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MOODYS.COM
9 MARCH 2015
NEWS & ANALYSIS Corporates and Infrastructure 2 » AbbVie's Big Bet on Pharmacyclics Is Credit Negative » Cardinal's Deal for Cordis Aids Its Lower-Cost Medical
Products Strategy » Vale Benefits from $900 Million-Plus Gold Deal with
Silver Wheaton » NXP's Planned Acquisition of Freescale Semiconductor Is
Credit Positive » Encana's Debt Reduction through Equity Funding Is Credit Positive » Aperam's Redemption of 7.75% Senior Notes Is Credit Positive » VimpelCom's Debt Buyback Offer Is Credit Positive » NLMK Reduces Stake in NBH, a Credit Positive » China Aoyuan's Investment in Australian Property Project Is
Credit Negative » Hong Kong Developers Eye Slowdown after Prudential Measures
on Mortgage Loans » RWE's Completion of Dea Sale Is Credit Positive
Banks 15 » Court Decision Moves Bank of America Closer to Credit-Positive
Countrywide RMBS Resolution » Federal Reserve Stress Test Shows US Banks' Capital Improved » AWAS Aviation Capital's Sale of 90 Aircraft Is Credit Negative » Springleaf's Acquisition of OneMain Is Credit Negative for Both » Annulment of ECB Policy on Euro Clearing Is Credit Positive for
Non-EU Clearinghouses » ING Completes Full Disposal of Its US Insurance Subsidiary, a
Credit Positive
Insurers 27 » Sun Life Financial's Pension Risk-Transfer Agreement with BCE Is
Credit Positive » Demutualization of Canadian Property and Casualty Insurers Is
Credit Negative » Argentine Insurers' New Reserve Rules Are Credit Positive
Asset Managers 33 » Pennsylvania Governor's Plan to Reduce Pension Fund Costs Is
Credit Positive for Large Passive Asset Managers » Proposal to Designate Asset Managers as Systemically Important Is
Credit Positive
Sovereigns and Sub-sovereigns 37 » China Lowers Its Growth Target to Around 7%, a Credit Positive » Lower Federal Transfers to Mexico's Oil-Producing States Are
Credit Negative
US Public Finance 40 » College Consolidations and Closures Are Credit Positive in an
Increasingly Competitive Sector
Securitization 42 » Expansion of India's SARFAESI Act Would Speed Up Lenders'
Repossession of Loans Against Property
CREDIT IN DEPTH Banks 43
Large Global Banks Close the Gap in Meeting Basel III Capital and Liquidity Requirements, a Credit Positive
RATINGS & RESEARCH Rating Changes 49
Last week, we downgraded Abbott Laboratories, DCP Midstream, Samson Investment, Teck Resources, Weight Watchers International, Peterborough (Progress Health), Central Bank of India, Indian Overseas Bank, Credit Europe Bank and Chicago Park District, and we upgraded BY Chemler, Sydney Water, Banco Psa Finance Brasil, Confianza, E*Trade Financial, Voya Financial and Ally auto ABS, among other rating actions.
Research Highlights 56
Last week, we published research on North American railroads, Hong Kong property developers, Chinese national oil companies, global integrated oil companies, European engineering and construction, Chinese corporates, China telecoms, Moody’s Liquidity Stress Index, EMEA corporates, US multinationals, Canadian corporates, Australian grocery retailers, Chinese oil field services, US airlines, global paper and forest, Korean corporates, global automakers, project finance defaults, Irish banks, Mongolian banks, global bank debt issuance, Indian banks, Russian banks, Oman and Bahrain banks, Brazilian banks, Malaysian banks, Japanese life insurers, European insurers, GCC reinsurers, Russian regions, US not-for-profit hospitals, Pennsylvania local governments and US local governments.
RECENTLY IN CREDIT OUTLOOK
» Articles in Last Thursday’s Credit Outlook 63 » Go to Last Thursday’s Credit Outlook
NEWS & ANALYSIS Credit implications of current events
2 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
Corporates
AbbVie’s Big Bet on Pharmacyclics Is Credit Negative AbbVie Inc. (Baa1 review for downgrade) on Wednesday announced plans to buy Pharmacyclics Inc. (unrated), the maker of blood cancer treatment Imbruvica, for $21 billion in cash and stock. The deal to buy what essentially amounts to a single – albeit rapidly growing and high-potential – drug is credit negative for AbbVie because the majority of funding will be incremental debt. We placed AbbVie’s ratings on review for downgrade following the transaction announcement.
AbbVie will pay Pharmacyclics shareholders $261.25 per share, 42% with AbbVie shares and 58% with cash. In order to reduce dilution to existing shareholders, AbbVie will then buy back at least half of the shares issued to Pharmacyclics shareholders in an accelerated share repurchase. As a result, the deal will ultimately be approximately 80% funded with cash. Assuming the share buyback and cash portion of the acquisition are fully debt-financed, it would amount to incremental debt of $16-$17 billion, although AbbVie has not finalized its financing plan. Based on our assumptions, we estimate AbbVie’s pro forma financial leverage would approximate 4.5x debt/EBITDA for the 12 months ended 31 December 2014, up from 2.3x.
By way of comparison, AbbVie’s attempt to buy Irish drug maker Shire plc last year for $55 billion would have raised its leverage to roughly 3.5x-3.7x, because of the higher contemplated equity component of the deal funding. Unlike Pharmacyclics, the Shire acquisition was structured as a corporate inversion, which would have provided AbbVie with better access to its offshore cash and lowered its corporate tax rate. AbbVie scuttled the deal after the US Treasury Department changed the rules governing inversions, reducing some of their tax benefits.
Shire also would have significantly diversified AbbVie’s revenue away from Humira, the world’s top-selling pharmaceutical product. About 60% of AbbVie’s revenues are concentrated in Humira, which treats rheumatoid arthritis and other immune-system disorders. Although Humira is highly lucrative and competition from biosimilars (i.e., copycat versions of biotechnology drugs) is not imminent, AbbVie’s high product concentration exposes it to several risks, including competitive dynamics, pricing pressure and manufacturing interruptions.
Pharmacyclics will also help diversify AbbVie’s revenue away from Humira, but to a lesser extent, at least in the near-term. Its primary product, Imbruvica, is approved to treat several blood cancers, an area that is a significant growth opportunity for the pharmaceutical industry owing to substantial innovation and unmet need. And Imbruvica will complement AbbVie’s oncology pipeline, which includes drugs that have the potential to be used in tandem with Imbruvica to treat some blood cancers and possibly some solid tumors.
While Pharmacyclics has been growing rapidly, its incremental revenue and EBITDA contribution at least over the next year or so will not be significant to AbbVie, whose revenue was $20.0 billion in 2014. Pharmacyclics had revenues of $730 million last year, up from $260 million in 2013. While Imbruvica has the potential to grow and generate several billions of dollars in revenues, roughly half of its profits go to Johnson & Johnson (Aaa stable) under an earlier collaboration agreement, and will continue to do so after the AbbVie deal. Imbruvica is also a small-molecule drug, which makes it more susceptible to eventual competition from a generic version than a more complex biologic, such as Humira.
However, AbbVie’s business profile is strong and we expect it to generate enough EBITDA growth to quickly de-lever post-deal. Its Humira franchise generated $12.5 billion of sales in 2014, up 13% from 2013, excluding effects from foreign exchange. In addition, strong growth in Imbruvica and AbbVie’s recent launch of Viekira Pak for Hepatitis C will boost significant EBITDA growth this year, which will drive deleveraging. We estimate that Viekira, which was approved by the US Food and Drug Administration in December, will
Jessica Gladstone, CFA Vice President - Senior Credit Officer +1.212.553.2988 [email protected]
Michael Levesque, CFA Senior Vice President +1.212.553.4093 [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 9 MARCH 2015
generate over $2 billion in revenue this year and that AbbVie’s Hep-C franchise will capture about 20% of the US market. AbbVie’s pipeline also includes several promising late-stage assets with large commercial potential, including Elagolix for endometriosis, veliparib for various types of cancer, and elotuzumab for multiple myeloma.
NEWS & ANALYSIS Credit implications of current events
4 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
Cardinal’s Deal for Cordis Aids Its Lower-Cost Medical Products Strategy Cardinal Health, Inc. (Baa2 stable) on Monday announced plans to buy Cordis, the vascular technology unit of Johnson & Johnson (Aaa stable), for $1.94 billion. The deal is credit positive for Cardinal because Cordis will significantly boost its plan to offer lower-cost alternative products, including off-branded or generic ones, to its hospital customers.
Although Cardinal is best known as one of the nation’s leading drug distributors, its medical segment not only distributes medical and surgical products, but also manufactures commodity-like hospital supplies, such as latex gloves. As part of its plan to capitalize on its hospital customers’ desire to contain costs, Cardinal is now focused on offering low-cost alternative medical devices as well. Cordis, with revenues of about $780 million, will further this strategy by adding its portfolio of branded but low-innovation cardiovascular products to Cardinal’s existing cardiovascular product line.
Cordis’ products include guidewires, sheaths and balloons that are often used alongside highly innovative medical devices, but which have, themselves, undergone limited innovation. Unlike similar assets acquired by Cardinal, Cordis’ products are branded and well established in the industry. Even so, Cardinal plans to offer better value to its hospital customers for these low-innovation products with low clinical differentiation.
Cordis’ endovascular business also offers Cardinal a new area of well-established products, some of which are used in treatment areas that, compared to the cardiovascular space, are still highly underpenetrated. For example, Cordis offers balloon catheters for peripheral artery disease as well as carotid artery stents. Cordis’ abdominal aortic aneurysm device, however, is a high-technology product that is outside of Cardinal’s medical product strategy. Cardinal is evaluating the strategic fit of this asset.
The transaction will initially increase Cardinal’s pro forma leverage to around 2.0x debt/EBITDA from 1.6x for the 12 months that ended 31 December 2014, but we expect the company will de-lever over the next several years. Cardinal plans to finance the deal with $1 billion of incremental debt and the remaining $940 million with cash, which totaled about $2.9 billion at 31 December 2014. Although we do not expect Cardinal to reduce gross debt taken on with Cordis, we do expect deleveraging through EBITDA improvement, driven in part by the realization of about $100 million in annual synergies by the end of fiscal year 2018. A portion of these synergies will be derived from reducing research expenses associated with product innovation.
About 70% of Cordis’ sales are outside the US, with stronger market shares in EMEA and China than in the US. Cardinal expects to see strong growth from emerging markets in these product lines.
Because Cordis manufactures more invasive medical products than Cardinal, albeit those that are well established, Cardinal will face greater regulatory risk. In addition, with the change in ownership, Cordis will be subject to potential disruption in its sales force by key players in the cardiovascular and endovascular space, including Boston Scientific, Medtronic, and St Jude Medical.
Cardinal kicked off its strategy of offering low-cost alternative devices to its hospital customers in July 2012, when it entered into an exclusive distribution partnership with Emerge Medical (unrated), which makes generic surgical screws, drill bits and guidewires used in orthopedic trauma cases. Cardinal expects these trauma products to be available at 30%-50% below the price of available branded products. Beyond orthopedic, cardiology and (now) endovascular products, Cardinal is also offering other products that fit this strategy, including wound-treatment devices.
Diana Lee Vice President - Senior Credit Officer +1.212.553.4747 [email protected]
NEWS & ANALYSIS Credit implications of current events
5 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
Vale Benefits from $900 Million-Plus Gold Deal with Silver Wheaton Last Monday, Vale S.A. (Baa2 stable) said that it had agreed to sell an additional 25% of the gold it extracted from its Salobo mine to Silver Wheaton (Caymans) Ltd. (unrated) for an upfront payment of $900 million plus $400 per ounce, or the prevailing market price, whichever is lower. The deal is credit positive for Vale because it will improve cash flow and reduce the need for additional debt to fund its projected $10.2 billion in capital spending this year. The cash infusion also supports Vale’s operations, improving its liquidity and contributing to its strategy of maintaining stable debt levels amid depressed iron ore prices.
The streaming deal, in which a mining company sells rights to a product for a set amount of money, consists of a sale of 25% of total future production of gold extracted as a by-product during the lifespan of the Salobo copper mine, which Vale estimates is 50 more years.
Vale, one of the world’s largest mining companies, had about $4.1 billion of cash and equivalents on hand as of December 2014, and $5 billion in revolving credit facilities. However, weak prices for iron ore, which constitutes the bulk of Vale’s earnings and cash flow generation, will keep straining Vale’s credit metrics this year. Iron ore prices have fallen about 52% since early 2014, and supply growth will outpace demand through at least early 2016.
The Silver Wheaton deal, plus Vale’s Moatize/Nacala nearly $1 billion deal in December 2014, will help mitigate the effects of the decline in Vale’s 2015 cash flow by around $2 billion. The company will further strengthen its liquidity by cutting dividends while still maintaining its large capital investment program, reducing its dividend distribution this year to $2 billion, as announced in January, from $4.2 billion in 2014.
The Silver Wheaton transaction supplements a February 2013 contract that established the sale of 25% of the Salobo gold production to Silver Wheaton. For that transaction, Vale received an upfront payment of $1.33 billion at a time when gold prices were close to $1,700 per ounce, compared with the current price of roughly $1,200 per ounce. Accordingly, Silver Wheaton is now entitled to 50% of the gold production at Salobo, which in 2014 accounted for 160,000 ounces, or half of Vale’s total gold production of 321,210 ounces for the year.
Moreover, Silver Wheaton bears the production risk for the deal, whose terms call for production to accrue retroactively to Silver Wheaton as of 1 January 2015. Vale makes no firm commitment to deliver production. If Salobo’s processing capacity expands within a predetermined period, Vale will receive an additional amount of $88-$720 million, depending on the amount and timeliness of the increase.
Barbara Mattos Vice President - Senior Analyst +55.11.3043.7357 [email protected]
NEWS & ANALYSIS Credit implications of current events
6 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
NXP’s Planned Acquisition of Freescale Semiconductor Is Credit Positive Last Monday, NXP B.V. (Ba2 positive) said it had agreed to acquire Freescale Semiconductor Inc. (B2 review for upgrade) for about $11.8 billion in cash and stock. The planned transaction is credit positive for NXP because it will substantially increase the company’s scale and diversity, without having a long-term effect on leverage. After the announcement, we changed NXP’s ratings outlook to positive from stable and placed Freescale’s ratings on review for upgrade.
NXP plans to complete the transaction in the second half of this year. The company will fund the acquisition with about $9.8 billion worth of NXP shares and $2 billion in cash. Through a combination of debt reduction and EBITDA growth, we expect the combined company to reduce adjusted leverage to about 3x during the year after the closing, compared to pro forma debt/EBITDA for the merged company of 4x for 2014 and about 2.5x for NXP alone for 2014.
The acquisition of Freescale will greatly increase NXP's scale and diversification, making it the leading manufacturer of automotive semiconductors. The acquisition will also broaden NXP’s offering to include strong market positions in automotive and industrial microcontrollers (MCUs), raising NXP’s market share to nearly that of MCU market leader Renesas Electronics Corp. (unrated), according to research firm IHS Inc. This broader offering should allow NXP to more fully participate in the automotive “Internet of things” trend, utilizing its historical strength in security with Freescale’s strength in MCUs. In addition to this broader offering, Freescale brings a strong selling presence in the US, which complements NXP’s strength in Europe and China.
We expect free cash flow to remain strong owing to both companies’ fab-lite manufacturing model in which they outsource a large portion of semiconductor fabrication to third party facilities. We expect NXP to focus its post-merger restructuring efforts on administrative and support functions rather than manufacturing functions, which are already efficient due to the fab-lite model, limiting integration risk. We expect the company to reap cost savings of about $200 million in 2016.
Terrence Dennehy Vice President - Senior Analyst +1.212.553.1015 [email protected]
NEWS & ANALYSIS Credit implications of current events
7 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
Encana’s Debt Reduction through Equity Funding Is Credit Positive Last Wednesday Encana Corporation (Baa2 stable) announced that it plans to raise CAD1.25 billion of equity through a bought deal. This is credit positive for the oil and gas company because it would use the proceeds along with cash on hand to reduce debt by about $1.3 billion, which would strengthen Encana’s balance sheet and improve leverage metrics in a period of low oil and gas prices. In addition to improving retained cash flow to debt, the debt reduction would offset lower reserves and production following a decline in average daily production and proved developed reserves that result from a portfolio realignment toward a more balanced mix of oil and natural gas.
Encana’s 2015 production will decline by 15% to about 410,000 barrels of oil equivalent per day from the 2014 level, but production of oil and natural gas liquids (NGL) will increase to about 33% of total production from 18% in 2014 because its two major 2014 acquisitions (oil production in Texas’ Eagle Ford and Permian formations) will contribute a full year’s production. In the current low oil price environment, Encana reduced its 2015 capital budget by 25% to $2.1 billion from its earlier guidance of $2.8 billion. This capex and its $230 million annual dividend will be funded through the company’s forecasted 2015 cash flow of about $1.5 billion along with proceeds from divestitures totalling about $800 million.
Under our 2015 oil and gas price assumptions of West Texas Intermediate at $52 per barrel and Henry Hub natural gas at $3.00 per million cubic feet (CAD2.95 per million cubic feet AECO natural gas) and pro forma for the debt reduction, we expect Encana’s pro forma 2015 leverage metrics will be better positioned in its Baa2 rating. E&P debt to average daily production will improve to $17,000 per barrel versus $20,000 per barrel, E&P debt to proved developed reserves will improve to $9.80 per barrel versus $11.50 per barrel and retained cash flow to debt will improve to 20% versus 15%.
Encana’s ability to maintain its credit quality will depend on its ability to successfully execute its transformation to a more balanced mix of oil and natural gas while preserving its balance-sheet strength and leverage metrics in a low oil and natural gas price environment.
Terry Marshall Senior Vice President +1.416.214.3863 [email protected]
Amaury Baudouin Associate Analyst +1.416.214.3849 [email protected]
NEWS & ANALYSIS Credit implications of current events
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Aperam’s Redemption of 7.75% Senior Notes Is Credit Positive On 27 February, Aperam S.A. (Ba3 positive) announced that it intended to repay in full the $250 million of senior notes initially maturing in 2018 at the first scheduled call date on 1 April 2015. We expect that the repayment will be made with a mix of cash on hand and a drawdown from existing banking facilities. The redemption is credit positive for Aperam because it will reduce its gross leverage and annual cash interest, leading to improved operating cash flow, without deteriorating a liquidity position that we consider adequate.
Based on our expected Moody’s-adjusted EBITDA and Moody’s-adjusted debt for full-year 2014, and assuming half of the transaction will be funded from available bank facilities, we estimate that Aperam’s gross leverage would decrease to 1.5x from 1.7x, pro forma for the proposed bond redemption. Moreover, the transaction will significantly lower the company’s cost of debt, given that the notes were bearing about $19 million of interest payment annually, and improve its interest coverage ratio. As a combined result of solid operating performance, reduced gross debt and a lower average cost of debt, we expect Aperam’s EBIT/interest expense ratio to materially improve to near 4.0x this year from approximately 2.5x at the end of 2014.
Per redemption clause provisions, the notes will be repaid at 103.875%. Once the redemption is complete, Aperam’s financial structure will no longer include high-yield bonds since its other 7.375% senior notes were prepaid in October 2014. Therefore, its debt structure will mainly comprise its two convertible bonds for a total aggregate outstanding amount of about $500 million and its banking facilities.
Florent Martel Associate Analyst +44.20.7772.5634 [email protected]
NEWS & ANALYSIS Credit implications of current events
9 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
VimpelCom’s Debt Buyback Offer Is Credit Positive Last Monday, VimpelCom Amsterdam B.V., a wholly owned subsidiary of VimpelCom Ltd (Ba3 review for downgrade), announced a $2.1 billion cash tender offer for certain outstanding US dollar-denominated eurobonds issued by VimpelCom Holdings B.V. (Ba3 review for downgrade), UBS (Luxembourg) S.A. and VIP Finance Ireland Limited, and guaranteed by VimpelCom’s Russian subsidiary, Vimpel-Communications OJSC (Ba3 review for downgrade). The offer expires on 30 March. It includes three Eurobond issues that will be repurchased at a premium if tendered by the 13 March 2015 deadline.
The tender offer is credit positive for VimpelCom because debt reduction will support VimpelCom Holdings’ financial metrics, which will be affected by the deteriorated operating environment and severe domestic currency depreciation in Russia, one of the core markets for VimpelCom group.
We base our assessment of VimpelCom’s business and financial profile primarily on VimpelCom Holdings because it consolidates VimpelCom’s businesses in Russia and Ukraine, which underpin the VimpelCom group’s ability to service its debt obligations through cash distributions from those entities.
We estimate that VimpelCom Holdings’ Moody’s-adjusted debt/EBITDA would grow above 3.2x by year-end 2015 from 2.8x as of September 2014, assuming no voluntary debt repurchase. The anticipated $2.1 billion debt reduction would result in a 0.5x decline in VimpelCom Holdings’ Moody’s-adjusted debt/EBITDA. The debt reduction would partially offset the negative effect on VimpelCom Holdings’ leverage in 2015 of rouble depreciation and the deteriorated operating environment in Russia. In addition, the reduction in foreign-currency denominated debt would reduce VimpelCom’s foreign currency risks at a time when two of its main functional currencies, the Russian rouble and Ukrainian hryvna, have sharply depreciated against the US dollar.
The offer is in line with VimpelCom’s stated plan to use the proceeds from the sale earlier this year of 51% in its indirect subsidiary Orascom Telecom Algerie SpA (Djezzy, unrated) to reduce debt. Although the $2.1 billion maximum amount of outstanding principal to be repurchased under the tender offer is lower than the group’s $3.8 billion of proceeds from the sale of a stake in Djezzy, we understand that VimpelCom will consider further options to reduce debt with the remaining proceeds from the deal.
VimpelCom’s ratings remain on review for downgrade.1 In addition to assessing the effect of the deteriorated operating environment in Russia and rouble depreciation on VimpelCom’s financial profile and liquidity, the review will take into account the outcome of the tender offer and its effect on VimpelCom’s financial metrics.
1 See Moody’s Reviews for Downgrade Ratings of 45 Russian Corporates, 23 December 2014.
Artem Frolov Vice President - Senior Analyst +7.495.228.6110 [email protected]
NEWS & ANALYSIS Credit implications of current events
10 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
NLMK Reduces Its Stake in NBH, a Credit Positive Last Wednesday, Russian steel company NLMK (Ba1 negative) announced that it had agreed to sell a portion of its stake in NLMK Belgium Holdings (NBH, unrated) to fellow NBH shareholder Societe Wallonne de Gestion et de Participations S.A. (SOGEPA, unrated). The transaction, which will reduce NLMK’s stake in NBH to 51% from 79.5% and increase SOGEPA’s stake in NBH to 49% from 20.5%, is credit positive for NLMK because it will reduce its financial exposure to the loss-making NBH.
We expect NLMK’s operating cash flows to improve as a result of its smaller stake in NBH. NLMK accounts for its investment in NBH by the equity method in its financial statements, reflecting its share in NBH’s net profits and losses, and for the nine months to 30 September 2014, NLMK’s share of net losses from its associates totaled $146 million, mainly because of its investment in NBH. Persistently low prices for steel products in Europe also resulted in an impairment loss on investments in NBH that totaled $83 million for the same period. Both factors negatively affected NLMK’s net profit, which totaled $627 million for the nine months to 30 September 2014, but would have been around $860 million excluding the NBH effects.
NLMK’s exposure to NBH via related-party loans to support NBH’s business activities also grew in 2014 as NBH burned through cash, with NLMK’s loans to NBH growing to $333 million at 30 September 2014 from $186 million at 31 December 2013. We expect that this transaction will be a precursor to NLMK substantially curtailing its loan exposure to NBH.
This transaction paves the way for NLMK to significantly reduce the guarantees it issues for NBH’s borrowings. As of 30 September 2014, these guarantees totaled $672 million. We treat these guarantees as a debt-like item and add them to our Moody’s-adjusted debt calculation, despite NLMK not including them as liabilities in its financial statements. If NLMK reduces its guarantees by half, reflecting its pro rata reduction in ownership, it would reduce the company’s Moody’s-adjusted debt/EBITDA by about 0.2x to 1.7x as of 30 September 2014.
NLMK will also benefit from the termination of SOGEPA’s put option on NLMK’s stake in NBH. In September 2013, as part of NLMK’s sale of a 20.5% stake in NBH to SOGEPA, NLMK and SOGEPA signed an option agreement that allowed SOGEPA to sell NLMK 5.1% of the common shares in NBH in 2016, 2017 and 2018, and any remaining stake after 2023. Terminating this option agreement will allow NLMK to focus on its higher-margin Russian business activities, while reducing its financial obligations under these options (which exceeded $80 million). It also sets the stage for NLMK to fully exit its investment in NBH sometime in the future.
As part of this transaction, NLMK and SOGEPA agreed to support NBH in obtaining financing for its working capital and to make pro rata contributions to NBH’s share capital. NLMK and SOGEPA also agreed to continue restructuring programmes at NBH, targeting a return to profitability NBH’s main production companies.
Despite having deconsolidated NBH since September 2013 and the stake reduction, NLMK continues to benefit from its business cooperation with NBH. During 2014, NBH companies purchased at market prices 1.91 million tonnes of slabs from NLMK, equal to 30% of total volume. The company expects this cooperation to continue in the future.
Denis Perevezentsev Vice President - Senior Analyst +7.495.228.6064 [email protected]
Karim Nagaria Associate Analyst +7.495.228.6068 [email protected]
NEWS & ANALYSIS Credit implications of current events
11 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
China Aoyuan’s Investment in Australian Property Project Is Credit Negative Last Tuesday, China Aoyuan Property Group Limited (B2 stable) announced that its 70%-owned joint venture had acquired a site in Sydney, Australia, for AUD121 million (RMB600 million). The acquisition is credit negative for China Aoyuan because it will weaken the company’s liquidity buffer and debt metrics, and raise its execution risk.
The cash outlay to acquire the site, the upfront cash support required before obtaining financing for construction, and the slow collection of cash proceeds from the sale of apartments it is developing will reduce China Aoyuan’s liquidity buffer over the next 12-24 months. China Aoyuan estimates the total sales value of project will be AUD400 million (RMB2 billion), equivalent to 16% of its 2014 contracted sales of RMB12.2 billion.
Cash collection will be slow because homebuyers in Australia pay most of the purchase price when they take delivery of the home. We estimate that construction of this project will take more than two years from now. Additionally, pre-sales proceeds that China Aoyaun receives from homebuyers are restricted and cannot be accessed until the company delivers the property.
Still, China Aoyuan’s cash on hand of RMB6.3 billion as of 30 June 2014 will be enough to cover its short-term debt of RMB3.0 billion as of 30 June 2014, unpaid land purchases in China of RMB2.0 billion and the cash outlay it needs to acquire the site. Also, its good contracted sales performance in 2014 of RMB12.2 billion, equal to year-on-year growth of 22%, supports the company’s cash position at the start of 2015.
China Aoyuan has an established brand name and track record in China’s Guangdong Province, but this is its first overseas project. It will take time for China Aoyuan to establish its brand in Australia and to understand the market dynamics and customer preferences. However, co-branding with its joint-venture partner Ecove (unrated), a local property developer with experience developing mid- to high-end residential and retail projects in Sydney, will reduce the development and execution risk.
The pool of buyers will also be relatively small given the high-end positioning of the project, whose apartments will sell for around AUD2.5 million on average. In addition, the Australian government’s announcement in late February that it plans to impose a fee on foreigners purchasing properties will weaken overseas demand, particularly for luxury properties. However, the project’s location in Sydney’s central business district and limited land supply nearby should support demand for the project.
The Australian land and construction costs will weaken China Aoyuan’s credit metrics slightly. Pro forma for the transaction, we estimate the company’s ratio of revenue to adjusted debt would drop to 45.5% from 47.1% for the 12 months ended 30 June 2014, while adjusted EBITDA/interest would remain at 1.1x because financing cost in Australia are lower than in China. But we expect China Aoyuan’s revenue to adjusted debt ratio to increase to 50%-55% in the next 12-18 months and adjusted EBITDA to interest to be 1.1x-1.2x, as increases in the company’s overall contracted sales will support the company’s revenue and EBITDA growth.
Gerwin Ho Vice President - Senior Analyst +852.3758.1566 [email protected]
Fiona Kwok Analyst +852.3758.1522 [email protected]
Victor Wong Associate Analyst +852.3758.1569 [email protected]
NEWS & ANALYSIS Credit implications of current events
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Hong Kong Developers Eye Slowdown after Prudential Measures on Mortgage Loans On 2 March, the Hong Kong Monetary Authority (HKMA) tightened its debt service ratio requirements for mortgage applicants, a measure that adds to other property mortgage loan measures put in place on 27 February to dampen demand in Hong Kong’s buoyant2 housing market. The new measures, which took effect upon their announcement, are credit negative for property developers because they will weaken demand for residential properties.
Among the affected rated Hong Kong-based property developers, Sun Hung Kai Properties (Capital Market) Ltd. (A1 stable) and Nan Fung International Holdings Limited (Baa3 stable) will likely face slower property sales and weakening cash flows given their significant exposure to the residential property market.
Sales of Sun Hung Kai’s upcoming Tseung Kwan O Town Lot No. 118 project launch, for instance, which has an attributable gross floor area of 721 thousand square feet for residential development and is mainly composed of small and midsize units, will likely be adversely affected. We expect that the company’s debt leverage, as measured by adjusted debt/capitalization, to increase to more than 17% from 16.6% at the end of December 2014, as it continues to fund its expansion with debt in light of slower property sales.
Specifically, the HKMA decreased the mortgage loan-to-value ratio (LTV) for self-use residential properties valued below HKD7 million, tightened the debt-service ratio (DSR) cap for borrowers who buy a second residential property for self-use, and lowered the maximum DSR of mortgage loans for non-self use properties. On 2 March, the HKMA further tightened the DSR requirement for mortgage applicants who seek additional funding if this causes the combined LTV ratio on their loan to exceed the applicable ceiling by 20 percentage points or more. Effective 27 February, the HKMA required banks to lower the maximum mortgage LTV ratio on self-use residential properties by 10 percentage points (see Exhibit 1).
EXHIBIT 1
Hong Kong’s Maximum LTV Ratios for Self-Use Residential Properties Valued below HKD7 million
Applicants’ Income Mainly Derived in Hong Kong
Applicants’ Income Mainly Derived Outside Hong Kong
Old New Old New
Applicants who have not borrowed or guaranteed other outstanding property mortgage loans
70% 60% 60% 50%
Applicants who have borrowed or guaranteed other outstanding property mortgage loans
70% 60% 50% 40%
Source: Hong Kong Monetary Authority
This is the first time in recent years that the HKMA has applied control measures that target small and midsize flats, which typically appraise at less than HKD7 million. This latest round of counter-cyclical measures will inevitably affect the home purchase plans of some, including first-time buyers.
Furthermore, the HKMA lowered to 40% from 50% the DSR cap for mortgage borrowers who buy a second residential property for self-use, and to 50% from 60% under the stressed-DSR3. Additionally, if a buyer
2 According to the Rating and valuation Department of Hong Kong, the residential home price index has surged 16.1% year over year
in January 2015. 3 Under stressed scenario, DSR is calculated with the assumption of an interest rate hike of 300 basis points.
Franco Leung Vice President - Senior Analyst +852.3758.1521 [email protected]
Victor Wong Associate Analyst +852.3758.1569 [email protected]
NEWS & ANALYSIS Credit implications of current events
13 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
seeks additional funding, such as through a second mortgage provided by Hong Kong Mortgage Corporation Limited or other non-bank financial institutions, such that the LTV ratio of the aggregate mortgage loans exceeds the applicable ceiling by 20 percentage points, the applicable DSR caps fall by an additional five percentage points.
In the recent past, property transaction volume growth for properties valued below HKD10 million has been robust. According to the Land Registry of Hong Kong, sales of these properties increased 56% year-over-year in the second half of 2014, and comprised 86% of all property transactions.
A February 2013 series of prudential measures, including the HKMA increasing stamp duties and thus the transaction costs on certain property transactions, led to a 30%-60% year-over-year decline in residential property transactions in subsequent months (see Exhibit 2).
EXHIBIT 2
Number of Sale and Purchase Agreements of Hong Kong Residential Building Units for 2013
Source: Land Registry of Hong Kong
The tightened DSR cap also applies to all non-self use properties, including residential properties, commercial and industrial properties and car park spaces.
The tighter financing requirements will weaken demand for non-residential properties. However, we do not expect material negative effects on our rated property investment companies, including Swire Properties Limited (A2 stable), Hong Kong Land Company Limited (A2 stable), The Link Real Estate Investment Trust (A2 stable), IFC Development (Corporate Treasury) Limited (A2 stable) and Hysan Development Co., Ltd. (A3 stable), because these long-term property investors typically do not rely on commercial property sales to maintain their liquidity profiles.
-70%
-50%
-30%
-10%
10%
30%
50%
70%
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13 Sep-13 Oct-13 Nov-13 Dec-13
Number - left axis Year-over-Year Change - right axis
NEWS & ANALYSIS Credit implications of current events
14 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
Infrastructure
RWE’s Completion of Dea Sale Is Credit Positive Last Monday, German utility RWE AG (Baa1 stable) announced that it had completed the sale of its international oil and gas exploration and production business RWE Dea AG (unrated) to LetterOne Group (unrated) for approximately €5.0 billion, including approximately €1 billion of net debt, based on current exchange rates. The transaction, which the companies announced in March 2014 and completed against a challenging political backdrop, is credit positive because it will reduce RWE’s net debt and will lower future annual capital expenditure outflows, thereby boosting cash flow generation.
RWE will use proceeds from the sale to reduce debt, in line with its efforts to strengthen its balance sheet. We expect RWE’s net reported debt to fall by around 15% to approximately €26 billion from nearly €30.7 billion at the end of December 2013. However, because of the company’s shrinking earnings and cash flows, the sale will not reduce RWE’s leverage, which may well exceed the 3.5x the company reported in 2013.
RWE recently announced that it would not meet its net leverage ratio target of 3.0x by 2016 owing to difficult market conditions. As a result of the Dea disposal, RWE will spend around €700 million less annually on capital expenditures. This is further progress toward RWE’s target for cash flows from operating activities covering investments and dividends by 2015. RWE’s capex programme (approximately €8 billion for 2014-16 excluding Dea) has been reduced to a maintenance level and the company expects to fund future growth projects with the proceeds of asset disposals or by finding an investment partner. The company is due to release its 2014 earnings on 10 March.
Despite the sale’s completion, uncertainty surrounds Dea’s UK assets, which include 12 North Sea oil and gas fields. LetterOne is an investment vehicle owned by Alfa Group, one of Russia’s largest privately held investment companies. If the European Union or US were to impose sanctions on LetterOne before the first anniversary of the deal’s completion, RWE would have to repurchase and sell these assets, which constitute approximately 20% of Dea’s gas production, to a third party.
RWE continues to face a challenging operating environment in its domestic market, as weak demand, low commodity prices and an increased penetration of renewables into the German electricity market put downward pressure on power prices and margins in conventional generation. The German one-off forward baseload is currently around €32 per megawatt-hour, versus €37 at the end of 2013.
Helen Francis Vice President - Senior Credit Officer +44.20.7772.5422 [email protected]
NEWS & ANALYSIS Credit implications of current events
15 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
Banks
Court Decision Moves Bank of America Closer to Credit-Positive Countrywide RMBS Resolution Last Thursday a New York State appeals court approved Bank of America Corporation’s (BAC, Baa2 stable) $8.5 billion settlement over mortgage repurchase claims involving private-label residential mortgage-backed securities (RMBS) originally issued by Countrywide Financial Corporation. The ruling upheld much of last year’s ruling by a lower court, but unlike that lower court ruling, the appeals court also approved the portion of the settlement covering certain repurchase claims related to modified loans. The decision is credit positive for BAC because it further reduces the risk of significant additional losses on mortgage repurchase claims.
The settlement covers a pool of mostly first-lien mortgages originated and sold by Countrywide via private label RMBS with an aggregate original balance of $409 billion. In June 2011, BAC reached a settlement with The Bank of New York Mellon (BNY Mellon) as trustee to pay $8.5 billion in settlement of RMBS investors’ repurchase claims over those loans. The bank provided for the full $8.5 billion at the time of the settlement and the amount is included within the bank’s existing repurchase reserves. However, the settlement was made subject to court approval, which has been pending ever since.
In January 2014 a lower court found that with one exception, BNY Mellon did not abuse its discretion as trustee and did not act in bad faith or outside the bounds of reasonable judgment. The exception involved the repurchase claims involving modified loans. The judge found that BNY Mellon, by agreeing to include such loan modification claims within the larger settlement without investigating their potential worth or strength, acted unreasonably or beyond the bounds of reasonable judgment on that issue. BNY Mellon appealed this ruling, as did several investors who objected to the settlement (i.e., the objectors).
In last week’s ruling, the appeals court (the New York Appellate Division, First Department) agreed with the lower court that BNY Mellon did not abuse its discretion or act unreasonably or in bad faith, and also ruled that the lower court’s exception regarding the modified loans was inappropriate. The appeals court said that by making such an exception, the lower court was “improperly imposing a stricter and far less deferential standard, one that allows a court to micromanage and second guess the reasoned, and reasonable decisions of a Trustee.”
Since the 2014 ruling, several objectors have withdrawn, but a handful remain. The remaining objectors have 30 days to request a hearing before the New York Court of Appeals, the highest court in the state. However, given that the appeals court ruling was unanimous, they might have a difficult time gaining approval for any such request.
In addition to being credit positive for BAC, by limiting the scope of New York courts to second guess the decisions of a trustee, the ruling is also credit positive for other cases pending under the same New York law, most notably cases involving RMBS settlements reached by JPMorgan Chase & Co. (A3 stable) and Citigroup Inc. (Baa2 stable).
David Fanger Senior Vice President +1.212.553.4342 [email protected]
NEWS & ANALYSIS Credit implications of current events
16 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
Federal Reserve Stress Test Shows US Banks’ Capital Improved Last Thursday the US Federal Reserve published the results of the 2015 Dodd-Frank Act stress test (DFAST) for 31 of the largest US bank holding companies. In addition, 23 banks released their own stress test results by close of business Friday. The results of both the Fed- and bank-conducted tests show higher US banks’ capital ratios under a severely adverse stress scenario, a credit positive.
All 31 banks tested exceeded the 5.0% minimum required Tier 1 common capital ratio under the Fed’s severely adverse stress scenario, and the aggregate ratio of the group improved to 8.2% in 2015 compared with 7.6% in 2014. Nonetheless, the capital ratios of some banks still declined materially under the Fed’s test, underlining the importance of the Fed’s annual process, which forces banks to incorporate stress conditions when evaluating their own capital adequacy. Several banks in fact made more conservative loss assumptions in their own tests compared with 2014, which will dampen any requests to return capital to shareholders.
Exhibit 1 compares the banks’ minimum Tier 1 common capital ratios under the Fed’s severely adverse scenario with their actual Tier 1 common capital ratios reported at 30 September 2014. Most, but not all, comfortably exceeded the 5% required minimum. Zions Bancorporation (Ba1 stable) had the lowest minimum ratio of 5.1% despite the equity it raised during 2014 in response to missing the minimum in last year’s Fed stress test. The positive outliers are Deutsche Bank Trust Corporation (Baa2 negative), which benefits from a very high starting capital position, and two credit card banks, Discover Financial Services (Ba1 stable) and American Express Company (A3 stable), which benefit from high starting capital ratios as well as very high earnings.
Rita Sahu, CFA Vice President – Senior Analyst +1.212.553.1648 [email protected]
David Fanger Senior Vice President +1.212.553.4342 [email protected]
NEWS & ANALYSIS Credit implications of current events
17 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
EXHIBIT 1
US Banks’ Tier 1 Common Ratios under the Federal Reserve’s Severely Adverse Scenario and Actual Ratios at 30 September 2014 Most banks comfortably exceeded the 5% minimum, but there is wide variation.
Note: The 31 US Bank Holding Companies Participating in the DFAST Exercise are: AXP = American Express Company; Ally = Ally Financial Inc.; BAC = Bank of America Corporation; BBT = BB&T Corporation; BBVA Compass = BBVA Compass Bancshares, Inc.; BK = Bank of New York Mellon Corporation; BMO Fin. = BMO Financial Corp., C = Citigroup, Inc.; CMA = Comerica Incorporated; COF = Capital One Financial Corporation; DB: Deutsche Bank Trust Corporation; DFS = Discover Financial Services; FITB = Fifth Third Bancorp; GS = Goldman Sachs Group, Inc.; HBAN = Huntington Bancshares Incorporated; HSBC N.A. = HSBC North America Inc.; JPM = JPMorgan Chase & Co.; KEY = Keycorp, MS = Morgan Stanley; MTB = M&T Bank Corporation; NTRS = Northern Trust Corporation; PNC = PNC Financial Services Group; Inc.; RBS Citizens = RBS Citizens Financial Group, Inc.; RF = Regions Financial Corporation; SHUSA = Santander Holdings USA, Inc.; STI = SunTrust Banks; Inc.; STT = State Street Corporation; UB = UnionBanCal Corporation, USB = U.S. Bancorp; WFC = Wells Fargo & Company; ZION = Zions Bancorporation. Ratings in the exhibit are the banks’ holding company senior rating. Source: US Federal Reserve
Even though all of the banks passed the test threshold of 5.0% minimum Tier 1 common, the results indicate that many banks, including some of the poorest performers from the previous test, would still have sizeable losses under the Fed’s severely adverse stress scenario. For those banks, it was their comparatively high initial capital ratios that allowed them to meet the Fed’s minimum capital level. This result underlines the importance of the Fed’s annual process, which forces banks to incorporate stress conditions when evaluating their own capital adequacy.
Exhibit 2 compares the banks’ reported Tier 1 common capital ratios at 30 September 2013 and 2014 with their ratios under the Fed’s severely adverse scenarios for 2014 and 2015. The minimum Tier 1 common ratios of Morgan Stanley (Baa2 positive), Goldman Sachs Group (Baa1 stable) and Zions under the Fed’s 2015 test were 880 basis points (bp), 810 bp and 680 bp, respectively, below their actual third-quarter 2014
0%
2%
4%
6%
8%
10%
12%
14%
16%
Actual Tier 1 Common Ratio Minimum Tier 1 Common Ratio in Stress Test5% Required Tier 1 Common Ratio
Off scale at 36.6%
& 34.7%
NEWS & ANALYSIS Credit implications of current events
18 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
levels. These stress Tier 1 common ratio losses increased at Morgan Stanley and Goldman compared with 2014 results. Zions’ stress loss declined slightly in 2015; its stress loss is driven by the Fed’s projected earnings, which are the lowest of the DFAST participants.
EXHIBIT 2
Decline in Banks’ Tier 1 Common Ratios Under the Federal Reserve’s Severely Adverse Scenario Stress losses are lower for many banks, but some names again suffer high losses.
Source: US Federal Reserve
Some banks also had notable changes in stress losses from 2014 to 2015. For example, BB&T Corporation’s (A2 negative) stress loss increased 240 bp in 2015, to the middle of the peer group, from only 100 bp and among the three lowest stress losses in 2014. However, the increase is likely driven primarily by BB&T’s pending acquisition of Susquehanna Bancshares, Inc. (Baa2 review for upgrade), which BB&T included in its own company-run stress test. The transaction, which is expected to close during the period covered by the stress projections, will result in a decline in BB&T’s capital ratios. This plus the need for additional stressed loan loss provisions on BB&T’s enlarged loan portfolio appears to be to a principal reason for the decline in its stress ratios compared with last year.
On a positive note, this year nine banks (30%) reported stress test results more conservative than the Fed’s compared with just six banks (20%) in last year’s test, a credit positive for these banks in that it will dampen their request to return capital to shareholders. Exhibit 3 shows the difference between the Fed’s results and the banks’ own tests for the minimum Tier 1 common ratio that would be reported over the testing time horizon. For example, Keycorp (Baa1 stable) and U.S. Bancorp (A1 stable), which last year had calculated losses 600 bp and 300 bp below the Fed’s result, respectively, now exceed the Fed’s losses by 500 bp and 600 bp.
-9%-8%-7%-6%-5%-4%-3%-2%-1%0%
2015 2014
NEWS & ANALYSIS Credit implications of current events
19 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
EXHIBIT 3
Difference in Minimum Tier 1 Common Ratio under Federal Reserve’s and Bank-Run Stress Tests Most banks had less conservative loss assumptions than the Fed; a negative result indicates the Fed’s stress test was more severe.
Source: US Federal Reserve
-5.7%
-3.5%-2.4%
-2.2%-2.0% -2.0%-1.2%-1.0%-1.0%-0.9%-0.5%-0.5%-0.4%-0.3%
0.4%0.5% 0.6% 0.8% 0.8%1.3% 1.6% 1.7%
2.2%
-7%-6%-5%-4%-3%-2%-1%0%1%2%3%
NEWS & ANALYSIS Credit implications of current events
20 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
AWAS Aviation Capital’s Sale of 90 Aircraft Is Credit Negative Last Wednesday, commercial aircraft leasing company AWAS Aviation Capital Limited (Ba3 stable) and its owners Terra Firma and Canada Pension Plan Investment Board announced that the company will sell 90 aircraft, nearly 30% of its total fleet, to Macquarie Group Limited (A3 stable) for $4 billion. The sale is credit negative because distributions of the sale’s net proceeds and capital will increase leverage and the company’s fleet composition will shift toward older aircraft and twin-aisle models that increase the company’s remarketing risks.
AWAS will distribute net proceeds from the aircraft sale to shareholders and, we expect, also pay dividends, thereby increasing the company’s leverage. The company’s effective leverage (debt divided by tangible net worth) measured 2.3x at fiscal 2014 year end (30 November 2014), but will likely trend toward 3.0x over the next few years (Exhibit 1). The company’s ratio of tangible common equity to tangible managed assets was 27% at the same date and we estimate 21%-23% over the next few years. AWAS’ leverage was lower than most peers while it grew through the purchase of a significant number of new aircraft from Airbus and Boeing. But with only 16 aircraft remaining in its order book as of 30 November 2014, nearly all of which are committed to leases, we expect that AWAS’ leverage will climb somewhat higher than its historical average.
EXHIBIT 1
AWAS Aviation Capital Leverage Trends Leverage will increase after its sale of 90 aircraft.
Sources: AWAS Aviation Capital and Moody’s Investors Service estimates
AWAS’ strategy remains focused on acquiring aircraft primarily through sale-leaseback transactions and purchases of used aircraft from other owners. The sale of 90 newer aircraft accelerates the alignment of AWAS’ fleet composition with its investment strategy. We expect that the company will acquire fewer new aircraft directly from manufacturers, which reduces the speculative lease-up and funding risks associated with new order positions. However, the company’s shift to somewhat older aircraft investments requires that it maintain a robust capital position.
The aircraft sale will moderately increase the risk profile of AWAS’ remaining fleet. The 90 aircraft being sold equal about 29% of AWAS’ existing fleet and include recent vintage narrow-body aircraft (Airbus A320 and Boeing 737-800; 90% by value) and twin-aisle aircraft (Airbus A330) with an average age of two years (see Exhibit 2). After the sale, AWAS’ portfolio will become somewhat more weighted toward older aircraft and wide-body aircraft with lower average remaining lease terms than the aircraft being sold. As a result, AWAS’ committed future revenues are lower and its revenue and earnings volatility will be higher. Additionally, the shift in fleet composition increases AWAS exposure to aircraft remarketing risks.
0%
5%
10%
15%
20%
25%
30%
35%
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
2009 2010 2011 2012 2013 2014 2015-16E
Effective Leverage - left axis Tangible Common Equity/Tangible Managed Assets - right axis
Mark Wasden Vice President - Senior Credit Officer +1.212.553.4866 [email protected]
NEWS & ANALYSIS Credit implications of current events
21 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
EXHIBIT 2
AWAS Aviation Capital’s Existing versus Sold Fleet Characteristics The fleet composition will shift to older aircraft and wide-body aircraft after the sale.
Owned1
$ Millions Sale Portfolio
$ Millions
Total Portfolio $ 11,796 $ 3,600
Narrow-Body $8,902 $3,240
Percentage of Fleet 75% 90%
Wide-Body $2,894 $360
Percentage of Fleet 25% 10%
Average Age Weighted by Current Market Value 4.9 years2 2.0 years
Average Remaining Lease Term Weighted by Current Market Value 5.8 years2 6.5 years
1 As of 30 November 2014, including purchase commitments of $1.1 billion.
2 Reflects only AWAS’ owned portfolio.
Sources: AWAS, Macquarie Group and Moody’s Investors Service estimates
AWAS’ owners have stated that they will continue to explore avenues for maximizing the returns from their AWAS investments, which could result in additional asset sales or an outright sale of the company. This increases the risks that the company’s investment strategies, risk tolerance and capital management will change.
NEWS & ANALYSIS Credit implications of current events
22 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
Springleaf’s Acquisition of OneMain Is Credit Negative for Both Last Tuesday, Springleaf Holdings, Inc. (B2 review for downgrade) announced its plan to acquire OneMain Financial Holdings, Inc. (B2 review for downgrade) from Citigroup Inc. (Baa2 stable) for $4.25 billion in an all cash transaction. The transaction is credit negative because it increases Springleaf’s leverage, weakens its liquidity, and introduces integration risk because of its size.
The acquisition will bring together the two largest branch-based consumer finance companies in the US, each with complementary strategies and locations. The combination is likely to drive growth, but even if the integration is executed as planned, we cannot assess whether it will drive performance improvements that will strengthen the franchise positioning of the combined entity.
We estimate that Springleaf’s balance sheet leverage, measured as tangible common equity to tangible managed assets, will weaken substantially. The deterioration in leverage would result from the additional borrowing of approximately $1 billion that Springleaf is contemplating at the time of the acquisition and from the assumption of OneMain’s debt. The small size of Springleaf’s pro forma tangible equity buffer compared to the combined assets of the two companies substantially reduces its loss-absorption capacity. Under US GAAP, the acquisition would be considered a business combination. Given that the acquisition will be 100% cash-financed, we assume that Springleaf’s pro forma total equity will not change at the time of the acquisition, assuming no capital actions. The premium paid by Springleaf over the fair market value of OneMain’s net assets would be recognized as goodwill on the acquisition date.
As shown in Exhibit 1, we estimate goodwill and other intangible assets of approximately $2 billion based on the difference between the purchase price of $4.25 billion and the book value of OneMain’s equity of $1.8 billion (adjusted for the $1.5 billion dividend to parent Citi) and assuming that some of the purchase price premium is allocated to OneMain’s identifiable tangible assets.
EXHIBIT 1
Springleaf’s Tangible Common Equity as a Percent of Tangible Managed Assets Tangible capital cushion weakens after the OneMain acquisition.
Note: For 30 September 2014 (third quarter 2014 in the exhibit), tangible common equity and tangible managed assets are both adjusted for the
intangible assets as of 31 December 2013, as no such disclosure is available on a quarterly basis. Sources: Springleaf, OneMain S1 and Moody’s Investors Service estimates
Springleaf’s liquidity will also materially weaken, given that the transaction will be cash-financed. The combined entity’s primary source of liquidity will be Springleaf’s conduit facilities ($1.2 billion as of second-
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
20%
22%
24%
2012 2013 3Q14 Pro forma
Anna Sherbakova Analyst +1.212.553.7946 [email protected]
Mark Wasden Vice President - Senior Credit Officer +1.212.553.4866 [email protected]
NEWS & ANALYSIS Credit implications of current events
23 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
quarter 2014) and OneMain’s secured warehouse facility ($3 billion as of February 20154), as well as proceeds from a potential sale or financing of Springleaf’s remaining non-core real estate loans. Although most of Springleaf’s assets are encumbered, its purchase of OneMain provides access to additional unencumbered assets that could be securitized, subject to market conditions. Post-acquisition, the company will need to build a liquidity buffer commensurate with the heightened liquidity risk stemming from a large acquisition that might require additional unforeseen expenses beyond day-to-day operating and financing needs, for at least next 12 months. Unanticipated expenditures could result from costs to adhere to heightened regulatory oversight; regulation could also impose other restrictions on the firm’s operations that affect the scope of its activities and its pricing.
The size of the business combination will result in operational challenges until the transition is completed. Measured on a core loan portfolio basis, OneMain is more than twice the size of Springleaf (Exhibit 2). At the same time, OneMain’s financial performance is strong, reflecting per-branch profitability and overhead that compares favorably with Springleaf’s weaker financial performance.
EXHIBIT 2
Comparison of Springleaf and OneMain at 30 September 2014 OneMain is larger and more profitable than Springleaf
Springleaf OneMain
Consumer loans, including auto, $ millions $3,607 $8,278
SpringCastle portfolio 2,083 0
Real estate loans 655 0
Retail sales finance 57 0
Net finance receivables, $ millions $6,402 $8,278
Number of branches 827 1,140
Number of states 26 43
Average consumer FICO score ~600 629
Consumer loan average size $4,200* $6,200
Receivables per branch, $ millions $4.3 $7.3
Core return on assets in first nine months of 2014 1.7% 5.7%
* As of 31 March 2014.
Sources: Springleaf, OneMain S1 and Moody’s Investors Service estimates
The combined entity will be run as separate companies, with senior management of both businesses in place, until integration of systems and consolidation of certain branches commences in mid-2016. If the integration is executed as planned, growth is pursued with adequate regard for liquidity and underwriting risks, and the capital buffer is strengthened, the combined entity’s performance could improve and its creditworthiness increase.
4 As of 30 September 2014, OneMain had $3.4 billion of related party debt outstanding, which we expect to be paid off prior to
consummation of the acquisition, possibly with funds from the $3 billion warehouse line.
NEWS & ANALYSIS Credit implications of current events
24 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
Annulment of ECB Policy on Euro Clearing Is Credit Positive for Non- EU Clearinghouses Last Wednesday, the European Union’s (EU) General Court annulled a European Central Bank (ECB) policy that would have required clearinghouses that clear large euro-denominated trades to be located in the euro area. The annulment is credit positive for non-euro-area clearinghouses such as CME Group Inc. (Aa3 stable), NASDAQ OMX Group, Inc. (NDAQ, Baa3 stable), Intercontinental Exchange, Inc. (ICE, A2 stable) and London Stock Exchange Group plc’s (Baa2 negative) majority-owned LCH.Clearnet Ltd. (unrated) because the ECB policy would have likely led to a decline in clearing activity, increased costs and additional operational risk.
The policy would have applied to clearing business in which the central counterparty clearinghouse (CCP) has more than €5 billion in daily net credit exposure in major euro-denominated products,5 or more than 5% of the aggregated daily net credit exposure of all CCPs for such products.
Had the court upheld the ECB policy, clearing members would have been more likely to move their clearing business to euro area domiciled CCPs, or to those CCPs outside the EU that are not subject to the policy.6 CCPs’ costs would have risen as they incurred additional operational and legal expenses when they established, or shifted, their euro clearing business to the euro area. Those cost increases could have affected CME and NDAQ more than ICE or LCH.Clearnet because neither CME nor NDAQ has euro area affiliates.
The ECB policy also would have created additional operational risk, as the shift to the euro area would have involved re-establishing a multitude of relationships with clearing members, counterparties, payment systems and custody banks.
Wednesday’s court decision concludes a challenge that the UK filed in 2011 against the ECB policy. In its decision, the court in part stated that the “ECB does not have the competence necessary to regulate the activity of securities clearing systems.” The ECB has the right to appeal the ruling.
The ECB in 2011 issued its location policy on euro-denominated clearing as part of the Eurosystem Oversight Policy Framework, and would have set a location requirement for CCPs established in EU member states not part of the euro area. The ECB’s goal was to help facilitate the ECB’s role in the oversight of payment, clearing and settlement systems. Less than 2% of euro-denominated OTC interest rate and credit default swaps are cleared within the euro area.
5 Although not defined, this likely refers to OTC derivatives for the following asset classes: commodities, credit, equities, foreign
exchange and interest rates. 6 It is possible that CCPs not subject to the ECB policy (e.g., CCPs domiciled in the US) would be able to clear euro-denominated
transactions whereas CCPs in EU member states subject to the ECB policy, however not domiciled in the euro area, would have been prevented from doing so.
Michael Eberhardt, CFA Vice President - Senior Credit Officer +44.20.7772.8611 [email protected]
Laurie Mayers Associate Managing Director +44.20.7772.5582 [email protected]
NEWS & ANALYSIS Credit implications of current events
25 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
ING Completes Full Disposal of Its US Insurance Subsidiary, a Credit Positive Last Tuesday, ING Groep N.V. (A3 negative) sold its remaining 18.9% investment in its US life insurance subsidiary Voya Financial, Inc. (Baa2 stable). The sale, ING’s fifth since it began divesting Voya in May 2013, is credit positive for ING Groep because it fully eliminates double leverage and nearly completes its restructuring with negligible remaining execution risk. ING Groep sold the remaining stake in Voya, which equals approximately 45.6 million shares, via a public offering and a buyback transaction that Voya Financial undertook, both at $44.20 per share.
The sale of Voya will generate around $2 billion (€1.8 billion) for ING Groep, resulting in a disposal profit of €286 million and a 60-basis-point improvement in the group’s Basel III fully loaded capital ratio from 10.5% at the end of 2014. The transaction will have no effect on ING Groep’s banking subsidiary, ING Bank N.V. (A2 negative, C-/baa1 stable7) because the bank is separately capitalised.
ING Groep has yet to indicate how it will use the proceeds from the sale, but we expect that at least a portion will go to ING Bank, whose capitalisation, although adequate for its risk profile, is the lowest among its domestic peers (see exhibit), although more in line with European peers. We do not expect ING Groep to return any excess funds to shareholders until the European Central Bank/Single Supervisory Mechanism finalises ING Bank’s future capital requirements, including leverage.
Common Equity Tier 1 Ratios for Large Dutch Banks as of the End of 2014
Notes: Data for SNS Bank N.V. is as of the end of June 2014. Capital ratios for ING Bank are fully loaded Basel III ratio, and for ABN AMRO and SNS
Bank are fully loaded CRDIV/CRR. Source: The banks
The sale is also credit positive for Voya, whose complete and successful separation from ING without damage to its franchise has for some time been factored into our view of the company’s standalone creditworthiness. Voya’s subsequently announced repurchase of $600 million shares as part of ING’s sale will reduce capital and increase its financial leverage by about half percentage point to 19%-20%, although within our expectations for the group’s regulatory capital adequacy and financial leverage.
The European Commission mandated that ING Groep restructure following the Dutch government’s €10 billion capital injection in 2008 at the height of the financial crisis. As a condition of the rescue, ING Groep had to fully dispose of its insurance and investment management operations. ING still owns a 54.6% stake in NN Group N.V. (Baa2 stable), corresponding to a market value of around €5.1 billion and broadly in line
7 The rating for ING Bank N.V. is its deposit rating, its standalone bank financial strength rating/baseline credit assessment and the
corresponding rating outlooks.
0%
2%
4%
6%
8%
10%
12%
14%
16%
ING Bank N.V. ABN AMRO Bank N.V. SNS Bank N.V.* Rabobank Nederland
Andrea Usai Vice President - Senior Credit Officer +44.20.7772.1058 [email protected]
Laura Bazer Vice President - Senior Credit Officer +1.212.553.7919 [email protected]
NEWS & ANALYSIS Credit implications of current events
26 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
with the book value. NN Group comprises ING Groep’s residual European and Japanese insurance activities, and we expect ING Groep to sell this business ahead of its target date of the end of 2016.
Once ING Groep completes the sale of its insurance operations, it will become a pure bank holding company, with stakes limited to its investment in ING Bank. We expect the bank to maintain the holding company to issue bail-inable debt as part of the requirements of the Bank Recovery and Resolution Directive.
NEWS & ANALYSIS Credit implications of current events
27 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
Insurers
Sun Life Financial’s Pension Risk-Transfer Agreement with BCE Is Credit Positive Last Tuesday, Sun Life Financial, Inc. (SLF, Baa2 (hybrid) stable), parent company of Sun Life Assurance Company of Canada (SLA, insurance financial strength Aa3 stable), announced that SLA and BCE Inc. (Baa2 stable) had reached a pension risk-transfer agreement, under which BCE would transfer longevity risk for CAD5.2 billion of pension liabilities to SLA.
The deal is credit positive for SLA because it diversifies the company’s earnings away from mortality risk. Given SLA’s actuarial, asset liability management and investment expertise, it has the resources to participate in the growth of the pension risk-transfer market in Canada. The transaction provides prospective earnings and some risk diversification, and although not a perfect hedge, the longevity risk somewhat offsets SLA’s large block of mortality exposure on its life insurance business. Future earnings include a syndication fee for managing the transaction. SLA reported that it ceded the majority of the longevity risk to a reinsurance syndicate.
The agreement is an inaugural transaction in Canada, allowing BCE to transfer from its pension scheme to SLA and a reinsurance syndicate the risk of BCE pensioners living longer than the company expected. BCE’s pension plan will make monthly payments to SLA, which in return will make monthly outlays into the plan for as long as current pensioners live (see exhibit). BCE, Canada’s largest communications company, will continue to administer the plan as the plan’s sponsor.
Schematic of BCE’s Pension Longevity Risk Transfer to Sun Life Financial
Source: Moody’s Investors Service
The key risk that SLA faces in this transaction is that pensioners outlive SLA’s pricing assumptions. To mitigate this risk, SLA will reinsure a portion of this longevity risk to a syndicate, including Reinsurance Group of America, Inc. (Baa1 stable) and SCOR Global Life SE (insurance financial strength A1 stable). Syndicating the transaction leaves SLA with incremental appetite to transact additional similar longevity swaps in the future. It also opens the door for alternative pension de-risking opportunities, such as the provision of liability driven investment strategies and services to pension sponsors.
Pensioners
BCE Inc.’s Pension
Sun Life Assurance Company of Canada
Agreed Schedule of Premium Payments
Actual Benefit Payments
Benefit Payments
David Beattie Senior Vice President +1.416.214.3867 [email protected]
Fadi Abdel Massih Associate Analyst +1.416.214.3834 [email protected]
NEWS & ANALYSIS Credit implications of current events
28 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
As a response to the apparent trend of greater longevity, SLF has recently increased its assumed rate of future mortality improvement in its valuation of insurance contract liabilities including annuities. The net effect was a decrease of CAD347 million in net income for the fourth quarter of 2014.
We believe that the pension risk-transfer agreement with BCE will hedge mortality risk and we expect more longevity transactions in Canada, which will generate revenue opportunities and diversify SLA’s longevity risk.
NEWS & ANALYSIS Credit implications of current events
29 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
Demutualization of Canadian Property and Casualty Insurers Is Credit Negative On 28 February, Canada’s Department of Finance released for comment draft regulations on the demutualization of Canada’s property and casualty (P&C) insurers. The draft outlines a detailed framework for an insurer owned by its policyholders to convert to a share-based company. Demutualization is credit negative for Canadian mutual P&C insurers because these companies are likely to adopt a more aggressive capital structure and a focus on shareholder returns, both of which often reduce creditworthiness.
Demutualization involves allocating the accumulated value of a mutual insurer among policyholders when it converts to a stock company. The value per policyholder depends on factors such as policy size, time since policy was issued and the amount of premiums paid. The Department of Finance’s framework calls for an insurer to be valued by an independent valuation expert and for an independent actuary to express an opinion on any proposed surplus apportionment. Once the board of a mutual insurer has approved the company’s demutualization, Canada’s minister of finance gives the final approval.
According to the Canadian Association of Mutual Insurance Companies, there are just over 100 mutual insurers in Canada, with a market share of about one third of the Canadian P&C industry. The framework would apply only to Canadian federally regulated mutual P&C participants, which consist of seven insurers (see exhibit). However, we expect ancillary effects on non-federally regulated mutual insurers that will face increased competitive pressures from larger industry participants.
Canada’s Federally Regulated Mutual Property and Casualty Insurers
Direct Written Premiums for Nine Months Ended 30
September 2014 (CAD Millions) OSFI Minimum Capital Test Ratio (Third-Quarter 2014)
Wawanesa Mutual (unrated) 1,950 300%
Economical Mutual (unrated) 1,467 290%
Gore Mutual (unrated) 269 230%
Portage la Prairie Mutual (unrated) 165 223%
North Waterloo Farmers Mutual (unrated) 70 279%
Saskatchewan Mutual (unrated) 47 293%
The Kings Mutual (unrated) 6 972%
Domestic P&C Insurer Average 242%
Sources: Canada Department of Finance and Canada Office of the Superintendent of Financial Institutions
Economical Mutual (unrated) and Wawanesa Mutual (unrated) rank among the top 10 largest P&C insurers in Canada, while the remaining five are much smaller and operate in rural areas of the country. The framework is particularly important for Economical, which announced demutualization plans in 2010, citing growth ambitions as a major factor in becoming a stock company. Wawanesa, Canada’s largest mutual insurer, has not expressed similar views.
We believe there are key differences between stock-based and mutual ownership that affect an insurer’s credit quality. Stock-based insurers must balance the inherent tension between the interests of policyholders with those of shareholders. As an example, the pressure for shareholder dividends may lead to some degree of decapitalization, resulting in lower capital ratios. As shown in the exhibit, five of the seven federally regulated mutual P&C insurers have minimum capital test ratios considerably higher than the domestic P&C insurer average.
Demutualization will reinforce the consolidation trend occurring in the industry, leading to a more concentrated market. We see many parallels to Canada’s life insurance industry, which began to
Jason R. Mercer, CFA Assistant Vice President - Analyst +1.416.214.3632 [email protected]
Lan Wang Associate Analyst +1.416.214.3853 [email protected]
NEWS & ANALYSIS Credit implications of current events
30 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
demutualize in 1999. In 1997, there were 140 life insurance companies in Canada and an insurer with a market share greater than 10% was rare. Today, there are about half that number of life companies and the three largest insurers have combined market share of between 60% and 70%. We expect that over time there will be more consolidation among mutual insurers as they compete against stock companies, which will have greater competitive advantages in terms of size, economies of scale and distribution technologies.
NEWS & ANALYSIS Credit implications of current events
31 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
Argentine Insurers’ New Reserve Rules Are Credit Positive Last Tuesday, the Argentine insurance regulator Superintendencia de Seguros de la Nación (SSN) published new guidelines, effective 30 June, to strengthen insurers’ premium deficiency reserves. The new guidelines are credit positive because they will reinforce insurers’ balance sheet strength, quality of earnings and, ultimately, capital adequacy.
A revised calculation base for this reserve will ensure a stronger cushion against inadequate risk pricing and is one of the key changes in the new resolution. Because the new base will increase upfront costs to companies with underwriting losses, which is the case for most P&C insurers, it should also prompt a more disciplined approach to pricing in Argentina’s intensely competitive property-casualty sector, which is likely to dampen cyclical volatility.
Another notable change is that gains from investment income used to offset reserve losses are limited to no more than 14% of the insurers’ net earned premiums. This measure should blunt insurers’ readiness to reach for yield to offset underwriting losses in net income, a practice that has elevated investment risk.
The new regulations will have the biggest credit-positive effect on insurers with significant underwriting losses, although in the short term they could see significant pressure on their capitalization and solvency margins. Those insurers’ will be able to ease the implementation burden by amortizing the higher reserve over two years. Conversely, insurers that have substantial capital cushions will be able to fund their reserves with little more than a short-term operating loss, and will emerge with strong reserves and adequate capital.
In the exhibit below, we estimate the additional required reserve for insurers that posted premium deficiency reserves (PDR) and unearned premium reserves as of 30 June 2014 for which the effect is greater than ARS1 million. Our three rated insurers, ALLIANZ Argentina Compania de Seguros S.A. (financial strength B1 negative), Chubb Argentina de Seguros (financial strength B1 negative), and Provincia Seguros (financial strength Caa1 negative), are among those insurers with the largest projected effect.
Estimate of Additional Regulatory Reserve Requirement for Argentine Insurers, ARS Millions
Insurer Premium Deficiency
Reserve [A] Moody’s Estimate of
New PDR [B] Additional Reserving Requirement [B] - [A]
Allianz Argentina 41 136 94.8
MAPFRE Argentina 17 81 63.8
Zurich Argentina Compañia de Seguros 63 88 24.5
Chubb Argentina 5 17 12.0
Provincia Seguros 0 8 8.2
Liderar Compañia General de Seguros 6 12 5.9
Nación Seguros 3 7 4.6
Paraná Sociedad Anonima de Seguros 4 8 3.6
La Meridional 3 7 3.4
Segurcoop Cooperativa de Seguros Limitada 4 7 3.3
La Holando Sudamericana Compañia de Seguros 2 5 2.8
Prudencia Compañia Argentina de Seguros 1 2 1.9
Metlife Seguros 0 2 1.9
Caminos Protegidos Compañía de Seguros 0 1 1.3
Compañía de Seguros El Norte 0 1 1.2
Prudential Seguros 0 1 1.2
Note: We expect companies’ actual PDR will differ from our estimates because we do not incorporate all regulatory changes.
Source: Superintendencia de Seguros de la Nación
Diego Nemirovsky Vice President - Senior Credit Officer +54.11.5129.2627 [email protected]
NEWS & ANALYSIS Credit implications of current events
32 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
Although the SSN has been active over the past decade in establishing new safety reserves and minimum capital and solvency standards for insurers, we believe that Argentine insurers still trail the more advanced insurance markets in their adoption of international accounting and solvency practices to address the broadest array of financial risks.
NEWS & ANALYSIS Credit implications of current events
33 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
Asset Managers
Pennsylvania Governor’s Plan to Reduce Pension Fund Costs Is Credit Positive for Large Passive Asset Managers Last Tuesday, Pennsylvania Governor Tom Wolf presented his 2015-16 fiscal year budget to Pennsylvania legislators. The budget includes a proposal to slash investment costs in the state’s two largest pension funds by shifting more assets into low-cost index funds. Governor Wolf’s proposal to increase investments in index funds is credit positive for large passive asset managers such as BlackRock, Inc. (A1 stable), Vanguard (unrated) and State Street Global Advisors (a subsidiary of State Street Corporation, A1 stable) because these firms will be the biggest beneficiaries of the strategic reallocation.
Conversely, the shift is credit negative for active asset managers because this proposal is yet another sign of investors’ increasing preference for lower-cost passive products. Governor Wolf’s public cry against active asset managers’ high fees is likely to spur a broader reexamination of fees paid to external active managers across public pension funds and lead to further increases in allocation to lower cost index funds.
Governor Wolf’s push to save money on management fees stems from his election promise to strengthen the funding position of Pennsylvania’s state and municipal pension systems, an issue facing many US states. Management costs for Pennsylvania’s two largest pension funds have generally exceeded those of public peers. In fiscal year 2014-15, Pennsylvania Public School Employees’ Retirement System and Pennsylvania State Employees’ Retirement System investment management fees and expenses totaled approximately 0.9% and 0.5% of fund assets, respectively.
Pennsylvania is not alone in its mission to reduce pension fund expenses. Other states, including California, have already taken bold action to reduce investment costs. Last September, California Public Employee Retirement System (Aa2 stable) exited all hedge fund investments to reduce the fund’s portfolio complexity and risk and investment management costs.8 A driving force behind this movement is active managers’ inability to consistently generate returns in excess of benchmark returns net of fees. Reducing the amount of assets that go to pay investment management fees annually, all else being equal, has a positive effect on investment returns and higher returns in turn help narrow pension systems’ funding shortfalls.
According to investment consultant Greenwich Associates, public pension funds’ adoption of lower-cost passive investment strategies, while having increased to 19%, continues to trail the 30% rate of individuals. The gap in adoption rates is a significant asset-gathering opportunity for the largest passive managers. While Governor Wolf's proposal, if implemented, would drive flows to large passive managers, the potential asset-under-management (AUM) opportunity is not meaningful given the funds’ relatively small size (approximately $80 billion in combined assets). However, Pennsylvania’s move should drive its peers to take similar action, substantially increasing the potential AUM opportunity.
Aggregate assets for the 15 largest US public pension funds totaled approximately $1.6 trillion at 30 June 2013, as shown in the exhibit below. Each 1% increase in investment in index funds from this asset base equals a $16 billion AUM opportunity. Although we will have to wait to see if Governor Wolf is successful in reducing pension fund management costs, pension funds increasing sensitivity to costs and their effects on investment performance should lead to higher allocations to passive investment strategies.
8 See CalPERS Exit from Hedge Funds Is Credit Positive for It, Credit Negative for Hedge Funds, 22 September 2014.
Rory Callagy Vice President - Senior Analyst +1.212.553.4374 [email protected]
NEWS & ANALYSIS Credit implications of current events
34 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
15 largest US Public Pension Funds Pension Fund Fund Assets $ Billions*
California Public Employees' Retirement System $262.0
California State Teachers' Retirement System 166.4
New York State and Local Employee Retirement System 164.2
Florida State Retirement System 129.7
Teacher Retirement System of Texas 117.4
New York City Retirement Systems 95.4
New York State Teachers' Retirement System 95.4
Ohio Public Employees Retirement System 89.0
New Jersey Division of Pensions and Benefits 81.9
North Carolina Retirement System 80.0
State Teachers Retirement System of Ohio 68.7
Washington State Investment Board 68.0
Teacher Retirement System of Georgia 58.6
Oregon Public Employees Retirement Fund 58.5
Virginia Retirement System 58.4
Total $1,593
* Market value of assets as of 30 June 2013 with the following exceptions: Florida State Retirement System as of 1 July 2013, Teacher Retirement System of Texas as of 31 August 2013 and Oregon Public Employees Retirement Fund as 31 December 2013.
Sources: Top 15 plan Comprehensive Annual Financial Reports and Moody’s Investors Service calculations
NEWS & ANALYSIS Credit implications of current events
35 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
Proposal to Designate Asset Managers as Systemically Important Is Credit Positive Last Wednesday, the Financial Stability Board (FSB) and the International Organization of Securities Commissions (IOSCO) published a consultative document that identifies asset managers as an important part of the shadow banking community, and, in some cases, as systemically important. Such a designation would lead to more stringent capital requirements and greater transparency, which would benefit debt investors, but would clearly increase SIFI-designated firms’ and costs.
The FSB and IOSCO’s proposal is a step toward tighter regulation of shadow banking, and if national regulators implement it, asset managers would face bank-style supervisory regimes. The FSB comprises senior policymakers from finance ministries, central banks and supervisory and regulatory authorities from the G-20 countries and Hong Kong, Singapore, Spain and Switzerland. This means that all of the main players that set financial stability policies across different sectors of the financial system are involved in formulating this proposal and have the authority to implement the rules.
Following a second consultation period, which will end on 20 May 2015, the FSB, in coordination with IOSCO, will finalise the methodologies by the end of this year. Thereafter, policy measures will be developed for implementation on a national level.
Although FSB and IOSCO have yet to finalize details, an institution will be designated a SIFI if its distress or disorderly failure would cause significant disruption to the global financial system and economic activity across jurisdictions, owing to its size, complexity and systemic interconnectedness (see exhibit).
Regulatory Indicators for Assessing Asset Managers’ Systemic Importance
Factors Indicators Threshold
Size Balance sheet total assets $100 billion or more
Net assets under management (AUM) $1 trillion or more
Interconnectedness Leverage ratio To be determined
Guarantees and other off-balance-sheet exposures To be determined
Substitutability Asset manager’s revenues versus the total revenues attributable to the relevant business
To be determined
Market share measured by a percentage of the asset manager’s AUM in a particular strategy versus the total AUM invested in the same strategy for all managers
To be determined
Complexity Effect of the organizational structure to capture spillover effects
To be determined
Difficulty in resolving a firm To be determined
Global Activity Number of jurisdictions in which an asset manager has a presence
To be determined
Sources: Financial Stability Board and International Organization of Securities Commissions
Although the consultative document does not identify any specific entities, we expect only a limited number of asset management companies, including BlackRock, Inc. (A1 stable), FMR LLC (A2 stable), FIL Limited (Baa1 stable) and Vanguard (unrated), to be designated as SIFIs given the $100 billion balance sheet and $1 trillion AUM thresholds the document outlines. SIFI designations and the ensuing regulatory requirements will result in lower-risk, but will lower asset managers’ margin because of the cost associated with maintaining higher required capital and amplified risk assessment procedures. Greater loss-absorbing capital for resolution of firms in bankruptcy and enhanced risk analysis will benefit debtholders.
Vanessa Robert Vice President - Senior Credit Officer +33.1.53.30.10.23 [email protected]
Soo Shin Kobberstad Vice President - Senior Analyst +44.20.7772.5214 [email protected]
NEWS & ANALYSIS Credit implications of current events
36 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
Stronger creditworthiness – all else being equal – could allow SIFI asset managers to lower their costs of debt capital. In addition, we expect that market participants will become more discriminating between well-capitalised and less-capitalised asset managers. The methodology for determining regulatory capital will highlight risks that asset managers (even though they only manage assets as agents) must manage on a corporate level to remain a going concern and that investors in general have been less sensitive to thus far. Investors will seek to invest in funds managed by less risky firms.
Because investment funds can also be designated as SIFIs, asset managers will have incentives to limit any of their funds’ assets under management and leverage. This limitation will likely lead asset managers to innovate and create different types of products with various investment strategies in order to maintain or increase revenue. Greater diversification in product offering will likely lead to less revenue volatility and stronger business profiles, which is credit positive.
NEWS & ANALYSIS Credit implications of current events
37 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
Sovereigns
China Lowers Its Growth Target to Around 7%, a Credit Positive On Thursday, the Government of China (Aa3 stable) lowered its growth target to around 7% for 2015, from about 7.5% in 2014. The lower target is credit positive because it underscores the administration’s commitment to achieving a more sustainable but still high rate of expansion that does not jeopardize long-term macroeconomic stability through the buildup of excessive leverage.
In a speech on the opening day of the third session of China’s 12th National People’s Congress, Premier Li Keqiang acknowledged that maintaining a stable rate of growth was becoming more difficult amid sluggish investment, rising production costs, and the inefficiency of China’s growth model.
Mr. Li’s comments indicate that Beijing is committed to easing China’s historically rapid economic expansion, which was turbo-charged between 2001, when China joined the World Trade Organization, and 2009, when the global financial crisis took hold. The authorities implicitly acknowledge that rapid growth is not sustainable if dependent on excessive credit.
Actual growth last year was 7.4%, the lowest in 24 years, but still among the strongest of emerging market economies (see Exhibit 1). The lower growth target signals that policymakers remain focused on rebalancing the world’s second-largest economy and relying more on the private sector.
EXHIBIT 1
China’s 2014 Real GDP Growth versus Select Emerging Market Economies Despite the slowdown, China’s growth remains strong compared with other big emerging markets.
*We estimated Turkey’s and Brazil’s calendar-year GDP growth. India’s estimate is for fiscal-year growth. Source: Moody’s Investors Service
The Shanghai government’s announcement in January that it was dropping its growth target entirely provides further evidence of this policy shift. Almost all of China’s other regional governments have reduced their growth targets for this year. Until recently, delivering rapid economic growth was an important part of officials’ performance assessments, which led to wasteful spending and a rapid increase in local- government debt.
Despite the slowdown, employment conditions in China remain favorable and will give policymakers confidence that they can avoid resorting to extraordinary stimulus measures. In his comments to Congress, Mr. Li maintained last year’s urban job creation target of about 10 million, following the actual generation of
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China India* Turkey* Russia Brazil*
Tom Byrne Senior Vice President +65.6398.8310 [email protected]
David Erickson Associate Analyst +65.6398.8334 [email protected]
NEWS & ANALYSIS Credit implications of current events
38 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
13.2 million new positions in China’s cities in 2014. Even after China’s GDP growth began slowing in 2009, total employment has risen in every year since then (see Exhibit 2).
EXHIBIT 2
China’s Economic Statistics China’s employment growth has strengthened even as GDP growth has slowed, but credit growth remains elevated.
Sources: National Bureau of Statistics, People’s Bank of China, Ministry of Human Resources and Social Security, Moody’s Investors Service
The Chinese authorities’ focus on high but sustainable rates of expansion supports limiting leverage, which rose sharply as a result of the government’s stimulus measures in response to the global financial crisis of 2008. Our estimate of year-on-year growth of outstanding total social financing – which includes bank loans, shadow banking products and corporate bonds – has been falling since the beginning of 2013 (see Exhibit 2). But credit growth continues to pose systemic risks at current levels.
We expect China’s GDP growth at 6.5%-7.0% this year, ebbing to around 6.5% in 2016. Domestic bank credit growth is likely to slow further this year to below its 2014 rate of 13%, with similar slowing for total bank and shadow bank credit, which expanded 14% in 2014. China’s credit growth has slowed but remains elevated relative to nominal GDP growth, which is only slightly higher than real GDP growth; its economic growth slowdown has not yet stabilized at a sustainable level.
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Newly Created Urban Jobs - left axis Real GDP Growth - right axisTotal Social Financing Growth - right axis
NEWS & ANALYSIS Credit implications of current events
39 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
Sub-sovereigns
Lower Federal Transfers to Mexico’s Oil-Producing States Are Credit Negative Last Tuesday, Mexico’s Ministry of Finance reported that special FEXHI transfers9 to oil-producing states fell 30% in real terms in the six months to January 2015 compared to the same period a year earlier (see exhibit below), and general purpose transfers (participaciones) in real terms declined 4.8% for Campeche (unrated), 2.8% for Chiapas (Ba2/A2.mx stable), 5.1% for Tabasco (Ba1/A1.mx positive), 2.0% for Tamaulipas (Ba1/A1.mx stable) and 6.7% for Veracruz (Ba3/A3.mx stable). These declines are credit negative for Mexico’s five oil-producing states. Annualized and combined, they reduce states’ discretionary revenues as follows: Campeche 7.4%, Chiapas 6.6%, Tabasco 9.5%, Tamaulipas 4% and Veracruz 8.6%.
FEXHI Transfers to Mexico’s Five Oil-Producing States
Source: Mexico Ministry of Finance
Oil-producing states risk a further drop in central government transfers in the coming months as low oil prices erode their GDP, one of the key variables used to determine participaciones. These states also score poorly on the other factors the federal government uses to set participaciones, including annual growth in own-source revenue collection and population.
Own-source revenue collection in Chiapas, Tabasco and Veracruz has historically been weak, reaching over the past three years an average of 7.3%, 8.3% and 6.4% of total revenues, respectively, which is below the national average of 8.4%. Campeche, Tabasco and Tamaulipas are hampered by their small populations, which account for just 0.7%, 2.0%, and 2.9% of the national population, respectively.
Historically, January tends to be a weak month for central government transfers. However, this is the first decline since a round of fiscal reforms last year resulted in the strongest growth in participaciones since the recovery from the global financial crisis. Growth in 2014 participaciones strengthened state and municipal loans, which are repaid by participaciones revenue and which constitute roughly 96% of total long-term debt issued by the states. In this case, these loans have ample debt service coverage of more than 7x, which allows the loans to absorb unforeseen shocks greater than the observed decrease in January’s participaciones level.
9 The Hydrocarbon Extraction Fund (FEXHI) is funded by oil and gas extraction revenues.
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Change in Oil Producers' FEXHI Transfer - right axis Mexican Oil Blend, Monthly Average Price - left axis
Francisco Uriostegui Associate Analyst +52.55.1253.5728 [email protected]
Rafael Rodriguez Associate Analyst +52.55.1253.5743 [email protected]
NEWS & ANALYSIS Credit implications of current events
40 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
US Public Finance
College Consolidations and Closures Are Credit Positive in an Increasingly Competitive Sector Last Tuesday, Sweet Briar College (unrated) announced that it would cease operations at the end of the 2015 academic year, the latest in a series of college mergers and closures. Proactive closures such as Sweet Briar’s are credit positive because they increase recovery rates on outstanding debt. However, unlike Sweet Briar, most troubled colleges will choose to operate as long as possible before announcing a closure, spending all available reserves, relying on extraordinary gifts for operations and limiting bondholder recovery. Few rural colleges will find viable merger partners, and sales of remaining assets could take years given the specialized nature of the facilities.
On the same day of Sweet Briar’s announcement, Tennessee Temple University (unrated) announced that it would merge with Piedmont International University (unrated). Several standalone professional schools have also recently announced mergers with larger four-year universities (see Exhibit 1). This increased consolidation is positive for the sector and offsets the effects of a highly competitive environment. Merged entities can benefit from increased enrollment, size and programmatic diversity, but they simultaneously face risks as they address the structural financial challenges that contributed to the merger.
EXHIBIT 1
Recently Announced College and University Mergers University Rating Merger Partner Rating
Arizona State University Aa3 stable Thunderbird School of Global Management unrated
Clarkson University A3 stable Union Graduate College unrated
Hamline University College of Law Baa2 stable William Mitchell College of Law unrated
Salem State University unrated Montserrat College of Art unrated
State University of Iowa Aa1 stable AIB College of Business unrated
Tennessee Temple University unrated Piedmont International University unrated
Source: University Press Releases
As colleges confront a multi-year period of heightened competition and price sensitivity, the pace of both mergers and closures will increase, although it will be small relative to other sectors such as healthcare. Sweet Briar’s closure is the most significant of the recent announcements because the college maintained an established brand within the niche market of women’s colleges, with a relatively sizable endowment and good alumni support. Nonetheless, Sweet Briar’s declining enrollment and a high tuition discount rate, with little prospect of reversal, highlights the difficult environment facing many small, rural colleges.
For small colleges, the combination of enrollment declines and higher tuition discounting can lead very quickly to structural deficits. We currently rate slightly more than 80 small private colleges and universities (defined as those with less than $100 million of operating revenue) whose ratings range from Aa2 to Ca. Two thirds are rated Baa1 or below, and 13% are speculative grade. In the past two years, more than half of these colleges have had tuition discount rates of greater than 40% (see Exhibit 2), a level that significantly hampers a college’s ability to grow net tuition revenue, the primary revenue source for more than 70% of the private universities we rate. Of these small colleges, approximately one third had operating deficits in their 2014 fiscal years, and one third have negative outlooks primarily because of enrollment declines that will lead to operating pressure and shrinking liquidity. The majority of these institutions rely heavily on gifts
Eva Bogaty Vice President - Senior Analyst +1.415.274.1765 [email protected]
NEWS & ANALYSIS Credit implications of current events
41 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
to fund their annual operations, and would be running much deeper deficits without philanthropy (see Exhibit 3).
EXHIBIT 2
Tuition Discounting Rates at Small Private Universities with Under $100 Million in Operating Revenue
Source: Moody’s Investors Service
EXHIBIT 3
Deficits and Surplus at Small Colleges With and Without Gifts
Including Gifts
Excluding Gifts
Source: Moody’s Investors Service
Narrow student market draw and a lack of geographic diversity will continue to be key credit challenges, especially among small rural colleges that do not have strong brand recognition. Most of the recently announced higher education mergers and acquisitions involve at least one partner that is operating in a niche market, particularly standalone law and business schools. Sweet Briar College is a women’s college while Tennessee Temple University is a faith-based institution.
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Deficit0% to -10%48%
Deficit-10% to -25%19%
Deficit<-25%4%
NEWS & ANALYSIS Credit implications of current events
42 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
Securitization
Expansion of India’s SARFAESI Act Would Speed Up Lenders’ Repossession of Loans Against Property On 28 February, India’s Finance Minister Arun Jaitley, as part of India’s union budget for the fiscal year ended 31 March 2016, proposed designating non-banking finance companies (NBFCs) with assets of more than INR5 billion as “financial institutions” under the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act (SARFAESI Act). Such designations would be credit positive for lenders of loans against property (LAPs), which is a loan made against residential or commercial property already owned by the borrower. Residential mortgage-backed securities (RMBS) backed by LAPs originated by these NBFCs would also benefit from speedier loan recovery.
LAPs are often taken out by small business proprietors who repay the loan using cash flow from the business housed in that property. The SARFAESI Act would expedite NBFCs’ repossession of the underlying property backing the LAP because NBFCs would have the ability to demand repayment of any defaulted loan within 60 days after the lender classifies such loans as nonperforming assets (NPAs).10 The budget, including the proposal, must pass the Parliament to become effective in the new fiscal year starting on 1 April.
Among the NBFCs that are active in LAPs and that would benefit from the proposal are Cholamandalam Investment & Finance (unrated), Indiabulls Financial Services (unrated), Magma Fincorp (unrated), Reliance Capital (unrated), Religare Finvest (unrated) and Fullerton India Credit Company (unrated), which have all been active in securitization.
If the defaulted borrower refuses to repay the outstanding loan in full within 60-days of notice, lenders would be allowed to seek repossession through the chief metropolitan magistrate or district magistrates in the jurisdictions in which the properties are located. Under the current practice, NBFCs must resort to civil court proceedings to recover their loans and take repossession of a property whose recovery time is difficult to determine. Repossession through the chief metropolitan magistrates and the district magistrates, which normally takes 18-24 months, should offer a speedier recovery.
Besides more standardized protocols around loan recovery, inclusion under the SARFAESI Act would allow lenders to take over the management of a borrower’s business if the defaulted borrower does not discharge his liability in full.
Based on fiscal 2013 data from the Reserve Bank of India, the country’s central bank, NPA recovery through the SARFAESI Act (as opposed to debt recovery tribunals and other recovery means) accounted for about 80% of the total amount of the banking sector’s NPAs recoveries at INR232 billion, and the collection rate was 27.1%.
10 As per a set of revised regulatory framework introduced by the Reserve Bank of India in November 2014, NBFCs with assets of more
than INR5 billion must incrementally tighten their classification of nonperforming assets (NPAs) on a level comparable to banks over the next three fiscal years to March 2018. Starting March 2018, these NBFCs must recognize a loan as an NPA when it is overdue for 90 days, down from six months currently.
Georgina Lee Assistant Vice Present +852.3758.1560 [email protected]
Elaine Ng Vice President - Senior Analyst +852.3758.1302 [email protected]
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43 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
Large Global Banks Close the Gap in Meeting Basel III Capital and Liquidity Requirements, a Credit Positive Last Tuesday, the Basel Committee on Banking Supervision published the results of its seventh Basel III monitoring exercise, which analyzes the progress that global banks have made in meeting Basel III capital and liquidity standards. Meanwhile, the European Banking Authority (EBA) published a similar report focused on European banks. The latest data for both exercises, based on financial results as of 30 June 2014, indicate that the banks have made credit-positive progress in reducing aggregate capital and liquidity shortfalls relative to final Basel III requirements that take effect in 2019. The European banks reported capital ratios comparable to those of the sample of global banks. However, among the largest banks, those in the EBA’s sample still lag their peers in terms of the Basel III leverage and liquidity ratios.
Both monitoring exercises split the banks into two categories: Group 1 banks, which are internationally active and have Tier 1 capital in excess of €3 billion, and Group 2 banks, which are either less internationally active or have Tier 1 capital of less than €3 billion. Group 1 banks include all global systemically important banks (G-SIBs) as designated by the Financial Stability Board (FSB).11 The exercise results show the different groups’ aggregate ratios based on fully loaded Basel III requirements, which, among other things, assumes a full phasing in of capital deductions and a phasing out of so-called old-style Basel II securities, thereby providing a picture of banks’ solvency, leverage and asset/funding liquidity positions relative to the final requirements.
The Basel Committee Assessment The Basel Committee’s monitoring exercise covered 224 banks split into two categories of 98 Group 1 banks (including all 30 G-SIBs) and 126 Group 2 banks.
Group 1 banks’ aggregate fully loaded common equity Tier 1 (CET1) ratio increased to 10.8% from 10.2% as of December 2013, while G-SIBs rose to 10.4% from 10.0% (see Exhibit 1). Leverage ratios, calculated as Tier 1 capital divided by the total exposure measure, generally exceeded the 3% proposed minimum requirement in all three groups, at 4.7% for Group 1 banks, 4.5% for G-SIBs and 5.6% for Group 2 banks. However, there are ongoing discussions among regulators to raise the minimum requirement.
EXHIBIT 1
Banks’ Aggregate Fully Loaded Common Equity Tier 1, Tier 1 and Total Capital Ratios by Category
Source: Basel Committee on Banking Supervision
11 Throughout this report data for Group 1 banks include the data of the G-SIBs.
0%
2%
4%
6%
8%
10%
12%
14%
1H11
2H11
1H12
2H12
1H13
2H13
1H14
1H11
2H11
1H12
2H12
1H13
2H13
1H14
1H11
2H11
1H12
2H12
1H13
2H13
1H14
Group 1 Banks G-SIBs Group 2 Banks
CET1 Ratio Tier 1 Ratio Total Capital Ratio
Alain Laurin Associate Managing Director +33.1.5330.1059 [email protected]
Nick Caes Associate Analyst +1.212.553.1382 [email protected]
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44 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
Exhibit 2 shows the aggregate capital shortfall for participating banks failing to meet minimum risk-based capital requirements, capital conservation buffers, G-SIB buffers and leverage requirements.12 The amount totaled €120 billion as of 30 June 2014, down from €209 billion at 31 December 2013. Banks with a capital shortfall will have to focus on filling Tier 2 capital requirements, which constitute €84 billion of the total shortfall, followed by a €30 billion shortfall in additional Tier 1 requirements and €6 billion in CET1 requirements. G-SIBs accounted for €83 billion, or 70%, of the aggregate capital shortfall, even though their total capital constitutes 59% of the total for all participating banks.
EXHIBIT 2
Aggregate Capital Shortfalls Compared with Fully Loaded Requirement
Note: The exhibit shows the aggregate shortfall of banks failing to meet minimum total risk-based capital requirements, capital conservation buffers, G-SIB buffers and leverage requirements. Source: Basel Committee on Banking Supervision
Driving the capital increase was a shoring up by many European banks of their capitalization in the run-up to the asset quality review (AQR) and stress tests conducted by the European Central Bank (ECB), the EBA and the Bank of England in late 2014. Indeed, rated banks subject to the ECB/EBA comprehensive assessment issued nearly $50 billion of contingent capital securities (CoCos) during 2014.13 Last Tuesday, the EBA announced that it will conduct a transparency exercise this year to provide detailed data on European Union (EU) banks’ balance sheets and portfolios. And next year, it will perform a stress test to assess whether the largest EU banks can withstand a severe financial crisis.
Although banks’ capitalization is improving, the reported shortfalls do not fully reflect a number of factors, including higher capital requirements and buffers that will be required in some jurisdictions, such as surcharges for domestic systemically important banks (D-SIBs) and countercyclical capital buffers. The shortfalls also do not take into account the FSB proposal on additional total loss absorbing capacity (TLAC) requirements for G-SIBs, including the proposed requirement of TLAC-eligible capital and debt securities equal to at least twice the leverage ratio requirement. Finally, regulators are moving toward increasing consistency across jurisdictions in terms of the calculation of risk-weighted assets, which could lead to a greater gap relative to final requirements, all else equal.
In terms of banks’ liquidity coverage ratio (LCR), which measures a bank’s ability to withstand a short-term liquidity stress that includes a loss of access to market funding, the June 2014 data show that many banks
12 Minimum risk-based capital requirements of 4.5% of risk-weighted assets (RWA) for CET1, 6.0% of RWA for Tier 1 and 8.0% of
RWA for total capital. Capital conservation buffers of 2.5% of RWA. G-SIB buffers of 1.0%-2.5% of RWA, depending on a banks’ systemic importance. Leverage requirements of 3.0% of total exposure measure.
13 See Moody’s Quarterly CoCo Monitor, 10 February 2015.
€0€20€40€60€80
€100€120€140€160€180€200
2H13 1H14 2H13 1H14 2H13 1H14
Group 1 Banks G-SIBs Group 2 Banks
€Bi
llion
s
CET1 Capital Tier 1 Capital Total Capital
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45 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
had met or were close to meeting the 2019 fully loaded requirement (the interim minimum is 60% coverage as of January 2015). Group 1 banks’ LCR was 121% as of June 2014, while G-SIBs’ was 126% and Group 2 banks’ was 140% (see Exhibit 3). Around 20% of participating banks still fall short of the 100% requirement, with their total shortfall in high-quality liquid assets and cash inflows net of cash outflows totaling €305 billion. Moreover, 4% of the banks do not yet meet the 60% interim minimum requirement and report a total shortfall of €155 billion.
EXHIBIT 3
Banks’ Aggregate Liquidity Coverage Ratios Generally Meet Basel Committee’s Final Requirement of 100%
Note: Black line shows the overall range, green bar shows the range of the 25th through 75th percentile and orange line shows the median. Source: Basel Committee on Banking Supervision
In terms of banks’ net stable funding ratio (NSFR), which measures a bank’s stable funding profile in relation to their on- and off-balance-sheet exposures, the results showed that around 80% of the banks exceeded the 100% minimum requirement to be introduced in 2018. As the green bars in Exhibit 4 show, the bulk of reported NSFRs are only just meeting the final requirements and the aggregate shortfall totaled €641 billion. Since the results were gathered before the release of the final NSFR framework in October 2014, they still rely on the previous framework set out in a January 2014 consultative paper, which, among other things, did not cover the required stable funding for derivative exposures and short-term exposures to other financial institutions. However, we do not expect material changes to the ratios because the final framework is mostly in line with the consultation document.
0%
100%
200%
300%
400%
1H13 2H13 1H14 2H13 1H14 1H13 2H13 1H14
Group 1 Banks G-SIBs Group 2 Banks
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46 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
EXHIBIT 4
Banks’ Aggregate Net Stable Funding Ratios Are Broadly Meeting the Basel Committee’s Final Requirement of 100%
Note: Chart is capped at 400%. Black line shows the overall range, green bar shows the range of the 25th through 75th percentile and orange line shows the median. Source: Basel Committee on Banking Supervision
The European Banking Authority’s Assessment
The EBA’s report focused on European banks that were similarly categorized as Group 1 and Group 2 banks, following the same criteria as the Basel Committee. However, the EBA covered a larger number of European banks in more countries and thus is not an exact subset of the Basel Committee’s sample (see Exhibit 5).
EXHIBIT 5
Number of European Banks Included in the Sample of Both Exercises
Banks Subject to
European Banking Authority Exercise European Banks Subject to Basel Committee Exercise
Group 1 Banks Group 2 Banks Group 1 Banks Group 2 Banks
Austria 3 3 0 0
Belgium 1 2 1 2
Denmark 1 2 0 0
France 5 4 5 4
Germany 8 37 8 36
Ireland 3 1 0 0
Italy 2 13 2 13
Latvia 0 2 0 0
Luxembourg 0 1 0 1
Malta 0 4 0 0
Netherlands 3 16 3 16
Norway 0 1 0 0
Poland 0 5 0 0
Portugal 2 4 0 0
Slovakia 0 4 0 0
Spain 2 4 2 4
Sweden 4 0 4 0
0%
100%
200%
300%
400%
2H13 1H14 2H13 1H14 2H13 1H14
Group 1 Banks G-SIBs Group 2 Banks
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47 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
EXHIBIT 5
Number of European Banks Included in the Sample of Both Exercises
Banks Subject to
European Banking Authority Exercise European Banks Subject to Basel Committee Exercise
Group 1 Banks Group 2 Banks Group 1 Banks Group 2 Banks
United Kingdom 6 5 5 3
Total 40 108 30 79
Sources: Basel Committee on Banking Supervision and the European Banking Authority
Since the last assessment, based on 31 December 2013 data, The EBA’s Group 1 banks’ fully loaded CET1 capital ratios rose by 110 basis points to 10.8%, while the aggregate capital shortfall of banks failing to meet the 7% threshold (4.5% minimum requirement plus a capital conservation buffer of 2.5% CET1), had become negligible at €2.8 billion, versus €10.2 billon based on December 2013 data.
The banks’ leverage ratio also slightly improved based on full implementation of the Basel III definition, albeit by just 20 basis points. Although the aggregate Tier 1 leverage ratio of the 40 banks composing the EBA’s Group 1 category was 3.9% as of 30 June 2014, well above the current 3% threshold, banks face the possibility of having to improve it further as the Basel Committee considers raising the minimum requirement to 4%. Under such a scenario, the EU would be under some pressure to follow suit, even though there appears to be a lack of consensus in Europe regarding imposing a higher leverage ratio owing to corporates’ reliance on bank funding and the importance of not excessively restraining bank lending. The leverage ratio is less of a constraint in cases where banks can securitize their loans on a large scale and where the corporate sector has broad access to the capital markets (e.g., in the US). So, if the Basel Committee imposes a higher leverage ratio, EU banks might be compelled to either shrink their balance sheets or raise capital.
The EBA Group 1 banks’ aggregate LCR rose to 113% as of 30 June 2014, versus 107% in the prior period, which is a significant improvement. The liquidity shortfall for banks that have not yet reached 100% constitutes liquid assets worth €100 billion. Between the last two EBA assessments, the composition of liquid assets between the highest quality (Level 1) and other assets (Level 2) has not changed. Level 1 assets comprise 84% of total high-quality liquid assets for the 40 EBA Group 1 banks. Within the Level 1 category, banks have increased their share of eligible securities (e.g., government bonds) to 50% from 47% at the expense of cash and central bank reserves. The negative rate applied by the European Central Bank on banks’ reserves drove this shift.
The EBA Group 1 banks’ aggregate NSFR of 102% at 30 June 2014 is largely unchanged from 31 December 2013, and is just above the minimum requirement of 100% that takes effect in January 2018. Sixty-seven percent of the 40 banks already meet this requirement, so those that do not will have to lengthen the maturity of their stable funding.
The EBA Group 1 sample had capital ratios that were on par with the Basel Committee’s sample, but the EBA Group 1 banks’ leverage and liquidity ratios fell short (see Exhibit 6). The Basel Committee’s sample reported a leverage ratio of 4.7%, compared with the EBA sample’s 3.9%, an LCR of 121%, versus the EBA sample’s 113%, and an NSFR of 110%, versus the EBA sample’s 102%. Ratios for EBA Group 2 banks look slightly better than the global aggregates from the Basel Committee.
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48 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
EXHIBIT 6
Comparison of Key Basel III Ratios Between Global and European Aggregates
Global Group 1 Global G-SIBs Global Group 2
Europe Group 1 Europe Group 2
Fully Loaded CET1 Ratio 10.8% 10.4% 11.8% 10.8% 12.3%
Fully Loaded Tier 1 Ratio 11.2% 11.0% 12.0% 11.2% 12.6%
Fully Loaded Total Capital Ratio
12.6% 12.3% 13.7% 13.3% 15.0%
Leverage Ratio 4.7% 4.5% 5.6% 3.9% 4.9%
LCR 121% 126% 140% 113% 156%
NSFR 110% 110% 114% 102% 111%
Sources: Basel Committee on Banking Supervision and the European Banking Authority
RATING CHANGES Significant rating actions taken the week ending 6 March 2015
49 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
Corporates
AbbVie Inc. Review for Downgrade 18 Jul ‘14 5 Mar ‘15
Long-Term Issuer Rating Baa1 Baa1
Short-Term Issuer Rating P-2 P-2 (affirmed)
Outlook Stable Review for Downgrade
The review for downgrade follows the announcement that AbbVie has made an offer to acquire Pharmacyclics Inc. for approximately $21 billion in cash and stock. The rating action thus reflects the large increase in the company’s financial leverage, based on the expectation of significant incremental debt to fund the cash portion of the deal. The review will assess the company’s ability and willingness to reduce leverage.
Abbott Laboratories Downgrade
16 Oct ‘13 4 Mar ‘15
Senior Unsecured Rating A1 A2
Short-Term Issuer Rating P-1 P-1 (affirmed)
Outlook Negative Stable
The downgrade reflects our view that Abbott’s financial policies have become more aggressive, making it difficult for the company to sustain credit metrics consistent with a A1 rating.
DCP Midstream, LLC Downgrade 23 Jan ‘15 4 Mar ‘15
Senior Unsecured Rating Baa3 Ba2
Outlook Review for Downgrade Negative
The downgrade reflects DCP Midstream’s significant exposure to weak liquids and natural gas prices and very high leverage.
RATING CHANGES Significant rating actions taken the week ending 6 March 2015
50 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
PPG Industries, Inc. Outlook Change 6 Nov ‘14 3 Mar ‘15
Long-Term Issuer Rating Baa1 Baa1
Short-Term Issuer Rating P-2 P-2
Outlook Stable Positive
The outlook change reflects the expected improvement in PPG’s credit metrics in 2015 after several years of transformative acquisitions to rapidly grow its architectural coating franchise and divestitures of the vast majority of its non-coatings related businesses.
Rockies Express Pipeline LLC Outlook Change
7 Jan ‘13 2 Mar ‘15
Corporate Family Rating Ba2 Ba2
Outlook Stable Positive
The outlook change reflects expected improvement in the company’s financial leverage during 2015 and 2016 due to increased earnings from new east to west transportation contracts and debt reduction.
Samson Investment Company Downgrade
12 Dec ‘14 2 Mar ‘15
Corporate Family Rating B3 Caa3
Outlook Review for Downgrade Negative
The downgrade reflects Samson’s high risk of default. The company's stressed liquidity position and delays in reaching agreements on potential asset sales, as well as its retention of restructuring advisors, increase the possibility that the company will pursue a debt restructuring that we would view as a default.
Teck Resources Limited Downgrade
13 May ‘14 5 Mar ‘15
Senior Unsecured Rating Baa2 Baa3
Outlook Negative Stable
The downgrade reflects our expectation that continuing weakness in commodity prices will limit Teck’s ability to improve its financial metrics through 2016.
Weight Watchers International, Inc. Downgrade 21 Feb ‘14 4 Mar ‘15
Senior Unsecured Rating B1 B3
Outlook Negative Negative
The downgrade reflects our expectation that the company’s revenues will decline to about $1.2 billion in 2015, with the potential for further material declines in 2016 unless new programs and marketing initiatives stabilize the membership base. Despite expected cost saving initiatives, profitability will drop sharply in 2015, leading to financial leverage above 9 times, which is very high for the B3 rating category.
RATING CHANGES Significant rating actions taken the week ending 6 March 2015
51 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
Infrastructure
BY Chemler plc. Upgrade 5 Oct ‘11 2 Mar ‘15
Senior Secured Bonds Baa1 A3
Outlook Stable Stable
The upgrade reflects the successful transition of BY Chelmer to a steady state operating profile following construction completion in 2010.
Peterborough (Progress Health) plc Downgrade 23 Jan ‘13 5 Mar ‘15
Senior Secured Bonds Baa1 Baa3
Outlook Stable on 13 Nov 2013 Review Direction Uncertain
The downgrade reflects the negative impact on Peterborough plc’s liquidity position resulting from the Peterborough and Stamford Hospitals NHS Foundation Trust withholding large portions of service payments in January and February 2015. Peterborough Plc now faces an increased risk of not being able to meet its senior debt service obligations in October 2015.
Sydney Water Corporation Upgrade 22 Dec ‘14 4 Mar ‘15
Issuer Rating A1 Aa3
BCA baa2 baa1
Outlook Positive Stable
The upgrade reflects the strengthening in Sydney Water’s baseline credit assessment, which resulted from our expectation of improved transparency in the regulatory framework. We expect that the Independent Pricing and Regulatory Tribunal, the water utilities regulator, will continue to exhibit consistency in its decision, translating into increased stability in revenue outcomes for Sydney Water.
RATING CHANGES Significant rating actions taken the week ending 6 March 2015
52 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
Financial Institutions
AWAS Aviation Capital Limited
Outlook Change 16 Apr ‘14 5 Mar ‘15
Long-Term Corporate Family Ratings Ba3 Ba3
Senior Unsecured Ba2 Ba2
Outlook Positive Stable
The outlook change follows the announcement by the company and its sponsors, Terra Firma and Canada Pension Plan Investment Board, that AWAS will sell a portfolio of 90 commercial aircraft to Macquarie Group for a total consideration of $4 billion. The rating action also reflects our expectation that AWAS’ leverage will moderately increase over the intermediate term as a result of distributions that the company makes to its owners.
Banco Angolano de Investimentos, S.A.
Outlook Change 13 Aug ‘14 4 Mar ‘15
Bank Financial Strength/Baseline Credit Assessment E+/b1 E+/b1
Long-Term Domestic and Foreign Currency Bank Deposit Ratings Ba3 Ba3
Outlook - Bank Financial Strength Stable Stable
Outlook - Deposit Ratings Stable Negative
The outlook change reflects our view that the challenging domestic operating environment will weigh on the bank's financial fundamentals, mainly its asset quality and profitability metrics; and the significant correlation between the bank's creditworthiness and the sovereign's own credit profile through the bank's holdings of government-related assets.
Banco Psa Finance Brasil S.A.
Upgrade 18 Apr ‘13 5 Mar ‘15
Long-Term Domestic and Foreign Currency Bank Deposit Ratings Ba2 Ba1
Outlook Stable Stable
The upgrade reflects the upgrade of the standalone bank financial strength rating of the bank’s parent Banque PSA Finance to D+ from D, which now is equivalent to a ba1 baseline credit assessment. The Brazilian subsidiary's Ba1 long-term deposit rating incorporates two notches of uplift from its standalone ba3 credit assessment to reflect our view of a high probability of parental support in the event of stress, based on the shared strategic focus of the subsidiary and its parent.
RATING CHANGES Significant rating actions taken the week ending 6 March 2015
53 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
Central Bank of India and Indian Overseas Bank Downgraded
3 Mar ‘15
We downgraded Central Bank of India’s and Indian Overseas Bank's local and foreign currency deposit ratings to Ba1 from Baa3. We also downgraded the rating on Indian Overseas Bank's senior unsecured debt issued from its Hong Kong branch to Ba1 from Baa3. The downgrades reflect our assumption of a lower level of support from the Government of India (Baa3 stable) following the government's recent announcements that indicate that it wishes to differentiate between state-owned banks when distributing capital. The change in government policy means that the standalone credit quality of public-sector banks has become a more important consideration for the senior unsecured and deposit ratings of the banks than in the past, when we rated all state-owned banks at the same level as the Government of India.
Compañía Aseguradora de Fianzas, S.A. Confianza
Upgrade 25 Sep ‘14 4 Mar ‘15
Insurance Financial Strength Baa3 Baa2
Outlook Review for Upgrade Stable
The upgrade reflects the granting of one notch of uplift to Confianza's Baa3 standalone credit profile, owing mainly to what we consider to be a strong degree of implicit support for Confianza by its 51% shareholder.
Credit Europe Bank N.V. and Credit Europe Bank Ltd Downgraded
Downgrade 4 Mar ‘15
We downgraded Credit Europe Bank N.V.’s long-term deposit rating to B1 from Ba3 and its standalone bank financial strength rating to E+ from D-, owing to the weakening in the standalone credit profile of the bank's main subsidiary Credit Europe Bank Ltd (CEBL). We maintained CEBL’s standalone bank financial strength rating at E+, now equivalent to a baseline credit assessment of b2 (formerly b1). The lowering of CEBL's BCA reflects the deterioration in the operating environment in Russia (Ba1 negative), which has a negative bearing on the banks' financial fundamentals.
E*Trade Financial Corporation Upgraded
Upgrade 2 Mar ‘15
We upgraded E*Trade Financial Corporation’s (ETFC) issuer rating and senior unsecured rating to Ba2 from Ba3 with a positive outlook. The upgrade follows ETFC’s announcement that it will reduce its holding company debt load by a net $340 million, which would improve ETFC's debt service capacity, representing another significant milestone in the company's efforts to improve its credit profile.
MBIA Insurance Corporation
Outlook Change 21 May ‘14 3 Mar ‘15
Insurance Financial Strength B2 B2
Outlook Stable Negative
The outlook change reflects the heightened risk in the Zohar I and II CLO notes that MBIA Insurance Corporation insures. Given the material size of these exposures, and the lack of transparency on the value of the underlying collateral, we believe that, absent a successful remediation, these exposures could result in meaningful strain on the company's capital and liquidity profiles.
RATING CHANGES Significant rating actions taken the week ending 6 March 2015
54 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
MBIA Mexico, S.A. de C.V.
Outlook Change 21 May‘14 4 Mar ‘15
Insurance Financial Strength B2 B2
Outlook Stable Negative
The outlook change follows the recent affirmation of MBIA Insurance Corporation’s ratings and the change in outlook to negative from stable. MBIA Mexico is fully owned by MBIA Insurance Corporation and is thus closely linked to its rating.
Rating Actions Taken on 10 Russian Banks
2 Mar ‘15
We have taken rating actions on 10 Russian banks, reflecting the deterioration in the operating environment in Russia (Ba1 negative), which negatively affects the banks' financial fundamentals. The banks are Absolut Bank, Home Credit & Finance Bank, Khanty-Mansiysk Bank Otkritie PJSC, NBD Bank, OTP Bank (Russia), Transcapitalbank JSC Bank, Commercial Bank Agropromcredit (LLC), Russian Standard Bank, Tinkoff.Credit Systems and AK BARS Bank. All 10 banks carry negative outlooks on their long-term ratings.
Springleaf Holdings, Inc. and OneMain Financial Holdings, Inc. Placed on Review for Downgrade
Review for Downgrade 3 Mar ‘15
We placed Springleaf Holdings, Inc.’s B2 corporate family rating, Springleaf Finance Corporation B2 senior unsecured rating, and OneMain Financial Holdings’ B2 corporate family and senior unsecured ratings on review for downgrade. The rating actions follow Springleaf’s announcement that it will acquire OneMain Financial Holdings, Inc. from Citigroup, Inc. for $4.25 billion in an all-cash transaction. They also reflect the pending transaction's risks to Springleaf's bondholders including (1) increased leverage, (2) weakened liquidity; and (3) integration complexity given the size of the acquisition.
Voya Financial, Inc. and Subsidiaries Upgraded
Upgrade 3 Mar ‘15
We upgraded the insurance financial strength rating of Voya Financial, Inc.’s subsidiaries (Reliastar Life Insurance Company, Reliastar Life Insurance Company of New York, ING USA Global Funding Trust 3, Security Life of Denver Insurance Company, Voya Insurance and Annuity Company, and Voya Retirement Insurance and Annuity Company) to A2 from A3 and upgraded its long-term issuer rating to Baa2 from Baa3. The upgrades reflect Voya's continuing improvement in its financial profile, particularly profitability and financial flexibility, as it focuses on re-pricing its core retirement businesses.
RATING CHANGES Significant rating actions taken the week ending 6 March 2015
55 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
US Public Finance
Chicago Park District, Illinois Downgrade 14 Mar ‘14 05 Mar ‘15
GO Bonds A3 Baa1
GOLT Bonds A3 Baa1
GOULT A3 Baa1
Outlook Negative Negative
The downgrade reflects the district's governance ties to the City of Chicago (Baa2 negative). Given the city's extreme budget pressures, we believe that the district’s financial operations and position could be indirectly affected through city officials' influence on policymaking and budgeting.
Union County, New Jersey Outlook Change 29 May ‘14 2 Mar ‘15
GO Bonds Aa1 Aa1
Outlook Negative Stable
The outlook change reflects the county's markedly improved financial position, which will remain sound given conservative budgeting practices.
Structured Finance
Ally Financial Prime Auto Loan ABS Upgraded On 27 February, we took actions on approximately $4 billion of auto loan asset-backed securities sponsored by Ally Financial Inc. (Ba3 positive). We upgraded 12 securities from transactions issued in 2013 and 2014, and affirmed another 24 securities from 2013 and 2014 vintage transaction. The upgrades reflect the buildup of credit enhancement resulting from sequential pay structures and non-declining reserve accounts.
RESEARCH HIGHLIGHTS Notable research published the week ending 6 March 2015
56 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
Corporates
North American Railroads: Freight Growth Resilient Despite Slowing Crude Oil Shipments Our analysis indicates that the revised forecasts for shipments of petroleum products and crushed stone, sand and gravel have only a modest impact on total freight volume growth. Our analysis indicates further that these freight groups would have to decline by roughly 15% before we would consider changing our outlook to stable from positive, all other freight and pricing assumptions being equal. We consider such a scenario unlikely in 2015.
Hong Kong Property Developers: Prudential Measures on Mortgage Loans Are Credit Negative The Hong Kong Monetary Authority has announced new prudential measures on property mortgage loans to dampen Hong Kong’s buoyant housing market and protect the stability of the banking system, effective immediately. We expect that the new measures will weaken demand for residential properties and have a credit negative effect on property developers. Among the rated Hong Kong-based property developers, Sun Hung Kai Properties (Capital Market) Ltd. (A1 stable) and Nan Fung International Holdings Limited (Baa3 stable) will likely face slower property sales and weakening cash flows, given their significant exposure to the residential property market.
Chinese National Oil Companies: Natural Gas Price Adjustment Will Have Limited Effect and Support Gas Market Growth On 28 February, China’s National Development and Reform Commission said that it will adjust the wholesale price of natural gas for non-residential users starting 1 April 2015, which will result in a net decrease in the average gas price for these industrial and commercial consumers. The adjustment will have limited negative impact on the financials of China’s three national oil companies because it will only moderately reduce the price increase that the commission implemented just seven months earlier.
Global Integrated Oil Companies: Oil Majors Take Steps to Withstand Crude Price Plunge Based on the plans announced by major international oil companies in response to the sharp drop in crude oil prices, we expect that none of these companies will be able to cover their capital spending from internal cash flow in 2015 and that hefty dividends will aggravate negative free cash flow across the board, unless there is an unexpected near-term rebound in oil prices. The companies will be borrowing or drawing on large cash positions (and increasing net leverage) to cover dividends and capital spending.
European Engineering and Construction: Trend To Spin Off YieldCos Will Help Reduce Leverage, a Credit Positive On 16 February 2015, Spanish construction company ACS (unrated) announced that it had successfully spun out and listed Saeta Yield S.A., an investment vehicle or “YieldCo,” which will hold ACS’s renewable energy assets. This transaction is in line with a general trend in the construction industry to spin off YieldCos. The sale of stakes in YieldCos can substantially reduce construction companies' financial leverage thanks to proceeds from the equity stakes and the decline of the companies' share in the concessions' financial debt.
Chinese Corporates: FAQs on Our Outlooks for Chinese Non-Property Companies We expect that department stores will reposition themselves as lifestyle centers to counter increasing competition from shopping malls and the Internet. This transition will increase their capital spending and operational needs and pressure their credit quality over the next 18-24 months.
RESEARCH HIGHLIGHTS Notable research published the week ending 6 March 2015
57 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
Chinese Telecommunications: 4G FDD License Grants to Competitors Is Only Modestly Credit Negative for China Mobile On 27 February, China’s Ministry of Industry and Information Technology granted China Telecom (CT, unrated) and China Unicom (unrated) nationwide permits to provide LTE/4G FDD service. The approvals were widely expected and the credit impact to China Mobile Limited (Aa3 stable), while negative, should be modest. The increased competition is unlikely to upend China Mobile’s dominant position in China’s growing telecommunications industry, especially since CT and Unicom were already offering FDD services in 56 of China’s largest cities, and China Mobile has established strong market leadership in 4G with its TDD offering.
SGL Flash Monitor: Spec-Grade Liquidity Remains Well Supported, Despite Oil- Related Volatility Moody’s Liquidity-Stress Index (LSI) ticked up to 4.0% in February from 3.9% in January, driven by an increase in the Oil & Gas LSI to 9.6% from 8.0%. Although the LSI is at a four-month high, the recent increase relates directly to pressure on oil and gas companies. We expect that liquidity in the energy sector will continue to weaken as oil price volatility persists.
EMEA Automakers, Chemicals and Tourism Are Biggest Beneficiaries from Euro's Slide The significant weakening of the euro against major currencies, including the US dollar and British pound, promises benefits for European companies in a number of industries for the next two years, including the automotive manufacturing, chemicals, and hotels and tourism sectors, while the airline sector will be hurt the most if the euro remains weak for a prolonged period. However, we do not expect the impact of the shift in exchange rates on the companies’ credit profiles on its own to be big enough to affect their ratings.
US Multinational Corporate Dollar Daze: Stronger Greenback is Credit Negative The strong US dollar will be credit negative for US-based multinational corporations in 2015. Large exporters, in particular, will face a choice between lower margins or higher prices as their products become less competitive in local markets.
Canadian Corporate Refunding Risk and Needs, 2015-2019 The rated debt issued by Canada’s non-financial companies and maturing in 2015-19 has declined 5%, primarily because of a drop in investment-grade maturities, but will peak in 2019. Debt maturities remain highly concentrated among a few issuers and industries, but our outlook for Canadian companies is stable. Rising interest rates remain a key risk, but most Canadian non-financial companies will be able to refinance.
Australian Grocery Retailers: Aldi's Growth Presents Long-Term Challenges For Woolworths and Coles Aldi’s aggressive expansion plans are a long-term threat to the duopoly structure in Australia’s grocery market, which is dominated by Woolworths Limited (A3 stable) and Coles, the supermarket operator owned by Wesfarmers Limited (A3 stable). Aldi's growth implies a lost opportunity for the Big Two, which could have picked up the incremental sales instead. We expect that Woolworths and Coles’ market share and margins will come under pressure over time.
Chinese Oilfield Services: Oil Price Plunge Will Slow Revenue Growth and Pressure Margins of Chinese Oilfield Services Companies Smaller exploration and production (E&P) budgets will dampen revenue growth for Chinese oilfield services (OFS) companies. Low oil prices will push E&P companies to cut their spending on exploration and drilling, slowing the organic revenue growth of Chinese OFS companies in 2015 and into 2016. Honghua Group (B2 negative) and Anton Oilfield Services (Ba3 negative) are the most reliant on E&P spending of the four Chinese OFS companies we rate, making their revenues most vulnerable to the oil price drop.
RESEARCH HIGHLIGHTS Notable research published the week ending 6 March 2015
58 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
US Airlines: Cheaper Fuel, Capacity Discipline to Drive Sharp ROIC Improvement US airlines can expect strong growth in profitability and improvements in return on invested capital in 2015. Maintaining capacity discipline while the cost of fuel is low will drive the better performance. Because we expect fuel prices to rebound after 2015, the windfall will only be temporary, however. Global Paper and Forest Products: Improving US Housing Starts Help Offset Decline in Paper Consumption Our outlook for the global paper and forest products industry is stable, reflecting our expectation that the consolidated operating income of the 49 paper and forest product companies that we rate globally will increase by 2%-4% over the next 12-18 months. North American wood products and timberland producers will benefit as the US housing market improves, while demand for packaging and market pulp will increase as the global economy experiences modest growth. Korean Corporates: Modest Leverage Improvement in 2015 Supports Credit Quality Most of the Korean corporates we rate will maintain their credit quality in 2015 because their financial leverage will improve modestly. The lowered financial leverage will be driven by a rebound in many companies’ earnings, after weakening in 2014, and their lower capex levels, which will enable them to reduce debt. The improvement will be the most pronounced for refining companies, which were hit hard in 2014 by the steep decline in crude oil prices. Global Automotive Manufacturers: US Demand, China Growth to Offset Weakness in European Markets We maintain our stable outlook on the global automotive manufacturing industry, reflecting our expectations that robust, albeit slowing, demand in China and improving demand in the US will be the primary drivers of auto sales growth. We expect that global light vehicle unit sales will grow 2.8% in 2015 and 3.0% in 2016, slowing from 3.5% growth in 2014.
Continued Strong Performance in 2014 for Moody's Nonfinancial Corporate Debt Ratings The one-year performance of Moody’s January 2014 ratings was very strong. One-year cumulative default rates through December 2014 by rating category sequentially increase moving down the rating scale, demonstrating that Moody’s ratings provided a strong rank-ordering of credit risk.
Infrastructure
Default and Recovery Rates for Project Finance Bank Loans 1983-2013 This special comment is an update to a study we published in March 2014 examining the default and recovery performance of unrated project finance bank loans. It is based on an updated and expanded aggregate data set from a consortium of leading project finance lenders and investors. The study data Set includes 5,308 projects, which account for some 60.6% of all project finance transactions originated globally during a 31-year period from 1 January 1983 to 31 December 2013.
RESEARCH HIGHLIGHTS Notable research published the week ending 6 March 2015
59 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
Financial Institutions
Irish Banks: Strong GDP Growth Drives Fundamentals; Change to Stable Outlook The Irish banks’ credit fundamentals have strengthened owing to strong domestic economic performance, and we expect above-peer GDP growth for 2015. The prospects for further material improvements in the banking sector are limited over the next 12 months, as the banks address longer-term challenges associated with the large stock of non-performing loans and commercial property exposures.
Mongolia Banking System Outlook Is Negative; Economic Pressure Rising The coming year will see further retrenchment of the monetary and fiscal stimuli that have played a key role in supporting the economy in recent years. Mongolia’s weak external position could keep its exchange rate under pressure and its inflation rate high, thereby requiring the Bank of Mongolia to maintain a tight monetary policy stance.
Global Bank Debt Issuance Levels Off in 2014 After Four Years of Decline Growth in the issuance of unsecured bank debt was in the mid-teens percentage range for Asia, the US and non-euro-area Europe in 2014, but was down another 4% in the euro area despite increases in Spain, Portugal and Ireland. Global rated issuance still stands at just 57% of the 2007 peak. For 2015, low economic growth in Europe, strengthening GDP in the US and myriad global and local regulatory developments will affect issuance.
Indian Banks: Government's Policy of Differentiation Among SOE Banks Leads to Lower Support Assumptions The change in the Indian government’s budget allocation for capital infusions will adversely affect the weaker SOE banks, whose capital requirements over the next few years will be significant. These banks have limited access to sources other than the government for fresh capital and will find meeting their capital requirements a challenge.
Russian Banks: Protracted Downturn and High Interest Rates Will Severely Pressure Asset Quality and Lead to Widespread Losses An economic downturn, with slowing GDP growth, high interest rates, rising funding costs and ongoing currency depreciation will hurt banks’ asset quality and result in most banks’ posting net losses in 2015, precipitating cost-cutting measures. We estimate that aggregate losses for the banking system will be in the range of 20% to 25% of total capital.
Oman and Bahrain Banks Are the Most Vulnerable to Lower Oil Prices Because of their sovereign high fiscal break-even oil prices and low or near zero reserve buffers, the Oman and Bahrain banking systems will face declining liquidity as well as growth, profitability and asset-quality pressures. Oman’s economy is undiversified and public spending constitutes around 48% of GDP. Bahrain’s economy is more diversified, but the banks are already suffering owing to domestic tensions and regional competition.
Brazilian Banks Could Face Ripple Effects from Petrobras’ Business Partners The deepening investigation into an alleged kickback scheme at Petrobras has triggered concerns for the Brazilian banks with exposures not only to the state-controlled oil company, but also to its suppliers, as well as the broader oil and gas sector and the construction sector. The risks are greatest for Brazil’s public banks, since the government could compel them to offer the sector support to prevent a credit crunch.
RESEARCH HIGHLIGHTS Notable research published the week ending 6 March 2015
60 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
Malaysia's Property Sector Risks Are Manageable for Banks and Developers The Malaysian banks are well positioned to weather a soft landing in property prices, despite deteriorating macroeconomic conditions owing to an ongoing downturn in commodity prices and the slowdown in China growth. We expect slower but still-solid 4.5%-5.0% GDP growth for Malaysia in 2015.
Japan Life Insurance Industry Outlook Persistently low interest rates are negatively affecting investment returns and profitability. Nevertheless, the insurers are continuing to adapt their strategies to maintain their current credit profiles, with the industry focusing increasingly on lucrative new products such as medical insurance, which are less vulnerable to interest rate risk.
European Insurers: Solvency II -- Answers to Frequently Asked Questions This report provides our responses to investor questions on Solvency II, which will tighten solvency and reporting requirements, risk management standards and supervision. For insurers, the new regime will entail expending significant resources as well as an increase in costs, amid persistent uncertainty about how the capital requirements will be calculated and how consistently the regime will be implemented across countries.
GCC Reinsurers' Underwriting Margins Face Pressure as Competition Intensifies Although underwriting loss ratios for many of the region’s rated players are generally healthy, overcapacity in the GCC reinsurance market has resulted in softening rates, further pressuring margins, even as investment returns are at historic lows. We expect these trends to continue in the coming years, barring significant deterioration in underwriting loss ratios.
Sub-sovereigns
Russia’s Oil Rich Regions Are Relatively Equipped to Cope with Oil Price Drop Counter-intuitively, Russia’s oil rich regions are better equipped than some peers to cope with the country’s economic downturn, despite their exposure to a steep decline in world oil prices since June 2014. The impact of the oil price drop on these regions’ revenues will be cushioned by a weaker rouble, their relative economic strength, their superior ability to cut costs and their lower than average exposure to refinancing risk. Nevertheless, we expect the entire Russian public sector to experience financial deterioration in 2015 because of a sharp contraction in the country’s economy.
RESEARCH HIGHLIGHTS Notable research published the week ending 6 March 2015
61 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
US Public Finance
Not-For-Profit Hospitals Face Significant Downside Risk from Legal Challenge to Affordable Care Act On 4 March, the Supreme Court will hear oral arguments in King v. Burwell, a case that will determine whether federal subsidies are legal in the 34 states that did not establish their own healthcare insurance exchange. We expect a ruling in June. If the Supreme Court rules in favor of the government, there will be no impact, but if the subsidies are struck down, there will be various credit effects.
Pennsylvania Local Governments Get Income Tax Boost from Act 32 A Pennsylvania law requiring better tax collection procedures has boosted income tax receipts for most of the state's municipalities and school districts. By strengthening income tax collections, the law has enabled the discovery of significant, previously unpaid income taxes, lifting revenues for many local governments.
Retiree Healthcare Contributions Typically Low for Largest US Local Governments; Potential Wildcard for Outliers in Bankruptcy Annual outlays associated with Other Post-Employment Benefits (OBEBs) will remain low for most of the 50 largest US local governments over the short term. OPEBs are the primary components of non-pension retirement benefit packages and include retiree health care and life insurance plans. We expect that the preponderance of these plans will continue to be funded on a pay-as-you-go basis, thus the median over the short term is not likely to significantly exceed the median 1.5% of operating revenues last reported in 2013. Future outlays may increase due to healthcare inflation, a growing retiree population, or changes from a pay-as-you-go to a prefunding approach.
RESEARCH HIGHLIGHTS Notable research published the week ending 6 March 2015
62 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
Structured Finance
US CMBS: CRE Liquidity Fuels Defeasance Surge Defeasance activity in 2014 reached its highest level since 2007, the result of strong liquidity, recovering real estate fundamentals and borrowers rushing to refinance before interest rates rise. US commercial mortgage-backed securities defeasance rose to $20.9 billion in 2014, a 58% year-over-year increase and in line with the 2005 level.
Korea and Singapore Covered Bonds: Legal Frameworks Protect Investors, Support Issuance Korea and Singapore introduced covered bond legal frameworks in December 2013 to facilitate issuance. The frameworks in both countries provide minimum legal protection on key credit risks, while relying on contractual arrangements to mitigate other risks. Structural features or additional assets will mitigate risks not covered by legal frameworks.
US CMBS Loss Severities: Q4 2014 Update Three loans that rank in the top 10 dollar losses to date drove US CMBS loss severity higher to 49.1% in 2014 from 45.7% in 2013. Fourth-quarter 2014 loss severity also rose slightly to 42.7% from 42.4% in the third quarter. Loss severity for loans that liquidated after a maturity default were significantly lower than for loans liquidated after a term default.
Italian RMBS and ABS: Banca Etruria's Special Administration Will Not Affect Outstanding RMBS and SME Transactions Although Banca Etruria will likely incur a severe equity loss from its placement under special administration by the Bank of Italy, the placement will not negatively affect the RMBS and ABS transactions for which Banca Etruria is servicer and originator. The transactions have sufficient liquidity sources that mitigate the risk of payment disruptions.
US RMBS: Trustee's Termination of Ocwen Servicing Agreements is Credit Neutral for Related RMBS Deals It is unlikely that Wells Fargo's termination of two servicing agreements with Ocwen will result in cash flow disruptions. All participants have strong incentives to implement an orderly transfer of servicing responsibilities from Ocwen to the desired successor servicer, Select Portfolio Servicing. In addition, the capital structures of the two deals mitigate the risk of cash flow disruption through a strong interest shortfall reimbursement mechanism on the senior bonds.
RECENTLY IN CREDIT OUTLOOK Select any article below to go to last Thursday’s Credit Outlook on moodys.com
63 MOODY’S CREDIT OUTLOOK 9 MARCH 2015
NEWS & ANALYSIS Corporates 2 » Hewlett-Packard's Acquisition of Aruba Networks Is
Credit Positive » Koppers' Long-term Debt Reduction Target and Dividend
Suspension Are Credit Positive » Mitel's Mavenir Acquisition Will Increase Leverage, a
Credit Negative » Braskem's Third Naphtha Supply Extension with Petrobras Is
Credit Negative » Heidelberg Reorganizes Its Pension Scheme and Acquires
Printing Systems Group, Both Credit Positive » Wireless License Grants to Competitors Are Only Modestly
Credit Negative for China Mobile
Infrastructure 10 » Illinois Bill Would Extend Life of Exelon Generation’s Nuclear
Reactors, a Credit Positive » Salt River Project Will Start to Charge Customers Using Solar
Power, a Credit Positive » Brazil's Extraordinary Tariff Reviews for Electricity
Distribution Companies Are Credit Positive » China's City Gas Operators Will Benefit from Natural Gas
Price Adjustments » KEPCO's Nuclear Reactor Operating Extension Is
Credit Positive
Banks 18 » Hong Kong's Macro-prudential Measures Are Credit Positive
for Banks » China's Rate Cut Is Credit Negative for Banks, Especially
Small and Midsize Banks » Korea's Banks Benefit from Latest Program to De-Risk
Mortgage Borrowing
Insurers 24 » UK Life Insurers Benefit from Increased Pensions Savings
Sovereigns 26 » India's Inflation Targeting Plan Increases Policy Transparency
and Predictability
US Public Finance 28 » Iowa Fuel Tax Hike Paves the Way for More Road Projects, a
Credit Positive
Securitization 30 » Spain's Securitizations and Covered Bonds Are Adversely
Affected by Easier Personal Bankruptcy Laws
MOODYS.COM
Report: 179668
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EDITORS PRODUCTION ASSOCIATE
News & Analysis: Elisa Herr and Jay Sherman Sol Vivero Ratings & Research: Bronwyn Collie
