Monday, December 16, 2002
The meeting was called to order at 6:00 p.m. Members present were Alderman Koehler, Tom Marciniak, John Goelz, and Chris Letang. Also present were Bob Kufrin and Wayne St. John.
Item 2. Approval of minutes
No minutes were available for approval.
Item 3. Presentation by Joe Veranth of Dana Investments
Joe provided handouts showing the City’s investment portfolio, which was started about 2 ½ years ago as a supplement to other short term investments. A little under $9 million is in the fund right now. The second page shows growth of almost a million dollars since inception. The performance has been strong especially versus the state pool and other shorter term investments. Since inception the total return is almost 5.7% net of fees, versus 3.83 for the State pool. So far, year to date, the unannualized return is 3.66 versus 1.62 for the state pool, so with a month to go, that will be close to 4% and the annualized yield has been running at about 4%. The current annualized yield, which takes into account price appreciation and the coupon resets, a snapshot as of 11/30, the yield to maturity is 3.22, so that reflects current coupon rates and expected resets if interest rates stay where they are. That’s still more than double the state pool. The average coupon is 5%. The interest rate risk, or effective duration, is just over one year and it’s all adjustable rate securities in the portfolio.
Although Joe indicated that making predictions is dangerous, the State pool came down almost 20 basis points or 2/10 of a percent last month. The fed cut interest rates at the beginning of November from 1.75 to 1.25, a 50 basis point cut. The market expected ¼ of a percent, so there was another quarter of a percent taken out of it. With the state pool having investments anywhere from overnight out to a couple of months, you can probably expect even a little more decline in rates on the state pool in December.
The gold line on the treasury yield curve represents year end 2001 and the red line is now. This doesn’t reflect what’s in the account, it reflects treasury yields going out anywhere from 3 months to 30 years. It’s a good proxy for what the market expects for interest rates and what people are willing to invest in in treasuries, which are risk free. In this portfolio as well is all agency level credit quality and AAA credit quality. The difference between the gold and the red lines is the amount interest rates have come down this year, generally a percent in the 5 and 10 year area. That’s a reflection of the fact that we’re not having a quick recovery and rates may not be going up any time soon.
In the Interest Rate Outlook, the Fed cut of ½ of a percent instead of ¼ of a percent was a surprise last month. They went to a neutral bias. That supposedly means that they’re as worried about inflation as they are about a slow economy, and it’s hard to believe that inflation would be a worry at all right now. The reason they went to a neutral bias was probably to tell the market that they want to stay put for a while on interest rates. There are a couple of good things about this. Real rates are non-negative and real interest rates are the difference between inflation and short term rates. Inflation is at about 2% and short term rates are all under 2% and that’s usually stimulative to the economy. Corporate bond spreads are tightening, that’s usually a good sign as well. It means corporate bonds are getting more valuable, it’s a reflection that the people that are in that market expect some improvement in corporate prospects. They move with the risk in the market as well and it varies according to a company’s rating or their prospects. For example, oil companies have had a bad time issuing corporate debt because they have so much debt outstanding and they’re not making money right now. Productivity has continued to improve and that’s good, however it hasn’t come through growth, it’s come through jobs being cut.
The net effect of what’s happened so far and what’s going on in the economy is that rates could maybe stay low for a more extended period of time even though they have been low throughout the year. That’s something to think about and to be aware of as a committee as we go into next year as well. With short term rates at 1.25, the state pool is headed down to the 1.50-1.25 range. The reason we think that rates could stay low for an extended period of time and we’re not headed back to 3-5% interest rates is because the economy has still had a very difficult time coming out of this slow down. The unemployment rate is up to 6%, jobless claims are still high, industrial production which was positive for the first seven months of the year was negative for the next three, so while slipping into a recession it’s been difficult to see a real recovery. The other reason we say that rates could stay low for an extended period of time is because we believe that Greenspan and the fed will probably keep rates low even for a while after the economy picks up. If we’re starting at 1.25 now, even if short term rates get to 3% by the end of the year, that may only be a 2% average through the year on short term rates. You have to be prepared for that as well, going forward. That’s another reason why this portfolio is really helping. The double short term rates at a yield of 4% this year and 3% going forward it’s certainly helping. But where the majority of funds are in shorter investments, you have to be prepared for a lower rate year in 2003 than we had in 2002.
A review of rates for bank CDs, savings, and jumbo CD (over $100,000) was provided. The latest jumbo CD yields are below 2% all the way out to 2 years. We certainly don’t want to take any risk in the portfolio for fractional returns because the market just isn’t allowing that right now.
Bob asked what the average maturity is on our portfolio. The stated maturities are out 30 years because they’re backed by mortgages. The average maturity is probably 3 years. The effective maturity (the way it behaves) is more like a one year bond. The reason you have to combine those figures is because 30 year mortgages are sold and packaged into a security by Fannie Mae or Freddie Mac. When we all make out our principal and interest payment every month, investors are just on the other end of those. The reason we say the average life is 3-4 years is because you have to think on average how long someone has a mortgage in this country before they move or refinance. Portions of these are paid back in full on refinancings as well and that’s typically a few years depending on interest rates and home situations. They behave like securities that are shorter than three years; they have less interest rate risk than fixed rate securities because they’re adjustable rate mortgages. Not only do we get cash back at the rate of about 25%, where about 1 in 4 mortgages prepays each year, but also the coupons are adjustable. That reduces the interest rate risk and the price volatility as well.
The report on holdings shows mortgages listed issued by Fannie Mae or Freddie Mac and most of them have a five or six digit pool number attached to them. That identifies the group of mortgages that’s in that pool and each pool may have anywhere from a few dozen to a few hundred mortgages. So with all of these securities you’re owning a little slice of tens of thousands or maybe even hundreds of thousands of mortgages around the country. The prices are all above 100 (100, 102, 103). We get paid back at 100, so part of what we’re trying to do is manage that prepayment risk. Ideally we want people to prepay more slowly. In other words the extreme example of a low return on these bonds, it could never happen, would be if we were to pay 102 for each bond and every single mortgage in that pool refinanced tomorrow or was paid off the next day, we’d have a 2 point loss on the security. That doesn’t happen since people refinance at different times for different reasons. We want these to be around for as long as possible because then we would collect the 4-7% mortgages for longer. There are a number of major factors that operate in different directions on these, so faster prepays are bad for us. As the coupons reset downward, if everything was staying the same, that would lower the price in the long run as well. The problem is, market rates have gone down even faster. These do react somewhat to moves in interest rates, but usually the price moves only a couple of percent in either direction over a year because in the long run the coupons are going to reset. If rates go up 3% tomorrow, everything in here isn’t going to reset 3% tomorrow, but over time it will. If rates go up, that also affects whether or not people will refinance adjustable rate mortgages. All other things being equal, most people would rather have a fixed rate mortgage and know what their payments are. What’s interesting right now is adjustable rate mortgages are so low that they’re more attractive to people now. Fixed rate mortgages may be 6.5-7% and adjustable rate mortgages may be 5% and people can also qualify for larger mortgages, so if they’re stretched on credit card payments or anything else, it helps. For that reason, even though fixed rates are below 7%, we really haven’t seen these refinance faster than about 25% a year even though fixed rates are low, because adjustable rate mortgages are even lower. To the extent that there’s a slow down in the housing market, that will help this portfolio too. It’s bad for the people that own the homes if banks start to tighten lending standards, if you have 90% borrowed on your home, and if fewer people move. Although is has occurred in a few focused areas, a housing market slowdown hasn’t happened on a widespread basis yet. Defaults don’t have a negative effect on this portfolio because these are guaranteed by Fannie Mae and Freddie Mac.
The Government Investment Pool portfolio can’t do what Dana Investments does because there is little bit of price movement in the plan, so they wouldn’t be able to hold it as a money market security dollar for dollar and they also have to keep a greater amount liquid. A lot of their investments have to be shorter because of the nature of the Local Government Investment Pool. They don’t want to introduce any price risk into that portfolio. For the most part they’re in short, liquid money market type items.
Our lowest return year on these types of portfolios in terms of total return, and the other advantage we have is since it’s secondary reserves, you don’t necessarily have to sell it out anyway. The lowest return year for a composite in these types of portfolios for Dana Investments was 1994 where the total return was about 2% but in 1995 the return was 11%.
The Performance section of the report shows that there is a price effect that moves in the opposite direction of the yield. On this account, the total return is pretty close to the yield for the year, but in any given year it could be above or below the yield. That difference is the price difference. On this portfolio there has been very little price movement this year. Any given year the total return might be above or below the actual yield for the year. Even if rates were to start going up, that would stop this average coupon from going down from 5%.
Holdings – the SBAs are business loans; adjustable and indexed off prime. The one listed is a quarterly adjust. Whenever short term rates move, these fully adjust to short term rates every quarter.
Joe will return 2-3 times per year to update the Committee.
Item 4. Discussion on rubbish collection options
The City had looked at privatizing rubbish in the 1970s, in the early 1990s and at that time there was a movement from a 3-person crew on a garbage truck down to a 1-person crew. When Bob was developing budget alternatives this past fall, he looked at alternatives that would lower the property tax rate by transferring a cost from the overall tax levy to a user charge where the property owner that was using the service would pay for it separate from property taxes. One of the key lines in Solid Waste, Fund 38 of the budget is 300, which is the amount of property tax support that the rubbish collection requires. In 2003 it will be $800,000, in 2002 it was $1,170,000, in 2001 it was $900,000 and in 2000 it was $930,000. We do get money back from the State of Wisconsin for recycling, a program that’s had its ups and downs. In 2003 we’ll get about $110,000. If that shared revenue disappeared, the real tax support would be about $1 million. What it doesn’t take into account is the fact that we accumulated money to buy garbage trucks over the past several years and we bought them all this year and we’ll again start to accumulate money to replace those trucks so when they wear out or we need to buy another one, we’ll have the cash there. We try to balance out those capital purchases.
Generally you could say that our rubbish collection operation costs $1 million per year on average. Wayne added that Solid Waste includes the recycling yard operations, brush pickup, spring and fall cleanups, and special pickups.
One of the ways that Bob was able to meet the Mayor’s goal of reducing the workforce by 7 people was to not fill three of the vacancies at the Street Division. We have a labor agreement that says we can’t lay people off in order to privatize an operation. Part of what Bob looked at was that we have these three vacancies and if there is a privatize, it’s when you can do it legally according to the contract. The flip side is that over the years, when we last looked at privatization in 1991, we had three employees on a garbage truck. Now we’re down to one. We have brand new trucks. Our workers are as efficient as anyone else in terms of collecting garbage. At a point in time you’re not necessarily going to make the job much more efficient as long as you’re having a person picking up bags and throw them in the truck. The only way you could possibly get more efficient is if you used the automated loaders and big carts. We talked about that a year ago.
In terms of efficiencies, we’re probably as efficient as a private operation. Where we might not be as cost effective is in terms of our labor and benefit costs for that position. We may be more expensive at the landfill because if the landfill owner is also the garbage collector, there’s some savings that can occur there. We may not be as cost effective on the trucks even though we’re not buying them all that often. An operation with a larger fleet can operate, maintain and purchase them a lot easier than if you only purchase 2-4 every 10 years.
A common complaint at Council meetings is that our tax rate is too high. If the tax rate is too high, then one way to lower it is to privatize. Take operations that are tax supported and let the users of the service pay for it. Right now business and industry, apartment owners and some condo owners are paying for rubbish collection and they’re not able to use it. The only people that are absolutely assured of having rubbish collection and paying for it and using it are single family homeowners. In general, the non-user tax support is around 45-48%.
The Council wanted Bob to prepare bid specs, go out for bid and bring it back and see how the numbers shaped up. The issues are (1) whether or not to privatize, and (2) who pays and how. Tom asked what the impetus to change is. He compared the garbage issue to schools. He no longer has kids in school, yet he still pays for school services. In response to Tom’s question, “why change the existing system”, Wayne indicated that it is driven by an objective to lower the tax rate. If you’re not going to change the method of charging, then the tax rate isn’t lowered. If you issue a bill for garbage and take it off the tax rate, you’ve got it off the tax rate.
Wayne indicated that it currently costs $104 per house for the City to do the pickup. Based on a municipal survey, it would cost $120 to privatize. In 2001, the average home on the tax rate pays $55.48 for garbage. The cost of collecting garbage is $104. If you take $728,000, which is the cost of collection, put in a tax rate of 38¢ per $1,000 times the average house value which is $146,000, comes out to a cost of $55.48. That’s what the average house in Oak Creek contributes toward a product we deliver that costs us $104. If they are filing long form tax and they’re in a 28% federal and 7% state income tax rate, they can drop their $55 down to $36.06. Their bottom line cost for garbage pickup on an average house is around $10 per month or $120 per year. One of the other impediments we have in trying to get a price equal to that is that we have two outstanding contracts. We have a recycling contract where we pay Waste Management to go by weekly and pick up the recycling presently. That expires in 2004 and we have a contract to take all of our refuse to a Waste Management landfill that expires in 2006. So our chances of getting a BFI to bid on this, when in the first two years they pick up waste and take it to Waste Management, and then for the next two years they pick up garbage and recycling and take the garbage to Waste Management and then after 2006 they can do with it the cheapest way possible. Plus, we bought three new garbage trucks next year. Council renewed extensions to both contracts last year, which were good business decisions at the time. The Committee discussed the disadvantages of an intermediary truck for transporting trash to the landfill. The operation of the yard with privatized garbage pickup has not been considered at this point; nor has brush pickup. Bob indicated that the Mayor wants the City to bid the services out to see how competitive we are and if there is any interest.
South Milwaukee, Oak Creek, Cudahy, Greendale, West Allis and Wauwatosa all do City garbage pickup. St. Francis, Caledonia, Greenfield, Menomonee Falls, Brookfield, Muskego, and Franklin bid out garbage pickup. However, there should be huge asterisks around the cities that have landfills: Menomonee Falls, Muskego and Franklin because they get a rebate back from the landfill companies; they get tipping fees back. New Berlin requires everyone to contract individually. Alderman Koehler recommended leaving the system as it is. Wayne added that it would be wise to only renew the recycling for two years so that everything expires at the same time and the next time the issue is reviewed it will have fewer contract complications. Alderman Koehler agreed.
If we get out of the business we would no longer need the trucks and would include them as an alternate in the bid.
The total solid waste budget in 2001 was $956,000, which includes pickup costs and yard costs. The $104 cost estimate does not include retiree insurance.
Alderman Koehler made a motion to leave the trash collection as is with City employees throughout 2006 and to also make the upcoming recycling contract just a two year contract in order to even them out that they all come due at the same time, which at that point in time we will again look at privatization. Debra seconded the motion. All aye; motion carried.
Item 5. Discussion on increasing various fees and charges
This issue was held to the next meeting.
The next Finance Committee meeting will be on January 20th.
Alderman Koehler, seconded by Tom Marciniak, made a motion to adjourn at 7:20 p.m. All aye; motion carried.