AGENDA ITEM
TO: HONORABLE MAYOR
AND MEMBERS OF THE CITY COUNCIL
FROM: CARLO TOMAINO
CITY MANAGER
BY: SHARON DEL ROSARIO
ADMINISTRATIVE SERVICES OFFICER/FINANCE DIRECTOR
SIAMLU COX
DEPUTY ADMINISTRATIVE SERVICES OFFICER/FINANCE DIRECTOR
DEBBIE PACHECO
INTERIM ACCOUNTING MANAGER
SUBJECT:
title
ANNUAL COMPREHENSIVE FINANCIAL REPORT FOR FISCAL YEAR 2023-24
summary
Summary:
The Annual Comprehensive Financial Report (ACFR) is an independently audited summary report of the City’s financial transactions for Fiscal Year (FY) 2023-24. The ACFR provides relevant financial information to the City Council, residents, current and future employees, grant entities, creditors, bond investors, rating agencies, and other interested parties. The audit is performed in compliance with the requirements of the City Charter, and the results are presented to the City Council for review.
The audit was completed by the City's independent auditor, Rogers, Anderson, Malody & Scott, LLP, Certified Public Accountants (RAMS), which issued an unqualified opinion audit report, otherwise known as a “clean opinion” finding nothing of material concern in the City’s internal controls, financial, and bookkeeping practices. The independent auditor’s unmodified report provides assurance that the ACFR, and audited information within, present fairly the City’s financial position for the Fiscal Year ending June 30, 2024.
As part of the ACFR, staff provides detailed information and recommendations regarding the General Fund Operating balance. For FY 2023-24 the General Fund reports a positive fund balance of $11.1 million. Staff will present recommendations for fund balance appropriations to the City Council in the first part of the 2025 calendar year. This proposed timeline allows staff to conduct a detailed analysis of the positive fund balance, including ongoing revenue updates, requests to re-appropriate unutilized budget appropriations, one-time expenditure requests for department operations, programs or special projects, and reserve allocations resulting in budget adjustments for the current fiscal year.
Strategic Plan Goal(s):
Goal No. 1 Financial Stability: Ensure the City’s long-term financial stability and resilience.
recommendation
Recommendations:
1. Receive and file the City’s ACFR for FY 2023-24.
2. Direct staff to return the first part of the 2025 calendar year with proposed appropriations for the FY 2023-24 General Fund positive fund balance.
3. Direct staff to distribute copies of the ACFR for FY 2023-24 as required, as well as to the Office of the City Clerk to be placed on file for the general public and posted on the City’s website.
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Fiscal Impact:
FY 2023-24 closed with General Fund revenues exceeding expenditures, including net transfers, in the amount of $11,092,416.
Background:
The City’s Charter requires that an annual audit be performed relating to the City's financial transactions, records, inventories, and reports. Accordingly, the City retains an independent external auditor. The auditor’s responsibility is to express opinions on the financial statements, and plan and perform an audit to obtain reasonable assurance about whether the financial statements are free from material misstatement. The results of these efforts are incorporated in the ACFR, which is a set of financial statements that present the City’s financial results at the end of the fiscal year (Attachment A).
The ACFR was prepared in accordance with Generally Accepted Accounting Principles (GAAP) as set forth in the pronouncements of the Governmental Accounting Standards Board (GASB), an organization that regulates governmental accounting as the source of generally accepted accounting principles. In addition to standards of reporting, GASB issues statements, interpretations, bulletins, and other guidelines for financial reporting.
Local Economy and Financial Landscape
California cities have effectively recovered from the pandemic recession of 2020 with a return to normalcy in most business sectors; however, there are still signs of stress in the overall economic outlook. Global economies continue to grapple with higher inflation affecting consumer spending trends, and volatile interest rates that are putting pressure on the housing market, car sales, and other parts of the economy. Work stoppages from major labor strikes may also impact domestic budget spending and the intense geo-political conflicts in Ukraine and Israel may also upset current growth patterns. Another impact is the November 2024 election results that could lead to new industrial policies on tariffs which, in turn, could affect the price of goods for consumers. Even with all this, many economic forecasts believe the US economy remains resilient with renewed consumer confidence and spending, and relatively low unemployment that has shielded the economy from recession. However, caution is advised, if the Federal Reserve keeps its benchmark interest rate elevated for a prolonged period, this may cause undue pressure on consumer spending, increase job losses, and weaken the overall economy.
Inflation continues to be one of the most challenging obstacles global economies have attempted to overcome. The Federal Reserve has taken an aggressive stance in combating inflation by raising the federal funds target rate from 0.25% in March 2022 to 5% in September 2024. The inflation rate met a 40-year high of 9.1% in 2022 but tapered off to 2.4% in September 2024 and is still higher in comparison to the Federal Reserve’s target of 2% inflation rate for the US economy. Even though inflation and interest rates were high, the US Gross Domestic Product (GDP) expanded by an annualized 2.8% pace by the quarter ending in September 2024, which is in line with the 3.4% average quarterly growth seen from 2021 to 2023. As the Federal Reserve continues with its current strategy of interest rate cuts to achieve a soft landing, the economy is still experiencing slow job growth and household incomes are still dealing with higher cost of goods. In the long run, the pace of the rate cuts through next year will have the biggest impact on improving the overall economy and inflation.
California’s 2.8% GDP growth rate in the second quarter of 2024 shows the State’s economy continues to expand but slower than the national annual average of 3.7% in 2023, primarily due to a higher unemployment rate and housing market stagnation. Between January 2020 (just before COVID) and September 2024, prices increased by approximately 20% with food, rent of a primary residence, and gasoline prices rising well above this. As of October 2024, California’s unemployment rate increased to 5.3%, which is the third highest of any state, and higher than the national average of 4.1% for the same period; a main component of this data trend is attributed to slower job growth in select labor markets. If these conditions continue to persist, this may further impede the State’s long-term economic growth by causing consumers to make tradeoffs in household spending budgets. The State of California also continues to grapple with budget deficits leaving uncertainty regarding how the State Legislature plans to balance its budget, creating possible impacts to local municipalities. As there are many variables driving the local economy, most economic forecasts are still predicting growth, but limited growth in the following years for 2025 and 2026.
During the COVID-19 pandemic, it was evident that the elasticity of the general fund’s revenue portfolio (property tax, sales tax, transient occupancy tax, and franchise fees) determined a city’s fiscal exposure during economic shifts. As a “low property” tax city, the City’s most significant revenue source for General Fund operating revenues is sales tax. Signal Hill’s revenue mix has proven to be resilient, with overall sales tax revenue remaining strong. Total point-of-sale tax revenues increased by 4% compared to the previous year. The City’s transaction and use tax Measure SHR continues to be the biggest contributor to an increase in overall sales tax revenue with a 5% increase over the prior year. Measure SHR generated 27% of the Bradley Burns amount, with general consumer goods continuing to produce the most sales tax revenue.
Overall sales trends for FY 2023-24 were forecasted to experience “flat” growth, a trend expected to persist into the following fiscal year. According to HdL, California’s sales tax performance for FY 2023-24 grew modestly, and trailing far behind the double-digit growth seen during the pandemic recovery. Looking ahead, households face tight budgets, and various industries grapple with challenges such as labor costs, inventory issues, and competition. Economic forecasts hinge on the Federal Reserve Board’s upcoming decisions on interest rates, which will be the main driver in shaping future consumer spending and overall economic growth.
The City’s major sales tax industry groups include Autos and Transportation, Business and Industry, County Pool Allocations and General Consumer Goods. The City’s Autos and Transportation industry sector experienced a robust year-over-year growth of 21%, mostly attributed to a new dealership and a one-time, prior year adjustment resulting in increased revenue. Net of the prior year adjustment, the year-over-year growth for Auto and Transportation was 11%. County Pool Allocations continue to grow with a 5% year-over year growth as projected by HdL. Business and Industry and General Consumer Goods both experienced a 2% loss over the prior year. Although the Business and Industry sector benefits from online shopping, which did increase, there were individual sectors that experienced a loss. Building and Construction continues to see a downward turn in home-improvements sales with conditions predicted to persist through the middle of 2025, and although interest rates have fallen in the short-term, consumers continue to suspend big-ticket purchases. As a result, the Building and Construction sector is not predicted to see growth until FY 2025-26. Overall sales tax revenue is still predicted to stay relatively flat through FY2024-25, and then an average of about 3% growth in the outer years.
Property taxes account for the next largest revenue source for the General Fund. Local property tax revenues are driven by the value of residential and commercial property and since property tax revenue typically reflects the value of a property anywhere from 18 months to many years prior, these are less immediately responsive to economic changes than other types of taxes. High mortgage rates continue to test California’s housing market as sales continue to decline, and buyers face challenges as median sales prices increase. In comparison, California’s median home price increased by 11.4% as of April 2024, with Southern California’s median home prices increasing by 7.4% based on HdL’s property tax division. Signal Hill’s home sales have continued to remain slow most likely due to rising interest rates and inflation, and the trend is not expected to change until FY 2025-26. The City’s overall net taxable property value changed by 4.4%. Notably, a large portion of Signal Hill properties are highly affected by the oil and gas assets within the City. As oil prices change, the related property values also fluctuate in the same direction and a portion of the property value changes are likely related to the current price of oil. Property tax rolls are set prior to the commencement of the fiscal year, and therefore property tax revenue was conservatively projected for FY 2024-25.
The City’s annual obligated costs, such as contract costs, insurance, pension obligations, and unfunded mandates, continue to rise over time and compete against other budget priorities. The largest obligated costs include pension costs related to the CalPERS Unfunded Accrued Liability (UAL). The UAL mainly fluctuates as a result of investment returns and changes in the discount rate. CalPERS recently announced a preliminary net return of 9.3% for FY 2023-24. When factoring in CalPERS’ discount rate of 6.8% and the FY 2023-24 preliminary return of 9.3%, the estimated funded status now stands at 75% as of June 30, 2024, for the Public Employees Retirement Fund (PERF). The recent gain and loss, change in the discount rate, and assumption changes have led to variable funding status, which directly impact the City’s pension costs and overall budget strategies. In April 2024, the City Council adopted the Fresh Start pension strategy for the City’s unfunded pension liability, administered through California Public Employee’s Retirement System (CalPERS) for all Miscellaneous and Sworn rate plans. This strategy is projected to stabilize the pension plan, preserve liquidity, reduce the annual cost of payments, reduce interest costs, and shorten the term of the unfunded accrued liability (UAL). The City will continue to monitor the result of the Fresh Start strategy and overall pension costs closely.
The City completed a comprehensive fee study in FY 2023-24 which reviewed the City’s overall user and regulatory fee structure, basis of fees, and cost recovery. The projected positive fiscal impact has been incorporated into the current biennial budget. In addition, the City has also embarked on a comprehensive economic and land use study for three areas of the community. Broadly defined, the purpose of an Opportunity Study Area is to assess future land use opportunities that will allow the City to grow economically, create jobs, encourage new development, and diversify the City’s tax basis for several years.
In 2023, the City Council authorized staff to issue a Notice of Funding Availability for up to $10 million in affordable housing funding to develop the Orange and Walnut Bluff affordable housing sites. The City initiated a competitive process and selected National Community Renaissance (National CORE) as the City’s preferred development partner. National CORE proposed a 380-unit affordable project that includes a Boys and Girls Club which would represent a $200 million investment in the community. Since embarking on the due diligence process, National CORE experienced delays due to new State legislation regulating oil and gas operations. In addition, due to its budget deficit, the State temporarily suspended the Infill Infrastructure Grant program, which National CORE proposed as a primary funding source for these projects. Despite these temporary setbacks, National CORE and the City will negotiate the terms of an Affordable Housing Agreement for the Walnut Bluff property in 2025 that will specify the terms, conditions, and timing of the City’s funding contribution.
Analysis:
ACFR Components
The ACFR includes three main sections: 1) Introductory; 2) Financial; and 3) Statistical.
Introductory Section (pages i through x)
This section includes the guide to the report and one of two key narratives, the Transmittal Letter, which provides a broad financial outlook of the City and legal requirements for financial reporting.
Financial Section (pages 1 through 125)
This section includes the second key narrative, the Management’s Discussion and Analysis (MD&A) section. The MD&A is audited information and is similar to financial reports in the private sector. The MD&A section of the ACFR provides a narrative overview of the City’s previous year’s activity and financial performance. This information should be read in conjunction with the basic financial statements and the extended footnotes to get an accurate overall representation of the City’s financial health. The Notes to the Basic Financial Statements provide narrative information about the City’s significant accounting policies and detailed disclosures on key financial matters. In addition, the MD&A includes a discussion of factors affecting the current year’s budget.
Also included in this section are the Independent Auditor’s Report, the Basic Financial Statements, the Fund Financials, Notes to the Basic Financial Statements, and other required supplementary information (RSI). The Government-Wide Financial Statements report information on all activities of the City, with the exception of where the City acts as a trustee for another agency, such as the Successor Agency; in addition, transfers of funds between City entities and reserves have been removed from these statements, and the statements only reflect events that resulted from activities between the City and non-City associations. Governmental activities, which normally are supported by taxes and grant revenues, are reported separately from business-type activities, such as the Water Department, which instead rely on user fees and charges that come from receiving a service.
The reporting includes the auditing standards of GASB Statement No. 68 (GASB 68), which requires that a governmental entity recognize its net pension liability (UAL) in the statement of net position (balance sheet). Under GASB Statement No. 75 (GASB 75), the City’s net Other Post-Employment Benefits Liability (OPEB) is recorded and extended discussions and disclosures are provided as part of the supplementary information in the footnotes. Under the reporting standards of GASB 68 and 75, City-wide financial statements present the net pension and OPEB liabilities.
Statistical Section (pages 126 through 147)
This section consists of information pertaining to the City, including financial trends, revenue and debt capacity, demographics and economic information, and other operating information.
General Fund Analysis
The General Fund is the City’s primary operating fund, comprised of local tax revenues and fees for services to fund core municipal services such as public works, police, planning, and recreation. The General Fund ended FY 2023-24 with revenues exceeding expenditures (including transfers) by $11,092,416.
The independent auditor reported that the FY 2023-24 General Fund Operating and Non-Operating Revenues were $41.9 million, which is $8.8 million above the FY 2023-24 final budget of $33.1 million and $5.1 million over the prior year’s FY 2022-23 actuals of $36.8 million. As the year progressed and during the budget preparation for Year 2, the City increased the current year revenue projections to reflect $38.5 million. The increase over the FY 2022-23 Operating results was mainly due to an increase in the City’s significant revenue sources. Sales tax exceeded the prior year by $1.6 million mainly driven by the Autos and Transportation business sector out-performing expectations and the City’s transactional tax, Measure SHR, continues to contribute to overall sales tax revenue. However, looking forward sales tax revenue is expected to remain relatively flat for FY 2025-26 with moderate overall growth going forward with signs of slowing growth in certain business sectors. Overall, sales tax revenue is budgeted conservatively using updated industry expert information. Another significant increase in revenues was attributed to an increase in interest income and the annual unrealized interest gain/loss accounting adjustment also called the mark to market adjustment required by GASB No. 31. Interest income was higher than prior year by $1.6 million due to the City’s investment portfolio performing better than projected in the current high-interest rate market. As the City’s investment portfolio performs better the prior year, mark to market adjustment for the unrealized loss reversed resulting in a one-time increase in non-cash revenues of $1.3 million. As noted in the economic outlook, interest rates are expected to decline in the near future which will have a direct impact on interest income revenue.
The General Fund’s Operating and Non-Operating Expenditures (net of subscription acquisition sources) were $29.2 million, which is $5.4 million below the FY 2023-24 Current Operating Budget of $34.6 million and $0.7 million above the prior year FY 2022-23 actuals of $28.5 million. All departments ended the year with expenditures below budget, primarily due to vacant positions across multiple departments, delayed projects, and lower use of planned contract services.
Net transfers-out were $1.6 million, which is $2.5 million less than the FY 2023-24 Current Operating Budget of $4.1 million. The net transfers are mainly made up of transfers-in to fund operating activities of $0.2 million, transfers-out to fund capital improvements of $1.8, and the annual transfer out to the Housing Authority for approximately $376K representing 20% of the annual loan repayment between the City and the Successor Agency.
The General Fund Operating Results are summarized in Table 1 and 2. Revenues and transfers-in less operating expenditures and transfers-out resulted in a net year-end positive fund balance of $11,092,416. The Beginning Fund Balance in the FY 2023-24 Operating Budget was $64.6 million. After reflecting revenues, expenditures, and net transfers, the actual Ending Fund Balance is $75.7 million.
General Fund Reserves
The auditor reported that the General Fund Unassigned Reserve is $31.6 million, and the Economic Uncertainties Reserve is $5.4 million, for a total of $37.1 million as of June 30, 2024. Based on the original FY 2023-24 General Fund budgeted expenditures, not including net transfers of $33.0 million, the General Fund Unassigned Reserve and Economic Uncertainties Reserve together represent a reserve level of 112%, meeting and exceeding the City’s practice of maintaining 50% in reserves. The City Council adopted a Reserve Policy on September 10, 2024, establishing the minimum target reserve level to be 75% to 100% which will replace the practice followed in FY2023-24.
The grand total of the General Fund Committed Reserves and the Unassigned General Fund Balance was $66.8 million on June 30, 2024. The Committed Reserves are classified fund balances that can only be used for the specific purposes determined by the City Council through the adoption of a resolution prior to the end of the fiscal year.
Committed Reserves balances and changes are summarized in Table 3.
GASB 68 and GASB 75
The City’s net pension liability is $39.6 million and the OPEB liability is $8.5 million. Net pension liability is the present value of projected benefit payments to current employees and retirees, less pension assets that are invested and maintained by CalPERS. Net pension liability associated with pensions for safety personnel is $22.2 million and for non-safety personnel is $17.4 million. The liability will fluctuate because of investment returns and changes in the discount rate. The weighted average funding status of the City’s two pension plans is approximately 76.2% based on the most recent GASB 68 actuarial valuation, which is above the average funded status of approximately 72%. The City has established committed reserve funds to address pension and OPEB costs, and also initiated the CalPERS Fresh Start strategy to address future CalPERS rate increases and stabilize annual pension costs.
Beginning in 2009, the City and its employees recognized the need to take proactive measures to address the rising costs of the pension and OPEB plans. All employees began contributing a portion of their compensation toward their pension plan costs, reducing the City’s employer-paid costs. In 2010, the City established new pension plans for employees hired after June 2010 (Tier II) that offered reduced retirement benefits in order to lower long-term pension liability. In 2013, the State passed the Public Employees’ Pension Reform Act (PEPRA) that affects employees hired on or after January 1, 2013. PEPRA capped the annual pension benefit that can be received, established a lower-cost pension formula for safety and non-safety employees with requirements to work longer in order to reach full retirement age, and capped the amount used to calculate a pension.
FY 2023-24 contribution rates for Classic Tier I, Classic Tier II, and Public Employees’ Pension Reform Act (PEPRA) employees are as follows:
• Classic Safety employees contribute 12%
• Classic Safety management contribute 9%
• PEPRA Safety employees contribute 14.5%
• Classic Tier I/Tier II miscellaneous and management employees contribute 7%
• PEPRA miscellaneous and management employees contribute 7.75%.
Additionally, non-safety employees contribute 1% of their compensation, and safety employees contribute $625 annually to offset the cost of OPEB obligations.
Water Fund
The City’s business-type activities consisted solely of the Water Utilities Enterprise Fund (Water Fund). The Water Fund is used to account for financial activity related to the purchase, production, storage, and distribution of water used by the community, as well as the maintenance, repair, and replacement of related equipment and pipelines. The intent of the Water Fund is to meet all operational costs through regular revenue from rate payers while also putting monies aside for future infrastructure replacement and repairs.
Water Fund revenues consist of charges for services and investment income which totaled $6.8 million. Operating revenues continue to grow year-over-year due to annual rate increases, in accordance with the approved Prop 218 rate schedule (the fifth of five rate increases). The City is conducting a water rate study and a water master plan to review the Water Utility fund to ensure overall fiscal sustainability and prioritize water infrastructure needs and future capital improvement planning. The water rate study is scheduled to be completed in 2025. Non-operating revenues include net investment income of $313,178. Operating expenses totaled $4.9 million, reflecting costs for repairs and maintenance. Interest expenses related to debt service totaled $96,800.
The Water Fund received net transfers of approximately $2.5 million, that include a transfer from the American Rescue Plan Act funds to support the 33rd Street Water Main improvements of $2,514,286.
GASB 68 requires that the year-over-year change to unfunded pension liability be reflected within the Statement of Revenues, Expenses, and Changes in Net Position. A change in the pension allocation reduced pension expense reported in the personnel services line-item by $323K for FY 2023-24. After non-operating results, transfers, and financial consolidation entries, the change in net position increased by $4,579,695, largely attributed to the increase in net investments of capital assets mainly related to the completion of the 33rd Street Water Main improvement project, and other factors resulting in a reduction of water supply costs by $556,840 compared to Fiscal Year 2022-23; a one-time increase in interest income of $261,763, driven by higher interest rates, a $444,200 increase in sales as a result of the approved Prop 218 rate schedule; and reduced expenditures mainly related to salary and benefits due to staffing vacancies.
The Water Fund’s operating results are summarized in Table 4.
Reserve Appropriations and Reallocations of FY 2023-24 Positive Fund Balance
For FY 2023-24, the General Fund closed with revenues exceeding expenditures in the amount of $11,092,416 (including net transfers), as shown in Graph 1.
The annual positive fund balance is available for a one-time allocation to projects, programs, or reserves as directed by the City Council. Staff proposes to return to the City Council the first part of the 2025 calendar year, to allow sufficient time to conduct a detailed analysis and propose the recommended allocations.
Attachment:
A. FY 2023-24 Annual Comprehensive Financial Report