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MOODYS.COM
17 JUNE 2013
NEWS & ANALYSIS Corporates 2 » Intelligence Contractors Are Negatively Affected by US
Surveillance Program Leak » Teva’s Pricey Patent Settlement Is Credit Negative » Boeing’s $4 Billion Chinook Helicopter Contract Is Credit
Positive » Safeway’s CAD5.8 Billion Sale of Canada Operations Is Credit
Negative » B&G’s Pirate’s Booty Deal Raises Leverage » New Brazilian Plant Raises Pressure on Latin American Pulp
Producers » Airbus’ A350 XWB First Flight Is Credit Positive for EADS
Banks 11 » Proposal to Transfer GSEs’ MBS Exposures Would Be Credit
Positive » US Regulator’s Overdraft Report Is Credit Negative for Banks » Caixa’s New Lending Program Raises Credit Risk
Insurers 17
» New York Regulators Highlight Use of Reinsurance Captives, a Credit Positive
» Assicurazioni Generali to Sell Mexican Insurance Stake to Banorte, a Credit Positive for Both
» ORIX’s Investment in MEDGULF Is Credit Positive
Sovereigns 22 » Greece Faces Credit Negatives from Fraying Political Consensus
and Slippage in Privatisation Program » Portugal Receives Next Tranche of IMF Funding, a Credit
Positive » Ecuador Loses Canadian Miner Kinross, a Credit Negative for
the Sovereign » Nationalizations in Belize’s Offshore Sector Are Credit Negative
US Public Finance 27
» Detroit’s Default and Restructuring Offer Are Credit Negative » New York City Storm Resiliency Plan Anticipates Federal Funds,
a Credit Positive
RATINGS & RESEARCH Rating Changes 31
Last week we downgraded Carnival Corporation, American Transmission Systems, Trans-Allegheny Interstate Line Company, Slovensky Plynarensky Priemysel, Aviva, Aviva Insurance, Aviva International Insurance, Aviva Life & Pensions UK, Banco Rural, Clientis and Valiant Bank, and upgraded Amadeus IT Holding, Georgia Advanced Technology Ventures and Sharp Healthcare, among other rating actions.
Research Highlights 41
Last week we published on European steel, Asian corporate liquidity, US retailers, Apple Inc., North American bond covenant quality, Canadian broadband, global independent exploration and production, global shipping, Latin American pulp, US intelligence contractors, US public power electric utilities, global infrastructure, global insurers, Mexican insurers, Canadian banks, sovereign default and recovery rates, Naucalpan, Mexico; the Czech Republic, Istanbul, and Chinese local governments, among other reports.
RECENTLY IN CREDIT OUTLOOK
» Articles in Last Thursday’s Credit Outlook 45 » Go to Last Thursday’s Credit Outlook
Click here for Weekly Market Outlook, our sister publication containing Moody’s Analytics’ review of market activity, financial predictions, and the dates of upcoming economic releases.
NEWS & ANALYSIS Credit implications of current events
2 MOODY’S CREDIT OUTLOOK 17 JUNE 2013
Corporates
Intelligence Contractors Are Negatively Affected by US Surveillance Program Leak Last Wednesday, Keith Alexander, director of the US National Security Agency (NSA), told the US Senate Appropriations Committee that he would fix the operational practices that allowed Edward Snowden, a young and relatively inexperienced former NSA private contractor employed by Booz Allen Hamilton Inc. (Ba3 stable), to gain access to the NSA’s highly classified telecom/internet surveillance programs and divulge it to the media. The fix will likely lead US intelligence agencies to tighten their control over access to highly classified work. We expect tighter controls to add costs for defense contractors and perhaps reduce the amount of highly classified work outsourced by government agencies, which would be credit negative for defense companies with material levels of intelligence-based contracts.
Costs associated with added scrutiny of defense contractor hiring and tighter surveillance practices over outsourced work will reduce the profit potential for defense sector earnings already pressured by defense spending cuts related to sequestration and other federal procurement reforms.
Affected issuers include defense service companies such as Booz Allen, TASC Inc. (B2 stable), The SI Organization, Inc. (B3 stable), Scitor Corporation (B2 stable), Sotera Defense Solutions, Inc. (Caa1 negative), Six3 Systems Inc. (B2 stable), SAIC, Inc. (A3 review for downgrade) and SRA International, Inc. (B2 negative). Although these companies benefit from a significantly larger and more diversified base of contracts, prime contractors such as Lockheed Martin Corporation (Baa1 stable), General Dynamics Corporation (A2 stable) and Northrop Grumman Corporation (Baa1 stable) also have significant exposure to classified, intelligence-related business with the Department of Defense and would also be affected.
The fallout from the NSA leaks is an unanticipated challenge for contractors with a heavy concentration in intelligence services, where funding levels appeared to be more resilient and less vulnerable to Pentagon budget cuts than other less specialized services.1
In fixed-price and time-based contracts, companies are likely to absorb much of the added cost of increased screening and oversight of workers, reducing profitability. In cost-based contracts, greater emphasis on security protocols will make it more difficult for contractors to earn incentive fees. Since such fees often comprise much of a cost-based contract’s profit potential, we expect that operating margins will suffer as a result.
Perhaps the greater risk is that as contracts mature, the outsourcing of highly classified programs may decline, reducing the market opportunity. Indeed, after a closed-door briefing 13 June on US surveillance programs, Senator Dianne Feinstein of California, chairman of the Senate Intelligence Committee, was quoted in the New York Times as saying that, “We will certainly have legislation which will limit or prevent contractors from handling highly classified and technical data.” But any efforts to reduce the outsourcing of intelligence-based work will likely take time and would expand the federal workforce during a time of fiscal austerity.
Companies may even face challenges and higher costs in hiring qualified employees, depending on the degree to which tighter controls on intelligence access reduces the number of people with security
1 See US Defense Industry: Defense Service Contractors Face Revenue, Margin Pressures, 21 May 2012.
Bruce Herskovics Assistant Vice President - Analyst +1.212.553.0192 [email protected]
Jadijhe (Gigi) Adamo Analyst +1.212.553.2977 [email protected]
NEWS & ANALYSIS Credit implications of current events
3 MOODY’S CREDIT OUTLOOK 17 JUNE 2013
clearances. The difficult balance for contractors in the intelligence community will be to meet the demand of their government customers for greater operational controls while maintaining their contract performance and avoiding margin erosion.
NEWS & ANALYSIS Credit implications of current events
4 MOODY’S CREDIT OUTLOOK 17 JUNE 2013
Teva’s Pricey Patent Settlement Is Credit Negative Last Wednesday, Teva Pharmaceuticals Industries Ltd. (A3 negative) agreed to pay Pfizer Inc. (A1 stable) and Takeda Pharmaceutical Company Limited (Aa3 stable) a total of $1.6 billion over the next 18 months to settle a patent lawsuit related to Protonix, Pfizer’s acid reflux drug. The payment is credit negative for Teva. While the company has sufficient liquidity to fund the liability, we believe some to all of the payment will be funded with incremental debt – thus increasing leverage. After the settlement’s announcement, we affirmed Teva’s A3 rating and changed its outlook to negative from stable.
The settlement relates to Teva’s launch of a generic version of Protonix in 2007, which the courts ultimately found infringed on Wyeth’s patents. (Wyeth, which Pfizer bought in 2009, had licensed the Protonix patent from Altana Pharma, now part of Takeda.) The $1.6 billion price tag comes as Teva faces multiple constraints on its earnings, including competitive product launches and global pricing pressure. The company is also committed to returning $1-$2 billion per year to shareholders, via buybacks and dividends, and to devoting around $2 billion per year to acquisitions and other business development activities. Added to these factors, the payment to Pfizer will leave Teva with little free cash to repay debt.
Teva will pay Pfizer and Takeda damages of $800 million in 2013 and $800 million in 2014. At 31 March, Teva had around $1.4 billion of cash. It also has access to a $3 billion bank revolving credit facility. Although Teva will likely fund at least a portion of the payment with cash (management projects operating cash flow of $4.5-$4.8 billion in 2013), if we assume revolver borrowings fund the full amount, we estimate adjusted debt to EBITDA will rise to around 2.7x by the end of 2013. Adjusted leverage was 2.4x for the 12 months ended 31 March. Previously, we had expected Teva’s leverage to decline to 2.0x by the end of 2013 owing to debt repayment.
Although the payment is manageable in the context of Teva’s liquidity and annual cash flow, it comes at a time when Teva is facing pressure in its core business. Following a number of years of very strong revenue and earnings growth owing to launches of generic versions of blockbuster drugs, including Lipitor, fewer patents on very large branded products will expire over the next 18 months.
The generic drug industry is also facing pricing pressure globally as governments grapple with ways to control increasing healthcare costs.
In Teva’s branded drug business, revenues of its sleep disorder drug Provigil have declined significantly following a competitor’s launch of a generic version of the drug. In addition, Teva’s blockbuster injectable multiple sclerosis (MS) drug Copaxone, which accounts for 20% of Teva’s sales, is facing increased competition from new MS drugs that are taken orally. In particular, Tecfidera, an oral MS drug launched by Biogen Idec Inc. (Baa2 positive) in March, is off to a very strong start and appears to be gaining traction with patients and physicians. Over time, it could become a greater threat to Teva’s key Copaxone franchise.
Despite these challenges, Petah Tikva, Israel-based Teva, the world’s largest generic drug company, has many strengths including significant scale and diversity, a strong track record of product innovation and strategic execution and solid operating cash flow. We also expect it to benefit from new product launches (including Tevagrastim, a competitive product to Amgen’s Neupogen that we expect will launch later this year), increased use of generic drugs in international markets and cost reduction efforts that, if successful, would save the company $1.5-$2.0 billion annually within the next five years.
Jessica Gladstone, CFA Vice President - Senior Analyst +1.212.553.2988 [email protected]
NEWS & ANALYSIS Credit implications of current events
5 MOODY’S CREDIT OUTLOOK 17 JUNE 2013
Boeing’s $4 Billion Chinook Helicopter Contract Is Credit Positive Last Tuesday, The Boeing Company (A2 stable) said it had signed a five-year, $4 billion contract to provide the US Army with 177 CH-47F Chinook helicopters, with options for another 38 helicopters. Deliveries are set to begin in 2015. We view the contract as credit positive for Boeing because it comes at a time when we expect US defense expenditures to continue shrinking.
Boeing estimates the multi-year purchase agreement will save the US government $800 million over the life of the contract versus annual lot purchases, implying that the company will have to enhance operating efficiencies even further to maintain profitability on the mature transport helicopter program. Even with some initial delivery margin compression on the new order, the stability and certainty afforded by this significant, long-term contract enhances the prospects for the company's defense, space and security segment. We anticipate that with a steady, long-term production contract, Boeing will find opportunities for margin improvement. Moreover, better stability in the supply chain should further enhance the prospects for additional cost savings.
The multi-year contract could be indicative of a transition in US government procurement practices for large, high-ticket programs. This more cost-effective approach for the US Department of Defense and other government customers could offer scope for defense contractors to better manage costs and pass some savings back through pricing. While this may result in margin pressure in the early years of such contracts, these types of contracts lock in valuable, long-term sources of revenue and earnings, which are of particular importance for defense contractors amid ongoing budgetary pressure and heightened uncertainty.
This contract should allow Boeing and its suppliers to enhance productivity gains over the life of the contract, recoup the $130 million investment Boeing made to modernize its Chinook factory in Pennsylvania and invest in additional process improvements that could ultimately maintain profitability over the life of the contract.
Russell Solomon Senior Vice President +1.212.553.4301 [email protected]
Dominique Sasson Associate Analyst +1.212.553.4760 [email protected]
NEWS & ANALYSIS Credit implications of current events
6 MOODY’S CREDIT OUTLOOK 17 JUNE 2013
Safeway’s CAD5.8 Billion Sale of Canada Operations Is Credit Negative Safeway Inc. (Baa3 negative) on Thursday said it would sell its Canada operations to Nova Scotia’s Sobeys Inc. (unrated) for CAD5.8 billion in cash. The sale is credit negative for the Safeway because it will result in the loss of a very good asset with stable earnings, healthy free cash flow and much higher margins than the company’s US operations. The loss of the Canadian operation will not be enough to offset the more modest benefit that Safeway will gain in reducing debt with some $2 billion of the sale proceeds. The company plans to use the rest of the proceeds for share repurchases.
We expect Safeway’s financials to remain constrained over the next 12-18 months. Its credit metrics remain weak for a Baa3 rating, reflected in a debt-to-EBITDA ratio of 4.8x and an EBITA-to-interest of 2.2x (both as adjusted by us) for the 12 months ended 23 March. Even after Safeway reduces debt by $2 billion from the proceeds of the sale, in addition to its planned debt reduction through free cash flow, we estimate that debt-to-EBITDA will only improve to about 4.5x over the next 12 or so months because the sale of the Canadian operations will lower the EBITDA of the remaining company by a meaningful CAD544 million. The EBITDA margin of the Canadian operation is currently about 8.5%, compared with about 4.5% for the US operations. Although the Canadian operation accounts for only about 15% of Safeway’s consolidated sales (about CAD6.7 billion in sales), it contributes about one quarter of the company’s consolidated EBITDA.
Safeway’s top line and operating performance have been pressured as consumers change their spending habits because of the fragile economic recovery and their becoming increasingly price conscious. The company’s identical store sales growth, excluding fuel, was a modest 0.5% for 2012 and 1.5% for the first quarter of 2013. Therefore, we expect the sale of the company’s Canadian operations to pressure its top line and margins further. We anticipate that revenue and operating margins will reflect longer-term volatility as a result of changes in food and gas prices, and continued competition from traditional supermarkets and alternative food retailers. We believe that Safeway will remain focused on price competition for the foreseeable future.
Mickey Chadha Vice President - Senior Analyst +1.212.553.1420 [email protected]
NEWS & ANALYSIS Credit implications of current events
7 MOODY’S CREDIT OUTLOOK 17 JUNE 2013
B&G’s Pirate’s Booty Deal Raises Leverage Last Monday, B&G Foods, Inc. (Ba3 stable) announced plans to buy snack food maker Pirate Brands (unrated) for $195 million in cash. Although strategically sound, the deal is credit negative for B&G because it will weaken its liquidity and raise its leverage.
B&G strengthened its liquidity last month with a bond issuance that provided balance sheet cash in excess of $185 million. The company will now use the majority of that cash, along with some revolver borrowings, to fund the Pirate Brands acquisition. Following the deal’s announcement, we lowered B&G’s Speculative Grade Liquidity Rating to SGL-2 from SGL-1 to reflect weaker liquidity. In addition, the deal will elevate B&G’s financial leverage to roughly 5.0x debt/EBITDA (as adjusted by us on a pro forma basis) from 3.8x before its May bond issuance.
Still, the acquisition of Pirate Brands adds another well-known name to B&G’s growing brand portfolio, which has been key to its strong operating performance and stable cash generation. B&G, whose brands include Cream of Wheat, Ortega, Polaner and its namesake pickles, has purchased 25 brands since 1997 and has a track record of successfully integrating its acquisitions. Prior to the Pirate Brands deal, B&G’s most recent acquisitions were TrueNorth nuts in May, and in October, New York Style bagel crisps and Old London, which marked its first foray into snack foods.
B&G financed the New York Style and Old London deals with proceeds from a $120 million equity offering, which we believe demonstrates its commitment to maintaining financial leverage below its stated target of 4.5x. We expect B&G will bring its leverage down to 4.5x over the next 12 months owing to continued solid cash flow generation and debt reduction. Over time, we expect B&G to maintain leverage below 4.0x.
Parsippany, New Jersey-based B&G expects to close the Pirate Brands acquisition in July. The privately owned company is best known for Pirate’s Booty, a baked rice and corn puff flavored with cheddar cheese. B&G said it expects Pirate Brands to generate net sales of $80-$90 million and annual adjusted EBITDA of $18-$20 million after it is fully integrated into B&G.
Brian Silver Analyst +1.212.553.1663 [email protected]
NEWS & ANALYSIS Credit implications of current events
8 MOODY’S CREDIT OUTLOOK 17 JUNE 2013
New Brazilian Plant Raises Pressure on Latin American Pulp Producers Last Wednesday, Klabin S.A. (unrated), Brazil’s largest producer of packaging paper, announced it would build a new BRL5.3 billion ($2.5 billion), 1.5 million tonne-capacity pulp plant in the Brazilian state of Paraná. The new plant, which would begin operating by early 2016, is credit negative for all Latin American pulp producers because it would further challenge Latin America’s pulp market, already struggling with weak pulp prices and looming overcapacity. The affected companies include Celulosa Arauco y Constitucion S.A. (Baa3 negative), Inversiones CMPC S.A. (Baa3 negative), Fibria Celulose S.A. (Ba1 stable) and Suzano Papel e Celulose S.A. (Ba2 stable).
Even before Klabin’s announcement, Latin American pulp producers had planned to add 5.6 million tonnes of capacity in 2013-15 – mainly hardwood pulp – and potentially a further 5.8 million tonnes of new capacity after 2015 (see exhibit below).
Announced Pulp Expansion Projects in Latin America
Company (Project) Capacity (Thousand Metric Tonnes) Start-up Date
JBS (Eldorado) 1,500 2012-13
Copec/Stora Enso (Montes del Plata) 1,300 2013
Suzano (Maranhão) 1,500 2013-14
CMPC (Guaíba) 1,350 2015
Klabin 1,500 2016
Veracel 1,500 Not Defined
Arauco 1,300 Not Defined
Fibria (Tres Lagoas II) 1,500 Postponed
Suzano (Piauí) 1,500 Postponed
Source: Company reports, Moody’s
These capacity additions will raise total market pulp capacity for Brazil and Chile – Latin America’s biggest pulp producers – to 25.8 million tonnes from 18.7 million tonnes today. Considering the world currently has about 50 million tonnes of market pulp capacity, these additions will test the global market’s ability to absorb output amid slower-than-expected growth in China, the key driver of demand, and persistent economic weakness in Europe.
We expect global demand for pulp to grow by 600,000 to 1 million tonnes annually over the next several years as population growth and cultural changes drive emerging markets’ demand for paper products, particularly tissue. Still, we do not expect the pulp industry to reach supply/demand equilibrium until after 2016. In the meantime, the market will become increasingly oversupplied, depressing pulp prices further, and forcing older, higher-cost mills in North America and Europe to close.
Klabin’s board believes its capacity additions, including 1.1 million tonnes of hardwood and 400,000 tonnes of softwood, will have low production costs, with ample pine and eucalyptus near the planned facility. The new plant will also benefit from good railway access to the port of Paranaguá and a 144 megawatt energy surplus.
Barbara Mattos, CFA Assistant Vice President - Analyst +55.11.3043.7357 [email protected]
Anna Zubets-Anderson Vice President - Senior Analyst +1.212.553.4617 [email protected]
NEWS & ANALYSIS Credit implications of current events
9 MOODY’S CREDIT OUTLOOK 17 JUNE 2013
Although the expansion will help Klabin add cost-competitive production capacity of both hardwood and softwood pulp, it will also raise leverage. However, this new capacity will give Klabin better vertical integration, a strong competitive advantage in Latin America. A significant addition of softwood capacity will also set Klabin apart, since most Latin American pulp expansion plans are for hardwood pulp.
Oversupply and soft pricing will keep credit metrics for Latin American pulp producers under pressure over the next 12-18 months, particularly for Suzano and CMPC, both of which have large expansion projects under way in Brazil. Suzano plans to spend $2.9 billion in capital on a 1.5 million tonne greenfield pulp plant in Maranhão state. The company will have difficulty pursuing its growth plans while managing its leverage until the start-up of the new capacity in late 2013. However, it should maintain decent liquidity as the pulp market enters a down-cycle.2
CMPC is expanding hardwood pulp production capacity at its Guaiba plant to nearly 1.75 million tonnes from 450,000 tonnes by the end of 2015. But with plans to spend $2.1 billion in capital for this effort, CMPC will raise its leverage to as much as 5.0x-5.5x in 2014 (as adjusted by us), even while maintaining acceptable liquidity.
Even pulp companies that no longer face big capex plans will struggle through at least 2015. Fibria has begun to deleverage, but weaker operating results from lower pulp prices in the coming months could hamper its efforts. And although Arauco’s capital spending will soon decline with the completion of its investment in a Montes del Plata mill in Uruguay, the coming drop in pulp prices will translate into only modest free cash flow for the company, thereby limiting its ability to de-lever.
2 See Suzano Papel e Celulose: Liquidity Adequate Even as Credit Metrics Come Under Threat, 3 May 2013.
NEWS & ANALYSIS Credit implications of current events
10 MOODY’S CREDIT OUTLOOK 17 JUNE 2013
Airbus’ A350 XWB First Flight Is Credit Positive for EADS Last Friday, European Aerospace Defence & Space Co. EADS (A2 stable) subsidiary Airbus’ new A350 XWB wide-body jet made its inaugural flight in southern France. This milestone is credit positive for EADS because it moves the company closer to making its first delivery and realizing a return on its multi-billion euro program investment.
To date, the A350 XWB has won 613 firm orders from more than 30 global customers. We expect the A350 XWB’s first flight to spur additional orders at the Paris Air Show, which is scheduled to begin 17 June. We also expect The Boeing Company (A2 stable) to use the big industry trade show to build interest in an updated 777X and to re-emphasize its still-new 787 Dreamliner, which is flying again after a temporary grounding related to widely reported lithium-ion battery issues.
The A350 XWB still requires 2,500 hours of certification testing over the next year before Airbus can begin scheduling deliveries to airline customers. Although about six months behind schedule, entry-into-service (EIS) as currently targeted in the second half of 2014 would still be a noteworthy feat for Airbus because it would require the company to complete certification faster than it has done for any other development program. Nevertheless, the timeline is feasible because Airbus has already completed pre-flight development testing for many key components of the aircraft.
As the aircraft approaches its EIS, it should spur additional orders as airlines are clamoring for more fuel-efficient, longer range and larger planes with more seats to replace aging models and to expand into new markets. Friday’s successful first flight is a key milestone for the program, which should aid in Airbus’ efforts to make further headway into Boeing’s market-leading share of the wide-body segment for large commercial aircraft.
The initial version of the A350 XWB – the 314-seat A350-900 XWB with a range of 8,100 nautical miles – will compete head-to-head with Boeing’s current generation 777-200ER. The new Airbus model will enjoy significantly enhanced operating efficiencies afforded by the use of new manufacturing processes, lighter composite materials and advanced power plant equipment. These advantages are perhaps the main impetus for the expected forthcoming stretched 787-10 from Boeing, which would be a more competitive offering vis-à-vis the A350-900 XWB and which we expect could be definitively announced as soon as next week at the Paris Air Show.
A smaller second version of the new Airbus plane – the 270-seat A350-800 XWB with an 8,500 nautical-mile range – will compete most directly with Boeing’s 787-9, the first stretched version of the Dreamliner that just entered production. Along with the 787-10, these two new derivative airframes from Boeing will replace the 777-200ER as they go up against Airbus’ new A350 XWBs.
The third and largest version of the A350 – the 350-seat A350-1000 XWB with a range of 8,400 nautical miles – will compete against the B777-300ER, which has that longer range, higher capacity market segment pretty much to itself at the moment. The forthcoming Boeing 777X (with an all-new composite wing and other advanced engineering enhancements) and 787-10 models, both of which still need final board approval, will lag the A350 XWB introductions by a year or more. That will provide the Airbus model a time-to-market advantage if it can keep to its currently proposed development and EIS schedules and ultimately demonstrate its much-touted operating efficiencies.
Russell Solomon Senior Vice President +1.212.553.4301 [email protected]
Brian Grieser Vice President - Senior Analyst +1.212.553.2955 [email protected]
Dominique Sasson Associate Analyst +1.212.553.4760 [email protected]
NEWS & ANALYSIS Credit implications of current events
11 MOODY’S CREDIT OUTLOOK 17 JUNE 2013
Banks
Proposal to Transfer US GSEs’ MBS Exposure Would Be Credit Positive During the week of 3 June, US Senators Bob Corker (R-Tennessee) and Mark Warner (D-Virginia) released a draft of a reform bill for the government-sponsored enterprises that would create a new federal agency, the Federal Mortgage Insurance Corporation (FMIC), which would provide an explicit government guarantee for catastrophic losses on mortgage securities. In addition, the bill, titled “Secondary Mortgage Market Reform and Taxpayer Protection Act of 2013,” would wind down Fannie Mae (Aaa negative) and Freddie Mac (Aaa negative), transferring their mortgage-backed securities (MBS) into receivership under the auspices of the FMIC.
The transfer of these mortgage securities to the FMIC would materially reduce the amount of GSE assets that would incur losses and require coverage from contingent capital from the US Treasury, a credit positive for GSE bondholders.
The FMIC would become the standard-setter for government guaranteed loans, responsible for approving eligible mortgage servicers and issuers, as well as developing risk-sharing products and structure. To be eligible for a guarantee under the new FMIC, private market participants would have to take at least 10% of the first-loss position for the security. In addition, the FMIC would charge guarantee fees to be paid into the Mortgage Insurance Fund (MIF). The MIF must maintain balances equal to 2.5% of the outstanding principal balance for which a guarantee is provided. The full faith and credit of the US government would support any obligation of the MIF.
Once the FMIC is operational, the wind down of the GSEs would begin. First, all assets and liabilities of the firms would be transferred to limited-life entities named Wisconsin Avenue Management for Fannie Mae and Jones Branch Avenue Management for Freddie Mac, and the FMIC would act as receiver of the two entities. Before receivership, the GSEs could continue guaranteeing MBS.
Because neither Freddie Mac nor Fannie Mae has any capital, their assets equal their liabilities. Each company has access to a limited amount of senior preferred stock from the US Treasury – $140.5 billion for Freddie Mac and $124.8 for Fannie Mae. Because the Corker-Warner bill would significantly reduce the amount of assets that could incur a loss and have to be covered by this contingent capital, it moves closer to an effective guarantee for GSE bondholders.
If all of Fannie Mae’s and Freddie Mac’s MBS were to benefit from a US Treasury guarantee under the new FMIC, a greater amount of senior preferred stock would be available to support unexpected losses in their remaining assets and pay off bondholders. As the exhibit below shows, Freddie Mac and Fannie Mae could incur approximately 38% and 21% losses on the their remaining assets, respectively, and still pay off all their bondholders. In addition, we expect the earnings from these assets to provide cash flows they could use to pay down debt, a further credit positive for bondholders.
Brian Harris Senior Vice President +1.212.553.4705 [email protected]
NEWS & ANALYSIS Credit implications of current events
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Fannie Mae and Freddie Mac Contingent Capital as Percent of Non-MBS-Related and Non-Treasury Assets, as of 31 March 2013, $ Millions
Freddie Mac Fannie Mae
Total assets $1,979,386 $3,320,675
Less mortgage loans pledged to mortgage-backed securities 1,505,211 2,678,057
Non-MBS-related assets 474,175 642,618
Less agency securities (Fannie Mae, Freddie Mac and Ginnie Mae MBS) 85,463 28,574
Less US Treasuries 12,329 28,406
Non-MBS-related and non-Treasury assets $376,383 $585,638
Contingent capital available from US Treasury $140,500 $117,600
Contingent capital as a percent of non-MBS-related and non-Treasury assets 37.33% 20.08%
Sources: Fannie Mae’s and Freddie Mac’s Form 10-Qs
Although passage of the Corker-Warner bill would be credit positive for GSE bondholders, we think it faces an uphill struggle. It is highly questionable if the bill, even if heavily amended to attract more support, will come to a vote in the Senate Banking Committee. We continue to believe that GSE reform is several years away at best and will likely occur only if the two entities are shrunk significantly. Ultimately, though, we believe GSE reform will take a form similar to this bill.
NEWS & ANALYSIS Credit implications of current events
13 MOODY’S CREDIT OUTLOOK 17 JUNE 2013
US Regulator’s Overdraft Report Is Credit Negative for Banks Last Tuesday, the US Consumer Financial Protection Bureau (CFPB) issued a report questioning bank and credit union overdraft practices and their effects on consumers. The report is credit negative for US banks because it raises the specter of enforcement actions by the CFPB to ensure that consumers are protected in accordance with federal consumer protection laws. Such actions will increase banks’ disclosure-related costs and reduce banks’ overdraft fees by helping consumers avoid these charges.
The CFPB report was a follow-up to initial market research that highlighted the agency’s concerns about bank overdraft practices. This initial research included responses to a CFPB request for information issued to the public in February 2012.3
The CFPB’s key findings include the following:
» Opting-in4 to overdraft puts consumers at greater risk. Consumers who opt in end up with more overdraft-related costs than consumers (including frequent overdraft users) who decline to opt in; moreover, consumers who opt in are more likely to end up with involuntary account closures.
» Overdraft practices vary by institution. The report raises questions about whether customers can anticipate overdraft costs and avoid them given the complicated fee structures that are not standardized throughout the industry.
» Costs and closures vary by institution. Average annual overdraft charges and involuntary account closures vary among institutions and some consumers incur much higher costs than others.
As Exhibit 1 shows, banks’ overdraft revenues have already been curtailed as a result of the federal regulation that went into effect on 1 July 2010 and requires that banks and credit unions obtain a consumer’s consent for allowing overdrafts.
EXHIBIT 1
All US FDIC Insured Institutions Overdraft Revenues, First-Quarter 2002 to First-Quarter 2013
Note: Charges for overdrafts defined as 61% of service charges on deposit accounts, as per CFPB report of 11 June 2013. Source: Federal Deposit Insurance Corp.
3 See US Consumer Financial Protection Bureau’s Overdraft Inquiry Is Credit Negative for US Banks, Weekly Credit Outlook, 27
February 2012. 4 Since 1 July 2010 (pursuant to rules announced by the Federal Reserve in November 2009), banks and credit unions have had to
obtain a customer’s consent before charging fees for allowing overdrafts on automatic teller machine withdrawals and most debit card transactions (i.e., the customer must explicitly opt in).
$0.0$0.5$1.0$1.5$2.0$2.5$3.0$3.5$4.0$4.5$5.0$5.5$6.0$6.5$7.0
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
3.5%
4.0%
4.5%
5.0%
1Q02
3Q02
1Q03
3Q03
1Q04
3Q04
1Q05
3Q05
1Q06
3Q06
1Q07
3Q07
1Q08
3Q08
1Q09
3Q09
1Q10
3Q10
1Q11
3Q11
1Q12
3Q12
1Q13
$ Bi
llion
s
Overdraft Revenues - right axis Overdraft Revenues as Percent of Net Revenues - left axis
Rob McGregor Associate Analyst +1.212.553.3685 [email protected]
Curt Beaudouin, CFA Vice President - Senior Credit Officer +1.212 .553.1474 [email protected]
NEWS & ANALYSIS Credit implications of current events
14 MOODY’S CREDIT OUTLOOK 17 JUNE 2013
As Exhibit 2 shows, smaller banks such as Commerce Bank (Aa3 stable, B/aa3 stable)5 and INTRUST Bank, N.A. (A3 stable, C/a3 stable) are more exposed to additional overdraft regulations than larger banks, which benefit from more diversified revenue streams.
EXHIBIT 2
Overdraft Revenues at Select US Banks, First-Quarter 2013
Entity Total Assets,
$ millions Estimated Overdraft Revenues,
$ millions Estimated Overdraft Revenues as
Percent of Net Revenues
Wells Fargo $1,436,634 $741 3.49%
US Bancorp $355,447 $175 3.63%
Commerce $22,241 $11 4.28%
INTRUST $4,086 $2 4.60%
Source: Regulatory FR Y-9Cs
The CFPB stated that it plans additional studies to better understand how consumers are affected by differing overdraft practices. The bureau explicitly stated that if it finds that banks’ policies or practices do not protect consumers in accordance with federal consumer protection law, it will use its authority – including rulemaking and enforcement – to provide such protection.
In short, the CFPB report has the potential to be one more profit challenge for US banks, which are already struggling with the effects of low interest rates.
5 The bank ratings shown in this report are the banks’ deposit rating, its standalone bank financial strength rating/baseline credit
assessment and the corresponding rating outlooks.
NEWS & ANALYSIS Credit implications of current events
15 MOODY’S CREDIT OUTLOOK 17 JUNE 2013
Caixa’s New Lending Program Raises Credit Risk Last Wednesday, Brazil’s federal government announced a provisional measure (MP 620) that exempts government-owned savings bank Caixa Economica Federal (Baa2 positive, D/ba2 stable)6 from paying dividends in 2013. In exchange, the government has asked Caixa to finance a new subsidized credit program for low-income households for the purchase of furniture and appliances for homes bought under Minha Casa, Minha Vida (My Home, My Life), a popular government housing program also financed by Caixa. The provisional measure is credit negative for Caixa because it will further increase its credit risk exposure to low-income borrowers who will finance these purchases at subsidized interest rates for long tenors.
Despite the favorable terms of this new program, which offers loans at 5% instead of the 12% of Caixa’s similar credit lines, the potential for asset quality problems is high because of Brazil’s rising inflation, which reduces borrowers’ purchasing power and repayment capacity. In addition, household indebtedness, which measures the relationship between household total debt and annual income, reached a high of 44% in April (see Exhibit 1), and Brazil’s economy remains sluggish.
EXHIBIT 1
Brazilian Household Indebtedness: Total Debt to Annual Income
Source: Brazil’s central bank, Moody’s
In 2012 alone, Caixa reported 42% loan portfolio growth (Exhibit 2), which is well above the 16.4% growth rate of total lending in the banking system. The strong expansion into non-traditional segments, such as vehicle financing and small and midsize enterprise lending, combined with limited investments in risk management technology, mean an increase in credit risk for Caixa. Although the bank’s non-performing loan ratio of around 3% as of year-end 2012 reflects sizable loan growth and the large proportion of low-risk mortgages in its loan book, a sudden deterioration in credit quality owing to the unseasoned unsecured consumer portfolio would weigh on capital adequacy and profitability.
6 The bank ratings shown in this report are the banks’ deposit ratings, their standalone bank financial strength ratings/baseline credit
assessments and the corresponding rating outlooks.
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Ceres Lisboa Vice President - Senior Credit Officer +55.11.3043.7317 [email protected]
Alexandre Albuquerque Assistant Vice President - Analyst +55.11.3043.7356 [email protected]
NEWS & ANALYSIS Credit implications of current events
16 MOODY’S CREDIT OUTLOOK 17 JUNE 2013
EXHIBIT 2
Caixa’s Non-performing Loan Ratios Have Changed Little Because of Loan Growth
Source: Moody’s Banking Financial Metrics
Under the new program, titled Minha Casa Melhor (My Better Home), Caixa will distribute credit cards with a BRL5,000 credit limit to 3.7 million households that are currently beneficiaries of the affordable-housing program. Credit will be available to borrowers who are current with their housing loans. The federal government will subsidize the difference between the program’s 5% rate and current market rates through payments directly to Caixa.
The proposed BRL18 billion ($8.7 billion) program would place additional pressure on Caixa’s Tier 1 ratio of 7.23% (as of the first quarter), an already modest ratio compared with rival Brazilian banks. Nonetheless, the Provisional Measure also states that Caixa will receive a BRL8 billion ($3.75 billion) capital infusion from the government in the form of a hybrid debt instrument that will be treated as Tier 1 equity and provide the bank with additional leverage to enable expanded lending under the program. The Brazilian government introduced a similar solution for Banco do Brasil S.A. (A3 positive, C-/baa2 stable) in October 2012 to boost agribusiness loans for 2013 crops.
The provisional measure exempts Caixa from distributing dividends on common equity that exceed a minimum payout ratio of 25%, as defined by the bank’s bylaws. The exemption is valid only during the period that Caixa provides loans under the program. Retained dividends should be used to cover credit risks and operational costs related to the loans extended to households. Nonetheless, the availability of these resources could be compromised if the bank’s profitability and overall asset quality deteriorate abruptly.
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Gross Loans - left axis NPLs Ratio - right axis
NEWS & ANALYSIS Credit implications of current events
17 MOODY’S CREDIT OUTLOOK 17 JUNE 2013
Insurers
New York Regulators Highlight Use of Reinsurance Captives, a Credit Positive Last Tuesday, the New York State Department of Financial Services (DFS) published a report detailing the results of its investigation into life insurance companies’ use of reinsurance captives.7 The DFS concluded that by shifting business to affiliated entities that are subject to looser reserve and regulatory standards, insurers are putting “insurance policyholders and taxpayers at greater risk.” We believe that a greater focus on captives by regulators is credit positive for the industry.
Over the past decade, the use of captives by US life insurers has increased materially, largely in response to perceived burdensome regulation. Based on our analysis, reserves ceded to unauthorized affiliates (which would include captives) increased 28% to $172 billion in 2012 from $134 billion in 2007.
Life insurers use captives to manage regulatory capital strain associated with life and health insurance products subject to what they perceive to be conservative reserve and/or capital requirements. They also use captives to manage the volatility of reserve and capital requirements associated with variable annuity guarantees. Both practices undermine the conservatism regulators have embedded in the reserving and capital regimes.
Our analysis of life insurance companies’ creditworthiness on an enterprise basis has determined that many companies’ captives are capitalized at lower levels than standard operating companies. This tends to weaken overall capital adequacy. Moreover, transactions such as those identified by the DFS can lead to complex corporate structures and reduced investor transparency, both credit negatives.
The DFS investigation revealed that the 80 life insurers based in New York engaged in at least $48 billion of shadow insurance transactions, and said that its findings are likely just the “tip of the iceberg” nationwide. Many large life insurers in the US use captives, including MetLife Inc.’s Metropolitan Life Insurance Company (financial strength Aa3 negative), Lincoln National Life Insurance Company (A2 positive), Genworth Life and Annuity Insurance Company (A3 stable) and Prudential Insurance Company of America (A2 positive).
The DFS report cited four areas of its concerns about shadow insurance:
» Conditional letters of credit (LOCs) that serve as collateral to support a reinsurance deal, but may not be available during periods of financial stress. New York requires LOCs to have unconditional terms.
» Two-step transactions, in which an insurer transfers insurance to an insurer outside New York, then transfers it to a captive, the performance of which the parent (holding company) ultimately guarantees.
» Hollow assets, which are undrawn LOCs with a parental guarantee that count as real assets.
» Naked parental guarantees, which are simple parental guarantees that serve as eligible collateral.
The DFS recommended a number of follow-up actions to address these concerns, including conducting additional investigations and having state insurance commissioners consider “an immediate national moratorium on approving additional shadow insurance transactions until those investigations are complete
7 Captives are entities that provide reinsurance to a member of the same insurance group.
Scott Robinson Senior Vice President +1.212.553.3746 [email protected]
NEWS & ANALYSIS Credit implications of current events
18 MOODY’S CREDIT OUTLOOK 17 JUNE 2013
and a fuller picture emerges.” We believe such a moratorium is unlikely, in part because not all regulators have reached the same conclusion as the DFS. On 13 June, Ben Nelson, CEO of the National Association of Insurance Commissioners (NAIC), an association that helps coordinate state insurance regulations, indicated that he did not see the need for a moratorium. It is also worth noting that a number of states have regulations that are in conflict with New York’s concerns related to shadow insurance.8
The attention placed on captives, not only by New York, but also by the NAIC,9 will likely be a positive development that will lead to more disclosure of transactions with captives. Furthermore, we expect that some companies will rely less on captives in the future. On 21 May, MetLife announced plans to bring onshore its variable annuity guaranteed product liabilities that it currently reinsures to an offshore subsidiary. We believe external developments, including the enhanced scrutiny of captives by regulators, were key factors behind MetLife’s announcement.
8 For example, the DFS identified Missouri, Delaware, Iowa, South Carolina, Nebraska and Vermont as having captives with LOCs
reported as admitted assets. 9 An NAIC subgroup on 6 June published a white paper titled “Captives and Special Purpose Vehicles.”
NEWS & ANALYSIS Credit implications of current events
19 MOODY’S CREDIT OUTLOOK 17 JUNE 2013
Assicurazioni Generali to Sell Mexican Insurance Stake to Banorte, a Credit Positive for Both Last Tuesday, Assicurazioni Generali S.p.A. (senior unsecured Baa2 negative) agreed to sell its 49% minority stakes in Mexican insurance company Seguros Banorte Generali (unrated) and annuities company Pensiones Banorte Generali (unrated) to Grupo Financiero Banorte (GFNorte, unrated), giving GFNorte full ownership of both companies for a total consideration of €649 million. The transaction is credit positive for both Generali and GFNorte.
The transaction is in line with Generali’s strategy to dispose of non-core assets and strengthen its capitalisation. The transaction gives GFNorte, holding company of Banco Mercantil del Norte, S.A. (Baa1 stable, C-/baa2 negative),10 full control of the insurance and annuities businesses as Mexico’s growing middle class is increasing its use of financial services.
For Generali, the disposal is one more step toward the rationalisation of its insurance operations around the globe and its 2015 target Solvency I capital ratio of 160%. The transaction generates a net capital gain for Generali of around €500 million on a consolidated basis, further strengthening its liquidity and capital position and improving its Solvency I ratio four percentage points from 145% at 30 April 2013, pre-transaction. This deal, together with the 4 June sale of Generali’s US Life reinsurance operation to France’s SCOR SE (financial strength A1 stable), shows Generali’s new management team is able to sell non-core assets at attractive valuations and indicates good progress on Generali’s restructuring. With this transaction, Generali’s asset disposals will have reached more than €2.2 billion since August 2012, more than half its €4 billion 2015 target.
GFNorte will gain attractive growth opportunities with its full ownership of the insurance and pension businesses as Mexico’s stable macroeconomic environment supports a growing middle class and domestic demand11 (Exhibit 1), which we expect will increase demand for financial services. And, because the penetration of insurance and pensions in Mexico is low, growth potential is high, as reflected by very attractive five-year compound annual growth rates of 9.4% in the insurance sector and 22.6% in the pension industry (Exhibit 2).
10 The ratings shown are the banks’ foreign currency deposit rating, standalone bank financial strength rating/baseline credit
assessment and the corresponding rating outlooks. 11 According to Mexico’s National Institute of Statistics, domestic demand is the sum of nominal consumption plus nominal
investment in the economy. Nominal consumption includes nominal private consumption and nominal public consumption. Nominal investment consists of nominal gross fixed capital formation and nominal change in inventories and valuables.
Antonello Aquino Senior Vice President +44.20.7772.1582 [email protected]
David Olivares Vice President - Senior Credit Officer +52.55.1253.5705 [email protected]
José Montaño Assistant Vice President - Analyst +52.55.1253.5722 [email protected]
NEWS & ANALYSIS Credit implications of current events
20 MOODY’S CREDIT OUTLOOK 17 JUNE 2013
EXHIBIT 1
Evolution of Mexico’s Domestic Demand and Middle Class Population
Note: Asociación Mexicana de Agencias de Investigación de Mercado y Opinión Pública, calculates Mexico’s socioeconomic levels based on several indicators. We include its “Middle Class” cohort of the Mexican population in the exhibit. Source: Asociación Mexicana de Agencias de Investigación de Mercado y Opinión Pública and Moody’s
EXHIBIT 2
Evolution of Mexico’s Insurance and Pension Gross Written Premiums
Source: Mexico’s Comisión Nacional de Seguros y Fianzas.
The transaction, which the companies expect to complete by the fourth quarter, is subject to final approval of regulatory authorities and other customary conditions. For the acquisition, GFNorte will use the proceeds from an initial public offering of up to $3 billion. Its acquisition of Generali’s stakes follows the 2012 acquisition of Afore Bancomer (unrated), the 2011 alliance with Afore XXI (unrated) and the 2010 acquisition of Ixe Grupo Financiero (unrated) and Ixe Banco S.A. (Baa1 stable, D+/ba1 stable), all broadening GFNorte’s franchise and operations.
Seguros Banorte is the ninth-largest company in Mexico with a 4% market share at year-end 2012, behind MetLife Mexico (unrated), GNP (unrated) and AXA Seguros (unrated), among others. Pensiones Banorte is the leading player in the annuities sector holding a 46% market share at year-end 2012.
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NEWS & ANALYSIS Credit implications of current events
21 MOODY’S CREDIT OUTLOOK 17 JUNE 2013
ORIX’s Investment in MEDGULF Is Credit Positive Last Wednesday, ORIX Corporation (Baa2 stable) announced that it had acquired approximately a 25.7% stake in The Mediterranean and Gulf Insurance & Reinsurance Company B.S.C. (MEDGULF, unrated) of Bahrain, one of the largest private insurance companies in the Middle East. This deal is credit positive for ORIX because it will diversify its revenue.
Although we expect ORIX to finance this acquisition with cash on hand, the deal will not financially burden ORIX. We estimate the deal will cost ORIX approximately ¥20 billion, which is low relative to its capital of ¥1.6 trillion and cash of ¥826 billion as of March 2013. We estimate MEDGULF’s contribution to ORIX’s consolidated net income at approximately ¥1 billion.
MEDGULF mainly engages in health and automobile insurance and has both a strong brand and a high market share in countries such as Saudi Arabia, Lebanon and Jordan. This acquisition would allow ORIX to tap Middle East markets, which we believe have stronger growth potential than ORIX’s mature home market in Japan. According to Swiss Re Sigma, insurance penetration (defined by insurance premium/GDP) in the Middle East averaged less than 2% in 2011, well below the 11% in Japan (see exhibit).
Comparison of Population and Insurance Penetration in Japan and the Middle East, 2011
Note: The Middle East includes the nine countries of Saudi Arabia, Iran, United Arab Emirates, Israel, Qatar, Kuwait, Oman, Lebanon, Jordan and Bahrain. Source: Swiss Re Sigma
Acquiring a stake in MEDGULF is also in line with ORIX’s strategy to expand its global franchise by seeking investment opportunities in high-growth developing markets. This acquisition followed its May investment in Mongolian financial group TenGer Financial Group (unrated) and its February acquisition of Netherlands-based asset management company Robeco Groep N.V. (unrated).
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Eri Saho Associate Analyst +81.3.5408.4048 [email protected]
NEWS & ANALYSIS Credit implications of current events
22 MOODY’S CREDIT OUTLOOK 17 JUNE 2013
Sovereigns
Greece Faces Credit Negatives from Fraying Political Consensus and Slippage in Privatisation Program Last Wednesday, the government of Greece (C) closed down Greek state television and radio broadcaster ERT, a move that threatened the political consensus behind the country’s fiscal consolidation efforts. Moreover, Greece’s privatisation program is falling short of its targets. Both the fraying of political consensus and the slippage of the privatisation program are credit negative for the sovereign.
Fraying political consensus. Closing ERT eliminated about 2,700 government employees, part of Greece’s effort to meet its commitment under the Troika (European Commission, International Monetary Fund and the European Central Bank) program to reduce the public sector workforce by 4,000 this year. However, closing the state’s radio and television broadcaster, which has operated since 1938, sparked widespread protest. Additionally, the net effect on workforce numbers is uncertain since the government has said that a new, smaller broadcasting company, NERIT, will be up and running by September. Under the Troika program for 2013, a reduction of about half the public sector workforce is targeted for completion by September.
Shutting ERT through a special decree has sparked considerable uproar among the members of the junior coalition partners, PASOK and DIMAR, who have stated that they will not support the measure in Parliament when it comes up for vote in the next 40 days. Without a compromise among coalition partners, the risk of new elections in Greece will increase, a credit negative for the sovereign. Although an early election is not our central scenario, the extremely contentious political environment continues to pose downside risks to the successful implementation of the Greece’s structural adjustment program and its economic recovery.
Slippage in privatisation program. Greece’s privatisation program is also proving problematic. Last Tuesday, Greek privatisation agency TAIPED announced that its efforts to sell the Greek public gas company DEPA had elicited no bids, and that it had received only one bid for gas transmission company DESFA. The shortfall in the privatisation program’s objectives highlights the program’s implementation risks, which are credit negative for the sovereign.
Under the Troika’s financing program for this year, Greece is to raise at least €1 billion from privatisation by the end of the third quarter and about €2.5 by the end of 2013. To date, the government has raised around €254 million by selling licences to run the state lotteries, land development and real estate properties outside of Greece. In addition, the government expects its sale of the state lottery company OPAP to raise around €712 million when it is finalised in the next few months.
Without privatising these gas companies and other state-owned companies, Greece will have trouble meeting the year’s privatisation target and will likely have a financing gap of around €1.5 billion this year that it will need to finance through additional fiscal measures. However, the fragile political environment and a contracting economy make effecting more current expenditure cuts challenging and threaten the government’s target of achieving a balanced primary budget this year.
Consequently, the government is renegotiating the privatisation targets under the Troika program and discussing a six-month decrease in the value-added tax rate for hotels and restaurants to take advantage of the upcoming tourist season.
Alpona Banerji Assistant Vice President - Analyst +44.20.73726.335 [email protected]
Michail Michailopoulos Associate Analyst +49.69.70730.740 [email protected]
NEWS & ANALYSIS Credit implications of current events
23 MOODY’S CREDIT OUTLOOK 17 JUNE 2013
Portugal Receives Next Tranche of IMF Funding, a Credit Positive Last Wednesday, the International Monetary Fund (IMF) announced it had completed its seventh review under the Extended Fund Facility agreement with the government of Portugal (Ba3 negative), enabling the release of €657 million of IMF financing to the country. The IMF’s successful review is credit positive for Portugal because it puts the support program back on track.
The successful review will enable the release of an additional €1.3 billion of European Union (EU) funding. Moreover, the Eurogroup (the finance ministers of the euro area countries) favourably reviewed and successfully fulfilled a precondition for its offer to lengthen by an average of seven years the maturities of the loans from the European Financial Stability Facility (EFSF) and the European Financial Stabilisation Mechanism (EFSM). Although repayments to the EU will not begin until 2015, extending the maturities will diminish pressure on government finances given that general government debt is a high 120% of GDP.
Approval of the review had been delayed because Portugal’s Constitutional Court rejected key consolidating measures of the 2013 budget and because of the lack of an updated fiscal plan at the time. The court ruling also raised questions about the feasibility of some fiscal measures that were under consideration for future years. Therefore, the government had to present a supplementary budget for this year, which parliament approved earlier this month, paving the way for the conclusion of the IMF review.
In March, the IMF and the European Commission agreed to a significant relaxation in the fiscal targets for Portugal, which is positive given the economy’s weakness. The budget deficit target for 2013 is now 5.5% of GDP, compared with a target of 4.5% before the revision. The 2014 target was also relaxed to 4% of GDP from an earlier target of 2.5%.
We consider the current 2013 budget deficit target achievable, given the one percentage point of GDP relaxation and the recently approved supplementary budget. Portugal’s chances of achieving the current 2014 target have also improved, given that the fiscal drag on the economy in 2013 will be smaller than previously expected and that some of the measures in the supplementary budget are structural. The coincident indicators for private consumption and GDP published by the Bank of Portugal point to economic stabilisation in the latter part of the year, which is our (and the IMF’s) base-case assumption. Still, the risks to the fiscal outlook remain substantial given the economic weakness in the EU and the decline in popular support for the program in Portugal itself.
The EU is scheduled on 20 June to discuss the release of its next EFSF and EFSM tranches and the maturity extension, which would provide support for Portugal’s return to capital market funding. We also note that the head of the Eurogroup, Jeroen Dijsselbloem, hinted at extending additional support to Portugal if it were needed. Beyond the maturity extension, any clarification of when and under what conditions Portugal would qualify for the European Central Bank’s Outright Monetary Transactions scheme following the end of the current support program would improve the sovereign’s capital market access. This is important given that, excluding treasury bills, Portugal’s financing needs for 2014 are substantial at around €24 billion, while disbursements from the EU and IMF will amount to €8 billion.
Kathrin Muehlbronner Vice President - Senior Analyst +44.20.7772.1383 [email protected]
Pamela Reyes Herrera Associate Analyst +44.20.7772.1068 [email protected]
NEWS & ANALYSIS Credit implications of current events
24 MOODY’S CREDIT OUTLOOK 17 JUNE 2013
Ecuador Loses Canadian Miner Kinross, a Credit Negative for the Sovereign Last Monday, Kinross Gold Corporation (Baa3 stable) decided to abandon its Fruta del Norte gold and silver mining project in Ecuador. The Canadian mining company’s decision followed two years of failed negotiations with the government of Ecuador (Caa1 stable) over its windfall tax structure for the mining industry. The company’s decision highlights the challenges Ecuador faces in attracting foreign direct investment (FDI), a credit negative for the country’s economic diversification and growth outlook.
Ecuador’s windfall tax for mining gives the government 70% of profits above a pre-negotiated base price. Kinross’ decision was made as Congress weighed changing the mining law. Just three days after Kinross announced its exit, Congress approved changes to the mining law, including one that states that the 70% windfall tax will not take effect until miners recover their investments.
Kinross had been negotiating with the government over the development of a $1.2 billion gold and silver mining project known as Fruta del Norte, which holds 6.7 million ounces of gold and 9.0 million ounces of silver in proven and probable reserves. The fact that the government implemented changes to its mining law only after Kinross halted the development of Fruta del Norte bolsters our assessment of very low institutional strength in Ecuador.
Furthermore, Kinross’ decision indicates that government policies are likely to continue discouraging foreign investment (average FDI has been 0.7% of GDP since 2006), which dampens the country’s growth outlook. We expect Ecuador’s real GDP growth to slow to 3.9% this year after growing by 8.0% in 2011 and 4.6% in 2012.
An oil-producing nation, Ecuador is trying to reduce its economic dependence on oil revenue and attract foreign investment in mining.
Sarah Glendon Assistant Vice President - Analyst +1.212.553.4534 [email protected]
NEWS & ANALYSIS Credit implications of current events
25 MOODY’S CREDIT OUTLOOK 17 JUNE 2013
Nationalizations in Belize’s Offshore Sector Are Credit Negative Last Tuesday, the government of Belize (Caa2 stable) nationalized the International Business Companies Registry (IBCR), a corporate registrar that provides non-financial companies with offshore tax-free status in Belize, and the International Merchant Marine Registry of Belize (IMMARBE), which sells Belize as a flag of convenience to foreign ship operators. The two foreign-owned entities control and operate the entire offshore business sector in Belize.
The government’s actions are credit negative because they expose the government to fiscal liabilities from compensation claims by former shareholders and act as a deterrent to foreign investment in the offshore sector. The latter will impair Belize’s competitiveness against regional peers.
Belize’s ability to attract company registration business relies on international customers regarding it as a well-regulated and policed jurisdiction, with a strong legal framework and efficient corporate services. Last week’s nationalizations undermine the stability of Belize’s offshore business environment and will adversely affect fiscal revenues from licensing fees and, more importantly, Belize’s attractiveness as a destination for foreign direct investment (FDI) into the broader economy. FDI inflows to Belize rose to 12% of GDP in 2012 from 6.8% in 2010, supporting growth of 5.2% last year, versus the rest of the Caribbean, which grew at around 0.5% in tourism-dependent economies and 3.5% in commodity exporting countries.
Belize ranks poorly in the World Bank’s Ease of Doing Business survey (see exhibit) compared with other jurisdictions in the Caribbean with which it competes for offshore tax-haven business, and we expect the recent nationalizations to further undermine the international perception of Belize’s investment climate.
Belize’s and Other Caribbean Countries’ Business Environment Rankings Rank in Enforcing Contracts Rank in Protecting Investors
Dominica (unrated) 170 32
Trinidad and Tobago (Baa1 stable) 170 25
Belize (Caa2 stable) 169 128
St. Lucia (unrated) 168 32
Grenada (unrated) 165 32
Jamaica (Caa3 stable) 129 82
Bahamas (Baa1 negative) 123 117
St. Kitts and Nevis (unrated) 119 32
Barbados (Ba1 negative) 105 169
St. Vincent and the Grenadines (B2 stable) 99 32
Antigua and Barbuda (unrated) 72 32
Source: World Bank Ease of Doing Business Report, 2013, covering 185 countries.
The expropriations come at a time when the government is facing an uncertain funding environment after restructuring its external commercial debt earlier this year, its second default since 2006. The expropriations also follow the government nationalizing two utilities, Belize Telemedia Limited (BTL, unrated) and Belize Electricity Limited (BEL, unrated), during 2009-11. Shareholders’ compensation claims, currently in litigation, could crystallize into fiscal liabilities large enough to trigger another default. The size of those claims range from a government estimate of 6% of GDP to the claimants’ estimate of 30% of GDP , or roughly $90-$450 million.
Petar Atanasov Associate Analyst +1.212.553.4515 [email protected]
Edward Al-Hussainy Assistant Vice President - Analyst +1.212.553.4840 [email protected]
NEWS & ANALYSIS Credit implications of current events
26 MOODY’S CREDIT OUTLOOK 17 JUNE 2013
The nationalized registries were operated and partially owned by Belize International Services Limited (unrated), a holding company incorporated in the British Virgin Islands and owned by BCB Holdings (BCBH, unrated), the former majority shareholder in BTL.
BCBH has filed multiple compensation claims against the government that are in various stages of arbitration and litigation in domestic and foreign courts. We expect last week’s nationalizations to ratchet up tensions between BCBH and the authorities and decrease the likelihood that the two parties will reach an out-of-court settlement in the BTL case. Although protracted litigation would offer temporary relief to the government, it keeps alive the odds that the ultimate fiscal liability will be large enough to trigger a liquidity crisis.
In addition to increasing the number of pending restitution cases against the government, the recent nationalizations might adversely affect fiscal revenues from administrative fees. The IBC system serves more than 100,000 companies, while IMMARBE has 942 vessels registered under the Belizean flag. According to government estimates, the registries will generate approximately $11 million of fiscal revenue (2.7% of current revenue) this year, which could now be lower as a result of the government’s diminished ability to attract company registration business.
NEWS & ANALYSIS Credit implications of current events
27 MOODY’S CREDIT OUTLOOK 17 JUNE 2013
US Public Finance
Detroit’s Default and Restructuring Offer Are Credit Negative Last Friday, the city of Detroit, Michigan (Caa2 review for downgrade) defaulted on a $39.7 million payment on its pension obligation certificates of participation (COPs), which constitutes Detroit’s first debt service default, a credit negative both for bondholders of the defaulted debt as well as other city debt. Separately, we downgraded the ratings on several classes of Detroit debt on Thursday, before the announcement, and placed all ratings on review for downgrade.
This default follows Detroit Emergency Manager (EM) Kevyn Orr on the same day presenting a proposal to the city’s creditors to restructure certain obligations. Mr. Orr’s proposal calls for nearly all creditors to be subject to some type of restructuring, with unsecured creditors taking a pro rata share of $2 billion of new limited recourse participation notes that would replace approximately $11 billion of obligations (see exhibit below), although unfunded pension and other post-employment benefit liability estimates are subject to further adjustments. The substantial reduction offered to unsecured creditors, the extent of the city’s financial stress and the complexity of the city’s debt add to the uncertainty of many classes of debt ultimately recovering their investment.
Detroit Emergency Manager’s Restructuring Proposal
Unsecured Obligation Type Approximate Aggregate Liability
$ Millions Approximate Percent of Total
Unsecured Obligations
General Obligation Bonds/Notes $650 6%
COPs 1,400 12%
Unfunded OPEB Liabilities 5,700 494%
Unfunded Pension Liabilities 3,500 30%
Other Liabilities 300 3%
Total Unsecured Liabilities $11,550
Source: City of Detroit, Proposal for Creditors, 14 June 2013.
The restructuring plan is unconventional and precedent-setting in the municipal market. It builds a strong case for insolvency, girding the city for a tough fight with creditors of all types. The report details the city’s history of economic, operating and liquidity challenges driving a worsening state of insolvency. This analytic backdrop lays a case for bankruptcy if parties are unable to agree on restructuring terms. The report articulates a case for service insolvency, or the inability to provide public health and safety services owing to substantial debt, pension and other obligations. This concept was a central element in a federal bankruptcy court’s recent decision to allow the city of Stockton, California, to file for Chapter 9 protection. Detroit’s case is unique in that, given its high level of indebtedness, it is looking specifically to bondholders, in addition to unionized labor and pensioners, to solve the city’s severe fiscal problems.
Detroit’s negotiations with creditors are also unusual in that the city proposes similar treatment of various debt security types that historically have enjoyed distinctions based on legal protections in state statutes and bond documents. The EM defines two broad categories of “secured” and “unsecured” creditors. Secured obligations include, among other things, the debt of the city’s water and sewer enterprises, the city’s general obligation debt enhanced by an intercept of state aid and claims related to the city’s interest rate swaps. The EM does not propose a specific restructuring plan for the creditors he considers secured, but noted that these obligations are subject to negotiation.
Hetty Chang Vice President - Senior Credit Officer +1.312.706.9960 [email protected]
NEWS & ANALYSIS Credit implications of current events
28 MOODY’S CREDIT OUTLOOK 17 JUNE 2013
Unsecured obligations include the remainder of the city’s general obligation unlimited and limited tax debt, payments related to the COPs, unfunded pension liabilities and other post-employment benefit (OPEB) obligations after modifications in benefits. The plan appears to treat the general obligation and pension obligation certificates similarly, which would be a break from tradition.
The proposal includes the unfunded liabilities of the city’s pension plans as part of the obligations to be restructured. In making the calculation for the city’s two pension plans, one for general employees and another for police and fire employees, the EM used discount rates of 6.9% and 6.5%, respectively, both of which are one percentage point lower than the current assumptions for the two plans and increases the reported unfunded actuarial accrued liability to $3.5 billion from the $643 million reported for fiscal 2011. The EM’s revaluation of the city’s pension obligations is consistent with our approach to apply a more realistic discount rate in adjusting net pension liabilities for state and local government issuers in our analyses.
The EM’s proposal to issue $2 billion of limited recourse participation notes to unsecured obligations on a pro rata basis is a significant reduction for those creditors. Although this initial offer may be a negotiating tactic, the magnitude of the proposed reduction to unsecured creditors and the comprehensive case for insolvency suggests substantial losses to creditors either through restructuring or Chapter 9.
NEWS & ANALYSIS Credit implications of current events
29 MOODY’S CREDIT OUTLOOK 17 JUNE 2013
New York City Storm Resiliency Plan Anticipates Federal Funds, a Credit Positive Last Tuesday, New York City (Aa2 stable) Mayor Michael Bloomberg announced a 10-year, $19.5 billion plan to buttress the city’s infrastructure against natural disasters, especially the type of coastal flooding that caused damage to low-lying areas during Superstorm Sandy last October. Like the emergency response and repair costs following the storm, the city expects most of the resiliency plan’s costs to be paid via federal funds, a credit positive.
Significantly, the city expects federal funds to pay for most of the projects in the NYC Special Initiative for Rebuilding and Resiliency, which will not unduly burden its balance sheet. Federal responsibility for paying for disaster relief has long been a credit strength for US state and local governments and is a factor that bolsters their ratings. For example, the Federal Emergency Management Agency (FEMA) pays no less than 75% of emergency response and debris cleanup costs following natural disasters, and often pays 90% or more.
City funding of $5.5 billion reflects spending it has already included in its $27.9 billion fiscal 2014-17 capital plan. These funds are earmarked for water and wastewater projects, other infrastructure projects and economic development initiatives, and the city does not expect additional borrowing beyond what is already included in the capital plan. The city says that it expects to dedicate an additional $1 billion of capital spending to the plan, largely to jumpstart projects that do not have dedicated funding already, and to serve as an inducement for additional state and federal funding.
In the case of Superstorm Sandy, the federal government is paying 100% of certain emergency response and cleanup costs, including emergency power restoration and emergency public transportation and reimbursement of regular time salaries and benefits to perform debris removal operations. Additionally, Congress stepped in to appropriate $51 billion of supplemental funds (an amount the federal budget sequestration later reduced to $48 billion). The city now intends to access some of those supplemental federal funds to finance the storm resiliency and climate change mitigation projects. For example, the city will use $4.8 billion of federal funding Congress allocated to it post-Sandy to help pay for the plan. The federal funds will come from Community Development Block Grants, FEMA and National Flood Insurance Program housing aid and other supplemental federal funds (see exhibit). The city also expects to receive additional funds from the Sandy supplemental measure of $4 billion. In the future, the city will try to get additional federal funding to pay for the unfunded portions of its plan.
Expected Sources of New York City Storm Resiliency Funding, $ Billions City Funds
City Capital Expenditures $5.5
Federal Funds
Community Development Block Grant: First Allocation $1.8
Housing Recovery Funding $0.7
Other Federal Aid $2.3
Community Development Block Grant allocations, Stafford Act hazard mitigation grants $4.0
Source: City of New York, A Stronger, More Resilient New York
The mayor’s resiliency plan reflects an array of projects to protect the city’s coastline and shield critical infrastructure such as its telecommunications network, liquid-fuel distribution network and the transportation system from storms and the effects of climate change.
Nick Samuels Vice President - Senior Credit Officer +1.212.553.7121 [email protected]
NEWS & ANALYSIS Credit implications of current events
30 MOODY’S CREDIT OUTLOOK 17 JUNE 2013
The plan itself describes its broad-based projects as “bold proposals.” Bolstering its infrastructure is necessary, the city says, because based on enhanced mapping techniques and updated federal data, 5% of the population and 48 square miles of the city (nearly 16%) lie in the 100-year floodplain, including all 14 wastewater treatment plants and 12 of 27 power plants.12 Additionally, a large share of the city’s power generation capacity, hospital beds, and public housing are at risk from future storms.
12 By comparison, based on National Oceanographic and Atmospheric Administration and US Census Bureau data, the city says 70%
of New Orleans’ population and 36% of Miami’s population live in these cities’ 100-year floodplains.
RATING CHANGES Significant rating actions taken the week ending 14 June 2013
31 MOODY’S CREDIT OUTLOOK 17 JUNE 2013
Corporates
Amadeus IT Holding, S.A. Upgrade
14 Jun ‘11 14 Jun ‘13
Long-Term Issuer Rating Baa3 Baa2
Outlook Stable Stable
The upgrade reflects the company's leading position in the market for global distribution services (GDS) providers; generally resilient profitability compared with that of the airline industry it serves; and the smaller, albeit higher-margin, IT solutions business, which has fairly high barriers to entry. The rating also captures several challenges inherent in the GDS industry, notably the risk of further disintermediation by airlines and the risk of alternative distribution models emerging.
Carnival Corporation Downgrade
21 Mar ‘13 10 Jun ‘13
Senior Unsecured Rating A3 Baa1
Short-Term Issuer Rating P-2 P-2 (affirmed)
Outlook Review for Downgrade Stable
The downgrade is because higher discounting and promotional activity in the aftermath of several ship incidents aboard Carnival ships in 2013 will cause profitability, leverage, and coverage metrics to deteriorate further outside of the levels appropriate for a A3 rating. Given the number of ship incidents and intense media coverage surrounding them, along with weak demand in Europe, it may take several years for Carnival to grow net yields to a level that will improve consolidated operating margins.
Celgene Corporation Outlook Change
4 Oct ‘10 12 Jun ‘13
Senior Unsecured Rating Baa2 Baa2
Short-Term Issuer Rating P-2 P-2
Outlook Stable Positive
The outlook change reflects continued robust growth driven by Revlimid and by recent and pending regulatory approvals. Expanding use of Revlimid and pending approvals of Apremilast in psoriatic arthritis and Abraxane in pancreatic cancer should sustain good growth momentum.
RATING CHANGES Significant rating actions taken the week ending 14 June 2013
32 MOODY’S CREDIT OUTLOOK 17 JUNE 2013
Endo Health Solutions Inc. Review for Downgrade
4 Mar ‘13 10 Jun ‘13
Senior Unsecured Rating Ba2 Ba2
Outlook Negative Review for Downgrade
Prompting the review is our increasing concern about Endo's ability to improve its growth prospects while maintaining a conservative capital structure. Although its recently announced cost restructuring is credit positive, Endo's core businesses will face significant headwinds and its debt levels may increase to support external growth.
JBS S.A. Review for Downgrade
22 Mar ‘13 10 Jun ‘13
Corporate Family Rating Ba3 Ba3
Outlook Stable Review for Downgrade
The announcement of the proposed acquisition of Marfrig's Seara Brasil and Zenda leather operations for BRL5.85 billion (approximately $2.8 billion) triggered the review. The purchase price will be entirely paid through the assumption of Marfrig's bank debt maturing between 2013 and 2017 and will hurt JBS's short-term leverage and cash flow generation.
Safeway Inc. Outlook Change
9 Jan ‘12 13 Jun ‘13
Long-Term Issuer Rating Baa3 Baa3
Short-Term Issuer Rating P-3 P-3
Outlook Stable Negative
The outlook change follows the announcement that the company plans to divest its Canadian operations for CAD5.8 billion in cash. It reflects the uncertainty over the company's ability to improve operating performance and credit metrics to levels appropriate for the current rating. We view the sale of the Canadian operations as a credit negative for the remaining company as the Canadian stores have a higher EBITDA margin than Safeway's US operations and generate a healthy free cash flow.
RATING CHANGES Significant rating actions taken the week ending 14 June 2013
33 MOODY’S CREDIT OUTLOOK 17 JUNE 2013
Votorantim Participacoes S.A. Outlook Change
23 Mar ‘10 11 Jun ‘13
Long-Term Issuer Rating Baa3 Baa3
Outlook Stable Positive
The outlook change was triggered by the announcement of Votorantim Cimentos' IPO, expected to be concluded by the end of June 2013. Votorantim intends to sell 20% to 25% of its share in Votorantim Cimentos. The proceeds of the IPO will be used to fund Votorantim Cimentos's expansion plans and will improve Votorantim's liquidity profile, with debt prepayment and a consequent reduction in leverage likely. Votorantim will continue to own a majority stake of Votorantim Cimentos, and will therefore continue to benefit from its stable cash flow generation and strong margins.
RATING CHANGES Significant rating actions taken the week ending 14 June 2013
34 MOODY’S CREDIT OUTLOOK 17 JUNE 2013
Infrastructure & Project Finance
American Transmission Systems, Inc. Downgrade
26 Feb ‘13 10 Jun ‘13
Senior Unsecured Rating Baa1 Baa2
Outlook Stable Stable
Trans-Allegheny Interstate Line Company Downgrade
26 Feb ‘13 10 Jun ‘13
Senior Unsecured A3 Baa1
Outlook Stable Stable
The downgrades were triggered by parent FirstEnergy Transmission, LLC’s decision to borrow against the future cash flows of its transmission businesses in order to enhance the family's liquidity position. This was achieved by having FirstEnergy Transmission borrow $1.0 billion under a $1.0 billion revolving credit facility, proceeds it has largely loaned to its affiliates through the company’s money pool.
Slovensky Plynarensky Priemysel a.s. Downgrade
17 Dec ‘12 11 Jun ‘13
Issuer Rating A2 Baa1
Outlook Review for Downgrade Developing
The downgrade reflects our re-assessment of SPP’s business and financial risk profile, coupled with our expectation that the group's leverage will increase as shareholders seek to maximize the dividends they receive.
RATING CHANGES Significant rating actions taken the week ending 14 June 2013
35 MOODY’S CREDIT OUTLOOK 17 JUNE 2013
Financial Institutions
Aviva Plc Downgrade
12 Mar ‘13 12 Jun ‘13
Guaranteed Senior Debt A1 A2
Guaranteed Senior MTN (P) A1 (P) A2
Senior Unsecured MTN (P) A2 (P) A3
Senior Subordinated MTN (P) A3 (P) Baa1
Subordinated MTN (P) A3 (P) Baa1
Junior Subordinated MTN (P) Baa1 (P) Baa2
Subordinate Shelf (P) A3 (P) Baa1
Subordinated A3 (hyb) Baa1 (hyb)
Junior Subordinated A3 (hyb) Baa1 (hyb)
Preferred Securities Baa1 (hyb) Baa2 (hyb)
Aviva Insurance Limited Downgrade
12 Mar ‘13 12 Jun ‘13
Insurance Financial Strength Aa3 A1
Aviva International Insurance Limited Downgrade
12 Mar ‘13 12 Jun ‘13
Insurance Financial Strength Aa3 A1
Aviva Life & Pensions UK Limited Downgrade
12 Mar ‘13 12 Jun ‘13
Insurance Financial Strength Aa3 A1
These rating actions conclude the review initiated on 12 March 2013 and are driven by our view that, despite making good progress on its transformation objectives, Aviva's near-term profitability is likely to remain suppressed, limiting the group's ability to materially better its profitability and improve earnings coverage in line with our expectations for an Aa rated insurer. In addition, the group's focus on improving margins and capital discipline is likely to result in lower volume growth than seen at Aa rated peers.
RATING CHANGES Significant rating actions taken the week ending 14 June 2013
36 MOODY’S CREDIT OUTLOOK 17 JUNE 2013
Banco Rural S.A. Downgrade
21 Sep ‘12 12 Jun ‘13
Standalone Bank Financial Strength Rating/Baseline Credit Assessment
E+/b3 E/caa1
Long-Term Global Local-Currency Deposit Ratings
B3 Caa1
Long-Term Foreign-Currency Deposit Ratings
B3 Caa1
Long-Term Brazilian National Scale Deposit Ratings
B1.br Caa1.br
The downgrade results from Rural’s prolonged delay in publishing audited financials for 2012 and the resulting opacity about the bank's financial performance and credit risk. Preliminary reports submitted to the Brazilian banking regulator indicate that Rural reported net losses as of year-end 2012, its second consecutive year of weak results that reflect high credit, operating and funding costs combined with poor revenues from its core activities.
Clientis AG Downgrade
24 Apr ‘13 14 Jun ‘13
Standalone Bank Financial Strength Rating/Baseline Credit Assessment
C/a3 C-/baa1
The lowering of Clientis’s BFSR reflects the bank’s less balanced liquidity and funding profile compared with peers’, which could expose the group to disruptions in confidence-sensitive wholesale funding markets; the bank's low profitability compared with similarly rated global peers’; and uncertainties regarding the development of Clientis’s franchise over the long term.
RATING CHANGES Significant rating actions taken the week ending 14 June 2013
37 MOODY’S CREDIT OUTLOOK 17 JUNE 2013
Penn Mutual Life Insurance Company Outlook Change
24 Jun ‘10 10 Jun ‘13
Insurance Financial Strength Rating Aa3 Aa3
Outlook Stable Negative
Penn Insurance and Annuity Company Outlook Change
24 Jun ‘10 10 Jun ‘13
Insurance Financial Strength Rating Aa3 Aa3
Outlook Stable Negative
The change in outlook is driven by the increasing product risk from Penn Mutual’s sales of higher-risk universal life with secondary guarantees (ULSG) and the company's modest earnings generation and profitability. While Penn Mutual has remained primarily a life protection-oriented company, it has grown significantly in ULSG, which we consider a relatively higher risk life insurance product because of its exposure to low interest rates and low policyholder lapses.
Valiant Bank AG Downgrade
22 Mar ‘13 13 Jun ‘13
Long-Term Deposit Ratings A1 A3
Standalone Bank Financial Strength Rating/Baseline Credit Assessment
C+/a2 C-/baa1
The downgrade reflects uncertainties regarding Valiant's longer-term franchise prospects, as well as the persistent pressure on the bank's profitability and efficiency ratios, which limits the bank’s capacity to build on its only adequate capitalization levels. It also takes into account that to some extent the bank relies on market funding.
Moody's Announces Reviews for Downgrade of Japanese Banks' Subordinated-Debt Ratings 11 Jun ‘13
Moody's Japan K.K. has placed on review for downgrade the following banks’ subordinated debt ratings, which have benefited from uplift linked to Moody’s prior assessment of systemic support in Japan: The Bank of Tokyo-Mitsubishi UFJ Ltd.; UFJ Finance Aruba A.E.C.; BTMU (Curacao) Holdings N.V.; Mitsubishi UFJ Securities International plc; Mizuho Bank, Ltd.; Mizuho Corporate Bank, Ltd.; Mizuho Finance (Aruba) A.E.C.; Mizuho Finance (Cayman) Ltd; Mizuho Finance (Curacao) N.V.; Mizuho Financial Group (Cayman) Ltd; Mizuho Financial Group (Cayman) 2 Ltd; Mizuho Trust and Banking Co., Ltd.; Norinchukin Finance (Cayman) Ltd; Shinsei Bank, Ltd.; Chiba Bank. Ltd.; Sumitomo Mitsui Trust Bank, Ltd; STB Finance Cayman Ltd.; Sumitomo Mitsui Banking Corp.; SMBC International Finance N.V.; Kansai Urban Banking Corp.; Minato Bank, Ltd (The); Resona Holdings, Inc.; Resona Bank, Ltd.; Saitama Resona Bank, Ltd.
RATING CHANGES Significant rating actions taken the week ending 14 June 2013
38 MOODY’S CREDIT OUTLOOK 17 JUNE 2013
Sovereigns
Bahrain Review for Downgrade
14 Jun ‘13
Gov Currency Rating Baa1 Baa1
Foreign Currency Deposit Ceiling Baa1 Baa1
Foreign Currency Bond Ceiling A2 A2
Local Currency Deposit Ceiling A1 A1
Local Currency Bond Ceiling A1 A1
Outlook Negative Review for Downgrade
The review was prompted by the fiscal implications of Bahrain's high and rising break-even oil price; the outlook for lower economic growth in the country over the medium term; and the impact of a low-growth, high government expenditure and weaker oil price scenario on Bahrain’s long-term debt sustainability. The review will focus on the degree to which Bahrain’s economic model has structurally weakened and the resilience of the country’s credit fundamentals under forecasted subdued global growth.
Belarus Affirmation
14 Jun ‘13
Gov Currency Rating B3 B3
Foreign Currency Deposit Ceiling Caa1 Caa1
Foreign Currency Bond Ceiling B3 B3
Local Currency Deposit Ceiling B1 B1
Local Currency Bond Ceiling Ba3 Ba3
Outlook Negative Negative
The affirmation reflects Belarus’s well-diversified economy; the achievement of fiscal surpluses, with a narrowing of the current account deficit and an increase in international reserves following the balance of payments crisis in 2010-11; tight foreign exchange liquidity position; continued reliance on energy subsidies from Russia and on external debt to finance domestic investment and growth; and policies that pursue growth via credit and investment spending rather than productivity increases.
RATING CHANGES Significant rating actions taken the week ending 14 June 2013
39 MOODY’S CREDIT OUTLOOK 17 JUNE 2013
US Public Finance
Detroit, MI Downgrade and Outlook Change
28 Nov ‘12 13 Jun ‘13
Unlimited Tax Bonds Caa1 Caa2
Limited Tax Bonds Caa2 Caa3
Lease Revenue Bonds Caa1 Caa3
Water and Sewer Senior Revenue Bonds
Baa3 Ba1
Water and Sewer Subordinate Revenue Bonds
Ba1 Ba2
Outlook Negative Review for Downgrade
The downgrades reflect the increased likelihood of a bankruptcy filing, a major general debt restructuring, or a combination of the two, following the appointment of the Emergency Manager (EM) in March 2013 and the EM's pronouncement that Detroit's current liabilities require significant restructuring to ensure the city's long-term financial health. Should default or bankruptcy occur, bondholder recovery could be quite low.
The review will focus on the EM's restructuring plan with respect to both bondholder repayment and potential treatment of the water and sewer system assets.
Georgia Advanced Technology Ventures Upgrade
25 Sep ‘09 12 Jun ‘13
Revenue Bonds A3 A2
Outlook Stable Stable
The upgrade reflects the strengthened commitment of Georgia Institute of Technology to support Georgia Advanced Technology Ventures (GATV), manifested in its decision to lease a vacant portion of GATV's Technology Enterprise Park 1 Building (TEP1). While previously Georgia Tech management had stated it would not directly support the TEP1 project, the space needs of its growing research enterprise and the strategic importance of the Technology Enterprise Park have caused it to revise that decision. Other strengths include GATV's role in developing facilities related to Georgia Tech’s economic development mission and the real estate value of its assets near the Georgia Tech campus.
RATING CHANGES Significant rating actions taken the week ending 14 June 2013
40 MOODY’S CREDIT OUTLOOK 17 JUNE 2013
Sharp Healthcare, CA Upgrade
8 Jan ‘12 12 Jun ‘13
Revenue Bonds A2 A1
Outlook Positive Positive
The upgrade reflects the maintenance of strong operating performance, the material improvement of balance sheet measures, and the absence of significant capital projects beyond the current fiscal year. Despite a challenging payer mix, management has been able to improve profitability, and sustain performance at the higher level. Patient volume growth has been good, and Sharp is growing market share.
RESEARCH HIGHLIGHTS Notable research published the week ending 14 June 2013
41 MOODY’S CREDIT OUTLOOK 17 JUNE 2013
Corporates
European Steel Outlook Remains Negative As Recovery May Take Longer To Materialise The profitability of the European steel industry will be lower in 2013 than in 2012, with no impetus for a change in steel market fundamentals visible at this time. The prolonged weakness of the European economy has now affected every steel-using end-market in Europe and is dampening demand in other regions.
Asian Liquidity Stress Index Falls in May Our Asian LSI declined to 25% in May from 27% in April, reversing two months of rises. The lower reading reflects a net decrease in the number of companies with our lowest speculative-grade liquidity score. The Index remains in the narrow and elevated range it has held since hitting a high of 29.1% in October 2012.
US Retailers' Private Equity-Backed Bond Covenants Are Much Weaker Than Non-PE Backed Issuers Investor protections in high-yield bonds from US retailers are generally in line with those provided by other North American non-financial issuers, except where private equity is involved. Covenant packages of US retail bonds backed by private equity offer far weaker protections than those that are not, scoring lower in all six categories of risk protection we measure.
Apple's New iTunes Radio Service Will Not Take Bite Out of Traditional Radio Apple recently announced that it plans to launch a streaming music service this fall, to join the ranks of alternative audio options and further reducing the time US consumers spend listening to traditional radio stations. But iTunes Radio will largely be irrelevant to the traditional radio broadcasters, grabbing far less market share from them than from alternative audio services such as Amazon.com and Spotify AB.
North American Bond Covenant Quality Remains Weak in May While the three-month rolling average and single-month scores improved slightly, May was still the fifth-worst month in terms of bond covenant quality of the past year. And two contrary forces were at play: Although the percentage of Ba rated bonds, which generally are of worse quality, fell to 21% from 41% the prior month, the covenant quality of lower-rated bonds materially worsened.
Canadian Broadband Communications’ Business Conditions Prompt Deal-Making and Regulatory Change Deal-making will continue as companies look for growth or abandon lost causes. Deal flow is forcing the regulators’ hands on wireless competition and the integration of content with distribution.
Global Independent Exploration and Production Companies Settle in for Period of Modest but Steady Growth Our stable outlook for the global independent exploration and production sector reflects our view that EBITDA will grow in the mid-to-high single digits year-on-year through late 2014. Today's stable oil and natural gas prices will keep encouraging healthy levels of investment in the industry, especially to develop oil and natural gas liquids reserves, while investment in natural gas wells will remain subdued
RESEARCH HIGHLIGHTS Notable research published the week ending 14 June 2013
42 MOODY’S CREDIT OUTLOOK 17 JUNE 2013
Global Shipping Industry’s Sustained Oversupply Keeps Outlook Negative We expect the supply of vessels to continue to outstrip demand for most shipping services. The dry-bulk and crude oil tanker segments are likely to face the greatest pressure, with freight rates remaining at low levels for at least the next 18 months.
New Brazilian Plant Raises Pressure on Latin American Pulp Producers Klabin’s new greenfield pulp plant, which would begin operating by early 2016, will add to already substantial expansion plans in the region, negatively impacting all Latin American pulp producers. This and other capacity additions will weaken the pulp producers’ ability to generate cash flow, and will make it more difficult for them to increase prices enough to offset rising input costs for labor, land and wood.
Leak of US Surveillance Programs Is Credit Negative for Intelligence Contractors In the wake of recent leaks related to a private contractor accessing the NSA’s highly classified telecom/Internet surveillance programs, US intelligence agencies will likely tighten their control over access to classified work, which will add costs for defense contractors and may eventually reduce the amount of work outsourced by government agencies. These developments are credit negative for defense companies with a material level of intelligence-based contracts.
Infrastructure & Project Finance
US Public Power Electric Utilities Face Limited Threats from Local Governance; Underscores Credit Stability Our stable outlook for US public power electric utilities reflects our expectations for multi-year improvements in financial metrics after the decline in 2009, while continued low fuel and energy prices will contribute to stable financial performance over next 12-18 months. Some small and midsized utilities will however face pressure from the phase-in of new generation project’s fixed costs, which has already begun to narrow their debt service coverage metrics.
Global Infrastructure Focus Newsletter, June 2013 In this issue: The prospect of US LNG exports influence pricing and gas markets worldwide; LNG export approval is credit positive for US exporters and the Japanese supply chain; North America’s shale revolution chemical, refining and utilities are among the sectors seeing the biggest benefits from shale; and US power project finance rides the covenant-lite wave.
RESEARCH HIGHLIGHTS Notable research published the week ending 14 June 2013
43 MOODY’S CREDIT OUTLOOK 17 JUNE 2013
Financial Institutions
Increased Regulatory Forbearance Poses Risks for Global Insurance Creditors The recent rise in regulatory forbearance seeks to avoid market disruption caused by pro-cyclical behavior, but we are cautious in assessing the credit implications of relaxing regulatory standards. We believe easing stringencies can relieve short-term pressures but also exacerbate long-term risk, such as encouraging the retention of deteriorating assets.
Mexico Insurance Industry Scorecard Although the Mexican insurance industry is the second largest in Latin America, representing approximately 14% of the region’s total premiums, insurance penetration in the economy still lags that of other major countries in the region. Despite falling interest rates and market volatility, Mexican insurers have remained profitable in recent years, with companies’ investment returns strongly positive and contributing significantly to internal capital generation.
Canadian Banks Face Headwinds As a Result of Slowing Consumer Loan Growth and Mortgage Insurance Restrictions Second-quarter 2013 results reinforced our expectation that the low growth, low interest rate environment will create profitability headwinds for Canadian banks in their critically important domestic personal and commercial franchises. Extended Canadian consumers appear to be moderating their appetite for increased leverage, encouraged by the tightening of CMHC insurance rules. Personal loan balances grew at 1.4% in the second quarter versus 2.8% in the first, indicating that the growth engine for Canadian banks may be low on fuel.
Sovereigns
Sovereign Default and Recovery Rates, 1983-2012 This is our ninth annual report on sovereign bond issuers’ default and rating experience. The study investigates the rating and default histories of 119 Moody’s-rated governments from 1983 to 2012.
RESEARCH HIGHLIGHTS Notable research published the week ending 14 June 2013
44 MOODY’S CREDIT OUTLOOK 17 JUNE 2013
Sub-sovereigns
Naucalpan's Retention of Mexico Federal Tax Revenue Is Credit Positive The mayor of the municipality of Naucalpan, Mexico, has announced that the municipality will take advantage of a federal government program allowing it to retain revenues that are rightfully owed to the federal government. Employing this legal measure is credit positive for Naucalpan, as it will reduce its payables and alleviate financial pressure.
Floods Are Credit Negative for the City of Prague and the Czech Region of Usti During the first week of June extensive floods struck the Czech Republic, hitting the City of Prague and the Usti region. While it will take several weeks to determine total losses, initial estimates indicate that nationwide damage will be more than CZK10 billion (€400 million), or 0.3% of national GDP. Although we expect the national government and European Union to bear a significant portion of reconstruction costs, Prague and Usti are likely to face temporary liquidity pressure as they advance money for infrastructure repairs and cleanup.
Istanbul Protests Threaten City's Plans to Leverage Its Assets Over the past two weeks the Metropolitan Municipality of Istanbul, Turkey, has been at the center of anti-government protests that have spread across the country. If the protests continue and intensify, they will negatively affect Istanbul’s ambitious urban development plan, as well as its ability to self-finance its large investment requirements through asset sales.
China's Report on Local Government Debt China’s National Audit Office has released a report on the debt of 36 local governments and their financing vehicles. The report highlights increases in less transparent forms of borrowing and questions about local governments’ debt-repayment capacities. Further, because the report covers only a small group of regional and local governments, the extent of such problems remains unclear.
RECENTLY IN CREDIT OUTLOOK Select any article below to go to last Thursday’s Credit Outlook on moodys.com
45 MOODY’S CREDIT OUTLOOK 17 JUNE 2013
NEWS & ANALYSIS Chinese Local Governments 2
» Report Shows Lack of Debt Transparency at Some Chinese Local Governments
» Limited Transparency of China’s Local Government Debt Is Credit Negative for the Sovereign
Corporates 5
» Google’s Acquisition of Waze Inc. Is Credit Positive » Iron Mountain’s REIT Conversion Is Delayed, a Credit
Negative » JBS’ Purchase of Marfrig Unit Is Credit Negative for JBS,
Credit Positive for Marfrig
Infrastructure 8 » Start-up of Duke Energy’s Edwardsport Power Plant Is Credit
Positive » DONG Energy Will Benefit from Norway Gas Field
Redetermination
Insurers 10 » Travelers Expands Canadian Presence with Acquisition of The
Dominion, a Credit Positive » Allstate’s Capital Restructuring Plan Is Credit Positive
Sovereigns 13
» Spain’s Pension Proposals Are Credit Positive for the Sovereign
Sub-sovereigns 15 » Floods Are Credit Negative for the City of Prague and the
Czech Region of Usti » Istanbul Protests Threaten City’s Plans to Leverage Its Assets
MOODYS.COM
Report: 155196
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EDITORS PRODUCTION ASSOCIATE News & Analysis: Jay Sherman, Elisa Herr and Alexis Alvarez
David Dombrovskis
Ratings & Research: Bronwyn Collie Final Production: Barry Hing
