TO:Policy and Finance Committee

FROM:Chief Financial Officer and Treasurer,

Acting Commissioner, Corporate Services

SUBJECT:1999 Vehicle and Equipment Replacement Programme

Purpose:

This report reviews the funding available for the 1999 vehicle and equipment replacement programme, recommends funding envelopes for each major service area, and recommends vehicle replacements where specific purchases have been identified within the funding envelopes.

Funding Sources, Financial Implications and Impact Statement:

Funds up to $44.2 million for 1999 purchases are available from the Vehicle and Equipment Replacement Reserve. Vehicles with a purchase value of $16.4 million (which includes police and ambulance requests) from the $44.2 million are recommended for authorization immediately, with the remainder to be approved by Council in a future report.

There are funding issues associated with the Vehicle and Equipment Replacement Reserve and, depending on the option chosen, there could be significant funding issues in 2000 and/or 2001.

Recommendation:

It is recommended that:

(1)a maximum of $44.2 million be set as the limit for the 1999 purchase of vehicles and equipment which includes the amount previously approved by Council for the Police Services Board, and 10 snowblowers for Transportation Services, and this funding be allocated by program as per Appendix E;

(2)the replacement of vehicles identified in Appendix F be approved in the amount of $16.4 million from the Vehicle and Equipment Replacement Reserve and that the Acting Commissioner of Corporate Services report to the Policy and Finance Committee on specific vehicle replacements for the balance of the allocation contained in Appendix E; and,

(3)the Chief Financial Officer and Treasurer in conjunction with the Acting Commissioner of Corporate Services report on the feasibility of leasing the corporation's fleet requirements, or a portion thereof.

Council Reference/Background/History:

At its meeting of April 16, 1999 the Budget Committee had before it a report (April 7, 1999) from the Commissioner of Corporate Services entitled '1999 Vehicle and Equipment Replacement Programme' requesting that expenditures totalling $60,170,860 be funded from the Vehicle and Equipment Replacement Reserve. This matter was referred back to the Chief Financial Officer and Treasurer and the Commissioner of Corporate Services for a further report.

Discussion:

Current status of Reserve

The January 1, 1998 balance in the Vehicle and Equipment Replacement Reserve was $81.7 million. As at December 31, 1998 there is an uncommitted balance of $62.7 million in the Vehicle and Equipment Replacement Reserve (see Appendix A for balance by former municipality). The Operating Budget will be contributing $18.4 million to the Vehicle and Equipment Replacement Reserve in 1999 which is a slight increase over the 1998 contribution of $17.1 million. The former municipalities funded this reserve in different ways. In most municipalities, the program areas made a contribution directly from the operating budget to a vehicle and equipment reserve while in others (Toronto and Scarborough) the contribution was a corporate amount. As a group, the municipalities have been underfunding the Reserve for more than just one year.

Appendix B shows (a) the amount that should be in the Replacement Reserve, if the Reserve contributions had kept pace with the depreciating value of the fleet (column entitled ' depreciation to date'), and (b) the contributions made in 1997, 1998 and 1999 on behalf of the service areas. If the contributions had kept pace with the wear and tear of the fleet and equipment, then the Reserve would contain $259.1 million instead of the $62.7 million that it currently contains. If it is assumed that the average useful life of a vehicle is 8 years, then in order to keep pace with the depreciation the contribution ought to be $48 million rather than $18.4 million that is being contributed in 1999. As an indication of the nature of the mismatch between contribution and withdrawal, the Police Service program will have contributed $5.9 million in 1998 and 1999 and yet, will have withdrawn $13.6 million over the same timeframe. On the other hand, other programs appear to have been contributing and withdrawing on a more or less even basis.

Not counting the backlog of vehicles and equipment which are fully depreciated (i.e. reached the end of their useful life) and should have been replaced ($46.3 million just for departments), the five year replacement schedule indicates that approximately $40 million will be required from departments and participating ABC's each year in the period 2000 to 2004. Based on the current vehicle and equipment portfolio, the total annual shortfall in the Operating Budget contribution is, therefore, approximately $22 million (approximately $1 million of this is rate supported).

Regardless of how the City proceeds from here on, it is clear that the Vehicle and Equipment Replacement Reserve has been, and as noted below, continues to be, underfunded and this presents a serious issue with regard to any options for replacing vehicles and equipment in the near future.

Issues surrounding future funding of the reserve will be the subject of a separate report.

Long Term

The current Vehicle and Equipment Replacement Reserve balance, combined with the estimated contribution to the Reserve from the Operating Budget of $18.4 million in 1999, provides total reserve funding of $81.1 million in 1999. The initial fleet replacement estimate proposed was $60.2 million in 1999. There is, however, demand for replacement from the City Fleet Operations totalling $78.7 million of which the initial estimate included $44.2 million in 1999, with the remainder of $37.2 million to be funded in future years. As well, there is demand in 1999 for replacement from other participating entities of $18.4 million.

While the initially requested purchases of $60.2 million could be funded from the Reserve in 1999, this would largely deplete the Reserve and may preclude a phase-in of an appropriate level of fleet funding in the Operating Budget. Even if the fleet value were to be reduced by 5% thus reducing the backlog, the resultant purchases would still substantially deplete the reserve.

Funding Options

Option #1 - Initial Request to Budget Committee

Based on the assumptions that the backlog is cleared in two years, that the Operating Budget contribution does not change, and that the best available information about the 2000 replacement programme is used, there will be a deficit in the Reserve by the end of 2000. If the projected shortfall of $39.2 million were to be made up from the 2000 Operating Budget, this would represent very significant budget pressure. Even allowing for a 5% reduction in the fleet on a go forward basis, there would be a shortfall of approximately $20-30 million which would create a significant pressure on the Operating Budget if required in one year.

Option #2 - Restrict the 1999 Request to the Replacement of $44.2 million

Restricting the 1999 withdrawals to $44.2 million would provide sufficient funding in the Vehicle and Equipment Replacement Reserve to fund the 2000 and 2001 replacement programme. Funding would run out in 2001. In order to sustain the Reserve in the long run it would be necessary to increase the Operating Budget contribution. The amount of the increase and the year in which it ought to start would depend on how much pressure any year's Operating Budget could withstand. It is recommended that an amount of $44.2 million be authorized from the Vehicle and Equipment Replacement Reserve to departments and agencies for vehicle and equipment replacement in 1999. Appendix E indicates the recommended distribution of funds amongst departments and agencies which was arrived at by first providing a proportionate share to each service area, consulting with service areas and making modifications where appropriate.

The Commissioner of Corporate Services in a previous report (April 7, 1999) indicated that the deferral of replacements in 1998 resulted in additional maintenance costs of $924,000 and a reduction in salvage value of $550,000. A deferral of the magnitude indicated above could have a similar impact on maintenance costs and salvage value in 1999.

Vehicle Replacement

Appendix F is a listing of the vehicles to be replaced as identified so far by departments and agencies. The replacement of these vehicles is within the envelope provided for in Appendix E. It is recommended that the Acting Commissioner of Corporate Services report further as the other departments identify their lists of vehicles to be replaced.

Lease Option

One of the options which KPMG (fleet consultant) suggests is that the City explore leasing rather than owning part of the fleet. According to KPMG there appear to be four ways in which leasing might present a better financial option for the City than owning. A leasing company might get better initial purchase prices than the City through bulk purchasing because the firm could purchase in even larger quantities than the City. For specialized equipment purchased in small quantities, this would probably not be the case. The second area which might provide a price advantage to the City is that the lessor might have a lower cost of money than the City; however, given the City's high credit rating, it is doubtful that a leasing company could provide a benefit from preferential rates. Third, a leasing company might be able to get a better salvage price on the disposal of equipment. The fourth area is that the leasing company can take advantage of the depreciation of the vehicles and equipment for tax purposes (capital cost allowance) and this might provide a price advantage to the City.

There are four additional advantages that leasing might provide. The leasing costs would be a fixed nondiscretionary operating budget expense which would be included in each program's budget. The appropriate cost would be applied to the appropriate cost centre and programs would know the exact cost of each piece of apparatus. This should lead to a rationalization of the fleet and better utilization between programs. Leasing provides flexibility in lease payments scheduling and this can provide the City with an opportunity to shift fleet expenses to subsequent years when amalgamation pressures would have subsided. Leasing might provide some other side services such as asset management, and planned replacement and reporting which might reduce administration and overhead costs associated with managing the Fleet Operations. As well, there is a further issue. If the Reserve were to become depleted, replacement financing could not come from the issuance of debentures, since the average useful life of a vehicle is 8 years and normally debenturing is for a term of at least 10 years. Therefore, another funding option would have to be pursued. Leasing is one such potential option.

A preliminary review of this option indicates that it is worth pursuing further. Appendix C is one illustration of the impact of leasing. All or some of the fleet could be leased, but in this illustration only cars, light trucks and heavy trucks (approximately 25% of the value of the fleet) are leased for a term of 8 years. (See Appendix D for the current mix of vehicles and equipment.) Assuming no savings from leasing vis-a-vis owning, with a modest annual increase in the Operating Budget, the lease payments can be accommodated and the Reserve preserved to be used for the other vehicle and equipment types. If there were savings from leasing, then they would moderate increases to the Operating Budget.

Therefore, it is being recommended that staff proceed to explore a leasing option so that the analysis can proceed with firm numbers. It is still necessary to do serious analysis to confirm whether leasing can be proven to be a financially viable option. If the City did decide to lease, then it is possible that fleet costs could be reduced in the short run (as in Appendix C). Available reserve funding could be used to phase in the lease payments in the Operating Budget over a longer time period. The contribution to the Vehicle and Equipment Replacement Reserve would be converted to lease payments (depending on the proportion of the fleet leased). Given the actual amounts involved, there would still be a shortfall between the amount currently in the Operating Budget and the funding necessary to cover the lease. Changing from a reserve approach to a leasing approach still requires that the Operating Budget increase in the long run. To lessen the immediate impact, the funds remaining in the Reserve could be used to cushion the schedule of this increase. Thus, it would make sense to minimize purchases in the short run so that more new units could be leased right away. In this way the reserve balance is preserved at as high a balance as possible for this purpose.

This option might increase maintenance costs in the short run and reduce the salvage value of the existing units. If the leasing option is viable, it will still take some time to implement and could therefore be explored to take effect for vehicles and equipment delivered in 2000. This option should be jointly explored by the Chief Financial Officer and Treasurer and the Commissioner of Corporate Services with a report to the Policy and Finance Committee in due course.

Conclusions:

The Reserve for Vehicle and Equipment Replacement is underfunded and continues to be underfunded. Any option will require an increase in the Operating Budget whether to sustain a replacement reserve or to pay for lease payments. The challenge is to find the most appropriate way to phase-in this increase. To fund $60.2 million of vehicle and equipment replacements this year from the Vehicle and Equipment Replacement Reserve as originally requested, while affordable in 1999, is not sustainable in the intermediate term. Restricting the replacement to $44.2 million this year and $40 million annually from then on (the 2001 - 2004 replacement programme average) along with a modest increase in the contribution to the Reserve from the Operating Budget is sustainable in the long run. Leasing a portion of the fleet might be a better option than owning. If this is a serious option, then the benefit to the City is maximized by minimizing fleet purchases in 1999 and pursuing a Request for Expression of Interest as quickly as possible. At a maximum, purchases should be restricted to $44.2 million in 1999.

Contact Names:

N. Donald E. Altman, Manager, Financial Planning

Phone: (416) 397-4220, Fax: (416) 392-3649

E-mail: daltman@mta1.metrodesk.metrotor.on.ca

Len Brittain, Director, Treasury and Financial Services

Phone: (416) 392-5380, Fax: (416) 392-3649

E-mail: lbrittai@toronto.ca

Stan Burrows, Director, Fleet Management Services

Phone: (416) 392-1034, Fax: (416) 392-7301

E-mail:sburrows@toronto.ca

W.A. LiczykB. Glover

Chief Financial Officer and TreasurerActing Commissioner, Corporate Services

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Appendix A

Vehicle and Equipment Replacement Reserve

(Net of Commitments)

$ in Million

	Replacement Cost	Reserve Balance as at Jan. 1, 1998	Reserve Balance as at Dec. 31, 1998 (subject to audit)	Reserve Balance as at Dec. 31, 1998 as a Percentage of the Replacement Cost (%)	1997 Actual Contributions (subject to audit)	Contribution as a Percentage of the Replacement Cost (%)
East York	13.3	2.1	2.7	20.3	0.5	3.8
Etobicoke	32.9	0.8	0.5	1.5	0.1	0.3
Metro	128.3	17.4	6.2	4.8	4.8	3.7
North York	65.5	15.4	11.1	16.9	4.5	6.9
Scarborough	39.0	14.2	14.1	36.2	0.8	2.1
Toronto	91.4	31.1	27.1	29.6	2.5	2.7
York	15.3	0.7	1.0	6.5	0.2	1.3
Total	385.7	81.7	62.7	16.3	13.4	3.5

Appendix B

* 0.0 contribution to Reserve - any purchases funded directly from operating budget.

Appendix C

Leasing Cars, Light and Heavy Trucks and

Impact on Reserve and Operating Budget

$ 000's

Assume:Lease has a term of 8 years and no savings from lease payments in the long run

Annual replacement programme (purchases) would have been $40 million if not leasing

Assume leasing valued at $10.7 million

Operating Budget is increased instead of using Reserve to fund lease payments

Cushion in Reserve not to fall below $5 million.

Appendix D

Schedule of Licensed and Unlicensed Fleet Units

* Transfers out were to City ABC's such as the Parking Authority.

** Transfers in were from the former Scarborough Public Utilities Commission.

Appendix E

Allocation of Funds to Departments and Agencies

*Details of replacement vehicles outlined in Appendix F

Appendix F

Vehicles to be Replaced

*To be reported under separate cover to Policy and Finance Committee

**Previously approved by Council on April 26, 1999