Water System Coverage and the Requested Feasibility Conclusion
The City of Lakeview owns a water system with $120 million in gross annual revenues and $95 million in cash operating expenses. Annual debt service on its outstanding revenue bonds is $30 million, and the bond ordinance rate covenant requires net revenues of at least 1.25 times debt service. The city council wants to issue $60 million of additional revenue bonds for a treatment plant, which would add $4.5 million of annual debt service. The finance director asks you to prepare a feasibility report showing the city 'can meet the covenant without a rate increase.' The city's last rate increase was six years ago, and consumption has declined 2% per year.
1. Compute current coverage and coverage after the new bonds without a rate increase. Is the finance director's requested conclusion supportable?
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Current net revenues = $120M − $95M = $25M. Current coverage = $25M / $30M = 0.83x, already below the 1.25x covenant. After the new bonds, debt service = $30M + $4.5M = $34.5M; coverage = $25M / $34.5M = 0.72x. The finance director's requested conclusion, no rate increase and covenant met, is not supportable. A feasibility report that assumes no rate increase would misstate the arithmetic and could mislead bondholders and the council.
2. What rate increase would be needed to meet 1.25x after the new issue, and what assumptions must be disclosed?
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To meet 1.25x on $34.5M, net revenues must be 1.25 × $34.5M = $43.125M. The required increase in net revenues is $43.125M − $25M = $18.125M. Assuming operating expenses stay flat and the increase comes entirely from rates, gross revenues must rise to $138.125M, an increase of 15.1% ($18.125M / $120M). Because consumption is declining 2% per year, the rate increase may need to be higher. The report must disclose assumptions about O&M, consumption elasticity, rate phasing, and reserve levels, and should show sensitivity cases.
3. What are your obligations if the city insists on the original conclusion?
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The advisor must not sign or issue a report that misstates coverage or omits the need for a rate increase. It should tell the City in writing that the requested conclusion is not supported by the numbers, offer alternative scenarios, and, if the City insists, decline to prepare the report and document the refusal. Under G-42(c), the advisor cannot subordinate the City's best interest to the finance director's preferred message. If the City issues bonds based on misleading projections, the advisor may have disclosure obligations and potential liability.