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Rating Action:

Moody's Assigns Baa1 Issuer Rating to Aquarion Water Company of Connecticut; Outlook Stable

Global Credit Research - 01 Mar 2011

New York, March 01, 2011 -- Moody's Investors Service today assigned a Baa1 Issuer Rating to Aquarion Water Company of Connecticut ("Aquarion"). The rating outlook is stable. This is the first time that Moody's has rated Aquarion.

RATINGS RATIONALE

New England based Aquarion is a relatively small regulated water utility primarily serving parts of western CT including the cities of Bridgeport and Stamford. Although operating in some form since 1857, it is currently owned by a consortium of investors led by Macquarie Group. Aquarion's ownership structure is complex as it has two smaller sister water subsidiaries in NH and MA and all are held under two intermediate parent holding companies. These entities are ultimately owned by Aquarion Holdings LLC. ("Holdings"). Holdings (not rated), was the primary vehicle for acquiring the water utilities in 2007. Holdings incurred approximately $320 million of debt associated with this transaction and it remains leveraged relative to Aquarion.

Aquarion's Baa1 issuer rating reflects the company's positive attributes including its long operating history, stability afforded by regulated cash flows, investment-grade credit metrics, good relationship with state regulatory authorities, largely residential customer base and a modest near-term capital spending profile. The rating also considers several challenges in our view, including the company's small size and geographic concentration, the significant amount of debt issued at the parent level, limited ring-fencing at Aquarion, lack of a dedicated external credit line, and modest trending decline of water consumption due to conservation efforts.

This rating comes at a time when Aquarion and its related companies are actively addressing certain refinancing and liquidity needs. These actions include, 1) refinancing approximately $320 million of term loan debt at Holdings, 2) establishing a new $70 million (approximately) senior unsecured revolving credit facility at Aquarion's intermediate parent, and 3) refinancing current notes payable to Holdings with a planned $40 million senior unsecured tax-exempt note offering at Aquarion as well as two smaller long-term note offerings at Aquarion's sister-subsidiaries. This first time rating and stable outlook for Aquarion is in part based on the expected successful closing of the above mentioned transactions. We expect the refinancing at Holdings to occur by early Q2-2011 and the newly installed revolving credit facility and note offerings to occur contemporaneously or shortly thereafter. Material delays in these events or associated impacts on liquidity would be viewed negatively.

Stand alone, Aquarion's capital structure is straightforward. At September 30, 2010 the operating company reported $208 million of long-term debt and $42 million of short-term borrowings payable to Holdings. On a historical basis credit metrics are well positioned for the Baa1 rating category. For example, for the three year period from 2007-2009, Aquarion achieved average funds from operations to debt of 20% and FFO interest cover of 4.7 times, these would both be considered in the "A" range, for water utilities as outlined in our Global Regulated Water Utilities Methodology. However, an additional metric we look to is retained cash flow (FFO -- dividends) cover of capital spending. On this measure the company has averaged .72 times over the same period, a level more associated with the "Ba" range, reflecting the somewhat aggressive dividend policy in recent years.

Although Connecticut can sometimes be viewed as a challenging regulatory jurisdiction, we believe the company continues to maintain a constructive relationship with the DPUC. We note the company's last general rate case fully litigated in 2010, concluding with a revenue increase of 11.3%, and an authorized ROE of 9.95%. While we believe the company's capital spending level is moderate, dividends have at times been in excess of current period earnings, and in recent years, Aquarion's profile has been managed to a modest negative free cash flow position (CFO-div-capex). Over the next several years we expect the company will generally manage its up-streamed dividends within generated earnings, while aligning its capital structure to, at least, sustain its current level of metrics.

In contrast to the investment grade utility profile at the utility, the consolidated profile, at the Holdings level, is substantially more levered. Approximately $320 million of term debt used to finance the acquisition remains (maturing April 2012) and accounted for 50% of consolidated debt at December 31, 2009. Although not rated, this is a significant amount of non-operating company debt and this structural subordination would typically result in at least a two notch differential between the parent and utility operating company. Further, the consolidated financial profile of Holdings is at or below what is typically demonstrated for investment-grade water utility holding companies. From 2008-2009, Holdings generated average FFO to debt of 6.4% and FFO interest cover of 2.1x. Both of these are more representative of the "Ba" range as outlined in Moody's methodology. Consequently, there is not a large cushion to absorb any unexpected financial deterioration at Aquarion, the primary cash flow driver. The absence of strong regulatory ring-fencing at Aquarion also implies that any future incremental weakness of Holdings could result in downward pressure on the rating of Aquarion as opposed to any implied wider "notching" down of Holdings.

Aquarion's regulated internal cash flows and moderate capital requirements provide the primary basis for the company's good liquidity profile, modest negative free cash flow notwithstanding. Externally, liquidity is currently provided by $98 million of committed credit lines at Holdings (an $83 million capex line and a $15 million working capital line). Holdings has approximately $60 million currently drawn under these lines. We view this arrangement as less than optimal given 1) that the lines are not based at the borrower (Aquarion), and 2) the presence of material adverse change language for ongoing borrowings.

However, as noted above, we expect these lines to be terminated upon the establishment of a new facility at Aquarion's intermediate parent, Aquarion Company by early Q2-2011. We expect this line to be initially sized at $70 million with amounts drawn at closing to be reduced with subsequent long-term financings at the subsidiaries, most importantly, the $40 million of water facility revenue bonds at Aquarion.

The stable outlook reflects Moody's expectation that Aquarion will continue to maintain a financial profile consistent with its Baa1 Issuer Rating. Weakness at the parent level, or up-streamed dividends from Aquarion that pressure its stand alone metrics would likely negatively impact the rating.

The principal methodology used in this rating was Global Regulated Water Utilities published in December 2009.

Headquartered in Bridgeport, CT, Aquarion is a regulated water utility company serving approximately 181 thousand customers in the state. Aquarion reported revenues of $129 million in 2009

REGULATORY DISCLOSURES

Information sources used to prepare the credit rating are the following: parties involved in the ratings, parties not involved in the ratings, public information, confidential and proprietary Moody's Investors Service information, and confidential and proprietary Moody's Analytics information.

Moody's Investors Service considers the quality of information available on the issuer or obligation satisfactory for the purposes of assigning a credit rating.

Moody's adopts all necessary measures so that the information it uses in assigning a credit rating is of sufficient quality and from sources Moody's considers to be reliable including, when appropriate, independent third-party sources. However, Moody's is not an auditor and cannot in every instance independently verify or validate information received in the rating process.

Please see ratings tab on the issuer/entity page on Moodys.com for the last rating action and the rating history.

The date on which some Credit Ratings were first released goes back to a time before Moody's Investors Service's Credit Ratings were fully digitized and accurate data may not be available. Consequently, Moody's Investors Service provides a date that it believes is the most reliable and accurate based on the information that is available to it. Please see the ratings disclosure page on our website www.moodys.com for further information.

Please see the Credit Policy page on Moodys.com for the methodologies used in determining ratings, further information on the meaning of each rating category and the definition of default and recovery.

New York
James O'Shaughnessy
Analyst
Infrastructure Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

New York
William L. Hess
MD - Utilities
Infrastructure Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Moody's Investors Service
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Moody's Assigns Baa1 Issuer Rating to Aquarion Water Company of Connecticut; Outlook Stable
No Related Data.
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