MOODYS.COM 14 OCTOBER 2013 NEWS & ANALYSIS Corporates 2 » Regency’s $5.6 Billion PVR Acquisition Is Credit Positive for Both » Buckeye’s Acquisition of Hess’ Storage Facilities Is Credit Positive for Both » Cancellation of H&R Block Bank Sale Is Credit Negative for Block Financial » Liberty Interactive’s Planned Spinoff of TripAdvisor Is Credit Negative » Consumer Concerns over Chicken Safety in China Continue to Hurt Yum! Brands’ Earnings » Xella’s Loan Repayment Is Credit Positive for Haniel » Expansion of Tax to Russian Automakers Would Be Credit Negative » Tata Chemicals Will Benefit from Its European Soda Ash Exit » Regulator Prohibits Korean Retailers from Supplier Rebates, a Credit Negative Banks 11 » Special Mention Growth Among Shared National Credits Is Credit Negative for US Banks » UK Government’s Early Launch of Mortgage Guarantee Scheme Benefits UK Mortgage Lenders » Lloyds’ Sale of Australian Operations Will Increase Its Core Tier 1 Capital » Banca Monte dei Pasci di Siena’s Challenging Restructuring Plan Is Credit Negative for Subordinated Bondholders » CreVal’s Decision Not to Proceed with an Acquisition of Banca Tercas Is Credit Positive » Turkish Banks’ Asset Quality Will Benefit from Proposed Credit Card Debt Limits » Sale of Woori F&I to a Private-Equity Firm Would Benefit Korean Banks and NPL Securitization Insurers 23 » Insurance Regulator’s Development of Global Capital Standard Is Credit Positive » Assurant’s Agreement to Lower Lender-Placed Insurance Rates in Florida Is Credit Negative Sovereigns 25 » Serbia’s Budget Measures Are Credit Positive Sub-sovereigns 26 » Court Ruling Is Credit Positive for South African Toll-Road Operator SANRAL Securitization 27 » Westpac’s Acquisition of CFAL Would Be Credit Positive for Bella ABS Transactions RATINGS & RESEARCH Rating Changes 28 Last week we downgraded Alpha Natural Resources, Arch Coal, Neiman Marcus Group, Telecom Italia, Doral Financial, INTRUST Bank, INTRUST Financial, Svyaznoy Bank, SKB-Bank, Broward County School Board and two classes of US commercial mortgage- backed securities, and upgraded Franz Haniel & Cie. and Wm Wrigley Jr., among other rating actions. Research Highlights 34 Last week we published on US corporate rating outlooks, Asian and EMEA corporate liquidity, Brazilian homebuilders, global aerospace and defense companies, European retailers, Canadian high yield bond covenants, Telecom Italia, CACI International, Saudi Arabian banks, Russian Banks, Polish banks, Argentinean banks, Japanese life insurers, sovereign defaults, African sovereign debt issuance, government debt statistics, CEE5 sovereigns, Brazil, Asia's capital markets, Asia-Pacific bond markets, Spanish regional governments, Texas schools, Kentucky public library districts, US universities, not- for-profit hospitals, Australian mortgage delinquencies, European ABS and MBS, Spanish covered bonds, US student loan ABS and US mortgage servicers, among other reports. RECENTLY IN CREDIT OUTLOOK » Articles in Last Thursday’s Credit Outlook 41 » 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.
Transcript
MOODYS.COM
14 OCTOBER 2013
NEWS & ANALYSIS Corporates 2
» Regency’s $5.6 Billion PVR Acquisition Is Credit Positive for Both
» Buckeye’s Acquisition of Hess’ Storage Facilities Is Credit Positive for Both
» Cancellation of H&R Block Bank Sale Is Credit Negative for Block Financial
» Liberty Interactive’s Planned Spinoff of TripAdvisor Is Credit Negative
» Consumer Concerns over Chicken Safety in China Continue to Hurt Yum! Brands’ Earnings
» Xella’s Loan Repayment Is Credit Positive for Haniel » Expansion of Tax to Russian Automakers Would Be Credit
Negative » Tata Chemicals Will Benefit from Its European Soda Ash Exit » Regulator Prohibits Korean Retailers from Supplier Rebates, a
Credit Negative
Banks 11
» Special Mention Growth Among Shared National Credits Is Credit Negative for US Banks
» UK Government’s Early Launch of Mortgage Guarantee Scheme Benefits UK Mortgage Lenders
» Lloyds’ Sale of Australian Operations Will Increase Its Core Tier 1 Capital
» Banca Monte dei Pasci di Siena’s Challenging Restructuring Plan Is Credit Negative for Subordinated Bondholders
» CreVal’s Decision Not to Proceed with an Acquisition of Banca Tercas Is Credit Positive
» Turkish Banks’ Asset Quality Will Benefit from Proposed Credit Card Debt Limits
» Sale of Woori F&I to a Private-Equity Firm Would Benefit Korean Banks and NPL Securitization
Insurers 23 » Insurance Regulator’s Development of Global Capital Standard
Is Credit Positive » Assurant’s Agreement to Lower Lender-Placed Insurance Rates
in Florida Is Credit Negative
Sovereigns 25 » Serbia’s Budget Measures Are Credit Positive
Sub-sovereigns 26
» Court Ruling Is Credit Positive for South African Toll-Road Operator SANRAL
Securitization 27 » Westpac’s Acquisition of CFAL Would Be Credit Positive for
Bella ABS Transactions
RATINGS & RESEARCH Rating Changes 28
Last week we downgraded Alpha Natural Resources, Arch Coal, Neiman Marcus Group, Telecom Italia, Doral Financial, INTRUST Bank, INTRUST Financial, Svyaznoy Bank, SKB-Bank, Broward County School Board and two classes of US commercial mortgage-backed securities, and upgraded Franz Haniel & Cie. and Wm Wrigley Jr., among other rating actions.
Research Highlights 34
Last week we published on US corporate rating outlooks, Asian and EMEA corporate liquidity, Brazilian homebuilders, global aerospace and defense companies, European retailers, Canadian high yield bond covenants, Telecom Italia, CACI International, Saudi Arabian banks, Russian Banks, Polish banks, Argentinean banks, Japanese life insurers, sovereign defaults, African sovereign debt issuance, government debt statistics, CEE5 sovereigns, Brazil, Asia's capital markets, Asia-Pacific bond markets, Spanish regional governments, Texas schools, Kentucky public library districts, US universities, not-for-profit hospitals, Australian mortgage delinquencies, European ABS and MBS, Spanish covered bonds, US student loan ABS and US mortgage servicers, among other reports.
RECENTLY IN CREDIT OUTLOOK
» Articles in Last Thursday’s Credit Outlook 41 » 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 14 OCTOBER 2013
Corporates
Regency’s $5.6 Billion PVR Acquisition Is Credit Positive for Both Last Thursday, Regency Energy Partners LP (RGP, Ba3 positive) said it would buy PVR Partners, L.P. (Ba3 positive) for about $5.6 billion on a unit-for-unit basis, including the assumption of $1.8 billion of PVR debt. The deal is credit positive for both RGP and PVR. Buying PVR will expand the scale and scope of RGP’s midstream gathering and processing (G&P) operations and bolster its predominantly fee-based earnings with another source of largely fee-based EBITDA.
Although RGP has not disclosed how it will treat PVR’s debt within the combined company’s capital structure, the deal makes PVR part of a larger, more diversified business – a move that led us to a change its outlook to positive from negative on Thursday.
Both RGP and PVR generate most of their operating margin under fee-based contract pricing structures, which tend to be fairly steady during commodity price cycles. RGP, a publicly traded master limited partnership (MLP), has midstream operations consisting of natural gas G&P, natural gas pipeline transmission and natural gas liquids transportation, processing and fractionation. PVR’s midstream operations focus on G&P activity, and, to a lesser extent, coal royalties.
But since the two companies have little geographic overlap, buying PVR will diversity RGP’s geographic footprint. RGP’s midstream footprint lies mainly in the Permian Basin of west Texas, the Eagle Ford shale in south Texas and in northern Louisiana. PVR will supplement and diversify RGP’s G&P operations, giving the combined company a midstream G&P asset base in the Marcellus Shale of Pennsylvania and Ohio, and other midstream G&P assets in the US Mid-Continent.
Both RGP and PVR had elevated debt leverage ratios as of 30 June, with more than 6x debt/EBITDA for each. This level of leverage will stay high after the acquisition, but in 2014, incremental EBITDA accruing from both companies’ recent growth projects and acquisitions will help lower the combined entity’s debt leverage toward 5x. However, both companies will remain exposed to significant volume risks given the weak fundamentals of the natural gas industry in North America.
RGP has grown rapidly, and its business mix continues to evolve, posing some credit risk. But that growth risk is mitigated by its large size and scale, even with the financial constraints of its MLP structure, its business and geographic diversification and the high level of fee-based income that the company draws from recent expansions and acquisitions. RGP also has a track record of issuing equity, rather than debt, and a commitment to the balanced funding of growth capital spending.
RGP’s general partner, Energy Transfer Equity, L.P. (ETE, Ba2 stable), owns 12.5% of its limited partnership units. Energy Transfer Partners, L.P. (ETP, Baa3 stable) also holds a 15% limited partnership interest in RGP.
The benefits of the PVR acquisition depend on ETE and ETP maintaining their current credit quality, and declining to pressure RGP into increasing its distribution payouts. Still, we expect credit benefits from the acquisition and the reliable, fee-based EBITDA that it promises.
Andrew Brooks Vice President - Senior Analyst +1.212.553.1065 [email protected]
NEWS & ANALYSIS Credit implications of current events
3 MOODY’S CREDIT OUTLOOK 14 OCTOBER 2013
Buckeye’s Acquisition of Hess’ Storage Facilities Is Credit Positive for Both Buckeye Partners, L.P. (Baa3 stable) on Thursday said it would spend $850 million to buy 20 liquid petroleum products terminals from Hess Corporation (Baa2 stable). The sale is credit positive for both Hess and Buckeye.
The sale adds 39 million barrels of storage capacity to Buckeye’s asset portfolio without putting its credit profile under significant strain, largely because Buckeye issued equity upfront to finance about 55% of the purchase price. For Hess, the asset sale will help finance its debt-reduction efforts and its share-repurchase program.
The 20 terminals will give Buckeye greater scale in refined-product storage near its existing asset base as well as expanded operations in higher-growth markets such as Florida. The terminals are primarily on the US East Coast, with 29 million barrels of domestic capacity, 15 million barrels of which is in New York Harbor. Buckeye will get another 10 million barrels of storage capacity in the Caribbean nation of St. Lucia. Most of the assets are marine terminals, 12 of which offer deepwater port access.
The large acquisition poses some integration and execution risk for Buckeye, but the price appears reasonable at around 9x EBITDA for 2013, especially if the multiple falls below 8x by 2015, as Buckeye expects. But Hess had operated the 20 storage terminals primarily on a proprietary basis, so Buckeye may not see similar returns from the terminals. Although the terminals provide valuable fee-based revenue, Buckeye will have exposure to considerable volume and storage rate risk since trends for both capacity utilization and storage rates have declined in recent years.
Even so, the assets offer a four-year storage and throughput contract with minimum volume commitments with Hess, which Buckeye anticipates will account for roughly 25% of the future EBITDA from the deal. Furthermore, Buckeye foresees manageable capital needs to meet its future earnings growth projections, putting around $25-$30 million toward several small projects.
Meanwhile, the sale of the storage terminals furthers Hess’ large asset sales program to support its debt reduction efforts and share repurchases. With this sale, Hess will have raised about $5.4 billion from asset sales since the beginning of this year, including $1 billion from the pending sale of the energy marketing business it announced in July. The energy marketing sale will eliminate collateral posting needs, while the terminals sale will free up some $900 million of working capital for Hess. Other asset sales, including upstream assets in Thailand and Indonesia, and the retail service stations, could take place going into 2014.
Having reduced its debt, Hess is now buying back stock under a $4 billion authorization and focusing on its upstream operations as it re-positions itself as a pure exploration and production company.
Gretchen French Vice President - Senior Credit Officer +1.212.553.3798 [email protected]
Thomas Coleman Senior Vice President +1.212.553.0365 [email protected]
NEWS & ANALYSIS Credit implications of current events
4 MOODY’S CREDIT OUTLOOK 14 OCTOBER 2013
Cancellation of H&R Block Bank Sale Is Credit Negative for Block Financial Last Wednesday, Block Financial LLC (Baa2 stable) said it had terminated its agreement to sell H&R Block Bank to Republic Bancorp Inc. (unrated). The announcement is credit negative because we believe the company is still motivated to sell the bank and will likely reach an agreement with another buyer on less favorable terms.
Block announced the termination of the sale after Republic said it was withdrawing its application for regulatory approval to switch to a national banking charter, which was a condition of the transaction. We had considered the bank sale agreement with Republic a credit-negative development because it would reduce Block’s profits on tax-related payment products. Under their sale agreement, the company and Republic were to share the lucrative fees that the bank generates from tax-related banking services – fees that Block currently keeps for itself.
But the likelihood of a sale at less favorable terms will lead to an even greater reduction in profits. Republic was perhaps the most ideal acquirer of H&R Block Bank because the company has unique experience as a provider of banking services to the tax-filing industry. A new acquirer is unlikely to have the same infrastructure in place to handle such services. As a result, we expect any eventual acquirer to demand a greater portion of the bank’s tax-related service fees.
Once the sale of the bank is completed, the Federal Reserve will no longer regulate Block as a savings-and-loan (S&L) holding company. This will enable Block to return to a historically more aggressive financial policy, which included using a large percentage of its free cash flow to repurchase stock. Share repurchases by S&L holding companies require regulatory approval, something Block has failed to obtain.
The more immediate effects of the bank sale’s termination are somewhat positive. Profits from tax-related payment services will not decline during the fiscal year ending 30 April 2014, and stock repurchases should remain muted as long as Block is regulated by the Fed. However, we expect Block to complete the sale of the bank to a new acquirer after the end of fiscal 2014, which will reduce profits and permit higher levels of share repurchase activity in fiscal 2015.
Edmond DeForest Vice President - Senior Analyst +1.212.553.3661 [email protected]
NEWS & ANALYSIS Credit implications of current events
5 MOODY’S CREDIT OUTLOOK 14 OCTOBER 2013
Liberty Interactive’s Planned Spinoff of TripAdvisor Is Credit Negative Last Thursday, Liberty Interactive LLC (Ba3 stable) said it planned to spin off its 22% economic and 57% voting interest in TripAdvisor and Buy Seasons into a publicly traded entity called Liberty TripAdvisor Holdings. The planned transaction is credit negative because it will remove $2.4 billion of assets from Liberty Interactive’s capital structure that generated approximately 10% of the company’s EBITDA. In addition, Liberty Interactive’s pro forma leverage (debt/EBITDA as adjusted by us) will rise to 4.1x from 3.9x.
The company expects to complete the spinoff in the first half of 2014. Holders of Liberty Interactive’s Liberty Ventures Group tracking stock will receive shares of Liberty TripAdvisor Holdings. After the transaction closes, Liberty Interactive’s leverage will remain well below the 5.25x level that we have indicated would prompt us to consider a ratings downgrade. The spinoff of approximately $385 million of TripAdvisor debt, which will remain non-recourse to Liberty Interactive, will soften the transaction’s effect on Liberty Interactive’s credit metrics.
Liberty Interactive also announced that its tracking stock will split into two new tracking stocks: QVC Group (QVC and Liberty Interactive’s roughly 38% stake in HSN) and Liberty Digital Commerce (which includes Bodybuilding.com, Provide Commerce, Backcountry.com and other e-commerce sites). The split will not change the company’s organizational structure and will not affect its ratings. Following the transactions, Liberty Interactive will still wield full control over its pool of equity investments, which mitigates some of the risk associated with the company’s exchangeable notes.
Scott Tuhy Vice President - Senior Credit Officer +1.212.553.3703 [email protected]
NEWS & ANALYSIS Credit implications of current events
6 MOODY’S CREDIT OUTLOOK 14 OCTOBER 2013
Consumer Concerns over Chicken Safety in China Continue to Hurt Yum! Brands’ Earnings Last Tuesday, Yum! Brands Inc. (Baa3 stable), the parent company of KFC, Pizza Hut and Taco Bell, warned that it will take longer than expected for its China restaurant sales to recover from consumer concerns stemming from a chicken safety scare last December that have been hurting its earnings ever since. The company said Yum’s China same-restaurant sales fell 11% in the third quarter, including a 14% decline at KFC and a 5% increase at Pizza Hut Casual Dining.
Owing to lower-than-expected sales in China and a higher-than-expected full-year tax rate, Yum now expects a high-single- to low-double-digit percentage decline in earnings per share for full-year 2013, which we view as credit negative given the forecast is lower than its prior guidance of a mid-single-digit decline. However, the company’s ratings and outlook are unaffected by the revised earnings guidance.
Yum’s China division has a particularly large influence on the company’s consolidated earnings because of its significant restaurant ownership in China compared with its franchise business model throughout the rest of the world. Yum owns a substantial majority of its restaurants in China and thus accounts for 100% of the earnings from these restaurants, versus a much smaller royalty rate stream for a typical franchised location. As a result, Yum’s China division generated about 42% of consolidated earnings (before unallocated costs and corporate expenses) for 2012, although it only accounted for about 15% of system-wide restaurants. China’s earnings contribution has declined to about 35% for the year-to-date period ended 7 September, but Yum’s consolidated earnings performance will remain heavily influenced by its China results because of its ownership structure in the region.
The China region is also important to other large food chains such as McDonald’s Corporation (A2 stable), which has also seen its comparable restaurant sales in China affected by consumer sensitivity around chicken-related food safety concerns and avian influenza. These issues contributed to a 4.6% decline in McDonald’s comparable first-quarter sales in China and 6.1% in the second quarter. However, McDonald’s earnings are significantly less influenced by China-related problems given its more diversified menu that includes other standard proteins such as beef and fish, its franchised based business model, global real estate strategy and fewer restaurants in China. McDonald’s owns and operates the majority of its approximately 1,700 restaurants in China, which only account for about 5% of system-wide locations.
William Fahy Vice President - Senior Credit Officer +1.212.553.1687 [email protected]
NEWS & ANALYSIS Credit implications of current events
7 MOODY’S CREDIT OUTLOOK 14 OCTOBER 2013
Xella’s Loan Repayment Is Credit Positive for Haniel Last Monday, Xella International S.A. (Ba3 review for downgrade) launched a €200 million issue of payment-in-kind (PIK) toggle notes, the proceeds of which it will use primarily to repay a loan it has currently outstanding to Franz Haniel & Cie. GmbH (Ba1 stable), its former owner. Repayment of the loan is credit positive for Haniel because it allows Haniel to further reduce its net debt and market value leverage. Haniel’s efforts to reduce its net debt and an increase in its portfolio valuation were the reasons we upgraded its rating on Thursday.
Haniel is an investment holding company predominantly invested in five businesses: German retailing group Metro AG (Baa3 stable), of which it owns 30%; European pharmaceutical wholesale and retail company Celesio (unrated), of which it owns 50%; business-to-business direct marketing specialist Takkt (unrated), of which it owns 50%; raw material recycling and trading company ELG (unrated), of which it owns 100%; and CWS-boco (unrated), a provider of washroom hygiene, dust control mats and textile care services, and of which it owns 100%.
The transaction is another step in Haniel’s disposal program, which has included reducing its ownership in Takkt to 50% from 70%, its interest in Metro by four percentage points and its stake in Celesio by five percentage points.
Combined with the rising stock prices of its portfolio holdings, Haniel’s leverage has fallen to 36% as of the end of September, compared with 50% at the end of 2012. Pro forma for the Xella transaction, leverage, as defined as the ratio of holding company debt to the value of the portfolio, would improve to 34%, as adjusted by us and which equals around 26% on a reported basis.
Following the repayment of its loan to Xella, Haniel has no more non-core holdings. This means Haniel’s leverage will only continue to improve if the share prices of its current holdings rise or if it disposes some of its core holdings. Although doing so would materially reduce the company’s diversification in its already highly concentrated portfolio, disposing of one of its five core holdings would significantly improve Haniel’s leverage. For example, a sale of Celesio would effectively make Haniel a debt-free company on a net basis.
Alex Verbov Vice President - Senior Analyst +49.69.70730.720 [email protected]
NEWS & ANALYSIS Credit implications of current events
8 MOODY’S CREDIT OUTLOOK 14 OCTOBER 2013
Expansion of Tax to Russian Automakers Would Be Credit Negative On Friday, the European Union (EU) asked the World Trade Organisation (WTO) to set up a settlement panel to rule on a disputed disposal tax (or recycling fee) on vehicles imported to Russia. Although the hearings may last up to one and a half years, it is very likely that Russia will have to extend its recycling fee to locally made vehicles, as the EU has requested. Such an extension would be credit negative for KAMAZ, OJSC (Ba1 stable) and other domestic automakers because it would reduce their margins and cash flows and negatively affect their leverage.
Russia introduced the disposal tax on new and used imported vehicles in September 2012 shortly after the country’s accession to the WTO to compensate Russian automakers for the significant reduction in import duties on used foreign cars and trucks that went into effect with its agreement with WTO.
The tax, which did not apply to domestic automakers and vehicles imported from Belarus and Kazakhstan, ranged from about €420 to €2,700 for a new vehicle and €2,600 to €17,200 for a vehicle older than three years, and helped domestic producers maintain their market shares and profitability. The EU challenged the tax in July on the grounds that recycling fees break WTO rules by discriminating against imports and this year will reduce imports of EU-made vehicles into Russia by 7%, or €10 billion, according to EU calculations. If Russia and the EU cannot reach a settlement, Russia could be forced to change its policy or become subject to sanctions. Other importers such as the US, Japan, China and Turkey have supported calls for a settlement.
In response to the pressure from the EU, the Russian government in July presented to parliament legislation to extend the tax to locally made vehicles, but the legislation has not passed. Under the proposal, domestic automakers would pay a total of RUB118.9 billion ($3.7 billion) in taxes in 2014, which in the absence of any compensation would adversely affect their credit quality.
In June, KAMAZ said that if it had to pay the fees from July onward, it would cost the company up to RUB10-RUB18 billion ($300-$600 million) annually and it would offset the tax by raising prices by up to 20% depending on vehicle model. Such an increase would make KAMAZ’s vehicles less competitive to imported vehicles and result in some lost market share (the company reported a 33% market share in 2012).
We estimate that the effects of the tax will shave up to two percentage points off KAMAZ’s adjusted EBITDA margin in 2014 to around 8% (we expect KAMAZ’s EBITDA margin in 2014 to exceed 10%) and increase its adjusted leverage by around 0.5x to 3.0x. Expanding the tax will also negatively affect other Russian automakers, costing OJSC AutoVAZ (unrated) around RUB14 billion ($450 million) and GAZ (unrated) around RUB13 billion ($430 million).
The Russian government is now developing measures that would compensate the major domestic automotive producers for the tax, such as certain kinds of subsidies. The Russian government hopes that these subsidies will be acceptable to the WTO. Nevertheless, the terms and conditions of the subsidies have not been released and we have doubts that the subsidies will pass WTO muster, meaning Russia may have to eliminate the subsidies if it wants to remain part of the WTO.
Sergei Grishunin Assistant Vice President - Analyst +7.495.228.6168 [email protected]
NEWS & ANALYSIS Credit implications of current events
9 MOODY’S CREDIT OUTLOOK 14 OCTOBER 2013
Tata Chemicals Will Benefit from Its European Soda Ash Exit Last Tuesday, Tata Chemicals Limited (TCL, Ba2 stable), the world’s second-largest soda ash manufacturer, announced it would close its synthetic soda ash capacity and expand its bicarbonate production facility at its Winnington plant in the UK. TCL’s decisions to more than halve its loss-making European synthetic soda ash capacity and expand its high-margin sodium bicarbonate facility are credit positive because they will boost the profitability of its European operations and strengthen its consolidated credit profile. The company expects to complete the closure and expansion by the first half of 2014.
The closure will take 470,000 tonnes out of TCL’s European synthetic soda ash capacity of 700,000 tonnes per year. Although the European operations’ contribution to consolidated revenue was stable at around 12%, its operating profit dropped 40% year over year in the quarter ended in June, driven by higher raw material and energy costs. Moreover, we expect the European soda ash market to remain challenging amid slack demand from the automotive and construction markets, the main users of flat glass obtained from soda ash. European producers have large underutilized capacity and imports are growing. We expect Turkey, the main exporter of natural soda ash to Europe, to add capacity of 2 million tonnes per year over the next few years.
TCL’s European operations have struggled for years, and have forced the company to seek covenant waivers on its European bank facility and to write down in May INR4.7 billion of goodwill incurred with its 2006 acquisition of Brunner Mond. TCL since 2006 has sought to protect its margins by purchasing British Salt to provide low-cost raw material and closing its Delfzijl soda ash plant in the Netherlands. But the cash cost of production of synthetic soda ash remains about 40% higher than natural soda ash because it requires more expensive raw materials and more energy. And although TCL has a joint venture with E.ON SE (A3 negative), its energy costs in the UK are high and rising.
Expanding its downstream, higher added value sodium bicarbonate business at its Winnington plant will allow TCL to benefit from the higher margins associated with sodium bicarbonate, which the food and pharmaceutical industries use and has more resilient demand. TCL expects to make up the shortfall in soda ash supplies to its European downstream activities and European customers with material from its facilities producing natural soda ash, which are run by Tata Chemicals North America, Inc. (Ba3 stable), a fully consolidated subsidiary based in Wyoming. Including the production from TCL’s facility in Kenya, 65% of TCL’s soda ash production is natural and competitive. This new supply arrangement will help TCL optimise the capacity utilisation of its global operations.
Alan Greene Vice President - Senior Credit Officer +65.6398.8318 [email protected]
NEWS & ANALYSIS Credit implications of current events
10 MOODY’S CREDIT OUTLOOK 14 OCTOBER 2013
Regulator Prohibits Korean Retailers from Supplier Rebates, a Credit Negative Last Tuesday, Korea’s Fair Trade Commission (FTC) began enforcing a rule issued the day before that prohibits major retailers from receiving suppliers’ rebates for purchasing goods in large volumes. The prohibition on rebates, which effectively discount the prices retailers pay for merchandise, will reduce the retailers’ earnings and cash flow and is credit negative. The rebates reflect the retailers’ strong bargaining power as the major sales channels for suppliers.
The top three hypermarket/supermarket operators in Korea by revenues, E Mart Co Ltd (Baa1 negative), Lotte Shopping Co Ltd (Baa1 negative) and Tesco Plc (Baa1 negative), received rebates of around KRW840 billion in their domestic hypermarket operations and about KRW220 billion in their supermarket businesses in 2012, according to the FTC. These rebates accounted for about 4% of the three retailers’ revenues from their domestic hypermarket/supermarket businesses. Additionally, four convenience store operators, including Lotte Shopping, received KRW110 billion in basic rebates last year, according to the FTC.
The rule will not affect the retailers’ 2013 financials because their existing contracts are not affected by the rule. However, beginning next year, we expect that retailers will act to maintain their profitability by, for instance, raising sales prices or negotiating with suppliers for lower purchasing costs when contracts are renewed. Whether these steps will be sufficient to offset the effects of the lost rebates is unclear, particularly since the FTC said that it will monitor to see if the retailers demand significant price cuts from suppliers in lieu of rebates.
E Mart, Korea’s largest hypermarket operator by revenue and number of stores, is most susceptible to the loss of rebates because its domestic hypermarket business accounts for almost all of its earnings. We estimate the loss of this rebate will increase its adjusted debt/EBITDA by about 0.9x-1.0x in 2014 to 4.5x-4.6x, absent any offsetting measures or deleveraging initiatives.
Lotte Shopping will be less affected because its domestic business, which includes hypermarkets, supermarkets and convenience stores, accounted for only about one third of its reported operating income in 2012 (ex-finance). We estimate its adjusted debt/EBITDA will increase by 0.4x-0.5x to 4.8x-4.9x in 2014, without mitigating measures.
The FTC’s new rule is another example of the government’s intervention in the retail industry, which increases the uncertainties facing Korean retailers. In 2011, for instance, the government began requiring hypermarket stores close two days a month to protect smaller retailers. As a result, same-store sales growth for the hypermarket segment has been negative since 2012. Lotte Shopping’s year-over-year same-store sales fell by 3% in 2012 and by about 5% in the first half of this year.
Jihoon Liu Assistant Vice President - Analyst +852.3758.1315 [email protected]
NEWS & ANALYSIS Credit implications of current events
11 MOODY’S CREDIT OUTLOOK 14 OCTOBER 2013
Banks
Special Mention Growth Among Shared National Credits Is Credit Negative for US Banks Last Thursday, the Federal Reserve, Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency released their 2013 interagency shared national credits (SNCs)1 program review. The review highlights significant growth in “special mention” credits, or credits with potential weaknesses that could result in deterioration of repayment prospects or credit position. Such growth is credit negative for US banks, which hold 40% of total SNC commitments.
Special mention credits increased 16% from the previous year, faster than the 8% growth in total SNC commitments. As shown in Exhibit 1, nearly all sectors reported an increase in special mention credits, with the exception of real estate, which improved markedly.
EXHIBIT 1
Dollar Amount of Special Mention Credits Among Shared National Credits Nearly All Industries Reported Increasing Special Mention Credits
Source: Interagency Shared National Credits Program Review 2013
This increase is particularly negative for regional banks that have become more active in the SNC market as a means of building up their commercial and industrial (C&I) loans since loan demand has been slack elsewhere. Many regional banks are growing C&I loans in an effort to reduce troubled real estate concentrations. However, we view the risk/reward equation of the SNC market for banks as unfavorable because for most banks the SNC commitment offers little benefit in deepening a business relationship with the underlying client and regional banks often have a limited influence in setting underwriting standards or determining the outcome of a workout of a problematic credit.
A positive attribute of the market is that US banks can sell some of their exposure to foreign banks and non-banks. Some non-banks, including hedge funds, insurance companies, and pension funds, purchase problematic loans and although the sale results in a loss for the banks, banks are able to move problem assets off their balance sheets. Indeed, non-banks owned 67% of all SNC-criticized credits, which are those classified as substandard, doubtful or a loss.
1 Any loan or loan commitment of at least $20 million that is shared by three or more supervised institutions.
$0
$50
$100
$150
$200
$250
2006 2007 2008 2009 2010 2011 2012 2013
Services Commodities Financial Manufacturers Real Estate Distribution Government
NEWS & ANALYSIS Credit implications of current events
12 MOODY’S CREDIT OUTLOOK 14 OCTOBER 2013
As Exhibit 2 shows, rated US regional banks have grown their C&I lending portfolios by 7.5% in the 12 months to 30 June, versus overall loan growth of 3.9% for the same period. There are inherent tensions between maintaining prudent underwriting standards and pursuing significant loan growth.
EXHIBIT 2
Amount of Commercial and Industrial Loans Held by US Regional Banks
Note: US regional banks include all rated traditional US banks, excluding Bank of America Corporation, Citigroup Inc., JPMorgan Chase & Co. and Wells Fargo & Company. Source: Regulatory filings
In the review, the examiners noted an increased occurrence of weak underwriting over the past year, and in particular cited significant risk in the leveraged-loan portfolio, with 42% qualifying as criticized credits. The review also indentified weak transaction structures in 34% of recent leveraged loan originations, specifically excessive leverage and weak or absent covenants. The review attributed this to aggressive competition and market liquidity. Indeed, our latest North American Covenant Quality Index highlights record low covenant quality for recently issued speculative-grade bonds.
NEWS & ANALYSIS Credit implications of current events
13 MOODY’S CREDIT OUTLOOK 14 OCTOBER 2013
UK Government’s Early Launch of Mortgage Guarantee Scheme Benefits UK Mortgage Lenders Last Tuesday, the UK government launched the “Help-to-Buy” (HTB) mortgage guarantee scheme three months ahead of schedule. The scheme aims to support mortgage lending in the high loan-to-value (LTV) segment to borrowers who can afford monthly mortgage payments but do not have enough savings for a large down payment. HTB is credit positive for UK mortgage lenders because it will positively affect their net interest income as a result of greater underwriting volume of higher yielding mortgages with LTVs of 80% or more.
HTB aims to help UK consumers access mortgage financing through a provision of government guarantees to lenders for up to 15% of the mortgage (or 9% for lenders using an internal-ratings-based approach for bank capital purposes). The guarantee, which will only be effective the first seven years of the mortgage term, will partially offset banks’ losses in the event of borrower default. If HTB is successful, it will increase participating UK mortgage lenders’ interest income by increasing loan volumes. Lenders will also be able to charge higher rates on mortgages with LTV ratios of 80%-95%. The positive effect on margins will also be partially offset by the guarantee fees.
The UK government has released most of the details of the HTB scheme, including customer eligibility criteria, the terms of the guarantee and the fees for 2014. We expect participating banks to price the loans to benefit their margins, taking into account the higher risk of borrowers with low down payments and the cost of the government guarantee. Concurrently, the UK Prudential Regulation Authority has disclosed that participating banks will treat the portion of the mortgages covered by the guarantee as an exposure to the UK government, which will attract smaller regulatory capital charges than the unguaranteed portion of the mortgage.
To date, Lloyds Bank Plc (A2 negative, C-/baa2 stable)2 and Royal Bank of Scotland plc (A3 review for downgrade, D+/baa3 review for downgrade) have begun offering mortgages under the HTB scheme. HSBC Bank plc (Aa3 negative, C/a3 stable), Barclays Bank PLC (A2 negative, C-/baa2 stable), Santander UK PLC (A2 negative, C-/baa1 stable), Virgin Money (unrated) and Aldermore (unrated) have signed up for the scheme and will begin offering these products in the coming months.
The mortgage guarantee scheme envisages that if a borrower defaults the mortgage lender will bear the first 5% of the loss and will receive compensation from the UK government for additional losses up to the amount covered by the guarantee. Any losses exceeding the guarantee amount will be borne by the mortgage lender. We note that the guarantee will not reduce the probability of default of higher risk borrowers. We believe that the proposed loss-sharing mechanism and the rules of the scheme will discourage banks from taking excessive risk in terms of customer affordability criteria.
The guarantee scheme has a maximum size of £12 billion, or £130 billion in notional amount of mortgages. In 2012, the top 10 UK mortgage lenders originated approximately £130 billion of mortgages, according to the Council of Mortgage Lenders. Although the HTB scheme will benefit participating UK banks, without a commensurate increase in the housing supply, HTB risks contributing to the creation of a housing bubble, particularly in areas with limited housing stock and high demand, such as Greater London.
2 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.
NEWS & ANALYSIS Credit implications of current events
14 MOODY’S CREDIT OUTLOOK 14 OCTOBER 2013
Lloyds’ Sale of Australian Operations Will Increase Its Core Tier 1 Capital Last Friday, Lloyds Banking Group (A3 negative) announced that it had reached an agreement to sell to Westpac Banking Corporation (Aa2 stable, B-/a1 stable)3 its Australian operations comprising Capital Finance Australia Limited (CFAL, unrated) and BOS International Australia Ltd (BOSI, unrated) for approximately £900 million. The sale is credit positive for Lloyds because it will increase its fully loaded CRD IV core Tier 1 capital ratio by approximately 20 basis points owing to the related reduction in risk-weighted assets.
The transaction is consistent with Lloyds’ strategy of selling non-core assets and focusing on a selected few markets. Although the combined gross assets of CFAL and BOSI is approximately £5.2 billion, and in 2012 the two businesses generated a combined profit of £80 million, Lloyds had previously announced that they were not part of its core strategy. The benefits of a narrower focus offset the reduction in Lloyds’ diversification. Westpac will incorporate the acquisitions to its existing businesses of St. George and Westpac Institutional Bank.
Proceeds from the asset disposal help Lloyds continue to make significant progress meeting the minimum 7% modified4 CRD IV capital ratio that the UK Prudential Regulation Authority outlined on 20 June. Following this transaction, Lloyds expects to diminish its remaining capital shortfall of approximately £900 million with retained earnings and capital accretive asset disposals (see Exhibit 1).
EXHIBIT 1
Lloyds’ Actions to Close Its Capital Shortfall, £ Billions
Capital Shortfall to Reach Minimum 7% Modified CRD IV Capital Ratio -£8.6
Net Capital Generation Plan £1.6
Sale of government securities £1.4
Sale of US RMBS portfolio £1.4
Two placing of shares in St James's Place £1.0
Other actions including disposal of UK CRE and sale of stake in Sainsbury's Bank £0.4
Additional actions before 1 August £0.9
Sale of Heidelberger Lebensversicherung £0.4
Sale of Australian operations £0.55
Total delivered management actions £6.1
Shortfall Lloyds expects to meet through retained earnings and capital accretive asset disposals -£0.9
Source: Moody’s estimate based on individual Lloyds Banking Group RNS Announcements
We believe that Lloyds will be able to generate the remaining £900 million mainly through its improved revenue-generation capacity as impairment losses decline along with the size of its non-core portfolio and its net interest margin increases because of a lower cost of funds, in line with other UK banks. In addition, the recent successful sale of approximately 6% of the government’ stake in Lloyds to private investors suggests that the bank would be able to issue additional equity or contingent capital if required. The disposal also contributes to Lloyds’ strategic objective to reduce its non-core portfolio, which totalled £83 billion at the end of June, having declined by 72% from £300 billion in 2009 (see Exhibit 2), and we expect it to fall further because Lloyds has targeted it to be less than £70 billion by the end of 2013. 3 The bank ratings shown in this report are the deposit rating, its standalone bank financial strength rating/baseline credit assessment
and the corresponding rating outlooks. 4 After making deductions to reflect future losses and conduct remediation charges, and adjusting the calculation of risk weighted assets.
Carlos Suarez Duarte Vice President - Senior Analyst +44.20.7772.1061 [email protected]
NEWS & ANALYSIS Credit implications of current events
15 MOODY’S CREDIT OUTLOOK 14 OCTOBER 2013
EXHIBIT 2
Lloyds Banking Group’s Non-Core Portfolio
*Target Source: Lloyds Banking Group
£0
£50
£100
£150
£200
£250
£300
£350
Jan-09 2009 2010 2011 2012 H1 2013 2013*
£ Bi
llion
s
Total Non-core Treasury Assets UK Commercial Rral Estate Other Corporate
International Corporate UK Mortgages UK Consumer Finance International Retail
Non-retail Retail
NEWS & ANALYSIS Credit implications of current events
16 MOODY’S CREDIT OUTLOOK 14 OCTOBER 2013
Banca Monte dei Paschi di Siena’s Challenging Restructuring Plan Is Credit Negative for Subordinated Bondholders Last Monday, Banca Monte dei Paschi di Siena (MPS, B2 negative, E/caa3)5 published its 2013-17 restructuring plan, prepared under guidelines agreed upon with the European Commission (EC). The plan faces higher implementation obstacles than MPS’s 2012-15 restructuring plan. We believe the plan has high execution risks, and a failure to raise the required capital from private shareholders would force the Italian Treasury to become a shareholder and likely cause subordinated creditors to sustain a loss in the event of a bank rescue.
From details disclosed so far, the entire restructuring plan hinges on the success of a planned €2.5 billion share issue in 2014, which we believe will be a challenge without the emergence of a “white knight” investor. So far, no such investor has appeared.
If the capital increase is unsuccessful, the Italian Treasury would partly convert into equity the €4.1 billion of state aid it has granted to MPS. In such an event, there is a heightened risk that European or Italian authorities would require subordinated creditors to share the cost of the recapitalisation. MPS has about €30 billion in senior subordinated debt outstanding and €6 billion in preferred stock and junior subordinated debt, and has already stopped payment of non-cumulative coupons on its preferred stock.
Proceeds from the share issue would be used in 2014 to repay €3 billion of the expensive (9% coupon, with step-up) €4.1 billion of state aid that MPS has already received. Repayment would potentially reduce MPS’s cost of funding by strengthening its creditworthiness and reducing bail-in risk.
Full details of the plan – particularly related to revenues – will only be disclosed after the EC’s final and formal approval of the plan, which we expect in mid-November. But in addition to the share issue, other elements appear very challenging given the adverse operating environment, including the following:
» The 50% cost-to-income target for 2017 (from 80% in 2012), considering that the bank’s brand has suffered and that this will constrain revenues
» A planned headcount reduction of 5,300 (in addition to 2,700 since 2011) to cut costs, which will likely encounter strong union opposition
» The €900 million net income target for 2017 (from a €3.2 billion loss in 2012), which will be constrained by significant deleveraging and a required reduction of MPS’s loan-to-deposit ratio by 34 percentage points to 100%
» The 9% return on tangible equity target, which, even if MPS achieves, will still be lower than the cost of capital
5 The banks’ ratings shown in this report are the banks’ debt and deposit ratings, their standalone bank financial strength
rating/baseline credit assessment and the corresponding rating outlooks.
NEWS & ANALYSIS Credit implications of current events
17 MOODY’S CREDIT OUTLOOK 14 OCTOBER 2013
CreVal’s Decision Not to Proceed with an Acquisition of Banca Tercas Is Credit Positive Last Tuesday, the board of directors of Credito Valtellinese (CreVal, Ba3 negative, E+/b1 stable)6 decided not to proceed with an acquisition of Banca Tercas (unrated), a troubled bank that has been under the administration of the Bank of Italy since April 2012. CreVal’s decision is credit positive because it will avoid increased risks, added complexity, integration challenges and lower capital ratios that would have emerged with the acquisition given Italy’s recessionary environment.
CreVal’s decision also indicates that the bank was able to reach an independent decision based on the merits of the possible acquisition free of regulatory influence. This addresses a concern in the market that healthier Italian banks might come under political pressure to acquire weak institutions to preserve the stability of Italy’s financial system at the expense of their own credit quality.
So far, CreVal has withstood the pressure on asset quality and earnings that has emerged in the Italian banking system. However, CreVal’s earnings have been affected by a rise in nonperforming loans and the low interest rate environment. CreVal also has avoided growth from acquisitions since 2008, and its decision not to acquire Tercas is a further sign of its limited risk appetite.
CreVal’s decision highlights that Italian regulators will find it challenging to find buyers for other banks that have recently entered administration, including Banca delle Marche S.p.A. (Caa1 review for downgrade, E/ca), Cassa di Risparmio di Ferrara (unrated) and Banca Popolare di Spoleto (unrated). In the past, the acquisition of weaker banks by stronger banks in the system had helped avoid government intervention. Such was the case in Intesa Sanpaolo Spa’s (Baa2 negative, D+/baa3 negative) 2011 acquisition of Banca Monte Parma (unrated), which at the time was facing a capital shortfall.
The exhibit below lists the banks that are currently under administration by the Bank of Italy.
Banks Currently Under Administration by the Bank of Italy Bank Name Latest Available Total Assets, € Millions Beginning of Administration
Banca delle Marche 21,907 as of June 2013 27 August 2013
Cassa di Risparmio di Ferrara 6,996 as of December 2012 27 May 2013
Banca Tercas 5,349 as of December 2011 30 April 2012
Banca Popolare di Spoleto 3,775 as of December 2012 8 February 2013
Istituto per il Credito Sportivo 2,006 as of December 2011 1 January 2012
BCC di Monastier e del Sile 1,556 as of December 2010 4 May 2012
BCC del Veneziano 1,135 as of December 2011 11 March 2013
Bene Banca Credito Cooperativo di Bene Vagienna 924 as of June 2012 26 April 2013
BCC di Alberobello e Sammichele di Bari 520 as of December 2012 19 June 2013
Banca dei due Mari di Calabria Credito Cooperativo 404 as of December 2011 28 March 2013
BCC “S. Francesco” 382 as of December 2011 24 August 2012
BCC Euganea di Ospedaletto Euganeo 263 as of December 2011 16 April 2013
Source: Bank of Italy and companies’ reports
6 The bank ratings shown in this report are the bank’s deposit rating, its standalone bank financial strength rating/baseline credit
NEWS & ANALYSIS Credit implications of current events
18 MOODY’S CREDIT OUTLOOK 14 OCTOBER 2013
CreVal’s decision also increases the uncertainties regarding the conclusion of Tercas’ administration. Without the intervention of an external investor, the risk to bondholders is high. Since the Bank of Italy placed Tercas into administration in April 2012, Tercas has not released any financial information. As such, we are not aware of the amount of capital that may be needed by the bank to return to a regular activity and exit administration.
NEWS & ANALYSIS Credit implications of current events
19 MOODY’S CREDIT OUTLOOK 14 OCTOBER 2013
Turkish Banks’ Asset Quality Will Benefit from Proposed Credit Card Debt Limits Last Tuesday, Turkey’s Banking Supervising and Regulation Agency (BRSA) proposed caps on aggregate credit card indebtedness and set stricter credit limits for new credit card holders. The proposed legislation is credit positive for Turkish banks because it will curtail households’ increasing indebtedness, thereby protecting banks’ asset quality.
The proposal aims to prevent consumers’ excessive use of multiple credit cards from different banks, and complements previously proposed stricter credit card regulation on risk-weighted assets and monthly amortization rates.7 Furthermore, the proposed limits will ensure that the debt balances of new credit card customers, which are increasingly from lower income households, remain affordable. Exhibit 1 shows the proposed credit card indebtedness limits.
EXHIBIT 1
Turkey’s Proposed Credit Card Indebtedness Limits per Consumer Type of Customer Limit
New credit card customer For the first year, 2x the cardholder’s average monthly income; from the second year, 4x their average monthly income
Existing credit card customers Upon cardholder’s card-renewal request, 4x cardholder’s average monthly income
Delinquent credit card customers No new charges accepted upon three consecutive non-payments of the minimum-due amount in a given calendar year. Limit reinstated only upon full payment of total outstanding credit card debt
Source: Turkey’s Banking Supervising and Regulation Agency
The legal initiative is aimed at addressing the 86% growth of credit card loans since 2010. In particular, installment credit card loans soared by 140% during the same period (Exhibit 2), contributing to a steep increase in the ratio of household liabilities to disposable income to 51% as of year-end 2012 from 44% in 2010 and 37% in 2008. Credit card repayments are sensitive to economic slowdowns; during Turkey’s short-lived 2009 recession, credit card loans were one of the worst performing loan segments as the nonperforming loan ratio doubled in one year to 12%.
EXHIBIT 2
Turkish Banking System Selected Indicators for Credit Card Loans
Source: Turkey’s Banking Supervising and Regulation Agency
7 See Turkey Proposes Stricter Regulations on Credit Card Loans, a Credit Positive, 26 August 2013.
0%
5%
10%
15%
20%
25%
30%
0
15
30
45
60
75
90
2007 2008 2009 2010 2011 2012
Total Credit Cards Loans - left axis Credit Card Installment Loans - left axis
Credit Card Non-Installment Loans - left axis Credit Cards Nonperforming Loan Ratio - right axis
TRY
Billi
ons
Arif Bekiroglu Assistant Vice President - Analyst +49.69.70730.773 [email protected]
NEWS & ANALYSIS Credit implications of current events
20 MOODY’S CREDIT OUTLOOK 14 OCTOBER 2013
Exhibit 3 shows our assessment of the business-prospect effect of the new legislation on our rated deposit-taking Turkish banks. We believe that the cap on credit card indebtedness will constrain banks’ franchise growth and the diversification of smaller banks focused in metropolitan areas where credit card penetration rates are already quite high. As a result, banks’ that currently have a low share of credit card loans will see their growth prospects severely limited. To grab market share, they are likely to compete on price to encourage existing card holders at competing banks to switch to their bank and credit cards, thereby elevating pressure on margins. However, for banks that already have sizable credit card business, the new legislation will have a muted effect.
EXHIBIT 3
Rated Deposit-Taking Banks’ Selected Indicators
Bank Rating
Total Loan Market Share
June 2013
Credit Card Loans/Total
Loans June 2013
Credit Card Loans
Growth June 2013/2010
Credit Card Market Share
June 2013
Business Prospects Effect
Türkiye Is Bankasi A.S. Baa2 stable, D+/baa3 stable 14% 7% 73% 12% Positive
Note: The bank ratings shown in this exhibit are the banks’ local currency deposit ratings, their standalone bank financial strength ratings/baseline credit assessments and the corresponding rating outlooks.
*For 2010 data, we use the unconsolidated balance sheet of Turk Ekonomi Bankasi A.S. and Fortis Bank A.S. The two entities merged under Turk Ekonomi Bankasi in 2011.
Sources: Moody’s, local GAAP bank financials and Turkey’s Banking Supervising and Regulation Agency
We expect future growth in credit card use mainly in the still under-banked eastern part of Turkey. Banks with stronger national franchises and access to rural areas will be at an advantage and will be able to continue to grow their credit card volumes through the acquisition of new customers.
NEWS & ANALYSIS Credit implications of current events
21 MOODY’S CREDIT OUTLOOK 14 OCTOBER 2013
Sale of Woori F&I to a Private-Equity Firm Would Benefit Korean Banks and NPL Securitization On 6 October, Maeil Business Newspaper reported that private-equity firms Kohlberg Kravis Roberts & Co. (unrated) and The Carlyle Group (unrated) were potential bidders for Woori F&I (unrated), a major player in the Korean securitization market for nonperforming loans (NPLs). Their emergence as bidders would mean more than a dozen entities are vying for Woori F&I.
A sale of Woori F&I to a non-bank entity such as a private-equity firm, rather than an acquisition by an existing competitor or bank, would be credit positive for Korean banks and the NPL market because it would promote competition and pricing transparency in the NPL market, upon which banks depend on to clean up their balance sheets. This is because the current structure of the NPL market has occasionally led to market concerns over pricing transparency, and whether a “true sale” takes place in the securitization process (that is, whether the market value of NPLs is established through a competitive bidding process and NPLs are legally removed from banks’ balance sheets).
The NPL market today is oligopolistic, with United Asset Management Company (UAMCO, unrated) controlling about 45% and Woori F&I controlling around 35%. Various funds, savings banks and asset management companies hold the remainder. The fact that UAMCO was established in 2008 with six domestic banks as shareholders8 and that Woori F&I was founded in 2001 as a wholly owned subsidiary of Woori Finance Holdings Co. Ltd. (WFH, A2 positive) means that 70% of NPL receivables are bought by entities that are affiliated with banks, which are major sellers of NPLs.
Although NPLs are sold through an auction system, the market dominance of bank-affiliated players occasionally prompted investors to question whether banks were being overpaid for their NPL receivables and whether NPLs are simply being moved off banks’ balance sheets without a true offloading of risks. Furthermore, the six shareholding banks’ stakes in UAMCO are not consolidated in financial statements, which means the potential risk of NPLs being mis-priced is not adequately reflected in shareholding banks’ balance sheets.
In light of this market structure, the potential sale of Woori F&I to a non-bank affiliated neutral player could improve the perceived risk of the NPL market and give investors confidence that a true sale process took place. Moreover, the fact that there are many potential bidders for Woori F&I itself is a positive sign for UAMCO and the market, since it is a testament to the NPL market’s profitability and that key players are not necessarily overpaying for NPLs for the benefit of shareholding banks.
Korea’s NPL securitization market emerged with the Asian financial crisis in 1998, when Korea Asset Management Corporation was tasked with offloading NPL receivables to clean up the balance sheets of distressed banks. At the time, the purchasers of NPLs were mostly foreign private-equity funds or investment banks, such as Lone Star (unrated) and Lehman Brothers.
The global financial crisis in 2008 prompted another surge in NPL receivables, but this time domestic entrants, such as UAMCO, Woori F&I and savings banks competed for the business, resulting in lower returns for these players, but better pricing for the banks.
8 Kookmin Bank (A1 stable, C-/baa1 stable), Shinhan Bank (A1 stable, C-/baa1 stable), Hana Bank (A1 stable, C-/baa1 stable) and
Industrial Bank of Korea (Aa3 stable, D+/baa3, stable) each hold 17.5% stakes in UAMCO, while Woori Bank (A1 negative, C-/baa2 negative) and NongHyup Bank (A1 stable, D+/baa3 stable) each hold 15%. The bank ratings shown in this report are the bank’s deposit rating, its standalone bank financial strength rating/baseline credit assessment and the corresponding rating outlooks.
Sophia Lee, CFA Vice President - Senior Analyst +852.3758.1357 [email protected]
NEWS & ANALYSIS Credit implications of current events
22 MOODY’S CREDIT OUTLOOK 14 OCTOBER 2013
Woori F&I came to the market as part of WFH’s privatization plan, and so far more than a dozen potential buyers9 have emerged, including domestic and foreign PE funds and domestic banks.
9 Other potential bidders the Maeil Business Newspaper identifies are Macquarie Korea Opportunities Management, Vogo Fund,
NEWS & ANALYSIS Credit implications of current events
23 MOODY’S CREDIT OUTLOOK 14 OCTOBER 2013
Insurers
Insurance Regulator’s Development of Global Capital Standard Is Credit Positive Last Wednesday, the International Association of Insurance Supervisors (IAIS) announced it would develop a risk-based global insurance capital standard for internationally active insurance groups by year-end 2016, with full implementation in 2019. The development of a global insurance capital standard is credit positive for insurers because globally active insurers currently lack comparative comprehensive capital rules. Progress in standardizing regulations and capital adequacy frameworks to improve clarity and comparability will benefit global credit investors.
Three months ago, the IAIS designated the following nine insurers as systemically important: Allianz SE (Aa3 negative), AXA (A2 negative), Prudential Financial Inc. (Baa1 stable), Prudential Public Limited Company (A2 stable), MetLife, Inc. (A3 negative), American International Group, Inc. (Baa1 stable), Assicurazioni Generali, S.p.A. (Baa2 negative), Aviva Plc (A2 stable) and Ping An Insurance (unrated). The new proposals also affect approximately 40 additional insurers. In determining internationally active insurance groups, regulators will look at size (total assets of at least $50 billion), premium volume ($10 billion of gross premium written) and international presence, but will not specifically consider interconnectedness with the global financial system.
IAIS will develop the insurance capital standard within ComFrame, an ambitious set of international supervisory requirements focusing on the effective group-wide supervision of internationally active insurance groups. ComFrame has three main objectives: develop methods of operating group-wide supervision of internationally active insurance groups; establish a comprehensive framework for supervisors to address group-wide activities and risks; and foster global regulatory convergence. Although progress on ComFrame has been limited, with distinct views separating the European and US approaches, the IAIS developing a global insurance capital standard is a step forward in achieving convergence and aligning global capital standards.
However, details are limited and there is uncertainty among the insurance industry, observers and local regulators about how global capital standards will be agreed upon and implemented. The IAIS has not indicated how it will calculate or calibrate the insurance capital standard, and it is uncertain how it will work alongside other global regulatory initiatives, including Solvency II, the European Union’s regulatory regime that is scheduled to take effect in 2016, and the state-based regulatory system in place in the US.
NEWS & ANALYSIS Credit implications of current events
24 MOODY’S CREDIT OUTLOOK 14 OCTOBER 2013
Assurant’s Agreement to Lower Lender-Placed Insurance Rates in Florida Is Credit Negative Last Tuesday, Assurant, Inc. (Baa2 stable) announced it had reached an agreement with the Florida Office of Insurance Regulation to lower by 10% Florida rates for its lender-placed insurance (LPI) product from its American Security Insurance Company (ASIC) subsidiary. The agreement, which concludes a review of Assurant’s rate filing from March, is credit negative for Assurant because we expect the LPI rate reduction to reduce profitability in the company’s most profitable business segment.
According to Assurant, ASIC in 2012 recorded direct earned premiums in Florida of $510 million and net earned premiums of $372 million before catastrophe reinsurance. We estimate that on a pro forma basis the effect of the 10% rate decrease would be a reduction in 2012 net operating income of about 6%-9% for Assurant’s Specialty Property segment (depending on the terms of the non-catastrophe reinsurance contracts), or a reduction in Assurant’s net income of about 4%-6%.
Florida is by far Assurant’s largest state for LPI, which is a highly profitable line for the company, accounting for 90% of the Specialty Property’s division’s net income. The Specialty Property division constituted 57% of Assurant’s operating profitability, but only 28% of premiums for 2012.
Under the terms of the agreement, Assurant will also end commissions and client quota share arrangements with mortgage servicers when new regulatory requirements go into effect in about a year. Regulators designed the rules to reduce prices for consumers and encourage more pricing competition in the LPI market. However, a key competitive advantage of the largest LPI writers remains their regulatory compliance systems, which continue to be a significant barrier to entry for smaller competitors. According to Florida regulators, Assurant and QBE Insurance Group Limited (Baa1 negative) together control about 90% of the US LPI premium market. Elimination of quota-share arrangements will also result in Assurant retaining additional premium and risk previously ceded to mortgage servicers and partially offset by additional catastrophe reinsurance purchases.
Once Assurant files and receives approval for the new rates, we expect them to take effect in first-quarter 2014 on new and renewal business. ASIC will need to re-file rates annually.
LPI is a type of specialized homeowners’ insurance placed on a home by a mortgage lender, as per terms of the mortgage, after a mortgage borrower has allowed standard homeowners’ insurance to expire. LPI is riskier for the insurer than standard homeowners’ insurance because insurers accept policies without traditional underwriting, such as an evaluation of property characteristics, and without choice as to which properties they accept or reject. Properties insured through LPI generally have a higher risk of being in poor condition, vacant or vandalized. Moreover, whereas standard homeowners insurers mitigate catastrophic risk through regional limits and geographic diversification, an LPI insurer has a geographic spread largely determined by the location of distressed real estate markets and homeowners’ insurance availability, leading to high concentrations in specific states, cities and neighborhoods.
LPI has attracted greater regulatory scrutiny in recent years. In March, Assurant announced an agreement with New York regulators to file for lower rates and pay a $14 million civil penalty. In October 2012, the company agreed to lower California LPI filed rates by 30.5%.
NEWS & ANALYSIS Credit implications of current events
25 MOODY’S CREDIT OUTLOOK 14 OCTOBER 2013
Sovereigns
Serbia’s Budget Measures Are Credit Positive Last Tuesday, the government of Serbia (B1 stable) announced several measures aimed at cutting government expenditures and raising tax revenues. These measures are credit positive because they will stabilize budget deficit and public debt ratios over the next three years.
The revenue raising measures include an increase in the value added tax on food and other basic items to 10% from 8%. Expenditure measures include wage cuts of 20% and 25% on public employee incomes over certain thresholds, reducing subsidies, restructuring state enterprises and increasing the female retirement age to 63 years from 60 years.
We expect these measures to help avoid a more substantial increase in the budget deficit, which rose to 6.4% of GDP in 2012 from 4.9% in 2011, and which we expect to rise to more than 7% of GDP in 2013. The deficit has been increasing steadily since 2009 and has resulted in public debt climbing to 59.3% of GDP in 2012 from 29.2% in 2008. This is significantly above the 45% limit set by Serbia’s 2010 Fiscal Responsibility Law. We forecast Serbia’s public debt to rise above 65% of GDP next year, and the implementation of these measures should help contain a further rise in debt ratios.
Serbia increasingly relies on the international debt markets to fund its budget deficits and refinance its debt. The government increased its international market borrowing over the past two years, as global liquidity was abundant. However, the government’s cost of international financing has climbed in recent months, with yields on Serbia’s 10-year US dollar bond rising to 6.37% in October from 4.51% in May.
The increase in budget deficits and government debt has affected investor sentiment and likely contributed to higher market financing costs for Serbia. The government lacks a significant source of multilateral financing as an alternative to market borrowing. The government’s 2011 Stand-By Agreement with the International Monetary Fund (IMF) was suspended in 2012 when fiscal and policy metrics did not meet the criteria laid out in the agreement.
We expect that efforts to strengthen government finances to pave the way for the resumption of IMF support. Greater certainty over Serbia’s fiscal and financing outlook could lower the market interest rates the government pays on new debt and thus stabilize the government’s interest payments to revenue ratio, which has increased to about 6% currently from 1.4% in 2008.
NEWS & ANALYSIS Credit implications of current events
26 MOODY’S CREDIT OUTLOOK 14 OCTOBER 2013
Sub-sovereigns
Court Ruling Is Credit Positive for South African Toll-Road Operator SANRAL Last Wednesday, South Africa’s Supreme Court of Appeal dismissed opposition to The South African National Roads Agency Ltd.’s (SANRAL, Baa3 review for downgrade) biggest toll-road scheme, the Gauteng Freeway Improvement Project (GFIP), thereby allowing it to begin implementing electronic tolling (e-tolling) in the Gauteng Province. The ruling is credit positive because it paves the way for SANRAL to begin realising e-toll revenues, which are necessary to defray SANRAL’s operating costs, including finance charges on the ZAR20 billion ($2 billion) of debt used to construct the GFIP.
Realising e-toll revenues will also enable SANRAL to resume regular infrastructure maintenance. SANRAL suspended maintenance on its toll road network to preserve its cash flow to pay interest on the GFIP debt. SANRAL projects that gross annual finance charges are more than ZAR3 billion for 2014-16, and implementing e-tolling will contribute significantly towards making the payments.
The court judgment follows South African President Jacob Zuma’s recent signing into law of the Transport and Related Matters Amendment Bill, which enables SANRAL to enforce the payment of electronic tolls.
Public opposition to SANRAL’s e-tolling system was the main cause of the delay in the realisation of e-toll revenues. SANRAL initially expected e-tolling to commence in June 2011, but missed its targeted launch amid public resistance and court challenges. The delay to date has led to revenue losses of approximately ZAR4.4 billion ($441 million), or 34% of SANRAL’s revenues for the fiscal year ended 31 March 2013. Last year, the South African government provided SANRAL with a ZAR5.8 billion ($582 million) extraordinary budget allocation to compensate for the lack of e-toll revenue and to defray operating costs, including servicing the GFIP debt used to build the toll road network. However, SANRAL has depleted these funds and began adding to its debt to cover debt maturities and operating costs.
The GFIP is responsible for most of the rapid surge in SANRAL’s debt, which rose to ZAR36.2 billion ($3.6 billion), or 4.6x its annual revenues, as of 31 March 2013, from ZAR6.2 billion in March 2007. Moreover, we expect that additional borrowings will increase SANRAL’s debt stock to ZAR39 billion at the end of fiscal 2014. Although revenues that SANRAL earns from e-tolling operations will not entirely eliminate its need to add more debt, it will ease the financial pressure and reduce the extent of SANRAL’s recourse to debt.
Significant cash flow pressures and the prolonged delays in e-tolling were the main factors incorporated into our 6 September downgrade of SANRAL’s rating to Baa3 from Baa2 and its placement on review for further downgrade. The enactment of e-tolling legislation and SANRAL’s capacity to generate significant additional revenue will be one of our primary areas of focus during the review. We expect SANRAL to begin e-tolling in approximately six weeks.
NEWS & ANALYSIS Credit implications of current events
27 MOODY’S CREDIT OUTLOOK 14 OCTOBER 2013
Securitization
Westpac’s Acquisition of CFAL Would Be Credit Positive for Bella ABS Transactions On 11 October, Westpac Banking Corporation (Aa2 stable) announced that it had entered into an agreement to acquire Capital Finance Australia Limited (CFAL, unrated), a wholly owned subsidiary of Lloyds Bank Plc (A2 negative, C-/baa2 stable).10 This acquisition would be credit positive for Lloyds’ six outstanding Bella asset-backed securities (ABS) transactions because Westpac’s credit strength is greater than Lloyds’. If Westpac were to take over some or all of the key roles of servicer, fixed-rate swap counterparty and collections account bank, it would reduce the operating risk associated with these functions.
Currently, CFAL or Lloyds acts as servicer, fixed-rate swap counterparty, collections account bank and trust manager for these transactions, which consist of motor vehicle and equipment finance contracts with a current outstanding balance of AUD1.0 billion.11
Although Westpac has not yet publicly disclosed its intentions for these roles, we expect that servicing will remain with CFAL initially because of differences in systems and processes between CFAL and Westpac. This will allow for a smooth transition during the acquisition and minimize the threat of servicing disruptions.
But if Westpac were ultimately to take over the servicing role, it would be credit positive because the bank’s credit strength implies a lower likelihood of servicing disruption caused by servicer insolvency. In addition, Westpac has extensive securitisation and servicing experience in both ABS and residential mortgage-backed securities, with more than AUD13.8 billion outstanding in term transactions across both asset classes through its WST and Crusade programs. Westpac, having a similar level of servicing experience as CFAL, would reduce the risk of poor servicing resulting in lower recoveries.
If the fixed-rate swaps were to be novated to Westpac from Lloyds, it would be credit positive because Westpac’s stronger creditworthiness gives greater certainty to the transactions of receiving payments under the swaps.
Transferring the collections account to Westpac from Lloyds also would be marginally credit positive because although we assess both Lloyds’ and Westpac’s short-term creditworthiness as P-1, Westpac’s stronger long-term rating implies a lower chance of losing the P-1 rating. In addition, the Bella ABS transaction documents include standard mitigants to protect noteholders, which require the account bank to have a rating of at least P-1.
The replacement of Lloyds as the trust manager would not have a credit effect because of similar levels of securitisation experience between Lloyds and Westpac. The trust manager is responsible for most calculations in the transaction, including payments to noteholders and key transaction notifications such as events of default.
10 The ratings shown are Lloyds Bank’s deposit rating, its standalone bank financial strength rating/baseline credit assessment and the
corresponding rating outlooks. 11 Total current outstanding balance of Bella Trust Series 2010-1, Bella Trust Series 2010-2, Bella Trust No. 2 Series 2011-1, Bella
Trust No. 2 Series 2011-2, Bella Trust No. 2 Series 2011-3, Bella Trust No. 2 Series 2012-1.
RATING CHANGES Significant rating actions taken the week ending 11 October 2013
28 MOODY’S CREDIT OUTLOOK 14 OCTOBER 2013
Corporates
Alpha Natural Resources, Inc. Downgrade
5 Aug ’13 7 Oct ‘13
Corporate Family Rating B1 B2
Outlook Review for Downgrade Stable
The downgrade reflects deteriorating performance and persistent weakness in market conditions for both thermal and metallurgical coal. Furthermore, even though thermal and metallurgical coal have reached bottom, we see limited potential for a material recovery in demand and pricing.
Arch Coal, Inc. Downgrade
5 Aug ’13 7 Oct ‘13
Corporate Family Rating B2 B3
Outlook Review for Downgrade Negative
The downgrade reflects deteriorating performance and persistent weakness in market conditions for both thermal and metallurgical coal. Arch's metrics will not be able to return to sustainable levels without an increase in coal prices, a recovery in settlements and an increase in prices of Central Appalachian thermal coal, which we view as unlikely.
Franz Haniel & Cie. GmbH Upgrade
26 Jun ’13 10 Oct ‘13
Corporate Family Rating Ba2 Ba1
Outlook Positive Stable
The upgrade takes into account the significant improvement in Haniel’s loan-to-value ratio, facilitated by a reduction in net debt and increased portfolio valuation. Haniel was able to reduce debt at the holding company from €2.4 billion last year to around €1.8 billion as of September 2013. As a consequence, its loan-to-value ratio has improved to around 36%.
Neiman Marcus Group Ltd. Inc. (The) Downgrade
10 Sep ’13 7 Oct ‘13
Corporate Family Rating B2 B3
Outlook Review for Downgrade Stable
The downgrade acknowledges the company’s rising debt levels as a result of its $6 billion leveraged buyout by Ares Management and the Canada Pension Plan Investment Board. The company’s debt to EBITDA ratio will remain above 7.0, limiting its ability to reduce debt over the next 18 months.
RATING CHANGES Significant rating actions taken the week ending 11 October 2013
29 MOODY’S CREDIT OUTLOOK 14 OCTOBER 2013
Telecom Italia S.p.A. Downgrade
8 Aug ’13 8 Oct ‘13
Senior Unsecured Rating Baa3 Ba1
Outlook Review for Downgrade Negative
The downgrade reflects our concern that the company will not be able to strengthen its balance sheet enough to offset declining domestic revenues and EBITDA. These concerns are exacerbated by the recent resignation of the company’s CEO.
Tesco Plc Outlook Change
20 Apr ’12 7 Oct ‘13
Senior Unsecured Rating Baa1 Baa1
Short Term Issuer Rating P-2 P-2
Outlook Stable Negative
Aggressive competition in the UK retail market and weak macroeconomic conditions across some of Tesco’s key international markets will continue to negatively affect the company’s performance. Tesco’s improving sales growth in the UK has not been enough to offset these negative trends and there was a decline in trading profit.
Wm. Wrigley Jr. Company Upgrade
10 May ’13 7 Oct ‘13
Corporate Family Rating Ba1 Baa2
Outlook Positive Positive
The company’s strong cash flows, high levels of liquidity and leading share of the global gum market triggered the upgrade. Additionally, Wrigley’s refinancing of $4.4 billion of 11.45% subordinated notes due in 2018 with senior unsecured debt will improve the company’s credit metrics.
The outlook change is in line with the outlooks on BBE's parent bank's ratings. We changed the outlook on Banco Bradesco’s ratings on 3 October to stable from positive as a result of the outlook outlook change on Brazil's government debt ratings on 2 October.
Credito Emiliano SpA Review for Downgrade
16 Jul ‘12 10 Oct ‘13
Long-Term Deposit Ratings Baa3 Baa3 (Review for Downgrade)
Short-Term Deposit Ratings Prime-3 Prime-3 (Review for Downgrade)
The review was prompted by Credem's deteriorating asset quality, the bank's capital levels, especially related to the higher-than-average exposure to Italian government bonds, Credem's plans to manage its higher-than-peers reliance on ECB funding and the prospects for the bank's profitability.
Doral Financial Corporation Downgrade
9 Sep ‘09 7 Oct ‘13
Senior Unsecured Rating Caa1 Caa3
The downgrade was driven by the company's extremely weak financial condition. Doral Financial's credit profile reflects very poor asset quality, weak capital, and a funding profile that is highly dependent on non-core sources.
The one-notch downgrade of the bank was driven by increased asset quality concerns. These concerns are reflected in INTRUST's larger net charge-off volatility and higher nonperforming assets relative to peers in recent periods. Some of this is the result of INTRUST's appetite for large single-client credit relationships relative to its size. INTRUST's strategic challenge is that a reduction of its large exposures would reduce earnings at a time when they are already challenged by limited growth and low interest rates. Therefore, we believe it is unlikely that this concentration risk could be reduced in the near term.
INTRUST Financial Corporation Downgrade
17 Jul ‘13 10 Oct ‘13
Issuer Rating Baa1 Baa3
The two-notch downgrade of the issuer rating of the holding company was the result of Intrust’s persistently high double leverage, which has worsened in recent years. As of 30 June, the double leverage ratio was 147%.
Svyaznoy Bank Downgrade
4 May ‘07 11 Oct ‘13
Long Term Foreign and Local Currency Deposit Ratings
Svyaznoy’s business remains loss-making, which is exerting pressure on the bank's capitalization and makes it reliant on external capital injections from its shareholder, leading to the downgrade. The negative outlook reflects the pressure on asset quality and profitability due to the increasing risks in the bank's loan portfolio, and the bank's weak loss-absorption capacity because of low pre-provisioning profitability and insufficient reserve coverage of non-performing loans.
RATING CHANGES Significant rating actions taken the week ending 11 October 2013
32 MOODY’S CREDIT OUTLOOK 14 OCTOBER 2013
SKB-Bank Downgrade
7 Jun ‘11 9 Oct ‘13
Long Term Foreign and Local Currency Deposit Ratings
B1 B2
Local-Currency Deposit Ratings B1 B2
Outlook Stable Negative
The downgrade of SKB-Bank's ratings is driven by the bank's low capital buffer which, in recent years, has been under pressure from the rapid increase in its exposure to the risky unsecured retail loans sector. The action also reflects the significant pressure on the bank's asset quality and profitability due to the increasing risks in its loan portfolio.
Sub-sovereigns
Cities of Spisska Nova Ves and Turcianske Teplice (Slovak Republic) Outlook Change
15 Feb ‘12 8 Oct ‘13
Issuer rating – NSR Aa2.sk Aa2.sk
Outlook Negative Stable
Trencin Region (Slovak Republic) Outlook Change
29 Nov ‘12 8 Oct ‘13
Issuer rating Baa2/Aa2.sk Baa2/Aa2.sk
Outlook Negative Stable
We have changed the outlook on the sub-sovereigns of the Slovak Republic after we changed the outlook on the Slovak Republic’s A2 government bond rating to stable on 4 October. The stabilization of the sub-sovereign outlooks follows the stabilisation in operating environment for the Slovak cities and regions, captured by the revised stable outlook on the sovereign. Also, we view sub-sovereign creditworthiness is strictly entwined with the sovereign.
RATING CHANGES Significant rating actions taken the week ending 11 October 2013
33 MOODY’S CREDIT OUTLOOK 14 OCTOBER 2013
US Public Finance
Broward County School Board Downgrade
29 Mar ‘12 7 Oct‘13
Lease Revenue Bonds Aa3 A1
Outlook Negative Stable
The downgrade reflects modest reserve and liquidity levels, as well as financial challenges going forward. The stable outlook reflects the slowly improving economy, manageable debt burden, and the sizable and diverse tax base.
Structured Finance
Two CMBS Classes of MSC 2006-HQ8 CMBS Downgraded, 13 Affirmed We have downgraded the ratings of two classes and affirmed 13 classes of Morgan Stanley I Trust 2006-HQ8 Commercial Mortgage Pass-Through Certificates, Series 2006-HQ8, affecting approximately $2.07 billion of structured securities. The downgrades reflect higher than anticipated realized and anticipated losses from specially serviced and troubled loans.
RESEARCH HIGHLIGHTS Notable research published the week ending 11 October 2013
34 MOODY’S CREDIT OUTLOOK 14 OCTOBER 2013
Corporates
Corporate Global Industry Sector Outlooks: Business Trends Show Hesitant Improvement Amid Mixed Signals for Major Economies
A slight uptick in industry sector outlooks for non-financial corporate companies during the third quarter does not signify overall economic improvement or a worldwide positive trend, but rather economic relief in some sectors as global economic uncertainty persists. Four industry outlooks changed in a positive direction during the quarter, but there was no clear guiding trend in these shifts since all were for different reasons.
Moody's Asian Liquidity Stress Index - October 2013
Our Asian Liquidity Stress Index (LSI) declined to 19.7% in September from 21.1% in August, resuming the downward trajectory seen from May through July. Liquidity in Asia remains weaker than in other regions because of the relative immaturity of its debt capital markets and the reliance on local bank markets for uncommitted funding.
EMEA SGL Monitor: Liquidity Stress Index Falls Further in Third-Quarter 2013
The EMEA Liquidity Stress Index fell below 14% in August 2013 from a peak of 19% in December last year. This primarily reflects the addition of newly rated companies. The liquidity of EMEA high-yield companies otherwise remains broadly stable in a continued favorable environment of low interest rates and open high-yield bond markets.
Brazilian Homebuilders: Economic Weakness, High Leverage to Keep Builders' Profits Under Pressure
Brazilian homebuilders face lower growth as a result of economic weakness and slowing GDP growth. The accompanying rise in inflation and in the level of household debt, along with decelerating growth in housing prices, will further pressure builders, especially as they result in contract cancellations and slowing sales growth.
Global Aerospace and Defense: Risks Remain High for Defense Contractors Without a Continuing Resolution
Although the Pay Our Military Act will allow some payments to defense contractors to be processed, it will not restore funding for orders of most equipment, supplies and materials. Without the US Congress passing a continuing resolution, contractors will need to take measures to preserve liquidity to offset the decline in cash flow from the government shutdown.
European Retailers: Gradual Resumption of Sales Growth, Easing Commodity Prices to Relieve Pressure on European Retailers
European retailers will benefit from the gradual resumption in sales growth in the euro and UK area. Consequently, the uptick in consumer spending will ease pressure on commodity prices for food and non-food retailers, resulting in a return to sales profitability in 2014.
RESEARCH HIGHLIGHTS Notable research published the week ending 11 October 2013
35 MOODY’S CREDIT OUTLOOK 14 OCTOBER 2013
Canadian Corporates: Canadian High-Yield Bonds Continue to Offer More Protection Than US Issues
Canadian high-yield bond offerings continue to have tighter covenants for the protection of investors than do US high-yield bond offerings. The quality of covenants for Canadian issuance has weakened over the past 20 months, however, and overall Canadian bonds have weaker covenant protections on average than do Asia, Europe and Latin America bonds.
Despite its Size, Telecom Italia's Fallen Angel Status Is Unlikely to Cause Major Ripples in High-Yield Market
The pull-back from recession in Europe will allow the market to absorb the impact of Telecom Italia’s downgrade to speculative grade, despite the size of the company. Even though the downgrade could initially pressure high-yield spreads, long term investor concern over interest rates will exert the most influence over market dynamics.
Global Aerospace and Defense: Consolidation Is Coming, but CACI-Six3 Deal Doesn't Signal the Start of M&A Wave
CACI International Inc.’s planned acquisition of Six3 Systems Inc. is a unique transaction that does not yet mark the start of an uptick in defense sector M&A. CACI said on 9 October that it has agreed to purchase Six3 from private equity firm GTCR LLC for $820 million. The price reflects the unique value inherent in Six3’s streamlined cost structure, coupled with a growing portfolio of signals-based subsystems and intelligence analytics services that work across the US defense/intelligence establishment.
RESEARCH HIGHLIGHTS Notable research published the week ending 11 October 2013
36 MOODY’S CREDIT OUTLOOK 14 OCTOBER 2013
Financial Institutions
Saudi Arabia Banking System Outlook
Our outlook for the Saudi Arabian banking system is stable, as it has been since 2009. The outlook reflects the benign operating environment, which is driven by high government spending and robust domestic consumption, our expectation of continued low problem loan levels, the banks’ strong loss-absorption capacity in the form of high capital buffers and stable internal capital generation, and the benefits of low-cost deposit-based funding and large liquidity buffers.
Russia Banking System Outlook
Our outlook for the Russian banking system remains negative, unchanged since October 2011. The negative outlook reflects our views that economic growth will weaken, banks’ asset quality will deteriorate, capitalisation will remain at a relatively low level, and profitability will decline because banks need to increase loan loss reserves. The banks’ stable funding and liquidity positions only partly offset the negative drivers.
Poland Banking System Outlook
We have changed our outlook for the Polish banking to stable from negative, principally because we expect a recovery in economic growth and consequent stabilisation in bank profitability. The stable outlook also reflects the banks’ improved capitalisation, increased risk-absorption capacity and largely self-sufficient funding profiles, which make the system resilient to the persistently challenging conditions in international wholesale markets.
Argentina Banking System Outlook
The outlook for the Argentine banking system is negative, as it has been since September 2011. We expect deteriorating business conditions to continue to weigh on the banks’ financial fundamentals in 2013 and 2014.
Japanese Life Insurance Outlook
Our outlook on Japan’s life insurance industry remains stable. We see Japan’s life insurers as among the biggest potential beneficiaries of the economic policies of the government led by Prime Minister Shinzo Abe. If these policies succeed in ending deflation and achieving stronger nominal GDP growth, they will help normalize Japan’s interest rate environment, which has been a drag on insurers’ profits for the past decade.
RESEARCH HIGHLIGHTS Notable research published the week ending 11 October 2013
37 MOODY’S CREDIT OUTLOOK 14 OCTOBER 2013
Sovereigns
Sovereign Defaults Series: Market Re-Access and Credit Standing After Sovereign Default
Looking at the 36 sovereign bond defaults since 1997, we find that market access remained impaired for many years following the default, with 45% of the sovereigns yet to regain market access. The length of market exclusion is highly correlated with the loss imposed on investors during the debt restructuring.
Sovereign Defaults Series Compendium: The Aftermath of Sovereign Defaults
Our compendium brings together the recent research reports of the Sovereign Defaults Series, which investigates credit-related themes pertaining to the aftermath of government defaults and restructurings. Our analysis scrutinizes the historical record and draws out insights for the current debt crisis.
International Sovereign Issuance in Africa 2013-14: A Rating Agency Perspective
We review recent and prospective international issuance in Africa, and offer an analysis of the outlook for African sovereign issuers and their local capital markets. We believe that the anticipated first-time entry of several African countries into the international debt capital markets will result in increased demand from investors for timely information on sovereign credit worthiness.
Government Debt Definition and Relevance to Creditworthiness: Answers to Frequently Asked Questions
Government debt levels have been the subject of intense scrutiny since the start of the financial crisis, especially in the euro area. Our report addresses recurring questions about the definition of government debt that we use when assessing sovereign creditworthiness and the role government debt plays in our assessments.
CEE5: Size and Liquidity of Domestic Funding Pool Determine Vulnerability to Liquidity Constraints in Post-QE World
Non-resident investor participation in domestic government debt markets differs widely among the CEE5 sovereigns—the Czech Republic, Poland, Slovakia, Romania and Hungary. Post-crisis portfolio inflows have been elevated and funding costs have decreased for all CEE5 sovereigns since January 2012. The vulnerability of sovereign funding post-QE will be determined by the size and liquidity of the domestic funding pool.
Brazil: Key Drivers of Change in Outlook on Baa2 Sovereign Rating to Stable from Positive
The key drivers of the outlook change were deterioration in Brazil’s debt and investment ratios, the fact that the economic growth outlook remains weak, and a weakening sovereign credit profile due to recurrent Treasury lending to public banks and deterioration in the reporting quality of the government’s accounts.
Integrating Asia's Capital Markets: The Dynamics of a Rapidly Evolving Landscape
A report based on the remarks made by Raymond McDaniel, President and CEO of Moody’s Corporation, at the APEC CEO Summit, Indonesia 2013. Discussing Asia’s emerging economies, he observes that the integration of their domestic local-currency bond markets with their regional and global counterparts lags the pace of integration of equity markets.
RESEARCH HIGHLIGHTS Notable research published the week ending 11 October 2013
38 MOODY’S CREDIT OUTLOOK 14 OCTOBER 2013
The Next Phase of Bond Market Development in Asia-Pacific
A report based on remarks made by Min Ye, Managing Director and Head of the Asia Pacific region for Moody’s Investors Service, at the APEC CEO Summit, Indonesia 2013. The past dozen or so years have witnessed impressive growth in bond issuance in emerging Asia. A diversity of investors, with different time horizons and risk appetites, is important to ensure a stable, deep and liquid bond market.
Sub-sovereigns
Spanish Regions: Government Liquidity Critical to Managing Persistent Deficits and Rising Debt
The financial pressures faced by Spanish regions are unlikely to subside over the medium term given their still high deficits and the continued increase of debt levels. Those regions with the weakest credit profiles will likely require the extension of liquidity support programmes from the central government in order to meet their debt obligations. But we believe that financial pressures on regional governments are well captured in current ratings.
RESEARCH HIGHLIGHTS Notable research published the week ending 11 October 2013
39 MOODY’S CREDIT OUTLOOK 14 OCTOBER 2013
US Public Finance
Drilling Revival in Texas’ Permian Basin Benefits Schools
Increased drilling activity in Texas’ Permian Basin is driving record growth in taxable values, especially for school districts. A number of school districts in the Permian Basin are experiencing double-digit year-over-year taxable value increases because of significant mineral value growth.
Kentucky Public Library Districts Face Funding Crisis
The Kentucky Court of Appeals is expected to rule in mid-2014 on whether library districts in the state will have to reduce property tax rates by ‘rolling back’ to prior rates. If the tax rate rollback is upheld, we would likely place the GO ratings of most districts on review for downgrade.
Eye on the Ball: Big-Time Sports Pose Growing Risks for Universities
As big-time college athletics bring universities greater and greater opportunities for improving brand as well as revenue, they also are bringing greater and greater risks. These risks go beyond the financial and include reputational risks should a program become embroiled in scandal. We also view the ultimate costs of these programs as uncertain, given exposure to potential litigation over head injuries as well as possible movement away from the amateur athlete model.
Health Insurance Exchanges Are a Modest Credit Negative for Not-for-Profit Hospitals in 2014
The public health insurance exchanges central to The Patient Protection and Affordability Act (ACA) that began enrollments at the start of October will be modestly negative to the credit quality of the not-for-profit hospitals in 2014. Risks to the hospitals include the migration of commercially insured patients to exchange insured patients, where reimbursement rates are likely to be lower, the uncertain terms and contracts between exchange plans and hospitals, as well as a growth in bad debt.
RESEARCH HIGHLIGHTS Notable research published the week ending 11 October 2013
40 MOODY’S CREDIT OUTLOOK 14 OCTOBER 2013
Structured Finance
Australian Regions with Education and Occupation Disadvantage Most Vulnerable to Mortgage Delinquencies in Economic Downturns
An analysis of 30-plus Australian mortgage delinquencies using the Index of Education and Occupation (IEO) shows that the greater the education and occupation disadvantage in a region, the higher the rate of delinquencies. The IEO can paint broader picture than loan-to-value ratios, which may not include occupancy data or whether a mortgage pool concentrates predominately on one region.
Spanish, Italian, Portuguese and Irish ABS and RMBS: High Credit Enhancement Mitigates Increased Sovereign and Counterparty Risks for ABS, but Not for RMBS
Our review of 104 ABS and 277 RMBS transactions, concluded in July 2013, indicates that while credit enhancement offset increased sovereign and counterpart risk for ABS, it did not have the same impact on RMBS transactions. This resulted in rating confirmations and upgrades for some ABS transactions, and an overall downward rating migration for RMBS transactions.
Spanish Covered Bonds: New Export-Finance Bonds Have Weaker Credit Profile Than Existing Export-Finance Covered Bonds, but Introduce Flexibility to Reduce Refinancing Risk
A new law in Spain allows banks to issue a new type of export-finance bonds that have weaker credit features than existing export-finance bonds. However, issuers can more easily create pass-through structures with these bonds, thereby lowering refinancing risks, but also reducing protection for bondholders.
US Student Loan Securitizations Will Have Sufficient Liquidity to Withstand Government Impasse
Since US student loan securitizations can use loan holders’ principal payments to cover interest due on the bonds, which is more than enough to cover interest payments, these FFELP loan securitizations will have enough liquidity to withstand the shutdown of the federal government. We estimate that 10%-30% of the total cash a securitization receives comes from the government.
Servicer Dashboard: Second Quarter 2013
Our spotlight this quarter focuses on approximately 1.1 million loans that were 60+ days delinquent and in foreclosure as of December 2008, the height of the mortgage crisis, and on where these loans stand as of June 2013. Our analysis shows that Ocwen’s overall performance ranked the best among the servicers we analyzed.
» Abengoa’s Equity Offering Is Credit Positive » Norske Skog’s Sale of Thai Mill Is Credit Positive
Infrastructure 7
» Public Service Enterprise Is Poised to Take Over Long Island’s Electric Utility Operations, a Credit Positive
Banks 8 » UK Regulators’ Proposal to Make Bank Stress Test Results
Public Will Benefit Bank Bondholders » UK Restrictions on Payday Lenders Are Credit Negative » Société Générale Expansion in Russia and Eastern Europe
Would Be Credit Negative
US Public Finance 13 » Federal Government Shutdown Hurts District of Columbia’s
Tax Revenues
CREDIT IN DEPTH US Local Government Pension Liabilities 15
Several large local governments have pension burdens large enough to cause material financial strain with annual pension costs that account for a growing portion of their total cost. Pension burdens of overlapping entities strain the tax bases of some local governments and perennial underfunding of actuarial contribution requirements amplifies pension burdens.
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EDITORS PRODUCTION ASSOCIATE News & Analysis: Jay Sherman, Elisa Herr and Neil Buckton
David Dombrovskis
Ratings & Research: Robert Cox Final Production: Barry Hing
