Harry E. Wells Building 300 Park Avenue Falls Church, Virginia

Transcription

1 INTEROFFICE MEMORANDUM DATE: September 12, 2014 TO: FROM: SUBJECT: Honorable Mayor and City Council F. Wyatt Shields, City Manager Council Action on Water Sale Proceeds At the August 4 Council Work Session, options were presented and discussed by the City Council for the highest and best long term public benefit from the proceeds from the sale of the water system. Council made significant progress toward reaching consensus on an allocation framework that would be put out for public input and comment prior to a final decision. Prior memoranda on those options are attached for reference purposes. This memo does not provide additional options, but proposes a public hearing and decision making timeline for the City Council. Since the August work session, the Interim City Attorney and staff have done additional research with outside counsel and have re-affirmed the legal authorizations for the City to fully fund its pension obligation and thereby accrue the benefit of a reduced annual required contribution for City tax payers. The City s actuarial firm, Cheiron, has begun work on the 2014 Valuation Report for the pension plan, and we expect to have an updated unfunded liability number for Council on Monday, September 15. Proposed Schedule: September 15, Work Session: Council consensus on preferred option(s) for public input and comment. October 14, Regular Meeting: Public Hearing (Well advertised in advance) 1 st Reading on Budget Amendment to allocate water sale proceeds. The Budget Amendment would establish the amount that goes to the City Retirement Funds & the amount for Capital (Endowment for Major Capital Projects & Capital Reserves). October 27, Regular Meeting: Public Hearing 2 nd Reading Budget Amendment to allocate water sale proceeds. November March: Development of Five Year Capital Improvements Program. March 9, 2015: City Manager s CIP recommendations presented to City Council. April 27, 2015: City Council Adoption of Five Year Capital Improvements Program. Harry E. Wells Building 300 Park Avenue Falls Church, Virginia

2 INTEROFFICE MEMORANDUM DATE: August 4, 2014 TO: Honorable Mayor and Members of City Council FROM: F. Wyatt Shields, City Manager SUBJECT: Proposal for the Use of Water System Sale Proceeds At City Council s May 16 Work Session, I presented a proposal for the use of the water sale proceeds for the Council s review and consideration. That proposal took two approaches with roughly half of the funds invested to earn a long term return on investment (ROI) of principal, and roughly half deployed for direct investment in City infrastructure in a planned manner. Council requested additional options for its consideration, and the Budget and Finance Committee discussed options at its July 22 meeting. Attached is a summary sheet of options (Attachment 1) that I presented to Budget and Finance for discussion. In addition, the attached May 16 Memo provides the background detail for this proposal. The attached April 7, 2014 presentation (Attachment 2) provides analysis of the Pension Fund investment strategy. I recommend that Council first decide on the broad strategy for the use of the sale proceeds in terms of allocating an amount for Return on Investment of Principal (ie, Pension Fund, or Endowment Fund) and Direct Investment in Capital Projects. Following that decision, allocation to specific capital projects could be made through the five year capital improvement program process. Presented in a simplified and concise form, the impact for the tax payer of the investment options can be viewed as follows: Direct Investment in Capital Infrastructure: Includes major capital and immediate investment depending on which allocation method is selected. Assuming interest rates of 3.5% to 5% on a 20 year bond, the annual cost to service the debt is between 8.5% and 10% of the debt issuance. The benefit to the tax payer is realized over 20 years. Decisions on which projects to fund through the Water Sale Proceeds would be made through the adoption of the 5-year Capital Improvements Program based on long-term infrastructure assessments and plans. Page 1 of 4 Example: $1M invested in capital projects that would otherwise be funded through debt, results in annual debt service savings from $85k to $100k for the twenty year life of the bond. Under this approach, the benefit to the tax payer has a 20-year duration (as compared to the longer term - or perpetual - benefit under the investment approaches, below).

3 Endowment Fund: local governments in Virginia are permitted to invest in highly rated government securities that safely yield between 1% to 4.5% depending on the term of the securities. The benefit of this approach is that the funds would remain available to the City for direct investment; the drawback is the relatively low yield. Funds could be invested in this way while they are waiting to be used for capital projects. Pension Fund: the long term returns for the pension fund have averaged over 7.5%. That return on investment is realized by the taxpayer through a reduction in the required annual contribution by the City to the Pension Fund. The benefit of this approach is the higher yield; the drawback is that once funds are invested in the pension fund, they cannot be removed. Actual investment returns will vary greatly year to year, and there is the possibility of the loss of principal, just as there is for the pension fund as a whole. Example: $1M invested in the Pension Fund, the annual average return on investment, using a 7.0% average, would be $70k. This savings could be, in turn, used to fund capital projects such as facilities, parks, multi-modal transportation and/or parking projects. Using the hypothetical $1M, the impact on the City budget on an annualized basis for these three approaches is presented graphically, below. $90,000 Return on Investment/Debt Service Savings Based on $1M $80,000 $70,000 $60,000 $50,000 $40,000 $30,000 $20,000 $10,000 $ Direct Investment in Capital Infrastructure Endowment Fund Pension Fund Page 2 of 4

4 Direct Investment Options: At the last work session, the Council asked for additional options for how the proceeds could be used for the benefit of the City and its taxpayers. As noted above, in terms of a process, I would recommend that the Council first decide the broad strategy: how much to allocate to the ROI on Principal approach, and how much to allocated toward direct investment in capital projects. Following that decision, allocations toward specific capital projects, such as those listed above, could be made in the context of the five year capital improvements program. Examples of direct investment in capital projects are described below. Commercial Land Banking for Economic Development: This option involves the City purchasing commercial property for strategic purposes to foster economic development. Investment in commercial real estate can provide a significant return on investment, but also requires special expertise, and carries significant risk of loss of principal. The Podolnic property is an example of this option in the City. The land was purchased in 1999 for 537,000 and sold in 2014 for $2.35 million. After accounting for lost real estate revenues during the period of City ownership, this transaction nets out to a 10% annualized return on investment. As a counter example, the purchase of the Mailboxes property in 2008 and sale four years later constituted annualized return on investment of -22%. However, due to special circumstances, neither the purchase nor the sale of this property was based on market based prices. The EDA currently has $1.85 million (its share of the proceeds of the sale of the Podolnic property) for land banking purposes. Investment in Public Parking: In partnership with the private sector, this option involves expanding the availability of public parking to allow for greater commercial density in designated areas of the City. The expense of structured parking is a frequently cited obstacle for office and retail development in the City, even when the market is favorable for those uses. The Area Planning process has identified locations where public parking would be most useful as part of the redevelopment of City economic opportunity areas. These planning documents, along the City s adopted Financial Incentives Policy would guide the use of funds for this purpose. Business District Improvements: This option involves setting aside an amount of funds for improvements in City business districts to create a more favorable environment for commercial success. Examples include creating a utility undergrounding fund, to be supplemented by developers as part of the project Page 3 of 4

5 approval process, to remove overhead utility wires to improve reliability, accessibility, and aesthetics. Lower cost but high impact projects, such as improved signage for parking and way finding, aesthetic improvements, and maintenance such as paving or striping, could be eligible projects for a business district improvement fund. The City is currently benefiting from federal and new state funds (administered through the NVTA) to carry out major pedestrian improvements in our commercial districts. The focus of this initial effort is on South Washington Street, where these funds will be used to expand the streetscape improvements along the Lincoln Properties project, to include safe, attractive pedestrian access from Annandale Avenue intersection to the Tinner Hill Historic Site. Stormwater Projects: This option involves investing in stormwater projects to reduce flooding, improve water quality, and potentially reduce future stormwater fee increases. If this option were pursued by City Council, staff would work with City Council to identify specific projects to be funded in this manner based on the adopted Watershed Management Plan. When the stormwater fee was first proposed, it was a higher rate sufficient to cover projected debt service for prioritized capital projects in the Watershed Management Plan as well as rehabilitative projects for existing system. The adopted fee does not cover future debt service. Accordingly, using water sale proceeds for stormwater projects could a) help accelerate projects; and b) help reduce future fee increases. The nature of stormwater projects in the currently prioritized plan are projects to improve water quality to meet federal regulations (citywide benefit), and projects to reduce the frequency of flooding on private property a specific locations in the city. If $1M was invested in stormwater, for example, the funds could be used to address priority rehabilitative failures on aging and damaged existing system. This would accelerate major repairs, for approximately linear feet of pipes, reducing flooding and costly but temporary maintenance fixes. Park and School Land Acquisition: City Park Master Plans, and City School Facility Plans both call for land acquisition. Using sale proceeds for land acquisition could be incorporated into the Capital Improvements Program. Traffic Calming and Neighborhood Improvements: This option involves setting aside fund that could be accessed through the Neighborhood Traffic Calming Program to carry out street improvements in residential neighborhoods. The CACT has recommended $400k/year, for capital and consulting and/or staffing, based on current neighborhood request patterns and documented needs. Page 4 of 4

6 Policy Framework In Resolution (Attachment 3), City Council established the principal goals for the use of sale proceeds: that the sale proceeds be put to use exclusively for the broad public interest and benefit of city taxpayers ; to produce the optimal long-term financial benefit for the City, its citizens, and taxpayers ; and the principal amount of the net proceeds shall be protected over the long term and used to generate a sustained return on investment for the taxpayers of the City. The City Manager s May 16 proposal encompassed two approaches for the use of the sale proceeds, with just over half dedicated to realizing a return on investment of principal over the long term, and just under half dedicated toward direct investment in city capital infrastructure. The additional examples provided in this memo broaden the possible uses of funds, but still fit within the basic structure proposed earlier. At the Work Session on August 4, we will focus on working toward Council consensus and direction on the allocation toward earning a perpetual ROI on principal and the allocation toward direct investment in capital projections. Upon reaching consensus on that allocation, the focus can then shift toward capital projects, and how the sale proceeds can be used to greatest effect in the capital planning process. As outlined in the Summary of Options (Attachment 2) provided to the Budget and Finance Committee on July 22, the allocations toward the two basic strategies ( ROI on Principal and Direct Investment in Capital Projects ) can vary based on priorities and desired outcomes. The allocation toward the Pension Fund (to earn a ROI of Principal) is capped by the amount of the unfunded liability, currently $11 million (and expected to drop with the 2014 actuarial report due this fall). Attachment 5 graphically presents the options and the policy options. Manager s Proposal 50% ROI on Principal (Pension Fund) 50% Direct Investment in Capital Projects Alternative 1 100% Direct Investment in Capital Projects - With a portion dedicated to economic development. Alternative 2 33% ROI on Principal (Pension Fund) 67% Direct Investment in Capital Projects - With a portion dedicated to economic development. Sumamry As noted earlier, I recommend that Council first decide on the broad strategy for the use of the sale proceeds in terms of allocating an amount for Return on Investment of Principal (ie, Pension Fund, or Endowment Fund) and Direct Investment in Capital Projects. Following that decision, Page 5 of 4

7 allocation to specific capital projects could be made through the five year capital improvement program process. Attachments: 1) City Manager s May 16 Memorandum 2) City Manager s Summary of Option for the Budget and Finance Committee (July 22) 3) April 7 Presentation by the Retirement Board 4) City Council Resolution ) Option and ROI graphs Page 6 of 4

8 Use of Water Sale Proceeds July 31,

9 Manager s Proposal $1,000,000 ROI from Pension $8,500,000 $11,000,000 Endowment for Major Capital Infrastructure Maintenance July 31,

10 Option 2: All Capital $20,500,000 Endowment for Major Capital July 31,

11 Option 3: One-Third $6,500,000 $7,000,000 ROI from Pension Endowment for Major Capital Immediate Investment $7,000,000 July 31,

12 ROI/Debt Service Savings $2,000,000 $1,800,000 $1,600,000 $1,400,000 $1,200,000 Manager Proposal All Capital One-Third $1,000,000 $800,000 $600,000 $400,000 $200,000 $ July 31,

13 ROI/Debt Service Savings $2,000,000 $1,800,000 $1,600,000 $1,400,000 $1,200,000 $1,000,000 $800,000 Manager Proposal All Capital One-Third $600,000 $400,000 $200,000 $- 1 (Short) 2-21 (Long) 22 (Long-Pension Only) July 31,

14 Principal $25,000,000 $20,000,000 Manager Proposal All Capital One-Third $15,000,000 $10,000,000 $5,000,000 $ July 31,

15 ROI/Debt Service Savings on $1M $90,000 $80,000 $70,000 $60,000 $50,000 $40,000 $30,000 $20,000 $10,000 $ Direct Investment in Capital Infrastructure Endowment Fund Pension Fund July 31,

16 INTEROFFICE MEMORANDUM DATE: May 16, 2014 TO: FROM: SUBJECT: Honorable Mayor and Members of City Council F. Wyatt Shields, City Manager Proposal for the Use of Water System Sale Proceeds At City Council s April 7, 2014 Work Session, the Council requested that the City Manager provide a proposal for the use of the water sale proceeds for the Council s review and consideration. This memorandum provides the outlines of a proposal designed to meet the Council direction provided in Resolution (attached) which expressed the broad goals of Council for the use of the water sale proceeds. The forecast for net proceeds from the sale of the water system on January 3, 2014 will be approximately $20.5 million. This projection includes an accounting for remaining accounts receivable and accounts payable. Balance: Cash and Investments $ 22,456,356 Accounts Receivable 409,792 Accounts Payable (2,348,956) Net Balance $ 20,517,192 The proposal outlined below would deploy the sale proceeds in three funds to provide a lasting public benefit for the citizens and taxpayers of the City. The proposal takes two approaches with roughly half of the funds deployed in order to earn a sustained return on investment (ROI) of principal, and roughly half deployed for direct investment in City infrastructure in a planned manner. A summary table of the proposed allocations is provided below, with additional detail following. Investment Allocations Pension Fund $ 11,000,000 Endowment Fund for Major Capital Reinvestment 8,500,000 Infrastructure Maintenance Fund for City Government and Schools 1,017,192 Harry E. Wells Building 300 Park Avenue Falls Church, Virginia

17 Retirement Fund The Council Resolution notes that investment in the Retirement Fund would be an advantageous way to produce a return on principal investment over the long term, relative to other options available to a municipality. This is due to the fact that the Retirement Fund is professionally managed in a balanced portfolio of stocks and bonds that has produced an average annual return more than 7.5% over the past 25-year and 10-year time horizons. This option was further developed by the Retirement Board in its recommendation to the City Council on April 7, The proposal reflects the Retirement Board recommendation and can be summarized as follows: Transfer $11 million to the City Retirement Fund, to be held as a sub-account of that fund. This sub-account is projected to provide an average return on investment (ROI) of 7%, or $770,000 per year. This ROI will be used to reduce the City s annual contribution to the Retirement Fund, an avoided cost that is projected to be on average equivalent to 2 cents on the Real Estate tax rate. The avoided cost will partially offset increases in debt service associated with the CIP. The annual ROI may be smoothed according to five-year investment returns, to avoid sharp variations from year-to-year in the annual budget process. There would be a $1 million cap on ROI in any given year (with any excess return remaining in the subaccount). While the expected return on investment over the long run can be reasonably expected to be positive (7% per year on average) this approach carries the risk of a decrease in value of the investment (loss of principal) at any time. This is the same risk carried by the Retirement Fund as a whole. The funds placed in the Retirement Fund cannot be removed at any time, unless the Plan is terminated. Reversion: legal counsel for the Retirement Board has prepared a Reversion Amendment to the Plan Documents for the Council s consideration. It declares it is the Employer s (the City s) intent that the $11 million in the subaccount shall revert to the Employer in the event of plan termination. However, as a general rule, plan termination is very expensive to the employer. Due to a number of unknowable variables related to the cost of a future plan termination, it is not possible to ensure that the $11 million would revert to the City in such an event. Termination of the City Pension Plan is not anticipated in the foreseeable future. The proposed Reversion Amendment is attached. Endowment Fund for Major Capital Reinvestment The City currently has an adopted CIP that calls for $138 million investment in City facilities and infrastructure over the coming five years. An endowment fund for major capital reinvestment would be established to provide financial resources toward accomplishing needed capital improvements. The structure of the fund is proposed as follows: Intended use: accomplish major long term capital projects through direct use (pay as you go) in lieu of debt. A super majority of Council (perhaps 5 votes) would be required to access the fund. Page 2 of 4

18 The fund would be invested highly rated government securities of varying terms. A small portion (10% to 20%) of the portfolio could be invested in shorter term bonds to provide liquidity for unforeseen needs. The key planning consideration is the time at which the City intends to access the main corpus of the endowment for a specific capital project. If that time horizon is at least five years, then it is reasonable to invest the remaining balances over a longer horizon in order to boost overall yield. Any earnings of the endowment fund would be kept in the endowment fund until used for the planned capital project. Sustainability: As an additional option for sustaining the Endowment Fund for Major Capital, the Council could establish that when funds are withdrawn from the Fund, the City would commit to restoring the fund on an annual basis at a rate of 5% to 10% per year of the total funds withdrawn. Infrastructure Maintenance Fund Relative to the Major Capital Fund, above, a lesser amount would be placed in an Infrastructure Maintenance Fund. Intended Use: The use of these funds would be for smaller and more immediate infrastructure maintenance needs that we currently fund through debt or pay as you go. This fund portfolio would be invested in shorter term government securities that would be more accessible (liquid) than the Endowment Fund. Fund would be appropriated through the normal budget process. Any earnings of the Maintenance Fund would stay in the fund and used for its stated purposes. Sustainability: As an additional option for sustaining the Infrastructure Maintenance Fund, the Council could establish that when funds are withdrawn from the Fund, the City would commit to restoring the fund on an annual basis at a rate of 5% to 10% per year of the total funds withdrawn. The annual budgetary impact of this proposal, in simplified form, is summarized below. In this table, the annual budget impact of using the Endowment Fund and the Maintenance fund is shown as the Annual Interest Payments avoided if the fund is used for a project in lieu of debt. This assumes that the Council agrees to re-charge the Endowment Fund and the Maintenance Fund on an annual basis. Investment Allocations Page 3 of 4 Projected Annual Impact Annual potential reduction in Annual Contribution (7.0%) Retirement Fund $11,000,000 $770,000 Endowment Fund for Major Capital 8,500, ,500 Annual Interest Payments avoided (3.5% assumed) Infrastructure Maintenance Fund 1,017,192 35,602 Annual Interest Payments avoided (3.5% assumed) Total $1,103,102

19 If the Council were to decide to not recharge the Endowment Fund or the Maintenance Fund on an annual basis, then the annual budget impact in terms of avoided cost is more positive. This is because both the principal and interest costs are avoided as an annual expense for debt service. See the table below. However, under this approach, once the money is spent, the benefit to the citizens and tax payers will extend for the life of the debt issuance, typically 20 years, rather than as a sustained, perpetual benefit. The funds themselves would cease to exist if they are not recharged on a regular basis. Investment Allocations Projected Annual Impact Annual potential reduction in Annual Retirement Fund $11,000,000 $770,000 Contribution (7.0%) Endowment Fund for Major Capital 8,500, ,500 Annual Principal & Interest Payments avoided (3.5% interest rate assumed) Infrastructure Maintenance Fund 1,017,192 86,461 Total $1,578,961 Annual Principal & Interest Payments avoided (3.5% interest rate assumed) Summary The proposal encompasses two approaches for the use of the sale proceeds, with just over half dedicated to realizing a return on investment of principal over the long term and just under half dedicated toward direct investment in city capital infrastructure. Return on Investment of Principal: the Retirement Fund investment is designed and intended to provide a long term financial return on the principal investment. Once the principal is invested in the Retirement Fund, it cannot be taken out. The long term benefit to the taxpayers is strictly the return on investment, which is used to reduce the employers (the City s) annual required contribution to the Retirement Fund. This approach carries the market risk of the entire Retirement Fund investment portfolio, including the loss of principal. Direct Investment: the two capital funds are designed and intended for capital improvements. The return on investment (or yield) on these funds while they sit in the funds is limited by Virginia law, and is not the primary purpose for the funds. Rather the purpose is to plan for the use of these funds for necessary capital projects, and realize the financial benefit of avoided debt service costs. For the two proposed capital funds, the City Council would have the option to re-charge the funds through the budget process on an annual basis in order to meet longer term capital needs. Page 4 of 4

20

21

22

23

24

25

26

27

28

29

30

31

32

33

34

35

36

37 RESOLUTION RESOLUTION EXPRESSING THE GOALS OF THE CITY COUNCIL FOR THE USE OF WATER SALE PROCEEDS WHEREAS, the City of Falls Church and Fairfax Water have agreed upon the terms for the sale of the City s water system ( the Agreement ), and the voters of the City voted to approve the sale of the water system in a public referendum on November 5, 2013; and WHEREAS, the terms for the sale of the water system include, among other things, the payment to the City of $40 million, and WHEREAS, the City Council, by separate resolution TR13-44, has established that a portion of those proceeds shall be used to defease the existing debt of the water system, the cost of which is expected to total $19 million; and WHEREAS, the City has pension obligations to current and retired employees, and pursuant to the Agreement a portion of the sale proceeds shall be used to fully fund those future pension obligations, as determined by the City s actuary, and WHEREAS, after deducting from the sale proceeds those amounts necessary for defeasement of debt, covering water employee pension obligations, and other closing costs, there will be net proceeds to the City from the sale totaling approximately $14 million; and WHEREAS, it is the intention of the City Council that the net proceeds from the sale shall be set aside to produce the optimal long-term financial benefit for the City, its citizens, and taxpayers. NOW THEREFORE, BE IT RESOLVED BY THE CITY COUNCIL OF THE CITY OF FALLS CHURCH, VIRGINIA, AS FOLLOWS: 1) It is the Council s fiduciary responsibility to ensure that the sale proceeds are put to use exclusively for the broad public interest and benefit of city taxpayers. 2) It is recognized that there will be further community discussion before any final decision is made. 3) It is the intention of the City Council that the net proceeds from the sale of the City s water system shall be set aside to produce the optimal long-term financial benefit for the City, its citizens, and taxpayers. 4) The use of the proceeds shall be in keeping with City financial policies.

38 Res Page 2 of 2 5) It is the intention of the City Council that the principal amount of the net proceeds shall be protected over the long term and used to generate a sustained return on investment for the taxpayers of the City. 6) It is the sense of the Council that an advantageous way to accomplish these goals, as described herein, is to place net proceeds of the sale, or a significant portion thereof, into the City Pension Plan, as this will, over the long term, produce a higher return on investment relative to other options, reduce the City s annual actuarially required contribution, and produce a long-term benefit for the City s taxpayers. Reading: Adoption: (TR13-42) IN WITNESS WHEREOF, the foregoing was adopted by the City Council of the City of Falls Church, Virginia on December 9, 2013 as Resolution Kathleen Clarken Buschow City Clerk