Overview -- Despite Iberdrola's strategic focus on debt reduction, we believe that the group's improvement in credit ratios could be constrained by potential delays in tariff deficit securitization and the difficult macroeconomic and business environment in its key markets. -- We are therefore lowering our corporate credit rating on Iberdrola to 'BBB', and affirming our short-term rating at 'A-2'. -- We consider that Iberdrola has taken actions to reduce its exposure to Spanish country risk, which we now see as "moderate". -- The stable outlook reflects our expectation that Iberdrola will maintain ratios in line with the rating. Furthermore, if we downgrade Spain by one notch, the rating on Iberdrola would not be affected, given our view of its "moderate" country risk exposure. Rating Action On Nov. 28, 2012 Standard & Poor's Ratings Services lowered its long-term corporate credit and senior unsecured debt rating on Spain-based utility Iberdrola S.A., and its subsidiaries Iberdrola USA and Iberdrola Renewables Holdings Inc., to 'BBB' from 'BBB+'. We also lowered the long-term CaVal (Mexico) national scale issue rating on Iberdrola Finanzas S.A.U. to MxAA+ from MxAAA. At the same time, we affirmed our 'A-2' short-term corporate credit ratings on Iberdrola and Iberdrola USA. The outlook is stable. Rationale The downgrade reflects our view that, despite its strong emphasis on improving credit quality, Iberdrola's strategic plan for 2012-2014 could fail to improve credit ratios to levels commensurate with the 'BBB+' rating, including Standard & Poor's-adjusted funds from operations (FFO) to debt of more than 20%. We believe that management is committed to reducing debt by EUR6 billion by 2014 through a combination of lower capital investments, asset disposals, tariff deficit securitization, and positive free cash flows in all businesses. Nevertheless, our projections of flat EBITDA over 2012-2014 due to the tough fiscal and economic environment in Spain, as well as potential delays in the receipt of EUR3.0 billion of past tariff deficit receivables, lead us to anticipate that Iberdrola will sustain adjusted FFO to debt of about 18%. Due to the ongoing erosion in both revenues and operating income from Spain, we believe that contributions from this jurisdiction will slightly exceed 40% over the near-to-medium term. This, combined with our assessment of the utility sector's "high" sensitivity to country risk, would generally lead us to assess Iberdrola's country risk exposure as "high". However, we view Iberdrola's exposure as "moderate" because the group effectively mitigates its exposure to Spanish country risk by its: -- High geographical diversification. A significant share of stable earnings is generated out of its majority-regulated U.K. operations, which have currently low external leverage, and its regulated U.S. activities. We believe that these assets remain financeable and could fully satisfy Iberdrola's refinancing requirements in the medium term, even if the crisis in Spain becomes more severe. -- Declining share of investments earmarked to the Spanish domestic market, which amount to less than 20% of the strategic plan's investment budget; -- Strategic emphasis on strong free cash flow generation in all businesses, including the Spanish operations; -- Strong and uninterrupted access to the global bank and capital funding markets; and -- Strong liquidity on the back of cash balances and available credit facilities, benefiting from relatively low reliance on Spanish banks. As a result, we assess Iberdrola's country risk as "moderate." Nevertheless, we could revise our assessment of Iberdrola's "moderate" country risk exposure if the earnings and operating income contribution from Spain does not decrease over the medium term or if we observe anything else that suggests that Iberdrola is being constrained by its Spanish domicile. This could include restricted access to funding or any ad hoc fiscal transfer measures implemented by the Spanish government. Given our assessment of "moderate" exposure to country risk, there is a maximum possible rating differential of three notches between the ratings on Iberdrola and those on its related investment-grade sovereign. Under the same criteria, in a theoretical scenario where we lower the sovereign rating to a speculative-grade level, we would allow the rating on Iberdrola to exceed the sovereign rating by a maximum of two notches. We continue to assess Iberdrola's financial risk profile as "significant," based on the group's relatively high leverage and credit metrics, which are below our rating guidelines. In our base-case scenario, we anticipate that Iberdrola will generate flat EBITDA in 2012-2014 as the international business offsets the reduction of profits from Spain due to the impact of regulatory reform. Factoring in the announced asset disposal plan, we project the balance sheet deleverage will result in credit ratios of adjusted FFO to debt of about 18% over the near term. If the Spanish Treasury securitizes the past tariff deficit, we see an upside possibility that credit ratios will improve to 20%. However, we are cautious to include potential proceeds of tariff deficit securitization as they are dependent on credit market conditions. Downside to our forecasts on the cash flow side could arise from weaker power market fundamentals in Spain and the U.K., increased political risk, and/or a more adverse effect of the planned electricity market reform in Spain. A number of factors continue to underpin our assessment of Iberdrola's "strong" business risk profile. Most importantly, the group benefits from cash flow stability of about 70% of group EBITDA (at financial year-end Dec. 31, 2011) from regulated and quasi-regulated renewable operations. Furthermore, the group benefits from significant scale and geographic diversity from its vertically integrated utility operations in the U.K., the U.S., and Latin America. Offsetting these strengths are the challenging macroeconomic, fiscal, and business environment in Spain, which heightens regulatory risk, and leads to intensifying pressure on the profitability of Iberdrola's domestic operations in both the liberalized and regulated markets. Liquidity The short-term corporate credit rating on Iberdrola is 'A-2', and reflects the long-term corporate credit rating and our view of Iberdrola's "strong" liquidity profile under our criteria. Over the next 12-24 months, we forecast that liquidity sources--mainly comprising operating cash flow and available bank lines--will cover projected uses--comprising capital expenditure, debt maturities, and dividends--by at least 1.5x and 1.0x, respectively. Our assessment of the group's liquidity is underpinned by: -- Iberdrola's access to unrestricted short-term cash and short-term marketable securities of about EUR2.5 billion as of Sept. 30, 2012; -- A total of about EUR7 billion in undrawn committed credit lines with maturities longer than 12 months; and -- Our forecast that Iberdrola will generate adjusted FFO of about EUR5.7 billion in 2012. This compares with our forecast that, over the next 12 months, Iberdrola faces: -- EUR3.5 billion in capex under our base-case scenario; -- Dividend payments of about EUR1 billion (part of which could be non-cash through a scrip dividend); and -- About EUR3.8 billion in short-term debt maturing over the next 12 months. About 40% of these maturities include commercial paper and short-term facilities that the group expects to roll over as it has done in the past. However, this depends on the strength of the Spanish banking system and its ability to support such a roll-over of short-term debt. Further supporting our opinion of Iberdrola's "strong" liquidity position is the group's ability to absorb high-impact, low-probability events and maintain a limited need for refinancing. Additional supports are the group's flexibility to reduce capital spending or sell assets; its sound bank relationships with a diversified pool of counterparties; its solid standing in credit markets; and its generally prudent risk management. Outlook The stable outlook reflects our expectation that Iberdrola will achieve and sustain adjusted FFO to debt of about 18%. It also reflects the fact that, given our assessment of Iberdrola's "moderate" country risk exposure, if we downgrade Spain by one notch, the rating on Iberdrola would not be affected, all else being the same. That said, in the event of a sovereign downgrade, we will review our assessment of country risk exposure. We could reassess our opinion of Iberdrola's country risk exposure if the earnings and operating income contribution from Spain does not decrease over the medium term or if we observe anything else to suggest that Iberdrola is being constrained by its Spanish domicile. We would likely lower the rating if we consider that Iberdrola could struggle to achieve and maintain adjusted FFO to debt of about 18%. This could occur if weaker conditions than we forecast in the group's key markets, Spain in particular, weigh on its profitability. In addition, a potential increase in political risk, for example, due to government policies that aim to extract cash from power utilities in Spain, could also prevent Iberdrola from achieving the guideline ratio. In our view, rating upside could arise if Iberdrola's financial risk profile strengthens ahead of our current base-case scenario. We see sustainable adjusted FFO to debt of 20% as commensurate with a higher rating, assuming no further negative action on the rating of Spain and no change in the assessment of Iberdrola's business risk profile. This outcome could result from the successful completion of the Spanish tariff deficit securitization and the elimination of the structural deficit. It would also likely depend on management's continued commitment to conservative financial policies and focus on sustained debt reduction. Related Criteria and Research -- How Regulatory Ring-Fencing Affects Our Ratings On U.K. Utilities, Nov. 22, 2012 -- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012 -- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- General Criteria: Nonsovereign Ratings That Exceed EMU Sovereign Ratings: Methodology And Assumptions, June 14, 2011 -- Use Of CreditWatch And Outlooks, Sept. 14, 2009 -- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 -- Methodology: Short-Term/Long-Term Ratings Linkage Criteria For Corporate And Sovereign Issuers, May 15, 2012 -- Corporate Criteria--Parent/Subsidiary Links; General Principles; Subsidiaries/Joint Ventures/Nonrecourse Projects; Finance Subsidiaries; Rating Link to Parent, Oct. 28, 2004 Ratings List Downgraded; CreditWatch/Outlook Action To From Iberdrola Renewables Holdings Inc. Corporate Credit Rating BBB/Stable/-- BBB+/Watch Neg/-- Iberdrola S.A. Senior Unsecured BBB BBB+/Watch Neg Iberdrola Finance Ireland Ltd. Senior Unsecured* BBB BBB+/Watch Neg Iberdrola Finanzas S.A.U. Senior Unsecured* BBB BBB+/Watch Neg Senior Unsecured* mxAA+ mxAAA/Watch Neg Iberdrola International B.V. Senior Unsecured* BBB BBB+/Watch Neg Iberdrola USA Senior Unsecured BBB BBB+/Watch Neg Downgraded; CreditWatch/Outlook Action; Ratings Affirmed To From Iberdrola S.A. Iberdrola USA Corporate Credit Rating BBB/Stable/A-2 BBB+/Watch Neg/A-2 Ratings Affirmed Iberdrola International B.V. Commercial Paper* A-2 *Guaranteed by Iberdrola S.A. 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. Use the Ratings search box located in the left column.