El Cerrito states that it expects to receive $4.8 million in funding from the federal American Rescue Plan Act and plans to use those proceeds to address its negative reserves, although it acknowledges that regulations for these funds are still pending. The city subsequently informed us of its understanding that such regulations will likely require it to spend these funds by December 2024 but may enable the city to use other funding sources to replenish its reserves.

The status of El Cerrito's financial condition is contingent on the city's ability to develop a fiscally prudent spending plan as part of its fiscal year 2021–22 budget. City management has taken some action thus far to involve the community in the development of the budget, which will assist in its efforts to manage its spending.

El Cerrito also implemented a procedure to improve its budget development process. To provide more detail for its fiscal year 2021–22 budget, the city now requires departments to complete a standard form justifying expenditures of more than $10,000 that are included in the budget.

To assist with its budget development and monitoring, El Cerrito prepared a five-year financial forecast in March 2021 after our audit's completion. This forecast includes options for permanent citywide spending reductions of $1 million and $2 million, which will help the city identify the amount and timing of specific expenditure reductions it will need to make. However, the city may still need to consider making additional spending reductions. Even if El Cerrito can achieve a $2 million reduction in spending in fiscal year 2021–22, the city stills projects to spend more than its revenue in fiscal years 2023–24 and 2024–25.

Despite the progress it has made, El Cerrito acknowledges that there are several recommendations from our audit that it is in the process of addressing. For instance, one of the critical budgeting practices we identified is the need to track and present financial information by individual department. The city council could use such information to hold departments responsible for their spending. El Cerrito states that it will research the issue and potentially make this change during fiscal year 2021–22.

Further, El Cerrito states that it complies with certain Government Finance Officers Association (GFOA) best practices. However, the city did not provide evidence during the audit of complying with such policies. Our audit identified that El Cerrito does not adhere to many GFOA best practices pertaining to budget development and monitoring. As we state in our report, El Cerrito does not develop revenue projections based on an analysis of past performance and assumptions regarding future performance, which has resulted in overspending by its departments. Further, the city does not disclose in its budget the specific assumptions used for expenditure projections in relation to revenue assumptions, as we note, thereby limiting the ability of the city council to determine the appropriateness of its spending.

In its corrective action plan, El Cerrito reiterates its belief that it is limited in its ability to conduct a compensation study. Although the city expressed concern regarding the cost of a study, it did not address other key actions we recommended that it perform beforehand, such as analyzing its organizational structure and the functions it needs to achieve its goals and analyzing the duties and responsibilities assigned to its current staff positions. Such an effort should be undertaken before seeking a consultant to conduct a compensation study. Further, the city's concern about the initial cost of conducting a compensation study does not acknowledge the long-term savings that could result from implementing changes recommended from the study, such as potential opportunities to reduce the costs of employee benefits, similar to the opportunities we note. By not conducting a compensation study and related analyses, El Cerrito is limiting its ability to reduce its spending.

Another example of an area that El Cerrito has not demonstrated its commitment to managing its spending pertains to salary increases for its management positions. Our audit described a process that the city used to authorize or agree to salary increases for certain management employees that exceeded the threshold established in the city's salary schedules. El Cerrito's response to the audit stated that the city had suspended the process for 2020 and would consider eliminating the process later in fiscal year 2020–21. However, El Cerrito now states in its corrective action plan that it will not consider permanently eliminating the process until the completion of a compensation study. The city manager stated that any changes to the city's salary structure would need to be studied to determine the best option for the city. However, our audit cited specific examples of management employees being paid in excess of the city's salary schedule and greater than similar positions of nearby cities, so we are unclear why a compensation study is necessary to determine whether this process should be eliminated.

Furthermore, El Cerrito's corrective action plan reiterates its initial response to the audit that it eliminated cost of living increases. However, this statement fails to disclose the full financial impact of the city's negotiations. Even though El Cerrito negotiated with its employee unions to eliminate cost-of-living salary increases for fiscal year 2020–21, it nevertheless agreed to such salary increases for subsequent years as we describe in our audit report. Consequently, the city should expect its costs to increase by at least $1.7 million in fiscal year 2021–22, thereby placing greater pressure on it to identify other cost reductions. El Cerrito stated that it will freeze salaries during fiscal year 2021–22 for management employees not represented by an employee union, but it is unclear how long the city can continue to defer pay increases for that group.

El Cerrito has been able to improve its financial position in large part because of one-time federal revenues and an unexpectedly robust real estate market. The change in the city's general fund can be attributed to its receipt of $6.1 million in ARPA funds during fiscal years 2020–21 and 2021–22. Nevertheless, the city cannot expect to sustain substantial revenue from this source in future years. In addition, the city's real estate transfer tax generated $4 million in fiscal year 2020–21, 53 percent more than expected. If the city had received the amount of the transfer tax that it budgeted for, the city would have $1.4 million less in revenue. A highly variable revenue source such as this tax can leave the city vulnerable to overspending if the city increases its revenue projection based on a peak year but ultimately receives a much lower amount.

Despite its recent progress, El Cerrito still needs to take long-term action to balance its revenue and expenditures. The city's budget for fiscal year 2021–22 includes a five-year forecast that shows expected revenue and expenditures through fiscal year 2025–26. That projection shows that El Cerrito expects to spend $3.2 million more than its revenue from fiscal years 2022–23 through 2025–26, which would reduce much of the reserve that resulted from ARPA funding.

Moreover, El Cerrito has taken only initial efforts to address its pension costs. The city states in its update that the police and fire chiefs, who are part of a union, have agreed to pay a higher proportion of their pension costs, although other unions that represent most employees have not agreed to any pension-related changes. El Cerrito also indicates that it is researching vendors to establish a Section 115 trust that can be used to pre-fund pension costs, which it expects to finalize in fiscal year 2022–23. In addition, the city states that it working with its benefits broker to address the health care subsidy the city provides to its retirees but has not yet identified any specific action it will take.

In our May 2021 assessment of El Cerrito's corrective action plan, we noted that one of the critical budgeting items still needed was to track and present financial information by department. Maintaining information at this level of detail could help the city council hold departments accountable for their spending. El Cerrito states in its update that it will begin presenting this information to its city council in October or November 2021 and is still researching if it will change its policies to budget by department.

To address its budget development and monitoring, city management has proposed to hire a budget manager. Such a position could assist El Cerrito with the budgetary issues we identified in our audit and help ensure that the city continues to maintain a budget that is relevant and useful for stakeholders. City management anticipates presenting the position to city council for approval in October and would seek to fill the position by December.

El Cerrito's other efforts to address its salary and benefit costs have not resulted in substantial savings. The city indicated in its update that it met with two employee unions to discuss changes in salary and benefits to current contracts but those unions declined to make any changes.

El Cerrito’s ability to meet its goal of a sufficient reserve can be attributed to multiple factors that it may not be able to rely on in the future, risking the depletion of that reserve. First, the city’s increased revenue can largely be attributed to an unexpectedly robust real estate market. The city’s real estate transfer tax generated $4 million in fiscal year 2020–21, 53 percent more than expected. If the city’s real estate market slows, the city may not generate sufficient revenue to cover its costs. If the city had received the amount of the transfer tax that it budgeted for, the city would have $1.4 million less in revenue. A highly variable revenue source such as this tax can leave the city vulnerable to overspending if the city increases its revenue projection based on a peak year but ultimately receives a much lower amount. As we note in our audit report, El Cerrito’s financial challenges occurred in large part because it did not adjust its spending to match its revenue.

Additionally, El Cerrito reduced its spending by decreasing the number of authorized staff positions. However, it is unclear how long El Cerrito will be able to serve the public without sufficiently staffing its departments. In its fiscal year 2021–22 midyear budget update, El Cerrito increased its planned spending by $2.1 million, due in large part to the need to hire additional staff or contract labor to address its workload. As we discuss later, El Cerrito has not taken steps to more sustainably address its costs, such as conducting a salary survey. Finally, recent federal assistance has significantly aided El Cerrito in improving its financial reserves. The city has received $3.1 million of the $6.1 million it expects from ARPA funding. However, El Cerrito cannot expect additional federal revenue to support the city’s reserves and will need to ensure that it can maintain such a balance through other resources.

Moreover, El Cerrito has taken only initial efforts to address its pension costs. As the city noted in its September 2021 update and reiterated in its March 2022 update, its police chief and fire chief, who are part of a union, agreed to pay a higher proportion of their pension costs. However, other unions that represent most employees have not agreed to deferrals of salary increases that could help control pension spending. El Cerrito also indicates that it is researching vendors to establish a Section 115 trust that can be used to pre-fund pension costs, but does not expect to finalize this strategy until fiscal year 2022–23. Nevertheless, unlike its approach for managing pension costs, the city has taken steps to address the health care subsidy it provided to retired employees. The city restructured its health care payments so that retirees are now assigned to a separate pool and will pay the full costs of their benefits.

Further, El Cerrito continues to defer a decision to permanently end its system of allowing certain management employees the ability to receive salary increases above the threshold established in the city’s salary schedules. At this time, the city states that it has indefinitely suspended this process but does not indicate why it has not decided to discontinue it entirely. Our audit cited specific examples of management employees being paid in excess of the city's salary schedule and greater than similar positions of nearby cities, so we are unclear why this process has not been eliminated.

El Cerrito also reports in its update that it is currently researching options to recover the cost of its emergency medical services and plans to provide information to its city council in April 2022. In addition, the city states that it is in negotiations to sublease modular buildings that it rented but was not using.

El Cerrito continues to make progress in improving its financial condition. As we noted in our review of the city’s March 2022 update, El Cerrito’s fiscal year 2020–21 audited financial statements reported a general fund reserve of $7.1 million, or 19 percent of the city’s general fund expenditures, and general fund revenues exceeded expenditures by $6 million. For fiscal year 2021–22, the city reported in its unaudited financial statements that general fund revenues exceeded expenditures by $8 million, thereby increasing its general fund reserve to $15 million. Because of its improved financial position, El Cerrito discontinued its practice of short-term borrowing in fiscal year 2022–23.

However, we continue to observe that two of the main drivers of El Cerrito’s improvement are factors that it may not be able to rely on in the future, which could potentially reduce the reserve that it has built. First, the city’s increase in revenue is largely attributed to an unexpectedly robust real estate market. According to the city’s unaudited financial statements for fiscal year 2021–22, the city’s real estate transfer tax generated $4.9 million—28 percent more than budgeted and more than it recognized in the prior year. In contrast, the city’s overall revenue was $1 million more than budgeted, but $2.5 million less than reported in the prior year. If the city’s real estate market slows, the city may not be able to generate sufficient revenue to cover its expenses. A highly variable revenue source such as this tax can leave the city vulnerable to overspending if the city increases its revenue projection based on a peak year but ultimately receives a much lower amount. As we note in our audit report, El Cerrito’s financial challenges occurred in large part because it did not adjust its spending to match its revenue.

Moreover, recent federal assistance has significantly aided El Cerrito in increasing its financial reserves. The city received $6.2 million through the American Rescue Plan Act, which it has used to supplement its reserves. This federal funding represents approximately 40 percent of the city’s reserve balance. However, El Cerrito cannot expect continued federal funding beyond this allocation and will need to ensure that it can maintain its reserves using its own financial resources.

Although El Cerrito passed a balanced budget for its general fund for fiscal year 2022–23, it will need to continue to monitor and reassess its spending throughout the year. The budget projects general fund revenue of $45.7 million compared to expenses of $44.9 million, resulting in a slight surplus of $812,000. In addition, El Cerrito chose to budget $460,000 from its reserve for one-time expenses for contracted studies, such as the classification and compensation study it references in its update. Because of the slim margin in its surplus, the city will need to monitor its spending closely so that it can react quickly in the event that conditions change. For example, even though the city’s budget took into account recent salary increases for some of its employees, it is currently in negotiations with the fire department employee union. Salary increases for that group of employees could lead to expenditures outpacing revenues, particularly if the city fails to closely monitor its financial condition.

Moreover, El Cerrito has taken some initial steps to address its pension costs. As part of an agreement with a union representing various employees who are not public safety employees, these individuals will begin paying 0.5 percent more towards their pension costs. The city expects this change will result in cost savings of $14,000 annually. However, public safety employees have not yet agreed to any pension-related changes. El Cerrito also indicates that it will be seeking the services of a vendor to establish and administer a Section 115 trust that can be used to pre-fund pension costs. It plans to meet to finalize this strategy in September 2022 and will solicit providers in October 2022.

Although El Cerrito’s current financial condition has improved, the city still needs to take specific action to control the growth of its salary and benefit costs. In response to our recommendations to reduce costs, El Cerrito issued a request for proposals for a classification and compensation study. The study began in August 2022 with an expected completion sometime in early Fall 2023. We expect that the city will use the results of the study to adjust salaries as needed and serve as a guide for the city to maintain financial viability by assessing the staff positions it needs to carry out the city’s operations.

The city continues to defer a decision to permanently end its system of allowing certain management employees the ability to receive salary increases above the threshold established in the city’s salary schedules. At this time, the city states that it has indefinitely suspended the process but notes that it is having retention and recruitment issues with its management staff. Our audit cited specific examples of management employees being paid in excess of the city's salary schedule and greater than similar positions of nearby cities, so we are unclear why this process should not be eliminated.

El Cerrito has made some recent progress in increasing its revenues. However, it continues to defer actions that could create more financial stability for the city. El Cerrito’s fiscal year 2021–22 budget expected that its swim center would generate more revenue than expenses, and its fiscal year 2022–23 budget projects that swim center revenues will cover 96 percent of its costs. However, the revenue generated from El Cerrito’s senior services covered only 25 percent of the cost of those services in fiscal year 2021–22 and the city’s fiscal year 2022–23 budget projects senior services revenue to cover only 26 percent of its costs. Maintaining user fees at a level that represents only a small percentage of its costs will not be sustainable for the city unless it makes a policy decision to reduce expenses in other programs as needed and subsidize its senior services from other revenue sources.

The city continues to state that it will conduct a demand and cost recovery analysis for recreation services after normal operations resume, and it endeavors to do so by the end of 2023. The city further emphasizes that its cost recovery rate is greater than those of other nearby cities. Regardless of these other cities’ policies, El Cerrito should not delay efforts to ensure that it establishes fees at appropriate levels to cover the cost of its services or find other sources of revenue so that it can continue to provide these services to the public.

El Cerrito was able to sublease one of the modular units that it rented but was not using. It sublet the unit to the Kensington Police Protection and Community Services District for a fee that will range from $45,000 to $52,000. The city also reported that it presented a proposal to its city council in April 2022 to recover the cost of its emergency medical services, but the city council chose not to make any changes to its operations. The city’s fire chief reported that the city would need to rely on a contractor to perform billing services, and the potential limitations on the types of incidents that the city could bill for would result in gross revenue of $50,000 per year with additional costs for staff and contractors to operate the program.