MOODYS.COM 14 SEPTEMBER 2017 NEWS & ANALYSIS Mexico’s Earthquake 2 » Credit Effects of Mexico’s Earthquake Are Limited Corporates 4 » Tanzanian Government’s Actions Are Credit Negative for Petra Diamonds » Yuzhou's Share Issuance Would Be Credit Positive Infrastructure 7 » Hurricane Irma Negatively Affects Caribbean Infrastructure Concessions Banks 8 » Credit Agricole’s Planned Sale of Stake in Banque Saudi Fransi Is Credit Positive » Natixis Acquires BPCE Assurances as a 100% Subsidiary, a Credit Positive Asset Managers 11 » Smart-Beta ETF Price War Is Credit Negative for Traditional Active Equity Managers Sub-sovereigns 13 » Mexico's Budget Proposal Is Credit Positive for Mexican States RECENTLY IN CREDIT OUTLOOK » Articles in Last Monday’s Credit Outlook 16 » 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.
Transcript
MOODYS.COM
14 SEPTEMBER 2017
NEWS & ANALYSIS Mexico’s Earthquake 2 » Credit Effects of Mexico’s Earthquake Are Limited
Corporates 4 » Tanzanian Government’s Actions Are Credit Negative for
Petra Diamonds » Yuzhou's Share Issuance Would Be Credit Positive
Banks 8 » Credit Agricole’s Planned Sale of Stake in Banque Saudi Fransi
Is Credit Positive » Natixis Acquires BPCE Assurances as a 100% Subsidiary, a
Credit Positive
Asset Managers 11 » Smart-Beta ETF Price War Is Credit Negative for Traditional
Active Equity Managers
Sub-sovereigns 13 » Mexico's Budget Proposal Is Credit Positive for Mexican States
RECENTLY IN CREDIT OUTLOOK
» Articles in Last Monday’s Credit Outlook 16 » 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 14 SEPTEMBER 2017 8
Mexico’s Earthquake
Credit Effects of Mexico’s Earthquake Are Limited Last Thursday, a magnitude 8.1 earthquake hit the southeastern coast of Mexico, the strongest quake in Mexico in 100 years. Although the quake exacted a tragic human toll, with at least 90 dead, the effects were largely limited to the small coastal states of Oaxaca (Ba3 negative) and Chiapas (Ba2 negative), and to a lesser extent the southwestern gulf state of Tabasco (Ba1 negative). Both Oaxaca and Chiapas will likely face short-term liquidity pressure, while banks, insurers and our rated residential mortgage-backed securities (RMBS) portfolio have little direct exposure to the affected areas.
The earthquake was stronger than the 1985 quake that inflicted significant damage and widespread loss of life in the nation’s capital, Mexico City. However, its effects appear to be much more limited than the 1985 quake because the epicenter was much farther from the city. Although the tremors could be felt as far away as Mexico City, approximately 450 miles to the north, there was little to no damage there or in the rest of the country. Even within the states of Oaxaca and Chiapas, the largest population centers, including the capital cities of Oaxaca and Tuxtla Gutiérrez, were largely spared; smaller cities nearer the coast were the hardest hit.
The states that were most affected are among the poorest and least developed in the country, with income levels less than 50% of the national average. Together, Oaxaca and Chiapas account for just 7.6% of Mexico’s population and 3.3% of its GDP. Hence, we do not expect the earthquake to have a significant effect on the country’s aggregate economic activity, and the monetary value of the property damage is likely to be quite limited. In contrast, damages from the 1985 earthquake equaled around 2.4% of GDP at the time.
LIMITED EFFECT ON INSURERS AND BANKS
The earthquake’s effect on Mexican property and casualty insurers will be limited. Insurance penetration in the states of Chiapas and Oaxaca is below the national average; catastrophic insured values for these two states account for just over 1% of total earthquake insured value in Mexico. Moreover, Mexican insurers hold MXN20.6 billion ($1.2 billion) in specific federally regulated catastrophic reserves created in accordance with regulations that we expect insurers will be permitted to use to cover losses related to the earthquake. Mexican insurers also use international reinsurance to transfer a significant part of their risk.
We expect that the effect on banks will be similarly limited because the affected areas are even more underbanked than Mexico’s already-low average. Had the quake struck closer to the nation’s capital, which accounts for a hefty 31.2% of total loans and 50.7% of banks’ residential mortgage portfolio, the effect could have been far more severe. However, Chiapas, Oaxaca and Tabasco together accounted for less than 1% of banking system total loans as of June. Although homes and infrastructure bore the brunt of the damage, mortgages in those states total just 1.8% of banks’ mortgage loan book. Furthermore, residential mortgages in Mexico have mandatory insurance that will cover losses related to the earthquake.
STATE GOVERNMENTS OF CHIAPAS AND OAXACA WILL LIKELY FACE LIQUIDITY PRESSURES Although the state governments of Oaxaca and Chiapas will likely face significant reconstruction costs relative to their limited resources, the federal government will provide the bulk of funding for reconstruction. Both states qualify for resources from Mexico’s Natural Disaster Fund (Fonden). As of June, MXN7.3 billion had been approved to cover costs associated with reconstruction following natural disasters in the country.
Aaron Freedman Associate Managing Director +52.55.1253.5713 [email protected]
Francisco Jose Uriostegui Analyst +52.551.253.5728 [email protected]
Felipe Carvallo Vice President - Senior Analyst +52.55.1253.5738 [email protected]
Maria del Carmen Martinez-Richa Vice President - Senior Analyst +52.55.1253.5729 [email protected]
Joel Sanchez Hernandez Assistant Vice President - Analyst +52.55.1253.5726 [email protected]
NEWS & ANALYSIS Credit implications of current events
3 MOODY’S CREDIT OUTLOOK 14 SEPTEMBER 2017
The states could nevertheless face liquidity pressure if there is a delay in the delivery of Fonden funds. Both states have average liquidity: as of June, Chiapas’ cash and equivalents were MXN7.6 billion, or 8.6% of annual expenditures, while Oaxaca’s totaled MXN7 billion, or 10% of expenditures. However, Oaxaca is less vulnerable than Chiapas because it holds insurance for natural disasters and Fonden funds are disbursed more rapidly for states that hold this type of protection.
DIVERSIFICATION MITIGATES EXPOSURE OF MEXICAN RMBS TO NATURAL DISASTERS Less than 3% of the underlying properties backing RMBS that we rate are located in Chiapas, Oaxaca and Tabasco, mitigating potential effects (see exhibit). Moreover, as with banks’ mortgage loan portfolios, our rated RMBS deals’ exposures to natural disasters are reasonably mitigated by a range of insurance products and programs designed to protect assets and prevent payment deterioration. Specifically, securitized mortgages in Mexico are covered against both physical damage and death or permanent disability of the borrower. The governing documents of RMBS transactions give the issuing trust first priority on all cash flows from insurance claims.
Moody’s-Rated RMBS Portfolios’ Exposure to Earthquake-Prone Areas of Mexico
Source: Moody’s Investors Service calculations, based on information provided by primary servicers
However, insurance claims may not be successful if the securitization’s primary servicer does not have strong operations and complete credit files. The claim timeline is uncertain, and delays in claims payments could disrupt deal cash flows if the primary servicer is unable to advance insurance premiums to the trust while claims payments are pending.
Earthquake Risk
Earthquake Impact
Chiapas1.2%
Oaxaca0.6%
Tabasco1.2%
Mexico City6%
Mexico12%
Puebla3%
Veracruz4%
NEWS & ANALYSIS Credit implications of current events
4 MOODY’S CREDIT OUTLOOK 14 SEPTEMBER 2017
Corporates
Tanzanian Government’s Actions Are Credit Negative for Petra Diamonds On Monday, Petra Diamonds Limited (B1 stable) announced that it had temporarily suspended operations at its Williamson mine in Tanzania after the government on Saturday seized a consignment of diamonds from the mine. The government has indicated its intent to nationalise the diamonds, which the Tanzanian government’s Diamonds and Gemstones valuation agency estimated were worth $14.7 million. Tanzania’s Finance and Planning Ministry disputes that valuation, saying the diamonds are worth $29.5 million. In a statement last Thursday, the Finance and Planning Ministry said that it would be launching a probe into irregularities around the valuation of Petra’s diamond exports. These developments are credit negative for Petra and will dent group profitability and adversely affect the company’s ability to meet its December 2017 bank covenant test.
Although Williamson contributes less than 5% to Petra’s EBITDA, and key personnel are in discussions with the government to resolve the matter, the company may be forced to put the mine on care and maintenance until it finds a suitable solution. The loss of revenue would make it likely that Petra would have to seek a waiver from its banking consortium, as it has in the past, for its December 2017 bank covenant test (see exhibit). Putting the mine on care and maintenance would slow the company’s deleveraging momentum, although not materially.
Petra’s Net Debt/EBITDA, as Defined by Bank Covenants Petra’s net debt/EBITDA covenants would likely be challenged at the December 2017 test if the Williamson mine is put on care and maintenance.
Sources: Company data and Moody’s Investors Service forecasts
Petra’s banking covenants are tighter than usual for a B1 mining company, which makes any deviation in Petra’s business plan immediately transparent to the banking consortium of South African banks.
The Tanzanian government’s Diamonds and Gemstones valuation agency, not Petra, make the provisional valuation of diamond parcels from Williamson before they are exported to Antwerp, Belgium. The government also has full oversight of the diamonds produced at the mine, and physical controls by a number of different government representatives in conjunction with Petra from the point of recovery until the point of sale.
4.00x
4.00x
0.0x
0.5x
1.0x
1.5x
2.0x
2.5x
3.0x
3.5x
4.0x
4.5x
Jun 2017 Dec 2017 Jun 2018 Dec 2018 Jun 2019 Dec 2019 Jun 2020
Scenario: Williamson Producing Scenario: Williamson Care and Maintenance Covenant-Required Ratio
Douglas Rowlings Vice President - Senior Analyst +971.4.237.9543 [email protected]
NEWS & ANALYSIS Credit implications of current events
5 MOODY’S CREDIT OUTLOOK 14 SEPTEMBER 2017
The government intends to double the mining sector’s contribution to GDP to 10% by 2025. In July 2017, Tanzania increased royalty rates to 6%. Williamson was previously subject to a 5% royalty. All final royalty payments to the Tanzanian government are based on the diamonds’ actual sales results in Antwerp. Tanzania’s diamonds and gemstones agency monitors the sales process.
The Tanzanian government in July 2017 also added a 1% levy on all mineral exports from country. At the same time, it introduced new laws allowing the government to renegotiate previously agreed mining contracts. Tanzania President John Magufuli in a television broadcast last Thursday announced a review of Petra’s diamond mining contract, which could have far reaching implications for the company. Mr. Magufuli also alleged widespread irregularities leading to unfavourable contracts and loss of government revenue across the entire gem industry.
Petra’s Williamson mine is 75%-owned by Petra and 25%-owned by the Tanzanian government. The government last Thursday also alluded to gross irregularities over its dilution of its original 50% stake in the mine.
We expect that Petra will continue to engage constructively with the Tanzanian authorities, but cannot predict how long the valuation dispute around the diamond exports will take to resolve. It is too early to assess the consequences of the government investigations into other irregularities.
NEWS & ANALYSIS Credit implications of current events
6 MOODY’S CREDIT OUTLOOK 14 SEPTEMBER 2017
Yuzhou’s Share Issuance Would Be Credit Positive Last Thursday, Yuzhou Properties Company Limited (B1 positive) announced a share subscription that will raise net proceeds of around HKD1.56 billion. The issuance, pending approval by the Hong Kong Exchange, would provide additional funding for Yuzhou’s growing property development business and slow its debt growth, a credit positive for the company. We expect the issuance to be completed this month.
We estimate that pro forma for the issuance, Yuzhou’s adjusted debt/total capitalization will decrease to 69.9% from 72.4% at the end of June 2017. In addition, we expect that Yuzhou’s debt leverage, as measured by revenue/adjusted debt, will trend toward 70% over the next 12-18 months from 52% for the 12 months that ended 30 June 2017, largely supported by the new equity funding and our expectation of strong revenue growth.
Yuzhou’s revenue will likely grow 30%-40% over the next 12-18 months, supported by strong contracted property sales. Its contracted sales increased by 59% year on year to RMB26.7 billion in the first eight months of this year, after growing 65.5% year on year to RMB23.2 billion in 2016. The company’s year-to-date sales put it on track to meet its revised full-year sales target of RMB40 billion.
To support its growth, Yuzhou has been active in land acquisitions following its strong sales performance over the past 12-18 months. The funds raised from the proposed share subscription will be able to support its land acquisitions and working capital needs in the second half of 2017.
Yuzhou is a Shanghai-based property developer that focuses on residential housing in the West Strait Economic Zone and Yangtze River Delta. At the end of July, it had a land bank of more than 10.1 million square meters in terms of total saleable gross floor area.
NEWS & ANALYSIS Credit implications of current events
7 MOODY’S CREDIT OUTLOOK 14 SEPTEMBER 2017
Infrastructure
Hurricane Irma Negatively Affects Caribbean Infrastructure Concessions Between 6 and 8 September, Hurricane Irma caused material damage to infrastructure in the Caribbean, but credit-negative effects vary across islands. The island of St. Maarten (Baa2 stable) was among the most affected. Princess Juliana International Airport (SXM) in St. Maarten had not resumed regular commercial operations as of Tuesday evening, although the extent of its damages were unknown as of publication.
SXM is owned by Princess Juliana Intl Airport Op Company N.V. (Baa2 stable), which the St. Maarten government wholly owns. The airport is a key infrastructure asset and a critical gateway for emergency support to the island. Non-commercial emergency operations have resumed and we expect that the airport will benefit from extraordinary support from the government of St. Maarten.
Nonetheless, tourism travel, the large majority of traffic and revenue for the airport, will have a profound and lasting reduction. We anticipate that the airport will have enough liquidity to meet debt service payments in the next six months, and that if its cash generation capacity is materially affected over the next 12 months, the airport would be able to draw additional liquidity from the six-month debt-service reserve.
Other rated infrastructure assets in the region, Aerostar Airport Holdings, LLC (Ba2 negative) and Metropistas (Ba3 negative) in Puerto Rico and Aeropuertos Dominicanos Siglo XXI, S.A. (Ba3 stable) in the Dominican Republic appear not to have been materially affected by the hurricane. We anticipate that post-hurricane traffic declines will be short lived and that operations will resume to a closer-to-normal trend before year-end.
Adrian Garza, CFA Vice President - Senior Analyst +52.55.1253.5709 [email protected]
NEWS & ANALYSIS Credit implications of current events
8 MOODY’S CREDIT OUTLOOK 14 SEPTEMBER 2017
Banks
Credit Agricole’s Planned Sale of Stake in Banque Saudi Fransi Is Credit Positive On Tuesday, Credit Agricole S.A. (CASA, A1/A1 stable, baa31) announced that its subsidiary Credit Agricole Corporate and Investment Bank (CACIB, A1/A1 stable, ba2) would sell a 16.2% stake in Banque Saudi Fransi (BSF, A1 stable, a3) to Kingdom Holding Company (unrated), a Saudi investment holding, for approximately €1.3 billion in cash. The transaction, which requires regulatory approval and which CASA expects to close by the end of the year, would reduce CACIB’s shareholding in BSF to 14.9%, a credit positive because it would improve CASA’s fully loaded common equity Tier 1 (CET1) ratio and reduce its stake in a non-core asset.
In the transaction, CACIB would sell 16.2% of BSF’s shares and potentially dispose of another 5% of shares in a private sale. However, CACIB is committed to keeping a stake of at least 9.9% in BSF for at least another year. CASA has been active in Saudi Arabia since 1949 and associated with BSF since its creation in 1977. Saudi Arabia remains an attractive country for CACIB, which intends to further develop its direct presence and activities there. Nonetheless, the disposal is in line with CASA’s strategy to focus on Western Europe and reduce its non-controlling participations.
In addition, the planned divestment would strengthen the fully loaded CET1 ratios of Group Credit Agricole (GCA) by five basis points and CASA by 20 basis points. BSF would be deconsolidated in GCA and CASA’s accounts2 and accounted for under available-for-sale financial institutions at fair value. The increase in regulatory capital would help compensate for the negative effect on CET1 of purchasing Pioneer Investments in December 2016 (43 basis points for GCA and 76 basis points for CASA3) and the recent non-binding offer for three Italian banks (less than 10 basis points each for GCA and CASA), and bring GCA closer to its CET1 target of 16% by 2020 versus a fully loaded CET1 ratio of 15% at 30 June 2017. The disposal also would increase the share available in cash of CASA’s reported net income by reducing the share of net income from investments accounted for under the equity method, a trend since the transfer in 2016 of CASA’s 25% stake in the French regional banks it owned and the disposal of its Eurazeo stake in June 2017.
The full effect on BSF of CASA’s reduced stake will take some time to crystallise. Although BSF’s association with CACIB, and by extension CASA, has benefited its development and standards through transfers of operational and technological expertise both on the commercial and risk management sides, BSF has always operated as a standalone Saudi domestic bank. BSF has focused on its strong domestic corporate banking franchise and we expect limited change in that area. We also expect that CACIB will remain an essential partner for the bank’s management through its remaining ownership in the next few years, while various service and management agreements also will remain in place until further notice. Finally, the acquirer, Kingdom Holding Company, is a longstanding and material investor in Citigroup Inc. (Baa1 stable) and would bring solid experience in global financial systems, combined with a commitment to Saudi Arabia’s development.
1 The bank ratings shown in this report are the bank’s deposit rating, senior unsecured debt rating (where available) and baseline
credit assessment. 2 This participation is currently accounted for under the equity method. 3 The integration of Pioneer Investments in GCA’s accounts will start as of the third quarter of 2017.
Guillaume Lucien-Baugas Vice President - Senior Analyst +33.1.5330.3350 [email protected]
NEWS & ANALYSIS Credit implications of current events
9 MOODY’S CREDIT OUTLOOK 14 SEPTEMBER 2017
Natixis Acquires BPCE Assurances as a 100% Subsidiary, a Credit Positive Last Thursday, Natixis (A2/A2 positive, ba14) announced that it had agreed with French insurance mutual companies MACIF (A2 stable) and MAIF (unrated) to buy their 40% stake in BPCE Assurances, making BPCE Assurances a 100% subsidiary of Natixis. The transaction moves Natixis’ parent, Groupe BPCE (unrated), another step closer to creating a full-fledged insurance franchise and is credit positive for both Natixis, a France-based bank, and Groupe BPCE because it consolidates their insurance activities, a growing source of profitability for the group.
Groupe BPCE insurance activities so far have been spread across multiple entities and business models (see Exhibit 1). This multiple-partner structure prevented synergies and deprived the group of part of the net profit generated by the sale of insurance products through the bank’s retail network, a key pillar of Groupe BPCE’s 2014-17 strategy.
EXHIBIT 1
Breakdown of Groupe BPCE’s Insurance Activities Insurance Type Groupe BPCE Insurance Entity Shareholding Distribution Network
Life Insurance Natixis Life Natixis' full subsidiary Banques Populaires
Partnership with CNP Assurance (modified from 1 January 2016) Caisses d'Epargne
BPCE Vie Natixis' full subsidiary Banques Populaires and Caisses d'Epargne
Personal Protection BPCE Prévoyance Natixis' full subsidiary Banques Populaires and Caisses
d'Epargne
Partnership with CNP Assurance (modified from 1 January 2016) Caisses d'Epargne
BPCE Prévoyance Natixis' full subsidiary Banques Populaires and Caisses d'Epargne
BPCE IARD Joint venture between Natixis (50%) and Covea (50%)
Banques Populaires and Caisses d'Epargne
Source: Groupe BPCE
In order to develop a single and coherent insurance platform within Natixis, Groupe BPCE has since year-end 2015 streamlined its insurance business. A first step was to create, in January 2016, a new partnership with CNP Assurances, which allowed the group to internalize life insurance contracts distributed within the Caisses d’Epargne (CE) network. Although CNP Assurances has managed all life insurance contracts distributed to CE customers so far, the new agreement transfers new life contracts to Natixis and the outstanding amount as of December 2015 is partly reinsured by Groupe BPCE. This translated into a 42% increase in Natixis’ life insurance business’ turnover in 2016.
The second step was Natixis’ acquisition of the 40% stake in BPCE Assurances, which collected €856 million of premium income in 2016. This acquisition will internalize 100% of property and casualty insurance distributed to CE’s customers and health insurance commercialized in both CE and Banques Populaires (BP) networks. It also will increase Natixis’ profits in non-life insurance and will allow the bank to fully implement its insurance growth strategy.
4 The bank ratings shown in this report are Natixis’ deposit rating, senior unsecured debt and baseline credit assessment.
Laurent Le Mouël Vice President - Senior Analyst +33.1.5330.3340 [email protected]
NEWS & ANALYSIS Credit implications of current events
10 MOODY’S CREDIT OUTLOOK 14 SEPTEMBER 2017
We expect the third step in the strengthening of Groupe BPCE’s insurance activities to be announced in November 2017 together with the group’s updated strategy. New measures could include Natixis’ 50/50 joint-venture with Covea, BPCE IARD, which covers property and casualty insurance sold to BP customers. It collected €353 million of premium in 2016.
The effect of this operation on Natixis’ capitalization will be negligible (six basis points of common equity Tier 1 capital ratio), while BPCE Assurances generates about €60 million in annual net profit. The bank-estimated growth outlook for all of its insurance activities are above 10% per year.
Once fully achieved, Natixis’ single insurance platform will allow the bank and Groupe BPCE to implement their growth strategy in the insurance sector (with the aim of selling a property and casualty contracts to at least one third of Groupe BPCE’s customers, an increase from about one quarter in 2016). It also will rationalize the contracts’ manufacturing and distribution processes and generate increased synergies between Natixis and the retail network.
Groupe BPCE’s insurance sector is currently far below the bank’s market share in retail banking (see Exhibit 2) and we expect it to grow materially in the coming years as a result of the new strategic plan to be announced in November. Increased diversification in insurance is positive for the group’s profitability and supports BPCE’s credit.
EXHIBIT 2
Five Largest French Banks’ Market Share in Retail Banking and Insurance Revenue as a Percent of Total Revenue
Source: Banks’ 2016 annual statements
0%
5%
10%
15%
20%
25%
30%
0%
2%
4%
6%
8%
10%
12%
14%
Groupe BPCE Groupe Crédit Agricole Groupe Crédit Mutuel BNP Paribas Société Générale
Share of Insurance in Total Revenues - left axis Market Share Retail Deposits - right axis
NEWS & ANALYSIS Credit implications of current events
11 MOODY’S CREDIT OUTLOOK 14 SEPTEMBER 2017
Asset Managers
Smart-Beta ETF Price War Is Credit Negative for Traditional Active Equity Managers On Monday, Goldman Sachs Asset Management (GSAM, unrated) announced plans for a new smart-beta exchange-traded fund (ETF) priced at a nine-basis-point management fee, well below the management fees of other smart-beta ETFs, aside from those sponsored by Vanguard. GSAM’s move expands the ETF price war beyond plain vanilla ETFs into smart-beta ETFs, implying that the industry’s higher pricing assumptions for smart-beta products will not hold.
The ETF price war beyond vanilla ETFs is credit negative for traditional active equity players entering the smart-beta realm, including Legg Mason, Inc. (Baa1 negative), Franklin Resources, Inc. (A1 negative) and Janus Capital Group Inc. (Baa3 positive). It is also credit negative for existing smart-beta managers including Invesco Ltd. (A2 stable), Blackrock, Inc. (A1 positive), State Street Corporation (A1 stable), and WisdomTree (unrated), which are likely to respond with price cuts on existing products (see exhibit).
Smart-Beta Expense Ratios Ticker Fund Name Sponsor AUM $ Billions Expense Ratio
IWF iShares Russell 1000 Growth ETF BlackRock $36.62 0.20%
IWD iShares Russell 1000 Value ETF BlackRock $35.50 0.20%
NEWS & ANALYSIS Credit implications of current events
12 MOODY’S CREDIT OUTLOOK 14 SEPTEMBER 2017
Traditional active managers including Legg Mason, Franklin Resources and Janus, as participants in an industry faced with a steadily declining market share, have been investing resources in smart-beta products in hopes that it is a product category that will reignite asset growth at a modestly lower price point in between plain vanilla index funds and traditional active mutual funds. These managers viewed smart beta as a product category with which they could grow assets without too much sacrifice on revenue. Smart beta is a broad term referring to a style of investing in which portfolio holdings are not solely selected and sized based on static indexes and market capitalization. These strategies typically use quantitative methods designed to outperform a market index.
To date, most smart-beta products have been priced between 24-39 basis points (the 33rd-66th percentile of the top 100 ETFs), or approximately half of the price of the traditional actively managed equity mutual fund of 63 basis points. GSAM has a long history in quantitative investing on behalf of institutions in both traditional and alternative strategies and had earlier forays launching competitively priced products. With this recent move, GSAM is now solidifying a price point below 10 basis points for simple smart-beta strategies. Individual investors are becoming increasingly cost conscious and discerning about the value they receive for the management fees they pay. Accordingly, the segment of the fund industry receiving the most flow has been the sub-10-basis-point category.
GSAM is now the first major market participant – outside of mutually owned company Vanguard – that is signaling pricing for smart-beta products below 10 basis points, a level traditionally associated with plain vanilla index products. The plain vanilla ETF category has experienced a severe price war in which products pricing has migrated toward zero basis points, and this aggressive price competition is migrating up toward the smart-beta category.
Smart-beta products will continue to grow and attract assets at a fast pace. However, it may now be that the vast majority of smart-beta products may not be able to command a meaningful premium over vanilla index products. As a result, much of the hope and investment traditional managers placed into smart beta as a product salvation may be at risk. This is negative for traditional active managers that move into this space and expect to charge active light management fees, but will rather face a more index-like pricing environment.
NEWS & ANALYSIS Credit implications of current events
13 MOODY’S CREDIT OUTLOOK 14 SEPTEMBER 2017
Sub-sovereigns
Mexico’s Budget Proposal Is Credit Positive for Mexican States Last Friday, the government of Mexico (A3 negative) presented its 2018 budget proposal, which increases federal fund transfers to states by 4%. The increase is credit positive for the states because federal transfers account for roughly 90% of their total revenue.
We expect this increase to benefit states that have strong institutional frameworks and display prudent financial practices, including Guanajuato (Baa1 negative), Queretaro (Baa1 negative), Puebla (Baa3 negative) and Tlaxcala (Baa3 negative). As a result, increasing revenue will not be used for financing existing deficits. Instead we expect these states to strengthen their infrastructure plans in 2018.
In addition, these increases (see Exhibit 1) will partially mitigate financial pressures on states given that 2018 is a year with federal, state and municipal elections. Generally, states increase operating expenditures adjusting infrastructure to earmarked revenue coming from the federal government. In 2016, Moody’s-rated Mexican states reported consolidated results as a percent of total revenue ranging between a 5.9% deficit and a 15% surplus. If the budget is approved as it stands, we would expect that metric to range between a 5% deficit and an 8% surplus in 2018, limiting further deterioration of the states’ consolidated deficits and liquidity, especially next year.
EXHIBIT 1
Change in Federal Transfers to Mexican States
Sources: Secretaría de Hacienda y Crédito Público and the Mexican government’s 2018 federal budget proposal
There are three types of federal transfers in Mexico: participaciones, aportaciones and transferencias (see Exhibit 2). Participaciones are non-earmarked resources that can also be used as debt collateral. Participaciones equal, on average, 35% of states’ total federal transfers.
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14 MOODY’S CREDIT OUTLOOK 14 SEPTEMBER 2017
EXHIBIT 2
Participaciones and Aportaciones Are 90% of Mexico’s Federal Transfers to States
Sources: Secretaría de Hacienda y Crédito Público and the Mexican government’s 2018 federal budget proposal
According to the 2018 budget proposal, participaciones would grow 8.6%, in line with their long-term average growth of 9% (see Exhibit 3). The increase in participaciones is the result of Mexico’s forecast of 2%-3% economic growth for 2018, higher oil prices ($46 per barrel oil for 2018, versus $43 per barrel for 2017), and an increase in oil production to 1.98 million barrels per day in 2018, versus 1.94 million barrels in 2017.
EXHIBIT 3
Mexico’s Participaciones Growth
Sources: Secretaría de Hacienda y Crédito Público and the Mexican government’s 2018 federal budget proposal
Aportaciones account for 35% of states’ federal transfers. Aportaciones are transfers earmarked for basic services such as education, health and basic infrastructure. Aportaciones are programmed to increase 5.1% over 2017 levels, below its historical growth average of 7%.
NEWS & ANALYSIS Credit implications of current events
15 MOODY’S CREDIT OUTLOOK 14 SEPTEMBER 2017
Otras transferencias (other transfers) are transfers earmarked for specific projects, such as infrastructure and social programs. Otras transferencias have been the most volatile historically, and have served as a substitute for financial debt. If the budget proposal is approved, Otras transferencias would fall 13.8% (see Exhibit 4). However, we believe that since states will continue adjusting capital expenditures downward, the risk for a decrease in other transfers is limited.
EXHIBIT 4
Change in Mexico’s Federal Transfers to States
Sources: Secretaría de Hacienda y Crédito Público and the Mexican government’s 2018 federal budget proposal
-20%
-10%
0%
10%
20%
30%
40%
50%
60%
70%Participaciones Aportaciones Other transfers
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16 MOODY’S CREDIT OUTLOOK 14 SEPTEMBER 2017 8
NEWS & ANALYSIS Hurricane Irma Credit Effects 2 » Primary Insurers Will Experience Significant Losses » Traditional Reinsurers Face Heavy Losses, Mitigated by
Increased Retrocessions » Florida Hurricane Catastrophe Fund's Reimbursement Cap
Insulates It from Severe Damage » Citizens Is Well Prepared and Assessment Revenue Provides
Additional Credit Protection » Southeast US Municipal Electric Utilities Are Financially and
Operationally Resilient
Corporates 13 » United Technologies’ Planned Acquisition of Rockwell Collins
Is Credit Negative » Breach of Equifax’s Cybersecurity Is Credit Negative » H.B. Fuller’s Planned Acquisition of Royal Adhesives &
Sealants Is Credit Negative » Nomad Foods’ Share Buyback Is Credit Negative » European Food Retailers Report Mixed Results Despite
Improving Economy » Schneider Merges Its Industrial Software Business with
AVEVA, a Credit Positive » China SCE’s Proposed Share Issuance Is Credit Positive » Korean Court’s Ruling on Kia Motors’ Wage Lawsuit Is
Credit Negative
Infrastructure 22 » China Cuts Natural Gas Prices; Negative for Pipeline
Operators, Positive for Gas Distributors » Australian Utilities Agree to Promote Electricity Price
Discounts, a Credit Negative
Banks 26 » Rate Changes Are Credit Negative for BNDES, but Positive
for Private Banks » German Retail Banks Face Challenges from Low Interest
Rates, a Credit Negative » Nordea’s Headquarters Relocation to Finland from Sweden Is
Credit Negative » Belfius Bank Issues Belgium’s First Senior Non-Preferred
Bond, a Credit Positive » Russia Central Bank’s Emergency Liquidity Facility Is Credit
Positive for Banks » Uzbekistan’s Currency Devaluation Is Credit Negative for
Banks with Foreign-Currency Exposures
Insurers 38 » Proposed Discount Rate Reforms Are Credit Positive for UK
Motor Insurers and Reinsurers
Exchanges 40 » Nasdaq’s Acquisition of eVestment Is Credit Negative
Sovereigns 42 » US Debt Ceiling Risks Linger Despite Prospect of a
Brief Suspension » Peru’s Planned Boost in Public Investment in 2018 Is
with Spain’s Central Government, a Credit Negative » Uzbekistan’s Currency Depreciates 50% after Move to
Floating Rate, a Credit Negative for the Sovereign » Repeat of Kenyan Presidential Election Is Credit Negative » Extent of Credit-Negative Effect of War on South Korea
Would Depend on Magnitude
Sub-sovereigns 52 » Nordrhein-Westfalen’s Unexpected Deficit Will Delay Fiscal
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EDITORS SENIOR PRODUCTION ASSOCIATE Elisa Herr and Jay Sherman Amanda Kissoon
