www.efc.unc.edu

Roadmap to Financial Health

Jeff Hughes

Shadi Eskaf

March 5-6, 2012

Chapel Hill, NC

Session Objectives

1. Improve ability to assess financial health

2. Improve understanding of strategies and

initiatives that support financial health

– Financial Policies

– Supplemental Services

– Pricing and Business Models

– Capital Planning

Is it variable or is it gone??

0

20

40

60

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180

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220

240

1930

1935

1940

1945

1950

1955

1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

An

nu

al M

GD

Actual Annual

5-Year Moving Average

1967 SWD Forecast

1973 RIBCO Forecast

1980 Complan Forecast Medium

1980 Complan Forecast Medium-Low

1985 Complan Forecast-Medium

1993 WSP Forecast

Source: Seattle Public Utilities

What happened in Seattle

• Prices went up

• Homes became more efficient

• Water users became more efficient

• Decentralized initiatives increased

0

100,000

200,000

300,000

400,000

500,000

600,000

700,000

800,000

900,000

1,000,000

1,100,000

1,200,000

1,300,000

1,400,000

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

0

20

40

60

80

100

120

140

160

180

200

220

240

260

280

Total Water Consumption

Population

Po

pu

lati

on

Source: Seattle Public Utilities

Water Use and Revenue

“Water demand is recalibrating according to

new economic realities and public policy

directives. Ignoring declining demand does

make it go away – or rather, come back. The

intractable manager will remain cash-flow

frustrated. The enlightened manager will be

better positioned for cost recovery in

accordance with a fluid equilibrium.”

Beecher, Janice A. 2010. The Conservation Conundrum: How declining demand

affects water utilities. Journal AWWA, February 2010, 78-80.

Rating Agencies Agency Rating Criteria Assessments and Special Reports Ratings

System

Fitch US Water and Sewer

Revenue Bond Criteria

(8/11)

2012 Water and Sewer Medians (12/8/11)

2012 Outlook: Water and Sewer Sector (12/8/11)

AAA

AA

A

BBB

+,-

Standard

and

Poors

Standard and Poors

Public Finance Criteria

(2007)

Sector Review: Funding Long-Term Needs Remains

The Biggest Risk For U.S. Municipal

Water And Sewer Utilities (1/31/12)

How U.S. Municipal Water And Sewer Bond Ratings

Correlate With Some Key Measures Of

Issuers‘ Credit Quality (9/26/2011)

AAA

AA

A

BBB

+,-

Moody’s

Research

and

Ratings

RATING

METHODOLOGY

Analytical Framework

For Water

And Sewer System

Ratings (8/1999)

WATER AND SEWER SECTOR OUTLOOK:

Water/Sewer Revenue Bonds Have Positive Rating

Trends,

With Billions In Issuance Expected Over Next 20

Years (2/2000)

UK Water Sector Outlook 2011

Industry Outlook (10/2011)

Aaa

Aa

A

Bb

1,2,3

North Carolina Benchmarking

• LGC Memo: Statistical Information on

Water and Sewer Operations

(forthcoming)

• EFC Water and Wastewater Financial

Benchmarking (any day now)

• SOG Benchmarking Project

Indicators

• Operating Ratio = Operating Revenues/ Operating Expenditures

• Operating Margin = (Operating Revenues –Operating Expenses**)/Operating Revenues

**Operating Expenses include Depreciation which is not a cash expenditure

8

Indicators

• Debt Service Coverage = Revenue

available to pay debt service/Debt Service

• Revenues available to pay debt service =

Operating Revenues – (Operating

Expenditures + Other Essential

Expenditures)

Example

• Operating Revenue $3.2 million

• Operating Expenditures $2 million

• Contractual Payment to City $200,000

• Combined Debt Service (P&I) $500,000

• Overall Debt Service Coverage Ratio = (3.2 – 2. – 0.2)/0.5 = 2.0

Reported NC Utilities’ Aggregate Operating

Revenues and Expenses (inc. dep.) (1997-2011)

0

200

400

600

800

1000

1200

1400

1600

1800

2000

$0

$500

$1,000

$1,500

$2,000

$2,500

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Mill

ion

s

Fiscal Year Ending

Number of Utilities

Operating Revenues

Operating Expenses

North Carolina Utilities’ Average Operating

Revenues and Expenditures (1997-2011)

$0

$1,000,000

$2,000,000

$3,000,000

$4,000,000

$5,000,000

$6,000,000

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Fiscal Year Ending

Average Operating Revenues

Average Operating Expenditures

Op. Revenues by Inflation (CPI)

Do Water and Wastewater Rates Cover System Costs?

Small Water Systems vs. Large

4.0

4.5

5.0

5.5

6.0

6.5

7.0

7.5

8.0

8.5

9.0

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004

Bille

d W

ate

r (M

GD

) Water Sales (1980-2009)

(Slide provided by Orange Water and Sewer Authority)

Lower than projected demands

have resulted in cumulative

net revenue reduction of about

$7.3 million over last 3 years.

Meeting Revenue Challenges

• Costs

• Finance Policies

• New pricing and

business models

• Supplemental services

(behind the meter)

• Affordability programs

• Communication,

communication…

What are you Doing?

Do you have an approved set of

water/wastewater finance policies?

1. Yes

2. No

3. Workin’ on

it…

31%

46%

23%

Yes No Workin’ on it…

Does your utility have a "finance policy" that sets financial targets and goals,

such as reserve balance, debt service ratios, etc.?

If yes: is your "financial policy" Governing Board-approved?

n = 260

Source: NCLM/EFC 2010 NC Water and Wastewater Financial Practices and Policies Survey

Do not have a finance policy

47%

Don't know if have a finance policy

12%

Finance policy is Board-approved

34%

Finance policy is not Board-approved

3% Don't know if

finance policy is Board-approvd

4%

Have a finance policy 41%

Orange Water and Sewer Authority

• http://www.owasa.org/about/FinancialDocu

ments.aspx

Financial Policies and Guidelines:

Internal financial policies EBMUD Financial Indicator Target

Working capital reserve ≥ 3x monthly net O&M

expenses

Self-insurance reserve 1.25x expected annual costs

Contingency/rate stabilization reserve 20% of annual water volume

revenues

Debt service coverage ratio ≥1.6x coverage

Debt-funded capital ≤65% of total CIP spending

over 5 year planning period

Other Measures

• Supplemental Services

• Affordability Programs

PRICING AND BUSINESS

MODELS

How satisfied are you with your rates and

the revenue they generate?

Not a

t all

– n

eed

an ..

.

Not v

ery

– th

ey n

eed a

...

Som

ewhat

– tw

eaks

...

Ver

y –

no ch

anges

n...

0% 0%0%0%

1. Not at all – need

an overhaul

2. Not very – they

need a lot of work

3. Somewhat –

tweaks needed

4. Very – no

changes needed

How satisfied are you with your rates and

the revenue they generate? (2011)

1. Not at all – need

an overhaul

2. Not very – they

need a lot of work

3. Somewhat –

tweaks needed

4. Very – no

changes needed

Rates background:

GS 160A-314 /153A-277

A) A city may establish and revise from time to time schedules of rents, rates, fees, charges, and penalties for the use of or the services furnished by any public enterprise……….

Rates per SL 2008-143/HB 2499

• “water rate structures that are adequate to

pay the cost of maintaining, repairing, and

operating the system, including payment of

principal and interest on indebtedness

incurred for maintenance or improvement of

the water system”

• “also consider the effect of water rates on

water conservation and recommend rate

structures that support water conservation.”

Rate Setting Resource

http://www.efc.unc.edu/publi

cations/2009/GuidelinesDes

igningRateStructures.pdf

Free guide written for

utility managers in

June 2009 (funded by

DENR).

CURRENT RATES

(PRELIMINARY RESULTS)

Annual NC Water and Wastewater

Rates Survey

• Collaboration since 2005 (8 years)

• Funded by the Public Water Supply Section at NC DENR

• In 2012: 494 utilities. 92% of local government, non-profit and multi-

system private utilities

• Free, online information: tables, summary report, Rates Dashboards,

rate sheets at http://efc.unc.edu/projects/NCWaterRates.htm and

http://www.nclm.org

NC League of Municipalities Environmental Finance Center

at the School of Government

Which Rates were Studied?

• Rates for 494 utilities across NC

• Rates for water, irrigation and wastewater

service

• Rates for residential and for non-

residential (small commercial) customers

• Rates for inside and outside customers

• Including base charges and allowances

Preliminary Results

Graphs and data shown in this presentation represent January 2012 rates, and are

PRELIMINARY results.

Please do not quote.

Final results will be shared in March 2012 and be made available at

http://efc.unc.edu/projects/NCWaterRates.htm

Base Charges

Low bills for low

consumption

amount

vs.

Revenue stability

Preliminary results – do not quote

Residential Rate Structures

Water Wastewater

Rate structures applicable to residential customers for consumption up to 15,000 gallons/month only

Preliminary results – do not quote

Pricing Different Services

• ~25% use separate rate structures for

non-residential customers

• ~12% use separate rate structure for

residential irrigation water

Residential Water Bills Among

521 Rate Structures

Preliminary results – do not quote

Affordability of Rates

The “average

North

Carolinian” pays

$69.70/month

for 5,000

gallons of water

and wastewater

Preliminary results – do not quote

Medians:

0.9% water, 1.1% sewer

Changes in Rate Structures and

Rates Since Last Year

• 50% increased rates last year

• 83% changed rates within the past two years

• Only 3% of utilities have not changed rates since 2008.

Preliminary results – do not quote

Changes in Rates Since Last Year Half of the rate increases

were for more than 4%.

Preliminary results – do not quote

www.efc.unc.edu

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2009 2010 2011 2012

Utilities Changing Water Rates (Among the Same 361 NC Utilities)

0%

2%

4%

6%

8%

10%

12%

14%

2009 2010 2011 2012

Water Rate Increases for 5,000 Gallons/Month (Among the Same 361 NC Utilities)

Median - 75th

25th - Median

$0

$10

$20

$30

$40

$50

$60

$70

2008 2009 2010 2011 2012

Median Water Monthly-Equivalent Bill (Same 361 NC Utilities Throughout the 5 Years)

14,000 gallons/month

10,000 gallons/month

5,000 gallons/month

2,000 gallons/month

Rates Dashboards • Interactive tool to compare rates (bills)

among all utilities, or utilities with similar characteristics:

– System size (number of accounts or revenues)

– Technology (water source type or river basin)

– Location (regional council, 50 miles distance)

– Economic development tiers

• Available online at www.efc.unc.edu/RatesDashboards/

Webpages on NC Rates

(with report, tables, Dashboards, more)

www.efc.unc.edu/projects/NCWaterRates.htm

www.nclm.org

The 2012 report, tables and Rates Dashboard will be

available in March 2012

PRICING

I think our utility’s business model in 15

years will….

Pricing Case Studies

1. City of Raleigh source water protection

component

2. City of Charlotte base charge

modification

3. Beufort Jasper

Source: Lisa Creasman, CTNC/UNCWI

Does your utility pay for watershed protection or land

acquisition from the revenues it collects from customers? n = 261

Yes 12%

No 77%

Don't know 11%

Source: NCLM/EFC 2010 NC Water and Wastewater Financial Practices and Policies Survey

INCREASING REVENUE

STABILITY BY INCREASING FIXED

CHARGES

Revenue and Expenses for Charlotte-Mecklenburg Utilities in a Given Year

Source: CMU Director Doug Bean’s presentation to the Charlotte City Council on

December 1, 2008.

Are there alternatives?

What would you do?

• Recent extreme drought revealed water supply vulnerability and the need for water efficiency and conservation

• Extreme monthly/yearly revenue variations have been problematic

• Annual average across the board rate increases of 7.5% over last 5 years with some unscheduled increases as high over 10%.

City of Charlotte Rate Study 2011, Red Oak Consulting

City of Charlotte Rate Study 2011, Red Oak Consulting

Charlotte-Mecklenburg Utilities

Adopted Rate Increase

Water Rates

Fixed Charges

Billing Charge $2.40

Availability Fee $2.25

Usage Rates

Tier 1: 0-4 ccf $0.98

Tier 2: 4-8 ccf $1.96

Tier 3: 8-16 ccf $3.41

Tier 4: <16 ccf $5.32

Sewer Rates

Fixed Charges

Billing Charge $2.40

Availability Fee $4.30

Usage Rate $4.14

Sewer Cap

Single-Family Res 16 ccf

Multi-Family Res 11 ccf

Non-Res None

2010

2011

2012

2012

ALTERNATIVES TO THE

CLASSIC PRICING MODEL

Case Study: Beaufort-Jasper Water and Sewer Authority

The Customerselect Model This model is based on the plans offered by the majority of cell phone

service providers, in which an allotment of use is included in one fixed

charge. The customer chooses a plan and pays an overage fee if

he/she uses more.

Plan name Monthly water allotment

Cost for w&s under current rate structure

Customerselect cost (w&s)

Overage

Lifeline 2,000 gallons $12.00-$31.02 $25.99 $12.00/kgal

Basic service/Small family

6,000 gallons $40.53-$69.06 $59.99 $12.00/kgal

Light irrigation/Large family

10,000 gallons $78.57-$88.95 $79.99 $12.00/kgal

Heavy irrigation 15,000 gallons $92.41-$106.25 $99.99 $12.00/kgal

Water waster Unlimited >$106.25 $139.99* NA

See your local Verizon Wireless store

Example residential structure

Potential Benefits

• Increased revenue stability: Customers “lock into” plans

• Gives customer a choice: This means less administrative burden than budget-based rates of utility determining block rate for customers

• Moves more to a model of water and sewer service, rather than a commodity

• Promotes conservation, especially around the “break points”

• Relatively easy to add ancillary services (like service line protection) a la carte

Potential Challenges

• Complicates budgeting process:

-How do you predict what plan customers will choose?

-When will they “lock in”?

-Can they change plans? How often? What is the optimal length of the contract?

• Does not fit with seasonal use of water: Water use is not as consistent month-to-month as cell phone use. Allowing roll-overs could help this, but would dissuade conservation.

• Customers will request real-time water use information: In order to provide this service, metering upgrades will be required.

The Peak-Set Base Model Under this rate structure, a customer’s base charge would be

individually set based on their three-year rolling average peak. This

would allow BJWSA to build more of their cost recovery into the base

charge while still promoting customer conservation and efficiency. It

would particularly encourage steady water use.

Example residential structure

Use by other utilities/industries

Energy utilities use a similar pricing model with demand charges. Demand charges are based on the highest rate of electrical flow (or current) during a billing period. The demand charge will be a large part of the bill if the customer uses a lot of power over short period of time, and a smaller part of the bill if the customer uses power at a more or less constant rate throughout the month.

Most water meters are not capable of capturing the highest rate of flow over a billing period. However, with relative ease, water utilities could adopt an inspired model by basing a year’s base charge on the previous three year’s rolling average.

Impact of Peak-Set Base on Utility

and Residential Customers

Potential Benefits

• Increased revenue stability: There would be a

larger percentage of revenue coming from base

charge.

• Promotes steady customer water use: A high

peaking ratio would be costly to a customer all

year long.

• Customers can expect more steady bills: This

might also mean reduced customer cutoffs.

• Would not require metering upgrades

Potential Challenges

• Requires methodology for determining base charges for new customers

• Potentially requires billing software upgrade

• BJWSA may expect more meter re-reads and high bill disputes because of the long-term impact of a high meter read.

• A customer that is planning moving will not have a large incentive to conserve.

Dividend Model

At the end of the fiscal year, BJWSA would return “profit”

to customers in the form of a dividend; the dividend

would be based on the water “stewardship” of that

customer. A dividend model could be combined with

existing or any other pricing model. BJWSA could define

water “stewardship” in any number of ways: budget-

based, customer-select, or relative to customer use

(average water use or peaking factor).

Example Structure

The following example shows a method for calculating dividends based on a customer’s recent water use compared to the rolling average of the past three years. After a third party audit, it is deemed that BJSWA earned $500 profit. In the following sample, there are six customers that reduced their average water use this year compared to the past three years. Their portion of the profits are calculated based on each “steward’s” share of the reduction. The following table shows how BJWSA might provide water stewardship dividends to their customers.

Example Structure 3-year

rolling

average (2008-2010)

2011

average water use

Reduction

(1 – 2011

average water

use/3-year

rolling average)

Portion of

Reduction

(Customer

reduction x total reduction)

Portion of

Profit (% of

total reduction x utility profit)

Household A

3,000 2,500 17% reduction 14% of total reduction

$70

Household B

8,000 4,000 50% reduction 41% of total reduction

$205

Household C

5,500 5,350 3% reduction 2% $10

Household D

4,000 4,200 No reduction 0% $0

Business A 2,500 2,450 2% reduction 2% $10

Business B 10,000 8,000 20% reduction 16% $80

Business C 500,000 350,000 30% reduction 25% $125

122% 100% $500

Potential Benefits

• This model drives the message that BJWSA is not a for-profit entity: “Profits” are returned to customers.

• Provides a positive way for BJWSA to interact with customers: Palmetto Electric issues checks on December 1.

• Ensures that utility first-and-foremost meets financial goals

• Depending on how this model was set up, it most likely would not require metering or billing upgrades.

Potential Challenges

• Added administrative costs of calculating

and cutting checks

• Disincentive to conserve during first years

as a customer establishes a baseline

• The more people that act as water

stewards, the less money there is to go

around more customers. This could be

discouraging.

NC Rate Setting Resources

• Guide to Billing…, Kara Millonzi Rates Book

• EFC Web Resources (data, guidelines, dashboard)

• LGC Data

• Painful Art of Rate Setting

• Rates Course 2/23/2010

• Rate Setting Guide

• AWWA M1 Guide

• Rural Water Association

• Consultants

• NCLM/EFC Practices Survey (Coming soon!!)

www.efc.unc.edu

Environmental Finance Center

University of North Carolina

CB #3330, Knapp-Sanders Building

Chapel Hill, NC 27599-3330

USA

Jeff Hughes

jhughes@sog.unc.edu

919-843-4956