Capital Needs

As part of the Department’s ongoing capital planning, staff currently assesses capital needs and identifies critical and non-critical capital projects over an extended time horizon for each utility. The prioritization of the capital program and its respective projects is determined based on a risk assessment. This assessment includes a review of capital asset condition and estimated useful lives, as well as criticality to the utility’s operation. Through this process, the Department has developed 30-year capital improvement plans (CIP) for its water, wastewater, storm drainage, and solid waste utilities. These plans were used in the rate analysis with specific emphasis in the near-term costs. In order to better forecast future capital cash flow needs, the analysis escalates capital expenditures by capital inflation (assumed to be 3.5% per year, as discussed above).

Historically, rate increases approved by City Council have been insufficient to fund necessary capital replacement needs. Many of these capital reinvestments are now critical to maintaining the utilities at the required levels of service. Therefore, the revenue requirement analysis assumes funding of critical capital projects. The capital projects included for water, wastewater, and storm drainage are based on minimal reinvestment levels, given the long-term replacement needs of each system. These capital programs do not account for future regulatory changes.

The following provides the different level of capital needs identified as part of each utility’s capital plan. These levels were determined by Department staff after an assessment of infrastructure condition and criticality, as well as the need to maintain required and expected levels of service for each utility.

Š Critical & Essential – This capital plan includes capital projects that are necessary to maintain the condition of assets and the long-term viability of their use in meeting the performance and

10 General fund taxes are included as “Operating Expenditures”. The calculation of this tax is contingent on the level of revenues for the utility, and therefore depends on the magnitude of adopted rate increases. Expenses listed in this table do not account for projected future rate increases.

quality standards required and expected for providing ongoing, uninterruptable service to its customers.

Š Essential 1 – This capital plan includes projects identified as “Critical & Essential” as well as additional projects that are not immediately necessary given current assessments of asset condition and criticality.

Š Essential 2 – This capital plan includes projects identified as “Critical & Essential” and

“Essential 1”; however, this capital plan also includes additional projects that are not yet deemed critical to maintaining the required and expected levels of service. This level of capital planning is not applicable to the storm drainage and solid waste utilities.

Š All – The storm drainage and solid waste utilities do not distinguish between critical and essential projects because all projects are considered to be necessary for maintaining the condition of assets and the long-term viability of the systems.

The following tables provide detail on the magnitude of capital costs planned for each utility in future years.

Table 6: Capital Improvement Plans in Nominal Dollars (FY 2011/12 – FY 2015/16)

FY

It should be noted that the City’s water treatment plant replacement is expected to begin during the five-year forecast period coverage within this study. The City is currently underway with pre-design.

Another capital-related expenditure, in addition to the CIP, is existing debt service.

Debt Service: The Department’s outstanding debt represents a deferral of capital investment in that it allows the Department to pay for a project over time (instead of in a lump sum, as cash funding would require). Table 7 summarizes the Department’s existing debt repayment schedule over the next five years for each utility (not including any future anticipated debt issuances).

Table 7: Existing Debt Service Repayment Schedules (FY 2011/12 - FY 2015/16)

The water enterprise has $271.1 million in total outstanding debt principal and interest, while the wastewater enterprise has $8.9 million in total outstanding debt principal and interest. The storm drainage enterprise has $40.6 million in total outstanding debt principal and interest and the solid waste enterprise has $49.6 million in total outstanding debt principal and interest.

As the Department is planning to incur over $530 million in capital costs (critical and essential) over the next five years across all utilities, a later section of this report considers scenarios for funding these projects through the bond market. Based on discussions with the Treasurer’s Department and based on their work with their underwriter, near term debt issuances could be cost prohibitive due to insufficient fund balances. Therefore, the debt issuance scenarios presented in this report assume that each utility should accumulate 120 days of unrestricted working capital prior to issuing debt.¹¹ Therefore, any scenarios that include debt, assume the first year of issuance occurs in FY 2012/13.

These issuances could potentially be accelerated if necessitated. Due to the need for voter approval for rate increases for the Department’s storm utility, it is assumed that debt cannot be issued until FY 2013/14 for this utility corresponding to the timing of potential rate increases. The following tables show the resulting necessary debt proceeds under these scenarios for each utility.

Table 8: Projected New Debt Proceeds (FY 2011/12 - FY 2015/16)

Fiscal Year

These are projected proceeds amounts and do include additional issuance costs and reserve requirements. Issuance costs for new debt are assumed to 2% of the par value per issuance, plus a reserve requirement of 10%. Given fluctuations in market conditions, and in conversations with the

11 The City Treasurer’s Department is currently working with Goldman Sachs to evaluate debt funding alternatives.

Based on market conditions and the Department’s current minimal reserve levels, Goldman Sachs recommended achieving a 120 day unrestricted fund balance. This fund balance level is consistent with industry standards for water utilities dependent upon variable rate revenues.

City’s Treasurers Department, this feasibility-level analysis assumes an interest cost of 6.5%, providing a reasonable degree of conservatism.¹² The debt service will be refined closer to the time of actual issuance. Further, as noted earlier, net revenues are targeted to be sufficient to generate a coverage ratio of 1.50 (or eligible revenues less operating expenses must be equal to at least 150% of annual debt service) by the time of the first issuance.