MOODYS.COM

7 JULY 2014

NEWS & ANALYSIS Corporates 2

» China’s Home-Grown IT Approach Is Credit Negative for US Technology Firms

» Kinetic Concepts’ Settlement with Wake Forest Is Credit Negative

» Devon Energy Sale of Natural Gas Assets to Linn Energy Is Credit Positive

» Ardagh’s Sale of Six Former Anchor Glass Plants Is Credit Positive

» Wienerberger’s Acquisition of Tondach Group Is Credit Positive

» KT’s Plan to Sell KT Rental and KT Capital Is Credit Positive

Infrastructure 10

» Vectren’s Agreement to Sell Mining Subsidiary Is Credit Positive for Its Utilities

Banks 11

» Norway’s Stricter Requirements on Capital Models Are Credit Positive for Banks and Covered Bonds Issuers

» Lithuanian Central Bank Proposals to Strengthen Credit Unions Are Credit Positive

» China’s Revision to Regulatory Liquidity Ratio Is Credit Negative for Domestic Banks

Insurers 16 » Puerto Rico’s New Debt Law Is Credit Negative for Financial

Guarantors

» US Treasury Rules on Longevity Annuities Are Credit Positive for Life Insurers

» Old Republic’s Corrective Plan for Mortgage Insurers Gains Regulatory Approval, a Credit Positive

» Norwegian Rules to Convert Guaranteed Paid-Up Policies Are Credit Positive for Life Insurers

Funds 23 » California Plan to Increase CalSTRS’ Contribution Rates Is

Credit Positive

Sovereigns 24 » Brazil’s Slowing Growth and Increasing Inflation Are Credit

Negative

» Egypt’s Commitment to Reducing Its Fiscal Deficit Is Credit Positive

US Public Finance 28 » New York State to Benefit from BNP Paribas Settlement

RATINGS & RESEARCH Rating Changes 30

Last week we downgraded Leidos Holdings, AES Puerto Rico, Banco Mercantil do Brasil, Cassa di Risp.di Bolzano-Sudtiroler Sparkasse, GCB Bank, NCG Banco, Municipality of Nogales (Mexico) and Puerto Rico, and upgraded Delta Air Lines, Forest Laboratories, Banco de Credito del Peru, Scotiabank Peru, Banco Internacional del Peru, Corporacion Financiera de Desarrollo, Peru and 10 Hyundai US auto ABS tranches, among other rating actions.

Research Highlights 39

Last week we published on global consumer products, US gaming, US oil and gas, Atlantic City casinos, US online retail, Indian oil companies, Australian public-private partnerships, Australian mining, US technology, European Union energy policy, Sri Lankan banks, Indonesian banks, Japanese insurers, Kuwaiti banks, Malaysian Islamic banks, aircraft leasing, US commercial auto insurers, US workers’ compensation, Latin American sovereigns, Mexican states, French local governments, the US Highway Trust Fund, US local governments, US public universities, US public pensions and US sewer utilities, among other reports.

RECENTLY IN CREDIT OUTLOOK

» Articles in Last Thursday’s Credit Outlook 45 » 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 7 JULY 2014

Corporates

China’s Home-Grown IT Approach Is Credit Negative for US Technology Firms Recent US technology company earnings calls suggest the Chinese government is encouraging Chinese companies to use domestic IT equipment suppliers whenever possible to aid in developing the capabilities of Chinese technology companies, reducing procurement and maintenance costs and ensuring the security of the country’s information technology infrastructure. Although the effect on US technology companies has been mixed so far, China’s move to cut back on foreign suppliers and buy locally will be credit negative for companies such as International Business Machines Corporation (IBM, Aa3 stable), Cisco Systems, Inc. (A1 stable), and potentially EMC Corporation (A1 stable) and Hewlett-Packard Company (HP, Baa1 negative), particularly because we expect China’s IT spending to outpace that of most major mature markets over the next several years (see Exhibit 1).

EXHIBIT 1

Chinese IT Spending Is Growing at a Faster Pace than GDP

2008 2009 2010 2011 2012 2013 2014

Projected

China IT Spending $69 billion $78 billion $95 billion $111 billion $124 billion $144 billion $167 billion

Annual Growth 13% 22% 18% 12% 16% 16%

China GDP $4.698 trillion

$5.077 trillion

$5.603 trillion

$6.123 trillion

$6.597 trillion

$7.104 trillion

$7.651 trillion

Annual Growth 8% 10% 9% 8% 8% 8%

Ratio of IT Spending Growth to GDP Growth

1.6 2.1 1.9 1.5 2.0 2.1

Sources: Statista, National Bureau of Statistics of the People’s Republic of China and Moody’s Investor Service forecast

Although some major US technology companies have seen China-based revenue fall over the past year (see Exhibits 2 and 3), others have experienced growth. Economic reforms and the slight slowdown in Chinese economic growth are contributing factors, but a less quantifiable, although perhaps more important, secular factor is rooted in the June 2013 revelations that the US National Security Agency (NSA) had been running surveillance programs across the globe. However, not all US manufacturers of mission-critical, information technology systems are feeling the same effect.

EXHIBIT 2

IBM and Cisco Have Reported Sharp Declines in Quarterly Year-over-Year Chinese Revenue Growth

Company Q1

2013 Q2

2013 Q3

2013 Q4

2013 Q1

2014

IBM Decline Decline -22% -23% -20%

Cisco 8% -6% -18% -8% -8%

Source: Company reports

Richard J. Lane Senior Vice President +1.212.553.7863 richard.lane@moodys.com

For research publications that reference Credit Ratings, please see the ratings tab on the issuer/entity page on www.moodys.com for the most updated Credit Rating Action information and rating history.

NEWS & ANALYSIS Credit implications of current events

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EXHIBIT 3

IBM’s and Cisco’s China Revenue Will Continue to Decline in 2014 Company 2013 2014 Projected

IBM $3.9 billion $3.1 billion

Cisco $2.0 billion $1.9 billion

Total $5.9 billion $5.0 billion

Annual Growth

IBM -21%

Cisco -5%

Total -15%

Percent of Total Revenue

IBM 3.9% 3.1%

Cisco 4.2% 3.9%

Sources: Company reports and Moody’s Investors Service estimates

In early 2013, IBM noted that a new leadership team in China had announced significant structural changes to China’s development of a broad-based economic reform plan. Many of those changes will affect China’s state-owned enterprises, which are some of IBM’s largest accounts. As a result, demand from state-owned enterprises and the public sector slowed significantly, as decision-making and procurement cycles lengthened. IBM further noted that the changes will take time to implement and that it does not expect demand in China to pick up until later this year.

Cisco has made similar comments, and in April 2013 noted (before the allegations of NSA snooping) that challenges in China will last for “several more quarters.” In its most recent quarter, Cisco projected that challenges throughout emerging markets would continue.

Although China certainly poses a headwind for both IBM and Cisco, both companies have diversified global operations. Neither company discloses China-specific revenue, but we estimate that both companies will generate less than 4% of total revenue from China in 2014 (see Exhibit 3), thereby limiting the pain felt by decisions to either delay or in-source IT purchasing. China constitutes about 7% of worldwide IT spending, indicating that IBM and Cisco are already underweight China.

But not all US companies have experienced declines in China (see Exhibit 4). Although EMC does not break out Chinese revenue, the company has noted solid growth in China over the past several quarters, including the most recent quarter, where EMC management noted that “China was actually our strongest market.”

NEWS & ANALYSIS Credit implications of current events

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EXHIBIT 4

EMC Sees Continuing Growth in China, while Hewlett-Packard Is More Mixed Our assessment of quarterly China revenue based on company earnings conference calls

Company Q1 2013

Q2 2013

Q3 2013

Q4 2013

Q1 2014

EMC Growth Growth Growth Growth Growth

Hewlett-Packard Slowing Weaker Weaker Flat Growth

Sources: Company reports and Moody’s Investors Service estimates

Similarly, HP does not disclose China-based revenue but noted that its business in China grew in the most recent quarter. Although it has acknowledged it is facing more challenging economic conditions in China, HP has also cited its relative strength in China, driven primarily by its networking and printing businesses. Given the highly sensitive nature of storage and networking to the security of an overall IT infrastructure, EMC’s and HP’s results stand in contrast to concerns about China in-sourcing more of its IT spending.

Although the revenue outlook in China over the next year may dim for some US infrastructure-oriented technology firms, others may not see their growth opportunities shrink in the broad and growing Chinese IT market.

This is an update of an article published 2 July 2014.

NEWS & ANALYSIS Credit implications of current events

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Kinetic Concept’s Settlement with Wake Forest Is Credit Negative Last Tuesday, Kinetic Concepts (B2 negative) said it was settling its long-running patent disputes with Wake Forest University Health Sciences for $280 million, to be paid in installments over the next three years. The settlement is credit negative because the substantial payments will constrain Kinetic Concepts’ ability to reduce leverage and invest in its businesses over the next several years.

Kinetic Concepts generates about $50-$100 million of free cash flow per year. The settlement payments will consume most of the company’s free cash flow over the next three years, which will reduce its ability to repay debt (currently almost $5 billion of debt outstanding) and to make investments and acquisitions to fuel growth. Kinetic Concepts’ ability to do this is already somewhat limited, given that its adjusted debt/EBITDA is approximately 7.0x.

Although the overall settlement is substantial for Kinetic Concepts, the litigation resolution will reduce its legal expense, which has been significant over the past several years. Further, settling the litigation (rather than going to trial) allows the company to structure its payments over multiple years, thereby preserving liquidity. The first payment will be made this month for $80 million, followed by an $85 million payment in June 2015, an $85 million payment in June 2016 and a $30 million payment in June 2017.

We expect that liquidity, although weakened by the payments, will remain strong over the next 12 months. Liquidity is supported by cash of approximately $265 million as of 31 March, and revolver availability of approximately $180 million. Excluding the settlement payments, we expect that Kinetic Concepts will generate positive free cash flow over any 12-month period. The company currently has a cushion of about 20% under its maximum total leverage covenant, which steps down each quarter going forward. If the company is not able to return to EBITDA growth, its covenant cushion would shrink substantially by mid-2016. Kinetic Concepts will reach its first debt maturity in November 2016, when its $318 million Term E-2 credit facility comes due. Its $200 million revolver also expires in November 2016.

Despite the credit-negative settlement, fundamental trends in the company’s key businesses, particularly Advanced Wound Therapeutics, will be the main drivers of Kinetic Concepts’ credit quality. Recent pricing pressure and a significant cut to Medicare reimbursements in the advanced wound business, which generates about 75% of the company’s total revenue, have contributed to lower year-over-year EBITDA trends for Kinetic Concepts. But the company may be able to return to EBITDA growth because the Medicare payment rate will be stable over the next year and the company’s newer product launches will continue to gain traction. Also, in June, Kinetic Concepts’ main competitor in the US, Smith & Nephew (unrated), temporarily ceased distribution of its negative pressure wound therapy product, providing Kinetic Concepts with the opportunity to gain market share.

Jessica Gladstone, CFA Vice President - Senior Credit Officer +1.212.553.2988 jessica.gladstone@moodys.com

NEWS & ANALYSIS Credit implications of current events

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Devon Energy Sale of Natural Gas Assets to Linn Energy Is Credit Positive Last Monday, Devon Energy Corporation (Baa1 stable) and Linn Energy, LLC (Ba3 stable) announced that Linn would pay $2.3 billion to buy certain of Devon’s non-core natural gas assets in five US areas. For Devon, the asset sale is credit positive because the company will use all the proceeds to pay down elevated debt balances. The transaction completes its North American non-core divestiture program.

For Linn the asset purchase is credit neutral. Although the acquired assets have a low production decline rate and capital intensity that will enhance its property portfolio, the company will need to execute on its proposed asset sales plan to offset the transaction’s effect on leverage.

The US assets comprise roughly 900,000 net acres in the Rockies, Mid-Continent and onshore Gulf Coast that produce 275 million cubic feet of natural gas equivalent per day. The companies estimate that the total proven reserves of the assets is 1.2-1.5 trillion cubic feet of natural gas equivalent. The companies expect the transaction to close in the third quarter of 2014.

Devon’s North American non-core asset divestiture program has been a success, with sale prices at the high end of estimates, mainly owing to the strategic value of the operations to the final buyers. The US asset sale follows Devon’s sale of Canadian conventional assets to Canadian Natural Resources Limited (Baa1 stable) in April for CAD3.125 billion. Devon will receive $4.5 billion in after-tax proceeds from the two asset sales, all of which it will use to pay down debt from its $6 billion acquisition of Eagle Ford Shale properties from GeoSouthern (unrated) in February.

The loss of production and proved developed reserves from its asset sales program will not change Devon’s financial leverage metrics materially in terms of debt/production and debt/proved developed reserves. However, we believe management is taking positive fundamental steps in high-grading the company’s asset base, as evidenced by its divestiture of non-core, lower margin assets. These divestitures should strengthen margins and returns, and improve cash flow coverage of debt. We project that projected retained cash flow/debt will reach close to 50% at the end of this year, compared with 35% for the 12 months ended 31 March 2014.

Linn plans to cover the purchase price with $2.3 billion of committed interim financing and eventually pay that off with proceeds from the sale of its own assets in the Granite Wash and Cleveland plays in the Texas Panhandle and western Oklahoma. These assets currently produce 230 million cubic feet per day, or about 39,000 barrels of oil equivalent (boe) per day, of liquids-rich natural gas.

Our expectation is that Linn, a master limited partnership based in Houston, Texas, will execute its planned asset sales to fund the acquisition, reversing an increase in leverage metrics while extending the reserve life of the overall property portfolio and reducing the rate of production decline. Pro forma for the close of the Devon assets acquisition and the sale of Linn’s proposed Mid-Continent assets by year-end 2014, we project Linn to exit 2014 with average daily production volumes approaching 190,000 boe and debt/production of $50,000-$55,000/boe and debt/proved developed reserves of $10.00-$12.00/boe.

Following its December 2013 acquisition of Berry Petroleum and its May Permian asset swap with Exxon Mobil Corporation (Aaa stable), Linn’s agreement with Devon underscores its effort to develop mature, long-lived assets while reducing their overall decline rate and extending reserve life.

Gretchen French Vice President - Senior Credit Officer +1.212.553.3798 gretchen.french@moodys.com

Michael Somogyi Vice President - Senior Analyst +1.212.553.0107 michael.somogyi@moodys.com

NEWS & ANALYSIS Credit implications of current events

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Ardagh’s Sale of Six Former Anchor Glass Plants Is Credit Positive On Monday, Ardagh Packaging Group Ltd. (B3 stable) announced that it had completed its disposal of six former Anchor Glass plants in the US to Glass Container LLC (unrated), an affiliate of KPS Capital Partners LP. The disposal is credit positive for Ardagh because together with related payments and other adjustments it will generate total proceeds of around $490 million (€360 million), which, after costs, the company will apply to the prepayment of debt as part of a partial debt refinancing totalling $3.1 billion. The refinancing and reduction of total gross debt will reduce leverage and the group’s interest expenses.

The debt repayment, in combination with pro forma synergies from the acquisition of Veralia North America (VNA) from Compagnie de Saint-Gobain SA (Baa2 stable), will result in a 0.3x decrease in reported gross leverage to 6.5x from 6.8x and lower our forecasted leverage to 7.0x from 7.4x for 2014. The debt refinancing extends the company’s debt maturity profile with the earliest repayment now occurring in 2019, versus 2017. In addition, the lower coupon resulting from the refinancing will save the company around €50 million per year in interest costs, which is in addition to the reduction in interest from applying the Anchor disposal proceeds, which equals approximately €25 million annually. After taking early repayment penalties into account, the payback period for the company will be close to 1.3 years.

The US Federal Trade Commission had required that Ardagh dispose of the Anchor Glass manufacturing facilities in order to obtain the regulator’s approval of Ardagh’s acquisition of VNA. Upon completion of its integration of VNA, Ardagh estimates it will generate synergies totalling $75 million over three years.

Following the acquisition of VNA and the divestment of the Anchor Glass plants, Ardagh’s North America glass division will generate annual revenues of approximately $2 billion from 16 glass manufacturing facilities. We estimate that the group controls approximately 40% of the US glass container manufacturing market.

Strategically, the combination of the debt refinancing, the disposal of the six Anchor Glass plants and the acquisition of VNA enhances Ardagh’s ability to complete a planned initial public offering (IPO) in the US in the second half of 2015. Because it is unclear when Ardagh would price the IPO, how much it would raise and how the company would use the proceeds, we have not yet factored any positive benefits from the IPO into our rating assessment.

Ardagh manufactures glass and metal packaging for the European and US food and beverage markets, and its customers include most of the world’s leading food, beverage and consumer care brands. Ardagh operates 94 production facilities in 23 countries. Pro forma for the VNA acquisition and the Anchor Glass divestments, the company generated sales of about €4.80 billion in 2013.

Martin Chamberlain Vice President - Senior Analyst +44.20.7772.5213 martin.chamberlain@moodys.com

Simon West Associate Analyst +44.20.7772.5479 simon.west@moodys.com

NEWS & ANALYSIS Credit implications of current events

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Wienerberger’s Acquisition of Tondach Group Is Credit Positive Last Tuesday, Wienerberger AG (Ba3 negative) announced that it had acquired Tondach Gleinstätten Group, an entity that was previously held as a joint venture, for approximately €170 million (7.3x EBITDA). The transaction, which is subject to customary closing conditions, is credit positive for Wienerberger because it improves its regional and product diversity and allows for full consolidation of Tondach, which will lead to a decrease of the group’s leverage ratio. The group’s pro forma net debt/EBITDA for the 12 months ended 31 March was 4.6x versus 4.7x, excluding the transaction.

Wienerberger will initially increase its interest in Tondach to 82% and the financing banks, which agreed to swap €26 million of debt into equity-like instruments, will own the remaining 18%. Wienerberger holds a call option on the equity-like instruments, which it can exercise in 2017 and 2018 to take over the remaining minority stake. Assuming the company realizes our projected deleveraging trajectory, exercising the call options will not adversely affect Wienerberger’s leverage metrics.

Tondach is a leading manufacturer of clay roof tiles, with a market focus in central and eastern Europe, particularly Austria, Czech Republic, Serbia, Hungary and Croatia. It generated revenues of €154 million and EBITDA of €19.5 million in 2013, but the company has undergone a significant restructuring program since 2012 amid adverse market conditions in its key markets. Tondach will complement Wienerberger because it adds regional and product diversification. In contrast to Wienerberger’s bricks business, which is very closely linked to the number of new housing starts, roofing products significantly benefit from renovation activities, which are less cyclical. We also foresee a recovery in Tondach’s key markets, which will contribute positively to Wienerberger’s earnings.

Wienerberger is currently weakly positioned in its rating category, with adjusted debt/EBITDA of 5.7x as of the 12 months that ended March 2014, compared with 7.0x a year earlier. We expect a further deleveraging to 5.0x by the end of the year. Wienerberger has a track record of buying out joint ventures, most recently PipeLife in 2012, a producer of plastic pipes used for water and sewage, agriculture, gas and electricity distribution, which is a clear source of diversification in the cyclical building materials market.

Falk Frey Senior Vice President +49.69.70730.712 falk.frey@moodys.com

Christoph Schneider Associate Analyst +49.69.70730.752 christoph.schneider@moodys.com

NEWS & ANALYSIS Credit implications of current events

9 MOODY’S CREDIT OUTLOOK 7 JULY 2014

KT’s Plan to Sell KT Rental and KT Capital Is Credit Positive On 27 June, KT Corporation (Baa1 stable) said it would sell two of its consolidated financial subsidiaries, KT Rental (unrated) and KT Capital Co. Ltd. (unrated), to focus on its core telecommunications businesses. The sales would be credit positive because they would strengthen KT’s overall financial profile.

The transactions should help KT improve its leverage. As of March 2014, the combined book value of KT Rental and KT Capital was KRW374 billion ($374 million). If, for example, KT were to sell the two subsidiaries for a combined total of KRW500 billion ($500 million) and use all the cash proceeds to reduce debt, its adjusted debt/EBITDA, excluding its financial subsidiaries, would decline to approximately 2.1x in 2014 from 2.5x in 2013.

Before last week’s announcement, we had expected KT’s leverage to improve to 2.2x this year, owing to a reduction in labor costs from the implementation of its early retirement program and a reduction in capex and dividends, which will lower its debt level. KT’s financial profile has weakened over the past several years amid competition in the mobile phone business and a high level of capex to expand the company’s 4G network infrastructure. KT’s adjusted debt/EBITDA, excluding its financial subsidiaries, was 1.8x in 2010.

The planned sale of KT Rental and KT Capital also eliminates the risk that KT would need to provide financial support to the subsidiaries if they run into trouble. Although the combined revenue from KT Capital and KT Rental is small at less than 5% of KT’s consolidated revenue as of 31 March, their combined debt accounts for about 28% of KT’s consolidated debt. It is unlikely that KT would need to provide financial support to service all the subsidiaries’ debt, but we consider its potential obligations to subsidiaries when we analyze KT’s overall credit profile and these contingent liabilities weigh on KT’s credit quality.

Our analysis of KT is based on an assessment of the core and non-financial businesses, rather than the full consolidation, which includes KT Capital and KT Rental, because KT’s financial subsidiaries can raise funds on their own without any recourse to the parent. Furthermore, inclusion of the relatively highly leveraged business model of the finance subsidiaries distorts KT’s underlying telecommunications-based financial profile.

KT’s decision to sell these two major non-core financial subsidiaries and focus on the telecommunications businesses should help strengthen its fundamental business model. KT’s telecommunications service segment has recorded a significant deterioration in operating performance over the past three years, as KT focused on the expansion of its non-core businesses to the detriment of its core franchise.

KT owns 58% of KT Rental, whose main business is automobile leasing. It owns 100% of KT Capital, 83.6% directly and 16.4% indirectly through its 100% subsidiary, KT Hitel Co. Ltd. (unrated). KT Capital provides corporate lending and leasing services, which have limited business synergies with KT’s telecommunications-service businesses.

Yoshio Takahashi Assistant Vice President - Analyst +852.3758.1535 yoshio.takahashi@moodys.com

Clara Kim Associate Analyst +852.3758.1565 clara.kim@moodys.com

NEWS & ANALYSIS Credit implications of current events

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Infrastructure

Vectren’s Agreement to Sell Mining Subsidiary Is Credit Positive for Its Utilities Last Tuesday, Vectren Corporation (unrated) reached an agreement to sell its wholly owned coal mining subsidiary Vectren Fuels, Inc. to Sunrise Coal, LLC (unrated) for roughly $296 million, plus any changes in working capital. The sale is credit positive for Vectren’s intermediate subsidiary holding company, Vectren Utility Holdings, Inc. (VUHI, A2 stable) and its operating utility subsidiaries Indiana Gas Company, Inc. (IGC, A2 stable) and Southern Indiana Gas & Electric Company (SIGECO, A2 stable). By selling the money-losing coal mining subsidiary, which the company expects to complete in the third quarter of this year, Vectren reduces potential contagion risk associated with its unregulated business activities.

The company will use after-tax net proceeds of approximately $280 million to retire $200 million in bank term loans and pay down revolver borrowings at Vectren Capital, an intermediate subsidiary used to meet the financing needs of Vectren Enterprises, another intermediate subsidiary holding company that houses Vectren’s unregulated businesses. The sale of the coal mining business follows the divestiture of Vectren’s retail and wholesale gas marketing businesses in 2011 and 2013, respectively, which eliminated its exposure to commodity-related businesses and improved liquidity with lower unexpected calls on cash.

VUHI’s regulated utility earnings contribute about 80% of Vectren’s consolidated earnings and, for the foreseeable future, we expect Vectren’s remaining unregulated businesses to contribute the remainder. Vectren Enterprises’ remaining unregulated businesses, which include energy and infrastructure services such as pipeline construction, have more utility-like earnings and cash flow stability through recurring revenues from sustainable, long-term customer relationships. In addition, the unregulated businesses are tangentially related to Vectren’s core utilities with VUHI or its subsidiaries usually acting as a major customer.

Vectren does not have any explicit ring-fencing provisions in place to insulate its utility operations from the unregulated operations. Instead, Vectren utilizes an organizational structure that silos the utilities under VUHI and maintains a separate $350 million revolving credit facility that expires in September 2016. Vectren Enterprises, the unregulated operation, is generally self-financing and has borrowing capacity of $250 million, which also expires in September 2016. After the sale of the coal mining operations, we expect Vectren’s unregulated businesses to remain self-funding.

Jeffrey Cassella Assistant Vice President - Analyst +1.212.553.1665 jeffrey.cassella@moodys.com

NEWS & ANALYSIS Credit implications of current events

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Banks

Norway’s Stricter Requirements on Capital Models Are Credit Positive for Banks and Covered Bonds Issuers Last Tuesday, the Norwegian financial regulator Finanstilsynet tightened its requirements on models that financial institutions use to estimate residential mortgage risk. The new requirements seek to counteract the decline in mortgage risk weights calculated by Norwegian banks that use the internal ratings based (IRB) capital approach. The stricter requirements are credit positive for those banks and will help limit excessive house-price inflation and credit growth.

Finanstilsynet is increasing its attention on residential mortgage risk weights because of its concern that current models fail to adequately reflect risks from rising household indebtedness and house prices. In October 2013, the Norwegian Ministry of Finance increased the minimum loss-given default parameter.1 Now, Finanstilsynet has increased the probability of default parameter.

The tightening ensures that banks strengthen the robustness of their internal models before 2017, when the regulator may remove transitional floors that limit the reduction in capital from the IRB method to 80% of the Basel I capital requirement. Under IRB, Norwegian banks’ risk weights for residential mortgages average 10%-15%. Finanstilsynet estimates that the two model changes will increase risk weights assigned to residential mortgage portfolios to 20%-25%, which exceeds the European-wide median of 15%.

The tightened regulation reduces the benefit that the banks get from using the IRB approach compared with Basel I. As a result, it increases capital requirements on mortgages without the transitional floor and ensures capital retention after the removal of the transitional floors.

The largest effect of the tightened requirements will be on IRB banks that previously estimated the lowest probability of default. Entities that issue covered bonds are particularly affected by this change because they exclusively hold mortgages with loan-to-value ratios (on average 53%) that are now subject to the IRB minimum.

Banks that use the IRB approach include DNB Bank ASA (A1 negative, C-/baa1 stable2), Nordea Bank Norge ASA (Aa3 negative, C-/baa1 stable), Sparebank 1 SR-Bank ASA (A2 negative, C-/baa2 stable), Sparebanken Vest (A2 negative, C-/baa1 stable), Sparebank 1 Nord-Norge (A2 negative, C-/baa1 stable), Sparebank 1 SMN (A2 negative, C-/baa2 stable), Bank 1 Oslo Akershus AS (unrated) and Sparebanken Hedmark (A2 negative, C-/baa2 stable). To ensure that domestic banks are not placed at a competitive disadvantage in terms of capital requirements relative to branches of foreign banks operating in Norway, the new requirement will also apply to banks with Danish and Swedish parents.

Norway’s regulators have taken numerous steps in recent years to ensure financial stability and prevent an overheating of the residential lending market, including establishing guidelines for prudent mortgage lending and stricter capital requirements. This is important, given that Norway’s banks have significant

1 See Norway’s Tightened Bank Capital Regulation is Credit Positive, 21 October 2013. 2 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.

Alexander Zeidler Vice President - Senior Analyst +44.20.7772.8713 alexander.zeidler@moodys.com

Julia Dulneva Associate Analyst +44.20.7772.1954 julia.dulneva@moodys.com

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exposure to residential mortgages: residential loans, most of which are mortgages, account, on average, for around 50% of total loans.

Despite high household indebtedness, with households’ debt/income ratio at 210%, according to Statistics Norway, the low interest rates for residential mortgages and the strong Norwegian economy over the past years support household affordability and largely explain the low level of residential nonperforming loans at less than 2%, which is used to calibrate IRB capital models. However, mortgage loans in Norway typically have variable interest rates, which means the borrowers’ repayment ability will fall as interest rates rise, pressuring borrowers’ repayment ability.

NEWS & ANALYSIS Credit implications of current events

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Lithuanian Central Bank Proposals to Strengthen Credit Unions Are Credit Positive On Tuesday, the Bank of Lithuania, the country’s central bank, said it will submit several proposals to legislators to strengthen the creditworthiness of Lithuanian credit unions. These measures would be credit positive for credit unions because they would strengthen capitalization and corporate governance.

Credit unions in Lithuania have a poor track record: in 2013-14, the Lithuanian central bank declared no fewer than five credit unions as insolvent, and on an accumulative basis, credit unions in Lithuania have been profitable in only two quarters since June 2009, according to the Bank of Lithuania. These trends portend additional insolvencies in the future, and explain why the authorities have proposed these measures.

One of the proposals seeks to strengthen the quality of capital held by credit unions. On their face, credit unions are well capitalised because on an accumulative basis they reported a capital adequacy ratio (CAR) of 18.4% at year end-2013. However, we believe this ratio overstates their capital position because this capital is mainly from their members, who can, and are likely to, reduce or withdraw the capital when they repay their debt to the credit union. Indeed, at year end-2013, credit unions’ CAR would have been negative if we exclude member contributions. Against this backdrop, authorities now want credit unions to satisfy capital requirements with retained earnings, which the authorities deem as less volatile. We understand that credit unions will achieve these targets via a mandatory transfer of profits into equity, rather than paying out profits to members in the form of interest on deposits.

Another proposal involves reforms to corporate governance. We understand from the central bank that many credit unions have failed because of weak management. The central bank has said that managers of credit unions lack skills, assume unjustified risks and do not have the knowledge to put in place effective internal controls. To address these issues, the authorities are proposing best-practise guidelines to ensure that credit union managers are competent, have relevant experience and that their responsibilities are clearly defined. The proposal also aims to strengthen credit unions’ risk-management functions.

There is some uncertainty associated with these proposals because the authorities have not said exactly when they would introduce the proposals, and the exact details are not public. Nevertheless, we believe that the proposals will become law because representatives from the credit union industry and government participated in the process of developing the proposals. We also believe that the legislative process could result in additional proposals becoming law because we understand that Lithuanian authorities are considering other proposals.

Jan Skogberg Analyst +44.20.7772.1319 jan.skogberg@moodys.com

NEWS & ANALYSIS Credit implications of current events

14 MOODY’S CREDIT OUTLOOK 7 JULY 2014

China’s Revision to Regulatory Liquidity Ratio Is Credit Negative for Domestic Banks On Tuesday, the China Banking Regulatory Commission began applying a new definition of the regulatory loan-to-deposit ratio (LDR) to commercial banks. The changes, announced on 30 June, narrow the types of loans (the numerator) covered in the LDR calculation, while expanding the types of deposits, essentially lowering the reported ratio from the previous definition, a credit negative for banks.

The new definition will give banks more room to expand their lending without exceeding the 75% LDR cap that the Commercial Bank Law imposes (see Exhibit 1).

EXHIBIT 1

China Banking Regulatry Commission’s Change to Loan-to-Deposit Ratio Definition Definition Before 1 July Revisions Effective 1 July

Loans (Numerator)

Gross loans excluding: » Loans to the agricultural sector funded by

designated central bank re-lending » Loans to agriculture-related borrowers

(including farmers and entities in the agriculture sector or operated in countryside) funded by designated bonds

» Loans to micro businesses funded by designated bonds

» For rural banks, loans to micro businesses and farmers supported by funds placed by the major founding banks

Additional exclusions: » Loans funded by bonds with maturities of

more than one year and without early redemption clauses

» Loans to micro businesses funded by designated central bank re-lending

» Loans funded by supranational organizations or foreign governments

Deposits (Denominator)

Customer deposits New inclusions: » Large negotiable certificates of deposits

issued to corporations or individuals » For foreign banks, deposits (net of lending)

with tenors of more than one year from their offshore parent banks

Source: China Banking Regulatory Commission

Increased bank lending would exacerbate the country’s rising leverage and the possibility of a credit bubble. Financial leverage in China has increased significantly in recent years, with total credit to the private non-financial sector reaching 186% of nominal GDP at the end of 2013, up from 117% in 2008 (see Exhibit 2).

Christine Kuo Vice President - Senior Credit Officer +852.3758.1418 christine.kuo@moodys.com

NEWS & ANALYSIS Credit implications of current events

15 MOODY’S CREDIT OUTLOOK 7 JULY 2014

EXHIBIT 2

China’s Total Credit to Private Non-Financial Sectors/Nominal GDP Financial leverage in China has increased significantly in recent years

Sources: National Bureau of Statistics of China and Bank for International Settlements

The new definition will make it easier for some banks to manage their day-to-day liquidity and will reduce the risk of banks scrambling for funds immediately before period ends, which causes distortions and volatility in the money market. In addition, by including negotiable certificates of deposit in its deposit definition, we think banks will focus more on raising longer-term funding, thereby reducing their exposure to sudden changes in system liquidity conditions, which is credit positive. Nonetheless, we think the added risks the changes will bring to the system’s leverage trend will outweigh these liquidity benefits.

Specifically, the LDR changes will have the most effect on the following:

» Banks with existing LDRs close to the 75% threshold. Although the average LDR for Chinese commercial banks at 31 March 2014 was only 66%, there were wide variations among China’s 2,500 banking institutions. For example, Bank of Communication Co., Ltd. (A2 stable, D+/baa3 stable3) reported a 74% LDR at the end of March 2014, while Agricultural Bank of China Limited (A1 stable, D+/baa3 stable) reported a 60% LDR.

» Joint-stock banks, city commercial banks and rural commercial banks, which have a comparatively higher focus on lending to midsize, small and micro businesses than the big five commercial banks and foreign banks. This focus will gain momentum from the new rules. This is a negative for their overall asset quality performance because small business loans tend to involve higher credit risk and more economic cyclicality than larger corporate loans.

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

assessment and the corresponding rating outlooks.

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NEWS & ANALYSIS Credit implications of current events

16 MOODY’S CREDIT OUTLOOK 7 JULY 2014

Insurers Puerto Rico’s New Debt Law Is Credit Negative for Financial Guarantors On 28 June, Puerto Rico Governor Alejandro Garcia Padillo signed into law the Puerto Rico Public Corporations Debt Enforcement and Recovery Act, which creates a path for a possible distressed restructuring for certain government-related enterprises and raises questions about Puerto Rico’s credit conditions and willingness to pay its debt. This is credit negative for financial guarantors such as Assured Guaranty Ltd. (Baa2 stable), MBIA Inc. (Ba1 negative), and Radian Group, Inc. (B3 positive), all of which have substantial exposure to Puerto Rico.

The law paves the way for certain corporations, including Puerto Rico Aqueduct and Sewer Authority (PRASA, Caa1 review for downgrade), Puerto Rico Electric Power Authority (PREPA, Caa2 review for downgrade) and Puerto Rico Highway and Transportation Authority (HTA, Caa1 review for downgrade), to negotiate new debt terms with bondholders or, failing that, to seek local court approval of restructuring.4 The impetus for this legislation appears to be the high leverage and strained finances of Puerto Rico’s public corporations and the diminished ability of Puerto Rico (B2 negative) and the Government Development Bank for Puerto Rico (B3 negative) to support these companies without severely compromising their own liquidity.

The new law is most imminently applicable to PREPA, which faces significant liquidity needs with the near-term maturities of large bank borrowings. PREPA also has longer-term challenges including chronic negative free cash flow, high electricity rates and large capital investment needs. PRASA and HTA appear to have less immediate liquidity needs, although both have significant leverage and additional borrowing needs for capital investments.

The size of the insurers’ aggregate exposure to Puerto Rico varies. As the exhibit below shows, some have very large exposures. For example, the aggregate exposure to Puerto Rico credits exceeded 140% of qualified statutory capital for National Public Finance Guarantee and Assured Guaranty Re as of 31 March. Exposure to PREPA, the weakest of the enterprises directly affected by the new law, reached 46% of qualified statutory capital for National Public Finance Guarantee. Build America Mutual (unrated) and Municipal Assurance Corp. (unrated), an Assured Guaranty subsidiary, do not have any exposure to Puerto Rico, while Berkshire Hathaway Assurance Corporation (Aa1 stable) has limited exposure.

4 See Puerto Rico’s Debt Restructuring Law Raises Default Risk for Public Corporations and the Commonwealth, 3 July 2014.

Stanislas Rouyer Associate Managing Director +1.212.553.3684 stanislas.rouyer@moodys.com

NEWS & ANALYSIS Credit implications of current events

17 MOODY’S CREDIT OUTLOOK 7 JULY 2014

Financial Guarantors’ Exposure to Puerto Rico as of 31 March 2014

Group MBIA Inc. Assured Guaranty Ltd. Radian

Group Inc.

Group Senior Debt Ba1 negative

Baa2 stable B3 positive

Financial Guaranty Subsidiary National Public

Finance

Assured Guaranty Municipal

Assured Guaranty

Corp.

Assured Guaranty

Reinsurance

Radian Asset

Assurance

Insurance Financial Strength A3 negative

A2 stable A3 negative Baa1 negative

Ba1 negative

Statutory Surplus $2.2 billion $1.8 billion $678 million $1.0 billion $1.2 billion

Contingency Reserves $1.2 billion $1.9 billion $1.2 billion $0 $271 million

Qualified Statutory Capital $3.3 billion $3.6 billion $1.9 billion $1.0 billion $1.5 billion

Net Puerto Rico Exposure $4.8 billion $2.4 billion $1.5 billion $1.5 billion $452 million

Including Public Corporations:

- PRASA $0 $0 $288 million $96 million $19 million

- PREPA $1.5 billion $480 million $81 million $291 million $22 million

- PRHTA $1.0 billion $532 million $428 million $294 million $172 million

$2.5 billion $1.0 billion $797 million $681 million $213 million

Net Puerto Rico Exposure as a Percent of Qualified Statutory Capital

145% 66% 81% 147% 31%

PREPA as a Percent of Qualified Statutory Capital

46% 13% 4% 28% 2%

Sources: The companies and Moody’s Investors Service

We view the probability of a Puerto Rico default as substantially more likely than we did several months ago, although it remains unclear what the potential loss severity among the various Puerto Rico related issuers would be if a default (or defaults) were to occur.

The increase risk of a Puerto Rican default comes while guarantors’ new business has been constrained by low interest rates, which keeps uninsured debt costs low, and some level of investor skepticism about the value proposition provided by financial guaranty insurance. Given the size of guarantors’ exposure, we believe that further deterioration in Puerto Rico’s credit profile would only increase investors’ concerns.

NEWS & ANALYSIS Credit implications of current events

18 MOODY’S CREDIT OUTLOOK 7 JULY 2014

US Treasury Rules on Longevity Annuities Are Credit Positive for Life Insurers On Tuesday, the US Treasury announced final rules aimed at combating longevity risk (i.e., outliving one’s income) and providing flexibility in retirement and estate planning. Among other things, the new rules allow pension plan participants to invest up to 25% of their account values (or a maximum $125,000) into deferred income annuities that pay guaranteed income for life, without having their value count toward required minimum distributions that apply to tax deferred plans such as individual retirement accounts.

These final rules are credit positive for US life insurers because they will boost demand from an already growing annuity market. In addition, the rules will allow insurers to offer more tax-favored options to deliver deferred guaranteed retirement income to pension plan participants along with the more typical lump-sum payout and immediate payout annuity options. The flexibility will strengthen insurers’ product offerings relative to their large mutual fund competitors.

In 2013, deferred income annuity (DIA) sales accounted for only 1% of the $230 billion individual annuity market. However, momentum for this relatively new product has been growing, as shown in Exhibit 1. DIAs provide retirees with a predictable stream of lifetime income; variable and indexed annuities do not, even when there is a minimum guaranteed income feature included in such contracts. For this reason, and because of their complexity, variable and indexed annuities will not receive the same preferential tax treatment under the new regulations.

EXHIBIT 1

US Deferred Income Annuity Sales

Sources: Life Insurance Marketing and Research Association (LIMRA) and Secure Retirement Institute.

Scale will be an important factor in determining the DIA writers’ profitability because of the relatively small policy size ($125,000 maximum allowable premium) that can be devoted to purchasing these qualifying DIA contracts. The insurers listed in Exhibit 2 are already well established in the US defined contribution market and have the most to gain from the final rules facilitating the use of DIAs in retirement planning. Those that are able to garner scale efficiencies to accommodate the smaller policies of the middle-income market will have a competitive advantage over money managers unable to offer consumers these DIA contracts.

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ions

Rokhaya Cissé Associate Analyst +1.212.553.3870 rokhaya.cisse@moodys.com

NEWS & ANALYSIS Credit implications of current events

19 MOODY’S CREDIT OUTLOOK 7 JULY 2014

EXHIBIT 2

Insurers Managing US Institutional Defined Contribution Plans at 31 December 2013

Rank Company Assets Under Management

Lead Insurance Company’s Insurance Financial Strength Rating and Outlook

1 Teachers Insurance and Annuity Assoc of America $472.1 billion Aaa review for downgrade

2 Prudential Financial, Inc. $258.8 billion A1 stable

3 Massachusetts Mutual Life Insurance Company $117.5 billion Aa2 stable

4 Voya Financial, Inc. $76.4 billion A3 positive

5 Principal Financial Group, Inc. $75.1 billion A1stable

6 Ameriprise Financial, Inc. $40.1 billion Aa3 stable

Source: Pensions & Investments

Plan participants are required to begin taking distributions from their retirement plans when they reach 70½ years of age. If a DIA were held in the plan under the old rules, its value would be included in the account value used to determine the required minimum distribution (RMD), a prescribed percentage of the total account value that had to be withdrawn from plan assets, based on the participant’s current age. Since a DIA would typically start paying benefits at a later age and it provides no liquidity, the previous RMD rules, which included the value of the DIA in the calculation, would force the entire RMD payout to come from plan assets other than the DIA. This level of RMD risks exhausting non-DIA plan assets before the DIA started paying out its guaranteed benefits. This risk of exhausting plan assets deterred the use of DIAs in retirement planning.

The new regulations modify the RMD rules to facilitate the purchase of DIAs that begin at an advanced age (for example, age 85). Now, before DIAs begin to pay out their guaranteed income, their value is excluded from the account value used to determine the RMD, mitigating the risk of exhausting the other plan assets.

NEWS & ANALYSIS Credit implications of current events

20 MOODY’S CREDIT OUTLOOK 7 JULY 2014

Old Republic’s Corrective Plan for Mortgage Insurers Gains Regulatory Approval, a Credit Positive Last Tuesday, Old Republic International Corporation (ORI, Baa3 stable) announced that the North Carolina Department of Insurance (NCDOI) approved its 16 April corrective plan for its subsidiaries, Republic Mortgage Insurance Company (RMIC, unrated) and Republic Mortgage Insurance Company of North Carolina (RMICNC, unrated), to pay off 100% of their deferred policy obligations (DPO). The plan’s approval is credit positive for ORI because it reduces the likelihood that the regulator would take over lead mortgage subsidiary RMIC, and as a result, trigger an event of default under ORI’s bond covenants and an acceleration of debt outstanding.

The deterioration of ORI’s mortgage operations since the mortgage crisis has been a significant problem for ORI. Despite recent steady improvements in mortgage sector fundamentals, RMIC’s vulnerability to a regulatory takeover and its classification pursuant to US Securities and Exchange Commission rules as a “significant” subsidiary, exposes ORI to an event of default under the indentures of its outstanding convertible senior notes.

Since 2012, ORI’s mortgage guaranty subsidiaries have been under regulatory supervision and under orders to defer payments on 40% of all settled claim amounts and record these as DPOs, which are counted toward statutory capital as per the regulator. Under the approved plan, RMIC and RMICNC will pay off 100% of their outstanding DPOs (approximately $650 million accrued as of 30 June 2014) and settle all subsequent claim liabilities entirely in cash, without incurring any additional DPOs.

The approved plan’s payout of the deferred policy claims at 100 cents on the dollar makes regulatory intervention less likely and reduces the size of the mortgage companies relative to the consolidated ORI group, thereby increasing the likelihood that RMIC will no longer be considered a significant subsidiary under the indentures. Both subsidiaries will remain under NCDOI supervision as they continue to operate in run-off mode.

ORI’s corrective plan includes a $125 million capital infusion to RMIC to shore up its capital position, an amount that we believe is manageable for the holding company in relation to its obligations (interest expense of about $23 million and stockholder dividend of $184 million). At year-end 2013, the parent company had approximately $169 million of cash and liquid securities and $427 million of dividend capacity for 2014 (permitted without prior regulatory approval) from its insurance operations. In addition, the capital adequacy of ORI’s property and casualty and title subsidiaries is strong and bolstered by the execution of the approved plan because the likelihood of capital calls on ORI’s property and casualty and title insurance operations will be less.

Pano Karambelas Vice President - Senior Credit Officer +1.212.553.1635 pano.karambelas@moodys.com

Benjamin Goldberg Associate Analyst +1.212.553.7486 benjamin.goldberg@moodys.com

NEWS & ANALYSIS Credit implications of current events

21 MOODY’S CREDIT OUTLOOK 7 JULY 2014

Norwegian Rules to Convert Guaranteed Paid-Up Policies Are Credit Positive for Life Insurers On 27 June, the Norwegian Ministry of Finance approved final rules outlining how policyholders with guaranteed paid-up policies5 starting in September can voluntarily convert these policies into products with investment choice that offer higher potential returns without minimum guarantees. Conversion to investment choice will benefit life insurers’ profitability and economic capital, which is credit positive for bondholders of Norwegian life insurers.

Storebrand Livsforsikring AS (subordinated debt Baa2(hyb) negative) and DNB Livsforsikring ASA, the life insurance subsidiary of DNB Bank ASA (A1 negative, C-/baa1 stable6) are likely to be the main beneficiaries because they are the largest players both in paid-up policies and more generally in Norway’s private pension market.

Paid-up policies have been among the products that are the least profitable and most capital intensive for Norwegian life insurers. These policies have high minimum guarantees, often at an average of 3.0%-3.5% across the entire portfolio for most players, and have been costly to provide given the current low interest rate environment. Paid-up policies are one of the main life insurance products in Norway and constituted around 35% of Norwegian life insurers’ liabilities in first-quarter 2014.

Storebrand estimates that conversion of NOK29 billion of existing paid-up policies, or 36% of its current portfolio, would be beneficial to both policyholders and itself. Nevertheless, the conversion into policies with investment choice is voluntary. Furthermore, there are reputational risks from insurers actively trying to convince customers to convert, notwithstanding the government’s detailed and strict rules on advising.

The Ministry of Finance’s announcement follows previous consultations to adapt the regulatory framework of paid-up policies given the significant capital consumption that these policies will require under forthcoming implementation of Solvency II. In order to reduce the substantial increases in capital requirements, life insurers have significantly reduced their exposure to high-risk equities and invested more in long-term bonds to meet their minimum contractual guarantee, but this creates limited upside potential for policyholders.

Storebrand’s and DNB Livsforsikring’s profitability will likely benefit significantly from the conversion to investment choice. Paid-up policies have delivered weak returns owing to their relatively high minimum guarantees in a low interest rate environment. Indeed, paid-up policies’ contribution to insurers’ profits has been 0%-12% of total technical profits despite constituting approximately 40% of total liabilities at year-end 2013. In addition, we expect that profitability in paid-up policies will continue to deteriorate as reinvestment yield continues to trend down amid low interest rates.

The conversion to investment choice will likely significantly benefit both groups’ economic capital under Solvency II, which remains a significant challenge for Norwegian life insurers, particularly those with significant exposure to paid-up policies. Storebrand and DNB Livsforsikring have been actively reducing their exposure to guaranteed products to de-risk their balance sheets and avoid the need for capital injections before Solvency II’s implementation in 2016. The conversions will also help both groups’ efforts

5 Contracts with earned rights that are issued upon withdrawal from or termination of defined benefit pension schemes. 6 The bank ratings shown in this report are DNB Bank’s deposit rating, its standalone bank financial strength rating/baseline credit

assessment and the corresponding rating outlooks.

Laura Perez-Martinez, CFA Assistant Vice President - Analyst +44.20.7772.1602 laura.perezmartinez@moodys.com

NEWS & ANALYSIS Credit implications of current events

22 MOODY’S CREDIT OUTLOOK 7 JULY 2014

to continue reducing the capital requirements under Solvency II and the sensitivity to declines in interest rates.

Storebrand publishes sensitivities to market consistent embedded value (MCEV) capital, which we consider to be a rough proxy for economic capital under Solvency II (see exhibit). Storebrand’s significant proportion of high guarantees leads to a substantial sensitivity to interest rate declines, with MCEV capital decreasing by 17% if interest rates fall by one percentage point from year-end 2013 levels.

Storebrand’s Reported Market Consistent Embedded Value Capital Remains Sensitive to Interest Rate Declines at Year-End 2013

Source: Storebrand

-20% -15% -10% -5% 0% 5% 10%

One Percentage Point Decrease in Interest Rate

10% Decrease in Equity and Property

10% Decrease in Operational Costs

One Percentage Point Increase in Interest Rate

Change in Market Consistent Embedded Value Capital

NEWS & ANALYSIS Credit implications of current events

23 MOODY’S CREDIT OUTLOOK 7 JULY 2014

Funds

California Plan to Increase CalSTRS’ Contribution Rates Is Credit Positive On Tuesday, California Assembly Bill 1469 became effective, increasing the contributions that school districts, teachers and the state government make to the California State Teachers’ Retirement System‘s (CalSTRS, Aa3 stable) defined benefit fund. The bill is credit positive for CalSTRS because it sets a clear path to reduce the system’s funding gap, which was nearly $74 billion as of 30 June 2013.

Under the bill, which became law on 24 June, California school districts will have the biggest increase. Districts’ aggregate annual contributions will rise to roughly $6.0 billion from $2.2 billion over seven years. The state and teachers will also see their annual contributions rise with rate increases phased in over three years. The state’s contributions will increase to $2.1 billion from $1.3 billion, while teachers’ contributions will increase the least, to $2.88 billion from $2.25 billion.

Passage of the CalSTRS’ funding plan is an important step for the pension fund’s financial health, because without a rate increase, CalSTRS would have depleted its $184 billion investment portfolio by 2046 (see exhibit). CalSTRS funds ongoing pension benefit payments through new contributions and earnings on its investment portfolio. Higher contribution rates will go a long way toward improving CalSTRS’ ability to meet future pension benefit payments, which stood at 66.9% (the funded ratio equals actuarial value of assets divided by actuarial value of liabilities) as of the fiscal year ended 30 June 2013.

CalSTRS Historic and Projected Funded Ratio

Source: California Department of Finance

Unlike its sister fund California Public Employees Retirement Fund (Aa3stable), CalSTRS requires legislative approval to impose rate increases on its members and member agents. Neither California Governor Jerry Brown nor state legislators approved previous recommendations to address CalSTRS’ funding gap with rate increases. Assembly Bill 1469 now provides CalSTRS’ retirement board with limited7 contribution rate-setting authority and will require the board to report on CalSTRS’ financial health every five years. 7 The board will have authority to increase or decrease the prescribed contribution rate increases in AB 1469 in order to reflect the

contribution required to eliminate the remaining unfunded actuarial obligation. If a rate increase is required, the board’s adjustment will be limited to a set percentage as defined in AB 1469, Amended Assembly Bill No. 1469, 12 June 2014.

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Rory Callagy Vice President - Senior Analyst +1.212.553.4374 robert.callagy@moodys.com

NEWS & ANALYSIS Credit implications of current events

24 MOODY’S CREDIT OUTLOOK 7 JULY 2014

Sovereigns

Brazil’s Slowing Growth and Increasing Inflation Are Credit Negative On 27 June, the Banco Central do Brasil (BCB) released its Quarterly Inflation Report, in which the central bank lowered its baseline scenario for Brazil‘s (Baa2 stable) 2014 real GDP growth to 1.6% from the 2.0% projected in its March report. The central bank also revised its inflation projections upward to 6.4% from 6.1% for 2014 and to 5.7% from 5.5% for 2015.

The credit-negative trends of lower growth and higher inflation (shown in the exhibit below) suggest that macroeconomic conditions will not improve during the rest of the year, even after uncertainty surrounding the upcoming October general election fades away. Accordingly, we now expect lower real GDP growth of 1.3% in 2014 and 1.5% in 2015, with risks tilted toward the downside.

Banco Central do Brasil’s 2014 Growth and Inflation Projections Are Diverging

Source: Banco Central do Brasil

The central bank’s revised projections also imply significant adjustments to current economic policies if the next administration is to restore macroeconomic conditions that support an improved sovereign credit outlook for Brazil.

Near-term economic weakness (e.g., first-quarter GDP increased at a weak seasonally adjusted annual rate of 0.8%) has been strongly influenced by declining investment and negative market sentiment. Furthermore, negative market sentiment has led to weaker investment spending.8 With the authorities unable to break this cycle, the latest central bank projections reinforce the notion that growth rates will continue to stumble − possibly into 2015 − while inflation remains elevated.

The government faces balancing two seemingly conflicting objectives: stimulating the economy without stoking inflation, which is running near the 6.5% upper limit of the central banks’ inflation band. Resolving this dilemma is complicated because existing inflationary pressures prevent the authorities from

8 See Brazil: Credit Outlook Hinges on Next Administration’s Ability to Reverse Negative Trends, 25 June 2014.

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Mauro Leos Vice President - Senior Credit Officer +1.212.553.1947 mauro.leos@moodys.com

Petar Atanasov Associate Analyst +1.212.553.4515 petar.atanasov@moodys.com

NEWS & ANALYSIS Credit implications of current events

25 MOODY’S CREDIT OUTLOOK 7 JULY 2014

loosening monetary conditions to support the economy, and the option of fiscal stimulus is limited, given the government’s relatively high debt burden.9

Looking past 2014, regardless of who wins the October general election, when the next administration comes into office on 1 January 2015, it will likely have to deal with an economic environment characterized by weak GDP growth, persistently high inflation, and, consequently, a general sense of pessimism regarding near-term economic prospects. Authorities will be hard-pressed in that environment to devise an appropriate policy mix to address the country’s ongoing economic and fiscal concerns. In addition, the next administration seems likely to face the extra challenge of convincing investors that the extent of new economic policy adjustments they undertake will be sufficient to reverse prevailing negative trends.

9 We expect the government debt ratio to increase to around 60% of GDP in 2014-15, which is significantly higher than the 40%

median for Baa-rated countries.

NEWS & ANALYSIS Credit implications of current events

26 MOODY’S CREDIT OUTLOOK 7 JULY 2014

Egypt’s Commitment to Reducing Its Fiscal Deficit Is Credit Positive On 29 June, Egypt (Caa1 negative) President Abd El Fattah El Sisi approved the budget for fiscal 2015, which started on 1 July and targets a deficit of 10% of GDP, down from the official deficit estimate of 12% in fiscal 2014. The fiscal 2015 budget is credit positive because it signals the authorities’ willingness to tackle Egypt’s challenging government finances, which have been considerably weakened by the growth slowdown following the 2008-09 global financial crisis and the fiscal stresses of the 2011 revolution.

The fiscal 2015 budget includes revenues of EGP549 billion and expenditures of EGP789 billion, resulting in a deficit of EGP240 billion ($33.6 billion), which is slightly lower than the estimated deficit of EGP243 billion for fiscal 2014. An initial budget proposal included a deficit of EGP292 billion, or 12.2% of GDP, according to the Ministry of Finance, but President El Sisi rejected it.

The authorities are planning to cut fuel subsidies by EGP30 billion to EGP100.2 billion in fiscal 2015, down from official estimates for the fiscal 2014 outcome. However, a concrete timeline for fuel subsidy reforms has not been announced yet, and the total subsidy bill will rise by EGP12 billion to EGP178.6 billion because of a budgeted increase in electricity subsidies.

Nevertheless, if the fiscal 2015 budget is implemented successfully, it will mark the second year of declining budget deficits as shown in Exhibit 1.

EXHIBIT 1

Egypt’s Budget Deficit as a Percent of GDP

Note: Deficit for the budget sector, excluding National Investment Bank and Social Insurance Funds. Source: Egypt Ministry of Finance

Declining budget deficits will also help slow the rise of Egypt’s government debt. However, the authorities’ plans to reduce the government debt/GDP ratio to 80%-85% by fiscal 2017 from 93.7% of GDP in fiscal 2014 sound ambitious unless economic growth picks up. According to the Ministry of Finance, gross issuance of government securities will reach EGP220 billion during the first quarter of fiscal 2015, slightly more than the EGP200 billion issued during the same period in fiscal 2014.

With the presidential elections complete and an appointed government in place, the Egyptian economy looks set for a more stable political environment. This is also reflected in government financing costs, which have remained stable since the beginning of the year, averaging less than 11% (see Exhibit 2). In addition to

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Steffen Dyck Vice President - Senior Analyst +65.6398.8324 steffen.dyck@moodys.com

NEWS & ANALYSIS Credit implications of current events

27 MOODY’S CREDIT OUTLOOK 7 JULY 2014

financial assistance from Gulf Cooperation Council countries, support is coming from the US, which has resumed military aid following the presidential elections at the end of May.

EXHIBIT 2

Yield on Egyptian Government 364-Day Treasury Bill

Source: Egypt Ministry of Finance

NEWS & ANALYSIS Credit implications of current events

28 MOODY’S CREDIT OUTLOOK 7 JULY 2014

US Public Finance

New York State to Benefit from BNP Paribas Settlement On Monday, New York State (Aa1 stable) and US officials announced that the state would receive a cash payment of $2.2 billion in penalties from BNP Paribas (A1 negative, C-/baa1 negative10), or 3.5% of the state’s projected general fund revenues for the fiscal year ending 31 March 2015. The settlement, which the bank must pay within 30 days, is credit positive for the state.

The settlement relates to BNP Paribas’ guilty plea on charges that it evaded US sanctions on Iran and other countries. It is the latest in a string of settlements with financial firms over the past year that have contributed to the state’s improving financial position. The BNP Paribas settlement alone equals the size of the state’s fiscal 2014 year-end budgetary surplus.

New York State has received nearly $3.9 billion in penalties associated with settlements from financial institutions since April 2013. The payments have ranged in size, but the largest before the BNP Paribas settlement was $715 million paid by Credit Suisse AG (A1 negative, C-/baa1 negative) in conjunction with its guilty plea in a tax evasion case (see exhibit).

Financial Institutions’ Settlement Payments to New York State since 1 April 2013

Source: New York State Division of Budget

The settlements are significant even relative to the revenue generated by the state’s large financial services sector. The securities industry accounted for about $10 billion of state income and corporate tax revenues in fiscal 2013, according to estimates by the state comptroller’s office.

The portion of the settlements received during fiscal 2014 totaled around $940 million and allowed the state to finish fiscal 2014 with a $2.2 billion budgetary general fund balance, or 3.6% of 2014 general fund revenue. This amount was about $400 million more than the ending balance projected in the Executive Budget and $600 million more than the ending balance in the previous year. The state operating funds’

10 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.

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Deloitte Financial Advisory Services

JP Morgan Metlife AXA Equitable Credit Suisse BNP Paribas

$ M

illio

ns

Marcia Van Wagner Vice President - Senior Credit Officer +1.212.553.2952 marcia.vanwagner@moodys.com

NEWS & ANALYSIS Credit implications of current events

29 MOODY’S CREDIT OUTLOOK 7 JULY 2014

closing balance increased to $4.8 billion (5.3% of state operating fund receipts) from $4.3 billion in fiscal 2013.

New York’s better-than-expected fiscal performance in 2014 allowed it to strengthen its reserves. The state prepaid approximately $700 million in fiscal 2015 expenses, mostly debt service payments, and added $175 million to the state’s rainy day reserve. The contribution is the first deposit to the rainy day reserve since the state deposited an initial $175 million at its inception in 2007 to supplement the tax stabilization reserve.

RATING CHANGES Significant rating actions taken the week ending 4 July 2014

30 MOODY’S CREDIT OUTLOOK 7 JULY 2014

Corporates Delta Air Lines, Inc.

Upgrade

5 Dec ‘13 2 Jul ‘14

Corporate Family Rating B1 Ba3

Outlook Positive Positive

The upgrade reflects our expectation of ongoing improvements in the company’s earnings, cash flow generation and financial leverage. The favorable location of Delta’s hubs, the benefits of a mainly non-union work force, effective revenue management practices, and a significantly smaller order book compared with direct competitors provide a solid foundation for steady improvements in Delta’s credit metrics.

Forest Laboratories, Inc. Upgrade

18 Feb ‘14 1 Jul ‘14

Senior Unsecured Rating Ba1 Baa3

Outlook Review for Upgrade Stable

The upgrade follows the close of the acquisition of Forest by Actavis plc. It also reflects the credit strength of the combined company as well as the guarantee provided by Actavis plc. The Baa3 rating reflects Actavis’ significant size and scale in the global generic pharmaceutical market.

Leidos Holdings, Inc. Downgrade

28 Mar ‘14 2 Jul ‘14

Senior Unsecured Rating Baa2 Baa3

Outlook Review for Downgrade Negative

The downgrade reflects the worse-than-expected financial performance of Leidos within a weak and still uncertain environment for defense services contracting. It also reflects the possibility that revenue could decline to about $5 billion during fiscal year 2015, which would be down about 20% since fiscal year 2013.

OJSC Gazprom Confirmation

1 Apr ‘14 1 Jul ‘14

Long-Term Issuer Rating Baa1 Baa1

Outlook Review for Downgrade Negative

The confirmation follows our confirmation of Russia’s Baa1 government bond rating and our assignment of a negative outlook on that rating on 27 June. It also reflects our view that OJSC Gazprom’s rating is closely aligned with that of the sovereign and thus remains sensitive to changes in sovereign creditworthiness.

RATING CHANGES Significant rating actions taken the week ending 4 July 2014

31 MOODY’S CREDIT OUTLOOK 7 JULY 2014

Russian Railways Joint Stock Company Confirmation

1 Apr ‘14 1 Jul ‘14

Long-Term Issuer Rating Baa1 Baa1

Outlook Review for Downgrade Negative

The confirmation follows our confirmation of Russia’s Baa1 government bond rating and our assignment of a negative outlook on that rating on 27 June 2014. It also reflects our view that Russian Railways has strong linkages with the government and that the company’s rating remains sensitive to changes in sovereign creditworthiness.

Infrastructure

AES Puerto Rico, L.P. Downgrade

10 Feb ‘14 2 Jul ‘14

Secured Bonds Ba2 B3

Outlook Negative Negative

AES PR’s revenues and cash flows are entirely dependent upon the contractual sale of electricity to the Puerto Rico Electric Power Authority (PREPA) and the utility’s willingness and ability to pay for that energy. On 26 June and subsequently on 1 July we downgraded PREPA’s rating to Ba3 and then to Caa2 and placed the rating under review for possible downgrade.

RATING CHANGES Significant rating actions taken the week ending 4 July 2014

32 MOODY’S CREDIT OUTLOOK 7 JULY 2014

Financial Institutions

Peruvian Banks Upgraded

3 Jul ‘14

We upgraded the ratings on Banco de Credito del Peru (Baa1 stable, C-/baa2 stable11) Scotiabank Peru (Scotiabank) (Baa1 stable, D+/baa3 stable), Banco Internacional del Peru S.A.A. (Baa2 stable, D+/baa3 stable) and Corporacion Financiera de Desarrollo S.A.(Baa2 stable). The rating actions follow our 2 July upgrade of Peru’s local and foreign currency government bond ratings to A3 stable from Baa2 positive.

Assured Guaranty Corp Outlook Change

17 Jun ‘14 2 Jul ‘14

Long Term Rating A3 A3

Outlook Stable Negative

The outlook change follows the enactment by the Commonwealth of Puerto Rico of the Puerto Rico Public Corporation Debt Enforcement and Recovery Act, which will allow public corporations to defer or reduce payments on outstanding bonds. By providing for defaults by certain issuers that the central government has long supported, Puerto Rico’s new law marks the end of the commonwealth’s long history of taking actions needed to support its debt. As of 31 March 2014, Assured had consolidated net par exposure of approximately $5.3 billion to Puerto Rico issuers.

Banco Mercantil do Brasil S.A. Downgrade

28 Aug ‘10 3 Jul ‘14

Bank Financial Strength/ Baseline Credit Assessment

D/ba2 E+/b1

LT Bank Deposits (Domestic/Foreign) Ba2 B1

Long Term Outlook Ba2 Ba2

Outlook Stable Negative

The downgrade of the standalone rating reflects the sharp deterioration of BMB’s asset quality in recent quarters, The increase in non-performing loans derives mostly from high delinquency in loans underwritten to small and medium sized companies. In addition, BMB’s profitability has declined also as a result of the current sluggish economic activity, which curbed loan demand, and the intense competition from large banks in BMB’s niche markets.

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

assessment and the corresponding rating outlooks.

RATING CHANGES Significant rating actions taken the week ending 4 July 2014

33 MOODY’S CREDIT OUTLOOK 7 JULY 2014

BNP Paribas Outlook Change

10 Jun ‘13 1 Ju1 ‘14

Bank Financial Strength/Baseline Credit Assessment

C-/baa1 C-/baa1

Outlook Stable Negative

The outlook change and affirmation of ratings follows the bank’s comprehensive settlement with the US Department of Justice and other parties. The bank continues to benefit from a capital position that even after absorbing the substantial fine and paying a dividend in line with the previous year will be in line with those of its peers; a diverse and durable franchise that generates substantial, stable earnings, which will allow it to rebuild capital; and a solid and improved liquidity and funding position. The negative outlook reflects the effectiveness of corporate governance, risk and compliance controls at BNP Paribas and the bank’s ability to manage tail risks inherent in a complex institution; potential franchise impairment that could result from the financial and reputational effects of the massive fine and guilty plea; and the immediate negative impact of its settlement on the bank’s capital position.

Cassa di Risp.di Bolzano-Sudtiroler Sparkasse Downgrade

14 May ‘12 3 Jul ‘14

Bank Financial Strength/ Baseline Credit Assessment

D+/ba1 D/ba2

LT Bank Deposits (Domestic/Foreign) Ba1 Ba2

Outlook Negative Stable

The downgrade reflects the bank’s deteriorated asset quality and profitability, which are only partly offset by the bank’s increased regulatory capital ratios and problem loan reserve coverage. CariBolzano’s asset quality has deteriorated significantly since 2011, in line with trends in the Italian banking system.

GCB Bank Limited Downgrade

22 Mar ‘11 2 Jul ‘14

LT Bank Deposits (Foreign) B1 B2

LT Bank Deposits (Domestic) B2 B3

The rating action follows our downgrade of Ghana’s sovereign rating to B2, from B1, with a negative outlook, on 27 June 2014. The weakening capacity of the government to provide support for the bank drives the downgrade.

IntercontinentalExchange Group Inc (ICE) Review for Upgrade

1 Jul ‘14

Senior Unsecured (Domestic) A3 A3

RATING CHANGES Significant rating actions taken the week ending 4 July 2014

34 MOODY’S CREDIT OUTLOOK 7 JULY 2014

The review follows the completion of the initial public offering of Euronext N.V., an important milestone in the execution of ICE’s NYSE Euronext post-merger plans. Furthermore, ICE announced its intention to use a significant portion of the IPO proceeds (€1.4 billion) to repay debt, following through on its commitment to deleverage.

MBIA Inc. Outlook change

21 May ‘14 2 Jul ‘14

Long Term Rating Ba1 Ba1

Outlook Stable Negative

The outlook change follows the enactment by the Commonwealth of Puerto Rico of the Puerto Rico Public Corporation Debt Enforcement and Recovery Act, which will allow public corporations to defer or reduce payments on outstanding bonds. By providing for defaults by certain issuers that the central government has long supported, Puerto Rico’s new law marks the end of the commonwealth’s long history of taking actions needed to support its debt. As of 31 March 2014, National had gross par exposure of approximately $4.8 billion to Puerto Rico issuers.

NCG Banco S.A. Downgrade

30 Dec ‘13 30 Jun ‘14

Bank Financial Strength/Baseline Credit Assessment

E+/b2 E/caa2

LT Bank Deposits (Domestic/Foreign) B3 Caa1

The downgrade follows the transfer on 25 June of NCG Banco’s ownership to Banesco Group (unrated) from a majority ownership by the Spanish government via the Fund for Orderly Bank Restructuring (FROB). The action reflects our assessment of a lower probability of systemic support following the exit of the FROB from the bank’s capital.

Penn Mutual Life Insurance Company Outlook Change

10 Jun ‘13 1 Ju1 ‘14

Long Term Rating Aa3 Aa3

Outlook Negative Stable

The outlook change is driven by the company’s product management actions to reduce the risk from new business and to improve profitability. The company has materially reduced its recent sales of universal life secondary guarantee (ULSG) insurance products, which we consider higher risk, and placed a greater emphasis on whole life insurance products. Additionally, Penn Mutual has made a number of changes to its products, including increasing prices, restricting external broker/dealer distribution and limiting deposits for its ULSG products.

RATING CHANGES Significant rating actions taken the week ending 4 July 2014

35 MOODY’S CREDIT OUTLOOK 7 JULY 2014

Sovereigns

Peru Upgraded to A3 from Baa2

On 2 July, we upgraded Peru’s sovereign rating to A3 from Baa2, changing the outlook to stable from positive. The key drivers of the rating action were our expectation of continued strengthening of the government’s balance sheet and fiscal framework, continued structural reform momentum to boost potential output growth while addressing institutional constraints, and our expectation that economic activity will accelerate through 2016, underpinning a sustained improvement in credit metrics relative to similarly rated peers.

Sub-sovereigns

Municipality of Nogales (Mexico) Downgrade

7 Feb’14 30 Jun ‘14

Issuer rating B1/Baa2.mx B2/Ba1.mx

Outlook Negative Stable

The downgrade reflects a much higher than expected increase in financial debt, the persistent recording of cash financing deficits, and the municipality’s structural weakness to adjust expenditures. Nogales’ debt increased sharply to 99.4% of operating revenues in 2013 from 65.1% in 2012 and now represents the highest level among rated Mexican municipalities.

RATING CHANGES Significant rating actions taken the week ending 4 July 2014

36 MOODY’S CREDIT OUTLOOK 7 JULY 2014

US Public Finance

Harris County Toll Road Authority, TX Outlook Change

16 Jul ‘12 2 Jul ‘14

Hospital Revenue Bonds Aa3 Aa3

Outlook Stable Positive

We expect that traffic growth and revenues will continue to produce strong debt service coverage ratios on a net basis, and that the toll road system will generate and maintain ample cash margins.

Maine Health & Higher Educ. Facs. Auth. Outlook Change

22 Apr ‘13 2 Jul ‘14

Revenue Bonds A1 A1

Outlook Negative Stable

The rating and outlook are notched off those of the State of Maine. On 4 June 2014, we changed the outlook on Maine’s Aa2 general obligation rating to stable.

Puerto Rico (Commonwealth of) Downgrade

7 Feb ‘14 1 Jul ‘14

General Obligation Bonds Ba2 B2

Commonwealth Appropriation Bonds Ba3 B3

COFINA Senior Lien Bonds Baa1 Ba3

COFINA Subordinate Lien Bonds Baa2 B1

Puerto Rico Electric Power Authority (PREPA) [Ratings Under Review/Downgrade]

Ba3 Caa2

Puerto Rico Aqueduct and Sewer Authority (PRASA) [Ratings Under Review/Downgrade]

Ba3 Caa1

Puerto Rico Highway and Transportation Authority (PRHTA) Senior Resolutions [Ratings Under Review/Downgrade]

Ba3 Caa1

Puerto Rico Highway and Transportation Authority (PRHTA) Subordinate Resolution [Ratings Under Review/Downgrade]

B1 Caa2

Government Development Bank (GDB) Ba2 B3

University of Puerto Rico System Revenue Bonds

Ba3 Caa1

University of Puerto Rico Educational Facilities Revenue Bonds

B1 Caa2

Outlook Negative Negative

The downgrades of Puerto Rico and its debt-issuing entities follow the commonwealth’s enactment of the Puerto Rico Public Corporation Debt Enforcement and Recovery Act, which will allow public corporations

RATING CHANGES Significant rating actions taken the week ending 4 July 2014

37 MOODY’S CREDIT OUTLOOK 7 JULY 2014

to defer or reduce payments on outstanding bonds. By providing for defaults by certain issuers that the central government has long supported, Puerto Rico’s new law marks the end of the commonwealth’s long history of taking actions needed to support its debt. It signals a depleted capacity for revenue increases and austerity measures, and a new preference for shifting fiscal pressures to creditors, which, in our view, has implications for all of Puerto Rico’s debt, including that of the central government. Application of the law may further limit the commonwealth’s market access, leaving it more vulnerable to financial risk and unable to fund capital projects.

Sutter Health (CA) Outlook Change

4 Apr ‘13 1 Jul ‘14

Revenue Bonds Aa3 Aa3

Outlook Stable Negative

The outlook change reflects the numerous challenges Sutter Health is currently facing. These include performance in FY 2013 that was well below budget and a capital plan of $5 billion over the next five years, with the possibility of additional debt.

WPPI Energy, WI Outlook Change

21 Mar ‘13 2 Jul ‘14

Power Supply System Revenue Bonds A1 A1

Outlook Negative Stable

The outlook change reflects the earlier-than-anticipated ongoing replenishment of the utility’s rate stabilization fund. It also reflects ongoing liquidity improvement and a construction schedule that is on time and under budget.

RATING CHANGES Significant rating actions taken the week ending 4 July 2014

38 MOODY’S CREDIT OUTLOOK 7 JULY 2014

Structured Finance Hyundai Prime Auto Loan US ABS Upgraded We upgraded the ratings on 10 subordinate notes in six Hyundai Auto Receivables Trust transactions from 2012 and 2013 because of stronger than expected collateral performance and buildup of credit enhancement from the sequential pay structure and non-declining reserve account. The upgrades affected approximately $4.2 billion of asset-backed securities.

RESEARCH HIGHLIGHTS Notable research published the week ending 4 July 2014

39 MOODY’S CREDIT OUTLOOK 7 JULY 2014

Corporates

Global Consumer Products: Steady Profit Growth Despite Promotions and Emerging Market Downshift We are maintaining a positive outlook on the global consumer products industry. Despite recent downward revisions in GDP growth estimates for key emerging markets, we expect that cost reductions, still-healthy emerging market gains, and a modest recovery in the US and Europe will support profit expansion.

US Gaming Industry: Moving to Negative Outlook on Weaker-than-Expected Gaming Revenue We have revised our outlook for the US gaming industry to negative from stable. We expect that gaming revenue in a majority of the larger, more mature regional gaming markets will continue to report year-over-year declines during the next 12 to 18 months. The fixed-cost nature of the industry will make it difficult to fully mitigate these revenue declines through expense reduction, causing earnings to decline more rapidly than revenue.

US Oil and Gas Industry: US Processed Condensate Exports Will Benefit E&P Companies But Raise Pressure on Refiners The US Department of Commerce has given private rulings to the US companies Pioneer Natural Resources and Enterprise Products Partners that confirmed eligibility under existing rules to export processed condensate. This eligibility will have a modest overall effect on the country’s oil and gas sector, temporarily affecting only condensate production, which is a fairly moderate but growing portion of the total US crude oil output.

Caesars to Close Showboat Atlantic City Caesars’ pending closure of Showboat casino in Atlantic City reflects the significant decline in Atlantic City fortunes as new supply in Pennsylvania and New York has eroded the city’s dominance of East Coast gaming. However, Caesars will undoubtedly use its Total Reward program to push Showboat customers towards its other three casinos in hopes of increasing utilization and reducing its cost structure in this market.

Online Retail Sales Are Set to Keep Expanding Through 2016 The successful development of online retail sales will be a credit positive for US retailers. A viable online channel is becoming more critical for brick-and-mortar retailers to maintain and strengthen their competitive positions. In our view, online sales are a cost-effective way to maximize existing physical locations and to leverage distribution capability.

Reduction in Fuel Subsidies Would Be Credit Positive for Indian Oil Companies We expect that the Indian government will increase the retail selling price of controlled fuel products to help control its subsidy burden. A one-time price increase would immediately reduce the country’s subsidy bill, which would be credit positive for oil marketing companies. However, such an increase would also be challenging to push through given the need to control inflation.

RESEARCH HIGHLIGHTS Notable research published the week ending 4 July 2014

40 MOODY’S CREDIT OUTLOOK 7 JULY 2014

Australian Public-Private Partnerships (PPPs) - Rating Actions on PPPs with Refinancing Exposures Explained We downgraded WLG and Praeco to reflect our ongoing concerns of the uncertainty surrounding whether these issuers will be able to achieve refinancing without additional equity support when their debt matures over the next few years. Although the final maturity dates of the bonds are still a few years away, WLG and Praeco have very limited financial flexibility because of their highly leveraged capital structure.

Declining Capex Is Credit Positive for Australian Miners, But Negative for Mining Services We expect a material decline in private-sector capital expenditure in Australia over the next 12 to 18 months. The bulk of the contraction will come from the mining sector and result from several factors, including the completion of major projects and downward pressure on commodity prices. Companies that rely heavily on the resources sector for business, such as mining services and building contractors, will see the biggest squeeze on revenues and margins.

Infrastructure

European Union Energy Policy and National Interests Conflict at the Expense of European Unregulated Utilities’ Credit Quality Conflicts arising from European Union energy policy implementation and the response of member states to the resulting fallout have resulted in repeated political and regulatory policy changes, which make the operating environment challenging for the European unregulated utility sector and increase credit risk. In our view, these conflicts are unlikely to be resolved in the foreseeable future.

RESEARCH HIGHLIGHTS Notable research published the week ending 4 July 2014

41 MOODY’S CREDIT OUTLOOK 7 JULY 2014

Financial Institutions

Sri Lanka Banking System Outlook Our stable outlook for the Sri Lankan banking system reflects our expectation of a healthy operating environment, stable liquidity and funding conditions. We also expect that asset quality and profitability will stabilize, following deterioration in 2013.

Indonesian Banks: Rising Cost of Deposits Will Introduce Credit Differentiation The significant increase in time-deposit interest rates, driven by increased competition, will introduce greater credit differentiation in the banking system. That is because many banks are unable to fully pass on the higher funding costs to borrowers, resulting in narrower net interest margins and lower overall profitability.

Rated Japanese Insurers Eliminate Negative Spread The near 10% year-on-year increase in core profits posted by the major eight Japanese life insurers for the full year ending March 2014 eliminated on an aggregate basis the negative spread problem of the last two decades. However, it would be premature to conclude that the negative spread issue has been completely eradicated.

Kuwait Banking System Outlook Our outlook for Kuwait’s banking system remains stable, reflecting our expectation of a favorable domestic operating environment supported by high oil revenues and government spending. Accommodative operating conditions will continue to underpin banks’ financial fundamentals, including robust capitalization and ample liquidity. Although stiff competition for new business will continue to pressure margins, credit growth will offset the impact on net interest income.

Malaysian Islamic Banks: Asset Growth, Funding and Basel III Capital Needs Drive Increasing Sukuk Volumes The $1 billion of ringgit-denominated sukuk issued by Islamic banks in the first half of 2014 is the largest in any year so far. Furthermore, five banks have launched programs that will allow them to issue more sukuk in the future. This record issuance is due mainly to rapid asset growth that is driving significant funding and capital needs.

Aircraft Leasing Industry: Strong Aircraft Demand Driving Leasing Volumes Higher; Increased Competition a Challenge to Margin Improvements Airlines are increasingly relying on lessors as a source of commercial aircraft to meet fleet replacement and growth needs. Sale-leaseback transactions will drive lessors’ growth in coming years, as airlines, which account for a large majority of manufacturer production backlogs, continue to be attracted to the favorable financial and operational advantages offered by leasing as an alternative to direct ownership.

US Commercial Automobile Insurance: Sector Profile The US commercial auto sector is slowly rebounding from a prolonged profitability slump over the past four years. A recovering economy has enabled insurers to increase both rates and exposures. However, the sector’s recovery has been gradual, since elevated loss ratio trends have made it challenging to improve profitability.

RESEARCH HIGHLIGHTS Notable research published the week ending 4 July 2014

42 MOODY’S CREDIT OUTLOOK 7 JULY 2014

US Workers’ Compensation: Sector Profile Unemployment rates have declined in large workers’ compensation states. While manufacturing and construction employment remain well below pre-recession levels, employment in both sectors has improved markedly since 2011. Insurers continue to moderate their legacy concentrations in both sectors, and instead divert capacity to industries with good prospects for employment growth such as technology.

RESEARCH HIGHLIGHTS Notable research published the week ending 4 July 2014

43 MOODY’S CREDIT OUTLOOK 7 JULY 2014

Sovereigns

Latin America Is Better Prepared to Confront El Niño in 2014 than in Years Past Over the past decade, Latin American governments have generally strengthened their credit profiles, which should help mitigate the credit risks posed by the 2014 El Niño. They have stronger public balance sheets than they did 15 years ago, owing to lower fiscal deficits and debt burdens, as well as the accumulation of assets that would be readily available to pay for infrastructure repairs.

Sub-sovereigns Mexican States’ Growing Pension Liabilities Pose a Mid-Term Challenge Pension liabilities are a growing expense that has started to exert financial pressure on various Mexican states. Though these liabilities are currently manageable, they are headed to becoming unsustainable in the absence of a structural reform.

French Local Governments: Capital Market Issuances to Soar Amid Ample Funding Options We expect the capital market debt issued by French regional and local governments will triple to around 18% of total debt stock by 2017. This further reduces liquidity risks as it increases their funding options at a time of heightened pressure on local public finances. Banks will continue to provide most of the sector’s funding over 2014-17.

RESEARCH HIGHLIGHTS Notable research published the week ending 4 July 2014

44 MOODY’S CREDIT OUTLOOK 7 JULY 2014

US Public Finance

Weak Highway Trust Fund and Uncertain Federal Support Place GARVEE Ratings in the A Category The inability of policymakers to agree on long-term solutions to the nation’s transportation funding challenges weakens the credit profile of the Grant Anticipation Revenue Vehicle, or GARVEE, sector, although it retains sufficient underlying strength to remain in the A category. The large and growing structural imbalance between the Highway Trust Fund’s (HTF) ongoing dedicated revenue sources and level of federally authorized grant expenditures requires periodic large transfers of US general revenues.

US Local Government General Obligation Focus We continue with more summations of the debt security pledges of the 50 states.

US Public Universities and Some Hospitals Confront Growing Pension Burden Underfunded pensions are a growing credit challenge for many public universities and GASB-reporting hospitals as pension costs escalate during a period of constrained revenue. Since many universities and hospitals participate in multi-employer cost-sharing plans, multiple factors determine the credit impact for a particular institution. The factors include whether the state makes payments on behalf of the institution, the status of state pension reform, and the size of the unfunded liability relative to the institution’s balance sheet and operations.

Moody’s US Public Pension Analysis Largely Unchanged By New GASB 67/68 Standards The revised accounting standards do not change our approach to calculating our Adjusted Net Pension Liability, or ANPL. The new information that will be disclosed on the sensitivity of discount rates, however, could materially impact the results of our adjustments in some cases, but the additional disclosure is unlikely to impact ratings in the vast majority of cases.

Most US Sewer Utilities Can Weather Costs of Federal EPA Consent Decrees Most of the sewer utilities that are subject to EPA consent decrees requiring large investments to meet Clean Water Act standards are able to handle the additional debt without stress to their credit quality. The costs of complying with a consent decree is usually spread out over many years, giving the utility time to build these costs into rate schedules.

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

45 MOODY’S CREDIT OUTLOOK 7 JULY 2014

RECENTLY IN CREDIT OUTLOOK

NEWS & ANALYSIS Corporates » ALL Will Benefit from Brazilian Government’s Extension of Tax

Cuts to Malha Norte » ABB Sale of Steel Structures Unit Brings Proceeds from Asset

Disposals to Nearly $1 Billion, a Credit Positive » Royal Philips Spinoff of Lighting Units Should Enhance

Earnings Stability » Kerling Will Benefit from Parent Ineos’ Joint Venture Agreement

with Solvay » Lower Iron Ore Prices Would Be Credit Negative for Australia’s

Mining Industry

Banks » Barclays’ Dark Pool Lawsuit Is Credit Negative » Banco Comercial Portugues Strengthens Its Capital,

a Credit Positive » apoBank Capital Increase and Risk Reduction Are Credit Positive » Russian Central Bank Supports Bank Liquidity with Longer Term

Loans, a Credit Positive » Russian Banks’ Conversion of Subordinated Loans into Tier 1

Capital Would Be Credit Positive » Taiwan’s Tightened Mortgage Lending Rules Are Credit Positive

for Banks

Insurers » Affordable Care Act Policies’ Automatic Renewal Is a Mixed Bag

for US Health Insurers » Highmark Transition Agreement with UPMC Is Credit Positive » Brazil’s New Auditing Requirements for Insurers Are

Credit Positive

Sovereigns » South African Metalworkers’ New Strike Will Cause More Pain

for the Economy

US Public Finance » Puerto Rico’s Debt Restructuring Law Raises Default Risk for

Public Corporations and the Commonwealth

MOODYS.COM

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EDITORS PRODUCTION ASSOCIATE News & Analysis: Jay Sherman, Elisa Herr and Jasmine Chia

Wing Chan

Ratings & Research: Robert Cox Final Production: Barry Hing