The View from Wall Street: A Capital Markets Perspective Debra G. Coy Svanda & Coy Consulting 2010 Mid-America Regulatory Conference June 7, 2010

What does Wall Street think of water utilities? Water utilities’ stock prices have typically held up better than broader market indexes during steep downturns – but have under-performed on recovery rallies

Drinking Water Investment Needs Remain High Treatment Projects $ 53.2 Other $ 2.3 Storage Projects $ 24.8 Source Projects $ 12.8  Estimate of infrastructure projects needed in for water systems to continue to provide safe drinking water  Emphasis is on transmission & distribution projects  Pipe replacement cycles are not keeping up with increasing deterioration Transmission & Distribution Projects $183.6 ($ Billions) $335 Billion needed for U.S. drinking water utilities over the next 20 years to ensure compliance with existing and future water regulations Source: EPA’s 2007 Drinking Water Infrastructure Needs Survey & Assessment

Where Does the Money Need to be Spent? Investor-owned utilities operate in 9 out of 10 states with the greatest infrastructure spending needs Not shown: Alaska (Less than $1.0 billion) Hawaii (partially surveyed state) Source: EPA’s 2007 Drinking Water Infrastructure Needs Survey & Assessment  4 of top 9 states with greatest spending needs are in MARC territory

Capital Spending Metrics Source: CA Turner Report, (2005) Capital Invested per Dollar of Revenue

Financial Implications of Capital Intensity It takes > $3 in capital spending to generate ~ $1 in revenue Replacement costs continue to rise, dramatically outpacing the book value of assets in the ground Water infrastructure has a long asset life, with long depreciation schedules, especially for transmission pipes What does this mean? Consistently negative free cash flow Necessary to regularly access debt and equity markets to fund capital investments Important to keep Wall Street comfortable with the “regulatory compact” – that fair returns will follow the needed investment Water is the most capital-intensive utility

Capital Spending Metrics Capital spending is very high relative to D&A and operating cash flow… Is this sustainable? Typical ratios for regulated water utilities Capital spending to depreciation & amortization3 - 4x Capital spending to operating cash flow1.2 – 1.5x Net plant to revenue4 – 5x

Is Current Capital Spending Sustainable? Water utilities can sustain current levels of capital spending Only if…  Water utilities can regularly access equity & debt markets to fund capital programs  AND, receive fair (and timely) returns on their investments Otherwise…  By delaying non-mandated capital expenditures, the water utilities could quickly generate positive operating cash and spend closer to their depreciation rates  BUT, then they will fall further behind on needed replacement infrastructure spending

Investment Risk Considerations –Infrastructure replacement needs –Pressure on critical water supplies –Costly environmental regulations –High cap ex requirements & low depreciation rates –Effects of regulatory lag –Local political risk – Ability to access capital markets Water utilities are supposed to be low-risk regulated monopolies… But are they really low risk?

Importance of Regulation Commissions that work with utilities to minimize rate shock, while stimulating infrastructure investments, are viewed most favorably by the investment community. Allowed ROEs and Ability to Earn the Allowed ROE – this is the bottom line Consistent Regulatory Treatment Timely Decision Making Mechanisms to Minimize Regulatory Lag There is no “one size fits all” approach to regulation – and regulators must balance the needs of investors with the needs of consumers How Investors Evaluate Regulatory Treatment

Source: US Consumer Expenditure Survey Anthology, (2008) Annual Household Utility Spending Water and the Consumer Water is still a relative small part of the overall consumer utility budget – this helps with the affordability discussion

Consolidation of Small Systems Pros –Opportunity for customer growth –Opportunity for additional capital spending with return on investment Cons –High capex needs with lagging return on investment –Potential dilution to overall earned returns on equity Investor point of view