McKinleyville Community Services District Reserves Policy

A key element of prudent financial planning is to ensure that sufficient funding is available for current operating, capital, and debt service needs. Additionally, fiscal responsibility requires anticipating the likelihood of, and preparing for, unforeseen events. McKinleyville Community Services District (District) will, at all times, strive to have sufficient funding available to meet its operating, capital, and debt service obligations. This policy is to develop and ensure the appropriate and necessary funds are accumulated and maintained in a manner consistent with the District’s guiding financial policies and Capital Improvement Plan. Furthermore, the Reserves policy will aid in the prevention of significant rate fluctuations due to unforeseen changes in cash flow requirements.

Utility Rate and Capacity Fee Reviews

The primary requirement for maintaining adequate District reserves is a regular review of the District’s utility rates and capacity fee structures. Accordingly, through this policy, the District requires that regular utility rate and capacity fee analyses be completed every five (5) years as allowed by California state law. This is not meant to be exclusive of other revenue generating methods, either alone or in combination, including regular review and adjustment of other fees and charges, capital financing, investment returns in accordance with the District’s investment policy, or adjusting the capital expenditures budget.

Categories of Reserves

Reserves can be categorized in various ways, including by the level of legal restrictions on use, and by how the reserves are held. Currently, District Reserves that are legally restricted for a particular use will be labeled Restricted. These reserves may not be used for any purpose other than that for which they are legally restricted.

Reserves that are designated by the Board for a purpose, but not legally restricted, will be labeled Designated. These reserves may be shifted or re-designated for any lawful purpose at the discretion of the District’s elected Board of Directors.

Reserves that need to be readily available to meet the District’s operating cash-flow needs can be held in a money-market account associated with the District’s operating checking account. These will be labeled Working Capital reserves. Invested reserves may be held in medium or long-term investment accounts according to the District’s Investment policy.

The Working Capital Reserves

The balances in the District’s Money Market account should never be less than the liabilities shown for the Reserves included in this category. Sufficient funds to cover Compensated Absences, Customer and Subdivision Deposits, the Operating Reserve, and one year of PayGo Capital projects should be maintained.
Compensated Absences Reserve
This Reserve is included in the Working Capital balance, as it is used to pay for vacation and sick leave during each fiscal year, as required. The total retained in this Reserve will equal the totals of the compensated absences liability accounts by fund, which are calculated annually as part of the year-end process.
 

Customer Deposits Fund

This Reserve is included in the Working Capital balance and used to refund Customer Deposits on a regular monthly cycle per the District’s policy. Customer Deposit refunds payable are verified every month, so the Payables balance is always current. Deposit totals for subdivisions will be tracked in a separate liability account. Enough cash should be held to cover the Subdivision Deposits and, not only the monthly Customer Deposit refunds, but also the entire Customer Deposit Balance. The Customer Deposit balance total does not vary greatly and is shown as a total on the Utility Accounts Receivable Aging report that includes all customers with a zero balance.

PayGo Capital Projects

This Reserve exists to allow the District to attend to smaller Capital Projects (less than $500,000) as approved during the Budget process, without incurring additional debt. The Board has recommended a $1,000,000 cumulative limit across all Funds (Water, Wastewater, and Parks) to be held in Working Capital. The purpose of this limitation is to encourage prudent, staggered timing of Capital Projects so that a healthy balance is maintained in the District’s Working Capital. Larger projects may be bundled together and financed in such a way as to maintain the Debt Parity Ratio required by the District’s lenders. Larger projects may also be financed by grants, single-project loans, reserves, or other legal and financially sound methods according to the market conditions that pertain when the project is funded.

Operating Reserve

The Operating Reserve is intended to act as a short-term line of credit for the District, covering unanticipated timing gaps between expenditures and revenues, or unanticipated necessary expenditures. As a current and short-term reserve, it will be held in the money market account with the other working capital reserves.
The Operating reserve will be calculated at thirty (30) days of total District expenditures, based on the currently approved budget. If any major Board-approved capital project temporarily requires additional working capital to bridge between the cash expenditure and the receipt of grant or loan funds, the General Manager and Finance Director may draw from the Repair and Replacement reserve to supplement the Operating reserve for the duration of the project.

Invested Reserves

Invested Reserves are not for immediate or ongoing expenses in the current Fiscal Year. These reserves are to be held in a Board-approved investment fund (such as the Local Agency Investment Fund (LAIF), CalTRUST, or the County of Humboldt), in accordance with the Board’s Investment policy.

Capacity Fees

Capacity Fees are a legally restricted reserve to be used to fund the expansion of the District’s capacity to provide water and wastewater services to rate payers. The collection of Capacity Fees must be reviewed at minimum every 5 years with a Capacity Fee Study to ensure that changes in the District’s capacity needs are accounted for in the way capacity fees are collected and used through buildout. Any unused balance of the

Capacity Reserve can be held in Invested Reserves.

The draw from this Reserve will be calculated annually according to the percentage capacity increase from completed capital projects. The amount to be drawn from the Capacity Fees reserve into the District’s working capital is comprised of the total capacity increase percentage from all completed capital projects in a year. For example, the WWMF upgrade that was completed in 2018 increased overall District sewage processing capacity by 30%. 30% of the overall project cost was therefore related to increasing District capacity, so 30% of the overall project cost would be drawn into working capital from the Capacity Reserves.

The capacity increase percentage of each capital project completed in a given fiscal year would be added together to create the total capacity increase for the year. Capacity fees equal to that total would be drawn into the District’s working capital funds. If the balance in the Capacity Fees Reserve is less than the total capacity increase, the entire balance could be moved into Working Capital. Capacity Fees collected in future years would be drawn into working capital until the entire total of capital project costs related to increased capacity is fully funded. Annual tracking and reconciliation of the multiple capital projects comprising this total is a necessary part of the District’s year-end closing process.

Repair and Replacement Reserve

This Reserve serves to accumulate and track funds for long-term capital projects that cost more than the Pay-Go limit and have no other designated funding source such as a grant or a dedicated rate stream. Examples would include projects like water tank re-coating, or biosolids removal from the wastewater treatment plant. Capital projects like mainline replacement have their own dedicated portion of utility rates and would not need to draw on this reserve. Grant and loan-funded capital projects would also not draw on this reserve, unless the grant had a match requirement that exceeded the District’s Pay-Go limitations for a given fiscal year.
Using the Repair & Replacement Reserve as a sinking fund to set aside money for these projects will allow the District to repair or replace various pieces of infrastructure at the end of useful life without causing major disruptions in the District’s operating cash flow. Funds should be held with Invested Reserves and may be drawn into working capital as the capital projects are completed and paid for.
The schedule of projects and the funding contribution required per fiscal year would be revised and reviewed annually as part of the Capital project budgeting process. As these projects might change over time, regular rate studies are necessary to ensure sufficient funds are available to complete the projects as they come due.

Catastrophe Reserve

This Reserve consists of funds that may be drawn to pay for operations during a catastrophic event, and to begin repair of the water and wastewater systems, and other District assets after such an event. Examples of catastrophic events include, but are not limited to, a severe earthquake, drought, storm, or fire. Unanticipated catastrophic spikes in expenditures or drops in revenue from any unforeseeable event would also be included in this category. Funds should be held in Invested Reserves and may be drawn from this account into working capital while long‐term financing is being arranged or insurance claims are being processed.
The Catastrophe reserve is based on operating expenditures and a District risk assessment. There are a wide range of available tools for risk analysis from a high-cost professional analysis done by an external contractor to the risk ranking system available from the Government Finance Officers’ Association (GFOA). The risk assessment tool utilized will depend on the District’s available resources, but as with capacity fee and rate studies, maintenance of an adequate Catastrophe reserve depends on regular risk assessments. Accordingly, through this policy, the District requires a regular risk assessment and expenditure analysis be completed every five (5) years.

Other Reserves

There are other reserves that fall outside the above listed categories, including loan and bond reserves, and reserves for accumulating unfunded pension liabilities and other post-employment benefits (OPEB). Where the law or a lender requires loan reserves to be held in a zero-interest account, they may be held in County Trust Fund 9390, which earns no interest. Reserves for the 1982 USDA Sewer Bonds are held at U.S. Bank with the bond service funds, but in a separate account. Reserves for any future bond issues should be held in a similar way.

Reserves for unfunded pension and OPEB liabilities should be held in a Section 115 Trust. The District’s pension is managed by CalPERS, which has a Section 115 Trust for additional contributions towards the unfunded accrued pension liability. Contributions towards the District’s OPEB liability are not eligible for any of the CalPERS trusts, as our health insurance is not run by CalPERS for reasons of cost effectiveness. A separate Section 115 Trust is necessary to hold contributions towards the unfunded accrued OPEB liability and will be invested according to the District’s Investment policy. Unfunded accrued liabilities are recalculated annually on an actuarial basis and amortized for the current year’s portion.

Prioritization of Reserves

Legally restricted reserves will be prioritized first for funding in any given fiscal year. Customer Deposits and Compensated Absences reserves would be funded first, as those are a necessary part of operational cash flow. Any new Loan or Bond reserves will be funded and placed in appropriate accounts according to whether they are legally allowed to accumulate interest or not. Capacity Fees and any reserve with a legally dedicated rate-funding stream, such as the Mainline Replacement Project reserve, will be sequestered into the appropriate investment reserve account.

The actuarially calculated current year’s portion of the Unfunded Accrued Pension and OPEB liabilities for the Enterprise Funds (Water and Wastewater) will be funded next by deposits to the appropriate Section 115 Trust. Contributions from the Governmental Funds (Streetlights, Parks & Recreation) will depend more on budget surpluses, as those Funds are only partially funded on a cost of services basis. The tax apportionment that forms the bulk of the Parks & Recreation budget is calculated by the County of Humboldt based on current property tax valuation rather than cost of services. Available surplus from the Governmental Funds will be applied towards funding the pension and OPEB reserves before Operating, Repair & Replacement, or Catastrophe reserves are funded from this source.

The next reserve funded would be the PayGo Capital Projects and Operating reserves, which are held in the working capital account and are needed for operational cash flow. The remaining two reserves funded would be the Repair & Replacement reserve, followed by the Catastrophe reserve. While the last-listed reserves will always be at greatest risk of reduced funding during any budget shortfall, the prioritization is designed to reduce risk produced by a lack of appropriate reserves to the District as a whole.

(Rev. 2020)