Moody's Investor Service -- Executive Summary and
Testimony of Daniel Heimowitz
Daniel Heimowitz, Director of Public Finance was invited to
speak on Wednesday, July 26, 1995 before a Congressional
Subcommittee. This is his Executive Summary and Testimony.
COMMITTEE ON BANKING AND FINANCIAL SERVICES
SUBCOMMITTEE ON CAPITAL MARKETS, SECURITIES AND GOVERNMENT-
SPONSORED
ENTERPRISES,
U.S. HOUSE OF REPRESENTATIVES
DEVELOPMENTS IN THE MUNICIPAL FINANCE MARKET
EXECUTIVE SUMMARY OF
TESTIMONY OF
DANIEL N. HEIMOWITZ
EXECUTIVE VICE PRESIDENT/DIRECTOR, PUBLIC FINANCE
MOODY'S INVESTORS SERVICE, INC.
Daniel Heimowitz is the Director of the Public Finance
Department of Moody's Investors Service.
Moody's has for almost 90 years published rating opinions and
now maintains 56,000 ratings on 22,000 issuers of municipal debt.
Moody's maintains ratings on Orange County and
on various
participants in the Orange County Investment Pool.
After the Federal Government's own securities, Municipal Bonds
are the most default-free of publicly offered bonds. The low cost
and relative ease of market access for issuers large and small
reflects that strong track record. Municipal issuer practices are
generally sound, with adherence to good management practices and
attention to maintaining creditworthiness even under fiscal
pressures. Since defaults on debts issued by established
municipalities and paid out of general municipal resources are
extremely rare, prior events offer limited precedent, making it
difficult to predict the ultimate market impact of the Orange County
events.
I. Orange County's Investment Practices and the Level of Orange
County's Investment Losses.
In rating general obligation bonds, such as those issued by
Orange County, Moody's weighs and relies on current and historical
evidence regarding a municipality's economy, financial performance,
debt burden, fiscal management and administrative skill. This
information is provided by issuers in a number of forms, including
in the Official Statements that accompany municipal bonds and the
audited financial statements prepared by professionals retained by
municipal issuers.
While Moody's, other market participants, the County's own
management, the State of California, the local governments investing
in the Pool, and the SEC, among others, was aware of the above-
market rate of earnings reported by the Orange County Pool over an
extended period of time, we were shocked by the unprecedented
magnitude of the County's investment loss. The County's debt was
not directly linked to its investment practices, rather, the
County's debt was secured by the County's general resources.
Based on the factors noted above, Orange County was perceived as
financially strong and sophisticated and otherwise responsible and
well-managed. As such, nothing led Moody's to believe that Orange
County's investment practices were a threat to repayment of its own
debt or the debt issued by local governments investing in the County
Pool. In addition, Moody's experience with other municipalities
that took investment risk and incurred losses was that they stepped
up and made payments on their debt obligations. This is the
behavior the market has grown to expect and by which Orange County
was and is being measured.
The Orange County investment experience has altered beliefs and
practices in the market. Orange County incurred losses through
commonly used investment practices but, as Moody's found in a
nationwide survey of municipal investment practices, its behavior
was beyond historical norms. Even though Orange County presents a
unique situation, Moody's has nevertheless responded to these events
by implementing changes to the information that all issuers must
provide in support of their investment practices and by giving
investment practices greater weight and closer, more continuous
scrutiny.
As with past financial crises, the Orange County experience has
brought to the public a greater understanding and appreciation of
risk, which in turn has focused individual issuers, states and
industry associations on better investment practices and improved
investment disclosure. We encourage these efforts.
II. Orange County's Decision to File for Bankruptcy.
Until Orange County's bankruptcy filing the market had no prior
experience with a large, sophisticated, and very wealthy general
purpose municipal government's operating in bankruptcy. Given the
enormous stigma and complexities of operating under bankruptcy,
there is no reason at this time to believe that a bankruptcy filing
will be viewed as a viable alternative to addressing the fiscal
challenges faced by municipal governments.
A broader concern raised by the bankruptcy filing is how
difficult it has been for Orange County to deal with its fiscal
crisis. This, in turn, has drawn market attention to the need to
rethink just how resilient even a wealthy municipal-debtor might be
when dealing with a fiscal crisis. The extreme magnitude of the
Orange County experience has heightened the municipal market's
awareness of investment risk and resulted in a greater appreciation
of the very real fiscal constraints under which the states and their
localities now operate.
III. The Effect of Orange County on the Trust Between Issuers and
Investors.
A far more difficult adjustment will be necessary if Orange
County's actions and inactions result in an undermining or erosion
of the trust between issuers and investors which is a fundamental
underpinning of the municipal market.
The market has looked for Orange County to state unequivocally
its intention to make good on its debt obligations in full and to
state that its losses would not interfere with the County's
recognition of its obligations to its creditors. As such, we were
disappointed by the resounding rejection of the sales tax proposal.
Presented as a means for the County to make good on its obligations,
it received at best lukewarm support from most County officials, and
was actively opposed by a number of city councils. We believe these
events are beginning to fray the edges of public trust.
Far greater potential damage to public trust will occur if
Orange County follows through on its threats to invalidate certain
debt obligations. Any such attempt will give the market substantial
pause and could be extremely disruptive. It would be naive to think
that Orange County could surgically extract itself from obligations
which in retrospect it wished it had not undertaken without damaging
the system by which state and local governments issue debt.
The market continually adjusts to new information, resulting in
improved relative risk assessment, and has and will continue to
adjust to the events in Orange County. However, if the County takes
any actions which undermine the market's trust, it would likely
affect all issuers and could result in higher costs, difficulty in
access to the public market for municipal issuers, and a rethinking
of the fundamental underpinnings of the public finance market.
TESTIMONY OF DANIEL N. HEIMOWITZ, EXECUTIVE VICE PRESIDENT/DIRECTOR,
PUBLIC FINANCE MOODY'S INVESTORS SERVICE, INC. BEFORE THE COMMITTEE
ON BANKING AND FINANCIAL SERVICES, SUBCOMMITTEE ON CAPITAL MARKETS,
SECURITIES AND GOVERNMENT-SPONSORED ENTERPRISES, U.S. HOUSE OF
REPRESENTATIVES
July 26, 1995
DEVELOPMENTS IN THE MUNICIPAL FINANCE MARKET
Chairman Baker, Members of the Committee, good afternoon.
I am Daniel Heimowitz, Director of the Public Finance Department
of Moody's Investors Service. I would like to thank the Committee
for inviting me to speak today on a topic of great significance to
me professionally and to the industry in which I work.
Moody's is a publisher of rating opinions. Moody's has been
publishing opinions on bonds since 1909 and now maintains 56,000
ratings on the debt obligations of 22,000 municipal issuers. A
rating is not a prediction of an outcome in a particular case. It
is the expression of an opinion about the relative likelihood of
different possible future outcomes.
With regard to Orange County, Moody's issued rating opinions on
a range of the County's securities, having rated the County's debt
since 1938. We have continued to follow the Orange County situation
closely since the December 6, 1994 bankruptcy filing and have issued
numerous credit comments updating the market on the status of events
as they have unfolded. (Moody's comments and press releases on the
events in Orange County and an explanation of Moody's bond ratings
have been provided to the Committee.)
After the Federal Government's own securities, Municipal Bonds
are the most default-free of publicly offered bonds. The low cost
and relative ease of market access for issuers large and small
reflects that strong track record. Municipal issuer practices are
generally sound, with adherence to good management practices and
attention to maintaining creditworthiness even under fiscal
pressures. Defaults on debts issued by established municipalities
and paid out of general municipal resources are extremely rare.
Consequently, prior events offer limited precedent, making it
difficult to predict the ultimate market impact of the Orange County
events.
The three areas that I would like to discuss today relating to
Orange County are:
These points, in turn, address issues raised by the Committee,
including the likelihood that other municipalities may follow Orange
County's lead, and whether the events surrounding Orange County's
collapse will alter beliefs or practices fundamental to the
municipal marketplace.
I. Orange County's Investment Practices and the Level of Orange
County's Investment Losses
In rating general obligation bonds and other debt paid from
general resources, similar to the debt issued by Orange County,
Moody's weighs and relies on current and historical evidence
regarding a municipality's economy, financial performance, debt
burden, fiscal management and administrative skill. This
information is provided by issuers in a number of forms, including
the Official Statements that accompany municipal bonds and the
audited financial statements prepared by professionals retained by
municipal issuers.
While Moody's, along with other market participants, the
County's own management, the State of California, the almost 200
local governments investing in the County's Pool, and the SEC, among
others, was aware of the above-market rate of earnings reported by
the Orange County Pool over an extended period of time, we were
shocked by the unprecedented magnitude of the Orange County
investment loss. The County's debt was not directly linked to the
investment practices of the Pool, rather, the County's debt was
secured by the County's general resources.
Orange County is one of the wealthiest counties in the nation.
In assessing the County's general resources, Moody's focused on the
strong and diverse economic base of the County as an indication of
the County's general economic wherewithal and ability to repay debt
obligations. Prior to the events of late 1994, Orange County had
moderate levels of debt and a history of sound fiscal management
that was reflected in growing operating reserves that had
accumulated over time. It was viewed, and its representatives,
Messrs. Citron and Raabe, presented it, as a sophisticated
investor. These were all positive credit factors that supported
Moody's ratings, which were in the A to Aa range.
Hexcel Reports Second Quarter Results; Improved Sales
and Margins Generate Net Income of $1.8 Million
PLEASANTON, Calif.--July 27, 1995--Hexcel
Corporation (NYSE/PSE:HXL)
today reported results for the second quarter ended July 2, 1995.
Net sales were $91.0 million, a 7% increase over net sales of
$85.0 million for the second quarter of 1994. Gross margin was
$18.1 million for the second quarter of 1995, or 19.8% of sales, and
net income was $1.8 million or $0.10 per share. This compares with
a 1994 second quarter gross margin of $14.2 million, or 16.7% of
sales, and a net loss of $4.4 million or $0.60 per share. There
were approximately 18.0 million shares outstanding during the second
quarter of 1995, reflecting the results of the company's recently
completed equity offering, versus 7.3 million shares in the second
quarter of 1994.
The quarterly sales increase reflects improvements in several of
the company's markets, especially in Europe, and higher sales to
customers in the recreation industry. The increase is also
attributable to the decline in the U.S. dollar relative to other
major currencies; over 40% of the company's sales are to
international markets. Honeycomb sales were slightly lower,
reflecting the sale of the Chandler, Arizona manufacturing facility
in the fourth quarter of 1994.
The increase in gross margin is the result of higher sales and
the beneficial impact of the company's restructuring activities.
The operating results of the company's honeycomb, composites and
fabrics businesses all improved. However, the company is not yet
experiencing the expected benefits from the consolidation of its
honeycomb operations. Successfully completing the restructuring of
these operations remains one of management's highest priorities.
For the year-to-date ended July 2, 1995, net sales were $176.2
million, compared with $162.6 million for the comparable period of
1994. The 1995 year-to-date gross margin was $32.9 million, or
18.6% of sales, and the net loss was $0.7 million or $0.05 per
share. Gross margin for the same period of 1994 was $25.8 million,
or 15.9% of sales, and the net loss was $9.4 million or $1.29 per
share. The year-to-date results include bankruptcy reorganization
expenses of $3.0 million for 1995 and $6.9 million for 1994. As
previously reported, Hexcel emerged from bankruptcy reorganization
proceedings on February 9, 1995. As a result of state income taxes
and taxable income for certain European entities, the company
recorded tax provisions of $1.6 million and $0.7 million for the
1995 and 1994 year-to-date periods, respectively.
Commenting on the second quarter results, John J. Lee, Chief
Executive Officer of the company, said, "The company generated
income from continuing operations for the first time since the third
quarter of 1992. This marks an important milestone in the company's
turnaround, and reflects the tremendous efforts of a dedicated
workforce. Nevertheless, we recognize that the company's return to
an acceptable level of profitability is not yet complete, and that
the competitive environment is more difficult than ever. We must
continue to improve profitability and pursue market opportunities,
and are committed to doing so."
As previously reported, Hexcel and Ciba-Geigy Limited have
signed a non-binding letter of intent, subject to various
conditions, to combine Ciba-Geigy's worldwide Composites Division
with Hexcel's business. The combined company would specialize in
lightweight, high-strength structural materials for the aerospace
and other industries.
Hexcel Corporation is an international developer and
manufacturer of honeycomb, advanced composites, and reinforcement
fabrics used in the commercial aerospace, space and defense,
recreation, and general industrial markets. -0-
Hexcel Corporation and Subsidiaries
Condensed Consolidated Statements of Operations
Unaudited
The Quarter Ended The Year-to-Date Ended
------------------- ----------------------
(In thousands, except July 2, July 3, July 2, July 3,
per share data) 1995 1994 1995 1994
--------------------------------------------------------------------
Net sales $ 91,023 $ 84,964 $ 176,178 $ 162,646
Cost of sales (72,968) (70,799) (143,328) (136,798)
--------------------------------------------------------------------
Gross margin 18,055 14,165 32,850 25,848
Marketing, general, and
administrative expenses (12,106) (11,813) (24,272) (23,704)
--------------------------------------------------------------------
Operating income 5,949 2,352 8,578 2,144
Interest expenses (2,079) (2,255) (4,442) (4,750)
Bankruptcy reorganization
expenses (826) (4,565) (2,951) (6,909)
--------------------------------------------------------------------
Income (loss) from continuing
operations before income
taxes 3,044 (4,468) 1,185 (9,515)
Provision for income taxes (1,094) (426) (1,604) (704)
--------------------------------------------------------------------
Income (loss) from
continuing operations 1,950 (4,894) (419) (10,219)
Discontinued operations:
Income from operations, net
of provision for income
taxes of $169 and $315 for
the quarter and year-to-
date ended July 3, 1994,
respectively -- 472 -- 773
Losses during phase-out
period (185) -- (297) --
--------------------------------------------------------------------
Net income (loss) $ 1,765 $ (4,422) $ (716) $ (9,446)
--------------------------------------------------------------------
Net income (loss) per share
and equivalent share:
Primary and fully diluted:
Continuing operations $ 0.11 $ (0.67) $ (0.03) $ (1.40)
Discontinued operations (0.01) 0.07 (0.02) 0.11
--------------------------------------------------------------------
Net income (loss) $ 0.10 $ (0.60) $ (0.05) $ (1.29)
--------------------------------------------------------------------
Weighted average shares
and equivalent shares 18,007 7,310 13,391 7,310
--------------------------------------------------------------------
CONTACT: Hexcel Corporation, Pleasanton
William P. Meehan, 510/847-9500
DOW CHEMICAL EARNINGS, EXCLUDING DOW CORNING CHARGE AND GAIN ON
PHARMACEUTICAL SALE, TRIPLED TO $2.46
MIDLAND, Mich.--July 27, 1995--The following was released by Dow
Chemical Company (NYSE: DOW):
Second Quarter of 1995 Highlights
% Sales were up 34 percent to $5.5 billion.
% Operating income increased by $749 million to $1.2 billion.
% Earnings more than tripled to $2.46 per share, excluding a
Dow Corning related charge of $1.24, and a gain of 62 cents
on the divestment of the pharmaceutical business.
--------------------------------------------------------------------
(In millions, except for share amounts)
3 Months Ended 6 Months Ended
June 30 June 30
1995 1994 1995 1994
Net Sales $5,517 $4126 $10,722 $7,914
Operating Income 1,207 458 2,282 869
Income from Continuing Operations 334.... 206 898 347
Net Income .. 503 250 1,085 421
Earnings per Common Share from
Continuing Operations 1.22.... 0.75 3.26 1.26
Earnings Per Common Share 1.84 0.91 3.94 1.53
.. Available for Common Stockholders
.... Includes impact of a Dow Corning related pretax charge of $330
million or $1.24 per share.
--------------------------------------------------------------------
Note: Results for 1994 and first quarter 1995 have been
restated to show Dow's pharmaceutical business as a discontinued
operation after its sale in second quarter of 1995.
Review of Quarterly Results
The Dow Chemical Company today announced sales of $5.5 billion
in the second quarter of 1995, up 34 percent versus the same period
in 1994, reflecting a volume gain of 9 percent and a price increase
of 23 percent. Operating income was $1.2 billion, almost tripling
from $458 million in the second quarter of 1994. Results from
second quarter 1994 have been restated to reflect the sale of Dow's
pharmaceutical business in 1995.
Income from continuing operations, it is important to note,
excludes the gain on the sale of the pharmaceutical business, as
well as earnings from that business in prior periods. Income from
continuing operations of $672 million was reduced to $334 million as
a result of a pretax charge of $330 million related to HREF="chap11.dow.html">Dow Corning's
filing for protection under Chapter 11 of the United States
Bankruptcy Code. Dow, a 50 percent shareholder in Dow Corning, has
fully reserved its net investment in that company and will not
record any proportional share of future equity earnings from Dow
Corning. Excluding this charge, second quarter of 1995 earnings
from continuing operations more than tripled to $2.46 per share,
compared to 75 cents per share for the same period last year.
Net income available to common shareholders was $503 million, or
$1.84 per share. This included an after tax gain on the sale of
Dow's pharmaceutical business of 62 cents per share, as well as the
Dow Corning charge of $1.24 per share.
Chemicals and Performance Products had strong second quarter
sales of $1.5 billion, up 47 percent versus a year ago. Operating
income was $425 million, an increase of 338 percent from the second
quarter of 1994. Improved prices for chlor-alkali products
contributed to these strong results. Performance Products set a
quarterly record for sales and profitability.
Plastics had sales of $2.4 billion in the second quarter of
1995, up 37 percent compared to the same period in 1994. Operating
income increased by 188 percent to $712 million. An improved
pricing environment versus the second quarter of last year
contributed to the strong performance of the plastics segment.
Thermoplastics, Thermosets and Fabricated Products each posted
record sales and profits for the quarter.
Hydrocarbons and Energy experienced a 37 percent sales increase
to $697 million with an operating loss of $21 million versus a gain
of $27 million in the same period in 1994. The decline in operating
income was due in large part to the expiration of two major power
contracts for Destec Energy Inc.
Consumer Specialties had $816 million in sales, an increase of 8
percent versus the same period a year ago. The 1994 results have
been restated to reflect the sale of Dow's pharmaceutical business.
Operating income increased to $152 million from $144 million in the
second quarter of 1994, reflecting continued strength in
Agricultural Products, as well as restructuring efforts in Consumer
Products.
"We are very pleased with our second quarter results. Our
businesses are strong. We experienced a significant turnaround in
sales and profits in Europe, while the United States showed
excellent performance in the quarter," said Enrique C. Falla, Dow
executive vice president.
"As we approach the second half of 1995, we are anticipating
continued improvements over last year. While there is softening in
some markets, reflecting inventory adjustments, Dow will continue to
enjoy strong results for the year as we remain focused on our
strategy for value growth and our commitment to cost reduction."
CONSOLIDATED STATEMENTS OF INCOME
The Dow Chemical Company and Subsidiaries
(Unaudited)
Three Months Ended Six Months Ended
June 30 June 30 June 30 June 30
In millions, except for 1995 1994 1995 1994
share amts.
--------------------------------------------------------------------
Net Sales $5,517 $4,126 $10,722 $7,914
--------------------------------------------------------------------
Operating Costs and Expenses
Cost of sales 3,571 2,978 6,897 5,713
Insurance and finance co.
operations, pretax income (9) (14) (22) (41)
Research and development
expenses 193 190 406 386
Promotion and advertising
expenses 109 113 226 208
Selling and administrative
expenses 437 391 913 759
Amortization of intangibles 9 10 20 20
-----------------------------------
Total operating costs and
expenses 4,310 3,668 8,440 7,045
--------------------------------------------------------------------
Operating Income 1,207 458 2,282 869
--------------------------------------------------------------------
Other Income (Expense)
Equity in earnings of
20%-50% owned companies 15 32 40 58
Interest expense (98) (113) (199) (208)
Interest income and foreign
exchange 35 50 73 40
Net loss on investments (Note B) (330) 0 (330) 0
Sundry 3 30 14 33
----------------------------------
Total other income (expense) (375) (1) (402) (77)
--------------------------------------------------------------------
Income before provision for taxes
on income and minority interests 832 457 1,880 792
Provision for taxes on income 420 174 834 306
Minority interests' share in
income 77 76 145 136
Net income 335 207 901 350
Preferred stock dividends 1 1 3 3
--------------------------------------------------------------------
Income from continuing operations $334 $206 $898 $347
--------------------------------------------------------------------
Discontinued Operations (Note C):
Income from pharmaceutical business,
net of taxes on income 0 44 18 74
Gain on sale of pharmaceutical
business, net of taxes on income 169 0 169 0
--------------------------------------------------------------------
Net income available for common
stockholders $503 $250 $1,085 $421
--------------------------------------------------------------------
Average common shares
outstanding 273.5 275.9 275.2 275.3
Earnings per common share from
continuing operations $1.22 $0.75 $3.26 $1.26
Earnings per common share $1.84 $0.91 $3.94 $1.53
Common stk dividends declared
per shr $0.75 $0.65 $1.40 $1.30
--------------------------------------------------------------------
Depreciation $309 $307 $668 $614
Capital expenditures (Note D) $575 $271 $778 $523
Notes to the Financial Statements
Note A: The unaudited interim financial statements reflect all
adjustments (consisting of normal recurring accruals) which, in the
opinion of management, are considered necessary for a fair
presentation of the results for the period covered. Certain
reclassifications of prior year amounts have been made to conform to
current year presentation. These statements should be read in
conjunction with the financial statements and notes thereto included
in the Company's Form 10-K for the year ended December 31, 1994.
Note B: On May 15, 1995, Dow Corning Corporation announced that
it had filed for protection under Chapter 11 of the United States
Bankruptcy Code with the United States Bankruptcy Court in Bay City,
Michigan. The Company is a 50 percent shareholder in Dow Corning
Corporation. The Company's investment in Dow Corning was $374
million at March 31, 1995.
Dow Corning reported an after tax net loss of $167 million for
the second quarter of 1995, of which the Company's share amounted to
$83 million. Dow Corning's second quarter loss was a result of a
$221 million after tax charge taken to reflect a change in
accounting method for its contribution to a breast implant global
settlement. The change in the method of accounting from a present
value or discounted basis, to an undiscounted basis, resulted from
uncertainties arising from Dow Corning's filing for protection under
Chapter 11.
As a result of Dow Corning's Chapter 11 filing and its 1995
second quarter loss, the Company has recognized a charge against
income of $330 million, has fully reserved its net investment in Dow
Corning and will not recognize its 50 percent share of future equity
earnings while Dow Corning remains in Chapter 11. The charge
impacted the Company's second quarter of 1995 earnings by $1.24 per
share.
Note C: On June 28, 1995, the Company completed the sale of its
approximately 197 million shares of Marion Merrell Dow to Hoechst
for about $5.1 billion or $25.75 per share. In addition,
subsidiaries of the Company have completed the sale of the Company's
Latin American pharmaceutical business based in Argentina, Brazil
and Mexico to Roussel Uclaf S.A. for about $133 million. These two
transactions, net of taxes on income of $382 million, increased the
Company's second quarter of 1995 earnings by approximately $169
million or 62 cents per share.
The Company's consolidated statements of income have been
restated to reflect the pharmaceutical business as a discontinued
operation. Net sales attributable to the pharmaceutical business
for the three months ended March 31, 1994, June 30, 1994 and March
31, 1995 were $753, $808 and $757 million, respectively. Taxes on
income from the pharmaceutical business for the three months ended
March 31, 1994, June 30, 1994, and March 31, 1995 were $25, $33 and
$36 million, respectively.
Note D: Capital expenditures for the second quarter of 1995
increased $304 million compared to the second quarter of 1994 as a
result of the Company investing $318 million in acquiring assets
formerly leased.
DOW CHEMICAL EPS RECONCILIATION
Three months ended Six months ended
June 30 June 30 June 30 June 30
1995 1994 1995 1994
Net gain from disposition of
pharmaceuticals business $0.62 --- $0.62 ---
Earnings from discontinued
pharmaceutical operations --- $0.16 0.06 $0.27
Impact of charge related to
Dow Corning (1.24) --- (1.24) ---
Other earnings 2.46 0.75 4.50 1.26
Net earnings per common share $1.84 $0.91 $3.94 $1.53
/CONTACT: Darlene MacKinnon of Dow Chemical, 517-636-2876/