MOODYS.COM

3 JUNE 2013

NEWS & ANALYSIS Corporates 2 » Royal Caribbean Cruise Ship Fire Keeps Consumer Concerns Afloat » US Regulator’s Challenge of Pinnacle-Ameristar Merger Is

Credit Negative » Service Corporation’s Planned Acquisition of Stewart

Enterprises Is Credit Negative » Valeant Faces More Risk from Bausch & Lomb Acquisition » Domtar’s Diaper Deal Diversifies Away from Declining Paper » China’s Plan to Cut Import Tax on Swiss Watches Is Credit

Positive for Hengdeli » EMP’s Divestment of Masela Gas Block Is Credit Positive

Infrastructure 9 » KEPCO’s Nuclear Power Shutdowns Are Credit Negative

Banks 11

» BIS Proposals on Asset Encumbrance Would Benefit Bank Bondholders » Bci’s Acquisition of City National Bank of Florida Is Credit Negative » German Banks’ Smaller Capital Shortfall Is Credit Positive, but

Short of Basel III Compliance » Despite Greece’s Improving Economic Sentiment, Indicators

Point to Continued Bank Asset Quality Deterioration » BMI’s Potential Merger with Al Salam Bank in Bahrain Is Credit Positive

Insurers 19

» Fidelity National’s Acquisition Of Lender Processing Service Is Credit Negative

» Cathay Financial’s Capital Raise Is Credit Positive for Its Bank and Life Insurance Subsidiaries

Sovereigns 21 » IMF Debt Restructuring Proposals Are Credit Negative for

Distressed Sovereign Bondholders » Hungary’s Exit from EDP Does Not Alleviate Debt Sustainability

Concerns » Romania’s Exit from EU’s Excessive Deficit Procedure Is Credit

Positive » Copper Mining Layoffs Are Credit Negative for Zambia » China’s Economic Reforms to Unleash Private Sector Are Credit

Positive » Philippines’ Record Fiscal Surplus, Robust Growth and Election

Results Are Credit Positive

» Thailand’s Increasingly Expensive Rice Buying Scheme Is Credit Negative

» Mongolia’s New Securities Law Is Credit Positive

US Public Finance 32

» Court Ruling Upholding Medi-Cal Cuts Is Negative for California Hospitals, Positive for State

Securitization 34

» SLM’s Restructuring Is Credit Negative for Its Private Student Loan Securitizations, Less So for FFELP

» Late Recognition of $1 Billion Losses on RMBS Previously Serviced by Homeward Is Credit Negative

RATINGS & RESEARCH Rating Changes 36

Last week we downgraded Alcoa, Carestream Health, AllianceBernstein, Tunisia, the Italian regions of Sicily, Campania, Piedmont and Lazio and Suffolk County, New York, and upgraded Building Materials Corporation of America, General Mills, LyondellBasell Industries, American Water Works, American Water Capital, New Jersey American Water, Pennsylvania American Water, five Indonesian banks, Deutsche Hypothekenbank, International Financial Club, and Tlalnepantla, Mexico among other rating actions.

Research Highlights 46

Last week we published on US for-profit hospitals, China property developers, US retailers, US life science, US gaming, US packaging, global commercial aerospace, UK electricity transmission, US banks, Swiss banks, Papua New Guinea, Nigeria, the euro area's southern perimeter, Finland, Montenegro, Sub-Saharan African sovereigns, CLOs, UK RMBS, Asia-Pacific securitizations, Canadian ABCP and US CMBS, among other reports.

RECENTLY IN CREDIT OUTLOOK

» Articles in Last Monday’s Credit Outlook 52 » Go to Last Monday’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 3 JUNE 2013

Corporates

Royal Caribbean Cruise Ship Fire Keeps Consumer Concerns Afloat A fire early last Monday morning aboard Royal Caribbean Cruises Ltd.’s (Ba1 stable) Grandeur of the Seas while en route to the Bahamas is credit negative because it will reduce the company’s earnings, take the ship out of service for six weeks and exacerbate consumers’ concerns about cruise-ship safety.

Royal Caribbean said last Wednesday that the incident would reduce earnings, net of insurance proceeds, by $0.10 per share. This is equal to $22 million, a small portion of the company’s $215 million of cash as of 31 March. The losses include full refunds and a discount on a future cruise for passengers aboard the stricken ship and thousands more who were booked on now-cancelled sailings. The company expects the ship, which equals roughly 2% of its fleet capacity of 98,650 berths, to return to service on 12 July.

Royal Caribbean’s bookings are insulated from the negative effect of this incident because it occurred late in the booking cycle for 2013. We estimate that the company has sold all but about 20% of its capacity for the year. We still expect the company to generate sufficient cash flow to reduce debt and maintain retained cash flow to total debt around the current level of 13.1%. The fire has no effect on Royal Caribbean’s credit ratings.

Nevertheless, the fire is another in a series of highly publicized cruise ship incidents that are pressuring pricing. The industry has grappled with heightened media scrutiny of ship incidents ever since the deadly Costa Concordia accident off the coast of Italy in January 2012. More recently, a shipboard fire in February left the Carnival Triumph adrift for days without key support systems. Carnival Corporation (A3 review for downgrade), operator of both ships, said on 20 May it expected a 2%-3% decline in net revenue yields this year, a consequence of ticket discounting arising largely from negative publicity surrounding the Carnival Triumph incident.

The Royal Caribbean fire, which did not cause injuries, was much less serious than the Costa Concordia and Triumph incidents. As such, it has faded from the media spotlight more quickly than the others. The Costa Concordia case is still making headlines because the ship’s captain faces criminal charges and the ship remains lying on its side awaiting removal. All of this reminds consumers of risks aboard cruise ships, which is likely to prompt further fare discounting, and is no help to the industry when it is also dealing with slow bookings in Europe and continued economic weakness in the US.

Margaret Holloway Vice President - Senior Credit Officer +1.212.553.4542 margaret.holloway@moodys.com

NEWS & ANALYSIS Credit implications of current events

3 MOODY’S CREDIT OUTLOOK 3 JUNE 2013

US Regulator’s Challenge of Pinnacle-Ameristar Merger Is Credit Negative Last Wednesday, the US Federal Trade Commission (FTC) challenged Pinnacle Entertainment, Inc.’s (B1 stable) $2.8 billion acquisition of Ameristar Casinos, Inc. (B1 stable), claiming that the deal would lead to higher prices for consumers. The FTC’s action is credit negative for both companies because it will likely delay closing of the acquisition and could result in cancellation of the deal or asset divestitures that would dilute its benefits.

The merger of the two US regional gaming operators, announced in December, would create a more formidable competitor to Penn National Gaming, Inc. (Ba1 stable), another regional operator that is larger, financially stronger and more geographically diverse than either Pinnacle or Ameristar. Unlike international rivals such as Las Vegas Sands Corp. (Ba2 stable) and Wynn Resorts, Limited (Ba1 stable), which have a large presence in Asia and other overseas markets, the US regional operators battle over smaller, local gaming markets.

The acquisition of Ameristar would boost Pinnacle’s current portfolio of owned-and-operated casinos to 15 from seven and significantly expand its geographic footprint. Pinnacle would eliminate Ameristar as a competitor, reduce business risk and improve its operating margins and free cash flow potential. Without the deal, both companies would be left in direct competition with each other and the larger Penn National.

Any action by the FTC that would weaken or prevent Pinnacle and Ameristar’s combination would be credit positive for Penn National because it would not have to face a larger competitor in St. Louis, Missouri, a market with significant strategic value for all three companies. Penn, with the acquisition of Harrah’s St. Louis, recently entered St. Louis, where Pinnacle and Ameristar currently get about 32% and 22% of their property-level EBITDA, respectively.

The FTC’s administrative complaint alleges that the acquisition will significantly reduce competition in St. Louis and Lake Charles, Louisiana, where the two companies would have competed directly upon completion of an Ameristar casino scheduled to open in 2014. The FTC’s main issue is that Pinnacle will be able to raise prices by manipulating payouts to gamblers. Pinnacle responded on 30 May that it is committed to completing the transaction as expeditiously as possible and within the timeframe agreed upon with Ameristar.

At a minimum, the FTC’s challenge will delay the closing of the Pinnacle-Ameristar acquisition until the end of 2013 or early 2014, and could also force Pinnacle to sell assets in Lake Charles or St. Louis. The companies originally expected the transaction to close in the second or third quarter of this year.

Keith Foley Senior Vice President +1.212.553.7185 keith.foley@moodys.com

NEWS & ANALYSIS Credit implications of current events

4 MOODY’S CREDIT OUTLOOK 3 JUNE 2013

Service Corporation’s Planned Acquisition of Stewart Enterprises Is Credit Negative Last Wednesday, Service Corporation International (Ba2 review for downgrade) said it had agreed to acquire Stewart Enterprises, Inc. (Ba3 review for downgrade) for $1.4 billion. The planned acquisition, which Service Corporation said it expected to complete by early 2014, is credit negative for the company because it will issue approximately $900 million of new debt and use about $300 million of cash from both companies to finance the deal.

As a result of the announced deal, we placed the debt ratings of Service Corporation and Stewart on review for downgrade. Our review will assess the regulatory consequences and the combined entity’s expected deleveraging plans, the amount and timing of synergies and the merger’s impact on the business, among other issues.

With the additional debt, and assuming the company will use free cash flow to reduce leverage, we expect debt to EBITDA of the combined entity to remain above 4x until at least 2015, up from Service Corporation’s 2012 year-end debt to EBITDA of 3.3x.

The planned acquisition will reinforce Service Corporation’s position as the largest North American operator of funeral homes and cemeteries, as the acquisition of Stewart, the second-largest operator by revenue, would result in a company with annual revenue more than 10x that of the next largest deathcare company.

Under the deal, Service Corporation will pay about $1.4 billion. The combined entity’s debt will total about $3.4 billion, 35% more than the two companies’ combined pre-merger debt load, after our standard adjustments.

With the additional debt to fund the purchase of Stewart’s equity, if the merger integration proceeds along the course that management outlined and if there is rapid deleveraging, the resulting financial metrics would be consistent with a corporate family rating of one notch lower.

Edmond DeForest Vice President - Senior Analyst +1.212.553.3661 edmond.deforest@moodys.com

NEWS & ANALYSIS Credit implications of current events

5 MOODY’S CREDIT OUTLOOK 3 JUNE 2013

Valeant Faces More Risk from Bausch & Lomb Acquisition Last Monday, Valeant Pharmaceuticals International, Inc. (Ba3 negative) announced plans to buy eye-care company Bausch & Lomb Incorporated (B2 review for upgrade) for $8.7 billion in debt and equity.

The acquisition is credit negative for Valeant because it will increase its financial leverage to more than 4.5x debt/EBITDA. That is higher than management’s previously stated target of 4.0x, raising questions about its commitment to its own policies. The pro forma leverage figure also assumes Valeant will obtain $800 million in cost synergies from Bausch & Lomb, which is not certain. The company’s rapid pace of acquisitions and its reliance on future synergies make it difficult to ascertain a true run-rate of pro forma EBITDA, also a credit negative.

The acquisition is credit positive for Bausch & Lomb, which will become part of a larger company with stronger credit quality. After the announcement, we affirmed Valeant’s rating with a negative outlook and put Bausch & Lomb’s rating on review for upgrade.

For Valeant, buying Bausch & Lomb will increase several risks associated with its aggressive acquisition strategy, including integration risk and those posed by an increasingly complex organizational structure. In December, Valeant completed a $2.6 billion purchase of Medicis Pharmaceuticals, a maker of dermatologic drugs.

The Bausch & Lomb deal, which the companies expect to close in the third quarter, will increase Valeant’s already strong product and geographic diversity, a credit positive. This will help reduce Valeant’s exposure to patent expirations and other risks faced by pharmaceutical companies with highly concentrated product portfolios. Geographically, following the Bausch deal, Montreal, Quebec-based Valeant will derive approximately 50% of its sales from the US and 50% of its sales from outside the US. The emerging markets, which have higher growth rates because of rising incomes and increasing utilization of pharmaceutical products, will generate about 20% of Valeant’s sales.

Coupled with the Medicis deal, Valeant’s Bausch acquisition also provides strategic clarity on the company’s main areas of focus: the specialty pharma sectors of dermatology and ophthalmology and the branded generics markets of emerging economies. This follows a spate of acquisitions in which the focus was less clear, including deals involving dental products, oncology products and sports nutrition. But as the global pharmaceuticals industry continues to consolidate, we cannot rule out Valeant pursuing acquisitions outside of its core areas of focus. Even the Bausch deal will take the company into new areas in which it does not have expertise, such as surgical devices, which might make realizing synergies more difficult.

But the Bausch acquisition will solidify the company’s presence in ophthalmology – an appealing market owing to the aging population and its greater need for eye-care products. Bausch will bring to Valeant a streamlined sales force targeting eye-care specialists. But while fewer pharmaceutical companies compete in eye care, those that do are very large, including Johnson & Johnson (Aaa stable) and Novartis AG‘s (Aa3 stable) Alcon division. The dermatology sector also has appealing characteristics, including high gross margins for many ointments and creams, and the cash-pay nature of certain aesthetics products, which make them less susceptible to cuts in reimbursements by insurers.

Michael Levesque, CFA Senior Vice President +1.212.553.4093 michael.levesque@moodys.com

NEWS & ANALYSIS Credit implications of current events

6 MOODY’S CREDIT OUTLOOK 3 JUNE 2013

Domtar’s Diaper Deal Diversifies Away from Declining Paper Last Tuesday, Canadian paper company Domtar Corporation (Baa3 stable) agreed to buy US diaper maker Associated Hygienic Products (AHP, unrated) for $272 million. The deal, which the companies expect to close in the second quarter, is credit positive for Domtar because it will increase its scale and diversification and help offset its declining paper-based operations. AHP’s sales of $320 million and EBITDA of $31 million will increase Domtar’s non-paper businesses (personal care and market pulp) to almost 20% of EBITDA from about 16% currently.

Since we expect Domtar to fund the purchase with cash on hand ($513 million as of March), it will slightly improve the company’s pro forma debt/EBITDA to 2.0x from 2.1x, including our standard adjustments for pensions and operating leases. Pro forma net debt/EBITDA will increase to 1.7x from 1.4x for the 12 months ended in March. We expect liquidity to remain strong, with pro forma March 2013 liquidity totaling around $830 million in cash and revolver availability. But for a $12 million letter of credit, Domtar has not drawn upon its unsecured $600 million committed credit facility, which matures in 2017.

Domtar expects deal synergies of $10 million over two years, which we consider reasonable. AHP, the largest manufacturer of private-label diapers in the US, will become part of Domtar’s personal care division, which should be able to obtain purchasing, general and administrative cost savings. The diaper company operates two large, modern manufacturing facilities in Ohio and Texas, and a distribution center in Georgia.

AHP is Domtar’s fourth acquisition in the personal care business in two years, beginning with its 2011 purchase of Attends Healthcare Inc., a maker of adult incontinence products. The acquisitions help Montreal, Quebec-based Domtar address the continuing secular decline in demand in the North American uncoated freesheet paper market, where it is the largest producer. Domtar’s leading branded adult incontinence businesses in the US and Europe should benefit from AHP’s distribution channels and long-established relationships with retailers of private label products.

Ed Sustar Vice President - Senior Credit Officer +1.416.214.3628 ed.sustar@moodys.com

NEWS & ANALYSIS Credit implications of current events

7 MOODY’S CREDIT OUTLOOK 3 JUNE 2013

China’s Plan to Cut Import Tax on Swiss Watches Is Credit Positive for Hengdeli Last Monday, the State Council of the People’s Republic of China said the country would cut the import tariff on Swiss watches by up to 60% over the next 10 years as part of a free-trade agreement with Switzerland. This tax cut is credit positive for Hengdeli Holdings Limited (Ba1 stable), China’s largest Swiss watch retail and distribution company, because it will increase the sale of luxury watches in China.

Under the current policy, Swiss watches sold in China are subject to an 11% import tax and a 17.5% value-added tax. Watches with an import price of more than RMB10,000 are also subject to a 20% luxury consumption tax. The import tax will decline by 18% in the first year of the agreement and by around 5% in each of the subsequent years. The tariff reduction will take effect after both countries have signed the free-trade agreement, which China said could occur in July.

We estimate that Swiss watches sold in China are 20%-40% more expensive than watches sold overseas because retailers roll the taxes into the price of the watch. As a result, Chinese consumers often buy watches in Hong Kong or Europe, where the taxes are lower. Still, China is the third-largest market for Swiss watch exports, behind Hong Kong and the US, according to April data from the Federation of the Swiss Watch Industry.

Increased sales of Swiss watches in China would boost sales for Hengdeli. Swiss watchmaker Swatch Group (unrated) is Hengdeli’s second-largest shareholder and its products accounted for around half of Hengdeli’s sales in 2012. Luxury-goods conglomerate LVMH Group (unrated) is Hengdeli’s third-largest shareholder and distributes most of its watch products through Hengdeli.

Hengdeli’s luxury retail chain, Elegant, accounted for around 40% of Hengdeli’s retail sales in 2012. About 80% of those sales were in Hong Kong. Most of Hengdeli’s retail stores (it had 452 stores as of 2012) are spread across China and Hong Kong and comprise three brands: Elegant, Prime Time and With Time (see exhibit below). China accounted for around 74% of the company’s retail stores in 2012. The percentage will increase as the company has said it plans to open new stores in China with a focus on expanding in second- and third-tier cities with the Prime Time and With Time brands.

Hengdeli’s Store Formats and Target Market

Store Brand Market Segment Average Selling Price

Elegant Top grade international brands RMB50,000+

Prime Time Mid-high international brands RMB15,000+

With Time Entry-level fine watches RMB5,000+

Solo brand boutique Solo brand shops Various

Source: Company annual reports and data

Roxane Tsang Associate Analyst +852.3758.1531 roxane.tsang@moodys.com

Alan Gao Vice President - Senior Analyst +852.3758.1362 alan.gao@moodys.com

NEWS & ANALYSIS Credit implications of current events

8 MOODY’S CREDIT OUTLOOK 3 JUNE 2013

EMP’s Divestment of Masela Gas Block Is Credit Positive Last Tuesday, Energi Mega Persada Tbk (P.T.) (EMP, [P]B2 stable) announced that its 99.99%-owned subsidiary PT EMP Energi Indonesia had signed an agreement to divest its 10% stake in the Masela Production Sharing Contract (PSC) block to its existing partners, INPEX Corporation (A1 stable) and Royal Dutch Shell Plc (Aa1 stable).

The divestment is credit positive for EMP because it will use part of the proceeds to repay its $200 million outstanding term loan from Credit Suisse and alleviate refinancing pressure. The much-needed cash injection will reduce EMP’s high leverage, improve its tight liquidity and lower its interest payments. Although the parties did not disclose the actual amount of proceeds from the asset sale, we expect EMP to have raised at least $290 million, based on the $870 million that Shell paid for its 30% stake in 2011.

If the company successfully repays its term loan facility and does not incur further indebtedness this year, we expect its total debt to proved developed reserves ratio to improve to $9-$10 per barrels of oil equivalent (boe) in 2013 from our earlier expectations of $11-$12/boe. A proved developed reserves ratio of $9-$10/boe, improved liquidity and no further covenant breaches would more securely position EMP in its B2 rating. Furthermore, we expect savings from the $152 million in capital expenditure the company projects for the Masela block in 2013-16.

While the sale will reduce EMP’s proved reserves to 116 million barrels of oil equivalent (mmboe) from the 278 mmboe the company reported at the end of 2012, the effect on EMP will not be significant over the next three years because the block is currently not producing any gas. However, the sale will slow the company’s growth plans.

EMP has been in breach of several operating and financial covenants of its term loan facility since it drew down from it in 2008. In October 2012, the company failed in its attempt to issue US dollar-denominated notes as part of a plan to refinance its loans.

Following the completion of the divestment, INPEX, the Masela block’s operator, will have a 65% stake and Shell will hold the remaining 35%. The company estimates the Masela block’s Abadi gas field, located in Indonesia’s Arafura Sea, has 18.47 trillion cubic feet of proved and probable gas reserves.

Rachel Chua Associate Analyst +65.6398.8313 rachel.chua@moodys.com

Simon Wong Vice President - Senior Analyst +65.6398.8322 simon.wong@moodys.com

NEWS & ANALYSIS Credit implications of current events

9 MOODY’S CREDIT OUTLOOK 3 JUNE 2013

Infrastructure

KEPCO’s Nuclear Power Shutdowns Are Credit Negative Last Tuesday, Korea Electric Power Corporation (KEPCO, A1 stable) shut down two of its 23 nuclear reactors after the company discovered the presence of substandard parts in the reactors. KEPCO also said it would extend the overhaul of a third reactor undergoing planned maintenance, and likely delay commission of a fourth reactor scheduled to start commercial operation in the fourth quarter.

The stoppages and delayed commissioning of the reactors are credit negative for KEPCO because it will have to rely on expensive liquefied natural gas (LNG) power plants run by KEPCO’s wholly owned power generation companies (gencos) and independent power producers (IPPs) to compensate for the lost power. This, in turn, will drive up costs.

We estimate KEPCO’s costs to produce and purchase power will rise by around 5% in 2013 over our initial projection. Because the company cannot automatically pass its increased fuel costs onto customers, we expect KEPCO’s funds from operations in 2013 to decrease by KRW1.0-KRW1.5 trillion from our initial projection of KRW8-KRW9 trillion. We do not expect the four reactors to be operational for at least four to six months because of the time required to replace the substandard parts and ensure safety at the plants.

Additionally, the stoppages and delayed commissioning of the reactors, which KEPCO’s wholly owned subsidiary, Korea Hydro and Nuclear Power Company Limited (A1 stable), operates, will raise execution risk in the construction and commissioning of its new nuclear plants because of heightened public concerns about nuclear safety and KEPCO’s safety culture. KEPCO used the substandard parts, whose product-quality results had been attested to by local verification companies that are independent of KEPCO.

IPPs such as SK E&S Co., Ltd. (unrated), POSCO Energy (unrated) and GS EPS (unrated) will benefit from the stoppages because they will likely continue to see high dispatch volume and margins owing to a further tightening of the power supply in Korea. The IPPs will continue to enjoy a favorable market environment over the next one to two years from a low level of competition.

The total capacity of the affected four reactors accounted for around 4% of Korea’s total power-generating capacity at year-end 2012. However, the effect of the stoppages on KEPCO’s power generation and purchase costs will be larger because the reactors are base-load power plants with the lowest trading price, as indicated in the exhibit below.

Mic Kang Vice President - Senior Analyst +852.3758.1373 mic.kang@moodys.com

Jae Woo Lee Associate Analyst +852.3758.1530 jaewoo.lee@moodys.com

NEWS & ANALYSIS Credit implications of current events

10 MOODY’S CREDIT OUTLOOK 3 JUNE 2013

Historical Trading Price of Power in Korea by Fuel Sources

Source: KEPCO

However, we do not expect KEPCO’s financial profile to deteriorate in 2013, compared with 2012, because of a combination of an average 4% tariff hike in January and the downward trend of fuel import costs since early 2011 for coal and since mid-2012 for LNG. We expect KEPCO to record a retained cash flow/debt of around 9%-10% and funds from operations/interest of around 3.0x for 2013-14, both of which are slight improvements over the 2012 levels of 8% and 2.6x, respectively.

Meanwhile, heightened execution risk for new nuclear reactors means that KEPCO’s reliance on more expensive LNG will remain high, while the uncertainty over returns on capital spending to build the reactors will rise. KEPCO plans to increase aggregate nuclear capacity to 24.5 gigawatts (GW) by 2015, an 18% increase over its current capacity of 20.7 GW.

Any weakening of KEPCO’s safety culture, as the lack of stringent oversight in the purchase of the substandard reactor components suggests, would likely pressure the company’s credit quality, because of the material consequences arising from a nuclear accident.

0

50

100

150

200

250

2005 2006 2007 2008 2009 2010 2011 2012

KRW

/KW

h

Nuclear LNG-Gencos LNG-IPPs

NEWS & ANALYSIS Credit implications of current events

11 MOODY’S CREDIT OUTLOOK 3 JUNE 2013

Banks

BIS Proposals on Asset Encumbrance Would Benefit Bank Bondholders Last Monday, the Committee on the Global Financial System (CGFS), a subsidiary of the Bank of International Settlement (BIS), published a series of policy recommendations to address risks stemming from rising asset encumbrance on banks’ balance sheets. Encumbered assets are those pledged to creditors and counterparties under security agreements. As secured funding increases, unsecured creditors become structurally subordinated to secured creditors and rising asset encumbrance decreases the amount of residual assets available to meet unsecured claims in case of liquidation.

To mitigate those risks, the CGFS called for stronger disclosure and transparency requirements around encumbrance levels, which would enhance creditors’ ability to assess the creditworthiness of banks. The committee also recommend that supervisory authorities develop prudential safeguards to either cap banks’ levels of asset encumbrance or limit their recourse to secured funding, a positive for banks’ unsecured bondholders. However, we note implementation of these recommendations requires endorsements from national banking regulators.

Shift in bank funding profiles towards secured sources increased asset encumbrance. Unlike previous periods of banking turmoil, in which investor demands for increased security recede once markets stabilize, the most recent shift appears likely to remain in place for the foreseeable future. This is because bail-in discussions and concepts of burden-sharing with creditors are currently limited to senior unsecured and subordinated instruments, and are set to increase the risk (and therefore cost) of these instruments. In addition, there is a regulatory preference across jurisdictions for institutionalized increases in collateralization requirements and haircuts to reflect greater counterparty risk and underlying asset volatility in derivative and repo markets. As a consequence, we expect a greater share of banks’ assets will be encumbered for some time.

Stronger disclosure and transparency requirements would enhance creditors’ ability to assess the creditworthiness of banks. Although general consensus and available information – including increasing covered bond issuance and collateralized European Central Bank borrowing – support the view that asset encumbrance is rising, banks’ disclosures of actual levels of encumbered assets remain incomplete. As a result, the CGFS recommends that central banks and policymakers agree on standardized definitions, a set of reporting requirements and timing for disclosures on asset encumbrance.

The CGFS also suggests that banks disclose the values of their encumbered and unencumbered assets, and the amount of unsecured funding and overcollateralization levels. Disclosing timely and comparable information across jurisdictions would facilitate a more detailed assessment of risks to bank creditors and the CGFS recommendations are a step in this direction.

Limiting banks’ levels of asset encumbrance would be positive for senior unsecured bondholders. The CGFS recommends that central banks build prudential safeguards against risks arising from rising asset encumbrance. One suggestion calls for a cap on either collateralized funding issued or on assets encumbered by banks – similar to caps on the amount of covered bonds that banks can include in their liabilities that a number of countries, including Australia, Canada and the UK, have instituted. Another suggestion is to increase the contributions of highly encumbered banks to deposit insurance funds to reflect the structural subordination of insured deposits. Either option would lead to lower asset encumbrance levels and benefit senior unsecured bondholders.

Nicolas Charnay, CFA Associate Analyst +1.212.553.1382 nicolas.charnay@moodys.com

Robard Williams Vice President - Senior Credit Officer +1.212.553.0592 robard.williams@moodys.com

NEWS & ANALYSIS Credit implications of current events

12 MOODY’S CREDIT OUTLOOK 3 JUNE 2013

Bci’s Acquisition of City National Bank of Florida Is Credit Negative On 24 May, Banco de Credito e Inversiones (Bci, A1 negative, C/a3 negative),1 Chile’s third-largest private bank, announced it would acquire CM Florida Holdings Inc., the owner of City National Bank of Florida (CNBF), from Spain’s Bankia (Ba2 uncertain, E+/b2 uncertain). The acquisition is credit negative because it signals a change in Bci’s traditional corporate and commercial lending strategy and poses asset quality risks, together with the challenge of managing and funding a new business that offers a relatively modest earnings contribution. The announcement prompted us to change Bci’s outlook to negative from stable on 30 May.

CNBF’s sizable concentrations of commercial and residential real estate loans, at about 40% of total loans, are a significant challenge for Bci’s management since it has limited expertise in US commercial and residential real estate. That portfolio also exposes the bank to unexpected credit costs related to the still healing south Florida real estate market. The remaining portion of the loan book is largely devoted to small and midsize companies, whose credit quality is usually more sensitive to economic downturns. As of year-end 2012, non-performing loans were about 1% of total loans, and were 255% covered with reserves.

The risk of higher-than-expected integration costs, coupled with the potential for client and business attrition, could limit CNBF’s future business generation capacity and thus its contribution to combined profitability, especially taking into account its modest and volatile earnings. CNBF posted net income of $190 million in 2012 (or $51 million net of deferred tax assets) and $34 million in 2011. This compares with Bci’s consolidated profits of $558 million in 2012 and $541 million in 2011.

This is Bci’s first cross-border acquisition and it differs from previous deals in Latin America, in which banks have generally targeted fast-growing markets with the potential for higher margin generation than their home markets. An example would be Chile’s CorpBanca (Baa1 negative, D+/baa3 negative), which recently purchased two banks in Colombia, where growth and margins can be robust and a regional presence increases the potential for trade business. Moreover, the acquisitions provide the bank with more relevant market share. Bci, on the other hand, is entering the mature and low-margin US market, where business conditions are relatively similar to those in Chile. Also, CNBF’s modest size will limit Bci’s position in the highly competitive South Florida market. CNBF had assets of $4.8 billion and gross loans of $2.5 billion at year-end 2012.

Bci is paying $882.8 million, or about 1.5x book value, a lower multiple than for other recent regional transactions. Bci plans to raise around $400 million in fresh capital, coupled with a still undefined amount of subordinated debt in order to maintain its capital ratios at current levels. The bank also intends to raise senior debt to complement the acquisition price tag, in amounts yet to be determined.

1 The ratings shown are the banks’ deposit rating, its standalone bank financial strength rating/baseline credit assessment and the

corresponding rating outlooks.

Georges Hatcherian Associate Analyst +1.212.553.2862 georges.hatcherian@moodys.com

Jeanne Del Casino Vice President - Senior Credit Officer +1.212.553.4078 jeanne.delcasino@moodys.com

NEWS & ANALYSIS Credit implications of current events

13 MOODY’S CREDIT OUTLOOK 3 JUNE 2013

German Banks’ Smaller Capital Shortfall Is Credit Positive, but Short of Basel III Compliance Last Tuesday, the Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin), the German financial regulator, reported its estimate of a remaining €14 billion capital shortfall based on December 2012 data for the largest German banks to comply with Basel III requirements, down from its June 2012 estimate of a €32 billion shortfall.2 The narrowing gap is credit positive because the remaining amount of capital banks must raise is more manageable in transitioning to Basel III than prior capital amounts.

In fact, based on BaFin’s calculations, the capital gap should be even smaller today, at around €10 billion, considering that Deutsche Bank AG (A2 stable, C-/baa2 stable)3 and Commerzbank AG (Baa1 stable, D+/ba1 stable) have each raised equity capital since the beginning of 2013. In addition, last Friday, DZ BANK AG (A1 stable, C-/baa2 stable) announced its plans for a €1.4 billion capital increase from its sector members to ensure compliance with Basel III.

Nevertheless, despite being more manageable, we believe that capital base improvements will still be challenging for German banks owing to their persistently weak profitability, which is further exacerbated by low interest rates.

In recent years, banks have mainly resorted to deleveraging and optimizing risk-weighted assets (RWAs) to improve capital ratios instead of raising new capital (see Exhibit 1). However, further progress through deleveraging will be difficult to achieve because banks will have to choose between holding onto long-term exposures until maturity with the aim of being repaid in full, or selling and realising losses on assets that trade below par. We expect non-core asset sales to continue given uncertainty about the credit risk of sovereign debt and other bank assets in parts of Europe. Sales at a loss will weigh on earnings and reduce already depressed internal capital generation.

EXHIBIT 1

Reduction of Risk-Weighted Assets of Selected German Banks, 2008-12

Note: BayernLB=Bayerische Landesbank (Baa1 stable, D-/ba3 stable); Helaba=Landesbank Hessen-Thueringen GZ (A2 stable, D+/baa3 stable); LBBW=Landesbank Baden-Wuerttemberg (A3 stable, D+/ba1 stable); NORD/LB=Norddeutsche Landesbank GZ (A3 stable, D/ba2 stable). Source: Moody’s Financial Metrics

2 See BaFin’s press release and speaker notes (in German only). 3 The bank ratings shown in this report are the banks’ deposit ratings, their standalone bank financial strength ratings/baseline credit

assessments and the corresponding rating outlooks.

0

50

100

150

200

250

300

350

400

450

BayernLB Commerzbank Deutsche Bank DZ BANK Helaba LBBW NORD/LB

€bi

llion

s

2008 2009 2010 2011 2012

Mira Carey Associate Analyst +49.69.70730.755 mira.carey@moodys.com

NEWS & ANALYSIS Credit implications of current events

14 MOODY’S CREDIT OUTLOOK 3 JUNE 2013

In addition, two Landesbanken will have to replace government-injected capital and/or risk shields that will gradually diminish, adding more pressure to close the capital gap. We expect capital repayments (or guaranty reductions) to offset further improvements in regulatory capitalisation for the respective banks,4 as they aim to reduce costs of capital and accept reductions of what they may consider to be “excess capital.”

We recognise that most German banks have not only improved their regulatory capital ratios (see Exhibit 2), but also the quality of their capital through various measures over recent years. This process accelerated in late 2011, following the European Banking Authority’s (EBA) higher core Tier 1 capital requirements, which some German banks could not meet initially because of their relatively high levels of hybrids, which the EBA does not include in its definition of core Tier 1 capital. However, the improved capitalisation of most banks is more than offset by the elevated – and rising – risk of external shocks and losses that may arise in the evolving European debt crisis.

EXHIBIT 2

Improving Tier 1 Capital Ratios for Selected German Banks, 2008-12

Source: Moody’s Financial Metrics

4 Four Landesbanken currently benefit from portfolio risk shields: BayernLB, HSH Nordbank AG (Baa2 review for downgrade,

E/caa2), LBBW and NORD/LB. In addition, BayernLB and HSH will also have to repay government-injected capital.

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

BayernLB Commerzbank Deutsche Bank DZ BANK Helaba LBBW NORD/LB

2008 2009 2010 2011 2012

NEWS & ANALYSIS Credit implications of current events

15 MOODY’S CREDIT OUTLOOK 3 JUNE 2013

Despite Greece’s Improving Economic Sentiment, Indicators Point to Continued Bank Asset Quality Deterioration Last Thursday, Eurostat published its latest economic sentiment indicator (ESI) for Greece, which shows increasing confidence in the country’s economic prospects. However, despite the recovery in sentiment, we expect banks’ asset quality to continue deteriorating over the coming quarters, as signalled by declines in industry orders, tourist receipts and retail trade turnover. These credit negative contractions all point to continued deterioration in banks’ already stressed loan books, which will generate additional loan-loss provisioning requirements and further strain profitability.

As Exhibit 1 shows, the May increase in Greece’s ESI marked the fourth consecutive month that the indicator rose, and is now at its highest level since September 2008. The increase points to Greek citizens being optimistic about the country’s economic prospects after six years of a deep and prolonged economic recession, and showed improvement in all areas, particularly in industry, services and retail trade confidence. At 93.8, the May sentiment index in Greece surpassed the European Union’s level of 90.8 and euro area’s level of 89.4.

EXHIBIT 1

Greece’s Economic Sentiment Indicator Continues to Improve

Source: Eurostat

However, despite the recovery in economic sentiment, we expect Greek banks’ credit portfolios to continue performing poorly over the coming quarters as a sustained turnaround in economic activity remains way off, as evidenced by industry orders, tourist receipts and retail trade turnover (see Exhibit 2), all of which historically have been correlated with banks’ asset-quality trends and typically lead asset-quality changes by three to six months.

60

65

70

75

80

85

90

95

100

105

110

Sep-

08

Nov

-08

Jan-

09

Mar

-09

May

-09

Jul-0

9

Sep-

09

Nov

-09

Jan-

10

Mar

-10

May

-10

Jul-1

0

Sep-

10

Nov

-10

Jan-

11

Mar

-11

May

-11

Jul-1

1

Sep-

11

Nov

-11

Jan-

12

Mar

-12

May

-12

Jul-1

2

Sep-

12

Nov

-12

Jan-

13

Mar

-13

May

-13

ESI Greece ESI Euro Area (17 countries) ESI European Union (27 countries)

Alexios Philippides Associate Analyst +357.25.693.031 alexios.philippides@moodys.com

NEWS & ANALYSIS Credit implications of current events

16 MOODY’S CREDIT OUTLOOK 3 JUNE 2013

EXHIBIT 2

Greece’s Industry Orders, Retail Trade and Travel Receipts Show Deterioration

March 2011 March 2012 Year-over-Year

Change 2012-11 March 2013 Year-over-Year

Change 2013-12

New orders in industry index (total market)

91.7 89.9 -2% 78.5 -13%

Retail trade turnover index 102.6 87.0 -15% 82.1 -6%

First-Quarter 2011

First-Quarter 2012

Year-over-Year Change 2012-11

First-Quarter 2013

Year-over-Year Change 2013-12

Travel receipts (€ millions) €466.7 €407.3 -13% €392.2 -4%

Tourist arrivals (thousands) 1108.4 978.6 -12% 1023.4 5%

Sources: Hellenic Statistical Authority, Bank of Greece

As the manufacturing and trade sectors together account for roughly 42% of Greek banks’ domestic corporate loan books, the 13% year-over-year decline in the new industrial orders index and the 6% year-over-year decline in the retail trade turnover index signal further weakness in cash flows and borrowers’ repayment capacity. Furthermore, despite a 5% year-over-year increase in the number of tourist arrivals in first-quarter 2013, the 4% decline in travel revenues indicates the still weak state of the tourism sector, which directly accounts for around 7% of the system’s corporate loan book, or approximately 15% of GDP. We note that numerous small and family businesses also depend on tourism.

The recent poor performance of these indicators supports our view that non-performing loans (NPLs), which rose to 25% of total loans at the end of 2012, from 16% in 2011,5 will continue to increase in 2013. We expect that these increases in NPLs will spark further high loan-loss charges (which reached €12 billion in 2012) and will result in additional losses for banks after recording €8 billion of net losses for 2012.

In the first quarter, the four largest Greek banks, National Bank of Greece S.A. (Caa2 negative, E/caa3 stable),6 Piraeus Bank S.A. (Caa2 negative, E/caa3 stable), Eurobank Ergasias S.A. (Caa2 negative, E/caa3 stable) and Alpha Bank AE (Caa2 negative, E/caa3 stable) all reported loan provision charges that exceeded their recurring pre-provision profitability. This is because although the rate of NPL generation decelerated somewhat in the quarter, it remained significantly high at around 150-200 basis points of total loans.

5 Data received from the Bank of Greece. NPLs are defined as loans more than 90 days past due. 6 The ratings shown are the banks’ deposit ratings, their standalone bank financial strength ratings/baseline credit assessments and the

corresponding rating outlooks.

NEWS & ANALYSIS Credit implications of current events

17 MOODY’S CREDIT OUTLOOK 3 JUNE 2013

BMI’s Potential Merger with Al Salam Bank in Bahrain Is Credit Positive On 23 May, BMI Bank B.S.C. (BMI, Ba1 negative, E+/b1 negative)7 and Al-Salam Bank-Bahrain B.S.C. (ASBB, unrated) announced that their boards had agreed in principal to a merger between the two Bahrain-based banks, a credit positive for BMI.

Despite implementation risks and the fact that this merger will not address BMI’s asset quality issues, it will enhance and entrench BMI’s franchise, strengthen its financial metrics and impart a greater likelihood of systemic support in case of need. BMI’s non-performing loans-to-gross loans ratio was 19.6% as of year-end 2012, with loan-loss reserves to non-performing loans of 47.3%. Also, BMI has high corporate credit and real estate concentrations. Although the combined entity’s ratio of non-performing loans to gross loans will drop to around 14.8% from 19.6%,8 ASBB also maintains relatively low provisioning coverage and has a relatively large investment portfolio (at 30% of assets), which is sensitive to market value fluctuations and has 27% of its assets exposed to real estate.

However, the merger will enhance both banks’ franchises because it would create the fourth-largest bank in Bahrain with total assets at $4.7 billion and a 9% domestic market share based on our estimates. With total assets of BHD754 million ($2.0 billion) as of December 2012, BMI currently has a modest market position in Bahrain, reflecting its small domestic-focused retail business. ASBB was formed in 2006 as an Islamic investment bank, had total assets of BHD942 million as of December 2012 and has been gradually strengthening its domestic commercial banking franchise both organically and through mergers and acquisitions. The merger will complement BMI’s brand recognition in Bahrain’s commercial banking, IT systems and local market expertise with the Islamic and investment banking experience of ASBB.

A merger will also lead to stronger financial fundamentals for the combined entity, compared with those of BMI. ASBB’s financial statements show a better capitalized and more profitable bank, with higher liquidity. On a pro forma basis, the combined banks’ 2012 Tier 1 equity increases to 19.6%, compared with BMI’s 17.7%, liquid assets to total assets increase to 34.5%, compared with BMI’s 29.4%, and net income to average risk-weighted assets rises to 0.9%, compared with BMI’s 0.1% (see exhibit below). As a result, BMI will leverage a stronger capital and liquidity base to meet upcoming Basel III requirements and grow its domestic and regional commercial banking franchise. We also expect profitability to benefit from potential synergies since the combined entity will have greater economies of scale and become more efficient as it attempts to grow its franchise in Bahrain’s competitive banking system.

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

assessments and the corresponding rating outlooks. 8 Includes all loans past due by more than 90 days.

Christos Theofilou, CFA Assistant Vice President - Analyst +357.25.693.004 christos.theofilou@moodys.com

NEWS & ANALYSIS Credit implications of current events

18 MOODY’S CREDIT OUTLOOK 3 JUNE 2013

BMI Bank and Al-Salam Bank-Bahrain’s Combined Financial Fundamentals

Source: Bank financial statements and Moody’s Financial Metrics

The new entity will also benefit from a higher likelihood of systemic support given its size and systemic importance, although we expect this implied support to be countered by a lower likelihood of support from Oman’s Bank Muscat S.A.O.G. (A1 stable, C-/ baa1 stable), BMI’s current 49% shareholder. The transaction will likely involve a material dilution in Bank Muscat’s share in the new entity.

If the potential merger proceeds, implementation risks will center on management’s ability to integrate the two banks’ branches and employees into a common IT system, platform and culture, achieve potential synergies and ensure BMI’s assets are fully Shari’ah compliant, which may take as many as two to three years.

Despite the merger discussions between the two banks’ boards of directors, ultimately the transaction is contingent upon the banks’ respective shareholders’ approvals and regulatory consent. This is ASBB’s second merger attempt following aborted discussions with Bahrain Islamic Bank (Ba3 negative, E+/b3 negative) in August 2011.

17.7%

29.4%

0.1%

20.9%

38.5%

1.5%

19.6%

34.5%

0.9%

Tier 1 Ratio (Basel II) Liquid Assets / Total Assets Net Income / Average RWA (Basel II)

BMI ASBB Aggregate of the Two Banks

NEWS & ANALYSIS Credit implications of current events

19 MOODY’S CREDIT OUTLOOK 3 JUNE 2013

Insurers

Fidelity National’s Acquisition Of Lender Processing Service Is Credit Negative Last Tuesday, Fidelity National Financial Inc. (FNF, Baa3 stable) announced it had agreed to acquire Lender Processing Services, Inc. (LPS, senior unsecured Ba2 review for upgrade) for total consideration of approximately $2.9 billion, 50% of which will be in FNF stock and 50% in cash largely funded through new debt issuance. The transaction is credit negative because of the significant increase in financial leverage.

FNF is the nation’s largest title insurance provider, with a 34% market share. A key credit challenge for the company is that its core title insurance revenue is volatile owing to its dependence on the volume of real estate transactions, including mortgage refinancings, which are cyclical and driven by interest rates. When interest rates decline, refinance transaction volume is high, but this can reverse quickly when rates begin to rise. The company has opportunistically used acquisitions to diversify. This transaction is consistent with FNF’s acquisition appetite and its propensity to use leverage as a key funding source.

The key negative effect of the transaction is our expectation of an increase in financial leverage. Under the current terms, leverage would go up to near 40% from 31% (as adjusted by us) as the company plans to raise about $1.4 billion in new debt and assume $600 million of LPS’ existing senior notes. Although this is a material increase in leverage, it lies within our previous expectations, based on FNF’s past acquisition record. We also expect the company over the next two years or so to reduce debt leverage to its long-term target of 25% or less (on an unadjusted basis), consistent with its past actions following an acquisition.

The transaction would also have a negative effect on asset quality because of the addition of significant goodwill to FNF’s balance sheet. Intangibles, including goodwill, are already high, and the transaction would result in a near doubling of total intangibles-to-equity to about 90%. However, FNF’s previous acquisitions have performed well over time, demonstrating real economic value embedded in its intangible assets.

The earnings effect of the transaction would be neutral over the next few years because the cash flows from LPS would largely fund the increased debt burden at the parent. Nevertheless, interest expense over a one- to two-year period would decline as FNF pays down debt, and the company is likely to achieve projected synergies and expense savings that could provide further upside to earnings.

LPS is a market leader in mortgage transaction processing. FNF previously owned LPS, though in 2006 FNF spun off LPS as part of Fidelity National Information Services. A key positive of the transaction is that FNF would benefit from LPS’ relatively stable revenue characteristics, which are based on recurring fees driven by overall mortgage volume.

Another positive characteristic of the transaction is that FNF’s previous ownership of LPS greatly reduces integration and execution risk. FNF has a good track record of integrating past acquisitions and achieving expense efficiencies while demonstrating a high level of operating flexibility. The company has a long record of acquiring (and often later selling) various niche businesses outside of its core title operation, including insurance claims management, flood insurance, restaurants, auto parts, human resources services and timberlands, with a focus on cutting costs and increasing operational efficiencies.

Paul Bauer, CFA Vice President - Senior Credit Officer +1.212.553.1334 paul.bauer@moodys.com

NEWS & ANALYSIS Credit implications of current events

20 MOODY’S CREDIT OUTLOOK 3 JUNE 2013

Cathay Financial’s Capital Raise Is Credit Positive for Its Bank and Life Insurance Subsidiaries On 24 May, Cathay Financial Holding Co., Ltd (Cathay FHC, Baa3 stable) announced that it would issue up to 400 million new shares by the third quarter, pending regulatory approval. The company estimates that the capital will total around TWD12 billion. Although a detailed scheme for the use of proceeds still depends on the group’s business strategy and plans, Cathay FHC plans to use proceeds to support Cathay United Bank Co., Ltd (CUB, A2 stable, C-/baa2 stable).9

A capital injection would improve CUB’s capital adequacy while reducing the need for Cathay Life Insurance Co. Ltd. (financial strength Baa2 stable) to upstream dividends to its parent to support CUB, a credit positive. CUB and Cathay Life respectively contributed 74.3% and 18.7% of Cathay FHC’s 2012 income from subsidiaries.

Assuming Cathay FHC injects two thirds of the new capital, presumably TWD8 billion, into CUB, the bank’s Tier 1 ratio would increase to 10.0% versus 9.2% at the end of 2012, which would help narrow CUB’s capital adequacy gap with its C-/baa2 Taiwanese peers, such as Taipei Fubon Commercial Bank Co Ltd (A2 stable, C-/baa2 stable). CUB’s Tier 1 capital ratio fell to as low as 8.4% in mid-2012 owing to its fast-growing interbank business, particularly with mainland Chinese banks. Despite its Tier 1 ratio rebounded to 9.2% at the end of 2012, this level remains slightly weaker than the 10.0%-11.0% of similarly rated peers. CUB’s last capital increase was in 2006, when the bank acquired Lucky Bank. Since then, CUB has mainly relied on its earnings to build up its capital.

The proposed capital injection will also support CUB’s increasing focus on more capital-intensive lending, such as foreign currency lending and unsecured personal loans, and its business expansion into China and southeast Asia. Foreign currency loans accounted for 16.0% of its total loans at first-quarter 2013, compared with 10.7% at the end of 2010.

For Cathay Life, CUB’s better capitalization reduces Cathay Life’s need to upstream dividends to Cathay FHC to support the bank’s growth. More directly, while not specified in the announcement, Cathay FHC will also have the option to directly inject some of the capital raised into Cathay Life to strengthen its capital position. We consider Cathay Life’ s current capital-to-total asset ratio low at 3.7% at the end of the first quarter, given the substantial foreign-exchange rate risk and market risk it is exposed to from its large overseas investments and domestic equities. At the end of the first quarter, overseas investments accounted for 45.1% and domestic equities accounted for 8.3% of Cathay Life’s total investments.

We also expect Cathay FHC to channel part of the proceeds to its upcoming shareholders’ dividend payment because it only had TWD7.1 billion of cash on hand at the end of 2012 and committed to pay out dividends totaling TWD 7.5 billion in July. On the surface, this has no immediate credit effect because the share issuance will partially net out the effect of the dividend payment. However, the decision to pay rather large shareholders’ dividends in a year that neither CUB nor Cathay Life are upstreaming dividends to the holding company reflects an aggressive capital management style, and thus discounts some of the credit positive message of this issuance.

9 The ratings shown are the bank’s deposit rating, its standalone bank financial strength rating/baseline credit assessment and the

corresponding rating outlooks.

Ginger Kao Analyst +852.3758.1317 ginger.kao@moodys.com

Sally Yim Vice President - Senior Credit Officer +852.3758.1450 sally.yim@moodys.com

NEWS & ANALYSIS Credit implications of current events

21 MOODY’S CREDIT OUTLOOK 3 JUNE 2013

Sovereigns

IMF Debt Restructuring Proposals Are Credit Negative for Distressed Sovereign Bondholders Last Thursday, the International Monetary Fund (IMF) organized a global conference call to discuss its report Sovereign Debt Restructuring – Recent Developments and Implications for the Fund’s Legal and Policy Framework. Although the report’s proposals are not yet approved by the IMF board and not official recommendations, the policies the report suggests are credit negative for distressed sovereigns’ private-sector creditors because they are likely to move forward the timing, increase the likelihood and increase the severity of debt restructurings.

Reviewing a number of country cases, the IMF found that sovereign debt restructurings since 2005 have often been too little and too late, and have failed to re-establish debt sustainability and market access in a durable way. The IMF recommends action on several fronts, including increasing the rigor of debt sustainability and market access assessments,10 exploring ways to prevent the use of IMF resources to bail out private creditors and measures to alleviate the costs associated with sovereign restructurings.

Other specific policies suggested in the Sovereign Debt Restructuring report, subject to further discussion and IMF board approval, include the following:

» Avoid delays of sovereign restructurings because of fear of international spillovers. Instead, dealing with contagion effects directly by establishing appropriate safeguards, such as proactive recapitalization of banks and provision of liquidity support.

» Adopt stricter requirements to prevent the use of IMF resources to bail out private creditors. For example, requiring creditor bail-in as a condition for IMF lending where market access is lost and regaining market access is uncertain, even if no clear determination has been made that the debt is unsustainable.

» Explore ways to reduce the costs of debt restructurings to encourage earlier initiation of restructurings, such as making available longer-term IMF financing, proactive recapitalization of creditor banks and central bank provision of liquidity.

» Consider introducing aggregate collective action clauses (CACs) in international bond contracts.

» Consider setting a clearer expectation that non-negotiated offers by the debtor rather than negotiated deals would be the norm in pre-default restructurings, as, in these cases, speed is of the essence.

These specified policies may improve the resolution of sovereign debt crises, but they will probably increase the likelihood, move forward the timing and increase the severity of debt restructurings, which would be credit negative for the private-sector creditors of distressed sovereigns. In the event that such developments lead investors to demand a greater risk premium, they could also be credit negative for sovereigns’ access to finance. Apart from the more rigorous debt sustainability analysis framework, which is currently being implemented in a separate but related policy guidance, the rest of the policies specified in the Sovereign Debt Restructuring report are subject to further work and discussions. Any policies adopted from the set discussed in the paper will depend on IMF board discussions and approval, which will likely take time.

10 On 9 May, the IMF released Staff Guidance For Public Debt Sustainability in Market-Access Countries.

Elena Duggar Group Credit Officer - Sovereign Risk +1.212.553.1911 elena.duggar@moodys.com

NEWS & ANALYSIS Credit implications of current events

22 MOODY’S CREDIT OUTLOOK 3 JUNE 2013

Hungary’s Exit from EDP Does Not Alleviate Debt Sustainability Concerns Last Wednesday, the European Commission (EC) recommended the abrogation of Hungary’s (Ba1 negative) Excessive Deficit Procedure (EDP), a rule-based process established in the Treaty on the Functioning of the European Union (EU) to ensure that member states correct fiscal policy deviations from the Maastricht Treaty’s threshold of a fiscal deficit of 3% of GDP.

The EC’s recommendation is an acknowledgement of the government’s efforts to keep its fiscal deficit to below 3% of GDP in 2012, and the EC’s expectation that the deficit will remain below the threshold for the next two years. However, Hungary’s debt sustainability remains a risk owing to the steps the government has taken to achieve its fiscal targets, which have resulted in a low growth environment. These include extraordinary taxes on the banking, telecom, electricity and retail sectors, which have resulted in investments contributing negatively to growth for six consecutive quarters since the second half of 2011.

Hungary has been under the EDP since its accession to the European Union in 2004, having run fiscal deficits above the Maastricht Treaty threshold. Although in 2011 Hungary had a large budget surplus, largely the result of its onetime nationalisation of second pillar pension assets, it was the only country in the EU facing a suspension of part of its EU Cohesion funds entitlement. This is because of its successive failure to cure the excessive deficit in a durable manner in the given timeframe.

The government took corrective steps to overcome the EC’s suspension, and made exiting from the EDP by 2013 a priority. To that end, it reduced the headline deficit to 1.9% of GDP in 2012, outperforming its own target of 2.5% (see Exhibit 1). However, according to the EC around two thirds of Hungary’s fiscal consolidation came from increasing taxes, duties and fees in select sectors, while the remaining one third involved cutting spending through freezing nominal public sector wages and procurement. The banking and corporate sectors, have borne the brunt of the tax measures, which has negatively affected Hungary’s business environment and stunted the sovereign’s economic growth.

EXHIBIT 1

Hungary’s General Government Debt and Fiscal Balance as a Percent of GDP

Source: European Commission and Moody’s

After contracting by 1.7% in 2012, the economy grew by a seasonally adjusted 0.7% in the first quarter, quarter on quarter. However, we still expect the economy to expand by just 0.2% in 2013, in large part because of Hungary’s weak investment climate, which has been undermined in recent years by unpredictable tax policies. Investment, for example, contracted by almost 8.7% in real terms in the first quarter on a year-on-year basis.

10%

20%

30%

40%

50%

60%

70%

80%

90%

-11%

-9%

-7%

-5%

-3%

-1%

1%

3%

5%

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013F 2014F

General Government Fiscal Balance - left axis General Government Debt - right axis

Alpona Banerji Assistant Vice President - Analyst +44.20.7772.1063 alpona.banerji@moodys.com

NEWS & ANALYSIS Credit implications of current events

23 MOODY’S CREDIT OUTLOOK 3 JUNE 2013

Hungary’s largely foreign-owned banking system has been weakened by the domestic operating environment, and thus cannot provide much support to domestic demand. Moreover, lacklustre economic growth in the EU, which absorbs around three quarters of Hungary’s exports, is undermining the country’s exports. As a result, we expect Hungary’s growth over the next two years to be significantly lower than other economies in Central and Eastern Europe (CEE) (see Exhibit 2), which will constrain the government’s ability to permanently reduce debt.

EXHIBIT 2

Regional Real GDP Growth Index (100=2004)

Source: Eurostat, Moody’s

We estimate that Hungary’s debt at 79.7% of GDP in 2013 will exceed rated CEE peers and the Maastricht threshold of 60%. This debt stock gives rise to a large gross borrowing requirement, which at 19% of GDP in 2013, is the highest in the region. Moreover, the dominance of foreign-currency denominated and non-resident investors in the general government debt mix heightens the risks stemming from exchange-rate pressures and investor confidence that arises from international volatility or potential domestic developments.

100%

105%

110%

115%

120%

125%

130%

135%

140%

145%

150%

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Hungary Poland Romania Slovakia

NEWS & ANALYSIS Credit implications of current events

24 MOODY’S CREDIT OUTLOOK 3 JUNE 2013

Romania’s Exit from EU’s Excessive Deficit Procedure Is Credit Positive Last Wednesday, the European Commission (EC) recommended abrogating the Excessive Deficit Procedure (EDP) for Romania (Baa3 negative). This is credit positive for the Romanian government because it eliminates the risk that Romania would be denied certain European Union (EU) funding because it was in the EDP. The EC’s recognition of Romania’s fiscal consolidation is also a credit positive signal to international bond investors, on whom the government depends for about half of its financing needs.

The EDP is a process established in the Treaty on the Functioning of the European Union and goes into effect when a sovereign’s general government deficit exceeds 3% of GDP. Romania entered the EDP in 2009, after the fiscal deficit rose to 5.7% of GDP in 2008 from 2.9% a year earlier. A country in EDP could be denied EU funding if it does not adhere to the EC’s recommendations on deficit reduction. For a government to exit the EDP, its fiscal deficit must fall below 3% of GDP in the prior year, and the EC forecasts the deficit will remain below 3.0% over the next two years. Romania has met these targets, and thus eliminated the EDP related risk of a freeze in EU funding that totals around $3-$5 billion annually.

Even beyond the abrogation of the EDP, the reduction in fiscal deficits is credit positive. Sustained lower fiscal deficits will stabilize the government’s debt-to-GDP ratio, which had increased to 37.8% of GDP in 2012 from 13.4% of GDP in 2008. Fiscal tightening has also helped rein in other macroeconomic imbalances in Romania, such as inflation, which was 4.4% in April, down from an average of 7.0% during the five years leading up to the global financial crisis, and the current account deficit, which declined to 3.9% of GDP in 2012 from 11.7% in 2008.

Romania’s fiscal consolidation over the past three years is notable because it came during a period of low GDP growth of 0.6%, versus an average of 7.0% in the five years prior to 2008, and following politically difficult expenditure cuts (see exhibit below).

Trends in Romania Government Revenues, Expenditures and Deficits

Source: Haver Analytics

In 2010, the government cut public wages by 25%, reduced social transfers by 15%, raised the value-added tax by five percentage points and eliminated 74,000 public sector jobs. Continued expenditure control helped lower the deficit in the following two years, including in 2012, when Romania had three governments – the first government change prompted by protests in part against fiscal tightening.

Although the government over the past year has eased some of the austerity measures it initiated two years ago, we agree with the EC’s forecast that the deficit is likely to remain below 3% of GDP in 2013.

-10%

-9%

-8%

-7%

-6%

-5%

-4%

-3%

-2%

-1%

0%0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

2006 2007 2008 2009 2010 2011 2012

Revenues/GDP - left axis Expenditure/GDP - left axis Fiscal Deficit/GDP - right axis

Atsi Sheth Vice President - Senior Analyst +1.212.553.4873 atsi.sheth@moodys.com

Andrew Schneider Associate Analyst +1.212.553.4749 andrew.schneider@moodys.com

NEWS & ANALYSIS Credit implications of current events

25 MOODY’S CREDIT OUTLOOK 3 JUNE 2013

Copper Mining Layoffs Are Credit Negative for Zambia On 24 May, Konkola Copper Mines (KCM), a subsidiary of UK-based Vedanta Resources Plc (Ba1 negative), announced that it would lay off 2,000 workers, a quarter of its workforce, at its mining operations in Zambia (B1 stable) in response to declining global copper prices and rising operating costs. The deteriorating operating environment in the mining sector is credit negative for Zambia, where foreign direct investment (FDI) is a key growth driver.

Given the government’s populist mandate and support for labor unions, we expect it to aggressively oppose any large-scale layoffs. In our view, this raises expropriation risk in the strategically important copper sector, which accounts for more than 80% of exports. In addition, labor agitation at KCM has the potential to trigger a broader deterioration of an already fragile industrial relations climate. Should expropriation materialize, we expect it to have an adverse effect on foreign investment and economic growth, with negative consequences for the government’s creditworthiness.

Foreign investment in copper mining has been a critical growth driver. Zambia’s economic growth ratcheted up to an average of 6.5% during 2005-12, compared with 3.0% over the previous decade, following structural reforms that included the privatization of government-owned copper mines in the late 1990s. As a result, FDI into Zambia, predominantly in copper production, rose to $2 billion in 2011 from a low of $122 million in 2000. Copper exports accounted for about 80% of total exports in 2012. Growth accelerated to 7.3% in 2012, in large part reflecting an intensification of mining activity and rising global copper prices (see Exhibit 1). Zambia’s Extractive Industry Transparency Initiative expects the value of mining sector production to grow to $1.35 billion in 2015 from $590 in 2010 (or about 11% of 2010 GDP). The indirect contribution to economic activity may be as much as half the economy and about a quarter of the labor force.

EXHIBIT 1

Growth and Foreign Direct Investment in Zambia

Source: Haver Analytics

Declining global copper prices and rising operating costs are pressuring mining profits and output. Growth in copper output decelerated in 2011-12 while copper prices have declined by 10.1% between January and April of this year and are 27.0% off their early 2011 peak (see Exhibits 2 and 3). At the same time, rising wages and energy costs are squeezing mining profits. KCM agreed to a 7.5% pay increase for its 2,000 workers and 18,000 contractors in Zambia in January, following a 17.0% wage hike last year that mirrored industry-wide collective agreements with unionized labor. As a result, mining firms face rising pressure to scale down production and cut costs through large-scale layoffs.

0%

2%

4%

6%

8%

10%

12%

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013F 2014F

Net Foreign Direct Investment/GDP Real GDP Change

Edward Al-Hussainy Assistant Vice President - Analyst +1.212.553.4840 edward.al-hussainy@moodys.com

NEWS & ANALYSIS Credit implications of current events

26 MOODY’S CREDIT OUTLOOK 3 JUNE 2013

EXHIBIT 2

Copper Prices Have Been on a Downward Trajectory Since 2011

Source: London Metals Exchange, Haver Analytics

EXHIBIT 3

Growth in Copper Output Has Decelerated

Source: Bank of Zambia, Moody’s

In our view, two factors combine to elevate the likelihood of government intervention in the mining sector. First, the government is facing a popular backlash to its subsidy reforms and may be tempted to intervene to prevent additional layoffs as a display of political strength. Second, fiscal revenues from the mining sector are small at a time when the government faces rising demands for spending on infrastructure and social development (we expect the budget deficit to exceed 4.5% of GDP in 2013). This makes it increasingly palatable for the government to justify nationalizing copper assets to boost state revenues.

0

0.2

0.4

0.6

0.8

1

1.2

1 2 3 4 5 6 7 8 9 10 11 12 1 2 3 4 5 6 7 8 9 10 11 12 1 2 3 4 5 6 7 8 9 10 11 12 1 2 3 4 5 6 7 8 9 10 11 12 1 2 3 4 5 6 7 8 9 10 11 12 1 2 3 4

2008 2009 2010 2011 2012 2013

Copp

er P

rice

(Jan

201

1 =

1)-27%

0.46 0.52

0.57 0.57

0.70

0.85 0.88

0.82

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1.0

2005 2006 2007 2008 2009 2010 2011 2012

Copp

er O

utpu

t (m

illio

n m

etric

ton

s)

NEWS & ANALYSIS Credit implications of current events

27 MOODY’S CREDIT OUTLOOK 3 JUNE 2013

China’s Economic Reforms to Unleash Private Sector Are Credit Positive On 24 May, China’s State Council released a National Development and Reform Commission (NDRC) document that details a wide-ranging collection of 2013 reform priorities. This policy statement indicates that the new generation of leaders who took power in March want to move beyond limited, incremental measures toward comprehensive and fundamental reforms. The new policy agenda is credit positive for China (Aa3 stable) because it will help advance market reform, boost household income, improve the efficiency of the financial sector and help maintain a sustainable, relatively rapid pace of economic growth.

The NDRC document, which follows up on the income redistribution manifesto11 published in February, details 22 priority reform areas for this year. The responsible ministries and departments will likely issue more detailed implementation measures throughout the rest of the year now that the NDRC and leadership have given the reforms their imprimatur.

One important reform area that will have a positive effect on China’s credit quality is continued interest rate liberalization, which will help improve the efficiency of the financial sector by promoting market pricing of capital. Allowing banks to offer higher deposit rates will raise household incomes and consequently lead to higher levels of private income and consumption.12 Other reforms that are likely to help increase private consumption include reforms of the household registration system, which would allow for greater rural-urban migration, and reforms of the medical insurance system, which could reduce savings.

The NDRC document emphasizes the role of the market and of private capital. To promote competition, the government will encourage private capital to enter the finance, energy, transportation and telecommunications sectors, all of which are currently dominated by state-owned enterprises. The commitment to liberalization was demonstrated this month when the Civil Aviation Administration allowed the establishment of two new independent airlines, Qingdao Airlines in eastern China and Ruili Airlines in western China.

These changes would help deflect the level of intermediation of China’s large domestic savings into investment dominated by state-owned enterprises. The document highlights the goal of accelerating the development of private financial institutions and increasing financing for small and midsize enterprises, which would also increase market competition.

As an example, the NDRC document mentioned the expansion of the value-added tax (VAT) trial as a policy priority. Last week, the Ministry of Finance and State Administration of Taxation issued detailed implementation measures for the nationwide expansion of the VAT trial, which will begin 1 August. As we highlighted last year, the shift to a VAT is credit positive because it will lessen the burden on the private sector by removing duplicate taxation on goods and services on small and midsize businesses, the largest source of job creation in the Chinese economy.13

The timely implementation of fundamental reforms would enhance the productivity of capital and boost China’s long-term economic growth prospects. The rise in leverage and diminishing productivity of financial intermediation in a system dominated by China’s state-owned enterprises has been one factor behind the marked deceleration in its real GDP growth in the wake of the global financial crisis.

11 See China’s Income Redistribution Plan, 11 February 2013. 12 See China’s Step Toward Interest Rate Liberalization Is Credit Positive, 11 June 2012. 13 See Expansion of Value-Added Tax Trial is Credit-Positive for China, 30 July 2012.

David Erickson Associate Analyst +65.6398.8334 david.erickson@moodys.com

Tom Byrne Senior Vice President +65.6398.8310 thomas.byrne@moodys.com

NEWS & ANALYSIS Credit implications of current events

28 MOODY’S CREDIT OUTLOOK 3 JUNE 2013

Philippines’ Record Fiscal Surplus, Robust Growth and Election Results Are Credit Positive Last Thursday, the Philippines (Ba1 stable) reported that first-quarter real GDP grew by 7.8% year on year, buoyed by private consumption and fixed capital formation. Earlier in the week on Monday the government released fiscal results for April showing a PHP36.8 billion surplus, the highest monthly surplus on record, which was largely the result of a 28.9% year-on-year increase in income tax receipts. These developments are credit positive.

The improvement in tax receipts demonstrates that the government’s efforts to bolster tax compliance are gaining traction and helping to boost revenue generation, one of the key weaknesses of the Philippines’ credit profile. The relatively moderate year-to-date fiscal deficit also suggests that a degree of spending restraint in the run-up to the midterm elections held last month and that the government’s spending decisions are increasingly driven by long-term economic objectives rather than short-term political ones.

GDP growth in the Philippines is on an upward trend, in contrast to lackluster global growth performance. On a year-on-year basis, the Philippines’ first-quarter real GDP growth is the strongest among all rated countries in the Asia-Pacific region, outpacing larger emerging markets such as China (Aa3 stable), which had 7.7 % growth, and Indonesia (Baa3 stable), which had 6.0% growth. On a seasonally adjusted quarterly basis, growth was a robust 2.2%, higher than the previous three quarters. Such healthy economic conditions will support revenue receipts and debt consolidation.

President Benigno Aquino III, in line with his campaign promise to not raise taxes, has largely kept the income tax regime intact since entering office in July 2010. Instead, his administration has focused on improving tax compliance by stepping up enforcement and enhancing administrative procedures. As the government records a large proportion of income tax payments in April, the efficacy of these measures best reveals itself by comparing year-on-year trends for that particular month. As such, the Bureau of Internal Revenue (BIR) – the agency tasked with income tax collection – has recorded a marked improvement in performance, with April receipts accelerating by 28.2% year on year, up from a 12.4% year-over-year rise in 2012 (see Exhibit 1).

EXHIBIT 1

Philippines Bureau of Internal Revenue’s April Receipts

Source: Philippines Bureau of the Treasury

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

2009 2010 2011 2012 2013

Chan

ge Y

ear

on Y

ear

Christian de Guzman Vice President - Senior Analyst +65.6398.8327 christian.deguzman@moodys.com

NEWS & ANALYSIS Credit implications of current events

29 MOODY’S CREDIT OUTLOOK 3 JUNE 2013

The Commission on Elections promulgates a ban on public disbursement in the weeks leading up to elections held in May every three years. Given its ambitious spending program, especially on infrastructure development, the Aquino government accelerated disbursements ahead of the ban, which took effect on 29 March. The fiscal deficit consequently came in at PHP29.7 billion through the first four months of the year and the government is likely to meet its full-year fiscal deficit target of PHP238.0 billion, or 2.0% of GDP. In contrast, the fiscal deficit for the same period in 2010 – when the Philippines last held elections – came in at PHP131.6 billion against a full-year target of PHP293.2 billion, or 3.5% of GDP (see Exhibit 2). The government thus largely honored the constraints imposed in order to provide for free and fair elections, while simultaneously maintaining fiscal discipline.

EXHIBIT 2

Philippines’ Cumulative Fiscal Balances, January to April

Source: Philippines Bureau of the Treasury

Parties aligned with the government won nine of 12 contested seats in the upper house of Congress and retained their majority in the lower house on 13 May. Given this strong mandate, the prospects for further fiscal reform over the next three years has improved. In particular, legislation related to the mining sector and the rationalization of fiscal incentives could provide a greater boost to government revenue.

-140

-120

-100

-80

-60

-40

-20

0

20

2009 2010 2011 2012 2013

PHP

billi

ons

NEWS & ANALYSIS Credit implications of current events

30 MOODY’S CREDIT OUTLOOK 3 JUNE 2013

Thailand’s Increasingly Expensive Rice Buying Scheme Is Credit Negative On 23 May, the Bangkok Post reported that losses from Thailand’s (Baa1 stable) rice buying scheme in the harvest season 2011-12 are bigger than the Ministry of Finance originally forecast. At the same time, the Thai authorities appear committed to maintaining the scheme unchanged. These recent losses, and any future losses from the unmodified rice buying scheme, increase the difficulty of the government’s task of reaching its goal of a balanced budget by 2017, and are credit negative for the Thai sovereign.

According to the report, which we were unable to confirm with government sources, new estimates based on actual amounts received imply losses of THB200 billion from the 2011-12 harvest year. This is significantly higher than previous estimates by the World Bank discussed in our April Credit Analysis, which pegged losses at THB115 billion, as well as Thailand’s Ministry of Finance forecast losses of THB70-THB100 billion.

The current iteration of the rice subsidy scheme was established in October 2011 in order to boost Thai farmers’ incomes. However, the government’s purchase of rice at around 50% above market prices carries a fiscal cost when the rice has to be resold at a loss. In the past five harvest seasons, rice farmer support programs required much smaller government outlays that averaged less than a third of the estimated cost of the 2011-12 program.

In addition, the government’s rice buying scheme is largely responsible for a decline in rice exports. Total earnings from rice exports fell in 2012 to $4.6 billion from $6.4 billion in the previous year, owing to the government withholding rice stocks for sale. In volume terms, Thailand’s rice exports fell to 6.7 million tons in 2012 from 10.7 million tons in 2011, the lowest level since 2000. However, given that rice exports make up a relatively small proportion of Thailand’s total exports (averaging 2.6% over the past 10 years), the direct and immediate effect on Thailand’s balance of payments is not material.

The major sovereign credit implications of the continuation of the program and its associated costs lie in the government’s fiscal accounts. Previous estimates of losses for the 2011-12 harvest year were equal to 1.0% of GDP, but the current estimate brings the cost up to 1.7% of GDP or 7.8% of total expenditures in 2012.

The overall budget deficit for the fiscal year ended 30 September 2012 reached 4.1% of GDP, revised slightly downward from 3.9% because of a larger-than-expected non-budgetary cash deficit. While financing of Thailand’s budget deficits is supported by the country’s deep onshore capital markets, the growing losses from the rice buying scheme and the potential need for additional government funding resulting from the continuation of the scheme increasingly jeopardize a reduced deficit, which we previously forecast will be 3.1% of GDP in fiscal 2013. In addition, this makes achieving a balanced budget by 2017 more challenging.

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

Cynthia Mar Associate Analyst +65.6398.8323 cynthia.mar@moodys.com

NEWS & ANALYSIS Credit implications of current events

31 MOODY’S CREDIT OUTLOOK 3 JUNE 2013

Mongolia’s New Securities Law Is Credit Positive On 24 May, Mongolia’s parliament approved revisions to the Securities Markets Law, including an important provision for “dual listing” of companies. Scheduled to come in to effect in January 2014, the changes to the capital markets framework are credit positive for Mongolia (B1 stable) since they will strengthen its investment regime, diversify government funding sources away from external debt and bolster investor confidence.

The provision for dual listing companies is the new law’s cornerstone. The dual listing provision permits a company whose securities are listed abroad to also list and trade within Mongolia, which enhances local market liquidity. Under the pre-existing law, a company issuing securities in Mongolia would have had to be registered within the country, which deterred secondary listings by foreign companies with interests or operations in Mongolia.

Other provisions of the new law include issuance of depository receipts based on underlying securities, specific distinctions between nominal versus beneficial ownership and well-defined criteria to issue and publicly offer securities, including clauses to reduce risks and improve responsibility. All these provisions are directed toward enhancing liquidity and strengthening transparency and disclosure requirements.

A significant consequence of the new law is that it allows state-owned Erdenes Tavan Tolgoi (ETT, unrated) to list within Mongolia and overseas. ETT, which controls a significant portion of Tavan Tolgoi, the world’s largest coking coal deposit, had scheduled an initial public offering last year to raise approximately $3 billion by listing on equity exchanges in London, Hong Kong, and Mongolia’s capital, Ulaanbaatar. However, Mongolia’s legal framework was not compatible with a listing in Hong Kong. The new law irons out this issue. A modernized capital market framework would also be better able to handle the additional capital markets activity we expect after ETT’s IPO.

Additionally, the new law opens up an alternate financing avenue for Mongolia. We expect successful IPOs and improved liquidity to shift some of the burden off debt financing. In order to bridge its funding needs, ETT planned to issue new debt in the interim, a move it can now avoid. Mongolia relies on debt financings to develop its vast mineral and mining resources and meet its infrastructure needs. Total government debt rose sharply in the past year and stood at 59.2% of GDP as of the end of 2012, while external debt amounted to 134% of GDP. External borrowing accounted for the large increase in the debt burden because the domestic market for government bonds is limited. Since last year, the government has issued $2 billion of global bonds (or 18.5% of GDP). The new law will facilitate opening up the equity markets and help service the large increase in debt.

Finally, we view the new law as positive for investor sentiment, which has been flagging recently owing to unpredictable shifts in the investment regime. Together with the recent liberalization of the Foreign Investment Law, the Securities Markets Law adds clarity to the foreign investment regime and marks the government’s attempt to balance the interests of foreign investors with populist demands for resource nationalism.

Anushka Shah Analyst +65.6398.3710 anushka.shah@moodys.com

Tom Byrne Senior Vice President +65.6398.8310 thomas.byrne@moodys.com

Cynthia Mar Associate Analyst +65.6398.8323 cynthia.mar@moodys.com

NEWS & ANALYSIS Credit implications of current events

32 MOODY’S CREDIT OUTLOOK 3 JUNE 2013

US Public Finance

Court Ruling Upholding Medi-Cal Cuts Is Negative for California Hospitals, Positive for State On 24 May, the Ninth US Circuit Court of Appeals upheld the right of California (A1 stable) to make cuts to Medi-Cal, the state Medicaid program. The ruling is credit negative for all California hospitals, but particularly those with high Medi-Cal exposure through affiliated physician practices or medical foundations. The ruling is positive for the state because it increases its budget flexibility and clears the way to cut costs in an area that has experienced spending pressure for many years.

In 2011, California enacted a 10% reduction in Medi-Cal reimbursement, but various Medi-Cal providers quickly sued and obtained an injunction, effectively delaying implementation of the cuts. The appeals court ruling upholds the legality of the cuts. Although providers have stated they intend to appeal the ruling to the US Supreme Court, we believe there is a low probability of the high court accepting the case because it already heard the case in 2012 and returned it to the lower court without making a ruling.

Statewide, the 10% cut amounts to $600 million annually, and the state will apply it retroactively to 2011. The state will recoup payments for the past two years by reducing future payments over four years, resulting in an approximately 15% rate reduction in Medi-Cal rates going forward.

It is important to note that the cuts only affect physician reimbursements and will not reduce hospital reimbursement directly. However, the cuts to physician reimbursement will affect hospitals indirectly. In California, many physicians are employed by medical foundations that in turn have exclusive contacts with particular hospitals. In such cases, the financial performance of the foundations (which are often loss-making) is rolled up into hospitals’ financial statements. Thus, for these institutions, reductions in Medi-Cal reimbursement rates for physicians will have a negative incremental effect on consolidated operating income. As a result, we expect hospitals and medical foundations to take a variety of actions to mitigate this effect, including reducing or eliminating unprofitable service lines and taking steps to reduce exposure to Medi-Cal patients. The cuts will likely also force physician practices with high Medi-Cal exposures to seek employment with medical foundations, effectively increasing hospital subsidies to these foundations.

The state’s estimated savings of $600 million from a 10% cut in the reimbursement rate is a very small portion (0.6%) of the state’s $95 billion General Fund budget for the fiscal year ending 30 June 2013, but is positive for the state because it provides it with additional budgetary flexibility in addition to the modest cost savings. Medicaid spending is a large portion of the state’s budgeted spending, making up 24.2% of California’s spending in fiscal 2011, according to the National Association of State Budget Officers’ 2010-12 State Expenditure Report, and so the court-tested ability of the state to make cuts to this portion of the budget is positive. Although there are several bills pending in the California legislature that would reverse the cuts, Governor Jerry Brown has vowed to veto those bills. The cuts are included in Governor Brown’s proposed budget for fiscal 2014.

The ruling has implications beyond California. At the heart of the lawsuit was a challenge to a state’s ability to make large cuts to Medicaid. Nationwide, National Association of State Budget Officers estimates Medicaid made up 23.9% of total state spending in fiscal 2012, up from 23.7% in fiscal 2011 and 22.2% in fiscal 2010. Healthcare providers argued that such cuts would reduce reimbursement to a point where providers would drop out of the Medicaid program, thereby endangering the health of Medicaid beneficiaries. The appeals court ruling effectively upholds a state’s right to make changes to the amount of

Daniel Steingart, CFA Assistant Vice President - Analyst +1.949.715.9595 daniel.steingart@moodys.com

Emily Raimes Vice President - Senior Credit Officer +1.212.553.7203 emily.raimes@moodys.com

NEWS & ANALYSIS Credit implications of current events

33 MOODY’S CREDIT OUTLOOK 3 JUNE 2013

Medicaid reimbursement. In January, many states will expand Medicaid and hospitals in those states will benefit from the expansion of insurance. However, the appeals court’s ruling demonstrates that states can change Medicaid reimbursements unilaterally.

NEWS & ANALYSIS Credit implications of current events

34 MOODY’S CREDIT OUTLOOK 3 JUNE 2013

Securitization

SLM’s Restructuring Is Credit Negative for Its Private Student Loan Securitizations, Less So for FFELP Last Wednesday, SLM Corporation (Ba1 review for downgrade) announced that it would split into two separate companies, a consumer banking business that would originate and service private student loans and a student loan management business that would service FFELP loans. The restructuring is credit negative for SLM’s student loan securitizations because their servicer will be smaller and less diversified than the currently combined SLM and therefore more vulnerable to financial distress. Private student loan securitizations are more affected than FFELP securitizations.14

Restructuring is credit negative for private student loan securitizations. The restructuring is credit negative for SLM private student loan securitizations because servicing risk will increase. The US Department of Education does not guarantee private student loans, whose performance thus depends on the borrower and the financial stability and ability of the servicer. The likelihood of servicer financial distress is greater because the consumer banking business that would house the company’s private student loan origination and servicing operations would be smaller and less diversified than the current SLM. The company’s focus on private student loans will expose it to potentially volatile credit performance, as was the case during the recession. The consumer banking business would retain only around 5% of the assets that SLM currently holds.

Servicing disruptions can lead to significant deterioration in the credit quality of the portfolio. SLM private student loan securitizations do not have a named backup servicer to mitigate this risk. In addition, transferring servicing is more difficult for non-guaranteed private student loans than for FFELP student loans because it requires significantly more expertise to collect on non-guaranteed debt since servicing is less standardized.

We rate approximately $25 billion of SLM private student loan securitizations.

Restructuring is less credit negative for FFELP student loan securitizations. The restructuring would be less credit negative for SLM FFELP securitizations and other FFELP securitizations for which SLM is the third-party servicer. According to the restructuring plan, the student loan management business would retain SLM’s FFELP and Direct Loan servicing operations of $236 billion as of 30 April 2013, but would not have access to the earnings, cash flow or equity of the consumer banking business.15 However, servicing risk is low for FFELP loans given the history of numerous servicing transfers and the ease of transferring loans because of standardized servicing platforms. In addition, the trustee’s responsibility to act as servicer of last resort mitigates the servicing risk in SLM FFELP securitizations.

We rate approximately $93 billion of SLM FFELP student loan securitizations.

Restructuring is likely to take place within the year. According to SLM, the restructuring is likely to take place within the next 12 months, subject to final approval by SLM’s board of directors, confirmation of the transaction’s tax-free status and the effectiveness of a registration statement that SLM will file with the US Securities and Exchange Commission, including information about the separation, distribution and related matters.

14 See Moody’s reviews for downgrade 60 notes from 24 Sallie Mae private student loan trusts, 31 May 2013. 15 See Moody’s reviews long-term ratings of SLM Corp. for possible downgrade, 29 May 2013.

Pedro Sancholuz Ruda Assistant Vice President - Analyst +1.212.553.1668 pedro.sancholuzruda@moodys.com

Jingjing (Nicky) Dang Assistant Vice President - Analyst +1.212.553.4801 jingjing.dang@moodys.com

NEWS & ANALYSIS Credit implications of current events

35 MOODY’S CREDIT OUTLOOK 3 JUNE 2013

Late Recognition of $1 Billion Losses on RMBS Previously Serviced by Homeward Is Credit Negative Last Tuesday, more than $1 billion of losses were retroactively recognized on 170 US residential mortgage-backed securitizations. The losses, which are the result of mortgage modifications, are credit negative for these transactions.

According to Ocwen Loan Servicing, which began servicing the transactions in December 2012, the transactions incurred the losses because of principal forbearance modifications the previous servicer, Homeward Residential Inc., undertook before July 2012. In 50 transactions, the losses exceeded $10 million each; in 13 of the 50, those losses exceeded $30 million each. In another 57, losses were $1-$10 million apiece. Subprime mortgage loans back the majority of the affected transactions.

The delay in recognizing losses allowed mezzanine bonds to continue receiving interest payments, thereby reducing excess spread available to amortize more senior bonds. The sudden write-down also affects some senior bonds whose payment priorities are now more likely to change earlier than previously expected.16 The exhibit below illustrates the change in payments in one transaction with a $14 million loss that was retroactively recognized.

Payments With and Without Recognition of $14 Million Principal Forbearance Write-Down

Without Recognition

Class Beginning

Certificate Balance Interest

Distribution Principal

Distribution Current Realized

Loss Ending Certificate

Balance

1-A1 $43,000,000 $11,000 $3,000,000 $40,000,000

1-A2 180,000,000 56,000 180,000,000

1-A3 130,000,000 53,000 130,000,000

M-1 14,000,000 6,000 14,000,000

With Recognition

Class Beginning

Certificate Balance Interest

Distribution Principal

Distribution Current Realized

Loss Ending Certificate

Balance

1-A1 $43,000,000 $11,000 $365,439 $42,634,561

1-A2 180,000,000 56,000 1,666,667 178,333,333

1-A3 130,000,000 53,000 2,708,333 127,291,667

M-1 14,000,000 6,000 $14,000,000 0

Source: Moody’s

Based on our conversations with Ocwen, the losses all relate to previously unrecognized forborne principal prior to July 2012. The 2009 HAMP guidelines require that servicers treat forborne principal on modified loans as realized losses on the mortgage pool, but on these transactions recognition of the forborne principal prior to July 2012 did not occur until last month. Ocwen believes the situation is a onetime occurrence and does not expect additional losses in these transactions resulting from old forbearance modifications.

16 The payment priority of some of the fast cash flow bonds changes to pro rata upon depletion of the mezzanine certificates.

Ola Hannoun-Costa Assistant Vice President - Analyst +1.212.553.1456 ola.hannouncosta@moodys.com

Mark Branton Assistant Vice President - Analyst +1.212.553.4175 mark.branton@moodys.com

Deepika Kothari Vice President - Senior Analyst +1.212.553.4585 deepika.kothari@moodys.com

RATING CHANGES Significant rating actions taken the week ending 31 May 2013

36 MOODY’S CREDIT OUTLOOK 3 JUNE 2013

Corporates

Alcoa Inc. Downgrade

18 Dec ‘12 29 May ‘13

Senior Unsecured Rating Baa3 Ba1

Outlook Review for Downgrade Stable

Alcoa has had some success in reducing costs and improving productivity, but the timeframe for achieving debt protection measures appropriate for an investment-grade rating has been getting longer and longer. Headwinds continue to pressure fundamentals in the aluminum industry and aluminum prices, and in turn the level of performance improvement that Alcoa can achieve in its primary business segment.

Alstom Review for Downgrade

17 Jan ‘12 28 May ‘13

Long Term Issuer Rating Baa2 Baa2

Short Term Issuer Rating P-2 P-2

Outlook Negative Review for Downgrade

The review follows publication of Alstom’s full-year results for the 12 months ending March 2013 and management's announcement that it anticipates improvements in revenue and profit generation to be slower than expected. Despite a significant improvement in operating profits, Alstom's leverage metrics have not improved materially. As a consequence, the company's key credit metrics remain materially below our expectations for the current rating.

Bausch & Lomb Incorporated Review for Upgrade

13 Apr ‘10 28 May ‘13

Corporate Family Rating B2 B2

Outlook Stable Review for Upgrade

The review follows news that the company has signed a definitive agreement to be acquired by Valeant Pharmaceuticals International for $8.7 billion in cash. It will focus on the benefits of Bausch becoming part of a larger combined company with a stronger credit profile. We understand that management expects Bausch's debt to be repaid, but if any debt remains outstanding, the review will also evaluate any support mechanisms Valeant provides to Bausch's debt.

RATING CHANGES Significant rating actions taken the week ending 31 May 2013

37 MOODY’S CREDIT OUTLOOK 3 JUNE 2013

Building Materials Corporation of America Upgrade

9 Aug ‘10 28 May ‘13

Corporate Family Rating Ba3 Ba2

Outlook Stable Stable

The upgrade is because we expect the company to continue to generate solid operating margins, earnings and cash flows. BMCA will continue to benefit from roofing repair activity, the main driver of its revenues. We believe EBITA margins will remain above 20%.

Carestream Health, Inc. Downgrade

6 Mar ‘07 29 May ‘13

Corporate Family Rating B1 B2

Outlook Stable Stable

The downgrade primarily reflects the significant increase in leverage as a result of a large dividend being paid to shareholders. With prospects for EBITDA growth modest and a substantial portion of excess free cash flow going toward paying dividends instead of repaying debt, we see limited prospects for deleveraging.

General Mills, Inc. Upgrade

30 Jan ‘13 31 May ‘13

Senior Unsecured Rating Baa1 A3

Short Term Issuer Rating P-2 P-2 (affirmed)

Outlook Review for Upgrade Stable

The upgrade recognizes the improved and stable operating performance that General Mills has achieved in recent years through a combination of cost efficiency initiatives that have enhanced cash flow, and a more disciplined business strategy focused on improved product mix and profit margin expansion. The upgrade also reflects the moderation of financial policies that have been more balanced than they were several years ago.

LyondellBasell Industries N.V. Upgrade

4 Nov ‘11 29 May ‘13

Senior Unsecured Rating Baa3 Baa2

Outlook Stable Positive

The upgrade reflects recent changes to LYB's board as well as the further decline in the equity ownership by affiliates of Apollo Management since November 2012. Despite the announced share repurchase program and increase in the dividend, we expect LyondellBasell to generate extremely strong financial metrics for the Baa2 rating over the next several years. The positive outlook reflects our belief that the equity stake held by Apollo will continue to decline along with its disproportionate board representation.

RATING CHANGES Significant rating actions taken the week ending 31 May 2013

38 MOODY’S CREDIT OUTLOOK 3 JUNE 2013

PepsiCo, Inc. Review for Downgrade

9 Feb ‘12 30 May ‘13

Senior Unsecured Rating Aa3 Aa3

Short Term Issuer Rating P-1 P-1 (affirmed)

Outlook Negative Review for Downgrade

Pepsi’s credit metrics have very gradually deteriorated as the company has increased its shareholder returns in recent years as it takes on the challenge of growth in the North American beverage business. Although Pepsi's performance has improved recently after 2012 was a year of repositioning, and liquidity remains excellent, the company's leverage metrics remain weaker than those of its Aa-rated peers.

RATING CHANGES Significant rating actions taken the week ending 31 May 2013

39 MOODY’S CREDIT OUTLOOK 3 JUNE 2013

Infrastructure

American Water Works Upgrade

14 Aug ‘ 12 29 May ‘13

Issuer Rating Baa2 Baa1

Outlook Positive Stable

American Water Capital Corp. Upgrade

14 Aug ‘12 29 May ‘13

Senior Unsecured Revenue Bonds Baa2 Baa1

Outlook Positive Stable

New Jersey American Water Upgrade

14 Aug ‘12 29 May ‘13

Issuer Rating Baa1 A3

Outlook Positive Stable

Pennsylvania American Water Upgrade

14 Aug ‘12 29 May ‘13

Issuer Rating Baa1 A3

Outlook Positive Stable

The upgrade of the ratings of AWK and its subsidiaries reflects our expectation that the company will continue to make progress toward enhancing cost recovery throughout its broad base of regulated operations, which will improve financial metrics. AWK has shown significant improvement in financial performance since 2010, because of focused investment in supportive regulatory jurisdictions, greater use of interim cost recovery mechanisms and heightened attention toward operating efficiency.

RATING CHANGES Significant rating actions taken the week ending 31 May 2013

40 MOODY’S CREDIT OUTLOOK 3 JUNE 2013

Mississippi Power Company Review for Downgrade

6 Aug ‘12 31 May ‘13

Senior Unsecured Rating A3 A3

Outlook Negative Review for Downgrade

The Southern Company Affirmation

12 Aug ‘10 31 May ‘13

Senior Unsecured Rating Baa1 Baa1

Outlook Stable Stable

The review on Mississippi Power reflects the regulatory, financial, economic and execution challenges facing the utility as it continues construction of the large and complex Kemper integrated coal gasification combined cycle plant. The utility recently announced a sudden and substantial $540 million increase in estimated costs to complete the plant, for which it took a charge to net income. The affirmation of the ratings of Southern considers the large and diverse nature of its sources of cash flow, with three major subsidiaries in addition to Mississippi Power.

TECO Energy, Inc. Affirmation

4 May ‘12 29 May ‘13

Senior Unsecured Rating (P) Baa2 (P) Baa2

Outlook Stable Stable

TECO Finance, Inc. Affirmation

4 May ‘12 29 May ‘13

Senior Unsecured Rating Baa2 Baa2

Outlook Stable Stable

Tampa Electric Company Affirmation

4 May ‘12 29 May ‘13

Senior Unsecured Rating A3 A3

Outlook Stable Stable

The affirmations of the ratings of TECO Energy and its subsidiaries follow the announcement that TECO Energy had reached a definitive stock purchase agreement to acquire New Mexico Gas Company from Continental Energy Systems LL for $950 million. The rating affirmation recognizes TECO's intention to finance the acquisition in a conservative manner, as well as the company's solid positioning in its rating category.

RATING CHANGES Significant rating actions taken the week ending 31 May 2013

41 MOODY’S CREDIT OUTLOOK 3 JUNE 2013

Financial Institutions

Five Indonesian Banks’ Standalone Financial Strength Assessments Upgraded 29 May ‘13

We upgraded the baseline credit assessments of four Indonesian banks by one notch after three years of consistently strong financial performance, marked by improving asset quality and strong profitability. We expect Indonesia's favorable operating environment to persist, supporting the banks’ asset quality and profitability, which will continue to be among the strongest recorded by banks globally. The upgrades were:

» PT Bank Central Asia Tbk to D+/baa3(standalone bank financial strength rating/baseline credit assessment)

» PT Bank Rakyat Indonesia (Persero) Tbk to D+/baa3

» PT Bank Mandiri (Persero) Tbk to D+/ba1

» PT Bank Negara Indonesia (Persero) Tbk to D/ba2

» PT Bank Permata Tbk to D/ba2

AllianceBernstein L.P. Downgrade

12 Aug ‘10 28 May ‘13

Senior Debt Rating A1 A2

Outlook Negative Stable

The downgrade reflects a transition in the company's market position relative to its peers. After years of heavy outflows of equity assets under management, and persistently weak equity performance, the equity platform is unlikely to regain its former scale and market position in the foreseeable future.

Deutsche Hypothekenbank AG Upgrade

6 Jun ‘12 31 May ‘13

Long-Term Senior Debt and Deposit Ratings

Baa2 Baa1

Subordinated Debt Ratings Ba3 Ba1

Non-Cumulative Preferred Securities B2 (hyb) Ba3 (hyb)

The upgrade reflects our view of an increased probability of parental support following the conclusion of a domination and profit and loss transfer agreement between Deutsche Hypo and NORD/LB.

RATING CHANGES Significant rating actions taken the week ending 31 May 2013

42 MOODY’S CREDIT OUTLOOK 3 JUNE 2013

International Bank of Azerbaijan Outlook Change

2 9 Nov ‘12 29 May ‘13

Standalone Bank Financial Strength / Baseline Credit Assessment

E+/b3 E+/b3

Long-Term Local and Foreign Currency Deposit Ratings

Ba3 Ba3

Long-Term Foreign Currency Senior Unsecured Debt Rating

Ba3 Ba3

Long-Term Foreign Currency Subordinated Debt Rating

B1 B1

Outlook Change Negative Stable

The outlook change is driven by the stabilisation in International Bank of Azerbaijan's standalone credit profile and reflects the bank's improvement in asset quality indicators, strengthened capital base, and improved revenue generation. At the same time, the ratings remain constrained by very high concentration levels in the bank's loan book, its low core capital level and moderate profitability.

IBA-Moscow Outlook Change

1 Dec ‘11 29 May ‘13

Long-Term Local and Foreign Currency Deposit Ratings

B3 B3

Outlook Negative Stable

The outlook change follows that on the ratings of its parent, International Bank of Azerbaijan.

International Financial Club Upgrade

5 Jul ‘12 28 May ‘13

Long-Term Deposit Ratings B3 B2

The upgrade was prompted by, first, the Russian bank's improved profitability and operating efficiency, which now provide a better loss absorption capacity; and, second, asset quality metrics that remain good despite the seasoning of the loan book following the loan book’s rapid growth.

RATING CHANGES Significant rating actions taken the week ending 31 May 2013

43 MOODY’S CREDIT OUTLOOK 3 JUNE 2013

SLM Corporation Review for Downgrade

17 Aug ‘11 29 May ‘13

Long-Term Ratings Ba1 Ba1 (Review for Downgrade)

Corporate Family Rating Ba1 Ba1 (Review for Downgrade)

The review follows SLM’s announcement that it intends to pursue a corporate restructuring in which it will be divided into two separate companies. SLM's legacy Federal Family Education Loan Program (FFELP) and private education loan portfolios, FFELP and Department of Education loan servicing operations, and collections business, will be housed in a new entity that will be spun off to SLM shareholders. We will evaluate the degree to which SLM's unsecured bondholders are negatively affected by what amounts to a dividend to shareholders of a major part of SLM's current operations.

Sovereigns

Tunisia Downgrade

29 May ‘13

Gov Currency Rating Ba1 Ba2

Foreign Currency Deposit Ceiling Ba2 Ba3

Foreign Currency Bond Ceiling Baa2 Baa3

Local Currency Deposit Ceiling Baa2 Baa2

Local Currency Bond Ceiling Baa2 Baa2

Outlook Review for Downgrade Negative

The key drivers of the downgrade are Tunisia's persistent political uncertainty and risk of instability, the fragile state of the undercapitalised government-owned banks, and the sizeable external pressures on Tunisia's balance of payments and government finances. The negative outlook reflects risks from the ongoing uncertain political situation and the sustained deterioration of the government balance sheet.

RATING CHANGES Significant rating actions taken the week ending 31 May 2013

44 MOODY’S CREDIT OUTLOOK 3 JUNE 2013

Sub-sovereigns

Region of Sicily, Italy Downgrade

13 Dec ‘12 28 May ‘13

Issuer & senior unsecured rating Baa3 Ba1

Outlook Review for Downgrade Negative

Regions of Campania and Piedmont, Italy Downgrade

12 Jul ’12 28 May ’13

Issuer & senior unsecured rating Baa3 Ba1

Outlook Negative Negative

Region of Lazio, Italy Downgrade

12 Jul ’12 28 May ’13

Issuer & senior unsecured rating Baa3 Ba2

Outlook Negative Negative

The downgrades reflect heightened concerns about these regions' financial positions in the current environment. Austerity-driven cuts in central government resources are stressing regional budgets, resulting in growing fiscal rigidity. Ongoing liquidity pressures have contributed to the accumulation of sizeable overdue payables and commercial debts. These regions are expected to cover a large proportion of this accumulated imbalance by incurring sizeable new borrowing from the national government under a recently introduced funding arrangement.

Municipality of Tlalnepantla, Mexico Upgrade

21 Jun 11 28 May 13

Issuer rating Ba3/A3.mx Ba2/A2.mx

Outlook Positive Stable

The upgrade reflects the sustained improvement in the municipality's gross operating balances, driven by growth in own-source revenues in conjunction with contained growth in operating expenditures. Tlalnepantla´s credit profile has been strengthened by the recording of positive operating margins during the 2009-12 period.

RATING CHANGES Significant rating actions taken the week ending 31 May 2013

45 MOODY’S CREDIT OUTLOOK 3 JUNE 2013

US Public Finance

Suffolk County, New York Downgrade

15 Oct ‘12 30 May ‘13

General Obligation Bonds A1 A2

Outlook Negative Negative

The downgrade reflects the county's failure to meet projected fiscal 2012 year-end estimates despite deficit mitigation plans and the use of non-recurring revenue adjustments to balance the fiscal 2013 budget. The rating also reflects the county's narrow liquidity resulting from recurring operating deficits that have significantly reduced reserve levels. The county continues to face a structural operating gap in the current fiscal year, necessitating significant midyear budget adjustments and significant annual cash flow borrowing. The negative outlook reflects ongoing use of non-recurring revenue adjustments and failure to implement meaningful spending reductions.

Omaha Public Power District Review for Downgrade

17 Dec ‘12 29 May ‘13

Senior Revenue Bonds Aa1 Aa1

Subordinate Revenue Bonds Aa2 Aa2

Outlook Stable Review for Downgrade

The single unit Fort Calhoun Nuclear Station, which OPPD fully owns, has been on an extended outage since April 2011, and revised estimates indicate July 2013 as the earliest likely restart date. This date remains uncertain and is well after our fall expectations of a February 2013 restart and our revised spring expectation of a May restart. The ongoing restart delays are indicative of additional NRC scrutiny.

Structured Finance

Sixty Notes from 24 Sallie Mae Private Student Loan Trusts Placed on Review for Downgrade On 30 May, we placed approximately $15.8 billion of securities on review because of the increased risk of servicing disruption for them after SLM's 29 May announcement that it would be separating its education loan management business from its consumer banking business. Under the plan, private student loans will be serviced by a consumer banking business, which will be materially smaller and less diversified than SLM in its current integrated form. The small scale and lack of diversification will increase the probability of servicing disruption, which would negatively affect performance of the underlying private student loan portfolio. In addition, the securitizations do not include back-up servicing provisions.

RESEARCH HIGHLIGHTS Notable research published the week ending 31 May 2013

46 MOODY’S CREDIT OUTLOOK 3 JUNE 2013

Corporates

US For-Profit Hospitals’ Quarterly Results Are Weak but Condition Is Not Yet Critical The for-profit hospital operators posted operating results for the first quarter that were universally worse than expected, with the median growth in same-facility adjusted admissions in at about -1.8% -- well below our estimate of 0.9%. But comparisons with the prior year are difficult and make the quarter’s results look worse than they are. The impact on credit profiles is not material.

China Property Focus - May 2013 The growth momentum in China’s property market continued in April but at a slower pace compared with March, following the State Council’s policy guidelines that were announced in February to increase controls on the sector, our newsletter says. Among other topics discussed: property prices extend growth in April, dim sum bond issuance dominates May, our liquidity index for Chinese property developers edges down.

US Retailers’ Earnings Growth Is Poised to Improve in 2013 We have revised our forecast for US retail operating income growth to 4%-5% for 2013, up from 3% - 4%, as we expect the retail industry will benefit from ongoing expense discipline, thus driving earnings growth from leveraging expenses off a slow revenue growth rate. The outlook for the US retailers remains stable.

Q&A on the Cape Town Convention The Convention on International Interests in Mobile Equipment promotes the financing or leasing of movable transportation equipment in cross-border transactions by removing or reducing the uncertainty about enforcement rights of creditors under default scenarios including insolvency. The three elements of Cape Town that are typically most relevant to our ratings are the international interest, the International Registry and remedies on insolvency.

US Life Science: Operating-Profit Growth Slowing as Industry Braces for Consolidation Profits in the life science industry will be slower this year than last, although emerging markets and pharmaceutical R&D spending will lift overall life science growth rates. With Thermo Fisher Scientific Inc.’s (Baa1 review for downgrade) announced plans to buy fellow laboratory product maker Life Technologies Corp. (Baa3 developing) for $16 billion, creating the largest life science company by far, we expect pressure on smaller players to develop over time.

US Gaming Industry: Federal Trade Commission Challenge of Pinnacle-Ameristar Deal Is Credit Negative The FTC’s action is credit negative for both companies because it will likely delay closing of the acquisition and could result in cancellation of the deal or asset divestitures that would dilute the benefits.

US Packaging Industry: Continuing Productivity Initiatives Support Sector The US packaging industry’s organic EBITDA will rise only modestly over the next year. Packaging manufacturers will remain focused on cost controls, profitability and productivity. We expect those packaging manufacturers with greater exposure to developing markets or in consolidated segments to fare better.

RESEARCH HIGHLIGHTS Notable research published the week ending 31 May 2013

47 MOODY’S CREDIT OUTLOOK 3 JUNE 2013

US Gaming Industry: Las Vegas Strip Recovery Lags Despite Record Visitor Volume An oversupply of hotel rooms and the lackluster US economy will keep the recovery of the Las Vegas Strip subdued in 2013. We expect gaming revenue and room rates in Las Vegas to grow in line with our US GDP growth forecasts of 1.5%-2.5% for 2013 and 2%-3% in 2014, leaving revenues on the Strip shy of their 2007 peaks.

Global Aerospace and Defense: Commercial Aerospace Growth to Offset Effect of Defense Budget Cuts Despite momentary Boeing 787 woes, growth in commercial airplane deliveries will be strong. Therefore, commercial aerospace growth will remain robust as defense spending shrinks. Our outlook for the industry is stable.

Infrastructure & Project Finance

Operational UK Offshore Transmission Owners’ Solid Credit Strength Comparable to That of UK Regulated Onshore Networks Operational offshore transmission owners (OFTOs) in the UK exhibit a favourable credit risk profile. We could consider OFTO transactions to be comparable with regulated onshore electricity and gas transmission network businesses that are rated in the Baa1/A3 range.

RESEARCH HIGHLIGHTS Notable research published the week ending 31 May 2013

48 MOODY’S CREDIT OUTLOOK 3 JUNE 2013

Financial Institutions

US Banking Quarterly Credit Update – 1Q 2013 Despite a seasonal improvement in profitability ratios in the first quarter, US banks' core profitability remains pressured from low interest rates, the competitive lending environment, and high overhead ratios driven by revenue pressures and administrative expenses related to the still-high levels of problem assets and increasing regulatory requirements. However, asset quality metrics continue to improve, despite still-high levels of nonperforming assets.

Banking System Outlook: United States of America The change in outlook on the US banking system to stable from negative reflects continued improvement in the operating environment and reduced downside risks to the banks from a faltering economy. Sustained GDP growth and improving employment conditions will help banks protect their now-stronger balance sheets. In addition, after another year of reducing credit-related costs and restoring capital, US banks are now even better positioned to face any future economic downturn.

New Swiss Rules Will Lift Regulatory Capital Ratios of Regional and Cantonal Banks, but Not Strengthen Their Loss-Absorption Capacity The announced changes in capital regulation will have no impact on the fundamental credit profiles of Swiss regional and cantonal banks, although the changes will increase the reported regulatory capital ratios of most of these banks.

RESEARCH HIGHLIGHTS Notable research published the week ending 31 May 2013

49 MOODY’S CREDIT OUTLOOK 3 JUNE 2013

Sovereigns

Papua New Guinea Credit Analysis Papua New Guinea’s B1 local and foreign government issuer ratings are based on its low degree of economic strength and its very-low-to-low institutional strength, although both have improved since our previous assessment. The ratings also incorporate the country’s moderate government financial strength and its low-to-moderate susceptibility to event risk.

Nigeria‘s State of Emergency Does Not Effect Credit Outlook The government of Nigeria (Ba3 stable) recently declared a state of emergency in three northern states in response to an escalation of violence linked to Boko Haram, an Islamist terrorist insurgency. While the action marks an intensification of the conflict between Nigeria’s security services and the insurgents, we do not expect it to affect the stability of the government and see no material impact on the sovereign’s creditworthiness at this time.

Moody's Sovereign Monitor - Focus on Euro Area's Southern Perimeter - May 2013 The negative outlooks we currently hold for the ratings of sovereigns in the euro area’s southern perimeter reflect these countries’ continued vulnerability to destabilising shocks, given their subdued economic prospects, their elevated debt levels, and the divergent views among policymakers. As crisis conditions recede, our recent research and rating actions have focused on sovereign-specific credit challenges, ranging from persistent budget deficits to ailing national banking systems.

Finland Credit Analysis Finland’s Aaa rating and stable outlook reflect successive governments’ track record of reform as well as the consistency and proactive nature of macroeconomic policy formation. This track record and the government’s moderate debt burden has allowed the Finnish Treasury to maintain ready access to both the local and global capital markets at relatively low interest rate spreads despite turbulent conditions in many parts of the euro area.

Montenegro Credit Analysis Montenegro’s Ba3 government bond rating incorporates the credit challenges posed by its small, and relatively undiversified economy, as well as its dependence on foreign investment. The rating also accounts for the economic and institutional benefits of EU accession.

Sub-Saharan Africa‘s Commodity Price Vulnerability Balanced by Favorable Economic Outlook and Gradual Structural Transformation The majority of our rating outlooks for sub-Saharan African (SSA) sovereigns is currently stable, balancing the region’s vulnerability to commodity price fluctuations with an improved fiscal resilience and the credit-supportive gradual structural transformation. In particular, we expect the region’s sovereign creditworthiness to be supported by our forecasts of continued growth of an average 5.2% in 2013 and 5.3% in 2014.

RESEARCH HIGHLIGHTS Notable research published the week ending 31 May 2013

50 MOODY’S CREDIT OUTLOOK 3 JUNE 2013

Moody's Country Credit Statistical Handbook - May 2013 The latest edition captures the unprecedented global economic cycle of the last decade and the significant impact on sovereign finances. Updated forecasts show persistent threats to the global economy from the ongoing European debt crisis. Includes historical data for 2003-12, two years of forecasts, and peer comparisons of macroeconomic, fiscal, external, liquidity and monetary indicators for our 118 rated countries.

Closing the Infrastructure Gap: Challenges and Prospects for Sub-Saharan Africa Sovereigns Infrastructure deficiencies in Sub-Saharan Africa (SSA) are a key challenge for the continent. However, unlocking further financing to bridge the infrastructure gap will be contingent on improvements in macroeconomic stability, governance and the business environment.

Structured Finance

CLO Interest European CLOs emerged from the 2009 downturn intact, thanks to the effectiveness of structural protections, and the likelihood of senior tranches in European arbitrage cash flow CLOs incurring principal losses is remote, our newsletter says. Also discussed: highlights of our global CLO methodology, how the benefits of amortization for synthetic CLOs vary considerably, and the rapid redemption of senior classes in CRE CLOs, among other topics.

UK RMBS Unaffected by Self-Employed Homeowners’ Exposure to UK Economic Weakness While self-employed borrowers are more exposed to the current weakness in the UK economy than employed borrowers, this exposure will not have a significant impact on the creditworthiness of UK RMBS deals because over three quarters of RMBS loans are made to employed borrowers.

Structured Thinking: Asia Pacific - May 2013 Our newsletter reviews our recently published settings for rating RMBS in the Asia Pacific. Also discussed: Australian dollar depreciation benefits Australian auto ABS, the variation in the benefits of amortization for synthetic CLOs in Hong Kong, among other topics.

Inside the Canadian ABCP Market: 1Q 2013 We summarize the activity and discuss the characteristics and performance of the Canadian asset-backed commercial paper (ABCP) programs. Performance across all the major asset types remains strong and stable, and continues to perform in line with our expectations.

RESEARCH HIGHLIGHTS Notable research published the week ending 31 May 2013

51 MOODY’S CREDIT OUTLOOK 3 JUNE 2013

New US CMBS Provisions Weaken the Effectiveness of Recourse to a Borrower’s Sponsor Loan documents for a number of recent commercial mortgage-backed securities transactions contain revisions to recourse liability provisions that are credit negative for CMBS. These provisions, a key factor in assessing a CMBS transaction’s legal risk, define the lender’s ability to pursue both the borrower and the borrower’s deep-pocketed controlling sponsor1 if the borrower commits any so-called “bad boy” acts. We evaluate bad-boy recourse liability provisions for deviations from standard provisions and adjust credit support levels accordingly.

US CMBS: Over-Reliance on In-Place Rents Can Miss Credit Signals in Both Directions Determining the value of income-producing commercial properties based on sustainable income is more accurate for credit analysis purposes than relying on only current income (in-place) or pro forma income. A recently complete transaction, backed by the Seagram Building in New York City, provides a good example of the disconnect that can occur between the value that results from simply capitalizing in-place income and the value that results from capitalizing sustainable income.

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

52 MOODY’S CREDIT OUTLOOK 3 JUNE 2013

NEWS & ANALYSIS Corporates 2 » Actavis' All-Stock Deal for Warner Chilcott Will Decrease

Leverage and Improve Cash Flow » Freeport-McMoRan Copper & Gold's Dividend Payout Adds

to Financial Burden » NetApp's Dividend and Share Repurchase Plans Are Credit

Negative » Dover Corp's Planned Communications Technologies Spin-off

Is Credit Negative » Laredo Asset Sale Tilts Producer Toward Higher-Margin

Liquids, a Credit Positive » Ply Gem's IPO Will Help Its Debt-Service Efforts » Sears’ Loss Highlights Growing Trouble at Kmart, a Credit

Negative » Embraer Wins Credit-Positive Order from SkyWest Airlines » CIFI's Land Acquisition Increases Execution Risk, a Credit

Negative

Banks 12 » European Banking Authority Mandates Asset Quality Reviews

Before Bank Stress Tests, a Credit Positive » Lloyds and RBS Say They Do Not Need Capital Issuance to

Meet New Requirements, a Credit Positive » US Regulator's Comments on Payday Lending Are Positive for

Credit Unions, Negative for Payday Lenders » Ally Financial's Proposed Rescap Settlement Is Credit Positive » BNDES’ Planned Non-performing Loans Auction Is Credit

Positive » Brazil's Central Bank Broadens Regulatory Oversight on the

Payment Industry, a Credit Positive

Insurers 19

» Oklahoma Tornadoes Are Apt to Pressure Exposed P&C Insurers' Earnings

» Oklahoma Tornado Losses Are Credit Negative for Combine Re Cat Bond

» MetLife to Move Variable Annuity Risk Onshore, a Credit Positive

» A Tokio Marine and Zenkyoren Alliance Would Be Credit Negative for Japanese P&C Insurers

» Taiyo Life's Increased Foreign Exchange Risk Is Credit Negative

» PICC Property and Casualty Capital Raising Is Credit Positive

Sub-sovereigns 26 » Mexico Defers Reporting Rules for States and Municipalities,

a Credit Negative » Acapulco Water Company's Inability to Pay for Extraction

Rights Is Credit Negative

Covered Bonds 29

» Proposed Amendments to German's Insolvency Statute Are Credit Negative for Consumer Assets

RATINGS & RESEARCH Rating Changes 31

Last week we upgraded Concho Resources, NV Energy, Nevada Power, Sierra Pacific Power, 12 Turkish banks, First Gulf Bank, MBIA, MBIA Insurance, National Public Finance Guarantee, MBIA UK Insurance, MBIA Mexico, Provident Funding, Vietnam Bank for Industry and Trade, Allegheny County Airport Authority, and downgraded Cash Store Financial Services, among other rating actions.

Research Highlights 40

Last week we reported on Mexican telecom, Freeport, Indonesian property developers, Korean corporates, North American auto suppliers, North American shale, European insurers, US life insurers, Caribbean sovereigns, Nicaragua, Oklahoma, Ascension Health Alliance, US state Housing Finance Agencies, US non-profit hospitals, US CMBS, US ABS, Spanish covered bonds, Russian RMBS, and US RMBS, among other reports.

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

David Dombrovskis

Ratings & Research: Robert Cox Final Production: Barry Hing