MOODYS.COM

14 JULY 2014

NEWS & ANALYSIS The Indian Budget 2

» For the Sovereign, a Lack of Specifics » For Corporates, Credit Positive » For the Infrastructure Sector, Credit Positive » For Banks, Credit-Positive Elements, but Capital Strains Are

Unaddressed

Corporates 8

» Boeing Wins Emirates’ $56 Billion Order for 777X Jets » Stronger-than-Expected PC Demand Is Credit Positive for HP,

Intel and the PC Supply Chain » Salix Pharma to Merge with Cosmo and Relocate to Ireland, a

Credit Positive » Volkswagen’s Planned Expansion in China Is Credit Positive

Infrastructure 13

» PREPA Buys Time with Lenders, but Liquidity and Structural Issues Remain

Banks 14

» Vehicle Production Decline Is Credit Negative for Brazil’s Captive Auto Finance Operations

» Bolivian Banks’ New Lending Rate Caps and Minimum Deposit Rates Are Credit Negative

» Citadele’s Uncertainty Ends, Paving the Way for Privatisation, a Credit Positive

» KBC Bank Will Significantly Raise Loan-Loss Provisions

Insurers 20 » Prudential Financial’s £16 Billion Longevity Risk-Transfer Deal Is

Credit Positive » Amlin Will Benefit from Its Increased Ownership Stake in

Leadenhall Capital Partners » UK’s General Insurers’ Motor Premium Rates Decline…Again, a

Credit Negative » China Pacific Property Insurance’s Acquisition of Anxin

Agricultural Insurance Is Credit Positive

US Public Finance 27 » Bethlehem, Pennsylvania Water System Gets Lower-than-

Requested Rate Increase

Securitization 29 » German Regulator Can Increase Covered Bonds’ Obligatory

Over-Collateralisation, a Credit Positive

CREDIT IN DEPTH Developments at Banco Espirito Santo are Credit Negative for It, Other Portuguese Banks and for Portugal Telecom 30

Credit problems at affiliates of Banco Espirito Santo’s major shareholder have no immediate effect on the Portuguese sovereign or corporates in the country.

RATINGS & RESEARCH Rating Changes 32

Last week, we upgraded Panasonic, Fidelity & Guaranty Life Holdings, and downgraded Sun Products, Walter Energy, CNG Holdings, Banco Espirito Santo, Espirito Santo Financial Group, MDM Bank, and PHH Corporation, among other rating actions.

Research Highlights 38

Last week, we published on US healthcare, global oil companies, Puerto Rico, our Asian Liquidity Stress Index, our B3 negative and lower US corporate list, North American auto parts, US cable, coal mining, Japanese real estate, US technology, global systemic bank support, Canadian banks, Singapore banks, our CDS insurance index, retail bank loan funds, GCC insurers, India, Asian Development Bank, Côte d’Ivoire, European banks, Mexican states, French local governments, US state rating changes from 1973, US higher education, Italian covered bonds, US CMBS and European CMBS, among other reports.

RECENTLY IN CREDIT OUTLOOK

» Articles in Last Thursday’s Credit Outlook 44

» Go to Last Thursday’s Credit Outlook

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

NEWS & ANALYSIS Credit implications of current events

2 MOODY’S CREDIT OUTLOOK 14 JULY 2014

The Indian Budget

Indian Budget Is a Mix of Credit Positive Policies and Intentions On Thursday, the Government of India (Baa3 stable) presented its first union budget under the administration of Prime Minister Narendra Modi, whose Bharatiya Janata Party and smaller coalition partners claimed a landslide victory in May’s general elections. The budget for the fiscal year 2015 (ending 30 March 2015) aims to improve public finances and revive economic growth.

In this report, we look at the credit implications for the Indian sovereign, corporates, infrastructure companies and banks:

» For the sovereign, unless a more specific implementation plan is put in place, we expect a modest credit positive effect.

» For corporates and infrastructure companies, the budget’s tax changes and business-friendly initiatives designed to revive India’s investment cycle and lower business costs are credit positive.

» For banks, we see limited credit effect because the measures do not address the more pressing issue of banks’ capital weakness.

FOR THE SOVEREIGN, A LACK OF SPECIFICS

On Thursday, the Government of India announced plans to lower the central government’s budget deficit to 3.0% of GDP by fiscal 2017 (ending 30 March 2017) from its forecasted 4.1% of GDP in fiscal 2015. A smaller fiscal deficit would be credit positive since India’s weakening public finances have fueled inflation, raised domestic interest rates and heightened macroeconomic imbalances, constraining sovereign credit quality.

However, the budget did not include specific revenue and expenditure measures to shrink the deficit, suggesting that various options are still under consideration. For instance, the government announced its intention to reduce subsidy spending, but did not outline changes to the current subsidy regime. Similarly, in its plan to implement a goods and services tax, it did not specify how it would resolve disagreements with state governments that have stymied implementation for years. This lack of detail makes it difficult to assess the feasibility and sustainability of the fiscal consolidation effort.

Moreover, the revenue assumptions underpinning the current fiscal year’s deficit target may prove too high if GDP growth does not accelerate significantly from our current projection of around 5% GDP growth for fiscal 2015.

The budget includes measures to support faster economic growth, such as allowing greater foreign direct investment in insurance and defense, increasing spending on infrastructure, and introducing tax incentives for savings and investment. These policies are credit positive for the corporate and infrastructure sectors, as we explain in the sections below. However, their effect on overall GDP growth will be muted without a decline in inflation, interest rates and regulatory constraints on private investment.

Unless the budget is followed by a more specific implementation plan, as well as additional measures to address macroeconomic imbalances, its credit effect will be modest.

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

This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on www.moodys.com for the most updated credit rating action information and rating history.

NEWS & ANALYSIS Credit implications of current events

3 MOODY’S CREDIT OUTLOOK 14 JULY 2014

FOR CORPORATES, CREDIT POSITIVE

Although the new government’s inaugural budget lacks transformational reforms, it includes a number of proposals that we consider credit positive for India’s corporates. The budget’s proposed tax changes and business-friendly initiatives aim to encourage much-needed investment in manufacturing and lower overall business costs, which would benefit all corporates. However, some of the proposals are statements of intention that require specific policies to be effective.

Investment allowance encourages spending on fixed assets. The government proposed that manufacturing companies investing INR250 million ($4 million) or more in plant and machinery between now and March 2017 be entitled to deduct 15% of the investment amount from their taxable income. This proposal will result in tax savings equal to about 5% of the investment amount, at the marginal tax rate of 33%. All Indian corporates that we rate would benefit from this tax concession.

Lower withholding tax on foreign-currency bonds will reduce the cost of offshore bond issuance. The government proposed reducing the withholding tax on interest payments for foreign currency bonds issued by Indian corporates to 5% from 20%. This will allow Indian corporates to access the international bond market at a lower effective cost, which is credit positive for them.

Review of retrospective tax cases will encourage foreign investment. Although rules on retrospective taxation would not change, the government has proposed curbing the use of these provisions to avoid creating fresh tax liabilities for companies. The government also pledged to implement a stable and predictable tax regime that will be investor friendly and spur growth. This is credit positive for corporates in India because it reduces the uncertainty created by retrospective changes to tax laws imposed in 2012, which created large tax liabilities for Vodafone Group Plc (A3 review for downgrade) and deterred foreign companies from investing in India.

Introduction of a goods & services tax will benefit all corporates through administrative savings. The government also proposed introducing a uniform national goods & services tax by December 2014 to replace the labyrinth of different sales taxes currently in place in different states. This will reduce administrative costs for companies with operations in multiple states and is also credit positive. However, implementation is subject to risk because state governments will have to agree to forgo their right to impose a state-level sales tax.

Higher export tax on bauxite will boost supply for aluminum producers. The government proposed doubling the export tax on bauxite to 20%. The higher export duty will increase the availability of bauxite for domestic producers of aluminum and is thus credit positive for Vedanta Resources Plc (Ba1 stable), one of the country’s largest aluminum producers.

Modestly higher fuel subsidy provision is positive for upstream oil companies. The government has marginally increased the provision for fuel subsidies in the current fiscal year to INR598 billion, up from INR573 billion in the February 2014 interim budget. The higher subsidy provision is credit positive for upstream companies Oil & Natural Gas Corporation Ltd. (Baa2 stable) and Oil India Limited (Baa2 stable) because it signals that the government will not ask them to share a higher portion of the subsidy burden this year. The total fuel subsidy is shared between the government and upstream companies on an ad-hoc basis, as the government decides.

Overhaul of subsidy framework would be credit positive for oil marketing companies. The government also proposed an overhaul of the subsidy framework, which would likely lower the overall subsidy burden.

Vikas Halan, Vice President - Senior Credit Officer +65.6398.8337 vikas.halan@moodys.com

NEWS & ANALYSIS Credit implications of current events

4 MOODY’S CREDIT OUTLOOK 14 JULY 2014

Lower subsidies would be credit positive for the three state-owned oil market companies, Indian Oil Corporation Ltd (Baa3 stable), Bharat Petroleum Corporation Limited (Baa3 stable) and Hindustan Petroleum Corporation (unrated), because it would reduce their borrowing requirements. The oil marketing companies currently fund the subsidies themselves until the government reimburses them some three to six months later.

The decision to lower import taxes on petrochemical products has negative credit implications for some domestic petrochemical producers. The government has proposed reducing the import taxes on petrochemicals, including the tax on reformate to 2.5% from 10%, crude naphthalene to 5% from 10%, and ethane, propane, ethylene and propylene to 2.5% from 5%. The cut in import taxes is credit negative for domestic petrochemical producers including Reliance Industries Limited (Baa2 positive) because it will make imports cheaper.

FOR THE INFRASTRUCTURE SECTOR, CREDIT POSITIVE

The budget for fiscal year 2015 (ending 31 March 2015) provides continued support for the power sector and includes several new private investment incentives, all of which are credit positive for India’s infrastructure companies.

As expected, the budget extended an income tax holiday for power projects, a credit positive for the sector, which has been struggling with fuel shortages and low operating efficiencies. The incentive’s extension beyond this year to fiscal 2017 affords more certainty to power project developers. We expect NTPC Limited (Baa3 stable) to benefit most given its plans to increase its generation capacity to 51gigawatts by the end of fiscal 2017, from about 43gigawatts currently.

The budget also promises to ensure an adequate supply of coal for coal-fired power plants commissioned by the end of fiscal 2015, but contained few specifics as to when this would be achieved. Coal-fired generation accounts for around 60% of capacity in power-deficient India and the lack of coal is a key structural challenge for power companies, which are running plants below capacity because of the shortage of fuel. We expect coal plants to remain undersupplied for at least the next one to two years given the inefficiencies affecting producers, such as Coal India (unrated).

Recognising the government’s limited fiscal room to fund large infrastructure projects, the budget also identified areas where public-private partnerships (PPPs) would be implemented. Infrastructure sectors earmarked for PPP participation include metro and light rail systems, airports, gas pipelines and rural and urban infrastructure. However, given the spotty track record of PPP procurement and financing in India, we expect successful implementation to take time and further policy initiatives to address the shortcomings of earlier PPPs.

To help facilitate PPPs, the budget also contains complementary measures to encourage private-sector funding for these partnerships. These include measures to allow banks to provide long-term financing for infrastructure projects and tax incentives for infrastructure investment trusts.

Another bottleneck in PPP implementation is the capacity of the state and local governments and agencies responsible for procuring PPPs. As such, the proposal to create “3P India,” an institution that will facilitate procurement, will enhance the effectiveness of PPP programmes. PPPs in India have a spotty track record, and although we believe this budget is a step in the right direction, successful implementation will take several years.

Ray Tay Vice President - Senior Analyst +65.6398.8306 ray.tay@moodys.com

NEWS & ANALYSIS Credit implications of current events

5 MOODY’S CREDIT OUTLOOK 14 JULY 2014

The new government’s budget offers no bold structural reforms in the power sector to address problems related to the cost pass-through of imported fuels, the shortage of domestic gas for gas-fired power plants, as well as the long-term financial health of state electricity boards. These are policy issues that will require focus and dedication, and the new government has only been in office for six weeks.

For Banks, Credit-Positive Elements, but Capital Strains Are Unaddressed The budget has only a limited credit effect on Indian banks because it does not address their immediate challenges, especially the challenge of capitalization.

The budget fails to increase the INR112 billion that the previous government committed to recapitalizing public-sector banks for fiscal 2015 (ending March 2015). The INR112 billion amount, which is lower than that of fiscal 2014, falls short of these banks’ high capital requirements. The banks need capital to support low- to mid-double-digit loan growth, comply with Basel 3 regulations and improve their loan loss coverage levels. The modest capital injection poses the risk that the banks will operate with thinner capital buffers than in fiscal 2013.

Besides the issue of direct capital injections, some budgetary measures were announced to facilitate the recapitalization of the banks, but we do not believe they will bring real benefits until 2015 or later.

» Government shareholding reduction. The new administration’s pledge to reduce the government’s stake in public-sector banks to no more than 51%, from the current 56%-89%, would eventually give the banks greater flexibility to raise capital from the equity market. However, this measure is unlikely to have any meaningful effect in the near term. This is because the key constraint on public-sector banks’ external capital raising has been their inability to attract fresh private capital, rather than a lack of willingness on the part of the government to reduce its stakes. It remains to be seen whether investors’ appetite for Indian public-sector bank equity has increased, which is something the budget has little to no ability to influence.

» Proposal to allow increased foreign direct investment and controlling shareholding in insurance companies. Banks with meaningful insurance operations like ICICI Bank Limited (Baa3 stable, D+/baa3 stable1) and State Bank of India (Baa3 stable, D+/ba1 negative) may benefit from the proposed increase in the foreign direct investment limit in the insurance sector, which will provide them with the opportunity to raise capital by selling stakes in their insurance subsidiaries to their foreign joint venture partners. The budget proposed increasing this limit to 49% from the current 26%. Such transactions take considerable time to execute and, most importantly, few public-sector banks other than SBI have substantial insurance operations.

The government also indicated that it wants public-sector banks to have increased autonomy with respect to their governance and strategic direction, and signalled it would support consolidation. Although this is a constructive shift in policy to address the banks’ governance issues, details are lacking on how this may be implemented.

1 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.

Srikanth Vadlamani Vice President - Senior Analyst +65.63988336 srikanth.vadlamani@moodys.com

Gene Fang Vice President - Senior Credit Officer +65.63988311 gene.fang@moodys.com

NEWS & ANALYSIS Credit implications of current events

6 MOODY’S CREDIT OUTLOOK 14 JULY 2014

Nevertheless, some targeted measures in the budget are outright, although modest, credit positives for banks:

» The budget promises some funding relief to the real estate and infrastructure sectors, which may also help improve their loan performance. Specifically, the government will allow banks to raise long-term funds for lending to infrastructure projects, and exempt such funds from reserve requirements.

» It has also proposed incentives to attract long-term funds into real estate investment trusts (REIT) and infrastructure investment trusts, which is a modified REIT type structure for infrastructure projects. The infrastructure sector is currently one of the key sources of asset quality stress for Indian banks, so improvements in that sector’s financing are likely to also help banks’ asset performance.

» Banks could see faster resolution of their bad loans from the proposed creation of six new debt-recovery tribunals. This is credit positive since the current lack of capacity at existing tribunals has been one of the factors hampering banks’ debt recovery efforts.

NEWS & ANALYSIS Credit implications of current events

7 MOODY’S CREDIT OUTLOOK 14 JULY 2014

Corporates

Boeing Wins Emirates’ $56 Billion Order for 777X Jets Last Wednesday, Emirates Airline (unrated) firmed up a $56 billion order (at list prices) for 150 777X jets from The Boeing Co. (A2 stable), with deliveries scheduled to begin in 2020. The order includes purchase rights for an additional 50 airplanes that, if exercised, could increase the order value to approximately $75 billion (again, at list prices). The order is credit positive for Boeing and sole-source engine provider General Electric Company (Aa3 stable), along with other key suppliers, given its sheer magnitude and importance to a critical program, coupled with Emirates Airline’s status as the leading carrier in the high-growth Middle East market.

The Emirates order builds on the strong momentum for the 777X program, which experienced record orders and commitments totaling 259 airplanes with a combined value exceeding $95 billion on a list-price basis upon its November 2013 launch at the Dubai Airshow. The four principal customers at the launch were Emirates (150), Qatar Airways (50; unrated), Deutsche Lufthansa Aktiengesellschaft (34; Ba1 positive), and Etihad Airways (25; unrated). Already the largest 777 operator, the dominant Middle Eastern carrier now comprises more than 40% of the nearly 500 undelivered firm orders in Boeing’s backlog. Although Emirates remains a significant customer of Airbus Group N.V. (A2 stable), particularly for its A380 jumbo jets, it cancelled an order for 70 of Airbus’ forthcoming A350 XWBs last month, including 20 of the largest A350-1000 variant, which upon its entry into service in 2017 will compete most directly with Boeing’s 777 (and 777X when it enters service in 2020).

The order did not include any current-generation 777 aircraft, however, highlighting Boeing’s challenge to bridge a multi-year production gap between current-generation 777s and forthcoming 777Xs. With 273 current-generation 777 aircraft in backlog at the end of June this year (including 40 777F freighters), Boeing can maintain its current production rate of 8.3 aircraft per month through 2016. But we believe cuts may be needed and/or more significant discounts will have to be offered to induce further orders of current-generation equipment prior to introduction of the 777X. In order to maintain optimal factory throughput at current rates, we estimate Boeing needs at least 300 individual or paired (with 777X) orders for 777-300ER and/or 777F aircraft.

Although a number of existing carriers with aging fleets are likely to exercise options to purchase current-generation aircraft over the next few years — potentially beginning as soon as next week at the Farnborough International Airshow — we think it will prove more difficult for Boeing to replicate its now successfully bridged 737-to-737 MAX production run, given the more limited customer base and much higher price point for 777 widebody aircraft.

In the escalating competition between Boeing and Airbus for market share, we see a nascent trend of enhanced bargaining power for key customers. However, the trend runs counter to logic given the effective industry duopoly for large commercial airframes and a still heady supply-demand imbalance as carriers broadly clamor for newer, more fuel-efficient aircraft with lower associated operating and maintenance costs. Although Airbus and Boeing’s substantial order books are broadly supportive of the healthy state of the commercial aerospace industry, we reiterate2 our opinion that the evolving industry competitive dynamic may be increasingly dilutive to airframer profitability. We are watchful that the relatively benign environment in recent years for order cancellations (order deferrals have already increased of late) may change course. 2 See Boeing to Widen Lead in Deliveries as Battle for Market Share Intensifies with Airbus, 5 November 2013.

Russell Solomon Senior Vice President +1.212.553.4301 russell.solomon@moodys.com

NEWS & ANALYSIS Credit implications of current events

8 MOODY’S CREDIT OUTLOOK 14 JULY 2014

Stronger-than-Expected PC Demand Is Credit Positive for HP, Intel and the PC Supply Chain Last Wednesday, research firms Gartner and IDC reported better-than-expected worldwide PC unit shipments in the second quarter of this year. IDC noted a 1.7% drop in year-over-year shipments, markedly better than its projected decline of 7.1% for the quarter. By Gartner’s calculations, PC shipments actually inched up by 0.1% year over year. Both results indicated stronger demand in developed markets such as the US, whose richer selling prices bode well for the profitability of the PC supply chain, including Microsoft Corporation (Aaa stable), Intel Corporation (A1 stable), Hewlett-Packard Company (Baa1 negative) and Dell Inc. (Ba3 stable).

The preliminary PC unit results provide another data point of a stabilizing PC market after declines since 2012 and are credit positive. The latest PC refresh cycle for business customers has been spurred by Windows XP operating system upgrades and the replacement of aging PCs, whose life cycles had been stretched in recent years.3

The preliminary results are particularly strong for Hewlett-Packard, which derives 30% of its revenue and 10% of operating profit from PCs. HP registered 10.2% growth in total unit sales to grab an 18.3% share of the worldwide PC market, second behind Lenovo (unrated), which once again led with 19.6% market share after growing unit sales 15.1%.

Importantly for HP, the company grew PC unit sales much faster in the US market, up 15.7%, compared with 7.7% growth in the rest of the world. This augurs well for continued improvement in HP’s PC segment profitability. Based on a mix of higher-priced PCs in the US than in international markets, comparatively stronger demand from the more profitable corporate market (about 60% of HP’s PC business), and what we expect to be HP’s continued focus on targeting higher-margin consumer PC products, we project HP’s PC segment operating profit could reach $300-$350 million in the fiscal quarter ending July, or 4.3% of revenue, a notable improvement from a low of $230 million or 3.0% of revenue for the same quarter a year ago. We also expect similarly improved results from privately owned Dell, whose unit sales increased 13%.

For Intel, stronger business PC demand is credit positive for the company because incremental unit demand for more profitable business PC processors drives higher revenue and improves gross profitability, which is key to supporting the company’s strong research and development and capital expenditure requirements, and which we project at $5.3 billion for the second quarter, which ended 30 June. Based on stronger PC demand, we project Intel’s gross profit for the June quarter at $8.6 billion, up from $7.5 billion in the same quarter a year ago. If our projection is accurate, it would be Intel’s highest second-quarter gross profit on record.

Despite the improving outlook for the sector’s primary players, the PC sector will remain an intensely competitive and low-margin business. But given the PC market’s recent outperformance, it appears that, in a nod to the American comedian, Rodney Dangerfield, the PC market may soon garner more respect.

This is an update of an article published 9 July 2014.

3 See Stronger PC Demand Is Credit Positive for Intel and Hewlett-Packard, 16 June 2014.

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

NEWS & ANALYSIS Credit implications of current events

9 MOODY’S CREDIT OUTLOOK 14 JULY 2014

Salix Pharma to Merge with Cosmo and Relocate to Ireland, a Credit Positive Last Tuesday, Salix Pharmaceuticals Ltd. (B1 stable) announced plans to merge with Cosmo Technologies Limited (unrated), an Ireland-based subsidiary of Italy’s Cosmo Pharmaceuticals S.p.A. (unrated). Structured as a corporate inversion, the deal is credit positive for Salix because it will allow the North Carolina-based company to re-domicile in Ireland, which will reduce its tax rate to the low-20% range from the high-30% range.

Salix will fund the merger, valued at about $1.7 billion, with 100% equity. The company’s credit ratios will not materially change in the short-term because Cosmo’s EBITDA and cash flow are relatively low. However, in addition to lowering its tax rate, the deal will provide several important benefits to Salix, including eliminating a royalty Salix currently pays to Cosmo based on a supply agreement between Cosmo and Santarus Pharmaceuticals Inc., which Salix acquired in January 2014. Under this agreement, which has been in place since 2008, Salix pays Cosmo royalties on Uceris, an ulcerative colitis therapy, of 12% on sales up to $120 million and 14% on sales over $120 million. The deal will also provide Salix with access to Cosmo’s portfolio of drugs and several pipeline opportunities.

Despite these benefits, Salix’s credit profile remains constrained by its high financial leverage, a consequence of its debt-funded acquisition of Santarus. Using run-rate EBITDA from the first quarter of 2014, because it includes Santarus’ EBITDA, we estimate debt/EBITDA in excess of 5.0x. It is too soon after the Santarus acquisition’s close to gauge management’s progress at deleveraging, although the company has publicly stated a debt/EBITDA target of 3.0x. Salix’s rating would face upward pressure if it demonstrates a track record of deleveraging.

However, management has indicated that it expects the Cosmo acquisition to create an efficient corporate platform for mergers and acquisitions, and it is unclear to what extent future deals will involve financial leverage. Salix’s credit profile is also constrained by the company’s high concentration in the product Xifaxan, which contributed 30% of first-quarter 2014 sales. We expect sales concentration in Xifaxan, which is used to treat both hepatic encephalopathy and traveler’s diarrhea, to rise because of upcoming patent expirations on Zegerid and Glumetza in the first half of 2016.

Salix continues to benefit from its strong expertise and focus in the gastroenterology pharmaceutical space; a strong growth outlook for many products (including Xifaxan), upside from several pending approvals from the US Food and Drug Administration, and possible cost synergies from the Santarus acquisition.

Salix expects to close the Cosmo deal by year-end. The merged company will be renamed Salix Pharmaceuticals plc and will be domiciled in Ireland, making Salix the latest in a string of US healthcare companies to pursue a corporate inversion strategy, as shown below. These transactions, which involve merging with a foreign company in order to re-domicile in a lower-tax jurisdiction and achieve tax reductions, can also provide previously US-focused companies with a new international infrastructure and platform for making more acquisitions, including those outside the US. It is possible that the US Congress will impose new restrictions on inversion structures, which we believe will drive more deals before any potential rule changes.

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

NEWS & ANALYSIS Credit implications of current events

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Recent Healthcare/Pharmaceutical M&A Involving Corporate Inversion Structures

Date Acquirer Target Post-Merger Domicile Transaction Value

$ Billions

(Announced) July 2014 Salix Cosmo Technologies Ireland $1.7

(Announced) June 2014 Auxilium QLT Inc. Canada $0.4

(Rejected*) June 2014, July 2014 AbbVie Shire plc Ireland $51.5

(Announced) June 2014 Medtronic Covidien Ireland $42.9

(Rejected*) May 2014 Pfizer Astra Zeneca United Kingdom $118.0

(Completed) February 2014 Endo Paladin Labs Ireland $2.7

(Completed) December 2013 Perrigo Elan Ireland $9.5

(Completed) October 2013 Actavis Warner Chilcott Ireland $9.2

Note: *Expressions of interest; not a formal bid.

Source: Moody’s Investors Service, company press releases and SEC filings, Moody’s estimates for some transaction values

NEWS & ANALYSIS Credit implications of current events

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Volkswagen’s Planned Capacity Expansion in China Is Credit Positive Last Monday, Volkswagen Aktiengesellschaft (A3 positive) announced it will build two new vehicle plants in China with its joint venture partner First Automotive Works (FAW). The new plants are credit positive for Volkswagen because they reinforce its relationship with FAW and expand its capacity in China, Volkswagen’s largest market and the world’s fastest growing automotive market.

Volkswagen is China’s leading automotive manufacturer through its two joint ventures, Shanghai Volkswagen Automotive Co. (SVW) and FAW-Volkswagen Automotive Co (FAW-VW). The two new plants on China’s east coast will help Volkswagen grow its capacity in China without eroding its free cash flow generation because FAW-VW, which VW accounts for using the equity method, will fund the investments. Therefore, the capital expenditure associated with the project will not be captured in Volkswagen’s accounts. In the 12 months to 31 March, we estimated Volkswagen’s free cash flow (adjusted by us) at €2.0 billion. Looking ahead, we expect the company’s free cash flow generation to remain solid throughout this year, despite a heavy investment programme.

By 2018, Volkswagen intends to increase its annual capacity in China to over 4 million vehicles, supported by around €18 billion of investments in new production capacity between now and then. The new investments are almost as much as its cumulative investment in China since 1985, when it first entered the country.

Even though China’s demand for passenger cars has softened in recent quarters on account of slower economic growth, it has outpaced GDP growth and far exceeded sales growth in Western Europe and in the US. As shown in the exhibit below, for the first five months of 2014, sales of passenger cars increased by 11.1% to 8.07 million vehicles, according to the China Association of Automobile Manufacturers. Volkswagen’s deliveries of new vehicles were up an even stronger 18.5% to 1.39 million units in the first half of the year.

Growth in Sales and Production of Passenger Cars in China

Source: China Association of Automobile Manufacturers

According to Volkswagen, its market share in China is approximately 21%. The company sold 9.73 million vehicles worldwide in 2013 including 3.27 million in China, the vast majority of which were produced locally by the Chinese joint ventures. The company currently has 17 manufacturing sites in China for both vehicles and components.

33.8%

4.23%7.17%

16.50% 15.16%

11.06%

33.17%

5.19% 7.07%

15.71%14.73%

11.13%

2010 2011 2012 2013 Jan - May 2013 Jan - May 2014

Production Sales

Yasmina Serghini-Douvin Vice President - Senior Credit Officer +33.1.5330.1064 yasmina.serghini-douvin@moodys.com

NEWS & ANALYSIS Credit implications of current events

12 MOODY’S CREDIT OUTLOOK 14 JULY 2014

Infrastructure

PREPA Buys Time with Lenders, but Liquidity and Structural Issues Remain On 7 July, the Puerto Rico Electric Power Authority (PREPA, Caa2 review for downgrade) announced that it had reached an agreement with lenders that provide credit lines to buy fuel, allowing PREPA to delay payments, which are currently due, until the end of this month. Although this agreement gives PREPA temporary breathing room, the extension is very limited and does not resolve PREPA’s significant underlying liquidity and structural issues.

Our Caa2 rating and review for downgrade reflect the risk that PREPA could default voluntarily under the newly enacted debt restructuring law because of its financial pressures, which include weak liquidity, a significant debt burden, negative free cash flow, high electricity rates and large capital investment needs to convert its generation fleet from high-cost oil to lower-cost natural gas. The short-term extension of the bank lines does not address these longer-term issues; nor does it reduce the possibility that PREPA may ultimately utilize the debt restructuring act.

The immediate liquidity issue relates to the near-term maturity of bank borrowings. Outstandings under the company’s two main bank facilities total about $671 million. One line is with Citibank and has $146 million in outstanding advances that mature this month and in August. The advances due this month have now been extended to 31 July under this short-term agreement. The other $550 million line is with a group of banks with Scotia Bank acting as administrative agent. It matures on 14 August and has $525 million outstanding. PREPA is in negotiations with these banks to extend the lines on a more permanent basis, but the likelihood of success and the terms of these credit facilities are uncertain.

Our calculation of debt service coverage by net revenues (after adjusting for contributions in lieu of taxes) is below 1.0x for fiscal 2013 (which ended 30 June 2013), indicating that PREPA runs operating deficits and relies on external funds to pay for operations, including fuel, and to meet debt service. We expect the debt service coverage ratio to be below 1.0x in fiscal 2014 as well. The bank lines have historically supplemented PREPA’s own weak internal liquidity, which its low 11 days cash on hand in fiscal 2013 highlights. Sustained high oil prices and increasing receivables reflecting weakness in the Puerto Rican economy have precluded paying down these lines. PREPA also drew $41.6 million from its reserve account to help cover its 1 July bond debt service payment, also highlighting its strained liquidity.

On 28 June, the Commonwealth of Puerto Rico (B2 negative) passed a new debt restructuring law that provides for the orderly restructuring of public authorities, including PREPA, with features that are similar to a municipal bankruptcy regime. The new law is potentially most applicable to PREPA because of its significant challenges, and its enactment signals that PREPA will not be able to rely upon financial support from the Commonwealth or the Government Development Bank for Puerto Rico (B3 negative) in the future.

Rick Donner Vice President - Senior Credit Officer +1.212.553.7226 richard.donner@moodys.com

NEWS & ANALYSIS Credit implications of current events

13 MOODY’S CREDIT OUTLOOK 14 JULY 2014

Banks

Vehicle Production Decline Is Credit Negative for Brazil’s Captive Auto Finance Operations On 7 July, Brazil’s car manufacturers association, Associação Nacional dos Fabricantes de Veículos Automotores (ANFAVEA), released data for the first six months of this year that showed a decline of 16.8% in vehicle production and a 7.6% drop in sales compared to the same period last year. Lower car production and sales are credit negative for captive auto finance banks because they reduce car financing volumes both to consumers and dealers, reducing lenders’ earnings. ANFAVEA also reviewed its estimates for full-year performance, projecting a 10% annual decline in production and a 5.4% decline in sales for 2014.

Banks such as Banco GMAC S.A. (Ba3 stable, D-/ba3 stable4), Banco PSA Finance Brasil S.A. (Ba2 negative, D-/ba3 stable), Banco Ford S.A. (Ba2 stable, D-/ba3 stable) and finance company Companhia de Crédito, Financiamento e Investimento RCI BR (Ba1 stable), which primarily finance dealer inventories and provide loans to consumers, will be particularly affected by the drop in production and sales.

New car inventories and sales at authorized dealers drive the volume of car loans originated by captive finance institutions. Loan origination had already been declining as a result of weaker consumer demand, rising interest rates and efforts among finance companies to adopt more prudent lending standards in response to the increase in household indebtedness. This was reflected by the 2.7% decline to BRL188.1 billion in the volume of car loans during the 12-month period that ended in May, according to data gathered by the Banco Central do Brasil, Brazil’s central bank (see Exhibit 1).

EXHIBIT 1

Brazil Auto Production, Sales and Loans to Individuals

Source: Central Bank of Brazil, Associação Nacional dos Fabricantes de Veículos Automotores

Rising interest rates have driven up banks’ funding costs, which led banks to raise lending rates to preserve their margins, further eroding car loan demand. Captive car finance companies tend to offer lower lending

4 The bank ratings shown in this report are the banks’ domestic deposit ratings, their standalone bank financial strength

ratings/baseline credit assessments and the corresponding rating outlooks.

180

183

185

188

190

193

195

198

200

-

50

100

150

200

250

300

350

400

Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 May-14

BRL

Billi

ons

Thou

sand

s

Auto Production - left axis Auto Sales - left axis Auto Loans to Individuals - right axis

Alexandre Albuquerque Assistant Vice President - Analyst +55.11.3043.7356 alexandre.albuquerque@moodys.com

NEWS & ANALYSIS Credit implications of current events

14 MOODY’S CREDIT OUTLOOK 14 JULY 2014

rates than universal banks because of subsidies offered by car manufacturers. Even so, during the 12 months that ended in May, the average interest rate charged by captive finance banks rose to 1.41% per month, from 1.24%, following a three-month period when the rate remained flat. Meanwhile, Brazil’s banking system’s average interest rate on auto loans increased to 1.74% for the 12-months that ended in May, from 1.51%, according to data from the central bank.

Although loan delinquency has been stable at 5% for the past three months, we expect asset quality at these banks will be hurt as sales volumes continue to decline. Captive finance institutions will likely attempt to offset the lower production and sales volumes the industry expects by increasing loan tenors or reducing loan-to-value ratios to attract potential buyers during the second half of the year, but both actions raise the risk that asset quality will weaken.

EXHIBIT 2

Brazilian Auto Loans Past Due and Average Monthly Interest Rate

Source: Central Bank of Brazil

1.45%

1.55%

1.65%

1.75%

1.85%

4.5%

5.0%

5.5%

6.0%

6.5%

Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 May-14

Percent of Auto Loans Past Due 90 Days or More - left Average Interest Rate of Auto Loans - right axis

NEWS & ANALYSIS Credit implications of current events

15 MOODY’S CREDIT OUTLOOK 14 JULY 2014

Bolivian Banks’ New Lending Rate Caps and Minimum Deposit Rates Are Credit Negative On Wednesday, the Government of Bolivia (Ba3 stable) passed a long-awaited decree that establishes a floor for deposit rates and caps interest rates for loans to so-called “productive” industries, which include agriculture, cattle, forestry, oil, gas, mining, manufacturing, electricity, construction and tourism.

These regulations aim to stimulate economic growth by lowering interest rates, but the effect on banks will be to shrink interest margins, limit internal capital generation capacity and restrain organic growth, limiting banks’ profitability, a credit negative. In addition, the new regulations may prompt some banks to shift more of their portfolios toward riskier market segments to maintain profitability, leading to a decline in asset quality.

Maximum interest rates depend on the type of loan and targeted segment: 6% for corporate loans, 7% for small and medium-sized enterprise loans and 11.5% for microfinance loans. In all three cases, the rate caps are below the current prevailing market rates. On the funding side, minimum interest rates for local-currency deposits are 2% for saving accounts and 0.2%-4.1% for term deposits, depending on their term.

These new rules add to the regulatory challenges Bolivian banks have had since financial sector reform was passed in 2013. Last year, rate caps of 5.5%-6.5% were also set on housing loans, depending on the value of the house being financed. As part of the 2013 reform, within five years, banks will have to direct at least 60% of their total portfolios to productive sector loans and housing loans.

The effects will be especially negative for Bolivian lenders that focus on the microfinance sector, such as Banco Solidario SA (Bolivia) (B1 negative, D-/ba3 negative5), Banco FIE SA (B1 negative, E+/b1 stable) and Banco Los Andes Procredit SA (B1 negative, D-/Ba3 negative), which have historically charged higher interest rates. Their margins have been higher because of the elevated risk profile of their typical clients and their high cost structure, which stems from the large overheads required to serve clients in micro-lending (see Exhibit 1).

EXHIBIT 1

Bolivia Banks’ Average Interest Spread We expect banks’ interest spreads will severely shrink, reducing banks’ earnings

Source: Autoridad de Supervisión del Sistema Financiero (ASFI)

5 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.

-5%

0%

5%

10%

15%

20%

Banco Nacional

de Bolivia S.A.

Banco Union S.A. (Bolivia)

Banco Mercantil

Santa Cruz S.A.

Banco BISA S.A.

Banco de Credito de Bolivia S.A.

Banco Ganadero

S.A.

Banco Economico

S.A. (Bolivia)

Banco Solidario

S.A. (Bolivia)

Banco Los Andes

Procredit S.A.

Banco FIE S.A.

Banco Fortaleza

S.A.

Fondo Financiero

Privado Fassil S.A.

Fondo Financiero

Privado Eco Futuro

S.A.

B. System

Average Lending Rate Average Funding Cost Average Interest Spread

Fernando Albano Assistant Vice President - Analyst +54.11.5129.2624 fernando.albano@moodys.com

NEWS & ANALYSIS Credit implications of current events

16 MOODY’S CREDIT OUTLOOK 14 JULY 2014

The decline in interest margins will reduce lenders’ earnings power, leading to a decline in internal capital creation. At the same time, shareholders are unlikely to provide new capital injections because the new regulations will make the financial sector less appealing to investors. However, risk-weighted assets will likely grow at a slower pace than in recent years, reducing capital needs. And, banks are currently well capitalized because they have been reinvesting earnings to build up capital cushions. The banking system’s average Tier 1 ratio of 10.7% as of 31 March, which is higher than the regulatory minimum (see Exhibit 2), reflects the reinvestment.

EXHIBIT 2

Bolivian Banks’ Total Capital and Tier 1 Ratios Banks’ capitalization has been boosted by high net income reinvestment

Source: Autoridad de Supervisión del Sistema Financiero (ASFI)

Bolivia’s banking system has been growing at a cumulative annual rate of 21.5% over the past four years amid an economic boom. Banks have managed to maintain strong profitability in spite of increasing competition, which has started to hurt banks’ pricing power, and increased tax pressure.

Asset quality indicators have been adequate, with nonperforming loans averaging less than 2% in recent years. Banks maintain high reserve buffers, giving them capacity to absorb loan losses. However, rapid loan growth may lead to a decline in banks’ asset quality as portfolios season, and as the pace of growth slows following this latest regulation.

0%

2%

4%

6%

8%

10%

12%

14%

16%

Banco BISA S.A.

Banco de Credito de Bolivia S.A.

Banco Economico

S.A. (Bolivia)

Banco FIE S.A.

Banco Fortaleza

S.A.

Banco Ganadero

S.A.

Banco Los Andes

Procredit S.A.

Banco Mercantil

Santa Cruz S.A.

Banco Nacional de Bolivia S.A.

Banco Solidario

S.A. (Bolivia)

Banco Union S.A. (Bolivia)

Fondo Financiero

Privado Eco Futuro S.A.

Fondo Financiero

Privado Fassil S.A.

Total Capital Tier 1

NEWS & ANALYSIS Credit implications of current events

17 MOODY’S CREDIT OUTLOOK 14 JULY 2014

Citadele’s Uncertainty Ends, Paving the Way for Privatisation, a Credit Positive Last Wednesday, the European Commission approved the Government of Latvia‘s (Baa1 stable) support measures in favour of Joint Stock Company Reverta (unrated) and SC Citadele Banka (B2 negative, E+/b3 stable6). The decision ends the uncertainty that had hovered over the banks and the paves way for Citadele’s privatisation.

Once privatised, Citadele would no longer be subject to restrictions on how much capital it can hold, restrictions imposed on it as a result of it being a state-aid recipient. It could strengthen its capital base and align itself more closely with other banks in Latvia, a credit positive. Currently, and most notably, Citadele is obliged to pay an asset relief fee to the Latvian government if its capital base exceeds the regulatory minimum plus 50 basis points. Citadele’s capital adequacy ratio was 10.3% at year end-2013 compared to a simple average of 23.8% across the Latvian banking system, according to our calculation based on data from the Association of Commercial Banks of Latvia.

On 14 April this year, the European Commission launched an in-depth investigation to determine if Latvia’s support measures for Citadele and Reverta exceeded measures Latvia had agreed with the European Commission. Latvia put support measures in place for the two financial institutions when they were created as a “good” bank (Citadele) and “bad” bank (Reverta) when Parex (unrated), Latvia’s second largest bank, failed in 2008.

We believe that Citadele is more likely to be sold now that the European Commission investigation is settled. We think it is now more likely that the sale will conclude before the end of 2014, as required by the European Commission. Indeed, Citadele reports that many buyers have expressed an interest in the bank.

In our view, Reverta will not gain as much as Citadele from the European Commission’s decision to conclude its investigation. Reverta is the government’s bad bank and we understand that it is not up for sale.

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

assessments and the corresponding rating outlooks.

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

NEWS & ANALYSIS Credit implications of current events

18 MOODY’S CREDIT OUTLOOK 14 JULY 2014

KBC Bank Will Significantly Raise Loan-Loss Provisions On Tuesday, Belgium’s KBC Bank NV (A2 negative, C-/baa2 stable7) announced it will increase its provisions on retail loans booked at its subsidiary Kereskedelmi & Hitel Bank Rt. (K&H, Ba3 negative, E+/b2 stable) by at least €162 million in the second quarter of this year, which is credit negative.

The increase was made after the Hungarian parliament on 4 July approved new legislation that retroactively voids banks’ exchange rate margins by requiring the use of the central bank’s mid rate in all foreign exchange (FX) calculations for retail loans. This new legislation applies to all Hungarian banks, which will have to refund borrowers the bid-ask spreads applied to their FX retail loans. Banks will also have to compensate customers for unilateral changes to interest rates and fees on their consumer loans unless they can demonstrate that such changes were clearly explained in loan contracts.

KBC Bank estimated impairment charges of €162 million linked to these measures, but the amount could rise to €230 million if the bank’s calculation methodology differs from the local supervisory authority’s still undisclosed guidance. The estimated increase in provisions more than doubles loan loss provisions KBC Bank’s Hungarian subsidiary took for the full year 2013 and could equal between 116% and 164% of its pre-provision income (PPI) based on 2013 figures. However, despite the material hit to its capital position, we estimate K&H would be able to maintain a Tier 1 ratio above 9% (at December 2013 it was 13.8%) and a total capital ratio at around 11% (14.7%) after taking the losses.

This provision can also be absorbed by KBC Bank in light of its strong capital positioning (Basel III fully loaded Tier 1 ratio at year-end 2013 of 12%) and its strong earning capacity. KBC Bank generated consolidated PPI of €3 billion in 2013. Nevertheless, KBC said it could incur additional losses if the Hungarian government were to impose an additional burden on banks that extended foreign currency loans.

This announcement illustrates that Hungary, together with Ireland, remains a source of asset quality concerns for KBC Bank. In 2013, KBC Bank recorded €1billion of loan-loss provisions in Ireland. More generally, this is credit negative because KBC Bank has reaffirmed that its Hungarian subsidiary is a core business unit. This means that KBC Bank will continue to be exposed to an operating environment in which the government has not hesitated to overrule private contracts.

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.

Yasuko Nakamura Vice President - Senior Analyst +33.1.5330.1030 yasuko.nakamura@moodys.com

NEWS & ANALYSIS Credit implications of current events

19 MOODY’S CREDIT OUTLOOK 14 JULY 2014

Insurers

Prudential Financial’s £16 Billion Longevity Risk-Transfer Deal Is Credit Positive Last Friday, BT Pension Scheme (BTPS, the defined benefit pension plan of British Telecommunications Plc [Baa2 positive]) announced that it had entered into a transaction with Prudential Financial Inc. (Baa1 stable) through its operating company, the Prudential Insurance Company of America (financial strength A1 stable), under which Prudential will reinsure a block of business underwritten by a BTPS insurance subsidiary. This transaction is the largest UK deal of its kind to date, covering approximately £16 billion of liabilities and a portion of its 320,000 members.

The deal is credit positive for Prudential because it diversifies the company’s earnings away from mortality risk, similar to the company’s past large pension risk-transfer transactions. We anticipate more longevity transactions with the addition of the more active UK market, which will add diversification to Prudential’s longevity risk, which has been dominated by large transactions thus far.

Given its actuarial, asset liability management and investment expertise, Prudential has the resources to participate in the growth of the pension closeout market. In addition, only Prudential and a few other comparably large insurers are able to participate in a transaction of this size. The transaction provides prospective earnings, as well as some risk diversification, and while not a perfect hedge, the longevity risk somewhat offsets Prudential’s large block of mortality exposure on its life insurance business, which increased significantly with the 2012 purchase of the individual life business of The Hartford Financial Services Group, Inc. (HIG, Baa3 positive).

The key risk that Prudential faces in this transaction with BTPS is that pensioners live longer than Prudential’s pricing estimates. In the deal, Prudential will receive “expected” periodic payments from BTPS based on a predetermined mortality table, which it will net against actual payments owed to the pensioners. The longer the pensioners live, the greater the payments Prudential will make. In addition to the longevity risk, the large and concentrated nature of the deal poses another risk, compared with executing multiple, smaller-size transfers.

Transaction Schematic of BT Pension Scheme - British Telecommunications Longevity Risk Transfer

Source: Moody’s Investors Service

In 2012, Prudential entered into two pension risk-transfer transactions in the US, for a total of about $30 billion in assets. Under this recently announced risk-transfer deal, unlike the previous deals, Prudential is only assuming longevity risk, and not asset risk. This reduces the risk associated with the deal, as well as the

Pensioners

BT Pension Scheme Trust

Benefit payments

Prudential Insurance Company of America

Actual benefit payments

Agreed schedule of premium payments

Scott Robinson Senior Vice President +1.212.553.3746 scott.robinson@moodys.com

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

NEWS & ANALYSIS Credit implications of current events

20 MOODY’S CREDIT OUTLOOK 14 JULY 2014

allocated capital. However, it also reduces the earnings attributable to the deal. We expect margins on a longevity-only deal to be substantially lower than that of the pension risk-transfer transactions.

In its investor presentation on 9 June, Prudential estimated that it had approximately $1.5 billion of readily deployable capital and $3.5 billion of balance sheet capacity. Prudential has over 15% of the approximately $28 billion notional amount available to back the deal, which is well above any reasonable capital allocation assumptions.

Providing longevity protection is a substantial growth opportunity for Prudential. In a report issued in August 2013, the Bank for International Settlements indicated that globally, there were about $20 trillion of pension assets held by private pension plans as of year-end 2011. In the UK, the market that has experienced the greatest volume of longevity-related deals, there are about £1 trillion of defined benefit plans, of which only 5% have entered into longevity risk-transfer transactions.

NEWS & ANALYSIS Credit implications of current events

21 MOODY’S CREDIT OUTLOOK 14 JULY 2014

Amlin Will Benefit from Its Increased Ownership Stake in Leadenhall Capital Partners On 7 July, Amlin Plc (Baa3 stable) announced that it had entered into a non-binding agreement to increase its stake in Leadenhall Capital Partners LLP (LCP, unrated) to75% from 40%. Amlin’s current stake in LCP, an investment manager of insurance- and reinsurance-linked securities, contributed £4.4 million in pre-tax profits during 2013. Although the earnings contribution is modest compared with Amlin’s other earnings streams, the increased ownership stake in LCP, itself a capital-light business, will help diversify Amlin’s earnings, which is credit positive given the current pressure on reinsurance catastrophe rates.

LCP, which managed £62.2 million of assets for Amlin Plc as of year-end 2013, is already 40% owned by Amlin, which also controls 50% of the voting rights in LCP. LCP’s total assets under management increased to £966 million as of year-end 2013, from £528.3 million at year-end 2012, and further increased to approximately $1.8 billion as of 7 July. Assuming the ownership change occurs,8 the remaining 25% stake in LCP would continue to be owned by LCP’s individual partners.

Following several years of low interest rates, some pension funds, high-net-worth individuals and institutional investors have invested in catastrophe bonds and insurance-linked securities (ILS). Some investors consider these non-traditional assets attractive in the current interest rate environment based on their yield and their lack of correlation with traditional asset classes. The proportion of global property catastrophe reinsurance business from non-traditional reinsurance (such as catastrophe bonds and ILS) increased to approximately 15% in 2013, from 8% in 2008, creating a demand for groups such as LCP to manage the assets. Investor demand for catastrophe bonds is likely to lead to increased assets under management, and therefore profitability, for LCP.

Although LCP contributed only approximately 1.4% of Amlin Plc’s pre-tax profits, we believe that the increased ownership stake, combined with the expected increase in assets under management at LCP, will lead to a low- to mid-single-digit million annual increase in pre-tax profits for Amlin over the 12-18 months after completion of the deal. This will help mitigate some of the current pricing pressures facing Amlin and other reinsurers. At the end of first-quarter 2014, Amlin reported an overall 2.3% rate reduction across its portfolio, but within catastrophe reinsurance the reduction was a more significant 8.8%. Furthermore, the combination of Amlin’s traditional reinsurance expertise with LCP will, in our opinion, enhance Amlin’s overall client proposition. The enhanced client proposition is due to Amlin now being able to offer its clients both traditional reinsurance solutions, as well as being able to steer the client towards an alternative capital solution, which LCP may ultimately manage, providing a relatively stable, fee-based revenue stream for Amlin.

Although the consideration for the additional 35% stake has not been publicly disclosed, it is likely to be modest from Amlin Plc’s perspective. The company reported consolidated shareholder equity of £1.7 billion as at year-end 2013 and total investments in associates (including the 40% stake in LCP and two other investments in associates) of £12.5 million.

8 The transaction currently remains subject to definitive legal agreements and regulatory approval.

David Masters, ACA Vice President - Senior Analyst +44.20.7772.1605 david.masters@moodys.com

NEWS & ANALYSIS Credit implications of current events

22 MOODY’S CREDIT OUTLOOK 14 JULY 2014

UK’s General Insurers’ Motor Premium Rates Decline…Again, a Credit Negative Last Wednesday, Confused.com published its quarterly UK personal motor insurance premium index, which showed that the average quoted comprehensive premium rate was down 3% between March and June, the tenth consecutive quarterly decline. For general insurers, the continued slide in motor insurance rates threatens profitability.

Insurers have been driving the rate reductions ahead of expectations that UK civil litigation reforms will reduce motor claims. However, these reforms are still ongoing and the ultimate effects, in terms of timing and degree of claims cost reductions, remain uncertain.9

If the declining premiums are not matched by a commensurate reduction in claims, underwriting profitability will deteriorate. Although a sharp increase in motor rates would be credit positive, it would also indicate that insurers have been under-pricing business in recent periods. According to Confused.com, one of the four main price comparison websites in the UK, motor premiums are down by a third since their peak three years ago and nearly 15% over the past 12 months.

This year, as insurers became increasingly competitive in the young-driver space, 17-25 year olds saved between 16% and as much as 32% on their motor policies, compared to the first quarter of 2014. We believe this is partly attributed to the small but rising number of young drivers taking out telematics or black box insurance policies, which provide insurers with more information about the driver’s behavior.

However, young drivers have historically proven a more volatile and high-cost portion of insurers’ motor portfolio, making a material increase in the portion of young drivers on an insurers’ underwriting portfolio credit negative. Notwithstanding the increasing use of telematics, such insurers are likely to face higher claims frequency, and also significantly higher claims severity from high value bodily injury motor accidents involving young drivers. In addition, such claims are increasingly likely to be settled as a periodical payment order, which significantly increase claims uncertainty by exposing insurers to annuity-style reserving risk.

Personal motor is the largest UK general insurance segment, accounting for around £13 billion in premiums, or approximately 25% of the market, according to the Association of British Insurers. UK domestic general insurers have the greatest exposure to personal motor lines and thus are at the most risk of being negatively affected by the continued decline in premiums (see exhibit).

9 See UK General Insurance: Motor Reforms Might Prompt Reduction in Claims Costs but Elevate Short-Term Uncertainty, 21

March 2013.

Helena Pavicic Associate Analyst +44.20.7772.1397 helena.pavicic@moodys.com

NEWS & ANALYSIS Credit implications of current events

23 MOODY’S CREDIT OUTLOOK 14 JULY 2014

Insurers’ Share of UK Personal Motor Insurance Market and Their Personal Motor Premiums as Percent of UK Gross Written Premiums Bubble size represents 2013 total UK gross written premiums

Notes: Admiral = Admiral Group; esure = esure Group; Co-Op = CIS General Insurance Ltd & Co-operative Insurance Society Ltd; LV = The Liverpool

Victoria Group; DLG = Direct Line Group plc; ageas = Ageas SA/NV; RSA = RSA Insurance Group plc; Aviva = Aviva Plc; Axa UK = Axa Group; Hastings = Hastings Insurance Group.

Source: Companies’ group consolidated annual reports and UK legal entity regulatory returns

0%

5%

10%

15%

20%

0% 20% 40% 60% 80% 100%

Shar

e of

UK

Pers

onal

Mot

or M

arke

t

Personal Motor As Percent of UK Gross Written Premiums

Admiral esure Co-Op LV DLG ageas RSA Aviva AXA Hastings

NEWS & ANALYSIS Credit implications of current events

24 MOODY’S CREDIT OUTLOOK 14 JULY 2014

China Pacific Property Insurance’s Acquisition of Anxin Agricultural Insurance Is Credit Positive On 7 July, China Pacific Insurance (Group) Co. Ltd (unrated) announced that its property and casualty insurance subsidiary, China Pacific Property Insurance Co Ltd (CPPIC, financial strength A1 stable), will purchase 34.34% of Anxin Agricultural Insurance Co Ltd (AAI, unrated) from Shanghai International Group (unrated) and Shanghai State-owned Assets Operations Co Ltd (unrated) for RMB224.1 million in cash.

The acquisition is credit positive for the insurer because it will accelerate product diversification with stronger growth in non-motor lines of business, and it will have a very limited effect on CPPIC’s financial profile. We expect CPPIC to fund the transaction with cash and other liquid assets on hand, which will not meaningfully affect its current capital and liquidity positions. The transaction is pending regulatory approval from the China Insurance Regulatory Commission. Once the deal is completed, CPPIC will become AAI’s largest shareholder.

Agricultural insurance, despite its current small scale, is one of the fastest growing business lines in China. Gross premiums written grew to RMB30.6 billion in 2013 from RMB11.1 billion in 2008, as shown in Exhibit 1. Agricultural premiums grew at an annualized pace of 30%-40% between 2011 and 2013, compared with the 15%-20% growth recorded for the total property and casualty insurance sector during the same period.

EXHIBIT 1

Gross Premium Income and Year-over-Year Growth Rate of China’s Agriculture Insurance Industry

Source: The 2013 Yearbook of China’s Insurance, Ministry of Finance of the People’s Republic of China, Moody’s Investors Service

Government subsidies for agricultural insurance will not only sustain the sector’s growth momentum, but will also aid profitability. The Chinese Ministry of Finance allocated RMB12.69 billion to subsidize the agricultural insurance sector, which is a six-fold increase from subsidies in 2007, when the subsidy program was first launched. We expect this strong support to continue, given the government’s focus on supporting rural incomes, particularly in light of frequent natural disasters. China is the second largest agricultural insurance market in the world after the US. The development of agriculture and the rural economy play an important role in the country’s socioeconomic system, contributing 10% of the country’s GDP in 2013.

This acquisition signifies a stepped-up effort by CPPIC to position itself for these favorable developments. If the agricultural insurance sector continues to grow, the insurer’s business mix and profitability will

0%

20%

40%

60%

80%

100%

120%

0

5

10

15

20

25

30

35

2008 2009 2010 2011 2012 2013

RMB

Billi

ons

Gross Premium Income - left axis YoY Growth Rate - right axis

Stella Ng Assistant Vice President - Analyst +852.3758.1506 stella.ng@moodys.com

NEWS & ANALYSIS Credit implications of current events

25 MOODY’S CREDIT OUTLOOK 14 JULY 2014

improve. CPPIC’s current premium mix is extremely reliant on the motor business, which accounted for 78% of its total premiums in 2013, compared with the industry level of 72% in 2012 (2013 data is not yet available). CPPIC is greatly exposed to the challenges that the motor business faces, including rising claims costs, intense competition, and not least, the imminent risks of further deregulation and potential reforms for both commercial (non-voluntary) and mandatory motor policies. This partly explains the deterioration in CPPIC’s underwriting performance in 2013 (see Exhibit 2). From this perspective, CPPIC’s acquisition of AAI will help steer its upcoming growth to the non-motor lines and mitigate some of the headwinds the insurer faces.

EXHIBIT 2

China Pacific Property Insurance Co Ltd’s Combined Ratio

Source: Company reports, Moody’s Investors Service

58.6% 61.2% 66.0%

34.5% 34.6%33.5%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2011 2012 2013

Loss Ratio Expense Ratio Combined Ratio

93.1% 95.8% 99.5%

NEWS & ANALYSIS Credit implications of current events

26 MOODY’S CREDIT OUTLOOK 14 JULY 2014

US Public Finance

Bethlehem, Pennsylvania Water System Gets Lower-Than-Requested Rate Increase Last Wednesday, the Pennsylvania Public Utility Commission unanimously approved a water rate increase for the City of Bethlehem, Pennsylvania (unrated) that was much lower than the one the township sought. The credit-negative settlement limits the magnitude by which the city will be able to strengthen debt-service coverage on its roughly $90 million of general obligation-guaranteed water revenue bonds.

Instead of the 15% increase the city requested, the PUC approved a 4.7% increase. The difference equals about $770,000 of annual revenue, just under 9% of net water revenues of $9 million. Bethlehem’s net water revenues in 2012 were sufficient to cover debt service by just 1.07x, a narrow coverage level that is likely to remain tight after approval of the lower rate increase.

The ruling exemplifies the PUC’s tendency to deny full rate increase requests to water and sewer utilities in the Commonwealth of Pennsylvania (Aa2 stable). In the past 10 years, the PUC has approved rate increases for municipal utilities below what was initially requested at least a dozen times (see exhibit).

Instances of Pennsylvania Public Utility Commission Approving Less than Full Increase for Public Utilities Municipality Service Date of Approval Increase Requested Increase Approved

City of Bethlehem Water 7/9/2014 15.0% 4.7%

City of DuBois Water 12/5/2013 97.3% 57.1%

City of Lancaster (A1) Sewer 4/18/2013 58.6% 42.4%

Borough of Hanover Water 12/5/2012 29.7% 24.0%

Borough of Quakertown (A1) Water 9/13/2012 87.9% 54.6%

City of Bethlehem Water 12/15/2011 13.6% 9.9%

City of Lock Haven Water 12/2/2010 41.6% 31.7%

City of Bethlehem Water 5/22/2008 12.5% 3.6%

Borough of Ambler Water 12/20/2007 45.0% 29.0%

Borough of Phoenixville Sewer 5/30/2007 99.0% 87.0%

City of DuBois Water 8/17/2006 36.4% 25.9%

City of Lancaster (A1) Water 6/1/2006 13.7% 13.0%

Note: This list is not comprehensive. PUC does not always publicly announce its rate decisions.

Source: Pennsylvania Public Utility Commission, Moody’s Investors Service

The PUC rate approval process often takes nine months, and seldom leads to approval of the full requested increase. Bethlehem initially filed its rate case in November 2013.

Although Pennsylvania’s municipal utilities do not need PUC approval to set rates within their own borders, the PUC has jurisdiction over rates charged by municipal utilities for providing service to other communities. For instance, Bethlehem sells water both within its own borders and to customers in 10 municipalities in Lehigh County (Aa1) and Northampton County (Aa1). The PUC denied the rate increase for the users in those municipalities, but in practice Bethlehem charges the same rates to all its users.

Dan Seymour, CFA Analyst +1.212.553.4871 dan.seymour@moodys.com

NEWS & ANALYSIS Credit implications of current events

27 MOODY’S CREDIT OUTLOOK 14 JULY 2014

To the extent that the PUC limits the cash-generating capabilities of regional utilities, it diminishes their ability to pay dividends to parent municipalities. It is common for Pennsylvania cities that are regional water providers to use their water and sewer utilities to generate cash for their general fund operations. Bethlehem’s water and sewer enterprises transfer money to the city’s general fund each year equaling about 5% of the city’s operating revenues.

Bethlehem’s lower approved rate increase bodes poorly for the City of Lancaster (A1 no outlook), which filed a case in January to increase water rates 46% for its customers outside the city. Should the actual rate increase prove to be much less than this, it would pressure the city in two ways. First, it would limit the improvement in general obligation-guaranteed water revenue bond debt service coverage. The city’s $6.9 million of net water revenues10 achieved a very narrow 1.0x coverage of debt service in 2012. Second, it limits how much cash the water utility is capable of generating for the city’s general fund: each year the utility pays an annual dividend of more than $2 million to supplement the city’s $42 million of general fund revenues.

10 This calculation includes a dividend from the water system to the city as an operating expense. Excluding this dividend, coverage

was a healthier 1.3x.

NEWS & ANALYSIS Credit implications of current events

28 MOODY’S CREDIT OUTLOOK 14 JULY 2014

Securitization

German Regulator Can Increase Covered Bonds’ Obligatory Over-Collateralisation, a Credit Positive On Wednesday the German government published its draft for an update to the German covered bond law (Pfandbrief Act). The most prominent new feature is the German regulator’s (BAFin) power to unilaterally increase the minimum level of over-collateralisation (OC) for a covered bond programme over and above the minimum level prescribed by the Pfandbrief Act, a credit positive for covered bonds.

This amendment strengthens the high level of specific supervision for the Pfandbrief product and improves its overall credit quality by allowing regulators to adjust collateral requirements based on the specific risk characteristics of individual covered bond programmes.

This new power allows the regulator to increase OC levels based on the risk characteristics of the programme, thereby safeguarding a higher OC level for Pfandbrief investors should an issuer default. Under the Pfandbrief Act, all issuers have to maintain a minimum level of 2% of over-collateralisation, regardless of the covered bond programme’s risk profile. Risk differs remarkably though because of the rather wide eligibility criteria under the Pfandbrief Act. The act, for example, imposes only limited restrictions on the geographic location of cover assets and the share of commercial loans in mortgage cover pools. A minimum OC over and above the one-size-fits-all 2% current requirement will allow covered bondholders to benefit from more tailor-made over-collateralisation levels in accordance with the risk profile of a particular programme.

Although German Pfandbriefe traditionally benefit from tight supervision, it is unclear how the regulator will use its new power. It will be interesting to see if it will react quickly to specific market events, or take a long term view depending on the expected asset mix of a given programme.

Volker Gulde Vice President - Senior Credit Officer +44.20.77725578 volker.gulde@moodys.com

Martin Rast Vice President - Senior Credit Officer +44.20.77728676 martin.rast@moodys.com

CREDIT IN DEPTH Detailed analysis of an important topic

29 MOODY’S CREDIT OUTLOOK 14 JULY 2014

Developments at Banco Espirito Santo are Credit Negative for It, Other Portuguese Banks and for Portugal Telecom On Wednesday, certain subsidiaries of Espirito Santo International (ESI, unrated) announced the restructuring of maturing debt that otherwise they would not have been able to repay. The defaults exposed the precarious financial health of ESI and its various subsidiaries.

These subsidiaries include Banco Espirito Santo, S.A. (BES, B2 review for downgrade, E/ca stable11). BES has balance-sheet exposure of at least €1.2 billion (17% of BES core equity Tier 1 capital) to some of the ESI subsidiaries that defaulted on their obligations last week. Our ratings for BES had been on review for downgrade since 26 June, and we made downgrades Friday.

The problems also affect the BES 25.1% shareholder and ESI indirect subsidiary Espirito Santo Financial Group S.A. (ESFG, Caa2 review for downgrade). We downgraded ESFG Wednesday. Its ratings had also been on review for downgrade since 26 June.

Although these developments are unique to BES, they challenge the nascent improvement in confidence in Portugal’s banking sector and the ability of other Portuguese banks to fund themselves, at least while the issue is roiling capital markets.

The problems are also credit negative for Portugal Telecom, SGPS, S.A. (Baa3 negative) which is 10% owned by BES and which owns €897 million of commercial paper issued by Rio Forte Investments, S.A, another subsidiary of ESI.

However, the situation is unlikely to jeopardize the Portuguese sovereign‘s (Ba2 review for upgrade) improving fundamentals, as we commented on Friday. Moreover, other Portuguese corporate issuers typically benefit from diversified sources of bank funding and banking services and are therefore also unlikely to be significantly affected by developments at BES.

Banco Espirito Santo, S.A. Uncertainty about the entirety of BES’ direct or indirect exposure (be it via credit, reputational or fiduciary risk) to ESI subsidiaries undermines confidence in BES’ financial strength. This is despite BES’ €1.0 billion capital increase earlier this year and, as of end of March 2014, available regulatory capital of €2.1 billion in excess of the 8% minimum regulatory common equity Tier 1 ratio requirement.

The likelihood that the Portuguese government or bank regulator will intervene to sustain the viability of BES has increased, and in that case, BES subordinated debtholders are clearly at risk of bail-in as a condition for the European Commission to approve any systemic support. Because the European Bank Recovery and Resolution Directive, which requires the bail-in of senior creditors, is not yet law in Portugal, the bail-in of senior creditors is less likely.

Portuguese Banks. While these developments are idiosyncratic to BES, they undermine the improvement in confidence in Portugal’s banking sector and reduce the ability of other Portuguese banks to fund themselves, at least until investors have time to digest the implications of the situation at BES. Portuguese banks only regained market access to capital in early 2014. This has enabled them to diminish solvency

11 The ratings shown are Banco Espirito Santo’s deposit rating, its standalone bank financial strength rating/baseline credit assessment

and the corresponding rating outlooks.

Pepa Mori Vice President - Senior Credit Officer +34.91.768.8227 mariajose.mori@moodys.com

Johannes Wassenberg Managing Director +44.20.7772.1543 johannes.wassenberg@moodys.com

Carlos Winzer Senior Vice President +34.91.768.8238 carlos.winzer@moodys.com

Kathrin Muehlbronner Vice President - Senior Credit Officer +44.20.7772.1383 kathrin.muehlbronner@moodys.com

CREDIT IN DEPTH Detailed analysis of an important topic

30 MOODY’S CREDIT OUTLOOK 14 JULY 2014

pressures stemming from the system’s very weak profitability and asset quality. The problem at BES comes as Portuguese banks face a potential need to raise capital ahead of the European Central Bank’s comprehensive assessment. A bright spot is that Portuguese banks’ funding requirements have been reduced by ongoing balance sheet deleveraging and increased deposits.

Portugal Telecom. On 30 June, Portugal Telecom announced that it owned €897 million in Rio Forte Investments SA commercial paper: €847 million that matures 15 July and €50 million that matures 17 July. Portugal Telecom also has €128 million of bank deposits at BES.

While credit negative, the effect of a default of Rio Forte Investments on Portugal Telecom debt holders is diminished because obligations of Portugal Telecom’s finance subsidiary, Portugal Telecom International Finance BV, have been fully and unconditionally guaranteed by Oi SA (Baa3 negative) as part of the merger of Portugal Telecom’s operations into Oi SA.Oi has also acquired 100% of the stock of Portugal Telecom principal operating subsidiaries and has merged Portugal Telecom’s treasury operations with its own. This guarantee is not dependent upon the merger of PT SGPS, Portugal Telecom’s holding company, with Oi SA. The only condition for the guarantee was the completion of Oi’s capital increase, which has been successfully executed.

Rio Forte’s commercial paper owned by Portugal Telecom equals just over 20% of Oi’s total liquidity. In addition, Portugal Telecom has available long-term committed lines of credit (€800 million) plus access to Oi’s own liquidity to cover its debt maturities of approximately €1.3 billion and other expected cash demands over the next 18 months. Portugal Telecom’s liquidity is further supported by additional bank facilities, amounting to €470 million.

In terms of the ongoing merger between Oi SA and PT SGPS, we believe that if Rio Forte Investments SA were to default on the commercial paper held by Portugal Telecom, Oi S.A. could delay the merger because shareholders could challenge the share exchange terms of the provisionally agreed merger. However, the guarantee extended to the bondholders would not be affected.

The Portuguese Sovereign. Portugal’s fiscal and economic situation has been improving over the past quarters and the government has cash buffers of at least €15 billion at its disposal, including a cushion of €6.4 billion that was set aside specifically for bank recapitalisation. Hence, any government capital support for BES would not affect Portugal’s public debt ratio, which is nevertheless very high at close to 130% of GDP. Although we believe that the situation at BES could potentially affect the budget deficit, it is unclear at this stage whether such public capital support would be required. The key focus of our ongoing review for upgrade of Portugal’s Ba2 government bond rating is the prospect of meaningful expenditure-focused fiscal consolidation over the coming years. We will also take into account any further information regarding the need for public capital support for BES.

RATING CHANGES Significant rating actions taken the week ending 11 July 2014

31 MOODY’S CREDIT OUTLOOK 14 JULY 2014

Corporates

IOI Corporation Berhad Review for Downgrade 14 May ‘13 10 Jul ‘14

Long Term Issuer Rating Baa2 Baa2

Outlook Stable Review for Downgrade

The action follows the recent announcement of a 41% increase in its second interim dividend, to be paid this month. Credit metrics were already challenged following the acquisition of Unico Desa in November 2013. Shareholder friendly distributions during the year seem to bear a limited relationship to the performance of the retained businesses in the financial year ended June 2014.

Panasonic Corporation Upgrade 18 Dec ‘13 9 Jul ‘14

Long Term Issuer Rating Baa3 Baa2

Outlook Stable Positive

The upgrade principally reflects the material improvement in Panasonic’s financial profile, as evidenced by a significant reduction in its leverage, mainly driven by a large lowering in debt through assets sales and working capital management. The rating action also acknowledges the company’s improved operating performance as a result of its successful restructuring initiatives over the past few years.

Sun Products Corporation Downgrade 10 Mar ‘14 11 Jul ‘14

Corporate Family B2 B3

Outlook Negative Negative

The downgrade reflects recent deterioration in the company’s credit metrics due to heavy competition in the laundry care category. It will likely cause financial leverage to remain above the 6.5x debt/EBITDA threshold for at least several quarters, after over a year above the threshold.

Walter Energy, Inc. Downgrade 19 Mar ‘14 8 Jul ‘14

Corporate Family Rating Caa1 Caa2

Outlook Stable Stable

The downgrade reflects the deterioration in performance, increased cash burn and increase in leverage we anticipate, given the recent metallurgical coal benchmark settlement of $120 per tonne for high quality coking coal and our expectation that meaningful recovery in the met coal markets is 12 to 18 months away.

RATING CHANGES Significant rating actions taken the week ending 11 July 2014

32 MOODY’S CREDIT OUTLOOK 14 JULY 2014

Whirlpool Corporation Review for Downgrade 14 Feb ‘14 11 Jul ‘14

Long Term Issuer Rating Baa2 Baa2

Outlook Stable Review for Downgrade

The review follows the company’s announcement that it had entered into an agreement to acquire approximately 66.8 percent of the voting stock of Indesit Company S.p.A. The rationale for the review is the increase in leverage that will result from the proposed acquisition and the deterioration in operating margins. We expect that adjusted pro forma leverage will be between 3 and 3.5 times debt/EBITDA, above our downgrade trigger of 3 times. However, any rating downgrade would likely be limited to one notch.

RATING CHANGES Significant rating actions taken the week ending 11 July 2014

33 MOODY’S CREDIT OUTLOOK 14 JULY 2014

Financial Institutions

CNG Holdings, Inc. Downgrade/ Outlook Change 25 Jan ‘10 7 Jul ‘14

LT Corporate Family Ratings (Domestic)

B3 Caa1

Senior Secured (Domestic) B3 Caa1

Outlook Stable Negative

The downgrade reflects the anticipated deterioration in CNG’s credit metrics as a result of substantial restructuring costs related to the company’s recent suspension of lending activities in the UK, as well as sizeable losses from its majority stake in the specialty finance business WhyNot Leasing, LLC (WNL).

Espirito Santo Financial Group S.A. Downgrade

26 Jun ‘14 9 Jul ‘14

LT Issuer Rating B2 Caa2 Review for Downgrade

Senior Unsecured (Domestic) B2 Caa2 Review for Downgrade

ESFG has higher credit risk, in our view, following the increase in its exposure to its indirect shareholders Espirito Santo International (ESI) and Rioforte, which it disclosed on 3 July. We are also concerned about the lack of transparency around both the Espirito Santo Group’s financial position and the extent of intra-group linkages, including ESFG’s direct and indirect exposure to ESI.

Fidelity & Guaranty Life Holdings, Inc Upgrade 18 Mar ‘13 7 Jul ‘14

Senior Unsecured (Domestic) B1 Ba3

The upgrade reflects FGLIC’s improved financial profile, which features good asset quality, higher investment yields resulting from a recent portfolio repositioning, and strong capital, which is resilient under a stress scenario. The upgrade also reflects improving profitability driven by healthy sales expansion and low asset impairments.

Nomura Holdings, Inc. Review for Upgrade 7 Jul ‘14

LT Issuer Rating Baa3 Baa3

Senior Unsecured (Domestic) Baa3 Baa3

The review is prompted by improvements in Nomura’s profits and profitability, as well as reduced earnings volatility. Furthermore, there have also been improvements in capitalization. The review was also driven by changes to Japan’s Deposit Insurance Act that may increase the probability of official support for Nomura.

RATING CHANGES Significant rating actions taken the week ending 11 July 2014

34 MOODY’S CREDIT OUTLOOK 14 JULY 2014

MDM Bank Downgrade 15 Apr ‘14 9 Jul ‘14

Bank Financial Strength/ Baseline Credit Assessment

E+/b1 E+/b2

LT Bank Deposits (Domestic/Foreign) B1 B2

Senior Unsecured (Domestic) B1 B2

The downgrade reflects: (1) the bank’s recently weak financial results; (2) a persistently high level of problem loans with, in our view, uncertain recovery prospects for some large credit exposures that are insufficiently provisioned; and (3) the recent decline in interest-bearing loans.

PHH Corporation Downgrade 7 Apr ‘10 7 Jul ‘14

LT Corporate Family Ratings (Domestic)

Ba2 Ba3

Senior Unsecured (Domestic) Ba2 Ba3

The downgrade follows the closing of the sale of PHH’s Fleet Management Services business, PHH Arval, to Element Financial Corporation to Element Financial Corporation. The sale of the Fleet Management business weakens the company’s franchise and results in a more concentrated monoline business solely focused on residential mortgage banking.

Promsvyazbank Review for Downgrade 9 Jul ‘14

Bank Financial Strength/ Baseline Credit Assessment

D-/ba3 D-/ba3

LT Bank Deposits (Domestic/Foreign) Ba3 Ba3

Senior Unsecured (Domestic) Ba3 Ba3

Triggering the downgrade is (1) the negative trends in Promsvyazbank’s asset quality and earnings-generating capacity in first-half 2013 and first-quarter 2014; and (2) the bank’s relatively weak loss-absorption buffer, as reflected in its modest capital cushion and low loan loss reserves compared to the volume of problem loans.

RATING CHANGES Significant rating actions taken the week ending 11 July 2014

35 MOODY’S CREDIT OUTLOOK 14 JULY 2014

Sovereigns

Cote d’Ivoire New

8 Jul ‘14

Gov Currency Rating B1

Foreign Currency Deposit Ceiling Baa3/p-3

Foreign Currency Bond Ceiling Baa3/p-3

Local Currency Deposit Ceiling Baa3

Local Currency Bond Ceiling Baa3

Outlook Positive

The main drivers of the Côte d’Ivoire’s B1 ratings are:

» The economy’s growing diversification and high growth prospects, underpinned by renewed political stability, but balanced by low per capita income.

» Weak institutional strength as reflected in weak governance indicators, although the country’s participation in the West African Economic and Monetary Union (WAEMU) promotes price stability.

» Moderate fiscal fundamentals, as debt-relief initiatives have lowered the government’s debt burden, while its fiscal deficit remains limited under IMF and donor oversight.

» Moderate susceptibility to event risk, which balances credit strengths such as strong external fundamentals under the WAEMU framework and lingering concerns about long-term political stability.

RATING CHANGES Significant rating actions taken the week ending 11 July 2014

36 MOODY’S CREDIT OUTLOOK 14 JULY 2014

US Public Finance Aurora Health Care, Inc., Wisconsin

Outlook Change

22 Jul ‘13 10 Jul ‘14

Revenue Bonds A3 A3

Outlook Stable Positive

The positive rating outlook reflects a gradual but persistent strengthening of the organization, as evidenced by increasing margins, improved balance sheet profile overall and healthier debt coverage ratios. If the organization is able to sustain current operating momentum, continues to reduce balance sheet leverage and maintains a solid market position, it is our view that upward rating pressure will follow.

Foothill-De Anza Community College District, California Outlook Change 14 Mar ‘12 7 Jul ‘14

General Obligation Bonds Aaa Aaa

Certificates of Participation Aa2 Aa2

Outlook No Outlook Stable

The outlook reflects our expectation that the district will continue to maintain a strong overall credit profile reflected in a healthy financial position, above average socioeconomic indicators and large, growing tax base.

Washington County School District 48J, Beaverton, Oregon Outlook Change 20 Nov ‘12 8 Jul ‘14

General Obligation Bonds Aa2 Aa2

Full Faith and Credit Bonds Aa3 Aa3

Outlook Negative Stable

The stable outlook reflects our expectation that the district will maintain adequate reserves going forward after the adoption and fulfillment of a new fund balance policy. We also expect the district’s tax base to continue to grow in the near term, and to remain very large relative to similarly-rated districts nationally.

RESEARCH HIGHLIGHTS Notable research published the week ending 11 July 2014

37 MOODY’S CREDIT OUTLOOK 14 JULY 2014

Corporates

Moody’s Healthcare Quarterly We look at what’s driving deal-making among healthcare organizations in six healthcare subsectors and consider the credit implications. For example, in branded pharmaceuticals, acquisitions can reinvigorate the top line and capture cost synergies, but most deals are credit negative because of acquisition-related debt. In generic pharmaceuticals, on the other hand, added scale and diversity are generally credit positive, subject to the mix of debt and equity.

Global Oil Companies: Iraq Crisis Is Only a Minor Credit Threat While we view the uprising led by the Islamic State of Iraq and the Levant against Iraq’s central government as disruptive to the investments and longer-term growth plans of the major oil companies operating in the country, it is unlikely that credit ratings within the sector will be affected even if the fighting reaches major oil fields in southern Iraq and leads to protracted production cutoffs..

Asian Liquidity Stress Index - July 2014 Our Liquidity Stress Index reversed direction in June, declining to 23.6% after jumping to 24.4% in May, reflecting a net decrease of one in the number of companies with our lowest speculative-grade liquidity score of four. The Chinese sub-index declined slightly, while the Indonesian sub-index ticked upward.

Moody’s B3 Negative and Lower Corporate Ratings List: Upticks Aside, Conditions Remain Benign The number of companies on the B3 Negative and Lower Corporate Ratings List increased to 166, up from 159 a quarter earlier and the third consecutive quarterly increase. But our other indicators of speculative-grade credit quality such as the Liquidity-Stress Index and Covenant Stress Index support the view that credit conditions will remain benign, with low default rates for the rest of the year.

North American Automotive Parts Suppliers: Sustained Global Auto Sales Growth to Support Gradual Improvement in Profits We are maintaining a stable outlook on the North American automotive parts sector amid a continued rise in US light-vehicle sales and a gradual improvement in European sales. We expect global commercial vehicle production to rise about 2% over the next 12 to 18 months. Profit growth will still be modest.

US Cable Industry: High-Speed Data Engine Keeps Chugging Our outlook for the US cable industry is stable. The industry remains on track to achieve our expected 3% EBITDA growth for 2014 and 2015. We also expect stable EBITDA margins as the continued shift toward commercial and broadband offsets ever-escalating programming costs.

Met Coal at or Near a Bottom, as $120 Benchmark Rolls Over to Third Quarter The current benchmark price of $120 per metric tonne of metallurgical coal is likely a bottom from which prices will post a modest recovery. But we don’t expect any substantial gains beyond the $140 per tonne we expect by the end of the year. Current prices leave as much as a half of global production underwater, with most rated US producers operating at a loss.

RESEARCH HIGHLIGHTS Notable research published the week ending 11 July 2014

38 MOODY’S CREDIT OUTLOOK 14 JULY 2014

Japan Real Estate: Supply-Side Shortages Will Weigh on Future Growth We expect Japan’s real estate market to grow strongly in the next 12-18 months. The expansionary monetary policy implemented by the Bank of Japan under the Abe administration has triggered an increase in real estate investments and developments. However, supply-side shortages–land, labor, construction materials and commercial properties–will weigh on future growth in the sector.

US Technology: Stronger-Than-Expected PC Demand Is Credit Positive for HP, Intel and PC Supply Chain On 9 July, research firms Gartner and IDC reported better-than-expected worldwide PC unit shipments in second-quarter 2014. IDC noted a 1.7% drop in year-over-year shipments, markedly better than its projected decline of 7.1% for the quarter. The preliminary PC unit results provide another data point illustrating the stabilization of the PC market after declines since 2012.

RESEARCH HIGHLIGHTS Notable research published the week ending 11 July 2014

39 MOODY’S CREDIT OUTLOOK 14 JULY 2014

Financial Institutions

Bank Systemic Support Global Update: Resolution Regimes Drive Shifts in Support With more governments implementing bank resolution regimes with provisions for sharing resolution costs with creditors (“bail in”), bank bondholders carry greater risk of losses. As a result, we revised our governmental support assumptions for the senior creditors of some banks, notably in the United States and European Union. We also revised our expectations for support of junior debt globally. Weakened sovereign balance sheets and public resistance to the use of taxpayer money have helped shift the stance of governments away from supporting banks. Still, the extent to which bail-in tools have been implemented varies substantially by country, as does the support we factor into our bank credit analysis.

Canada Banking System Outlook We have changed our outlook for the Canadian banking system to negative from stable. This change reflects our view that the Canadian government’s plan to introduce a bail-in regime for senior debt, combined with the accelerating global trend towards burden-sharing with senior debtholders as a means of reducing the public cost of bank resolutions, could reduce the predictability of support being provided to the senior debtholders and uninsured depositors of the large Canadian banks.

Singapore Banking System Outlook Our outlook on Singapore’s banking system remains negative, as it has been since July 2013. Singapore banks have rapidly grown both their domestic and cross-border loans in recent years, and we continue to expect a moderate increase in problem loans as interest rates rise and asset prices potentially decrease. These developments will result in a modest increase in credit costs over the next 12 to 18 months.

Moody’s CDS Insurance Index Rallies in Q2; Travelers in Focus We review the performance of our Global Insurance Credit Default Swap (CDS) Index during second-quarter 2014. In the US, the economic recovery will likely accelerate in the coming months. This positive view is consistent with a narrowing of already low spreads during Q2 2014. CDS spreads of both below-investment-grade issuers and investment-grade issuers tightened during Q2.

Mind the Gap: Retail Bank Loan Funds Pose Liquidity, Reputational Risks for Managers Unlike most ETFs and mutual funds, which settle redemption requests to investors within three to seven days, bank loan funds have a structural mismatch between the cash settlement of their assets and their liabilities to fund investors. This misalignment poses liquidity risk for fund products and reputational risks for sponsors, including Eaton Vance, Fidelity and Invesco.

Evolution of the GCC Insurance Regulatory Landscape Is Positive for Credit Quality In response to rapid growth in the Gulf Cooperation Council insurance sector, regional regulators are implementing enhanced insurance regulations and guidelines. These reforms will improve the credit profile of the region’s insurance market and aid market stability and transparency by strengthening several aspects such as capital requirements, asset quality and reserve adequacy.

Puerto Rico’s New Debt Law Is Credit Negative for Financial Guarantors The Puerto Rico Public Corporations Debt Enforcement and Recovery Act creates a path for a possible distressed restructuring for certain government-related enterprises and raises questions about Puerto Rico’s

RESEARCH HIGHLIGHTS Notable research published the week ending 11 July 2014

40 MOODY’S CREDIT OUTLOOK 14 JULY 2014

credit conditions and willingness to pay its debt. This is credit negative for financial guarantors such as Assured Guaranty Ltd. (Baa2 stable), MBIA Inc. (Ba1 negative), and Radian Group, Inc. (B3 positive), all of which have substantial exposure to Puerto Rico.

RESEARCH HIGHLIGHTS Notable research published the week ending 11 July 2014

41 MOODY’S CREDIT OUTLOOK 14 JULY 2014

Sovereigns

Moody’s Sovereign Monitor - Focus on India - July 2014 This issue of the Monitor brings together our recent research on the credit strengths and challenges that underpin India’s Baa3 rating. India’s large and diversified economy, robust private savings and potential for high growth support the sovereign credit profile.

Asian Development Bank We assess the Asian Development Bank’s capital adequacy, liquidity, and the quality of its members’ support to be very strong and consistent with a Aaa rating. The ADB has sustained its robust financial performance and credit metrics through recent periods of global and regional economic stress.

Côte d’Ivoire Analysis Côte d’Ivoire’s B1 rating is primarily supported by the economy’s growing diversification and high growth prospects, which are underpinned by structural reforms and public investment in infrastructure. Côte d’Ivoire’s major credit constraint is its weak institutional strength. ECB’s TLTROs: Credit Positive for Banks, But Unlikely to Boost Bank Lending to the Economy On 3 July, the European Central Bank (ECB) outlined further details surrounding its Targeted Long-Term Refinancing Operations (TLTROs), which start in September. We highlight that the operations will raise banks’ profitability, a credit positive, by providing relatively long-term and low-cost funding with undemanding lending conditions. However, liquidity has not been a key constraint on lending for many banks.

RESEARCH HIGHLIGHTS Notable research published the week ending 11 July 2014

42 MOODY’S CREDIT OUTLOOK 14 JULY 2014

Sub-sovereigns

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

French Local Governments: Capital Market Issuances to Soar Amid Ample Funding Options In the second report in a series on European sub-sovereigns’ financing needs and access to market funding, we say we expect the capital market debt issued by French regional and local governments to triple to around 18% of total debt stock by 2017. This further reduces liquidity risks as it increases their funding options at a time of heightened pressure on local public finances.

US Public Finance

Rating Changes for the 50 States from 1973 Our latest quarterly summary of changes in state general obligation and issuer ratings says state fiscal conditions have stabilized and no state was late adopting a fiscal 2015 budget. Since 2 April, we have upgraded two states (New York and California), downgraded two states (Kansas and New Jersey) and revised the outlook for two states to stable from negative (Kentucky and Maine). Negative Outlook for US Higher Education Continues Even as Signs of Stability Emerge The outlook on the US higher education sector continues to be negative, with prospects for revenue growth and also for controlling expenses limited. However, there are signs that credit conditions may stabilize over the next year: the uptick in employment should lead to increased demand for educated works while improved household balance sheets should create more willingness to invest in education.

RESEARCH HIGHLIGHTS Notable research published the week ending 11 July 2014

43 MOODY’S CREDIT OUTLOOK 14 JULY 2014

Structured Finance

Final Regulation Enhances Credit Positive Features of Draft Law on Italian Covered Bonds On 24 June, the Bank of Italy updated its regulation on Italian covered bonds three months after the consultation on the draft law. The minor changes from the initial proposal generally augment the benefits of the credit positive features contained in the draft law and facilitate better market understanding of the OBG product.

CMBS: Red-Yellow-Green® Update First-Quarter 2014 Assessment of US Property Markets The major US property markets were broadly stable in first-quarter 2014, consistent with the generally slow pace of both construction and absorption. The overall composite score based on real estate supply/demand variables increased by one point to Green 70.

European CMBS Loan Maturities Update: Fewer Loans to Mature in the First Half of 2014 The number of loans securitised in European commercial mortgage backed securities (CMBS) due to mature will be noticeably fewer in second-half, when only 12 loans (€1.26 billion) will have their originally scheduled maturity dates. We expect only a third of the loans with original scheduled maturity dates in second-half 2014 to repay, in line with the average repayment rate observed in previous quarters.

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

44 MOODY’S CREDIT OUTLOOK 14 JULY 2014

Recently

NEWS & ANALYSIS Corporates » Archer Daniels Midland Increases Debt Burden with Purchase

of WILD » TeliaSonera’s Acquisition of Tele2 Norway Is Credit Positive and

Reduces Competition » Philips Expects Its Healthcare Division’s Second-Quarter EBITA

to Decline, a Credit Negative

Infrastructure » Tata Power’s Partial Divestment of PT Kaltim Prima Coal Is

Credit Positive

Banks » Hungary’s Law on Retail Loans Increases Loss Expectations for

Banks, a Credit Negative » Philippine Banks’ New Real Estate Stress Test Is Credit Positive

Insurers » ACE Limited’s Purchase of Itaú Seguros’ Corporate Insurance

Division Is Credit Positive for Itaú Seguros » German Life Insurance Reform Is Credit Negative for

Holding Companies » Dai-ichi Life Will Fund Acquisition of Protective Life with Share

Issuance, a Credit Positive

Sovereigns » A China-Korea Free Trade Agreement Is Credit Positive for

Both Countries

US Public Finance » Illinois Supreme Court Casts Doubt on Recent State and

Local Pension Reform Efforts, a Credit Negative

MOODYS.COM

Report: 172848

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EDITORS PRODUCTION SPECIALIST News & Analysis: Jay Sherman, Elisa Herr and Shem Pennant

Wing Chan

Ratings & Research: Robert Cox Final Production: Barry Hing