City Council
Report
City Council Meeting: April 23, 2024
Agenda Item: 5.A
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To: Mayor and City Council
From: Oscar Santiago, Director, Finance Department, Financial Operations Subject: Present Annual Comprehensive Financial Report (ACFR) for Year Ended June 30, 2023
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, 2023; and
2. Adopt a finding of no significant effect pursuant to Section 15061(b)(3) (Common Sense Exemption) of the California Environmental Quality Act (CEQA) Guidelines.
Summary
In compliance with accounting and financial reporting standards established by the Governmental Accounting Standards Board (GASB), the ACFR communicates the City’s financial condition and activity in a transparent and organized manner. The report, included as Attachment A, presents historical and comparative information that can be useful to City staff and elected officials, external users such as debt rating agencies, businesses, other public agencies, bondholders, and City residents. A hard copy of the ACFR for the fiscal year ended June 30, 2023 (FY 2022-23) 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#/ 2 of 15
The ACFR 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 before it is submitted to the full City Council for receipt and filing. This audit was performed in compliance with City Charter requirements. The independent auditors’ unmodified report, included within the ACFR, communicates that the ACFR, and audited information within, fairly present the City’s financial position for FY 2022-23.
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 39 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) noted no instances of non-compliance. An additional submittal letter from LSL (Attachment C) stated 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 2022-23.
FY 2022-23 year saw sustained economic recovery that continues, but challenges persist.
• While General Fund revenues grew, they were below the levels they would have been had the economy not been disrupted by the pandemic. • One-time federal funding in response to economic losses was discontinued. • The City experienced cost increases coming from the highest levels of inflation in forty years, supply chain issues, other 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. 3 of 15
• The City continued to operate at 88% of previous staffing levels (excluding vacancies) and when vacancies occurred they were difficult to fill due to labor shortages.
• Since March 2020, the City entered into a series of settlement agreements totaling $229.8 million in suits related to a former employee and the City has received additional claims which are being evaluated.
The Statement of Net Position, similar to a balance sheet, reported 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 $1,450.8 million at June 30, 2023, compared to $1,487.8 million at June 30, 2022 as restated, which is a decrease of $37.0 million or 2.5%. The net position for business-type activities, such as water and transit services, increased $7.1 million and the net position for governmental activities, such as public safety and community services, decreased $44.1 million.
The General Fund fund balance decreased by $63.5 million, to $146.4 million over the prior year, primarily due to a $122.5 legal settlement offset by transfers in from other funds.
The City’s three pension plans were approximately 78% funded with a combined unfunded long-term actuarial liability of approximately $497 million. All pension figures presented in the ACFR were based on California Public Employees’ Retirement System (CalPERS) GASB 68 valuations that had a measurement date of June 30, 2022. 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.
Staff presented the ACFR to the Audit Subcommittee of the City Council on February 20, 2024 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 4 of 15
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.
Background
As required by the City Charter, financial statements were prepared by the City and audited by independent auditors. The City selected 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 up to an additional three years. LSL was 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 2022-23 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 noted 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 established 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 City of Santa Monica has received an unqualified/unmodified audit report and the GFOA Award for 39 years, since the City first participated in the GFOA program in FY 1983-84.
City staff met with Audit Subcommittee Chair Marc Verville and Audit Subcommittee Member Jeff Bush on February 15, 2024, to discuss the results of the audit and answered questions on the audited financial statements.
The ACFR was presented to the Audit Subcommittee of the Council on February 20, 2024 by staff and Ryan Domino, 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:
• Overall financial results of the City.
• Auditors’ evaluation of the City’s financial reporting and related systems of internal control.
• Development of a Popular Annual Financial Report, where information from the ACFR would be summarized in a short form document.
• Pensions, particularly the unfunded liability and future contributions and their impact on the budget.
• Contingent liabilities possibly arising from existing claims against the City. 6 of 15
• Disclosures included in the Notes to the Basic Financial Statements called “Notes Receivables” including a sample disclosure.
The Audit Subcommittee made a motion to recommend to staff and Council that next year’s ACFR include additional loan disclosures in the Notes Receivable note, including amount and activity by borrower for both non-forgivable and forgiven at maturity, to increase transparency. Based on recommendation from the Audit Subcommittee, staff will include this additional level of disclosure in next year’s ACFR, subject to availability of data and adherence to related laws and regulations. The Audit Subcommittee received and filed the ACFR with a 5-0 vote.
The City’s ACFR included 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 included 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) – provided an analytical overview of the City’s financial status and results for the year • Basic Financial Statements – reported 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 on the Balance Sheet and Statement of Revenues, Expenditures and Changes in Fund Balance
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o Notes to the Financial Statements (Notes) – a narrative explanation that accompanied 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) • 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 showed that City finances were 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 $146.4 million as of June 30, 2023. This balance is comprised of the following categories:
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• $6.7 million nonspendable fund balance included amounts that are not in spendable form, such as prepaid items and advances to other funds; • $8.6 million restricted fund balance is required for specific purposes as stipulated by either external resource providers or enabling legislation, including $6.5 million for bond funded projects;
• There is no committed fund balance, which represented amounts designated for a specific purpose by formal action from City Council;
• $85.9 million assigned funds were 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 continued to recover over the next five years; and
• $45.2 million in unassigned funds as follows:
o $52.2 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 increased to 13% in FY 2022-23. FY 2023-24 revenues are being set aside to allow the contingency level to increase to 13.5% at June 30, 2024, with the commitment to increase it by 0.5% each fiscal year until it reaches 15.0% at June 30, 2027);
o ($12.0) 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 an emergency or a devastating downturn. Strong reserves contributed to a AAA general obligation bond rating, which allowed 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 because 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 -- 9 of 15
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 2023. There were no changes to any bond ratings during FY 2022-23.
Citywide Net Position
The Statement of Net Position, similar to a balance sheet, reported total assets and liabilities of the City as of June 30, 2023. The total net position of the City for all activities was $1.5 billion. Net position was broken out into three categories: capital, restricted, and unrestricted.
Net Investment in Capital Assets - $1,147.9 million
Net Investment in Capital Assets included land, buildings, improvements, intangibles, infrastructure and utility systems, and construction in progress net of accumulated depreciation/amortization and related debt. Intangible assets represented 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, 2023 included City Yards Modernization and numerous Sustainable Water Master plan infrastructure projects to help the City achieve water self-sufficiency.
Restricted Net Position - $258.4 million
These assets were subject to agreements with creditors, developers, grantors, or laws or regulations of other governments. Approximately $145 million or 56% is restricted for community development, which included affordable housing and commitments to various other projects. Approximately $40 million or 15% is restricted for transportation, which included federal, state and other grant funds. The remaining amount was restricted for the Cemetery’s trust fund, debt service, development agreement terms, and other grant and legislative constraints.
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Unrestricted Net Position – $44.5 million
This represented the balance of net position that is neither part of capital assets nor restricted. Capital and operating reserves of $111.9 million in the business-type activities demonstrated increased revenues as the City recovers from the COVID-19 pandemic and an increase in the pension liability due to CalPERS negative 6.1% return on plan assets. Governmental activities reported a negative unrestricted net position of $67.4 million, primarily due to the cumulative shortfalls from the pandemic and settlement payments made in the past few years plus an increase in the pension liability. 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 continued to rebuild the City’s unrestricted net position balance.
The Citywide Net Position utilized 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 utilized the modified accrual basis of accounting, which recognized 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, did 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 $326.6 million, a $4.8 million decrease from the prior year.
This decrease was primarily due to draws on the City’s water loan offset by a prearranged $4 million forgiveness of the water loan.
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More information on Long-Term Debt can be found in Note 10, page 51 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 $496.7 million as of June 30, 2023, an increase of $265.8 million from the $230.9 million as of June 30, 2022 as a result of the negative 6.1% return on pension plan assets.
Total net pension liability, or unfunded liability, was based on projected future benefit payments attributed to the current and past employees’ service, less the assets accumulated to pay those liabilities. This was the difference between a total pension liability of approximately $2.2 billion and current plan assets of approximately $1.7 billion, making the City’s three pension plans approximately 78% funded overall. The City’s annual required contributions included a portion to fund currently earned benefits as well as an amount to pay down the unfunded liability.
CalPERS calculated the annual contributions to amortize the unfunded liability. 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 reduce the amortization period thus lowering interest costs over time. In FY 2018-19, the City Manager convened a pension advisory committee consisting of residents and employees. An information item dated April 19, 2019, contained a discussion of the history of the unfunded liability and different methods of management such as utilizing a supplemental trust fund and issuing pension obligation bonds. Included was the advisory committee’s recommendation of making additional payments that would amortize the unfunded liability over 13 years. The pension policy was updated in 2019 to include this 13-year payment schedule and the first additional payment of $9.3 million was made in October 2019, Due to the economic impact of the pandemic and legal settlements, the 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 April 11, 2023 meeting, the Council voted to suspend any further additional paydowns in order to reprogram the funds to 12 of 15
critical restorations or enhancements while the City continues to operate at a lower service level. The suspension of the paydown policy will be revisited in FY2027-28 and may based on an evaluation of the City’s financial position.
In the meantime, a number of initiatives have mitigated the pressure of this cost driver on the budget.
• 52% 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 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 had 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. Because of the Federal Reserve raising interest rates, the return on the City’s portfolio was in excess of what would have been earned prepaying the amortization of the unfunded liability, the City did not prepay in FY 2023-24.
A detailed explanation of the Employee Benefits Programs including detailed pension information by plan is included in Note 12 (pages 57 through 75) and the Required Supplementary Information (pages 106 through 111). Further information on the City’s 13 of 15
efforts to control pension liability is included in the Letter of Transmittal (pages i through xiv).
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 was 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- 20 or FY 2020-21. ADC contributions to the trust resumed in FY 2021-22 and will continue.
A detailed explanation of OPEB is included in Note 12 (pages 69 through 74) and the Required Supplementary Information (pages 112 through 113).
GASB 96 Subscription Based Information Technology Arrangements With GASB 96, the City recognized a Subscription Based Information Technology Arrangement (SBITA) as an intangible right-to-use subscription asset and a corresponding subscription liability at the commencement of the subscription term. The subscription asset is valued at the present value of the subscription payments expected to be made during the subscription term. The City recognized interest expense on the subscription liability and amortization expense on the subscription asset. These changes were incorporated in the City’s financial statements and had an effect on the beginning 14 of 15
net position of the Water, Wastewater, Fleet, Self-insurance general liability, Selfinsurance bus and Self-insurance workers compensation funds. The total impact of the implementation on the Statement of Net Assets was less than $1 million.
Pending Litigation
The City was 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 had entered into settlement agreements totaling $229.8 million with claimants in suits filed against the City. The City is evaluating additional claims pending based on similar allegations of 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’ request for costs and attorneys’ fees remains pending further litigation in the Los Angeles Superior Court.
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 which was repaid to the Airport subsequent to year end.
More information pertaining to pending litigation is included in Note 16, page 83 of the ACFR.
Cash and Investments
The ACFR also included detailed information on the City’s cash and investments. As of June 30, 2023, the City had $753 million in total cash and investments, all of which were in the form of investments authorized by the California Government Code and the City’s investment policy or in compliance with bond indenture agreements. 15 of 15
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 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: Steve Gomez, Financial Operations Manager
Approved Forwarded to Council
Attachments:
A. Attachment A - Annual Comprehensive Financial Report B. Attachment B - Independent Auditors’ Report on Internal Control Over Financial Reporting and on Compliance with Other Matters Based on an Audit of Financial Statements
C. Attachment C - Auditors’ Communication Letter to Council D. Notes Receivable Sample Disclosure