Fremont City Council Meeting: 03/07/23 07:00 PM
3300 Capitol Avenue Div/Dept: Finance Department
Fremont, CA 94538 Category: Budget
SCHEDULED
Sponsors:
COUNCIL STAFF REPORT (ID # 4818) DOC ID: 4818
Updated: 3/2/2023 3:12 PM by Alberto Quintanilla Page 1 FISCAL YEAR 2022/23 MID-YEAR BUDGET REPORT - Update on the Status of the FY 2022/23 General Fund Operating Budget and Preliminary Three-Year Forecast; Approve Budget Adjustments; Make Findings of CEQA Exemption Contact Persons:
Name: David Persselin
Title: Finance Director
Div/Dept: Finance Department
Phone: 510-494-4631
E-Mail: [email protected]
EXECUTIVE SUMMARY: The Mid-Year Budget Report is an opportunity for staff to update the City Council on current-year budget performance based on actual operating results.
Staff will present a brief review of economic trends, discuss revised General Fund revenue and expenditure projections for the current year, provide a preliminary General Fund forecast for the next three years, and present recommendations for mid-year budget adjustments.
BACKGROUND:
The Fiscal Year 2022/23 operating budget was adopted by the City Council on June 14, 2022. The adopted budget was developed on the assumption that the local economy would continue to recover from the pandemic-related recession and that General Fund ongoing revenues would increase by about 4.1%. The costs of the adopted budget were expected to be covered by projected ongoing resources and fiscal recovery funds held as unreserved fund balance.
As labor negotiations were under way when the 2022/23 operating budget was prepared, the adopted budget included 3% placeholder compensation increases. The final labor agreements, completed in July 2022, provided for higher increases and resulted in approximately $3.9 million of additional costs which have been incorporated into the adjusted budget.
As part of the FY 2021/22 Year End Report presented to the City Council on October 18, 2022, staff noted that a fourth-quarter surge in sales tax revenue and unanticipated expenditure savings resulted in $13.2 million of available ending fund balance in the General Fund. To address the increasing amount and volatility of sales tax revenue, the City Council increased the General Fund Budget Uncertainty Reserve from $10 million to $12.5 million. To create funding capacity for critical maintenance and capital needs as well as unfunded future capital investments, the City Council then transferred the remaining $10.7 million of the available ending fund balance to the Capital Improvements Fund.
DISCUSSION AND ANALYSIS:
Economic Trends: After small contractions in the first two quarters of calendar year 2022, the national economy returned to a healthy level of expansion with third quarter growth of
3.2% and fourth quarter growth of 2.9%. Consistent with an economic expansion, the labor Council Staff Report (ID # 4818) Meeting of March 7, 2023 Updated: 3/2/2023 3:12 PM by Alberto Quintanilla Page 2 market has remained tight, with the national unemployment rate staying at or close to record low levels in the range of 3.5%.
This economic growth, coupled with economic sanctions on Russia and lingering supply chain disruptions resulting from COVID restrictions, has created sustained high inflation. To combat inflation, the Federal Reserve has raised interest rates repeatedly over the last year and may continue to raise rates through the middle of 2023. The combination of higher prices and higher interest rates has led to a decline in consumer confidence, which ultimately could result in an economic slowdown or a recession later this year.
While the City’s preliminary revenue forecast assumes continued increases over the next few years, it is important to recognize the significant economic uncertainties facing our community.
FY 2022/23 General Fund Revenue and Expenditure Estimates: The General Fund’s largest source of revenue, property tax, is performing slightly above the budget estimate, with expected growth of 8.3% over the prior year. Sales taxes, however, constituting the General Fund’s second largest source of revenue, are projected to increase by 22.6%, a $37.6 million increase above the adopted budget revenue estimate. The significant growth in sales tax revenue is almost completely attributable to the new auto sales category. Hotel tax revenue appears to be recovering more rapidly than anticipated and is projected to exceed the budgeted estimate by $1.2 million.
Overall, General Fund revenues and transfers in are estimated to grow 2.9% in FY 2022/23 from the FY 2021/22 level, resulting in $43.7 million more of estimated resources than included in the adopted budget. This report includes a recommended adjustment to bring the budgeted revenue estimates for property tax, sales tax, and hotel tax in line with the current projections.
General Fund expenditures and transfers out for FY 2022/23 are projected to end the year $13 million below the adjusted budget, primarily due to higher than anticipated citywide vacancy savings. In total, General Fund expenditures and transfers out are anticipated to fall about 1% below the FY 2021/22 level.
The adjusted budget assumed that the General Fund would end the year with $17.8 million of unreserved fund balance. The $43.7 million increase in estimated General Fund resources, combined with $13 million of additional expenditure savings, results in an estimated ending fund balance for FY 2022/23 of $74.5 million.
Staff will return to the City Council on May 16, 2023, with updated estimates for FY 2022/23 incorporated into the FY 2023/24 Proposed Operating Budget.
The following table presents a comparison of FY 2021/22 actual results with the FY 2022/23 adjusted budget and staff’s FY 2022/23 mid-year estimate.
Council Staff Report (ID # 4818) Meeting of March 7, 2023 Updated: 3/2/2023 3:12 PM by Alberto Quintanilla Page 3
Preliminary General Fund Forecast: Revenue projections for the next three fiscal years are based on the most current information available and take into account historical trends, current-year performance through mid-year, projected development activity, and scheduled changes in various fees and rates.
The FY 2023/24 and subsequent year expenditure projections are net of estimated citywide savings and include adjustments to reflect labor agreements, CalPERS pension contributions, retiree healthcare contributions, scheduled debt service payments, and contractual obligations. In accordance with the City Council’s Pension Liability Funding Policy, an additional pension contribution has been included in each year as well. It is important to note that the City’s labor agreements expire on June 30, 2025, and no compensation increases have been assumed in the FY 2025/26 expenditure projection.
As this forecast is preliminary, the expenditures shown represent a “base budget” that delivers the existing level of services with no assumed compensation or staffing increases.
These expenditure levels may increase as the FY 2023/24 Proposed Operating Budget is developed with the benefit of additional information, including any recommendations for service level enhancements.
Council Staff Report (ID # 4818) Meeting of March 7, 2023 Updated: 3/2/2023 3:12 PM by Alberto Quintanilla Page 4
Revenue and Expenditure Adjustments: As discussed above, the current revenue projections for property tax, sales tax, and hotel tax are exceeding their budgeted estimates by $41.6 million, and expenditures are projected fall below the budgeted appropriations by $13 million. Staff recommends that the City Council increase the budget estimates for those three revenues and the expenditure savings estimate to match the current projections.
At the same time, staff is recommending three appropriation actions to address priority needs, with a fourth set of Council actions to be presented separately later in the fiscal year.
Restore the Unreserved Balance in the Risk Management Fund The City maintains approximately $14.1 million of self-insurance reserves in the Risk Management Fund for workers compensation claims up to $500,000 and general liability claims up to $1,000,000. In addition to the reserves, the Risk Management Fund also includes an unreserved balance, targeted at $3 million, that is used to make actuarially determined adjustments to the reserve levels.
As part of the budget balancing actions included in the FY 2020/21 budget, annual operating fund contributions to the Risk Management Fund were reduced to a level that appeared to be sustainable. However, over the past three years, a combination of increasing claims costs and rising insurance premiums for excess claims liability and property coverage have depleted the unreserved balance in the Risk Management Fund. Staff is recommending that the City Council allocate $3.5 million of additional General Fund revenue to restore the unreserved fund balance to its targeted level.
Council Staff Report (ID # 4818) Meeting of March 7, 2023 Updated: 3/2/2023 3:12 PM by Alberto Quintanilla Page 5 Create an Accrued Leave Reserve in the Employee Benefits Fund Each year, the City’s unfunded liability for earned but unused vacation leave increases. The maximum accrual for each employee is capped, but the value increases at the same rate as the annual compensation increases. For the year ended June 30, 2022, the unfunded liability was approximately $13.5 million. A portion of accrued leave can be paid out to some employees during the year, but all accrued leave is payable on termination or retirement.
The General Fund annual operating budget currently includes $1.4 million to address the cost of these payouts on a pay-as-you-go basis, but as with our unfunded pension and retiree healthcare liabilities, it would be more prudent to establish a reserve to ensure that sufficient funds are available to meet the increasing cost of these obligations. The reserve would be used instead of the General Fund and the other operating funds to make accrued leave payments, and each year the General Fund and the other operating funds would make contributions to the reserve reflecting the value of that year’s earned but unused leave.
To accommodate the additional leave hours earned but unused in the current year, and recognizing that the prior year unfunded leave liability is increasing at the same rate as salaries, between 5% and 6%, staff is recommending that the City Council transfer $15 million to the Employee Benefits Fund to establish an accrued leave reserve.
Provide Additional Funding for Priority Maintenance and Capital Needs On several occasions over the last year, staff has presented to the City Council a list of critical maintenance and capital replacement needs as well as unfunded future capital investments. These include major City initiatives such as the parks master plan and the climate action plan, but also traffic signal modernization, replacement of deteriorating facilities in Central Park, and technology upgrades. Although the cost of these unfunded needs far exceeds the resources available, the unanticipated increase in current year revenue creates an opportunity to make progress on the highest priority projects. To create the capacity to fund some of these projects in the next capital improvement plan, staff recommends that the City Council appropriate $25 million of the additional revenue as a transfer to the Capital Improvements Fund.
Future Action - Pay Down General Fund Bonded Debt
Over the course of the last forty years, the City has financed a wide variety of capital facilities and land acquisition including City Hall, the Police Administration Center, the Development Services Center, the Maintenance Facility, and the Main Library. The remaining balance owed for these financings, $76.2 million, is reflected in two series of bonds payable from General Fund revenues.
As a separate set of actions later in the fiscal year, staff will be bringing forward a recommendation to pay off the City’s 2017B Lease Revenue Bonds. The cost of that payoff will include the $16.6 million of outstanding principal, as well as a portion of the interest that will be payable until the bonds can be redeemed on October 1, 2027. Paying off the 2017B Lease Revenue Bonds will save the General Fund approximately $1.3 million each year in debt service costs through the final maturity date of October 1, 2038. Additionally, by redeeming the bonds early, the City will avoid approximately $2.6 million of future interest payments.
In total, these four recommendations will account for approximately $60 million of the $74.5 million projected unreserved fund balance. As part of the FY 2023/24 propos ed Council Staff Report (ID # 4818) Meeting of March 7, 2023 Updated: 3/2/2023 3:12 PM by Alberto Quintanilla Page 6 operating budget, staff will likely be recommending that a portion of the remaining unreserved fund balance be used to increase the General Fund Budget Uncertainty Reserve.
FISCAL IMPACT: The recommended budget adjustments will better align the General Fund revenue and expenditure estimates with the current projections, restore the unreserved fund balance in the Risk Management Fund, establish a reserve for the City’s unfunded accrued leave liability, and create additional funding capacity for the FY 2023/24-2027/28 Capital Improvement Plan. Staff will return to the City Council on May 16, 2023, with the FY 2023/24 Proposed Operating Budget and a revised General Fund forecast.
ENVIRONMENTAL REVIEW: Action on this item is exempt from the requirements of the California Environmental Quality Act (CEQA) per CEQA Guidelines Section 15378(b), as an administrative and/or fiscal activity that does not involve commitment to a specific project that will result in any significant physical impact on the environment.
ATTACHMENTS: None.
RECOMMENDATIONS:
1. Increase the General Fund revenue estimates for property tax by $2.8 million, sales tax by $37.6 million, and hotel tax by $1.2 million.
2. Increase the General Fund citywide savings estimate by $13 million.
3. Approve the transfer of $3.5 million to the Risk Management Fund (Fund 609).
4. Approve the transfer of $15 million to the Employee Benefits Fund (Fund 630).
5. Approve the transfer of $25 million to the Capital Improvements Fund (Fund 501).