Financial Markets and
Access to Capital for the
Water Industry
James M. Kalinovich, VP Treasurer, American Water
MARC Conference
Traverse City, Michigan
June 15, 2009
American Water’s Regulated Presence
Ontario
WA
MT
ME
ND
OR
VT
MN
ID
NH
SD
NY
WI
WY
MI
NE
NV
PA
IA
IL
UT
CO
CA
KS
IN
OH
MD
WV
MO
VA
MA
CT
RI
NJ
DE
Washington DC
KY
AZ
OK
NM
AR
SC
AL
GA
LA
Hawaii
AK
2008
Revenues
($ in millions)
NC
TN
MS
TX
State
Customers
Served
FL
New Jersey
643,330
$517.7
Pennsylvania
648,958
447.9
Illinois
307,734
187.5
Missouri
456,887
181.1
Indiana
283,886
156.4
California
170,853
128.6
West Virginia
170,404
115.7
Other
639,663
347.8
3,321,715
$2,082.7
Total Regulated
Business
American Water serves approximately 5% of the U.S. population
2
Facts & Figures
(owned Assets)
• 372 individual
service areas
• 46,000 miles of
distribution mains
• 80 surface water
treatment plants
• 600 groundwater
treatment plants
• 1,000 groundwater
wells
• 45 wastewater
treatment plants
3
Background
• Current financial and credit crises are causing severe
challenges and dislocations throughout virtually every sector
of the economy, but . . . No sector is more important to public
health and welfare than high quality drinking water and
sanitation services:
 Water is ingested and essential to life
 Critical infrastructure, such as energy, health care, fire fighting,
disaster recovery, etc depend on water
 Effective wastewater management is critical to health and
environmental quality
 Access to and cost of capital affected
4
Economic Crises’ Impact on AWK
• Increases in cost of debt
• Market volatility hampers new equity issuance and raises
implied costs of equity
• Potential effects on Capex program
• Depressed housing sector hurts customer growth
• Increase in bad debt expense
• Credit Markets’ performance negatively impacts retirement
plans assets, thus increasing the Pension and Other Post
Retirement Benefits Costs and Cash Contributions
5
Market Volatility still remains and is main factor for
increased cost of capital
CBOE S&P Volatility Index
LTM TED Spread
The VIX Index represents the market’s expectation of volatility of the
S&P 500 over the next 30 day period
90
The TED spread is the difference between the 3 month T bill and the 3
month LIBOR and is an indicator of perceived risk in the economy
5
75
4
60
3
45
2
30
1
15
0
4/29
5/29
6/28
7/28
8/27
9/26
10/26
11/25
12/25
1/24
2/23
3/25
During the month of April the VIX continued a
sideways trading pattern, lower than October
2008 highs but still 50% higher than before
onslaught of credit crisis in November 2008
4/24
0
4/29
5/29
6/28
7/28
8/27
9/26
10/26
11/25
12/25
1/24
2/23
3/25
4/24
TED spreads continue to show lower perceived
market risk, as spreads to LIBOR have remained
steady at around 100 basis points. TED spreads
averaged 15 basis points from 2000-2005
6
Weighted Average Cost of Debt: By Subsidiary
10.50%
9.00%
7.50%
Current New Debt Issuance Rates: 6.5% to 8.5%
6.00%
4.50%
W
V
VA
TX
TN
PA
O
H
M
N
J
N
M
I
M
O
M
D
LI
Y
K
IN
Il
IA
I
H
A
C
Z
A
A
W
CC
A
W
E
A
W
K
3.00%
Interest Rates
7
Spreads: 30 Year US Treasury Notes and “A” & “BBB+” Utilities
500
450
400
350
300
250
200
150
100
50
0
Dec-07
Jun-08
Sep
2008
Oct-08
Nov-08
Dec-08
BBB+ Utilities
Jan-09
Feb-09
Mar-09
Apr-09
A Utilities
Source: Spread History for “A” and “BBB+” Utilities on Bloomberg
8
Challenges:
• Capital Attraction
 Drinking Water: $334.8 Billion/20 years
 February 2009 USEPA Drinking Water Infrastructure Needs
Survey (2002 Estimate: $154 Billion)
 Clean Water: $331-450 Billion/20 years
 2002 USEPA GAP Analysis
 20 Year Water/Wastewater Need: Approximately $1 Trillion
• Fragmentation
 53,000 Community Water Systems
 3,200 Electric; 2,700 Gas
• Expanding Water Quality Requirements
 98 Inorganic, Organic, Microbiological, Disinfection by Products,
Radionuclides
 More Coming
9
No Utility Sector is More Capital Intensive Than the Water
Industry
2007 Capital Intensity
$4.00
$3.50
$3.35
$3.00
$2.50
$1.67
$2.00
$1.31
$1.50
$1.17
$1.13
$0.33
$0.88
$1.00
$0.50
$0.00
Water
Electric
Comb E&G
Gas Dist.
Tel Cos
Avg All Ind.
S&P 500
Source: AUS Utility Reports – 2008
10
Enhanced Importance of Policies that Promote
Capital Attraction
• Reduction of Regulatory Lag
 Prospectively relevant test years
 Infrastructure replacement surcharges
• Promotion of Consolidation
 Economies of scale
 Viability
 Single tariff pricing
11
CAPITAL ATTRACTION:
Timely Recovery of Invested Capital – Regulatory Lag
Historic Test Year
Jan ’03
Jan ‘ 04

Jan 1 ‘05
Jan 1 ‘06




Mar ’04 Rate
Case Filed


June ’04
Investment
New Rates
Effective
Test Year
Loss of Return & Depreciation

Investment
Mitigation: Prospectively relevant test years:
•Future test years (eg, IL, KY, TN, NY)
•Step Increase (eg, CA – 3-year rate cycle)
•DSIC (IL, PA, DE, MO, IN, NY, OH, CT)

Sept ’05
Investment
Jan 1 ’08
Jan 1 ‘07



Mar ’07 New
Rate Case File

New Rates
Effective
Assuming a nine month rate proceeding and a goal to
stay out of a rate case for two years:
The utility will earn no return of or on an
investment made in June ’04 for 3 ½ years
Results:
• Dilutes allowed returns
• Skews efficient capital invested
• Forces more frequent rate cases
12
Negative Impact of Regulatory Lag and Potential Impact on Cost
of Capital for Capital Intensive Regulated Industries
“Primarily because of regulatory lag and increased financing expenses that
cause balance sheet strain and execution risks, utilities suffer sub par
returns during periods of heavy capital investment.”
(Source: Lehman Brothers; Power and Utilities: Regulated Utilities; Global Equity Research, North America, May 22, 2007)
Infrastructure Replacement Surcharge Programs Permit Utilities to
Better Manage Cash Flows and Capitol Programs in Times of
Extreme Financial /Market Volatility
“Firms can also reallocate capital to projects with more timely return
periods and take advantage of regulatory mechanisms that recover
investment more quickly. Pennsylvania’s distribution system
infrastructure charge (DSIC), which allows a monthly customer
surcharge for pipe repair costs, is an example of this.”
(Source: Janney Montgomery Scott, LLC; Water Industry Report; October 30, 2008)
13
Perception of Regulatory Support (Maintenance of
“Regulatory Compact”) Essential to Continued
Access to Capital for Water Utilities
120%
110%
100%
90%
80%
70%
60%
50%
AWK
DJIA
S&P 500
4/
29
4/
17
4/
5
3/
24
3/
12
2/
28
2/
16
2/
4
1/
23
1/
11
12
/1
8
12
/3
0
12
/6
10
/7
10
/1
9
10
/3
1
11
/1
2
11
/2
4
9/
25
9/
13
9/
1
8/
20
8/
8
7/
27
7/
15
7/
3
6/
21
6/
9
5/
28
5/
4
5/
16
4/
22
40%
Water - Peers
Price as a percent of base (April 23, 2008 = 100%)
Water Peers:
WTR CWT AWR SJW SWWC MSEX CTWS YORW
14
NAWC Infrastructure Initiatives
• Investment Tax Credits
• Public Utility Dividend Reinvestment Plans
• Tax Exempt Financing
• Depreciation/Bonus Depreciation
• State Revolving Loan Funds
15
Status of Stimulus Package Tax Incentives
Some success on each of the following:
• Bonus Depreciation Provision Extension
• Alternative Minimum Tax (AMT) Exemption on Tax Exempt
Bonds
• State Revolving Loan Funds (SRF)
16