MOODYS.COM 24 APRIL 2017 NEWS & ANALYSIS Corporates 2 » Post Holdings’ Purchase of Weetabix Is Credit Positive » PetSmart’s Acquisition of Chewy Will Increase Leverage » Bright Food’s Sale of Its Stake in Weetabix Is Credit Positive » Fujifilm Holdings’ Accounting Irregularities at Subsidiary and Delayed Financial Reporting Are Credit Negative Infrastructure 6 » Kansas Regulator Rejects Great Plains Energy’s Acquisition of Westar Energy, a Credit Positive » AES Tietê Energia’s Alto Sertão II Acquisition Is Credit Positive Despite Higher Leverage Banks 8 » Ontario’s Foreign Buyer Tax Is Credit Positive for Canadian Banks » Russia’s First Large-Scale Bank Bail-in Is Credit Negative for Senior Creditors » Nomura’s Plan to Expand US Staff Again Is Credit Negative » Daewoo Shipbuilding & Marine Engineering’s Third Round of Restructuring Is Credit Negative for KDB and KEXIM Insurers 16 » Western & Southern’s Acquisition of National Life’s Retail Mutual Funds Business Is Credit Positive » National Life’s Sale of Its Retail Mutual Fund Business Is Credit Positive » Mexican Regulator Confirms that Virtually All Insurers Comply with Solvency II Standards, a Credit Positive Sovereigns 20 » Panama’s Measures to Control Wage Bill Growth Are Credit Positive » Turkey’s Narrow Approval of Referendum on Executive Presidency Reveals Polarized Electorate, a Credit Negative » Côte d’Ivoire and Ghana’s Increased Cooperation on Cocoa Production Is Credit Positive » Mongolia’s Supplementary Budget Sets Stage for IMF Funding, a Credit Positive Securitization 27 » US Wireless Tower Securitizations Will Benefit from T-Mobile’s Spectrum Auction Purchase RECENTLY IN CREDIT OUTLOOK » Articles in Last Thursday’s Credit Outlook 28 » Go to Last Thursday’s Credit Outlook
Transcript
MOODYS.COM
24 APRIL 2017
NEWS & ANALYSIS Corporates 2 » Post Holdings’ Purchase of Weetabix Is Credit Positive » PetSmart’s Acquisition of Chewy Will Increase Leverage » Bright Food’s Sale of Its Stake in Weetabix Is Credit Positive » Fujifilm Holdings’ Accounting Irregularities at Subsidiary and
Delayed Financial Reporting Are Credit Negative
Infrastructure 6 » Kansas Regulator Rejects Great Plains Energy’s Acquisition of
Westar Energy, a Credit Positive » AES Tietê Energia’s Alto Sertão II Acquisition Is Credit Positive
Despite Higher Leverage
Banks 8 » Ontario’s Foreign Buyer Tax Is Credit Positive for
Canadian Banks » Russia’s First Large-Scale Bank Bail-in Is Credit Negative for
Senior Creditors » Nomura’s Plan to Expand US Staff Again Is Credit Negative » Daewoo Shipbuilding & Marine Engineering’s Third Round of
Restructuring Is Credit Negative for KDB and KEXIM
Insurers 16 » Western & Southern’s Acquisition of National Life’s Retail
Mutual Funds Business Is Credit Positive » National Life’s Sale of Its Retail Mutual Fund Business Is
Credit Positive » Mexican Regulator Confirms that Virtually All Insurers Comply
with Solvency II Standards, a Credit Positive
Sovereigns 20 » Panama’s Measures to Control Wage Bill Growth Are
Credit Positive » Turkey’s Narrow Approval of Referendum on Executive
Presidency Reveals Polarized Electorate, a Credit Negative » Côte d’Ivoire and Ghana’s Increased Cooperation on Cocoa
Production Is Credit Positive » Mongolia’s Supplementary Budget Sets Stage for IMF Funding,
a Credit Positive
Securitization 27 » US Wireless Tower Securitizations Will Benefit from T-Mobile’s
Spectrum Auction Purchase
RECENTLY IN CREDIT OUTLOOK
» Articles in Last Thursday’s Credit Outlook 28 » Go to Last Thursday’s Credit Outlook
NEWS & ANALYSIS Credit implications of current events
2 MOODY’S CREDIT OUTLOOK 24 APRIL 2017
Corporates
Post Holdings’ Purchase of Weetabix Is Credit Positive Last Tuesday, Post Holdings, Inc. (B2 stable) announced that was planning to buy Weetabix Food Company (unrated) for about $1.8 billion, a credit positive for Post because the acquisition has strong merits for a reasonable price that will contribute to just a modest increase in gross leverage. Although Weetabix will increase Post’s concentration in cereal, a category that is flat to declining, Weetabix is the UK’s top cereal brand and boasts high margins and cash flows, which Post can leverage for future acquisitions. Additionally, the acquisition will add new geographies in Europe, Asia and Africa that allow Post to extend its mostly US brands into new markets.
Weetabix generates attractive EBITDA margins approaching 30% and high cash flow conversion given our expectation of low capital expenditure needs. The company generates about £410 million ($520 million) in sales and £120 million ($151 million) in EBITDA before £20 million of annual synergies that Post expects to achieve within three years after closing. Given these merits, the purchase price of 11.7x EBITDA (or 10x taking into account the company’s minimum expected synergies) appears reasonable. Post expects the deal to close in June or July.
The transaction will only modestly increase gross leverage. Post currently plans to finance the deal with a combination of cash on hand (current cash balances total $1.5 billion) and secured bank debt borrowings. If the company were to use all of its cash for the transaction, debt/EBITDA would decline to approximately 5.4x from about 5.9x currently, and net leverage would increase to 5.4x from 4.3x.
Earlier this year, Post expanded its revolving credit facility by $400 million and its senior unsecured notes by $670 million, net of retirements, increasing its liquidity war chest to $2.3 billion. We expect that Post will use this capacity to fund acquisitions. Assuming that the company continues to target bolt-on acquisitions with profiles and valuations similar to its own (10x-12x EBITDA), financial leverage should remain within the bounds of the B2 rating.
Brian Weddington, CFA Vice President - Senior Credit Officer +1.212.553.1678 [email protected]
This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on www.moodys.com for the most updated credit rating action information and rating history.
NEWS & ANALYSIS Credit implications of current events
3 MOODY’S CREDIT OUTLOOK 24 APRIL 2017
PetSmart’s Acquisition of Chewy Will Increase Leverage Last Tuesday, PetSmart, Inc. (B1 review for downgrade) announced that it will acquire Chewy, Inc. (unrated), a privately owned leading online retailer of pet products, at a price that we estimate exceeds $3 billion, the majority of which PetSmart will finance with new debt. The acquisition is credit negative for PetSmart because we estimate that it will increase the company’s pro forma leverage to 6.25x-6.5x from 5.4x currently, assuming the deal is financed with about $2 billion of new debt. Following the announcement, we placed PetSmart’s ratings on review for downgrade.
Our quantitative prompt for a ratings downgrade is sustained leverage above 6.0x, but any downgrade will depend on the company’s defined path to deleveraging post acquisition. The Chewy acquisition comes at a hefty price tag, and, like most high-growth, pure-play online retailers, we estimate that Chewy is neither profitable nor generates EBITDA, and we do not expect it to be profitable during the next 12-18 months. The acquisition also comes with execution and integration risks that are inherent in integrating a technology startup with a traditional brick-and-mortar retailer.
Strategically, the acquisition makes sense because it adds online expertise and scale, and complements PetSmart’s brick-and-mortar business while immediately increasing its online penetration with an already-built online platform. The deal can also create synergies that we estimate to be modest at $100-$200 million. However, the acquisition will cause margin compression over the next 12-24 months because of the overall lower margins of online sales, which we expect will grow faster than the company’s brick-and-mortar sales. Upon closing, key Chewy executives will remain, and Chewy will operate largely as an independent PetSmart subsidiary.
Although PetSmart’s sales, profit and margins have grown over the past several years, top-line growth was challenged in fiscal 2016 (which ended 29 January 2017), as evidenced by lower same-store sales as a result of competition from mass merchandisers, supermarkets and online retailers such as Chewy and Amazon.com, Inc. (Baa1 stable). Because of the high operating leverage associated with the fixed cost structure of PetSmart’s store base, it has to grow sales to gain economies of scale and improve profits. The online sales that come with the acquisition of Chewy have much lower fixed costs, but in order to increase the profitability of the combined company, online sales must grow to levels high enough to counterbalance the negative effect of lower brick-and-mortar sales on overall profitability.
The pet products and care industry has demonstrated resilience over the past decade: although growth in the US pet population is stagnant, spending by pet owners is rising amid the demand for higher-quality products such as healthier food, a trend known as “premiumization.” Such products command higher prices, and generally higher margins for retailers. Pet owners also increasingly view their pets as part of the family, which contributes to making pet spending more essential. We expect that consumers will continue to spend on non-discretionary pet supplies, particularly food and healthcare, over the next several years.
NEWS & ANALYSIS Credit implications of current events
4 MOODY’S CREDIT OUTLOOK 24 APRIL 2017
Bright Food’s Sale of Its Stake in Weetabix Is Credit Positive Last Tuesday, US-based cereal company Post Holdings, Inc. (B2 stable) announced that it had agreed to acquire Bright Food (Group) Co., Ltd.’s (Baa3 negative) 60% stake in UK-based cereal maker Weetabix Food Company (unrated) for £1.4 billion ($1.76 billion), based on enterprise value and including the value of Weetabix’s equity and debt. The planned sale is credit positive for Bright Food because it will likely reduce the company’s debt and indicates that the company will pursue a more prudent strategy for future growth.
We estimate that Bright Food will receive net proceeds of £800-£900 million from the transaction and book a gain from the sale. Bright Food will likely use most of the proceeds to repay debt associated with its 2012 acquisition of the Weetabix stake. However, repaying this debt will not materially lower Bright Food’s leverage metrics, which are elevated. Bright Food’s adjusted debt/EBITDA was around 9.2x at the end of 2015. We estimate that the proceeds will account for around 10% of Bright Food’s reported debt as of the end of September and that Weetabix contributed around 10% of our expected EBITDA for Bright Food in 2016.
Weetabix owns the eponymous cereal brand in the UK, which generated 76% of Weetabix’s 2016 revenue of £410 million. We do not believe the synergies between Bright Food and Weetabix have been significant, with sales in China accounting for only a small proportion of Weetabix’s total revenue. Although Bright Food greatly increased Weetabix’s sales in China by leveraging its sales network, Weetabix’s overall revenue growth has been sluggish during the past few years.
Bright Food’s overseas acquisitions during 2012-15 resulted in adjusted debt/EBITDA rising from 6.5x at the end of 2012. But we regard the planned Weetabix transaction as an indication that Bright Food’s management will focus more on integrating acquired businesses and improving operational efficiency in the future.
NEWS & ANALYSIS Credit implications of current events
5 MOODY’S CREDIT OUTLOOK 24 APRIL 2017
Fujifilm Holdings’ Accounting Irregularities at Subsidiary and Delayed Financial Reporting Are Credit Negative On Thursday, Fujifilm Holdings Corporation (A1 stable) announced that it will launch an independent investigation to review accounting practices related to sales leasing transactions at Fuji Xerox New Zealand Limited (unrated), an overseas sales subsidiary of Fuji Xerox Co., Ltd. (unrated), one of Fujifilm Holdings’ two main operating companies. Fujifilm Holdings also postponed the announcement of its financial results for the fiscal year that ended March 2017, originally scheduled for 27 April. The disclosure of financial irregularities at Fuji Xerox’s New Zealand subsidiary and the postponement of Fujifilm Holdings’ financial results are credit negative for Fujifilm Holdings because it raises questions about the quality of the corporate parent’s oversight, control and governance over its overseas subsidiaries.
Fujifilm Holdings estimates that the losses caused by Fuji Xerox New Zealand’s irregular accounting practices on past fiscal years’ net income are approximately ¥22 billion, based on preliminary results of an investigation by an internal committee. That amount will not materially affect Fujifilm Holdings’ overall financial profile: Fujifilm Holdings posted consolidated net income of ¥123.3 billion in the fiscal year that ended March 2016, and in January 2017 estimated that net income for the fiscal year that ended March 2017 would be ¥112 billion.
The company did not revise its forecast with the latest announcement. However, the company has not yet fully quantified the effect of the financial irregularities. If the final calculation of the effects rises significantly, there is a possibility that it will create negative pressure on Fujifilm Holding’s rating.
Fujifilm Holdings said that its review of Fuji Xerox New Zealand’s accounting practices will focus on, among other things, the recording and recoverability of receivables relating to sales leasing transactions up through the fiscal year 2015. If the investigation determines that the financial irregularities are not just confined to the New Zealand subsidiary, and that Fujifilm Holdings has broader control issues over its overseas subsidiaries, this, too, will create negative pressure on the rating.
Fujifilm Holdings is a holding company with two core operating entities, Fujifilm Corporation (unrated) and Fuji Xerox Co., Ltd.
Takashi Akimoto Assistant Vice President - Analyst +81.3.5408.4208 [email protected]
NEWS & ANALYSIS Credit implications of current events
6 MOODY’S CREDIT OUTLOOK 24 APRIL 2017
Infrastructure
Kansas Regulator Rejects Great Plains Energy’s Acquisition of Westar Energy, a Credit Positive Last Wednesday, the Kansas Corporation Commission (KCC) rejected Great Plains Energy Incorporated’s (GPE, Baa3 stable) application to acquire Westar Energy, Inc. (Baa1 stable) in a $12.2 billion transaction. The rejection is credit positive for GPE because we expect that GPE will unwind the financing of the transaction, thereby improving its credit metrics.
Following the issuance of the $4.3 billion of debt last month, we downgraded GPE’s rating to Baa3 from Baa2 with the expectation that the proposed acquisition would receive all required regulatory approvals. The additional debt weakened GPE’s financial profile, including reducing the company’s ratio of cash from operations pre-working capital (CFO pre-WC) to debt to 13% as of 6 March 2017 (when GPE issued the debt) from 18% at year-end 2016, and raising holding company debt to 35% of the consolidated total debt from approximately 4% over the same period.
The KCC’s primary objections to the proposed acquisition included the price GPE is paying to acquire Westar, which the KCC considered to be too high, and that the transaction was not in the public interest. The regulator also argued that the deal was too risky, and left no room for any margin of error in the business plan that GPE provided to the KCC in its application for approval.
Under the terms of the transaction, originally announced on 31 May 2016, GPE would have benefited from increasing the size and scale of the utility operations. However, the benefits were offset by GPE’s weaker financial profile. We expect that GPE will unwind the financing of the transaction, including the $4.3 billion of debt issued as well as $750 million of the mandatory convertible preferred shares it issued. GPE will also buy back the common stock it issued to fund the transaction. Although there will be some unwinding cost and a $380 million breakup fee paid to Westar, we expect these costs to be manageable and onetime in nature for GPE.
As the exhibit below shows, GPE’s adjusted CFO pre-WC/debt was 18.4% as of 31 December 2016, and its cash flow pre-working capital interest coverage was 5.9x. Without the additional debt associated with the failed transaction, we expect that GPE’s standalone metrics will return to their prior level in the mid to high teens.
Great Plains Energy’s CFO Pre-WC, Total Debt and Ratio of CFO Pre-WC to Debt
NEWS & ANALYSIS Credit implications of current events
7 MOODY’S CREDIT OUTLOOK 24 APRIL 2017
AES Tietê Energia’s Alto Sertão II Acquisition Is Credit Positive Despite Higher Leverage Last Tuesday, AES Tietê Energia S.A. (Ba2 stable) announced that it had reached an agreement with Renova Energia S.A. (unrated) to acquire the 386-megawatt Alto Sertão II wind power complex for BRL600 million, plus an additional BRL100 million earn-out depending on the project’s performance over the next five years. The transaction is credit positive for AES Tietê because it will contribute to more stable cash flows owing to Alto Sertão II having power purchase agreements (PPAs) with terms of 20 years, versus AES Tietê’s average of three to five years.
Additionally, the acquisition will diversify AES Tietê’s power-generation mix away from its concentration in hydro power, and reduce its exposure to a potential hydro deficit after the company decided not to take advantage of a recent passed law that allows the hedging of hydrological risk by paying a premium negotiated with the Brazilian regulator, Aneel. The deal, which requires approvals from creditors, regulators and antitrust authorities, should be concluded by the third quarter of 2017.
Despite the deal’s credit-positive aspects, we estimate that AES Tietê’s leverage will increase because the company is likely to raise additional debt to finance the acquisition and must incorporate Alto Sertão II’s total debt of BRL1.15 billion. We assume the successful negotiation of creditors’ waivers was a preceding condition for concluding the deal, given that Alto Sertão II was not in compliance with its minimum debt service coverage ratio covenant of 1.2x as of December 2016.
AES Tietê’s leverage as measured by net debt/EBITDA should increase to around 3.3x versus 1.1x as of December 2016, approaching the 3.5x leverage financial covenant ceiling embedded in some of AES Tietê’s financing agreements, and which rises to 3.85x for 36 months in the event of asset acquisitions. We expect that AES Tietê’s debt maturity will lengthen by around two years and that AES Tietê will maintain its high dividend payout practice, projected at BRL350-BRL400 million for 2017. However, retaining the dividends could be an alternative source of liquidity in case of need.
AES Tietê has an outstanding contractual obligation to increase its current generation capacity in the Brazilian state of Sao Paulo by 15% (approximately 400 megawatts), which the Alto Sertão II acquisition does not mitigate since the complex is located in the state of Bahia. The company has had difficulty meeting this commitment because there are few sites in the state of Sao Paulo available for new hydroelectric facilities or wind power projects. The company eventually will need to adhere to the obligation, and we understand that additional expansion and acquisitions could increase leverage and EBITDA margins.
AES Tietê is a hydropower generation company with a 30-year concession, granted in December 1999, to operate an installed capacity of 2,658 megawatts, equal to around 2% of Brazil’s electricity capacity. The company has nine hydro-power plants and three small hydro-power plants in the state of Sao Paulo. Based on our standard adjustments, AES Tietê had 2016 net operating revenues of BRL1.561 billion and EBITDA of BRL886 million.
NEWS & ANALYSIS Credit implications of current events
8 MOODY’S CREDIT OUTLOOK 24 APRIL 2017
Banks
Ontario’s Foreign Buyer Tax Is Credit Positive for Canadian Banks On Thursday, the government of the Canadian province of Ontario announced a 15% tax on foreign purchases of residential real estate in Toronto and its surrounding suburbs, as part of an effort to slow the double-digit home price growth that has occurred over the past two years. The tax is credit positive for Canadian banks because it will reduce the potential for a house price bubble in their uninsured mortgage portfolios by slowing the pace of house price growth and reducing the potential for precipitous price declines.
Home price growth in the Toronto area has led to reduced affordability and overvaluation concerns among policymakers and industry observers for several years. In the past two years, house prices in both Toronto and Vancouver, British Columbia, have significantly outpaced the rest of the country, leading to fears of overvaluation in these markets (see Exhibit 1).
EXHIBIT 1
Toronto, Ontario, and Vancouver, British Columbia, Real Estate Price Growth Versus Other Canadian Cities, Indexed to 100 at 2005
Sources: Teranet-National Bank House Price Index and Moody’s Investors Service
Policymakers in Ontario and British Columbia, along with the Canadian government, have enacted a series of prudential measures to reduce price growth and protect lenders and consumers. These measures include enhanced capital and underwriting standards for banks and reduced access to government-sponsored mortgage default insurance. Last July, British Columbia introduced a similar foreign buyer tax aimed at reducing speculation in Vancouver’s real estate markets. As Exhibit 1 shows, the introduction of this tax coincided with a dip in house prices in Vancouver.
Real estate overvaluation is a risk for Canadian banks because mortgages are secured by houses that can be sold by banks in the event the borrower defaults. If those houses fall in value, banks become more exposed to loss from mortgage defaults. Indeed, Toronto has experienced precipitous house price declines historically, most recently in the early 1990s (see Exhibit 2). Canadian banks held more than CAD1 trillion in residential mortgage loans at the end of 2016. Of those, almost 50% were in Ontario (see Exhibit 3).
120
140
160
180
200
220
240
260
2013 2014 2015 2016 2017
Toronto Vancouver Montreal Calgary Ottawa
Jason Mercer, CFA Assistant Vice President - Analyst +1.416.214.3632 [email protected]
David Beattie Senior Vice President +1.416.214.3867 [email protected]
NEWS & ANALYSIS Credit implications of current events
9 MOODY’S CREDIT OUTLOOK 24 APRIL 2017
EXHIBIT 2
Toronto, Ontario’s New House Prices, Indexed to 100 in 2007
Sources: Statistics Canada and Moody’s Investors Service
EXHIBIT 3
Canadian Chartered Banks’ Residential Mortgage Loans by Province as of 31 December 2016 Almost half of Canadian mortgages were in Ontario.
Sources: Bank of Canada and Moody’s Investors Service
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12 320 14
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496
20 24
147190
0
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NL PE NS NB QC ON MB SK AB BC
CAD
Bill
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NEWS & ANALYSIS Credit implications of current events
10 MOODY’S CREDIT OUTLOOK 24 APRIL 2017
Russia’s First Large-Scale Bank Bail-in Is Credit Negative for Senior Creditors Last Wednesday, the Central Bank of Russia (CBR) announced that bondholders and more than 70 senior creditors of Peresvet Bank (unrated) had agreed to restructure their claims on the bank. A total of RUB69.7 billion ($1.2 billion) in bilateral senior unsecured debt will be converted into 15-year subordinated debt, while the maturity of six of nine bond issues will be extended to 20 years, with a concurrent reduction of the interest rate to 0.51%. The Deposit Insurance Agency (DIA) additionally will provide RUB66.7 billion of funding to the bank. Control of Peresvet will be transferred to Russian Regional Development Bank (RRDB, Ba2 stable, b11), which will oversee Peresvet’s financial rehabilitation.
The news is credit negative for senior creditors of Russian banks, because the shift in the bank resolution framework toward greater use of bail-in, as opposed to the prevailing practice of a bailout, means higher potential losses for creditors. The credit implications for RRDB are also negative, yet moderate: the deal will likely result in certain deterioration of the merged entity’s capital adequacy metrics, but given the size of RRDB’s current capital buffers (regulatory Tier 1 of 40.9% as of 1 April 2017), such deterioration will not be significant for the bank’s overall credit quality.
Until now, the Russian authorities’ preferred approach to the financial rehabilitation of failed banks has involved the DIA selecting investor banks to oversee the rehabilitation and providing them with liquidity and capital support, usually in the form of 10-year loans under favorable terms. According to the DIA’s 2016 annual report, 26 Russian banks were under financial rehabilitation under the direction of the DIA at the end of 2016 (see Exhibit 1). The agency has allocated more than RUB1.5 trillion ($25 billion) to bail out insolvent banks, which equals 17% of the total banking system capital as of the end of 2016. The CBR funded 83% of this amount.
EXHIBIT 1
Number of Russian Banks under Financial Rehabilitation and DIA’s Cumulative Spending
Russia is a G-20 member country and, as such, has pledged to apply the Financial Stability Board’s recommendations and recently implemented steps to strengthen its bank resolution framework.2 There is currently no specific legislation in Russia with respect to senior creditor bail-in. However, starting in 2015, the authorities in some bank resolution cases, including Fundservicebank (unrated) and Bank Tavrichesky (unrated), have selectively converted corporate deposits into subordinated debt. The Peresvet case is the first one involving a broad range of creditors, including senior bondholders, and we believe it signals an important policy shift to greater creditor losses in bank rehabilitations.
1 The bank ratings shown in this report are Russian Regional Development Bank’s deposit rating and baseline credit assessment. 2 See Banking - Europe, Middle East and Africa: A Compendium of Bank Resolution and Bail-in Regimes in non-EU EMEA, 2 March
2017.
11
14
11
75 6
16
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26
641 641653
1,046
1,5381,575
0
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Number of Russian Banks under Financial Rehabilitation - left axis DIA's Cumulative Spending on Financial Rehabilitation of Banks - right axis
Svetlana Pavlova Assistant Vice President - Analyst +7.495.228.60.52 [email protected]
NEWS & ANALYSIS Credit implications of current events
11 MOODY’S CREDIT OUTLOOK 24 APRIL 2017
We expect that Russian authorities will more frequently opt for imposing losses on certain groups of senior creditors, as long as doing so does not contradict with the local legislation with respect to individual depositor protection and the resulting loss to creditors is lower than the loss associated with a bank liquidation. Based on publically available information regarding the bail-in parameters and Peresvet’s funding structure (see Exhibit 2), we estimate that the haircut to Peresvet’s restructured debt is 60%-70%. That means the expected recovery is higher than the 12.6% average recovery rate for unsecured legal-entity creditors in all Russian bank liquidations completed in 2005-14.3
EXHIBIT 2
Peresvet’s Funding Structure as of 1 October 2016, RUB Billions
Source: Peresvet
3 See Banks-Russia: Frequent Liquidations Will See Continued High Creditor Losses, 13 April 2016.
NEWS & ANALYSIS Credit implications of current events
12 MOODY’S CREDIT OUTLOOK 24 APRIL 2017
Nomura’s Plan to Expand US Staff Again Is Credit Negative On 14 April, Nomura Holdings, Inc. (Baa1 stable) announced that it would increase its US personnel after announcing just a year earlier that it was reducing its activities in the US and Europe, the Middle East and Africa (EMEA). Nomura’s plan to expand US staff again is credit negative because it increases the risk of potentially large losses, which have occurred in the past, and threatens to reduce capitalization.
Just last year, Nomura closed its stock coverage, underwriting of domestic stocks, equity derivatives, equity financing, and equity futures and options businesses in EMEA. Nomura also refocused research, streamlined its acquisition and leveraged finance cost base, restructured the securitized products and corporate credit businesses in the Americas, and downsized its workforce in these regions. Its Asia-Pacific platform was not affected by the restructuring.
Nomura’s latest announcement exemplifies its corporate behavior of frequently changing its strategic direction. Nomura has had a pattern of expanding and contracting its employee headcount in the US over the past five years (see Exhibit 1), in line with its opportunistic and frequently changing approach to business in the US.
EXHIBIT 1
Nomura’s Employee Headcount in the Americas
Source: Nomura
Nomura’s rationalized its latest expansion as a desire to improve its standing in Japan investment banking league tables for mergers and acquisitions after placing sixth in 2016, well behind peers including Mizuho Financial Group, Inc. (A1 stable), which placed first. Nomura’s focus on market share as it relates to its rank in league tables also exemplifies its aggressive and opportunistic corporate behavior. Even so, we expect that Nomura’s overseas profits for the fiscal year that ended 31 March 2017 will be positive for the first time in seven years largely because of its efforts to control costs through its restructuring (see Exhibit 2).
NEWS & ANALYSIS Credit implications of current events
13 MOODY’S CREDIT OUTLOOK 24 APRIL 2017
EXHIBIT 2
Nomura’s Overseas Profits and Number of Overseas Staff
Source: Nomura
We continue to view Nomura’s financial targets outlined in its March 2020 plan as ambitious. In particular, to achieve its goals for its wholesale segment, we estimate that Nomura would have to increase risks that would reintroduce greater earnings volatility.
In August 2014, Nomura announced a plan to roughly double its earnings per share to ¥100 by the fiscal year ending March 2020 from levels during the fiscal year that ended March 2014. Although Nomura’s targets for the retail and asset management segments appear achievable, it plans for the majority of the earnings growth to come from the wholesale segment. We estimate that Nomura has set ambitious targets that it can only achieve by growing at a faster pace than the market.
Nomura forecasts that the pre-tax income of its wholesale segment will roughly double to a range of ¥200-¥220 billion from ¥111.8 billion in the fiscal year that ended March 2014. This equals a compounded annual growth rate of 10%-12%. Nomura’s plan assumes increased revenue opportunities resulting from a retreat by its peers, but such an ambitious strategy exposes the company to high execution risk and may increase its risk appetite, exposing it to greater earnings volatility.
Nomura Overseas Profits (Losses) - left axis Nomura Overseas Employees - right axis
NEWS & ANALYSIS Credit implications of current events
14 MOODY’S CREDIT OUTLOOK 24 APRIL 2017
Daewoo Shipbuilding & Marine Engineering’s Third Round of Restructuring Is Credit Negative for KDB and KEXIM Last Tuesday, Daewoo Shipbuilding & Marine Engineering Co., Ltd. (DSME, unrated) disclosed that its bondholders had agreed to measures proposed under the third round of DSME’s restructuring. The agreement means that its two policy banks, Korea Development Bank (KDB, Aa2/Aa2 stable, ba24) and The Export-Import Bank of Korea (KEXIM, Aa2 stable), can now formally implement the third round of DSME’s restructuring, subject to a court decision.
In securing the agreement, KDB and KEXIM offered bondholders and commercial paper holders a pledge to keep funds equal to 6.6%, which is the liquidation value of the principal (KRW1.55 trillion), in an escrow account for bond repayments before their maturity. The two banks also agreed that DSME would pay bondholders before the banks sought their own repayment, in effect subordinating themselves to bondholders, which is credit negative for the banks. Additionally, the banks’ willingness to do so risks setting a credit-negative precedent for future restructurings.
As part of measures first announced on 23 March, KDB and KEXIM will each provide half of the KRW2.9 trillion ($2.6 billion) of additional funding to DSME (see exhibit), and will restructure their KRW1.6 trillion ($1.4 billion) of existing debt to the company through 100% debt-to-equity swaps. However, these measures depended on DSME’s bondholders and commercial paper holders agreeing to convert half of their KRW1.55 trillion of debt for equity, and extend maturities for the other half of the loans over three years. The agreement was reached between 17 and 18 April and involves five different types of bonds and commercial paper.
Daewoo Shipbuilding & Marine Engineering’s Restructuring Measures Additional Funding KRW2.9 trillion from KDB and KEXIM
Debt Restructuring
Maturity extension and restructuring of existing KRW3.85 trillion of debt
Creditor Amount of Debt Restructuring Plan
KDB, KEXIM KRW1.6 trillion ($1.4 billion)
Debt-to-equity swap of 100% of debt
Commercial Banks KRW700 billion ($600 million)
80% of debt: debt-to-equity swap 20% of debt: five-year maturity extension and installment payments, with a 1% annual interest rate
Corporate Bonds and Commercial Paper
KRW1.55 trillion ($1.4 billion)
50% of debt: debt-to-equity swap 50% of debt: three-year maturity extension and installment payments, with a 1% annual interest rate
Source: Korea’s Financial Services Commission
The systemwide ratio of nonperforming loans (NPL) in Korea at year-end 2016 was high for the shipbuilding industry at 11.2%. As a result, KEXIM’s NPL ratio rose 1.28 percentage points year on year to 4.52%, while its common equity Tier 1 capital (CET1) ratio fell to 9.16% at year-end 2016 from 9.34% the year before.5 KDB’s NPL ratio fell 2.12 percentage points to 3.56% following a debt-to-equity swap of its exposure to STX Offshore & Shipbuilding Co., Ltd. (unrated), which was put into court receivership in May 2016. KDB’s CET1 ratio rose to 12.77% at year-end 2016 from 12.19% the year before because of its equity earnings stream from its 32.9% investment in Korea Electric Power Corporation (Aa2 stable).
4 The bank ratings shown in this report are KDB’s deposit rating, senior unsecured debt rating and baseline credit assessment. 5 For a consistent annual comparison at both banks, the capital ratios for 2015 account for contingent loan-loss reserves, which
were recognized as common equity capital at 20 December 2016.
Hyun Hee Park Assistant Vice President - Analyst +852.3758.1514 [email protected]
NEWS & ANALYSIS Credit implications of current events
15 MOODY’S CREDIT OUTLOOK 24 APRIL 2017
It is also notable that KDB’s loss rate on the equity acquired through the debt-to-equity swaps will be higher than on its loans in the event that DSME is not successfully restructured. KDB wrote off more than 90% of its 49.7% equity stake in DSME’s November 2016 restructuring.
NEWS & ANALYSIS Credit implications of current events
16 MOODY’S CREDIT OUTLOOK 24 APRIL 2017
Insurers
Western & Southern’s Acquisition of National Life’s Retail Mutual Funds Business Is Credit Positive Last Wednesday, Western & Southern Financial Group, Inc. (W&SFG, A3 stable) announced that its wholly owned and indirect subsidiary Touchstone Advisors (unrated) had agreed to acquire certain assets from Sentinel Asset Management Inc. (unrated), a direct wholly owned subsidiary of NLV Financial Corporation (Baa2 stable). The proposed acquisition is credit positive for W&SFG because it increases revenue diversification and scale to existing operations and prudently grows the asset management business at W&SFG’s subsidiary Touchstone Investment (unrated) to approximately $20 billion. However, a greater dependence on asset management-related third-party revenues would increase W&SFG’s exposure to the mounting competitive pressure in the asset management industry and, if material enough, will weigh on its credit profile.
The deal involves nine Sentinel Funds and four variable products funds of approximately $5.5 billion that W&SFG will place into either existing or newly created Touchstone mutual funds. The purchase agreement is subject to customary closing conditions, and the parties expect it to close by year-end.
Although the companies did not disclose the deal’s terms and conditions, W&SFG has sufficient liquidity to fund the moderately sized acquisition given its profitable operations. Additionally, the deal provides W&SFG the ability to increase its operating scale at its wholly owned indirect subsidiary, Fort Washington Investment Advisors (FWIA, unrated). The additional equity and fixed income funds will complement FWIA’s investment management capabilities, which include managing fixed income, public equities, private equity and multi-strategy portfolios and investment advisory services to institutional and high-net-worth individual investors. The exhibit below details W&SFG’s assets under management.
Western & Southern Financial Group’s Assets under Management
Source: Western & Southern Financial Group, Inc.
Although the acquisition strengthens W&SFG’s third-party asset management business, we still consider W&SFG to be a small participant in a large, fragmented and consolidating asset management industry. We expect that W&SFG will continue to evaluate and make modest acquisitions of asset management companies.
$0
$10
$20
$30
$40
$50
$60
$70
$80
Feb 2017 with Sentinel 2016 2015 2014 2013 2012
$ B
illio
ns
Western & Southern Financial Group Touchstone Sentinel
Bob Garofalo Vice President - Senior Credit Officer +1.212.553.4663 [email protected]
NEWS & ANALYSIS Credit implications of current events
17 MOODY’S CREDIT OUTLOOK 24 APRIL 2017
W&SFG is a Cincinnati, Ohio-based financial services holding company that provides life and health insurance, annuity, mutual fund, retirement planning and investment products. It offers insurance through Western and Southern Life Insurance Company (financial strength Aa3 stable), its primary life insurance company, and through other insurance subsidiaries, including Western-Southern Life Assurance Company (financial strength Aa3 stable), Integrity Life Insurance Company (financial strength Aa3 stable), National Integrity Life Insurance Company (financial strength Aa3 stable), Columbus Life Insurance Company (financial strength Aa3 stable) and Lafayette Life Insurance Company.
NEWS & ANALYSIS Credit implications of current events
18 MOODY’S CREDIT OUTLOOK 24 APRIL 2017
National Life’s Sale of Its Retail Mutual Fund Business Is Credit Positive Last Wednesday, NLV Financial Corporation (National Life, Baa2 stable) and Western & Southern Financial Group, Inc. (A3 stable) announced that Touchstone Investments (unrated), a wholly owned subsidiary of Western & Southern, had agreed to acquire the retail mutual fund business of Sentinel Asset Management, Inc. (unrated), a wholly owned National Life subsidiary. The sale of National Life’s retail mutual fund business is credit positive for National Life because the company will benefit from the divestiture of a non-core operation that is not currently at scale and has had declining fee income. The companies expect to complete the transaction before the end of 2017, pending regulatory approvals.
Although terms of the sale were not disclosed, we expect National Life to use the sale proceeds to continue expanding its core operations, which are its life insurance, annuity insurance and flow annuity businesses. The company has had good growth in each of these segments, with 2016 sales growth over 2015 levels of 5% in life insurance, 23% in annuity insurance and 23% in flow annuity.
Sentinel, which operates Sentinel Group Funds, Inc., includes 13 mutual funds that had net assets of $5.54 billion as of 28 February 2017. This retail mutual fund business comprises the majority of Sentinel’s third-party assets, and include variable product trusts. Sentinel also manages National Life’s general account portfolio, with $24.4 billion of general account assets as of 31 December 2016.
The decision by National Life to exit the retail mutual fund business came after an extensive strategic review of Sentinel’s future amid intense competition from index and passive products. As seen in the exhibit below, declining assets under management arose from negative retail mutual fund flows. Large competitors that benefit from scale have been challenging small, actively managed companies such as Sentinel. We believe the decline in assets under management was the result of a shift in customers’ investment preferences as the demand for exchange traded funds and other passive investment products surpasses active and equity-focused mutual funds.
Sentinel’s Mutual Funds Assets Under Management
Source: The company
Vermont-based National Life is a mutual insurance holding company that provides individuals, professionals and small businesses with various insurance and investment products and services, including life insurance, annuities and mutual funds. The primary insurance operating companies, National Life Insurance Company and Life Insurance Company of the Southwest, market life insurance and annuity products primarily to professionals, middle- to upper-income individuals and small business owners, through multiple distribution channels, including career agents and independent agents.
$8.8
$7.7
$6.9$6.6
$5.7 $5.5
$0
$1
$2
$3
$4
$5
$6
$7
$8
$9
$10
2011 2012 2013 2014 2015 2016
$ Bi
llion
s
Manoj Jethani Vice President - Senior Analyst +1.212.553.1048 [email protected]
NEWS & ANALYSIS Credit implications of current events
19 MOODY’S CREDIT OUTLOOK 24 APRIL 2017
Mexican Regulator Confirms that Virtually All Insurers Comply with Solvency II Standards, a Credit Positive Last Wednesday, Mexico’s insurance regulator published new solvency capital requirement (SCR) ratios using Solvency II-assimilated guidelines, and revealed that property and life companies comprising 95% of total premiums in the industry are already in compliance with the new standards. The results are the final test for Mexico’s insurance industry in its adoption of a risk-based capital model, a credit positive.
The median result was an SCR equal to 2.2x estimated worst potential losses. The SCR is based on a calculation of the highest probable loss under a set of scenarios meant to represent 99.5% of the possible results. This highest probable loss aims to exhaustively reflect the insurer’s total risk exposure, and takes into account a firm’s insurance policies, reinsurance recoverables, market risks, asset liability management, liquidity, counterparties, concentration in products and operating activities. Once the highest loss is calculated, it is compared with the named own admissible funds that are capital resources available to cover the liability.
The outcome removes uncertainty about whether insurers would need to raise additional capital to comply with new standards. Such a need risks limiting the capacity of some firms to pursue growth opportunities. Because most Mexican insurance companies are privately held, their ability to raise capital in the market is limited, meaning that firms would have had to reduce exposures and cede premiums, reducing profitability.
These results confirm that Mexican insurers have ample growth capacity, which will support a further deepening of the country’s relatively thin insurance market, where premiums currently equal just 2.2% of GDP, below the insurance penetration average of 3.1% for the region and 6.23% globally. Coverage at 53% of Mexican insurers was 2.1x or higher (see exhibit), and these firms will be best positioned to expand their client base and exposures.
Solvency Coverage Ratio Distribution of Mexican Insurers in Compliance with New Standards
Note: We eliminated six companies with atypical coverage’s above 30x in our calculation. Source: Mexico’s Comision Nacional de Seguros y Fianzas
NEWS & ANALYSIS Credit implications of current events
20 MOODY’S CREDIT OUTLOOK 24 APRIL 2017
Sovereigns
Panama’s Measures to Control Wage Bill Growth Are Credit Positive Last Monday, the government of Panama (Baa2 stable) announced that it will freeze hiring for 50% of the job openings in the public sector. The measure is credit positive because it seeks to contain growth in the government’s wage bill, which through March 2017 has doubled since 2011. Additionally, savings from this measure will allow the government to compensate for revenue shortfalls or to increase capital expenditures, which is necessary to comply with the country’s fiscal rule and stabilize the government’s debt trend.
According to the Ministry of Finance, the number of people employed by Panama’s central government rose 19% to 145,338 in 2016 from 122,290 in 2011. However, the government’s wage bill between 2011 and March of this year has risen 105% to $2.9 billion from $1.4 billion. Public service wages constituted 25% of total expenditures last year, up from a low point of 20% in 2013. Growth in the wage bill has also outpaced economic growth, with wages accounting for 4.5% of GDP in 2016, up from 3.9% in 2013 (see Exhibit 1).
EXHIBIT 1
Panama’s Government Wage Bill by Amount and Percent of GDP
Sources: Panama’s Ministry of Finance via Haver Analytics and Moody’s Investors Service
The increase in the wage bill has occurred amid the government’s fiscal consolidation efforts. Although the administration of President Juan Carlos Varela, who took office in July 2014, cut capital expenditures by 5% on average in 2014 and 2015 to reduce the fiscal deficit, public investment grew by 8.5% last year.6 As a result, the deficit at the non-financial public sector level7 fell to 2.5% of GDP in 2016 from 3.1% in 2014. However, a growing wage bill in recent years has led the central government’s deficit to rise to 4.4% of GDP in 2016, versus a relatively constant 4.0% in 2014-15.
The larger central government deficit has contributed to a deterioration in the government’s debt metrics. Panama’s debt/GDP ratio rose to 39.4% in 2016 from 35.0% in 2013 despite strong average economic growth of 5.9% during this period.
6 During 2010-13, capital expenditures grew on average 23% annually. 7 The non-financial public sector in Panama consolidates the fiscal accounts of the central government, local governments, social
security funds and some non-financial public corporations.
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
3.5%
4.0%
4.5%
5.0%
$0.0
$0.5
$1.0
$1.5
$2.0
$2.5
$3.0
2010 2011 2012 2013 2014 2015 2016
$ Bi
llion
s
Amount - left axis Percent of GDP - right axis
Renzo Merino Assistant Vice President - Analyst +1.212.553.0330 [email protected]
NEWS & ANALYSIS Credit implications of current events
21 MOODY’S CREDIT OUTLOOK 24 APRIL 2017
Authorities estimate that the freeze of job openings in the public sector will lead to gradual monthly savings of $10 million, or 0.2% of GDP annually, and we expect that this measure will allow the government to partially compensate for any revenue shortfalls relative to its budget. Over the past two years, current revenues have risen 4% year on year on average, but revenues missed budget projections by about $200 million on average, or 0.4% of GDP (see Exhibit 2). Also, any savings from this measure will give the government more space to increase its capital expenditures.
EXHIBIT 2
Panama Government’s Current Revenues Relative to Budget Projections
Sources: Panama’s Ministry of Finance and Moody’s Investors Service
Following the opening of the new locks in the Panama Canal in June 2016, we expect the Panama Canal Authority (ACP) to increase its transfers to the government by about $600 million (1% of GDP) in 2017 to $1.6 billion. We expect that this increase in ACP contributions will allow the government to finance higher capital expenditures. However, the design of Panama’s fiscal rule means that an increase in ACP transfers will reduce the deficit ceiling for the non-financial public sector to 1.8% of GDP this year from 3.2% in 2016. Consequently, authorities must balance their goal of supporting public investment with reducing the fiscal deficit to comply with the fiscal rule. If the government achieves this balance, we expect that its debt metrics will improve over the next few years.
$0
$1
$2
$3
$4
$5
$6
$7
$8
Budget Actual Budget Actual
2015 2016
$ Bi
llion
s
NEWS & ANALYSIS Credit implications of current events
22 MOODY’S CREDIT OUTLOOK 24 APRIL 2017
Turkey’s Narrow Approval of Referendum on Executive Presidency Reveals Polarized Electorate, a Credit Negative On 16 April, a national referendum in Turkey (Ba1 negative) seeking popular approval for amendments to the country's constitution passed narrowly. The measures will shift the government from a parliamentary system headed by a prime minister to an executive presidency that gives the president sweeping powers over the country’s institutions. According to preliminary results, 51.4% of the votes supported the constitutional changes, while 48.6%, including a majority in Turkey’s five largest cities, rejected them. The day after the referendum, the government announced another three-month extension of the country’s state of emergency (the third such extension), which is likely to keep the country’s businesses and consumers on edge. In our view, the slim margin of victory for the political changes and ongoing policy uncertainty amid large external financing requirements suggest that the country’s vulnerability to shocks will continue to weigh on Turkey’s creditworthiness.
The slender win for President Recep Tayyip Erdoğan’s bid for greater authority vis-à-vis both the parliament and the judiciary is symptomatic of the current polarization of Turkish society. Particularly noteworthy was that the two parties that supported the amendments, Mr. Erdoğan’s ruling AKP party and the Nationalist Movement Party (MHP), lost a full 10 percentage points in their combined voting share compared with what they garnered in the November 2015 election, reflecting a major loss of support over this specific issue.
The state of emergency already gives the president far-reaching powers over the country’s institutions. Since last year’s failed coup attempt, the government has used the state of emergency to purge, arrest or sanction individuals believed to be involved with, or sympathetic to, the plotters of last July’s military coup attempt. These measures have undermined the country’s administrative capacity, weakened policy predictability and the effectiveness of economic policymaking – important aspects of institutional strength – and hindered growth by impairing business and consumer confidence.
We believe that political uncertainty is likely to persist in Turkey if the deep societal divisions illustrated in the referendum campaign continue, particularly as the presidency continues to consolidate its control over the government apparatus and its institutions and suppresses opposition ahead of national elections, currently scheduled for November 2019. Given that opposition challenges over alleged voting irregularities have apparently been unsuccessful, the executive presidency will come into effect after that election, when the presidential and parliamentary elections will be held together for the first time.
The political uncertainty is weighing on economic activity. In 2016, Turkey grew by 2.9%, less than half of the average of the previous six years. In the face of this slow growth, the government’s fiscal stimulus policies are likely to persist. The government recently extended various tax and excise duty relief measures by another five months to the end of September, suggesting its concern for growth despite official forecasts calling for the economy to expand more than 4% in 2017. We are projecting that growth will barely reach 3% in 2017-18, and not grow much faster than that pace without a revival of business confidence.
At times in late 2016 and early 2017, political uncertainty in Turkey led to occasional shortfalls in capital inflows to finance the current account deficit and refinance foreign debt amortization, and the central bank’s already-weak reserves have been declining further. Although these trends have abated more recently, the combination of a polarized electorate, ongoing policy uncertainty and large external financing requirements suggests that the country’s vulnerability to shocks continues to weigh on its creditworthiness.
Kristin Lindow Senior Vice President +1.212.553.3896 [email protected]
NEWS & ANALYSIS Credit implications of current events
23 MOODY’S CREDIT OUTLOOK 24 APRIL 2017
Côte d’Ivoire and Ghana’s Increased Cooperation on Cocoa Production Is Credit Positive On 14 April, Côte d’Ivoire (CDI, Ba3 stable) and Ghana (B3 stable) announced that they will deepen their cooperation and increase their coordination of cocoa production, with their respective regulators, CDI’s Conseil du Café-Cacao and Ghana’s Cocobod, planning to schedule periodic meetings and establish a technical committee to better manage production. This announcement follows a 30% drop in cocoa prices since mid-2016, the largest drop in more than 10 years. The decision to boost coordination is credit positive for the two sovereigns because it will allow greater control over global cocoa production and ultimately over cocoa bean prices, which would reverse the effect of low prices on the countries’ real growth rates, current accounts and fiscal positions.
Weather, political crises and other supply disruptions historically have triggered significant volatility in cocoa prices, while recent price declines result more from speculation around surplus production for the mid-crop season in April-September. The world’s largest cocoa producers, CDI, with 39% of the global production, and Ghana, with 21%, are significantly affected by deteriorating current account deficits, declines in government revenues and slowing growth resulting from eroding household incomes.
The current account effect is significant because cocoa exports account for around 40% of CDI’s total goods exports and 24% of Ghana’s. We forecast that CDI will move to a current account deficit of nearly 3% of GDP from 0.6% in 2016, while Ghana’s current account deficit will remain around 6% of GDP. And, because agriculture employs a large part of the working population at about two thirds of CDI’s population and more than 40% of Ghana’s, household revenue is vulnerable. We expect the effect on consumption and growth to materialize next year once the production is effectively sold in September.
CDI lowered minimum guaranteed producer prices for the mid-crop season by 36% to CFA700 per kilogram from CFA1,100, signaling its commitment to fiscal consolidation. This politically difficult decision also seeks to maintain the sector’s long-term competitiveness and limit the spending of government resources to artificially maintain high guaranteed producer prices. Revenues and royalties from Ghana’s burgeoning oil sector, especially the ramping up of production at its new TEN oil field, will offset the effect of cocoa prices on the sovereign’s credit profile.
Although sub-Saharan African countries collectively account for nearly 75% of global cocoa production, the continent accounts for only around 20% of the grinding process. In fact, the value added that farmers receive from a chocolate bar has fallen to 6%-7% currently from around 16% in 1980s and as much as 50% in the 1970s. The value added is skewed toward manufacturers, which take up 35.2% of the total value added, and retailers, which take up 44.1% (see exhibit). Euromonitor estimated that the chocolate market’s total sales value were around $100 billion in 2015.
Value Distribution Along the Cocoa Supply Chain
Source: Cocoa Barometer 2015
Aurelien Mali Vice President - Senior Credit Officer +971.4.237.9537 [email protected]
NEWS & ANALYSIS Credit implications of current events
24 MOODY’S CREDIT OUTLOOK 24 APRIL 2017
Cocoa producers are more exposed to cocoa prices than other stakeholders in the supply chain because most farms are small and unorganized relative to manufacturing and trading, which are controlled by a small number of global companies. In particular, the long-term sustainability of the cocoa sector depends on producer countries extracting more value added to support farmer revenues. This is why both countries aim to move up the supply chain by achieving a higher processing rate of agricultural products to increase the domestic value added and the value of exports. This strategy will also be supported by growing demand from the developing world that will lead to a recovery in cocoa prices. However, transforming the sector will take time and require long-term investment in the producing countries in securing other raw materials such as sugar and milk.
NEWS & ANALYSIS Credit implications of current events
25 MOODY’S CREDIT OUTLOOK 24 APRIL 2017
Mongolia’s Supplementary Budget Sets Stage for IMF Funding, a Credit Positive Last Wednesday, the International Monetary Fund’s (IMF) resident representative in Mongolia (Caa1 stable) confirmed that the government there had met all conditions to enter into an IMF Extended Fund Facility (EFF). If ratified by the IMF’s executive board, as we expect, the program would be credit positive for Mongolia because it unlocks loans from multilateral and bilateral institutions that will stabilize the sovereign’s external payments position and anchor the country’s fiscal consolidation prospects.
This development followed the Mongolian parliament’s 15 April approval of a supplementary budget that includes a series of new revenue and expenditure measures designed to narrow the fiscal deficit. The approval of a supplementary budget was the third and final condition that Mongolia had to meet to get the EFF, but was the most at risk because fiscal consolidation measures could prove unpopular ahead of June 2017 presidential elections. The other two conditions were an asset-quality review of the country’s banks and a commitment from the Bank of Mongolia that it would refrain from off-budget fiscal activities. Mongolian authorities and the IMF reached a staff-level agreement in February, and we expect the IMF executive board to approve the EFF on 26 April.
The IMF program will support Mongolia’s ability to refinance 2018 bond maturities through market access. The program involves $440 million of funding support over three years, potentially followed by concessional lending of $3 billion from international and bilateral institutions. Such support should enhance investor confidence, and continued market access should allow the authorities to refinance obligations coming due in 2018-19. With the prospect of new funding coming in, we expect foreign-exchange reserves to recover to $1.6 billion in 2017 and $2.1 billion in 2018 from a low $1.0 billion in January.
Mongolia’s deficit will remain high, despite corrective measures. The approved supplementary budget targets fiscal revenue of MNT6.1 billion, or 23.2% of GDP, and spending of MNT8.7 billion, or 33.6% of GDP, with a deficit of MNT2.7 billion, or 10.4% of GDP, down from 15.2% of GDP in 2016. The authorities estimate that the fiscal deficit would be around 14.2% of GDP without corrective actions. The measures introduced in the supplementary budget include privatizations, cuts in construction projects, a 10% tax on interest on all savings accounts, a 30% increase in the tariff on imported cigarettes, tax hikes on gasoline and diesel fuel, and a 20% increase on the excise taxes on alcoholic beverages and cigarettes during 2018-20.
The IMF program has implementation risks, given the short-term economic costs of fiscal and monetary policy tightening. Sustaining such a tight policy stance over several years will be politically challenging, and repeated fiscal slippages would lead to a suspension of IMF disbursements and weaken investor confidence. Moreover, even with a tight fiscal policy for the next several years, we expect government debt to continue rising to an elevated 98% of GDP by 2018 from 92% of GDP at the end of 2016 (see exhibit). Refinancing of debt will continue to challenge government liquidity.
NEWS & ANALYSIS Credit implications of current events
26 MOODY’S CREDIT OUTLOOK 24 APRIL 2017
Mongolia’s Debt and Fiscal Balance as Percent of GDP, with and without IMF Program
Sources: International Monetary Fund and Moody’s Investors Service
-16%
-14%
-12%
-10%
-8%
-6%
-4%
-2%
0%
0%
20%
40%
60%
80%
100%
120%
2015 2016 2017 2018
Government Debt With IMF Program - left axis Government Debt Without IMF Program - left axisFiscal Balance With IMF Program - right axis Fiscal Balance Without IMF Program - right axis
NEWS & ANALYSIS Credit implications of current events
27 MOODY’S CREDIT OUTLOOK 24 APRIL 2017
Securitization
US Wireless Tower Securitizations Will Benefit from T-Mobile’s Spectrum Auction Purchase On 13 April, the US Federal Communications Commission (FCC) announced that T-Mobile USA, Inc. (Ba3 stable) had spent $8 billion in the $19.8 billion 600-megahertz spectrum auction and won the most number of licenses. T-Mobile’s win is credit positive for wireless tower asset-backed securitizations (ABS) sponsored by American Tower Corporation (Baa3 stable), Crown Castle International Corp. (Baa3 stable) and SBA Communications Corporation (B1 stable) because the spectrum sale will stimulate T-Mobile to spend more to upgrade or install new equipment at tower operators’ sites. These upgrades will increase revenue and cash flows available to the ABS bonds.
The 600-megahertz spectrum is often called “beachfront spectrum” because this band is at a low frequency that travels farther, which is better suited for macro wireless tower sites in rural areas with sparse tower coverage. Given that T-Mobile’s average spend per license was below the national average, it appears T-Mobile spectrum acquisitions were primarily in smaller rural markets. The other major winners of the spectrum auction were Dish Network ($6.2 billion) and Comcast ($1.7 billion).
Further build-out of spectrum will benefit tower operators because the incremental increase in revenue per tower arising from T-Mobile’s deployment of the 600-megahertz spectrum can total $500-$800 a month. To install new equipment on the towers to handle the new frequency, T-Mobile will have to amend its existing leases with cell tower operators. This revenue growth from the deployment of new spectrum equals a monthly revenue increase of 9%-25% of the revenue from T-Mobile per tower.
To the extent that T-Mobile successfully executes its plan to put the spectrum to use this year, we would expect the auction results to trigger an increase in tower operators’ organic revenue growth in late 2017, with the primary benefit in 2018. However, given that broadcasters have up to 39 months to transfer the spectrum to the winning bidders, the benefit to the tower operators could be two to four years away. Since SBA Communications has a bigger rural footprint and larger exposure to T-Mobile than the other tower operators, we expect it to benefit the most from T-Mobile’s spectrum deployment.
The wireless tower-backed ABS that the tower operators sponsor will benefit from increased spending by carriers on renting tower space. The exhibit below shows that cash flows in wireless tower ABS are highly concentrated among the four largest US wireless carriers, with the securitizations having the 16%-20% exposure to T-Mobile.
Sources of Wireless Tower ABS Revenue, 2016 Sponsor GTP Acquisition Partners I* Crown Castle American Tower Trust I SBA Tower Trust
Transaction Series 2015-1 and 2 Series 2010- 3, 5 and 6; 2015-1 and 2
Series 2013-1 and 2 Series 2012-1; 2013-1 and 2; 2014-1 and 2 ; 2015-1; 2016-1; and 2017-1
AT&T 38.8% 31.0% 44.1% 36.1%
Verizon Wireless
15.9% 27.7% 9.9% 18.4%
Sprint 12.9% 14.4% 22.8% 19.9%
T-Mobile 17.0% 19.5% 16.2% 18.8%
Other 15.4% 7.40% 7.0% 6.8%
Note: * American Tower Corporation acquired Global Tower Partners (GTP) in 2013. Source: Moody’s Investors Service, based on securitization data and transaction offering memoranda.
Jayesh Joseph Assistant Vice President - Analyst +1.212.553.7412 [email protected]
Gregory A. Fraser, CFA Vice President - Senior Analyst +1.212.553.4385 [email protected]
RECENTLY IN CREDIT OUTLOOK Select any article below to go to last Thursday’s Credit Outlook on moodys.com
28 MOODY’S CREDIT OUTLOOK 24 APRIL 2017
NEWS & ANALYSIS Corporates 2 » Delta Air Lines’ Contributions to Pension Plans Are
Credit Positive » SUPERVALU’s Acquisition of Unified Grocers Will Increase
Scale, a Credit Positive » Synlab Will Benefit from Novo’s Equity Investment » Nexteer’s Joint Venture with Dongfeng Is Credit Positive » TPG’s Entry into Australia Is Credit Negative for Telstra
and Optus
Banks 7 » Wells Fargo's Independent Investigation and Remedial
Actions Are Credit Positive » Raymond James Financial’s Investor Settlement Is
Credit Negative » Skipton Building Society’s Sale of Legacy Mortgage Portfolio
Is Credit Positive
Insurers 11 » Rules to Stabilize US Health Insurance Exchanges Are Credit
Positive, but Still Do Little for Insurers
Exchanges 12 » CME Will Close Its European Derivatives Exchange and
Clearinghouse, a Credit Positive
US Public Finance 14 » Atlantic City, New Jersey, Balances Budget by Trimming
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All information contained herein is obtained by MOODY’S from sources believed by it to be accurate and reliable. Because of the possibility of human or mechanical error as well as other factors, however, all information contained herein is provided “AS IS” without warranty of any kind. MOODY'S adopts all necessary measures so that the information it uses in assigning a credit rating is of sufficient quality and from sources MOODY'S considers to be reliable including, when appropriate, independent third-party sources. However, MOODY’S is not an auditor and cannot in every instance independently verify or validate information received in the rating process or in preparing the Moody’s publications.
To the extent permitted by law, MOODY’S and its directors, officers, employees, agents, representatives, licensors and suppliers disclaim liability to any person or entity for any indirect, special, consequential, or incidental losses or damages whatsoever arising from or in connection with the information contained herein or the use of or inability to use any such information, even if MOODY’S or any of its directors, officers, employees, agents, representatives, licensors or suppliers is advised in advance of the possibility of such losses or damages, including but not limited to: (a) any loss of present or prospective profits or (b) any loss or damage arising where the relevant financial instrument is not the subject of a particular credit rating assigned by MOODY’S.
To the extent permitted by law, MOODY’S and its directors, officers, employees, agents, representatives, licensors and suppliers disclaim liability for any direct or compensatory losses or damages caused to any person or entity, including but not limited to by any negligence (but excluding fraud, willful misconduct or any other type of liability that, for the avoidance of doubt, by law cannot be excluded) on the part of, or any contingency within or beyond the control of, MOODY’S or any of its directors, officers, employees, agents, representatives, licensors or suppliers, arising from or in connection with the information contained herein or the use of or inability to use any such information.
NO WARRANTY, EXPRESS OR IMPLIED, AS TO THE ACCURACY, TIMELINESS, COMPLETENESS, MERCHANTABILITY OR FITNESS FOR ANY PARTICULAR PURPOSE OF ANY SUCH RATING OR OTHER OPINION OR INFORMATION IS GIVEN OR MADE BY MOODY’S IN ANY FORM OR MANNER WHATSOEVER.
Moody’s Investors Service, Inc., a wholly-owned credit rating agency subsidiary of Moody’s Corporation (“MCO”), hereby discloses that most issuers of debt securities (including corporate and municipal bonds, debentures, notes and commercial paper) and preferred stock rated by Moody’s Investors Service, Inc. have, prior to assignment of any rating, agreed to pay to Moody’s Investors Service, Inc. for appraisal and rating services rendered by it fees ranging from $1,500 to approximately $2,500,000. MCO and MIS also maintain policies and procedures to address the independence of MIS’s ratings and rating processes. Information regarding certain affiliations that may exist between directors of MCO and rated entities, and between entities who hold ratings from MIS and have also publicly reported to the SEC an ownership interest in MCO of more than 5%, is posted annually at www.moodys.com under the heading “Investor Relations — Corporate Governance — Director and Shareholder Affiliation Policy.”
Additional terms for Australia only: Any publication into Australia of this document is pursuant to the Australian Financial Services License of MOODY’S affiliate, Moody’s Investors Service Pty Limited ABN 61 003 399 657AFSL 336969 and/or Moody’s Analytics Australia Pty Ltd ABN 94 105 136 972 AFSL 383569 (as applicable). This document is intended to be provided only to “wholesale clients” within the meaning of section 761G of the Corporations Act 2001. By continuing to access this document from within Australia, you represent to MOODY’S that you are, or are accessing the document as a representative of, a “wholesale client” and that neither you nor the entity you represent will directly or indirectly disseminate this document or its contents to “retail clients” within the meaning of section 761G of the Corporations Act 2001. MOODY’S credit rating is an opinion as to the creditworthiness of a debt obligation of the issuer, not on the equity securities of the issuer or any form of security that is available to retail investors. It would be reckless and inappropriate for retail investors to use MOODY’S credit ratings or publications when making an investment decision. If in doubt you should contact your financial or other professional adviser.
Additional terms for Japan only: Moody's Japan K.K. (“MJKK”) is a wholly-owned credit rating agency subsidiary of Moody's Group Japan G.K., which is wholly-owned by Moody’s Overseas Holdings Inc., a wholly-owned subsidiary of MCO. Moody’s SF Japan K.K. (“MSFJ”) is a wholly-owned credit rating agency subsidiary of MJKK. MSFJ is not a Nationally Recognized Statistical Rating Organization (“NRSRO”). Therefore, credit ratings assigned by MSFJ are Non-NRSRO Credit Ratings. Non-NRSRO Credit Ratings are assigned by an entity that is not a NRSRO and, consequently, the rated obligation will not qualify for certain types of treatment under U.S. laws. MJKK and MSFJ are credit rating agencies registered with the Japan Financial Services Agency and their registration numbers are FSA Commissioner (Ratings) No. 2 and 3 respectively.
MJKK or MSFJ (as applicable) hereby disclose that most issuers of debt securities (including corporate and municipal bonds, debentures, notes and commercial paper) and preferred stock rated by MJKK or MSFJ (as applicable) have, prior to assignment of any rating, agreed to pay to MJKK or MSFJ (as applicable) for appraisal and rating services rendered by it fees ranging from JPY200,000 to approximately JPY350,000,000.
MJKK and MSFJ also maintain policies and procedures to address Japanese regulatory requirements.
EDITORS SENIOR PRODUCTION ASSOCIATE Jay Sherman Amanda Kissoon
