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HomeMy WebLinkAbout2023-03-07; Council Policy No. 96 - Utilities Reserve PolicyPolicy No. 96 City Council Date Issued March 7, 2023 POLICY STATEMENT Resolution No. 2023-074 Subject: Utilities Reserve Policy Purpose The Utilities Reserve Policy is designed to establish guidelines to ensure the fiscal stability of the potable water, recycled water and wastewater funds and provide guidance to staff in the management of each utility's finances.1 Background Properly designed utility reserve policies send a positive signal to ratepayers, investors and regulatory and credit rating agencies that the city and the Carlsbad Municipal Water District, or CMWD, are committed to maintaining long-lasting fiscal strength. Strong and transparent financial policies, including maintaining prudent reserves for emergencies, rate stability, working capital and capital improvement program, or CIP, projects, are consistent with best practices in the utility industry and are important to the city and the CMWD as it helps to: • Maintain the short-term and long-term financial health of each system's utility • Maintain stable rates for customers and help ensure manageable rate increases • Fund unanticipated cost contingencies • Ensure funds exist for system improvements • Ensure cash exists for the timely payment of bills • Act as a significant positive credit factor in bond and other credit ratings Reserve policies typically consist of multiple components set based on operational, capital and financial metrics. The sum of the component reserves should meet the overall reserve goal, typically between 180 and 365 days of operating costs. The appropriate target for days of cash on hand is unique to any utility and should reflect its specific finances, physical system and risks. Based on the Standard and Poor's 2021 Sector Summary for Municipal Water and Wastewater Utilities, agencies with ratings of BBB+ and above held average cash on hand at a minimum of approximately 200 days. Statement of policy SECTION 1: MINIMUM AND TARGET RESERVES Each utility should have sufficient unrestricted, undesignated reserves to maintain or improve its credit ratings, ensure that operating and maintenance costs will be paid in a timely manner, pay debt service obligations, and invest in needed capital improvements and equipment 1 The policy, as it applies to potable water and recycled water funds, was approved by the Board of Directors of Carlsbad Municipal Water District of the City of Carlsbad on [date] by Resolution No. [number]. Utilities Reserve Policy March 7, 2023 Page 2 replacement on a timely basis. In addition, each system utility should maintain sufficient reserves to minimize rate increases due to market volatility, weather impacts on demands, emergencies (such as natural disasters), and regulatory changes. The table below summarizes the desired reserve levels for each category Table 1 Minimum and Target Reserves PROPOSED MINIMUM AND TARGET RESERVES Reserve metric Operating (working capital) Days of operating costs Debt service Percent of annual debt service Potable water and recycled water Minimum 90 100% Target 120 100% Wastewater Minimum 90 100% Target 120 100% Capital construction 5-year average Percent of 5-year rolling average of annual spending on capital improvement projects 50% 100% 25% 50% SECTION 2: OPERATING (WORKING CAPITAL). Emergency capital Percent of system replacement value 0.5% 1% 0.5% 1% Rate stabilization fund Percent of rate revenues 10% 20% 5% 10% The operating or working capital reserve component provides a source of funds to manage normal monthly changes in revenues or expenses. It ensures sufficient resources to pay budgeted operating and maintenance expenses, including power supply costs, recognizing the timing differences between payment of expenditures and receipt of revenues. Minimum and target levels for the operating reserve component are set based on operating costs, specifically a number of days' worth of operating and maintenance expenses as described below. Minimum Level Potable Water and Recycled Water: Equal to 90 days of operating and maintenance expenses based on the most recent adopted budget. Wastewater: Equal to 90 days of operating and maintenance expenses based on the most recent adopted budget. Target Level Potable Water and Recycled Water: Equal to 120 days of operating and maintenance expenses based on the most recent adopted budget. Wastewater: Equal to 120 days of operating and maintenance expenses based on the most recent adopted budget. Utilities Reserve Policy March 7, 2023 Page 3 Events or Conditions Prompting Use of the Operating Component The operating reserve component may be routinely used to cover temporary cash flow deficiencies caused by timing differences between receipt of revenues and incurring expense obligations and unexpected increases in operating expenses or decreases in revenues. SECTION 3: DEBT SERVICE The debt service reserve component ensures ability to make debt service payments in an extreme event that may impact the ability to provide services, thus impacting revenues at a time critical infrastructure repairs are needed to restore systems. The debt service reserve is intended to prevent an event in which the city and/or the CMWD would be unable to pay its debt service obligations during such emergencies, or extreme market disruptions. The minimum and target levels for the debt service reserve are set based on a percentage of the amount of debt service to be paid in a given fiscal year. Due to the strong negative implications of missed debt service payments, both the minimum and target levels are equal to 100% of the maximum annual debt service in the current fiscal year. Minimum Level Potable Water and Recycled Water: 100% of the maximum annual debt service payment in the current fiscal year. Wastewater: 100% of the maximum annual debt service payment in the current fiscal year. Target Level Potable Water and Recycled Water: 100% of the maximum annual debt service payment in the current fiscal year. Wastewater: 100% of the maximum annual debt service payment in the current fiscal year. Events or Conditions Prompting Use of the Debt Service Component The debt service reserve may be utilized in the event that one of the utilities is otherwise unable to pay its debt service obligations. It is not anticipated that the city and/or the CMWD would ever utilize these reserves absent a significant disaster or extreme market disruption. SECTION 4: CAPITAL CONSTRUCTION The capital construction reserve component provides funds to ensure continuity of construction over fiscal years as well as a source of funds to complete in-progress projects in the event that their intended funding source becomes unavailable during the course of construction. The capital construction reserve is set as a percentage of the forward-looking five- year rolling average Utilities Department and CMWD CIP budget. The capital construction minimum and target levels for wastewater are inclusive of the city's Encina Wastewater Authority (EWA) costs as EWA does not plan to hold reserves internally. EWA provides wastewater treatment for the City of Carlsbad and operates the Carlsbad Water Recycling Facility. Due to the proportionally higher CIP costs for the wastewater fund (as compared to the potable water and recycled water funds), a lower percentage minimum and target values are used for wastewater. This helps to keep the overall reserve target in alignment with the Policy goals as well as to avoid undue pressure on wastewater rates. Utilities Reserve Policy March 7, 2023 Page 4 Minimum Level Potable Water and Recycled Water: 50% of the projected five-year rolling average annual CMWD CIP expenditures for the potable water utility or recycled water utility. Wastewater: 25% of the projected five-year rolling average annual Utilities Department CIP expenditures for the wastewater utility. Target Level Potable Water and Recycled Water: 100% of the projected five-year rolling average annual CMWD CIP expenditures for the potable water utility or recycled water utility. Wastewater: 50% of the projected five-year rolling average annual Utilities Department CIP expenditures for the wastewater utility. Events or Conditions Prompting Use of the Capital Construction Component The capital construction reserve component may be used to fund capital expenditures during the year as funding resources are acquired (e.g., bond proceeds, capital contributions, revenues, etc.) or to fund projects in the event that their intended funding source is no longer available. SECTION 5: EMERGENCY CAPITAL The emergency capital reserve component provides funds to ensure ability to repair the system after an emergency or natural disaster such as a flood or an earthquake. It is set based on a percentage of the estimated replacement value of each utility's system. The replacement values used for this analysis are determined by adjusting the original cost of each utility's assets (from the city and the CMWD's fixed asset records) to current fiscal year dollars using the regional Engineering News-Record Construction Cost Index. While an annual evaluation of the system replacement value is not necessary for setting the minimum and target reserve levels, the replacement value should be adjusted annually (between evaluations) to account for cost inflation. Minimum Level Potable Water and Recycled Water: Equivalent to 0.5% of the replacement value of depreciable capital assets for the potable and recycled water systems. Based on the 2019 Asset Management Plan, the replacement value of the potable water system is currently estimated at $1.5 billion, yielding a minimum reserve balance of $7.5 million, and the replacement value of the recycled water system is currently estimated at $346 million, yielding a minimum reserve balance of $1.7 million. Wastewater: Equivalent to 0.5% of the replacement value of depreciable capital assets for the wastewater system. Based on the 2019 Asset Management Plan, the replacement value of the wastewater system is currently estimated at $780 million, yielding a minimum reserve balance of $3.9 million. Utilities Reserve Policy March 7, 2023 Page 5 Target Level Potable Water and Recycled Water: Equivalent to 1% of the replacement value of depreciable capital assets for the potable and recycled water systems. Based on the 2019 Asset Management Plan, the replacement value of the potable water system is currently estimated at $1.5 billion, yielding a minimum reserve balance of $15.0 million, and the replacement value of the recycled water system is currently estimated at $346 million, yielding a target reserve balance of $3.5 million. Wastewater: Equivalent to 1% of the replacement value of depreciable capital assets for the wastewater system. Based on the 2019 Asset Management Plan, the replacement value of the wastewater system is currently estimated at $780 million, yielding a target reserve balance of $7.8 million. Events or Conditions Prompting Use of the Emergency Capital Component The emergency capital reserve component may be used in an emergency event requiring the need to fund necessary capital expenditures (e.g., natural disaster causing significant damage to the distribution or collections system). SECTION 6: RATE STABILIZATION The rate stabilization reserve component provides a source of funds to smooth rates or avoid rate increases in the event of short-or mid-term disruptions to revenues such as drought- related demand reductions. The minimum and target levels are set based on a percentage of expected user rate revenues. The selected percentages reflect the revenue risk associated with potential decreases in water demands. The potential demand decreases assumed for each reserve level are informed by an analysis of customer usage data and the CMWD drought response plan. Minimum Level The percentage assumptions for the minimum levels are set to provide sufficient reserve funds to cover a demand reduction of approximately 15%, which is the average of the conservation targets for dro.ught response levels 1 and 2 as described in the Drought Response Plan. Because a greater share of wastewater revenue is generated through fixed charges, they are less sensitive to changes in demands; therefore, the percentage for wastewater is lower than for potable water and recycled water. Utilities Reserve Policy March 7, 2023 Page 6 Potable Water and Recycled Water: Equal to 10% of budgeted rate revenues in each fiscal year. Wastewater: Equal to 5% of budgeted rate revenues in each fiscal year. Target Level The percentage assumptions for the minimum levels are set to provide sufficient reserve funds to cover a demand reduction of approximately 30%, which is the average of the conservation targets for drought response levels 2 and 3 as described in the Drought Response Plan. That reduction would reflect usage roughly equivalent to the average usage in the three lowest demand months of the year. Because a greater share of wastewater revenues is generated through fixed charges, they are less sensitive to changes in demands; therefore, the percentage for wastewater is lower than for potable water and recycled water. Potable Water and Recycled Water: Equal to 20% of budgeted rate revenues in each fiscal year. Wastewater: Equal to 10% of budgeted rate revenues in each fiscal year. Events or Conditions Prompting Use of the Reserve The rate stabilization reserve component may be used to cover unexpected changes in operating revenues and changes in operating costs to reduce year-over-year volatility in needed rate increases. Procedure SECTION 1: USE AND REPLENISHMENT OF RESERVES The city or the CMWD's potable water, recycled water and wastewater utilities will treat the minimum reserve levels as practical reserve floors and allow reserves to increase or decrease as necessary within the minimum and target levels prescribed above. To the extent that unrestricted, undesignated reserves are above the minimum level and below the target level, the utility has the flexibility to utilize those available funds to pay for capital projects (reducing the need for future debt), pay down unfunded liabilities such as pension obligations, decrease outstanding debt or fund other strategic objectives. No other action would be required if reserves are between the minimum and target levels unless directed by the City Council or the CMWD Board. If reserve funds exceed the target level, the utility would seek the City Council or the CMWD Board's approval to use the excess to finance capital improvements on a pay-as- you-go basis, pay down existing debt, offset other long-term liabilities such as pension obligations, reduce rates or for other strategic purposes. Reserve levels below the minimum targeted reserves would leave the city and/or the CMWD exposed to significant operational risks. Should a utility draw down reserves below the minimum levels, it w ill implement plans to return reserves to their minimum levels within a set timeframe. Such plans will be provided to the City Council and/or the CMWD Board for approval within 12 months of occurrence. Utilities Reserve Policy March 7, 2023 Page 7 SECTION 2: REPORTING AND OVERSIGHT Reserve levels will be monitored during the fiscal year and reported in annual financial reports and/or presentations. Reserve minimum and target levels will be analyzed annually, and an over/under reserve determination shall be made in conjunction with year-end financial results. These results will be reported to the City Council and the CMWD Board as part of the year-end financial report presentation. Should unrestricted designated or undesignated reserve levels need adjustment due to new risk factors or due to changes in the industry, these will be brought to the City Council and the CMWD Board as part of the year-e nd report. The Policy will be reviewed annually and updated {at a minimum once every three years) if there are material changes in the risk exposures or new conditions that require changes in reserve levels.