Overview -- The Israeli government has confirmed an expanded support package for Israel's electricity monopoly Israel Electric Corp. Ltd. (IEC) that includes an additional new Israeli shekel (NIS) 2 billion in debt guarantees. -- The guarantees will facilitate the debt issuance that IEC needs to complete to cover its remaining fuel costs between now and the end of 2012. -- We are therefore affirming our 'BB+' long-term foreign currency corporate credit rating on IEC and removing it from CreditWatch negative. -- The negative outlook reflects our opinion that there remains an element of execution risk in the new state support package, which aims to resolve IEC's funding gap in the near term, and support its financial and operational recovery in the medium term. Rating Action On Aug. 21, 2012, Standard & Poor's Ratings Services affirmed its 'BB+' long-term foreign currency corporate credit rating on Israel Electric Corp. Ltd. (IEC). At the same time, we removed the rating from CreditWatch, where it was placed with negative implications on April 5, 2012. Rationale The rating actions reflect our understanding that the Israeli government will expand its package of support measures to address the immediate liquidity crisis resulting from a dramatic escalation in IEC's fuel costs for its electricity generation. The escalation in costs follows a fuel crisis in Israel triggered by the cessation of natural gas from Egypt, which forced IEC to purchase more expensive fuels. In particular, we understand that the government will provide an additional new Israeli shekel (NIS) 2 billion in guarantees to facilitate new debt issuance that IEC needs to cover its remaining funding deficit between now and the end of 2012. The NIS2 billion of new guarantees will bring the total government-guaranteed debt that IEC raised in 2012 to NIS6.4 billion, out of total outstanding debt of about NIS52 billion. The guarantees form part of a wider package of support measures that include tax breaks on fuel, the postponement of deposits into an emergency capital expenditure (capex) fund, and relief from IEC's environmental obligations. In our view, the overall support package demonstrates the government's previously stated commitment that it would fully support IEC in relation to the current fuel crisis. We anticipate that IEC will report weak credit metrics in 2012 and potentially in the first half of 2013. This is because IEC has not been able to pass on the rise in fuel costs to consumers through tariffs on a timely basis, which has led to a rapid increase in debt. However, we anticipate that ratios could recover from 2013, due to the establishment of a new connection with the domestic offshore gas fields, and to tariff increases that the regulator has approved for 2012-2014, aimed specifically at recovering the additional fuel costs. A stabilization of the rating on IEC is conditional on the successful execution of the government's liquidity support package, and on a material strengthening in IEC's liquidity management, which we consider has been weak in recent years. Over the medium term, if liquidity management has strengthened and, in addition, we assess that debt coverage ratios are recovering on a sustainable basis to at least levels before the fuel crisis, there could be upside to the rating on IEC, in our view. We view IEC as a government-related entity (GRE). In accordance with our criteria for GREs, the rating on IEC reflects our opinion that there is a "very high" likelihood that the State of Israel would provide timely and sufficient extraordinary support to IEC in the event of financial distress. We base our assessment on IEC's: -- "Very important" role for Israel's economy, given its virtually unchallenged monopoly position and ownership of essentially all strategically important electricity distribution, transmission, and generation assets in the country. We anticipate some new competition in generation by way of independent power producers but, in our view, IEC's market share in this segment is unlikely to decrease to less than 80% of Israel's total capacity over the medium term; and -- "Very strong" link with the Israeli state, which owns 99.85% of IEC and is actively involved in defining IEC's strategy and approving its borrowing plans. Over the long term, we understand that Israel intends to partly privatize IEC, while remaining a major shareholder. We assess IEC's stand-alone credit profile (SACP) at 'b-', based on our assessment of the company's "fair" business risk profile and "highly leveraged" financial risk profile. IEC's "fair" business risk profile reflects its vertical integration and monopoly position, offset by its high exposure to regulatory risk. We consider that the company's weak liquidity management is the main constraint to its financial risk profile and, consequently, to its SACP. The SACP might otherwise be higher in light of historically satisfactory debt coverage ratios, notwithstanding the weak ratios in the current financial year. Large ongoing funding needs, especially during the current fuel crisis, and high financial leverage also constrain IEC's financial risk profile. Liquidity We assess IEC's liquidity as "less than adequate" under our criteria. We base this on what we view as the company's "weak" stand-alone liquidity position, combined with our view that the Israeli government has the ability and willingness to provide sufficient liquidity support to IEC in a timely manner. Our view of IEC's "weak" stand-alone liquidity profile reflects that the ratio of sources to uses of funds over successive 12-month periods has, under our criteria, been persistently and materially less than 1x. If the government support package to cover fuel costs is implemented as we anticipate, we would assess the ratio of sources to uses of funds at about 1x to the end of 2012, which is less than six months away. To achieve a "less than adequate" liquidity profile on a stand-alone basis, IEC needs to demonstrate that the ratio is at least 1x on a six-month basis, and that there is no material shortfall on a 12-month basis. In this respect, we note that IEC has significant debt maturities in February 2013. We understand from IEC that it is considering introducing measures to strengthen its liquidity management. These measures include the introduction of committed bank facilities, and/or increasing the minimum cash buffer to NIS2 billion, from NIS1 billion currently. For the period August to December 2012, we understand from IEC that total uses of funds will be about NIS18.4 billion. This will be covered by the following sources, amounting to about NIS19.7 billion: -- An opening cash balance in August 2012 of NIS2.08 billion, which includes part of the proceeds from a NIS2.9 billion government-guaranteed debt issue in July 2012. -- NIS2.0 billion in a new debt issue that will be guaranteed by the government, including NIS1.5 billion to be raised in September 2012 and an additional NIS0.5 billion in November 2012. -- NIS733 million in funding for specific projects, to be raised in November 2012. We understand from IEC that it is close to signing bank agreements for this amount. -- NIS14.66 billion in net tariff collection. This includes the first-year tariff increase that the regulator has approved for 2012-2014. -- NIS0.23 billion of income from other sources. The NIS18.4 billion funding requirement assumes that other components of the government support package, such as tax breaks and relief from environmental liabilities, are implemented as planned. In this respect, we assume that in the coming days, IEC will reach an agreement with the regulator to source at least NIS670 million by postponing transfers to the special-purpose emergency capex fund. The government has stated that it would provide an alternative funding solution should IEC and the regulator not reach an agreement on the postponement of transfers. Outlook The negative outlook reflects our view that there is an element of execution risk in the expanded support package for IEC. For example, the Israeli parliament still needs to approve the guarantees and IEC still needs to raise the debt in the market. If the liquidity support package is not executed as we currently anticipate, we see the risk of a multi-notch downgrade of IEC. This is because we would likely lower both the SACP and the likelihood of extraordinary government support to reflect the government's failure to address the funding shortfall in a full and timely manner. We would consider revising the outlook to stable if the guarantees and other components of the liquidity support package are executed as we anticipate in the immediate term. A stable outlook is also contingent on IEC's liquidity improving to a level we consider at least "less than adequate" on a stand-alone basis, or "adequate" including government support. In our view, an assessment of "less than adequate" stand-alone liquidity could result from IEC demonstrating that it can sustainably fund its liquidity needs at least six months in advance, with no material funding gaps in a 12-month period. Related Criteria And Research All articles listed below are available on RatingsDirect on the Global Credit Portal, unless otherwise stated. -- Methodology and Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Rating Government-Related Entities: Methodology and Assumptions, Dec. 9, 2010 -- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, May 27, 2009 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 -- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008 Ratings List Ratings Affirmed; CreditWatch/Outlook Action To From Israel Electric Corp. Ltd. Corporate Credit Rating BB+/Negative/-- BB+/Watch Neg/-- Senior Secured Debt BB+ BB+/Watch Neg Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. 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