MOODYS.COM

17 OCTOBER 2016

NEWS & ANALYSIS Corporates 2 » Coke's Africa Purchase Will Temporarily Increase Leverage » Phillips 66 Partners' Debt Funding of Asset Drop-Down Is

Credit Negative for Parent » Newell's Plan to Repay Debt with Proceeds from Tools Sale Is

Credit Positive » Ericsson's Weak Third-Quarter Results and Market Outlook Are

Credit Negative » Verallia Holding Company's Postponement of PIK Issuance Is

Credit Positive » Gazprom Would Benefit from Turk Stream Pipeline » India Telcos' Spectrum Acquisitions Will Further Stretch

Balance Sheets, a Credit Negative » Alliance Between Toyota and Suzuki Is Credit Positive for Both » Japanese Steel Majors Will See Shrinking Margins with Met

Coal Price Jump » Samsung Electronics' Galaxy Note 7 Production Halt Is

Credit Negative

Infrastructure 14 » Duke Paranapanema Will Benefit from Its Acquisition by China

Three Gorges » Court Ruling Increases Likelihood of Tax Refund for Korea

Railroad Corp, a Credit Positive

Banks 17 » Wells Fargo’s Board Appointments Are Positive, but May Be

Insufficient to Address the Problem » Results at JPMorgan and Wells Fargo Bode Well for Banks with

Oil and Gas Exposures » HSBC Mexico's Capital Injection Is Credit Positive » Citi's Sale of Its Retail Businesses in Brazil and Argentina Is

Credit Positive » Julius Baer's Placement of Additional Tier 1 Securities Is

Credit Positive » Romania's Plan to Convert Swiss Franc Mortgages to Romanian

Lei Is Credit Negative for Banks » Taiwan's Charges against CTBC Financial Holding's Controlling

Shareholder Are Credit Negative

Sovereigns 27 » Côte d'Ivoire to Receive $647 Million in IMF Financing » Audit of Mozambique's State-Owned Enterprises Would Allow

Resumption of International Aid, a Credit Positive

US Public Finance 31 » Illinois to Benefit from Banks Agreeing to Buy and Hold State's

Variable-Rate Debt

RECENTLY IN CREDIT OUTLOOK

» Articles in Last Thursday’s Credit Outlook 33 » Go to Last Thursday’s Credit Outlook

Click here for Weekly Market Outlook, our sister publication containing Moody’s Analytics’ review of market activity, financial predictions, and the dates of upcoming economic releases.

NEWS & ANALYSIS Credit implications of current events

2 MOODY’S CREDIT OUTLOOK 17 OCTOBER 2016

Corporates

Coke’s Africa Purchase Will Temporarily Increase Leverage Last Tuesday, The Coca-Cola Company (Coke, Aa3 stable) said that it plans to purchase Anheuser-Busch InBev SA/NV’s (ABI, A3 stable) stake in Coca-Cola Beverages Africa (CCBA) following the close of ABI’s combination with SABMiller Plc (A3 review for downgrade). The purchase is credit negative for Coke because it will temporarily increase its net leverage to 2.1x-2.2x net debt/EBITDA from approximately 2.0x as of year-end 2015.

However, Coke said that it plans to sell CCBA to another bottling partner shortly after purchasing it. Although it is not clear how long such a sale would take, if Coke sells CCBA to an independent third party, we expect that the event will leave Coke’s leverage unchanged. However, if the re-sale increases leverage at one of Coke’s larger rated bottlers, consolidated system leverage will likely remain elevated.

We expect Coke to fund the CCBA purchase with a portion of its more than $20 billion of overseas cash, so that its gross debt/EBITDA leverage will remain unchanged. The company will negotiate terms of the transaction with ABI according to pre-existing contractual parameters. The deal, which also requires regulatory approval, will likely not close before mid-2017.

We believe other Coca-Cola bottling partners that operate in Africa will be interested in purchasing the CCBA stake from Coke. CCBA is the largest bottler in that market, constituting some 40% of Coca-Cola’s African distribution. We assume Coke will use the proceeds from re-selling the business to replace the international cash it uses to purchase the stake from ABI.

The move is Coke’s latest step to further consolidate the fragmented African bottling system, which we estimate is composed of more than 30 bottlers. Coke believes that consolidation will help improve efficiency and execution in the market, which would be credit positive. In a similar move, over the past decade, Coke consolidated the once-fragmented German bottling system, which it ultimately sold to Coca-Cola European Partners plc (A3 stable).

Atlanta, Georgia-based Coke is the world’s largest manufacturer, marketer and distributor of nonalcoholic beverage concentrates and syrups. It goes to market through a network of bottlers. Our analysis of Coke focuses on the strength of its system as a whole. To do this, we aggregate the financials of the concentrate producer (Coke) with its major rated bottlers. The company has revenues of more than $43 billion on a standalone basis and system revenues of more than $81 billion.

Linda Montag Senior Vice President +1.212.553.1336 linda.montag@moodys.com

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 17 OCTOBER 2016

Phillips 66 Partners’ Debt Funding of Asset Drop-Down Is Credit Negative for Parent Last Tuesday, Phillips 66 Partners (PSXP, Baa3 stable) said it would acquire midstream assets from its parent, Phillips 66 (P66, Baa1 negative) for $1.3 billion, and would fund the majority of the purchase price with $1.1 billion in debt. The proceeds of the drop-down will effectively debt-fund share buybacks at P66.

The effective debt funding of share buybacks is credit negative for P66 amid an industry downturn and a period of high leverage at the Houston-based refining and marketing company. We changed P66’s A3 rating outlook to negative from stable because of the moves, which have no strong credit implications for PSXP.

The move is part of P66’s gradual effort to transfer its midstream and refining logistics operations to PSXP. A staged sequence of drop-downs will fuel PSXP’s commitment to a five-year distribution compound annual growth rate of 30% through 2018.

P66 generates about two-thirds of its proportionately consolidated EBITDA from its refining and marketing and midstream businesses, and much of the rest from its 50% ownership stakes in Chevron Phillips Chemical Company LLC (A2 stable) and DCP Midstream, LLC (Ba2 stable). This diversification eases the strain of its increased leverage.

The drop-downs will eventually place most of P66’s midstream and refining logistics operations under PSXP. The staged drop-downs also imply strong growth prospects for PSXP, and even though future drop-downs will dilute P66’s ownership stake in the MLP, P66 can still expect to share a significant part of PSXP’s cash flow and growth.

Even so, P66’s leverage will weaken sharply as it continues to buy back shares and pay dividends to shareholders in the face of a currently weak refinery market. P66 spent $1.5 billion to buy back shares in 2015, and $623 million in the first half of 2016; the $1.1 billion debt issuance during refinery-market weakness will reduce its adjusted ratio of consolidated retained cash flow to debt to about 15% by the end of 2017, from 33% for the 12 months through 30 June 2016.

P66 will generate about $3.5 billion of consolidated cash from operations in 2017, excluding equity investments, to fund less than $3 billion of capital investments and another $1.4 billion in dividends, producing negative free cash flow of $1-$1.3 billion. The company will likely fund some of the buybacks using cash (including from the proceeds of last week’s $1.1 billion debt issue at PSXP) and we expect that P66’s consolidated debt/EBITDA ratio will rise somewhat from roughly 2.7x at the end of 2016, up from 1.5x in 2015.

P66 has excellent liquidity, with $2.2 billion of cash as of 30 June 2016 and almost full availability under its $5 billion revolving credit facility maturing in October 2021, which is ample to finance about $2 billion of negative free cash flow and share buybacks for the four quarters through June 2017. Still, P66’s consolidated EBITDA from its refining and midstream businesses will drop by some 40% for the full-year 2016 from 2015 levels.

Terry Marshall Senior Vice President +1.416.214.3863 terry.marshall@moodys.com

NEWS & ANALYSIS Credit implications of current events

4 MOODY’S CREDIT OUTLOOK 17 OCTOBER 2016

Newell’s Plan to Repay Debt with Proceeds from Tools Sale Is Credit Positive Last Wednesday, Newell Brands (Baa3 stable) announced plans to sell its tools business to Stanley Black & Decker Inc. (Baa1 stable) for about $2 billion, taking the first major step in its plan to streamline its business after acquiring Jarden Corporation in April. Newell plans to use proceeds to pay down debt, a credit positive because it will reduce the company’s financial leverage and increase its ability to invest in the business. The sale will also allow Newell to dispose of assets that are not strategic, and concentrate instead on core operations.

We estimate that if Newell applies the majority of the sale’s net proceeds to debt repayment, its adjusted debt/EBITDA will decline to a little over 4.0x at the end of 2016, pro forma for the sale, versus our previous expectation of around 4.4x. Management expects to close the transaction in the first half of 2017, subject to certain conditions, including regulatory approvals.

The tools business, which includes the Irwin, Lenox and Hilmor brands, has revenues of about $780 million, and we estimate EBIT of about $80 million. Its sale is part of Newell’s recently announced plan to divest about 10% of its product portfolio and use the majority of the proceeds to pay down debt. The company has a stated goal of decreasing leverage to 3.0x-3.5x debt/EBITDA (about 3.5x-4.0x on a Moody’s-adjusted basis). Newell’s pro forma debt/EBITDA is about 5.0x as of 30 June 2016. We do not expect Newell to make any significant acquisitions or shareholder distributions until it is close to achieving its goal, which we expect will happen sometime in 2017.

In addition to the tools business, Newell expects to sell its winter sports businesses (such as K2 skis), heaters, humidifiers, and fans, and its consumer storage container business. The total revenue of these businesses in 2015, including the tools business, was approximately $1.5 billion. Newell said sales processes for these businesses are underway and it expects to sell them in the first half of 2017.

Headquartered in Atlanta, Georgia, Newell is a global marketer of home and office products. Its brands include Rubbermaid, Sharpie and Dymo, as well as baby and youth products sold under the Graco brand. Earlier this year, it combined with fellow consumer products maker Jarden, which brought it brands including Sunbeam, Mr. Coffee, Yankee Candle and Rawlings, among others.

Kevin Cassidy Vice President - Senior Credit Officer +1.212.553.1676 kevin.cassidy@moodys.com

NEWS & ANALYSIS Credit implications of current events

5 MOODY’S CREDIT OUTLOOK 17 OCTOBER 2016

Ericsson’s Weak Third-Quarter Results and Market Outlook Are Credit Negative Last Wednesday, Telefonaktiebolaget LM Ericsson (Baa2 review for downgrade) reported weak preliminary third-quarter 2016 results that were markedly below our and management’s previous expectations, and reflect an accelerating decline of the company’s sales and earnings. The results are credit negative for Ericsson because they indicate credit metrics weakening to levels outside our quantitative guidance for a Baa1 rating. As a result, we downgraded Ericsson’s ratings to Baa2 from Baa1 and placed them on review for further downgrade.

The company reported that third-quarter revenue fell 14% from a year ago, driven in part by a 19% year-over-year revenue decline (on a reported basis) at Ericsson’s Networks division (see exhibit). Ericsson also reported a drop in its gross margin to a 15-year low of 28% from 34% a year earlier, and quarterly operating income of only SEK300 million, versus SEK5.1 billion a year ago. We expect that the sales and earnings decline will continue into 2017, thereby extending Ericsson’s negative free cash flow generation and cash burn.

Ericsson’s Business Segments Year-over-Year Change in Revenue 2013-16 Revenue declines at Ericsson’s core Networks division are accelerating.

Source: Ericsson

In light of the company’s preliminary third-quarter results, we now expect Ericsson to report a revenue decline in 2016, versus an 8% increase in 2015, with material operating margin compression and negative free cash flow generation for a second consecutive year. The company expects third-quarter negative operating trends to continue over the next two to three quarters, including during its seasonally stronger fourth quarter, which portends further negative credit pressure over the coming year.

The underlying drivers of Ericsson’s revenue and earnings declines in the quarter included continued macroeconomic weakness in key emerging markets such as Brazil, Russia and the Middle East, as well as lower sales in Europe following the completion of multi-year mobile broadband projects such as Vodafone’s Project Spring. These results follow similarly weak results from Ericsson in the first half of 2016. The results come as the industry’s overall growth is waning and entering a cyclical downturn following a wave of 4G coverage rollout projects over the past two years. Consequently, we expect Ericsson’s operating weakness risk limiting its ability to maintain its competitive position over the next two years.

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Networks Global Services Support Solutions Total

Alejandro Núñez Vice President - Senior Analyst +44.20.7772.1389 alejandro.nunez@moodys.com

NEWS & ANALYSIS Credit implications of current events

6 MOODY’S CREDIT OUTLOOK 17 OCTOBER 2016

Verallia Holding Company’s Postponement of PIK Issuance Is Credit Positive Last Monday, Horizon Parent Holdings S.a.r.l. (unrated), a holding company of Horizon Holdings I S.A.S. (Verallia, B1 stable), announced that it had cancelled its plans to issue €500 million of senior secured payment-in-kind (PIK) toggle notes. Proceeds of the PIK issue would have financed a distribution to existing shareholders and paid transaction costs. Calling off the transaction is credit positive for Verallia because, according to our estimates, issuing the notes would have cost the company approximately €39 million in annual cash interest costs, thereby affecting the company’s free cash flow and liquidity.

The PIK toggle issuance would not have affected Verallia’s Moody’s-adjusted debt/EBITDA metrics because Horizon Parent Holdings, as issuer of the now-cancelled PIK notes, would have been located outside of the restricted borrowing group. Cash payments to service the PIK notes would have been made via distributions permitted under existing terms of the company’s senior secured and unsecured facilities.

Verallia’s corporate family rating is weakly positioned in the B1 category owing to the company’s high Moody’s-adjusted debt/EBITDA leverage of around 6.0x as of 30 June 2016. We expect that continued positive trading performance will gradually reduce the company’s leverage over the next 18 months because of improving fixed-cost absorption and operating efficiencies. Paris-based Verallia generated sales of €2.4 billion in 2015.

Suspension of the transaction came after investor pushback over the shareholder-friendly use of proceeds to pay a €490 million distribution to shareholders. We considered the proposed return of capital as another example of the company’s aggressive financial policy following a €230 repayment of share premium in June this year. We view positively that shareholders are retaining a cash equity stake in the business, rather than taking out more than the initial equity that they had put in via a leveraged buyout last year.

Martin Chamberlain Vice President - Senior Analyst +44.20.7772.5213 martin.chamberlain@moodys.com

Simon West Associate Analyst +44.20.7772.5479 simon.west@moodys.com

NEWS & ANALYSIS Credit implications of current events

7 MOODY’S CREDIT OUTLOOK 17 OCTOBER 2016

Gazprom Would Benefit from Turk Stream Pipeline Last Monday, Russia and Turkey signed an intergovernmental agreement to implement the Turk Stream natural gas pipeline project to deliver gas to Turkey and potentially Europe beginning in 2020. This project, which Gazprom, PJSC (Ba1 negative) will implement, is in line with Gazprom’s strategy to diversify its export routes to mitigate transit risks and improve the reliability of gas supplies. Apart from reducing transit exposure to Ukraine after Gazprom’s gas transit contract expires in December 2019, Turk Stream can potentially increase Gazprom’s exports to the growing Turkish gas market and is credit positive.

Turkey’s domestic gas production is insignificant and it relies on imports to cover around 99% of its domestic gas demand. Turkey’s gas imports have almost doubled over the last decade, growing to 48.4 bcm in 2015 from 26.6 bcm in 2005. Gazprom accounted for more than 55% of Turkey’ gas import volumes in 2015 and Turk Stream would allow Gazprom to reinforce its position in this market where Russian gas competes with Iranian, Azerbaijani, Algerian and Nigerian natural and liquefied petroleum gas.

Turk Stream entails construction of two parallel underwater lines in the Black Sea with annual capacity 15.75 billion cubic meters per year (bcmpy) each from Russia to Turkey. Onshore, the first line will connect to a gas pipeline system delivering gas to the Turkish domestic market. The second (transit) line will extend to the border between Turkey and Greece and will be used for Gazprom’s export sales to Europe. Gazprom intends to complete Turk Stream by 2019.

Gazprom will own and finance construction of underwater sections of both pipelines while BOTAS Petroleum Pipeline Corporation, Turkey’s national oil and gas transportation company, will be responsible for the onshore link to the Turkish gas pipeline system. Gazprom will form a 50:50 joint venture with Turkish partners, which will build and operate an extension of the second line to the border between Turkey and Greece, where export delivery would be organised. Gazprom will have full access to this transit line’s capacity and will enter a binding agreement with this joint venture to supply gas. Gazprom will start construction in 2018 with both lines (including their respective onshore extensions) coming into operation by 30 December 2019. Gazprom has the right to cancel construction of the transit line to the Turkey-Greece border.

Turkey is the second-largest off-taker of Russian gas after Germany, with 2015 volumes totalling 27 billion cubic meters (bcm) and accounting for almost 17% of Gazprom’s exports. Gazprom delivers gas to Turkey primarily via the Blue Stream pipeline (16 bcm in 2015) via the Black Sea and the Trans-Balkan pipeline (11 bcm in 2015), which extends across the territories of Ukraine, Moldova, Romania and Bulgaria.

Upon completion, Turk Stream would replace the Trans-Balkan pipeline, reducing Gazprom’s exposure to transit risks via Ukraine. In 2015 Gazprom delivered about 63 bcm of gas to Europe via Ukraine. Turk Stream, reinforced by the Nord Stream-2 pipeline connecting Russia and Germany via the Baltic Sea, with an annual capacity of 55 bcmpy, would allow Gazprom to materially reduce transit volumes via Ukraine by the end of 2019, when its transit agreement with Ukraine expires. Gazprom is in a dispute with Ukraine’s Naftogaz over transit tariffs (which Naftogaz unilaterally increased in January 2016, despite contractually agreed terms effective through the end of 2019) and a number of other gas transit and gas supply contract matters. Ongoing disputes between Russia and Ukraine over gas matters disrupted gas exports to Europe in 2009 for three winter weeks.

Denis Perevezentsev Vice President - Senior Credit Officer +7.495.228.6064 denis.perevezentsev@moodys.com

NEWS & ANALYSIS Credit implications of current events

8 MOODY’S CREDIT OUTLOOK 17 OCTOBER 2016

India Telcos’ Spectrum Acquisitions Will Further Stretch Balance Sheets, a Credit Negative On 7 October, India’s Department of Telecommunications (DoT) announced the provisional results of its spectrum auctions, saying it raised a significant INR658 billion after 31 rounds of bidding. The high spectrum costs, which the buyers will most likely fund with new debt, are credit negative for India’s telecom operators, which are already highly levered. Rising debt following the auction and lower profitability from competition-induced pricing pressure will likely raise leverage throughout the industry.

The high capital outlay comes at a time when competition is intensifying following the September launch of mobile services by new operator Reliance Jio Infocomm Limited (Jio, unrated), a subsidiary of Reliance Industries Limited (local currency: Baa2 positive; foreign currency: Baa2 stable). These spectrum wins will weigh on the buyers’ balance sheets and cash flows by materially raising debt levels for most operators, and consequently reducing their ability to fund further expansion or to absorb the effects of weaker profitability as competition mounts.

As shown in the exhibit below, Vodafone India (unrated), a subsidiary of Vodafone Group plc (Baa1 stable), was the biggest spender, bidding INR202.8 billion, followed by Bharti Airtel Ltd. (Baa3 stable) at INR142.4 billion, Jio at INR136.7 billion, and Idea Cellular (unrated) at INR128.0 billion.

Four Leading Bidders in India’s 2016 Spectrum Auctions Spent INR609.9 Billion

Vodafone India Bharti Reliance Jio Idea Total

Spectrum Cost INR Billions INR202.8 INR142.4 INR136.7 INR128.0 INR609.9

Spectrum Cost $ Billions $3.1 $2.2 $2.1 $2.0 $9.4

Spectrum Won (Mhz) 365.2 173.8 269.2 349.2 1,157.4

800 MHz - - 30.0 - 30.0

1800 MHz 85.2 18.8 79.2 109.2 292.4

2100 MHz 80.0 25.0 - 40.0 145.0

2300 MHz - 130.0 160.0 30.0 320.0

2500 MHz 200.0 - - 170.0 370.0

Note: Exchange rate INR65/$1. Sources: The companies and India’s Department of Telecommunications

Vodafone India acquired the largest amount of spectrum and its spectrum payment was modestly above our expectations, resulting in estimated group leverage, as measured by adjusted debt/EBITDA, of 3.1x-3.4x over the next 12-18 months, versus our previous estimate of 3.0x-3.3x, absent any additional management actions. Although these metrics are weak for its rating category, leaving no headroom for deviation, we expect its leverage metrics to improve gradually because of positive operating performance.

We estimate that Bharti’s leverage will rise to 3.3x-3.4x by March 2017, above our quantitative downward guidance of 3.00x-3.25x. However, we expect the company to reduce debt toward 3.0x over the next six to 12 months through cash flow from operations and proceeds from monetization opportunities, including investments in subsidiaries.

Although Jio’s spending on spectrum will increase Reliance Industries Limited’s consolidated borrowings, the expenditure amount was in line with our expectations.

Annalisa Di Chiara Vice President - Senior Credit Officer +852.3758.1537 annalisa.dichiara@moodys.com

Carole Herve Associate Analyst +852.3758.1505 carole.herve@moodys.com

NEWS & ANALYSIS Credit implications of current events

9 MOODY’S CREDIT OUTLOOK 17 OCTOBER 2016

The auction did not attract bids for the highly expensive 700 megahertz band. This implies that Jio and another leading wireless operator in India, Reliance Communications Limited (Ba3 review for downgrade), which have a spectrum-and infrastructure-sharing agreement, will remain the only players with access to pan-India spectrum in the sub 1 gigahertz band, which is well suited for 4G services in urban centers.

Greater competition, in part spurred by Jio’s launch, is likely to drive tariffs lower, cause average revenues per user to contract, and lower industry revenue and profitability over the next 12-18 months, thereby risking an increase in the companies’ leverage. Additionally, growing demand for 3G/4G data services will continue to drive each company’s spectrum cost recoveries. Even so, the spectrum acquisitions will help the companies maintain their competitive positions, support their strategies on data growth and enhance cash-flow generation. Their high debt burdens may also pave the way for further industry consolidation, which in turn would benefit those companies well positioned in 4G and therefore able to capture growth in data consumption.

NEWS & ANALYSIS Credit implications of current events

10 MOODY’S CREDIT OUTLOOK 17 OCTOBER 2016

Alliance Between Toyota and Suzuki Is Credit Positive for Both Last Wednesday, Toyota Motor Corporation (Aa3 stable) announced that it would explore a potential partnership with Suzuki Motor Corporation (unrated) to develop environmental, safety, and information technologies.

An alliance would be credit positive for Toyota and enable the company to spread its fixed cost over greater unit sales. Increasing global market share would also help Toyota standardize evolving technology in such areas as carbon reduction, safety and auto-drive, and capture a leadership position in these areas.

In addition, the partnership potentially allows Toyota to leverage Suzuki’s strength in the mini car segment, in which Suzuki holds a 30% share in Japan. However, Toyota would risk cannibalizing the small-car market share of its fully consolidated subsidiary, Daihatsu Motor Co., Ltd. (unrated), which focuses on the small-car segment. The collaboration between Toyota and Suzuki is also likely to help Toyota leverage Suzuki’s solid 40% share of the overall vehicle market in India.

The alliance would allow Suzuki to leverage Toyota’s technology on hybrid vehicles and its initiative on artificial intelligence technologies. Suzuki’s total sales are only about 10% of Toyota’s total sales in the latest fiscal year. For the 2015 fiscal year that ended 31 March 2016, Toyota sold 10.09 million units globally and Suzuki sold 2.86 million units.

Toyota has been a pioneer in hybrid technology, introducing hybrid vehicles to customers in 1997. Toyota sold 1.2 million hybrid cars in 2015, accounting for 12% of its total unit sales. Toyota also established Toyota Research Institute, Inc., a wholly owned subsidiary, in January to invest $1 billion in artificial intelligence over the next five years.

In the competitive global automotive market, with expanding areas such as alternative-fuel vehicles and artificial intelligence that require investment, it is increasingly important to increase investment efficiency and to lead the market in technology. The rising importance of new engines and information technology for vehicles has prompted new entrants such as Google Inc (unrated), an operating company of Alphabet Inc. (Aa3 stable), and Tesla Motors Inc. (unrated) to enter an already-crowded market.

For fiscal 2016, Toyota will be increasing its R&D expenses and capex to maintain a competitive edge, despite the company expecting a decline in profit mainly from exchange rate fluctuations over the same period (see exhibit).

Toyota’s R&D Expenses and Capex Have Continued to Increase

Source: Company disclosures

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Motoki Yanase Vice President - Senior Analyst +81.3.5408.4154 motoki.yanase@moodys.com

Yukiko Asanuma Associate Analyst +81.3.5408.4215 yukiko.asanuma@moodys.com

NEWS & ANALYSIS Credit implications of current events

11 MOODY’S CREDIT OUTLOOK 17 OCTOBER 2016

Despite some past unsuccessful business alliances, such as that of DaimlerChrysler AG, stiffer competition in the global automotive industry is likely to prompt further collaborations to use limited resources more efficiently.

NEWS & ANALYSIS Credit implications of current events

12 MOODY’S CREDIT OUTLOOK 17 OCTOBER 2016

Japanese Steel Majors Will See Shrinking Margins with Met Coal Price Jump Last Thursday, the Nikkei news reported that Nippon Steel & Sumitomo Metal Corporation (NSSM, Baa1 negative) agreed to pay Peabody Energy Corporation (unrated) $200 per tonne for met coal for the October-December 2016 quarter, about 120% higher than the previous quarter.

This significant jump in the met coal price to its highest price in four years (see exhibit) is credit negative for all Japanese steel majors including NSSM and JFE Holdings, Inc. (Baa2 negative). The increased prices will pressure their margins, unless they successfully transfer the increase to their customers.

Met Coal Quarterly Contracted Price per Tonne

Sources: JFE Holdings and Moody’s Investors Service estimates

Although NSSM and JFE are aiming to raise selling prices more than ¥10,000 (around $96) per tonne, they are finding it difficult to transfer any of the increased costs to customers on a timely basis. Difficult steel market conditions with sluggish demand for steel and its overproduction in China have delayed a recovery in the supply-demand balance in Japan’s domestic and export markets. For the April-June 2016 quarter, NSSM’s average selling price per tonne was ¥68,100, and JFE’s was ¥58,500, prices that were around 20% lower than the year before.

Met coal prices have risen significantly in the spot market since July 2016. The rise reflects supply concerns after the Chinese government’s announced reduction in met coal output capacity, as well as weather-related problems in China and mining operations problems in Australia.

The quarterly fixed prices (as opposed to spot prices) help the majors mitigate risks associated with volatile raw material costs. However, the market’s consolidation by major suppliers as well as the increasing presence of Chinese steel manufacturers as spot buyers weakens the Japanese steel majors’ buying power. In fact, since 2010, Japanese steel majors have generally procured met coal from major resource companies based on quarterly price contracts, whereas before 2010, Japanese steel majors and resources companies negotiated annual price contracts. A further transfer of price risks from coal suppliers to the steel majors through, for instance, the shortening of contract durations or a move toward spot prices would be credit negative for the Japanese steel majors.

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Takashi Akimoto Assistant Vice President - Analyst +81.3.5408.4208 takashi.akimoto@moodys.com

Kenichiro Sano Associate Analyst +81.3.5408.4157 kenichiro.sano@moodys.com

NEWS & ANALYSIS Credit implications of current events

13 MOODY’S CREDIT OUTLOOK 17 OCTOBER 2016

Samsung Electronics’ Galaxy Note 7 Production Halt Is Credit Negative Last Tuesday, Samsung Electronics Co. Ltd. (A1 stable) announced that it would cease production and was recalling its latest smartphone, the Galaxy Note 7, because of faulty batteries that were causing handsets to burst into flames. The production halt and associated product recall are credit negative, but we expect Samsung’s strong financial profile to continue to support its A1 rating and stable outlook.

Samsung launched the Galaxy Note 7 in mid-August and announced a recall in September after having shipped more than 2.5 million units to more than 10 countries. Samsung decided to halt production and recall all of the phones following reports that replacement units had similar flaws.

We expect that the cash costs of the production halt and recall will exceed our original estimate of KRW1.0-KRW1.5 trillion ($900 million-$1.4 billion) when the product recall started in September. Samsung has announced that expected operating profit for third-quarter 2016 would be about KRW5.2 trillion ($4.7 billion), down from its previous forecast of KRW7.8 trillion ($7.1 billion). The company added that the discontinuation of Galaxy Note 7 sales would reduce operating profit by approximately KRW3.5 trillion ($3.2 billion) between fourth-quarter 2016 and first-quarter 2017.

Still, the cash costs of the production halt and recall are manageable given the company’s substantial liquid holdings and cash flow. At 30 June 2016, Samsung had liquidity holdings of around KRW77.1 trillion ($70 billion), while for the 12 months that ended June 2016, adjusted free cash flow was KRW21.3 trillion ($19 billion) and total debt was only KRW12.2 trillion ($11 billion).

Samsung’s Adjusted Revenue, Funds from Operations and Free Cash Flow

Source: Moody’s Financial Metrics

However, the production halt and recall is likely to reverse improving profitability at Samsung’s IT and mobile communications (IM) segment, which accounted for about 55% of total operating profit in first-half 2016. Since the introduction of the Galaxy 7 line of products this year, reported operating margins in the IM segment have improved to more than 16% as of second-quarter 2016 from about 10% in 2015. That level of improvement now appears unsustainable.

Although Samsung had been using its advantage in hardware technology to take market share from Apple Inc. (Aa1 stable), the initial recall, followed by the production halt, threaten to have a more lasting negative effect on the Samsung brand and require significant marketing expense to regain consumer confidence.

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Joe Morrison, CFA Vice President - Senior Credit Officer +852.3758.1376 joe.morrison@moodys.com

Chris Wong, CFA Associate Analyst +852.3758.1531 chris.wong@moodys.com

NEWS & ANALYSIS Credit implications of current events

14 MOODY’S CREDIT OUTLOOK 17 OCTOBER 2016

Infrastructure

Duke Paranapanema Will Benefit from Its Acquisition by China Three Gorges On 10 October, Duke Energy Corporation (Baa1 negative) announced that it reached an agreement to sell its operations in Brazil through the disposal of Duke Energy International Geraçao Paranapanema S.A. (Duke Paranapanema, Ba2 negative) to China Three Gorges Corporation (CTG, Aa3 negative) for an enterprise value of $1.2 billion. The amount is around 4.5x EBITDA based on Duke Paranapanema’s EBITDA for the 12 months that ended 30 June 2016. The transaction is credit positive for Duke Paranapanema and is subject to regulatory approvals in Brazil and China.

Duke Paranapanema would benefit from CTG’s solid experience in large scale hydroprojects (CTG is the world’s largest hydropower operator). With the acquisition of Duke Paranapanema, CTG would become the second-largest hydropower operator in Brazil with an installed capacity of 8.27 GW, which is almost 6% of the country’s installed capacity.

Duke Paranapanema would also benefit from CTG’s ample and lower-cost funding sources. CTG did not disclose its financing for the acquisition but we believe that it could refinance the company’s capital structure under better conditions if it so chooses. A lower interest burden would help Duke Paranapanema improve its funds from operations interest-coverage metrics, which for the 12 months that ended in June 2016, was 4.5x, compared with 6.4x for CTG. Most of Duke Paranapanema’s debentures are callable upon premium payment.

CTG’s credit quality will not be affected by the sale, given that the acquisition is equivalent to less than 1.5% of the group’s assets. We expect that CTG will partially debt fund the acquisition, letting the operating cash flows from the acquired assets offset the incremental debt-service. The deal leverages CTG’s expertise in hydropower and strengthens its growing presence in Latin America.

The deal is consistent with CTG’s strategy to expand in renewable energy overseas and follows recent acquisitions in the hydropower sector. CTG has been invested in Brazil since 2011, when it purchased a 21.35% stake in EDP - Energias de Portugal, S.A. (Baa3 stable). More recently in January 2016, CTG added almost 5 GW of installed capacity to its operations in Brazil with the hydroelectric power plants of Jupiá and Ilha Solteira operated under a 30-year concession that it won at an auction in November 2015 for BRL13.8 billion ($3.7 billion).

Duke Paranapanema is an electricity generation company and subsidiary of Duke Energy Corporation, which indirectly holds 99.06% of its voting capital and 95.06% of its total capital. Duke Paranapanema has installed capacity of 2,274 MW (1,125MW of physical energy) in eight hydroelectric power plants along the Paranapanema River and accounts for approximately 1.5% of Brazil’s current total installed capacity. In the 12 months that ended 30 June 2016, Duke Paranapanema reported net revenues of BRL1.2 billion ($348 million) and net profit of BRL295 million ($80 million).

China Three Gorges Corporation is a wholly state-owned enterprise directly under the purview of China’s State-owned Assets Supervision and Administration Commission of the State Council. CTG was set up in 1993 as the owner and operator of the Three Gorges Project — along the Yangtze River — the largest hydroelectric project globally by total installed capacity. At year-end 2015, CTG had a total hydropower installed capacity of around 60GW and another 28GW planned or under construction until 2021. The company also had an installed capacity of 6GW for wind and solar power.

Paco Debonnaire Analyst +55.11.3043.7341 paco.debonnaire@moodys.com

Ada Li Vice President - Senior Analyst +852.375.816.06 ada.li@moodys.com

NEWS & ANALYSIS Credit implications of current events

15 MOODY’S CREDIT OUTLOOK 17 OCTOBER 2016

Court Ruling Increases Likelihood of Tax Refund for Korea Railroad Corp, a Credit Positive Last Thursday, Korea’s Daejeon High Court ruled that Korea Railroad Corporation’s (Korail, Aa2 stable) request for a cash tax refund for cancelled land sales to the now bankrupt Dream Hub Project Financial Investment Co. Ltd (unrated), a real estate development project, is legitimate. This ruling is credit positive for Korail because it increases the likelihood of a cash tax refund, which will likely be used to reduce the railway operator’s debt and improve its capital base.

Korail estimates that it will receive a cash tax refund of KRW900-KRW950 billion from the National Tax Service (NTS), which includes the already paid income tax, local tax and interest, if the NTS does not seek a final appeal at the Supreme Court of Korea. The likelihood of a cash tax refund to Korail is high, even if the NTS decides to launch a final appeal, given that the latest judgment was the second favorable court decision for the company on the same case after Daejeon District Court’s similar judgment in January 2015.

The potential tax refund accounts for 7.5%-8.0% of Korail’s adjusted gross debt at year-end 2015 and we believe it will allow Korail to reduce its debt leverage. In this situation, we expect Korail’s ratio of funds from operations (FFO) to debt will improve to 2.0%-2.5% over the next 12-18 months compared with our initial forecast of 1.5%-2.0%. Korail’s debt-to-capitalization ratio will likely decline to 71%-73%, from our initial forecast of 76%-79% during the same period (see exhibit) because one-off profits from the potential tax refund will help Korail improve its capital base.

Effect of Potential Tax Refund on Korail’s Key Credit Metrics

Note: Funds from operations excludes one-off items, such as tax refunds, from 2013 to the forecasted 2017-18. Sources: Moody’s Financial Metrics and Moody’s Investors Service forecast

The potential tax refund will help Korail improve its liquidity because, together with operating cash inflows, it will likely cover most of the railway operator’s capital expenditure and maturing debt for 2017. Korail’s access to debt capital markets will also remain strong on the back of its 100% government ownership and its status as a government-related issuer with an important policy role for Korea’s railway sector.

Korail filed a lawsuit against the NTS in May 2014 because it rejected the company’s request to reassess income taxes of around KRW700 billion, which were paid in 2008-11 on the gains from its progressive land sales to Dream Hub Project for a total of KRW8 trillion between 2007 and 2011. Korail was supposed to receive cash proceeds from the sales as the project progressed. However, the project went bankrupt in 2013 without any major development amid weakness in Korea’s real estate market. As a result of the bankruptcy, the land sales were cancelled and Korail recognized write-off losses of KRW4.7 trillion in 2013 and 2014 associated with the land sales and wrote off its equity investments of KRW250 billion in the project in 2013.

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FFO/Debt - left axis Pro Forma Tax Refund - left axisDebt/Capitalization - right-axis Pro Forma Tax Refund - right axis

Mic Kang Vice President - Senior Analyst +852.3758.1373 mic.kang@moodys.com

Sean Hwang Associate Analyst +852.3758.1587 sean.hwang@moodys.com

NEWS & ANALYSIS Credit implications of current events

16 MOODY’S CREDIT OUTLOOK 17 OCTOBER 2016

Dream Hub Project was a special purpose vehicle established in 2007 to develop the Yongsan railway station in Seoul. Korail was the single largest shareholder, while SH Corp (unrated), a property developer wholly owned by Seoul Metropolitan Government (unrated), held a 5% stake. Private shareholders owned the remaining 70%.

NEWS & ANALYSIS Credit implications of current events

17 MOODY’S CREDIT OUTLOOK 17 OCTOBER 2016

Banks

Wells Fargo’s Board Appointments Are Positive, but May Be Insufficient to Address the Problem Last Wednesday, Wells Fargo & Company (A2 stable) announced the immediate retirement of its Chairman and CEO John Stumpf and appointed long-time company veteran Tim Sloan as its new CEO. The board also named lead director Stephen Sanger as its new non-executive chairman and appointed independent director Elizabeth Duke to the board’s newly created role of vice chair.

The appointment of an independent non-executive chairman and designation of an independent non-executive vice chair have the potential to strengthen board independence and management accountability and are a credit-positive response to the sales-practice wrongdoings that were exposed last month.1 However, the long tenures of both the incoming chairman and the CEO raise the immediate question of whether both are sufficiently distanced from the wrongdoing, particularly since the board’s independent investigation into the bank’s retail sales practices is not yet complete.2

Following Mr. Stumpf’s abrupt retirement, the board essentially accelerated a CEO succession plan that was already in place following its decision to elect Mr. Sloan as president and chief operating officer in November 2015, which the board characterized as part of its oversight of management succession planning.

The promotion of a CEO with significant Wells Fargo experience suggests limited change to the company’s strategy beyond fixing the sales practices, incentives, and controls that undermined its retail banking business model. Additionally, since the extent of Mr. Sloan’s distance from the wrongdoing is not clear, his appointment may not go far enough to appease certain stakeholders, including politicians and regulators, who have been particularly vocal in airing their displeasure. The same applies to Mr. Sanger, who has been on Wells Fargo’s board for 13 years and has served as its lead director since 2012.

In the US, the role of independent chairman is rare among large banks. Following the announcement, of the 10 largest US banks by total assets, only Wells Fargo and Citigroup now have independent non-executive chairmen. The others combine the roles in a single individual and designate an independent lead director, as is common practice among large US public companies.

There are good arguments both for and against splitting the roles; our view in this instance and in general is that the presence of an independent chair or independent lead director with substantive responsibilities improves board effectiveness.3

Given Ms. Duke’s background as a former member of the Federal Reserve Board of Governors (Fed) from August 2008 to August 2013, we believe she has a good understanding of governance best practices, particularly since she was a member of the Fed’s Committee on Bank Supervision and Regulation and its Committee on Board Affairs. Also, since she only joined the board in January 2015, she is comparatively distanced from the uncovered deficiencies than the vast majority of Wells Fargo’s other board members.

1 See Deficiencies in Wells Fargo’s Consumer Banking Sales Practices Are Credit Negative, 12 September 2016. 2 See Wells Fargo’s Board Takes First Step to Repair the Bank’s Reputation, a Credit Positive, 3 October 2016. 3 See Board Leadership: A Positive View on Non-Executive Chairs and Lead Directors, August 2006.

Allen Tischler Senior Vice President +1.212.553.4541 allen.tischler@moodys.com

Christian Plath Vice President – Senior Credit Officer +1.212.553.7182 christian.plath@moodys.com

NEWS & ANALYSIS Credit implications of current events

18 MOODY’S CREDIT OUTLOOK 17 OCTOBER 2016

In our view, the best practice following a crisis of this magnitude often dictates naming an independent outsider with no connection to the bank as chairman or CEO. Indeed, an outsider’s perspective would go further to signal a sharp break from the past and potentially allow for greater freedom to implement changes. Naming an outsider as chairman could also help the board address its own oversight shortcomings. The results of the board’s investigation, which we think will continue for several months, will likely determine next steps.

NEWS & ANALYSIS Credit implications of current events

19 MOODY’S CREDIT OUTLOOK 17 OCTOBER 2016

Results at JPMorgan and Wells Fargo Bode Well for Banks with Oil and Gas Exposures On Friday, JPMorgan Chase & Co. (A3 stable) and Wells Fargo & Company (A2 stable) released their third-quarter earnings results, which showed improving trends in their oil and gas portfolios. This is credit positive for energy-concentrated banks’ third-quarter earnings because lower energy credit costs will boost profitability, which has been hampered in recent quarters by outsize loan-loss provisions against banks’ energy exposures.

JPMorgan reported a negative provision of $121 million, which was driven by a release in loan-loss reserves allocated for oil and gas exposure in its US commercial bank footprint, a market where regional banks compete. Offsetting this against the $67 million provision for oil and gas exposure in its corporate and investment bank, JPMorgan reported a net benefit of $54 million in reserve releases related to improvements in its oil and gas exposure. On its earning call, management attributed this to pay downs, opportunistic loan sales and select upgrades stemming from better access to capital markets for energy borrowers.

Wells Fargo reported that energy net charge-offs in the third quarter declined by more than one third from the second quarter. It also reported declines in nonaccrual loans and criticized loans in the energy portfolio from the second quarter, which management attributed to improving industry conditions. Additionally, the bank reported a reserve release in its wholesale banking segment, but did not indicate the role that the energy-sector improvement played in that release.

These results bode well for most energy-concentrated banks’ third-quarter earnings, which will be released in the coming weeks. Exhibit 1 shows the rated US banks with the highest energy-lending concentrations, as measured by outstanding energy loans to tangible common equity as of 30 June 2016. As Exhibit 1 shows, the most exposed banks are BOK Financial Corporation (A3 stable), Hancock Holding Company (Baa3 stable), Cullen/Frost Bankers, Inc. (A3 stable), Texas Capital Bancshares, Inc. (Baa3 negative), BBVA Compass Bancshares, Inc. (Baa3 stable), Comerica Incorporated (A3 negative) and Zions Bancorporation ((P)Ba1 no outlook).

EXHIBIT 1

US Regional Banks with the Largest Energy Concentrations, 30 June 2016

Key: BOKF = BOK Financial Corporation; HBHC = Hancock Holding Company: CFR = Cullen/Frost Bankers, Inc.; TCBI = Texas Capital Bancshares, Inc.; BBVA Compass = BBVA Compass Bancshares, Inc.; CMA = Comerica Incorporated; ZION = Zions Bancorporation. Sources: The banks and Moody’s Banking Financial Metrics

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Megan Snyder Analyst +1.212.553.4986 megan.snyder@moodys.com

NEWS & ANALYSIS Credit implications of current events

20 MOODY’S CREDIT OUTLOOK 17 OCTOBER 2016

Exhibit 2 shows the effect that loan-loss provisions have had on profitability for the most energy-concentrated banks since the prolonged oil price slump began. In 2014, provisions were quite low, which helped boost banks’ profitability. The stress in the energy sector has led to outsize energy provisions for the most concentrated banks, reducing net income. Lower third-quarter provisions because of improving credit conditions in the energy sector will bolster energy-concentrated banks’ earnings, provided that credit quality in their non-energy portfolios remains benign.

EXHIBIT 2

Energy-Concentrated US Banks’ Loan-Loss Provisions as a Percent of Pre-Provision Income and Return on Average Assets, 2015 to Second-Quarter 2016

Key: BOKF = BOK Financial Corporation; HBHC = Hancock Holding Company: CFR = Cullen/Frost Bankers, Inc.; TCBI = Texas Capital Bancshares, Inc.; BBVA Compass = BBVA Compass Bancshares, Inc.; CMA = Comerica Incorporated; ZION = Zions Bancorporation. Sources: Moody’s Banking Financial Metrics

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BOKF HBHC CFR TCBI BBVA Compass CMA ZION

Loan Loss Provisions/Pre Provision Income - right axis Return on Average Assets - left axis

NEWS & ANALYSIS Credit implications of current events

21 MOODY’S CREDIT OUTLOOK 17 OCTOBER 2016

HSBC Mexico’s Capital Injection Is Credit Positive Last Tuesday, HSBC Mexico, S.A. (Baa2/Baa2 stable, ba34) announced that it had received a MXN5.55 billion (about $290 million) capital injection from its foreign parent, HSBC Holdings plc (A1 negative). In addition to providing an immediate boost to HSBC Mexico’s capitalization, the injection signals that HSBC Holdings supports the Mexican bank’s ambitious growth plans, which will help improve the subsidiary’s weak profitability, a credit positive.

We estimate that the capital increase will lift the bank’s tangible common equity (TCE) ratio to around 11% from 9.5% reported in June 2016. Given the high level of capital that expected loan growth will consume, the capital injection will bolster the bank’s core equity until profitability begins to recover. Although we expect the TCE ratio to fall back to around 10% by the end of 2017 as a result of loan growth, rising business volumes should continue to propel earnings growth and internal capital generation, which should eventually help stabilize the TCE ratio.

HSBC Mexico is in the midst of a business turnaround that began after its parent company’s broad review of its global operations in 2015. That review led HSBC Holdings to pull out of some countries, including Brazil, and keep the Mexican subsidiary despite its weak performance because of its strategic importance to HSBC’s global footprint. In retaining the Mexican subsidiary, HSBC Holdings ordered HSBC Mexico’s domestic parent, Grupo Financiero HSBC, S.A. de C.V. Sociedad Controladora Filial y Subsidiarias (GF-HSBC, unrated) to generate $600 million in profit before taxes by 2017, as per a commitment made in June 2015. During the six months that ended in June 2016, GF-HSBC’s profit before taxes was just $135 million, although this result partly reflects the 18% depreciation in the Mexican peso since June 2015. That amount would have equaled around $165 million using the June 2015 foreign-exchange rate.

Although HSBC Mexico posted losses in 2015 and its net income equaled negative 0.1% of its total banking assets, it returned to profitability this year. Annualized net income equaled a still meager 0.3% of total banking assets in first-half 2016, when loan growth accelerated to a robust annual pace of 18% from 7% a year earlier. Declining asset risks have supported HSBC Mexico’s earnings turnaround, with loan-loss provisions falling to 2.6% of gross loans in first-half 2016 from 5.5% at the end of 2015. This reflects a decline in nonperforming loans to 4.2% of gross loans from 5.2% during the same period, driven by improvements in the commercial portfolio.

We expect that the bank’s net income will continue to increase gradually, although it will remain modest at around 0.6% of total banking assets in 2017. However, the bank’s ability to achieve this level of profitability hinges upon keeping provisions at bay, even as the rapid planned lending expansion and sluggish economy threaten to increase asset risks and make it difficult for the bank to contain credit costs.

4 The bank ratings shown in this report are HSBC Mexico’s deposit rating, senior unsecured debt rating and baseline credit

assessment.

Georges Hatcherian Analyst +52.55.1555.5301 georges.hatcherian@moodys.com

NEWS & ANALYSIS Credit implications of current events

22 MOODY’S CREDIT OUTLOOK 17 OCTOBER 2016

Citi’s Sale of Its Retail Businesses in Brazil and Argentina Is Credit Positive On 8 October, Citibank, N.A.’s (A1/A1 stable, baa25) subsidiary in Brazil, Banco Citibank S.A. (Citi Brazil, Ba1/Ba1 negative, ba1), announced the sale of its retail businesses to Itaú Unibanco Holding S.A. (Itaú, Ba3 negative); on 9 October, Citibank N.A. Argentina Branch (unrated) sold its retail business in Argentina to Banco Santander Rio S.A. (Santander Rio, Ba3 stable, b3).

The transactions are credit positive for Citi Brazil, which will be able to focus on its more profitable core corporate and investment banking business, and for Santander Rio, which will consolidate its position as Argentina’s leading private bank. The credit effect for Itaú, which agreed to buy the Brazil business, will be limited. Both transactions are subject to regulatory approval.

Itaú agreed to pay BRL710 million ($221.7 million) for Citi Brazil’s retail deposits and assets, including its 1.1 million credit card accounts. The transaction should lead to improvements in Citi Brazil’s profitability, asset quality metrics and capitalization, with only a modest decline in its overall market share. Although loans will decline by 30%, the bank’s total assets will drop by just 10%, leaving it Brazil’s tenth-largest bank overall and the second-largest foreign-owned bank.

Citi Brazil’s retail business never achieved a sufficient scale to operate cost effectively. Narrowing its focus to its remaining businesses will allow it to improve efficiency. Although the sale of its retail business will reduce the bank’s business diversification, asset risks in Citi Brazil’s corporate book should remain moderate because of its strong underwriting. The sale will reduce the bank’s exposure to risky retail assets, including unsecured personal and credit card loans, which should help lower its overall nonperforming loan (NPL) ratio of 2.53% as of June 2016.

Citi Brazil’s capitalization will improve as a result of the transfer of assets to Itau and the premium received on the sale. We estimate that Citi Brazil’s Moody’s-adjusted tangible common equity (TCE) ratio will rise by about 120 basis points from the 10.9% reported in June 2016. The sale will increase Citi Brazil’s reliance on market funds as it loses access to its granular retail deposit base, but substantial funding from its parent will continue to benefit the bank.

The credit effect for Itaú is limited because the acquisition is small relative to the bank’s size, at only 0.65% of total assets as of June 2016. The acquisition is primarily a defensive move, because it will preserve Itau’s position as Brazil’s leading bank in the high-end customer segment, and will reinforce its leadership in the credit card business, where it has a 32.5% market share. We estimate that the purchase will lead to a modest 40-basis-point (bp) decline in Itaú’s core capitalization, but it should be able to easily reverse that decline through internal capital generation, which averaged 160 bp in each of the past three years.

In Argentina, Santander Río will benefit from the acquisition by building upon its already strong position as the country’s largest private bank. The bank will gain access to Citi’s base of high-income individual clients, and will grow its personal loan book 28%, and its credit card business by 24%. In addition to the benefits of increased market share, Santander expects to realize meaningful operating synergies, which should allow significant cost savings on the acquired operations. Additionally, cross-selling opportunities to Citi’s clients, including cash and wealth management services, should boost its earnings in the next three years. Given the size of the transaction and the goodwill that it is likely to generate for Santander, we estimate that the deal will lead to a substantial 260 bp decline in Santander Rio’s adjusted capitalization ratio, equivalent to four to six quarters of net income based on most recent results. Nevertheless, we expect capitalization to remain adequate at 10.6%. Santander expects to finance the transaction with cash, but we expect liquidity to remain ample.

5 The bank ratings shown in this report are the bank’s deposit rating, senior unsecured debt rating and baseline credit assessment.

Ceres Lisboa Senior Vice President +55.11.3043.7317 ceres.lisboa@moodys.com

Alcir Freitas Vice President - Senior Credit Officer +55.11.3043.7308 alcir.freitas@moodys.com

Maria Valeria Azconegui Vice President - Senior Analyst +54.115.129.2611 mariavaleria.azconegui@moodys.com

NEWS & ANALYSIS Credit implications of current events

23 MOODY’S CREDIT OUTLOOK 17 OCTOBER 2016

Julius Baer’s Placement of Additional Tier 1 Securities Is Credit Positive Last Thursday, Julius Baer Group Ltd. (JBG, A3 negative) announced that it had issued SGD325 million ($235 million) of perpetual Tier 1 securities (additional Tier 1 or AT1) to be listed on the Singapore stock exchange. JBG’s issuance, its second on the Singapore exchange, is credit positive because it will bolster the bank’s loss-absorption capacity. It also helps offset the declining capital recognition of its outstanding preferred securities, which are subject to a gradual phase-out until 1 January 2019, thereby supporting its regulatory capital ratios.

The securities carry a 5.75% coupon and can be called on 20 April 2022. The amount that JBG issued exceeded our expectations by SGD150 million and the securities’ coupon was lower than the 5.9% coupon on JBG’s first SGD-denominated AT1 issued in November 2015. On 10 October, we assigned a provisional (P)Baa3(hyb) rating to the securities in the most recent issuance.

The new AT1 issuance will improve JBG’s overall capitalisation because it will increase its loss-absorbing going-concern capital and offer additional protection to senior bondholders. We expect JBG’s Tier 1 capital ratios to improve by 110 basis points following the issuance of the high-trigger AT1 securities. The same considerations on capital apply to JBG’s Tier 1 leverage ratio, which we expect will improve by 25 basis points to approximately 4.0% (see exhibit).

Julius Baer Group’s Capital Ratios, 2012-16

Sources: Julius Baer Group and Moody’s Investors Service estimates

The announcement follows JBG’s total capital ratio significant decline to 17.3% as of 30 June 2016 from 23.4% at year-end 2014, driven by a CHF521 million ($547 million) charge in 2015 for a tax settlement with the US Department of Justice over allegations of tax evasion by JBG’s US-based private banking clients. Other factors that led to a decline in capital ratios include the acquisition of an additional 60% stake in Kairos Investment Management SpA (unrated) as of 1 April 2016 and the takeover of selected parts of former Commerzbank International S.A. (renamed Bank Julius Baer Luxembourg S.A.).

The higher loss-absorbing capital available following the latest AT1 capital issuance will help safeguard capital buffers at their current levels. Additionally, the issuance will partially alleviate pressure on the bank’s financial profile from the continued phasing-out of capital instruments burdening its capital adequacy metrics in coming years.

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Michael Rohr Vice President - Senior Credit Officer +49.69.70730.901 michael.rohr@moodys.com

NEWS & ANALYSIS Credit implications of current events

24 MOODY’S CREDIT OUTLOOK 17 OCTOBER 2016

Romania’s Plan to Convert Swiss Franc Mortgages to Romanian Lei Is Credit Negative for Banks Last Tuesday, Romania’s lower house of Parliament preliminarily approved the mandatory conversion of retail mortgages denominated in Swiss francs (CHF) to Romanian lei (RON) using the prevailing exchange rate at the time of the loan’s origination. We estimate that the conversions would cost Romanian banks around RON2.6 billion (€580 million), which is equivalent to 54% of their 2015 net income or 8.2% of total capital as of December 2015, a credit negative. The final vote on the draft law in the lower house is likely on 18 October.

CHF has appreciated about 80% against the RON since most of the CHF-denominated mortgages were originated in 2006-08. However, the conversion of mortgages into Romania’s local currency will remove the credit risk of further CHF appreciation and would lower the risk-weighting for these assets, reducing banks’ capital requirements. We estimate that as of December 2015, Romanian banks held RON5.6 billion (€1.24 billion) of CHF-denominated mortgages, which equalled 5.3% of total mortgage loans (see exhibit).

Romanian Banks’ Mortgage Loan Originations by Currency

Note: Mortgages in other currencies are predominantly CHF-denominated. Source: National Bank of Romania:

Individual bank’s disclosures about CHF-denominated mortgages as a percentage of the total mortgage book is very limited. However, according to the National Bank of Romania, as of November 2014, three banks accounted for 69% of CHF-denominated loans, and they had a combined market share of only 14% of total banking assets.

According to the current version of the draft law, mortgages with an original value of more than CHF250,000 will be excluded from the mandatory conversion. However, given Romania’s modest nominal GDP per capita of $8,938 in 2015 and relatively inexpensive housing market, we believe that such large mortgages account for a very small portion of the total mortgages.

The current version of the draft law does not affect euro-denominated loans, which accounted for a larger 39% of retail loans as of August 2016. Given the euro’s appreciation of around 30% against RON since 2006-08, a conversion of euro-denominated loans to the Romanian lei at historical exchange rates would potentially result in about €6 billion of losses. We believe euro-denominated loan conversion at historical exchange rates is unlikely because it would deplete more than 80% of the banking system’s total capital, undermining financial stability in the country.

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Armen Dallakyan Vice President - Senior Analyst +44.20.7772.1688 armen.dallakyan@moodys.com

Alexander Zeidler Vice President - Senior Credit Officer +44.20.7772.8713 alexander.zeidler@moodys.com

NEWS & ANALYSIS Credit implications of current events

25 MOODY’S CREDIT OUTLOOK 17 OCTOBER 2016

For comparison, Hungary mandated the conversion of all foreign-currency retail loans, which accounted for 55% of total retail loans in 2015.The conversion at current market exchange rates spared banks from material costs. However, because of a separate law adopted in 2014, Hungarian banks were required to compensate retail borrowers for any extra charges previously levied on loans denominated in both foreign and local currency. The compensation charges amounted to around €2 billion, or approximately 20% of the banks’ total capital as of year-end 2013.

Romania’s conversion of CHF-denominated loans is also credit negative for the development of the country’s covered bond market because it increases uncertainty for investors that rely on the collateral value of mortgage pools. Romanian legislators surprised investors in April when they approved a law on mortgage obligations that allows most Romanian mortgage borrowers to opt for a strategic default (i.e., defaulting on the debt despite being financially able to service it), another policy measure supporting mortgage borrowers and but additionally burdening banks’ profit lines.6

6 See Romanian Legislation Allowing Strategic Mortgage Defaults Increases Banks’ Asset Risk, 18 April 2016.

NEWS & ANALYSIS Credit implications of current events

26 MOODY’S CREDIT OUTLOOK 17 OCTOBER 2016

Taiwan’s Charges against CTBC Financial Holding’s Controlling Shareholder Are Credit Negative On 5 October, Taiwan’s Supreme Prosecutors Office brought charges against CTBC Financial Holding Co., Ltd.’s (Baa1 stable) and CTBC Bank Co., Ltd.’s (A2 stable, baa27) controlling shareholder Jeffrey Koo, Jr. and former senior executives for violating Taiwanese banking, securities, insurance and anti-money laundering laws. The charges include embezzlement and the purchase of real estate at inflated prices from the controlling shareholder of CTBC Financial’s takeover target, Taiwan Life Insurance Co., Ltd. (unrated). The charges are credit negative and although CTBC Financial disputes them, they raise questions about the company’s governance and the trial may discourage new business and relationships.

Prosecutors allege that between 2004 and 2007, Mr. Koo, with the help of certain former senior executives, embezzled approximately $300 million from CTBC subsidiary CTBC Asset Management Company (unrated) through a series of transactions involving offshore entities. CTBC Financial maintains that the company ultimately recovered all funds and profited from the transactions. CTBC Financial has yet to explain the strategic rationale for the transactions or how they benefit its various stakeholders, although it may provide such details during the trial.

The prosecutors also allege that in 2015, as the group prepared a takeover bid for Taiwan Life, Mr. Koo and CTBC Financial’s former chief financial officer arranged for CTBC Financial’s insurance subsidiary to lend funds against insufficient collateral to Gobo Group (unrated) to allow the group to gain effective control of Taiwan Life. Additionally, prosecutors assert that CTBC Financial’s insurance subsidiary subsequently purchased the property collateral from Gobo at inflated valuations.

CTBC Financial’s purchase of the real estate property from Gobo for TWD1.57 billion is modest compared with the former’s total assets of TWD3.8 trillion as of 30 June 2015, before the completion of the Taiwan Life acquisition. The company asserts that it purchased the real estate property from Gobo through an open auction in adherence to all applicable rules and regulations, while the prosecutor alleges that CTBC Financial’s insurance subsidiary overpaid by TWD118 million for the real estate property.

The prosecutors have not named CTBC Financial or its subsidiaries as defendants in the lawsuit against Mr. Koo and the group’s former senior executives. CTBC Financial has undertaken measures to improve its corporate governance in recent years. The bank has four independent non-executive directors on its nine-member board of directors. The board also has an audit committee composed of these four independent non-executive directors.

7 The bank ratings shown in this report are the bank’s deposit rating and baseline credit assessment.

Sonny Hsu Vice President - Senior Analyst +852.3759.1383 sonny.hsu@moodys.com

NEWS & ANALYSIS Credit implications of current events

27 MOODY’S CREDIT OUTLOOK 17 OCTOBER 2016

Sovereigns

Côte d’Ivoire to Receive $674 Million in IMF Financing Last Tuesday, the government of Côte d’Ivoire (Ba3 stable) reached a staff level agreement with the IMF on a $674 million financing programme. The financing is under the IMF’s Extended Credit Facility (ECF) and the Extended Fund Facility (EFF) in aid of the National Development Plan, a €45 billion policy plan to enhance Côte d’Ivoire’s competitiveness via infrastructure improvements and structural reforms to accelerate its economic diversification. The IMF programme will support Côte d’Ivoire’s authorities in this policy agenda with external liquidity during the implementation phase of the plan. More importantly, the IMF programme will be a catalyst for additional financing from the private sector and the international community.

The ECF is a three- to four-year financial instrument that the IMF uses in low-income countries to support the balance of payments and provide a framework that tailors policy to country-specific challenges. It generally attracts further support from multilateral development banks or countries, either in the form of grants to the government or loans on favourable terms. And, because disbursements are conditioned to progress under the identified reforms, it also provides policy discipline that can have positive effect on investor confidence.

In Côte d’Ivoire, the programme’s role as a catalyst for other donors is a key credit positive because the country’s balance of payments is already, pre-programme, on a positive trend. The increased contribution of Côte d’Ivoire to the foreign-exchange reserves pooled at the central bank of the West African Economic and Monetary Union (UEMOA) reflects this positive trend (see exhibit). Moreover, the institutional arrangement between UEMOA member countries and France’s (Aa2 stable) fiscal authorities, whereby France’s authorities guarantee the convertibility of the local currency into euro, further contains Côte d’Ivoire’s external vulnerability.

Côte d’Ivoire’s Foreign-Exchange Reserves

Sources: Haver Analytics and Moody’s Investors Service

The National Development Plan allocates public sector (40%) and private (60%) funding to key areas such as infrastructure, protection of environment, and promotion of the economy’s industrialisation, all with the ultimate objective of obtaining emerging economy status by 2020. Because of increased public spending, we project Côte d’Ivoire’s fiscal deficit widening to 3.8% of GDP in 2016 from 3.0% in 2015, and 3.5% in 2017. However, given that we expect GDP to increase substantially, we forecast the government debt-to-GDP ratio remaining stable at 42% both in 2016 and 2017.

$0

$1

$2

$3

$4

$5

$6

$ Bi

llion

s

Lucie Villa Vice President - Senior Analyst +1.212.553.1990 lucie.villa@moodys.com

Elisa Parisi-Capone Vice President - Senior Analyst +1.212.553.41.33 elisa.parisi-capone@moodys.com

NEWS & ANALYSIS Credit implications of current events

28 MOODY’S CREDIT OUTLOOK 17 OCTOBER 2016

Although the exact details of the programme have not yet been finalised, the key objectives, as stated by the IMF, are to support further improvements in tax revenue-generation capacity and more effective public spending. In addition, the programme will include reforms aimed at improving debt management and public-sector risk management, including public banks.

We believe that several factors point to the Ivorian authorities’ capacity to stick to the IMF program’s detailed conditions. These include the government’s own formalisation of the policy agenda mirroring the National Development Plan as well as a satisfactory track record in the previous economic plan. During 2012-15, when the prior economic plan was in effect, the economy grew on average by 9% in real terms and government debt grew modestly to 42% of GDP in 2015 from 34% in 2012. While political stability will remain the key source of uncertainty regarding the success of the National Development Plan, the re-election of President Alassane Ouattara in October 2015, for a second five-year mandate, substantially dispels political uncertainty.

NEWS & ANALYSIS Credit implications of current events

29 MOODY’S CREDIT OUTLOOK 17 OCTOBER 2016

Audit of Mozambique’s State-Owned Enterprises Would Allow Resumption of International Aid, a Credit Positive On 8 October, International Monetary Fund (IMF) African Department Director, Mr. Abebe Selassie, announced that the IMF and Mozambique (Caa3 negative) have agreed to an audit of state-owned enterprises (SOE) that borrowed more than $1 billion in undisclosed debt. The IMF official statement identified an external audit of the SOEs as a precondition to resuming its financial support.

The renewed flow of aid would be credit positive and timely given the substantial budgetary pressure facing the government. External funds would bolster the country's budget and the Bank of Mozambique’s foreign-exchange reserves, and the audit itself would increase transparency of the government’s liabilities.

The transparency of an independent and credible audit of these unrated SOEs, Empresa Mocambicana de Atum (EMATUM), Mozambique Asset Management (MAM) and Proindicus, using parameters that the IMF and Mozambique agreed to, even with negative findings, would begin to restore Mozambique’s standing with international donors. The IMF, World Bank and the UK Department for International Development suspended some of their aid in April 2016 after the Mozambican government revealed the SOEs’ previously undisclosed debt equaling 9% of its GDP. We estimate support from these three donors amounted to 2%-3% of 2016 GDP in available funds. Soon after, G148 donor countries suspended their aid too, exacerbating the financing and external liquidity challenges that drove our downgrades of Mozambique’s ratings in May and July 2016. Aid to the government from the international community in 2015 was approximately 10% of GDP.

Given financing and liquidity challenges and other pressures, the Mozambican parliament approved a revised 2016 budget in July, which aimed to pare non-essential expenditures while preserving important social programs. Under the new 2016 budget, the fiscal deficit is set to reach to 6.4% of GDP, versus 4.0% in the original 2016 budget law, according to the Ministry of Economics and Finance. Expenditures were cut by 0.5% of GDP to MZN228 billion, or 33.1% of GDP. Total revenues were also revised down by three percentage points to 26.7% of GDP from 29.6%.

A key component to international support comes from the IMF, which established a short-term credit facility with Mozambique in December 2015. Of the $285 million facility, $120 million was disbursed immediately in 2015, while the balance was frozen following the April 2016 debt revelations. Mozambique’s significant external pressure have had concomitant declines in the central bank’s foreign-exchange reserves.

While central bank policy has been adjusted to preserve reserve levels, including by allowing the exchange rate to move more freely, foreign-exchange reserves fell 18% for the year to May 2016, before recovering and stabilizing (see exhibit). The Mozambican metical has been one of the currencies that has depreciated the most globally against the US dollar, depreciating 42% to 77 metical against the US dollar since the end of 2015.

8 G14 countries include Brazil, Canada, China, Egypt, France, Germany, India, Italy, Japan, Mexico, Russia, South Africa, the UK and US.

Lucie Villa Vice President - Senior Analyst +1.212.553.1990 lucie.villa@moodys.com

David Kamran Associate Analyst +1.212.553.2109 david.kamran@moodys.com

NEWS & ANALYSIS Credit implications of current events

30 MOODY’S CREDIT OUTLOOK 17 OCTOBER 2016

Mozambique’s Foreign-Exchange Reserve and the MZN versus USD

Sources: IMF, Banco de Moçambique and Moody’s Investors Service

40

45

50

55

60

65

70

75

80

$1,850

$1,900

$1,950

$2,000

$2,050

$2,100

$2,150

$2,200

$2,250

$2,300

$2,350

Dec-15 Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16 Jul-16 Aug-16 Sep-16

$ M

illio

ns

Foreign Exchange Reserves - left axis USD/MZN - right axis

NEWS & ANALYSIS Credit implications of current events

31 MOODY’S CREDIT OUTLOOK 17 OCTOBER 2016

US Public Finance

Illinois to Benefit from Banks Agreeing to Buy and Hold State’s Variable-Rate Debt Last Tuesday, the State of Illinois (Baa2 negative) announced that four commercial banks had agreed to buy and hold $600 million of its variable-rate debt for two years, removing a threat to the state’s liquidity. The agreement is positive for the state, which otherwise faced accelerated maturity of the debt under the terms of existing letters of credit.

The banks will each buy a portion of the state’s Series B of October 2003 general obligation bonds in a 7 November direct placement. The institutions are among the six currently extending support to the 2003 bonds under direct-pay letters of credit, which provide cash to purchase any securities not successfully remarketed to investors in periodic auctions that determine the bonds’ interest rates.

The letters of credit expire on 27 November. Failure to either renew or replace these agreements before then would have precipitated a three-year amortization of debt originally set to mature in 2033. As shown in Exhibit 1, the accelerated payments would have amounted to only about 5% of the state’s normal debt service in the first two years. In the third year, when the state would face $360 million of principal amortization, we estimate that payments associated with the expiration of bank letters would have equaled about 12% of normally scheduled debt service on the state’s fixed-rate general obligation bonds.

EXHIBIT 1

Illinois Debt Service 2017-19

Source: State of Illinois bond offering documents, Moody’s estimates.

The principal and interest associated with this amortization schedule would have been relatively small because the 2003 bonds, the state’s sole variable-rate debt outstanding, account for only 2.3% of its general obligation debt. Yet, the liquidity required to meet these payments would have been large relative to the state’s current available operating fund cash. Illinois’ general funds cash balance as of 30 June 2016 fell to $246 million from $621 million a year earlier. Exacerbated by a deficit of about $5 billion, weak operating fund liquidity is driving up an already large (approximately $9 billion) unpaid bill backlog.

$0.0

$0.4

$0.8

$1.2

$1.6

$2.0

$2.4

$2.8

$3.2

$3.6

2017 2018 2019

$ Bi

llion

s

Fixed Rate Debt Variable Rate Debt

Ted Hampton Vice President - Senior Credit Officer +1.212.553.2741 ted.hampton@moodys.com

NEWS & ANALYSIS Credit implications of current events

32 MOODY’S CREDIT OUTLOOK 17 OCTOBER 2016

The carrying cost of Illinois’ variable-rate debt is currently about 6.8%, including letter-of-credit and remarketing fees and related interest rate swap agreements. The bank facility expense increased as the state was downgraded to Baa2 in June from A3 in 2013, when the letters of credit were executed. The annual cost under the existing letters of credit is 2.85% and would have risen to 3.35% if the state were to have been downgraded to Baa3, and 5.35% if the state were to have been downgraded to Ba1. The total expense will be contained under the bank purchase agreement because the banks will benefit from owning securities paying tax-exempt interest. The exact cost remains to be determined, and would still rise in the event of subsequent credit downgrades.

The state this month also renegotiated the interest rate exchange agreements linked to its variable-rate debt, so its deteriorating credit ratings are less likely to allow termination of the swaps, which could cost the state $153 million owing to the swaps’ negative market value as of 15 September. Credit thresholds on the swaps (see Exhibit 2) were reduced to accommodate further rating deterioration.

EXHIBIT 2

Rating Thresholds for Illinois’ Swap Termination Have Been Lowered Counterparty Notional Value New Termination Trigger Prior Termination Trigger

Barclays Bank PLC $54,000,000 Baa3 or BBB- Baa2 or BBB

Barclays Bank PLC $54,000,000 Baa3 or BBB- Baa2 or BBB

Bank of America, N.A. $54,000,000 Baa3 or BBB- Baa2 or BBB

JP Morgan Chase, N.A. $54,000,000 Baa3 or BBB- Baa2 or BBB

Deutsche Bank AG $384,000,000 Ba1 or BB+ Baa2 or BBB

Source: State of Illinois bond offering document

Illinois still faces the task of extricating itself from the swaps before the two-year agreement with the letter-of-credit banks ends. One option – replacing the debt and paying the swap termination costs with bond proceeds – would require legislative approval.

RECENTLY IN CREDIT OUTLOOK Select any article below to go to last Thursday’s Credit Outlook on moodys.com

33 MOODY’S CREDIT OUTLOOK 17 OCTOBER 2016

NEWS & ANALYSIS Corporates 2 » Boeing Lands Significant Order from Qatar Airways, a

Credit Positive » EU Tariffs on Chinese Steel Are Credit Positive for

European Producers » Misys' Planned IPO and Refinancing Are Credit Positive

Infrastructure 6 » Duke Energy's Agreements to Sell Its Latin American

Businesses Are Credit Positive

Banks 7 » ING's Updated Strategic Plan Is Credit Positive » Portugal's Banco BPI Agrees to Reduce Exposure to Angola, a

Credit Positive » Attica Bank's Emergency Liquidity Assistance Increase Is

Credit Negative » Norway Proposes Financial Services Tax, a Credit Negative

for Banks » Korean Banks' Loan Delinquencies Climb as Shipbuilders and

Shippers Restructure » Bank of East Asia's Sale of Tricor Holdings Stake Is

Credit Positive

Insurers 18 » Penn Mutual's Acquisition of Vantis Life Is Credit Positive

MOODYS.COM

Report: 192694

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