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MOODYS.COM
14 DECEMBER 2015
NEWS & ANALYSIS Corporates 2 » Dow-DuPont Merger Announcement Lacks Credit Details » Kinder Morgan Plan to Cut Its Dividend and Reduce Leverage Is
Credit Positive » Cott’s Water Service Business Spills into Canada with Credit-
Positive AquaTerra Deal » CMA CGM’s Acquisition of Neptune Orient Lines Would Push
Up Leverage » Alliance Automotive’s Coler Acquisition Brings Credit-Positive
Scale and Geographic Diversification » Greenland’s Proposed Private Share Placement Is Credit Positive » Reliance Communications’ Towers Sale Would Be Credit Positive
Infrastructure 11 » Korea’s Toll Rate Hike Is Credit Positive for Korea
Expressway Corporation
Banks 13 » Canada’s Increased Capital Requirements for Residential
Mortgages Are Credit Positive for Banks » Canada Mortgage and Housing Corporation Increases Minimum
Down Payment and Securitization Fees, a Credit Positive » Guatemala’s New Credit-Card Law Is Credit Negative for Banks » Russian Auto Lenders Face Declining Loan Originations as Vehicle
Sales Slump » State Support to National Bank of Greece Triggers a Bail-in of
Security Holdouts and Preference Shares
Insurers 22 » Pacific Life’s Potential IPO of Aircraft Leasing Subsidiary Is
Credit Positive
Funds 24 » Third Avenue High-Yield Fund’s Liquidation Is Not Indicative of
Wider High Yield Sector
Sovereigns 26 » IMF Rule Change Permits Its Ongoing Lending to Ukraine, a
Credit Positive
Sub-sovereigns 28 » Lower Share of Income Tax Would Negatively Affect
Serbian Municipalities
US Public Finance 30 » Illinois’ Release of Revenues Is Credit Positive for Chicago and
Other Local Governments
RATINGS & RESEARCH Rating Changes 32
Last week we downgraded Clear Channel Worldwide Holdings, Banco Angolano de Investimentos, Khanty-Mansiysk bank Otkritie and VTB Bank (Armenia), and upgraded E*TRADE Financial Corp., E*TRADE Bank, Jefferson County (Alabama) and seven US CMBS, among other rating actions.
Research Highlights 42
Last week we published on German corporates, US building materials, US high-tech medical-devices, global base metals, Canadian broadband communications, North American covenant quality, US healthcare, US correctional healthcare management, EMEA speculative-grade corporates, North American soft beverages, global banks, US banks, Canadian banks, Latin American banks, African banks, Gulf Cooperation Council banks, US specialty finance companies, Dutch banks, Cypriot banks, Russian banks, United Arab Emirates banks, Baltic banks, global life insurers, global P&C insurers, global reinsurers, global money market funds, global asset managers, Italian insurers, Chinese banks, Belgian banks, Canadian life insurers, US life insurers, European insurers, US health insurers, global insurers, global bond funds, Kazakhstan, Qatar, Albania, Brazil, Indonesia, Cuba, Panama, Solomon Islands, English housing associations, European sub-sovereigns, US states, US housing finance agencies, California, US hospitals and health systems, marketplace lending platforms, US auto ABS, Japanese securitization, European securitization, private US student-loan ABS, European SME ABS, Canadian securitization, global covered bonds, global structured credit and US mortgage lenders, among other reports.
RECENTLY IN CREDIT OUTLOOK
» Articles in Last Thursday’s Credit Outlook 54 » Go to Last Thursday’s Credit Outlook
NEWS & ANALYSIS Credit implications of current events
2 MOODY’S CREDIT OUTLOOK 14 DECEMBER 2015
Corporates
Dow-DuPont Merger Announcement Lacks Credit Details Last Friday, E.I. du Pont de Nemours and Company (A3 negative) and The Dow Chemical Company (Baa2 stable) announced plans to merge in a $130 billion deal that would initially combine two of the world’s biggest chemicals companies and then split them into three new entities, each with a distinct focus on agricultural, material sciences and specialty products. The deal is credit negative for DuPont because it will be a significantly smaller and less diversified company on a post-split basis, and, if the company retains all or most of its existing debt, would potentially be more highly levered. The deal does bring DuPont’s better scale, significant cost synergies and strengthening of the agriculture portfolio.
We changed the outlook on DuPont’s rating to negative from stable to also reflect the complexities of combining and restructuring the agriculture business, which comes at a time when the industry is facing significant headwinds and DuPont’s metrics are already weak for the A3 category. The change reflects the lack of details regarding the legal structure post-merger and the financial policies and balance sheet targets on a post-split basis. We affirmed Dow’s Baa2 ratings and stable outlook given that its credit quality is not likely to change over the next year and management has stated that it intends to keep all three post-split companies investment grade. However, Dow’s credit quality is tempered by similar questions regarding the lack of detailed information.
The merger will propel Dow and DuPont to $83 billion in revenues and create the leading global agricultural player in seeds and crop protection products with roughly $19 billion in revenues. Additionally, it will create a larger and more technologically diverse producer of resins for the plastics packaging, transportation and construction sectors. The combined company plans to remove an additional $3 billion of costs, which is in addition to Dow’s and DuPont’s existing cost reduction programs.
The merger offers the US chemical giants the opportunity to accelerate earnings and cash flow growth during a period of low organic growth and increasingly competitive markets. The merger-of-equals structure presents tax advantages, particularly in Dow’s agricultural chemicals business, and avoids raising additional debt, as an acquisition with an equity premium might require. The structure of the deal also avoids agreeing upon valuations for these businesses and instead determines ownership based on current market valuations.
The merger would strengthen the main segments of the combined company, primarily to create an agricultural company that is much more sustainable and competitive in both chemicals and seeds. The two-step process – merging the two entities initially, then splitting into three separate businesses later – allows a comprehensive portfolio realignment and restructuring in preparation for splitting into independent companies. The merger will also facilitate additional cost-cutting opportunities, which both companies had already been pursuing on their own.
It makes good strategic sense for the companies to improve their scale and market position in a number of businesses, as well as lowering combined costs across the increasingly competitive markets in which Dow and DuPont compete, particularly at time when market dynamics, falling farmer income owing to low crop prices and the depreciation of the Brazilian real impede growth and margin improvement. The combined agricultural business will elevate the new company’s market position in insecticides, herbicides and seeds, while the materials and specialty businesses will gain advantages in technology, market shares, sales and operational synergies.
However, there is a lack of clarity and detail at this early stage of the process. The legal structure of the combined entity and how it will turn into three independent companies remain unclear from company announcements. As a result, we do not know exactly which assets will service Dow’s or DuPont’s bonds, and
John Rogers Senior Vice President +1.212.553.4465 [email protected]
Joseph Princiotta Vice President - Senior Analyst +1.212.553.6823 [email protected]
This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on www.moodys.com for the most updated credit rating action information and rating history.
NEWS & ANALYSIS Credit implications of current events
3 MOODY’S CREDIT OUTLOOK 14 DECEMBER 2015
how the composition of those assets will change as the portfolio is realigned and prepared for separation into three distinct companies.
To assess the credit effects on Dow’s and DuPont’s bonds, we will need to know the historical performance of each of the three new entities, and specifically which assets and liabilities will remain in the Dow and DuPont legal entities to support the existing debt. We do not expect that the combined company’s total debt will increase with the merger, but we do not know how it, its pension obligations or other liabilities, will be apportioned among the three companies.
NEWS & ANALYSIS Credit implications of current events
4 MOODY’S CREDIT OUTLOOK 14 DECEMBER 2015
Kinder Morgan Plan to Cut Its Dividend and Reduce Leverage Is Credit Positive Last Tuesday, Kinder Morgan Inc. (KMI, Baa3 stable) announced that it would slash its annual dividend by 75% to $1.1 billion from $4.4 billion, and would reduce its leverage target to a net debt/EBITDA ratio of 5.5x from 5.6x. The dividend cut is credit positive because it eliminates KMI’s need to tap the debt and equity markets in 2016 to finance its dividends or capital expenditures.
With the lower dividend, KMI, North America’s largest midstream energy company, can fund its expected $2.2 billion in negative free cash flow in 2016 under its revolving credit facility. The move led us to change KMI’s outlook back to stable roughly a week after we changed it to negative based on KMI’s plan to raise its ownership stake in NGPL PipeCo. LLC (Caa2 negative)1 and pressure its already high leverage.
KMI’s leverage in 2016 will be high for an investment-grade company at 5.7x, including our standard adjustments (5.8x including proportionate consolidation of NGPL), but eliminating its reliance on the markets will give the company much greater flexibility in managing its leverage. Even this high level will still easily comply with KMI’s sole financial covenant, requiring a consolidated total debt/EBITDA ratio of no greater than 6.5x.
KMI benefits from relatively stable cash flow generated by a combination of long-term contracts and regulated returns from energy infrastructure assets. We estimate that about 10% of the company’s operating cash flow is subject to short-term market volatility, primarily related to oil production tied to the carbon dioxide business segment, which we expect will remain weak through 2016 owing to low commodity prices.
With the change in dividend policy, KMI’s dividend coverage moves to a very large 4.4x from a very tight 1x – a level comparable to non-master limited partnership (MLP) and non-MLP-like companies, reflecting the significance of this change in KMI’s corporate strategy.
KMI’s liquidity is also strong. For 2016, we expect that the company will have about $5.5 billion of cash from operations, and a $4 billion undrawn revolver expiring in 2019. These are more than enough to fund roughly $7.6 billion in cash needs, including $4.8 billion in capital investments, $1.1 billion in dividends and $2.2 billion in negative free cash flow, which includes $1.7 billion in debt maturities. The company can use its revolver to fund its roughly $2.1 billion shortfall in cash from operations.
1 See Kinder Morgan’s Purchase of NGPL Stake Is Credit Negative, 7 December 2015.
Terry Marshall Senior Vice President +1.416.214.3863 [email protected]
NEWS & ANALYSIS Credit implications of current events
5 MOODY’S CREDIT OUTLOOK 14 DECEMBER 2015
Cott’s Water Service Business Spills into Canada with Credit-Positive AquaTerra Deal Last Tuesday, Cott Corporation (B2 stable) said that it would buy AquaTerra Corp., Canada’s oldest and largest direct-to-consumer home and office water delivery business, for $47 million. The credit-positive deal will expand Cott’s water service and delivery business beyond the US and into Canada, a core market for Cott’s legacy beverages business. It will also further diversify Cott away from carbonated soft drinks and shelf-stable juices and offer cross-selling opportunities through US bottled water office coffee and water filtration services provider DS Services’ (DSSA) established commercial relationships with US companies that also have a presence in Canada. We believe that these opportunities will help fuel Cott’s top- line growth.
The AquaTerra deal is both larger and more expansive in terms of geographic reach than Cott’s typically smaller bolt-on water services purchases since entering the business last year with the $1.25 billion DSSA acquisition. The AquaTerra purchase will also provide DSSA with vertical-integration cost savings through the use of Cott’s Canadian facilities.
AquaTerra was founded in 1882 and has grown through acquisitions within Canada. With 42 distribution centers and more than 200 delivery vehicles, AquaTerra distributes drinking water, supplies water filtration systems and offers a comprehensive coffee and tea program to homes and offices across Canada.
We estimate that the acquisition will slightly increase Cott’s leverage to 4.8x from 4.7x. But this is still within the range we expected one year after the DSSA acquisition, which reduced Cott’s reliance on the shrinking carbonated soft drink category to less than 20% from 40% in 2012. DSSA also reduced Cott’s lower-margin private-label business to 49% from 74% of revenues and lowered customer concentration.
Cott, based in Toronto, Ontario, and Tampa, Florida, is one of the world’s largest private-label and contract manufacturing beverage companies and has annual sales of approximately $3 billion. Cott’s product portfolio includes carbonated soft drinks; clear, still and sparkling flavored waters; juice; juice-based products; bottled waters; energy related drinks; and ready-to-drink teas. Cott’s customers include many of the largest national and regional grocery, drugstore and convenience store chains, and wholesalers. Following the DSSA acquisition, Cott is also a provider of bottled water and related services delivered directly to residential and commercial customers in the US.
Linda Montag Senior Vice President +1.212.553.1336 [email protected]
NEWS & ANALYSIS Credit implications of current events
6 MOODY’S CREDIT OUTLOOK 14 DECEMBER 2015
CMA CGM’s Acquisition of Neptune Orient Lines Would Push Up Leverage Last Monday, French container shipping company CMA CGM S.A. (B1 stable) announced a pre-conditional voluntary general cash offer to acquire Singaporean counterpart Neptune Orient Lines Limited (NOL, unrated) for $2.4 billion (SGD1.30 per share). Although the proposed deal makes strategic sense for CMA CGM by strengthening its position as the world’s third-largest player, it is credit negative for the company because its leverage would initially increase substantially as a result of the transaction being fully cash and debt financed. Following the announcement, we changed the outlook on CMA CGM’s B1 rating to stable from positive and affirmed its ratings.
Under the proposed deal, CMA CGM would acquire 100% of NOL for $2.4 billion and assume NOL’s financial net debt, which totalled $2.6 billion as of 30 September 2015. The acquisition, which will be funded with a mix of cash and bank financing from a syndicate of international banks, would materially increase CMA CGM’s leverage (i.e., gross debt/EBITDA, including our adjustments) to approximately 5.5x in 2016 (pro forma for a full-year of NOL’s cash flows) from 4.2x for the last 12 months to September 2015. CMA CGM intends to review the combined company’s assets and make disposals totalling at least $1 billion. Assuming the company is successful in these efforts, it will contribute to CMA CGM’s leverage declining to a level in line with its B1 rating, namely 4x-5x, within 18 months after the NOL deal closes.
Temasek Holdings (Private) Limited (Aaa stable), NOL’s largest shareholder with a 67% stake, has irrevocably undertaken to tender all of its shares into the offer. However, the acquisition still needs regulatory approvals from the European Union, US and China, which we expect by mid-2016, before CMA CGM can launch its offer for NOL.
The proposed transaction involves some execution risk, including a successful sale of assets, NOL’s exit from alliances such as G62 (which could take up to 12 months), and NOL’s subsequent entrance into CMA CGM’s alliances. NOL’s weak performance over the past years, with negative core EBIT since 2011, and the challenging market environment in container shipping, where freight rates have continued to decline in 2015, also pose downside risks.
Still, we understand the strategic rationale behind the proposed deal because it would strengthen CMA CGM’s business profile. Acquiring NOL would increase CMA CGM’s capacity by approximately one third: currently, CMA CGMA has a capacity of 1,781 thousand twenty-foot equivalent unit (TEUs), and NOL has a capacity of 618 thousand TEUs. This would consolidate its position as the third-largest player in the container shipping segment, narrowing the gap with Maersk Line, the market leader owned by A.P. Møller Mærsk A/S (Baa1 positive) and Mediterranean Shipping Company (unrated).
Acquiring NOL would also strengthen CMA CGM’s position on certain routes, particularly Transpacific and intra-Asia routes, increasing its geographic diversification. We expect that the proposed transaction will generate material cost synergies, notably related to network optimisation and headcount reduction, which has been the case in previous acquisitions in the sector. We estimate that cost synergies will reach 2%-3% of the combined group’s revenues.
2 G6 is an alliance on East-West trades, whose members include APL, Hapag-Lloyd, Hyundai Merchant Marine, Mitsui O.S.K. Lines,
Nippon Yusen Kaisha and Orient Overseas Container Line.
Marie Fischer-Sabatié Senior Vice President +33.1.53.30.10.56 [email protected]
NEWS & ANALYSIS Credit implications of current events
7 MOODY’S CREDIT OUTLOOK 14 DECEMBER 2015
Alliance Automotive’s Coler Acquisition Brings Credit-Positive Scale and Geographic Diversification On Wednesday, automotive spare parts distributor Alliance Automotive Holding Limited (B1 stable) announced that it had completed its acquisition of Coler GmbH & Co KG. (unrated), a leading automotive aftermarket player in the West of Germany, for €39 million. The acquisition is credit positive because it will strengthen Alliance’s scale and geographic and brand diversification without increasing financial leverage.
Alliance will pay the €39 million price for Coler in cash, €14 million of which is from cash on the balance sheet while €25 million is from cash injected by Alliance’s shareholders on a pari-passu basis. Based on management’s expected run-rate EBITDA of €9.9 million, and including fixed-cost synergies and €27 million debt at Coler, the implied purchase multiple is around 6.8x.
Including the Coler acquisition, the company has acquired 12 companies this year in France, the UK and Germany. These bolt-on acquisitions are funded by €65 million of cash raised through a bond tap issuance in May 2015 and the €25 million cash injection from equity holders. Management estimates a total run-rate EBITDA contribution of around €21 million for all 12 acquisitions after synergies, implying an EBITDA purchase multiple of around 4.5x (excluding the equity injection). As a result, the company expects the acquisitions to be leverage neutral based on its 12-month pro forma run-rate EBITDA.
Although management has experience building the company through acquisitions, this aggressive strategy carries execution risk. With the Coler acquisition, Alliance enters a new country, adding Germany as a third market after France and the UK. Compared with the other 11 acquisitions this year, the Coler acquisition is the largest. With €150 million in revenue, Coler is a distant No. 3 player in the German automotive aftermarket, behind Stahlgruber GmbH (unrated) and Wessels+Mueller (unrated), but ahead of the fragmented rest of the German market.
However, the €25 million cash injection from equity holders significantly reduces the debt-funded portion of the Coler acquisition, improves the potential for deleveraging and points to the continued strategic support of Alliance’s owners, The Blackstone Group and management. Additionally, Alliance’s entrance into Germany presents the company with an opportunity to improve Alliance’s product and geographic diversification. Management estimates the size of the German automotive aftermarket was €14.2 billion in 2013, greater than the French market (€8.5 billion including tires in 2012) and the UK market (€6.5 billion in 2012).
We note that the company reported strong current trading, with revenue for the first nine months of 2015 up 12.3% over the previous year, while EBITDA was up 22.9% over the same period. We consider Alliance’s liquidity position to be good, with €87.8 million of cash on the balance sheet and an undrawn €50 million super senior revolving credit facility as of September 2015.
Pieter Rommens Vice President - Senior Analyst +44.20.7772.1346 [email protected]
NEWS & ANALYSIS Credit implications of current events
8 MOODY’S CREDIT OUTLOOK 14 DECEMBER 2015
Greenland’s Proposed Private Share Placement Is Credit Positive On Wednesday, Greenland Holding Group Company Limited (Baa3 negative) announced plans to raise up to RMB30.15 billion from a private share placement constituting around 14.59% of its enlarged share capital. If successful, the private share placement would be credit positive because it will lower the company’s debt leverage and strengthen its liquidity.
The equity issuance would lower Greenland’s debt leverage because the company plans to use part of the net proceeds to repay bank loans, and because it will reduce the company’s need to raise additional debt to fund its business expansion. We estimate that the company’s pro forma adjusted debt/total capitalization will decline to about 69% from around 77% at the end of September 2015 (see exhibit).
Greenland’s Adjusted Debt/Capitalization, 2011-September 2015
Source: Moody’s Financial Metrics
However, we continue to expect the company’s debt leverage to remain high, with its forecasted adjusted debt/capitalization to be 70%-75% over the next 12-18 months. These levels are weak for its Baa3 rating category. We believe that Greenland’s rising debt leverage is a result of its fast expansion and slow collection of contracted sales proceeds. If such weaknesses persist, the company’s Baa3 issuer rating will be under pressure for downgrade.
The share placement will provide Greenland with a boost to its liquidity immediately after completion of the share placement. However, we expect the boost to be temporary because the company plans to use RMB11 billion of the issuance proceeds to fund its property project development, RMB10 billion to invest in financial service businesses and RMB9 billion to repay its bank loans.
Greenland is a Shanghai, China-based state-controlled company whose largest shareholder is the Shanghai State-Owned Assets Supervision and Administration Commission. Although its main focus is on the real estate sector, it has interests in energy, construction, finance and auto dealerships.
64%
66%
68%
70%
72%
74%
76%
78%
2011 2012 2013 2014 30 Sept. 2015 Pro Forma 30 Sept.2015
Franco Leung, CFA Vice President - Senior Analyst +852.3758.1521 [email protected]
Chris Wong, CFA Associate Analyst +852.3758.1531 [email protected]
NEWS & ANALYSIS Credit implications of current events
9 MOODY’S CREDIT OUTLOOK 14 DECEMBER 2015
Reliance Communications’ Towers Sale Would Be Credit Positive On 4 December, Indian telecommunications company Reliance Communications Limited (RCOM, Ba3 stable) announced that it had signed a non-binding term sheet with Tillman Global Holdings, LLC and TPG Asia, Inc. regarding the proposed sale of RCOM’s nationwide tower assets and related infrastructure. The transaction, if consummated, would be credit positive for RCOM because it would allow the company to meet its deleveraging target of 4.0x-4.5x by the fiscal year ending March 2017, which is significantly lower than its leverage of 6.1x for the last 12 months that ended September 2015.
The transaction, which the parties expect to close in second-quarter 2016, calls for RCOM to sell its tower assets, held under its subsidiary, Reliance Infratel Limited (RITL, unrated). Based on previous tower transactions in India, we expect the sale price of the approximately 43,500 towers owned by RITL to be around INR220 billion ($3.4 billion). RCOM intends to use all of the proceeds to reduce balance-sheet debt.
Although RCOM’s operating costs for its towers will decline with the sale, it will lease back the towers, which will increase the company’s consolidated lease expenses and which we will capitalize and add to gross debt in our analysis. We assume that RCOM will enter into long-term leaseback arrangements for the towers sold, with monthly fixed lease rental payments of $500 per tower. This rental expense assumption is consistent with previous tower transactions and prevailing rents in the Indian tower sector.
For capitalizing operating leases, we use the higher of a rent multiple or net present value of future minimum lease commitments. The final adjustment will depend on the accounting treatment and disclosures adopted by the company. Using a rent multiple produces an additional $783 million of debt operating lease adjustment for the 43,500 towers (43,500 towers x $500 per month x 12 months x a 3 times multiple based on our methodology for capitalizing of operating leases). Using net present value produces an additional $1.9 billion assuming a 10-year lease.
As shown in the exhibit below, the company had around $7.0 billion of adjusted debt as of 30 September 2015, which will fall to $4.4-$5.5 billion pro forma for the transaction (see Exhibit 1).
EXHIBIT 1
Reliance Communications Limited’s Adjusted Debt Before and After the Tower Sale Our operating lease adjustment will partially offset the reduction in balance-sheet debt.
Sources: Reliance Communications Limited, Moody’s Financial Metrics and Moody’s Investors Service estimates
When we assigned RCOM its Ba3 stable rating in March, we considered its deleveraging plans based on sales of its sub-sea cable subsidiary, its direct-to-home cable business and property assets in Mumbai and Delhi that we expected would reduce adjusted leverage to 4.5x-5.0x for fiscal 2016 from 5.3x a year earlier. However, to date the company has not announced any asset disposals, and we do not expect RCOM to receive any significant proceeds from these asset sales for the next two or three quarters.
$7.0
$3.4
$0.8
$4.4
$0
$1
$2
$3
$4
$5
$6
$7
$8
*Moodys Adj Debtas of 30 Sept 2015
100% of CashProceeds for Debt
Reduction
New Op Lease Adj Moody's Pro FormaAdj Debt Post Tower
Sales
$ Bi
llion
s
Assumptions: - 43,500 towers sold for a total of $3.4 billion and proceeds used to pay down balance sheet debt - RCOM leases back the full portfolio of 43,500 towers which results in $0.8 billion debt adjustment (i.e., Moody’s operating lease adjustment) - Therefore, total effect on Moody’s adjusted debt is around a $2.6 billion reduction
Refers to incremental operating lease adjustment using NPV
$1.1 $1.1
Nidhi Dhruv Assistant Vice President - Analyst +65.6398.8315 [email protected]
Carole Herve Associate Analyst +852.3758.1505 [email protected]
NEWS & ANALYSIS Credit implications of current events
10 MOODY’S CREDIT OUTLOOK 14 DECEMBER 2015
Deleveraging as a result of the tower sale will be slower but steeper as compared with our initial expectations (see Exhibit 2).
EXHIBIT 2
Comparison of Reliance Communications’ Adjusted Debt/EBITDA under Asset-Sale and Tower- Sale Scenarios
Sources: Moody’s Financial Metrics and Moody’s Investors Service estimates
RCOM is pursuing a separate sale of RITL’s fibre optics business in the next few months. We estimate the valuation of the fibre business to be INR80-INR100 billion ($1.2-$1.5 billion). Assuming the transaction materializes and the proceeds are applied to debt reduction, we estimate that RCOM’s adjusted leverage will decrease by an additional 50 basis points over the next two years.
4.5
5.95.8
5.45.3
4.5-5.0
3.5-4.0
6.15.9
4.0-4.5
3.5-4.0
2.5
3.0
3.5
4.0
4.5
5.0
5.5
6.0
6.5
FYE 2011 FYE 2012 FYE 2013 FYE 2014 FYE 2015 12 months toSept 2015
FYE 2016 (Est) FYE 2017 (Est) FYE 2018 (Est)
Assuming non-core asset sales, our expectation when we assigned the rating in March 2015
Assuming tower sales under the current transaction
NEWS & ANALYSIS Credit implications of current events
11 MOODY’S CREDIT OUTLOOK 14 DECEMBER 2015
Infrastructure
Korea’s Toll Rate Hike Is Credit Positive for Korea Expressway Corporation Last Thursday, Korea’s Ministry of Land, Infrastructure and Transport (MOLIT) approved an average expressway toll rate hike of 4.7%, the first upward adjustment since 2011. The move is credit positive for Korea Expressway Corporation (KEC, Aa3 positive) because it will improve the company’s operating cash flow and financial profile. It also demonstrates the Government of Korea’s (Aa3 positive) continued commitment to support the company’s financial health.
The toll rate hike will take effect on 29 December 2015. The increase will apply to long-haul expressways in Korea that connect Seoul to major cities in the southern and eastern parts of the Korean peninsula, and connect Busan, Korea’s second-largest city, to Changwon, an industrial city in the south.
We expect the toll rate hike to increase KEC’s annual funds from operations (FFO) by around KRW160 billion over our initial projection. This incremental FFO is equal to about 10% of KEC’s projected FFO over the next 12-18 months. As a result, we forecast that over the next 12-18 months, KEC’s FFO/debt will improve to 6%-7% from 5.6% in 2014 and its FFO interest coverage to around 2.5x from 2.2x in 2014 (see Exhibit 1).
EXHIBIT 1
Korea Expressway Corporation’s Funds from Operations Metrics The toll rate hike will improve KEC’s financial profile over the next one to two years.
Sources: Moody’s Financial Metrics and Moody’s Investors Service forecast
We expect the toll rate hike to have minimal effect on traffic volumes because there are effectively no alternative expressways for the country’s inter-city traffic. In addition, traffic volumes in Korea were unaffected by past toll rate increases in 2006 and 2011, and have continued to grow over the past 10 years, except for during the economic slowdown in 2008-09 (see Exhibit 2).
0.0x
0.5x
1.0x
1.5x
2.0x
2.5x
0%
1%
2%
3%
4%
5%
6%
7%
2010 2011 2012 2013 2014 2015-16(F)
FFO/Debt - left-axis FFO Interest Coverage - right-axis
Mic Kang Vice President - Senior Analyst +852.3758.1373 [email protected]
Sean Hwang Associate Analyst +852.3758.1587 [email protected]
NEWS & ANALYSIS Credit implications of current events
12 MOODY’S CREDIT OUTLOOK 14 DECEMBER 2015
EXHIBIT 2
Traffic Volume on Korea Expressway Corporation-Affected Routes 2005-14 Traffic volume has been unaffected by toll rate increases.
Note: The traffic volume is for the long-haul expressways that connect the major cities and are affected by the upcoming toll rate hike. Source: Korea Expressway Corporation
We expect that KEC’s credit metrics will improve over the next 12-18 months because the company will boost its profitability through the toll rate hike and a cut in debt-funded capital expenditures and operating costs under its government-initiated 2013-17 financial management plan. The plan aims to curb excessive debt increases at KEC and other major government-related corporations, thereby strengthening their financial profiles.
The government’s approval for the toll rate hike (on top of its ongoing capital injections to KEC) reflects its commitment to support the company’s financial health. The capital injections generally account for 40%-50% of the company’s total capital expenditures. The government provides capital injections to KEC because construction of new expressways requiring massive capital expenditures is a part of the company’s mandated policy role.
We expect the government to remain highly supportive of KEC over at least the next two to three years, given the company’s strategic importance as a near-monopoly operator and implementer of mandated policies for Korea’s toll-roads, as well as KEC’s ownership by the government.
0
100
200
300
400
500
600
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Mill
ion
Veh
icle
s
Feb 2006: 4.9% toll increase
Nov 2011: 2.9% toll increase
NEWS & ANALYSIS Credit implications of current events
13 MOODY’S CREDIT OUTLOOK 14 DECEMBER 2015
Banks
Canada’s Increased Capital Requirements for Residential Mortgages Are Credit Positive for Banks Last Friday, the Office of the Superintendent of Financial Institutions (OSFI), Canada’s bank regulator, announced that it is planning to increase regulatory capital requirements for residential mortgages and home-equity lines of credit held by Canadian banks. Increased capital requirements for mortgages is credit positive for Canadian banks because they will help to counteract two of the Canadian banking system’s key vulnerabilities: high household debt to income and elevated housing prices.
The announcement of these new rules coincided with an announced tightening of the down-payment requirements for government-insured mortgages, and is part of a package of macro-prudential measures aimed at slowing the rapid rise of housing prices in major urban markets in Canada. OSFI will consult with banks and other stakeholders over the course of 2016 before making any changes. We expect the final rules to be in place no later than 2017.
The planned changes to the regulatory capital framework will help to ensure that capital requirements keep pace with housing market developments and reflect underlying risks. However, in contrast with recent regulatory actions in Australia, which imposed more stringent capital requirements retroactively on existing mortgage portfolios, the OSFI action will be applied on a go-forward basis to new mortgage loans. This approach will dilute the immediate credit benefits to the Canadian banks, but nonetheless will be positive in the future.
The expected changes will affect the regulatory capital requirements of those banks using internal models for mortgage default risk, which includes all of the large Canadian banks that we rate. The change will affect banks’ uninsured mortgages only. Low capital requirements on mortgages that are insured against default will continue, in recognition of the government backstop on that insurance. As noted in the exhibit below, Canadian banks vary in their proportionate exposure to residential mortgages. Those with the highest relative uninsured exposures – Royal Bank of Canada (Aa3/Aa3 negative, a23) and Bank of Nova Scotia (Aa2/Aa2 review for downgrade, a1 review for downgrade) – will be most affected by OSFI’s action, but given that the new requirements will only be applicable to new mortgages, the benefit will accrue over time.
3 The bank ratings shown in this report are the bank’s deposit rating, senior unsecured debt rating and baseline credit assessment.
David Beattie Senior Vice President +1.416.214.3867 [email protected]
NEWS & ANALYSIS Credit implications of current events
14 MOODY’S CREDIT OUTLOOK 14 DECEMBER 2015
Canadian Banks’ Insured and Uninsured Mortgage Exposures as of 31 October 2015 Bank of Nova Scotia and Royal Bank of Canada would be most affected by higher residential mortgage capital requirements.
Note: BMO = Bank of Montreal; BNS = Bank of Nova Scotia; CIBC = Canadian Imperial Bank of Commerce; NBC = National Bank of Canada; RBC = Royal Bank of Canada; TD = Toronto-Dominion Bank. Sources: Company financials and Moody’s Investors Service
There is little detail in the OSFI announcement, other than that it expects to incorporate the rule change by way of a loss-given default floor. OSFI will propose a risk-sensitive floor for losses in the event of default that will be tied to increases in local property prices and/or to house prices that are high relative to borrower incomes. This will ensure a level of consistency and conservatism in the protection provided to depositors and unsecured creditors. We expect the increased requirements to be tailored to address the Greater Toronto Area and Greater Vancouver Area markets, which we believe are most vulnerable to a housing price correction.
42%
51%36%
37%
57%
37%
0
50
100
150
200
250
BMO BNS CIBC NBC RBC TD
CAD
Bill
ions
Uninsured Insured
NEWS & ANALYSIS Credit implications of current events
15 MOODY’S CREDIT OUTLOOK 14 DECEMBER 2015
Canada Mortgage and Housing Corporation Increases Minimum Down Payment and Securitization Fees, a Credit Positive Last Friday, Canada’s Department of Finance announced that Canada Mortgage and Housing Corporation (Aaa stable) will increase the minimum down payment on new insured mortgages above CAD500,000, effective 15 February 2016. The new rule is credit positive for CMHC because higher down payments will increase homeowner equity in insured properties, lowering CMHC’s potential credit losses should the borrower default. Concurrently, CMHC also announced an increase in National Housing Act Mortgage-Backed Securities (NHA MBS4) fees and changes to the fee structure of the Canada Mortgage Bond (CMB) program, effective 1 July 2016. These changes are also credit positive for CMHC because higher guarantee fees will add to CMHC’s capital and strengthen its solvency should an economic downturn increase mortgage default claims.
Since the global recession, Canada’s home prices have increased significantly, particularly in Greater Toronto and Greater Vancouver, diminishing housing affordability. With elevated home prices and low housing affordability, highly leveraged homeowners are vulnerable to unemployment or rising interest rates, exposing CMHC, the mortgage loan insurer, to credit losses should an economic shock occur.
The new 10% minimum down payment applies only to the portion of the mortgage above CAD500,000; the current 5% minimum will apply to lesser amounts.5 Although this affects only a fraction of the mortgage insured by CMHC, record high consumer debt levels in Canada mean borrowers of these mortgages are more susceptible to default, potentially creating losses for the mortgage lender. As Exhibit 1 shows, the proportion of new insured residential mortgage loans greater than CAD600,000 has grown to 5.5% for the first nine months of 2015 from 4.1% for the same period in 2013.6
EXHIBIT 1
Proportion of Insured Canadian Homeowner Mortgages above CAD600,000 Canada Mortgage and Housing Corporation is insuring more expensive homes.
Note: Data reflect loans insured during the first nine months of each period. Sources: Canada Mortgage and Housing Corporation and Moody’s Investors Service
4 Issuers participate in the NHA MBS program by issuing NHA MBS backed by pools of loans. The program provides a mechanism to
convert the supply of private investor funds to loans at reasonable interest rates and provides a more efficient secondary mortgage market. As part of the announcement, CMHC is also changing guarantee fees on covered mortgage bonds to 30 basis points plus a market NHA MBS fee from a flat 40 basis points.
5 CMHC does not insure homes valued above CAD1 million. 6 CMHC does not disclose the distribution at the CAD500,000 threshold.
4.4%
5.3%5.5%
3.0%
3.5%
4.0%
4.5%
5.0%
5.5%
6.0%
2013 2014 2015
Jason R. Mercer, CFA Assistant Vice President - Analyst +1.416.214.3632 [email protected]
Lan Wang, CFA Associate Analyst +1.416.214.3853 [email protected]
NEWS & ANALYSIS Credit implications of current events
16 MOODY’S CREDIT OUTLOOK 14 DECEMBER 2015
The minimum down payment increase is designed to increase a borrower’s equity in these higher-priced properties, reduce loan-to-value ratios and therefore reduce CMHC’s loss should residential mortgage defaults increase.
Canadian mortgage borrowers are legally required to purchase mortgage default insurance on their mortgages when they borrow more than 80% of the value of the property. As Exhibit 2 illustrates, two thirds of the insurance that CMHC issued in the first nine months of 2015 was on mortgages in the Canadian provinces of Ontario, Alberta and British Columbia. These provinces have the highest average insured loan amount because they have major urban centres with high property price values, such as Toronto and Vancouver. The higher down payment announcement targets borrowers in these centres.
EXHIBIT 2
Geographic Distribution of Insured Canadian Loans and Average Loan Amount The biggest effect is on urban centres in Ontario, Alberta and British Columbia.
Key: NL = Newfoundland and Labrador; PE = Prince Edward Island; NS = Nova Scotia; NB = New Brunswick; PQ = Quebec; ON = Ontario; MB = Manitoba; SK = Saskatchewan; AB = Alberta; BC = British Columbia; Terr = Yukon Territory, Northwest Territories and Nunavut. Note: Data are for the first nine months of 2015. Sources: Canada Mortgage and Housing Corporation and Moody’s Investors Service
On the same day, CMHC also announced that it will increase guarantee fees on the CMHC-sponsored NHA MBS program. Fees on NHA MBS guarantees above an annual CAD7.5 billion threshold will increase to 80 basis points from 60. Although the rate increase will have a marginal effect on funding costs of Canadian banks, which are the primary users of CMHC’s NHA MBS program, it will incrementally strengthen the mortgage insurer’s solvency against mortgage defaults.
1.3% 0.2% 1.8% 1.6% 21.3% 32.8% 3.8% 3.7% 20.7% 12.2% 0.5%
$ 197
$ 134$ 159
$ 116
$ 170
$ 284
$ 217$ 240
$ 331$ 303
$ 256
$
$
$
$
$
$
$
$
NL PE NS NB PQ ON MB SK AB BC Terr0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
35.0%Proportion of Loans Insured Average Insured Loan Amount (CAD Thousands)
NEWS & ANALYSIS Credit implications of current events
17 MOODY’S CREDIT OUTLOOK 14 DECEMBER 2015
Guatemala’s New Credit-Card Law Is Credit Negative for Banks Last Tuesday, Guatemala President Alejandro Maldonado approved a new law that caps credit-card interest rates considerably below current market rates. The law is credit negative for banks because it will reduce their profitability and curtail new credit-card issuance.
Starting in March 2016, the maximum interest rate that credit-card issuers can charge will be set at 2x the weighted average annual lending rate of the banking system, which the central bank reports. As of November, the weighted average local currency lending rate was 13.1%, which would multiply to a 26.2% cap on interest rates for local currency credit-card balances, well below the 47% average market rate as of October. The cap on foreign currency credit-card balances would be 11.8%, or twice the 5.9% average foreign currency lending rate and significantly below the 32% average market rate on foreign currency credit-card loans as of October.
The effect on earnings will be greatest at Banco Citibank Guatemala (unrated) and Banco Ficohsa Guatemala (unrated), which devote about 65% of their loan books to credit cards, and Banco Promerica Guatemala (unrated), whose credit-card loans composed around 40% of total loans as of October 2015. Among our rated banks, BAC Credomatic, the Guatemalan subsidiary of BAC International Bank, Inc. (Baa3 stable, baa37), has the highest exposure to credit cards at about 20% of loans and one third of its consolidated interest income. We expect BAC Credomatic’s return on assets to gradually decline to approximately 2.1% from 2.5% currently, all else remaining equal. BAC Credomatic constitutes around 15% of its parent’s consolidated assets.
The effect on Guatemala’s largest banks, including Banco Industrial S.A. (Ba1 negative, ba3), Banco de Desarrollo Rural (unrated) and Banco Agromercantil de Guatemala (unrated), will be more modest because credit cards account for just 5%, on average, of their consolidated total loans.
The rate caps also discourage credit-card lending growth because the caps impair banks’ ability to adequately price risks, which will lead them to reduce their exposure to riskier borrowers. As the volume of new credit-card issuance declines, it will also reduce overall fee generation, which was around 15% of the reported net revenue in the Guatemalan banking system as of October 2015.
In addition, the new legislation requires banks to offer to restructure credit-card debt once a borrowers’ credit-card debt reaches 150% of the bank-authorized cardholder credit limit, or when the borrower considers that he or she cannot pay the obligation on schedule. The monthly instalment on the restructured debt cannot exceed 20% of the borrower’s monthly wage.
Although Guatemalan banks remain highly profitable, with a return on assets of 1.8% as of October 2015, slightly above the 1.6% average for Central America, the new rate caps, combined with continued competitive pressure on net interest margins, will constrain future returns. This, in turn, will restrict core equity growth, which at 7% of average assets is among the lowest in Central America.
7 The bank ratings shown in this report are the banks’ local currency deposit rating and baseline credit assessment.
Georges Hatcherian Analyst +52.55.1555.5301 [email protected]
NEWS & ANALYSIS Credit implications of current events
18 MOODY’S CREDIT OUTLOOK 14 DECEMBER 2015
Russian Auto Lenders Face Declining Loan Originations as Vehicle Sales Slump Last Tuesday, the Association of European Business reported that sales of new passenger cars and light commercial vehicles in Russia fell 42.7% in November from a year earlier. The decline (see Exhibit 1) is credit negative for Russian banks that originate large volumes of auto loans because it will reduce their interest and fee income.
EXHIBIT 1
Year-on-Year Change in Russian Monthly New Car and Light Commercial Vehicle Sales
Source: Association of European Business
We expect car sales and originations of new car loans to decline further, particularly given that we forecast a 1% GDP decline in 2016 amid a continued recession. We expect sharp declines in bank earnings in 2015 and into 2016, particularly at Rusfinance Bank (Ba1/Ba1 negative, b18), iMoneyBank (unrated), Toyota Bank (unrated), Metallurgical Commercial Bank (B2 stable, b2) and BystroBank JSC (B2 negative, b2). Exhibit 2 shows auto loans as a proportion of total loans for Russia’s top 15 auto lenders in 2014.
8 The bank ratings shown in this report are the bank’s local currency deposit rating, senior unsecured debt rating (where available),
and baseline credit assessment.
-50%
-40%
-30%
-20%
-10%
0%
10%
Alexander Proklov Vice President - Senior Analyst +7.495.228.6072 [email protected]
Polina Krivitskaya Associate Analyst +7.495.228.6062 [email protected]
NEWS & ANALYSIS Credit implications of current events
19 MOODY’S CREDIT OUTLOOK 14 DECEMBER 2015
EXHIBIT 2
Russian Largest Auto Lenders by Loan Volume in 2014
Rank Bank
The Bank’s Local Currency Deposit/Senior Unsecured Debt Rating and Baseline
Credit Assessment
Car Loans, as of 1 Jan 2015
RUB Millions
Car Loans as Percent of
Retail Loan Book as of 1 Jan 2015
Car Loans as Percent of
Gross Loan Book as of 1 Jan 2015
1 Sberbank Ba1/Ba1 stable, ba2 170,400 3.5% 0.9%
2 JSB Rosbank Ba1/Ba1 negative, ba3 146,623 30.2% 20.0%
3 VTB24 Ba1 negative, b1 120,522 7.3% 6.4%
4 Rusfinance Bank Ba1/Ba1 negative, b1 86,624 76.0% 75.1%
5 UniCredit Bank unrated 75,128 46.8% 8.9%
6 Toyota Bank unrated 45,877 99.8% 91.8%
7 iMoneyBank unrated 34,063 94.8% 92.1%
8 Credit Europe Bank Ltd. B1/B1 negative, b2 33,620 39.0% 28.1%
9 Bank Uralsib Caa2 positive, ca 24,791 19.3% 10.3%
10 Metallurgical Commercial Bank B2 stable, b2 19,080 96.5% 77.8%
11 Gazprombank Ba2/Ba2 negative, b1 15,556 4.7% 0.5%
12 BystroBank JSC B2 negative, b2 11,928 53.6% 48.8%
13 Locko-bank B2 stable, b2 10,200 54.7% 19.8%
14 Vostochny Express Bank Caa1/Caa1 negative, caa1 9,568 5.7% 5.6%
15 CREDIT BANK OF MOSCOW B1/B1 stable, b1 8,494 6.6% 2.2%
Sources: The banks’ IFRS reports, Banki.ru and Moody’s Investors Service estimates
The decreasing volumes of new auto loans will also adversely affect the average performance of retail loans in Russia because car loans are largely collateralized, whereas many other retail loans are unsecured. As of 30 November 2015, auto loans were 7% of total loans provided to individuals, down from 9.6% as of 1 January 2014 (see Exhibit 3).
EXHIBIT 3
Russian Car Loans as Percent of Total Loans to Individuals
Source: The Central Bank of Russia
0%
1%
2%
3%
4%
5%
6%
7%
8%
9%
10%
11%
Jan-
13
Feb-
13
Mar
-13
Apr-
13
May
-13
Jun-
13
Jul-
13
Aug-
13
Sep-
13
Oct
-13
Nov
-13
Dec
-13
Jan-
14
Feb-
14
Mar
-14
Apr-
14
May
-14
Jun-
14
Jul-
14
Aug-
14
Sep-
14
Oct
-14
Nov
-14
Dec
-14
Jan-
15
Feb-
15
Mar
-15
Apr-
15
May
-15
Jun-
15
Jul-
15
Aug-
15
Sep-
15
Oct
-15
Nov
-15
NEWS & ANALYSIS Credit implications of current events
20 MOODY’S CREDIT OUTLOOK 14 DECEMBER 2015
State Support to National Bank of Greece Triggers a Bail-in of Security Holdouts and Preference Shares Last Tuesday, the European Stability Mechanism (ESM, Aa1 stable) released €2.7 billion to Greece to recapitalise National Bank of Greece S.A. (NBG, Caa3 negative, ca9) after the bank was unable to raise the full amount of its capital needs from the private sector. As a result, a cabinet act was issued detailing the burden-sharing terms affecting the holdout securities from the bank’s recent voluntary exchange offer and the existing preference shares, suggesting that these investors face significant credit losses.
Following the capital injection and the bail-in, NBG will more than fully meet its current capital needs of €4.5 billion, of which €2.3 billion are additional provisioning requirements based on the European Central Bank’s (ECB) asset quality review. However, the bank will continue to be highly challenged to reduce its high level of nonperforming loans, increase its customer deposits and reduce its reliance for capital credit on a high level of deferred tax assets (DTAs).
NBG announced that it was only able to raise around €1.5 billion of new capital from private sources, and thus will need a capital injection from the state-owned Hellenic Financial Stability Fund’s (HFSF) backstop facility to cover the shortfall. The ECB estimated the bank’s capital needs at €4.6 billion under the adverse scenario of its 31 October comprehensive assessment. That amount later fell by €120 million as a result of other ECB-approved capital-mitigating actions by the bank. NBG raised part of the new capital from private sources through an exchange offer to existing bondholders for new shares (€717 million), which we consider a distressed exchange tantamount to a default, and through investors’ subscription in new shares (€757 million).
To cover NBG’s remaining capital needs, the ESM will extend €2.7 billion to the HFSF in the form of ESM notes that HFSF will provide to NBG by investing 25% (€676 million) in the bank’s common shares and 75% (€2 billion) in the bank’s newly issued contingent convertible bonds (CoCos), which the ECB recognises as common equity Tier 1 (CET1) capital. However, this state support also triggered the bail-in tool of remaining bondholders, in line with the Eurogroup’s August 2015 decision. Consequently, any security holdouts from the bank’s recent exchange offer, as well as the bank’s preference shares and preferred capital, have suffered significant losses through a combination of write-offs and conversion to equity (see exhibit below).
Enforced Bail-in of NBG’s Preference Shares and Holdout Creditors, € Millions
Nominal Outstanding
Securities Bail-in
Percentage Immediate Loss
to Investors
To Be Converted into
Common Shares
State Preference Shares €1,350 71% €959 €392
Other Preference Shares and Preferred Capital €343 70% €240 €103
Tier 2 Securities-Holdouts €17 25% €4 €13
Senior Bonds-Holdouts €35 -- -- €35
Source: Greek Cabinet Act 45/2015
This enforced bail-in on the bank’s creditors will only generate around €302 million of new CET1 capital, given that the ECB already recognised the bank’s state preference shares of €1.4 billion as CET1 capital. We also note the bank’s intention to pay back the HFSF’s €2 billion of new CoCos10 in first-quarter 2016 using
9 The bank ratings shown in this report are the bank’s deposit rating, senior unsecured debt rating (where available) and baseline
credit assessment. 10 Redeemable by the issuer fully or partially in cash, at any point of time subject to regulatory approval.
Nondas Nicolaides Vice President - Senior Credit Officer +357.25.586.586 [email protected]
NEWS & ANALYSIS Credit implications of current events
21 MOODY’S CREDIT OUTLOOK 14 DECEMBER 2015
the sale proceeds of its sale of Turkish subsidiary Finansbank AS (Ba2/Ba2 negative, b1), for which NBG is in the final stage of a bidding process with interested buyers.
Although NBG expects a pro forma CET1 capital ratio of around 21% following these capital actions (including the sale of Finansbank), around 60% of such capital will be in the form of DTAs eligible to be converted into deferred tax credits (DTCs) and which totalled €4.9 billion as of September 2015. We consider such DTCs as non-tangible equity owing to Greece’s (Caa3 stable) weak credit standing. In addition, the bank will continue to face significant challenges in dealing with the sizable volume of problem loans (nonperforming exposure of 47.4% of gross loans in Greece) and increasing its deposit base in Greece following a significant decline of €10.3 billion since September 2014.
NEWS & ANALYSIS Credit implications of current events
22 MOODY’S CREDIT OUTLOOK 14 DECEMBER 2015
Insurers
Pacific Life’s Potential IPO of Aircraft Leasing Subsidiary Is Credit Positive Last Tuesday, Pacific Life Insurance Company (financial strength A1 stable) announced that it is considering an initial public offering (IPO) for Aviation Capital Group (ACG, unrated), its wholly owned commercial aircraft leasing subsidiary. Additionally, Pacific Life announced that its current president, Khanh T. Tran, had been named ACG’s next CEO, effective 1 January 2016, smoothing the way for a minority IPO, after which Pacific Life would retain a majority equity stake in ACG.
An ACG IPO would be credit positive for Pacific Life because ACG’s aircraft leasing business has a weaker credit profile than Pacific Life’s core life insurance business. A minority IPO would enhance ACG’s scale using external capital, thus limiting additional Pacific Life equity investments while allowing Pacific Life to benefit from ACG’s continuing growth and uncorrelated earnings stream.
ACG’s business is globally diversified and its performance adds some diversification to Pacific Life’s insurance business, which is part of the rationale for Pacific Life entering the business. Additionally, ACG provides some tax benefits to the organization. As of the third quarter of 2015, ACG reported total assets on a GAAP basis of $9.1 billion and equity of $1.7 billion. For the first nine months of the year, the company reported $86 million of net income. To put this in context, Pacific Mutual Holding Company, the ultimate parent of Pacific Life, reported consolidated GAAP total assets of $137 billion and equity of $10.2 billion as of year-end 2014. The company reported consolidated net income of $536 million for the same year.
Since the financial crisis, Pacific Life has emphasized product line diversification in order to lower its risk profile, especially its equity market sensitivity, and better manage volatility of income and capital. Meanwhile, the aircraft leasing subsidiary has remained consistently profitable through challenging economic times, but exposes the company to the operating and financial risks of the aircraft leasing business, including credit exposure to the cyclical airline industry, aircraft residual and remarketing risks, confidence-sensitive market funding risk and event risk.
Although ACG has been a meaningful contributor to Pacific Life’s earnings, the nature of the aircraft leasing business tends to have a lower credit profile than implied by Pacific Life’s A1 insurance financial strength rating. Hence, growth of ACG at a more rapid rate than Pacific Life could ultimately put pressure on Pacific Life’s credit quality and rating. If Pacific Life owns less of ACG, the latter is able to grow more rapidly without affecting Pacific Life’s credit quality.
ACG is a midsize participant in the aircraft leasing space (see exhibit). By raising and expanding its sources of capital, ACG should be able to grow and take advantage of opportunities in the aircraft leasing space. ACG’s fleet is primarily composed of popular, mostly recent-vintage narrow-body aircraft in the B737 and A320 families as well as new B787 twin-aisle aircraft. In recent years the company has shifted its funding toward senior unsecured notes and away from secured structures, enhancing its financial and operational flexibility by reducing encumbered asset levels and diversifying with new investors. However, ACG’s leverage is higher than certain peers.
Scott Robinson Senior Vice President +1.212.553.3746 [email protected]
Mark Wasden Vice President - Senior Credit Officer +1.212.553.4866 [email protected]
NEWS & ANALYSIS Credit implications of current events
23 MOODY’S CREDIT OUTLOOK 14 DECEMBER 2015
Top 10 Commercial Jet Aircraft Leasing Companies by Number of Aircraft Aviation Capital Group is a midsize aircraft leasing company.
Note: * Includes transfer of first 37 of the 90 aircraft sale from AWAS to Macquarie. Source: AtlasData as of July 2015
0
200
400
600
800
1,000
1,200
1,400
1,600
1,800
GECAS AerCap BBAM (incl.NBB & Fly)
SMBCAviationCapital
CITAerospace
AWAS* AviationCapitalGroup
BOC Aviation Air LeaseCorporation
MacquarieAirFinance*
Regional Jet Narrow-Body Wide-Body
NEWS & ANALYSIS Credit implications of current events
24 MOODY’S CREDIT OUTLOOK 14 DECEMBER 2015
Funds
Third Avenue High-Yield Fund Liquidation Is Not Indicative of Wider High Yield Sector Last Wednesday, Third Avenue Management, LLC (TAM) announced that its Third Avenue Focused Credit Fund (FCF) will be liquidated. This development has no credit implications for Affiliated Managers Group, Inc. (AMG, A3 stable), TAM’s majority owner. Assets in the liquidating fund were $789 million, only 0.13% of AMG’s $594 billion assets under management (AUM) at 30 September. Additionally, TAM, whose other mutual funds are equity products, retains an estimated $7 billion AUM, adjusting for the decline in FCF’s value.
FCF’s portfolio was also of too low credit quality and too concentrated for its fate to be indicative of the high-yield market, let alone the wider fixed-income market (which rallied on Friday). While other high yield vehicles are also under pressure, the immediate pressure on them is far less severe, owing to their stronger credit quality and greater diversity.
Yet, the announcement triggered anxiety that declining market liquidity for high-yield bonds would cause other high yield open-end mutual funds to experience runs, and that the resulting selling pressure risked spilling over into the asset class and markets more generally. On Thursday and Friday, high-yield exchange-traded funds (ETFs), which report both prices and net asset values on a daily basis, experienced price declines that exceeded their net asset value (NAV) declines by 99 basis points (see Exhibit 1). The ETFs’ trading premiums flipped to discounts, an indication of the selling pressure in the market. On Friday, NAVs declined 1.33%.
EXHIBIT 1
iShares iBoxx $ High Yield Corporate Bond ETF Reacted Adversely to FCF’s Liquidation
Source: iShares
However, FCF is not representative of the high-yield mutual fund sector, and it is not a bellwether for other funds. It invested in riskier credits: the fund invested half of its assets in credit instruments rated below B and another 40% was unrated, according to Morningstar. Toggle or payment-in-kind credits were 22% of the fund, which included loans made to bankrupt companies (debtor-in-possession loans). It was concentrated: the top five names equaled 20% of the portfolio, including bankrupt and Caa and Ca-rated credits. The portfolio accumulated significant losses as shown in Exhibit 2.
79.0
79.5
80.0
80.5
81.0
81.5
82.0
-0.9%
-0.8%
-0.7%
-0.6%
-0.5%
-0.4%
-0.3%
-0.2%
-0.1%
0.0%
0.1%
0.2%
0.3%
9-Dec 10-Dec 11-Dec
Premium/(Discount) - left axis NAV - right axis Price - right axis
Neal M. Epstein, CFA Vice President - Senior Credit Officer +1.212.553.3799 [email protected]
NEWS & ANALYSIS Credit implications of current events
25 MOODY’S CREDIT OUTLOOK 14 DECEMBER 2015
EXHIBIT 2
Third Avenue Focused Credit Fund’s Portfolio Had Unrealized Losses of 22% as of July 2015
Asset Class Cost
$ Millions Value
$ Millions Change Percent of Assets
Corporate Bonds & Notes $1,643 $1,207 -27% 58%
Term Loans $253 $238 -6% 11%
Claims $35 $27 -23% 1%
Municipal Bonds $3 $2 -50% 0%
Convertible Preferred Stocks $18 $13 -29% 1%
Preferred Stocks $94 $69 -26% 3%
Private Equities $31 $27 -11% 1%
Common Stocks & Warrants $267 $223 -16% 11%
Closed-End Funds $82 $72 -12% 3%
Short-Term Investments $75 $75 0% 4%
Total Investment Portfolio $2,501 $1,953 -22% 93%
Of which:
Toggle (cash or PIK interest) $362 17%
PIK interest only $99 5%
Other Assets less Liabilities $143 $143 0% 7%
Source: Fund filings
Reflecting its unique characteristics, FCF’s performance was extremely volatile, returning 16.8% in 2013, exceeding the high-yield category benchmark by 9.9 percentage points, but losing 22.4% in 2015 through November, underperforming its category by 20.6 percentage points. In our view, FCF’s idiosyncratic portfolio and its performance were particular to its own management style, and not representative of the high-yield mutual fund sector. It is neither surprising that investors tried to redeem their interests, nor that they were unable to do so en masse. This should not be taken as an indicator for the industry as a whole.
Under FCF’s plan of liquidation, investors will receive distributable cash assets and interests in a liquidating trust that will hold the funds’ remaining assets and distribute cash over time. In its letter to shareholders, TAM justified suspending the redemption of FCF shares, arguing, “Investor requests for redemption… in addition to the general reduction of liquidity in the fixed income markets… have made it impracticable for FCF going forward to create sufficient cash to pay anticipated redemptions.”
NEWS & ANALYSIS Credit implications of current events
26 MOODY’S CREDIT OUTLOOK 14 DECEMBER 2015
Sovereigns
IMF Rule Change Permits Its Ongoing Lending to Ukraine, a Credit Positive On Monday, the International Monetary Fund (IMF) officially revised its lending-into-arrears policy, allowing it to continue providing financial support to member countries even if they fall behind or stop paying their debt service to official creditors. The policy change is credit positive for Ukraine (Caa3 stable) because it allows the country to avoid having to decide between scuppering its IMF program or tapping into its foreign exchange reserves to make a $3 billion payment to Russia (Ba1 stable). Making the payment to Russia would also violate pari passu clauses in Ukraine’s recent bond restructuring agreement.
The IMF’s action allows Ukraine to continue to work on its socio-economic reforms, the success of which will lead to additional multilateral and bilateral financial support from the West. This in turn will allow the country to gradually rebuild its foreign reserves buffers and negotiate the restructuring of the Russian bond without the threat of losing IMF funding.
Although IMF internal discussions surrounding the policy modifications began as early as 2013, it was likely that Ukraine’s pending $3 billion bond payment to Russia prompted the IMF to take action at this time. Ukraine and Russia have been at loggerheads in recent months regarding whether the Russian bond qualifies as commercial or official debt.
Russia was the only holdout in a comprehensive restructuring of Ukrainian sovereign bonds that took place in November under the IMF-led Extended Fund Facility (EFF) program (see exhibit). Under the terms of that exchange, Ukraine cannot offer better repayment terms to Russia than those received on 12 November by bondholders of Ukraine’s 13 renegotiated Eurobonds. Those bondholders took a 20% principal haircut and an average four-year postponement of principal payments. Russia countered with a demand for full repayment of the bond on its due date and has threatened to take Ukraine to court over the matter.
Ukraine’s Previous and Current Debt Service Obligations The Russian bond is Ukraine’s only unrestructured Eurobond.
Sources: Final consolidated exchange offer memorandum and Moody’s Investors Service
Under the IMF’s previous rules, had the Russian bond been classified as bilateral debt and had Ukraine missed the principal payment, the IMF would be unable to continue lending to Ukraine under the EFF. The EFF is the largest piece of the financial rescue package put in place in February to address Ukraine’s ongoing economic, political and financial challenges.
$0
$1
$2
$3
$4
$5
$6
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Joshua Grundleger Associate Analyst +1.212.553.1791 [email protected]
Kristin S. Lindow Senior Vice President +1.212.553.3896 [email protected]
Dmytro Matt Kulakovskyi Associate Analyst +1.212.553.2755 [email protected]
NEWS & ANALYSIS Credit implications of current events
27 MOODY’S CREDIT OUTLOOK 14 DECEMBER 2015
Additionally, the continuing stalemate under the previous rules had been a source of leverage for Russia as the 20 December deadline for repayment of the Russian bond approached. However, the change in the rules allows the IMF to continue lending to a country even if the country has debt service arrears on either commercial and bilateral loans, provided financial support to the country is deemed essential, the debtor has been determined to be making good faith efforts to reach an agreement with the creditor, and the financing does not unduly limit the IMF’s ability to offer financing packages in the future. As such, the new policy negates the debate surrounding the bilateral/commercial nature of the Russian bond, and thereby permits Ukraine to miss the 20 December payment without jeopardizing its EFF program and the associated lending of up to $6 billion that compliance with the program would free up in the next three years.
In light of the IMF’s decision, Russian Finance Minister Anton Siluanov and Prime Minister Dmitry Medvedev have said that they will sue Ukraine if it fails to pay the bond when it is due. Although we expect that the Russian bond will eventually be restructured, probably under similar terms as received by other bondholders, any such negotiations are likely to be protracted and contentious. As a consequence, we rate this bond at Ca, one notch lower than the Caa3 rating we assigned to the nine new bonds created in the recent restructuring agreement.
NEWS & ANALYSIS Credit implications of current events
28 MOODY’S CREDIT OUTLOOK 14 DECEMBER 2015
Sub-sovereigns
Lower Share of Income Tax Would Negatively Affect Serbian Municipalities Last Monday, Serbia’s Ministry of Finance proposed to lower to 50% from 80% the share of proceeds from the country’s income tax destined to local governments. If approved, the new bill would become effective in January 2017, a credit negative for Serbian municipalities.
As a result of the proposal, we estimate that the reduced contribution will total approximately RSD33 billion (€270 million), or 15% of municipal sector operating revenues (see Exhibit 1). Such a decline would pose a credit risk because proceeds from the income tax constitute a key revenue source. In 2014, shared income tax accounted for about 43% of municipalities’ operating revenues.
Following the proposed changes, the municipalities’ share of the income tax will substantially decrease to approximately RSD67 billion in 2017 from RSD100 billion projected for 2016. Consequently, income tax as a percentage of operating revenue will decline to 30% of estimated operating revenues.
EXHIBIT 1
Serbian Municipalities’ Proceeds from Income Tax
Note: E=estimate. Sources: Serbia Ministry of Finance and Moody’s Public Sector Europe
A decline in shared income tax revenues has the potential to deteriorate Serbian municipalities’ sound operating surpluses. The sector’s gross operating balance totaled RSD38 billion, or 17% of operating revenue in 2014, and we expect the sector’s gross operating balance to decline to 12% of operating revenues in 2017 (see Exhibit 2) if the reduction in income tax proceeds is adopted.
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Gjorgji Josifov Assistant Vice President - Analyst +420.221.666.340 [email protected]
NEWS & ANALYSIS Credit implications of current events
29 MOODY’S CREDIT OUTLOOK 14 DECEMBER 2015
EXHIBIT 2
Serbian Municipalities’ Operating Performance, Assuming a Reduction in Tax Proceeds
Note: E=estimate Sources: Serbia Ministry of Finance and Moody’s Public Sector Europe
The revenue decline will add budgetary pressure that will threaten financial performance of the rated municipalities City of Novi Sad (B1 stable) and the City of Valjevo (B2 stable). The drop in proceeds from the income tax will test Serbian municipalities’ traditionally prudent budgetary management because of limited revenue-raising capacity and rigid operating expenditures. Serbian municipalities are highly dependent on intergovernmental revenues in the form of shared taxes and central government transfers, which constitute around 65% of municipal sector operating revenues. As a result, we expect Novi Sad’s ratio of gross operating balance to operating revenue to decline to 14% in 2017 from 20% projected in 2015, and Valjevo’s to decline to 11% from 16% over the same period.
Although the central government will increase other non-earmarked transfers to partially offset the decline in shared taxes, the Ministry of Finance has not yet articulated specifics. The new draft law on local government finance introduces five formula-based state transfers that will be anchored to GDP. However, the correlation of state transfers with economic performance will introduce volatility into municipalities’ budgets.
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NEWS & ANALYSIS Credit implications of current events
30 MOODY’S CREDIT OUTLOOK 14 DECEMBER 2015
US Public Finance
Illinois’ Release of Revenues Is Credit Positive for Chicago and Other Local Governments Last Monday, Illinois (Baa1 negative) Governor Bruce Rauner signed SB 2309, which released state motor fuel taxes (MFT), casino gaming funds and other revenues that had not been distributed to local governments since this past summer because of the absence of an adopted full state budget for the fiscal year ending June 2016. The release is credit positive for Illinois cities and counties including the City of Chicago (Ba1 negative), which carries debt secured by MFT revenue (bonds rated Ba1 negative). The distributions (see Exhibit 1) will have the most significant benefit for Chicago and the small number of local governments that depend on casino gaming distributions.
EXHIBIT 1
Illinois’ SB 2309 Local Government Allocations Revenue Allocated Funds Released
Motor Fuel Tax Fund Payments $583 million
Use Tax Payments $340 million
911 Centers $154 million
Casino and Video Gaming Revenue Sharing $145 million
Note: The City of Des Plaines must remit back to the state the first $10 million of distributions and share the 40% of the remaining proceeds to benefitting communities. Netting transfers from the revenue and expenses, gaming distributions composed 12% of the city’s revenues. The City of East St. Louis received $7.0 million in 2014 gaming distributions, but the city’s audit is not yet available.
Source: Illinois Municipal League
Chicago is the only rated city that issues bonds primarily backed by the MFT without an additional property tax security. Chicago’s MFT revenue bonds are secured by 75% of its annual MFT allocation. Since the state ceased distributions of motor fuel taxes in August, Chicago assumed responsibility for making monthly deposits with the bond trustee using unspent motor fuel tax collections received through July 2015. The city made its final deposit for the 1 January 2016 debt payment in November. The release of MFT revenues will allow Chicago to use current-year allocations to cover the next debt payment due in July 2016.
Casino gaming revenues are a significant revenue source for the handful of municipalities that are eligible for distributions (see Exhibit 2). All four cities that we rate and which receive casino revenue distributions maintain healthy reserves (they reported operating fund balances of more than 25% of revenues as of fiscal 2014) that have bridged the delay in payments. The City of Des Plaines (Aa2 no outlook), which received the largest total gaming distributions in 2014, adopted a conservative policy to use gaming receipts only for capital expenditures and early debt retirement.
David Levett Analyst +1.312.706.9990 [email protected]
Matt Butler Assistant Vice President - Analyst +1.312.706.9970 [email protected]
NEWS & ANALYSIS Credit implications of current events
31 MOODY’S CREDIT OUTLOOK 14 DECEMBER 2015
EXHIBIT 2
Casino Gaming Distributions to Illinois Cities
Rating Gaming Distributions as a Percent of 2014 Revenues
2014 Gaming Distribution, $ Thousands
Metropolis Unrated 51.4% $4,752
Des Plaines Aa2 no outlook 27.6% $24,793
East Peoria Unrated 19.8% $5,699
Joliet Aa2 no outlook 11.6% $18,811
Alton Unrated 10.3% $3,476
Elgin Aa1 stable 8.4% $9,961
Rock Island Aa2 no outlook 7.1% $4,907
Aurora Unrated 4.7% $7,444
Sources: Illinois Gaming Board, the cities’ audited financial statements and Moody’s Investors Service
Note: The City of Des Plaines must remit back to the state the first $10 million of distributions and share the 40% of the remaining proceeds to benefitting communities. Netting transfers from the revenue and expenses, gaming distributions composed 12% of the city’s revenues. The City of East St. Louis received $7.0 million in 2014 gaming distributions, but the city’s audit is not yet available.
Most of the revenues released by SB 2309 were not primary operating revenue streams. The principal revenue streams that the state shares with local governments, income taxes and sales taxes, continued to flow before SB 2309, even in the absence of a state budget. Under Mr. Rauner’s fiscal 2016 budget proposal, which the legislature did not pass, local governments would have had their state-shared income tax distributions cut in half. The potential for income tax distribution cuts or other reductions remains a credit negative for Illinois local governments given the state’s deteriorating financial operations.
RATING CHANGES Significant rating actions taken the week ending 11 December 2015
32 MOODY’S CREDIT OUTLOOK 14 DECEMBER 2015
Corporates
Plains All American Pipeline L.P. Outlook Change
30 Apr ‘15 7 Dec ‘15
Senior Unsecured Rating Baa2 Baa2
Short-Term Issuer Rating P-2 P-2
Outlook Stable Negative
The outlook change reflects the company’s high leverage, poor distribution coverage, about 20% merchant risk, and significant negative free cash flow with associated reliance on both equity and debt market access. Declines in EBITDA in 2015 in the supply and logistics segment, a slow recovery in 2016 and high distributions negatively affecting leverage underpin our expectation of debt/EBITDA of 5.4x in 2016.
Devon Energy Corporation Review for Downgrade
3 Mar ‘14 7 Dec ‘15
Senior Unsecured Rating Baa1 Baa1
Short-Term Issuer Rating P-2 P-2 (affirmed)
Outlook Stable Review for Downgrade
The review for downgrade reflects our belief that the associated production and cash flow benefits from Devon’s acquisitions of Felix Energy and certain Powder River Basin properties may not be sufficient to offset our expectation of Devon generating very weak leveraged cash margins, returns and cash flow-based leverage metrics in 2016 and into 2017. Compared with the price of the acquisition, the acquired production and proved reserves is very small, and both properties are still in early development stages.
EnLink Midstream Partners, LP Outlook Change
10 Mar ‘14 7 Dec ‘15
Senior Unsecured Rating Baa3 Baa3
Outlook Stable Negative
The negative outlook reflects the high price EnLink Midstream Partners will pay for TOM-STACK, LLC and TOMPC LLC, collectively known as Tall Oak. It also reflects execution risk regarding the degree of EBITDA growth from the acquired assets, and the uncertainty regarding how the remaining $500 million installment payment will ultimately be financed, all of which could result in weaker leverage metrics through 2017.
RATING CHANGES Significant rating actions taken the week ending 11 December 2015
33 MOODY’S CREDIT OUTLOOK 14 DECEMBER 2015
Textron Inc. Outlook Change
27 Dec ‘13 8 Dec ‘15
Senior Unsecured Rating Baa3 Baa3
Short-Term Issuer Rating P-3 P-3
Outlook Stable Positive
The positive outlook reflects our expectation of continued albeit gradual improvement in Textron’s underlying credit profile in 2016, notwithstanding some ongoing headwinds in certain of the company’s key end markets. The company successfully executed on its heavily debt-funded acquisition of Beechcraft and managed well through a difficult operating environment over the past year. Cost-saving and improved profitability should continue through 2017-18, solidly underpinning a stronger Baa credit profile.
Clear Channel Worldwide Holdings, Inc. Downgrade
14 Dec ‘09 8 Dec ‘15
Corporate Family Rating B2 B3
Outlook Stable Stable
The downgrade reflects the issuance of $225 million of senior notes at subsidiary Clear Channel International B.V. that increases the pro-forma leverage level to 7.6x as of third-quarter 2015 from 7.3x, which is above the threshold for the B2 corporate family rating level. Weak operating performance in international markets due to the strong US dollar combined with a debt structure denominated in US dollars has been a headwind for the company over the last year. We expect foreign exchange risk to continue as we expect that the debt balances will remain unhedged.
Votorantim Participacoes S.A. Review for Downgrade
25 Feb ‘15 11 Dec ‘15
Long-Term Issuer Rating Baa3 Baa3
Outlook Stable Review for Downgrade
The review for downgrade follows our rating action on 9 December 2015 that placed Brazil’s Baa3 government bond rating under review for downgrade. The review will focus on the result of Brazil’s sovereign rating review process and on Votorantim’s correlation to the Brazilian economy and its effects on the company’s credit metrics, liquidity and foreign-exchange exposure.
RATING CHANGES Significant rating actions taken the week ending 11 December 2015
34 MOODY’S CREDIT OUTLOOK 14 DECEMBER 2015
Financial Institutions
AHML Insurance Outlook Change
2 Mar ‘15 10 Dec ‘15
Insurance Financial Strength (Domestic) Ba2 Ba2
Outlook Negative Stable
The outlook change follows our affirmation of Russia’s government bond rating at Ba1 and the change of the outlook to stable from negative on 4 December 2015, and the affirmation of AHML JSC’s issuer rating at Ba1 and change of outlook to stable from negative on 8 December 2015.
Banco Angolano de Investimentos, S.A Downgrade
29 May’ 15 7 Dec ‘15
Counterparty Risk Assessment Ba2(cr) Ba3(cr)
Long-Term Bank Deposits (Domestic) Ba3 B1
Long-Term Bank Deposits (Foreign) Ba3 B1
Adjusted Baseline Credit Assessment b1 b3
Baseline Credit Assessment b1 b3
Outlook Negative Negative
The downgrade reflects the ongoing tightening of foreign currency liquidity in Angola arising from lower dollar inflows in the context of low oil prices; the bank’s recent decision to introduce a limit on the amount of hard dollar currency (cash) that can be withdrawn on a weekly basis, underlining the bank’s restricted access to hard dollar currency; and continued asset quality deterioration, owing to the weakening macroeconomic environment.
Brazilian Banks Review for Downgrade
10 Dec ‘15
We have placed under review for downgrade the deposit and foreign currency debt ratings and counterparty risk assessments assigned to 17 Brazilian banks and their respective offshore branches, and local currency issuer and foreign currency debt ratings assigned to two other financial institutions. The rating actions followed the placement of Brazil’s Baa3 government bond rating on review for downgrade.
Brazilian Insurers Review for Downgrade
10 Dec ‘15
We have placed under review for downgrade the global local currency and national scale insurance financial strength ratings of four Brazilian insurance and reinsurance companies: ACE Seguradora S.A., Chubb do Brasil Companhia de Seguros, Swiss Re Corporate Solutions Brasil Seguros and Munich Re do Brasil Resseguradora S.A. The rating actions reflect the close linkages between the credit profiles of the companies and the sovereign. They also consider the increased likelihood that a further significant weakening of Brazil’s macroeconomic environment and sustained reduction in economic growth will adversely affect key drivers of insurance growth and profitability.
RATING CHANGES Significant rating actions taken the week ending 11 December 2015
35 MOODY’S CREDIT OUTLOOK 14 DECEMBER 2015
BDMG, Fomento Parana, and Desenvolve Review for Downgrade
10 Dec ‘15
We have placed under review for downgrade the long-term local currency global and national scale issuer ratings of Banco de Desenvolvimento de Minas Gerais S.A., Agencia de Fomento do Parana S.A. and Desenvolve SP – Agencia de Fomento do Estado de São Paulo S.A.
The rating actions reflect the placement on review for downgrade of the ratings assigned to the states of Minas Gerais, São Paulo and Parana, which followed the announcement of a similar review on the sovereign bond rating on 9 December 2015. The government-related issuers’ ratings all benefit from uplift reflecting the likelihood that they would receive financial support from their respective shareholders in the event of financial stress.
E*Trade Financial Corp. and Subsidiaries Upgrade
9 Dec ‘15
We upgraded the ratings of E*TRADE Financial Corp. (E*TRADE, Baa3 senior unsecured) and the long-term ratings of E*TRADE Bank (A3 deposits), and affirmed E*TRADE Bank’s Prime-2 short-term deposit rating. The outlook is stable. The upgrade of E*TRADE reflects its continued strong and deliberative execution of credit-positive strategic and operational priorities with strong oversight by an active board. E*TRADE derives its primary credit strength from the solid cash flow generation of its retail brokerage franchise, which serves over three million US clients.
Khanty-Mansiysk bank Otkritie PJSC Downgrade
11 Jun ‘15 10 Dec ‘15
Counterparty Risk Assessment Baa3(cr) B1(cr)
Long-Term Bank Deposit Rating B1 B2
Subordinate (Foreign) B3(hyb) Caa1(hyb)
Adjusted BCA b1 b2
Baseline Credit Assessment b2 b3
Outlook Negative Negative
The downgrade reflects intensified downward pressure on the bank’s standalone financial profile and reduced loss absorption buffers.
Moscow Mortgage Agency Outlook Change
28 May ‘15 8 Dec ‘15
Counterparty Risk Assessment Ba2(cr) Ba2(cr)
Long-Term Bank Deposits (Domestic) Ba3 Ba3
Long-Term Bank Deposits (Foreign) Ba3 Ba3
Adjusted Baseline Credit Assessment b1 b1
Baseline Credit Assessment b1 b1
Outlook Negative Stable
The outlook change reflects the change in outlook on the Ba1 rating of the bank’s 100% owner, the City of Moscow, to stable from negative.
RATING CHANGES Significant rating actions taken the week ending 11 December 2015
36 MOODY’S CREDIT OUTLOOK 14 DECEMBER 2015
VTB Bank (Armenia) Downgrade
3 Jun ‘15 10 Dec ‘15
Counterparty Risk Assessment Ba2(cr) Ba2(cr)
Long-Term Bank Deposits (Domestic) Ba3 Ba3
Long-Term Bank Deposits (Foreign) B1 B1
Adjusted Baseline Credit Assessment ba3 ba3
Baseline Credit Assessment b1 b2
Outlook Negative Negative
The downgrade reflects the high, and increasing, share of nonperforming assets in the bank’s loan book that are insufficiently covered by provisions; the loss-making nature of its operations; and dependence on capital injections from its core shareholder, VTB Bank.
RATING CHANGES Significant rating actions taken the week ending 11 December 2015
37 MOODY’S CREDIT OUTLOOK 14 DECEMBER 2015
Sovereigns
Brazil Outlook Change
9 Dec ‘15
Government Currency Rating Baa3 Baa3
Foreign Currency Deposit Ceiling Baa3/P-3 Baa3/P-3
Foreign Currency Bond Ceiling Baa2/P-2 Baa2/P-2
Local Currency Deposit Ceiling A1 A1
Local Currency Bond Ceiling A1 A1
Outlook Stable Review for Downgrade
The outlook change reflects rapidly and materially deteriorating macroeconomic and fiscal trends and diminished likelihood of trend reversal in the next two to three years and worsening governability conditions and increased risk of policy paralysis. The review will assess the likelihood of further deterioration in the government’s fiscal position against the agency’s baseline assumptions supporting the current Baa3 rating, and the prospect of a faster and more significant rise in the government’s debt trajectory amid heightened political uncertainty, declining investor confidence and a deeper-than-expected recession.
Cuba Outlook Change
10 Dec ‘15
Gov Currency Rating Caa2 Caa2
Foreign Currency Deposit Ceiling Caa3/NP Caa3/NP
Foreign Currency Bond Ceiling Caa2/NP Caa2/NP
Local Currency Deposit Ceiling Caa2 Caa2
Local Currency Bond Ceiling Caa2 Caa2
Outlook Stable Positive
The outlook change reflects our view that Cuba’s dependence on Venezuela has lessened since 2014, and despite pressure on Cuba’s external finances from lower economic and financial support from its main trade partner, risks remain manageable and continued reform momentum and increased rapprochement with the US have supported favorable macroeconomic performance and raise the likelihood that US economic sanctions might be eased further.
RATING CHANGES Significant rating actions taken the week ending 11 December 2015
38 MOODY’S CREDIT OUTLOOK 14 DECEMBER 2015
Sub-sovereigns
Brazilian Sub-sovereign Ratings Put on Review for Downgrade The reviews for downgrade reflect our view that the ongoing deterioration of Brazil’s economy will continue to have a direct effect on the operating environment of Brazilian states and municipalities. In addition, the fiscal position of Brazilian states and municipalities weakened during 2015 and will remain negatively pressured by lower tax revenues and expenditure rigidities in the near future.
Belo Horizonte, City of
Review for Downgrade
12 Aug ‘15 10 Dec ‘15
Long-Term Issuer Rating (Domestic) Ba1 Ba1
Long-Term Issuer Rating (Foreign) Ba1 Ba1
Outlook Stable Review for Downgrade
Maranhao, State of
Review for Downgrade
12 Aug ‘15 10 Dec ‘15
Long-Term Issuer Rating (Domestic) Ba2 Ba2
Long-Term Issuer Rating (Foreign) Ba2 Ba2
NSR LT Issuer Rating (Domestic) Aa3.br Aa3.br
Outlook Stable Review for Downgrade
Minas Gerais, State of
Review for Downgrade
12 Aug ‘15 10 Dec ‘15
Long-Term Issuer Rating (Domestic) Ba1 Ba1
Long-Term Issuer Rating (Foreign) Ba1 Ba1
Outlook Stable Review for Downgrade
Parana, State of
Review for Downgrade
12 Aug ‘15 10 Dec ‘15
Long-Term Issuer Rating (Domestic) Ba1 Ba1
Long-Term Issuer Rating (Foreign) Ba1 Ba1
NSR Long-Term Issuer Rating (Domestic) Aa2.br Aa2.br
NSR Long-Term Issuer Rating (Foreign) Aa2.br Aa2.br
Outlook Stable Review for Downgrade
RATING CHANGES Significant rating actions taken the week ending 11 December 2015
39 MOODY’S CREDIT OUTLOOK 14 DECEMBER 2015
Rio de Janeiro, City of
Review for Downgrade
12 Aug ‘15 10 Dec ‘15
Long-Term Issuer Rating (Domestic) Baa3 Baa3
Long-Term Issuer Rating Baa3 Baa3
NSR Long-Term Issuer Rating (Domestic) Aaa.br Aaa.br
Outlook Stable Review for Downgrade
Sao Paulo, State of
Review for Downgrade
12 Aug ‘15 10 Dec ‘15
Long-Term Issuer Rating (Domestic) Baa3 Baa3
Long-Term Issuer Rating (Foreign) Baa3 Baa3
Outlook Stable Review for Downgrade
Aguascalientes, Mexico Outlook Change
13 Mar ‘14 8 Dec ‘15
LT Issuer Rating (Domestic) Baa2 Baa2
NSR LT Issuer Rating (Domestic) Aa2.mx Aa2.mx
Outlook Negative Stable
The outlook change reflects the fact that the municipality has continually recorded positive gross operating balances during the past two years, in contrast to our previous expectations of a further deterioration in this metric. Additionally, we expect Aguascalientes’ gross operating balance to remain positive in 2015 and 2016.
Russian Sub-sovereign Outlooks Changed to Stable The outlook changes follow the strengthening of Russia’s credit profile, as reflected by our 3 December rating action. We believe that the entities will maintain adequate fiscal performance, despite the still-weak economy, because of its low or moderate level of market debt, consistently adequate or strong budgetary performance, relatively stable revenue streams owing to a strong local economy, and moderate to low refinancing risks.
Republic of Bashkortostan, Russia
Outlook Change
24 Feb ‘15
Long-Term Issuer Rating (Domestic) Ba2 Ba2
Long-Term Issuer Rating Ba2 Ba2
Outlook Negative Stable
RATING CHANGES Significant rating actions taken the week ending 11 December 2015
40 MOODY’S CREDIT OUTLOOK 14 DECEMBER 2015
Khanty-Mansiysk AO, Russia
Outlook Change
24 Feb ‘15 4 Dec ‘15
Long-Term Issuer Rating (Domestic) Ba2 Ba2
Long-Term Issuer Rating (Foreign) Ba2 Ba2
Outlook Negative Stable
Moscow, Russia
Outlook Change
24 Feb ‘15 4 Dec ‘15
Long-Term Issuer Rating (Domestic) Ba1 Ba1
Long-Term Issuer Rating Ba1 Ba1
Outlook Negative Stable
St. Petersburg, Russia
Outlook Change
24 Feb ‘15 4 Dec ‘15
Senior Unsecured (Domestic) Ba1 Ba1
Long-Term Issuer Rating (Domestic) Ba1 Ba1
Long-Term Issuer Rating Ba1 Ba1
Outlook Negative Stable
Tatarstan, Russia
Outlook Change
14 Apr ‘15 4 Dec ‘15
Long-Term Issuer Rating (Foreign) Ba2 Ba2
Outlook Negative Stable
OJSC Western High-Speed Diameter, Russia
Outlook Change
24 Feb ‘15 4 Dec ‘15
BACKED Senior Unsecured (Domestic) Ba3 Ba3
Outlook Negative Stable
The outlook change reflects OJSC Western High-Speed Diameter’s status as a government-related issuer fully owned by the St. Petersburg, Russia, government and its strong credit linkages to the city.
RATING CHANGES Significant rating actions taken the week ending 11 December 2015
41 MOODY’S CREDIT OUTLOOK 14 DECEMBER 2015
SUE Vodokanal of St. Petersburg
Outlook Change
24 Feb ‘15 4 Dec ‘15
Long-Term Issuer Rating (Domestic) Ba2 Ba2
Long-Term Issuer Rating (Foreign) Ba2 Ba2
Outlook Negative Stable
25 Feb ‘15 5 Dec ‘15
NSR LT Issuer Rating (Domestic) Aa2.ru Aa2.ru
Outlook Negative Stable
The outlook change reflects SUE Vodokanal of St. Petersburg’s status as a government-related issuer fully owned by the St. Petersburg, Russia, government and its strong credit linkages to the city.
US Public Finance
Jefferson County, Alabama Upgrade
18 Feb ‘14 8 Dec ‘15
GOLT Bonds Ba3 Baa3
Outlook Stable Stable
The upgrade reflects the county’s continued strengthening financial position through the trimming of its overall cost structure and restoration of general fund reserves, atop a broadly well-performing regionally significant economic base.
Structured Finance
Rating Upgrades and Affirmations of Approximately $2.29 Billion of BACM 2007-3 Securities On 10 December we upgraded seven and affirmed 10 classes of BACM 2007-3. The upgrades were due to an increase in credit support resulting from loan paydowns and amortization. The deal has paid down 9.6% since our last review.
RESEARCH HIGHLIGHTS Notable research published the week ending 11 December 2015
42 MOODY’S CREDIT OUTLOOK 14 DECEMBER 2015
Corporates
German Corporates’ Modest Bond Issuance Growth in 2016 Will Be Driven by Large Repeat Issuers Macroeconomic uncertainty and the long-term expectation that interest rates will rise will result in steady but modest issuance next year. Investor caution has resulted in much fewer deals in 2015 but an average size that has nearly doubled, indicating a preference for higher-rated repeat issuers, a trend we believe will continue in 2016. High-yield bond issuance remains strong owing to the overall stable credit quality of German high-yield issuers.
The FAST Act Is Credit Positive for US Building Materials Industry The five-year plan to spend approximately $205 billion on highways and $48 billion on transit projects is credit positive for the building materials industry because it provides certainty of federal funding to states for highway projects. The act provides states with confidence to pursue long-term infrastructure projects. Although it will not benefit the industry meaningfully until 2017, the positive effect will continue for years after.
US Makers of High-Tech Medical Devices Will Be Pressured by China's Healthcare Reforms China’s reforms are credit negative for US medical device manufacturers such as Medtronic plc, Boston Scientific Corporation and St. Jude Medical, Inc. The reforms will lengthen the approval process and favor local manufacturers, pressuring sales particularly for companies that make high-technology devices. A series of investigations of multinational nutritional and pharmaceutical manufacturers also reflect the risk of looking to China as an emerging market to fuel growth.
Global Base Metal Demand and Growth Deteriorate Further, Driving Prices Lower We have lowered our price assumptions for base metals as uncertainty about demand from China amid slowing growth, the strong US dollar and weaker global growth expectations for 2016 have led to a steep decline in base metals prices. These low prices, which we expect to stay lower for a longer period of time, raise the risk of weakening the credit profiles of global base metals issuers.
Canadian Broadband Communications Companies Will Experience Modest Growth in 2016, but Challenges Loom Following a lackluster 2015, the Canadian broadband communications sector will see continued modest growth in 2016. Broadband communications companies face disruption as television content is replaced by Internet streaming and as smartphone handsets become mobile microcomputers. The carriers’ services are becoming that of providing connectivity and data transport, and the historic, content-based revenue stream is waning.
North American Covenant Quality Improves Marginally in November The covenant quality of North American high-yield bonds saw a marginal improvement in November but remains in the weakest-level range. The weakest-level covenant quality indicates that despite marginal improvements, investors continue to trade away covenant protection and take on risk in search of higher yield.
RESEARCH HIGHLIGHTS Notable research published the week ending 11 December 2015
43 MOODY’S CREDIT OUTLOOK 14 DECEMBER 2015
Final Medicare Updates for 2016 Are Negative to Modestly Positive for US Healthcare Services Providers The final updates are credit negative for outpatient services at acute care hospitals, home health providers and radiation oncology providers, whose reimbursement levels will decline in 2016. Modest reimbursement increases to ambulatory surgery centers, dialysis providers and physicians will not meaningfully benefit the credit profiles of companies in these segments, while the effect will be mixed for diagnostic laboratories. The final rules are largely in line with earlier proposals.
Contract Volatility and Increasing Customer Demands Weigh On Credit Quality of US Correctional Healthcare Management We expect contract turnover to continue due to heightened scrutiny and negative perceptions of inmate healthcare quality, raising the risk of losses for correctional healthcare service providers. Rising demand for additional services, such as behavioral health programs and electronic health records, is also creating pressures within the industry.
EMEA Speculative-Grade Corporates’ Capacity to Incur Debt Plateaus, but Remains High Under €1 Debt Test High-yield issuers' capacity to incur additional quantifiable debt stabilized in the first three quarters of 2015 compared with 2014. This year saw a significant decrease in the number of high yield bonds issued, compared to 2014. This is unlikely to change in 2016 as companies will continue to only have windows of opportunity to tap the market and there will be continued volatility in spreads and capital flows. As Carbonated Drinks Lose Their Fizz, North American Soft Beverage Companies Diversify to Float Growth Shifting consumer preferences in the US away from carbonated soft drinks, including diet soda, will cause North American soft beverage companies to pursue different growth strategies to compensate for declining soda sales. The Coca-Cola Company, PepsiCo Inc., Dr Pepper Snapple Group Inc. and Cott Corp. will continue to diversify geographically and by expanding into other product groups including energy drinks, branded bottled waters (both flavored and vitamin-enriched), mixers and ready-to-drink coffees and teas.
RESEARCH HIGHLIGHTS Notable research published the week ending 11 December 2015
44 MOODY’S CREDIT OUTLOOK 14 DECEMBER 2015
Financial Institutions
Global Banks’ Outlook Is Stable: Macro Challenges, Regulation Will Offset Improved Fundamentals (Presentation) Banks in many countries have improved their capitalization and strengthened their balance sheets, supporting the stable outlook for global banking in 2016. However, risks – including weakening asset quality in emerging markets – could derail progress. The prospects for banks will continue to center around global growth and interest rates, the evolving regulatory environment and generally weak profitability, as well as regional considerations such as the implementation of the Banking Union in Europe.
US Banks’ Outlook Is Stable, but Credit Pressure Builds (Presentation) Strong balance sheets support a stable outlook for US banks over the next 12-18 months despite persisting earnings headwinds, though early indicators signal increasing pressure on the credit quality of commercial loans. Employment and housing market gains, along with raising interest rates, will provide some relief in terms of profitability, but revenue growth will remain constrained. Banks’ cost-cutting measures will continue in 2016, but will not fully offset revenue pressures.
Canadian Banks’ Outlook Is Negative, Driven by Reduced Support and Increasing Asset Risk (Presentation) The outlook for Canadian banks, among the most highly rated banks in the our rated universe, remains negative for 2016 as asset quality risks increase and governmental support remains uncertain. While Canadian banks are expected to maintain stable profitability despite low oil prices and low interest rates, mounting financial strain on households could lead to a deterioration in banks’ asset quality.
Latin American Banks’ Outlook Is Stable, Supported by Adequate Capital, Funding and Liquidity Amid a Modest Rise in Asset Risks (Presentation) The outlook for Latin American banks is stable. The banks will maintain conservative underwriting standards, and though nonperforming loans will rise slightly, asset risks will generally remain contained. In most countries banks’ loss-absorption capacity is strong, while liquidity will remain adequate as economic growth picks up slightly in 2016, with the exception of Brazil.
Africa Banks’ Outlook Is Stable: Rising Credit Risks Will Be Balanced Against Resistant Earnings, Solid Capital Buffers and Deposit-Based Funding (Presentation) Africa's banking system has a stable outlook for 2016, reflecting resilient earnings, solid capital buffers and deposit-based funding set against rising asset quality risks. While challenging operating conditions will lead to increased credit risks for African banks over the next 12 to 18 months, robust earnings, business opportunities stemming from greater financial inclusion and strong deposit bases will support the banks' credit profiles.
Gulf Cooperation Council Banks’ Outlook Is Stable (Presentation) Public spending will continue to support operating conditions for banks in the Gulf Cooperation Council (GCC) in 2016, ensuring their performance remains resilient, though liquidity will continue to tighten. Despite the headwinds generated by low oil prices, we expect a broadly supportive operating environment for GCC banks in 2016 due to regional governments' commitment to counter-cyclical spending policies.
RESEARCH HIGHLIGHTS Notable research published the week ending 11 December 2015
45 MOODY’S CREDIT OUTLOOK 14 DECEMBER 2015
US Specialty Finance Companies’ Outlook Is Positive for Credit Cards and Stable for Auto and Non-Bank CRE Lenders (Presentation) Strong profitability, asset quality and underwriting will drive a positive outlook for the credit card industry in 2016. While credit risk for card companies has remained low, underwriting could become more aggressive as competition between the big six credit card companies and regional banks intensifies. The outlooks for auto and commercial real estate lenders are stable, but a potential easing of underwriting standards remains a concern for both.
Netherlands Banks’ Outlook Is Stable, Supported by Improving Profits and Loan Performance We have changed our outlook on the Dutch banking system to stable from negative, reflecting a material improvement in banks’ loan performance, underpinned by a sustained economic recovery. Dutch banks are entering a new phase after years of restructuring and profitability is improving due to lower loan-loss provisioning requirements.
Cyprus Banking System Outlook Is Stable, Driven by Gradual Economic Recovery and Improved Funding We have changed our outlook for the Cypriot banking system to stable from negative, reflecting the country's modest economic recovery, which will bring an end to five years of acute asset quality deterioration. Although Cypriot banks' problem loans will remain high and their provision buffers low, we expect problem loans to begin to ease toward the end of 2016.
Russian Banks: Large Privately Owned Banks Taking Market Share Amid Recession Amid Russia's recession, the country's largest private banks are consolidating their market share – a credit positive trend likely to continue next year. The share of assets at the top five privately owned banks increased to 12.5% in mid-2015, from 10.8% at the end of 2014 and 8.4% at the end of 2013, while the share of smaller private banks fell to 18.9% from 23.4% at end-2013.
United Arab Emirates Banks’ Outlook Is Stable, Driven by Resistant Capital and Liquidity Buffers We have maintained our stable outlook on the United Arab Emirates' banking system, reflecting our expectation for resilient capital and liquidity buffers. We expect UAE banks' credit profiles to broadly remain resilient despite the economic slowdown driven by low oil prices, owing to their strong capital and liquidity buffers coupled with resilient profitability.
Baltic Countries Banks’ Outlook Is Stable, Supported by Economic Growth and Asset Quality We have changed our outlook on the Baltic banking systems to stable from negative, anticipating that solid economic fundamentals will support credit growth, asset quality and profitability over the next 12 to 18 months. We expect the Baltic operating environment to remain favorable for banks on the back of consistently strong economic growth, solid fiscal health and stability resulting from the successful adoption of the euro.
Global Life Insurers’ Outlook: Intensifying Shift in Product Mix Offsets Low Rates, While Higher Volatility Creates Risks Global insurers’ reduced emphasis on spread-based and guaranteed products will partly offset declining investment margins and the still robust equity markets will also support income from fee-based products in 2016. Accelerated changes in product mix and higher fees on still rising asset prices will support profitability, but delayed increase in interest rates and higher asset volatility will increase credit risk.
RESEARCH HIGHLIGHTS Notable research published the week ending 11 December 2015
46 MOODY’S CREDIT OUTLOOK 14 DECEMBER 2015
Global P&C Insurers’ Outlook Is Stable: Emerging Markets Grow P&C Premiums Despite Economic Headwinds (Presentation) Whilst the global life and property and casualty (P&C) insurance industries both have stable outlooks for 2016, the outlook for the global reinsurance industry is negative, reflecting excess capacity and shrinking demand. In P&C insurance, although global growth will be modest, the rating agency expects still strong growth from emerging markets, despite economic headwinds. In life insurance, profitability will be supported by an intensifying shift in product mix, offset by continued low interest rates.
Global Reinsurers’ Outlook Is Negative, Reflecting Excess Capacity and Shrinking Demand capacity and decrease in demand from primary insurers along with sustained pressure on pricing and erosion of terms and conditions. Reinsurers taking steps to reposition for the new reality, including M&A and innovation in new products and markets, which could expose them to outsized risks.
Global Money Market Funds’ Outlook Is Negative from Asset Scarcity and Higher Costs The outlook remains negative for money market funds (MMFs), reflecting our expectation that conditions in liquidity markets globally will remain challenged in 2016. Money market funds will struggle to maintain the highest credit and stability profiles as they face volatility in short-term rates, potentially seismic shifts in US MMF assets under management to government funds from prime funds, and widening supply/ demand imbalances.
Global Asset Managers’ Outlook Is Stable, Reflecting Rising Demand Despite Uneven Growth (Presentation) Although we expect higher interest rates and subsequent market volatility to lead to blunted growth for global asset managers in 2016, the outlook for the industry will be stable over the next 12-18 months due to increased demand. Competition between active and passive asset management strategies will continue to drive products development and distribution – including within the retirement market – for products that provide both cost and performance efficiency.
Italian Insurers: Strong P&C Results and Changing Life Product Mix Support Stable Outlook The Italian Property & Casualty (P&C) insurance sector remains stable, based on the rating agency's expectation that insurers in the sector will preserve sound profitability over the next 12-18 months, despite weakened earnings from increased price competition. We also maintained a stable outlook on the life sector as insurers are quickly adapting their products to the challenging low interest rate environment. The rating agency expects that P&C profitability will weaken somewhat in Italy, as price competition in the motor segment will push down prices by as much as 5% in 2016.
China’s Banking System Outlook: Weakening Operating Environment and Asset Quality Drive Negative Outlook The outlook considers that the overall creditworthiness of the banks is likely to deteriorate over the next 12-18 months, as the operating environment worsens and our baseline scenario now assumes a further moderation in Chinese GDP growth to 6.3% in 2016 from 6.8% in 2015. Against this backdrop, problem loan and delinquency formation rates are increasing and there is evidence that problem loan recognition has become less stringent.
RESEARCH HIGHLIGHTS Notable research published the week ending 11 December 2015
47 MOODY’S CREDIT OUTLOOK 14 DECEMBER 2015
Chinese City Commercial Banks Will Face Asset Quality and Capital Pressures in 2016 Most city commercial banks will see their profitability levels weaken as a result of narrower net interest margins in a liberalized interest rate environment and growing credit costs in a moderating domestic economy. The banks will also face increasing strain on their capital ratios if they maintain their recent 20%-plus loan growth rates.
Belgian Banking System Outlook: Improved Profitability, Asset Quality Support Our Stable Outlook Belgium banks have now addressed the bulk of their legacy issues and costs, and will be more able to focus on their stable and cash-rich domestic market, which is credit positive for the overall system in the medium-to-long term. The stable outlook for Belgium banks incorporates these improvements, notably reduced funding costs and decreasing loan loss provisions over the next 12-18 months.
Fourth-Quarter 2015 Canadian Banking Quarterly: Credit Metric Deterioration Deferred for Now In the fourth quarter of 2015, Canadian P&C segment reported 9% earnings growth compared to Q4 2014. Much of the momentum was generated by continued volume growth in deposits and loans, while net interest margin remained under pressure. Expense control remained a focus and credit trends were largely stable with few new formations of impaired loans arising from corporate and commercial oil and gas accounts.
Canadian Life Insurers’ Outlook Is Stable as Largest Firms' Earnings Likely to Stay Strong Our continued stable outlook on the Canadian life insurance industry reflects our expectation that over the next 12-18 months the industry’s three most dominant players – which share 65% to 70% of gross premiums – will continue to benefit from the scale and pricing power afforded them by this concentrated industry structure. The acquisition by Manulife Financial Corporation of the Canadian operations of Standard has led to further concentration in the industry, and we expect stable and predictable earnings growth to continue in 2016.
US Life Insurers’ Prolonged Period of Low Interest Rates Pressures Reserve Margins Although our baseline economic scenario assumes a gradual recovery with a slow rise in interest rates, continued stagnation amid a further period of low interest rates is a plausible downside scenario. Insurers most likely to be hurt in a low rate environment include those with large legacy exposures and/or those with specialization in sale of certain products. Analysis of actuarial cash flow testing results of over 40 US life insurance groups shows that pressure on reserve margins is increasing with significant variability among insurers.
US Banks: Third Quarter Credit Update Bank balance sheets remained strong in the third quarter, with ongoing improvement in the employment and real estate markets supported by sound asset risk metrics. Non-performing loan ratios improved, while net charge-off and early-stage delinquency ratios remained low. Capital ratios continued to improve in response to regulatory pressures. Although positive, regulatory pressures, combined with a difficult earnings environment, continue to create a challenge for banks not earning their cost of capital, which could spur more risk taking.
RESEARCH HIGHLIGHTS Notable research published the week ending 11 December 2015
48 MOODY’S CREDIT OUTLOOK 14 DECEMBER 2015
European Insurance: Solvency II Ratios Will Not Always Reflect Economic Capitalization Reported Solvency II ratios will not always reflect economic capitalization of insurers. In fact, Solvency II ratios may underestimate or overestimate insurers' actual economic capitalization because of the challenges in calibrating all risks on a pure economic basis at a 99.5% confidence level and the effect of the transitional measures agreed to smooth Solvency II implementation. As a result, the emphasis we place on Solvency II ratios in our assessment of insurers' capitalization will vary, notably by category of insurer.
US Health Insurers’ Industry Scorecard Despite continued uncertainties in the US health insurance sector, healthcare insurers have continued to report strong earnings margins, with solid membership growth. We expect the changing landscape to continue to pressure the sector in 2016. Additionally, the proposed consolidations (Centene and Health Net, Aetna and Humana, Anthem and Cigna), if approved, will result in significant debt and integrations risks for the companies involved.
Global Insurers’ Low Interest Rates Are the Top Credit Risk in 2016 - Poll At our annual Insurance conferences in London, Zurich and New York in November, we polled more than 170 professional market participants on what they see as the most pressing credit issues affecting the insurance sector. The poll results noted persistently low interest rates pose the greatest challenge for global insurers in 2016. In addition, participants surveyed said they expect the industry’s M&A trend is likely to continue over the next 12-18 months, predominantly driven by further consolidation in the reinsurance and European life sectors.
Global Bond Funds’ Outlook Is Stable as US Recovery Offsets Weaker LatAm Prospects The 2016 outlook for the bond fund sector remains stable and in line with the credit quality of corporate bonds, in which bond funds predominantly invest. The outlook reflects our expectation that despite the lackluster global economic outlook corporate default rates will remain low, companies will maintain solid liquidity profiles and banks will continue to strengthen their capital.
RESEARCH HIGHLIGHTS Notable research published the week ending 11 December 2015
49 MOODY’S CREDIT OUTLOOK 14 DECEMBER 2015
Sovereigns
Kazakhstan Sovereign: Fiscal, External Buffers Curb Credit-Negative Effect of Currency Fall The tenge’s depreciation occurs in the context of the sharp drop in oil prices since 2014, which has lowered foreign exchange earnings and GDP growth for Kazakhstan. Weaker economic conditions in China (Aa3 stable), Russia (Ba1 stable) and other important trading partners further cloud the export outlook. Foreign direct investment and financial flows remain in positive territory, but there are some signs of capital outflows.
Qatar Sovereign Credit Analysis Qatar’s Aa2 government bond rating and stable outlook reflects our expectation of economic, fiscal, and external resilience to the current environment of low oil prices. The non-hydrocarbon sector has been the primary driver of growth in recent years, propelled by the ongoing infrastructure push ahead of the 2022 FIFA World Cup and in line with the government’s development framework, the National Vision 2030. Qatar’s fiscal breakeven oil price – the oil price that would balance the budget – remains amongst the lowest in the Gulf Cooperation Council. And although current oil prices are below the breakeven price, the government’s large net creditor position will cushion the fiscal effect.
Albania Sovereign Credit Analysis Albania’s B1 government bond rating incorporates the Albanian government’s fiscal consolidation and arrear repayment measures under its three-year extended arrangement with the International Monetary Fund. The programme helps to counterbalance the sharp deterioration in the country’s fiscal strength in the run-up to the June 2013 elections. In particular, the programme is expected to boost revenue generation, an area in which Albania underperforms relative to regional peers.
Brazil Sovereign: Key Drivers for Placing Baa3 Government Bond Rating on Review for Downgrade On 9 December 2015, we placed Brazil’s Baa3 government bond rating on review for downgrade. Brazil’s fiscal challenges require significant political will and consensus to reverse the negative medium-term trends for public spending and rising debt trajectory. During the review period, we will evaluate the authorities’ ability to put fiscal policy back on track, restore economic growth and arrest the rise in the ratios.
Inside ASEAN: The View from Indonesia In early December, we held our inaugural Inside ASEAN – Spotlight on Indonesia credit briefing in Jakarta. The event brought together some of the country’s largest investors, intermediaries, regulators and debt issuers, with over 60 market participants in attendance. After a year characterized by slowing growth, currency volatility and commodity price weakness, our discussions focused on whether such challenges will persist into 2016 and the extent to which rated entities in the country can absorb further credit pressures.
Cuba Sovereign: Key Drivers for Outlook Change to Positive from Stable The positive outlook on Cuba’s Caa2 rating reflects our expectation that measures to diversify trade and financial links will contribute to favorable macroeconomic trends and will coincide with continued easing of economic sanctions by the US. The positive outlook also anticipates that the Cuban authorities will maintain the current reform momentum following the Communist Party Congress in April 2016, while managing challenges stemming from weaker external finances.
RESEARCH HIGHLIGHTS Notable research published the week ending 11 December 2015
50 MOODY’S CREDIT OUTLOOK 14 DECEMBER 2015
Panama Sovereign Credit Analysis Panama’s Baa2 rating reflects the country’s continued strong economic performance and broad macroeconomic stability that has been supported by dollarization. Also bolstered by the key role of the Panama Canal in global trade, Panama’s economy has averaged nearly 7.8% annual growth over the past 10 years. Despite the country’s high degree of economic openness and heavy reliance on foreign financing, the economy has proven resilient through weak external economic conditions.
Cuba Sovereign Credit Analysis Cuba’s Caa2 sovereign rating reflects credit weaknesses that include limited access to external financing, high dependence on imported goods, political transition risk, and most importantly, a lack of data transparency. These weaknesses more than offset credit strengths that include a dynamic and growing tourism sector, nickel-related mining activities, and the potential for future economic diversification.
Solomon Islands Sovereign Credit Analysis Solomon Islands’ B3 government bond rating is supported by the sovereign’s robust fiscal balances, low government debt burden, and strong donor institutional and financial support. These strengths are counterbalanced by the narrowly diversified nature of the economy and its own relatively nascent political and policy institutions.
Sub-Sovereigns
English Housing Association Outlook Is Negative, Driven by Adverse Policy Changes We expect English Housing Associations’ financial performance to peak in 2016 before adverse policy changes introduced in 2015 begin to bite from 2017 onwards, eroding margins and interest coverage ratios. The changes have threatened the historical stability of the English HA sector, driving our negative outlook for the sector. Individual HAs’ varied responses to the policy changes increase the probability of rating divergences in what has so far been a tightly-rated sector.
ECB to Buy Sub-sovereign Debt, a Credit Positive for the Sector On 3 December 2015, the European Central Bank (ECB) added euro-denominated debt issued by euro area regional and local governments (RLGs) to the list of bonds it can buy under its quantitative easing programme. The move is credit positive for European RLGs, as large scale purchases of their bonds by the ECB will tend to reduce their cost of debt, and make it easier for them to refinance expiring bank loans by issuing bonds.
RESEARCH HIGHLIGHTS Notable research published the week ending 11 December 2015
51 MOODY’S CREDIT OUTLOOK 14 DECEMBER 2015
US Public Finance
States Have Time to Prepare for ACA's 'Cadillac Tax' The Affordable Care Act's 40% excise tax on high-cost employer-sponsored health plans will not materially affect most state government employee health costs until several years after the tax is implemented in calendar 2018. States offering their employees and retirees the most generous coverage will bear the greatest effect of the levy, dubbed the “Cadillac tax.” When the tax first bites during fiscal 2018, it will affect only a handful of state governments, and most governments will have time to adjust employee benefits to minimize their exposure.
Aging Baby Boomers to Drive Growth in State HFA Rental Programs State housing finance agencies (HFAs) will capitalize as demand for affordable rental housing grows among aging baby boomers. Americans 65 and older are a rapidly expanding demographic group. Though most seniors will continue to be homeowners, an influx of renters will significantly increase HFA profitability. Still, HFAs will need to navigate declining federal subsidies to developments targeting seniors.
California Tax Allocation Bonds Bolstered by Proven Payment Process and Real Estate Recovery With a now well-tested payment process, risks affecting California's (Aa3 stable) tax allocation bonds (TABs) have declined. The dissolution of redevelopment agencies (RDAs) in 2012 raised the prospect of interruptions in debt service payments, with a new administrative and procedural framework for successor agencies (SAs) to the RDAs. We recently upgraded nearly all of the $4.7 billion of Moody's-rated TABs, reflecting not only smooth SA management of the new flow of funds, but an improving economy and real estate market
Physician Employment Suppresses Profitability in Fiscal 2014 Medians Hospitals and health systems with very high physician employment show stronger revenue growth but lower profitability, according to FY 2014 physician employment medians. This dynamic will continue for several years as hospitals employ greater numbers of physicians in order to gain market share, align economic and clinical incentives to prepare for risk-based contracts, and take advantage of a growing number of physicians seeking employment.
RESEARCH HIGHLIGHTS Notable research published the week ending 11 December 2015
52 MOODY’S CREDIT OUTLOOK 14 DECEMBER 2015
Structured Finance
Marketplace Lending Platforms Will Continue to Evolve in 2016, Expand Loan Types Marketplace lending will expand in terms of both volume and loan type next year. In the US and the UK marketplace lenders will continue to deepen their footholds, while in the less mature European markets they will likely further establish themselves at a faster pace. In the Asia-Pacific, China will remain by far the largest industry player.
US Auto ABS Credit Quality Will Remain Strong in 2016, but Underwriting Standards Will Slip Modestly The overall credit performance of US auto loan, lease and floorplan asset-backed securities (ABS) will be strong in 2016, supported by a stable economic environment, strong used car values and, in the case of floorplan ABS, steady to growing rates of vehicle sales. Although underwriting standards for auto loans will continue to weaken modestly, the looser criteria will result in only slightly higher losses on new securitized loan pools than were seen in 2015.
Japanese ABS, RMBS and CMBS Outlook: Supportive Job Market Will Underpin High Credit Quality The credit quality and performance of Japanese asset-backed securities and residential mortgage-backed securities will remain strong in 2016. At the same time, default rates for Japanese commercial mortgage-backed securities will remain low.
Credit Quality of European RMBS and ABS Set to Improve in 2016 Improving credit quality in 2016 will benefit European residential mortgage-backed securities and asset-backed securities, with prudent lending conditions, especially for mortgages. However, lending conditions could ease for small and medium-sized enterprises (SMEs), encouraging originators to securitize SME loans. In the face of increasing competition, particularly in the UK, niche mortgage lenders will also try to expand their market shares, but for mortgages in particular, regulations will dictate what needs to be taken into account in underwriting. Credit Quality of US Private Student Loan ABS Will Remain Strong in 2016 The credit quality of new private student loan asset-backed securities will remain strong in 2016. Loans that traditional lenders originate and securitize will be of relatively good credit quality. The credit quality of loan pools underlying securitizations from new lenders, including deals sponsored by marketplace lenders, will also remain strong. However, these loan pools will have marginally weaker credit characteristics than new lenders’ loan pools in 2015 due to recent market entrants expanding both the types of loans they offer and their borrower base.
European SME ABS: Growing Number of SMEs Reflects Spain's Improved Business Environment The increasing number of small and midsize enterprises (SMEs) in Spain is credit positive for Spanish SME securitizations, with new business formation reflecting the country’s improved business climate. As the business environment improves, the credit quality of existing SMEs in asset-backed securities will strengthen, owing to expanded business opportunities that will reduce SME failure rates. This will translate into a lower likelihood of default for the securitized loans in ABS SME.
RESEARCH HIGHLIGHTS Notable research published the week ending 11 December 2015
53 MOODY’S CREDIT OUTLOOK 14 DECEMBER 2015
Canadian Securitizations to Perform Well in 2016 The assets backing Canadian ABS, RMBS and covered bonds are mainly consumer receivables, whose performance is aligned with that of the wider economy. We expect the Canadian economy to grow at slow but steady pace next year, supporting our positive outlook for all these securitization types.
Global Covered Bonds’ Outlook Is Stable Amid Positive Regulatory Environment Strong and increasing regulatory support for European covered bonds is credit positive, as are the improving outlooks for the issuers themselves. This improvement, along with the roll-out of our new bank rating methodology, has meant that the proportion of issuers whose senior unsecured ratings carry a negative outlook fell by 53% in the past year. Elsewhere, the economic backdrop in Canada will support covered bond credit quality there, while the credit quality of covered bonds in Australia, New Zealand, Korea and Singapore will reflect the credit strength of the respective issuers and sovereigns.
Credit Quality of Global Structured Will Improve in 2016 In 2016, the credit performance of senior notes in US structured finance (SF) collateralized debt obligations (CDOs) will improve, due primarily to the stable to improving credit quality of the US residential mortgage-backed securities and commercial mortgage-backed securities backing the transactions. Senior notes in SF CDOs will continue to build credit enhancement, while manager replacement and subsequent deal liquidations will also continue. The credit quality of senior notes in European cash SF CDOs will improve due to the ongoing amortization and improvement in the credit quality of their underlying collateral.
US Mortgage Lenders Face Difficulties Complying with New Rules, a Credit Negative for RMBS Several third-party review firms have revealed that more than 90% of the first pipeline of residential mortgage loans subject to the US Consumer Financial Protection Bureau’s recently enacted TILA-RESPA Integrated Disclosure Rules (TRID) that they reviewed had TRID compliance violations, although many of them were only “technical” in nature. These results suggest that some lenders are having difficulty complying with the rules, a credit negative because this increases the likelihood that loans with compliance violations will be included in future residential mortgage-backed securities pools.
RECENTLY IN CREDIT OUTLOOK Select any article below to go to last Thursday’s Credit Outlook on moodys.com
54 MOODY’S CREDIT OUTLOOK 14 DECEMBER 2015
NEWS & ANALYSIS Corporates 2 » General Electric Terminates Appliance Unit Sale to
Electrolux, a Credit Negative » Devon Energy’s Pending Acquisitions Are Credit Negative » Fluor’s $756 Million Acquisition of Stork Holding Is
Credit Negative » Naspers’ $2.5 Billion Equity Raise Improves Its Ability to
Pursue Investment Strategy » Nan Fung’s Disposal of Sino-Ocean Stake Is Credit Positive
Infrastructure 7 » Electricité de France Sells No Electricity under Regulatory
Price Mechanism, a Credit Negative
Banks 9 » Ex-Im Bank Reauthorization Is Credit Positive for PEFCO » Russian Mortgage Loan Performance Worsens as Originations
Slow, a Credit Negative for Exposed Banks
US Public Finance 12 » Kentucky Lowers Investment Return Assumption for Severely
Underfunded Pension Plans, a Positive for the State
Securitization 14 » US Mortgage Lenders Face Difficulties Complying with New
Rules, a Credit Negative for RMBS
MOODYS.COM
Report: 186593
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MJKK or MSFJ (as applicable) hereby disclose that most issuers of debt securities (including corporate and municipal bonds, debentures, notes and commercial paper) and preferred stock rated by MJKK or MSFJ (as applicable) have, prior to assignment of any rating, agreed to pay to MJKK or MSFJ (as applicable) for appraisal and rating services rendered by it fees ranging from JPY200,000 to approximately JPY350,000,000.
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EDITORS PRODUCTION ASSOCIATE News & Analysis: Jay Sherman and Elisa Herr Sol Vivero Ratings & Research: Bronwyn Collie