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MOODYS.COM
22 JULY 2013
NEWS & ANALYSIS Corporates 2
» Mexico Blocks Sherwin-Williams’ Bid for Comex, a Credit Positive » Oi’s Asset Sales Will Aid Deleveraging, a Credit Positive » Wesfarmers’ Quarterly Coal Price Declines, a Credit Negative
Infrastructure 6
» Colstrip Generator Outage Is Credit Negative for Pacific Northwest Utilities
» Arqiva’s New High-Definition TV License Is Credit Positive » China’s Higher Solar Power Target Strengthens State Grid’s
Strategic Importance » China Three Gorges’ Hydropower Station Start-Up Is Credit
Positive » APA’s Proposed Merger with Envestra Would Be Credit Positive
Banks 12 » US Treasury and Banks Step Up Coordinate to Counter Cyber
Attacks, a Credit Positive » US Decision on LCH.Clearnet Is Credit Positive for London
Stock Exchange » DekaBank’s Acquisition of LBB’s Capital Markets Activities Is
Credit Positive » Central Bank of Russia’s Expansion of Collateral Financing Is
Credit Positive » Chinese Central Bank’s Removal of Lending Rate Floor Is Credit
Negative for Banks » Reserve Bank of India’s Measures to Bolster Exchange Rate Are
Credit Negative for Banks
Sovereigns 22 » Bhutan Election Results Signal Closer Economic Ties with India,
a Credit Positive
US Public Finance 23
» Detroit’s Bankruptcy Filing Increases Probability of Payment Disruption
» New York State Sales Tax Growth Is Positive for Downstate Counties, Negative for Upstate Ones
Structured Credit 27 » Further Delay of FATCA Implementation Is Credit Positive for
CLOs
RATINGS & RESEARCH Rating Changes 29
Last week we downgraded Nucor, OGX Petroleo e Gas Participacoes, ServiceMaster, SOFTBANK, Arab National Bank, Banque Saudi Fransi, Abu Dhabi Commercial Bank, Emirates NBD, First Gulf Bank, Mashreqbank PSC, Commercial Bank of Qatar, Doha Bank, Qatar National Bank, Burgan Bank, Bank Muscat, BBK, Cassa di Risparmio di Cesena, Raiffeisen Schweiz, UniCredit, UniCredit Bank Austria, City of Valjevo Serbia, City of Novi Sad Serbia, City of Cincinnati Ohio, City of Chicago Illinois and Temple University Health System, and upgraded Grifols, Sprint Communications, Synovus Financial, and 192 tranches in 95 US CLOs, among other rating actions.
Research Highlights 39
Last week we published on US retailers, speculative-grade European companies, Brazilian corporates, US wireless, US packaged foods, Asia-Pacific oil and gas, US healthcare and health insurers, Argentine oil and gas, synthetic rubber producers, Asian steelmakers, Singapore banks, Denmark banks, Azerbaijan banks, German development banks, US life insurers, European insurers, Colombia, Guatemala, Iceland, Asia-Pacific sovereigns, the US, Chinese local governments, Croatian sub-sovereigns, covered bonds, and European ABS and RMBS, among other reports.
RECENTLY IN CREDIT OUTLOOK
» Articles in Last Thursday’s Credit Outlook 45 » Go to Last Thursday’s Credit Outlook
Click here for Weekly Market Outlook, our sister publication containing Moody’s Analytics’ review of market activity, financial predictions, and the dates of upcoming economic releases.
NEWS & ANALYSIS Credit implications of current events
2 MOODY’S CREDIT OUTLOOK 22 JULY 2013
Corporates
Mexico Blocks Sherwin-Williams’ Bid for Comex, a Credit Positive Last Thursday, The Sherwin-Williams Company (A3 negative) said that Mexico’s Federal Competition Commission had blocked its $2.3 billion cash bid for Consorcio Comex, S.A. de C.V. (Comex, unrated), a move we regard as credit positive.
In a statement, the regulator said the merger of the two paint makers would create a company with a market share of 48%-58%, depending on the product, much larger than the nearest competitor in Mexico. Sherwin-Williams said it and Comex would work with regulators to address their concerns, and that the process could take up to 90 additional working days for the appeals and possible follow-up review process.
Although Sherwin-Williams is already the biggest paint retailer in the US, its geographic reach and scale would have increased significantly with the Comex acquisition, but at the expense of its debt level. The transaction would nearly triple Sherwin-Williams’ debt. In late 2012, the company issued about $1 billion of new notes to help finance part of its planned Comex acquisition, which increased leverage to 2.9x as of year-end 2012. The company said it intended to raise the rest of its funding needs over 2013, once the acquisition was nearly complete, and that if the acquisition fell through, it would use the $1 billion of proceeds for general corporate purposes, including possible share repurchases.
In addition to leverage considerations, our negative rating outlook reflects the challenges Sherwin-Williams would likely have integrating Comex in a challenging economic environment.
Scott Tuhy Vice President - Senior Credit Officer +1.212.553.3703 [email protected]
NEWS & ANALYSIS Credit implications of current events
3 MOODY’S CREDIT OUTLOOK 22 JULY 2013
Oi’s Asset Sales Will Aid Deleveraging, a Credit Positive Last Monday, Oi S.A. (Baa3 negative) said it would sell both its Globenet fiber-optic cable subsidiary to BTG Pactual YS Empreendimentos e Participações S.A. (unrated) for BRL1.75 billion ($770 million) and about 2,100 fixed-line telecommunications towers to SBA Torres Brasil (unrated) for BRL686.7 million ($300 million). These sales of non-core assets are credit positive for Oi because they will enable the company to reduce leverage.
Along with a sale of about 4,000 fixed-line towers for BRL 1.1 billion ($490 million) in April, the latest transactions will shore up the company’s cash balance and help it reduce leverage. If Oi were to use the full proceeds of the transactions for debt reduction, debt/EBITDA, including our standard adjustments, would decline to 3.9x from 4.2x for the 12 months ended 31 March.
Although the asset sales will be positive for liquidity and leverage, Oi is likely to see a reduction in EBITDA owing to the Globenet sale. In addition, it will also have to make payments to use the submarine cables that it is selling as part of that deal. Similarly, Oi will likely have to lease back some of the tower capacity it is selling to SBA Torres.
Lowering leverage is critical for Oi given that its investment-grade credit rating is under pressure owing to its debt load. The sales demonstrate that Oi management is following through on its commitment to sell non-core assets to reduce leverage. All three transactions are still subject to regulatory approvals.
For now, our negative outlook on Oi’s Baa3 rating remains unchanged. A stable outlook will depend on the company reducing leverage closer to 3.5x and not doing so by reducing critical capital investments. Revenue growth and stable margins are also conditions for a positive rating action. With the recent appointment of new CEO Zeinal Bava, there is a potential for changes to Oi’s business plan, dividend policy, capital spending and operating performance that could also affect the company’s rating.
Soummo Mukherjee Vice President - Senior Credit Officer +55.11.3043.7341 [email protected]
NEWS & ANALYSIS Credit implications of current events
4 MOODY’S CREDIT OUTLOOK 22 JULY 2013
Wesfarmers’ Quarterly Coal Price Declines, a Credit Negative Last Wednesday, Australian supermarket conglomerate Wesfarmers Limited (A3 stable) announced that recent coal price negotiations for the quarter ending in September will result in an average 15% price decline for its metallurgical coal exports, versus the prior quarter. The material decline is credit negative for Wesfarmers because it comes amid weaker consumer confidence and low retail sales growth.
Wesfarmers advised that on average, its bilateral coal contract prices for the coming quarter will drop around 15% across the mix of its hard coking, semi-hard coking and pulverised coal injection products, which it mainly exports to Japanese and other Asian steel mills.
In 2012, coal’s contribution to Wesfarmers group earnings was around 12%, but had been as high as around 30% in 2009 after spot met coal prices reached a high of around $400/tonne. Should Wesfarmers’ bilateral contract prices remain at the new average of around $140/tonne, we estimate that coal earnings will fall by around $200 million in 2014,1 or almost 50% of 2012 coal EBIT.
At the same time, we expect that the lower trending Australian dollar will assist in mitigating the negative price effects and that Wesfarmers will increase production at the recently expanded Curragh mine. Exhibit 1 shows the negative trend in coal prices since 2011 and the AUD/USD rate, which recently provided a degree of insulation from the coal price decline, ignoring the effects of existing currency hedging contracts on coal sales.
EXHIBIT 1
Hard Coking Coal Price in USD versus AUD/USD Exchange Rate
Source: Bloomberg, Reserve Bank of Australia
Although coal earnings have been volatile and will likely dent Wesfarmers’ 2014 earnings, the company has a robust credit profile overall and strong record of growing its retail businesses, including its Coles supermarket chain and Bunnings home-improvement business. Wesfarmers’ credit profile also gets support from its conglomerate-like diversification and stable growth in the majority of its other, predominantly retail, businesses. These factors underpin the company’s rating and outlook despite the weak outlook for coal prices. Exhibit 2 shows Wesfarmers’ significant business diversification, which is atypical among major publicly rated issuers.
1 Based on an assumed volume of 8 million tonnes in 2014 and a revised hard coking coal benchmark price of $140 per tonne.
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Hard Coking Coal in USD - left axis AUD/USD - right axis
Ian Lewis Senior Vice President +612.9270.8120 [email protected]
NEWS & ANALYSIS Credit implications of current events
5 MOODY’S CREDIT OUTLOOK 22 JULY 2013
EXHIBIT 2
Wesfarmers EBIT Breakdown by Business
Source: Moody’s Financial Metrics
The company has a robust track record of retail growth since acquiring Coles in late 2007, and it has convincingly executed Coles’ turnaround. Nevertheless, against the backdrop of broad regional uncertainty and significant commodity price volatility and weak consumer environment, a synchronised drop in both commodity prices and an unexpected or sharp deterioration in Australian GDP from current levels of around 2.6% per year would challenge the company. Consequently, as coal earnings trend lower, the defensive characteristics of Wesfarmers’ strong diversification will be an important anchor for its credit profile.
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Food & Liquor Home Improvement Coal Kmart
Target Industrial & safety Chemicals & Fertilisers Energy
Officeworks Insurance Fuel
NEWS & ANALYSIS Credit implications of current events
6 MOODY’S CREDIT OUTLOOK 22 JULY 2013
Infrastructure
Colstrip Generator Outage Is Credit Negative for Pacific Northwest Utilities Last Monday, Portland General Electric Company (PGE, Baa1 stable) announced that critical components of the 740-megawatt (MW) coal-fired generator Colstrip Unit 4 had sustained damage, requiring that the unit be out of service for at least six months, at a cost of least $30 million for repair. The unit closure is credit negative for utilities in the Pacific Northwest because it removes a source of low-cost baseload generation during summer months when power demand is at its peak in the broader Western region.
The outage will force the utilities to replace the lost power with higher cost spot market purchases or other contractual arrangements. In terms of comparison, the facility’s total production costs for 2012 were around $25 per megawatt-hour (MWh), while current power prices in the region are approximately $40/MWh.
Located in Rosebud County, Montana, the 2,094-MW Colstrip generating facility is a strategic coal-fired generating asset for many utilities in the Pacific Northwest, producing more than 12 terawatt-hours (TWh) of net generation in 2012, including nearly 5 TWh from Unit 4.
Unit 4’s outage will negatively affect PPL Montana, LLC (PPLM, Baa3 stable), a subsidiary of PPL Corporation (Baa3 stable), which operates the plant, as well as many Pacific Northwest utilities. Among the affected utilities will be PGE, which owns approximately 20% of Unit 4; Puget Sound Energy, Inc. (Baa2 positive), which owns around 25%; NorthWestern Corporation (Baa1 stable), which owns 30%, but whose cost exposure is 15% owing to a cost-sharing agreement with PPL; Avista Corp. (Baa2 stable), which owns 15%; and PacifiCorp (Baa1 stable), which owns approximately 10%.
We assume that each owner will respond to the lack of Unit 4 output using a varied mix of short-term purchase agreements, spot market purchases and greater use of other thermal generating facilities they own. The financial effect will vary by company, but erosion to near-term margins should be manageable for each utility, including PSE, which will be the most affected given its 25% share of the $30 million repair costs. PGE estimated that its replacement power costs (which include replacement costs for another coal facility that will be offline for one month) will be $10-$12 million; in 2012, its annual purchased power and fuel costs were $726 million. We currently assume that PPLM, unlike the utility owners, will likely lose expected merchant sales associated with its share of Unit 4’s output.
Each of the utility owners receives a regulated cost recovery of purchased power costs through a fuel and purchased power tracking mechanism that limits the downside risk for recovery of these excess costs. In addition, each owner could recover a majority of its pro rata costs through insurance claims, once they determine final costs and file claims.
Ryan Wobbrock Assistant Vice President - Analyst +1.212.553.7104 [email protected]
NEWS & ANALYSIS Credit implications of current events
7 MOODY’S CREDIT OUTLOOK 22 JULY 2013
Arqiva’s New High-Definition TV License Is Credit Positive Last Tuesday, Ofcom, the UK’s independent regulator and competition authority for the communications industries, announced that it would award a license for additional high-definition television (HDTV) capacity in the 600-megahertz (MHz) frequency band to the Arqiva group of companies, whose parent company is Arqiva Broadcast Parent Limited (B1 stable). The award is credit positive for Arqiva, the UK’s monopoly provider of terrestrial TV broadcasting services. Compared with our prior projections, the additional capacity will provide Arqiva extra income from television companies, albeit at additional cost, over the next two to five years.
We had previously assumed limited growth potential in terrestrial TV revenues owing to digital TV capacity constraints, but the license award provides opportunities for growth in operational cash flows and improvement in Arqiva’s headroom under debt covenants. We estimate that Arqiva’s EBITDA, which was reported to be around £402 million for the fiscal year ended in June 2012 (or £414 for the 12 months ended in December 2012), will be higher by 3% per year between 2015 and 2018 than our previous assumptions, which included minimal growth. We expect the provision of new HDTV channels will also strengthen Arqiva’s long-term position by encouraging the adoption of more efficient technologies by consumers.
The license Ofcom provided lasts until at least 2018, at which point the regulator may use the frequency to free up the 700-MHz frequency band for mobile broadband services. Thus, the agreement’s positive effects are likely to end in 2018 and the long-term viability of digital terrestrial television, including HDTV, will depend on obtaining additional spectrum capacity.
However, Arqiva also has a substantial mobile towers business, so any future growth of mobile broadband services is likely to benefit the company and mitigate its exposure to the risk of digital TV capacity constraints.
The 600-MHz band became available because UK television fully transitioned to digital frequencies from analogue at the end of 2012. Initially, Ofcom planned to auction the 600-MHz spectrum at the end of 2012. However, a proposal at the World Radio Communication Conference in Geneva recommended that the 700-MHz spectrum should be made available for mobile use across Europe, Middle East and Africa after 2015. Consequently, Ofcom decided to retain the 600-MHz band for TV, to allow the reallocation of existing TV channels to 600-MHz from 700-MHz to free up the 700 MHz spectrum for 4G mobile data.
Because the free-up and reallocation of the 700-MHz frequency to 4G mobile data will not be required before 2018, Ofcom’s interim use of the 600-MHz frequencies for additional digital HDTV services protects the long-term future of digital TV and avoids potential capacity problems.
Arqiva’s license will run until 2026, with early termination possible (after 24 months’ advance notice) in December 2018. The license includes a clause that will allow variation or substitution of the frequencies awarded in the 600-MHz band, as necessary, ahead of the end of 2018 to facilitate any transition of digital TV from the 700-MHz spectrum.
Arqiva owns and operates a portfolio of communications infrastructure assets and provides television and radio transmission services, tower sites rental to mobile network operators, media services and radio communications in the UK and satellite services in the UK, Continental Europe and the US. We currently have a B3 rating on the £600 million notes issued by Arqiva Broadcast Finance Plc. The notes rank junior to around £2.3 billion of senior debt (unrated) raised in a ring-fenced financing structure around the operating companies in the Arqiva group.
Stefanie Voelz Assistant Vice President - Analyst +44.20.7772.5555 [email protected]
NEWS & ANALYSIS Credit implications of current events
8 MOODY’S CREDIT OUTLOOK 22 JULY 2013
China’s Higher Solar Power Target Strengthens State Grid’s Strategic Importance Last Monday, the State Council of China announced that it had raised its target for solar power capacity over the next three years. Aside from benefitting China’s solar power industry, a higher target is credit positive for State Grid Corporation of China (Aa3 stable), the largest power grid company by revenue in both China and the world. The increased generating capacity will strengthen State Grid’s strategic importance to China because it helps the government execute its policy objective of increasing the use of clean energy and promoting the development of renewable energy related manufacturing in industries such as solar panels.
The new target calls for the annual installation of 10 gigawatts (GW) of solar power capacity during 2013-15, which would boost the country’s installed solar capacity to more than 35 GW by 2015. According to Bloomberg News, China’s solar capacity was 7 GW at the end of 2012.
State Grid’s service region covers 88% of China’s land mass. The government-owned entity must expand its infrastructure to handle the rapid expansion of solar power and other renewable energy sources as the government seeks to boost clean energy sources. We expect the government to provide State Grid with policy and funding support in the form of favourable policies, capital subsidies and tax incentives to facilitate the expansion and achieve the policy goal. The country’s Twelfth Five-Year Plan, released in 2011, calls for China to increase the proportion of non-fossil fuels in total primary energy consumption to 11.4% in 2015 from 8.3% in 2010.
To help meet the government’s clean energy targets, State Grid developed ultra-high-voltage grids to improve electricity transmission and distribution over long distances. In China, renewable energy resources such as solar power are concentrated in the northern, northwestern and southwestern inland provinces. However, the country’s high energy consumption areas are mainly in the more developed eastern and southeastern coastal regions. State Grid is also developing smart-grid technology that enhances the efficiency and flexibility of integrating the transmission and distribution of renewable energy sources into the national grids. Thus, State Grid plays a crucial role in enabling power generation companies to expand into solar power generation and procure solar panels and related equipment from Chinese manufacturers, which currently depend largely on Europe.
Despite the government’s push for increased solar power, the financial effect on State Grid will be moderate. Solar power accounts for just a small fraction of State Grid’s total capital spending plan, compared with its investments for thermal power, hydro power and wind power. By 2015, State Grid expects its grid, after expansion and upgrades, to accommodate 466 GW of newly installed generation capacity and 1,780 terawatt-hours of power demand. The addition of 28 GW in China’s solar power installed capacity by 2015 will be just 6% or less of the new installed generation capacity of the country at that time.
We expect State Grid’s total annual capital spending will be around RMB350-RMB360 billion ($57-$58 billion) over the next three years, including its investment in solar power. In addition, we consider any increase in costs from purchasing solar power to be manageable for State Grid. Although the company will need to pay higher on-grid tariffs to purchase solar power than thermal power, the grid companies’ effective on-grid tariffs are capped at the thermal power tariff level and the rest are covered by government subsidies. State Grid’s EBITDA margins have been a stable 14%-15% over the past five years, despite the volatile generation costs of power producers.
The government’s increased target is primarily meant to help domestic solar panel manufacturers, which are facing numerous challenges, including oversupply, a substantial decline in the price of solar panels and lower export demand from the US and European Union. The government expects the rise in domestic solar power generation will help shift export sales of solar panel to local consumption.
Ivy Poon Analyst +852.3758.1336 [email protected]
Ivan Chung Vice President - Senior Credit Officer +852.3758.1399 [email protected]
NEWS & ANALYSIS Credit implications of current events
9 MOODY’S CREDIT OUTLOOK 22 JULY 2013
China Three Gorges’ Hydropower Station Start-Up Is Credit Positive Last Monday, China Three Gorges Corporation (CTG, A1 stable) said its new Xiluodu hydropower plant was operational and its first power-generating unit officially started work following a 72-hour test run. The start of the first of 18 planned power-generating units at Xiluodu is credit positive for CTG. The project will provide a large amount of cash flow for CTG’s ongoing hydropower station development and its on-schedule start largely eliminates the risk of project delay, which is a common challenge for large infrastructure projects.
The company plans to have 10 generating units of 770 megawatts (MW) each begin operating this year. These units will increase CTG’s total installed capacity by 7.7 gigawatts (GW), or around 28% of its installed hydropower capacity as of year-end 2013. On a full-year basis, the new generation capacity will bring around RMB8-RMB9 billion in additional revenue, assuming an average annual utilization rate of 4,000 hours.
Based on CTG’s historical adjusted EBITDA margin of around 70%, the 10 new units will generate approximately RMB5.6-RMB6.3 billion of adjusted EBITDA on a full-year basis and reduce the company’s adjusted debt/EBITDA to around 4x from around 5x, barring any other changes.
The Xiluodu hydropower station, located alongside the Jinsha River, a major headstream of the Yangtze in the Yunnan and Sichuan provinces, will have a total generating capacity of 13.86 GW when it is fully operational. It will be the world’s third-largest hydropower station after the Three Gorges project in China, which CTG also owns and operates, and the Itaipu project in Brazil, which was created in 1973 through an international treaty between the governments of Brazil and Paraguay.
CTG began constructing the Xiluodu project in 2005 and expects to complete it in 2015. It will have 18 power-generating units, each with 770 MW of generating capacity. The on-schedule start of the first unit is an important milestone for the project because it means that the more challenging parts, such as the construction of the body of the dam and relocation of people, have largely been completed.
CTG said that the Xiluodu station has been connected to the transmission network of China Southern Power Grid (unrated), the second-largest national grid in China. The National Development and Reform Commission also approved the on-grid tariff for Xiluodu at the beginning of 2013.
The cash flow generated by the new units will supplement cash flow for CTG’s ongoing hydropower station development. In addition to the Xiluodu and Xiangjiaba projects, another major hydropower station along the Jinsha River that began operating last year, CTG plans to build two other mega-power stations along the Jinsha River before 2018.
Kai Hu Vice President - Senior Credit Officer +86.10.6319.6560 [email protected]
Anthony Lee Associate Analyst +852.3758.1305 [email protected]
NEWS & ANALYSIS Credit implications of current events
10 MOODY’S CREDIT OUTLOOK 22 JULY 2013
APA’s Proposed Merger with Envestra Would Be Credit Positive Last Tuesday, APA Group, whose financing vehicle is APT Pipelines Limited (Baa2 stable), announced that it had proposed an all-share merger with Envestra Ltd. (Baa2 stable). The proposed merger, which is subject to conditions including finalizing financing arrangements and approvals, would be credit positive for APA, Australia’s largest owner of gas pipelines, because it would strengthen its business and financial profile, outweighing execution and integration risks associated with the merger. The merger would also be credit positive for Envestra because it will become part of Australia’s largest owner of regulated and infrastructure assets.
Assuming that APA fully refinances Envestra’s existing debt as part of the merger, we expect an improvement in APA’s interest cover ratio, defined as the ratio of funds from operations (FFO) to cash interest, and financial leverage (see exhibit).
Our Expected Change in APA’s Interest Cover Ratio If It Merges with Envestra
Source: Moody’s
The merger will also strengthen APA by rebalancing its earnings from contracted pipelines (to 45% from 65%) towards regulated pipelines (to 55% from 35%). We regard revenues from APA’s existing pipelines, which mainly operate under bilateral contracts with industrial counterparties, as more volatile than Envestra’s regulated pipelines because contracted pipelines are exposed to competition from other pipelines that are linked to alternative gas fields and to counterparty risk. The contracted pipelines generally depend on a few industrial offtakers continuing to purchase stable volumes of gas at contract renewal dates.
Envestra’s regulated pipelines benefit from a natural monopoly with negligible bypass risk from competing pipelines, a highly diverse customer base and the transparency of the Australian regulatory framework that governs tariff-setting. The regulatory regime allows for full cost recovery and reduces the pipelines’ exposure to volume risk by using updated volume projections in periodic tariff resets.
However, the transaction does have risks. The proposed merger is the second large corporate transaction APA has undertaken in the past 18 months, which will result in it becoming one of the largest listed utilities in Australia. Although we believe that these recent transactions point to the increased probability of APA making additional acquisitions to further build scale, we expect the company will fund such transactions in a manner that maintains APA’s financial leverage, as measured by the ratio of FFO to debt, at around 8%, and interest cover ratio in the 2x range.
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Fiscal Year 2014 Forecast Fiscal Year 2015 Forecast
APA Standalone Merged Group
Arnon Musiker Vice President - Senior Credit Officer +612.9270.8161 [email protected]
NEWS & ANALYSIS Credit implications of current events
11 MOODY’S CREDIT OUTLOOK 22 JULY 2013
Mergers bring execution risk and integration challenges, which often distract management from its operational focus and lead to unanticipated cash outflows. In this case, however, APA has operated Envestra’s pipelines since 2007, which mitigates this risk.
NEWS & ANALYSIS Credit implications of current events
12 MOODY’S CREDIT OUTLOOK 22 JULY 2013
Banks
US Treasury and Banks Coordinate to Counter Cyber Attacks, a Credit Positive Last Thursday, the US Treasury, the US Department of Homeland Security and a number of US financial firms and exchanges participated in a cyber security exercise titled Quantum Dawn 2, which the Securities Industry and Financial Markets Association (SIFMA) coordinated. This exercise is credit positive because it demonstrates the government’s and financial sector’s acknowledgement that they must be better prepared to handle the increased sophistication of cyber attacks that threaten to breach databases holding client information or accounts holding money. Such breaches would be particularly disruptive given the confidence-sensitive nature of the banking industry.
For some time, US banks have been working independently to address cyber attacks, notably denial-of-service attacks. These attacks seek to disable firms’ networks and servers in order to deny customers access to Internet banking systems or automated teller machine systems. After several attacks over the past few years that resulted in the banks’ websites and online banking applications being inaccessible for hours, they have successfully responded by developing a capability to divert questionable requests during an attack, but allow access for legitimate customers.
Although denial-of-service attacks aim to simply disrupt business, other cyber security threats hold far more damaging potential. More sophisticated attacks include data breaches, in which hackers access confidential client information, or system breaches, in which hackers steal money from bank and customer accounts. A successful attack could evaporate confidence in a particular bank or exchange, requiring US government support to restore confidence in the system.
According to the participants, Quantum Dawn 2 was designed to test incident response, resolution and coordination processes to a large-scale cyber attack on the financial services industry and on individual firms. US banks stand to benefit from the involvement of the US government, which faces its own cyber security threats and likely has many subject matter experts dedicated to this issue. US banks also stand to benefit from knowledge-sharing among themselves. Collaboration on this scale is unusual, but is indicative of the potential harm that cyber security attacks pose to the financial system.
Allen Tischler Senior Vice President +1.212.553.4541 [email protected]
Megan Snyder Associate Analyst +1.212.553.4986 [email protected]
NEWS & ANALYSIS Credit implications of current events
13 MOODY’S CREDIT OUTLOOK 22 JULY 2013
US Decision on LCH.Clearnet Is Credit Positive for London Stock Exchange Last Thursday, the US Commodity Futures Trading Commission’s (CFTC) Division of Clearing and Risk issued a letter of no-action relief to LCH.Clearnet SA, allowing its credit default swaps (CDS) clearing business, CDSClear, to clear European index CDS on behalf of US CDS clearing members. Without this letter, CDSClear and its US member banks would have faced enforcement action because CDSClear is not yet registered as a derivatives clearing organization (DCO) with the CFTC. For London Stock Exchange Group plc (Baa2 stable), majority owner of LCH.Clearnet, this relief action is credit positive because it allows CDSClear to add more US member banks to its platform during the pendency of its DCO registration application.
The no-action relief helps CDSClear continue developing its European index business, especially because it allows its US member banks, including Goldman Sachs, and new participating US banks, such as Bank of America Merrill Lynch, Citigroup, JPMorgan Chase and Morgan Stanley, to clear European index CDS (iTraxx Europe – Main, HiVol and CrossOver) on its platform without facing CFTC enforcement action. This relief benefits CDSClear’s US CDS clearing members because European index CDS comprise more than 45% of global gross notional index and index tranche CDS, according to the Depository Trust & Clearing Corp. Furthermore, index CDS notional amounts outstanding have demonstrated a relative stability as single-name CDS notional amounts outstanding have declined since December 2010 (see Exhibit 1).
EXHIBIT 1
Single-Name and Index CDS Notional Amount Outstanding CDS Index Products Are Relatively Stable versus Single-Name CDS
Source: Bank for International Settlements
Although the CDSClear business starts from a low base, we expect the business to contribute more meaningfully to its parent’s revenue over time. Since the launch of its international business in May 2012, both notional cleared and open interest on CDSClear have grown considerably (see Exhibit 2). The no-action relief allows this growth to continue, especially as membership broadens to include more US banks. CDSClear is also expanding its product offering beyond index CDS. The firm received regulatory approval on Friday to clear single-name CDS for European clients.
$4
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illio
ns
Single-Name CDS CDS Index Products
Michael Eberhardt, CFA Vice President - Senior Analyst +44.20.7772.8611 [email protected]
NEWS & ANALYSIS Credit implications of current events
14 MOODY’S CREDIT OUTLOOK 22 JULY 2013
EXHIBIT 2
CDSClear Volume Growth
Source: London Stock Exchange Group
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Notional Cleared Open Interest
NEWS & ANALYSIS Credit implications of current events
15 MOODY’S CREDIT OUTLOOK 22 JULY 2013
DekaBank’s Acquisition of LBB’s Capital Markets Activities Is Credit Positive Last Wednesday, DekaBank Deutsche Girozentrale (A1 stable, C-/baa2 stable)2 and Landesbank Berlin AG (LBB, A1 stable, D+/baa3 stable) announced that they had agreed on terms for DekaBank to acquire LBB’s capital market activities and sister company, Landesbank Berlin Investment GmbH (LBB-INVEST, unrated). The acquisition will enhance DekaBank’s franchise and is credit positive, despite short-term negative effects on its earnings and capital.
LBB-INVEST is the Berlin, Germany-based regional fund manager and research house of the German Savings Bank Association (or Sparkassen-Finanzgruppe, Aa2 stable, C+/a2 stable), a business that overlaps with DekaBank’s fund management operations. The association had announced in December 2012 that it was considering transferring these operations to DekaBank as part of a wider realignment and consolidation of businesses it has conducted through several wholly owned group members.
DekaBank will primarily acquire the operations of LBB’s capital markets business, but not its related portfolios of assets and derivatives. Instead, DekaBank will generate all-new capital markets businesses from the date of the transfer, which will have a slight and short-lived negative effect on its cost position of what we estimate to be €20 million per year (plus some one-off charges); however, this is small in the context of DekaBank’s €443 million pre-tax profit last year, and will decline over time. LBB-INVEST, which DekaBank plans to take over after acquiring LBB’s capital markets business in the two-part transaction, will remain a separate entity, with assets under management of roughly €10 billion.
Although several key elements of the transaction have yet to be finalised, the positive effects we expect for DekaBank include the following:
» Cost synergies, because predictable additional business volumes can be processed at marginal costs (although the bank will likely have to adjust its initial cost base post-transfer)
» Less intra-group competition in its capital markets and asset management business
» An improved strategic position as a result of becoming the securities house and fund manager of choice in Sparkassen-Finanzgruppe
In contrast to initial plans reported last year, this transaction will not raise DekaBank’s balance sheet leverage, a strong positive. Although there is an amount to be paid (which remains undisclosed), we expect it to have a negligible effect on DekaBank’s regulatory capitalisation. DekaBank reported a satisfactory Tier 1 ratio of 14% at the end of 2012, which it raised from 11.6% during the preceding 12 months, mostly through retention of its 2011 earnings (€270 million retained from 2012 net profit was not yet included). In this context, we expect DekaBank will report broadly stable capital ratios after closing the transaction.
DekaBank has a strong and profitable asset-management franchise in Germany as a leading provider of retail and institutional investment funds. The bank ranks as one of the largest mutual funds managers for capital and money-market products in Germany and remains the preferred retail asset manager of the savings bank sector.
2 The bank ratings shown in this report are the bank’s deposit rating, its standalone bank financial strength rating/baseline credit
assessment and the corresponding rating outlooks.
Katharina Barten Vice President - Senior Credit Officer +49.69.70730.765 [email protected]
NEWS & ANALYSIS Credit implications of current events
16 MOODY’S CREDIT OUTLOOK 22 JULY 2013
Central Bank of Russia’s Expansion of Collateral Financing Is Credit Positive Last Thursday, the Central Bank of Russia (CBR) expanded its list of illiquid collateral that banks can pledge against CBR loans. The regulator’s move is credit positive for Russian banks because it increases their access to CBR liquidity.
In addition to loans granted to companies rated B3/B- and higher, banks can now pledge to the CBR loans they extended to unrated subsidiaries of these rated companies. Also eligible are government-guaranteed loans extended to strategic enterprises (as listed by the government).3 The expansion of the illiquid collateral list follows the regulator’s recent decision to lower the cost of funding provided to banks against such illiquid assets by introducing a floating-rate auction, where the minimum rate is set at the one-week repo rate (currently 5.5%) plus 25 basis points, compared with the previously applied fixed rate of 7.5%.
To date, illiquid asset refinancing has been a relatively small source of liquidity for Russian banks. As of 18 July, banks borrowed around $70 billion from the CBR, and only 4% of that was through illiquid asset refinancing. The rest was via securities repo (see Exhibit 1).
EXHIBIT 1
Russian Banks’ Outstanding Central Bank Funding, RUB Trillions
Source: Central Bank of Russia
The easing of illiquid asset refinancing rules comes at a time when banks have already pledged about 50% of their liquid collateral against CBR loans at 1 June 2013, according to the CBR. By contrast, banks pledged only 15% of their eligible illiquid assets at 31 March 2013, the latest available data (see Exhibit 2). We expect banks to increasingly pledge their illiquid assets against CBR loans now that the CBR has lowered the cost of such funding and expanded the list of eligible collateral. Some redistribution of CBR funding from securities repo towards illiquid asset refinancing will be credit positive for the banks because a higher amount of unpledged liquid collateral will support the banks’ liquidity buffers in case of market shocks.
3 Available in Russian here.
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13
RUB
Trill
ions
Securities Repo Illiquid Asset Refinancing Uncollateralized
Svetlana Pavlova Assistant Vice President - Analyst +7.495.228.6052 [email protected]
Eugene Tarzimanov Vice President - Senior Credit Officer +7.495.228.6051 [email protected]
NEWS & ANALYSIS Credit implications of current events
17 MOODY’S CREDIT OUTLOOK 22 JULY 2013
EXHIBIT 2
Percent of Available Asset Pledged in Securities Repo and Illiquid Asset Refinancing
Source: Central Bank of Russia
0%
10%
20%
30%
40%
50%
60%
Oct
-12
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-12
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-12
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-12
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-12
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-12
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-12
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13
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13
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13
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13
Mar
-13
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-13
Securities Repo Illiquid Asset Refinancing
NEWS & ANALYSIS Credit implications of current events
18 MOODY’S CREDIT OUTLOOK 22 JULY 2013
Chinese Central Bank’s Removal of Lending Rate Floor Is Credit Negative for Banks Last Saturday, the People’s Bank of China (PBOC), China’s central bank, removed the regulated floor for lending rates, allowing financial institutions to set their own rates on all loans except mortgage loans, which will remain subject to the existing floor. Although the removal of the lending rate floor is an important step in China’s reform of its financial system, the PBOC’s action is credit negative for Chinese banks because it is another move towards interest rate deregulation that will narrow their net interest margins.
Before this announcement, the PBOC controlled China’s lending rates with a floor set at 0.7x the central bank’s benchmark rates. The PBOC still controls deposit rates with a cap of 1.1x benchmark rates.
We expect the removal of the lending rate floor will allow borrowers with strong bargaining power to obtain cheaper funding, thus reducing banks’ profitability. This will have the largest effect on China’s four largest banks, Industrial & Commercial Bank of China Ltd. (A1 stable, D+/ba1 stable),4 China Construction Bank Corporation (A1 stable, D+/ba1 stable), Agricultural Bank of China (A1 stable, D/ba2 stable) and Bank of China Limited (A1 stable, D/ba2 stable), all of which have relatively large exposures to large state-owned enterprises (SOEs) that could negotiate for lower lending rates.
However, because mortgage loans remain subject to the lending floor and currently only a few large creditworthy state-owned enterprises (SOEs) benefit from lending rates close to the floor, we expect most banks will largely retain their pricing power. Moreover, our analysis points to Chinese banks’ margins being more sensitive to a liberalization of deposit rates than lending rates.5
The exhibit below shows that only a small portion of new loans is priced below PBOC benchmark rates.
Pricing of Chinese Loans Relative to the People’s Bank of China Benchmark Rate
Source: People’s Bank of China
What is more important is that the PBOC’s announcement demonstrates the central bank’s resolve to further liberalize interest rates, and the broader effect that such resolve will have on bank lending. The fact
4 The bank ratings shown in this report are the bank’s deposit rating, its standalone bank financial strength rating/baseline credit
assessment and the corresponding rating outlooks. 5 See Chinese Banks: Interest Rate Liberalization Brings More than Interest Rate Risk, 16 October 2012.
0%
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30%
40%
50%
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80%
90%
100%Below Benchmark Rate At Benchmark Rate Above Benchmark Rate
Bin Hu Vice President - Senior Analyst +852.3758.1503 [email protected]
Sonny Hsu Vice President - Senior Analyst +852.3758.1363 [email protected]
NEWS & ANALYSIS Credit implications of current events
19 MOODY’S CREDIT OUTLOOK 22 JULY 2013
that the PBOC’s action followed a sharp tightening in money market liquidity in late June6 suggests that the authorities are not worried about the risk of banks’ margins narrowing.
We expect the PBOC’s latest move will accelerate Chinese banks’ expansion into more profitable businesses, such as loans to small and midsize enterprises (SMEs), as a way to offset rising margin pressure, which will hasten their shift towards making riskier loans. This will also mean that banks currently focused on SME lending, including China Minsheng Banking Corporation (unrated), Ping An Bank Co. Ltd. (Ba1 stable, D/ba2 stable) and China Merchants Bank (Baa3 stable, D+/ba1 stable), will face more competition for high-quality SME borrowers.
Although the PBOC’s latest move stops short of a full rate liberalization, it increases the likelihood that the central bank will take steps to deregulate deposit rates on things such as certificates of deposit. However, given that banks are likely to be more affected by deposit rate liberalization, we expect the central bank will maintain its current control on deposit rates until it puts in place proper institutional safeguards, such as deposit insurance and a bank resolution scheme.
Hong Kong banks. We expect Hong Kong banks’ exposures to Mainland Chinese corporates to continue growing despite the liberalization of mainland bank lending rates. Hong Kong banks’ increasing exposures to mainland corporates is credit negative. Although the mainland’s economic growth is moderating, we expect mainland corporates will engage in further cross-border trade, investments and acquisitions, and that Hong Kong banks, including Hong Kong subsidiaries of mainland banks, will provide mainland corporates with crucial financing for such activities.
As China’s capital controls remain in place, Hong Kong banks are more likely to finance mainland corporates’ overseas investments and acquisitions than their onshore counterparts. Borrowing costs (in both US dollars and renminbis) will also remain lower in Hong Kong than on the mainland. Thus, although the liberalization of lending rates in Mainland China may reduce mainland corporates’ incentives to borrow funds offshore, we expect Hong Kong banks’ mainland exposures to continue growing unabated.
6 See China’s Liquidity Contraction Has Credit Positive Intent but Entails Risks, 24 June 2013.
NEWS & ANALYSIS Credit implications of current events
20 MOODY’S CREDIT OUTLOOK 22 JULY 2013
Reserve Bank of India’s Measures to Bolster Exchange Rate Are Credit Negative for Banks Last Monday, the Reserve Bank of India (RBI) announced measures to tighten liquidity and bolster the rupee-dollar exchange rate, which has recently reached historic lows. Money markets reacted by dramatically raising rates in the interbank market and yields on government bonds. These measures are credit negative for Indian banks because rising market rates will negatively affect economic growth if they persist, putting negative pressure on asset quality and earnings. In addition, bank funding costs will rise if higher rates persist.
The RBI’s new measures include the following:
» Increasing by 200 basis points both the marginal standing facility (MSF) rate and bank rate to 10.25%. The bank rate is the rate at which banks can borrow from the RBI’s discount window and the MSF rate is the rate at which banks can borrow from the RBI against government securities in distressed situations (the RBI left its base rate, its benchmark rate for monetary policy, unchanged)
» Limiting funds available through its liquidity adjustment facility to INR750 billion. Banks use this facility to adjust for short-term liquidity mismatches at a rate of 7.25%
» Holding an open market auction for government securities worth INR120 billion to further remove liquidity. The sale has not yet been finalized owing to investor demand for higher rates
These measures seek to support the exchange rate and discourage currency speculation by reducing short-term liquidity and soaking up excess liquidity. However, there is a risk that the period of tight money market liquidity in India may persist, which would eventually have a material negative effect on bank funding. We expect banks to be negatively affected if higher rates persist for one or two months. In particular, banks that rely more on wholesale funding, such as Yes Bank Limited (Baa3 stable, D+/ba1 stable)7 and IDBI Bank Ltd (Baa3 stable; D-/ba3 stable), will be more vulnerable because their margins would suffer if they fail to pass on higher costs to borrowers (see Exhibit 1).
EXHIBIT 1
Moody’s-Rated Indian Banks’ Ratio of Market Funds Less Liquid Assets to Total Assets for Fiscal 2012
Note: Fiscal 2012 ended 31 March 2013 ICICI = ICICI Bank Ltd; IDBI = IDBI Bank Ltd; Yes = Yes Bank Limited; Axis = Axis Bank Ltd; Syn = Syndicate Bank; SBI = State Bank of India; BOI = Bank of India; UBI = Union Bank of India; BOB = Bank of Baroda; PNB = Punjab National Bank; CBI = Central Bank of India; HDFC = HDFC Bank Ltd; IOB= Indian Overseas Bank; OBC = Oriental Bank of Commerce; CAN = Canara Bank Source: Banks’ financial statements, Moody’s
7 The bank ratings shown in this report are the bank’s deposit rating, its standalone bank financial strength rating/baseline credit
assessment and the corresponding rating outlooks.
-25%
-20%
-15%
-10%
-5%
0%
5%
ICICI IDBI Yes Axis Syn BOI UBI SBI BOB PNB CBI HDFC IOB OBC CAN
Gene Fang Vice President - Senior Analyst +65.6398.8311 [email protected]
Nick Caes Associate Analyst +65.6398.8332 [email protected]
NEWS & ANALYSIS Credit implications of current events
21 MOODY’S CREDIT OUTLOOK 22 JULY 2013
More generally, the RBI’s measures add to the challenges already affecting India’s economy and which will affect banks’ operating environment. We note that market reactions to the RBI’s announcement have been dramatic, with market interest rates rising across all maturities (see Exhibit 2) despite the RBI’s measures only targeting short-term rates.
EXHIBIT 2
Indian Interest Rates Between January and July 2013
Source: Bloomberg; we extrapolated data for 21-28 May.
To be sure, the market’s reaction may have been exaggerated. However, the threat of a broad rise in market interest rates, at a time when expectations for economic growth are already waning, threatens to outweigh the RBI’s efforts to support India’s exchange rate.
The combination of slower growth and higher rates could also negatively affect borrowers’ ability to service their debt. With corporate borrowers already suffering from weak domestic demand, asset-quality deterioration could negatively affect lenders, particularly public sector banks8 that already have higher non-performing loan ratios and large exposures to corporate borrowers (Exhibit 3).
EXHIBIT 3
Average Impaired Loans at Moody’s-Rated Indian Banks
Source: Banks’ quarterly financial statements
8 Public sector banks are those that the Indian government holds at least a 50% stake. They include IDBI Bank Ltd, Syndicate Bank,
State Bank of India, Bank of India, Union Bank of India, Bank of Baroda, Punjab National Bank, Central Bank of India, Indian Overseas Bank, Oriental Bank of Commerce and Canara Bank.
7%
8%
8%
9%
9%
10%
10%
11%
Jan-
13
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13
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13
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-13
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13
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13
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13
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13
Jul-1
3
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3
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3
10 year Government Bond 12 Month CD Rate 3 Month MIBOR
0%
2%
4%
6%
8%
10%
12%
Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12 Mar-13 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12 Mar-13
Public Sector Banks Private Sector Banks
Average Gross Non-Performing Loan Ratio Average Restructured Loans As Percent of Gross Loans
NEWS & ANALYSIS Credit implications of current events
22 MOODY’S CREDIT OUTLOOK 22 JULY 2013
Sovereigns
Bhutan Election Results Signal Closer Economic Ties with India, a Credit Positive On 13 July, Bhutan (unrated) held its second election since the country transitioned to a democracy in 2008 from a monarchy, handing the majority in parliament to the former opposition People’s Democratic Party (PDP). The PDP platform emphasizes rebuilding Bhutan’s ties with India, which were strained by the previous administration’s political overtures to China. Maintaining India’s robust provision of aid and its consumption of hydropower exports is credit positive for Bhutan.
The small Himalayan nation is geographically wedged between India and China, which have competing interests in the region. But Indian foreign policy seeks to keep Bhutan well within its sphere of interest. Maintaining close ties with India will ensure that Bhutan’s neighbor to the southwest continues to import electricity and fund further hydropower development. In 2012, India’s purchases comprised approximately 90% of total electricity sales from Bhutan’s plants. Bhutan’s electricity exports generate revenue for the government, as well as Indian rupee inflows, allowing it to finance the large public debt.
In addition to trade flows, India provides significant budgetary support in the form of grants. Although the Bhutanese government had run modest surpluses since fiscal 2007, the fiscal balance fell to a deficit of 2% of GDP in fiscal 2011 and an estimated deficit of 4% of GDP in fiscal 2012. Foreign aid has averaged about 50% of total revenue in the past seven years, of which approximately 70% was from India.
Bhutan’s $1.8 billion economy has been growing quickly, averaging 10% growth in real terms over the past five years, and driven by the development of hydropower. These investments have led to a steep build-up of public debt. The International Monetary Fund projects public debt will exceed 93% of GDP in fiscal 2015, up from 66.2% of GDP in fiscal 2008. Nearly all of Bhutan’s public debt is external, of which approximately 60% is denominated in Indian rupees and which it borrowed to develop hydropower. Although the debt level is high, the risk of distress is mitigated by the concentration of the debt in commercially viable power plants.
Cynthia Mar Associate Analyst +65.6398.8323 [email protected]
Tom Byrne Senior Vice President +65.6398.8310 [email protected]
NEWS & ANALYSIS Credit implications of current events
23 MOODY’S CREDIT OUTLOOK 22 JULY 2013
US Public Finance
Detroit’s Bankruptcy Filing Increases Probability of Payment Disruption Last Thursday, the City of Detroit, Michigan (Caa3 review for downgrade) filed a petition for relief under Chapter 9 of the US Bankruptcy Code, a credit negative for bondholders given the increased probability of payment disruption it creates.
The petition followed the recommendation on Wednesday by state-appointed emergency manager (EM) Kevyn Orr to Michigan (Aa2 positive) Governor Rick Snyder that the city file for bankruptcy, pursuant to the process outlined in Public Act 436. The recommendation was based on the EM’s findings that there is no reasonable alternative to rectify the city’s financial emergency. The governor approved Mr. Orr’s recommendation and authorized him to proceed with a filing last Thursday. Detroit is the largest US municipality and the first Michigan local government to file for bankruptcy.
The bankruptcy filing follows closely the city’s 15 June first debt payment default on pension certificates of participation. The filing is the first step in determining the city’s eligibility for bankruptcy, a legal process that could take years.
If the city’s eligibility for filing is granted by the federal court and separate state law challenges are unsuccessful, the bankruptcy is likely to interrupt payment on the city’s general obligation and limited tax bonds and potentially other debt security types. Although we expect the city’s water revenue bonds, sewer revenue bonds and distributable state aid bonds to be excluded from the automatic stay, those bonds’ treatment in bankruptcy is untested.
Currently, the city’s general obligation unlimited tax (GOULT) rating is Caa3, with the general obligation limited tax (GOLT) and certificates of participation (COPs) rated Ca, reflecting the city’s 15 June payment default on the COPs and the EM’s announcement that debt service payments will be halted on each security, citing a lack of immediately available general fund resources in his June 2013 Proposal to Creditors.
The Water and Sewage Disposal Systems’ senior lien ratings are B1 and second-lien ratings are B2, reflecting the statutory protections afforded to holders of revenue bonds, and the secured status of debt service payments outlined in the EM’s report. They also reflect the significant uncertainty of the EM’s plan to negotiate with creditors, which leads to heightened risk of a distressed exchange, which we would view as a default, and the uncertainty for bondholders arising from potential creation of a new authority for the system.
The city’s GOULT, GOLT, COPs, Water Supply System Revenue and Sewage Disposal System Revenue ratings remain on review for downgrade pending our assessment of whether a negotiated settlement is likely and the potential effects on the various debt security classes. The rating on the city’s outstanding Distributable State Aid bonds remains on review for downgrade because of uncertainty about the treatment of these securities under a negotiated settlement.
The bankruptcy filing opens the door to what will likely be unprecedented litigation, as well as a complicated and protracted process. Federal law imposes a number of prerequisites before a city is declared eligible to proceed under Chapter 9. One important requirement is that the municipality must be deemed cash flow insolvent. However, the burden of demonstrating cash flow insolvency is extremely difficult and
Genevieve Nolan Assistant Vice President - Analyst +1.312.706.9957 [email protected]
NEWS & ANALYSIS Credit implications of current events
24 MOODY’S CREDIT OUTLOOK 22 JULY 2013
requires that a bankruptcy-eligible municipality show that it is generally not paying its debts on time or is not able to pay its debts as they become due.
Additionally, the city must satisfy one of the creditor negotiation tests, which may require that the city demonstrate that it has negotiated in good faith with its creditors. Exceptions to the good faith negotiation requirement exist, but exigent circumstances are typically cited. In addition to the federal analysis, lawsuits have been filed at the state level challenging the city’s ability to proceed with a Chapter 9 filing. On Friday, an Ingham County judge ruled that the filing violated the Michigan Constitution, a decision that is likely to be appealed to the Michigan Court of Appeals. There is no specific timeframe for determining eligibility.
NEWS & ANALYSIS Credit implications of current events
25 MOODY’S CREDIT OUTLOOK 22 JULY 2013
New York State Sales Tax Growth Is Positive for Downstate Counties, Negative for Upstate Ones Last Monday, New York State (Aa2 stable) reported a 5.7% statewide increase in county sales tax collections for the first half of 2013. The results are credit positive for New York City (Aa2 stable) and nearby counties, including Westchester (Aaa negative), Nassau (A2 stable), Suffolk (A2 negative) and Rockland (Baa3 negative), which all experienced healthy sales tax growth. However, the results are credit negative for many upstate counties where sales taxes mostly declined.
Some of the downstate growth resulted from rebuilding activity following Superstorm Sandy last October, but it also reflects a return to long-term economic trends and the economic strength of the New York City area. In addition, the new figures point to the ongoing disparity between the upstate and downstate economies.
More than 92% of the statewide sales tax growth was in New York City and the four nearby counties. Nassau County, which suffered relatively severe storm damage, alone accounted for 16% of the increase, according to the New York State Department of Taxation and Finance. A temporary jump in retail sales, and subsequently sales tax collections, related to cleanup and reconstruction is the typical pattern after a natural disaster. However, the statewide increase also reflects growth in retail activity unrelated to the storm. Suffolk County was heavily affected by the storm and recorded a 6.3% annual sales tax increase. Rockland County’s storm damage was much less severe, but sales taxes there rose by 9.3%.
Sales tax revenues are a major source of New York counties’ revenue. In Nassau County, sales tax collections accounted for 28.3% of fiscal 2012 revenue. In Rockland County, 39% of revenues came from sales tax collections in fiscal 2011. New York City and its suburbs benefit from large global firms with high wages, as well as highly skilled workers and wealthy demographics, all of which support the retail activity feeding sales tax revenues.
New York City sales taxes, which accounted for 13.8% of fiscal 2012 tax revenues, are exceeding the city’s forecast through April 2013 by $54 million, or approximately 1%, according to the city’s Office of Management and Budget. Two factors have helped drive the positive sales tax trend: strong job recovery, with private-sector employment nearly 5% greater than the pre-recession peak, and tourism, with 52 million visitors in 2012, 21% of them from outside the US, according to city data.
Sixteen upstate counties, including Broome (A2 negative), Chemung (A1), Sullivan (Aa3), and Tioga (Aa3), experienced sales tax declines in the first half of 2013, compared with the same period last year. Chemung County had the largest sales tax decline at 6.4%, driven by the closing of a Sikorsky military aircraft completion center and the loss of 1.4% of the county’s labor force. Overall, the weak sales tax results indicate that upstate economies continue to decline amid a shrinking and aging population and weakening income and wealth indicators. The three notable exceptions to the generally poor results are counties near the Canadian border – Niagara (Aa3), Genesee (Aa3) and Essex (Aa3) – all of which recorded sizable revenue increases. These results are largely because of cross-border retail activity driven by a weak US dollar and lower sales tax rates than in Canada.
The exhibit below lists the New York counties that recorded the largest sales tax gains and losses in the first half of 2013.
Shannon McCue Associate Analyst +1.212.553.7968 [email protected]
Nicholas Samuels Vice President - Senior Credit Officer +1.212.553.7121 [email protected]
NEWS & ANALYSIS Credit implications of current events
26 MOODY’S CREDIT OUTLOOK 22 JULY 2013
New York Counties with the Largest Sales Tax Gains and Losses
Fiscal 2013 January-June
Fiscal 2012 January-June Changes in Dollars Percent Change
Top Gains
Nassau $581,434,144 $523,793,189 $57,640,955 11.00%
Rockland $91,843,431 $83,998,203 $7,845,228 9.34%
Genesee $18,658,773 $17,192,648 $1,466,124 8.53%
Niagara $57,596,607 $53,433,105 $4,163,502 7.79%
Essex $11,383,558 $10,678,144 $705,414 6.61%
Suffolk $621,423,916 $585,135,072 $36,288,844 6.20%
Westchester $243,486,675 $230,100,708 $13,385,967 5.82%
Top Losses
Chemung $28,278,355.19 $30,215,648.75 -$1,937,294 -6.41%
Tioga $9,453,103.76 $9,990,817.53 -$537,714 -5.38%
Broome $61,789,417.73 $65,091,746.11 -$3,302,328 -5.07%
Schoharie $6,806,515.13 $7,093,052.71 -$286,538 -4.04%
Steuben $21,845,840.16 $22,697,015.61 -$851,175 -3.75%
Schuyler $4,249,846.55 $4,400,539.27 -$150,693 -3.42%
Sullivan $15,399,640.04 $15,804,191.85 -$404,552 -2.56%
Total Growth $364,843,464
Source: New York State Department of Taxation and Finance
NEWS & ANALYSIS Credit implications of current events
27 MOODY’S CREDIT OUTLOOK 22 JULY 2013
Structured Credit
Further Delay of FATCA Implementation Is Credit Positive for CLOs On 12 July, the US Internal Revenue Service (IRS) announced that implementation of the Foreign Account Tax Compliance Act (FATCA),9 scheduled to begin on 1 January 2014, would be delayed six months. The additional delay is credit positive for collateralized loan obligation (CLO) transactions with offshore issuers because it will save the administrative burden and expense of FATCA compliance during that time, extend applicability of FATCA’s grandfathering exclusion, and increase the potential for achieving other avenues of FATCA relief prior to implementation.
FATCA requires that foreign financial institutions (FFIs), which the statute defines as including CLO issuers formed outside the US, provide specified information on their US accounts (accounts foreign issuers maintain for US investors) to the IRS or to withhold 30% of payments to US accounts from US sources.
Postponement benefits existing and new CLOs. The additional six-month wait for implementation will benefit all offshore CLOs, whether they were originally issued prior to FATCA’s enactment in 2010 (i.e., first generation CLOs) or will be issued prior to the new 1 July 2014 implementation date. For those CLOs that seek to avoid withholding payments to investors, the delay provides more time to complete the administrative preparation for compliance reporting, including collecting and reporting investor information, while saving six months of the administrative costs of compliance. Compliance costs will depend on the nature of a CLO’s assets and investors, varying from a few thousand dollars annually to much more.
Delay and grandfathering extension will be most helpful to first-generation CLOs. The IRS also extended FATCA’s “grandfathering” exclusion, which will apply to assets outstanding at initial implementation. Therefore, distributions a CLO receives from assets outstanding on 30 June 2014 need not be included in FATCA reporting of payments a CLO makes to US investors or withheld against, so long as none of the assets undergoes a “material” amendment after 30 June 2014. A related consequence of this extension is that currently existing assets will also have another six months to make material amendments without losing FATCA grandfathered status.
Grandfathering extension lowers risk of assets losing grandfathered status. The FATCA delay allows first-generation CLOs extra time to develop a plan to stay out of FATCA’s purview for assets originated or materially amended following 30 June 2014. Also helpful is that only 43 transactions, or around 9%, of the first-generation CLOs we rate will still be in their reinvestment periods after 30 June 2014. CLOs typically have limited ability to purchase new assets after the end of their reinvestment periods. Weighted-average-life requirements in these transactions may be a determinative constraint for managers in any event, and one that already limits the acquisition of newly originated assets.
Delay increases potential to finalize intergovernmental agreements addressing reporting and withholding. The delay could also allow more jurisdictions to finalize intergovernmental agreements with the US Treasury before FATCA implementation starts, which could be helpful to CLOs. FATCA allows for the use of intergovernmental agreements to simplify individual FFI tax information reporting compliance via governmental arrangements. Some intergovernmental agreements have been signed, but the Cayman
9 IRS Notice 2013-43.
Ruth Olson Vice President - Senior Analyst +1.212.553.4092 [email protected]
NEWS & ANALYSIS Credit implications of current events
28 MOODY’S CREDIT OUTLOOK 22 JULY 2013
Islands, where many CLOs are formed, does not yet have one, although discussions are in progress. The implementation delay provides governments an additional six months to work toward finalization of this intergovernmental agreement, with the potential to limit or eliminate most FATCA compliance issues for Cayman Islands-formed CLO issuers.
RATING CHANGES Significant rating actions taken the week ending 19 July 2013
29 MOODY’S CREDIT OUTLOOK 22 JULY 2013
Corporates
Grifols S.A. Upgrade
9 Jul ‘12 15 Jul ‘13
Corporate Family Rating Ba3 Ba2
Outlook Positive Stable
The upgrades reflects Grifols’ strong levels of operating trading and continued progress toward achieving synergies from the acquisition of Talecris Biotherapeutics Holding Corp., leading to a debt to EBITDA ratio of 3.7x. The upgrade also reflects the company’s sustainably high profitability, which in turn enables it to generate positive free cash flows, leading to a strongly increased cash position and therefore to a growing gap between gross and adjusted net debt.
Leap Wireless International, Inc. Review for Upgrade
26 Feb ‘13 16 Jul ‘13
Corporate Family Rating B3 B3
Outlook Stable Review for Upgrade
The review follows the announcement that Leap has entered into a definitive agreement with AT&T Inc. under which AT&T will acquire Leap for $15 per share in cash, for an approximate total cost of $1.2 billion. Leap gains from the transaction due to the relative strength of AT&T, which has investment-grade credit ratings and greater access to capital. The transaction also gives Leap customers access to AT&T’s nationwide LTE network.
The review will focus on AT&T’s plans with regard to existing Leap debt and Leap’s post-close capital structure.
Nucor Corporation Downgrade
22 Oct ‘12 19 Jul ‘13
Senior Unsecured Rating A3 Baa1
Short-Term Issuer Rating P-2 P-2 (affirmed)
Outlook Negative Stable
The downgrade incorporates the slow improvement in Nucor’s debt protection and leverage metrics and our expectation that the degree of improvement necessary to support a higher rating will only occur over a more protracted timeframe than we previously envisioned. Fundamentals in the steel industry in 2013 continue to face headwinds and performance trends indicate a year that will at best be comparable to 2012 but more likely will be somewhat weaker. Nucor is not immune to these trends.
RATING CHANGES Significant rating actions taken the week ending 19 July 2013
30 MOODY’S CREDIT OUTLOOK 22 JULY 2013
OGX Petroleo e Gas Participacoes SA Downgrade
2 Jul ‘13 15 Jul ‘13
Corporate Family Rating Caa2 Ca
Outlook Negative Negative
The downgrade was driven by our diminished expectations that OGX will be able to rely on a $1 billion put option granted by its controlling shareholder, given the recent departure of all of the company’s independent board members. The new rating reflects OGX’s high financial leverage relative to the company’s production and cash flows and its weak liquidity profile, with impaired asset coverage of its unsecured notes. It also reflects weakening corporate governance practices and a highly uncertain outlook for the company, with the risk of a default, debt restructuring or bankruptcy filing.
Quintiles Transnational Holdings Inc. Outlook Change
22 Feb ‘12 15 Jul ‘13
Corporate Family Rating B1 B1
Outlook Stable Positive
The positive outlook reflects our expectation for improvement in the company’s credit metrics following approximately $350 million of debt repayment using proceeds from its recent initial public equity offering.
ServiceMaster Company Downgrade
31 Jan ‘13 15 Jul ‘13
Corporate Family Rating B2 B3
Outlook Negative Stable
The downgrade reflects our expectations for lower revenue and EBITDA this year, given ongoing disappointing performance in the TruGreen segment. Debt to EBITDA is expected to remain above 7x through 2014, which is a high level of financial leverage for a B3 rating. Capital investment needs at TruGreen and Terminix could limit free cash flow available for debt repayments.
Smithfield Foods, Inc. Review for Downgrade
30 May ‘13 15 Jul ‘13
Corporate Family Rating Ba3 Ba3
Outlook Review Uncertain Review for Downgrade
The review follows the proposed acquisition of Smithfield by Shuanghui International Holdings Ltd. The transaction is subject to shareholder and regulatory approval, which the companies expect to receive this year. The review will focus on details of the merger agreement, Smithfield’s post-closing capital structure and the terms of related financing arrangements. We will also assess Shuanghui’s credit profile and the company’s likely influence on Smithfield’s business profile.
RATING CHANGES Significant rating actions taken the week ending 19 July 2013
31 MOODY’S CREDIT OUTLOOK 22 JULY 2013
SOFTBANK CORP. Downgrade
15 Oct ‘12 18 Jul ‘13
Long-Term Issuer Rating Baa3 Ba1
Outlook Review for Downgrade Stable
The downgrade reflects our view that the debt-financed acquisition of Sprint will significantly weaken SoftBank’s financial flexibility, as well as the possibility that SoftBank will have to extend additional financing to help Sprint execute its large capital expenditure program of $16 billion for 2013 and 2014. It also takes into account our concerns about whether Sprint can generate positive free cash flow by fiscal year-end 2015.
Sprint Communications, Inc. Upgrade
15 Apr ‘13 19 Jul ‘13
Corporate Family Rating B1 Ba3
Outlook Review Uncertain Stable
The upgrade follows the closing of the merger agreement with SoftBank Corp. and a separate merger agreement with Clearwire Corp. SoftBank acquired a 78% stake in Sprint in a transaction valued at $21.6 billion. We expect the merger with SoftBank will help Sprint improve its operating performance in the highly competitive US wireless industry. First, there will be an infusion of $5.0 billion of new equity capital. Second, SoftBank has a track record of operational turnarounds of wireless companies in Japan. The merger with Clearwire, a company with a vast holding of spectrum, addresses Sprint’s spectrum needs for at least the next several years.
RATING CHANGES Significant rating actions taken the week ending 19 July 2013
32 MOODY’S CREDIT OUTLOOK 22 JULY 2013
Financial Institutions
Aaa Rated Institutions Directly Linked to US Government Bond Rating Outlook Change
As we affirmed their ratings, we changed the outlook on our Aaa-rated financial institutions with credit quality directly linked to that of the federal government to positive: Fannie Mae, Freddie Mac, the Federal Home Loan Banks, and the Federal Farm Credit Banks. These actions follow the affirmation of the Aaa rating assigned to the US government and revision of the US government’s rating outlook to stable.
Review Concluded on 12 GCC Banks’ Subordinated Debt Ratings Downgrade
On 18 July, we downgraded the subordinated debt ratings of 12 banks in the Gulf Cooperation Council (GCC) countries, namely Saudi Arabia, United Arab Emirates, Qatar, Kuwait, Oman and Bahrain. The affected banks are Arab National Bank, Banque Saudi Fransi, Abu Dhabi Commercial Bank PJSC, Emirates NBD PJSC, First Gulf Bank, Mashreqbank PSC, Commercial Bank of Qatar, Doha Bank Q.S.C., Qatar National Bank, Burgan Bank SAK, Bank Muscat S.A.O.G. and BBK B.S.C. All other ratings and outlooks for these banks remain unaffected.
The downgrade reflects the heightened risk of the imposition of losses on these instruments. Although the downgrades capture the evolving risk profile of subordinated debt, we also continue to recognise the unique record, capacity and willingness of Gulf authorities to extend support, particularly to government-owned banks.
Cassa di Risparmio di Cesena SpA Downgrade
14 May ‘12 17 Jul ‘13
Long-Term Deposit Ratings Ba3 Caa1
Outlook Ratings Under Review Ratings Withdrawn
The downgrade reflects the weakening operating environment in Italy, as well as our concerns about CariCesena’s weak asset quality, profitability, and capital adequacy. These weaknesses have significantly increased the likelihood that the bank may require third-party support to ensure its longer-term viability. We are withdrawing all the bank’s ratings because we believe we have insufficient or otherwise inadequate information to maintain them.
RATING CHANGES Significant rating actions taken the week ending 19 July 2013
33 MOODY’S CREDIT OUTLOOK 22 JULY 2013
Caja Laboral Popular Coop. de Credito Review for Downgrade
27 Nov ‘12 19 Jul ‘13
Long-Term Deposit Ratings Ba1 Ba1
Standalone Financial Strength/ Baseline Credit Assessment
D+/ba1 D+/ba1
Outlook Negative Review for Downgrade
The review reflects our concerns over the bank’s asset quality, particularly in the corporate sector, where we expect further asset quality deterioration, not only affecting real-estate companies but also those operating in other economic sectors. The deterioration is increasingly driven by the weak performance of Spain’s domestic economy and subdued domestic consumption and investment, only offset somewhat by the good performance of the export sector.
Raiffeisen Schweiz Downgrade
22 Nov ‘11 19 Jul ‘13
Long-Term Debt & Deposit Ratings Aa2 Aa3
Subordinated Debt A2 A3
Outlook Negative Stable
The key drivers of the action are, first, Raiffeisen Group’s (unrated) above-average residential mortgage-loan growth over recent years, leading to increased susceptibility to shocks under a scenario of a significant slowdown in the Swiss housing market; and, second, the continued challenging operating environment, characterized by net interest margin compression and low interest rates, which constrain prospects for the group’s profitability.
Synovus Financial Upgrade
On 18 July we upgraded the long-term ratings of Synovus Financial Corporation and its bank subsidiary, Synovus Bank. We upgraded the senior unsecured debt of Synovus Financial to B1 from B2. At Synovus Bank, we upgraded the rating on long-term deposits to Ba2 from Ba3 and the standalone bank financial strength rating/baseline credit assessment to D/ba2 from D-/ba3. Following the upgrade, the rating outlook is positive.
The upgrade follows Synovus’ announcement that it intends to redeem its $968 million of TARP preferred stock. The redemption will be funded mostly from dividends from the bank, as well as preferred and common equity issuances. The upgrade reflects the progress Synovus has made in improving the sustainability of its franchise and its asset quality and earnings, which is reflected by the regulators allowing the company to redeem TARP.
RATING CHANGES Significant rating actions taken the week ending 19 July 2013
34 MOODY’S CREDIT OUTLOOK 22 JULY 2013
UniCredit SpA Downgrade
16 Jul ‘12 15 Jul ‘13
Standalone Financial Strength/ Baseline Credit Assessment
C-/baa2 D+/baa3
Subordinated Debt Baa3 Ba1
We also affirmed UniCredit SpA’s Baa2 long-term debt and deposit ratings and its Prime-2 short term ratings. The downgrade of the bank financial strength rating and baseline credit assessment reflects weakening profitability because of very high loan-loss provisions in Italy and low efficiency levels, and weak and deteriorating asset quality. We believe that problem loans, particularly non-performing loans, will continue to deteriorate until at least 2014, considering the recessionary operating environment in key Italian market, the still high inflows to problem loans, and the long work-out times in Italy.
UniCredit Bank Austria AG Downgrade
6 Jun ‘12 15 Jul ‘13
Long-Term Debt & Deposit Ratings A3 Baa1
The downgrade follows that of parent UniCredit’s financial strength rating. The weaker credit strength of UniCredit, as captured in the downgrade, has led us to lower our parental support assumptions.
RATING CHANGES Significant rating actions taken the week ending 19 July 2013
35 MOODY’S CREDIT OUTLOOK 22 JULY 2013
Sovereigns
Serbia Rating Assigned
14 Jul’13
Gov Currency Rating B1
Foreign Currency Deposit Ceiling B2
Foreign Currency Bond Ceiling Ba2
Local Currency Deposit Ceiling Baa3
Local Currency Bond Ceiling Baa3
Outlook Stable
The first driver of the B1 sovereign rating is the government’s weak financial position due to widening fiscal deficits and rising debt levels. The general government fiscal deficit increased to about 6.4% GDP in 2012 from 2.6% of GDP in 2008. The second driver is the economy’s relatively modest growth and its macroeconomic imbalances, as reflected in wide current account deficits, high inflation and unemployment and rising external debt. The third driver underpinning Serbia’s rating are the institutional and economic benefits anticipated from participating in the EU accession process over the next several years.
South Africa Rating affirmed
27 Sep ‘12 17 Jul ‘13
Gov Currency Rating Baa1 Baa1
Foreign Currency Deposit Ceiling Baa1 Baa1
Foreign Currency Bond Ceiling A2 A2
Local Currency Deposit Ceiling A1 A1
Local Currency Bond Ceiling A1 A1
Outlook Negative Negative
The key drivers for maintaining current ratings are, first, stricter public spending discipline, second, the incorporation of the National Development Plan (NDP) into existing budget execution structures following the plan’s adoption by the African National Congress (ANC) during its National Conference in December, and third, comprehensive initiatives comprising policies aimed at achieving financial and labour market stability.
RATING CHANGES Significant rating actions taken the week ending 19 July 2013
36 MOODY’S CREDIT OUTLOOK 22 JULY 2013
United States Outlook changed
2 Aug ‘11 18 Jul ‘13
Gov Currency Rating Aaa Aaa
Foreign Currency Deposit Ceiling Aaa Aaa
Foreign Currency Bond Ceiling Aaa Aaa
Local Currency Deposit Ceiling Aaa Aaa
Local Currency Bond Ceiling Aaa Aaa
Outlook Negative Stable
The US budget deficit has been declining and is expected to continue to decline over the next few years, and economic growth has demonstrated resilience to major reductions in growth of government spending. Therefore, the government’s debt-to-GDP ratio through 2018 will decline faster than we had anticipated when we assigned the negative outlook. However, we emphasize that, despite the more favorable fiscal outlook over the next several years, the US government’s longer-term debt trajectory still presents challenges.
Sub-sovereigns
City of Valjevo, Serbia Downgrade
24 Jun ‘10 19 Jul ‘13
Issuer rating Ba3 B1
Outlook Stable Stable
City of Novi Sad, Serbia Downgrade
24 Jun ‘10 19 Jul ‘13
Issuer rating Ba3 B1
Outlook Stable Stable
The downgrades of Novi Sad and Valjevo reflect the more challenging operating conditions for local governments in Serbia, resulting from the country’s weakening macroeconomic prospects and the sovereign’s rising fiscal deficits. Both of these factors may prompt the central government to consolidate its finances, and we note that any austerity measures may be shared with lower-tier governments in the form of lower state transfers and tax revenues. This is credit negative for both cities, as they are dependent on the central government for a substantial portion of their revenue.
RATING CHANGES Significant rating actions taken the week ending 19 July 2013
37 MOODY’S CREDIT OUTLOOK 22 JULY 2013
US Public Finance
Cincinnati, Ohio Downgrade
21 Nov ‘12 15 Jul ‘13
General Obligation Bonds Aa1 Aa2
Economic Development Bonds Aa2 Aa3
Non-tax Revenue Bonds Aa2 Aa3
Convention Facilities Second Lien Revenue Bonds
Aa2 Aa3
Outlook Stable Negative
The downgrade reflects the city’s exposure to two statewide multi-employer cost-sharing pension plans as well as its single-employer plan. The city’s current financial position is pressured but still satisfactory, with income tax revenue recently stabilizing and financial flexibility moderate. The city has an economically diverse economic base, but relatively weak socio-economic indices. The outlook is negative because we expect the city to continue to face challenges in attaining structurally balanced operations.
Chicago, Illinois Downgrade
7 Jun ‘13 17 Jul ‘13
General Obligation Rating Aa3 A3
Sales Tax Debt Aa3 A3
Water and Sewer Senior Lien Debt Aa2 A1
Water and Sewer Subordinate Lien Debt
Aa3 A2
Outlook Negative Negative
The downgrade reflects Chicago’s very large and growing pension liabilities and the accelerating budget pressures associated with those liabilities. The city’s budgetary flexibility is already burdened by high fixed costs, including unrelenting public safety demands and significant debt service payments. The current administration has made efforts to reduce costs and achieve operational efficiencies, but the magnitude of the city’s pension obligations has precluded any meaningful financial improvements. We had placed Chicago’s ratings on review for downgrade in April because of the city’s large adjusted net pension liability relative to its ratings as we introduced a new approach to analyzing state and local government pension liabilities.
RATING CHANGES Significant rating actions taken the week ending 19 July 2013
38 MOODY’S CREDIT OUTLOOK 22 JULY 2013
Temple University Health System, Pennsylvania Downgrade
25 May ‘12 16 Jul ‘13
Revenue Bonds Ba1 Ba2
Outlook Stable Negative
The system’s operating losses are likely to be significant in fiscal year 2013, a material negative variance from budgeted expectations. The lower rating also reflects the ongoing challenges of a weak fundamental credit profile, including challenging demographics, a highly leveraged balance sheet and operating profile, and also an increasing dependence on supplemental funding from the state.
Structured Finance
Positive Rating Actions on 287 Tranches in 102 Amortizing US CLOs On 15 July we upgraded the ratings on 192 tranches in 95 US collateralized loan obligations (CLOs), totaling approximately $4.5 billion of outstanding rated balance. The magnitude of the upgrades ranged between one to three notches. The ratings on all of the tranches upgraded, except for those already upgraded to Aaa (sf), remain on review for upgrade. We also placed on review for upgrade the ratings on another 95 tranches in 63 CLOs, totaling approximately $1.6 billion of outstanding rated balance.
The rating actions are primarily a result of the substantial deleveraging of senior notes and increases in the overcollateralization (OC) levels in the CLOs, which improved the credit enhancement levels of outstanding tranches in these deals. The deleveraging and OC improvements primarily resulted from high prepayment rates of leveraged loans in the CLO portfolios.
RESEARCH HIGHLIGHTS Notable research published the week ending 19 July 2013
39 MOODY’S CREDIT OUTLOOK 22 JULY 2013
Corporates
US Retail Industry: Solid Second-Quarter Sales Bode Well for Back-to-School Season
June retail sales data indicates a modest acceleration in the pace of consumer spending growth. According to data released by the US Department of Commerce, unadjusted retail and food service sales grew by 3.4% year-over-year in the second quarter of 2013, a healthy increase from the 2.5% growth experienced in the first quarter. This level of growth is in line with our forecast, and we believe the trend will continue during the back-to-school season.
Substantial Bond Issuance by Speculative-Grade European Companies Still Leaves Record Refinancing Needs
The amount of debt held by rated speculative-grade companies in Europe, the Middle East and Africa that is maturing next year has risen to $101 billion from $84 billion a year ago, due to an increase in the number of fallen angels and first-time issuers. This contrasts with the US, where maturing speculative-grade debt in 2014 fell to $79 billion from $168 billion, and where speculative-grade issuance is likely to significantly cover next year’s maturities.
US Wireless Industry: AT&T’s Leap Deal Is Negative for Prepaid Services Providers
On 12 July AT&T Inc. announced plans to acquire Leap Wireless International, Inc. in a $4.0 billion deal designed to accomplish two strategic priorities for AT&T: enhance its spectrum holdings and accelerate its previously announced expansion into prepaid services. AT&T’s push into the prepaid market is negative for competitors T-Mobile and Sprint Corp., as AT&T’s scale and cost structure will allow it to offer robust and affordable services to the prepaid segment.
US Packaged Foods: Operating Income Set for Faster Growth
We have revised our outlook for the US packaged-foods industry to positive from stable based on our view that industry-wide sales will increase 3%-4% and operating income will increase 6%-8% over the next 12-18 months. Cost savings will help branded foods. Branded food makers will expand their gross margin as higher pricing prompted by the 2012 drought complements falling input prices. Cost-cutting and plant closings will also contribute to earnings growth.
US Healthcare: Value over Volume: Risks, Pitfalls and Opportunities
The various sectors of the US healthcare industry will see mixed effects as they transition to delivery and reimbursement models that emphasize quality care over quantity of care. Medical device makers will be the most vulnerable and both for-profit and not-for-profit hospitals will face risks during the transition, while insurers stand to gain the most.
Exploration and Production: New Argentine Shale Deal Reflects Affect of Revised Rules on Energy Exports
The Argentine government has announced that oil and gas companies will be allowed to export up to 20% of their production without incurring export duties in exchange for a minimum investment over five years, a move that will result in higher realized prices on such exports. The decree is credit positive for companies operating within Argentina’s heavily regulated energy sector, giving energy companies with operations there a pathway to higher returns on their upstream investments.
RESEARCH HIGHLIGHTS Notable research published the week ending 19 July 2013
40 MOODY’S CREDIT OUTLOOK 22 JULY 2013
Weak Tyre Demand Keeps Synthetic Rubber Producers Under Pressure
The European Tyre and Rubber Manufacturers’ Association reported a 6% year-on-year decline in the European consumer replacement tyre market in the first half of 2013. We estimate the replacement market accounts for approximately 70%-80% of all tyre sales in Europe and other developed markets, while tyre sales in emerging markets are driven by new car sales. Weak customer demand is credit negative for producers of styrene butadiene rubber, as it reduces their pricing power and drives down revenues.
Asia Steel Industry: Plant Cancellations Highlight Weak Conditions
ArcelorMittal (Ba1 negative) said on 17 July that it is dropping its plan to build a steel plant in eastern India with an annual production capacity of 12 million tonnes, according to news reports. The announcement came two days after news reports that POSCO (Baa1 negative) is cancelling its plan to build a $5.3 billion steel plant in India. We expect the operating environment will remain challenging for steel companies in Asia over the next 12 months given slowing GDP growth in China.
SGL Monitor: Liquidity-Stress Index Dips Despite Market Volatility
Although credit markets have been volatile in recent weeks, our Liquidity-Stress Index fell slightly to 3.5% as of mid July from 3.7% at the end June, continuing at a low level that indicates few US speculative-grade companies are experiencing liquidity problems. However, the index is up from its record low of 2.8% at the end of April.
RESEARCH HIGHLIGHTS Notable research published the week ending 19 July 2013
41 MOODY’S CREDIT OUTLOOK 22 JULY 2013
Financial Institutions
US Healthcare: Value over Volume: Risks, Pitfalls and Opportunities As healthcare delivery and reimbursement models transition to ensuring quality care versus quantity of care, they will have a mixed effect on various healthcare sectors. Adoption of new reimbursement systems will help provide incentive for more cost-effective care. Health insurers will benefit from lower use rates and cost-effective care. Medical device companies will be most at risk.
Singapore Banking System Outlook We have revised our outlook on Singapore’s banking system to negative from stable. The two main drivers underpinning our opinion are the recent period of rapid loan growth and rising real estate prices in Singapore and in regional markets where Singapore banks are active. These have increased the probability of deterioration in the banks’ credit profiles under potential adverse conditions in the future.
Denmark Banking System Outlook Our outlook on Denmark’s banking system remains negative, as it has been since November 2008. Over the outlook period, the system’s low profitability and reduced earnings quality will restrict the banking system’s ability to absorb any further weakening of asset quality or other earnings shocks, and constrain the banks’ ability to build capital to support their future growth.
Azerbaijan Banking System Outlook Our outlook on Azerbaijan’s banking system remains stable, because we expect the banks to continue to benefit from a favorable operating environment, improving asset quality and sufficient capital buffers to absorb losses under our central scenario. Counterbalancing these supportive factors are the banking system’s structural weaknesses, related to the lack of diversification in Azerbaijan’s economy, banks’ limited access to long-term funding, low transparency and corporate-governance deficiencies, and significant exposure to single borrowers and related parties.
German Development Banks: Strong Public-Sector Support and Legal Framework Underpin Aaa-Aa1 Ratings The strong public-sector support arrangements provided by the development banks’ owners are the key driver of the banks’ ratings. Under their mandate to help stimulate economic growth, the development banks are exempt from corporate tax and the bank levy, but subject to certain competitive restrictions.
Gradually Rising Interest Rates Would Be Positive for US Life Insurers The recent rise in interest rates, as reflected in the approximate 85 basis point increase in the 10-year US Treasury bond yield to about 2.6% on July 11 from late April, is positive for the US life insurance sector. Growing interest rates would increase appetite for spread products, such as fixed annuities, which fell out of favor due to tight spreads. In addition, rising rates would reduce investment risk, and new money rates and portfolio yields would rise.
RESEARCH HIGHLIGHTS Notable research published the week ending 19 July 2013
42 MOODY’S CREDIT OUTLOOK 22 JULY 2013
European Insurance: Low Rates and New Regulations Will Drive Increase in Illiquid Investments The post-2008 trend by European insurers to invest in new asset classes will accelerate in the coming years because insurers are keen to reduce concentration risk to sovereign and banking debts, interest rates are at historically low levels, and both P&C and life insurers will increasingly chase yields. Finally, the introduction of Basel III and the resulting deleveraging from banks creates new investment opportunities for insurers, and there is an increasing willingness from public authorities to incentivise insurers to at least partly replace bank financing.
RESEARCH HIGHLIGHTS Notable research published the week ending 19 July 2013
43 MOODY’S CREDIT OUTLOOK 22 JULY 2013
Sovereigns
Colombia Credit Analysis Colombia’s Baa3 government bond rating balances a history of coherent and predictable macroeconomic policies, an impeccable debt-service track record, and ample access to financing in domestic and external markets with comparatively low levels of economic development. The country has shown remarkable resilience dealing with both economic and political shocks and, in recent years, has reduced the threat from armed groups while keeping debt levels first stable, and then falling, in the midst of the global economic crisis.
Guatemala Credit Analysis Guatemala’s Ba1 government bond rating reflects the government’s long track record of prudent fiscal management and the economy’s resiliency to domestic and external shocks but also the country’s high poverty levels and weak institutional strength. Guatemala’s economy has been marked by macroeconomic stability since we began rating the country in 1997, one year after its 36-year civil war came to an end.
Iceland Credit Analysis Iceland’s Baa3 government bond rating reflects our assessment of the country’s moderate economic strength, which balances the high levels of wealth with the small size and undiversified structure of the economy. Iceland also exhibits high institutional strength, reflecting the authorities’ significant progress in bringing the economy, the financial system and the public finances back onto a sustainable path. We consider Iceland’s government financial strength in turn to be low, mainly on account of its still elevated debt burden.
Asia-Pacific 2013 Sovereign Mid-Year Update: Broad Regional Stability Amid Continuing External Volatility Since we published our Asia-Pacific outlook in January, the rating outlooks for China, Hong Kong, and Sri Lanka have changed to stable from positive, while we affirmed their respective ratings. There is one regional sovereign with a non-stable rating outlook: Pakistan with a negative outlook on its Caa1 rating. The outlook for global growth has not changed significantly since January with the ongoing recession in the euro area still representing a prominent risk, while the moderate pace of recovery in the US provides a degree of buoyancy.
United States of America The Aaa rating of the United States is based on our assessment of the country’s very high economic strength, very high institutional strength, very high government financial strength, and low susceptibility to event risk. On 18 July, we moved the outlook on the Aaa government bond rating back to stable, replacing the negative outlook we had in place since August 2011, and affirmed the rating. The outlook change reflects our assessment that the federal government’s debt trajectory is on track, at least through 2018, to meet the criteria we laid out in August 2011 for a return to a stable outlook.
RESEARCH HIGHLIGHTS Notable research published the week ending 19 July 2013
44 MOODY’S CREDIT OUTLOOK 22 JULY 2013
Sub-sovereigns
What’s Ahead for Local Government Bond Market in China? The Chinese central government’s new guidelines for its pilot municipal bond program is another significant step towards the development of a bond market for the country’s regional and local governments (RLGs). Ultimately, a local government bond market would help enhance monitoring and regulation of RLG indebtedness improve RLG accountability for their own investments and borrowing decisions, and discourage RLGs from engaging in irregular financing activities.
Croatian Sub-sovereigns: EU Membership Funding Opportunities, a Credit Positive On 1 July, Croatia (Ba1 stable) became the 28th member of the European Union (EU), which is credit positive for the country’s regional and local governments as it gives them access to the EU’s Cohesion and Structural Funds. We expect the increase in funding to support efforts to expand infrastructure and stimulate economic growth, diminish the regional and local governments’ need to issue debt to fund their investments, and create an incentive for them to improve their ability to prepare, plan and implement complex, multi-year investment projects.
Structured Finance
Timely Payment Indicators Improved Over the Crisis in Stronger Sovereigns, Even as Banking Sector Weakened Our Timely Payment Indicators consider the likelihood of the issuer continuing timely payments on the covered bonds after the supporting bank defaults. Over the crisis, TPIs have increased in stronger sovereigns, but in weaker sovereigns, TPIs have fallen markedly. The more pronounced fall of TPIs in sovereigns with weaker creditworthiness reflects increased linkage between the credit strength of the covered bonds and the supporting bank, and the lowering of the maximum rating uplift.
Credit Insight The July edition of our newsletter discusses the credit negative implications for Spanish RMBS and SME transactions of the lack of housing demand in the country. We also discuss the long-term credit negative implications for UK non-conforming RMBS deals of interest-only loan delinquency levels over the next 20 years, the credit positive ramifications for SMEs of non-traditional lenders increasingly entering the direct lending space, and the credit positive implications for EMEA RMBS and ABS transactions of the recent Council of the European Union’s proposal to give depositors preference over senior unsecured creditors.
RECENTLY IN CREDIT OUTLOOK Select any article below to go to last Thursday’s Credit Outlook on moodys.com
45 MOODY’S CREDIT OUTLOOK 22 JULY 2013
NEW ANALYSIS Corporates 2
» China’s Slowdown Is Credit Negative for Chemical Sector » Argentina’s Energy Decree Is Credit Positive for Upstream
Producers » Heineken’s Agreement to Sell Its Hartwall Business Is Credit
Positive » Yuzhou’s Jiading Land Acquisition Is Credit Negative
Infrastructure 7
» Mexico Launches $100 Billion Transport and Telecom Investment Program, a Credit Positive
Banks 9 » MATba and MAE’s Single-Quoting Trading Platform Is Credit
Positive for MATba » Russia’s Relaxation of Basel III Capital Rules Is Credit
Negative for Banks » Indonesia’s Plan to Tighten Property Lending Is Credit
Positive for Banks
US Public Finance 15 » Declining Gaming Revenues Are Credit Negative for Atlantic
City, New Jersey
CREDIT IN DEPTH United Kingdom and Singapore Bank Systems 17
We have changed our outlook for the UK banking system to stable from negative, reflecting the stabilisation of key rating drivers for the standalone credit assessments of UK banks, including the UK’s increasingly stable economic outlook, asset quality improvement, and rising capital ratios, profitability and efficiency ratios owing to lower impairments. We also have revised our outlook on Singapore’s banking system to negative from stable, reflecting the recent period of rapid loan growth and rising real estate prices in Singapore and in regional markets where Singapore banks are active, which have increased the probability of deterioration in banks’ credit quality under adverse conditions.
MOODYS.COM
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EDITORS PRODUCTION ASSOCIATE News & Analysis: Jay Sherman, Elisa Herr and Alexis Alvarez
David Dombrovskis
Ratings & Research: Robert Cox Final Production: Barry Hing
