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HomeMy WebLinkAboutAppendix D - ReservesWorking together to serve, build community and enhance quality of life. Appendix D Reserves Reserves Council’s Reserve Policy directs that eleven measurement criteria be analyzed prior to the start of each budget cycle to determine the appropriate level of General Fund reserves for the City at that time. These measurement criteria are: 1. State of the Economy 2. The level of diversity in General Fund revenues 3. The stability of the revenue base 4. Potential actions of State and Federal agencies 5. Cash flow needs 6. Costs of potential natural disasters and emergencies 7. Asset replacement requirements 8. The consistency desired in service levels 9. Available opportunities 10. Needs of future commitments 11. Interest income earned on reserves Measurement #1 – State of the Economy In the City’s reserve strategy, the largest driver of what should be done with reserves is the state of the economy. If the City is in an economic boom, then some reserves should be put away for a rainy day. If the City is in a severe recession, then some of the reserves should be used to stabilize services and the organization. If the City is in a period of recovery, then some reserves may still be needed to stabilize services, but we need to be looking to the future to ensure that reserves will last. If the City is in a stable period of flat growth, then we should neither add to, nor use reserves. Our simple reserve strategy graph tells us what action we should take. So the question becomes, where are we on the graph? Is the economy booming, busting, recovering or somewhere in between? The State Legislative Analyst’s Office’s (LAO’s) 2025/26 California Fiscal Outlook indicates that earnings of high-income Californians have surged in recent months, driven by increases in the stock market. This source of Personal Income Tax revenue to the state is very volatile and the sustainability of the recent surge is questionable without improvements to the state’s overall economy. The LAO projects that while revenues currently exceed budget expectations, the higher revenues will be offset with higher-than- expected costs. At the current levels of programs and commitments, the LAO projects the State will face a $2 billion budget shortfall in 2025/26. Financial Strategy Years D o l l a r s Expenses Revenues X The Beacon Outlook California Winter 2025 projects that while the LAO might currently project a budget shortfall of $2 billion in 2025/26, starting in 2026/27 the State’s annual deficits are projected to balloon to between $20 billion and $30 billion, highlighting the risk of California’s heavy reliance on tech wealth and high-income taxpayers. While the State’s current budget may appear stable, it is heavily based on volatile revenue sources. Beacon Economics’ Winter 2025 The Beacon Outlook United States projects that the national economy will continue its positive trajectory for the short-term. The report indicates that U.S. household incomes have risen faster than inflation over the last five years, household debt-to-income ratios are falling, savings rates as stable, and household net worth is at a record high. Additionally, the report notes that while income inequality is still high, it is lower today than it was a decade ago. Because consumer spending accounts for such a large percentage (70%) of U.S. output, the nationwide economy does well when the American household does well, despite interest rate increases. Consumer demand is expected to remain strong and the national economic expansion will continue in the short-term. The Beacon Report further projects that the real economic concerns are the Federal deficit and high asset prices, both of which cannot continue at current growth levels and at some point, will revert to more sustainable levels. The Report indicates that the new administration will likely amplify the current growth trends in the short run which may have the effect of an even more severe correction to sustainable levels. The Central Coast Economic Forecast from November 2024 projects that in addition to the Federal deficit and high asset prices, lack of labor and housing supply will challenge the health of future economic growth. The UCLA Anderson Forecast from October 2024 predicted the State will continue to experience sub-par growth through 2024 but estimate that California will once again outpace the nation’s economic growth in 2025 and 2026. The forecast analyzed the state labor market, as well as trends in California’s logistics industry, film and television production, and the housing market. The Conference Board’s US Outlook in January 2025 projects growth in 2025 of 2.3%, and projects that inflation will normalize by mid-2026. The bottom line is that while economist may vary somewhat in their predictions, the overall trend seems to be toward a somewhat bland 2025 with slow a upward trend starting in 2026 and forward. However, concerns continue to linger regarding a number of issues:  What will happen if the Federal deficit continues to expand at its current rate?  How will changes to inflation impact consumer confidence?  Will the Federal Reserve make additional adjustments?  What changes are in store due to the results of the 2024 elections and which policies are expected to impact the economy?  What impact will global unrest have on the economy?  Will the high cost and limited supply of housing be a deterrent to labor force growth and limit business development?  Will local businesses be able to sustain their customers in light of increases in minimum wage and the relatively low unemployment rate, especially in the entry- level jobs sector?  How will the recent natural disasters and weather events impact the statewide economy? These issues that may influence the economy are all important points to watch and consider as the City moves into the new budget cycle. Measurement #2 – Level of Diversity in General Fund Revenue One measurement to quantify an appropriate level of reserves concerns how broad a range of General Fund revenues the City receives and what the future holds for such revenue. Some cities have a very broad range of General Fund revenues not associated with fees. For example, Pismo Beach and Morro Bay enjoy a large amount of transient occupancy taxes (hotel tax) and Paso Robles and San Luis Obispo have large amounts of sales tax revenue. This table shows General Fund revenue by type for Atascadero as compared to other cities in the county: Cities with fewer sources of General Fund revenue will require a greater amount in reserves in order to successfully weather a downturn in one revenue area. This is true for the City of Atascadero. Property tax revenue accounted for 35% of General Fund revenues in fiscal year 2023/24, with sales tax (excluding Measure F-14) accounting for 32%, and TOT accounting for 6%. These three revenues sources alone account for 73% of the City’s General Fund revenues. In the graph above, you can compare this to the revenue base of other cities which have different make-ups. 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% General Fund Revenue by Type San Luis Obispo County Cities (Adopted Budget FY24-25) Other Revenue Utility users tax Franchise Fees TOT Sales tax Property Taxes One reserve methodology dictates that reserve levels should be tied to the broadness of General Fund tax revenues sources. The greater number of revenue sources require fewer layers of reserves. Conversely, the fewer number of revenue sources require higher levels of reserves. As Atascadero’s property tax and sales tax revenues comprise two large components of the City’s General Fund revenues, the City is defined as having a narrow base of revenue-just two significant categories. Measurement #3 – Stability of Revenue Base General Fund revenues for fiscal year 2023/24 were $35.4 million (excluding Measure F- 14 revenue). To examine the tax base more closely, it is helpful to break it down. Property tax usually comprises about 35% of the revenues, sales tax typically about 30%-35%, TOT is generally about 6%, development revenues usually are about 5%, and a variety of other items make up the remainder. Property tax is considered to be one of the more stable sources of revenue. Historically the property tax revenues have two components: (1) a stable base that does not vary drastically from year to year and (2) a housing market expansion and correction component. While there is a stable underlying base, this revenue does vary with the strength of the housing market. The table below shows property tax per capita on a constant dollar basis. The constant dollar smooths out changes for normal inflation so that we can see if we are better off than we were in 1987 or worse. In California in the late 80’s/early 90’s and then again in the mid-2000’s, the housing market did not follow normal inflation. Housing prices and new construction boomed, causing spikes in the property tax revenue base, followed by a smoothing or flat period. Overall the smooth or flat period of revenue is the stable portion of the revenue base and is what the City can count on year after year. The spikes are periods of boom where there are opportunities for the City to sock away reserves and address one-time fixes. It is reasonable to assume that we are now again in the gentle growth period where the entire property tax base is considered very stable. There remains some question $- $20.00 $40.00 $60.00 $80.00 $100.00 $120.00 Property Tax per Capita (Constant $) regarding the interest rates and limited supply of housing. However, Atascadero’s weather and community is very desirable for buyers and demand for residential properties in the Central Coast as a whole appears to remain strong. Atascadero has some significant commercial projects currently in progress and continues to see robust private investment in economic development. It is also interesting to compare Atascadero’s property tax per capita with other cities in the county. The chart to the right shows that our community has the lowest per capita property tax in the county according to fiscal year 2024/25 budgeted figures. It is true that in this county, each city has its own unique characteristics which often make it hard to do comparisons. Even with that in mind, however, this chart does make one thing painfully clear. Atascadero has less money per person to spend on essential functions such as public safety and parks that are critical to citizens of the community. In other words, the relative strength of our dollars per capita is not as good as that of our neighbors. Sales tax is much more susceptible than property tax to fluctuations in the economy. During fiscal year 2023/24, 32% of General Fund revenues came from sales. A majority of the City’s sales tax comes from fuel, the County pools, and the building industry, all which can fluctuate quite rapidly with changes in the economy. The following chart depicts sales tax per capita, constant dollar, over the last 35 years. Like property tax, it too shows evidence of the ebbs and flows of the market, but to a greater extent. Atascadero started experiencing an increase in this revenue after a new retailer came on line in fiscal year 2000/01, but then a sharp decrease with the loss of two new car dealerships. The good news is that Measure D-20 is making a big impact as the graph below shows starting in fiscal year 2021/22. $- $20.00 $40.00 $60.00 $80.00 $100.00 $120.00 $140.00 Sales Tax per Capita (Constant $) $449.17 $493.45 $476.64 $565.21 $482.59 $911.19 $465.29 $- $100.00 $200.00 $300.00 $400.00 $500.00 $600.00 $700.00 $800.00 $900.00 $1,000.00 2024-2025 Property Tax per Capita by City Adopted Budget FY2024-25 Measurement #4 – Potential Actions of Federal and State Agencies or Public Policy As a subdivision of the State, the City is vulnerable changes in State legislation and regulation that can shift local revenue to the State or shift unfunded costs to the City. Unfunded mandates are becoming more typical and apply to regulations concerning water, storm water, housing, homelessness, pollution, employment, reporting/transparency, and law enforcement, just to name a few. Affordable housing legislation removes aspects of local control for cities statewide, and impacts the City’s decisions for economic development and policy. Another example, the Surplus Land Act, requires that all local agencies offer surplus land for affordable home developers first before selling the land to any others. After suffering from prior acts of State legislation hurting cities, Proposition 1A was approved by California voters in 2004. Proposition 1A is an amendment to the state constitution intended to restore predictability and stability to local government budgets by strengthening prohibitions against unfunded state mandates and state take-aways of city funds. This legislation certainly made strides to protect local funding, however, the State continues to search for ways to balance the State budget on the back of the cities. The Legislative Analyst’s Office (LAO) projects the State will see a “balanced budget” in 2025/26, with only a $2 billion deficit. That number assumes no new spending commitments and that Personal Income Tax, one of the State’s three largest sources of income, comes in at its currently overinflated level. Future State deficits are being projected between $20 billion and $30 billion, annually. With the State budget in projected deficit position, the City’s financial well-being continues to be vulnerable to political action. Measurement #5 – Cash Flows Needs The cash flow needs of the City have a direct bearing on the amount of reserves needed. Unlike many private organizations and businesses with a steady cash stream, the City receives large portions of its annual revenues in chunks, twice a year. The fiscal year begins in July and ends in June. During the summer months, the City incurs more expenses for fire reserves, recreation programs, and capital projects than during other months of the year. However, the City does not receive its first fiscal year injection of property tax until late December, and then waits to receive the rest in late April. In other words, the City’s general fund receipts go down from April through November while the City’s disbursements go up during the same period. 0 10,000,000 20,000,000 30,000,000 General Fund Cash Flow Five Years 2019-2020 2020-2021 2021-2022 2022-2023 2023-2024 At the current rate of continued use of General Fund reserves, the General Fund is not anywhere near having a negative cash balance. However, in the event the economy has another severe and prolonged downturn that further depletes the General Fund reserves, the City does have a couple of fairly simple options at its disposal. 1. The City overall does NOT have a cash flow issue. The citywide cash and investments balance on hand at June 30, 2024 was about $64.5 million and the lowest cash balance in the last five years was $41.7 million. The City’s General Fund can borrow funds from other available funds within the City. The City has almost 40 funds in total. Some funds, such as the internal service funds, are not restricted at all and may be loaned or transferred back to the General Fund at Council’s direction. Other funds may have legal restrictions on how they can be spent. The restricted funds, however, may be loaned to other funds as long as they receive at least the same interest as they would’ve received without the loan, and the loan does not interfere with the purpose of the funds (i.e. the monies are not slated to be spent prior to the payback period). The City does have many funds available to loan, especially for the very short period (2 – 3 months). As always, borrowing funds does not come without concerns. Prior to any borrowing, projections of incoming funds and the ability to pay back should be evaluated and assessed. 2. As of June 30, 2024, the General Fund had about $72,000 in loans that it had made to other funds. Typically loans to other funds are made for expenditures purposefully made in advance of receiving the revenues. This may be for a grant, where the funds must spend funds first and then be reimbursed, or it may be for impact fees, where the Council decides to build a specific project now in order to benefit future development, and then collects the funds as development occurs. These loans have historically been from the General Fund as it has had available funds on hand. Council could determine that these loans would be more appropriate from different funds, thus paying the General Fund back its cash. 0 10,000,000 20,000,000 30,000,000 40,000,000 50,000,000 60,000,000 70,000,000 80,000,000 90,000,000 Citywide Cash Flow 2019-2020 2020-2021 2021-2022 2022-2023 2023-2024 Ideally the City General Fund would have enough cash on hand to cover the annual cash ebbs and flows; however the City does have options for these annual fluctuations. A much harder look must be taken though, when the annual negative cash balance is no longer annual, but instead a long-term loan. It would not be consistent with Council’s conservative fiscal policy to allow reserves to fall so low that interfund loans are not paid back within the fiscal year. While the current seven-year projection does not anticipate such an occurrence, it is something that must be monitored. Measurement #6 – Potential Natural Disasters or Emergencies Atascadero is subject to potential natural disasters including earthquakes, floods, fires, major auto and train accidents, and hazardous materials spills. Pandemic should now be added to the list of emergency situations. The 2003 San Simeon Earthquake, the 2023 and 2017 storms, and the COVID-19 pandemic are all proof these events can and will occur in Atascadero. City staff are well trained in responding to emergencies and meeting the needs of the community. Any natural disaster or emergency will undoubtedly cause unbudgeted expenditures, fortunately however, in the event of a declared disaster, agencies such as FEMA and CalOES provide assistance to help the City recover. The funding received from these agencies are typically reimbursement funds; in other words, the City spends the funds and then requests reimbursement. The City continues to work with FEMA and CalOES for reimbursements of 2023 storm-related costs. In the event of a disaster or emergency, the number one priority of the City must be to respond to the emergency and protect the community. When looked at as a whole, the City has ample cash on hand to respond to an emergency until assistance funds could be received. It may mean once the emergency is over and the accounting done, that the General Fund cash is low and it had to borrow from other funds, but the Council’s higher priority to ensure the safety of its citizens was attained. The City is fully insured against property damage and liability claims. Additionally, Atascadero is very aggressive in applying for all applicable grants, when available, particularly to pay for the cost of responding to emergency situations. Measurement #7 – Asset Replacement Requirements The City of Atascadero owns large amounts of assets that have lives longer than a year such as buildings, infrastructure, technology, and vehicles. Council began back in the late 1990’s putting money into the reserves for many of these items so they could be replaced as needed. While not all of these assets reserves are fully funded, many of those that most directly affect community service levels have been funded. These include technology and vehicles. Measurement #8 – Service Level Consistency Another issue to consider is how important it is to the organization and residents that services levels are consistently maintained. Looking back to the late 1990’s, this was a key concern. A less fiscally conservative policy was in effect during that time, and when the economy became sluggish, reserves were insufficient to carry the City through the tight times. Services were cut. Many families had to seek alternate sources for youth recreational activities. Parks and Public Safety services were at a bare minimum. Employees were laid off. The few employees that remained to run the City were overworked and frustrated. Morale was at an all-time low. Recruitment during the recovery period was difficult at best. Fortunately, as the Council put the fiscal sustainability policy in place, things began to turn around. This strategy of putting aside reserves in good times and then using those reserves during down periods to achieve stable operations has allowed the City to maintain fairly consistent operations. Instead of burdening the ongoing operations budget with significant new purchases and programs when times were good, the Council kept level heads and tucked away some extra funds. As the economy started to turn south, instead of cutting programs and staff to uncomfortable levels, Council was again able to maintain services to the public by utilizing some of the reserves that were saved up. The ability to maintain level and consistent services is important to consider when evaluating reserve levels. Maintaining a service level consistency is even more of a delicate balance when there is an expansion of revenue due to growth in the economy or a new revenue source such as the new Sales Tax Measure D-20. The wants of the citizens, employees and other constituents are immediate. Over the years with very constricted revenues, people understood why services may have been somewhat minimized. With Measure D-20, it is a natural reaction to want service levels to improve. Things are better; the City is receiving more revenue, so services should be better. However, the cornerstone of the fiscal policy is to set aside money in good times for use in bad times so that service levels remain constant. This means that in the bad times, while the City did cut back where possible, in most areas, the service levels remained constant. In addition, many “hidden” expenses were going completely unfunded. The City was providing services at a level higher than revenues could afford, and budgets didn’t allow to put funds away for replacement of assets like storm drains, equipment, and buildings. Since the start of Measure D-20, some, but not all, of these assets are now being funded. The issue of how to fund more of these hidden costs will be a topic for the upcoming budget cycle. There remains a high level of needed funding that well exceeds even the more enhanced revenues. Measurement #9 – Available Opportunities Previous Councils have wanted the flexibility to take advantage of opportunities as they arose, and used reserves at times as a tool to achieve such goals. Beginning with the economic downturn and since then, the focus was directed not at new programs or services, but ways to improve and streamline existing programs, improve services to better serve the public, promote economic development, and attract businesses and visitors in an even more efficient manner. Available reserves can be used for these opportunities. Alternatively, if it makes fiscal sense, financing can be another option to achieve identified goals or pursue opportunities. Measurement #10 – Needs of Future Commitments It is important to consider the City’s future commitments when discussing reserves. The City has made financial obligations that will affect future budget cycles. There are several projects and future expenses including those such as the Public Safety Facilities, Downtown Infrastructure Enhancement Project, the General Plan Update, the Broadband Enhancement Project, and the City’s CalPERS Unfunded Accrued Liability (employee retirement obligations). The City renewed its commitment toward the Council’s three priority goals in 2023-25 budget cycle and will have the opportunity to address them at Council’s strategic planning session. The key goals that have been focused on in the prior budget cycle are: 1. Economic and Community Vibrancy 2. Fiscal and Infrastructure Efficiency and Sustainability 3. Ensuring Public Safety and Providing Exceptional City Services Measurement #11 – Interest Income Earned on Reserves The City’s reserve policy is in place to provide guidelines for the prudent investment of the City’s temporary idle cash. Investing the City’s temporary idle cash to earn interest income will enhance the economic status of the City. Reserves provide an opportunity to further increase investment income for the City that will fund important services to residents. Summary The financial policy has worked for the City in the past, and if we stick to it, it appears that it will work through this next financial planning horizon. Current projections show that using current assumptions and strategies in place, reserves will not fall below $14 million (excluding Measure F-14) in the forecast period. Reserves as a percentage of General Fund expenditures stay strong as well, and are in alignment with Council’s reserve policy. In prior strategic planning sessions, the Council agreed that it was critical to maintain service levels and felt that it was prudent to cut a little bit deeper into reserves with the mindset to turn to building reserves again as soon as possible. The organization may need to continue using reserves for several more years before starting to build them up. The general financial plan laid out in the Seven Year Projection ensures that we are responsibly planning for the future and that there are sufficient reserves to take the organization through the next seven years and even more with fiscal health as a top priority.