March 8, 2018International Woman’s Day

National Peanut Cluster Day Jeff Hughes

Environmental Finance CenterUNC School of Government

919.843.4956jhughes@unc.edu

www.efc.sog.unc.edu

Foundations of

Finance

Water and Wastewater Leadership Center

Environmental Finance Center

2

How you pay for it matters

Supporting the fair, effective, and financially sustainable delivery of environmental programs through:• Applied Research

– Fees and finance

• Teaching and Outreach• Program Design and Evaluation

– Dashboard– Capital planning tools

Water Quantity Management Challenges

Water Infrastructure Challenges

4

Water Quality Management Challenges

Customer Confidence Challenges

6

Objectives for the Day1. Improve ability to identify finance information

that is relevant (and irrelevant) to the sustainability and success of your operations.

2. Improve understanding of basic financial terminology and trends.

3. Gain confidence to help answer key finance questions.

4. Strengthen ability to communicate financial information to customers/“shareholders,”management, and elected officials.

Agenda

1. Introduction to financial leadership2. Financial health/benchmarking3. Looking beyond budgetary line item costs4. Revenue trends5. Affordability6. Capital finance trends

Finance Questions and…

….Burning Issues

Financial Leadership??

Krispy Kreme Corporate Accomplishments

• Sales of $778.6 million, a 28 % increase over last fiscal year (52-week year).

• Net income of $39.1 million, up 51.6 percent over last fiscal year

• Opening 53 factory stores and 10 commissaries.• Acquiring Montana Mills Bread Co., Inc., • Achieving a 24.0 percent national market share• Successfully rolling out our new Krispy Kreme

Signature Coffees across North America.• Being recognized by Restaurants and

Institutions SOURCE: Krispy Kreme Annual Report

Orange Water and Sewer Authority Corporate Accomplishments

• Renovation of Pump Station ($540,000)• Replacement of 14,000 of water ft of water line ($2.9 Million)

• Rehabilitation of 19,000 ft of sewer line ($650,000)• Begun evaluation of reclaimed water project.• In house study of establishing more comprehensive water conservation program.

• Ambitious 15 year CIP identifies $251 million of necessary system improvements.

SOURCE: Annual Report

Net (Plant) Assets/Operating Revenue

http://www.waterrf.org/publicreportlibrary/91257.pdf

Penn and Teller

http://www.amazon.com/gp/product/B00MQMVQTE/ref=asc_aa?ie=UTF8&redirect=true&redirectToAsin=B00MQMVQTE&t=0m0s&tag=clicker_piv-20

https://www.youtube.com/watch?v=YFKT4jvN4OE

Assessing Financial Condition

20

Assessing and Presenting Financial Information

• For your lender• For yourself• For your board• For your boss

– Engineer– Finance

• For your neighbor

Assessment of Your UtilityAnnual Report or Management Discussion

• Overall fiscal health?• Biggest finance related accomplishment?• Biggest financial challenge?

Rating Agency’s View of Industry

24

Outlook according to Moody’s

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Ratings

Source: Moodys Municipal Bond Rating Scale, November 2002

The ‘Nessie’ Curve

Source: Dawn of the Replacement Era, AWWA

Water Distribution System

• Average yearly expenditure over the last 20 years is $226,000

• This equates to a 1,396 year replacement schedule

• Yearly funding should average $4,000,000

• 162 miles of unlined cast iron mains

• Poor condition of distribution system directly affects water quality

Source: Linda Sims, City of Durham, Department of Water Management

Whiteboard Video:Financial Benchmarking

http://www.waterrf.org/Pages/Projects.aspx?PID=4366

The Most Common Financial Indicator??Compare with Caution!!

$563

$753

$298 $282

$524

$1,032

$497$582

$414

$643$669

$843

$0

$200

$400

$600

$800

$1,000

$1,200

2004

2005

Operating Expenditure vs. Operation Expense

• Financial terminology is not always consistently applied but…– “Expense” may includes non “monetized” items

such as depreciation that tend to be “related” to what the utility is or should be seeing in their capital expenditures

– Sometimes, we are more concerned about cash “expenditures”

– Key take-away – know what you are comparing!

Operating Expenditures

Graphic Source: NACWA 2014 Finance Survey and Report Executive Summary

Major non-cash costs that are not considered operating expenditures

• Principal payments• Interest payments (for governmental utilities) • Pay as you go outlays• Transfers other than reimbursements• Depreciation expense

Depreciation “Simplified”• Method of allocating initial cost over time to

be in sync with income generation.• Estimate of value of asset being used up

(worn down) over time.• Formulaic conversion a capital expense to a

recurring expense– Deductible against income for tax purposes (for

tax paying entities)– Useful indicator of “full cost pricing” -- whether

revenue (rates) are covering capital costs

King of the Investor Indicators: Debt Service Coverage

• Debt Service Coverage = Revenue available to pay debt service divided by debt payments

• Multiple variations on how this is calculated (what gets added to revenues and what gets subtracted)

• Simplest Version: Revenues available to pay debt service = Operating Revenues –Operating Expenditures

Debt/Needs Indicators

• Net Assets = Total Assets – Total Liabilities• Long Term Debt/Net Assets• Debt per account• CIP costs per account

Assessment Exercise

48

“Costs”

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Single vs. Triple Bottom Line

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

Source: Fayetteville Observer 2/6/04

Fixed vs. Variable

Why does this happen?Revenue and Expenses for Charlotte-Mecklenburg Utilities in a Given Year

Source: CMU Director Doug Bean’s presentation to the Charlotte City Council on December 1, 2008.

Dividends vs. Reimbursements

• Reimbursements for indirect services• Payment in Lieu of Taxes• Dividends

– Based on equity– Based on revenues– Based on net income

Initial Capital Costs vs. Life Cycle

Common Applications• Type of pipes• Type of pumps• Treatment facilities

Initial Cost vs. PV of:• Repair• Energy usage• Replacement• Labor• ….• …

Revenues

57

Revenue case study?

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004

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

Trends in Demand Growth(Orange Water and Sewer Authority, Chapel Hill/Carrboro, NC)

Courtesy of Pat Davis, Orange Water and Sewer Authority

Raw

Wat

er D

eman

d (M

GD

)

1965 1975 1985 1995 2005 2015 2025 2035 2045 2055

Is it variable or is it gone??

0

20

40

60

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120

140

160

180

200

220

240

1930

1935

1940

1945

1950

1955

1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

Annu

al M

GD

Actual Annual 5-Year Moving Average1967 SWD Forecast1973 RIBCO Forecast1980 Complan Forecast Medium1980 Complan Forecast Medium-Low1985 Complan Forecast-Medium1993 WSP Forecast

Source: Seattle Public Utilities

What is happening?

0

100,000

200,000

300,000

400,000

500,000

600,000

700,000

800,000

900,000

1,000,000

1,100,000

1,200,000

1,300,000

1,400,000

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

0

20

40

60

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280

Total Water Consumption

Population

Popu

latio

n

• Prices went up• Homes became more efficient• Water users became more efficient• Decentralized initiatives increased

Source: Seattle Public Utilities

Revenue and Expenses for Charlotte-Mecklenburg Utilities in a Given Year

Source: CMU Director Doug Bean’s presentation to the Charlotte City Council on December 1, 2008.

Are there alternatives?

Evolving Pricing: Water Utility 2.0?

New business models?

• Airlines – sur charge model• Phone/cable – bundled services for

predetermined fixed fees• Customer specific peaking charges?

Affordability

67

Finance Highlight

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Trends in User Charges

Affordability Indicators• Annual User Charge/Median Household

Income– Can be dominated/blurred by denominator or

numerator– Families that don’t pay utility bills?– Statistical precision

• Poverty rate• General socio demographic indicators

(unemployment..)• Range of emerging indicators

Diverse Affordability Criteria

• Credit worthiness (Rating Agencies)• System Financial Capability Assessment

(Regulatory Purposes)• Funding Agency Affordably Criteria for

awarding grants and subsidized interest (Allocating Scarce Public Subsidy)

• Criteria for customers applying for assistance from their utility

EPA Financial Capability Assessment Guidance (1997)

CSO Financial Capability Assessment Guidance, 1996

Panel Findings and Recommendations

• “Fragmented Governance”

• “Varied viewpoints”• “Bifurcated regulatory

and organizational structures.”

• “separately-managed silos for drinking water, wastewater, and stormwater at all levels of government.”

Cost of Water Service in Terms of Hours Worked

75

S&P Affordability

Local Customer Assistance Criteria

Utility Level Customer Assistance Programs and Strategies

• Water efficiency• Payment plans• Need based rate classifications• Structuring rates to minimize impact on low

volume/basic use• One time assistance payments• Recurring discounts

Affordability Exercise

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

80

Capital Finance Developments

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Basic Questions Behind Debt

1. What are terms (interest rate, length)2. What is security (General Obligation vs.

Revenue)3. What will be used to retire debt (Taxes vs.

utility revenues)4. Is a referendum needed5. What is the coverage requirement6. Is it taxable?

Capital Financing Trends?• Impact of Tax Cut Act• Longer term debt

– Need asset life, investors, and legal framework• Green Bonds• Environmental Impact/Pay for Performance

Bonds• Public Private Partnerships

– Typically much higher cost of capital rates but risk incorporated into capital rates

Paying for the Big Stuff

Graphic Source: NACWA 2014 Finance Survey and Report

Cost of Capital

0.00

1.00

2.00

3.00

4.00

5.00

6.00

Revenue Bond Index

Tax Exempt Revenue Bonds Rule

• Backed by enterprise revenue• May or may not need referendum (usually

don’t)• Great rates for those with good ratings• 20 to 40 years (occasionally longer)

Private Sources of Capital

• Bond market 2 to 6 percent capital that does not absorb risk

• Public Private Partnership Equity 5 to 20% capital that

• Public Private Partnership Debt 4 to 8 % percent blended with equity

87

Example of Flows of Capital

• Insert P3 diagram

88

https://efc.sog.unc.edu/project/alternative-water-project-delivery-models

Retiring Private Capital

89

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

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Objectives for the Day

1. Improve ability to identify finance information that is relevant (and irrelevant) to the sustainability and success of your operations.

2. Improve understanding of basic financial terminology and trends.

3. Continue to strengthen techniques of communicating financial information to customers/“shareholders,” management, and elected officials