Response to the Audit
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November 15, 2018
Elaine M. Howle
621 Capitol Mall, Suite 1200
Sacramento, CA. 95814
Re: Response to November 7, 2018 letter from State Auditor
Dear Ms. Howle:
The following is the City of Montebello's response to your draft report, which was received by the City on November 7, 2018. The report focused on various areas of operational concern and stems from your audit efforts, aided by City staff's full cooperation and participation, from June of 2018 to the date of this letter.
The City of Montebello believes this report augments and complements actions that the City has already undertaken and/or is currently developing, and will help confirm issues and concerns that the City has shared with its community. The City of Montebello appreciates the common ground that was created by City staff's sharing of information with the State Auditor and supports many of the conclusions reached in the report. In fact, as your staff is aware, the City has already identified many of the same conclusions in your report and taken many steps toward improving its fiscal and operational efficiencies. As we all recognize, while much improvement has been made, there are still areas that the City needs to address. The City of Montebello has and will continue to make the needed improvements that are necessary to improve operational effectiveness and productivity.
A strong contributory factor for many of the underlying operational concerns contained in your report is City staff turnover in key positions. This was also recognized by both the City and State Controller in the Controller's 2011 audit report. This factor has been an ongoing challenge for the City, particularly in the past few years.
Your report recommends solutions to sell assets in order to improve the City's economic picture. While these solutions may be operationally necessary in the future, they will not entirely solve the City's fiscal challenges essential to operating as a full-service city. The Montebello community will need to understand that these solutions and many actions already being taken by the City are steps, not final solutions, toward resolving the fiscal issues facing the City. Some of your recommendations reflect many of the same actions that the City has already pursued and been expressly criticized for in the past, such as "selling its assets to meet short-term needs."
The City of Montebello needs to develop a better communication system to educate the community and develop the trust necessary to create sustainable long-term solutions to properly staff its departments to a level that the community wants and needs.
It is important to highlight the significant issues and challenges that have confronted the City, the internal and external influences and factors the City has responded to, and the specific steps the City has taken to address its fiscal issues to date. For well over a decade, different City Councils and different City Administrations have adjusted and adapted to formulate strategies for operating this full-service city.
Over the past decade, the City has experienced the following economic, political, and organizational challenges:
- Since 2003, CALPERS has modified pension assumptions at least 5 times, causing an increase to the unfunded pension liability from $89,000,000 to $136,000,000. This represents a $47 million increase. The City has no control over these changes.
- In 2009, the City investigated contracting out public safety services in an effort to reduce costs, but voters responded with a ballot measure (Measure M) requiring a 55% voter approval prior to any transfer of the City's fire or police services to another public entity. This voter approved Measure substantially limited the City's ability to adjust to meet the increasing public safety service costs.
- In 2016, the City Council in recognizing the limitations in operating the water system, including the cost to users and the need for ongoing repairs, chose to present a ballot measure to the community seeking approval to sell the City's struggling water system in order to raise additional revenue for the City. The voters rejected this measure, thus tying the hands of City leadership in their desire to properly address a significant water infrastructure problem.
- In 2017, the City Council sought voter support to minimize the impact of layoffs and service cuts by presenting a ballot measure to the electorate seeking approval to raise the sales tax by up to 1 cent to finance public safety and general municipal services and address budget shortfalls. Montebello voters once again rejected this measure.
Despite these many ongoing challenges, the City of Montebello has persevered by implementing improvements and taking corrective actions. Prior to your report, the City had already updated policies and procedures to increase internal controls, raised additional revenue, and implemented cost-saving measures in order to maintain financial stability. These actions include the following:
- Since 2013, the City has exchanged restricted Proposition A transportation funds with neighboring communities who could continue to meet the mandate of addressing regional transportation needs. These funds were used to increase the City's available General Fund cash reserves and also were used for deferred capital improvement projects. These exchanges of funds did not adversely impact the City's transportation services, but instead provided needed funds for other City priorities.
- In 2016, it became evident that additional changes were needed. The City initiated layoffs and, in 2017, initiated hiring freezes to reduce its expenses. Many of the hiring freezes are still in effect today, and as a result, the FY 2017-18 operating revenues exceeded operating expenditures by $2.7 million.
- In August 2016, the City adopted a debt management policy.
- In 2016 and 2018, the City's Finance Department provided citywide purchasing training as a result of the purchasing department's decentralization and to implement proper purchasing practices.
- In 2017, the City formally drafted and implemented a capital asset policy, a federal grant procurement policy, and a grant management policy.
- In 2018, the City updated and formalized standard operating procedures (SOPs) regarding accounts payable payments and invoice approval, cash receipts and refunds, bank account reconciliation, payroll and collections.
- In 2018, the City reviewed and increased user fees for FY 2018-19.
- In 2018, the City received $2 million of a $5 million advance for a new development project. These funds are not included in the current year's budget projections.
- The City has interviewed several financial advising firms and is in the process of selecting a consultant to assist with debt and investment decisions.
- The City is in the process of analyzing its hotel cash flows, comparing them to the associated bond documents and identifying areas of needed improvement.
- The City is in the process of reviewing and updating its policies and procedures regarding procurement, contracts, petty cash, credit cards, etc.
- In 2013, 2014 and 2017, the City raised its water rates to cover ongoing expenses and eliminate subsidizing of the City's water system. As a result, the City's Water Fund operating revenues exceeded operating expenditures by $800,000 at the end of FY 2017-18. As a result, the Water Fund will begin to pay down loans made by the General Fund to the Water Fund, while still completing some deferred capital improvements.
- In 2018, after years of planning, the City will see reductions in the Golf Course operating deficit through the use of reclaimed water.
- Since 2017, the City has prepaid to CALPERS the annually billed unfunded liability, saving the City 3% of the annual amount.
The aforementioned list is not all-inclusive but illustrative of the City's commitment to improving operational efficiencies. The City has taken many other actions and has many additional planned improvements. The City will continue to prioritize its services in order to balance its budget.
Not addressed in your report but materially important to the City's fiscal condition is the fact that there is a major housing development underway in the community. This project consists of 1,200 new homes and is anticipated to generate over $4 million annually in new property and other tax revenues at build-out.
Lastly, while the City agrees with many of the conclusions reached within the report, there are areas the City believes need clarification or correction, including the following:
1. The draft report (page 5) references that "in fiscal year 2016-2017 Montebello added $4.7 million in restricted redevelopment funds to its general fund balance. Had it not done so, the city would have ended the fiscal year in an operating deficit."
The City takes issue with this statement as written since it is misleading. The City never intended to use the $4.7 million restricted funds to balance its budget. The funds as noted were specifically excluded from the "unassigned fund balance." The City actually ended the year with an operating deficit of approximately $71,000. This amount, in context of the City's overall budget, is negligible.
2. The draft report states that the "the city unfunded retiree pension . . . obligations continue to grow, and these expenses will place increasing pressure on the city finances."
CALPERS has recently changed its pension billing methods to fully amortize the unfunded liability over 30 years. Therefore, the current unfunded liability pension obligation will reduce over time.
3. The draft report (page 13) references that "Montebello has relied on these exchanges for the past five fiscal years to bolster its general fund but there is no guarantee that the city will be able to negotiate such an exchange in any given fiscal year."
The statement is partially correct. The City has historically exchanged Proposition A funds in the past five years. The City did not use the exchange to bolster its General Fund. The City used the funding to address more than $1.9 million in deferred street improvements as is evidenced from the FY 13-14 through FY 15-16 CIP budgets. The City did not use the funds to balance the FY 17-18 budget but improved its city reserves. FY 18-19 is the first year in which the City identified this exchange as a budgeted item for balancing the budget.
4. The draft report (page 5) references that "the bonds issued to construct the hotels, meanwhile, continue to expose the city's general fund to significant risks."
We agree that there is a slight risk, but it is important to note that the investment risk factors and remedies are fully disclosed in the bonds' official statements. The risks are not extraordinary, but typical for investments of this nature. In addition, the risks for both hotels are not the same inasmuch as the first hotel has additional remedies through the RDA. Further, there is no indication that the hotel revenues will fall short of its expenses.
In examining the overall efforts of the City of Montebello, the City Council and City management, the collective City team should be commended for its efforts in addressing the difficult economic challenges that face not just the City of Montebello, but all local governmental agencies throughout the State of California. We recognize the need to apply "best practices" in providing services to the residents of our City. Change is welcomed, but any unfounded criticism is detrimental to the continued progress of the City.
Montebello has for many years been the "jewel" of the San Gabriel Valley and the County of Los Angeles. Many developers, businesses and new residents find Montebello to be a wonderful location to live, work and operate their businesses. The City will take seriously the recommendations of the State Auditor, but will challenge any attempt to extend and direct improper criticism towards the hard work of the City's leadership and management team.
We thank the State Auditor's Office for your review of the City's operations. The City of Montebello stands committed to improve upon our efforts to make Montebello the best it can be.
CITY OF MONTEBELLO
Acting City Manager
California State Auditor's Comments on the Response From the City of Montebello
To provide clarity and perspective, we are commenting on Montebello's response to the audit. The numbers below correspond to the numbers we have placed in the margin of Montebello's response.
The city states that we recommend that the city sell assets; however, our recommendations offer several options, which may include selling assets. We note that the city has the ability to sell the golf course. However, we recommend that the city evaluate the effectiveness of its current plans and consider alternate uses for the golf course. Further, we note that the city had already attempted to sell its water utility, but was not successful. We recommend that Montebello reevaluate selling its water system in light of recent state legislation that would allow for the sale without seeking voter approval, among other options. We made these recommendations not to meet "short-term needs" but because these enterprises have been a drain on the general fund.
Throughout this audit report we acknowledge steps the city has taken and plans to take to maintain financial stability. For example, we discuss the city's hiring freeze here and here, updated procedures here, and increased water rates here.
The city is incorrect. We include the acting city manager's perspective on this housing development here and note that construction will begin in 2020.
While preparing our draft report for publication, some page numbers shifted. Therefore, the page numbers Montebello cites in its response do not correspond to the page numbers in our final report.
Our statement is accurate. In its financial report for fiscal year 2016–17, Montebello states that its surplus in that fiscal year was due to a transfer of $4.7 million of restricted funds to its general fund. The city notes that without taking the transfer into consideration, its general fund would have ended the year with a slight deficit, as we discuss here.
We stand by our conclusion that the city faces increasing retirement costs. The city did not make us aware that CalPERS included payments to Montebello's unfunded liabilities in the payments CalPERS required the city to make until the day we received the city's response to our draft report. However, after reviewing additional documentation, we modified the text discussing retirement costs—beginning here—and updated our recommendation to reflect this new information.
As shown in Figure 1, without one-time revenues—including exchanges of the Proposition A transportation funds for unrestricted funds—the city would have had an operating deficit in its general fund in three of the last four fiscal years.
We acknowledge that the city made an agreement with its former redevelopment agency to lend money for the first hotel in the event of a shortfall. However, we note that the city would still have to repay the loan in future years. Further, such an agreement does not exist for the second hotel. Therefore, we stand by our conclusion that the city's general fund is exposed to significant financial risks.