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Rating Action:

Moody's downgrades Aiful's rating to Ba2 from Baa3; outlook is negative

28 May 2009

Tokyo, May 28, 2009 -- Moody's Investors Service has downgraded the long-term senior unsecured debt rating and issuer rating of Aiful Corporation (Aiful) to Ba2 from Baa3 and assigned a negative outlook.

This action concludes the review initiated on March 5, 2009, and incorporates Moody's revision to its stress simulation assumptions for the consumer loan specialists, and a concomitant re-assessment of Aiful's stand-alone financial strengths.

Since June 2007, Moody's has monitored the difference between the simulation's annualized three-year "risk chunk" and the rated firms' annual overpaid interest claims cash out plus write-offs, including the impact of loan amount caps (LAC), as well as changes in ROA, to verify their progress in stabilizing operations, given the severe operating environment. Through its monitoring, Moody's has confirmed the sufficiency of the rated firms' risk tolerance thus far. The number of overpaid interest claims filed has been high since the latter half of 2007, but since actual losses have been within the risk estimate, Moody's view that the companies' reserves are sufficient to cover the estimated risk remains the same.

However, the filing of overpaid interest claims may continue for some time, for the following reasons: (1) given the practical difficulties, the rated companies' portfolios will not be completely "cleaned up" (of the assets subject to an interest rate over 18%) immediately after full enforcement of the revised Money-Lending Business Control and Regulation Law (MBCRL); (2) of the claims filed, the number of those already paid out is growing, suggesting that the filing of claims may decline, even though they will likely continue even after full enforcement; (3) a campaign by legal and judicial advocates that encourages borrowers to file claims will likely continue until at least full enforcement; and (4) given the ongoing downturn in the economy, more borrowers may become financially distressed and file claims.

In light of these concerns, Moody's has taken a "conservative" approach -- conservative in that the assumptions are set at a level sufficient to provide all around coverage -- in adjusting the risk chunk. Specifically, Moody's added 1.5 years to the original three, reflecting the assumption that the filing of claims will continue for one to two years after full enforcement.

The revised risk chunk may seem overly stressed, given that the original stress assumptions and actual losses have been lower than the annualized risk chunk -- in the process providing a buffer for remaining risk. However, given the growing uncertainty over the regulatory environment, as well as the weakening environment for financial institutions, Moody's believes the adjustment is reasonably conservative.

Moody's has also revised several of its simulation assumptions, including the one for top-line revenue, which reflects the rated firms' conservative lending stance. The revisions also reflect the restructuring cost effects the rated companies have achieved, which had not previously been incorporated.

The rating downgrade reflects Moody's view that Aiful's current reserves are not sufficient to fully cover the revised risk chunk, which could negatively impact the company's profitability-- hence, the concern over the lengthening process to stabilize operations.

In Moody's view, Aiful has also become even more stringent in extending loans, viz. downsizing of its operation, where the overall market has been shrinking, the associated decline in revenue could give rise to downward pressures on the franchise over the medium term.

In addition, in light of the lengthened stabilizing process, Moody's is of the view that the company's less flexible funding profile may pose a challenge to management given the increasingly severe operating environment, not just for Aiful but also for financial institutions in general. Its funding and liquidity remains less flexible, as 1) the number of domestic borrowing sources is limited, 2) debt duration is relatively shorter than that of its peers, and 3) the market's appetite to provide funding through credit facilities with covenants is limited.

Moody's retains its negative ratings outlook, based on the view that operating stabilization may take longer than expected if the number of overpaid interest claims remains high, and that the company's reserves are insufficient to cover the revised risk chunk in full. The negative outlook also incorporates the constraints to funding in a persistently severe operating environment.

Given the need for closely monitoring the actual changes on borrowers' debt relief, the prospect of the rated firms facing upward rating pressure is limited.

Downward triggers include 1) ongoing, consistently high declines in the reserves compared to Moody's revised risk chunk -- resulting from actual losses (due to claims cash out and write-offs, including additional credit costs emerging from LAC) -- or declines that increase to a point that risk coverage is further jeopardized; 2) deterioration in the process of stabilizing operations -- in other words, a lack of improvement in ROA because the dynamic between top-line revenue and broadly defined credit costs, including claims cash out, has not stabilized; and 3) a lack of material improvement in funding flexibility, such that the company's operations are harmed further.

The ratings outlook may revert to stable if Aiful can demonstrate that its operating stabilization is evolving smoothly -- more specifically, that it is improving its risk tolerance -- and that it is also improving its funding profile.

Moody's will soon publish a Special Comment elaborating its revised simulation assumptions for Japan's consumer loan specialists, including Aiful.

Moody's last rating action with respect to Aiful was taken on March 5, 2009, when the long-term senior unsecured debt rating and issuer rating were downgraded to Baa3 from Baa2 and placed under further review for possible downgrade.

Aiful's rating was assigned by evaluating factors we believe are relevant to its credit profile, such as franchise value, risk positioning, operating and regulatory environment, and financial fundamentals versus its competitors, as well as the company's projected performance in the near to medium term. These attributes were compared to those of other issuers both inside and outside its core industry. Thus, Moody's believes Aiful's rating to be comparable to those of other issuers with similar credit risk.

Aiful Corporation, headquartered in Kyoto, was established in 1967. It is a major specialized consumer finance company in Japan, with about JPY1.6 trillion in total assets on a consolidated basis as of March 31, 2009.

Tokyo
Naoki Morimura
Analyst
Financial Institutions Group
Moody's Japan K.K.
JOURNALISTS: (03) 5408-4110
SUBSCRIBERS: (03) 5408-4100

Tokyo
Tetsuya Yamamoto
Vice President - Senior Analyst
Financial Institutions Group
Moody's Japan K.K.
JOURNALISTS: (03) 5408-4110
SUBSCRIBERS: (03) 5408-4100

Moody's downgrades Aiful's rating to Ba2 from Baa3; outlook is negative
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