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- San Gabriel’s Poor Financial Management Has Eroded Its Financial Condition
- San Gabriel Needs to Consider Additional Expenditure Reductions and Revenue Increases
- Gaps in San Gabriel’s Management Controls Increase the Risk of Inefficiency and Waste
San Gabriel’s Poor Financial Management Has Eroded Its Financial Condition
San Gabriel Continues to Rank as High Risk for Most Indicators of Financial Health
San Gabriel’s lack of available cash will continue to constrain its efforts to respond to unforeseen events and to reduce the risk to its financial health. This situation began when city leadership—city council and city management—prevented San Gabriel from using $7.8 million of its general fund cash beginning in fiscal year 2014–15 when it entered into a questionable loan and committed that amount as collateral. As a result, San Gabriel had no available cash in its general fund by the end of fiscal year 2015–16. Despite this condition, from fiscal years 2015–16 through 2017–18, the city continued to spend more than the revenues it received—further deteriorating its financial health—and had to rely on borrowing from other city funds to support its operations. Even though the city has taken recent steps to address its financial condition, the effects of the pandemic and its lack of available cash have negatively affected the city’s financial stability.
Since fiscal year 2016–17, San Gabriel has remained high risk in many indicators of financial health. Based on our analysis of its audited financial statements for fiscal year 2019–20, San Gabriel continues to show signs of fiscal distress for seven out of 10 of our financial indicators, as shown in Table 1. Specifically, it remains high risk for general fund reserves and liquidity indicators because it still has a general fund reserves deficit of $8.1 million and roughly $6.4 million of its cash continues to be restricted as collateral with a lender. Furthermore, the city’s fiscal year 2019–20 level of risk related to its ability to fully pay for retirement benefits—pensions and OPEB—continues to mirror its risk during fiscal year 2016–17. Current and former employees have earned these benefits, but the city has not set aside enough funds to pay for the full cost of these retirement obligations. In addition, these obligations are expected to grow, putting more pressure on the city’s finances. If San Gabriel does not implement changes and adequately plan for the city’s long‑term financial health, the status of its financial condition will continue to be poor—raising concerns about the impact this could have on the future operations of the city.
San Gabriel Continues to Exhibit High Financial Risk
|FINANCIAL RISK INDICATOR||INDICATOR EVALUATION||INDICATOR EVALUATION||INDICATOR EVALUATION||INDICATOR EVALUATION|
|General Fund Reserves||High Risk||High Risk||High Risk||High Risk|
|Debt Burden||Low Risk||Low Risk||Low Risk||Low Risk|
|Liquidity||High Risk||High Risk||High Risk||High Risk|
|Revenue Trends||Moderate Risk||High Risk||Moderate Risk||Moderate Risk|
|Pension Obligations||High Risk||High Risk||Moderate Risk||High Risk|
|Pension Funding||High Risk||High Risk||High Risk||High Risk|
|Pension Costs||High Risk||High Risk||Moderate Risk||High Risk|
|Future Pension Costs||High Risk||High Risk||Moderate Risk||High Risk|
|OPEB Obligations‡||Moderate Risk||Moderate Risk||Low Risk||Moderate Risk|
|OPEB Funding‡||High Risk||High Risk||High Risk||High Risk|
|California State Auditor’s Local High Risk Dashboard||San Gabriel’s audited financial statements|
Source: State Auditor’s local high risk dashboard at https://www.auditor.ca.gov/local_high_risk/dashboard‑csa, and State Auditor’s analysis of San Gabriel’s audited financial statements for fiscal year ended June 30, 2020.
* Several financial indicators temporarily improved in fiscal year 2018–19 because of a one‑time noncash contribution of $70 million that San Gabriel received from the San Gabriel Valley Council of Governments related to infrastructure, which cannot be used to pay for the city’s obligations.
† The fiscal year 2019–20 results are based on audited financial statements but are not yet available on our local high risk dashboard.
‡ OPEB = other post‑employment benefits.
San Gabriel’s City Council and Former Management Have Allowed the City to Deplete Its Financial Reserves
San Gabriel remains in a precarious financial condition because it does not have financial reserves and has no available cash in its general fund. As a result, San Gabriel has had to borrow from its other funds to cover its obligations. As Figure 2 shows, San Gabriel had positive general fund reserves of $10.2 million in fiscal year 2014–15. That decreased over the next three years to a deficit of $9.9 million in fiscal year 2017–18. The city got into this tenuous financial position primarily based on three factors: the city council’s decision to enter into a loan in 2014 that restricted the use of much of its general fund cash, a lack of sufficient financial oversight by the city council, and a lack of fiscal transparency by former city management. The biggest part of the city’s general fund reserves deficit is related to this loan, which we discuss later in this report. The remainder is the result of deficit spending not supported by revenue, such as taxes or fees. In fiscal year 2019–20, San Gabriel’s general fund reserves deficit was $8.1 million—$6.4 million of which is due to the collateral requirement of this loan. This lack of general fund reserves and available cash limits the city’s ability to respond to fiscal emergencies and revenue shortfalls, and it could cause the city to have trouble maintaining services to its residents, especially considering the prolonged and uncertain economic impacts of the pandemic.
San Gabriel Has Depleted Its General Fund Reserves
Source: Analysis of San Gabriel’s audited financial statements for fiscal years 2014–15 through 2019–20.
Note: General fund reserves exclude cash that the city must hold as collateral for its public works loan and is thus unavailable for use, as we discuss here.
San Gabriel’s general fund reserves decreased steadily from fiscal years 2014–15 through 2017–18 because the city council did not exert adequate oversight over former city management. During these years, the former finance director and staff developed and presented general fund budgets and staff reports to the city council that showed that San Gabriel’s revenues were generally covering expenditures and that the general fund had a positive fund balance. In reality, San Gabriel was consistently receiving less revenue than budgeted and frequently spent more than budgeted. Specifically, from fiscal years 2014–15 through 2017–18, actual general fund revenues were $11.4 million lower than budgeted and general fund expenditures were $8.9 million higher than budgeted for a total budget overrun of $20.3 million during these four years.
Former city management did not clearly disclose these revenue shortfalls and expenditure overruns to the city council and the public. The city’s municipal code requires the city’s finance department to prepare and present various reports to the city council with sufficient detail to show the exact financial condition of the city. However, from fiscal years 2014–15 through 2017–18, we did not find—and the city could not provide—documentation showing that the former city manager and former finance director provided to the city council periodic budget updates or that they presented the city’s audited financial statements publicly, even though such information would have shown that the city’s financial condition was in significant decline. Although the former finance director distributed audited financial statements to the city council via interoffice memos, these memos did not include descriptions or explanations of San Gabriel’s revenue shortfalls, expenditure overruns, or declining general fund reserves. Further, the city was unable to provide us with documentation that the city council ever asked for budget updates, formal presentations of the city’s audited financial statements that would include an explanation of the city’s financial concerns, or additional information on the city’s financial condition from the former management.
By failing to exercise the necessary oversight to ensure that city management had fully apprised it of the true financial condition of the city, the city council failed to fulfill its fiduciary responsibility over the city and in overseeing the city’s financial health. The city council adopted unrealistic budgets that overestimated revenues and underestimated expenditures, did not ensure that management held city departments accountable for overspending budget appropriations, and approved spending that depleted the city’s financial reserves.
The current city manager, who was appointed in February 2018, told us he learned of the city’s dire financial situation around the end of 2018 after its former finance director and its independent auditors informed him of the depleted general fund balance for fiscal year 2017–18. However, the city council should have already known of its declining general fund balance especially since its general fund reserves—the amount of its fund balance that is available to use without restriction—became negative at the end of fiscal year 2015–16. For fiscal year 2016–17, the city’s auditors issued a finding concerning the decline in the general fund balance during the previous two fiscal years. In its response to the audit, city management claimed it would address the situation to avoid further depletion of its general fund balance. However, for fiscal years 2017–18 through 2019–20, the auditors continued to express concern that the city had suffered significant reductions in its general fund balance in the audit opinion and in footnotes to the financial statements. They mentioned further that this condition raised concerns about the impact this would have on future operations of the city. Thus, the city council should have taken a more active role in overseeing former city management and in understanding the true financial condition of the city.
Beginning in fiscal year 2018–19, San Gabriel’s leadership implemented a number of improvements to increase transparency and communication between the city council and city management and to control department spending. For example, in May 2019, the city adopted its fiscal sustainability policy, which requires, among other things, that city management develop budget documents that include actual past revenue and expenditure results, that it disclose and communicate San Gabriel’s financial condition in periodic budget updates to the city council and the public, and that it similarly present the city’s audited financial statements to the city council publicly. We found that city management has generally provided this information since 2019. In addition, the fiscal sustainability policy established notification and approval requirements to prevent city departments from exceeding their approved budget. For example, the policy requires departments to monitor their budgets and notify the city manager and finance director of possible budget overages. According to the city’s audited financial statements for fiscal years 2018–19 and 2019–20, the city has ceased expenditure overruns.
While these actions are an improvement over previous city practices, the city continues to have a significant reserves deficit, and the current measures in place may not be sufficient to fully address its financial problems. In October 2019, to raise revenues, San Gabriel city council put Measure SG, a 0.75 percent increase in sales tax, on the ballot for March 2020. Voters approved this tax, which went into effect on July 1, 2020. According to the city’s midyear budget update, the new tax generated $1.3 million in revenue as of January 2021, which is generally on track with the $2.8 million the city budgeted for fiscal year 2020–21. At the time voters approved it, the city projected that this new tax would generate $3 million annually in new revenue and would help rebuild its depleted reserves, but almost simultaneously with Measure SG’s passage, the pandemic began to negatively affect San Gabriel’s economy. Although the pandemic has caused other city revenues—like the hotel tax revenues generated by San Gabriel’s hotels—to decline dramatically by about $1 million for fiscal year 2020–21, the new Measure SG revenue has mitigated some of these losses. According to the city manager, this revenue has allowed the city, at least in the short term, to avoid potential furloughs, layoffs, and cuts to city services that might have otherwise occurred. While we recognize that this tax measure would have helped the city to reduce its deficit if it had not been for the pandemic, the city will need to eliminate its general fund borrowing from other funds, which we discuss later, before it can build a reserve.
Because San Gabriel’s general fund reserves continue to have a deficit balance, the city may have difficulty sustaining its future operations because cities that do not have enough reserves to pay for at least two months of expenditures may have trouble maintaining service levels in times of declining revenues or increasing costs. As we have seen, San Gabriel has had a lack of adequate reserves for the last five fiscal years and may experience difficulty maintaining service levels in the future. With the prolonged and uncertain economic impact of the pandemic exacerbating the situation, San Gabriel’s lack of financial reserves will continue to threaten the city’s financial health and its ability to provide services to its residents.
San Gabriel Entered Into a Questionable Loan That Further Exacerbated Its Financial Problems and Restricted Its Available Cash
To pay for capital improvements, San Gabriel entered into two major loans in 2014 and 2015. In December 2014, the city entered into a loan agreement with Citizens Business Bank (Citizens Bank) for $7.8 million to complete the construction of the city’s public works yard (public works loan). As Figure 3 shows, this public works loan required San Gabriel to pledge an amount equal to the borrowed amount that would be held by the bank as collateral for 10 years. The bank charges a relatively low annual interest rate of 1.6 percent on the loan balance and the city earns about 0.6 percent interest on the collateral balance. On the other hand, the city cannot use the pledged amount to support city operations until it pays off the outstanding balance of the loan.
San Gabriel Restricted Its Access to Its General Fund Cash When It Collateralized Its Public Works Loan
Source: Analysis of San Gabriel’s audited financial statements from fiscal years 2014–15 through 2019–20.
Because the city has used its general fund cash to fulfill the collateral requirement, it has significantly restricted its ability to pay for city services using cash from the general fund. Since fiscal year 2015–16, the city has not had any available cash in its general fund at year‑end, yet it continued to overspend for two more years. To pay for this overspending and to adhere to the collateral requirement, the general fund borrowed money from other funds. This agreement to hold a significant portion of the general fund’s cash as collateral is unusual for a local government. The California Debt and Investment Advisory Commission (CDIAC) Debt Financing Guide, which provides guidance on how public agencies can use debt financing in the State, does not mention any loans that require a significant cash collateral requirement. The CDIAC lists many types of public debt, including direct loans, and often these forms of debt are secured through an existing revenue source such as a sales tax or a capital asset, like a building.
As of June 2020, San Gabriel still had a significant balance on the loan. According to the city’s audited financial statements, the loan and collateral requirement had decreased from $7.8 million in fiscal year 2014–15 to $6.4 million as of the end of fiscal year 2019–20, as the city has paid down $1.4 million of the loan balance. The city must pay off the remaining balance of $5.4 million, of which $5.2 million is in the form of a balloon payment, in fiscal year 2024–25.A balloon payment is a large payment due at the end of a loan. A balloon loan is set up for a relatively short term, and only a portion of the loan’s principal balance is amortized over the period. The remaining balance is due as a final payment at the end of the loan term. Balloon payment debts are more common in commercial lending than in consumer lending. This means that, unless the city takes other actions, its general fund cash will continue to be constrained by this loan until then if not longer. In a December 2014 letter, Citizens Bank indicated that San Gabriel has an option to extend the loan for two additional 10‑year terms generally under the same terms as the original loan, but the interest rate charged will be based on the 10‑year certificate of deposit rate at the date of the agreement plus 1 percent. According to the terms of the extensions, the city must also continue to maintain a cash amount equal to the loan balance as collateral with the bank. If the city chooses the first extension, we estimate it will pay roughly an additional $350,000 in interest over 10 years if the current rate remains the same, and its access to its cash will continue to be restricted until 2035.
The city council and management team at the time failed to adequately evaluate the financial impact of this loan. Although the city had approximately $6 million in its general fund reserves at the end of fiscal year 2013–14, this was below the amount it projected that it needed to fully pay for its public works project. San Gabriel did not have any outstanding third‑party debt in fiscal year 2013–14, the year before it entered into the loan, and the current city manager indicated that to his knowledge the city has not had a credit rating from a rating agency, which is used to assess creditworthiness. A credit rating, although not generally required, can be advantageous for issuing bonds. One city council member indicated that the former finance director told the city council that the city had limited financing options because it did not have a credit rating. In a September 2014 staff report, the former finance director informed the city council that the finance department sought financing options from a number of entities, including bond underwriting firms, and that the public works facility loan was the lowest cost and best option. As a result, he recommended that the city council approve the loan.
However, it does not appear that the former city management provided the city council complete information on the financial impacts of funding this project through such a loan, nor did it provide other funding options. The city council meeting minutes and documents that city management provided to us do not show any discussion of potential negative effects or risks to the city’s financial condition, like the impact the loan would have on the general fund by tying up most, if not all, of San Gabriel’s general fund cash. Additionally, we did not find evidence that former city management provided to the city council alternatives, such as using its existing reserves to pay for at least part of the project or delaying the project. In 2014 the city council unanimously approved city management’s recommendation to enter into the loan. According to one city council member, he had concerns about the collateral requirement of the loan, but the former finance director said the city did not have other options and would need to approve the loan to finish the public works yard, which was completed in fiscal year 2016–17.
San Gabriel’s Special Revenue and
Internal Service Funds
- The Waste Management Special Revenue Fund accounts for a solid waste surcharge from rate payers and is restricted for financing solid waste management‑related programs.
- The Sewer Assessment Special Revenue Fund accounts for sewer user fees and is restricted for paying for the maintenance and capital improvements of the sewer system.
- The Development Impact Fee Special Revenue Fund accounts for fees from developers and is restricted for financing public facility improvements.
- The three Self‑Insurance Internal Service Funds are used to account and pay for risk management services related to workers’ compensation and liability claims.
Source: San Gabriel’s adopted budgets and audited financial statements.
The collateral requirement of the loan has had a disastrous impact on the city’s finances. At the end of fiscal year 2014–15, the general fund had a $10.2 million reserves balance. As Figure 3 describes, $7.8 million of San Gabriel’s cash was restricted as collateral. As San Gabriel used the loan proceeds during fiscal year 2015–16 on the public works project, it continued to spend more than its revenues, which caused its general fund reserves to fall to a deficit of $4 million. Because the collateralized amount is not available for the city’s use, the general fund has had to borrow from other funds to pay the city’s obligations and maintain the collateral, which creates challenges in stabilizing its finances.
Specifically, the city used money from other city funds to cover general fund shortfalls and maintain the required collateral at the bank—a practice it has employed since fiscal year 2015–16. This practice is problematic because the general fund represents the financial health of the city and is expected to support city services and provide money for other funds as necessary. It should not regularly borrow money from other funds to support city operations. Figure 4 shows that in fiscal year 2019–20, San Gabriel’s general fund borrowed $8.5 million from other funds, including development impact fees and sewer assessments. As the text box describes, these funds generally receive funding through charges and fees paid by users, such as residents, and developers, and these revenues are intended to cover the costs of improvements related to those activities. As of June 2020, the city’s total borrowing from other funds and its outstanding loan balance equated to 49 percent of its general fund revenue in fiscal year 2019–20.
San Gabriel’s General Fund Borrowed Extensively From Other Funds Beginning in Fiscal Year 2015–16
Source: San Gabriel’s audited financial statements for fiscal years 2014–15 through 2019–20.
Because the general fund does not have the money to repay the other funds, this situation increases the risk that such borrowing could affect the services for which the other funds were intended, such as future improvements and repairs of San Gabriel’s sewer system. As of fiscal year 2020–21, the city has $5.4 million of funding budgeted for nine sewer system projects but has scheduled spending of only $1.1 million through 2024. The public works director asserted that the city is delaying those projects until it completes its sewer master plan update to avoid spending funds on projects that may no longer be relevant. Nevertheless, if the city’s general fund continues to borrow a significant portion of the sewer fund’s balance, there is a risk that the city will be unable to pay for its current or future sewer improvement projects. As of June 2020, the sewer fund had a balance of $6.5 million, but the city’s general fund borrowed $5 million of these funds, leaving $1.5 million to use for sewer‑related projects. Thus, the city cannot continue to afford to borrow funds dedicated for capital improvements to support its general fund shortfalls.
It is imperative that the city renegotiate or refinance the public works loan to free up its general fund cash, and San Gabriel is actively trying to refinance the loan to improve its liquidity and general fund reserves. Given that the public works loan carries a relatively low interest rate, if San Gabriel refinances the loan, it is probable the city’s new loan will have higher annual debt payments and possibly higher interest costs. We estimate that a 15‑year loan with an interest rate of 2.6 percent—1 percent above its current rate—will result in roughly $650,000 in additional interest costs spread over the term of the loan. However, doing so would free up more than $6 million of cash that San Gabriel has currently pledged as collateral. A new loan without the cash collateral requirement would also reduce San Gabriel’s general fund reserves deficit by 78 percent and significantly reduce the need to borrow from other funds. Nevertheless, the general fund reserves would still have a deficit of approximately $1.7 million, based on the city’s fiscal year 2019–20 financial statements. However, when San Gabriel reaches a positive general fund balance, those funds would not be restricted as collateral and generally could be used for other purposes. Unfortunately, because San Gabriel has had a deficit general fund reserves balance since fiscal year 2015–16, it will likely have difficulty finding willing lenders.
San Gabriel also entered into a second loan, one that the city did not manage appropriately, which resulted in the city paying interest costs for a loan it was not yet using. In May 2015, the city borrowed $3.8 million from the California Infrastructure and Economic Development Bank (IBank) for 15 years at 3.5 percent interest primarily to help pay for repairs to Del Mar Avenue, a major commercial corridor. Unlike the public works loan, San Gabriel secured this second loan by pledging Measure R revenues to pay the loan debt service. Measure R was a Los Angeles County ordinance that county voters approved effective July 2009 to implement a sales tax in the county for transportation projects. The San Gabriel city council, the board of directors of IBank, and the Los Angeles County Metropolitan Transportation Authority approved the IBank loan. This loan was costly because it required the city to accrue interest on the full balance beginning immediately regardless of when the city received the loan proceeds. Unlike other types of loans in which a lender charges interest as the borrower draws down the funds, the terms of the IBank loan stated that the interest accrues on the entire principal balance, whether or not the funds are disbursed. IBank loans are sometimes structured in this manner.
Given these loan terms, the city should have delayed entering into the loan until it was ready to begin work on the project. Initially the city planned to start the project in the spring of 2016 with completion expected by the fall of 2017, but the city did not finish disbursing these loan proceeds until fiscal year 2019–20—nearly three years later. The city expended only $200,000 of the $3.8 million on the project in fiscal year 2015–16. According to the San Gabriel public works director, the San Gabriel Trench project, which was already in progress, crossed Del Mar Avenue and likely delayed the starting of the project. Consequently, the city paid more than $100,000 in interest costs for a loan it was not then using. Ultimately, the city disbursed the remainder of the funds: $900,000 in fiscal year 2016–17, $525,000 in fiscal year 2017–18, $2.2 million in fiscal year 2018–19, and $211,000 in fiscal year 2019–20. However, the structure and timing of this loan caused the city to incur interest costs on a loan it was not using.
San Gabriel Needs to Consider the Continuing Impact of the Pandemic and Other Key Factors in Its Financial Projections
In its February 2021 midyear budget update, San Gabriel projected that it will continue to experience a negative general fund balance in fiscal year 2020–21, and this deficit will likely linger unless the city makes significant changes. The city manager’s office included a five‑year forecast along with its meeting agenda for an October 2020 city council meeting and it has twice provided us updates to this forecast, in December 2020 and February 2021. In its February update, the city projects its general fund balance to steadily increase over the next five years. According to the city’s management specialist, this forecast model is a living document that is intended to be used as a guideline in preparing the city’s budget and as a tool during the year to adjust expenditures if revenues are not meeting projections. We used the city’s model and data from its February update to create our own forecast for the city’s general fund over the next five years.
Although many of the assumptions the city used to develop its projections were reasonable, the city did not consider key factors. For example, as of February 2021, the city projects that it will have around a $6.4 million general fund balance by the end of fiscal year 2025–26; however, potential salary increases and the sustained impact of the pandemic on revenues may prevent the city from increasing its general fund balance from what it is now. Moreover, the city’s projections do not account for the amount the city must set aside as collateral for the public works loan, and thus, they do not reflect the amount the city has available as reserves. Unless the city refinances its public works loan, it will continue to lack access to the cash it pledged as collateral. As Figure 5 shows, considering these factors we project that the city’s general fund will likely continue to have a significant deficit over the next few years, and this effect will appear even more striking for the city’s general fund reserves when taking its collateralized funds into account.
San Gabriel Will Likely Continue to Have a Significant Reserve Deficit Through Fiscal Year 2025–26
Source: Analysis of San Gabriel’s most recent financial forecast.
Note: In March 2021, President Biden signed the American Rescue Plan Act of 2021, which provides money to state and local governments to assist them in recovering from the negative effects of the pandemic. Because this occurred at the end of our fieldwork and was not included in the city’s projections at the time of our review, the impact of these funds is not reflected in our projections. However, we discuss the potential effect these funds will have on the city’s finances here.
* State Auditor’s projections exclude cash that the city must hold as collateral for its public works loan and is thus unavailable for use. This loan contributes between $6.1 million and $4.8 million to the general fund reserves deficit. We also factor a lower growth rate for hotel tax revenue, a modest personnel cost increase, and pension cost increases that will need to be covered by the general fund.
As they have elsewhere, the economic consequences of the pandemic have had a significant effect on the city’s revenues, particularly hotel transient occupancy taxes (hotel tax). The city projects that it will receive additional revenue in the coming years from a new hotel. However, San Gabriel’s hotel occupancy and the associated tax revenue may recover at a slower pace than the city expects and therefore could be insufficient to address its financial problems. San Gabriel experienced a decline in hotel tax revenue from $3 million in fiscal year 2018–19 to $2.2 million in fiscal year 2019–20. The city expects a further decline to $1.2 million for fiscal year 2020–21, which is consistent with our projections. The city’s hotel revenue derives primarily from two hotels, and the city anticipates that the third hotel will be built by February 2022. The city expects that this new hotel will contribute significant additional hotel tax revenue and it projects a 108 percent increase in hotel tax revenue for fiscal year 2021–22.
However, we believe that hotel tax revenue will continue to be significantly affected by the pandemic and will recover more slowly. When we asked the city for support for its projected increase, the management specialist said that it was loosely based on educated assumptions and the city’s historical occupancy rates. The city manager stated that the city arrived at its hotel tax projections based on quarterly verbal conversations with the two major hotel operators. According to the agreement between the hotel developer and the city, the new hotel will have 225 rooms and the city anticipates it will have an occupancy of 85 percent, based on the occupancy rates of the two other similarly‑sized hotels in San Gabriel; however, the occupancy rate that the city cited was for fiscal year 2018–19, the last pre‑pandemic fiscal year.
Conversely, forecasts by tourism and hotel industry‑focused organizations predict that hotel occupancy rates and hotel revenue will grow far more slowly. One such organization—Visit California—projects that occupancy rates for hotels in the Los Angeles region will increase to about 68 percent by 2023, which is below the 2019 rate of 78 percent. Another organization predicts that the Los Angeles area will not return to 2019 occupancy levels until mid‑2024. Using revenue growth forecasts from Visit California and because the new hotel is not expected to open until at least February 2022, we believe a conservative projection of $1.6 million—a 33 percent increase from fiscal year 2020–21—is more reasonable than the city’s projection of $2.5 million (a 108 percent increase) for fiscal year 2021–22. Further, the city has an agreement to repay the hotel developer for offsite improvements, in part, with 50 percent of hotel tax receipts from the new hotel for up to 12 years. If the new hotel opens fully in March 2022, we estimate that the city would repay the developer between $100,000 to $150,000 through the end of fiscal year 2021–22, which would cause its net hotel tax revenue for 2021–22 to fall as low as $1.5 million.
Additionally, while San Gabriel has recently forgone increases to some personnel costs for city employees, future adjustments may have a considerable impact on the city’s general fund if savings are not found elsewhere. The city manager indicated that the city has deferred salary increases for certain employee groups. For example, as of January 2021, the city has current memorandums of understanding in place with two of its four collective bargaining units that include only minor benefit increases and do not include salary increases through fiscal year 2020–21. However, if we add a modest cost‑of‑living adjustment of 1 percent for city employees from the general fund, the city’s total personnel costs between fiscal years 2021–22 and 2025–26 would increase by more than $2 million. Although any future salary increases will depend on negotiations between the city and its labor groups, even small increases will have a significant effect on the city finances.
Moreover, the city’s projections likely understate the amount its general fund must pay in future years to cover its rising retirement costs. As we discuss in the Introduction, San Gabriel receives revenue from a property tax to pay for the city’s share of CalPERS retirement costs. Although the city includes the required pension contributions for the next five years in its model, we project that the city’s retirement fund will not be able to completely pay for retirement costs in future years and that the general fund will have to make up any shortfalls. We estimate that the general fund may have to provide more than $2 million total to meet the retirement costs between fiscal years 2022–23 and 2025–26, as we discuss further in the next section.
Further, the city’s current financial projections fail to account for the balloon payment that will be due in January 2025 for its public works loan, which will likely have an outstanding balance of $5.2 million at that point unless the city renegotiates its loan agreement. Even if the city has a positive general fund balance in fiscal year 2024–25, a balloon payment of $5.2 million would have a profound effect on the city’s finances.
The city manager told us that the city believes its projections of its revenues and expenditures are reasonable and that the city has made an effort to be conservative in the assumptions in its model. For example, it included a 4 percent increase for property tax revenues even though the city’s property tax revenue has trended higher. However, we believe that the city could improve its projections. According to the Government Finance Officers Association (GFOA), it is a budgeting best practice to analyze major revenue sources to identify forecasting assumptions and whether potential trends are likely to continue. This analysis is useful beyond creating budgetary projections by also enabling a city to uncover potential issues in advance and develop options so as to take action in a timely manner. By delaying an in‑depth analysis of key revenue sources and future costs, including factors that are unusual, such as the pandemic and the effect of the loan collateral on its general fund reserves, San Gabriel may miss opportunities to help build a positive general fund balance.
The federal government has recently provided a substantial boost to San Gabriel’s financial condition. In March 2021, President Joe Biden signed the American Rescue Plan Act of 2021. This act provides money to state and local governments to assist them in recovering from the negative effects of the pandemic. Specifically, San Gabriel is allotted more than $7.5 million over two years. The city will receive up to $3.75 million each year in fiscal years 2020–21 and 2021–22. These recovery funds will assist the city in reducing its general fund reserve deficit and likely reduce the amount it borrows from other city funds. We estimate that San Gabriel could reduce the city’s reserves deficit balance to $2.8 million for fiscal year 2020–21. Likewise, with the second infusion of federal stimulus funds it could further reduce its general fund reserves deficit to $177,000 for fiscal year 2021–22. According to the city manager, the city intends to use the bulk of the stimulus funds to reduce its general fund deficit. However, these are specific appropriations of federal funds, and the city will not be able to rely on them for future ongoing expenditures. Further, because of the public works loan, the city will likely continue to have insufficient reserves for the next few years. Therefore, to meet its financial obligations, the city must develop a comprehensive plan to guide its financial recovery in the long term, including how it will handle this loan, reduce expenditures, and increase revenues.
San Gabriel Has Not Implemented a Comprehensive Financial Recovery Plan
Although San Gabriel has adopted and implemented several stand‑alone policies aimed at improving the city’s long‑term financial health, the city lacks a formal, comprehensive, long‑term financial recovery plan. The city finance department developed a long‑term financial plan that finance staff presented to the city council in January 2019. However, the city council did not formally adopt the plan, and the current city manager indicated that the city has not used this plan. According to the current city manager, the city only used the January 2019 plan to identify options for creating additional revenue sources to aid in its recovery. The city eventually arrived at the need to adopt a new sales tax, which voters approved in March 2020.
The city has taken some steps to strengthen some of its financial policies. In May 2019, city management recommended and the city council adopted a fiscal sustainability policy that established guidelines for San Gabriel’s overall fiscal planning and management. Some of the guidelines in the policy include requirements that the city fund current operating expenditures only with current operating revenues, place one‑time revenues in reserves and not use them for operating expenses, and establish user fees and charges for services to achieve full cost recovery. San Gabriel leadership also adopted a fund balance reserves policy (reserves policy) in May 2019 that requires that the city maintain a minimum general fund reserves balance of 17 percent of its annual operating expenditures. This threshold represents the equivalent of two months of reserves—the minimum amount the GFOA recommends. In this policy, San Gabriel also established a seven‑year schedule for reaching its reserves requirement, and it requires the city manager to develop a plan for replenishing the reserves in a reasonable time frame should the reserves fall below the required minimum level in the future. Furthermore, the city has developed a five‑year forecast that, according to the current city manager, allows the city to gauge its progress in building its general fund reserves following the schedule set in its reserves policy.
Although these policies, practices, and forecasts are important, they lack specific actions for how the city will achieve its financial goals. When we asked the city manager why San Gabriel has not developed and adopted a formal financial recovery plan, he disagreed that it did not have one, stating that San Gabriel’s fiscal sustainability policy, fund balance reserves policy, and five‑year forecast, taken together, serve as its long‑term financial plan although it is not in a single formal document. The city manager also told us that implementing the new Measure SG sales tax, monitoring revenues for shortfalls and expenditures for overruns, and deferring salary increases for city employees is evidence that the city has a long‑term recovery plan to rebuild the city’s general fund reserves and is following it. We verified that the city has taken action or plans to take action on each of these items. However, as previously discussed, the city needs to consider the ongoing impact of the pandemic and other key factors in its five‑year forecast, and these policies do not outline specific recovery strategies or actions for how the city will rebuild its general fund reserves and address other significant financial challenges, such as its large unfunded pension and OPEB obligations. The lack of a comprehensive plan addressing all the city’s areas of financial risk could affect its financial recovery. The city should develop a more robust plan that specifies, both in the short term and long term, how the city will rebuild its general fund reserves, and it should address the city’s lack of general fund liquidity, its unfunded pension and OPEB obligations, and refinancing of the public works loan.
Developing this comprehensive and detailed plan will help city leadership focus its direction, identify key recovery strategies, and articulate the specific actions needed for the city to reach financial sustainability. The GFOA notes several essential elements of a financial recovery plan. As Table 2 shows, San Gabriel’s current policies are lacking in specific recovery strategies or an operational action plan for how the city will achieve these goals in both the short and long term. By developing a comprehensive financial recovery plan that includes these elements city leadership can introduce more accountability into the financial recovery process and more consistency into the actions of the city should there be future turnover of city council members or members of the management staff. A comprehensive and formal financial recovery plan will also provide the public an additional benchmark with which to gauge the progress of the city’s financial recovery and the performance of city leadership in achieving that recovery.
San Gabriel’s Policies Lack Key Elements of a Comprehensive Financial Recovery Plan
|RECOVERY PLAN ELEMENTS AS OUTLINED BY THE GFOA||DESCRIPTION OF ELEMENT||SAN GABRIEL POLICIES|
|Description of goal||Description of short‑ and long‑term financial goals.||YES|
|Financial projections||Projections of both current and future revenues and expenditures.||YES|
|Recovery strategies||Specific strategies to be undertaken to preserve an entity and to remain financially viable.||NO|
|External environmental analysis||A process to identify all the external elements that can affect an organization’s performance.||NO|
|Budget process analysis||An analysis of where improvements in the budgeting process can be made.||YES|
|Budget reform plan||Changes to how the government collects and spends money.||YES|
|Operational analysis||A systematic analysis to determine whether each area of the organization is contributing effectively to overall performance and the furthering of the organization’s strategic goals.||NO|
|Operational action plan||A highly detailed plan of how a team or department will contribute to the organization’s goals.||NO|
|Risk assessment||An identification of hazards that could negatively impact an organization’s ability to conduct business.||NO|
Source: Analysis of current San Gabriel’s financial policies, GFOA best practices, and financial industry publications and websites.
Recommendations to Address This Risk:
- To ensure efficacy and accountability in its financial recovery process, city management should develop and the city council should formally adopt a comprehensive financial recovery plan by October 2021, that includes the following:
- Descriptions of short‑term and long‑term goals.
- A description of financial challenges the city faces, such as low reserves.
- An analysis of the external and internal elements that may affect the city’s ability to reach its goals.
- Strategies to build and preserve its general fund balance, including building and maintaining general fund reserves sufficient to fund at least two months of expenditures.
- Actions that the city plans to take to address its challenges and a timeline for completing those actions.
- Identification of individuals or departments responsible for monitoring and reporting the city’s progress to the city council.
- To ensure that San Gabriel has relevant information for making decisions, it should update its financial projections to include in‑depth analysis of key revenue sources and future costs, including factors such as the pandemic and the effect of the loan collateral on its general fund reserves, among other factors.
- To eliminate the general fund’s need to borrow from other funds, San Gabriel should develop a plan by October 2021 to renegotiate or refinance the public works loan to free up its general fund cash. In making its decision, it should consider the short‑ and long‑term impact of its financing choice on its general fund and on the operations of the city.
- San Gabriel should create a policy by October 2021, that describes options and considerations it will evaluate and present to its city council when entering into debt, including the following:
- An analysis of alternative methods of financing.
- The impact on city finances, in both the short term and long term.
San Gabriel Needs to Consider Additional Expenditure Reductions and Revenue Increases
Retirement Cost Terms
Pension liability: The total cost of pension benefits a city’s employees and retirees have earned that the city is obligated to pay.
Unfunded pension liability: The difference between an entity’s total pension liability and the assets that it has invested in its pension fund.
Normal payment: A city’s annual payment to CalPERS to cover the cost of pension benefits earned by its employees that year, calculated as a percentage of the city’s payroll.
Unfunded liability payment: An additional annual payment a city makes to CalPERS to decrease its unfunded pension liability.
Source: CalPERS annual valuation reports.
San Gabriel Needs to Address Its Rising Employee Retirement Costs
San Gabriel’s growing retirement benefit costs will likely put additional pressure on its general fund. The text box summarizes key terms related to the city’s retirement costs. San Gabriel, like other California cities, is experiencing high pension costs and a large unfunded pension liability in part because of these reasons:
- CalPERS experienced large decreases in the market value of the investments it held on the city’s behalf to cover the cost of these pension obligations during the financial crisis in fiscal year 2008–09.
- CalPERS decreased its expected rate of return on its investments.
- The population of retirees has tended to live longer and draw upon pension assets for a longer duration than initially anticipated.
San Gabriel had a total pension liability of $229.8 million as of June 2020. However, the city has only set aside funding to pay for a portion of those pension benefits that its employees have already earned. As of June 2020, the city had a pension funded ratio of 69 percent, meaning that the city has funded only $158.6 million of these benefits, leaving an unfunded balance of $71.2 million. We consider cities with a funded ratio below 70 percent to be at high risk. Because San Gabriel has not fully funded the pension benefits already earned by its employees, CalPERS projects that San Gabriel’s annual required pension payment will increase by about 25 percent, or $1.9 million, by fiscal year 2024–25.
Although it has a special property tax to help pay the retirement costs of city employees (retirement tax), the city may need to find additional sources of funding to pay for its increasing pension costs. San Gabriel voters originally approved the retirement tax in 1948. Since at least fiscal year 2015–16, the city council has annually approved a tax rate intended to generate revenue not to exceed the amount needed to meet the city’s pension obligations. Currently the city has set the tax rate at 14 cents per $100 of assessed property value. The city manager noted that the retirement tax has kept pace with growth in the city’s normal payments and annual unfunded liability payments, and we verified that the tax revenue was greater than the city’s total retirement costs for fiscal years 2016–17 through 2019–20. By continuing to pay the annual required pension payments to CalPERS, the city is projected to pay down its current unfunded pension liability by fiscal year 2045–46. However, if CalPERS achieves lower than expected or negative returns on its investment portfolio, the value of the investments that it holds on San Gabriel’s behalf will decrease, creating more unfunded liability and in turn increasing the city’s annual payments.
In the event that the city’s total retirement payments exceed the retirement tax revenue, the city will either have to cover the shortfall with general fund revenue or request an increase in the retirement tax rate through the voters. We estimate that the revenue generated by the retirement tax will likely be insufficient to cover its annual required pension payment from fiscal years 2020–21 through 2024–25 by an average of about $230,000 annually. Therefore, the city may benefit from temporarily increasing the tax rate or issuing pension obligation bonds (pension bonds), as we discuss below. However, as Table 3 shows, these options are not without risks.
San Gabriel Should Weigh the Benefits and Risks of Its Options to Secure Funding for Its Retirement Costs
|PENSION FUNDING STRATEGY||BENEFITS||RISKS|
|Temporarily Increase the Retirement Tax Rate||
||San Gabriel’s voters may reject a tax increase measure.|
|Issue Pension Obligation Bonds||The city could transfer the proceeds to CalPERS, resulting in significantly lowered annual unfunded liability payments.||
Source: Analysis of San Gabriel’s financial statements, CalPERS reports, and GFOA guidance.
Although raising sufficient additional tax revenue to pay for increasing retirement costs is an option, the city would need to obtain voter approval. By our estimate, an increase from the current 14 cents to 15 cents per $100 of assessed property value would likely generate enough revenue to cover the city’s annual required pension payment through fiscal year 2024–25. San Gabriel’s city manager noted that the city cannot increase the current rate without voter approval. State law generally prohibits a local government from increasing a tax unless its voters approve the increase. If the city’s voters gave the city council the ability to increase the tax rate as needed, the city would have greater flexibility to secure funding for its retirement costs without needing to use general fund dollars. However, San Gabriel’s voters could reject such an initiative, or the city council could opt not to increase the rate even if the initiative did pass. Therefore, the city would benefit from proactively identifying additional sources of potential funding to guard against years in which its retirement costs will be greater than its retirement tax revenue.
Alternatively, or in conjunction with increasing the retirement tax rate, the city could issue pension bonds to reduce the annual cost of its unfunded pension liability. By issuing pension bonds, the city could transfer the bond proceeds to CalPERS to reduce its unfunded pension liability and potentially lower its annual unfunded liability payments. The city manager stated that the city is exploring the possibility of issuing pension bonds and plans to present an analysis to the city council. However, the city could still have difficulties issuing pension bonds because of its general fund deficit. The city manager indicated that although he is not inclined to recommend that the city issue further debt, favorable market interest rates make issuing pension bonds an option worth considering. He added that the retirement tax as a dedicated revenue source could mitigate creditor’s concerns over the city’s poor financial condition.
Pension bonds do carry considerable risks. The city’s unfunded pension liability could still increase if CalPERS experiences lower than expected investment returns or negative returns, in which case the city would need to identify revenues to cover both its debt payments and any increase in the cost of its unfunded liability payments. Further, the GFOA warns that issuing pension bonds reduces a city’s ability to take on debt for other purposes, such as infrastructure improvements. To ensure that it can continue funding its increasing retirement costs without using general fund revenue, the city should assess the extent to which it can increase its retirement tax rate and weigh the benefits and risks of issuing pension bonds.
Other Post‑Employment Benefits
San Gabriel’s total net obligation for OPEB, which includes other benefit costs such as retiree health care, has also increased in recent years in part because the city has paid less than the amount needed to fully fund the costs of those benefits. From June 2018 to June 2020, San Gabriel’s accumulated unfunded OPEB liability increased from $24 million to $46 million, nearly doubling in only two years in part because the expected rate of return on the investment of the plan’s assets was lowered in fiscal year 2017–18 and because the city has stopped prefunding these costs. As of June 2020, the city has set aside only 11 percent—about $5.9 million—of the funds needed to pay for OPEB costs for benefits already earned by employees.
As the city’s unfunded OPEB liability increases, its annual payments to CalPERS also increases. Over the next five years, the city’s annual OPEB payments are projected to increase from $1.8 million to $2.4 million—more than 31 percent. This is problematic, in part because the city does not require its employees to contribute toward their OPEB costs. The city also currently does not prefund its OPEB costs by contributing to its OPEB trust, which includes money set aside to pay for anticipated OPEB costs. Instead the city uses the pay as you go method, only covering the annual cost of the benefits for current retirees but not making payments to proactively fund the health benefits it will be obligated to pay for its current and future employees when they retire. Although the city previously contributed to an OPEB trust—for example, allocating $113,000 in fiscal year 2017–18—the city stopped contributing to its OPEB costs in fiscal year 2018–19 because of the city’s increasing pension costs and poor financial condition.Beginning in fiscal year 2008–09 San Gabriel established a trust with CalPERS—specifically, the California Employers’ Retiree Benefit Trust—for OPEB.
However, if the city does not address its unfunded OPEB liability, the liability will continue to grow and put further pressure on its general fund. For example, if the city were to negotiate with its employee unions and its employees agreed to contribute 3.5 percent of their salaries to fund OPEB costs—the rate normally paid by state employees represented by the Service Employees International Union—that contribution would enable the city to pay an additional amount of approximately $500,000 annually toward its total OPEB liability. According to the city manager, the city will consider these benefit costs during its negotiations with its employee unions and will pursue employee contributions with them. The city should also develop a long‑term plan for fully funding OPEB obligations.
San Gabriel’s Mission Playhouse’s Operating Deficits Contribute Significantly to the City’s Ongoing General Fund Deficit
The city owns and operates the Mission Playhouse—a community center that hosts various events, such as theater and music performances and public meetings. Its main sources of revenue are rental and service fees that clients pay to use the playhouse and funding that the city provides to the playhouse to help cover its costs.
Since at least fiscal year 2014–15, the playhouse’s operating expenditures have exceeded operating revenues. As Figure 6 shows, playhouse operating expenditures have exceeded operating revenues by amounts ranging from approximately $500,000 in fiscal year 2014–15 to more than $1.1 million in fiscal year 2016–17.
Mission Playhouse Operating Expenditures Have Significantly Exceeded Operating Revenues Since at Least Fiscal Year 2014–15
Source: San Gabriel’s audited financial statements for fiscal years 2014–15 through 2019–20.
Note: Revenue amounts here do not include funding to the playhouse from San Gabriel’s general fund or retirement fund.
As a result of the significant and consistent operating deficits, the city has had to provide funding for the playhouse to remain solvent. Between fiscal years 2014–15 and 2019–20, the city used the general fund to give the playhouse more than $4.2 million—an average of $700,000 a year—despite the poor financial condition of the city. In fiscal year 2020–21, San Gabriel limited the amount of funding it will contribute to the playhouse to $250,000. The city manager also indicated that the city is only planning to contribute between $250,000 and $350,000 for every fiscal year thereafter. According to the city manager, the city anticipates that these amounts should be enough to cover the costs of the playhouse going forward because the city has attracted nontraditional sources of revenue for the playhouse, such as socially distanced video‑streamed dance contests. In addition, the city revised its playhouse fee structure in late 2019 to generate more revenue, and the city manager anticipates that the city will not need to increase transfer amounts to the playhouse once activity ramps back up to pre‑pandemic levels.
The city hired a consultant to conduct an evaluation of the playhouse and its operations, which was presented to the city council in August 2020. The report noted that the playhouse had been scheduled for use only 45 percent of the days in fiscal year 2017–18 and 57 percent of the days in fiscal year 2018–19. The consultant observed—among other items—that increasing the use of the facility, especially on weekdays, to maximize revenue should be a critical goal. However, the city manager explained that due to the pandemic, the city has not implemented many of the report’s recommendations, which included creating a Mission Playhouse Advisory Committee, developing a strategic plan for the playhouse, and creating a pool of volunteers for playhouse events.
Because of pandemic‑related closures, the Mission Playhouse has been operating in a limited capacity with reduced revenue and expenditures, a situation that may be prolonged as the economic effects of the pandemic continue. Although the city has limited the funding it plans to contribute, the playhouse will continue to burden the city’s general fund if the city does not ensure that the playhouse reduces ongoing expenditures or raises additional revenue to fully support its operations. According to the city manager, once the playhouse is open again to live audiences, the city intends to work with the city council and the community to implement the consultant’s recommendations and—should fiscal expectations not be met—to evaluate the playhouse’s revenues and expenditures and work with the city council to determine what actions to take.
San Gabriel May Have Forgone Additional Revenue Because It Has Not Updated Its Fees for Certain City Services
By not periodically updating its fees, San Gabriel has not ensured that it collected much‑needed revenue that could help relieve the financial burden on the city’s general fund. Under state law, the city may establish its fees at levels that allow it to recoup the full cost of the services it provides as long as it does not exceed the reasonable costs of providing those services—a concept referred to as full cost recovery. Most of San Gabriel’s fees help pay for services such as recreation programs, public safety, and public works, and they include fee types covering services such as facility rentals, building permits, and waste management services. However, city management has not evaluated whether the fees it charges for services align with the full cost of those services since 2016. Although the city contracted for a comprehensive review of all city fees in 2016, the city did not fully implement recommendations in the fee study. According to its fiscal year 2019–20 fee schedule, although it updated some fees based on the 2016 fee study, the city has not adjusted the majority of its fees in the last four years, and some have not been updated since 2002.
The cost of providing the majority of the fee services is primarily paid through the general fund; the city uses the general fund to pay for costs incurred as a result of a service, and the fees the city collects for the service are intended to help reimburse the general fund for that cost. By not periodically assessing the cost of providing these services and increasing the fees to cover them, San Gabriel is continuing to miss an opportunity to minimize the burden on its general fund. Moreover, state law defines a charge for a service that exceeds the reasonable price of providing the service as a tax, which is then subject to the State’s requirements for imposing taxes, including a requirement that the city submit and obtain voter approval in order to implement the tax. Thus, because the city has not evaluated the full cost of services and the fees to cover those services since 2016, it risks both undercharging and overcharging fees for those services. If it undercharges, the city further subsidizes those services from the general fund. However, if it overcharges, the city exposes itself to taxpayer lawsuits for imposing a tax in violation of state law.
Because the city has not assessed whether its fees were fully recovering costs since 2016 and because it was undergoing a new contracted fee study during our audit, we were unable to determine the total revenue it has forgone by charging less than full cost recovery. However, using a conservative approach, we estimated that if the city increased just half of its general fund revenues from fees to keep pace with inflation, it may have been able to collect more than $300,000 over four years—additional revenue that could have helped reimburse its general fund for the cost of providing these services.
The city presented to the city council the results of its latest fee study in early April 2021 and it plans to update its fees as part of the budget adoption in June 2021. The new fee study could provide the city with information regarding charges for services and help ensure that it is recovering costs.
Recommendations to Address This Risk:
- To ensure that its rising pension costs do not create a burden on the general fund, San Gabriel should identify and develop an analysis of the benefits and risks of alternative methods of paying for these rising costs, such as increasing the retirement tax or issuing pension obligation bonds.
- To limit costs related to employee retirement benefits, San Gabriel should negotiate with its unions for employees to contribute a reasonable portion of their salaries to fund their future OPEB benefits.
- San Gabriel should develop a long‑term funding plan to address its OPEB liability. The plan should include actions necessary to ensure that the city will be able to meet its obligations to its employees and retirees.
- To reduce the negative impact of the Mission Playhouse on the city’s financial condition, San Gabriel should implement recommendations from its consultant reports including developing a strategic plan that maximizes the use of volunteers and pursuing other measures that reduce expenditures and increase revenue.
- To ensure that the fees it charges for services align with costs, San Gabriel should develop and implement policies and procedures to require it to do the following:
- Develop methodologies for determining the full cost of those services to ensure that it is not overcharging or undercharging for services.
- Reevaluate the costs of its fee‑funded services at least every three years. It should develop a plan to adjust its fees to fully recover costs, including a phased‑in approach for large increases.
Gaps in San Gabriel’s Management Controls Increase the Risk of Inefficiency and Waste
San Gabriel Does Not Monitor Contract Costs or Ensure That It Receives the Best Value for Its Procurements
San Gabriel has not always adhered to its policies requiring competitive bidding of contracts. Specifically, of the eight contracts we reviewed, we identified one instance in which the city council approved contract amendments that extended the terms of the original contract over several decades and another instance when the city council approved new contracts for different services with the same vendor without seeking competitive bids. As a result, the city contracted exclusively with certain vendors for many years without seeking competitive bids from other firms to evaluate their services and costs. The city’s purchasing policy requires a formal competitive bid process for contracts worth more than $15,000 and notes that contracts should generally have a maximum term of three years. The State Contracting Manual (SCM)—which provides guidance for managing contracts to state agencies and identifies government contracting best practices—also recommends that contracts for services should generally not exceed three years unless the contracting entity can provide a written justification for a longer term for business reasons. For example, in the event that a contractor for the city needs to acquire financing to purchase equipment necessary to provide the service, the required loan repayment may be for a period of longer than three years. The SCM also notes that entities should not use amendments to circumvent the competitive bidding process.
Through repeated use of contract amendments, the city has not competitively bid its waste collection contract for more than 70 years. Figure 7 shows that the city initially executed two contracts in 1948 and 1951 with a waste collection firm and then amended those contracts a total of 16 times and substantively revised the terms of those contracts two times, once in 1957 and again in 2000. Nine of those contracts and amendments increased the duration of the contract, ranging from an additional three years to an additional 25 years. In 2000 the city executed a substantially rewritten, amended, and restated agreement with its then‑current contractor, again without competitive bidding. That amendment was effectively a newly rewritten contract, intended to consolidate the terms of all of the amendments the city had previously executed. The most recent amendment, from 2020, extended the contract term to an ongoing service period of 25 years with an automatic one‑year extension each year, referred to as an evergreen period. If the city subsequently decides to terminate its waste collection contract, the one‑year term would not automatically renew, but the city would still be obligated to remain in the contract for 25 years from the termination date. The city manager noted that it is not unusual for cities to have such evergreen terms in their waste collection contracts.
The City Has Not Conducted a Competitive Bid for Waste Collection for More Than 70 Years
Source: San Gabriel contract documents and city council meeting minutes.
Nevertheless, by failing to seek competitive bids from other waste collection companies to evaluate proposed collection rates, the city cannot ensure that its residents and businesses are paying competitive rates. Although the city itself does not make any payments under this contract, the contractor collects fees directly from San Gabriel’s residents and local businesses. By forgoing a competitive bidding process and systematically extending the contract’s term, the city has committed its residents to paying the contractor’s rates without verifying that the contract is providing the best value to them. Consequently, the city residents and businesses may be overpaying for these services.
By not procuring waste collection services through a competitive bidding process, the city also likely missed opportunities to obtain franchise fee revenue for more than 60 years. A franchise fee is a fee paid by a contractor providing a utility—such as waste collection—for the right to provide that service in a city and to use the city’s streets. The original contract from 1948 stipulated that the waste contractor pay the city 25 percent of its gross annual receipts from the contract. However, a substantively revised contract executed in 1957 removed that term and the contractor was allowed to keep the whole of the amount it collected from its customers. Thereafter, the city did not collect any fees from the contractor until 1992, when the city council adopted an additional waste management fee that the contractor collects directly from its customers and remits to the city.
Nevertheless, the city did not charge a separate franchise fee until 2020. In 2019 the city conducted a survey of 10 other cities in Los Angeles County and found that seven of those cities charged a franchise fee to their waste collection contractors, including three cities that used the same waste collection company as San Gabriel. According to the city manager, the results of the survey provided San Gabriel with information that it used to negotiate with its contractor, which ultimately led to the city’s 2020 amendment requiring the contractor to make an annual payment to the city of $350,000 that will increase each year in alignment with the Consumer Price Index (CPI). Had the city previously charged such a franchise fee that increased in alignment with the CPI, it could have collected a total of $3.4 million in revenue from fiscal years 2009–10 through 2019–20. The city’s failure to solicit proposals from multiple waste collection companies likely contributed to its failure to secure such a revenue opportunity at an earlier date.
In another instance, the city did not competitively bid two architectural service contracts for different phases of a project but instead re‑awarded them to the same company, even though long delays in construction paused the project for a total of 17 years. The city executed three separate contracts with the company, each for a specific phase of the project: a needs assessment phase, a schematic design phase, and a design refinement and construction requirements phase. In 2000 the city competitively bid a needs assessment contract for a new police facility and executed a contract with a vendor. Upon completion of that first phase of the project, the city executed a new contract with the same company in 2001 without rebidding. The police chief, city attorney, and city council at the time asserted that consistency was in the city’s best interest. However, the city delayed the project for nine years, citing design changes, relocation, and budget constraints, so the contractor did not complete the second phase until 2010. The city then awarded a third contract to the same vendor in 2010 totaling $1.7 million, again without a rebidding process. The city again delayed the project for eight years, citing similar reasons, before finally entering the construction phase in 2018.
Despite spending this money, this project was not completed and the city cancelled its contract with the company in fiscal year 2019–20. The assistant finance director stated that the city has removed the incomplete project from its capital improvement program. Nevertheless, the city has had multiple contracts with the same vendor for nearly 20 years without competitive bidding despite executing three separate contracts for distinct project phases for a facility that was ultimately not built. Although the delays may have been unrelated to the contractor’s performance, the city could have requested proposals from a variety of vendors before executing a new contract to ensure that it was receiving the best value instead of continuing to rely on the results of the original competitive bid from 17 years before.
We also found that San Gabriel does not have a centralized system for monitoring its current contracts, which compromises its ability to prevent departments from overspending the amount of their contractual service budgets. Because of its insufficient contract tracking system, the city cannot track the total costs associated with each of its contracts over multiple years, and city management cannot determine total citywide annual contract costs. This increases the risk of cost overruns and decreases the city’s ability to oversee its departments’ spending, likely contributing to some city programs routinely exceeding their contractual expenditure budgets. In fiscal year 2017–18, for example, San Gabriel exceeded its total citywide budget for contractual service expenditures by $468,000, or 19 percent.
Because the city does not have a central system to identify all of its current contracts, city officials were unable to provide us with a comprehensive list of its contracts. In response to our request for an updated list of all of the city’s contracts, the city provided information from two different sources: the chief city clerk provided a spreadsheet used to track contract expiration dates, and the city’s management specialist prepared a list of contracts based on vendors in the city’s accounting system. However, the two lists do not agree, and neither is complete as each is missing several contracts. By generating expenditure reports from the city’s accounting system and using the account code designated for recording expenditures pertaining to contract services, the management specialist was able to determine the amount the city paid to vendors providing contracted goods and services. In doing so, she was able to create a list of the city’s existing contracts. However, this method identifies only those contracts against which the city has made payments, so it would overlook other contracts without payment activity, including newer contracts for which the city had not yet received invoices for goods or services provided. Thus, the city cannot rely on the accounting system to manage its contracts.
The city is unable to account for all of its current contracts and their associated costs in part because it has not consistently followed its contract management policies. The city’s municipal code designates the City Clerk’s Department (city clerk) as the custodian of the city’s contract documentation, though the department does not have a contract oversight role. To ensure that executed contracts are provided to the city clerk, the city’s purchasing policy requires departments to receive signatures from vendors before presenting the contracts to the city council for its approval. This policy gives the city the ability to fully execute a contract upon city council approval and send the final document to the city clerk directly, instead of needing to return to the vendor for its signature. However, the city does not consistently follow its policy: of the seven contracts we reviewed that required city council approval, we verified that only two were signed by the vendor first. The city’s failure to follow this policy contributed to the city clerk not having complete contract documentation—such as fully executed contracts and bid documents—and in turn hampered its ability to account for all of its contracts.
The city also does not sufficiently monitor the performance of its contracts. The city’s purchasing policy requires department heads to provide documentation annually to the city manager indicating that they have completed a review of the services associated with each contract that has a term of more than one year and to make recommendations for any changes to the contract. However, the city has not followed this policy. The only monitoring effort that the city has undertaken is to prepare a biennial summary of on‑call professional service contracts for the city council in which departments identify vendors, services provided, contract lengths, and recommendations for continuing their use. However, this summary includes only certain professional service contracts that are not project specific and excludes contracts associated with capital projects and contracts that do not require the city to make payments, such as the waste collection contract. Of the eight contracts we reviewed, only two appeared in any of the past three biennial summaries. Consequently, the city does not ensure that it monitors all of its current contracts.
Recommendations to Address This Risk:
- To ensure that it consistently receives the best terms and value for services, the city should strengthen its purchasing policies to require the following:
- Departments to competitively bid services at least every three years or to document a justification for services that require a longer contract duration.
- Departments to justify in writing reasons for amending contracts that extend the term or alter the services of the original contract instead of using a competitive bidding process. The city council should approve these justifications.
- To ensure that it is able to track its costs related to its contracts citywide, the city should do the following:
- Develop a centralized depository with information on all current contracts, including the payments to date, full contract value, and the status of the performance of services.
- Develop and implement procedures to monitor and update that centralized depository and to use this information to ensure that departments do not exceed their budgeted contractual service costs.
- Develop and implement a process to ensure the enforcement of the city’s policy to submit all executed contracts, including supporting documents, to the city clerk.
- To ensure that its waste collection contract represents the best value for the city, its residents, and its other community members, before the next automatic extension on October 17, 2021, San Gabriel should do the following:
- Negotiate with its waste collection company to revise key terms of its contract, including the contract’s duration and the city’s right to terminate the agreement.
- Conduct annual surveys of comparable cities to identify their waste collection franchise fees to ensure that it is receiving a competitive fee from its contractor.
- Solicit information on rates that residents and businesses in other cities are paying for waste collection services to ensure that it negotiates fair rates for its residents and businesses.
We conducted this audit under the authority vested in the California State Auditor by Government Code section 8543 et seq. and according to generally accepted government auditing standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objectives specified in the Scope and Methodology section of the report. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objectives.
ELAINE M. HOWLE, CPA
California State Auditor
April 27, 2021