The US Government Shutdown and Debt Limit
» For the US Sovereign, Failure to Raise Debt Limit Would Be

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Worse Than a Shutdown
» Some Defense Contractors Are Better Prepared Than Others » Fannie Mae and Freddie Mac Face No Direct Effect » Health Insurers Would Not Be Directly Affected by a

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Shutdown, But Are Exposed to a Failure to Raise Debt Limit
» Surety Insurers Face Delays in New Business, But Little, If Any,

Increase in Claims
» Certain Public Finance Credits Are Exposed

» Stryker's Acquisition of MAKO Surgical Is Credit Negative » Labco's Sale of Its German Subsidiary to Sonic Is Credit Positive

» NorthWestern Corp. Purchase of Hydro Assets Is Credit


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Credit Negative for Utilities
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Enel Banks
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Credit implications of current events

The US Government Shutdown and Debt Limit
Two legislative deadlines for the United States (Aaa stable) government have the potential to disrupt US financial markets and economic growth. If Congress fails to pass a budget or a continuing resolution to authorize spending by the evening of 30 September, the federal government will shut down. The shutdown would force a halt in discretionary spending, which is 38% of non-interest government expenditures. The second deadline is likely in mid-October, when the Treasury will have exhausted the extraordinary measures it can use to finance government operations without increasing government debt, which is prohibited unless Congress increases the statutory debt limit. Failure to raise the debt ceiling would require a 15%-20% cut in total spending. Our expectation is that the US will avoid a government shutdown and will increase the debt limit. These articles address the credit implications if in fact there is either a government shutdown or a failure to raise the debt ceiling:

» For the US sovereign, failure to raise the debt limit would be worse than a shutdown » Some defense contractors are better prepared than others for a shutdown or failure to raise the debt limit » Fannie Mae and Freddie Mac face no direct effect from a shutdown or failure to raise the debt limit » Health insurers would not be directly affected by a shutdown, but are exposed to a failure to raise the debt limit » Surety insurers face delays in new business, but little, if any, effect on claims with a shutdown or failure to raise the debt limit » Certain public finance credits are exposed to a shutdown and failure to raise the debt limit

Steven Hess Senior Vice President - Manager +1.212.553.4741 steven.hess@moodys.com

For the US Sovereign, Failure to Raise Debt Limit Would Be Worse Than a Shutdown
If the shutdown occurs or if Congress fails to raise the debt limit, the consequences for the economy and government revenues would be negative. A failure to raise the federal debt limit would have greater adverse financial market and economic consequences than a government shutdown because market participants would perceive an increased probability of a sovereign default. A government shutdown would not affect debt service. Federal discretionary spending authorization, which ceases 30 September, accounts for about 38% of total non-interest federal spending and includes most day-to-day government operations. Spending on mandatory programs – mainly Social Security, Medicare, Medicaid and other social programs – would continue, as would interest payments on Treasury securities, since these do not need annual authorization. If a shutdown occurred, the government would still service its debt, but like the government shutdown from late 1995 to early 1996, we would expect most federal employees to be unpaid and not to work. In fact, on 17 September, Office of Management and Budget Director Sylvia Burwell instructed federal executive department and agency heads to make contingency plans for a federal government shutdown. Government revenues would be adversely affected by the ensuing slowdown in economic activity, a credit negative. Failure to raise the debt ceiling would have more severe financial market and economic consequences. The Treasury cannot increase its debt above the $16.7 trillion statutory debt limit unless Congress votes to




Credit implications of current events raise the limit. Although we expect that the debt limit will be increased, if borrowing authority is not increased, all government spending would be limited to the amount of incoming revenues. In contrast to the government-shutdown scenario, failure to increase the statutory debt limit could theoretically affect all categories of government spending, including debt service. The magnitude of the reduction in spending would be less, and hence have a smaller direct effect on economic activity. According to Congressional Budget Office (CBO) projections, tax and other revenues will have financed about 81% of spending in fiscal 2013 and will finance 84% of spending in fiscal 2014, which begins 1 October. Borrowing finances the remainder. Therefore, without authorization to increase borrowings, the government would have to reduce total spending by somewhere in the 15%-20% range, an amount likely to drag on the economy, but less so than the shutdown’s potential 38% reduction in non-interest government spending. We believe that the government would continue to pay interest on Treasury securities. However, the government would have to make painful choices as to which expenditure to cut, and there is no historical precedent that provides confidence that interest payments would be prioritized over discretionary spending. In the 2014 fiscal year, the CBO projects that interest payments will account for about 7% of total federal spending, leaving still considerable room to meet interest payments in the event of 15%-20% expenditure cuts. October interest payments are relatively small, but on 15 November, the Treasury will need to pay interest of about $16 billion – equal to about 6% of average monthly revenues in fiscal 2014, although monthly revenue collection varies considerably. Financial market and economic consequences would likely be more severe if the debt limit is not raised than under a government shutdown. Although the expenditure reduction under the debt limit scenario is smaller, the perception that the US government could default on servicing its debt if the debt limit is not raised could roil financial markets and damage business and consumer confidence.




Credit implications of current events

Bruce Herskovics Vice President - Senior Analyst +1.212.553.0192 bruce.herskovics@moodys.com Russell Solomon Senior Vice President +1.212.553.4301 russell.solomon@moodys.com

Some Defense Contractors Are Better Prepared Than Others for a Shutdown or Failure to Raise the Debt Limit
The two US budget deadlines threaten to weaken liquidity for US defense contractors. Although it is not our expectation, failure to avoid a shutdown and to increase the debt limit would clearly be credit negative for defense contractors. Nearly all defense spending is technically “discretionary” for budget purposes, but specific components related to national security have been excepted in the past. Quantification of the potential effect on issuers in the sector is therefore difficult because the scope, duration and prospective targets of potential government payment deferrals are not yet known. Despite significant spending cutbacks dealt by sequestration — the financial consequences of which we expect will be more noteworthy in 2014 and beyond — we believe defense contractors are only marginally better prepared for a potential disruption in government payments than they were during the most recent debt-ceiling crisis in 2011. We base our view on our Defense Contractor Liquidity Index (DCLI), which measures vulnerability to a government shutdown accompanied by a complete cessation of such government payments. A fair amount of variability — and hence perceived underlying preparedness — is evidenced in our DCLI scores. Scores are based on each company’s current sources of near-immediate liquidity (cash and available committed bank lines) as of 30 June 2013 relative to the company’s estimated annual US governmentrelated revenue. A score of 50 indicates liquidity is half government-related revenue. The 65 companies in our study are split about equally into three categories:

» well protected - DCLI scores of 100, the best outcome on our scale, generally reflecting low exposure to the US government, and/or strong liquidity relative to such exposure » better protected - DCLI scores of 21-90, indicating the equivalent of several months of liquidity cushion to withstand prospective disruptions with respect to collecting on US government receivables » more exposed - DCLI scores below 20, for companies most at risk in the event of a government shutdown, wherein only a few weeks of backstop liquidity may be available to mitigate the risk of government payments ceasing
More commercially oriented companies with comparatively limited exposure to the US government, such as Honeywell International Inc. (A2 stable, 100 DCLI score), BE Aerospace, Inc. (Ba1 stable, 100) and TransDigm Inc. (B2 stable, 100), score the best. Larger, more diversified investment grade-rated companies that also maintain reasonably large exposures to the US government, such as Boeing Co. (A2 stable, 49), Rockwell Collins, Inc. (A2 review for downgrade, 69) and Textron Inc. (Baa3 stable, 42), score well, but lower. Those with DCLI scores below 20 are generally mid- to low-tier contractors with elevated leverage, ongoing and more niche-oriented exposure to US military outlays and comparatively limited near-immediate sources of liquidity relative to this exposure. Examples of such companies that we believe are most vulnerable to a government shutdown, depending of course on each one’s ability to take offsetting, cash-conserving actions, include Kratos Defense & Security Solutions, Inc. (B3 stable, 18), The SI Organization (B3 stable, 14) and Hunter Defense Technologies, Inc. (Caa1 negative, 13), among others. But this “more exposed” group also includes some of the larger, more highly rated companies that are just more heavily wed to the US government, given their heavy skew toward defense- or intelligence-oriented business lines. This group includes the likes of Lockheed Martin Corp. (Baa1 stable, 11), L-3 Communications Corp. (Baa3 stable, 13), Huntington Ingalls Industries, Inc. (Ba2 stable, 18), Alliant Techsystems Inc. (Ba2 review for downgrade, 13) and Booz Allen Hamilton Inc. (Ba3 stable, 16).




and as elsewhere. The risks related to a potential disruption in cash collections from the US government remain elevated for all. We would be particularly concerned in the event of a wholesale government shutdown wherein bill payments cease for more than just a few weeks. the strongest chain is vulnerable to its weakest link. 27 September 2013. 5 MOODY’S CREDIT OUTLOOK 30 SEPTEMBER 2013 . there is considerable variability on an individual company basis. We discuss the findings of our latest Defense Contractor Liquidity Index in greater depth in Global Aerospace and Defense: Liquidity Profiles Only Slightly Improved from Previous Debt-Ceiling Crisis.NEWS & ANALYSIS Credit implications of current events So although overall liquidity is deemed to be modestly improved for the rated aerospace and defense industry at large. especially because many of the smaller companies characterized as more at risk are critical suppliers to the larger companies.

Neither Fannie Mae nor Freddie Mac currently depend on government funds. based on our conversations with government officials. However. The Treasury’s capital injections were also significant. for Fannie Mae and Freddie Mae. However. to offset the losses. we believe that any payments to the two GSEs as part of their capital agreement would be mandatory spending and.6 billion for Fannie Mae and $140.553. the two GSEs have reported positive net income as the housing market recovered and they increased guarantee fees (see exhibit below). in the unlikely event that a financial disruption resulted in the GSEs reporting a loss.4705 brian. respectively.harris@moodys.212. these events will not affect the credit strength of these GSEs.1 billion for Fannie Mae and $71. since first-quarter 2012. The Treasury committed to provide contingent capital. as such. there is a high likelihood that the Treasury would honor the capital agreement with them. would not be affected by a government shutdown. The two GSEs were put into conservatorship in September 2008 when the US housing market was crashing and both faced significant losses. Even if they did not perform as expected. Furthermore. which were substantial: fourth-quarter 2008 through fourth-quarter 2011 losses totaled $128. or if a failure to raise the debt limit were to place at risk all government expenditures.5 billion for Freddie Mac.7 billion.3 billion for Freddie Mac. Fannie Mae and Freddie Mac Report Record Net Income Fannie Mae $70 $60 $50 Freddie Mac $ Billions $40 $30 $20 $10 $0 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 Source: Company reports 6 MOODY’S CREDIT OUTLOOK 30 SEPTEMBER 2013 . totaling $116. as needed. a situation that is unlikely to change. even if it were not a mandatory expenditure.NEWS & ANALYSIS Credit implications of current events Brian Harris Senior Vice President +1. because to not do so would damage the US economy in general and more specifically the US housing market.1 billion and $64. We expect both GSEs will continue to report robust earnings over the next several quarters because they remain the largest and most reliable providers of mortgage credit and have an aggregate market share approaching 80%.com Fannie Mae and Freddie Mac Face No Direct Effect from a Shutdown or Failure to Raise the Debt Limit The government-sponsored entities (GSEs) Fannie Mae (Aaa stable) and Freddie Mac (Aaa stable) are exposed to financial market disruptions from a government shutdown or failure to raise the US debt limit. the GSEs would continue to have access to contingent capital from the Treasury totaling $117. We also believe the government would honor its agreement with Fannie Mae and Freddie Mac even if it meant rationalizing other discretionary expenditures. And.

administrative delays could disrupt payment stream to insurers. The state portion of Medicaid payments would not be directly affected by a federal government shutdown. potentially including both Medicare and Medicaid payments. or to suspend insurance coverage until the government resumes payments. we believe they are unlikely to be affected. or a failure to raise the debt ceiling.212. Health insurers also receive payments under the Medicaid program. but they would likely be hurt if Congress does not raise the debt limit.NEWS & ANALYSIS Credit implications of current events Steve Zaharuk Senior Vice President +1. or participate in managed care Medicaid programs. rely on federal government payments. with the federal government paying somewhere between 50% and 75% of Medicaid costs (the percentage varies by state). Medicare Advantage payments to health insurers are typically paid at the beginning of the month from Medicare trust funds that are separate from Congressional appropriations. the federal Medicaid payments to the states. are considered non-discretionary spending. If the debt ceiling is reached. But Are Exposed to a Failure to Raise Debt Limit Health insurers would not be directly affected by a government shutdown.553. Health insurers that offer Medicare Advantage products to US seniors. But since Medicare payments are paid from the Medicare trust funds.com Health Insurers Would Not Be Directly Affected by a Shutdown. which is largely state-run. In addition. a government shutdown would not affect them. If the shutdown were to extend for a long period. and a government shutdown would not affect. and therefore. however. insurers will be faced with the decision as to whether to continue to cover beneficiaries and make payments to doctors on credit.zaharuk@moodys. In the case of payment delays. which are typically paid in advance on a quarterly basis.1634 stephen. 7 MOODY’S CREDIT OUTLOOK 30 SEPTEMBER 2013 . all federal payments are theoretically at risk.

Increase in Claims in a Shutdown or Failure to Raise the Debt Limit Surety insurers face the risk that a government shutdown or failure to raise the debt limit would reduce spending on infrastructure projects. work stoppages could well occur on projects that fall below the high-priority threshold. the contractor does not have to go through the legal process of halting work. based on the contract terms. Surety companies insure the risk that contractors are not able to meet their commitments in such projects. a number of government-driven projects experienced stops or delays in payments.NEWS & ANALYSIS Credit implications of current events Alan Murray Senior Vice President +1.com Surety Insurers Face Delays in New Business. The surety insurers only cover a contractor’s failure to complete work for which it has been contracted and paid. 8 MOODY’S CREDIT OUTLOOK 30 SEPTEMBER 2013 .murray@moodys. Consequently. With the exception of certain very high priority projects. If Any. if the government suspends or cancels a project. The effect would occur only gradually.212. This way. if any effect at all. But. but surety insurers did not suffer elevated losses as a result. Importantly. because of nonpayment by the government. or that are not pre-funded. such stoppage should not generate claim losses for sureties. Insurers generally advise their insured contractors to communicate with the government contract officers assigned to their projects to request that the government formally “suspend” work in the event of a shutdown. and therefore a shutdown would have only a very minor effect on their creditworthiness.553.7787 alan. as stated. But Little. a government shutdown may lead to an increase in payment delays on federally funded projects. because projects are typically planned and funded over long periods. Most insurers in the surety market are diversified. During and after the global financial crisis in 2008-10. Fewer projects mean less demand for surety insurance. surety insurers are not responsible for a contractor’s uncompleted project.

as seen in Exhibit 1. New Mexico. In this scenario. It would be more problematic for issuers if the debt ceiling is not raised because all spending. The federal government would not be allowed to increase its outstanding debt if it reaches the statutory debt ceiling.60% 8 2 1 Note: 10%-20%: Alaska. Florida. Kentucky. EXHIBIT 1 30 25 24 Federal Revenues as a Percent of State Total Governmental Funds Number of States 20 15 15 10 5 10% . A binding debt ceiling limit could jeopardize funding to some muni issuers. The Treasury estimates that if an agreement on the debt ceiling is not reached by 17 October it will have only $30 billion per day to fund commitments. A failure to raise the US debt ceiling would be more credit negative for municipal issuers. Pennsylvania. New York. Hawaii. The types of public finance issuers and securities exposed to federal government transfers are outlined below.Senior Credit Officer +1. or in some cases to pay for debt service. Utah. Arkansas. particularly for issuers with thin liquidity and a need to refinance debt or access the short-term note market for cash-flow purposes. including non-discretionary spending. 41%-50%: Alabama. North Carolina. South Dakota. Wyoming. including funding to public finance issuers that receive related federal transfers to pay for services.31%40%: California. Arizona.50% 51% . 21%-30%: Connecticut. However.40% 41% . Maine. Montana.samuels@moodys. or rely on cash-flow borrowing and variable-rate financing. which would not be enough to meet its net daily expenditures that reach as high as $60 billion. Wisconsin. Vermont. Michigan.212. South Carolina. Nebraska. most public finance issuers have already allocated funds or scheduled payments to protect against the possibility that federal transfers could be delayed or reduced for an extended period.com Certain Public Finance Credits Are Exposed to a Shutdown and Failure to Raise the Debt Limit A US government shutdown would have a limited credit effect on public finance issuers if it is as short-lived as we expect any shutdown would be. all or some federal funding could be reduced. would be eligible for cuts. Tennessee. Minnesota.7121 nicholas. However. Maryland. Illinois. West Virginia.20% 21% . Washington. Mississippi. Missouri. specifically Medicaid matching funds. Colorado. Texas. Public finance issuers would also likely face higher borrowing costs.NEWS & ANALYSIS Credit implications of current events Nick Samuels Vice President . Massachusetts. Oregon. Nevada. Iowa. Idaho. 51%-60%: Louisiana Source: Fiscal 2012 State Comprehensive Annual Financial Reports 9 MOODY’S CREDIT OUTLOOK 30 SEPTEMBER 2013 . During a shutdown. Delaware. Oklahoma. Ohio. Indiana. Georgia. only discretionary spending is on the chopping block. Kansas. Rhode Island. and market access would be challenging. North Dakota. Virginia. New Hampshire.30% 31% . healthcare providers and other procurement contractors will in the end bear the brunt of delayed payments because states will delay transfers to these entities in response to delayed federal government transfers. New Jersey.553. States have relatively high dependence on federal revenues and some have relatively high economic reliance on federal procurement and healthcare spending.

California Children's Medical Center of Dallas. Medicaid spending is generally the largest expenditure for states. Texas Rady Childrens Hospital. although it is usually half funded by the federal government. but some rely heavily on aid from states.3% The municipal bonds that are most exposed to the risk of a shutdown are those that rely on payments from the federal government as their primary source of revenue to pay debt service. meaning a shutdown could affect its operations. EXHIBIT 2 Hospitals with the Largest Percentage of Medicaid Funding Hospital Rating Outlook Medicaid as Percent of Revenue All Children's Hospital. Cuts to Medicaid funding could delay reimbursements to healthcare providers.NEWS & ANALYSIS Credit implications of current events Local governments generally have low dependence on federal revenues. However.3% 65. Florida Arkansas Children's Hospital.1% 63. Arkansas Children's Healthcare of Atlanta.6% 70.5% 64. some of which sequestration and Medicare reforms already pinch. a Congressionally enacted statute explicitly permits payment of debt service without the need for federal appropriation.0% 69. The District of Columbia (Aa2 stable) is a unique case because it requires Congressional approval for its budget.1% 53. New Jersey Texas Children's Hospital. California Source: Moody’s A1 stable A1 stable Aa2 stable A1 stable A2 positive Baa2 stable Aa3 stable Baa3 stable Aa2 stable A2 stable 64. Local governments with strong financial reserves and effective governance are more equipped to mitigate funding cuts. which may themselves experience direct cuts in federal funding. which would be credit negative for hospitals (see Exhibit 2). Hospitals that treat a large number of low-income patients (those on Medicaid) would be disproportionately affected by Medicaid cuts or reimbursement delays. Healthcare institutions are very reliant on federal revenues via Medicare and Medicaid.6% 53. Georgia Children's Hospital Central California Children's Hospital of Alabama Children's Hospital of Los Angeles. Texas Children's Specialized Hospital.7% 56. and are shown in Exhibit 3.0% 53. 10 MOODY’S CREDIT OUTLOOK 30 SEPTEMBER 2013 .

In the case of a government shutdown. but they typically include national parks.NEWS & ANALYSIS Credit implications of current events Municipal Bonds Whose Primary Revenue Source Is Federal Payments Type of Credit Do Federal Payments Require Reappropriation or Reauthorization? Structural Mitigants to Payment Delay EXHIBIT 3 Highway and mass transit debt Federal lease financings Public housing authority bonds New housing authority bonds Section 8 bonds Military housing bonds Yes Yes for some Yes. but payments are deemed essential and therefore exempt from shutdown risk Timing of debt service payments Debt service reserve funds Timing of debt service payments Debt service reserve funds Timing of debt service payments Debt service reserve funds Timing of debt service payments Timing of debt service payments Debt service reserve funds Debt service reserve funds Source: Moody’s Government shutdown would have limited effect. but funds for 2011 have already been appropriated No. DC metro area. potentially leading to income and sales tax declines. a prolonged shutdown would negatively affect economic activity in states and localities with a heavy federal presence. including the Washington. which would have less effect on public finance issuers than in the case of a debt-ceiling breach. 11 MOODY’S CREDIT OUTLOOK 30 SEPTEMBER 2013 . funds for payment were appropriated at time of debt issuance Yes Yes. However. The federal government has not yet identified services and programs that would be cut. only discretionary spending would be suspended or reduced. passport offices and administrative staff.

using the RIO arm requires use of MAKO’s RESTORIS family of implants. including dividends. it is credit negative for now because we expect the company to use a significant portion of its US cash to buy a technology that is not yet widely used by orthopedic surgeons. Reducing complications and improving outcomes has become more important for hospitals as both commercial and government insurers increasingly base reimbursement on the quality of care rather than the volume of care. However. having reported sales of about $103 million and negative cash flow from operations for fiscal 2012. which is used primarily in partial knee resurfacing procedures and was recently approved for total hip arthroplasty procedures. buybacks and future US acquisitions. Although the transaction has the potential to ultimately benefit Stryker. Stryker Corporation (A3 stable) said it had reached a definitive agreement to buy MAKO Surgical Corp. (unrated). which offers more growth opportunities.com Stryker’s Acquisition of MAKO Surgical Is Credit Negative Last Wednesday. Inc. 12 MOODY’S CREDIT OUTLOOK 30 SEPTEMBER 2013 . It is too early to determine if the robotic technology will give Stryker a strategic advantage and allow it to gain market share. For both procedures. (Baa1 stable) and Biomet. for $1. a manufacturer of devices for robotic-assisted orthopedic surgery. Along these lines.65 billion. a credit positive. Inc. MAKO manufactures the RIO Robotic Arm.7x at 30 June) will remain steady. In addition to ensuring that orthopedic surgeons receive appropriate training on the robotic equipment.553. and about 50% of this cash is held in the US. Inc. (B2 stable).212. including the proceeds from a recent $1 billion bond offering. MAKO will not immediately add a material level of sales or positive cash flow. A reduction in its US cash will reduce Stryker’s cushion for its other US cash needs. Stryker has been competing against other large orthopedic players. (unrated) recently received approval for its robotic equipment to be used in knee procedures. The acquisition would accelerate Stryker’s ability to enter the robotic space.7 billion at 30 June. But because the acquisition will not likely be funded with debt. it is unclear how quickly doctors and hospitals will adopt this robotic technology. Zimmer Holdings.lee@moodys. Stryker had total cash and marketable securities of about $4.Senior Credit Officer +1. Blue Belt Technologies. in selling patient-specific instrumentation and computer-assisted guide technology aimed at improving implant technique.NEWS & ANALYSIS Credit implications of current events Corporates Diana Lee Vice President .4747 diana. Stryker’s leverage (debt/EBITDA of about 1. Other companies are also pursuing robotic devices. including Johnson & Johnson (Aaa stable). future clinical outcomes will help determine the speed of adoption. orthopedic companies have begun to focus more on implant technique and alignment than the actual implants. As a result.

which is already a major player in Germany. Labco is disposing of a non-core asset that contributed revenue of €54 million in 2012. how the company will use the cash is unclear.20. The disposal is credit positive for Labco because its liquidity will improve.west@moodys. Although the deal will improve liquidity. Italy 6% and Belgium 5%. Labco can redeem bonds. Spain and Portugal 26%. and Spain and Portugal.375%. by the end of this year. Labco has a pan-European network of medical laboratories and collection points that provides routine and semi-routine clinical testing services for individual patients. which currently trade at around 106.5x. which accounted for 26%. a leading medical diagnostics company. allowing the company to focus on core markets. increasing Labco’s cash reserves by around €70 million (after accounting for debt within the division). France accounted for 54% of Labco’s revenues.7772. By selling its German subsidiary. we expect the positive effect on liquidity from sale proceeds will be short lived. 13 MOODY’S CREDIT OUTLOOK 30 SEPTEMBER 2013 . or around 9% of Labco’s group revenue. Labco’s German operations will be of greater strategic importance to Sonic.0x the subsidiary’s EBITDA contribution for the 12 months ended 30 June 2013. including a €36 million impairment charge in 2012 to take into account lower German quotas for Labco testing services and the consequences of alleged fraudulent activities in the division’s laboratory in Dillenburg. such as France. (B2 stable). which is subject to antitrust approval and other usual closing conditions. Given its active acquisition strategy. For the six months to 30 June. Pro forma for the transaction.com Labco’s Sale of Its German Subsidiary to Sonic Is Credit Positive Last Thursday.NEWS & ANALYSIS Credit implications of current events Simon West Associate Analyst +44. announced the sale of its German subsidiary to Sonic Healthcare Limited (unrated) for €76 million. The companies expect to complete the transaction. Germany 9%. spending €44 million on acquisitions in 2012 and €93 million in 2011. which accounted for 53% of 2012 sales. Nevertheless. Labco has pursued a buy-and-build strategy. The sale will allow Labco to focus attention on markets where its leadership offers better margins. as adjusted by us. The German division suffered from large impairment write-downs. The company also has a foothold in the UK through its joint venture with Sodexo. Earnings did not benefit from economies of scale because Labco was a relatively small player in Germany. Sonic is paying a multiple of more than 10. Labco S. versus €67 million a year earlier. On or after January 2014.A. at 106. then we expect debt/EBITDA would decline to less than 5. Based in Paris. the cash will give the company additional ability to maintain its growth strategy in core markets. the disposal will increase Labco’s cash to around €170 million as of 30 June. If Labco uses the funds to pay down debt.5479 simon. Historically. Germany by its previous owners.

NWE’s owned-generation assets will increase by 80%.NEWS & ANALYSIS Credit implications of current events Infrastructure Ryan Wobbrock Assistant Vice President +1.com NorthWestern Corp. The company expects the acquisition to close upon regulatory approval.553. Hydro generation. The company plans to finance the acquisition with a credit neutral combination of debt and equity. targeting to maintain its current capital structure of around 50%-55% debt to total capitalization. NWE will acquire 11 hydroelectric facilities with a capacity of 633 MWs along five different rivers in Montana. Given the timing and effect of debt coming on balance sheet. The acquisition’s financing includes a $900 million bridge loan facility with permanent financing expected to target NWE’s regulatory allowed capital structure of 52% debt and 48% equity. NWE’s operations will benefit from greater supply and fuel diversity as it incorporates 633 MW of low-cost baseload power. However.7104 ryan.wobbrock@moodys. 14 MOODY’S CREDIT OUTLOOK 30 SEPTEMBER 2013 . while the rate base will increase by nearly 50%. will also benefit NWE over the long term because it reduces the company’s exposure to stringent and costly environmental mandates on chemical emissions. which it expects in the second half of 2014. rather than near the 20% that we had expected. making them a strategic fit from both an operational and geographical perspective. we expect a near-term decline in key financial metrics. while reducing the company’s exposure to potentially volatile fuel and market power prices. which has no chemical emissions. we expect NWE’s cash flow from operations preworking capital to debt to measure around 13% for year-end 2014. These assets were originally part of the integrated electric system that includes NWE’s transmission and distribution assets. The acquisition. Purchase of Hydro Assets Is Credit Positive Last Thursday. is credit positive for NWE. NorthWestern Corporation (NWE. if approved by the Montana Public Service Commission (MPSC). whose size and scale will increase with low-cost and environmentally favorable power-generation assets. once a full year’s worth of cash flow contribution begins to evidence itself. The exhibits below show the change in NWE’s supply sources. prior to the cash flow contribution of the hydro assets. we believe that NWE's financial metrics will again be within a range more appropriate for a Baa1-rated utility. Baa1 stable) announced an agreement with PPL Montana LLC (Baa3 negative) to acquire 633 megawatts (MWs) of PPL Montana’s hydroelectric generation portfolio for approximately $900 million. For example.212.

Miliband estimates the negative effect of the freeze would be £4.1%.A. this has been driven by both a 30% increase in wholesale electricity and gas costs. In contrast. However. Capping electricity and gas tariffs would be credit negative for UK energy suppliers. the effect of this tariff freeze would likely make UK energy supply a loss-making activity. RWE AG (Baa1 stable) and E. such as transportation charges and environmental schemes (e. scheduled for May 2015. which would be unable to raise prices if their costs increase as we expect.2 billion of profit per annum. Mr. 15 MOODY’S CREDIT OUTLOOK 30 SEPTEMBER 2013 . and also for the UK subsidiaries of Iberdrola S.5 billion for the sector.francis@moodys. (Baa1 negative). increasing the probability of the tariff freeze being passed.phillips@moodys.20. and a 31% increase in other costs. the leader of the UK opposition Labour Party. promised to freeze gas and electricity tariffs until 2017.com UK Opposition Labour Party Pledge to Freeze Energy Tariffs Is Credit Negative for Utilities On 24 September.7772.000 £800 £600 £400 £200 £0 -£200 2006 2007 2008 2009 2010 2011 2012 2013 Wholesale Costs Network Charges / Other Costs Operating Costs Source: Ofgem Given that network charges and renewable subsidies increase annually with inflation. If Labour maintains its advantage in the polls.com Scott Phillips Vice President . which seems reasonable as industry consensus is for costs to rise from current levels. and with tariff caps in place. Electricite de France (Aa3 negative). renewable subsidies).7772..5 billion hit is accurate.Senior Credit Officer +44. which account for 44% of the final tariff . Last April. negative). as seen in the exhibit below. Miliband’s policy would necessitate legislation to introduce temporary price controls that would prevent energy suppliers from increasing their tariffs for 20 months from the date of the next election. the percentage attributable to net margin only amounts to around 6%-7% of the end-user bill.5206 scott.Senior Analyst +44. it will likely lead to it forming a majority in the House of Commons post-election.g. Mr. A YouGov opinion poll published last Wednesday showed the Labour Party with a nine percentage point lead over the ruling Conservatives. Components of the Average Annual UK Domestic Energy Bill Net Profit £1. According to the energy regulator.NEWS & ANALYSIS Credit implications of current events Helen Francis Vice President .600 £1. A tariff freeze would be credit negative for all utilities with UK supply exposure. the cost base of suppliers is expected to rise accordingly. the average domestic energy bill in the UK currently stands at £1.200 £1.5422 helen. if elected prime minister at the next general election.400 £1. If Labour’s forecast for a £4. Ed Miliband. particularly Centrica plc (A3 stable) and SSE plc (A3 stable). two of the largest energy retailers.ON SE (A3. equivalent to around £1.420 per customer per annum (based on standard consumption). the Office of Gas and Electricity Markets (Ofgem). Ofgem published a report showing that the total revenue of the UK supply industry (domestic and non-domestic) is around £40 billion and that companies’ margin is 3.20. which together account for around 40% of the end-user tariff. an increase of 30% since 2010. profit margins will quickly erode.

NEWS & ANALYSIS Credit implications of current events In our view. For a liberalised and established energy market such as the UK. and investors may well require higher returns going forward. 16 MOODY’S CREDIT OUTLOOK 30 SEPTEMBER 2013 . which may now be negatively affected. such high-level political interference is unexpected. leading to an increase in the sector’s overall cost of debt. there is also a broader credit negative effect for the whole of the UK utilities sector following Labour’s announcement. The announcement also comes as the current government is attempting to pass legislation to incentivise investment in low-carbon technologies.

On a pro-forma basis.25 billion (€926 million). which is €16 billion for 2013. as illustrated by projected group EBITDA. Enel’s completion of its third hybrid issuance. The combination of the recent disposals and the hybrid issuance.8 billion (€1. Enel’s agreement to sell its stake in Russian Severenergia.francis@moodys.33 billion disposal of its stake in Russian Severenergia (unrated) and the completion of the third of three recent hybrid issuances totalling approximately €2.A. and after taking account of the equity cushion they provide. For accounting reasons.33 billion).0% when taking these measures into account and after including the approximately €850 million in cash the company expects from the securitisation of some Spanish regulatory receivables also transacted during the week.9% in 2012 would have improved to 19.65 billion. the hybrids will be treated as 100% debt in Enel’s books. as such.9 billion under our financial ratio calculations. a US dollar-denominated tranche of $1. (Baa2 negative) announced both the €1. which are the main driver behind its debt-reduction plans.25 billion.com Recent Deleveraging Announcements Are Credit Positive for Enel Last Wednesday. Nonetheless.7772.63 billion out of Enel’s planned €6 billion worth of divestments. funds from operations (FFO) to net debt of 17. they improve the company’s capital structure. announced in March. half debt in our analysis because they are deeply subordinated to senior debt and. disposals have totaled €1.Senior Credit Officer +44. and hence do not contribute to its net debt targets. These go more than half way to meet Enel’s target of €5 billion. down from €16. the large and diversified Italian power group. 17 MOODY’S CREDIT OUTLOOK 30 SEPTEMBER 2013 . to reduce net debt by €5 billion to €37 billion by the end of 2014 and to improve its capital structure through the issuance of €5 billion of hybrid capital instruments by 2015. follows issuances earlier in September of £400 million (€475 million) and €1.20. adding to divestments agreed upon earlier in 2013 worth €304 million for its Belgian and Spanish assets.NEWS & ANALYSIS Credit implications of current events Helen Francis Vice President . Enel’s progress on asset disposals and its hybrid issuance reduce its leverage amid negative earnings pressure in its core Italian and Spanish markets from lower electricity prices and narrower margins on gas-fired generation and regulatory cuts in Spain. So far this year. an upstream gas company. These measures are credit positive for Enel and help the company meet its strategic goals. Enel S. give the benefit of an equivalent debt reduction of €2. The deal is subject to applicable antitrust clearance.7 billion at the end of 2012. to Rosneft will produce proceeds of $1. This moves Enel’s financial profile closer to our current rating’s targeted FFO/net debt guideline of around 20% by the end of 2014.p. they strengthen the position of senior bondholders. This is Enel’s largest disposal announced to date. We treat these particular instruments as half equity.5422 helen.

No.Y. 7527 (JMF).” as in a criminal case. United States v.wyszomierski@moodys. e-mail.553. » Because FIRREA authorizes only civil remedies. Wells Fargo Bank allowed the government to use the Financial Institutions Reform. all of which held that the “affected” institution could be the alleged perpetrator of the fraud.S.NEWS & ANALYSIS Credit implications of current events Banks Teresa Wyszomierski Chief Legal Officer . there were no decisions interpreting that term until recently.” FIRREA does not define the term “affecting. Countrywide Financial Corporation et al. Dist.212. FIRREA therefore gives the DOJ a civil hook to investigate and prosecute mortgage fraud. 11 Civ. a New York federal district court on 24 September in United States v.N.Y. Wells Fargo Bank. 1422 (JSR). The judges based this interpretation on the plain language of the statute. predicate offenses) involving financial institutions and government agencies. This is credit negative for banks and other financial institutions facing government probes related to mortgage and other fraud because it is easier to obtain a conviction under FIRREA than in traditional criminal or civil fraud cases. » These pre-suit investigations can last a long time and uncover numerous violations that would ordinarily be time-barred because FIRREA has a 10-year statute of limitations. To be actionable under FIRREA. 1 United States v. thanks to the inclusion of mail and wire fraud as one of the predicate offenses.4129 teresa. and Enforcement Act of 1989 (FIRREA) not just to protect banks victimized by the fraudulent acts of third parties.A. certain of these offenses require that the violation be one “affecting a federally insured financial institution.” and not “beyond a reasonable doubt.N. LEXIS 117140 (S. or other electronic communication.D. 12 Civ. The DOJ can therefore engage in extensive discovery pre-suit.Financial Institutions Group +1.S. The Bank of New York Mellon et al.6969 (LAK). Recovery. Starting last April. and with the view that because Congress’ intent was to deter fraudulent conduct that might put federally insured deposits at risk.S. 12 Civ. Dist. » FIRREA is one of the few federal statutes that authorizes the DOJ to issue subpoenas in contemplation of a civil proceeding without first obtaining court approval. Dist. but to prosecute the banks themselves when they are damaged by their own fraudulent conduct. the federal court in the Southern District of New York rendered three decisions1 by three different judges.. 2013 U.N.e. the DOJ only has to prove that the defendant committed one of the predicate offenses by a “preponderance of the evidence. LEXIS 58816 (S. FIRREA also covers banks that harm themselves by engaging in fraudulent activity. FIRREA gives the government a number of tactical advantages that significantly increase the likelihood of conviction compared to traditional fraud prosecutions. telephone. 24 September 2013). faxes. The mail and wire fraud statutes cover virtually any fraud involving interstate mail. N.Y. 2013 U.” and because the statute has rarely been used. and not necessarily a third-party victim or innocent bystander.. 2013 U. 16 August 2013).D.. FIRREA was enacted in response to the US savings and loan crisis over two decades ago and authorizes the Department of Justice (DOJ) to seek civil money penalties for violations of one or more of 14 enumerated criminal statutes (i. 18 MOODY’S CREDIT OUTLOOK 30 SEPTEMBER 2013 .D. No.. LEXIS 136539 (S. 24 April 2013). United States v.com New York District Court Expands FIRREA’s Reach to Prosecute Banks Accused of Fraud For the third time in recent months. No. which is far longer than the typical three to five years applicable to civil lawsuits. » The scope of the statute is wide.

given the preeminent role of the Southern District in financial litigation. the monetary penalties can be as high as the amount of the gain to the perpetrator or loss to the victim.NEWS & ANALYSIS Credit implications of current events » Although FIRREA does not authorize the imposition of criminal sanctions. 19 MOODY’S CREDIT OUTLOOK 30 SEPTEMBER 2013 . In any case. the building momentum for expanding FIRREA’s reach means greater potential liability for banks and other federally insured institutions accused of fraud. Nevertheless. The decisions are not binding authority for federal courts outside the Southern District and are still subject to appeal. such as imprisonment. they are influential opinions.

11. and relatively high participation of lesser quality hybrid debt and capital instruments has resulted in poor quality core capital ratios for all three banks. Additionally. their standalone bank financial strength ratings/baseline credit assessments and the corresponding rating outlooks.36%. MOODY’S CREDIT OUTLOOK 30 SEPTEMBER 2013 .3043. which has been increasing lately. C-/baa2 stable) will reduce their rates of loan growth. Central Bank of Brazil High loan growth rates have largely masked asset quality deterioration in these banks’ balance sheets. Rousseff noted that reducing the banks’ market share in lending was a necessary step for the government to maintain its balance of the national accounts and for the country to achieve economic stability. while that for BNDES was 9.NEWS & ANALYSIS Credit implications of current events Alexandre Albuquerque Assistant Vice President . compared with 33% in 2008. Ms.com Brazil’s State-Owned Banks Will Reduce Loan Growth.Analyst +55. The combination of strong growth. we expect the slowdown in loan origination to reduce pressure on capital. reflecting the seasoning of their loan portfolios.A. our adjusted Tier 1 capital ratio for Banco do Brasil was 9.7356 alexandre. with the three banks’ lending accounting for 50. we view moderation in loan origination as a positive move that will limit future nonperforming loans and alleviate pressure on asset quality. and thus the government’s plan to slow loan growth will lead to higher delinquencies. Moreover. Loan Growth of Brazil’s Three State Banks versus Private Banks Private Banks 550 500 450 400 350 300 250 200 150 100 Dec-08 Jun-09 Dec-09 Jun-10 Dec-10 Jun-11 Dec-11 Jun-12 Dec-12 Jun-13 Banco do Brasil Caixa BNDES Source: Moody’s. as lower credit supply reduces the risk of adverse selection at a time when private-sector banks are cautious about taking on risk. As of June 2013. Brazil President Dilma Rousseff announced that government-owned banks Caixa Econômica Federal (CAIXA. The announcement is credit positive for these public-sector banks because it will reduce the asset and revenue volatility caused by their aggressive loan expansion of the past four years. D/ba2 stable).albuquerque@moodys. This approach has resulted in a sizable expansion. Baa2 positive. 2 20 Loans in December 2008 = 100 The bank ratings shown in this report are the banks’ domestic deposit ratings. and Banco do Brasil and BNDES each growing at 23% over the same period. Since 2008. with CAIXA growing at a compound annual rate of 44% between June 2009 and June 2013. a Credit Positive Last Wednesday.2 Banco Nacional de Desenvolvimento Econômico e Social (BNDES.53% and for CAIXA 6. large dividend payouts to the government. However.5% of total system loans in July. Baa2 positive) and Banco do Brasil S.55%. (A3 positive. the government has relied on public-sector banks as the main agents of its countercyclical policies to bolster credit supply and stoke domestic demand following the global financial crisis. each bank reported robust loan growth compared with the privately owned banks (see exhibit).

compared to 53. we view the execution of this plan as critical and challenging. We forecast the ratio will reach 59. Brazil’s economic recovery has been modest. and we anticipate below-trend GDP expansion in 2014. The government also faces the challenge of reconciling its talk of reducing the public-sector banks’ market share with its proposed agenda of infrastructure investments totaling around BRL552 billion ($240 billion) at a time when participation by the private sector remains weak. 21 MOODY’S CREDIT OUTLOOK 30 SEPTEMBER 2013 .4% in 2010. the government’s announcement provides no guidance about a proposed timeframe or target market share that the public banks should aim to achieve. and has contributed to the increase in gross government debt relative to GDP. particularly as we approach an election on 5 October 2014 for the president and National Congress.NEWS & ANALYSIS Credit implications of current events That the robust expansion of the public-sector banks has been largely funded by the government itself has not helped its fiscal position. Therefore. However.7% by the end of 2013.

5% 9. their standalone bank financial strength ratings/baseline credit assessments and the corresponding rating outlooks. not all seven banks are in compliance with Basel III regulatory minimum.69.765 katharina.70730. C-/baa2 stable). Landesbank Baden-Wuerttemberg (A3 stable. According to the study.9% Note: Data as of year-end 2012 Source: Deutsche Bundesbank Although the average CET1 ratio for the seven large banks was 7%. Bayerische Landesbank (Baa1 stable.com Alexander Hendricks. The findings are credit positive for large German banks’ creditors because it will prompt the banks to continue boosting their capital under the new Basel III criteria to satisfy regulators and catch up with their international peers.com Bundesbank Study Will Prompt Large German Banks to Continue Boosting Their Capital Last Wednesday. the so-called Group 1 banks. Commerzbank AG (Baa1 stable. Germany’s seven largest banks. The bank ratings shown in this report are the banks’ deposit ratings.70730. DZ Bank AG (A1 stable. D-/ba3 stable) and Norddeutsche Landesbank GZ (A3 negative. D/ba2 negative). as illustrated by their lower leverage ratio (CET1 capital as percentage of total exposure) relative to the average for the largest EU banks. CFA Associate Managing Director +49. The study highlights that at the end of 2012 the banks collectively would have needed €14 billion of common equity for all seven to comply with the 7% minimum. 22 MOODY’S CREDIT OUTLOOK 30 SEPTEMBER 2013 .hendricks@moodys.NEWS & ANALYSIS Credit implications of current events Katharina Barten Vice President . Although the study’s findings do not suggest German banks are more vulnerable to market shocks – the banks’ Tier 1 capital ratios under Basel II rules compare well with their international peers – they do point to the banks needing more capital. Germany’s largest banks also display considerably lower absolute (or non-risk weighted) capitalisation.0% at the end of 2012. the German Bundesbank released a study showing that Germany’s leading banks continue to lag their European peers in complying with Basel III’s stricter capital ratios. well shy of the 8. C-/baa2 stable). They include: Deutsche Bank AG (A2 stable. market participants are increasingly expecting banks to report capital buffers in excess of the Basel III 7% minimum and typically demand above-average bond yields from institutions with weaker capitalisation levels.4% average for large banks in the European Union (EU) (see Exhibit 1). UniCredit Bank AG (A3 negative. Moreover.3 had an average fully phased-in Common Equity Tier 1 (CET1) ratio of 7. D+/ba1 stable).Senior Credit Officer +49. D+/ba1 stable).69. Positively. the Bundesbank data illustrate that German banks have made significant progress in boosting their capital. C-/baa2 negative).barten@moodys. EXHIBIT 1 Results from the Bundesbank’s Basel III Study on Germany’s Group 1 Banks German Banks 10% 8. According to the Bundesbank 3 Group 1 banks have at least €3 billion of Tier 1 capital and international banking activities.6% 2. and we expect that trend to continue over the next few quarters.4% 8% 6% 4% 2% 0% Core Equity Tier 1 Total Capital Ratio Leverage Ratio 1.779 alexander.0% European Union Banks 9.9% 7.

These options include reducing still-sizable legacy assets earmarked for unwinding. Since the study. The Bundesbank study also surveyed 35 smaller German banks. for Basel III compliance.2% 3. all seven banks have the ability to improve their capital under Basel III using a number of options. and found that they have considerably higher capital levels on average and that their CET ratios exceeded the European average (see Exhibit 2).9% Note: Data as of year-end 2012 Source: Deutsche Bundesbank 23 MOODY’S CREDIT OUTLOOK 30 SEPTEMBER 2013 .9% European Union Banks 10.9% 10. Group 1 banks’ CET1 ratio rose to 7% from 5% in just 12 months to December 2012. thereby decreasing their capital requirements. or divesting financial holdings that under Basel III are partially deducted from CET1 capital. which limits profit retention. and thus have improved their CET1 ratios.NEWS & ANALYSIS Credit implications of current events study. and the banks also reduced their capital shortfall to €14 billion from €46 billion during that period.1% 7. Deutsche Bank and Commerzbank.4% 8. known as Group 2 banks. each raised common equity during the first half of the year. EXHIBIT 2 Results from the German Bundesbank’s Basel III Study on Germany’s Group 2 Banks German Banks 12% 10% 8% 6% 4% 2% 0% Core Equity Tier 1 Total Capital Ratio Leverage Ratio 3. the largest private-sector banks. Although some Group 1 banks’ profitability is poor. thereby allowing them to close the €14 billion capital gap by mid-2014 and raise their CET1 ratios.

Without the amendment.” given their complex structure) was to be amended and replaced by the so-called “legal interest rate. Even if the court judgment was favorable for a minority of local governments that contracted risky loans. Aa2 negative) would incur a significant loss in revenues. DCL appealed the legal decision and SFIL lobbied the government to have the legal framework amended. If adopted. SFIL and DCL have seen litigation proceedings triple to 196 and 96 cases. the mention of the TEG in initial documentations was often either omitted or slightly different from the definitive TEG. disrupting its loans to the sub-sovereign sector.5330.nakamura@moodys. Apart from the DCL case. The 2014 draft Finance Law submitted to the National Assembly last Wednesday includes a provision that will eliminate the risks surrounding TEG documentation for the lenders. Since the court’s judgment on the DCL case. This has wide ranging implications because the TEG applies to all bank loans to French customers. the law will certainly enable SFIL to meet its business objective of lending €3 billion to the sub-sovereign sector in 2013. which would amend the treatment of the effective annual percentage rate (TEG) in loan documentation.8222 sebastien. the measure is also credit positive for the sub-sovereign sector as a whole. and up to €5 billion going forward out of the sector’s annual financing needs of €20 billion.Senior Analyst +33. Hence. 4 The TEG calculation at the initiation of contracts is particularly complex for such loans.com Société De Financement Local Would Avoid Legal Risk with Amended Finance Law Last Wednesday.91. the rate applied to loans4 (often referred to as “toxic. 24 MOODY’S CREDIT OUTLOOK 30 SEPTEMBER 2013 .loan documentation. While DCL was not accused of any wrongdoing vis-á-vis local governments.” which is much lower than the contractual rate on the TEG-referenced loans.1030 yasuko. it will set a precedent that eventually will involve a rate change for many loans that SFIL inherited. As a result of this decision. as of the beginning of September. Given the role assigned to SFIL by the French state as a specialized lender for regional governments and public hospitals.NEWS & ANALYSIS Credit implications of current events Yasuko Nakamura Vice President .768. A specialized lender to public sector entities. As a result. the French government published the 2014 draft Finance Law. the court censured the bank for the way in which the TEG was referenced in -or omitted from -. the legal risks for SFIL could have had serious negative implications for its capacity to provide lending to the broader subsovereign sector.hay@moodys.Senior Credit Officer +34. respectively. the Société de Financement Local (SFIL. SFIL inherited the bulk of French public-sector lending from Dexia Credit Local (DCL.1. If the decision of the court is confirmed. which would have had material implications on its financial situation and its ability to do business with French sub-sovereigns.com Sebastien Hay Vice President . Baa2 negative) earlier this year. SFIL was concerned about the risk of contagion to its entire portfolio.

the company’s pro forma financial fundamentals would remain solid overall owing to ProAssurance’s strong operating profitability.2x $4.7x 157. Moody's estimate of pro forma key financial indicators combining ProAssurance and Eastern 2012 results.877 $2.0% 6.212.1% 2. Source: GAAP financial statements.271 $275 $536 $528 28. $ millions Net Income. Although ProAssurance’s post-acquisition return on capital would improve slightly given the marginal addition of Eastern’s profits.cooper@moodys. $ millions Gross Premiums Written.2% 10. for $205 million in cash.193 $2. which.2% 6. one year Cashflow Coverage.2% 115.1x $381 $136 $10 $224 $170 36. ProAssurance Corporation ((P)Baa2 stable). EXHIBIT 1 Change in ProAssurance’s Financial Metrics Pro Forma for the Eastern Acquisition Combined Pro Forma Eastern ProAssurance Total Assets.3x from about 1. Its profitability in part depends on generating investment income.3x 12.9% 5.2% 1.4% -13. $ millions Shareholders' Equity.8% 10.8% -2. a monoline workers’ compensation insurer. It is a long-tail line of business whose losses are paid many years after premiums are collected. The proposed transaction would be credit negative for ProAssurance because of the significant execution and integration risks associated with expanding out of ProAssurance’s traditional business into workers’ compensation insurance. announced that it had agreed to acquire Eastern Insurance Holdings. Moody’s estimates Workers’ compensation is a highly specialized line of business with a number of risks.5% 1.2x 12. is a challenge.6% 9. Workers’ 25 MOODY’S CREDIT OUTLOOK 30 SEPTEMBER 2013 .0% 6. (unrated).com ProAssurance’s Proposed Acquisition of Eastern Is Credit Negative Last Tuesday.2x. most of ProAssurance’s other pro forma key financial metrics would be slightly weaker (see Exhibit 1). $ millions Net Premiums Written.2% 6.2% 30.8% 14.NEWS & ANALYSIS Credit implications of current events Insurers Jasper Cooper Analyst +1. conservative operational leverage.6% 5. and high-risk assets would increase to about 31% of shareholders’ equity from about 29%.553.7x 7.0% -13. in today’s low interest rate environment. and its shareholders’ equity would stay about the same. Inc. modest financial leverage and sound reserve position.5% 11.1% 13.1366 jasper. $ millions High Risk Assets as Percent of Shareholders' Equity Reinsurance Recoverables as Percent of Shareholders’ Equity Goodwill & Intangibles as Percent of Shareholders' Equity Gross Underwriting Leverage Return on Capital. one year Adjusted Financial Leverage Total Leverage Earnings Coverage. and because it would slightly weaken several key financial measurements. However. The company’s operating leverage would rise to about 1.271 $286 $760 $698 30.5x 201. a monoline medical professional liability (MPL) insurer.4x Note: Information based on GAAP financial statements.1x 20.9% 129. one year Adverse/(Favorable) Development as Percent of Beginning Reserves. one year $5.

with only three states in common (Indiana. Acquiring Eastern would broaden ProAssurance’s capabilities for offering multiple products to these larger medical facilities. However. 26 MOODY’S CREDIT OUTLOOK 30 SEPTEMBER 2013 . but are still unprofitable in the current low interest rate environment. Michigan and Delaware) being among the top 10 for both companies. ProAssurance and others have lost market share (excluding acquisitions). In addition. The profitability of workers’ compensation insurers has been negatively pressure in recent years as a result of a competitive underwriting environment and low interest rates. See US P&C Insurance Pricing Generates Margin Expansion. Partially mitigating ProAssurance’s execution risks is an agreement that Eastern’s management team will stay on following the acquisition. both lines are also different enough that knowledge of one market does not necessarily apply to the other. Industry combined ratios (the ratio of losses and expenses paid to premiums earned) fell to about 107. historically volatile. ProAssurance’s MPL line of business faces many of the same risks as workers’ compensation insurance: both lines are long-tail. Rate Needed In Casualty. However. As larger medical facilities have acquired individual physicians and small group practices. for recipient’s use only. although it has steadily improved since 2011 owing to cumulative rate increases and moderate loss-cost trends. ProAssurance generates the majority of its business from individual physician practices and small doctor groups. and require disciplined underwriting and claims-adjusting operations. and the line’s pricing and profitability have historically been volatile.5% for the 2012 accident year from about 118% in 20105 (see Exhibit 2). Contains copyrighted and trade secret materials distributed under license from SNL. About 65% of Eastern’s direct written premium are in Pennsylvania. one challenge in executing this strategy could be the relatively low degree of geographic overlap.NEWS & ANALYSIS Credit implications of current events compensation insurers are also subject to higher losses if there is an uptick in medical inflation or fraud. 23 August 2013. EXHIBIT 2 Industry Workers’ Compensation Accident Year Combined Ratio and Net Premium Earned Net Premiums Earned $36 $35 $34 Combined Ratio 125% 120% 115% 110% 105% 100% 95% 90% 85% 80% 2009 2010 2011 2012 $ Bilions 5 $33 $32 $31 $30 $29 $28 Source: SNL Financial LC and Moody’s. with a smaller share of premiums written on larger medical facilities. a state that accounts for less than 1% of ProAssurance’s premiums.

Declining from very strong levels. Although these annuity businesses are riskier than whole life insurance products. which includes a large component of universal life insurance business.gonen@moodys. thereby mitigating the negative pressure. we reiterated our review for downgrade of Global Atlantic’s life operating subsidiaries. Global Atlantic Financial Group (unrated) announced that it would buy Forethought Financial Group.Analyst +1. The combination of Forethought’s primary operating subsidiary. expansion into commodity-like higher risk annuity products. The Aviva USA life insurance and Forethought acquisitions will serve as a platform for retail-oriented life and annuity sales. Global Atlantic will also face financial risks by operating at lower capital levels and greater financial leverage than it had previously. and the greater diversity and balance the combined entities will have. The transaction is credit negative for both parties because Forethought will be acquired by a lower credit quality insurer and because Global Atlantic is displaying an aggressive risk appetite following several transformative or sizable transactions. with the lower-rated Global Atlantic’s life operating subsidiaries. In May.2 billion in sales in 2012 from $662 million in 2011.553. but continued aggressive growth could pressure capital. and transaction risk. Commonwealth and First Allmerica. Forethought is a privately held life insurance-based financial services firm focused on the senior middle market with an array of life insurance and annuity products. Forethought Life Insurance Company (financial strength A3 review for downgrade).212. the risks are offset by the relatively stable and consistent performance of Forethought’s pre-need business. complementing Global Atlantic’s historical reinsurance/transaction business model that focused on institutional clients. 27 MOODY’S CREDIT OUTLOOK 30 SEPTEMBER 2013 . investment and capital management. plays out and affects earnings. Inc. We expect these pressures to manifest themselves in the commonality of corporate governance. (financial strength Baa1 review for downgrade) and First Allmerica Financial Life Insurance Co. and we also put Forethought’s ratings on review for downgrade. Global Atlantic’s metrics will be more in line with insurance industry averages over the next year. The company is a market leader in low-risk pre-need insurance (whole life policies designed to cover funeral expenses upon death) and has strong distribution relationships with funeral directors. Global Atlantic expects to complete the acquisition early in 2014. which achieved $1. the Forethought businesses complement Global Atlantic. We expect the combined entities to continue Forethought’s rapid sales growth in fixed and variable annuities.com Global Atlantic’s Acquisition of Forethought Is Credit Negative for Both Last Thursday. (A3 review for downgrade) and in October expects to close its acquisition of Aviva USA’s life insurance business from Athene Holding Ltd. Prospective metrics will be weaker than before the acquisitions. (unrated). and we will have to see how the Aviva USA acquisition. The terms of the deal were not disclosed.3711 shachar. The Forethought acquisition follows closely two other material transactions by Global Atlantic. but we expect some debt financing to fund the acquisition. These deals over a very short time reflect Global Atlantic’s aggressive risk appetite in terms of rapid growth and consumption of capital. Its pro forma financial fundamentals are adequate. (financial strength Baa1 review for downgrade). However.NEWS & ANALYSIS Credit implications of current events Shachar Gonen Assistant Vice President . and could be combined with minimal business disruption. Commonwealth Annuity and Life Insurance Co. (Baa3 review for downgrade) for an undisclosed amount. Inc. Global Atlantic completed its separation from The Goldman Sachs Group. After the announcement. and the risk tolerance/mitigation of the combined entities. negatively pressures Forethought’s credit quality.

reducing the risk of increased waivers of money market fund fees. the remaining participants include six government-sponsored entities. a credit positive for US money market funds and particularly the 94 money market funds eligible to participate in the facility. but the 94 eligible money market funds6 will benefit most.callagy@moodys. and continue to waive management fees in order to deliver a positive net yield. such as US Treasury and agency securities. including $4. The liquidity and credit profiles of money market funds stand to benefit from an increase in the supply of high-quality short-term assets. a wide range of counterparties are eligible to lend cash to the Fed on an overnight basis. with the loans collateralized by US Treasury securities held in the Fed’s $3. the Federal Reserve Bank of New York (FRBNY) initiated a new overnight fixed-rate reverse repo facility in an effort to provide the US Federal Reserve (Fed) with greater control over short-term rates. The new facility will significantly increase the supply of high-quality liquid assets available in the market. The Fed set the initial rate at which it is willing to borrow at one basis point. That rate backstop will help money market fund managers. Investors are not likely to accept lower overnight lending rates than the benchmark rate paid by the Fed. 6 7 Among others. 18 banks and the 21 primary broker-dealers. as they are the only ones eligible to access reverse repos with the Fed. Greater supply of high-quality short-term assets will benefit all US money market funds. the Fed’s eligibility criteria requires a fund to have had $5 billion in net assets over the last six consecutive months. In addition to the 94 eligible money market funds. but indicated that this rate could move up to as high as five basis points.4374 robert. The facility will be particularly beneficial as regulatory-driven bank deleveraging has reduced the level of short-term broker dealer repos available to money market funds.8 billion in 2012. Facility participants will initially be limited to maximum loans of $500 million with the potential for that limit to increase to $1 billion over the life of the facility. Source: Investment Company Institute 28 MOODY’S CREDIT OUTLOOK 30 SEPTEMBER 2013 . Another benefit to money market funds is that the reverse repo facility will tend to set a floor on money market rates. The Fed’s new facility is likely to provide fee pressure relief over time as the Fed increases its reverse repo overnight borrowing rate. US money market funds have waived $18 billion7 in fees over the last four years.212. at a time when these assets are scarce owing to high demand. Under the new facility. The Fed expects the facility to conduct overnight operations through January 2014.NEWS & ANALYSIS Credit implications of current events Money Market Funds Rory Callagy Vice President .4 trillion System Open Market Account (SOMA) portfolio.Senior Analyst +1. who have struggled to generate returns in a low-yield environment.553.com Fed’s New Overnight Reverse Repo Facility Offers Supply Benefits to US Money Market Funds On Monday.

The district’s revenue base has shrunk in recent years as a result of state aid cutbacks. We adjust the reported pension liabilities of US state and local governments by applying a bond index rate to future liabilities in order to discount the present value of these obligations. when APS diverted $2. 29 MOODY’S CREDIT OUTLOOK 30 SEPTEMBER 2013 . Contributions to the city plan were 6.4% of the APS expenditures in fiscal 2012 (see exhibit below). The APS annual contributions to the city plan are greater than its TRSG payments.5% 6. and is badly underfunded.212. The latter has been closed to most classes of new school district employees since the late 1980s.0% 2008 2009 2010 2011 2012 $ Millions 8 $630 $610 $590 $570 $550 Source: Atlanta Independent School System. the Georgia State Supreme Court ruled that Atlanta’s charter schools have no legal obligation to pay a share of the Atlanta Independent School System’s (Aa2) annual pension costs. the Teachers Retirement System of Georgia (TRSG) multi-employer plan and the City of Atlanta (Aa2 stable) General Employees Pension Plan (GEPP). which accounted for 11.9% of total APS expenditures in fiscal 2012.3x annual operating revenues.8 million from its payments to local charter schools to help fund a $38.3830 michael. and will more than double to $78 million by 2026.darcy@moodys. less money has been available for APS to cover its pension contributions.0% 6.5% 7. Per our calculations.0% 5. declining property tax revenues. net of its payments to the charter schools.com Court Rules Atlanta Public Schools Won’t Get Help Funding Pensions from Charter Schools On 23 September.5% 5. annual financial reports The adjusted net pension liability (ANPL) is the difference between the fair market value of a pension plan’s assets and its adjusted liabilities.left axis $690 $670 $650 APC as Percent of General Fund Revenues .NEWS & ANALYSIS Credit implications of current events US Public Finance Michael D’Arcy Analyst +1.553. The suit began in 2012. The ruling is credit negative for the system. We also distribute the liabilities of multiple-employer costsharing plans to participating governments based on their pro rata share of contributions. and other K-12 public school districts in the state with an increasing charter school presence. equal to 1. Atlanta Public Schools’ Revenues and Contributions to Atlanta’s Pension Plan Revenues have shrunk even as annual pension contributions (APC) rose as a percent of budget Total General Fund Revenues . because it bars districts from offloading a portion of their legacy costs onto charter schools. the APS adjusted net pension liability (ANPL)8 for its share of the city plan was $796 million as of 2011. also called Atlanta Public Schools (APS). APS participates in two pension plans.right axis 7. The ruling in favor of the charter schools will result in APS having to cover its full pension costs from its own revenue base. As a result. and the end of the federal stimulus program.6 million annual pension contribution payment to one of its two retirement plans.

However. Some 10% of Atlanta’s 49. while typically making offsetting cost reductions.500 public school students were enrolled in charter schools in the 2011-12 school year.8 million of revenue that APS will return to the charter schools as a result of the ruling is not a large amount for the school system. making continued growth in Georgia a distinct possibility. The $2. charter schools -. but their enrollments are rising steadily throughout the US. As charter school enrollments rise. which was central to the charter schools’ legal argument before the state supreme court. 30 MOODY’S CREDIT OUTLOOK 30 SEPTEMBER 2013 .NEWS & ANALYSIS Credit implications of current events Charter school employees do not participate in either of the APS retirement plans. The host district must remit these funds to the charter schools in installments throughout the year. reducing school costs can be a lengthy and expensive process because students tend to move to charter schools in small numbers across all schools. minus a small number of permitted exclusions. making it challenging to close half-vacant buildings and reassign or cut staff.based on enrollments -. but the dispute underscores the larger issue of charter school funding in Georgia and the negative implications for public school districts. Georgia’s charter schools have achieved a modest penetration rate outside the Greater Atlanta metro area. traditional districts must transfer a greater share of revenues to fund the charter schools.receive a portion of all the revenues of the local K-12 district in which they operate. Under Georgia statute.

leaving it reliant on the success of two products: Eliquis and Nivolumab. our upgrade reflects strong industry drivers such as growth in specialty pharmaceuticals. based on new product introductions in the US. 11 Jun ’12 Downgrade 24 Sep ‘13 Senior Unsecured Rating Outlook A1 Negative A2 Stable We based our downgrade on ITW’s plans to divest its Industrial Packaging Segment and to offset EPS dilution from the potential loss of IPS's earnings by repurchasing shares. We also base our outlook on the possibility of rising debt levels to fund the company’s US cash needs. 31 MOODY’S CREDIT OUTLOOK 30 SEPTEMBER 2013 . Additionally.RATING CHANGES Significant rating actions taken the week ending 27 September 2013 Corporates Bristol-Myers Squibb Company 3 Aug ’09 Outlook Change 23 Sep ‘13 Senior Unsecured Rating Short-Term Issuer Rating Outlook A2 P-1 Stable A2 P-1 Negative The change in outlook reflects our concern that 2015 patent expirations will weaken the company’s credit ratios over the next several years. branded drugs coming off patent and rising generic utilization rates. ITW’s willingness to add debt as it pursues higher leverage and accelerated shareholder returns is more representative of an A2 rating. its solid footprint in the Chinese auto market and its focus on maintaining its liquidity profile. an increasing population over the age of 65. CVS/Caremark Corp. Illinois Tool Works Inc. General Motors Company 27 Oct ’11 Upgrade 23 Sep ‘13 Corporate Family Rating Outlook Ba1 Positive Baa3 Stable Improvements in GM’s operations and finances since emerging from bankruptcy prompted the upgrade. We believe GM will continue to improve its credit metrics. 31 May ’12 Upgrade 23 Sep ‘13 Senior Unsecured Rating Short-Term Issuer Rating Outlook Baa2 P-2 Positive Baa1 P-2 Stable Improvements in operating margins and growth in operating income prompted the upgrade.

32 MOODY’S CREDIT OUTLOOK 30 SEPTEMBER 2013 . 8 Sep ’11 Outlook Change 24 Sep ‘13 Long-Term Issuer Rating Short-Term Issuer Rating Outlook Baa3 P-3 Stable Baa3 P-3 Positive Our view that operating performance will remain positive for the next 12 months.A. prompted the change in outlook. based on increasing demand for spirits in the US and sustained demand in emerging markets. Earnings growth will lead to the generation of free cash flow and further de-leveraging.RATING CHANGES Significant rating actions taken the week ending 27 September 2013 Pernod Ricard S.

33 MOODY’S CREDIT OUTLOOK 30 SEPTEMBER 2013 . Despite BGE's solid standalone financial position.RATING CHANGES Significant rating actions taken the week ending 27 September 2013 Infrastructure Black Hills Corp. (BHC) / Black Hills Power (BHP) 18 Oct ‘12 Upgrade 25 Sep ‘13 Senior Unsecured Rating Issuer Rating (Black Hills Power) Outlook Baa3 Baa2 Positive Baa2 Baa1 Positive The outlook change reflects BHC's improved business risk profile. following the sale of unregulated assets and commensurate deleveraging Bord Gais Eireann (BGE) / BGE Finance Public Limited Company 14 Jul ‘11 Outlook Change 24 Sep ‘13 Long & Short-Term Issuer & Debt Ratings Senior Unsecured Rating Outlook Baa3/Prime-3 Baa3/(P)Baa3 Negative Baa3/Prime-3 Baa3/(P)Baa3 Stable The change in outlook follows the change in our outlook on Ireland's Ba1 government bond rating to stable from negative on 20 September. DirectRoute (Limerick) Finance Limited 14 Jul ‘11 Outlook Change 24 Sep ‘13 Guaranteed Secured Loan Facilities – Guildhall Asset Purchasing Company Guaranteed Secured Loan Facilities – European Investment Bank (EIB) Outlook Ba3 Ba3 Negative Ba3 Ba3 Stable The change in outlook follows the change in our outlook on Ireland's Ba1 government bond rating to stable from negative on 20 September. its ratings are constrained by that of Ireland due to the company's inability to disconnect itself from local economic and market circumstances.

A.p. we view the company's revenues and cash flows.RATING CHANGES Significant rating actions taken the week ending 27 September 2013 DTEK Holdings B.V. both those generated inside and outside of the country. as exposed to foreign-currency transfer and convertibility risks. 10 Dec ‘12 Downgrade 24 Sep ‘13 Senior Unsecured Bond Rating Outlook B3 Negative Caa1 Review for Downgrade DTEK Finance plc. 29 May ‘12 Outlook Change 26 Sep ‘13 Issuer Rating Senior Unsecured Rating Outlook Baa3 Baa3(P) Negative Baa3 Baa3(P) Stable The outlook change on the ratings of the Italian gas and electricity company follows the September 2012 acquisition of Edison's remaining minority shares by the more diversified French-based group. (DTEK) 10 Dec ‘12 Downgrade/Outlook Change 24 Sep ‘13 Corporate Family Rating (CFR) Probability of Default Rating (PDR) Outlook B3 B3-PD Negative Caa1 Caa1-PD Review for Downgrade DTEK Finance B. Electricite de France (Aa3 negative). Although DTEK's Ukraine-based business generates foreign currency in an amount exceeding its debt-servicing needs. DTEK's capacity to service its foreign currency debt is substantially exposed to actions that the Ukrainian government may take to preserve the country's foreign-exchange reserves and earnings. Edison S. 34 MOODY’S CREDIT OUTLOOK 30 SEPTEMBER 2013 .V. 9 Apr ‘13 Downgrade 24 Sep ‘13 Senior Unsecured Bond Rating Outlook B3 Negative Caa1 Review for Downgrade The downgrade follows our action lowering Ukraine's foreign-currency bond country ceiling to Caa1 from B3.

RATING CHANGES Significant rating actions taken the week ending 27 September 2013 Electricity Supply Board (ESB) / ESB Finance Limited 17 Oct ‘11 Outlook Change 24 Sep ‘13 Long & Short-Term Issuer Ratings Outlook Baa3/Prime-3(P-3) Negative Baa3/Prime-3(P-3) Stable The change in outlook follows the change in our outlook on Ireland's Ba1 government bond rating to stable from negative on 20 September. even as it continues to rely on debt financing over the next few years of a sizable capital program. we expect that the cooperative can sustain its sound financial metrics through periodic rate increases. if necessary. Hoosier Energy Rural Electric Cooperative. Instituto Costarricense de Electricidad (ICE) 8 May ‘13 Outlook Change 24 Sep ‘13 Senior Unsecured Rating Outlook Baa3 Stable Baa3 Negative The change in outlook follows our 23 September announcement that we have changed the rating outlook of the Government of Costa Rica (Baa3) to negative from stable. 35 MOODY’S CREDIT OUTLOOK 30 SEPTEMBER 2013 . Inc 23 Aug ‘11 Outlook Change 26 Sep ‘13 Senior Secured First Mortgage Bond Rating Senior Unsecured Issuer Rating Outlook A3 Baa1 Stable A3 Baa1 Positive We understand that Hoosier is in the process of extending its all-requirements wholesale power contracts to 2050. ICE is wholly owned by the Costa Rican government. Moreover.

in line with the macro-economic trend in Italy. Banco de Córdoba received a capital injection from the province of Córdoba of ARS100 million in 2011 and has been continuously capitalizing its earnings. Notwithstanding the improvement.RATING CHANGES Significant rating actions taken the week ending 27 September 2013 Financial Institutions Banco de Costa Rica 30 Jul ‘13 Outlook Change 24 Sep ‘13 Long-Term Rating Outlook Baa3 Stable Baa3 Negative The rating action is in line with our 23 September action changing the outlook on our Baa3 rating for the government of Costa Rica to negative from stable as well as the outlook for the foreign currency country ceiling for deposits.6% Tier 1 ratio in June 2013. Banca Sella's asset quality has weakened in recent years. weakening credit conditions and decelerating business growth will likely affect earnings generation and keep capitalization under pressure in coming quarters. with a 5. Banca Sella 14 May ‘12 Review for Downgrade 24 Sep ‘13 Deposit Ratings Standalone Financial Strength/ Baseline Credit Assessment Baa3/Prime-3 D+/ba1 Baa3/Prime-3 (Review for Downgrade) D+/ba1 (Review for Downgrade) The review is triggered by concern over the negative prospects for the bank's weakening asset quality. 36 MOODY’S CREDIT OUTLOOK 30 SEPTEMBER 2013 . the bank reported problem loans of €870 million. Banco de la Provincia de Córdoba 22 Jun ‘12 Downgrade 26 Sep ‘13 Standalone Financial Strength/ Baseline Credit Assessment E+/b3 E/caa1 The downgrade incorporates Banco de Córdoba's still-weak capitalization level. in the context of the persistently challenging operating environment and low capitalisation. In 2012.

We will evaluate the benefits to GMF of its ownership by a financially stronger parent. characteristic of its focus on low-risk payroll loans. at the same time that elevated delinquencies in the bank's commercial portfolio has led to high credit costs. Global Atlantic’s. is lower rated at Baa1 (on review for downgrade) for insurance financial strength. as intense competition within Bonsucesso’s core business of payroll-deductible loans has limited loan origination. Commonwealth Annuity and Life Insurance Company (CALIC). Forethought Financial Group.A.RATING CHANGES Significant rating actions taken the week ending 27 September 2013 Bonsucesso S. Inc 22 Mar ‘11 Review for Downgrade 26 Sep ‘13 Senior Debt Rating Insurance Financial Strength Rating Baa3 A3 Baa3 (Review for Downgrade) A3 (Review for Downgrade) The company's announced acquisition by Global Atlantic drives the review. primary life operating subsidiary. as well as the increased level of integration with GM including GMF's recent acquisition of most of the international auto finance operations of Ally Financial. 20 Apr ‘12 Downgrade 24 Sep ‘13 Standalone Financial Strength/ Baseline Credit Assessment Long-Term Global Local and Foreign Currency Deposit Ratings Long-Term Foreign-Currency Subordinated Debt Rating E+/b1 B1 B2 E+/b2 B2 B3 The downgrade reflects the weakening profitability metrics over the past 18 months. 37 MOODY’S CREDIT OUTLOOK 30 SEPTEMBER 2013 . We expect to align the insurance financial strength rating of Forethought's life operating subsidiary with that of CALIC upon the closing of the transaction. Bonsucesso's historically low nonperforming loan ratios. have trended upwards over the past years as the bank sought to increase lending to small and middle size companies (SMEs). GM Financial 27 Oct ‘11 Review for Upgrade 23 Sep ‘13 Corporate Family Rating Senior Unsecured Debt Rating Ba3 Ba3 Ba3 (Review for Upgrade) Ba3 (Review for Upgrade) The rating action comes in conjunction with our upgrade of GMF's parent General Motors Company (GM).

first. (AIB). 20 Mar ‘13 Review for Downgrade Continued 25 Sep ‘13 Senior Debt Rating Insurance Financial Strength Rating Caa1 Ba2 Caa1 (Review for Downgrade) Ba2 (Review for Downgrade) We are continuing the review for downgrade. p. and. EBS Ltd (EBS). Other drivers include Phoenix's weak accounting procedures and controls. MedioCredito Trentino-Alto Adige 17 Jul ‘12 Review for Downgrade 24 Sep ‘13 Deposit Ratings Standalone Financial Strength/ Baseline Credit Assessment Baa2/Prime-2 D+/ba1 Baa2/Prime-2 (Review for Downgrade) D+/ba1 (Review for Downgrade) The review reflects the negative prospects for the bank's weakening asset quality in the context of. The action was on the ratings of Allied Irish Banks. and the potential challenges in managing the underlying business operations given the current management distractions as well as the potential for increased surrenders by policyholders. which we took on 20 September. and Permanent tsb p.c (PTSB). Bank of Ireland (BoI).l. third. second.RATING CHANGES Significant rating actions taken the week ending 27 September 2013 Outlook on Irish Banks' Government-Guaranteed Debt Changed to Stable from Negative 24 Sep ‘13 The action follows our changing the outlook on Ireland's Ba1 government's bond ratings to stable from negative. 38 MOODY’S CREDIT OUTLOOK 30 SEPTEMBER 2013 . the persistently challenging operating environment in Italy.l. Inc. full reliance on wholesale funding. low and weakening profitability. initiated on 12 December.c. The Phoenix Companies. Phoenix will likely conclude it has multiple material weaknesses once it completes its restatement. because of the company's prolonged delays in filing its GAAP financial statements driven by the complexity and detailed level of auditor review.

Ukrainian Financial Institutions Downgraded.as well as National Scale Ratings (NSRs) -. SBI's standalone credit profile continues to face negative pressures in the context of a slowdown of the Indian economy. First. Large fiscal deficits and a rising debt burden remain Costa Rica's main medium-term credit risk and ratings constraint. of 13 banks (2 banks' deposit ratings were at Caa1 level already) and one leasing company. we placed on review for further downgrade the deposit and debt ratings. 39 MOODY’S CREDIT OUTLOOK 30 SEPTEMBER 2013 . The bank will have to compete with other public sector banks that have similar recapitalization needs.RATING CHANGES Significant rating actions taken the week ending 27 September 2013 State Bank of India 5 Sep ‘13 Downgrade 23 Sep ‘13 Senior Unsecured Debt Rating Local Currency Deposit Ratings Financial Strength Rating Baa2 Baa2 Stable Baa3 Baa3 Negative The decision to lower SBI's senior unsecured debt rating to the same Baa3 level as the Government of India's foreign currency bond rating reflects two negative factors affecting SBI's credit profile. The negative outlook also reflects the country's difficulty in passing legislation to reduce high fiscal deficits and limit the increase in the debt burden. Sovereigns Costa Rica Outlook Changed 23 Sep ‘13 Gov Currency Rating Foreign Currency Deposit Ceiling Foreign Currency Bond Ceiling Local Currency Deposit Ceiling Local Currency Bond Ceiling Outlook Baa3 Ba1 Baa1 A3 A3 Stable Baa3 Baa3 Baa1 A3 A3 Negative Since 2009 Costa Rica’s main debt have increased because of a jump in the fiscal deficit. Second. Placed on Review for Further Downgrade 25 Sep ‘13 We lowered the baseline credit assessments (BCAs) of 10 banks.of 11 banks and one leasing company in Ukraine to reflect the weakening of Ukraine's credit profile. as captured in our 20 September downgrade of Ukraine's government bond rating to Caa1 from B3. and NSRs. At the same time. and downgraded the debt and deposits ratings -. SBI is likely to seek another capital injection from the Indian government at the end of the current fiscal year in March 2014.

given their institutional. Ukraine 6 Dec ’12 Downgrade 25 Sep ‘13 Issuer rating Outlook B3 Negative Caa1 Review for Downgrade Our downgrade of Ukraine's government bond rating on 20 September and review for further downgrade has direct implications for the ratings of Kyiv and Kharkiv.RATING CHANGES Significant rating actions taken the week ending 27 September 2013 Sub-sovereigns Cities of Kyiv and Kharviv. financial and macroeconomic linkages with the sovereign. as the central government annually sets up indicative budget revenues and spending targets for the cities. 40 MOODY’S CREDIT OUTLOOK 30 SEPTEMBER 2013 . These institutional and financial linkages include the strict dependence of Ukrainian municipalities on government budget planning.

41 MOODY’S CREDIT OUTLOOK 30 SEPTEMBER 2013 .0% in 2014 in the US for–profit hospital sector underpins our stable outlook. low coal production costs and the ability to extend debt maturities will be best-equipped to weather the next 12-18 months. US Leveraged Finance: A Different Flavor of PIKs PIK toggle bonds are back. strong cash positions. US For-Profit Hospitals: Reduction in Bad Debt Expense Fuels EBITDA Growth in 2014 EBITDA growth of 3. Because the airline. Producers with solid credit quality. Asia Pacific Coal Industry: Liquidity Is Vital for Asian Coal Producers Amid Oversupply. the new crop differs from the bubble-era deals in a number of ways. and SBA Communications would be credit negative if financed with a significant amount of debt and would likely result in a downgrade.5-4. Sector revenue growth will exceed 10% through 2014. pent-up demand will carry the recovery over the next 12-18 months. All three are already debt-constrained because of recent aggressive debt-financed acquisitions. Crown Castle International Corp. and even though real income growth has lagged. High Leverage Weak coal prices stemming from excess supply will raise the risk of default for the least liquid Asian producers. affordability and home prices well below their 2006-7 peak are driving homebuilder’s growth. One thing has not changed.RESEARCH HIGHLIGHTS Notable research published the week ending 27 September 2013 Corporates AT&T Cell Tower Sale Would Be Credit Negative for Acquirers The possible purchase of AT&T’s wireless towers by American Tower Corp. US Homebuilding Industry: Wave of Pent-Up Demand Carries US Housing Recovery into Second Year Historically low mortgage rates. however: Today’s PIK issuers are just as highly leveraged as their bubble-era predecessors. they will be most negatively exposed to the depreciation of the real. longterm it will have a neutral or positive effect on most sectors as the weaker real leads to higher export volumes and stronger GDP growth.. Brazilian Corporates: Brazilian Currency Depreciation Has Neutral or Positive Effect on Most Sectors Although the depreciation of the Brazilian real will drive inflation higher over the next few months. oil and steel sectors tend to have high levels of debt but less revenue denominated in foreign currencies. Expanded insurance coverage with the implementation of the Affordable Care Act in 2014 will significantly reduce bad debt and will outweigh weak volume trends and reduction in Medicare reimbursement. so the deals still present significant risk to investors. and while their reappearance in the US has some drawing parallels to the credit crisis.

and accelerate to 13%-15% in 2014. while a rise in cash taxes will pressure free cash flow. A total of 34 bonds issued by 30 North American manufacturing companies drawn from our High-Yield Covenant Database have an average Covenant Quality score of 3. Revenue growth remains elusive.74. US Fixed-Line Telecommunications: Wireline Margins Will Stabilize. Ply Gem Industries.RESEARCH HIGHLIGHTS Notable research published the week ending 27 September 2013 Moody's High-Yield Covenant Database: North American Manufacturing Covenants Provide Investors Average Protection Covenant protections provided by US and Canadian manufacturing bonds are in line with the North American average. supported by solid underlying demand for residential properties and improved sentiment. This report highlights USG. whose half-yearly results were in line with expectations. as well as property prices in the country’s 70 major cities. We expect big improvements at TMobile and Sprint next year. We estimate that EBITDA-Capex will be roughly flat over the next 12 to 18 months as margins will likely stabilize in 2014 and capital spending will continue to fall. While the housing recovery will ultimately benefit the entire sector. It also looks at our rated property developers. while smaller operators like US Cellular will remain under pressure. 42 MOODY’S CREDIT OUTLOOK 30 SEPTEMBER 2013 . which continue to climb. compared with 3. But Cash Flow Looks Constrained Our outlook for the US fixed-line telecom industry is stable. US Wireless Industry Outlook: Industry Cash Flow Will Accelerate in 2014 Our outlook for the US wireless industry is positive. Owens Corning’s insulation segment and Masco’s installation business. China Property Focus This edition looks at the strong growth in property sales in China so far this year. US Building Products: Housing Recovery and Increased Repair and Remodeling Work Fuel Growing Optimism Companies involved in the initial stages of home construction will be the first to benefit from continued growth in the US homebuilding industry.72 for a sample of 900 North American non-financial corporate bonds. We expect that 2013 EBITDA minus capital spending will increase about 8% on a combined basis for the six carriers we follow. companies that manufacture and provide varying services for the initial construction stages will benefit sooner.

Latvia and Lithuania is stable for the first time since 2008.RESEARCH HIGHLIGHTS Notable research published the week ending 27 September 2013 Infrastructure & Project Finance China General Nuclear Power Corporation: Credit Effect of Recent Developments China’s commitment to nuclear power remains strong. two initiatives will help the industry’s credit profile through boosting profitability. such as high unemployment and high absolute levels of problem loans. The first is the industry’s efforts to change the pricing model for its key business line of auto insurance. 43 MOODY’S CREDIT OUTLOOK 30 SEPTEMBER 2013 . Neither the Husab uranium mine project nor delays in commissioning two reactors will not be hurting CGN’s credit quality. Core EU toll roads will continue to outperform periphery ones while airports able to accommodate the expansion of low-cost carriers will be best placed to capture growth. We expect these issues will be particularly challenging for the smaller Takaful operators. Japanese Property and Casualty Insurance Outlook Our outlook on Japan’s P&C insurance industry remains stable. If successful. resource or scope to capture growth and defend against competitors. as it has been since July 2012. Global Takaful Trends: Strong Growth Continues. and expected to reach $20 billion by 2017. But Challenges Ahead A type of Islamic insurance. as we expect traffic growth to improve in 2014 for core EU toll roads and airports as GDP recovers. Strong GDP growth in the wake of a deep recessions has helped fuel bank profitability and reduced levels of problem loan. Financial Institutions Baltics Banking System Outlook Our outlook for the banking systems of Estonia. Changing the outlook from negative follows the broad effects of the improved economic environment across the region. Takaful has continued to grow over the past decade with premiums exceeding $4 billion in 2007. European Transport Infrastructure Industry: Positive 2014 Growth for Core EU Traffic Underpins Stable Outlook We have changed our outlook for the European transport infrastructure sector to stable from negative. who may lack the expertise. These trends have offset the effects of lingering pressure points. The second is its move to reduce costs and improve efficiency through group consolidation. However. Takaful insurers face several challenges that may limit their growth opportunities.

Assuming there are no further industrial accidents and Bangladesh makes sufficient progress on improving its labor standards. despite anemic growth and the deterioration of its external position. Bangladesh: Weak Governance and Political Tensions Constrain Sovereign Creditworthiness As elections approach. would have greater adverse financial market and economic consequences because market participants would perceive an increased probability of sovereign default. The LATAM 5 sovereigns (Brazil. we see three possible scenarios: the military steps in. political tensions are likely to escalate. Trinidad and Tobago: New Budget Reinforces Credit Strengths Despite Weak Growth and Deteriorating External Balance Trinidad and Tobago’s recently released 2014 budget proposal is encouraging in some respects and supports the continued stable outlook for the country’s Baa1 sovereign rating. But the region is more resilient to rising rates and capital outflows than it was during the financial crises of the 1990s and early 2000s.RESEARCH HIGHLIGHTS Notable research published the week ending 27 September 2013 Sovereigns Latin America: Strengthened Sovereigns. Our forecast for Spain’s general government budget deficit for this year is very close to the revised target of 6. The Spanish Sovereign: Frequently Asked Questions The recent economic data mostly point to a stabilisation or slight improvement of the Spanish economy in the second half of the year and into 2014. A failure to raise the federal debt limit. A government shutdown would not affect debt service 44 MOODY’S CREDIT OUTLOOK 30 SEPTEMBER 2013 . failure at either would have negative economic consequences.5% of GDP that the Spanish government agreed with the European Commission last May. Banking Systems Will Help Region Navigate a Post-QE World Latin American debt issuers will face higher funding costs and reduced availability of credit as the US Federal Reserve eventually tapers quantitative easing. Colombia. which will support corporate credit quality. The first two weigh on the sovereign credit profile. Mexico and Peru) and their banking systems have become more creditworthy. tension persists. or the parties make piece. however. Chile. Failure to Raise US Debt Limit Would Be Worse than Government Shutdown We expect the US will both avoid a shutdown and increase the debt limit.

and its ability to garner voter support for tax cap overrides. The discrepancies between costs and federal transfers are unlikely by themselves to lead to rating actions in the short term. recovery of the state’s municipal property tax revenue will be slow. Although concerns for regional and local government credit profiles are mitigated because the servicing of rinzai-sai debt is fully subsidized by future transfers. However. US Public Finance Adjusted Pension Liability Measures for 50 Largest US Local Governments We rank the 50 largest US local governments by amount of debt outstanding according to our adjusted net pension liabilities (ANPL) relative to several measures of funding ability including operating revenue and full value. whether the growth is driven by new construction or appreciation. Privatized Military Housing: Continuing Stable Performance at Risk Due to Looming Federal Cuts Rated privatized military housing transactions have recently demonstrated stable credit performance.rinzai-sai -.continues to grow and is contributing to their high levels of indebtedness. Initiated as a temporary measure in 2001. which are already limited in their financial flexibility. 45 MOODY’S CREDIT OUTLOOK 30 SEPTEMBER 2013 . We find more than half have liabilities from pension underfunding that exceed 100% of their revenues. Michigan Tax Caps Limit Benefit of Real Estate Gains Despite the improving Michigan housing market. over time the funding of operating expenditures through debt adds to the central government’s already heavy debt burden.RESEARCH HIGHLIGHTS Notable research published the week ending 27 September 2013 Sub-sovereigns Japanese Regional and Local Governments Challenged by Rising Debt Through Increased Rinzai-Sai Issuances The government-directed debt of Japanese regional and local governments -. Education Expenditures Constrain Financial Flexibility of Mexican States Mexican states. if not addressed. also that burdens vary enormously. could have this flexibility further compromised because of structural pressures from education funding. The key to how much a municipality will benefit from housing gains depends on its rate of recovery. but face significant risks from increasingly probable federal budget actions in the coming years. the states could consequently have less financial flexibility. resulting in cash financing deficits and downward rating pressure over the medium term. this type of borrowing has become an ongoing replacement for cash transfers.

A Comparison of Japanese. the resolution status of conflicting language in documents governing 11 RMBS transactions. Although the decisions could be indicative of the decisions for other years. mortgage insurance for lenders in Australian and Dutch RMBS. Note types also vary among the countries. mitigating credit risk. Arbitration Panel’s Decisions Are Credit Positive for Tobacco Securitizations The decisions by an arbitration panel that nine of 15 US states. They pose analytical challenges because their risk profiles are affected by absolute levels of losses and prepayments as well as timing. Australian.RESEARCH HIGHLIGHTS Notable research published the week ending 27 September 2013 Structured Finance Pre-crisis RMBS Structures Re-appear in Recent Transactions Structural features common in pre-crisis transactions are re-emerging in new RMBS. Super senior support bonds. which is bolstered by affordable housing. have “diligently enforced” certain statutes in 2003 is credit positive for these states’ tobacco securitizations. But bonds are likely to incur losses in only low-probability scenarios given their seniority and the strong credit quality of recent transactions. Also discussed: Nationstar’s higher advances help it remit more cash to RMBS than Ocwen. Resi Landscape Softening housing metrics will not halt the US housing market rebound. and Dutch RMBS having the most significant set-off risk. future arbitration panels could reach a different conclusion about enforcement of the statutes for those years. exchangeable securities. the September edition of our newsletter says. 46 MOODY’S CREDIT OUTLOOK 30 SEPTEMBER 2013 . Dutch and UK RMBS and Mortgage Markets Key differences among these markets include varying receivable characteristics. principal-only bonds and pool interest-only bonds can increase risks to senior bonds in the event of very high mortgage losses. low home inventories and positive employment numbers. including four states that sponsored rated securitizations. among other topics.

a CREDIT IN DEPTH Latin American Sovereigns Latin American debt issuers will face higher financing costs and reduced availability of credit as the US Federal Reserve’s eventual tapering of its $85 billion in monthly bond purchases prompts rising interest rates. 16 Credit Negative Negative » Illinois Tool Works' Latest Divestiture Plans Are Credit Infrastructure » RWE's Dividend Cut Is Credit Positive 6 7 Banks » Several Mexican Banks Will See Their Asset Quality Damaged by the Recent Hurricanes » Ukraine's Deteriorating Credit Is Negative for Domestic Banks and Their Foreign Shareholders » Ukraine's Higher FX Reserve Requirements Will Decrease Bank Liquidity Insurers » Fairfax Bid for BlackBerry Is Credit Negative 12 47 MOODY’S CREDIT OUTLOOK 30 SEPTEMBER 2013 . The new environment entails a re-pricing of credit risk and a reduction in global investors’ appetite for risk exposure in Latin America.RECENTLY IN CREDIT OUTLOOK Select any article below to go to last Thursday’s Credit Outlook on moodys. we view the region as far more resilient to rising rates and investment outflows than it was during the financial crises of the 1990s and early 2000s. However. These trends will prove more longlasting than the volatile market reaction that followed initial indications in May that the Fed would begin to wind down quantitative easing later this year.com NE EWS & ANALYSIS Corporates » Agilent's Spinoff of Electronic Measurement Business Would Sovereigns 2 » Terrorist Attack in Kenya Harms Economic Growth and 13 Government Revenues Be Credit Negative » Gentiva Is Acquiring Harden Amid Operating Challenges.

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