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
UƟlity
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
StabilizaƟon Reserve
funds within 5 years.
10 to 65% of either revenues or
expenses
Gas UƟlity 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
StabilizaƟon Reserve
funds within 5 years.
10 to 65% of either revenues or
expenses
Water UƟlity 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
StabilizaƟon Reserve
funds within 5 years.
10 to 65% of either revenues or
expenses
Wastewater
UƟlity
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
StabilizaƟon Reserve
funds within 5 years.
10 to 65% of either revenues or
expenses
Wastewater
Treatment
No
OperaƟons
Reserve
Baker Tilly
views
maintaining
OperaƟons
Reserve as a
best pracƟce.
No CIP Reserve Baker Tilly views
maintaining CIP
Reserve as a best
pracƟce.
Minimum: 15%, Target
22.5%, Maximum 30%
% of sales revenue
Baker Tilly proposes management
should consider the need for the
exisƟng reserve funds. If no longer
necessary, these funds should be
closed out and the money
transferred to other funds in place.
Refuse No
OperaƟons
Reserve
Baker Tilly
views
maintaining
OperaƟons
Reserve as a
best pracƟce.
No CIP Reserve Baker Tilly views
maintaining CIP
Reserve as a best
pracƟce.
Minimum: 10%, Target
15%, Maximum 20%
% of sales revenue
Baker Tilly proposes management
should consider the need for the
exisƟng reserve funds. If no longer
necessary, these funds should be
closed out and the money
transferred to other funds in place.
Stormwater No
OperaƟons
Reserve
Baker Tilly
views
maintaining
OperaƟons
Reserve as a
best pracƟce.
No CIP Reserve Baker Tilly views
maintaining CIP
Reserve as a best
pracƟce.
Target: $500,000 Baker Tilly proposes management
should consider the need for the
exisƟng reserve funds. If no longer
necessary, these funds should be
closed out and the money
transferred to other funds in place.