MOODYS.COM

6 DECEMBER 2012

NEWS & ANALYSIS Corporates 2 » Baxter’s Planned Acquisition of Gambro Would Raise Leverage, a

Credit Negative » Atlas Pipeline’s Cardinal Acquisition Will Boost Its Revenue Stream » Sale of Credit Services Unit Is Credit Positive for Computer

Sciences Corp., Credit Negative for Equifax » CWC’s Sale of Its Monaco & Islands Division Is Credit Positive » iPhone 5 Launch in Korea Is Credit Positive for KT and SKT

Banks 9 » Banca Monte dei Paschi Increases Its State Aid Request, a Credit

Negative » Banca Comerciala Romana Shareholders Approve Credit Positive

Capital Injection

Insurers 12 » NAIC’s New Reserving Approach Is Credit Negative for US Life

Insurers » Japanese Life Insurers’ Declining Savings Product Sales Is Credit

Positive

Covered Bonds 14 » Transfer of Spanish Cover Pools to Bad Bank Is Credit Positive

CREDIT IN DEPTH Indian and Cypriot Banks 16

Annual banking system outlooks express our expectation of how the creditworthiness of banks in a particular country will evolve over the next 12-18 months. Here, we summarize recent reports explaining our negative outlooks on the banking systems of India and Cyprus.

RECENTLY IN CREDIT OUTLOOK

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NEWS & ANALYSIS Credit implications of current events

2 MOODY’S CREDIT OUTLOOK 6 DECEMBER 2012

Corporates

Baxter’s Planned Acquisition of Gambro Would Raise Leverage, a Credit Negative

On Tuesday, Baxter International Inc. (A3 review for downgrade) said it had entered into a definitive agreement to acquire Gambro AB (unrated), a privately held Swedish manufacturer of kidney dialysis equipment, for about $4 billion. The acquisition would be credit negative for Baxter because it would likely increase the medical-product company’s leverage and weaken credit metrics. We placed Baxter’s A3 long-term debt rating on review for downgrade following the acquisition announcement.

Baxter would fund about $3 billion of the purchase with debt. Management estimates that unadjusted leverage would rise to 2.3x following the transaction, compared with current unadjusted leverage of about 1.6x based on financials for the 12 months ended 30 September. However, based on management’s estimate and adjusting for current capital lease and unfunded pension obligations, we estimate the ratio would rise to around 2.7x from current adjusted leverage of about 2.0x.

Baxter’s announcement follows the company’s decision earlier this year to increase its capital spending for a new manufacturing plant and raise its dividend by 34%, which, on their own, will stress the company’s retained and free cash flow. Free cash flow to debt, which was about 16% during the 12 months ended 30 September, will decline because of the increased dividend and will be further suppressed for several years by the increased capital spending because the company does not expect cash flow benefits from the new plant until 2018. We expect the Gambro purchase to constrain cash- flow-to-debt metrics even more. We also believe a large portion of Gambro’s sales come from Europe, where austerity measures are pressuring sales of medical devices.

Gambro’s hemodialysis portfolio would augment Baxter’s peritoneal dialysis offerings and provide an opportunity for cost synergies. However, Baxter does not expect to fully realize these synergies for several years.

Diana Lee Vice President - Senior Credit Officer +1.212.553.4747 diana.lee@moodys.com

NEWS & ANALYSIS Credit implications of current events

3 MOODY’S CREDIT OUTLOOK 6 DECEMBER 2012

Atlas Pipeline’s Cardinal Acquisition Will Boost Its Revenue Stream

Atlas Pipeline Partners, L.P. (B1 stable), a midstream gathering and processing company, on Monday said it had agreed to a $600 million debt-and-equity-funded acquisition of Cardinal Midstream LLC (unrated). The deal is credit positive for Atlas.

Buying Cardinal should give Atlas several advantages, including operations that Atlas estimates will contribute about $60 million in incremental EBITDA to the new parent in 2013. We believe the combined company’s fee-based revenue will increase to roughly 36% from 27%, and have an improved geographic reach with promising opportunities for organic growth.

To help finance the acquisition, Atlas issued $300 million of common equity on Tuesday, and could raise an additional $47 million if underwriters exercised their option within the next 30 days. We expect Atlas to fund the rest of the purchase price with a combination of senior notes and revolver borrowings, which will raise Atlas’ leverage in the near term.

Acquiring Cardinal will immediately boost Atlas’ earnings, cash flows and fee-based revenue. The deal also gives Atlas a new foothold in the liquids-rich Arkoma Woodford shale play, and will give the company future organic growth opportunities at reasonable costs. Cardinal’s gathering, processing, and treating operations in southeastern Oklahoma include three cryogenic gas processing plants with a combined gross capacity of 220 million cubic feet of gas per day (MMcf/d). This will increase Atlas’ cryogenic gas processing capacity by 160 MMcf/d, since MarkWest Energy Partners L.P. (Ba2 stable) owns a 40% non-operating interest in two of the Cardinal plants.

The deal also gives Atlas 15 amine plants and two propane refrigeration plants that offer gas treating operations under long-term contracts in several unconventional plays, including the Woodford, Eagle Ford, Granite Wash, Avalon, Haynesville and Fayetteville shales.

Atlas’ higher leverage after buying Cardinal will partly temper these credit benefits and delay the deleveraging of its balance sheet, which is needed to move to a higher rating category. Still, with the added EBITDA and cash flow from the deal, Atlas by 2014 should be able to bring its leverage back within striking distance of its current 3.91x debt/EBITDA ratio.

Sajjad Alam Analyst +1.212.553.1150 sajjad.alam@moodys.com

NEWS & ANALYSIS Credit implications of current events

4 MOODY’S CREDIT OUTLOOK 6 DECEMBER 2012

Sale of Credit Services Unit Is Credit Positive for Computer Sciences Corp., Credit Negative for Equifax

Last Monday, Computer Sciences Corp. (Baa2 stable) said it had agreed to sell its credit services unit to Equifax Inc. (Baa1 stable) for $1 billion in cash. The announcement is credit positive for CSC because it would use $300-$400 million of the sale’s $750-$800 million in after-tax proceeds to reduce pension liabilities. Although the agreement to acquire the profitable credit services business would be strategically sound for Equifax, the deal is credit negative because it would materially increase financial leverage and reduce liquidity. Moreover, the purchase price, which is more than 9x Equifax management’s expected 2013 EBITDA of $105-$110 million, is at the top end of its previous estimate of $750 million-$1 billion.

The two companies expect to complete the sale by the end of the year. CSC views its credit services business as non-core. The planned divestiture is in line with CSC’s strategy of placing greater emphasis on newer, higher-growth technology products and services.

The sale of the credit services business would be mostly neutral to CSC’s adjusted debt-to-EBITDA leverage because the positive effect of the lower pension obligations would be slightly more than offset by the loss of earnings from the unit, which accounted for about 10% of the company’s profits. CSC management expects the credit services business to generate approximately $230 million in revenue and $100 million in operating income in the current fiscal year, which makes it far more profitable than the company’s average of mid-to-high-single-digit operating margins.

In addition to contributing about half of the sale proceeds to its pension plans, CSC plans to use $300-$400 million to repurchase common stock and use the rest for general corporate purposes. Returning some capital to shareholders is consistent with our view that CSC will gradually resume a modest level of share buybacks as the US Securities and Exchange Commission’s investigation of the company’s accounting and disclosure practices plays out and the company achieves further traction with cost reductions.1

For Equifax, acquiring CSC’s credit services unit would increase pro forma leverage. As of 30 September, Equifax’s debt/EBITDA ratio was 1.8x as adjusted by us and 1.4x on a reported basis, well below management’s target leverage range of 1.75x-2.00x. After Equifax takes on an incremental $800 million of debt to complete the purchase, the company’s debt/EBITDA would initially rise on a pro forma basis to about 2.5x (as adjusted by us). But we expect Equifax to quickly reduce leverage to its stated target range, which is around 2.1x-2.4x using our standard adjustments for leases and pensions. Equifax plans to eliminate share repurchases in 2013 and use free cash flow to reduce debt. Following its 2007 purchase of TALX Corp., the company demonstrated that it is capable of reducing debt after a significant acquisition.

Although the deal would weaken Equifax’s credit metrics and reduce liquidity, we consider the acquisition strategically sound. It presents little execution risk because CSC’s files are already located on Equifax’s IT platform and Equifax has been processing CSC’s credit information and selling those files since 1988. CSC’s files cover almost 20% of the US population across 15 states, granting Equifax ownership and control of credit files in all 50 states, on par with its primary competitors, Experian Finance plc (Baa1 stable) and TransUnion Holding Company Inc. (B2 stable).

1 See Computer Sciences Corporation: Rebuilding Plan Taking Shape, 29 November 2012.

Stephen Sohn Vice President - Senior Credit Officer +1.212.553.2965 stephen.sohn@moodys.com

Suzanne Wingo Vice President - Senior Analyst +1.212.553.0571 suzanne.wingo@moodys.com

NEWS & ANALYSIS Credit implications of current events

5 MOODY’S CREDIT OUTLOOK 6 DECEMBER 2012

In addition to realizing modest cost savings, Equifax may have the opportunity to cross-sell analytics services to former CSC customers. Nonetheless, the company’s ratings would come under pressure if the incremental EBITDA from the credit business unit misses company projections or if debt reduction takes longer to achieve.

NEWS & ANALYSIS Credit implications of current events

6 MOODY’S CREDIT OUTLOOK 6 DECEMBER 2012

CWC’s Sale of Its Monaco & Islands Division Is Credit Positive

Last Monday, Cable & Wireless Communications plc (CWC, Ba2 negative) announced that it had signed an agreement with the Bahrain Telecommunications Company (Batelco, unrated) for the sale of its Monaco & Islands division for a potential total consideration of $1.025 billion. Although the Monaco & Islands division is one of CWC’s more stable businesses, its sale is credit positive.

The company would use the initial $680 million of sale proceeds to repay $330 million outstanding under its revolving credit facility, while the rest would remain as cash on the balance sheet. This would allow CWC to reduce its net debt to around $937 million pro forma from $1.58 billion, bringing its pro forma proportionate net debt/EBITDA ratio down to 1.8x, well within its public guidance of net leverage between 1.5x and 2.5x.

The sale would occur in two stages. First, CWC would dispose of the Islands businesses2 and a 25% stake in Compagnie Monegasque de Communications SAM (unrated), through which CWC owns a 55% stake in Monaco Telecom, for a total consideration of $680 million. The parties expect this phase of the transaction to close in March 2013.

The second stage of the sale would involve a series of put and call options between CWC and Batelco, whereby upon approval of the transaction by the Monegasque regulator, Batelco would acquire the remaining 75% of CWC’s Monaco operations for a cash payment of $345 million, bringing the transaction total to $1.025 billion. If the regulator does not approve the sale of the Monaco operations, Batelco would return the 25% stake in Monaco Telecom to CWC for $100 million, bringing the transaction total to $580 million.

If the entire transaction receives all necessary approvals and CWC receives the additional $345 million, we expect the company to use the additional funds for acquisitions, in line with its stated strategy to reposition itself as a Pan-American telecom operator.

2 Maldives, Guernsey, Jersey, the Isle of Man, Seychelles, South Atlantic and Diego Garcia.

Christian Azzi Analyst +44.20.7772.5470 christian.azzi@moodys.com

NEWS & ANALYSIS Credit implications of current events

7 MOODY’S CREDIT OUTLOOK 6 DECEMBER 2012

iPhone 5 Launch in Korea Is Credit Positive for KT and SKT

Last Friday, the two major Korean telecom operators, SK Telecom Co., Ltd. (SKT, A3 negative) and KT Corporation (A3 negative), began accepting pre-orders for Apple Inc.’s (unrated) iPhone 5, which supports 4G wireless services, or long-term evolution (LTE) technology. The launch of iPhone 5 in Korea, which officially begins tomorrow, is credit positive for KT and SKT because it provides the companies with an opportunity to boost their LTE subscriber base and average revenue per user (ARPU).

According to SKT, the 50,000 units that it had allotted for online pre-orders were sold out by last Saturday, while KT said the number of customers who placed pre-orders surged to 200,000 by last Sunday.

The arrival of the iPhone 5 will give both KT and SKT a distinct advantage over the third major mobile operator in Korea, LG Uplus (unrated), whose LTE service has successfully lured customers from KT and SKT (see Exhibit 1).

EXHIBIT 1

Net Increase in Subscribers in the Mobile-Number-Portability Market

Note: We calculate the net increase of an operator by deducting the number of subscribers who switched to other operators from the number of new subscribers it obtained from other operators. Source: Korea Telecommunications Operators Association

We expect both SKT and KT to gain a lead over LG Uplus in terms of adding new LTE subscribers because the companies can sell the iPhone 5 to new customers and existing iPhone customers wanting to upgrade their devices.

According to the companies, there were around 3.4 million iPhone users in Korea as of October 2012, accounting for about 11% of the country’s 31.4 million smartphone users. In addition, a large number of smartphone users have not yet switched to LTE platforms, thus presenting an attractive opportunity for KT and SKT.

Although KT has lagged its competitors in achieving its year-end target of 4.0 million LTE subscribers (see Exhibit 2), we expect it to benefit most from the launch of the latest iPhone. KT has about 2.5 million iPhone users, more than 70% of the total, compared with SKT, which has about 900,000 users. We note that KT introduced the iPhone in Korea a few months before SKT did. Of KT’s 2.5 million iPhone users, we estimate that about 1.0-1.5 million users are likely to upgrade to the iPhone 5, based on the number of customers whose mandatory subscription period will have expired by the end of 2012.

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Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12

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Serena Won Associate Analyst +852.3758.1527 serena.won@moodys.com

NEWS & ANALYSIS Credit implications of current events

8 MOODY’S CREDIT OUTLOOK 6 DECEMBER 2012

EXHIBIT 2

Number of LTE Subscribers by Operators

Source: Korea Communications Commission, company reports

The positive effect of the iPhone 5’s launch will be at least partially offset by ongoing marketing spending. The Korean telecommunications industry has experienced a significant decline in profit margins owing to a hike in marketing expenses in the race to gain LTE subscribers. Another round of competition triggered by iPhone 5’s launch is likely to force the operators to continue pursuing large promotions, and this will lead to further erosion of margins, which were already declining (see Exhibit 3).

EXHIBIT 3

Industry EBITDA Margins versus Marketing Spending

Note: EBITDA is calculated as the sum of operating income, depreciation and appreciation. Source: Moody’s, company reports

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29%

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Marketing Spending - left axis EBITDA to Revenue - right axis

NEWS & ANALYSIS Credit implications of current events

9 MOODY’S CREDIT OUTLOOK 6 DECEMBER 2012

Banks

Banca Monte dei Paschi Increases Its State Aid Request, a Credit Negative

On 28 November, Banca Monte dei Paschi di Siena (MPS, Ba2 negative; E/caa1 stable)3 disclosed that it had raised its request for state aid to meet the European Banking Authority’s (EBA) capital requirement. The increase to €3.9 billion from €3.4 billion would cover losses the bank will incur when it closes out structured transactions on Italian sovereign bonds. Two days later, legislators proposed a change in Italian law that specifically allows MPS to pay the interest on state aid using hybrid bonds if it reports a full-year loss. The additional public support, while immediately beneficial, is credit negative because it reveals that MPS lacks a capital buffer that exceeds the minimum requirement, thereby increasing its vulnerability if it suffers unexpected losses.

The request for additional state aid reflects MPS’ weak profitability and loss absorption capacity and highlights its significant government securities holdings, both of which are credit negative. In 2009, MPS received €1.9 billion of state aid, which it will repay with the new state aid the bank requested in June 2012 and will receive by January 2013.

We believe that the goal of unwinding MPS’ structured transactions is to enable the bank to fully benefit from the income of its sovereign bond holdings, which would provide a critical boost in profitability. However, we consider income generated from a carry trade to be opportunistic because it relies on the low cost of European Central Bank (ECB) funding. At the same time, carry trades create credit and concentration risks that can often outweigh the additional income.

Although the bank has disclosed few details, we understand that it will unwind structured transactions funding part of its €24 billion, largely long-dated Italian government bond portfolio. The funding structures, carried out in previous years, locked in a high cost for MPS, although the bank has not disclosed details. But funding costs for Italian borrowers have declined significantly since last year, with the yields on 10-year Italian government bonds falling to 4.5% from around 6.5% at the end of 2011, when the ECB launched its first long term refinancing operation (LTRO). The drop in yields has resulted in a substantial negative mark-to-market of the transactions, which are included in the EBA’s calculation of MPS’ capital shortfall. The bank will close these transactions and fund its high-yielding government bond portfolio with cheaper sources, including €29 billion from the LTRO at an interest rate of 0.75%.

For 2012, the bank will likely pay €170 million of interest on the outstanding €1.9 billion of state aid by issuing additional hybrid bonds, given the loss we expect the bank to report for the year. Including the €3.9 billion MPS expects to receive by January 2013, total aid will rise to €4.07 billion. If the bank reports a full-year loss for 2013, which is a distinct possibility, it would pay €407 million in interest (assuming 10% interest on the €4.07 billion of state aid) by issuing additional hybrid bonds, further increasing total state aid. Increased state aid makes the bank more reliant on the state and reduces the possibility of full repayment, reinforcing our negative read of last week’s news.

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

assessment, and the corresponding rating outlooks.

London +44.20.7772.1000

NEWS & ANALYSIS Credit implications of current events

10 MOODY’S CREDIT OUTLOOK 6 DECEMBER 2012

Banca Comerciala Romana Shareholders Approve Credit Positive Capital Injection

Last Monday, Romania’s Banca Comerciala Romana S.A.’s (BCR, Ba1 negative; E+/b1 negative)4 shareholders, led by the Austria-based Erste Group Bank AG (A3, negative; D+/baa3, negative), which owns 93.3% of BCR, approved a RON501 million (€110 million) recapitalisation of the troubled bank. The recapitalisation is credit positive for BCR because it replenishes some of the capital it lost during the first nine months of 2012 and provides more evidence of parental support.

With RON76.4 billion (€16.8 billion) in assets as of September, BCR is the leading bank in Romania by total assets and had a Tier 1 capital ratio of 12.75% as of the first half. Although capital appears adequate, a weakening operating environment in Romania poses significant challenges to BCR’s profitability and current capital buffer, which we conclude would only be sufficient in a moderate macroeconomic stress scenario. The announced capital injection would add approximately 100 basis points to BCR’s Tier 1 capital ratio.

BCR’s Romanian peers, including BRD-Groupe Societe Generale (Baa3 negative; D-/ba3 negative) and Raiffeisen Bank SA (Ba1 stable; D-/ba3 stable), have reported higher capitalisation (see Exhibit 1), which indicates that doing business in Romania is generally risky and requires high capital buffers.

EXHIBIT 1

Tier 1 Capital Ratio and Returns on Equity Among the Three Banks in Romania

Source: Moody’s Banking FM, the banks

BCR’s susceptibility to Romania’s fragile operating conditions was particularly visible in the first nine months, when the bank lost RON758.9 million (€171.3 million), compared with a year-earlier net profit of RON68.9 million (€16.4 million). Driving the loss was a sharp increase in loan-loss charges related to weakening asset quality, as reflected by an increase in BCR’s non-performing loan (NPL) ratio to 25.8% for the third quarter from 20.8% a year earlier. BCR had the weakest NPL ratio among the three rated Romanian banks, with BRD reporting an NPL ratio of 20.1% in the third quarter and Raiffeisen reporting an NPL of 7.2% in the first half. BCR’s NPL ratio was also significantly higher than the Romanian banking system average of 17.34% (see Exhibit 2).

4 The 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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BCR BRD Raiffeisen

Tier 1 Ratio – left axis Return on Equity – right axis

Simone Zampa Vice President - Senior Analyst +39.02.91481130 simone.zampa@moodys.com

Jakub Lichwa Associate Analyst +44.20.7772.1395 jakub.lichwa@moodys.com

NEWS & ANALYSIS Credit implications of current events

11 MOODY’S CREDIT OUTLOOK 6 DECEMBER 2012

EXHIBIT 2

Non-Performing Loan Ratios of the Three Romanian Banks and Banking System

Source: Moody’s Banking FM, banks’ interim reports

The capital injection confirms Erste’s ongoing commitment to BCR, which accounted for approximately 9% of Erste’s total assets at the end of 2011. Erste already provided a similar capital increase of approximately €100 million to BCR in December 2011, which aimed to support BCR’s risk absorption capacity in the deteriorating operating environment.

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BCR BRD Raiffeisen Romanian Average

NEWS & ANALYSIS Credit implications of current events

12 MOODY’S CREDIT OUTLOOK 6 DECEMBER 2012

Insurers

NAIC’s New Reserving Approach Is Credit Negative for US Life Insurers Last Sunday, the National Association of Insurance Commissioners (NAIC) voted to adopt a new principles-based approach to establishing life insurance company reserves. This reserving change is credit negative for US life insurers because reserves are likely to decline, freeing up capital that issuers are likely to deploy in shareholder-friendly ways. In addition, state regulators could find it challenging to effectively monitor the complex internal company models that would replace the simpler, more conservative current approach.

The new rules would require the approval of at least 42 of the NAIC’s 56 member jurisdictions, and the approval must also equal 75% or more of the industry’s affected premium. The latter requirement may prove challenging to achieve because two major states, New York and California, which together account for approximately 18% of the industry premiums and deposits, oppose the new rule. Since approval and phase-in of the new methodology would take several years and would then apply only to new business, the reserve change’s full financial effect would be several years off if it was approved.

The principles-based reserving methodology relies heavily on complex simulation models that give individual companies significant latitude in setting capital markets and actuarial assumptions based on companies’ own experience, as opposed to prescribed, conservative assumptions. We expect that as insurers are able to lower reserves, they would remove the “excess” capital from their operating companies, using that capital to buy back stock, increase shareholder dividends, make acquisitions, or leverage existing capital to support additional business. As a result, the total capital and reserve cushion available in times of stress would decrease.

However, we expect principles-based reserving would reduce “redundant” reserves for certain term life and secondary guarantee universal life products. Many insurers have executed capital efficient reinsurance transactions, moving these reserves and required capital to captive reinsurers, incurring costs as they finance the reserves with borrowed money or letters of credit. When insurers no longer need to incur these extra costs, they can theoretically pass those savings to customers through more competitive product pricing.

State regulators face a daunting task of assessing and monitoring the complex computer models that incorporate varying assumptions set by individual company judgment. Based on the lessons that banks and their regulators learned during the financial crisis, new skills and substantial additional staffing for insurance regulators are necessary to thoroughly validate appropriate reserves in times of stress. The financial crisis underscored the banks’ inadequate capital and reserving methodologies. In response, banking regulators, including the Federal Reserve, now provide the economic scenarios and perform formal stress tests for the nation’s largest banks.

Compared with the banks, insurers generally fared well during the financial crisis, in large part because statutory reserves were conservative, providing protection in a stress environment. It is less likely that the same level of reserve cushion would be present in the next stress environment under principles-based reserving.

Ann G. Perry Vice President - Senior Credit Officer +1.212.553.4607 ann.perry@moodys.com

NEWS & ANALYSIS Credit implications of current events

13 MOODY’S CREDIT OUTLOOK 6 DECEMBER 2012

Japanese Life Insurers’ Declining Savings Product Sales Is Credit Positive

On 28 November, Japanese life insurers released half year results that showed a drop in the sales of savings-type products such as single-payment whole life. A decline in the sales of these products is credit positive for life insurers because it is evidence that they have tightened their risk controls to curtail their exposure to savings-type products that are likely to generate losses in the currently low interest rate environment.

Low interest rates threaten to undercut the guaranteed yields on these products, prompting many insurers to restrict their sale. Some insurers including Meiji Yasuda Life Insurance Company (A1 stable) have placed explicit caps on the number of policies they sell through the bancassurance channel.

As shown in the exhibit below, in the first half of the fiscal year ending 31 March 2013, sales of single-payment whole life policies, a savings-type product, through bancassurance decreased 28% from a year earlier, reversing a sharp increase in past years.

Japanese Insurers’ Sales of Single-Payment Whole Life Products

Note: Data for fiscal years ended 31 March, except 2012, which is annualized through September 2012. Source: Major traditional insurers that disclose their sales of single-payment whole life products, including Nippon Life Insurance Company (Aa3 stable), Dai-ichi Life Insurance Company Ltd. (A1 stable) and its bancassurance subsidiary Meiji Yasuda Life Insurance Company (A1 stable), Sumitomo Life Insurance Company (A2 stable) and Fukoku Mutual Life Insurance Company (A2 stable) and its bancassurance subsidiary.

The decline in savings-type policy sales also reflects some insurers reducing the guaranteed yield on these policies. Currently, the standard rate (which Japan’s Financial Services Agency regulates when calculating necessary policy reserves) is 1.5%, but we expect it to fall to 1.0% in April. We understand that insurers have begun considering reducing guaranteed rates on their policies ahead of this schedule to forestall customers wishing to lock into policies with higher rates.

A recent decline in premium flows has alleviated the risk that Japanese insurers would again experience their negative spread burden, which plagued them for more than 10 years. The threat of negative spreads has waned as a result of the gradual decline of guaranteed rates via the termination or surrender of policies and insurers’ efforts to accumulate additional policy reserves from retained earnings. Curtailed sales of savings-type products reflect that insurers have tightened their risk underwriting and management to minimize the threat of negative spreads, particularly as recent calls by high-ranking political figures for further quantitative easing measures could send interest rates even lower in 2013.

For the past several years, savings-type products, as well as so-called third-sector products (medical, nursing care, cancer), have been drivers of insurers’ premium income, reflecting Japanese customers’ demand for longevity products as the country’s population ages. The main customers of these products are people saving for life after retirement, a population we expect to grow over the next five years.

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2008 2009 2010 2011 2012 Annualized

Kenji Kawada Vice President - Senior Analyst +81.3.5408.4056 kenji.kawada@moodys.com

NEWS & ANALYSIS Credit implications of current events

14 MOODY’S CREDIT OUTLOOK 6 DECEMBER 2012

Covered Bonds

Transfer of Spanish Cover Pools to Bad Bank Is Credit Positive

On 28 November, the European Commission approved the restructuring plans of four nationalized banks, under which the banks will begin transferring real estate developer loans to Sociedad de Gestión de Activos Procedentes de la Reestructuración Bancaria (SAREB), Spain’s bad bank, before year-end. Although the loan transfers will decrease the collateralisation supporting these banks’ covered bonds, the transfers are credit positive for covered bondholders because they enable the banks to clean up their balance sheets and raise the likelihood that the banks’ covered bonds will transfer to stronger entities.

The four nationalized banks undergoing a restructuring are Banco Financiero y de Ahorros (B2 review direction uncertain) and its subsidiary Bankia (Ba2 review uncertain; E+/b2 review uncertain),5 NCG Banco S.A. (B1 review for downgrade; E+/b2 review for downgrade), Catalunya Banc SA (B1 review for downgrade; E+/b2 review for downgrade) and Banco de Valencia S.A. (Caa1 outlook developing; E/ca stable).

Among the €45 billion of assets that SAREB will acquire from the four banks, collectively referred to as Group 1 banks, are all real estate developer loans above €250,000 that back mortgage covered bonds (or cédulas), every foreclosed real estate asset above €100,000, and all significant interests linked to the real estate sector.6 Other banks that require capital, classified as Group 2 banks, will transfer their toxic assets to SAREB in 2013.

The transfer of real estate assets to Spain’s bad bank will strengthen the banks. The thorough clean-up of the banks’ balance sheets7 will help restore investor confidence in the recapitalised entities and enable stronger entities to acquire those non-viable ones, without entering into insolvency proceedings.

We expect Spanish authorities to transfer the cover pools of non-viable banks to stronger entities, as evidenced by the 27 November announcement that Caixabank (Baa3 negative; D+/ba1 negative) would buy Banco de Valencia. The restructuring plans also envisage selling Catalunya Banc and NCG Banco to third parties, while Bankia would continue serving its core retail and small and midsize enterprise customers after reducing its balance sheet.

The loan transfers will lead some banks to breach their over-collateralisation statutory minimums. Unlike securitizations, cédulas are on-balance sheet debt instruments backed by a dynamic cover pool. Because an issuer’s entire mortgage loan book backs covered bonds, any transfer of the mortgage book reduces the over-collateralisation that protects cédulas holders. Issuers may issue a maximum of 80% against those assets that qualify as eligible, providing for 25% statutory over-collateralisation of the eligible share of the cover pool.

As a result of the transfer, we estimate that the average total protection for each euro of cédulas in Group 1 and Group 2 banks would immediately drop to €1.63 per mortgage loan from €2.11. Expressed another way, total over-collateralisation would drop to 63% from 111% (see exhibit). In

5 The 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. 6 For more information, click here. 7 See Details on Spain’s Bad Bank Enhance Its Ability to Clean Up Balance Sheets, Credit Outlook, 19 November 2012

and European Commission Okays Credit Positive Restructuring Plans for Four Spanish Banks, Credit Outlook, 3 December 2012.

Jose de León Senior Vice President +34.91.768.8218 jose.deleon@moodys.com

Miguel López Patrón Associate Analyst +34.91. 768.8225 miguel.lopezpatron@moodys.com

Tomás Rodríguez-Vigil Associate Analyst +34.91.768.8231 tomas.rodriguez-vigil@moodys.com

NEWS & ANALYSIS Credit implications of current events

15 MOODY’S CREDIT OUTLOOK 6 DECEMBER 2012

addition, on average, the statutory eligible over-collateralisation would drop to 18% from 40%, thereby obliging banks to restore their statutory minimums. Once the issuers restore their statutory minimums, the total over-collateralisation would increase to 80% from 63% and eligible over-collateralisation would rise to 30% from 18% (see WA OC After Adjustments data in exhibit).

Spanish Covered Bond Over-Collateralisation Following Asset Transfer to SAREB

Source: Moody’s

Issuers will early redeem retained cédulas. Issuers have to restore any breach of 25% statutory over-collateralisation within 10 days of the breach by depositing cash or government debt at the Bank of Spain. Within four months of the breach, they must either increase the size of eligible assets or reduce the volume of outstanding cédulas by cancelling retained cédulas or forcing the early redemption of outstanding cédulas.

Given that issuers’ mortgage lending has declined sharply in the past few years, we expect banks to cancel retained cédulas and free up eligible assets by winding down retained residential mortgage-backed securities.

Although the law is not clear, we believe that forced early redemption is the last option and in any case it would be at least at 100% of the nominal value. Otherwise, investors could consider it as a default and challenge the early redemption.

111%

40%

63%

18%

80%

30%

0%

20%

40%

60%

80%

100%

120%

Total Over-Collateralisation Eligible Over-Collateralisation

Current Weighted Average OC Weighted Average OC After Transfer to SAREB

WA OC After Adjustments Statutory Eligible OC

CREDIT IN DEPTH Detailed analysis of an important topic

16 MOODY’S CREDIT OUTLOOK 6 DECEMBER 2012

India and Cyprus Banking System Outlooks Annual banking system outlooks express our expectation of how the creditworthiness of banks in a particular country will evolve over the next 12-18 months. Below, we summarize recent reports explaining our negative outlooks on the banking systems of India and Cyprus. Our full reports can be accessed here and here.

India

Our outlook is negative for the Indian banking system, as it has been since November 2011, reflecting the challenging nature of an operating environment characterized by slow economic growth, high inflation, high interest rates and a weak local currency. We expect these factors to lead to a further deterioration in asset quality, an increase in provisioning costs and a decline in profitability.8

Furthermore, loan classification (more particularly with regards to restructured loans) and provisioning practices in India are weak and mask the extent of the banks’ asset quality and capital challenges. When we adjust for these, we find that many banks’ impaired asset levels are at or close to the assumptions we use under our adverse scenario for stress testing purposes.

On the positive side, one anchor of stability for Indian banks is their strong business franchises, which support their low-cost funding profiles and help them maintain sizable lending margins to sustain pre-provision earnings.

Operating environment. The operating environment will remain difficult, and the limited fiscal capacity of the Indian government is constraining it from exercising growth policies. Our central scenario assumes GDP growth of 5.4% for fiscal 2013,9 down from 6.5% in fiscal 2012, which was already significantly below the 8.5% average growth rate of the previous five years. The weaker economic activity and the persistently high interest rates resulting from chronic inflation above 8% is in turn challenging borrowers’ debt servicing capacity.

Asset quality and capital. We expect India’s difficult economic conditions to cause both gross non-performing loans (NPLs) and restructured loans to continue to rise. We believe it is important to monitor restructured loans alongside NPLs in order to capture the true asset quality risks facing Indian banks. This is because loan classification rules allow banks to report as “restructured loans” some assets that banks in other jurisdictions would report as impaired. In doing so, Indian banks avoid the higher provisioning requirements attached to NPLs, which are already weaker than international standards.

Furthermore, Indian banks do not perform particularly well under scenario analysis (stress testing). This is largely for the reasons mentioned above, but also because we consider that under stressful conditions, asset quality risks may be amplified by the banks’ high levels of loan concentrations, exposing capital to the shock of a large exposure turning delinquent.

But even without stress, we estimate the banks’ capitalization and loss-absorbing buffers to be modest. While the Indian banking system’s current reported average core capital levels is 10%, well above the minimum regulatory capital requirement, we expect that a majority of banks (especially public banks) will need to raise additional capital by the end of the period covered by our outlook (i.e., 12-18 months) owing to the combined effects of the following:

8 Unless noted otherwise, Moody’s-rated data originate from company reports and Moody’s Banking Financial Metrics

whereas system-wide trends are sourced from the Reserve Bank of India and Moody’s Country Credit Statistics. 9 India’s fiscal 2013 runs from 1 April 2012 to 31 March 2013.

Vineet Gupta Vice President - Senior Analyst +65.6398.8336 vineet.gupta@moodys.com

CREDIT IN DEPTH Detailed analysis of an important topic

17 MOODY’S CREDIT OUTLOOK 6 DECEMBER 2012

» Loan growth outstripping internal capital generation

» A rise in credit costs, as asset quality worsens

» The government’s expectation that public banks shall maintain a Tier 1 ratio of 9%, and the de facto benchmark this expectation sets for other banks, especially given the impending implementation of Basel III rules and the gradual introduction of a minimum Tier 1 ratio of 8%, which the banks are already meeting.

That said, barring a significantly worse-than-expected scenario, we do not expect banks to face difficulties in raising capital. The Indian government remains committed to injecting capital into the public sector banks. At the same time, we expect private-sector banks to maintain sufficiently healthy credit metrics to instill confidence and raise capital from the market if needed.

Funding and liquidity. The banks’ funding profile is a key credit strength of Indian banks, reflecting their strong business franchises and India’s high savings rate. The system boasts a loan-to-deposit ratio of 79% and the banks generally have limited reliance on wholesale borrowings.

Furthermore, the banks’ large holdings of government securities (at about 21% of total banking assets) provide ample local currency liquidity coverage. And despite deterioration in the country’s balance of payments, the banks remain only marginally exposed to foreign exchange risks because their foreign currency assets account for only 4% of total assets and are almost entirely funded by foreign currency term market funds and sticky foreign currency deposits.

Profitability and efficiency. We expect a slowdown in lending income because of the deteriorating nature of the operating environment, although the banks’ currently wide lending margins (net interest margins of 300 basis points) would allow for steady pre-provision incomes as a percentage of average risk-weighted assets.

However, net income in the next 12-18 months will be challenged by higher provisioning costs from our expectation of a rise in problem loans, which, on balance, underpins our negative assessment of Indian banks’ profitability prospects.

Support. We assume a high probability of systemic support. The government already provides strong ongoing support in the form of annual equity infusions (INR158 billion, or approximately 0.2% of GDP, is included in the fiscal 2013 budget) for the public sector banks. Moreover, all banks must meet loan quotas for certain sectors of the economy, implying a high degree of involvement by the government in the banking sector. If needed, we believe the government would provide extraordinary support in the form of unsecured loans or capital injections to both the public and the rated private banks.

India Banking System Outlook Overview Key Credit Drivers Assessment

Operating Environment Negative

Asset Quality and Capital Negative

Funding and Liquidity Stable

Profitability and Efficiency Negative

Systemic Support Stable

Banking System Outlook Negative

CREDIT IN DEPTH Detailed analysis of an important topic

18 MOODY’S CREDIT OUTLOOK 6 DECEMBER 2012

Cyprus

The outlook for Cyprus’s banking system remains negative, as it has been since 2007. The negative outlook reflects our expectation of severe capital shortfalls owing to highly adverse operating environments in Cyprus and Greece, the banks’ primary markets, continuing to drive a sharp deterioration in asset quality. The negative outlook also reflects a further weakening of the sector’s funding and liquidity, as evidenced by persistent and significant deposit outflows from Greece and Cyprus. We expect these acute asset quality and funding pressures to continue over the next 12-18 months, and most likely beyond. In our view, ongoing funding and capital support from the local and euro area authorities will be necessary to avoid severe financial disruptions in the system.

Capital. Over the outlook period, we expect Cypriot banks to face substantial recapitalisation needs driven by acute asset quality deterioration, with the degree of recapitalisation requirements varying among individual banks. Based on our expectations of further asset quality deterioration, we estimate that the cost of recapitalising the three largest banks to a 10%10 core Tier 1 capital ratio will exceed €8 billion (around 47% of GDP). Although we expect the two largest banks to continue their efforts to find a private-sector solution, the bulk of the recapitalisation will have to come from official support. Furthermore, the banks’ capital shortfall would be significantly larger if Greece were to exit the euro area, a risk we currently assign a probability of one in three.

Operating environment. Cypriot banks face adverse operating environments in Cyprus and Greece, with a severe decline in consumption and business activity that has prompted the sector to significantly deleverage. In Cyprus, we expect real GDP to contract by 4% in 2013, following a 2.3% contraction in 2012, owing to the steep correction in real-estate prices and the continued retrenchment of the real-estate sector; declining activity in the services sector; and our expectation that austerity measures will further suppress domestic consumption.

We expect credit contraction of around 5% in the banks’ domestic market mainly because of the banking sector’s need to deleverage owing to liquidity and capital constraints, and limited demand for credit from overleveraged Cypriot households. Declining credit will also create a negative feedback loop, weakening domestic economic prospects. In Greece, following a 7.1% contraction in real GDP in 2011, we expect real GDP to contract by 6.9% in 2012 and 4.2% in 2013, bringing the cumulative contraction to 25% since 2008.

Asset Quality. We expect acute deterioration in asset quality and estimate that non-performing loans (NPLs) will exceed 30% of gross loans over the outlook horizon, up from an estimated 22% in June 2012. We expect the acceleration in NPLs in recent quarters in Greece (combined Greek loans account for around 38%11 of our rated banks’ gross loans) to continue, weakening banks’ asset quality in proportion to their relative lending exposure in Greece. Furthermore, we expect further deterioration of domestic asset quality, driven by banks’ significant exposures to the depressed real-estate and construction sectors (accounting for an estimated 26% of aggregate loans), and individual borrowers’ weakening ability to service their debt, owing to a sharp rise in unemployment and pressured disposable income levels. The recent build-up of rescheduled loans, which we currently estimate to be 16% of gross loans for the largest banks, also underpins our view of further rapid asset-quality deterioration. Moreover, we expect the banks’ relatively low current stock of loan-loss reserves, which

10 The 10% core Tier 1 has been a requirement for other countries receiving Troika support packages (e.g. Ireland, Portugal

and Greece). 11 Source: Banks’ financial statements

Melina Skouridou, CFA Analyst +357.25.693.021 melina.skouridou@moodys.com

CREDIT IN DEPTH Detailed analysis of an important topic

19 MOODY’S CREDIT OUTLOOK 6 DECEMBER 2012

we estimate at 42% of non-performing loans as of June 2012, and high reliance on real-estate collateral to estimate credit losses, will lead to increased provisioning needs over the outlook horizon.

Funding and liquidity. We expect further deposit outflows in Greece and Cyprus to exacerbate funding and liquidity pressures, triggering increased reliance on central bank funding. Deposits in Greece declined by 38% between December 2010 and June 2012, while we estimate that non-resident, international business unit deposits in Cyprus declined 22% over the same period. This exhausted certain banks’ liquidity buffers and increased their use of central bank funding. Although Cypriot banks remain primarily deposit funded with deposits at 70%12 of assets as of June 2012, we consider that a high portion of the deposits are confidence sensitive, rendering the banks’ funding base vulnerable to further shocks.

Profitability and efficiency. We expect Cypriot banks to continue posting large losses over our outlook period owing to declining pre-provision income (PPI) and large credit costs. Over first-half 2012, Cypriot banks reported a combined loss of €1.4 billion, following a €5.1 billion loss in 2011, owing to lower PPI and higher impairments, which we anticipate will remain elevated. We expect the decline in PPI to continue to be driven by lower interest income arising from deleveraging efforts leading to very weak new lending levels and rising deposit costs, particularly in Greece, and lower fee income owing to declining business volumes, particularly in the profitable international banking business.

Systemic support. While the deposit ratings on the largest Cypriot banks incorporate two notches uplift from our assumptions on the likelihood of systemic support, the delay in negotiations between the government and the Troika (the European Commission, the European Central Bank and the International Monetary Fund) on a support package that would finance bank recapitalisations has prompted us to review these assumptions. As such, following the review for downgrade of the Cypriot government’s bond rating on 16 November, we placed the deposit ratings of Cypriot banks under review for downgrade on 19 November. The bank review will closely track the government rating review and will focus on the progress that Cypriot authorities make in securing a support programme with the Troika.

Cyprus Banking System Overview Key credit drivers Assessment

Operating Environment Negative

Asset Quality and Capital Negative

Funding and Liquidity Negative

Profitability and Efficiency Negative

Systemic Support Negative

Banking System Outlook Negative

12 Source: Banks’ financial statements

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

20 MOODY’S CREDIT OUTLOOK 6 DECEMBER 2012

NEWS & ANALYSIS Corporates 2 » NCR Corp.'s Planned Retalix Acquisition Is Credit Negative » Dividend Announcements Since US Election Leave Creditors

Empty-Handed » AVG's Renewal of Advertising and Search Contract with Google

Is Credit Positive

Infrastructure 6 » Argentina Raises Utility Rates, a Credit Positive for

Distribution Utilities

Banks 7

» Iceland's Housing Financing Fund Wins Initial Approval for Capital Injection

» France's Proposals on Bank Resolution and Speculative Activities Are Credit Positive

» European Commission Okays Credit Positive Restructuring Plans for Four Spanish Banks

» China Lowers Merchant Fees for Bankcards, a Credit Negative for Banks

» Basel III Capital Rules for Taiwanese Banks Are Credit Positive » Indonesia's Higher Capital Requirements and Multi-Licensing

for Banks Would Be Credit Positive

Asset Managers 18

» Short Duration ETFs Are Credit Positive for Money Market Managers

» Banorte's Acquisition of Afore Bancomer Is Credit Positive

Sovereigns 22 » El Salvador's $800 Million Bond Issuance Is Credit Positive » Belize's Revised Debt Restructuring Offer Is Credit Positive

US Public Finance 25

» New York Transit Authority’s Hurricane Sandy Debt Issuance Would Be Credit Negative

Accounting 27

» Revised IASB Proposal on Financial Instruments Is Positive for Investors

RATINGS & RESEARCH Rating Changes 29

Last week we downgraded Alere, Hewlett-Packard, inVentiv Health, Western Union, Caja Laboral, Commerce Bank of Missouri, Hypo Tirol, Siena Italy, 56 tranches of four US prime jumbo RMBS deals, and upgraded Consort Healthcare, among other rating actions.

Research Highlights 38

Last week we published on EMEA telecom service providers, Asia steel, global drilling and oilfield service, US retail, US healthcare, US gaming, US packaging, North American auto parts, North American capital goods, China property, Sweden banking system, Cyprus banking system, US banks, asset managers, Lebanon, India, Botswana, El Salvador, US public finance housing, US auto ABS, Spanish RMBS, and Asia securitization, among other reports.

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