Agenda Index City of Vancouver

ADMINISTRATIVE REPORT

TO:

Vancouver City Council

FROM:

General Manager of Corporate Services / Director of Finance

SUBJECT:

2003 - 2005 Capital Plan Financial Limits

 

RECOMMENDATION

CITY MANAGER COMMENTS

COUNCIL POLICY

Council has a policy of developing long range strategic plans to guide the City's capital expenditure program. These long range plans are translated into more manageable three-year Capital Plans which define specific expenditure programs and a supporting financing strategy.

PURPOSE

The purpose of this report is to recommend financial limits that will govern the development of the 2003 - 2005 Capital Plan.

BACKGROUND

The City plans its capital expenditures over periods that correspond to the life-cycle of its assets. Sewer and water infrastructure maintenance and replacement are planned over periods of up to 100 years while major maintenance and replacement of buildings and other facilities are planned on a nine-year cycle. These longer range plans are brought to a more manageable three year planning horizon through the Capital Plan process.

The Capital Plan outlines the projects and programs that will be undertaken during the three years of the plan. An associated financial plan the defines the sources of funding that willbe utilized and how these sources will be allocated to the capital expenditure program. There are a number of sources of funding available to the Capital Plan, including:

· debenture debt approved by Council for sewer and water projects
· debenture debt approved by the voters for all other projects
· capital from revenue, reflected through the transfer from the annual operating budget to fund the pay-as-you-go portion of the Capital Plan.
· funding from senior governments or their agencies
· funding from outside organizations, including community centre associations, social and cultural groups

The 2003 - 2005 Capital Plan can also benefit from the application of development cost levies (DCLs) that are intended to assist the City in dealing with the capital costs associated with growth. Several area-specific DCLs have been approved over the last 10 years and, in addition, in 2000, Council implemented a City-wide DCL. At present, Council policy is to withhold the allocation of City-wide DCLs pending decisions arising from the Financing Growth Study (introduced for Council on June 11, 2002). However, it is the recommendation of the Staff Review Group and the Corporate Management Team that an initial allocation of funding be approved as part of the 2003 - 2005 Capital Plan to begin to address the costs of growth related projects that would not otherwise proceed in the next three years.

DISCUSSION

In the fall of 2001, staff began the process of putting together the capital plan for the period 2003 - 2005. The process and issues to be addressed in the plan were reported to Council in January 2002. The process is being undertaken by the Capital Plan Staff Review Group, comprised of representatives from the major service groups, that will be responsible for bringing a draft plan for consideration first by the Corporate Management Team and then by Council.

Current Financial Polices

The City has a number of financial policies and practices in relation to its capital expenditureprogram. These policies seek to establish the appropriate financing sources for capital expenditures and to ensure that limits on the level of capital spending are established. The following briefly summarizes the pertinent policies and objectives:

· the capital program is planned on a long term horizon to ensure orderly maintenance, replacement and upgrading of civic infrastructure and to ensure that the financial implications of the program can be managed within the fiscal constraints faced by the City.
· capital expenditures that arise as a result of demands from population growth should be funded from developer contributions - DCLs or CACs. The City has established policies that define how development cost levies and community amenity contributions can contribute to these expenditures. Ongoing operating costs associated with these expenditures are appropriately funded from new property tax revenues related to development.
· use of borrowed funds allows the cost of capital expenditures to be financed over several years, more related to the life of the asset. Each capital plan has a financing plan that incorporates the use of debt as a financing tool.
· borrowed funds are generally paid back over ten years to ensure and that outstanding debt does not accumulate to unacceptable levels. The use of ten-year debt ensures that a systematic borrowing program can be administered and that interest costs are maintained at a reasonable level.
· the Capital Plan financing plan incorporates pay-as-you-go funding from current taxes to maintain a balance between borrowed and "current" funding. Use of current tax revenues to fund capital expenditures also assists in managing the overall levels of debt and the constraints of future debt repayment obligations.
· pay-as-you-go funding from current taxes ensures that a portion of the capital expenditure program can be funded without the need for and limitations associated with plebiscite approval.
· internal financing of capital expenditures is appropriate in situations where the capital expenditure can be justified on the basis of a business case, providing a source for repayment without impacting on property taxes.
· While the Capital Plan strives to identify program/project expenditures over the three year period, there are emergent issues that must be addressed during the course of the planning period for which funding should be set aside. Recent Capital Plans haveprovided $5.0 million to deal with these issues.

These policies and objectives have been applied on a consistent basis over the years and have resulted in considerable stability and predictability in capital expenditure planning and funding. These policies, along with a commitment to maintaining the City's existing infrastructure, are one of the reasons why the City has been able to maintain a AAA credit rating since 1980, and benefit from easy and low-cost access to financial markets, both in Canada and internationally.

Establishing Funding Limits for the Capital Program

In developing the 2003 - 2005 Capital Plan it is important for the Staff Review Group to have a funding target within which the recommended projects must be accommodated. This financial limit allows the group to determine priorities and to test the relative priority of projects that fall near the limit.

The financial limit is for planning purposes only. In finalizing the 2003 - 2005 Capital Plan in September, Council will make final decisions about the funding to be included in the plan based on input from the Director of Finance, the Staff Review Group and the public.

There are three financial limits discussed in this report:

· tax supported funding that will be provided from the Operating Budget;
· funding from development cost levies that must be targetted to "growth-related" capital projects defined in the applicable DCL By-laws;
· user fee supported funding from the water utility that supports the water capital expenditure plan.

While there are other outside sources of funding available to support the capital program these do not directly affect the amount of City funding that will be directed to the program and are not the focus of this report. To the extent these are known at the draft Capital Plan stage, they will be reported to Council.

The following sections summarize the factors affecting a funding target from the two primary sources of City funding to be accessed in the Capital planning process.

i) Operating Budget Funding

The Operating Budget has and will continue to provide the majority of the funding for the capital plan. In the current plan, 80% of the funding is being provided by the Operating Budget in two ways:

The financial limits on the capital program are generally defined by the ability of the Operating Budget to support the cost of the program over a longer planning horizon. The aggregate cost of these components is referred to as the Capital Envelope. The policy that has been adopted by Council in developing the financial limits in recent capital plans is that:

· debt charges (principal and interest) for City and GVS&DD debt should not exceed 15% of the revenue budget. This ensures that debt charges do not become a burden on the operating budget.
· the total of debt charges and capital from revenue should fall in the range of 17.5% to 20% of the revenue budget. This ensures an appropriate balance between operating and debt funding for the capital program.
· the cost of the capital program (the Capital Envelope) should not be a long term driver of general purpose taxes.

In practice, it is the last of these criteria that has constrained the financial limits of recent Capital Plans. While there has been room in the Capital Envelope to increase funding, doing so would have resulted in the capital program being a significant driver in the Operating Budget. As a result, Council has limited capital expenditures so as to ensure that they didnot generate tax increases in excess of property tax objectives over the longer term.

The Director of Finance believes these are sound financial policies that ensure the capital program remains affordable and that the debt burden carried by the City is manageable in the long term. It is recommended that these form the basis for establishing the tax supported limits on the 2003-2005 Capital Plan.

ii) Development Cost Levies

The City currently collects development cost levies (DCLs) in two ways. Beginning in the early 1990s, Council addressed growth related issues by approving a number of area-specific DCLs. Presently, there are seven area-specific DCLs in place. In 2000, Council extended the DCL mechanism on a City-wide basis. This approval was for an interim period while staff reviewed the overall costs of growth and developed a strategy for utilizing DCLs to fund a portion of growth costs on a City-wide basis. The Financing Growth Study was introduced to Council on June 11, 2002 and referred to a public consultation process.

DCLs are expected to become an important source of funding for the capital program. However, the Vancouver Charter limits the application of DCL funds to the following purposes:

Area-specific and City-wide DCL bylaws are specific about the purposes to which DCL funds will be applied and over the period in which growth occurs it is a requirement that the funds be spent in these proportions.

A second limitation on the use of DCL funds is that in individual areas, or on a city-wide basis, there will never be sufficient DCLs to pay all of the capital costs identified with"growth". As a result, DCLs must be used in concert with existing City funding (in Financing Growth terms this is referred to as the "municipal assist"). This makes inclusion of DCL funding in the capital planning process critical to achieving the needs for infrastructure, parks, daycare and replacement housing as the City grows.

These limits on the use of DCL funds suggests that their use must be meshed with other funding priorities identified in the capital planning process. In putting the next capital plan together, the City must find opportunities to use DCL funding without otherwise jeopardizing the overall capital expenditure priorities.

In addition, since Council has not established longer term policies about the use of City-wide DCL funding, it is recommended that the Staff Review Group follow the proposed recommendations of the Financing Growth Study in applying DCL funding. These policies provide some limits on the use of DCL funding as follows:

· the allocation of City-wide DCL funding should not exceed the funds in reserve plus a partial allocation of DCL revenues anticipated over the next capital plan.
· the allocation of City-wide DCL funding should be based on the interim allocations established in the City Wide DCL By-Law.

These policies seem prudent for planning purposes in the first Capital Plan that will enjoy access to City-wide DCL funding.

The Current Capital Envelope

In 1999, when Council established the funding limits for the 2000 - 2002 Capital Plan, it was evident that the Capital Envelope, as defined above, was below the level allowed in Council's policy. The envelope was in the range of 17% of the Operating Budget compared to the 20% maximum provided for in the policy. Moreover, it was noted that the capital from revenue portion of capital plan funding was at approximately 2.5%, the lower limit of the guideline.

However, in reviewing the impact that increasing plan funding to take advantage of the guidelines would have on the Operating Budget, it was noted that the property tax levywould come under pressure. As a result, the Director of Finance made three recommendations:

· that Council maintain the capital envelope as a percentage of the Operating Budget.
· that debenture borrowing in the plan be maintained at then current levels (inflation adjusted) and
· that Capital from Revenue be increased up to the limits provided in the capital envelope policy. This followed from the fact that, over the prior years, the reliance on debt to fund capital expenditures had increased relative to capital from revenue and it was prudent to reverse that trend.

This recommendation would have led to a tax-supported capital plan of $184 million for 2000 - 2002 with $138.5 million in debt financing and $45.5 million from Capital from Revenue. As water capital expenditures are funded from user fees, these were considered outside this limit.

While it was clear there was the opportunity to increase capital funding and still remain within the capital expenditure guidelines, the funding plan approved by Council provided for a smaller capital plan of $175 million, of which $137 million was funded from debt and $38 million was funded from Capital from Revenue. This smaller plan, coupled with a slower debenture program and with lower than anticipated debt costs, has resulted in the Capital Envelope continuing to decline as a percentage of the Operating Budget.

Figure 1 shows the Capital Envelope, excluding the water plan, since 1998 and the projection based on the plan recommended in this report. As can be seen the Capital Envelope is currently just over 15% of the operating budget compared to the 17.5% - 20.0% guideline that is Council policy, The current envelope includes debt charges at approximately 12.% andCapital from Revenue at 2.8%.

This current level reflects a number of factors, including lower borrowing costs than anticipated when the 2000 - 2002 Capital Plan was developed and faster than anticipated growth in the operating budget.

Recommended Strategy and Funding Levels for the 2003 - 2005 Plan

i) Tax Supported Funding

As can be seen by Figure 1, the Capital Envelope remains below the limits established by Council. While there would be some benefits to increasing the funding for capital expenditures, Council faces the same situation as in 1999. Increasing the level of capital expenditures will have a negative impact on taxation in the future. As a result the Director of Finance is recommending the following:

· Allow the Capital Envelope to increase to the point where it begins to impact on taxes. This strategy is intended to begin working the capital envelope toward the 17.5% - 20.0% guideline that is part of Council's criteria for an appropriate level of capital expenditures. As a result it means a plan that is larger than inflationary growth alone would suggest. That growth should be possible because of the anticipated growth in the operating budget and because the cost of new debt over the next two to four years should be lower than debt that is being retired. This strategy should allow Council to maintain its taxation policies, with capital expenditures neither increasing nor declining in comparison to the overall Operating Budget. The risk is that should interest rates increase beyond those utilized in the projection there could be an impact on property taxes.

· Maintain the current balance between debt financing and capital from revenue. There are often arguments made for substituting debt for capital from revenue becausethe cost of $1 of debt on an annual basis is less than $1 of current tax revenue. However, the Director of Finance believes that the balance between debt and capital from revenue (78%:22%) is already tipped in favour of the former and would look for opportunities to increase rather than decrease capital from revenue. In the recommended capital envelope this ratio is maintained.

If Council accepts this strategy, the recommended funding limits for the 2003 - 2005 Capital Plan would be as follows:

Source of Funding

Funding

   

Debenture Borrowing

$155,600,000

Capital from Revenue

$44,400,000

 

$200,000,000

This funding level represents an increase of approximately 14% over the 2000 - 2002 Capital Plan, or approximately 4.6% per annum. However, much of this growth is in the Sewers Capital Plan, where an increase in funding to address infrastructure needs has been requested by the City Engineer.

The impact of this recommended Capital Envelope is indicated in Figure 1 above. As the chart indicates, there is anticipated to be modest growth of the Capital Envelope compared to the Operating Budget, moving above the current level during the last borrowing cycle for the plan.

ii) Development Cost Levy Funding

As noted above, City wide DCL funding is available to support capital expenditures over the next Capital Plan. In addition, area specific DCLs can also be allocated where projects meet the geographic restrictions imposed by these DCL By-Laws.

Working with the Financing Growth Study team, a strategy for introducing City-wide DCLfunding into the Capital Plan has been developed for the 2003 -2005 Capital Plan. This strategy would see an upper limit put on the allocation in the next plan equivalent to the existing DCL funds anticipated to be on hand by the end of 2002, plus 50% of the funds anticipated over 2003 - 2005. This ensures that funds available for "growth-related" projects can be utilized over the planning period but that the allocation limit does not exceed the revenues that might reasonably be expected to be earned. This strategy will also ensure that should additional capital projects be identified during the plan, DCL funding would be available to assist with their funding.

At December, 31, 2001, the City wide DCL had generated $5.5 million. For planning purposes, it is anticipated another $4.0 million ($1.7 million to date) will be generated in 2002 and $3.0 million annually thereafter through 2005. Based on the allocation methodology outlined above, the DCL allocation in the 2003 -2005 Capital Plan would be:

Using this methodology the Staff Review Group developed the 2003 - 2005 Capital Plan using an upper limit of $12.0 million in DCL revenue.

Limits on the Water Capital Plan

The foregoing discussion has not dealt specifically with the funding for the Waterworks Capital Plan. The City's Water Utility is heavily capital intensive and is funded from water user fees which are levied separately from property taxes. As a result, credit rating agencies tend to treat water debenture debt separately from debt supported by property taxes. Theprimary concern is that funding is provided at levels that ensure appropriate renewal and upgrading programs can be maintained.

The City Engineer has submitted a proposed waterworks capital plan that is approximately 25% lower than the level approved in the 2000 - 2002 Capital Plan, at $43.9 million. In the accompanying report on the draft Capital Plan, the Staff Review Group is recommending this level of funding to maintain Council's policy for water infrastructure maintenance and renewal, to undertake regional water quality initiatives and to complete the first phase of the Dedicated Fire Protection System. This level of funding will ease the impact of increases in water rates that are forecast as a result of significant improvements to regional water quality planned by the regional district.

Other Funding Sources

The foregoing sections focus on the limits to capital funding from City sources: The Operating Budget and Development Cost Levies. There are other sources that are important components of the overall funding plan associated with the Capital Plan. These could include:

· Translink funding for the Major Road Network
· Community Amenity Contributions (CACs) available in a number of areas of the City
· other negotiated contributions from developers, including the provision of non-market housing
· senior government and government agency funding to support specific initiatives
· contributions from community organizations
· potential public-private partnerships for the development of civic facilities.

While these outside sources are important to completing the City's capital expenditure program, they are often small in comparison to the overall plan and uncertain at the time the plan is developed. It is therefore inappropriate to include them in the financial limits. However, where funding from these sources is available to complement City funding, it will be factored into the Capital Plan and reported to Council with final plan.

Risk Factors Associated with the Recommended Funding Levels

In developing these recommended funding levels, a number of assumptions have been made regarding future events. Council is urged to consider this funding level as a base level and to be prepared to consider changes should circumstances change during the course of the plan. There are a number of factors that might lead to reconsideration of the financing strategy:

i) Significant Changes in Interest Rates

ii) Operating Budget Challenges

CONCLUSION

This report recommends that the financial limits for the 2003 - 2005 Capital Plan be established as follows (with current plan comparisons):

Funding Source

2000 - 2002 Capital Plan

2003 - 2005 Capital Plan

%
Change

       

Debenture Program

$137.0 million

$155.6 million

13.5%

Capital from Revenue

38.0 million

44.4 million

16.8%

Waterworks Program

58.9 million

43.9 million

(25.5)%

 

$233.9 million

$243.9 million

4.1%

DCL Funding

-

12.0 million

  

Total

$233.9 million

$255.9 million

9.5%

The recommended funding levels represent an overall increase of tax and utility fee supported capital expenditures of 4.1%. Although there is room within the financial guidelines to increase tax supported capital expenditures beyond this level, doing so will begin to put pressure on future property taxes. The report also recommends the inclusion of a guideline for utilizing funding from the City-wide development cost levy, with funding being directed to projects that have a "growth" component.

The funding limits recommended in this report is consistent those utilized by the Capital Plan Staff Review Group in developing the funding allocation detailed in the accompanying report. Once the draft plan is considered by Council and the public have had the opportunity to review it, final decisions on the overall level of funding will be made by Council. This final step will take place in September, 2002.

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