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13 L: REA 1)01 RECLAMATION

t\ H~ ‘I V RI I-fR 1(1 (.oIflnhIssIoflcr OITue

P0 130K 25007

Denver Federal Center

D-5200 Denvci; Colorado 80225-0007 AUG I 3 ~99

WTR-1 .00

MEMORANDUM

To: Regional Director, PN, MP, LC, UC, GP

Attention: PN-1000, MP-100, LC-1000, UC-100, GP-1000

From: I~’Kfargaret W. Sibley ~O.~j~47~—

Director, Office of Policy

Subject: Directives and Standards for Periodic Review ofIrrigation Ability-to-Pay Analyses

The Reclamation policy memorandum, dated March 25, 1994, requires that all new contracts,

and all existing contracts when they are amended, include a provision for periodic

re-examination ofirrigation ability-to-pay and for resulting adjustments in waterservice and

repayment rates. The Commissioner issued a supplementary memorandum dated July 7, 1999,

which reaffirmed the basic policy, but provided some modifications and clarifications on certain

issues. The attached directives and standards provide additional information on the timing and

level oftechnical detail required forthe ability-to-pay reviews.

Determination ofability-to-pay and subsequent negotiations with the contracting entity can be a

lengthy and intensive process for Reclamation economists and contract specialists. There is a

need to balance the required staff effort for a thorough re-examination ofability-to-pay with the

expected benefit, which is a more current and equitable annual repayment rate. The directives

and standards establish thresholds based on the length ofthe repayment term and the present

value ofthe repayment stream below which the level ofreview can be reduced. However, all

contracts will continue to include a provision for periodic reviews.

These directives refer to the terms “payment capacity” and “ability-to-pay” with specific

meaning. Payment capacity is defined as the residual net farm income ofirrigators available to

pay both federally and non-federally assessed water costs, after deduction for on-farm production

and investment expenses. Payment capacity is a farm-level analysis and is usually determined in

Reclamation by preparation ofdetailed farm budgets or enterprise studies. In contrast,

ability-to-pay is defined as the payment capacity ofirrigators expanded to the applicable project

or service area, less irrigation-related water distribution, operations and debt-servicing costs of

the contracting entity. Ability-to-pay is a district-level analysis, and is the increment of district

revenues over expenses available for a contract obligation with the United States.
2

The directives and standards will be incorporated into the Reclamation Manual at the time a

comprehensive policy on ability-to-pay is finalized for inclusion. Ifthere are questions on these

Directives and Standards, you may contact Alonzo D. Knapp, Manager, Reclamation Law,

Contracts and Repayment Office (D-5200) at 303-445-2889 or Robert Hamilton, Manager,

Economics Group in the Technical ServiceCenter (D-8270) at 303-445-2724.

I Concur - Commissioner

AUG 20199

Date

Attachments
Directives and Standards

5-year Re-examination of Irrigation Ability-to-Pay

1. Number of 5-year reviews. The 5-year re-examination of ability-to-pay shall not be

conducted in cases where less than 5 years would remain in the repayment term ofthe contract.

For example, a contract which would “pay out” in 8 years at the initial annual repayment rate

would not include a provision forre-examination of ability-to-pay; that is because at the end of

year 5 when a review would normally be scheduled, only 3 years remain in the repayment term.

Similarly, a contract with a clause forre-examination which has been re-examined at year 5 and

year 10, and would “pay out” in year 17, would not be re-examined at year 15. The 5-year reexamination requirement can be avoided altogether in contracts with terms of9 orless years.

2. Threshold forConducting Reviews. The present value ofthe existing (remaining) repayment

stream should be computed based on the current yield ofU.S. Treasury securities with a

comparable term. Ifthe present value is less than $100,000, then no reviews, expeditious or indepth, are required. The $100,000 threshold is based on an approximation ofmaximum potential

staff costs to perform and implement the studies.

3. Calculation of expeditious estimate ofability-to-pay

.

a. Ifa review is required in accordance with 1 and 2, certain key indicators ofpayment

capacity and ability-to-pay will be considered and expeditious estimates ofboth will be

developed prior to initiation of an in-depth re-examination. An in-depth re-examination

is generally considered to be one which is consistent with all Reclamation policies,

directives and technical guidelines.

b. Key indicators for payment capacity are cropping patterns, farm prices received, crop

yields, and U.S. Department ofAgriculture’s (USDA) Indexfor Prices Paid. The key

indicator for ability-to-pay (other than the estimate ofpayment capacity) is the current

assessment that the contracting entity charges irrigators.

c. In terms of payment capacity, the current cropping pattern, the average ofthe most

recent 5 years of prices received, and the average ofthe most recent 5 years ofyields

should be compiled to generate a current estimate ofrepresentative per acre or per acrefoot gross farm income. Iflivestock contributed significantly to gross farm income in the

previous payment capacity analysis, new 5-year average livestock prices should be

compiled and applied to the previous livestock output. After gross farm income is

estimated, the sum ofproduction and investment expenses and the labor, equity, and

management allowances from the previous payment capacity analysis should be indexed

from the last year represented in the previous analysis to the current year, using USDA’s

Index ofPrices Paid. This per acre or per acre-foot estimate ofcurrent expenses should

be deducted to arrive at the estimate ofpayment capacity

.
2

d. Once the estimate ofpayment capacity is developed, the current irrigation assessment (

charged by the contracting entity is deducted to arrive at the current per-acre or per acrefoot estimate of ability-to-pay. Normally, this estimate is incremental to the original

ability-to-pay because current assessmentsreflect collections for contract repayment.

Since district expenses and resulting assessments generally trend upward, the current

year’s assessment is usually acceptable, although if assessments have fluctuated up and

down, a 5-year average would be appropriate for use. Data on assessments for the

expeditious ability-to-pay will usually be readily available from the contracting entity.

Validation ofthe assessments by means of a thorough examination of financial records,

which is required for an in-depth analysis, is not required for the expeditious estimate.

The incremental ability-to-pay estimate should be expanded to the project orservice area

based on the relevant acres or acre-feet.

4. Decision rule for expeditious estimate ofability-to-pay. The expeditious estimate of

incremental ability-to-pay detailed above should be used to develop a repayment stream for the

remaining length ofthe contract. The repayment stream should reflect adjustments from the

current ability-to-pay estimate in future years ifsignificant financial changes are expected to

occur. The present value ofthat stream should be compared to the present value ofthe existing

repayment stream. Ifthe difference in present value between the two streams is $100,000 or

more, plus or minus, then an in-depth re-examination ofability-to-pay should be conducted.

Otherwise, no further analysis is undertaken and annual payments are not adjusted. The

expeditious estimate ofability-to-pay is used only to determine ifmore detailed analysis is

required; it will not be used to establish actual repayment terms. A simplified example is

appended.

5. Need for periodic in-depth re-examination ofability-to-pay. Ifan in-depth re-examination of

ability-to-pay is not necessary as a result ofnumber 4, an in-depth re-examination must be

conducted at the conclusion ofthe next 5-year interval. In this way, in-depth re-examinations

occur at no less than 10-year intervals. This directive is necessary due to the sensitivity of

ability-to-pay to small changes in the data, as well as the imprecision ofthe expeditious

estimating process. However, in cases where there is no existing ability-to-pay or ability-to-pay

is near zero, the in-depth review can be curtailed once sufficient analysis has been performed to

conclude that positive ability-to-pay will not result from additional analysis. Similarly, the indepth review can be curtailed if it is clear that additional analysis will not achieve the $100,000

threshold noted in 6 below. These conclusions must be documented.

6. Decision rule for in-depth estimate ofability-to-pay. When an in-depth re-examination of

ability-to-pay is conducted, the resulting revised repayment stream for the remaining termofthe

contract should be compared to the present value ofthe existing repayment stream. Ifthe

difference in present value between the two streams is $100,000 or more, plus or minus, then the

contract repayment stream should be adjusted in accordance with the revised ability-to-pay.

Otherwise, no further action is taken and annual payments are not adjusted.
7. Repayment floor. In certain cases, it will be desirable to establish in the contract a repayment

floor, or lowest annual payment, below which no periodic adjustments will be made. For

example, if no power assistance is available, a mechanism should be in place to assure repayment

within the statutory repayment period. In other cases, the contracting entity may be willing to

pay some base amount without regard to Reclamation’s ability-to-pay analysis.

8. Reclamation responsibilities. The Regional Directors have the responsibility to arrange for

the payment capacity and ability-to-pay re-examinations. Payment capacity and ability-to-pay

analyses (either expeditious or in-depth) shall be reviewed and approved by the Director, Office

of Policy in consultation with the Economics Group, Technical Service Center. Exceptions to

these directives can be granted by the Director, Office of Policy.

9. Need for consultation. Reclamation staffshall closely consult with the contracting entity in

the ability-to-pay re-examination process, in both the expeditious and in-depth analyses.
4

SimDlified ExamDle ofExpeditious Review

Baseline Data

:

loan type:

maximum authorized repayment term:

power assistance assumption:

initial payment capacity:

initial district water assessment:

initial district ability-to-pay (difference): .

irrigated acres:

initial annual payment (acres x ability-to-pay):

initial repayment obligation:

initial repayment term (obligation — payment):

remaining loan balance after 5 years:

interest rate of 12 year U.S. securities:

present value of 12 remaining payments

Safety ofDams (SOD)

50 years

not applicable

$10/acre

$8/acre

$2/acre

100,000

$200,000

$3,400,000

17 years

$2,400,000

5.25%

$1,748,000

Case A: Assumes that the expeditious estimate ofability-to-pay conducted after year 5 increases

:

Data:

estimate ofpayment capacity:

current district assessmenta:

estimate ofincremental ability-to-pay (difference)a:

incremental annual payment (acres x ability~to~pay)a:

initial annual payment (from baseline data)~

revised annual payment (incremental payment + initial payment):

loan balance after 5 year (from baseline data):

revised remaining repayment term (balance revised payment): ...

interest rate of 8 year U.S. securities

present value of8 remaining payments:

present value ofexisting repayment (from baseline data):

difference (positive):

$13/acre

$12/acre

$1/acre

$100,000

$200,000

$300,000

$2,400,000

8years

5.2%

$1,923,000

$1,748,000

$175,000

am this example, it is assumed that the current district assessment includes collections

necessary to make the initial $200,000 district payment; therefore, any computed abilityto-pay or payment is incremental to the initial estimates.

Conclusion for Case A: The absolute change in present value ($175,000) exceeds $100,000;

therefore, a detailed ability-to-pay analysis should be conducted.
5

Case B: Assumes that the expeditious estimate of ability-to-pay conducted after year 5 decreases

:

Data:

estimate of payment capacity: $

11/acre

current district assessment3 $1 2.50/acre

estimate ofincremental ability-to-pay (difference)a: ($1.50)/acre

incremental annual payment (acres x ability-to-pay) (negative)~: . ($150,000)

initial annual payment (from baseline data): $200,000

calculated revised annual payment (incremental payment + initial payment): . . . $50,000

loan balance after year 5 (from baseline data): $2,400,000

calculated remaining repayment term (balance -~- revised payment): 48 years

authorized remaining repayment term(50 years - 5 years): 45 years

adjusted revised annual payment (balance + authorized years)b: $53,333

interest rate of 30-plus year U.S. marketable securities: 5.4%

present value of 45 remaining payments: $895,000

present value ofexisting repayment (from baseline data): $1,748,000

difference (negative): ($853,000)

am this example, it is assumed that the current district assessment includes collections

necessary to make the initial $200,000 district payment; therefore, any computed abilityto-pay or payment is incremental to the initial estimates.

bIn this example, no power assistance is available; if power assistance had been available,

the contracting entities estimated annual payment would have been equal to ability-to-pay

($50,000) and they would have repaid $2,200,000 ofthe $2,400,000 remaining

repayment obligation over 45 years subject to periodic 5-year reviews. Power assistance

would be estimated at $200,000. Without power assistance, the entire repayment

obligation must be paid by the contracting entity within the statutory term of 50 years,

even if payments are greater than ability-to-pay.

Conclusion for Case B: The absolute change in present value ($853,000) exceeds $100,000,

therefore, a detailed ability-to-pay analysis should be conducted.