NEWS & ANALYSISweb1.amchouston.com/flexshare/001/CFA/Moody's/MCO 2015 08 31… · Schlumberger’s Credit-Positive Purchase of Cameron Enhances Scale and Diversifies Business Line

MOODYS.COM

31 AUGUST 2015

NEWS & ANALYSIS Corporates 2 » Schlumberger's Credit-Positive Purchase of Cameron Enhances

Scale and Diversifies Business Line » ADP's Planned Debt-Funded Share Repurchase Is

Credit Negative » Oshkosh's US Defense Contract Win Is Credit Positive for It,

Credit Negative for AM General » CRH's Acquisition of C.R. Laurence Is Credit Negative » SoftBank's Alliance with Netflix Is Credit Positive

Banks 8 » Depressed Oil Prices Will Lead to Higher Loan-Loss Provisions

at US Banks » Expropriation of Banco de Santiago del Estero's Stake in Nuevo

Banco de la Rioja Is Credit Negative for Both » Paraguay's Interest Rate Cap on Credit Cards Is Credit Negative

for Banks » Bank of Cyprus Makes Timely Progress Implementing Its

Restructuring Plan » France Adopts European Bank Recovery and Resolution

Directive, a Credit Negative » HSH Nordbank Capital Buffers Deteriorate Amid US

Dollar Strength » Korean Banks Face Pressure from Weakness in Currencies, Oil

and Equities

Insurers 20 » Nippon Life Acquisition of Mitsui Life Would Allow

Shareholders to Exit, a Credit Positive » Recent Stock Market Decline and Volatility Are Credit Negative

for Insurers

Asset Managers 24 » BlackRock Purchase of Upstart Robo-Advisor Is Credit Positive

Sovereigns 26 » Ukraine's Bond-Restructuring Agreement Reduces Likelihood of

Near-Term Payment Moratorium » Saudi Commitment to Riyal's US Dollar Peg Lowers Reserves, a

Credit Negative » Indonesia's Tax Cuts Will Spur Credit-Positive

Economic Growth

Sub-sovereigns 31 » China Broadens Provincial Pension Fund Investment Options, a

Credit Positive

US Public Finance 33 » Hillview, Kentucky, Chapter 9 Filing Shows that Municipal

Bankruptcy Is an Increasingly Viable Option » Higher Education Benefits from Income-Driven Repayment

Plan Growth » Chicago Public Schools Assume $480 Million of Uncertain

Assistance from Illinois, a Credit Negative

RATINGS & RESEARCH Rating Changes 37

Last week, we upgraded Alcatel-Lucent, Amey Roads NI Financial and 14 US subprime RMBS, and downgraded Automatic Data Processing, Peabody Energy and AIG Taiwan Insurance, among other rating actions.

Research Highlights 43

Last week, we reported on Japanese pharmaceuticals, European real estate, Chinese technology services, global chemicals, global lodging and cruise, Chinese property developers, European gaming, US retail, Japanese issuers, Chinese banks, US property & casualty insurers, Peruvian insurers, Canadian life insurers, our global macro outlook, Mozambique, Brazil, Oman, Angola, Vietnam, Cambodia, Mexican sub-sovereigns, US community colleges, US solar ABS, US RMBS, US CMBS and Australian RMBS and covered bonds, among other research.

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NEWS & ANALYSIS Credit implications of current events

2 MOODY’S CREDIT OUTLOOK 31 AUGUST 2015

Corporates

Schlumberger’s Credit-Positive Purchase of Cameron Enhances Scale and Diversifies Business Line Last Wednesday, Schlumberger Limited (Aa3 stable) said that it had agreed to acquire Cameron International Corporation (Baa1 review for upgrade) in a $14.8 billion cash and equity deal. The acquisition is credit positive for Schlumberger and Cameron. The combination will increase Schlumberger’s scale and business line diversification with only a modest increase in financial leverage. Meanwhile, the deal creates the possibility that Cameron’s debt will be supported by a company with a stronger credit profile, and led us to put Cameron’s rating on review for upgrade.

The acquisition of Cameron extends the companies’ existing relationship in their OneSubsea joint venture. This combination will add much more oilfield equipment manufacturing to Schlumberger’s mix of products and services, which is a step away from its primary focus on oilfield services. The transaction entails inherent execution and valuation risks, but mitigating these challenges significantly from a credit perspective is the high proportion of equity funding.

The acquisition will only modestly increase Schlumberger’s existing financial leverage. The addition of Cameron’s existing $2.8 billion debt to Schlumberger will result in pro forma adjusted debt/EBITDA rising to around 1.5x from 1.4x as of 30 June 2015. The positive credit implications of the deal for Cameron depend on Schlumberger’s level of support for its debt, Cameron’s strategic importance to Schlumberger, and the Cameron notes’ structural position in the combined company’s capital structure.

The two companies have limited product overlap, with Cameron’s surface drilling, processing and flow control technologies being largely complementary to Schlumberger’s reservoir and well technologies. Management expects that reduced operating costs, streamlined supply chains and improved manufacturing processes will contribute $300 million of synergies in the first year after closing, followed by $600 million of synergies in the second year with increased revenue synergies.

Under the terms of the merger agreement, Cameron’s shareholders will receive 0.716 shares of Schlumberger stock, comprising 78% of the total purchase price, and $14.44 of cash (22%) in exchange for each Cameron share. Cameron had about $1.7 billion of cash and marketable securities as of 30 June 2015. The cash portion of the purchase price appears likely to be funded using some combination of Schlumberger’s existing cash balances and available cash held at Cameron.

Pete Speer Senior Vice President +1.212.553.4565 [email protected]

Amol Joshi Vice President - Senior Analyst +1.212.553.7267 [email protected]

This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on www.moodys.com for the most updated credit rating action information and rating history.

NEWS & ANALYSIS Credit implications of current events

3 MOODY’S CREDIT OUTLOOK 31 AUGUST 2015

ADP’s Planned Debt-Funded Share Repurchase Is Credit Negative Last Friday, Automatic Data Processing, Inc. (ADP, Aa3 stable) said that it planned to issue $2 billion in debt to fund the repurchase of an additional 25 million common shares. The planned share repurchase, ADP’s first-ever debt-funded buyback, is credit negative because it would signal an abrupt shift away from the company’s historically conservative financial practices. In response to the announcement, we downgraded the senior unsecured rating on a revenue bond backed by ADP to Aa3 from Aa1, and affirmed the company's P-1 short-term rating. The rating outlook remains stable.

By the close of ADP’s fiscal year ending 30 June 2016, we expect adjusted debt/EBITDA leverage to rise to more than 1.0x from 0.3x as of 30 June 2015. We expect free cash flow/debt to drop to below 18% from more than 75% in 2015. Even at these levels, the metrics will remain consistent with the Aa rating category.

The diminished scale of its operations from previous asset divestitures and the decreased diversification of its product portfolio have led ADP’s credit profile to gradually deteriorate over the past decade and elevated the company’s credit risk within its rating category. Still, we believe that ADP places a high value on maintaining a high credit rating in support of its payroll processing business and to maintain the trust of its customers as it moves more than $1.5 trillion in payroll, tax and benefits payments on behalf of its clients every year. The timing of cash inflows and outflows is favorable to ADP, providing the company with an opportunity to generate investment income from the float on deposited client funds, and mitigating the risk of individual clients failing to fully fund their tax and net pay obligations.

ADP is a leading service provider in the human capital management industry, which encompasses outsourced human resources, payroll, tax and benefits administration services. ADP’s customer retention rate remains above 91%: employer services clients stay with the company an average of 12 years and professional employer organization clients stay an average of seven years. ADP also has a diverse customer base, limited customer turnover owing to high switching costs, and predictable revenues, 90% of which it generates from recurring service fees.

In part because of high valuations in the human capital management industry, ADP plans to scale back acquisitions and focus more on organic growth. The company plans to increase research-and-development spending to develop new products and services and update databases and interfaces. But if these internal initiatives fail to deliver growth or compelling products, the company risks losing market share | to competitors.

After spinning off or selling non-core units, ADP’s concentration in the human capital management industry leaves it more exposed to global employment levels, especially among small and midsize enterprises. Compared with its Aa-rated peers, ADP has a relatively small revenue base of about $11 billion a year. The company faces growing competition from new service providers that use web and cloud-based services and applications to sign up new clients, especially among small and midsize enterprises, which we expect will drive most future growth.

Gerald Granovsky Senior Vice President +1.212.553.4198 [email protected]

NEWS & ANALYSIS Credit implications of current events

4 MOODY’S CREDIT OUTLOOK 31 AUGUST 2015

Oshkosh’s US Defense Contract Win Is Credit Positive for It, Credit Negative for AM General Last Tuesday, the US Department of Defense awarded Oshkosh Corporation (Ba2 stable) a $6.7 billion contract to manufacture the joint light tactical vehicle (JLTV). The announcement is credit positive because it will help reverse the recent contraction of Oshkosh’s defense business.

The development is negative for AM General LLC (Caa2 positive), which manufactures the high mobility multipurpose wheeled vehicle (commonly known as HUMVEE) that the JLTV will gradually replace. As US Army HUMVEE purchases declined sharply in 2013, so did AM General’s revenue, earnings and interest coverage. Over 2012-14, revenue fell to $527 million from $1.7 billion. Winning the JLTV contract would have significantly raised the company’s backlog and sustained the company’s position as an important wheeled-vehicle manufacturer to the US Army. Small orders from foreign and US government customers have helped sustain HUMVEE production and the global fleet is large (estimated at 230,000), which supports demand for refurbishment and parts.

Under the contract, Oshkosh expects to deliver approximately 17,000 vehicles and provide related sustainment services. The contract is favorable for Oshkosh and we do not expect it to require significant incremental and working capital investment in the next couple of years. However, it will be some time before the contract begins to contribute to the company's profitability because we expect few deliveries in the first three years.

Oshkosh’s defense segment revenue has declined sharply with the winding down of sales to the Department of Defense and declining international sales of mine-resistant ambush-protected all-terrain vehicles (M-ATVs). During the nine months that ended 30 June 2015, the company’s defense segment swung to an operating loss of $9.3 million (before corporate overhead) from operating income of $78.4 million a year earlier. During that same period, Oshkosh’s defense revenue plunged 57% to $617.9 million.

Of Oshkosh’s four key operating segments, access equipment, which manufacturers aerial work platforms and telehandlers for the construction and other industrial end markets, now accounts for more than half of the company’s revenue and nearly all of its operating income. The segment experienced strong growth following the 2008-09 economic downturn as companies replaced old equipment. But demand has weakened as aggressive re-fleeting has tapered off and appears likely to stabilize at a lower level.

Despite the pressures facing its access equipment and defense segments, Oshkosh has been able to maintain a strong balance sheet compared with other Ba2-rated companies. Even with its reduced earnings, debt/EBITDA was at about 2x for the 12 months that ended 30 June 2015, while EBITDA/interest was more than 7x.

As we have stated previously, Oshkosh’s balance sheet gave it the option of pursuing growth through acquisitions. The JLTV contract award will allow the company to grow organically, although it may still consider acquisitions for strategic reasons. As the contract generates revenue, operating income streams will be more diversified.

Even though Oshkosh has aggressively reduced costs in recent years, the defense segment’s contraction led to a reduction in profitability. As a result, we believe the decline in the company’s operating margin has been primarily the result of lost scale, which has made it difficult to absorb fixed costs in its defense segment. Oshkosh will manufacture JLTVs using many of the same assets it used to produce M-ATVs, resulting in cost synergies that could have a significant effect on segment operating income.

Paul Aran Vice President - Senior Analyst +1.212.553.7849 [email protected]

Bruce Herskovics Vice President - Senior Analyst +1.212.553.0192 [email protected]

NEWS & ANALYSIS Credit implications of current events

5 MOODY’S CREDIT OUTLOOK 31 AUGUST 2015

CRH’s Acquisition of C.R. Laurence Is Credit Negative On Thursday, CRH plc (Baa2 stable) announced that it will acquire C.R. Laurence Co., Inc. (CRL, unrated) for a total consideration of $1.3 billion (€1.2 billion) on a debt-free basis from the Friese family.

The debt-funded acquisition of CRL is credit negative because it comes on top of the purchase of the global portfolio of cement assets from Lafarge SA and Holcim Ltd in connection with their merger to form LafargeHolcim Ltd for an enterprise value of €6.5 billion. As a result, retained cash flow (RCF)/net debt will materially weaken on a pro forma 2015 basis and fall below what we consider appropriate for the Baa2 rating category.

We also anticipate adjusted gross debt/EBITDA to remain below 4.0x at 3.5x-3.7x in 2015 versus 3.8x in 2014 (Exhibit 1) and RCF/net debt to decline to 17%-18% from 27.7% at year-end 2014 (Exhibit 2). The primary drivers for our metric forecasts are a significant reduction in the company’s cash balance and the subsequent increase in net debt to fund the acquisitions, which is disproportionately larger than incremental RCF from the acquired assets.

EXHIBIT 1

CRH’s Moody’s-Adjusted Debt/EBITDA Gross leverage remains fairly unaffected as of year-end 2015 on pro forma basis.

Sources: Moody’s Financial Metrics and Moody’s Investors Service estimates

EXHIBIT 2

CRH’s Moody’s-Adjusted Retained Cash Flow/Net Debt RCF/Net Debt will temporarily dip below 20% as per pro forma 2015.

Sources: Moody’s Financial Metrics and Moody’s Investors Service estimates

3.1x

3.4x3.2x

3.5x

3.9x

3.5x-3.7x3.8x

3.0x-3.2x

2.0x

2.5x

3.0x

3.5x

4.0x

4.5x

5.0x

12/31/09 12/31/10 12/31/11 12/31/12 12/31/13 12/31/14 12/31/2015 PF 12/31/2016 PF

Actual Debt / EBITDA Forecast Debt / EBITDA

Baa3 range

Baa1 range

30.3%

26.6%

21.8%23.6% 24.3%

27.7%

17.0%-18.0%

21.0%-23.0%

10%

15%

20%

25%

30%

35%

12/31/09 12/31/10 12/31/11 12/31/12 12/31/13 12/31/14 12/31/2015 PF 12/31/2016 PF

Actual RCF / Net Debt Forecast RCF / Net Debt

Baa3 range

Baa1 range

Falk Frey Senior Vice President +49.69.707.30.712 [email protected]

NEWS & ANALYSIS Credit implications of current events

6 MOODY’S CREDIT OUTLOOK 31 AUGUST 2015

This leaves little room for deviation from anticipated performance within the next two years, especially in case of adverse market developments in the UK and US or failure to smoothly integrate acquired assets from LafargeHolcim as well as CRL. However, the Baa2 rating with a stable outlook remains unchanged following this announcement because we also anticipate a recovery of RCF/net debt to comfortably above 20% in 2016, back to the target range of the Baa2 rating for CRH, largely because of improvements in the operating performance and the consolidation of the profits and cash flows of the newly acquired assets.

CRH expects CRL to generate revenues of approximately $570 million and EBITDA of around $115 million in 2015. The acquisition will add to the diversification of CRH’s product portfolio. By combining this business with CRH’s BuildingEnvelope division, a supplier of fully integrated building envelope products (architectural glass, aluminium glazing systems) to the commercial glazing industry in North America, the company expects annual synergies in procurement, overheads, and cross-selling of $40 million from the second year onwards.

CRH will fund the roughly €1.2 billion cash consideration related to the CRL transaction by using cash on balance sheet, which was €3.3 billion at year-end 2014, and existing undrawn credit lines, which were €2.7 billion at year-end 2014. By year-end 2015, we anticipate a pro forma cash balance of roughly €1.3 billion, as the acquisition of the LafargeHolcim assets also weighs on the company’s cash position. However, we expect liquidity to remain good given the company’s cash balance and access to roughly €2.4 billion undrawn credit lines (after funding of the CRL acquisition). We also note that selective asset disposals as well as a share issuance of €1.7 billion in 2015 mitigate pressure on the company’s liquidity profile to some extent.

CRL, headquartered in Los Angeles, is North America’s leading manufacturer and distributor of high-value custom hardware products to the glazing industry and has 43 locations mainly in US and Canada with some presence in Western Europe and Australia.

NEWS & ANALYSIS Credit implications of current events

7 MOODY’S CREDIT OUTLOOK 31 AUGUST 2015

SoftBank’s Alliance with Netflix Is Credit Positive Last Monday, SoftBank Corp. (unrated), Japan’s second-largest mobile telecommunications operator in Japan by subscribers, announced that it has partnered with Netflix, Inc. (B1 stable) to launch a video streaming service in Japan on 2 September, a credit positive for SoftBank Corp. and SoftBank Group Corp. (Ba1 stable), the group holding company.

The alliance will enhance the mobile operator’s content offering, and bundle payment for customers, which will help the company retain and expand its mobile subscriber base, which was 44.4 million as of 30 June 2015. The alliance with Netflix will help SoftBank narrow the gap between it and NTT DOCOMO, INC (Aa3 stable), which had 67.5 million subscribers, as of 30 June. NTT DOCOMO also provides video-streaming subscriber services and benefits to 4.5 million subscribers. We estimate SoftBank’s current video-streaming subscribers to be approximately one third of NTT DOCOMO’s.

In an effort to penetrate the Japanese market, where terrestrial broadcasting remains dominant, Netflix (through SoftBank) will offer a competitive subscription fee starting at ¥650 ($5) per month. The price is lower than the approximately $10 that Netflix charges its customers in the US, and close to what NTT DOCOMO charges for its video streaming service. Beginning in October, SoftBank will also pre-install the Netflix application in some of the smartphones it sells.

Attractive service and product offerings can be a strong differentiating factor for SoftBank. Its alliance with Netflix will help differentiate SoftBank from its competitors and help SoftBank lower its churn rate of 1.24% for the three months to 30 June, which remains higher than NTT DOCOMO’s 0.59% and KDDI CORPORATION’s (unrated) 0.72% during the three months to 30 June. Having realized a rapid increase in subscribers, SoftBank’s churn remains higher than its competitors, which it aims to improve with better product offering, customer service and connectivity. We expect that the partnership will have a positive effect, although it is likely to have less effect than SoftBank’s debut of the iPhone in 2008, which helped SoftBank turn around its mobile business and become Japan’s second-largest mobile phone provider. Netflix content is not proprietary to SoftBank; for instance, the same content can be viewed on desktop computers and other Internet devices.

Nevertheless, an increase in video streaming usage through SoftBank’s mobile lines will help increase its average data revenue per user and result in subscribers migrating to more expensive data packages. In order to monetize increasing mobile data traffic, SoftBank and its competitors introduced in 2014 a new mobile monthly program with data plans with step-up fees along with data usage, together with a flat fee for unlimited voice calls. In contrast to increasing data traffic, usage of voice service has been declining. The new video-streaming service can also attract users to sign up for SoftBank’s broadband service.

For the new video-streaming business to succeed in Japan, SoftBank and Netflix will need to offer attractive local content. To that end, Netflix is collaborating with Fuji Television Network, Inc. (unrated), a major TV broadcaster in Japan, and plans to offer programs produced by Fuji Television and to work with SoftBank in creating content.

Motoki Yanase Vice President - Senior Analyst +81.3.5408.4154 [email protected]

Mirai Kaneuchi Associate Analyst +81.3.5408.4026 [email protected]

NEWS & ANALYSIS Credit implications of current events

8 MOODY’S CREDIT OUTLOOK 31 AUGUST 2015

Banks

Depressed Oil Prices Will Lead to Higher Loan-Loss Provisions at US Banks Last week, West Texas Intermediate oil prices – the North American benchmark crude – closed below $40 per barrel for the first time since 2009. This price decline, along with our expectation that oil prices will remain depressed until at least the end of 2016, is credit negative for US banks with significant energy-lending concentrations because it will result in higher loan-loss provisions in coming quarters.

Exhibit 1 shows the US bank holding companies with the highest consolidated energy-lending concentrations, as measured by outstanding energy loans to common equity Tier 1 capital. The most exposed bank holding companies are BOK Financial Corporation (A2 stable), Hancock Holding Company (Baa1 stable), Cullen/Frost Bankers, Inc. (A2 stable), Texas Capital Bancshares, Inc. (Baa3 stable), Zions Bancorporation ((P)Ba1), Comerica Incorporated (A3 stable) and BBVA Compass Bancshares, Inc. (Baa3 stable).

EXHIBIT 1

US Bank Holding Companies with Highest Energy Loans as a Percent of Common Equity Tier 1 Capital, Second-Quarter 2015

Notes: BOKF = BOK Financial Corporation; HBHC = Hancock Holding Company; CFR = Cullen/Frost Bankers, Inc.; TCBI = Texas Capital Bancshares, Inc.; ZION = Zions Bancorporation; CMA = Comerica Incorporated; BBVA Compass = BBVA Compass Bancshares, Inc. Ratings shown in the exhibit are lead banks’ standalone baseline credit assessments. Sources: Company 10-Qs and US Federal Reserve FR Y-9C reports

The major risk for these banks is a prolonged slump in oil prices, which would weaken energy company borrowers’ ability to offset diminished cash flow with expense cuts. This problem worsens the longer prices remain depressed, leading to higher provisions for the banks. Before the recent drop in oil prices, each bank in Exhibit 1, with the exception of Hancock, had significantly increased its provision within the past three quarters.

Exhibit 2 shows the recent trend in oil prices. After a modest recovery in the spring, when oil prices rose to about $60 per barrel, they have fallen sharply in recent weeks from a peak of $115 per barrel as recently as June 2014. The exhibit also shows our latest forecast (revised on 7 August) for oil prices through 2017. We now expect oil prices to rise only gradually in 2016 and to average $52 per barrel. We lowered our oil price assumptions because of the large buildup in inventories and the possibility that increased Iranian oil exports could reach global markets beginning in 2016. Lower oil prices for a longer period means a greater negative effect on these banks.

99%91% 90%

80%

56% 55%50%

0%

20%

40%

60%

80%

100%

120%

BOKF HBHC CFR TCBI ZION CMA BBVA Compass

a1 a3 a1 baa2 baa3 a2 baa2

Joseph Pucella Vice President - Senior Credit Officer +1.212.553.7455 [email protected]

NEWS & ANALYSIS Credit implications of current events

9 MOODY’S CREDIT OUTLOOK 31 AUGUST 2015

EXHIBIT 2

West Texas Intermediate Actual and Forecast Price per Barrel

Sources: US Energy Information Administration and Moody’s Investors Service

In addition to the negative effect of low oil prices on banks’ direct energy exposures, some local economies, such as Texas and Oklahoma, will also be negatively affected. However, reduced energy costs are positive for the operating environment of US banks more broadly. Low oil prices support GDP growth, driving business investment and increased real wages that support borrowers’ debt repayment capacity. Consumers also benefit from lower expenditures on gasoline. These positive effects showed themselves in banks’ second-quarter results through continued asset quality improvement in the consumer loan portfolios.

$0

$20

$40

$60

$80

$100

$120

Spot Moody's Forecast (Annual Average)Moody's Stress Forecast (Annual Average) Moody's Prior Forecast (Annual Average)

NEWS & ANALYSIS Credit implications of current events

10 MOODY’S CREDIT OUTLOOK 31 AUGUST 2015

Expropriation of Banco de Santiago del Estero’s Stake in Nuevo Banco de la Rioja Is Credit Negative for Both Last Monday, Argentina’s central bank announced that it had no objection to a law passed by the Province of La Rioja’s congress that classified the shares of Nuevo Banco de la Rioja S.A. (NBLR, Caa1 negative, caa11) belonging to Banco de Santiago del Estero S.A. (BSE, Caa1 negative, caa1) as being in the public interest and subject to expropriation.

An expropriation of BSE’s stake is credit negative for BSE because it will likely have to take a loss on its participation in NBLR, and will reduce BSE’s footprint in northwest Argentina, which would reduce its revenue diversification and economies of scale. It is also credit negative for NBLR because even though the province has yet to outline its plans for NBLR, it is likely that the bank will be subject to political interference and will increase its exposure to small and midsize enterprises in the province. That, in turn, risks hiking NBLR’s asset risks and credit cost and lowering its currently high liquidity position.

BSE held a 70% stake in NBLR that BSE in its unconsolidated balance sheet as of 31 March reported as worth ARS166 million ($18 million), or 1.9% of BSE’s total assets. The remaining 30% belonged to Province of La Rioja, which, as a result of the expropriation, will own 100% of the bank.

Province of La Rioja authorities cited BSE’s failure to comply with the 2000 privatization agreement objective to lend to companies in the province at below market rates as the reason for expropriation. The expropriation is another example of the unpredictability of Argentina’s legal system and the weak rule of law that remains a key driver of Argentina’s Caa1 sovereign rating and the “very weak” macro profile applicable to Argentina’s banking system.

The final terms of the expropriation have not been disclosed. However, if the province makes no payment for the expropriation, BSE would take a loss that would hurt its ratio of tangible common equity to risk-weighted assets, which would also be hurt as a result of its lower standalone ratio relative to NBLR’s ratio as of March 2015 (see Exhibit 1).

EXHIBIT 1

BSE’s Tangible Common Equity to Risk-Weighted Assets Will Deteriorate After Recording an Expropriation Loss as of March 2015.

Sources: Banco Central de la República Argentina and Moody’s Investors Service

1 The bank ratings shown are the bank’s local deposit rating and baseline credit assessment.

0%

3%

6%

9%

12%

15%

18%

21%

24%

27%

30%

33%

Nuevo Banco de la Rioja Banco de Santiago del Estero Banco de Santiago del Estero AfterTaking Loss

Fernando Albano, CFA Assistant Vice President - Analyst +54.11.5129.2624 [email protected]

NEWS & ANALYSIS Credit implications of current events

11 MOODY’S CREDIT OUTLOOK 31 AUGUST 2015

As a result of the expropriation, around 15% of BSE’s consolidated assets and liabilities will be removed from its balance sheet. This would improve BSE’s asset risk profile given that NBLR has historically reported higher loan delinquencies (see Exhibit 2). As a result, we expect BSE’s nonperforming loan ratio (NPLs) to decline to 4.3% from 4.7% as of March 2015.

EXHIBIT 2

BSE’s Nonperforming Loan Ratio Will Decline as It Removes NBLR’s Higher Delinquencies from Its Loan Book

Sources: Banco Central de la República Argentina and Moody’s Investors Service

We also expect a negative effect on both banks’ earnings, which have also been affected by Argentina’s low economic growth and high inflation in the past year. The national government has pressed financial institutions to provide more credit to support the economy by implementing lending rate caps, lending quotas, restrictions on non-interest income and limits on net foreign currency holdings, all of which have negatively affected banks’ income generation capacity.

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

2011 2012 2013 2014 1Q2015

Banco de Santiago del Estero Nuevo Banco de la Rioja

NEWS & ANALYSIS Credit implications of current events

12 MOODY’S CREDIT OUTLOOK 31 AUGUST 2015

Paraguay’s Interest Rate Cap on Credit Cards Is Credit Negative for Banks Last Wednesday, the government of Paraguay (Ba1 stable) approved a new law that caps interest rates on credit cards to no more than three times the average funding rate, which, as of July, was 8.9%. The new law is credit negative for Paraguayan banks because it will reduce their profitability. The average interest rate on credit cards has exceeded 40% this year, and the capped rate under the new law would lower rates to around 27%.

As of July, credit cards constituted 4.2% of banks’ total loan portfolio, and the fees and commissions cards generated accounted for 5.9% of banks’ total revenue (see exhibit). Among the most affected banks are Banco Itaú Paraguay S.A. (unrated), which issued nearly 40% of all credit cards in Paraguay as of July and financed more than 52% of the country’s credit card loans; Banco Continental S.A.E.C.A. (Ba1/Ba1 stable, ba22), which has an 8.9% market share; and Banco Bilbao Vizcaya Argentaria Paraguay S.A. (BBVA Paraguay, Ba1/Ba1 stable, ba2), which has a 6.3% market share. We expect these more exposed banks to have reduced interest margins, profitability, and capital generation capacity.

Paraguayan Banks’ Fees and Commissions in 2015

Source: Banco Central del Paraguay

Under the new law, banks must lend at below-market rates (current rates are 30%-50%) to a consumer segment with the highest delinquency levels in Paraguayan loan books: consumer NPLs were 5% of gross loans as of July 2015, more than twice that of the system as a whole. The credit cards’ below-market interest rates will reduce banks’ net interest margins in a market segment that has grown significantly in recent years amid government pressure on banks to expand financial services to sectors and workers that were previously underserved, including in consumer finance. The credit card segment has grown by approximately 15% over the past year, with growth at banks such as Banco Regional S.A.E.C.A. (Ba1/Ba1 stable, ba2) and Banco Atlas S.A. (unrated) two or three times as high.

The new law aims to add transparency to credit card interest rates and prevent credit card users from being charged what the government considers usurious interest rates. Before the new law took effect, the central bank provided guidance regarding the maximum rate that would not be deemed usurious. However, the maximum rate in the new law is far below the central bank’s latest guidance of 55%.

2 The bank ratings shown in this report are the bank’s local currency deposit rating, senior unsecured debt rating (where available)

and baseline credit assessment.

Credit Card Fee Income6%

Net Financial Income76%

Other Net Fee Income10%

Net FX Income5%

Other Income3%

Christian Pereira Associate Analyst +54.11.5129.2634 [email protected]

NEWS & ANALYSIS Credit implications of current events

13 MOODY’S CREDIT OUTLOOK 31 AUGUST 2015

Bank of Cyprus Makes Timely Progress Implementing Its Restructuring Plan Last Wednesday, the Bank of Cyprus Public Company Limited (BoC, Caa3/(P)Caa3 stable, caa33) announced that it repaid an additional €500 million of Emergency Liquidity Assistance (ELA) during July and August, reducing its stock to €5.4 billion or 23% of assets. This repayment will lower the bank’s funding expense and strengthen confidence in its ability to continue implementing the restructuring plan it agreed on with the European Union in 2013. The progress thus far allows the bank to continue focusing on its significant asset quality challenges, including nonperforming loans (NPLs) at 52.7% of gross loans at the end of June.

Since April 2013, when ELA funding peaked at €11.4 billion, the BoC has repaid around €6 billion, as shown in the exhibit below, reducing funding costs. We estimate that the cost of ELA funding is higher than the cost of European Central Bank funding and the return paid on deposits. During the second quarter of this year, BoC’s deposits in Cyprus stabilised at €11.6 billion, and as assets declined by €1.4 billion, deposits increased to 53.7% of assets from 51% in March.

Bank of Cyprus’ Eurosystem Funding

Sources: Bank of Cyprus financial disclosures and Central Bank of Cyprus

In addition to the significant challenges that the Bank of Cyprus’ high stock of NPLs pose, the bank runs the risk of its balance sheet repair efforts derailing if Greece were to exit the euro, but this is not our central scenario. Although the bank’s on- and off-balance-sheet exposure to Greece and Greek entities is modest at around 15.1% of equity, a Greek exit from the euro would likely lead to market disruptions and negatively affect confidence in Cyprus, affecting the bank’s funding and asset quality.

New tools available to banks will support BoC’s efforts to repair its balance sheet. According to the Cyprus Broadcasting Corporation, on 17 August, the first day of implementation of the revised legal framework governing foreclosures, the bank sent notice letters to around 25 defaulted corporate borrowers with €84.9 million of total loans outstanding regarding foreclosure proceedings on their real estate collateral. Even though the amount is only a fraction of the bank’s €12.1 billion of NPLs, the letters signal the legal change to strategic defaulters who have refused to repay their loans despite having capacity to pay. Such strategic defaults were facilitated by the previous legal framework, which delayed the auction of real estate collateral for more than 10 years.

Although the ELA repayment is ahead of plan, we nevertheless expect BoC’s balance sheet repair process to be lengthy given its high stock of NPLs, and we expect high provisions and write-offs to burden the bank for years. Cyprus’s economic growth has been better than expected, with second-quarter real GDP growth at 3 The bank ratings shown in this report are BoC’s deposit rating, senior unsecured debt rating, and baseline credit assessment.

€ 11.40 € 11.11 € 9.86 € 9.56 € 9.51 € 8.79

€ 7.68 € 7.40 € 6.90 € 5.90 € 5.40

€ 1.30 € 1.40 € 1.40 € 1.40

€ 0.92 € 0.88 € 0.80

€ 0.50 € 0.50

0%

5%

10%

15%

20%

25%

30%

35%

40%

€ 0

€ 2

€ 4

€ 6

€ 8

€ 10

€ 12

Apr-13 Jun-13 Sep-13 Dec-13 Mar-14 Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 Aug-15

€Bi

llion

s

ELA - left axis ECB - left axis Euro-System Funding / Total Assets - right axis

Melina Skouridou, CFA Analyst +357.2569.3021 [email protected]

Antypas Asfour, CFA, PRM Associate Analyst +357.2569.3033 [email protected]

NEWS & ANALYSIS Credit implications of current events

14 MOODY’S CREDIT OUTLOOK 31 AUGUST 2015

0.9% versus our 0.5% estimate, but growth forecasts are jeopardized by recent heightened downside risks to global growth. We recently revised our 2016 global economic outlook and now forecast average GDP growth of 2.8% in the G20 economies, 0.3 percentage points lower than in our previous forecast.

NEWS & ANALYSIS Credit implications of current events

15 MOODY’S CREDIT OUTLOOK 31 AUGUST 2015

France Adopts European Bank Recovery and Resolution Directive, a Credit Negative On 21 August, President François Hollande of France (Aa1 negative) enacted the European Bank Recovery and Resolution Directive (BRRD) into French law. This law is credit negative for bank investors because it allows resolution authorities (national or European) to impose a bail-in on senior creditors of French banks after 1 January 2016.

France was among 11 countries (Bulgaria, Czech Republic, France, Italy, Lithuania, Luxembourg, Netherlands, Malta, Poland, Romania and Sweden) that were late in transposing BRRD into national law (due on 1 January 2015). The European Commission requested on 28 May 2015 that those countries should fully implement BRRD within two months.

France adopted the BRRD by way of ordinance, a mechanism that requires neither prior discussion of the text nor its approval by the Parliament. Rather, it empowers the executive branch to enact legislation within strict limits. As a result, the ordinance was written in accordance with a specific mandate whereby the government had to transpose BRRD’s provisions without deviating from them.

The transposition of BRRD into French law is in line with the European directive, but there is a risk of deviation whenever EU countries transpose European legislation into national law. Such differences can conflict with the objective of harmonization and the creation of a single market across the region.

For example, the so-called German proposal, which is meant to be enacted into the German Banking Act, materially differs from BRRD on how a bail-in would be implemented. Although BRRD has established a partial depositor preference, whereby household and SME deposits are ranked above the deposits of more sophisticated large corporate and institutional investors and bondholders, the German amendment goes one step further. Under the German proposal, tradable senior unsecured debt obligations (i.e., bonds) would rank below other senior unsecured liabilities (e.g., corporate deposits, private placements and derivatives) and would therefore bear initial losses once capital and subordinated debt instruments are depleted. This proposal, which has not yet been adopted, seeks to simplify the bail-in procedure during the resolution of a distressed bank by establishing a clearer separation between a bank’s senior unsecured bonds and other debt instruments.

Although the French authorities recognize the merits of the German proposal, they have (thus far) refrained from following suit, and seem more inclined to amend the BRRD itself rather than deviating from it. In fact, the German initiative has triggered a discussion at the European Union (EU) level because Germany as well as other EU members have doubts about the feasibility of a bail-in under current BRRD rules. Even if EU members seem to have no intention to amend BRRD at this point in time, many of them recognize that the German proposal is worth further discussion, and more work on this issue will be completed under the European Commission’s auspices in the months ahead.

Last, France is keen to have the results of the upcoming discussion at the Financial Sector Board and G-20 on total loss-absorbing capital before considering amendments to BRRD given that both the EU framework and the total loss-absorbing capital future framework are intended to address the same issue (i.e., bank resolution), even though the framework targets only global systemically important banks.

Alain Laurin Associate Managing Director +33.1.5330.1059 [email protected]

NEWS & ANALYSIS Credit implications of current events

16 MOODY’S CREDIT OUTLOOK 31 AUGUST 2015

HSH Nordbank Capital Buffers Deteriorate Amid US Dollar Strength Last Friday, HSH Nordbank AG (Baa3/Baa3 negative, b34) reported that the strength of the US dollar and deteriorating asset quality in its ship finance portfolio are weighing heavily on its regulatory loss-absorption capacity, as reflected by increased utilisation of its €10 billion asset guaranty to 91% as of June 2015 from 84% six months earlier. The owner-provided asset guaranty shields the bank from the default risk of €51 billion, or 47%, of its €108 billion total assets. This asset guaranty is a key component of HSH’s capital structure, and the remaining room under the guaranty is a key indicator of the bank’s loss-absorption capacity. HSH’s higher regulatory utilisation reflects increased risk in the guaranteed portfolio, as determined by internal ratings and severity-of-loss indicators, and leaves HSH more vulnerable to capital impairment from market movements beyond the bank’s control, a credit negative.

The continued deterioration of HSH’s two capital buffers – the second one stemming from claw-back rights of guaranty fees paid, which HSH claims when its CET1 capital ratio falls below 10% (see exhibit) – highlights two problems for the bank. First, the buffer under the claw-back arrangement trends lower because the €3.3 billion guaranty fees HSH has paid since 2009 have proved unaffordable, so that the bank has been paying a portion of the guaranty costs from its capital rather than profits. Second, HSH is exposed to material tail risk, in particular from further US dollar appreciation against the euro, and from rating downgrades in its legacy portfolios owing to continued pressures in the shipping sector.

HSH Nordbank’s Regulatory Capital Buffers Since 2013

Notes: The guaranty buffer refers to the capital-equivalent amount (in percent of reported risk-weighted assets) of potential negative rating migration or currency effects in the guaranteed portfolio that HSH could absorb without reducing its reported 10% transitional CET1 ratio. Source: HSH Nordbank

The remaining capital buffer offered by the guaranty remains below our expectation. We expected that the gradual unwinding of the bank’s guaranteed assets, which shrank 8% in 2014, coupled with reducing nonperforming loans, which decreased 7% to €15.3 billion in 2014, would translate into gradual capital relief and therefore a stable or even stronger capital buffer under the asset guaranty. Only such a positive trend would allow the bank to consider reducing the €10 billion guaranty and related costs.

The adverse trend during the six months to June 2015 complicates HSH’s state-aid proceedings, which have been pending since 2013. The high regulatory utilisation of the asset guaranty as of June is a reminder of how very premature the bank’s decision was in 2011 to reduce the asset guaranty to €7 billion from €10 billion. If the (subsequently reinstated) €10 billion guaranty now proves to be inadequate, the European Commission’s state aid department may be less inclined to give its approval. The reinstatement to €10 4 The bank ratings shown in this report are HSH Nordbank’s deposit rating, senior unsecured debt rating and baseline

credit assessment.

10.0% 10.0% 10.0% 10.0%

3.1% 2.8% 2.6% 2.4%

4.0% 3.8% 3.3%2.3%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

Dec 2013 Jun 2014 Dec 2014 Jun 2015

Transitional CET1 Claw Back Buffer Guarantee Buffer

Katharina Barten Senior Vice President +49.69.70730.765 [email protected]

NEWS & ANALYSIS Credit implications of current events

17 MOODY’S CREDIT OUTLOOK 31 AUGUST 2015

billion in 2013, required amid renewed capital pressures, triggered HSH’s second state-aid procedure since 2010. The unresolved case makes the bank’s future as a going concern uncertain.

However, the bank and its owners have been in talks for several months about proposing a revised structure of the current support arrangements to the European Commission because the asset guaranty incurs unsustainably high costs. Following delays, a proposal is now expected in autumn. If such a new deal entails a large-scale divestment of underperforming assets and lower costs, and also ensures adequate capital levels, it would be credit positive for HSH. With the stronger US dollar offsetting the bank’s dedicated efforts to work out its high €15.4 billion stock of nonperforming loans, an alternative aid deal appears even more urgent.

NEWS & ANALYSIS Credit implications of current events

18 MOODY’S CREDIT OUTLOOK 31 AUGUST 2015

Korean Banks Face Pressure from Weakness in Currencies, Oil and Equities Last Thursday, the Chinese renminbi fell to a four-year low against the US dollar, depreciating by 3.4% year-to-date. The renminbi weakening, as well as Japanese yen weakening, undermines the export competitiveness of Korea (Aa3 positive), which we expect will lower real GDP growth and pressure Korean banks’ asset quality, whose exposure to corporate loans was 56% of KRW loans as of March 2015.

Weaker renminbi or yen can disrupt exports of Korean goods and services, which accounted for 50.6% of Korea’s GDP in 2014. According to the Korea International Trade Association, the Export Similarity Index (ESI) between Korea and China for the US rose to 0.346 in 2014 from 0.290 in 2010, where one indicates identical export composition and zero indicates no similarity. ESI between Korea and Japan is even higher, and was 0.517 in 2014.

Other developments in the global markets that we see as net negative to the asset quality and profitability of Korean banks include a further drop in oil prices, which would hurt Korean shipbuilders, already a beleaguered sector, and increase banks’ nonperforming loans ratio. Brent crude dropped to $42 a barrel for the first time since March 2009. Low oil prices reduce oil exploration and production capital expenditures, which delays or leads to the cancellation of offshore oil rig projects, an area in which Korean shipbuilders diversified in recent years. For example, the world’s second largest shipbuilder Daewoo Shipbuilding & Marine Engineering Co. (DSME, unrated) recorded a loss of $2 billion in the second quarter because of margin pressure on offshore projects.

For Korea’s seven largest banks -- The Export Import Bank of Korea (Aa3/Aa3 positive5), Hana Bank (A1/A1 stable, baa1), Kookmin Bank (A1/A1stable, baa1), Korea Development Bank (KDB, Aa3/Aa3 positive, ba2), NongHyup Bank (A1/A1 stable, baa3), Shinhan Bank (Aa3/Aa3 stable, a3) and Woori Bank (A1/A1 negative, baa2) -- we estimate their exposures to shipbuilders at about 4.5% of their KRW loans as of year-end 2014 and expect their 30-day delinquency rate to rise later this year, despite a slight decline in June, as shown in the exhibit.

Korea’s Big Seven Banks’ 30-Day Delinquency Rate of Loans to Shipbuilders

Source: Financial Supervisory Service

A significant correction in the Korean equities market by more than 10% would lower banks’ profitability, especially policy banks. For the system as a whole, investment in equities, subsidiaries and foreign securities accounted for 4.7% of total assets as of March 2015 on an unconsolidated basis. Even though the systemwide investment is small, policy banks such as the KDB and the Export-Import Bank of Korea have 5 The bank ratings shown in the report are the bank’s deposit rating, senior unsecured debt rating and baseline credit assessment.

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

Sophia Lee, CFA Vice President - Senior Credit Officer +852.3758.1357 [email protected]

NEWS & ANALYSIS Credit implications of current events

19 MOODY’S CREDIT OUTLOOK 31 AUGUST 2015

significantly greater exposures to equities because of their history of debt-to-equity swaps to restructure various companies. For example, KDB’s equity investments amounted to KRW32 trillion, or 15% of its total assets as of year-end 2014.

Lastly, we expect active policy measures from the government if the economy weakens. For example, with the July inflation rate at 0.7%, the Bank of Korea may further cut the benchmark rate even though it is at the historical low of 1.5%. The regulator could also expand measures to further boost liquidity in the corporate sector. Together, these would put downward pressure on Korean banks’ profitability, which is already at a very low level. For the first half of 2015, the annualized return on assets was just 0.42%.

We note that Korean banks are much better positioned in terms of their foreign-currency funding and liquidity positions than during the global financial crisis of 2008, when foreign-currency funding and liquidity were key vulnerabilities. In fact, the Financial Supervisory Service held an emergency meeting with bank treasury departments on 25 August, and announced that all Korean banks should be able to withstand a foreign currency liquidity crisis similar to that of 2008 and lasting more than three months.

NEWS & ANALYSIS Credit implications of current events

20 MOODY’S CREDIT OUTLOOK 31 AUGUST 2015

Insurers

Nippon Life Acquisition of Mitsui Life Would Allow Shareholders to Exit, a Credit Positive Last Wednesday, Japan’s Nikkei newspaper reported that Nippon Life Insurance Company (financial strength A1 stable) will announce in September an agreement to acquire approximately an 80% stake in Mitsui Life Insurance Company Limited (financial strength Baa1 stable) for between ¥300-¥400 billion by March 2016. The agreement would mark the first realignment in Japan’s (A1 stable) insurance market in over a decade.

Nippon Life plans to first launch a tender offer to acquire all of Mitsui Life’s shares, and then sell 15%-20% back to current shareholders Sumitomo Mitsui Banking Corporation (SMBC, A1/A1 stable, a36), Mitsui & Co., Ltd. (A2 stable), and Mitsui Fudosan Co., Ltd. (A3 positive). The deal is credit positive for the shareholders of Mitsui Life that will exit rather than re-acquire a stake because the present investment is capital consumptive, does not generate a return, and the sale price will be accretive to retained earnings.

We believe four companies will exit: Sumitomo Mitsui Trust Bank, Limited (A1/A1 stable, a3), Mitsui Sumitomo Insurance Co., Ltd. (financial strength A1 stable), and private-equity firms Daiwa SMBC Principal Investments (unrated), in which the Daiwa Securities Group Inc. (Baa1 stable) holds 60% and SMBC holds 40%, and Nomura Financial Partners (unrated), which is a wholly owned subsidiary of Nomura Holdings, Inc. (Baa1 stable). Furthermore, an exit rather than a re-investment provides evidence that the Japan Corporate Governance Code, which was put into effect in June 2015, is having a positive effect on the decision making of certain investee companies. Japan’s Corporate Governance Code seeks to improve transparency and increase corporate profitability, which we expect will lead to the sale of shares in listed companies that do not meet a minimum return threshold or otherwise enhance corporate value.

We estimate that SMTB could book a pre-tax gain of ¥30-¥40 billion on the sale of its 9.11% stake, based upon the acquisition price Nippon Life will pay. In addition, SMTB’s capital ratios will also benefit, considering that investments in insurance companies incur a capital deduction under Basel III. At the same time, we estimate Daiwa Securities could book a pre-tax gain of ¥20-¥30 billion based upon its 12.16% holding, while Nomura could book an amount similar to SMTB based upon its 8.94% holding and Mitsui Sumitomo Insurance would book an amount similar to Daiwa Securities based upon its 7.2% holding. However, considering that Daiwa and Nomura only hold common shares, their dilution is a possibility if certain capital instruments are converted into common shares, which would materially reduce their return.

6 The ratings shown are the banks’ deposit rating and senior unsecured debt rating and outlook, and its baseline

credit assessment.

Raymond Spencer Senior Vice President +81.3.5408.4051 [email protected]

NEWS & ANALYSIS Credit implications of current events

21 MOODY’S CREDIT OUTLOOK 31 AUGUST 2015

Recent Stock Market Decline and Volatility Are Credit Negative for Insurers The recent volatility and decline in US equity markets, particularly last Monday, are negative for US insurers with significant equity market exposure, both directly through their general account investment portfolios and as a result of market exposure via the separate accounts backing variable product offerings.

When equity markets decline, the account values on variable life or variable annuities (VAs) also decline because of the performance of the underlying funds. This not only hurts fee income based on assets, but also places life insurers on the hook for any guarantees. Volatility is also problematic because it makes dynamic hedging more expensive (costs of options rise with rising volatility) and less effective against managing market risks when second-order effects are magnified.

If these market conditions persist, earnings will be negatively affected by lower fee income, potentially higher reserve charges and the need to add capital. Add to this the uncertainty of policyholder behavior (unanticipated benefit claims) and life insurers’ capitalization risks weakening.

We use life insurers’ separate account assets as a proxy for their variable insurance business with market exposure. Exhibit 1 captures insurers such as The Hartford Financial Services Group, Inc. (Baa2 stable), which has a large legacy VA business, and Jackson National Life Insurance Company (financial strength A1 stable), the leading provider of VAs for the past three years. The exhibit also includes large pension providers such as Principal Financial Group, Inc. ((P)Baa2 stable). However, to the extent that such pension writers rely on account-value-based fees, they too would be negatively affected if current market conditions persist.

EXHIBIT 1

US Life Insurers with the Highest Equity Exposure in Variable Product Offerings as of Year-end 2014

Rank Group

Lead US Life Company Insurance Financial

Strength Rating

Net Separate Account Assets

$ Millions

Separate Account Assets as Percent of

Total Assets

Separate Account Assets as Multiple of

Statutory Capital

1 Hartford Financial Services A2 stable $140,208 79.0% 19.6x

2 Delaware Life Partners LLC Baa2 stable $31,061 71.5% 19.5x

3 Ameriprise Financial Inc. Aa3 stable $79,412 71.5% 23.8x

4 AXA Group Aa3 stable $119,070 69.9% 19.5x

5 Jackson National Life Group A1 stable $127,459 66.9% 28.2x

6 Ohio National Mutual Holdings A1 stable $20,707 66.5% 18.9x

7 Nationwide Mutual Group A1 stable $89,208 65.5% 20.1x

8 Prudential Financial Inc. A1 stable $341,060 61.8% 31.2x

9 Principal Financial Group Inc. A1 stable $95,131 61.7% 22.2x

10 Zurich Insurance Group A3 stable $12,729 58.2% 16.6x

11 AEGON Group A1 stable $121,315 58.0% 12.7x

12 Manulife Financial Corp. A1 stable $154,551 56.8% 29.x

13 Lincoln National Corp. A1 stable $128,842 56.6% 16.7x

14 Securian Financial Group Aa3 stable $20,081 56.0% 7.7x

15 Voya Financial Inc. A2 stable $107,716 55.4% 15.8x

Source: SNL Financial LC. Contains copyrighted and trade secret materials distributed under license from SNL. For recipient’s use only.

Rokhaya Cissé, CFA Associate Analyst +1.212.553.3870 [email protected]

Jasper Cooper, CFA Assistant Vice President - Analyst +1.212.553.1366 [email protected]

NEWS & ANALYSIS Credit implications of current events

22 MOODY’S CREDIT OUTLOOK 31 AUGUST 2015

From a statutory capital perspective, both US life and property and casualty (P&C) insurers’ investment holdings are vulnerable to recent market movements. Life insurers’ investment portfolios are typically dominated by fixed maturity securities, with allocations to equities that, on average, are 2%-3%7 of cash and invested assets, or about 23% of statutory surplus. Among the US P&C insurers we rate, the average allocation to common stock is 8% of cash and invested assets, with equity investments typically constituting about 20% of statutory surplus. Exhibits 2 and 3 separately rank the top 10 life and P&C insurers by unaffiliated equity holdings as a percent of statutory surplus.

EXHIBIT 2

Top 10 US Life Insurers with the Highest Percentage of Non-Affiliated Common Stocks Relative to Surplus as of Year-end 2014

Rank Group

Lead US Life Company

Insurance Financial Strength Rating

Total Unaffiliated Common Stock

Holdings1

$ Millions

Unaffiliated Common Stock Holdings as

Percent of Policyholders' Surplus

Unaffiliated Common Stock Holdings as Percent of Cash &

Invested Assets

1 Phoenix Companies Inc. Unrated $613 100.7% 4.5%

2 Manulife Financial Corp. A1 stable $4,899 92.0% 4.5%

3 American International Group A2 stable $9,024 91.4% 4.9%

4 Allstate Corp. A1 stable $2,340 76.3% 6.5%

5 Prudential Financial Inc. A1 stable $8,075 73.8% 4.1%

6 Americo Life Unrated $260 57.5% 5.8%

7 Western & Southern Financial Aa3 stable $2,508 55.7% 7.8%

8 Athene Holding Ltd. Unrated $482 40.2% 0.9%

9 MetLife Inc. Aa3 stable $8,834 39.0% 2.7%

10 State Farm Mutl Automobile Ins Aa1 stable $3,529 37.4% 5.6%

Notes: Data are for life insurers with at least $5 billion of total assets. 1 As reported in Schedule D and BA of the annual statutory financial statements. Source: SNL Financial LC. Contains copyrighted and trade secret materials distributed under license from SNL. For recipient’s use only.

Exhibit 3 shows that GEICO (financial strength Aa1 stable) maintains a high allocation to equities, including some large individual positions, which could cause volatility in the group’s earnings and capital base. But GEICO also carries a significant amount of fixed income securities, equal to 89% of its reserves. Markel Insurance Company (financial strength A2 stable) also maintains sizable equity holdings. However, when we take into account the GAAP capital including its international operations, the equity exposure declines to 54% of GAAP equity rather than the 84% of statutory capital in Exhibit 3.

7 In 2014, the life industry allocated approximately 2% of invested assets to equities, according SNL Financial LC.

NEWS & ANALYSIS Credit implications of current events

23 MOODY’S CREDIT OUTLOOK 31 AUGUST 2015

EXHIBIT 3

Top 10 Rated US P&C Insurers with the Highest Percentage of Non-Affiliated Common Stocks Relative to Surplus as of Year-end 2014

Rank Group

Lead US Life Company Insurance Financial Strength

Rating

Total Unaffiliated

Common Stock Holdings1 $ Millions

Unaffiliated Common Stock Holdings as

Percent of Policyholders' Surplus

Unaffiliated Common Stock Holdings as Percent of Cash &

Invested Assets

1 GEICO Corp. Aa1 stable $18,589 100.7% 67.3%

2 Markel Corp. A2 stable $2,198 84.1% 31.5%

3 Cincinnati Financial Corp. A1 stable $3,029 67.7% 31.1%

4 Old Republic International Corp. A2 stable $1,291 41.3% 15.5%

5 Crum & Forster Ins Group Baa1 stable $420 35.2% 11.1%

6 Progressive Corp. Aa2 stable $2,413 34.0% 12.6%

7 State Auto Mutual Ins Co. A3 negative $401 34.0% 11.6%

8 American Financial Group, Inc. A1 stable $719 31.0% 8.7%

9 Hanover Insurance Group, Inc. A3 stable $561 27.2% 9.8%

10 Allstate Corp. Aa3 stable $2,538 14.8% 6.4%

Notes: Data are for rated insurers with at least $3 billion of total assets.

1 As reported in Schedule D of the annual statutory financial statements. Source: SNL Financial LC. Contains copyrighted and trade secret materials distributed under license from SNL. For recipient’s use only.

Moody’s-rated P&C insurers’ allocation to common stocks has more than doubled in the past few years, reaching 8% of cash and invested assets as of year-end 2014 from 3.0% as of year-end 2010 with most of the increase driven by share price appreciation. This trend may soon come to an end if equity markets continue to decline.

NEWS & ANALYSIS Credit implications of current events

24 MOODY’S CREDIT OUTLOOK 31 AUGUST 2015

Asset Managers

BlackRock Purchase of Upstart Robo-Advisor Is Credit Positive Last Wednesday, BlackRock, Inc. (A1 stable) reported that it had reached a definitive agreement to acquire FutureAdvisor, an automated wealth management service, or robo-advisor, for an undisclosed purchase price. FutureAdvisor will operate as a business within BlackRock Solutions (BRS), the firm’s investment and risk management platform. The acquisition is credit positive for BlackRock because it provides the company a foothold in the rapidly growing digital advice market. Specifically, the purchase will allow BlackRock to strengthen its relationships with financial institutions through licensing FutureAdvisor’s automated investment advice technology and will enable the firm to distribute its exchange-traded fund (ETF) and multi-asset class products through the robo-advice channel.

Robo-advisors are a disruptive force within the traditional face-to-face financial advice market, providing low-fee automated, algorithm-based investment services with limited or no interaction from a human financial advisor. Despite significant early growth, the robo-advice market is small, but growth prospects are strong: market data shows fee-conscious and technology savvy millennial investors favor robo-advisor low-fee automated advice services over traditional advice offerings. Consulting firm A.T. Kearney estimates that total US robo-advisor assets under management are likely to grow to $2.2 trillion (see exhibit) in five years. The Department of Labor’s fiduciary standard proposal could also provide a big growth opportunity for robo-advisors, since small investors affected by the standard will likely consider turning to robo-advisors as an alternative to traditional advice firms.

Total Estimated US Robo-Advisor Assets Under Management

Source: A.T. Kearney

FutureAdvisor, a five-year-old robo-advisor with approximately $600 million in assets under management, operates today as a business-to-customer (B2C) platform, but BlackRock intends to extend its services into the business-to-business (B2B) domain. BlackRock will license the firm’s digital advice technology to financial institutions such as banks, insurers, broker-dealers, 401(k) platforms and other advisory firms. FutureAdvisor should be a good cultural fit within BRS, which has a strong reputation as a provider of innovative investment and risk management tools to institutional investors around the world.

The FutureAdvisor acquisition benefits BlackRock’s business profile. The extension of FutureAdvisor’s platform into the B2B market positions BlackRock to capitalize on a slow but accelerating shift in traditional financial advice markets toward a hybrid advice model that includes both human and automated offerings. In addition to the relatively small new fee stream that will come from licensing FutureAdvisor’s technology

$0.0

$0.5

$1.0

$1.5

$2.0

$2.5

2016 2017 2018 2019 2020

$ Tr

illio

ns

Rory Callagy Vice President - Senior Credit Officer +1.212.553.4374 [email protected]

Scudder Clay Associate Analyst +1.212.553.7809 [email protected]

NEWS & ANALYSIS Credit implications of current events

25 MOODY’S CREDIT OUTLOOK 31 AUGUST 2015

to financial institutions, BlackRock will strengthen relationships with important distribution partners by helping them increase retention of existing clients and better position themselves to attract a new generation of younger investors. This aligns well with the firm’s strategy to increase its penetration of US retirement planning channels.

The second key benefit of the acquisition will be increased distribution opportunities for BlackRock’s ETF and multi-asset products through FutureAdvisor’s B2C and B2B platforms. FutureAvisor’s current B2C platform is an open-architecture platform that includes index fund and ETF offerings from Vanguard, State Street Global Advisors, PIMCO and BlackRock. As FutureAdvisor’s assets under management grows, BlackRock will earn management fees on the iShares ETF products included in FutureAdvisor’s managed portfolios. FutureAdvisor is also likely to introduce new services over time which will include more BlackRock investment products, further increasing the revenue opportunity from this new channel.

NEWS & ANALYSIS Credit implications of current events

26 MOODY’S CREDIT OUTLOOK 31 AUGUST 2015

Sovereigns

Ukraine’s Bond-Restructuring Agreement Reduces Likelihood of Near-Term Payment Moratorium Last Thursday, Ukraine (Ca negative) authorities announced an agreement with sovereign bondholders to restructure $18 billion of government and government-guaranteed eurobonds. The agreement includes an extension of debt maturities as well as a 20% haircut on the outstanding debt principal, finally settling the main sticking point that had held up the agreement in the five months since the Ukrainian authorities began the International Monetary Fund (IMF)-approved negotiations.

Although the new accord is more favorable to Ukraine’s creditors than many alternatives (including government officials’ threat to impose a payment moratorium in the absence of a deal), Ukraine’s considerable political, economic and financial risks could still create payment problems before initial repayments on the restructured debt fall due in 2019.

The agreement’s negotiated terms include a 20% haircut (halfway between the authorities’ original demand for a 40% haircut and bondholders’ insistence that none was needed); postponement of all principal repayments for the next four years (the minimal time acceptable to the IMF); and a 7.75% interest rate on the nine new bonds that replace the current 14 bonds, whose average 7.20% coupons ranged between 4.95% and 9.25%. The higher coupon on the new bonds is a concession to bondholders, since the government initially sought lower coupons on the new bonds. According to the Ministry of Finance, the new, higher coupon leaves the government’s overall interest payments now owed to bondholders relatively unchanged because of the principal haircut.

The provision of value-recovery instruments (VRIs) to bondholders is one of the agreement’s important innovations. The VRIs provide bondholders an equity-like return contingent upon the Ukrainian economy’s growth between 2021 and 2040. Should the economy recover strongly, the VRIs provide creditors an opportunity to recoup losses from the initial haircut and maturity extensions. We estimate losses will be about 30%-35% compared to original cash flows in net-present value terms.

The agreement comes just ahead of the IMF’s next quarterly review in September and at around the same time as the due date on a $500 million eurobond issued in 2012. In our view, that repayment would have been in jeopardy had a comprehensive agreement on outstanding bonds been stymied.8 As targeted in Ukraine’s 2015-19 $17.5 billion IMF Extended Fund Facility, the restructuring permanently trims $3.6 billion of debt principal and defers $11.5 billion of principal payments for the next four years, allowing the country to improve its liquidity and solvency to focus on the many other difficulties confronting the economy.

Indeed, Ukraine still faces considerable challenges over the next several years as it continues to shore-up its economy and debt position while managing double-digit declines in real GDP, soaring inflation, deep political divisions and ongoing military conflict in the nation’s eastern regions that has resulted in the loss of thousands of lives and the country’s richest industrial assets.

Additionally, although the debt restructuring covers the majority of Ukraine’s debt to private creditors, an agreement has yet to be completed on another $1.8 billion of such debt, including bonds issued by the City of Kiev, Ukrzaliznytsia (the state railway company) and sovereign-guaranteed loans made to state-owned enterprises.9 In addition, Russia remains a holdout on the $3 billion eurobond lent by its National Wealth

8 See Ukraine’s 24 July Interest Payment Does Not Eliminate Risk of Payment Moratorium, 27 July 2015. 9 Restructuring negotiations have already been completed for the $2.8 billion in bonds issued by Oschadbank and Ukreximbank.

Kristin S. Lindow Senior Vice President +1.212.553.3896 [email protected]

Joshua Grundleger Associate Analyst +1.212.553.1791 [email protected]

NEWS & ANALYSIS Credit implications of current events

27 MOODY’S CREDIT OUTLOOK 31 AUGUST 2015

Fund to Ukraine in 2013 under Ukraine’s previous pro-Russian administration of President Viktor Yanukovich. The Ukrainian authorities negotiating on behalf of the government say that the Russian bond will be treated identically to any other bond included in the deal. We expect the two sides’ contentions about this bond payment will become a central issue in the next round of peace talks between Ukraine, the EU and Russia scheduled for September in Minsk, Belarus.

NEWS & ANALYSIS Credit implications of current events

28 MOODY’S CREDIT OUTLOOK 31 AUGUST 2015

Saudi Commitment to Riyal’s US Dollar Peg Lowers Reserves, a Credit Negative Last Tuesday, the Deputy Governor for Research and International Affairs at the Saudi Arabian Monetary Authority (SAMA) Ahmed Abdulkarim Alkholifey said that the central bank was committed to maintaining the Saudi riyal’s (SAR) peg to the US dollar, despite growing currency speculation.

When oil prices began to fall last year, Saudi Arabia (Aa3 stable) began tapping reserves to sustain government spending amid its oil revenue shortfall. Consequently, foreign reserves dropped from a high of about $746 billion in August 2014 to under $670 billion in July 2015. The authorities began issuing debt last month to slow the drain, but defending the peg will also lower the Kingdom’s reserves, a credit negative.

Saudi Arabia’s fixed exchange rate, which has been in place since 1986, aims to smooth the effect of oil price swings on the non-oil economy, but the peg limits SAMA’s ability to use monetary policy to respond to shocks. During times of economic stability, fixed exchange rates are generally associated with lower transaction costs, higher trade openness, lower inflation, and disciplined macroeconomic policies. But pegs can be costly to maintain when significant domestic and external imbalances develop, which is happening now in Saudi Arabia. We project a fiscal deficit of around 15% of GDP over the next two years, compared to a 10% surplus on average in the two years preceding the oil price decline, and a current account deficit of 6%-7% of GDP over the same period, compared to a 20% surplus on average in 2012 and 2013.

The last time the Kingdom experienced speculation that threatened to lead to a devaluation was in the 1990s. The Central Bank was able to maintain its peg back then through small-scale currency intervention. SAMA is likely to aim to do the same this time around, and is in a much better position to do so. In the 1990s, Saudi Arabia was running fiscal deficits averaging around 9% of GDP, whereas over the past decade, the Kingdom has run fiscal surpluses averaging around 11% of GDP. The current account deficit averaged 7% of GDP in the 1990s, whereas it recorded an average surplus of 19% over the past decade. These surpluses enabled the country to pay off its debt and amass large foreign reserves, which were just under $670 billion in July, compared to less than $12 billion on average in the 1990s (see exhibit below).

Saudi Arabia’s Reserves and Debt Levels Are Well Positioned to Withstand Negative Pressures

Sources: Saudi Arabian Monetary Authority, International Monetary Fund and Moody’s Investors Service

During the period of adjustment, the Kingdom’s ability to sustain sizeable reserve buffers and avoid a sharp rise in indebtedness will be an important credit driver.

103%

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96%

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63%

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Gross Government Debt / GDP Government Reserves / GDP Government Expenditures / GDP

Shirin Mohammadi Associate Analyst +1.212.553.3256 [email protected]

Steve Hess Senior Vice President +1.212.553.4741 [email protected]

NEWS & ANALYSIS Credit implications of current events

29 MOODY’S CREDIT OUTLOOK 31 AUGUST 2015

Indonesia’s Tax Cuts Will Spur Credit-Positive Economic Growth Last Thursday, the government of Indonesia (Baa3 stable) announced that new companies with a minimum investment of IDR1 trillion ($71.4 million) in nine so-called pioneer industries will receive tax cuts of 10%-100% for up to 20 years. These measures are credit positive for the sovereign because they set the stage for the government to diversify the country’s economic base, increase investment and address slowing GDP growth and the currency depreciation of the past year.

The decision to forego future tax revenues has limited negative credit implications despite Indonesia’s relatively low government revenue to GDP ratio of around 15% (the median for similarly rated countries is 33.4%). If the tax cuts spur investment, the employment and income growth that that would generate would likely lead to government revenue growth from other taxes. Rupiah depreciation, relatively high inflation because of cuts in fuel subsidies and international capital market volatility have limited the scope for monetary policy stimulus this year, even as growth has slowed. With its tax holiday program, the government is stepping in with fiscal stimulus instead.

Indonesia also has among the lowest fiscal deficits (2.4%) and government debt ratios (24.9%) of its similarly rated peers, giving it the fiscal space to offer economic stimulus. The government had intended to use savings from fuel subsidy reductions to invest in infrastructure, but that is proving difficult to implement. These most recent measures invite private-sector investment to be the growth engine that, so far, the public sector has not been.

By targeting sectors such as marine transport, energy and telecom, and firms that increase value- added manufacturing activity in traditional sectors such as agriculture, fisheries and forestry, the government is renewing efforts to offset the negative effect of falling commodity prices on Indonesia’s export revenues, investment and growth. As Exhibit 1 shows, GDP growth dropped to 4.7% in second-quarter 2015 from around 6% on average in 2012.

EXHIBIT 1

Indonesia’s Year-on-Year Real GDP and Investment Growth

Sources: Badan Pusat Statistik, Haver Analytics and Moody’s Investors Service

In conjunction with the government’s ongoing efforts to improve the operating environment for private investors by simplifying regulations, and given the large size of Indonesia’s economy, the tax measures are likely to invite foreign direct investment, which would bolster Indonesia’s capital account and support the rupiah, which has been depreciating this year (see Exhibit 2). Securing a resilient mix of external funding sources including foreign direct investment will lower Indonesia’s vulnerability to shifts in global financial market sentiment, which has been evident this year.

0.0%0.5%1.0%1.5%2.0%2.5%3.0%3.5%4.0%4.5%5.0%5.5%6.0%6.5%

0.0%1.0%2.0%3.0%4.0%5.0%6.0%7.0%8.0%9.0%

10.0%11.0%

Real GDP Growth - right axis Real Investment Growth - left axis

Atsi Sheth Senior Vice President +65.6398.3727 [email protected]

Amelia Tan Associate Analyst +65.6398.8323 [email protected]

NEWS & ANALYSIS Credit implications of current events

30 MOODY’S CREDIT OUTLOOK 31 AUGUST 2015

EXHIBIT 2

Rupiah Exchange Rate versus the US Dollar, Indexed to 100 on 2 January 2015

Source: Bloomberg

Although the flow of foreign direct investment into Indonesia has been stable over the past few years at around 2.1% of GDP, this ratio remains lower than in other countries in the region such as Malaysia and Thailand, where the foreign-direct-investment-to-GDP ratio averages more than 3% of GDP.

In addition to supporting the growth rate and balance of payments, foreign direct investment can also bring benefits such as technology transfers and other productivity enhancements that would raise Indonesia’s potential growth.

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31 MOODY’S CREDIT OUTLOOK 31 AUGUST 2015

Sub-sovereigns

China Broadens Provincial Pension Fund Investment Options, a Credit Positive On 23 August, China’s (Aa3 stable) State Council expanded permissible investment options for provincial pension funds to include debt and equity market instruments, in addition to already-allowable Chinese sovereign bonds and bank deposits. Access to additional investment options will be through asset placement with national trustee institutions, which are experienced professional investment advisors and managers that are authorized by the State Council. Currently, the Social Security Fund (SSF) is the only qualified trustee. We expect credit-positive higher returns from SSF-managed investment will help address provincial pension funding gaps, which the International Monetary Fund estimated at 76% of 2014 GDP.

The guideline caps at 95% of a pension fund’s net asset value for debt securities including Chinese sovereign and provincial bonds, money-market instruments, investment-grade securities such as medium-term notes, bonds, convertible and asset-backed securities, fixed-income funds, and bond futures. It sets a 30% cap on a fund’s net asset value for equity-related products such as stocks, stock funds, balanced funds, stock index futures and equity-linked pension products, consistent with the government’s desire to nurture a long-term institutional investor base for the domestic stock market. It also caps investment in non-traded equities of state-owned enterprises and project financing at 20% of a pension fund’ net asset value.

The wider investment options will likely enhance the investment returns. Annual returns of provincial pension funds were 2.0%-2.9% in 2009-14, compared to the 2.7% average annual inflation rate. Average returns on the SSF and corporate pension funds were higher (see Exhibit 1).

EXHIBIT 1

Relative Return on Chinese Provincial Pension Fund Assets

Sources: Ministry of Human Resources and Social Security and the Social Security Fund

Total provincial pension fund assets stood at RMB3.56 trillion ($556 billion) at end of 2014, much larger than the assets of the SSF (RMB1.24 trillion) or corporate pension funds (RMB0.77 trillion). One percentage point of improvement in yield implies a RMB35.6 billion increase in asset value.

Provinces with larger pension assets such as Guangdong (RMB512.8 billion at year-end 2014), Jiangsu (RMB279.8 billion), Zhejiang (RMB263.2 billion), Beijing (RMB216.1 billion) and Shandong (RMB193.3) will benefit sooner than smaller provinces. This is because smaller provinces will take months if not years to collect from their cities and counties sufficiently large amounts of pension assets for meaningful management by the SSF (see Exhibit 2).

-1%

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2009 2010 2011 2012 2013 2014

Provincial Pension Funds Social Security Fund Corporate Pension Funds

Nicholas Zhu, Ph.D. Vice President - Senior Analyst +86.10.6319.6536 [email protected]

NEWS & ANALYSIS Credit implications of current events

32 MOODY’S CREDIT OUTLOOK 31 AUGUST 2015

EXHIBIT 2

Chinese Provincial Pension Assets as of December 2013

Source: National Bureau of Statistics

Guangdong and Shandong have already placed significant portions of their pension assets with the SSF to improve investment return. In March 2012, Guangdong placed RMB100 billion, or close to one third of its pension assets at the time, with the SSF; and in July 2015, Shandong decided to place RMB100 billion, or close to half of its pension assets, with the SSF and has already transferred the first RMB10 billion tranche.

To manage the increased volatility associated with capital market investment, the guideline limits leverage through repo of fixed-income instruments to 40% of a pension fund’s net asset value. For liquidity management, the guideline requires a minimum of 5% of a pension fund’s net assets invested in short-term fixed-income or money-market instruments. The guideline also prohibits investment in foreign-currency-denominated assets and requires a set-aside of 1% of investment returns as risk reserves until the reserve amount reaches 5% of a pension fund’s net asset value. One risk we see in the new investment options is the potential concentration of provincial bonds in a province’s pension fund portfolio.

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NEWS & ANALYSIS Credit implications of current events

33 MOODY’S CREDIT OUTLOOK 31 AUGUST 2015

US Public Finance

Hillview, Kentucky, Chapter 9 Filing Shows that Municipal Bankruptcy Is an Increasingly Viable Option On 20 August, the City of Hillview, Kentucky (unrated), filed a bankruptcy petition arguing an $11.4 million legal judgment will leave it insolvent. Hillview’s filing is more evidence that municipalities increasingly consider Chapter 9 as a way to cure balance-sheet problems, a credit negative for the city and the entire local government sector. Hillview has not defaulted on its general obligation bonds, which carry a full faith and credit pledge.

The filing follows examples such as the Town of Mammoth Lakes, California (unrated), Boise County, Idaho (unrated), and the Township of Westfall, Pennsylvania (unrated), where local governments also cited legal judgments as the reason for a Chapter 9 filing. After a period of failed negotiations, Mammoth Lakes successfully settled with a developer and requested dismissal of its filing. Westfall received court approval to reorganize under Chapter 9 and used the process to reduce repayment on a $20.8 million legal obligation to a developer.

Hillview had $13.8 million in total debt, including the legal judgment, equal to 40x the city’s $347,000 unassigned general fund balance at 30 June 2014. Yet it still may face difficulties proving insolvency in federal bankruptcy court. Generally, a municipality must prove that it is not paying its debts on time or is unable to pay the obligations as they become due. Although the legal judgment is 4.5x the city’s fiscal 2014 general fund revenues of $2.5 million, the city under state law can issue bonds to pay for losses in legal judgments, and Kentucky courts can order periodic payment of the judgment over a period not to exceed 10 years.

Also, the city has considerable ability to increase its two largest sources of operating revenue: occupational license taxes and property taxes. Occupational license taxes accounted for 50% of fiscal 2014 general fund revenues, while property taxes constituted 30%.

Despite obvious practical limitations, Hillview has full autonomy to increase its 1.5% occupational license tax rate levied on wages, salaries and business net profits earned within its taxing jurisdiction. Hillview can also increase its annual property tax levy up to 4% without voter approval. The city has significant margin to increase property tax rates and remain within the maximum rate of $7.50 per $1,000 of full valuation established by the Kentucky Constitution. The city’s real and tangible property tax rates totaled $2.97 per $1,000 in fiscal 2015, which is 40% of the maximum permitted tax rate. Kentucky courts have held that local governments can exceed the maximum tax rate to pay debt service on general obligation bonds, providing a local government did not exceed the maximum tax rate at the time of the bond sale.

Fixed costs, including debt service and pension contributions, accounted for 20.1% of the city’s fiscal 2014 general fund expenditures. Assuming level amortization of the legal judgment over 10 years, the additional principal payments alone would increase the city’s fixed costs to 66.8% ($1.6 million) of 2014 general fund expenditures.

Unlike most recent Chapter 9 petitioners, Hillview participates in a multi-employer, cost-sharing pension plan, Kentucky County Employees’ Retirement System (CERS). If bankruptcy is granted and reductions to pensions are part of Hillview’s recovery plan, other entities that participate in the plan could be saddled with increased costs as Hillview’s share of CERS’ net pension liability is redistributed among other participating governments. Based on fiscal 2014 reporting of government contributions to CERS, we estimate that Hillview’s share of the plan’s NPL is approximately $2.3 million and a de minimus 0.05% of the plan’s total net pension liability of $4.4 billion as of 30 June 2014.

Nathan Phelps Analyst +1.214.979.6853 [email protected]

NEWS & ANALYSIS Credit implications of current events

34 MOODY’S CREDIT OUTLOOK 31 AUGUST 2015

Higher Education Benefits from Income-Driven Repayment Plan Growth On 20 August, the US Department of Education reported that participation in income-driven repayment plans for federal student loans had grown 56% as of June, versus June 2014. Increased use of these federal repayment plans is credit positive for US colleges and universities. Federal student loans contribute a material 15% or more of total operating revenue across the higher education sector, and income-driven repayment loans enhance their attractiveness to borrowers by limiting the borrower’s potential financial burden.

Income-driven repayment programs make student loan debt more affordable by capping monthly payments based on a borrower’s income and forgiving debt not repaid by the end of the payment period. Predictable repayments, which can be capped at 10%-15% of a borrower’s income, provide greater comfort, confidence and appeal upfront, particularly since new graduates often have lower incomes and higher unemployment rates. According to The College Board, approximately 60% of all college graduates have student loans.

Increased eligibility and active marketing of the income-driven repayment plans contributed to strong growth by number of participants and dollar amount (see exhibit). As of 30 June 2015, almost $250 billion of federal loans were in one of several plans, compared with approximately $110 billion two years earlier.

Federal Income-Driven Repayment Plans Gain Traction

Source: National Student Loan Data System

Although the growth and success of income-driven repayment plans does not directly address the question of affordability and the growing cost of education at US colleges and universities, it will help alleviate some of the negative political and public discourse on the value of a college degree. Over the past few years, politicians and the media have pointed to growing student debt burden as evidence of how unaffordable a four-year degree has become.

Amid a slow economic recovery and heightened price sensitivity, US higher education tuition prices have risen at a slower pace, resulting in weak net tuition revenue growth. Median growth of net tuition per student was 3.0%-3.5% for public and private universities in the fiscal year that ended 30 June 2014, significantly below the strong pre-recessionary median growth of 7%-9% for public universities and 5%-6% for private universities during fiscal 2005-08.

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Income-Contingent Income-Based Pay As You Earn Alternative Other

Eva Bogaty Vice President - Senior Analyst +1.415.274.1765 [email protected]

NEWS & ANALYSIS Credit implications of current events

35 MOODY’S CREDIT OUTLOOK 31 AUGUST 2015

Chicago Public Schools Assume $480 Million of Uncertain Assistance from Illinois, a Credit Negative On 26 August, the Chicago, Illinois Board of Education unanimously approved a $5.7 billion budget for the Chicago Public Schools (CPS, Ba3 negative) for fiscal 2016, which began on 1 July. The board’s action is credit negative because the budget is structurally imbalanced and relies heavily on several uncertain and non-recurring resources to close a $1.1 billion gap.

The budget assumes an additional $480 million in aid from the State of Illinois (A3 negative) to assist with the district’s required annual pension contribution (see exhibit), though it is not yet certain what form this assistance would take. The district’s assumption of additional state support is risky because the state has not yet appropriated the additional funding. In fact, given the state’s own challenged finances and ongoing budget impasse, any such increase in state aid to CPS is uncertain. Two months after the start of the state's fiscal year, Illinois lawmakers have yet to pass a state budget for fiscal 2016.

Chicago Public Schools’ Fiscal 2016 Budget Revenue Assumptions

Source: Chicago Public Schools

Should budgeted state revenue enhancements fail to materialize, the district would face a substantial budget gap, requiring measures such as significant increases to class sizes. The district has implemented nearly $1 billion in cumulative expenditure reductions since fiscal 2011. After years of such sizeable cuts, the district has less ability to further cut expenditures to offset budgeted state funds that do not come to fruition. In the event that the district does not receive the additional budgeted state resources and is unable to make commensurate budget adjustments, the district’s financial position will likely become more reliant on access to capital markets to issue short-term debt.

Other non-recurring measures in the district's fiscal 2016 budget include:

» $200 million in reduced debt service costs through debt restructuring, which involves extending principal and interest payments on outstanding general obligation debt

» $79 million in reserve use from the district’s $263 million General Operating Fund balance

» $55 million in reserve use from the district’s non-operating funds

» $62 million in a one-time transfer of tax increment finance surplus from the City of Chicago (Ba1 negative)

An additional budgetary variable is the district’s ongoing contract negotiations with the Chicago Teachers Union. A three-year contract between the district and the union expired on 30 June, and recent negotiations

Local48%

State - Excluding Uncertain Pension Aid28%

Federal15%

Miscellaneous1%

State - Uncertain Pension Aid8%

Mark Lazarus Assistant Vice President +1.312.706.9976 [email protected]

NEWS & ANALYSIS Credit implications of current events

36 MOODY’S CREDIT OUTLOOK 31 AUGUST 2015

for a new contract remain unresolved. The expired contract was negotiated in 2012, following a multi-day strike. The approved 2016 budget optimistically assumes no salary increases. With salaries and benefits close to 70% of General Operating Fund expenditures, any personnel-related increases that result from contract negotiations would exacerbate the district’s operating pressures.

Revenue shortfalls, including the failure to receive the budgeted $480 million of supplemental state aid for pensions, or higher personnel cost will exacerbate the size and scope of the district's structural imbalance. Failure to maintain access to short-term borrowing programs in an amount sufficient to maintain operations would be an additional credit pressure. Such variances and their effect on the district’s liquidity and cash flow would likely result in a weaker overall credit profile.

RATING CHANGES Significant rating actions taken the week ending 28 August 2015

37 MOODY’S CREDIT OUTLOOK 31 AUGUST 2015

Corporates

Alcatel-Lucent Upgrade 20 Apr ‘15 28 Aug ‘15

Corporate Family Rating B3 B2

Outlook Review for Upgrade Review for Upgrade

The rating upgrade was triggered by the gradual improvement in Alcatel-Lucent's operating performance and, in particular, in its free cash flow generation over the past several quarters and our expectations that this will continue over the next 12-18 months, driven by an ongoing restructuring program targeting a significant reduction in fixed costs.

Automatic Data Processing, Inc. Downgrade 10 Apr ‘14 28 Aug ‘15

Long-Term Issuer Rating Aa1 Aa3

Short-Term Issuer Rating P-1 P-1 (affirmed)

Outlook Stable Stable

The downgrade follows ADP’s announcement that it is planning a $2 billion debt issuance with proceeds to be used largely for share repurchases, its first-ever debt-funded buyback, which represents an abrupt shift away from its historically conservative financial practices.

Newell Rubbermaid, Inc. Outlook Change 17 Mar ‘10 24 Aug ‘15

Senior Unsecured Rating Baa3 Baa3

Short-Term Issuer Rating P-3 P-3

Outlook Stable Positive

The outlook change reflects our expectation that Newell will continue to improve its operating performance and credit metrics and will continue to grow its product portfolio as it executes it strategic focus around its core brands in growth regions.

Peabody Energy Corporation Downgrade 25 Jun ‘15 27 Aug ‘15

Corporate Family Rating B3 Caa1

Outlook Negative Review for Downgrade

The downgrade reflects our expectation of continued deterioration in Peabody’s credit metrics due to the ongoing decline in the seaborne metallurgical coal markets and weakness in the US and seaborne thermal coal markets, as well as our expectation that market recovery will be slower and more protracted than previously anticipated.

RATING CHANGES Significant rating actions taken the week ending 28 August 2015

38 MOODY’S CREDIT OUTLOOK 31 AUGUST 2015

Petroleos Mexicanos Review for Downgrade 20 Feb ‘15 25 Aug ‘15

Long-Term Issuer Rating A3 A3

Outlook Stable Review for Downgrade

The review reflects our expectation that depressed oil prices will further undercut Pemex's cash-flow generation and result in rising balance sheet leverage over the next several years. The company has increased debt for a number of years to fund large outflows for taxes, duties and capital spending, without achieving any sustained increases in production or operating efficiencies.

Transocean Inc. Review for Downgrade 25 Feb ‘15 24 Aug ‘15

Corporate Family Rating Ba1 Ba1

Outlook Stable Review for Downgrade

The review reflects our concern that offshore drilling contractors will face an extremely challenging operating environment through at least 2017. Sustained weak crude oil prices and a steady supply of newbuild rigs will cause significant credit erosion as contracted backlogs, revenues and cash flows continue to fade.

RATING CHANGES Significant rating actions taken the week ending 28 August 2015

39 MOODY’S CREDIT OUTLOOK 31 AUGUST 2015

Infrastructure

EVN AG Outlook Change 10 Jul ‘14 28 Aug ‘15

Senior Unsecured Debt Ratings A3 A3

Outlook Negative Stable

The outlook change takes into account EVN’s improving financial profile, better operating performance and continued focus on domestic regulated and stable markets as its main source of future investment and growth. Following release of its Q1-Q3 2015 results, we expect that EVN will meet the ratio guidance of funds from operations/net debt of at least 20% and retained cash flow/net debt of at least 15% in fiscal year 14-15 for the A3 rating, absent any further material adverse regulatory decisions or unforeseen shocks.

Amey Roads NI Financial plc Upgrade 23 Aug ‘13 28 Aug ‘15

Underlying Senior Secured Bonds Baa2 Baa1

Outlook Stable Stable

The upgrade of the GBP146.4 million index-linked guaranteed secured bonds due 2037 reflects Amey Roads NI Financial’s improved financial metrics after a slight reduction in the principal amount of the bonds in 2014 and continuing solid operational performance.

Alliant Enery Corporation Outlook Change 30 Jan ‘14 27 Aug ‘15

Senior Unsecured Debt Ratings A3 A3

Outlook Stable Negative

The negative outlook reflects the Alliant family’s weak financial metrics for its rating and their likely deterioration over the next few years as its utility subsidiaries incur incremental debt to finance their extensive, multi-year capital expenditure plans. Given the small size of Alliant’s unregulated business, the outlook is driven largely by the negative outlooks on its two utility subsidiaries, IP&L and WP&L, whose debt coverage metrics are decreasing owing to incremental debt and lagging operating cash flow recovery.

RATING CHANGES Significant rating actions taken the week ending 28 August 2015

40 MOODY’S CREDIT OUTLOOK 31 AUGUST 2015

Interstate Power & Light Company Outlook Change 27 Sept ‘12 27 Aug ‘15

Senior Unsecured Debt Ratings A3 A3

Outlook Stable Negative

The negative outlook reflects the Alliant family’s weak financial metrics for its rating and their likely deterioration over the next few years as its utility subsidiaries incur incremental debt to finance their extensive, multi-year capital expenditure plans. Given the small size of Alliant’s unregulated business, the outlook is driven largely by the negative outlooks on its two utility subsidiaries, IP&L and WP&L, whose debt coverage metrics are decreasing owing to incremental debt and lagging operating cash flow recovery.

Talen Energy Supply, LLC Outlook Change 11 May ‘15 25 Aug ‘15

CFR Ba2 Ba2

Outlook Stable Negative

The negative outlook reflects the sustained downward trend in gas and power prices in the unregulated markets in the US. Although the results of PJM’s capacity market auction for 2018-19 will lead to an incremental improvement to Talen’s cash flow, this will not be sufficient to offset declines in the broader energy markets. The outlook is also driven by our expectation that the pending acquisition of Mach Gen LLC will incrementally worsen Talen’s cash flow to debt leverage.

The Southern Company Outlook Change 12 Aug ‘10 24 Aug ‘15

Senior Unsecured Debt Rating Baa1 Baa1

Outlook Stable Negative

The outlook change was prompted by The Southern Company’s announcement that it has agreed to acquire AGL Resources, Inc. for approximately $8 billion in cash. The transaction will result in a significant increase in debt at the Southern holding company level at a time when holding company debt has already been increasing, partly to support funding needs at utility subsidiary Mississippi Power and portfolio growth at wholesale power company, Southern Power.

RATING CHANGES Significant rating actions taken the week ending 28 August 2015

41 MOODY’S CREDIT OUTLOOK 31 AUGUST 2015

Wisconsin Power & Light Company Outlook Change 30 Jan ‘14 27 Aug ‘15

Senior Unsecured Debt Ratings A1 A1

Outlook Stable Negative

The negative outlook reflects the Alliant family’s weak financial metrics for its rating and their likely deterioration over the next few years as its utility subsidiaries incur incremental debt to finance their extensive, multi-year capital expenditure plans. Given the small size of Alliant’s unregulated business, the outlook is driven largely by the negative outlooks on its two utility subsidiaries, IP&L and WP&L, whose debt coverage metrics are decreasing owing to incremental debt and lagging operating cash flow recovery.

Financial Institutions

AIG Taiwan Insurance Co Ltd Downgrade 15 Jun ‘15 28 Aug ‘15

Insurance Financial Strength Ratings (Domestic) A2 A3

Outlook Review for downgrade Stable

The downgrade reflects the removal of parental support from AIG since AIG announced its intention to sell AIG Taiwan to Nan Shan Life.

Nanyang Commercial Bank, Ltd Review for Downgrade 28 May ‘15 28 Aug ‘15

Long-Term Bank Deposit Ratings A1 A1

Counterparty Risk Assessment Aa3(cr) Aa3(cr)

Baseline Credit Assessment baa1 baa1

Adjusted Baseline Credit Assessment a2 a2

Outlook Negative Review for downgrade

The review follows the announcement by BOC Hong Kong (Holdings) Ltd (unrated) that Cinda Financial Holdings Co., Ltd, an entity 100% owned by China Cinda Asset Management Co., Ltd, was the sole bidder for Nanyang Commercial Bank’s sale. A change in ownership would likely lead to less support in Nanyang’s ratings, given that Cinda has lower issuer ratings than Bank of China (Hong Kong).

RATING CHANGES Significant rating actions taken the week ending 28 August 2015

42 MOODY’S CREDIT OUTLOOK 31 AUGUST 2015

QBE Insurance Group Limited Review for Upgrade 10 Dec ‘13 24 Aug ‘15

Senior Unsecured Rating (Foreign) Baa2 Baa2

Long-Term Issuer Rating (Foreign) Baa2 Baa2

Outlook Stable Review for upgrade

The review follows various actions QBE management has taken to redirect the group’s corporate strategy, reduce financial leverage and improve earnings and profitability. The review will therefore focus on the sustainability of QBE’s improved capital structure and path for sustainable improvement in its earnings and profitability profile.

Sub-sovereigns

State of Mexico

Outlook Change 07 Feb ‘15 21 Aug ‘15

Long-Term Issuer Rating (Domestic) Ba2 Ba2

NSR Long-Term Issuer Rating (Domestic) A2 A2

Outlook Stable Positive

The outlook change reflects the recording of roughly balanced financial results in 2013 and 2014 and the maintenance of moderate debt levels and a strong liquidity position. Liquidity measured by net working capital was equivalent to 6% of total revenues in 2014, which is higher than the Ba1 median. Furthermore, in 2014 the state made progress on own-source revenues collection and in unfunded pension liabilities, with own-source revenues increasing by 50% and pension reform reducing unfunded pension liabilities to 330% of total revenues in 2014 from 560% in 2012.

Structured Finance

Rating Upgrades of $347 Million of Subprime RMBS Issued by Various Issuers On 28 August we upgraded the ratings on 14 tranches from eight transactions put out by various issuers and backed by subprime mortgage loans. The upgrades are a result of improving performance of the related pools and/or build-up in credit enhancement of the tranches. The actions reflect the recent performance of the underlying pools and our updated loss expectations on the pools.

RESEARCH HIGHLIGHTS Notable research published the week ending 28 August 2015

43 MOODY’S CREDIT OUTLOOK 31 AUGUST 2015

Corporates Japanese Pharmaceuticals: Increased Generic Use to Pressure Earnings, Drive Cross- Border M&A We expect the revenue contribution from the domestic market to contract for Japan’s five largest pharmaceutical companies during the next five years as the use of generic drugs expands at the expense of the companies’ key off-patent branded products. Nevertheless, revenues and profits from outside Japan will continue increasing for all five companies and support modest overall earnings growth.

European Real Estate: Stronger Credit Quality Allows Access to Cheaper Debt Improved credit and economic conditions in most of Europe have resulted in stronger credit quality for the region’s publicly listed real estate companies since the financial crisis. Creditworthiness is likely to remain strong on the back of growing rental income supported by increased occupier demand and lower vacancy rates in all property sectors, leading to steadier cash flows and greater profitability.

Chinese Technology Services: Online-to-Offline Platforms Create New Revenue Sources Investments that Alibaba Group Holding Limited (A1 stable), Tencent Holdings Limited (A2 stable) and Baidu Inc. (A3 positive) have made in online-to-offline (O2O) platforms during the past two years will gain traction and boost the companies’ revenues in the next 12-24 months. We expect the companies to sell advertisements and collect commissions from the growing number of offline merchants and service providers keen to access the Internet companies’ large consumer bases through O2O partnerships.

Global Chemicals: Titanium Dioxide Cycle Yet to Hit Bottom, Recovery Possible by 2017 The titanium dioxide industry will continue to weaken in the near term amid growing supply and sluggish demand growth. Low global operating rates have led to price declines in the first half of this year. Prices will likely fall further as the industry enters the seasonally weak second half and as new capacity in China and Mexico comes online.

Global Lodging and Cruise: New Methodology Offers More Transparent View of Risk On 21 May 2015, we transitioned our rated lodging and cruise companies to Moody’s Business & Consumer Service Industry Rating Methodology. While this did not trigger any rating changes, our new approach offers a clearer view of how we weigh certain risks, using two qualitative factors: demand characteristics and competitive profile.

China Property Focus - August 2015 Feature articles include: National Sales Growth to Remain Healthy in 2H 2015; Pressure on Residential Home Prices to Continue Gradual Easing; and China's Exchange Rate Reform Is Credit Negative for Property Developers.

European Gaming: Consolidation Will Help Operators Cope With More Regulation The £5 billion merger between Paddy Power Plc and Betfair Group Plc is the latest in a wave of M&A in the European gaming industry as operators seek to get bigger and more diversified. Greater scale will allow operators to absorb tighter regulation, including increasing compliance and taxation costs, while preserving sufficient capacity to invest in marketing and product development. However, these benefits will be muted given the magnitude of the industry's exposure to regulatory risk.

RESEARCH HIGHLIGHTS Notable research published the week ending 28 August 2015

44 MOODY’S CREDIT OUTLOOK 31 AUGUST 2015

US Retail: Christmas in August? Walmart Cranks up the Competitive Heat, Especially for Toys Wal-Mart Stores, Inc.’ s (Aa2 stable) announcement Thursday morning (27 August) that it is beginning its layaway program on Friday, as well as rolling out its first-ever Toy Week promotion, is credit positive for the company. These actions will heighten the pressure on its key holiday competitors, including Toys “R” Us, Inc. (B3 negative), Target Corp. (A2 stable), Best Buy Co., Inc. (Baa1 stable) and Amazon.com, Inc. (Baa1 negative) to react in some fashion.

Default and Rating Transitions of Japanese Debt Issuers, 1990-2014 This special comment presents our sixth annual default study. Here we update the default and rating transition experience among Moody’s-rated Japanese debt issuers for the period of 1990-2014.

Financial Institutions

China’s Latest Rate Cuts Will Alleviate Liquidity Pressure in the Banking System The People’s Bank of China has reduced both the country’s benchmark lending and deposit rates by 25 basis points, and removed the rate cap of 1.5x the benchmark deposit rate on time deposits exceeding one year. It will also lower the reserve requirement ratio by 50 basis points for all banks, with an additional 50 basis point reduction for rural financial institutions. On balance, we think these policy actions are positive for Chinese banks. The cuts will add to system liquidity and drive down borrowing costs, mitigating the slowdown in growth.

US P&C Insurers: Second-Quarter Earnings Flat; Low Rate Environment Continues to Weigh on Insurers Moody’s-rated US property & casualty insurers reported flat earnings for second-quarter 2015 compared to the year-ago quarter. Net written premiums for the group grew by 3% despite foreign-exchange headwinds for firms with significant international operations, given the strengthening US dollar. Reported combined ratios improved one point year-over-year to 96%, while investment income declined 3%, reflecting lower portfolio yields in the low interest rate environment.

Peruvian Insurance Industry Scorecard The Peruvian insurance market is a small and still under-penetrated market in Latin America, with 18 international and domestic insurers writing life and non-life insurance products. The country’s life and general insurers produced premiums of approximately US$3.5 billion during 2014. The market should continue to grow but at a slower pace than between 2010 and 2013, when Peru benefited from high global prices for its commodities exports.

Canadian Life Insurers Second Quarter Results: Asia and Europe Segments Drive Sales, While US Asset Management Falters Each of the three Canadian life insurers recorded continued top-line momentum in the second quarter, supported by strong growth in insurance sales and higher wealth and asset management fees. Domestic earnings growth was muted, with the exception of a strong performance by Sun Life Financial. Asian and European sales performance was largely strong and favorable foreign-exchange movements continued, though for less benefit than in the prior quarter.

RESEARCH HIGHLIGHTS Notable research published the week ending 28 August 2015

45 MOODY’S CREDIT OUTLOOK 31 AUGUST 2015

Sovereigns

Global Macro Outlook: Downward Revisions to 2016 Global Economic Outlook We have revised our Global Macro Outlook for 2016 downward to reflect information that has become available since our forecast published earlier this month. We forecast GDP growth in the G20 economies to average 2.8% next year, 0.3 of a percentage point lower than in our previous forecast. In most cases our downward revisions are focused on 2016 forecasts, while in a few countries weaker-than-expected activity in Q2 2015 led us to revise 2015 GDP growth down as well.

Mozambique Sovereign Analysis Mozambique’s B2 rating reflects the country’s very low income levels and dependence on the primary sector, e.g., coal and natural gas, as well as agriculture. Upgrading the country’s infrastructure network to support the exploitation of Mozambique’s abundant natural resources presents risks for public finances. As a result of high government capital expenditure, fiscal deficits have been large and debt increasing. It will take some time for natural resource production to translate into increased revenue, with uncertainty over the level of returns.

Brazil Sovereign Analysis On 11 August, we downgraded Brazil's government bond rating to Baa3 from Baa2 and changed the outlook to stable from negative. The drivers of the rating change were weaker-than-expected economic performance, an upward trend in government expenditures and a lack of political consensus on fiscal reforms.

Oman Sovereign Analysis On 20 February 2015, we affirmed Oman’s A1 government bond rating and changed the outlook to negative from stable. The negative change was driven by uncertainty around the effectiveness of the government's policies with regard to a multi-year period of low oil prices, which will exert downward pressures on economic growth, government finances and the country’s external payments position.

Angola Sovereign Analysis Angola’s Ba2 government rating reflects the country’s limited institutional capacity and vulnerability to oil price volatility, but is supported by the economy’s robust medium-term growth prospects and the strength of the government balance sheet. Angola is grappling with an oil price shock to its oil-dependent economy. Though it is better prepared than it was in 2009 and its policy response has been swift and far-reaching, its external position has weakened sharply and its fiscal position and growth prospects are being challenged in the near term.

Vietnam Sovereign Analysis Vietnam’s B1 government bond rating and stable outlook reflect macroeconomic stability, characterized by low inflation and external surpluses since 2012. Real GDP growth continues to recover from a two-year lull as the country benefits from compositional shifts in Asia’s cross-border production networks, helping to accelerate progress towards higher value-added manufacturing.

Cambodia Sovereign Analysis Cambodia’s B2 foreign-currency bond rating is supported by the country’s healthy growth path and modest debt burden, which presents low fiscal risks. These strengths are offset by Cambodia’s low per capita income and weak institutional framework.

RESEARCH HIGHLIGHTS Notable research published the week ending 28 August 2015

46 MOODY’S CREDIT OUTLOOK 31 AUGUST 2015

Sub-sovereigns

Mexico's 2016 Federal Budget Will Likely Curtail States' Project Transfers, a Credit Negative Federal funding for infrastructure and ministerial projects grew faster than any other form of Mexican federal government support to states between 2010 and 2014. We expect the government to curtail funding for states’ infrastructure projects and for a range of other transfers overseen by federal ministries as part of its 2016 budget.

Mexican Financial Discipline Law for Sub-sovereigns Would Be Credit Positive Mexico President Enrique Pena Nieto has presented the Financial Discipline Law for states and municipalities that will be submitted to Mexico’s congress. The proposed law requires positive budgetary balances, limits personnel spending growth, improves the transparency and visibility of sub-sovereign debt and finances and sets clear debt contracting and related definitions. The proposed regulation is credit positive owing to its potential to improve the financial management of Mexico’s second-tier governments.

US Public Finance

Community Colleges: Ongoing Constrained Revenue Growth Evident in Fiscal 2014 Community colleges issuing revenue bonds continued to experience constrained revenue growth from student charges and state appropriations in fiscal year 2014, leading to tighter expense controls and more restrained capital investment than in prior years. Diversification of revenue was a key indicator of financial success in fiscal 2014; community colleges that receive tax revenue were better able to offset declines in other revenue sources and outperformed the rest of the industry.

RESEARCH HIGHLIGHTS Notable research published the week ending 28 August 2015

47 MOODY’S CREDIT OUTLOOK 31 AUGUST 2015

Structured Finance

US Solar ABS: California's Utility Rate Reform Increases Contract Risk in Outstanding Securitizations A new electric rate structure for residential customers of California’s three major investor-owned utilities will cut electricity rates for many homeowners who installed solar energy systems, increasing the risk in outstanding solar asset-backed securitizations (ABS) that some obligors will try to renegotiate their contracts because they are not seeing the cost savings they anticipated. Also, consumers who are considering buying homes already equipped with solar systems will have less incentive to assume the solar leases or power purchase agreements, which could jeopardize the contracts or lead to contract renegotiations.

US RMBS: Invitation Homes' Atlanta-Area Property Sales Are Credit Neutral for Its Rated Transactions The recently announced sale of roughly 1,300 properties from the portfolio of Blackstone Group's Invitation Homes (IH) subsidiary in Atlanta is credit neutral for IH single-family rental (SFR) securitizations. Because the Atlanta sales come out of IH’s unsecuritized property portfolio, IH SFR securitizations will not benefit from premium release. The sales will not lessen IH’s commitment to the Atlanta market or harm its SFR business, because the sale properties represent only a modest portion of its Atlanta-area portfolio and a very small proportion of its overall portfolio.

US CMBS Loss Severities Second Quarter Update Our quarterly loss severities report tracks loan losses upon liquidation and cumulative deal losses in conduit and fusion transactions in US commercial mortgage-backed securities (CMBS). This report details losses for the 1998 to 2015 vintages based on liquidations that took place from 1 January 2000 to 30 June 2015. It also compares losses upon liquidation and cumulative deal losses quarter over quarter and year over year.

Australian RMBS and Covered Bonds: Proposed Rules for Interest-Only Mortgages Are Credit Positive Last Thursday, the Australian Securities and Investment Commission published its recommendations to improve underwriting standards for interest-only loans. The recommendations are credit positive for future Australian residential mortgage-backed securities and covered bond collateral because they will reduce interest-only borrowers’ probability of default.

RECENTLY IN CREDIT OUTLOOK Select any article below to go to last Thursday’s Credit Outlook on moodys.com

48 MOODY’S CREDIT OUTLOOK 31 AUGUST 2015

NEWS & ANALYSIS Corporates 2 » Baytex Preserves Free Cash Flow by Cutting Dividend and

Capital Budget » DaVita HealthCare's Planned Acquisition of Renal Ventures Is

Credit Positive

Infrastructure 4 » Regulators Reject Exelon's Application to Acquire Pepco

Holdings, a Credit Negative for Both Companies » Southern's Acquisition of AGL Resources Will Significantly

Increase Debt

Banks 6 » Russia's Renewed Ruble Depreciation Adds Pressure to Banks'

Weak Fundamentals » SMBC and ORIX Will Increase Stakes in Cambodia's Largest

Bank, a Credit Positive

Sovereigns 9 » Turkey's Early Elections Prolong Policy Indecision and

Intensify Economic Headwinds » Botswana's Reduced 2015 GDP Forecast Reflects Less Sparkle

in Diamonds

US Public Finance 13 » Griggs County, North Dakota, Sues to Terminate Lease for

Unwanted Courthouse, Increasing Default Likelihood

Securitization 15 » Australia's Proposed Rules for Interest-Only Mortgages Are

Credit Positive for RMBS and Covered Bonds

MOODYS.COM

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EDITORS PRODUCTION ASSOCIATE News & Analysis: Elisa Herr and Jay Sherman Sol Vivero Ratings & Research: Bronwyn Collie