until recently Petaluma had a rating of A2. The City was downgraded and
currently has an issuer rating of A3. Obtaining an upgraded rating would be extremely beneficial
as we consider refinancing existing debt and possibly issuing debt to accomplish a large amount
of street improvements. As of June 30, 2012, Petaluma had about 3.9% of revenues in fund
balance and would need to significantly increase this amount in order to be considered for a
rating upgrade.
The Government Finance Officers Association recommends that governments adopt a formal
fund balance policy that defines the appropriate level of fund balance target levels. Also,
designating specific purposes for which various:,portions of the fund balance are intended should
also be considered. For example, one portion of the fund balance may be for working capital,
one for budgetary stabilization, and one for responding to extreme events. This additional
transparency is designed to help decision makers understand the reason for maintaining the target
levels described in the fund balance policy.
After evaluating reserve policies in other cities, and reviewing the above mentioned policy
development criteria from GFOA, Staff believes it would be prudent to establish a reserve policy
that requires 20% of expenditures be achieved and maintained. It is recommended that the
policy contain two components:
• 15% of expenditures, designated for economic downturns,and emergencies including
natural disasters, catastrophic events and emergency capital projects and purchases. This
past recession has caused the City's reserves to dramatically decrease. The City is also at
risk for natural disasters such as flooding and earthquakes, and the General Government
infrastructure has aged significantly. A.contingency reserve of this type is extremely
prudent.
• 5% of expenditures would remain as an un-designated working capital reserve.
Staff recognizes that setting aside an amount equal to 20 percent of expenditures is in all
likelihood going to be difficult to achieve. Expenses will increase over time, and will want to
compete with the reserves for what will continue to be limited resources. The Council may be
concerned that 20 percent may be unachievable, at least in the window of a five-year financial
plan. Should that be the case, and Council wishes to establish policies of a lesser reserve
amount, it is recommended that amount be not less than 17 percent. This will, as was previously
indicated, provide for two months expenses.
GFOA also recommends that governments consider providing broad guidance in their financial
policies for how resources be directed to fund balance replenishment. For example, a policy may
define the revenue sources that would typically be looked to for replenishment of fund balance.
This might include non-recurring revenues, budget surpluses, and excess resources in other funds
(if legally permissible and with a defensible rationale).
Finally, a government should consider including in its financial policy a statement that
establishes the broad strategic intent of replenishing fund balances as soon as economic
conditions allow. This helps to emphasize fund balance replenishment as a financial
management policy.
With these criteria in mind, the City should develop a replenishment strategy and timeline for
replenishing fund balances as soon as possible, that is still appropriate to prevailing budgetary
and economic conditions, and that considers the following:
• The policy should define the time period within which and contingencies for which fund
balances will be used
• The policy should describe how the government's expenditure levels will be adjusted to
match any new economic realities that are behind the use of fund balance as a financing
bridge
• The policy should describe the time period over which the components of fund balance
will be replenished and the means by which they will be replenished
Generally, GFOA recommends that governments should seek to replenish their fund balances
within one to three years of use. Factors influencing the replenishment time horizon would
include:
• The budgetary reasons behind the fund balance targets
• Recovering from an extreme event
• Political continuity
• Financial planning time horizons
• Long term forecasts and economic conditions
• Milestones for gradual replacement
• External financing expectations
The City currently utilizes a five-year General Fund forecasting process for revenues,
expenditures, and projected fund balance. While the significant economic downturn seen over
the past several years has ended, recovery is occurring at a slow pace. The housing market and
tourism are bright spots, but unemployment remains high. Recovery is anticipated to continue at
a slow pace over the duration of the five-year forecast. With that in mind, we are recommending
a five year reserve replenishment schedule initially. As reserves are spent in the future, however,
it is recommended that they be replenished in 1-3 years, in conformance with GFOA's suggested
best practices.
The forecasted General Fund budget for FY 12-13 was estimated at $33.2 million at February's
Mid-Year Financial Update. Reserve targets based on the policy recommended earlier would be
$5.0 million for the 15%economic and emergency contingency reserve. $1.7 million would be
needed to fund the 5% working capital reserve.
There are currently two opportunities for the City to begin to replenish General Fund reserves.
There is a one-time payment of$500,000 related to the new Solid Waste franchise agreement,
and a one-time payment of nearly $600,000 related to a Property Tax Administration Fee
settlement with Sonoma County. There will also be recurring opportunities in the future, as
additional one-time revenue sources come available, and by designating a portion of the revenues
derived from new development projects and revenue sources to reserve replenishment, the most
visible of these at the present time being the Regency and Deer Creek projects.
One possible reserve funding scenario for the current year would be to break out the current fund
balance, along with the one-time PTAF payment, and the first annual payment related to the
updated refuse franchise agreement as follows:
Total Econ/ Working
Fund Emerg Capital
Balance Reserve Reserve
One-Time PTAF payment $.6 $.5 $.1
FY12-13 refuse agreement payment $.5 $.4 $.1
Total @ 6/30/13 $1.1 $.9 $.2
% of Expenditures 3.3% 2.7% .6%
The five-year forecast presented in February indicated the need to use working capital reserves
over the next two years in order to balance revenues and expenditures. Another reserve funding
scenario would be to place the one-time PTAF payment of$.6 million and the $.5 million FY 12-
13 refuse agreement payment directly into the designated Economic/Emergency reserve. That
would leave approximately $1,4 million in the working;capital reserve available to assist with
budget balancing strategies over the next two years. Should any additional working capital
become available as the FY13-14 budget is developed it could be transferred into the designated
reserve, if desired.
With regard to one-time revenues, it is recommended that the City's reserve policy include
guidance that any one-time revenues received by the City, which are not directly related to
offsetting a particular expense, be directed to Reserves. As has been mentioned in the past, this
could include the proceeds from the sale of surplus property. Other opportunities, unknown at
this time, will doubtlessly present themselves, as did the payment that will be received from a
new Solid Waste franchise agreement, and from the settlement the City will receive from the
County related to the Property Tax Administration Fee.
As mentioned, there are also anticipated new revenues to be received from both the Regency and
Deer Creek projects. A total of$2.5 million of additional sales tax revenue is included in the
current five year forecast. This amount will undoubtedly increase as the Regency Project adds
retail establishments and additional tenants are identified for the Deer Creek Project.
Earmarking a portion, such as 15% of these incremental sales tax revenues in order to build
reserves, would be prudent. Based on current revenue estimates in the five year forecast, 15% of
estimated new revenues from Deer Creek and Regency would add between $40,000 and
$125,000 to reserves each year. The total added to reserves by 2017 would be $375,000. As
mentioned earlier, revenue projections will be refined and most likely increased for these
projects as more information becomes available. 15% of any incremental revenue added to the
revenue projections would also be earmarked for reserves. This could also include revenues
related to proposed projects including Riverfront, Silk Mill, etc.
As mentioned earlier in this report, achieving the recommended reserves will likely be very
difficult to accomplish over the next five years. It is recommended that we set the policy now,
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and review the results annually in conjunction with the budgeting/forecasting process. Policy
objectives could then be modified accordingly as updated results are known.
The final part of this discussion relates to the discretionary revenues that are available, beginning
this fiscal year, from the new Solid Waste franchise agreement. The new agreement provides an
additional $250,000 in franchise fees related to roadway impacts. Those funds will be directed
to the Street Fund. In addition, the franchise provides $8,000,000 over the 15-year term: two
$500,000 payments in FY 12/13, and one $500,000 payment annually, thereafter, through the
Franchise term. As mentioned earlier in this report, one of the two $500,000 payments for
FY2012/13 is recommended to be placed into reserves. If the Council accepts that
recommendation, it is left to consider how it will dedicate the remaining payments. There is far
more need in the General fund than can be met by an additional.$500,000 per year. These funds
could be used for vehicle replacement, OPEB liability payments, storm drainage maintenance, or
Capital projects, to name a few possible and necessary uses. As your Council is aware, however,
there is also a multi-million dollar unmet need for Street system improvements. Additional
investment in our Street system would improve the quality of City streets, and reduce what will
otherwise be a geometric escalation of costs associated with continued deferred maintenance. In
recognition of these competing:needs, staff recommends that the Council dedicate one half of
each year's $500,000 payment to the General Fund, where it can be used to meet one or more of
the previously identified needs, or a host of others. It is recommended that the other half be
directed to the Street fund. When added to the$250,000 previously mentioned, and other monies
in that fund that are available for Street work, a significant balance can be assembled to provide
for an ongoing debt service payment mechanism to finance the bonding of a large streets project.
Analysis of this option will be forthcoming as another deliverable related to the Financial
Stability goal. At the present time, the Council:is only asked for a consensus regarding the
dedication between these two funds, equally and in halves, of the annual $500,000 payment.
Based on Council feedback at tonight's workshop, Staff will draft an updated General Fund
Reserve policy, along with a proposed funding schedule, and bring it back for adoption in
conjunction with the FY13-14 budget recommendation. The draft budget will be delivered to
Council on Monday, May 6`h. A workshop has been scheduled on Monday, May 13t11 for
presentation and review of the budget information. The scheduled date for budget adoption is
May 20, 2013.
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