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Rating Action:

Moody's downgrades Volkswagen's ratings to A3/P-2; negative outlook

04 Nov 2015

London, 04 November 2015 -- Moody's Investors Service has today downgraded to A3/(P)A3 from A2/(P)A2 the long-term senior unsecured ratings and to Prime-2/(P)Prime-2 from Prime-1/(P)Prime-1 the commercial paper and other short-term ratings assigned to Volkswagen Aktiengesellschaft (Volkswagen or 'the company') and its guaranteed rated subsidiaries. Concurrently, Moody's has downgraded to Baa2 from Baa1 the junior subordinate rating assigned to the undated euro-denominated subordinated notes issued by Volkswagen International Finance N.V. and guaranteed by Volkswagen. The outlook on all ratings is negative.

"Today's downgrade reflects mounting risks to Volkswagen's reputation and future earnings following its announcement on 3 November regarding irregularities in CO2 and fuel consumption levels for certain Volkswagen group vehicles, as well as fresh allegations from the US EPA on 2 November that defeat devices were also installed in certain Audi, Porsche and Volkswagen Touareg models in the US," says Yasmina Serghini, a Moody's Senior Credit Officer and lead analyst for Volkswagen.

"These new claims pose further challenges to Volkswagen's financial flexibility and competitive position, and heighten Moody's concerns about Volkswagen's internal control and governance issues, thus further weakening its rating profile," adds Ms. Serghini.

RATINGS RATIONALE

Today's downgrade of Volkswagen's ratings to A3 from A2 follows the company's announcement that it has discovered irregularities related to previously disclosed CO2 and fuel consumption levels for approximately 800,000 Volkswagen group vehicles, spread across a range of model types, the majority of which have diesel engines.

Volkswagen has evaluated the financial risk at around EUR2 billion, though this estimate may vary as the company completes its assessment of the legal and economic risks arising from this new issue. This charge is in addition to the EUR6.7 billion provision that Volkswagen already booked in its accounts for the third quarter of the current financial year ending 31 December 2015. The new EUR2 billion charge is a reserve only at this point, for which Volkswagen has the financial capacity to address. However, uncertainty remains as to the amount that will ultimately be required to address these issues, the length of time it will take, and the eventual impact on Volkswagen's brands perception.

In addition, Moody's cautions that the US Environmental Agency (EPA) issued a second notice of violation of the US Clean Air Act to Volkswagen alleging that certain of the company's six- cylinder (3.0 litre) diesel vehicles are also equipped with so-called 'defeat devices', which circumvent EPA emissions standards. This second notice of violation concerns the 2014 Volkswagen Touareg, the 2015 Porsche Cayenne, and the 2016 Audi A6 Quattro, A7 Quattro, A8, A8L, and Q5. Volkswagen said these devices were not designed to manipulate emissions tests.

At this juncture, Moody's expects that Volkswagen will respond rapidly to these new allegations to establish whether they are well founded. The rating agency also notes that the notice of violation has a more reduced scope than the previous notice (issued on 18 September) with an estimated 10,000 vehicles sold in the US (though there is an unknown number of 2016 vehicles). However, the rating agency cautions that this new notice of violation concerns the last generation of diesel engines and more widely affects Volkswagen's premium brands -- Audi and Porsche -- which are top contributors to Volkswagen's profitability. The most recent EPA notice provides further evidence of Moody's concern that the regulatory investigations will be protracted and are likely to result in some costly remediation, not just in fines but also in potentially greater scrutiny and restrictions going forward.

In Moody's view, these new developments pose additional risk to Volkswagen's reputation, future sales and cash. They also suggest serious internal control and governance issues, which may be more widely spread than believed initially, that Volkswagen will have to address aggressively in the coming months. These elements further weaken the company's rating position.

Over time, Moody's recognizes that the emissions issue could be an opportunity for Volkswagen to accelerate its execution of efficiency measures and internal restructuring, which will enhance its competitiveness and governance in the long run. Moreover, Moody's acknowledges that Volkswagen can take actions in order to partially offset the adverse effects on its earnings from the emissions issue, which could ultimately help the company preserve its financial flexibility and defend its credit quality. Fundamentally, Volkswagen's ratings continue to be supported by the company's geographic and brand diversification, prudent financial policies and ability to generate solid and positive free cash flow.

Volkswagen has a strong liquidity position, reflected by a robust positive Moody's-adjusted free cash flow in the 12 months to 30 September 2015 and a reported net liquidity of its automotive division of EUR27.8 billion as of 30 September 2015. Its liquidity benefited in the third quarter of 2015 from the proceeds from the sale of Volkswagen's 19.9% stake in Suzuki Motor Corporation (unrated) with an additional cash inflow related to the divestment of the company's 50% stake in LeasePlan Corporation N.V., which is expected in the final quarter of 2015. In light of the substantial cash costs facing the company, Moody's expects that Volkswagen will take the necessary steps to protect its free cash flow generation and financial flexibility.

RATIONALE FOR THE NEGATIVE OUTLOOK

The negative outlook reflects Moody's view that the emissions issue is likely to have a number of adverse effects on Volkswagen's future earnings and cash flows, which may only become visible over time. Moreover, Volkswagen is under investigation in many jurisdictions and the potential fines and additional costs for class action lawsuits will be a strain on its cash, though this is difficult to quantify at this stage.

WHAT COULD CHANGE THE RATINGS UP/DOWN

The ratings could come under pressure if Moody's notes (1) an erosion in Volkswagen's market shares in its core markets; (2) deterioration in the company's operational performance as a result, for example, of weaker earnings of its premium brands or of its commercial vehicle division; or (3) an inability to enhance the Volkswagen Passenger Cars' profitability to a level sustainably more competitive and (4) severe pressure on the company's liquidity profile as a result of fines and legal costs.

Quantitatively, a downgrade could occur if (1) Volkswagen's Moody's-adjusted EBITA margin drops below 7%; (2) its free cash flow/debt ratio deteriorates below the mid-single digit range in percentage terms for a prolonged period of time as a result of an operational weakness or more aggressive financial policies; and (3) EBITA/Interest Expense decreases below 5x (all ratios as adjusted by Moody's).

Moreover, signs of a weakening of Volkswagen's liquidity coverage could put downward pressure on the ratings.

An upgrade of the rating is not likely in the near term in light of today's rating action. A stabilization of the outlook could occur if there is evidence that the effects of the emissions issue are contained with manageable effects on Volkswagen's brand image, pricing power, earnings and cash position.

Upward pressure on the ratings could occur if Volkswagen (1) continues to at least protect its market share in the major markets where it operates, especially in Western Europe and in China, regardless of potential changes in global macro-economic conditions; and (2) significantly grows its competitive position for the Volkswagen Passenger Cars brand and in the US market. Volkswagen would also need to deliver a more consistent earnings pattern across its commercial vehicle brands as a result of the successful execution of its long-term plan for the division.

Quantitatively, an upgrade of the ratings would require sustained robust cash flow generation, despite elevated capital expenditure, supported by Moody's-adjusted EBITA margins sustainably above 7%. This means a (1) free cash flow/debt ratio at around 10%; and (2) EBITA/interest expense above 7x (all ratios including Moody's adjustments).

PRINCIPAL METHODOLOGY

The principal methodology used in these ratings was Global Automobile Manufacturer Industry published in June 2011. Please see the Credit Policy page on www.moodys.com for a copy of this methodology.

Headquartered in Wolfsburg, Germany, Volkswagen Aktiengesellschaft manufactures mass-market and premium cars under the Volkswagen Passenger Cars, Skoda, Seat, Audi, Bentley, Lamborghini, Bugatti and Porsche brands, as well as commercial vehicles under the Volkswagen Commercial Vehicles, MAN and Scania brands. In addition, Volkswagen has a 100.0% stake in Ducati. In 2014, Volkswagen delivered over 10 million vehicles to its customers and had group revenues of about EUR202.5 billion.

List of affected ratings

Downgrades:

..Issuer: Volkswagen Aktiengesellschaft

.... Issuer Rating, Downgraded to A3 from A2

....Senior Unsecured Commercial Paper, Downgraded to P-2 from P-1

....Senior Unsecured Medium-Term Note Program, Downgraded to (P)A3 from (P)A2

..Issuer: MAN SE

.... Issuer Rating, Downgraded to A3 from A2

.... Issuer Rating, Downgraded to P-2 from P-1

....Senior Unsecured Medium-Term Note Program, Downgraded to (P)A3 from (P)A2

....Senior Unsecured Regular Bond/Debenture, Downgraded to A3 from A2

..Issuer: Volkswagen Group Canada, Inc.

....BACKED Senior Unsecured Commercial Paper, Downgraded to P-2 from P-1

..Issuer: Volkswagen Group of America Finance, LLC

....BACKED Senior Unsecured Commercial Paper, Downgraded to P-2 from P-1

....BACKED Senior Unsecured Regular Bond/Debenture, Downgraded to A3 from A2

..Issuer: Volkswagen Group of America, Inc.

....BACKED Senior Unsecured Commercial Paper, Downgraded to P-2 from P-1

..Issuer: Volkswagen Group Services SA

....Senior Unsecured Commercial Paper, Downgraded to P-2 from P-1

..Issuer: Volkswagen International Finance N.V.

....BACKED Junior Subordinated Regular Bond/Debenture, Downgraded to Baa2 from Baa1

....BACKED Senior Unsecured Medium-Term Note Program, Downgraded to (P)A3 from (P)A2

....BACKED Senior Unsecured Medium-Term Note Program, Downgraded to (P)P-2 from (P)P-1

....BACKED Senior Unsecured Regular Bond/Debenture, Downgraded to A3 from A2

..Issuer: VW Credit Canada, Inc.

....BACKED Senior Unsecured Commercial Paper, Downgraded to P-2 from P-1

....BACKED Senior Unsecured Medium-Term Note Program, Downgraded to (P)A3 from (P)A2

....BACKED Senior Unsecured Medium-Term Note Program, Downgraded to (P)P-2 from (P)P-1

....BACKED Senior Unsecured Regular Bond/Debenture, Downgraded to A3 from A2

..Issuer: VW Credit, Inc.

....BACKED Senior Unsecured Commercial Paper, Downgraded to P-2 from P-1

....BACKED Senior Unsecured Medium-Term Note Program, Downgraded to (P)A3 from (P)A2

....BACKED Senior Unsecured Medium-Term Note Program, Downgraded to (P)P-2 from (P)P-1

....BACKED Senior Unsecured Regular Bond/Debenture, Downgraded to A3 from A2

Outlook Actions:

..Issuer: Volkswagen Aktiengesellschaft

....Outlook, Remains Negative

..Issuer: MAN SE

....Outlook, Remains Negative

..Issuer: Volkswagen Group of America Finance, LLC

....Outlook, Remains Negative

..Issuer: Volkswagen International Finance N.V.

....Outlook, Remains Negative

..Issuer: VW Credit Canada, Inc.

....Outlook, Remains Negative

..Issuer: VW Credit, Inc.

....Outlook, Remains Negative

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the rating action on the support provider and in relation to each particular rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this rating action, and whose ratings may change as a result of this rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Yasmina Serghini-Douvin
VP - Senior Credit Officer
Corporate Finance Group
Moody's France SAS
96 Boulevard Haussmann
Paris 75008
France
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Matthias Hellstern
MD - Corporate Finance
Corporate Finance Group
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Releasing Office:
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JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Moody's downgrades Volkswagen's ratings to A3/P-2; negative outlook
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