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Rating Action:

Moody's downgrades 12 Japanese regional/local governments to Aa3 following sovereign downgrade

 The document has been translated in other languages

Global Credit Research - 24 Aug 2011

Tokyo, August 24, 2011 -- Moody's Japan K.K. today downgraded the ratings on 12 regional and local governments (RLGs) in Japan to Aa3 with a stable outlook from Aa2.

The rating action follows Moody's decision to downgrade the Japanese Government Bond (JGB) rating to Aa3 with a stable outlook from Aa2.

Today's rating actions conclude the review for downgrade initiated in May 2011.

The 12 RLGs are:

Fukuoka City

Fukuoka Prefecture

Hamamatsu City

Hiroshima Prefecture

Kyoto, City of

Nagoya, City of

Niigata Prefecture

Osaka City Government

Sakai City

Sapporo, City of

Shizuoka City

Shizuoka Prefecture

Rating Rationale

The downgrade reflects Moody's view that RLGs are closely tied to the Japanese central government as a result of the nature of the country's public sector system, which is highly integrated, and Japan's historical tradition of risk socialization.

These features indicate there should be no distinction between the JGB rating and RLG ratings. Therefore, a downgrade of the JGB rating will inevitably result in a downgrade of the RLG ratings.

RLGs are closely linked to the central government due to Japan's highly developed institutional framework for local governments, which includes effective monitoring of all RLG activities, a system of fiscal transfers that aims to reduce disparities among RLGs and ensure a national minimum level of services, and strong policies providing ongoing support for financially weak RLGs.

The considerable level of oversight and supervision of RLGs exercised by the central government ensures that any credit issues at the RLG level are uncovered and addressed early.

A well-developed equalization system of transfers, or the Local Allocation Tax (LAT) system, makes certain that if any individual entity begins to experience fiscal difficulties related to declines in own source revenues, it will receive offsetting increases in LAT transfers.

Under this program, it is unlikely that any RLG's overall income would fall to a level that would require emergency assistance.

Finally, the probability of extraordinary support—in the unlikely event that a RLG experienced a liquidity crisis—is at the highest level, reflecting again the very tight oversight mechanisms and the perceived risk to Japan's reputation, should a regional or local government default.

In the wake of the global economic crisis and the March 11 earthquake, the central government's provision of significant assistance to RLGs -- including larger LAT transfers, the provision of government funds to underwrite RLGs' new debt at low interest rates, and other subsidies -- is clear evidence of the highly supportive government policy framework for RLGs.

As a consequence of the importance of the Japanese government's role as the ultimate supporter of RLGs, as well as its powers to unilaterally modify intergovernmental arrangements and intervene in a local government's operations, it is Moody's view that the rating of any RLG cannot be higher than that of the sovereign bond rating.

Therefore, as indicated, a downgrade in the JGB rating results in a downgrade of the RLG ratings.

Moody's also downgraded the standalone credit quality (or baseline credit assessment or BCA) of all RLGs by one notch to reflect a less supportive operating environment and a potential for lower transfers, both of which could affect the financial performance of local governments. Those BCAs that were formerly 4 (Aa3) have been revised to 5 (A1), and those that were previously 5 (A1) have been revised to 6 (A2).

This BCA downgrade reflects our view that the key determinants of the standalone quality of RLGs — that is the operating environment, which is largely determined by national macro-economic conditions, and the institutional framework, which determines the powers and responsibilities of local governments within a country — while remaining strong in Japan compared to its international peers, have weakened with respect to their historical position. This trend is reflected in Japan's downgrade to Aa3.

Principally, the less supportive macro-economic conditions that have persisted in Japan in the wake of the global financial crisis, earthquake and nuclear accident have correspondingly dampened the short-term economic prospects for all RLGs in the country.

The resultant slowdown in local tax revenues and expected upward pressures on social spending over the medium term are likely to challenge RLG budget operations, bringing them closer to requiring additional assistance from the central government.

In addition, while we do not foresee any substantial reduction in the supportive institutional framework, there are clear pressures to reform and potentially reduce the high level of transfers to RLGs, given the government's own substantial fiscal challenges and high debt burden. A potentially less generous funding framework would similarly increase pressure on RLGs' financial operations.

With regard to individual characteristics that determine the standalone BCAs -- such as debt, financial performance and governance -- Moody's notes that these features have not deteriorated to the same extent, largely due to significant additional assistance provided by the central government subsequent to the global financial crisis and March 11 earthquake.

WHAT COULD CHANGE THE RATING

Given the strong linkages between the sovereign and Japanese RLGs, Moody's would likely downgrade the RLGs further if the sovereign rating were downgraded again. Furthermore, any policy changes that would result in a weakening of the highly centralized system, with its high level of oversight and supervision, would apply downward pressure on the ratings. However, recent history suggests that policy changes of this direction are highly unlikely.

Conditions that would lead to a sovereign rating upgrade would also likely lead to an upgrade of the Japanese RLG ratings. This is because we assign -- as indicated -- an extremely high probability of extraordinary support, such as liquidity assistance, from the central government, if ever required, due to the unique history of risk socialization and the highly centralized system in Japan.

The principal methodologies used in this rating were Moody's "Regional and Local Governments Outside the US", and "The Application of Joint Default Analysis to Regional and Local Governments". Both were published on September 30, 2010, and are available on www.moodys.co.jp.

REGULATORY DISCLOSURES

Information sources used to prepare the credit rating are the following: parties involved in the ratings, parties not involved in the ratings, public information, confidential and proprietary Moody's information.

Measures taken to ensure the quality of this information include use of public information, reviews by a third party and verification by the lead analyst.

Moody's considers the quality of information which was available on the issuer or obligations satisfactory for the purpose of maintaining a credit rating.

Moody's adopts all necessary measures so that the information it uses in assigning a credit rating is of sufficient quality and from sources Moody's considers to be reliable including, when appropriate, independent third-party sources. However, Moody's is not an auditor and cannot in every instance independently verify or validate information received in the rating process.

Credit ratings are Moody's current opinions of the relative future credit risk of entities, credit commitments, or debt or debt-like securities. Moody's defines credit risk as the risk that an entity may not meet its contractual, financial obligations as they come due and any estimated financial loss in the event of default. Credit ratings do not address any other risk, including but not limited to: liquidity risk, market value risk, or price volatility. Credit ratings do not constitute investment or financial advice, and credit ratings are not recommendations to purchase, sell, or hold particular securities. No warranty, express or implied, as to the accuracy, timeliness, completeness, merchantability or fitness for any particular purpose of any such rating or other opinion or information is given or made by Moody's in any form or manner whatsoever. The credit risk of an issuer or its obligations is assessed based on information received from the issuer or from public sources. Moody's may change the rating when it deems necessary. Moody's may also withdraw the rating due to insufficient information, or for other reasons.

Moody's Japan K.K. is a credit rating agency registered with the Japan Financial Services Agency and its registration number is FSA Commissioner (Ratings) No. 2. The Financial Services Agency has not imposed any supervisory measures on Moody's Japan K.K. in the past year.

Please see ratings tab on the issuer/entity page on the Moody's website for the last rating action and the rating history.

The date on which some Credit Ratings were first released goes back to a time before Moody's Credit Ratings were fully digitized and accurate data may not be available. Consequently, Moody's provides a date that it believes is the most reliable and accurate based on the information that is available to it. Please see the ratings disclosure page on the Moody's website for further information.

Please see the Credit Policy page on the Moody's website for the methodologies used in determining ratings, further information on the meaning of each rating category and the definition of default and recovery.

Tokyo
Yuka Tamba
Vice President - Senior Analyst
Sub-Sovereign Group
Moody's Japan K.K.
JOURNALISTS: (03) 5408-4110
SUBSCRIBERS: (03) 5408-4100

London
David Rubinoff
MD - Sub-Sovereigns
Sub-Sovereign Group
Moody's Investors Service Ltd.
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Moody's Japan K.K.
Atago Green Hills Mori Tower 20fl
2-5-1 Atago, Minato-ku
Tokyo 105-6220
Japan
JOURNALISTS: (03) 5408-4110
SUBSCRIBERS: (03) 5408-4100

Moody's downgrades 12 Japanese regional/local governments to Aa3 following sovereign downgrade
No Related Data.

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