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Rating Action:

Moody's Places American Water on Review for Possible Downgrade

28 Aug 2007

New York, August 28, 2007 -- Moody's Investors Service has placed both the long-term and short-term ratings of American Water Capital Corporation (Capital: Baa1, senior unsecured - Prime-2 and VMIG-2 short-term ratings) on review for possible downgrade. Capital is the finance subsidiary of American Water Works Company, Inc. (American Water). Today's rating action is in advance of Capital's planned $1.5 billion senior unsecured note offering. The notes are a component of American Water's strategy to recapitalize the company as it prepares to spin off, via initial public offering, from its current parent, RWE AG (A1 stable).

The review will primarily focus on the anticipated loss of its funding support from RWE following the full or partial sale of its equity interest in American Water. We note the proceeds from the note offering will in part be used to refinance approximately $2.0 billion of existing inter-company debt and preferred stock of American Water currently held by RWE. 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 needs from the public debt and equity markets as a standalone entity. The company has advised that they expect the IPO transaction to take place sometime in late-2007 and that all state regulatory approvals needed for RWE's divestiture have now been received.

American Water's cash flow derived credit metrics have also exhibited weakness for some time and are below what is commensurate with a Baa1 rating. For example, funds from operations (FFO) to total adjusted debt was approximately 7.5% for the trailing twelve month period ended June 30, 2007. Moody's would generally expect to see this measure at or near 10% for the Baa rating category for regulated water utilities. We note as well that the water utility industry remains capital intensive with infrastructure spending often times at a multiple of depreciation. As such, the review will focus on the extent and pace to which American Water can improve its credit profile through expected rate increases across its service areas given the ongoing need for substantial capital investment and usual regulatory lag. Moody's will also assess the profitability and level of contributions made by American Water's non-regulated subsidiaries (approximately 12% of fiscal 2006 revenues) and how these businesses fit into the company's strategy going forward. The factors noted above notwithstanding, Moody's will continue to consider the long-term stability associated with investor-owned water utilities in the U.S. and, in an environment of supportive regulatory treatment, the good level of cash flow historically generated from such regulated operations. As such, any potential downgrade to the long-term rating would likely be limited to no more than two rating notches.

Moody's will also focus on American Water's liquidity during this process and the extent to which any potential delays, with respect to the senior note offering or the IPO, due to market conditions can be accommodated. Capital currently has a $700 million commercial paper program backed by a committed multi-year $800 million revolving bank facility. Although currently lightly drawn, Moody's expects the company to increase its utilization of commercial paper borrowings over the balance of 2007 to serve as bridge financing prior to the IPO.

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.

New York
William L. Hess
Managing Director
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

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

No Related Data.
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