PFM Financial Projections Update 04/16/18

PFM LOgo

 

 

 

 

City of Reading:

Financial Projections Update

 

 

 

 

April 16, 2018   

PFM Group

Consulting, LLC


1735 Market Street

43rd Floor

Philadelphia, PA 19103


215.567.6100

pfm.com

 

 

 

 

Revisiting Plan Projections

 

Under the five-year time limit established in Act 47, PFM has to write a “Coordinator’s Report” to be released midway through 2019. That report will either recommend that Reading exit Act 47 successfully, adopt a three- year “exit plan” or start a “fiscal emergency” process that could culminate in receivership. As Coordinator, PFM does not make the decision on which direction the City goes, but it recommends a path to PA DCED which makes the decision.

 

Last year during the budget process City Council asked for a projection of the City’s finances beyond 2019.

 

As we have done at other points in the oversight process, we’ve put together a high level baseline projection that shows the City’s revenues and expenditures in a status quo situation. It assumes the City exits Act 47 oversight at the end of 2019 but takes no corrective action to change its finances.

 

The projection is a diagnostic tool, not a prediction of what is likely to happen. Please note that the City has historically taken steps to outperform the projections in the baseline (such as implementing the 2010 and 2014 Recovery Plans), which is the intention.

 

 

2013

2014

2015

2016

2017

2018

2019

2020

2021

2022

2023

2014 Plan

Audit

Mid-Year

Budget

Proj.

Proj.

Proj

Proj

N/A

N/A

N/A

N/A

April 2018 Update

Audit

Audit

Audit

Audit

Est.

Budget

Proj.

Proj.

Proj.

Proj.

N/A

2019 Report

Audit

Audit

Audit

Audit

Audit

Est.

Budget

Proj.

Proj.

Proj.

Proj.

 

Criteria for successful exit

Section 255.1c of Act 47 provides four factors that the Secretary of DCED shall consider in concluding whether the conditions that led to a determination of municipal financial distress are no longer present. The factors are:

 

  1. Operational deficits have been eliminated and the financial condition of the City demonstrates a reasonable probability of future balanced budgets;

     

  2. Obligations issued to finance the municipality’s deficit have been retired, reduced or reissued;

     

  3. All claims or judgments that would have placed the City in imminent jeopardy of financial default have been negotiated and resolved; and

 

4) The City is projected to have positive operating balances for the first five years after the termination of distressed status. “Projections of revenues shall include any anticipated tax or fee increases to fund ongoing expenditures for the first five years after a termination of distress.”

 

At this point the City checks the box on the first criterion, which has been mostly interpreted in terms of past performance. The City checked the box on the second when it paid off the 2010 unfunded debt loan and the third one isn’t an issue to our knowledge. That leaves the fourth as the most pivotal.

 

As we discussed in February, we also want the City to demonstrate strong financial management capacity with respect to financial reporting, hitting State deadlines, filling key vacancies, etc. That speaks to the question, “How do we know Reading will get out of Act 47 and stay out?”

 

How has this played out elsewhere?

Since Act 47 was amended in late 2014, five communities have exited Act 47 successfully. One adopted the three- year exit plan and two more are headed that way:

 

  • Pittsburgh exited Act 47 in February 2018. The five-year projection showed no deficits and no tax increases through 2022.

     

  • Altoona exited Act 47 in September 2017. The five-year projection showed deficits returning in 2020 and growing through 2022. However Altoona’s Coordinator noted that the City went Home Rule during its time in Act 47 so it had more flexibility to increase taxes than before it entered Act 47.

     

  • Clairton exited Act 47 in November 2015. The five-year projection showed no deficits. The same applied to

    Plymouth Township in May 2016.

     

  • Nanticoke exited Act 47 in August 2015. The five-year projection showed deficits returning in 2016 and growing through 2019 driven in part by increased pension payments. However the City’s Coordinator noted that the City went Home Rule during its time in Act 47. The Coordinator’s report projected real estate tax increases, EIT increases or a mix of the two. The Secretary’s order stated that the City could also reduce “nonessential operating expenditures” to pay for debt and pensions.

     

  • Scranton reached its five-year decision point last summer. The Coordinator projected deficits arriving in 2017 and rapidly growing through 2020 and recommended a three-year exit plan.

     

  • Greenville will hit its five-year decision point later this year. Its Coordinator noted last year that a three-year exit plan is likely because the Borough still relies on the Act 47 EIT and doesn’t have a source to fund its capital budget once it exits Act 47. The same is true for New Castle which hits its decision point in 2019.

 

Baseline projection: 2018 – 2022 (Millions)

 

The baseline projection shows a $1.8 million deficit in 2019 absent any corrective action and assuming no tax increases. The deficit grows in 2020 and 2022 and finishes at $3.3 million. Please keep in mind that the City has taken the corrective actions necessary to balance its budget since entering Act 47 oversight (see next slide).

 

 

baseline projection

 

Two important pieces of context

The baseline projection is a diagnostic tool to help quantify the size of the City’s financial challenges and inform decisions about how to close the deficits. The key is to take action to avoid them, which the City has done consistently. The City has not had a General Fund deficit since 2010, setting aside the additional debt payments that the City made in 2016.

 

2010 Recovery Plan

 

2014 Amended Recovery Plan

 

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

Baseline deficit?

Yes

Yes

Yes

Yes

Yes

Yes

Yes

Yes

Yes

Yes

Actual deficit?

Yes

No

No

No

No

No

No*

No

TBD

TBD

 

Corrective action should not just close the deficit for one year but also shrink it in the future. The baseline projection in the 2014 Plan showed a $14.8 million deficit. Actions taken during late 2014 and 2015 shrunk it to

$2.3 million. Actions taken since then have reduced it even further to $1.8 million. It would be better if it were zero, but the deficits are getting more manageable.

 

General Fund Result ($ Millions)

 

 

2015

2016

2017

2018

2019

2020

2021

2022

2014 Baseline projection

-$3.1

-$8.8

-$11.3

-$13.1

-$14.8

   

2016 Baseline projection

 

$1.3

-$0.6

-$0.9

-$2.3

   

2018 Baseline projection

    

-$1.8

-$2.5

-$2.6

-$3.3

 

Key revenue: Earned income tax

 

We monitor the City’s EIT receipts very closely on a month-to-month basis since it is one of the City’s largest sources of revenue and higher EIT receipts often cover shortfalls in other revenues. We’ve noted in the past that the City’s resident EIT revenues have grown much faster the tax base and that continued through 2017. The graph below shows how much each 0.1 percent of EIT generates each quarter from residents and commuters in current year revenue. Revenue per 0.1 percent from residents grew by 8.1 percent on a cash basis across all funds last year. Over the five-year period revenue per 0.1 percent from residents grew by 6.9 percent per year versus 0.9 percent from commuters.

 

External data concludes that resident employment and wage levels remain largely flat while there is modest growth in employment and wages for commuters. The most likely explanation for resident EIT growth is increased compliance with new collection requirements under Pennsylvania Act 32 of 2008.

 

eit revenue

 

Key revenue assumption: EIT growth gradually slows

The baseline projection assumes the City shifts the final 0.1 percent of the commuter EIT from the operating budget to the capital budget in 2019 and then eliminates it entirely in 2020 as required under Act 47.

 

The projection also assumes that the City shifts 0.1 percent of the resident EIT to the capital fund next year and then continues the 0.3 percent capital EIT after 2019. We recommend keeping some portion of the EIT for capital costs after the City exits Act 47 since the City needs money to repair and replace its large vehicles, facilities, parks, roads, etc.

 

Our projections start with the 2018 budget and then assumes that growth in the resident EIT slows to 6.0 percent in 2019,

5.0 percent in 2020, 4.0 percent in 2021 and 3.0 percent in 2022. This is a really critical assumption because EIT revenue swings by $3 million per year at the end of the projection period depending on the growth assumption.

 

image

init growth

 

Key expenditure assumption: Base salaries

The City’s largest expenditure category is salaries and wages for employees. The City’s General fund spending on employees in 2016 is very close to 2012 levels, with some movement in between. The 2017 budget was 4.0 percent higher than 2016 actuals, but actual 2017 spending was likely lower once vacancies and turnovers are included. Our baseline projection assumes wage growth resumes at 2.25 percent per year after the City exits Act 47, which is close to inflation. In this simple projection we do not assume any changes in headcount, any tenure-based step increases, any turnover or any vacancies other than in police and management employees where the City has a vacancy allowance in the budget.

 

base salaries

image

 

Key expenditure assumption: Pension contribution

Earlier this year the City received updated pension valuation reports, which set the parameters for calculating the City's Minimum Municipal Obligations (MMOs) to the employee pension plans. The 2018 budget continues the cycle of multi- million dollar increases every couple of years. The actuary also provided projected MMOS through 2022. Those projections show the City’s total MMOs peaking in 2020 and then dropping by $1.3 million for police in 2021 because of the expiration of amortization bases established in prior valuations. The fire MMO drops by $0.5 million in 2022.

 

 

pension contribution

 

Upside and risks

 

Potential upside

(Financial results could be better if…)

Potential downside (Financial results could be worse if…)

 

Properties come back onto the real estate tax rolls when KOZ benefits expire

 

EIT revenue growth drops back into alignment with the actual tax base growth

 

City eventually has better terms under its federal consent decree related to the wastewater treatment plant

 

Spending on employee compensation grows more than projected, particularly after the City leaves Act 47

 

More revenue from per capita tax, business privilege license or other areas of focus

 

Pension MMOs do not drop in 2020 and 2021 as projected

 

Reduced spending through continued efficiency gains

 

Emergency capital projects that require General Fund support

 

Debt refunding opportunities beyond 2019

 

 

So what: Key takeaways

  • PFM will write the Coordinators Report during the first half of 2019 recommending that the City either exit Act 47 successfully, adopt a three-year “exit plan” or start down the “fiscal emergency” path that can end in receivership. DCED makes the decision on which direction the City goes.

     

  • Based on the criteria in the law and the experience of other Act 47 cities, we are focused on the financial performance of the City (avoiding deficits, funding capital projects, eliminating the Act 47 tax) and the financial management of the City (filling key vacancies, complying with State deadlines, resolving audit findings).

     

  • As a diagnostic tool, the baseline projection shows deficits in 2019 through 2023 if the City does not take any corrective action. The City has taken corrective action to avoid deficits and the out-year deficits look more manageable.

     

  • The projected deficits depend in part on when the resident EIT revenue growth slows down and comes back into line with the tax base growth.

     

  • The City will need to manage its spending, particularly on employee compensation, even if it leaves Act 47 in 2019. Pension contributions are projected to grow through 2020 and then hopefully will drop in 2021 and 2022.

     

  • Bottom line: There’s still work to do leading up to next year’s rescission decision, but the financial results are going in the right direction.