Taking Stock

In spite of the limited shelf life of New Year?s resolutions, using the beginning of the calendar year to at least ?take stock? is simply too ingrained a ritual for most to pass up. It is therefore inevitable that a discussion of infrastructure finance themes in early 2016 would include some form of reflection on the past year.

Perhaps one of the better barometers to examine as part of this exercise would be the primary source of a utility?s CIP funding ? the vast and dynamic municipal debt market. Never before has this market shrunk (i.e., negative net issuances) for five consecutive years, as it did in 2015. Many of the factors constraining the growth of this market are connected to the general austerity of the state and local governments and utilities that issue this debt. The rising interest rates at the end of 2015 also pumped the brakes on whatever small momentum the new-issue market could muster in the final quarter.

Conversely, appetite among investors for these tax-exempt bonds ? particularly for the water and wastewater revenue bonds that are measurably less risky than their general obligation counterparts ? sustained a level of demand that outstripped the supply last year. Notwithstanding the anticipation of high-profile defaults, coupled with relatively low investor yields (when measured against Treasuries historically), the muni bond remains a core element of a fixed income portfolio. Public debt investors are seemingly at-the-ready, so bring on the infrastructure funding gap!

Given this apparent willingness of the public securities market to lend, it would be difficult then to place any blame for this nagging infrastructure funding gap on a scarcity of capital. Even setting aside the financing alternatives and innovations such as WIFIA/SRF, green bonds, PPP, etc. that promise to further catalyze water/wastewater investment, the key thesis here is capital funding is available.?

So why have utility capital expenditures declined consistently since 2009? More importantly, will 2016 be the year bond sales actually rise in support infrastructure projects?

From the utility?s perspective, there are countless factors to consider when determining the CIP budget and how to pay for it.? The expression ?taking stock? ? making an appraisal of resources and potentialities ? would naturally be broader than examining just this one [liability] side of a utility?s balance sheet.? Assets, and asset management, are grabbing a greater share of the conversation ? and central to this subject is information.

Take for instance, the assets comprising a distribution system ? can a sensible replacement/CIP program succeed without the results of a current condition assessment?? In a ?big data?, digital city, isn?t an integrated GIS essential for sound decision-making (not to mention daily operations)? This ?taking stock? can also mean an inventorying of goods ? so can utilities prioritize their spending and devise renewal strategies if they lack remaining useful life estimates for their buried assets?? Perhaps even more pressing than the infrastructure funding gap, then, is the information gap. This is the deficit to close, and by doing so, a utility can more efficiently obtain capital funding and consequently pay more attention to optimal capital deployment.?

The more glaring capital need that came into view in 2015 is the understandable ? yet still unfortunate ? shortage of political capital. According to a research study by Black & Veatch, even after bearing the brunt of conservation programs and enduring droughts, more utilities (just above one-third) were able to cover their financial obligations with their revenues last year vs. the prior year.? But the warning flag inherent in that factoid is that the majority (two-thirds) cannot. More than half of the respondents to the B&V survey will require annual rate increases of at least 5 percent annually over the next 10 years to fully cover their operating budgets. Most politicians are only now properly arming themselves to push these important rate increases through, but will there be enough rate-hike ?willingness and ability? to go around and overcome the forceful rate resistance?

Obviously, the need to sustainably cover an entity?s operating expenses with revenue is universal, and critical to achieving target levels of ?resilience? as the industry is now defining it. In the case of water utilities, as the aggregate capital outlays and underlying balance sheets have contracted, O&M budgets have grown ? by over 25 percent in the past ten years, in fact. Based on last year?s report from the U.S. Congressional Budget Office, this five-year trend has driven the O&M-to-CIP spend ratio of 2:1.

On its face, this ?cannibalization? of CIP runs counter to the basic principle of finance which ideally matches the term of a liability with the useful life of the asset. Moreover, it reinforces the importance of tapping of the capital markets to put meaningful dollar figures into CIP programs, rather than succumb to what appears to be an undue reliance on the annual O&M funding cycle.? Although a solution is not as simple as reapportioning operating funds for incremental debt service (for its companion leverage), what balance sheet capacity does exist can and should be put to good use.

Our industry?s primary trade association ? the AWWA ? confirmed through their own State of the Water Industry for 2015 that, indeed, the consensus top challenge is ?Establishing and following a financial policy for capital reinvestment.? Meeting this challenge will no doubt incorporate the conclusions from, and lessons learned, in 2015. As utility leadership resolves to manage their balance sheets and income statements holistically, it is reasonable to expect that the combined efforts of this initiative will reverse the trend and stimulate the necessary infrastructure investment growth in 2016.


Scott Hales is director of finance for the Americas for Pure Technologies. He is a senior finance professional with 25 years? experience in corporate finance, banking and advisory services, in a variety of markets including utilities and oil & gas. At Pure Technologies (a publicly-traded infrastructure management provider, and parent company to Wachs Water Services), he is responsible for the financial performance and accounting of Pure?s largest region. Previously, Hales has served as vice president at Citi Capital Strategies (division of Citigroup?), where he was involved in the successful completion of more than 35 transactions valued at nearly one billion dollars in the aggregate.

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