UK- and South Africa-listed financial services group Old Mutual plc (OML) has expressed "disappointment but no surprise" with the decision by Moody's, the international financial ratings agency, to downgrade the ratings of Old Mutual by one notch, to A3 and P-2 for commercial paper.

Reacting to the downgrade, Julian Roberts, Group Finance Director, pointed out that Old Mutual has recently taken steps as a result of which the capital strength of its principal South African businesses, individually and together, is stronger than a year ago.

Nedcor has been strongly recapitalised with a successful 5.1 billion rand rights issue of new equity capital.

"In South Africa, Old Mutual Life Assurance strengthened capital from 2.3 times the (minimum) statutory capital adequacy requirement (SCAR) at December 2002 to 2.4 times at the end of December 2003, a healthy balance between good capital cover and the most efficient use of capital.

"Old Mutual's US businesses are developing in line with business plans.

Prudent capital planning has provided higher risk-based capital cover for sales of new policies whilst growing both assets under management and sales."

He added that, in the UK, the sale of Gerrard with its volatile equity- market earnings was widely seen as strengthening the capital of the group.

"Old Mutual was put on the Moody's `Negative Watch List' on 27 January 2004, following the announced recapitalisation of our 53% owned banking subsidiary, Nedcor. It was therefore not unexpected that they would follow through by reducing the rating," said Roberts. "But we're disappointed, because the group is looking stronger."

Old Mutual had held the previous rating since December 2000, since which time the average ratings of its international peer group of life assurance companies based in Europe has dropped by two full notches.

In South Africa, Old Mutual Life Assurance Company, following the recent transactions involving Mutual and Federal Ltd, now owned 88.2% by Old Mutual South Africa, and Nedcor rights issues to which the group subscribed in full, remains strongly capitalised.

"In Old Mutual's US Life Assurance business, Fidelity and Guaranty, Moody's recognises the fact that Old Mutual continues to expand the business and expand its market position seizing opportunities through capital injection from the cash earnings generated from its other businesses," Roberts noted.

"This approach of optimising capital management throughout Old Mutual Group companies is a critical strategy for the group.

"Old Mutual remains firmly committed to maintaining the capital strength of the Group as a whole, exploiting to the full the opportunities to optimise capital synergies between group companies in each of its principal territories. This support is one of the principal reasons for the successful performance of the group since listing in 1999," he concluded.

Late Monday, Moody's said it had downgraded Old Mutual's ratings by one notch, with its senior debt now rated "A3" versus "A2" prevously. The ratings also include the group's lead US life insurance company Fidelity and Guaranty Life (F&G Life), whose insurance financial strength rating was downgraded to A3 from A2.

Negative outlooks continue to apply to all ratings except Old Mutual plc's

Prime-2 commercial paper rating, which has a stable outlook.

Moody's said that the downgrade for the long-term ratings at Old Mutual Group reflected Moody's views of the deterioration in quality of some of Old Mutual's South African businesses, as well as the lower quality of hard- currency earnings from the US and UK businesses. Moody's added, however, that Old Mutual's A3 senior rating will continue to be rated above the South African foreign currency sovereign ceiling (Baa2, positive outlook), reflecting the group's continued strong level of hard currency earnings.

In Moody's view, the credit quality of the group's major South African businesses had declined and was expected to remain under pressure. Nedbank had recently announced a significant loss in relation to charges for interest rate mismatches, foreign exchange losses and asset value impairments, but had recently completed a successful 5 billion rand rights issue to support its capital position.

However, in Moody's view, the earnings power of Nedbank was likely to be weaker in the short- to medium-term, driving the lowering of Nedbank's bank financial strength rating to C from C+ in March 2004.

In terms of Old Mutual's life insurance businesses in South Africa, it had, like its peers, suffered a weakening in its statutory capital coverage over recent years, mainly due to declining external equity markets. Furthermore, it had been a major player in Old Mutual's support of Nedcor (through following its 51% rights allocation) as well as through the recent purchase of a significant minority interest in its majority-owned non-life insurer Mutual & Federal.

"Moody's regards OMLACSA's quality and quantum of capital, although still above most of its peers, as having shown some deterioration in recent years, the ratings agency noted. "A decline in the level of surplus capital adequacy, combined with a gradual reduction in operating profits (after shareholders' investment income and tax), were the drivers behind the lowering of the local currency insurance financial strength rating (IFSR) for OMLACSA to A1 from Aa3."

In terms of hard currency earnings, Moody's noted that, on a UK GAAP basis, Old Mutual continued to produce strong levels of non-South African earnings, enabling the debt rating to remain above the foreign currency sovereign ceiling.

However, in Moody's view, the quality of hard currency earnings has decreased in recent years and is expected to remain under pressure over the near-term. The UK operations now only produce a small earnings contribution, and the majority of the US-based UK GAAP profit is derived from Old Mutual's growing US life business (F&G Life) which, Moody's notes, requires continued growth capital to operate successfully in its core market of low-margined, competitively-priced annuity products.

The US asset management business, despite market timing allegations at fund manager Pilgrim Baxter, continues to show positive cash flow and good growth, although income from this source has declined from its peak in recent years as markets have fallen and the portfolio has been rationalised.

Consequently, Moody's views the quality of non-South African earnings as being somewhat weaker. In combination with Moody's views on the weakness of the South African business profile, this supports Moody's ratings downgrade of Old Mutual plc.

Commenting on the downgrade of the commercial paper rating at Old Mutual plc (to P-2 from P-1), Moody's said that Old Mutual currently showed a strong liquidity position, reflecting the retention at the holding company level of substantial sales proceeds from the recent Gerrard sale in the UK. However, in Moody's view, Old Mutual's general liquidity profile -- reflecting the need to fund growing business in the US and the potential for cashflow restrictions from South Africa -- is now more commensurate with a P-2 rating.

F&G Life was downgraded to A3 insurance financial strength rating with a negative outlook in recognition of its high continuing dependence on capital infusions from the group to support its rapid business growth and resultant statutory operating losses. F&G Life's insurance financial strength rating continues to benefit from the support of the Old Mutual group.

Key metrics that Moody's will monitor on an ongoing basis in evaluating the appropriateness of F&G Life's rating are the company's statutory capitalisation ratio, amount of business reinsured to offshore affiliates, statutory operating and net income, and the capital infusions required to support the company's growth.

Moody's added that the negative outlook for Old Mutual's long-term ratings reflects some ongoing uncertainty in relation to the level of any fines likely to be levied in relation to US fund market timing issues at subsidiary Pilgrim Baxter. In addition, the outlook reflects the need for the group to continue to support the growth of F&G Life, and the fact hard currency earnings from the UK remain at very low levels.

The following ratings were downgraded with a negative outlook: Old Mutual plc Senior debt to A3 from A2; Old Mutual Life Assurance Co (South Africa) Ltd Domestic insurance financial strength to A1 from Aa3; Old Mutual Finance (Cayman Islands) Ltd Senior convertible bonds to A3 from A2 (guaranteed by Old Mutual plc); Old Mutual Capital Funding LP Preferred stock to Baa2 from Baa1; and Fidelity & Guaranty Life Insurance Company Insurance financial to

A3 from A2.

Finally, rating of Old Mutual plc's commercial paper was downgraded with a stable outlook to P-2 from P-1.

I-Net Bridge 18 May 2004