Moody's assigns (P)Baa3 to ICE's US$500 million senior unsecured notes; stable outlook

Approximately US$1 billion of debt securities affected

New York, May 08, 2013 -- 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 new proposed 30-year US$500 million senior unsecured note offering due in 2043. The outlook is stable.

ICE plans to use $386 million of the proceeds from this additional offering to refinance maturing debt and to fund its capital expenditure (capex) program.

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 guarantees certain loans executed by ICE (around 10% of its outstanding indebtedness) but does not guarantee ICE's debt obligations rated by Moody's, including the US$500 million senior unsecured note offering. 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 ba3, based on a scale of aaa to ca which aaa indicates the highest credit quality (Aaa).

The ba3 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. 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. 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. In reaching this assessment,we consider the new methodology for the recovery of variable fuel related costs which allows for quarterly tariff adjustments to reflect gaps between the actual and estimated fuel costs used when setting the rate schedule for the following quarter. Somewhat tempering this positive view is the time elapsed between the methodology implementation in March 2012 and the first related adjustments that began in February 2013 (based on the previous quarter expenses). Furthermore, rate implementation is subject to ARESEP's final approval such that the first increase became effective in April 2013. That said, Moody's believes this is a significant improvement compared to the previous methodology that will enhance ICE's financial and liquidity profile, particularly during periods of high volatile fuel-oil prices.

The rating 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. However, Moody's believes the issuer faces significant challenges including the existence of two new entrants that began mobile operations end of 2011 and have the financial strength to implement very aggressive competitive strategies. That said, Moody's acknowledges that according to ICE's estimates, its market share in the mobile segment still exceeded 75% at year-end. However, Moody's notes that in order to maintain its dominant position, ICE's related marketing expenses increased significantly leading to a a material reduction in the operations profitability, a credit negative.

A credit concern captured in ICE's BCA is its exposure to foreign currency exchange risk as the vast majority of its indebtedness has been incurred in foreign currency, primarily US$. Our concerns are exacerbated by ICE's limited ability to hedge this exposure due to the lack of market depth that currently exists for Colones (currently only around 22%) and particularly in the absence of electric tariff adjustments to reflect changes in the exchange rate, unlike other jurisdictions in the region. That said, we gain some comfort from the limited volatility recorded over the last years by the exchange rate between the Costa Rican colones and US$.

Similar to other Central and Latin American issuers, ICE has no committed credit facilities in place. Its reliance on the capital markets to fund its substantial capital requirements is a credit negative. ICE's BCA is also tempered by the anticipated deterioration in credit metrics, as calculated by Moody's owing to increased financial leverage in light of ICE's aggressive in-country expansion plan for capex in the electricity sector, including the 305MW US$1.2 billion El Reventazon hydro-electric project (completion expected by mid 2016). A portion of the investments required to meet the country's growing power demand is funded through special purpose vehicles and operating lease structures where asset ownership can be transferred to ICE at a later date. We consider these off-balance sheet obligations in the calculation of ICE's leverage based metrics. Furthermore, Moody's factors 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. Net profits are required to be reinvested back into the business. Therefore, Moody's anticipates ICE's key credit metrics to remain commensurate within the Ba-rating category assigned to the BCA, Specifically, that it will report a retained cash flow (RCF) to debt ratio of at least 10% and cash flow (CFO pre-W/C) interest coverage of at least 2.0x.

An area of greater concern for Moody's is our perception of ICE's weak corporate governance which currently caps its BCA. Our negative opinion considers ICE's continued failure to comply with all of its financial covenants, and the qualified opinion issued by the auditors, KPMG, for ICE's 2010 and 2011 financial statements, as well as its repeatedly restatement of ICE's financial statements with retroactive adjustment.

Moody's acknowledges that during 2012 ICE managed to amend the financial covenant-thresholds under several of its bank loan agreements allowing for a greater cushion between the previous thresholds and ICE's operating results while undertaking its current expansion plans; however, as anticipated when Moody's rated the last piece of senior unsecured debt issued by ICE in May 2012 ICE is currently not in compliance with the tighter leverage test thresholds. Specifically, ICE does not comply with the covenant-threshold level under its 2005 loan agreement with Citibank that caps its Debt to EBITDA to 4.0x (5.07x at year-end 2012; 5.2x pro-forma after the new debt issuance). Moreover despite the amendment in March 2012 of its AF Loan Agreement, ICE is not in compliance with the maximum debt to EBITDA of 5.0x and the minimum EBITDA to debt service of at least 1.6x (at year-end 2012 and pro-forma after the new debt issuance: 1.1x). The latter violation is partially due to the components of the calculation which considers in the denominator bullet debt payments due at maturity for certain pieces of debt. We understand that both banks have provided temporary waivers given the covenant breaches. We also understand that Citibank is currently internally assessing the appropriate levels for the covenant thresholds that would allow for a greater cushion. However, we understand that an amendment to the definition of the leverage threshold under the CAF loan is less likely to happen over the short term. That said, ICE's BCA assumes that as a multilateral bank CAF is unlikely to accelerate the outstanding balance of its loan. This is particularly relevant as Moody's understands that certain pieces of ICE's indebtedness, including the senior unsecured notes rated by Moody's, include cross-default provisions, particularly considering its dependence on the capital markets mentioned earlier.

Moody's also considers a credit negative the existence of qualified opinions issued for ICE's 2012, 2011 and 2010 financial statements from KPMG. Similar to 2011 and 2010, the qualified opinion at year-end 2012 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 gains some comfort from the fact 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 while progress is continuing, albeit at a slower than expected pace, 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 2012 to around Colones 68,902 million (about US$140 million). While the project is still experiencing significant delays, Moody's believes that a write-off of the El Diquis project's capitalized costs, 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 Baa3 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.. An important expectation embedded in the current outlook and rating is that ICE will improve its governance management, that ICE will comply with its financial leverage covenants after the expected amendment of the 2005 Citibank credit agreement, and that CAF will not accelerate the outstanding balance of its loan when ICE continues not to comply with all its financial basis on a consistent basis. The stable rating outlook further incorporates our expectation that ICE's exposure to foreign currency risk will not cause major liquidity challenges.

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 ba3 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 full elimination of KMPG's qualifications are important factors for consideration of 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 over 12% of total adjusted debt and cash flow interest coverage higher than 3x, on a sustained basis.

The ratings or outlook would come under pressure if there is any downgrade in the sovereign rating or its outlook is changed to negative. ICE's rating is also likely to experience negative momentum 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 issuer's credit metrics deteriorate and cash flow interest coverage falls below 2.0x or the ratio of 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. As of year-end 2012, ICE reported assets and cash flows from operations of approximately US$10 billion and US$714 million, respectively.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series 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 rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the rating action on the support provider and in relation to each particular rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain 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, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this rating action, and whose ratings may change as a result of this rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Natividad Martel
Asst Vice President - Analyst
Infrastructure Finance Group
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

William L. Hess
MD - Utilities
Infrastructure Finance Group
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Releasing Office:
Moody's Investors Service, Inc.
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JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653