In a year of continued economic uncertainty driven by the COVID-19 pandemic, persistently high inflation, rising oil prices, conflict in Europe, and anticipated increases in interest rates, the Finance Department has prepared the FY2021-22 Mid-Year Budget Update for City Council review and discussion. Despite turmoil in the national and global financial markets and economies, the City's fiscal position remains stable. The General Fund, which supports most of the City’s core public services, is projected to end FY2021-22 with revenues over expenditures of approximately $2,700,000, mainly due to projected year-end revenues exceeding budget estimates across several major revenue categories, including Property Taxes, Sales/Transaction Taxes, Permits, and Fees & Charges. This projected positive year-end position is also bolstered by Department management closely tracking their budgets, which are generally projected to come in at or slightly below budget by the end of the fiscal year.

General Fund Revenues:
Based on mid-year revenue performance and department projections through the end of the fiscal year, staff estimates General Fund revenues will close FY2021-22 approximately $2,400,000 more than the adopted budget, a positive difference of 4.8 percent.

Although the COVID-19 pandemic impacted many cities that rely upon revenue generated by tourism, the majority of La Habra’s revenue is generated through property taxes and more traditional retail sales activity at local big box, discount and building material stores. As such, the City has benefited from better than anticipated performance by these types of businesses throughout the pandemic. These, and other similar retail businesses, have outperformed budget expectations based on revenue data received and analyzed by the City’s Finance staff and the City's external revenue consultants.
   
In the area of recurring General Fund revenues:

With regard to budgeted expenditures, staff anticipates General Fund actual expenses to end the fiscal year approximately $300,000 below the adopted expenditure budget, which represents a savings of approximately 0.6 percent.  Most of these savings are a direct result of a number of budgeted staff positions that have been unfilled for a portion of the current fiscal year. Non-General Fund operating budgets are expected to end the fiscal year at or below their approved expenditure budgets, with associated revenues tracking to budget projections.

Mid-Year Budget Adjustments
There are no Mid-Year Budget Adjustments being requested at this time.

Unfunded Pension Liability Update

Pursuant to City Council direction, the City successfully issued the Pension Obligation Bonds (POB) in January 2022 to pay down its Unfunded Accrued Pension Liability (UAL). The issued POB carries an average interest rate of 3.09 percent, compared to the 7 percent rate being charged by CalPERS on the City's UAL. The lower interest rate secured as a result of the POB issuance is anticipated to generate approximately $23.3 million in savings to the City over the next 20 years. After the UAL lump sum payments were made in January 2022, the remaining UAL balances, based on valuation as of June 30, 2020, were $10,597,913 and $11,163,534, for the miscellaneous and safety plans respectively. Due to the CalPERS higher than anticipated investment return of 21.3 percent as of June 30, 2021, the UAL balances are expected to be eliminated when the next valuation reports as of June 30, 2021, are issued in July/August 2022.  This adjustment was taken into account when the City structured its POB transaction. 

Prior to the issuance of the POB, the City’s UAL payment for FY 2022-23 would have been $7,953,595 based on information provided by CalPERS. After the issuance of the POB, the remaining UAL and debt service payments for FY 2022-23 will be $490,096 and $4,820,567 respectively. This results in net cash flow savings to the City of approximately $2,600,000. In accordance with the City Council's Pension Funding Policy, 50 percent of the first year cash flow savings amount, calculated at $1,300,000, will be budgeted for deposit into the City’s Section 115 PARS Pension Trust Fund when the FY 22/23 proposed budget is developed for Council review and consideration. The City can access this trust fund reserve in the future if a new Unfunded Pension Liability once again forms due to changing market conditions or changes in CalPERS actuarial assumptions.

The following table illustrates the cash flow savings calculations:
 

 
Future Fiscal Challenges
While the City has taken significant steps recently, and over the past several years, to address its Unfunded Pension Liabilities, it still faces two serious fiscal challenges in the near future. The first challenge concerns the global, national and regional economic recovery as the world continues to emerge from the global COVID-19 pandemic. Supply chain shipping backlogs that were caused by the pandemic continue to delay the receipt of goods, materials and supplies across numerous industry segments. This has impacted manufacturers, suppliers, retailers, shoppers, businesses and government agencies. The City has, itself, faced delays in supply orders, computer equipment, street signal poles, repair parts, and replacement vehicles for the City fleet.

The recent conflict between Russia and Ukraine is expected to exacerbate a surge in inflation, higher oil prices, additional supply chain disruptions, and impacts on interest rates. Since January 2021, the Consumer Price Index (CPI) has been increasing at an alarming rate. In January 2022, the inflation rate hit a 39-year high of 7 percent. While some economists anticipate that higher than normal inflation will subside by calendar year-end, the immediate impact is being felt in rising fuel costs for City vehicles, increasing costs for construction materials such as concrete and asphalt, and increased costs for services and labor as vendors and contractors adjust their pricing.  

The second, more serious, long-term fiscal threat facing the City is the pending loss of the City’s voter-approved transaction tax (Measure T), which is scheduled to sunset in December 2028. This critical locally controlled half-cent sales tax was approved by the voters in 2008 and currently generates approximately $7 million in revenue per year for the City’s General Fund, the majority of which is used to fund public safety and infrastructure maintenance for the City. Currently, Measure T accounts for approximately 13.1 percent of the total General Fund revenue. How to address the pending loss of this critical, locally controlled General Fund revenue will be of primary importance. 

There is no fiscal impact for receiving this report.  The final determination and allocation of any potential year-end carryover will be made after the end of FY 2021-22, at which time actual revenue and expenditure performance will be audited and reported to the City Council.