Title
Resolution Regarding Approval of Schedule of Member Partner Bad Debt Recovery Credits #2023-2 Totaling $20,026,500 With Conditions Precedent Utilizing the Highland Park Bad Debt Recovery Credits Methodology
Body
Agenda of: November 16, 2023
Item No.: 2023-427
Amount: $20,026,500.00
TO: The Honorable
Board of Directors
Great Lakes Water Authority
FROM: Suzanne R. Coffey, P.E.
Chief Executive Officer
Great Lakes Water Authority
DATE: October 25, 2023
RE: Resolution Regarding Approval of Schedule of Member Partner Bad Debt Recovery Credits #2023-2 Totaling $20,026,500 With Conditions Precedent
MOTION
Upon recommendation of Nicolette N. Bateson, Chief Financial Officer & Treasurer, the Board of Directors (Board) of the Great Lakes Water Authority (GLWA), adopts Resolution #2023-427 to:
1. Approve the Schedule of Member Partner Bad Debt Recovery Credits #2023-2 totaling $20,026,500 with $5,026,500 for the water system and $15,000,000 for the sewer system with conditions precedent utilizing the Highland Park Bad Debt Recovery Credits Methodology;
2. Acknowledge that the following actions (collectively the “Conditions Precedent”), which provide indirect budget relief, are conditions precedent that must occur prior to the funding, application, and distribution of the credits:
a. Execution of the implementation agreements as described in the October 18, 2023 Term Sheet (attached) between the City of Highland Park, Great Lakes Water Authority, and the State of Michigan (“Term Sheet”) including the successful implementation of the all-receipts trust;
b. Appropriation by State of Michigan of “a $5M grant for work to be conducted by GLWA on drinking water infrastructure” referenced in section 2.c. of the Term Sheet.”;
c. Release by the State of Michigan and transfer to GLWA of “the $25M sewer infrastructure grant funds previously allocated in the FY 2023 budget to GLWA on or before December 31, 2023”;
d. Payment of “$241,418.75 cash bond deposited by HP [Highland Park] with the U.S. District Court Clerk [which] shall be released to GLWA from E.D. Mich. Case No. 16-cv-13840”
3. Request that staff report to the Board of Directors when conditions precedent are met to seek approval to apply credits totaling $20,026,500 as outlined in the above methodology and related Schedule of Member Partner Bad Debt Recovery Credits #2023-2 no sooner than the fourth quarter of FY24;
4. Provide contingent funding for credits to Member Partners subject to the conditions precedent in the FY 2024 First Quarter Budget Amendments of $5,026,500 for the water system and $15,000,000 for the sewer system;
5. Authorize staff to deposit the $241,418.75 cash bond to the sewer system deposited by Highland Park with the U.S. District Court Clerk related to E.D. Mich. Case No. 16-cv-13840; and
6. Authorize the Chief Executive Officer to take such other action as may be necessary to accomplish the intent of this vote.
BACKGROUND
In accordance with contractual terms for service and related court orders, Member Partner communities are explicitly responsible for funding certain bad debt expense. Over an extended period, Member Partner communities have been charged for bad debt expense related to partial non-payment by the City of Highland Park. Simultaneously, litigation with Highland Park and the State of Michigan has occurred as it relates to water, sewer, and industrial waste control service charges.
Recently, developments in a confidential mediation process between the City of Highland Park, the Great Lakes Water Authority (GLWA) and the State of Michigan resulted in the parties entering into the attached Term Sheet. The Term Sheet includes the following excerpted provisions which are most pertinent to the release of funds to GLWA to fund Member Partner bad debt expense recovery credits.
• Item #1 - “The Great Lakes Water Authority (GLWA), the City of Highland Park (HP), and the State of Michigan (SOM) shall enter into a settlement agreement by January 15, 2024 that incorporates the basic terms set forth below including mutually agreeable release language.”
• Item #2c - “The SOM shall: …. Release the $25M sewer infrastructure grant funds previously allocated in the FY 2023 budget to GLWA on or before December 31, 2023 and appropriate a $5M grant for work to be conducted by GLWA on drinking water infrastructure.”
• Item #4i - “HP will enter into contracts based on GLWA’s model contract by January 15, 2024 covering the period of January 1, 2014 to December 31, 2044 for water and sewer services. ...
i. The settlement agreement and contracts shall require all amounts paid for HP water, sewer (including industrial waste control) and stormwater services be placed into a trust in which the trustee pays GLWA and any remaining amounts to HP on the same date.”
• Item #9 - “Upon effectuation of the settlement agreement, its attachments and related documents, including initial funding consistent with this agreement and after receipt by the trustee of one month of HP’s water and sewer receipts and distribution of one month’s payment of funds to GLWA under Paragraph 4.i, all litigation between GLWA, Detroit Water and Sewerage Department (DWSD), HP, or SOM shall be dismissed …”
• Item #10 - “The $241,418.75 cash bond deposited by HP with the U.S. District Court Clerk shall be released to GLWA from E.D. Mich. Case No. 16-cv-13840.”
• Item #13 - “This term sheet is conditional and dependent upon (a) final approval of terms by the Governor, (b) appropriation of funds from the legislature to the extent necessary, and (c) approval by the governing bodies of GLWA, and any other necessary party on or before October 26, 2023. “
JUSTIFICATION
History of Bad Debt Expense & Member Partners Charges
The 2011 federal court Order to Incorporate Rate Settlements into Wastewater Contracts and Dismiss All Prior Rate Settlements, requires then Detroit Water & Sewerage Department and now GLWA to allocate the bad debt expense in its sewer charges. The 2011 Order also identifies the allocation of bad debt expense by customer class. Under the 2011 Order, bad debt expense recovery from “wholesale contract customers” must be recovered from that same customer class. The status of bad debt expense is discussed every year during charges rollout meetings and several years ago, the cost was shown as a line item of the charge calculation sheet. A similar approach has been applied to water charges. From a utility sector charge setting perspective, bad debt expense is an operating cost that should be accounted for in charges and it is therefore not uncommon. The larger issue for GLWA and its Member Partner communities is that it had likely not envisioned that an unpaid account would reach $54 million. As we look to bring closure to the past with the recent Term Sheet of October 18, 2023, a more wholistic approach is warranted to balance the financial burden.
Highland Park Accounts Receivable as of June 30, 2023 and Member Partner Interests
For the water system, as of June 30, 2023, the Highland Park accounts receivable balance (all amounts rounded for discussion purposes), is $12 million. Of that amount, all Member Partner communities, including suburban wholesale and DWSD, were charged $5 million of bad debt expense and GLWA has absorbed $7 million. Member Partner communities are interested to know if there is a way that they can be made fully or partially whole given the recently agreed upon Term Sheet. The entire amount contributed by Member Partners, in an exact amount is $5,026,500 (which is $5,152,500 previously charged less the one-time credit of $126,000 based upon a specific payment made by Highland Park on June 9, 2023).
For the sewer system, as of June 30, 2023, the Highland Park accounts receivable balance (all amounts rounded for discussion purposes), is $41 million. Of that amount, suburban wholesale Member Partner Communities were charged $35 million of bad debt expense and GLWA has absorbed $6 million. Member Partner communities are interested to know if there is a way that they can be made fully or partially whole given the recently agreed upon Term Sheet. The entire amount contributed by Member Partners, in an exact amount, is $34,782,400 (which is $35,656,400 previously charged less the one-time credit of $874,000 based upon a specific payment made by Highland Park on June 9, 2023).
What Options Does GLWA Have to Ease the Prior Bad Debt Expense Burden?
The nature of all public utility finances is that the entire cost of operations and capital improvements are borne by the customers. And those costs are largely fixed in nature. Public utilities use break-even budgeting; there is no “profit.” If the fixed cost system has a shortfall in year one, that shortfall directly or indirectly is reflected in future charges - largely because there are less funds carried forward for the capital improvement needs in subsequent years. Barring the availability of other resources, this results in higher charges requests in subsequent years.
Within the past month, there were two concurrent efforts underway which we would like to discuss as a wholistic view of the Member Partner credit requests from availability of other available resources.
Starting with the term sheet itself. First, there will be approximately $250,000 for past legal fees which was agreed upon to be released to GLWA and would be recorded in an operating account. That is a straightforward decision to tag those funds for member partner credits. Second, there is also the potential $5 million water infrastructure grant (pending legislative approval) and the $25 million sewer infrastructure grant (pending release by the State and aligning project costs with federal requirements). These grants are great news for the system overall, but appropriately have spending restrictions and are to be used for capital improvements, not operating expenses, as well as carry a myriad of other restrictions. Also, since they are capital in nature, and will be paid on a reimbursement basis that may extend over a year, they cannot be tagged for Member Partner credits. Our challenge in leveraging how the economic benefit of these grants over a period of time and with restricted uses, can be used for providing charge relief. Understanding timing and cashflow are at the center of evaluating the request.
Turning to the other concurrent matter which is the analysis and preparation of the first quarter FY 2024 budget amendments. The downside is that we are continuing to see intense budget pressure as discussed in great detail at the GLWA Board Workshop on September 13, 2023. Attached is a synopsis of the budget status for the fiscal year that began on July 1, 2023. Note the following related to that attached table.
Water System - Negative FY 2024 Q1 proposed amendment of $18 million due to $4 million water revenue shortfall (wet weather in summer months), $10 million in increased operating expenses (chemicals, utilities and the change in funding source from Improvement & Extension to Operations & Maintenance for the Workday implementation and other services that cannot be capitalized), and $3 million net of other items with the most significant being increased debt service due to new money transaction this fall to keep pace with the water system improvements underway.
We do have good news on forecasted investment earnings as our investment manager continues to optimize the portfolio with an $8 million positive variance.
The net of the $18 million negative variance and the $8 million uptick in investment earnings meant that the FY 2024 Q1 budget amendment would be a decrease to the Improvement & Extension (I&E) Fund for future capital improvements by $10 million. Instead, we propose to tag the $5,000,000 of unrestricted positive investment earnings in FY 2024 along with $26,500 in other operating funds to credit Member Partners based on the previously approved “Highland Park Bad Debt Recovery Credits Methodology.” While it means that we would further decrease the I&E contribution this year, the receipt of the grant would make up for it in the future. This is of course, dependent upon the actions of all parties to carry out the tasks outlined in the term sheet. It should be noted that the sum of $5,026,500 would fully reimburse water system Member Partners.
Sewer System - Negative FY 2024 Q1 proposed amendment of $15 million are due to a $14 million increase in operating expenses (chemicals, utilities, repairs & maintenance contracts, and the change in funding source from Improvement & Extension to Operations & Maintenance for the Workday implementation and other services that cannot be capitalized), and $1 million net of other items with the most significant being increased debt service due to new money transaction this fall to keep pace with the sewer system improvements underway.
We did have good news on investment earnings as our investment manager continues to optimize the portfolio with an $9 million positive variance.
The net of the $15 million negative variance and the $9 million uptick in investment earnings meant that the FY 2024 Q1 budget amendment would be a decrease to the Improvement & Extension (I&E) Fund for future capital improvements by $6 million. Instead, we propose to tag the $9 million of the positive unrestricted investment earnings in FY 2024 to credit Member Partners based on the previously approved “Highland Park Bad Debt Recovery Credits Methodology”. In addition, given that the economic benefit of the grant of $25 Million will accrue to the entire system, we have been asked if there is a way to recognize that 60% of the revenue comes from the suburban customer class - which was charged for bad debt expense. This results in a request of $15 million (60% multiplied by $25 million) for a credit to Member Partners. While it means that we would further decrease the I&E contribution by $6 million this year, the receipt of the grant would make up for it in the future. Bottom line would be $15 million tagged for suburban wholesale Member Partner credits. This is also, of course, dependent upon the actions of all parties to carry out the tasks outlined in the term sheet.
Highland Park Bad Debt Recovery Credits Methodology
On June 28, 2023, the Board of Directors adopted a methodology for credit allocation among Member Partners (File #2023-234 <https://glwater.legistar.com/LegislationDetail.aspx?ID=6272560&GUID=2A37FBAB-903C-4838-A7AC-04EDDC974FEB>). The overall allocation is 87.4% Sewer System and 12.6% Water System based on a proportional share of what was included in previous years’ charges for services to first-tier Member Partners. Attached is a schedule which identifies a percentage for each Member Partner community and their relative share based on the discussion above.
BUDGET IMPACT
The financial impact on the budget is outlined above. In summary, it is reduction to the I&E Fund contribution in FY 2024 with a corresponding increase in construction fund capital grant revenue that spans potentially FY 2024 and subsequent years, pending completion of the conditions precedent.
Water System FY 2024 - I&E contribution reduced by $5,026,500 for Member Partner Credits with timing of future $5 million capital grant for the construction fund at a future data.
Sewer System - I&E contribution reduced by $15 million (representing 60% suburban wholesale class allocation) for Member Partner Credits with timing of future $25 million capital grant for the construction fund at a future date.
In terms of timing, it is proposed that this proposal be reflected in the FY 2024 Q1 Budget Amendments. Timing of the credits applied is dependent upon a number of actions, including the establishment of an all receipts trust and 30 days to ensure that the overall agreements are working as intended. There are complexities to the Term Sheet, but it should be reasonably expected that credits could occur in late FY 2024 Q3 or early Q4.
COMMITTEE REVIEW
This matter was presented at the November 9, 2023 Audit Committee with a unanimous recommendation to move the items to the full Board of Directors for discussion at its meeting on November 16, 2023.
SHARED SERVICES IMPACT
This item does not impact the shared services agreement between GLWA and DWSD.