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Home My WebLink AboutStaff Report 2509-5177CITY OF PALO ALTO Policy & Services Committee Special Meeting Tuesday, April 14, 2026 6:00 PM Agenda Item 2.Office of the City Auditor Presentation of the City of Palo Alto Utility Reserves Advisory Report. CEQA Status: Not a Project. Staff Presentation 8 1 5 9 Policy & Services Committee Staff Report From: City Manager Report Type: ACTION ITEMS Lead Department: City Auditor Meeting Date: April 14, 2026 Report #:2509-5177 TITLE Office of the City Auditor Presentation of the City of Palo Alto Utility Reserves Advisory Report. CEQA Status: Not a Project. RECOMMENDATION The Office of the City Auditor recommends the Policy & Services Committee accept the results of the City of Palo Alto Utility Reserves Advisory Report. BACKGROUND Baker Tilly Advisory, in its capacity serving as the Office of the City Auditor (OCA), performed a citywide risk assessment that evaluated a wide range of risk areas, including strategic, financial, operational, compliance, technological, and reputational risks. The purpose of the assessment was to identify and prioritize risks to develop the annual audit plan. The annual audit plan includes both traditional audits and advisory projects to provide information for the City to improve processes and outcomes. During the FY 2025 risk assessment, the OCA identified Utility reserves as a potential area of risk and was asked to include this as a non-audit advisory project in FY 2026 Audit Plan. ANALYSIS The objective of the Utility Reserves Advisory Project was to assess and benchmark the City’s current utilities reserves and identify best practices related to reserve policies, structures, and levels. The City’s utility reserve funds play a critical role in maintaining financial stability, supporting emergency response, and funding long-term capital needs. Our assessment noted that some reserve policies – particularly for the Wastewater Treatment, Refuse, and Stormwater utilities – are outdated and not fully aligned with more recently updated policies across other utilities. In addition, we noted that the current structure includes multiple reserve funds with varying guideline levels which can be administratively complex, requiring staff to track multiple reserve funds against minimum, target, and maximum levels. In a few cases, such as the Electric Special 8 1 5 9 Projects Reserve, additional clarification on the purpose of the reserve could further improve understanding, consistency and minimize the potential for overlap. FISCAL/RESOURCE IMPACT STAKEHOLDER ENGAGEMENT 8 1 5 9 ENVIRONMENTAL REVIEW ATTACHMENTS APPROVED BY: City of Palo Alto Office of the City Auditor City of Palo Alto Utility Reserves Advisory Report March 27, 2026 Contents network of Baker Tilly International Ltd., the members of which are separate and independent legal entities. Baker Tilly US, LLP is a licensed CPA firm that provides assurance services to its clients. Baker Tilly Advisory Group, LP and its subsidiary entities provide tax and consulting services to their clients and are not licensed CPA firms. EXECUTIVE SUMMARY .................................................................................................. 1 PURPOSE OF THE ASSESSMENT ........................................................................................................ 1 REPORT HIGHLIGHTS ............................................................................................................................... 1 INTRODUCTION ............................................................................................................... 7 OBJECTIVE ................................................................................................................................................... 7 OVERVIEW .................................................................................................................................................... 7 SCOPE AND PROCEDURES ................................................................................................................... 7 DETAILED ANALYSIS ..................................................................................................... 8 Executive Summary Purpose of the Assessment Baker Tilly Advisory Group, LP (Baker Tilly), in its capacity serving as the Office of the City Auditor (OCA) for the City of Palo Alto (the City or Palo Alto), conducted a City of Palo Alto Utilities (CPAU) Advisory Project based on approved Task Order 4.38 as part of the City’s Fiscal Year (FY) 2026 Audit Plan. The purpose of this project was to assess CPAU's Reserve policies and benchmark them against peer agencies. Report Highlights Overview of Current Reserves: (Page 9) Consistency w/ Regulatory Reserve Margin Requirements: (Page 16) Utility reserve funds provide a safety net for municipal utilities and can help agencies stabilize rates, respond to emergencies and plan for capital improvements, while ensuring the utility remains credit worthy and financially healthy. • Current reserve policies contain multiple prescribed transfer rules that require the tracking of reserve funds to minimum, target, and maximum levels resulting in significant administrative burden. • Reserve funds and policies for the Wastewater Treatment Utility, Refuse Utility, and Stormwater Utility date back to the early 1990s and are no longer aligned with other utilities reserve policies which were updated in June 16, 2025. The Electric Special Projects Reserve appears to serve similar purposes with the CIP Reserves. As such, additional clarity on the intended use of these funds may be necessary. Consistency with Regulatory Reserve Margin Requirements Policies The City’s bond covenants contain specific reserve requirements for the outstanding Water Revenue Bonds, 2009 Series A (2009 Bonds) and the Utility Revenue Refunding Bonds, 2011 Series A (2011 Bonds)(collectively, Utility Bonds). Relevant cash reserve credit rating targets from S&P and Moody’s are also discussed in this section of the report. • Both the Rate Covenant and Available Reserves Covenants are monitored and tracked by the Administrative Services Department. Current utility reserve policies do not specifically address the Rate Covenants or Available Reserve Covenants made by the City in the official statements and legal documents for the outstanding 2009 and 2011 bonds. According to the latest Ratings Affirmation from S&P on the outstanding 2011 and 2009 bonds, Palo Alto is in compliance with the Rate and Available Reserves Covenants. The City could consider referencing these documents in its reserve policies. EXECUTIVE SUMMARY Operational / Industry Best Practices: (Page 20) • When determining credit ratings, rating agencies ultimately rate a utility based on a holistic financial profile. Rating agencies outline cash reserve targets as a guideline and is one of the many differing levels of creditworthiness. While the current reserve policies do not include cash reserve targets that correspond to the amounts laid out in credit agency rating guidelines, an important factor to consider is maintaining sufficient cash reserves to maintain credit ratings for the City’s utilities. • The outstanding 2009 and 2011 Bonds contain an overly burdensome reserve requirement covenant that is not a market standard, particularly for high-grade utility credits. The reserve requirement for the 2009 and 2011 Bonds require that the Electric Fund, the Gas Fund, and the Water Fund be combined for an Available Reserves Test. With future issuances, City Utilities can remove this Available Reserves Test form its covenants. The 2011 Bonds mature in June 2026. Refunding the 2009 Bonds is being evaluated by the City. Once both Utility Bonds are defeased, City Utilities will no longer have to consider compliance to the Available Reserves Test separate from its reserve policies. Operational / Industry Best Practices This section of the report includes information on common best practices for operational reserves and capital improvement reserves from the Government Finance Officers Association (GFOA) and best practices that Baker Tilly employs when working with Utility clients. • Current operations reserve fund policies are in alignment with the GFOA’s recommendations for operating reserves, however, the Wastewater Treatment Utility, Refuse Utility and Stormwater Utility do not currently have operations reserve funds. Wastewater Treatment Utility is currently working with a consultant to review their reserves. • Current reserve policies for the City’s CIP reserve funds specify a maximum reserve guideline level that is equivalent to one-year of average capital improvements. In Baker Tilly’s experience, one-year of average capital improvements is the amount most frequently used as a target level of reserves in a CIP reserve fund. We consider this a best practice as setting aside one-year worth of capital improvement expenditures allows for the ongoing replacement of necessary infrastructure. It should be noted that when determining the one-year average capital improvement amount, Baker Tilly recommends that reappropriations and commitments (and the funds set aside for them) should not be considered. • While Baker Tilly considers one-year of average capital improvements a best practice CIP reserve level, GFOA recommends that capital reserve level development should be designed to best serve the particular needs EXECUTIVE SUMMARY Benchmarked Comparables: (Page 22) recommendation could be considered. Alternatively, another approach to determining a CIP reserve fund guideline level could be to maintain one- year or a percentage of one-year of depreciation expense in reserve balances. • The current CIP reserve fund policy does not make a distinction between budgeted CIP expenses to be funded by cash or CIP expenses to be funded by Bonds or other funding sources. The best practice for this reserve policy would be to separate those two types of CIP expenses, and craft reserve guideline levels based on CIP expenses to be funded by cash. This ensures that reserve fund amounts in a given year are not artificially inflated due to large projects that will be funded through other funding sources. Local Economy Specific Reserves Through Benchmarking Comparables This assessment benchmarked reserve policies from the Roseville, Santa Clara, Healdsburg and Pasadena cities, as well as, San Jose Energy CCA (collectively, the “benchmarked communities”) and compares their policies to CPAU’s reserve policies. • Rate stabilization reserve funds for the City’s Electric, Water, and Wastewater Collection Utilities do not contain formally established guideline reserve levels while most benchmarked communities specify varying target levels. • Operation and maintenance reserve funds for the City’s Electric, Water, and Wastewater Collection Utilities have more prescriptive guidelines reserve levels through the establishment of minimum, target, and maximum guideline levels compared to the benchmarked communities. The benchmark communities, with just one exception used only minimum guideline levels for the operation and maintenance reserve funds. The minimum guideline levels were most typically based on a specified amount of days operating expenses. • Note that when analyzing operating reserves vs. rate stabilization reserves, Baker Tilly specifically compared Palo Alto’s rate stabilization reserve fund policies to only rate stabilization reserve fund policies for the Benchmark Communities, and Palo Alto’s operation reserve fund policies to operation reserve fund policies for the Benchmark Communities. • The Benchmark Communities typically have some or all of the three commonly established reserve funds that Palo Alto Utilities with updated reserve policies have, which are the rate stabilization reserve, the operations and maintenance reserve, and the CIP reserve. • The City’s Electric, Water, and Wastewater Collection Utilities have set minimum and maximum guideline levels for the capital replacement and improvement reserve funds, while all other benchmark communities with EXECUTIVE SUMMARY Reserve Tracking: (Page 35) capital replacement and improvement reserve funds only had target guideline levels. • In general, the reserve policies for CPAU are more detailed and cumbersome than the policies of the benchmarked communities. CPAU has more funds established to hold cash reserves and its policies are more detailed in terms of guideline levels and sources and uses of those reserve funds when compared to others. Reserve Tracking – Key Observations This section of the report examines the current requirements and processes for tracking reserves. • Utility Management tracks reserves on an annual basis in conjunction with the development of each individual Utility’s Financial Plan. A reserve tracking policy with guidance included to report instances when reserve fund balances do not meet guideline levels to Council may provide more assurance that reserve targets are being met throughout the year and equip the Council with better information to make financial decisions than the current reporting process. Key Recommendations 1. Update Dated Policies - the Wastewater Treatment, Refuse, and Stormwater Utilities’ operations, rate stabilization, and CIP reserve funds policies should be updated to align with similar reserve policy guidelines in other CPAU utilities. When updating, management should consider the need for the existing reserve funds in these Utilities that are not common across other CPAU utilities, including the Emergency Plant Replacement Reserve Fund, the Notes and Loans Reserve Fund for the Wastewater Treatment Utility, and the Landfill Corrective Action and Geng Road Reserve funds for the Refuse Utility. If no longer necessary, these funds should be closed out and the money transferred to other funds in place. 2. Do not eliminate any of the current reserve funds in place – With the exception of the utilities with dated policies mentioned above, all City Utilities have in common three reserve funds: operations, rate stabilization, and CIP reserve funds. Baker Tilly views maintaining each of these reserve funds as a best practice. Additionally, as shown in the Benchmarking Comparables section of the report, many of the Benchmark Communities share these same common reserve funds in their utilities. Specifically, the City of Roseville Water and wastewater utilities, the City of Santa Clara electric utility, and the San Jose clean energy electric utility all have both rate stabilization and operation EXECUTIVE SUMMARY wastewater utilities have operation and maintenance, rate stabilization, and capital improvement reserve funds. What’s more, all Benchmark communities utilities that were reviewed had at least one of the three of these reserve funds. Palo Alto Utilities reserve funds separate from the three commonly shared reserve funds are in place for specifically defined and valid purposes and should remain in place until those purposes are accomplished or are no longer applicable. 3. Clarify CIP Reserve Fund Language – the Electric Special Project Reserve within the Electric Utility is distinct from the CIP Reserve Fund. While both of these funds are purposed for capital projects clarity on intended use of funds is recommended. 4. Consider adjustment to CIP Reserve Fund Guideline Levels – Consider adjustment to CIP Reserve guideline levels to align with Baker Tilly’s recommendation to maintain in the CIP reserve fund 20% of 60 months of budgeted CIP expenses or alternatively, one-year of depreciation expense in the CIP reserve fund. CIP expenses should only include those intended to be funded by Utility cash and not those projects intended to be funded by bonds or other outside sources of funding. 5. Adjust Rate Stabilization Reserve Policy to align with Bond Covenants and Benchmark Communities – Consider establishing: • Minimum guideline levels in the Rate Stabilization Reserve Funds for the Electric, Gas, and Water Utilities to ensure reserve balances meet or exceed the current Available Reserves Bond Covenants. Note: Staff is evaluating refunding of the 2009 Bonds and a normal payoff of the 2011 Bonds in June 2026, which would eliminate the need to make a change to these minimum guideline levels due to this Bond Covenant. • Target guideline levels for these funds for the Electric, Gas and Water Utilities should be at the higher of the minimum guideline level required by the Available Reserve Bond Covenants or a specified percentage of the total operating revenues or operating expenses in the current fiscal year so that the Rate Stabilization Reserve could hold funds in excess of the amount dictated by bond covenants to be used for its defined purposes. • The rate stabilization fund for Utilities without the Available Reserve Bond Covenants in place (Wastewater Collection, Wastewater Treatment, Refuse, and Stormwater) should have a target guideline level based on a specified percentage of total operating revenues or operating expenses in EXECUTIVE SUMMARY • varied between 10 to 65% of either revenues or expenses. The larger the percentage selected, the more reserve funds would be available to stabilize future rate increases. The percentage of operating revenues or expenses to be used as a target guideline level should be determined by Utility Management based on the amount desired to be held in the fund to help stabilize future rate increases. • Revising wording in the policy from “If there are funds in the Rate Stabilization Reserve at the end of any fiscal year, any subsequent Utility Financial Plan must result in withdrawal of all funds from this Reserve by the end of the Financial Planning Period.” to “If a Utility Financial Plan proposes a rate increase, the funds in the Rate Stabilization Reserve Fund in excess of the target amounts must be drawn down to offset the proposed rate increase.” 6. Formalize Reserve Tracking – Develop a reserve tracking policy with reporting requirements to City Council on a regular basis. The policy could include a schedule prepared for each Utility showing the current reserve fund balances compared to the amount that should be held in those funds based on established guideline levels, as well as an explanation of how those guideline levels are calculated and the reserve funds are used based on the Introduction The purpose of this assessment was to assess and benchmark the City’s current Utilities Reserves Policies. Overview and Reserve Policies, Compliance with Regulatory Reserve Margin Requirements, Operational/Industry Best Practices, Local Economy Specific Reserves Through Benchmarking Comparables, and Reserve Tracking. These sections include the information obtained through our research and outline our thought process in developing the proposed recommendations for adjustments to the City's current Utility Reserve Policies. Scope and Procedures The OCA performed the following procedures: • Gathered all relevant information on the Utility Reserve Policies currently in place; • Interviewed Utility personnel to gain a comprehensive understanding of these policies; • Researched applicable information on Utility reserve policies, operational & industry best practices; • Researched reserve policies for comparable communities to provide benchmarking information regarding the reserve funds; • Analyzed and outlined observations regarding the current Utility Reserve Policies against best practices, and • Developed recommendations for decision makers to consider for updating the current Utility Reserve Policies. The OCA greatly appreciates the support of the CPAU and Administrative Services Department in conducting this assessment. Thank you! DETAILED ANALYSIS Detailed Analysis Overview of Current Reserve Funds and Reserve Policies Utility reserve funds provide a safety net for municipal utilities and can help an agency stabilize rates, respond to emergencies and plan for capital improvements, while ensuring the utility remains credit worthy and financially healthy. This section of the report to provides a detailed overview of the current reserve funds and reserve policies for each of the City’s Utilities. Below is a chart that provides a listing of all the reserve funds in place and whether those reserve funds are in place in the individual utility listed at the top of each column. Utilities not listed in this chart were not analyzed as a part of this engagement. The remainder of this section provides the details of these reserve funds and their associated policies categorized by the reserve funds that are common across all utilities and the reserve funds that are unique to specific utilities. Current Reserve Funds in Place for the Utility? Electric Gas Water Stormwater Operations No No No Rate Stabilization CIP Reserves No No No Electric Special Projects No No No No No No Underground Loan No No No No No No Hydroelectric Stabilization No No No No No No Electrification Reserve No No No No No No Public Benefits No No No No No No Low Carbon Fuel Standard No No No No No No Cap and Trade Program No No No No No Emergency Plant Replacement No No No No No No Landfill Corrective Action Reserve No No No No No No Geng Road Reserve No No No No No No Notes and Loans No No No No No No Reserve Funds included in all Utilities Unless otherwise noted, guideline levels for reserve funds are based on the reserves management practices document for each utility. Rate Stabilization The purpose of the Rate Stabilization Reserve Fund is to manage the trajectory of future year rate increases. Withdrawal of funds from Rate Stabilization Reserves requires action by the City Council. If there are funds at the end of any fiscal year, any subsequent Financial Plan must result in the withdrawal of all funds from the Reserves by the end of the Financial Planning Period. The Council may approve exceptions to this requirement, when proposed by staff to provide greater rate stabilization to customers. City of Palo Alto ACFR FYE June 30, 2025 (Page 112) DETAILED ANALYSIS Rate Stabilization Reserves for Wastewater Treatment and Refuse have set Minimum, Target, and Maximum Levels, which are defined as a % of sales revenue. There is only a Target Level for Stormwater. Guideline Levels Wastewater Treatment (1) Refuse (1) Stormwater (2) Rate Stabilization Reserves for Electric, Gas, Wastewater Collection and Water do not have set Minimum, Target and Maximum Levels. Reserve Funds unique to specific utilities Operations The purpose of the Operations Reserve Fund is to manage normal variations in costs and as a reserve for contingencies. The Operations Reserve Fund is found within the Electric Utility, Gas Utility, Wastewater Collection Utility, and Water Utility. The Minimum, Target, and Maximum level of reserves for the Electric, Gas, Wastewater Collection, and Water Utilities are defined by the number of days of expenses that should be covered. Based on the current reserve policies, these guideline levels are as follows: Guideline Levels Electric Supply (1) Electric Distribution (2) Gas (3) Wastewater Collection (4) Water (5) Electric Utility Reserves Management Practices, Gas Utility Reserves Management Practices, Wastewater Collection Utility Reserves Management Practices, Water Utility Reserves Management Practices, City Council CMR:320:0, City Council CMR:263:3 DETAILED ANALYSIS Based upon policy, it should be noted that if, at the end of any fiscal year, the funds remaining in the Operations Reserves are lower than the minimum level set forth above, staff shall present a plan to the City Council to replenish the reserve. The plan shall be delivered within six months of the end of the fiscal year, and shall, at a minimum, result in the reserve reaching its minimum level by the end of the following fiscal year. In addition, staff may present an alternative plan that takes longer than one year to replenish the reserve. The policy also states that if, at the end of any fiscal year, either Operations Reserve is higher or lower than the target level, any Financial Plan for a Utility shall be designed to return Operations Reserves to their target levels by the end of the forecast period considered in the Financial Plan. Also, based upon policy, if at any time the Operations Reserve reaches its maximum level, no funds may be added to this Reserve. Any further increase in that fund's Fund Balance shall be automatically included in the Unassigned Reserves. CIP Reserves The purpose of the CIP Reserve Fund is to manage cash flow for capital projects and to act as a reserve for capital contingencies such as overage amounts for a project. The CIP Reserve Fund is found within the Electric Utility, Gas Utility, Wastewater Collection Utility, and Water Utility. The Minimum and Maximum Level guidelines are the same for Electric, Gas, Wastewater Collection, and Water for the CIP Reserves Fund. Guideline Levels These guideline levels are calculated for each fiscal year of the Financial Planning Period and approved by Council resolution. Based upon policy, it should be noted that if, at the end of any fiscal year, the minimum guideline is not met, staff shall present a plan to the City Council to replenish the reserve. The plan shall be delivered by the end of the following fiscal year, and shall, at a minimum result in the reserve reaching its minimum level by the end of the next fiscal year. Electric Utility Reserves Management Practices, Gas Utility Reserves Management Practices, Wastewater Collection Utility Reserves Management Practices, Water Utility Reserves Management Practices, City Council CMR:320:0, City Council CMR:263:3 DETAILED ANALYSIS Also, based upon policy, it should be noted that if, at any time, the CIP Reserve reaches its maximum level, no funds may be added to this reserve. If there are funds in this reserve in excess of the maximum level staff must propose to transfer these funds to another reserve or return them to ratepayers in the next Financial Plan. Staff may also seek Council approval to hold funds in this reserve in excess of the maximum level, if they are held for a specific future purpose related to the CIP. Electric Special Projects The purpose of the Electric Special Projects (ESP) Reserve Fund is to fund projects that benefit electric rate payers. The Electric Special Projects Reserve Fund is found within the Electric Utility. The Electric Special Projects Reserve Fund will be managed in accordance with the policies set forth in Resolution 9206 (Resolution of the Council of the City of Palo Alto Approving Renaming the Calaveras Reserve to the Electric Special Project Reserve and Adoption of Electric Special Project Reserve Guidelines) which was passed in 2011. Below are the Electric Special Projects (ESP) Reserve Fund guidelines set forth in Resolution 9206: • The purpose of the ESP Reserve is to fund projects that benefit electric ratepayers. • The ESP Reserve Funds must be used for projects of significant impact. • Projects proposed for funding must demonstrate a need and value to electric ratepayers. The projects must have verifiable value and must not be speculative, or high-risk in nature. • Projects proposed for funding must be substantial in size, requiring funding of at least $1 million. • Set a goal to commit funds by the end of FY 2025. • Any uncommitted funds remaining at the end of FY 2030 will be transferred to the Electric Supply Operations Reserve and the ESP Reserve will be closed. Underground Loan The purpose of the Underground Loan Reserve Fund is to fund a reserve for principal payments of outstanding Underground Loan(s). The Underground Loan Reserve Fund is found within the Electric Utility. Based upon policy, it should be noted that, at the end of each fiscal year, the Underground Loan Reserve will be adjusted by the principal payments made against outstanding underground loans. There are no set Minimum, Target and Maximum Levels. Electric Utility Reserves Management Practices DETAILED ANALYSIS Hydroelectric Stabilization Reserve The purpose of the Hydroelectric Stabilization Reserve Fund is to manage the supply cost impacts with variations in generation from hydroelectric resources. The Hydroelectric Stabilization Reserve Fund is found within the Electric Utility. Based upon policy, it should be noted that, near the end of each fiscal year, staff will determine the actual and expected hydro output for that fiscal year, compare that to the long-term average annual output level, and multiply the difference by the average of the monthly round-the-clock forward market prices for each month of the current fiscal year for the projected hydro output. Staff is authorized to transfer the amount calculated for the projected hydro output (described above) from the Operations Reserve to the Hydroelectric Stabilization Reserve for hydro output deviations above long-term average levels, or transfer this amount from the Hydroelectric Stabilization Reserve to the Operations Reserve for hydro output deviations below long-term average levels. The level of the Hydroelectric Stabilization Reserve after the transfers described above shall be the basis for staff's determination, with Council approval, of whether to implement the Hydro Rate Adjuster (Electric Rate E-HRA) for the following fiscal year. For the Hydroelectric Stabilization Reserve Fund there are set Minimum, Target and Maximum Levels. Guideline Levels Electrification Reserve The purpose of the Electrification Reserve Fund is to track funding of City buildings, appliance and vehicle electrification projects and programs, including development and implementation costs and associated financial incentives, loans and rebates for participating customers. The Electrification Reserve Fund is found within the Electric Utility. Electric Utility Reserves Management Practices DETAILED ANALYSIS Based upon policy, the Electrification Reserve may be funded by any lawful source of funds available for such programs, including new or ongoing utility revenues derived from customer participation. The Electrification Reserve balance shall be annually adjusted based on the net of revenues and expenses associated with the City's building appliance and vehicle electrification projects and programs using this reserve. Public Benefits The purpose of the Public Benefits Reserve Fund is to track unspent Public Benefits Revenues. The Public Benefits Reserve Fund is found within the Electric Utility. Based upon policy, the Public Benefits Reserve Fund will be increased by the amount of unspent Public Benefits Revenues remaining at the end of each fiscal year. Expenditure of these funds requires actions by the City Council. Low Carbon Fuel Standard The purpose of the Low Carbon Fuel Standard (LCFS) Reserve Fund is to track the revenues earned via the sale of Low Carbon Fuel Credits allocated by the California Air Resources Board to the City, as well as expenses incurred, in accordance with California's Low Carbon Fuel Standard Program. The Low Carbon Fuel Standard Reserve Fund is found within the Electric Utility. Based upon policy, at the end of each fiscal year, the Low Carbon Fuel Standard Reserve will be adjusted by the net of revenues and expenses associated with California's Low Carbon Fuel Standard program Cap and Trade Program The purpose of the Cap-and-Trade Program Reserve Fund is to track unspent or unallocated revenues from the sale of carbon allowances freely allocated by the California Air Resources Board to the Electric Utility and Gas Utility, under the State's Cap and Trade Program. The Cap-and-Trade Program Reserve Fund is found within the Electric Utility and Gas Utility. Based upon policy, funds in this reserve are managed in accordance with the City's Policy on the Use of Freely Allocated Allowances under the State's Cap and Trade Program, adopted by Council Resolution 9487 in January 2015. At the end of each fiscal year, the Cap-and-Trade Program Reserve will be adjusted by the net of revenues and expenses associated with the Cap-and-Trade program. Electric Utility Reserves Management Practices, Gas Utility Reserves Management Practices DETAILED ANALYSIS Emergency Plant Replacement The purpose of the Emergency Plant Replacement Reserve Fund is to manage cash flow for replacement or emergency repairs of damaged equipment. Reserves in this fund are to be used on the most expensive pieces of equipment which, if lost, would interrupt Wastewater Treatment activity. The Emergency Plant Replacement Reserve Fund is found within the Wastewater Treatment Utility. Based upon policy, uses of funds in this reserve require special appropriation by the Council. For the Emergency Plant Replacement Reserve Fund there are set Minimum and Maximum Levels. Guideline Levels (1) Notes and Loans The purpose of the Notes and Loans Reserve Fund is to manage cash flow reserves for any outstanding Notes and Loans. The Notes and Loans Reserve Fund is found within the Wastewater Treatment Utility. There are no set Minimum, Target, and Maximum Levels explicitly stated in the policies as required amounts are established in the respective loan agreements. Landfill Corrective Action Reserve The purpose of the Landfill Corrective Action Reserve Fund is to manage cash flow reserves for any costs of closure/post closure maintenance and corrective action for the respective facilities to protect the environment. The Landfill Corrective Action Reserve is found within the Refuse Utility. There are no set Minimum, Target, and Maximum Levels. Geng Road Reserve The purpose of the Geng Road Reserve is to manage cash flow reserves for any costs associated with Geng Road. The Geng Road Reserve is found within the Refuse Utility. There are no set Minimum, Target, and Maximum Levels. City Council CMR:320:0, City Council CMR:263:3 DETAILED ANALYSIS Overview of Current Reserve Funds and Reserve Policies Observations Observation #1 Based on the information discussed within the Reserve Funds included in all Utilities category, and the Reserve Funds that are unique to specific Utilities category, current reserve policies result in significant administrative burden through multiple prescribed transfer rules and the necessary tracking of reserve funds to minimum, target, and maximum levels. The policies for many reserve funds dictate that reserve funds money must be transferred into the fund if below the minimum level or out of the fund if above the maximum level. For example, this is a requirement for the Operations and Maintenance Reserve, CIP Reserve, and Hydroelectric Stabilization Reserve for the Electric Utility. This requirement necessitates tracking reserve funds to the specific minimum and maximum amounts and transferring funds accordingly. Observation #2 The current reserve funds and policies for the Wastewater Treatment Utility, Refuse Utility, and Stormwater Utility are from May 24, 1990 and May 6, 1993 and are not up to date compared to the other Utilities. Reserve policies for the other utilities were updated June 16, 2025. Observation #3 The purpose of the Electric Special Projects Reserve appears to be similar to the CIP Reserves, and the combination of the two reserves into just one, could assist in relieving the administrative burden of having two reserve funds within the Electric Utility that are for similar purposes. Consistency With Regulatory Reserve Margin Requirements Outstanding Bond Requirements There are two series of publicly-sold utility bonds outstanding: • $35,015,000 City of Palo Alto Water Revenue Bonds, 2009 Series A (Taxable Direct Payment Build America Bonds), which mature on June 1, 2035 • $17,225,000 City of Palo Alto Utility Revenue Refunding Bonds 2011 Series A, which mature on June 1, 2026 The 2009 Bonds are payable only from Net Revenues of the Water System. Proceeds of the 2009 Bonds funded a debt service reserve fund for the 2009 Bonds in the amount of $2,567,280. The City is required to maintain the debt service reserve fund while the 2009 Bonds remain outstanding. Water Revenue Bonds, 2009 Series A, OS, Utility Revenue Refunding Bonds, 2011 Series A, OS DETAILED ANALYSIS The 2011 Bonds were separated into sub-series, with 45% ($7,751,250) allocated to the Water System and 55% ($9,473,750) allocated to the Gas System. The Water System’s 2011 sub-series is payable only from Net Revenues of the Water System on a parity basis with the 2009 Bonds. The Gas System 2011 sub-series is payable only from Net Revenues of the Gas System. Proceeds of the 2011 Bonds funded a debt service reserve fund for the 2009 Bonds in the amount of $1,462,600. The City is required to maintain the debt service reserve fund the 2011 Bonds remain outstanding. Rate Covenant 2009 Bonds. In the Indenture for the 2009 Bonds, the City covenanted to fix, prescribe, revise and collect Charges for the Water System during each Fiscal Year which (together with other funds transferred from stabilization reserve funds for the Water System, and which are lawfully available to the City for payment of any of the following amounts during such Fiscal Year) are at least sufficient, after making allowances for contingencies and error in the estimates, to pay the following amounts in the following order: • All Maintenance and Operation Costs of the Water System estimated by the City to become due and payable in such Fiscal Year; • the Debt Service; • All other payments required for compliance with the Indenture and the instruments pursuant to which any Parity Bonds relating to the Water System shall have been issued; and • All payments required to meet any other obligations of the City which are charges, liens, encumbrances upon or payable from the Gross Revenues of the Water System or the Net Revenues of the Water System. In addition, the City covenanted to fix, prescribe, revise and collect Charges for the Water System during each Fiscal Year which, when added to the balance then on hand in Available Reserves for the Water System, are sufficient to yield Net Revenues of the Water System at least equal to one hundred twenty-five percent (125%) of the amounts payable under the preceding clause (a)(2) in such Fiscal Year for Bonds which have a lien on such Net Revenues. 2011 Bonds. In the Indenture for the 2011 Bonds, the City covenanted, separately for each of the Water System and the Gas System, to fix, prescribe, revise, and collect Charges for each System during each Fiscal Year which (together with other funds transferred from stabilization reserve funds for such System, and which are lawfully available to the City for payment of any of the following amounts during such Fiscal Year) are at least sufficient, after making allowances for contingencies and error in the estimates, to pay the following amounts in the following order: • All Maintenance and Operation Costs of Such System estimated by the City to become due and payable in such Fiscal Year; • The Debt Service on the Sub-Series of the 2011 Bonds issued for such System; Water Revenue Bonds, 2009 Series A, OS, Utility Revenue Refunding Bonds, 2011 Series A, OS DETAILED ANALYSIS • All other payments required for compliance with this Indenture and the instruments pursuant to which any Parity Bonds relating to such System shall have been issued; and • All payments required to meet any other obligations of the City which are charges, liens, encumbrances upon or payable from the Gross Revenues of such System or the Net Revenues of such System. In addition, the City covenanted for each of the Water System and the Gas System to fix, prescribe, revise, and collect Charges for such System during each Fiscal Year which, when added to the balance then on hand in Available Reserves for such System, are sufficient to yield Net Revenues of such System at least equal to one hundred twenty-five percent (125%) of Debt Service that is payable from Net Revenues of the such System. Available Reserves 2009 Bonds. In the Indenture for the 2009 Bonds, the City covenanted to maintain the funds on hand in Available Reserves in an aggregate amount at least equal to five (5.0) times maximum annual debt service on all outstanding bonded indebtedness secured by Net Revenues of the Water, Gas or Electric Systems. In addition, the City covenanted to transfer from Available Reserves, to the Water Revenue Fund, as needed, amounts sufficient to enable the City to pay all maintenance and operation costs of the Water System, and all debt service on the Bonds, when and as the same become due and payable. The 2009 Indenture defines “Available Reserves” to mean funds held in the City’s: (i) Rate Stabilization Reserve for the Water System, (ii) Distribution Rate Stabilization Reserve for the Electric System, (iii) Distribution Rate Stabilization Reserve for the Gas System, (iv) Supply Rate Stabilization Reserve for the Electric System, (v) Supply Rate Stabilization Reserve for the Gas System, and (vi) the Electric System’s Calaveras-Stranded Costs Reserve. 2011 Bonds. In the Indenture for the 2011 Bonds, the City covenanted to maintain the funds on hand in Available Reserves (as defined above) in an aggregate amount at least equal to five (5.0) times maximum annual debt service on all outstanding bonded indebtedness secured by Net Revenues of the Water System and the Gas System. Water Revenue Bonds, 2009 Series A, OS, Utility Revenue Refunding Bonds, 2011 Series A, OS DETAILED ANALYSIS In addition, the City covenanted to transfer from Available Reserves, to the Revenue Fund, as needed, amounts sufficient to enable the City to pay all Maintenance and Operation Costs of the applicable Water System or Gas System, and all Debt Service, when and as the same become due and payable. The City covenanted in the 2011 Indenture that any depletion of the Available Reserves which causes the balance therein to fall below the required level shall be restored from Net Revenues of the System which caused such depletion to take place. Application of the Available Reserves Requirement As described above, the City covenanted in the Indentures for the 2009 Bonds and the 2011 Bonds to maintain in the Available Reserves an aggregate amount at least equal to five (5.0) times maximum annual debt service on all outstanding bonded indebtedness secured by Net Revenues of the Water, Gas or Electric Systems. The Maximum Annual Debt Service on the 2009 and 2011 Bonds is $4,025,221.26. There is no outstanding bonded indebtedness payable from the Electric System. Five times the Maximum Annual Debt Service is $20,126,106.30. Consequently, the City is obligated to maintain $20,126,106.30 in the Available Reserves as long as the 2009 Bonds and the 2011 Bonds are outstanding. The 2011 Bonds mature in 2026. The City intends to refinance the 2009 Bonds, if market conditions permit. Water Revenue Bonds, 2009 Series A, OS, Utility Revenue Refunding Bonds, 2011 Series A, OS DETAILED ANALYSIS Credit Rating Reserve Targets Standard & Poor's Standard & Poor’s (S&P) has a methodology known as “S&P Criteria for U.S. Municipal Water Sewer, and Solid Waste Utilities” that S&P applies for rating any water, sewer or solid waste utility nationally. S&P also has a methodology known as “S&P Criteria for U.S. Municipal Retail Electric and Gas Utilities” that S&P applies for rating any electric or gas utility nationally. More information about the S&P methodologies are provided below. Standard & Poor's (S&P) issued a Global Ratings Affirmation for the outstanding Utility Revenue Refunding Bonds, 2011 Series A and Water Revenue Bonds, 2009 Series A, and affirmed its 'AAA' rating on the outstanding bonds and determined that the outlook is stable. The outstanding bonds fall under the S&P Criteria for U.S. Municipal Water, Sewer, and Solid Waste Utilities, since they are backed by multiple Utility revenues. For the S&P Criteria for U.S. Municipal Water, Sewer, and Solid Waste Utilities, Liquidity and Reserves have a 40% weighting when it comes to a rating. Due to the significant weight of liquidity and the reserves on the overall rating criteria, An important factor in maintaining the City’s 'AAA' Rating is ensuring that their Water, Sewer, and Solid Waste Liquidity and Reserves meet the reserve balance category of Extremely Strong. Below is a table that lists the Liquidity and Reserves S&P criteria for U.S. Municipal Water, Sewer, and Solid Waste Utilities. Days' Cash Available Reserves Water Revenue Bonds, 2009 Series A, OS, Utility Revenue Refunding Bonds, 2011 Series A, OS, S&P Ratings Report from April 7, 2025, S&P Criteria | Governments | U.S. Public Finance: U.S. Municipal Water, Sewer, And Solid Waste Utilities: Methodology And Assumptions DETAILED ANALYSIS For the S&P Criteria for U.S. Municipal Retail Electric and Gas Utilities, Liquidity and Reserves have a 25% weighting when it comes to a rating. The City does not currently have outstanding debt that is rated using this criteria. Below is a table that lists the Liquidity and Reserves S&P Criteria for U.S. Municipal Retail Electric and Gas Utilities. The following table measures liquidity through a Days' Liquidity metric, which measures how many days the Utility can continue to operate and pay for its expenses using only its currently available cash on hand. If the City intends to issue rated electric or gas utility debt in the future, the available reserves for those utilities would be considered against the amounts listed in the table below to help determine the liquidity and reserves scoring component for a bond rating. Total Days' Extremely Strong =>270 =>$250 Very Strong 150-270 $100-$250 Strong 90-150 $50-$100 Adequate 45-90 $10-$50 Vulnerable 15-45 $2-$10 Highly Vulnerable <=15 <=$2 Moody's Moody's issued a credit opinion on December 16, 2024 for the City of Palo Alto, the water system, and water and gas as a combined utility. The City's rating of 'Aaa' was determined to be stable, the water system's rating of 'Aa1' was determined to be stable, and the water and gas combined utility's rating of 'Aa2' was determined to stable. The criteria Moody's utilizes for their ratings from the credit opinion is their rating methodology over US Municipal Utility Revenue Debt. For Moody's US Municipal Utility Revenue Debt, Financial Strength has a 40% weighting when it comes to a rating. Of the 40% weighting, Annual Debt Service Coverage is 15%, Days Cash on Hand is 15%, and Debt to Operating Revenues is 10%. Below is a table that lists the Financial Strengths Moody's criteria for US Municipal Utility Revenue Debt. S&P Criteria | Governments | U.S. Public Finance: U.S. Municipal Retail Electric And Gas Utilities: Methodology And Assumptions, Moody's Rating Methodology: US Municipal Utility Revenue Debt DETAILED ANALYSIS Annual Debt Service Coverage Days Cash on Hand Debt to Operating Revenues Aaa >2.00x >250 days <2.00x Aa A Baa 35 > n > 15 7.00x < n < 8.00x Ba 15 > n > 7 8.00x < n < 9.00x B and Below <0.70x <7 days >9.00x Compliance With Regulatory Reserve Margin Requirements Observations Observation #1 Current reserve policies do not specifically address the Rate Covenants or Available Reserve Covenants listed above as Outstanding Bond Requirements. These covenants were made by the City in the official statements and legal documents for the outstanding 2009 and 2011 bonds. The City could consider referencing these documents in its reserve policies. • It is important to note that aaccording to the latest Ratings Affirmation from S&P on the outstanding 2011 and 2009 bonds, Palo Alto is in compliance with the Rate and Available Reserves Covenants Observation #2 Current reserve policies do not specifically address relevant credit rating reserve targets. By formulating reserve policies that specify guideline levels for reserve funds with these credit rating reserve targets in mind, the City can better position itself to maintain its strong bond ratings. Moody's Rating Methodology: US Municipal Utility Revenue Debt DETAILED ANALYSIS Operational/Industry Best Practices Government Finance Officers Association (GFOA) Operating Reserves GFOA recommends, at a minimum, regardless of a governments size, to maintain operating reserves at no less than two months of regular operating revenues or regular operating expenditures. The choice of revenues or expenditures as a basis of comparison may be dictated by what is more predictable for the government's particular circumstances. GFOA also states that a government's particular situation often may require a level of operating reserves to be significantly in excess of the recommended minimum level of no less than two months of regular operating revenues or regular operating expenditures. An example of a particular situation could be a government that knows it is exposed to certain economical or climate risks with complex potential effects of them in the future. GFOA also recommends that if the reserve balance falls below the government's policy level, there should be a solid plan to replenish it, and governments should seek to replenish the reserve balance within one to three years. Capital Improvement Program Reserves GFOA states that Capital Improvement Program Reserves may be used to proactively manage capital assets, for instance by annually setting aside 20% of a five-year asset's replacement costs so that funding is available when replacement is necessary. Furthermore, the GFOA provides two examples of annual funding allocations/levels for a Capital Improvement Program Reserves, which are listed below. • Maintain an ending balance equal to a dollar amount or a percentage of the five-year average of the entity's annual capital budget. (The actual dollar amount or percentage should be set based on the particular entity's capital needs and financial capabilities.) • Baker Tilly considers maintaining 20%, which is the equivalent of one- year of average capital improvements, of the total capital anticipated to be funded with cash on hand in the five-year capital budget in CIP reserves as a best practice. GFOA Fund Balance Guidelines for the General Fund, GFOA Strategies for Establishing Capital Asset Renewal and Replacement Reserve Policies DETAILED ANALYSIS • Annually contribute an amount based on a percentage of the annual depreciation of the entity's assets. Funding sources will vary and may includes transfers from the Operations Fund or one-time revenues. An entity may wish to consider initial funding levels for the first one to five years with a plan for increasing funding thereafter until the target funding level is achieved. In addition, organizations should consider the pros and cons of the level of reliance on one-time versus recurring revenues based upon the financial conditions of the jurisdiction and the goals of the reserve. Additional Industry Best Practices Capital Improvement Program Reserves An additional best practice for the Capital Improvement Program Reserves it to have at least one year worth of depreciation expense in a fund for capital improvements. Note that a reserve target for a CIP fund would typically be based on either a percentage of average annual capital spending based on a CIP plan or based on depreciation expense amounts. Operational/Industry Best Practices Observations Observation #1 The City of Palo Alto's current reserve policies for its operations reserve funds are in alignment with the GFOA's recommendations for operating reserves. However, the Wastewater Treatment Utility, Refuse Utility, and Stormwater Utility do not currently have operations reserve funds. Observation #2 The City of Palo Alto's current reserve policy for its CIP reserve funds outlines a maximum reserve guideline level that aligns with Baker Tilly’s recommendation for a target ending balance for a CIP reserve fund (approximately one-year of average capital improvement spending held in reserve). Current reserve policy outlines a minimum reserve guideline level that is 20% of this amount. While Baker Tilly considers one-year of average capital improvements a best practice CIP reserve level, GFOA recommends that capital reserve level development should be designed to best serve the particular needs of a given organization. As such, an amount less than our recommendation could be considered. Alternatively, another approach to determining a CIP reserve fund guideline level could be to maintain one-year or a percentage of one-year of depreciation expense in reserve balances. DETAILED ANALYSIS Local Economy Specific Reserves Through Benchmarking Comparables The purpose of this section is to provide an overview of the local economy specific reserves by benchmarking the reserve funds and reserve policies of communities comparable to the City of Palo Alto ("benchmark communities"). The benchmark communities that we researched are City of Roseville, City of Santa Clara, City of Healdsburg, City of Pasadena, and San Jose Clean Energy. Within this section, we list the reserve funds and the guideline cash reserve levels for the reserve funds from the benchmark communities and compare them to the City of Palo Alto's Utility reserve funds and reserve policies guidelines. This information is broken down into two sections; Reserve Funds Palo Alto Utilities Have and Reserve Funds Palo Alto Utilities Do Not Have. The chart below indicates for each comparable community what reserve funds they have (indicated by “Yes”) and do not have (indicated by “No”) for each of their utilities. Benchmarking Comparables City of Roseville City of Santa Clara City of Healdsburg City of Pasadena Jose Clean Electric Water Electric Water Electric Water Electric Electric Rate Stabilization Yes Yes Yes No Yes No No Yes Yes No Yes Operations No Yes Yes Yes Yes No Yes Yes Yes Yes Yes Capital Replacement & Improvement No No No No No Yes Yes Yes Yes Yes No No Yes Yes No No No No No No No No Yes No No No No No No No No Yes No Reserve Funds Palo Alto Utilities Do Not Have: Debt Service Yes No No No No No No No No No No Yes No No No No No No No No No No Fixed Cost Coverage Yes No No No No No No No No No No No No No No No No No No No Yes No No No No No No No No No No Yes No No No No No No No No No No Yes No Contingency Reserve No No No No No No No No No Yes No DETAILED ANALYSIS Reserve Funds Palo Alto Utilities Have Rate Stabilization As noted in the overview of current reserve funds and reserve policies section, the City of Palo Alto has a rate stabilization reserve fund for each of its utilities. The current City reserve policies outline the guideline levels for rate stabilization reserves as follows: Table 1 - Palo Alto Rate Stabilization Fund Minimum 15% 10% N/A Target 22.5% 15% $500,000 Maximum 30% 20% N/A (1) % of sales revenue. Levels found in City Council CMR:263:3 from May 6, 1993 (2) Target Level found in City Council CMR:320:0 from May 24, 1990 Rate Stabilization Reserves for Electric, Gas, Wastewater Collection and Water do not have set Minimum, Target and Maximum Levels. Similar to Palo Alto, many of the benchmark communities researched had rate stabilization reserve funds for their utilities. The guideline levels of reserves outlined in the benchmark communities reserve policies for the rate stabilization reserve funds were as follows: City of Roseville Electric Table 2 - Roseville Electric Rate Stabilization Fund Minimum 40% of operating expenses Target 65% of operating expenses Maximum 90% of operating expenses City of Roseville Water and Wastewater Table 3 - Roseville Water and Wastewater Rate Stabilization Fund City of Roseville Financial Policies (Pages 106-108 and 118-120) 50% of operating expenses or roughly 180 Days' Cash Target DETAILED ANALYSIS City of Santa Clara Electric Based upon research, it is determined that the City of Santa Clara Electric Utility has an Electric Rate Stabilization Reserve Fund with a balance as of May 31, 2025 of $70,000,000; however, we were unable to track down guideline levels for their Electric Rate Stabilization Reserve Fund. When calculating $70,000,000 divided by the City of Santa Clara's Electric Utility Fiscal Year 2024-2025 adopted budget for Electric Utility Operating Expenses of $649,513,582, the reserve balance comes out to approximately 10.78% of budgeted Electric Utility Operating Expenses. City of Healdsburg Water and Wastewater Table 4 - Healdsburg Water and Wastewater Rate Stabilization Fund San Jose Clean Energy Table 5 - San Jose Clean Energy Rate Stabilization Fund Comparison to City of Palo Alto Electric Table 6 - Electric Rate Stabilization Fund Guideline Reserve Levels Comparison Palo Alto City of Electric Santa San Jose Clean Energy Minimum N/A N/A N/A Target N/A 65% of expenses operating non-operating revenues Maximum N/A N/A N/A There are no set Minimum, Target and Maximum Levels for City of Palo Alto Electric. City of Santa Clara Financial Status Report as of May 31, 2025 (Pages 23-24), City of Healdsburg Ordinance No. 1240, San Jose Clean Energy Financial Reserves Policy Guideline Level Guideline Level DETAILED ANALYSIS Comparison to City of Palo Alto Water Table 7 - Water Rate Stabilization Fund Guideline Reserve Levels Comparison Guideline Levels City of Palo Alto Water City of Roseville Water Minimum N/A N/A N/A Target N/A 50% of operating expenses or roughly 180 Days' Cash $1,000,000 There are no set Minimum, Target and Maximum Levels for City of Palo Alto Water. Comparison to City of Palo Alto Wastewater Table 8 - Wastewater Rate Stabilization Fund Guideline Reserve Levels Comparison Palo Alto Wastewater Collection Palo Alto Wastewater Treatment (1) City of Roseville Wastewater City of Healdsburg Wastewater Minimum N/A 15% N/A N/A Target N/A 22.5% 50% of operating expenses or roughly 180 Days' Cash There are no set Minimum, Target and Maximum Levels for City of Palo Alto Wastewater Collection. Also, it should be noted that the Gas, Refuse and Stormwater Systems for the City of Palo Alto all had rate stabilization reserve funds as well, but as none of the benchmark communities had rate stabilization reserve funds for these utilities, no charts are shown for them. Rate Stabilization Observations Observation #1 The City of Palo Alto Electric Utility does not have a set minimum, target, or maximum guideline level. For the benchmark communities, the City of Roseville Electric has a minimum, target, or maximum guideline level found in Table 2, our calculation for City of Santa Clara Electric of 10.78% of operating expenses is assumed to be the target guideline level, and San Jose Clean Energy only has a target guideline level found in Table 5. Table 6 shows these benchmark communities reserve guideline levels compared to the City of Palo Alto's Electric Utility. DETAILED ANALYSIS Observation #2 The City of Palo Alto Water Utility does not have a set minimum, target, or maximum guideline level, while the City of Roseville Water and City of Healdsburg Water both have target guideline levels found in Table 3 and Table 4. Table 7 shows these benchmark communities reserve guideline levels compared to the City of Palo Alto's Water Utility. Observation #3 The City of Palo Alto Wastewater Collection Utility does not have a set minimum, target, or maximum guideline level, while the City of Palo Alto Wastewater Treatment Utility does as shown in Table 1. The City of Roseville Wastewater and City of Healdsburg Wastewater both have target guideline levels found in Table 3 and Table 4. Table 8 shows these benchmark communities reserve guideline levels compared to the City of Palo Alto's Wastewater Collection Utility. Operations and Maintenance As noted in the overview of current reserve funds and reserve policies section, the City of Palo Alto has an operations reserve fund for its Electric Utility, Gas Utility, Wastewater Collection Utility, and Water Utility. The current City reserve policies outline the guideline levels for operations reserves are found in the below table. Table 9 - Palo Alto Operations and Maintenance Fund Supply (1) Distribution (2) Gas (3) Collection (4) Water Minimum 60 60 60 60 60 Target 90 90 90 105 90 Maximum 120 120 120 150 120 (1) Days of Electric Supply Fund O&M and Commodity Expense (2) Days of Electric Distribution Fund O&M Expense (3) Days of Gas O&M and Commodity Expense (4) Days of Wastewater Collection O&M and Commodity Expense (5) Days of Water O&M and Commodity Expense City of Roseville Water Table 10 - Roseville Water Operations and Maintenance Fund City of Roseville Financial Policies (Pages 118-120) Minimum 90 days' cash worth of operating expenses. DETAILED ANALYSIS City of Roseville Wastewater Table 11 - Roseville Wastewater Operations and Maintenance Fund City of Roseville Solid Waste Table12 - Roseville Solid Waste Operations and Maintenance Fund City of Santa Clara Electric Based upon research, it is determined that the City of Santa Clara Electric Utility has an Operations and Maintenance Reserve Fund with a balance as of May 31, 2025 of $257,000,000; however, we were unable to track down guideline levels for their Electric Operations and Maintenance Reserve Fund. When calculating $257,000,000 divided by the City of Santa Clara's Electric Utility Fiscal Year 2024-2025 adopted budget for Electric Utility Operating Expenses of $649,513,582, the reserve balance comes out to approximately 39.57% of budgeted Electric Utility Operating Expenses, or 145 days of operating expenses. City of Healdsburg Electric Table 13 - Healdsburg Electric Operations and Maintenance Fund City of Healdsburg Water Table 14 - Healdsburg Water Operations and Maintenance Fund City of Healdsburg Wastewater Table 15 - Healdsburg Wastewater Operations and Maintenance Fund City of Roseville Financial Policies (Pages 118-120), City of Santa Clara Financial Status Report as of May 31, 2025 (Pages 23-24), City of Healdsburg Ordinance No. 1240, City of Healdsburg Biennial Budget (Page 70) Minimum 90 days' cash worth of operating expenses. Minimum 90 days' cash worth of operating expenses. 183 days of operating expenses Minimum 92 days of operating expenses Minimu 92 days of operating expenses Minimum DETAILED ANALYSIS City of Pasadena Electric Table 16 - Pasadena Electric Operations and Maintenance Fund Minimum 60 days of operating expenses Target 90 days of operating expenses San Jose Clean Energy Table 17 - San Jose Clean Energy Operations and Maintenance Fund Comparison to City of Palo Alto Water Table 18 - Water Operations and Maintenance Fund Guideline Reserve Levels Comparison Minimum 60 days of operating expenses. of operating expenses. City of Pasadena Code of Ordinances 13.04.175, San Jose Clean Energy Financial Reserves Policy 180 days liquidity on hand Minimum DETAILED ANALYSIS Comparison to City of Palo Alto Wastewater Collection Table 19 - Wastewater Operations and Maintenance Fund Guideline Reserve Levels Comparison Wastewater Collection Wastewater Wastewater Minimum 60 days of operating expenses. of operating expenses. Comparison to City of Palo Alto Electric Table 20 - Electric Operations and Maintenance Fund Guideline Reserve Levels Comparison Guideline Levels City of Palo Alto Electric Supply (1) City of Palo Alto Electric Distribution (2) City of Santa Clara Electric City of Healdsburg Electric City of Pasadena Electric San Jose Clean Energy Minimum 60 days of operating expenses 60 days of operating expenses. N/A 183 days of operating expenses 60 days of operating expenses days liquidity on Target operating operating operating N/A operating N/A Maximum 120 days of operating expenses 120 days of operating expenses N/A N/A N/A N/A (1) Defined in the reserve policy as Electric Supply Fund O&M and Commodity Expense (2) Defined in the reserve policy as Electric Distribution Fund O&M Expense Also, it should be noted that the Gas System for the City of Palo Alto had operations and maintenance reserve fund as well, but as none of the benchmark communities had operations and maintenance reserve funds for Gas, no charts are shown for it. DETAILED ANALYSIS Operations and Maintenance Observations Observation #1 As shown in Tables 18 and 19, the City of Palo Alto Water Utility and Wastewater Collection Utility both have a set minimum, target, and maximum guideline levels, while the City of Roseville and City of Healdsburg Water and Wastewater Utilities only have minimum guideline levels. While the City of Palo Alto's minimum guideline levels for both utilities are lower than the City of Roseville or the City of Healdsburg Water and Wastewater Utilities, Palo Alto's maximum guideline levels are higher than the minimum guideline levels for the City of Roseville and City of Healdsburg Water and Wastewater Utilities. Observation #2 As shown in Table 20, the City of Palo Alto Electric Utility has set minimum, target, and maximum guideline levels for Electric Supply and Electric Distribution, while City of Healdsburg Electric and San Jose Clean Energy only have a minimum guideline level, City of Pasadena Electric has both a minimum and target guideline levels, and while the City of Santa Clara Electric does not have specified guideline levels, we have listed their current balance expressed as days operating expenses as their target guideline level. Based on these guideline levels of reserves, the City of Palo Alto Electric Utility minimum and target guideline levels are the same as the City of Pasadena Electric, but the minimum and target guideline levels are lower than any minimum or target guideline levels for City of Santa Clara Electric, City of Healdsburg Electric, and San Jose Clean Energy. The City of Palo Alto Electric Utility maximum guideline level is lower than City of Healdsburg Electric and San Jose Clean Energy minimum guideline levels, and the Santa Clara Electric target guideline level. See Table 20. Capital Replacement & Improvement As noted in the overview of current reserve funds and reserve policies section, the City of Palo Alto has a CIP reserve fund for its Electric Utility, Gas Utility, Wastewater Collection Utility, and Water Utility. The current City reserve policies outline the guideline levels for CIP reserves as follows: Table 21 - Palo Alto Capital Replacement & Improvement Fund Minimum 20% of the maximum CIP Reserve guideline level Maximum Average annual (12 month) CIP budget, for 48 months of budgeted CIP expenses City of Santa Clara Water Based upon research, it is determined that the City of Santa Clara Water has a Capital Replacement & Improvement Reserve Fund with a balance as of May 31, 2025 of $303,090; however, we were unable to track down guideline levels for their Water Capital Replacement & Improvement Reserve Fund. DETAILED ANALYSIS City of Healdsburg Electric Table 22 - Healdsburg Electric Capital Replacement & Improvement Fund City of Healdsburg Water Table 23 - Healdsburg Water Capital Replacement & Improvement Fund City of Healdsburg Wastewater Table 24 - Healdsburg Wastewater Capital Replacement & Improvement Fund City of Pasadena Electric Table 25 - Pasadena Electric Capital Replacement & Improvement Fund Comparison to City of Palo Alto Electric Table 26 - Electric Capital Replacement & Improvement Fund Guideline Reserve Levels Comparison Palo Alto Healdsburg Pasadena Minimum 20% of the maximum CIP Reserve guideline level N/A N/A Target N/A $4,000,000 capital expenditures budget, for 48 months of City of Santa Clara Financial Status Report as of May 31, 2025 (Pages 23-24), City of Healdsburg Ordinance No. 1240, City of Healdsburg Biennial Budget (Pages 66 and 69-70) One year of budgeted capital expenditures Target $1,000,000 Target $1,000,000 Target $4,000,000 Target DETAILED ANALYSIS Comparison to City of Palo Alto Water Table 27 - Water Capital Replacement & Improvement Fund Guideline Reserve Levels Comparison Palo Alto Healdsburg Minimum 20% of the maximum CIP Reserve guideline level N/A Target N/A $1,000,000 Maximum Average annual (12 month) CIP budget, for 48 months of budgeted CIP expenses N/A Table 28 - Wastewater Capital Replacement & Improvement Fund Guideline Reserve Levels Comparison Palo Alto Healdsburg Minimum 20% of the maximum CIP Reserve guideline level N/A Target N/A $1,000,000 Maximum Average annual (12 month) CIP budget, for 48 months of budgeted CIP expenses N/A Also, it should be noted that the Gas System for the City of Palo Alto had capital replacement & improvement reserve fund as well, but as none of the benchmark communities had capital replacement & improvement reserve funds for Gas, no charts are shown for it. Capital Replacement & Improvement Observations Observation #1 The City of Palo Alto Electric, Water, and Wastewater Collection Utilities have set minimum and maximum guideline levels for the capital replacement & improvement reserve funds, while all other benchmark communities that had utilities with capital replacement & improvement reserve funds only had target guideline levels. See Tables 26 - 28 for the comparisons between Palo Alto and the benchmark communities for each of these Utilities. System Critical Failure As noted in the overview of current reserve funds and reserve policies section, the City of Palo Alto has an Emergency Plant Replacement reserve fund for its Wastewater Treatment Utility. The current City reserve policies outline the guideline levels for Emergency Plant Replacement reserves as follows: Table 29 - Palo Alto Wastewater Treatment System Critical Failure Fund Minimum 5% of annual increase in the net book value of fixed assets Maximum 5% of total net book value of fixed assets (1) Levels are found in City Council CMR:320:0 DETAILED ANALYSIS City of Roseville Water Table 30 - Roseville Water System Critical Failure Fund City of Roseville Wastewater Table 31 - Roseville Wastewater System Critical Failure Fund System Critical Failure Observations Observation #1 The City of Palo Alto Wastewater Treatment Utility has set minimum and maximum guideline levels for the emergency plant replacement reserve, while the City of Roseville Water and Wastewater Utilities only had minimum guideline levels. See Table 29, Table 30, Table 31. Debt Service Reserve City of Roseville Electric Table 35 - Roseville Electric Debt Service Reserve Fund City of Pasadena Electric Table 36 - Pasadena Electric Debt Service Reserve Fund Reserve Funds Palo Alto Utilities Do Not Have Debt Service Coverage City of Roseville Electric Table 32 - Roseville Electric Debt Service Coverage Ratio City of Roseville Financial Policies (Page 118-120), City of Pasadena Code of Ordinances 13.04.175 Minimum 1% - 2% of the Capital Assets belonging to the Water Utility Minimum 1% - 2% of the Capital Assets belonging to the Wastewater Utility Minimum 2.0x annual debt service payments Minimum Maintain a fully funded debt service reserve as required by bond covenants. Minimum Maintain a reserve equivalent to one year of debt service payments for outstanding bond or credit obligations. DETAILED ANALYSIS Days Cash on Hand City of Roseville Electric Table 33 - Roseville Electric Days Cash on Hand Fund City of Roseville Electric Table 34 - Roseville Electric Fixed Cost Coverage General Fund Transfer City of Pasadena Electric Table 37 - Pasadena Electric General Fund Transfer Energy Services Charge City of Pasadena Electric Table 38 - Pasadena Electric Energy Services Charge Minimum 60 days of projected power supply costs Target 90 days of projected power supply costs Transmission Services Charge City of Pasadena Electric Table 39 - Pasadena Electric Transmission Services Charge Minimum 60 days of transmission services cost Target 90 days of transmission services cost City of Roseville Financial Policies (Page 106-108), City of Pasadena Code of Ordinances 13.04.175 Minimum 1.5x of annual fixed costs Guideline Level One year of the budgeted General Fund Transfer Target Guideline Level Minimum >250 days Guideline Level DETAILED ANALYSIS Contingency Reserve City of Pasadena Electric Table 40 - Pasadena Electric Contingency Reserve Fund Minimum Sum of 60 days of operating expenses and 60 days of capital expenditures Target Sum of 90 days of operating expenses and 90 days of capital expenditures Local Economy Specific Reserves Through Benchmarking Comparables Observations Observation #1 The Benchmark Communities typically have some or all of the three commonly established reserve funds that Palo Alto Utilities with updated reserve policies have, which are the rate stabilization reserve, the operations and maintenance reserve, and the CIP reserve. Observation #2 Based upon the research of the City of Roseville, City of Santa Clara, City of Healdsburg, City of Pasadena, and San Jose Clean Energy Reserve Policies, it is determined that the City of Palo Alto's Reserve Policies are more cumbersome than the comparables identified. The City of Palo Alto Utilities Operations and Maintenance Reserve Funds include a minimum, target and maximum guideline level while the other benchmark communities only include a minimum and/or a target. The City of Palo Alto Utilities Capital Replacement and Improvement Reserve Funds also include a minimum, target, and maximum, while the other benchmark communities only include a target. Overall, the City of Palo Alto Utilities have not only more funds established to hold cash reserves, but their policies are more detailed in terms of guideline levels and sources and uses of those reserve funds compared to the other benchmark communities reserve policies. Observation #3 While there are reserve funds that benchmark communities have in place that Palo Alto Utilities does not have in place, none of these reserve funds are vital or in line with industry best practices. In many cases, these reserve funds serve the same or a similar purpose as other reserve funds the benchmark communities and Palo Alto Utilities have in place. For example, the City of Roseville Electric days cash on hand reserve and fixed cost coverage reserve, and the City of Pasadena electric energy services charge and transmission services charge reserve funds serve a similar purpose to the operation and maintenance fund reserve for these Utilities. The City of Pasadena Contingency Reserve serves the same purpose as both the operation and maintenance reserve fund and the capital replacement and improvement reserve fund. City of Pasadena Code of Ordinances 13.04.175 DETAILED ANALYSIS Reserve Tracking Reserve Tracking Requirements and Processes Current Requirements for Tracking Palo Alto's Reserves The Reserve Management Practices (policies) all state that they should be used when developing each individual Utility's Financial Plan. Guideline levels included in the reserve policies that are not a fixed dollar amount are calculated for each fiscal year of the financial planning period for each individual Utility's Financial Plan. Current Processes Being Performed for Tracking Palo Alto's Reserves Reserve targets are recalibrated annually to calculate the dollar amount planned to be held in reserve. The dollar amount for each reserve target calculated annually does not always represent the target outlined in the policy statement when the policy statement guideline levels are not fixed (for example, a guideline level based on number of days may not have a reserve target in a Financial Plan that matches this metric). During the update of a Utility's Financial Plan, reserve policies are reviewed to determine if they need to be updated. Reserve Tracking Observations Observation #1 Reserve tracking appears to be done on an annual basis in conjunction with the development of each individual Utility's Financial Plan for Palo Alto. A reserve tracking policy with guidance included to report instances when reserve fund balances do not meet guideline levels to Council would provide more assurance that reserve targets are being met throughout the year and equip the Council with better information to make financial decisions than the current process being performed for reserve tracking. ATTACHMENT B TO: Baker Tilly FROM: City of Palo Alto (Office of the City Manager, Administrative Services, Utilities & Public Works Departments) DATE: April 2, 2026 SUBJECT: Utilities Reserve Advisory Report UTILITIES RESERVE ADVISORY REPORT Management Response Staff is appreciative of the work Baker Tilly has done to provide the City of Palo Alto Utility Reserves Advisory Report (Reserves Advisory Report) that reviews the reserve policies and peer agency benchmarks in the various enterprise funds in the Utilities and Public Works Departments. The City Council directed staff to do a review of reserve policies as part of the FY 2026 Budget Adoption. This advisory report provides impartial analysis of best practices and recommendations based on Baker Tilly analysis and research. While the City supports the intent to improve utility reserve levels, streamline reserve management and improve reserve reporting to the City Council, City staff recommends exploring approaches that align with existing structures and resources and that can be implemented with gradual impacts to utility rates that are paid for by residents and businesses in Palo Alto. Any financial decision must be right sized for the risk profile, impact to customers, and regulatory requirements. After a general review of the recommendations to assess order of magnitude of financial impacts, staff estimate individual utility rate increases could range from increases of approximately 2% to 8% at the low range and between 20 – 26% at the high range of the recommendations (this assumes implementation over a five‐year period). These increases would be significantly impactful to Palo Alto’s residents and businesses. The primary drivers of these increases would be to achieve the reserve levels of peers described in the Reserves Advisory Report as 10‐65% of Operating Revenue in the Rate Stabilization Reserves and 20% of 60 months of budgeted CIP. As such, following the Policy and Services Committee review of this Reserves Advisory Report on April 14, 2026 and City Council review to follow, staff recommend a workplan over the coming year to review and revise reserve policies for City Council consideration with the assistance of the Utility Advisory Commission and the Finance Committee that balance need to be attractive to private markets with having rates that are affordable to residents and competitive for businesses while remaining within the range of recommendations from Baker Tilly in terms of industry standards and peer comparisons. Staff expect in advance of the FY 2028 rate setting, to prepare discussion and ultimately recommendations on policy‐related issues including setting the target levels for utility reserves. Staff will strive for a coordinated approach across Electric, Gas, Water, Wastewater Collection, Wastewater Treatment, Refuse, and Stormwater Utilities. Staff review will inform the strategic direction and timing of any changes. ATTACHMENT B Staff have provided more detailed responses to the specific recommendations below as well as a summary comparison table of existing reserve policies and recommendations from Baker Tilly in Table 1. Baker Tilly Recommendations and Responses from City Staff 1. Update Dated Policies ‐ Target Date: CY 2026 for Wastewater Treatment, CY Q2 2027 for Refuse and Stormwater Management City staff agrees and plans to align reserve policies across Utilities and Public Works enterprise funds as appropriate. Public Works is currently working with an outside consultant to update the Wastewater Treatment Fund’s reserves policy. As part of this effort, the consultant will review Baker Tilly’s recommendations from the Reserves Advisory Report and incorporate them, as appropriate, into the overall comprehensive approach. The Wastewater Treatment Fund is an example of a more specific business operation as it is reflective of a regional operation with other local government partner agencies that are all contributors and members of the services and funds. 2. Do not eliminate any of the current reserve funds in place City staff agrees that having operations, rate stabilization and CIP Reserve funds in place makes sense and that each of the other Utilities reserve funds are in place for specifically defined and valid purposes. 3. Clarify CIP Reserve Fund Language ‐ Target Date: CY Q2 2027 Council renamed the Calaveras Reserve to the Electric Special Projects (ESP) Reserve in 2011 (Resolution 9206) to fund projects that benefit electric ratepayers. In 2015 (Resolution 9510), Council established guidelines for managing the ESP Reserve and those guidelines were revised by Council in 2022 (Resolution 10076) . City staff agrees an update of the council‐adopted policy on the use of ESP Reserve funds is appropriate. Previously, the ESP reserve has been used to fund Electric’s share of the Advanced Metering Infrastructure (~$10M) and provide seed funding to the Electrification Reserve (~$4.5M). Future uses of the funds as well as the sunset date and full review of ESP Reserve guidelines should be considered by Council. The City’s reserve management policies cover how the CIP Reserve is used. 4. Consider adjustment to CIP Reserve Fund Guideline Levels – Target Date: CY Q2 2027 City staff acknowledge the CIP Reserve guideline recommendations made by Baker Tilly to maintain the CIP Reserve fund at 20% of 60 months of budgeted CIP expenses or alternatively, one‐year of depreciation expense in the CIP reserve fund and the research used to identify like agencies and best practices. As noted previously, staff has preliminarily evaluated the rate implications of this recommendation for the Electric, Gas, Water and Wastewater Funds – assuming the funds are recovered over five years, a 0% to 4% rate increase specific to each fund is estimated to be needed to bring reserves to this level. Public Works will consider this recommendation as it brings forward the comprehensive reserve policy recommendations for Wastewater Treatment, Refuse, and Storm Water Funds. As part of City staff’s recommendations that it will bring forward, the rate and bill impacts across each utility need to be considered to find alignment with Baker Tilly’s recommendation while considering customer affordability. This approach aligns with the GFOA recommendation mentioned by Baker Tilly that recommends capital reserve level development should be designed to best serve the particular needs of a given organization. In evaluating appropriate rate stabilization reserve levels, staff plans to ATTACHMENT B assess each utility holistically, taking into account the full suite of available reserves and overall financial position and compliance with bond covenants, preservation of credit ratings, and affordability. 5. Adjust Rate Stabilization Reserve Policy to align with Bond Covenants –Target Date: CY Q2 2027 – CY Q2 2028 As noted in the Reserves Advisory Report, staff plans to refund the 2009 Bonds later in 2026 and a normal payoff of the 2011 Bonds is expected in June 2026 which would eliminate the need to make a change to these minimum guideline levels due to this Bond Covenant as reserve policies will align with bond or loan covenants as applicable. According to the latest Ratings Affirmation from S&P on the outstanding 2009 and 2011 bonds, Palo Alto is in compliance with the Rate and Available Reserves Covenants. City staff agrees with the recommendation to weigh the need for additional Rate Stabilization Reserve fund levels, comparability to peer agencies, and the impacts to customer rates among other considerations in order to determine an appropriate level of funding for each reserve fund. Staff will work through these considerations depending on the individual circumstances for each reserve, staff will consider the options available in the context of the totality of reserves for each fund. 6. Formalize Reserve Tracking – Target Date: CY Q4 2026 City Staff agrees transparency of reserve fund balances, reserve policies and guideline levels, and use of reserves is important. Staff already provide this information about the reserve balances in the annual budget, Annual Comprehensive Financial Report, and utility financial plans each year. Staff plans to continue its current practices of providing this information to the City Council. Staff recommends exception‐based reporting added to the existing quarterly financial report to Council to supplement current transparency reporting. The Reserves Advisory Report mentions the following observations regarding further specificity of the flow of funds and reserve targets in the reserve policies and credit rating reserve targets. While staff agree specificity is helpful, policies are intended to be evergreen so staff will review and include this feedback in the recommended policy updates as appropriate. Staff agree that exploring the use of a target or guideline levels could reduce administrative burden. ATTACHMENT B Table 1: Palo Alto Current and Baker Tilly Proposed Reserve Targets and Guidelines for the Operations, CIP, and Rate Stabilization Reserves OPERATIONS RESERVE CIP RESERVE RATE STABILIZATION RESERVE Current Palo Alto Target Proposed Baker Tilly Target Current Palo Alto Guidelines Proposed Baker Tilly Guidelines Current Palo Alto Guidelines Proposed Baker Tilly Guidelines Electric U lity 90 days of O&M and Commodity Expense No Change Minimum: 5% of 48 months of budgeted CIP Maximum: 25% of 48 months (12 months) of budgeted CIP 20% of 60 months (12 months) of budgeted CIP Each year, the Financial forecast must plan for the withdrawal of all Rate Stabiliza on Reserve funds within 5 years. 10 to 65% of either revenues or expenses Gas U lity 90 days of O&M and Commodity Expense No Change Minimum: 5% of 48 months of budgeted CIP Maximum: 25% of 48 months of budgeted CIP 20% of 60 months of budgeted CIP Each year, the Financial forecast must plan for the withdrawal of all Rate Stabiliza on Reserve funds within 5 years. 10 to 65% of either revenues or expenses Water U lity 90 days of O&M and Commodity Expense No Change Minimum: 5% of 48 months of budgeted CIP Maximum: 25% of 48 months of budgeted CIP 20% of 60 months of budgeted CIP Each year, the Financial forecast must plan for the withdrawal of all Rate Stabiliza on Reserve funds within 5 years. 10 to 65% of either revenues or expenses Wastewater U lity 105 days of O&M and Commodity Expense No Change Minimum: 5% of 48 months of budgeted CIP Maximum: 25% of 48 months of budgeted CIP 20% of 60 months of budgeted CIP Each year, the Financial forecast must plan for the withdrawal of all Rate Stabiliza on Reserve funds within 5 years. 10 to 65% of either revenues or expenses Wastewater Treatment No Opera ons Reserve Baker Tilly views maintaining Opera ons Reserve as a best prac ce. No CIP Reserve Baker Tilly views maintaining CIP Reserve as a best prac ce. Minimum: 15%, Target 22.5%, Maximum 30% % of sales revenue Baker Tilly proposes management should consider the need for the exis ng reserve funds. If no longer necessary, these funds should be closed out and the money transferred to other funds in place. Refuse No Opera ons Reserve Baker Tilly views maintaining Opera ons Reserve as a best prac ce. No CIP Reserve Baker Tilly views maintaining CIP Reserve as a best prac ce. Minimum: 10%, Target 15%, Maximum 20% % of sales revenue Baker Tilly proposes management should consider the need for the exis ng reserve funds. If no longer necessary, these funds should be closed out and the money transferred to other funds in place. Stormwater No Opera ons Reserve Baker Tilly views maintaining Opera ons Reserve as a best prac ce. No CIP Reserve Baker Tilly views maintaining CIP Reserve as a best prac ce. Target: $500,000 Baker Tilly proposes management should consider the need for the exis ng reserve funds. If no longer necessary, these funds should be closed out and the money transferred to other funds in place. Baker Tilly Advisory Group, LP and Baker Tilly US, LLP, trading as Baker Tilly, are members of the global network of Baker Tilly International Ltd., the members of which are separate and independent legal entities. Baker Tilly US, LLP is a licensed CPA firm that provides assurance services to its clients. Baker Tilly Advisory Group, LP and its subsidiary entities provide tax and consulting services to their clients and are not licensed CPA firms. City of Palo AltoOffice of the City Auditor (OCA) Policy & Services Committee Meeting City of Palo Alto Utility Reserves Advisory Report, March 27, 2026 Presenter: Ross Hagen, Director for Municipal Advisory, Baker Tilly April 14, 2026 2 Advisory Project Objective •To assess City of Palo Alto Utilities reserve policies and benchmark them against peer agencies. 3 Background Reserve Funds in Place Electric Gas Wastewater Collection Water Wastewater Treatment Refuse Stormwater Operations Yes Yes Yes Yes No No No Rate Stabilization Yes Yes Yes Yes Yes Yes Yes CIP Reserves Yes Yes Yes Yes No No No Electric Special Projects Yes No No No No No No Underground Loan Yes No No No No No No Hydroelectric Stabilization Yes No No No No No No Electrification Yes No No No No No No Public Benefits Yes No No No No No No Low Carbon Fuel Standard Yes No No No No No No Cap & Trade Program Yes Yes No No No No No Emergency Plant Replacement No No No No Yes No No Landfill Corrective Action No No No No No Yes No Geng Road No No No No No Yes No Notes & Loans No No No No Yes No No 4 Overview of Current Reserves Observations •Current reserve policies contain multiple transfer rules resulting in significant administrative activities •Wastewater Treatment, Refuse and Stormwater Utility reserve fund policies have not been updated in more than 20 years and may not align with other reserve policies •Electric Special Projects Reserve and CIP Reserves appear to have similar purposes and policies lack clarity on appropriate use 5 Consistency with Regulatory Reserve Margin Requirements Observations •Current reserve policies do not appropriately address Rate Covenants or Available Reserve Covenants made by the City, however, the City is in compliance with these covenants based on Ratings Affirmation •Current reserve policies do not include overall cash reserve targets. Cash reserves are an important factor in maintaining credit ratings •Outstanding 2009 and 2011 Bonds contain an overly burdensome reserve requirement covenant inconsistent with market standards which should be avoided with future bond issuances 6 Operational and Industry Best Practices Observations •Wastewater Treatment, Refuse and Stormwater Utilities do not have operations reserve funds. •Current CIP reserve funds set a maximum guideline of one-year average improvements. Baker Tilly typically sees one-year averages as a target guideline for CIP improvements. •Current CIP reserve fund policy does not distinguish between CIP expenses funded by cash, bonds or other sources as recommended. 7 Benchmarking Comparables Observations The City’s Electric, Water and Wastewater Collection Utilities: •Rate stabilization reserve funds do not contain formal reserve guideline levels as compared to peers •Operation and maintenance reserves are more prescriptive with minimum, target and maximum guideline levels as compared to peers that typically only set minimum guideline levels. •Capital replacement and improvement reserve funds have minimum and maximum guideline levels as compared to peers that only had target guideline levels. •Generally, have more detailed and cumbersome policies when compared to benchmarked communities. 8 Reserve Tracking Observation Reserves are tracked on an annual basis in conjunction with the development of each Utility’s Financial Plan. However, a reserve tracking policy with guidance to report instances where fund balances to not meet guideline levels may provide Council with more assurances that targets are met throughout the year and provide more timely information for making decisions. 9 Key Recommendations Key Recommendations •Update dated policies •Do not eliminate any of the current reserve funds in place •Clarify CIP reserve fund language •Consider adjustments to CIP reserve fund guideline levels •Consider adjusting rate stabilization reserve policy to align with benchmark communities •Formalize reserve tracking Questions? Baker Tilly Advisory Group, LP and Baker Tilly US, LLP, trading as Baker Tilly, operate under an alternative practice structure and are members of the global network of Baker Tilly International Ltd., the members of which are separate and independent legal entities. Baker Tilly US, LLP is a licensed CPA firm that provides assurance services to its clients. Baker Tilly Advisory Group, LP and its subsidiary entities provide tax and consulting services to their clients and are not licensed CPA firms. The name Baker Tilly and its associated logo is used under license from Baker Tilly International limited. The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. © 2024 Baker Tilly Advisory Group, LP