City Council
Report
City Council Meeting: April 11, 2023
Agenda Item: 5.C
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To: Mayor and City Council
From: Gigi Decavalles-Hughes, Director, Finance Department, Financial Operations Subject: Presentation of the Annual Comprehensive Financial Report (ACFR) to the Audit Subcommittee
Recommended Action
Staff recommends that the City Council:
1. 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 and 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, 2022; and
2. Consider a request by the Audit Subcommittee to instruct staff to increase the amount of disclosure related to Notes Receivables to include the gross amount of loans and amount of allowances, as well as a summary of the accounting principles driving the loan allowances, for inclusion in the ACFR for the fiscal year ending June 30, 2023.
3. Adopt a finding of no significant effect pursuant to Section 15061(b)(3) (Common Sense Exemption) of the California Environmental Quality Act (CEQA) Guidelines
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Summary
The (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, included as Attachment A, presents historical and comparative information that can be useful to City staff and elected officials, to external users such as debt rating agencies, businesses, other public agencies, bondholders, and to the City’s residents.
A hard copy of the ACFR for the fiscal year ended June 30, 2022 (FY 2021-22) is available at the City Clerk’s office and is also available, along with ACFRs dating back to 2005, on the City’s website at: https://finance.smgov.net/budgets-reports/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 City Council for receipt and filing. This audit is performed in compliance with City Charter requirements. The independent auditor’s unmodified report, included within the ACFR, communicates that the ACFR, and audited information within, fairly present the City’s financial position for FY 2021-22. 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 38 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.
LSL’s report on the City’s internal control over financial reporting and compliance (Attachment B) notes no instances of non-compliance. An additional submittal letter from LSL (Attachment C) 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 2021-22.
This year saw sustained economic recovery that continues, but challenges persist. 3 of 17
• While General Fund revenues are growing, they are below the levels they would have been had the economy not been disrupted by the pandemic. • One-time federal funding in response to the economic losses is discontinued. • The City is experiencing significant cost increases coming from high levels of inflation, supply chain issues, the market disruptions occurring as a result of the continuing war in Ukraine, and staff compensation increases after two years marked by pay reductions or no cost-of-living increases. • The City continues to operate at 88% of previous staffing levels (excluding vacancies) and when vacancies occur they are difficult to fill due to labor shortages.
• Since March 2020, the City entered into settlement agreements totaling $107.3 million with 104 claimants in suits filed against the City and Santa Monica Police Activities League (SM-PAL) related to a former employee and the City has an estimated 130 additional claims pending based on similar allegations of abuse by the same former employee.
This year’s ACFR was delayed because of reductions to the Financial Reporting staff, obligations to comply with complex emergency financial operations cost tracking requirements, and the addition of the new GASB Statement No. 87 “Leases” this year.
The provisions of GASB 87 include complex accounting and reporting, requiring a detailed review of each lease managed by the City, a labor-intensive process as the City is lessor on hundreds of leases.
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The Statement of Net Position, similar to a balance sheet, reports total assets and total deferred outflows of resources plus total liabilities and total deferred inflows of resources of the City. The total net position of the City for all activities was $1,505.2 million at June 30, 2022, compared to $1,394.2 million at June 30, 2021 as restated, which is an increase of $111.0 million or 8.0%. The net position for business-type activities, such as water and transit services, increased $36.8 million and the net position for governmental activities, such as public safety and community services, increased $74.1 million.
The General Fund fund balance increased by $28.7 million, to $209.9 million over the prior year, primarily due to an increase in revenues as the City began to recover from the COVID-19 pandemic. Sales and use tax revenue increased as businesses reopened after pandemic related closures, transient occupancy tax revenue increased as hotels reopened and domestic travel increased, and parking revenues began to rebound.
The City’s three pension plans are approximately 89% funded with a combined unfunded long-term actuarial liability of approximately $231 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, 2021.
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. It should be noted that the CalPERS portfolio posted a loss of 6.1% for the year ending June 30, 2022, so the unfunded actuarial liability will report an increase in the FY 2022-23 ACFR.
Following Council direction on February 28, 2017, staff presented the ACFR to the Audit Subcommittee of the City Council on March 22, 2023 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 staff and the independent auditors, and an opportunity for Subcommittee members to ask questions of the auditors and staff. 5 of 17
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 July 14, 2020, Council approved a modification to the LSL external auditing services contract to extend services for an additional three years. LSL is in their seventh 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 GFOA, 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.
Discussion
The ACFR for FY 2021-22 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.
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The Statement on Auditing Standards (SAS) 114 (Attachment B) establishes standards for the auditors’ communication with those charged with governance. SAS 115 (Attachment C) 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 City of Santa Monica has received an unqualified/unmodified audit report and the GFOA Award for 38 years, since the City first participated in the GFOA program in FY 1983-84.
Engagement partner Ryan Domino from LSL communicated via Teams with Audit Subcommittee Chair Elizabeth VanDenburgh and Audit Subcommittee Vice Chair Marc Verville on March 13, 2023 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 22, 2023 by City staff and the engagement partner from LSL. Audit Subcommittee members were given the opportunity to review the report and ask questions of the external auditor and staff.
Topics discussed included:
• The process of restating prior years’ financials, including the number of years restated, when a new GASB statement is implemented
• Reasons for, and recommendations that could be included in, a management letter from an external auditor
• How often the auditors come on site as part of the audit • Reasons for Enterprise Funds to be accounted for separately when they are not “self-supporting” through fees
• Disclosures included in the Notes to the Basic Financial Statements called “Notes Receivables”, including:
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o if there is an expectation that the loans will be paid back to the City, o situations where doubtful accounts are recorded,
o what amount is recorded as an asset, and
o a desire to have more transparency on loans issued by the City, including gross loan amounts and identifying loans that are fully or partially written off, and a list of the borrowers.
The Audit Subcommittee made a motion to Council to recommend that next year’s ACFR include the following additional disclosures in the Notes Receivable note to increase transparency:
• gross amount of loans, including those that were fully or partially allowed • gross amount of allowances
• summary of accounting principles driving the loan allowances • list of borrowers
If Council instructs staff to include this additional level of disclosure, staff intends to expand the note disclosure in next year’s ACFR, subject to availability of data, adherence to related laws and regulations, and availability of resources necessary to make this change. The Audit Subcommittee received and filed the ACFR with a 5-0 vote.
The City’s ACFR includes the following major sections and information:
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.
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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
• Pension Information – schedule of changes in the net pension liability and related ratios; schedule of contributions by plan
• 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) 9 of 17
• Financial Trends
• Tax Revenue Information
• Debt Capacity Information
• Demographic and Economic Information
• Operating Information
The following is an explanation of some key indicators reported in the ACFR. Overall, the City’s ACFR shows that City finances are stable.
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 $209.9 million as of June 30, 2022. This balance is comprised of a number of categories, as follows:
• $6.6 million nonspendable fund balance includes amounts that are not in spendable form, such as prepaid items and advances to other funds; • $20.3 million restricted fund balance is required for specific purposes as stipulated by either external resource providers or enabling legislation, including $17.6 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;
• $143.2 million assigned funds are set aside to cover continuing capital improvement projects; prior year reappropriations; compensated absences; respond to contingent liabilities and other unanticipated costs; and to provide working capital to support essential services, partial service restorations, contractual labor obligations while revenues continue to recover over the next five years; and
• $39.8 million in unassigned funds as follows:
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o $50.0 million rainy day contingency. Historically this has been 15% of the annual expenditure budget; however, the amount was reduced to 12.5% in FY 2019-20 and remains at this level in FY 2021-22. FY 2022-23 revenues are being set aside to allow the contingency level to increase to
13.0% at June 30, 2023, with the commitment to increase it by 0.5% each fiscal year until it reaches 15.0% at June 30, 2027);
o ($10.2) 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 an emergency or a devastating downturn. Strong reserves 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 the global pandemic and have also provided funding for legal settlements. 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.” The City of Santa Monica maintains a “AAA” rating from both Standard and Poor’s and Fitch, and a “Aaa” rating from Moody’s, which were reaffirmed in June 2022. There were no changes to any bond ratings during FY 2021-22.
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, 2022. The total net position of the City for all activities was $1.5 billion. Net position is broken out into three categories: capital, restricted, and unrestricted.
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Net Investment in Capital Assets - $1,153.3 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, 2022 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 - $262.1 million
These assets are subject to agreements with creditors, developers, grantors, or laws or regulations of other governments. Approximately $164 million or 66% is restricted for community development, which includes affordable housing and commitments to various other projects. Approximately $37 million or 15% is restricted for transportation, which includes federal, state and other grant funds. 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 – $89.8 million
This represents the balance of net position that is neither part of capital assets nor restricted. Capital and operating reserves of $108.6 million in the business-type activities demonstrate increased revenues as the City recovers from the COVID-19 pandemic and a decrease in the pension liability due to CalPERS 21.3% return on plan assets. Governmental activities reported a negative unrestricted net position of $18.8 million, primarily due to the cumulative shortfalls from the pandemic and settlement payments made in the past few years. The City already managed its financial challenges by reducing its workforce, focusing on essential services, scaling back or eliminating capital projects, and increasing employees’ cost sharing of benefits. These strategies, recovering revenues, one-time state and Federal government subsidies and lowered expenses continue to rebuild the City’s unrestricted net position balance. 12 of 17
The Citywide Net Position utilizes the full accrual basis of accounting, requiring the City to report the full amount of long-term liabilities, such as pension and bond payments, which will be paid over many fiscal years with future revenues. Governmental fund statements utilize the modified accrual basis of accounting, which recognizes the current portion of long-term debt to be paid by revenues as they are measurable and available. This difference in accounting method can result in a negative net position on the Citywide financial statements, while individual fund statements, such as the General Fund, do not have a negative fund balance.
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 $331.4 million, a $155.4 million increase from the prior year.
This increase was primarily due to $135.3 million in new debt issuance in FY 2021-22.
On August 4, 2021, the Santa Monica Public Financing Authority issued $64.8 million in Santa Monica Public Financing Authority Lease Revenue Bonds (City Yards Modernization project) Series 2021, bearing interest from 2.125% to 5.00% with a final maturity of July 1, 2051. On August 25, 2021, the City issued $70.5 million of City of Santa Monica Water Enterprise Revenue Bonds Series 2021, bearing interest from
2.25% to 5.00% with a final maturity of August 1, 2051.
More information on Long-Term Debt can be found in Note 9, page 55 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 $230.9 million as of June 30, 2022, a decrease of $250.3 million from the $481.2 million as of June 30, 2021 as a result of the greater than expected CalPERS 21.3% return on pension plan assets.
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 13 of 17
accumulated to pay those liabilities. This is the difference between a total pension liability of approximately $2.13 billion and current plan assets of approximately $1.9 billion, making the City’s three pension plans approximately 89% funded overall. 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 a series of paydowns funded from year end savings, Council adopted the first of a set of policies to pay down a portion of the liability each year in addition to the actuarially determined contribution amount in order to lower interest costs over time. The policy was updated in 2019 to include a 13-year payment schedule. In June 2020, Council changed the schedule of the accelerated paydowns per the emergency provisions of the policy, to shift to a 15-year paydown schedule. At its March 11, 2023 meeting, the Council voted to suspend any further additional paydowns in order to reprogram the funds to critical restorations or enhancements while the City continues to operate at a lower service level. The paydown policy will resume once the City is in a stronger financial position.
In the meantime, a number of initiatives are mitigating the pressure of this cost driver on the budget.
• 49% of current employees receive a reduced level of pension benefits.
Employees in all bargaining groups hired after January 1, 2013 receive lower benefits per the Public Employee Pension Reform Act (PEPRA). A lower Tier 2 benefit level was established by Council for non-sworn employees who entered the City between July 1, 2012 and December 31, 2012, or who continue to join the City from previous employment where they were under a non-PEPRA pension plan. 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. In addition to 14 of 17
paying the employee portion of the contribution, Public Safety employee bargaining groups reimburse the City for a portion of the employer 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.
• The City has been prepaying its annual employer contributions to CalPERS since FY 2007-08 and receives a discount. The savings from the discount is used to offset paydowns of the net pension liability.
A detailed explanation of the Employee Benefits Programs including detailed pension information by plan is included in Note 11 (pages 61 through 71) and the Required Supplementary Information (pages 109 through 114). Further information on the City’s efforts to control pension liability is included in the Letter of Transmittal (pages vii through viii).
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 public agency 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 benefits for public safety employees provided by the City’s contract with its healthcare provider CalPERS.
The 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, City Council authorized the suspension of the prefunding contributions to the trust and the City did not make contributions in FY 2019- 15 of 17
20 or FY 2020-21. ADC contributions to the trust resumed in FY 2021-22 and are continuing.
A detailed explanation of OPEB is included in Note 11 (pages 72 through 77) and the Required Supplementary Information (pages 115 through 116).
GASB No. 87 Leases
GASB 87 establishes a single model for lease accounting based on the foundational principle that leases are financings of the right to use an underlying asset. Therefore, a lessee is required to recognize a lease liability and an intangible right-to-use lease asset and a lessor is required to recognize a lease receivable and a deferred inflow of resources. With the implementation of GASB Statement No. 87, the City as a lessor will recognize a lease receivable and a deferred inflow of resources at the commencement of the lease term. The lease receivable is measured at the present value of lease payments expected to be received during the lease term. The deferred inflow of resources is measured at the value of the lease receivable plus any payments received at or before the commencement of the lease term that relate to future periods. The City will recognize interest revenue on the lease receivable and an inflow of resources from the deferred inflows of resources in a systematic and rational manner over the term of the lease. These changes were incorporated in the City’s financial statements and had an effect on the beginning net position or fund balance of the General Fund, Beach Fund, Water Fund, Pier Fund, Airport Fund, and Big Blue Bus Fund.
A detailed explanation of Leases is included in Note 3, page 37 of the ACFR.
Pending Litigation
The City is a party in numerous pending litigations and the outcome of these cases can have a significant impact on the General Fund.
Since March 2020, the City has entered into settlement agreements totaling $107.3 million with 104 claimants in suits filed against the City and SM-PAL alleging abuse.
The City has an estimated 130 additional claims pending based on similar allegations of 16 of 17
abuse by the same former employee. The City continues to work diligently to prevent these liabilities from impacting services and is actively seeking reimbursement from its excess insurance carriers.
In 2017, The Pico Neighborhood Group sued the City of Santa Monica alleging that the City’s at-large method of electing City Council members violates the California Voting Rights Act (CVRA). Plaintiffs’ requests for costs and attorneys’ fees remain pending in the trial court awaiting the final outcome of the Supreme Court proceedings and any subsequent proceedings in the Court of Appeal.
On July 15, 2022 the FAA ruled that all of the previously made loans between the General Fund and the Airport Fund should be voided as inconsistent with federal law and required that the City write off loans and accrued interest in the amount of $5.6 million and repay the Airport $7.4 million of previously made loan payments which the FAA disallowed. The City is currently in negotiations to enter into a payment plan.
More information pertaining to pending litigation is included in Note 15, page 85 of the ACFR.
Cash and Investments
The ACFR also includes detailed information on the City’s cash and investments. As of June 30, 2022, the City had $798 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 2, page 29 of the ACFR.
Environmental Review
The ACFR is exempt from CEQA pursuant to Section 15061(b)(3) of the CEQA Guidelines. The ACFR is covered by the common sense exemption which states that CEQA does not apply, “where it can be seen with certainty that there is no possibility 17 of 17
that the activity in question may have a significant effect on the environment.” Therefore, it can be seen with certainty that actions would not result in adverse physical impacts on the environment, and as such, is exempt from CEQA.
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 Approved Forwarded to Council
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...
C. Auditors’ Communication Letter to Council
D. Written Comments