COMMUNITY COMMENT: Why We Should Sell the Water System
By IRA KAYLIN
February 20, 2012
This week the City of Falls Church announced that Requests for Expression of Interest for possible purchase of the Falls Church Water System had been broadly circulated to potential buyers. I believe this is a great opportunity to convert a problem into a benefit.
At the same time it was mentioned that the process of a possible sale would be deliberative with all options being considered and citizen input sought. Clearly, any process that involves the possible sale of the City’s largest single asset should be a careful, thoughtful process. There can be no argument with such an approach.
However, there are really only two available options: sell the system or don’t sell the system. There is no range of options. It makes little sense to continue to operate a water system under the legal challenges that have been imposed upon us by the Judge Ney decision and, more recently, by the adoption of an ordinance by the Fairfax County Board of Supervisors that purports to establish an exclusive service area in Fairfax County for the Fairfax County Water Authority and to improperly and unfairly regulate the City’s water rates even though the City is in full compliance with Judge Ney’s rulings.
Falls Church City Councilman Ira Kaylin
It is important to emphasize that we are in no way operating in a stress situation. There will be no fire sale, subsidized sales, or giveaways to anyone. The court’s decision is counter intuitive in the extreme as it states, in effect, that the owner of an asset is not entitled to a return on equity. Nevertheless, it is what it is.
The decision converted a water system that was generating over $2 million per year for the City’s General Fund into a system that generates zero income to the City. On top of that Fairfax County is attempting to add another blow in the form of the new ordinance, the result of which would be the City’s water system generating negative income from service in Fairfax County, a loss that would have to be funded by the citizens of Falls Church. At the same time, the City was and is providing clean and affordable water to over 100,000 County residents and businesses. Unfortunately, the water system has become an engine of litigation and associated costs. Falls Church citizens are being treated like a Pinata whose hidden treat just happens to be our water system.
I believe the best approach is the same as the one any business would employ. Sell the non performing asset and invest the proceeds of the sale into another asset—one which does make money on a periodic and long term basis.
Ultimately, there will be four issues involved in the sale of the system: 1) to whom might we sell it; 2) the terms and conditions of a possible sale including the determination of best price, 3) impact on water rates and, 4) possible uses of future proceeds. While it is premature to discuss the first two issues, it is appropriate to discuss the latter two. First, will water rates increase? And second, what is the best use of the water sale proceeds?
Rate Impact
The rate impact of the sale of the water supply system is not possible to predict. It could go up or it could decrease depending on a wide variety of variables including the long term business strategy of the purchasing firm or authority.
It is useful to note that water rates, subject to Council approval, are already scheduled to increase by 8% for the years 2012 and 2013, 3% for 2014 and 2015. These increases are based on an outside consultant analysis of the financial status of the system which requires significant infrastructure maintenance and upgrades if reliable and safe water is to be provided to all customers. No matter what path we pursue, we can expect continued interference from Fairfax County making it increasingly difficult for Falls Church to be able to continue to provide water service to its valued customers in Fairfax County. Fairfax County officials may believe it is their destiny to wrest the water system from Falls Church for free, and to monopolize water service in Fairfax County through its own water authority. That is why it is prudent now for Falls Church to explore its options in the open marketplace, free from duress, for the sale of its water system, so that it can obtain the best price for the water system. Fairfax County and its water authority have been invited to participate in that fair and open process.
Use of Proceeds
The question is, how can the citizens be assured that the funds will not be poorly spent? I believe that is a totally justified concern. Even though I am an elected official, it is recognized that, over time, there is the magnetic attraction of elected officials to spend money until it is no longer available.
A basic consideration when selling an equity asset is retention of the long term income generating capacity of the new equity asset. Use of the proceeds of an equity sale for capital and/or operating cost coverage is a reduction in the value of an equity asset. Such transformation is frequently by used firms that are on the brink of failure.
Virginia statutes prohibit Cities from investing General Fund resources in long term assets. Rightly so. Some long term assets are not easily converted to cash without paying a penalty. Also, well-intentioned, but not well-informed officials may be tempted to engage in market speculation with taxpayer money. Only the largest cities would have “in house” capability to understand and monitor large scale, long term asset management.
Because of the above constraints, under current market conditions cities receive virtually no return on assets sitting in bank accounts eligible for General Fund uses.
One Approach to be Considered
I believe we should consider investing the proceeds in a yet-to-be-created Falls Church City Teacher Pension Plan whose returns would be used to help pay for the City’s Virginia Retirement System obligations and add to the City’s existing pension plan.
Pension plans are expected to invest primarily in long term assets that earn much higher return than short term assets. These funds are never mixed together with General Fund resources. Pension plan returns fluctuate with market movements but can be expected, over the long term, to generate annual returns of 6% to 8%. To put it in another way, for every $10 million of sale proceeds we can be expected to earn $600 to $800 thousand per year.
The business climate is unusually good for a utility sale. Cash rich companies can not place these funds in easily accessible, low risk securities that generate a decent rate of return. If funds are to be borrowed, long term bond rates are now at historic lows. In the current market environment, Falls Church becomes even more interesting as an investment opportunity.
Importantly resources used to fund pensions can not be directly accessed by a City Government for current expenses. They are effectively “lock boxed”.
Impact on Tax Rate
The pension-generated income would lessen transfers from the City’s General Fund to cover pension expenses by an equivalent amount. These returns could amount to two to three cents on the tax rate for every $10 million in proceeds.
It is possible that the City’s employment attractiveness would be enhanced since our pension plans would be well funded and more robust than other municipalities.
We should recognize the caveat, however, that returns generated by the pension plans would effectively represent a new revenue stream that will greatly help in the short and medium term, but is in no manner sufficient to cover Falls Church’s long term needs. Economic development must proceed at the fastest prudent way possible.
A Start to the Discussion
There may be other viable approaches which could be presented during the deliberative process. The information and opinion presented above is provided to help start the community discussion.
Ira Kaylin is a member of the Falls Church City Council.
By (see byline)
February 20, 2012
Falls Church in the News
Interesting discussion. Thank you for providing your viewpoint from a councilman’s perspective.
Since community owned assets like the water system are essentially non-replaceable should this asset be sold and the city subsequently changes its mind, I am at first blush against the sale. I would be most strongly opposed to the sale of the water authority to a private concern and much less opposed to a sale to either Arlington or Fairfax county.
Mr. Kaylin….thanks for your statement. Are you proposing we put all the money from selling our water system (if we do) in the pension plans? I realize the in-the-weeds discussion is putting the cart before the horse but I am interested your framework.
Excellent discussion, Ira. Thank you. I will reserve judgement on sale or not until I learn more about the pros and cons.
I am getting tired, however, of the continuing whining about the outcome of the “water litigation.” The City got what it deserved for poking its finger in the eye of our much bigger neighbor: 1) the City was negligent in not renewing the water service agreement with Fairfax that expired in the 1980s; 2) the City STARTED the fight by foolishly suing Fairfax in federal court on an obvious losing issue; and 3) while legal details vary among state and federal jurisdictions, the general rule is that PUBLIC utilities, like the City water system, may not impose charges in excess of those necessary to cover capital expenses and the costs of operation and maintenance, hence no ROI.
I wonder, Fairfax City Water System benfits its citizens without putting money in the general fund and they don’t consider it a “non performing asset”. If we sell we are at the will of the buyer and I don’t see how they could run it cheaper, especially if a private company is the buyer. Many questions un answered.
With FC residents paying 60% more than Fairfax County for water and sewer, it seems to me that the common sense thing would be to sell it to our neighbor, regardless of the bad feelings due to the legal mess. We get some cash, and presumably, lower rates. Selling it to a private for profit company would probably be a boon for the City, but we citizens would end up paying even more for our water service and subject to the rate paying/review process similar to the electricity provider, Dominion.
Good discussion about what to do with the money from the sale. I, for one, would need a lot more information to be able to have an informed decision.
Ira, many thanks for laying out the issues so succinctly. I am particularly aware/concerned about the use of whatever assets the City will receive and like the idea of “ringfencing” the resulting revenue. I am happy to see that comments are geared to getting more information and thinking strategically about next steps. The real costs associated with maintaining our independence as a City are important to consider in this and other new or enhanced revenue streams as we move forward.
Ira,
This is an excellent idea … and the only sensible route in view of the facts and circumstances. It is not logical for FCC to own the water system and receive no return on investment … while spending considerable management time and resources on managing the situation with Fairfax County. Sale of such water systems is very common across the globe. This is the best route for the citizens of FCC.
I thought the City didn’t start taking a return on investment as transfers to the general fund until 2002 or so. How is the situation prior to 2002 different from now, other than the City not being able to take a profit? If the City sells the system to Fairfax, how can we be sure not to be charged more for water than Fairfax Co. residents – as is already happening in Vienna and Reston?
Good point, Mr. Thomas. I’ve seen sales contracts that contain a “best price” condition, essentially guaranteeing a price equal to the lowest price charged to any customer. Dunno if this can be done in the context of a public utility, but it is the kind of conditioned sale that can produce a desired result.
If you look online there are quite a few articles on municipal water system sales. Seems the trend is growing although, many note municipalities often try to sell water systems when they can’t afford to maintain/upgrade the municipal-owned system. Many note the rate increases that usually follow. The language Linda describes might help
Lou mentions a few things that I always wonder about when this issue comes up. I think he’s absolutely right that the City dropped the ball back in the 1980s when the original agreement with Fairfax County expired… but what can we do about it now?
From what I understand I’m not sure I agree with Lou’s second point. My understanding is that Fairfax County required one of the new developments (in Merrifield, I think) to hook into Fairfax Water in an area that was normally controlled by Falls Church Water. At that point the City was faced with a tough issue. If they didn’t challenge the requirement by Fairfax County then it would be the start of a free-for-all of Fairfax Water taking Falls Church customers… which, I think, would have eventually lead to the end of Falls Church Water or greatly increased prices as the shrinking system lost more economies of scale. By challenging Fairfax County there was some hope that the status quo could be maintained.
Now, maybe I’m wrong about all that – and maybe the City’s approach wasn’t good – but if some of what I said is right then it’s not quite a clear cut issue that the City started this problem.
And I think Lou’s third item is one I have no idea about. Plenty of people have said that other municipalities in Virginia take a return on their water utility. Either that’s true or it isn’t – does anyone know? If it’s not true then yeah, we should have seen this day coming. If it is true, then it’s really strange that we’re being singled out.
But whatever – it seems clear that we can’t take a return on the water system.
My gut feeling is to try to sell the system and do something like what Ira suggests. Even if water rates go up some don’t you think we could use the proceeds of a sale to offset the tax rate by as much or more than the increased water rates (for example, via the approach Ira suggests)? And certainly our risks would be reduced if we weren’t operating a water system.
Robert does make a good point – the City hasn’t always taken a return on the water system so now that we can’t what’s different than before? It seems like the obvious answer is that before we had an agreement with Fairfax County that allowed our water system to remain healthy financially. Now, it seems like Fairfax County is doing various things that will eventually have a negative impact on the financial health of our water system (if new developments will now hook in to Fairfax Water and Fairfax County can cap the rates charged by Falls Church Water we’ll eventually get pinched). So, the risk of running the utility is now much greater than before. Also, it sounds like the industry of privatized utilities wasn’t as robust back in the day – so maybe selling the system back then wasn’t really an option.
Is control over the water rates the only upside we have if we keep running the water utility?
So, how exactly can Fairfax County regulate our water system? They pass legislation that commands us to sell water at their price and we just do it? Can they also legislate where we build sidewalks in the city also? How does this work? Or is it just another smoke screen so we will run wild in the streets…..?
It’s time to issue a request for a proposal (RFP) for the sale of the water system rather than an expression of interest (EOI). The EOI approach is so “Falls Church” and is reflective of a clutch of citizens and officials who revel in discussion and debate without resulting in positive action benefitting the entire community.
In that regard, in another venue—the lack of economic development to achieve a broad and diversified tax base—is the result of decades long vacuous talk and it is all too evident along the lengths of Broad and Washington Streets. While other communities are discussing ways to manage growth, we are still trying to generate it.
An RFP can be crafted in such a way to secure all possible information relative to a decision to secure an eventual sale. Requesting an expression of interest does not. So it appears that the discussion and debate crowd are in the driver’s seat and once more taking us on a circuitous route.
Which begs the question: While the Council leadership and city staff are mulling, debating and discussing what do they think Fairfax Water is doing? Waiting for us to finish the evaluation of the expressions we receive? I doubt it.
But there is an election coming up and the proper, timely and beneficial disposition of an asset worth tens of millions of dollars should be on the questioning minds of the voters and the ways and means to achieve it clearly articulated by the candidates.
I would like to thank everyone who has provided comments. A number of questions have been asked which deserve a response. Apologies in advance if questions have been missed and for the length of the response.
rc hatfield
As regards selling the Water System, Falls Church has invited Fairfax to express an interest in purchasing the system. We genuinely hope that a reasonable offer would result.
At the moment the only concrete offer we have from Fairfax, which was presented months ago, is to give our water system to Fairfax for free, though we would get one seat on the Fairfax Water Authority in return.
TFC
Your question is right on the money. Yes, I am proposing to place all our money in Pension Plans. However, further funding of our Post Retirement Fund (health care costs) is an option that accomplishes the same financial objective.
I am a Falls Church taxpayer as well and want to ensure to the extent possible that the proceeds of a potential sale is used for the maximum benefit of the citizens of Falls Church, including fulfuilling pension obligations to our teachers and city staff.
Moreover, if the proceeds are used to generate a long term income stream it is possible that the tax rate could be suppressed by an amount equivalent to the rate of return of the Plan. In the example provided in the Commentary 2 to 3 cents on the tax rate could be saved for every $10 million in proceeds. Please recall that the City’s General Fund is not permitted to invest long term. Also a Pension Plan can not be directly accessed by future City Councils for operational expenses.
It is a basic tenant of sound financial management that long term predictable obligations like pensions should be funded through assets that permanently generate income every year. At the moment the City is paying the Virginia Retirement System (VRS Teachers Pension) pension obligations out of yearly tax dollars. This is one of the most inefficient methods of funding long term predictable. obligations.
If the Board of Trustees of the Virginia Retirement System recommendation is accepted by the Virginia legislature Falls Church Teachers pension costs will increase by $1 million this year and permanently remain at the higher level. All things being equal taxpayers, through transfers to the School System, will require 3 cents of the tax rate to cover these additional costs.
Moreover the proposed almost 100% increase in contributions reduces the underfunding of the VRS by less than half. That is the City will be required to fund at least another $1 million in the near future. If the Legislature reduces this year’s municipal contribution the shortfall is simply added to future year costs at a higher amount.
The State of Virginia has no legal obligation to cover pensions even though the Legislature is the source of much of the funding problem.
The City’s Pension has been much better run and is in relatively good financial condition. Nonetheless it is still underfunded and would benefit from an infusion of resources for pensions and health care cost coverage.
Barry Buschow
I can’t speak to the financial operations of cities located in Fairfax County. However, the objective of the sale is not specifically to lower the cost of water service, though that would be fine outcome. The issue is how we convert a non performing asset to one that is a performing asset.
The true test of the real cost to consumers, as Andy Rankin correctly notes, would be the difference between the tax suppression benefits and possible increases in water rates. A tax rate saving at 2 cents for every $10 million in proceeds is $120 and for 3 cents it would be $180 for a home assessed at $600 thousand. The actual savings would depend on the amount of proceeds received, the assessed value of the individual home and the rate of return of the plan.
Utilities are heavily regulated including water. Arrangements could be negotiated for a rate freeze for a fixed period of time. Linda Neighborgall and Dave Phelps have raised good points on this issue as well.
Finally the likelihood of a water rate increase being greater than the tax savings is very, very low.
To the point in your second comment: The City will be challenging Fairfax’s unilateral decision to try to regulate our water fees.
Sam Mabry
Yes, we must move quickly.
Further Thought
Fairfax County’s VRS unfunded pension obligations is measured in the $ billions. It would seem that a more urgent issue for them would be dealing with their pension issues rather than concentrating on absorbing the Falls Church Water System, whose revenues can not be transferred to their General Fund.
I think that the sale of the water company is a very interesting idea and deserves consideration by the Council. The idea of using the proceeds to support pension costs makes this idea even more interesting.
I just do not see any good coming out of divesting ourselves of the water utility. I remember the fairly recent sale to private concerns of two city owned properties on which schools stood, only to turn around not too many years later and see ourselves strapped for land on which to expand our existing school infrastructure. If we divest ourselves of the water utility, there will be no future chance to recoup that loss. We will be forever at the whim of whomever is running the service.
First off, thank you Mr. Kaylin for laying out the issues so clearly. Secondly, thank you for laying out an actual plan for what to do if we actually sell the system and see some proceeds. While i agree that your suggestons make sense, I am more than willing to listen to other reasonable thoughts on this matter. Selling the system and figuring out what to do with the proceeds later is a formula for fiscal disaster.
As for Fairfax offering to take the system for free, well, did anyone really expect the local bully to make a serious offer?
Oh please,Mike Smith, don’t play the victim card here – it was Falls Church City who woke the sleeping giant (remember how the city sued the county?). So when the city steals millions of dollars over the course of decades with no ability of county residents to vote officials out of office, yeah, i think the county has a right to be mad and take action.
Right on Tony! Let’s remember that the asset in question here (FCC’s water system) was built on the financial backs of the water rates charged primarily to Fairfax County residents. Any discussion of FCC’s selling this “asset” and using the proceeds to fund the pensions of FCC teachers is beyond outrageous.
Fairfax County is well within its rights to offer FCC the tidy sum $0… In fact, the FCC officials who authorized and sought to continue the egregious general fund transfers from its water system should feel obligated to handover the keys to the system on bent knee!