HomeMy WebLinkAbout1997-05-13 City CouncilBUDGET 1997-98
City of Palo Al~o
C ty Manager’s Sum nary Repor
TO:HONORABLE CITY COUNCIL
ATTENTION: FINANCE CO~E ’
FROM:
AGENDA DATE:
SUBJECT:
CITY MANAGER DEPARTMENT: ADMINISTRATIVE
SERVICES
MAY13, 1997 CMR:210:97
FINANCING ALTERNATIVES FOR TH~ GENERAL FUND’S
INFRASTRUCTURE BACKLOG, INCLUDING: PROPOSED
CHANGES TO TH~ GENERAL FUND RESERVES POLICY TO
ESTABLISH PARAMETERS FOR AN INFRASTRUCTURE
RESERVE;~ A PROPOSED SET OF DEBT GUIDELINES
As part of the planning process for financing the General Fund’s infimtmcture backlog, staff
requests Council approval of a revised General Fund Reserves Policy that establishes a
separate reserve for infrastructure capital improvements. The reserve would be .funded by
reducing the Budget Stabilization Reserve (BSR). Staff also requests Council approval of
proposed debt guidelines. Both of these requests will help the City better 3osition itself to
address the infrastructure backlog.
Staff recommendsthat the Council:
o
Approve the changes to the General Fund reserves policy included as a Attachment
I, to incorporate the establishment of an infrast~ucturereserve. This reserve will be
funded with the Year End Budget Closing Ordinance this Fall;.
Approve the proposed debt guidelines included as Attachment II.
CMR:210:97 Page 1 of 13
EXECUTIVE SUMMARY:
Infrastructure Backlog
Over the past year, much attention has been given to the need to fund a backlog of General
Fund infrastructure capital improvements. To further this effort, Council established
infrastructure as a formal Council Priority in the 1996-98 Budget. The backlog of
infrastructure projects exists in part because the available Capital ImProvement Program
(CIP) funding (approximately $4.5 to $5.0 million annually) in the General Fund has not
been sufficient to meet all infrastructure needs.
While the Utility Funds have their own source of funding for infrastructure improvements
through rates, the General Fund must rely in large part on the health of the local economy.
Infrasirueture capital projects must compete for funding with other important city priorities.
In order to help address the financing needs for the four infrastructure modules, staff
recommends the creation of an infrastructure reserve, and has suggested guidelines
issuing debt.
The City of Palo Alto recognizes the need for spending a prudent amount every year for
ongoing capital replacement and rehabilitation needs.- Because an ongoing capital
improvement plan is vital to ensure the future viability of services, the City will always place
first priority on funding its regular and ongoing capital needs on a pay-as-you-go basis. In
spite of this;there are special or extraordinary capital improvement projects in which it is
appropriate to consider debt financing. A set of guidelines is included in order to support the
decision making process.
Staff proposes changing the General Fund reserves policy (Attachment.I) in order to establish
and maintain an infrastructure reserve. The reeornmended policy reduces the Budget
Stabilization Reserve (BSR) target level to create the new reserve. The current BSR target
for 1996-97, which is 10 to 30 percent of the annual General Fund expenditure budget, is
$8.7 to $26.1 million.
While this report itself does not result in any financial impacts, staff is recommending that
th~ BSR target be reduced to the range of 10 to 20 percent of annual budgeted expenditures.
This would result in a target of $8.7 to $17.4 million. Because the BSR has been projected
in the midyear financial report (CMR:167:97) to end the year at approximately about $24.5
million, with the change in BSR target levels, an infrastructure reserve of approximately $7
million could be established. The intent of creating the new infrastructure reserve is
precisely to encourage that dollars be spent on infrastructure priorities. Therefore, if Council
CMP~:210:97 Page 2 o~ 13
approves the recommendations of this report, General Fund reserves will be reduced over
time in. order to finance more capital improvement work.
Attachment I
Attachment II
General Fund Reserve Policy
Debt Guidelines
PREPARED BY: Jim Steele, Manager of Investments and Debt
DEPARTMENT HEAD APPROVAL~
Assistant City Manager,
Acting Director, Administrative Services
CITY MANAGER APPROVAL:
CC: n/a
Manager
CM~:210:97
City of Palo Alto
City Manager’s Report
FINANCING ALTERNATIVES FOR THE GENERAL FUND’S INFRASTRUCTURE
BACKLOG, INCLUDING: PROPOSED CHANGES TO THE GENERAL FUND
RESERVES POLICY TO ESTABLISH PARAMETERS FOR AN
INFRASTRUCTURE RESERVE; A PROPOSED SET OF DEBT GUIDELINES
INFRASTRUCTURE BACKLOG
.Over the past year, much attention has been given to the need to fund a backlbg of General
Fund infrastructure capital improvements. To further this effort, Council. established
infrastructure as a formal Council Priority in the 1996-98 Budget. The backlog of
infrastructure projects exists in part because the available Capital Improvement Program
(CIP) funding (approximately $4.5 to $5.0 million annually) in the General Fund has not
been sufficient to meet all infrastructure needs. It is within this context that staff began to
quantify and pfiofitize the backlog in a comprehensive infrastructure study. The first module
¯ of that study, on public buildings and building systems and components has been reviewed
by the Council. The second module, traffic and transportation, will be submitted to the
Finance Committee this July. The third module, parks and open space, is scheduled to be
presented to the Finance Committee this Fall. The fourth and final module~ for
miscellaneous capital needs, is expected to be eomp!eted in the summer of 1998.
While the Utility Funds have their own source of funding for infrastructure improvements
through rates, the General Fund must rely in large part on the health of the local economy.
Infrastructure capital projects must compete for funding with other important city priorities.
In order to help address the financing needs for the four infi~astrueture modules, staff
recommends the creation of an infrastructure reserve, and has suggested guidelines for
issuing debt.
Staffreeommends that an infrastructure reserve be established in the General Fund. Rwould
be used exclusively to finance capital improvements that couldn’t otherwise be
aeeornmodated in the ongoing capital budget. This reserve can be thought of as a "sinking
fund" or a reserve for future capital needs, and would be funded .by reducing the BS1L As
of Jtme 30, 1996, the BSR had a healthy balanee of $20.4 million, or about 24 percent of the
adopted 1996-97 budget. Setting up the reserve would require revising the General Fund
Reserve policy, adopted by Council in December 1992 (CMR:487:92).. Suggested
CM~:210:97 .Page
parameters for the reserve are included below, and a revised reserves policy is included in
this report as Attae~hment I.
Infrastructure Reserve Paramete~
The proposed reserve would be used for General Fund capital projects that cannot be
reasonably accommodated in the ongoing capital budget process. This sometimes occurs
when a project’s cost is high relative to the annual capitalbudget. That is, capital needs are
often identified that are large enough that funding them over 1-2 years would require
eliminating many other needed capital projects in the ongoing capital budget. The
infrastructure reserve would also be useful when a large backlog of infrastructure
replacement needs has been identified, which is now the case.
Although the infrastructure reserve would serve as a source for funding, the process for
review and approval of infrastructure capital projects would not change. To this end~ projects
would be considered for reserve financing if they are otherwise screened and approved as
part of the internal capital review committee and submitted as part of the five year capital
budget process. Such projects would fall into one or more of the following categories:
Priority projects of large dollar amounts, generally over $1.0 million each, which are
non-recurring in nature;
Projects that have been expressly identified as part of the infrastructure backlog and
which do not lend themselves as easily to debt financing, i.e., non-building projects;
To the extent that sufficient funds accumulate in the reserve, and no-significant
backlog of infrastructure existed, use of the fund could be considered for all or part
of the financing for a new facility as an alternative to full debt financing;
In addition, the reserve could be used to finance large capital repairs of a non-
emergency nature that come up during the year, but which are not practical or prudent
to delay until the next budget year. StatTbelieves projects of an emergency nature
would be more appropriately funded from the BSR or the Reserve for Emergencies.
Finally, in years of fiscal strain, the City could use the reserve fund as a supplemental
source of financing those capital improvements that might otherwise be proposed for
reduction as part of a budget savings plan in an effort to stay within overall revenue
constraints.
CMR:210:97 ~.Page ~ of L3
Establishment of the Reserve and Fiscal Impact
Staff proposes changing the General Fund reserves policy (Attachment I) in order to establish
and maintain the reserve. The recommended policy reduces the BSR target level to create
the new reserve. The current BSR target for 1996-97, which is 10 to 30 percent of the
annual General Fund budget, is $8.7 to $26.1 million.
Staff recommends that the BSR target be reduced to the range of 10 to 20 percent of annual
budgeted expenditures.. This would result in a target of $8.7 to $17.4 million.
Because the B SR has been projected in the midyear financial report (CMR: 167:97) to end
the year at approximately about $24.5 million, with the change in BSR target levels, an
infrastructure reserve of approximately $7 million could be established. If the
recommendations in this CMR are approved by Council, staff will include these revised
reserve amounts in the 1996-97 Year End Closing Budget Amendment Ordinance in the Fall.
Ongoing contributions .to the infrastructure reserve would be accommodated through the
Year- End Report and budget amendment ordinance each year.
The implications for lowering the cap on the BSR are that in years With favorable financial
results, the City’s General Fund would not only be able to continually maintain the BSR
within established minimum and maximum targets, but could also contribute year end excess
revenues and budget savings into the infrastructure reserve. That would allow for a continual
source of future capital improvements during times of healthy revenues. Conversely, in
years of fiscal strain, such as during a recession, the reserve could be considered as a source
of funding to maintain an ongoing level of capital budget appropriations that might otherwise
be reduced to realize one-time budget savings. ~
The intent of creating the new infrastructure reserve is precisely to encourage that dollarsbe
spent on the in~astrueture backlog. Therefore, if Council approves the recommendations of
this report,_General Fund reserves will be reduced over time in order to finance more capital
improvement work.
Staff believes that the revised Reserves Policy still leaves the City in sound financial shape.
Over the last ten years, the BSR has continued to grow. The ~City has arigorous .budget
process, and does not enter into new spending programs casually. Therefore, even in years
of fiscal strain, prudent fiscal planning and year end expenditure savings have resulted in
¯ reserves growth. Because the General Fund has a separate Reserve for Emergencies, and is
insured for over $1.0 million per incident through a liability insurance pool program with
other cities, the need for a BSR that totals 30 percent of the General Fund budget while there
are critical infrastructure needs does not seem warranted. A BSR total of 20 percent of the
annual budget would still-total about $17.4 million this year, would cover almost 2 ½ months
of full General Fund operations, or. roughly four months of General Fund employee costs.
CMR:210:97 Page ~ o1’ 13
PROPOSED DEBT GUIDELINES
There have been numerous occasions over the last several years when the possibility of using
debt financing has been evaluated. Staffbelieves it would be appropriate and prudent to have
a set of guidelines in place for considering when debt financing may be appropriate.
The City of Pal. Alto recognizes the need for spending a prudent amount every year for
ongoing capital replacement and rehabilitation needs. Because an ongoing capital
improvement plan is vital to ensure the future viability of services, the City will always place
first priority on funding its regular and ongoing capital needs on a pay-as-you-go basis. In
spite of this, there are special or extraordinary capital improvement projects in which it is
appropriate to consider debt financing. A set of guidelines is included below in order to
support the decision making process, and is not intended to be used as a set of rigid rules for.
issuing debt. ~
~pecific Parameters for D_D_e_b_!
Debt financing is only appropriately considered for capital improvements, and not for
operating budget items.
Annual debt service payments should not exceed 10 percent of the annual expenditure
budget of the General Fund.~
3~The term of the debt issuance should not exceed the useful life expectancy of the asset
acquired, constructed, or improved. "
4.It is appropriate to consider debt financing under the following circumstances:
When the project financing can be paid for directly by the users of the facility.
One example is capital improvements made to the City’s golf course, where
debt service payments can be made from the green fees paid by golfers. A
second example is for capital improvements paid by assessments to property
owners, such as a parking assessmentfor a downtown parking garage.
For Enterprise Fund projects, if a significantbacklog o~f capital improvements
has developed, and if that backlog cannot be addressed through the ongoing
capital budget without having a significant impact on utility rates. In this ease,
debt financing can be used to "smooth-out" the wide rate variations in an
otherwise stable capital plan.
CMR::~10:97 Page
If funding a large project (or grouping of similar projects) would have a
significant negative impact on the availability of funding for other Ongoing
capital needs. Large projects can include a new building, a substantial upgrade
or rehabilitation to an existing building, a new non,building facility (suehas
a park), a grouping of similar facilities (such as a several athletic fields or
tennis courts or heating Ventilation, and air conditioning systems (HVAC), or
bike bfidges),.or land acquisition costs. While a rigid dollar parameter should
not be established, a General Fund project that exceeds $2.0 million and
which can not be phased over several years of funding would be a likely
candidate to consider for debt financing, provided that a logical grouping, of
projects can be made to justify the issuance costs of the debt package.
Capital leases may be considered for purchases of large pieces of equipment,
such as mhjor computer equipment or specialized vehicles.
ClV~:210:97
Attachment I
General Fund Reserve Policy
[Reserve ,,Level Discussion
Determination. of the appropriate level of General Fund reserves is a policy decision. Some
general guidelines have been suggested by the literature in the government finance field. The
Government Finance Officers of America (GFOA) recommend that reserve levels.be directly
related to the degree of uncertainty the local government faces: the greater the uncertainty,
the greater the financial resources necessary. Past ex 9erience should be used as a guide, with
particular attention being paid to the following:
0 Diversity of revenue base
o Volatility of revenue structure
o Volatility of political environment
0 Consistent operating surpluses/occasional or frequent
operation deficits
Uneven cash flows, requiring short-term borrowing
Diversity of Revenue Base: Palo Alto has a comparatively di~,erse reyenue base: in 1995-96,
about half of the $78.5 million General Fund revenues came from non-tax sources. This
means that in periods of economic recessions, Palo Alto is more resilient to revenue
reductions than cities in which tax revenue makes up the overwhelming majority of their
revenue base. (In contrast, for all cities in California of Palo Alto’s size, taxes make up
roughly .two-thirds of total General Fund revenue.)
Volatility of Revenue Structure: Tax revenues show the most volatility in terms of growth,’
although Palo Alto’s revenues have been far more stable than other cities in. Santa Clara
County or the Bay Area in general. Sales tax is spread broadly across consumer retail,
business-to-business sales and other sales (transportation, food products, and miscellaneous).
In general, Palo Alto’s tax revenues have considerable ability to withstand economic
downturns; they are less able to withstand political vagaries, however.
Political Volatility: WhiIe Palo Alto’s revenues have shown strength and resilience in
relation to the general economy, Considerable volatility has been introduced, by the inability
CMR:210:97 Page 9 of 13
of the State government to deal with its own budget problems~ In 1990-91, the State gave
counties authority, through SB 2557, to charge cities for the cost of booking prisoners and
for property tax administration; this action cost Palo Alto approximately half a million
dollars on an annual basis. In 1991-92, the State shifted 47 percent of cities’ cigarette tax
away to fund trial courts. In addition, the State took half of all non-parking fines and
forfeitures attributable to cities. From 1992-94, the State reduced cities’ property tax
revenues by almost 15 percent, eliminated the balance of cigarette tax revenues, and
extended the definition of booking fees so that counties may potentially double or triple the
charges they assess. In November 1996, voters passed Proposition 218, theRight to Vote
on Taxes initiative. It further limits the City’s ability to raise new funds.
Of all the factors to be considered in setting reserve levels, none appears more critical ihan
political volatility in the current economic environment.
Operating Surplus/Operating Deficit: The General Fund’s operating results have been
favorable for the past several years, and have become more predictable as budget projections
have become more sophisticated.
Uneven Cash Flow: General Fund reserves are invested as part of a pool which includes
idle cash in all City funds, including the Enterprise and the Special Revenue Funds. At
December-31, 1996, the portfolio totaled $213 million. Cash flow projections for the
portfolio reflect no need for short-term boi’rowing, and the City has not experienced this need
in the past.
Budget Stabilization Reserve
In examirfing the key elements of setting adequate reserve levels, it is clear that the City has
the most vulnerability in the area of political volatility. Events in recent years have left little
doubt that the City’s careful budget planning can be completely negated by the actions of the
State Legislature and the Governor in Sacramento. There is reason to be concerned that theCity may face a reduction in sales tax revenues in.. the next several years, if per capita
allocation were to take the place of situs basis allocation. Consequently, a reserve level of
no less than 10 percent of General Fund operating expenditures, to a maximum of 20 percent
shall be maintained.
r Re .
An infrastructure reserve in the General Fund shall be used to finance capital improvements
that can’t otherwise be accommodated in the ongoing capita! budget.
The reserve would be used for:
CM~:210:97 Page 10 of 13
Priority projects of large dollar amounts, generally over $1.0 :million each, and which
are non-recurring in nature;
Projects that are expressly identified as part of the infrastructure backlog and which
do not lend themselves as easily to debt financing, i.e., non-building projects;
To the extent that sufficient funds aeeurnulate in the infrastructure reserve, and no
significant backlog of infrastructure existed, use of the fund may be considered for all
or part of the financing for a new facility as an alternative to full debt financing;
In addition, the fund could be used to finance large capital repairs of a non-emergency
nature that come up during the year, but which are not practical or prudent to delay.
until the next budget year. Staff believes projects of an emergency nature would be
more appropriately funded from the BSR or the Reserve for Emergencies.
Finally, in years of fiscal strain, the City may use the sinking fund as a supplemental
source of financing those capital improvements that might otherwise be proposed for
reduction as part of a budget savings plan in an effort to stay within overall revenue
constraints.
Because this fund is to be used for priority capital projects that will be reviewed by the
Council, no maximum fund level is recommended. Conversely, because of the discretionary
nature of this fund, no minimum balance is required..
Reserve for Eme~
The Reserve for Emergencies represents funds which could be made immediately available
for funding expenditures in an emergency situation. The reserve level shall be maintained
at roughly. 10 percent of General Fund salaries’and .benefits, or the equivalent of
approximately 30 days. ofpersormel costs.
Reserve for Streets an~
Funds that would otherwise accumulate in the Budget Stabilization Reserve may, from time
to time, at the recommendation of the City Manager and withthe approval of the Council,
be reserved for special streets, sidewalks, and Cubberley Community Center rehabilitation
and maintenance projects.
CMR:210:97 Page 11 of 13
Attachment II
Debt Guidelines
~_eneral statement
The-City of Pal. :Alto recognizes the need for spending a prudent amount every year for
ongoing capital replacement and rehabilitation needs. Because an ongoing capital
improvement plan is vital to ensure the future viability of Services, the City will always place
first priority on funding its regular and ongoing capital needs on a pay as a you go basis.
There are special or extraordinary capital improvement projects in which it is appropriate to
consider debt financing. A set of guidelines is included below in order to support the
decision making process, and is not intended to be used as a a set of rigid rules for issuing
debt.
Debt financing is only appropriately considered for capital improvements, and not for
operating budget items.
Annual debt service payments should not exceed 10 percent of the annual expenditure
budget of the General Fund.
The term of the debt issuance should not exceed the useful life expectancy of the asset
acquired, constructed, or improved.
It is appropriate to consider debt financing under the following circumstances:
a.When the project financing can be paid for directly by the users of the facility.
One example is capital improvements made to the City,s golf course, where
debt service payments can be made from the green fees paid by golfers. A
second example is for capital improvements paid by assessments to property
owners, such as a parking assessment for a downtown parking garage.
For Enterprise Funded projects, if a significant backlog of capital
improvements has developed, and if that baeldog cannot be addressed through
the ongoing capital budget without having a significant impact on utility rates.
In this ease, debt financing Can.be used to smooth out the wide rate variations
in an otherwise stable capital plan.
CMR:210:97
If funding a large project (or grouping of similar projects) would have a
significant negativeimpaet on the availability of funding for other ongoing
capital needs. Large projects can include a new building, a substantial upgrade
or rehabilitation to an existing building, a new non-building facility (such as
a park), a grouping of similar facilities (such as several athletic fields or tennis
courts or heating ventilation, and air conditioning systems (HVAC), or bike
bridges), or land acquisition costs. While a figid dollar parameter should not
be established, a General Fund project that exceeds $2.0 million and which
can not be phased over several years of funding would be a likely candidate
to consider for debt financing, provided that a logical grouping of projects can
be made to justify the issuance costs of the debt package. (The threshold
would be greater for larger funds, such as the Electric Fund).
Capital leases may be considered for purchases of large pieces of equipment,
such as major computer equipment or specialized vehicles.
CMR:210:97 ~ge 13 of 13