Foundations of Finance

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Finance Center UNC School of Government 919.843.

1 Foundations of Finance March 8, 2018 International Woman s Day National Peanut Cluster Day Jeff Hughes Environmental Finance Center UNC School of Government jhughes@unc.edu Water and Wastewater Leadership Center

environmental programs through: Applied Research Fees and finance

2 Environmental Finance Center How you pay for it matters Supporting the fair, effective, and financially sustainable delivery of environmental programs through: Applied Research Fees and finance Teaching and Outreach Program Design and Evaluation Dashboard Capital planning tools 2

3 Water Quantity Management Challenges

4 Water Infrastructure Challenges 4

5 Water Quality Management Challenges

6 Customer Confidence Challenges 6

7 Objectives for the Day 1. Improve ability to identify finance information that is relevant (and irrelevant) to the sustainability and success of your operations. 2. Improve understanding of basic financial terminology and trends. 3. Gain confidence to help answer key finance questions. 4. Strengthen ability to communicate financial information to customers/ shareholders, management, and elected officials.

8 Agenda 1. Introduction to financial leadership 2. Financial health/benchmarking 3. Looking beyond budgetary line item costs 4. Revenue trends 5. Affordability 6. Capital finance trends

14 Finance Questions and.burning Issues

15 Financial Leadership??

16 Krispy Kreme Corporate Accomplishments Sales of $778.6 million, a 28 % increase over last fiscal year (52-week year). Net income of $39.1 million, up 51.6 percent over last fiscal year Opening 53 factory stores and 10 commissaries. Acquiring Montana Mills Bread Co., Inc., Achieving a 24.0 percent national market share Successfully rolling out our new Krispy Kreme Signature Coffees across North America. Being recognized by Restaurants and Institutions SOURCE: Krispy Kreme Annual Report

17 Orange Water and Sewer Authority Corporate Accomplishments Renovation of Pump Station ($540,000) Replacement of 14,000 of water ft of water line ($2.9 Million) Rehabilitation of 19,000 ft of sewer line ($650,000) Begun evaluation of reclaimed water project. In house study of establishing more comprehensive water conservation program. Ambitious 15 year CIP identifies $251 million of necessary system improvements. SOURCE: Annual Report

18 Net (Plant) Assets/Operating Revenue

19 Penn and Teller VQTE/ref=asc_aa?ie=UTF8&redirect=true&re directtoasin=b00mqmvqte&t=0m0s&tag=cli cker_piv OE

20 Assessing Financial Condition 20

22 Assessing and Presenting Financial Information For your lender For yourself For your board For your boss Engineer Finance For your neighbor

23 Assessment of Your Utility Annual Report or Management Discussion Overall fiscal health? Biggest finance related accomplishment? Biggest financial challenge?

24 Rating Agency s View of Industry 24

25 Outlook according to Moody s 25

26 Ratings Source: Moodys Municipal Bond Rating Scale, November 2002

27 The Nessie Curve Source: Dawn of the Replacement Era, AWWA

28 Water Distribution System Average yearly expenditure over the last 20 years is $226,000 This equates to a 1,396 year replacement schedule Yearly funding should average $4,000, miles of unlined cast iron mains Poor condition of distribution system directly affects water quality Source: Linda Sims, City of Durham, Department of Water Management

30 Whiteboard Video: Financial Benchmarking

31 The Most Common Financial Indicator?? Compare with Caution!! $1,200 $1,000 $800 $ $669 $643 $753 $1,032 $600 $563 $414 $582 $497 $524 $400 $298 $282 $200 $0

34 Operating Expenditure vs. Operation Expense Financial terminology is not always consistently applied but Expense may includes non monetized items such as depreciation that tend to be related to what the utility is or should be seeing in their capital expenditures Sometimes, we are more concerned about cash expenditures Key take-away know what you are comparing!

35 Operating Expenditures Graphic Source: NACWA 2014 Finance Survey and Report Executive Summary

36 Major non-cash costs that are not considered operating expenditures Principal payments Interest payments (for governmental utilities) Pay as you go outlays Transfers other than reimbursements Depreciation expense

38 Depreciation Simplified Method of allocating initial cost over time to be in sync with income generation. Estimate of value of asset being used up (worn down) over time. Formulaic conversion a capital expense to a recurring expense Deductible against income for tax purposes (for tax paying entities) Useful indicator of full cost pricing -- whether revenue (rates) are covering capital costs

39 King of the Investor Indicators: Debt Service Coverage Debt Service Coverage = Revenue available to pay debt service divided by debt payments Multiple variations on how this is calculated (what gets added to revenues and what gets subtracted) Simplest Version: Revenues available to pay debt service = Operating Revenues Operating Expenditures

47 Debt/Needs Indicators Net Assets = Total Assets Total Liabilities Long Term Debt/Net Assets Debt per account CIP costs per account

48 Assessment Exercise 48

49 49 Costs

50 Single vs. Triple Bottom Line Graphic Source, El Paso Triple Bottom Line: Desalination and Reuse Water Final Report, Prepared for El Paso, Stratus Consulting

51 Fixed vs. Variable Source: Fayetteville Observer 2/6/04

52 Why does this happen? 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.

53 Dividends vs. Reimbursements Reimbursements for indirect services Payment in Lieu of Taxes Dividends Based on equity Based on revenues Based on net income

55 Initial Capital Costs vs. Life Cycle Common Applications Type of pipes Type of pumps Treatment facilities Initial Cost vs. PV of: Repair Energy usage Replacement Labor.

57 57 Revenues

58 Revenue case study?

Water Sales (1980-2009) (Slide provided by Orange Water and Sewer

60 Water Sales ( ) (Slide provided by Orange Water and Sewer Authority)

61 Trends in Demand Growth (Orange Water and Sewer Authority, Chapel Hill/Carrboro, NC) Raw Water Demand (MGD) Courtesy of Pat Davis, Orange Water and Sewer Authority

62 Is it variable or is it gone?? Annual MGD Actual Annual 5-Year Moving Average SWD Forecast RIBCO Forecast 1980 Complan Forecast Medium Complan Forecast Medium-Low 1985 Complan Forecast-Medium 1993 WSP Forecast Source: Seattle Public Utilities

63 Prices went up What is happening? Homes became more efficient Water users became more efficient Decentralized initiatives increased 1,400, ,300, ,200,000 Population 240 1,100, ,000, , , , , ,000 Total Water Consumption , , , , Population Source: Seattle Public Utilities

64 Are there alternatives? 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.

65 Evolving Pricing: Water Utility 2.0?

66 New business models? Airlines sur charge model Phone/cable bundled services for predetermined fixed fees Customer specific peaking charges?

67 67 Affordability

68 Finance Highlight 68

69 Trends in User Charges

71 Affordability Indicators Annual User Charge/Median Household Income Can be dominated/blurred by denominator or numerator Families that don t pay utility bills? Statistical precision Poverty rate General socio demographic indicators (unemployment..) Range of emerging indicators

72 Diverse Affordability Criteria Credit worthiness (Rating Agencies) System Financial Capability Assessment (Regulatory Purposes) Funding Agency Affordably Criteria for awarding grants and subsidized interest (Allocating Scarce Public Subsidy) Criteria for customers applying for assistance from their utility

73 EPA Financial Capability Assessment Guidance (1997) CSO Financial Capability Assessment Guidance, 1996

74 Fragmented Governance Varied viewpoints Bifurcated regulatory and organizational structures. separately-managed silos for drinking water, wastewater, and stormwater at all levels of government. Panel Findings and Recommendations

75 Cost of Water Service in Terms of Hours Worked 75

76 S&P Affordability

77 Local Customer Assistance Criteria

78 Utility Level Customer Assistance Programs and Strategies Water efficiency Payment plans Need based rate classifications Structuring rates to minimize impact on low volume/basic use One time assistance payments Recurring discounts

79 Affordability Exercise Is there a problem? How do you measure it? How should it be addressed? Who should pay? How should they pay?

80 80

81 81 Capital Finance Developments

82 Basic Questions Behind Debt 1. What are terms (interest rate, length) 2. What is security (General Obligation vs. Revenue) 3. What will be used to retire debt (Taxes vs. utility revenues) 4. Is a referendum needed 5. What is the coverage requirement 6. Is it taxable?

83 Capital Financing Trends? Impact of Tax Cut Act Longer term debt Need asset life, investors, and legal framework Green Bonds Environmental Impact/Pay for Performance Bonds Public Private Partnerships Typically much higher cost of capital rates but risk incorporated into capital rates

84 Paying for the Big Stuff Graphic Source: NACWA 2014 Finance Survey and Report

85 Cost of Capital 6.00 Revenue Bond Index

86 Tax Exempt Revenue Bonds Rule Backed by enterprise revenue May or may not need referendum (usually don t) Great rates for those with good ratings 20 to 40 years (occasionally longer)

87 Private Sources of Capital Bond market 2 to 6 percent capital that does not absorb risk Public Private Partnership Equity 5 to 20% capital that Public Private Partnership Debt 4 to 8 % percent blended with equity 87

88 Example of Flows of Capital Insert P3 diagram 88

89 Retiring Private Capital 89

90 Infrastructure Plan Incentiving state and local investment tapping into private capital $200 Billion of New? Federal Investment 90

91 Objectives for the Day 1. Improve ability to identify finance information that is relevant (and irrelevant) to the sustainability and success of your operations. 2. Improve understanding of basic financial terminology and trends. 3. Continue to strengthen techniques of communicating financial information to customers/ shareholders, management, and elected officials

System Fiscal Sustainability

System Fiscal Sustainability Jeff Hughes UNC Environmental Finance Center UNC School of Government jhughes@unc.edu www.efc.sog.unc.edu www.efc.unc.edu Agenda 1. Fiscal sustainability challenges 2. Strategies