moody's credit outlook issuance

8/12/2019 Moody's Credit Outlook Issuance

1/48

MOODYS.CO

30 SEPTEMBER 2013

NEWS & ANALYSISThe US Government Shutdown and Debt Limit 2 For the US Sovereign, Failure to Raise Debt Limit Would Be

Worse Than a Shutdown

Some Defense Contractors Are Better Prepared Than Others Fannie Mae and Freddie Mac Face No Direct Effect Health Insurers Would Not Be Directly Affected by a

Shutdown, But Are Exposed to a Failure to Raise Debt Limit

Surety Insurers Face Delays in New Business, But Little, If Any,Increase in Claims

Certain Public Finance Credits Are ExposedCorporates 12 Stryker's Acquisition of MAKO Surgical Is Credit Negative Labco's Sale of Its German Subsidiary to Sonic Is Credit PositiveInfrastructure 14

NorthWestern Corp. Purchase of Hydro Assets Is CreditPositive

UK Opposition Labour Party Pledge to Freeze Energy Tariffs IsCredit Negative for Utilities

Recent Deleveraging Announcements Are Credit Positive forEnel

Banks 18

New York District Court Expands FIRREA's Reach to ProsecuteBanks Accused of Fraud

Brazil's State-Owned Banks Will Reduce Loan Growth, a CreditPositive

Bundesbank Study Will Prompt Large German Banks toContinue Boosting Their Capital

Socit De Financement Local Would Avoid Legal Risk withAmended Finance Law

Insurers 25 ProAssurance's Proposed Acquisition of Eastern Is Credit

Negative

Global Atlantic's Acquisition of Forethought Is Credit Negativefor Both

Money Market Funds 28

Fed's New Overnight Reverse Repo Facility Offers SupplyBenefits to US Money Market Funds

US Public Finance

Court Rules Atlanta Public Schools Won't Get Help FundingPensions from Charter Schools

RATINGS & RESEARCHRating Changes

Last week we upgraded CVS/Caremark, General Motors, and BlackHills Corp. / Black Hills Power and downgraded Illinois Tool Works,

DTEK Holdings, DTEK Finance BV, DTEK Finance plc, Banco de la

Provincia de Crdoba, Bonsucesso, State Bank of India, 12 Ukrainianfinancial institutions, and the cities of Kyiv and Kharviv in the

Ukraine, among other rating actions.

Research Highlights

Last week, we published on AT&T, Asia-Pacific coal, US for-profit

hospitals, Brazilian corporates, US homebuilders, US leveragedfinance, North American manufacturers, China property, USbuilding products, US wireless, US fixed-line telecoms, China

General Nuclear Power, European transport infrastructure, theBaltics banking system, Japanese property and casualty insurers,

global takaful, Latin American sovereigns, Bangladesh, Trinidad andTobago, Spain, the US, Japanese regional and local governments,

Mexican states, US states, Michigan, US military housing, US RMBS,tobacco securitizations, and Japanese, Australian, Dutch and UK

RMBS, among other reports.

RECENTLY IN CREDIT OUTLOOK

Articles in Last Thursdays Credit Outlook Go to Last Thursdays Credit Outlook

Click here forWeekly Market Outlook, our sister publication containing

Moodys Analytics review of market activity, financial predictions, and

the dates of upcoming economic releases.
http://www.moodys.com/http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_158654http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_158654http://www.moodys.com/wmohttp://www.moodys.com/wmohttp://www.moodys.com/viewresearchdoc.aspx?docid=PBC_158654http://www.moodys.com/


2/48

NEWS & ANALYSISCredit implications of current events

2 MOODYS CREDIT OUTLOOK 30 SEPTEMBER

The US Government Shutdown and Debt LimitTwo legislative deadlines for theUnited States(Aaa stable) government have the potential to disrupt US

financial markets and economic growth. If Congress fails to pass a budget or a continuing resolution to

authorize spending by the evening of 30 September, the federal government will shut down. The shutdownwould force a halt in discretionary spending, which is 38% of non-interest government expenditures. The

second deadline is likely in mid-October, when the Treasury will have exhausted the extraordinary measures

it can use to finance government operations without increasing government debt, which is prohibited unless

Congress increases the statutory debt limit. Failure to raise the debt ceiling would require a 15%-20% cut

in total spending.

Our expectation is that the US will avoid a government shutdown and will increase the debt limit. These

articles address the credit implications if in fact there is either a government shutdown or a failure to raise

the debt ceiling:

For the US sovereign, failure to raise the debt limit would be worse than a shutdownSome defense contractors are better prepared than others for a shutdown or failure to raise the debt limitFannie Mae and Freddie Mac face no direct effect from a shutdown or failure to raise the debt limitHealth insurers would not be directly affected by a shutdown, but are exposed to a failure to raise the debt

limit

Surety insurers face delays in new business, but little, if any, effect on claims with a shutdown or failure toraise the debt limit

Certain public finance credits are exposed to a shutdown and failure to raise the debt limitFor the US Sovereign, Failure to Raise Debt Limit Would Be Worse Than a Shutdown

If the shutdown occurs or if Congress fails to raise the debt limit, the consequences for the economy and

government revenues would be negative. A failure to raise the federal debt limit would have greater adverse

financial market and economic consequences than a government shutdown because market participants

would perceive an increased probability of a sovereign default.

A government shutdown would not affect debt service.Federal discretionary spending authorization,

which ceases 30 September, accounts for about 38% of total non-interest federal spending and includes

most day-to-day government operations. Spending on mandatory programs mainly Social Security,

Medicare, Medicaid and other social programs would continue, as would interest payments on Treasury

securities, since these do not need annual authorization.

If a shutdown occurred, the government would still service its debt, but like the government shutdownfrom late 1995 to early 1996, we would expect most federal employees to be unpaid and not to work. In

fact, on 17 September, Office of Management and Budget Director Sylvia Burwell instructed federal

executive department and agency heads to make contingency plans for a federal government shutdown.

Government revenues would be adversely affected by the ensuing slowdown in economic activity, a credit

negative.

Failure to raise the debt ceiling would have more severe financial market and economic consequences.The Treasury cannot increase its debt above the $16.7 trillion statutory debt limit unless Congress votes to

teven Hessenior Vice President - Manager

[email protected]
https://www.moodys.com/credit-ratings/United-States-of-America-Government-of-credit-rating-790575https://www.moodys.com/credit-ratings/United-States-of-America-Government-of-credit-rating-790575https://www.moodys.com/credit-ratings/United-States-of-America-Government-of-credit-rating-790575mailto:[email protected]:[email protected]://www.moodys.com/credit-ratings/United-States-of-America-Government-of-credit-rating-790575


3/48



raise the limit. Although we expect that the debt limit will be increased, if borrowing authority is not

increased, all government spending would be limited to the amount of incoming revenues.

In contrast to the government-shutdown scenario, failure to increase the statutory debt limit could

theoretically affect all categories of government spending, including debt service. The magnitude of thereduction in spending would be less, and hence have a smaller direct effect on economic activity.

According to Congressional Budget Office (CBO) projections, tax and other revenues will have financed

about 81% of spending in fiscal 2013 and will finance 84% of spending in fiscal 2014, which begins 1

October. Borrowing finances the remainder. Therefore, without authorization to increase borrowings, the

government would have to reduce total spending by somewhere in the 15%-20% range, an amount likely

to drag on the economy, but less so than the shutdowns potential 38% reduction in non-interest

government spending.

We believe that the government would continue to pay interest on Treasury securities. However, the

government would have to make painful choices as to which expenditure to cut, and there is no historical

precedent that provides confidence that interest payments would be prioritized over discretionary spending.In the 2014 fiscal year, the CBO projects that interest payments will account for about 7% of total federal

spending, leaving still considerable room to meet interest payments in the event of 15%-20% expenditure

cuts. October interest payments are relatively small, but on 15 November, the Treasury will need to pay

interest of about $16 billion equal to about 6% of average monthly revenues in fiscal 2014, although

monthly revenue collection varies considerably.

Financial market and economic consequences would likely be more severe if the debt limit is not raised than

under a government shutdown. Although the expenditure reduction under the debt limit scenario is

smaller, the perception that the US government could default on servicing its debt if the debt limit is not

raised could roil financial markets and damage business and consumer confidence.


4/48



Some Defense Contractors Are Better Prepared Than Others for a Shutdown orFailure to Raise the Debt Limit

The two US budget deadlines threaten to weaken liquidity for US defense contractors. Although it is not

our expectation, failure to avoid a shutdown and to increase the debt limit would clearly be credit negative

for defense contractors. Nearly all defense spending is technically discretionary for budget purposes, but

specific components related to national security have been excepted in the past. Quantification of the

potential effect on issuers in the sector is therefore difficult because the scope, duration and prospective

targets of potential government payment deferrals are not yet known.

Despite significant spending cutbacks dealt by sequestration the financial consequences of which we

expect will be more noteworthy in 2014 and beyond we believe defense contractors are only marginally

better prepared for a potential disruption in government payments than they were during the most recent

debt-ceiling crisis in 2011.We base our view on our Defense Contractor Liquidity Index (DCLI), which

measures vulnerability to a government shutdown accompanied by a complete cessation of such

government payments.

A fair amount of variability and hence perceived underlying preparedness is evidenced in our DCLI

scores. Scores are based on each companys current sources of near-immediate liquidity (cash and available

committed bank lines) as of 30 June 2013 relative to the companys estimated annual US government-

related revenue. A score of 50 indicates liquidity is half government-related revenue. The 65 companies in

our study are split about equally into three categories:

well protected- DCLI scores of 100, the best outcome on our scale, generally reflecting low exposure tothe US government, and/or strong liquidity relative to such exposure

better protected- DCLI scores of 21-90, indicating the equivalent of several months of liquidity cushion towithstand prospective disruptions with respect to collecting on US government receivables

more exposed- DCLI scores below 20, for companies most at risk in the event of a government shutdown,wherein only a few weeks of backstop liquidity may be available to mitigate the risk of governmentpayments ceasing

More commercially oriented companies with comparatively limited exposure to the US government, such as

Honeywell International Inc.(A2 stable, 100 DCLI score),BE Aerospace, Inc.(Ba1 stable, 100) and

TransDigm Inc.(B2 stable, 100), score the best. Larger, more diversified investment grade-rated companies

that also maintain reasonably large exposures to the US government, such asBoeing Co.(A2 stable, 49),

Rockwell Collins, Inc.(A2 review for downgrade, 69) andTextron Inc.(Baa3 stable, 42), score well, but

lower.

Those with DCLI scores below 20 are generally mid- to low-tier contractors with elevated leverage, ongoing

and more niche-oriented exposure to US military outlays and comparatively limited near-immediate sources

of liquidity relative to this exposure. Examples of such companies that we believe are most vulnerable to agovernment shutdown, depending of course on each ones ability to take offsetting, cash-conserving actions

includeKratos Defense & Security Solutions, Inc.(B3 stable, 18),The SI Organization(B3 stable, 14) and

Hunter Defense Technologies, Inc.(Caa1 negative, 13), among others. But this more exposed group also

includes some of the larger, more highly rated companies that are just more heavily wed to the US

government, given their heavy skew toward defense- or intelligence-oriented business lines. This group

includes the likes ofLockheed Martin Corp.(Baa1 stable, 11),L-3 Communications Corp.(Baa3 stable,

13),Huntington Ingalls Industries, Inc.(Ba2 stable, 18),Alliant Techsystems Inc.(Ba2 review for

downgrade, 13) andBooz Allen Hamilton Inc.(Ba3 stable, 16).

ruce Herskovicsice President - Senior Analyst

[email protected]

ussell Solomonenior Vice President

[email protected]
https://www.moodys.com/credit-ratings/Honeywell-International-Inc-credit-rating-26800https://www.moodys.com/credit-ratings/Honeywell-International-Inc-credit-rating-26800https://www.moodys.com/credit-ratings/BE-Aerospace-Inc-credit-rating-600010331https://www.moodys.com/credit-ratings/BE-Aerospace-Inc-credit-rating-600010331https://www.moodys.com/credit-ratings/BE-Aerospace-Inc-credit-rating-600010331https://www.moodys.com/credit-ratings/TransDigm-Inc-credit-rating-600045854https://www.moodys.com/credit-ratings/TransDigm-Inc-credit-rating-600045854https://www.moodys.com/credit-ratings/Boeing-Company-The-credit-rating-108050https://www.moodys.com/credit-ratings/Boeing-Company-The-credit-rating-108050https://www.moodys.com/credit-ratings/Boeing-Company-The-credit-rating-108050https://www.moodys.com/credit-ratings/Rockwell-Collins-Inc-credit-rating-600059599https://www.moodys.com/credit-ratings/Rockwell-Collins-Inc-credit-rating-600059599https://www.moodys.com/credit-ratings/Textron-Inc-credit-rating-747000https://www.moodys.com/credit-ratings/Textron-Inc-credit-rating-747000https://www.moodys.com/credit-ratings/Textron-Inc-credit-rating-747000https://www.moodys.com/credit-ratings/Kratos-Defense-Security-Solutions-Inc-credit-rating-820748569https://www.moodys.com/credit-ratings/Kratos-Defense-Security-Solutions-Inc-credit-rating-820748569https://www.moodys.com/credit-ratings/Kratos-Defense-Security-Solutions-Inc-credit-rating-820748569https://www.moodys.com/credit-ratings/SI-Organization-Inc-The-credit-rating-822327329https://www.moodys.com/credit-ratings/SI-Organization-Inc-The-credit-rating-822327329https://www.moodys.com/credit-ratings/SI-Organization-Inc-The-credit-rating-822327329https://www.moodys.com/credit-ratings/Hunter-Defense-Technologies-Inc-credit-rating-820395455https://www.moodys.com/credit-ratings/Hunter-Defense-Technologies-Inc-credit-rating-820395455https://www.moodys.com/credit-ratings/Lockheed-Martin-Corporation-credit-rating-600015909https://www.moodys.com/credit-ratings/Lockheed-Martin-Corporation-credit-rating-600015909https://www.moodys.com/credit-ratings/Lockheed-Martin-Corporation-credit-rating-600015909https://www.moodys.com/credit-ratings/L-3-Communications-Corporation-credit-rating-600023687https://www.moodys.com/credit-ratings/L-3-Communications-Corporation-credit-rating-600023687https://www.moodys.com/credit-ratings/L-3-Communications-Corporation-credit-rating-600023687https://www.moodys.com/credit-ratings/Huntington-Ingalls-Industries-Inc-credit-rating-822367248https://www.moodys.com/credit-ratings/Huntington-Ingalls-Industries-Inc-credit-rating-822367248https://www.moodys.com/credit-ratings/Huntington-Ingalls-Industries-Inc-credit-rating-822367248https://www.moodys.com/credit-ratings/Alliant-Techsystems-Inc-credit-rating-600015494https://www.moodys.com/credit-ratings/Alliant-Techsystems-Inc-credit-rating-600015494https://www.moodys.com/credit-ratings/Alliant-Techsystems-Inc-credit-rating-600015494https://www.moodys.com/credit-ratings/Booz-Allen-Hamilton-Inc-credit-rating-820590061https://www.moodys.com/credit-ratings/Booz-Allen-Hamilton-Inc-credit-rating-820590061https://www.moodys.com/credit-ratings/Booz-Allen-Hamilton-Inc-credit-rating-820590061mailto:[email protected]:[email protected]:[email protected]:[email protected]://www.moodys.com/credit-ratings/Booz-Allen-Hamilton-Inc-credit-rating-820590061https://www.moodys.com/credit-ratings/Alliant-Techsystems-Inc-credit-rating-600015494https://www.moodys.com/credit-ratings/Huntington-Ingalls-Industries-Inc-credit-rating-822367248https://www.moodys.com/credit-ratings/L-3-Communications-Corporation-credit-rating-600023687https://www.moodys.com/credit-ratings/Lockheed-Martin-Corporation-credit-rating-600015909https://www.moodys.com/credit-ratings/Hunter-Defense-Technologies-Inc-credit-rating-820395455https://www.moodys.com/credit-ratings/SI-Organization-Inc-The-credit-rating-822327329https://www.moodys.com/credit-ratings/Kratos-Defense-Security-Solutions-Inc-credit-rating-820748569https://www.moodys.com/credit-ratings/Textron-Inc-credit-rating-747000https://www.moodys.com/credit-ratings/Rockwell-Collins-Inc-credit-rating-600059599https://www.moodys.com/credit-ratings/Boeing-Company-The-credit-rating-108050https://www.moodys.com/credit-ratings/TransDigm-Inc-credit-rating-600045854https://www.moodys.com/credit-ratings/BE-Aerospace-Inc-credit-rating-600010331https://www.moodys.com/credit-ratings/Honeywell-International-Inc-credit-rating-26800


5/48


6/48



Fannie Mae and Freddie Mac Face No Direct Effect from a Shutdown or Failure toRaise the Debt Limit

The government-sponsored entities (GSEs)Fannie Mae(Aaa stable) andFreddie Mac(Aaa stable) are

exposed to financial market disruptions from a government shutdown or failure to raise the US debt limit.

However, these events will not affect the credit strength of these GSEs.

Neither Fannie Mae nor Freddie Mac currently depend on government funds, a situation that is unlikely to

change. We expect both GSEs will continue to report robust earnings over the next several quarters because

they remain the largest and most reliable providers of mortgage credit and have an aggregate market share

approaching 80%. Even if they did not perform as expected, the GSEs would continue to have access to

contingent capital from the Treasury totaling $117.6 billion for Fannie Mae and $140.5 billion for Freddie

Mac. And, based on our conversations with government officials, we believe that any payments to the two

GSEs as part of their capital agreement would be mandatory spending and, as such, would not be affected

by a government shutdown.

Furthermore, in the unlikely event that a financial disruption resulted in the GSEs reporting a loss, there is

a high likelihood that the Treasury would honor the capital agreement with them, even if it were not a

mandatory expenditure, or if a failure to raise the debt limit were to place at risk all government

expenditures. We also believe the government would honor its agreement with Fannie Mae and Freddie

Mac even if it meant rationalizing other discretionary expenditures, because to not do so would damage the

US economy in general and more specifically the US housing market.

The two GSEs were put into conservatorship in September 2008 when the US housing market was crashing

and both faced significant losses. The Treasury committed to provide contingent capital, as needed, to

offset the losses, which were substantial: fourth-quarter 2008 through fourth-quarter 2011 losses totaled

$128.1 billion and $64.7 billion, respectively, for Fannie Mae and Freddie Mae. The Treasurys capital

injections were also significant, totaling $116.1 billion for Fannie Mae and $71.3 billion for Freddie Mac.

However, since first-quarter 2012, the two GSEs have reported positive net income as the housing market

recovered and they increased guarantee fees (see exhibit below).

Fannie Mae and Freddie Mac Report Record Net Income

Source: Company reports

$0

$10

$20

$30

$40

$50

$60

$70

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

Fannie Mae Fr ed die Mac

$Billions

rian Harrisenior Vice President

[email protected]
https://www.moodys.com/credit-ratings/Federal-National-Mortgage-Association-credit-rating-276550https://www.moodys.com/credit-ratings/Federal-National-Mortgage-Association-credit-rating-276550https://www.moodys.com/credit-ratings/Federal-National-Mortgage-Association-credit-rating-276550https://www.moodys.com/credit-ratings/Federal-Home-Loan-Mortgage-Corp-credit-rating-276455https://www.moodys.com/credit-ratings/Federal-Home-Loan-Mortgage-Corp-credit-rating-276455https://www.moodys.com/credit-ratings/Federal-Home-Loan-Mortgage-Corp-credit-rating-276455https://www.moodys.com/credit-ratings/Federal-Home-Loan-Mortgage-Corp-credit-rating-276455https://www.moodys.com/credit-ratings/Federal-National-Mortgage-Association-credit-rating-276550


7/48


MOODYS CREDIT OUTLOOK 30 SEPTEMBER

Health Insurers Would Not Be Directly Affected by a Shutdown, But Are Exposed to aFailure to Raise Debt Limit

Health insurers would not be directly affected by a government shutdown, but they would likely be hurt if

Congress does not raise the debt limit. Health insurers that offer Medicare Advantage products to US

seniors, or participate in managed care Medicaid programs, rely on federal government payments.

Medicare Advantage payments to health insurers are typically paid at the beginning of the month from

Medicare trust funds that are separate from Congressional appropriations, and therefore, a government

shutdown would not affect them.

Health insurers also receive payments under the Medicaid program, which is largely state-run, with the

federal government paying somewhere between 50% and 75% of Medicaid costs (the percentage varies by

state). The state portion of Medicaid payments would not be directly affected by a federal government

shutdown. In addition, the federal Medicaid payments to the states, which are typically paid in advance on

a quarterly basis, are considered non-discretionary spending, and a government shutdown would not affect.

If the shutdown were to extend for a long period, however, administrative delays could disrupt payment

stream to insurers.

If the debt ceiling is reached, all federal payments are theoretically at risk, potentially including both

Medicare and Medicaid payments. But since Medicare payments are paid from the Medicare trust funds,

we believe they are unlikely to be affected.

In the case of payment delays, or a failure to raise the debt ceiling, insurers will be faced with the decision as

to whether to continue to cover beneficiaries and make payments to doctors on credit, or to suspend

insurance coverage until the government resumes payments.

teve Zaharukenior Vice President

[email protected]


8/48



Surety Insurers Face Delays in New Business, But Little, If Any, Increase in Claims in aShutdown or Failure to Raise the Debt Limit

Surety insurers face the risk that a government shutdown or failure to raise the debt limit would reduce

spending on infrastructure projects. Surety companies insure the risk that contractors are not able to meet

their commitments in such projects. Fewer projects mean less demand for surety insurance. The effect

would occur only gradually, because projects are typically planned and funded over long periods. Most

insurers in the surety market are diversified, and therefore a shutdown would have only a very minor effect

on their creditworthiness, if any effect at all.

Importantly, if the government suspends or cancels a project, surety insurers are not responsible for a

contractors uncompleted project. During and after the global financial crisis in 2008-10, a number of

government-driven projects experienced stops or delays in payments, but surety insurers did not suffer

elevated losses as a result. The surety insurers only cover a contractors failure to complete work for which it

has been contracted and paid.

With the exception of certain very high priority projects, a government shutdown may lead to an increase in

payment delays on federally funded projects. Consequently, work stoppages could well occur on projects

that fall below the high-priority threshold, or that are not pre-funded.

But, as stated, such stoppage should not generate claim losses for sureties. Insurers generally advise their

insured contractors to communicate with the government contract officers assigned to their projects to

request that the government formally suspend work in the event of a shutdown. This way, the contractor

does not have to go through the legal process of halting work, based on the contract terms, because of

nonpayment by the government.

lan Murrayenior Vice President

[email protected]


9/48



Certain Public Finance Credits Are Exposed to a Shutdown and Failure to Raise theDebt Limit

A US government shutdown would have a limited credit effect on public finance issuers if it is as short-lived

as we expect any shutdown would be. A failure to raise the US debt ceiling would be more credit negative

for municipal issuers. It would be more problematic for issuers if the debt ceiling is not raised because all

spending, including non-discretionary spending, would be eligible for cuts. During a shutdown, only

discretionary spending is on the chopping block.

A binding debt ceiling limit could jeopardize funding to some muni issuers. The federal government

would not be allowed to increase its outstanding debt if it reaches the statutory debt ceiling. The Treasury

estimates that if an agreement on the debt ceiling is not reached by 17 October it will have only $30 billion

per day to fund commitments, which would not be enough to meet its net daily expenditures that reach as

high as $60 billion. In this scenario, all or some federal funding could be reduced, including funding to

public finance issuers that receive related federal transfers to pay for services, or in some cases to pay for debt

service. Public finance issuers would also likely face higher borrowing costs, and market access would be

challenging, particularly for issuers with thin liquidity and a need to refinance debt or access the short-term

note market for cash-flow purposes. However, most public finance issuers have already allocated funds or

scheduled payments to protect against the possibility that federal transfers could be delayed or reduced for

an extended period.

The types of public finance issuers and securities exposed to federal government transfers are outlined

below.

Stateshave relatively high dependence on federal revenues and some have relatively high economic reliance

on federal procurement and healthcare spending, specifically Medicaid matching funds, or rely on cash-flow

borrowing and variable-rate financing, as seen in Exhibit 1. However, healthcare providers and other

procurement contractors will in the end bear the brunt of delayed payments because states will delay

transfers to these entities in response to delayed federal government transfers.

EXHIBIT 1

Federal Revenues as a Percent of State Total Governmental Funds

Note:10 -20 : Alaska, Wyoming; 21 -30 : Connecticut, Delaware, Hawaii, Kansas, Massachusetts, Minnesota, New Jersey, North Dakota;31%-40%: California, Colorado, Florida, Illinois, Indiana, Iowa, Kentucky, Maryland, Michigan, Nebraska, New Hampshire, New Mexico, New York, NorthCarolina, Oklahoma, Pennsylvania, South Carolina, Texas, Utah, Vermont, Virginia, Washington, West Virginia, Wisconsin; 41 -50 : Alabama,Arizona, Arkansas, Georgia, Idaho, Maine, Mississippi, Missouri, Montana, Nevada, Ohio, Oregon, Rhode Island, South Dakota, Tennessee; 51 -60 :Louisiana

Source: Fiscal 2012 State Comprehensive Annual Financial Reports

2

8

24

15

1

-

5

10

15

20

25

30

10% - 20% 21% - 30% 31% - 40% 41% - 50% 51% - 60%

NumberofStates

ick Samuelsice President - Senior Credit Officer

[email protected]


10/48



Local governments generally have low dependence on federal revenues, but some rely heavily on aid from

states, which may themselves experience direct cuts in federal funding. Local governments with strong

financial reserves and effective governance are more equipped to mitigate funding cuts. TheDistrict of

Columbia(Aa2 stable) is a unique case because it requires Congressional approval for its budget, meaning a

shutdown could affect its operations. However, a Congressionally enacted statute explicitly permitspayment of debt service without the need for federal appropriation.

Healthcare institutions are very reliant on federal revenues via Medicare and Medicaid. Medicaid spending

is generally the largest expenditure for states, although it is usually half funded by the federal government.

Cuts to Medicaid funding could delay reimbursements to healthcare providers, which would be credit

negative for hospitals (see Exhibit 2), some of which sequestration and Medicare reforms already pinch.

Hospitals that treat a large number of low-income patients (those on Medicaid) would be

disproportionately affected by Medicaid cuts or reimbursement delays.

EXHIBIT 2

Hospitals with the Largest Percentage of Medicaid Funding

Hospital Rating Outlook Medicaid as Percent of Revenue

All Children's Hospital, Florida A1 stable 64.3%

Arkansas Children's Hospital, Arkansas A1 stable 65.1%

Children's Healthcare of Atlanta, Georgia Aa2 stable 53.6%

Children's Hospital Central California A1 stable 70.7%

Children's Hospital of Alabama A2 positive 56.0%

Children's Hospital of Los Angeles, California Baa2 stable 69.5%

Children's Medical Center of Dallas, Texas Aa3 stable 64.1%

Children's Specialized Hospital, New Jersey Baa3 stable 63.0%

Texas Children's Hospital, Texas Aa2 stable 53.6%

Rady Childrens Hospital, California A2 stable 53.3%

Source: Moodys

The municipal bonds that are most exposed to the risk of a shutdown are those that rely on payments from

the federal government as their primary source of revenue to pay debt service, and are shown in Exhibit 3.
https://www.moodys.com/credit-ratings/District-of-Columbia-credit-rating-600023199https://www.moodys.com/credit-ratings/District-of-Columbia-credit-rating-600023199https://www.moodys.com/credit-ratings/District-of-Columbia-credit-rating-600023199https://www.moodys.com/credit-ratings/District-of-Columbia-credit-rating-600023199https://www.moodys.com/credit-ratings/All-Childrens-Hospital-FL-credit-rating-800000577https://www.moodys.com/credit-ratings/All-Childrens-Hospital-FL-credit-rating-800000577https://www.moodys.com/credit-ratings/Arkansas-Childrens-Hospital-credit-rating-600026941https://www.moodys.com/credit-ratings/Arkansas-Childrens-Hospital-credit-rating-600026941https://www.moodys.com/credit-ratings/Childrens-Healthcare-of-Atlanta-GA-credit-rating-808094966https://www.moodys.com/credit-ratings/Childrens-Hospital-Central-California-credit-rating-809389768https://www.moodys.com/credit-ratings/Childrens-Hospital-Central-California-credit-rating-809389768https://www.moodys.com/credit-ratings/Childrens-Hospital-of-Alabama-credit-rating-800006598https://www.moodys.com/credit-ratings/Childrens-Hospital-of-Alabama-credit-rating-800006598https://www.moodys.com/credit-ratings/Childrens-Hospital-Los-Angeles-credit-rating-171736https://www.moodys.com/credit-ratings/Childrens-Hospital-Los-Angeles-credit-rating-171736https://www.moodys.com/credit-ratings/Childrens-Medical-Center-of-Dallas-TX-credit-rating-800006605https://www.moodys.com/credit-ratings/Childrens-Medical-Center-of-Dallas-TX-credit-rating-800006605https://www.moodys.com/credit-ratings/Childrens-Specialized-Hospital-NJ-credit-rating-800006612https://www.moodys.com/credit-ratings/Texas-Childrens-Hospital-credit-rating-600029336https://www.moodys.com/credit-ratings/Texas-Childrens-Hospital-credit-rating-600029336https://www.moodys.com/credit-ratings/Rady-Childrens-Hospital-CA-credit-rating-809947258https://www.moodys.com/credit-ratings/Rady-Childrens-Hospital-CA-credit-rating-809947258https://www.moodys.com/credit-ratings/Texas-Childrens-Hospital-credit-rating-600029336https://www.moodys.com/credit-ratings/Childrens-Specialized-Hospital-NJ-credit-rating-800006612https://www.moodys.com/credit-ratings/Childrens-Medical-Center-of-Dallas-TX-credit-rating-800006605https://www.moodys.com/credit-ratings/Childrens-Hospital-Los-Angeles-credit-rating-171736https://www.moodys.com/credit-ratings/Childrens-Hospital-of-Alabama-credit-rating-800006598https://www.moodys.com/credit-ratings/Childrens-Hospital-Central-California-credit-rating-809389768https://www.moodys.com/credit-ratings/Childrens-Healthcare-of-Atlanta-GA-credit-rating-808094966https://www.moodys.com/credit-ratings/Arkansas-Childrens-Hospital-credit-rating-600026941https://www.moodys.com/credit-ratings/All-Childrens-Hospital-FL-credit-rating-800000577https://www.moodys.com/credit-ratings/District-of-Columbia-credit-rating-600023199https://www.moodys.com/credit-ratings/District-of-Columbia-credit-rating-600023199


11/48



EXHIBIT 3

Municipal Bonds Whose Primary Revenue Source Is Federal Payments

Type of CreditDo Federal Payments RequireReappropriation or Reauthorization? Structural Mitigants to Payment Delay

Highway and mass transit debt Yes Timing of debt service paymentsDebt service reserve funds

Federal lease financings Yes for some Timing of debt service paymentsDebt service reserve funds

Public housing authority bonds Yes, but funds for 2011 have alreadybeen appropriated

Timing of debt service paymentsDebt service reserve funds

New housing authority bonds No, funds for payment wereappropriated at time of debt issuance

Timing of debt service payments

Section 8 bonds Yes Timing of debt service paymentsDebt service reserve funds

Military housing bonds Yes, but payments are deemedessential and therefore exempt fromshutdown risk

Debt service reserve funds

Source: Moodys

Government shutdown would have limited effect.In the case of a government shutdown, only

discretionary spending would be suspended or reduced, which would have less effect on public finance

issuers than in the case of a debt-ceiling breach. The federal government has not yet identified services and

programs that would be cut, but they typically include national parks, passport offices and administrative

staff. However, a prolonged shutdown would negatively affect economic activity in states and localities with

a heavy federal presence, including the Washington, DC metro area, potentially leading to income and sales

tax declines.


12/48



Corporates

Strykers Acquisition of MAKO Surgical Is Credit Negative

Last Wednesday,Stryker Corporation(A3 stable) said it had reached a definitive agreement to buy MAKO

Surgical Corp. (unrated), a manufacturer of devices for robotic-assisted orthopedic surgery, for $1.65

billion. Although the transaction has the potential to ultimately benefit Stryker, it is credit negative for now

because we expect the company to use a significant portion of its US cash to buy a technology that is not

yet widely used by orthopedic surgeons.

Stryker had total cash and marketable securities of about $4.7 billion at 30 June, including the proceeds

from a recent $1 billion bond offering, and about 50% of this cash is held in the US. A reduction in its US

cash will reduce Strykers cushion for its other US cash needs, including dividends, buybacks and future US

acquisitions. MAKO will not immediately add a material level of sales or positive cash flow, having reported

sales of about $103 million and negative cash flow from operations for fiscal 2012. But because the

acquisition will not likely be funded with debt, Strykers leverage (debt/EBITDA of about 1.7x at 30 June)will remain steady.

MAKO manufactures the RIO Robotic Arm, which is used primarily in partial knee resurfacing procedures

and was recently approved for total hip arthroplasty procedures. For both procedures, using the RIO arm

requires use of MAKOs RESTORIS family of implants. The acquisition would accelerate Strykers ability

to enter the robotic space, which offers more growth opportunities, a credit positive.

However, it is unclear how quickly doctors and hospitals will adopt this robotic technology. In addition to

ensuring that orthopedic surgeons receive appropriate training on the robotic equipment, future clinical

outcomes will help determine the speed of adoption.

Reducing complications and improving outcomes has become more important for hospitals as bothcommercial and government insurers increasingly base reimbursement on the quality of care rather than the

volume of care. As a result, orthopedic companies have begun to focus more on implant technique and

alignment than the actual implants. Along these lines, Stryker has been competing against other large

orthopedic players, includingJohnson & Johnson(Aaa stable),Zimmer Holdings, Inc.(Baa1 stable) and

Biomet, Inc.(B2 stable), in selling patient-specific instrumentation and computer-assisted guide technology

aimed at improving implant technique. It is too early to determine if the robotic technology will give

Stryker a strategic advantage and allow it to gain market share. Other companies are also pursuing robotic

devices. Blue Belt Technologies, Inc. (unrated) recently received approval for its robotic equipment to be

used in knee procedures.

iana Leeice President - Senior Credit Officer

[email protected]
https://www.moodys.com/credit-ratings/Stryker-Corporation-credit-rating-600045716https://www.moodys.com/credit-ratings/Stryker-Corporation-credit-rating-600045716https://www.moodys.com/credit-ratings/Stryker-Corporation-credit-rating-600045716https://www.moodys.com/credit-ratings/Johnson-Johnson-credit-rating-426225https://www.moodys.com/credit-ratings/Johnson-Johnson-credit-rating-426225https://www.moodys.com/credit-ratings/Johnson-Johnson-credit-rating-426225https://www.moodys.com/credit-ratings/Zimmer-Holdings-Inc-credit-rating-600060409https://www.moodys.com/credit-ratings/Zimmer-Holdings-Inc-credit-rating-600060409https://www.moodys.com/credit-ratings/Zimmer-Holdings-Inc-credit-rating-600060409https://www.moodys.com/credit-ratings/Biomet-Inc-credit-rating-820223230https://www.moodys.com/credit-ratings/Biomet-Inc-credit-rating-820223230https://www.moodys.com/credit-ratings/Biomet-Inc-credit-rating-820223230https://www.moodys.com/credit-ratings/Zimmer-Holdings-Inc-credit-rating-600060409https://www.moodys.com/credit-ratings/Johnson-Johnson-credit-rating-426225https://www.moodys.com/credit-ratings/Stryker-Corporation-credit-rating-600045716


13/48



Labcos Sale of Its German Subsidiary to Sonic Is Credit Positive

Last Thursday,Labco S.A.(B2 stable), a leading medical diagnostics company, announced the sale of its

German subsidiary to Sonic Healthcare Limited (unrated) for 76 million. The disposal is credit positive

for Labco because its liquidity will improve, allowing the company to focus on core markets.

Sonic is paying a multiple of more than 10.0x the subsidiarys EBITDA contribution for the 12 months

ended 30 June 2013, increasing Labcos cash reserves by around 70 million (after accounting for debt

within the division). Pro forma for the transaction, the disposal will increase Labcos cash to around 170

million as of 30 June, versus 67 million a year earlier.

Although the deal will improve liquidity, how the company will use the cash is unclear. If Labco uses the

funds to pay down debt, then we expect debt/EBITDA would decline to less than 5.5x, as adjusted by us.

On or after January 2014, Labco can redeem bonds, which currently trade at around 106, at 106.375%.

Historically, Labco has pursued a buy-and-build strategy, spending 44 million on acquisitions in 2012 and

93 million in 2011. Given its active acquisition strategy, we expect the positive effect on liquidity from

sale proceeds will be short lived. Nevertheless, the cash will give the company additional ability to maintain

its growth strategy in core markets.

By selling its German subsidiary, Labco is disposing of a non-core asset that contributed revenue of 54

million in 2012, or around 9% of Labcos group revenue. Earnings did not benefit from economies of scale

because Labco was a relatively small player in Germany. The sale will allow Labco to focus attention on

markets where its leadership offers better margins, such as France, which accounted for 53% of 2012 sales,

and Spain and Portugal, which accounted for 26%. Labcos German operations will be of greater strategic

importance to Sonic, which is already a major player in Germany.

The German division suffered from large impairment write-downs, including a 36 million impairment

charge in 2012 to take into account lower German quotas for Labco testing services and the consequences

of alleged fraudulent activities in the divisions laboratory in Dillenburg, Germany by its previous owners.

Based in Paris, Labco has a pan-European network of medical laboratories and collection points that

provides routine and semi-routine clinical testing services for individual patients. For the six months to 30

June, France accounted for 54% of Labcos revenues; Spain and Portugal 26%; Germany 9%; Italy 6% and

Belgium 5%. The company also has a foothold in the UK through its joint venture with Sodexo.

The companies expect to complete the transaction, which is subject to antitrust approval and other usual

closing conditions, by the end of this year.

imon Westssociate Analyst

[email protected]
https://www.moodys.com/credit-ratings/Labco-SA-credit-rating-822310467https://www.moodys.com/credit-ratings/Labco-SA-credit-rating-822310467https://www.moodys.com/credit-ratings/Labco-SA-credit-rating-822310467https://www.moodys.com/credit-ratings/Labco-SA-credit-rating-822310467


14/48



Infrastructure

NorthWestern Corp. Purchase of Hydro Assets Is Credit Positive

Last Thursday,NorthWestern Corporation(NWE, Baa1 stable) announced an agreement with

PPL Montana LLC(Baa3 negative) to acquire 633 megawatts (MWs) of PPL Montanas hydroelectric

generation portfolio for approximately $900 million. The company plans to finance the acquisition with a

credit neutral combination of debt and equity, targeting to maintain its current capital structure of around

50%-55% debt to total capitalization. The acquisition, if approved by the Montana Public Service

Commission (MPSC), is credit positive for NWE, whose size and scale will increase with low-cost and

environmentally favorable power-generation assets.

NWEs owned-generation assets will increase by 80%, while the rate base will increase by nearly 50%.

NWE will acquire 11 hydroelectric facilities with a capacity of 633 MWs along five different rivers in

Montana. These assets were originally part of the integrated electric system that includes NWEs

transmission and distribution assets, making them a strategic fit from both an operational and geographicalperspective. NWEs operations will benefit from greater supply and fuel diversity as it incorporates 633

MW of low-cost baseload power, while reducing the companys exposure to potentially volatile fuel and

market power prices. The exhibits below show the change in NWEs supply sources.

The acquisitions financing includes a $900 million bridge loan facility with permanent financing expected

to target NWEs regulatory allowed capital structure of 52% debt and 48% equity. Given the timing and

effect of debt coming on balance sheet, prior to the cash flow contribution of the hydro assets, we expect a

near-term decline in key financial metrics. For example, we expect NWEs cash flow from operations pre-

working capital to debt to measure around 13% for year-end 2014, rather than near the 20% that we had

expected. However, once a full years worth of cash flow contribution begins to evidence itself, we believe

that NWE's financial metrics will again be within a range more appropriate for a Baa1-rated utility.

Hydro generation, which has no chemical emissions, will also benefit NWE over the long term because it

reduces the companys exposure to stringent and costly environmental mandates on chemical emissions.

The company expects the acquisition to close upon regulatory approval, which it expects in the second half

of 2014.

yan Wobbrockssistant Vice President

[email protected]
https://www.moodys.com/credit-ratings/NorthWestern-Corporation-credit-rating-807878251https://www.moodys.com/credit-ratings/NorthWestern-Corporation-credit-rating-807878251https://www.moodys.com/credit-ratings/NorthWestern-Corporation-credit-rating-807878251https://www.moodys.com/credit-ratings/PPL-Montana-LLC-credit-rating-600054328https://www.moodys.com/credit-ratings/PPL-Montana-LLC-credit-rating-600054328https://www.moodys.com/credit-ratings/PPL-Montana-LLC-credit-rating-600054328https://www.moodys.com/credit-ratings/NorthWestern-Corporation-credit-rating-807878251


15/48



UK Opposition Labour Party Pledge to Freeze Energy Tariffs Is Credit Negative forUtilities

On 24 September, the leader of the UK opposition Labour Party, Ed Miliband, promised to freeze gas and

electricity tariffs until 2017, if elected prime minister at the next general election. A tariff freeze would be

credit negative for all utilities with UK supply exposure, particularlyCentrica plc(A3 stable) andSSE plc

(A3 stable), two of the largest energy retailers, and also for the UK subsidiaries ofIberdrola S.A.(Baa1

negative),Electricite de France(Aa3 negative),RWE AG(Baa1 stable) andE.ON SE(A3, negative). Mr.

Miliband estimates the negative effect of the freeze would be 4.5 billion for the sector, which seems

reasonable as industry consensus is for costs to rise from current levels.

Mr. Milibands policy would necessitate legislation to introduce temporary price controls that would

prevent energy suppliers from increasing their tariffs for 20 months from the date of the next election,

scheduled for May 2015. A YouGov opinion poll published last Wednesday showed the Labour Party with

a nine percentage point lead over the ruling Conservatives. If Labour maintains its advantage in the polls, it

will likely lead to it forming a majority in the House of Commons post-election, increasing the probability

of the tariff freeze being passed.

Capping electricity and gas tariffs would be credit negative for UK energy suppliers, which would be unable

to raise prices if their costs increase as we expect. According to the energy regulator, the Office of Gas and

Electricity Markets (Ofgem), the average domestic energy bill in the UK currently stands at 1,420 per

customer per annum (based on standard consumption), an increase of 30% since 2010. However, this has

been driven by both a 30% increase in wholesale electricity and gas costs, which account for 44% of the

final tariff , and a 31% increase in other costs, such as transportation charges and environmental schemes

(e.g., renewable subsidies), which together account for around 40% of the end-user tariff, as seen in the

exhibit below. In contrast, the percentage attributable to net margin only amounts to around 6%-7% of the

end-user bill.

Components of the Average Annual UK Domestic Energy Bill

Source: Ofgem

Given that network charges and renewable subsidies increase annually with inflation, the cost base of

suppliers is expected to rise accordingly, and with tariff caps in place, profit margins will quickly erode. Last

April, Ofgem published a report showing that the total revenue of the UK supply industry (domestic and

non-domestic) is around 40 billion and that companies margin is 3.1%, equivalent to around 1.2 billion

of profit per annum. If Labours forecast for a 4.5 billion hit is accurate, the effect of this tariff freeze

would likely make UK energy supply a loss-making activity.

-200

0

200

400

600

800

1,000

1,200

1,400

1,600

2006 2007 2008 2009 2010 2011 2012 2013

Net P ro fit Wh olesale Co sts Netwo rk Ch arges / O th er Co sts O per ating Co sts

elen Francisice President - Senior Credit Officer

[email protected]

cott Phillipsice President - Senior Analyst

[email protected]
https://www.moodys.com/credit-ratings/Centrica-plc-credit-rating-600046924https://www.moodys.com/credit-ratings/Centrica-plc-credit-rating-600046924https://www.moodys.com/credit-ratings/Centrica-plc-credit-rating-600046924https://www.moodys.com/credit-ratings/SSE-plc-credit-rating-18030https://www.moodys.com/credit-ratings/SSE-plc-credit-rating-18030https://www.moodys.com/credit-ratings/SSE-plc-credit-rating-18030https://www.moodys.com/credit-ratings/Iberdrola-SA-credit-rating-425000https://www.moodys.com/credit-ratings/Iberdrola-SA-credit-rating-425000https://www.moodys.com/credit-ratings/Iberdrola-SA-credit-rating-425000https://www.moodys.com/credit-ratings/Electricite-de-France-credit-rating-260000https://www.moodys.com/credit-ratings/Electricite-de-France-credit-rating-260000https://www.moodys.com/credit-ratings/Electricite-de-France-credit-rating-260000https://www.moodys.com/credit-ratings/RWE-AG-credit-rating-635550https://www.moodys.com/credit-ratings/RWE-AG-credit-rating-635550https://www.moodys.com/credit-ratings/RWE-AG-credit-rating-635550https://www.moodys.com/credit-ratings/EON-SE-credit-rating-600010489https://www.moodys.com/credit-ratings/EON-SE-credit-rating-600010489https://www.moodys.com/credit-ratings/EON-SE-credit-rating-600010489https://www.moodys.com/credit-ratings/EON-SE-credit-rating-600010489https://www.moodys.com/credit-ratings/RWE-AG-credit-rating-635550https://www.moodys.com/credit-ratings/Electricite-de-France-credit-rating-260000https://www.moodys.com/credit-ratings/Iberdrola-SA-credit-rating-425000https://www.moodys.com/credit-ratings/SSE-plc-credit-rating-18030https://www.moodys.com/credit-ratings/Centrica-plc-credit-rating-600046924


16/48



In our view, there is also a broader credit negative effect for the whole of the UK utilities sector following

Labours announcement. For a liberalised and established energy market such as the UK, such high-level

political interference is unexpected, and investors may well require higher returns going forward, leading to

an increase in the sectors overall cost of debt. The announcement also comes as the current government is

attempting to pass legislation to incentivise investment in low-carbon technologies, which may now benegatively affected.


17/48



Recent Deleveraging Announcements Are Credit Positive for Enel

Last Wednesday, the large and diversified Italian power group,Enel S.p.A.(Baa2 negative) announced both

the 1.33 billion disposal of its stake in Russian Severenergia (unrated) and the completion of the third of

three recent hybrid issuances totalling approximately 2.65 billion. These measures are credit positive for

Enel and help the company meet its strategic goals, announced in March, to reduce net debt by 5 billion

to 37 billion by the end of 2014 and to improve its capital structure through the issuance of 5 billion of

hybrid capital instruments by 2015.

Enels agreement to sell its stake in Russian Severenergia, an upstream gas company, to Rosneft will produce

proceeds of $1.8 billion (1.33 billion). The deal is subject to applicable antitrust clearance. This is Enels

largest disposal announced to date, adding to divestments agreed upon earlier in 2013 worth 304 million

for its Belgian and Spanish assets. So far this year, disposals have totaled 1.63 billion out of Enels planned

6 billion worth of divestments, which are the main driver behind its debt-reduction plans.

Enels completion of its third hybrid issuance, a US dollar-denominated tranche of $1.25 billion (926

million), follows issuances earlier in September of 400 million (475 million) and 1.25 billion. These go

more than half way to meet Enels target of 5 billion. For accounting reasons, the hybrids will be treated as

100% debt in Enels books, and hence do not contribute to its net debt targets. Nonetheless, they improve

the companys capital structure. We treat these particular instruments as half equity, half debt in our

analysis because they are deeply subordinated to senior debt and, as such, they strengthen the position of

senior bondholders.

The combination of the recent disposals and the hybrid issuance, and after taking account of the equity

cushion they provide, give the benefit of an equivalent debt reduction of 2.9 billion under our financial

ratio calculations. On a pro-forma basis, funds from operations (FFO) to net debt of 17.9% in 2012 would

have improved to 19.0% when taking these measures into account and after including the approximately

850 million in cash the company expects from the securitisation of some Spanish regulatory receivables

also transacted during the week. This moves Enels financial profile closer to our current ratings targeted

FFO/net debt guideline of around 20% by the end of 2014.

Enels progress on asset disposals and its hybrid issuance reduce its leverage amid negative earnings pressure

in its core Italian and Spanish markets from lower electricity prices and narrower margins on gas-fired

generation and regulatory cuts in Spain, as illustrated by projected group EBITDA, which is 16 billion for

2013, down from 16.7 billion at the end of 2012.

elen Francisice President - Senior Credit Officer

[email protected]
https://www.moodys.com/credit-ratings/ENEL-SpA-credit-rating-600045247https://www.moodys.com/credit-ratings/ENEL-SpA-credit-rating-600045247https://www.moodys.com/credit-ratings/ENEL-SpA-credit-rating-600045247https://www.moodys.com/credit-ratings/ENEL-SpA-credit-rating-600045247


18/48



Banks

New York District Court Expands FIRREAs Reach to Prosecute Banks Accused of Fraud

For the third time in recent months, a New York federal district court on 24 September in United States v.

Wells Fargo Bankallowed the government to use the Financial Institutions Reform, Recovery, and

Enforcement Act of 1989 (FIRREA) not just to protect banks victimized by the fraudulent acts of third

parties, but to prosecute the banks themselves when they are damaged by their own fraudulent conduct.

This is credit negative for banks and other financial institutions facing government probes related to

mortgage and other fraud because it is easier to obtain a conviction under FIRREA than in traditional

criminal or civil fraud cases.

FIRREA was enacted in response to the US savings and loan crisis over two decades ago and authorizes the

Department of Justice (DOJ) to seek civil money penalties for violations of one or more of 14 enumerated

criminal statutes (i.e., predicate offenses) involving financial institutions and government agencies. To be

actionable under FIRREA, certain of these offenses require that the violation be one affecting a federallyinsured financial institution. FIRREA does not define the term affecting, and because the statute has

rarely been used, there were no decisions interpreting that term until recently.

Starting last April, the federal court in the Southern District of New York rendered three decisions1by three

different judges, all of which held that the affected institution could be the alleged perpetrator of the

fraud, and not necessarily a third-party victim or innocent bystander. The judges based this interpretation

on the plain language of the statute, and with the view that because Congress intent was to deter fraudulent

conduct that might put federally insured deposits at risk, FIRREA also covers banks that harm themselves

by engaging in fraudulent activity.

FIRREA gives the government a number of tactical advantages that significantly increase the likelihood of

conviction compared to traditional fraud prosecutions.

The scope of the statute is wide, thanks to the inclusion of mail and wire fraud as one of the predicateoffenses. The mail and wire fraud statutes cover virtually any fraud involving interstate mail, e-mail,telephone, faxes, or other electronic communication. FIRREA therefore gives the DOJ a civil hook toinvestigate and prosecute mortgage fraud.

Because FIRREA authorizes only civil remedies, the DOJ only has to prove that the defendant committedone of the predicate offenses by a preponderance of the evidence, and not beyond a reasonable doubt,as in a criminal case.

FIRREA is one of the few federal statutes that authorizes the DOJ to issue subpoenas in contemplation ofa civil proceeding without first obtaining court approval. The DOJ can therefore engage in extensivediscovery pre-suit.

These pre-suit investigations can last a long time and uncover numerous violations that would ordinarilybe time-barred because FIRREA has a 10-year statute of limitations, which is far longer than the typicalthree to five years applicable to civil lawsuits.

1 United States v. The Bank of New York Mellon et al., No. 11 Civ.6969 (LAK), 2013 U.S. Dist. LEXIS 58816 (S.D.N.Y. 24 April2013). United States v. Countrywide Financial Corporation et al., No. 12 Civ. 1422 (JSR), 2013 U.S. Dist. LEXIS 117140(S.D.N.Y. 16 August 2013). United States v. Wells Fargo Bank, N.A. , No. 12 Civ. 7527 (JMF), 2013 U.S. Dist. LEXIS 136539(S.D.N.Y. 24 September 2013).

eresa Wyszomierskihief Legal Officer - Financial

nstitutions Group

[email protected]


19/48



Although FIRREA does not authorize the imposition of criminal sanctions, such as imprisonment, themonetary penalties can be as high as the amount of the gain to the perpetrator or loss to the victim.

The decisions are not binding authority for federal courts outside the Southern District and are still subject

to appeal. Nevertheless, they are influential opinions, given the preeminent role of the Southern District infinancial litigation. In any case, the building momentum for expanding FIRREAs reach means greater

potential liability for banks and other federally insured institutions accused of fraud.


20/48



Brazils State-Owned Banks Will Reduce Loan Growth, a Credit Positive

Last Wednesday, Brazil President Dilma Rousseff announced that government-owned banksCaixa

Econmica Federal(CAIXA, Baa2 positive, D/ba2 stable),2Banco Nacional de Desenvolvimento

Econmico e Social(BNDES, Baa2 positive) andBanco do Brasil S.A.(A3 positive, C-/baa2 stable) will

reduce their rates of loan growth. The announcement is credit positive for these public-sector banks because

it will reduce the asset and revenue volatility caused by their aggressive loan expansion of the past four years

Ms. Rousseff noted that reducing the banks market share in lending was a necessary step for the

government to maintain its balance of the national accounts and for the country to achieve economic

stability. Since 2008, the government has relied on public-sector banks as the main agents of its

countercyclical policies to bolster credit supply and stoke domestic demand following the global financial

crisis. This approach has resulted in a sizable expansion, with the three banks lending accounting for 50.5%

of total system loans in July, compared with 33% in 2008. Moreover, each bank reported robust loan

growth compared with the privately owned banks (see exhibit), with CAIXA growing at a compound

annual rate of 44% between June 2009 and June 2013, and Banco do Brasil and BNDES each growing at

23% over the same period.

Loan Growth of Brazils Three State Banks versus Private Banks

Source: Moodys, Central Bank of Brazil

High loan growth rates have largely masked asset quality deterioration in these banks balance sheets, and

thus the governments plan to slow loan growth will lead to higher delinquencies, reflecting the seasoning of

their loan portfolios. However, we view moderation in loan origination as a positive move that will limit

future nonperforming loans and alleviate pressure on asset quality, as lower credit supply reduces the risk of

adverse selection at a time when private-sector banks are cautious about taking on risk.

Additionally, we expect the slowdown in loan origination to reduce pressure on capital, which has been

increasing lately. The combination of strong growth, large dividend payouts to the government, andrelatively high participation of lesser quality hybrid debt and capital instruments has resulted in poor quality

core capital ratios for all three banks. As of June 2013, our adjusted Tier 1 capital ratio for Banco do Brasil

was 9.55%, while that for BNDES was 9.53% and for CAIXA 6.36%.

2 The bank ratings shown in this report are the banks domestic deposit ratings, their standalone bank financial strengthratings/baseline credit assessments and the corresponding rating outlooks.

100150

200

250

300

350

400

450

500

550

Dec-08 Jun-09 Dec-09 Jun-10 Dec-10 Jun-11 Dec-11 Jun-12 Dec-12 Jun-13

LoansinDecember2008=100

Private Banks Banco do Brasil Caixa BNDES

lexandre Albuquerquessistant Vice President - Analyst

[email protected]
https://www.moodys.com/credit-ratings/Caixa-Economica-Federal-CAIXA-credit-rating-600036458https://www.moodys.com/credit-ratings/Caixa-Economica-Federal-CAIXA-credit-rating-600036458https://www.moodys.com/credit-ratings/Caixa-Economica-Federal-CAIXA-credit-rating-600036458https://www.moodys.com/credit-ratings/Caixa-Economica-Federal-CAIXA-credit-rating-600036458https://www.moodys.com/credit-ratings/Banco-Nac-Desenv-Economico-e-Social-BNDES-credit-rating-85600https://www.moodys.com/credit-ratings/Banco-Nac-Desenv-Economico-e-Social-BNDES-credit-rating-85600https://www.moodys.com/credit-ratings/Banco-Nac-Desenv-Economico-e-Social-BNDES-credit-rating-85600https://www.moodys.com/credit-ratings/Banco-Nac-Desenv-Economico-e-Social-BNDES-credit-rating-85600https://www.moodys.com/credit-ratings/Banco-do-Brasil-SA-credit-rating-85560https://www.moodys.com/credit-ratings/Banco-do-Brasil-SA-credit-rating-85560https://www.moodys.com/credit-ratings/Banco-do-Brasil-SA-credit-rating-85560https://www.moodys.com/credit-ratings/Caixa-Economica-Federal-CAIXA-credit-rating-600036458mailto:[email protected]:[email protected]://www.moodys.com/credit-ratings/Banco-do-Brasil-SA-credit-rating-85560https://www.moodys.com/credit-ratings/Banco-Nac-Desenv-Economico-e-Social-BNDES-credit-rating-85600https://www.moodys.com/credit-ratings/Banco-Nac-Desenv-Economico-e-Social-BNDES-credit-rating-85600https://www.moodys.com/credit-ratings/Caixa-Economica-Federal-CAIXA-credit-rating-600036458https://www.moodys.com/credit-ratings/Caixa-Economica-Federal-CAIXA-credit-rating-600036458


21/48



That the robust expansion of the public-sector banks has been largely funded by the government itself has

not helped its fiscal position, and has contributed to the increase in gross government debt relative to GDP.

We forecast the ratio will reach 59.7% by the end of 2013, compared to 53.4% in 2010.

However, the governments announcement provides no guidance about a proposed timeframe or targetmarket share that the public banks should aim to achieve. Brazils economic recovery has been modest, and

we anticipate below-trend GDP expansion in 2014.

The government also faces the challenge of reconciling its talk of reducing the public-sector banks market

share with its proposed agenda of infrastructure investments totaling around BRL552 billion ($240 billion)

at a time when participation by the private sector remains weak. Therefore, we view the execution of this

plan as critical and challenging, particularly as we approach an election on 5 October 2014 for the president

and National Congress.


22/48



Bundesbank Study Will Prompt Large German Banks to Continue Boosting TheirCapital

Last Wednesday, the German Bundesbank released a study showing that Germanys leading banks continue

to lag their European peers in complying with Basel IIIs stricter capital ratios. The findings are credit

positive for large German banks creditors because it will prompt the banks to continue boosting their

capital under the new Basel III criteria to satisfy regulators and catch up with their international peers.

According to the study, Germanys seven largest banks, the so-called Group 1 banks,3had an average fully

phased-in Common Equity Tier 1 (CET1) ratio of 7.0% at the end of 2012, well shy of the 8.4% average

for large banks in the European Union (EU) (see Exhibit 1). Although the studys findings do not suggest

German banks are more vulnerable to market shocks the banks Tier 1 capital ratios under Basel II rules

compare well with their international peers they do point to the banks needing more capital. Germanys

largest banks also display considerably lower absolute (or non-risk weighted) capitalisation, as illustrated by

their lower leverage ratio (CET1 capital as percentage of total exposure) relative to the average for the largest

EU banks. Moreover, market participants are increasingly expecting banks to report capital buffers in excess

of the Basel III 7% minimum and typically demand above-average bond yields from institutions with

weaker capitalisation levels.

EXHIBIT 1

Results from the Bundesbanks Basel III Study on Germanys Group 1 Banks

Note: Data as of year-end 2012

Source: Deutsche Bundesbank

Although the average CET1 ratio for the seven large banks was 7%, not all seven banks are in compliance

with Basel III regulatory minimum. The study highlights that at the end of 2012 the banks collectively

would have needed 14 billion of common equity for all seven to comply with the 7% minimum.

Positively, the Bundesbank data illustrate that German banks have made significant progress in boostingtheir capital, and we expect that trend to continue over the next few quarters. According to the Bundesbank

3 Group 1 banks have at least 3 billion of Tier 1 capital and international banking activities. They include:Deutsche Bank AG(A2stable, C-/baa2 stable),Commerzbank AG(Baa1 stable, D+/ba1 stable),DZ Bank AG(A1 stable, C-/baa2 stable),UniCredit Bank

AG(A3 negative, C-/baa2 negative),Landesbank Baden-Wuerttemberg(A3 stable, D+/ba1 stable),Bayerische Landesbank(Baastable, D-/ba3 stable) andNorddeutsche Landesbank GZ(A3 negative, D/ba2 negative). The bank ratings shown in this report arethe banks deposit ratings, their standalone bank financial strength ratings/baseline credit assessments and the corresponding ratingoutlooks.

7.0%

9.5%

1.9%

8.4%

9.6%

2.9%

0%

2%

4%

6%

8%

10%

Core Equity Tier 1 Total Capital Ratio Leverage Ratio

German Banks European Union Banks

atharina Bartenice President - Senior Credit Officer

[email protected]

lexander Hendricks, CFAssociate Managing Director

[email protected]
https://www.moodys.com/credit-ratings/Deutsche-Bank-AG-credit-rating-232500https://www.moodys.com/credit-ratings/Deutsche-Bank-AG-credit-rating-232500https://www.moodys.com/credit-ratings/Deutsche-Bank-AG-credit-rating-232500https://www.moodys.com/credit-ratings/Commerzbank-AG-credit-rating-191950https://www.moodys.com/credit-ratings/Commerzbank-AG-credit-rating-191950https://www.moodys.com/credit-ratings/Commerzbank-AG-credit-rating-191950https://www.moodys.com/credit-ratings/DZ-BANK-AG-credit-rating-277550https://www.moodys.com/credit-ratings/DZ-BANK-AG-credit-rating-277550https://www.moodys.com/credit-ratings/DZ-BANK-AG-credit-rating-277550https://www.moodys.com/credit-ratings/UniCredit-Bank-AG-credit-rating-96025https://www.moodys.com/credit-ratings/UniCredit-Bank-AG-credit-rating-96025https://www.moodys.com/credit-ratings/UniCredit-Bank-AG-credit-rating-96025https://www.moodys.com/credit-ratings/UniCredit-Bank-AG-credit-rating-96025https://www.moodys.com/credit-ratings/Landesbank-Baden-Wuerttemberg-credit-rating-600009668https://www.moodys.com/credit-ratings/Landesbank-Baden-Wuerttemberg-credit-rating-600009668https://www.moodys.com/credit-ratings/Landesbank-Baden-Wuerttemberg-credit-rating-600009668https://www.moodys.com/credit-ratings/Bayerische-Landesbank-credit-rating-96010https://www.moodys.com/credit-ratings/Bayerische-Landesbank-credit-rating-96010https://www.moodys.com/credit-ratings/Bayerische-Landesbank-credit-rating-96010https://www.moodys.com/credit-ratings/Norddeutsche-Landesbank-GZ-credit-rating-551525https://www.moodys.com/credit-ratings/Norddeutsche-Landesbank-GZ-credit-rating-551525https://www.moodys.com/credit-ratings/Norddeutsche-Landesbank-GZ-credit-rating-551525https://www.moodys.com/credit-ratings/Norddeutsche-Landesbank-GZ-credit-rating-551525https://www.moodys.com/credit-ratings/Bayerische-Landesbank-credit-rating-96010https://www.moodys.com/credit-ratings/Landesbank-Baden-Wuerttemberg-credit-rating-600009668https://www.moodys.com/credit-ratings/UniCredit-Bank-AG-credit-rating-96025https://www.moodys.com/credit-ratings/UniCredit-Bank-AG-credit-rating-96025https://www.moodys.com/credit-ratings/DZ-BANK-AG-credit-rating-277550https://www.moodys.com/credit-ratings/Commerzbank-AG-credit-rating-191950https://www.moodys.com/credit-ratings/Deutsche-Bank-AG-credit-rating-232500


23/48


24/48



Socit De Financement Local Would Avoid Legal Risk with Amended Finance Law

Last Wednesday, the French government published the 2014 draft Finance Law, which would amend the

treatment of the effective annual percentage rate (TEG) in loan documentation. This has wide ranging

implications because the TEG applies to all bank loans to French customers. Without the amendment, the

Socit de Financement Local(SFIL, Aa2 negative) would incur a significant loss in revenues, disrupting its

loans to the sub-sovereign sector.

A specialized lender to public sector entities, SFIL inherited the bulk of French public-sector lending from

Dexia Credit Local(DCL, Baa2 negative) earlier this year. While DCL was not accused of any wrongdoing

vis--vis local governments, the court censured the bank for the way in which the TEG was referenced in --

or omitted from -- loan documentation. As a result of this decision, the rate applied to loans4(often referred

to as toxic, given their complex structure) was to be amended and replaced by the so-called legal interest

rate, which is much lower than the contractual rate on the TEG-referenced loans.

Apart from the DCL case, SFIL was concerned about the risk of contagion to its entire portfolio, which

would have had material implications on its financial situation and its ability to do business with French

sub-sovereigns. As a result, DCL appealed the legal decision and SFIL lobbied the government to have the

legal framework amended.

If the decision of the court is confirmed, it will set a precedent that eventually will involve a rate change for

many loans that SFIL inherited. Since the courts judgment on the DCL case, SFIL and DCL have seen

litigation proceedings triple to 196 and 96 cases, respectively, as of the beginning of September. The 2014

draft Finance Law submitted to the National Assembly last Wednesday includes a provision that will

eliminate the risks surrounding TEG documentation for the lenders.

Given the role assigned to SFIL by the French state as a specialized lender for regional governments and

public hospitals, the measure is also credit positive for the sub-sovereign sector as a whole. Even if the court

judgment was favorable for a minority of local governments that contracted risky loans, the legal risks for

SFIL could have had serious negative implications for its capacity to provide lending to the broader sub-

sovereign sector. If adopted, the law will certainly enable SFIL to meet its business objective of lending 3

billion to the sub-sovereign sector in 2013, and up to 5 billion going forward out of the sectors annual

financing needs of 20 billion.

4 The TEG calculation at the initiation of contracts is particularly complex for such loans. Hence, the mention of the TEG in initiadocumentations was often either omitted or slightly different from the definitive TEG.

asuko Nakamuraice President - Senior Analyst

[email protected]

ebastien Hayice President - Senior Credit Officer

[email protected]
https://www.moodys.com/credit-ratings/Societe-de-Financement-Local-credit-rating-823291494https://www.moodys.com/credit-ratings/Societe-de-Financement-Local-credit-rating-823291494https://www.moodys.com/credit-ratings/Dexia-Credit-Local-credit-rating-132050https://www.moodys.com/credit-ratings/Dexia-Credit-Local-credit-rating-132050https://www.moodys.com/credit-ratings/Dexia-Credit-Local-credit-rating-132050https://www.moodys.com/credit-ratings/Societe-de-Financement-Local-credit-rating-823291494


25/48



Insurers

ProAssurances Proposed Acquisition of Eastern Is Credit Negative

Last Tuesday,ProAssurance Corporation((P)Baa2 stable), a monoline medical professional liability (MPL)

insurer, announced that it had agreed to acquire Eastern Insurance Holdings, Inc. (unrated), a monoline

workers compensation insurer, for $205 million in cash. The proposed transaction would be credit negative

for ProAssurance because of the significant execution and integration risks associated with expanding out of

ProAssurances traditional business into workers compensation insurance, and because it would slightly

weaken several key financial measurements.

Although ProAssurances post-acquisition return on capital would improve slightly given the marginal

addition of Easterns profits, and its shareholders equity would stay about the same, most of ProAssurances

other pro forma key financial metrics would be slightly weaker (see Exhibit 1). The companys operating

leverage would rise to about 1.3x from about 1.2x, and high-risk assets would increase to about 31% of

shareholders equity from about 29%. However, the companys pro forma financial fundamentals wouldremain solid overall owing to ProAssurances strong operating profitability, conservative operational

leverage, modest financial leverage and sound reserve position.

EXHIBIT 1

Change in ProAssurances Financial Metrics Pro Forma for the Eastern AcquisitionCombined -

Pro Forma Eastern ProAssurance

Total Assets, $ millions $5,193 $381 $4,877

Shareholders' Equity, $ millions $2,271 $136 $2,271

Net Income, $ millions $286 $10 $275

Gross Premiums Written, $ millions $760 $224 $536

Net Premiums Written, $ millions $698 $170 $528

High Risk Assets as Percent of Shareholders' Equity 30.8% 36.8% 28.6%

Reinsurance Recoverables as Percent of Shareholders Equity 10.1% 14.5% 9.2%

Goodwill & Intangibles as Percent of Shareholders' Equity 13.2% 11.1% 10.5%

Gross Underwriting Leverage 1.3x 2.7x 1.2x

Return on Capital, one year 12.4% 7.8% 12.0%

Adverse/(Favorable) Development as Percent of Beginning Reserves, one year -13.0% -2.0% -13.6%

Adjusted Financial Leverage 6.2% 6.2% 5.9%

Total Leverage 6.2% 6.2% 5.9%

Earnings Coverage, one year 115.7x 30.1x 129.5xCashflow Coverage, one year 157.1x 20.2x 201.4x

Note: Information based on GAAP financial statements. Moody's estimate of pro forma key financial indicators combining ProAssurance and Eastern

2012 results.

Source: GAAP financial statements, Moodys estimates

Workers compensation is a highly specialized line of business with a number of risks. It is a long-tail line of

business whose losses are paid many years after premiums are collected. Its profitability in part depends on

generating investment income, which, in todays low interest rate environment, is a challenge. Workers

asper Coopernalyst

[email protected]
https://www.moodys.com/credit-ratings/ProAssurance-Corporation-credit-rating-822347983https://www.moodys.com/credit-ratings/ProAssurance-Corporation-credit-rating-822347983https://www.moodys.com/credit-ratings/ProAssurance-Corporation-credit-rating-822347983https://www.moodys.com/credit-ratings/ProAssurance-Corporation-credit-rating-822347983


26/48



compensation insurers are also subject to higher losses if there is an uptick in medical inflation or fraud, and

the lines pricing and profitability have historically been volatile.

Partially mitigating ProAssurances execution risks is an agreement that Easterns management team will

stay on following the acquisition. In addition, ProAssurances MPL line of business faces many of the samerisks as workers compensation insurance: both lines are long-tail, historically volatile, and require

disciplined underwriting and claims-adjusting operations. However, both lines are also different enough

that knowledge of one market does not necessarily apply to the other.

The profitability of workers compensation insurers has been negatively pressure in recent years as a result of

a competitive underwriting environment and low interest rates, although it has steadily improved since

2011 owing to cumulative rate increases and moderate loss-cost trends. Industry combined ratios (the ratio

of losses and expenses paid to premiums earned) fell to about 107.5% for the 2012 accident year from

about 118% in 20105(see Exhibit 2), but are still unprofitable in the current low interest rate environment.

EXHIBIT 2

Industry Workers Compensation Accident Year Combined Ratio and Net Premium Earned

Source: SNL Financial LC and Moodys. Contains copyrighted and trade secret materials distributed under license from SNL, for recipients use only.

ProAssurance generates the majority of its business from individual physician practices and small doctor

groups, with a smaller share of premiums written on larger medical facilities. As larger medical facilities have

acquired individual physicians and small group practices, ProAssurance and others have lost market share

(excluding acquisitions). Acquiring Eastern would broaden ProAssurances capabilities for offering multiple

products to these larger medical facilities. However, one challenge in executing this strategy could be the

relatively low degree of geographic overlap, with only three states in common (Indiana, Michigan and

Delaware) being among the top 10 for both companies. About 65% of Easterns direct written premium are

in Pennsylvania, a state that accounts for less than 1% of ProAssurances premiums.

5 SeeUS P&C Insurance Pricing Generates Margin Expansion, Rate Needed In Casualty,23 August 2013.

80%

85%

90%

95%

100%

105%

110%

115%

120%

125%

$28

$29

$30

$31

$32

$33

$34

$35

$36

2009 2010 2011 2012

$Bilions

Net Premiums Earned Combined Ratio
http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_157608http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_157608http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_157608http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_157608


27/48



Global Atlantics Acquisition of Forethought Is Credit Negative for Both

Last Thursday, Global Atlantic Financial Group (unrated) announced that it would buyForethought

Financial Group, Inc.(Baa3 review for downgrade) for an undisclosed amount. The transaction is credit

negative for both parties because Forethought will be acquired by a lower credit quality insurer and because

Global Atlantic is displaying an aggressive risk appetite following several transformative or sizable

transactions. After the announcement, we reiterated our review for downgrade of Global Atlantics life

operating subsidiaries,Commonwealth Annuity and Life Insurance Co.(financial strength Baa1review for

downgrade)andFirst Allmerica Financial Life Insurance Co.(financial strength Baa1review for

downgrade), and we also put Forethoughts ratings onreview for downgrade.

The Forethought acquisition follows closely two other material transactions by Global Atlantic. In May,

Global Atlantic completed its separation fromThe Goldman Sachs Group, Inc.(A3 review for downgrade)

and in October expects to close its acquisition of Aviva USAs life insurance business from Athene Holding

Ltd. (unrated). These deals over a very short time reflect Global Atlantics aggressive risk appetite in terms

of rapid growth and consumption of capital, expansion into commodity-like higher risk annuity products,

and transaction risk.

Global Atlantic will also face financial risks by operating at lower capital levels and greater financial leverage

than it had previously. Prospective metrics will be weaker than before the acquisitions. Declining from very

strong levels, Global Atlantics metrics will be more in line with insurance industry averages over the next

year. Its pro forma financial fundamentals are adequate, but continued aggressive growth could pressure

capital, and we will have to see how the Aviva USA acquisition, which includes a large component of

universal life insurance business, plays out and affects earnings.

Forethought is a privately held life insurance-based financial services firm focused on the senior middle

market with an array of life insurance and annuity products. The company is a market leader in low-risk

pre-need insurance (whole life policies designed to cover funeral expenses upon death) and has strong

distribution relationships with funeral directors.

The combination of Forethoughts primary operating subsidiary,Forethought Life Insurance Company

(financial strength A3 review for downgrade

moody's credit outlook issuance

Documents