ADMINISTRATIVE REPORT

Dated: March 9, 1999

Author/Local: H. Creighton/2156

RTS No: 00601
CC File No: 1611

Council: 23 March 1999

TO: Vancouver City Council

FROM: Director of Finance, in consultation with the Corporate Management Team

SUBJECT: 2000-2002 Capital Plan - Funding Limits

RECOMMENDATION

A. THAT Council set the guideline financial limit for the 2000-2002 Capital Plan at $184 Million (excluding Waterworks) as outlined in this report, subject to final consideration by Council prior to the adoption of the Plan in September.

B. THAT Staff Review Group report to Council on a recommended 2000-2002 Water Capital Plan based on consideration of program needs and projected financial impacts on water user fees.

C. THAT the Capital Plan Staff Review Group provide Council with recommendations for the Park Board capital funding for the 2000-2002 Plan within the context of the overall financial limits and corporate priorities for the Plan.

D. THAT the Staff Review Group report on the recommended funding for the Supplementary Capital Plan, based on an assessment of the demand for funding for emergent issues.

CITY MANAGER'S COMMENTS

The Corporate Management Team, in considering the foregoing recommendation A, were concerned about the projected 13% increase in capital expenditures. In the context of low inflation and other challenges which the Operating Budget might face in the next three years, the CMT felt it would be more prudent for the Capital Plan Staff Review Group to start off with a funding limitation equal to the previous plan, plus an inflation allowance of 2% per year. This would result in a Plan amounting to $173 million, or a reduction of $11 million from the level suggested by the Director of Finance. However, the CMT also recommend that the Staff Review Group give consideration to, and report on those projects which they would recommend to be added to the Plan, should Council wish to use the full funding envelope at the $184 million level.

COUNCIL POLICY

The City’s present policy is to plan for capital expenditures on a three year cycle. Funding for capital expenditures comes from:

· borrowed funds
· contributions from the Operating Budget (referred to as Capital from Revenue)
· contributions/levies related to property development
· cost-sharing agreements with other levels of government
· cost-sharing agreements with community groups

With the exception of sewer and water borrowing, which Council may approve without voter approval, all borrowing must be approved by plebiscite. Borrowing questions for capital plans are normally submitted to the electorate at the triennial civic elections.

PURPOSE

The purpose of this report is to present for Council consideration the financial policies and limits which will govern development of the 2000-20002 Capital Plan.

BACKGROUND

On September 29, 1998, Council approved a process for developing the 2000-2002 Capital Plan. The planning process will culminate with Council adoption of a three year capital expenditure program and associated financial plan in September 1999. The questions to approve borrowing for portions of the Capital Plan will be presented to the electors as part of the 1999 civic election.

DISCUSSION

Current Financial Policies

The City has a number of financial policies and objectives in relation to its capital programs. These policies seek to establish funding sources for capital expenditures and to set limitations on the level of capital spending. The following briefly summarize the pertinent policies and objectives:

· capital expenditures generated by new construction should be funded from developer contributions, including DCLs and CACs
· use of borrowing allows the cost of the capital expenditure to be funded over several years, more related to the life of the asset.
· borrowed funds are repaid over ten years to ensure that outstanding debt does not accumulate to unacceptable levels.
· use of Capital from Revenue funding allows for a portion of the capital funding to be allocated without reference to the limitations of plebiscite questions
· use of Capital from Revenue funding avoids the build up of debt and the constraints of future debt repayment obligations
· internal financing (from the PEF or CFF) is appropriate where the capital expenditure will generate new revenues or reduce operating costs, thus providing a source for repayment without impacting on the tax levy.
· a portion of the capital plan is set aside for Supplementary Capital, to fund emergent issues that arise during the course of the Plan

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. These policies, along with a commitment to maintaining the existing infrastructure, are one of the reasons why the City has been able to sustain its AAA credit rating since 1980, and benefit from easy and low cost access to financial markets, both in Canada and Europe, for the purpose of borrowing.

Funding Limitations

The financial limits of the capital program are generally defined by the ability of the Operating Budget to support the cost of the program over a number of years. In past years, Council has sought to limit capital expenditures so as to ensure that they did not generate tax increases in excess of Council’s tax objectives.

The major cost components arising from the capital programs are:

· debt charges (principal and interest) on City debt:
· debt charges on the City’s portion of GVSDD debt; and
· capital from revenue, reflected in a transfer from the annual operating budget to fund the pay-as-you-go component of the capital budget.

These costs show themselves as part of the City’s annual operating budget and are reflected, in part, in the annual tax levy. Managing their growth therefore impacts on the growth of the tax levy.

The aggregate cost of these components is referred to as the Capital Envelope. The policy that has been utilized by Council in developing financial limits in recent capital plans is that:

· debt charges (principle and interest) for City and GVSDD debt should not exceed 15% of the annual operating budget;
· the total of these three items (debt charges plus Capital from Revenue) should fall within the range of 17% to 20% of the annual operating budget; and
· the costs of the capital program should not adversely impact on Council’s objectives regarding the increase in the general purposes taxes.

The Director of Finance believes that these are sound financial policies and that they be confirmed in developing the 2000-2002 Capital Plan.

Application of Financial Policies to the 1997-1999 Capital Plan

In March 1996, when Council established the financial plan for the 1997-1999 Capital Plan, the Capital Envelope was projected to increase to 20.1% by 1999, slightly above the upper limit. Faced with this expectation, Council suggested that future Capital Plans be constrained to ensure that costs remain within acceptable limits.

The concern over exceeding the upper limits on the Capital has proven to be unfounded. Based on current projections, the envelope is projected to reach 17.0% in 1999, well below the forecasted level. There are a number of factors which gave rise to that variance, including:

· the capital expenditure program has proceeded more slowly than projected, resulting in debenture borrowing being delayed, and repayment costs being deferred to future years.

· the projected increase in GVS&DD capital expenditures did not materialize, with a similar impact on repayment costs.
· interest rates have declined below projected levels, resulting in lower costs of borrowing.
· budget management reductions in Capital from Revenue funding..
· growth in the size of the Operating Budget, primarily in the public safety areas, has effectively increased the capacity of the capital envelope.
· Council’s decision to pass the increases in GVS&DD levies through to taxpayers also increased the capacity of the capital envelope and ensured that these levies did not squeeze out City programs and expenditures.
· Council approved a reduction of the Capital Envelope, when it approved the transfer of $3 million per year of Capital from Revenue funding to the Information Technology Long Term Financing Plan.

Capital Plan Challenge

The current position with respect to capital budgeting and operating budgets reflects both problems and opportunities. The following summarizes several elements that have a positive impact on the Capital Envelope:

· the Capital Envelope is well below the guidelines adopted in previous years (17.0% versus the acceptable limit of up to 20%). If it were not for the resulting tax impacts, there might be an argument for increasing capital expenditures in the next Plan up to the guideline levels in order to address infrastructure and growth issues.
· lower interest rates and maturing debt will result in a decline in the Capital Envelope, if future borrowing is constrained to previous levels, plus inflation.
· the emergence of capital funding from outside of the Operating Budget, including cost sharing with users of City facilities, the potential of City-wide Development Cost Charges, and cost-sharing with the GVTA for road works.
· more moderate growth in the GVS&DD debt levies, reducing the pressure on the capital envelope.

While these elements impact positively on the Capital Envelope and increase the City’s ability to maintain and potentially increase the capital expenditure program, there are several negative elements which would suggest some caution. These negative elements have arisen primarily from the ongoing challenges the City has faced with its Operating Budget. During the 1990s, the City has seen significant reductions in Provincial funding, cyclical reductions in some revenue areas, and increasing expenditure demands from a variety of program areas.

In response, Council has increased user fees, imposed adjustments to the expenditure program, including reductions to service levels, and increased taxes above inflationary target levels. There is no indication that the future will be any different nor will these challenges will abate. In order to be better prepared, Council has mandated a review of core services to ensure that expenditure growth is more effectively controlled.In this context, it seems premature to contemplate making commitments for increased expenditures, including changes in the capital program.

Another consequence of the specific actions taken by Council over the past decade is that the City is increasingly relying on debt, as opposed to Capital from Revenue, to finance capital works. The impacts of this are two-fold:

· debt repayment charges are a fixed commitment in the Operating Budget and cannot be reduced in the face of budget pressures.
· having a significant proportion of capital projects funded from Capital from Revenue provides a very effective mechanism to meet budget challenges, as projects can be deferred with significant and immediate savings to the annual budget. The current low levels of Capital from Revenue preclude the effective use of that tool.

Recommended Strategy and Funding Levels

In the context of the foregoing, the two strategic decisions being recommended to guide the funding limitations for the next three years are:

· Maintain the Capital Envelope, as a percentage of the Operating Budget at current 1999 levels. This strategy should allow Council to maintain its taxation policies, with capital expenditures neither increasing or declining, in comparison to the overall Operating Budget.

· Maintain debenture borrowing at current levels, plus inflation, and increase Capital from Revenue contributions, up to the limits of the Capital Envelope. This strategy will, at a minimum, maintain existing capital expenditure levels, but also move towards a reduced reliance on debt financing.

If Council accepts this strategy, the recommended funding limits for the 2000-2002 Capital Plan would be as follows:

	2000-2000 Plan	1997-1999 Plan
	$(000)	$(000)
Debenture Borrowing	138,500	132,800
Capital from Revenue	45,500	30,068
Total	184,000	162,868

These funding limits provide for a 13% increase over the level of the 1997-1999 Plan. It also provides for a reduction in the reliance on debt, with Capital from Revenue projected to rise from 18.5% of the total plan to 24.7%.

Risk Factors Associated with Recommended Funding Levels

In developing these recommended funding levels, a number of assumptions are 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. Some of the contingencies which might prompt Council to consider changes, either prior to the adoption of the Plan, or during the course of the next three years include:

a) Increases in Funding from Outside Sources

Should funding from the GVTA or DCLs or from senior government cost-sharing programs be higher than anticipated, Council might use these increases to reduce the size of the Plan or convert the room in the Capital Envelope to allow a greater use of Capital from Revenue rather than borrowing to finance capital programs.

b) Deferral of expenditure plans

Projections of the Capital Envelope are based, in part, on the timing of capital expenditures and the resulting timing of debenture borrowing. As was the case in the previous plan, some capital expenditures and debenture borrowing did not proceed as fast as forecasted and debt charges were deferred. If that situation arises in the next Plan, Council might take the opportunity to convert those savings to allow a greater use of Capital from Revenue rather than borrowing to finance work.

c) Changes in interest rates

Projections for the Capital Envelope are based on a continuation of interest rates at levels slightly above current rates. Should there be significant changes to interest rates, Council will want to consider whether these changes should be reflected in changes to the Plan, or to taxation targets.

d) Operating Budget Challenges

In developing the Capital Envelope projections, certain assumptions were made about the Operating Budget and general purposes taxes. These included assumptions about relatively stable growth in the budget. Past experience suggests that there will be changes, and that the nature and direction of that change will be largely unpredictable. Council will want to have a variety of potential actions at its disposal to respond to any changes that arise over the course of the next Capital Plan. Increased flexibility to deal with budget pressures is one reason for recommending a higher proportion of Capital from Revenue - which is probably the easiest area to make sizable impacts on the Operating Budget.

Other Funding Sources

The foregoing discussion focuses attention on the limitations imposed on those elements of capital funding which are funded out of the Operating Budget. There are other funding sources, including:

· GVTA cost-sharing for road improvements for the Major Roads Network
· existing Community Amenity Contributions, primarily in the western part of the downtown peninsula
· existing Development Cost Levies, with the major revenues being received in Downtown South
· the new interim city-wide Development Cost Levy
· other negotiated contributions from developers, including provisions for social housing
· potential private-public partnerships for the development of civic facilities.
· potential senior government cost-sharing programs

Staff continue to explore these alternative funding sources as a way to supplement existing internal funding. One of the considerations of the Capital Plan Review Group in developing the draft 2000 - 2002 Capital Plan, will be to identify alternative funding sources, including those identified above. Where possible, the group will include comments or recommendations on the treatment of these sources when the plan is reported to Council. However, because most of these alternative sources are neither significant nor predictable at this stage of the planning proces, they are not being brought into consideration in setting funding limits to the Capital Plan.

Limits on the Water Capital Plan

The foregoing discussion has also not dealt specifically with funding for the Waterworks Capital Plan. As Council is aware, the operations of the Water utility are funded from water user fees, which are levied separately from property taxes. Credit Rating agencies tend to treat water debenture debt separately from the City’s general obligation debt, due to its separate funding source.

During the planning phase for the 2000-2002 Capital Plan, the Staff Review Group will give consideration to the priorities in the Waterworks capital request and will make a recommendation to Council on the total amount of funding that should be allocated to such work as regional water quality initiatives, maintenance of the existing water infrastructure and construction of the dedicated fire protection system. This work will be completed in consultation with the Director of Finance and General Manager of Engineering Services to ensure that the needs for maintenance and upgrading of the system are adequately addressed and that the impact on future water charges are considered.

Funding for Emergent Issues

In the previous 1997-1999 Capital Plan, $5 million was set aside for the Supplementary Capital Plan. A major component of that funding was to provide for major building maintenance and upgrading work, with the balance allocated to emergent issues. For the next Plan, the Staff Review Group intend to recommend that the building maintenance issues be folded into the Basic Plan, and thus lessen the demand for funding in the Supplementary Plan. In light of that, it is recommended that the decision on the amount of funding for the Supplementary Plan be deferred for now, and that the Staff Review Group cover off that issue in the subsequent report.

CONCLUSION

This report has recommended a funding limit for the 2000 - 2002 Capital Plan at $184 million (excluding waterworks), which is projected to maintain the Capital Envelope at 17%. This funding increase amounts to 13% over the level of the previous plan, and also results in the Capital from Revenue, as a percentage of the Operating Budget, increasing from 2.3% in 1999 to 2.7% in 2002, thus reducing the reliance on borrowing and increasing Council’s flexibility with respect to the Capital Plan. This recommended funding limit is in advance of consideration of the detailed submissions for the Plan, and Council can adjust the overall funding limit prior to the adoption of the Plan.

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(c) 1998 City of Vancouver