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Attachment 5Subject: Attachments: Agenda Item #6 - Fund Balance Resolution Establishing June 30, 2018 Fund Balance final letter - fund resolution CLEAN.docx From: Phil Koen [snF iro_2k n@monteropartners.con-] Sent: Monday, December 17, 2018 6:43 AM To: Rob Rennie; Marico Sayoc; Marcia Jensen; BSpector; Steven Leonardis Cc: jak vannada; _ ; n ft .'d_ ' Rick Tinsley; Laurel Prevetti; Robert Schultz Subject: Agenda Item #6 - Fund Balance Resolution Establishing June 30, 2018 Fund Balance Dear Town Council Members, Please read the attached letter requesting a "no" vote on the proposed fund resolution and approval of a new resolution establishing a new committed General Fund reserve dedicated to making a onetime $10m payment to Calpers. We will be attending the Town Council meeting and plan to have agenda item 6 removed from the consent calendar. We will be available to answer any questions regarding our proposal and look forward to a robust discussion. I have also copied the resident members of the FC since this matter was never discussed by the FC. Phil Koen 1 Dear Council Members, Summary The Town Council should not approve the proposed resolution. This resolution is designed to assign an "excess balance" from a year end surplus to various General Fund Reserves. While the resolution does not specifically state the amount of the "excess balance" to be assigned, it appears that the effect of the resolution is to allocate $6,972,871 to the following reserves: • Budget Stabilization Reserves $67,396 • Catastrophic Reserves $67,396 • CALPERS/OPEB $690,000 • Capital Projects Reserves $6,148,079 o Total Excess Balance $6,972,871 While the assignment of the excess balance appears consistent with existing policy, it is not in the best interest of the Town to do so since it is not fiscally prudent given the continued rapid growth in unfunded pension liabilities. The Town Council has total discretion and authority to assign any "excess balance" in the best interest of the Town, including departing from existing policy. Recommendation Assuming the "excess balance" is $6,972,871, my thought is that a more prudent approach would be for the Town Council to take the following actions: 1. Assign $6,838,079 to a newly established General Fund committed reserve for a "one-time" payment to CALPERS to reduce the growing unfunded pension liability. The fiscal soundness of this action comes from the recommendation in the April 2018 Bartel study. Please see the attachment with Bartels slides, 61-64. This newly created committed reserve is distinct from the existing Pension/OPEB reserve. The newly created committed reserve must be used for a payment to CALPERS as opposed to being held by the Town or making payments into an IRS 115 Trust. The importance of making a direct payment to CALPERS is more fully explained below but we are guaranteed the reduced interest cost (the discount rate) if we pay down the debt, and the Section 115 is only attempting to match that rate. 2. Assign $134,792 of the "excess balance" split evenly, to the budget stabilization reserve and the catastrophic reserve accounts. While I firmly believe that the total amounts in these two reserve accounts are excessive, it is probably best to follow the adopted policy for funding these reserve accounts. The amounts added are not material. 3. Transfer $3,032,831 of excess cash in the Internal Services Fund Balance (this is a proprietary fund) to the newly established General Fund committed reserve discussed above. This incremental cash will increase the newly created General Fund committed reserve to $10,000,000 and will reduce the cash in the Internal Services Funds from $10,747,866 (page 44 of the CAFR) to $7,715,035. I have written extensively about how the Internal Services Funds have been used for years as a "cookie jar" and that the cash accumulated in these funds is routinely transferred back to the General Fund for specific funding needs. An example of this was the funding of the Almond Grove project. The current cash balances are excessive, especially since there are no employees budgeted in these funds effective FY 2019. Over a 9 year period, the average cash payments for employees has been $1,149,653. A reduced cash balance of $7,715,035 still exceeds 2.25x the 9 year average annual cash payments to all suppliers and payment of all claims for workman's compensation and self-insurance (the 9 year average of annual cash payments is $3.297,455). The 2.25x safety factor is greater than the target safety factor of 2x the Staff has historically used. I suggest that this excess cash be redeployed to save the town high interest costs now and well into the future. Analysis Since FY 2014, the Town has accumulated an additional $13.5m in cash while watching its unfunded pension liability explode. As of June 30, 2018 the Town held $73.9m in cash and had recorded a $53.2m in unfunded pension liabilities. I don't think it is a fiscally responsible decision for the Town to hold excess amounts of cash which earn 1.84% while incurring approximately 7.25% interest charges from CALPERS on its unfunded pension liability. Staff calls it conservative, but one could also consider it fiscally irresponsible as we watch our cash increase while at the same time watching our pension liabilities increase even faster. And, consequently, CaIPERS has told us that this rate of pension growth will accelerate. If you look at page 76 of the CAFR, you can see that in FY 2018.for just the Miscellaneous Pension Plan, the Town incurred $6.8m in interest expense on the Miscellaneous Pension Plan liability. While the interest expense on the Safety Pension Plan liability is not reported in the CAFR, it can be reasonably computed to be approximately $5.0m. That means the Town is incurring approximately $11.8m per year on the combined pension liabilities of the Miscellaneous and Safety Plans. Please keep in mind that we also incur interest on the OPEB debt. The only way to meaningfully reduce this is by making a material one-time payment to CALPERS. By doing this, the Town will get the full benefit of "time value of money" with an immediate decrease in the UAL which will also reduce the annual contribution. My calculations as well as the recommendation of Bartel show this to be a superior solution vs. making smaller payments over time. I also previously provided the Town Council will a detailed analysis prepared by the City of La Palma which showed the benefit of a one-time payment vs. smaller annual payments. If you need to see that again, please let me know and I will forward that to you. The Town ran very efficiently in FY 2014 with $60.4m of cash. There is no objective evidence to suggest that the Town cannot run very efficiently with $63.9m (after having made a $10m onetime payment to CALPERS). If the Town follows this recommendation, the following circumstance will be that the General Fund reserve for capital projects will remain $8,273,124; the same level as the prior year. This will not have any impact on the Town's ability to fund the current 5 year Capital Plan That current plan was based on the $8,273,124. Additionally, the current 5 year Capital Plan did not include the impact of Measure B funds, about $582,000 per year which will now flow to the Town, nor the impact of the new Sales Tax of about $800,000 per year. Lastly, by making a $10m payment to CALPERS, there will be an additional savings from the reduced interest expense. It should also be pointed out that when looking at the General Fund reserve for capital projects, the Town Council should factor into their analysis that exclusive of the reserve for Almond Grove, there is a "net" GFAR reserve of $6,730,345 available for all other capital projects. Summing these two, there is $15,003,469 currently available to the Town for capital projects as of June 30, 2018, other than the Almond Grove. This compares to $16,020,571 which was available as of June 30,2017. Simply put, there are sufficient resources available for the Town to fund its currently adopted 5 year Capital Plan. Summary I don't think it prudent for the Town Council to adopt the resolution being proposed. It does not seem to make sense for excess cash to be held in low yielding accounts while simultaneously incurring very high interest debt. Subject: Attachments: Agenda Item #6 - Approval of the FY 2018 CAFR Letter - 2018 CAFR.final.docx From: Phil Koen [rnailto: sikoenCa@m,,onterapartnerscc corn] Sent: Monday, December 17, 2018 10:11 AM To: Rob Rennie; BSpector; Marico Sayoc; Marcia Jensen; Steven Leonardis Cc: jak vannada; _' '_'r �:` ,t =; Rick Tinsley; Laurel Prevetti; Robert Schultz Subject: Agenda Item #6 - Approval of the FY 2018 CAFR Dear Town Council Members, Attached is letter urging the Council Members not to adopt the FY 2018 CAFR. This draft has not been approved by the full FC nor has the current draft even been reviewed by the full FC. This is a departure from the long standing process of having the FC approve the CAFR and make a recommendation to the Town Council for adoption. To be clear, this has not occurred. I am copying the resident members of the,FC so they are aware of the current resolution sitting in front of the Town Council. Additionally, the CAFR does not meet the most basic requirement of GASB 34 which is to provide an "objective and easily readable analysis" of the Town's financial performance, including providing an "analysis of significant budget variances". These variances can be found on page 42 in a scheduled titled "Statement of Revenues, Expenditures and Changes in Fund Balance". In the letter I have specifically identified a number of significant budget variances that need to be explained. Lastly, the only sentence that addresses the budget variances can be found on page 26 of the CAFR. From all of the information known to me, I believe the sentence is materially misleading and factually incorrect. This needs to be corrected and a clear statement made as to the magnitude and impact of the practice of "over budgeting salaries and benefits" that the Staff has used in preparing the budget. To put a very sharp point on this, the Staff has suggested that there are "operational cost savings" arising from actual staff costs. The word "savings" is factual incorrect and intentionally misleading. For example, if I hire a staff member at an annual salary of $100,000 and I budget that position at $200,000, is it accurate to then claim that I "saved" the Town $100,000, knowing that there was never any intention to pay that individual $200,000? This is what the Staff wants the public to believe. This is wrong and needs to be corrected. Please do not approve this CAFR. It is too important a document not to get "right". Sincerely, Phil Koen 1 Dear Council Members, Summary The Town Council should not adopt the draft FY 2018 CAFR. This current draft has not been reviewed nor approved by the FC. Process matters, just like facts and transparency matter. When the FC was established, one of its fundamental duties was to review and approve the CAFR. Lacking this approval, the Town Council should send this draft back to the FC for a complete review and FC vote on approval. Receiving an award should not trump accuracy nor process. It is a critical document that the Council should use to understand and manage the town's business. It should be easily understood by the Council and non -financial citizens. This CAFR does not meet basic disclosure requirements and contains materially false and misleading statements that should never be sent to the GFOA. Background GASB 34 requires financial managers to discuss in the management's discussion and analysis (referred to as MD&A) section of the CAFR their insights on the financial results by giving readers an "objective and easily readable analysis" of the government's financial performance of the year. Specifically, GASB 34 requires that "this analysis should provide users with the information they need to help them assess whether the governments financial position has improved or deteriorated as a result of the year's operations". In addition, the MD&A should specifically "provide an analysis of significant budget variances". These are not discretionary rules, rather they are mandated by the GASB. The MD&A is prepared by Staff. While a required part of the CAFR, the auditor does not audit the MD&A for completeness nor express an opinion on the MD&A. The Auditor Report as outlined on slide 8 of his presentation (attachment 3) does not state that the MD&A section is fairly presented. His opinion only extends to the financial statements. By approving this draft CAFR, the Council is representing to the residents that you are reasonably knowledgeable of the financial results of the Town, you can explain them and the MD&A as presented provides an objective and easily readable analysis of the government's financial activities, including but not limited to an analysis of significant budget variances. As our elected officials, you are a fiduciary and as such it is assumed that you have taken the required steps to insure you have acted appropriately. The CAFR is a public document that many interested parties will rely upon, including but not limited to the residents, creditors and credit agencies to name of few. Please do not act without proper consideration and reflection of this CAFR and your responsibilities to us. The MD&A is wholly inadequate and fails to meet basic disclosure requirements This CAFR's MD&A section does not meet the most basic level of required disclosure. Ask yourself if reading the current MD&A section provides you with a reasonable level of understanding as to what has happened over the past year. Specifically on page 26 there is only one sentence that addresses significant budget to actual variances. Is that adequate? Is it even correct? I will address this in a moment. On page 42 of the CAFR, there is a scheduled presented entitled "Statement of Revenues, Expenditures and Changes in Fund Balance, Budget and Actual". This is a required schedule and is the only schedule where the reader can review how the Town performed versus both the adopted budget and the final budget. Upon reviewing this schedule there are some very basic questions that have not been addressed in the MD&A that should have been. With a thoroughly written MD&A, the Council should be able to answer the following: • What caused the $1.3m positive variance in charges for services revenue? Was this driven by changes in service fee rates or more volume? • Why are expenses for Administrative Services 11 % ($389K) under the final budget? What programs weren't done that led to this underspending? Were there open positions that weren't filled during the year? • Why are expenses for Public Safety 7% ($1.1 m) under than the final budget? Is the police department understaffed? Are there a number of unfilled positions? What drove this? Didn't we just pass a sales tax so the Town can increase the spending in public safety? Why did we do that if we aren't spending what is currently budgeted? • Why are expenses for Library Services 10% under the final budget? What was planned to be done that didn't get done? • Why did the Town's Final Budget call for a $(1.8m) deficit of revenues over expenditures only to record an actual $3.5m surplus? This is a massive turnaround totaling $5.3m. What is the impact on the Town of not being able to properly forecast a surplus? When you have these answers, they will facilitate your understanding of the CAFR and help you plan your Strategic Priorities for the next year. All of these answers need to be in laymen's language such that the Council and the public can understand what is being stated. The more informed everyone becomes, the more it will raise the level of the town's performance. I would like to make one more important point regarding the $5.2m variance between the final budget and actual surplus of revenues over expenditures. You may say to yourself, "isn't that a good thing? The Town did better than what was expected." This is not a good thing! The $5.2m variance is almost equal to 15% of the Town's original budget for Total Revenues and Total Expenditures! This variance is material and should raise some basic questions as to how well the Staff is performing as financial stewards. This inability to forecast denied the Town Council the ability to make budgetary adjustments and reallocate available capital to other critical programs. This "opportunity cost" is massive and real and cannot be over looked. The MD&A contains factually incorrect and materially misleading statements On page 26 of the CAFR, there is only one statement that addresses budget vs actual results. The statement is: • Comparing the FY 2017/18 final amended budget to the actual result shows $2.4 million in savings due to operational cost savings primarily from $1.9 million of salary and benefit savings related to staff vacancies and actual staff costs. Over the past 4 weeks I have sent four emails to the Town Council and staff requesting a full and clear explanation as to how the Staff budgets salaries and benefits. I also attended the FC this past Monday and specifically asked the Staff to revise the MD&A to include a clear explanation of this $2.4m variance. To date, the Staff has given conflicting explanations and refused to provide a fully transparent explanation. I deserve an answer, and the Council deserves an answer. This should not be the way Staff works with the FC, nor the public. The Staff doesn't get to pick and choose which questions to answer and from whom. As financial stewards they are required to answer all questions asked. That is the nature of accountability. The explanation provided is factually incorrect and misleading. While it is correct that there were some limited vacancies during the year, the "savings" attributable to vacant positions was very small when compared to the "over budgeting" which occurred in preparing the budget for salaries and benefits. Based on the facts as I know them, there was an intentional budget cushion built into the plan for salaries and benefits that was around $1.5m. Why not disclose the exact amount that was actually included in the plan as a result of budgeting salaries at "top step" regardless of actual pay rates? Why conceal this from the public? What is worse is that the public has been purposely mislead for years regarding this "cushion" in salary and benefits. The following are the exact statements taken from the MD&A sections for 2016 and 2017 CAFR's: • Comparing the FY 2015/16 final amended budget to actual result shows $3.1 m is savings due to operational cost savings primarily from savings related to staff vacancies • Comparing the FY 2016/17 final amended budget to actual result shows $2m in savings due to operational cost savings primarily from savings related to staff vacancies. All of the above are false and misleading. These "savings" were not due to any operational cost savings. Rather, they were almost entirely due to the budget for salaries and wages being purposely inflated every year. You should ask staff why they did this. When we talked to three of you, it was evident you either didn't know about the 3 year total over -budgeting, or did not comprehend the financial impact. We were given 3 different stories as to this annual over budgeting. It is staff's responsibility to make sure you fully understand what they have done, and why. There is a very real difference to "savings" attributable to being more efficient vs "savings" because you purposely over -budgeted. Before this CAFR can be approved, adequate disclosure regarding the $2.4m variance is required. That means that the amount of variance due to the budget "cushion" needs to be disclosed in addition to the amounts attributable to staff vacancies. Conclusion The MD&A section closes with a paragraph titled "request for information". The Staff specifically states "the financial report is designed to provide residents, taxpayers, customers, investors and creditors with a general overview of the Town's finances and to demonstrate the Town's accountability for the money it receives". Without accurate and transparent MD&A discussion, this CAFR will not give the reader any confidence that the Town has been accountable over the money it has received. It is my opinion the MD&A is the perfect vehicle to fully explain all of the information in the CAFR. To date, too much information is hidden in plain site that could, and should, be brought to the Council's, and public's attention.