City of Culver City, California
City Council Agenda Item Report
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RECOMMENDATION:
Staff recommends the City Council receive and file a brief report on current
economic conditions and how they may affect Culver City, and provide input to staff.
BACKGROUND:
At the joint meeting of the City Council and Redevelopment Agency on October 6,
2008, the City Manager briefly described some proactive steps the City would be
taking to protect itself from the current conditions that exist in the economy and
financial markets. In order to weather these economic conditions and attempt to
prevent deeper cuts in the future, the City Manager informed the City Council of the
following actions that are being taken:
• Implementation of an immediate hiring freeze, excluding Public Safety
positions. All vacant positions will be reviewed on a case-by-case basis with
the City Manager.
• Cessation of overtime, excluding Public Safety or emergency situations. All
exceptions to be reviewed by the City Manager.
• Assessment of current usage of part-time and contract employees.
• Assessment of current usage of consultants.
The City Manager also informed City Council that a more comprehensive memo
would be issued detailing these actions, and that the Finance Department was in the
process of putting together a budget review based on the first quarter of the fiscal
year as well as updating the Comprehensive Financial Report. After some initial
Meeting Date: 10/13/08 Item Number: A-1
AGENDA ITEM: Discussion of Current Economic Conditions and Effects on
Culver City, and Input to Staff as Deemed Appropriate.
Contact Person/Dept.:
Jeff Muir, CFO
Phone Number:
(310) 253-5865
Fiscal Impact: Yes [X] No [] General Fund: Yes [X] No []
Public Hearing: [] Action Item: [X] Attachments: []
Public Notification: Master E-Mail Notification List (10/09/08)
Department Approval:
Jeff Muir (10/09/08)
City Attorney Approval:
Carol Schwab (by H. Baker) (10/09/08)
Chief Financial Officer Approval:
Jeff Muir (10/09/08)
City Manager Approval:
Jerry B. Fulwood (10/09/08) City of Culver City, California
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comments and questions by City Council, it was agreed that since this item was not
agendized, it would be most prudent to add it to the next agenda so that City Council
could have discussion and provide any information requests or questions to staff.
This written report will provide only some basic information of the current economic
conditions and how they might affect Culver City. Staff anticipates bringing the first
quarter budget report and updated Comprehensive Financial Plan back in
November.
Economic Update
One year has made a significant difference in the economic reality and outlook faced
by the entire nation. The dramatic shift in the housing market has been the driving
force in the economic downturn that has occurred. Over the last few years, a huge
number of “unconventional” mortgages were offered to borrowers who may not have
otherwise qualified for or been able to afford a conventional loan. An unconventional
loan offers creative financing terms that allow the borrower to pay only interest, or
offers a very low “teaser” interest rate (i.e. subprime loan) for a specified term,
typically 1 to 7 years. When the initial term expires, the loan typically resets to a
more conventional principal and interest payment at a higher interest rate. The idea
behind these types of loans is that the home will increase in value enough to allow
the borrower to refinance, or the borrower’s income will increase enough to cover
the more conventional terms. The success of these loans is highly dependent on
continuous large increases in home values.
Unfortunately, as large numbers of these loans began to reset, home values were
not increasing sufficiently to allow borrowers to refinance to a fixed rate loan. As a
result, many borrowers experienced significant increases in their monthly mortgage
cost, to the point that they could not afford to make the payment. An increase in
foreclosures flooded the real estate market with supply, causing home prices to fall
even further. The decline in prices resulted in even more foreclosures as the
number of borrowers that were unable to refinance increased. It has been a vicious
cycle that has led to an all-time record number of homes in foreclosure status.
The number of foreclosures has had such a devastating impact on financial
institutions because they began experiencing huge losses on their investments in
sub-prime mortgages (called mortgaged back securities). As a result of the losses,
banks do not have nearly as much capital for new loans, and have become wary of
giving new loans without putting a significant burden on the prospective borrower to
document their financial stability. In fact, the borrowing restrictions have gotten so
burdensome and the amount of capital banks have available to lend has gotten so
short, that many lending markets are currently non-existent (this has been referred
to as the “credit crunch”).
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Additionally, the losses experienced by the financial institutions heavily invested in
mortgage backed securities have been so severe, that a number of companies that
were previously thought to be financially infallible (e.g. AIG, Lehman Brothers, Bear
Stearns, Washington Mutual, Indymac Bank, etc.) have filed for bankruptcy, been
taken over by the government, or have been forced to merge with other institutions
for pennies on the dollar. The federal government has recently pushed through
legislation to provide $700 billion to failing banks to try to keep the U.S. economy
from plunging even further into a hole.
All of this has had a devastating impact on consumer confidence and the stock
market (the Dow Jones has declined by nearly 3,000 points in the last month, from
11,500 in the beginning of September to 8,500 and falling). Most recently, this
financial crisis has spread to the world markets with many European banks
experiencing solvency troubles and big losses in the Asian stock markets. Many
economists are new predicting that this will be a prolonged economic contraction
that will last a year or longer.
DISCUSSION:
While there have certainly been economic ups and downs during the last ten to
fifteen years, the housing crisis which has precipitated the collapse of the financial
markets has placed the economy in ‘uncharted waters’. While there was some
debate over the past year as to whether the country was entering a recession, based
on recent events it is becoming widely accepted that we are entering a recessionary
period that could last for some time. It is necessary for Culver City to react now in
order to avert its own potential financial disaster. During the last few years the City
has seen growth and development. This recession and tightening of the credit
markets, though, will continue to affect everyone: governments, large and small
businesses, developers, individuals, etc.
The credit crunch during September intensified to the point where Lehman Brothers
filed for bankruptcy protection, Washington Mutual was bought by JP
Morgan/Chase, AIG needed an $85 billion dollar line of credit from the Federal
Reserve (and has subsequently requested an additional $23 billion infusion from the
US Treasury), and the government fast-tracked a comprehensive bailout plan that
provides support to the overall market. To make matters worse, the outlook for the
U.S. economy is beginning to deteriorate at an increasing rate. Second quarter
Gross Domestic Product (GDP) growth has been revised downward from 3.3
percent to 2.8 percent. More alarming is that GDP growth is projected to be 1.0
percent in the third quarter and 0.2 percent in the fourth. While the U.S. economy is
not yet technically in a recession, which is defined as two consecutive quarters of City of Culver City, California
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negative growth, there is a 43 percent chance it will be in the next six months,
according to Moody’s.
Culver City’s revenue streams are being affected by these conditions, and the
likelihood is that it will get worse before it gets better. Below are a few of Culver
City’s major General Fund revenue sources and how they can be affected by an
economic downturn:
Sales Tax
Sales Tax represents about 20% of the City’s General Fund revenues. Specific
Sales Tax data lags receipts by about six months. Based on our most recent
information from our Sales Tax consultant, the first quarter of 2008 was down 5%
compared to the same quarter in 2007. It is likely we will see larger declines as data
comes in for the subsequent quarters based on the negative events that have
occurred in the marketplace. The budget estimate of Sales Tax for FY 2008/09 is
$17.8 million. Coming in only 5% under for the year would be a $900,000 loss
compared to budget.
Utility Users Tax (UUT)
UUT represents about 17% of the General Fund revenues for FY 2008/09, or about
$14.5 million. As economic conditions tighten, individuals become more apt to take
steps to reduce utility consumption to reduce related costs. This can have an effect
on the City’s tax receipts. Staff will provide information on our UUT trend in the
quarterly budget update.
Business Tax
Business Tax represents about 12% of the General Fund revenues for FY 2008/09,
or about $10.15 million. Receipts from this category were strong in FY 2007/08, and
can be partly attributable to strong staff oversight and increased compliance from
business. Funding is included in the FY 2008/09 budget for a business tax audit,
which is anticipated to identify further non-compliant businesses in the city and
should then bring in additional tax receipts. Since the Business Tax is often based
on gross sales receipts, Business Tax revenues generally mirror the trend in Sales
Tax revenues. Despite increased oversight and compliance, there is the possibility
of this revenue category seeing a dip due to lower sales volume or companies going
out of business.
Property Tax
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Culver City is a “low property tax” city and only receives 10.5% of the 1% property
tax rate paid by property owners, which equates to only about 3.5% to 4.5% of
General Fund revenues, on average. Fortunately, Culver City has not seen a
significant drop in this category the last few years, and has not experienced the
severe mortgage and foreclosure meltdowns felt by other locales. The adopted
revenue projection for FY 2008/09 is $3.94 million. This amount has subsequently
been adjusted by our property tax consultant, HdL, and will be further addressed
during upcoming finance presentations.
Major Development Taxes and Fees
FY 2007/08 saw some major development activity get underway, including the
Westfield Shopping Mall and Sony. Combined Commercial Industrial Development
Tax from these two sources alone was close to $2 million for FY 2007/08. Building,
electrical and plumbing permits, plan check fees, and other related fees and charges
saw dramatic increases related to this development also. Projections for FY
2008/09 include $1.18 million in Commercial Industrial Development Tax and
approximately $500,000 in related fees and charges. Due to the current economic
climate and the difficulty for commercial development in securing financing, it is
extremely possible the projects these revenues were based on will be significantly
delayed. Further developments are also slated to begin in FY 2009/10, and the
budget projections for that fiscal year will need to be revisited depending on how the
current business climate shakes out over the next several months.
Interest Income
Culver City maintains an investment portfolio in order to achieve earnings on idle
cash balances. The portfolio includes balances maintained in passbook accounts or
money market accounts to cover immediate obligations, in highly liquid pooled
investment accounts through the California Local Agency Investment Fund, in
federal agency issues and in medium term corporate notes. The collapse of several
significant companies in the financial sector has placed some exposure on the City
and Redevelopment Agency portfolios.
The City holds a $1 million corporate note from Lehman Brothers, which is now in
the process of bankruptcy liquidation. We have joined a working group with other
agencies similarly positioned to work collectively in identifying options to recover as
much of this investment as possible. The City and Agency also hold several notes
from AIG wholly owned subsidiaries: Bear Stearns and Merrill Lynch. Bear Stearns
was bought out by J.P Morgan, and Merrill Lynch by Bank of America, so the
prognosis for these notes is strong as long as the parent companies remain so. It is
important to note that these medium term corporate notes were AAA rated at the
time of purchase. Based on market conditions we see yields being lower than City of Culver City, California
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anticipated during the budget process, and could see lower than expected
investment income in the coming years. Staff is closely monitoring this situation and
will keep the City Council informed.
State Budget Issue
After 85 days after the beginning of the State’s fiscal year on July 1, the state
budget was finally adopted. At the time of its adoption, cities escaped relatively
unscathed, and relatively little city funding was used to balance it. Transportation is
expected to lose $1 million in STA funding for FY 2008/09. The Redevelopment
Agency will also have $2.26 million taken away in FY 2008/09 to help balance the
state budget.
With the recent announcement of an imbalance already of $4.6 billion for FY
2008/09 and the need of $7 billion in cash just to pay bills, it is now uncertain if the
state will come back and shift, divert, or takeaway funds from local governments.
Staff will be watching closely for any developments on this critical issue, and report
any information to City Council and the City Manager.
PERS
The City of Culver City, like most local government agencies in California, contracts
with CalPERS for pension system operation and administration. CalPERS holds
and invests pension payments from local agencies, and is one of the largest pension
systems in the country. As of July 31, 2008, the CalPERS investment portfolio
market value was $235.9 billion. According to the CalPERS website, the investment
portfolio market value as of October 8, 2008 was $198.3 billion. During the last
stock market incident surrounding the ‘dot com’ collapse and then September 11
th
,
CalPERS saw three years of negative earnings. This resulted in dramatic increases
in required pension contributions from local agencies. As a result of the outcry from
contracting agencies, CalPERS instituted a ‘smoothing’ formula to avoid huge ups
and downs in required contributions. If CalPERS sustains huge losses in its
portfolio, we can expect higher contributions in the future, but likely not of a
magnitude seen earlier in the decade.
FISCAL ANALYSIS:
There is no fiscal impact from this report. As mentioned previously in the report,
Staff will return with a detailed budget update based on results through the first
quarter, and update the Comprehensive Financial Plan with these results and
revised future assumptions.
City of Culver City, California
City Council Agenda Item Report
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ATTACHMENTS:
None
MOTION:
That the City Council:
Receive and file this report and direct Staff as deemed appropriate.