Approximately US$500 million of debt securities affected
New York, May 03, 2012 -- Moody's Investors Service affirmed the Baa3 foreign currency senior unsecured
rating of Costa Rica's Instituto Costarricense de Electricidad (ICE) and
assigned a (P)Baa3 rating to ICE's proposed US$250 million
senior unsecured note offering to be issued under the indenture,
dated November 10, 2011, pursuant to which ICE issued initially
the US$250 million 6.95% senior unsecured notes due
2021. The outlook is stable.
ICE plans to use the proceeds from this additional offering for general
corporate purposes.
RATINGS RATIONALE
"ICE's Baa3 rating largely reflects its ownership structure
and linkages with the Government of Costa Rica" said Natividad Martel,
Assistant Vice President at Moody's. Given that it is fully owned
by the Costa Rican government (Baa3, stable), it falls under
the scope of Moody's rating methodology for government-related
issuers (GRIs).
The Costa Rican government does not guarantee ICE's debt obligations rated
by Moody's; however, Moody's believes that there is a
"high" likelihood of government extraordinary support in the case of distress
for several reasons including reputational given the company's status
as a major government-owned entity, its strategic importance
to the country's economy overall, and the low likelihood of privatization
in the foreseeable future. Moody's estimate of "high" default dependence
reflects the expectation that there is an elevated likelihood that the
government and ICE would default simultaneously due to common risk factors.
ICE's Baseline Credit Assessment (BCA), which is a representation
of the group's intrinsic creditworthiness before taking into account possible
extraordinary support from the sovereign is 13 (maps to Ba3), based
on a scale of 1-21 in which 1 indicates the highest credit quality
(Aaa).
The BCA captures ICE's role as an autonomous government entity established
to develop the Costa Rican resources to provide electricity and telecommunication
services, and is especially driven by its dominant position as the
largest vertically integrated utility in the country. It also factors
in the fully regulated nature of its electric operations and, in
our opinion, a regulatory framework that is stable and the overall
constructive relationship that ICE has with the regulatory body for public
services, ARESEP. However, the BCA considers the relatively
low allowed rates of return on ICE's asset base when compared to other
global utilities. That said, Moody's considers a credit
positive ARESEP's authorization in mid March 2012 of the new methodology
for extraordinary adjustments on a quarterly basis of the tariffs in order
to reflect substantial changes in the fuel expenses for thermal power
generation in the country. This change should reduce ICE's
recovery lag of those costs, which is expected to enhance its financial
performance and future cash flows.
The rating also acknowledges ICE's incumbent position in the Costa Rican
telecommunication industry that provides some diversification benefits
from a product offering perspective and cash flow generation. That
said, Moody's attributes limited upside potential to ICE's
rating in connection with this business segment given the strong challenges
faced by ICE due to the worldwide trend of declining demand for fixed-landline
services and the recent introduction of competition in the mobile segment
from two international large carriers, namely América Móvil
S.A.B. de C.V. (A3; stable) and
Telefónica S.A. (Baa1; negative) which commenced
their operations in November 2011. While Moody's acknowledges the
growth potential associated with the country's relatively low current
penetration rate of mobile services compared to other Latin American markets,
Moody's also believes that the two new entrants have the financial
strength to implement very aggressive competitive strategies in order
to gain substantial market share in the country.
The BCA is tempered by the modest size of ICE's operations and service
territory which leaves its electric operations more exposed to storms
and other natural disasters than can impact the region. Further
factors limiting ICE's BCA include its exposure to foreign currency
exchange risk as the vast majority of its indebtedness has been incurred
in foreign currency, primarily in US$, all of which
is exacerbated by ICE's limited ability to hedge this exposure due to
the lack of market depth that currently exists for Colones.
Another factor tempering ICE's BCA is the anticipated deterioration
in credit metrics, as calculated by Moody's, as a result
of the increased financial leverage in light of ICE's aggressive
in-country expansion plan for capital expenditures in the electricity
sector due to growing power demand and, to a lesser extent,
in telecommunications in the wake of the new competition in the mobile
segment. A substantial portion of these investments is to be funded
through operating lease structures where asset ownership can be transferred
to ICE at a later date. Consistent with our standard adjustments
for off-balance liabilities, including operating leases,
Moody's has adjusted ICE's indebtedness to reflect the eventual incurrence
of these leases and the resulting increase in consolidated financial leverage.
Moody's also considers in its assessment ICE's key role to execute
Costa Rica's national electrification plans and the promotion of
the country's power industry that indirectly enhances ICE's
internal cash flows given that it is exempt from paying income tax payments
for its electric operations and from making dividend distributions as
net profits are required to be reinvested back into the business.
Moody's anticipates ICE's adjusted credit metrics to remain commensurate
within the Ba-rating category assigned to the BCA, namely
that retained cash flow (RCF) to debt is expected to be at least 10%,
while cash flow (CFO pre-W/C) interest coverage should approximate
2.0x in most years.
An area of greater concern for Moody's is our perception of ICE's
weak corporate governance which currently caps ICE's BCA.
Our concerns are based on ICE's failure to comply with all of its
covenants at year-end 2011, the qualified opinion issued
by the auditors, KPMG, for ICE's 2010 and 2011 financial
statements, as well as the restatement of ICE's 2010 and 2009
financial statements after a retroactive adjustment of certain historical
line items.
Contrary to Moody's expectations when the Baa3 senior unsecured
rating was assigned in early November 2011, ICE has not been able
to comply with certain covenants under some of its loan agreements.
Moody's understands that various factors contributed to the failure
at year-end 2011, including a timing difference arising from
the delayed reimbursement of certain development costs (around US$80
million) that had been expected during 2011 in connection with the Toro
III hydro-power facility but are now expected this year,
or the delay in the recovery, under the previous methodology,
of the materially higher fuel costs incurred during 2011 amid soaring
worldwide fuel expenses compared to the expected costs considered when
the tariffs were set earlier in the year. Moody's acknowledges
ICE's efforts initiated in early December 2011 to modify its covenant
package. That said, while the commercial banks have amended
the covenant-thresholds under their respective loan agreements,
the multilateral banks as of today have provided only temporary waivers
given the covenant breaches. It is Moody's understanding
that the multi-lateral banks are still internally assessing the
appropriate levels for the covenant-thresholds considering the
required funding of ICE's new hydro-projects. The
current BCA assumes that it is unlikely that the multilateral banks will
accelerate the outstanding balance of their relevant debt, and that
these banks and the B-lenders will approve within the next few
months, an amendment of ICE's covenant-package that
would allow for a greater cushion between the current thresholds and the
expected future operating results.
Nevertheless, Moody's remains concerned about ICE's
management of its liquidity position and covenant package amendment process.
According to disclosures included in ICE's May 2012 Offering Memorandum
and audited financial statements at year-end 2011, the leverage
test under the 2005 Citibank loan agreement was amended but only for 2011
and 2012 to a maximum level of 5.10x, and 4.65x times,
respectively. Based on ICE's own projections it expects to
comply with this covenant in 2013 when the threshold level declines again
to 4.0x. That said, Moody's expects that the
cushion will be extremely tight leaving very little margin for error.
Although Moody's recognizes that the recent change in the fuel cost
recovery methodology is likely to enhance ICE's cash flows and possibly
improve the accuracy of ICE's projections, Moody's also
currently assigns a relatively high probability that ICE may not be able
to comply with the tighter leverage test threshold during 2013.
Moody's also notes that certain pieces of ICE's current indebtedness
include cross-default provisions which further increases our concerns.
Therefore, failure to address this potential covenant violation
appropriately and/or breaching the covenants again is likely to trigger
a negative rating action.
Moody's also considers a credit negative the existence of qualified
opinions issued for ICE's 2011 and 2010 financial statements from KPMG,
and the restatement of certain items in the 2010 statements. Similar
to 2010, the qualified opinion at year-end 2011 highlights
the auditor's inability to perform sufficient audit procedures on a few
items in the financial statements, such as certain account receivables
and prepaid income. Moody's observes that these qualifications
remain specific and narrowly focused on particular accounts, and
that such amounts are not considered material data points in determining
ICE's overall credit rating. Moody's also understands that
management is continuing to implement new procedures and systems that
are intended to address these deficiencies. Also, while not
included as part of the qualification in the auditor's opinion,
KPMG also points out that ICE's capitalized amounts in connection
with the El Diquis hydro-electric project continued to grow during
2011 to around Colones 60,954 million (about US$118 million;
year-end 2010: approximately US$78 million).
While the project is still experiencing delays in its construction,
Moody's believes that a write off of the capitalized costs associated
with the El Diquis project, if undertaken, would not impact
the ICE's current BCA or foreign currency rating.
ICE's stable rating outlook reflects the stable outlook on the rating
of the Costa Rican government and Moody's expectation that the implied
extraordinary support or dependence levels from the sovereign will not
change. The stable outlook also reflects our belief that ICE will
be able to successfully manage the increasing leverage associated with
its material investment program and the associated liquidity in a way
that the credit metrics remain appropriate for its current BCA rating.
The stable rating outlook further incorporates our expectation that ICE's
exposure to foreign currency risk will not cause major liquidity challenges.
Another key expectation embedded in the current outlook is that ICE will
improve its governance management, particularly with respect to
the amendment of certain financial covenants to be approved with new thresholds
defined at levels that allow ICE to comfortably comply with them while
undertaking its current expansion plans.
Since ICE's Baa3 rating is based on Moody's methodology for GRIs,
upward rating pressure is unlikely given the stable rating outlook for
the Costa Rican government and ICE's BCA. The BCA rating
of ICE could be upgraded if ICE successfully executes its capital investment
plans and manages the on- and off-balance sheet indebtedness
in a prudent fashion, or if evidence surfaced of a more credit supportive
Costa Rican regulatory framework which enhances ICE's ability to
earn a higher rate of return on rate base on a sustainable basis.
Evidence of improved governance in terms of appropriate covenant management
and elimination of KMPG's qualifications could also result in a
BCA upgrade. Quantitatively, an upgrade of the BCA could
be triggered if after completion of the construction of its large generation
plants, ICE reports RCF that represents at least 12% of total
adjusted debt and cash flow interest coverage higher than 2.5x
on a sustained basis.
The ratings or outlook would come under pressure if there is any downgrade
in the sovereign rating or outlook or in the case of a lower than anticipated
implied sovereign support or a downgrade of the BCA. Negative rating
pressure on the BCA could surface from a deterioration in the credit supportiveness
of the Costa Rican regulatory framework or if ICE's expansion plan is
poorly executed or indebtedness increases significantly above anticipated
levels such that the credit metrics deteriorate and cash flow interest
coverage falls below 2.0x or RCF to debt declines below 6%
for an extended period. In addition, ratings could be downgraded
if the issuer is not able to successfully secure greater financial flexibility
in the covenant-package under its loan agreements.
The methodologies used in this rating were Regulated Electric and Gas
Utilities published in August 2009, Global Telecommunications Industry
published in December 2010, and Government-Related Issuers:
Methodology Update published in July 2010. Please see the Credit
Policy page on www.moodys.com for a copy of these methodologies
Headquartered in San Jose, Costa Rica, ICE is a government-owned
vertically integrated electric utility as well as an integrated telecommunications
service provider. ICE is the largest electric utility in Costa
Rica accounting for the vast majority of the country's transmission assets
as well as over 75% of the installed capacity and electricity generation.
The group's market share in the distribution of power also exceeds 75%
after considering ICE's 98.6% ownership stake in Compañia
Nacional Fuerza y Luz that serves the capital. The group's 2,252.4
megawatt fleet approximates 77.2% of the country's installed
capacity, and generates about 78% of the power, with
the bulk of its fleet being hydro capacity. ICE's telecommunication
operations include fixed-line and mobile as well as data transmission
services. As of year-end 2011, ICE reported assets
of approximately US$9.6 billion.
REGULATORY DISCLOSURES
The Global Scale Credit Ratings on this press release that are issued
by one of Moody's affiliates outside the EU are endorsed by Moody's
Investors Service Ltd., One Canada Square, Canary Wharf,
London E 14 5FA, UK, in accordance with Art.4 paragraph
3 of the Regulation (EC) No 1060/2009 on Credit Rating Agencies.
Further information on the EU endorsement status and on the Moody's
office that has issued a particular Credit Rating is available on www.moodys.com.
For ratings issued on a program, series or category/class of debt,
this announcement provides relevant regulatory disclosures in relation
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or category/class of debt or pursuant to a program for which the ratings
are derived exclusively from existing ratings in accordance with Moody's
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this announcement provides relevant regulatory disclosures in relation
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rating action for securities that derive their credit ratings from the
support provider's credit rating. For provisional ratings,
this announcement provides relevant regulatory disclosures in relation
to the provisional rating assigned, and in relation to a definitive
rating that may be assigned subsequent to the final issuance of the debt,
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the lead rating analyst and to the Moody's legal entity that has issued
the rating.
Natividad Martel
Asst Vice President - Analyst
Infrastructure Finance Group
Moody's Investors Service, Inc.
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William L. Hess
MD - Utilities
Infrastructure Finance Group
JOURNALISTS: 212-553-0376
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Moody's assigns (P)Baa3 to ICE's US$250 million senior unsecured notes
