RATIONALE FOR THE DOWNGRADE

The downgrade of Naples' rating reflects the materialisation of a EUR850 million unfunded budgetary deficit in its realised accounts for 2011, which were recently approved by the city's executive body. Moody's understands that this deficit stems from the write-off of EUR875 million in doubtful receivables (uncollectable taxes and service charges accrued in previous years), which substantially exceeds the EUR430 million in doubtful receivables disclosed in October and reflects the extent of Naples' fiscal problems. The coverage of this cumulated imbalance -- which represents about two thirds of Naples' annual operating budget -- exceeds the city's fiscal capacity.

Moody's notes that the institutional framework in Italy is being refined with the introduction of a new mechanism aimed at helping underperforming municipalities and provinces to address their immediate liquidity pressures and to rebalance their accounts through a rehabilitation plan assisted by the central government. The rating agency expects that Naples will soon enter this framework and will commit to a multi-year rehabilitation plan aimed at rebalancing its finances through tax hikes, large-scale asset sales and expenditure rationalisation, including its municipal companies. While any funding received from the central government via this scheme would alleviate the city's short-term liquidity pressure, it does not necessarily guarantee regular cash flows in the medium term, which will depend on the credibility and effectiveness of the recovery actions implemented by Naples.

Moody's says that persistently poor revenue-generating capacity and spending pressures have led to mounting commercial debts in Naples' books, exerting growing liquidity pressure over time. More recently, austerity measures imposed by the central government and fragile current economic conditions are contributing to significant cash strains. Furthermore, the city is exposed to material off-balance sheets risk through existing swaps. Termination risk may represent an additional liquidity challenge.

Naples' direct debt at year-end 2011 was EUR1.63 billion, which is equivalent to around 134% of operating revenue for the year; this ratio rises to over 160% when estimates of the financial debt of major municipal companies are included. The city has an amortising debt structure, with debt-service costs representing 11% of operating revenue. Thus far, the city has maintained adequate cash reserves to cover debt-service payments. Credit-protection measures embedded in Italy's institutional framework -- primarily the delegation of payment mechanism -- provides comfort that debt-service payments remain prioritised. The next debt-service installment is due in December 2012 (around EUR70 million, including interest and principal).

Naples' B1 rating also reflects the uplift provided by Moody's assessment of a moderate likelihood of support from the Government of Italy (Baa2 negative) in the event that Naples face extreme liquidity stress.

RATIONALE OF THE REVIEW

Moody's review will focus on (1) Naples' liquidity profile; and (2) the credibility and effectiveness of any recovery action aimed at structurally rebalancing the municipal budget. Moody's expects to receive timely and complete information to conclude the rating review within the next few months.

WHAT COULD CHANGE THE RATING DOWN/UP

In view of the current review for downgrade on Naples' rating, no upward rating movement is likely over the short term. However, the introduction of a credible plan to address Naples' budget challenges and place the city on a sustainable fiscal and liquidity footing could lead to a confirmation of Naples' B1 rating.

Further exacerbation of liquidity pressure and the lack of clear and credible policy responses to consolidate municipal finances and achieve a structural balance could result in a downgrade of the B1 rating.

The methodologies used in this rating were Regional and Local Governments Outside the US published in May 2008, and The Application of Joint-Default Analysis to Regional and Local Governments published in December 2008. Please see the Credit Policy page on www.moodys.com for a copy of these methodologies.

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Francesco Soldi Vice President - Senior Analyst Sub-Sovereign Group Moody's Italia S.r.l Corso di Porta Romana 68 Milan 20122 Italy Telephone:+39-02-9148-1100David Rubinoff MD - Sub-Sovereigns Sub-Sovereign Group JOURNALISTS: 44 20 7772 5456 SUBSCRIBERS: 44 20 7772 5454 Releasing Office: Moody's Italia S.r.l Corso di Porta Romana 68 Milan 20122 Italy Telephone:+39-02-9148-1100(C) 2012 Moody's Investors Service, Inc. and/or its licensors and affiliates (collectively, "MOODY'S"). All rights reserved.

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