The Budget Analyst, Public Utilities Commission and Office of the Legislative Analyst have reviewed best practices for financing capital improvement projects at municipal utilities in the State of California.

Methodology

The Public Utilities Commission (PUC) and Office of the Legislative Analyst (OLA) surveyed municipal utilities for a description of practices utilized in financing Capital Improvement Programs (CIP). In order to identify best practices, between April and May 2002, we conducted a telephone survey of key financial staff and also reviewed publicly available financial statements. The sample of 10 utilities listed below were selected because of their similarities to the San Francisco Public Utilities Commission in terms of nature of utility (water or sewer), service area and size.

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• Contra Costa Water District (water)

• East Bay Municipal Utilities District (water)

• East Bay Municipal Utilities District (wastewater)

• Los Angeles Department of Water and Power (water)

• Orange County Sanitation District (wastewater)

• Orange County Water District (water)

• Sacramento County Sanitation District (wastewater)

• City of San Diego Wastewater System (wastewater)

• City of San Diego Water System (water)

• Santa Clara Valley Water District (water)

The survey focused primarily on the comparative credit ratings, utility rate setting process, bond issuance authority, and debt management practices. A summary of the survey results is attached.

General Description

• Size of Capital Improvement Projects (CIP) - California"s population growth combined with aging utility systems has necessitated capital improvement requirements for most utilities. With one exception, all of the utilities surveyed have formal CIPs. Of those surveyed, the average CIP is approximately $885 million, with $2 billion, $1.5 billion, and $1.2 billion projects in the Los Angeles Department of Water and Power, Orange County Sanitation District, and San Diego County Water Authority, respectively. (Note that the data are not perfectly comparable because of the different time horizons for implementation of the respective CIPs.)

• Outstanding Debt Per Capita - We divided outstanding debt by the population size of each utility"s service area as a means to gauge relative debt burden. Of the five wastewater utilities surveyed, two of the three with the highest debt per capita (including SFPUC) had lower credit ratings, but the third had the highest credit rating. For the seven water utilities surveyed, SFPUC has the lowest credit rating, but also the second lowest debt per capita. The utility with the highest debt per capita (Contra Costa Water District) has a split rating (meaning the agencies view the credit very differently).

• Debt Service Coverage Covenant - Issuers of revenue bonds typically covenant to raise revenues (utility user charges) to cover debt service by a specific margin. Most of the utilities surveyed use a coverage factor of 1.25x, which means that revenues, after deducting operating and maintenance charges and as further defined in bond indentures, must equal at least 125% of annual debt service. A few used lower factors, but none lower than 1.1x. While SFPUC has a 1.25x coverage covenant, it is the only utility that includes unappropriated fund balance in the definition of revenue - thus effectively overstating it"s coverage.

• Ratings - The range of credit ratings among the utilities was small (from Aa/AA to A2/A), but the average ratings were high within that range (Aa3 for Moody"s and AA for Standard & Poors. Note that Standard & Poor"s has fewer gradations of ratings than Moody"s.) The rating for SFPUC"s Clean Water Enterprise, an A2/A with negative outlooks, was the lowest rating among those in the sample.

Governance and Authority

• Utility Rate Setting Authority - Of the utilities surveyed, most empower the board of directors to set rates. The typical process is for the boards to set rates after performing financial audits that calculate financially prudent rates. Some exceptions include the Los Angeles Department of Water and Power, which, per City Charter, gives the City Council the responsibility of approving rate increases forwarded for consideration by the LADWP. The San Francisco Public Utilities Commission operates similarly. The Board of Supervisors is responsible for considering rate increases which the PUC forwards. The City Council and Mayor set rates for the City of San Diego Wastewater System. While on the surface, SFPUC"s rate setting process is not unusual, SFPUC is the only utility with a rate freeze imposed by the voters in 1998. This rate freeze, known as Proposition H, is in effect through fiscal year 2006.

• Bond Issuance Authority - SFPUC and two other utilities require voter approval prior to the issuance of revenue bonds. The boards of directors of all other utilities have the authority to issue debt without voter approval. Both of the utilities which require voter approval have other means to finance capital projects without voter approval. For example, Contra Costa Water District may not issue new money bonds without voter approval, but may issue commercial paper without voter approval. The commercial paper is eventually permanently financed with refunding bonds, which also may be issued without voter approval. Similarly, San Diego County Water Authority funds its capital improvements through the issuance of certificates of participation, which, unlike revenue bonds, do not require voter approval.