CITY OF SAN MATEO
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CITY OF SAN MATEO
Agenda Report
City Hall
330 W. 20th Avenue
San Mateo CA 94403
www.cityofsanmateo.org
Agenda Number: 22 Section Name: {{section.name}} Account Number: 10-2011 File ID: {{item.tracking_number}} TO: City Council
FROM: Alex Khojikian, City Manager
PREPARED BY: Finance Department
MEETING DATE: April 7, 2025
SUBJECT:
General Fund Reserve Policy – Review
RECOMMENDATION:
Review and discuss the General Fund Reserve Policy and provide direction on potential modifications.
BACKGROUND:
The General Fund Reserve Policy provides a structured approach to maintaining sufficient financial reserves to ensure the City can maintain its services in the face of economic downturns, emergencies, and unforeseen events. A well-structured reserve policy enhances financial stability, mitigates risk, and supports long-term operational needs.
Staff conducted a comprehensive review of the General Fund Reserve Policy, including an analysis of the City’s reserve levels against best practices recommended by the Government Finance Officers Association (GFOA) and policies of similar- size cities. Staff also assessed the City risk factors, including vulnerability, liquidity, fund dependency, leverage, and capital project funding and needs, as well as AAA credit rating criteria.
Problems and Challenges
The City’s current General Fund Reserves consist of three categories: the Operating Reserve, Housing Set-Aside, and Rainy Day Reserve. The Operating Reserve is set at 25 percent of General Fund budgeted expenditures. The Housing Set-Aside is allocated per prior Council actions and is funded with 20 percent of RDA residual property tax annually. After meeting these first two reserve requirements, the remaining General Fund balance goes to the Rainy Day Reserve.
Through the review, staff identified the following issues with the current structure:
•Capital Improvement Projects (CIP) carryovers are misclassified. The Rainy Day Reserve currently includes funds budgeted for CIP but not yet spent and transferred to the Capital Project Funds, i.e. CIP carryovers. This gives the impression that the City has more in the Rainy Day Reserve than it actually does. Staff have manually adjusted for this in the past, but a policy change is needed to correct this classification. •Overlapping functions between the Operating Reserve and Rainy Day Reserve. Clear definitions are needed to guide their use in emergencies, economic downturns, or unexpected costs. •Lack of distinction between reserves and unassigned fund balance. Currently, all General Fund balances are classified as reserves, even though reserves are set-aside for specific purposes, while unassigned funds can be used at the Council’s discretion. Separating these two will improve financial planning and decision-making. •Right-sizing reserves: The City’s reserve levels should be adjusted to balance financial prudence with flexibility to address operational and capital needs.
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Proposed Changes
To address these issues, staff developed a draft General Fund Reserve Policy (Attachment 1) for Council consideration.
Key recommendations are:
•Separate the CIP Carryovers from the Rainy Day Reserve to support proper financial planning. •Rename the Operating Reserve to Contingency Reserve and reduce its reserve level from 25 percent to 15 percent of General Fund budgeted expenditures. This reserve shall be strictly for extraordinary, one-time, unforeseen non- financial emergencies (e.g. natural disasters, public health crises, emergency infrastructure repairs). It is not intended to address revenue losses due to economic cycles. This change will release $17 million from reserves.
Liquidity Consideration: The City manages its cash on a pooled basis, where various funds contribute to central investment pools for efficient cash and investment management. This ensures funds are available when needed without having to hold large, idle reserves. In a major emergency, immediate funding needs could be met through pooled cash and short-term interfund borrowing. Due to our strong cash flow and liquidity, maintaining a lower level of contingency reserves is appropriate. To align with best practice, adopting a formal Interfund Borrowing Policy is recommended.
•Rename the Rainy Day Reserve to Budget Stabilization Reserve and set its target level at 15 percent of General Fund budgeted revenues. This reserve is intended to stabilize the budget during economic downturns and unforeseen fiscal emergencies. This reserve level will adjust automatically with revenue changes, increasing in strong economic periods and decreasing during downturns to provide operational support. This restructuring will release an additional $18 million from the General Fund reserves. •Establish a Pension Stabilization Reserve, with an initial $10 million set-aside, to mitigate pension risk and prevent unexpected increases from impacting city services. Additional contributions may come from surplus, one-time revenues, or other unrestricted funds. Investment earnings from this reserve shall remain in the reserve. If pension cost uncertainty declines, this reserve could be used for one-time discretionary payment to CalPERS to reduce the City’s unfunded pension liabilities.
•Add guidelines for replenishment and use to ensure reserves are maintained appropriately.
The draft policy also requires an annual review of the General Fund reserve levels by the Finance Director as part of the budget development process. If the Budget Stabilization Reserve falls below 10 percent in the next two budget cycles per the General Fund long-range forecast, the City Manager shall propose a plan to restore the reserve to target level, subject to Council approval.
General Fund Reserve Levels
By restructuring the reserves, the City will release $35 million from reserves ($17 million from the former Operating Reserve and $18 million from the former Rainy Day Reserve), reducing the total General Fund reserves from $112 million to $77 million.
Capital Investment Reserve
Staff analysis found that the revised reserve levels will be adequate as a hedge for unexpected losses from events such as natural disasters and economic downturns, but it also recognized that then-current reserves were not adequate to fund growing capital improvement needs. As a result, staff recommend establishing a Capital Investment Reserve under the Capital Project Funds and transferring $25 million of the $35 million released from reserves to serve as “seed money” for critical unfunded infrastructure projects.
A draft Capital Investment Reserve Policy (Attachment 2) is included in this report for Council consideration. The draft policy defines this reserve is dedicated to for critical, unfunded capital project needs and will not be used for operating expenses or recurring costs. The policy also defines funding sources and Council authorization for spending.
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Unassigned General Fund Balance
The remaining $10 million from released funds will remain in the General Fund as unassigned fund balance, classified as funds available for operational and capital improvement needs at the Council’s discretion.
Unlike the current structure, where all General Fund balance is considered reserves, the revised policy establishes a clear framework distinguishing between required reserves and unassigned funds. This will enhance financial transparency and support more informed decision-making.
As part of the budget process, the Finance Director shall review the General Fund unassigned fund balance. If it exceeds 10 percent of General Fund budgeted expenditures, the Finance Director shall propose options (e.g. one-time capital improvements, pension liability reduction, or other long-term financial priorities) for City Council consideration on how to allocate the excess funds.
Factor Comparison - Before vs. After
Factor Before After Improvement
Transparency Unclear definitions on
certain reserves
Clear definitions and five
designated reserves
Easier to understand and
manage
Reserve Levels for
Unforeseen
Emergencies
25 percent Operating
Reserve;
No clear cap for Rainy Day
15 percent Contingency Reserve
(non-fiscal emergencies);
15 percent Budget Stabilization
Reserve (fiscal emergencies)
More flexible, aligns with
best practices
Pension Risk Mitigation Under Rainy Day Reserve $10 million set aside for Pension Stabilization Reserve
Mitigate risk from pension
cost spikes
Unassigned Funds Not clearly defined After meeting reserve levels, the remaining General Fund balance
will be classified as “unassigned”
Support more informed and
strategic decision-making
AAA Credit Rating Meet credit rating criteria Meet credit rating criteria Changes to reserve levels will not impact the City’s
AAA credit rating
Uncertainty Resilience General Fund: $112 million
in reserves
General Fund: $77 million in
reserves + $10 million
unassigned fund balances
Capital Project Funds: $25
million in Capital Investment
Reserve
Sufficient reserves to
mitigate risk, and provide
$25 million “seed money”
for critical unfunded capital
projects
Next Steps:
Staff seek City Council’s direction on the proposed reserve policy changes. The proposed policy changes will not alter the amount of funds managed but will optimize their allocation, ensuring fiscal sustainability while setting aside funds for infrastructure needs. Should the Council wish to move forward with the proposed Reserve Policy, staff will bring the new Policy for adoption as part of the upcoming budget process.
BUDGET IMPACT:
There is no immediate budget impact associated with this report. Regular reviews of reserve policies will ensure policies remain effective, aligned with financial best practices, and responsive to the City’s evolving fiscal needs.
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ENVIRONMENTAL DETERMINATION:
This report is not a project subject to CEQA, because it is an organizational or administrative activity that will not result in direct or indirect physical changes in the environment. (CEQA Guidelines Section 15378(b)(5).)
NOTICE PROVIDED
All meeting noticing requirements were met.
ATTACHMENTS
Att 1 – Proposed General Fund Reserve Policy
Att 2 – Proposed Capital Investment Reserve Policy
STAFF CONTACT
Karen Huang, Finance Director
[email protected]
(650) 522-7110