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MOODYS.COM
17 JANUARY 2013
NEWS & ANALYSIS Corporates 2
» St. Jude Medical’s Warning Letter on Cardiac Rhythm Management Plant Is Credit Negative
» SUPERVALU’s Sale of Five Retail Grocery Banners to Cerberus Is Credit Positive
» Cable & Wireless’ Sale of Its Macau Operations Is Credit Positive
» Ardagh Packaging’s Purchase of Verallia North America Is Credit Negative
» Saint-Gobain’s Sale of Verallia North America to Ardagh Is Credit Positive
» Telkomsel’s Win of Bankruptcy Appeal Is Credit Positive
Infrastructure 8
» ConEd’s Loss of Tax Deduction Is Credit Negative for Utilities with Similar Leveraged Leases
» E.ON and GDF SUEZ Sell Stake in SPP, Reducing Debt
Banks 11
» Singapore’s Measures to Stabilize Property Prices Are Credit Positive for Banks
Insurers 14
» Genworth’s Isolation of Its US Mortgage Insurance Subsidiaries Is Positive for Parent, Negative for Subsidiaries
» Compulsory Health Insurance for French Workers Would Be Credit Negative for Most Traditional Insurers
US Public Finance 19
» Kansas Court Ruling Requiring Increased Education Funding Is Credit Negative for State
» US Allows Two Rhode Island Cities to Use Google Settlement to Bolster Pensions, a Credit Positive
RECENTLY IN CREDIT OUTLOOK
» Articles in Last Monday’s Credit Outlook 22 » Go to Last Monday’s Credit Outlook
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NEWS & ANALYSIS Credit implications of current events
2 MOODY’S CREDIT OUTLOOK 17 JANUARY 2013
Corporates
St. Jude Medical’s Warning Letter on Cardiac Rhythm Management Plant Is Credit Negative
Last Friday, St. Jude Medical, Inc. (Baa1 stable) filed a form 8-K stating that its cardiac rhythm management (CRM) division received a warning letter from the US Food and Drug Administration (FDA) for its Sylmar, California, facility related to observations that certain quality system regulation practices did not adhere to so-called good manufacturing practice standards. This development is credit negative because the FDA will not approve new Class III (highly regulated) devices or provide export certificates to foreign governments for products made at Sylmar until the issues that gave rise to the warning letter are resolved to the FDA’s satisfaction.
It is too early to determine whether the new warning letter will affect future sales of CRM products, which are more than 50% of St. Jude Medical’s total revenues. Importantly, the letter did not identify concerns or field actions related to the performance of specific CRM products, including Durata defibrillator leads. However, although these products will remain on the market, it is possible that this warning letter will prompt some physicians and hospitals to be more cautious and turn to competitors’ products. The actual warning letter, released on Tuesday by the FDA, indicated, among other things, that St. Jude Medical failed to put in place adequate processes to verify the design of the device and failed to maintain adequate records of design changes.
Although details regarding the percentage and the exact types of CRM products manufactured at Sylmar aren’t public, St. Jude Medical also makes CRM devices in FDA-approved plants in Malaysia and Puerto Rico. If the Sylmar warning letter remains outstanding for a protracted period and important new products are delayed, the letter could have a more significant effect on the company’s credit quality. St. Jude Medical also has a warning letter outstanding at its neuro-modulation facility.
St. Jude Medical has faced challenges following the November 2011 recall of its Riata high-voltage lead because of insulation failure or premature erosion of the insulation around the electrical conduction wires. In August 2012, the FDA requested that St. Jude Medical conduct a three-year, post-market surveillance study of the Riata lead. Around the same time, a clinical report authored by a cardiologist at the Minneapolis Heart Institute suggested that the currently marketed Durata lead also could be vulnerable to insulation abrasion.
The overall market for CRM devices has been under pressure owing to concerns regarding safety as well as inappropriate implantation. The company in its preliminary fourth-quarter results reported a 5% decline in CRM sales and a 3% decline in implantable cardioverter defibrillator (ICD) sales compared with the same period last year. That said, new products including its Quadripolar CRT-D device have buoyed St. Jude Medical’s ICD market share.
The January warning letter follows news that the company plans to complete its previously announced $1 billion share buyback program by the end of first-quarter 2013. This accelerated buyback initiative will temporarily increase debt levels, but we expect St. Jude Medical to bring gross debt down to pre-buyback levels and refrain from any additional buybacks until 2014.
Diana Lee Vice President - Senior Credit Officer +1.212.553.4747 [email protected]
NEWS & ANALYSIS Credit implications of current events
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SUPERVALU’s Sale of Five Retail Grocery Banners to Cerberus Is Credit Positive
Last Thursday, SUPERVALU, Inc. (B3 negative) announced that it would sell five grocery banners to an investment consortium led by Cerberus Capital Management LP for $3.3 billion, including $3.2 billion in assumed debt and $100 million in cash. The sale is credit positive because it will improve the business mix of the remaining company, significantly reduce its exposure to the highly competitive and challenging traditional retail grocery business and improve its asset quality.
With a much smaller retail grocery footprint, no debt maturities for the next three years, and a new management team, SUPERVALU will be in a better position to reverse its revenue and profit declines. SUPERVALU will sell its Albertsons, Acme, Jewel-Osco, Shaw’s and Star Market stores and related Osco and Sav-on in-store pharmacies to AB Acquisition LLC, an affiliate of a Cerberus-led investor consortium. Concurrently with the sale, another Cerberus-led consortium, Symphony Investors, will conduct a tender offer of up to 30% of SUPERVALU’s outstanding shares at a price of $4.00 a share.
The sale’s aim is to unwind SUPERVALU’s June 2006 acquisition of Albertsons and leave it with only 191 of the pre-sale total of 1,068 retail food stores. The regional chains remaining at SUPERVALU will be Cub Foods, Farm Fresh, Shoppers, Shop ’n Save and Hornbacher’s, the wholesale distribution business, and the Save-A-Lot hard discount store segment.
Based on the number of stores being sold, we estimate that post-sale SUPERVALU’s traditional grocery retail business will decline to less than 30% of total sales from about 65%, with the distribution business and the Save-A-Lot segment accounting for about 70% of its pro forma sales and pro forma EBITDA, respectively. SUPERVALU’s current rating reflects the underperformance of the company’s traditional retail grocery business, which has been the primary cause for its continuing decline in its sales and profitability.
For the nine months ended 1 December 2012, the grocery retail business’ operating margin was 0.6%, while the operating margins for Save-A-Lot and the wholesale distribution business were 3.2% and 2.6%, respectively. The sale will not only reduce the company’s funded debt but will also lower its operating lease commitments and multiemployer pension plan (MEPP) liabilities, including future MEPP contributions. Required capital expenditures will also be lower as the retained businesses are less capital intensive.
We estimate that the transaction will be moderately deleveraging for SUPERVALU, with pro forma adjusted leverage improving to about 5.5x from 5.8x for the 12 months ended 1 December. We expect a new $900 million revolver and $1.5 billion term loan to replace and refinance the company’s existing $1.65 billion asset-based revolver, $846 million term loan, and $490 million of 7.5% bonds maturing in November 2014, which will be called. Pro forma this refinancing, there will be no significant debt maturities until May 2016, when $1 billion of senior unsecured notes mature.
The company’s wholesale distribution business has been relatively stable compared with its traditional retail grocery business despite the erosion in its margins. The company’s Save-A-Lot format, which includes licensed and company-owned stores, has the potential to improve SUPERVALU’s profitability by leveraging fixed costs of its distribution operation and catering to a growing segment of thrifty consumers.
Mickey Chadha Vice President - Senior Analyst +1.212.553.1420 [email protected]
NEWS & ANALYSIS Credit implications of current events
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Cable & Wireless’ Sale of Its Macau Operations Is Credit Positive
Last Monday, Cable & Wireless Communications Plc (CWC, Ba2 negative) announced that it had signed an agreement with CITIC Telecom International Holdings Limited (unrated) for the sale of its 51% stake in Companhia de Telecomunicações de Macau S.A.R.L. (CTM, unrated) for a consideration of $750 million.
Although the Macau division is CWC’s most stable business and has been generating the bulk of the company’s growth over the past few years, the sale is credit positive. The sale achieved a high implied enterprise value to EBITDA multiple of 8.9x, based on results for the 12 months ended 31 March 2012.
The transaction is a further step in CWC’s strategy to refocus its operations on pan-America. As part of this strategy, the company had recently announced the sale of its Monaco & Islands division. Gearing the business towards a smaller geographic area will free up some management time and facilitate operations.
To build momentum in pan-America, CWC will need to invest in both organic and inorganic growth in those markets. The sale of Macau, coupled with the results from the Monaco & Islands sale, which could bring in $1.025 billion, would leave CWC with a net cash position of around $150 million. In addition, CWC has ruled out using the funds from the sale to pay any immediate special dividend or engage in any share buybacks.
The company expects to complete the sale within the next six to nine months, pending regulatory approval and various shareholder sign-offs.
Christian Azzi Analyst +44.20.7772.5470 [email protected]
NEWS & ANALYSIS Credit implications of current events
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Ardagh Packaging’s Purchase of Verallia North America Is Credit Negative
Last Monday, Ardagh Packaging Group plc (B2 negative), a leading European producer of glass and metal containers, announced that it had reached an agreement to acquire Verallia North America, the second-largest producer of glass containers in the US, for a total consideration of $1.7 billion, including assumed liabilities. The purchase of Verallia from its current shareholder, Compagnie de Saint-Gobain SA (Baa2 negative), is credit negative for Ardagh because it will increase its debt load and reduce its financial flexibility at a time when cyclical pressures, particularly weak demand in its metal division, are harming its overall profitability.
This transaction is further evidence of management’s aggressive financial policy to transform Ardagh into one of the world’s leading rigid packaging companies. Ardagh has already effected a string of debt-funded acquisitions in less than three years, which, pro forma for Verallia, has more than quadrupled its size since 2010. The acquisitions have so far resulted in a significant increase in Ardagh’s financial leverage, with debt/EBITDA at around 7x on a pro forma basis as of year-end 2012.
Although the transaction multiple of about 6.3x Verallia’s EBITDA (pro forma for targeted synergies; 6.5x excluding those synergies) is slightly below the current leverage, it will not have a material effect on the group’s debt protection metrics. However, we still caution that the pace of deleverage will be slower than what we had expected prior to this transaction because the integration of Verallia will require restructuring, resulting in additional cash outflows.
In addition, the group’s existing operations’ profitability has weakened over the past year, owing to the challenging macroeconomic situation in Europe. Against this backdrop, we had expected Ardagh to concentrate on improving profitability in its existing business by focusing on integrating prior acquisitions and restructuring its metal operations. Incorporating Verallia will add a further degree of complexity to the business when the existing operations already require significant management attention.
Strategically, the transaction is in line with Ardagh’s aim to expand into mature markets that benefit from stable end-customer demand. Verallia’s footprint is largely complementary to Ardagh’s existing production base in the US, allowing the group to expand into higher margin wine bottles and adding significant new customers. The combination of Verallia with Ardagh’s existing US glass operations will allow it to increase its market share to approximately 50% in North America. Ardagh should, in our view, be able to leverage its position in a market where capacity is tight at the moment, limiting customers’ ability to move to other suppliers.
While the operating profit margins of glass container producers in North America are below that of Ardagh’s European glass operations, we note that we see some potential for rising margins given the strong market consolidation that this acquisition will achieve. In addition, Ardagh targets to reach annual synergies of $70 million by 2016. But we caution that upfront integration costs in the initial quarters following the transaction’s closing will mitigate any benefits.
Anke Rindermann Assistant Vice President - Analyst +49.69.70730.788 [email protected]
NEWS & ANALYSIS Credit implications of current events
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Saint-Gobain’s Sale of Verallia North America to Ardagh Is Credit Positive
Last Monday, Compagnie de Saint-Gobain SA (Baa2 negative) received a binding and irrevocable offer from Ardagh Packaging Group plc (B2 negative) to acquire its US-based glass container operations, Verallia North America, for a total consideration of $1.7 billion (approximately €1.3 billion). This transaction, which is subject to a regulatory review, is credit positive for Saint-Gobain because it will mainly use the sales proceeds to strengthen its balance sheet.
The sales multiple of 6.5x 2012 EBITDA of $261 million that Ardagh is paying is higher than valuations we have seen in recent deals in the glass container business in the US, and higher than the envisaged valuations for Verallia’s cancelled 2011 IPO.
The use of the sales proceeds mainly for debt reduction confirms our earlier assessment that Saint-Gobain’s management would make all necessary efforts to restore credit metrics in line with our expectation for its current rating after a challenging 2012. The weak performance of Saint-Gobain’s flat glass and exterior solutions activities dragged down the group’s performance last year.
However, the pro forma effect of the sale on Saint-Gobain’s credit metrics will be relatively modest because Verallia is a profitable and cash flow generative business. We expect a positive effect on its retained cash flow/net debt ratio of less than 1.5 percentage points on a pro forma basis. This would not be enough to prompt us to revise our negative outlook. In addition, Saint-Gobain will deconsolidate a stable, albeit low-growth, earnings and cash flow contributor, which will slightly weaken its business profile.
Stanislas Duquesnoy Vice President - Senior Credit Officer +49.69.70730.781 [email protected]
NEWS & ANALYSIS Credit implications of current events
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Telkomsel’s Win of Bankruptcy Appeal Is Credit Positive
On Tuesday, Telekomunikasi Selular (P.T.) (Telkomsel, Baa1 stable) announced that the Indonesian Supreme Court had accepted its appeal to overturn a lower court’s ruling that declared it bankrupt last September. The ruling is credit positive for Telkomsel and its parent, Telekomunikasi Indonesia (P.T.) (Telkom Indonesia, Baa1 stable), because it closes the litigation and removes the risks of an accelerated repayment of some of Telkomsel’s bank loans. Such a payment could have triggered a cross-default at the parent. In addition, the court win enables Telkomsel to participate in an upcoming spectrum auction.
Telkomsel is Indonesia’s largest wireless telecommunication operator, with 121 million total subscribers as of September 2012. Telkom Indonesia, which is 53.8%-owned by the Indonesian government, is the largest integrated telecommunications company in the country.
On 14 September 2012, the Central Jakarta District Court accepted a bankruptcy petition filed by Prima Jaya Informatika against Telkomsel for non-payment of IDR5.3 billion ($558,000). Prima Jaya Informatika had a two-year contract with Telkomsel to distribute prepaid cards and SIM cards, which was at the center of their dispute. Prima Jaya Informatika was able to succeed in its initial bankruptcy petition against Telkomsel because of an idiosyncrasy of Indonesian law that allows for any two creditors to file such a claim regardless of the defendant’s creditworthiness. Telkomsel retains very strong liquidity, with cash on hand of IDR6.8 trillion ($716 million) as of 30 September 2012.
Had the Supreme Court upheld the lower court decision, it would have put downward pressure on the credit quality and ratings of both Telkomsel and its parent, reflecting the companies’ exposure to an uncertain legal and regulatory environment in Indonesia. The Supreme Court decision in favour of Telkomsel removes these risks. In addition, because the closure of the bankruptcy litigation came ahead of 3G license auctions in Indonesia, Telkomsel can now bid for additional 3G spectrum, as local laws prohibit a bankrupt company from participating in the auction.
Operators are required to submit bids for additional 2.1 gigahertz (GHz) 3G spectrum by 31 January, and the outcome of the auction process will be announced on 27 February.
Currently, Telkomsel and Indosat Tbk. (P.T.) (Ba1 stable) and XL Axiata Tbk. (P.T.) (Ba1 stable), the second- and third-ranked players, respectively, have equal 2.1 GHz 3G spectrum allocations of 10 megahertz (MHz) each. In September, Indosat reallocated part of its existing 10 MHz of 900 MHz spectrum for 3G services, giving it the maximum allocation of spectrum for 3G. However, Indosat lags its peers on 3G network coverage owing to its late start.
After incorporating Telkomsel’s participation in 3G auctions, we project 2013 capex of around IDR10.5 trillion ($1.1 billion), an increase of around 12% from the 12 months ended September 2012, and this may be partially be financed with debt. However, Telkomsel continues to maintain a strong operating and financial profile, with adjusted debt/EBITDA of 0.2x for the 12 months ended September 2012.
We expect data revenue in Indonesia to grow 10%-15% over the next 12-15 months, while voice and text-messaging revenues will to grow 5%-6%. As data revenues rapidly replace voice and text-messaging revenues, we expect Indonesian cellular operators to become more competitive on data services. Hence, additional 3G spectrum and bandwidth will enhance operators’ ability to compete for future revenue growth.
Nidhi Dhruv Analyst +65.6398.8315 [email protected]
Agnes Lee Associate Analyst +65.6398.8326 [email protected]
NEWS & ANALYSIS Credit implications of current events
8 MOODY’S CREDIT OUTLOOK 17 JANUARY 2013
Infrastructure
ConEd’s Loss of Tax Deduction Is Credit Negative for Utilities with Similar Leveraged Leases
On 9 January, the US Court of Appeals for the Federal Circuit issued a decision disallowing Consolidated Edison, Inc. (Baa1 stable) from claiming tax deductions related to leveraged leases dating back to 1997. This decision could result in $370 million of tax payments for ConEd, a credit negative. However, this issue is not isolated to ConEd because several other utilities entered into similar transaction in the late 1990s and early 2000s. While there are several utilities with legacy leveraged lease tax issues, ConEd and Pepco Holdings Inc. (Baa3 stable) remain the most exposed, disclosing potential payments of $1.1 billion, including interest and penalties in their most recent financial statements.
Since the mid- to late-1990s, many companies engaged in leasing transactions involving cross-border leases with tax-exempt or tax-neutral entities. These deals involved US companies buying or leasing assets in a foreign country and immediately leasing them back to the original owner. These deals are commonly known as lease in/lease out (LILO) or sale in/lease out (SILO) transactions.
LILO and SILO structures have been used as financing vehicles since the mid-1980s, when the Tax Reform Act (P.L. 99-514) modified depreciation rules applicable to foreign and tax-exempt use property. Simply put, this amendment enabled the transfer of the tax benefits associated with owning property, namely accelerated depreciation, from a tax-indifferent entity to a taxable entity. As the tax-indifferent entity could not take advantage of accelerated depreciation deductions for tax purposes, these tax benefits were going to waste.
By entering into these LILO and SILO deals with tax-indifferent entities, US companies were able to gain substantial tax and accounting benefits in the early years of the leases, and they became very popular among banks and utilities in the mid- to late-1990s. By some estimates, during the peak of the LILO/SILO market, the volume of US leases to foreign entities increased to $20 billion from $3 billion between 1994 and 1998.1 The Internal Revenue Service (IRS) estimated that 56 US taxpayers were involved in these deals, with some taxpayers entering into dozens of leases. Of these taxpayers, approximately 15% were utilities.
Owing to the exponential increase in deals and resulting tax deductions, the IRS naturally began examining the validly of the tax deductions claimed. After reviewing these tax structures, the IRS stated in 1999 that the tax benefits received from these deals were not valid if the transaction lacked “economic substance.” This ruling effectively required companies to prove their deals had economic substance. The banking industry threw in the towel on the issue several years ago and settled with the IRS. However, the utility industry is now in its 14th year of fighting the issue. During this time there have been victories on both sides of the LILO/SILO tax battle, the latest being the 9 January decision in favor of the IRS. Despite earlier victories, two other large utilities with large LILO’s tax exposures, Public Service Enterprise Group Incorporated (Baa2 stable) and Edison International (Baa2 stable) previously settled the issue with the IRS.
1 David Nemschoff, “A Growing Substantial Role; Financial Intermediaries and U.S. Leases to Tax-Exempt Entities,”
Equipment Leasing, January 1999.
Wesley Smyth Vice President - Senior Accounting Analyst +1.212.553.2733 [email protected]
Mihoko Manabe Vice President - Senior Credit Officer +1.212.553.1942 [email protected]
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9 MOODY’S CREDIT OUTLOOK 17 JANUARY 2013
Although there are other utilities with legacy LILO/SILO portfolios, ConEd is the furthest down the road in terms of the appeals process. While most utilities will argue their facts and circumstances are different than ConEd’s, we believe these differences will be only around the edges. Therefore, this ruling will substantially weaken other utilities’ cases. Besides ConEd’s exposure of $370 million, PEPCO disclosed potential payments of $760 million, including interest and penalties. There are several other utilities with legacy LILO/SILO issues, but the potential amounts are not material to merit disclosure.
Although the combined total of $1.1 billion is a large number and clearly credit negative, from a liquidity perspective if payments are required they will probably not be in paid in a lump sum and will not occur in 2013. If the affected companies proactively manage their liquidity in light of this negative credit development, ratings will not be affected, all else equal.
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E.ON and GDF SUEZ Sell Stake in SPP, Reducing Debt
Last Tuesday, E.ON SE (A3 stable) and GDF SUEZ SA (A1 negative), the giant European power groups, agreed to sell their joint 49% stake in Slovenský Plynárenský Priemysel (SPP, A2 review for downgrade), a Slovak gas operator, to Energeticky a Prumyslovy Holding (unrated) for more than €2.5 billion. The deal, which will net each partner €1.3 billion, is credit positive for both companies because it will reduce debt and is a further step towards completion of their asset disposal programmes. The sale is also consistent with both companies’ strategies to simplify their asset portfolios and reduce minority holdings.
The transaction follows E.ON’s sale two weeks ago of a 43% stake in E.ON Thuringer Energie, a regional power supply and distribution company, for approximately €900 million.
E.ON’s aggregate proceeds of €2.2 billion from the two deals mean it has comfortably achieved ahead of schedule its €15 billion disposals target by the end of 2013, and will reduce the company’s approximately €14.8 billion of net debt (as of the end of September) by roughly 15%, a credit positive for E.ON.
The deal is also credit positive for GDF SUEZ because its €1.3 billion share of the proceeds from the sale of SPP will reduce its approximately €45.9 billion net debt (as of the end of September) by roughly 3%. The sale completes more than €11 billion of asset sales for the group since 2011. In December, it announced a new disposals target of €11 billion for 2013-14 that, combined with other measures, is designed to reduce net debt to approximately €30 billion by the end of 2014.
E.ON’s and GDF SUEZ’s progress on their asset disposal programmes is credit positive because it reduces their leverage in response to the negative earnings pressure both companies are facing in Europe in 2013 from lower electricity prices and narrower margins on gas-fired generation. In addition, like other nuclear power producers in Germany, E.ON will be required to pay the nuclear fuel rod tax that we estimate will be in the range €700-€800 million a year in 2012-13. GDF SUEZ, which we estimate will also pay a net €250 million in tax on its nuclear fleet in Belgium, is aiming to reduce borrowings following its acquisition in June of International Power plc (Baa2 negative), which increased debt by approximately €8.7 billion.
Niel Bisset Senior Vice President +44.20.7772.5344 [email protected]
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Banks
Singapore’s Measures to Stabilize Property Prices Are Credit Positive for Banks
Last Friday, the Singapore government, through the Monetary Authority of Singapore (MAS), the Ministry of Finance, the Ministry of National Development and the Ministry of Trade & Industry, released new regulations2 to curb speculation on residential and industrial property transactions. Whereas previous measures targeted residential properties,3 these new regulations mark the first time that the government has levied a seller’s stamp duty (SSD) on industrial properties. These measures are credit positive for Singapore banks because they will reduce the threats of property price bubbles, future price shocks and loan losses.
The main measures, which took effect last Saturday, are summarized in Exhibit 1.
EXHIBIT 1
Key Measures to Stabilize Industrial and Residential Property Prices Residential Properties
Citizenship Additional Buyer’s Stamp Duty1 (ABSD) Rate on First Purchase
ABSD Rate on Second Purchase
ABSD Rate on Third & Subsequent Purchases
Singapore Citizens New: 0%, Old: 0% New: 7%, Old: 0% New: 10%, Old: 3%
Permanent Residents2 New: 5%, Old: 0% New: 10%, Old: 3% New: 10%, Old: 3%
Foreigners and non-individuals3
New: 15%, Old: 10% New: 15%, Old: 10% New: 15%, Old: 10%
Loan-to-Value Limits First Loan Second Loan4 Third or More Loan4
No change from current rule of 80%, or 60% if loan term is more than 30 years or extends past age 65
New: 50%, or 30% if loan term is more than 30 years or extends past age 65 Old: 60%, or 40% if loan term is more than 30 years or extends past age 65
New: 40%, or 20% if loan term is more than 30 years or extends past age 65 Old: 60%, or 40% if loan term is more than 30 years or extends past age 65
For non-individuals3: New: 20%, Old: 40%
Minimum Cash Down Payment5
First Loan Second Loan4 Third or More Loan4
No change from current rule of 5% (for LTV of 80%), or 10% (for LTV of 60%)
New: 25% Old: 10%
New: 25% Old: 10%
Industrial Properties Seller’s Stamp Duty6
If the property is sold in the first year after purchase 15%
If the property is sold in the second year after purchase 10%
If the property is sold in the third year after purchase 5%
2 See joint press release. 3 See Singapore’s New Measures to Stabilize Home Prices Are Credit Positive for Banks, 11 October 2012.
Shaoyong Beh Associate Analyst +65.6398.8309 [email protected]
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Note:
[1] Additional Buyer’s Stamp Duty (ABSD) is charged on the purchase price or market value, whichever is higher (excluding goods and services tax).
[2] Foreigners who meet certain criteria as determined by the Immigration & Checkpoints Authority and may reside in Singapore for an extended period.
[3] Non-individuals include, but are not limited to, corporations.
[4] Applicable to borrowers with outstanding housing loans.
[5] Based on the market value or purchase price, whichever is lower.
[6] SSD is charged on the purchase price or market value, whichever is higher (excluding goods and services tax).
Source: MAS, Urban Redevelopment Authority, Inland Revenue Authority of Singapore
The expanded coverage is the government’s reaction to mounting evidence that speculative activities are rising, particularly with industrial properties. According to the MAS, about 18% of multiple-user factory sales that occurred during January-November 2012 were resale transactions carried out within three years of purchase. This compares with 15% in 2011 and an average of about 10% during 2006-10.
Furthermore, as seen in Exhibit 2 below, industrial property prices have risen since third-quarter 2009 at a pace that has surpassed the price increases in private and public residential properties since mid-2010. In addition, despite the last round of measures announced on 5 October 2012, both private and public property price increases have shown signs of re-accelerating based on the fourth-quarter 2012 flash estimates.
EXHIBIT 2
Singapore Residential and Industrial Property Price Indices, First Quarter 2007=100
Source: Urban Redevelopment Authority, Housing & Development Board. Fourth-quarter 2012 data are flash estimates:
We expect the new measures to dampen bank loans for residential and industrial property purchases, particularly those disbursed to investors. Higher minimum cash down payments and the additional buyer’s stamp duty (ABSD), along with lower LTV limits, will reduce demand on residential properties for investment or speculative purposes.
With the government now levying the SSD according to the holding period, the potential return on short-term bets will fall, thereby helping to limit speculative demand on industrial properties. Investors are also more likely to reassess their options and debt serviceability since they will have to hold on to a property for a longer period if they want to avoid the SSD.
90
100
110
120
130
140
150
160
170
180
190
Industrial Property Price Index Private Housing Price Index Public Housing Resale Price Index
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At third-quarter 2012, our rated Singaporean banks, DBS Bank Ltd. (Aa1 negative; B/aa3 negative),4 United Overseas Bank Limited (Aa1 stable; B/aa3 stable) and Oversea-Chinese Banking Corp. Ltd. (Aa1 stable; B/aa3 stable) had 36%-42% of their loan portfolio5 exposed to the property sector, including loans to building and construction companies and housing loans.
4 The ratings shown are the banks’ deposit rating, its standalone bank financial strength rating/baseline credit assessment and
the corresponding rating outlooks. 5 The lack of disclosures on the amount of loans exposed to the industrial properties prevents us from assessing which banks
might be more or less affected.
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Insurers
Genworth’s Isolation of Its US Mortgage Insurance Subsidiaries Is Positive for Parent, Negative for Subsidiaries
On Wednesday, Genworth Financial Inc. (Baa3 stable) announced a reorganization that would reduce the linkages of the holding company with Genworth’s US mortgage insurance (US MI) operating subsidiaries, including, Genworth Mortgage Insurance Corporation (GMICO, insurance financial strength Ba2 negative) and Genworth Residential Mortgage Insurance Corporation of NC (insurance financial strength Ba2 negative). Genworth’s plan is credit positive for the parent because it limits the potential downside of the lower rated US MI business on the rest of the company, thereby aiding holding company creditors. However, because the action delinks the two operations, we expect less holding-company support for the US MI subsidiaries in a stress scenario, which is credit negative for those subsidiaries.
Genworth’s plan involves three steps. First is a legal entity reorganization that includes the creation of a new ultimate parent entity (New Parent) to facilitate the separation of the US MI business from the holding company that has issued the senior note obligations. Second is the creation of the option, under certain conditions, to write future US MI business using a new operating company (NewCo). Third is the transfer of the ownership of the European MI operating subsidiaries to GMICO. The third step, in addition to a $100 million cash infusion, improves GMICO’s capitalization. However, this benefit is more than offset by the de-linkage from the parent, as discussed below.
After the first step, legally executed under Delaware corporate law, New Parent will own Genworth, the old parent, and the US MI subsidiaries. Genworth’s outstanding senior and subordinated notes will remain obligations of the old parent. As a result of the reorganization, under which the old parent no longer owns the US MI subsidiaries, the latter are no longer among the companies covered by the indenture governing the old parent’s senior notes.
The reorganization, which the company expects to complete by the second quarter, does not require shareholder or noteholder consent. North Carolina, the state regulator for GMICO, has approved the plans. The plans have also been filed with other regulators and are subject to their approval.
The NewCo option gives Genworth the choice to write new business out of a new operating company in the unexpected event that business at GMICO deteriorates significantly, effectively walling off GMICO’s existing liabilities and placing the entity into runoff. The option to create NewCo has received requisite approvals from US government sponsored enterprises (GSEs), the main counterparties for MIs. In addition, if Genworth created a new US mortgage insurance company under the NewCo option, Genworth and GMICO would also have to meet certain obligations, pursuant to the approvals granted by the GSEs. While the NewCo option provides more flexibility for Genworth, and some additional capital for GMICO, it is a net credit negative for GMICO because it facilitates the ability of Genworth to place the company into runoff.
Genworth had previously indicated to the market that it is having ongoing discussions with regulators and the GSEs about various structural alternatives for its US MI business. Although they have been improving, the US MI subsidiaries’ earnings came under significant pressure following the 2008 downturn in the US housing market. For the first three quarters of 2012, the US MI subsidiaries reported a net operating loss of $106 million. Excluding the loss from the US MI subsidiaries,
Scott Robinson Senior Vice President +1.212.553.3746 [email protected]
Helen Remeza Vice President - Senior Analyst +1.212.553.2724 [email protected]
NEWS & ANALYSIS Credit implications of current events
15 MOODY’S CREDIT OUTLOOK 17 JANUARY 2013
Genworth reported operating income for the same period of $338 million, as shown in the exhibit below.
Genworth Net Operating Income
Source: Genworth Financial Third-Quarter 2012 Financial Supplement:
-$300
-$200
-$100
$0
$100
$200
$300
Q1 11 Q2 11 Q3 11 Q4 11 Q1 12 Q2 12 Q3 12
$mill
ions
Genworth Excluding US MI US MI
NEWS & ANALYSIS Credit implications of current events
16 MOODY’S CREDIT OUTLOOK 17 JANUARY 2013
Compulsory Health Insurance for French Workers Would Be Credit Negative for Most Traditional Insurers
Last Friday, French unions and employers reached an agreement on labor market reforms, including compulsory health insurance coverage for all employees through group contracts. The new rule, which we expect three of France’s five main union confederations to approve, would provoke a shift from individual health insurance to group health insurance, which is credit negative for traditional insurers focusing on retail clients. Furthermore, although insurers involved in group insurance may be able to offset the loss of individual policies through higher group insurance sales, the effect on margins would be negative for most of them because group policies are traditionally less profitable than individual policies.
As part of the negotiations to increase labor flexibility, French unions and employers agreed to make health insurance coverage compulsory for all employees. Employers would purchase and partly finance group contracts for the benefit of their employees. The government intends to use this agreement as the basis for a draft law that will be discussed in Parliament in May.
More than 90% of France’s population is already covered by health insurance,6 and virtually all employees currently not covered by group policies are covered by individual policies.7 Therefore, this new rule does not necessarily present an additional business opportunity for the insurance sector as a whole. However, it will prompt a transfer from individual health insurance to group health insurance for employees currently not benefiting from group contracts. We estimate this transfer will equal up to €4 billion of premiums,8 or around 20% of the individual health insurance market.
As detailed in Exhibit 1, three categories of insurers are involved in the French health insurance market. This transfer will create a loss of individual policies mainly for traditional insurers and health mutuals, which have the highest shares in the individual health market.
EXHIBIT 1
Health Insurance Premiums for 2011 by Insurer Category and Policy Category
Traditional
Insurers[1] Provident
Associations[2] Health
Mutuals[3] Total Market
Premiums €9.6 billion €4.8 billion €16.8 billion €31.1 billion % Individual Policies 59% n/a 71% approx. 60% % Group Policies 41% n/a 29% approx. 40% Market share total health insurance approx. 30% approx. 15% approx. 55% 100% Market share individual health approx. 30% approx. 5% approx. 65% 100% Market share group health approx. 30% approx. 35% approx. 35% 100%
[1] Regulated by the Insurance Code; traditional insurers may be public companies or mutuals.
[2] Regulated by the Social Security Code; provident associations specialize in providing group contracts for companies, and their corporate governance is characterized by an equal representation of employees and employers.
[3] Regulated by the Mutuality Code.
Sources: Chiffres de l’assurance 2011, Autorité de Contrôle Prudentiel; Assurances de Personnes 2011, Fédération Française des Sociétés d’Assurance; Chiffres de la Mutualité, Mutualité Française; Direction de la Recherche des Etudes, de l’Evaluation et des Statistiques; Moody’s
6 Source: Enquête sur la santé et la protection sociale 2008, Institut de recherche et documentation en économie de la santé
(IRDES). 7 Nearly 98% of employees are covered by health insurance, either through group contracts or individual contracts, per
Enquête de protection sociale complémentaire d’entreprise 2009, IRDES. 8 Considering that 16 million employees in France (excluding civil servants), and that 12 million employees are currently
already covered by a group contract (source: Centre Technique des Institutions de Prévoyance), we estimate that around 4 million employees are not yet covered. As total premiums for group health insurance amount to around €13 billion, employees without coverage equal up to €4 billion in premiums.
Benjamin Serra Vice President - Senior Analyst +33.1.5330.1073 [email protected]
NEWS & ANALYSIS Credit implications of current events
17 MOODY’S CREDIT OUTLOOK 17 JANUARY 2013
However, some of these players are also large players in group health insurance, and will be able to offset losses of individual policies by underwriting more group contracts. As most large corporates have already purchased group health policies for the benefit of their employees, new business opportunities in group health will lie in the small- to medium-size company segment. Traditional insurers present in this segment, such as AXA France Vie (insurance financial strength Aa3 negative), Allianz IARD (Aa3 negative) and Generali Vie (Baa1 negative) will be best positioned to capture these opportunities.
However, among the largest traditional individual health insurers listed in Exhibit 2, those with limited presence in group health insurance, such as Covéa (unrated), Swiss Life (unrated) and MACIF (A2 stable), or bankinsurers, such as Crédit Agricole Assurances (unrated) and Groupe ACM (unrated), would be the most negatively affected by the new rule.
EXHIBIT 2
Top 20 Individual Health Insurers, € millions
Type of Insurer 2011 Premiums in Individual Health
2011 Premiums in Group Health
MGEN Health mutual 1,566 n/a
Groupama Traditional insurer 1,365 508
Union Harmonie Mutuelles Health mutual 1,321 843
Covéa Traditional insurer 996 261
Swiss Life Traditional insurer 776 337
AXA Traditional insurer 729 1,041
Unéo Health mutual 631 n/a
MNH Health mutual 623 n/a
Pro BTP Provident association 592 717
La Mutuelle Générale Health mutual 547 n/a
Allianz Traditional insurer 535 670
MNT Health mutual 527 n/a
AG2R-La Mondiale Provident association 449 785
Adrea groupe Health mutual 435 339
Crédit agricole assurances Traditional insurer 429 n/a
Groupe ACM Traditional insurer 427 147
Eovi Groupe Health mutual 391 194
Malakoff-Mederic Provident association 386 1,104
MACIF Traditional insurer 367 86
Humanis Provident association 363 841
Source: L’Argus de l’Assurance, Top 30 de la Mutualité 2012
The agreement between trade unions and employers also allows for the possibility of an entire industry sector to negotiate one single group contract. In this case, provident associations, because of their nature and their low profitability target, would probably capture most of this business. Traditional insurers reinsuring or having co-insurance agreements with provident associations, such as AXA France Vie, Generali Vie or MACIF, would then also capture these business opportunities, but indirectly and with a lower control of the underwriting.
NEWS & ANALYSIS Credit implications of current events
18 MOODY’S CREDIT OUTLOOK 17 JANUARY 2013
Nonetheless, the replacement of individual policies by group policies remains credit negative overall, because margins of group contracts are lower than that of individual contracts. Group health policies also include legal constraints, such as the obligation to provide similar coverage to employees leaving a company in certain circumstances. Although these clauses have had a limited financial effect thus far, they are an additional risk for insurers.
NEWS & ANALYSIS Credit implications of current events
19 MOODY’S CREDIT OUTLOOK 17 JANUARY 2013
US Public Finance
Kansas Court Ruling Requiring Increased Education Funding Is Credit Negative for State
Last Friday, a Kansas state district court ordered the state to restore more than $500 million of school district aid next fiscal year, finding that recent education funding cuts violated court mandates and the state’s constitution. Although subject to appeal, this ruling is credit negative for Kansas (Aa1 negative) and highlights challenges the state faces as it tries to offset revenue losses from the income tax cuts it enacted last year.
The District Court of Shawnee County, Kansas, said education funding policy during the past five years violated judicial precedent and Article 6, subsection 6(b) of the Kansas Constitution, which requires the legislature to “make suitable provision for finance of the educational interests of the state.” The legislature “wholly disregarded the considerations required to demonstrate compliance with Article 6,’’ by repeatedly cutting state’s funding to school districts, District Court Judge Franklin R. Theis wrote in his opinion. The court said the state should raise its base aid per pupil by 17%, to $4,492 from the current year’s $3,838, a state funding increase of $511 million.
Lawsuits challenging the fairness of state education policies can drag on for years before being settled, and they are fairly common in US states. Kansas is one of 10 states currently involved in such litigation, according to the National Conference of State Legislatures. The current Kansas litigation, Gannon v. State of Kansas, is a successor to a suit that the state settled in 2006.
The latest education-funding ruling comes at an inopportune time for Kansas. The state last year passed a law that consolidates its personal income tax rates at 3% and 4.9%, removing the 6.25% and 6.45% top rates as well as the low rate of 3.5%. The state legislature projected the income tax cuts will reduce general fund revenues by about $800 million, or 13%, in fiscal 2014, which starts 1 July. In addition, prior sales-tax hikes sunset this fiscal year, returning the state’s sales-tax rate to 5.7% from 6.3%.
Cuts in education and other core state expenditures could help return the state to fiscal balance as these policy changes take hold. Attorney General Derek Schmidt said he will appeal the Shawnee County District Court ruling to the state’s Supreme Court. If the lower court’s view prevails, about 63% of the state’s budget will be off-limits for spending cuts and, in fact, will require increased funding. Governor Sam Brownback’s budget proposal, due out this week, may indicate how Kansas will address the impact of the tax cuts and education funding needs in fiscal 2014 and beyond.
Ted Hampton Vice President - Senior Analyst +1.212.553.2741 [email protected]
NEWS & ANALYSIS Credit implications of current events
20 MOODY’S CREDIT OUTLOOK 17 JANUARY 2013
US Allows Two Rhode Island Cities to Use Google Settlement to Bolster Pensions, a Credit Positive
Last Friday, federal authorities granted permission to Rhode Island’s Town of North Providence (General Obligation Baa2 stable) and City of East Providence (General Obligation Ba1 positive) to use funds from a federal settlement with Google Inc. (Aa2 stable) to reduce significant unfunded liabilities in their municipal police pension funds. This is credit positive for both municipalities because the settlement funds will alleviate pension underfunding and reduce annual pension contributions. The decision to allow the exceptions also indicates a growing recognition among political entities that pension underfunding is a widespread financial strain for state and local governments.
North Providence and East Providence each received $60 million in Google settlement funds last April after they participated in a federal probe into illegal online prescription drug sales to US citizens by Canadian companies. The US Department of Justice (DOJ) originally required the cities to earmark the funds for non-operational expenses, such as police vehicles, training and equipment, but the DOJ is allowing an exception for these communities to apply a portion to their pensions.
DOJ authorized North Providence to deposit $20.6 million of the money into its police pension fund, which will eliminate most of the town’s estimated $22.5 million unfunded liability and greatly increase the funded ratio, which was 45% as of the 2011 actuarial valuation. The reduction in the unfunded liability will significantly lower the town’s annual required contribution (ARC) for police pensions, which made up 2.2% of General Fund expenditures in 2012. The town underfunded its police pension ARC for several years, as shown in Exhibit 1, in response to financial strain driven by severe state aid cuts and assessed value declines.
EXHIBIT 1
North Providence’s Underfunded Police Pension Annual Required Contributions
Source: North Providence, Rhode Island, Financial Audits:
DOJ similarly authorized East Providence to contribute $49.2 million of the settlement money into its public safety pension fund, which will eliminate close to half of its $105.8 million unfunded liability. The city, which has faced more financial stress than North Providence, has more severely underfunded its annual pension contributions over the past few years (see Exhibit 2), and its funded ratio was only 33.6% as of the 2011 actuarial valuation. While the city will still have a significant unfunded liability, the Google settlement funds will reduce the city’s ARC payment, providing much-needed budgetary relief.
$0.0
$0.2
$0.4
$0.6
$0.8
$1.0
$1.2
$1.4
$1.6
2006 2007 2008 2009 2010 2011 2012
$ m
illio
ns
Amount Paid Amount Underfunded
Vito Galluccio Analyst +1.212.553.2738 [email protected]
NEWS & ANALYSIS Credit implications of current events
21 MOODY’S CREDIT OUTLOOK 17 JANUARY 2013
EXHIBIT 2
East Providence’s Underfunded Public Safety Pension Annual Required Contributions
Source: East Providence, Rhode Island, Financial Audits
The DOJ’s decision followed a persistent lobbying effort by the Rhode Island Governor Lincoln Chafee, its two US senators, the two municipalities’ mayors, and other state officials to allow the exception. The DOJ’s agreement to the exception reflects continued attention by policymakers to growing pension costs in Rhode Island and elsewhere, and a recognition of the ongoing financial stress that such fixed costs are placing on local and state governments.
$0
$1
$2
$3
$4
$5
$6
$7
$8
2006 2007 2008 2009 2010 2011
$ m
illio
ns
Amount Paid Amount Underfunded
RECENTLY IN CREDIT OUTLOOK Select any article below to go to last Monday’s Credit Outlook on moodys.com
22 MOODY’S CREDIT OUTLOOK 17 JANUARY 2013
NEWS & ANALYSIS Corporates 2 » DISH’s Offer to Buy Clearwire Is Credit Negative » ABB Concise’s Purchase of Optical Distributor Group Is Credit
Negative » VW’s Plan to Conclude a Domination Agreement with MAN Is
Credit Positive for Both » SKF’s Acquisition of Blohm + Voss Industries Is Credit Negative » GPT’s Sale of Homemaker Stores Is Credit Positive
Infrastructure 9 » KEPCO Will Benefit from Korea’s Electricity Tariff Hike and
Nuclear Safety Measures » Korea’ s Proposed Transfer of Policy Roles Is Negative for Korail
but Positive for KRNA » Yangtze River’s Stronger Flow Is Credit Positive for China Three
Gorges » Tata Power’s Mundra Power Project Will Increase Losses, a
Credit Negative
Banks 16
» Fannie Mae’s Resolution of Repurchase Tussle with Bank of America Is Credit Positive
» Shanghai Stock Exchange Encouragement of Higher Cash Dividends Is Credit Negative
» Korean Regulator’s Emphasis on Consumer Protection Is Credit Negative for Banks
» Taiwan Moves to Increase Bank Provisioning, a Credit Positive
Insurers 22
» MetLife’s Extension on Federal Reserve Capital Test Is Credit Negative
» Sale of CIGNA’s Variable Annuity Business Would Be Credit Positive
Funds 24 » Disclosure of Daily NAV Is Credit Positive for Money Market
Investors » BlackRock’s Agreement to Buy Credit Suisse’s ETF Business Is
Credit Positive
Sovereigns 28
» Ireland’s Bond Issue Is a Step Toward Regaining Full Capital Market Access
Sub-sovereigns 29
» Mexico Increases Oversight of States and Municipalities, a Credit Positive
US Public Finance 30
» Easing of Bank Liquidity Requirements Is Credit Positive for Issuers of Municipal Variable Rate Demand Bonds
» New Texas Revenue Forecast Underscores State’s Strong Energy Economy
» Federal Officials Deny Some of Maine’s Medicaid Cuts, a Credit Negative
Securitization 35
» Consumer Financial Protection Bureau Rule on Qualified Mortgages Is Credit Positive
RATINGS & RESEARCH Rating Changes 37
Last week we downgraded Rockies Express Pipeline, NuStar Logistics and Cyprus, and upgraded HD Supply and Paraguay, among other rating actions.
Research Highlights 42
Last week we published on the US restaurants, US healthcare, North American covenant quality, US sports stadiums, Central and Eastern European banks, Venezuela, Asia-Pacific sovereigns, US colleges, Michigan municipalities, US state rating changes, Massachusetts municipalities, Asian structured finance, and US commercial real estate, among other reports.
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EDITORS PRODUCTION ASSOCIATE News & Analysis: Jay Sherman Ginger Kipps
