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Transcript Document

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 OR CA NV ID UT WY CO ND SD NE KS MN IA MO WI IL IN MI OH KY WV PA NY VT NH MA CT RI MD NJ DE VA ME Washington DC AZ NM AR TN SC NC

State New Jersey Pennsylvania

MS AL GA TX LA

Illinois

Hawaii FL AK

Missouri Indiana California West Virginia Other Total Regulated Business Customers Served 643,330 648,958 307,734 456,887 283,886 170,853 170,404 639,663 3,321,715 2008 Revenues ($ in millions) $517.7

447.9

187.5

181.1

156.4

128.6

115.7

347.8

$2,082.7

American Water serves approximately 5% of the U.S. population

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

15 30 45 60 75

Market Volatility still remains and is main factor for increased cost of capital

CBOE S&P Volatility Index 90 The VIX Index represents the market’s expectation of volatility of the S&P 500 over the next 30 day period LTM TED Spread 5 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 4 3 2 1 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

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

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% 3.00% A W C C A W E A W K AZ CA HI IA Il IN KY LI MD MI MO NJ NM OH PA TN TX VA WV Interest Rates

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 Jan-09 Feb-09 BBB+ Utilities

Source: Spread History for “A” and “BBB+” Utilities on Bloomberg

A Utilities Mar-09 Apr-09

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

$3.00

$2.50

$2.00

$1.50

$1.00

$0.50

$0.00

$3.35

$1.67

$1.31

$1.13

$0.88

$1.17

$0.33

Water Electric Comb E&G Gas Dist.

Tel Cos Avg All Ind.

S&P 500

Source: AUS Utility Reports – 2008

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   Mar ’04 Rate Case Filed  June ’04 Investment  New Rates Effective  Sept ’05 Investment Jan 1 ‘06  

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)

Jan 1 ‘07   Mar ’07 New Rate Case File Jan 1 ’08   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

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% 40% 4/ 22 5/ 4 5/ 16 5/ 28 6/ 9 6/ 21 7/ 3 7/ 15 7/ 27 8/ 8 8/ 20 9/ 1 9/ 13 9/ 25 10 /7 10 /1 9 10 /3 1 11 /1 2 11 /2 4 12 /6 12 /1 8 12 /3 0 1/ 11 1/ 23 2/ 4 2/ 16 2/ 28 3/ 12 3/ 24 4/ 5 4/ 17 4/ 29 AWK DJIA S&P 500 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

Status of Stimulus Package Tax Incentives

Some success on each of the following: