Staff Report Supporting
The Recommendations of the Long Range Financial Plan

BACKGROUND

In October 2002, City Council approved the first LRFP and a number of recommendations related to the long term funding required to meet the capital needs facing the City. Significant progress has been made on those recommendations particularly with getting other levels of government to recognize the problems municipalities are facing with respect to infrastructure. The recommendations from that report, those made by the Committee, and an update on their status are included at Appendix 1 for information.

At the time LRFP was approved it was recognized that until the Official Plan was finalized and the accompanying studies and master plans were completed the full capital needs of the City would be incomplete. It was also recognized that further work needed to be completed to determine the state of the existing infrastructure and the future funding requirements to maintain the City’s capital assets in an on-going state of good repair.

The Official Plan has now been completed, the master plans developed, the study of growth costs and new development charges completed and the analysis of existing assets are now in place. Accordingly, the costs that will be faced over the next decade are in a more complete form reflecting the visions of the 20/20 plan. As well, a number of funding changes have been introduced by the upper levels of government which improve the funding picture for the City. These and other changes will be detailed in this report which provides a view of the next ten-year period.

This report details only the City tax-supported capital programs. The rate supported program and police services plan will be brought forward to the Long Range Financial Plan Committee and Corporate Services and Economic Development Committee during the month.

The purpose of the Long Range Financial Plan is to provide a high level funding strategy for the capital program. Detailed project listings will follow as part of 2005 Capital Budget and 2006-2014 forecast.

DISCUSSION

THE 10-YEAR NEEDS

The capital program has been divided into three specific categories, Renewal of City Assets, Growth, and Strategic Initiatives.

The Renewal of City Assets category reflects the funding required to maintain and/or replace all existing capital assets throughout the full life of those assets. These assets include buildings, structures, roadways, transitways, bridges, vehicles, equipment, computers, computer networks and various other facilities. A number of studies have been undertaken throughout the various City program areas to determine the funding levels required to meet acceptable standards and reports have been brought forward to Council in a number of those areas over the past two years.

The capital projects identified within the Long Range Financial Plan are based on those studies and will reach a level that fully meets the identified lifecycle needs within the ten-year review period. Each program area has developed its own timetable for reaching the full needs and the costs contained herein reflect its estimates. This category totals $2.4 billion over the ten-year period compared to $2.1 billion identified in the first Long Range Financial Plan. Although comparison to other municipalities is difficult in that few municipalities have completed the same process as we have undertaken, a review of similar municipal jurisdictions indicates that these estimates compare to those jurisdictions.

The next category is Growth expenditures. This category includes all projects that would have been identified in the Development Charges background study that reflects the new Official Plan and formed the basis for the new development charges approved by Council in July.

The total cost of growth projects is $4.093 billion. The growth program has approximately doubled since the original Long Range Financial Plan with the Light Rail Transit program representing almost 75% of that increase.

As part of determining the growth costs and revenues, it was assumed that the revenues from the provincial and federal governments identified in support of the first phases of the light rail transit program will continue throughout the future phases. In total, revenues fund approximately 33% of the growth program, with development charges picking up 46%, leaving 21% to be funded by the tax base.

Since development charges fund a very significant share of the growth program, the City has an obligation to provide the non-growth funding share to put in place the infrastructure to serve the growth areas.

The third category of expenditure is Strategic Initiatives. This category includes all other capital expenditures. The types of expenditures shown here include initiatives such as implementing various master plans or the Ottawa 20/20 plan, acquisition of environmental areas, the enhancement of services currently being provided and growth costs not eligible for development charges. It also includes initiatives to enhance organizational effectiveness, implement new legislated requirements, and respond to changes in demand for services. Spending requirements in these areas total approximately $1.1 billion over the ten-year period. One of the major new initiatives within this category that was not included in the first LRFP is social housing.

Social Housing

Over the next 10 years, the Housing Branch has identified a need for up to $403 million of capital investment to support the development of 500 units of low-income affordable housing per year. Targeted to households at and below the 20^th income percentile ($30,055 in 2003), this direct public investment is needed to ensure that the City’s targets for affordable housing under Ottawa 20/20 and the Official Plan include a range of households and incomes. The City’s Official Plan defines affordable housing as being affordable to households at or below the 40th income percentile ($54,273 in 2003). The low-income target of 500 units per year represents about 40% of the expected annual number of affordable housing starts as defined by the Official Plan targets, or about 10% of the total expected number of housing starts, and over 10 years will result in 5,000 units affordable to the 11,500 households currently on the social housing waiting list.

The core issue for affordable housing is the gap between what it costs to provide the units and what low-income households can afford to pay. The former social housing programs provided on-going operating subsidies to bridge that gap. These programs ended in 1995. The current approach is to provide a one-time capital subsidy to developers to reduce the cost of construction enough so that the units can be affordable without the need for an on-going operating subsidy. Based on estimates from the Federation of Canadian Municipalities (FCM), capital subsidies of up to $100,000 per unit may be required to achieve low-income affordability. The Housing Branch projection assumes a capital subsidy of between $70,000 and $90,000 per unit.

The City is currently providing an average capital subsidy of $60,000 per unit via the Action Ottawa program, supporting 368 units to date, with 220 additional units to be funded in 2005. The City is the primary funder of Action Ottawa, although funds from the federally funded, Provincially administered "Community Rental Housing Program" started to flow in 2004. The current capital subsidy is comprised of $33,000 City, $25,000 Federal, $2,000 Provincial per unit.

The Long Range Financial Plan proposal is based on an assumption of at least 50% of the required funds coming from other levels of government, although equal (1/3) cost sharing would be a more desirable outcome that staff will continue to lobby for. The Province currently has approximately $320 million available via the Federal program, and is expected to increase its contribution to match the Federal portion in 2005. Affordable housing was the priority issue identified in the Liberal Task Force on Urban Issues. Both the Federal and Provincial governments have moved towards recognition of housing as essential "social" infrastructure, partly because of the scale of the need and the mechanisms for funding.

Council should continue to advocate for increased and more appropriate funding from other levels of government, and staff will continue to work with staff from other municipalities via the FCM for a more systemic approach to dealing with housing issues. Staff will also pursue alternative sources of funding for affordable housing. Some of the mechanisms identified for further exploration in the discussions for the affordable housing policies in the Official Plan include: dedicated fees or levies for affordable housing, including linkage fees for commercial development to ensure housing is affordable to workers; dedicating proceeds from the sale of civic assets to an affordable housing fund; cash-in-lieu payments for developments that do not fully meet the Official Plan targets that 25% of new housing be affordable; increased use of tax receipts for donations of property (land trust); and new mechanisms to support more financing more appropriate for low-income housing.

For the time being, staff will bring forward annual requests for capital funding to meet the current needs and opportunities. The intent is to move towards a more predictable funding process to help sustain the necessary longer-term planning by developers in the community. Only minimal production will be able to be supported if city funding is the only capital available. Full Federal and Provincial participation will be required to meet the desired target of 500 units per year.

Definition of Capital Projects

In 2003 and 2004, considerable discussion occurred regarding a number of projects included within the capital budget that could be considered to be operating expenditures. In the 2004 budget, a number of these were transferred to the operating budget and staff undertook to review all other projects for consistency. In doing so a consistent definition of what was a capital project was required. Staff reviewed a number of jurisdictions for a definition and recommends the following which is derived from a former provincial definition.

"A capital expenditure is any significant expenditure incurred to acquire or improve land, buildings, engineering structures, machinery and equipment. It normally confers a benefit lasting beyond one year and results in the acquisition or extension of the life of a fixed asset. It includes vehicles, office furniture and equipment. An expenditure on repair or maintenance designed to maintain an asset in its original state is not a capital expenditure. A capital expenditure may include the costs of studies, etc., undertaken in connection with acquiring land or constructing buildings. It may also include interest on temporary borrowing for capital purposes and transfers for capital purposes to unconsolidated local entities, hospitals, universities and similar organizations. Notwithstanding the proceeding definition expenditures that qualify for development charge funding will remain as capital projects, even if not in compliance with the capital expenditure definition."

The list of projects that are recommended to be transferred from the capital budget to the operating budget based upon this definition are attached as Appendix 2. It is also recommended that since these projects are currently using Pay-as-you-go funding that an equal amount of funding also be transferred to eliminate any operating budget impact for 2005.

FUNDING THE CITY’S NET SHARE

The overall costs and revenues that have been identified for the three categories for the next ten-year period are summarized below:

A functional breakdown of each category of expenditure is shown in Appendix 3.

The balance of this report will focus on the net city share and how to fund this requirement or as much of it as possible.

The following chart illustrates the net City share of identified capital needs annually over the period 2005 to 2014.

The chart illustrates the on-going funding that existing infrastructure will require in order to avoid future major reconstruction and ultimately greater costs. The total costs for the renewal of city assets dramatically exceed those of the other two categories. The growth costs are fairly evenly spread over the years with the exception of those years when new light rail projects are initiated. The Strategic Initiatives projects fluctuate more noticeably from year to year reflecting the nature of the projects that are contained in that grouping.

There have been a number of new funding sources that have evolved since the first Long Range Financial Plan. A brief outline of each funding source is described below.

GST and Gas Tax

In 2004, the federal government announced that the portion of the Goods and Services Tax (GST) that municipalities were required to pay would be refunded as the first step of introducing new revenues to the municipal sector to assist with their infrastructure deficiencies. This initiative will generate approximately $16 million annually from tax supported City operations.

Also in 2004, the Province of Ontario approved the transfer of up to 2 cents of provincial gas tax revenues to the municipal sector starting in late 2004 and reaching full value in 2007. The full on-going annual new revenue to the City is estimated to be $37 million annually.

In the throne speech this month, the federal government introduced the sharing of gas tax revenue with municipalities starting in 2005 and being phased in over the next four years. The phase-in period that is now anticipated is slightly different than staff had forecast, therefore, the numbers included in this report are slightly different than those provided to the Long Range Financial Plan Committee. The commitment outlined by the federal government is to share five cents of gas tax which will result in annual revenues to the City that are estimated at $60 million upon full implementation. The details of how these revenues will be allocated to each municipality have not been finalized, however, staff believe the estimates are on the conservative edge. Since the LFRP is planned to be updated every three years, these revenues will also be updated based on the most recent information available.

The Long Range Financial Plan utilizes development charge revenues that are consistent with the development charge work plan and the rates approved by Council. Any changes to the rates now in place will have some impact on the overall growth costs and the net City share that are shown here.

Ottawa Hydro Funds

City Council has approved a refinancing plan for Hydro Ottawa and will be receiving $200 million as part of the refinancing. It is recommended that these funds be used to derive the maximum benefit to the City in funding its capital program in the future.

A review of other major cities in Canada indicates that when major assets have been sold that the money has been put into an endowment type of fund and the income from that fund used to provide monies annually to the cities. These types of funds are invested by professional investment firms and managed by the cities as a type of trust fund. They are allowed to invest in both bonds and equities and have provided returns well in excess of 10% annually. Staff believe that this type of fund would derive the maximum benefit over time for the City of Ottawa.

Staff recommend that the City of Ottawa establish an Endowment Fund with the proceeds of the Hydro Ottawa refinancing and that the annual income from the fund be used to provide monies to finance the City’s capital program. It is further recommended that the City request special legislation that would allow the fund to be invested under the Trustees Act allowing for a broader range of investments than allowed under municipal legislation.

The investment process would operate in a manner similar to the two City pension funds with the actual investments outsourced to investment firms who would invest based upon a statement of investment policies and procedures established by the City. The performance of the investors would be monitored and reported upon on a regular quarterly basis through a trustee relationship.

The primary advantage to this type of structure is that the $200 million remains intact while providing a perpetual source of income to the City.

In addition to the refinancing of Hydro Ottawa, the City will also receive dividends on an annual basis. In order to leave flexibility for the utilization of some of these revenues within the operating budget in 2005, the Long Range Financial Plan has assumed that the first $12 million of dividends will be allocated to the operating budget and the remainder to capital. This will provide up to $7 million annually for the capital program.

Pay-As-You-Go and Debt

Each year monies are provided within the operating budget in the form of pay-as-you-go contributions to finance the capital program. These amounts have remained fairly constant over the years and in effect decreased from a spending power point of view. It is recommended that these contributions be increased based upon the increase in the Ottawa Construction Index which is used as an indexing for development charge rates. This will ensure that there is continued progress towards Pay-as-you-go each year.

As well, Council’s policy has been to approve new debt each year restricted to the amount of new debt that can be repaid each year within the existing repayment envelope. In effect, this has created a revolving debt fund that is used to fund some capital programs without adding costs to the overall tax bill. It is recommended that this practice continue without change in order to fund projects such as road reconstruction where the life of the asset is extended and used over a long period of time.

These revenues provide an estimated revenue stream over the ten-year period as shown below:

Funding Strategy

In an effort to confine debt financing to only certain types of projects, the first Long Range Financial Plan contained the following recommendation:

"Long-term debt financing should be restricted to specific project types. Debt funding for lifecycle projects should be reduced and ultimately eliminated. Instead, debt financing should be employed on projects related to capacity expansion or growth, projects financed by development charges, future new non-traditional infrastructure projects, and projects tied to third party matching funding. These restrictions may have to be phased in to meet short-term budget challenges."

The rationale for the use of debt as an effective financing mechanism for the City of Ottawa is that it allows major growth projects to be paid for over a number of years, similar to a mortgage on a home. It spreads the benefit of the capital project over a longer benefit period providing for the project to be paid for by a broader tax base, and it makes the development of required capital works within the 10 year time frame achievable.

In a publication entitled "Mind the Gap, Finding the Money to Upgrade Canada’s Aging Infrastructure" the TD Bank Financial Group in May 2004 addressed the national infrastructure problem and provided a number of proposals. When speaking of the use of debt they said, "Maintaining low debt-load may be a laudable goal, but if it comes at a cost of foregoing or delaying capital projects because non-debt sources of financing aren't available, then a low-debt strategy is counter-productive." and "Besides, a healthy level of borrowing passes the test of equity, since benefits, which are normally consumed over the life of several decades, are matched with the costs"

The question for the City is how can the use of debt be effectively used without increasing the costs on the property tax bill itself. What staff is recommending is the use of the new non-property tax revenues as a source of funding new debt that could be issued under the existing policy wording. The debt that would be eligible under the definition is predominately associated with the public transit and transportation areas and would be a natural tie into the use of gas tax revenues as a repayment source. It is recommended that debt financing be used to fund the growth portion of the expansion of rapid transit and other growth-related projects by debt financing some projects and using the future stream of gas tax payments to pay the debt charges.

The City of Ottawa is authorized under Section 401 of the Municipal Act, 2001 to issue debentures. The debt capacity limit for the repayment of long-term debentures is established by the Ministry of Municipal Affairs and Housing. The most recent limit provided by the Ministry, indicates that the City’s Annual Repayment Limit (ARL) which is the amount available each year to service new debt, is $262,385,885. This limit allows the City to undertake additional long-term borrowing of up to $2,780,000,000 depending on the interest rate and repayment terms, before exceeding the ARL.

The City of Ottawa is currently repaying $442 million in debt and has an additional $191 million in debt for projects that has been authorized but the project spending has not been completed. The principle and interest repayments in 2004 total $87.5 million of which, $73.6 is coming from taxation and $13.9 from the water/sewer rate. Therefore debt service costs, including the costs of the proposed issue, are well within this debt capacity limit.

As can be seen in the following table, since amalgamation the City has benefited from lower interest rates, as the debt being retired is being replaced with debt at lower interest rates. This has allowed the City to service more debt at a lower cost. As the debt servicing budget has been reduced since amalgamation and there are more taxpayers contributing to the debt repayments, the amount debt servicing represents on the tax bill has also been reduced. The decreases in the debt servicing envelope have been contributed to the contributions to capital reserves (PAYG). In 2005, the tax supported debt servicing is forecast to increase to $77 million, but the increase will be offset by a decrease to PAYG.

*The $177 for debt servicing, as a portion of a $2,401 average tax bill, is higher than reported in the Budget Workbook as it includes transit and police debt servicing, which in the workbook is included in their functional lines.

The LRFP2 makes two recommendations that will affect the tax bill. The first is that the PAYG contributions will increase by the Infrastructure Price Index every year. In 2004, the PAYG contributions represented $345 (including transit and police) on an average tax bill. In 2005, the cost of the increase on the tax base is $3.35 million which is $8.63 on the tax bill.

The second recommendation is that the new debt to be issued, as per the strategy, be funded from the gas tax revenues to be received from the Province and the Federal government. This has the effect of keeping the tax-supported debt servicing budget fixed at the 2005 level of $77M. As the City grows and new taxpayers are added to the tax roll, if debt servicing does not grow at the same rate as new taxpayers are added, the cost per taxpayer will decrease.

Similarly, while the PAYG contributions have been targeted to increase every year, if the increase is the same as the growth in taxation, the amount on the tax bill will remain constant. Assuming 2% assessment growth every year from now until 2014, and assuming that the PAYG contribution will increase by 2% every year, by 2014 the PAYG portion of the tax bill would be $353 and the debt servicing portion will be $147. Combined this means the average taxpayer will pay $500 per year for capital costs in 2014 compared to $522 per year in 2004.

The City currently has an AAA credit rating from Moody’s and an AA(high) rating from DBRS. In establishing the City’s credit rating, the two agencies look at the debt burden and how it is funded. The authorization of $761 million in debt during the next ten-year timeframe may or may not affect the credit rating of the City, but as the increased servicing costs will not be reflected on the tax bill, any rating change should be minor.

Funding Priorities

Staff also recommend that the funding strategy for the overall capital program be to fund growth at 100% and split the balance of available funding between Renewal of City Assets and Strategic Initiatives with a goal of meeting full Renewal of City Assets needs as soon as possible within the ten-year plan.

The results of this recommendation and the others within the report are illustrated for each of the three project categories as shown in the following charts.

This would result in the full funding of growth projects consistent with the development charge study and the Official Plan.

The chart shows dramatic movement towards the full funding of renewal needs reaching 100% within the period. Even in the early years 75% to 90% of the program can be met. Achieving 100% would place the City in an enviable position among municipalities in Canada.

The Strategic Initiative category is the area where the remaining funding shortfall is most obvious. The staff recommendation has an emphasis on meeting renewal needs leaving the shortfall here. The chart above splits out the Social Housing initiatives from the others for presentation purposes. Social Housing needs a specific funding strategy and greater participation by upper levels of government. Staff will be bringing a report forward recommending a specific housing funding strategy.

The options for the balance of the shortfall at this time are: (1) provide additional taxation for these over the 10-year period, (2) provide additional new tax supported debt financing if the initiative meets adopted debt policy (resulting in an increased tax requirement), and (3) develop a priority setting tool to establish annual program within available funding. The priority setting may become clearer as the corporate planning process is implemented and priorities established. This will not be in place for the 2005 budget but will assist in future years.

Operating Costs Resulting From the Capital Program

The capital program will bring additional operating costs as new programs are initiated and new facilities and infrastructure are constructed and operated. As part of the gathering of the cost information for the projects, the operating impacts were also identified and will be shown within the capital budget documents. On average over the ten years the capital program will bring additional operating costs of approximately $12 million annually. These costs vary significantly from year to year based on the projects being constructed. The assessment growth from new properties over each of the years will offset these costs.

SUMMARY

The following table provides a summary of the capital needs and funding available in the 2005 to 2014 period.

The overall shortfall compares to an identified tax-supported shortfall of $1.2 billion in the first Long Range Financial Plan, even with significantly increased costs related to public transit and social housing.

The Long Range Financial Plan is to be updated on a three-year basis on the final year of each term of Council. The next update will therefore occur in 2006 and will provide updates regarding the solutions put in place. As well, each capital budget can be measured against the Long Range Financial Plan to identify the progress being made.

In summary, this plan and its recommendations accomplish the following:

1. Advances and builds on the recommendations from the first Long Range Financial Plan
2. Meets growth requirements without an increased burden on the property taxpayer
3. Addresses deferred maintenance issues and moves to full life cycle funding
4. Allows Hydro Ottawa refinancing payment to have long term impact on the capital program
5. Maximizes the use of new Gas Tax revenues to meet transportation and growth needs now

The staff recommendations made to the Long Range Financial Plan Committee are:

That the Long Range Financial Plan Sub-Committee recommend Corporate Services and Economic Development Committee and Council approve:

1. The definition of a capital program as described in the Instructions for Completing the Financial Information Return amended by adding a disclaimer related to development charges funded projects."A capital expenditure is any significant expenditure incurred to acquire or improve land, buildings, engineering structures, machinery and equipment. It normally confers a benefit lasting beyond one year and results in the acquisition or extension of the life of a fixed asset. It includes vehicles, office furniture and equipment. An expenditure on repair or maintenance designed to maintain an asset in its original state is not a capital expenditure. A capital expenditure may include the costs of studies, etc., undertaken in connection with acquiring land or constructing buildings. It may also include interest on temporary borrowing for capital purposes and transfers for capital purposes to unconsolidated local entities, hospitals, universities and similar organizations."Notwithstanding the proceeding definition expenditures that qualify for development charge funding will remain as capital projects, even if not in compliance with the capital expenditure definition, above.
   
   
2. The list of projects that are to be transferred from the capital budget to the operating budget (attached as Appendix 1) be approved and that a similar transfer of pay-as-you-go funding offset them.
   
   
3. A portion of the Hydro Ottawa dividends be set aside for the operating budget consistent with the Budget Directions Report with the remaining future dividends used to fund the capital program.
   
   
4. The annual Pay-as-you-go contributions be indexed in accordance with the City’s Infrastructure Price Index as published by Statistics Canada.
   
   
5. That the funding directions and strategies identified in the staff presentation be included in a staff report to Corporate Services Committee and be used as the basis for developing the 2005 Capital Budget.
   
   
6. The city established an Endowment Fund with the proceeds of the Hydro Ottawa refinancing and that the City request special legislation that would allow the fund to be invested under the Trustees Act.
   
   
7. That a future funding strategy be brought forward for future affordable housing initiatives.

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