Capital Plan Discussions Lead To Reserve Policy Debate

OCEAN CITY – A review of the capital improvement plan at the outset of the fiscal year 2023 budget wrap-up session led to a larger debate about the level of minimum reserve fund balance and a shift of funds to the relatively new capital reserve fund.

Every two years, the Mayor and Council works with the town’s various departments to establish a capital improvement plan (CIP), or a list of significant projects that need to be funded in the budget through a combination of bonds and pay-as-you-go projects funded in the budget or through the reserve fund balance. A couple of years ago, the Mayor and Council established a capital reserve fund (CRF) in addition to and apart from the general budget reserve fund.

The operational reserve fund balance is a rainy-day fund of sorts in the event of an emergency, such as a hurricane or major storm, or most recently the pandemic. The capital reserve fund was established as a means to pay for annual ongoing maintenance projects, such as street paving and canal dredging, for example.

At the outset of last Thursday’s marathon budget wrap-up session, City Manager Terry McGean led off with a review of the CIP and what it means in terms of the proposed fiscal year 2023 operating budget.

“We do the full capital improvement plan every other year,” he said. “That’s when the staff puts all of our projects together and we send them to you to work together to establish the plan.”

McGean explained in terms of the draft fiscal year 2023 budget on the table, the town was working with a CIP established last year.

“This is an off-year,” he said. “The last was fiscal year 2022. We will start a full update of the plan in the fall. What we’re doing in the current fiscal year is essentially following the plan that was adopted last year.”

The CIP breaks down projects in a variety of ways, from those that are bonded long-term to those that are paid internally, either through fund balance or the capital reserve fund. They are also broken down to those that have been completed, those that are in progress and those that are stalled waiting for materials.

Projects in the current CIP that have been completed include canal dredging, the new Northside Park west gym floor, the Sunset Park re-decking, the Northside Park soccer field lights and the convention center expansion. Projects listed as still in progress in the CIP include the Boardwalk re-decking, the Chicago Avenue seawall, street paving and storm drain repairs and storm drain outfall repairs. Projects listed in the CIP as waiting for materials include the fire headquarters elevator repairs, the Northside Park public address system upgrades and an upgrade in the backup communications system at the Public Safety Building.

The list of projects in the CIP are rated first by staff from less important to very important to critical. The Mayor and Council then review those rankings and establish their own rankings based on their priorities. The projects are then established in the CIP and a plan is developed for how best to pay for them.

McGean said based on the growing number of significant projects in the CIP, it would be challenging to add more in the next version until some of them are crossed off. He said the draft fiscal year 2023 budget is based on some optimistic projections on revenue, and if those projections play out as expected, the CIP could be revisited in the fall.

“In my opinion, if we talk about what else we want to do, given what we have in progress for fiscal year 2022 and what we’re adding in fiscal year 2023 in terms of our current staffing levels, I think that we are very close to being maxed out on our ability to manage that many projects,” he said. “If you take everything that I’ve just talked about plus water and wastewater projects, we’re pretty close to saying we have all we can handle right now in the next few years.”

Again, the Mayor and Council a couple of years ago created a separate capital reserve fund to pay for ongoing significant maintenance projects. The town shifted $3 million into the CRF as seed money, and has contributes $1.5 million into it each year. The current balance in the CRF is around $1.6 million, before a contribution from the proposed fiscal year 2023 budget is added, according to McGean.

“The capital reserve fund remains in pretty good shape,” he said. “We can talk about a couple of things we want to do after the summer. If we continue to put in the $1.5 million, it will allow us to do everything that is shown in the capital improvement plan.”

That led to a larger discussion of the ongoing minimum reserve fund balance. Under current policy, the town maintains a reserve fund at 15% of the overall operating budget. There has been discussion in recent months of increasing that minimum threshold to 20%. In reality, the minimum threshold is largely a paper one as fund balance as soared to over 30% in recent years. McGean said fiscal year 2021 was a bit of an aberration in terms of growth in fund balance because of contributions from federal COVID-related grants.

“Excluding fiscal year 2021, fund balance has increased by an average of $1.3 million per year,” he said. “In fiscal year 2021, it grew significantly. That’s largely because of one-time COVID-related grants. If you take out 2021, the contribution has averaged around $1.3 million.”

McGean explained some potential threats to the healthy fund balance. He said a change to the assumption for the annual rate of return on the pension fund from the current 7% to 6.5%, for example, could increase the pension fund liability by over $8 million. Of course, there is always concern about the expense of the potential disaster.

“The budget estimates room tax at $22.5 million, which is our highest budgeted estimate ever,” he said. “A disaster could eliminate or at least reduce that revenue. We would like to hold the line right where we are through the summer.”

If the Mayor and Council ultimately decide to maintain the minimum reserve fund balance at 15%, that would ultimately lead to more growth in the fund’s bottom line. McGean said if the council opted to hold the line on the policy of maintaining the fund balance at 15%, the excess funding could be directed at other significant projects rather then bonding them entirely.

“If we don’t increase the minimum fund balance from 15% to 20%, what would we do with the difference?” he said. “The difference would be about $4.5 million. That’s one thing you could do to pay down Baltimore Avenue without bonding the entire project. I would not recommend making that decision right now.”

McGean pointed out the intent of the separate CRF was to pay for ongoing and annual maintenance projects such has street paving and canal dredging, for example.

“When we established the capital reserve fund, the concept was we would add $1.5 million to that every year,” he said. “That fund is basically for ongoing maintenance projects like canal dredging and street paving. It’s not really intended for other capital projects.”

Councilman Peter Buas said he liked the concept of the CRF, but voiced concern about the continued growth in the reserve fund balance. He proposed an alternative which would shift the estimated $4.5 million difference between a 15% minimum reserve fund balance and a 20% reserve fund balance to the capital reserve fund. The concept is to shift excess fund balance to the CRF in a one-time installment rather than adding $1.5 million over a period of a few years.

“I like the idea of putting $1.5 million in the capital reserve fund every year,” he said. “What I don’t like is sitting on a $10 million unreserved fund this year. A good plan is doing capital projects as a way to give back to the taxpayers. Sitting on the $10 million makes me uncomfortable because I’d like to see it at $4.5 million, which still gives you a cushion for any revenue deficiencies.”

McGean said Buas’ recommendation had merit.

“I understand Councilman Buas’ point in that it is a way to reserve more fund balance without it growing every year,” he said. “I understand the logic behind that.”

McGean said the reserve fund balance is a means to insulate the town from unforeseen setbacks or disasters. In addition, having a healthy fund balance improves the town’s ratings when it has to go to the bond market to fund major projects.

“There has always been a question of how much we are comfortable with taking out of fund balance,” he said. “What do we want to pay cash for versus what we want to bond? I like the idea of taking out $4 million and putting it in the capital reserve fund to pay down capital maintenance projects. Whatever you want to call it, instead of the policy being we’re going to increase the minimum fund balance reserve from 15% to 20%, I like the idea of saying 15% and putting $3 million and that number is going to be fixed.”

After considerable debate, McGean attempted to boil down the two separate issues of reserve fund balance and the capital reserve fund.

“We’re talking about two different things,” he said. “The first would be a one-time $4.5 million that would move from fund balance to the capital reserve fund instead of pulling out $1.5 million every year for the next five years. The second thing is a policy change that would say in addition to a minimum of 15% of operating budget in fund balance, there will also be $3 million set aside for immediate disaster relief or hurricane relief or whatever you want to call it. It would be revisited every four or five years.”

Buas said he remained uncomfortable with the proposal to increase the reserve fund balance to 20%.

“I don’t want to raise it to 20%,” he said. “This is a compromise between the two. That way, we’re spending money on the town rather than having it sit in the bank.”

Council Secretary Tony DeLuca said he would like to rely on the opinions of McGean, Finance Director Chuck Bireley and Budget Manager Jennie Knapp on the minimum reserve fund balance issue.

“What would you recommend?” he said. “The finance director, the budget manager and the city manager are all here recommending we go to 20%.”

Bireley said Buas’ suggestion had merit, but the policy decision on the minimum threshold did not always meet the reality.

“If you do what Peter is suggesting, you’re still going to be over 15%,” he said. “You might not be at 20%. Our recommendation was to go to 20%. Given the way fund balance is going, last year it was over 30%. Going to 20% was a reasonable suggestion. I still like 20%, but I’m not opposed to what I’ve heard here today.”

After considerable debate, the council voted unanimously to approve Buas’ suggestion to shift $4.5 million to the CRF in the current budget instead of the annual $1.5 million contribution over a number of years. The issue of raising the minimum reserve fund balance threshold from 15% to 20% was left open. DeLuca asked McGean, Bireley and Knapp to come back with a recommendation on that decision at a future work session.

“Can the three of you come back with a recommendation based on what you’ve heard today?” he said.

About The Author: Shawn Soper

Alternative Text

Shawn Soper has been with The Dispatch since 2000. He began as a staff writer covering various local government beats and general stories. His current positions include managing editor and sports editor. Growing up in Baltimore before moving to Ocean City full time three decades ago, Soper graduated from Loch Raven High School in 1981 and from Towson University in 1985 with degrees in mass communications with a journalism concentration and history.