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HomeMy WebLinkAboutMINUTES-2007-09-05-2007CITY COUNCIL ROLL CALL — PRESENT: A Quorum was present. ABSENT: PRESIDING: EV�s n� Alderman Wynne Alderman Bernstein Alderman Moran Alderman Tisdahl Alderman Hansen September 5, 2007 Alderman Rainey Alderman Hansen Alderman Wollin Alderman Jean -Baptiste Mayor Lorraine H. Morton City Clerk Mary Morris read the call of Mayor Morton for a SPECIAL MEETING of the City Council for the purpose of discussing staff recommendations regarding police and fire pension funding. The meeting started at 7:06 p.m. in the Council Chambers. Mayor Morton announced there would be no public comment and reported that Alderman Holmes was not present due to attendance at the funeral of Herman Ruff that evening. City Manager Report City Manager Julia Carroll recalled that four months ago, staff outlined issues for Council consideration to fund fire and police pensions and begin a process of developing long-term solutions. Ms. Carroll introduced advisers who have worked with staff to solve this funding problem. Bond Counsel, Lou Greenbaum of Katten, Muchin and Rosenman; the City's new actuary, Alex Rivera of Gabriel, Roeder, Smith & Company; Phoebe Selden and Claire Goodman of Scott Balice Strategies, the City's financial adviser; and the internal team: Finance Director Matt Grady, Assistant Finance Director Steve Drazner and herself. She explained that police and fire pension funds are amortized over a 40 year period in Illinois. Both funds are to be fully funded by 2033, which is 26 years from now. Issues raised at the April meeting included an increased unfunded actuarial liability and concerns by one rating agency regarding this liability. One risk of not addressing this growing pension liability is a possible bond rating downgrade. Staff has worked to evaluate the problem and causes with bond counsel and financial advisers and spent a lot of time reviewing actuarial evaluations and the assumptions the City has used for some time. A nationally known actuary was hired to give Council an independent review of assumptions for pension funding levels. Credit considerations by the rating agencies and investors made this a necessary move. It is important to review and reflect on past practices and do a comparative analysis with current conditions of other governmental pension funds. They learned that past assumptions may have been overly optimistic in terms of investment returns that pension funds could achieve, given statutory restrictions for investments. Both funds are limited to 45% investment in equities and 55% in fixed instruments. There are other changes to the actuarial assumptions that were necessary to bring the valuations into up-to-date best practices in actuary science. The actuary report was sent to Council on Friday to report that the unfunded liability is apparently closer to $140 million for both funds than $100 million. The unfunded actuarial liability is an estimate of future liability of the City to fund the pension obligations, which are promises already made for certain pension benefits to police and fire employees. Parallel to the actuarial update, staff looked at funding strategies. One strategy was to look at a separate trust that would manage the assets generated by the sale of pension obligation bonds. They consulted with bond counsel about this strategy. The advantages to this structure can be discussed later. She was not ready to recommend the trust structure without more due diligence. Staff has worked on the City's first ever five-year financial operating plan, to be presented in October. Meetings with the pension boards will continue and their cooperation sought for any solution recommended to Council. During this time, the City's financial adviser has looked at funding options and the impact on tax levies; how the market would react to a pension obligation bond, and conducted credit and risk analyses of various options. Several financing 2 September 5, 2007 ideas were evaluated by soliciting ideas from underwriters through an RFP process. She showed a slide evaluating various financing ideas. No one has been hired. Staff has picked the underwriters' brains to get ideas, creative solutions and some advice. If Council wishes to issue pension obligation bonds, the City will need to engage an underwriter to structure a bond sale and the proceeds from it. Information will be shared to bring them to the next step in finding a long- term solution to this funding problem. How did the City get to this point? Benefit increases; poor investment performance for several years and changes in actuarial assumptions. What is an appropriate funding level? Staff believes they should move toward a 75% funding level for several reasons. Aaa communities statewide average about 76%, while the overall statewide average is lower. Illinois is one of the worst states in funding its pensions. The national average for pension funding is closer to 85%. Each year that Evanston lags, compared to these averages, the unfunded liability will continue to grow. What is the best way to achieve the target funding level? They have options such as pay-as-you-go or cash, which means increased property taxes, versus a one -rime infusion through bonds. They will show the impact on taxes with either scenario. If pension bonds are issued, they will show that they still have the capacity to issue debt for infrastructure needs. Ms. Carroll thought most of these questions would be answered by the experts. She asked that questions be held until the end of the segment being presented. Actuarial Analysis — Alex Rivera, Gabriel, Roeder Smith & Company (GRS) Mr. Rivera explained that an actuarial valuation is performed as a way to measure progress of a pension system. The key measurement is to look at assets and liabilities. They look at when a member will retire and live a number of years. The second key is to determine how much should be deposited into the trust. When not enough assets are accumulated, (investment income and contributions not at the appropriate rate) that causes the funded ratio to deteriorate. An actuarial valuation also provides needed accounting information for financial disclosure and _ it depends on the actuarial assumptions and methods. The statute allows an independent actuary to make recommendations based on assumptions used to determine liabilities. They review the plan's experience to assess the liabilities and, generally, assumptions are updated every five to ten years. In examining Evanston's plans, it appeared the assumptions had not been updated for eight years, so one was due. Part of their objective was to make sure all assumptions were current, reasonable and doable. The key assumption is investment return. The biggest constraint is the statutory asset allocation policy of 45% equity and 55% in bonds (fixed -income). Those constraints make it difficult to support a higher investment return. The former actuary used an investment return of 7.5%. GRS thought that was aggressive and reduced it to 7.25%. This assumption should be monitored annually to ensure that it can be defended. Currently the asset mix for both plans is 43% equity, 47% fixed and 10% cash, which is consistent with the amounts in statutes. Other assumptions are critical. GRS changed the mortality assumption (a person's likelihood of living a certain number of years after retirement). GRS expects retirees to live longer and receive more pension benefits. Other assumptions GRS examined were retirement rates that they thought were too optimistic. GRS thought people would retire sooner rather than later and changed the actuarial cost method from projected unit credit to entry age normal (a means of spreading contributions over the plan's life). Entry age normal produces cost that is level as a percentage of pay, a feature attractive in the public sector that produces equity among different generations of taxpayers. Entry age normal is used by 80-90% of public sector plans and increased cost slightly. The unfunded actuarial accrued liability (UAAL) after all assumption changes increased from $44 million to $62.6 million for the fire pension and from $54 million to $77.6 million for police pension -- a significant jump. It is important to use assumptions that are reasonable and don't create future losses, which result in contributions being pushed up in the future. When assumptions used are too optimistic, costs are pushed to the next generation. Their purpose is to ensure stability in the contribution rates. They define stability as measuring in terms of the contribution as a percent of pay. The funded ratio is assets divided by liabilities. The funded ratio for the fire pension went from 48% to 41 % and the police pension went from 52 % to 44%. He noted the expected unfunded actuarial liability of the Police fund went from $54 million to $77 million and the Fire pension expected unfunded actuarial liability went from $44 million to $62 million. A chart showed the actuarial liability using the prior actuary and GRS--both funds showed different assumptions. 3 September 5, 2007 The key objective of GASB 27 is accrual accounting. That is a historical comparison of the actuarially determined contributions versus what the employer actually contributed. To the extent the employer makes the actuarially determined contribution into the trust, the balance sheet liability should be zero. Bond rating agencies like to see that at zero and a high -funded ratio such as 80-90%. To the extent the balance sheet liability could be limited and the funded status increased would help from an actuarial perspective when a bond rating agency looks at the financial health of a pension. The accounting requirement became effective in 1997 and compels an employer to examine ten years of history. It was $5.4 million for the police pension and $3 million for the firefighter's pension fund so that $8.52 million was transitioned. But it is not necessarily proof the pensions were under funded. Sometimes there is a mismatch as to when the expense is recognized on the employer's books and when the money actually comes into the fund to offset the expense. They found that there could be a two-year lag, which is not uncommon. When the actuary provides a report, it won't happen then, but maybe six months or a year later. So there is lag built in for the accounting policy and actuarial policy. There are ways to correct the lag. One way is to adjust the contribution so that it better matches the expenses. The balance sheet liability is the accumulation of balance sheet shortfalls since 1987. It is about $14.5 million for both plans in 2007. GRS recommends that the City look at its accounting policy and better match the spread between the actuarially determined contribution and what actually is deposited into the fund. The funded status represents the difference between actuarial liabilities less the market value -- about $140 million as of March 1, 2007. The actuarial liabilities are the present value of future benefits. The balance sheet liability looks at history and shortfalls. The funded status looks at present value of future benefit versus actual assets in a trust to finance future obligations. The key is a funded ratio of between 80-90%. There is a relationship between the two but it is complex. If the balance sheet liability is controlled and in the future expects contributions to match perfectly, then the net pension obligation (NPO) should decrease slowly to zero after 26 years. Another way to reduce the balance sheet liability is to make contributions in excess of the actuarially determined amounts. Similarly, based on the current 26-year closed amortization period, the funded liabilities should be fully funded after a 26-year period. Assets should equal liabilities in about 26 years. This assumes no actuarial gains or losses or no lag between actuarially determined contributions in the future. In response to Alderman Rainey, the most recent actuary was with the City for 10 years. Did the City fund less than the actuarial recommendation? Mr. Rivera could not answer. Ms. Carroll noted that one year the actuarially required contribution was not fully funded but was made up the next year. Alderman Rainey asked when the investment earnings were assumed to be 7.5%, did they know the average gain on investment. Mr. Rivera thought it fell within the range but that was an aggressive assumption. How well did investments perform? The pension boards have more data as to whether 7.5% was met. All of the history was not reviewed. Alderman Rainey asked for help in understanding the two-year lag concept. Mr. Rivera stated anytime there is an accounting policy change it requires a significant amount of analysis. They have to ensure the change in the accounting policy or actuarial policy is a good decision. This was an observation they saw on the mismatch. It will take work to correct it going forward. Could he explain the implication of this lag and where is the money? What would happen if there were no lag? Mr. Rivera stated if there were no lag, the net pension obligation would be smaller. The matching of the contribution and the actuarially determined amounts would be much closer and the balance sheet liability, instead of being $14 million, could be a lot less. Alderman Rainey noted they would be talking about real money, not an assumption. Mr. Rivera explained the money is in the trust and this is an accounting rule. To the extent that contributions are not made within the time period, they get hit with a penalty that grows. He stated the accounting policy could be changed so that the two are in sync. Ms. Carroll said staff will make the change. She explained that each year the City levies taxes in December and collects them the next year. Meanwhile, they have the interest assumption that the portfolio will earn 7.25% interest and don't have the money yet. The second issue is that employees' wages go up another year. So a lag of interest and wage growth occurs. A way to avoid this is to remove the actuarially required contribution (ARC) and levy for that dollar amount now to eliminate the lag. Staff will correct this, which is due to timing and the taxation system. She thought if they did the math from the time that GASB 27 became effective and carried it forward, staff would realize this was occurring. Alderman Tisdahl asked him to explain the 7.251% if they don't know what the funds have earned. Mr. Rivera stated they look at some history, but more important is the current asset allocation and capital market assumptions. Historically in better economic times, the average rate was 8.5% in the equity markets. Financial advisers may not be as optimistic about future equity returns because expected returns have been dropping. That is taken into account in the model evaluated annually. They have a wide range to work with, so if they are off by 25 or 50 basis points, they are okay. But to the extent 4 September 5, 2007 that they are at the 751h percentile of the return, net of expenses, then they are at the limit. They want to be in the 50`h to 60`h percentile of the return. Once they approach the 75 h percentile it becomes an aggressive assumption. They want to build in enough cushioning so they don't have a situation where an investment assumption cannot be defended three years from now because the markets dropped. History is important and constraints on asset allocations are the problem. With 45% in equities, it becomes difficult to assume a higher return. Ms. Carroll explained the reason that history is unimportant now is because they view funding as a future liability. They need to consider what has happened, but there have been changes in investment policy allowed by statute. In the past pension funds could have only 10% equities; then it was raised to 45% so pension funds have moved toward that number over time. She thought both funds were committed to 45% in equities and 55% in fixed instruments. Past restrictions would have resulted in a lower number and if the funds did not make 7.5%, that would have caused the unfunded liability to increase. Mayor Morton confirmed that all pensioners have received their pensions; assuming continued contributions to the pension funds and with the funds already in the pension how long will the funds last? Mr. Rivera stated if assumptions are not changed to create some margin, the funded ratio would continue to slide and, potentially, they could be a position with funds at 30%. There is still time to make corrections at 45-50%. At 30-35% it is virtually impossible to make the correction. (Contributions would have to be 80-100% of pay.) Mayor Morton asked if they assumed the return on investments would continue. Mr. Rivera explained that in their model, they believe assets would continue to earn 7.25% in the future. It is up to the investment consultant to provide a proper mix of assets so that at least 7.25% could be earned. Mayor Morton asked if the City was doing anything wrong. Mr. Rivera said the City is not doing anything wrong, but funding policy can be improved to minimize future risk. Mayor Morton did not want taxes increased and noted that Council has been under the assumption they were doing the right thing. Finance Director Matt Grady thought Mayor Morton was asking, "what if they do nothing." Mayor Morton confirmed it would be the Fire Pension and Police Pension members and retirees who would hold the City responsible. Mr. Grady explained that the City has a fiscal responsibility to make sure those funds are healthy. Mr. Rivera told them that they had not put enough assets into these funds to keep them healthy. After examining this actuarial evaluation, they are looking at a fund ratio of 41 %. Mr. Grady explained that each pension board has a financial adviser to invest the funds and get the best return. Ms. Carroll said this meeting is to talk about funding levels, which are too low. It is a credit concern and, if the funding levels aren't increased, the pensions could become bankrupt. State statutes recommend a 90% funding level and Evanston is at 40 or 45%. They said the City has 26 years to fund this liability for future promises to pensioners and don't want to do all that at the end because earnings are lost by not having time to grow. They are better off to make payments over time to allow the pension boards to invest the money. Staff has shared that past actuarial assumptions were optimistic, have reviewed it and has some recommendations. Financial advisers will tell staff how to deal with this liability. Ultimately, Council must deal with this. They can use pay -as -you go, not do anything and let the next Council deal with this, but the problem will increase. The responsible thing to do is address the issue now and find a solution. What Alderman Jean -Baptiste heard was that Council had not been as responsible as they should be. Will they run out of money? No. Ms. Carroll stated that each fund has assets. Currently the liability in the police pension fund is $139 million with $62 million in assets. They need to come up with $77 million more in the next 26 years. Assets of $139 million are needed by 2033. Staff has drawn attention to this because the funding ratio has dropped. Council was told in April that Evanston is at the bottom of the barrel, not where we want to be. The promise to retirees continues to grow. Phoebe Selden, Financial Strategies Ms. Selden noted that if employees and the City continue to contribute at last year's rate, the funds would run out of assets in 2018. At that point, there will be 160 employees in the plan plus retirees. Ms. Carroll stated that determining when the fund will run out was not the best way to look at it; suggested they view this as "what is the proper funding." Ms. Selden explained that once they decide the right funding level, the next question is how to get there. There are two options. One is to pay the actuarially required contribution with cash. Another scenario is to use pension obligation bonds. She showed a chart outlining the pros and cons of three strategies. Compared to the prior year's level, they will need to increase actuarially required contributions by $3.3 million for next year. The funded ratio will improve slowly with this scenario, but there would be a negative credit and budget impacts. They could exceed the annual pay-as-you-go contribution, thus amortizing the liability more quickly. That would have a positive credit impact, but negative impact on the budget and higher property taxes. The third option is to issue pension obligation bonds. Those are expected to lower NO 5 September 5, 2007 the amount the City needs to fund because it is more efficient to issue debt than contribute cash on a pay-as-you-go basis. However, there are risks. The negatives are that it becomes a "hard" obligation as opposed to a "soft" obligation. There is a contract with the bond holder and payments must be made. As they have seen with the growth of the net pension obligation, if they don't make the full payment, pensioners might be angry, but there is not a pension default. The City has to budget to pay the debt service. The goal is to manage the pension liability while limiting the budget and property or other tax impacts and maintain Evanston's Aaa rating. Evanston's Credit Rating Ms. Selden reported that they cannot get a firm answer on the City's credit rating without taking the whole package to rating agencies and asking for a committee vote. What financial advisors do is present "what if' scenarios to try and get feedback. Evanston has AAA with Fitch and Aaa with a negative outlook with Moody's. The two main concerns are the City's relatively high debt burden and the police and fire pension funded ratios. Evanston has a fairly high debt burden of General Obligation Bonds and more debt than comparable Aaa communities. The debt burden is perceived as manageable and likely to decrease over time. The City has a fast debt amortization that helps mitigate concerns. (They could look at variable rate TIF bonds that could be switched into the TIF credit out of GO bonds that could reduce pressure of the GO bonds.) Measures have been taken to shore up the relationship with the rating agencies. Management has regular and ongoing dialog with the analysts. A supplemental economic analysis highlighting the strong demographic trends and successful economic development strategies was used in Evanston. A tour of Evanston by rating agencies was received favorably. Evanston has fundamental credit strength. The five-year financial plan is a strong credit positive. The rating agencies perceive the management team as one of the four factors. Evanston has received favorable feedback regarding the management team. Potential Rating impact of various Pension Strategies What is the right funding ratio`' Funding to Illinois AAA median or 75% is the minimum range while higher is better (90% not necessary). There has been discussion of increasing the real estate transfer tax, which is a credit positive. Another topic that would be received favorably with pension obligation bonds is to devote a portion of savings to the budget reserve. There are risks associated with any kind of debt scenario. Primary is the investment risk. It is important to guard against catastrophic type of loss of principal. They are actively soliciting how that risk has been managed by other entities. She showed a slide of the forecast of actuarially required contributions on pay-as-you-go cash funding. Using this methodology, the City's contribution could be expected to increase from approximately $8 million in FY 2006-07 to $12.1 million in FY 2007-08 with increases thereafter. (This approach would likely result in a rating downgrade.) With Finance Director Matt Grady they looked at the increase in property taxes using the pay-as-you-go scenario. Without additional revenues, the increases in property tax receipts needed to pay the increased actuarially funded contribution of $3.3 million in FY 2007-08 would grow annually to an increase of $20.5 million in 2032-33. A tax bill increase of $18.90 for each $1,000 of tax bill in the prior year would be required to fund this increase in FY2007-08. Alderman Rainey pointed out if the tax bill is $10,000 it would be l Ox 18.90 for the first year. Ms. Selden noted it would increase a smaller amount each year after that; pointed out that the Downtown II TIF could be partially used to fund the actuarial required contribution. How pension obligation bonds can help with financing the pension funds. The pension obligation bond proceeds become an asset of the police and fire pension plans and are assumed to earn interest at a rate higher than the cost of borrowing. Going back to the actuarial assumptions, the assumed rate of 7.25% interest on the assets is greater than the assumed rate ofborrowing. That is a key element. Assumed rate of borrowing is at 5.95% in the current market. They see a gap between these numbers and, to the extent that this can be guaranteed, it can be turned into savings by the City. Summary of two pension obligation bond assumptions. One is a 75% funding goal and the other a 90% funding goal. To get to the 75% funding goal, bonds issued would total $79 million. The actuarially assumed investment rate of return is 7.25% and 5.95% to borrow with final maturity of 2034. To make the 90% funding goal, $118 million would be issued in bonds with a similar scenario. The difference between the 7.25% actuarially assumed rate of return and 5.95% of taxable pension obligation bonds results in an expected net present value savings to the City of approximately $12 million. With the 90% funding there would be net present value savings of about $18 million over the life of the bond. HID 6 September 5, 2007 Looking at debt in context of outstanding GO bonds. The City's GO debt service has a declining profile and that is desirable. They have tried to consider how the City will fund its capital program. Pension obligation bonds can be structured to allow capacity for future bond issues. What is happening in the markets? Claire Goodman updated Council on current market conditions noting that August had one of the most volatile markets. Investors are looking for "safe" notes and have flocked to the Treasury market. Evanston's AAA credit has made it attractive to investors during this volatile market. A lot of taxable debt has gone overseas. Whatever legal structures they go with, there will be some risk. Managing Investment Risk. Alderman Rainey asked, if they project a cost of $18.90 per thousand on a tax bill with pension obligation bonds, what would be the burden at the 75% funding goal and the 90% goal. Ms. Selden said they would get back to her the next day with an answer. Alderman Wynne asked, to protect the principal ofpension obligation bonds, how do they get a guarantee and what do they give up to get it. Ms. Selden stated that 2 of 23 respondents to their RFP, had interesting products. Their underlying structure is either colateralized or guaranteed with Treasuries or highly rated credit. The return is probably using a certain level of derivatives and is linked to an index. If there is a spectacular growth in equities, one would receive 75% of that and there would be fees. Alderman Rainey asked for an explanation of the makeup of the pension boards and the contribution of employees versus the taxpayer contribution. Mr. Grady is a member of the Fire Pension Board and attends Police Pension Board meetings but is not a member. Ms. Carroll stated there are two Mayoral appointments to each board composed of active employees and a retired employee. Fire Chief Berkowsky was appointed by the Mayor to the Fire Board. Robert Costello and Mark Weisberg were appointed by the Mayor to the Police Pension Board. The employee contribution rate to the Police Pension is 9.91 % of their salary or about $1.1 million. The employer contribution should be 61.8% of salaries. Fire employee contributions are 9.455% of salary and those employer contributions should be 69.5% of salary. Employer contributions in the police pension fund are stable for about ten years then start to decline. The fire fund employer contribution starts at 69.5% and goes up to 73.9% in 2014, then starts to go down to the low sixties. Ms. Selden noted the actuary had forecast the annual required contribution (ARC) to grow. This makes assumptions on overall salary about what is needed to make the fund whole. Ms. Carroll reiterated the three components to funding the pensions: employee contributions, interest on investments with the difference made up by the taxpayer. They are trying to improve the funded ratio and the goal is to get the City in a better position. Scott Balice has looked at other communities. Board members of the pension funds make the decisions on investments based upon their financial adviser. Staff has no control over these pension funds. Mayor Morton said when compared to other cities, the salary scales and populations are different. Unless all other factors are the same, she did not like the comparisons. Those who served on past Councils thought they had done the right thing. They have advisers and how do they know that in three years, another group will come with a different opinion. Ms. Carroll responded that pension funds are governed by state statutes that apply statewide, with the exception of the City of Chicago. When Evanston is compared to other plans, the formula for calculating benefits is the same and the formula for employee contributions as a percentage of salary is the same. The only difference is how the funds are invested and the earnings on the investments. Ms. Carroll thought it important to know where Evanston fits in compared to other communities because it affects the City's credit rating and is important for the City's future. Rating agencies look at peer communities and compare Evanston to them. Ms. Carroll said this was not blame for past actions, but a look at future liabilities. The City will try to put together a long-term financial plan for the benefit of taxpayers and retirees. When Alderman Wollin read the 9.91 % figure, she confirmed it is the state figure and covers the basic salary, with no overtime or other salary. She asked if other cities use a combination of property tax increases and pension obligation bonds. Ms. Selden said the full spectrum is used. There are some with the "do-nothing" approach that are in the twenties. Alderman Wollin asked if the guaranteed principal is similar to an annuity. Ms. Selden said it depends on the index used. Y9/ 7 September 5, 2007 Ms. Carroll stated they want to pursue further analysis of pension obligation bonds so staff could come back with a solution that would cost less than a pay-as-you-go scenario. Alderman Rainey felt that Council was bombarded on one night with a lot of information; then there will be another appearance of this group and they will be told the staff recommendation with little choice and have to make a decision on the spot. She felt the Council should have been brought along with more advice and discussion. She found this overwhelming; asked what will pension obligation bonds cost the taxpayers. There'are other issues, including Alderman Tisdahl's recommendation. She wanted another meeting before making a decision. Ms. Carroll suggested they pursue analysis of the pension obligation bond option. They can get an estimate of tax impacts. There is more work to be done. Alderman Rainey expected Council to be involved in this work; noted they have the A&PW Committee and discussion of this could be held as they go along. Ms. Carroll had not set a time frame to solve this. Alderman Wynne thought they should direct staff to do more due diligence; has many questions. Ms. Carroll stated the discussion would be continued. Mayor Morton said if they could make it more readable, that would be helpful. Alderman Wollin did not see how they could raise funds without raising taxes. Mayor Morton suggested they look at everything before raising property taxes. Alderman Bernstein said these obligations are non -discretionary. They have to do this. Leveraging was suggested so it would cost less over time. Mayor Morton said if one pension fund can extend the time (teacher's fund) why cannot that happen with these two. She commented that cities are not without money and have to decide what to do with the money they have to meet their obligations. There being no further business to come before the Council, Mayor Morton asked for a motion to adjourn and the Council so moved at 9:16 p.m. Mary P. Morris, City Clerk A videotape recording of this meeting has been made part of the permanent record and is available in the City Clerk's office.