The commutation option

I have received some questions recently about the two letters that went out to ratepayers on the new West Bench water system last week.  The first letter contained information about the option to commute payments for the capital costs of the West Bench water system upgrade.  The second letter was a mock water bill, giving people some preliminary information about their water usage relative to other West Bench properties.

Commutation letter (template)

Mock water bill (template)

I can address some of the comments about these letters below:

Q: Why were the letters sent out just before the election?

This strikes me as an odd question. Public Works at the RDOS does not and should not alter its activities to advantage or disadvantage one candidate or another in an election.  Indeed, one of the benefits of going with a professionally-managed RDOS water system is to get politics out of water.  Public Works staff sent out the letter as soon as they could following the passage of the borrowing bylaw by the RDOS board at the November 6 meeting.  It is as simple as that.  I certainly appreciate people's concern that these letters would hurt my chances as the incumbent in the election.  But withholding these letters in order to achieve some political objective would have been a serious ethical breach.  

Q: Why weren’t we told the capital bill was coming?

Ratepayers of the West Bench system voted overwhelmingly in 2012 to authorize the RDOS to borrow money to complete the West Bench water system upgrade.  The recent letter simply provided information to each household about its share of the capital cost.  There should be no surprises here.  Indeed, the number is quite a bit smaller than what was promised prior to the referendum.

Specifically, the wording of the 2012 referendum was the following:

Are you in favour of the Regional District of Okanagan Similkameen adopting West Bench Water Supply and Distribution System Loan Authorization Bylaw No. 2590, 2012 to upgrade the water system in the West Bench Water Service area by entering into an agreement with the City of Penticton to purchase bulk water, construct a pump station, construct a transmission line from the pump station to the West Bench distribution system, install water meters and up-grade the distribution system at a total cost of $9,750,000; consisting of $5,730,000 Federal & Provincial grants and $4,050,000 borrowing.

The borrowing bylaw passed a few weeks ago authorizes the RDOS to borrow $2,290,000.  This is clearly much less than the amount authorized in 2012.  This is good news.

Update 17 Nov 2014: There are 349 connections to the West Bench water system.  Capital costs are assessed as a parcel tax (flat rate per property) so the $2.29M is divided by 349 to get the $6,562.

Q:  Is the water system project over budget or under budget?

Roughly two-thirds of eligible expenses for the West Bench water system upgrade are covered by grants.  But we do not get the grants unless we also incur our one-third share of the cost.  We therefore have strong incentives to be exactly on budget.  If we are over budget West Bench ratepayers are on the hook for 100% of the overruns.  If we are under budget we leave grant money on the table.  The West Bench water system, even after the significant upgrade, is far from perfect. There are many desirable and grant-eligible upgrades that were put onto a “complete if money is available” list.  Some of these small improvements are now being undertaken in order to ensure we maximize our grant funding.  In this sense, the project is a financial success because we are getting to some of the non-core (but important) upgrades.

So if the project is on budget, why are we borrowing less than authorized?  First, when crafting the referendum, RDOS staff was careful to set the borrowing amount at the upper end of their expectations.  This is common practice and is where the $4.05M number came from in the referendum question above.  Our best guess for borrowing at the time (the number I used in my presentations to West Bench residents) was only $3.2M.  Now that the project is almost 100% complete, we are only borrowing $2.29M even though (as noted above) the project is on budget.  The reason for the difference is reserves.  We have been accumulating reserves for contingencies over the last few years and these reserves, being unused, are being applied against the debt.  So it is not that the system is costing you less than we promised.  It is costing what we promised but you have already paid about 28% of your share.  That might count as a pleasant surprise.

Q: The letter says I can pay $6,562 now or $548 for 20 years.  But $548 over 20 years is $10,960!

Careful here: you have to do the math the same way the bank does the math.  $548 dollars today is not the same as $548 in 20 years.  There is interest.  Put it this way: If you went to your bank tomorrow and asked them to lend you some money now in exchange for $548 per year for the next 20 years, they certainly would not give you $10,960.  In fact, they would not even give you $6,562.  Why?  The interest rate the RDOS will get through the Municipal Financing Authority of BC is lower than the interest rate you can get as an individual.  Bottom line: the net present value of a series of 20 annual payments of $548 is approximately $6,562.  These two patterns of cash flow are financially equivalent.

The next question is whether you should exercise the option to commute your share of the West Bench water system debt?  That is, should you pay upfront as a lump sum or pay over 20 years?  This is up to you and you should contact a competent financial advisor if you are having difficulty making the choice.  For me, this is a complete no brainer. Do not commute.

To illustrate, consider the case of my parents who live on the West Bench.

  1. If they pay annually they are certainly paying some interest.  But it is a low rate of interest.  MFA is currently showing 3.03% fixed for 10 years.  If you factor in inflation, the real interest rate is about 1.5-2%.  That is like free money.  And if one can find an investment that pays more than 3.03% interest, it makes sense to invest the $6,562 there instead.
  2. My parents are not going to live on the West Bench forever.  If they pay the $6,562 now there is no guarantee they will get that money back when they sell.  Yes, the new buyer will not have to pay $548 per year for the remainder of the loan term.  However, ask any realtor: buyers tend not to think this way.  Good luck getting the buyer to up his or her bid in response to this logic.
  3. My parents are at an age at which it makes sense to defer their property taxes. The $548 per year will appear on their RDOS taxes as a parcel tax.  It therefore can be deferred until the house is sold.

 

Update 17 Nov 2014: The present value of the $548 payment:

Here is a nerdy aside for those who really care: If you use the on-line calculator linked to above and enter the current MFA rate of 3.03%, you will see that the present value of $548 annually for 20 years is closer to $8,130.  That implies that paying the lump sum of $6,562 is a bargain. The problem is (a) we have not yet gone to MFA for the money and therefore do not know our interest rate and (b) the rate is only for 10 years.  We have to refinance in Year 11, possibly at a higher rate.  It looks like RDOS staff have used an interest rate of approximately 5.5% to come up with the $6,562 lump sum payment.  Appreciate that this is a tricky balance.  If we use a rate that turns out to be too low, people who commute their payments (pay up front) are overcharged; if we use a rate that is too high, we won't collect enough money from commuters to pay our creditors.  I would say 5.5% represents a good balance.  Close to the historical average cost of capital.

 

Q: What will my water bill look like in 2015? Is this $548 a new cost?

We have always talked about the cost of water on the West Bench in terms of total cost: capital, debt servicing, operations, payments to Penticton for water, reserves, and so on.  Here is an early estimate provided to me by RDOS staff for 2014 (already billed) and 2015. Our estimates at this point are that an average property on the West Bench will see a slight decline in its water bill.

The full budget for the West Bench water system can be found on the RDOS site (page 230). I am working with RDOS Finance to simplify this budget somewhat.  "Renewal fund" and other such terminology were inherited from the WBID.

So these are some responses to the questions I have received so far.  Please let me know if you have others.

 

Neighborhoods: 

Comments

I received the following question from a resident:

Our understanding was that the system sizing was designed to accommodate potential future additional users such as Sage Mesa and West Hills.  One would assume that at such time those respective communities would have to pay an allocation of that infrastructure cost as well as their consumption costs?  How would the RDOS then propose to reimburse the West Bench property owners for that portion of the capital cost that would be recovered from those future users?  This could also impact one’s decision whether to pay the capital cost upfront or over 20 years.  Just trying to get our heads wrapped around all of this.  It occurs to me that no doubt others would have similar concerns.

You are correct: provisions have been made for the Sage Mesa water system to connect to the City of Penticton's treated water system through the new West Bench infrastructure*.  If the Sage Mesa system were to connect in this way, it would have to buy into the West Bench infrastructure (water mains and pump house)  through a latecomers fee.  The mechanisms for such fees are well laid out in the Local Government Act and elsewhere.  My guess is that the exact allocation scheme would be based on water usage in the Sage Mesa system versus West Bench.

What happens to the latecomers fee?  I will double check this with RDOS Finance, but my understanding is that the latecomer's is split into 349 pieces.  Those properties that pre-paid their share of the capital costs would see a rebate for their 1/349th portion of the credit.  The balance would be applied to debt (thus reducing the term of the loan for those who did not pre-pay).  So the process works pretty much the way you might think it should work.  The only hitch is that the latecomers fee benefits the people who own the West Bench property at the time of the Sage Mesa buy in, not the person who pre-paid the capital cost.

The optimal strategy for accounting for this possibility in your pre-pay/don't prepay decision is not immediately obvious to me.  Much depends on whether Sage Mesa actually joins, when this happens, whether you are still on the West Bench, and so on.  Again, it seems to me that the safest bet is not to pre-pay.

* As you know, the Sage Mesa water system is currently privately owned so the decision to connect to Penticton would have to be initiated by the owner of the utility, the ratepayers, and the Province of BC.  The RDOS would enable such an arrangement, but is not the decision maker.

THE ORGINAL VOTE WAS 351 RATEPAYERS... WHO IS NOT INCLUDED & WHY

Two RDOS employees who live on the West Bench used their insider status to remove themselves from the taxroll...

Just kidding, of course. Nothing untoward here.  From Candace at the RDOS:

Currently, there are 351 properties on the West Bench and 352 water meters. Three of these meters are from RDOS owned properties (parks). If you remove the parks, you will have the 349 properties that are taxable. We cannot recover the parcel tax associated with RDOS owned properties as we are a non-taxable entity. 

I contacted the RDOS about this issue. They told me to contact the internet and that Michael Brydon's information and assessment would be available. Is this the best info I can get ? Where is the rational to this. I think all rate payers are due an explanation. Still waiting...

I need to know what information your are looking for.  I am not sure what "this" refers to in "Where is the rational to this?"  Can you be more specific?

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