Audit Report on the Financial and Operating Practices of the New York City Water and Sewer System and the Determination of Water Rates

AUDIT REPORT IN BRIEF

The New York City water and sewer system (the System) is a network of watersheds, reservoirs, tunnels, aqueducts, water mains, sewers, treatment plants, and pumping stations, including more than 7,000 miles of pipes running from upstate New York to every building in New York City (the City). The water supply system delivers more than one billion gallons of high quality drinking water every day to more than eight million people in the City and nearly one million residents in four counties north of the City. The System provides service to approximately 836,000 customer accounts in the City. Approximately 91 percent of the water and sewer system’s City customers are residential.

In 1984, the New York City Municipal Water Finance Authority (the Authority) and the New York City Water Board (the Board) (collectively NYW) were created to change the way the City’s water and sewer infrastructure was operated and funded. Under the new structure, the Authority is primarily responsible for (1) issuing bonds to finance the System’s capital construction and infrastructure improvements, and (2) hiring a rate consultant to provide professional services in connection with determining water rates.

The Board leases the System from the City and is primarily responsible for (1) establishing water and sewer rates, and (2) ensuring revenues received are sufficient to place the System on a self-sustaining basis. The lease agreement provides for the City to manage the physical operation and capital improvement of the System, and bill and collect water and sewer charges on behalf of the Board. The operation and maintenance expenses incurred by the City are reimbursed by the Board. The Department of Environmental Protection (DEP) is the primary City agency that handles the operation of the System and provides billing services to the Board.

For Fiscal Year 2012, the combined certified financial statements of the Authority and the Board reported total revenue of $3.48 billion and expenses of $3.5 billion.

Audit Findings and Conclusion

DEP did not maintain accurate and reliable accounts receivable data in the Customer Information System (CIS).   Accordingly, given the heavy reliance on CIS data, NYW may be underestimating the collectability of accounts receivable—a factor that can affect the rate- setting process.  We attribute this problem to NYW’s failure to establish a consistent and reasonable methodology to value accounts receivable and a lack of oversight over DEP operations.

In addition, we identified problems with DEP’s procedures for billing and collecting revenue from customer accounts that led to at least $15 million in foregone revenues during Fiscal Year 2012.    As NYW is responsible for ensuring that the System has sufficient revenue to be “self-sustainable,”  ensuring that DEP collects all legitimate revenue is an important NYW function.   However, there was no evidence that NYW was cognizant of DEP’s problems in:

• properly assessing late payment charges,
• accurately maintaining customer account information, and
• monitoring accounts with significant outstanding balances.

In a related matter, City-owned properties operated by private entities, State-owned properties, and Housing Development Fund Corporation cooperatives owed the City $27 million in delinquent charges as of June 30, 2012.  Given that these properties are largely excluded from lien sales, DEP has limited options to enforce collection of these charges.   Nevertheless, there was no evidence that NYW directed DEP to pursue alternative methods to collect these funds.

Some of NYW’s underlying budget decisions used to establish water and sewer rates may not be based on reasonable assumptions.  To ensure that the System meets debt coverage ratios expected by rating agencies, NYW budgets to ensure a surplus.  However, the actual surplus for the audit period has exceeded the amount forecasted by 24 to 41 percent over the past four fiscal years. This leads us to believe NYW’s cash flow projections might have overly estimated the water and sewer revenue needs.

Audit Recommendations

This report makes 15 recommendations. NYW should:

• Establish internal control procedures to ensure all the System’s revenue data is properly reviewed and reported.  This would include procedures to conduct independent review of the data extracted from CIS to ensure the extracted data is accurate and reliable.
• Re-evaluate the methodology used to calculate the allowance for uncollectible accounts and unbilled receivables.
• Ensure the data used to calculate the allowance for uncollectible accounts is relevant, sufficient, and reliable, so that the net realized value of the accounts receivable is reasonable and appropriate.
• Use consistent accounting methods when reporting revenue including receivables, late payment charges, and allowance for uncollectible accounts.
• Work with DEP to strengthen internal controls over the billing and collection process in order to increase collectability from customers.
• Ensure late payment charges are assessed for the frontage accounts that maintain delinquent balances.
• Ensure DEP carefully review the customer account history and includes all eligible properties in lien sales.
• Establish alternate methods to collect delinquent charges from City-owned properties that are operated by private entities, State-operated properties, and properties exempt from lien sales.
• Ensure DEP adheres to the City’s solicitation process and properly reviews all supporting documents submitted by the vendors and all invoices paid were appropriate.
• Ensure cash flow assumptions are established based on data that is adequately substantiated to justify water and sewer rates before they are enacted.

Agency Response

In their response, NYW officials disagreed with the audit’s findings and most of the recommendations.  NYW officials maintain that:

“the draft ‘audit’ (1) confused the legal and management relationship among the Authority, the Board, and DEP, (2) failed to comprehend that water and sewer charges are a lien on the property served and collectible upon transfer of the property, which renders a traditional corporate write-off policy inapplicable, (3) ignored the transformation of revenue collection through the installation of DEP’s automated meter reading (“AMR”) system . . . and, amazingly, (4) questioned common-place and prudent practices, such as debt defeasance to achieve lower interest payments and conservative planning to avoid shortfalls and the necessity of a mid-year rate increase.”

These representations by NYW officials about the audit are simply not credible. Although NYW officials present several arguments which attempt to refute the report’s findings, each argument presents either an irrelevant or unsupported conclusion. In some cases, the statements made are contradicted by NYW officials’ own documents and appear to be factually inaccurate.  Further, despite providing NYW officials with ample meeting opportunities to disprove our findings, NYW officials failed to provide relevant information that would allow us to form a basis for any substantial revision of the draft audit report.  In contrast to NYW officials’ complaint about each finding, NYW officials overlooked a salient message of our audit—that budget decisions such as cash flow projections and amounts set aside for debt defeasance must be reasonable and transparent to the public and currently are not.

While we agree with NYW officials’ assertion that planning for an annual surplus is prudent financial practice, we found that the actual expenses for debt defeasance were substantially higher than the budgeted amounts.  Further, when comparing the surplus forecast at the time the water and sewer rates were established to the actual surplus, the actual surplus was substantially higher than originally forecasted.  In that regard, water and sewer rates may have been set higher than necessary.