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CC 05-21-2024 Item No. 11. FY 2024-25 Proposed Budget - Attachment W - Report from Baker Tilley on budget assumptions
To: Pamela Wu, City Manager Matt Morley, Assistant City Manager Kristina Alfaro, Administrative Services Director Thomas Leung, Budget Manager From: Steve Toler, Director Noemi Barter, Project Manager Steve Montano, Special Advisor Subject: Cupertino Financial Forecast Review Date: May 21, 2024 The City engaged Baker Tilly to conduct an independent review of the City’s long-range financial forecast and to support the City in developing a fiscal sustainability plan for future years based on any fiscal gap identified within the resulting forecast. In the first phase of this project our focus was to conduct an independent analysis of the long-range forecast being prepared as part of the proposed FY 2025 annual budget. Our work encompassed five primary activities, culminating in a report to the City Council of the results. Those activities included our independent review and analysis of the items shown in this graphic. We have prepared a comprehensive slide deck that includes an overview our approach, background information on financial forecasting, and our observations and recommendations to improve the forecast, most of which have been incorporated in the City’s FY 2025-2034 financial forecast that is being presented to the Council this evening. The slide deck is attached to this memorandum. We will provide highlights of our work during the Council’s budget study session. Overall, we believe that the FY 2025 financial forecast being presented to the Council this evening provides a reasonable basis upon which to inform Council’s decisions for the proposed FY 2025 budget and incorporates the key recommendations that were discussed with staff during this phase of the project. Attachment: Baker Tilly Slide Deck: City of Cupertino Financial Forecast Review, May 21, 2024 Baseline budget vs. actual data Revenue and expenditure assumptions Fund balance reserves and policies Economic assumptions City's proposed budget strategies for FY 2025 Attachment W Baker Tilly US, LLP, trading as Baker Tilly, is a member of the global network of Baker Tilly International Ltd., the members of which are separate and independent legal entities. © 2024 Baker Tilly US, LLP. City of Cupertino Financial Forecast Review Steve Toler, Director May 21, 2024 2 Project Overview CUPERTINO FINANCIAL FORECAST REVIEW Phase I –Independent Analysis of Long-Range Forecast •Review baseline budget vs. actual data •Review revenue assumptions •Review expenditure assumptions •Analyze fund balance reserves and policies •Review economic assumptions •Analyze City’s proposed budget strategies for FY 2025 •Report results Phase II –Prepare Fiscal Sustainability Plan •Identify additional budget strategies to address long-term gap (if any) •Conduct comparative research •Analyze budget strategies and prepare budget scenario packages •Facilitate community engagement •Support Council decisions on development of fiscal sustainability plan •Prepare implementation action plan 3 “Financial forecasting is basically math. What makes it powerful is: Accurate baseline data Realistic assumptions The ability to tell a story about the fiscal health of an agency But remember, the numbers never sleep.” Financial Forecasting 4 Financial Forecasting in Local Government CUPERTINO FINANCIAL FORECAST REVIEW •Fiscal management tool to inform and assist in decision-making •Government policies •Strategic goals •Provision of community services •Identifies future revenue and expenditure trends •Integral to annual budget process •Promotes sound fiscal discipline in service delivery •Credible •Transparency •Descriptive of external forces •Within acceptable accuracy tolerances •Solid set of assumptions •Understandable •Clear, simple, reasoned •Relating assumptions to projections •Implications •Linked to sound fiscal practices •Reserve policies •Maintaining structural balance •Long-term fiscal planning How They Are Used What Makes Them Useful 5 Financial Forecasting in Local Government CUPERTINO FINANCIAL FORECAST REVIEW •Setting fees and charges •Determining what services and level of services to provide •Determining service delivery model (e.g., employee, contract, shared services) •Establishing staffing levels •Setting compensation and benefit levels •Determining type and level of investment in capital project/infrastructure investment •Increasing taxes •Economic trends •Recessionary impacts •Private investment in development and retail business •Travel and tourism •Pension costs •Bond market interest rates •Emergency events and emergency response Things Within the City’s Control Things Outside the City’s Control 6 City’s Forecast – Our Initial Reactions CUPERTINO FINANCIAL FORECAST REVIEW Excel-based model Trend analysis of historical actual results Future trends at detailed categories for revenues and expenditures Tracks overall impacts to reserves Provides good storytelling graphics to inform decisions Has ability to grow based on the agency’s needs 7 Executive Summary of Our Independent Review CUPERTINO FINANCIAL FORECAST REVIEW FY 2025 financial forecast provides a reasonable basis upon which to inform Council’s decisions for the proposed FY 2025 budget Staff has improved the forecast based on our interactions and discussions during the project Improvement recommendations will not significantly change the story of the City’s fiscal health, but should be considered to better refine future forecasts 8 Economic Assumptions in the Region CUPERTINO FINANCIAL FORECAST REVIEW Recessionary impacts Not likely to hit local government until 2027 Investment returns Soften within 12 months Glideslope to around 2% over the next several years Interest rates Same softening trend Impact on housing vs. household earnings Real estate prices Prices leveled off in midst of lingering interest rates Commercial vacancies and Prop 8 appeals 9 Analysis of Key Assumptions Used in City’s Forecast - Revenues CUPERTINO FINANCIAL FORECAST REVIEW Category City’s Original FY 2024 Assumptions Fiscal Impact1 City’s Revised FY 2025 Assumptions Baker Tilly’s Comments Recessions Start in FY 2025, flatline for all revenue categories; repeats every 4 years Start in FY 2028, repeat every 7 years Start in FY 2028 with 7-year cycle is reasonable; future forecasts should revise impact based on revenue category assuming 3-year recovery period (e.g., sales tax, TOT, development fees) Property tax 3.7% in FY 2024, reducing to 2.9% by FY 2033 3.7% in FY 2025 tapering to 2.8% by 2034 Historical growth of 4.7% included significant development; long-range expectations will depend on commercial occupancy recovery Sales tax Combined average 2% growth per year Combined average 3.3% growth per year Revised assumptions better approximate historical trends extracting impact from CDTFA decision Hotel tax (TOT) 3.3% in FY 2024, reducing to 2.1% by FY 2033; pre-Pandemic levels not achieved until FY 2033 3.1% in FY 2024, reducing to 2% by FY 2034; pre-Pandemic levels not achieved until FY 2032 Realistically conservative assumptions; business travel growth and occupancy rates must be monitored closely; other agencies in region seeing 3.5% growth on average and have recovered back to pre-Pandemic levels in FY 2024 1 – Net positive impact on forecast Net neutral impact Net negative impact 10 Analysis of Key Assumptions Used in City’s Forecast - Revenues CUPERTINO FINANCIAL FORECAST REVIEW Category City’s Original FY 2024 Assumptions Fiscal Impact1 City’s Revised FY 2025 Assumptions Baker Tilly’s Comments Development fees 3% growth in FY 2024 leveling off to average 1.7% after FY 2026 6.7% and 8.9% in FY 2025 and 2026, reducing to average 1.7% after FY 2028 Higher development fees is reasonable based on development in pipeline and historical trends; future forecasts should consider detailed calculations of projects in pipeline and reasonably expected to complete. Utility users tax 0.7% growth long-term 0.7% growth long- term UUT may increase significantly in FY 2025 based on PG&E rate increases; long-term growth typically seen at 3% or more depending on gas and electric rate increase expectations; telecom is typically stagnant Franchise fees Average 1.7% long-term growth Average 1.7% long- term growth Reasonable given cord-cutting impact on video services; refine estimates in FY 2026 based on solid waste anticipated impacts 1 – Net positive impact on forecast Net neutral impact Net negative impact 11 Analysis of Key Assumptions Used in City’s Forecast - Revenues CUPERTINO FINANCIAL FORECAST REVIEW Category City’s Original FY 2024 Assumptions Fiscal Impact1 City’s Revised FY 2025 Assumptions Baker Tilly’s Comments Cost allocation plan Reset based on study; 2.5% growth long-term Reset based on study; 3.5% growth long- term Increased growth assumptions better match personnel cost expectations Interest earnings Used 0.5% growth based on baseline year Assumes current investment yield, tapering to 2% return long-term Interest earnings now calculated based on reserve balances; better approximation of interest earnings that fluctuate based on reserve balances and yields Summary: Revised revenue forecast better approximates future results based on currently-known market trends; continued improvements in refining impacts from future recessions, and updating TOT revenues and future development projects will be helpful to refine future forecasts 1 – Net positive impact on forecast Net neutral impact Net negative impact 12 Analysis of Key Assumptions Used in City’s Forecast – Expenditures (Personnel Costs) CUPERTINO FINANCIAL FORECAST REVIEW Category City’s Original FY 2024 Assumptions Fiscal Impact1 City’s Revised FY 2025 Assumptions Baker Tilly’s Comments Salaries and employee compensation Long-range placeholder based on reduced CPI estimate Long-range placeholder based on increased CPI estimate Updated assumption is more realistic as a placeholder based on historical trends and potential future CPI trends Health insurance 5.9% increase in FY 2024, reducing to 5% by FY 2033 5.9% increase in FY 2024, reducing to 5% by FY 2033 Assumptions are within reason; most agencies used a 6% growth factor based on historical PEMHCA trends Pension costs Employer normal and UAL costs based on 2022 CalPERS report Employer normal and UAL costs based on 2023 CalPERS pension outlook tool Continue to use the most updated CalPERS pension outlook tool to project future costs Vacancy rates Assumed reduction in force of up to 45 FTE by FY 2033, no other vacancy Placeholder vacancy rate of 2% of salaries and benefits from turnover Vacancy assumptions better reflect baseline forecast trends based on historical averages Summary: Revised personnel costs forecast will better approximate future trends; watch health care costs closely in future years based on latest information from PEMHCA 1 – Net positive impact on forecast Net neutral impact Net negative impact 13 Analysis of Key Assumptions Used in City’s Forecast – Expenditures (Non-Personnel Costs) CUPERTINO FINANCIAL FORECAST REVIEW Category City’s Original FY 2024 Assumptions Fiscal Impact1 City’s Revised FY 2025 Assumptions Baker Tilly’s Comments SCSO Law Enforcement 6.3% growth in FY 2025 reducing to average 4.5% long-term 5% in FY 2025 reducing to average 4.4% long- term Reasonable assumptions based on anticipated increase in FY 2025; County negotiations with SCSO and pension costs should be monitored closely to inform future trends Materials and other services 4.3% growth in FY 2024 reducing to 2.3% average long-term 3% growth in FY 2025 reducing to average 2.4% growth long-term Current market trends assume long-term CPI of over 3% long-term; to the extent that the City implements cost efficiency strategies, trend should be achievable Transfers out Transfers based on unique needs Transfers based on unique needs City’s practice of estimating future transfers based on transportation, capital projects, Blackberry Farm and Sports Center subsidies and retiree medical set-asides appear reasonable Expenditure savings (non- personnel) No assumptions No assumptions Consider expenditure savings from non-personnel costs in future forecasts (perhaps up to 2% of budgeted amounts) Summary: Reevaluate CPI assumptions and impacts from negotiated contracts with SCSO employee groups; consider expenditure savings from non-personnel costs in future forecasts 1 – Net positive impact on forecast Net neutral impact Net negative impact 14 Executive Summary - Recap CUPERTINO FINANCIAL FORECAST REVIEW FY 2025 financial forecast provides a reasonable basis upon which to inform Council’s decisions for the proposed FY 2025 budget Staff has improved the forecast based on our interactions and discussions during the project Improvement recommendations will not significantly change the story of the City’s fiscal health, but should be considered to better refine future forecasts Questions? Baker Tilly US, LLP, trading as Baker Tilly, is a member of the global network of Baker Tilly International Ltd., the members of which are separate and independent legal entities. © 2024 Baker Tilly US, LLP. Steve Toler DIRECTOR M: +1 (650) 740-7007 E: steve.toler@bakertilly.com