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Council weathers potential crisis in wastewater funding

The Metropolitan Council has weathered a potential crisis that threatened its longstanding and effective method for financing part of the regional wastewater collection and treatment system. The improved outlook is due largely to a new law that was supported by Metro Cities, the Public Facilities Authority and individual cities, passed by the 2010 Legislature and signed by Governor Pawlenty.

The near crisis resulted from a precipitous decline in one of the Council’s major sources of revenue for the wastewater system: the sewer availability charge, or SAC. The SAC fee, a one-time fee for new connections or increased volume to the regional wastewater system, is charged to pay for capacity built into the system for future growth.

As a result of the recent housing market crash and severe recession, the number of SAC units plummeted from an average of 20,000 per year a decade ago to 15,193 in 2007 and 6,675 in 2009. Consequently, the Council’s SAC Reserve Fund shrank from $100 million to $72 million in 2007 and $32 million in 2009.  Another $10-16 million will likely be needed to be drawn from the fund in 2010.

At stake was the Council’s ability to comply with state law regarding how to finance improvements to the wastewater system, as well as the Council’s AAA bond rating, according to Jason Willett, director of financial management for the Council’s Environmental Services division (MCES).  But the new law gives the Council temporary flexibility to use some revenue from municipal wastewater charges to pay for the reserve capacity in the system.

“Regardless of how quickly the economy recovers, we are in a much better position to manage our wastewater finances, and we will maintain reasonable and nationally competitive rates for our customers,” Willett said.

On June 16, the Council will hold a public hearing to provide information and receive input on its plans to reduce the amount of money transferred from SAC to the MCES operating fund for 2011. Cities will see an increase in municipal wastewater charges to make up for the difference. The Council is also making extraordinary efforts, Willett said, to share the pain of its municipal customers by reducing its expenses.

Navigating the financial intricacies of SAC

Regional wastewater collection and treatment is funded entirely by user fees. The two primary revenue sources are the municipal wastewater charge and the SAC. The municipal wastewater charge is the fee paid by a municipality to MCES based on that community’s volume of wastewater.

In addition, state law requires the Council to charge municipalities for the costs of “reserve capacity” built into the metropolitan wastewater system for future users. For this purpose, the Metropolitan Sewer Board – a predecessor agency to MCES – set up the SAC system in 1973, and it has been used ever since. The SAC fee is set annually by the Council.

Since SAC pays for a substantial part of Council debt service for wastewater capital projects, having a sustainable plan to deal with variable economic circumstances is important to bond-rating agencies, and thus to metropolitan rate-payers, Willett said. And because much of the Council’s wastewater project financing is through the state’s Public Facilities Authority (PFA), a reduction in the Council’s bond rating could adversely affect the attractiveness of PFA’s bonds or even its bond rating  – leading to higher interest costs for wastewater projects throughout the state.

Thanks to the region’s household growth, net SAC units averaged about 20,000 units per year before the housing crisis and the deep recession. The SAC fee receipts are put in the SAC Reserve Fund, and annually a portion is withdrawn to pay directly for capital projects (pay-as-you-go) or for debt service for capital projects.

For decades the amount of that required withdrawal was based on a calculation of how much reserve capacity was in the system in any given year. In addition, the Council established a minimum SAC reserve balance policy to mitigate the financial impact of a slowdown in new connections to the wastewater system.

SAC revenue decline triggers action

The formula worked well until the recession and the unprecedented decline in SAC revenues, down about two-thirds from the historic average. Suddenly, the withdrawal requirements from the reserve fund meant it was being drained quickly.  By mid-2008, it became evident that action would be required.  

In order to relieve pressure on the SAC reserves, MCES staff reviewed the method for computing reserve capacity and made improvements. Because this would result in higher municipal wastewater charges, Metro Cities weighed in on behalf of the region’s municipal customers.

“We saw the proposed changes as a potentially dramatic policy shift regarding which users (current or future) paid for what,” explained Patricia Nauman, executive director of Metro Cities. As a result, Metro Cities asked for the proposed increase in municipal charges to be phased in, and requested that a task force be established to take a comprehensive look at the SAC program and its future viability.  

The Council agreed to both requests and adopted the change for 2010 rates. Regarding the task force, Council Chair Peter Bell made it clear that he would support changes to the SAC program only if the wastewater system continued to be funded entirely by user fees, and that no tax dollars be part of the revenue mix.

Council seeks legislation to avert crisis

When the number of SAC connections made another sharp drop in 2009, the Council knew it needed to take additional action to shore up SAC before the task force finished its deliberations, Willett said. The Council proposed legislation to give it flexibility to shift more of the burden of paying for reserve capacity from SAC (future users) to the municipal wastewater charge (current users).

Metro Cities asked for three amendments to make the legislation more palatable for municipalities:

• Language was added to more specifically define when the law’s provisions would be triggered;
• A sunset date of 2015 was added to the bill to guarantee reexamination of the issue; and
• A requirement was added to shift the funding back to SAC when financial times improve.

“We obviously want to make sure that the regional wastewater utility is solvent,” Nauman said. “But we did want to tighten up the bill so that the legislative authority wasn’t overly flexible and granted in perpetuity.”  The Council agreed to the amendments.

The Council also agreed to raise the SAC rate a minimum of 6% in any year the shift from SAC to the municipal charges is made. But making the increase greater than that could further dampen new housing construction and cause new development to go outside the sewered part of the metro area, and perhaps not increase revenue, Willett said.

Terry Kuhlman, executive director of the Public Facilities Authority, said the PFA supported the legislation because it represented a good business practice for the Council. “Anytime a government agency can diversify its revenue stream to gain a little more financial stability, that’s a good thing,” Kuhlman said. The Council is the PFA’s biggest borrower, and the Council’s financial standing impacts the attractiveness of PFA-issued bonds to investors, he said.

The amended bill – carried by Rep. Paul Gardner and Sen. Sandy Rummel – was supported by Metro Cities, the SAC Task Force, the PFA and individual cities, and was passed by the Legislature and signed by Governor Pawlenty in April.

Outlook for 2010 and beyond

The legislation should help the Council weather the next few years because a major uptick in development is not expected anytime soon, according to Libby Starling, manager of Metropolitan Council Research.

“While it is unlikely that construction can fall below the record lows of 2009, residential builders are reluctant to increase building again until jobs are more plentiful,” Starling said. “And between businesses searching for cost reductions at every corner and the continued sluggishness of the credit markets, commercial development is down as well.  Commercial construction is unlikely to pick up again until the global economy fully restabilizes at some point in the unknown future.”

The Council’s SAC Task Force is still deliberating, but consensus is starting to build around a proposal to ensure that SAC fees pay directly the cost of new growth, Willett said. The task force looked at different means for computing reserve capacity but decided that a “growth cost” methodology would be best. That would mean that SAC would pay 100% of the costs for growth of the metro sewer system and not pay at all for the cost of rehabilitation or quality improvements to the system.

The task force is also dealing with special issues, like SAC charges for outdoor restaurant space and day-care centers. It is expected to have recommendations to the Council before the end of the year.

Public hearing on SAC shift slated for June 16

For 2011, MCES staff proposes a shift of $4.5 million from the SAC to municipal wastewater charges. This would result in an average increase on a household’s water bill of 23 cents per month or $2.78 for the year. A public hearing on the proposal is scheduled for June 16, followed by a 10-day written comment period.

In July, the Environment Committee will review the public input, and make recommendations for the 2011 rates and charges. Council approval is scheduled to follow in late July.

Even with the shift, the region’s retail wastewater rates will likely still be ranked at least fifth lowest in a group of 22 peer metro areas (based on a 2008 rate analysis). In addition, as of the end of May 2010, the Council had gone 40 consecutive months without a single violation of its state and federal discharge permits at any of its treatment plants. MCES continues to win national awards, including an Environmental Achievement Award in 2009 from the National Association of Clean Water Agencies for its innovative program to reduce the amount of storm water and groundwater getting into the wastewater system and being treated unnecessarily, then discharged into area rivers.

“We’re finding common ground with the cities and the state, who are all interested in us retaining our excellent bond rating, because it means lower project costs and rates in the long run,” Willett said. “And MCES is continuing its strong environmental performance. It is all turning out well.”