Financial Analysis INTRODUCTION FINDINGS AND TRENDS PAST FINANCIAL PERFORMANCE. Comparative Financial Statement

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1 9 INTRODUCTION This chapter has been prepared by FCS Group to provide a financial program that enables the City of Sultan (City) to remain financially viable through the next 6-year planning period and beyond, and to provide stable revenue for execution of the Capital Improvement Plan identified in this General Sewer Plan (GSP). This financial viability analysis considers the historical financial condition of the City, the sufficiency of City revenues to meet current and future financial and policy obligations, the need to provide sufficient revenue to meet operation and maintenance needs and the City s ability to support the financial impact related to the completion of the identified projects in the Capital Improvement Plan. Appendix T presents additional documentation related to this financial chapter. FINDINGS AND TRENDS The results of this analysis indicate that rate increases are necessary to fund ongoing operating needs and future debt requirements to fund the Capital Improvement Plan. Implementation of the proposed rate increases should provide continued financial viability while generally maintaining affordable rates. It is important to note that the analysis performed in this chapter assumes growth rates from Chapter 3 of this GSP, which are projected to be more aggressive than the trends that the City is currently experiencing. These growth rates, however, are consistent with the projections prepared by EcoNorthwest, the City s consultant, and presented in the City s 2008 Comprehensive Plan. In addition, the analysis assumes that the new general facilities charges will be adopted and become effective starting in If the reduced growth trends continue, or the proposed general facilities charges are not adopted, the proposed annual rate increases will need to be updated and revised. It is recommended that the City regularly review and update the key underlying assumptions that compose the multi-year financial plan to ensure that adequate revenues are collected to meet the total sewer utility financial obligations. For short term planning purposes, the City also requested an alternative financial scenario which considers growth rates that are more consistent with the current trends the City is experiencing. Appendix U includes the results of this alternative growth scenario. PAST FINANCIAL PERFORMANCE This section includes a historical summary of financial performance as reported by the City on the fund resources and uses arising from cash transactions specific to the sewer utility. Comparative Financial Statement The City s enterprise funds operate on a cash basis; therefore, annual balance sheets and income statements are not prepared. Table 9-1 and 9-2 summarize the available level of financial detail for the previous 6 years (2005 through 2010) for the Operating Fund (401), CR Reserve Fund (404), CITY OF SULTAN GENERAL SEWER PLAN 9-1 J:\Data\SUL\ \PLAN\SUL_GSP Chapter9.doc (4/11/2011 1:54 PM)

2 C H A P T E R 9 Improvement Fund (407) and the Sewer Debt Fund (413). Noteworthy findings and trends are highlighted to demonstrate the historical performance and condition of the utility. Table 9-1 Summary of Historical Fund Resources and Uses Arising from Cash Transactions Fund 401 Sewer Fund Beginning Net Cash and Investment $171,993 $123,659 $113,513 $38,006 $25,348 $117,012 Revenues and Other Sources Inspection Fees $2,775 $8,025 $27,471 $4,952 $3,000 - FEMA Disaster Funds $31, Engineering Review Services - - $ Sewer Service $727,242 $815,896 $891,694 $1,023,843 $1,033,676 $1,125,539 Miscellaneous $78 $2,115 $9,450 $16,957 $13,990 $10,873 Interfund Transfers Received $1, Total Revenue and Other Sources $731,242 $826,037 $929,116 $1,077,328 $1,050,666 $1,136,413 Total Resources $903,235 $949,696 $1,042,629 $1,115,334 $1,076,014 $1,253,425 Expenditures Salaries/Wages $258,938 $247,864 $281,605 $279,830 $263,114 $271,396 Benefits $78,410 $74,306 $90,088 $94,685 $81,884 $84,194 Supplies $47,262 $34,603 $46,866 $42,239 $30,983 $32,149 Other Services $181,042 $262,303 $257,335 $360,841 $253,690 $278,117 Intergovernmental $13,157 $65,043 $84,874 $72,729 $58,579 $104,101 Capital Outlay $19,771 $9,850 $26,379 $26,863 $5,971 $33,449 Interfund Transfers $180,995 $142,213 $217,476 $212,800 $264,781 $282,538 Total Expenditures $779,575 $836,182 $1,004,623 $1,089,987 $959,002 $1,085,944 Ending Net Cash and Investments $123,660 $113,513 $38,006 $25,347 $117,012 $167,481 Notes: Includes minor rounding. Findings and Trends The following identifies findings and trends for Fund 401 for the 2005 through 2010 historical period. Through a combination of rate increases and customer growth, rate revenues have been increasing every year. Total expenses have increased every year, with the exception of There was a reduction in expenditures from 2008 to 2009 (excluding interfund transfers). Fund balances were used to meet ongoing expenses in 2006, 2007 and 2008, and were slowly regenerated in 2009 and The operations and maintenance (O&M) coverage ratio is the service revenue divided by operating expenses. The O&M coverage ratio remained above 100 percent in every year, starting at 126 percent in 2005, dropping to 117 percent in 2007 and rebuilding back up to 146 percent in A ratio below 100 percent leaves little capacity for capital. The operating ratio is the total operating expenses divided by the total operating revenues. The operating ratio remained below 90 percent every year, starting at 82 percent in 2005, increasing to 85 percent in 2007 and dropping to 71 percent in A ratio greater than 90 percent indicates there is little room for new debt service and capital replacement without additional revenues and is indicative of an unsustainable financial condition. J:\Data\SUL\ \PLAN\SUL_GSP Chapter9.doc(4/11/2011 1:54 PM) 9-2 CITY OF SULTAN GENERAL SEWER PLAN

3 Table 9-2 Summary of Historical Fund Resources and Uses Arising from Cash Transactions Fund 404, 407 and 4013 Sewer Funds Beginning Balance Fund 404/405 - CR Reserve $805,345 $1,268,406 $974,576 $888,399 $684,621 Total Revenues $526,561 $137,870 $83,822 $411,185 $93,475 Total Expenditures $63,500 $431,700 $170,000 $614,962 $384,897 Ending Balance Fund 404/405 $1,268,406 $974,576 $888,398 $684,621 $393,199 Beginning Balance Fund Sewer Improvement Fund $204,573 $792 $42,743 $55,742 $364,474 Total Revenues $34,859 $541,308 $764,693 $1,128,342 $1,030 Total Expenditures $238,639 $499,357 $751,694 $819,610 $49,321 Ending Balance Fund 407 $792 $42,743 $55,742 $364,474 $316,183 Beginning Balance Fund Sewer Debt Fund $353 $459 $48,980 $39,094 $12,134 General Facilities Charge Revenue $63,866 $88,733 $47,384 $138,390 $57,160 Other Revenue $188,483 $209,981 $213,155 $350,981 $454,235 Total Revenue $252,349 $298,714 $260,539 $489,372 $511,395 Total Expenditures $252,243 $250,193 $270,425 $516,332 $470,598 Ending Balance Fund 413 $459 $48,980 $39,094 $12,134 $52,931 Annual General Facilities Charge Revenue Collected $101,384 $148,332 $51,897 $138,390 $57, Detailed data was not available for Prior to 2009, the Sewer CR Fund was combined with the Water CR Fund 405 Findings and Trends The following identifies findings and trends for Funds 404, 407 and 413 for the 2006 through 2010 historical period. Detailed revenue and expenditure data was not available for The sewer CR Fund 404 was separated from the water CR Fund 405 starting in Prior to 2009, all sewer revenues were combined with the water revenue. Combined CR Fund 404/405 ending fund balances have been decreasing every year; ending 2006 with $1,300,000 million reducing to $400,000 in This indicates that the City has been using reserves to fund capital. If this trend continues, the reserves will be depleted and the City will not be able to fund any capital unless it is funded through new debt. Since 2009, the City has been using 100 percent of the annual general facilities charge revenue to pay for annual debt service. Prior to 2009, the City split the general facilities charge revenue between the Sewer Debt Fund, CR Fund and the Improvement Fund. Relying on general facilities charge revenue to pay for annual debt service can create volatility from year to year due to the nature of the revenue source. If the revenue is not coming in at the expected levels, retail rates will have to be adjusted to subsidize for a sudden reduction of resources. CURRENT FINANCIAL STRUCTURE This section summarizes the current financial structure used as the baseline for the capital financing strategy and financial forecast developed for this GSP. Financial Plan The City s sewer utility is responsible for funding all of its related costs through user fees. It does not depend on general tax revenues or general fund resources. The primary source of funding for the sewer utility is derived from ongoing charges for service, with additional revenues coming from miscellaneous fees, inspection fees and interest income. The City controls the level of user charges CITY OF SULTAN GENERAL SEWER PLAN 9-3 J:\Data\SUL\ \PLAN\SUL_GSP Chapter9.doc (4/11/2011 1:54 PM)

4 C H A P T E R 9 by ordinance, and subject to statutory authority, can adjust user charges as needed to meet financial objectives. The financial plan can only provide a qualified assurance of financial feasibility if it considers the total system costs of providing sewer services, both operating and capital. To meet these objectives, the following elements have been completed. 1. Capital Funding Plan: Identifies the total Capital Improvement Plan obligations of the planning period. The plan defines a strategy for funding the Capital Improvement Plan, including an analysis of available resources from rate revenues, existing reserves, general facility charges, debt financing and any special resources that may be readily available (e.g., grants, developer contributions, etc.). The capital funding plan impacts the financial plan through the use of debt financing (resulting in annual debt service) and the assumed rate revenue resources available for capital funding. 2. Financial Forecast: Identifies future annual non-capital costs associated with the operation, maintenance and administration of the sewer system. Included in the financial plan is a reserve analysis that forecasts cash flow and fund balance activity along with testing for satisfaction of actual or recommended minimum fund balance policies. The financial plan ultimately evaluates the sufficiency of utility revenues in meeting all obligations, including cash uses such as operating expenses, debt service, capital outlays and reserve contributions, as well as any coverage requirements associated with long-term debt and identifies the future adjustments required to fully fund all utility obligations in the projection period. Capital Funding Plan The Capital Improvement Plan developed for this GSP identifies $23.59 million in project costs over the 6-year planning period and $36.60 million in the 20-year planning period (total costs do not include developer donated capital). This Capital Improvement Plan consists of Short-term wastewater treatment plant (WWTP) improvement projects, WWTP upgrades, general replacement and extension projects. Costs are stated in 2010 dollars and are escalated by 3.42 percent annually to the year of planned construction for financing projections. A summary of the 20-year Capital Improvement Plan is shown in Table 9-3. As shown, each year has varied capital cost obligations depending on construction schedules and infrastructure planning needs. Approximately 64.5 percent (2010 dollars) of the capital costs are included in the 6-year planning period. The WWTP Short-term improvements and WWTP Phase I upgrades account for 81.6 percent of the 6-year Capital Improvement Plan. Table 9-4 provides the detail for the 6-year Capital Improvement Plan. J:\Data\SUL\ \PLAN\SUL_GSP Chapter9.doc(4/11/2011 1:54 PM) 9-4 CITY OF SULTAN GENERAL SEWER PLAN

5 Table and 20-Year Capital Improvement Plan Summary Year 2010 $ Inflated 2011 $14,899,100 $15,408, $4,645,400 $4,968, $1,339,000 $1,481, $962,000 $1,100, $905,000 $1,070, $841,000 $1,029,013 6-Year Total $23,591,500 $25,058, $13,012,000 $20,659, Year Total $36,603,500 $45,718,333 Table Year Capital Improvement Plan Detail (2010 Dollars) Project Total Wastewater Treatment Plant Improvements WWTP Short-Term Improvements $4,623,500 $4,623,500 WWTP Phase I Improvements $10,232,600 $4,385,400 $14,618,000 Miscellaneous WWTP Improvements $43,000 $40,000 $107,000 $50,000 $240,000 WWTP Phase II Improvements $75,000 $75,000 Gravity Sewer Main Improvements Collection/Interceptor Sewer System Video Inspection $190,000 $190,000 $190,000 $570,000 Annual Sewer Pipe Evaluation/Repair/Replacement Program $475,000 $475,000 $475,000 $475,000 $1,900,000 Collection/Interceptor Inflow and Infiltration Rehabilitation $190,000 $190,000 $190,000 $190,000 $760,000 WWTP Upgrades Predesign/Design Report $440,000 $440,000 General Sewer Plan Update $101,000 $101,000 Sewer Rate Study $44,000 $44,000 WWTP Facility Plan $220,000 $220,000 Total $14,899,100 $4,645,400 $1,339,000 $962,000 $905,000 $841,000 $23,591,500 Capital Financing Strategy An ideal capital funding strategy would include the use of grants and low-cost loans when debt issuance is required. However, these resources are very limited and competitive in nature and do not provide a reliable source of funding for planning purposes. It is recommended that the City pursue these funding avenues but assume bond financing to meet needs for which the City s available cash resources are insufficient. Revenue bonds have been used as the debt funding instrument in this analysis. The capital financing strategy developed to fund the Capital Improvement Plan identified in this GSP assumes the following funding resources: Sewer system improvement fund (407) only pays for capital projects and typically does not maintain an ongoing balance. Based on the information provided by the City, fund 407 begins 2011 with $315,743. In 2009, the City acquired $400,000 in debt proceeds to help fund its centrifuge capital project. Through the construction period, the City was able to use existing cash balances to pay for the project without the need to draw any proceeds from the loan. The City is planning to repay the remaining loan principal outstanding in Based on this assumption, fund 407 beginning fund balance was reduced by $360,000 ($400,000 draw less 2010 principal payment of $40,000), which leaves the beginning fund balance with CITY OF SULTAN GENERAL SEWER PLAN 9-5 J:\Data\SUL\ \PLAN\SUL_GSP Chapter9.doc (4/11/2011 1:54 PM)

6 C H A P T E R 9 negative $44,257. To ensure that fund 407 has enough proceeds, $44,257 will be transferred from the CR Reserve 404; Any funding for the improvement projects comes from the CR Fund (404). CR Reserve 404 begins 2011 with $59,705 in cash reserves; Transfers are to be made from the operating fund (401) to help fund capital once the operating target is met; An interfund loan repayment will be made in 2011 from the General Fund (001) in the amount of $23,500 which includes interest. The loan will be repaid in full by December 2011; There will be annual general facility charge revenue collections at an annual amount of $56,000 in 2011, increasing to $6,527,851 by 2016, ranging from 5 to 462 connections per year (it is important to note that there is a spike of 462 connections in 2016; average revenue from general facilities charges 2012 through 2015 is approximately $1,638,221, or 116 connections); Starting in 2012, 60 percent of revenue collected from general facilities charges is allocated toward annual debt service (not exceeding the annual debt service payment) with the remainder to be used toward capital improvement projects; the City is currently using 100 percent of general facilities charge revenue to pay for annual debt service; There will be new debt proceeds of $21,000,000 in The expenditures are spread over three years from 2011 through The $21,000,000 is needed to fund Short-term WWTP and phase I WWTP improvements outlined in the 2006 WWTP Upgrades Engineering Report (2006 Engineering Report) from Brown and Caldwell. The 2006 Engineering Report recommended the improvements to serve new development and growth in accordance with the 2025 population allocation of 11,119 people. The cash resources identified above are forecasted to fund 100 percent of the 20-year Capital Improvement Plan. Table 9-5 presents the corresponding 20-year capital financing strategy. Year Capital Expenditures 2010 $ Table Year Capital Funding Strategy Capital Expenditures Escalated General Facility Charges Revenue Bond Financing CR Reserve Cash Funding Total Financial Resources 2011 $14,899,100 $15,408,636 - $15,408,636 - $15,408, $4,645,400 $4,968,570 $235,305 $4,733,265 - $4,968, $1,339,000 $1,481,130 $623,031 $858,098 - $1,481, $962,000 $1,100,504 $1,100, $1,100, $905,000 $1,070,704 $880,380 - $190,324 $1,070, $841,000 $1,029,013 $1,029, $1,029,013 Subtotal $23,591,500 $25,058,558 $3,868,233 $21,000,000 $190,324 $25,058, $13,012,000 $20,659,775 $18,225,842 - $2,433,934 $20,659,775 Total $36,603,500 $45,718,333 $22,094,075 $21,000,000 $2,624,258 $45,718,333 J:\Data\SUL\ \PLAN\SUL_GSP Chapter9.doc(4/11/2011 1:54 PM) 9-6 CITY OF SULTAN GENERAL SEWER PLAN

7 The 20-year capital funding plan identifies 54.1 percent of cash funding for capital projects. The cash funding represents 48.3 percent from general facilities charge revenue and 5.8 percent from CR Reserve balance. It is assumed that revenue bonds will cover the remaining capital costs. AVAILABLE FUNDING ASSISTANCE AND FINANCING RESOURCES Feasible long-term capital funding strategies must be defined to ensure that adequate resources are available to fund the Capital Improvement Plan identified in this GSP. In addition to the utility s resources, such as accumulated cash reserves, capital revenues, and rate revenues designated for capital purposes, capital needs can be met from outside sources such as grants, low-interest loans and bond financing. The following is a summary of the City s sewer utility resources and outside resources. Utility Resources Sewer utility resources appropriate for funding capital needs include accumulated cash in the capital reserve, rate revenues designated for capital spending purposes, and capital-related charges such as general facilities charges and other connection fees. The first two resources will be discussed in the Financial Policies section. Capital-related charges are discussed below. General facilities charges A general facilities charge, also called a connection charge, as provided by the Revised Code of Washington (RCW) , refers to a one-time charge imposed on new customers as a condition of connection to the utility system. The purpose of the connection charge is two-fold: to promote equity between new and existing customers and to provide a source of revenue to fund capital projects. Revenue can only be used to fund utility capital projects or to pay debt service incurred to finance those projects. The City currently charges all new sewer customers a general facilities charge of $11,282 per equivalent residential unit (ERU). Based on the City s approach to calculating the general facilities charges, this financial analysis recommends increasing the charge to $12,895 per ERU in Based on the capital funding identified, the charge is projected to increase to $16,587 by The City s policy is to update this charge annually based on the capital projects completed the previous year. Local Facilities Charges While a general facilities charge is the manner in which new customers pay their share of general facilities costs, local facilities funding is used to pay the costs of local facilities that connect each property to the system s infrastructure. Local facilities funding is often overlooked in rate forecasts because it is funded up-front by either connecting customers, by developers, or through an assessment to properties, but never from rates. Although these funding mechanisms do not provide a capital revenue source toward funding Capital Improvement Plan costs, the discussion of these charges is included in this chapter, because they impact new customers of the system. A number of mechanisms can be considered for funding local facilities. One of the following scenarios typically occurs: (a) The utility charges a connection fee based on the cost of the local facilities (under the same authority as the general facilities charge); (b) a developer funds extension CITY OF SULTAN GENERAL SEWER PLAN 9-7 J:\Data\SUL\ \PLAN\SUL_GSP Chapter9.doc (4/11/2011 1:54 PM)

8 C H A P T E R 9 of the system to its development and turns those facilities over to the utility (contributed capital); or (c) a local assessment is set up called a Utility Local Improvement District, which collects tax revenue from benefited properties. A local facilities charge is a variation of the connection charge authorized through RCW It is a City-imposed charge to recover the cost related to service extension to local properties. Often called a front-footage charge and imposed on the basis of footage of main fronting a particular property, it is usually implemented as a reimbursement mechanism to a city for the cost of a local facility that directly serves a property. It is a form of connection charge and thus can accumulate up to 10 years of interest. It typically applies to instances when no developer-installed facilities are needed through developer extension due to the prior existence of available mains already serving the developing property. The developer extension is a requirement that a developer install on-site and sometimes off-site improvements as a condition of extending service. These are in addition to the connection charge required and must be built to City standards. The City is authorized to enter into developer extension agreements under RCW Part of the agreements between the City and the developer for the developer to extend service might include a latecomer agreement, resulting in a latecomer charge to new connections to the developer extension. Latecomer charges are a variation of developer extensions whereby new customers connecting to a developer-installed improvement make a payment to the City based on their share of the developer s cost (RCW ). The City passes this charge on to the developer who installed the facilities. This is part of the developer extension process, and defines the allocation of costs and records latecomer obligations on the title of affected properties. No interest is allowed, and the reimbursement agreement cannot exceed 20 years in duration. Utility Local Improvement District formation is another mechanism for funding infrastructure that assesses benefited properties based on the special benefit received by the construction of specific facilities (RCW ). Most often used for local facilities, some Utility Local Improvement Districts also recover related general facilities costs. Substantial legal and procedural requirements can make this a relatively expensive process and there are mechanisms by which a Utility Local Improvement District can be rejected. Outside Resources This section outlines various grant, loan and bond opportunities available to the City through federal and state agencies to fund the Capital Improvement Plan identified in the GSP. Grants and Low Cost Loans Historically, federal and state grant programs were available to local utilities for capital funding assistance. However, these assistance programs have been mostly eliminated, substantially reduced in scope and amount or replaced by loan programs. Remaining miscellaneous grant programs are generally lightly funded and heavily subscribed. Nonetheless, even the benefit of low-interest loans makes the effort of applying worthwhile. Grants and low-cost loans for Washington State utilities are available from the Washington State Department of Ecology (Ecology) and the Department of Community, Trade and Economic Development. Each department offers programs for which the J:\Data\SUL\ \PLAN\SUL_GSP Chapter9.doc(4/11/2011 1:54 PM) 9-8 CITY OF SULTAN GENERAL SEWER PLAN

9 City might be eligible. They are primarily targeted at sewer programs or low-income and/or rural communities. Department of Ecology Ecology s Water Quality Program administers funding programs that provide low-interest loans, grants or loans and grant combinations for projects that protect, preserve and enhance water quality in Washington State. Department of Community, Trade and Economic Development The Department of Community, Trade and Economic Development has three grant and loan programs for which the City might be eligible. These programs are: The Community Development Block Grants General Purpose Grant; The Community Economic Revitalization Board (CERB) Grant and Loan Program; and The Public Works Trust Fund (PWTF) Loan Program. While the CERB programs are currently funded and accepting applications, the PWTF is providing no funding in the 2009 to 2011 biennium and may or may not be restored in the near future. Regardless, each of these programs is described in greater detail below. Community Development Block Grants General Purpose Grants These grants are made available to small cities, towns and counties in Washington State carrying out significant community and economic development projects that principally benefit low and moderate income persons. Eligible applicants are Washington State cities and towns with populations less than 50,000 and counties with populations less than 200,000 that are non-entitlement jurisdictions or are not participants in a Housing and Urban Development (HUD) Urban County Entitlement Consortium. Eligible projects include public facilities for water, wastewater, storm sewer and streets. Approximately $13 million is expected to be available in 2011 with a maximum single grant amount of $1.5 million. Based on income, Sultan s eligible area for Community Development Block Grants is limited to a portion of the historic city center between 8th Street and 1st Street, south of High Avenue. Community Economic Revitalization Board Community Economic Revitalization Board (CERB) primarily offers low-cost loans. Grants are made available only to the extent that a loan is not reasonably possible. The CERB targets public facility funding for economically disadvantaged communities, specifically targeting job creation and retention. Priority criteria include the unemployment rates, number of jobs created and/or retained, wage rates, projected private investment and estimated state and local revenues generated by the CITY OF SULTAN GENERAL SEWER PLAN 9-9 J:\Data\SUL\ \PLAN\SUL_GSP Chapter9.doc (4/11/2011 1:54 PM)

10 C H A P T E R 9 project. Traditional construction projects are offered at a maximum dollar limit per project of $1 million. A local match of 25 percent is targeted. Eligible applicants include cities, towns, port districts, special purpose districts, federally recognized Indian tribes, and municipal corporations. Public facilities, bridges, roads, domestic and industrial water, earth stabilization, sanitary sewer, storm sewer, railroad, telecommunications, electricity, transportation, natural gas, buildings or structures and port facilities are all eligible. The CERB s policy is that all loans made by the CERB will be secured by a general obligation pledge of the taxing power of the borrowing entity. Terms do not exceed 20 years, including available payment deferral of interest and principal for up to 5 years. Interest rates match the most current rate of Washington State bonds but will not exceed 10 percent. Public Works Trust Fund Cities, towns, counties and special purpose districts are eligible to receive loans from the Public Works Trust Fund (PWTF) for water, sewer, storm, roads, bridges and solid waste/recycling projects. Funds may be used for repair, replacement, rehabilitation, reconstruction and improvements including reasonable growth (generally the 20-year growth projection in the comprehensive plan). PWTF loans are available at interest rates of 0.5, 1 and 2 percent, with the lower interest rates given to applicants who pay a larger share of the total project costs. The loan applicant must provide a minimum local match of funds of 5 percent toward the project cost to qualify for a 2 percent loan; 10 percent for a 1 percent loan; and 15 percent for a 0.5 percent loan. The useful life of the project determines the loan term up to a maximum of 20 years. In 2006, the city borrowed $1,000,000 to fund 50% of the design of the WWTP Upgrade. Since the loan was used for design, the City was required to repay the loan in five years. Due to a short-fall in general facility charges used to repay the loan, the City received a one-time, two-year extension in 2010 to repay the loan over seven years. Rural Development Loan Program Rural Development funds a grant and loan program for rural communities (less than 10,000 people) for water and wastewater projects. The amount of grant relative to loan is based on the income level of the community and how high rates will be relative to household income. If a grant is offered, the recipient also needs to accept loan funding. The terms for loans are typically on the order of 3.5 to 4.5 percent interest for 40 years. For the most recent year on record, Rural Development obligated $19.3 million in loans and grants. Because Rural Development is a federal program, compliance with the National Environmental Policy Act is required. Rural Development has a standardized format for the National Environmental Policy Act Environmental Report that needs to be prepared to document impacts and proposed mitigation measures for a project. The National Environmental Policy Act Environmental Report that is produced typically satisfies the documentation requirements for other federal agencies. The City is limited in Rural Development Funds because the WWTP is located in the floodplain. The Rural Development Loan Program restricts funding to projects outside the floodplain. J:\Data\SUL\ \PLAN\SUL_GSP Chapter9.doc(4/11/2011 1:54 PM) 9-10 CITY OF SULTAN GENERAL SEWER PLAN

11 Bond Financing General Obligation Bonds General obligation bonds are bonds secured by the full faith and credit of the issuing agency, committing all available tax and revenue resources to debt repayment. With this high level of commitment, general obligation bonds have relatively low interest rates and few financial restrictions. However, the authority to issue general obligation bonds is restricted in terms of the amount and use of the funds, as defined by state constitution and statute. Specifically, the amount of debt that can be issued is linked to assessed valuation. RCW (2)(a)(ii) and (b) states, (a) Counties, cities, and towns are limited to an indebtedness amount not exceeding one and one-half percent of the value of the taxable property in such counties, cities, or towns without the assent of three-fifths of the voters therein voting at an election held for that purpose. (b) In cases requiring such assent counties, cities, towns, and public hospital districts are limited to a total indebtedness of two and one-half percent of the value of the taxable property therein. While bonding capacity can limit availability of general obligation bonds for utility purposes, these can sometimes play a valuable role in project financing. A rate savings may be realized through two avenues: the lower interest rate and related bond costs, and the extension of repayment obligation to all tax-paying properties (not just developed properties) through the authorization of an ad valorem property tax levy. Revenue Bonds Revenue bonds are commonly used to fund utility capital improvements. The debt is secured by the revenues of the issuing utility and the debt obligation does not extend to the City s other revenue sources. With this limited commitment, revenue bonds typically bear higher interest rates than general obligation bonds and also require security conditions related to the maintenance of dedicated reserves (a bond reserve) and financial performance (added bond debt service coverage). The City agrees to satisfy these requirements by ordinance as a condition of bond sale. Revenue bonds can be issued in Washington State without a public vote. There is no bonding limit, except perhaps the practical limit of the utility s ability to generate sufficient revenue to repay the debt and provide coverage. In some cases, poor credit or lack of reserves might make issuing bonds problematic. Build America Bonds (From munibondadvisor.com) The Economic Recovery and Reinvestment Act created a new form of bonds known as Build America Bonds. Build America Bonds are taxable and, through federal subsidies or tax credits, are intended to reduce municipal borrowing costs. The Economy Recovery and Reinvestment Act created two types of Build America Bonds. The first type of Build America Bond provides a federal subsidy to investors equal to 35 percent of the interest payable by the issuer (Tax Credit Build America Bonds). The second type of Build America CITY OF SULTAN GENERAL SEWER PLAN 9-11 J:\Data\SUL\ \PLAN\SUL_GSP Chapter9.doc (4/11/2011 1:54 PM)

12 C H A P T E R 9 Bonds provides a direct federal subsidy that will be paid to state and local governments in an amount equal to 35 percent of the interest (Direct Payment Build America Bonds). Both types of Build America Bonds must be issued before January 1, This funding source has currently expired. It may be available again as legislature is attempting to acquire more funds. Tax Credit Build America Bonds provide a 35 percent interest subsidy (net of the tax credit) to investors that results in a federal subsidy to the issuer equal to approximately 25 percent of the total return to the investor (interest and the tax credit). Tax Credit Build America Bonds may be issued to finance any governmental purpose for which tax-exempt government bonds (excluding private activity bonds) could be issued including current refunding and one advance refunding. The bonds must comply with all requirements applicable to the issuance of tax-exempt governmental bonds. Direct Payment Build America Bonds offer a larger federal subsidy than Tax Credit Build America Bonds; however, they are subject to more restrictions. In general, Direct Payment Build America Bonds may be issued to finance capital expenditures for any governmental purpose for which taxexempt government bonds may be issued, excluding private activity bonds and excluding refunding bonds. Costs of issuance paid from Direct Payment BAB proceeds are limited to 2 percent. In order to receive a federal subsidy, issuers will be required to submit a payment request form no earlier than 90 days, and no later than 45 days, before each interest payment date. Issuers will receive the requested payment within 45 days of the date the form is filed with the Internal Revenue Service. In the future, the payment procedures may be changed to an electronic platform. Financing for a project may be subdivided into two issues: one comprised of traditional tax-exempt municipal bonds and one comprised of Build America Bonds. FINANCIAL FORECAST The financial forecast, or revenue requirement analysis, forecasts the amount of annual revenue necessary from sewer rates. The analysis incorporates operating revenues, O&M expenses, debt service payments, rate-funded capital needs and any other identified revenues or expenses related to operations. The objective of the financial forecast is to evaluate the sufficiency of the current level of rates. The revenue needs of the utility not only include annual operating costs, but debt covenant requirements, specific fiscal policies and financial goals of the City. The analysis determines the amount of revenue needed in a given year to meet that year s expected financial obligations. For this analysis, two revenue sufficiency tests have been developed to reflect the financial goals and constraints of the City: Cash needs must be met and debt coverage requirements must be realized. In order to operate successfully with respect to these goals, both tests of revenue sufficiency must be met. Cash Test The cash flow test identifies all known cash requirements for the City in each year of the planning period. Cash requirements typically include O&M expenses, debt service payments, depreciation funding or directly funded capital outlays and any additions to specified reserve balances. The total annual cash needs of the utility are then compared to projected cash revenues using the current rate structure. Any projected revenue shortfalls are identified and the rate increases necessary to make up the shortfall are established. J:\Data\SUL\ \PLAN\SUL_GSP Chapter9.doc(4/11/2011 1:54 PM) 9-12 CITY OF SULTAN GENERAL SEWER PLAN

13 Coverage Test The coverage test is based on a commitment made by the City when issuing revenue bonds and some other forms of long-term debt. For purposes of this analysis, revenue bond debt is assumed for any needed debt issuance. As a security condition of issuance, the City would be required per covenant to agree that the revenue bond debt would have a higher priority for payment (a senior lien) compared to most other utility expenditures; the only outlays with a higher lien are O&M expenses. Debt service coverage is expressed as a multiplier of the annual revenue bond debt service payment. For example, a 1.0 coverage factor would imply that no additional cushion is required. A 1.25 coverage factor means revenue must be sufficient to pay O&M expenses, annual revenue bond debt service payments, plus an additional 25 percent of annual revenue bond debt service payments. The excess cash flow derived from the added coverage, if any, can be used for any utility purpose, including funding capital projects. Targeting a higher coverage factor can help the City achieve a better credit rating and provide lower interest rates for future debt issues. An ideal coverage target is 2.0 or above. In determining the annual revenue requirement, both the cash and coverage sufficiency test must be met and then the test with the greatest deficiency drives the level of needed rate increase in any given year. Current Financial Structure The City maintains a fund structure and implements financial policies that target management of a financially viable and fiscally responsible enterprise fund utility. Fiscal Policies In developing the financial plan underlying the recommended rate structures, the City has assumed the attainment of certain recommended fiscal policies. The purpose of establishing fiscal policies for the City s sewer utility is to promote the financial integrity and stability of the utility and help ensure the sustainability of essential utility services. A brief summary of the key financial policies employed by the City, as well as those recommended and incorporated in the financial program are discussed below. Minimum Fund Balances Operating reserves are designed to provide a liquidity cushion to ensure that adequate cash working capital will be maintained to deal with significant cash balance fluctuations, such as seasonal fluctuations in billings and receipts, unanticipated cash expenses, or lower than expected revenue collections. The City s current policy is to maintain a minimum balance in the Operating Fund equal to 45 days of O&M, ranging from $96,000 in 2011 and increasing to $192,000 by 2016 as shown in Table 9-7. The City does not have a formal policy for cash reserves in the Improvement Fund or the CR Reserve; discussions with City staff and industry standards established an internal target of 2 percent of existing plant in service, approximately $689,000 in 2011 to $883,000 in 2016 based on annual plant in service additions. A capital contingency reserve is an amount of cash set aside in case of an emergency should a piece of equipment or a portion of the utility s infrastructure fail unexpectedly. The reserve also could be used for other unanticipated capital needs including capital project cost overruns. There are various industry practices in use such as maintaining a balance equal to 1 to 2 CITY OF SULTAN GENERAL SEWER PLAN 9-13 J:\Data\SUL\ \PLAN\SUL_GSP Chapter9.doc (4/11/2011 1:54 PM)

14 C H A P T E R 9 percent of fixed assets, an amount equal to a 5-year rolling average of Capital Improvement Plan costs or an amount sufficient to fund an equipment failure (other than catastrophic failure). The final target level should balance industry standards with the risk and comfort level of the City. System Reinvestment The purpose of system reinvestment funding is to provide for the replacement of aging system facilities to ensure sustainability of the system for ongoing operation. Each year, the utility s assets lose value, and as they lose value they are moving toward eventual replacement. That accumulating loss in value and future liability is measured for reporting purposes through annual depreciation expense, which is based on the original cost of the asset. While this reported expense reflects the consumption of the existing asset and its original investment, the replacement of that asset will likely cost much more, factoring in inflation and construction conditions. Therefore, the added annual replacement liability is even greater than the annual depreciation expenses. Depreciation expense is used many times as a surrogate for minimum system reinvestment funding. Because the City s sewer utility operates on a cash basis, the City does not track depreciation. An estimate can be calculated if asset data is available by applying straight line depreciation to the useful lives of the assets in the utility. Based on the available asset data, the sewer utility s annual depreciation expense was estimated at $1,780,000. The City historically has not funded annual system reinvestment. Due to the significant capital projects identified in the 20-year plan and the additional rate increases which would be required to fund annual depreciation, the analysis assumes no annual system reinvestment funding. This is a funding component that should be considered in future updates. Debt Management It is prudent to consider policies related to debt management as part of broader utility financial policy structure. Debt management policies should be evaluated and formalized, including level of acceptable outstanding debt, debt repayment, bond coverage and total debt coverage targets. The City s existing bond covenants require a 1.25 debt coverage test. Table 9-6 presents the City s existing debt service. J:\Data\SUL\ \PLAN\SUL_GSP Chapter9.doc(4/11/2011 1:54 PM) 9-14 CITY OF SULTAN GENERAL SEWER PLAN

15 Table 9-6 Existing Debt Service Existing Debt Service Water & Sewer Bond Annual Interest Payment $19,786 $15,488 $12,437 $9,131 $5,658 $1,938 - Annual Principal Payment $45,000 $47,500 $52,500 $55,000 $57,500 $62,500 - Total Annual Payment $64,786 $62,988 $64,937 $64,131 $63,158 $64,438 - PWTF PW Annual Interest Payment $6,461 $5,384 $4,307 $3,230 $2,154 $1,077 - Annual Principal Payment $107,676 $107,676 $107,676 $107,676 $107,676 $107,676 - Total Annual Payment $114,136 $113,060 $111,983 $110,906 $109,829 $108,752 - PW Annual Interest Payment $4,890 $4,541 $4,192 $3,842 $3,493 $3,144 $12,575 Annual Principal Payment $69,859 $69,859 $69,859 $69,859 $69,859 $69,859 $558,875 Total Annual Payment $74,750 $74,400 $74,051 $73,702 $73,352 $73,003 $571,450 PW PRE-131 Annual Interest Payment $2,083 $1, Annual Principal Payment $208,333 $208, Total Annual Payment $210,417 $209, LTGO Sewer Revenue Bonds 1 Annual Interest Payment $18, Annual Principal Payment $40, Total Annual Payment $58, (1) Assumed to be repaid in full in 2011 with cash balances LTGO = Limited tax general obligation Financial Forecast The financial forecast is developed from 2011 budget documents along with other key factors and assumptions to develop a complete picture of the sewer utility annual financial obligations. The following is a list of the key revenue and expense factors and assumptions used to develop the financial forecast. Revenue The City has two general revenue sources: revenue from charges for service (rate revenue) and miscellaneous (non-rate) revenue. In the event of a forecasted annual shortfall, rate revenue can be increased to meet the annual revenue requirement. Non-rate revenues are forecast to increase with inflation or growth depending on the nature of the revenue. General facilities charge Revenue The general facilities charge was updated as part of the new capital provided in this GSP, and is applied to the projected new ERUs starting in Based on the projected growth outlined in Chapter 3 of this GSP, the general facilities charge will generate between $56,000 in 2011 and $6,527,851 in 2016 (it is important to note that there is a spike of 462 connections in 2016). Average annual general facilities charge revenue from 2012 to 2015 is approximately $1,638,221, or 116 connections per year. The City currently applies all general facilities charge revenue toward annual debt service. The total general facilities charge revenue applied to annual debt service will be reduced to 60 percent starting in The remaining general facilities charge revenue will be allocated toward annual capital. Growth Rate revenue were escalated based on the growth rate in Chapters 3 and 4 of this GSP, which on average is approximately 5.49 percent per year. The growth rate projected CITY OF SULTAN GENERAL SEWER PLAN 9-15 J:\Data\SUL\ \PLAN\SUL_GSP Chapter9.doc (4/11/2011 1:54 PM)

16 C H A P T E R 9 seems to be higher than the recent trends experienced by the City; therefore, actual growth should be closely monitored. Expenses O&M expense projections are based on the 2011 budget. Future years are escalated based on various factors and are forecast based on a general cost inflation of 2.6 percent, labor cost inflation of 3.0 percent and benefits inflation of 10.0 percent. Excise tax projections use the 2011 budget and future taxes are calculated based on forecast revenues and prevailing tax rates. Additional annual WWTP O&M expenses are incorporated starting after the completion of Phase I of the WWTP upgrades in 2013 at $338,631 and are escalated by flow and general cost inflation. Existing Debt The City currently has a total of five outstanding debt issues: a water/sewer revenue bond loan allocated 50 percent to each utility with an annual payment of $65,000 from each utility; three PWTF loans ranging from $74,000 to $210,000 per year, with the $210,000 loan scheduled to be paid off in 2012; and a Limited Tax General Obligation loan at $58,000 per year scheduled to be fully repaid in Table 9-6 shows the existing debt service schedule. Future Debt The capital financial strategy developed for this GSP forecasts the need to issue new debt in the amount of $21.0 million in 2011 to help pay for the WWTP Short-term Improvements and WWTP Phase I Improvements in order to meet the projected growth target of 11,119 people by The new debt issue is assumed to occur at the end of 2011, with the first payment due in The City actively pursues low-cost loans where appropriate, and issues revenue bonds to finance capital projects costs in excess of available cash resources. The analysis performed assumes revenue bond financing for all debt issues. Revenue Bond Assumptions The forecast assumes a revenue bond interest rate of 5- percent, an issuance cost of 1.5 percent and a term of 20 years. The first three years are assumed to be interest only payments of $1,125,000 per year. Full principal and interest payments begin in 2015 at $1,862,000 per year. Transfers to Capital Any Operating Fund balance above the minimum requirement is assumed to be available to fund capital projects and is projected to be transferred to the CR Reserve. The 2011 Sewer Operating Fund balance (401) is expected to end the year at 45 days of O&M. The ending operating fund balances are projected to remain at the 45 day level except for 2012, 2013 and 2015, when the balances temporarily drop and rebuild to 45 days thereafter. The Improvement Fund/CR Reserve balance is expected to end the year above the target of 2.0 percent of plant in service assuming the new debt proceeds of $21.0 million. The Improvement Fund/CR Reserve ending balances are above the 2 percent of plant in service in every year except 2014 and 2015, when they reduce to $484,000, rebuilding and exceeding the target level in Although the financial plan is completed for the 20-year planning period of this GSP, the rate strategy focuses on the shorter-term planning period of 2011 through It is imperative that the City revisit the proposed rates every 2 to 3 years to ensure that the rate projections developed J:\Data\SUL\ \PLAN\SUL_GSP Chapter9.doc(4/11/2011 1:54 PM) 9-16 CITY OF SULTAN GENERAL SEWER PLAN

17 remain adequate. Any significant changes should be incorporated into the financial plan and future rates adjusted as needed. Table 9-7 summarizes the annual revenue requirement based on the forecast of revenues, expenditures, fund balances and fiscal policies. Table Year Financial Forecast Financial Forecast Revenues Rate Revenues Under Existing Rates $1,244,552 $1,320,039 $1,396,145 $1,475,176 $1,580,127 $1,914,420 GFCs Towards Debt $56,000 $913,362 $786,881 $786,025 $1,227,398 $1,226,542 Non-Rate Revenue $12,688 $12,870 $13,860 $14,858 $17,263 $20,748 Total Revenue $1,313,240 $2,246,271 $2,196,886 $2,276,060 $2,824,788 $3,161,711 Expenses Cash O&M Expenses $780,552 $837,417 $890,490 $923,497 $960,431 $1,004,433 O&M Additions (Phase I) - - $338,681 $413,563 $490,709 $550,566 Existing Debt Service - Revenue Bond $64,786 $62,988 $64,937 $64,131 $63,158 $64,438 Existing Debt Service - PWTF Loans $399,302 $396,835 $186,034 $184,608 $183,182 $181,756 Existing Debt Service - Other Loans $58, New Debt Service - $1,125,435 $1,125,435 $1,125,435 $1,862,482 $1,862,482 Total Expenses $1,302,666 $2,422,674 $2,605,575 $2,711,233 $3,559,961 $3,663,674 Total Surplus (Deficiency) $10,574 ($176,403) ($408,690) ($435,173) ($735,173) ($501,963) % of Rate Revenue 0.00% 13.36% 29.27% 29.50% 46.53% 26.22% Annual Rate Adjustment 0.00% 14.30% 14.30% 6.70% 6.70% 0.00% Rate Revenues After Rate Increase $1,244,552 $1,508,805 $1,823,992 $2,056,368 $2,350,246 $2,847,466 Net Cash Flow After Rate Increase $10,574 $5,092 $2,677 $123,631 $5,280 $395,142 Coverage After Rate Increase Notes: Coverage assumes the use of general facilities charge (GFC) revenue. The financial forecast indicates existing rates need to increase approximately 47.0 percent for the 6- year period. The rate strategy developed includes the need for a 14.3 percent rate increase in 2012 and 2013, followed by 6.7 percent rate increases in 2014 and The rate increases are required to cover the existing level of O&M expenses beginning in 2013, rebuild and maintain adequate ending fund balance targets and support the capital program through funding the additional debt service from the $21.0 million debt issue. Appendix U provides an alternative analysis based on growth rates experienced within the City and Urban Growth Area over the last 3 years. City Funds and Reserves Separate accounting is provided for utility restricted and unrestricted cash reserves. Restricted reserves typically include funds set aside as part of revenue bond covenants and cannot be used for purposes other than financial payment on outstanding revenue bond debt obligations. Unrestricted cash is maintained in the Sewer Operating Fund (401) and the Sewer CR Reserve (404). Restricted funds include the Sewer System Improvement Fund (407), Water/Sewer Revenue Bond Fund (403) and the Sewer System Debt Service Fund (413). The financial plan has considered the use and maintenance of the operating, improvement and capital funds. The water/sewer revenue debt and the sewer system debt service funds are only used to make annual debt service payments. Table 9-8 shows a summary of the projected City operating and capital fund ending balances through 2016, based on the rate forecasts presented herein. The operating forecast has a minimum CITY OF SULTAN GENERAL SEWER PLAN 9-17 J:\Data\SUL\ \PLAN\SUL_GSP Chapter9.doc (4/11/2011 1:54 PM)