The embattled city of Hercules faces drastic cuts from its general fund or default, according to a presentation given to the City Council last night.

The city had hired Municipal Resource Group to review the state of revenues and expenses facing the city. And the results paint a bleak picture for the city’s future.

By the end of the current fiscal year, the city’s reserves will be virtually depleted, having slipped below 5% of the annual expenses. Furthermore, without drastic cuts and reorganization of services by July 1, the city is expected to end the 2011-2012 Fiscal Year nearly $10 million negative.

“I would characterize the situation as lacking the basic fiscal responsibility needed to put together a budget,” said Mike Oliver, Managing Consultant for Municipal Resource Group.

When Oliver and his group looked at the proposed budget for 2011-2012, he described it as “a total departure from reality.”

The problem comes from poor budgeting in previous years and even less sound assumptions of economic recovery and tax revenues.

“There were so many loans coming due and so much cross-collateralization between funds that it was impossible for the city to know how much available capital they actually had,” said Oliver.

The adopted 2010 budget assumed there would be a $2 million deficit, but after the Redevelopment Agency failed to pay its general fund loan, that deficit ballooned to $4.7 million. Additionally, actualized revenues were $1 million below projected levels, which left the city with a $5.7 million deficit in the current fiscal year.

In next year’s budget, the city will start with a balance of only $853,000, down from more than $6 million the year before.

“We’re moving full speed ahead to be effective by July 1,” said Michelle Harrington, Hercules’ Public Information officer. “We are taking the Municipal Resource Group’s recommendations very seriously, and we know that time is of the essence.”

You can view last night’s presentation to the City Council here.

Unfortunately, as Harrington confirmed, the deepest cuts are going to have to come from the general fund, where salaries account for a large portion of the expenses.

Further contributing to the problem is the insolvency of the city’s Redevelopment Agency. With more than $100 million in outstanding debts, tax revenues coming into the agency are insufficient to cover its operating expenses and loan payments.

“The redevelopment agency is basically extinguished,” said Oliver. “Total revenues coming in will be $2 million short of its indebtedness, so it can’t do anything other than pay off its debts. We recommend that they use general fund revenues, at least on the one year basis, to avoid default.”

Because the issue is the clearest cut, Harrington said that the council is looking to address the Redevelopment Agency’s deficits first.

“The Redevelopment Agency is in some ways the simplest,” Harrington said. “Because there is no money, the general fund is basically the funding for the Agency. Any dollar that they spend essentially comes out of the general fund.”

Similarly, ever since the city funded the creation of the Hercules Municipal Utility, it has been unable to maintain a sustainable budget. Its revenues have never equaled its expenses, forcing the city to write checks from its general fund to keep the utility afloat.

Unless fees and rates are increased or expenses reduced, the fund continues to lack sufficient funds to cover its long-term anticipated expenses, including regular maintenance, debt service, and operating funds.

Even without any unanticipated capital repairs or replacements, the fund’s annual deficit will grow to as much as 20% of its revenues by 2014-2015.

Still complicating the finances of HMU is that its Five Year Capital Improvement Program is underfunded. Even though the city’s utility received $6 million from bond sales in 2010, there are already $7.695 million of approved projects, leaving the utility with the choice of cancelling contracts (which would incur a fee) or using the utility’s reserves to cover the difference. However, with reserves already on track to be depleted by normal operating expenses, that isn’t a viable option.

The problems facing the utility may be too much for the city to handle and the consultants recommended that the city investigate divesting the utility.

“What we’re saying is find another user, either PG&E or some other entity, to take over HMU and extinguish that general liability, because, it is a general fund liability. They’ve been writing checks to support it for a number of years.”

However, divesting from the utility may not be that easy. According to Harrington, even optimistic estimates say that complete divestiture could take 6 to 12 months.

The conclusions drawn from the financial review were harsh: the city has a structural deficit that will cost it at least $6 million per year unless drastic steps are taken.

“It’s simple arithmetic,” said Oliver. “They have $12 million of reliable revenues – the basic taxes – that they can use for GF activities. And they currently have an expenditure of $18 million.”

The city council’s task, between now and July 1, is to cut at least $6 million from their services budget. That would keep the city afloat for another year, but unless they find ways to bring their budget down further, the Redevelopment Agency will face default.

The consultants’ recommendation, then, is to bring expenses to $10.5 million, freeing up $1.5 million to cover the debts of the Redevelopment Agency. That would be a total reduction of $7.5 million, or 41%.

But cutting that much from a budget in 12 weeks is daunting for any council and would be difficult for the public to stomach.

“This is not an issue that’s going away any time soon. The community will need to be involved in this issue, as well as labor groups. To make cuts of this magnitude, there has to be community involvement in trying to determine what is essential to the community.”

To increase involvement from the community, the city has already established a Citizens Financial Advisory Ad hoc Committee.

“There could be more meetings or workshops called,” said Harrington, as the city seeks as much input as possible.

Some of the suggestions from the public, however, are not on the table yet. During the meeting, at least one member of the public rose to ask if the city would be better suited by filing for bankruptcy.

“At this time,” said Harrington, “we are following the advice of the Municipal Resources Group and the council is not considering bankruptcy.”

Originally published March 30, 2010 at 12:06 PM