What factors should municipalities consider when attempting to create a stabilization fund to help offset COVID-19-related financial losses?

A stabilization fund is, in essence, a rainy-day fund or budget reserve fund, and is not considered an eligible use of Coronavirus State and Local Fiscal Recovery Funds (“CSLFRF”). Specifically, the U.S. Department of the Treasury’s (“Treasury”) Final Rule provides that the following uses of funds are not eligible under the revenue replacement eligible use category:

Contributions to rainy day funds, financial reserves, or similar funds; payment of interest or principal on outstanding debt instruments; fees or issuance costs associated with the issuance of new debt; and satisfaction of any obligation arising under or pursuant to a settlement agreement, judgment, consent decree, or judicially confirmed debt restructuring plan in a judicial, administrative, or regulatory proceeding, except to the extent the judgment or settlement requires the provision of services that would respond to the COVID-19 public health emergency.[1]

The replenishment of a rainy-day fund is not an eligible use of CSLFRF either to respond to the public health emergency and its negative economic impacts, or as a provision of government services to the extent of revenue loss.[2] Similarly, funds made available for the provision of governmental services (to the extent of reduction in revenue) are intended to support direct provision of services to citizens. Contributions to rainy day funds are not considered a provision of government services since such expenses do not directly relate to the provision of services to constituents.[3]

When contemplating the creation of a stabilization fund, municipalities should consult the guidance provided by the Government Finance Officers Association (“GFOA”), which may be adapted to the municipality’s specific intent.[4] The following are some strategic factors that municipalities may consider:

1. Existing state or local legislation or policies that govern stabilization funds

The municipality must also comply with existing state or local laws as well as policies that address stabilization funds. A planned new stabilization fund must not contravene those laws.

2. How the stabilization fund will be created

Stabilization funds are generally created by legislation (approved by a legislative body), administratively (approved by the executive branch), or through another approach (approved by an independent body or a body with legislative and/or executive representatives). Municipalities should consider their respective jurisdictions’ legislation, ordinances, and other requirements along with the responsibilities of various branches of government and/or administrative bodies when determining the best approach.

Moreover, a stabilization fund’s design may impact how credit rating agencies view the fund. Municipalities should consider reviewing credit rating methodologies with their financial advisors and/or debt management staff to understand those perspectives prior to making a determination as to the best approach.

3. The policies that govern the stabilization fund

Municipalities should consider policies that govern stabilization funds and how the fund operates. The factors to consider will ultimately be determined by the exact type of stabilization fund that the municipality seeks to create. In general, factors to consider may include uses, replenishment, reporting requirements, and risks.

• Uses: What can (and cannot) the fund be used for? How flexible or specific are the uses? What is the time period for using the fund? What are the processes for using the fund?
• Replenishment: Does the fund need to be replenished and, if so, over what time period?
• Reporting: Is it required to report to the legislative branch, executive branch, or other stakeholders on the use of funding? What data points may stakeholders require and/or be interested in monitoring via reporting? How will leadership use reporting to drive decision-making?
• Risks: Is the municipality more susceptible, for example, to natural disasters that may deplete stabilization funds more quickly? It is important to articulate these types of risks in the policy so that stakeholders have transparency on the fund rationale.

Policies should clearly delineate roles and responsibilities and, where applicable, explain the rationale(s) behind specific policy components.

4. The amount or size of the stabilization fund

Municipalities must consider the intended use of the fund, volatility of revenue sources, the municipality’s susceptibility to disasters (including COVID-19), and the current or potential state actions that may impact future revenue.

For example, GFOA recommends “at a minimum, that general-purpose governments, regardless of size, maintain unrestricted budgetary fund balance in their general fund of no less than two months of regular general fund operating revenues or regular general fund operating expenditures.”[5] Alternatively, credit rating agencies view reserve levels more or less favorably based on their own methodologies. It is recommended to review credit rating methodologies with the municipality’s financial advisor and/or debt management staff.

If the stabilization fund is to be used for COVID-19-related financial losses, a municipality may consider estimating the temporary and permanent impact COVID-19 has had on revenues and expenditures. That impact should be taken into consideration when determining an appropriate amount or size. Estimations should remain reasonable, transparent, and compliant with any policies, guidelines, or other legislative requirements.

Some questions a municipality should ask and answer include: What lost revenue from COVID-19 is expected to be regenerated? Are there permanent changes to specific revenue streams post-COVID-19? Are there one-time fluctuations in expenditures, and if so, how long is that fluctuation projected for? Are there permanent changes in expenditures due to COVID-19-related changes in government operations, services, or programs?[6]

The municipality should also consider which funding source(s) may be used to build a stabilization fund. Federal funds have a prescribed purpose and intent, so a municipality should review the specific rules and regulations associated with federal funds to determine if these funds may be used to build a stabilization fund.