City Council
Report
City Council Meeting: April 26, 2022
Agenda Item: 3.B
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To: Mayor and City Council
From: Gigi Decavalles-Hughes, Director, Finance Department Subject: Present Annual Comprehensive Financial Report for Year Ended June 30, 2021
Recommended Action
Staff recommends that the City Council receive and file the City’s Annual Comprehensive Financial Report (ACFR), the Auditors’ Letter to Council, and the Independent Auditors’ Report on Internal Control Over Financial Reporting and on Compliance with Other Matters Based on an Audit of Financial Statements Performed in Accordance with Government Auditing Standards for the City’s financial statements for the fiscal year ended June 30, 2021.
Executive Summary
The Annual Comprehensive Financial Report (ACFR) communicates the City’s financial condition and activity in a transparent and organized manner and in compliance with accounting and financial reporting standards established by the Governmental Accounting Standards Board (GASB). The report presents historical and comparative information that can be useful to City staff, elected officials, and external users such as debt rating agencies, businesses, other public agencies, and the City’s residents. The most recent ACFR is available at the City Clerk’s office and ACFRs dating back to 2005 are available on the City’s Finance website at: https://finance.smgov.net/budgetsreports/annual#/.
This document is prepared annually by Finance staff and audited by the City’s independent audit firm, Lance, Soll & Lunghard (LSL), CPAs, and presented to the Audit Subcommittee and the full Council for receipt and filing. The independent auditors’ 2 of 17
unmodified report communicates that the ACFR, and audited information within, fairly present the City’s financial position for the fiscal year ended June 30, 2021. This audit is performed in compliance with City Charter requirements. The City of Santa Monica has received an unmodified audit report for more than three decades and has been awarded the Certificate of Achievement for Excellence in Financial Reporting by the Government Finance Officers Association of the United States and Canada (GFOA) for its ACFR for 37 consecutive years, since it began participating in the program. To make the ACFR more transparent, staff has provided an explanation for key financial performance indicators shown in the report.
An attached report on the City’s internal control over financial reporting and compliance notes no instances of non-compliance. An additional attached submittal letter states that the City’s independent auditors encountered no difficulties and had no disagreements with management during the audit. If the auditors identified any adjustments that management elected not to adjust in the financial statements, they would be noted on the report under Corrected and Uncorrected Misstatements. There were none noted for FY 2020-21.
This year, COVID-19 once again presented unique challenges, including devastating economic losses as a result of the global economic shutdown and worldwide health crisis. The result of the City’s financial challenges and related adjustments in response to the pandemic are detailed throughout the financial statements, schedules and notes included in the ACFR, including a COVID-19 pandemic note detailing key dates and funding received.
Typically, a portion of each audit is performed outside of City facilities, however this year’s entire audit was conducted remotely, with both City staff and external audit staff working off site. Requested files were shared on a secured site and the City’s current web based financial system, Tyler Munis, provided remote access to both the audit team and Finance staff. Financial staff resources shifted to the emergency operations of the City and cuts made to reporting staff resulted in a slight delay in the ACFR’s publication.
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Santa Monica has long relied on conservative fiscal assumptions to plan for the future, with two-year operating budgets and five-year financial forecasts and capital plans and continuous review and refinement of fiscal policies and processes. This careful planning allowed the City to quickly reposition itself in response to the COVID-19 pandemic.
Beginning in mid-March 2020, with the initial State and County Stay at Home Orders, the public health emergency changed how, and whether, the City could operate programs and facilities. These Health Officer orders resulted in protracted closures and contractions in services, and the financial impact of these previous restrictions continues to result in reduced services today. The COVID-19 pandemic ravaged most of the City’s revenue streams, with the majority of the impact in the City’s General Fund, the fund making up two-thirds of the City’s overall budget and supporting public safety, libraries, streets, recreation, and funding to the School District. Cities like Santa Monica, with strong tourism, retail and entertainment amenities, were hit the hardest. Santa Monica’s economy has been and will continue to be significantly impacted by the COVID-19 pandemic.
The FY 2020-21 Adopted Budget reflected dramatically restructured and reduced operations to meet the public health and fiscal challenges. In addition, $117 million in funding from deferred or reduced capital projects, economic uncertainty, contingency and other reserves, was appropriated or set aside to balance the budget. Council also authorized staff to temporarily suspend or defer discretionary transfers to the Housing Trust Fund for affordable housing uses per a November 2016 voter-approved advisory measure, and the allocation of resources to address the City’s unfunded pension and other post-employment benefit liabilities. These measures enabled the City to maintain essential and emergency operations during the pandemic while preserving the City’s financial resilience to the greatest extent possible. The receipt of American Rescue Plan Act (ARPA) funding also contributed to maintaining City operations. These funds, signed into law by President Biden in March 2021, provided $350 billion in direct aid to state and local government through the Coronavirus Local Fiscal Recovery Fund (CLFRF). The City received $14.285 million of its $28.57 million allocation in May 2021; the remaining $14.285 million will be received in May 2022. The funds were used under 4 of 17
the provision of lost revenue to provide government services. While this funding is welcome, it is disproportionate to the City’s revenue losses when compared to most other cities and states.
The Statement of Net Position, similar to a balance sheet, reports total assets and liabilities of the City. The total net position of the City for all activities was $1,386.1 million at June 30, 2021, compared to $1,520.1 million at June 30, 2020 as restated, which is a decrease of $134.0 million or 8.8%. The net position for business-type activities decreased $67.1 million and the net position for governmental activities decreased $66.9 million.
In comparison to FY 2019-20, the ending General Fund balance for FY 2020-21 decreased by $44.0 million, to $180.9 million, primarily due to the decrease in revenues as a result of the global COVID-19 pandemic. As noted above, the City’s strong retail and hospitality sector was particularly hard hit, resulting in significant declines in Transient Occupancy and Sales Taxes and in parking-related revenue. Capital spending on projects such as the City Yards Modernization project also contributed to the lower fund balance. However, the City issued lease revenue bonds in FY 2021-22 netting $70.0 million to fund the City Yards Modernization project, including a portion that will reimburse the General Fund for capital expenses already incurred. Lastly, the General Fund transferred funds to the General Liability Self-Insurance Fund to fund a large settlement.
The City’s three pension plans are approximately 77% funded with a combined unfunded long-term actuarial liability of approximately $481 million. All pension figures presented in the ACFR are based on California Public Employees’ Retirement System (CalPERS) GASB 68 valuations that have a measurement date of June 30, 2020.
These valuations are used for financial reporting purposes only and are separate from the CalPERS funding valuations that are used to determine the City’s annual contribution requirements.
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Council established an Audit Subcommittee in 2015 to oversee the work of the City’s auditors and on February 28, 2017, Council directed staff to present the ACFR to the Audit Subcommittee of the City Council for a detailed review before presenting the report to the Council as a Consent Calendar item. The Subcommittee has received the annual ACFR report which included details of the audit process and the financial reports, a presentation by the independent auditors, and an opportunity for Subcommittee members to ask questions of the auditors and staff.
Background
As required by the City Charter, financial statements are prepared by the City and audited by independent auditors. The City selects its independent auditor through a competitive procurement process that includes members of the Audit Subcommittee as proposal reviewers. The original contract length was for five years. On February 16, 2020, the Audit Subcommittee directed staff to execute a modification of the LSL external auditing services contract to extend services for an additional three years and requested that a new engagement partner be assigned to the City, as recommended by best practice. LSL is in their sixth year auditing the City.
The quality of the City’s financial reporting and the ACFR are measured in two ways: (1) an unmodified audit report by the independent auditors; and (2) the Certificate of Achievement for Excellence in Financial Reporting, awarded by the Government Finance Officers Association of the United States and Canada (GFOA). The attainment of the latter is the highest form of recognition in governmental accounting and financial reporting.
Auditors follow audit industry standards established by the American Institute of Certified Public Accountants (AICPA). These standards require auditors to provide an opinion on specific areas of the City’s financial statements based on observations, inquiries, testing of transactions, and analysis.
The City’s ACFR includes the following major sections and information:
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Introductory Section
• Letter of Transmittal – prepared by management and used to communicate information on areas that may have an impact on the City’s finances now and in the future. This includes economic factors as well as budget and management factors.
Financial Section (the main body of the ACFR for current year information) • Independent Auditors’ Report – the City’s report card on the content of the ACFR • Management’s Discussion and Analysis (MD&A) – provides an analytical overview of the City’s financial status and results for the year • Basic Financial Statements – reports finances at a point in time (assets - liabilities) and throughout the year (revenues - expenditures), and cash flows o City-Wide Statements – overview of financial information including all of the City’s operations by financial activity
o Fund Financial Statements – a detailed look at funds, reporting the Balance Sheet and Statement of Revenues, Expenditures and Changes in Fund Balance
o Notes to the Financial Statements (Notes) – a narrative explanation that accompanies the Basic Financial Statements
Required Supplementary and Supplementary Information Sections • Budget to Actual Comparisons – for all governmental funds with a legally adopted budget
• Notes to Required Supplementary Information
• Pension Information – schedule of changes in the net pension liability and related ratios; schedule of contributions by plan
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• OPEB Information – schedule of changes in the net Other Post-Employment Benefits (OPEB) liability and related ratios; schedule of contributions • A breakout of individual non-major funds – for funds that were presented in a cumulative manner in the Financial Section
Statistical Section (current and historical information – up to 10 years) • Financial Trends
• Revenue Capacity Information
• Debt Capacity Information
• Demographic and Economic Information
• Operating Information
Discussion
The attached ACFR for FY 2020-21 has received an unmodified opinion by LSL. An unmodified opinion communicates that the financial statements are fairly presented and that the information used in the report is reliable. In their written communications to Council, the auditors note that they encountered no significant difficulties with management in performing or completing the audit.
The Statement on Auditing Standards (SAS) 114 establishes standards for the auditors’ communication with those charged with governance. SAS 115 provides guidance on communicating matters related to the City’s internal controls over financial reporting that have been identified in an audit of the financial statements. These statements require the auditors to consider and report on internal controls, significant audit findings, and other matters as prescribed in the standards as they relate to the audit of the financial statements. The letters that satisfy the SAS requirements are attached to this report. 8 of 17
The City of Santa Monica has received an unqualified/unmodified audit report and the GFOA Award for 37 years, since the City first participated in the GFOA program in FY 1983-84.
Engagement partner Deborah Harper from LSL communicated via email with Mayor / Audit Subcommittee Chair Sue Himmelrich and Audit Subcommittee Vice Chair Elizabeth VanDenburgh on February 24, 2022 to discuss the results of the audit and answer questions on the audit, financials, and related letters without staff present. The ACFR was presented to the Audit Subcommittee of the Council on March 14, 2022 by LSL. Audit Subcommittee members were given the opportunity to review the report and ask questions to the external auditor and staff. Topics discussed included:
• Deficit Citywide in unrestricted net position on the Statement of Net Position • Reasons for and recommendations that could be included in a management letter from an external auditor
• Unfunded pension liability and contributions
• OPEB unfunded liability and contributions
• Guiding Principles to Handle Pension Liability
The Audit Subcommittee received and filed the ACFR with a 5-0 vote.
Overall, the City’s ACFR shows that City finances are stable. The following is an explanation of some key indicators reported in the ACFR.
General Fund Balance
The most notable measure of a City’s financial health is the General Fund balance. As presented in the Basic Financial Statements, the City’s General Fund assets exceeded liabilities by $180.8 million as of June 30, 2021. This balance is comprised of a number of categories, as follows:
• $9.6 million nonspendable fund balance includes amounts that are not in spendable form, such as prepaid items and advances to other funds; 9 of 17
• $11.1 million restricted fund balance is required for specific purposes as stipulated by either external resource providers or enabling legislation, including $8.6 million for bond funded projects;
• There is no committed fund balance, which represents amounts designated for a specific purpose by formal action from City Council and can only be changed or lifted by the City Council taking the same formal action that originally imposed the constraint;
• $114.3 million assigned funds set aside for specific purposes based on budget priorities (i.e., continuing capital improvement projects; prior year reappropriations; and funds set aside to sustain the City’s essential services during the COVID-19 emergency, including a $20 million Shutdown Reserve in the event prolonged closures further impact revenue streams); and • $45.9 million in unassigned funds as follows:
o $46.9 million rainy day contingency (historically this has been 15% of annual operating and revenue-supported capital expenditure budget.
However, it was reduced to 12.5% last year. As the City recovers from the pandemic, the amount will gradually return to 15%);
o ($1.0) million unrealized loss on investments;
The General Fund’s rainy day and economic uncertainty reserves have long been an important safeguard for Santa Monica in the event of a devastating downturn. In the past, this sound financial practice has contributed to a AAA general obligation bond rating, allowing the City to pursue lower cost financing structures. Since March 2020, these reserves and contingency funds have allowed the City to continue essential operations despite the severe revenue dip as a result of the economic crisis caused by 10 of 17
the global pandemic. In March 2021, all three of the United States’ leading credit rating agencies -- Moody’s, S+P, and Fitch Ratings -- affirmed the City of Santa Monica’s AAA credit rating. Fitch cited that the ‘AAA’ credit rating “is driven by the exceptional resilience of the city to periods of economic stress, underpinned by its very high reserves, notwithstanding recent large operating deficits, and a strong expenditure framework.”
Citywide Net Position
The Statement of Net Position, similar to a balance sheet, reports total assets and liabilities of the City as of June 30, 2021. The total net position of the City for all activities was $1.4 billion. Net position is broken out into three categories: capital, restricted, and unrestricted.
Net Investment in Capital Assets - $1,206.9 million
Net Investment in Capital Assets includes land, buildings, improvements, intangibles, infrastructure and utility systems, and construction in progress net of accumulated depreciation/amortization and related debt. Intangible assets represent rights of use for items such as software, water rights and payments for Santa Monica’s cost of improvements to the City of Los Angeles sewage treatment system. Some notable capital projects that were underway as of June 30, 2021 include City Yards Modernization and numerous Sustainable Water Master plan infrastructure projects to help the City achieve water self sufficiency by 2023.
Restricted Net Position - $251.7 million
These assets are subject to agreements with creditors, developers, grantors, or laws or regulations of other governments. Approximately 61% of this amount is restricted for affordable housing and committed to various projects, 21% is restricted per federal, state and other grant regulations, and the remaining amount is restricted for the Cemetery’s trust fund, debt service, development agreement terms, and other grant and legislative constraints.
Unrestricted Net Position – ($72.6) million
This represents the balance of net position that is neither part of capital assets nor restricted. Healthy capital and operating reserves of $71.2 million in the business-type 11 of 17
activities support rate stabilization and recovery strategies for the City’s many activities.
Governmental activities reported a negative unrestricted net position of $143.7 million, primarily due to the economic effects of the COVID-19 pandemic and related revenue loss, legal settlement costs, and an increase in the employee benefit liability. The City has already managed its financial challenges by reorganizing the City’s departments and reducing its workforce, focusing on essential services, scaling back or eliminating capital projects, and increasing employees’ cost sharing of benefits. These strategies, recovering revenues, state and Federal government subsidies and lowered expenses should help rebuild the City’s unrestricted net position balance. Additionally, while the City utilized operating cash to fund the City Yards Modernization Project, subsequent to year end, the City issued lease revenue bonds to fund the project. If the bonds had been issued before year end, the governmental activities unrestricted net position would have increased by $42.6 million, the amount of operating cash used to date.
Long Term Debt
The primary source of long-term debt is in the form of bonds issued by the City. At the end of the current fiscal year, the City’s total long-term debt outstanding (excluding issuance premiums) was $176.0 million, a $14.1 million increase from the previous year.
The City refunded the Santa Monica Public Financing Authority Lease Revenue Bonds Series 2011 A for the Parking Structure 6 project and issued $19.7 million of Lease Revenue Refunding Bonds Series 2021 A&B bearing interest from 0.30% to 4.00%.
This refunding resulted in an economic gain of $4.2 million.
On September 21, 2017, the City entered into a Construction Installment Sale agreement with the State Water Resources Control Board (SWRCB) to fund certain water recycling and conservation projects. The original agreement provided funding in the amount of $56.9 million payable with interest at 1.8% over a period of 30 years. On May 27, 2020, to fund additional eligible projects, the SWRCB and the City modified the agreement to increase the loan amount to $75.9 million. In FY 2020-21, the City drew $22.5 million of the available loan for a cumulative total of $28.1 million as of June 30, 12 of 17
2021. More information on Long Term Debt can be found in Note 9, page 57 of the ACFR.
Pension Liability
As noted in the Statement of Net Position on page 1 of the ACFR, the City’s largest liability is the unfunded actuarial pension liability, which was $481.2 million as of June 30, 2021, an increase of $15.5 million from the $465.7 million as of June 30, 2020.
Total net pension liability, or unfunded liability, is based on projected future benefit payments attributed to the current and past employees’ service, less the assets accumulated to pay those liabilities. This is the difference between a total pension liability of approximately $2.05 billion and current plan assets of approximately $1.57 billion, making the City’s three pension plans approximately 77% funded. The City’s annual required contributions include a portion to fund currently earned benefits as well as an amount to pay down the unfunded liability.
Annual actuarial valuations provide the City with the amount of the contribution that must be paid annually into the plan to ensure that the current unfunded liability is paid off. In 2014, after allocating resources to address the City’s unfunded pension liability from year end savings, Council adopted a policy that provided that when there are sufficient funds, the annual budget would include a minimum set-aside of $1.0 million in the General Fund, and commensurate set-aside amounts in all other funds, to be used to address the City’s unfunded pension liability. Based on the availability of additional funds, staff would annually assess the set-aside of additional CalPERS payments against other unfunded needs and present the Council with a recommendation. This policy has now been replaced by the Principles for Pension Funding policy, as developed by the ad hoc Pension Advisory Committee and adopted by Council in 2019.
This policy, incorporated into the City’s Fiscal Policy, accelerated the paydown of the unfunded liability at the time to 13 years, with an alternative 15-year timeline in case of fiscal emergency. Due to the economic crisis the City is currently experiencing, Council changed the schedule of the accelerated paydowns per the emergency provisions of the 13 of 17
policy, to shift to a 15-year paydown schedule. The next additional discretionary payment is budgeted to be made in FY 2022-23.
The City has enacted a number of initiatives to mitigate the impact of pensions on the City’s budget:
• 49% of current employees receive a reduced level of pension benefits based on those mandated by the Public Employee Pension Reform Act (PEPRA) or the City’s own “Tier 2” levels. Tier 2 was established on July 1, 2012, six months before the enactment of PEPRA, for employees who entered the City during those six months as new Miscellaneous bargaining group (non-sworn) employees.
• Employees in all bargaining groups hired after January 1, 2013 receive lower benefits per PEPRA.
• All employee groups have eliminated the employer paid member contribution (EPMC) benefit and the employee-paid portion of the pension cost is deducted from employees’ paychecks and paid directly to PERS. The City’s Coalition of Miscellaneous Employees (Coalition) eliminated the EPMC benefit in March 2020, and it was anticipated that this change would result in a $35 million decrease in the City’s unfunded pension liability.
• In addition to paying the employee portion of the contribution, Public Safety employee bargaining groups reimburse the City for a portion of the employer cost. Both Police and Fire Classic (non-covered by PEPRA) sworn employees (those hired before PEPRA benefits were established) pay over a quarter of the annual pension contribution cost, while Miscellaneous Classic employees, who have a lower level of benefits and therefore a lower cost contribution, pay approximately 23% of the annual cost.
Since FY 2010-11, the City has made $88.1 million in payments towards unfunded pension liability beyond the actuarially required contribution determined by CalPERS.
Yet another cost-saving measure is the City’s prepayment of its annual employer contributions to CalPERS since FY 2007-08. The City continued this practice in FY 14 of 17
2021-22. Discounts received from such prepayments are used for paydowns of the net pension liability.
Despite the mitigating steps taken by the City, CalPERS has made a number of changes to actuarial assumptions that have increased the City’s pension contribution rates, including, but not limited to:
• Decreasing the discount rate from 7.5% to 7.0%, and most recently to 6.8%; • Shortened the period over which future actuarial gains and losses are amortized from 30 years to 20 years; and
• Removed the phasing of new costs associated with assumption changes, and gains and losses.
These changes mitigate further increases in unfunded liability but have the effect of increasing contributions in the short term. In FY 2020-21, a 21.3% net return on the CalPERS investment portfolio triggered a reduction in the discount rate from 7.0% to
6.8% per CalPERS’ Funding Risk Mitigation Policy. The lower discount rate change, the high returns, and the elimination of the EPMC for miscellaneous employees will be reflected in the FY 2023-24 contribution rates. A detailed explanation of the Employee Benefits Programs including detailed pension information by plan is included in Note 16 (pages 80 through 89) and the Required Supplementary Information (pages 110 through 115).
Other Postemployment Benefits (OPEB)
Employees of the Executive Pay Plan group and management employees of the Rent Control Board are eligible for a City paid post-employment medical insurance benefit if their combined retirement age and years of City service equals or exceeds 70. Under the terms of a MOU between the City and the Coalition, all non-sworn permanent retirees are allowed to continue participating in one of the City’s health plans at the same rate as active employees. As with other MOU’s, this benefit is subject to bargaining between the City and the Coalition. The City also maintains minimum 15 of 17
benefits for public safety employees provided by the City’s contract with its healthcare provider CalPERS.
The City’s annual contribution is based on an actuarially determined contribution (ADC).
Prior to FY 2019-20, the City annually prefunded its OPEB obligations into a 115 trust, CERBT, administered by CalPERS. In response to the global pandemic and the devastating effects on the economy, Council authorized the suspension of the ADC payments to the trust up to June 30, 2023 and the City did not make contributions in FY 2019-20 or FY 2020-21. As a result, the discount rate used by the actuaries to determine the unfunded liability in the FY 2020-21 ACFR is blended and lowered to reflect the 2 years without payment to the trust. Staff has budgeted a resumption of the OPEB prefunding payment in the FY 2021-22 budget and expects to resume ADC payments to the trust. A detailed explanation of OPEB is included in Note 16 (pages 89 through 94) and the Required Supplementary Information (pages 116 through 117).
Pollution Remediation
During FY 2020-21, the City increased its pollution remediation liability estimate for both the Charnock and Olympic Well Field restoration projects to incorporate the most current information available. The remediation liability for the Olympic Well Field increased to reflect a refinement of the remediation process and related operating costs based on updated engineering estimates provided by the City’s consultants that are currently constructing the remediation system, where both the capital and operating costs of the remediation system are now higher than determined in the 2017 pollution remediation evaluation. The remediation liability for the Charnock Well Field increased due to longer periods of remediation than determined in the previous evaluation in 2017.
The City believes it has sufficient funds from the Gillette/Boeing settlement to fund current and future estimated remediation costs. To estimate the potential remediation liability, the City applied an expected cash flow and present value to the anticipated cost of remediation, both construction and operating costs, as required under the remediation agreements and included a 10% contingency for unforeseen costs. 16 of 17
The balance of the pollution remediation liability is $2.0 million in the governmental activities of which $0.3 million is due within one year and $54.7 million in the businesstype activities, of which $20.4 million is due within one year. More information on Pollution Remediation is found in Note 4, page 33 of the ACFR.
Cash and Investments
The ACFR also includes detailed information on the City’s cash and investments. As of June 30, 2021, the City had $694 million in total cash and investments, all of which are in the form of investments authorized by the California Government Code and the City’s investment policy or in compliance with bond indenture agreements. More information on cash and investments is found in Note 5, page 35 of the ACFR.
Financial Impacts and Budget Actions
There is no immediate financial impact or budget action necessary as a result of the recommended action to receive and file this annual report.
Prepared By: Stephanie Manglaras, Financial Operations Manager Attachments:
A. Annual Comprehensive Financial Report
B. Independent Auditors’ Report on Internal Control Over Financial Reporting and on Compliance with Other Matters Based on an Audit of Financial Statements Performed in Accordance with Government Auditing Standards C. Auditors’ Letter to Council
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Prepared By: Gigi Decavalles-Hughes, Director
Approved Forwarded to Council
Attachments:
A. Annual Comprehensive Financial Report
B. Attachment B Independent Auditors' Report on Internal Control C. Attachment C City of Santa Monica Audit Communication Letter