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MOODYS.COM
2 DECEMBER 2013
NEWS & ANALYSIS Corporates 2
» New Jersey Internet Gaming Is Credit Positive for Atlantic City Operators
» Medicare Rate Cuts Are Credit Negative for Dialysis Providers » Mexican Homebuilders See Credit-Positive Housing Subsidy Increase » Petrofac Joint Venture Wins $2.1 Billion Refinery Contract in
Oman, a Credit Positive » Ansell's Acquisition of BarrierSafe Is Credit Negative » Chinese Developers in Second-Tier Cities Face Credit-Negative
Housing Controls
Infrastructure 12
» Virginia Electric and Power Company Gets Multi-Year Rate Clarity, a Credit Positive
Banks 13 » Dearth of New US Bank Charters Reflects the Industry's Challenges » Mexican Banks’ Consumer Loan Portfolios Deteriorate » Crédit Immobilier de France Orderly Resolution Is Approved, a
Credit Positive » Banca Monte dei Paschi di Siena Will Raise Capital, a Credit
Positive » National Bank of Greece Sale of Non-Core Assets Is Credit Positive » Russian Banks' Large Exposure to Ukraine Is Credit Negative » Chinese Banks Will Gain Opportunities With Expanded
Consumer Finance Program » Problems at Kookmin Bank Show Weakness in Internal Controls » Taiwanese and Chinese Banks Benefit from Relaxed Formosa
Bond Regulations
Insurers 26 » Affordable Care Act Changes Are Credit Negative for US Health
Insurers
Sovereigns 27
» Thailand's Anti-Government Protests Jeopardize 2014 Growth
Sub-sovereigns 29 » UK Local Governments Would Benefit from a Municipal Bond
Agency
US Public Finance 30 » Pennsylvania Gets Credit-Positive Transportation Funding Bill
RATINGS & RESEARCH Rating Changes 32
Last week we downgraded Global A&T Electronics, POSCO, Ibercaja Banco, Tunisia and five Tunisian banks, and upgraded Manitowoc, Starbucks, Rosneft International Holdings, and Citibank Japan, among other rating actions.
Research Highlights 37
Last week we published on European business services, European cable operators, global beverage, US holiday retail sales, the US packaging industry, North American automotive parts suppliers, European banks, US state housing finance agencies, US not-for-profit hospitals, US higher education, US auto ABS, Spanish RMBS, and Austrian mortgage covered bonds, among other reports.
RECENTLY IN CREDIT OUTLOOK
» Articles in Last Monday’s Credit Outlook 40 » 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 2 DECEMBER 2013
Corporates
New Jersey Internet Gaming Is Credit Positive for Atlantic City Operators Last Tuesday, the state of New Jersey formally launched Internet gaming, becoming the third US state to allow gamblers to bet on poker and other casino games online. Internet gaming is credit positive for casino operators in Atlantic City, New Jersey, because the licenses are limited to them and their partners. It is credit negative for operators in eastern Pennsylvania because it is likely to cost them business from New Jersey residents.
We think online gaming revenues in New Jersey will reach $250-$500 million in the first year, far less than the roughly $2.8 billion in annual gaming revenues that Atlantic City currently generates. Operating margins will be about 10%-20%, but start-up costs will likely lead to operating losses for at least the first year. Nevertheless, online gaming provides a much-needed boost for a market that has suffered protracted declines in gaming revenues amid increased competition from neighboring states and weak consumer demand for gaming.
Online play will help New Jersey casino operators expand their gaming market, and operators can use Internet gaming sites to draw patrons to their brick-and-mortar casinos with special offers. To use the gaming sites, players will have to be physically located in New Jersey, which will limit the cannibalization of Atlantic City’s customer base in New York City.
For individual operators, profitability will depend on market share and their contractual arrangements with technology partners that provide the infrastructure for the gaming sites. Based on the high end of our estimates for revenue and margins, there would be about $100 million in operating profit to split among seven licensees and their partners.
Given the limited profit potential for any individual operator, Internet gaming is unlikely to materially improve credit quality enough to affect ratings for the foreseeable future. For example, we estimate a $14-$40 million EBIT contribution from online gaming to Caesars Entertainment Operating Company, Inc. (Caa2 negative), which is Atlantic City’s largest casino operator with four properties, which represents about 2%-4.5% of EBIT for the 12 months ended 30 September.1
Still, Caesars is likely to benefit the most from online gaming because it already has an approximately 40% market share in Atlantic City, strong brands in Caesars and the World Series of Poker, experience operating online gaming internationally, a large database of customers, cash on hand2 to support marketing, and an existing relationship with 888 Holdings Public Limited Company (unrated), a popular online gaming entertainment and solutions provider.
Borgata, owned equally by Boyd Gaming Corp. (B2 stable) and MGM Resorts International (B2 stable) through Marina District Finance Company, Inc. (B2 negative), will also benefit. Borgata has a strong brand in Atlantic City and Boyd has partnered with bwin.party digital entertainment plc (unrated), one of the world’s largest publicly traded online gaming companies and operator of the PartyPoker online brands. As a single-asset company, Borgata stands to benefit more from incremental revenue from online gaming. In the
1 Caesars interactive business is conducted through a non-guarantor subsidiary, Caesars Acquisition Company, which owns 57.6% of
Caesars Growth Partners LLC, and so, does not provide direct credit support to bonds issued by Caesars Operating Company Inc.
2 Cash is held at Caesars Acquisition Corporation.
Peggy Holloway Vice President - Senior Credit Officer +1.212.553.4542 [email protected]
Brian Hueter Associate Analyst +1.212.553.0593 [email protected]
NEWS & ANALYSIS Credit implications of current events
3 MOODY’S CREDIT OUTLOOK 2 DECEMBER 2013
same vein, online gaming is likely to have a more significant effect on Tropicana Entertainment, Inc. (B2 review for upgrade).
The eastern Pennsylvania casinos are most at risk because a large percentage of their patrons are New Jersey residents who may decide to gamble online and take advantage of promotions based upon their online play to visit Atlantic City casinos. Eastern Pennsylvania casino revenues are already negatively affected by sluggish trends in regional gaming demand. The market also faces competition from Delaware, which launched online gaming earlier this month.
Sugarhouse HSP Gaming Prop. Mezz, L.P. (B2 stable) is most vulnerable to the increased competition because it is taking on debt to fund a casino expansion. Other vulnerable eastern Pennsylvania casinos are Harrah’s Philadelphia, owned by Chester Downs & Marina, LLC (B3 stable), Parx Casino (unrated) and Valley Forge Casino Resort (unrated).
NEWS & ANALYSIS Credit implications of current events
4 MOODY’S CREDIT OUTLOOK 2 DECEMBER 2013
Medicare Rate Cuts Are Credit Negative for Dialysis Providers On 22 November, the Center for Medicare & Medicaid Services (CMS) said its proposed 11.9% cut to the reimbursement rate that Medicare pays to dialysis providers would be phased in over a three- to four-year period, rather than being fully implemented on 1 January 2014. It also said that overall reimbursement payments for 2014 will remain the same.
The reimbursement rate reduction is credit negative for dialysis providers American Renal Holdings (B2 stable), DaVita HealthCare Partners Inc. (Ba3 stable) and U.S. Renal Care, Inc. (B2 negative). Even though the phase-in spares dialysis providers from full implementation of the rate cut on 1 January, it does not decrease the rate cut’s size. The dialysis industry had been asking CMS to implement a smaller rate cut ever since the agency proposed an 11.9% cut in July, arguing that the full rate cut would hamper patients’ ability to access dialysis services.
We expect all three companies to implement cost-reduction initiatives to mitigate some of the revenues lost because of the rate cuts. The three companies have each recently undertaken significant debt-financed acquisitions or debt-financed dividends. As a result, they have higher leverage and are absorbing higher debt-service requirements than in prior years, thereby restricting their ability to make acquisitions or invest in existing businesses.
If the 11.9% cut was fully implemented on 1 January, we estimate that American Renal, DaVita and U.S. Renal would have sustained EBITDA reductions in 2014 of about 14% ($16 million), 15% ($397 million and 15% ($30 million), respectively. This likely would have resulted in rating downgrades for American Renal and U.S. Renal, particularly if commercial payer rates decreased, or if the companies failed to mitigate some of the lost revenue with cost cutting.
But because the rate reduction will be phased-in over three to four years, its effect on dialysis providers will be offset by several factors, including the roughly 4% compound annual growth rate of the population that requires dialysis treatment. CMS’ annual market-basket inflation adjustment, which is set at 2.5% for 2014, also mitigates the lost revenue. Furthermore, since the CMS decision covers Medicare reimbursement rates through fiscal 2017, we expect it to provide the sector with some pricing stability over the medium term.
The rate cut is meant to address a decline in the use of expensive end stage renal disease (ESRD) drugs, including Epogen, from 2007-12, when the average Medicare reimbursement for drugs used during a dialysis treatment fell to $51.42 from $83.76, according to CMS. This $32.34 difference, when adjusted for various government budget neutrality modifications and outliers, results in a rate cut of $29.52, or 11.9%. When incorporating CMS’s market-basket increase of 2.5% (2.9% ESRD market-basket increase, less 0.4% estimated multi-factor productivity adjustment), the proposed 11.9% rate cut is lowered to 9.4%.
Ron Neysmith Vice President - Senior Analyst +1.212.553.1364 [email protected]
NEWS & ANALYSIS Credit implications of current events
5 MOODY’S CREDIT OUTLOOK 2 DECEMBER 2013
Mexican Homebuilders See Credit-Positive Housing Subsidy Increase Last Tuesday, Jorge Carlos Ramírez Marín, head of Mexico’s Ministry of Agrarian, Land and Urban Development (SEDATU), announced a MXN12.6 billion budget to grant housing subsidies to homebuyers in 2014, well above the MXN8.3 billion of subsidies provided in 2013. The announcement is credit positive for Mexican homebuilders because the record subsidies will enhance the demand for low-income housing.
The subsidies are granted through a program called Esta es tu casa, operated by the National Housing Commission (CONAVI), SEDATU’s housing arm, and will benefit homebuilders with significant exposure to the low-income segment. Also, given the eligibility rules, homebuilders with land banks already registered in eligible areas will benefit the most.
Corpovael S.A. de C.V. (B1 stable) and Servicios Corporativos Javer, S.A.P.I. de CV (B2 stable) are likely to see the most effect. Because of the recent delays in subsidy distribution, these companies had shifted their portfolios toward higher-priced houses, reducing their dependence on subsidies, as shown in Exhibit 1. With the increase in subsidies, we expect them to be able to capture the additional demand, boosting their volumes.
EXHIBIT 1
Corpovael and Javer Total Housing Units Titled
Note: Data reflects nine months ended in September 2012 and 2013 Source: Corpovael and Javer earnings reports
The 2014 subsidy figure far exceeds the MXN8.3 billion of subsidies provided in 2013, which will be 43% higher than the government’s target at the beginning of this year, as seen in Exhibit 2.
- 2,000 4,000 6,000 8,000 10,000 12,000 14,000
Javer 2012
Javer 2013
Corpovael 2012
Corpovael 2013
Subsidized Unsubsidized
Sandra Beltrán Analyst +52.55.1253.5718 [email protected]
NEWS & ANALYSIS Credit implications of current events
6 MOODY’S CREDIT OUTLOOK 2 DECEMBER 2013
EXHIBIT 2
Mexican Housing Target and Actual Subsidies 2010-14
Note: 2013 includes the announced subsidy increase Source: National Housing Commission (CONAVI)
We estimate that the government will allocate MXN1.3 billion of subsidies per month in November and December, more than double the 2013 monthly averages shown in Exhibit 3. This increase should help strengthen demand for low-income housing heading into 2014, and reflects the Mexican government’s support of homeownership and construction.
EXHIBIT 3
Mexican Housing Subsidy Amounts 2013
Source: National Housing Commission (CONAVI), Moody’s estimates for November and December 2013
In 2012, subsidies were around MXN7.5 billion, with just 10% provided in the fourth quarter, as shown in Exhibit 3, owing to delays on account of presidential elections and a transition to new leadership in the main federal housing institutions. These delays materially affected the operating performance of homebuilders exposed to subsidized sales and ultimately contributed to the defaults of the three largest homebuilders.
The purpose of the program is to increase access to housing financing for the lower-income population. The subsidies can be used for either housing construction, improvement or acquisition. For housing acquisition, the maximum amount that can be granted to an individual is around MXN72,800 for a house valued at up to MXN394,000. In general, a property needs to be located in defined areas to receive the subsidy.
5.8 5.2
7.4 8.3
-
5.8 5.3
8.2
5.8
12.6
0
2
4
6
8
10
12
14
2010 2011 2012 2013 2014
MXN
Bill
ion
Actual Target
0
200
400
600
800
1000
1200
1400
MXN
Mill
ion
NEWS & ANALYSIS Credit implications of current events
7 MOODY’S CREDIT OUTLOOK 2 DECEMBER 2013
Eligibility and the amount granted are a function of the property’s development in terms of infrastructure, proximity to urban centers and accessibility to employment sources.
NEWS & ANALYSIS Credit implications of current events
8 MOODY’S CREDIT OUTLOOK 2 DECEMBER 2013
Petrofac Joint Venture Wins $2.1 Billion Refinery Contract in Oman, a Credit Positive Last Monday, oil and gas construction company Petrofac Limited (Baa1 stable) announced that its 50/50 joint venture with Korea-based Daelim Industrial Co. Ltd. (unrated) received a three-year, $2.1 billion engineering, procurement and construction (EPC) contract from Oman Oil Refineries and Petroleum Industries Company (ORPIC, unrated).
The award is credit positive because it increases Petrofac’s backlog to a record of approximately $15 billion. It also comes just a week after Petrofac said it needed new contract awards this year and early next year to meet its 2015 guidance of net profit of more than $862 million, following delays of two of its largest projects: the $2.9 billion Upper Zakum project in Abu Dhabi and the approximately $500 million second stage of the Berantai project in Malaysia.
As of 31 October, Petrofac’s backlog was an all-time high of $14.3 billion after recent wins for an integrated petrochemical project in Kazakhstan and the Alrar gas field life extension in Algeria. The ORPIC award increases that record backlog by approximately 7%.
ORPIC’s EPC contract with Petrofac’s joint venture is for improvements, start-up and commissioning services at a refinery built in 2006 in the Sohar Industrial Area of Oman and the expansion of new refining units at the same location. The contract aims to improve the facility and boost production capacity by more than 70%. Although this project is the first time that Petrofac will work for ORPIC, which is owned by Oman Oil Company (OOC, unrated), Petrofac has been operating in Oman since 1988, having completed two projects over the past three years for Petroleum Development Oman (PDO, unrated), the national oil company.
In November, Petrofac announced that it would post “flat to modest growth” in profit from 2013 levels as a result of the Upper Zakum and Berantai delays. The company reiterated its 2015 guidance of net profit of more than $862 million, but acknowledged that achieving that goal relied on securing contracts during the remainder of this year and the first half of next.
The Upper Zakum project postponement resulted from the initiation of capacity enhancement studies that have the potential to increase the size and length of the project and will lead to revenue deferrals of $400-$600 million and income deferrals of $30-$50 million to 2015 or 2016 from 2014. With respect to the Berantai delay, Petrofac in its risk service contract3 is undertaking concept engineering studies for the second stage of the development, which points to a delay in the bulk of the execution that will likely result in the deferral of $200 million in revenue and $10-$20 million in income recognition starting in 2014.
The ORPIC award will make its 2015 target more achievable. We expect this new contract to partly compensate for the delays of the Abu Dhabi and Malaysia projects, which prompted us to adjust our expected 2014 gross debt/EBITDA (as adjusted by us) toward 1.5x from our October forecast of approximately 1.0x owing to lower EBITDA and higher debt.
3 Petrofac manages the development of an asset, operates and maintains that asset and invests capital in the project. The capital is
generally reimbursed from production cash flow, with a return based on its performance across factors such as schedule, cost and operational performance.
Douglas Crawford Vice President - Senior Analyst +44.20.7772.5215 [email protected]
NEWS & ANALYSIS Credit implications of current events
9 MOODY’S CREDIT OUTLOOK 2 DECEMBER 2013
Ansell’s Acquisition of BarrierSafe Is Credit Negative Last Tuesday, Ansell Limited (Baa3 stable) announced that it has reached an agreement to acquire BarrierSafe Solutions International (BSSI, unrated), a major North American provider of single-use gloves, from private equity firm Odyssey Investment Partners and others for approximately $615 million.
Ansell’s BSSI acquisition is credit negative given size and integration challenges. Specifically, the BSSI acquisition is a significant shift to a single large-scale acquisition from Ansell’s past strategy of growing via bolt-on acquisitions. The BSSI acquisition will increase Ansell’s overall asset base by around a third. Ansell risks losing BSSI’s key customers, suppliers and even key management personnel during the integration process. The acquisition’s size, integration and implementation risks are higher than Ansell’s previous transactions.
The acquisition also raises operating performance risks. BSSI has grown revenues and EBITDA strongly, with revenue up by a compound annual growth rate of 10% over the past six years. We have doubts about Ansell’s ability to sustain this strong performance. Also, BSSI growth partly reflects its acquisitions in 2012, thereby adding complexity.
Ansell’s financial metrics are broadly unchanged as a result of the transaction, but this does not compensate for integration, operational and other risks. The $615 million BSSI acquisition is funded about 49% by debt, through an AUD300 million bank facility; and 51% by equity, via a fully underwritten equity placement of AUD338 million and up to AUD100 million in a non-underwritten stock purchase plan. We expect debt/EBITDA to be around 3.0x in fiscal 2014 (ending 30 June), which would be in line with the level achieved in fiscal 2013. We expect EBIT to interest expense to remain above 6.0x.
If BarrierSafe is integrated successfully and generates consistent earnings in line with projections, Ansell will enhance its brand name and have a more diversified product mix and improved, larger economies of scale. Until then, the transaction will weigh negatively on Ansell’s credit profile. Its post-acquisition pro-forma revenue will increase by 20.5%, as shown in the exhibit below.
Sources of Ansell’s Pro-forma Combined Contribution (Fiscal 2013, AUD millions)
Source: Ansell Limited
AUD 1,655 AUD 255
AUD 1,373 AUD 198
AUD 282 AUD 57
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Revenue EBITDA
Heritage Ansell BarrierSafe
Jason Lu Associate Analyst +61.2.9270.8190 [email protected]
Maurice O’Connell Vice President - Senior Analyst +61.2.9270.8167 [email protected]
NEWS & ANALYSIS Credit implications of current events
10 MOODY’S CREDIT OUTLOOK 2 DECEMBER 2013
Chinese Developers in Second-Tier Cities Face Credit-Negative Housing Controls Between 25 and 28 November, the governments of eight second-tier cities in China – Nanjing, Hangzhou, Shenyang, Changsha, Xiamen, Nanchang, Fuzhou and Xian (all unrated) – issued policy guidelines aimed at increasing their housing supply and controlling home prices. The spread of government controls to a wider group of cities is credit negative for developers with material operations in those cities because the tightened controls will reduce housing demand over the next three to six months. Homebuyers are apt to curtail their purchases while they wait for more clarity on the effects of the measures, which in turn will reduce developers’ sales, price growth and, accordingly, their margins.
The Wuhan city government (unrated), following the lead of several first-tier cities, on 22 November became the first second-tier city to issue such regulatory measures. These housing-related measures affirm the central government’s firm position in preventing property prices from rising too rapidly, and are likely to expand to other cities recording significant year-on-year price growth.
A number of rated developers, including Franshion Properties (China) Limited (Baa3 stable), Yanlord Land Group Limited (Ba3 stable), Greentown China Holdings Limited (B1 positive), Yuzhou Properties Company Limited (B1 stable) and Zhong An Real Estate Limited (B2 negative), are exposed to the new measures, given their significant presence in some of the cities that issued new guidelines (see Exhibit 1). Among them, Zhong An is the most vulnerable, given its small and concentrated operation in Hangzhou and its weak sales and liquidity.
EXHIBIT 1
Contracted Sales of the Five Rated Developers with a Presence in Second-Tier Chinese Cities Controlling Home Prices
Developer Rating City Where Developer Has a Presence
Contracted Sales in that City as a Percent of Total Contracted
Sales, First-Half 2013
Franshion Baa3 stable Changsha 37%1
Yanlord Ba3 stable Nanjing 15%2
Greentown B1 positive Hangzhou 34%
Yuzhou B1 stable Xiamen 76%
Zhong An B2 Negative Hangzhou 40%
Notes: 1) Contract sales included primary land sales for January through July 2013, 2) Moody’s estimates
Sources: Company interim results 2013 and Moody’s estimates
The nine second-tier cities that have instituted the new policies have experienced strong property price growth over the past three to six months (see Exhibit 2), which we expect will slow because of the new policies. Among the measures are increases in the supply of low- and mid-priced housing, the supply of land for residential use and the minimum required down payment for a second-home mortgage. In addition, cities such as Shenyang, Wuhan, Nanchang and Fuzhou have tightened the eligibility requirements for non-local residents to purchase homes (Exhibit 3).
Lisa Tao Associate Analyst +852.3758.1307 [email protected]
Franco Leung Assistant Vice President - Analyst +852.3758.1521 [email protected]
Kaven Tsang Vice President - Senior Analyst +852.3758.1304 [email protected]
NEWS & ANALYSIS Credit implications of current events
11 MOODY’S CREDIT OUTLOOK 2 DECEMBER 2013
EXHIBIT 2
Year-on-Year Residential Property Price Growth in Nine Second-Tier Chinese Cities
Sources: National Bureau of Statistics of China
EXHIBIT 3
Highlights from the Cities’ New Housing Policy Guidelines
Nanjing and Hangzhou Shenyang Changsha Xiamen Wuhan Nanchang Fuzhou Xian
Increase in land supply for residential use
Yes No change Not less than the average supply over the past five years
Yes Yes Yes Yes Yes
Increase in low- and mid-income housing supply
Yes Yes Yes Yes Yes Yes Yes Yes
Down payment for second-home mortgage
Increase to 70%
Increase to 65%
Increase (by how much not disclosed)
Increase to 70%
Increase to 70%
Increase (by how much not disclosed)
Not mentioned
No change
Eligibility requirements for non-local residents to purchase homes
Not mentioned
Tightened to two years’ payment of income tax or social security
Not mentioned
No change Tightened to two years’ payment of income tax or social security
Tightened to two consecutive years’ payment of income tax or social security
Tightened to two years’ payment of income tax or social security in the past three years
No change
Source: Municipal governments and the People’s Bank of China
-8%-6%-4%-2%0%2%4%6%8%
10%12%14%16%18%
Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13 Sept-13 Oct-13
Nanjing Hangzhou Shenyang Changsha Xiamen
Wuhan Nanchang Xian Fuzhou
NEWS & ANALYSIS Credit implications of current events
12 MOODY’S CREDIT OUTLOOK 2 DECEMBER 2013
Infrastructure
Virginia Electric and Power Company Gets Multi-Year Rate Clarity, a Credit Positive Last Wednesday, the Virginia Electric and Power Company (VEPCO, A3 review for upgrade) received a final order from the Commonwealth of Virginia’s utility regulator, the State Corporation Commission (SCC), about its biennial review of VEPCO’s electric rates, terms and conditions for the provision of generation, distribution and transmission services. In summary, the SCC’s final order is credit positive for VEPCO because it provides for the timely recovery of prudently incurred costs and investments, and sets the stage for rate stability until VEPCO’s next biennial rate review filing, around March 2015.
In the final order, the SCC authorized a 10.0% base rate return on equity (down from 10.4%), which would be sufficient to maintain VEPCO’s financial integrity, its ability to attract capital on reasonable terms, and generate earnings commensurate with returns on investments of comparable risk. This compares to the 10.25% return on equity that VEPCO earned during the biennial review period (2011-12). In addition, the SCC authorized a 50% equity layer in the capital structure, down from the 55% reported in 2012. The final order eliminated a 50-basis-point “adder” for investments associated with the renewable portfolio standards and increased the maximum allowed ROE “collar” to 70 basis points from 50 basis points. This translates into a maximum allowed ROE of 10.7% in the next biennial review period.
The SCC also addressed the recovery of deferred costs, biomass and demand-side management programs, and other tariffs. Although there were positive and negative points across a broad range of regulatory considerations, overall, we view the transparency of the rate proceedings and the final authorizations of cost and investment recovery as credit positive.
We found several instances in the final order where the SCC used relatively strong language to rebut some of VEPCO’s assertions and/or interpretations with respect to the legislative underpinnings of the regulatory framework. The most notable was the language surrounding rate adjustment clauses (RACs). Unlike base rates, RACs are collected and “trued-up” on an annual basis, which helps reduce any cost recovery lag. These RAC collections consider VEPCO’s weighted average cost of capital, and the SCC appeared to object to certain assertions that VEPCO presented regarding the SCC’s authorization associated with the RACs.
In other jurisdictions, the rhetoric written into the final order would be an early warning sign of brewing contentiousness, typically a credit negative. But in Virginia, where the legal jurisdictional framework that underpins utility regulation is relatively new and untested, we see these issues as testing boundaries, and a necessary re-establishing of the legal precedents that are often helpful with creating transparency in future regulatory proceedings.
This most recent SCC decision exemplifies the strong credit support we see embedded in the regulatory process, and is a principal factor behind our decision to put VEPCO’s ratings on review for upgrade, and indirectly with VEPCO’s parent, Dominion Resources (Baa2 review for upgrade).
Jim Hempstead Associate Managing Director +1.212.553.4318 [email protected]
NEWS & ANALYSIS Credit implications of current events
13 MOODY’S CREDIT OUTLOOK 2 DECEMBER 2013
Banks
Dearth of New US Bank Charters Reflects the Industry’s Challenges Last Tuesday, the Federal Deposit Insurance Corporation (FDIC) released its Quarterly Banking Profile, which showed a continuing lack of newly chartered banks. This is a reflection of the industry’s challenges, including a return on equity (ROE) well below pre-global-financial-crisis levels. Although the industry’s balance sheet has returned to health, with fewer bank failures and stronger asset quality, modest returns and difficult prospects explain why the business remains unattractive to newcomers. All banks are grappling with these challenges.
Historically, the industry attracted capital in the form of newly chartered banks, even in periods of stress. Exhibit 1 shows that when bank failures last spiked in the early 1990s, the FDIC continued to report significant numbers of newly chartered institutions. Then, in the relatively benign period from the mid-1990s through 2007, the number of new charters increased further. However, that pattern has since changed, and abruptly. Excluding one credit union that converted to an FDIC-insured cooperative savings bank in the third quarter this year, the FDIC has not added a new charter to its roster since the second quarter of 2011, an unprecedented period of no new charters for more than two years.
EXHIBIT 1
Number of New US Bank Charters and Failures Since 1991 Until recently, the banking business was attractive to newcomers
Source: Federal Deposit Insurance Corporation
An examination of the long-term trend in the US banking industry’s ROE, as reported by the FDIC, explains the dearth of new entrants. Exhibit 2 shows that what had been a low- to mid-teens ROE business before the recent downturn is now a high-single-digit ROE business benefitting from unsustainable circumstances. In particular, as a consequence of continued asset quality improvement, a number of individual banks’ recent earnings reports have benefited from the ongoing release of loan-loss reserves, an earnings and ROE benefit that will soon end.
0
50
100
150
200
250
300
Num
ber
New Charters Failed Institutions
Allen Tischler Senior Vice President +1.212.553.4541 [email protected]
NEWS & ANALYSIS Credit implications of current events
14 MOODY’S CREDIT OUTLOOK 2 DECEMBER 2013
EXHIBIT 2
US Banks’ Profitability Metrics Remain Modest and Unenticing
Source: Federal Deposit Insurance Corporation
A key driver of the industry’s current profitability woes has been depressed net interest margins (NIMs), a particularly pertinent measurement for US banks because it accounts for well over half of total revenue. FDIC data in Exhibit 2 also shows that from 1991 to 2003, the industry’s NIM exceeded 3.7% each year and was greater than 4.0% for much of that period. In contrast, the industry’s NIM for the first nine months of 2013 was 3.26%, and we expect continued margin pressure absent an increase in short-term interest rates, which we expect to remain at historic lows.
Moreover, NIM pressure is only one of the challenges that the industry faces. The tepid state of the economic recovery has constrained loan growth, mortgage banking revenue has declined as a result of higher long-term interest rates, intense regulatory scrutiny has significantly increased compliance costs, and litigation risk from the housing downturn continues to linger. On top of these challenges, we expect higher regulatory capital and liquidity to present another daunting challenge for potential new entrants.
0%
1%
2%
3%
4%
5%
-2%
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
Return on Equity - left axis Net Interest Margin - right axis
NEWS & ANALYSIS Credit implications of current events
15 MOODY’S CREDIT OUTLOOK 2 DECEMBER 2013
Mexican Banks’ Consumer Loan Portfolios Deteriorate On 22 November, Banco de México, the Mexican central bank (Banxico) reported a 38% year-over-year increase in banks’ retail nonperforming loans (NPL) as of 30 September, which is credit negative for banks. The data suggests further asset quality deterioration as a consequence of banks’ more lenient loan origination practices earlier this year and Mexico’s unexpectedly sharp economic deceleration through September.
The banks most negatively affected are those that are focused on consumer finance, such as Banco Azteca S.A. (unrated) and Banco Compartamos, S.A. (unrated), as well as large commercial banks, such as BBVA Bancomer, S.A. (Baa1 stable, C-/baa1 stable4), Banco Nacional de México, S.A. (Banamex, Baa1 stable, C-/baa1 stable), Banco Santander (México), S.A. (Baa1 stable, C-/baa1 stable), Banco Mercantil del Norte, S.A. (Banorte, Baa1 stable, C-/baa2 stable), HSBC México, S.A. (Baa1 stable, C-/baa1 stable), and Scotiabank Inverlat S.A. (Baa1 stable, C-/baa2 stable). Deterioration in asset quality ranges between a low 22 basis points and a substantial 427 basis points (see Exhibit 1).
EXHIBIT 1
Nonperforming Loan Ratio Evolution in Mexico’s Eight Largest Retail Banks
Source: Comisión Nacional Bancaria y de Valores
Since early 2012, banks have sought to increase lending in the riskier consumer portfolio so as to increase or maintain intermediation margins. However, GDP growth of 1.3% through September 2013 was much lower than the 3.5% the government forecast earlier this year, and well below the 3.8% growth during 2012.
Personal and payroll-linked loan portfolios have experienced the greatest deterioration, as shown in Exhibit 2.
4 The bank ratings shown in this report are the bank’s deposit rating, its standalone bank financial strength rating/baseline credit
assessment and the corresponding rating outlooks.
0%
1%
2%
3%
4%
5%
6%
7%
8%
9%
10%
11%
BBVA Bancomer Banamex Santander Banorte Azteca HSBC Scotiabank Compartamos
September 2012 September 2013
Lauren Kleiman Associate Analyst +52.55.1253.5734 [email protected]
Felipe Carvallo Vice President - Analyst +52.55.1253.5738 [email protected]
David Olivares Vice President - Senior Credit Officer +52.55.1253.5705 [email protected]
NEWS & ANALYSIS Credit implications of current events
16 MOODY’S CREDIT OUTLOOK 2 DECEMBER 2013
EXHIBIT 2
Banking System’s Retail Nonperforming Loan Ratio by Type
Source: Comisión Nacional Bancaria y de Valores
Rapid credit growth has also raised household indebtedness, which we estimate, as a percentage of household available income, increased to 2.9x in June from 2.6x in June 2012. According to Banxico’s governor, Agustín Carstens, individuals may be increasing their personal leverage through the acquisition of more than one personal credit card and other types of consumer loans. This indicates that individuals may be using new loans to repay old ones, momentarily masking deterioration.
Higher consumer NPLs have also negatively affected banks’ core earnings (pre-provision income); systemwide consumer loan loss provisions increased 41% from the same period in 2012 (see Exhibit 3) and now account for 31% of core earnings, despite consumer loans equaling 23% of loans.
EXHIBIT 3
Banking System Consumer Credit Costs versus Pre-provision Income
* Annualized Source: Comisión Nacional Bancaria y de Valores
2%
3%
4%
5%
6%
7%
8%
All Retail Loans Credit Card Personal Loans Payroll-Linked Loans
0
20
40
60
80
100
120
140
160
180
2007 2008 2009 2010 2011 2012 Sep 2013*
MXN
Bill
ions
Pre-Provision Income Net Income Consumer Provisions
NEWS & ANALYSIS Credit implications of current events
17 MOODY’S CREDIT OUTLOOK 2 DECEMBER 2013
Crédit Immobilier de France Orderly Resolution Is Approved, a Credit Positive Last Wednesday, the European Commission (EC) approved the French government’s orderly resolution of French mortgage lender Crédit Immobilier de France (CIF, unrated). The approval, which means that the plan is compatible with the European Union’s (EU) state aid rules, is credit positive for CIF’s debtholders because it makes permanent a temporary state guarantee in place since September 2012. Moreover, the aid guarantees that all secured and unsecured creditors will be repaid, absent major losses in the bank’s loan book.
Under the resolution plan, the French government will provide up to €28 billion of guarantees for up to 22 years. As a condition for this support, CIF is prohibited from generating new business and must wind down its activities.
Major funding difficulties at CIF prompted the French government in September 2012 to implement a guarantee scheme to ensure that the wholesale-funded lender would meet all of its obligations. The government did so to ameliorate the systemic risks it believed a CIF failure would pose, particularly given the lender’s role as a major player in the covered bond market through its subsidiary CIF Euromortgage. The aid package consisted of guarantees that allowed Caisse Centrale du Crédit Immobilier de France (3CIF, Baa2 stable, E/ca), the rated funding entity of CIF, to issue long-term unsecured debt of up to €16 billion (the external guarantee) to address CIF’s identified funding gaps, plus €12 billion to cover CIF’s intra-group obligations (the internal guarantee).
On 21 February, the EC gave temporary approval for support totalling €18 billion for a maximum of six months, during which time the EC would determine if the aid complied with the EU’s state aid guidelines. On 19 August, CIF announced that it had received an extension of the review period to 28 November.
The EC’s final approval of CIF’s orderly resolution caps the state guarantees at €28 billion and will expire 31 December 2035. A condition of the EC’s approval is the bank’s run-off. Although the securities that CIF issued before 21 February are not covered by the external guarantee, CIF’s ability to tap the market will allow it to address any liquidity gaps that occur during the run-off period. As such, this support will allow the lender to repay all outstanding debt at maturity (senior unsecured and covered bonds) through the issuance of guaranteed debt and mortgage amortizations. If the run-off of the loan book (€34 billion at year-end 2012) were to generate heavy losses, which we think is unlikely, the bank’s capital cushion (€1.7 billion) would be sufficient to absorb them.
The EC approval is also credit positive for the covered bonds that CIF Euromortgage has issued. The EC endorsed the view that the failure of this entity could spill into the entire market. The guarantee covers CIF Euromortgage’s deposits at 3CIF (either in cash deposits or certificates of deposit), which account for 23% of the cover pool.5 It also supports CIF’s covered bonds because the guaranteed debt that CIF issues during the run-off will help refinance CIF Euromortgage’s maturing covered bonds.
5 See figures on the cover pool in the latest Performance Overview, 21 November 2013 and for more information on the law passed
to approve the guarantee to CIF, see CIF Euromortgage: New Finance Law is Credit Positive for French Covered Bonds, 31 January 2013.
Guillaume Lucien-Baugas Assistant Vice President - Analyst +33.1.5330.3350 [email protected]
Elise Lucotte Vice President - Senior Analyst +33.1.5330.1022 [email protected]
NEWS & ANALYSIS Credit implications of current events
18 MOODY’S CREDIT OUTLOOK 2 DECEMBER 2013
Banca Monte dei Paschi di Siena Will Raise Capital, a Credit Positive Last Wednesday, Banca Monte dei Paschi di Siena (MPS, B2 negative; E/caa36) announced it had reached a binding pre-underwriting agreement with a group of international investment banks to raise up to €3 billion of equity that will repay a portion of aid provided by the Italian government. The announcement is credit positive because it strengthens the MPS balance sheet, lowers its funding costs, and reduces the likelihood that the Italian Treasury will convert into equity the state aid it provided to MPS, a scenario that would significantly increase subordinated bondholders’ risk of burden-sharing.
MPS plans to launch the issue in the first quarter of 2014 and use the proceeds to repay €3 billion of the €4.1 billion of state aid it received in 2013. The bank will also use the funds to cover the interest on the state aid (which has a 9% coupon with a step-up) and the cost of the share issue. MPS plans to repay the remaining €1.1 billion of state aid by 2017.
The share issue’s size, which exceeds MPS’ €2.17 billion market capitalization, its timing and the binding pre-underwriting agreement all surpass our earlier expectations. We expected MPS to be challenged to place €2.5 billion of equity in 2014. By anticipating the issue and by aiming to complete it by January 2014, the bank looks to exploit currently favorable market conditions.
However, bondholders continue to face significant risks. MPS’ largest shareholder, a not-for-profit foundation that owns 33.5%, could oppose the share issue to stop its dilution. In addition, the bank remains exposed to failing the European Central Bank’s comprehensive assessment because it has the highest ratio of problem loans relative to equity and loan-loss reserves among the Italian banks we rate and that are subject to the assessment (see exhibit).
Italian Banks’ Problem Loans as a Percent of Equity and Loan-Loss Reserves
Source: Moody’s Financial Metrics as of 30 June 2013
Moreover, the bank’s four-year turnaround plan will be difficult to execute, given the challenging operating environment for Italian banks, notwithstanding the removal of its main stumbling block, the share issue. Nevertheless, completion of the share issue would lower these risks.
6 The bank ratings shown in this report are the bank’s deposit ratings, its standalone bank financial strength rating/baseline credit
assessment and the corresponding rating outlooks.
37.04%
53.85%60.58% 63.22% 65.16% 65.46%
92.92% 93.97%
129.17%
0%
20%
40%
60%
80%
100%
120%
140%
Credito Emiliano
Intesa Sanpaolo
Banca Carige Unione di Banche Italiane
Banca Popolare di
Milano
UniCredit Banco Popolare
Credito Valtellinese
MPS
London +44.20.7772.5454
NEWS & ANALYSIS Credit implications of current events
19 MOODY’S CREDIT OUTLOOK 2 DECEMBER 2013
National Bank of Greece Sale of Non-Core Assets Is Credit Positive Last Tuesday, National Bank of Greece (NBG, Caa2 negative, E/caa3 stable7) announced the sale of a 66% stake in its real estate subsidiary, National Pangaea, for a total consideration of €653 million.8 On the same day, NBG also announced that it has four binding acquisition offers from Greek and international investors for its hotel resort, Astir Palace Vouliagmenis. The sale of these non-core assets will strengthen NBG’s capital position and is credit positive.
After its June €9.8 billion recapitalisation by the HFSF and private investors, NBG has endeavoured to enhance its capital position by selling non-core assets and deleveraging both locally and from regional markets following significant losses from the Greek government debt-exchange in 2012.
The sale of a majority stake in National Pangaea to a foreign real estate company (Invel Real Estate (Netherlands) II BV) is one of the steps toward this goal, with the bank’s core Tier 1 ratio benefiting around 40 basis points from this transaction. According to its third-quarter results announced last week, NBG’s pro-forma core Tier 1 ratio improved to 9.4% from 7.8% in December 2012. Upon completion of the sale, NBG will retain a 34% stake and control for up to five years, appointing the majority of the board of directors and the investment committee, and aiming to list the company on the Athens Stock Exchange in 2015.
In addition, the bank has received four binding offers (with bank guarantees) for the acquisition of a majority participation in the share capital of its hotel resort, Astir Palace Vouliagmenis. NBG expects this sale to add a similar size boost to its core Tier 1 ratio, as the transaction above. We also expect NBG to sell up to 40% of its well-performing Turkish subsidiary, Finansbank AS (Ba2 negative, E+/b2 negative), which could further increase its core Tier 1 ratio by around 300 basis points.
All these capital-enhancing measures would help NBG meet any capital needs that might emerge when BlackRock conducts its second assessment of credit losses for Greek banks, which the Bank of Greece commissioned and is due to be completed before year-end. Moreover, NBG will be better positioned relative to the 9% minimum core Tier 1 required by the Bank of Greece, and will strengthen its loss-absorption cushion for its elevated non-performing loans in Greece, which were 27.1% as of September 2013.
7 The bank ratings shown in this report are the bank’s deposit rating, its standalone bank financial strength rating/baseline credit
assessment and the corresponding rating outlooks. 8 The sale was contingent upon the consent of the Hellenic Financial Stability Fund and approval by the European Commission’s
Directorate of General Competition.
Nondas Nicolaides Vice President - Senior Analyst +357.25.586.586 [email protected]
NEWS & ANALYSIS Credit implications of current events
20 MOODY’S CREDIT OUTLOOK 2 DECEMBER 2013
Russian Banks’ Large Exposure to Ukraine Is Credit Negative Last Tuesday, Russian President Vladimir Putin said that Ukrainian borrowers owed around $28 billion to four Russian banks,9 and named Gazprombank (Baa3 stable, D-/ba3 stable10), Vnesheconombank (Baa1 stable), Sberbank (Baa1 stable, D+/ba1 stable) and Bank VTB, JSC (Baa2 stable, D-/ba3 stable) as creditors. We estimate that these banks’ exposure to Ukrainian risk is $20-$30 billion, a sizeable amount indeed, considering that their combined Tier 1 capital was $105 billion in June. This material exposure poses risks to their asset quality and capital adequacy because of the weak creditworthiness of Ukrainian borrowers and the government of Ukraine (Caa1, review for downgrade), which is credit negative for Russian banks.
While Ukraine’s recent steps to normalize political and economic relations with Russia11 have reduced the immediate risk for the country’s external liquidity position, the creditworthiness of Ukrainian borrowers will remain weak because of the country’s severe economic problems, which will lead to higher credit losses for the four Russian banks. We estimate that 35% of all loans in the Ukrainian banking system are problem loans with limited recovery opportunities. If Ukraine does not sign the association agreement with the European Union, Russian-Ukrainian trade will likely increase and the four large Russian banks, which the government of Russia (Baa1 stable) directly and indirectly controls, will likely increase their exposure to Ukraine.
As shown in the exhibit below, we estimate that Russian banks’ Ukrainian subsidiaries have the largest part of the exposure (i.e., around $12 billion), followed by $4-$5 billion of loans secured either by natural gas or OJSC Gazprom’s (Baa1 stable) payments for gas transit. The remaining exposures come from bilateral loans to Ukrainian companies, securities and guarantees.
Russian Banks’ Subsidiaries in Ukraine Pose High Risks for Their Parents
Subsidiary Name Total Assets at Year-
End 2012, $ Billion 2010-12 Assets CAGR* Parent
Prominvestbank (Caa2 review for downgrade, E/caa1 stable)
$4.7 5% Vnesheconombank
Subsidiary Bank Sberbank of Russia (Caa2 review for downgrade, E/caa1 stable)
$3.3 37% Sberbank
VTB Bank PJSC (Ukraine) (unrated) $4 0.4% Bank VTB
*CAGR = Compound Annual Growth Rate
Source: Moody’s, bank reports
Apart from the size of the subsidiaries and gas-related loans, the exact exposure of each bank is not publicly disclosed, adding uncertainty. Still, we consider that Gazprombank is less exposed to Ukrainian risk than Vnesheconombank, VTB or Sberbank because it mainly provides loans secured by gas and gas-transit payments, and does not have a subsidiary in Ukraine.
9 The official transcript is available in Russian here. 10 The bank ratings shown in this report are the bank’s deposit rating, its standalone bank financial strength rating/baseline credit
assessment and the corresponding rating outlooks. 11 See Suspension of Ukraine's Agreement with the European Union Hinders Economic and Institutional Credit Improvements, 25
November 2013.
Eugene Tarzimanov Vice President - Senior Credit Officer +7.495.228.6051 [email protected]
NEWS & ANALYSIS Credit implications of current events
21 MOODY’S CREDIT OUTLOOK 2 DECEMBER 2013
Chinese Banks Will Gain Opportunities With Expanded Consumer Finance Program On 22 November, the China Banking Regulatory Commission published revised rules that expand the Consumer Finance Company Pilot Program and will take effect next year. The modified rules are credit positive for China’s consumer finance companies and for banks because both will benefit from new growth opportunities.
The rule revisions do the following:
» allow qualified non-financial companies to invest in consumer finance companies
» reduce the minimal shareholding requirement for an individual shareholder of these companies to 30% from 50%
» increase the lending limit for a particular customer to RMB200,000 from 5x monthly salary
» remove restrictions limiting consumer finance companies to operate only in regions where they are domiciled, and allow them to take deposits from domestic shareholders and their affiliates
» enhance internal risk management practices by encouraging shareholders to commit to providing liquidity and capital support at time of distress.
These rules are credit positive for banks because they aim to jump-start growth in China’s formal, but insignificant and underdeveloped, consumer finance market. Banks currently offer limited types of consumer loan products with inefficient customer services. As of end-2012, household debt (excluding mortgages) accounted for merely 5% of China’s GDP (see exhibit below), much lower than the levels in neighboring countries.
Select Asian Countries’ Household Credit as Percent of GDP (Excluding Mortgage Loans)
Source: China central bank data as of year-end 2012
Promoting growth in the consumer finance industry aligns with China’s current efforts to rebalance its economy toward domestic demand and the strong growth of its consumption-minded middle class. An economic growth model driven more by consumption will set a healthy backdrop for Chinese banks.
Although lowering the entry barriers to set up consumer finance companies will intensify competition for banks, especially in overlapping market segments such as credit cards and unsecured consumer loan lending, we believe that China’s current nascent market has considerable room for growth before competition becomes a negative factor for the industry. Furthermore, commercial banks, thanks to their extensive
5.3%
16.4%
25.6%33.2%
39.1%
57.2%
0%
10%
20%
30%
40%
50%
60%
70%
China Hong Kong Japan Malaysia Korea Thailand
Sherry Zhang Associate Analyst +852.3758.1392 [email protected]
NEWS & ANALYSIS Credit implications of current events
22 MOODY’S CREDIT OUTLOOK 2 DECEMBER 2013
customer base and low funding costs, tend to capture customers with different risk profiles than consumer finance companies. The revised consumer finance rules will also have a limited effect on deposits and funding pressure because consumer finance companies are not allowed to take deposits from customers.
We nevertheless believe that new rules will challenge banks’ risk-management capabilities. Along with the short history of China’s consumer credit bureau system, the banks do not yet have seasoned risk management and governance systems. However, as the market develops, we expect accurate consumer credit data to become more available.
NEWS & ANALYSIS Credit implications of current events
23 MOODY’S CREDIT OUTLOOK 2 DECEMBER 2013
Problems at Kookmin Bank Show Weakness in Internal Controls On 25 November, Korea’s Financial Supervisory Service (FSS) launched a special investigation into the suspected embezzlement of KRW9 billion by employees of Kookmin Bank (A1 stable, C-/baa1 stable12) -- in addition to an ongoing inquiry into allegedly unauthorized loans of KRW170 billion at Kookmin Bank’s Tokyo branch. Kookmin Bank has admitted these events occurred, which is credit negative for Korea’s largest lender and points to internal control weaknesses for both its domestic and overseas operations.
In the latest problem, a staff member within the bank’s Housing Fund Division with responsibility for national housing bonds forged and redeemed bearer bonds with the collusion of other employees. National housing bonds are issued by the National Housing Fund to finance the construction of public housing. If the bearer bonds are not redeemed five years after their maturity, they expire. Usually when the bond has not been redeemed for a long time after maturity, the bearer either has forgotten about it or is deceased, which facilitated the fraud, which began in 2010 and involved about KRW9 billion. In our opinion, the most credit-negative factor is that the fraud evaded internal checks for close to three years and only became known on 19 November when an employee reported it internally.
At the Tokyo branch, allegations of KRW170 billion of unauthorized lending between 2010 and 2012 came to light in September. In order to avoid breaching single-credit concentration limits, the branch manager and staff allegedly forged loan documents. In exchange for the loans, staff pocketed illegal fees and repatriated them to Korea. The bank will likely have to write off a significant portion of the loans.
The Tokyo branch incident underscores the difficulty Kookmin Bank has had ensuring effective internal control of its foreign operations. The bank’s traditional focus has been domestic retail banking and its overseas operation accounts for only 1.7% of total assets. Therefore, internal checks on overseas lending were not as rigorous as in domestic operations. This is not the first issue the bank has had with its overseas operations (Kookmin Bank currently has 12 overseas outlets). In March, the CEO failed to receive timely notification from staff that the National Bank of Kazakhstan had suspended for a month the foreign-exchange operation of Bank CenterCredit (B2 stable, E+/b3 stable), in which Kookmin Bank owns 41.9%.
The investigations point to the broader issue of managers’ relatively short tenures: the average tenure of the previous three CEOs was only four years. The new chairman and CEO were appointed in July this year, and many board members have since been replaced. Short CEO tenures result in a lack of management consistency, which, in turn, weakens corporate governance.
12 The bank ratings shown in this report are the bank’s deposit rating, its standalone bank financial strength rating/baseline credit
assessment and the corresponding rating outlooks.
Sophia Lee, CFA Vice President - Senior Analyst +852.3758.1357 [email protected]
NEWS & ANALYSIS Credit implications of current events
24 MOODY’S CREDIT OUTLOOK 2 DECEMBER 2013
Taiwanese and Chinese Banks Benefit from Relaxed Formosa Bond Regulations On 27 November, a day after Taiwan’s Financial Supervisory Commission said Chinese companies could issue Renminbi (RMB)-denominated bonds in Taiwan -- so called Formosa bonds – (i.e., non-Taiwan dollar bonds issued in Taiwan) to institutional investors, the Hong Kong branch of Bank of Communications (A3 stable; D+/ba1 stable13) applied to issue RMB1.2 billion of 3-year 3.4% bonds and 5-year 3.7% bonds. GreTai Securities Market, which reviews and approves bond listings in Taiwan, also announced on 26 November that in addition to the Chinese subsidiaries of Taiwanese-listed companies and banks, Chinese policy banks, state-owned commercial banks and joint-stock commercial banks could also issue offshore RMB bonds in Taiwan.
We believe that Taiwanese banks will benefit, and those with large outstanding RMB deposits, such as Mega International Commercial Bank (A1 stable; C-/baa2 stable) and CTBC Bank Co., Ltd. (A2 review for downgrade; C-/baa2 review for downgrade), will benefit the most. The Formosa bonds will allow Taiwan’s banks to diversify their RMB assets and better match their RMB assets and liabilities. Taiwan has seen steady growth in RMB deposits since the formal establishment in February this year of direct RMB and Taiwan dollar clearing across the Taiwan Strait. However, Taiwanese banks have limited options to deploy these offshore funds because China’s capital account restrictions prevent the free flow of funds back to mainland China.
Taiwan life insurers will also benefit because the Formosa bond market potentially widens their investment choices. If the Financial Supervisory Commission allows them to invest in these bonds, they will gain an additional outlet for their RMB-denominated insurance funds and improve asset-liability management.
Chinese banks will also gain broader access to offshore RMB funds. Experience from Hong Kong’s dim sum bond market suggests that Chinese banks will be active issuers of Formosa bonds because they need to fund their growing offshore RMB loans. In 2012 and 2013, more than 55% of dim sum bonds were issued by Chinese policy banks or major Chinese commercial banks.
As shown in Exhibit 1, the Taiwanese banks’ RMB deposit balance reached RMB123.25 billion at end-October 2013, which far surpassed their RMB loans of only RMB9.52 billion. Banks have filled this gap by placing their excess RMB funds mainly in the interbank market, or partially in dim sum bonds. The Formosa bond market will broaden Taiwanese banks’ investment options.
13 The ratings shown in this report are the banks deposit rating, its standalone bank financial strength rating/baseline credit
assessment and the corresponding rating outlooks.
Ginger Kao Analyst +852.3758.1317 [email protected]
Stella Ng Assistant Vice President - Analyst +852.3758.1506 [email protected]
Frank Wu Associate Analyst +86.10.6319.6576 [email protected]
NEWS & ANALYSIS Credit implications of current events
25 MOODY’S CREDIT OUTLOOK 2 DECEMBER 2013
EXHIBIT 1
Offshore RMB Deposits and Loans of Taiwanese Banks
Note: Excludes balance in overseas branches of Taiwanese banks Source: Central Bank of the Republic of China (Taiwan)
Furthermore, dim sum bonds with significant size issued by major Chinese banks often offer longer tenors and higher yields over interbank rates, as tracked by the CNH HIBOR fixing rate (Exhibits 2 and 3). Therefore, we expect Taiwanese banks to also benefit from a yield pick-up on Formosa bonds, which will in turn help improve the margins on their RMB books.
EXHIBIT 2
CNH Hong Kong Interbank Offered Rate Fixing Date Tenor Interest Rate
28-Nov-13 1 Year 2.88667
19-Nov-13 1 Year 2.91200
13-Nov-13 1 Year 2.94600
Source: Treasury Markets Association
EXHIBIT 3
Selective RMB-denominated Bonds Issued in Hong Kong by Chinese Banks Issuer Name Issue Date Tenor Coupon Size RMB million
Industrial & Commercial Bank of China, Singapore Branch 28-Nov-13 2 Year 3.2% 2,000
Industrial & Commercial Bank of China 19-Nov-13 3 Year 3.35% 1,300
Industrial & Commercial Bank of China 19-Nov-13 5 Year 3.75% 700
China Development Bank 13-Nov-13 2 Year 2.6878% 1,900
China Development Bank 13-Nov-13 5 Year 3.6% 1,700
China Development Bank 13-Nov-13 15 Year 4.5% 900
Source: Bloomberg
0
20
40
60
80
100
120
140
Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13 Sep-13 Oct-13
RMB
Billi
on
Deposits Loans
NEWS & ANALYSIS Credit implications of current events
26 MOODY’S CREDIT OUTLOOK 2 DECEMBER 2013
Insurers
Affordable Care Act Changes Are Credit Negative for US Health Insurers The announcement on 22 November by the Department of Health and Human Services (HHS) to delay the Affordable Care Act (ACA) open enrollment period for 2015, along with other recent last-minute administrative changes made by the Obama Administration are credit negative for US health insurers as they expose the sector to additional financial and operational risks.
The changes and their credit effects include the following:
1. Allowing individuals to remain enrolled in non-ACA-compliant policies for 2014 – This change will likely have a negative effect on the risk profile of the exchange health risk-pool, should healthy younger members take advantage of this last-minute waiver. The uncertainty created as state insurance commissioners and insurance companies decide whether or not to offer this option to their insured members has further delayed enrollment in the exchanges.
2. Extending deadlines for 2014 enrollment – Two extensions have been announced so far. The first allows individuals to wait until 31 March 2014 to enroll and avoid a penalty. Since individuals who enroll during the second half of March will not have their coverage in effect until May, insurers will be losing up to two months of premium on these individuals as a result of the extension. In addition, it is more likely that younger, healthier individuals will take advantage of this extension, resulting in an adverse risk-pool for the first few months of the year.
The second extension allows individuals to enroll up until 23 December this year, and still have a policy effective date of 1 January 2014. The extra week allowed by this change will cause insurers various administrative problems because they will have to make sure that these individuals have been coded correctly in their systems in time to receive healthcare benefits on the first of the year. If there is a surge in enrollment activity in late December as website issues and other uncertainties are resolved, it will be nearly impossible for insurers to complete the enrollment process in time.
3. Change in 2015 open enrollment period – The beginning of open enrollment for 2015 has been pushed back to mid-November 2014 from October 2014. The changes create several issues for insurers. The mid-November date creates an administrative challenge of enrolling members in time for 1 January 2015 over a compressed timeline; also, the original open enrollment was to end in mid-December, resulting in all individuals being enrolled for a full year.
We expect additional changes as the Administration addresses the operational and political problems that have arisen during the enrollment process. Any further enrollment deadline extensions will exacerbate adverse selection and significantly increase the probability that these products will lower insurers’ expected profits, or even result in financial losses for them. Unless the healthcare.gov website is vastly improved by the first week of December, we expect the Administration will be pressured to again extend enrollment deadlines. In addition, the Administration’s disclosure that the back-end payment system intended to transfer government subsidies to insurers has not been built, casts doubt on the government’s ability to make timely payments to insurers.
Steve Zaharuk Senior Vice President +1.212.553.1634 [email protected]
NEWS & ANALYSIS Credit implications of current events
27 MOODY’S CREDIT OUTLOOK 2 DECEMBER 2013
Sovereigns
Thailand’s Anti-Government Protests Jeopardize 2014 Growth Last Tuesday in Thailand (Baa1 stable), anti-government protesters began occupying several government buildings in Bangkok, including the Ministry of Finance as well as the front yard of the army’s headquarters, and protests spread beyond Bangkok. Prime Minister Yingluck Shinawatra extended the Internal Security Act until year end, and widened its coverage to the whole of Bangkok, the neighboring province of Nonthaburi, and several districts in Samut Prakan and Pathum Thani provinces.
The protests will likely undermine investor confidence and detract from an already fragile growth outlook for 2014, a credit negative for the sovereign. Although protests have mostly been peaceful, four people were killed and dozens wounded during clashes on Saturday night. Prolonged or escalating protests will adversely affect foreign investment and tourism, and exacerbate delayed public infrastructure investment, which will weigh on Thailand’s future growth in 2014 and beyond. While Thailand’s credit fundamentals still compare favorably with similarly rated peers, weaker growth will negatively affect the fiscal balance and contribute to rising debt ratios.
Since US tapering fears emerged in May 2013, emerging market countries with relatively weak policy frameworks or external current account and domestic budget deficits have had more volatile capital flows. Thailand has become more vulnerable to diminished investor confidence because it has these twin deficits. And, its foreign exchange reserves have declined since May (see Exhibit 1).
EXHIBIT 1
Thailand’s Foreign Exchange Reserves Adversely affected by tapering fears in May and growing political protests since October
Sources: Bank of Thailand, Moody’s
Revised balance of payments data released in late September showed a current account deficit equal to 0.4% of GDP in 2012 as opposed to a small surplus previously. During January to September, Thailand's current account deficit was $6.1 billion, up from a $3.4 billion deficit in the same period a year earlier. Recent customs trade data point to continued weakness in export growth, with a trade deficit of $1.77 billion in October. We expect the current account to remain in deficit of about 1%-1.5% of GDP throughout 2014 and the fiscal deficit at around 3% of GDP.
$152$154$156$158$160$162$164$166$168$170$172$174
$ Bi
llion
Steffen Dyck Assistant Vice President - Analyst +65.6398.8324 [email protected]
NEWS & ANALYSIS Credit implications of current events
28 MOODY’S CREDIT OUTLOOK 2 DECEMBER 2013
Thailand’s growth momentum is also slowing: third-quarter real GDP growth declined to 2.7% year on year from 5.4% in the first quarter. This contrasts with Korea, Malaysia and Singapore, which all reported stronger third-quarter annual growth rates. Although slowing growth also reflects the strong base effects of a growth rebound in first half 2012, as a result of post-flood reconstruction and government stimulus measures, we also see indications of underlying structural weaknesses, with weak export growth in key manufacturing sectors, such as automotive, electronics, and agro-manufacturing. Overall, export growth for the 10 months through October was stagnant and momentum lags that of other open economies in the region (see Exhibit 2).
EXHIBIT 2
Change in Merchandise Exports for Select Asian Countries; Year-On-Year Three-Month Moving Average Thailand’s export growth momentum lags those of the region’s open economies
Note: Based on exports in local currency Sources: Haver Analytics, Moody’s
Fraying investor confidence reflects itself in rising government bond yields: the 10-year yield was 4.13% as of 28 November, up from 3.79% on 24 October. Responding to conditions, the Bank of Thailand cut its policy interest rate by 25 basis points to 2.25% on 27 November, citing downside risks to growth from the current political situation, on top of a weak export recovery, delays in government investment, and fragile private confidence.
-10%
-5%
0%
5%
10%
15%
20%
Thailand (Baa1 stable) Korea (Aa3 stable) Malaysia (A3 positive) Taiwan (Aa3 stable)
NEWS & ANALYSIS Credit implications of current events
29 MOODY’S CREDIT OUTLOOK 2 DECEMBER 2013
Sub-sovereigns
UK Local Governments Would Benefit from a Municipal Bond Agency On 22 November, the UK’s Local Government Association voted in favour of establishing a municipal bond agency to offer local governments a cheaper source of funding. Eighteen local government councils made formal expressions of interest in creating an entity modelled on the specialised lenders in operation in Scandinavia and the Netherlands. If this entity is created, it would be credit positive for UK regional and local governments.
A municipal bond agency would deliver lower borrowing costs to local governments by pooling several governments’ funding needs and providing economies of scale: the proposal suggests borrowing rates of 70-80 basis points above the gilt rate. The agency would also provide a viable alternative and a complementary funding source to the Public Works Loans Board, which currently provides approximately 75% of the local government funding with the lowest rate of 80 basis points over gilts. Additionally, the new class of bonds would broaden investors’ options.
The proposal assumes that local authorities would still assess their borrowing capacity in reference to the “Prudential Code for Capital Finance,” the institutional framework that governs borrowing limits. Therefore, the Local Government Association’s expectation, as noted in its proposal, is that local authority debt would not increase overall. In a typical year, local authorities in England and Wales borrow about £5 billion for infrastructure.
Local governments rely on the Public Works Loans Board for the lion’s share of their funding needs, but are vulnerable to changes in the terms of trade because of their lack of alternative lending sources. For example, in October 2010, the Board increased its interest rate to 100 basis points above the government benchmark gilt rate; the March 2012 budget decreased the interest rate 20 basis points.
The proposed agency is modelled on Nordic and Dutch specialised lenders (all rated Aaa, stable or negative outlook). The key credit positive factors for the specialised lenders have been 1) their close relationship with and beneficial support from their sovereigns; 2) the strength of their respective regional and local governments, which the sovereign closely monitors; 3) their unfettered access to capital markets; and 4) their healthy liquidity. Similarly, the institutional framework that would govern the UK’s proposed new entity would be a critical factor in assessing the new agency’s underlying creditworthiness, as would its securities portfolio, investor confidence and refinancing costs.
Overall, the creation of this entity would expand options for local government financing within the UK. In addition, it would further expand the UK public sector’s access to the capital markets. As the past three-year trend in English Housing Associations shows, the sector’s bond financing has increased significantly: as of February 2013, more than £3 billion of bond financing had been raised for the year to date, a 67% increase from the £1.8 billion raised from 14 issuances in 2011-12.
Roshana Arasaratnam Vice President - Senior Analyst +44.20.7772.5302 [email protected]
NEWS & ANALYSIS Credit implications of current events
30 MOODY’S CREDIT OUTLOOK 2 DECEMBER 2013
US Public Finance
Pennsylvania Gets Credit-Positive Transportation Funding Bill Last Monday, Pennsylvania Governor Tom Corbett signed into law a comprehensive transportation funding bill that the state expects will generate approximately $7.3 billion in new revenue over five years. The bill is credit positive for the Commonwealth of Pennsylvania (Aa2 stable) because it provides a new and recurring revenue stream to address the state’s large backlog of transportation improvement and maintenance projects.
Additionally, the bill is credit positive for other entities. It phases out the annual funding burden that the prior transportation bill created for the Pennsylvania State Turnpike Commission (senior revenue bonds A1 stable; subordinate revenue bonds A3 stable), and addresses the funding needs of the state’s two largest mass transit agencies; the Southeastern Pennsylvania Transportation Authority (A1 stable) in Philadelphia and the Port Authority of Allegheny County (A1 stable) in Pittsburgh.
The new law provides a new recurring revenue stream for transportation by increasing various fees, including oil company franchise tax, vehicle registration, driver’s license, county vehicle registration and other various motor vehicle-related fees. The state estimates the new revenues will provide up to $2.4 billion annually after the law is fully implemented in 2018. For the remaining seven months of the current 2014 fiscal year, the state estimates an increase of $320 million.
The largest revenue source after implementation will be derived from the gradual elimination of the cap imposed on the oil company franchise tax (OCFT). The state currently caps the average wholesale price of fuel subject to the OCFT at $1.25 per gallon. The cap will rise to $1.87 on 1 January 2014, then $2.49 on 1 January 2015, until completely eliminated on 1 January 2017. The current average wholesale price of a gallon of gasoline is $3.00. The increase in the OCFT will help pay for state road improvements and provide additional revenue to support the Pennsylvania State Turnpike Commission Oil Franchise Tax Bonds (senior Aa3 stable; subordinate A2 stable).
The legislation also provides for $500 million of new bonding capacity for the Pennsylvania Department of Transportation (PennDOT) secured by revenues in the state’s Motor License Fund. The funding will alleviate the financial and leverage burden on the turnpike, mass transit agencies and the state that the prior transportation bill (ACT 44) created.
Pennsylvania has not had a structurally sound transportation funding policy for the seven years since enactment of Act 44. That Act created a long-term annual payment obligation between the PTC and PennDOT of $450 million, but the payment obligation was not supported by a revenue stream. Consequently, PTC raised tolls and issued debt to make the payment. The debt was secured by Turnpike toll revenues as well as a security enhancement provided by the state. The $450 million supported $200 million of highway funding and $250 million of mass transit funding. The new law phases out the PTC’s annual payment in eight years. After the sunset, PTC will be required to provide PennDOT with $50 million annually in cash (not debt proceeds) for use in mass transit funding. Additionally, effective on 1 July 2014, PTC’s annual contribution will be allocated differently, with $420 million to support mass transit operating and capital needs and $30 million dedicated to multi-modal projects (i.e., rail freight, passenger rail, aviation, port, waterway, bicycle and pedestrian projects). Overall, the bill is credit positive for the commonwealth, as well as a number of entities within the state, as detailed below.
Kimberly Lyons Assistant Vice President - Analyst +1.212.553.4673 [email protected]
NEWS & ANALYSIS Credit implications of current events
31 MOODY’S CREDIT OUTLOOK 2 DECEMBER 2013
Pennsylvania Transportation Bill’s Credit Effects on Various Entities Credit Ratings Effect
Pennsylvania (Commonwealth) G.O. Aa2 stable Positive - Legislation provides a structural plan to address infrastructure needs. New recurring revenue source to fund all modes of transportation: highways, mass transit, and multi-modal.
Pennsylvania State Turnpike Commission Senior revenue lien: A1 stable; Subordinate revenue lien: A3 stable
Positive - Legislation eliminates annual payment obligation to PennDOT of $450 million after 2022 (payments went to 2053 under ACT 44); increase in certain taxes will flow to PTC; new law will slow the growth in debt which we have highlighted as a credit challenge for the Turnpike
Pennsylvania State Turnpike Commission Oil Franchise Tax Bonds
Senior lien: Aa3 stable; Subordinate lien: A2 stable
Positive - Legislation incrementally lifts the cap on the average wholesale price of fuel used to calculate the oil franchise tax by January 2017, when the cap will be completely eliminated. The current cap is $1.25 and the current average wholesale price is $3.00. This change will increase the revenues that secure these bonds.
Southeastern Pennsylvania Transit Agency A1 stable Positive - Legislation increases annual funding to $430 million in fiscal 2015 from $250 million, then to $450 million in fiscal 2023
Port Authority of Alleghany County A1 stable Positive - Legislation increases annual funding to $430 million in fiscal 2015 from $250 million, then to $450 million in fiscal 2023
Source: Moody’s
RATING CHANGES Significant rating actions taken the week ending 29 November 2013
32 MOODY’S CREDIT OUTLOOK 2 DECEMBER 2013
Corporates
Global A&T Electronics Ltd. Downgrade
13 Nov ’13 25 Nov ‘13
Corporate Family Rating B2 Caa1
Outlook Review for Downgrade Negative
The downgrade reflects GATE's weak operating performance, which remains below our expectations. The weak performance reflects significantly lower revenues this year, softer market demand and continued price erosion.
Manitowoc Company, Inc. Upgrade
29 Mar ’12 25 Nov ‘13
Corporate Family Rating B2 B1
Outlook Positive Stable
The upgrade reflects the favorable business outlook for both the Crane and Foodservice segments and our expectation of continued deleveraging over the near term, offset by the company's high leverage for the rating category.
POSCO Downgrade
24 Oct ’12 25 Nov ‘13
Senior Unsecured Rating Baa1 Baa2
Outlook Negative Stable
The downgrade mainly reflects POSCO's high level of debt, the challenging fundamentals it faces in the steel industry and the significant uncertainties about its ability to implement significant deleveraging measures. The rating action also reflects our expectation that despite a gradual improvement, POSCO's financial leverage will remain elevated and weak for the Baa1 rating level over the next one to two years.
Starbucks Corporation Upgrade
3 Sep ’13 25 Nov ‘13
Senior Unsecured Rating Baa2 Baa1
Outlook Review for Upgrade Positive
The upgrade reflects Starbucks positive same-store sales performance that further strengthens its brand, and drives higher earnings and cash flows. The upgrade also reflects the company’s improved credit metrics and incorporates the resolution of the Kraft arbitration.
RATING CHANGES Significant rating actions taken the week ending 29 November 2013
33 MOODY’S CREDIT OUTLOOK 2 DECEMBER 2013
Rosneft International Holdings Limited (RIHL) Upgrade
24 Oct ’12 27 Nov ‘13
Long Term Issuer Rating Baa2 Baa1
Outlook Review for Downgrade Negative
The upgrade represents the alignment of RIHL’s ratings and its guaranteed subsidiary Rosneft Finance S.A. with those of its parent Rosneft. The upgrade reflects our understanding that (1) Rosneft has confirmed that it intends to manage the business and debt obligations of its subsidiary in the same manner as it manages its own debt obligation; (2) there is a high degree of operating integration between the two companies; and (3) RIHL's creditworthiness prior to it being acquired by Rosneft was comparable to that of the parent.
RATING CHANGES Significant rating actions taken the week ending 29 November 2013
34 MOODY’S CREDIT OUTLOOK 2 DECEMBER 2013
Financial Institutions
Citibank Japan Upgrade
26 Aug ‘13 29 Nov ‘13
Long-Term Bank Deposit Rating Baa1 A3
Standalone Financial Strength/ Baseline Credit Assessment
D+/baa3 C-/baa2
The upgrade follows our decision to upgrade the ratings of Citibank N.A. (A2 stable, C-/baa2 stable).14 Citibank Japan's standalone credit profile is strongly aligned with that of its parent, Citibank N.A., due to their close business integration. Therefore, changes in its parent's standalone credit prolife are generally reflected in the ratings of Citibank Japan.
Ibercaja Banco SA Downgrade
24 Oct ‘12 28 Nov ‘13
Long-Term Senior Debt and Deposit Ratings
Ba2 Ba3
Standalone Financial Strength/ Baseline Credit Assessment
D-/ba3 E+/b1
The downgrade reflects the bank's weakened financial profile following the integration with Grupo Banco Cajatres S.A. (unrated) and the deterioration of the group's asset-quality metrics, particularly in the corporate segment, which we expect will deteriorate further.
Rossiyskiy Kredit Bank Outlook Change
4 Oct ‘07 28 Nov ‘13
Long-Term Rating Caa1 Caa1
Outlook Stable Negative
The change in outlook reflects our view of the credit risks associated with (1) the rapid growth of Bank Rossiyskiy Kredit's loan book; (2) the deterioration of the bank's capital adequacy level; and (3) the bank's increasing reliance on interbank funding.
14 The ratings are the deposit rating, standalone bank financial strength rating/baseline credit assessment and the corresponding rating
outlooks.
RATING CHANGES Significant rating actions taken the week ending 29 November 2013
35 MOODY’S CREDIT OUTLOOK 2 DECEMBER 2013
Downgrades of Four Tunisian Banks Downgrades
27 Nov ‘13
The rating actions were driven by (1) the weakening of the government's capacity to provide support to the banks, as indicated by the recent downgrade of the government bond rating to Ba3 (negative) from Ba2; and (2) our view that the fragile domestic operating environment will continue to weigh on the banks' financial fundamentals, mainly their asset quality, profitability and capitalization.
RATING CHANGES Significant rating actions taken the week ending 29 November 2013
36 MOODY’S CREDIT OUTLOOK 2 DECEMBER 2013
Sovereign
Tunisia's Government Issuer Rating Downgraded to Ba3, Outlook Negative On 25 November, we downgraded Tunisia's government issuer rating to Ba3 from Ba2. The outlook on the rating remains negative. The key drivers of the rating action were:
» Tunisia's ongoing political uncertainty and increased polarization, as highlighted by the lack of timely progress in the national dialogue. This is augmented by heightened security risks at the national level and in the wider region;
» Increased external funding challenges, exacerbated by delays in completing Tunisia's democratic transition and resuming economic reforms;
» Tunisia's persistently large external and fiscal imbalances;
» The fragile state of the country's banking sector, particularly the undercapitalized government-owned banks.
US Public Finance
State of Arizona Outlook Change
6 Feb ‘12 26 Nov ‘13
Issuer Rating Aa3 Aa3
Outlook Stable Positive
The change in outlook reflects recent strong economic trends in Arizona and that we expect continued growth in the state in the near term, as well as improvement in the state's liquidity and General Fund balances. Job growth has out-paced the US in 2012 and 2013, and the employment gap between the state and the US has largely closed.
RESEARCH HIGHLIGHTS Notable research published the week ending 29 November 2013
37 MOODY’S CREDIT OUTLOOK 2 DECEMBER 2013
Corporates
European Business Services: Recovery Is Fragile, But Prospects Are Improving The outlook is becoming more positive for certain business-to-business (B2B) segments of the European business and consumer services universe. Some B2B companies are increasingly reporting a return to organic growth or a deceleration of sales declines for their European operations. At the same time, stringent cost control has protected profit margins and restructuring costs should abate in 2014. While a return to economic growth would particularly benefit companies with high operating leverage, current economic weakness has not led to a significant deterioration of credit quality. There has been very limited downward rating pressure on European services companies over the past 12-15 months as balance sheets have remained largely intact.
European Cable Operators: Positive Outlook Hinges on Fending off Greater Competition Our outlook for the European cable TV industry is positive. Despite likely revenue growth of between 3%-4% in 2014 for European cable TV operators, competitive pressures are limiting the scope of growth in mature markets. As a result, cable operators are looking to add enhanced products, diversify their revenue streams or raise prices, all of which present challenges. If the cable companies are not successful in these strategies, revenue growth could ease to the point where the outlook would shift to stable during the coming year.
Global Beverage Industry: Good Cheer for Spirits Makers We expect the global spirits industry to generate sales growth in the high single digits during the next few years, driven by global expansion, the rising popularity of premium brands and innovations such as new flavors of vodka and whiskey. The spirits sector is growing both volume and sales value in most major global markets and we expect this to continue, while the desire of consumers to trade up to pricier spirits brands is driving sales growth for spirits companies globally. Lastly, innovation is also driving growth, by, for example, the introduction of premixed cocktails and new flavors.
US Holiday Sales Will Offer More Cheer for the 2013 Season Although US holiday sales growth will likely be at the lower end of our 4.5-5.5% range for the November-December shopping season, this would still represent a healthy improvement over last year’s 3.8% gain. Most of the improvement stems from pent-up demand as lingering US fiscal uncertainties ease, at least for now, and as consumers snap up pivotal new video game systems, such as Playstation 4 and the Microsoft Xbox One. We expect that consumers will look past US fiscal policy debates and continued economic uncertainties, as they have in the past, and the best-performing segments will continue to be toys, electronics, party goods, luxury goods and retailers whose goods are perceived to offer value.
US Packaging Industry Growth Relatively Flat as Productivity Offsets Soft Volumes Our outlook for the US Packaging industry is stable. The outlook principally reflects relatively flat organic EBITDA, within a range of minus 1% to 1%, as continued cost controls and productivity initiatives offset limited volume growth. However, companies with greater scale, in more consolidated segments or exposure to faster-growing developing markets will see relatively greater EBITDA stability than others. At the same time, sales volumes will continue to be soft due to ongoing consumer stress, but will be supported by the food and beverage segment, which represents about 70% of rated companies’ sales.
RESEARCH HIGHLIGHTS Notable research published the week ending 29 November 2013
38 MOODY’S CREDIT OUTLOOK 2 DECEMBER 2013
North American Automotive Parts Suppliers Operating Profit to Rise Modestly on Strong US Auto Sales, Stabilizing European Market Our outlook for the North American automotive parts suppliers industry is stable. In our view, North American auto parts suppliers will see a more modest uptick in revenues on US auto sales growth and the stabilizing European market, while cash flow will strengthen in 2014. However, higher launch costs associated with new platforms and efforts by automakers to seek annualized pricing reductions on recently launched platforms will constrain margin improvement.
Financial Institutions
European Banks: ECB's Comprehensive Assessment Is Credit Positive, But Crucial Questions Left Unanswered The ECB’s assessment of significant euro area banks is credit positive because it will likely improve the transparency and comparability of EU banks’ financials. The ECB’s assessment will also lead to credit-enhancing measures at many assessed banks, particularly weaker ones. However, for the exercise to achieve the ECB’s goal of enhancing investor confidence in EU banks, some key questions have yet to be answered, such as the treatment of sovereign exposures, the threshold capital requirement for the stress test, parameters for banks to address any capital shortfall, and remedial measures if banks fall short on corrective capital measures.
US Public Finance
US State Housing Finance Agencies: HFAs Have Evolved to Meet the Demands of the New Lending Environment We have revised our sector outlook to stable from negative as HFAs have diversified their business models to address their loan financing challenges. HFAs’ asset positions and profitability remained solid during the downturn and are trending upwards.
US Not-for-Profit Hospitals: Revenue Growth Will Decline; Margins to Contract on Physician and IT Investments Our sector outlook for not-for-profit hospitals remains negative reflecting the challenging operating landscape over the next 12-18 months as patient volumes shrink and revenue growth slows. The negative outlook also reflects the struggle for hospitals to reduce costs while making investment necessary to adjust to changing reimbursement methodologies brought on by the Affordable Care Act and the demands of other industry participants such as insurers and employers.
US Higher Education, Not-for-Profits and Independent Schools Continued price sensitivity of prospective students and a challenged federal budget will suppress revenue growth, which expense growth will likely outpace in all sectors. Independent K-12 schools show resilience.
RESEARCH HIGHLIGHTS Notable research published the week ending 29 November 2013
39 MOODY’S CREDIT OUTLOOK 2 DECEMBER 2013
Structured Finance
US Auto ABS 2014 Outlook Our stable outlook for the US auto asset-backed securities sector in 2014, unchanged from 2013, rests on our expectation that underlying credit trends of auto ABS collateral pools will continue their modestly negative trajectory. Less cautious underwriting will manifest in a marginal decline in the credit profile of underlying borrowers, slightly longer loan terms, and higher loan-to-value ratios. However, rational lending, healthy used car prices and robust 2014 new vehicle sales will support the steady performance of the collateral backing auto loan, lease and floorplan asset-backed securities in 2014.
Spanish RMBS: Spanish Touristic Belt Posts Highest Loss Severities on Repossessed Assets Our loss severity calculations on the repossessed properties show highest loss severities on the Mediterranean coast, Andalucia and the Canary Islands, albeit within our assumptions for defaulted loans. Although they will not lead to any rating actions, high loss severities on repossessed mortgaged properties are credit negative. Recovery rates on repossessed properties vary across regions.
Austrian Mortgage Covered Bonds: Loan Amounts Above 60% LTV Ratio Increase Amount of Assets Available to Covered Bondholders Under the Austrian Mortgage Bank Act (Hypothekenbankgesetz), loan parts exceeding a 60% loan-to-value ratio are eligible for inclusion in the cover pool and available to covered bondholders if the full loan amount is registered in the cover pool register, our legal analysis shows, a credit positive for Austrian covered bonds.
RECENTLY IN CREDIT OUTLOOK Select any article below to go to last Monday’s Credit Outlook on moodys.com
40 MOODY’S CREDIT OUTLOOK 2 DECEMBER 2013
NEWS & ANALYSIS Corporates 2
» US Proposal to Loosen Fuel Requirements Would Benefit Refiners
» Devon’s Reliance on Debt to Purchase Eagle Ford Shale Assets Is Credit Negative
» Visant De-levers with Acquisition of American Achievement » Lightstream’s Plan to Operate Within Its Cash Flow and
Reduce Debt Is Credit Positive » US Regulatory Approval of Oman Oil’s Acquisition of Oxea Is
Credit Positive » Vedanta Would Benefit from Cairn India’s Share Buyback
Infrastructure 8
» Korea’s Second Electricity Tariff Hike in 2013 Is Credit Positive for KEPCO
» CLP Holdings’ Acquisitions of CAPCO and PSDC Are Credit Negative
Banks 11 » Lloyds’ Sale of Its Asset Management Business Is Credit
Positive » Russia’s Rising Personal Leverage Is Negative for Consumer
Finance Banks » Hungarian Banks’ Retail Nonperforming Loans Reach Record
High, a Credit Negative » Korea’s Rising Household Debt Is Credit Negative for Its
Financial System
Insurers 17 » ACE Limited’s Share Repurchase Program Is Credit Negative;
Capital Remains Strong » China’s Plan Is Credit Positive for Life Insurers, but Negative
for P&C Insurers
Sovereigns 20
» Suspension of Ukraine’s Agreement with the European Union Hinders Economic and Institutional Credit Improvements
Sub-sovereigns 21 » New Brunswick, Canada, Pension Reform Would Be Credit
Positive » Russian Regions Face Credit Negative Declines in Federal
Subsidies and Loans
US Public Finance 23 » California’s Income Tax Surge Drives Big Surpluses » Pension Reform Lawsuit Is Credit Negative for Atlanta,
Georgia » Desert Hot Springs, California, Abruptly Declares Fiscal
Emergency, a Credit Negative
Securitization 27 » Centralized Payroll of Mexican Teachers Is Credit Positive for
TFOVIS
RATINGS & RESEARCH Rating Changes 29
Last week we downgraded Western Union Financial Services, Principal Financial Group, Principal Financial Services, Principal Life Insurance Company, the Port of Seattle Washington and Westchester County New York and upgraded Home Depot, Quintiles Transnational, TRW Automotive, Discovery Education, Citigroup Pty, DDR and the Republic of Tatarstan, among other rating actions.
Research Highlights 37
Last week we published on the outlook for Asia credit, China property developers, China's Third Plenum, US mobile phone carriers, US oil refiners, German bonds issuance, US corporate liquidity, EMEA electric and gas utilities; Latin American, Indian, Canadian and US banks; US life insurers, Canadian life insurers, US mortgage insurers, US property and casualty insurers, Albania, Qatar, Argentina, Mexican states, Michigan public schools, US higher education, US state housing finance agencies, US ABS, global CDOs and CLOs, UK RMBS, US credit card ABS, and Japan and Australia securitization outlook, among other reports.
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EDITORS News & Analysis: Elisa Herr, Jay Sherman and
Barry Hing Ratings & Research: Greg Davies Final Production: Barry Hing
