Erie County Water Authority Annual Report

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ERIE COUNTY WATER AUTHORITY
Notes to Financial Statements

Organization and significant accounting policies
Organization and summary of operations

The Erie County Water Authority (the Authority) is a public benefit corporation created in 1949 by the State of New York. The accounts of the Authority are maintained generally in accordance with the Uniform System of Accounts prescribed by the New York State Public Service Commission (PSC), although the Authority is not subject to PSC rules and regulations or those of any other state or federal regulatory agency. The rates established by the Authority do not require PSC approval.

The Erie County Water Authority operates its business activities on a direct service basis where the Authority owns the assets and is responsible for their operation, maintenance, improvement and replacement; on a leased managed service basis where the Authority leases the assets and is responsible for the operation and maintenance of the assets while the lessor is responsible for the improvement and replacement of assets; and on a bulk sales basis where the Authority contracts with the customer to provide water while the customer owns the assets and is responsible for their operation, maintenance, improvement and replacement as well as billings and customer collections.

The Authority began with a mandate to provide potable water to all locations within Erie County, except Buffalo, Tonawanda and Grand Island, and has fulfilled this mandate by providing water to over 540,000 residents of Erie County operating on one of the three bases set forth above - direct service, leased managed service or bulk service. The Authority has had a regional outlook for many years as evidenced by our service expansion throughout the county and by the Inter-Community Transmission main built in the early 1990's to expand water service to the Cattaraugus Indian Reservation and some Chautauqua County customers. During fiscal year 2000 the Authority converted the Village of Depew and the Town of Clarence from bulk service to direct service and added over ten thousand direct service customers to its operations and asset base. The Authority has also agreed to provide water to residents of Western Genesee County in a shared venture with the Monroe County Water Authority and the State of New York. In addition, the Authority is under agreement to provide direct service to the City of Tonawanda in 2003.

Basis of Accounting

The Authority prepares its financial statements using the accrual basis of accounting. The activities of the Authority are reported in conformity with governmental accounting and financial reporting principles of the Governmental Accounting Standards Board (GASB). As allowed by governmental accounting standards, the Authority has elected not to apply Financial Accounting Standards Board pronouncements issued after November 30, 1989.

Reclassification

Certain prior year amounts have been reclassified to conform with the current year presentation.

Water Plant The cost of additions to water plant including purchased or contributed property and replacements of retired units of property is capitalized. Cost includes direct material, labor, overhead and an allowance for funds used during construction equivalent to the cost of borrowed funds used for construction purposes. Overhead is added proportionately to the cost of a project on a monthly basis. The cost of retirements of water plant is charged against accumulated depreciation. Maintenance and repairs are charged to expense as incurred, and major betterments are capitalized.

Depreciation of water plant is computed using the straight-line method based upon annual rates established in accordance with PSC guidelines, which range from 1% to 20%.

Depreciation expense approximated 2.3% and 2.4% of the original cost of average depreciable property for the years ended December 31, 2001 and 2000.

Investment securities

Investments are carried at market value based on quoted market prices for those investments subject to market forces and at amortized cost for investments not subject to market forces. The cost of investments sold is determined using the specific identification method and then adjusted to market value changes to reflect the combined net change in these elements in the income statement.

The Authority's deposits at December 31, 2001 were entirely covered by federal deposit insurance or by collateral held by the Authority's custodial banks in the Authority's name.

Materials and supplies

Materials and supplies are stated at the lower of cost or market, cost being determined on the basis of moving-average cost.

Accrued sick pay

Certain Authority employees who enter retirement, or who are separated from employment other than for cause, are paid 80% of their earned and unused sick leave pursuant to collective bargaining agreements and board policy. Sick pay is accrued when earned.

Unamortized bond discount and expense

Bond discount and expense resulting from the issuance of water revenue bonds have been deferred and are being amortized over the life of the bonds using the straight-line method.

Long-term investment

The long-term investment is accounted for at cost plus accrued income. See further discussion at Note 8. Advances for construction and contributions in aid of construction

Advances for construction primarily represent amounts received from contractors for water main extensions. Upon completion of the extension, the remaining advance is transferred to contributions in aid of construction.

Contributions in aid of construction represent amounts received from individuals, governmental agencies, and others, to reimburse the Authority for construction costs incurred on capital projects or the original cost of water plant systems contributed to the Authority by municipalities and others. During 2000, the Authority recorded asset values and contributions in aid of construction from the Village of Depew and the Town of Clarence in excess of $11,036,000 and assumed responsibility for the operation, maintenance and improvements to these water systems now and in the future.

Operating revenues

Operating revenues are recorded as water service is supplied. Water supplied, but not billed, as of the calendar year-end is estimated based upon historical usage and has been accounted for as earned but unbilled revenue. Billings in advance of water supplied are accounted for as a reduction to earned but unbilled revenue.

Statement of cash flows

For purposes of the statement of cash flows, the Authority considers cash and cash equivalents to be all unrestricted cash accounts and short-term investments purchased with an original maturity of generally three months or less. Cash paid for interest on the water revenue bonds amounted to $6,077,179 for 2001 versus $5,790,082 for 2000 (consisting of $4,591,771 current interest and $1,198,311 related to the partial defeasance of the 1992 and 1993 Capital Appreciation Bonds).

Income taxes

As a public benefit corporation, the Authority is exempt from Federal and State income taxes.

Water Plant

	December 31,
	2001	2000
	(in thousands)
Buildings and structures	$ 166,620	$ 164,675
Mains and hydrants	151,518	146,588
Equipment	26,937	25,465
Land	2,194	2,194
Other	37,272	35,861
Water plant in service	384,541	374,783
Less accumulated depreciation	130,836	122,751
	253,705	252,032
Construction work in progress	2,703	4,009
	$ 256,408	$ 256,041

Water revenue bonds

Water revenue bonds are summarized as follows:

Series

Final annual
installment
payment due

Year of
earliest
redemption

Interest
rate

Original
issue

Balance as of December 31,
2000	1999
(in thousands)

Series 1992FR

12/01/08

2006

6.20-6.30%

$ 50,270

$ 4,473

Series 1993A

12/01/16

2009

Variable (*)

27,500

Series 1993B

12/01/16

2009

Variable (*)

15,000

Series 1993FR

12/01/05

1997

4.88-6.17%

43,886

18,206

21,181

Series 1998B

12/15/17

1998

3.65-5.20%(**)

7,781

6,525

6,835

Series 1998D

10/15/19

2000

3.90-5.15%(**)

16,860

15,630

16,255

$ 87,334

$ 91,244

Less portion due within one year

3,726

3,910

$ 83,608

$ 87,334

    (*) The interest rate was 1.40% and 4.55% at December 31, 2001 and 2000, respectively.
    (**) Gross rates subject to subsidy from the New York State Environmental Facilities Corporation (EFC).
    FR Fourth Resolution

The Series 1992 Bonds represent Capital Appreciation Serial Bonds (Appreciation Bonds), the Series 1993A and Series 1993B Bonds represent Variable Weekly Bonds and the Series 1993 Fourth Resolution Bonds represent Current Interest Bonds and Appreciation Bonds. Interest on the Current Interest Bonds and Variable Weekly Bonds is payable semi-annually on June 1 and December 1. Interest on the Appreciation Bonds is compounded semi-annually on June 1 and December 1 but is not payable until bond maturity. The accrued interest on the Appreciation Bonds is reflected as current and long-term interest payable.

Concurrent with the issuance of the Series 1993A Bonds and the Series 1993B Bonds, the Authority entered into interest rate swap agreements as a hedge against fluctuating interest rates. The forward interest rate swap agreement for the Series 1993B Bonds became effective in March 1996. The interest rate swap agreements provide for the Authority and a counterparty to exchange a net dollar amount calculated as the difference between a weekly variable rate and a contractual fixed rate of 5.24% and 5.89%, for the Series 1993A Bonds and the Series 1993B Bonds, respectively. Settlement with the counterparty occurs with the semi-annual payment of interest on May 31 and November 30. Amounts receivable or payable are accrued as a component of interest expense. The notional amount of the interest rate swap agreement is consistent with the Series 1993A Bond and Series 1993B Bond issuance amounts and decreases concurrent with subsequent maturities of the Series 1993A Bonds and Series 1993B Bonds.

The Current Interest Serial 1998B and 1998D Series Bonds were issued to the EFC under their aggregate pool financings identified as New York State Environmental Facilities Corporation State Water Pollution Control Revolving Fund Revenue Bond Series 1998B (EFC Project No. 15568) and Bond Series 1998D (EFC Project No. 16504) in 1998. The 1998B and 1998D bonds in the amounts of $7,780,931 and $16,859,700, respectively, representing the Authority's portion of these financings, were issued to cover the costs of the construction of two new clearwell water tanks and a new pumping station at the Authority's Sturgeon Point plant. Payments are made to the bondholders as follows:

	Interest	Principal
1998B	June 15 and December 15	December 15
1998D	April 15 and October 15	October 15

The bonds bear a variable rate of interest from 3.65% to 5.20% over their respective installment payment dates ending on December 15, 2017 and October 15, 2019, respectively. The terms of the borrowings provide for an interest subsidy of approximately one-third of the stated interest rates shown above. The subsidy is generated from a United States Environmental Protection Agency grant to the EFC which EFC invests and credit the borrower with the earnings on the invested funds as an offset to the interest payable on the bonds.

Total principal and interest payments relating to Water Revenue Bonds for the next five years are summarized as follows:

Year Ending December 31,	Principal	CAB Interest	Current Interest	Total
2002	$ 3,725,917	$ 1,959,083	$ 4,305,251	$ 9,990,251
2003	5,805,000	---	4,196,668	10,001,668
2004	5,955,000	---	3,869,494	9,824,494
2005	6,740,000	---	3,522,976	10,262,976
2006	3,238,577	2,996,423	3,215,281	9,450,281
2007-2019	61,869,253	3,635,747	21,989,821	87,494,821
	$ 87,333,747	$ 8,591,253	$ 41,099,491	$ 137,024,491
Less Portion due within one year	3,725,917	1,959,083	4,305,251	9,990,251
	$ 83,607,830	$ 6,632,170	$ 36,794,240	$ 127,034,240

As provided by the respective bond resolutions, the Series 1993A Bonds and the Series 1993B Bonds are redeemable prior to maturity at the election of the Authority, at any time. In order to redeem these bonds the Authority would be required to unwind the swap agreements.

Prior to 1993, the Authority completed a plan of restructuring a significant portion of its debt through a series of bond issuances. The net proceeds from these issuances and certain existing funds were deposited with an escrow agent pursuant to refunding agreements, and invested in U.S. Government securities. The maturities of these invested funds and related earnings thereon are expected to provide sufficient cash flow to meet the debt service requirements of the defeased bonds as they mature. These advance refunding transactions effectively released the Authority from its obligation to repay these bonds and constituted in-substance defeasances. The principal outstanding on the bonds defeased prior to 1993 is $70,447,330 at December 31, 2001 with maturities ranging from the year 2002 to the year 2014.

Beginning in 1998, the Authority has significantly reduced its debt. On December 1, 1998, the Authority paid $7,701,125 to discharge principal and accrued interest on the Series 1992 Bond Issue due December 1, 2017.

In November 1999, the Authority defeased a portion of the 1993 Fourth Resolution Taxable Bonds. Available cash of $13,684,547 was deposited with an escrow agent pursuant to an escrow agreement, and invested in U.S. Government securities. The maturities of these securities and related earnings thereon are expected to provide sufficient cash flow to meet the debt service requirements of the defeased portion of the 1993 Fourth Resolution Taxable Bonds as they mature. This transaction effectively released the Authority from its obligation to repay the defeased portion of the Series 1993 Fourth Resolution Bonds and constituted an in-substance defeasance. This transaction resulted in a difference of $19,422 between cash put into escrow and the net carrying amount of the debt. This difference has been deferred and will be amortized as a component of interest expense over the remaining life of the debt. The principal outstanding is $9,369,880 at December 31, 2001 with maturities ranging from the year 2002 to the year 2005.

In December 2000, the Authority defeased a portion of the 1992 Fourth Resolution Bonds and a portion of the 1993 Fourth Resolution Taxable Bonds. Securities and available cash of $4,191,215 was deposited with an escrow agent pursuant to an escrow agreement, and invested in U.S. Government securities. The maturities of these securities and related earnings thereon are expected to provide sufficient cash flow to meet the debt service requirements of the defeased portion of the 1992 and 1993 Fourth Resolution Bonds as they mature. This transaction effectively released the Authority from its obligation to repay the defeased portion of the Series 1992 and 1993 Fourth Resolution Bonds and constituted an in-substance defeasance. This transaction resulted in a difference of $50,121 between cash and securities put into escrow and the net carrying amount of the debt. This difference has been deferred and will be amortized as a component of interest expense over the remaining life of the debt. The principal outstanding is $2,742,804 at December 31, 2001 with maturities ranging from the year 2002 to the year 2007.

Debt service reserve fund
During 1993, the Authority established a debt service reserve fund as required by the Series 1993A and 1993B bond resolutions to maintain a specified amount of funds to meet future debt service requirements. These requirements state that the Authority must deposit funds equal to the lesser of the maximum amount of principal and interest becoming due in any succeeding calendar year on the Series 1993A and Series 1993B Bonds or 9.9% of the initial principal amount of the Series 1993A and Series 1993B Bonds.

The 1992 and 1993 Fourth Resolution Bond Series established a debt service reserve fund as required by the Series 1992 and 1993 Fourth Resolution bond resolutions to maintain a specified amount of funds to meet future debt service requirements. These requirements state that the Authority must deposit funds equal to the lesser of the maximum amount of principal and interest becoming due in any succeeding calendar year on the Series 1992 and 1993 Fourth Resolution Bonds or 9.9% of the initial principal amount less the original issue discount on the Series 1992 and 1993 Fourth Resolution Bonds. Surety bonds issued by AMBAC Indemnity Corporation have been deposited in the Reserve Account in full satisfaction of the Reserve Account Requirements for the Series 1992 and Series 1993 Fourth Resolution Bonds.

During 1998, the Authority established a debt service reserve fund as required by the Series1998B and 1998D bond resolutions to maintain a specified amount of funds to meet future debt service requirements. These requirements state that the Authority must deposit funds equal to the lesser of ten percent of the total principal of the loan, the maximum annual debt service or 125% of the average annual debt service for the Series 1998B and 1998D Bonds.

At December 31, 2001 the debt service reserve fund was $5,696,514 and at December 31, 2000 the debt service reserve fund was $5,759,357.
Debt service fund
The 1992 Fourth Resolution, 1993A, 1993B, 1993 Fourth Resolution, 1998B and 1998D bond resolutions require that a specified amount of funds be maintained in the debt service fund. The requirements of the debt service fund state that the Authority must deposit funds to provide for monthly interest and principal payments to start not later than six months prior to the payment of interest and twelve months prior to the payment of principal. Accordingly, the Authority had funds set aside in the debt service fund amounting to $4,142,336 and $4,878,389 at December 31, 2001 and 2000, respectively.
Future construction reserve fund
The Authority is required by the water revenue bond resolutions to maintain, on deposit, funds in the amount of one-twelfth of the subsequent year's budgeted improvement and replacement expenditures, but not less than one-twelfth of one half of 1% of the total gross cost of water plant in service and under construction. Accordingly, as the budgeted expenditures exceeded one half of 1% of water plant, the Authority was required to have reserve funds for future construction set aside in the amount of $1,071,975 and $840,877 at December 31, 2001 and 2000 respectively. Additionally, certain funds provided by the Series 1992, Series 1993A and 1993B Bonds are required to be maintained in this fund to pay for future acquisition and construction costs.

During 2001, and for future years, the Board has committed to pay for capital costs from available operating funds in excess of reserve requirements and other defined financial commitments.

At December 31, 2001, the future construction reserve was $3,925,943 and at December 31, 2000 the future construction reserve was $3,905,792.

Investment securities

In March 1997, the GASB issued Statement No. 31, Accounting and Financial Reporting for Certain Investments and for External Investment Pools (the Statement), which establishes standards of financial accounting and reporting for certain investments held by most governmental entities and all investments held by governmental external investment pools. Included in interest income in the Statement of Net Income and Earnings Reinvested in the Business were changes in the fair value of investments of a loss of $101,414 in 2001 and a gain of $89,336 in 2000.

The Authority's bond resolutions allow for monies to be invested in the following instruments:

Obligations of the United States Government;
Obligations of Federal Agencies which represent full faith and credit of the United States Government;
Bonds issued by the Federal National Mortgage Association or the Federal Home Loan Mortgage Corporation with remaining maturities not exceeding three years;
Time deposits and money market accounts;
Commercial paper which matures not more than 270 days after the date of purchase; and
Municipal obligations of any state, instrumentality, or local governmental unit of such state.

The amortized cost and market value of investment securities were as follows:

	December 31, 2001		December 31, 2000
	Amortized Cost	Market Value	Amortized Cost	Market Value
Future construction fund
Cash and equivalents	$ 1,329,856	$ 1,329,856	$ 1,451,647	$ 1,451,647
Mortgage-backed securities	1,049,465	1,049,919	1,817,132	1,831,220
Commercial Paper	1,546,622	1,546,622	637,013	637,013
Total	$ 3,925,943	$ 3,926,397	$ 3,905,792	$ 3,919,880
Debt service reserve fund
Cash and equivalents	$ 184,547	$ 184,547	$ 370,037	$ 370,037
U.S. Treasury securities	1,712,676	1,712,676	1,712,676	1,712,676
Mortgage-backed securities	2,003,256	2,003,949	2,701,316	2,722,189
Commercial Paper	1,796,035	1,796,035	975,328	975,328
Total	$ 5,696,514	$ 5,697,207	$ 5,759,357	$ 5,780,230
Debt service fund
Cash and equivalents	$ 4,142,336	$ 4,142,336	$ 4,878,389	$ 4,878,389
Total	$ 4,142,336	$ 4,142,336	$ 4,878,389	$ 4,878,389
Operating and Maintenence Fund
Cash and equivalents	$ 8,169,025	$ 8,169,025	$ 6,740,311	$ 6,740,311
Mortgage-backed securities	6,198,223	6,200,759	8,725,344	8,795,480
Commercial Paper	7,882,704	7,882,704	4,573,812	4,573,812
Total	$22,249,952	$22,252,488	$20,039,467	$20,109,603
Total	$36,014,745	$36,018,428	$34,583,005	$34,688,102
Market Value Less Amortized Cost		$ 3,683		$ 105,097

Long-term investment
During 1990, the Authority entered into a zero coupon bond agreement which requires the Authority to make monthly deposits into an investment account through December 2008. During 1997, the Board established a policy that all earnings and proceeds to be distributed in conformance with the agreement shall be deposited into the capital fund to be used solely for future capital expenses. At December 31, 2001 and 2000, the zero coupon bond investment balance is $8,154,128 and $8,673,074, respectively. Interest on the investment is compounded monthly at a rate of 7.45%. The annual deposit for next year will be approximately $456,000. The second year will be approximately $363,000, the third year will be approximately $277,000, the fourth year will be approximately $197,000, and the fifth year will be approximately $119,000. The total amount due for the two years thereafter is approximately $70,000. On December 1, 2001 the Authority received $1,743,267 as the second guaranteed annual payment from this investment. Varying amounts will be received each December 1 through 2008. The total amount to be received in future years is approximately $12.1 million.
Pension plan and other post retirement benefits
The Authority contributes to the New York State and Local Employees Retirement System (State Plan), which is a cost-sharing, multi-employer, public employee retirement system. The State Plan provides retirement, disability, and death benefits to members as authorized by the New York State Retirement and Social Security Law. The State Plan issues publicly available financial reports that contain financial statements and required supplementary information for the State Plan. The State Plan report may be obtained by writing to the New York State and Local Retirement Systems - Employees Retirement System, Gov. Smith State Office Building, Albany, New York 12244.

Plan members who joined the State Plan before July 27, 1976 are not required to make contributions. Those joining on or after July 27, 1976 are required to contribute 3% of their annual salary for the first ten years of their membership, or credited service, in the Retirement System.

The contribution requirements of the State Plan members and the Authority are established by the New York State Retirement and Social Security Law and may be amended by the State Legislature. The Authority's contribution to the State Plan amounted to $285,783 and $182,174 in 2001 and 2000, respectively.

In addition to providing pension benefits, the Authority provides certain health care benefits to retired employees. The Authority's employees covered by collective bargaining units may become eligible for these benefits if they reach normal retirement age while working for the Authority for at least 15 years. For exempt employees the Authority uses a formula based on years of service and age. The Authority recognizes the cost of providing health care benefits to retired employees by expensing the annual premiums, which totaled $472,998 and $418,071 for 2001 and 2000, respectively.
Deferred compensation plan
Employees of the Authority may elect to participate in the Erie County Water Authority Deferred Compensation Plan (the Plan) created in accordance with Internal Revenue Code Section 457. The Plan permits participating employees to defer a portion of their salary until future years, usually after retirement.

Section 457 of the Internal Revenue Code was recently amended by the Small Business Job Protection Act of 1996 to require that an eligible deferred compensation plan must, by January 1, 1999, provide that all amounts deferred and the income thereon be held in trust for the exclusive benefit of participants and their beneficiaries. The Plan was amended effective October 1, 1997 to comply with the law, and the plan assets were placed into trust at that time. The plan was further amended in December 2001 to comply with the provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001, which increased contribution limits and provided new portability provisions.
Commitments and contingencies
The Authority maintains and operates certain facilities employed in the sale and distribution of water, which it leases from various local water district municipalities pursuant to lease management agreements. Such agreements generally are for ten-year terms, are noncancellable during the initial nine years and provide that the lessor purchase and obtain in return water exclusively from the Authority. Subsequent to its initial term, these agreements continue on a month-to-month basis until a new agreement is negotiated. Future maintenance and operating costs to be incurred by the Authority under such arrangements presently in effect are not determinable.

The Authority is subject to various laws and regulations, which primarily establishes uniform minimum national quality standards. The Authority has established procedures for the on-going evaluation of its operations to identify potential exposures and assure continued compliance with these regulatory standards.

The Authority is also committed under various operating leases for the use of certain equipment and office space. Rental expense for 2001 and 2000 aggregated $515,236 and $475,076, respectively. Future minimum annual rentals to be paid under such leases are not significant.

The Erie County Water Authority and the City of Tonawanda entered into a Direct Service Agreement on January 10, 2002. Included in the agreement is a commitment to invest approximately $3,000,000 in the City of Tonawanda water system infrastructure, which will revert to the beneficial ownership of the Authority at such time that both parties have met the conditions in the executory agreement.

The Authority has committed approximately $2,200,000 to build a pipeline and pump station within Erie County to the Genesee County line under the "Genesee County Public Supply Program." This involves a three party agreement with New York State providing a $3,000,000 grant under its "Pipeline For Jobs" program. The Authority will receive $1,300,000 with the balance going to Monroe County Water Authority and Genesee County for their portions of the project. The remaining balance of the Authority's commitment as of December 31, 2001 is $2,000,000, of which $1,100,000 will be funded by the remaining portion of the state grant.

The Authority is involved in litigation and other matters arising in its normal operating, financing, and investing activities. While the resolution of such litigation or other matters could have a material effect on earnings and cash flows in the year of resolution, none of this litigation, and none of these other matters, are expected to have a material effect on the financial condition of the Authority at this time.