4. Authority Sought and Discussion

CWS seeks Commission approval to: 1) enter into a SDWSRF loan in the amount of $7,442,700, to finance improvements in its Lucerne water system and to reimburse its treasury for funds expended prior to the loan contract being signed; 2) establish a surcharge only on its Lucerne customers to repay that loan; 3) establish a service fee which would be chargeable to customers requesting future services to undeveloped lots in the Lucerne service area; 4) encumber its assets in connection with the loan; 5) establish a balancing account to record surcharge revenues, loan and associated payments, and interest earned on funds ; 6) increase the total aggregate amount of debt financing approved by the Commission for CWS in D.02-03-017; and 7) granting such other relief as may be deemed by the Commission to be necessary or proper.

4.1 Construction Budget

CWS' construction budget for the construction of the water treatment plant in its Lucerne service area is summarized as follows, as of May 13, 2008:⁶

Total Construction Budget, Including Previous Expenditures

Item	2002	2003	2004	2005	2006	2007	2008	Total
Cal Water Purchased Equipment	-	$55,642	$508,658	-	-	$435,647	$234,156	$1,234,103
Consultant Services	-	$46,723	$30,888	$205,458	$424,861	$801,655	$236,876	$1,746,461
Syblon-Reid Contractors	-	-	-	-	-	$358,581	$2,329,419	$2,688,000
Permitting	-	-	-	-	-	$23,990	-	$23,990
CDPH Approved - Completed Work	-	-	-	-	-	$605,060	-	$605,060
Additional Anticipated Direct Costs	-	-	-	-	-	-	$42,500	$42,500
CWS Labor, Benefits, Overhead, & Customer Center Rental	$5,141	$49,205	$27,706	$40,542	$58,840	$117,012	$35,136	$333,582
Project Contingency	-	-	-	-	-	$25,000	$380,000	$405,000
Allowance For Funds Used During Construction (AFUDC)								$364,000
Total	$5,141	$151,570	$567,252	$246,000	$483,701	$2,366,945	$3,258,087	$7,446,700
NOTE: CWS only showed AFUDC as a total in its response to DR 0711020-04, and did not spread AFUDC across the years.

CDPH requires that the entity requesting an SDWSRF loan submit a written request to begin construction prior to receiving a funding agreement.⁷ Based on correspondence received by CWS from CDPH, the following construction has been authorized by CDPH to begin prior to final funding:

1. May 9, 2007 - Approval to begin construction on pier.

2. May 31, 2007 - Approval to complete remaining piling work, pier welding, and upgrades, and to install raw water intake pumps, pipe supports, and pipeline related to pier work.

3. June 19, 2007 - Approval to complete pier work, including asbestos removal work.

4. October 25, 2007 - Approval to: a) Issue a Notice to Proceed; b) execute a construction agreement with CWS' contractor in order to start materials procurement; and c) allow the contractor to begin potholing on the site to determine the exact location of certain pipes in order to complete planning. CDPH indicated that this authorization does not guarantee that the expenditures will be reimbursable by the SDWSRF loan.

5. November 5, 2007 - Approval to authorize CWS' general contractor to proceed with specifically identified work on a new electrical transformer, a garage storage room area, and underground yard piping.

6. February 8, 2008 - Approval to proceed with all work according to the plans and specifications approved by CDPH. CDPH indicated that this authorization does not guarantee all the expenditures will be reimbursable by the SDWSRF loan.

7. March 19, 2008 - CDPH again addresses which costs are eligible and which are ineligible under the SRF program and indicates that there is no guarantee of reimbursement for costs incurred. CDPH pointed out that it reviews all claims for repayment and documentation submitted before approving costs for reimbursement.

CDPH did not attribute specific dollar amounts to any of these approved activities. The CDPH letters did not authorize any further construction activities prior to execution of the funding agreement.

Until final SDWSRF funding is received, CWS states that it plans to temporarily fund any authorized expenditures with a combination of its operational income and its previously authorized debt and equity. CWS indicated that it intends to use the proceeds from the SDWSRF loan to fund any approved construction that is not complete at the time of funding, and to reimburse its treasury for its funds used for construction already completed.

Included in CWS' construction budget are in-house labor costs as well as an AFUDC. Per the Notice of Acceptance signed by CWS on December 8, 2006, CWS agreed that, among other terms, it would only charge up to $20,000 of in-house construction labor for the construction project being funded with this SDWSRF loan.⁸ CDPH reiterated this requirement regarding the use of in-house construction labor in a letter to CWS, dated December 7, 2007.⁹ CDPH also stated in this letter that accrued interest (AFUDC) is an ineligible cost under the SRF program, and therefore is not recoverable through the loan. ¹⁰ CDPH pointed out that only planning, design, and construction costs are eligible for funding. In a letter dated March 19, 2008, CDPH stated again that accrued interest is not an eligible cost under the SRF program.

Based on the correspondence between CDPH and CWS, it appears that CDPH may not authorize CWS to reimburse its treasury for certain budget items with the SDWSRF loan proceeds.

4.2 Cash Requirements Forecast

This Cash Requirements Forecast was developed from data provided by CWS in its Cash Flow Analysis, provided in response to data request DR 0711020-05. The Cash Requirements Forecast is estimated as follows:

	2008	2009
Funds Needed For Construction	$106,260,311	$114,510,723
Payment of Debt Interest	22,110,798	23,395,230
Total Cash Required	$128,373,117.00	$137,907,962.00
Less: Estimated Cash Available from Internal Sources11	$ 96,985,840	$ 94,985,840
External Financing Needed	$ 31,715,983	$ 42,922,122

Given the total company estimated Cash Requirements Forecast, it appears that CWS does not have sufficient funds to finish construction of the Lucerne Treatment Plant in 2008. Therefore, it is reasonable to authorize CWS to incur the debt being requested in the current application. Also, as discussed in more detail in Section 4.5 of this decision, it is in the public interest to use the lowest cost financing, which in this case is a SDWSRF loan.

4.3 Effect of Proposed Loan on Capital Structure

CWS' capital ratios, as of December 31, 2007, are shown below, as recorded and as adjusted, to give pro forma effect to the proposed issuance of $7,442,700 of debt authority under the Application:

Description	Recorded		Adjustments	Pro Forma
Long-Term Debt	$286,958,699	42.4%	$7,442,700	$294,401,399	43.0%
Preferred Stock	$ 3,475,000	.5%	-	$ 3,475,000	.5%
Common Equity	$386,304,294	57.1%	-	$386,304,294	56.5%
Total	$676737993	100%		$684,180,693.00	100%

Although the financing requested in the current application does not change the capital structure for regulatory purposes, the Commission shows the recorded capital structure as compared to the pro forma for illustrative purposes. As shown in the table above, the estimated change in the recorded capital structure, given the proposed issuance of the SDWSRF loan, is minor.

Capital structures are normally subject to review in cost of capital or general rate case proceedings. We will not make a finding in this decision on the reasonableness of the projected capital ratios for ratemaking purposes.

4.4 Permissible Purposes for Loan

A public utility must satisfy certain conditions before entering into loan agreements with terms longer than twelve months. Chapter 4, Article 5 of the Public Utilities Code (Pub. Util. Code) sets forth conditions a public utility must satisfy to enter into such a loan agreement.

One condition is that the loan be for a permitted purpose, listed in Pub. Util. Code §817. Among the permissible purposes, applicable in this instance, is for the construction, completion, extension, or improvement of utility facilities, under Pub. Util. Code §817(b). Pursuant to Pub. Util. Code §817(h), another permissible purpose for such a loan is reimbursement of money actually expended for proper purposes from the treasury of a public utility.¹² CWS' use of SDWSRF loan proceeds to reimburse the use of its own treasury funds for the construction, completion, extension, or improvement of utility facilities meets this description, as long as those expenditures are not chargeable to income or operating expenses. The construction of a treatment plant in the Lucerne service area is a necessary capital addition to satisfy the Environmental Protection Agency's Interim Enhanced Surface Water Treatment Rule, other CDPH minimum water quality standards, and applicable CDPH compliance orders. As such, the construction is for the public good, and thus qualifies under these statutory provisions.

A second condition is that a public utility first secure from the Commission an order authorizing the debt. The authorization must specify the amount of the debt, and the purpose to which the proceeds are to be applied. The authorization must also find that the money to be procured is reasonably required for the purposes specified in the order, and that such purposes are not reasonably chargeable to operating expenses or to income (Pub. Util. Code § 818). CWS has satisfied these conditions.

While the construction costs of the Lucerne Treatment Plant appear to be a proper use of loan funds based on the Pub. Util. Code, we do not make a finding as to the reasonableness of those construction costs in this decision. This type of review is normally performed during a GRC.

4.5 Surcharge and Service Fee

Pub. Util. Code §454 governs the conditions upon which a customer surcharge may be established. Those conditions are that a public utility must present a showing for the surcharge, and the Commission must find that the surcharge is justified.

Financing the treatment plant with funds generated internally or by issuing privately placed debt or equity would ultimately result in an addition to ratebase. Including the necessary treatment plant in CWS' rate base, would result in rates higher than those generated by a SDWSRF surcharge, because the rate base would earn CWS' authorized rate of return. A zero or low interest SDWSRF loan, and the associated surcharge to repay it, is the least expensive and therefore most reasonable option for financing the construction of the Lucerne Treatment Plant. Therefore, it is in the public interest to authorize CWS to establish a surcharge. We next calculate the surcharge rates.

CWS estimated that it will need $136,450 semi-annually or $272,900 per year for the first ten years, and $124,045 semi-annually or $248,090 annually for the last twenty years, to make principal payments, on a SDWSRF loan of $7,442,700, throughout the 30-year loan term, as well as to accumulate a reserve. To comply with DWR regulations, the utility must establish a reserve equal to two semiannual loan payments during the first ten years.

CWS estimates that the surcharge for a typical residential customer, with a 5/8 x ¾-inch meter for the first ten years, would be $17.37 per month, based on a loan amount of $7,442,700, an increase in the average monthly bill of about 22%. A detailed surcharge schedule by individual 5/8 x 3/4-inch to 6-inch meter size is set forth in Attachment B. The surcharge would be separately identified on each customer's bill.

However, since the final loan amount may be less than the amount requested by CWS in its application, the surcharge may need to be revised to reflect the lower loan amount. Within 30 days of entering into a loan agreement with DWR and CDPH, CWS shall file an advice letter in order to revise the monthly surcharge amount.

CWS also proposes to establish a service fee, which would be chargeable to customers requesting future service to undeveloped lots. This fee would be based on the accumulated total of monthly surcharges, applicable to that piece of property for the period from the effective date of this decision to the date of the connection. The benefits that accrue to owners of currently undeveloped lots include (1) the availability of water furnished by a public utility which meets health standards, and (2) potentially increased property values. Therefore, it is reasonable to establish a service fee for new connections pertaining to vacant or undeveloped lots since these lots will benefit from the improvements made with the expenditures being made from the proceeds of the SDWSRF loan.

However, per Standard Practice U-13-W,¹³ as well as past authorizations for similar types of financing, this Commission has limited this service fee to $2,000 per customer.¹⁴

As discussed above, CWS has shown that the surcharge and service fee are reasonable and that authority to institute these charges should be granted, with the condition that the service fee be limited to no more than $2,000 per customer.

The revenue collected from the rate surcharge and service fees authorized in this decision should only be used to repay the SDWSRF loan and any related charges of a fiscal agent.

4.6 Other Requests and Requirements

CWS proposes to secure this loan with a first priority lien on its real and personal property and assets, constituting the project for which the loan proceeds shall be used. Use of the property and assets that constitute the Lucerne water treatment plant project as an encumbrance for the SDWSRF loan, in order to procure the loan, is reasonable.

CWS requests that it be authorized to establish a separate balancing account to be: 1) credited (increased) with revenues collected through the surcharge and service fee, as well as interest earned on funds deposited with a fiscal agent; and 2) debited (reduced) with the payment of principal on the loan, as well as charges for the services of the fiscal agent. It is reasonable to establish a separate balancing account, in order to track the above referenced transactions, as well as keep them separate from other regulated activity.

In the future, the number of customers that are served by CWS in the Lucerne service area may change; therefore, the Commission believes it is reasonable to periodically adjust the surcharge and service fee. The surcharge rates should be adjusted via a Tier 1 advice letter, no more than once a year, either by CWS or at the request of DWA after review of CWS' customer data for the Lucerne service area.

CWS requests that the total amount of the SDWSRF loan requested in the current case be added to the total financing previously authorized by the Commission. Currently, CWS is authorized to issue securities in the aggregate amount of $250,000,000.¹⁵ Based on the fact that the SDWSRF loan is repaid by a separate surcharge and therefore has no effect on the regulated operating revenue, it does not change the regulated capital structure of CWS. Therefore, the Commission authorizes the addition of the SDWSRF loan amount to the amount of debt financing currently authorized for CWS.

As discussed earlier, CDPH may not permit the use of SDWSRF loan proceeds for certain CWS expenditures related to the Lucerne Treatment Plant. While CWS has financing authority remaining pursuant to D.04-09-002, the authority granted therein does not permit the use of funds procured with that authority to reimburse expenditures made with CWS treasury funds. CWS has not requested to modify D.04-09-002 regarding the use of the proceeds from offering common shares, preferred stock or debt securities for reimbursing its treasury. However, CWS has requested, among other relief in the current application, permission to use proceeds from the SDWSRF loan to reimburse its treasury for funds expended prior to signing the SDWSRF loan contract, and to add the authority granted herein to the authority granted in D.04-09-002.

We have determined that using proceeds from the SDWSRF loan to reimburse CWS' treasury for funds expended for the construction, completion, extension or improvement of utility facilities is a proper use of the SDWSRF funds, based on our criteria and regulations. However, if CDPH does not permit the use of the loan proceeds for all of these purposes, based on its regulations, CWS may still need to issue common shares, preferred stock, or debt securities to meet its cash requirements. In this instance, to accomplish CWS' request to reimburse its treasury for expenditures made on the Lucerne Treatment Plant, we believe it is reasonable and appropriate to modify D.04-09-002. We will permit the use of proceeds from the issuance of common shares, preferred stock or debt securities, issued pursuant to D.04-09-002, to reimburse CWS' treasury for funds expended for the construction, completion, extension or improvement of the Lucerne Treatment Plant, that are not reasonably chargeable to operating expenses or income, and are not permitted by CDPH to fund with SDWSRF loan proceeds.

The services of a fiscal agent are required by DWR to administer repayment of the loan. ¹⁶ In order to be in compliance with that requirement and to ensure the availability of funds to repay the loan, CWS shall deposit all rate surcharge revenue with a fiscal agent, approved by DWR, within 30 days after collection from customers. CWS shall exclude the surcharge and service fees from regulated operating revenue, and shall exclude plant financed through the surcharge from rate base, for ratemaking purposes.

In order to facilitate an audit and review of revenues collected through the surcharge and service fees, and payments of principal on the loan and fiscal agent fees, CWS will need to maintain adequate records of all transactions associated with this SDWSRF loan, including but not limited to the retention of all invoices associated with the Lucerne Treatment Plant and all supporting documentation for all balancing account transactions.

4.7 CEQA Requirements

The California Environmental Quality Act (CEQA) applies to discretionary projects to be carried out or approved by public agencies.¹⁷ A basic purpose of CEQA is to inform governmental decision-makers and the public about the potentially significant environmental effects of proposed activities.¹⁸ CEQA requires that a responsible agency consider the lead agency's Environmental Impact Report, Negative Declaration or Mitigated Negative Declaration, prior to acting upon or approving a project.¹⁹

In a memorandum dated May 30, 2007, CDPH stated that it prepared a Mitigated Negative Declaration as the lead agency under CEQA. After consideration of comments received, CDPH made the following finding:

The project will not result in any significant environmental impacts, however California Water Service Company is required to pay the California Department Fish and Game filing fees in the amount of $1,800 at the time the Notice of Determination is filed with the State Clearinghouse.

Construction activities were commenced in compliance with CDPH's environmental review. The construction of the water treatment plant is now complete. This Decision approves CWS' SDWSRF financing application, pursuant to Pub. Util. Code §§817, 818, and 851. Since the project is already built, approval of this financing request is not a project under CEQA because it has no potential to result in a physical change in the environment.

4.8 Competitive Bidding Rule

The Competitive Bidding Rule set forth in Resolution F-616, dated October 1, 1968, exempts debt issues of $20,000,000 or less from the competitive bidding requirement.

Since CWS' loan request is for less than $20,000,000, it is exempt from the Commission's competitive bidding requirement.

⁶ As shown in CWS' response to DWA's Data Request DR 0711020-05, dated January 29, 2008. CWS' data response was due on February 11, 2008, but CWS did not submit its data response to DWA until May 13, 2008.

⁷ In addition, the following criteria must be complied with:

1) The water utility received a letter of invitation from CDPH to submit a project application and the water utility responded positively to the invitation by the deadline (Note: Construction could not have started prior to receiving the invitation to apply); 2) A technical report was issued by the CDPH district office prior to initiation of construction; 3) CDPH reviewed and approved plans and specifications for the project or phase of the project before construction went out to bid and before construction started; and 4) The entire project, including all phases, has environmental clearance.

⁸ "Privately owned water systems and [sic] can only use force account for a minor portion ($20,000) of the construction."

⁹ This issue is also discussed in the SRF Contract for a Private Entity, Article H-6(g): Supplier may use its own employees for engineering including development of plans and specifications; legal; and administrative costs, as provided for in Supplier's Budget of Eligible Project Costs. Supplier may use its own employees for construction or construction related activities if Supplier meets the following requirements: 1) obtains prior State approval; and 2) does not exceed $20,000 in Force Account costs.

¹⁰ Per California Code of Regulations, Title 22, Division 4, Chapter 12, Article 2, §63010(b)(1): Only those project costs that are directly associated with the planning, design, and construction of a project shall be eligible for funding.

¹¹ For 2008: Operating Revenue of $371,025,380 - Operating Expenses of $274,368,246 = $96,985,840. For 2009: Operating Revenue of $385,157,869 - $290,172,029 = $94,985,840.

¹² Not secured by or obtained from the issuance of stocks, stock certificates, other evidence of interest or ownership, bonds, notes, or other evidence of indebtedness of a public utility.

¹³ Standard Practice U-13-W - Water Company Filings for Financing, Section B.9: SDWSRF loans should also include a vacant lot fee on all unimproved lots in the service territory. The fee applies the monthly surcharge to all vacant lots and requires that the owner of the lot pay the accrued surcharge before being provided water service. The maximum accrued fees should be $2,000. The utility should add this lien to the title of each unimproved lot.

¹⁴ See D.05-01-048, pages 10-11 and Finding of Fact 24.

¹⁵ D.04-09-002, page 17 and Ordering Paragraph 1(a).

¹⁶ Per California Code of Regulations, Title 22, Division 4, Chapter 12, Article 5, §63040, borrower must complete and sign a Fiscal Services Agreement (Department of Water Resources Form DWR-4280). This requirement is also detailed in Title 23, Division 2, Chapter 2.5, §470(a)(2) and Chapter 2.5.1, §488(a)(2), and is reiterated in the Notice of Acceptance signed by CWS on December 8, 2006.

¹⁷ Public Resources Code Section 21000, et seq.

¹⁸ See CEQA Guideline § 15002.

¹⁹ See CEQA Guideline §§ 15050(b) and 15096.