**Testimony of**

**Debra G Coy**

**Director -- Research/Water**

**Janney Montgomery Scott LLC**

**1255 23^rd^ St., N.W.**

**Suite 150**

**Washington DC 20037**

**To**

**Committee on Transportation and Infrastructure**

**Subcommittee on Water Resources and Environment**

**US House of Representatives**

**2167 Rayburn House Office Building**

**On**

**The Need for Renewed Investment in\
Clean Water Infrastructure**

**January 19, 2007**

Mr. Chairman, members of the committee and the subcommittee -- thank you
for the opportunity to be here today to discuss the need for investment
in clean water infrastructure. My name is Debra Coy, and I am a senior
investment research analyst with Janney Montgomery Scott, a Philadelphia
brokerage firm founded in 1832. Based in Washington, DC, I have been
covering the water industry for investors for more than 15 years, for
various investment firms before joining Janney, including Charles
Schwab, HSBC Securities, and NatWest Securities.

Working from Washington during these years, I have observed the debate
over funding for water and wastewater infrastructure, through the demise
of the Clean Water grants program, the development of the State
Revolving Funds (SRF) program, and the more recent discussion of how to
address the "gap" between needed funding and available funding,
identified by U.S. EPA in its widely-quoted 2002 "Gap Analysis" to be in
the range of \$23 billion per year.

During this period, and particularly in recent years, I have heard a
steady refrain: there isn't enough money available for water
infrastructure investment, and we need dramatic increases in federal
funding.

The purpose of my comments today is to point out that there is in fact a
tremendous amount of money now becoming available for infrastructure
investment -- but that the current structure and asset investment
approach in the U.S. water and wastewater industry likely will need some
adjustments in order to successfully access it.

The source of funds that I am referring to is private sector capital.
The global financial markets have "discovered" infrastructure in the
past couple of years, and this is fast becoming a popular asset class
that is attracting many billions of dollars in private investment
capital. Investors have recognized the huge and growing need for
infrastructure investment around the world -- in transportation and
energy as well as water -- and are looking for ways to participate in
this market.

**Rapid rise in global infrastructure funds**. A recent S&P report said
that about \$100 billion in new money for infrastructure funds was
raised globally in 2006, and more new funds are planned for 2007.
Managers of these funds are now actively (some would say desperately)
looking for deals where they can put all that new money to work for
their investors. Key targets are transportation, energy, and
water-related assets.

Most recently, Goldman Sachs announced on Dec. 28, 2006, that it had
closed a new infrastructure fund, its first, with more than \$6.5
billion in funding, making it the largest single fund of its kind. The
new fund, called GS Infrastructure Assets, ended up being more than two
times larger than originally planned, due to high demand from investors,
and Goldman put \$750 million of its own money into the fund. The fund
is seeking investment opportunities in toll roads, airports and ports,
as well as gas, water, and electric utilities, primarily in North
America and Europe.

Other major financial firms that have recently established large new
infrastructure funds include AIG, Barclays Bank, the Carlyle Group,
Deutsche Bank, and Macquarie Bank, as well as several Asian financial
groups. In addition, firms such as Morgan Stanley, Merrill Lynch, and
Credit Suisse have also indicated plans to create or participate in
infrastructure funds.

Australia's Macquarie Bank was the pioneer and has become the dominant
player in this relatively new market of creating managed vehicles
through which investors are able to gain exposure to an underlying
portfolio of infrastructure assets. Macquarie has actively developed
this business over the last decade and now manages more than \$30
billion in infrastructure assets globally, through a network of listed
and unlisted investment funds, with several billion in new funding
raised in 2006. As a result, it has become by far the largest
non-government owner and manager of infrastructure assets world-wide.

Investors in these funds are often pension funds, insurance companies,
or foundations, which have large amounts of capital to invest and are
looking for stable, long-term investment returns that basic
infrastructure assets can provide. Macquarie looks for infrastructure
assets that have low demand elasticity, high asset cost, long-lived
assets, and predictable and stable cash returns that are indexed or
hedged against inflation. Macquarie says that the average annual
compound return on its infrastructure funds in the 11 years since
inception is 19%, handily outpacing returns for the S&P 500 stock index
during that period.

**Lots of money and limited investment choices**. Ironically, the huge
pools of new capital that have been pouring into infrastructure funds in
the past two years are creating another problem -- increasing difficulty
in putting the money to work. There are currently limited opportunities
in toll roads, ports, and water and energy utilities, given government
ownership of most of these facilities worldwide.

This has pushed up the valuations of available assets. For example,
Macquarie and a consortium of its funds is paying £8 billion (US \$15.8
billion) in cash and debt to buy Thames Water, the largest UK regulated
water utility. Macquarie is paying a higher-than-expected premium of 20%
above Thames' regulated asset value, as it competed against other
potential buyers. These premium acquisition prices have become the norm
in the past couple of years, since the water investment sector is so
awash in available capital looking for deals.

Publicly traded water stocks as a group have also continued to
outperform the broader financial markets in the past year, reflecting
investor enthusiasm for the sector. The PowerShares Global Water
Portfolio, for example, is an exchange-traded fund based in the U.S.,
with more than \$1 billion in assets under management, mirroring the
performance of an index or group of global water stocks. According to
Bloomberg data, this water portfolio posted a return of 21% in 2006,
compared to 15% for the S&P 500 index.

As a research analyst, I frequently speak to investors who are looking
for ways to invest in water, which they perceive to be a long-term
growth industry, given the critical and rising demand for clean water
supplies and for reliable water infrastructure. In recent articles in
the financial press and in investment newsletters, water is now commonly
referred to as "blue gold" or "the oil of the 21^st^ century."

**Why isn't private investment capital going into U.S. water
infrastructure?** The question for us here today is, why -- if there is
such great investor interest in water, and billions of dollars of
investment capital looking for ways to invest in clean water
infrastructure -- are we facing a critical funding shortage in this
sector? I believe the answer lies in the way the U.S. water and
wastewater industry is structured and financed.

As most of us here know, the vast majority of water and wastewater
infrastructure in the U.S. is owned by local government entities,
including cities, towns and sometimes regional water or sewer
authorities. Approximately 15% of the population in the U.S. is served
by investor-owned water utilities, and an even smaller proportion, some
5-8%, is served by investor-owned wastewater utilities. According to EPA
data, the industry is highly fragmented, with more than 50,000 water
systems around the country, mostly small ones serving fewer than 3,500
people.

Historically, in the U.S., investment in water infrastructure has also
been fragmented.

Investor-owned water utilities fund their infrastructure needs through a
combination of equity, which they periodically raise through offerings
of stock to investors, and debt, usually a combination of bank debt,
bond debt, and sometimes low-cost state or SRF-supported debt. State
public utility regulators then approve periodic customer rate increases
that pay for these investments, allowing a return on equity and coverage
for interest costs and debt repayment.

Municipally owned utilities, on the other hand, typically pay for their
investments in infrastructure by issuing tax-exempt municipal bond debt.
They may also receive some contribution from general tax funds, from
state or federal grant programs, or from the SRF, but the majority of
funds are raised locally. Increasingly, municipalities are also raising
customer rates, or user fees, to pay for infrastructure improvements,
though some cross-subsidization between water and sewer services and
other city services still exists in some municipalities. Historically,
municipal bond financing has worked well in this market, but the rising
clean water investment needs being faced by many cities are now
stretching their bond-raising capacity, since they must also fund a wide
range of other municipal services and facilities.

Standard & Poor's, the bond rating agency, has said in recent
presentations to investors that despite its historic stability, the
public water and sewer utility sector is facing increasing challenges
that may impact credit quality. The New York City Municipal Water
Finance authority alone is planning \$17 billion in water and sewer
capital spending over the coming decade. S&P has also noted that
deferred costs -- the neglect of needed investment in water and sewer
pipes and treatment facilities -- is becoming a higher risk facing many
cities, since the costs compound over time as replacement and repair
costs rise.

As a result of this bifurcated industry structure, municipally owned
water and wastewater utilities have typically not had access to private
sector investment capital outside the municipal bond market. And on the
other side, investors have typically not been able to invest in the
municipal water market other than through municipal bonds.

Equity investors do buy stock in investor-owned water utilities, and
they buy stock in the companies that provide equipment and services to
municipal utilities. Stocks of companies that provide water pipes,
pumps, filtration systems, engineering services, and pipe repair
technology, for example, have all performed well in the past year.

The new infrastructure funds are buying private utilities and ports and
toll roads, but they aren't putting money into municipal water and sewer
utilities in the U.S., for the most part.

For one thing, most of these assets simply aren't for sale. Goldman
Sachs, for example, proposed last year to lease the county sewer system
in Birmingham, Alabama, in a deal that could have netted the county some
\$4 billion over a period of time, but it appears that the deal fell
apart amidst local political opposition. Private sector ownership, or
even operation, of municipal water and sewer assets remains
controversial, while lease structures such as Goldman proposed are still
largely unheard of in this industry.

**Looking for solutions**. So what can be done to help close the "gap"
between private sector money and municipal sector need in the water
sector? Briefly, here are some thoughts that have emerged from my
conversations with various people in the industry in past months.

-   **Need for increased public awareness of the pending infrastructure
    investment crisis**. A 2005 Aspen Institute report called it "the
    silent tsunami" -- the lack of clean water and sanitation that is
    causing the deaths of millions of people around the world. Even in
    the U.S., despite the recent *e.coli* outbreaks in various food
    sources, the American public is generally unaware of the amount of
    "flu" sickness annually caused by *giardia*, *e. coli*, and other
    bacterial contamination within water systems. The public is also
    generally unaware of the billions of gallons of water and sewer
    leakages and overflows that are happening all over the U.S. While
    media coverage of this issue has been rising, it has yet to generate
    broad public support for investment to fix our nation's water and
    sewer systems. If such public support could be achieved, demand for
    solutions would likely also rise.

-   **Need for a more common view of water and sewer utilities, with
    more consensus on costs and rates**. As noted earlier, the industry
    remains highly fragmented, with thousands of individual water and
    sewer utilities and wide variation in rates and levels of public
    education about rates and costs required to provide safe, reliable
    service. More consolidation of utilities under regional umbrellas,
    even informally, could potentially allow more unified rate
    structures, sharing of central infrastructure and management
    expertise, and lower cost of capital, with access to more
    sophisticated forms of finance beyond traditional municipal bonds.

-   **Need for more innovative financing approaches that can more
    broadly access available sources of capital for clean water
    infrastructure projects**. Various firms are looking to overcome the
    barriers to bringing private sector capital into the municipal water
    sewer markets in creative ways outside of direct utility asset
    purchases. Classic project finance, with a combination of debt and
    private equity, long used in the independent power project market,
    is beginning to be applied in the water sector.

    -   GE's Energy Financial Services group, for example, last year
        formed a water finance group. The new group is offers structured
        equity and customized debt financing for water and wastewater
        projects, targeting transactions from \$15 million to \$500
        million in size. GE believes that its strong balance sheet and
        project finance expertise can help lower the overall cost of
        financing for customers.

    -   Project developers are beginning to look at this structure when
        working with municipalities. For example, Insituform, a company
        that provides sewer pipe rehabilitation services, is working
        with some of its municipal clients and with GE to provide
        project financing with outside equity to complement traditional
        bond financing. Other project finance groups are also beginning
        to experiment in this market.

    -   Others in the industry have suggested grouping regional water
        infrastructure projects, with pooled capital needs and cash
        flows from the projects in one investment trust vehicle, similar
        to what has been used in energy financing. This could allow
        access to larger sources of capital, with lower risk, more
        sophisticated structures, and higher credit rating due to the
        consolidation of projects.

These ideas are simply a very brief sampling of potential approaches
that could help municipalities to gain access to the billions of dollars
in private infrastructure funds that are now available. And, in addition
to large pools of capital, I would note that there are also large pools
of financial expertise in the project finance and energy finance markets
that could likely help policymakers devise and support solutions to meet
the needs of municipal water infrastructure owners as well as private
investors.

I thank the committee for the opportunity to raise attention to this
issue today.