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Capital Improvement Project Funding and Debt Management

Frequently Asked Questions

Post Date:04/12/2011

Responses provided by Mark Price, EID Finance Director

Q.1. In recent months, I have heard about a new EID business financial model that has been developed and is now in use. Can you tell me about it and what it includes?

A.1. The District is required to annually have revenues exceed its operating expenses and debt service requirements for that year by 125 percent. The revenue consists of rate and hydroelectric revenue, property tax, and other non-operating revenue as well as facility capacity charges (FCC’s, also known as hook-up fees). The new financial model now requires the District’s revenue, excluding FCC revenue, exceed or be equal to its operating expenses and debt service. Internally this is called the 1.0 test. Rate revenue should pay for operating expenses and debt service expenses. In the past the District relied too heavily on FCC’s to help fund debt service. This past reliance caught up with the District when the real estate market stalled and the FCC revenue almost became nonexistent. At that point in time it was necessary to raise rates and greatly reduce operating costs in order to meet the existing District’s debt service obligations and bondholder covenants. Now, as part of the new plan and in contrast to our past practice, as FCC’s are collected, a small percentage will go to make annual debt payments, and the rest will go to fund capital improvements (otherwise known as “pay-as-you-go” funding) or to pay off debt early. Finally, the new model consists of a 10-year financial forecast with the first year being the currently adopted budget which is tracked on a quarterly basis and is compared to prior years over the same period of time. Results are then communicated to the management team with action plans developed, if needed, to address any issues.

Q.2. What is an operating fund and operating expenses?

A.2. An operating fund is the primary fund of the District’s water and wastewater systems. Most of the District’s revenues, including water and wastewater rate revenue, flow into the operating fund and all operating and maintenance costs, including new equipment purchases, and most debt service payments are funded from there. Funds are also transferred from the operating fund to the capital fund to help support a pay-as-you-go capital improvement project plan. Operating expenses are those expenses that are funded primary from service charge revenue that ratepayer’s pay. The expenses include but aren’t limited to wages, supplies, chemicals, contracted services and repairs and insurance.

Q.3. What is a capital fund and what are examples of capital improvement projects paid for out of the capital fund?

A.3. A capital fund is used to pay for capital improvement projects. Revenues and other funds for the capital fund include participation fees paid by new development, facility capacity charges, transfers from the operating fund, debt proceeds, and interest earnings on money in the capital fund. Capital improvement projects are major projects which are larger in scale that increase the District’s ability to provide safe and reliable drinking water and wastewater services. Because of their higher cost, they require specific funding. Examples of capital projects are those related to making improvements to our drinking water and wastewater treatment plants, replacement of aging sewer lines and lift stations, increasing seasonal water storage capacity, and replacement of our water canal flumes, which are part of the District’s 22.3-mile High-Sierra water delivery system. There are also projects that are required by state and federal regulation, such as the reservoir line and cover programs and disinfection methods.

Q.4. How does the District pay for capital improvement projects?

A.4. Capital projects are paid for by different means. One way is through issuing bonds, or “bond financing.” The District issues various types of bonds, including fixed rate certificates of participation payable over a period of time. Another type of bond financing which the District uses is called variable rate demand obligations (VRDOs). This debt carries a variable rate of interest and accounts for about 30 perecent of the outstanding long-term debt of the District. For the last year or so the rate of interest on this debt has been less than one-half of one percent on an annual basis. When bond financing is done, it is important to maintain a healthy debt service ratio in order to meet the District’s obligations to its bondholders. Another way of funding capital projects is by what is called the pay-as-you-go method, meaning the District pays for smaller capital projects through rates. The District can fund these projects through careful planning and by holding the line on the operating expenses which is a major component of the new business model that it is now working under.

Q.5. What does “debt service ratio” mean?

A.5. The debt service ratio is a requirement within the bond documents for the District to meet as a covenant to its bondholders. The District’s bond covenants require the ratio to be at, or exceed, a specific level which for the District is 125 percent. This requirement gives the bondholder the assurance the District will have sufficient resources to pay its annual debt payments. If this ratio is not met, the District’s Board of Directors have agreed, as part of the bond covenants, to adjust rates, expenses, or a combination of both to meet the obligation in the subsequent year. If this were not done the District would incur higher borrowing costs for future debt needs, higher costs and fees on the existing variable rate demand obligations, and a lowering of its credit ratings.

Q. 6. What is the District’s debt management strategy?

A.6. The District manages its debt to ensure high-quality credit, access to credit markets, financial flexibility, and the lowest overall long-term cost of debt—all in compliance with the District’s debtmanagement policy. EID’s general philosophy on debt is to use pay-as-you-go funds for minor construction projects and debt issuances for major, long-term construction projects. This enables future users to share in the costs without overburdening existing ratepayers. Also, the useful life of the asset exceeds the term of the debt issuance.

Q.7. How do ratepayers know that the District is making sure they are compliant with its
debt management policy?

A.7. The Board receives regular updates on the District’s financial condition, results of operations and future looking financial forecast updates. Also, as part of the District’s newly negotiated letter of credit which is used to back its VRDOs, the bank requires the District to provide updated information regarding the financial projections for the current year on a quarterly basis. If there exists a possibility the District will not meet the 125 percent debt ratio test then the District is required to report to the bank what actions it will take to correct the situation. This requirement is very similar to the requirements of the underlying VRDOs and for the District’s fixed rate certificates of participation. The savings from the VRDO debt has been calculated to be approximately $15 million through the end of 2010.
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