BRIEF-Fitch says 'bad bank' may push India loan clean-up
* Fitch: Bad bank may push India loan clean-up; leaves capital gap
Overview -- We no longer believe Finmeccanica SpA's credit metrics will improve markedly in 2013, even if some possible disposals are forthcoming. -- We are therefore lowering our corporate credit ratings on the company to 'BB+/B' from 'BBB-/A-3'. We are also assigning a recovery rating of '3' to the company's unsecured notes, corresponding to an issue rating of 'BB+'. -- The outlook is stable, reflecting our base-case assumption that Finmeccanica can slightly improve its operating profits in 2013. Rating Action On Jan. 18, 2013, Standard and Poor's Ratings Services lowered its long- and short-term corporate credit ratings on Italy-based aerospace and defense group Finmeccanica SpA to 'BB+/B' from 'BBB-/A-3'. The outlook is stable. At the same time, we assigned a recovery rating of '3' to Finmeccanica's unsecured notes, indicating Standard & Poor's expectation of meaningful (50%-70%) recovery in the event of a payment default. This corresponds to an issue rating of 'BB+' for the unsecured notes, in line with the corporate credit rating on the group. Rationale The downgrade reflects our base-case assumption that Finmeccanica is unlikely to achieve a financial risk profile in line with a 'BBB-' rating in the near term. The previous rating was underpinned by our expectation that Finmeccanica would be able to improve its credit metrics through disposal proceeds of at least EUR1.0 billion in 2012. This would have resulted in stronger credit ratios, such as funds from operations (FFO) to debt of 25% by year-end 2012. However, Finmeccanica has not achieved this ratio, which we would have viewed as commensurate with a 'BBB-' rating, owing to ongoing delays in planned disposals. Our rating action factors in the operational improvements reported in 2012 in some of Finmeccanica's business lines and the likely benefits of the company's continued efficiency programs in 2013 and beyond. We believe that operating profits and cash generation in 2012 were in line with our expectations. In 2012, however, Finmeccanica only completed the sale of its 14% stake in Avio, generating proceeds of EUR260 million. This was insufficient to achieve a marked improvement in its financial risk profile. Finmeccanica's financial ratios have been weak for the rating for some time. For example, we estimate FFO to debt for 2012 to have been about 20%, which is below our indicative ratio of 25%. We estimate fully adjusted debt to EBITDA to have been about 4.0x at year-end 2012, which is also at the lower end of the range we consider commensurate with a "significant" financial risk profile. In 2013, we anticipate that credit ratios such as FFO to debt or debt to EBITDA are unlikely to improve markedly. Although the full disposal of Finmeccancia's stake in Ansaldo Energia that could yield proceeds of EUR400 million-EUR500 million would be a positive, it would still leave the company's financial risk profile in the "significant" category, according to our criteria, with no positive rating implications. Given continuing uncertainty regarding the company's disposal decisions and their timing, we are now less confident that Finmeccanica will be able to carry out disposals as it previously planned. We will therefore include the proceeds of any such disposals in our base-case calculation of credit ratios once any transactions are closed. We believe Finmeccanica was able to achieve its public financial guidance for 2012. We estimate that revenues for 2012 will be EUR16.9 billion-EUR17.3 billion, EBITA about EUR1.1 billion, and free operating cash flow (FOCF) minimally positive. Our base-case for 2013 incorporates a mild improvement in operating profits on the back of a flat sales development. We expect that defense procurement spending in Italy will increase moderately and stay flat in the U.K. in 2013, limiting growth opportunities. We think that Finmeccanica can achieve FOCF of about EUR0.2 billion-EUR0.3 billion in 2013. This is supported by the existing order backlog of EUR44.7 billion of as of Sept. 30, 2012, and our belief that efficiency measures initiated in 2011 will continue to bear fruit. However, in view of Finmeccanica's fully adjusted debt of about EUR5.8 billion expected at year-end 2012, we view a FOCF of EUR0.2 billion-EUR0.3 billion as insufficient to allow for any marked deleveraging. We continue to classify Finmeccanica's business risk profile as "satisfactory" under our criteria. This is supported by our view of the group's diverse positions in the European aerospace and defense industry and favorable business mix, which is skewed toward predictable military activities. The business risk is constrained, however, by some reliance of the group on its domestic Italian military market, moderate profitability compared with peers in the industry, and the weak business positions of its noncore activities, notably its transportation division. Our management and governance score on Finmeccanica is "satisfactory" according to our criteria. Liquidity We assess Finmeccanica's liquidity as "strong," as defined in our criteria, and calculate that liquidity sources will exceed needs by more than 2x over the next 24-36 months. This is mainly because Finmeccanica's average debt maturity is about 10 years. Sources of liquidity include: -- Surplus cash of about EUR0.7 billion as of Sept. 30, 2012. This is reported cash of EUR1.1 billion, less EUR0.4 billion that we consider to be tied to operations. The cash balance in September is at its seasonally lowest point. As is usual in the defense industry, the majority of free cash flow is generated in the second part of the year. Therefore, we expect Finmeccanica's cash balance at year-end 2012 will be significantly higher than at end-September. -- A EUR2.4 billion revolving credit facility (RCF) maturing in September 2015. To our knowledge, this RCF does not contain financial covenants. As of Sept. 30, 2012, EUR930 million of this RCF was used. We believe that Finmeccanica generated significant FOCF in the fourth quarter of fiscal 2012. We therefore expect the RCF to be undrawn again at year-end 2012. In our liquidity analysis, we disregard uncommitted lines amounting to EUR0.6 billion as of Sept. 30, 2012. Finmeccanica's financial maturities over the next 36 months are: -- Debt of about EUR800 million due in 2013. This primarily relates to the EUR750 million due in December 2013. This is the remaining outstanding amount of a bond with a face value of EUR1.0 billion at issuance, after deducting EUR250 million of face value that Finmeccanica bought back in the market. In November 2012, Finmeccanica placed a five-year EUR600 million bond, the proceeds of which will be used to refinance the EUR803 million due in December 2013. -- Debt of EUR46 million due in 2014. -- Debt of EUR46 million due in 2014. For 2013, we anticipate that FOCF will be positive by EUR0.2 billion-EUR0.3 billion. Because Finmeccanica suspended dividend payments, we likewise anticipate a positive discretionary cash flow in 2013. Therefore, we believe that cash flows from ongoing operations will not affect Finmeccanica's liquidity in 2013. Recovery analysis The recovery rating (which is based on Standard & Poor's assumptions and calculations) on the existing unsecured notes issued by Finmeccanica SpA and its 100% owned finance subsidiaries Finmeccanica Finance S.A. and Meccanica Holdings USA Inc. is '3', indicating Standard & Poor's expectation of meaningful (50%-70%) recovery in the event of a payment default. This corresponds to an issue rating of 'BB+' for the unsecured notes, in line with the corporate credit rating on the group. The recovery rating is supported by the group's significant asset valuation and its strong position as a supplier to the Italian and U.K. defense markets. At the same time, the recovery rating is constrained at '3' by the group's significant debt outstanding at our simulated point of default, the notes' weak documentation, and Italy's insolvency regime, which we view as a less creditor-friendly jurisdiction than those of other countries in the region. The capital structure includes an unsecured RCF of EUR2.4 billion due 2015 and EUR500 million of unsecured European Investment Bank (EIB) loans due 2022 borrowed by Finmeccanica, debt at various subsidiaries of about EUR400 million, and unsecured notes of an amount equivalent to EUR3.6 billion. The company provides guarantees of an amount of EUR21 billion to its clients. We understand that these guarantees are primarily made up of parent company guarantees issued in favor of clients, commercial counter guarantees issued in favor of banks, and sureties against their guarantees issued in favor of clients. We believe that from all these guarantees, those most at risk of a call on the company at default would be progress payment bonds of about EUR4 billion. We have therefore included them in the waterfall. We have excluded the debt and valuation of the joint ventures from our analysis. Finmeccanica and Finmeccanica Finance S.A. have issued notes amounting to about EUR3.6 billion under the existing EUR3.8 billion euro medium-term note (EMTN) program. Meccanica Holdings USA Inc. has issued notes of about EUR1.0 billion outside the EMTN program. The EMTN notes' documentation and the documentation for the bonds issued by Meccanica Holdings is weak. The notes are unsecured, benefit from a guarantee from the parent company Finmeccanica, and do not contain any incurrence covenants. Nonpayment of debt borrowed by the finance subsidiaries or any material subsidiary for an amount exceeding EUR25 million would trigger a cross-default. Given the absence of any maintenance or incurrence covenants, securities, or guarantees, we view the RCF documentation as weak. The documentation includes restrictions on provisions of security to tradable debt and we understand that bank loans are not included in the definition of negative pledge in the documentation. Furthermore, the documentation includes provisions for additional debt with a carve-out for debt in respect of guarantees to third parties, debt raised by finance subsidiaries, and any other debt not exceeding 50% of the total net worth of Finmeccanica. To calculate recoveries, Standard & Poor's simulates a hypothetical default scenario, which, in the case of Finmeccanica, would be caused by a prolonged economic slowdown paired with an inability to raise additional debt in a stressed capital market. We assume that the primary insolvency proceedings would occur in Italy. We have relied on the EBITDA multiple approach and discrete asset valuation approach to calculate the stressed enterprise value of Finmeccanica. We believe the group would reorganize as a going concern because it has, in our view, a sustainable business and strong position as supplier of defense products. We have applied a stressed EBITDA multiple of 6x to the stressed EBITDA, resulting in a stressed enterprise value of about EUR7.0 billion (excluding joint ventures) at our hypothetical point of default in 2018. We have assumed that debt maturing prior to 2018 is refinanced under similar terms, and that all facilities are fully drawn at the point of default. To calculate recoveries, we deduct priority liabilities of about EUR1.2 billion, comprising enforcement costs, 50% of the present value of net pension liabilities, part of the factoring amounts, and debt at subsidiaries' level. This gives us a net stressed enterprise value of about EUR5.4 billion for the pari passu-ranking unsecured debt. This includes the unsecured notes, the unsecured RCF, outstanding EIB loan in the hypothetical default year, and progress payment bonds. This leads to our expectation of recovery prospects in the 50%-70% range for the notes, and a recovery rating of '3'. Outlook The stable outlook reflects our view that Finmeccanica can slightly improve its operating profits on the back of flat sales in 2013. Under our base case, we believe the company will generate FOCF of about EUR0.2 billion-EUR0.3 billion in 2013 and, consequently, we expect credit metrics to improve mildly in 2013. We would view an adjusted FFO-to-debt ratio in the range of 20%-25% and positive FOCF generation as commensurate with the current rating. We could consider a positive outlook or rating action on Finmeccanica if it reduces its sizable fully adjusted debt. We would be unlikely to revise the outlook as a result of higher cash generated from ongoing operations because of the limited discretionary cash flow it generates relative to its sizable fully adjusted debt. In view of the slow execution of asset disposals, we will include proceeds from such disposals in our calculation of financial credit metrics once the transactions are closed. We would view an improvement in Finmeccanica's adjusted FFO-to-debt ratio toward 30% as indicative of a possible positive rating or outlook action. If the company is able to close the sale of Ansaldo Energia, it would strengthen its financial risk profile but not necessarily lead to positive rating action. This is because we think that upon a potential closing of any such transaction, the resulting credit metrics such as FFO-to-debt would remain around 25%. We could take a negative rating action if FFO to debt fell toward 15% and debt to EBITDA dropped to about 4.5x. This is because these credit ratios would be indicative of an "aggressive" financial risk profile. Ratings List Downgraded; CreditWatch/Outlook Action To From Finmeccanica SpA Corporate Credit Rating BB+/Stable/B BBB-/Negative/A-3 Senior Unsecured BB+ BBB- Recovery Rating 3 NR Finmeccanica Finance S.A. Meccanica Holdings USA Inc. Senior Unsecured* BB+ BBB- Recovery Rating 3 NR *Guaranteed by Finmeccanica SpA.
* Fitch: Bad bank may push India loan clean-up; leaves capital gap
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