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Rating Action:

Moody's assigns a Baa2 rating to COELBA up to BRL350 million bonds; Outlook stable

 The document has been translated in other languages

Global Credit Research - 18 Apr 2011

Approximately BRL350 million of debt instruments affected

Sao Paulo, April 18, 2011 -- Moody's Investors Service (Moody's) assigned a Baa2 rating to up to BRL350 million unsecured bonds due in 5 years to be issued by Companhia de Eletricidade do Estado da Bahia S.A (Coelba) in the international markets. The outlook is stable. This is the first time Moody's has assigned a rating to Coelba.

RATINGS RATIONALE

The proceeds of the issuance will be used to pay-off short-term debt and strengthen the company's liquidity profile.

The Baa2 rating reflects Coelba's inherently stable and predictable cash flow supported by a long-term concession to distribute electricity in the state of Bahia and its relatively adequate credit metrics for the rating category. The Baa2 rating is one notch higher than the rating indicated by Moody's methodology grid to reflect the financial strength of Neoenergia (not rated) on a consolidated basis and the implicit support of its ultimate shareholders, which include the Spanish company Iberdrola S.A (A3; negative), Banco do Brasil (Baa2 (pos), Senior Unsecured Debt Rating) and PREVI (not rated).

The rather aggressive distribution of dividends and relatively high capital expenditures constrain the rating as does the Brazilian evolving regulatory framework.

The change of the accounting principles from the Brazilian GAAP to the IFRS (International Financial Reporting Standards) for Coelba's 2009 and 2010 financial statements does not interfere with Moody's comparative analysis of the utilities' cash flow statements for these years against the previous years.

This stems from the fact that the main cash flow parameter used in Moody's methodologies for electric utilities cash from operations before changes in working capital needs (CFO Pre-WC), already captured the variations in the regulatory assets and liabilities.

Unlike the Brazilian GAAP accounting method the IFRS does not recognize the concept of regulatory assets and liabilities. As a result, going forward Moody's expects higher volatility in cash flow parameters as measured by funds from operations (FFO). Any change in the so-called regulatory assets and liabilities will be recognized either as expense or revenue in the profit and loss statement.

Coelba has posted outstanding operating performances over the past three years with both profitability and cash flow remaining relatively stable. In 2010, largely as a result of a 7.5% expansion in volume sales FFO expanded to BRL1,150 million from BRL1,010 million in 2009.

Despite the improvement in FFO, Coelba's cash flow metrics showed some deterioration in 2010, because of a higher level of indebtedness while CFO Pre WC remained virtually flat. The higher level of debt mainly derived from the sizeable distribution of dividends of BRL1 billion in 2010 up from BRL334 million in 2009 and BRL873 million in 2008. As a result, the CFO pre-WC - Dividends over total debt ratio fell to just 2.2% in 2010 from 45.4% in 2009 and 13.2% in 2008.

Going forward, Moody's projects that CFO will increase until April 2013, when lower tariffs from the application of the third tariff review will go into effect resulting in a lower level of CFO. The higher CFO over the next two years will derive mainly from expected growth in annual sales volume of around 4%, in line with the forecasted increase in the Brazilian GDP, but impaired somewhat by projected higher interest expenses. The projected higher level of debt along with the recent spike in the local interest rates explains the expected higher level of interest expenses.

In April 2013, the regulator ANEEL will apply the third tariff review to Coelba, which will transfer productivity gains to consumers. The application will also apply a lower WACC in the face of lower capital costs (equity and borrowings) among the Brazilian electricity distribution companies. At the end of last year, ANEEL signaled a significant reduction of tariffs for all Brazilian electricity distribution companies when it placed for public hearing the new procedures for the third electricity tariff review, to be implemented from 2011 through 2013. According to the Brazilian electricity regulatory model all Brazilian electricity distribution companies are subject to periodic tariff reviews every four to five years in order to transfer any productivity gains to consumers.

Based on public information available at ANEEL's website, a very preliminary estimate indicates that the average reduction in EBITDA for the Brazilian electricity distribution companies could reach as much as 30% if the tariff review parameters the regulator has suggested are strictly followed. Moody's expects that electricity tariffs will eventually be reduced but by a lower percentage amount than the regulator initially suggested. Moody's expects the reduction in EBITDA to stay within the 20-25% range, which translates into a tariff reduction of 5% to 7%.

Moody's projects that debt will increase in 2011 and remain relatively stable over the following two years. The projected higher level of debt in 2011 mainly results from planned capital expenditures of over BRL900 million and from maintaining the high dividend pay-out ratio of close to 100%.

The stable outlook reflects Moody's expectations that, despite some forecasted deterioration in credit metrics in comparison with the historical three- year average, Coelba will post credit metrics in line with the Baa3 rating category. It also reflects that Moody's feels the company will be able to continue to count on the support of its immediate and ultimate shareholders.

Given the recent rating action and the fact some deterioration in credit metrics is expected, an upgrade rating action over the medium term is very unlikely. A pronounced improvement in the level of the support of the Brazilian electricity regulatory framework could prompt upward rating pressure.

Moody's would consider a downgrade rating action if CFO Pre WC -- dividends over debt falls below 13% and interest coverage stays below 3.5x for a prolonged period. Deterioration of the financial condition of Neoenergia and the perception of lower support from its immediate and ultimate shareholders could also prompt a downgrade rating action.

Coelba distributes electricity to 415 municipalities out of 417 in the state of Bahia through a 30-year concession agreement granted by ANEEL which expires in 2027. In 2010, Coelba distributed 15,329 GWh to the regulated and free consumers, which is equivalent to around 3.5% of all the electricity consumed in the Brazilian integrated system. In 2010, Coelba posted net revenues of BRL3.7 billion (USD 2.1 billion), which does not include construction revenues of BRL693 million (USD394 million) and net profit of BRL946 million (USD 538 million).

Coelba is controlled by Neoenergia, which has 89.8% of its voting capital and 87.8% of its total capital. Neoenergia is a holding company with interests in three electricity distribution companies with also a relevant participation in the generation business. Neonergia is controlled through a shareholding agreement by the Spanish group Iberdrola (39% of the voting capital), Previ (49% of the voting capital), which is the pension fund of Banco do Brasil's employees and the federal owned bank Banco do Brasil (12% of the voting capital).

The principal methodology used in this rating was Regulated Electric and Gas Utilities published in August 2009.

REGULATORY DISCLOSURES

Information sources used to prepare the credit rating are the following: parties involved in the ratings, parties not involved in the ratings, public information, confidential and proprietary Moody's Investors Service information, and confidential and proprietary Moody's Analytics information.

Moody's Investors Service considers the quality of information available on the issuer or obligation satisfactory for the purposes of assigning a credit rating.

Moody's adopts all necessary measures so that the information it uses in assigning a credit rating is of sufficient quality and from sources Moody's considers to be reliable including, when appropriate, independent third-party sources. However, Moody's is not an auditor and cannot in every instance independently verify or validate information received in the rating process.

Please see ratings tab on the issuer/entity page on Moodys.com for the last rating action and the rating history.

The date on which some Credit Ratings were first released goes back to a time before Moody's Investors Service's Credit Ratings were fully digitized and accurate data may not be available. Consequently, Moody's Investors Service provides a date that it believes is the most reliable and accurate based on the information that is available to it. Please see the ratings disclosure page on our website www.moodys.com for further information.

Please see the Credit Policy page on Moodys.com for the methodologies used in determining ratings, further information on the meaning of each rating category and the definition of default and recovery.

Sao Paulo
Jose Soares
Vice President - Senior Analyst
Infrastructure Finance Group
Moody's America Latina Ltda.
JOURNALISTS: 800-891-2518
SUBSCRIBERS: 55-11-3043-7300

New York
William L. Hess
MD - Utilities
Infrastructure Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Moody's America Latina Ltda.
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Moody's assigns a Baa2 rating to COELBA up to BRL350 million bonds; Outlook stable
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