The Global Outlook Isnt Bad. But When Will It Be Good?

Global Chief Economist: Paul Sheard, New York (1) 212-438-6262; paul_sheard@standardandpoors.com Global Analytics: Paul A Coughlin, Executive Managing Director, New York (1) 212 512 4503; paul.coughlin@standardandpoors.com Sovereigns and International Public Finance: Curt Moulton, Managing Director, New York (1) 212-438-2064; Curt.Moulton@standardandpoors.com U.S. Public Finance Ratings: Steven J Murphy, Senior Managing Director, New York (1) 212-438-2066; steve.murphy@standardandpoors.com Corporate & Government Ratings: Jayan U Dhru, Senior Managing Director, New York (1) 212-438-7276; jayan.dhru@standardandpoors.com Financial Services Ratings: Dominic Crawley, Senior Managing Director, London (44) 20-7176-3784; dominic.crawley@standardandpoors.com

Table Of Contents
The Austerity Debate Companies Profit, But Revenues Lag Many Banks Continue To Struggle Still Waiting

WWW.STANDARDANDPOORS.COM/RATINGSDIRECT

JUNE 13, 2013 1

1144488 | 301674531

The Global Outlook Isnt Bad. But When Will It Be Good?

Five years ago, in the midst of the financial crisis, market participants and ordinary citizens alike wondered if the teetering global economy would fall off a cliff. After an edgy dance at the precipice, the question today isn't whether the economy will fall, but how soon and how much it will expand. The answer depends strongly on what part of the global economy one looks at. Standard & Poor's Rating Services expects modest growth in the world's two biggest economies, the U.S. and China, through the end of 2013 and into next year. But there is a recession in much of Europe, growth is decelerating in many emerging markets, and no one knows for sure how Japans anticipated structural reforms and expansionist monetary policy will ultimately pan out. These forecasts point to an uncertain future, with the mixed blessing of historically low interest rates, generally sluggish business revenue growth, and new regulatory initiatives taking root in America's and Europes financial sectors.

The Austerity Debate

More than just modest growth is elusive, but not at all impossible, agreed credit analysts and economists at Standard & Poor's Midyear Global Credit Outlook Roundtable discussion (see "2013 Midyear Credit Outlook: Despite Progress, Global Economies And Industries Are Still Waiting To Exhale," published June 12, 2013, on RatingsDirect). But this will involve finding the delicate balance in many nations between governments' cost-cutting austerity efforts and the expansionary monetary policy they hope will spur growth. While inflation is not a problem now, unemployment is, and further steps toward reducing it seem the way to go, especially in Europe, where joblessness, especially in the southern tier, remains dangerously high: In Spain, for instance, unemployment was a record 27.2% in April. The austerity measures instituted in the eurozone in the wake of the crisis may have outlived their usefulness. They have certainly outlived their welcome. Sovereign creditworthiness plays a part in economic growth too, and on this front, the world appears in better shape than it has been. Most recently, on June 10 Standard & Poor's revised the outlook on the U.S. sovereign to stable, from negative, while affirming the 'AA+' rating. That revision reflected, in part, Congress' successful measures to avoid the "fiscal cliff" at the end on 2012, our expectation of falling government deficits (as a share of GDP) through 2015, and the presumption that Congress and the president, their deep partisan wrangling notwithstanding, will reach an agreement on setting a new debt limit this fall. Overview The U.S. and China expect moderate economic growth in the near term, with Europe likely lagging. The Japanese government is attacking its economic doldrums with new fiscal and monetary techniques. Corporations have cut costs and are waiting for revenue growth to materialize. Interest rates are likely to remain low, and corporate debt issuance high, both in the West and in Asia.

WWW.STANDARDANDPOORS.COM/RATINGSDIRECT

JUNE 13, 2013 2

1144488 | 301674531

The Global Outlook Isnt Bad. But When Will It Be Good?

Within the U.S., states are recovering from the fiscal distress many of them suffered in the recession. State sales tax revenues have been increasing recently, though they're still below 2007 levels, while gains from higher income tax revenues could prove unsustainable. And some localities are still reeling from sharp declines in property tax revenues attributable to the real estate bust. But we are somewhat more sanguine about the future of the states with regard to their pension and other postretirement benefits. There is usually too little mention of the fact that 48 states have already taken action of some kind to address this burden, although policies affecting state employee benefits rarely occur without a political fight. States are also under pressure to reinstate services that were cut during the recession, while trying to sort out the fiscal implications of the Affordable Care Act, which will start taking a toll in 2014. Twenty-seven states have already refused to accept Medicaid funds to expand health coverage, which raises many unanswered questions about the impact on state and local budgets. Policy developments, whether fiscal, political, or monetary, have already helped sovereign creditworthiness in two emerging markets, and the benefits are likely to keep the momentum going. On March 12, 2013, Standard & Poor's revised the outlook on Mexico to positive, from stable, while affirming the 'BBB' foreign long-term credit rating, reflecting actual and anticipated structural reforms that are likely to strengthen its economy. Similarly, on May 2, 2013, we revised the ratings and outlook on the Philippines to BBB-/Stable/A-3 from BB+/Positive/B, reflecting a strengthening external profile, moderating inflation, and the government's declining reliance on foreign currency debt. We added that certain structural reforms could result in higher ratings. We affirmed our AA-/Negative/A-1+ ratings on Japan on Feb. 17, 2013, though we are closely watching developments there under Prime Minister Shinzo Abe and Bank of Japan Governor Haruhiko Kuroda to see whether fiscal and monetary can work together to boost the long-somnolent Japanese economy. The combination of structural changes and aggressive monetary policy has marked a dramatic shift from the recent past and could, if successful, boost domestic spending and reflate the economy. The risk, however, is that Japan could end up a much more heavily indebted nation.

Companies Profit, But Revenues Lag

While nations are working to boost growth, so too are businesses. The weak global economy has dampened top-line growth in many firms, which have nevertheless seen strong profits because they have assiduously fought to keep costs down. But they would see higher revenues in a stronger economy. U.S. companies, in lieu of a stronger domestic economy, are looking to overseas markets for a boost. The effect of the sequestration in the U.S., which will restrict revenue growth for some companies, has not been large overall. But the potential remains for negative ratings actions at smaller companies in the defense, health care, and tech industries. If low interest rates in a sluggish economy are depressing revenues for many companies, they are making for big increases in debt issuance. We foresee continuing growth in those markets as companies lock in cheap financing when they can. All told, there was $24 trillion in outstanding corporate debt in the U.S., the eurozone (European Economic and Monetary Union), Canada, and the U.K. at the end of 2012. And we expect that to rise, barring any significant unforeseen shocks, to $31 trillion by 2017. All told, the resurgence in debt issuance is whipping up froth in the market,

WWW.STANDARDANDPOORS.COM/RATINGSDIRECT

JUNE 13, 2013 3

1144488 | 301674531

The Global Outlook Isnt Bad. But When Will It Be Good?

though we don't see big asset bubbles forming like we've seen before in the housing or tech sectors. Outstanding debt in the West, however, could soon be surpassed by the total debt in the Asia-Pacific region, which could rise to $32 trillion on the strength of the faster-growing Asian economies. By itself, China's outstanding corporate debt could be more than that in the U.S. in only two years.

Many Banks Continue To Struggle

Many banks are still fighting to regain their footing after the recession. We see the European banks struggling, and that's likely to continue in the near term, even as Europe inches toward a unified banking system. Worldwide, about 70% of banks have stable outlooks. But of the 160 rated banks in Western Europe only about one-third have stable outlooks, and very few have positive ones. The combination of Europe's economic downturn, regulatory issues, balance sheet restructuring, and outmoded business models will make higher earnings and ratings tough to come by. Although low interest rates may make borrowing cheaper, they indicate low demand and contribute to lower bank earnings. The situation in the U.S. is somewhat better, thanks to fewer bad loans, more capital, and stronger liquidity. In addition, demand has picked up in some consumer loan categories such as education and autos. (Higher demand for auto loans has helped strengthen the sector's asset-backed securities market in the U.S.) But interest rates are still depressing bank revenues and we expect net interest margins for the larger banks to shrink between 18 and 24 basis points this year. While Standard & Poor's has had negative outlooks on several large banks we consider systemically important, subsequent to the roundtable discussion we revised the outlooks on the operating subsidiaries of Bank of New York Mellon, State Street, and Wells Fargo to stable, from negative, reflecting the June 10, 2013, outlook revision on the U.S. sovereign credit rating. We also revised the outlook on select government-sponsored entities in the U.S. to stable from negative. But it remains unclear what the role of Freddie Mac and Fannie Mae will ultimately be in the U.S. mortgage market. That is a political decision that along with certain regulatory ones, such as required levels of bank capital, the scope of allowable proprietary trading, and the final rules on orderly liquidation, could affect U.S. banks and potentially their ratings in the coming year.

Still Waiting
The good news for the outlook is that none of the worst things that could happen to wreck the global economy seem likely to happen. It appears as if the U.S. will, however messily, raise its debt limit and not default. And that the U.S. will avoid the severe fiscal tightening--even with the sequestration--that could derail its growth. Policymakers seem determined to resolve the complex sovereign debt and banking crises in the eurozone. The demand for goods and services from China seems likely to continue, though at a lower rate than previously, as the authorities there have avoided a hard landing. And the Japanese don't seem willing to abandon the new course they have charted. But if the bad things for the global economy appear unlikely, the question remains: When will the good times begin again?

WWW.STANDARDANDPOORS.COM/RATINGSDIRECT

JUNE 13, 2013 4

1144488 | 301674531

The Global Outlook Isnt Bad. But When Will It Be Good?

Writer: Robert McNatt

WWW.STANDARDANDPOORS.COM/RATINGSDIRECT

JUNE 13, 2013 5

1144488 | 301674531

Copyright 2013 by Standard & Poor's Financial Services LLC. All rights reserved. No content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor's Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an "as is" basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT'S FUNCTIONING WILL BE UNINTERRUPTED, OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages. Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P's opinions, analyses, and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw, or suspend such acknowledgement at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal, or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof. S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain nonpublic information received in connection with each analytical process. S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, www.standardandpoors.com (free of charge), and www.ratingsdirect.com and www.globalcreditportal.com (subscription) and www.spcapitaliq.com (subscription) and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at www.standardandpoors.com/usratingsfees.

WWW.STANDARDANDPOORS.COM/RATINGSDIRECT

JUNE 13, 2013 6

1144488 | 301674531