Detroit Water and Sewerage Department 2006 ANNUAL REPORT For The Fiscal Year Ending June 30, Driving for Excellence

Transcription

1 Detroit Water and Sewerage Department 2006 ANNUAL REPORT For The Fiscal Year Ending June 30, 2006 MEASURE MANAGE PERFORM Driving for Excellence

2 CITY OF DETROIT Kwame M. Kilpatrick, Mayor DETROIT CITY COUNCIL Kenneth V. Cockrel, Jr., President Monica Conyers, President Pro Tem Alberta Tinsley-Talabi Sheila M. Cockrel Brenda Jones Martha Reeves Kwame Kenyatta JoAnn Watson Barbara-Rose Collins Janice M. Winfrey, City Clerk DETROIT WATER AND SEWERAGE DEPARTMENT Victor M. Mercado, Director Gary Fujita, Deputy Director BOARD OF WATER COMMISSIONERS Mary E. Blackmon, President Marilynn E. Gosling, Vice President Jimmy L. Cooper Kenneth R. Daniels Hilliard L. Hampton Carla Walker-Miller William G. Westrick Kimberly Mitchell Graphic Designer S.R. Boland Editorial Content Childers Printing Printer 2007 Detroit Water and Sewerage Department

3 Contents Message from the Mayor Letter from the President Board of Water Commissioners Executive Management Team Director s Report Dashboard System Financial Data Water Fund Suburban Customers Served Water Facilities Location Map Auditors Report Statements of Net Assets Statements of Liabilities and Net Assets Statements of Revenues, Expenses, and Changes in Fund Net Assets Statements of Cash Flows Notes to Financial Statements Sewage Disposal Fund Suburban Customers Served Regional Wastewater Districts Auditors Report Statements of Net Assets Statements of Liabilities and Net Assets Statements of Revenues, Expenses, and Changes in Fund Net Assets Statements of Cash Flows Notes to Basic Financial Statements Required Supplementary Information (Unaudited)

4 MESSAGE FROM THE MAYOR KWAME M. KILPATRICK It almost goes without saying that we appreciate our customers and we are continually seeking to improve the level of service. However, to emphasize our focus on greater efficiency in all that we do, the Detroit Water and Sewerage Department (DWSD) has instituted the Performance and Dashboard System (PaDS), a computerized way to track performance throughout the department. Because of the leadership of Director Victor M. Mercado, DWSD now has a means to ensure accountability to you, our customers. That s accountability from DWSD employees, management, the department s senior staff, and Mr. Mercado himself. The bar of expectations is raised which means our level of service will improve. This is good news for you, the customer. Not only does DWSD deliver the best-tasting drinking water in the state, it also delivers outstanding value for the cost of services. Through efficiencies implemented by Director Mercado, we are sure to see more bang for the buck in the future. PaDS is one more tool that will tell us when and where we re doing well, and when and where we need to improve. With PaDS, we ll get even better at what we do. Standing behind PaDS are hundreds of DWSD employees who are proud of their work for one of the largest water and sewer utilities in the nation. I, too, am proud of DWSD s products: high-quality drinking water and dependable wastewater treatment. However, I am just as proud of DWSD s commitment to customer service, and its employees dedication to excellence. Sincerely, Kwame M. Kilpatrick Mayor 3

5 LETTER FROM THE PRESIDENT MARY E. BLACKMON, BOARD OF WATER COMMISSIONERS At the Detroit Water and Sewerage Department, our customers continue to be our highest priority. DWSD is determined to provide Detroit residents and suburban wholesale customers with the best quality water and wastewater services at the lowest possible cost. That s not an idle claim. It s why we re always upgrading technology, improving our infrastructure, and instituting managerial innovations to bring about greater operational efficiencies. The result? Rates stay reasonable, and DWSD water continues to be a great value just pennies per gallon. We are proud of that, and we intend to see that it stays that way. For public health, fire protection, regional economic development, and overall quality of life only tap water delivers, to borrow a catchphrase from the American Water Works Association. Our desire to better serve our customers is expressed not only through our products, but also through community outreach and education efforts such as Water Works Park tours and Drinking Water Month. In addition, DWSD has always urged its customers to use water wisely, and in an environmentally-friendly manner. Dialogue with our customers on water issues continues through venues such as the area Technical Advisory Committee (TAC) for our wholesale water customers, Steering Committee for wholesale sewer customers, and the Southeast Michigan Consortium for Water Quality. The 2006 Regional Forum on Water and Wastewater Security and Prosperity, held in April and jointly hosted by DWSD and the Southeast Michigan Council of Governments emphasized the theme, Partnering For The Future, and was attended by more than 100 area leaders. The forum keyed on regional cooperation, security, future advances in technology, and the importance of investing in infrastructure improvement, among other themes. Moreover, it was at the forum that our new Performance and Dashboard System (PaDS) was first demonstrated for our wholesale customers. They were impressed. PaDS, an innovation recently introduced to the Detroit Water and Sewerage Department by Director Victor M. Mercado, is a new way of measuring just how each unit within DWSD is performing. It s a computer-driven program that, for the first time, allows us to see just where we re excelling and where we need work. The red, yellow, and green lights are the key feature of an easy-to-follow system that tells us what we need to know at a glance. PaDS graphically shows that our managers are accountable to senior management; and senior management is accountable to the Director. In turn, the Director is accountable to the Board of Water Commissioners. Ultimately, we re ALL accountable to our customers. Accountability and constructive discourse are paramount when it comes to regional water and wastewater topics. If we continue to open communication lines and build trust, the best years for DWSD and its customers are ahead of us. Sincerely Mary E. Blackmon President Board of Water Commissioners 4

6 BOARD OF WATER COMMISSIONERS CITY OF DETROIT WATER AND SEWERAGE DEPARTMENT Mary E. Blackmon President Marilynn E. Gosling Vice President Kenneth R. Daniels Hilliard L. Hampton Gregory Terrell Carla Walker-Miller William G. Westrick 5

7 EXECUTIVE MANAGEMENT TEAM CITY OF DETROIT WATER AND SEWERAGE DEPARTMENT Victor M. Mercardo Director Gary Fujita, P.E. Deputy Director Louise Lieberman, P.E. Assistant Director Wastewater Operations Woodrow McCarty Assistant Director Financial Services Ramesh Shukla, P.E. Assistant Director Engineering Services Pamela Turner Assistant Director Water Supply Operations George Ellenwood General Manager Public Affairs Darryl Latimer General Manager Contracts & Grants André Lowe, P.E. General Manager Program Management Charlotte Bush Manager Human Resources Terri Tabor Conerway Manager Process & Quality Control 6

8 DIRECTOR S MESSAGE VICTOR M. MERCADO We at the Detroit Water and Sewerage Department are always striving for greater efficiency, better customer service, and to offer consistent, high-quality water and wastewater services. To better achieve those ends, one of the most notable events of fiscal year was the launch of a new program the Performance and Dashboard System, or PaDS. The Performance and Dashboard System is literally that a visual way to gauge how we at DWSD are performing, just as a dashboard shows an automobile s efficiencies or malfunctions at a glance. PaDS is a computer-driven program that displays data and performance indicators from all of DWSD s divisions, in terms of green (satisfactory), yellow (cautionary), and red (unsatisfactory) traffic lights, or ratings. Spearheaded by Process and Quality Control Manager Terri Tabor Conerway, PaDS not only points out our strengths and deficiencies at any given time, but also demonstrates that we are accountable to Detroit city government and to our customers including city residents, as well as suburban municipalities that purchase services from us. PaDS measures all DWSD functions, from engineering to operations to administration. PaDS shows that we take accountability to our customers seriously. We are driving for excellence. Collaboration and synergy The department s wholesale water customer outreach program centered on the Technical Advisory Committee (TAC) continued to make important contributions to the way DWSD and customers interact. The TAC, made up of suburban customer representatives as well as DWSD officials, has held numerous workshops to discuss rates, infrastructure improvements, emergency preparedness, master planning, and other topics of mutual interest. The TAC s biggest project might be the new proposed model contract; work on it is progressing very satisfactorily and dialogue on key issues has been substantive. Detroiters have their say Members of the Public Affairs Division and Commercial Operations represented DWSD at various public meetings, including Mayoral and City Council Town Hall meetings as well as Ombudsman-sponsored outreach sessions. At these events, Detroiters were able to express their concerns about DWSD and submit questions for responses from managers. That kind of two-way communication is important so that we can continue to improve our customer service. Monthly billing In February 2006, DWSD implemented a change that will have major positive impacts. We began monthly billing for residential customers in the City of Detroit. Monthly billing will provide for easier account management and quicker resolution of customer concerns. Engineering accomplishments The top engineering achievement of was the launch of the new, 50-million gallon Conner Creek Combined Sewer Overflow Facility, which went operational in the summer of When flows exceed sewer capacity, the basin works in conjunction with the Freud and Conner storm water facilities to provide settling, skimming and disinfection. After screening and disinfection, the flow is distributed to retention basins. During most storm events, the treated effluent flows into Conner Creek as the retention basins fill. However, when the combined sewer overflow event is over, basins at the facility are dewatered to the Detroit River Interceptor, which 7

9 sends wastewater to the Wastewater Treatment Plant. The work on the facility included dredging Conner Creek and establishing a fish habitat at the nearby Maheras-Gentry Park in line with Michigan Department of Environmental Quality (MDEQ) requirements. DWSD s engineers also were busy with other capital improvement projects that upgraded our system and made it more efficient and cost-effective. They included: Inauguration of the Baby Creek, Lieb, and St. Aubin Combined Sewer Overflow facilities/pumping stations, designed to screen and disinfect combined sanitary and storm flow before it is discharged into either the Rouge or Detroit River during periods of heavy rainfall or snow melt. Installation of inflatable rubber dams inside sewers, which allow a controlled release of storm water to the Wastewater Treatment Plant and prevent a discharge of wastewater into the Detroit and Rouge Rivers during overflow conditions. Intake improvements and rehabilitation of the Southwest Water Treatment Plant. Rehabilitation of high-lift and low-lift pump equipment at the Northeast Water Treatment Plant. A power source change from the City s Public Lighting Department to DTE Energy at the Water Board Building, the Central Services Facility, the Springwells Water Treatment Plant, and the Fairview Sewerage Pumping Station. New transformers at the Lake Huron and Southwest Water Treatment Plants to eliminate any potential PCB risks. Construction of a new electrical facility at the Schoolcraft Pumping Station to house new high-voltage equipment. Implementation of emergency generators that may be operated Station, and the West Service Center. Installation of more than 27,000 lineal feet of new water mains and more than 16,000 lineal feet of sewer pipes within the City of Detroit. Repair of 160,000 feet of sewer, using Cured In Place Pipe (CIPP) method. Rehabilitation of 68 filter systems at the Springwells Water Treatment Plant. Design of a 42-inch water main to run along 24 Mile Road, from Romeo Plank to Fairchild roads. We at DWSD continue to focus on improving the efficiency of our entire system. We are constantly making infrastructure improvements while keeping an eye on costs, and cutting expenditures when possible. Our goal, as always, is to provide high-quality water and wastewater services at an unbeatable value to our 4-million-plus customers throughout southeastern Michigan. Sincerely, Victor M. Mercado Director 8

10 DASHBOARD SYSTEM SHOWS WHERE WE RE STRONG, WHERE WE CAN IMPROVE Measure. Manage. Perform. You could could say that those are the watchwords of DWSD s new performancetracking system. Until recently, the Detroit Water and Sewerage Department had no viable means to quickly measure how its various divisions and locations were performing. However, with the implementation of the Performance and Terri Tabor-Conerway Manager Process & Quality Control Dashboard System (PaDS) in late 2005, that s changed. The computerized system, which displays key performance indicators in green (everything A-OK), yellow (minor concern) or red (major concern that needs immediate attention) can be accessed by managers anywhere in the department. Information is displayed right in front of the viewer like the data on a car s dashboard. Performance measures are established to provide staff (from management to operator) with information as to how well their unit is performing. DWSD senior staff can see the data for quick assessments and development and implementation of actions to improve performance. It s also easy to tell at a glance which manager is responsible for each unit and its performance; ultimately, Assistant Directors and General Managers are accountable for the performance of their divisions. However, Terri Tabor Conerway, Process and Quality Control Manager and PaDS Administrator, emphasized that PaDS is not an avenue for censure, but rather that it s a tool for continuous improvement, which is accomplished by opening up dialogue and solving problems and potential challenges. PaDS incorporates between 300 and 400 key performance indicators (KPIs), and the system is set up so that it can be revamped each fiscal year. Although KPIs were analyzed manually in the days before PaDS, the new system makes them easier to assess. PaDS is published monthly, which then appears on the DWSD Director and Deputy Director s desktops. The June figures are the most important, for they represent the closing of the fiscal year. The target areas within PaDS are determined by Director Victor M. Mercado and department Executive Management Team members. The American Water Works Association has benchmark recommendations for certain operational areas. DWSD officials also keep an eye on how standards and expectations are being met in other utilities across the country and compare that data with what s recorded in PaDS. Many years of data can be stored and referenced. A comments section is provided in the program to enter notes that may shed light on why an indicator is yellow or red, and also incorporates an action plan section to describe what steps the performance measure owner will take to improve performance in problematic areas. Because PaDS is new and cutting-edge, it is the kind of management tool that s currently only being used in the private sector. Until now, it was rarely used by public utilities to track performance in that way. Already, DWSD officials say that department-wide performance is improving. That s good news for management, employees, and customers. 9

11 Samples of charts used with the Performance and Dashboard Systems (Pads). 10

12 SUBURBAN CUSTOMERS SERVED WITH WATER BY DETROIT WATER AND SEWERAGE DEPARTMENT - FY Listed By Date Service Began Since No. Community Since No. Community Since No. Community Detroit Sterling Heights Davison Twp River Rouge Clawson Imlay City Hamtramck Birmingham Plymouth Twp Ecorse Hazel Park Rochester Hills Grosse Pointe Park Madison Heights Ypsilanti Twp Lincoln Park Beverly Hills Village Mt. Morris Ferndale Huron Twp Mundy Twp Melvindale Canton Twp Pittsfield Twp Eastpointe Centerline Vienna Twp Grosse Pt. Woods Farmington Burton St. Clair Shores Plymouth Twp Clayton Twp Lathrup Village Fraser Chesterfield Twp Roseville Pontiac Gaines Twp Taylor Utica Oakland Co. Drain Comm Allen Park Van Buren Twp Almont Village Dearborn Heights Troy Genesee Twp Grosse Pt. Shores Village Bloomfield Twp Greenwood Twp Oak Park Belleville Washington Twp Pleasant Ridge Northville Twp Montrose Twp Riverview Auburn Hills Montrose Trenton Novi Augusta Twp Dearborn Northville Orion Twp Inkster Shelby Twp Superior Twp Livonia Clinton Twp York Twp Royal Oak Keego Harbor Romeo Village Wayne Flint Macomb Twp Garden City Sumpter Twp Bingham Farms Village Grosse Ile Twp Flushing Mayfield Twp Harper Woods South Rockwood Village Rockwood Royal Oak Twp Ash Twp Flat Rock Farmington Hills Carleton Commerce Twp Redford Twp Lapeer Walled Lake Warren Clio Lenox Twp Southfield W. Bloomfield Twp New Haven Village Huntington Woods Berlin Twp Sylvan Lake Southgate Estral Beach Grand Blanc Twp Brownstown Twp Bloomfield Hills Orchard Lake Village Gibraltar Harrison Twp Lake Orion Village Romulus Flint Twp Ypsilanti Woodhaven Flushing Twp Richfield Twp Berkley Mt. Morris Twp Burtchville Twp Westland Swartz Creek Wixom Please Note: All Townships and Villages are called out; the rest are Cities. 11

13 DETROIT WATER AND SEWERAGE DEPARTMENT WATER FACILITIES LOCATION MAP Water Treatment Plants Service Yards 12

14 KPMG LLP 150- West Jefferson, Suite 1200 Detroit, MI Independent Auditor s Report The Board of Water Commissioners, the Honorable Mayor, and Members of the City Council City of Detroit, Michigan: We have audited the accompanying basic fmancial statements of the Water Fund (the Fund), an enterprise fund of the City of Detroit, Michigan (the City), as of and for the years ended June 30, 2006 and 2005, as listed in the table of contents. These basic financial statements are the responsibility of the Fund s management. Our responsibility is to express an opinion on these basic financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America and the standards applicable to financial audits contained in Government Auditing Standards, issued by the Comptroller General of the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the basic fmancial statements are free of material misstatement. An audit includes consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the City s internal control over financial reporting of the Fund. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the basic financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. As discussed in note 1, the financial statements referred to above present only the Water Fund of the City and are not intended to present fairly the financial position of the City as of June 30, 2006 and 2005, and the changes in its financial position, and, where applicable, cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles. In our opinion, the basic financial statements referred to above present fairly, in all material respects, the financial position of the Water Fund of the City as of June 30, 2006 and 2005, and the changes in its net assets and its cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles. In accordance with Government Auditing Standards, we also audited the financial statements of the City, as described above in this report on the Fund s fmancial statements. This report does not include the results of our testing of internal control over financial reporting and on our tests of the City s compliance with certain provisions of laws, regulations, contracts, and grant agreements and other matters that are reported on separately by us for the City. The purpose of that report is to describe the scope of our testing of internal control over financial reporting and compliance and the results of that testing, and not to provide an opinion on the internal control over financial reporting or on compliance. That report is an integral part of an audit performed in accordance with Government Auditing Standards and should be considered in assessing the results of our audit. The Fund has not presented Management s Discussion and Analysis, which U.S. generally accepted accounting principles have determined is necessary to supplement, although not required to be part of, the basic financial statements. The schedule of funding progress on page 31 is not a required part of the basic financial statements but is supplementary information required by U.S. generally accepted accounting principles. We have applied certain limited procedures, which consisted principally of inquiries of management regarding the methods of measurement and presentation of the required supplementary information. However, we did not audit the information and express no opinion on it. March 20, 2008 KPMG LLP, a U.S. limited liability partnership, is the U.S. member firm of KPMG International, a Swiss cooperative. 13

15 CITY OF DETROIT WATER FUND STATEMENTS OF NET ASSETS, JUNE 30, 2006 AND 2005 Assets Current assets: Cash and cash equivalents $ 3,997, ,259 Investments 22,345,923 7,520,716 Due from other funds 56,884,330 53,149,298 Accounts receivable (including $28,558,437 and $29,934,243, respectively, for unbilled water services and net of allowance for doubtful accounts of $39,119,680 and $36,887,901 for June 30, 2006 and 2005, respectively) 63,789,759 68,971,401 Inventories 8,967,419 6,330,165 Prepaid expenses 5,930, ,211 Restricted cash and cash equivalents 34,465,603 25,052,140 Restricted investments 362,605, ,158,969 Restricted due from other funds 6,021,460 40,475,299 Total current assets 565,007, ,096,458 Noncurrent assets: Restricted long-term investments 10,717,537 30,072,332 Net pension asset 148,590, ,452,508 Issuance costs pension obligation certificates of participation 8,910,507 5,154,834 Unamortized bond issuance costs 30,603,648 32,088,822 Capital assets: Land and land rights 6,529,308 6,527,438 Structures 825,649, ,846,651 Mains 763,588, ,856,603 Services, meters, and improvements to land 106,085, ,323,777 Equipment 864,457, ,635,010 Construction work in progress 140,815, ,027,160 Total capital assets 2,707,125,660 2,581,216,639 Less accumulated depreciation (743,068,280) (688,863,364) Net capital assets 1,964,057,380 1,892,353,275 Total noncurrent assets 2,162,879,346 2,110,121,771 Total assets $ 2,727,886,735 2,725,218,229 14

16 CITY OF DETROIT WATER FUND STATEMENTS OF LIABILITIES AND NET ASSETS, JUNE 30, 2006 AND 2005 Liabilities and Net Assets Current liabilities: Accounts and contracts payable $ 22,718,139 16,543,893 Accrued salaries and wages 1,706,286 2,171,724 Accrued workers compensation 2,913,177 3,470,751 Accrued compensated absences 3,715,980 8,604,763 Due to other funds 53,873,011 65,882,639 Other current accrued liabilities 8,142,609 3,053,509 Total current liabilities payable from current assets 93,069,202 99,727,279 Current liabilities payable from restricted assets: Revenue bonds payable within one year 25,535,000 24,595,000 Accrued bond interest payable 38,626,382 38,521,332 Accounts and contracts payable 20,501,071 20,117,305 Other current accrued liabilities 459, ,346 Due to other funds 10,982,590 6,515,574 Total current liabilities payable from restricted assets 96,104,765 90,378,557 Total current liabilities 189,173, ,105,836 Long-term liabilities: Revenue bonds payable, net 1,900,402,692 1,915,294,379 Pension obligation certificates of participation payable, net 159,017, ,548,214 Accrued workers compensation 15,198,239 15,240,595 Accrued compensated absences 14,912,321 9,808,909 Deferred swap termination fees 16,213,524 16,797,795 Total long-term liabilities 2,105,744,234 2,114,689,892 Total liabilities 2,294,918,201 2,304,795,728 Net assets: Invested in capital assets, net of related debt 217,225, ,520,234 Restricted for capital acquisitions and bond payments 81,914, ,409,825 Unrestricted 133,829,027 94,492,442 Total net assets 432,968, ,422,501 Total net assets and liabilities $ 2,727,886,735 2,725,218,229 See accompanying notes to basic financial statements. 15

17 CITY OF DETROIT WATER FUND STATEMENTS OF REVENUES, EXPENSES, AND CHANGES IN FUND NET ASSETS, JUNE 30, 2006 AND Operating revenues: Water sales Detroit $ 68,736,614 58,921,494 Water sales suburban 205,581, ,050,339 Miscellaneous 1,912,850 1,641,252 Total operating revenues, net 276,230, ,613,085 Operating expenses before depreciation: Source of supply 2,856,385 2,244,535 Low-lift pumping 8,258,270 6,081,177 Purification 18,441,764 18,983,784 High-lift pumping 15,306,817 19,338,389 Water quality operations 1,705,680 1,876,012 Transmission and distribution 35,101,901 45,417,478 Services and meters 5,939,668 5,645,086 Hydrant division 1,199,902 1,386,783 Commercial 5,084,493 7,227,323 Administrative and general 52,320,068 48,753,131 Total operating expenses before depreciation 146,214, ,953,698 Operating income before depreciation 130,015, ,659,387 Depreciation 54,628,100 41,529,608 Operating income 75,387,718 62,129,779 Nonoperating revenue (expense): Earnings on investments 18,843,877 7,175,672 Interest expense, net of capitalized interest (83,963,811) (63,260,449) Miscellaneous 2,278,249 (62,246) Total nonoperating expense (62,841,685) (56,147,023) Contributed capital 6,938,882 Increase in net assets 12,546,033 12,921,638 Net assets beginning of year 420,422, ,500,863 Net assets end of year $ 432,968, ,422,501 See accompanying notes to basic financial statements. 16

18 CITY OF DETROIT WATER FUND STATEMENTS OF CASH FLOWS, JUNE 30, 2006 AND Cash flows from operating activities: Receipts from customers $ 283,573, ,740,367 Loans to other funds 23,176,195 (28,698,398) Payments to suppliers (86,907,411) (115,305,031) Payments to the General Retirement System in excess of annual required contribution (150,452,508) Payments to employees (57,564,022) (53,688,328) Net cash provided by (used in) operating activities 162,278,606 (87,403,898) Cash flow from noncapital and related financing activities: Proceeds from issuance of Personal Obligation Certificates of Participation 157,548,214 Issuance costs Pension Obligation Certificates of Participation (2,286,429) (5,154,834) Net cash (used in) provided by noncapital and related financing activities (2,286,429) 152,393,380 Cash flows from capital and related financing activities: Contributions received from customers 2,278,249 6,938,882 Acquisition and construction of capital assets, net (107,519,457) (134,448,175) Principal paid on revenue bond maturities (24,595,000) (22,440,000) Interest paid on revenue bonds (102,671,509) (85,928,089) Principal paid on refunded debt (125,985,000) Proceeds from bond issuance and increase in revolving note payable, net 4,723, ,791,474 Unamortized discount and bond issuance cost 7,404,533 5,175,110 Net cash (used in) provided by capital and related financing activities (220,379,230) 68,104,202 Cash flows from investing activities: Proceeds from sales and maturities of investments 449,752, ,876,577 Purchase of investments (395,668,526) (449,752,017) Interest received on investments 18,843,877 7,175,672 Net cash provided by (used in) investing activities 72,927,368 (132,699,768) Net increase in cash 12,540, ,916 Cash at beginning of year 25,922,399 25,528,483 Cash at end of year $ 38,462,714 25,922,399 Reconciliation of operating income to net cash provided by operating activities: Operating income $ 75,387,718 62,129,779 Adjustments to reconcile operating income to net cash provided by operating activities: Depreciation 54,628,100 41,529,608 Provision for uncollectible accounts 2,231,779 6,650,637 Changes in certain assets and liabilities: (Increase) decrease in accounts receivable 2,949,862 (10,919,185) (Increase) decrease in inventories (2,637,254) 501,841 (Increase) in prepaid expenses (5,362,507) (461,392) Increase (decrease) in accounts and contracts payable 6,558,012 (13,787,881) Increase (decrease) in accrued salaries and wages (465,438) 354,027 Increase (decrease) in Issuance cost POC 1,862,234 (150,452,508) Increase in other accrued liabilities, compensated absences, and workers compensation 3,949,904 5,749,574 Net change in due to (from) other funds 23,176,196 (28,698,398) Net cash provided by (used in) operating activities $ 162,278,606 (87,403,898) Noncash capital financing activities: Capital assets of $2,278,249 were acquired through contributions from developers. See accompanying notes to financial statements. 17

19 CITY OF DETROIT WATER FUND NOTES TO BASIC FINANCIAL STATEMENTS JUNE 30, 2006 AND 2005 (1) Summary of Significant Accounting Policies The City of Detroit (the City) Charter established the Water Department (the Department) in the year 1836 to supply water within and outside the City under the administration of the Board of Water Commissioners. The Water Fund (the Fund), an Enterprise fund, separately accounts for the Water Supply System (the System), as is required by bond ordinances of the City. The following is a summary of the more significant accounting policies followed in the preparation of the Fund s financial statements. These policies conform to U.S. generally accepted accounting principles. The financial statements of the Water Fund have been included in the City of Detroit s Comprehensive Annual Financial Report (CAFR) and reported as an Enterprise fund. Copies of these reports, along with other financial information, can be obtained at the Fund s administrative office, located at 735 Randolph, Detroit, Michigan, (a) Basis of Accounting The accounting policies of the Fund conform to U.S. generally accepted accounting principles (GAAP) as applicable to governmental entities. The accounts of the Fund, which are organized as an Enterprise fund, are used to account for the Fund s activities, which are financed and operated in a manner similar to a private business enterprise. Accordingly, the Fund maintains its records on the accrual basis of accounting. Revenues from operations, investments, and other sources are recorded when earned. Expenses (including depreciation and amortization) of providing services to the public are accrued when incurred. In accordance with Governmental Accounting Standards Board (GASB) Statement No. 20, Accounting and Financial Reporting for Proprietary Funds and Other Governmental Entities That Use Proprietary Fund Accounting, the Fund applies all applicable GASB pronouncements, as well as all Financial Accounting Standards Board (FASB) Statements and Interpretations, Accounting Principles Board (APB) Opinions, and Accounting Research Bulletins (ARBs) issued on or before November 30, 1989, unless those pronouncements conflict with or contradict GASB pronouncements. The Fund also has the option of following FASB guidance issued after November 30, 1989, but has elected not to do so. (b) Cash and Cash Equivalents Cash and cash equivalents include cash on hand, demand deposits, and short-term investments with original maturities of three months or less from the date of acquisition. (c) Investments Investments are reported at fair value based on quoted market price. (d) Inventories Inventories consist of operating and maintenance and repair parts for water lines and are valued at the lower of cost or market, with cost being determined on an average cost method. (e) Capital Assets Capital assets are recorded at historical cost, together with interest capitalized during construction. Depreciation is computed using the straight-line method over the estimated useful lives of the related assets as follows: Improvements to land Structures Mains Services Meters and equipment 67 years 40 years 67 years 67 years 3 20 years (f) Workers Compensation The Fund has no insurance coverage for workers compensation claims. Workers compensation expenses are recorded when the occurrence of the liability is probable and the amount is reasonably estimable. The amounts recorded as of June 30, 2006 and 2005 are based on compensation expected to be paid, along with estimated medical costs, for all claims known as of the (f) Workers Compensation June Balance at beginning of year $ 18,711,345 15,778,254 13,778,575 Current year claims and changes in estimates 4,356,803 7,345,178 6,756,198 Claims payments (4,956,732) (4,412,087) (4,756,519) Balance at end of year $ 18,111,416 18,711,345 15,778,254 18

20 CITY OF DETROIT WATER FUND NOTES TO BASIC FINANCIAL STATEMENTS JUNE 30, 2006 AND 2005 balance sheet date, and historical data are used in computing the liability for estimated incurred but unknown claims as of the balance sheet date. (g) Capitalized Interest The Fund capitalizes qualifying net interest costs of the System on bonds issued for capital construction in accordance with Statement of Financial Accounting Standards (SFAS) No. 34 Capitalization of Interest Cost and Statement No. 62 Capitalization of Interest Cost in situations Involving Certain Tax-Exempt Borrowings and Certain Gifts and Grants an Amendment of FASB Statement No. 34. Accordingly, capitalized interest for the years ended June 30, 2006 and 2005 was $18,812,748 and $28,942,595, respectively. (h) Taxes and City Services The Fund pays no direct federal, state, or local taxes, except local taxes on excess property and federal Social Security taxes. The Fund reimburses the City for most of the direct services furnished by other City departments, including general staff services. Charges are billed for all water services provided to City departments. (i) Shared Costs Costs related to shared facilities and personnel are allocated to the Fund on a basis that relates costs incurred to the fund benefited. (j) Compensated Absences The Fund records as a liability estimated vested vacation, sick pay, and banked overtime in accordance with GASB Statement No. 16, Accounting for Compensated Absences. Unused vacation pay accumulates until termination of employment, while there is no vesting of sick pay until an employee reaches age 60 or completes 25 years of service. (k) Accrued Revenue The Fund records unbilled revenues for services provided prior to year-end by accruing actual revenues billed in the subsequent month. (l) Net Assets Net assets are categorized as follows: Invested in Capital Assets: This consists of capital assets, net of accumulated depreciation and related debt. Restricted: This consists of net assets that are legally restricted by outside parties or by law through constitutional provisions or enabling legislation. When both restricted and unrestricted resources are available for use, generally it is the City s policy to use restricted resources first, and then unrestricted resources when they are needed. Unrestricted: This consists of net assets that do not meet the definition of restricted or invested in capital assets. (m) Classification of Revenues The Fund has classified its revenues as either operating or nonoperating revenues according to the following criteria: Operating Revenues: Operating revenues include activities that have the characteristics of exchange transactions, such as revenue from charges for water service. Nonoperating Revenues: Nonoperating revenues include activities that have the characteristics of nonexchange transactions, which are defined as nonoperating revenues by GASB Statement No. 9, Reporting Cash Flows of Proprietary and Nonexpendable Trust Funds and Governmental Entities That Use Proprietary Fund Accounting, and GASB Statement No. 34, Basic Financial Statements and Management s Discussion and Analysis for State and Local Governments, such as investment income and interest expense. (n) Use of Estimates The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. (o) New Accounting Pronouncements The Fund adopted GASB Statement No. 42, Accounting and Financial Reporting for Impairment of Capital Assets and for Insurance Recoveries. This Statement establishes accounting and financial reporting standards for impairment of capital assets. The Fund implemented GASB Statement No. 42 with the year ended June 30, The Fund adopted GASB Statement No. 46, Net Assets Restricted by Enabling Legislation-an amendment of GASB Statement No. 34. This Statement clarifies that a legally enforceable enabling legislation restriction is one that a party external to a government such as citizens, public interest groups, or the judiciary can compel a government to honor. This Statement also specifies the accounting and financial reporting requirements if new enabling legislation replaces existing legislation or if legal enforceability is reevaluated. The Fund implemented GASB Statement No. 46 with the year ended June 30, In July 2004, the GASB issued Statement No. 45, Accounting and Financial Reporting by Employers for Postemployment Benefits Other Than Pensions. This Statement establishes accounting and 19

21 CITY OF DETROIT WATER FUND NOTES TO BASIC FINANCIAL STATEMENTS JUNE 30, 2006 AND 2005 financial reporting standards for employers that participate in a defined-benefit other postemployment benefit (OPEB) plan. The Fund will implement GASB Statement No. 45 beginning with the year ended June 30, The Fund is currently evaluating the impact of adopting Statement No. 45. (2) Deposits and Investments The following is a complete listing of deposits and investments held by the Fund at June 30, Deposits $ 12,237,801 Investments 421,893,439 Total deposits and investments $ 434,131,240 The deposits and investments of the Fund at June 30, 2006 are reflected in the financial statements as follows: Unrestricted: Cash and cash equivalents $ 3,997,111 Investments 22,345,923 Restricted: Cash and cash equivalents 34,465,603 Investments current 362,605,066 Investments noncurrent 10,717,537 Total cash and investments $ 434,131,240 State law authorizes the Fund to make deposits in the accounts of federally insured financial institutions. Cash held by fiscal agents or by trustees is secured in accordance with the requirements of the agency or trust agreement. The Fund is authorized to invest in obligations of the U.S. government or its agencies, certificates of deposit, savings and depository accounts of insured institutions, commercial paper of certain investment quality, repurchase agreements, banker s acceptances, mutual funds of certain investment quality, and investment pools as authorized by state law. Custodial Credit Risk of Bank Deposits Custodial credit risk is the risk that in the event of bank failure, the Fund s deposits may not be returned by the bank. The Fund does not have a deposit policy for custodial credit risk. At June 30, 2006 and 2005, the Fund had deposits of $6,739,465 and $27,464,345, respectively, which were exposed to custodial credit risk, as they were uninsured and uncollateralized. Custodial Credit Risk of Investments Custodial credit risk is the risk that in the event of failure of the counterparty, the Fund will not be able to recover the value of its investments or collateral securities that are in the possession of an outside party. The Fund does not have a policy for custodial credit risk. As of June 30, 2006 and 2005, the Fund had no investments subject to custodial credit risk. Interest Rate Risk Interest rate risk is the risk that, over time, the value of investments will decrease as a result of a rise in interest rates. The Fund s investment policy does not specifically restrict investment maturities other than commercial paper, which can only be purchased with a 270-day maturity. The Fund s policy minimizes interest rate risk by requiring that the Fund attempt to match its investments with anticipated cash flow requirements. Unless related to a specific cash flow, the Fund is generally not permitted to directly invest in securities maturing more than 10 years from the original date of purchase. See chart below. Credit Risk The Fund s investment policy complies with state law. The Fund limits its investments in commercial paper, mutual funds, and external investment pools that purchase commercial paper to the top two rating classifications issued by two nationally recognized statistical rating organizations (NRSROs). See chart on page 21. Concentration of Credit Risk Concentration of credit risk is the risk of loss attributed to the magnitude of the Fund s investment in a single issuer. The Fund s policy specifies a number of limitations to minimize concentration of credit risk, including prohibiting investing more than 5% of the Interest Rate Risk Investment maturities in years Fair Less than one to value one year five years Investment: U.S. government agency securities $ 118,632, ,914,610 10,717,537 Certificate of deposit 8,860,656 8,860,656 Commercial paper 52,283,902 52,283,902 Money market 242,116, ,116,734 Total investments $ 421,893, ,175,902 10,717,537 20

22 CITY OF DETROIT WATER FUND NOTES TO BASIC FINANCIAL STATEMENTS JUNE 30, 2006 AND 2005 Credit Risk As of June 30, 2006, the Fund had the following investments, maturities, and credit quality ratings of debt securities: Fair Rating value Rating organization Investment: U.S. government agency securities $ 46,790,138 AAA, Aaa S & P and Moody s U.S. government agency securities 61,124,472 A-1+ S & P U.S. government agency securities 10,717,537 AAA, Aaa S & P and Moody s Money market 14,058,155 Aaa Moody s Money market 97,792,234 AAAm, Aaa S & P and Moody s Money market 130,266,345 N/A N/A Certificate of deposit 8,860,656 N/A N/A Commercial paper 52,283,902 N/A N/A Total investments $ 421,893,439 portfolio in securities (other than U.S. government, mutual funds, external investment pools, and other pooled investments) of any one issuer. More than 5% of the Fund s investments are in Federal Home Loan Bank, Federal Home Loan Mortgage, and Federal National Mortgage Association securities. These investments are 7%, 13%, and 7%, respectively, of the Fund s total investments. (3) Restricted Assets Restricted assets, principally cash and investments, are available for debt service on revenue bonds and to provide funds for improvements, enlargements, extensions, and construction. In certain instances, minimum levels of assets are required by bond ordinance provisions or by Board of Water Commissioners decree. These assets are maintained as follows: (1) With respect to the Bond and Interest Redemption Fund, after provision has (4) Capital Assets Capital asset activity for the fiscal years ended June 30, 2006 and 2005 is as follows: Balance, Balance, June 30, June 30, 2005 Additions Disposals 2006 Nondepreciated capital assets: Land and land rights $ 6,527,438 1,870 6,529,308 Construction in progress 418,027, ,675,454 (409,887,458) 140,815, ,554, ,677,324 (409,887,458) 147,344,464 Depreciated capital assets: Services, meters, and improvements to land 103,323,777 2,823,010 (61,475) 106,085,312 Structures 707,846, ,053,519 (359,250,642) 825,649,528 Mains 714,856, ,730,672 (102,998,885) 763,588,390 Equipment 630,635, ,020,895 (212,197,939) 864,457,966 Accumulated depreciation (688,863,364) (54,628,100) 423,184 (743,068,280) 1,467,798,677 1,022,999,996 (674,085,757) 1,816,712,916 Total $ 1,892,353,275 1,155,677,320 (1,083,973,215) 1,964,057,380 21

23 CITY OF DETROIT WATER FUND NOTES TO BASIC FINANCIAL STATEMENTS JUNE 30, 2006 AND 2005 (4) Capital Assets Capital asset activity for the fiscal years ended June 30, 2005 and 2006 is as follows: Balance, Balance, June 30, June 30, 2004 Additions Disposals 2005 Nondepreciated capital assets: Land and land rights $ 6,527,438 6,527,438 Construction in progress 679,745, ,715,631 (433,433,858) 418,027, ,272, ,715,631 (433,433,858) 424,554,598 Depreciated capital assets: Services, meters, and improvements to land 96,834,157 6,489, ,323,777 Structures 453,406, ,440, ,846,651 Mains 689,057,547 25,799, ,856,603 Equipment 492,782, ,004,268 (151,748) 630,635,010 Accumulated depreciation (647,652,745) (41,529,608) 318,989 (688,863,364) 1,084,427, ,203, ,241 1,467,798,677 Total $ 1,770,700, ,919,466 (433,266,617) 1,892,353,275 been made for expenses of operation and maintenance of the System, a sum proportionately sufficient to provide for payment, when due, of the current principal and interest is set aside. The Bond Reserve Account is part of the Bond and Interest Redemption Fund, and the amounts credited to this account are to be used only to pay principal and interest on the bonds when current revenues are not sufficient. (2) With respect to the Extraordinary Repair and Replacement Reserve Fund, after meeting the requirements of the foregoing funds, monthly deposits in an amount equal to one twelfth of 3% of the budgeted operation and maintenance expense of the System for the fiscal year must be set aside until the aggregate amount funded totals at least 15% of that year s budgeted operating and maintenance costs. These deposits are to be used for major unanticipated repairs and replacement to the System with actual or anticipated cost exceeding $1 million. Once this fund is fully funded, deposits required are amounts needed to maintain fully funded status. Borrowings of up to 50% of the balance in this fund on the first day of the related fiscal year are allowed for transfer to and use from the Improvement and Extension Fund. (6) Long-Term Obligations - Future debt service requirements as of June 30, 2006 are as follows: Bond Swap Total Principal interest interest requirements Year ending June 30: 2007 $ 25,535,000 93,995,842 25,260, ,791, ,025,000 93,168,039 25,540, ,733, ,145,000 91,782,661 25,499, ,426, ,755,000 90,148,553 25,453, ,356, ,625,000 88,720,191 25,364, ,709, ,743, ,440, ,130, ,314, ,225, ,333, ,104, ,663, ,090, ,434, ,020, ,545, ,620, ,380,804 66,156, ,157, ,980,000 69,464,886 35,724, ,169,727 $ 1,971,743,954 1,780,870, ,254,745 4,322,868,765 22

24 CITY OF DETROIT WATER FUND NOTES TO BASIC FINANCIAL STATEMENTS JUNE 30, 2006 AND 2005 Any such borrowings must be repaid prior to any deposits being made to the Improvement and Extension Fund. (3) After the above deposits have been made, excess amounts may be deposited in the Improvement and Extension Fund, established for the payment of improvements, enlargements, repairs, extensions, or betterment to the System. (4) With respect to the Construction Fund, the portion of the proceeds of the sale of bonds for building or improving the System is deposited in this fund. A separate depository account is required for each series of bonds. Proceeds for construction purposes received from federal and state grants and other sources that restrict the use of such proceeds are also deposited into this account. When both restricted and unrestricted resources are available for use, generally it is the Fund s policy to use restricted resources first, and then unrestricted resources when they are needed. The Fund s statement of net assets reports $81,914,130 of restricted net assets, of which $71,543,172 is restricted by enabling legislation. (5) Impaired Capital Assets Beginning fiscal year ended June 30, 2006, the Fund implemented GASB Statement No. 42. As of June 30, 2006, the Fund did not have impaired assets reportable under GASB Statement No. 42. (6) Long-Term Obligations The outstanding indebtedness of the Fund for revenue bonds was approximately $1,971,743,954 and $1,991, at June 30, 2006 and 2005, respectively. The interest rates on the outstanding fixed-rate revenue bonds range from 4.30% to 6.38%. Net revenues of the Fund are pledged to repayment of bonds. See chart on page 22. In fiscal 2005, the Fund issued $105,000,000 of City of Detroit, Michigan Water Supply System Revenue Senior Lien Bonds, Series 2005-A, $195,000,000 of City of Detroit, Michigan, Water Supply System Revenue refunding Second Lien Bonds (Variable Rate Demand), and Series 2005-B, $126,605,000 of City of Detroit, Michigan, Water Supply System Revenue Refunding Senior Lien Bonds, Series 2005-C. The net proceeds were used to refund a portion of the City s outstanding Water Supply Systems Revenue Bonds and Revenue Refunding Bonds and to pay cost of issuance associated with the 2005 Bonds. The proceeds of the Revenue Refunding Senior Lien Bonds, Series 2005-C will be used to (a) to advance-refund $69,285,000 principal amount of the City s Water Supply Revenue Senior Lien Bonds, Series 1997-A comprised of serial bonds maturing in the years 2010, 2016 and 2017: the 2018 through 2021 mandatory redemption payment for serial 1997-A term bonds maturing July 1, 2027 (Refunded 1997-A Bonds) with an average interest rate of 5.5% (b) to refund $56,700,000 principal amount of the City s Water Supply System Revenue Senior Lien Bonds, Series 1999-A bonds maturing in the years 2011 through 2018 with interest rate of 7.48% (Refunded 1999-A bonds and collectively with the Refunded 1997-A Bonds, and the Refunded bonds) and (c) for payment of the related costs of issuance, including the premium for the municipal bond insurance. Those refunded securities were deposited in an irrevocable trust with an escrow agent to provide for all future debt service payments on the Refunded 1999-A Bonds when due to including July 1, 2010 and redeem the Refunded 1997-A Bonds on July 1, 2007 at 101%. The advance refunding resulted in a difference between the reacquisition price and the net carrying amount of the old debt of $4,938,589. This difference, reported in the financial statements as a deduction from bonds payable, is being charged to operations through the year 2024 using the straight-line method. The Fund completed the advance refunding to reduce its total debt service payments over the next 20 years and to obtain an economic gain (difference between the present values of the old and new debt service payments) of $4,567,184. In prior years, the Fund defeased certain bonds by placing the proceeds of new bonds in an irrevocable trust to provide for all future debt service payments on the old bonds. Accordingly, the trust account assets and the liability for the defeased bonds are not included in the Fund s financial statements. Similarly, the interest expenses related to the defeased bonds and the related interest income earned on the escrow fund investments have not been recognized in the statements of revenues, expenses, and changes in fund net assets. As of June 30, 2006 and 2005, approximately $666,845,000 and $511,265,000 respectively, of bonds outstanding are considered defeased. Bonds outstanding at June 30, 2006 include $1,718,013,954 of bonds callable at various dates after June 30, These bonds are callable at varying premiums, depending on the issue and length of time to maturity. (7) Pension Obligation Certificates (POC s) 2005 Issuance In June 2005, the Detroit Retirement Systems Funding Trust issued $1,440,000,000 ($640 million of fixed rate, Series A, and $800 million of floating rate, Series B) of taxable Pension Obligation Certificates of Participation (POCs). The Trust was created by the General Retirement System Service Corporation (GRSSC) and the Police and Fire Retirement System Service Corporation (PFRSSC), both blended component units of the City. The City entered into service contracts with the GRSSC and PFRSSC to facilitate the transaction. 23

25 CITY OF DETROIT WATER FUND NOTES TO BASIC FINANCIAL STATEMENTS JUNE 30, 2006 AND 2005 The POC s were issued for the purpose of funding certain unfunded accrued actuarial liabilities (UAAL) of the two retirement systems of the City, which include the General Retirement System (GRS) and the Police & Fire Retirement System (PFRS), and a portion of the then current year normal contribution. The GRS includes employees and retirees of certain governmental funds, proprietary funds (Transportation Fund, Sewage Disposal Fund and Water Fund) and the Detroit Public Library, a discretely presented component unit. A proportionate amount of the liability was recorded on the books of the City s Governmental Activities, Transportation Fund, Sewage Disposal Fund and Water Fund, based on each fund s portion of the overall UAAL liquidated by the use of the 2005 POC net proceeds. In connection with the 2005 transactions, the Service Corporations entered into interest rate exchange agreements (swap agreements) to hedge the variable rate interest exposure associated with the issuance of the 2005 Series-B Certificates. The present value of the net economic loss from refunding of the COP s Series 2005 by the COP s Series 2006 is $89,265,111. Certificates of Participation Series 2006 $948,540,000 Cash flow requirements to service Series 2005 COP s $ 2,267,195,204 Less cash flow requirements for new COP s 2,356,736,036 Net loss from refunding actually realized in years 2026 to 2035 $ (89,540,832) Economic loss (annually) $ (89,265,111) The redemption dates and a summary of the aggregate principal and interest amounts for the remaining 2005 POC s are as follows: Primary Government Principal Business-type activities Governmental Sewer Disposal Transportation Water Maturity (June 15) activities Fund Fund Fund Totals 2007 $ ,861,370 28, , ,698 4,750, ,905,539 66, ,268 1,198,587 10,955, ,686, ,288 10,011,862 15,300, ,850, ,857,304 1,150,731 13,549,481 20,707, ,265, ,369,335 1,162,040 13,682,639 20,910, ,125,000 Total $ 435,680,410 3,258,545 38,368,303 58,637, ,945,002 Primary Government Interest Business-type activities Governmental Sewer Disposal Transportation Water Maturity (June 15) activities Fund Fund Fund Totals 2007 $ 20,942, ,636 1,844,333 2,818,669 25,762, ,942, ,636 1,844,333 2,818,669 25,762, ,942, ,636 1,844,333 2,818,669 25,762, ,942, ,636 1,844,333 2,818,669 25,762, ,776, ,390 1,829,663 2,796,249 25,557, ,492, ,248 8,233,418 12,583, ,007, ,177, ,077 5,299,514 8,099,174 74,025, ,083, ,212 1,768,692 2,703,068 24,705,859 Total $ 278,300,711 2,081,471 24,508,619 37,456, ,346,986 24

26 CITY OF DETROIT WATER FUND NOTES TO BASIC FINANCIAL STATEMENTS JUNE 30, 2006 AND 2005 The redemption dates and a summary of the aggregate principal and interest amounts for Series 2006 Pension Obligation Certificates are as follows: Primary Government Principal Business-type activities Governmental Sewer Disposal Transportation Water Maturity (June 15) activities Fund Fund Fund Totals 2007 $ ,557, ,982 2,955,235 4,516,445 41,280, ,689, ,408 7,458,175 11,398, ,179, ,531,321 2,382,363 28,051,539 42,870, ,836, ,309,285 2,500,370 29,441,030 44,994, ,245,000 Total $ 771,087,137 5,767,123 67,905, ,779, ,540,000 Primary Government Interest Business-type activities Governmental Sewer Disposal Transportation Water Maturity (June 15) activities Fund Fund Fund Totals 2007 $ 40,020, ,324 3,524,442 5,386,356 49,230, ,079, ,682 3,881,901 5,932,655 54,224, ,826, ,705 4,211,857 6,436,922 58,833, ,826, ,705 4,211,857 6,436,922 58,833, ,826, ,705 4,211,857 6,436,922 58,833, ,132,754 1,788,524 21,059,285 32,184, ,165, ,954,334 1,772,231 20,867,442 31,891, ,485, ,400,997 1,670,863 19,673,864 30,067, ,813, ,038,717 1,234,359 14,534,175 22,212, ,019, ,643, ,733 4,636,075 7,085,248 64,758,691 Total $ 1,144,750,720 8,561, ,812, ,070,728 1,408,196,034 (8) Deferred Amount on Refunding Governmental Transportation Water Disposal activities Fund Fund Fund Library POC payable 2005 Series $ 435,683,032 38,362,255 58,635,556 3,264,157 POC payable 2006 Series 771,087,136 67,905, ,779,761 5,767,123 Advance payable Primary Government 24,554,826 Deferred amount on refunding (24,733,155) (2,223,313) (3,397,859) (188,822) (513,048) Net POC Payable $ 1,182,037, ,044, ,017,458 8,842,458 24,041,778 Net advance payable to Primary Government $ 20,041,778 25

27 CITY OF DETROIT WATER FUND NOTES TO BASIC FINANCIAL STATEMENTS JUNE 30, 2006 AND 2005 The original Series A and Series B certificates were not specifically related to either of the Service Corporations. The amount of proceeds from the 2005 issuance recorded on each Service Corporation s books was based on the respective proportion of UAAL funding required for the corresponding Pension System. Fiscal Year 2006 Events Michigan law entitles each Retirement System to have its UAAL funded over a specified period (Amortization Period), which may be duly changed up to a 30-year maximum. Each 2005 Service Contract required the City to make 2005 POC service payments over a period that was limited to the PFRS or GRS Amortization Period (13 years for PFRS and 20 years for the GRS). The funding Ordinance anticipated the possible future extension of the PFRS and GRS Amortization Periods and authorized the Service Corporations, in that event, to assist the City in gaining the financial benefits of making its 2005 POC Service payments over a similarly lengthened period. On February 8, 2006, the governing board of the GRS extended the Amortization Period for GRS UAAL from 20 to 30 years. On March 30, 2006, the governing board of the PFRS UAAL extended the amortization period for PFRS UAAL from 13 to 30 years. The Taxable Certificates of Participation Series 2006 were issued to enable the City to replace certain scheduled payment obligations that it incurred to provide funding for the 2005 Subject UAAL with new scheduled payment obligations payable over the extended 30-year periods under the 2006 Service Contracts. This will enable the City to achieve financial benefits from the lengthened payment periods compared to the payment period included within the 2005 Series A and B payment schedules. Accordingly, the Detroit Retirement Systems Funding Trust 2006 issued $948,540,000 ($148,540,000 of fixed rate Series A, and $800 million of floating rate Series B) of taxable Series The City also terminated the Swap agreements entered into in the 2005 transaction and received $48,932,455 as a result of the swap termination. The City did not pay off the $104,055,000 of optionally redeemed Series A 2005 POC s until July 13, At June 30, 2006 the portion of the 2006 POC s proceeds to pay the $104,055,000 POC s were in irrevocable trust investment accounts. (9) Long-Term Liabilities - Long-term activity for the years ended June 30, 2006 and 2005 is as follows: Balance, Balance, due within June 30, 2005 Increase Decrease June 30, 2006 one year Revenue bonds payable $ 1,991,615,000 (24,595,000) 1,967,020,000 25,535,000 State revolving loan 4,723,954 4,723,954 Total revenue bonds payable 1,991,615,000 4,723,954 (24,595,000) 1,971,743,954 25,535,000 Add unamortized premium 17,976,690 (1,078,078) 16,898,612 Less: Deferred charges on refunding 49,223,977 6,221,498 55,445,475 Discount 20,478,334 (13,218,935) 7,259,399 Net revenue bonds 1,939,889,379 (1,497,544) (12,454,143) 1,925,937,692 25,535,000 Pension obligation certificates payable 2005 series 157,548,214 (98,912,658) 58,635,556 Pension obligation certificates payable 2006 series 103,779, ,779,761 Less deferred defeasance cost 3,397,859 3,397,859 Net pension obligation certificate payable 157,548, ,381,902 (98,912,658) 159,017,458 Other liabilities: Accrued workers compensation 18,711,346 4,356,803 (4,956,733) 18,111,416 2,913,177 Accrued compensated absences 18,413,672 5,103,411 (4,888,782) 18,628,301 3,715,980 Deferred swap termination 16,797,795 (584,271) 16,213,524 Total other liabilities 53,922,813 9,460,214 (10,429,786) 52,953,241 6,629,157 Total $ 2,151,360, ,344,572 (121,796,587) 2,137,908,391 32,164,157 26

28 CITY OF DETROIT WATER FUND NOTES TO BASIC FINANCIAL STATEMENTS JUNE 30, 2006 AND 2005 (9b) Long-Term Liabilities Amount Balance, Balance, due within June 30, 2004 Increase Decrease June 30, 2005 one year Revenue bonds payable $ 1,713,435, ,605,000 (148,425,000) 1,991,615,000 24,595,000 Add unamortized premium 6,257,305 12,302,729 (583,344) 17,976,690 Less: Deferred charges on refunding 44,223,565 8,298,346 (3,297,934) 49,223,977 Discount 21,604,144 (1,125,810) 20,478,334 Net revenue bonds 1,653,864, ,609,383 (144,584,600) 1,939,889,379 24,595,000 Pension obligation certificates payable 157,548, ,548,214 Other liabilities: Accrued workers compensation 15,778,254 7,345,178 (4,412,086) 18,711,346 3,470,751 Accrued compensated absences 15,589,521 4,203,964 (1,379,813) 18,413,672 8,604,763 Deferred swap termination 16,943,863 (146,068) 16,797,795 Total other liabilities 48,311,638 11,549,142 (5,937,967) 53,922,813 12,075,514 Total $ 1,702,176, ,706,739 (150,522,567) 2,151,360,406 36,670,514 (10) Derivatives Not Reported at Fair Value Sweep Associated Notional Effective Fixed rate Variable rate Fair termination Final maturity Counterparty financing issue amounts (1) date paid received values date of bonds credit rating Water 2001-C (3) $ 47,723,000 6/7/ % BMA $ 1/1/2006 7/1/2029 (3) Aaa/AA+NR Water 2001-C (3) 29,972,000 6/7/ BMA (1,214,171) 7/1/2011 7/1/2029 (3) Aaa/AA+NR Water 2001-C (3) 47,628,000 1/1/ BMA (3,490,184) 7/1/2011 7/1/2029 (3) Aaa/AA+NR Water 2001-C 114,150,000 6/7/ BMA (10,802,162) 7/1/2026 7/1/2026 Aa3/A+/AA Water 2003-B 1,980,000 1/30/ CPI % 57,777 7/1/2009 7/1/2009 Aa3/A+/AA Water 2003-B 2,290,000 1/30/ CPI % 67,167 7/1/2010 7/1/2010 Aa3/A+/AA Water 2003-B 2,500,000 1/30/ CPI % 74,359 7/1/2011 7/1/2011 Aa3/A+/AA Water 2003-B 2,175,000 1/30/ CPI % 59,662 7/1/2012 7/1/2012 Aa3/A+/AA Water 2003-B 2,800,000 1/30/ CPI % 66,848 7/1/2013 7/1/2013 Aa3/A+/AA Water 2003-B 2,505,000 1/30/ CPI % 47,560 7/1/2014 7/1/2014 Aa3/A+/AA Water 2003-C 2,005,000 1/30/ CPI % 47,885 7/1/2013 7/1/2013 Aa3/A+/AA Water 2003-C 2,330,000 1/30/ CPI % 44,237 7/1/2014 7/1/2014 Aa3/A+/AA Water 2003-D 150,545,000 2/6/ BMA (3,674,234) 7/1/2033 7/1/2033 Aa2/AA-/NR Water 2004-A 77,010,000 5/13/ BMA (903,397) 7/1/2025 7/1/2025 Aa2/AA-/NR Water 2004-B 163,590,000 5/13/ BMA (856,979) 7/1/2023 7/1/2023 Aa2/AA-/NR Water 2005-B 195,000,000 4/1/ BMA (6,703,870) 7/2/2035 7/2/2035 Aa3/A+/AA- Water Forward St art ing Swap 120,000,000 3/1/ BMA (7,616,810) 7/3/2036 7/3/2036 Aa3/A+/AA- Pension Obligation 99,621,000 6/7/ MTH LIBOR (183,936) 6/15/2034 6/15/2034 Aa3/A+/AA- Certificates-GRS +.34% Pension Obligation 42,252,000 6/7/ MTH LIBOR (84,084) 6/15/2029 6/15/2029 Aa3/A+/AA- Certificates-GRS +.30% (1) Notional amount balance as of June 30, 2006 (2) The Bond Market Association Municipal Swap Index (3) Denotes the the swap termination date does not match the final maturity of the financings 27

29 CITY OF DETROIT WATER FUND NOTES TO BASIC FINANCIAL STATEMENTS JUNE 30, 2006 AND 2005 Retirement Trust 2006 account statements reflect that, on July 13, 2006 approximately $104,404,000 of funds were disbursed to pay the POC s service obligation and accrued interest from June 15, 2006 (the last interest payment date) to July 13, In economic substance, the City paid off $904,055,000 of 2005 Series Certificates with the net proceeds from the $948,540,000 received from the issuance of the 2006 POC. The net effect of this on the City s balance sheet is to add on additional $44,485,000 of POC obligations to the governmentwide balance sheet. The present value of the net economic loss from refunding of the COP s Series 2005 by the COP s Series 2006 is $89,265,111. See chart on page 24. Certain maturities of the Series 2005-A POCs still remain outstanding concurrently with the 2006 Certificates. The 2005 POCs and the 2006 Certificates are wholly independent of each other. See charts on page 24 and 25. (8) Deferred Amount on Refunding See chart on page 25 for the calculation of the total deferred amount on refunding and the effect on the Pension Obligation Payable by each fund. The total Deferred Amount on Refunding is comprised of the amount transferred from Series 2005 issuance costs of $27,651,925 plus tender and redemption premiums paid of $3,404,274, or a total of $31,056,197. It will be amortized over the remaining life of the old POC s Series 2005 (19 years), which is shorter than the life of the new POC s Series 2006 (29 years). (9) Long-Term Liabilities Long-term activity for the years ended June 30, 2006 and See charts on page 26 and 27. (10) Derivatives Not Reported at Fair Value The Fund is party to derivative financial instruments consisting of interest rate swaps that are intended to effectively convert variable-rate financings to fixed-rate financings. These are not reported at fair value on the statement of net assets at June 30, See chart on page 27. Objective of the Swaps. In order to better manage its interest rate exposure and to reduce the overall costs of its financings, the Fund has entered into 15 separate fixed-payor interest rate swaps. The Fund is also a party in the City s POC s related to the GRS. The City has entered into two separate fixed-payor interest rate swaps related to the POC s and the GRS. Market Access Risk. The Fund is exposed to market access risk on its hedge swaps or forward starting swaps in the event that it will not be able to enter credit markets or in the event that credit will become more costly. Terms, Fair Values, and Credit Risk. Certain key terms, fair market values, and counterparty credit ratings relating to the outstanding swaps as of June 30, 2006 are presented below. The notional amounts of the swaps, except those with effective dates of September 1, 2006 and March 1, 2007, match the principal amounts of the outstanding financings. The swaps with effective dates of September 1, 2006 and March 1, 2007, were entered into to hedge future interest rate risk and will be associated with financings expected to be issued prior to the effective dates. Except as discussed under rollover risk, the Fund s swap agreements contain scheduled reductions to outstanding notional amounts that match scheduled or anticipated amortization of associated financings. Fair Value. Because interest rates have generally declined since the time the swaps were negotiated, most of the Fund s swaps have a negative fair value as of June 30, The negative fair values may be countered by lower total interest payments required under the variable-rate financings, creating lower synthetic interest rates. Credit Risk. As of June 30, 2006, the Fund was not significantly exposed to net credit risk, as the majority of the swaps had net negative fair values. However, should interest rates change and fair values of the swaps become positive, the Fund would be exposed to credit risk in the amount of the derivatives positive fair value. The swap agreements contain varying collateral agreements with the counterparties. The swaps require full collateralization of the fair value of the swap should the counterparty s credit rating fall below certain rating levels by Fitch Ratings, Standard & Poor s, and/or Moody s Investors Service. Collateral on all swaps is to be in the form of U.S. government securities held by a third-party custodian. Basis Risk. The Fund is not exposed to significant basis risk on its swaps because most of the variable payments received are based on the Bond Market Association (BMA) index. The Consumer Price Index (CPI) indexed swaps are associated with CPI indexed financings and thus create no basis risk. Termination Risk. The Fund or counterparty may terminate any of the swaps if the other party fails to perform under the terms of the contract. In such cases, the Fund may owe or be due a termination payment, depending on the value of the swap at that time. In addition, the Fund is exposed to termination risk, but not termination payments, on certain of the Fund s swaps related to Water Series 2001-C, Water Series 2003-D, Water Series 2004-A, and Water Series 2004-B. These swaps provide the counterparty with the option to terminate the swap agreement beginning on January 1, 2010, July 2, 2011, July 1, 2008, and July 1, 2008, respectively, upon the passing of certain BMA thresholds. If any of 28

30 CITY OF DETROIT WATER FUND NOTES TO BASIC FINANCIAL STATEMENTS JUNE 30, 2006 AND 2005 these swaps were terminated, the associated variable-rate financings would no longer carry synthetic interest rates, but there would be no termination payment. Rollover Risk. The Fund is exposed to rollover risk on swaps that mature or may be terminated prior to the maturity of the associated financings. When these swaps terminate or, in the case of the termination option, if the counterparty exercises its option, the Fund will not realize the synthetic rate offered by the swaps on the underlying issues. The Fund has this risk for the three (3) Water Series 2001-C financing issues. (11) Employee Benefit Plan Substantially all City employees, including the Water Fund employees, are covered by a single-employer plan composed of a defined benefit with an optional employee-contributed annuity through the GRS. The GRS pays a monthly pension to qualified individuals upon retirement. The amount is based upon a combination of years of service and annual salary. Plan Description The GRS is administered in accordance with the City of Detroit Charter and union contracts, which assign the authority to establish and amend contributions and benefit provisions to the Retirement System s board of trustees. The GRS issues separate, stand-alone financial statements annually. Copies of these financial statements can be obtained at the Coleman A. Young Municipal Center, 2 Woodward Ave., Rm. 908, Detroit, Michigan, Funding Policy The GRS funding policy provides for periodic employer contributions at actuarially determined rates that, expressed as percentages of annual covered payroll, are sufficient to accumulate sufficient assets to pay benefits when due. The contribution requirements are established and may be amended by the GRS s board of trustees based on information provided by the GRS s consulting actuary. The City s contribution is set by the City Council in conjunction with its approval of the City s annual budget based on information provided by the GRS s consulting actuary. The recommended contribution rate is determined by the GRS s consulting actuary using the entry age normal actuarial cost funding method. Significant actuarial assumptions used to compute contribution requirements are the same as those used to compute the actuarial accrued liability. Based upon the June 30, 2005 actuarial valuation, which was the most recent actuarial data available when the budget was developed for the year ended June 30, 2006, the actuary recommended a Water Fund contribution rate of 20.84%. Contributions for the Water Fund totaled $5,156,381. Employees may elect to contribute 3%, 5%, or 7% of the first $90,000 of annual compensation and 5% or 7% of any excess over $90,000 for annuity savings. Contributions are voluntary for all union and nonunion employees. Contributions received from Water Fund employees during the year ended June 30, 2006 amounted to $3,032,044. (11) Administrative Expenses Annual Percentage Net Fiscal year pension of APC pension ended cost (APC) contributed asset General Retirement System June 30, 2004 $ 16,814, $ June 30, ,571, ,452,508 June 30, ,018, ,590,274 (11 b) The annual pension cost and net pension asset as of June 30, 2006 is as follows: Annual required contributions $ 10,457,713 Interest on net pension asset (11,885,748) Adjustment to annual required contribution 8,446,650 Annual pension cost 7,018,615 Contributions made (employer) 5,156,381 Changes in net pension asset (1,862,234) Net pension asset, beginning of year 150,452,508 Net pension asset, end of year $ 148,590,274 29

31 CITY OF DETROIT WATER FUND NOTES TO BASIC FINANCIAL STATEMENTS JUNE 30, 2006 AND 2005 (11 c) The actuarial methods and significant assumptions used to determine the annual required contributions for June 30, 2006 were as follows: Actuarial cost method Amortization method Remaining amortization period for unfunded accrued liabilities** Asset valuation method Entry age Level percent 30 years 3-year smoothed market Actuarial assumptions: Investment rate of return 7.9% Projected salary increases* 4% 9.5% Cost-of-living adjustments* 2.25% *Includes inflation rate of 4% **Amortization period was changed in FY 2006, see note 7. (12) Other Post-Employment Benefits The costs of benefits, which are financed on a pay-as-you-go basis, for the year ended June 30, 2006, are as follows: City Retiree Total Benefits cost cost cost Hospitalization $ 139,306,757 14,933, ,240,265 Dental 6,160,524 6,160,524 Eye care 1,969,690 1,969,690 Life insurance 143,579 26, ,319 $ 147,580,550 14,960, ,540,798 The contribution requirements of plan members and the City are established and may be amended by the board of trustees in accordance with the City Charter, union contracts, and plan provisions. Members may retire with full benefits after attaining 30 years of service; age 55 with 30 years of service if hired after January 1, 1996; age 60 with 10 years of service; or age 65 with 8 years of service. Employees may retire after 25 years of service and collect an actuarially reduced retirement benefit. Monthly pension benefits, which are subject to certain minimum and maximum amounts, are determined according to fixed rates per year of credited service. Members of the GRS who separated prior to July 1, 1981, met the age and service requirements, and who did not withdraw their accumulated annuity contributions are generally eligible for a pension at the time they would have been eligible had they continued in City employment. Members who separate after July 1, 1981 are not required to leave their accumulated annuity contributions in the System. Pension benefits for all members of the GRS are increased annually by 2.25% of the original pension. Administrative Expenses Actuarial investment management and bank trustee fees and expenses are included in the GRS plan s administrative expenses when incurred. In addition, the GRS plan s administrative salary, rent, accounting services, duplicating, telecommunications, and travel expenses are included in the GRS plan s administrative expenses when incurred. (12) Other Post-Employment Benefits In addition to the pension benefits described above, the City provides postretirement benefits to its retirees, which include hospitalization, dental care, eye care, and life insurance, The number of City retirees at June 30, 2006 is 22,451. Costs are accounted for in accordance with GASB Statement No. 12, Disclosure of Information on Postemployment Benefits Other Than Pension Benefits by State and Local Governmental Employers. The benefits are provided in accordance with the City Charter and union contracts. (13) Due to (from) Other Funds During the course of operations, numerous transactions occur between individual funds and other City of Detroit funds for goods provided or services rendered. Related receivables and payables are classified as due from other funds or due to other funds on the balance sheets and are summarized. See chart on page

32 CITY OF DETROIT WATER FUND NOTES TO BASIC FINANCIAL STATEMENTS JUNE 30, 2006 AND 2005 (13) Due to (from) Other Funds Due from other funds (unrestricted): General Fund $ 804, ,819 Sewage Disposal Fund 56,079,411 52,391,479 Total due from other funds $ 56,884,330 53,149,298 Due from other funds (restricted): General Fund $ 357,919 33,628,639 Sewage Disposal Fund 5,663,541 6,846,660 Total due from other funds $ 6,021,460 40,475,299 Due to other funds (unrestricted): General Fund $ 6,038,572 17,324,357 General Fiduciary 506,181 Sewage Disposal Fund 47,328,259 48,558,282 Total due to other funds $ 53,873,012 65,882,639 Due to other funds (restricted): General Fund $ 33, ,175 Sewage Disposal Fund 10,948,627 6,225,399 Total due to other funds $ 10,982,590 6,515,574 (14) Capital Improvement Programs The Fund is engaged in a variety of projects that are a part of its five-year Capital Improvement Program (the Program). The total cost of this program is anticipated to be approximately $1.68 billion through fiscal year The Program is being primarily financed from revenues of the Fund and proceeds from the issuance of revenue bonds. The total amount of construction contract commitments outstanding at June 30, 2006 and June 30, 2005 was approximately $156 million and $101 million, respectively. (15) Rate Adjustments The U.S. Environmental Protection Agency (EPA), in attempting to ensure that user charges are proportional in effect as well as in their design, requires grantees to compare budgeted wastewater contributions, revenues from users, and user classes to actual results and make appropriate rate adjustments in the second succeeding year. The accompanying financial statements reflect management s estimates of the current and noncurrent amounts receivable from and refundable to customers in accordance with the regulations. Although subsequent adjustments to these amounts may occur, management does not believe the impact would be material to the Fund s financial position or results of operations. (16) Contingencies The Fund is also a defendant in numerous alleged claims, lawsuits, billing disputes, and other stated and pending demands. The Fund and the City s Legal Department have estimated a reserve, which is included in the accompanying financial statements, for the potential outcome of such claims or the amount of potential damages in the event of an unfavorable outcome for each of the above contingencies. The Fund s management and the City s Legal Department believe that any differences in reserved amounts and final settlement, after consideration of claims covered by insurance, resulting from such litigation will not materially impact the Fund s financial position or results of operations. The City holds various commercial insurance policies to cover potential loss exposures. (17) Subsequent Events On August 14, 2006 the Water Supply System issued $1,136,585,000 of Series 2006 bonds to finance a portion of the costs of the Water Supply System capital improvement program, refund certain prior outstanding bonds, fund reserve requirements and pay cost of issuance of the 2006 Bonds. These were comprised of: (1.) $767,235,000 of new issued bonds ($280,000,000 Revenue Senior Lien Bonds-Series 2006(A), 31

33 CITY OF DETROIT WATER FUND NOTES TO BASIC FINANCIAL STATEMENTS JUNE 30, 2006 AND 2005 $120,000,000 System Revenue Second Lien Bonds (Variable Rate Demand), Series 2006 (B), $220,645,000 Revenue Refunding Second Lien Bonds, Series 2006 (C), and, $146,590,000 Revenue Refunding Senior Lien Bonds, Series 2006 (D). The Series (A) bonds begin to mature July 1, 2007 and will fully mature in the year The Series (B) bonds mature July 1, The Series 2006 (C) and (D) both begin to mature July 1, 2007 and will fully mature in the years 2012 and 2013, respectively. (2.) $142,755,000 of refunded fixed rate Revenue Senior Lien Bonds Series 2003(D). These were remarketed/converted on September 1, 2006 and begin maturing January 1, (3.) $226,595,000 of Refunded Revenue Senior Lien Bonds, Series 2004(A) and (B). ($72,765,000 Refunding Second Lien Bonds fixed rate Series 2004(A) and $153,830,000 Refunding Senior Lien Bonds fixed rate Series 2004(B)). Both of the Series 2004 Bonds have a remarketing date of August 16, In September 2005, several customers of the Fund challenged the method of allocating costs associated with the 800 MHz project. In early 2007, the court issued a preliminary ruling acknowledging that the Fund had been overcharged, but is yet to issue a final ruling. In management s opinion, the final resolution will not have a material effect on the Fund s financial statements. The Fund issued Revenue Refunding bonds that are insured with bond insurance coverage purchased through rated bond insurers. The bond insurance helps the Fund to obtain a lower cost of borrowing. As of February 20, 2008 the major rating agencies downgraded one of the Fund s bond insurers. The rating of the Fund s bonds that are insured by the downgraded bond insurer has not been affected. See accompanying independent auditors report. REQUIRED SUPPLEMENTARY INFORMATION Schedule of Funding Progress (in millions) for the General Retirement System (unaudited): Actuarial Actuarial valuation Actuarial accrued Unfunded date, value of liability Funded AAL Covered June 30 assets (AAL) ratio (UAAL) payroll 2001 (a) (b) $ 2, , % $ , , , , , , , , (a) After changes in actuarial assumptions. (b) Plan amended. 32

34 SUBURBAN CUSTOMERS SERVED WITH SEWERAGE SERVICES BY DETROIT WATER AND SEWERAGE DEPARTMENT - FY Listed By Date Service Began Since No. Community Since No. Community 1940 City of Detroit Bloomfield Township City of Grosse Pointe City of Bloomfield Hills City of Grosse Pointe Farms City of Farmington Hills City of Grosse Pointe Park City of Keego Harbor City of Grosse Pointe Woods City of Lathrup Village City of Hamtramck City of Auburn Hills City of Harper Woods City of Allen Park City of Highland Park Canton Township Redford Township City of Romulus St. Clair Shores Van Buren Township City of Southfield City of Inkster City of Berkley City of Wayne City of Clawson City of Sylvan Lake* City of Ferndale City of Novi City of Hazel Park Village of Bingham Farms City of Huntington Woods City of Rochester Hills City of Oak Park Chesterfield Township City of Pleasant Ridge Harrison Township City of Royal Oak Village of Lake Orion Royal Oak Township Orion Township City of Troy Oxford Township City of Eastpointe City of Sterling Heights City of Roseville Waterford Township City of Dearborn Clinton Township City of Dearborn Heights City of Fraser City of Birmingham Independence Township City of Center Line Oakland Township City of Garden City Village of Oxford Village of Grosse Pointe Shores City of Utica City of Livonia Village of Clarkston City of Northville Macomb Township Northville Township Shelby Township City of Plymouth West Bloomfield Township Plymouth Township City of Orchard Lake Village City of Westland Washington Township City of Farmington New Haven City of Madison Heights Lenox Township City of Melvindale Franklin Village Village of Beverly Hills City of Rochester Please Note: All Townships and Villages are called out; the rest are Cities. * Sylvan Lake is no longer served 33

35 REGIONAL WASTEWATER DISTRICTS DETROIT WATER AND SEWERAGE DEPARTMENT Name of District 34

36 KPMG LLP 150- West Jefferson, Suite 1200 Detroit, MI Independent Auditor s Report The Board of Water Commissioners, the Honorable Mayor, and Members of the City Council City of Detroit, Michigan: We have audited the accompanying basic financial statements of the Sewage Disposal Fund (the Fund), an enterprise fund of the City of Detroit, Michigan (the City), as of and for the years ended June 30, 2006 and 2005, as listed in the table of contents. These basic financial statements are the responsibility of the Fund s management. Our responsibility is to express an opinion on these basic financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America and the standards applicable to financial audits contained in Government Auditing Standards, issued by the Comptroller General of the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the basic financial statements are free of material misstatement. An audit includes consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the City s internal control over financial reporting of the Fund. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the basic financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall fmancial statement presentation. We believe that our audits provide a reasonable basis for our opinion. As discussed in Note 1, the financial statements referred to above present only the Sewage Disposal Fund of the City and are not intended to present fairly the financial position of the City as of June 30, 2006 and 2005, and the changes in its financial position, and, where applicable, cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles. In our opinion, the basic financial statements referred to above present fairly, in all material respects, the financial position of the Sewage Disposal Fund of the City as of June 30, 2006 and 2005, and the changes in its net assets and its cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles. In accordance with Government Auditing Standards, we also audited the financial statements of the City, as described above in this report on the Fund s financial statements. This report does not include the results of our testing of internal control over financial reporting and on our tests of the City s compliance with certain provisions of laws, regulations, contracts, and grant agreements and other matters that are reported on separately by us for the City. The purpose of that report is to describe the scope of our testing of internal control over financial reporting and compliance and the results of that testing, and not to provide an opinion on the internal control over financial reporting or on compliance. That report is an integral part of an audit performed in accordance with Government Auditing Standards and should be considered in assessing the results of our audit. The Fund has not presented Management s Discussion and Analysis, which U.S. generally accepted accounting principles have determined is necessary to supplement, although not required to be part of, the basic financial statements. The schedule of funding progress on page 30 is not a required part of the basic financial statements but is supplementary information required by U.S. generally accepted accounting principles. We have applied certain limited procedures, which consisted principally of inquiries of management regarding the methods of measurement and presentation of the required supplementary information. However, we did not audit the information and express no opinion on it. August 20, 2007 KPMG LLP, a U.S. limited liability partnership, is the U.S. member firm of KPMG International, a Swiss cooperative. 35

37 CITY OF DETROIT SEWAGE DISPOSAL FUND STATEMENTS OF NET ASSETS, JUNE 30, 2006 AND 2005 Assets Current assets: Cash and Cash Equivalents $ 5,418,283 Investments 47,205,044 47,948,538 Due from other funds 52,798,669 66,388,078 Accounts receivable (including $50,156,539 and $41,695,332 for unbilled sewage services and net of allowance for doubtful accounts of $85,033,589 and $64,482,340 for June 30, 2006 and 2005, respectively) 101,428,204 88,501,230 Rate adjustments receivable from customers 46,062,009 12,174,737 Prepaid expenses 5,423, ,847 Inventories 10,456,963 11,173,380 Restricted cash 39,168,566 21,666,661 Restricted investments 312,884, ,046,651 Restricted due from other funds 5,541,786 37,638,549 Total current assets 626,387, ,919,671 Noncurrent assets: Restricted long-term investments 111,020, ,770,507 Net pension asset 8,371,380 7,850,281 Noncurrent rate adjustments receivable from customers 30,820,615 44,946,430 Issuance costs pension obligation certificates of participation 509, ,646 Unamortized bond issuance costs 33,720,782 35,433,200 Capital assets: Land 13,834,957 13,876,751 Structures 1,703,001,142 1,143,914,922 Interceptors, regulators, and improvements 474,689, ,769,689 Equipment 1,385,071, ,031,859 Construction work in progress 310,502,398 1,219,986,063 Total capital assets 3,887,099,080 3,628,579,284 Less accumulated depreciation (750,972,844) (681,127,715) Net capital assets 3,136,126,236 2,947,451,569 Total noncurrent assets 3,320,569,000 3,344,738,633 Total assets $ 3,946,956,737 3,896,658,304 36

38 CITY OF DETROIT SEWAGE DISPOSAL FUND STATEMENTS OF NET ASSETS, JUNE 30, 2006 AND 2005 Liabilities and Net Assets Current liabilities: Current liabilities payable from current assets: Book cash overdraft $ 758,762 Accounts and contracts payable 13,303,914 7,683,870 Due to other funds 57,747,466 53,133,721 Accrued salaries and wages 1,246,496 1,629,152 Rate adjustments payable to customers 7,054,465 4,938,657 Accrued workers compensation 811, ,155 Accrued compensated absences 2,281,068 5,556,011 Other current accrued liabilities 958, ,691 Total current liabilities payable from current assets 83,403,300 75,350,019 Current liabilities payable from restricted assets: Revenue bonds and revolving loan payable within one year 53,205,000 50,035,000 Accrued bond interest payable 41,115,497 38,654,433 Other liabilities 89,017 Accounts and contracts payable 35,307,217 62,465,874 Due to other funds 10,262,102 11,074,002 Total current liabilities payable from restricted assets 139,889, ,318,326 Total current liabilities 223,293, ,668,345 Long-term liabilities: Revenue bonds and revolving loan payable 2,611,323,633 2,609,004,255 Pension obligation certificates of participation payable 9,031,280 8,760,811 Deferred swap termination fees 2,504,243 2,286,256 Rate adjustments payable to customers 2,610,365 7,054,465 Accrued workers compensation 4,321,980 3,832,814 Accrued compensated absences 11,618,703 8,361,795 Total long-term liabilities 2,641,410,204 2,639,300,396 Total liabilities 2,864,703,320 2,876,968,741 Net assets: Invested in capital assets, net of related debt 532,734, ,808,681 Restricted for capital acquisitions and bond payments 303,465, ,369,102 Unrestricted 246,053, ,511,780 Total net assets $ 1,082,253,417 1,019,689,563 Total Liabilities liabilities and net assets $ 3,946,956,737 3,896,658,304 37

39 CITY OF DETROIT SEWAGE DISPOSAL FUND STATEMENTS OF REVENUES, EXPENSES, AND CHANGES IN FUND NET ASSETS, JUNE 30, 2006 AND Operating revenues: General customers $ 160,510, ,456,155 Suburban customers 188,762, ,120,913 City departments 530, ,062 Sewage surcharge 774,798 5,914,639 Miscellaneous 3,876,014 2,815,506 Total operating revenues, net 354,455, ,588,275 Operating expenses before depreciation: Sewage treatment plant 123,392, ,536,940 Interceptors and regulators 1,237, ,870 Sewer pumping stations 2,963,775 3,122,298 Sewer maintenance and engineering 15,775,123 12,348,658 Combined sewage overflow control basins 1,697, ,252 Commercial 5,870,839 5,698,629 Administrative and general [includes bad debt] 46,666,958 37,441,707 Total operating expenses before depreciation 197,603, ,400,354 Operating income before depreciation 156,851, ,187,921 Depreciation 69,951,016 44,053,316 Total operating income 86,900, ,134,605 Nonoperating revenues (expenses): Earnings on investments 18,920,649 14,930,952 Interest expense, net of capitalized interest (43,912,587) (44,205,957) Miscellaneous 655,601 (7,038) Total nonoperating expense (24,336,337) (29,282,043) Increase in net assets 62,563,854 76,852,562 Net assets beginning of year 1,019,689, ,837,001 Net assets end of year $ 1,082,253,417 1,019,689,563 See accompanying notes to basic financial statements. 38

40 CITY OF DETROIT SEWAGE DISPOSAL FUND STATEMENTS OF CASH FLOWS, JUNE 30, 2006 AND Cash flows from operating activities: Receipts from customers $ 320,864, ,617,651 Internal activity - Payments to other funds 49,488,016 (18,598,461) Payments to suppliers (156,302,328) (124,774,098) Payments to the General Retirement System in excess of annual required contributions (7,850,281) Payments to employees (69,072,910) (68,354,091) Net cash provided by operating activities 144,977, ,040,720 Cash flows from non capital and related financing activities: Proceeds from issuance of Personal Obligation Certificates of participation 8,760,811 Issuance costs-pension Obligation Certificates of Participation 170,460 (286,646) Bank overdraft 758,762 Net cash Net provided cash provided by non by capital non and capital related and financing related activities financing activities 170,460 9,232,927 Cash provided by capital and related financing activities: Contributions received from customers 655,600 Acquisition and construction of capital assets, net (204,612,868) (364,680,084) Principal paid on revenue bond maturities and revolving loan (27,840,000) (32,590,000) Interest paid on revenue bonds (95,464,337) (82,010,501) Principal paid on refunded debt (108,765,000) Proceeds from bond issuance and increase in revolving note payable, net 31,459, ,848,891 Swap termination fee (11,750,000) Unamortized discount and bond issuance cost 3,756,736 2,542,333 Net cash used in capital and related financing activities (292,045,320) (170,404,361) Cash flows from investing activities: Proceeds from sales and maturities of investments 622,765, ,726,904 Purchase of investments (471,109,766) (623,524,459) Interest received on investments 18,920,649 14,930,952 Net cash used in investing activities 170,576,580 43,133,397 Net increase in cash 23,678,951 (10,997,317) Cash at beginning of year 20,907,898 31,905,215 Cash at end of year $ 44,586,849 20,907,898 Reconciliation of operating income to net cash provided by operating activities: Operating income $ 86,900, ,134,605 Adjustments to reconcile operating income to net cash provided by operating activities: Depreciation 69,951,016 44,053,316 Provision for uncollectible accounts 20,551,250 21,580,685 Changes in certain assets and liabilities: (Increase) decrease in accounts receivable (33,478,223) 2,510,949 (Increase) in rate refund receivable from customers (19,761,457) (21,982,296) (Increase) in prepaid expenses (5,041,957) (375,967) (Increase) decrease in inventories 716,417 (282,877) (Increase) in Net Pension Asset (521,099) (7,850,281) (Decrease) in accounts and contracts payable (21,538,613) (22,701,285) Increase (decrease) in accrued salaries and wages (382,656) 173,323 Increase (decrease) in rate refund payable to customers (2,328,292) 2,615,338 Increase in other accrued liabilities and accrued compensated absences and accrued workers compensation 422,638 1,763,672 Net change in due from (to) other funds 49,488,016 (18,598,462) Net cash provided by operating activities $ 144,977, ,040,720 See accompanying notes to financial statements. 39

41 CITY OF DETROIT SEWAGE DISPOSAL FUND NOTES TO BASIC FINANCIAL STATEMENTS, JUNE 30, 2006 AND 2005 (1) Summary of Significant Accounting Policies The City of Detroit (the City) Charter established the Water and Sewerage Department (the Department) in the year 1836 to supply water, drainage, and sewage service within and outside the City under the administration of the Board of Water Commissioners. The Sewage Disposal Fund (the Fund), an enterprise fund, separately accounts for the Sewage Disposal System (the System), as is required by bond ordinances of the City. The following is a summary of the more significant accounting policies followed in the preparation of the Fund s basic financial statements. These policies conform to U.S. generally accepted accounting principles. The basic financial statements of the Fund have been included in the City of Detroit s Comprehensive Annual Financial Report and reported as an Enterprise fund. Copies of these reports, along with other financial information, can be obtained at the Fund s administrative office located at 735 Randolph, Detroit, Michigan, (a) Basis of Accounting The accounting policies of the Fund conform to U.S. generally accepted accounting principles (GAAP) as applicable to governmental entities. The accounts of the Fund, which are organized as an enterprise fund, are used to account for the Fund s activities, which are financed and operated in a manner similar to a private business enterprise. Accordingly, the Fund maintains its records on the accrual basis of accounting. Revenues from operations, investments, and other sources are recorded when earned. Expenses (including depreciation and amortization) of providing services to the public are accrued when incurred. In accordance with Governmental Accounting Standards Board (GASB) Statement No. 20, Accounting and Financial Reporting for Proprietary Funds and Other Governmental Entities That Use Proprietary Fund Accounting, the Fund applies all applicable GASB pronouncements, as well as all Financial Accounting Standards Board (FASB) Statements and Interpretations, Accounting Principles Board (APB) Opinions, and Accounting Research Bulletins (ARBs) issued on or before November 30, 1989, unless those pronouncements conflict with or contradict GASB pronouncements. The Fund also has the option of following FASB guidance issued after November 30, 1989, but has elected not to do so. (b) Cash and Cash Equivalents Cash and cash equivalents include cash on hand, demand deposits, and short-term investments with original maturities of three months or less from the date of acquisition. (c) Investments Investments are stated at fair value based on quoted market price. (d) Inventories Inventories consist of operating and maintenance and repair parts for sewage lines and are valued at the lower of cost or market, with cost being determined on an average cost method. (e) Capital Assets Capital assets are recorded at historical cost, together with interest capitalized during construction. Depreciation is computed using the straight-line method over the estimated useful lives of the related assets as follows: Improvements to land Structures Interceptors and regulators Equipment 67 years 40 years 100 years 3 20 years (f) Workers Compensation The Fund has no insurance coverage for workers compensation claims. Workers compensation expenses are recorded when the occurrence of the liability is probable and the amount is reasonably estimable. The amounts recorded as of June 30, 2006 and 2005 are based on compensation expected to be paid, along with estimated medical costs, for all claims known as of the balance sheet date, and historical data are used in computing the liability for estimated incurred but unknown claims as of the balance sheet date. (g) Capitalized Interest The Fund capitalizes qualifying net interest costs of the System on bonds issued for capital construction in accordance with Statement of Financial Accounting Standards Statement No. 34 Capitalization of Interest Cost and Statement No. 62 Capitalization of Interest Cost in situations Involving Certain Tax-Exempt Borrowings and Certain Gifts and Grants an Amendment of FASB Statement No. 34. Accordingly, capitalized interest for the years ended June 30, 2006 and 2005 was $54,012,814 and $50,767,951, respectively. (f) Workers Compensation June Balance at beginning of year $ 4,727,969 5,206,684 4,844,529 Current year claims and changes in estimates 964, ,827 1,543,501 Claims payments (558,999) (954,542) (1,181,346) Balance at end of year $ 5,133,518 4,727,969 5,206,684 40

42 CITY OF DETROIT SEWAGE DISPOSAL FUND NOTES TO BASIC FINANCIAL STATEMENTS, JUNE 30, 2006 AND 2005 (h) Taxes and City Services The Fund pays no direct federal, state, or local taxes, except local taxes on excess property and federal Social Security taxes. The Fund reimburses the City for most of the direct services furnished by other City departments, including general staff services. Charges are billed for all sewage services provided to City departments. (i) Shared Costs Costs related to shared facilities and personnel are allocated to the Fund on a basis that relates costs incurred to the Fund benefited. (j) Compensated Absences The Fund records as a liability estimated vested vacation, sick pay, and banked overtime in accordance with GASB Statement No. 16, Accounting for Compensated Absences. Unused vacation pay accumulates until termination of employment, while there is no vesting of sick pay until an employee reaches age 60 or completes 25 years of service. (k) Accrued Revenue The Fund records unbilled revenues for services provided prior to year-end by accruing actual revenues billed in the subsequent month. (l) Net Assets Net assets are categorized as follows: Invested in capital assets: This consists of capital assets, net of accumulated depreciation and related debt. Restricted: This consists of net assets that are legally restricted by outside parties or by law through constitutional provisions or enabling legislation. When both restricted and unrestricted resources are available for use, generally it is the Fund s policy to use restricted resources first, and then unrestricted resources when they are needed. Unrestricted: This consists of net assets that do not meet the definition of restricted or invested in capital assets. (m) Classification of Revenues The Fund has classified its revenues as either operating or nonoperating revenues according to the following criteria: Operating revenues: Operating revenues include activities that have the characteristics of exchange transactions, such as revenue from charges for sewage service. Nonoperating revenues: Nonoperating revenues include activities that have the characteristics of nonexchange transactions, which are defined as nonoperating revenues by GASB Statement No. 9, Reporting Cash Flows of Proprietary and Nonexpendable Trust Funds and Government Entities That Use Proprietary Fund Accounting, and GASB Statement No. 34, Basic Financial Statements and Management s Discussion and Analysis for State and Local Governments, such as investment income and interest expense. (n) Use of Estimates The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. (o) New Accounting Pronouncements The Fund adopted GASB Statement No. 42, Accounting and Financial Reporting for Impairment of Capital Assets and for Insurance Recoveries. This Statement establishes accounting and financial reporting standards for impairment of capital assets. The Fund implemented Statement No. 42 with the year ended June 30, The Fund adopted GASB Statement No. 46, Net Assets Restricted by Enabling Legislation - an amendment of GASB Statement No. 34. This Statement clarifies that a legally enforceable enabling legislation restriction is one that a party external to a government such as citizens, public interest groups, or the judiciary can compel a government to honor. This statement also specifies the accounting and financial reporting requirements if new enabling legislation replaces existing legislation or if legal enforceability is reevaluated. The Fund implemented Statement No. 46 with the year ended June 30, In July 2004, the GASB issued Statement No. 45, Accounting and Financial Reporting by Employers for Postemployment Benefits Other Than Pensions. This Statement establishes accounting and financial reporting standards for employers that participate in a defined-benefit other postemployment benefit (OPEB) plan. The Fund will implement Statement No. 45 beginning with the year ended June 30, The Fund is currently evaluating the impact of adopting Statement No. 45. (2) Deposits and Investments The following is a complete listing of deposits and investments held by the Fund at June 30, 2006: Deposits $ 8,833,849 Investments 506,862,766 Total deposits and investments $ 515,696,615 41

43 CITY OF DETROIT SEWAGE DISPOSAL FUND NOTES TO BASIC FINANCIAL STATEMENTS, JUNE 30, 2006 AND 2005 The deposits and investments of the Fund at June 30, 2006 are reflected in the basic financial statements as follows: Unrestricted: Deposits $ 1,418,283 Investments 51,205,044 Restricted: Deposits 7,415,566 Investments current 344,637,409 Investments noncurrent 111,020,313 Total cash and investments $ 515,696,615 State law authorizes the Fund to make deposits in the accounts of federally insured financial institutions. Cash held by fiscal agents or by trustees is secured in accordance with the requirements of the agency or trust agreement. The Fund is authorized to invest in obligations of the U.S. government or its agencies, certificates of deposit, savings and depository accounts of insured institutions, commercial paper of certain investment quality, repurchase agreements, banker s acceptances, mutual funds of certain investment quality, and investment pools as authorized by state law. Custodial Credit Risk of Bank Deposits Custodial credit risk is the risk that in the event of bank failure, the Fund s deposits may not be returned by the bank. The Fund does not have a deposit policy for custodial credit risk. At June 30, 2006 and 2005, the Fund had deposits of $8,436,281 and $12,918,713, respectively, that were exposed to custodial credit risk, as they were uninsured and uncollateralized. Custodial Credit Risk of Investments Custodial credit risk is the risk that in the event of failure of the counterparty, the Fund will not be able to recover the value of its investments or collateral securities that are in the possession of an outside party. The Fund does not have a policy for custodial credit risk. As of June 30, 2006 and 2005, the Fund had no investments subject to custodial credit risk. Interest Rate Risk Interest rate risk is the risk that, over time, the value of investments will decrease as a result of a rise in interest rates. The Fund s investment policy does not specifically restrict investment maturities other than commercial paper, which can only be purchased with a 270-day maturity. The Fund s policy minimizes interest rate risk by requiring that the Fund attempt to match its investments with anticipated cash flow requirements. Unless related to a specific cash flow, the Fund is generally not permitted to directly invest in securities maturing more than 10 years from the original date of purchase. Credit Risk The Fund s investment policy complies with state law. The Fund limits its investments in commercial paper, mutual funds, and external investment pools that purchase commercial paper to the top two rating classifications issued by two nationally recognized statistical rating organizations (NRSROs). Interest Rate Risk Investment maturities in years Fair Less than one to Investment value one year five years U.S. government agency securities $ 257,920, ,876,955 96,043,556 Certificate of deposit 23,421,649 23,421,649 Commercial paper 34,981,735 34,981,735 Repurchase agreements 19,985,604 5,008,847 14,976,757 Money market 170,553, ,553,267 Total investments $ 506,862, ,842, ,020,313 Credit Risk As of June 30, 2006, the Fund had the following investments, maturities, and credit quality ratings of debt securities: Fair Rating Investment value Rating organization U.S. government agency securities $ 161,876,955 AAA, Aaa S & P and Moody s U.S. government agency securities 96,043,556 AAA, Aaa S & P and Moody s Repurchase agreements 14,976,757 AAA, Aaa S & P and Moody s Repurchase agreements 5,008,847 AAA, Aaa S & P and Moody s Money market 60,160,500 Aaa Moody s Money market 21,834,727 Not rated N/A Money market 88,558,040 AAAm, Aaa S & P and Moody s Certificates of Deposit 23,421,649 Not rated N/A Commercial paper 34,981,735 Not rated N/A Total investments $ 506,862,766 42

44 CITY OF DETROIT SEWAGE DISPOSAL FUND NOTES TO BASIC FINANCIAL STATEMENTS, JUNE 30, 2006 AND 2005 Concentration of Credit Risk Concentration of credit risk is the risk of loss attributed to the magnitude of the Fund s investment in a single issuer. The Fund s policy specifies a number of limitations to minimize concentration of credit risk, including prohibiting investing more than 5% of the portfolio in securities (other than U.S. government, mutual funds, external investment pools, and other pooled investments) of any one issuer. More than 5% of the Fund s investments are in Federal Home Loan Bank and Federal National Mortgage Association securities. These investments are 28% and 22%, respectively, of the Fund s total investments. (3) Restricted Assets Restricted assets, principally cash and investments, are available for debt service on revenue bonds and to provide funds for improvements, enlargements, extensions, and construction. In certain instances, minimum levels of assets are required by bond ordinance provisions or by Board of Water Commissioners decree. These assets are maintained as follows: (1) With respect to the Bond and Interest Redemption Fund, after provision has been made for expenses of operation and maintenance of the System, a sum proportionately sufficient to provide for payment, when due, of the current principal and interest is set aside. The Bond Reserve Account is part of the Bond and Interest Redemption Fund, and the amounts credited to this account are to be used only to pay principal and interest on the bonds when current revenues are not sufficient. (2) With respect to the Extraordinary Repair and Replacement Reserve Fund, after meeting the requirements of the foregoing funds, monthly deposits in an amount equal to one twelfth of 3% of the budgeted operation and maintenance expense of the System for the fiscal year must be set aside until the aggregate amount funded totals at least 15% of that year s budgeted operating and maintenance costs. These deposits are to be used for major unanticipated repairs and replacement to the System with actual or anticipated cost exceeding $1 million. Once this fund is fully funded, deposits required are amounts needed to maintain fully funded status. Borrowings of up to 50% of the balance in this fund on the first day of the related fiscal year are allowed for transfer to and use from the Improvement and Extension Fund. Any such borrowings must be repaid prior to any deposits being made to the Improvement and Extension Fund. (3) After the aforementioned deposits have been made, excess amounts may be deposited in the Improvement and Extension Fund, established for the payment of improvements, enlargements, repairs, extensions, or betterment to the System. (4) With respect to the Construction Fund, the portion of the proceeds of the sale of bonds for building or improving the System is deposited in this fund. A separate depository account is required for each series of bonds. Proceeds for construction purposes received from federal and state grants and other sources that restrict the use of such proceeds are also deposited into this account. When both restricted and unrestricted resources are available for use, generally it is the Fund s policy to use restricted resources first, and then unrestricted resources when they are needed. The Fund s statement of net assets reports $303,996,408 of restricted net assets, of which $299,071,259 is restricted by enabling legislation. (5) Impaired Capital Assets Beginning fiscal year ended June 30, 2006, the Fund implemented GASB Statement No. 42-Accounting and Financial (4) Capital Assets Capital asset activity for the fiscal years ended June 30, 2006 and 2005 is as follows: Balance, Balance, June 30, June 30, 2005 Additions Disposals 2006 Nondepreciable assets: Land $ 13,876,751 (41,794) 13,834,957 Construction in progress 1,219,986, ,368,969 (1,193,852,634) 310,502,398 1,233,862, ,368,969 (1,193,894,428) 324,337,355 Depreciable assets: Interceptors, regulators, and land improvements 542,769, ,574,102 (174,654,520) 474,689,271 Structures 1,143,914, ,622,796 (405,536,576) 1,703,001,142 Equipment 708,031, ,940,701 (233,901,249) 1,385,071,311 Accumulated depreciation (681,127,715) (69,951,016) 105,887 (750,972,844) 1,713,588,755 1,912,186,583 (813,986,458) (813,986,458) 2,811,788,880 Total $ 2,947,451,569 2,196,555,552 (2,007,880,886) 3,136,126,235 43

45 CITY OF DETROIT SEWAGE DISPOSAL FUND NOTES TO BASIC FINANCIAL STATEMENTS, JUNE 30, 2006 AND 2005 (4) Capital Assets Capital asset activity for the fiscal years ended June 30, 2005 and 2004 is as follows: Balance, Balance, June 30, June 30, 2004 Additions Disposals 2005 Nondepreciable assets: Land $ 13,876,751 13,876,751 Construction in progress 1,203,738, ,665,001 (423,417,016) 1,219,986,063 1,217,614, ,665,001 (423,417,016) 1,233,862,814 Depreciable assets: Interceptors, regulators, and land improvements 532,455,750 10,313, ,769,689 Structures 891,488, ,665,492 (239,425) 1,143,914,922 Equipment 572,095, ,220,745 (284,257) 708,031,859 Accumulated depreciation (637,571,035) (44,053,316) 496,636 (681,127,715) 1,358,468, ,146,860 (27,046) 1,713,588,755 Total $ 2,576,083, ,811,861 (423,444,062) 2,947,451,569 Reporting for Impairment of Capital Assets and for Insurance Recoveries. As of June , the Fund did not have any impaired assets reportable under Statement No. 42. (6) Revenue Bonds The outstanding indebtedness of the Fund was $2,657,446,122 and $2,653,826,572 at June 30, 2006 and 2005, respectively. The interest rates on the outstanding bonds range from 4.2% to 6.5%. Net revenues of the Fund are pledged to repayment of bonds. In fiscal 2005, the Fund issued $273,355,000 of City of Detroit, Michigan, Sewage Disposal System Revenue Second Lien Bonds, Series 2005-A; $40,215,000 of City of Detroit, Michigan Sewage Disposal System Revenue Refunding Second Lien Bonds, Series 2005-B; and $63,160,000 of City of Detroit, Michigan Sewage Disposal System Revenue Refunding Second Lien Bonds, Series 2005-C. The net proceeds were used to refund a portion of the City s outstanding Sewage Disposal System Revenue Bonds and Revenue Refunding Bonds and to pay costs of issuance associated with the 2005 bonds. The net proceeds of the Sewage Disposal System Revenue Second Lien Bonds, Series 2005-A, will be used (a) to deposit into the Construction Fund and (b) for the payment of the related costs of issuance, including the premium for the municipal bond insurance. The net proceeds of the Sewage Disposal System Revenue Refunding Second Lien Bonds, Series 2005-B, will be used (a) to advance-refund the $22,355,000 principal amount of the City s Sewage Disposal System Senior Lien Bonds, Series 1997-A, comprising serial bonds maturing in the year 2022 (the Advance Refunded 1997-A Bonds), with an average interest rate of 5%, (b) (6) Revenue Bonds Future debt service requirements at June 30, 2006 are as follows: Bond Swap Total Principal interest interest requirements Year ending June 30: 2007 $ 53,205,000 98,382,197 32,993, ,580, ,704, ,782,453 33,554, ,040, ,925, ,542,236 32,780, ,247, ,795, ,879,518 33,307, ,982, ,270, ,905,996 32,646, ,822, ,454, ,844, ,428,909 1,024,727, ,230, ,294, ,035,091 1,063,560, ,147, ,634, ,211,098 1,053,993, ,335, ,394,897 97,112, ,842, ,380,000 68,643,718 19,553, ,577,383 $ 2,657,446,122 2,230,304, ,623,466 5,751,374,511 44

46 CITY OF DETROIT SEWAGE DISPOSAL FUND NOTES TO BASIC FINANCIAL STATEMENTS, JUNE 30, 2006 AND 2005 to advance-refund $115,000 of 1999-A Sewage Disposal System Senior Lien Bonds, maturing in 2011, and $3,425, B Sewage Disposal System Senior Lien Bonds, maturing in 2012 (the Advance Refunded 1999-A Bonds), with an average interest rate of 5.20% and 5.25%, respectively, (c) to advance-refund $8,215,000 of 2003-A Sewage Disposal System Senior Lien Bonds, maturing in 2014, and $8,470,000 Sewage Disposal System Senior Lien Bonds, maturing in 2015 (the Advance Refunded 2003-A Bonds), with an average interest rate of 5.0%, and (d) the payment of the related costs of issuance, including the premium for the municipal bond insurance. The proceeds of the Sewage Disposal System Revenue Refunding Second Lien Bonds, Series 2005-C, will be used (a) to currently refund $6,770,000 principal amount of the City s Sewage Disposal System Senior Lien Bonds, Series 1995-A bonds, maturing in the year 2025, with an average interest rate of 5%, (b) to currently refund the following amounts of the City s Sewage Disposal System Senior Lien Bonds, Series 1995-B bonds, $2,400,000 principal amount maturing in the year 2008, with an average interest rate of 5.25%, $20,410,000 principal amount of term bonds maturing in the year 2015, with an average interest rate of 5.25%, and $36,605,000 principal amount of term bonds, maturing in the year 2021, with an average interest rate of 5.25% (together with the Currently Refunded 1995-A/B Bonds ), and (c) for the payment of the related costs of issuance, including the premium for the municipal bond insurance. Proceeds of the Refunding Bonds were deposited into an irrevocable trust with an escrow agent to provide for all future principal and interest payments on the Currently Refunded 1995-A/B Bonds when due to and including July 1, 2005 at 100% and 101%; the Advance Refunded 1997-A Bonds when due to and including July 1, 2007 at 101%; the Advance Refunded 1999-A Bonds when due to and including July 1, 2010 at 101%; and the Advance Refunded 2003-A Bonds when due to and including July 1, 2013 at 100%. The advance refunding resulted in a difference between the reacquisition price and net carrying amount of the old debt of $8,987,394. This difference, reported in the basic financial statements as a deduction from bonds payable, is being charged to operations through the year 2024 using the straight-line method. The fund completed the advance refunding to reduce its total debt service payments over the next 20 years and to obtain an economic gain (difference between the present values of the old and new debt service payments) of $6,143,299. In prior years, the Fund defeased certain bonds by placing the proceeds of new bonds in an irrevocable trust to provide for all future debt service payments on the old bonds. Accordingly, the trust account assets and liabilities for the defeased bonds are not included in the Fund s financial statements. Similarly, the interest expense related to the defeased bonds and the related interest income earned on the escrow fund investments have not been recognized in the statements of revenues, expenses, and changes in fund net assets. As of June 30, 2006 and 2005, approximately $400,800,000 and $593,330,000 of bonds outstanding are considered defeased. Bonds outstanding at June 30, 2006 include $2,439,587,743 of bonds callable at various dates after June 30, These bonds are callable at varying premiums, depending on the issue and length of time to maturity. (7) Pension Obligation Certificates of Participation (POC s) 2005 Issuance In June 2005, the Detroit Retirement Systems Funding Trust issued $1,440,000,000 ($640 million of fixed rate, Series A, and $800 million of floating rate, Series B) of taxable Pension Obligation Certificates of Participation (COPs). The Trust was created by the General Retirement System Service Corporation (GRSSC) and the Police and Fire Retirement System Service Corporation (PFRSSC), both blended component units of the City. The City entered into service contracts with the GRSSC and PFRSSC to facilitate the transaction. The POC s were issued for the purpose of funding certain unfunded accrued actuarial liabilities (UAAL) of the two retirement systems of the City, which include the General Retirement System (GRS) and the Police & Fire Retirement System (PFRS), and a portion of the then current year normal contribution. The GRS includes employees and retirees of certain governmental funds, proprietary funds (Transportation Fund, Sewage Disposal Fund and Water Fund) and the Detroit Public Library, a discretely presented component unit. A proportionate amount of the liability was recorded on the books of the City s Governmental Activities, Transportation Fund, Sewage Disposal Fund and Water Fund, based on each fund s portion of the overall UAAL liquidated by the use of the 2005 POC net proceeds. In connection with the 2005 transactions, the Service Corporations entered into interest rate exchange agreements (swap agreements) to hedge the variable rate interest exposure associated with the issuance of the 2005 Series-B Certificates. The original Series A and Series B certificates were not specifically related to either of the Service Corporations. The amount of proceeds from the 2005 issuance recorded on each Service Corporation s books was based on the respective proportion of UAAL funding required for the corresponding Pension System. 45

47 CITY OF DETROIT SEWAGE DISPOSAL FUND NOTES TO BASIC FINANCIAL STATEMENTS, JUNE 30, 2006 AND 2005 Fiscal Year 2006 Events Michigan law entitles each Retirement System to have its UAAL funded over a specified period (Amortization Period), which may be duly changed up to a 30-year maximum. Each 2005 Service Contract required the City to make 2005 COP service payments over a period that was limited to the PFRS or GRS Amortization Period (13 years for PFRS and 20 years for the GRS). The funding Ordinance anticipated the possible future extension of the PFRS and GRS Amortization Periods and authorized the Service Corporations, in that event, to assist the City in gaining the financial benefits of making its 2005 COP Service payments over a similarly lengthened period. On February 8, 2006, the governing board of the GRS extended the Amortization Period for GRS UAAL from 20 to 30 years. On March 30, 2006, the governing board of the PFRS UAAL extended the amortization period for PFRS UAAL from 13 to 30 years. Accordingly, the Detroit Retirement Systems Funding Trust 2006 issued $948,540,000 of taxable Certificates of Participation Series The City also terminated the Swap agreements entered into in the 2005 transaction and received $48,932,455 as a result of the swap termination. The Taxable Certificates of Participation Series 2006 were issued to enable the City to replace certain scheduled payment obligations that it incurred to provide funding for the 2005 Subject UAAL with new scheduled payment obligations payable over the extended 30-year periods under the 2006 Service Contracts. This will enable the City to achieve financial benefits from the lengthened payment periods compared to the payment period included within the 2005 Series A and B payment schedules. The 2006 Certificates were issued to fund the optional redemption $104,055,000 aggregate principal amount of Series 2005-A COPs of certain maturities and the purchase and cancellation of $800,000,000 aggregate principal amount of Series 2005-B COPs of certain maturities. The City did not pay off the $104,055,000 of optionally redeemed Series A 2005 COPs until July 13, At June 30, 2006 the portion of the 2006 COP proceeds to pay the $104,055,000 COPs were in irrevocable trust investment accounts and on July 13, 2006 were disbursed to pay the COP service obligation and accrued interest from June 15, 2006 (the last interest payment date) to July 13, For financial reporting purposes, this disbursement was treated as if it had occurred on June 30, In economic substance, the City paid off $904,055,000 of 2005 Series Certificates with the net proceeds from the $948,540,000 received from the issuance of Certificates of Participation Series The net effect of this on the City s balance sheet is to add on additional $44,485,000 of Certificates of Participation obligations to the government-wide balance sheet. The refunding resulted in an increase of approximately $992 million in required aggregate future cash outflows for debt service. This resulted in an economic loss (difference between the present values of the old and new debt service requirements) of $89,265,111. Certain maturities of the Series 2005-A COPs still remain outstanding concurrently with the 2006 Certificates. The 2005 COPs and the 2006 Certificates are wholly independent of each other. (8) Deferred Swap Termination Proceeds and Payments During the year ended June 30, 2004, the Fund and its counterparty terminated a forward starting swap agreement related to the future issuance of debt in fiscal year The Fund received a termination payment in the amount of $14,056,137 that has been deferred to offset future debt service. The proceeds will be recognized over the life of the debt using the straight -line method. During the year ended June 30, 2005, the Fund and its counterparty terminated a forward starting swap agreement related to the issuance of debt in fiscal year The Fund paid a termination payment in the amount of $11.75 million that has been reserved to offset future debt service. The (7) The redemption dates and a summary of the aggregate principal and interest amounts for the remaining 2005 POC s are as follows: Primary Government Principal Business-type Activities Maturity Governmental Sewer Disposal Transportation Water (June 15) Activities Fund Fund Fund Total s ,861,370 28, , ,698 4,750, ,905,539 66, ,268 1,198,587 10,955, ,686, ,288 10,011,862 15,300, ,850, ,857,304 1,150,731 13,549,481 20,707, ,265, ,369,335 1,162,040 13,682,639 20,910, ,125,000 Total $ 435,680,409 $ 3,258,546 $ 38,368,303 $ 58,637,742 $ 535,945,000 46

48 CITY OF DETROIT SEWAGE DISPOSAL FUND NOTES TO BASIC FINANCIAL STATEMENTS, JUNE 30, 2006 AND 2005 Primary Government Interest Business Type Activities Maturity Governmental Sewer Disposal Transportation Water (June 15) Activities Fund Fund Fund Totals ,942, ,636 1,844,333 2,818,669 $ 25,762, ,942, ,636 1,844,333 2,818,669 25,762, ,942, ,636 1,844,333 2,818,669 25,762, ,942, ,636 1,844,333 2,818,669 25,762, ,776, ,390 1,829,663 2,796,249 25,557, ,492, ,248 8,233,418 12,583, ,007, ,177, ,077 5,299,514 8,099,174 74,025, ,083, ,212 1,768,692 2,703,068 24,705,859 Total $ 278,300,709 $ 2,081,470 $ 24,508,620 $ 37,456,183 $ 342,346,982 The redemption dates and a summary of the aggregate principal and interest amounts for Series 2006 Pension Obligation Certificates are as follows: Primary Government Principal Business-type Activities Maturity Governmental Sewer Disposal Transportation Water (June 15) Activities Fund Fund Fund Total s 2007 $ - $ - $ - $ - $ ,557, ,982 2,955,235 4,516,445 41,280, ,689, ,408 7,458,175 11,398, ,179, ,531,321 2,382,363 28,051,539 42,870, ,836, ,309,285 2,500,370 29,441,030 44,994, ,245,000 Total $ 771,087,137 $ 5,767,123 $ 67,905,979 $ 103,779,761 $ 948,540,000 Primary Government Interest Business Type Activities Maturity Governmental Sewer Disposal Transportation Water (June 15) Activities Fund Fund Fund Totals 2007 $ 40,020,806 $ 299,324 $ 3,524,442 $ 5,386,356 $ 49,230, ,079, ,682 3,881,901 5,932,655 54,224, ,826, ,705 4,211,857 6,436,922 58,833, ,826, ,705 4,211,857 6,436,922 58,833, ,826, ,705 4,211,857 6,436,922 58,833, ,132,754 1,788,524 21,059,285 32,184, ,165, ,954,334 1,772,231 20,867,442 31,891, ,485, ,400,997 1,670,863 19,673,864 30,067, ,813, ,038,717 1,234,359 14,534,175 22,212, ,019, ,643, ,733 4,636,075 7,085,248 64,758,691 Total $ 1,144,750,722 $ 8,561,832 $ 100,812,754 $ 154,070,728 $ 1,408,196,036 47

49 CITY OF DETROIT SEWAGE DISPOSAL FUND NOTES TO BASIC FINANCIAL STATEMENTS, JUNE 30, 2006 AND 2005 expense will be recognized over the life of the debt that was issued in fiscal year 2005 using straight-line method. During the year ended June 30, 2006, The City terminated the Swap agreements entered into in the 2005 transaction and received $48,932,455. The Fund s allocated share is $297,509. The proceeds will be recognized over the life of the debt using the straight-line method. During fiscal year ended June 30, 2006, the amount of amortization expense was $79,522. The remaining balance of the Sewer Swap Termination Fee as of June 30, 2006 and 2005 is $2,504,243 and 2,286,256, respectively. (9) Long-Term Liabilities - Long-term liability activity for the years ended June 30, 2006 and See chart below and page 49. (10) Derivatives Not Reported at Fair Value The Fund is party to derivative financial instruments consisting of interest rate swaps that are intended to effectively convert variable-rate financings to fixed-rate financings. These are not reported at fair value on the statement of net assets at June 30, Objective of the swaps. In order to better manage its interest rate exposure and to reduce the overall costs of its financings, the Fund has entered into nine separate fixed-payor interest rate swaps. The Fund is also a party in the City s POC s related to the GRS. The City has entered into two separate fixedpayor interest rate swaps related to the POC s and the GRS. Market access risk. The City is exposed to market access risk on its hedge swaps or forward starting swaps in the event that it will not be able to enter credit markets or in the event that credit will become more costly. Terms, fair values, and credit risk. Certain key terms, fair market values, and counterparty credit ratings relating to the outstanding swaps as of June 30, 2006 are presented below. The notional amounts of the swaps, except those with effective dates of September 1, 2006 and March 1, 2007, match the principal amounts of the outstanding financings. The swaps with effective dates of September 1, 2006 and March 1, 2007, were entered into to hedge future interest rate risk and will be associated with financings expected to be issued prior to the effective dates. Except as discussed under rollover risk, the Fund s swap agreements contain scheduled reductions to outstanding notional amounts that match scheduled or anticipated amortization of associated financings. Fair value. Because interest rates have generally declined since the time the swaps were negotiated, most of the Fund s swaps have a negative fair value as of June 30, The negative fair (9) Long-term liability activity for the years ended June 30, 2006 and 2005 is as follows: Amount Balance, Balance, due within June 30, 2005 Increase Decrease June 30, 2006 one year Revenue bonds payable $ 2,653,826,572 53,654,550 (50,035,000) 2,657,446,122 53,205,000 Total revenue bond payable 2,653,826,572 53,654,550 (50,035,000) 2,657,446,122 53,205,000 Add: Unamortized premium 83,676,956 (5,128,099) 78,548,857 Less: Deferred charges on refunding 63,094,656 10,013,373 (3,707,707) 69,400,322 Discount 15,369,617 (13,303,593) 2,066,024 Net revenue bonds payable 2,659,039,255 43,641,177 (38,151,799) 2,664,528,633 53,205,000 Pension obligation certificates payable 8,760, ,469 9,031,280 Other liabilities: Accrued workers compensation 4,727, ,548 (558,999) 5,133, ,538 Accrued compensated absences 13,917,806 3,256,908 (3,274,943) 13,899,771 2,281,068 Deferred swap termination 2,286, ,509 (79,522) 2,504,243 Total other liabilities 20,932,031 4,518,965 (3,913,464) 21,537,532 3,092,606 Total $ 2,688,732,097 48,430,611 (42,065,263) 2,695,097,445 56,297,606 48

50 CITY OF DETROIT SEWAGE DISPOSAL FUND NOTES TO BASIC FINANCIAL STATEMENTS, JUNE 30, 2006 AND 2005 (9) Long-Term Liabilities Amount Balance, Balance, due within June 30, 2004 Increase Decrease June 30, 2005 one year Revenue bonds payable $ 2,375,152, ,028,972 (141,355,000) 2,653,826,572 50,035,000 Add: Unamortized premium 70,051,130 17,150,459 (3,524,633) 83,676,956 Less: Deferred charges on refunding 62,230,146 4,456,953 (3,592,443) 63,094,656 Discount 16,297,959 (928,342) 15,369,617 Net revenue Pension obligation certificates bonds payable 2,366,675, ,722,478 (140,358,848) 2,659,039,255 50,035,000 payable 8,760,811 8,760,811 Other liabilities: Accrued workers compensation 5,206, ,827 (954,542) 4,727, ,155 Accrued compensated absences 12,158,263 2,255,075 (495,532) 13,917,806 5,556,011 Deferred swap termination 14,056,137 (11,769,881) 2,286,256 Total other liabilities 31,421,084 2,730,902 (13,219,955) 20,932,031 6,451,166 Total $ 2,398,096, ,214,191 (153,578,803) 2,688,732,097 56,486,166 (10) Derivatives Not Reported at Fair Value Sweep Final Notional Effective Fixed rate Variable rate Fair termination maturity Counterparty Associated financing issue amounts (1) date paid received values date of bonds credit rating Sewage 1998-A $ 68,000,000 12/10/ % BMA (2) $ (3,258,018) 7/1/2023 7/1/2023 Aa2/AA-/NR Sewage 1998-B 67,900,000 12/10/ BMA (3,260,270) 7/1/2023 7/1/2023 Aa2/AA-/NR Sewage 1999-A 27,900,000 10/22/ IMT+.28% (9,227,590) 7/1/2029 7/1/2029 Aa1/AA-/AA+ Sewage 2001 C-1 156,500,000 10/23/ BMA (7,116,931) 7/1/2027 7/1/2027 Aa2/AA+/AAA Sewage 2001 C-2 124,500,000 10/23/ BMA (6,565,848) 7/1/2029 7/1/2029 Aa2/AA+/AAA Sewage 2003-B 150,000,000 5/22/ BMA 1,924,401 7/1/2033 7/1/2033 Aa2/AA+/AAA Sewage Hedge Swap 125,000,000 9/1/ BMA 7,867,616 7/1/2036 N/A Aa2/AA+/AAA Sewage Hedge Swap 56,250,000 3/1/ BMA 1,320,373 7/2/2039 N/A Aa3/A+/AA- Sewage Hedge Swap 168,750,000 3/1/ BMA (4,141,786) 7/3/2039 N/A Aa3/A+/AA- Pension Obligation 99,621,000 6/7/ MTH LIBOR (183,936) 6/15/2034 6/15/2034 Aa3/A+/AA- Certificates - GRS +.34% Pension Obligation 42,252,000 6/7/ MTH LIBOR (84,084) 6/15/2029 6/15/2029 Aa3/A+/AA- Certificates - GRS +.30% (1) Notional amount balance as of July 1, 2006 (2) The Bond Market Association Municipal Swap Index (3) Denotes the the swap termination date does not match the final maturity of the financings 49

51 CITY OF DETROIT SEWAGE DISPOSAL FUND NOTES TO BASIC FINANCIAL STATEMENTS, JUNE 30, 2006 AND 2005 values may be countered by lower total interest payments required under the variable-rate financings, creating lower synthetic interest rates. Credit risk. As of June 30, 2006, the Fund was not significantly exposed to net credit risk, as the majority of the swaps had net negative fair values. However, should interest rates change and fair values of the swaps become positive, the Fund would be exposed to credit risk in the amount of the derivatives positive fair value. The swap agreements contain varying collateral agreements with the counterparties. The swaps require full collateralization of the fair value of the swap should the counterparty s credit rating fall below certain rating levels by Fitch Ratings, Standard & Poor s, and/or Moody s Investors Service. Collateral on all swaps is to be in the form of U.S. government securities held by a third-party custodian. Basis risk. The Fund is not exposed to significant basis risk on its swaps because most of the variable payments received are based on the Bond Market Association (BMA) index. The Consumer Price Index (CPI) indexed swaps are associated with CPI indexed financings and thus create no basis risk. The London Interbank Offered Rate (LIBOR)-based swap has basis risk on $28.3 million of swaps. Termination risk. The Fund or counterparty may terminate any of the swaps if the other party fails to perform under the terms of the contract. In such cases, the Fund may owe or be due a termination payment, depending on the value of the swap at that time. In addition, the Fund is exposed to termination risk, but not termination payments, on certain of the Fund s swaps related to Sewer Series 1998-A, Sewer Series 1998-B, Sewer Series 1999-A, Sewer Series 2001-C-1, Sewer Series 2001-C-2, and Sewer Series 2003-B. These swaps provide the counterparty with the option to terminate the swap agreement beginning on January 1, 2010, July 2, 2011, July 1, 2008, July 1, 2008, January 1, 2010, January 1, 2010, and July 1, 2013, respectively, upon the passing of certain BMA thresholds. If any of these swaps were terminated, the associated variable-rate financings would no longer carry synthetic interest rates, but there would be no termination payment. Rollover risk. The Fund is exposed to rollover risk on swaps that mature or may be terminated prior to the maturity of the associated financings. When these swaps terminate or, in the case of the termination option, if the counterparty exercises its option, the Fund will not realize the synthetic rate offered by the swaps on the underlying issues. (11) Employee Benefit Plan Substantially all City employees, including the Sewage Disposal Fund employees, are covered by a single-employer plan composed of a defined benefit with an optional employee-contributed annuity through the General Retirement System (GRS). The GRS pays a monthly pension to qualified individuals upon retirement. The amount is based upon a combination of years of service and annual salary. Plan Description The GRS is administered in accordance with the City of Detroit Charter and union contracts, which assign the authority to establish and amend contributions and benefit provisions to the Retirement System s board of trustees. The GRS issues separate, stand-alone financial statements annually. Copies of these financial statements can be obtained at the Coleman A. Young Municipal Center, 2 Woodward Ave., Rm. 908, Detroit, Michigan Funding Policy The GRS funding policy provides for periodic employer contributions at actuarially determined rates that, expressed as percentages of annual covered payroll, are sufficient to accumulate sufficient assets to pay benefits when due. The contribution requirements are established and may be amended by the GRS s board of trustees based on information provided by the GRS s consulting actuary. The City s contribution is set by the City Council in conjunction with its approval of the City s annual budget based on information provided by the GRS s consulting actuary. The recommended contribution rate is determined by the GRS s consulting actuary using the entry age normal actuarial cost funding method. Significant actuarial assumptions used to compute contribution requirements are the same as those used to compute the actuarial accrued liability. Based upon the June 30, 2005 actuarial valuation, which was the most recent actuarial data available when the budget was developed for the year ended June 30, 2006, the actuary recommended the Sewage Disposal Fund contribution rate of 2.04% Contributions for the Sewage Fund totaled $4,185,887. Employees may elect to contribute 3%, 5%, or 7% of the first $87,900 of annual compensation and 5% or 7% of any excess over $87,900 for annuity savings. Contributions are voluntary for all union and nonunion employees. Contributions received from Sewer Fund employees during the year ended June 30, 2006 amounted to $2,638,158. The contribution requirements of plan members and the City are established and may be amended by the Board of Trustees in accordance with the City Charter, union contracts, and plan provisions. Members may retire with full benefits after attaining 30 years of service; age 55 with 30 years of service if hired after 50

52 CITY OF DETROIT SEWAGE DISPOSAL FUND NOTES TO BASIC FINANCIAL STATEMENTS, JUNE 30, 2006 AND 2005 January 1, 1996; age 60 with 10 years of service; or age 65 with 8 years of service. Employees may retire after 25 years of service and collect an actuarially reduced retirement benefit. Monthly pension benefits, which are subject to certain minimum and maximum amounts, are determined according to fixed rates per year of credited service. Members of the General Retirement System who separated prior to July 1, 1981, met the age and service requirements, and who did not withdraw their accumulated annuity contributions are generally eligible for a pension at the time they would have been eligible had they continued in City employment. Members who separate after July 1, 1981 are not required to leave their accumulated annuity contributions in the System. Pension benefits for all members of the GRS are increased annually by 2.25% of the original pension. (a) Administrative Expenses Actuarial investment management and bank trustee fees and expenses are included in the GRS plan s administrative expenses when incurred. In addition, the GRS plan s administrative salary, rent, accounting services, duplicating, telecommunications, and travel expenses are included in the GRS plan s administrative expenses when incurred. General Retirement System Annual Percentage Net Fiscal year pension of APC pension ended cost (APC) contributed asset June 30, 2004 $ $ 2,559, % $ $ June 30, ,359, % 7,850,281 June 30, ,795,979 8,240,189 The annual pension cost and net pension asset as of June 30, 2006 are as follows: The actuarial methods and significant assumptions used to determine the annual required contributions for June 30, 2006 were as follows: Valuation date Actuarial cost method Amortization method Remaining amortization period for unfunded accrued liabilities Asset valuation method Actuarial assumptions: Investment rate of return Projected salary increases* Cost-of-living adjustments* *Includes inflation rate of 4% June 30, 2005 Entry age Level percent 30 years 3-year smoothed market 7.9% 4% 9.5% 2.25% (12) Other Post-employment Benefits In addition to the pension benefits described above, the City provides post-retirement benefits to its retires, which include hospitalization, dental care, eye care, and life insurance, The number of City retirees at June 30, 2006 is 22,451. Costs are accounted for in accordance with GASB Statement No. 12, Disclosure of Information on Post-retirement Benefits Other Than Pension Benefits by State and Local Governmental Employers. The benefits are provided in accordance with the City Charter and union contracts. The costs of benefits, which are financed on a pay-as-you-go basis, for the year ended June 30, See chart on page 52. (13) Due to (from) Other Funds During the course of operations, numerous transactions occur between individual funds and other City of Detroit funds for goods provided or services rendered. Related receivables and payables are classified as due from other funds or due to other funds on the balance sheets and are summarized on the chart on the following page. Annual required contributions Interest on net pension asset Adjustment to annual required contribution Annual pension cost Contributions made employer Changes in net pension asset Net pension asset, beginning of year Net pension asset, end of year $ 3,975,424 (620,172) 440,727 3,795,979 4,185, ,908 7,850,281 $ 8,240,189 (14) Capital Improvement Programs The Fund is engaged in a variety of projects that are a part of its five-year Capital Improvement Program (the Program). The total cost of this Program is anticipated to be approximately $1.81 billion through fiscal year The Program is being financed primarily from revenues of the Fund and proceeds from the issuance of revenue bonds. The total amount of construction contract commitments outstanding at June 30, 2006 and 2005 was approximately $356 million and $453 million, respectively. (15) Rate Adjustments The U.S. Environmental Protection Agency (EPA), in attempting to ensure that user charges are proportional in effect as well as in their design, requires grantees to compare budgeted wastewater 51

53 CITY OF DETROIT SEWAGE DISPOSAL FUND NOTES TO BASIC FINANCIAL STATEMENTS, JUNE 30, 2006 AND 2005 (12) Other Post-employment Benefits City Retiree Total Benefits cost cost cost Hospitalization $ 139,306,757 14,933, ,240,265 Dental 6,160,524 6,160,524 Eye care 1,969,690 1,969,690 Life insurance 143,579 26, ,319 $ 147,580,550 14,960, ,540,798 (13) Due from (to) Other Funds Due from other funds (unrestricted): General $ 30,513 11,887,394 Water 52,768,156 54,500,684 Total due from other funds (unrestricted) $ 52,798,669 66,388,078 Due from other funds (restricted): General $ 33,067 37,355,552 Water 5,508, ,997 Total due from other funds (restricted) $ 5,541,786 37,638,549 Due to other funds (unrestricted): General $ 5,824,511 4,921,074 General Fiduciary 411,500 Water 51,511,455 48,212,647 Total due to other funds (unrestricted) $ 57,747,466 53,133,721 Due to other funds (restricted): General $ 30,605 48,509 Water 10,231,497 11,025,493 Total due to other funds (restricted) $ 10,262,102 11,074,002 contributions, revenues from users, and user classes to actual results and make appropriate rate adjustments in the second succeeding year. The accompanying financial statements reflect management s estimates of the current and noncurrent amounts receivable from and refundable to customers in accordance with the regulations. Although subsequent adjustments to these amounts may occur, management does not believe the impact would be material to the Fund s financial position or results of operations. (16) Contingencies The operation of the Fund s Waste Water Treatment Plant (WWTP) is subject to extensive regulation pursuant to the Federal Water Pollution Control Act, as amended by the Clean Water Act of 1977 and the Water Quality Act of 1987 (collectively, the Clean Water Act). Included in the regulatory framework established by the Clean Water Act is the National Pollutant Discharge Elimination System (NPDES) permit program, which requires operation of wastewater treatment facilities according to discharge limitations and other requirements as set forth in permits issued to each facility. The U.S. EPA has authorized the State of Michigan Department of Environmental Quality (MDEQ) to implement and enforce the federal NPDES permit program. The Fund and the City s Legal Department operate the WWTP pursuant to an NPDES permit that took effect on January 1, 2004 and which is due to expire on October 1,

54 CITY OF DETROIT SEWAGE DISPOSAL FUND NOTES TO BASIC FINANCIAL STATEMENTS, JUNE 30, 2006 AND 2005 The Fund is also a defendant in numerous other alleged claims and lawsuits. The Fund and its legal counsel have estimated a reserve for the potential outcome of such claims or the amount of potential damages in the event of an unfavorable outcome for each of the above contingencies, which is included in the accompanying financial statements. The Fund s management and the City s Legal Department estimate that any differences in reserved amounts, and other potential claims against the Fund not covered by the Fund s insurance, resulting from such litigation will not materially impact the Fund s financial position or results of operations. The City holds various commercial insurance policies to cover potential loss exposures. (17) Subsequent Events On August 4, 2006, the Fund issued $401,560,000 of bonds that comprised: (1) Sewage Disposal System Revenue Second Lien Bond Series 2006-A (Variable Rate Demand) of $125,000,000, (2) Sewage Disposal System Revenue Second Lien Bond Series 2006-B for $250,000,000 and, (3) Sewage Disposal System Refunding Senior Lien Bonds, Series 2006-C for $26,560,000. The bonds begin to mature July 1, 2009 and will be fully matured in the year The proceeds (includes offering premium less cost of issued) of the Sewage Disposal System Refunding Senior Lien Bonds, Series 2006-C is used to refund Sewage Disposal System Senior Lien Bond, Series 2003-A of various maturities with aggregate principal of $27,470,000 plus defeasement cost. In September 2005, several customers of the Fund challenged the method of allocating costs associated with the 800 MHz project. In early 2007, the court issued a preliminary ruling acknowledging that the Fund had been overcharged, but is yet to issued a final ruling. In management s opinion, the final resolution will not have a material effect on the Fund s financial statements. REQUIRED SUPPLEMENTARY INFORMATION (unaudited) June 30, 2006 Schedule of Funding Progress (in thousands) for the General Retirement System (unaudited): Actuarial Actuarial UAAL valuation Actuarial accrued Unfunded as a date, value of liability Funded AAL Covered percentage June 30 assets (AAL) ratio (UAAL) payroll of payroll 2004 $ 190, , % $ (16,442) , , % (53,609) , , % (58,288) 53

55 AWARDS DWSD S WATER NAMED BEST-TASTING IN THE STATE by the American Water Works Association s Michigan Section Community Partner Award Jefferson East Business Association in recognition of your commitment to promoting and supporting community service and economic development in the Jefferson East community Nov. 17, 2006 Audiovisual Section/Public Affairs Division Communicator Award Award of Excellence (Cinematography) Detroit International Auto Show November 2006 Communicator Award Award of Excellence (Information) Detroit International Auto Show November 2006 Communicator Award Award of Distinction Mayor s Time November 2006

56 For more information, contact the: Public Affairs Division 735 Randolph Street, Suite 1001 Detroit, Michigan Office Fax