Enterprise and Utilities Dividend Policies

Enterprise and Utilities Dividend Policies

Recommendation:
That the recommended amendment to the definition of Land Revolving Activity as set out in Section 2.03 of the Land Enterprise Dividend Policy (Page 3 of Attachment 1 of the September 11, 2008, Finance and Treasury Department report 2008FTF003), be approved.

Report Summary

This report provides a review of the operations and respective dividend policies of Drainage Services Utility, Land Enterprise, and Mobile Equipment Services. It also outlines how the City uses the 2007 favourable operating variances from the three areas.

Previous Council/Committee Action

At the March 12, 2008, City Council meeting, the following motion was passed:

That Administration:

  • Conduct a review of current and future revenue from enterprise and utility operations and associated dividend policies.
  • Indicate in the report how the 2007 favourable variance of $41.9 million will be used.

Report

  • This report has been organized to answer both Council instructions by operational area. This includes the operations of Drainage Services Utility, Land Enterprise, and Mobile Equipment Services.
  • Part b. of the motion indicated a favourable variance of $41.9 million. This is comprised of the following:

2007 Net Income in Excess of Budget
Drainage Services / $10.1M
Land Enterprise / 30.4M
Mobile Equipment Services / 1.4M
$41.9M

Drainage Services

  • Drainage Services operations are governed under the Approval to Operate provided by the Province of Alberta’s Environmental Protection and Enhancement Act, that is effective from June 1, 2005, through to May 31, 2015.
  • The implementation of Drainage Services operations is governed under Council approved Drainage Services Master Plan 2004-2014.
  • The financial management of Drainage Services is governed under Council approved Policy C304B, Utility Fiscal Policy, updated on June 20, 2006, by City Council. The policy provides fiscal guidelines for the operations of the Sanitary and Land Drainage Utilities, including dividend payment.
  • The following is a summary of Drainage Services’ 2007 operating results:

2007 Net Income in Excess of Budget
Sanitary Drainage / $ 9.4M
Land Drainage / 0.7M
$10.1M
  • Currently, Sanitary Drainage is required by policy to pay a 30% dividend on actual net income to the City of Edmonton in the first quarter of the following year. This will increase to 40% in 2013. Land Drainage is exempt from a dividend payment until 2014.
  • As a result of the 2007 positive operating results, the actual 2008 dividend paid was $10.3 million (instead of $6.2 million).
  • At the July 9, 2008, City Council meeting, report 2008PW2309, Independent Review of Drainage Utility, was received for information.
  • The external review of the financial statements was conducted by Drazen Consulting Group while GrantThornton, LLP provided a review of the Performance Based Regulation (PBR). These reviews provided positive feedback on the existing model, with some suggested changes to over-strength rates and modifications to some of the performance measures for clarity and closer alignment to the Business Plan. These will be brought back for Council’s consideration during the 2009 budget process.
  • The external reviews did not result in any recommended changes to the dividend policy for Drainage Services.

Land Enterprise

  • Land Enterprise purchases land for its Land Development Activity as well as acquires land required for Future Municipal Purposes (FMP).
  • The operations and activities of Land Enterprise are governed by City Policy C511 – Land Management Policy and are supported by revenues generated from land sales. This operation is not supported by property tax levy.
  • In June 2006, Council adopted the current City Policy C516A – Land Enterprise Dividend Policy, which provides for a 25% dividend payment to the City of Edmonton based on the actual net income generated from Land Development Activity.
  • The basis for Council’s adoption of this policy at that time was reflective of the 2000 Office of the City Auditor’s Corporate Land Inventory Audit recommendations in moving Land Enterprise towards a self-sustaining operation, with minimal reliance on short-term borrowing. At December 31, 2007, Land Enterprise did not have any short-term borrowing outstanding.
  • The 2007 Office of the City Auditor’s Corporate Properties Branch Audit further recommended the adoption of a long-term strategy for land acquisition. Funding options for developing a long-term strategy to facilitate the purchase of municipal property will be addressed in report 2008PW2483, which will be provided to Executive Committee on November 5, 2008.

Net Income and Dividend

  • Land Enterprise pays a 25% dividend on net income from its Land Development Activity.
  • Between 2003 and 2006, Land Enterprise average net income from Land Development Activity was $5.9 million. Initially, the dividend was paid based on budgeted net income instead of actual net income. The average dividend paid over this period was $2.7 million.
  • The policy does not require a dividend payment from Land Enterprise Revolving Activities (FMP) on the premise that land purchased for municipal purchases is transferred to the capital project at cost. Therefore, little to no net income was anticipated from these activities.
  • In reviewing the actual operations over the past number of years, it has been identified that while FMP lands were transferred at cost, there were times when parcels originally purchased for future municipal purposes were no longer suitable or required. Such lands, along with any remnant project parcels, were sold to the private market. This gave rise to net income being generated under FMP activities.
  • Once land in inventory is identified as not required for future municipal purposes, it could be transferred to Land Enterprise Land Development Activity at cost. When sold, it would then contribute to the Land Development Activity’s net income, upon which the 25% dividend will be calculated and paid. This would require a change to the definition in the existing Land Enterprise Dividend Policy (as identified on page 3 in Attachment 1).
  • The impact of amending the dividend payment to be based on all activities would have provided an additional $0.3 million in 2007 and $2.6 million (net of $2.5 million in one-time dividend paid) in 2008.

Cash Position

  • Administration must point out that increasing the actual amount of dividend paid will have implications to the cash position of Land Enterprise, something that was cautioned in the Office of the City Auditor 2000 Land Inventory Audit.
  • Based on approved sales and acquisitions in 2008, the August 2008 cash position of Land Enterprise includes short-term borrowing of $8.7 million. This may rise to the order of $20 million by the end of the year, depending on pending sales and other potential acquisitions that have not been finalized by Council. This projection is exclusive of development costs.
  • Increasing the current policy on dividend payment would increase the Land Enterprise’s need for greater short-term financing.

Budget Forecast

  • Land Enterprise 2008 operations contain budgeted net income from the Land Development Activity of $16.3 million. Under the current policy, this translates to $4.1 million in dividend to the City of Edmonton in 2009. This amount has been reflected in Corporate Revenues in the proposed 2009 operating budget.
  • An update of projected net income from the Land Development Activityreveals that only $9.8 million will be realized. This would translate to $2.5million in actual dividend payment under existing policy.
  • The budgeted 2008 net income from Land Revolving Activity is $7.0 million. Projected net income to the end of the year is $17.8 million. If Council were to amend the definition of Land Revolving Activity as described earlier, then an additional $4.5 million will be payable in 2009, bringing the total anticipated dividend to $7.0 million. Compared with the figure that has been included in the proposed 2009 budget, this would be an increase of $2.9 million ($7.0 million less $4.1 million).
  • Further details of the Land Enterprise operations are included in Attachment 2.

Mobile Equipment Services

  • Mobile Equipment Services (MES) operates as a municipal enterprise under the authority of City Directive A1422 Mobile Equipment Services Branch Fiscal Policy.
  • MES manages the City’s vehicle and equipment fleet and generates revenues mostly derived from charges to user departments and subsidiaries.
  • MES does not pay a dividend on its net income, which has averaged $3.0 million annually between 2003 and 2007. Annual surplus flows into Retained Earnings, which had a balance of $41.5 million at December 31, 2007.
  • This balance will be used to fund the replacement of vehicles and equipment.
  • The amount of Retained Earnings has an impact on the rates charged to user departments, which reflect what is required to finance the replacement of vehicles, equipment and other fleet related capital projects such as MES facilities. If a dividend were to be paid, then the rates to users (and therefore tax levy) would have to be increased accordingly.

Conclusion

  • The approach taken in the determination of a dividend from Drainage Utilities is appropriate, and is expected to increase from the current 30% to 40% in 2013.
  • The definition of Land Revolving Activity should be modified such that all land that will not be used for future municipal purposes are first transferred to Land Development Activity at cost prior to sale to third parties. With this amendment, the effective financial implication is that dividend will be paid on total net income. This will generate an additional $2.7 million in dividend payment to the City in 2009 over what is included in the 2009 budget.
  • MES should continue with its current operating model whereby any resulting net income is taken into consideration in its rate structure to client departments.

Policy

  • Policy C511 – Land Management Policy
  • Policy C516A – LandEnterprise Dividend Policy
  • Directive A1422 – Mobile Equipment Services Branch Fiscal Policy
  • Policy C217A – Reserve and Operating Equity Accounts
  • Policy C304A – Utility Fiscal Policy

Focus Area

  • Diverse Communities
  • Balanced Infrastructure Management

Justification of Recommendation
Modifying the definition of Land Revolving Activity to more closely reflect the actual operational activities will result in a slightly higher dividend payment to the City while balancing the need to maintain a reasonable cash position needed for land purchase and land servicing.

Attachments

  1. Proposed Amendment to Policy C516A.
  2. Land Enterprise Operations

Others Approving this Report

  • L.Rosen, General Manager,

Asset Management and Public Works Department

  • D. H. Edey, General Manager,

Corporate Services Department

Page 1 of 5

Attachment 1

Proposed Amendment to Policy C516A

Page 1 of 3Report: 2008FTF003 Attachment 1

Attachment 2

Land Enterprise Operations

City Council adopted the current Land Development Policy on July 13, 2005, outlining the City’s development objectives in residential and industrial land strategies. In addition, the Policy adopted the Office of the City Auditor’s recommendation that these activities be carried out on a self-sustaining basis (i.e. without tax levy support and without significant short-term borrowing).

A subsequent policy, the Land Enterprise Dividend Policy, was adopted by City Council on March 7, 2006 whereby a 25% dividend would be paid to the City of Edmonton based on budgeted net income. This was modified on June 20, 2006 to be calculated based on actual net income. In determining the amount of annual dividend to be paid, the activities of Land Enterprise were divided into two groups: land development activity and land revolving activity.

Land development activity refers to land transactions including purchasing, servicing, and marketing to third parties on a for-profit basis. Land purchased for residential development is intended for affordable housing (target market to reflect lot prices that are 10% or more below the average prices as determined by CMHC), and that the number of residential lots made available from the City will not exceed 10% of the total single family residential lot development in the Edmonton region. IndustrialLand development is geared towards the provision of providing a 3-year supply of serviced industrial land. 25% of the annual net income from these activities will be the amount of dividend paid to the City of Edmonton as a return on investment.

Land revolving activity refers to land transactions including the purchasing and servicing of land for City uses. The land is transferred to the City at cost for the construction of roads, facilities, and other City needs. Surplus or remnant land after the completion of a capital project is then returned to Land Enterprise, which over time, may be able to consolidate with other parcels for sale to third parties at fair market value. Historically, no dividend has been paid from these transactions and any income generated has been reinvested in other land purchases.

Since the adoption of the Land Enterprise Dividend Policy, Land Enterprise has paid annual dividends in the range of $2.9 million and $3.1 million between 2005 and 2007. The 2008 dividend increased to $6.9 million, comprising of $4.4 million by policy and $2.5 million one-time dividend directed by Council. Future dividends will be dependent upon Council’s long-term land acquisition strategy. Please refer to Report 2008PW2483, which will be provided to Executive Committee on November 5, 2008.

Page 1 of 1Report: 2008FTF003 Attachment 2