City Auditor Report Says Water Dept. Has Collected Water/Sewer Rate Increases For Projects Planned And Delayed; Advises Better Budgeting

Explicitly noting that its audit doesn't address whether the Water Dept's reserve balances are reasonable or sufficient, only if they agree with the Department's stated policy, the City Auditor's report states in its Executive Summary that "project delays have resulted in resulted in substantially less work being performed [and] these delays were not considered in the budgeting process over the three years reviewed, resulting in inflated budgets."

The City Auditor's office says Water Dept. management based its rate increase decisions in part on projected budget numbers...and the City Auditor recommends that "[t]o ensure these projections are realistic, LBWD should evaluate existing processes and policies to improve the effectiveness of their annual budget estimates."

The City Auditor's report raises -- but doesn't address -- a potential Prop 218 issue:

[City Auditor report text] Proposition (Prop) 218 became effective on July 1, 1997 and limits the methods by which local governments can create or increase taxes, fees and charges without taxpayer consent. It created substantive and procedural requirements for fees and charges for property-related services, such as water and sewer. Prop 218 specifies requirements for how rates are set and how the funds generated by those rates are used. Some of the requirements include:

• Fees imposed must not exceed the cost of providing the service.
• Revenues generated from collection of the fee may not be used for any other purpose other than that for which the fee was imposed. Reasonable operating reserves may be maintained.

When a public entity proposes to impose or increase any property related fee it must calculate the amount of the fee proposed, provide written notice by mail to customer, and conduct a public hearing on the proposed new or increased fee not less than 45 days after the mailing of the notice. The entity may impose the fee upon a determination that there is no majority protest.

As previously mentioned, the scope of our audit was limited to the budget process for establishing rates; therefore, compliance with Prop 218 was outside the scope of this audit.

The City Auditor's report doesn't advise reexamining planned capital projects or reducing current water and sewer rates, which are set by Mayor-nominated, Council approved Water Commissioners whose annual budgets are subject to review and approval or disapproval by the City Council.

In pertinent part, the City Auditor's report on Water & Sewer Rate increases states:

[Executive summary text] For the period of the audit [FY09-11], LBWD’s policy was to maintain operating reserves close to $6 million for water operations. This audit does not address whether the reserve balances set by LBWD are reasonable or sufficient, but only if the fund balances agreed with the department’s policy. We found that since the double-digit rate increases occurred in FY 2009 and 2010, the department’s fund balance has consistently exceeded the $6 million target. By FY 2011, fund balances had grown to $43.3 million, a 566% increase since FY 2008.

Fund balances increased because budget assumptions did not always appear realistic when compared to what actually occurred. Although deficits were projected in each of the three years reviewed, actual expenses and revenues instead produced large surpluses. While the timing of the budget preparation, which is seven months before the end of the fiscal year, can make accurate revenue and expense projections difficult, the current budgeting approach seems to include inflated contingencies which are resulting in increasing reserves.

We were able to assert that a large portion of the variances can be attributed to the Capital Improvement Program (CIP). While project delays have resulted in substantially less work being performed, these delays were not considered in the budgeting process over the three years reviewed, resulting in inflated budgets. This problem was apparent in both the water and sewer CIP projects. For FY 2009 through 2011, water CIP projects spent only 57% of the amounts projected, and sewer CIP projects spent even less at 25% of estimated costs.

Management is basing decisions on whether to raise rates, in part, on projected budget numbers. To ensure these projections are realistic, LBWD should evaluate existing processes and policies to improve the effectiveness of their annual budget estimates...

In a September 27, 2012 memo response to the City Auditor (included in the report), LB Water Dept. General Manager Kevin Wattier says the audit "identified several opportunities to enhance budget planning, monitoring and reporting processes that assist in ensuring that LBWD's budget and rate setting processes continue to be implemented in an open and transparent manner" and states in pertinent part:

Management of Reserves

In 2009 and 2010, LBWD implemented two debt related actions. First, the Board of Water Commissioners (Board) authorized the creation of a Commercial Paper Program to finance the initial ramp up of Sewer Fund capital projects in response to an updated Sewer Master Plan; and secondly, the Board authorized the refunding of Water Fund Bonds to take advantage of market rates to provide up front savings and a source of funds for City water conservation projects.

In the course of those transactions, staff communicated to the Board that rating agencies were placing heightened emphasis and scrutiny on reserves as a factor in assessing LBWD's cred it rating for each transaction. The result was the establishment of the metric of "days cash" for Water and Sewer fund balances. The initial guidance offered by LBWD's financial advisors was that a minimum 90 days cash would be an acceptable metric, given that industry averages for water and sewer enterprises were greater than 300 days, and given LBWD's other strong financial metrics, including its rates and coverage ratios.

As part of our regular budget process with the Board for Fiscal Year 2012-2013, we have established the annual reporting of fund balance components, including operating reserves based on the days cash metric, and reserves for specific projects and programs. For the Fiscal Year 2013-2014 budget process, we will include a discussion of the industry averages of days cash for other similarly rated agencies, as well as the reporting of debt coverage ratios as required .

CIP Budget Planning and Monitoring

For the Fiscal Year 2012-2013 Budget, staff instituted a revised planning process for the longer term , Five Year CIP list of projects and budget, as well as the CIP project list and budget for FY2012-2013. The revised process includes focused discussions on the following inputs to the CIP for both Water and Sewer Funds:

• Monthly and quarterly projections of project schedules
• Assessment of the appropriate timing and priority for the projects
• Risk assessment and potential impacts to schedule and costs
• Grant funding and partnerships affecting CIP project costs

Additionally, the same review process was applied to the current FY201 1-2012 CIP to better ascertain Estimates-to-Close (ETCs), and any impacts or risks to project schedules and costs that would affect those ETCs. This review of the current CIP has occurred almost monthly since the beginning of the FY2012-2013 budget process, and LBWD has incorporated the more detailed review of the annual CIP into its budget process and as part of the overall maintenance and monitoring of the CIP. During LBWD's annual budget process, information from monitoring the annual CIP will be factored into the Five Year CIP for long range budget planning.

Under the revised process, the Water Fund CIP for FY2012-2013 is 30% lower than FY2011 -20 12, reflecting the additional review process for proposed CIP project schedules and budgets. Staff reported to the Board unforeseen circumstances that impacted a critical water supply project in the current Water Fund CIP. The impacts of a reduced CI P and the implications from the project delay were then incorporated into ETCs for the current year and the development of the FY2012-2013 budget.

Review of the Sewer Fund CIP program established the need for reassessment of the Sewer Master Plan and long-term Sewer Fund CIP list of projects. A number of the larger-scale Sewer CIP projects have been completed, along with several cement pipe rehabilitation projects. Condition assessment of the clay pipe portion of the sewer system has commenced, and analysis of the initial data gathered indicates th is portion of the system may be more structurally sound than originally anticipated in the Sewer Master Plan. The reassessment has been included in the FY2012-2013 CIP, and will lead to changes in the Five Year CIP.

Review of current Sewer Fund CIP also allowed for a strategic decision to cancel a draw on funds from the Sewer Fund Line of Credit for FY2011-2012 and to draw instead from Sewer Fund reserves.

Continued Evaluation of Budget Projections

As part of its regular budget monitoring process, LBWD has monitored and tracked its overall budget on a quarterly basis, updating ETCs in response to updated information on major budget components. During the current fiscal year, the process of additional monitoring of the CIP has been added, enhancing the reporting of budget information to track against proposed expense and revenue budgets.

For Fiscal Year 2011-2012, consistent review and monitoring of Water and Sewer CIP, coupled with regular reporting assessment of other budget ETCs, indicate that LBWD's budgeted expenses will more closely match ETC estimates that formed the basis for the FY2012-2013 budget adopted by the Board and City Council.

Conclusion

The audit identified several opportunities to enhance budget planning, monitoring and reporting processes that assist in ensuring that LBWD's budget and rate setting processes continue to be implemented in an open and transparent manner. LBWD thanks the Auditor's staff for their assistance and efforts.

Matt Veeh, the LB Water Dept's Director of Government & Public Affairs adds in this emailed statement:

In July 2012, Standard & Poor’s completed a comprehensive financial review of the Long Beach Water Department, including its debt instruments and reserve levels.

The review determined that the Water Department maintains a good credit rating predicated on a number of factors. One of the primary factors noted by the rating agency is the strength of the Department’s liquidity levels, or reserves. According to Standard & Poor’s analysis, "The water fund’s liquidity position is strong, in our view."

Standard & Poor’s further concluded that the Water Department has a stable outlook for the future.

"The stable outlook is based on our anticipation that debt service coverage and liquidity will be good-to-strong going forward. If coverage and or liquidity were to decline substantially during the next two years, we could lower the ratings. If coverage and liquidity remain at historically strong levels, we could raise the ratings."...

Mr. Veeh also cites this Water Dept. wage page comparing LB water and sewer rates to other cities, click here.

The City Auditor's office says in a release that it will recommend that the City Council ask LB Water Dept. management "to update the City Auditor on the status of the audit recommendations within nine months in order to gain a clear understanding of the Department’s progress in improving their budgeting process and CIP planning and management."