Agenda Report
Fullerton City Council
MEETING DATE: FEBRUARY 1, 2022
TO: CITY COUNCIL / SUCCESSOR AGENCY
FROM: JEFFREY W. COLLIER, ACTING CITY MANAGER
PREPARED BY: ELLIS CHANG, DIRECTOR OF ADMINISTRATIVE SERVICES
STEVEN AVALOS, BUDGET AND PURCHASING MANAGER
CINNDY BARRIOS, BUDGET ANALYST II
SUBJECT: SECOND QUARTER FINANCIAL REPORT AND MID-YEAR BUDGET AMENDMENTS FOR FISCAL YEAR 2021-22
SUMMARY
The Second Quarter (Q2) Financial Report, also known as the Mid-Year Budget Report, provides an overview of the City’s financial position through the second quarter of Fiscal Year (FY) 2021-22. The Report identifies the City’s revenue performance and expenditures incurred from July 1, 2021 through December 31, 2021 in comparison to adopted budget levels, assessing the City’s financial position through the midpoint of the fiscal year. The Report also presents FY 2021-22 Mid-Year Budget Amendments, provides an update on the City’s current economic outlook and presents updated General Fund Financial Forecasts.
RECOMMENDATION
Receive and file Second Quarter Financial Report for FY 2021-22.
Approve FY 2021-22 Budget Amendments (Attachment 3) and authorize City Manager, or designee, to make approved amendments to the FY 2021-22 Budget.
BUDGET POLICY PRIORITY STATEMENT
This item matches the following Budget Policy Priority Statement:
Fiscal and Organizational Stability.
FISCAL IMPACT
Staff will use the information provided in these reports to ensure continued budgetary diligence and compliance to adopted budget levels through the end of the fiscal year.
The Proposed Mid-Year Budget Amendments for FY 2021-22, as presented in Exhibit A (Attachment 3), total $5,175,875 in revenue adjustments to the General Fund. There are no expenditure adjustments in the General Fund. Higher than anticipated economic recovery from the onset of the COVID-19 pandemic with anticipated higher sales tax and transient occupancy tax (TOT) revenues account for increased revenues. This will assist the City in reducing its operating deficit by this same $5.2 million.
Budget adjustments for all other City funds total $1,725,000 in revenue adjustments and $743,258 in expenditure adjustments. These budget adjustments primarily restore funding for Tennis Center operations in the Brea Dam Fund (Fund 42) and to account for increased Golf Course revenues, a positive effect the City has realized since the pandemic. In addition, staff proposes various budget amendments to the Information Technology (IT) Internal Service Fund due to corrections needed after consolidating all department-related IT costs in FY 2021-22.
On January 18, 2022, City Council ratified the use of $11.6 million of ARPA funds for Revenue Replacement-Provision of Government Services to stabilize government finances and the General Fund’s financial position with $2 million recommended for non-budgeted Water Main Replacements. The application of the remaining $9.6 million will provide stability to the City’s financial position.
DISCUSSION
Introduction
As part of the City’s budget monitoring and financial reporting practices, Staff provides quarterly financial reports on the current year budget to City Council. This is a sound financial practice and fiscal transparency tool to report the City’s ongoing fiscal condition and identify and address any budget issues as they arise and strengthens the City’s financial planning efforts. Quarterly reports provide a measurement of the City’s overall fiscal health and condition relative to adopted budget levels and keeps City Council informed and updated on the City’s ongoing financial condition.
The FY 2021-22 Q2 Financial Report identifies all revenues received and expenditures incurred through the second quarter of the fiscal year, from July 1, 2021 through December 31, 2021, in comparison to adopted budget levels. Staff has provided estimated Q2 financial information as the Administrative Services Department works toward completing month end closing for the quarter. However, as the City has posted all cash and estimated unrecorded material journal entries, staff presents the balances in substantially completed form. The Q2 Report also includes FY 2021-22 Budget Amendments (Attachment 3) for City Council consideration to amend the FY 2021-22 Adopted Budget.
While assessing the fiscal condition of all City funds is important, the Q2 Report will primarily focus on the General Fund - the City’s chief operating fund that supports traditional municipal services, such as public safety, community and economic development, parks and recreation and library community services and public works. The discussion section addresses other City funds that require financial attention.
FY 2021-22 Mid-Year Review of General Fund (including Library and Parks and Recreation) Through the second quarter, or first half, of FY 2021-22, General Fund revenues total $40.1 million and are at 40% of adopted revenues of $100.9 million. General Fund expenditures total $48.4 million and are at 45% of adopted expenditures of $107.1 million.
Revenues
General Fund revenues total $40.1 million and are at 40% of adopted revenues of $100.9 million. While revenues appear low at around 40% received through the mid-point of the year, this is not atypical as the City receives two large installments of Property Tax (VLF In-Lieu) in the second half of the year in January and May, in addition to a large installment of franchise fees received in the latter half of the year. In comparison to mid-year last fiscal year, General Fund revenues are performing well and are up by $5.2 million or by 15%. The following summarizes City’s major revenues.
Property Tax – Property Tax revenues, the City’s largest revenue for the General Fund, are up by about $86,000 compared to the same period last fiscal year and are at $18.5 million through December 31, 2021. While property tax receipts to date are slightly up, the City receives the majority of its property tax revenues during the second half of the fiscal year and property tax revenues appear to be on track with budgeted levels. Property Tax continues as the City’s most stable revenue and is indicative of the strong assessed valuation of Fullerton properties. Property Tax revenues have continued to grow during the pandemic.
Sales Tax – Sales Tax revenues are up by $1.6 million (or 20.5%) from this same period in FY 2020-21 primarily due to faster than expected economic recovery from estimates developed during the first year of the COVID-19 pandemic. For FY 2021-22, and based on latest projections (Q3 2021 Report) from the City’s sales tax consultant, the City expects sales tax revenues to exceed budgeted levels by $3.9 million. Other factors include a substantial increase from the City’s County Pool allocation resulting from the State’s 2019 law requiring online marketplace vendors to remit sales tax to the State which then gets redistributed to the county pools. In addition, new business retailers have come to the city, contributing to this increase in sales tax. Staff requests a $3.9 million budget adjustment increasing sales tax revenue for FY 2021-22.
Transient Occupancy Tax – Transient Occupancy Tax, or TOT, has also increased since FY 2020-21. The onset of the COVID-19 pandemic and State mandated stay-at-home orders significantly reduced TOT revenue in FY 2020-21. As the economy rebounds and travel and places of tourism have largely remained open in FY 2021-22, hotel occupancy rates have also rebounded. Through the first half of FY 2021-22, TOT revenues have already reached $1.0 million which is 81% of budget levels of $1.25 million. Staff conservatively estimates TOT revenues are on pace to exceed budgeted revenues by approximately $1.0 million.
In addition, the City’s Short-Term rental program, approved by City Council last year, generates user fees and TOT revenues for short-term rentals in the City. FY 2021-22 represents the first full year of this Short-Term Rental TOT collection and staff conservatively estimates the City will receive about $100,000 in FY 2021-22. Staff requests budget adjustments for both TOT revenues FY 2021-22.
All other major revenues are performing in line with budgeted levels and staff requests no further adjustments at this time.
Expenditures
Expenditures follow a more linear path as the City processes payables such as payroll biweekly and invoices on a weekly basis. General Fund expenditures total $48.4 million and are at 45% of adopted expenditures of $107.1 million. The expenditure budget includes the $3.8 million of vacancy savings approved by City Council at budget adoption. As a result, expenditures total currently at 45% through the first half of the year and fall in line with adopted budget levels. Staff requests no General Fund expenditure budget adjustments at this time.
City Council approved an additional 2.5% budget reduction at the December 7, 2021 budget study session. The City Manager is working with departments to identify the 2.5% of proposed budget reductions for City Council consideration and will bring these reductions for ratification at the February 15, 2022 City Council meeting.
The following provides updated Financial Forecasts with and without the additional 2.5% budget reductions. The updated forecasts incorporate the City’s improved financial condition resulting from sales tax and TOT revenue recovery and the application of $9.6 million of ARPA for revenue replacement for budgeted services. Staff presents the updated forecasts with and without the additional 2.5% budget reductions and with and without estimated CalPERS pension projections due to recent investment returns and changes in actuarial assumptions.
FY 2021-22 Budget Amendments
The Proposed FY 2021-22 Mid-Year Budget Amendments, as presented in Exhibit A (Attachment 3), primarily reflect the projected increase of revenues to the General Fund. The following provides a short summary of the revenue adjustments:
General Fund Revenue Adjustments
FY 21-22 Adopted
FY 21-22 Projected
Proposed Budget Adjustment
Sales Tax Revenue
$23,623,613
$27,536,155
$3,912,542
TOT Revenue
1,250,000
2,350,000
1,100,000
Developer Fees (various)
-
163,333
163,333
Total Revenue Adjustments
$5,175,875
As previously mentioned, the $5.2 million revenue adjustments are primarily due to a faster and higher than anticipated economic recovery from the COVID-19 pandemic. As discussed in the revenue section, staff expects sales tax to come in $3.9 million above budgeted levels resulting in the requested budget adjustment. For TOT, staff requests a $1.0 million and a $100,000 budget adjustment for both increased general TOT revenue and new Short-Term Rental TOT revenue. In addition, staff request a budget adjustment for developer fee increases. Developer fee increases, approved in August 2021, will assist the City in moving towards full cost recovery of performing theses services.
The other budget adjustments presented pertain to the Brea Dam Enterprise Fund (Fund 42) and the IT Fund (Fund 68). The budget amendments for the Brea Dam Fund primarily associate with Tennis Center operations. At the time of budget adoption in June 2021, staff was assessing options with respect to Tennis Center operations. As a result, staff did not request Tennis Center operating costs in the proposed FY 2021-22 budget. Since budget adoption, the City has continued operating the Tennis Center in-house and recently approved Tennis Center fee increases. Staff requests budget adjustments to incorporate this program’s budget.
The IT Fund budget amendments primarily relate to consolidating all IT costs into the IT Fund in FY 2021-22, requiring adjustments to department-reflected IT costs. Staff proposes additional amendments related to the City’s cybersecurity and emergency infrastructure needs which City Council approved earlier in the year.
Attachment 3 lists in detail and outlines all Proposed FY 2021-22 Mid-Year Budget Amendment.
CalPERS Actuarial Update
In mid-November 2021, the CalPERS Board adopted actuarial assumptions for their June 30, 2021 actuarial valuation which will take effect in FY 2023-24. These assumption changes include a discount rate reduction from 7.0% to 6.8%, reduction of the inflation assumption from 2.5% to 2.3%, increase to the wage growth assumption from 2.75% to 2.8% and other minor demographic adjustments to mortality, terminations and disability. These actuarial assumption changes will offset CalPERS investment gains of 21.3% experienced in FY 2020-21.
The impact of this new amortization base will result in a net “credit” (reduction) to the City’s Unfunded Accrued Liability (UAL) as investment gains are amortized over 20 years with an initial five-year ramp up per the CalPERS Smoothing Policy. The net impact is an estimated $69 million Net Credit which will be added as an amortization base in the June 30, 2021 CalPERS actuarial valuation effective FY 2023-24.
Staff incorporated the estimated reduction in UAL beginning in FY 2023-24 as a separate row (shaded grey) reducing expenditures in the Model #3 and #4 forecasts. However, the estimated expenditure reductions should be tempered as future CalPERS gains and/or losses are unknown.
The following presents a lookback of CalPERS earnings since 1984. CalPERS lowering of its discount rate from 7.0% to 6.8% is indicative of CalPERS reducing investment risk and the 6.8% discount rate is what CalPERS anticipates earning on its investments over a long period of time. The 21.3% gains experienced in FY 2020-21 are not likely to be sustained in future years and future losses will increase the City’s UAL expenditures in the years they become effective.
As the City develops a pension policy, staff may recommend proposed budgetary savings from CalPERS gains for contribution to the City’s 115 Pension Trust. The 115 Pension Trust is one tool City Council may consider utilizing to help mitigate budgetary instability resulting from future UAL increases.
Financial Forecast
Since the start of FY 2021-22, City Council directed changes to the adopted budget, particularly the additional 2.5% budget reductions approved by City Council and the designation of $11.6 million of ARPA funds towards revenue replacement for the stabilization of City finances. This $11.6 million is reduced by $2 million that is recommended for Water Main Replacements under the Infrastructure US Treasury category.
In addition, there have been significant changes to key assumptions in the Financial Forecast, starting with increased revenue projections for sales tax and TOT revenues, as discussed in this Q2 report and changes to CalPERS pension projections resulting from recent actuarial assumption changes and CalPERS investment gains of 21.3%. The CalPERS changes will lower the City’s annual UAL payments starting in FY 2023-24 and provide savings over the course of the 20-year amortization period. Further, CalPERS lowered its discount rate from 7.0% to 6.8% which will increase the City’s normal cost contributions as well as made other adjustments estimated and reflected in the updated financial forecasts.
The following sections present the updated Financial Forecasts.
Model #1 – Baseline Forecast
Model #2 – Baseline Forecast with 2.5% Additional Budget Reductions Model #3 – Baseline Forecast with CalPERS Projections
Model #4 – Baseline Forecast with 2.5% Additional Budget Reductions and CalPERS Projections.
The Baseline Forecast, which includes the $3.8 million of vacancy savings, incorporates updated revenue assumptions (resulting from improved sales tax and TOT revenues) and $9.6 million of ARPA for Revenue Replacement. This Baseline Forecast is used as the underlying forecast for Models #2, 3 and 4.
Model #1 - Baseline Forecast
The Baseline Forecast (Model #1) demonstrates improvement from prior projections as a result of sales tax and TOT revenue recovery. While staff projects that FY 2021-22 and FY 2022-23 will still end with a negative Net Change in Fund Balance (deficit), the application of ARPA for Revenue Replacement in FY 2021-22 and FY 2022-23 offsets this, thereby stabilizing the General Fund’s ending financial position not just in the early years of the forecast, but in all subsequent years as well.
Because of economic uncertainty and the difficulty of projecting the start, depth and duration of the next recession, the Baseline Forecast includes a projection for a mild recession in FY 2025-26.
Model #2 - Baseline Forecast with 2.5% Additional Budget Reductions The Baseline Forecast with 2.5% Additional Budget Reductions incorporates the additional budget cuts in the yellow highlighted row labeled ‘Expenditure Reductions – Add’l 2.5% Budget Cuts.’ Model #2 demonstrates that with 2.5% additional reductions, the General Fund with the $9.6 million of ARPA for Revenue Replacement would be in a position to achieve its contingency reserve goal of 17% in every year of the forecast but comes at the cost of service level impacts resulting from the 2.5% additional reductions.
Model #3 - Baseline Forecast with CalPERS Projections
The Baseline Forecast with CalPERS Projections incorporates the estimated impact of CalPERS gains experienced in FY 2020-21 and actuarial assumption changes. Staff incorporated these estimated CalPERS projects in the grey row labeled ‘Estimated CalPERS Projections.’ The City will primarily begin experiencing the benefit from the CalPERS projections with the addition of the new CalPERS amortization base which will take effect in FY 2023-24.
While the addition of the new amortization base benefits the City’s budgetary outlook, staff cautions that CalPERS anticipates long term returns of 6.8%, making the 21.3% gains experienced in FY 2020-21 unlikely to be sustained in future years and future losses will increase the City’s UAL expenditures in the years they become effective.
However, the addition of the new CalPERS amortization base does provide budgetary relief, positioning the City to achieve its General Fund contingency reserve goal of 17% and the ability to direct any unassigned fund balance to one-time projects and / or make additional contributions to the City’s 115 Pension Trust should City Council elect to do so.
Model #4 - Baseline Forecast with 2.5% Additional Budget Reductions and CalPERS Projections The Baseline Forecast with 2.5% Additional Budget Reductions and CalPERS Projections incorporates both the additional budget cuts of 2.5% and the estimated CalPERS projections.
The additional budget cuts place the General Fund in a positive Net Change in Fund Balance in the early years, supplemented by the decrease in expenditures from the reduction in pension costs in the subsequent years (FY 2023-24 through end of forecast).
With improved revenue recovery and the application of ARPA for Revenue Replacement alone, this appears to accomplish stabilizing the General Fund and its financial net position in every year of the forecast. As City Council considers additional measures in the coming months (pension obligation bond, OCFA proposal, etc.) the City could see even further positive improvement in the City’s fiscal health.
Attachment 4 provides all updated Financial Forecasts (Model #1, 2, 3, and 4).
Next Steps
The City will continue to exercise fiscal diligence and monitor budgets and revenue performance through quarterly reports for the remainder of FY 2021-22.
In addition, staff has begun the FY 2022-23 budget development process. The City plans to hold an initial FY 2022-23 budget study session on February 15, 2022 to seek direction on City Council Budget Priorities to utilize as a budgetary guide and planning tool in development of the FY 2022-23 budget. Staff will look for input into the proposed Work Plan for FY 2022-23 and will take this input and prepare costing and further analysis so City Council can prioritize and select items for inclusion in the final budget during a study session in April or May, ahead of the City budget adoption hearing.
Attachments:
Attachment 1 – Revenue Summaries - Q2 FY 2021-22
Attachment 2 – Expenditure Summaries - Q2 FY 2021-22
Attachment 3 – Exhibit A - FY 2021-22 Mid-Year Budget Amendments Attachment 4 – Financial Forecasts
FY 2021-22 Q2 Financial Report and Mid-Year Budget Amendments February 1, 2022 - Page 11