MOODYS.COM 29 AUGUST 2013 NEWS & ANALYSIS Corporates 2 » Amgen’s Onyx Deal Raises Debt for an Uncertain Payoff » Brown-Forman’s Expansion of Jack Daniel’s Production Is Credit Positive » Tube City’s Privatization Would Be Credit Negative » Siemens’ Completion of Offshore Converter Station Is Credit Positive » Baidu’s Planned Acquisition of Nuomi Is Credit Positive Infrastructure 7 » Entergy’s Vermont Nuclear Plant Retirement Is Credit Negative » Covanta’s Big Apple Trash Contract Is Credit Positive Banks 9 » NASDAQ’s Trading Shutdown Is Credit Negative for US Exchanges » Colombia’s Law for Guarantees Is Credit Positive for Banks » Bank of Israel Moves to Protect Banks from Mortgage Lending Risks Insurers 13 » Afianzadora Aserta’s Acquisition of HSBC Fianzas’ Mexican Surety Insurance Is Credit Positive » ING Groep and ING Verzekeringen Benefit from Sale of South Korean Life Insurer Sovereigns 16 » India’s Rising Food Subsidies Will Exacerbate Its Macroeconomic Imbalances CREDIT IN DEPTH US Banks 18 On 22 August, we placed on review the ratings of the six largest US bank holding companies as we consider lowering our government, or systemic, support assumptions. Goldman Sachs, JPMorgan Chase, Morgan Stanley and Wells Fargo are on review for downgrade. Bank of America and Citigroup are on review direction uncertain as we consider the potentially offsetting influence of improvements in the standalone credit strength of their main operating subsidiaries. We also included in our review the other two US banks that we consider systemically important: Bank of New York Mellon and State Street. In this report, we answer questions about the key drivers and implications of the current review. RECENTLY IN CREDIT OUTLOOK » Articles in Last Monday’s Credit Outlook 23 » Go to Last Monday’s Credit Outlook Click here for Weekly Market Outlook, our sister publication containing Moody’s Analytics’ review of market activity, financial predictions, and the dates of upcoming economic releases.
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MOODYS.COM
29 AUGUST 2013
NEWS & ANALYSIS Corporates 2
» Amgen’s Onyx Deal Raises Debt for an Uncertain Payoff » Brown-Forman’s Expansion of Jack Daniel’s Production Is Credit
Positive » Tube City’s Privatization Would Be Credit Negative » Siemens’ Completion of Offshore Converter Station Is Credit
Positive » Baidu’s Planned Acquisition of Nuomi Is Credit Positive
Infrastructure 7
» Entergy’s Vermont Nuclear Plant Retirement Is Credit Negative » Covanta’s Big Apple Trash Contract Is Credit Positive
Banks 9
» NASDAQ’s Trading Shutdown Is Credit Negative for US Exchanges
» Colombia’s Law for Guarantees Is Credit Positive for Banks » Bank of Israel Moves to Protect Banks from Mortgage Lending
Risks
Insurers 13
» Afianzadora Aserta’s Acquisition of HSBC Fianzas’ Mexican Surety Insurance Is Credit Positive
» ING Groep and ING Verzekeringen Benefit from Sale of South Korean Life Insurer
Sovereigns 16
» India’s Rising Food Subsidies Will Exacerbate Its Macroeconomic Imbalances
CREDIT IN DEPTH US Banks 18
On 22 August, we placed on review the ratings of the six largest US bank holding companies as we consider lowering our government, or systemic, support assumptions. Goldman Sachs, JPMorgan Chase, Morgan Stanley and Wells Fargo are on review for downgrade. Bank of America and Citigroup are on review direction uncertain as we consider the potentially offsetting influence of improvements in the standalone credit strength of their main operating subsidiaries. We also included in our review the other two US banks that we consider systemically important: Bank of New York Mellon and State Street. In this report, we answer questions about the key drivers and implications of the current review.
RECENTLY IN CREDIT OUTLOOK
» Articles in Last Monday’s Credit Outlook 23 » Go to Last Monday’s Credit Outlook
Click here for Weekly Market Outlook, our sister publication containing Moody’s Analytics’ review of market activity, financial predictions, and the dates of upcoming economic releases.
NEWS & ANALYSIS Credit implications of current events
2 MOODY’S CREDIT OUTLOOK 29 AUGUST 2013
Corporates
Amgen’s Onyx Deal Raises Debt for an Uncertain Payoff On Sunday, biotech company Amgen Inc. (Baa1 negative) announced plans to buy Onyx Pharmaceuticals Inc. (unrated) for about $9.7 billion in cash. The deal is credit negative for Amgen because it will raise its gross debt/EBITDA to 4.5x from 3.3x as of 31 March, with an uncertain payoff. Although Amgen is buying Onyx primarily for its blood cancer drug Kyprolis, the results of several important clinical trials for that drug are still unknown. Following the deal’s announcement, we changed Amgen’s rating outlook to negative from stable.
The US approved Kyprolis last month as a treatment of last resort for multiple myeloma, a bone marrow cancer. But it is still awaiting approval for use in the European Union and in treating earlier stages of the disease. Kyprolis also faces steep competition in the multiple myeloma market from Celgene Corporation’s (Baa2 positive) blockbuster Revlimid and from Johnson & Johnson (Aaa stable) and Takeda Pharmaceutical Company Limited’s (Aa3 stable) Velcade. In addition, Celgene recently won approval for Pomalyst, which competes against Kyprolis as a treatment of last resort for the disease.
Amgen said it plans to finance the purchase with $8.1 billion in committed banks loans and the balance with available US cash. It expects to close the transaction in the beginning of the fourth quarter of this year.
By providing Amgen with a new platform in blood cancer treatments, Onyx does help Amgen, the world’s largest standalone biotechnology company, decrease its product concentration risk. The company derives about 75% of its $17.3 billion in revenues from three key product franchises: ESAs (Aranesp and Epogen, which boost red blood cells), G-CSFs (Neulasta and Neupogen, which boost white blood cells) and Enbrel (which treats various autoimmune diseases). Although concentration in these products is declining owing to the rapid growth of Amgen’s Xgeva and Prolia franchises, which treat osteoporosis and bone metastases, its product concentration is high compared with pharmaceutical companies with more broad-based portfolios, such as Eli Lilly and Company (A2 stable) and Bristol-Myers Squibb Company (A2 stable).
The acquisition also furthers Amgen’s international expansion plans, as Onyx has global rights to Kyprolis, excluding Japan.
Michael Levesque, CFA Senior Vice President +1.212.553.4093 [email protected]
NEWS & ANALYSIS Credit implications of current events
3 MOODY’S CREDIT OUTLOOK 29 AUGUST 2013
Brown-Forman’s Expansion of Jack Daniel’s Production Is Credit Positive On 22 August, Brown-Forman Corporation (A1 stable) said it would invest $100 million to expand its Jack Daniel’s production facilities in Lynchburg, Tennessee. The expansion is credit positive because it will allow the spirits maker to accommodate surging global demand for the iconic brand without boosting leverage.
We expect that the expansion will drive Brown-Forman’s capital spending to about $150 million in the fiscal year ending 30 April 2014 – the highest amount ever – from the usual level of about $65 million per year. The Jack Daniel’s expansion follows the company’s announcement in June of a $35 million expansion of its Woodford Reserve Distillery in Kentucky. The company also raised capital spending to about $95 million in fiscal 2013.
Brown-Forman will be able to easily cover the higher capital spending with its strong cash flow, much of which is attributable to the global success of Jack Daniel’s. Sales of the Jack Daniel’s family of brands rose 9% in fiscal 2013 and sales volumes of the core brand, Jack Daniel’s Tennessee Whiskey, have increased for 21 consecutive years, according to Brown-Forman. In the 12 months ended 30 April, the company generated total funds from operations of almost $700 million.
Even with the increased capital spending, we expect leverage to decline to 1.15x-1.25x by the end of 2014 from 1.40x currently (see exhibit). Leverage rose in the latest fiscal year because of a $4-per-share special dividend at the end of 2012 that was driven by potential changes in the federal tax treatment of dividends this year. The company also boosted its regular quarterly dividend by 9.3% last year.
Brown-Forman’s Leverage Has Declined Despite Increasing Capex
Source: Moody’s Financial Metrics and estimates
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Linda Montag Senior Vice President +1.212.553.1336 [email protected]
NEWS & ANALYSIS Credit implications of current events
4 MOODY’S CREDIT OUTLOOK 29 AUGUST 2013
Tube City’s Privatization Would Be Credit Negative On Monday, TMS International Corp., parent of Tube City IMS Corp. (Ba3 stable), said it would be taken private by The Pritzker Organization LLC (unrated) for about $1 billion in cash, including refinanced debt.
If the majority of the cash consideration is funded with debt, the deal would be credit negative for Tube City, which provides onsite services to steel mills, including materials handling and scrap management. Pritzker and TMS said they had secured committed debt and equity funding for the transaction, but did not disclose financing terms. The equity funding is being provided by business interests of Tom Pritzker and Gigi Pritzker, two of the heirs to the Pritzker family fortune.
Based on the general economics of going-private deals and the current availability of financing at attractive rates, we believe TMS is likely to add significant debt to complete the transaction. Even funding the transaction with 50% equity and 50% debt would add more than $100 million to Tube City’s $312 million of debt. That would increase Tube City’s adjusted leverage to more than 3x debt to EBITDA from about the mid-2x range as of 30 June 2013. Given the cyclicality of the steel business, such an increase in financial leverage would pressure Tube City’s rating.
Pritzker and Tube City expect to close the transaction, which is subject to regulatory approval, by the fourth quarter of this year. The deal has already been approved by TMS’s largest shareholder, Canadian private-equity firm Onex Corp. and its affiliates, which own a 60% stake in the Glassport, Pennsylvania-based company.
The merger agreement includes various break-up fees that Tube City would pay if the transaction does not close for certain reasons. However, the company has $275 million of available liquidity, which it could use to pay such fees.
Benjamin Nelson Assistant Vice President - Analyst +1.212.553.2981 [email protected]
NEWS & ANALYSIS Credit implications of current events
5 MOODY’S CREDIT OUTLOOK 29 AUGUST 2013
Siemens’ Completion of Offshore Converter Station Is Credit Positive On Monday, Siemens Aktiengesellschaft (Aa3 negative) announced that on 23 August it had completed the installation of a converter station for an offshore wind park in the North Sea, one of the major hurdles to completing construction of the long-delayed offshore wind farms. The news is credit positive because it reduces the risk of further project delays that could result in additional penalty payments and tarnish Siemens’ reputation in the grid connection industry, the latter of which could adversely affect future orders for grid connection projects.
The group on Friday completed the first installation of a 12,000-ton converter station that bundles the electricity produced by the wind turbines and converts it into direct current for transmission to the coast. Transporting and installing the converter station were some of the biggest challenges of the project and the connection of the offshore wind parks remains approximately one year behind plan.
Siemens is constructing offshore high-voltage direct current links with a total capacity of 2.9 gigawatts in the North Sea. The project is a technological breakthrough because no other company has been able to build and connect offshore wind parks of this project’s size to the coast, which is 80-100 kilometres away. Although the technology is new, Siemens in 2010 won four orders for its mega offshore wind parks connection: Helwin 1 and 2, Sylwin 1 and BorWin 2. Two years later, major technical difficulties transporting and installing the converter stations and transmitting the electricity to the coast resulted in project delays and large cost overruns that led to €700 million of charges over the past two years. With the latest announcement, Siemens expects to complete the other North Sea grid connections by 2015 at the latest.
Although an ambitious project, we do not expect Siemens’ grid connections to positively contribute to the group’s results because it won the projects using turnkey contracts, and the unexpected technological challenges have made those contracts loss-making. The market for offshore wind power is significantly more concentrated and less subject to pricing pressure than the market for onshore wind power. At the same time, the project risk for offshore wind farms is significantly higher, which can result in material cost overruns and penalties.
Although we expect Siemens to further improve its profitability and credit metrics starting this year, it is unclear if the group can sustain that improvement and meet our expectations for profitability, free cash flow and leverage for its current Aa3 rating. It is unclear if Siemens’ substantial cost reduction plan and recent corporate actions, such as the replacement of its CEO, can offset the costs related to the group’s expansion into renewable energy and the weakening of some of the group’s significant markets, which currently weigh on the rating.
Roberto Pozzi Vice President - Senior Analyst +49.69.7073.0719 [email protected]
Michael Sonnefeld Associate Analyst +49.69.7073.0912 [email protected]
NEWS & ANALYSIS Credit implications of current events
6 MOODY’S CREDIT OUTLOOK 29 AUGUST 2013
Baidu’s Planned Acquisition of Nuomi Is Credit Positive On 23 August, Chinese Internet-search provider Baidu Inc. (A3 stable) said that it will acquire a 59% stake in the group-buying website Nuomi (unrated) for $160 million. The acquisition is credit positive for Baidu because it will complement the company’s location-based services (LBS), which will ultimately drive mobile revenue growth and subsequently overall revenue growth.
Baidu’s revenue growth rate slowed to 35%-40% during the first half of this year from 50%-70% in 2010-12 as an increasing portion of its Internet-search traffic came from smartphones and other mobile devices. The price that companies pay search providers when consumers navigate to the companies’ websites through links on mobile search results pages is lower than the price for searches through personal computers because mobile search is a new and untested marketing tool for advertisers. We expect Baidu’s revenue growth rate to continue slowing during the next 12-18 months because we do not expect significant revenue contribution from the Nuomi and other planned acquisitions during this period. Baidu’s revenue was RMB22.3 billion ($3.55 billion) in 2012.
But the user preference information that Baidu will gather as consumers search and make purchases on Nuomi (which offers coupons and discounts to customers who sign up for the service) will help Baidu refine its database and target advertisements more accurately. This refinement will eventually allow Baidu to increase the prices it charges companies when consumers navigate to its websites on both mobile devices and PCs.
Baidu will fund the acquisition with cash on hand, which will not affect its credit metrics. We estimate that pro forma for Baidu’s new debt issuance of $1 billion in July, the cash outlay for the Nuomi acquisition and its previously announced planned $1.9 billion acquisition of 91Wireless, a mobile games and applications distribution platform, Baidu will have about $1.5 billion net cash on hand. Baidu hasn’t has not said when the two transactions will close.
The Nuomi and 91Wireless deals are the latest in a series of moves that Baidu has made to expand the product and service offerings on its mobile platform. During the past 12-18 months, Baidu merged its maps business unit into its LBS unit, which will help the company focus its resources on LBS-related products and subsequently draw more consumers to these products. Baidu also increased its stake in its video subsidiary iQiyi (unrated) to close to 100% from 60% and consolidated it with the online video business of leading Internet video provider PPS (unrated). These moves should help Baidu leverage its dominant PC market position in the fast-growing mobile segment.
Lina Choi Vice President - Senior Analyst +852.3758.1369 [email protected]
NEWS & ANALYSIS Credit implications of current events
7 MOODY’S CREDIT OUTLOOK 29 AUGUST 2013
Infrastructure
Entergy’s Vermont Nuclear Plant Retirement Is Credit Negative On Tuesday, Entergy Corporation (Baa3 stable) announced that it would close and decommission its Vermont Yankee nuclear power plant in the fourth quarter of 2014. The decision is credit negative for Entergy because it raises questions about the future of some of its other merchant nuclear plants, as well as the ongoing profitability and viability of its entire wholesale generation business.
In today’s low power price environment, smaller merchant nuclear plants operating in competitive markets face unfavorable economics and are vulnerable to early retirement. Although Entergy expected operational earnings from the 605-megawatt (MW) Vermont Yankee plant to be breakeven in 2013, the plant had little financial cushion to cover additional costs or unexpected capital expenditures, such as additional safety features required after the Fukushima Daiichi nuclear power plant accident in Japan in March 2011. The prospects for improving the plant’s profitability were limited given persistent low gas prices and a competitive wholesale power market in New England.
Entergy may be required to add to the plant’s decommissioning fund, or provide additional financial assurance for the fund, which stood at $582 million as of 31 July. The company may also have to dedicate funds for spent fuel management. However, like several other US nuclear plants designated for retirement, Entergy plans to use the SAFSTOR (SAFe STORage) method of decommissioning, in which the plant is maintained in a condition that allows it to be safely stored and subsequently decontaminated at a later date, allowing time for the decommissioning trust fund to grow.
Entergy’s management has indicated that it was considering strategic alternatives for its Entergy Wholesale Commodities (EWC) business segment, which includes five other nuclear power plants, a nuclear services business and ownership of all or part of seven fossil and wind generating facilities. Although the retirement of Vermont Yankee itself will have little effect on Entergy’s financial performance, the company may take additional steps to streamline and rationalize this business segment. This increases the possibility that one or more of its other merchant nuclear plants will face a similar fate, having a more material negative effect on Entergy’s credit quality. With most of the nearly $3 billion of Entergy parent company debt attributable to its EWC business, additional plant closures will negatively affect debt service coverage ratios.
Entergy’s 688-MW single unit Pilgrim nuclear plant in Massachusetts, for example, is of similar size and vintage as Vermont Yankee and operates in the same New England power market, although this plant has not faced the same degree of political and regulatory opposition. Similarly, the 838-MW single unit Fitzpatrick nuclear plant in upstate New York operates in a market where depressed power prices are severely hurting margins. Finally, Entergy’s larger and somewhat better positioned Indian Point dual nuclear units, each at just over 1,000 MWs of capacity, also face significant political opposition in the state of New York.
Michael G. Haggarty Senior Vice President +1.212.553.7172 [email protected]
NEWS & ANALYSIS Credit implications of current events
8 MOODY’S CREDIT OUTLOOK 29 AUGUST 2013
Covanta’s Big Apple Trash Contract Is Credit Positive On Monday, Covanta Holding Corporation (Ba2 stable) said it had signed a 20-year contract with the New York City Sanitation Department to transport and dispose of about 800,000 tons of municipal solid waste (MSW) delivered annually to a pair of marine transfer stations in the city boroughs of Queens and Manhattan. The contract is credit positive for Covanta primarily because it locks in a new meaningful source of contracted fee revenue that the city will pay Covanta for 20 years.
As the largest owner and operator of energy from waste (EfW) facilities in North America, Covanta intends to convert the city’s MSW into electric energy by utilizing available capacity at its existing EfW facilities. Covanta converts 20 million tons of waste into electricity each year, so this 800,000-ton annual contract with the city will increase the annual amount of trash converted into electricity by a meaningful 4%.
In addition to the incremental fee revenue that the city will pay Covanta to transport and dispose of the waste, Covanta will earn additional positive net income after converting the MSW into electricity and selling it to utilities under predetermined rates or into the wholesale power market at a market-determined rate. Either way, the transaction will be incrementally accretive to earnings and cash flow, particularly because Covanta will use the existing capacity at two of its underutilized plants to convert the MSW into electricity.
The company expects service for the Queens marine transfer station to begin in early 2015, with service for the Manhattan marine transfer station to follow in 2016. The costs required to implement the terms of the contract are fairly modest at $110 million, particularly in light of Covanta’s historical annual free cash flow averaging $131 million during 2010-12 and factoring in the multi-year nature of this investment. As such, we expect the company to internally fund the required capital needed to execute the contract.
Commencing the New York City contract in 2015 and 2016 will come at an opportune time for Covanta because it helps to partially address a revenue cliff that occurs with the expiration of many existing MSW contracts over the 2012-16 period. Although Covanta has been quite successful in extending the terms of nearly all of its expiring MSW contracts, the financial terms of each extension are often less favorable than the original terms, leading to mounting revenue pressure. Monday’s announcement should help to materially offset this risk.
A.J. Sabatelle Associate Managing Director +1.212.553.4136 [email protected]
NEWS & ANALYSIS Credit implications of current events
9 MOODY’S CREDIT OUTLOOK 29 AUGUST 2013
Banks
NASDAQ’s Trading Shutdown Is Credit Negative for US Exchanges Last Thursday’s three-hour trading suspension on the NASDAQ OMX Group, Inc.’s (Baa3 stable) US stock exchange is the latest evidence that the demand being placed on the US securities trading infrastructure is outpacing the functionality of the controls and technologies that support it. Regulators’ commitment to reduce this performance gap seems certain to significantly increase exchange operators’ compliance and technology costs, a credit negative.
The longer-term consequences for the exchanges and other market participants will depend on the extent to which processes and technologies improve to meet participants’ diverse and often complex needs. Consequences also depend on the extent to which regulators determine that the existing market structure needs to be reformed or scaled back because of technological limitations.
Cash equities markets are now almost entirely electronic and dependent on sophisticated computer technologies. Last week’s failure, the cause of which is still under investigation, was the latest in a series of high-profile issues that have surfaced in recent years. These issues include the “flash-crash” in 2010, problems with the initial public offerings of Facebook, Inc. (unrated) and BATS Global Markets, Inc. (B1 positive) in 2012, and the two-day widespread market shutdown resulting from Superstorm Sandy in 2012.
In response to last week’s event, US Securities and Exchange Commission (SEC) Chairman Mary Jo White indicated she would advance SEC proposals made in March 2013 to update the automated system standards of various market participants, including exchanges and alternative trading systems. She also plans to convene a meeting of the exchanges and other market participants to accelerate efforts to strengthen the markets.
Increased regulatory scrutiny and higher compliance and technology costs would be credit negative for exchanges and execution venues, especially in an increasingly competitive environment with shrinking market volumes and reduced profit margins (see exhibit). Last week’s outage is especially negative for NASDAQ, coming so soon after the problems with its initial public offering of Facebook, and since recurring issues of this nature could weaken franchise value and lead to enhanced regulatory scrutiny and additional fines.
Donald Robertson Vice President - Senior Credit Officer +1.212.553.4762 [email protected]
NEWS & ANALYSIS Credit implications of current events
10 MOODY’S CREDIT OUTLOOK 29 AUGUST 2013
US Equity Exchanges’ Trading Volumes and Profit Margins Have Been Declining
[1] Last 12 months ended 30 June 2013. Source: NYSE Euronext Matched Volume Summary, company filings
The SEC’s proposed rules include stipulations that entities should do the following:
» Establish written policies and procedures to ensure that their systems have adequate capacity, integrity, resiliency, availability and security to maintain their operational capability, and that they operate in the manner intended
» Participate in business continuity and disaster recovery plans, including backup systems, and coordinate such testing on an industry-wide basis with other entities
» Provide notices and reports to the SEC, and take relevant corrective actions, regarding systems issues including disruptions, compliance issues, intrusions and material changes
» Provide information regarding certain systems issues to other regulated entities
» Review their systems at least annually
These proposals seek to ensure that exchanges maintain and improve controls and technologies to a level that meets market participants’ evolving needs. Such an outcome would benefit bondholders of traditional exchanges if it resulted in a more stable marketplace with reasonable ongoing compliance costs.
The unknown factor with potentially significant industry effects is the regulatory treatment of high-frequency trading firms. Since the trading activities of these firms have been a significant contributor to transactional activity, and their evolution has coincided with increased control challenges at the exchanges, securities regulators might determine that these activities are part of the problem and should be curtailed in some manner. This is not part of the SEC’s current regulatory proposals, but would be more likely if the above proposals are implemented and the markets still experience broad disruptions. Curtailing the activity of these firms would result in further reductions in trading volumes, which would negatively affect the exchanges’ creditworthiness.
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NEWS & ANALYSIS Credit implications of current events
11 MOODY’S CREDIT OUTLOOK 29 AUGUST 2013
Colombia’s Law for Guarantees Is Credit Positive for Banks On 20 August, Colombian President Juan Manuel Santos signed into law Ley 1676 de Garantías Mobiliarias, which establishes norms and procedures regarding the use of non-real-estate goods as guarantees. The new law is credit positive for all Colombian banks and non-bank financial institutions because the legal framework around the guarantees will establish a more secure mechanism for repossession in case of default when lending to individuals and small and midsize enterprises (SMEs).
The new law establishes clear rules for borrowers to use any item with an economic value as a guarantee, including inventories, receivables, machinery, accounts payable and future flows, all of which are what SMEs and individuals pledge when seeking financing from financial institutions. The Colombian Confederation of Chambers of Commerce (Confecámaras) will establish a new nationwide registry to provide easy verification of guarantees.
The lack of a recovery mechanism had been a major obstacle for banks wanting to make asset-backed loans to individuals or receivables-backed loans to SMEs. We expect the new law to promote easier access to credit.
The law is also credit positive because a clearer legal framework will allow these types of guarantees to be accepted within Colombia’s Organic Law of the Financial System. If guarantees are deemed admissible, banks can apply lower loss rates when calculating provisioning requirements established by the banking regulator. The loss given default of loans without a guarantee ranges between 55% and 60%, versus a real estate guarantee’s loss given default of 40%.
The new law encourages SME and retail lending in a country where 61% of loans are commercial loans, with considerable concentrations in Colombia’s large and complex economic and financial groups. A greater focus on SME and retail lending could also increase intermediation in Colombia, from its current 42% loans to GDP, to something comparable to Brazil’s 54% or Chile’s 77%.
Felipe Carvallo Vice President - Senior Analyst +52.55.1253.5738 [email protected]
NEWS & ANALYSIS Credit implications of current events
12 MOODY’S CREDIT OUTLOOK 29 AUGUST 2013
Bank of Israel Moves to Protect Banks from Mortgage Lending Risks Last Thursday, the Bank of Israel (BoI) published new draft guidelines for mortgage loans, including capping monthly repayments to a maximum of 50% of monthly salaries, limiting the portion of a loan at a variable interest rate and keeping repayment periods to no longer than 30 years. The Israeli central bank’s new guidelines, the latest in a series of measures taken by the BoI recently, are credit positive for Israeli banks because they raise affordability requirements and reduce the risk of variable-rate loans in rising interest rates. However, because house prices continue rising, the credit risk of mortgage lending continues to increase.
The draft guidelines, which take effect 1 September, call for the following:
» Limiting monthly repayments/instalments to a maximum of 50% of a borrower’s monthly salary. In addition, housing loans in which the monthly repayment is between 40% and 50% of monthly salary will be risk-weighted at 100% for the purpose of calculating capital adequacy ratios
» Limiting the portion of the loan at a variable interest rate to a maximum of 66.7%
» Limiting housing loan tenors to no more than 30 years
These new guidelines seek to protect banks against the risks of unemployment and rising interest rates that would increase variable-rate mortgage payments. According to the BoI, 17% of loans are from borrowers that dedicate more than 40% of their monthly income to mortgage payments, while a significant 72% of loans have variable interest rates.
According to the BoI, new housing loan repayments as a share of available income rose to around 36% in 2012 from less than 30% in the years prior to 2009. A sensitivity analysis performed by the BoI revealed that a four-percentage-point increase in interest rates would increase the share of high-risk loans (which the BoI defines as loans with a payment to income ratio greater than 40% and a loan-to-value ratio greater than 60%) to 14% from 7%.
Despite the new guidelines, BoI’s numerous prudential requirements and limits and a low average loan-to-value ratio of 55%, the credit risks of mortgage lending continue to increase. These stem from nominal house prices jumping 75% between December 2007 and May 2013 because of a shortage of homes relative to the population and the limited issuance of building permits, which has negatively affected the supply of homes.
Concurrently, low interest rates at 1.25% support the demand for housing both for residential purposes and as investments. As a result, mortgage loans have increased by an average annual growth rate of 7.5% over the past 10 years against a 3.5% increase in total bank credit, with the average mortgage size increasing to more than NIS550,000 from around NIS320,000 in 2008, according to Mizrahi Tefahot Bank.
NEWS & ANALYSIS Credit implications of current events
13 MOODY’S CREDIT OUTLOOK 29 AUGUST 2013
Insurers
Afianzadora Aserta’s Acquisition of HSBC Fianzas’ Mexican Surety Insurance Is Credit Positive
On 22 August, Mexico’s Grupo Financiero HSBC, S.A. de C.V. (unrated), announced that it had reached a definitive agreement to sell its surety insurance subsidiary, HSBC Fianzas, S.A. (unrated), to Afianzadora Aserta, S.A. de C.V. (financial strength Baa3/Aa3.mx stable), which is part of leading Mexican surety group Grupo Financiero Aserta, S.A. de C.V. (unrated). The parties did not reveal sale details. The transaction is credit positive for Grupo Financiero Aserta because it will strengthen the group’s market-leading position.
Although HSBC Fianzas is smaller than Grupo Financiero Aserta, the acquisition will strengthen Grupo Financiero Aserta’s market presence and should create opportunities for greater economies of scale and expense savings. With this acquisition, HSBC Fianzas will join Grupo Financiero Aserta’s other two surety companies, Afianzadora Aserta and Afianzadora Insurgentes, S.A. de C.V. (financial strength Baa3/Aa3.mx stable).
We expect Afianzadora Aserta to fund the transaction with internal resources, which will not materially affect the company’s liquidity position. The acquisition will strengthen Grupo Financiero Aserta’s capitalization and better prepare it to comply with new Solvency II regulations that take effect in Mexico in 2015. The transaction awaits regulatory approval and the companies expect the deal to close in first-quarter 2014.
Based on the Mexican surety industry’s total gross premiums written (GPW) in 2012, Grupo Financiero Aserta’s market share would increase to 26.2% from 25.5%, consolidating its leading position in the industry. The exhibit below lists Mexico’s top 10 surety insurers by gross premiums written in 2012.
Mexico’s Top 10 Surety Insurance Companies, MXN Millions
Source: Mexico’s Comisión Nacional de Seguros y Fianzas
This transaction is the second merger within the highly concentrated Mexican surety industry over the past year. Last September, ACE Limited (unrated) agreed to acquire Fianzas Monterrey, S.A. (financial strength Baa1/Aa1.mx stable), the second largest surety insurance company in Mexico, from New York Life.
José Montaño Assistant Vice President - Analyst +52.55.1253.5722 [email protected]
NEWS & ANALYSIS Credit implications of current events
14 MOODY’S CREDIT OUTLOOK 29 AUGUST 2013
ING Groep and ING Verzekeringen Benefit from Sale of South Korean Life Insurer On Monday, ING Groep N.V. (A3 negative) announced that it had reached an agreement to sell ING Life Korea (unrated) to private-equity firm MBK Partners. Although ING is selling the operation at a loss, this transaction is credit positive for ING Verzekeringen N.V. (Baa2 developing), the intermediate holding company that consolidates ING Groep’s insurance operations, because it will use the sale proceeds to repay debt and reduce leverage.
The sale is also credit positive for ING Groep because it allows the company to comply with a condition of the restructuring plan it negotiated with the European Commission (EC) in November 2012, and allows it to maintain flexibility to eliminate the group’s double leverage1 without affecting the capitalization of ING Bank N.V. (A2 negative, C-/baa1 negative).2
ING will receive €1.2 billion in cash for the sale of 100% of its life insurance business in South Korea. ING will use most of the proceeds (€1.1 billion)3 to reduce ING Verzekeringen’s debt, reducing its non-consolidated leverage to 14.6% on a pro forma basis from 17.5% as of 30 June 2012 (see Exhibit 1). However, because this transaction values the South Korean business at 0.5x its book value under International Financial Reporting Standards, the sale will generate a loss of around €1 billion for ING Groep.
EXHIBIT 1
Effect of the Sale of ING Life Korea on ING Verzekeringen’s Financial Position As of 30 June 2013 Pro forma for the sale of ING Life Korea
Hybrids issued to ING Groep €2.5 billion €2.5 billion
Hybrids issued to third parties €0.5 billion €0.5 billion
Other debt €1.7 billion €0.6 billion
Leverage B/(A+B) 17.5% 14.6%
* Excluding minority interest in ING U.S., Inc. Sources: ING, Moody’s calculations
The sale will also improve ING’s insurance operations’ overall risk profile. The majority of the policies underwritten in South Korea offered long-term fixed guarantees with an average guaranteed rate of around 4%, which exposes the group to a significant level of interest rate risk.
At ING Groep, the sale will have a negative financial effect, reducing shareholders’ equity by around €1 billion with no reduction in debt. The sale is part of a restructuring plan negotiated with the EC and which requires the divestment of all insurance operations, including at least 50% of all its Asian operations before year-end 2013. The sale of the South Korean operation is a major step towards the completion of this plan and reduces the risk of potential penalties imposed by the EC. Following the sale of the South Korean operation, the Japanese operation remains the main Asian operation ING Groep must sell.
1 Double leverage refers to the issuance of debt by a holding company to finance the equity of a subsidiary. 2 The ratings shown are ING Bank’s deposit rating, its standalone bank financial strength rating/baseline credit assessment and the
corresponding rating outlooks. 3 ING will also use part of the proceeds (€80 million) to purchase an approximate 10% equity stake in ING Life Korea through a
private-equity fund.
Benjamin Serra Vice President - Senior Analyst +33.1.53.30.10.73 [email protected]
NEWS & ANALYSIS Credit implications of current events
15 MOODY’S CREDIT OUTLOOK 29 AUGUST 2013
Despite the loss generated by the sale of the South Korean operation, the price of the transaction strengthens ING’s ability to eliminate double leverage (see Exhibit 2) without affecting ING Bank’s capitalization. To do that, ING had to sell the insurance operations for at least around 40% of their book value as of 30 June 2012.4 As of 30 June 2013, taking into account the financial effect of the sale of ING Life Korea, we estimate that the minimum sales price of the remaining insurance operations to leave ING Bank’s capital untouched is now around 30% of their book value.
EXHIBIT 2
ING Groep’s and ING Verzekeringen’s Double Leverage as of 30 June 2013 Before and After the ING Life Korea Sale
ING Groep Simplified Unconsolidated Balance Sheet, € Billions
Assets
Liabilities
ING Bank €34.4
Equity** €48.9
ING Verzekeringen** 21.1
Core Tier 1 Securities 2.2
Hybrids ING Bank 6.8
Hybrids 9.3 Hybrids ING Verzekeringen 2.5
Other debt* 4.4
ING Verzekeringen Simplified Unconsolidated Balance Sheet, € Billions
Assets
Liabilities
Europe €13.8
Equity** €21.1
US** 6.9
Hybrids Group* 2.5
Asia 2.0
Other Hybrids* 0.5
Others 2.0 Other debt* 0.6
* Shaded cells are the double leverage of ING Groep. Our calculation of the threshold sale price of ING insurance operations that leaves ING Bank’s capital untouched takes into account these liabilities.
** Excludes minority interest in ING U.S., Inc.
Sources: ING, Moody’s calculations
4 See ING Groep: Amendments to Restructuring Plan Are Credit Positive, 11 December 2012.
NEWS & ANALYSIS Credit implications of current events
16 MOODY’S CREDIT OUTLOOK 29 AUGUST 2013
Sovereigns
India’s Rising Food Subsidies Will Exacerbate Its Macroeconomic Imbalances On Monday, India’s lower house of parliament, Lok Sabha, passed the Food Security Bill, which will subsidize food grains for 75% of India’s rural population and 50% of the country’s urban population. The measure is credit negative for the Indian government (Baa3 stable) because it will raise government spending on food subsidies to about 1.2% of GDP per year from an estimated 0.8% currently, exacerbating the government’s weak finances.
As shown in Exhibit 1, India’s fiscal deficits are already higher than those of its emerging market peers. Because the bill will take effect only in the last few months of the fiscal year that ends March 2014, it will not significantly affect the fiscal 2014 budget. However, it will raise future subsidy expenditure commitments, hindering the government’s ability to consolidate its finances.
EXHIBIT 1
India’s Fiscal Balance and Government Debt Relative to Other Emerging Markets
General Government Fiscal Balance/GDP General Government Debt/GDP
2012 2013F 2012 2013F
India (Baa3 stable) -7.2% -7.2% 68.3% 66.6%
Indonesia (Baa3 ) -1.9% -2.4% 24.0% 23.7%
Turkey (Baa3) -2.0% -2.0% 36.1% 33.6%
Philippines (Ba1) -2.4% -1.9% 44.9% 42.7%
Source: Moody’s
In addition to the fiscal effect, the government subsidies will contribute to India’s already high food inflation5 (Exhibit 2).
EXHIBIT 2
India’s Inflation Is Already High CPI Year-over-Year Change Food Inflation Year-over-Year Change
As we have noted previously,6 India’s fiscal deficits contribute to the current account deficit by keeping domestic demand high, thus increasing imports. Loose fiscal policy has also underpinned recurrent inflationary pressures. Inflation further widens the current account deficit by lowering the competitiveness 5 See India’s Food Inflation Exacerbates India’s Macro-Economic Imbalances and is Credit Negative, 14 March 2013. 6 See Credit Implications of India’s Current Account Depreciation, 14 February 2013.
NEWS & ANALYSIS Credit implications of current events
17 MOODY’S CREDIT OUTLOOK 29 AUGUST 2013
of exports and of import-competing sectors. India’s current account deficit has widened in recent quarters, peaking at 6.8% of GDP in the quarter ending December 2012 from an average of 1% in the first half of the 2000s. The almost 18% depreciation of the Indian rupee against the US dollar over the past three months partly reflects this widening.
CREDIT IN DEPTH Detailed analysis of an important topic
18 MOODY’S CREDIT OUTLOOK 29 AUGUST 2013
Moody’s Review of Systemically Important US Banks – Frequently Asked Questions This is an excerpt of an article that can be found here.
On 22 August, we placed on review the ratings of the six largest US bank holding companies as we consider lowering our government (or systemic) support assumptions.7 Four – Goldman Sachs, JPMorgan Chase, Morgan Stanley and Wells Fargo – are on review for downgrade. Two, Bank of America and Citigroup, are on review direction uncertain, as we consider the potentially offsetting influence of improvements in the standalone credit strength of their main operating subsidiaries. We also included in our review the other two US banks that we consider systemically important: Bank of New York Mellon and State Street. Their ratings had previously been placed on review for downgrade, and our reassessment of government support assumptions now will be part of that review as well.
In addition, we placed on review several other ratings of the eight affected groups, also related to potential changes in government support assumptions. These reviews include subordinated debt ratings of the groups’ operating bank subsidiaries and the ratings of several of their US non-bank and non-US systemically important subsidiaries. Exhibit 1 below shows a summary of rating actions.8 The 22 August announcement followed our March research report that discussed our ongoing monitoring of developments related to support assumptions.9
In this report, we answer questions about the key drivers and implications of the current review.
7 See Moody's Reviews US Bank Holding Company Ratings to Consider Reduced Government Support, 22 August 2013. 8 For a full list of rating actions and affected ratings, click here. 9 See Reassessing Systemic Support in US Bank Ratings – An Update and FAQs, 27 March 2013.
Sean Jones Associate Managing Director +1.212.553.0845 [email protected]
David Fanger Senior Vice President +1.212.553.4342 [email protected]
CREDIT IN DEPTH Detailed analysis of an important topic
19 MOODY’S CREDIT OUTLOOK 29 AUGUST 2013
EXHIBIT 1
Summary of Direction of Reviews of Systemically Important US Banking Groups
Notes: For a full list of rating actions and affected ratings, click here.
[1] The Prime-1 ratings for Bank of New York Mellon and State Street were affirmed on 2 July 2013 when the companies' long-term ratings were originally placed on review.
WHAT PROMPTED MOODY’S TO INITIATE THE RATING REVIEW?
The reviews reflect the progress US bank regulators are making in developing single point of entry receivership (SER). In the US, SER is becoming an increasingly credible alternative to the provision of government support to avoid risks of contagion and systemic crisis that would stem from a disorderly failure of one of these institutions.
If we conclude that SER has become more likely to be executed in the future, then holding company creditors of systemically important US banks will be less likely to receive government support in the event of financial distress, signaling a higher risk of default. We also see implications for the severity of losses to US bank holding company creditors in the event of default and for the default risk of operating bank-level subordinated debt.
Lead US Bank SubsidiaryBFSR/BCA/Adjusted BCA B/aa3/aa3 Down B/aa3/aa3 Down C+/a2/a2 AFFIRM C/a3/a3 AFFIRMSenior Aa1 Down Aa2 Down Aa3 AFFIRM Aa3 AFFIRMSubordinate Aa2 Down Aa3 Down A1 Down A1 DownShort-Term Rating P-1 [1] P-1 [1] P-1 AFFIRM P-1 AFFIRM
Trust Preferred Issued By Bank-Level SubsidiariesJunior Subordinate/TruPS -- -- -- -- A3 (hyb) Down -- --
Holding Company & Holdco Guaranteed ObligationsSenior Aa3 Down A1/RUR-D Uncertain A2 Down A2 DownSubordinate A1 Down A2/RUR-D Uncertain A3 Down A3 DownJunior Subordinate/TruPS A2 (hyb) Down A3 (hyb) Down Baa1 (hyb) Down Baa2 (hyb) DownNoncumulative Preferred Baa1 (hyb) Down Baa1 (hyb) Down Baa3 (hyb) AFFIRM/-- Ba1 (hyb) AFFIRMShort-Term Rating P-1 [1] P-1 [1] P-1 Down P-1 Down
Lead US Bank SubsidiaryBFSR/BCA/Adjusted BCA C-/baa1/baa1 AFFIRM D+/baa3/baa2 AFFIRM D+/baa3/baa3 Up D+/baa3/baa3 UpSenior A2 AFFIRM A3 AFFIRM A3 Up A3 UpSubordinate -- -- -- -- Baa1 Uncertain -- --Short-Term Rating P-1 AFFIRM P-2 AFFIRM P-2 Up P-2 Up
CREDIT IN DEPTH Detailed analysis of an important topic
20 MOODY’S CREDIT OUTLOOK 29 AUGUST 2013
WHAT FACTORS ARE DRIVING MOODY’S REVIEW? HOW ARE THESE FACTORS RELATED?
We will consider several relevant factors, primarily:
» Assumptions about US government support for creditors of bank holding companies (probability of default)
» Estimated amount of losses in the event of default (loss given default)
» Default risk for subordinated creditors at the operating bank level
» Standalone credit considerations for four of the eight banks on review
The first three factors are direct implications of the developing SER concept on our assessment of systemic support in the US. They are closely linked. The fourth factor, standalone credit considerations, is unrelated to the development of SER.
WHAT IS SINGLE POINT OF ENTRY RECEIVERSHIP AND HOW WILL IT WORK?
Single point of entry receivership (SER) is the stated preferred approach of the Federal Deposit Insurance Corporation (FDIC) to implement the Orderly Liquidation Authority (OLA) enacted as part of the Dodd-Frank Act. SER is a response to the demands and limits set by the Dodd Frank Act, which states that taxpayer funds cannot be used to recapitalize banks but also requires the FDIC under OLA to mitigate the potential for adverse effects to the financial system, maximize the value of the company’s assets, minimize losses, and minimize moral hazard.
Dodd-Frank gives the FDIC the legislative authority to put a bank holding company into resolution, which in the past it did not have. The Act also restricts the ability of the Federal Reserve to provide idiosyncratic support, such as unusual secured credit, to a specific bank holding company in order to prevent a systemic crisis.
Under SER, US regulators aim to use the resources of the holding company to recapitalize a banking group, providing an alternative to using taxpayer funds. The intent is to mitigate contagion risks by maintaining the operations of systemically important subsidiaries under a recapitalized bridge holding company, supported by liquidity from the US Treasury. Exhibit 3 illustrates the SER framework. The SER process is described in more detail in our March 2013 special comment.10
10 See Reassessing Systemic Support in US Bank Ratings – An Update and FAQs, 27 March 2013.
CREDIT IN DEPTH Detailed analysis of an important topic
21 MOODY’S CREDIT OUTLOOK 29 AUGUST 2013
EXHIBIT 2
Single Entry Receivership – A Schematic Depiction
1. Authorities choose OLA (Title II of Dodd-Frank) for a troubled SIFI instead of seizing the bank and putting the holding company into bankruptcy.
2. A new bridge holding company is formed with a new management team. 3. All systemically important operating subsidiaries are transferred to the bridge holding company. 4. Holding company equity is wiped out and holding company debt could be written down or exchanged for a combination of new debt and
equity in the bridge holding company. Bridge holding company recapitalizes subsidiaries, as necessary. 5. The US government provides temporary liquidity to the bridge holding company, and the bridge holding company funds subsidiaries, as
necessary, through intra-company advances. Source: Moody’s, Federal Deposit Insurance Corporation
HOW LIKELY IS IT THAT SER WILL BE UTILIZED?
Since SER was conceived in early 2012,11 the concept has been embraced by the Federal Reserve and the FDIC. SER is also getting traction with international regulators. This growing acceptance improves the likelihood that the FDIC could obtain the needed international cooperation to successfully apply SER to banking groups with significant international operations, given a common understanding of its intent and implementation
WHY IS MOODY’S NOT REVIEWING THE SENIOR RATINGS AT THE OPERATING COMPANY LEVEL OF SYSTEMICALLY IMPORTANT US BANKS, EXCEPT WHERE MOODY’S IS ALSO REVIEWING THE BANKS’ STAND-ALONE CREDIT PROFILES?
Our government support assumptions at the operating company level for the eight systemically important US banks have historically been very high or high. As a result, the bank-level deposit and senior debt ratings of these institutions are one to three notches higher than their standalone credit assessments.
The goal behind the SER framework is to resolve a systemically important, distressed banking group without using taxpayer funds and without causing a broader financial crisis that may result from losses for senior creditors at the operating company level. To achieve this goal, holding company creditors incur losses, or are “bailed in” under SER. The bail-in of holding company creditors can be seen as a substitute for government support that would have been necessary to prevent a systemically important bank’s failure without SER. Given the government’s goal under SER is to maintain the operating companies intact, which would benefit senior bank-level creditors, we currently expect no significant change in the risk position of these creditors.
11 See FDIC presentation Resolution Strategy Overview, 25 January 2012.
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22 MOODY’S CREDIT OUTLOOK 29 AUGUST 2013
Moreover, there is some likelihood that, despite Orderly Liquidation Authority (OLA) and SER, US authorities may feel compelled to provide direct support to senior bank-level creditors of systemically important institutions to prevent contagion and risks to the economy from a contraction of credit.
In addition, if SER were utilized but the amount of debt at the holding company was insufficient to recapitalize the company and prevent a default at the operating bank, then we believe the US government may feel compelled to provide additional support to senior operating company creditors to prevent contagion and systemic disruption.
WHY HAS MOODY’S PLACED SUBORDINATED DEBT AT THE OPERATING COMPANY LEVEL ON REVIEW FOR DOWNGRADE?
We recognize that the aim of SER is to allow systemically important operating subsidiaries to continue to operate without defaulting on their own obligations, even if holding company creditors experience a default. Still, we believe subordinated creditors at the operating level may well face increased credit risk.
The initial focus under SER is on utilizing resources at the holding company to support the operating subsidiaries. But if US bank regulators believe additional resources may be warranted, we believe that regulators might also consider impairing bank-level subordinated debt through a distressed debt exchange. This would provide additional capital for an operating subsidiary by imposing losses on subordinated creditors, while potentially keeping its operations and franchise intact.
Furthermore, if SER turned out to not be sufficient to prevent a default at the operating bank, we believe bank-level subordinated creditors are unlikely to benefit from any additional systemic support. Senior creditors at the operating bank level, by contrast, might benefit from additional support.
Please go here, for answers to other frequently asked questions.
RECENTLY IN CREDIT OUTLOOK Select any article below to go to last Monday’s Credit Outlook on moodys.com
23 MOODY’S CREDIT OUTLOOK 29 AUGUST 2013
NEWS & ANALYSIS Corporates 2
» Sears' Weak Earnings Reveal Credit Negative Trends » Polymer's Bid for Fiberweb, if Debt-Funded, Would Be Credit
Negative » Gold Fields' Acquisition of Barrick's Yilgarn South Mines Is
Credit Positive » Thai Beverage Uses Fraser & Neave Proceeds to Pay Down
Debt » China Railway Construction Will Benefit from Accelerated
Railway Development
Banks 8
» US Banks Benefit from Fed's Appeal of Court-Ordered Swipe Fee Cuts
» Ally Financial's Plan to Sell Shares and Buy Back Preferred Securities Is Credit Positive
» Bolivia's New Financial Law Will Hurt Banks' Profitability » UK Regulator's Fine Against British Banks Is Credit Negative » Lloyds Boosts Capital Ratio with Heidelberger
Lebensversicherung Sale » Higher GDP Growth Is Not Credit Positive for German Banks » Spanish Banks' Nonperforming Loan Ratio Rises to 11.6% » Turkey Proposes Stricter Regulations on Credit Card Loans, a
Credit Positive
Insurers 21 » Modest Increase in Employer Health Premiums Is Credit
Positive for Insurers
RATINGS & RESEARCH Rating Changes 23
Last week, we upgraded CDW Corporation, CenterPoint Energy/CenterPoint Energy Houston Electric, Empresa Electrica de Guatemala, Mortgage Guaranty Insurance, and downgraded Italcementi, Nokia Oyj, Peabody Energy, Weight Watchers International, Elwood Energy, EquiPower Resources, Teplarna Strakonice, Prominvest Bank, and Bridgeport Connecticut among other rating actions.
Research Highlights 32
Last week, we published on US telecommunications towers, Indian oil companies, European building materials, Asian Pacific oil and gas, Canadian wireless, systemically important US banks, Taiwanese banks, US life insurers, US P&C insurers, Canadian life insurers, European money market funds, Oman, Eastern Caribbean Currency Union, Georgia, Cambodia, North Carolina, US local governments, US states, Japanese CMBS, European CLOs, New Zealand RMBS, and our US CMBS delinquency tracker, among other reports.
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EDITORS PRODUCTION ASSOCIATE News & Analysis: Jay Sherman and Elisa Herr Alisa Llorens
