Moody's Credit Outlook Issuance

30 SEPTEMBER 2013
NEWS & ANALYSIS

The US Government Shutdown and Debt Limit
For the US Sovereign, Failure to Raise Debt Limit Would Be
US Public Finance 2
Court Rules Atlanta Public Schools Won't Get Help Funding
29
Pensions from Charter Schools
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
RATINGS & RESEARCH

Rating Changes Last week we upgraded CVS/Caremark, General Motors, and Black Hills Corp. / Black Hills Power and downgraded Illinois Tool Works, DTEK Holdings, DTEK Finance BV, DTEK Finance plc, Banco de la Provincia de Crdoba, Bonsucesso, State Bank of India, 12 Ukrainian financial institutions, and the cities of Kyiv and Kharviv in the Ukraine, among other rating actions. 12 Research Highlights Last week, we published on AT&T, Asia-Pacific coal, US for-profit hospitals, Brazilian corporates, US homebuilders, US leveraged finance, North American manufacturers, China property, US building products, US wireless, US fixed-line telecoms, China General Nuclear Power, European transport infrastructure, the Baltics banking system, Japanese property and casualty insurers, global takaful, Latin American sovereigns, Bangladesh, Trinidad and Tobago, Spain, the US, Japanese regional and local governments, Mexican states, US states, Michigan, US military housing, US RMBS, tobacco securitizations, and Japanese, Australian, Dutch and UK RMBS, among other reports. 41 31
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
Corporates
Stryker's Acquisition of MAKO Surgical Is Credit Negative Labco's Sale of Its German Subsidiary to Sonic Is Credit Positive
Infrastructure
NorthWestern Corp. Purchase of Hydro Assets Is Credit
14
Positive
UK Opposition Labour Party Pledge to Freeze Energy Tariffs Is
Credit Negative for Utilities

Recent Deleveraging Announcements Are Credit Positive for
Enel Banks
New York District Court Expands FIRREA's Reach to Prosecute
18
Banks Accused of Fraud

Brazil's State-Owned Banks Will Reduce Loan Growth, a Credit
RECENTLY IN CREDIT OUTLOOK

Articles in Last Thursdays Credit Outlook Go to Last Thursdays Credit Outlook
Positive
Bundesbank Study Will Prompt Large German Banks to
47
Continue Boosting Their Capital

Socit De Financement Local Would Avoid Legal Risk with
Amended Finance Law Insurers

ProAssurance's Proposed Acquisition of Eastern Is Credit
25
Click here for Weekly Market Outlook, our sister publication containing Moodys Analytics review of market activity, financial predictions, and the dates of upcoming economic releases.
Negative
Global Atlantic's Acquisition of Forethought Is Credit Negative
for Both Money Market Funds

Fed's New Overnight Reverse Repo Facility Offers Supply
28
Benefits to US Money Market Funds
MOODYS.COM
NEWS & ANALYSIS

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
MOODYS CREDIT OUTLOOK
30 SEPTEMBER 2013
NEWS & ANALYSIS

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 shutdowns 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.
30 SEPTEMBER 2013
NEWS & ANALYSIS

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 companys current sources of near-immediate liquidity (cash and available committed bank lines) as of 30 June 2013 relative to the companys 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 ones 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).
30 SEPTEMBER 2013
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, there is considerable variability on an individual company basis. The risks related to a potential disruption in cash collections from the US government remain elevated for all, especially because many of the smaller companies characterized as more at risk are critical suppliers to the larger companies, and as elsewhere, the strongest chain is vulnerable to its weakest link. We would be particularly concerned in the event of a wholesale government shutdown wherein bill payments cease for more than just a few weeks. 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, 27 September 2013.
30 SEPTEMBER 2013
NEWS & ANALYSIS

Brian Harris Senior Vice President +1.212.553.4705 brian.harris@moodys.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. However, these events will not affect the credit strength of these GSEs. Neither Fannie Mae nor Freddie Mac currently depend on government funds, a situation that is unlikely to change. 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%. Even if they did not perform as expected, the GSEs would continue to have access to contingent capital from the Treasury totaling $117.6 billion for Fannie Mae and $140.5 billion for Freddie Mac. And, based on our conversations with government officials, we believe that any payments to the two GSEs as part of their capital agreement would be mandatory spending and, as such, would not be affected by a government shutdown. Furthermore, in the unlikely event that a financial disruption resulted in the GSEs reporting a loss, there is a high likelihood that the Treasury would honor the capital agreement with them, even if it were not a mandatory expenditure, or if a failure to raise the debt limit were to place at risk all government expenditures. We also believe the government would honor its agreement with Fannie Mae and Freddie Mac even if it meant rationalizing other discretionary expenditures, because to not do so would damage the US economy in general and more specifically the US housing market. The two GSEs were put into conservatorship in September 2008 when the US housing market was crashing and both faced significant losses. The Treasury committed to provide contingent capital, as needed, to offset the losses, which were substantial: fourth-quarter 2008 through fourth-quarter 2011 losses totaled $128.1 billion and $64.7 billion, respectively, for Fannie Mae and Freddie Mae. The Treasurys capital injections were also significant, totaling $116.1 billion for Fannie Mae and $71.3 billion for Freddie Mac. However, since first-quarter 2012, the two GSEs have reported positive net income as the housing market recovered and they increased guarantee fees (see exhibit below). 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
30 SEPTEMBER 2013
NEWS & ANALYSIS

Steve Zaharuk Senior Vice President +1.212.553.1634 stephen.zaharuk@moodys.com
Health Insurers Would Not Be Directly Affected by a Shutdown, But Are Exposed to a Failure to Raise Debt Limit
Health insurers would not be directly affected by a government shutdown, but they would likely be hurt if Congress does not raise the debt limit. Health insurers that offer Medicare Advantage products to US seniors, or participate in managed care Medicaid programs, rely on federal government payments. 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, and therefore, a government shutdown would not affect them. Health insurers also receive payments under the Medicaid program, which is largely state-run, with the federal government paying somewhere between 50% and 75% of Medicaid costs (the percentage varies by state). The state portion of Medicaid payments would not be directly affected by a federal government shutdown. In addition, the federal Medicaid payments to the states, which are typically paid in advance on a quarterly basis, are considered non-discretionary spending, and a government shutdown would not affect. If the shutdown were to extend for a long period, however, administrative delays could disrupt payment stream to insurers. If the debt ceiling is reached, all federal payments are theoretically at risk, potentially including both Medicare and Medicaid payments. But since Medicare payments are paid from the Medicare trust funds, we believe they are unlikely to be affected. In the case of payment delays, or a failure to raise the debt ceiling, insurers will be faced with the decision as to whether to continue to cover beneficiaries and make payments to doctors on credit, or to suspend insurance coverage until the government resumes payments.
30 SEPTEMBER 2013
NEWS & ANALYSIS

Alan Murray Senior Vice President +1.212.553.7787 alan.murray@moodys.com
Surety Insurers Face Delays in New Business, But Little, If Any, 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. Surety companies insure the risk that contractors are not able to meet their commitments in such projects. Fewer projects mean less demand for surety insurance. The effect would occur only gradually, because projects are typically planned and funded over long periods. Most insurers in the surety market are diversified, and therefore a shutdown would have only a very minor effect on their creditworthiness, if any effect at all. Importantly, if the government suspends or cancels a project, surety insurers are not responsible for a contractors uncompleted project. During and after the global financial crisis in 2008-10, a number of government-driven projects experienced stops or delays in payments, but surety insurers did not suffer elevated losses as a result. The surety insurers only cover a contractors failure to complete work for which it has been contracted and paid. With the exception of certain very high priority projects, a government shutdown may lead to an increase in payment delays on federally funded projects. Consequently, work stoppages could well occur on projects that fall below the high-priority threshold, or that are not pre-funded. But, as stated, 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. This way, the contractor does not have to go through the legal process of halting work, based on the contract terms, because of nonpayment by the government.
30 SEPTEMBER 2013
NEWS & ANALYSIS

Nick Samuels Vice President - Senior Credit Officer +1.212.553.7121 nicholas.samuels@moodys.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. A failure to raise the US debt ceiling would be more credit negative for municipal issuers. It would be more problematic for issuers if the debt ceiling is not raised because all spending, including non-discretionary spending, would be eligible for cuts. During a shutdown, only discretionary spending is on the chopping block. A binding debt ceiling limit could jeopardize funding to some muni issuers. The federal government would not be allowed to increase its outstanding debt if it reaches the statutory debt ceiling. 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, which would not be enough to meet its net daily expenditures that reach as high as $60 billion. In this scenario, all or some federal funding could be reduced, including funding to public finance issuers that receive related federal transfers to pay for services, or in some cases to pay for debt service. Public finance issuers would also likely face higher borrowing costs, and market access would be challenging, particularly for issuers with thin liquidity and a need to refinance debt or access the short-term note market for cash-flow purposes. However, 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. The types of public finance issuers and securities exposed to federal government transfers are outlined below. States have relatively high dependence on federal revenues and some have relatively high economic reliance on federal procurement and healthcare spending, specifically Medicaid matching funds, or rely on cash-flow borrowing and variable-rate financing, as seen in Exhibit 1. However, 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.
EXHIBIT 1
30 25 24
Federal Revenues as a Percent of State Total Governmental Funds
Number of States
20 15 15 10 5 10% - 20% 21% - 30% 31% - 40% 41% - 50% 51% - 60%
Note: 10%-20%: Alaska, Wyoming; 21%-30%: Connecticut, Delaware, Hawaii, Kansas, Massachusetts, Minnesota, New Jersey, North Dakota;31%40%: California, Colorado, Florida, Illinois, Indiana, Iowa, Kentucky, Maryland, Michigan, Nebraska, New Hampshire, New Mexico, New York, North Carolina, Oklahoma, Pennsylvania, South Carolina, Texas, Utah, Vermont, Virginia, Washington, West Virginia, Wisconsin; 41%-50%: Alabama, Arizona, Arkansas, Georgia, Idaho, Maine, Mississippi, Missouri, Montana, Nevada, Ohio, Oregon, Rhode Island, South Dakota, Tennessee; 51%-60%: Louisiana Source: Fiscal 2012 State Comprehensive Annual Financial Reports
30 SEPTEMBER 2013
NEWS & ANALYSIS

Credit implications of current events Local governments generally have low dependence on federal revenues, but some rely heavily on aid from states, which may themselves experience direct cuts in federal funding. Local governments with strong financial reserves and effective governance are more equipped to mitigate funding cuts. The District of Columbia (Aa2 stable) is a unique case because it requires Congressional approval for its budget, meaning a shutdown could affect its operations. However, a Congressionally enacted statute explicitly permits payment of debt service without the need for federal appropriation. Healthcare institutions are very reliant on federal revenues via Medicare and Medicaid. Medicaid spending is generally the largest expenditure for states, although it is usually half funded by the federal government. Cuts to Medicaid funding could delay reimbursements to healthcare providers, which would be credit negative for hospitals (see Exhibit 2), some of which sequestration and Medicare reforms already pinch. Hospitals that treat a large number of low-income patients (those on Medicaid) would be disproportionately affected by Medicaid cuts or reimbursement delays.
EXHIBIT 2
Hospitals with the Largest Percentage of Medicaid Funding

Hospital Rating Outlook Medicaid as Percent of Revenue
All Children's Hospital, Florida Arkansas Children's Hospital, Arkansas Children's Healthcare of Atlanta, Georgia Children's Hospital Central California Children's Hospital of Alabama Children's Hospital of Los Angeles, California Children's Medical Center of Dallas, Texas Children's Specialized Hospital, New Jersey Texas Children's Hospital, Texas Rady Childrens Hospital, California
Source: Moodys
A1 stable A1 stable Aa2 stable A1 stable A2 positive Baa2 stable Aa3 stable Baa3 stable Aa2 stable A2 stable
64.3% 65.1% 53.6% 70.7% 56.0% 69.5% 64.1% 63.0% 53.6% 53.3%
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, and are shown in Exhibit 3.
10
30 SEPTEMBER 2013
NEWS & ANALYSIS

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 funds for 2011 have already been appropriated No, funds for payment were appropriated at time of debt issuance Yes 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: Moodys
Government shutdown would have limited effect. In the case of a government shutdown, only discretionary spending would be suspended or reduced, which would have less effect on public finance issuers than in the case of a debt-ceiling breach. The federal government has not yet identified services and programs that would be cut, but they typically include national parks, passport offices and administrative staff. However, a prolonged shutdown would negatively affect economic activity in states and localities with a heavy federal presence, including the Washington, DC metro area, potentially leading to income and sales tax declines.
11
30 SEPTEMBER 2013
NEWS & ANALYSIS

Corporates
Diana Lee Vice President - Senior Credit Officer +1.212.553.4747 diana.lee@moodys.com
Strykers Acquisition of MAKO Surgical Is Credit Negative

Last Wednesday, Stryker Corporation (A3 stable) said it had reached a definitive agreement to buy MAKO Surgical Corp. (unrated), a manufacturer of devices for robotic-assisted orthopedic surgery, for $1.65 billion. Although the transaction has the potential to ultimately benefit Stryker, 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. Stryker had total cash and marketable securities of about $4.7 billion at 30 June, including the proceeds from a recent $1 billion bond offering, and about 50% of this cash is held in the US. A reduction in its US cash will reduce Strykers cushion for its other US cash needs, including dividends, buybacks and future US acquisitions. MAKO will not immediately add a material level of sales or positive cash flow, having reported sales of about $103 million and negative cash flow from operations for fiscal 2012. But because the acquisition will not likely be funded with debt, Strykers leverage (debt/EBITDA of about 1.7x at 30 June) will remain steady. MAKO manufactures the RIO Robotic Arm, which is used primarily in partial knee resurfacing procedures and was recently approved for total hip arthroplasty procedures. For both procedures, using the RIO arm requires use of MAKOs RESTORIS family of implants. The acquisition would accelerate Strykers ability to enter the robotic space, which offers more growth opportunities, a credit positive. However, it is unclear how quickly doctors and hospitals will adopt this robotic technology. In addition to ensuring that orthopedic surgeons receive appropriate training on the robotic equipment, future clinical outcomes will help determine the speed of adoption. 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. As a result, orthopedic companies have begun to focus more on implant technique and alignment than the actual implants. Along these lines, Stryker has been competing against other large orthopedic players, including Johnson & Johnson (Aaa stable), Zimmer Holdings, Inc. (Baa1 stable) and Biomet, Inc. (B2 stable), in selling patient-specific instrumentation and computer-assisted guide technology aimed at improving implant technique. It is too early to determine if the robotic technology will give Stryker a strategic advantage and allow it to gain market share. Other companies are also pursuing robotic devices. Blue Belt Technologies, Inc. (unrated) recently received approval for its robotic equipment to be used in knee procedures.
12
30 SEPTEMBER 2013
NEWS & ANALYSIS

Simon West Associate Analyst +44.20.7772.5479 simon.west@moodys.com
Labcos Sale of Its German Subsidiary to Sonic Is Credit Positive

Last Thursday, Labco S.A. (B2 stable), a leading medical diagnostics company, announced the sale of its German subsidiary to Sonic Healthcare Limited (unrated) for 76 million. The disposal is credit positive for Labco because its liquidity will improve, allowing the company to focus on core markets. Sonic is paying a multiple of more than 10.0x the subsidiarys EBITDA contribution for the 12 months ended 30 June 2013, increasing Labcos cash reserves by around 70 million (after accounting for debt within the division). Pro forma for the transaction, the disposal will increase Labcos cash to around 170 million as of 30 June, versus 67 million a year earlier. Although the deal will improve liquidity, how the company will use the cash is unclear. If Labco uses the funds to pay down debt, then we expect debt/EBITDA would decline to less than 5.5x, as adjusted by us. On or after January 2014, Labco can redeem bonds, which currently trade at around 106, at 106.375%. Historically, Labco has pursued a buy-and-build strategy, spending 44 million on acquisitions in 2012 and 93 million in 2011. Given its active acquisition strategy, we expect the positive effect on liquidity from sale proceeds will be short lived. Nevertheless, the cash will give the company additional ability to maintain its growth strategy in core markets. By selling its German subsidiary, Labco is disposing of a non-core asset that contributed revenue of 54 million in 2012, or around 9% of Labcos group revenue. Earnings did not benefit from economies of scale because Labco was a relatively small player in Germany. The sale will allow Labco to focus attention on markets where its leadership offers better margins, such as France, which accounted for 53% of 2012 sales, and Spain and Portugal, which accounted for 26%. Labcos German operations will be of greater strategic importance to Sonic, which is already a major player in Germany. The German division suffered from large impairment write-downs, 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 divisions laboratory in Dillenburg, Germany by its previous owners. Based in Paris, Labco has a pan-European network of medical laboratories and collection points that provides routine and semi-routine clinical testing services for individual patients. For the six months to 30 June, France accounted for 54% of Labcos revenues; Spain and Portugal 26%; Germany 9%; Italy 6% and Belgium 5%. The company also has a foothold in the UK through its joint venture with Sodexo. The companies expect to complete the transaction, which is subject to antitrust approval and other usual closing conditions, by the end of this year.
13
30 SEPTEMBER 2013
NEWS & ANALYSIS

Infrastructure
Ryan Wobbrock Assistant Vice President +1.212.553.7104 ryan.wobbrock@moodys.com
NorthWestern Corp. Purchase of Hydro Assets Is Credit Positive

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

Helen Francis Vice President - Senior Credit Officer +44.20.7772.5422 helen.francis@moodys.com Scott Phillips Vice President - Senior Analyst +44.20.7772.5206 scott.phillips@moodys.com
UK Opposition Labour Party Pledge to Freeze Energy Tariffs Is Credit Negative for Utilities
On 24 September, the leader of the UK opposition Labour Party, Ed Miliband, promised to freeze gas and electricity tariffs until 2017, if elected prime minister at the next general election. A tariff freeze would be credit negative for all utilities with UK supply exposure, particularly Centrica plc (A3 stable) and SSE plc (A3 stable), two of the largest energy retailers, and also for the UK subsidiaries of Iberdrola S.A. (Baa1 negative), Electricite de France (Aa3 negative), RWE AG (Baa1 stable) and E.ON SE (A3, negative). Mr. Miliband estimates the negative effect of the freeze would be 4.5 billion for the sector, which seems reasonable as industry consensus is for costs to rise from current levels. Mr. Milibands 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, scheduled for May 2015. A YouGov opinion poll published last Wednesday showed the Labour Party with a nine percentage point lead over the ruling Conservatives. If Labour maintains its advantage in the polls, it will likely lead to it forming a majority in the House of Commons post-election, increasing the probability of the tariff freeze being passed. Capping electricity and gas tariffs would be credit negative for UK energy suppliers, which would be unable to raise prices if their costs increase as we expect. According to the energy regulator, the Office of Gas and Electricity Markets (Ofgem), the average domestic energy bill in the UK currently stands at 1,420 per customer per annum (based on standard consumption), an increase of 30% since 2010. However, this has been driven by both a 30% increase in wholesale electricity and gas costs, which account for 44% of the final tariff , and a 31% increase in other costs, such as transportation charges and environmental schemes (e.g., renewable subsidies), which together account for around 40% of the end-user tariff, as seen in the exhibit below. In contrast, the percentage attributable to net margin only amounts to around 6%-7% of the end-user bill. Components of the Average Annual UK Domestic Energy Bill
Net Profit 1,600 1,400 1,200 1,000 800 600 400 200 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, the cost base of suppliers is expected to rise accordingly, and with tariff caps in place, profit margins will quickly erode. Last April, 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 3.1%, equivalent to around 1.2 billion of profit per annum. If Labours forecast for a 4.5 billion hit is accurate, the effect of this tariff freeze would likely make UK energy supply a loss-making activity.
15
30 SEPTEMBER 2013
NEWS & ANALYSIS

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

Helen Francis Vice President - Senior Credit Officer +44.20.7772.5422 helen.francis@moodys.com
Recent Deleveraging Announcements Are Credit Positive for Enel

Last Wednesday, the large and diversified Italian power group, Enel S.p.A. (Baa2 negative) announced both the 1.33 billion disposal of its stake in Russian Severenergia (unrated) and the completion of the third of three recent hybrid issuances totalling approximately 2.65 billion. These measures are credit positive for Enel and help the company meet its strategic goals, announced in March, 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. Enels agreement to sell its stake in Russian Severenergia, an upstream gas company, to Rosneft will produce proceeds of $1.8 billion (1.33 billion). The deal is subject to applicable antitrust clearance. This is Enels largest disposal announced to date, adding to divestments agreed upon earlier in 2013 worth 304 million for its Belgian and Spanish assets. So far this year, disposals have totaled 1.63 billion out of Enels planned 6 billion worth of divestments, which are the main driver behind its debt-reduction plans. Enels completion of its third hybrid issuance, a US dollar-denominated tranche of $1.25 billion (926 million), follows issuances earlier in September of 400 million (475 million) and 1.25 billion. These go more than half way to meet Enels target of 5 billion. For accounting reasons, the hybrids will be treated as 100% debt in Enels books, and hence do not contribute to its net debt targets. Nonetheless, they improve the companys capital structure. We treat these particular instruments as half equity, half debt in our analysis because they are deeply subordinated to senior debt and, as such, they strengthen the position of senior bondholders. The combination of the recent disposals and the hybrid issuance, and after taking account of the equity cushion they provide, give the benefit of an equivalent debt reduction of 2.9 billion under our financial ratio calculations. On a pro-forma basis, funds from operations (FFO) to net debt of 17.9% in 2012 would have improved to 19.0% 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. This moves Enels financial profile closer to our current ratings targeted FFO/net debt guideline of around 20% by the end of 2014. Enels 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, as illustrated by projected group EBITDA, which is 16 billion for 2013, down from 16.7 billion at the end of 2012.
17
30 SEPTEMBER 2013
NEWS & ANALYSIS

Banks
Teresa Wyszomierski Chief Legal Officer - Financial Institutions Group +1.212.553.4129 teresa.wyszomierski@moodys.com
New York District Court Expands FIRREAs Reach to Prosecute Banks Accused of Fraud
For the third time in recent months, a New York federal district court on 24 September in United States v. Wells Fargo Bank allowed the government to use the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA) not just to protect banks victimized by the fraudulent acts of third parties, but to prosecute the banks themselves when they are damaged by their own fraudulent conduct. 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. 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.e., predicate offenses) involving financial institutions and government agencies. To be actionable under FIRREA, certain of these offenses require that the violation be one affecting a federally insured financial institution. FIRREA does not define the term affecting, and because the statute has rarely been used, there were no decisions interpreting that term until recently. Starting last April, the federal court in the Southern District of New York rendered three decisions1 by three different judges, all of which held that the affected institution could be the alleged perpetrator of the fraud, and not necessarily a third-party victim or innocent bystander. The judges based this interpretation on the plain language of the statute, and with the view that because Congress intent was to deter fraudulent conduct that might put federally insured deposits at risk, 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.
The scope of the statute is wide, thanks to the inclusion of mail and wire fraud as one of the predicate offenses. The mail and wire fraud statutes cover virtually any fraud involving interstate mail, e-mail, telephone, faxes, or other electronic communication. FIRREA therefore gives the DOJ a civil hook to investigate and prosecute mortgage fraud. Because FIRREA authorizes only civil remedies, the DOJ only has to prove that the defendant committed one of the predicate offenses by a preponderance of the evidence, and not beyond a reasonable doubt, as in a criminal case. 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. The DOJ can therefore engage in extensive discovery pre-suit. 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, which is far longer than the typical three to five years applicable to civil lawsuits.
1
United States v. The Bank of New York Mellon et al., No. 11 Civ.6969 (LAK), 2013 U.S. Dist. LEXIS 58816 (S.D.N.Y. 24 April 2013). United States v. Countrywide Financial Corporation et al., No. 12 Civ. 1422 (JSR), 2013 U.S. Dist. LEXIS 117140 (S.D.N.Y. 16 August 2013). United States v. Wells Fargo Bank, N.A., No. 12 Civ. 7527 (JMF), 2013 U.S. Dist. LEXIS 136539 (S.D.N.Y. 24 September 2013).
18
30 SEPTEMBER 2013
NEWS & ANALYSIS

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

Alexandre Albuquerque Assistant Vice President - Analyst +55.11.3043.7356 alexandre.albuquerque@moodys.com
Brazils State-Owned Banks Will Reduce Loan Growth, a Credit Positive

Last Wednesday, Brazil President Dilma Rousseff announced that government-owned banks Caixa Econmica Federal (CAIXA, Baa2 positive, D/ba2 stable),2 Banco Nacional de Desenvolvimento Econmico e Social (BNDES, Baa2 positive) and Banco do Brasil S.A. (A3 positive, C-/baa2 stable) will reduce their rates of loan growth. 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. Ms. 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. Since 2008, 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. This approach has resulted in a sizable expansion, with the three banks lending accounting for 50.5% of total system loans in July, compared with 33% in 2008. Moreover, each bank reported robust loan growth compared with the privately owned banks (see exhibit), with CAIXA growing at a compound annual rate of 44% between June 2009 and June 2013, and Banco do Brasil and BNDES each growing at 23% over the same period. Loan Growth of Brazils 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: Moodys, Central Bank of Brazil
High loan growth rates have largely masked asset quality deterioration in these banks balance sheets, and thus the governments plan to slow loan growth will lead to higher delinquencies, reflecting the seasoning of their loan portfolios. However, we view moderation in loan origination as a positive move that will limit future nonperforming loans and alleviate pressure on asset quality, as lower credit supply reduces the risk of adverse selection at a time when private-sector banks are cautious about taking on risk. Additionally, we expect the slowdown in loan origination to reduce pressure on capital, which has been increasing lately. The combination of strong growth, large dividend payouts to the government, and relatively high participation of lesser quality hybrid debt and capital instruments has resulted in poor quality core capital ratios for all three banks. As of June 2013, our adjusted Tier 1 capital ratio for Banco do Brasil was 9.55%, while that for BNDES was 9.53% and for CAIXA 6.36%.
20
Loans in December 2008 = 100
The bank ratings shown in this report are the banks domestic deposit ratings, their standalone bank financial strength ratings/baseline credit assessments and the corresponding rating outlooks.
30 SEPTEMBER 2013
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, and has contributed to the increase in gross government debt relative to GDP. We forecast the ratio will reach 59.7% by the end of 2013, compared to 53.4% in 2010. However, the governments announcement provides no guidance about a proposed timeframe or target market share that the public banks should aim to achieve. Brazils 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. Therefore, we view the execution of this plan as critical and challenging, particularly as we approach an election on 5 October 2014 for the president and National Congress.
21
30 SEPTEMBER 2013
NEWS & ANALYSIS

Katharina Barten Vice President - Senior Credit Officer +49.69.70730.765 katharina.barten@moodys.com Alexander Hendricks, CFA Associate Managing Director +49.69.70730.779 alexander.hendricks@moodys.com
Bundesbank Study Will Prompt Large German Banks to Continue Boosting Their Capital
Last Wednesday, the German Bundesbank released a study showing that Germanys leading banks continue to lag their European peers in complying with Basel IIIs stricter capital ratios. 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. According to the study, Germanys seven largest banks, the so-called Group 1 banks,3 had an average fully phased-in Common Equity Tier 1 (CET1) ratio of 7.0% at the end of 2012, well shy of the 8.4% average for large banks in the European Union (EU) (see Exhibit 1). Although the studys 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. Germanys largest banks also display considerably lower absolute (or non-risk weighted) capitalisation, as illustrated by their lower leverage ratio (CET1 capital as percentage of total exposure) relative to the average for the largest EU banks. Moreover, 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.
EXHIBIT 1
Results from the Bundesbanks Basel III Study on Germanys Group 1 Banks
German Banks 10% 8.4% 8% 6% 4% 2% 0% Core Equity Tier 1 Total Capital Ratio Leverage Ratio 1.9% 7.0% European Union Banks 9.5% 9.6%
2.9%
Note: Data as of year-end 2012 Source: Deutsche Bundesbank
Although the average CET1 ratio for the seven large banks was 7%, not all seven banks are in compliance with Basel III regulatory minimum. 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. Positively, the Bundesbank data illustrate that German banks have made significant progress in boosting their capital, and we expect that trend to continue over the next few quarters. According to the Bundesbank
Group 1 banks have at least 3 billion of Tier 1 capital and international banking activities. They include: Deutsche Bank AG (A2 stable, C-/baa2 stable), Commerzbank AG (Baa1 stable, D+/ba1 stable), DZ Bank AG (A1 stable, C-/baa2 stable), UniCredit Bank AG (A3 negative, C-/baa2 negative), Landesbank Baden-Wuerttemberg (A3 stable, D+/ba1 stable), Bayerische Landesbank (Baa1 stable, D-/ba3 stable) and Norddeutsche Landesbank GZ (A3 negative, D/ba2 negative). The bank ratings shown in this report are the banks deposit ratings, their standalone bank financial strength ratings/baseline credit assessments and the corresponding rating outlooks.
22
30 SEPTEMBER 2013
NEWS & ANALYSIS

Credit implications of current events study, Group 1 banks CET1 ratio rose to 7% from 5% in just 12 months to December 2012, and the banks also reduced their capital shortfall to 14 billion from 46 billion during that period. Since the study, Deutsche Bank and Commerzbank, the largest private-sector banks, each raised common equity during the first half of the year, and thus have improved their CET1 ratios. Although some Group 1 banks profitability is poor, which limits profit retention, all seven banks have the ability to improve their capital under Basel III using a number of options. These options include reducing still-sizable legacy assets earmarked for unwinding, thereby decreasing their capital requirements; or divesting financial holdings that under Basel III are partially deducted from CET1 capital, thereby allowing them to close the 14 billion capital gap by mid-2014 and raise their CET1 ratios. The Bundesbank study also surveyed 35 smaller German banks, known as Group 2 banks, for Basel III compliance, and found that they have considerably higher capital levels on average and that their CET ratios exceeded the European average (see Exhibit 2).
EXHIBIT 2
Results from the German Bundesbanks Basel III Study on Germanys Group 2 Banks
German Banks 12% 10% 8% 6% 4% 2% 0% Core Equity Tier 1 Total Capital Ratio Leverage Ratio 3.2% 3.4% 8.9% European Union Banks 10.9% 10.1%
7.9%
Note: Data as of year-end 2012 Source: Deutsche Bundesbank
23
30 SEPTEMBER 2013
NEWS & ANALYSIS

Yasuko Nakamura Vice President - Senior Analyst +33.1.5330.1030 yasuko.nakamura@moodys.com Sebastien Hay Vice President - Senior Credit Officer +34.91.768.8222 sebastien.hay@moodys.com
Socit De Financement Local Would Avoid Legal Risk with Amended Finance Law
Last Wednesday, the French government published the 2014 draft Finance Law, which would amend the treatment of the effective annual percentage rate (TEG) in loan documentation. This has wide ranging implications because the TEG applies to all bank loans to French customers. Without the amendment, the Socit de Financement Local (SFIL, Aa2 negative) would incur a significant loss in revenues, disrupting its loans to the sub-sovereign sector. A specialized lender to public sector entities, SFIL inherited the bulk of French public-sector lending from Dexia Credit Local (DCL, Baa2 negative) earlier this year. While DCL was not accused of any wrongdoing vis--vis local governments, the court censured the bank for the way in which the TEG was referenced in -or omitted from -- loan documentation. As a result of this decision, the rate applied to loans4 (often referred to as toxic, given their complex structure) was to be amended and replaced by the so-called legal interest rate, which is much lower than the contractual rate on the TEG-referenced loans. Apart from the DCL case, SFIL was concerned about the risk of contagion to its entire portfolio, which would have had material implications on its financial situation and its ability to do business with French sub-sovereigns. As a result, DCL appealed the legal decision and SFIL lobbied the government to have the legal framework amended. If the decision of the court is confirmed, it will set a precedent that eventually will involve a rate change for many loans that SFIL inherited. Since the courts judgment on the DCL case, SFIL and DCL have seen litigation proceedings triple to 196 and 96 cases, respectively, as of the beginning of September. 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. Given the role assigned to SFIL by the French state as a specialized lender for regional governments and public hospitals, the measure is also credit positive for the sub-sovereign sector as a whole. Even if the court judgment was favorable for a minority of local governments that contracted risky loans, the legal risks for SFIL could have had serious negative implications for its capacity to provide lending to the broader subsovereign sector. If adopted, the law will certainly enable SFIL to meet its business objective of lending 3 billion to the sub-sovereign sector in 2013, and up to 5 billion going forward out of the sectors annual financing needs of 20 billion.
The TEG calculation at the initiation of contracts is particularly complex for such loans. Hence, the mention of the TEG in initial documentations was often either omitted or slightly different from the definitive TEG.
24
30 SEPTEMBER 2013
NEWS & ANALYSIS

Insurers
Jasper Cooper Analyst +1.212.553.1366 jasper.cooper@moodys.com
ProAssurances Proposed Acquisition of Eastern Is Credit Negative

Last Tuesday, ProAssurance Corporation ((P)Baa2 stable), a monoline medical professional liability (MPL) insurer, announced that it had agreed to acquire Eastern Insurance Holdings, Inc. (unrated), a monoline workers compensation insurer, for $205 million in cash. The proposed transaction would be credit negative for ProAssurance because of the significant execution and integration risks associated with expanding out of ProAssurances traditional business into workers compensation insurance, and because it would slightly weaken several key financial measurements. Although ProAssurances post-acquisition return on capital would improve slightly given the marginal addition of Easterns profits, and its shareholders equity would stay about the same, most of ProAssurances other pro forma key financial metrics would be slightly weaker (see Exhibit 1). The companys operating leverage would rise to about 1.3x from about 1.2x, and high-risk assets would increase to about 31% of shareholders equity from about 29%. However, the companys pro forma financial fundamentals would remain solid overall owing to ProAssurances strong operating profitability, conservative operational leverage, modest financial leverage and sound reserve position.
EXHIBIT 1
Change in ProAssurances Financial Metrics Pro Forma for the Eastern Acquisition
Combined Pro Forma Eastern ProAssurance
Total Assets, $ millions Shareholders' Equity, $ millions Net Income, $ millions Gross Premiums Written, $ millions Net Premiums Written, $ 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 Adverse/(Favorable) Development as Percent of Beginning Reserves, one year Adjusted Financial Leverage Total Leverage Earnings Coverage, one year Cashflow Coverage, one year
$5,193 $2,271 $286 $760 $698 30.8% 10.1% 13.2% 1.3x 12.4% -13.0% 6.2% 6.2% 115.7x 157.1x
$381 $136 $10 $224 $170 36.8% 14.5% 11.1% 2.7x 7.8% -2.0% 6.2% 6.2% 30.1x 20.2x
$4,877 $2,271 $275 $536 $528 28.6% 9.2% 10.5% 1.2x 12.0% -13.6% 5.9% 5.9% 129.5x 201.4x
Note: Information based on GAAP financial statements. Moody's estimate of pro forma key financial indicators combining ProAssurance and Eastern 2012 results. Source: GAAP financial statements, Moodys estimates
Workers compensation is a highly specialized line of business with a number of risks. It is a long-tail line of business whose losses are paid many years after premiums are collected. Its profitability in part depends on generating investment income, which, in todays low interest rate environment, is a challenge. Workers
25
30 SEPTEMBER 2013
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, and the lines pricing and profitability have historically been volatile. Partially mitigating ProAssurances execution risks is an agreement that Easterns management team will stay on following the acquisition. In addition, ProAssurances MPL line of business faces many of the same risks as workers compensation insurance: both lines are long-tail, historically volatile, and require disciplined underwriting and claims-adjusting operations. However, both lines are also different enough that knowledge of one market does not necessarily apply to the other. 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, although it has steadily improved since 2011 owing to cumulative rate increases and moderate loss-cost trends. Industry combined ratios (the ratio of losses and expenses paid to premiums earned) fell to about 107.5% for the 2012 accident year from about 118% in 20105 (see Exhibit 2), but are still unprofitable in the current low interest rate environment.
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 Moodys. Contains copyrighted and trade secret materials distributed under license from SNL, for recipients use only.
ProAssurance generates the majority of its business from individual physician practices and small doctor groups, with a smaller share of premiums written on larger medical facilities. As larger medical facilities have acquired individual physicians and small group practices, ProAssurance and others have lost market share (excluding acquisitions). Acquiring Eastern would broaden ProAssurances capabilities for offering multiple products to these larger medical facilities. However, one challenge in executing this strategy could be the relatively low degree of geographic overlap, with only three states in common (Indiana, Michigan and Delaware) being among the top 10 for both companies. About 65% of Easterns direct written premium are in Pennsylvania, a state that accounts for less than 1% of ProAssurances premiums.
See US P&C Insurance Pricing Generates Margin Expansion, Rate Needed In Casualty, 23 August 2013.
26
30 SEPTEMBER 2013
NEWS & ANALYSIS

Shachar Gonen Assistant Vice President - Analyst +1.212.553.3711 shachar.gonen@moodys.com
Global Atlantics Acquisition of Forethought Is Credit Negative for Both

Last Thursday, Global Atlantic Financial Group (unrated) announced that it would buy Forethought Financial Group, Inc. (Baa3 review for downgrade) for an undisclosed amount. 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. After the announcement, we reiterated our review for downgrade of Global Atlantics life operating subsidiaries, Commonwealth Annuity and Life Insurance Co. (financial strength Baa1 review for downgrade) and First Allmerica Financial Life Insurance Co. (financial strength Baa1 review for downgrade), and we also put Forethoughts ratings on review for downgrade. The Forethought acquisition follows closely two other material transactions by Global Atlantic. In May, Global Atlantic completed its separation from The Goldman Sachs Group, Inc. (A3 review for downgrade) and in October expects to close its acquisition of Aviva USAs life insurance business from Athene Holding Ltd. (unrated). These deals over a very short time reflect Global Atlantics aggressive risk appetite in terms of rapid growth and consumption of capital, expansion into commodity-like higher risk annuity products, and transaction risk. Global Atlantic will also face financial risks by operating at lower capital levels and greater financial leverage than it had previously. Prospective metrics will be weaker than before the acquisitions. Declining from very strong levels, Global Atlantics metrics will be more in line with insurance industry averages over the next year. Its pro forma financial fundamentals are adequate, but continued aggressive growth could pressure capital, and we will have to see how the Aviva USA acquisition, which includes a large component of universal life insurance business, plays out and affects earnings. 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. 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. The combination of Forethoughts primary operating subsidiary, Forethought Life Insurance Company (financial strength A3 review for downgrade), with the lower-rated Global Atlantics life operating subsidiaries, Commonwealth and First Allmerica, negatively pressures Forethoughts credit quality. We expect these pressures to manifest themselves in the commonality of corporate governance, investment and capital management, and the risk tolerance/mitigation of the combined entities. However, the Forethought businesses complement Global Atlantic, and could be combined with minimal business disruption, thereby mitigating the negative pressure. We expect the combined entities to continue Forethoughts rapid sales growth in fixed and variable annuities, which achieved $1.2 billion in sales in 2012 from $662 million in 2011. Although these annuity businesses are riskier than whole life insurance products, the risks are offset by the relatively stable and consistent performance of Forethoughts pre-need business, and the greater diversity and balance the combined entities will have. The Aviva USA life insurance and Forethought acquisitions will serve as a platform for retail-oriented life and annuity sales, complementing Global Atlantics historical reinsurance/transaction business model that focused on institutional clients. Global Atlantic expects to complete the acquisition early in 2014. The terms of the deal were not disclosed, but we expect some debt financing to fund the acquisition.
27
30 SEPTEMBER 2013
NEWS & ANALYSIS

Money Market Funds

Rory Callagy Vice President - Senior Analyst +1.212.553.4374 robert.callagy@moodys.com
Feds New Overnight Reverse Repo Facility Offers Supply Benefits to US Money Market Funds
On Monday, 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, a credit positive for US money market funds and particularly the 94 money market funds eligible to participate in the facility. Under the new facility, 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 Feds $3.4 trillion System Open Market Account (SOMA) portfolio. The Fed set the initial rate at which it is willing to borrow at one basis point, but indicated that this rate could move up to as high as five basis points. 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. In addition to the 94 eligible money market funds, the remaining participants include six government-sponsored entities, 18 banks and the 21 primary broker-dealers. The Fed expects the facility to conduct overnight operations through January 2014. The liquidity and credit profiles of money market funds stand to benefit from an increase in the supply of high-quality short-term assets, such as US Treasury and agency securities, at a time when these assets are scarce owing to high demand. 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. Greater supply of high-quality short-term assets will benefit all US money market funds, but the 94 eligible money market funds6 will benefit most, as they are the only ones eligible to access reverse repos with the Fed. Another benefit to money market funds is that the reverse repo facility will tend to set a floor on money market rates, reducing the risk of increased waivers of money market fund fees. Investors are not likely to accept lower overnight lending rates than the benchmark rate paid by the Fed. That rate backstop will help money market fund managers, who have struggled to generate returns in a low-yield environment, and continue to waive management fees in order to deliver a positive net yield. US money market funds have waived $18 billion7 in fees over the last four years, including $4.8 billion in 2012. The Feds new facility is likely to provide fee pressure relief over time as the Fed increases its reverse repo overnight borrowing rate.
6 7
Among others, the Feds eligibility criteria requires a fund to have had $5 billion in net assets over the last six consecutive months. Source: Investment Company Institute
28
30 SEPTEMBER 2013
NEWS & ANALYSIS

US Public Finance
Michael DArcy Analyst +1.212.553.3830 michael.darcy@moodys.com
Court Rules Atlanta Public Schools Wont Get Help Funding Pensions from Charter Schools
On 23 September, the Georgia State Supreme Court ruled that Atlantas charter schools have no legal obligation to pay a share of the Atlanta Independent School Systems (Aa2) annual pension costs. The ruling is credit negative for the system, also called Atlanta Public Schools (APS), and other K-12 public school districts in the state with an increasing charter school presence, because it bars districts from offloading a portion of their legacy costs onto charter schools. The suit began in 2012, when APS diverted $2.8 million from its payments to local charter schools to help fund a $38.6 million annual pension contribution payment to one of its two retirement plans. The ruling in favor of the charter schools will result in APS having to cover its full pension costs from its own revenue base, net of its payments to the charter schools. The districts revenue base has shrunk in recent years as a result of state aid cutbacks, declining property tax revenues, and the end of the federal stimulus program. As a result, less money has been available for APS to cover its pension contributions, which accounted for 11.9% of total APS expenditures in fiscal 2012. APS participates in two pension plans, the Teachers Retirement System of Georgia (TRSG) multi-employer plan and the City of Atlanta (Aa2 stable) General Employees Pension Plan (GEPP). The latter has been closed to most classes of new school district employees since the late 1980s, and is badly underfunded. Per our calculations, the APS adjusted net pension liability (ANPL)8 for its share of the city plan was $796 million as of 2011, equal to 1.3x annual operating revenues. The APS annual contributions to the city plan are greater than its TRSG payments, and will more than double to $78 million by 2026. Contributions to the city plan were 6.4% of the APS expenditures in fiscal 2012 (see exhibit below). Atlanta Public Schools Revenues and Contributions to Atlantas Pension Plan
Revenues have shrunk even as annual pension contributions (APC) rose as a percent of budget
Total General Fund Revenues - left axis $690 $670 $650 APC as Percent of General Fund Revenues - right axis 7.5% 7.0% 6.5% 6.0% 5.5% 5.0% 2008 2009 2010 2011 2012
$ Millions
8
$630 $610 $590 $570 $550
Source: Atlanta Independent School System, annual financial reports
The adjusted net pension liability (ANPL) is the difference between the fair market value of a pension plans assets and its adjusted liabilities. 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. We also distribute the liabilities of multiple-employer costsharing plans to participating governments based on their pro rata share of contributions.
29
30 SEPTEMBER 2013
NEWS & ANALYSIS

Credit implications of current events Charter school employees do not participate in either of the APS retirement plans, which was central to the charter schools legal argument before the state supreme court. The $2.8 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, but the dispute underscores the larger issue of charter school funding in Georgia and the negative implications for public school districts. Some 10% of Atlantas 49,500 public school students were enrolled in charter schools in the 2011-12 school year. Under Georgia statute, charter schools -- based on enrollments -- receive a portion of all the revenues of the local K-12 district in which they operate. The host district must remit these funds to the charter schools in installments throughout the year, minus a small number of permitted exclusions. As charter school enrollments rise, traditional districts must transfer a greater share of revenues to fund the charter schools, while typically making offsetting cost reductions. However, reducing school costs can be a lengthy and expensive process because students tend to move to charter schools in small numbers across all schools, making it challenging to close half-vacant buildings and reassign or cut staff. Georgias charter schools have achieved a modest penetration rate outside the Greater Atlanta metro area, but their enrollments are rising steadily throughout the US, making continued growth in Georgia a distinct possibility.
30
30 SEPTEMBER 2013
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 companys credit ratios over the next several years, leaving it reliant on the success of two products: Eliquis and Nivolumab. We also base our outlook on the possibility of rising debt levels to fund the companys US cash needs. CVS/Caremark Corp.
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. Additionally, our upgrade reflects strong industry drivers such as growth in specialty pharmaceuticals, an increasing population over the age of 65, branded drugs coming off patent and rising generic utilization rates. General Motors Company
27 Oct 11
Upgrade
23 Sep 13
Corporate Family Rating Outlook
Ba1 Positive
Baa3 Stable
Improvements in GMs operations and finances since emerging from bankruptcy prompted the upgrade. We believe GM will continue to improve its credit metrics, based on new product introductions in the US, its solid footprint in the Chinese auto market and its focus on maintaining its liquidity profile. Illinois Tool Works Inc.
11 Jun 12
Downgrade
24 Sep 13
Senior Unsecured Rating Outlook
A1 Negative
A2 Stable
We based our downgrade on ITWs plans to divest its Industrial Packaging Segment and to offset EPS dilution from the potential loss of IPS's earnings by repurchasing shares. ITWs willingness to add debt as it pursues higher leverage and accelerated shareholder returns is more representative of an A2 rating.
31
30 SEPTEMBER 2013
RATING CHANGES
Pernod Ricard S.A.

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, based on increasing demand for spirits in the US and sustained demand in emerging markets, prompted the change in outlook. Earnings growth will lead to the generation of free cash flow and further de-leveraging.
32
30 SEPTEMBER 2013
RATING CHANGES
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. Despite BGE's solid standalone financial position, its ratings are constrained by that of Ireland due to the company's inability to disconnect itself from local economic and market circumstances. 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.
33
30 SEPTEMBER 2013
RATING CHANGES
Significant rating actions taken the week ending 27 September 2013 DTEK Holdings B.V. (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.V.

10 Dec 12
Downgrade
24 Sep 13
Senior Unsecured Bond Rating Outlook
B3 Negative
Caa1 Review for Downgrade
DTEK Finance plc.

9 Apr 13
Downgrade
24 Sep 13
Senior Unsecured Bond Rating Outlook
B3 Negative
The downgrade follows our action lowering Ukraine's foreign-currency bond country ceiling to Caa1 from B3. 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. Although DTEK's Ukraine-based business generates foreign currency in an amount exceeding its debt-servicing needs, we view the company's revenues and cash flows, both those generated inside and outside of the country, as exposed to foreign-currency transfer and convertibility risks. Edison S.p.A.
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, Electricite de France (Aa3 negative).
34
30 SEPTEMBER 2013
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. Hoosier Energy Rural Electric Cooperative, 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. Moreover, we expect that the cooperative can sustain its sound financial metrics through periodic rate increases, if necessary, even as it continues to rely on debt financing over the next few years of a sizable capital program. 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. ICE is wholly owned by the Costa Rican government.
35
30 SEPTEMBER 2013
RATING CHANGES
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. Banco de la Provincia de Crdoba
22 Jun 12
Downgrade
26 Sep 13
Standalone Financial Strength/ Baseline Credit Assessment
E+/b3
E/caa1
The downgrade incorporates Banco de Crdoba's still-weak capitalization level, with a 5.6% Tier 1 ratio in June 2013. Banco de Crdoba received a capital injection from the province of Crdoba of ARS100 million in 2011 and has been continuously capitalizing its earnings. Notwithstanding the improvement, weakening credit conditions and decelerating business growth will likely affect earnings generation and keep capitalization under pressure in coming quarters. 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, in the context of the persistently challenging operating environment and low capitalisation. Banca Sella's asset quality has weakened in recent years, in line with the macro-economic trend in Italy. In 2012, the bank reported problem loans of 870 million.
36
30 SEPTEMBER 2013
RATING CHANGES
Bonsucesso S.A.
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, as intense competition within Bonsucessos core business of payroll-deductible loans has limited loan origination, at the same time that elevated delinquencies in the bank's commercial portfolio has led to high credit costs. Bonsucesso's historically low nonperforming loan ratios, characteristic of its focus on low-risk payroll loans, have trended upwards over the past years as the bank sought to increase lending to small and middle size companies (SMEs). Forethought Financial Group, Inc
22 Mar 11

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. Global Atlantics, primary life operating subsidiary, Commonwealth Annuity and Life Insurance Company (CALIC), is lower rated at Baa1 (on review for downgrade) for insurance financial strength. 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. 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). We will evaluate the benefits to GMF of its ownership by a financially stronger parent, 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.
37
30 SEPTEMBER 2013
RATING CHANGES
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, which we took on 20 September. The action was on the ratings of Allied Irish Banks, p.l.c. (AIB), Bank of Ireland (BoI), EBS Ltd (EBS), and Permanent tsb p.l.c (PTSB). MedioCredito Trentino-Alto Adige
17 Jul 12

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, first, the persistently challenging operating environment in Italy, second, low and weakening profitability; and, third, full reliance on wholesale funding. The Phoenix Companies, Inc.
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, initiated on 12 December, because of the company's prolonged delays in filing its GAAP financial statements driven by the complexity and detailed level of auditor review. Other drivers include Phoenix's weak accounting procedures and controls, 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. Phoenix will likely conclude it has multiple material weaknesses once it completes its restatement.
38
30 SEPTEMBER 2013
RATING CHANGES
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. First, SBI's standalone credit profile continues to face negative pressures in the context of a slowdown of the Indian economy. Second, SBI is likely to seek another capital injection from the Indian government at the end of the current fiscal year in March 2014. The bank will have to compete with other public sector banks that have similar recapitalization needs. Ukrainian Financial Institutions Downgraded, Placed on Review for Further Downgrade
25 Sep 13
We lowered the baseline credit assessments (BCAs) of 10 banks, and downgraded the debt and deposits ratings -- as well as National Scale Ratings (NSRs) -- 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. At the same time, we placed on review for further downgrade the deposit and debt ratings, and NSRs, of 13 banks (2 banks' deposit ratings were at Caa1 level already) and one leasing company.
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 Ricas main debt have increased because of a jump in the fiscal deficit. 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. Large fiscal deficits and a rising debt burden remain Costa Rica's main medium-term credit risk and ratings constraint.
39
30 SEPTEMBER 2013
RATING CHANGES
Sub-sovereigns
Cities of Kyiv and Kharviv, Ukraine
6 Dec 12
Downgrade
25 Sep 13
Issuer rating Outlook
B3 Negative
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, given their institutional, financial and macroeconomic linkages with the sovereign. These institutional and financial linkages include the strict dependence of Ukrainian municipalities on government budget planning, as the central government annually sets up indicative budget revenues and spending targets for the cities.
40
30 SEPTEMBER 2013
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&Ts wireless towers by American Tower Corp., Crown Castle International Corp. and SBA Communications would be credit negative if financed with a significant amount of debt and would likely result in a downgrade. All three are already debt-constrained because of recent aggressive debt-financed acquisitions.
Asia Pacific Coal Industry: Liquidity Is Vital for Asian Coal Producers Amid Oversupply, High Leverage
Weak coal prices stemming from excess supply will raise the risk of default for the least liquid Asian producers. Producers with solid credit quality, strong cash positions, low coal production costs and the ability to extend debt maturities will be best-equipped to weather the next 12-18 months.
US For-Profit Hospitals: Reduction in Bad Debt Expense Fuels EBITDA Growth in 2014
EBITDA growth of 3.5-4.0% in 2014 in the US forprofit hospital sector underpins our stable outlook. 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.
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, 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. Because the airline, oil and steel sectors tend to have high levels of debt but less revenue denominated in foreign currencies, they will be most negatively exposed to the depreciation of the real.
US Homebuilding Industry: Wave of Pent-Up Demand Carries US Housing Recovery into Second Year
Historically low mortgage rates, affordability and home prices well below their 2006-7 peak are driving homebuilders growth. Sector revenue growth will exceed 10% through 2014, and even though real income growth has lagged, pent-up demand will carry the recovery over the next 12-18 months.
US Leveraged Finance: A Different Flavor of PIKs

PIK toggle bonds are back, and while their reappearance in the US has some drawing parallels to the credit crisis, the new crop differs from the bubble-era deals in a number of ways. One thing has not changed, however: Todays PIK issuers are just as highly leveraged as their bubble-era predecessors, so the deals still present significant risk to investors.
41
30 SEPTEMBER 2013
RESEARCH HIGHLIGHTS
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. 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 3.74, compared with 3.72 for a sample of 900 North American non-financial corporate bonds.
China Property Focus

This edition looks at the strong growth in property sales in China so far this year, supported by solid underlying demand for residential properties and improved sentiment, as well as property prices in the countrys 70 major cities, which continue to climb. It also looks at our rated property developers, whose half-yearly results were in line with expectations.
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. While the housing recovery will ultimately benefit the entire sector, companies that manufacture and provide varying services for the initial construction stages will benefit sooner. This report highlights USG, Ply Gem Industries, Owens Cornings insulation segment and Mascos installation business.
US Wireless Industry Outlook: Industry Cash Flow Will Accelerate in 2014

Our outlook for the US wireless industry is positive. We expect that 2013 EBITDA minus capital spending will increase about 8% on a combined basis for the six carriers we follow, and accelerate to 13%-15% in 2014. We expect big improvements at TMobile and Sprint next year, while smaller operators like US Cellular will remain under pressure.
US Fixed-Line Telecommunications: Wireline Margins Will Stabilize, But Cash Flow Looks Constrained
Our outlook for the US fixed-line telecom industry is stable. 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. Revenue growth remains elusive, while a rise in cash taxes will pressure free cash flow.
42
30 SEPTEMBER 2013
RESEARCH HIGHLIGHTS
Infrastructure & Project Finance

China General Nuclear Power Corporation: Credit Effect of Recent Developments
Chinas commitment to nuclear power remains strong. Neither the Husab uranium mine project nor delays in commissioning two reactors will not be hurting CGNs credit quality.
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, as we expect traffic growth to improve in 2014 for core EU toll roads and airports as GDP recovers. 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.
Financial Institutions
Baltics Banking System Outlook
Our outlook for the banking systems of Estonia, Latvia and Lithuania is stable for the first time since 2008. Changing the outlook from negative follows the broad effects of the improved economic environment across the region. Strong GDP growth in the wake of a deep recessions has helped fuel bank profitability and reduced levels of problem loan. These trends have offset the effects of lingering pressure points, such as high unemployment and high absolute levels of problem loans.
Japanese Property and Casualty Insurance Outlook

Our outlook on Japans P&C insurance industry remains stable, as it has been since July 2012. If successful, two initiatives will help the industrys credit profile through boosting profitability. The first is the industrys efforts to change the pricing model for its key business line of auto insurance. The second is its move to reduce costs and improve efficiency through group consolidation.
Global Takaful Trends: Strong Growth Continues, But Challenges Ahead

A type of Islamic insurance, Takaful has continued to grow over the past decade with premiums exceeding $4 billion in 2007, and expected to reach $20 billion by 2017. However, Takaful insurers face several challenges that may limit their growth opportunities. We expect these issues will be particularly challenging for the smaller Takaful operators, who may lack the expertise, resource or scope to capture growth and defend against competitors.
43
30 SEPTEMBER 2013
RESEARCH HIGHLIGHTS
Sovereigns
Latin America: Strengthened Sovereigns, 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. 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. The LATAM 5 sovereigns (Brazil, Chile, Colombia, Mexico and Peru) and their banking systems have become more creditworthy, which will support corporate credit quality.
Bangladesh: Weak Governance and Political Tensions Constrain Sovereign Creditworthiness

As elections approach, political tensions are likely to escalate. Assuming there are no further industrial accidents and Bangladesh makes sufficient progress on improving its labor standards, we see three possible scenarios: the military steps in, tension persists, or the parties make piece. The first two weigh on the sovereign credit profile.
Trinidad and Tobago: New Budget Reinforces Credit Strengths Despite Weak Growth and Deteriorating External Balance
Trinidad and Tobagos recently released 2014 budget proposal is encouraging in some respects and supports the continued stable outlook for the countrys Baa1 sovereign rating, despite anemic growth and the deterioration of its external position.
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. Our forecast for Spains general government budget deficit for this year is very close to the revised target of 6.5% of GDP that the Spanish government agreed with the European Commission last May.
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; failure at either would have negative economic consequences. A failure to raise the federal debt limit, however, would have greater adverse financial market and economic consequences because market participants would perceive an increased probability of sovereign default. A government shutdown would not affect debt service
44
30 SEPTEMBER 2013
RESEARCH HIGHLIGHTS
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 -- rinzai-sai -- continues to grow and is contributing to their high levels of indebtedness. Initiated as a temporary measure in 2001, this type of borrowing has become an ongoing replacement for cash transfers. Although concerns for regional and local government credit profiles are mitigated because the servicing of rinzai-sai debt is fully subsidized by future transfers, over time the funding of operating expenditures through debt adds to the central governments already heavy debt burden.
Education Expenditures Constrain Financial Flexibility of Mexican States

Mexican states, which are already limited in their financial flexibility, could have this flexibility further compromised because of structural pressures from education funding. The discrepancies between costs and federal transfers are unlikely by themselves to lead to rating actions in the short term. However, if not addressed, the states could consequently have less financial flexibility, resulting in cash financing deficits and downward rating pressure over the medium term.
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. We find more than half have liabilities from pension underfunding that exceed 100% of their revenues, also that burdens vary enormously.
Michigan Tax Caps Limit Benefit of Real Estate Gains

Despite the improving Michigan housing market, recovery of the states municipal property tax revenue will be slow. The key to how much a municipality will benefit from housing gains depends on its rate of recovery, whether the growth is driven by new construction or appreciation, and its ability to garner voter support for tax cap overrides.
Privatized Military Housing: Continuing Stable Performance at Risk Due to Looming Federal Cuts
Rated privatized military housing transactions have recently demonstrated stable credit performance, but face significant risks from increasingly probable federal budget actions in the coming years.
45
30 SEPTEMBER 2013
RESEARCH HIGHLIGHTS
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, exchangeable securities, principal-only bonds and pool interest-only bonds can increase risks to senior bonds in the event of very high mortgage losses. They pose analytical challenges because their risk profiles are affected by absolute levels of losses and prepayments as well as timing. But bonds are likely to incur losses in only low-probability scenarios given their seniority and the strong credit quality of recent transactions.
Arbitration Panels Decisions Are Credit Positive for Tobacco Securitizations

The decisions by an arbitration panel that nine of 15 US states, including four states that sponsored rated securitizations, have diligently enforced certain statutes in 2003 is credit positive for these states tobacco securitizations. Although the decisions could be indicative of the decisions for other years, future arbitration panels could reach a different conclusion about enforcement of the statutes for those years.
Resi Landscape
Softening housing metrics will not halt the US housing market rebound, which is bolstered by affordable housing, low home inventories and positive employment numbers, the September edition of our newsletter says. Also discussed: Nationstars higher advances help it remit more cash to RMBS than Ocwen, the resolution status of conflicting language in documents governing 11 RMBS transactions, among other topics.
A Comparison of Japanese, Australian, Dutch and UK RMBS and Mortgage Markets

Key differences among these markets include varying receivable characteristics, mortgage insurance for lenders in Australian and Dutch RMBS, mitigating credit risk, and Dutch RMBS having the most significant set-off risk. Note types also vary among the countries.
46
30 SEPTEMBER 2013
RECENTLY IN CREDIT OUTLOOK

Select any article below to go to last Thursdays Credit Outlook on moodys.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, 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 Reserves eventual tapering of its $85 billion in monthly bond purchases prompts rising interest rates. The new environment entails a re-pricing of credit risk and a reduction in global investors appetite for risk exposure in Latin America. 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. However, 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. 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
30 SEPTEMBER 2013
EDITORS
News & Analysis: Elisa Herr, Jay Sherman and Barry Hing Ratings & Research: Robert Cox Final Production: Barry Hing
PRODUCTION ASSOCIATE
David Dombrovskis
2013 Moodys Investors Service, Inc. and/or its licensors and affiliates (collectively, MOODYS). All rights reserved. CREDIT RATINGS ISSUED BY MOODY'S INVESTORS SERVICE, INC. (MIS) AND ITS AFFILIATES ARE MOODYS CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES, AND CREDIT RATINGS AND RESEARCH PUBLICATIONS PUBLISHED BY MOODYS (MOODYS PUBLICATIONS) MAY INCLUDE MOODYS CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES. MOODYS DEFINES CREDIT RISK AS THE RISK THAT AN ENTITY MAY NOT MEET ITS CONTRACTUAL, FINANCIAL OBLIGATIONS AS THEY COME DUE AND ANY ESTIMATED FINANCIAL LOSS IN THE EVENT OF DEFAULT. CREDIT RATINGS DO NOT ADDRESS ANY OTHER RISK, INCLUDING BUT NOT LIMITED TO: LIQUIDITY RISK, MARKET VALUE RISK, OR PRICE VOLATILITY. CREDIT RATINGS AND MOODYS OPINIONS INCLUDED IN MOODYS PUBLICATIONS ARE NOT STATEMENTS OF CURRENT OR HISTORICAL FACT. CREDIT RATINGS AND MOODYS PUBLICATIONS DO NOT CONSTITUTE OR PROVIDE INVESTMENT OR FINANCIAL ADVICE, AND CREDIT RATINGS AND MOODYS PUBLICATIONS ARE NOT AND DO NOT PROVIDE RECOMMENDATIONS TO PURCHASE, SELL, OR HOLD PARTICULAR SECURITIES. NEITHER CREDIT RATINGS NOR MOODYS PUBLICATIONS COMMENT ON THE SUITABILITY OF AN INVESTMENT FOR ANY PARTICULAR INVESTOR. MOODYS ISSUES ITS CREDIT RATINGS AND PUBLISHES MOODYS PUBLICATIONS WITH THE EXPECTATION AND UNDERSTANDING THAT EACH INVESTOR WILL MAKE ITS OWN STUDY AND EVALUATION OF EACH SECURITY THAT IS UNDER CONSIDERATION FOR PURCHASE, HOLDING, OR SALE. ALL INFORMATION CONTAINED HEREIN IS PROTECTED BY LAW, INCLUDING BUT NOT LIMITED TO, COPYRIGHT LAW, AND NONE OF SUCH INFORMATION MAY BE COPIED OR OTHERWISE REPRODUCED, REPACKAGED, FURTHER TRANSMITTED, TRANSFERRED, DISSEMINATED, REDISTRIBUTED OR RESOLD, OR STORED FOR SUBSEQUENT USE FOR ANY SUCH PURPOSE, IN WHOLE OR IN PART, IN ANY FORM OR MANNER OR BY ANY MEANS WHATSOEVER, BY ANY PERSON WITHOUT MOODYS PRIOR WRITTEN CONSENT. All information contained herein is obtained by MOODYS from sources believed by it to be accurate and reliable. Because of the possibility of human or mechanical error as well as other factors, however, all information contained herein is provided AS IS without warranty of any kind. MOODY'S adopts all necessary measures so that the information it uses in assigning a credit rating is of sufficient quality and from sources MOODY'S considers to be reliable including, when appropriate, independent third-party sources. However, MOODYS is not an auditor and cannot in every instance independently verify or validate information received in the rating process. Under no circumstances shall MOODYS have any liability to any person or entity for (a) any loss or damage in whole or in part caused by, resulting from, or relating to, any error (negligent or otherwise) or other circumstance or contingency within or outside the control of MOODYS or any of its directors, officers, employees or agents in connection with the procurement, collection, compilation, analysis, interpretation, communication, publication or delivery of any such information, or (b) any direct, indirect, special, consequential, compensatory or incidental damages whatsoever (including without limitation, lost profits), even if MOODYS is advised in advance of the possibility of such damages, resulting from the use of or inability to use, any such information. The ratings, financial reporting analysis, projections, and other observations, if any, constituting part of the information contained herein are, and must be construed solely as, statements of opinion and not statements of fact or recommendations to purchase, sell or hold any securities. Each user of the information contained herein must make its own study and evaluation of each security it may consider purchasing, holding or selling. NO WARRANTY, EXPRESS OR IMPLIED, AS TO THE ACCURACY, TIMELINESS, COMPLETENESS, MERCHANTABILITY OR FITNESS FOR ANY PARTICULAR PURPOSE OF ANY SUCH RATING OR OTHER OPINION OR INFORMATION IS GIVEN OR MADE BY MOODYS IN ANY FORM OR MANNER WHATSOEVER. MIS, a wholly-owned credit rating agency subsidiary of Moodys Corporation (MCO), hereby discloses that most issuers of debt securities (including corporate and municipal bonds, debentures, notes and commercial paper) and preferred stock rated by MIS have, prior to assignment of any rating, agreed to pay to MIS for appraisal and rating services rendered by it fees ranging from $1,500 to approximately $2,500,000. MCO and MIS also maintain policies and procedures to address the independence of MISs ratings and rating processes. Information regarding certain affiliations that may exist between directors of MCO and rated entities, and between entities who hold ratings from MIS and have also publicly reported to the SEC an ownership interest in MCO of more than 5%, is posted annually at www.moodys.com under the heading Shareholder Relations Corporate Governance Director and Shareholder Affiliation Policy. For Australia only: Any publication into Australia of this document is pursuant to the Australian Financial Services License of MOODYS affiliate, Moodys Investors Service Pty Limited ABN 61 003 399 657AFSL 336969 and/or Moodys Analytics Australia Pty Ltd ABN 94 105 136 972 AFSL 383569 (as applicable). This document is intended to be provided only to wholesale clients within the meaning of section 761G of the Corporations Act 2001. By continuing to access this document from within Australia, you represent to MOODYS that you are, or are accessing the document as a representative of, a wholesale client and that neither you nor the entity you represent will directly or indirectly disseminate this document or its contents to retail clients within the meaning of section 761G of the Corporations Act 2001. MOODYS credit rating is an opinion as to the creditworthiness of a debt obligation of the issuer, not on the equity securities of the issuer or any form of security that is available to retail clients. It would be dangerous for retail clients to make any investment decision based on MOODYS credit rating. If in doubt you should contact your financial or other professional adviser.
MOODYS.COM
Report: 158866

Moody&#39;s Credit Outlook Issuance

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Moody&#39;s Credit Outlook Issuance

Uploaded by

Copyright:

Available Formats

30 SEPTEMBER 2013

NEWS & ANALYSIS

Pensions from Charter Schools

Worse Than a Shutdown

RATINGS & RESEARCH

Shutdown, But Are Exposed to a Failure to Raise Debt Limit

Credit Negative for Utilities

Banks Accused of Fraud

RECENTLY IN CREDIT OUTLOOK

Continue Boosting Their Capital

Amended Finance Law Insurers

for Both Money Market Funds

Benefits to US Money Market Funds

NEWS & ANALYSIS

The US Government Shutdown and Debt Limit

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