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HomeMy WebLinkAbout65B - FINANCIAL REVIEWkelly associates Management Group June 1, 2017 Ms. Cynthia J. Kurtz, Interim City Manager Mr. Francisco Gutierrez, Executive Director of Finance City of Santa Ana 20 Civic Center Plaza Santa Ana, CA 92701 SUBJECT ANALYSIS OF CITY OF SANTA ANA RESERVE FUNDS Dear Ms. Kurtz and Mr. Gutierrez: The City of Santa Ana retained Kelly Associates Management Group LLC ("KAMG") to perform a review of the City's financial operating reserve balances. The Scope of Work for this engagement included the following tasks: • A review of the last three years audited financial statements to ascertain the level and prior historical use and classification of fund reserves. This would include not only the General Fund but all funds to ensure that fund reserves are being used and accounted for accurately. • A review of the last three years adopted budgets to identify any City Council directives regarding use of fund balance reserves or one-time budget savings. • Identify the financial events that led to the budget savings in fiscal years 2014-15 and 2015-16. Confirm that the remaining savings are accounted for properly in the 2015-16 financial statements • Review and reconfirm that any identified one-time budget savings are indeed one-time savings and not ongoing structural budget surpluses. Review methodologies of budgeting for full-time positions, as well costing allocations. • Review potential 2016-17 and 2017-18 budget shortfalls, including budgeting practices that are followed to ensure that best practices are being followed to produce fiscally sound citywide budgets. This would include a detail review of the budget practices and philosophies implemented in each budget cycle that led to, one, balanced budgets, and two, any potential structural budget surpluses and/or budget savings. • Prepare a Status Memorandum to the City summarizing its findings and recommendations. • Prepare and submit a final report and will assist in the preparation of any required follow-up reports to the City Council as directed. KAMG has now completed its data collection and analysis and offers this report with ourfindings and recommendations. 1,1=10 north harbor botilevard w suite 900 m hillerlon m ca m 92835 7g.gBA Analysis of City of Santa Ana Reserve Funds Page 2 Report Overview The City of Santa Ana has engaged Kelly Associates Management Group ("KAMG"), to conduct a review of the current reserve balances to verify that the financial information presented to the City Council in prior budget adoption processes was accurate and clearly identified. KAMG had two preliminary meetings with City staff to discuss the specific needs of the City. The focus of this engagement was to review the composition of the General Fund reserve balances at June 30, 2016 so that information could be presented to the City Council to enable them to differentiate between reserves that could be used to potentially balance the General Fund budget and/or used for one-time special programs or projects, or, reserves that are restricted, per the City Council's discretion, for safeguards against economic downturns which would require special circumstances to be used. The City of Santa Ana's General Fund reserves increased significantly between 2010-11 and 2015-16. In addition, a new Budget and Fiscal policy was adopted in 2012. New reserve classifications were created to separate monies available for citywide needs and monies available for fiscal emergencies. Six (6) years of audited financial statements were reviewed to determine how the reserve balances were accumulated and if they were classified correctly, per the Fiscal and Budget policy. Our conclusion is that the reserves identified in the June 30, 2016 Comprehensive Annual Financial Report "(CAFR"), accurately reflect the financial activity of the City of Santa Ana through this date. The financial reserves are also correctly identified, per the Fiscal and Budget policy, at June 30, 2016. One area of concern was the "Attrition Savings" process that was used during the 2016-17 budget adoption. This process redirected anticipated personnel savings into other programs and/or projects, but did so without reducing the number of funded personnel positions in the budget. This process should be discontinued as it does not clearly identify the number of funded positions in the budget. In 2016-17 a higher number of positions were authorized by the City Council, but were not funded. Regarding potential changes to the Budget and Fiscal Policy, City staff should closely monitor and project future cost increases that could dramatically affect the required reserve level amounts. Scope of Review KAMG has completed its review of the General Fund Reserves as of June 30, 2016. Our scope of review was focused on the 2010-11 fiscal year through the last completed fiscal year of 2015-16. Fiscal years 2010-11 through 2015-16 have been audited by an independent CPA firm, and each fiscal year's audit has been given an unqualified/unmodified opinion. KAMG has relied on these audit reports for the analysis of the General Fund reserve amounts for each year. Each annual audit produced a financial report called a Comprehensive Annual Financial Report, ("CAFR"), which includes the City of Santa Ana's financial statements, notes to the financial statements, supplementary information, management's discussion and analysis, and the transmittal letter. KAMG relied on this information to form assumptions as to the reasonableness of the General Fund reserves. 65B-2 Analysis of City of Santa Ana Reserve Funds Page 3 KAMG also reviewed the City Council approved budgets for fiscal years 2013-14 through 2016-17. Each City Council budget was approved as a balanced budget. Each budget document approved by the City Council contain a detailed discussion about the Fiscal and Budget Policy. KAMG also reviewed the budgeting philosophies used by staff in preparing the budgets submitted to the City Council for their adoption. Budget concepts and assumptions were reviewed for reasonableness and accuracy. Fiscal and Budget Policy The City Council adopted a Fiscal and Budget Policy on June 4, 2012. This policy follows Government Finance Officers Association ("GFOA") recommended Best Practices by establishing two distinct reserve amounts. The first one is the Operating Reserve Account. It is accounted for in the Unassigned Reserve Account Section of the City's financial statements. This also follow's GFOA's recommended Best Practices. The Operating Reserve Policy established a minimum of 15% of General Fund operating expenditures be used as the target goal. The City Council set an additional goal for the Operating Reserve Account. Upon attaining the 15% benchmark, the City would strive to reach an operating reserve of 20% of operating expenditures. Any funds allocated to the Operating Reserve would not be used to fund/pay for any type of operating expenditures or to cover any budgetary shortfall other than to preserve ongoing cash flow needs of the City. In other words, these funds should not be used to balance a proposed budget, whether it is a structural unbalanced budget, or a budget that needs one time funds to balance it. The City of Santa Ana was able to reach the 15% benchmark goal by the end of the 2013-14 fiscal year. The City was also able to reach the 20% reserve goal during this period as well. (Not a mandated goal per the policy, but a goal for the City to strive for.) It is a GFOA recommendation that at least two months of operating expenditures be kept to ensure that the liquidity needs of the city are met. The two months benchmark is approximately 16.67% of expenditures. Since the 2013-14 fiscal year, the City has maintained the 20% reserve level. Based on the 2015-16 actual General Fund expenditures, the current reserve level should be close to $43 million. Currently the reserves are at $42.4 million. This is an acceptable amount. The City Council also established an Economic Uncertainty Reserve Account. This account was established to maintain a minimum reserve level of 1% to 10% of recurring General Fund revenues, with a goal of attaining the maximum 10%. Funds in this account should only be used to offset negative variations in projected revenues from the largest revenues sources in the City. It is common for this reserve account to be used of offset negative fluctuations in expenditure accounts. A downturn in the economy will usually effect revenues first, but can cause expenditures to increase as markets constrict. An example of this is the increase in cities PERS rates over the last few years, which have been due in part to CALPERS generating lower investment earnings than they had projected. LIRW Analysis of City of Santa Ana Reserve Funds Page 4 The Economic Uncertainty Reserve Fund was funded in Fiscal Year 2012-13 with a $3.85 million contribution. This was made possible by General Fund revenues exceeding General Fund expenditures at the end of the 2012-13 fiscal year. This reserve amount has not changed through the 2015-16 fiscal year. The current amount represents a 1.5% reserve level. Governmental Accounting Standards Board, ("GASB") Statement No. 54 states that governmental funds' fund balances should be classified based primarily on the extent of which the City is bound to honor the constraints on the specific purposes for which the amounts in the funds can be spent. Both the Operating Reserve Account and the Economic Uncertainty Account have been correctly classified as an Unassigned Fund Balance. An Unassigned Fund Balance is an amount that does not have legal or committed restrictions on its use. City staff has recently brought to the City Council for their consideration revisions to the Fiscal and Budget Policy. After reviewing the recommended changes, KAMG supports the changes. The revisions will keep the City of Santa Ana up to date with the current best practices for establishing and maintaining local government fund reserves. The City is recommending a target reserve balance of two months of operating expenditures. This equates to about 16.67% of operating expenditures and is an acceptable amount. In addition, KAMG recommends a five -to ten-year expenditure projection be prepared to forecast the growth in General Fund expenditures because the dollar amount tied to the 16.67% will grow with the increase in General Fund expenditures. Significant PERS rate increases are anticipated over the next five to ten years. Because pension costs are a large part of the General Fund budget, these potential rate increases will drive the total General Fund budget up. This will in turn drive up the two month operating reserve (16.67%) requirement. The more that funds have to be allocated to meet the operating reserve requirement, the more strain will be put on the overall General Fund budget to fund any other reserve accounts, or to fund any potential city project. By preparing the five to ten year financial projection, the City will be aware of what monetary commitments will be required annually to meet the reserve policy. This will impact the annual budget process. The City is not proposing any fiscal policy changes to the Economic Uncertainty Reserve.. The 10% reserve level is still the goal for the City. KAMG recommends that the City Council make it a priority to try and fund this reserve up to the 5% level. At June 30, 2016, the reserve is at 1.5%. The 3.5% increase would equate to an approximate contribution to reserves of $7 million, based on the 2015-16 actual expenditures. Putting the two reserve amounts together, the overall goal of the City would be to obtain a 21.67% (16.67% plus 5%) reserve level. This is a sound financial goal that meets best practices standards. LIMM Analysis of City of Santa Ana Reserve Funds Page 5 Six Year Analysis of General Fund Reserves The attached "Exhibit A" is an analysis of reserves of the last six fiscal years. The analysis focuses on the accumulation of reserves year over year, including not only the Operating Reserve and the Economic Uncertainty Reserve, but also the Unallocated Amount Reserve, (not designated for anything), and the Assigned Amount Reserve, (earmarked for future projects and/or programs by the City Council). The Santa Ana City Council and City staff should be commended for their ability to increase their reserves from very low levels in fiscal year 2010-11 to financially stable amounts by fiscal year 2013-14. The exhibit shows that the Operating Reserve Account was able to meet the Budget Fiscal Policy goal by the end of the 2013-14 fiscal year. It has been able to stay very close to the 20% reserve goal ever since. The accumulation of most of these reserves occurred in fiscal years 2011-12 through 2013-14. In 2011-12, property tax, sales tax, hotel tax, and business license tax revenues came in almost $5 million over budget. On the expenditure side, one-time citywide expenditures were approximately $8 million less than expected. These were the main factors in reserves increasing approximately $13 million for the year. In 2012-13, all revenues, but primarily property tax, sales tax, hotel tax, and business license tax revenues came in approximately $9.6 million over budget. On the expenditure side, personnel cost savings, primarily in Recreation and Community Services, the Police Department, and Planning and Building, were approximately $7 million. These were the main factors in spendable reserves increasing approximately $15.5 million for the year. In 2013-14, all revenues, but primarily property tax, sales tax, hotel tax, and business license tax revenues, came in approximately $9.3 million over budget. On the expenditure side, personnel cost savings, primarily in Recreation and Community Services and the Fire Department (contract savings), were approximately $5.4 million. Capital Outlay expenditures were almost $2.7 million less than anticipated. These were the main factors in spendable reserves increasing approximately $15 million for the year. In 2014-15, property tax, sales tax, hotel tax, business license tax, and revenues from other agencies came in approximately $7 million over budget. This was offset by a $4 million rental income loss due to the Police Departmentjail operations. On the expenditure side, personnel cost savings, primarily in Recreation and Community Services, the Police Department, Planning and Building, and Community Development, were approximately $9.3 million. One-time citywide expenditures were approximately $1 million less than expected. These were the main factors in reserves increasing approximately $13 million for the year. Of the $13 million new reserves added at the end of the 2015-16 fiscal year, approximately $11 million was designated by the City Council to be spent on specific future projects / programs. This is what staff refers to as the Assigned Accounts. In 2015-16, property tax, sales tax, hotel tax, business license tax, and revenues from other agencies came in approximately $1 million over budget. This was offset by a $4.5 million rental income loss due to the Police Department jail operations. On the expenditure side, personnel and operational cost o• Analysis of City of Santa Ana Reserve Funds Page 6 savings across all departments, but primarily in the Police Department, were approximately $14 million. These were the main factors in spendable reserves increasing approximately $10 million for the year. Overall, from the 2011-12 fiscal year through the end of the 2015-16 fiscal year, total reserves grew from approximately $11 million to almost $77 million. Out of the $77 million, approximately $75 million is reserved, in some form, for a specific purpose. The remaining $2 million has not been designated for a specific purpose. Of the $77 million at June 30, 2016, $29 million was available at the discretion of the City Council. During the last two budget adoptions by the City, $27 million of the $29 million has been earmarked by the City Council for one-time uses and/or special projects. As of to date, a number of these funds have not been spent. The remaining reserve amounts are separately identified as reserve goals set by the City's Fiscal and Budget Policy. This is an important point because these unspent funds, even though they have been earmarked by the City Council, may be needed and/or considered as one-time funds to balance an upcoming budget. In reviewing the City's other (non -General Fund) funds, all the funds classified as Governmental Funds had reserves that are classified as Restricted. Forthe Proprietary Funds, all of these funds' reserves are restricted for the enterprise operation that they operate. Nothing came to our attention that these funds' reserves are misrepresented in the City's financial statements. Budgeting Methods ("Attrition Savings") Used During the 2016-17 budget adoption process, the City Manager initiated an "Attrition Savings Process", which was aimed at redirecting potential personnel and operational cost savings for the upcoming year to other General Fund programs and/or projects. The philosophy of the program worked as follows. Based on historical data, each operating department within the General Fund, (i.e., the Police Department, the City Clerk's Office), had a historical record of salary savings and operational cost savings each year, mainly due to funded personnel positions that were not filled (for the full year or part of the year), during a given budget year. Based on the historical average of vacant positions, and the corresponding salary and benefits cost, the average cost of salary savings, and unused operational savings, was removed from the respective department's overall budget. The accumulation of these savings across all operating departments within the General Fund were than reprogramed into other programs and/or projects for the 2016-17 fiscal year. As far as communications with the City Council, it should be noted that the attrition savings were identified as a line item in the General Fund Trial Budget that was presented to the City Council in April, 2016. Beyond that, there did not seem to be any substantial discussion about the reprograming at any further budget meetings. There also does not seem to be any direct correlation between the savings removed from department's budgets and any new and/or additional programs that were added. The "attrition savings" process of removing a portion of a department's personnel budget, which in essence is what was done, is a budgeting methodology that has been done in other cities. Recognizing o• � •, Analysis of City of Santa Ana Reserve Funds Page 7 that there will most likely by salary savings in any given year and taking those funds and appropriating them to other city services is an acceptable practice. What is important during the budget process is that the true number of funded personnel positions for the fiscal year be clearly identified. During the City of Santa Ana's 2016-17 budget process, it is not clearly evident that the City Council approved a specific amount of personnel positions for the fiscal year. By not doing this it allowed budgeted funds to be redirected to other needs without clearly identifying that a certain number of positions were not funded for the upcoming year. KAMG recommends the City Council, as part of the budget adoption, approve a specific number of full- time positions for the upcoming budget year. This will demonstrate transparency to the public, and it will clearly communicate to each department what the approved number of personnel staffing is for the new fiscal year. Granted, it still may be difficult to fill all vacant positions for any given department, and personnel cost savings may occur in some years. If that is a situation that exits in one or more departments, staff should discuss with the City Council the possibility of reducing the number of budgeted positions, and possibly redirecting the funds, for other citywide needs. Long -Term Financial Projections The reserve amounts on hand by the City of Santa Ana are a result of, one, a much improved local and national economy and, two, General Fund savings over the last five years. The additional funds (revenues generated but not spent), at the end of each of the last six fiscal years, has enabled the City to establish and meet reserve policy goals, and to have create additional discretionary funds. As the City is actively preparing its 2017-18 budget, one-time reserves may be needed to balance the budget. Two reasons for this situation are the slowdown in the local and state economy and the constant pressure of increased operational costs. Pension costs have the highest risk of dramatically increasing over the next 5 to 10 years. Because of this financial uncertainty is it critically important that the potential large increases in the PERS pension rates be incorporated into the current long-range General Fund financial forecasts of the City. This will enable the City Council and Staff to make better informed decisions regarding, one, the use of one-time reserves to balance future budgets, and, two, new revenue sources and/or expenditure cuts. The use of reserves to balance a budget that is structurally unbalanced should not be an ongoing practice that is put into place. It can be used for a short period of time, one to two years, but only if during that time period long term solutions are found to structurally balance the budget, and also to potentially repay the reserves account. As the City considers the use of one-time reserves to balance the 2017-18 General Fund budget, and potential future year budgets, it is also very important that an estimated cost of labor negotiations be incorporated into the budget. All represented employee groups' labor contracts are expiring June 30, 2017. If there is a possibility that salary and/or benefit enhancements could be given to any or all employee groups, then estimates should be factored into the current year budget and any long-range financial projections. These estimates will better represent the true costs of future projects, and will better inform the City Council and Staff as to use of future reserves. 65B-7 Analysis of City of Santa Ana Reserve Funds Page 8 Findings/Recommendations In conclusion, based on the audited financial statements reviewed and the budgets adopted by the City Council, the following reflects KAMG's findings and recommendations regarding the status of the General Fund Reserves of the City of Santa Ana, at June 30, 2016: • The reserves identified in the June 30, 2016 Comprehensive Annual Financial Report "(CAFR" ), accurately reflect the financial activity of the City of Santa Ana through this date. The financial reserves are also correctly identified, per the Fiscal and Budget policy, at June 30, 2016. • The City of Santa Ana's General Fund reserves increased significantly between 2010-11 and 2015-16. • A new Budget and Fiscal policy was adopted in 2012. New reserve classifications were created to separate monies available for citywide needs and monies available for fiscal emergencies. Changes to the current policy have been discussed with the City Council. KAMG agrees with the proposed changes, but also recommends that the City Council fund the Economic Uncertainty Fund to 5%. • Since the 2013-14 fiscal year, the City has maintained the 20% reserve level in the Operating Reserve Account. Based on the 2015-16 actual General Fund expenditures, the current reserve level should be approximately $43 million. If the proposed changes to the Budget and Fiscal Policy are adopted, the Operating Reserve Account would be overfunded. KAMG recommends these potential excess funds stay in the Operating Reserve Fund. These excess funds will slowly evaporate (as a percentage of reserves), as the General Fund expenditures increase year over year. When the Operating Reserve Account, as a percentage, drops to 16.67%, the City will need to start funding this reserve. • The "Attrition Savings" process that was used during the budget adoptions redirected anticipated personnel savings into other programs and/or projects, but did so without reducing the number of funded personnel positions in the budget. KAMG recommends that if this process is to continue, the potential savings be based only on personnel savings, and that the specific number of funded personnel positions be clearly identified in the budget adoption process. KAMG recommends a five- to ten-year expenditure projection be prepared to forecast the growth in General Fund expenditures because the dollar amount tied to the 16.67% will grow with the increase in General Fund expenditures. Regarding the potential changes to the Budget and Fiscal Policy, KAMG recommends City staff should closely monitor and project future cost increases that could dramatically affect the required reserve level amounts. KAMG appreciates the opportunity to work with the City of Santa Ana. Please feel free to contact us if you have any questions regarding this report or would like to discuss our findings and recommendations further. Respectfully submitted, KELLY ASSOCIATES MANAGEMENT GROUP, LLC om w • William R. Kelly President/CEO Analysis of City of Santa Ana Reserve Funds Page 9 Mark D. Alvarado, CPA Principal Attachment 1—Six-Year Analysis of General Fund Reserve o• Analysis of City of Santa Ana Reserve Funds Page 10 City of Santa Ana 6 Year Analysis of General Fund Reserves _tI 2014-15 2015.1 — — _—_� -- 2010-11 2011-12 2012-13 2013-1__4 Operating Reserve Account Economic Uncertainty.Account $6,673,2901 $19,335,569 $26,842,243 $3,845,592 $40,538,518J41,512,985 $3,845,592 $3,8455 _$42,397,974 $3,845,592 Assigned Account = _$2,986,397 $4,660,762 $5,424,045 $5,403,946 $16,618.376 $27,077,619 Unallocated Account Prepaid @ems __T$1,314,3311 Restricted/Committed" I $3,266,819 $913,595 _$3,357,089 $532,895 _$3,434,420 $954954 $2,151,297 _ $1454962 1 $10,974,0181 $23,996,3311 $39,378,6991 $54,058,7401 $66,899,2221 $76,927,444 - Target Goal for Reserve Operating Reserve Account (20%) 1 $40,400,000 $41,000,000 - $38,800,000 $40,538,518 $41,512,985 $42,397,974 1 i 1 1 ` Carryforward of projects not completed in prio _y_qar,_ and supplemental programs identified. " Restricted for contractual obligations and/or debt service agreements. JT — — 65B-10