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MOODYS.COM
17 MAY 2018
NEWS & ANALYSIS Corporates 2 » US Supreme Court makes sports betting legal in the US, but
casinos will see little upside
» Brazilian steelmaker Companhia Siderúrgica Nacional’s sale of US subsidiary lightens leverage
» Liberty Global’s asset disposals are credit negative, but using proceeds for strategic M&A could restore business profile
» China Three Gorges’ proposed acquisition of EDP would be credit negative if it materialized
» Wanhua Chemical’s planned merger with BorsodChem is credit positive
» Lotte Shopping’s sale of hypermarket stores in China is credit positive
» Mitsui Fudosan’s share repurchase is credit negative
Banks 12 » Scotiabank Peru’s Banco Cencosud investment enhances its
position in Peru’s retail consumer sector, a credit positive
» Banca Monte dei Paschi di Siena’s return to profitability is credit positive
» For Saudi banks, lower interest and credit costs are credit positive
» China’s unification of the supervisory structure for leasing companies is credit positive
Exchanges 18 » Cboe’s successful migration of its C2 options exchange onto Bats’
technology platform is credit positive
Sovereigns 19 » Colombia’s revised fiscal deficit targets will delay fiscal
consolidation, a credit negative for the sovereign
RECENTLY IN CREDIT OUTLOOK
» Articles in Last Monday’s Credit Outlook 21
» Go to Last Monday’s Credit Outlook
»
Click here for Weekly Market Outlook, our sister publication containing Moody’s Analytics’ review of market activity, financial predictions, and the dates of upcoming economic releases.
NEWS & ANALYSIS Credit implications of current events
2 MOODY’S CREDIT OUTLOOK 17 MAY 2018
Corporates
US Supreme Court makes sports betting legal in the US, but casinos will see little upside On Monday, the US Supreme Court gave the much-anticipated green light to legalize sports betting across the US, eliminating an existing 25-year ban for all but four states, including Nevada. Although there has been plenty of speculation that casinos are set to cash in as sports betting shifts to the legal domain, we do not expect the industry to realize a material benefit for some time.
Estimates put illegal gambling at $150 billion or more, but it is unclear how many illegal sports bettors will convert to legal betting and whether the monetary incentive to do so exists. Additionally, the casino “win” is a very small percentage of the total wager. Based on Nevada data, it would be only around 5% of that $150 billion estimate, or $7.5 billion. From this amount, operators would have to cover state gaming taxes, fees or revenue-sharing with third parties that may run the casino’s sports book, and operating expenses, resulting in very thin margins. In addition, regulation will be established on a state-by-state basis and some rules risk actually inhibiting growth. For example, some states may only allow gambling at a casino and prohibit it on mobile devices.
New Jersey, which approved sports betting in 2012, will be an early adopter of the new law. For example, MGM Resorts International (Ba3 positive), owner of The Borgata Hotel Casino & Spa in Atlantic City, said in November 2017 that the property was planning to build a $7 million sports book in anticipation of a favorable ruling from the Supreme Court. Connecticut and Pennsylvania have previously said that they were considering some form of sports betting, and at least 16 other states have also previously stated an interest in legalizing sports betting.
In Nevada, sports betting accounted for just 2% of state gaming revenue. Applying this to New Jersey suggests gross sports betting revenue of just $52 million (2% of gross gaming revenue of $2.6 billion) before taxes and operating costs spread across New Jersey’s eight casino operators.
Peggy Holloway Senior Vice President +1.212.553.4542 [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 17 MAY 2018
Brazilian steelmaker Companhia Siderúrgica Nacional’s sale of US subsidiary lightens leverage On Monday, Brazilian steelmaker Companhia Siderúrgica Nacional S.A. (CSN, B3 stable) said that it had agreed to sell its US flat-steel subsidiary, CSN LLC, to Steel Dynamics, Inc. (Ba1 stable) for at least $400 million (about BRL1.5 billion). The sale, whose price could rise by as much as $90 million based on working capital adjustments, is credit positive for CSN, enhancing the company’s ability to reduce debt, with little effect on future EBITDA generation.
On a pro forma basis, the $400 million in proceeds, which CSN will use mostly to pay down debt, will help reduce the company’s reported total debt/EBITDA ratio to 6.2x from 6.5x at the end of March 2018 (see exhibit). CSN has targeted leverage of 3.5x net debt/EBITDA through mid-2019, versus a reported ratio of 5.8x at the end of the first quarter of 2018, or 5.4x pro forma for the transaction, which requires approval from US regulators.
Sale of US unit will help reduce CSN’s pro forma leverage
Sources: Company financials and Moody’s Investor Service
CSN has historically shipped hot-rolled steel sheets and coils produced in Brazil to the US subsidiary’s 800,000-ton-capacity plant in Indiana for processing into higher-value products, including cold-rolled coils and galvanized products. In 2017, exports accounted for about 42% of CSN's total steel sales, of which North America contributed 31%, or about 650,000 tons. Yet even after the sale, CSN will maintain its steel-products imports and commercialization in the US through a new subsidiary that it will create for this purpose.
Although this transaction helps CSN's deleveraging process, the steelmaker must continue to sell assets and manage liabilities to improve its liquidity profile, reduce debt and extend debt maturities. A leveraged capital structure and significant liquidity risk are CSN’s main challenges. The company generated about BRL19.2 billion in revenue for the 12 months through March 2018, had BRL29.6 billion in total debt with around 35% of it due 2018-19, and only a BRL2.9 billion cash balance at the end of March 2018.
BRL29BRL31
BRL35
BRL32 BRL31 BRL30BRL28
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10.9x
7.8x6.6x 6.5x 6.2x
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4x
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2013 2014 2015 2016 2017 Q1 2018 Q1 2018 (proforma)
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Reported debt - left axis Reported debt/EBITDA - right axis
Barbara Mattos Senior Vice President +55.11.3043.7357 [email protected]
NEWS & ANALYSIS Credit implications of current events
4 MOODY’S CREDIT OUTLOOK 17 MAY 2018
CSN in January 2018 concluded the refinancing of BRL4.9 billion of bank debt with Banco do Brasil, S.A. (Ba2 stable, ba21), and we expect that it will do so with Caixa Economica Federal (Ba2/Ba2 stable, b1) in the first half of 2018. The two banks hold a substantial portion of CSN’s bank debt – about BRL14 billion ($3.9 billion) or 47% of its total reported debt. In February 2018, CSN issued $350 million in unsecured notes due in 2023 and completed a $350 million tender offer for its notes due in 2019 ($750 million outstanding) and for its notes due in 2020 ($1.2 billion outstanding).
Although the bank debt refinancing and tender offer ease immediate liquidity pressures, CSN must still address about BRL10.5 billion of debt maturing through 2019, including roughly $547 million of bonds due in September 2019, assuming it successfully concludes its negotiation with Caixa.
1 The bank ratings shown in this report are the bank’s domestic deposit rating, senior unsecured debt rating (where available) and
Baseline Credit Assessment.
NEWS & ANALYSIS Credit implications of current events
5 MOODY’S CREDIT OUTLOOK 17 MAY 2018
Liberty Global’s asset disposals are credit negative, but using proceeds for strategic M&A could restore business profile On 9 May, Liberty Global plc (Ba3 stable) announced the disposal of its German business Unitymedia GmbH (B1 review for upgrade) and the Central and Eastern European (CEE) assets of its subsidiary UPC Holding B.V. (Ba3 negative) to Vodafone Group Plc (Baa1 review for downgrade) for a combined value of €18.4 billion. The amount equals an enterprise value/adjusted-segment operating cash flow (OCF) of around 11.5x on a European Union IFRS basis. The disposals will leave Liberty and UPC with weaker top-line growth prospects and a smaller scale of operations, a credit negative.
The German and CEE operations have been among Liberty's fastest-growing markets, with German revenue up 8.7% in first-quarter 2018 and CEE revenue up 4.3% on a rebased basis, versus overall rebased revenue growth of 4.2%. The disposals (including Austria, announced late last year), which the company expects will close in 2019, will reduce Liberty’s overall scale and increase exposure to the UK, which will account for around 58% of revenue and 52% of OCF (see exhibit).
Liberty's disposals will reduce scale and increase exposure to the UK
The 2018 data exclude Unitymedia and UPC’s operations in Austria, Hungary, the Czech Republic and Romania, which Liberty has agreed to sell. Growth is on a rebased basis. The 2018 estimate is based on average 2017 currency assumptions. Sources: Company data and Moody’s Investors Service estimates
Unitymedia’s 64% OCF margin in 2017 (versus 47% for Liberty) is the highest within Liberty’s businesses and its sale will dilute margins and weaken cash flow. In addition, capital-spending intensity among Liberty’s remaining businesses is high amid network upgrades and expansions.
Although Liberty will determine its use of disposal proceeds only after completion in mid-2019, we expect it to use most for strategic M&A and debt reduction, bringing leverage down (as measured by net debt/OCF) toward the lower end of its financial policy target range of 4.0x-5.0x (leverage was 5.2x as of 31 March 2018).
Strategically compelling acquisitions at the right price, especially in Switzerland and the UK, where incumbent telecom operators are entrenched, would allow Liberty to strengthen its business profile as a provider of products that bundle mobile, data, telephony and TV. Such acquisitions will likely generate meaningful operational synergies but could bring significant integration risks.
$0
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$15,000
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2016 2017 Pro forma 2018 estimate
Rev
enue
, $ m
illio
ns
UK/Ireland Belgium/LuxembourgSwitzerland/Austria CEEGermany NetherlandsLiberty Global Latin America and Caribbean Central, corporate and other, Intersegment eliminations
2.5-3.5%
-0.5-0%
0-1.0%
3.0-4.0%
4.3%
5.2%
-0.3%
1.2%
2.1%
+2.3% year on year
+2.0%-3.0% year on year
+2.5% year on year
Post-disposals
Gunjan Dixit Vice President - Senior Credit Officer +44.20.7772.8628 [email protected]
Michelle H Cheng Associate Analyst +44.20.7772.1038 [email protected]
Ivan Palacios Associate Managing Director +34.91.768.8229 [email protected]
NEWS & ANALYSIS Credit implications of current events
6 MOODY’S CREDIT OUTLOOK 17 MAY 2018
UPC will have a significantly weaker business with the sale of a majority of its CEE operations. These businesses were growing well, even though its main market, Switzerland, lagged amid competitive challenges. Altogether, Austria, Romania, Hungary and Czech Republic account for 37% of UPC’s revenue. Post-disposal, Switzerland would generate around 73% of UPC’s revenue and 79% of its OCF. For 2018, we expect revenue growth in Switzerland to remain subdued, with declining OCF because of higher content costs from investments in quality sports content. UPC’s capex (around 26% of 2017 revenue), challenged by network expansion in CEE, will nevertheless decline with the sale of the majority of UPC’s CEE assets.
Proceeds from disposals in Austria, Czech Republic, Hungary and Romania could be reinvested into UPC’s business within 12-18 months, used for debt prepayments in the absence of reinvestments or up-streamed to Liberty under certain covenant carve-outs. However, given the weakness in UPC's business profile, with 34% of OCF stripped off via disposals (including Austria), we expect the company to prioritize strategic asset investment and reduce debt. Moody’s-adjusted gross leverage for UPC at around 5.5x remains higher than our quantitative leverage threshold of below 5.25x for its Ba3 rating. The absence of deleveraging at UPC could lead to downward ratings pressure.
NEWS & ANALYSIS Credit implications of current events
7 MOODY’S CREDIT OUTLOOK 17 MAY 2018
China Three Gorges’ proposed acquisition of EDP would be credit negative if it materialized Last Friday, China Three Gorges Corporation (CTG, A1 stable) announced a tender offer to acquire the outstanding shares of Energias de Portugal, S.A. (EDP, Baa3 stable), CTG’s 23.27%-owned associate, and EDP Renovaveis, S.A., EDP’s 82.6%-owned subsidiary, for a maximum of €10.2 billion. To the extent that a transaction emerges, the credit effect on CTG would likely be negative because the sizable acquisition would raise its already-high leverage and increase its exposure to unregulated utilities. We expect that CTG would finance the acquisition predominantly with debt, weakening its leverage metrics, including funds from operations/debt, relative to our quantitative guidance for its A1 rating.
The acquisition would diversify CTG’s power-generation portfolio, consistent with its clean energy development strategy, and would be in line with the Chinese government’s “Belt and Road Initiatives,” under which China seeks to deepen economic integration with central Asia, Africa and the North and Mediterranean region. Additionally, the combined group’s installed capacity would rise by 38% to 96.7 gigawatts, while its share of installed capacity in China will fall to 60% from 83% as of the end of 2017.
The acquisition might also increase CTG’s business risks because of higher exposure to unregulated and contracted power sales versus China’s regulated power market, which offers preferential treatment to hydropower generation. However, CTG’s solid experience in managing overseas expansion and its expertise in clean and renewable power mitigate those risks. CTG has cooperated with EDP since 2012, which includes collaborations on various power projects in Latin America. CTG’s past overseas acquisitions include Brazilian hydro projects such as Rio Panapanema Energia S.A. (Ba1 stable) and Rio Parana Energia S.A. (Ba1 stable) and German offshore wind power project WindMW GmbH (Baa3 stable).
The potential acquisition is at a preliminary stage, and we expect the confidential submission of a draft prospectus to EDP and CMVM, the Portuguese securities body, by the end of May. Also, the offer, which EDP rejected, is subject to several conditions, including regulatory approval across the various jurisdictions in which EDP operates, including Portugal, Spain, the US and Brazil. The offer will not proceed if CTG cannot secure controlling voting rights in EDP. Additionally, CTG pitched its offer at a modest premium to the EDP’s market price.
CTG’s A1 issuer rating primarily combines its Baseline Credit Assessment of baa2 and our assessment of the “very high” likelihood of extraordinary support from China (A1 stable), which results in four notches of uplift to its final rating. We expect that CTG will continue to receive a very high level of support from the Chinese government, considering its status as China’s iconic mega infrastructure and systematic importance as the country’s largest clean energy generation company.
CTG is a wholly state-owned enterprise directly under the purview of the State-owned Assets Supervision and Administration Commission of the State Council. It was set up in 1993 as the owner and operator of the Three Gorges Project along the Yangtze River, the largest hydroelectric project globally in terms of total installed capacity. At the end of 2017, CTG had a total installed capacity of 70 gigawatts, of which domestic hydropower accounted for 50.6 gigawatts and wind and solar capacity for 7.7 gigawatts. The company also has an additional 8.5 gigawatts of operating capacity in overseas projects, including Brazil and Germany, and has 31 gigawatts of hydro capacity under construction until 2021.
EDP is a vertically integrated utility company and Portugal's leading electric utility, accounting for around 50% of installed capacity in generation, 99% of distribution and around 46% of liberalised electricity supply at the end of 2016. EDP Renovaveis had 11 gigawatts of wind and solar businesses at year-end 2017, with a particular focus on the US and Europe.
Ada Li Vice President - Senior Analyst +852.3758.1606 [email protected]
NEWS & ANALYSIS Credit implications of current events
8 MOODY’S CREDIT OUTLOOK 17 MAY 2018
Wanhua Chemical’s planned merger with BorsodChem is credit positive Last Thursday, Wanhua Chemical Group Co., Ltd. (Baa3 positive), the world's largest diphenylmethane diisocyanate (MDI) manufacturer, announced plans to acquire its parent company Yantai Wanhua Chemical Co., Ltd. (Wanhua Group) for a total consideration of RMB52 billion. Wanhua Group’s major asset, other than Wanhua Chemical, is its 100%-owned subsidiary BorsodChem in Hungary. The consideration equals 17x BorsodChem's 2017 pre-tax income.
An acquisition would be credit positive for Wanhua Chemical because the geographic expansion and addition of new product lines would further solidify its market position in the global polyurethane industry. Additionally, because Wanhua Chemical plans to fund the transaction with equity, it would not dampen credit quality.
The transaction, which requires regulatory and shareholder approval, would combine the two premier producers in the global polyurethane manufacturing industry with complementary technical know-how, product offerings and geographic footprints that are likely to increase Wanhua Chemical’s market influence and diversification and potentially drive additional cost savings.
We expect that the company's pro forma revenue would increase to more than RMB55 billion in 2018, from RMB53 billion in 2017, after factoring in a potential fall in MDI prices following the sharp rise in 2017 (see exhibit). The transaction is unlikely to materially affect Wanhua Chemical's leverage because it will be funded entirely with equity issued to Wanhua Group’s existing shareholders. We estimate that on a pro forma basis, after consolidating Wanhua Group, Wanhua Chemical’s adjusted debt/EBITDA in 2018-19 will remain low at 1.9x, versus 1.5x for 2017.
Wanhua Chemical’s revenue will be larger with BorsodChem
Pro forma sales and leverage for 2017-18, assuming a potential fall in MDI prices following the sharp rise in 2017. Sources: Moody's Financial Metrics and Moody’s Investors Service estimates
Both companies have had strong operating performance over the past 12-18 months owing to favorable MDI and toluene diisocyanate (TDI) prices amid a global recovery in polyurethane demand and limited new capacity.
Wanhua Group acquired BorsodChem for about €1.26 billion in 2011 and placed it under the management of Wanhua Chemical. Since then, BorsodChem has become profitable. We expect that the integration risk associated with the transaction will be manageable because of the close ties between BorsodChem and Wanhua Chemical and the long track record of operation under Wanhua Chemical’s management.
1.5x
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Wanhua's revenue - left axis BorsodChem's revenue - left axis
Danny Chan Analyst +852.3758.1558 [email protected]
Shane Yip Associate Analyst +852.3758.1397 [email protected]
NEWS & ANALYSIS Credit implications of current events
9 MOODY’S CREDIT OUTLOOK 17 MAY 2018
Lotte Shopping’s sale of hypermarket stores in China is credit positive Last Friday, leading Korean retailer Lotte Shopping Co., Ltd. (Baa3 stable) announced that it will sell 53 hypermarket stores in eastern China to Liqun Group. The announcement follows its 26 April announcement that it would sell 21 hypermarket and supermarket stores in northern China to Wumei Holdings Inc. These transactions, which Lotte Shopping is likely to close this year and next, are credit positive because they will improve the company’s adjusted debt/EBITDA given the sizable operating losses and adjusted debt associated with its China hypermarket business. Additionally, the sales will improve Lotte Shopping's business profile because of its weak market position in China’s highly competitive hypermarket sector.
Lotte Shopping's hypermarket operations in China have been loss-making, and political tensions between Korea and China since March 2017 have further deteriorated performance. According to the company, 87 of its 99 hypermarket stores in China suspended operations at the end of 2017 after its affiliate, Lotte International Co., Ltd., agreed to a land swap with the Korean government that allowed the latter to deploy a missile-defense system on that land. Consequently, Lotte Shopping reported operating losses of KRW269 billion in its Chinese hypermarket business in 2017, a significant weakening compared with a loss of KRW139 billion in 2016 (see Exhibit 1).
EXHIBIT 1
Lotte Shopping's revenue and operating losses from its hypermarket business in China
Source: Lotte Shopping
Operating losses from the hypermarket stores in eastern and northern China accounted for about 83% of the total losses in Lotte Shopping's hypermarket business in China in 2017. According to the company, it plans to close down its remaining 21 stores in eastern China and dispose of the remaining stores in other regions as part of its decision to exit the Chinese hypermarket sector.
Although uncertainties exist about the closure or disposal of 36 remaining hypermarket stores in China, if we assume that Lotte Shopping successfully disposes the remainder during 2018-19, we expect the company's adjusted debt/EBITDA to improve to 4.9x-5.0x in 2019 from 6.0x in 2017 because of a significant improvement in earnings and a decrease in adjusted debt (see Exhibit 2). A moderate recovery in the operating performance of Lotte Shopping’s domestic department store business would also support the improvement. This level of financial leverage is consistent with its current rating level, particularly given its sizable cash balance of about KRW3 trillion as of the end of March 2018.
-400
0
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Wan Hee Yoo Vice President - Senior Credit Officer +852.3758.1316 [email protected]
NEWS & ANALYSIS Credit implications of current events
10 MOODY’S CREDIT OUTLOOK 17 MAY 2018
EXHIBIT 2
Lotte Shopping’s adjusted debt/EBITDA will improve in 2018-19 because of the sale of loss-making hypermarket stores in China
Data are based on consolidated financials (excluding Lotte Card) using the 5x lease multiple to calculate adjusted debt for 2015-16. Present value of minimum lease commitment is used to calculate adjusted debt for 2017-19F. We assumed all hypermarket stores in China will be sold or closed by the end of 2019. Financials for 2019 do not include adjusted debt or adjusted EBITDA from the hypermarket operations in China. Sources: Moody’s Investors Service
0.0x
1.0x
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2015 2016 2017 2018F 2019F
NEWS & ANALYSIS Credit implications of current events
11 MOODY’S CREDIT OUTLOOK 17 MAY 2018
Mitsui Fudosan’s share repurchase is credit negative Last Friday, Mitsui Fudosan Co., Ltd. (A2 stable) announced that it will spend ¥15 billion to repurchase up to 0.76% of its total outstanding shares, excluding treasury shares. The repurchase is credit negative because it will reduce cash flow otherwise available to deleverage or to reinvest in the business.
The company aims to complete the transaction by the end of March 2019. Although Japanese corporates in other sectors have recently increased their shareholder rewards, real estate companies have been constrained thus far because of the highly cyclical, capital-intensive and leveraged character of the business. Mitsui Fudosan’s share repurchase is the first by a Moody’s-rated Japanese real estate operating company. It points to increased pressure for shareholder rewards at a time when real estate companies find it more difficult to grow in a low-yield environment that has depressed returns on new investments.
Mitsui Fudosan’s “total payout” ratio, that is, the share repurchase and dividend/net income, will be around 35% for fiscal 2018 (ending 31 March 2019), an increase from 25% in fiscal 2017. The financial effect of the initial repurchases will be minor, accounting for only 6% of about ¥246 billion of reported consolidated operating income for fiscal 2017. Net debt/EBITDA at less than 0.1x will be little affected by the repurchase, even if the company uses debt to finance the repurchase.
However, more share repurchases are likely to raise Mitsui Fudosan’s leverage over time. Mitsui Fudosan has not officially announced a specific repurchase plan after fiscal 2018. But we expect that the company will repurchase more shares to keep meeting its 35% total payout target.
The repurchase will incrementally add to Mitsui Fudosan’s leverage, which is already high for its rating. Debt/EBITDA in fiscal 2017 increased to 7.6x, based on preliminary fiscal results, from 6.9x in fiscal 2016, mainly because of investments in new development projects. Even without the repurchase, debt/EBITDA will likely remain elevated over the next few years while the company completes investment in large development projects.
Akifumi Fukushi Vice President - Senior Analyst +81.3.5408.4167 [email protected]
NEWS & ANALYSIS Credit implications of current events
12 MOODY’S CREDIT OUTLOOK 17 MAY 2018
Banks
Scotiabank Peru’s Banco Cencosud investment enhances its position in Peru’s retail consumer sector, a credit positive On 9 May, Bank of Nova Scotia (A1/A1 negative, a32) said its Peruvian subsidiary Scotiabank Peru (A3 stable, baa3) had agreed to buy a 51% stake in Peruvian retail bank Banco Cencosud from Cencosud Peru, a subsidiary of retail conglomerate Cencosud S.A. (Baa3 negative) for around $100 million. Following the acquisition, which remains subject to regulatory approval, Scotiabank Peru will become Peru’s second-largest credit-card issuer, a credit positive. In addition to the immediate increase in market share, Scotiabank Peru will be able to leverage the acquisition by offering additional products and services to Cencosud’s customers.
Cencosud operates stores in Chile, Argentina, Peru, Brazil and Colombia. Banco Cencosud offers credit cards and consumer loans primarily to Cencosud customers. As a result of the acquisition, Scotiabank Peru’s share of the active credit card market will rise to 21.5%, including CrediScotia, its subsidiary dedicated to consumer finance, from 18.3% currently. That will put it just behind the market leader, Banco de Credito del Peru (Baa1/Baa1 stable, baa2), and just ahead of the next-largest credit card issuer, Banco Internacional del Peru (Baa2/Baa2 positive, baa3).
In conjunction with the acquisition, for which Scotiabank Peru is paying a premium that is more than double Banco Cencosud’s book value, the two companies will enter a 15-year partnership under which Scotiabank Peru will manage the credit card business and cross-sell products and services. At the end of the 15-year period, Banco Cencosud will have the option to repurchase its shares. Bank of Nova Scotia and Cencosud S.A. already have similar partnerships in Chile and Colombia.
Although Banco Cencosud’s profitability is slightly higher than Scotiabank Peru’s, the agreement will not have an immediate effect on Scotiabank Peru’s already very strong net income to tangible banking asset ratio of 2%. However, we expect that new cross-selling opportunities will eventually boost earnings. Given the monoline nature of Banco Cenconsud’s retail business and its focus on low- and middle-income customers, its asset risk is higher than the system’s median, as reflected in a nonperforming loan ratio of 4.9% as of March 2018. Because of the relatively small size of the acquisition, however, the deal will only modestly increase Scotiabank Peru’s consolidated delinquencies to 3.28% from 3.24% as of March 2018. Similarly, despite the large premium that Scotiabank Peru is paying, the effect on its capital will be limited and capital will remain strong; we estimate that its pro forma adjusted capital ratio as of year-end 2017 will decline by 68 basis points to 13.5%.
Banco Cencosud had a loan portfolio of PEN656 million ($200 million) as of March 2018, accounting for 0.26% of Peru’s total system loans, and more than 315,000 active customers. The bank has branches in 63 of its parent company’s supermarkets and department stores, and offers its own Cencosud branded credit cards, as well as Visa and Mastercard, in all of the company’s 137 markets and stores.
2 The bank ratings shown in this report are the bank’s deposit rating, senior unsecured debt rating (where available) and Baseline
Credit Assessment.
Rodrigo Marimon Bernales Associate Analyst +54.11.5129.2651 [email protected]
NEWS & ANALYSIS Credit implications of current events
13 MOODY’S CREDIT OUTLOOK 17 MAY 2018
Banca Monte dei Paschi di Siena’s return to profitability is credit positive Last Friday, Banca Monte dei Paschi di Siena, S.p.A. (MPS, B1/B3 negative, caa13) reported a €188 million first-quarter 2018 profit after six quarters of losses.4 The return to profitability came as MPS reduced its stock of problem loans5 through a combination of securitizations and asset disposals that sharply decreased loan-loss provisions (see exhibit), which had driven large losses and culminated in the bank’s bailout by the Italian government in 2017. The improvement in the bank’s asset risk profile and earnings generation is credit positive, although we will need more evidence pointing to the bank’s long-term viability on a standalone basis.
MPS' losses have been driven mainly by high loan-loss provisions
Source: Banca Monte dei Paschi di Siena
MPS’ ongoing asset de-risking provides positive evidence that the bank’s restructuring plan agreed with the European Commission, which included the disposal of €26 billion in bad loans, is proceeding, even though it remains at an early stage. MPS is in the process of completing a securitization of gross bad loans worth €24 billion with the support of an Italian government guarantee scheme on senior tranches (Garanzia sulle Cartolarizzazioni delle Sofferenze). The scheme will prompt the deconsolidation of the loans from MPS’ balance sheet in June 2018. The bank is also selling smaller portfolios of loans that are unlikely to pay, which will have a minimal effect on the bank’s income statement, thanks to adequate coverage levels that exceed those of most of its peers.
These actions could bring MPS’ problem-loan ratio to below 20% by the end of 2018 from a high 34% in March 2018, making the bank’s target of reducing its problem-loan ratio below 10% by 2021 more achievable. Doing so would improve MPS’ solvency and overall credit profile. However, MPS’ stock of problem loans is significantly higher than most of its domestic peers, whose problem-loan ratios are already close to 10% or are aimed to fall below the 10% target by no later than 2019.
3 The bank ratings shown in this report are MPS’ deposit rating, senior unsecured debt rating and Baseline Credit Assessment. 4 The exception was the third-quarter 2017 net result, which was adjusted by a €544 million gain on a debt-to-equity swap that
was part of a burden-sharing measure. 5 We define problem loans as the sum of the three categories that Italian banks have reported since 2015 (from most to least
problematic): bad loans, which are loans to insolvent borrowers; unlikely to pay; and past due by more than 90 days and not already included in the previous two categories.
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Fourth-quarter2016
First-quarter2017
Second-quarter2017
Third-quarter2017
Fourth-quarter2017
First-quarter2018
€m
illio
ns
Loan-loss provisions Net income (loss)
Paris +33.1.5330.1020
NEWS & ANALYSIS Credit implications of current events
14 MOODY’S CREDIT OUTLOOK 17 MAY 2018
MPS’ structural profitability also benefits from an aggressive operating-cost restructuring plan that has been in effect for the past 12 months. Last year, MPS reduced personnel by about 1,800 employees and closed more than 400 branches to produce what the bank estimates are annual cost savings of €135 million (operating costs in first-quarter 2018 fell 9% from a year earlier). In January 2018, MPS entirely repaid €3 billion of expensive government-guaranteed debt. These developments have improved the bank’s earnings-generation capacity.
Notwithstanding these credit-positive steps, MPS remains at an early stage in its restructuring plan. The main challenges for the bank include continuing its de-risking plan without compromising profitability and capital, and regaining market confidence in the wholesale funding market, which we believe are difficult but achievable objectives. MPS has sustained significant deposit outflows in recent years, although first-quarter 2018 data show customer deposits increased by almost €3 billion. The bank also plans to issue subordinated and senior debt to wholesale investors, which will be further evidence that its fundamentals are sufficiently strong to attract private investors.
NEWS & ANALYSIS Credit implications of current events
15 MOODY’S CREDIT OUTLOOK 17 MAY 2018
For Saudi banks, lower interest and credit costs are credit positive On Sunday, Riyad Bank (A2 stable, baa16) submitted its preliminary first-quarter 2018 financial results to the Saudi stock exchange, the final Saudi Arabian domestic bank to submit its results. In aggregate, Saudi banks reported a 7.5% year-on-year increase (18% quarter-on-quarter growth) in net profit for the first quarter, mainly because of lower interest expenses and provisioning charges. The results are credit positive for Saudi banks because the improvement occurred amid subdued economic activity that negatively affected credit demand (lending contracted by 1% year on year as of March 2018) and banks’ revenue.
Saudi banks’ interest expenses declined 12.5% year on year (and 2% quarter on quarter), reflecting improving funding conditions in Saudi Arabia after significant tightening in 2016, when falling oil prices and large sovereign debt domestic issuance reduced funding available to Saudi banks and negatively affected their funding costs. Saudi Arabia’s improving liquidity and funding conditions since 2017 have narrowed the Saudi Arabian Interbank Offered Rate’s (SAIBOR) spread against US dollar-denominated London Interbank Offered Rate, even reaching negative spreads in March 2018, despite a number of rate hikes by the US Federal Reserve.
Since April 2018, the SAIBOR has risen to around 2.4%, its highest level since 2009, following a decision by the Saudi Arabian Monetary Authority, the central bank, to increase its repo rate in response to a decline of Saudi money rates below US rates. However, we do not expect that this increase will create immediate upward pressure on interest expenses, given limited credit growth and Saudi banks’ favorable funding profile (banks have an average net-loans-to-deposits ratio of 83% and more than 60% of their liabilities were in non-interest-bearing deposits as of March 2018).
Lower interest expenses supported a 7% year-on-year increase in net interest income and offset the effects of 3% growth in interest income. On a quarterly basis, however, both net interest income and interest income declined by 1%, reflecting a contraction in net loans for the second consecutive quarter. We expect interest income generation to remain challenged given subdued lending activity, somewhat balanced by higher returns on investment portfolios and the gradual re-pricing of variable-rate assets. However, the positive trend in net interest income was partly offset by an 8% year-on-year reduction in non-interest income, leading to 3% growth in operating income (see exhibit). Declining non-interest income arises from less demand (and thus fee-based income) for loans, credit cards, trade and foreign-exchange transactions.
Saudi banks’ change in first-quarter 2018 profits versus a year earlier
NCB = National Commercial Bank; Al Rajhi = Al Rajhi Bank; SAMBA = Samba Financial Group; BSF = Banque Saudi Fransi; SABB = Saudi British Bank; RIYAD = Riyad Bank; ANB = Arab National Bank; Alawwal = Alawwal Bank; SAIB = Saudi Investment Bank; BAB = Bank AlBilad; BAJ = Bank Al-Jazira; Alinma = Alinma Bank Sources: Saudi Arabian Stock Exchange and Moody’s Investors Service
6 The bank ratings shown in this report are Riyad Bank’s deposit rating and Baseline Credit Assessment.
-20%
-10%
0%
10%
20%
30%
40%
50%
NCB Al Rajhi SAMBA BSF SABB RIYAD ANB Alawwal SAIB BAB BAJ Alinma BankingSystem
Net interest income Total operating income Net profit
Jonathan Parrod Associate Analyst +971.4.237.9546 [email protected]
Olivier Panis Vice President - Senior Credit Officer +971.4.237.9533 [email protected]
NEWS & ANALYSIS Credit implications of current events
16 MOODY’S CREDIT OUTLOOK 17 MAY 2018
Higher operating revenue and flat operating expenses supported an increase in Saudi banks’ pre-provision income to 2.6% of total assets in the first quarter, versus 2.5% a year earlier. Another credit-positive development was a 21% year-on-year decline in net impairment charges (47% quarter on quarter). Weak economic conditions, asset quality deterioration in lending books and banks’ preparation for the implementation of the IFRS 9 standards this year drove prudent provisioning in 2017. As a result, Saudi banks’ cost of risk declined to 12% of pre-provision income in the first quarter from 15% a year earlier.
Although we expect a slowing economy and more conservative provisioning policy under IFRS 9 to drive higher and more volatile impairment charges at banks, we do not expect banks’ credit costs to exceed 30% of operating income, considering the moderate growth in lending volumes and banks' high loan-loss coverage.
NEWS & ANALYSIS Credit implications of current events
17 MOODY’S CREDIT OUTLOOK 17 MAY 2018
China’s unification of the supervisory structure for leasing companies is credit positive On Monday, China’s Ministry of Commerce (MOFCOM) announced that it transferred the regulatory role of leasing companies to the China Banking and Insurance Regulatory Commission (CBIRC) on 20 April 2018. The change is credit positive for China’s leasing companies because it will streamline the regulatory framework for the industry and strengthen supervision.
Before the change, China’s leasing companies were supervised by either the CBIRC as non-bank financial institutions or the MOFCOM and its authorized provincial-level commerce departments as corporations (see exhibit). CBIRC-regulated leasing companies are subject to higher entry thresholds, more comprehensive capital requirements and a regular supervision process than their MOFCOM-regulated counterparts, which explained why the latter far outnumbered the former.
Key differences between CBIRC-regulated and MOFCOM-regulated leasing companies CBIRC-regulated leasing companies MOFCOM-regulated leasing companies
Regulatory authority CBIRC MOFCOM
Company type Financial institution Corporation
Number of companies 52 as of 30 September 2016 6,158 as of year-end 2016
Total assets RMB1.9 trillion as of 30 September 2016
RMB2.2 trillion as of year-end 2016
Funding channel » Borrow from financial institutions » Borrow from the interbank market » Take deposits over three months
from non-bank shareholders » Issue financial bonds » Issue asset-backed securities (ABS)
» Borrow from banks » Issue corporate bond » Issue ABS » Transfer leasing receivables » Cannot borrow from the
interbank market » Cannot take deposits
Sources: MOFCOM, CBIRC and Moody’s Investors Service
A unified supervisory structure will enhance CBRIC’s effectiveness as a finance regulator. It remains unclear whether the CBIRC will eventually apply its current regulations to leasing companies previously regulated by the MOFCOM. However, by placing all leasing companies under its jurisdiction, the CBRIC will ensure that its coming regulatory actions and standards will be coherently applied across the leasing industry, eliminating the risk of regulatory arbitrage.
For leasing companies previously regulated by the MOFCOM, the credit effect of this change will depend on the requirements and practice that the CBIRC will apply to them. In particular, aside from a more rigorous supervision process, these companies could benefit from expansion of funding sources under a full CBIRC regime. Currently, they are not allowed to borrow in the interbank market, and thus would benefit from any plan by the CBIRC to open their access to such funding.
Although the CBIRC’s capital/leverage requirements for leasing companies previously regulated by the MOFCOM remain unclear, we do not expect them to face capital pressure under CBIRC’s existing capital requirements, which essentially are the same set of capital adequacy requirements as for commercial banks. We assess these leasing companies’ aggregate leverage as not high, having been constrained by the maximum liabilities/total assets ratio set by their funding partners for corporate borrowers.
At the end of 2016, the aggregate liabilities/total assets of MOFCOM-regulated leasing companies was 65.4%, and their aggregate total assets were only 2.9x their net assets. At such levels, there will be no imminent negative capital pressure for most leasing companies, even if they are immediately subject to CBIRC regulations. However, the actual effect on individual companies may vary depending on their asset mix and available capital.
David Yin Vice President - Senior Analyst +852.3758.1517 [email protected]
NEWS & ANALYSIS Credit implications of current events
18 MOODY’S CREDIT OUTLOOK 17 MAY 2018
Exchanges
Cboe’s successful migration of its C2 options exchange onto Bats’ technology platform is credit positive On Tuesday, Cboe Global Markets, Inc. (Baa1 positive) reported the successful migration of its C2 options exchange onto Bats’ technology platform, a credit-positive milestone signaling that Cboe continues to successfully execute its strategy following its transformative February 2017 acquisition of Bats Global Markets, Inc.
One of Cboe’s key drivers in acquiring Bats was to migrate its exchange trading technology for its futures and options exchanges onto Bats’ superior technology to gain scale and efficiency and to improve client service capabilities. Cboe expects to take until October 2019 to complete the migration of its exchanges onto Bats’ technology, illustrating the scale and complexity of the project. Technology migration is a key credit risk for Cboe since any significant problem could lead to delayed implementation, cost overruns, revenue pressure from customer defections and regulatory issues.
The C2 migration completes another major milestone in the technology integration, following the successful February 2018 migration of the Cboe Futures Exchange (CFE) onto Bats’ technology, and other conversions of Cboe’s index platform and of SPX options to a hybrid options marketplace. Bats’ technology has better order handling and functionality, expanded support for complex orders and improved performance with decreased latency and enhanced order bandwidth, among a number of other comparative benefits, according to Cboe.
Cboe’s flagship exchange, Cboe Options, will be the last of its exchanges to move onto Bats’ technology, with the transition scheduled for October 2019, subject to regulatory approval. This technology migration will be more complex than those that have already occurred because Cboe Options is by far the largest of Cboe’s exchanges (see exhibit), with substantially more transaction volume than C2 and CFE combined.
Cboe Options Exchange has the largest volume and will be the last Cboe exchange to migrate onto Bats’ technology Fourth-quarter 2017 contract volume
Sources: Cboe Global Markets, The Options Clearing Corporation and Moody’s Investors Service
In another signal that the Bats’ acquisition integration is proceeding well, Cboe recently revised its acquisition-related cost synergy target to $85 million from $65 million, and said that it now expects to achieve these cost benefits in 2020, one year ahead of schedule.
1837
292
0
50
100
150
200
250
300
350
Cboe Futures Exchange Cboe C2 Exchange Cboe Options Exchange
Volu
me
in m
illio
ns
Donald Robertson Senior Vice President +1.212.553.4762 [email protected]
Bruno Baretta Associate Analyst +1.212.553.6032 [email protected]
NEWS & ANALYSIS Credit implications of current events
19 MOODY’S CREDIT OUTLOOK 17 MAY 2018
Sovereigns
Colombia’s revised fiscal deficit targets will delay fiscal consolidation, a credit negative for the sovereign On 9 May, Colombia’s (Baa2 negative) Fiscal Rule Consultative Committee (FRCC) revised the government’s potential growth and fiscal deficit targets. The FRCC’s outlook for 2018-29 for the government’s public finances calls for a relaxation of fiscal targets from 2019 through 2026, delaying the pace of fiscal consolidation and Colombia’s return to a structurally balanced budget. Although the new fiscal targets are more feasible because they rely on more realistic assumptions regarding long-term oil prices and Colombia’s potential economic growth, the higher fiscal deficit targets will result in a larger debt burden, a credit negative for the sovereign.
The FRCC projects a larger output gap, the difference between actual and potential GDP, than it previously estimated during last year’s annual revision to the government’s fiscal deficit targets (the Medium Term Fiscal Plan, or MTFP). The output gap, which authorities expect to peak at 4.0% in 2019, would remain negative until 2027, a percentage point wider and a year longer than the trajectory envisioned in 2017 (see Exhibit 1). The revision in the output gap would allow for larger fiscal deficits between 2019 and 2026, as oil and non-oil revenue growth adjusts to longer, below-potential GDP growth (see Exhibit 2). GDP growth in Colombia has decelerated annually since 2013 and averaged just 2.1% during 2015-17, less than half the 4.8% average growth during the last economic upswing between 2010-14.
EXHIBIT 1
Colombia’s output gap between actual and potential GDP
Sources: Colombia’s Ministerio de Hacienda y Crédito Publico and Moody’s Investors Service
-2.8%
-3.0%-2.7%
-2.2%
-1.6%
-1.0%
-0.5%
-0.1% 0.0% 0.0%
-2.7%
-3.8%-4.0%
-3.7%
-3.2%
-2.5%
-1.7%
-1.0%
-0.4%
0.0%
-4.5%
-4.0%
-3.5%
-3.0%
-2.5%
-2.0%
-1.5%
-1.0%
-0.5%
0.0%
2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029
MTFP 2017 2018 FRCC update
Samar Maziad Vice President - Senior Analyst +1.212.553.4534 [email protected]
Gabriel Agostini Associate Analyst +1.212.553.4534 [email protected]
NEWS & ANALYSIS Credit implications of current events
20 MOODY’S CREDIT OUTLOOK 17 MAY 2018
EXHIBIT 2
Colombia’s structural balance under the new and old fiscal deficit targets
Sources: Colombia’s Ministerio de Hacienda y Crédito Publico and Moody’s Investors Service
We estimate that Colombia’s debt burden will not decline until 2019 as a result of the relaxed targets. Before the FRCC’s revisions, we estimated that the debt burden would begin a slow downward trajectory this year and converge with the Baa-rated median in 2019 as consolidation under the 2017 MTFP continued and economic growth rebounded. However, we now estimate that Colombia’s debt/GDP ratio will remain above the Baa-median through at least 2019, as larger fiscal deficits contribute to a slower downward trajectory of the debt burden (see Exhibit 3).
EXHIBIT 3
Colombia’s debt burden will decline at a slower pace following the fiscal rule revision General government debt
Source: Moody’s Investors Service
Colombia’s fiscal rule framework calculates the structural balance by removing the effect of cyclical fluctuations in oil prices and the output gap on fiscal revenue. The rule guides medium-term fiscal consolidation, while allowing automatic stabilizers such as transfers to low-income households and unemployment insurance to work, avoiding pro-cyclicality in fiscal policy and mitigating the negative effect of shocks on growth. The government is also allowed to adopt counter-cyclical measures should growth fall below potential by more than two percentage points and/or the output gap is negative. We placed a negative outlook on Colombia’s sovereign rating in February, in anticipation of a revision to the fiscal targets and a slower pace of fiscal consolidation.
-2.2%
-1.6%-1.3%
-1.0% -1.0% -1.0% -1.0% -1.0% -1.0%
-2.3% -2.3%-2.4%
-3.0%
-4.0%
-3.6%
-3.1%
-2.4%-2.2%
-1.8%-1.5%
-1.3% -1.2% -1.1% -1.1% -1.0%
-4.5%
-4.0%
-3.5%
-3.0%
-2.5%
-2.0%
-1.5%
-1.0%
-0.5%
0.0%
2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027
Perc
ent o
f GD
P
Structural balance MTFP 2017 2018 FRCC update
46.0%
46.5%
47.0%
47.5%
48.0%
48.5%
49.0%
2015 2016 2017E 2018F 2019F
Perc
ent o
f GD
P
2017 MTFP Update Baa median
RECENTLY IN CREDIT OUTLOOK Select any article below to go to last Monday’s Credit Outlook on moodys.com
21 MOODY’S CREDIT OUTLOOK 17 MAY 2018
NEWS & ANALYSIS Corporates 2 » Walmart's planned $16 billion acquisition of India's Flipkart is
credit positive
» Nestlé's transaction with Starbucks is credit negative
» Swire Pacific's asset disposal would enhance its capital structure
Infrastructure 5 » Gener and AES will benefit from restructured agreements for
Chilean hydroelectric project Alto Maipo
Banks 6
» US banks report modestly tighter underwriting standards for credit cards and auto loans, a credit positive
» RBS' settlement with US Department of Justice removes a large litigation risk
» Potential CYBG and Virgin Money merger is credit positive
» UniCredit accelerates problem-loan disposal, a credit positive
» Public bailout of Bangladesh's Farmers Bank is credit positive
Insurers 17 » MetLife's $6 billion pension risk transfer deal with FedEx is
credit positive
» AXA's IPO of US unit will improve capitalization and help secure funding for XL acquisition
Sovereigns 20
» Indonesia's currency and interest rate weaknesses, if persistent, would be credit negative
» Malaysian opposition's electoral win creates economic policy uncertainty
US Public Finance 24
» Proposed de-annexation of Stockbridge, Georgia, is a potential blow to municipalities in the state
Securitization 25
» California's proposed building standards are credit negative for the state's utilities, credit positive for solar ABS
CREDIT IN DEPTH For governments and corporates, marijuana brings possible gains and pressures 26
Ongoing legalization in some US states and likely legalization in Canada nationwide would be slightly beneficial for local government revenues, while alcoholic beverage, tobacco, consumer products and pharmaceutical companies would likely gain if they innovatively expand into the market.
In this report, we examine the credit implications and challenges of marijuana legalization in the US and Canada.
MOODYS.COM
Report: 1125622
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