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12 Oct 2007
Moody's Downgrades American Water to Baa2; Confirms P-2 Short-Term Rating
New York, October 12, 2007 -- Moody's Investors Service today downgraded to Baa2 from Baa1 the
senior unsecured issuer rating of American Water Capital Corp ("Capital").
Moody's also confirmed Capital's P-2 short-term
rating. At the same time, Moody's assigned a (P) Baa2
senior unsecured rating to Capital's planned $1.5
billion note offering and a Baa2 senior unsecured issuer rating to Capital's
parent, American Water Works Company, Inc ("American
Water"). The rating outlook for both issuers is stable.
Today's rating action concludes the review for possible downgrade
initiated on August 28, 2007.
Moody's review of Capital's short and long-term ratings
was prompted by American Water's planned recapitalization of the
company in advance of the divestment, via initial public offering,
from its current parent, RWE AG (A1 stable). The initial
sale of RWE's interest in American Water is expected to happen in
late-2007; however, preceding that transaction,
Capital is expected to issue $1.5 billion of senior unsecured
notes in order to substantially repay approximately $2.0
billion of inter-company debt currently owed to RWE. These
notes are expected to be issued in October 2007. It is Moody's
understanding that the company will also issue $500 million of
"equity units" concurrent with the IPO that will fund out
the balance of inter-company debt owed to RWE.
The one-notch downgrade of Capital's senior unsecured issuer
rating, and the assignment of a Baa2 issuer rating to its parent,
American Water, reflects the loss of implied support from RWE following
the IPO, historically weak consolidated credit metrics, and
the increase in financial and operating risk going forward as a publicly
traded stand-alone company. Moody's has also taken
this opportunity to equalize the new rating for American Water,
a holding company, with its finance subsidiary, Capital,
due to the existence of a "support agreement" between the
two entities that effectively backstops Capital's timely payment
of principal and interest, as needed. Nevertheless,
an additional concern is that approximately 60% of American Water's
consolidated debt will be borrowed at Capital, with the balance
at the various regulated operating subsidiaries where the material cash
flows are generated. We note that debt at Capital does not benefit
from any upstream guarantees from the regulated utility operations nor
does the debt obligations of the subsidiaries, including Capital,
benefit from any downstream guarantee from American Water.
Moody's considers American Water's position as the largest
investor-owned water utility in the U.S. and geographic
diversity with regulated operations in 20 states as being positive credit
qualities. Moody's views investor-owned water utilities
in the U.S. as having greater long-term stability
and supportive regulatory treatment than most of their electric utility
counterparts which has resulted good levels of historical cash flow from
such regulated operations. Although American Water's cash
flow derived credit metrics have exhibited weakness for some time and
are considered somewhat soft for the Baa2 rating (funds from operations
(FFO) to total adjusted debt was approximately 7.5% for
the trailing twelve month period ended June 30, 2007), Moody's
believes there is capacity for improvement as the company has either filed
or is planning to file for rate increases in all of the jurisdictions
in which it operates after a long period following RWE's acquisition
where the company's ability to increase rates was limited due to
stay-out provisions agreed to in some jurisdictions. Timely
rate increases and the ability to attract new equity capital will be two
key drivers for maintaining the rating going forward as the water utility
industry remains capital intensive with infrastructure spending often
times at a multiple of depreciation. American Water is facing a
sizeable capital spending plan and will need to finance additional rate
base with debt and equity at levels appropriate for the rating category
to avoid future downward pressure on the rating or outlook given the magnitude
of the planned expenditures.
We note that American Water also has a much smaller non-regulated
water-related services segment (approximately 12% of fiscal
2006 revenues) that will remain a part of its business model going forward.
While this business segment is considered a growth area and is less capital
intensive, it is also less profitable. Consequently,
the regulated operating subsidiaries will continue to be the primary source
of funds to service debt and to pay the expected dividends to its public
The stable outlook reflects Moody's expectations that going forward
there will be no material change to the currently envisioned capital structure.
The refinancing will likely have a negative impact on American Water's
financial flexibility going forward as the company terminates its historical
reliance on funding from its larger and more financially secure parent
and switches to meeting those capital needs from the public debt and equity
markets as a standalone entity. Moody's expects the company
to maintain adequate liquidity for its operations primarily through Capital's
$700 million commercial paper program which is currently back-stopped
by a committed multi-year $800 million revolving bank facility
expiring in September 2012. Although currently lightly drawn,
Moody's expects the company may moderately increase its utilization
of commercial paper borrowings over the balance of 2007.
Headquartered in Voorhees, New Jersey, American Water Works
Company, Inc. is an indirect wholly-owned subsidiary
of RWE AG and is the largest investor-owned provider of water,
wastewater and related services in North America. It is the parent
company of numerous water utilities in the United States and reported
revenue in 2006 of $2.1 billion.
William L. Hess
Corporate Finance Group
Moody's Investors Service
Corporate Finance Group
Moody's Investors Service
No Related Data.
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