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MOODYS.COM
1 JUNE 2015
NEWS & ANALYSIS Corporates 2 » Avago’s Planned Acquisition of Broadcom Is Credit Positive » Expedia’s Sale of Majority Stake in eLong Will Improve Liquidity
and Profitability » Nordstrom’s Card Receivables Sale Would Reduce
Earnings Volatility » Cott Delivers Debt-Reducing Stock Sale » Consmin’s Receipt of $51 Million from Former Customer Is
Credit Positive » Mondi’s Acquisition of Extrusion Coating Plants Is
Credit Positive » Suntory Beverage & Food Will Buy Japan Tobacco’s Vending
Machine Business, a Credit Positive » China Travel Service’s Planned Sale of Its Iron and Steel
Business Is Credit Positive
Infrastructure 10 » Korean Government Plan to Boost Korea Railroad Corporation’s
Profitability Is Credit Positive
Banks 12 » Merger of Seattle and Des Moines Federal Home Loan Banks Is
Credit Positive » Kuwait’s Al Ahli Bank Acquires Greece’s Piraeus Bank in Egypt, a
Credit Negative » Krung Thai Bank’s Additional Loan-Loss Provisioning Is
Credit Negative
Insurers 17 » Higher Taxes Are Credit Negative for Brazilian Insurers
Sovereigns 18 » Venezuela Rules Out Dollarizing the Economy, Avoiding a
Credit Negative » The Bahamas’ Fiscal Consolidation Outperformance Is
Credit Positive » Australia’s Declining Capital Expenditures Signal Growth
Challenges
Sub-sovereigns 24 » Mexico’s New Efficiency Rule for Water Companies Will Reduce
Operating Costs
US Public Finance 25 » States Benefit from Increase of Workers Joining Labor Force
Securitization 27 » SEC Disclosure Rule for Due Diligence Reports Enhances US
RMBS Transparency » Nelnet Student Loan ABS Includes Structural Feature to
Mitigate Slow Loan Repayment
RATINGS & RESEARCH Rating Changes 29
Last week we downgraded Baxter International, E.I. du Pont de Nemours and 19 US reverse-mortgage RMBS, and upgraded Dillard's, Banco de la República Oriental del Uruguay, China Life Insurance, Kapital Bank, Kyongnam Bank, Novo Banco, Shinhan Bank, Jamaica and two US reverse mortgage RMBS. Additionally, we downgraded and upgraded various obligations of 13 global investment banks, six Dutch banks, Paraguayan and Uruguayan banks, and three Russian banks as a result of implementing our updated rating methodology for banks.
Research Highlights 37
Last week we published on Spanish corporates, Chinese property developers, Malaysian issuers, US building products, Brazil's sugar-ethanol producers, green bonds, Russian utilities and infrastructure, European high yield corporates, US healthcare, North American covenant quality, US gaming, global base metals, Latin American mining, a Greek exit from the euro, global investment banks, Korean banks, Malaysian banks, Islamic banks, Australian banks, Basel III liquidity requirements, contingent capital instruments, Chilean banks, Belarusian banks, Sub-Saharan African sovereigns, Spain, Croatia, Thailand, sovereign defaults, Honduras, Mauritius, Uruguay, Spanish regions, Chinese sub-sovereigns, US independent schools, New York schools, US seaports, US not-for-profit hospitals, US state and local governments, US federal highway funding, US auto loan ABS, European auto loan ABS, Japanese auto loan ABS, Japanese RMBS and Japanese apartment loan securitizations, among other reports.
RECENTLY IN CREDIT OUTLOOK
» Articles in Last Monday’s Credit Outlook 46 » Go to Last Monday’s Credit Outlook
NEWS & ANALYSIS Credit implications of current events
2 MOODY’S CREDIT OUTLOOK 1 JUNE 2015
Corporates
Avago’s Planned Acquisition of Broadcom Is Credit Positive Last Thursday, Avago Technologies Finance Pte. Ltd. (Ba2 review for upgrade) said that it had agreed to acquire Broadcom Corporation (A2 review for downgrade) for $37 billion in Avago shares and cash. The planned acquisition is credit positive for Avago because it will increase scale and provide about $750 million in annual cost savings by late 2017. Following the announcement, we placed Avago’s ratings under review for upgrade and Broadcom’s ratings under review for downgrade.
Avago expects to complete the transaction in early 2016. The combined company will have a revenue base of about $15 billion, more than double Avago’s trailing annual revenue. The acquisition combines two strong players with large research and development scale and a more diversified portfolio of complementary semiconductor products serving the wireless communications, wireless infrastructure, enterprise storage and industrial end markets.
Avago plans to fund the acquisition with about $20 billion worth of Avago shares and $17 billion of cash, which will be funded with about $9 billion of new debt and $8 billion of cash from the combined company. Avago has obtained $15.5 billion of committed debt financing, which it will use to refinance $6.5 billion of debt and to provide $9 billion of incremental debt.
Based on the preliminary plan outlined by Avago, we estimate that adjusted debt/EBITDA for the combined company will be about 3.5x upon closing, up from about 2.6x for Avago alone for the 12 months ended 3 May 2015. This increase reflects both the incremental acquisition debt and Broadcom’s EBITDA margin profile, which is lower than that of Avago. Still, based on Avago’s public comments, we expect the company to prioritize debt reduction after investing in the business, improving its leverage profile over time.
Because of the scale of the acquisition, there are meaningful integration and execution risks. Although the deal will also reduce liquidity of the combined company, we expect annual free cash flow of more than $2 billion, which should allow for debt reduction and rebuilding cash balances.
Terrence Dennehy Vice President - Senior Analyst +1.212.553.1015 [email protected]
This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on www.moodys.com for the most updated credit rating action information and rating history.
NEWS & ANALYSIS Credit implications of current events
3 MOODY’S CREDIT OUTLOOK 1 JUNE 2015
Expedia’s Sale of Majority Stake in eLong Will Improve Liquidity and Profitability On 22 May, Expedia, Inc. (Ba1 stable) said that it had sold its 62.4% majority stake in eLong Inc. (unrated) to several purchasers in China, including Ctrip.com International Ltd. (unrated), for a total purchase price of about $671 million. The sale is credit positive because it will enhance Expedia’s already-strong liquidity and jettison a money-losing business that had dampened the company’s profitability.
Expedia incurred losses from eLong because of significant selling and marketing costs, as well as investments to build hotel supply in China. During the six months that ended 31 March 2015, eLong generated an adjusted EBITDA loss of $60 million on $71 million of revenue, versus earnings of nearly $412 million for the remainder of Expedia on $2.66 billion of revenue. In the first quarter of 2015, adjusted EBITDA including eLong declined 5% from a year earlier, but grew 25% excluding eLong. Company executives had indicated that they had expected to post similar or larger quarterly losses from eLong through 2015.
The divestiture does not signal a shift away from Expedia’s acquisitive strategy. In March 2015, the company announced a $270 million cost-method investment in Decolar, the leading Latin American online travel company (OTC). That followed its February announcement of its planned acquisition of Orbitz Worldwide, Inc. (B2 positive) for about $1.6 billion in enterprise value, and the completion in January of its acquisition of Travelocity, the fourth-largest US OTC, for $280 million in cash.
Before these domestic deals, Expedia acquired Wotif Group, an Australian-based online travel company, for about $612 million in 2014, and a majority interest in trivago, a European metasearch company, for about $630 million in 2013. These acquisitions are consistent with our expectation that Expedia will continue to acquire companies to support profitable revenue growth in the highly competitive online travel market.
With the sale of eLong and the anticipated funding of the Orbitz acquisition, we expect pro forma adjusted debt/EBITDA (including Orbitz’s projected earnings without synergies) to be in the mid-to-high 2x range, up from 2.1x for the 12 months that ended 31 March 2015. This level is within our expectation that Expedia will maintain leverage at below 3x, our guidance for its Ba1 rating. The company may use a portion of the net proceeds from the eLong sale to help fund the Orbitz transaction, but this would depend on the timing of the acquisition’s close and the lag associated with repatriating any funds from China.
Expedia continues to maintain very good liquidity and access to debt funding, including a €650 million bond issuance priced on 28 May 2015, which will allow it to fund the purchase of Orbitz with cash on hand, additional debt or some combination thereof. We expect Expedia to generate about $1 billion of free cash flow (after dividend payments) over the coming year. In addition, we expect that the company will maintain at least $1 billion in cash and short-term investments to support its merchant payable and seasonal working capital needs (cash and short-term investments totaled about $2 billion at the end of March). Also supporting liquidity is a $1 billion revolving credit line that expires in September 2019, substantially all of which is available, excluding $13 million in letters of credit.
Stephen Sohn Vice President - Senior Credit Officer +1.212.553.2965 [email protected]
NEWS & ANALYSIS Credit implications of current events
4 MOODY’S CREDIT OUTLOOK 1 JUNE 2015
Nordstrom’s Card Receivables Sale Would Reduce Earnings Volatility Last Tuesday, Nordstrom, Inc. (Baa1 stable) said that it had agreed to sell its existing $2.2 billion US Visa and private-label consumer credit card portfolio to TD Bank USA, N.A., a subsidiary of The Toronto-Dominion Bank (Aa1/Aa1 negative, aa31). Even if the effect of this transaction is modestly negative for Nordstrom’s credit metrics, the reduced exposure to the credit card portfolio makes the move credit positive for Nordstrom overall.
Historically, credit card income has been Nordstrom’s most volatile earnings stream. Nordstrom’s credit card segment accounts for around 16% of its overall pretax profit, with the balance derived from its retail activities. In the most recent fiscal year that ended 31 January 2015, the segment generated $184 million of Nordstrom’s $1.18 billion of pre-tax profits. But during recessions, the credit card segment tends to lose money because customers default on payments more frequently. For example, the credit card segment incurred losses before tax of $82 million in 2010 and $72 million in 2009.
Nordstrom is one of the last big retailers to have a credit card portfolio and has viewed it as strategically important in serving customers. We view Nordstrom’s exemplary customer service as a key underpinning of its business profile. Although Nordstrom will reduce its ownership of the portfolio, it will continue to service accounts, which are integral to its customer experience. In most transactions of this type, the owning bank controls the servicing, hence the ability to negotiate this aspect was integral to Nordstrom’s willingness to sell. Nordstrom said one reason for the portfolio sale is to improve returns on capital for shareholders. The company has experienced some margin pressure in its retail business owing to growth investments including, but not limited to, costs related to its Canadian expansion.
Although Nordstrom has not yet specified how it will use the sale proceeds (either for debt repayment or buybacks), we expect that management will maintain leverage in line with the company’s target of rent-adjusted leverage (as defined by Nordstrom) in the 1.5x-2.5x range. For the fiscal quarter ended 2 May 2015, its company’s leverage ratio was 2.1x.
The increasing portion of sales from the Nordstrom Rack “off-price” channel, which now generates almost one quarter of Nordstrom’s total retail sales, is positive because this channel has been gaining share at the expense of full-price retailers. Nordstrom’s full-price stores benefit from their unique position as a “value price” luxury retailer, which provides a similar customer experience to that of a luxury retailer, but at a more affordable price. Its diverse channels also give it a competitive advantage over other traditional department stores, which do not provide the same high level of service.
1 The bank ratings shown are The Toronto-Dominion Bank’s deposit rating, senior unsecured debt rating and baseline credit
assessment.
Scott Tuhy Vice President - Senior Credit Officer +1.212.553.3703 [email protected]
NEWS & ANALYSIS Credit implications of current events
5 MOODY’S CREDIT OUTLOOK 1 JUNE 2015
Cott Delivers Debt-Reducing Stock Sale Last Tuesday, beverage company Cott Corporation (B2 stable) said that it had agreed to sell about $130 million in common equity ($150 million if an overallotment is fully exercised) to a syndicate of banks on a bought deal basis. Cott said that it will use the net proceeds to pay down high-coupon preferred stock it used to fund its $1.25 billion purchase of DS Services of America (DSSA), a water delivery and services company, in December.
Issuing common equity to repay preferred shares, which we treat as debt in calculating leverage, is credit positive for Cott because it will allow the company to accelerate its deleveraging following the DSSA deal. We now expect Cott’s financial leverage to be about 4.8x debt/EBITDA in 2015, versus our previous expectation of at or slightly above 5.0x by the end of the year. We expect leverage to decline to the high-3x range by 2017, versus our previous expectation of 4.0x or slightly above. Cott’s adjusted financial leverage increased to slightly more than 5.0x debt/EBITDA following the DSSA acquisition.
Cott agreed to sell the bank syndicate 14.1 million common shares, priced at $9.25 per share. It will use the net proceeds to redeem all of its Series B, 10% non-convertible preferred shares and a portion of its Series A, 9% convertible preferred shares. The convertible preferred shares were initially convertible to common stock at $6.28 per share after three years, almost $3 per share less than Cott is receiving for its common stock from the bank syndicate. Redeeming the preferreds will also save Cott $11.4 million in annual dividend payments, or $13.2 million if the overallotment is fully exercised.
Headquartered in Toronto, Ontario, and Tampa, Florida, Cott is the largest private-label beverage producer and a leading home and office water delivery provider in North America. Although buying DSSA last December improved its customer concentration, scale and product diversification, Cott remains a niche player in a broad beverage industry dominated by Coca-Cola and PepsiCo. Its product portfolio includes carbonated soft drinks; clear, still and sparkling flavored waters; juice; juice-based products; bottled waters; energy related drinks; and ready-to-drink teas. Cott’s customers include many of the largest national and regional grocery, drugstore, and convenience store chains and wholesalers.
Recently acquired DSSA is a provider of bottled water and related services delivered directly to residential and commercial customers in the US. Its core business is the bottling and direct delivery of drinking water in three and five gallon bottles to homes and offices and the rental of water dispensers. Pro forma for the acquisition of DSSA, Cott has revenues of approximately $3 billion.
Linda Montag Senior Vice President +1.212.553.1336 [email protected]
NEWS & ANALYSIS Credit implications of current events
6 MOODY’S CREDIT OUTLOOK 1 JUNE 2015
Consmin’s Receipt of $51 Million from Former Customer Is Credit Positive Last Thursday, Consolidated Minerals Limited (Consmin, B3 negative) announced that it had received a $51 million payment from Tianyuan Manganese Industry Ltd. (TMI, unrated), its former main customer, to settle litigation claims and restart commercial relationships. This development is credit positive because it supports Consmin’s liquidity, and signals the possibility of resuming shipping volumes over the coming weeks from the company’s Ghanaian mine to an important former customer. Until mid-2014, TMI purchased approximately 65% of the output of Consmin’s manganese mine in Ghana, and accounted for 25% of the miner’s annual consolidated revenues.
The payment from TMI increases Consmin’s liquidity during what has otherwise been another challenging 2015 for both the company and the broader manganese industry, with average prices in first-quarter 2015 down 15% from the previous quarter. TMI, along with other potential new customers that Consmin is targeting in China, will allow Consmin to gradually return the Ghanaian mine operations toward annual capacity of almost 3 million tonnes. The company drastically reduced mining activities in Ghana last September following the termination of an exclusive offtake agreement with TMI.
Consmin is actively marketing its Ghanaian ore to potential new customers and we expect these efforts to result in a much more diversified customer base in the coming quarters compared with previous years, when the company sold the bulk of its manganese ore from Ghana to TMI. We expect that resuming a commercial relationship with a big customer such as TMI will also help Consmin in its ongoing negotiations with new Chinese customers.
An improvement in the company’s financial performance over the next several quarters could result in our changing the company’s outlook to stable from negative. In the absence of a meaningful recovery in manganese prices, such a scenario could arise if sales volumes out of Ghana return to capacity levels and translate into lower unit costs and higher EBITDA and cash flows. In particular, we would look at a ratio of cash flow from operations minus dividends to debt of 15% or more, versus just 1.1% in 2014, and EBIT/interest expense in the 1.5x-2.0x range, versus 1.2x in 2014.
Jersey-based Consmin is a leading producer of manganese ore, with mining operations in Australia and Ghana. Consmin is wholly owned by Gennady Bogolyubov, a Ukrainian citizen. For 2014, the company had sales of $421 million.
Gianmarco Migliavacca Vice President - Senior Credit Officer +44.20.7772.5217 [email protected]
NEWS & ANALYSIS Credit implications of current events
7 MOODY’S CREDIT OUTLOOK 1 JUNE 2015
Mondi’s Acquisition of Extrusion Coating Plants Is Credit Positive On 22 May, Mondi Plc (Baa2 stable), an integrated paper and packaging company, said that it had agreed to acquire two extrusion coating plants in Finland and Poland from Finland-based packaging materials specialist Walki Oy (unrated) for €60 million on a debt and cash-free basis. That is the equivalent of 6.7x pro forma consolidated adjusted EBITDA of €9 million (excluding synergies). Although the transaction will not affect Mondi in terms of size and financial metrics, it is credit positive because it will strengthen Mondi’s position in the European extrusion coatings market within its fibre packaging business, and expand the services it can offer to customers. The parties expect to close the transaction, which is subject to competition clearance and other conditions by the third quarter of 2015.
The acquisition will support Mondi’s improving profitability, which has been the result of investments in high-growth low-cost countries, cost rationalisation initiatives, the disposal and closing of non-core underperforming businesses and a diversified business model. Mondi’s credit quality improves when it builds long-term value through acquisitions funded from operating cash flow, rather than pursuing more shareholder friendly financial policies. Both Mondi’s relatively lower cost asset base in emerging markets and its integrated business model have contributed to more robust earnings, with Moody’s-adjusted EBITDA margin above 16% in recent years.
The acquisition is Mondi’s first in 2015 and follows the June 2014 purchase of the US industrial bags and kraft paper business of Graphic Packaging International Inc. (Ba1 stable) for $105 million. Although Mondi remains fully committed to its investment-grade rating, the company continues to allocate its free cash flow to selective capital investment opportunities and to supporting a dividend to shareholders that the company recently increased by 17%. Beyond this, Mondi continues to evaluate alternative uses of capital, including looking for complementary acquisition opportunities in its faster-growing packaging segment and returning surplus capital to shareholders.
Mondi has a track record of stable financial leverage, with Moody’s-adjusted debt/EBITDA dropping to less than 2x during 2013 and 2014 through a mix of debt repayments and improvements in operating profitability. Mondi’s leverage is unlikely to improve further over the next 12 months owing to ongoing capex and potential bolt-on acquisitions or returns to shareholders. The company is focused on growing its packaging business and optimising costs in fine paper and expects its annual capex to remain at €550-€560 million in 2015 and 2016.
Nevertheless, we expect Mondi to remain free cash flow generative and strongly committed to its investment-grade rating, including conservative credit metrics that would allow for a temporary increase in Moody’s-adjusted debt/EBITDA of up to 3x in the event of higher growth investments, with a subsequent return to 2.5x or less.
Matthias Volkmer Vice President - Senior Analyst +49.69.70730.745 [email protected]
Dirk Steinicke Associate Analyst +49.69.70730.949 [email protected]
NEWS & ANALYSIS Credit implications of current events
8 MOODY’S CREDIT OUTLOOK 1 JUNE 2015
Suntory Beverage & Food Will Buy Japan Tobacco’s Vending Machine Business, a Credit Positive On 25 May, Suntory Beverage & Food Ltd. (SBF, A3 stable) said that it would acquire the vending machine business of Japan Tobacco Inc. (Aa3 stable) for around ¥150 billion (about $1.2 billion), and fund the acquisition with approximately ¥100 billion of debt and cash on hand. The acquisition is credit positive for SBF, a 60%-owned subsidiary of Suntory Holdings Limited (Baa2 stable), because it materially expands the scale of the company’s existing vending machine network and locks out other potential competitors. After the announcement, we affirmed SBF’s, Suntory Holdings’ and its group companies’ ratings and outlooks.
The Suntory soft drink arm will acquire approximately 170,000 vending machines from Japan Tobacco, as well as two popular non-alcoholic beverage brands, Roots and Momo no Tennensui. Based on data from Japanese independent research firm Inryou Souken Inc. and the Japan Vending Machine Manufacturers Association, we expect SBF to have around 661,000 soft drink vending machines after the acquisition, compared with Coca Cola’s 830,000 machines. This will give SBF a meaningful 27% of Japan’s annual $16 billion of soft drink vending machine beverage sales and a second-place market share after Coca Cola’s 34%. Japanese consumers are avid users of the ubiquitous machines, making Japan’s market only around 20% smaller than the US soft drink vending machine market.
Debt funding for the acquisition will increase the company’s leverage to around 2.8x debt/EBITDA by December 2015 from 2.5x a year before. However, we expect leverage to decline in December 2016 as full-year earnings of the acquired business are reflected and counterbalance the debt increase.
Many of the acquired vending machines are situated inside prime office locations and offer various products, including food. This diversifies SBF’s direct sales channel and provides a new opportunity to market its products, although we expect that it will take several years before we see the synergies in earnings.
Although SBF will pay a high earnings multiple of around 16x 2014 EBITDA, excluding synergies, securing prime vending machine sites also locks out other key competitors, such as Kirin Holdings Company Limited (A3 stable) and Asahi Group (unrated). Kirin and Asahi also have substantial vending machine networks and market share is typically attained by painstaking organic growth amid increasingly scarce sites for the machines.
The deal is the latest in a string of debt-funded acquisitions by Japanese beverage titan Suntory Holdings Limited, which acquired US whiskey maker Beam Inc., now Beam Suntory Inc. (Baa2 stable), in mid-2014 for $16 billion. Although Suntory Holdings’ leverage is already high at an adjusted debt/EBITDA of 6.0x as of December 2014, we consider the effect on the holding company’s credit metrics to be manageable, given the amount of additional debt relative to Suntory Holdings’ consolidated debt of nearly ¥2 trillion (about $16 billion) as of December 2014. Nevertheless, additional debt-funded acquisitions by the company at similar earnings multiples would likely add material negative pressure to its credit profile.
Motoki Yanase Vice President - Senior Analyst +81.3.5408.4154 [email protected]
Mirai Kaneuchi Associate Analyst +81.3.5408.4026 [email protected]
NEWS & ANALYSIS Credit implications of current events
9 MOODY’S CREDIT OUTLOOK 1 JUNE 2015
China Travel Service’s Planned Sale of Its Iron and Steel Business Is Credit Positive Last Wednesday, China Travel Service (Holdings) Hong Kong Ltd. (CTS, Baa3 stable) announced that it would sell its 58.49% equity interest in China Guofeng Group Co., Ltd. (unrated), its iron and steel business, to Tangshan Fengnan District Fengnan Town Economic Development Company (unrated), a local state-owned enterprise that holds the remaining 41.51% stake in Guofeng. We estimate the proceeds from the transaction are RMB5.5-RMB6.0 billion.
The proposed transfer is credit positive because we expect CTS’ overall revenue stability to improve, given that the iron and steel business is cyclical and has only a moderate market share in the challenging domestic steel industry. As shown in the exhibit below, CTS’ iron and steel revenue has been volatile and has affected CTS’ overall performance. Although the company sold a similar quantity of iron and steel from 2011 to 2014, revenue was affected by changes in average sale prices as a result of demand in China. Excluding the iron and steel business, CTS’ remaining business revenue is more stable.
Revenue Growth for China Travel Service and Its Iron and Steel Segment The iron and steel segment has driven total firm revenue volatility.
2011 2012 2013 2014
Iron and Steel +18% -20% 0% -8%
All Other +10% +11% +1% -3%
Total +15% -8% +1% -6%
Source: Company information
CTS, whose business is split between travel services, steel, real estate and logistics, plans to use the sale proceeds mainly to invest in its core travel services business, which has a strong market position in China owing to its extensive travel agency network, a track record dating back to 1928 and strong brand recognition in China. CTS benefits from rising demand for leisure travel in China, driven by growing disposable incomes and infrastructure improvements for increased capacity for railways, roads, airports and hotels.
China’s State-Owned Assets Supervision and Administration Commission (SASAC) has approved the proposed transfer in principle. But, the transfer is still subject to completion of all requisite registration and filings; obtaining regulatory and other approvals, permits, consents and waivers; and completion of all listing and bidding procedures related to the transfer of state-owned assets.
The transfer, if it materializes, should increase CTS’ adjusted debt/EBITDA to 7.0x from 6.2x for 2015, and reduce its business diversity and scale. However, these factors will be more than offset by the expected improvement in its revenue stability. By exiting the cyclical iron and steel business and focusing on the less cyclical travel services business, CTS’ revenue will be more stable.
CTS’ iron and steel business is the largest segment in the company’s business portfolio, reporting revenues of RMB23.8 billion in 2014, or about 53% of CTS’ total sales. We estimate that Guofeng’s assets and debt accounted for about 40% of CTS’ total assets of RMB67.5 billion and adjusted debt of RMB22.9 billion at the end of 2014.
Chenyi Lu Vice President - Senior Analyst +852.3758.1353 [email protected]
Tina Xu Associate Analyst +852.3758.1431 [email protected]
NEWS & ANALYSIS Credit implications of current events
10 MOODY’S CREDIT OUTLOOK 1 JUNE 2015
Infrastructure
Korean Government Plan to Boost Korea Railroad Corporation’s Profitability Is Credit Positive Last Wednesday, the Korean government (Aa3 positive) announced an initiative to boost Korea Railroad Corporation’s (Korail, Aa3 positive) profitability over the next three to five years, mainly through efficiency improvements in the company’s loss-making logistics operations and tighter cost controls. The government’s initiative is credit positive for Korail because it will help the national railway operator maintain positive momentum in its operating performance over the next two to three years, following a turnaround in its operating performance in 2014. The company’s unprofitable logistics business has been one of the major drags on Korail’s profitability.
The government plans to streamline Korail’s logistics operations, mainly by consolidating its railway stations for logistics to 80 from 127 and extending the average freight delivery distance between the stations to 38 kilometers from 24 kilometers to improve economies of scale. In addition, the government plans to implement tighter cost controls on Korail through the establishment of individual business divisions under the umbrella of the company.
Assuming successful implementation of the initiative, we expect Korail’s adjusted operating profits to improve to KRW200-KRW250 billion over the next two to three years and more than KRW300 billion starting in 2020, although the company will remain highly leveraged with its funds from operation/debt at 1%-3%, absent material measures to delever. The government aims to reduce Korail’s operating losses from the logistics operations to KRW160 billion by 2017 from around KRW200 billion in 2014 and KRW270 billion in 2013, and turn the operations profitable by 2020.
Korail’s adjusted operating profit increased to KRW138 billion in 2014 from a loss of KRW155 billion in 2013, owing mainly to an increased number of passengers and cost reductions through a curtailment of running frequency for its loss-making railway lines and labor costs.
However, Korail’s loss-making logistics operations caused the company’s profitability to remain weak. Despite last year’s operating-profit improvement, Korail’s EBITDA of KRW619 billion in 2014 was slightly above its adjusted interest expense of KRW583 billion, mainly because of the consistently loss-making operations at its logistics business and its conventional passenger railway operations (see exhibit).
Mic Kang Vice President - Senior Analyst +852.3758.1373 [email protected]
NEWS & ANALYSIS Credit implications of current events
11 MOODY’S CREDIT OUTLOOK 1 JUNE 2015
Korail’s Operating Profits (Losses) by Key Business Segments Korail’s weak profitability stems from logistics as well as conventional passenger railway operations.
Sources: Korea Rail Corporation and Moody’s Investors Service
The government’s initiative for Korail reflects its commitment to support the company’s financial health. We expect that the government will maintain its strong support of Korail over at least the next two to three years, given the company’s strategic importance as an effective monopoly in the country’s railway operation.
The government this year plans to split Korail’s operations into three business divisions: railroad freight, rolling stock management and repair/maintenance and convert the three business divisions into Korail subsidiaries by 2017. Korail itself will continue to operate the majority of Korea’s high-speed and conventional railways for passengers.
We do not expect these changes to weaken Korail’s policy role in the country’s railway operation sector or its strategic importance. The government’s primary objective is to implement tighter cost controls on Korail by allowing the company to understand the areas where it can improve efficiencies and reduce losses, not to privatize Korail’s operations after a spinoff of the business divisions. Korail will also maintain control of the business divisions over at least the next two to three years.
-900 -800 -700 -600 -500 -400 -300 -200 -100 0 100 200 300 400 500 600 700 800
2013
2014
KRW Billion
High-Speed Passenger Railways Conventional Passenger Railways Logistics Metropolitan Railways Airport Railroad
NEWS & ANALYSIS Credit implications of current events
12 MOODY’S CREDIT OUTLOOK 1 JUNE 2015
Banks
Merger of Seattle and Des Moines Federal Home Loan Banks Is Credit Positive On Sunday, we expected the Federal Home Loan Bank of Des Moines (Aaa stable) and the Federal Home Loan Bank of Seattle (Aaa stable) to complete their merger. Post-merger, FHLBank Des Moines will be the continuing bank. The merger is credit positive for FHLBank Des Moines and the Federal Home Loan Banks System, a member-owned national cooperative of 11 regional banks post-merger that each provide a stable source of funding to member financial institutions (primarily banks).
We expect the merger to allow FHLBank Des Moines to take advantage of business opportunities in FHLBank Seattle’s former jurisdiction that were unrealized because regulatory oversight of FHLBank Seattle limited its activities leading up to the merger. Regulatory oversight also restricted FHLBank Seattle’s ability to repurchase capital stock from its members, which has resulted in a large balance of mandatorily redeemable capital stock (MRCS) that is past contractual redemption dates. A significant amount of these outstanding shares of regulatory-restricted MRCS were redeemed pre-merger, a positive development for FHLBank Seattle member banks looking to participate with its FHLBank free of regulatory restriction.
Post-merger, FHLBank Seattle members will have access to an FHLBank without restrictions, which should increase mortgage advances. The advance business is the core of an FHLBank franchise and is key to its financial health because it is a very low risk portfolio whose revenue covers the FHLBank’s costs. The FHLBanks System issues debt, for which all FHLBanks are jointly and severally liable. All FHLBanks have similar business models: each offers member financial institutions advances, manages an investment portfolio and many purchase mortgage loans from member financial institutions, although the mix of these three elements varies by region.
Exhibit 1 summarizes outstanding advance balances for all of the FHLBanks as of 31 March 2015, and then combines FHLBank Des Moines and FHLBank Seattle for illustrative purposes. Combined, the Des Moines and Seattle will have the third-largest advance portfolio in the system, a stronger position than either had on a standalone basis.
EXHIBIT 1
Federal Home Loan Banks Total Advances
Source: Quarterly earnings releases
Exhibit 2 shows advances as a percentage of total assets for all FHLBanks as of 31 March 2015, and then combines Des Moines and Seattle for illustrative purposes. Pre-merger, FHLBank Seattle had the lowest advances-to-assets ratio. On a pro forma basis, the combined Des Moines and Seattle FHLBank ratio of advances to total assets is very close to the median for all FHLBanks.
1Q15 Median $38
$0
$10
$20
$30
$40
$50
$60
$70
$80
$90
Atlanta Boston Chicago Cincinnati Dallas Des Moines Indianapolis New York Pittsburgh SanFrancisco
Seattle Topeka Des Moines+ Seattle
$ Bi
llion
s
3/31/2015 3/31/2014 1Q15 Median
Jason Grohotolski Vice President - Senior Analyst +1.212.553.1067 [email protected]
NEWS & ANALYSIS Credit implications of current events
13 MOODY’S CREDIT OUTLOOK 1 JUNE 2015
EXHIBIT 2
Federal Home Loan Banks Advances/Total Assets
Source: Quarterly earnings releases
Among the FHLBanks, Seattle had one of the largest exposures to private-label residential mortgage-backed securities (RMBS), with balances close to 5% of total assets during 2014. During the first quarter of 2015, FHLBank Seattle sold its private-label RMBS and reinvested the proceeds in higher quality government sponsored enterprise RMBS in preparation for the merger. The sale of the private-label RMBS eliminates future volatility from these securities and improves the overall quality of assets being merged into FHLBank Des Moines.
We expect continued alignment of the regional FHLBanks’ business models and operations over the next couple of years, with consolidation a natural part of that alignment.
1Q15 Median 57%
0%
10%
20%
30%
40%
50%
60%
70%
80%
Atlanta Boston Chicago Cincinnati Dallas Des Moines Indianapolis New York Pittsburgh SanFrancisco
Seattle Topeka Des Moines+ Seattle
3/31/2015 3/31/2014 1Q15 Median
NEWS & ANALYSIS Credit implications of current events
14 MOODY’S CREDIT OUTLOOK 1 JUNE 2015
Kuwait’s Al Ahli Bank Acquires Greece’s Piraeus Bank in Egypt, a Credit Negative On 24 May, Al Ahli Bank of Kuwait K.S.C.P. (ABK, A2 stable, baa32) announced that it would acquire the Egyptian subsidiary of Piraeus Bank S.A. (Caa3/Caa3 negative, caa3), Piraeus Bank Egypt, for $150 million, pending regulatory approvals. The acquisition is credit negative for ABK, which will face increased credit risk from Egypt’s weak operating environment, integration challenges and a dent to its capital over the next 12-18 months. Although the sale will provide Piraeus Bank with marginal incremental capital and liquidity support, the small scale of the support will be insufficient to counter the acutely strained funding and asset quality challenges facing it and its peers in Greece (Caa2 negative).
This is ABK’s first major foray outside the Gulf region. The acquisition provides ABK diversification from the cramped and competitive home market in Kuwait (Aa2 stable), where it holds a 6% market share by assets. However, the deal exposes ABK to the relatively weaker operating environment in Egypt (B3 stable), which has chronically high unemployment, weak governance and remains susceptible to security risks. Other challenges include Piraeus Bank Egypt’s roughly $200 million holding of Egyptian government securities, which equals 11% of ABK’s shareholder equity, according to our estimates. Post-acquisition, Egypt will account for around 10% of ABK’s assets and 7% of its net loans (see exhibit below).
Al Ahli Bank of Kuwait’s Balance Sheet Egypt will account for around 10% of ABK’s consolidated assets post-acquisition.
Sources: Al Ahli Bank of Kuwait and Moody’s Investors Service
ABK’s strong capitalisation helps offset the risks. Although we estimate that the purchase will lower ABK’s capital ratios by two to three percentage points, this will still leave the bank with a solid common equity Tier 1 ratio of around 20% (versus 22.7% at year-end 2014), considerably higher than most regional peers.
Kuwait’s competitive market offers limited opportunities for growth. Domestic credit expanded by 6% in 2014, limited by Kuwait’s non-oil GDP growth, which has lagged that of other Gulf Cooperation Council countries. Diversification of assets and earnings will benefit ABK in the future and the transaction will allow the bank to leverage Egypt’s growth potential and trade links with Kuwait, provided ABK is successful in extracting such benefits.
Piraeus Bank’s sale of its Egyptian subsidiary was part of the restructuring plan the European Commission approved following the bank’s recapitalisation in 2013 through the state-owned Hellenic Financial Stability Fund. According to Piraeus Bank, this sale will increase its pro forma common equity Tier 1 ratio as of 31 2 The bank ratings shown in this report are the bank’s deposit rating, senior unsecured debt rating (where available) and baseline
credit assessment.
$0
$2
$4
$6
$8
$10
$12
$14
Total Assets Net Loans Deposits Equity
$ Bi
llion
s
Al Ahli Bank of Kuwait Piraeus Bank Egypt
Nondas Nicolaides Vice President - Senior Credit Officer +357.25.693.006 [email protected]
Alexios Philippides Analyst +357.25.693.031 [email protected]
NEWS & ANALYSIS Credit implications of current events
15 MOODY’S CREDIT OUTLOOK 1 JUNE 2015
March 2015 by 30 basis points to around 11.9%, and will increase liquidity by around €200 million. However, the transaction and its associated marginal benefits do not significantly improve Piraeus Bank’s credit quality, and the benefits are largely overwhelmed by the current challenges in Greece.
All Greek banks are borrowing heavily from the Bank of Greece’s emergency liquidity assistance and from the European Central Bank to fund their daily operations as deposits flee the system. Piraeus Bank has lost around €11.3 billion of deposits since September 2014, while its dependence on central bank funding surged to €33.2 billion by mid-May, or around 37% of its total assets. In addition, the bank’s first-quarter 2015 loss of around €69 million amid increasing nonperforming loans suggest that its capital base will remain under pressure this year, eliminating the capital benefit from this deal.
Nonetheless, the sale of one of the group’s largest subsidiaries will allow management more time to focus on the bank’s core problems in its home market, including the restructuring of its mounting nonperforming loans, which were 39% of gross loans at the end of March 2015.
NEWS & ANALYSIS Credit implications of current events
16 MOODY’S CREDIT OUTLOOK 1 JUNE 2015
Krung Thai Bank’s Additional Loan-Loss Provisioning Is Credit Negative On 21 May, Krung Thai Bank Public Company Limited (KTB, Baa1 stable, ba13) announced to Thailand’s stock exchange that the bank’s board of directors had approved THB3.6 billion ($107 million) in additional provisioning expenses for bad and doubtful debts. This increase in credit costs is credit negative because it signals that the banks’ asset quality is deteriorating in Thailand’s challenging operating environment and will negatively affect the bank’s profitability.
As the exhibit below shows, pro forma for the additional THB3.6 billion, KTB’s provisioning expense sharply increased in the first quarter of 2015. Additionally, the bank’s annualized credit cost (loan-loss provisions as a percent of gross loans) increased to 94 basis points versus an average of 70 basis points in 2013 and 2014.
Krung Thai Bank’s Loan-Loss Provisioning Expense and Credit Costs
Sources: Moody’s Banking Financial Metrics and Moody’s Investors Service estimates
After weak real GDP growth of 0.7% in 2014, we expect Thailand’s economic conditions to remain challenging, and forecast real GDP growth of 3% this year, versus an average of 4.6% in 2010-13. The slowdown in economic growth has made it more difficult for leveraged households and small and midsize enterprises (SMEs) to service high debt levels. We expect systemwide asset quality to deteriorate further in these segments.
KTB’s asset quality deterioration in the first quarter of 2015 has been much faster than the system average. At the end of March 2015, the bank reported a gross nonperforming loan (NPL) ratio of 3.5%, up from 2.9% at the end of 2014. The systemwide NPL ratio at the end of March 2015 was 2.3%, up from 2.2% at the end of 2014. Given that the most vulnerable segments of retail and SME constituted more than 50% of KTB’s loan book at the end of 2014, we expect the bank to be susceptible to further downside risks that would put further pressure on its credit costs and profitability levels.
3 The ratings shown are KTB’s deposit rating and baseline credit assessment.
0.0%
0.1%
0.2%
0.3%
0.4%
0.5%
0.6%
0.7%
0.8%
0.9%
1.0%
0
1
2
3
4
5
6
7
8
THB
Billi
ons
Loan Loss Provisions - left axis Loan Loss Provisions / Gross Loans - right axis
Alka Anbarasu Vice President - Senior Analyst +65.6398.3712 [email protected]
NEWS & ANALYSIS Credit implications of current events
17 MOODY’S CREDIT OUTLOOK 1 JUNE 2015
Insurers
Higher Taxes Are Credit Negative for Brazilian Insurers On 22 May, Brazil announced that financial institutions’ social contribution tax, a corporate income tax, would increase to 20% from 15% effective 1 September 2015, pending congressional approval. The increase is credit negative for insurers, given its negative earnings pressure and their need to maintain risk-margins to support solvency and capital adequacy.
We estimate that the increased tax burden will reduce insurers’ after-tax earnings by approximately 8% on average and reduce their return on capital by 1.5 percentage points, which will constrain internal capital generation and contribute to weakened capital adequacy and rising operating leverage in 2016 and beyond.
Property and casualty insurers will be challenged to offset the tax increase with higher premium rates for their coverages because some insurers seeking to gain market share over the past years have adopted aggressive pricing strategies and lowered their prices. Life and pension insurers, will also be adversely affected, but generally have more cushion to absorb the tax increase because earnings in the sector are supported by solid operating results and underwriting margins owing to high plan administration fees and management fees, as shown in the exhibit below.
Brazilian Insurers’ Return on Capital in 2014 Property and Casualty Insurers
Life and Pension Insurers
Sources: Brazil’s Superintendência de Seguros Privados and Moody’s Investors Service
Overall, insurers that have managed their risks effectively and have reported strong results – where capital growth exceeds risk in-force growth – will have an advantage in maintaining risk-adjusted capitalization levels over their less efficient competitors.
The ability to maintain capital strength will be challenging for less profitable insurers, further contributing to merger and acquisition activity among those firms already facing pressure from more rigorous solvency standards. Companies with weaker profitability and less capacity to generate capital internally and not affiliated with larger and stronger groups, such as Nobre Seguradora (unrated) and Companhia Mutual de Seguros (unrated), will more likely need to pursue business combinations among themselves.
The increase in the social contribution tax comes as the government intends to combine spending cuts with tax increases to boost revenues. The government last raised the social contribution tax to 15% from 9% in 2008, when Brazil’s economy was also experiencing a slowdown.
25%
15%17%
15%
9%
24%
14%16%
14%
8%
0%
5%
10%
15%
20%
25%
30%
ItaúSeguros
PortoSeguro
Sul América TokioMarine
BradescoAuto/Re
Actual Pro Forma Tax Increase
58%55%
44%
28%24%
54%50%
40%
27%23%
0%
10%
20%
30%
40%
50%
60%
70%
Brasilprev BradescoVida e
Previdência
Caixa Vidae
Previdência
ZurichSantander
Itaú Vida ePrevidência
Actual Pro Forma Tax Increase
Diego Kashiwakura Vice President - Senior Analyst +55.11.3043.7316 [email protected]
Nicole Salum Associate Analyst +55.11.3043.7350 [email protected]
NEWS & ANALYSIS Credit implications of current events
18 MOODY’S CREDIT OUTLOOK 1 JUNE 2015
Sovereigns
Venezuela Rules Out Dollarizing the Economy, Avoiding a Credit Negative Last Tuesday, Venezuela (Caa3 stable) President Nicolas Maduro ruled out dollarizing Venezuela’s economy (i.e., adopting the US dollar as the country’s official national currency) as a means of dealing with its ongoing currency crisis. In a phone call to state television, Mr. Maduro said that the Venezuelan bolivar (VEF) will remain the official currency.
Local economists suggested dollarization as a way to deal with Venezuela’s external liquidity pressures amid low global oil prices. As an oil-producing nation, the decline of oil prices has pushed the economy into a recession, left the government in need of dollar inflows to pay for priority imports and to service debt, and weakened the Venezuelan bolivar. The decision not to dollarize avoids a credit negative development because it would have proven disruptive (the accompanying adjustment would have led to a strong contraction of the economy and a collapse of imports) and would have jeopardized the timely repayment of external debt given a likely shortage of hard currency during the transition.
Embracing dollarization would have practically eliminated the risk of a balance-of-payments crisis, which the ongoing currency crisis threatens to trigger, but the government would have had to curb price controls and subsidies in place throughout the economy to make the system sustainable. However, given the government’s policy stance, adopting such measures would have been highly uncertain.
In addition to the difficult adjustment measures, the central bank would have had to release its international reserves to complete the process, leaving the government without a buffer against potential shortages of hard currency inflows. Given the logistical complexity of making the switch, implementation risks would raise the already high probability of a missed debt payment.
Mr. Maduro’s announcement followed a precipitous slide in the bolivar’s black market, or so-called parallel rate to VEF423 per US dollar on 22 May from VEF300 the previous week, according to DolarToday, a service that tracks the parallel rate along the border with Colombia. Rumors of the possible switch to a dollarized economy were partly responsible for the parallel rate’s 21% two-day decline during 20-22 May. The current rate is back above VEF423 per US dollar, following a decline to VEF343 on 26 May after Mr. Maduro’s announcement (see Exhibit 1).
EXHIBIT 1
Venezuela’s Parallel Exchange Rate Versus the US Dollar The volatility of the parallel exchange illustrates substantial pressure on external finances.
Sources: DolarToday, Central Bank of Venezuela and Moody’s Investors Service
0
50
100
150
200
250
300
350
400
450
Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 Jan-15 Feb-15 Mar-15 Apr-15
VEF
/USD
Jaime Reusche Vice President - Senior Analyst +1.212.553.0358 [email protected]
Anna Snyder Associate Analyst +1.212.553.4037 [email protected]
NEWS & ANALYSIS Credit implications of current events
19 MOODY’S CREDIT OUTLOOK 1 JUNE 2015
The economy’s deterioration since oil prices collapsed has led to three official exchange rates for the bolivar. The three official exchange rates are set at VEF6.3 for the CENCOEX rate used to buy priority imports such as foodstuffs and medicine; VEF12 for the SICAD I rate used by the public sector and government contractors to purchase non-priority imports; and just under VEF199 for the SIMADI rate4 offered as a more flexible rate to all other sectors of the economy.
Following Mr. Maduro’s announcement, local press reported that Nelson Merentes, president of the central bank, will soon meet with members of the banking sector to enact measures to decrease pressure on the exchange rate. Officials also stated that the government is considering consolidating its system of three official exchange rates down to two. Similar measures have been announced over the past year, but none has been implemented.
Although avoiding dollarization averted a logistically complex process that could have resulted in a missed debt payment, pressures on Venezuela’s currency and balance-of-payments remain significant. Total international reserves have fallen steeply in recent months to $17.4 billion as of 27 May (see Exhibit 2), their lowest level since 2003. The country risks running down its external assets to continue covering external obligations, but its ability to avoid a full balance-of-payments crisis through the end of 2016 will depend on a recovery in oil prices.
EXHIBIT 2
Venezuela’s Total Official International Reserves International reserves continue to decrease.
Sources: Central Bank of Venezuela and Moody’s Investors Service
4 CENCOEX = Centro Nacional de Comercio Exterior (National Center for Foreign Commerce); SICAD = Sistema Complementario de
Administración de Divisas (Complementary System of Currency Administration); and SIMADI = Systema Marginal de Divisas (Marginal Currency System). In early February, SIMADI system replaced the SICAD II rate, which traded at around VEF50 per dollar. See Venezuela: New Exchange Rate Mechanism Unlikely to Materially Curb Relative Price Distortions in the Economy, 27 February 2015.
$0
$5
$10
$15
$20
$25
Jan-14 Feb-14Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 Jan-15 Feb-15 Mar-15 Apr-15 May-15
$ Bi
llion
s
NEWS & ANALYSIS Credit implications of current events
20 MOODY’S CREDIT OUTLOOK 1 JUNE 2015
The Bahamas’ Fiscal Consolidation Outperformance Is Credit Positive Last Wednesday, the government of the Bahamas (Baa2 stable) presented its budget for the fiscal year ending 30 June 2016, which showed that the fiscal deficit in fiscal 2015 will be significantly lower than the government had previously forecast. Additionally, authorities now estimate that once the current fiscal year ends in June there will be a primary surplus that will arrest the upward trend in the government’s debt/GDP ratio, a credit positive. Although we forecast that fiscal consolidation will be slightly more moderate than the government’s estimates, the general trend of the fiscal accounts supports our expectation that the deterioration of past years will subside.
The government now expects a deficit of 2.3% of GDP in fiscal 2015, versus its previous estimate of 3.2%, and down from 5.8% in fiscal 2014. Driving the significant reduction in the fiscal deficit was an increase in revenues derived from the implementation of a value added tax (VAT) in January and controlled expenditure growth.
Authorities forecast that VAT revenues in a half fiscal year should total about $150 million; however, during the first three months of 2015, VAT revenues were $110 million, pointing to a likely outperformance of the new tax once fiscal 2015 ends. Consequently, the government expects revenues to rise by 20% from the previous fiscal year. Meanwhile, the government expects expenditures (excluding amortization of debt) to increase 0.7% from a year earlier.
Although we forecast that the deficit will be slightly larger than the government’s estimate (on a nominal basis, we expect the deficit in fiscal 2015 to be $237 million, or $40 million higher than the official forecast), the fiscal deficit trend supports the government’s medium-term fiscal consolidation goals (see Exhibit 1).
EXHIBIT 1
The Bahamas’ Financial Balance and Primary Balance as a Proportion of GDP
Note: Forecasts are not directly comparable owing to different GDP estimates. Sources: The Bahamas Ministry of Finance and Moody’s Investors Service
The large reduction in the fiscal deficit and the potential primary surplus (the difference between revenues and expenditures, excluding interest payments) will help to reverse the increase in the government debt/GDP ratio of recent years. At 65.8% of GDP in calendar 2014, the Bahamas’ ratio greatly exceeded the 40.2% median for Baa-rated sovereigns (see Exhibit 2). We expect a gradual decline in this ratio as relatively subdued economic performance counterbalances the government’s fiscal consolidation efforts.
-4.5%-5.1%
-2.1%
-5.5%
-6.5%-5.8%
-2.3%-1.5%
-0.7%
-2.7%-2.2%
-1.3%
-2.5% -2.7%
0.5%
-3.1%-3.8%
-2.8%
0.6%
1.5%2.1%
-7%
-6%
-5%
-4%
-3%
-2%
-1%
0%
1%
2%
3%
2008/09 2009/10 2010/11 2011/12 2012/13 2013/14 2014/15 2015/16 2016/17
Financial Balance/GDP (Budget Forecasts) Financial Balance/GDP (Moody's Forecasts) Primary Balance/GDP (Budget Forecasts)
Forecasts
Renzo Merino Analyst +1.212.553.0330 [email protected]
NEWS & ANALYSIS Credit implications of current events
21 MOODY’S CREDIT OUTLOOK 1 JUNE 2015
EXHIBIT 2
The Bahamas’ Debt/GDP Ratio Exceeds Baa-Rated Peers, but Trend Reversal Is Positive
Source: Moody’s Investors Service
The Bahamas still faces challenges that will complicate the consolidation process over the next few years. First, economic growth, which averaged 1.1% over the past five years, will likely remain low. As a consequence of the delay of the opening of the $3.5 billion Baha Mar resort further into 2015, we have lowered our growth estimate for this year to 1.7% from 2.0% previously. Once the resort becomes operational, it will likely boost economic output in 2016 (2.5% forecast), but its influence in the years beyond will decrease, leading to a moderation in growth. For this reason, increasing the Bahamas’ competitiveness, particularly on energy generation, will be key to maintaining the economy’s dynamism.
The second important challenge is the implementation of a national health insurance (NHI) program in 2016. Authorities have stated that they will not levy new taxes to fund this program, which will require the reallocation of expenditures to the NHI and could create upward pressure on expenditures.
0%
10%
20%
30%
40%
50%
60%
70%
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015F 2016F
Bahamas Baa Median
NEWS & ANALYSIS Credit implications of current events
22 MOODY’S CREDIT OUTLOOK 1 JUNE 2015
Australia’s Declining Capital Expenditures Signal Growth Challenges Last Thursday, the Australian Bureau of Statistics announced that Australia’s (Aaa stable) capital expenditures had fallen 4.4% in first-quarter 2015 from fourth-quarter 2014. The day before, the Australian Bureau of Statistics released data showing that construction activity had fallen 2.4% during the same period. These numbers and accompanying projections for investment in the coming year signal a decline in investment in Australia despite historically low global and domestic interest rates. Unless the trend reverses, Australia’s growth over the next two years will be lower than the 2.9% average of the past decade. We forecast 2% GDP growth this year.
Lower growth is credit negative for the sovereign because government tax revenues will grow more slowly, impeding efforts to stabilize government debt, which increased to 30.7% of GDP in 2014 from 9.7% in 2008. In addition, lower growth could reduce foreign direct investment inflows, which would either exacerbate lower growth or increase the country’s reliance on more volatile portfolio and debt capital to finance its current account deficit.
The decline in construction activity and capital expenditures stems from a slowdown in commodity-related investments, which helped Australia’s economy rebound from the global financial crisis (see Exhibit 1), but now contribute less to growth as projects are completed and low commodity prices limit new investment.
EXHIBIT 1
Australia’s Private Capital Expenditures and GDP Growth
Sources: Australian Bureau of Statistics, Haver Analytics and Moody’s Investors Service
The end of the commodity-led investment boom is not surprising; what the recent data highlight is that low interest rates have not yet prompted other sectors to replace commodities as a driver of growth. Investment fell by 4.1% in mining, 9.4% in manufacturing and 4.2% in the so-called other selected industries, which includes services.
Lower interest rates did drive up residential construction activity by 4.8%, but this was not enough to offset a 9.8% decline in private-sector engineering activity, which tends to be related to mining investment.
Australia’s GDP growth has exceeded most other high income economies for two decades, and was relatively resilient following the global financial crisis. Nonetheless, average annual growth slowed to 2.5% between 2009 and 2014 from 3.3% in the prior six years. The fiscal effect of this slowdown was a decline in general government revenues to 33% of GDP, on average, during 2009-14 from 36% during 2003-08. A decline in revenue ratios partly explains the shift to an average annual fiscal deficit of 3.9% between 2009 and 2014, from an average fiscal surplus of 1.4% between 2003 and 2008.
0%
1%
2%
3%
4%
5%
0
20
40
60
80
100
120
140
160
180
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
AUD
Bill
ions
Mining - left axis Other - left axis Real GDP Growth - right axis
Atsi Sheth Senior Vice President +65.6398.3727 [email protected]
David Erickson Associate Analyst +65.6398.8334 [email protected]
NEWS & ANALYSIS Credit implications of current events
23 MOODY’S CREDIT OUTLOOK 1 JUNE 2015
A continued slowdown in growth risks further weakening government finances, particularly if it is accompanied by lower corporate profitability. Corporate income tax receipts have already declined to about 18% of revenues in 2014 from around 21% in 2008. Total revenues grew by 25% between 2009 and 2014, helped by indirect and personal income tax receipt growth of more than 30%; corporate income tax receipts rose only 13%.
Lower growth also risks hurting foreign direct investment (FDI). The stock of FDI in Australia increased annually by 8.9% on average between 1996 and 2008, when average real GDP growth was 3.6%. Over the past five years, average annual GDP growth slowed to 2.7% and FDI growth slowed to 6.7%. Lower FDI would increase Australia’s reliance on portfolio and debt flows to finance its current account deficit. These flows have generally been higher than FDI, but can also be more volatile.
On the other hand, subdued growth could lower the current account deficit, limiting the reliance on financial inflows. Australia’s current account deficit declined to an average 3.4% of GDP between 2010 and 2014 from 4.7% between 1996 and 2009. But such a decline in the current account deficit could be an indication of lower domestic consumption and investment, which have been important drivers of GDP growth (see Exhibit 2).
EXHIBIT 2
Australia’s Contributors to GDP Growth
Sources: Australian Bureau of Statistics, Haver Analytics and Moody’s Investors Service
-3%
-2%
-1%
0%
1%
2%
3%
4%
5%
6%
7%
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Private Consumption Private Investment Public Spending Net Exports Real GDP Growth
NEWS & ANALYSIS Credit implications of current events
24 MOODY’S CREDIT OUTLOOK 1 JUNE 2015
Sub-sovereigns
Mexico’s New Efficiency Rule for Water Companies Will Reduce Operating Costs On 21 May, Mexico enacted a new rule to increase the efficiency of municipal pump systems by establishing the maximum level of energy consumption that municipal water companies should use, and ordering water companies that exceed the maximum to replace pump systems. The new rule is credit positive for municipal water systems’ finances because it will reduce electricity charges, which currently account for 37% of water companies’ operating costs. Mexico’s national water commission has financed up to 60% of capital improvements in the water sector, while states have financed 20% and municipalities 11%; the water companies must finance the remaining 9%.5
There are roughly 2,436 water companies in Mexico and they face significant challenges, including weak operating margins and low physical efficiency that averages 57% versus the optimal level of 95%. Some 372 municipal water companies account for 85% of the sector’s overall electricity consumption and provide water services for 90% of Mexico’s population.
One of the biggest components of a water company’s costs is its electricity consumption: it accounts for 37% of variable costs and pump systems drive 94% of total electricity costs. The installation of more efficient pump systems will reduce systemwide electrical operating costs by up to 15% annually beginning September 2015, strengthening operating margins. The purchase of new equipment also will reduce expenditures for parts and repairs of old machinery, which currently constitute 7% of sector expenditures. The exhibit below shows Mexican water companies’ current cost structure and our forecast changes as a result of the new rule.
Mexican Water Companies’ Cost Structure Before and After the New Efficiency Rule Before
After
Source: Moody’s Investors Service, based on Mexico’s national statistics agency data
The rule will require new investments of up to $577 million (MXN8.8 billion) that we expect will be financed by federal government funds, municipal financial aid and in some cases by water company borrowing. However, because most water companies have poor credit quality, it is very likely that municipalities will provide direct financing, and that additional borrowing will increase total Mexican municipal debt by less than 10%.
5 Mexico’s national water commission water and sewer sector report, 2014.
Electricity37%
Salaries20%
Water Rights16%
Chemicals15%
Parts and Repairs7%
Fuel and Lubricants5%
Potential Cost Reduction16%
Electricity22%
Salaries20%
Water Rights16%
Chemicals15%
Parts and Repairs6%
Fuel and Lubricants5%
Francisco Uriostegui Associate Analyst +52.55.1253.5728 [email protected]
NEWS & ANALYSIS Credit implications of current events
25 MOODY’S CREDIT OUTLOOK 1 JUNE 2015
US Public Finance
States Benefit from Increase of Workers Joining Labor Force Last Wednesday, US government employment data showed that average labor force participation rates in 22 states increased in January-April 2015 from the same period a year earlier, double the number of states with increases in January-April 2014. This is the largest number of states with increases in those months since the beginning of 2007. The gains are credit positive for states such as Arkansas (Aa1 stable) and South Carolina (Aaa stable), where workers withdrew from the labor force in large numbers after the Great Recession hit in 2007.
Long-term demographic trends compounded by recession-induced malaise have depressed the share of the adult population working or seeking work in every state. This year’s reversal indicates that economic growth is countering those forces. Growing labor force participation rates in a period of economic expansion show more capacity for spending and income growth that help fuel state revenues. Although many states saw continuing declines in labor participation rates into early 2015, the number of states with year-over-year gains in the first four months of the year has increased every year since 2010. State labor force participation rates in 2014 encompass a wide span, from a low of 53.2% in West Virginia (Aa1 stable) to a high of 72.8% in North Dakota (Aa1 stable).
The best performers in the first four months of 2015 included some of the worst performers in 2007-14, as shown in the exhibit below. For example, Arkansas saw a 6.3-percentage-point slide in labor force participation from 2007, but gained 1.3 percentage points in early 2015. Delaware (Aaa stable), New Mexico (Aaa stable) and South Carolina also switched to the “best” list in 2015 from the “worst” list in 2007-14. In contrast, Texas (Aaa stable) weathered the post-recession period with only a slight decline in labor force participation, reflecting its relatively young population and stronger economic growth. However, weak oil prices placed the state among the 10 worst performers for the first four months of 2015.
Although the deep recession and weak recovery contributed to declining labor force participation rates, the trend predates the recession. The labor force participation rate has been declining from 67% nationwide since 2000 primarily because of the aging and retirement of the baby boom generation. The national rate fell to 62.9% in 2014 from 66% in 2007.
Low labor force participation rates reflect demographic and economic factors that reduce incomes and spending and create a drag on state revenues. The turnaround in the trend is an indicator that the economy has gained enough momentum to offset the effects of demographics in a growing number of states. Greater optimism about job prospects should translate into more spending and sales tax collections. Furthermore, growth in participation rates reveals slack in the labor market and greater potential for economic expansion.
Marcia Van Wagner Vice President - Senior Credit Officer +1 212.553.2952 [email protected]
NEWS & ANALYSIS Credit implications of current events
26 MOODY’S CREDIT OUTLOOK 1 JUNE 2015
Best and Worst US State Labor Force Participation Trends Average Participation 2014 Versus 2007
Average Participation Jan-Apr 2015 Versus Jan-Apr 2014
Percentage Point Change
Average 2014 Participation
Percentage Point Change
Average January-April 2015 Participation
Best Best Texas -0.5 65.2% Louisiana 2.0 61.2%
Louisiana -0.9 60.8% Arkansas 1.3 57.7%
North Dakota -1.3 72.8% Oklahoma 1.1 61.6%
Massachusetts -1.4 65.3% Connecticut 1.0 66.0%
Iowa -1.6 70.4% Massachusetts 1.0 65.7%
Nebraska -1.6 71.3% South Carolina 1.0 58.8%
New York -2 60.7% Delaware 0.7 61.4%
Pennsylvania -2 62.5% Missouri 0.7 65.0%
New Hampshire -2.1 68.7% New Mexico 0.6 57.8%
Missouri -2.1 64.8% Arizona 0.6 60.1%
Worst Worst South Carolina -4.6 58.4% Colorado -0.6 67.2%
Washington -4.9 63.1% Illinois -0.8 63.9%
North Carolina -5.1 60.5% Texas -0.8 64.4%
Delaware -5.2 61.2% Florida -0.9 59.3%
Nevada -5.5 63.1% Virginia -0.9 65.4%
Tennessee -5.5 58.9% Nebraska -0.9 70.3%
Mississippi -5.6 54.4% Alabama -1.1 55.9%
New Mexico -5.6 57.4% Maine -1.5 62.3%
Georgia -6.1 62.0% West Virginia -1.5 51.9%
Arkansas -6.3 56.9% Kentucky -1.6 57.4%
Sources: US Bureau of Labor Statistics and Moody’s Analytics
NEWS & ANALYSIS Credit implications of current events
27 MOODY’S CREDIT OUTLOOK 1 JUNE 2015
Securitization
SEC Disclosure Rule for Due Diligence Reports Enhances US RMBS Transparency Starting 15 June, the US Securities and Exchange Commission’s (SEC) Rule 15Ga-2 takes effect for new residential mortgage-backed securities (RMBS). The rule will provide transparency into the credit quality of mortgage loans underlying transactions.
The rule will require issuers or underwriters of asset-backed securities (ABS) that nationally recognized statistical rating organization rate to publish the findings and conclusions of any third-party review (TPR) firms’ due-diligence reports on loan quality.
The SEC’s Rule 15Ga-2 will improve investors’ ability to assess the risk in the assets that back the transactions. Prior to the rule becoming effective, issuers and underwriters typically kept loan-level TPR findings private and made them available only to rating agencies while providing a summary of the findings to investors. Once the rule becomes effective, in the likely case that the reports are consistent with what issuers previously provided to rating agencies, investors in prime jumbo RMBS will be able to view reports that include:
» Credit reviews that assess the extent to which the loans in the transaction conform to the originator’s lending guidelines
» Property valuation reviews that assess whether information in the loans’ files reasonably support the loans’ appraised values
» Compliance reviews that assess whether the loans were originated in accordance with federal, state and local laws
» Data integrity reviews that assess whether the data provided by the issuer is the same as the information in the loan files
Transactions backed by other types of loans may also be accompanied by other types of reports. For example, TPR reviews for RMBS backed by re-performing loans have typically covered the quality of additional reporting fields, such as borrower pay histories.
Issuers will develop their own formats for summary reports that satisfy Rule 15Ga-2, and the quality of the TPR information will vary across transactions. Over time, these variances should diminish as due diligence reports become more standardized as investors provide feedback to issuers.
Some issuers may remove detail from their reports now that they will be more broadly distributed, in an effort to reduce their potential legal liability. Any such deletions are likely to consist of redundant data or borrower personal information, so the reports should not exclude information that would have helped rating agencies form a credit opinion. Deleted redundant data might include data that are available from loan data tapes, TPR firms’ own internal flags or codes, and data that are available on other reports.
If, however, an issuer makes more material omissions that make it more difficult to assess loan quality, the added uncertainty could mean that the transaction would need more credit enhancement to achieve particular ratings. We would likely decline to rate a transaction if, in an extreme case, we thought that the information an issuer provided was insufficient for us to analyze the loans’ risk.
Lima Ekram Assistant Vice President - Analyst +1.212.553.0335 [email protected]
Peter McNally Vice President - Senior Analyst +1.212.553.3610 [email protected]
Yehudah Forster Vice President - Senior Credit Officer +1.212.553.7995 [email protected]
Navneet Agarwal Managing Director +1.212.553.3674 [email protected]
NEWS & ANALYSIS Credit implications of current events
28 MOODY’S CREDIT OUTLOOK 1 JUNE 2015
Nelnet Student Loan ABS Includes Structural Feature to Mitigate Slow Loan Repayment Nelnet, Inc.’s (Ba1 stable) latest student loan asset-backed securitization (ABS), which closed on Thursday, includes a structural feature that will help mitigate the negative effects of a slow paydown of US government-backed student loans in the securitized pool. The underlying collateral in the ABS deal consists of Federal Family Education Loan Program (FFELP) non-consolidation, consolidation and rehabilitated student loans.
The slow paydown rate of loans issued under the FFELP program is a result of loan repayment trends that began during the financial crisis. More FFELP student loan borrowers are using repayment plans that reduce or defer their monthly payments, at least temporarily, and the percentage of borrowers who are making any extra payments beyond the required amount remains low. Because more borrowers are pushing off their loan payments into the future, the lives of the loans are lengthening. As a result, some outstanding FFELP securitizations are at risk of default because some tranches are not amortizing fast enough to pay off by their final maturity dates. We recently placed several tranches in FFELP ABS on review for downgrade as a result of the risk of default at maturity.6
Nelnet’s new student loan ABS deal, Nelnet Student Loan Trust 2015-3, includes a structural feature that helps address this risk. Before the financial crisis, Nelnet used a similar structural feature in some of its deals, but neither Nelnet nor other FFELP ABS issuers have used it subsequently. The feature accelerates principal payments on the notes, which increases the likelihood that they will pay off by their final legal maturity if the collateral amortizes at a slower rate than initially expected. Transaction terms stipulate that after June 2025 (10 years into the life of the transaction), the deal must use any excess funds to pay principal sequentially to the Class A and Class B noteholders until all notes are paid off, regardless of the over-collateralization level of the transaction. This structure differs from that of a typical FFELP ABS transaction, in which most excess funds are released to the deal sponsor throughout the life of the deal. As a result, in the case of low loan amortization, the Nelnet transaction will pay down faster than will a similar deal without such a structural feature.
The slowdown in FFELP loan repayment comes as many borrowers have enrolled in income-based repayment or other repayment plans that allow them to reduce their monthly payments or waive payments temporarily. Approximately 35% of borrowers in the Nelnet Student Loan Trust 2015-3 are currently enrolled in such repayment plans.
If some outstanding FFELP securitizations were to default because some of the tranches are not amortizing fast enough to pay off by their final maturity dates, final recoveries would likely be high because FFELP loans have a guarantee from the US government for at least 97% of principal and accrued interest. Also, most FFELP securitizations have sufficient cash reserves and other forms of credit enhancement that would protect investors against losses.
6 See Moody's Reviews for Downgrade Several Tranches in FFELP Student Loan Securitizations as a Result of the Risk of Default at
Maturity, 8 April 2015, and Slowdown in Loan Repayment Raises Default Risk for Some Notes Backed by US Government-Guaranteed Student Loans, 16 April 2015.
Barbara Lambotte Associate Managing Director +1.212.553.1094 [email protected]
RATING CHANGES Significant rating actions taken the week ending 29 May 2015
29 MOODY’S CREDIT OUTLOOK 1 JUNE 2015
Corporates
Baxter International Inc. Downgrade 26 Mar ‘15 27 May ‘15
Senior Unsecured Rating A3 Baa2
Short-Term Issuer Rating P-2 P-2
Outlook Review for Downgrade Stable
The downgrade follows the disclosure of the company’s planned capital structure and financial policies after the separation of its biopharmaceutical business into a new public entity, to be named Baxalta, Inc. The rating action thus reflects our view that, post-separation, Baxter will be less diversified with sales concentrated in low-tech, lower-margin medical products.
Charter Communications Inc. Review for Upgrade 30 Oct ‘14 26 May ‘15
Corporate Family Rating Ba3 Ba3
Outlook Stable Review for Upgrade
The review for upgrade follows the announcement that Charter will purchase Time Warner Cable, Inc. for approximately $80 billion. Post close, we expect that Charter will gain leverage with respect to the procurement of content and capital equipment, which should yield a meaningful cost-savings opportunity. The increased scale will also allow for more robust product capability investments, as development costs will now be spread across a much larger subscriber and revenue base.
Dillard’s Inc. Upgrade 19 Mar ‘15 27 May ‘15
Senior Unsecured Rating Ba1 Baa3
Outlook Positive Stable
The upgrade reflects Dillard’s move to an unsecured capital structure and our expectation that the company will maintain a commitment to an investment-grade financial profile. It also reflects our view that Dillard’s operating performance has shown increasing stability as a result of improved merchandising, cost controls, and integration of its online business.
E.I. du Pont de Nemours and Company Downgrade 29 Jan ‘15 28 May ‘15
Senior Unsecured Rating A2 A3
Short-Term Issuer Rating P-1 P-2
Outlook Review for Downgrade Stable
The downgrade reflects the company’s extended period of strained credit metrics, and recognizes that shareholder pressures and operational headwinds are likely to impede a near-to-medium term resurgence in metrics to levels that are commensurate with the A2 ratings.
RATING CHANGES Significant rating actions taken the week ending 29 May 2015
30 MOODY’S CREDIT OUTLOOK 1 JUNE 2015
Time Warner Cable Enterprises LLC Review for Downgrade 24 Apr ‘15 26 May ‘15
Senior Unsecured Rating Baa2 Baa2
Outlook Negative Review for Downgrade
The review for downgrade follows the announcement that Charter will purchase Time Warner Cable, Inc. for $200 per share in a cash-and-stock transaction. The review considers Time Warner’s intention to merge with a lower-rated and more leveraged entity, which given the financing plans that include a significant debt component, will lead to deterioration in the newly combined entity’s balance sheet strength and credit metrics.
RATING CHANGES Significant rating actions taken the week ending 29 May 2015
31 MOODY’S CREDIT OUTLOOK 1 JUNE 2015
Financial Institutions
Multiple Actions Taken on 13 Global Investment Banks 28 May ‘15
We affirmed 12 baseline credit assessments (BCAs) and raised one (Morgan Stanley). We affirmed 12 adjusted BCAs and raised one (Morgan Stanley). We upgraded nine long-term deposit ratings and affirmed four. We upgraded six long-term bank issuer/senior unsecured debt ratings, affirmed four, confirmed two, and left one on review for downgrade (UBS AG). Further, nine of the 13 global investment banks have ratings at the holding company level, among which we upgraded four long-term holding company senior unsecured debt ratings, downgraded four and affirmed one.
In light of the new bank rating methodology, the rating actions reflect the following considerations: the banks’ "Strong" to "Very Strong -" macro profiles; the banks’ adequate core financial ratios; the negative qualitative adjustments made given the groups’ organizational complexity and balance sheet opacity; the protections offered to depositors and senior creditors in the US, EU and Switzerland as assessed by Moody’s Advanced Loss Given Failure analysis, reflecting the benefit of instrument volume and subordination protecting creditors from losses in the event of resolution; and the moderate likelihood of government support for the operating companies of most of these banking groups and the low likelihood of such support for their holding companies.
Multiple Actions Taken on Six Dutch Banks 28 May ‘15
We upgraded the baseline credit assessment (BCA) of one bank, and upgraded four long-term deposit ratings and two long-term senior unsecured debt ratings. We affirmed six BCAs, four long-term deposit ratings and five long-term senior unsecured debt ratings. At the same time, we downgraded the BCA of one bank and downgraded one long-term senior unsecured debt rating.
The rating actions reflect the “Strong +” Macro Profile of the Netherlands; Dutch banks’ generally strong core financial metrics; the protection offered to senior creditors by substantial volumes and subordination of bail-in-able securities, as captured by Moody’s Advanced Loss Given Failure liability analysis; and the reduced likelihood of government support for these institutions.
The actions conclude the reviews we initiated on 17 March 2015 following the publication of our bank rating methodology. They also reflect revisions in our government support assumptions. We have not concluded our reviews on three Dutch banks, which we expect to do by the end of June.
Multiple Actions Taken on Paraguayan and Uruguayan Banks 28 May ‘15
We raised the baseline credit assessments of Itaú Uruguay, BHU and Amambay, as well as the local and foreign currency deposit ratings of Amambay. The rating actions reflect the implementation of our new bank methodology, which highlighted these issuers as being either positive or negative outliers at their previous rating levels. We consider these issuers to be more appropriately positioned at their current revised rating levels.
RATING CHANGES Significant rating actions taken the week ending 29 May 2015
32 MOODY’S CREDIT OUTLOOK 1 JUNE 2015
Multiple Actions Taken on Three Russian Banks 28 May ‘15
We downgraded MDM Bank’s long-term local-currency and foreign-currency deposit ratings to B3 from B2, and its baseline credit assessment (BCA) to b3 from b2. We confirmed Moscow Mortgage Agency’s long-term local-currency and foreign-currency deposit ratings at Ba3, and upgraded its BCA to b1 from b2. We also upgraded Natixis Bank JSC’s long-term local-currency and foreign-currency deposit ratings to Ba2 from Ba3, and its BCA to ba3 from b1.
In light of the new bank rating methodology, the rating actions reflect the "Weak+" macro profile of Russia; the banks’ core financial ratios; affiliate support provided to some of the affected banks by their parents; and our view of the likelihood of government (including regional) support for some institutions.
Banco de la República Oriental del Uruguay Upgrade 17 Dec ‘13 28 May ‘15
Baseline Credit Assessment baa3 baa2
Adjusted Baseline Credit Assessment baa3 baa2
The upgrade reflects Uruguay’s improved macro profile, as well as the bank’s strong liquidity profile, marked by its stable funding and ample liquid resources.
China Life Insurance Co Ltd Upgrade 16 Apr ‘13 29 May ‘15
Insurance Financial Strength A1 Aa3
Outlook Stable Stable
The upgrade reflects the improvement in China Life’s profitability, capitalization and product structure in the past two years. It also reflects our view that the level of government support would be high for China Life in the event of need.
Kapital Bank OJSC Upgrade 17 Mar ‘15 29 May ‘15
Long-Term Local and Foreign Currency Deposit Rating B1 Ba3
Baseline Credit Assessment b2 b1
Outlook Review for Upgrade Stable
The upgrade reflects the bank’s significantly strengthened capitalization and profitability, which provide a sufficient cushion against expected heightening credit losses amid the currently challenging operating environment in Azerbaijan.
RATING CHANGES Significant rating actions taken the week ending 29 May 2015
33 MOODY’S CREDIT OUTLOOK 1 JUNE 2015
Kyongnam Bank Upgrade 30 Jun ‘14 29 May ‘15
Long-Term Deposit Rating A3 A2
Outlook Positive Stable
The upgrade follows the joint announcement on 27 May 2015 by Kyongnam Bank and BNK Financial Group (BNK FG, unrated) that they have successfully completed a share-swap deal. The rating action therefore accounts for the increased importance of Kyongnam Bank to BNK FG, given that it now owns 100% of Kyongnam Bank and the increased expectation of support from its sister bank
Nanyang Commercial Bank Outlook Change 18 Mar ‘15 28 May ‘15
Long-Term Deposit Rating A1 A1
Baseline Credit Assessment baa1 baa1
Adjusted Baseline Credit Assessment a1, Review for Downgrade a2
Outlook Stable Negative
The outlook change follows the announcement by the bank’s indirect parents BOC Hong Kong (Holdings) Limited and Bank of China Limited on the potential sale of the bank to a third-party. The outlook change, therefore, reflects the potential for less affiliate support incorporated into the bank’s rating following its possible sale.
Novo Banco Upgrade 17 Mar ‘15 28 May ‘15
Long-Term Deposit Rating B2 B2
Senior Debt Rating B3 B3
Baseline Credit Assessment ca caa2
Outlook Review Direction Uncertain Review Direction Uncertain
The upgrade reflects the bank’s improved credit fundamentals compared with those of its predecessor Banco Espirito Santo S.A., which stems from the fact that most of the problematic assets remained at BES and that Novo Banco received a capital injection from the Portuguese Resolution Fund of €4.9 billion.
Outlooks for Four Tunisian Banks Revised to Stable 28 May ‘15
We affirmed and changed the outlooks to stable from negative on the deposit ratings of Amen Bank, Arab Tunisian Bank, Banque de Tunisie and Banque Internationale Arabe de Tunisie. The outlook change reflects improvement in the Tunisian government’s capacity to provide support to the banks, if needed. This action is in line with the stable outlook assigned to Tunisia’s Ba3 sovereign rating. It also reflects our expectation that the improvement in Tunisia’s operating environment will help to stabilize existing asset and liquidity risks in the banking system.
RATING CHANGES Significant rating actions taken the week ending 29 May 2015
34 MOODY’S CREDIT OUTLOOK 1 JUNE 2015
ProbusinessBank Outlook Change 30 Oct ‘13 27 May ‘15
Long-Term Local and Foreign Currency Deposit Ratings B3 B3
Baseline Credit Assessment b3 b3
Outlook Stable Negative
The outlook change reflects the heightened risks in the bank’s loan portfolio that have caused a rapid deterioration of the bank’s asset quality and profitability and its weakening capital buffer, which, coupled with substantial net IFRS losses posted in 2014 and insufficient coverage of problem loans by loan loss reserves, reveals overall weak loss-absorption capacity.
Shinhan Bank Upgrade 18 Mar ‘15 26 May ‘15
Long-term Foreign Currency Deposit Ratings A1 Aa3
Senior Unsecured Debt Rating A1 Aa3
Baseline Credit Assessment baa1 a3
Outlook Review for Upgrade Stable
The upgrade follows the publication of our new bank rating methodology. The methodology includes a number of elements that we have developed to help accurately predict bank failures and determine how each creditor class is likely to be treated when a bank fails and enters resolution. In light of the new bank rating methodology, the rating action reflects the "Strong +" macro profile of Korea and the bank’s strong core financial ratios.
RATING CHANGES Significant rating actions taken the week ending 29 May 2015
35 MOODY’S CREDIT OUTLOOK 1 JUNE 2015
Sovereigns Guatemala
Outlook Change
26 May ‘15
Gov Currency Rating Ba1 Ba1
Senior Unsecured Ba1 Ba1
Foreign Currency Deposit Ceiling Ba2 Ba2
Foreign Currency Bond Ceiling Baa3 Baa3
Local Currency Deposit Ceiling Baa1 Baa1
Local Currency Bond Ceiling Baa1 Baa1
Outlook Stable Negative
The outlook change reflects an ongoing political crisis that has rapidly escalated, triggered by corruption scandals that implicate high-ranking government officials and that have led to widespread street demonstrations. The probability that domestic political events could negatively affect macroeconomic stability and government financial strength remains low, but has risen as a result of the heightened uncertainty surrounding the outcome of the political crisis.
Jamaica Upgrade
26 May ‘15
Gov Currency Rating Caa3 Caa2
Senior Unsecured Ba1 Ba1
Foreign Currency Deposit Ceiling Ca/NP Caa3/NP
Foreign Currency Bond Ceiling B3/NP B2/NP
Local Currency Deposit Ceiling Caa3 B1
Local Currency Bond Ceiling Caa3 B1
Outlook Positive Positive
The upgrade reflects the country’s fiscal consolidation and strong commitment to structural reforms, as well as its improving balance-of-payments position and reduced external vulnerabilities. The positive outlook reflects that we expect Jamaica to sustain the reform momentum under its IMF-supported program and solidify fiscal adjustments to put government debt metrics firmly on a downward trajectory.
RATING CHANGES Significant rating actions taken the week ending 29 May 2015
36 MOODY’S CREDIT OUTLOOK 1 JUNE 2015
Tunisia Outlook Change
25 May ‘15
Gov Currency Rating Ba3 Ba3
Foreign Currency Deposit Ceiling B1 B1
Foreign Currency Bond Ceiling Ba1 Ba1
Local Currency Deposit Ceiling Baa3 Baa2
Local Currency Bond Ceiling Baa3 Baa2
Outlook Negative Stable
The outlook change reflects a significant decline in domestic political risk emphasized by the country’s successful democratic transition and installing of a broad unity government; reduced external funding challenges following the resumption of official financing and access to international capital markets; and the gradual reduction in fiscal and external imbalances.
Structured Finance
Actions Taken on $4.5 Billion of Reverse Mortgage Bonds On 27 May, we downgraded 13 securities from 10 deals backed by Home Equity Conversion Mortgages (HECM), and six HECM reverse mortgage backed re-securitization bonds from two deals. In addition, we upgraded the rating of class A-1 issued by Structured Assets Securitization Corporation (SASCO) 2005-RM1 and the rating of class A1 issued by SASCO 2007-RM1. The collateral backing HECM transactions consists primarily of HECM reverse mortgages that benefit from mortgage insurance protection from the Federal Housing Administration, a federal agency in the Department of Housing and Urban Development. The collateral backing SASCO transactions consists primarily of first lien, non-recourse and uninsured reverse mortgage loans. The actions are primarily based on the application of our new methodology "Moody’s Global Approach to Rating Reverse Mortgage Securitizations."
RESEARCH HIGHLIGHTS Notable research published the week ending 29 May 2015
37 MOODY’S CREDIT OUTLOOK 1 JUNE 2015
Corporates
Spanish Corporates: We Expect Modest Growth in Bond Issuance Despite Favourable Market Conditions Historical low interest rates, the reduction in country risk premium and improved macroeconomic trends in Spain will allow Spanish corporates to continue accessing the bond markets at attractive rates in order to diversify funding sources and extend debt maturities. However, with improved access to bank financing, partly driven by quantitative easing by the European Central Bank, corporates do not feel the same pressure to access the bond markets. Limited refinancing needs and low M&A volumes will offset new issuance from first-time issuers.
China Property Focus - May 2015 The May interest rate cut by the People’s Bank of China, alongside recent policy easing measures, is credit positive for property developers. The various supportive macro policies will lower financing costs, improve mortgage availability and support residential property demand as mass-market buyers expect borrowing costs to decline.
Malaysia: Most Rated Entities Will Withstand External and Domestic Challenges Malaysia’s (A3 positive) economy is demonstrating an ability to absorb multiple headwinds such as low commodity prices, currency weakness and contingent liability risks. We expect Malaysia to continue demonstrating macroeconomic resilience – namely, moderating but still positive GDP growth, low inflation rates and a sustained current account surplus – despite an adverse external environment and slower domestic consumption. This situation should ensure a reasonably supportive backdrop for rated issuers.
US Building Products: Stabilizing as Remodeling Index Declines Modestly from Record High Although we expect the US building products sector to remain healthy throughout 2015, the sector’s growth has stabilized, declining from its previously stronger level. Most rated US building products companies benefit from solid end-market fundamentals today, but their high leverage today raises their risk from any rise in benchmark interest rates. While building products companies within the sector will post good operating performance through mid-to-late 2016, their increasingly aggressive financial policies will likely keep their ratings from improving.
Brazilian Sugar- Ethanol Industry: Rainfall Supports Higher Output and Benefits Producers On 22 May, UNICA, Brazil’s sugarcane industry association, announced that it projects a 3.3% growth in the sugarcane volumes crushed in the Center-South region of Brazil in the 2015-16 harvest. The increased output will be supported by a favorable rain regime and is positive news for sugar and ethanol producers amidst low international prices for the sweetener.
Environmental Risks and Developments: Green Bonds Start to Bloom We expect that the nascent green bond market in Europe and the US will become more sophisticated, while developing countries start to explore this source of finance for environmentally friendly projects. Capital market financing needs, combined with rising demand from SRI (sustainable, responsible and impact) investors and the issuance of benchmark-sized deals that are effectively priced, should lift green bond issuance over the next few years.
RESEARCH HIGHLIGHTS Notable research published the week ending 29 May 2015
38 MOODY’S CREDIT OUTLOOK 1 JUNE 2015
Russian Utilities and Infrastructure: Liquidity and Domestic Exposure to Shape Credit Quality We have concluded the bulk of reviews on Russian non-financial corporates, rated Ba3 and above, that we started on 23 December2014. Liquidity was a key rating differentiator among corporates already rated at Ba1 or lower. We have extended our liquidity analysis to three years from the original 18 months for Russian non-financial corporates because in a market where reliable, timely market access cannot be taken for granted even for some of the strongest corporates, resilience to such market access interruptions is a further point of credit differentiation.
European Corporate Finance High-Yield Conference: Investors Expect European High-Yield Bond Volumes to Remain Stable in 2015 Despite recent market volatility, a poll of the attendants of Moody’s 2015 High-Yield Conference in London on 18 May 2015 showed that the majority expect issuance at, or just below, 2014 issuance levels. Conference attendants, mostly investors and bank representatives, listened to a morning of briefings and presentations as well as a panel discussion of issuer, bank, investor and private equity representatives. This report summarizes the main conclusions from the conference.
US Healthcare Reimbursement Roundup: Proposed Medicare Rates for Fiscal 2016 Will Be Mostly Credit Positive Under proposals released by the Centers for Medicare & Medicaid Services, providers of inpatient healthcare and hospice services will see increased Medicare reimbursement rates in fiscal 2016. The proposals will affect acute care hospitals, long-term acute care hospitals, inpatient rehabilitation facilities, inpatient psychiatric facilities, skilled nursing facilities and hospice providers. They will have a slightly different impact on the reimbursement rates paid to each of these subsectors, though they will be mostly credit positive if enacted as proposed.
Moody’s North American Covenant Quality Report: Protection Weakens Across 12 Sectors The covenant quality of high-yield bonds from all but one North American non-financial corporate sector worsened during the year ended 31 March 2015. The average CQ score for the services sector was the only score to improve, strengthening just 0.05 to 3.90. The average score for full-package high-yield bonds weakened by similar amounts during the 12 months ended March this year and the previous period, suggesting that weakening in the overall market has begun to stabilize.
US Gaming Sector Gets Innovation Boost As Nevada Approves Skill-Based Gaming Now that Nevada is on the path to letting its casinos offer skill-based gaming, the potential for other states to follow suit appears to be gaining momentum. While this latest development is a positive next step for the broader industry, the real test will be whether or not a skill-based slot product will be enough to encourage the millennials, generally known as the age group born in or after 1980, to participate in gaming. This demographic is showing less interest to spend their time and income on casino games of pure chance, like slot machines, than previous generations, which is a problem for the future of this industry.
Global Base Metals Industry: Low Prices, Slowing Growth In China Keep Outlook Negative Base metal prices are unlikely to materially improve over the next 12 to 18 months and face downside risks amid an uncertain global economic recovery. The market will remain volatile and sensitive to changes in, and expectations for, economic and global growth rates. The downward price trajectory reflects the market’s response to slowing global economic indicators, particularly in China, which consumes at least 40% of the world’s copper, aluminum, nickel and zinc.
RESEARCH HIGHLIGHTS Notable research published the week ending 29 May 2015
39 MOODY’S CREDIT OUTLOOK 1 JUNE 2015
Latin American Mining: Growing Local Opposition Defies Expansion of Peru’s Mining Industry Southern Copper Corporation’s (SCC, Baa2 stable) decision to shelve its $1.4 billion Tia Maria copper mining project in Peru until at least mid-July 2015 will not damage the mining company’s credit quality, but the move signals the Peruvian mining industry’s increasing wariness of local opposition. Mining projects in Peru, most of which involve copper expansion or greenfield investments in copper, must compete with local communities and municipalities for limited water resources. Stricter environmental rules force mining companies to increase their capital spending on projects, increasingly located in more remote and arid regions that further increases their costs and development times.
Greek Exit from Euro Area Would Be a Political Decision, Not an Unavoidable Consequence of Default Determining the sequence of events that could bring about a Greek exit from the euro area is not straightforward. Our principal conclusion is that the decision to split would be a political act. That decision might reflect a conscious, evolving political strategy by politicians on one or both sides reflecting a positive view of the broader or longer-term benefits of Greek exit. Alternatively, it could reflect the failure of policymakers to reach an agreement even though it is in both sides’ interests to do so.
RESEARCH HIGHLIGHTS Notable research published the week ending 29 May 2015
40 MOODY’S CREDIT OUTLOOK 1 JUNE 2015
Financial Institutions
Global Investment Banks: Key Analytic Considerations in Our Rating Actions on Global Investment Banks The review of 13 rated global investment banking (GIB) groups resulted in upgrades of the long-term bank issuer/senior unsecured debt ratings for six GIB groups, four rating affirmations, and two rating confirmations, with one GIB remaining on review for downgrade. Nine of the GIBs also have long-term senior unsecured debt ratings at the holding company level, of which four were upgraded, four downgraded and one affirmed. The actions reflect the application of loss given failure analysis and revisions in our government support assumptions for these groups.
Korea Banking System Outlook The stable outlook, unchanged since 2010, reflects the expected stable operating environment for Korean banks over the next 12 to 18 months and strong systemic support. But the banks’ asset quality faces tail risks from problematic sectors plagued by overcapacity, although asset quality should be stable relative to 2014.
Malaysia Banking System Outlook The key drivers of the stable outlook are the banks’ strong capital and stable funding levels, and our expectation of a continued high degree of government support. These positive factors offset a moderate deterioration in the banks’ operating environment and profitability profiles.
Islamic Finance: Indonesian Government Roadmap Will Drive Growth and Consolidation of Islamic Banks The Islamic finance roadmap, which is being released incrementally by the Indonesian Financial Services Authority, will provide a platform for further growth of the Islamic banking sector, which even after 33% compound annual growth in the past decade, still constituted only 4.6% of total banking assets in Indonesia as of 2014, compared with a 20%-50% penetration rate in Malaysia and the Gulf countries. We expect the banking sector guidance due in the second half of 2015 will encourage consolidation amongst the smaller Islamic banks and foster the development of a more significant domestic sukuk market, both of which will help address key constraints to future growth.
Australian Banks’ Moves to Curb Residential Investment Lending Are Credit Positive Given growing regulatory and market scrutiny of investment lending, the major Australian banks have taken a number of steps to curb the growth of their residential investment lending portfolios, which will lower their exposures to higher-risk loans. Further initiatives will likely be required in 2015 to bring investment lending in line with regulatory guidelines, as well as to adjust lending criteria and capital levels to respond to rising tail risk in the banks’ housing portfolios.
Malaysia: Most Rated Entities Will Withstand External and Domestic Challenges Malaysia’s (A3 positive) economy has demonstrated its ability to absorb the effects of multiple hurdles, such as low commodity prices, currency weakness and contingent liability risks, which is in turn supporting the credit profiles of the country’s rated entities. We expect Malaysia to maintain its macroeconomic resilience, with moderating but still positive GDP growth, low inflation rates, and a sustained current account surplus, despite an adverse external environment and slower domestic consumption.
RESEARCH HIGHLIGHTS Notable research published the week ending 29 May 2015
41 MOODY’S CREDIT OUTLOOK 1 JUNE 2015
Basel III Liquidity and Funding Requirements Are Credit Positive for Banks Despite Compliance Costs The liquidity coverage ratio and net stable funding ratio in the Basel III capital framework will be positive for banks and their creditors, with retail banks and other largely deposit-funded institutions particularly benefitting. However, other types of banks, especially those primarily wholesale-funded or focused on institutional clients, will find that meeting the stricter standards will create significant costs and could hurt profitability.
Global Banking - Moody’s Quarterly CoCo Monitor: Issuance Slows From Brisk 2014 Global issuance of contingent capital instruments has slowed since January, but will likely recover in the second half of 2015, as banks strive to meet their capital requirements. In addition, 2015 issuance will remain concentrated among the top 10 issuers, even though the issuance base is broadening.
Chile Banking System Outlook The outlook for Chile’s banking system remains stable. We expect Chile’s banks to maintain their sound fundamentals, with moderate economic growth in 2015 and 2016. The system is characterized by healthy asset quality and capital buffers, stable core funding and liquidity, and durable profitability that benefits from diverse earnings sources and strict management of operating and credit costs. Strong sovereign credit fundamentals and a strengthening regulatory framework also support the outlook.
Belarus Banking System Outlook The key drivers of our negative outlook are our expectations for a weakening operating environment amid a recession; further deterioration of asset quality and capital adequacy; low foreign-currency liquidity relative to high levels of foreign currency deposits; and further worsening in profitability. The negative outlook also takes into account the government’s limited and potentially weakening ability to extend support to the banks.
RESEARCH HIGHLIGHTS Notable research published the week ending 29 May 2015
42 MOODY’S CREDIT OUTLOOK 1 JUNE 2015
Sovereigns
Moody’s Sovereign Monitor - New Sovereign Ratings in Sub-Saharan Africa - May 2015 Over the past 18 months, we have assigned three first-time sovereign ratings in Sub-Saharan Africa (Gabon, Côte d’Ivoire and Ethiopia) as well as three first-time supranational institution ratings (the West African Development Bank, GuarantCo and the Africa Finance Corporation). These initial ratings add to the nine first-time ratings assigned in Sub-Saharan Africa in 2012-13. Our expansion of ratings and research activities on African sovereign and supranational issuers (and banking and corporate finance credit) is consistent with the continent’s economic expansion, rising international issuance and increasing investor demand for credit ratings and research.
Spain Analysis Spain’s Baa2 rating and positive outlook reflect the country’s credit strengths as well as the material credit challenges that it faces. Credit strengths include the size and wealth of the economy. The economy is supported by solid medium-term growth prospects, made more sustainable by recent rebalancing. The structural reforms that the authorities have undertaken in recent years, which include actions to strengthen the banking system and reform the country’s inflexible labour market, are also positive for the sovereign’s credit profile.
Malaysia: Most Rated Entities Will Withstand External and Domestic Challenges Malaysia’s (A3 positive) economy is demonstrating an ability to absorb multiple headwinds, such as low commodity prices, currency weakness and contingent liability risks, which is in turn supporting the credit profiles of the country’s rated entities. We expect Malaysia to continue demonstrating macroeconomic resilience — namely, moderating but still positive GDP growth, low inflation rates, and a sustained current account surplus — despite an adverse external environment and slower domestic consumption.
Croatia Analysis Croatia’s Ba1 government bond rating incorporates its economy’s competitiveness challenges and the deterioration in government finances caused by six years of recession. However, the rating also reflects the credit support provided by high per-capita incomes compared with those of similarly rated peers, strong scores on World Bank governance indicators and our expectation that policy efforts to restore macro-economic balance are likely.
Thailand Analysis Thailand’s ratings reflect a very strong government financial position, marked by low funding costs and a favorable debt structure. This core strength in the government’s debt-carrying capacity stems from the sovereign’s pro-active and credible management of debt and monetary policy. In addition, external vulnerabilities are limited by Thailand’s high stock of official foreign exchange reserves.
Sovereigns and Supranationals: Credit Effect of Sovereign Defaulting on Official Sector Debt Recent negotiations between Greece and its official creditors have reignited market concerns that Greece might miss a payment on its obligations to official sector entities. This FAQ summarizes how we would reflect the credit implications of such an event in our sovereign ratings.
RESEARCH HIGHLIGHTS Notable research published the week ending 29 May 2015
43 MOODY’S CREDIT OUTLOOK 1 JUNE 2015
Honduras Analysis The positive outlook on Honduras reflects our expectation that it will continue to make steady progress in 2015 in terms of fiscal consolidation and that the government will continue to comply with targets set in the IMF program. While a positive outlook suggests that, if current conditions are preserved, this may lead to a material reduction in Honduras’ credit risks, the track record is short with only the first IMF review being completed.
Mauritius Analysis Mauritius’s diversified, upper-middle income economy supports its Baa1 rating, despite its small size. The economy has proven resilient to an unfavorable external environment, thanks to its successful attraction of foreign direct investment (in the financial sector, tourism and real estate) and diversification of exports. The authorities’ proactive stance in maintaining Mauritius’s attractiveness, coupled with the stable political environment, has contributed to this success.
Uruguay Analysis Uruguay’s Baa2 sovereign rating is supported by a strong institutional framework that reinforces political and social stability and makes the country an attractive destination for foreign direct investment. Comparatively large fiscal reserves and external buffers, along with a low central government debt burden and very strong liability management practices, also support creditworthiness.
Sub-sovereigns
Spanish Regions: Controlling Costs Is a Challenge for Newly Elected Officials as Economy Normalises New representatives will take office in 13 of Spain’s 171 regions after regional elections on 24 May 2015. Their arrival coincides with an improvement in economic conditions and a consequent increase in revenue generation. We believe the new regional administrations will also reap the benefits of far-reaching structural reforms implemented during the economic crisis. However, they face pressure to increase spending on healthcare, education, capital expenditure and civil service pay, raising the long-term risk of expenditure deviation.
China Sub-Sovereign: Policies Allow Higher Leverage for Local Government Financing Vehicles, a Credit Negative A new policy by China’s (Aa3 stable) National Development and Reform Commission(NDRC) on 27 May relaxes approval guidelines on bond issuance by local government financing vehicles (LGFVs). For a given province, city or county, the new policy raises the cap on total corporate bond issuance, including LGFV bonds, from 8% to 12% of local GDP. For individual projects, it raises the bond-financing component from 60% to 70% of a project’s total cost. The total amount of debt held by LGFVs could increase as a result of this policy.
RESEARCH HIGHLIGHTS Notable research published the week ending 29 May 2015
44 MOODY’S CREDIT OUTLOOK 1 JUNE 2015
US Public Finance
Independent Schools Maintain Strong Revenue Growth in FY 2014 Medians Growing household income and net worth fortify families’ willingness to pay for elite private K-12 education, contributing to a solid median 4.9% increase in net tuition revenue in FY 2014. We expect our rated schools to continue to retain their pricing power, with projected net tuition revenue growth of 3%-5% over the next two fiscal years.
New York School Budget Votes Signal Favorable Sector Trends All but nine of New York State’s nearly 700 school districts successfully passed their fiscal 2016 budgets on the first attempt, a record first-round passage rate since the implementation of the 2% property tax cap. Increased state aid in fiscal 2016 will help mitigate some of the challenges of the tax cap, while declining mandated pension costs will help ease the fixed-cost burden.
Port Transparency Bill Would be a Positive for US Seaports On 12 May, four US senators introduced Senate Bill 1298, which would create a national port performance statistics program. Should S.1298 be passed into law, it would create a detailed standardized data set of historical port performance trends, thereby making it easier to identify and address the effects of operational issues on both the ports themselves and the national economy. If the transparency results in early remediation of operational issues at the ports or force quicker outside intervention, port credit profiles will improve.
Growth in Hospital Revenue Edges Ahead of Expenses in 2014 Not-for-profit hospital operating margins and operating cash flow margins stabilized as the revenue growth rate edged ahead of the expense growth rate, the first time since the fiscal year 2011 medians. Revenue growth was supported by consolidation in the not-for-profit hospital sector and the initial influence of the Affordable Care Act, as benefits of the exchanges and Medicaid expansion were realized.
US Federal Disaster Aid Is Critical for State and Local Governments The credit quality of US state and local governments will continue to significantly rely on federal government aid after a natural disaster. Federal disaster assistance is the only substantial, dependable source for these issuers’ recovery from a catastrophic event. When a disaster occurs, state and local government budgets and borrowing capacities are often not equipped to handle the financial burden of unexpected costs and rebuilding.
Congress Extends Highway Funding, Protecting GARVEE Payments Through End of July Congress’s decision to extend spending authority from the federal Highway Trust Fund (HTF) through July 2015 averts a disruption in the flow of federal funds that support $11 billion of highway and mass transit grant anticipation revenue vehicles (GARVEEs). The extension’s July 31 expiration coincides with what the federal government estimates will be critically low HTF cash balance levels that will trigger delays or reductions of reimbursements to states and transit agencies. To avoid that, Congress needs to both extend the transportation funding authorization again and transfer funds into the HTF to keep it solvent.
RESEARCH HIGHLIGHTS Notable research published the week ending 29 May 2015
45 MOODY’S CREDIT OUTLOOK 1 JUNE 2015
Structured Finance
US Auto ABS: Growth in Longer-Term Loans Poses Risks The increasing number of auto lenders offering loan terms of 84 months raises the risk of higher losses in auto loan asset-backed securities (ABS) transactions. Longer-term loans will incur higher losses in auto loan ABS transactions when compared with shorter-term loans of similar credit quality and from similar lenders, owing to the increased amount of time that the longer-term loan is outstanding and subject to potential borrower default.
European Auto ABS Investors Should Be Aware of Increasing Exposure to Residual Value Risk The practice of securitizing lease products to finance vehicle sales exposes European auto asset-backed securities (ABS) to residual value (RV) risk stemming from the typical auto lease structure. With RV risk, the risk of the lessee’s non-payment is transformed into the market value risk that the proceeds of the vehicle’s sale will be insufficient to repay the outstanding balance. The growth of RV exposure in securitizations reflects originators’ incentives to use leases, rather than loans that do not entail RV exposure, as a financing product.
Japan Auto ABS: Default Rate for Corporate Obligors Declines, but Further Improvement Is Unlikely The decline in the average default rate for corporate obligors is credit positive for Japanese auto loan asset-backed securities (ABS) that have auto loans to corporate obligors as the underlying assets, and these transactions will benefit from the better performance while defaults remain low. The decline primarily reflects the improved business environment for Japan’s small to medium-sized enterprises, which are the main type of corporate obligors in Japanese auto loan ABS, along with stronger credit screening by lenders.
Japan RMBS: High CPR and PDL Mechanism Are Credit Positive for Sequential Pay Structures In Japanese residential mortgage-backed securities deals with a sequential payment structure, a high constant prepayment rate (CPR) and the presence of a principal deficiency ledger (PDL) mechanism accelerate the build-up of credit enhancement, which is credit positive. High CPR results in the faster pay-down of senior classes of notes in a sequential payment structure, while a PDL offsets losses that may result from a deterioration in pool performance and so maintains the subordination amount.
Japan Apartment Loan Securitizations: Credit Effect of High CPR Depends on Waterfall Structure In deals with a sequential pay structure, a high constant prepayment rate (CPR) is credit positive because it accelerates the build-up of credit enhancement for all classes of notes. However, a high CPR can negatively affect securitizations of Japanese apartment loans by reducing the number of obligors in the securitization pool, thereby increasing in turn the level of concentration risk. It will also reduce the amount of excess spread that can be used as future credit enhancement. The build-up of credit enhancement from the high CPR in deals with sequential pay structures mitigates these negative effects and even strengthens the credit of the notes.
RECENTLY IN CREDIT OUTLOOK Select any article below to go to last Monday’s Credit Outlook on moodys.com
46 MOODY’S CREDIT OUTLOOK 1 JUNE 2015
NEWS & ANALYSIS Corporates 2 » CVS Enters a New Market with $12.7 Billion Omnicare Deal, a
Credit Positive
» Computer Sciences' Planned Spinoff of North American Public Sector Business Is Credit Negative
» Argentina Extends Holding Period for Corporate Foreign-Denominated Deposits, a Credit Positive
Infrastructure 5 » Petrobras Secures New Loan, a Credit Positive for
Drillship Transactions
» Kansai Electric Gains Approval for Rate Hike
» Australia Cuts Renewable Energy Target, a Credit Positive for Incumbent Generators
Banks 9 » Six Global Investment Banks Settle with US and UK for
Foreign Exchange Misconduct
» Brazil Raises Banks' Taxes, a Credit Negative
» Sweden's Nordea and Handelsbanken Fall Short on Anti-Money-Laundering Compliance, a Credit Negative
» Nigeria’s New Cash Reserve Regime Benefits Banks with More than 20% Public Deposit Exposure
» Taiwan's Proposed Property Tax Reform Is Credit Positive for Banks
Insurers 18 » FASB's Enhanced Disclosure Requirements on Insurance
Contracts Will Aid Credit Analysis
» Brazil's Insurers Will Benefit from New Law Regulating Motor Vehicle Disassembly
» Westpac's Revised Mortgage Insurance Arrangements Are Credit Negative for Australian Mortgage Insurers
Sovereigns 21 » Dominican Republic's Credit Credit-Positive Macroeconomic
Results Bolster Debt Stabilization
US Public Finance 23 » US State Tax Collections Bounced Back in Fourth-
Quarter 2014
RATINGS & RESEARCH Rating Changes 25
Last week, we downgraded Epicor Software, Centrias Electricas Brasileiras, Algeco Scotsman Global, Algeco Scotsman Global Finance, Qishloq Qurilish Bank, Vostochny Express Bank and Puerto Rico, and upgraded Ancora (OAHS), Ancora (RCH), LGT Bank, 18 US credit card ABS and six US option-ARM RMBS. Additionally, we downgraded and upgraded various obligations of three Chilean banks, three Irish banks, nine Philippine banks, 10 Polish banks, and 12 Swiss banks as a result of implementing our updated rating methodology for banks.
Research Highlights 34
Last week, we reported on Chinese pharmaceuticals, US tobacco, global oil, US chemicals, Carlsberg Breweries and Coca Cola HBC, US oil & gas, US speculative-grade liquidity, Latin American currency risks for sovereigns, corporates and banks; North American paper, packaging and forest product covenants; Canadian retailers, Electricite de France, Tata Power, US unregulated power and project finance, US life insurers, US mortgage insurers, global money market funds, Greek banks, Kazakhstan banks, sub-Saharan African banks, US Federal Home Loan Banks, Japanese regional banks, Australian life insurers, Montenegro, Caribbean sovereigns, North American Development Bank, sub-Saharan sovereigns, Uruguay, European housing associations, South African metropolitan municipalities, US states, US RMBS and Australian auto ABS, among other reports.
MOODYS.COM
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EDITORS PRODUCTION ASSOCIATE News & Analysis: Jay Sherman and Elisa Herr Sol Vivero Ratings & Research: Robert Cox
