Reserve Requirements Presented by: John Farnkopf, HF&H - - PowerPoint PPT Presentation

Reserve Requirements

Presented by: John Farnkopf, HF&H Consultants, LLC.

HF&H Consultants, LLC 1

May 10, 2016 CCWD Board Meeting

Reserve Requirements

■ Purpose of reserves

– Account for revenues – Manage risks

■ Two broad categories

– Unrestricted reserves

• Established as needed
• Typically funded from rate revenue

– Restricted reserves

• Legally required according to funding source

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Common Types of Reserves

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Unrestricted Reserve Practices

■ No absolute standard ■ All water utilities have at least one unrestricted reserve ■ Most have separate unrestricted reserves for operating and capital requirements ■ Some have additional unrestricted reserves to help manage special requirements

– Reflects approaches to managing risk

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Operating Reserve

■ Highest priority unrestricted reserve ■ Purpose – Cash flow – cover lag time between when District pays expenses and receives revenue from rate payers – Manage operating surpluses and deficits caused by variances between projected and actual expenses and revenues

• Unpredictable changes in costs outside the District’s control

– Cost of SFPUC purchased water – Cost of power and chemicals for pumping and treatment

• Buffer fluctuating water sales caused by climate and water supply

conditions

– Smooth rate increases from year to year

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Operating Reserve

■ Target balance

– To cover cash flow, bill frequency is a key consideration – California PUC rule of Thumb

• Minimum = 1.5 times bill frequency
• For bi-monthly billing, 90 days of revenue
• Equivalent to 25% of annual operating

revenue

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Capital Reserve

■ Second highest priority unrestricted reserve ■ Purpose

– Cash flow for pay-as-you-go capital projects

• Provides liquidity to pay contractors without

construction delays

– Not needed for debt-funded projects when there is a separate restricted Debt Reserve – District does not have a Debt Reserve

• Can include an allowance for one year’s debt

service in the Capital Reserve or create a separate Debt Reserve

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Capital Reserve

■ Target balance – Industry practice varies considerably – Considerations that increase requirements

• Significant annual fluctuations in costs construction costs
• Preference to fund capital projects without debt
• Predictable facility master plans
• Uncertain regulatory environment
• Unfavorable bidding economics
• Low tolerance for asset failures, natural disasters, and
• ther emergencies

– Minimum recommended

• Annual average for next five years CIP

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Emergency Reserve

■ Lower priority

– Provide funding after Operating and Capital Target balances are met

■ Purposes

– A type of capital reserve for self insurance – Can be targeted toward a specific facility

• utage

– Provides immediate funding until loans are arranged and before rates can be increased

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Stabilization Reserve

■ Lower priority – Provide funding after Operating and Capital Target balances are met ■ Purposes – A type of operating reserve – Used to stabilize rate increases caused by uncertain operating conditions

• Conservation during droughts
• Reduces need for rate increases that make rate payers feel

penalized for using less

• Can be funded from surpluses in years of high water sales

without the need for rate increases

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Meeting Reserve Targets

■ Unrestricted reserves are funded from rate revenue

– Building reserves requires rate increases – To avoid chasing the targets, affirmative rate increases may be needed

• Try to avoid deferring capital projects to build

reserves

• Rely on realistic conditions to close the gap
• Earlier action can take advantage of the

compounding of subsequent rate increases

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Evaluation of District’s Operating Reserve

■ Current

– 15% of operating revenue – Intended for other unrestricted reserve needs

■ Recommendation

– Should be a minimum of 25% – Rate increase required

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Evaluation of District’s Capital Reserve

■ Current – None – Not separate from Operating Reserve ■ Recommendation for PAYGo CIP – Create separate Capital Reserve – Annual average for next five years ■ Recommendation for debt-funded CIP – One year’s maximum annual debt service – Can be included in Capital Reserve in addition to PAYGo component

• Better as a separate Debt Reserve

– Rate increase required

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