NEWS & ANALYSIS - web1.amchouston.comweb1.amchouston.com/flexshare/002/CFA/Affiniscape... · coverage metrics, even though new convertible preferred securities that Corning will use

MOODYS.COM

28 OCTOBER 2013

NEWS & ANALYSIS Corporates 2

» Corning’s Planned Purchase of the Rest of Samsung Corning Is Credit Positive

» Tata Steel UK Will Benefit from Its Increased High-Grade Capacity

» Telekom Austria Overpays for 4G Spectrum, a Credit Negative » Holcim’s Cement Subsidiaries’ Weak Results Are Credit

Negative for the Parent » Haniel’s Sale of Celesio Stake to McKesson Is Credit Positive for

Haniel, Negative for McKesson » CMGC’s Change of Control in Subsidiary Is Credit Positive » CSR Zhuzhou Wins Credit Positive Rolling Stock Orders from

China and Malaysia » Housing Controls Are Credit Negative for Beijing Developers

Banks 13

» US Justice Department’s Mortgage Fraud Win Is Credit Negative for Banks

» Commercial Loan Growth Poses Risks for Some Regional US Banks

» ECB’s Capital Assessment Is Credit Negative for Weak Italian Banks

» Banca Popolare dell’Alto Adige’s Proposed Merger with Banca Popolare di Marostica Is Credit Negative

» Bank of Ireland’s Latest Pension Deficit Reduction Plan Is Credit Positive

» Rising Apartment Prices Pose No Threat to German Mortgage Lenders and Covered Bonds

» Indian Government’s Capital Injection into Public-Sector Banks Is Credit Positive

Insurers 25

» Old Republic’s Recapitalization Plan for RMICC Is Credit Positive

» Old Republic’s Recapitalization Plan Is Credit Positive for RMIC » UK Motor Insurers Lose Potential Savings as Government

Defers Small-Claims Threshold Increase

Sovereigns 30

» Egypt’s Bigger Supplementary Budget and Deficit Are Credit Negative

US Public Finance 32

» Atlantic City, New Jersey, Faces Large, Credit-Negative Property Tax Refund to Borgata Casino

RATINGS & RESEARCH Rating Changes 34

Last week we downgraded Darden Restaurants, Telekom Austria, Banco Paulista, Caja Rural de Granada, Duff & Phelps, LGT Bank, Comision Estatal de Servicios Publicos de Tijuana Mexico, Municipality of Mexicali Mexico, and Orlando Health; and upgraded Aldar Properties, Jebel Ali Free Zone, and some US auto ABS tranches; among other rating actions.

Research Highlights 40

Last week we published on Indian steel companies, Chinese government bonds, US healthcare, US for-profit hospitals, North American capital goods, European building materials, European ethylene, Beijing residential developers, Thai banks, German life insurers, insurance brokerages, Taiwan, Indonesia, the Eurasian Development Bank, Malta, California counties, New York local governments, California, Ontario, US ABS, EMEA SME securitizations and project finance CDOs, among other reports.

RECENTLY IN CREDIT OUTLOOK

» Articles in Last Thursday’s Credit Outlook 43 » Go to Last Thursday’s Credit Outlook

Click here for Weekly Market Outlook, our sister publication containing Moody’s Analytics’ review of market activity, financial predictions, and the dates of upcoming economic releases.

NEWS & ANALYSIS Credit implications of current events

2 MOODY’S CREDIT OUTLOOK 28 OCTOBER 2013

Corporates

Corning’s Planned Purchase of the Rest of Samsung Corning Is Credit Positive Last Tuesday, Corning Incorporated (A3 stable) said it had entered into a series of agreements under which it will increase its ownership stake in Samsung Corning Precision Material Co. Ltd. (unrated) to 100%. The agreements are credit positive for Corning because the company will gain full control of Samsung Corning’s cash flows and reap strategic and operational benefits that should improve profitability.

Corning, which currently holds a 50% stake in Samsung Corning, expects to complete the deals in early 2014. Upon closing, Corning will acquire additional manufacturing capacity at Samsung Corning that will reduce its capital expenditure requirements. The company will also gain access to roughly $1.2 billion in cash at Samsung Corning, which will bring little, if any, funded debt.

The additional earnings and cash flows from Samsung Corning will reduce Corning’s leverage and raise its coverage metrics, even though new convertible preferred securities that Corning will use to fund most of the deal will require about $98 million in annual payments.

Corning will issue $1.9 billion of convertible preferred stock to Samsung Display for its 43% stake in Samsung Corning and will pay $300 million in cash to other shareholders for the remainder of the company. Samsung Display will invest $400 million in additional Corning convertible preferred stock, giving it a combined 7.4% stake in Corning if converted. The two parties also entered into a 10-year supply agreement for Samsung Corning liquid crystal display (LCD) glass.

Contingent upon closing, Corning’s board approved an additional $2 billion share repurchase authorization that could be utilized through December 2015. The company has some $1.5 billion remaining under an existing authorization.

The pace at which Corning proceeds with repurchases and the funding used to expedite those returns to shareholders could offset the financial benefits of the Samsung transaction if Corning incurs material levels of additional debt to do so. The transaction would elevate the significance of Corning’s display segment in its business mix, diminishing some of the diversification the company has achieved through acquisitions in its life science segment and organic trends in its other business units.

Moreover, the transaction will heighten Corning’s economic exposure to yen/dollar and won/dollar exchange rate volatility and test the effectiveness of its currency hedging programs. LCD glass is priced in yen and much of Samsung Corning’s cost structure is denominated in won, while Corning reports in US dollars. Pricing pressure in LCD glass and lower glass sales to LG Electronics Inc. (Baa2 negative) have reduced revenue and operating profit at Samsung Corning.

Samsung Corning’s annual revenues fell to $3.1 billion in 2012 from a peak of $4.9 billion in 2010, while reported operating profits fell to $1.7 billion from $3.2 billion. Corning projects 2014 Samsung Corning revenues will be around $2 billion and we estimate that operating profit may decline further to $1.2 billion for 2013. Samsung Corning’s book depreciation in 2012 was $335 million, suggesting 2013 EBITDA of around $1.5 billion.

Our measure of adjusted debt/EBITDA at Corning (excluding equity earnings or dividends received from joint ventures) was 1.3x at the end of June. If the estimates of Samsung Display results are on target, and

Edwin Wiest Vice President - Senior Credit Officer +1.212.553.1461 [email protected]

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3 MOODY’S CREDIT OUTLOOK 28 OCTOBER 2013

Corning does not increase debt, Corning’s debt/EBITDA on a pro forma basis could fall below 1x, excluding any contributions from its other investments. EBITA/interest coverage would improve several turns from 7.8x for the 12 months ended 30 June. These estimates do not include Corning’s estimated cost savings, which could start at $80-$90 million a year in 2014-15 and increase to $170 million a year by 2017.

NEWS & ANALYSIS Credit implications of current events

4 MOODY’S CREDIT OUTLOOK 28 OCTOBER 2013

Tata Steel UK Will Benefit from Its Increased High-Grade Capacity Last Wednesday, Tata Steel UK Holdings Limited (TSUKH, B3 negative), a 100%-owned subsidiary of Tata Steel Ltd. (Ba3 negative) and the second-largest steel producer in Europe, opened a new heat-treatment plant at its Hayange plant in the Lorraine region of France. The new plant will more than double TSUKH’s annual output of heat-treated rail to 125,000 tonnes from 55,000, which will secure the company’s position in the resilient rail infrastructure market. Increased deliveries of high-grade steel will strengthen TSUKH’s profitability, a credit positive for TSUKH and Tata Steel.

TSUKH has invested €47 million ($65 million) in the plant. The new facility produces heat-treated rails (up to 108 meters long) for uses requiring high resistance. Since 2000, TSUKH has invested more than £160 million ($320 million) in its other advanced rail manufacturing facilities at its Scunthorpe plant in the UK.

Last Monday, Network Rail, which owns and operates UK rail infrastructure, chose to source more than 95% of its rail from Tata Steel until 2019, with an option to extend until 2024. The deal involves supplying up to 1 million tonnes and several hundred million GBP in revenue. At the same time, TSUKH announced it would build a new £15 million ($24 million) furnace at its Stocksbridge, UK, site, which it expects to commission in early 2015. The new furnace will enable TSUKH to address demand from the aerospace and oil and gas industries.

High-grade steel offers the best growth opportunities in Europe. In its steel outlook published 25 October, the European steel federation, or Eurofer, forecast that demand for non-auto transport material, a sub-segment of the high-grade segment that composes 2% of the European Union’s steel consumption and includes railway and aerospace material, would grow 2.6% in 2013 and 4.2% in 2014. Meanwhile, Eurofer forecast that overall steel demand would fall 2.3% in 2013 and grow 2.2% in 2014.

In the fiscal year ending March 2014, we expect TSUKH, which generates around 55% of Tata Steel’s revenue, to show better operating margins. In the quarter ended in June, TSUKH’s EBITDA margin was 4%, compared with 31% for Tata Steel India. In fiscal 2013, Tata Steel India had an EBITDA margin of 31% and TSUKH’s margin was 1%, reflecting TSUKH’s higher shipments and capacity utilization and a £200 million reduction of its controllable costs.

Whereas a turnaround in TSUKH would benefit Tata Steel’s profitability, we expect Tata Steel’s free cash flow to remain negative in the coming quarters owing to ongoing capex in India and a build-up of working capital brought on by higher production in Europe. This will limit Tata Steel’s ability to reduce its growing adjusted debt, which rose to 5.4x EBITDA in fiscal 2013 from 3.8x in fiscal 2011.

Alan Greene Vice President - Senior Credit Officer +65.6398.8318 [email protected]

Vincent Tordo Associate Analyst +65.6398.8331 [email protected]

NEWS & ANALYSIS Credit implications of current events

5 MOODY’S CREDIT OUTLOOK 28 OCTOBER 2013

Telekom Austria Overpays for 4G Spectrum, a Credit Negative Last Monday, the Austrian Regulatory Authority for Broadcasting and Telecommunications announced that Telekom Austria (Baa2 stable) paid €1 billion for spectrum in its 2x140 megahertz (MHz) mobile spectrum auction. Telekom Austria gained high-quality spectrum in the lower bands, but at double what we expected it to pay. Although Telekom Austria’s mobile business will benefit from the additional spectrum, the acquisition will be substantially debt-financed, increasing the group’s financial risk, which is not fully offset by the expected benefits of the new spectrum. Consequently, we expect the company’s leverage ratio, measured by adjusted gross debt/EBITDA, to deteriorate this year to around 3.4x from 2.8x.

The auction was for the new 800 MHz band (six blocks auctioned) and the existing 900 MHz (seven blocks auctioned) and 1,800 MHz (15 blocks auctioned) bands. Telekom Austria acquired four blocks of the 800 MHz spectrum, three blocks of the 900 MHz spectrum and seven blocks of the 1,800 MHz spectrum. In total, Telekom Austria acquired 2x70 MHz of spectrum (50% of total made available) out of a total available spectrum of 2x140 MHz. The government raised €2 billion in what was Europe’s most expensive 4G spectrum auction to date (see exhibit below).

Proceeds of European Multiband Spectrum Auctions to Date Austria’s Auction Was Most the Expensive European 4G Auction So Far Total Proceeds

Proceeds Scaled to Austria

Note: The exhibit on right scales proceeds to the Austrian population, license duration and available spectrum. To convert package prices inherent to combinatorial clock auctions, we assigned a relative value of 4:4:2:2:1 to the 800 MHz, 900 MHz, 1,800 MHz, 2,100 MHz and 2,600 MHz frequency bands, respectively, while we deemed the value of time division duplex spectrum to be negligible. Source: Telekom Austria

Enhanced network capacity is critical as the mobile business increasingly relies on products and services that require high bandwidth. Generally, spectrum below one gigahertz requires one third the number of base stations required by higher spectrum to cover the same territory. The lower the frequency of the spectrum, the more valuable it is; as penetration and distance travelled improve, fewer base stations are required to provide coverage.

The maturity date for the 800 MHz spectrum band is 31 December 2029, while all blocks in the 900 MHz and 1,800 MHz bands will now have a common maturity date of 31 December 2034 for all operators. This is distinctively longer than other recently auctioned spectrum in other countries in Europe.

Telekom Austria’s newly acquired spectrum provides the company with a unique strategic advantage because no new entrants gained spectrum, limiting the market to the three existing infrastructure-based players (Telekom Austria, T-Mobile and Hutchison 3G), and it gained the best quality spectrum.

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Carlos Winzer Senior Vice President +34.91.702.6610 [email protected]

NEWS & ANALYSIS Credit implications of current events

6 MOODY’S CREDIT OUTLOOK 28 OCTOBER 2013

Consequently, Telekom Austria is in a strong position to undertake an efficient rollout of a 4G network across Austria and will also benefit from better coverage and greater speed for data transmission. This supports the group’s business strategy, which focuses on mobile and fixed broadband investments. However, we do not expect the financial benefits from the spectrum acquired to materialize before 2015.

Although Telekom Austria had sufficient spectrum to meet the demand in mobile voice, it needed additional spectrum to fulfill future demand and enhance indoor coverage and the speed of mobile data networks. For example, while greater use of Apple Inc.’s iPhone can be very profitable, it also consumes an increasing amount of network capacity.

Telekom Austria has a stable leading market position in the mobile domestic market, with a reported market share exceeding 43%, which will be reinforced as a result of this spectrum auction.

NEWS & ANALYSIS Credit implications of current events

7 MOODY’S CREDIT OUTLOOK 28 OCTOBER 2013

Holcim’s Cement Subsidiaries’ Weak Results Are Credit Negative for the Parent Last Wednesday, ACC Ltd (unrated) and Ambuja Cement (unrated), two cement companies based in India, each reported weak results for the third quarter ended 30 September. This is credit negative from Holcim Ltd (Baa2 stable), which owns around 50% of each entity1 and fully consolidates both listed subsidiaries.

We expect ACC’s and Ambuja’s weak performance to reflect badly on Holcim’s consolidated performance in its third-quarter results, which are due 5 November. The two entities accounted for 17% of Holcim’s consolidated turnover in 2012 and we estimate the 2012 EBITDA contribution to have been around 20% owing to the higher margins generated in India versus the rest of the group.

ACC posted a 1.3% decline in sales and a 39% decline in operating EBITDA for the three months ended 30 September. Ambuja posted a 7.4% decline in revenues and a 49% decline in EBITDA for the same period. Both companies attributed the weak results to sluggish demand, which led to lower capacity utilisation. In addition, input and logistics costs (mainly prices for diesel, coal and railway freights) rose. The input cost pressures were exacerbated by the Indian rupee’s depreciation versus the US dollar over the quarter. Both entities also expect relatively subdued market conditions going forward (neither company provided a precise timeframe in their outlook statements) and a very gradual and modest recovery in volumes.

Beyond the decline in EBITDA generated in local currency, Holcim also faced material foreign exchange challenges during the quarter because of the sharp INR/USD depreciation on a sequential and year-on-year basis, as shown in the exhibit below.

Indian Rupee versus US Dollar, Index = 100 at 7 January 2012

Source: Bloomberg

The negative foreign exchange effect will be mostly a translation effect because Holcim’s cost basis is largely denominated in local currency (the cement business is a very regional business because transporting cement over long distances is not economically viable). However, Holcim is exposed to some currency mismatches between its Indian cash flows and the debt used to finance its operations. Holcim in the past has tried to reduce the currency mismatch between cash flows and debt by issuing local debt, but as of year-end 2012, 8.2% of group debt was in Australian dollars, 3.2% in Mexican pesos and 8.1% in other currencies including the Indian rupee and Thai baht.

1 Holcim has recently announced that it will increase its share in Ambuja Cement to around 61%, pending regulatory approval.

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Stanislas Duquesnoy Vice President - Senior Credit Officer +49.69.70730.781 [email protected]

NEWS & ANALYSIS Credit implications of current events

8 MOODY’S CREDIT OUTLOOK 28 OCTOBER 2013

Haniel’s Sale of Celesio Stake to McKesson Is Credit Positive for Haniel, Negative for McKesson Last Thursday, Franz Haniel & Cie. GmbH (Ba1 stable), an investment holding company, announced the sale of its entire 50.01% stake in German drug wholesaler and retail pharmacy operator Celesio AG (unrated) to McKesson Corporation (Baa2 review for downgrade). The disposal is credit positive for Haniel because the estimated net proceeds of €1.94 billion exceed its net debt of €1.58 billion.

The transaction is subject to regulatory approval and a tender offer achieving 75% shareholder consent. If achieved, the deal will likely close in the first quarter of 2014. The sale does not affect Haniel’s ratings.

In addition to buying Haniel’s stake in Celesio, the San Francisco, California-based McKesson will start a tender offer for Celesio’s remaining shares in a deal valued at $8.3 billion. We expect the deal will likely add a significant amount of incremental debt and increase McKesson’s exposure to highly competitive and regulated markets, which prompted us to put McKesson’s ratings on review for downgrade on Thursday.

Haniel’s sale of its Celesio stake, which was a core holding for 41 years, likely concludes a series of disposals in recent months, including the Xella vendor loan disposal earlier this month to reduce its debt. With the Celesio transaction, Haniel would have negative net debt on a reported basis, even though our leverage (loan-to-market value) calculation on a pro forma basis would still be slightly positive at around 4% owing to the inclusion of the operating subsidiaries’ debt, which are part of profit and loss agreements.

However, we expect that Haniel will reinvest a large portion of the proceeds from this disposal. Other than a €472 million bond repayment due in 2014, Haniel does not have large upcoming maturities until 2017, and we estimate that existing bonds maturing after 2014 will remain as core debt for Haniel. This would imply that around €1.4 billion of new investments may be made, which on a pro forma basis implies reported leverage of at least 16%, or 24% after our adjustments. Although this leverage would place Haniel in the Baa range of our investment holding methodology, Haniel’s portfolio concentration will further increase and be unusually high for an investment holding company. Before any new investments, Metro AG (Baa3 stable), one of Haniel’s core-holdings, would account for around two thirds of the total portfolio market value, a credit negative that constrains Haniel’s current rating.

In addition, we expect the company’s cash coverage ratio to remain well below our investment grade criteria of at least 3x. The cash cover ratio will be weak after the Celesio disposal, but is unlikely to reach 2.0x even after reinvestment owing to still-sizable interest payments of around €54 million on 2017-18 bonds. Even if Haniel expects some return on cash balances, relatively high holding costs and the likely resumption of shareholder dividends would continue to affect actual free cash flow.

As a result, although Haniel’s overall credit profile would continue to improve, driven by low leverage, we expect the rating to remain unchanged. The rating will be solidly positioned in the Ba1 category, but a positive action would require a better indication of the future portfolio composition, increased diversification and improved cash flow coverage. Further improvement of Metro’s performance, valuation and credit quality would also benefit Haniel’s rating.

Alex Verbov Vice President - Senior Analyst +49.69.70730.720 [email protected]

Benedikt Schwarz Associate Analyst +49.69.70730.942 [email protected]

NEWS & ANALYSIS Credit implications of current events

9 MOODY’S CREDIT OUTLOOK 28 OCTOBER 2013

CMGC’s Change of Control in Subsidiary Is Credit Positive Last Tuesday, Chinese engineering and construction company China Metallurgical Group Corporation (CMGC, Baa3 stable) subsidiary Metallurgical Corporation of China Ltd. (MCC, unrated) announced that Shijiazhuang Iron & Steel Co., Ltd. (Shigang, unrated) had acquired a 51% stake in MCC subsidiary CERI (Yingkou) Equipment Development and Manufacturing Co., Ltd. (Yingkou, unrated). The change of control of loss-making Yingkou is credit positive for CMGC because it will help the state-owned company improve its earnings, cash flow and debt leverage.

Shigang acquired the stake by injecting RMB490 million of equity into Yingkou, thereby becoming a strategic partner of CMGC. Accordingly, Yingkou will cease to be a consolidated subsidiary of CMGC. In addition, Shigang will now share in any future cash injections into Yingkou.

Yingkou’s scale is small relative to CMGC; it generated revenue of RMB431 million in 2012, compared with CMGC’s reported revenue of RMB232 billion. Still, its performance has been a drag on CMGC’s operations.

Yingkou generated negative EBITDA of RMB72 million in the first eight months of 2013 and negative EBITDA of RMB233 million in 2012 amid weak demand for its metallurgical equipment and critical components (large castings and forgings and welded structure) for heavy equipment. Yingkou this year generated negative cash flow from operations of RMB167 million through August and negative cash flow from operations of RMB294 million in full-year 2012.

Yingkou’s reported debt was around RMB1 billion at the end of August, which accounted for about 1% of CMGC’s reported debt. In addition, CMGC injected a total of RMB850 million in cash into Yingkou in August 2013 and December 2012 to support its weak operations.

Reducing CMGC’s stake in Yingkou will have modest positive effects for CMGC. The stake sale is the latest in a series of steps that CMGC has taken to cut costs, increase its focus on profitable operations and dispose of unprofitable businesses. It disposed of its loss-making paper business in 2012 and has been working on the bankruptcy process of its subsidiary Huludao Non-Ferrous Metal Group (unrated).

We expect these moves to improve CMGC’s adjusted EBITDA margin to around 8%-9% in 2013 and 2014 from 7.7% in 2012. We also expect it to reduce CMGC’s adjusted debt/EBITDA to 7x-8x over the next 12-18 months from at 9.5x at the end of June 2013.

Chenyi Lu Vice President - Senior Analyst +852.3758.1353 [email protected]

Cindy Yang Associate Analyst +86.10.6319.6570 [email protected]

NEWS & ANALYSIS Credit implications of current events

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CSR Zhuzhou Wins Credit Positive Rolling Stock Orders from China and Malaysia Last Tuesday, CSR Corporation Limited (unrated) announced that its wholly owned subsidiary CSR Zhuzhou Electric Locomotive Co., Ltd. (Baa3 stable) had recently received two major rolling stock orders from China Railway Corporation (unrated) and Malaysia’s Ministry of Transport (unrated). The new orders will contribute to CSR Zhuzhou earnings and strengthen its domestic and international footprint in the rolling stock industry, both of which are credit positive for the company.

CSR Zhuzhou will produce and sell electric locomotives worth RMB6 billion to China Railway. Its agreement with Malaysia is for 60 electric multiple units worth RMB960 million. The two orders equal about 46% of its sales in 2012 (RMB15.2 billion or $2.4 billion) and materially improve CSR Zhuzhou’s visibility into its sales over the next 12-18 months. The company’s current order backlog of RMB17 billion, including the recent new orders, equals one year of sales.

CSR Zhuzhou benefits from a resumption of railway investment in China. The company is the nation’s largest manufacturer of electric locomotives and says it has about a 50% market share and a capacity to produce 1,000 units per year.

The new orders for electric locomotives were among the first batch of orders coming from China Railway, a state-owned entity set up in March to take over the defunct Railway Ministry’s businesses. China Railway recently pledged to revitalize railway investment and it has increased the budget to RMB660 billion for 2013.

The order from Malaysia indicates CSR Zhuzhou’s growing presence in overseas rolling stock markets. CSR Zhuzhou’s improving product technology and quality owing to a large-scale domestic market and its competitive pricing compared with western peers has helped it win new orders in emerging markets. We expect export sales to spur the company’s growth and reduce its reliance on the domestic market. CSR Zhuzhou’s sales from overseas markets increased 13% year on year to RMB3.3 billion, accounting for 22% of total sales in 2012.

We expect CSR Zhuzhou’s financial profile to remain solid amid its business growth. CSR Zhuzhou has been funding its capital expenditure through operating cash flows and equity injections from its parent, CSR Corporation. Moreover, CSR Zhuzhou has completed major capacity expansions over the past few years and its existing capacity will satisfy its growth plan for the next two years. It has maintained a solid financial profile, with only RMB408 million of debt outstanding at the end of 2012. We expect debt/EBITDA to remain below 1.0x and its debt/book capitalization to be less than 10% over the next two years, consistent with the past three years.

Jiming Zou Assistant Vice President - Analyst +852.3758.1343 [email protected]

NEWS & ANALYSIS Credit implications of current events

11 MOODY’S CREDIT OUTLOOK 28 OCTOBER 2013

Housing Controls Are Credit Negative for Beijing Developers Last Tuesday, Beijing, China’s Municipal Commission of Housing and Urban-Rural Development issued policy guidelines aimed at increasing the supply of housing and controlling home prices in the city. The government’s effort to ease the growth in home prices is credit negative for developers with material operations in Beijing because the controls will pressure sales volumes and prices.

The government intends to increase the supply of owner-occupied affordable housing in 2014 to 50,000 units from at least 20,000 in 2013, and lower prices for such homes by 30% versus prices of comparable residential properties nearby. Although the price measures are aimed at lower-end housing, demand for mid- to high-end housing could also fall. In addition, homebuyers could curtail their purchases over the next three to six months while they wait for more clarity on the effects of the government measures. The developers could therefore face lower sales growth and margins.

Of our rated developers, Franshion Properties (China) Limited (Baa3 stable), Beijing Capital Land Limited (Ba2 stable), Guangzhou R&F Properties Co., Ltd. (Ba2 stable), Sunac China Holdings Limited (Ba3 stable), CIFI Holdings (Group) Co. Ltd. (B1 stable) and Hopson Development Holdings Limited (B3 stable) are more exposed to the new government measures because of their significant operations in Beijing. All six generated 15%-30% of their contracted sales from Beijing during the first half of this year (see exhibit below), and 7%-17% of their land banks were located in the city at the end of June 2013.

Proportion of Contracted Sales in Beijing for Six Rated Developers

Issuer Rating

Contracted Sales in Beijing to Total

Contracted Sales, First-Half 2013

Gross Margins 12 Months to June 2013

Cash to Short Term Debt as of June 2013

Franshion Baa3 stable 17%1 40.6% 132%

Beijing Capital Land Ba2 stable 29% 22.8% 114%

Guangzhou R& F Ba2 stable 21% 39.0% 205%

Sunac Ba3 stable 29%2 23.0% 221%

CIFI B1 stable 23% 23.5% 300%

Hopson B3 stable 25%3 38.9% 43%

Notes: [1] January to July 2013; [2] Full-year 2012; [3] Moody’s estimates

Sources: Company annual reports 2012 and interim results 2013, Moody’s

Among them, those with strong liquidity and high profit margins, such as Franshion and Guangzhou R&F, will have a greater ability to manage a slowdown in sales or a drop in prices. Although the government’s measures are aimed at the low end of the market, Hopson is the most vulnerable to a sales slowdown given its weak liquidity.

The government measures are a clear sign that the authorities are prepared to manage rapidly growing property prices. Strong demand in Beijing resulted in prices increasing 20.6% year on year in September, the seventh consecutive month that the city has recorded more than 10% year-on-year growth in housing prices.

The government’s plan to increase the supply of homes is significant in terms of both the number of homes and additional floor space, relative to the size of the residential property market in Beijing. According to Beijing Municipal Commission of Housing and Urban-Rural Development, in terms of residential housing, around 14.8 million square meters of contracted gross floor area (GFA) were sold in Beijing in 2012. The

Kaven Tsang Vice President - Senior Analyst +852.3758.1305 [email protected]

Franco Leung Assistant Vice President - Analyst +852.3758.1521 [email protected]

Fiona Kwok Associate Analyst +852.3758.1522 [email protected]

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12 MOODY’S CREDIT OUTLOOK 28 OCTOBER 2013

50,000 extra housing units next year, which are mostly 90 square meters each, would total around 30% of the contracted GFA in 2012. Such a significant amount of new supply will pressure property prices.

The moves by the Beijing government are in line with the General Office of the State Council’s previous calls for an increase in affordable housing and a stricter implementation of real estate purchase restrictions. These latest measures will serve as a reminder to the market of the central government’s commitment to curtail large price increases in the real estate sector.

NEWS & ANALYSIS Credit implications of current events

13 MOODY’S CREDIT OUTLOOK 28 OCTOBER 2013

Banks

US Justice Department’s Mortgage Fraud Win Is Credit Negative for Banks Last Wednesday, the US Department of Justice (DOJ) won its first judgment against a major US bank for fraud under a novel interpretation of the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA). This judgment is credit negative for banks facing government probes because it may encourage the DOJ to take more cases to trial or extract heftier penalties as part of a settlement.

A federal jury in New York found Bank of America Corporation (BAC, Baa2 review direction uncertain) guilty of fraud related to mortgages that Countrywide Financial Corporation, which BAC acquired in 2008, sold to Fannie Mae and Freddie Mac. The DOJ brought the civil lawsuit under FIRREA, which enables the government to seek civil money penalties for violations of certain criminal statutes (predicate offenses) if the violation affects a federally insured financial institution.

Last August, BAC tried to get the lawsuit dismissed by arguing that FIRREA was not applicable in this case because it was enacted to protect banks victimized by the fraudulent acts of third parties, not to prosecute them when they are damaged by their own fraudulent conduct. However, the district court disagreed based on the plain language of the statute and became the second ruling in the Southern District of New York to hold that an affected institution could also be the alleged perpetrator of a fraud. Since then, the same court reached a similar conclusion in September.2

In the BAC case, the DOJ is seeking civil money penalties of up to $848.2 million, which is the gross loss that Fannie and Freddie allegedly incurred on the loans. Press reports indicate the net loss suffered by the two firms was significantly lower. Over the past several years, BAC has set aside litigation provisions well in excess of these amounts, although it is unclear how much of those provisions, if any, relate this particular case. BAC has not yet disclosed its intentions regarding a possible appeal, however, it is likely that an appeal will challenge the applicability of FIRREA in such cases.

Beyond the case at hand, the judgment is significant because FIRREA gives the government a number of tactical advantages that significantly increase the likelihood of conviction compared with traditional fraud prosecutions. The scope of the statute is wide, owing to its 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 also 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 before it files a lawsuit. Because FIRREA has a 10-year statute of limitations, far longer than the typical three to five years applicable to civil lawsuits, these pre-suit investigations can last a long time and uncover numerous violations that would ordinarily be outside the timeframe of a typical civil lawsuit.

2 US 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); US

v. Countrywide Financial Corporation et al., No. 12 Civ. 1422 (JSR), 2013 U.S. Dist. LEXIS 117140 (S.D.N.Y. 16 August 2013); US v. Wells Fargo Bank, N.A., No. 12 Civ. 7527 (JMF), 2013 US Dist. LEXIS 136539 (S.D.N.Y. 24 September 2013).

Teresa Wyszomierski Chief Legal Officer - Financial Institutions Group +1.212.553.4129 [email protected]

David Fanger Senior Vice President +1.212.553.4342 [email protected]

NEWS & ANALYSIS Credit implications of current events

14 MOODY’S CREDIT OUTLOOK 28 OCTOBER 2013

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.

Pending a reversal, last Wednesday’s verdict may embolden the DOJ to take more cases to trial. In any event, the DOJ now has more leverage to extract heftier fines as part of any settlement.

NEWS & ANALYSIS Credit implications of current events

15 MOODY’S CREDIT OUTLOOK 28 OCTOBER 2013

Commercial Loan Growth Poses Risks for Some Regional US Banks Over the past couple of weeks, regional US banks’ quarterly earnings revealed that commercial loan growth was far higher than overall loan growth, reflecting banks’ desire to diversify away from real estate. Commercial loan growth has led to heightened competition, resulting in weaker underwriting standards and narrower pricing. This growth has occurred while corporate borrowers have become more levered as their debt has increased more than their profits.

As shown in Exhibit 1, US banks are growing commercial and industrial (C&I) loans faster than other loan categories. For US bank managements, C&I has been a bright spot for loan growth, as have certain consumer loan sectors, such as auto lending. The median growth rate for C&I loans was 7.4% for the 12 months ended 30 September, compared with 0.2% for all other loans. The two negative standouts regarding commercial loan growth are Fifth Third Bancorp (Baa1 stable) and Regions Financial Corporation (Ba1 stable), both of which accelerated their year-over-year C&I loan growth in the third quarter by 14.7% and 13.2%, respectively. Conversely, BB&T Corporation (A2 negative), Comerica Incorporated (A3 stable) and Zions Bancorporation (Ba1 stable) took a more cautious approach.

EXHIBIT 1

US Regional Banks Loan Growth Third-Quarter 2013 to Third-Quarter 2012 C&I Loans Grew Significantly at Some Regional Banks

Note: BBT = BB&T Corporation; CMA = Comerica Incorporated; FITB = Fifth Third Bancorp; HBAN = Huntington Bancshares Incorporated; KEY= KeyCorp; MTB = M&T Bank Corporation; PNC = PNC Financial Services Group; RF = Regions Financial Corporation; STI = SunTrust Banks, Inc.; USB = US Bancorp; WFC = Wells Fargo & Company; ZION = Zions Bancorporation Source: Company earnings releases

Exhibit 2, which is the US Federal Reserve’s quarterly Senior Loan Officer Opinion Survey, shows that large US banks (i.e., banks with assets of more than $20 billion) continue to ease loan covenants and prices aggressively. Although a lower percentage of respondents to the Fed’s July survey reported easing covenants than in the April survey, the trend remains negative. Meanwhile, an increasing percentage of large banks reported spread narrowing.

-10%

-5%

0%

5%

10%

15%

20%

FITB RF KEY USB PNC WFC MTB STI HBAN ZION CMA BBT

C&I Loans All Other Loans

Megan Snyder Associate Analyst +1.212.553.4986 [email protected]

NEWS & ANALYSIS Credit implications of current events

16 MOODY’S CREDIT OUTLOOK 28 OCTOBER 2013

EXHIBIT 2

Percentage of Large US Banks Reporting Narrowing Loan Spreads and Weakening Covenants for Large and Middle-Market Commercial and Industrial Loans

Source: US Federal Reserve Senior Loan Officer Opinion Survey

The more aggressive pricing of bank C&I loans has occurred while corporate borrowing has grown faster than profits. Over the past year, corporate profits have grown annually at a pace of less than 5% while non-financial corporate debt has grown at a faster clip each quarter, reaching 9.5% annual growth for the 12 months ended 30 June (see Exhibit 3). This divergence indicates that corporate borrowers are becoming more levered at a time when banks are pricing their C&I loans more aggressively because of heightened competition.

EXHIBIT 3

Growth in US Corporate Debt versus Corporate Profits, Second-Quarter 2011 = 100 US Corporations Are Growing Debt Faster than Profits

Note: Data series indexed to 100 at second quarter 2011. Source: Federal Reserve Flow of Funds Accounts of the United States and the US Bureau of Economic Analysis

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13

Narrowing Loan Spreads Easing Loan Covenants

100

102

104

106

108

110

112

114

116

118

120

2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13

Corporate Indebtedness Corporate Profits

NEWS & ANALYSIS Credit implications of current events

17 MOODY’S CREDIT OUTLOOK 28 OCTOBER 2013

ECB’s Capital Assessment Is Credit Negative for Weak Italian Banks Last Wednesday, the European Central Bank (ECB) published details of its comprehensive assessment of some 130 significant banks in the European Union (EU) that will begin in November. The assessment will take 12 months to complete and will primarily include an asset quality review and a stress test. The ECB is doing this assessment in advance of officially assuming bank supervisory responsibility. The assessment will be based on a capital benchmark of a common equity Tier 1 capital ratio of 8%, therefore accelerating Basel III implementation.

The 8% minimum capital buffer is credit negative for junior bondholders of Italian banks that are now close to or below this threshold or that have weak asset quality. It will be challenging for these banks to close the capital shortfall with private resources, which raises the possibility of a public intervention and ultimately a bail-in. There is currently no disclosure of a public backstop measure to plug any capital shortfall.

As shown in Exhibit 1, Banca Carige SpA (B2 review for downgrade, E+/b3 review for downgrade),3 Banca Popolare di Milano S.C.a r.l. (B1 negative, E+/b2 stable) and Credito Valtellinese (Ba3 negative, E+/b1 stable) have low capital. Exhibit 2 shows that Banca Monte dei Paschi di Siena S.p.A. (MPS, B3 negative, E/caa3) and Banco Popolare Societa Cooperativa (Ba3 negative, E+/b3 negative) have weak asset quality. Banca Carige, Banca Popolare and MPS plan to raise capital in the market and through asset disposals.

EXHIBIT 1

Italian Banks’ Core Tier 1 Ratio versus the European Central Bank Minimum Requirement and European Union Average

Source: Moody’s Financial Metrics

3 The bank ratings shown in this report are the banks’ deposit ratings, their standalone bank financial strength rating/baseline credit

assessment and the corresponding rating outlooks.

0%

2%

4%

6%

8%

10%

12%

14%

Banca Carige Banca Popolare di

Milano

Banco Popolare

Credito Emiliano

Credito Valtellinese

Intesa Sanpaolo

UniCredit Unione di Banche Italiane

MPS

European Union Average Common Equity Minimum Requirement

London +44.20.7772.5454

NEWS & ANALYSIS Credit implications of current events

18 MOODY’S CREDIT OUTLOOK 28 OCTOBER 2013

EXHIBIT 2

Italian Banks’ Problem Loans as Percent of Equity and Loan-Loss Reserves

Source: Moody’s Financial Metrics and company reports

On a European comparison, Italian banks will benefit from the European Banking Authority’s 21 October harmonisation of the problem loan definition to 90 days past due because the Bank of Italy’s problem loan definition is stricter than those of other countries and a portion of their watchlist loans (loans in temporary difficulty) is performing. This benefit is likely to be offset by greater scrutiny on debt forbearance measures, defined by European Banking Authority as concessions extended to debtors in difficulty. The frequent increase in cost of risk (loan-loss provisions over loans) after the Italian central bank’s inspections, (see two examples in Exhibit 3) suggests that forbearance is an issue at some banks.

EXHIBIT 3

Cost of Risk Before and After Bank of Italy Inspection Banca Carige SpA

Source: Moody’s Financial Metrics and company reports

Banca delle Marche

37.0%

53.8% 60.6% 63.2% 64.9% 65.2%

92.9% 94.0%

129.2%

0%

20%

40%

60%

80%

100%

120%

140%

Banca Carige Banca Popolare di

Milano

Banco Popolare

Credito Emiliano

Credito Valtellinese

Intesa Sanpaolo

UniCredit Unione di Banche Italiane

MPS

36 43 45 43

143

168

0

20

40

60

80

100

120

140

160

180

2008 2009 2010 2011 2012 Jun-13

Basis

Poi

nts

49

73 74 72

555

0

100

200

300

400

500

600

2008 2009 2010 2011 2012

Basis

Poi

nts

NEWS & ANALYSIS Credit implications of current events

19 MOODY’S CREDIT OUTLOOK 28 OCTOBER 2013

Banca Popolare dell’Alto Adige’s Proposed Merger with Banca Popolare di Marostica Is Credit Negative Last Tuesday, Banca Popolare dell’Alto Adige - SuedtirolerVolksbank (BP Alto Adige, Ba1 negative, D+/ba1 negative)4 and Banca Popolare di Marostica (BP Marostica, unrated) announced that they had begun preliminary talks to merge the two banks. A merger or acquisition would be credit negative for BP Alto Adige, but credit positive for BP Marostica, owing to BP Alto Adige being stronger than BP Marostica, particularly in asset quality.

We are not aware of the rationale that prompted BP Alto Adige to begin these talks. As we have noted previously,5 a common market concern is that healthier Italian banks will come under political pressure to acquire weak institutions to preserve Italy’s financial stability, although we have no evidence that this is a driver of this proposed transaction.

BP Alto Adige has been resilient throughout the euro area sovereign and financial crisis, and in December 2012 reported financials that were among the strongest in Italy. BP Marostica, on the other hand, has been severely hit by the recession and has a much weaker asset quality than BP Alto Adige. BP Marostica’s ratio of problem loans to gross loans was 17.2% for 2012, compared with 7.0% for BP Alto Adige and a system average of 10.5%, and was among the weakest in Italy. The pro forma problem loans ratio for the combined entity at December 2012 would have been 9.6%.

The exhibit below shows the problem loans ratio for BP Alto Adige and BP Marostica, in the context of the Italian average over the past five years.

BP Alto Adige’s and BP Marostica’s Ratio of Problem Loans to Gross Loans

Source: Bank of Italy and company reports

Although not as large as BP Alto Adige, BP Marostica’s assets are still material. In December 2012, BP Alto Adige’s total assets were €5.9 billion, compared with €2.0 billion for BP Marostica. If BP Alto Adige were to merge with BP Marostica, it would lead to a significant deterioration of BP Alto Adige’s main asset quality ratios. Such deterioration would raise integration risks, particularly against the backdrop of Italy’s current recessionary environment, where asset quality continues to deteriorate.

4 The bank ratings shown in this report are the bank’s deposit rating, its standalone bank financial strength rating/baseline credit

assessment and the corresponding rating outlooks. 5 See CreVal’s Decision Not to Proceed with an Acquisition of Banca Tercas Is Credit Positive, 14 October 2013.

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

2008 2009 2010 2011 2012

BP Alto Adige BP Marostica Italian Aggregate

London +44.20.7772.5454

NEWS & ANALYSIS Credit implications of current events

20 MOODY’S CREDIT OUTLOOK 28 OCTOBER 2013

Bank of Ireland’s Latest Pension Deficit Reduction Plan Is Credit Positive Last Wednesday, Bank of Ireland (Ba1 negative, D/ba2 negative)6 announced that it had reached an agreement with its largest union on a shared solution to reduce its pension deficit of €1 billion. Two days later, the bank’s largest union threw its support behind the plan, which, pending union and non-union members’ approval, would reduce the pension deficit by approximately €400 million. This is credit positive for the bank because it will improve its Basel III fully loaded core equity Tier 1 (CET1) ratio and positively affect profits once the changes take effect.

The bank made significant changes to its pension scheme in 2010, reducing its deficit by €750 million through benefit reductions. The bank also committed to make extra cash contributions of €750 million to the scheme through 2015 to fully offset the remaining deficit. However, the pension gap widened in 2012 following a decrease in the discount rate.

The changes will benefit the bank because it will help offset the capital deduction for the pension deficit under Basel III rules and increase the bank’s fully loaded CET1 ratio. We calculate the bank would record a 76-basis-point improvement in its CET1 ratio, based on Basel III risk-weighted assets reported at the end of June. Bank of Ireland’s Basel III CET1 ratio was 8.6% at the end of June, including €1.8 billion of preference shares that will no longer qualify as CET1 after 31 December 2017.

Reducing the deficit will also create a one-off pension credit of approximately €400 million, reducing the bank’s operating expenses significantly and generating some cost savings in subsequent years.

The effect on Bank of Ireland’s core Tier 1 ratio under current rules will be neutral. The bank’s core Tier 1 ratio was 14.2% at the end of June, exceeding the 10.5% regulatory minimum. As market participants are increasingly focusing on Basel III fully loaded capital positions, the implementation of the changes to the pension scheme will alleviate part of the pressure on Bank of Ireland to increase its Basel III CET1 ratio above the requirement that the bank expects will be around 10% by 2018.

6 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.

Elsa Dargent Associate Analyst +44.20.7772.1645 [email protected]

Carlos Suarez Duarte Vice President - Senior Analyst +44.20.7772.1061 [email protected]

NEWS & ANALYSIS Credit implications of current events

21 MOODY’S CREDIT OUTLOOK 28 OCTOBER 2013

Rising Apartment Prices Pose No Threat to German Mortgage Lenders and Covered Bonds Last Monday, the Deutsche Bundesbank, the German central bank, published its monthly report, which showed that apartment prices in Germany’s seven largest cities7 had risen 25% since 2010. Applying a fundamental valuation model, the central bank estimates that property prices in these cities may be overvalued by up to 20%. A price reversal would inevitably negatively affect the credit quality of mortgage loans backed by such properties. However, a sharp price reversal is unlikely because we consider recent price increases to be mainly driven by a shortage of supply and thus do not pose an imminent risk for residential mortgage lenders and covered bonds.

When looking at broader aggregates such as residential property prices in 125 German cities, increases since 2010 at 8.25% in aggregate, or 2.75% per year, are moderate and mark a reversal of the decline in real value of the past 10 years. Moreover, these property price rises have not been accompanied by higher credit volumes, and the Deutsche Bundesbank lender survey shows banks continue to apply tighter lending standards.

Real property prices in German cities are still below their levels in 2000 (see exhibit below), following a more than 15% decline in property values in real terms over the past decade.

House Prices in 125 German Cities, Index = 100 in 2000

Sources: Deutsche Bundesbank, BulwienGesa AG and Moody’s

According to the central bank, residential mortgage volume has increased €42 billion, or 3.8%, since 2010, which points more to a lack in the supply of housing than speculative demand. In fact, the supply of new apartments had diminished until 2009 and has only risen significantly since 2011. Moreover, the Bundesbank in July released its latest quarterly survey of lending conditions among German banks, which showed that banks have continuously tightened their credit standards for home loans since fourth-quarter 2012.

Specifically in the case of covered bonds, the 60% loan-to-value (LTV) ratio threshold in the Pfandbrief Act ensures that only loan parts equal to the first 60% LTV are eligible for the cover pool. This provides a buffer in case of price declines and borrower default because proceeds from the sale of the property will first be allocated to the loan part included in the cover pool.

7 Berlin, Hamburg, Munich, Cologne, Frankfurt, Stuttgart and Düsseldorf.

80

85

90

95

100

105

110

115

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Nominal Real

Mathias Kuelpmann, CFA Senior Vice President +49.69.70730.928 [email protected]

Martin Lenhard Vice President - Senior Analyst +49.69.70730.743 [email protected]

NEWS & ANALYSIS Credit implications of current events

22 MOODY’S CREDIT OUTLOOK 28 OCTOBER 2013

In addition, the lending value, not the market value, of the property is used to determine the 60% LTV threshold. The Pfandbrief framework defines the lending value as the long-term sustainable property value excluding any speculative price components. The Pfandbrief Act also stipulates that property valuations are not indexed after loan origination in case of property price increases. Therefore, rising property prices do not introduce additional risk to cover pools with respect to loans that originated before the recent increase in property prices, and would only affect recently originated loans.

NEWS & ANALYSIS Credit implications of current events

23 MOODY’S CREDIT OUTLOOK 28 OCTOBER 2013

Indian Government’s Capital Injection into Public-Sector Banks Is Credit Positive Last Wednesday, the government of India finalized the allocation of INR140 billion ($2.3 billion) of capital to 20 public-sector banks for the fiscal year ending March 2014 through a preferential allotment of equity shares. The recapitalization is credit positive because it improves the odds that public sector banks will meet regulatory capital requirements while maintaining loan growth to economically important sectors.

Before the capital infusion, we estimated that at the end of fiscal 2014 just six of the 11 public-sector banks we rate would have reported Tier 1 capital ratios of more than 8% regulatory minimum under Basel II. The government’s capital infusion will not only raise the capital levels of all rated banks, but we also expect that it will allow three more banks to meet the minimum.

Even so, the need for larger capital injections to an ever-greater number of public sector banks is symptomatic of the more fundamental economic and credit challenges that capital injections are not addressing. For fiscal 2013, the government injected INR125 billion into 13 public-sector banks, with eight banks we rate receiving a total of INR110 billion.

Of the total amount the government is allocating for fiscal 2014, INR102 billion will go to the 11 public-sector banks we rate. State Bank of India (SBI, Baa3 stable, D+/ba1 negative)8 will receive INR20 billion, while IDBI Bank Ltd (IDBI, Baa3 stable, D-/ba3 stable) and Central Bank of India (CBI, Baa3 negative, E+/b1 stable) will each get INR18 billion. Indian Overseas Bank (IOB, Baa3 stable, D-/ba3 negative) will receive INR12 billion and Bank of India (BOI, Baa3 stable, D/ba2 negative) will receive INR10 billion. The remaining public-sector banks we rate will receive INR1.5-INR5.5 billion.

The capital injection will allow IDBI, CBI and BOI to remain over the Basel II Tier 1 threshold in fiscal 2014 (see Exhibit 1). Without the capital injection, we estimate they would have fallen short of that threshold, assuming loan growth and profit levels similar to those of past years. However, we anticipate that IOB and Union Bank of India (UBI, Baa3 stable, D/ba2 negative) may face difficulties in meeting the 8% target at the end of fiscal 2014 even after the capital infusion.

8 The bank ratings shown in this report are the bank’s deposit rating, its standalone bank financial strength rating /baseline credit

assessment and the corresponding rating outlooks.

Nick Caes Associate Analyst +65.6398.8332 [email protected]

Daphne Cheng Associate Analyst +65.6398.8339 [email protected]

NEWS & ANALYSIS Credit implications of current events

24 MOODY’S CREDIT OUTLOOK 28 OCTOBER 2013

EXHIBIT 1

Estimated Effects of the Indian Government’s Capital Injection on Rated Public Sector Banks in Fiscal 2014

Note: BOB = Bank of Baroda, BOI = Bank of India, CAN = Canara Bank, CBI = Central Bank of India, IDBI = IDBI Bank Limited, IOB = Indian Overseas Bank, OBC = Oriental Bank of Commerce, PNB = Punjab National Bank, SBI = State Bank of India, Syn = Syndicate Bank, UBI = Union Bank of India Source: Banks’ quarterly reports

We expect IDBI, CBI and IOB to benefit most from the capital injection because their lower baseline credit assessments reflect weaker internal capital generation capabilities and higher levels of impaired loans (see Exhibit 2, which combines gross nonperforming loans and restructured loans).

EXHIBIT 2

Impaired Loans for Rated Indian Public-Sector Banks as of June 2013

Source: Banks’ quarterly reports

The INR140 billion capital allocation is in line with our expectations and reaffirms our view that the government will continue to encourage public-sector banks to keep lending despite India’s challenging economic environment. However, it does not leave the banks better equipped to withstand the risks of further asset quality deterioration. The bank’s gross nonperforming loan ratio rose to a weighted average of 4.3% in June, the highest in more than five years, and a similar rise in restructured loans suggests that provisioning costs might further increase. As such, the benefits of the capital injections might last shorter than our assumptions based on past trends suggest.

10.6% 10.6% 10.0%8.6% 8.6% 8.5%

7.5% 7.2% 7.7% 7.7% 7.2%

20bps 15bps16bps

17bps 9bps 15bps63bps 87bps 31bps 21bps 68bps

0%

2%

4%

6%

8%

10%

12%

CAN PNB BOB SBI OBC Syn IDBI CBI BOI UBI IOB

Projected Tier 1 Ratio FY2014 Before Proposed Capital Injection Projected Tier 1 Capital FY2014 After Proposed Capital Injection

6.0% 4.8% 4.5% 4.3% 3.4% 3.0% 2.9% 3.5%5.6%

3.0% 2.4%

13.2%

10.2% 10.5%7.8%

8.0%7.3% 7.1% 5.1%

3.0%5.2% 5.8%

0%

5%

10%

15%

20%

CBI PNB IOB IDBI OBC BOB CAN UBI SBI BOI Syn

Gross Nonperforming Loan Ratio Standard Restructured Loans as Percent of Gross Loans

NEWS & ANALYSIS Credit implications of current events

25 MOODY’S CREDIT OUTLOOK 28 OCTOBER 2013

Insurers

Old Republic’s Recapitalization Plan for RMICC Is Credit Positive Last Thursday, Old Republic International Corporation (Baa3 positive) announced it would recapitalize its mortgage insurance unit RMIC Companies, Inc. (RMICC) using a combination of outside capital and up to $50 million of its own resources. This transaction, which would result in Old Republic owning less than 10% of the newly recapitalized company, would be credit positive for Old Republic because it would allow the company to exit its troubled and financially weak mortgage insurance operation. It would also eliminate the risk that a regulatory takeover of the unit would trigger an event of default and acceleration of Old Republic’s senior debt. As a result of this announcement we changed Old Republic International’s outlook to positive from stable on Friday.

RMICC, which is currently 100%-owned by Old Republic, houses the group’s three mortgage insurance subsidiaries, including lead company Republic Mortgage Insurance Company (RMIC), which has very weak financial strength (we withdrew our Caa2 insurance financial strength ratings in February 2012). RMIC is currently in run-off and has been operating under a regulatory supervision order from the North Carolina Department of Insurance, its primary regulator, since January 2012. The order has allowed Old Republic to maintain control of RMIC and maintain solvency by deferring a portion (currently 40%) of its claims payments.

Old Republic said its capitalization plan would allow RMIC to pay its existing deferred payment obligations (which totaled $443 million as of 30 June), support existing policies, end its current regulatory supervision status and begin writing new business by early 2014.

Old Republic’s ownership of RMIC has been a significant credit negative for the company and its bondholders over the past two years because further deterioration at RMIC could cause the North Carolina regulator to place the subsidiary into full receivership for liquidation or rehabilitation. Such a scenario would constitute an event of default under Old Republic’s existing bond covenants and would require an immediate principal repayment of the company’s $550 million in senior notes. Although we believe the company has adequate contingency plans in place to manage this scenario, liquidity would nevertheless be negatively pressured because, with liquid assets of $279 million at 30 September, the parent company does not currently have adequate resources to make a full principal repayment.

If Old Republic successfully executes its plan, RMIC would no longer be a “significant subsidiary” under Old Republic’s senior notes covenants, and thus could no longer trigger a default and debt acceleration. The transaction would also remove Old Republic’s weakest and highest risk operation from under its umbrella, thereby improving the consolidated group’s overall credit quality.

Although Old Republic previously said it would not support RMIC with additional capital, the potential $50 million cash contribution is modest relative to the parent’s $3.7 billion in book value, and would not materially affect the liquidity of the parent or the capital strength of its core property and casualty or title insurance operations.

The company’s current plan is its second attempt to exit its mortgage business. In May 2012, Old Republic said it would spin off its mortgage insurance business to existing shareholders, but later withdrew that plan following pressure from stakeholders, including state regulators, Fannie Mae, Freddie Mac, and financial institution counterparties.

Paul Bauer, CFA Vice President - Senior Credit Officer +1.212.553.1334 [email protected]

NEWS & ANALYSIS Credit implications of current events

26 MOODY’S CREDIT OUTLOOK 28 OCTOBER 2013

Because of the numerous steps involved and approvals that will be required, we remain cautious about the current proposal. Nevertheless, we believe Old Republic has been careful to construct a plan that is likely to gain support from RMIC’s major constituencies.

NEWS & ANALYSIS Credit implications of current events

27 MOODY’S CREDIT OUTLOOK 28 OCTOBER 2013

Old Republic’s Recapitalization Plan Is Credit Positive for RMIC Last Thursday, Old Republic International Corporation (Baa3 positive), the parent of Republic Mortgage Insurance Company (RMIC, unrated), announced it would recapitalize and re-launch RMIC in early 2014. If successful, the recapitalization, which involves a combination of outside capital and up to $50 million of Old Republic’s own resources, would be credit positive for RMIC. It would allow the company to pay off deferred claim obligations, exit a special regulatory supervision currently in place and resume normal business operations subject to regulatory and counterparty approval.

Old Republic indicated that the new company, RMIC Companies, Inc. (RMICC, unrated), which would mainly be composed of RMIC, would allow policyholders, which include Fannie Mae and Freddie Mac (the government-sponsored enterprises, or GSEs), to collect 100% of the deferred claims payments that totaled $443 million at 30 June, together with an agreed-upon interest charge. In addition, to resume new business production, RMICC must capitalize to comply with the GSEs’ and regulatory capital requirements. RMIC’s statutory surplus was $251 million as of 30 June, reflecting net funds retained for claims payments.

Old Republic would contribute up to $50 million upfront, and intends to reduce its ownership to less than 10% and ultimately dispose of its equity stake in the recapitalized company. In 2012, as a result of heavy mortgage insurance claims payments, RMIC’s liquidity and capital dried up, and its parent decided not to support it. The regulator placed the company under supervision and approved RMIC to defer 40% of its claims payments, significantly alleviating the pressure on RMIC’s liquidity and statutory surplus.

Although the re-launch of RMIC would lead to greater competition among mortgage insurers, private insurers in general have more opportunities to write new business. The Federal Housing Administration, a US government mortgage insurer, has been cutting back on new insurance written by raising prices and the GSEs are seeking to do more risk-sharing transactions with the private sector. Private mortgage insurers’ market share increased to about 36% of the overall insured market as of 30 June 2013 from as low as 14% in late 2009.9

Old Republic attempted to spin off its mortgage insurance business in May 2012, but withdrew the plan amid pressure from its key stakeholders. Although we remain cautious about the current plan, we believe the company likely has gained support from its major constituencies, and a receptive capital market for mortgage insurers is a plus.

9 We excluded insurance written by the US Department of Veterans Affairs in our calculations.

Helen Remeza Vice President - Senior Analyst +1.212.553.2724 [email protected]

NEWS & ANALYSIS Credit implications of current events

28 MOODY’S CREDIT OUTLOOK 28 OCTOBER 2013

UK Motor Insurers Lose Potential Savings as Government Defers Small-Claims Threshold Increase Last Wednesday, the UK Ministry of Justice announced that it had deferred its decision to increase the monetary threshold for motor accidents captured by the claims portal process. This was one of the two key measures the government had proposed to reduce the number and cost of fraudulent and exaggerated motor personal injury claims. The government’s decision, made on the grounds that it might deter access to justice for the genuinely injured, is credit negative for motor insurers because they will not benefit from the associated potential cost savings.

In December 2012, as part of its consultation on whiplash claims, the government proposed to increase the minimum claim amount eligible for the claims portal process. The increased threshold aimed to reduce personal injury claims in the claims portal process and allow small claims courts to handle more motor claims. This may have reduced the frequency of very low-value personal injury claims overall and would have reduced insurers’ legal expenses in handling such claims.

In small claims courts, individuals pay their own court fees, which would likely have deterred opportunistic and fraudulent claimants. Under the current minimum threshold, legal fees in the claims portal process can be disproportionate to the overall cost of low-value personal injury claims. For example, a £1,001 and a £10,000 claim could both carry the same £500 legal fee.

The government’s announcement coincided with the Automobile Association’s release of its latest British Insurance Premium Index report, which showed that motor insurance premium rates fell a record 12.4% over the past 12 months. In our view, market competition as well as insurers’ anticipation of lower motor costs from an increased lower claims threshold in addition to previously implemented reforms, drove the decline in premium rates.

The consultation also considered the introduction of independent medical panels in the assessment of whiplash to make it harder to claim exaggerated injuries, thereby reducing the frequency of whiplash claims. The government intends to move forward and develop specific proposals on whiplash assessments. The government has also given its support to other related measures including a requirement for insurers to receive a claimant’s formal medical examination for whiplash cases before settling and better data sharing across stakeholders on known fraudsters.

Whiplash accounts for around 75% of UK personal injury claims, according to the Comité Européen des Assurances’ study of minor cervical trauma claims. Therefore, reducing the volume of whiplash claims is likely to significantly decrease the overall cost of motor claims. However, the government expects insurers to pass any savings on to consumers. Furthermore, the extent to which independent medical panels, in addition to the previously implemented initiatives, will reduce the cost of motor claims remains uncertain, thereby increasing pricing risk and threatening profitability, particularly for those insurers with the greatest exposure to personal motor lines, as shown in the exhibit below.

Helena Pavicic Associate Analyst +44.20.7772.1397 [email protected]

NEWS & ANALYSIS Credit implications of current events

29 MOODY’S CREDIT OUTLOOK 28 OCTOBER 2013

UK Insurers’ Personal Motor Gross Written Premiums

Source: Company data and Moody’s

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

£0.0

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£1.2

£1.4

£1.6

£1.8

£ Bi

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Personal Motor GWP Amount - left axis Personal Motor GWP as Percent of Group GWP - right axis

NEWS & ANALYSIS Credit implications of current events

30 MOODY’S CREDIT OUTLOOK 28 OCTOBER 2013

Sovereigns

Egypt’s Bigger Supplementary Budget and Deficit Are Credit Negative Last Monday, the Finance Ministry of Egypt (Caa1 negative) announced an EGP29.7 billion ($4.3 billion, or 1.7% of GDP) stimulus package to be spent during the fiscal year that began in July. This package increases by EGP7.4 billion the original stimulus package of EGP22.3 billion ($3.2 billion), which was initially announced in August.

The extra spending is credit negative because we think that it will likely widen Egypt’s fiscal deficit beyond the 10% of GDP in fiscal year 2014 that is the government’s target. We also expect it will add to Egypt’s debt and its exceptionally large gross financing needs, which the International Monetary Fund estimates will be 39.9% of GDP in fiscal 2014 (see exhibit).

Egyptian Government Revenue, Expenditure and Financial Balance The Fiscal Deficit Has Widened Substantially Since the 2011 Revolution

Sources: International Monetary Fund and Moody’s

The Ministry of Finance maintains that it will be able to achieve its 10% of GDP deficit target because foreign grants have been higher and interest payments have been lower than it budgeted. The fiscal 2014 budget includes only EGP2.4 billion ($350 million) in grants, but the government has already received EGP7 billion ($1 billion) in grants from foreign governments in the first two months of the fiscal year, according to its September monthly bulletin.

Financial support from three Gulf Cooperation Council (GCC) member countries, Saudi Arabia (Aa3 stable), Kuwait (Aa2 stable) and the United Arab Emirates (Aa2 stable), has added liquidity to Egypt’s financial system and helped lower interest rates on government debt. Yields on one-year treasury bills tightened to 10.5% at the end of September from 14.9% in June. This will lower interest payments, which composed about 17% of general government expenditures in fiscal 2013.

However, the performance of the budget in the first two months of fiscal 2014 shows that despite the receipt of EGP7 billion in grants, total revenue collection fell to 6.8% of the annual budget target from 8.3% of the preliminary annual budget outcome a year earlier. Spending was 10.7% of the budgeted target, versus 11.4% of the budget outcome a year earlier. But future expenditure pressure will come from the inclusion in the stimulus package of an EGP470 increase in the minimum public sector salary to EGP1,200

-40%

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30%

2008/09 2009/10 2010/11 2011/12 2012/13 2013/14F

Perc

ent o

f GD

P

General Government Revenue/GDP General Government Expenditures/GDP

General Government Financial Balance/GDP

Mathias Angonin Associate Analyst +971.4.237.9548 [email protected]

Steffen Dyck Assistant Vice President +65.6398.8324 [email protected]

Tom Byrne Senior Vice President +65.6398.8310 [email protected]

NEWS & ANALYSIS Credit implications of current events

31 MOODY’S CREDIT OUTLOOK 28 OCTOBER 2013

($174) starting 1 January. This will cost EGP9 billion in fiscal 2014 and add EGP18 billion in structural expenditures annually in coming years. Meanwhile, foreign grants are a temporary source of financing.

Although additional grants from the GCC countries may be forthcoming, it will only be an incremental source of deficit financing. Persistently high deficits will continue to strain the domestic capital market and financial system. Banks’ exposure to government securities is currently 38% of total assets, up from 26% in December 2010. But a reduction in the fiscal deficit would free up domestic resources for more productive private sector economic activity and would also contain the rise in government debt, which we project will amount to at least 92.2% of GDP by the end of fiscal 2014, versus 73.2% in June 2010.

Most of the budget package consists of growth-enhancing capital expenditures, such as construction of social housing and transport and health infrastructure. However, the benefits to economic growth may be limited until there is political stability. Political turmoil has weighed on investor confidence since the outbreak of the Egyptian revolution in January 2011.

NEWS & ANALYSIS Credit implications of current events

32 MOODY’S CREDIT OUTLOOK 28 OCTOBER 2013

US Public Finance

Atlantic City, New Jersey, Faces Large, Credit-Negative Property Tax Refund to Borgata Casino Last Monday, a New Jersey state court ruled that Atlantic City, New Jersey (Baa1 negative), has to pay the Borgata Casino a $49.8 million property tax refund to settle a property tax appeal driven by declining gaming revenues. The ruling is credit negative for the city because it has limited internal resources to pay the refund, which totals 20% of its annual revenues. Atlantic City will likely resort to issuing debt, as it has had to do to pay refunds to other casinos in recent years.

The court decision on Borgata could trigger a new round of downward tax assessments of casino properties. The refund to Borgata, the city’s top taxpayer, is Atlantic City’s largest casino tax appeal settlement to date. Since 2007, the city has issued debt to pay $200 million in tax refunds to other casinos that appealed for lower taxes because of their strained and declining gaming revenues. Similarly, the city estimates it only has $2.7 million of reserves for 2013, so we expect it will issue debt to pay Borgata’s $49 million refund.

Atlantic City’s assessed property value has declined by 34% over the past five years (see Exhibit 1), largely because of casino tax appeals. The city’s total direct debt as a percentage of its tax base is above average at 1.3%, and the ratio will increase to about 2.0% in 2014 (see Exhibit 2), double the 1% national median level for the local governments we rate. Debt service payments are also high at 15.1% of its 2013 budget.

EXHIBIT 1

Atlantic City, New Jersey’s Assessed Property Value Is Declining

Source: Atlantic City, New Jersey, financial audits

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$5

$10

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$25

2008 2009 2010 2011 2012 2013

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Vito Galluccio Analyst +1.212.553.2738 [email protected]

NEWS & ANALYSIS Credit implications of current events

33 MOODY’S CREDIT OUTLOOK 28 OCTOBER 2013

EXHIBIT 2

Atlantic City, New Jersey’s Debt as a Percentage of Assessed Property Value Is Growing

Source: Atlantic City, New Jersey, financial audits and Moody’s 2014 estimate

We expect casinos to continue appealing their property taxes because gaming revenues are likely to continue declining. Gaming revenues fell by 41% from 2006 through 2012, and were down 9.3% year to date through September. The decline is driven by heightened competition from surrounding states, particularly from newer and expanding casinos in Pennsylvania and New York. High unemployment and high gas prices are also weighing on demand for gaming in the region.

The Borgata case is the first appeal that was decided in court. Borgata is also the first casino to lower its property tax assessment by successfully arguing that declining gaming revenue is a main factor of determining a casino’s current assessment value. Previous property assessment methodologies did not fully incorporate casino revenue, but instead based assessments on an estimated cost to build the property and depreciation levels. The judge’s decision to side with Borgata’s revenue-based approach for assessing casino property values is likely to encourage a new wave of casino appeals.

0.0%

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2.5%

2008 2009 2010 2011 2012 2013 2014F

RATING CHANGES Significant rating actions taken the week ending 25 October 2013

34 MOODY’S CREDIT OUTLOOK 28 OCTOBER 2013

Corporates

Aldar Properties PJSC Upgrade

1 Jul ’13 23 Oct ‘13

Corporate Family Rating B1 Ba1

Outlook Review for Upgrade Positive

Following the completion of the merger of Aldar and Sorouh, there is now greater visibility regarding the combined entity’s transactions with the government of Abu Dhabi and its project pipeline and cash-flow projections. In our view, contracted transactions until 2017 between the government and the company materially de-risk Aldar. Further, we expect the company’s development risk from third-party homebuilding activities to diminish and the net recurring rental cash flow from its investment properties to grow to levels that support its pro-forma debt load by the end of this year.

Darden Restaurants, Inc. Downgrade

2 Oct ’13 21 Oct ‘13

Senior Unsecured Rating Baa2 Baa3

Short-Term Issuer Rating P-2 P-3

Outlook Review for Downgrade Stable

The downgrade reflects Darden’s weaker than expected earnings performance, particularly since its debt financed acquisition of Yard House, which has resulted in a steady deterioration in debt protection metrics. It also reflects our view that soft consumer spending and discounting by competitors will limit Darden’s ability to materially improve earnings and credit metrics over the intermediate term.

McKesson Corporation Review for Downgrade

21 Jun ’10 24 Oct ‘13

Senior Unsecured Rating Baa2 Baa2

Short-Term Issuer Rating P-2 P-2

Outlook Stable Review for Downgrade

The review follows the company's announcement that it plans to acquire German drug wholesaler and operator of retail pharmacies, Celesio AG, for $8.3 billion, including the assumption of Celesio's outstanding debt. Although the company has not determined how much debt it will use to fund the acquisition, we believe McKesson could add a significant amount of incremental debt, raising the likelihood that its credit ratios will not meet our expectations for its Baa2 rating.

RATING CHANGES Significant rating actions taken the week ending 25 October 2013

35 MOODY’S CREDIT OUTLOOK 28 OCTOBER 2013

Merlin Entertainment S.a.r.l Outlook Change

3 Jun ’13 22 Oct ‘13

Corporate Family Rating B1 B1

Outlook Stable Positive

The positive outlook reflects the company’s announcement on 21October that it intends to list its shares on the London Stock Exchange, with at least a 20% free float, and obtain proceeds of about £200 million, which we expect will be largely used for debt reduction.

Telekom Austria AG Downgrade

14 Jan ’13 23 Oct ‘13

Long Term Issuer Rating Baa1 Baa2

Short-Term Issuer Rating P-2 P-2

Outlook Negative Stable

The rating downgrade reflects the negative financial implications of Telekom Austria's €1 billion debt-financed spectrum acquisition. As a result of the acquisition, for which the group paid more than twice the amount we had expected, Telekom Austria's leverage ratio, measured by gross debt/EBITDA, will deteriorate this year to around 3.4x from 2.9x in 2012. This exceeds the maximum level of 3.0x that we had indicated for the previous rating category.

RATING CHANGES Significant rating actions taken the week ending 25 October 2013

36 MOODY’S CREDIT OUTLOOK 28 OCTOBER 2013

Financial Institutions

Banco Paulista S.A. Downgrade

23 Jul ‘13 24 Oct ‘13

Long-term local- and Foreign-Currency Deposit Ratings

B1 B2

Standalone Financial Strength/ Baseline Credit Assessment

E+/b1 E+/b2

The downgrade reflects Paulista’s shift in business profile towards foreign exchange services, and away from the commercial lending activity, which has resulted in growing earnings dependence on a single business line. The reduction in the loan portfolio over the past two years has led to loans accounting for only about 12% of total assets, generating an even lower percentage of revenues. Over the same period, foreign exchange earnings have grown to account for around two thirds of total revenues. Foreign exchange activities involve operational and compliance risks that are difficult to anticipate.

Caja Rural de Granada Downgrade

23 Jul ‘13 24 Oct ‘13

Deposit Rating Ba2 B1

Standalone Financial Strength/ Baseline Credit Assessment

D/ba2 E+/b1

The downgrade reflects Caja Rural de Granada’s weakened financial profile and the deterioration of asset-quality metrics, particularly in the corporate segment. We believe that the pace of asset-quality deterioration has accelerated in the context of the ongoing real-estate crisis and the continuing weak outlook for the non-export-oriented corporate sector, in view of the ongoing contraction in the domestic economy. These ongoing economic challenges are exacerbated by the bank's operating focus on Andalusia (Ba2 negative), one of Spain's weakest regions.

Duff & Phelps Corporation Downgrade

10 Jul ‘08 22 Oct ‘13

Corporate Family Rating B1 B2

Senior Secured Term Loan Rating B1 B2

Revolving Credit Facility Rating B1 B2

The downgrade follows the company's announcement that it is seeking to increase its term loan by $135 million and use the proceeds to fund a $131 million distribution to its shareholders. The company has also indicated that it recently paid $19 million towards reducing its Tax Receivable Agreement (TRA) liability at a significant discount to the gross obligation. The one-notch downgrade reflects the adverse effect of the significantly increased debt on the company's creditworthiness, which out-weighs some recent credit positive developments such as the better than expected operating results and cost savings the company has achieved in 2013.

RATING CHANGES Significant rating actions taken the week ending 25 October 2013

37 MOODY’S CREDIT OUTLOOK 28 OCTOBER 2013

Jebel Ali Free Zone FZE Upgrade

13 Jun ‘13 24 Oct ‘13

Corporate Family Rating Ba3 Ba2

Standalone Financial Strength/ Baseline Credit Assessment

E+/b1 D/ba2

The upgrade reflects JAFZ's strengthened standalone profile as a result of the marked improvement in the company's financial metrics, and its strong competitive advantages over Dubai-based peers, including being situated next to the busy Jebel Ali Port and being able to attract companies through various incentives such as sponsoring foreign workers.

LGT Bank Downgrade

2 Jul ‘12 24 Oct ‘13

Long-term Issuer Rating Aa3 A1

Debt and Deposit Ratings Aa3 A1

Standalone Financial Strength/ Baseline Credit Assessment

B-/a1 C+/a2

The downgrade reflects a combination of bank-specific as well as external factors including our assessment of the continued pressures on LGT Bank's recurring profitability in a difficult operating environment for private bank franchises in Switzerland and Liechtenstein, and LGT Bank's earnings being partly dependent on capital-market developments which, in an adverse environment, may put significant pressure on earnings and, potentially, capital.

RATING CHANGES Significant rating actions taken the week ending 25 October 2013

38 MOODY’S CREDIT OUTLOOK 28 OCTOBER 2013

Sub-sovereigns

Comision Estatal de Servicios Publicos de Tijuana Mexico Downgrade

15 Jun ‘12 22 Oct ‘13

Issuer rating Ba1/A1.mx Ba2/A2.mx

Outlook Negative Negative

The downgrade was prompted by the recent downgrade of the State of Baja California's issuer ratings to Baa2/Aa2.mx from Baa1/Aa1.mx, reflecting CESPT's ties with the state and the latter's role in the decisions of the company's management. The action also incorporates CESPT's persistently high debt levels and the ongoing deterioration of the company's operating margins.

Municipality of Mexicali (Mexico) Downgrade

15 Jan ‘13 24 Oct ‘13

Issuer rating B1/Baa2.mx B3/Ba2.mx

Outlook Negative Negative

The rapid deterioration in the municipality's operating and liquidity metrics and the increase in its debt levels prompted the downgrade. Because of operating margin deterioration, the municipality has posted recurrent cash financing requirements. These reached a maximum of -14.8% of total revenues in 2012. We anticipate this trend continuing.

RATING CHANGES Significant rating actions taken the week ending 25 October 2013

39 MOODY’S CREDIT OUTLOOK 28 OCTOBER 2013

US Public Finance

Orlando Health Inc., FL Downgrade

30 Jul ‘13 22 Oct ‘13

Issuer A2 A3

Outlook Stable Negative

The downgrade is due to Orlando Health's material downturn in financial performance through nine months of fiscal year 2013, decline in combined same-store inpatient admissions and observation stays, loss of market share, and declines in liquidity. The negative outlook reflects additional challenges faced by Orlando Health that distract the organization as it attempts to implement its performance improvement plan. These include the lack of a permanent chief executive officer and strained labor relations that has resulted in some union activity on its hospital campus. In addition, the system is in the middle of a large construction project.

Iowa Health System Outlook Change

2 Jul ‘13 24 Oct ‘13

Issuer Aa3 Aa3

Outlook Stable Negative

The negative rating outlook captures our concerns with expansion of the system through completed or proposed control over hospitals and systems with weaker operating profiles, and the increase demand on management to successfully integrate these systems into IHS.

Structured Finance

Santander Subprime Auto Loan ABS On 22 October we took a variety of rating actions on tranches in 2011 and 2012 vintage securitizations sponsored by Santander Consumer USA (SCUSA), affecting approximately $5.7 billion of asset-backed securities. The upgrade and reviews of the 2012 transactions reflect stronger-than-expected performance of the underlying collateral pools and the resulting reduction in lifetime loss expectations. Santander’s repurchases of early period defaulted loans contributed to the stronger performance by lowering cumulative net loss levels in the securitized pools. The upgrades of the ratings in both vintages reflect the build-up of credit enhancement, attributable to the sequential pay structure and non-declining reserve account.

RESEARCH HIGHLIGHTS Notable research published the week ending 25 October 2013

40 MOODY’S CREDIT OUTLOOK 28 OCTOBER 2013

Corporates

Tata Steel, Large Indian Steel Companies Reap Benefits of Capacity Additions Despite Lackluster Demand

The Joint Plant Committee, a section of India’s steel ministry that tracks Indian steel market developments, has recently published its latest statistics on consumption and production. It appears that, despite the lukewarm economic environment and slowing Indian steel consumption, India’s largest steel producers are churning out steel at record level. This credit-positive event will help boost their profitability. Tata Steel’s reliance on its Indian operations to support its credit metrics is expected to grow, as losses at its European assets continue to mount.

Chinese Government Will Take More Steps to Spur Development of Dim Sum Bond Market

We expect that the Chinese central government will move in the coming weeks or months to develop the dim sum bond market further by allowing a more diverse group of companies to issue these bonds. We believe some of the companies will be based in China and owned by regional and local governments. The central government will likely allow these state-owned entities to tap the dim sum market directly, without going through the usual regulatory approval process for offshore US dollar bond issuance.

US Healthcare: Proposed Medicare Rate Cuts Would Pressure Dialysis Providers

Implementing a proposed 11.9% cut in Medicare reimbursement rates on 1 January 2014 would have a draconian impact on dialysis providers and could lead to rating downgrades. The new rates are meant to address changes in utilization trends for end-stage renal disease drugs, and the Center for Medicare & Medicaid Services is expected to finalize them around 1 November. In this report, we look at the effect of implementing the rates in January and of phasing them in over three years, as well as the impact of a 9% cut phased in over two years.

US For-Profit Hospitals: The Drive For Size

We expect acquisitions, joint ventures and other strategic alignments to continue as for-profit-hospitals seek to offset anticipated declines in reimbursement under the Affordable Care Act. Payment models that focus on outcomes rather than the number of procedures performed will reduce reimbursement, so hospitals will need to leverage administrative costs, purchasing power and investments in infrastructure.

North American Capital Goods: Growth to Accelerate Modestly on Agricultural Demand, Gradual Construction Recovery

We are maintaining a stable outlook for the North American capital goods industry based on our expectations for a modest acceleration in EBITA and investment growth. Demand will remain strong for agricultural equipment and should soon begin to recover in the construction market, offsetting further weak demand for mining equipment.

RESEARCH HIGHLIGHTS Notable research published the week ending 25 October 2013

41 MOODY’S CREDIT OUTLOOK 28 OCTOBER 2013

European Building Materials: Windfall Profits from Europe's CO2 Trading Scheme Crumble for European Cement Producers

The third phase of the European Emissions Trading System began in 2013. The cap-and-trade system, which allocates allowances for carbon dioxide emitting plants, proved to be an effortless and stable source of windfall profits for cement producers, as they sold allowances. But while we do not expect the system to become a cost burden, the period of significant windfall profits seems to be over.

Ineos' Closure of Grangemouth Site Would Not Reverse Negative Trend in European Ethylene Sector On 23 October, Ineos AG has announced its intention to close its petrochemicals site at Grangemouth, Scotland, which is one of Europe's largest ethylene cracker facilities. But while the closure of the Grangemouth cracker will be significant for the industry, we do not expect it will be enough to recover sector-wide utilization rates, which have been languishing in the low 80s percentage range. This is a sustained negative credit trend for the European ethylene industry, and we do not think it will reverse anytime soon.

Beijing's Housing Market Controls Are Credit Negative for Developers with Material Beijing Operations

The Beijing Municipal Commission of Housing and Urban-Rural Development issued policy guidelines on 22 October aimed at increasing the supply and controlling housing prices in the city. The latest efforts by the government to ease the growth in property prices is credit negative for developers with material operations in Beijing because the controls will pressure sales volumes and prices.

RESEARCH HIGHLIGHTS Notable research published the week ending 25 October 2013

42 MOODY’S CREDIT OUTLOOK 28 OCTOBER 2013

Financial Institutions

Cross-Sector Rating Methodology - Financial Statement Adjustments in the Analysis of Financial Institutions Our request for comment seeks feedback on our proposed changes to our approach to performing analytical adjustments to the financial statements of financial institutions. These changes include standardizing adjustments to the financial statements of insurance companies for hybrid securities, defined benefit pension plans, non-controlling interest of minority shareholders, operating leases and operating debt.

Thailand Banking System Outlook The outlook for Thailand’s banking system remains stable, as it has been since 2010. Economic growth has been slowing moderately, while banks face risks from household indebtedness, which has increased to 79% of GDP as of June from 64% in first- quarter 2011, and rising property prices. However, Thai banks are well positioned to withstand potential asset-quality challenges due to their strong capitalization and increasing provisioning coverage.

German Life Insurance Industry Faces Losses If Interest Rates Stay Low The German life insurance industry stands out among life markets globally for its heavy exposure to low interest rates. With interest rates having fallen to the lowest levels in a generation, we estimate that the industry would ultimately face losses in a scenario where interest rates remained at their current level. Despite a recent increase in interest rates, we continue to factor this “low-for-long” tail-risk scenario into our financial strength assessments of German life insurers.

Insurance Brokerage Industry Scorecard The global insurance brokerage industry remains healthy based on its valuable service offering and steady cash flow supported by a largely variable cost structure. The industry also benefits from modest capital requirements and low balance sheet risk. Challenges for the industry include potential liabilities arising from errors and omissions, high financial leverage among private brokers, and integration risk related to acquisitions.

RESEARCH HIGHLIGHTS Notable research published the week ending 25 October 2013

43 MOODY’S CREDIT OUTLOOK 28 OCTOBER 2013

Sovereigns

Government of Taiwan Analysis Taiwan’s Aa3 stable rating is underpinned by its dynamic and competitive economy. Taiwan’s track record of macroeconomic stability and its strong institutional framework – as reflected by the very cautious monetary policy and sound governance indicators – represent additional credit strengths. Moreover, Taiwan’s very strong external financing position and high domestic savings rate ensure high debt affordability and stability in refinancing, underpinning Taiwan’s fiscal strength.

Government of Indonesia Analysis Indonesia’s Baa3 stable rating is supported by healthy economic prospects, structurally narrow fiscal deficits, and low public indebtedness. The country’s very large scale and ample natural resource endowment also buttress the rating, although GDP per capita is still low for an investment grade country. Credit challenges include a relatively shallow and volatile domestic capital market, which contributes to Indonesia’s reliance on external funding.

Eurasian Development Bank The Eurasian Development Bank’s A3 reflects the strength of the bank’s capitalisation, as well as the likelihood of financial support from its shareholders, given its importance as a vehicle for regional development and integration. The EDB had no non-performing loans in its loan portfolio at the end of 2012. However, we expect that regional economic trends, a maturing loan portfolio and the expansion of the bank’s activities in lower-rated member countries could lead to some weakening in asset quality over the next few years.

Government of Malta Analysis Overall, Malta’s credit profile balances the government’s relatively high debt levels with its ability to easily access ample domestic resources to finance its deficits. We expect Malta’s debt metrics will stabilize in 2014 given the country’s economic recovery and the newly elected government's commitment to fiscal consolidation, one reason we changed the outlook on Malta’s A3 government bond rating to stable from negative on 4 October.

RESEARCH HIGHLIGHTS Notable research published the week ending 25 October 2013

44 MOODY’S CREDIT OUTLOOK 28 OCTOBER 2013

US Public Finance

Health Insurance Expansion Will Not Be a Windfall for California Counties California counties will not garner much savings from healthcare insurance expansion under the Affordable Care Act, even though the expansion will lessen their burden of providing healthcare to the uninsured. Though California counties will reap gross savings from Medi-Cal expansion, the state will in turn offset much of these savings by reducing other funding to the counties.

Key Credit Drivers of New York Local Governments Strong local fiscal management and state oversight continue to support the credit quality of the New York local governments as they generally handle negative credit pressures such as tax caps and the sluggish economy. Overall, we expect the credit ratings of the New York local governments to remain resilient, although rating downgrades in the coming year are likely to exceed rating upgrades.

California and Ontario Peer Comparison California (A1 stable) and Ontario (Aa2 stable) each boast the largest economy among sub-sovereigns in their respective countries, but each has a rating that is relatively low among peers. California’s legal and political environment creates obstacles to timely budget management and revenue raising, which restricts its freedom of action relative to other US states and some sub-sovereigns, including Ontario. Ontario is heavily leveraged, standing apart from other Canadian provinces and most sub-sovereign peers and US states, including California.

Structured Finance

Moody's ABS Spotlight In this edition, we examine the impact on FFELP student loan obligations if Congress does not raise the federal debt limit in February, analyze the narrowing difference in used auto resale values between domestic and Japanese manufacturers, detail the implications of an anti-assignment court ruling on structured settlements and discuss Hertz’s entrance into the fleet lease ABS market.

A Short Guide to EMEA SME Balance Sheet Securitisations An EMEA SME balance sheet securitisation is a bond backed by a pool of secured and unsecured loans granted to SMEs domiciled in the EMEA region. The EU categorises an obligor as an SME if its headcount is lower than 250, and its turnover, between €1million and €50 million. However, microenterprises (that is, those with a turnover below €1 million) and large corporates (with a turnover above €50 million, although typically to a very limited extent) can also be part of EMEA SME balance sheet securitisations.

Project Finance CDO Methodology We published a new rating methodology outlining our approach to rating collateralized debt obligations backed by project finance and infrastructure assets (PF CDOs). Changes to the methodology are limited to the update and additional standardization of correlation and recovery assumptions. Based on preliminary analysis, we expect the rating impact on existing transactions to be limited to two notches.

RECENTLY IN CREDIT OUTLOOK Select any article below to go to last Thursday’s Credit Outlook on moodys.com

45 MOODY’S CREDIT OUTLOOK 28 OCTOBER 2013

NEWS & ANALYSIS Corporates 2

» Occidental’s Asset Sales and Probable Use of Proceeds Are Credit Negative

» Devon and Crosstex’s Plan to Form New Midstream Company Is Credit Positive for Crosstex

» Carlisle Companies’ Planned Sale of Transportation Unit Is Credit Positive

» Changes to Mexico’s Fiscal Reform Bill Are Credit Positive for Homebuilders

» Rosneft and CNPC’s Joint Venture Is Credit Positive for Both Companies

» Privatization of Glorious Property Would Be Credit Negative » Softbank’s Acquisition of Brightstar and Supercell Heighten

Operational Risks

Infrastructure 9

» TransAlta’s Purchase of FPL Energy National Wind Portfolio Is Credit Positive

Banks 10 » Europe’s Disclosure Requirements for Nonperforming and

Forborne Loans Improve Bank Asset Transparency

Insurers 12 » Mexican Lower House Approval of Fiscal Reform Bill Is Credit

Positive for Insurers » New Capital Adequacy Criteria Is Credit Positive for Dutch

Life Insurers

CREDIT IN DEPTH Italian Banks 16

Our outlook for Italy’s banking system remains negative, unchanged since May 2009, when we first assigned a negative outlook. The outlook reflects Italy’s persistently fragile economic environment, problem loans that continue to increase from already high levels and weak core profits. These drivers offset some positive developments over the past year, such as banks further strengthening their solvency profiles, improved access to funding and increased liquid assets.

MOODYS.COM

Report: 159675

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EDITORS PRODUCTION ASSOCIATE News & Analysis: Jay Sherman, Elisa Herr and Neil Buckton

David Dombrovskis

Ratings & Research: Robert Cox Final Production: Barry Hing