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MOODYS.COM
10 JANUARY 2013
NEWS & ANALYSIS Corporates 2
» Fiscal Cliff Legislation Is Credit Negative for For-Profit Hospitals
» Extension of Bonus Depreciation Will Save US Companies Nearly $23 Billion
» Avis Budget Group's Planned Acquisition of Zipcar Is Credit Negative
» Mohawk's Agreement to Buy Marazzi Group Is Credit Negative » Chevron's Entry in Kitimat Liquid Natural Gas Project Is
Credit Positive » Pan American Energy Increases Argentine Natural Gas
Investment at Higher Prices, a Credit Positive » Shanghai Industrial Urban Development Group’s Chengdu
Project Exit Would Be Credit Positive » SK Broadband's Merger with Broadband Media Is Credit Positive
Infrastructure 13
» US Extends Tax Credit for Wind Power, a Credit Positive for Developers and Utilities
» MidAmerican’s Acquisition of World's Largest Solar Development Is Credit Negative
» New Mexico Commission Suspends Tri-State G&T Rate Increase, a Credit Negative
Banks 16
» Bank of America Takes Another Step in Resolving Its Mortgage Exposures
» Brazil to Ease Banks' Reserves to Stimulate Lending, a Credit Positive
» Grupo Aval's Porvenir Makes Credit Positive Acquisition of BBVA's Colombian Asset Manager
» Germany's Extension of SoFFin's Bank Rescue Fund Is Credit Positive
» VietinBank Sells 20% Stake to Tokyo-Mitsubishi Bank, a Credit Positive
Asset Managers 22
» US Money Fund Managers to Benefit from End of Unlimited Guarantee on Bank Accounts
Sovereigns 24
» US Fiscal Package Has Limited Positive Credit Implications » Czech Sovereign Beats Its 2012 Fiscal Target, a Credit Positive » Slovakia's 2012 Fiscal Outcome Makes Final Consolidation Push
a Challenge » Myanmar Secures More Financial Assistance from Japan
Covered Bonds 28
» Dexia Municipal Agency Restructuring Is Credit Positive for French Covered Bonds
Accounting 29
» US FASB Proposal on Financial Asset Impairment Will Lead to More Timely Recognition
Click here for Weekly Market Outlook, our sister publication containing Moody’s Analytics’ review of market activity, financial predictions, and the dates of upcoming economic releases.
NEWS & ANALYSIS Credit implications of current events
2 MOODY’S CREDIT OUTLOOK 10 JANUARY 2013
Corporates
Fiscal Cliff Legislation Is Credit Negative for For-Profit Hospitals
The legislation that President Barack Obama signed into law on 2 January to avert the so-called “fiscal cliff” is credit negative for for-profit hospitals because it reduces Medicare payments to acute care hospitals in order to narrow a federal funding gap.
The reduced Medicare payments will constrain hospitals’ revenue growth. Traditional Medicare accounts for an average of about 29% of for-profit-hospital operators’ net revenue, based on financial information filed with the Securities and Exchange Commission by a number of for-profit hospital operators we rate. HCA Inc. (B1 stable), CHS/Community Health Systems, Inc. (B1 stable) and Tenet Healthcare Corporation (B2 positive) are three of the largest for-profit hospital operators by revenue.
The legislation prevents a 26.5% reduction in Medicare payments to physicians this year. But it cuts Medicare payments for inpatient hospital services to pay for the funding necessary to maintain physician payments at current levels.
The Congressional Budget Office (CBO) estimates that keeping payment rates for physicians who treat Medicare patients at current levels will cost the Medicare program $25 billion over the next 10 years.
The legislation doesn’t quantify future reimbursement rate reductions for hospitals. But nearly half of the funding gap will be filled by reductions in payments for inpatient hospital services, according to the CBO. It estimates that decreased payment rates for inpatient procedures will reduce Medicare payments to hospitals by $10.5 billion between 2014 and 2018. The CBO expects an additional $4.2 billion in savings from a decrease in the allotment of disproportionate share funding to states, which use those funds to reimburse hospitals that treat indigent patients.
The legislation also postponed by two months the 2% federal spending cuts that were to take effect at the start of 2013. The postponement leaves open the possibility that for-profit hospitals could still see an additional 2% reduction in Medicare payments.
Dean Diaz Vice President - Senior Credit Officer +1.212.553.4332 [email protected]
NEWS & ANALYSIS Credit implications of current events
3 MOODY’S CREDIT OUTLOOK 10 JANUARY 2013
Extension of Bonus Depreciation Will Save US Companies Nearly $23 Billion
Last Wednesday, President Barack Obama signed into law legislation that extends by a year a 2012 tax benefit allowing companies to deduct 50% of their capital expenditures (CAPEX), significantly more than normal. The extension of bonus depreciation is credit positive for non-financial companies because larger tax deductions reduce taxes, thereby improving liquidity over the next 12 months. We estimate the extension will save companies nearly $23 billion in cash taxes for 2013.
Congress negotiated the benefit as part of a bill1 designed to avert the full tax consequences of the lapse in Bush-era tax cuts – commonly referred to as the “fiscal cliff.” Normally, tax deductions for CAPEX are much lower. Companies are permitted to depreciate, for tax purposes, property plant and equipment acquired and placed into service during the year using a Modified Accelerated Cost Recovery System (MACRS). Under this system, a company depreciates the capitalized cost basis of tangible property over its useful life using guidelines published by the Internal Revenue Service that categorize by asset class and among six useful-life categories (three, five, seven, 10, 15 and 20 years).
Although cash positive today, accelerated depreciation merely shifts tax deductions to earlier periods. Had a company not used bonus depreciation, fewer tax deductions in the second and subsequent years of an asset’s life would result in higher taxes. Therefore, bonus depreciation, while a significant cash flow benefit in the first year, generally reduces cash flows in the following years and is net neutral over the life of an asset.
Exhibit 1 below shows the CAPEX for the 12 months ended 30 September for the five industries most likely to benefit from the bonus deprecation extension including utilities, energy, telecommunications and retail. These industries’ CAPEX totaled $426 billion, or 52% of $815 billion in last-12-month (LTM) CAPEX for all rated, non-financial companies.
EXHIBIT 1
Top Five Industries with the Highest Capital Expenditures for 12 Months Ended 30 September 2012 $ billions
Source: Moody’s Financial Metrics
For illustration, Exhibit 2 compares the estimated tax benefit (e.g., cash savings) with and without bonus depreciation in 2013. We used the LTM CAPEX as of 30 September 2012 for more than 1,100 public, non-financial rated companies. We assumed 75% of capital expenditures were eligible for
1 The American Taxpayer Relief Act of 2012.
Regulated Electric and Gas Utilities19%
Energy, Oil & Gas -Independent E & P15%
Energy, Oil & Gas - Integrated7%
Telecommunications6%
Retail5%
All others48%
Jason Cuomo Vice President - Senior Accounting Analyst +1.212.553.7795 [email protected]
Wesley Smyth Vice President - Senior Accounting Analyst +1.212.553.2733 [email protected]
NEWS & ANALYSIS Credit implications of current events
4 MOODY’S CREDIT OUTLOOK 10 JANUARY 2013
bonus depreciation, a 60% election rate, an average asset life of 10 years (equal to a normal MACRS deprecation rate of 14.3%), a corporate tax rate of 35%, and that the company is subject to US federal income taxes. Without 50% bonus depreciation, the estimated tax benefit in 2013 would have been $41 billion (using MACRS). With 50% bonus depreciation, we estimate the benefit will be approximately 56% higher, or $64 billion.
EXHIBIT 2
Comparison of the Estimated Tax Benefit with and Without Bonus Depreciation $ billions
2013 Pro forma
10 Year MACRS Rate
Estimated Tax Benefit at MACRS Rate Bonus Depreciation at Each MACRS Rate
With 50% Bonus
Depreciation Without Bonus
Depreciation Differential
3 Years 3.8%
5 Years 5.0%
7 Years 10.0%
10 Years 14.3%
15 Years 20.0%
20 Years 33.3%
[a] Capital expenditures $815 $815 $0
$815 $815 $815 $815 $815 $815
[b] Eligible (75%) $611 $0
[b] Take-up rate (60%) $367 $0
MACRS rate 0.0% 14.3% 14.3%
3.8% 5.0% 10.0% 14.3% 20.0% 33.3%
Bonus rate 50.0% 0.0% -50.0%
0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
Total rate 50.0% 14.3% -35.7%
3.8% 5.0% 10.0% 14.3% 20.0% 33.3%
Estimated tax deduction $183 $117 ($66)
$31 $41 $82 $117 $163 $271
[c] Estimated tax benefit $64 $41 ($23)
$11 $14 $29 $41 $57 $95
[a] Capital expenditures for the last 12 months at 30 September 2012 for all public, non-financial, corporate rated issuers
[b] Source: Corporate Response to Accelerated Tax Depreciation: Bonus Depreciation for Tax Years 2002-2004 - Office of Tax Analysis, US Department of Treasury OTA Working Paper 98, May 2007
[c] Assumed corporate tax rate of 35%
Source: Moody’s Investors Service
Much of the information necessary to estimate the tax benefit for a particular industry or individual company does not require disclosure under US GAAP. However, we know the actual tax benefit for each industry, and each company will be different depending on many factors including eligibility, take-up rates, asset classes, asset lives and the method a company uses to depreciate the assets. For example, we know take-up rates in the utilities industry are closer to 100%, which would increase the benefit.
Bonus depreciation is not a new benefit: prior to this current extension, President Obama in December 2010 signed a bill2 into law that allowed US companies to fully deduct 2011 capital expenditures, up from 50% previously. The rate reverted back to 50% in 2012 and would have gone back to the normal rates under MACRS in 2013.
2 The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010.
NEWS & ANALYSIS Credit implications of current events
5 MOODY’S CREDIT OUTLOOK 10 JANUARY 2013
Avis Budget Group’s Planned Acquisition of Zipcar Is Credit Negative
On 2 January, Avis Budget Group Inc. (B1 stable) said it had agreed to purchase Zipcar Inc. (unrated) for about $500 million. The company expects to fund most of the purchase price with incremental debt. Although Avis will reap long-term operating benefits from the acquisition, we view it as credit negative because it will modestly weaken the company’s interest coverage and leverage in the near term and slow its efforts to reduce its sizable corporate debt of about $3 billion.
Despite the reasonable likelihood that the acquisition will yield synergies, we believe the purchase price equals a high multiple over Zipcar’s EBITDA run rate of about $15 million. In addition, even if Avis succeeds in realizing cost and revenue improvements following the close of the transaction, we expect that the incremental debt incurred to fund the transaction will cause the company’s pro forma credit metrics to weaken from their current levels, with debt/EBITDA rising to approximately 4.6x from 4.4x. Moreover, the acquisition of Zipcar will slow Avis’ progress in a critical area related to its overall credit profile – the company’s efforts to reduce its corporate debt of about $3 billion, which is 28% of its total funded debt of $10.8 billion.
Avis’ credit currently reflects the healthy fundamentals of the US car rental industry, the company’s success in growing revenue and cutting costs in its North American operations, and the progress it has made in integrating its 2011 acquisition of Avis Europe despite the region’s economic slowdown. These factors have enabled Avis to maintain credit metrics that are solidly supportive of the B1 rating: during the 12 months ended 30 September, the company maintained an EBITDA margin of 44.6%, EBIT/interest ratio of 1.5x and debt/EBITDA of 4.4x (reflecting our standard adjustments). Although we expect Avis to remain comfortably positioned at its current rating level, the Zipcar transaction’s addition of $500 million in corporate debt could delay improvement in the rating.
Following the Zipcar acquisition, Avis will become the leading player in the growing North American car-sharing market. Given the complementary nature of car sharing with Avis’ core daily car rental business, we expect the transaction to yield cost and revenue synergies, most notably lower vehicle acquisition costs for Zipcar and more efficient fleet utilization for both the car-sharing and rental sides of Avis’ expanded operations. The company’s rental fleet is heavily utilized during the week and relatively underutilized during the weekend; Zipcar’s fleet has high utilization during the weekend and much lower utilization during the week. These factors support the likelihood that the combination will yield meaningful cost savings.
Avis expects to reap about $50-$70 million in synergies within three years of the deal’s closing, which seems optimistic relative to Zipcar’s historical annual revenue base of approximately $270 million. To deliver on those expectations, Avis will need to aggressively pursue the benefits of lower vehicle acquisition costs and improved utilization rates.
Bruce Clark Senior Vice President +1.212.553.4814 [email protected]
NEWS & ANALYSIS Credit implications of current events
6 MOODY’S CREDIT OUTLOOK 10 JANUARY 2013
Mohawk’s Agreement to Buy Marazzi Group Is Credit Negative
Mohawk Industries (Ba1 stable) said on 21 December that it had signed a definitive agreement to acquire Marazzi Group (unrated) for $1.5 billion. The acquisition is credit negative for Mohawk because it will increase the floor-covering company’s financial leverage and increase its revenue exposure to the weak European market. We affirmed the company’s ratings, but changed the outlook to stable from positive following the announcement.
Mohawk said it will finance the purchase with a combination of cash on hand, debt and equity, which we expect will raise the company’s debt to EBITDA to 3.4x from 2.7x as of 30 September. The additional debt will delay the company’s ability to reduce financial leverage to around 2.5x, our stated target level for a ratings upgrade.
The acquisition will, however, increase Mohawk’s revenue by more than $1 billion to over $7 billion and enhance its EBITDA by around $150 million to nearly $1 billion. In addition, the purchase will further expand Mohawk’s footprint outside the US through the company’s existing international distribution channels. It will also leverage Marazzi’s distribution network and market presence in the fast-growing Russian flooring market.
Although the acquisition will increase Mohawk’s European revenue exposure to around 20% from 15%, it positions the company to capture the eventual rebound in European discretionary consumer spending.
Mohawk said it expects the transaction to close in the first quarter of 2013, subject to customary closing conditions, including receipt of applicable regulatory approvals.
Kevin Cassidy Vice President - Senior Credit Officer +1.212.553.1676 [email protected]
NEWS & ANALYSIS Credit implications of current events
7 MOODY’S CREDIT OUTLOOK 10 JANUARY 2013
Chevron’s Entry in Kitimat Liquid Natural Gas Project Is Credit Positive
On 24 December, Chevron Corporation (Aa1 stable) announced that its subsidiary Chevron Canada Ltd.(unrated) had agreed to acquire 50% stakes in the Kitimat liquefied natural gas (LNG) project, the Pacific Trail Pipeline, and development rights on 644,000 acres in the Horn River and Liard Basins in British Columbia, Canada, a credit positive for Chevron.
Chevron’s move would buy out smaller Kitimat partners and give it a 50% stake in related upstream natural gas acreage, enhancing its leading position in global and key Asian LNG markets while securing early-mover status and boosting Kitimat’s momentum among various competing LNG export projects in Canada.
As part of the deal, Chevron will buy out the 30% positions of Encana Corp. (Baa2 stable) and EOG Resources Inc. (A3 stable) in the liquefaction, pipeline and certain acreage related to the project, and also acquire from Apache Corporation (A3 stable) upstream acreage interests. In turn, Apache will increase its existing pipeline and liquefaction interests in Kitimat to 50% via a purchase from Chevron. The company expects to close the transactions in the first quarter of 2013.
An advantage for Kitimat LNG is that it will have a streamlined ownership structure between financially strong partners with aligned interests, giving stronger impetus to move forward on one of western Canada’s most promising LNG export projects. Kitimat LNG is the only project to so far obtain an export license from the National Energy Board, but has not signed up any anchor long-term customers, which will be key to reaching a final investment decision.
Chevron will provide its leading expertise in LNG project development to the pipeline and export facilities and, importantly, the marketing and commercial relationships in Asia to help sign up long-term customers for the project. Apache, in turn, will provide its upstream expertise as operator for the exploration and development of highly prospective shale gas resources in the Horn River and Liard Basins, which the company has characterized as among the most prolific shale gas basins globally.
Other than $400 million that Chevron will pay Apache for the Liard/Horn interests, net of equalization payments, Chevron’s entry costs and the total size of the transaction are relatively modest (and undisclosed). Still, the ultimate cost and scope of the integrated project will be sizable. The liquefaction facility is still in the preliminary front-end design phase, with no established price tag or schedule for completion. If the project goes forward, first deliveries would not likely occur until after 2016.
We believe earlier cost estimates in the $15 billion range for the total integrated project may go higher because of changes in scope, sector cost inflation in western Canada, and the recent experience of other large projects in the Pacific Basin such as Gorgon LNG and Papua Guinea LNG that have experienced large cost overruns.
However, the ultimate costs of Kitimat LNG should be within the capabilities of both partners, particularly if downstream customers investing as equity partners in Kitimat reduce the financial exposure. The project has good long-term viability based on Canada’s need to find new outlets for its gas resources and supported by demand from Asian customers seeking diversified and politically safe energy supplies.
Thomas S. Coleman Senior Vice President +1.212.553.0356 [email protected]
NEWS & ANALYSIS Credit implications of current events
8 MOODY’S CREDIT OUTLOOK 10 JANUARY 2013
Pan American Energy Increases Argentine Natural Gas Investment at Higher Prices, a Credit Positive
On 28 December, Pan American Energy LLC (PAE, B1 negative) signed an agreement with the Argentina government to increase its investments in natural gas drilling. The agreement is credit positive for the company because the government’s willingness to provide higher natural gas prices is likely to improve returns on the investment.
Under the terms of the agreement, PAE and the Argentina-based Bridas (unrated) have committed to invest $3.4 billion over the next five years to increase their natural gas production. The agreements also commit the companies to deliver a certain level of natural gas in Argentina over the next five years, which poses a risk if there are production shortfalls. In return, the government agreed to raise the wellhead price for its incremental natural gas production to $7.5 per million British thermal unit (mmbtu), meaningfully above current wellhead prices, which for residential customers is below $1 per mmbtu.
PAE is the second-largest producer of natural gas in Argentina, with around a 16% market share. PAE’s average realized natural gas price is currently slightly above $2 per thousand cubic feet (mcf). With the latest agreement, we expect PAE’s average natural gas price realizations to slowly start growing over the next five years.
PAE’s agreement is similar to an earlier agreement the government made with YPF Sociedad Anonima (Caa1 stable), and we expect other upstream producers to sign additional agreements within the next three to six months. These agreements follow the government’s new Hydrocarbon Sovereignty decree in July 2012, which provided for government review of company budgets and government setting reference prices for hydrocarbons and derivative products.
Despite the government’s history of interference in the energy sector and a highly unpredictable operating environment in Argentina, we believe a trend toward higher natural gas prices is a move in a positive direction for PAE and the industry. Government price controls have challenged Argentina’s natural gas sector over the past decade. Since its 2000-01 economic crisis, the government has essentially frozen natural gas prices for certain segments of consumption. While there have since been some limited increases in prices under the government’s Gas Plus program and for certain industrial users, residential gas prices remain artificially low at below $1 per mcf. Therefore, demand for natural gas in Argentina greatly exceeds supply and the country relies on costly imports of liquefied natural gas at spot prices reaching over $15 per mcf.
PAE engages in the exploration and production of oil and gas in the Southern Cone region of South America and is headquartered in Buenos Aires, Argentina. PAE is 60% owned by BP plc (A2 stable) and 40% owned by Bridas Corporation.
Gretchen French Vice President - Senior Credit Officer +1.212.553.3798 [email protected]
NEWS & ANALYSIS Credit implications of current events
9 MOODY’S CREDIT OUTLOOK 10 JANUARY 2013
Shanghai Industrial Urban Development Group’s Chengdu Project Exit Would Be Credit Positive
On 27 December, Shanghai Industrial Urban Development Group Ltd. (SIUD, B1 stable) announced on the Hong Kong Stock Exchange that it would cease its property development project in Chengdu, Sichuan, and sell its wholly owned company there, Chengdu Zhongxin Jintai Real Estate Development Co. Ltd. (unrated). The asset disposition, if successful, would be credit positive for SIUD because it would improve its liquidity and near-term profitability and support its strategic focus in the Yangtze River Delta region.
In addition to selling Chengdu Zhongxin Jintai Real Estate Development Co. for an equity consideration of RMB158 million to an independent third party, SIUD’s RMB827 million outstanding loan to the company will be repaid in full.
As of 30 June, SIUD’s short-term maturing debt totaled RMB4.6 billion, including a RMB2.8 billion shareholders’ loan. SIUD has relied on the shareholders’ loan and has successfully refinanced it in the past, but if it were unable to refinance the loan, its RMB2.2 billion of cash on hand and operating cash flow would be inadequate to cover its maturing short-term debt. Disposing of the Chengdu project would reduce SIUD’s reliance on the shareholder’s loan by adding RMB985 million of fresh funds to the company.
The project disposal would improve SIUD’s near-term profitability. SIUD’s operating performance remains weak owing to the ongoing integration of its 2010 acquisition, Neo-China. SIUD reported a pre-tax loss of HKD296 million in the first half of 2012 mainly reflecting low-margin products inherited from Neo-China (see exhibit). Although revenue recognition has been volatile because of varying product delivery schedules, net profits have been declining because of unprofitable products.
Shanghai Industrial Urban Development’s Operating Performance
Source: Company interim and annual reports
While we expect weak operating performance in 2012 owing to the ongoing recognition of presold low-margin products, the company estimates that disposing of Chengdu Zhongxin Jintai Real Estate Development will result in a gain of approximately RMB200 million before tax and expenses, boosting profitability.
The disposal also supports the company’s strategy adopted in the second half of 2012 of focusing on property development projects in the Yangtze River Delta region. Following its acquisition of Neo-
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Revenue - left axis Net Profit (After Tax) - left axis Net Profit Margin - right axis
Franco Leung Assistant Vice President - Analyst +852.3758.1521 [email protected]
Fiona Kwok Associate Analyst +852.3758.1522 [email protected]
NEWS & ANALYSIS Credit implications of current events
10 MOODY’S CREDIT OUTLOOK 10 JANUARY 2013
China in 2010 and Shanghai Urban Development (unrated) in 2011, SIUD’s project portfolio is geographically diversified.
The Chengdu project disposal is the first major disposition since November, when SIUD successfully obtained a consent from its bondholders with respect to amendments on the definition of asset disposition, essentially allowing the company to dispose of undeveloped or partially developed projects that are not compatible with its Yangtze River Delta focus. We expect other asset dispositions in the next year to redirect SIUD’s resources to its home base, where it has better competitive advantage.
NEWS & ANALYSIS Credit implications of current events
11 MOODY’S CREDIT OUTLOOK 10 JANUARY 2013
SK Broadband’s Merger with Broadband Media Is Credit Positive
Last Friday, SK Broadband Co., Ltd. (SKB, Baa3 positive), Korea’s second-largest fixed-line telecommunications operator by subscribers, announced that it would merge with its wholly owned consolidated subsidiary, Broadband Media Co., Ltd. (unrated). The merger is credit positive for SKB because it would help boost the efficiency of its internet protocol television (IPTV) services and increase the strategic value of SKB to its parent, SK Telecom Co. Ltd. (SKT, A3 negative).
Prior to the merger, SKB plans to subscribe to a KRW279 billion rights issue proposed by Broadband Media. We expect SKB to fund the rights issue through debt, while Broadband Media will use the proceeds to repay borrowings. Thus, the transaction will be leverage neutral on a consolidated basis. A benefit will be a reduction in consolidated interest costs given SKB’s cheaper cost of funding, and we estimate the amount of saving to be equivalent to 4%-5% of its operating profit for the 12 months ending September 2012.
The merger will also enhance SKB’s IPTV operation by creating a single business platform where it previously had two, with SKB focused on real-time IPTV and Broadband Media providing video on demand. Such a structure has limited operational efficiency. The merger into one business platform would enable SKB to remove operational and administrative duplication and allow it to compete more effectively against fully integrated rivals KT Corporation (A3 negative) and LG Uplus (unrated), which have shown faster rate of subscriber growth (Exhibit 1).
EXHIBIT 1
IPTV Operator Subscriber Growth In Korea
Source: The companies
This consolidation will eventually give SKB a better opportunity to reap greater earnings at a time when the demand for IPTV in Korea is growing (Exhibit 2). We expect that growth to accelerate following the demise of analog terrestrial broadcasting in December.
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IPTV
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KT SKB LGU+
Serena Won Associate Analyst +852.3758.1527 [email protected]
Yoshio Takahashi Assistant Vice President - Analyst +852.3758.1535 [email protected]
NEWS & ANALYSIS Credit implications of current events
12 MOODY’S CREDIT OUTLOOK 10 JANUARY 2013
EXHIBIT 2
IPTV Subscribers versus Cable TV Subscribers in Korea
Source: Korea Cable Television & Telecommunications Associations, the companies
By creating a more competitive IPTV operation, we expect SKB to foster deeper business integration with SKT, particularly through the quadruple-play strategy of bundling TV, high-speed internet, fixed-line telephony and wireless services, which has been the key driver of SKB’s improving credit profile.
In particular, mobile IPTV can help telecommunications operators retain wireless customers by offering improved mobile entertainment packages. In the wireless segment, Korean telecommunications firms are keen to boost data revenue, given the saturated state of the voice market, and with the nationwide rollout of long-term evolution networks in Korea substantially complete, the focus of competition is shifting from network coverage and quality to mobile content.
In this context, we consider IPTV to be a core part of the telecommunications companies’ bundling strategies. Therefore, SKB will become more strategically valuable to the SKT group, because the latter, unlike its integrated competitors, does not have an in-house IPTV operation.
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NEWS & ANALYSIS Credit implications of current events
13 MOODY’S CREDIT OUTLOOK 10 JANUARY 2013
Infrastructure
US Extends Tax Credit for Wind Power, a Credit Positive for Developers and Utilities
On 1 January, as part of the “fiscal cliff” agreement, the US House of Representatives extended the production tax credit (PTC) for wind power, a subsidy available to renewable energy facilities that commence construction before the end of 2013. The extension is credit positive for renewable energy project developers and regulated utilities that buy wind power.
The PTC subsidy has been a catalyst for the wind industry in the US. Its extension sustains project economics for renewable developers, such as MidAmerican Energy Holdings (Baa1 stable), Tenaska Energy (unrated) and ArcLight Capital (unrated), and it gives them better visibility of the revenue stream of future wind farms. Because it takes at least nine months to build a wind farm, subsidy benefits lag development expenditures.
The wind PTC extension also provides credit-positive clarity for regulated utilities that must procure some incremental amount of their electric power from renewable energy sources to meet individual state renewable energy portfolio standards.
In terms of annual wind installation, new capacity in the US in 2013 is likely to be lower than the roughly 7 gigawatts (GW) for 2012 because uncertainty about the PTC extension froze the project pipeline. According to the US Joint Committee on Taxation, a one-year PTC extension costs around $12 billion. The exhibit below shows wind capacity additions falling prior to earlier PTC expiration dates (the PTC was extended in 2010).
Annual US Wind Capacity Additions Declined Prior to Production Tax Credit Expiration
Source: US Energy Information Administration and American Wind Energy Association
Although we doubt the PTC credits will be renewed for much longer, we do think the cost of wind power generation is quickly approaching grid-parity, or the costs of electricity from the installed fleet of available generation on the wholesale market. Technological advancements, declining equipment costs, operating improvements and the potential for rising fuel costs that increase wholesale grid power will combine to make wind power economically viable without PTC subsidies in the future.
Nevertheless, we still think many wind operators will look to diversify their assets to new jurisdictions that have strong wind resource characteristics. Northern Europe and Latin America’s Brazil are both poised as attractive regional alternatives over the next two years. In China, which is in the midst of a major wind build-out, a tariff friendly regulatory regime is pushing for approximately 12.7 GWs to become operational each year over the next three years.
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Rick Donner Vice President- Senior Credit Officer +1.212.553.7226 [email protected]
NEWS & ANALYSIS Credit implications of current events
14 MOODY’S CREDIT OUTLOOK 10 JANUARY 2013
MidAmerican’s Acquisition of World’s Largest Solar Development Is Credit Negative
On 2 January, MidAmerican Energy Holdings Co. (MEHC, Baa1 stable) kicked off the new year by announcing its acquisition of Antelope Valley Solar Projects (AVSP), the world’s largest solar photovoltaic power development, from SunPower (unrated). According to SunPower’s 8-K filing, AVSP could cost up to $2.5 billion, which is credit negative for MidAmerican because we expect it will result in additional debt, with a lag in related cash flow during the three-year construction. The investment is also a significant addition to MEHC’s portfolio of renewable projects, which entail more business risk than MEHC’s regulated businesses.
The Antelope Valley projects consist of two neighboring solar photovoltaic power plants with a total capacity of 579 megawatts (MWs), underpinned by 20-year power purchase agreements with Southern California Edison Company (A3 stable). The AVSP financing plans have yet to be announced, but we expect a mix of non-recourse project debt financing, tax credits, and a minor cash equity contribution. The combination is similar to MEHC’s financing for its 2012 $2.4 billion acquisition of Topaz Solar, a 550-MW photovoltaic power plant that was one of the two largest solar facilities in the US when it was acquired. Project debt is financing most of the construction costs not covered by tax credits. Topaz Solar Farms LLC (Baa3 stable) issued $850 million of debt in 2012 and plans to issue as much as $400 million more in 2013, leaving it well capitalized at roughly 50% debt.
Solar projects generate a significant amount of investment tax credits, which help finance much of the construction costs and improve returns for MEHC. The availability of these valuable tax benefits motivated MEHC to create a new business segment, MEHC Renewables, in early 2012. Since then, this portfolio has grown to include 12 projects with capacity totaling 2,707 MW and their non-recourse debt, which comprises 11% of MEHC’s debt.
Over the next three years of construction, AVSP will incur some debt upfront, but a full year’s effect will not be reflected in operating cash flow until 2016. This construction period will delay the slight improvement we had anticipated in MEHC’s cash flow-to-debt ratios. The construction of the Antelope Valley and concurrent Topaz projects present the risk of construction cost overruns and delays over the next three years, and after their completion, the risk that sale volumes fall short of MEHC’s expectations.
MEHC Renewables will remain a significant minority within MEHC’s expanding, diverse balance sheet. In California, which requires use of power generated in-state, AVSP and Topaz are attractive projects and are fully contracted with long-term purchase agreements with investment-grade utility customers. This project structure should yield relatively stable and predictable cash flows.
Mihoko Manabe, CFA Vice President - Senior Credit Officer +1.212.553.1942 [email protected]
Lesley Ritter Associate Analyst +1.212.553.1607 [email protected]
NEWS & ANALYSIS Credit implications of current events
15 MOODY’S CREDIT OUTLOOK 10 JANUARY 2013
New Mexico Commission Suspends Tri-State G&T Rate Increase, a Credit Negative
On 20 December, the New Mexico Public Regulation Commission (NMPRC) determined that there was just cause for the protests filed by three of 12 New Mexico members of Tri-State Generation and Transmission Association Inc. (Tri-State, first mortgage bonds A3 stable) and voted 4-1 to suspend implementation of Tri-State’s 4.9% wholesale electric rate increase on 1 January, a credit negative for Tri-State.
Even though the expected $14 million revenue shortfall from New Mexico members versus the 2013 budget is only about 1% of Tri-State’s total annual revenue, the NMPRC order is credit negative for Tri-State because of the unprecedented challenge to the cooperative’s rate autonomy. The NMPRC’s order raises questions about Tri-State’s historically strong member and regulatory relationships.
Creditors have long relied on Tri-State’s substantial rate setting autonomy and solid member/regulatory relationships to ensure that the cooperative’s increased operating costs can be met through timely rate increases to avoid stress in cash flow generation. However, Tri-State’s latest experience in New Mexico shows that creditors cannot always assume that the cooperative’s members will act in creditors’ best interest. Tri-State’s thin margins of debt coverage and heavily leveraged balance sheet are typical for an electric generation and transmission cooperative, so the financial ramifications of not implementing timely and sufficient rate increases can be swift and severe.
Under New Mexico statute implemented in 2000, the NMPRC can, if requested by three or more of the New Mexico members, intervene in the wholesale rate setting process; however, this is the first time that three New Mexico members protested a rate increase. Moreover, Tri-State argues that it has legal rights under federal law to avoid state intervention from the NMPRC.
The matter will be heard by an NMPRC Hearing Examiner, but a specific hearing date has not yet been scheduled. Regardless of the outcome, we anticipate Tri-State will challenge NMPRC’s jurisdiction and pursue all legal rights and remedies in the federal courts.
In the interim, Tri-State began charging the new rates to its remaining 32 members in Colorado, Wyoming and Nebraska on 1 January.
Kevin Rose Vice President - Senior Analyst +1.212.553.0389 [email protected]
NEWS & ANALYSIS Credit implications of current events
16 MOODY’S CREDIT OUTLOOK 10 JANUARY 2013
Banks
Bank of America Takes Another Step in Resolving Its Mortgage Exposures
On Monday, Bank of America Corporation (BAC, Baa2 negative) announced a number of actions aimed at resolving its legacy mortgage exposures, including a settlement to resolve repurchase claims on most loans originated and sold to Fannie Mae by BAC or Countrywide Financial through year-end 2008. With Monday’s actions, BAC has eliminated most of its risk related to government-sponsored enterprise (GSE) repurchase claims. Although the effects of the announcements will negatively affect BAC’s fourth-quarter earnings, they are credit positive. Nonetheless, BAC’s still considerable exposure to repurchase claims on its non-GSE mortgage exposures continues to constrain its credit profile.
During 2004-08, BAC and its affiliates originated and sold $2.1 trillion in residential mortgages, which equal the vast majority of loans against which BAC is exposed to potential repurchase claims owing to violations of representations and warranties. Of this total, BAC sold $1.1 trillion to the GSEs (Fannie Mae and Freddie Mac). Following Monday’s settlement with Fannie Mae, BAC is unlikely to face significant additional repurchase claims on that pool of mortgages (BAC settled with Freddie Mac in 2010).
BAC still has non-GSE exposure with an original balance of $963 billion. In 2011, BAC entered into a settlement of repurchase claims covering most of Countrywide’s first-lien, non-GSE mortgage-backed securities, with an original balance of $409 billion. That settlement awaits court approval. If it is not approved, BAC would remain exposed to repurchase claims on those mortgages, although the $8.5 billion in repurchase reserves set aside for the settlement would still be available to cover any such claims. BAC also remains exposed to additional repurchase claims on other non-GSE exposures originated between 2004 and 2008 with an original balance we estimate to be roughly $500 billion. We estimate that following the Fannie Mae settlement, BAC will still have roughly $5 billion in repurchase reserves in excess of those set aside for the Countrywide settlement that can be used to meet these claims.
The settlement with Fannie Mae will cost BAC $2.7 billion in incremental expense in the fourth quarter, including $2.5 billion in additional reps and warranties expense, which was modestly higher than we expected, and $260 million in additional provisions for compensatory payments on foreclosure delays. BAC reported that fourth-quarter results would also be negatively affected by approximately $2.5 billion for the independent foreclosure reviews, litigation (primarily mortgage-related) and other mortgage-related matters. Unless results are significantly stronger than in the past three quarters, we estimate that these charges will leave BAC with a pre-tax loss for the quarter. BAC expects to report modestly positive after-tax earnings after a $1.3 billion tax benefit from the recognition of foreign tax credits.
As we have previously noted, BAC’s earnings are under pressure on a variety of fronts, and we believe they are likely to remain weak until many of these matters are resolved. The latest announcement provides further evidence of this. A key source of earnings pressure for the bank is the high cost of mortgage servicing. In addition to the settlement with Fannie Mae, BAC also announced an agreement to sell mortgage servicing on a pool of 2 million mortgage loans for a gain of approximately $650 million. We expect the sale to help BAC lower its servicing expenses, but its ability to do so will still depend on continued improvements in asset quality and a successful transfer of servicing to the acquirers during the course of 2013.
David Fanger Senior Vice President +1.212.553.4342 [email protected]
NEWS & ANALYSIS Credit implications of current events
17 MOODY’S CREDIT OUTLOOK 10 JANUARY 2013
Brazil to Ease Banks’ Reserves to Stimulate Lending, a Credit Positive
On 27 December, Brazil’s Central Bank announced it would ease banks’ reserve requirements starting 30 January to free up resources for them to specifically finance capital-goods and investment projects for small and medium size companies (SMEs). The measure is credit positive for large Brazilian banks because they can use reserves on demand deposits to finance equipment, machinery and exports and thus generate earnings on what are now non-interest bearing reserves.
The lower reserve requirements are intended to raise spending on industrial investment, whose growth in 2012 was below trend. Nonetheless, we expect banks to lend cautiously given economic weakness and persistently high delinquencies among this particular group of borrowers.
Banks with at least BRL6 billion in capital are eligible to use up to 20% of their non-remunerated reserves on demand deposits, equal to BRL15 billion, to finance exports, capital goods, and technological innovation for SMEs, among other projects. Reserve requirements are levied on about 40% of banks’ combined demand, savings, and time deposits, a large portion of which bears no interest. The measure would free up the equivalent to 4% of the stock of BRL350 billion in reserve requirements deposited at the central bank as of November 2012.
The measure benefits banks such as Itaú Unibanco S.A. (Baa2 positive; C-/baa1 positive),3 Banco do Brasil S.A. (Baa2 positive; C-/baa2 stable), Banco Santander (Brasil) S.A. (Baa2 positive; C-/baa2 stable), Banco Bradesco S.A. (Baa2 positive; C-/baa1 positive) and Caixa Econômica Federal (Baa2 positive; D+/baa3 stable) because these are the largest retail deposit takers in the system, and thus hold a significant portion of reserves at the central bank.
The financing conditions should mirror the broad scope, government-sponsored Sustainable Investment Program (Programa de Sustentação do Investimento, or PSI) currently run exclusively by federal development bank Banco Nacional de Desenvolvimento Econômico e Social - BNDES (Baa2 positive). Financing under the PSI carries lending rates between 3% and 4% per year with maximum 10-year tenors.
Although the returns on the program’s rates are low relative to banks’ regular commercial lending rates, they are still attractive because they offer incremental earnings and cross-selling opportunities for banks. However, because banks’ willingness to lend remains subdued in light of the weak economy, particularly on the part of private-sector banks, we anticipate private banks will primarily confine lending to export-related and capital goods projects, the financing of which tends to be short-term and on secured basis, which limits credit and liquidity risk.
3 The ratings shown are the banks’ deposit rating, its standalone bank financial strength rating/baseline credit assessment and
the corresponding rating outlooks.
Ceres Lisboa Vice President - Senior Credit Officer +1.212.553.7317 [email protected]
NEWS & ANALYSIS Credit implications of current events
18 MOODY’S CREDIT OUTLOOK 10 JANUARY 2013
Grupo Aval’s Porvenir Makes Credit Positive Acquisition of BBVA’s Colombian Asset Manager
On 24 December, Grupo Aval Acciones y Valores S.A. (Baa3 negative) announced that its pension fund management company, Sociedad Administradora de Fondos de Pensiones y Cesantías Porvenir, S.A. (Porvenir, unrated), would acquire 99.99% of BBVA Horizonte Sociedad Administradora de Fondos de Pensiones y Cesantías S.A. (Horizonte, unrated). The acquisition is credit positive for Porvenir, which, pending regulatory approval, will pay $530 million to current owners Banco Bilbao Vizcaya Argentaria S.A. of Spain (BBVA, Baa3 negative; D+/baa3 negative)4 and BBVA’s investment subsidiary Compañía Chilena de Inversiones S.L. (unrated).
Porvenir’s market position in Colombia will gain significant strength at a time when the pension fund segment has seen significant consolidation, as the exhibit below shows. Porvenir will increase its share in all three of its business lines: based on private-sector October 2012 data, mandatory pension funds will increase to a 44% share from 28%; severance funds to 50% from 34%; and voluntary pension funds to 20% from 16%. The increased market share will maintain Porvenir’s dominance in the administration of mandatory pension funds and severance funds and will ensure its position as third-largest provider of voluntary pensions in Colombia.
Total Spanish Private Pension and Severance Assets Under Management As of October 2012
Source: Superintendencia Financiera de Colombia; excludes government funds such as FNA or Colpensiones
The pension business acquisition will be credit positive for Porvenir’s controlling owner Grupo Aval and the banks through which it holds indirect ownership, Banco de Bogotá S.A. (Baa1 stable; C-/baa2 stable), with 46.9% ownership, and Banco de Occidente S.A. (unrated), with 33.1%. The acquisition
4 The ratings shown are the banks’ deposit rating, its standalone bank financial strength rating/baseline credit assessment and
the corresponding rating outlooks.
26%
14%
25%
10%12%
7%4%
0
5
10
15
20
25
30
35
40
45
Porvenir Horizonte Protección ING Colfondos Skandia Other
COP
trill
ions
On 24 Dec 2012, Grupo Aval announced the merger to take place between Porvenir and Horizonte.
On 31 Dec 2012, Grupo Sura's merger of Protección and ING took place.
On 19 Dec 2012, Scotiabank acquired Colfondos.
Felipe Carvallo Assistant Vice President - Analyst +1.212.553.5738 [email protected]
NEWS & ANALYSIS Credit implications of current events
19 MOODY’S CREDIT OUTLOOK 10 JANUARY 2013
will boost dividend income for its owners and is a modest amount relative to the group’s liquid assets, equity or net income.
We believe the deal consolidates Grupo Aval’s presence in the pension segment and complements its strong banking franchise. On 31 December, Grupo Aval’s closest competitor, Grupo de Inversiones Suramericana S.A. (unrated) announced it had completed the merger of ING’s Colombian operations into its asset manager, Pensiones y Cesantías Protección S.A. (Protección, unrated). The merger increased Protección’s market shares as of October to 37% in mandatory pension funds, 38% in severance funds, and 33% in voluntary pension funds.
However, if, as we expect, Grupo Aval makes additional acquisitions in the region, managing the transition risks related to the various acquisitions of the past years is likely to strain the holding company’s financial and management capacity, a concern we also have more generally for Colombian financial institutions because of their large-scale acquisitions in the past three years. This concern is reflected in our negative outlook on Grupo Aval’s ratings, changed from stable on 18 September 2012.
Grupo Aval’s acquisition increases competition for Colfondos S.A. Cesantías y Pensiones (Colfondos, unrated), which on 19 December was acquired by Canada’s Bank of Nova Scotia (51% ownership). Colfondos was Colombia’s fifth-largest provider of pension and severance funds with a 12% market share, as of October 2012.
NEWS & ANALYSIS Credit implications of current events
20 MOODY’S CREDIT OUTLOOK 10 JANUARY 2013
Germany’s Extension of SoFFin’s Bank Rescue Fund Is Credit Positive
On 1 January, an amended version of the Sonderfonds Finanzmarktstabilisierung (SoFFin)5 fund went into effect, extending German bank support facilities for another two years until December 2014 and shifting the burden of future rescues to banks from taxpayers. SoFFin’s extension and modifications are credit positive for German banks because it still aims to remedy distress at an early stage and avoid imposing losses on senior bondholders.
The latest version of the SoFFin legislation (SoFFin III) extends the government-sponsored €80 billion capital facility and €400 billion for liquidity guaranties. In the event losses arise as a result of new support measures, SoFFin may eventually draw on the funds currently raised through Germany’s bank levy. However, given that bank levy funds may only be used upon the SoFFin’s final closure, which we expect will only occur in the distant future, there is no immediate extra burden on German banks.
Although the SoFFin fund will continue to coexist with Germany’s less investor-friendly resolution regime,6 the extension reflects the German government’s (Aaa negative) commitment to maintaining financial market stability. This implies the government believes in using stabilising support measures to address cases of bank distress over the next two years, rather than relying on debt restructurings or other more disruptive measures. The SoFFin legislation differs from the resolution regime, which allows the government to intervene in cases of distress and impose losses on bondholders, in that it requires that banks apply for, and voluntarily accept, support.
While the SoFFin’s changes include banks paying for their support, the terms of the SoFFin extension have eased banks’ fears that the cost of support would have to be borne by the banking system through a surcharge to the bank levy; such extra costs would be challenging during the Basel III phase-in period because earnings retention and capital generation remain critically important for many German institutions. Without the SoFFin extension, any future rescue measures would have had to be based on the restructuring act that relies on banking system contributions to cover any losses or costs incurred (although these can be pre-financed by the government).
According to the Deutsche Bundesbank’s monthly report in September, Germany’s banks posted a rather modest net profit of €11 billion in 2011, of which the bank levy required just over 5%. A substantially higher levy would take away precious income from the banking system. While using the restructuring act (and its bank-funded resources) for future support measures always remains open to the government, we consider it to be a less likely option, at least for the next two years, owing to the continued fragility of the European financial markets and the government’s decision to extend SoFFin.
5 The Sonderfonds Finanzmarktstabilisierung (SoFFin) was first established under the German Financial Market Stabilisation
Fund Act in 2008, and reopened on 1 March 2012. See here. 6 The resolution regime was introduced in January 2011, based on the German Bank Restructuring Act.
Katharina Barten Vice President - Senior Credit Officer +49.69.70730.765 [email protected]
NEWS & ANALYSIS Credit implications of current events
21 MOODY’S CREDIT OUTLOOK 10 JANUARY 2013
VietinBank Sells 20% Stake to Tokyo-Mitsubishi Bank, a Credit Positive
On 28 December, Vietnam’s regulators approved the sale of about a 20% stake in Vietnam Bank for Industry and Trade (VietinBank, B3 stable; E/caa1 stable)7 to Bank of Tokyo-Mitsubishi UFJ. Ltd. (BTMU, Aa3 stable; C/a3 stable), which had announced the transaction the day before.
As part of the deal, VietinBank, the country’s second-largest state-owned bank by asset size, will issue new shares to BTMU for VND15.5 trillion (about $743 million). The transaction is credit positive for VietinBank because it will provide a significant and timely boost to its loss-absorbing buffer, including its Tier 1 capital.
We estimate that VietinBank’s loan-loss reserve coverage ratio was low at 43% in mid-2012, after taking into account both reported non-performing loans (NPLs) and special mention loans. The $743 million capital injection gives VietinBank more leeway to address this under-reserving without eroding its capital position, especially in view of Vietnam’s challenging operating environment. We estimate that VietinBank’s Tier 1 capital ratio will increase to about 17% from 11.15% at the end of June 2012 as a result of the capital injection.
The sharp slowdown in loan growth in 2012 weakened VietinBank’s capacity to increase its capital through earnings retention. Its loan growth was a mere 2.6% for the first nine months of 2012, down from 30% over the previous five years. Consequently, net interest income dropped 6.7% between January and September.
Notwithstanding the immediate relief provided by this capital injection, we expect VietinBank -- like other Vietnamese banks8 -- to remain pressured by poor profitability, asset quality and transparency.
VietinBank will challenge BTMU to bring about positive fundamental changes in both its financial performance and governance practices, issues that have plagued Vietnam’s banks. Moreover, BTMU’s 20% stake, after the completion of the acquisition, will remain far below the 64% held by the government of Vietnam (B2 stable), which will continue to exert considerable influence.9
More generally, foreign strategic partners in Vietnam’s banks have had very little success in making sweeping changes. For example, Asia Commercial Bank (B3 stable; E/caa1 stable) has received technical assistance from its foreign shareholder, Standard Chartered PLC (A2 stable)10 since 2005, but corporate governance issues resulted in the arrest of its senior executives in 2012.11
Given that VietinBank will remain a policy-driven bank, with its clientele consisting mainly of state-owned enterprises, the challenges for BTMU will be daunting.
7 The ratings shown are the banks’ deposit rating, its standalone bank financial strength rating/baseline credit assessment and
the corresponding rating outlooks. 8 See our 8 October 2012 analysis of the challenges facing the Vietnamese banks in our report Key Drivers of Vietnamese Bank
Rating Actions. 9 The Vietnamese government indirectly owns VietinBank through the stake held by the State Bank of Vietnam, the country’s
central bank. BTMU’s acquisition reduces the government’s stake to about 64% from 80%, and the International Finance Corporation’s (Aaa stable) stake to about 8% from 10%.
10 Standard Chartered’s 15% stake in Asia Commercial Bank is held via its Hong Kong- and UK-based subsidiaries. 11 See Moody’s Comments on ACB and the Arrest of its Co-Founder, 23 August 2012.
Falemri Rumondang Associate Analyst +65.6398.8330 [email protected]
NEWS & ANALYSIS Credit implications of current events
22 MOODY’S CREDIT OUTLOOK 10 JANUARY 2013
Asset Managers
US Money Fund Managers to Benefit from End of Unlimited Guarantee on Bank Accounts
On 27 December, the Federal Reserve’s Senior Credit Officer Opinion Survey on Dealer Financing Terms reported that about three-fourths of responding US dealers anticipate lower bank deposits in 2013 because the Federal Deposit Insurance Corporation’s (FDIC) unlimited guarantee on non-interest bearing transaction accounts expired at the end of 2012.12 Lower bank deposits are credit positive for larger managers of institutional money market funds (MMFs) and their parent companies, such as FMR LLC (A2 stable), JPMorgan Chase & Co. (A2 negative), BlackRock Inc. (A1 stable) and Federated Investors (unrated), which will attract at least some of the $446 billion in deposits now in play and bolster their depressed management fee income in a low interest rate environment.
The FDIC’s unlimited guarantee on non-interest bearing transaction accounts reverted back to its original $250,000 limit. The unlimited guarantee began in late 2008 as a way to restore confidence in the banking system. When the Transaction Account Guaranty (TAG) program expired at the end of 2010, it was extended temporarily with the adoption of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank). Participation became mandatory (no opt-outs) for all insured depositary institutions and unlimited coverage was available to all depositors, including consumers, businesses and government entities.
According to FDIC quarterly focus reports, and as shown in the exhibit, non-interest-bearing transaction account balances greater than $250,000 grew by $446 billion, or 42.6% to $1.492 trillion at the end of September 2012 from $1.046 trillion as of 30 June 2010, the reporting date closest to the extension that served as a catalyst for attracting deposits from larger institutional investors. Much of the total is held at 19 of the largest banks with assets over $100 billion, accounting for $1.1 trillion or 76%. of the balances. Non-interest-bearing transaction account balances accumulated since the date of the adoption of Dodd-Frank are likely to remain in the same non-interest-bearing bank accounts, reallocated among a group of different banks, or be invested directly in Treasury bills and other government securities, repos or money market funds.
12 The survey includes responses from 22 institutions that account for almost all of the dealer financing of dollar-denominated
securities to non-dealers and are the most active intermediaries in the over-the-counter derivatives markets.
Henry Shilling Senior Vice President +1.212.553.1948 [email protected]
NEWS & ANALYSIS Credit implications of current events
23 MOODY’S CREDIT OUTLOOK 10 JANUARY 2013
US Non-Interest-Bearing Deposits Above the $250,000 Guarantee Limit
Source: FDIC Quarterly Banking Profiles
The likely beneficiaries of whatever institutional short-term investments are directed away from bank deposits include institutional government or institutional prime money market funds (MMFs). According to an Association for Financial Professionals study published in June, 17% of financial professionals indicated a preference for prime MMFs, while 16% favored treasury-based MMFs. Based on these survey results, money funds could gain as much as $147 billion in assets under management (AUM), which would generate incremental annualized fees of about $248 million, or an uptick of about 9%.13
The increased balances and their accompanying fees are most likely to be garnered by the largest institutional managers, 10 of which control about three-quarters of institutional AUM. The incremental fees would supplement depressed fees owing to historically low yields, but will account for only a fraction of roughly $5.2 billion of fees14 money managers waived to sustain positive yields for investors.
13 Assumes average charged expense ratios of 17 basis points (bp) for prime funds and 16 bp for government funds apply and
that account balances flow into money market funds at one time, based on iMoneyNet data as of October 2012. 14 Investment Company Institute Trends in the Expenses and Fees of Mutual Funds, 2011.
$0
$200
$400
$600
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$1,000
$1,200
$1,400
$1,600
Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12
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s
NEWS & ANALYSIS Credit implications of current events
24 MOODY’S CREDIT OUTLOOK 10 JANUARY 2013
Sovereigns
US Fiscal Package Has Limited Positive Credit Implications
The fiscal package passed by both houses of Congress on 1 January further clarifies the deficit and debt trajectory of the federal government over the coming several years. It does not, however, provide a meaningful improvement in the government’s debt ratios over even a longer time horizon. It is credit positive in that it will avert a recession, but its direct effects on US government (Aaa negative) creditworthiness are only marginally positive.
We believe that further fiscal measures that lower future budget deficits are likely in coming months, which will be positive for the government’s creditworthiness. However, the extent of those positive measures remains uncertain, and they will likely be tied to negotiations over the federal government’s statutory debt limit. The limit was reached on 31 December, and an increase was notably absent from the 1 January fiscal package. The need to raise the debt limit may affect the outcome of future budget negotiations.
Although the fiscal package raises some revenue through higher tax rates on individuals earning more than $400,000 ($450,000 for joint filers) and through some other smaller measures, the estimated amount of increased revenue over the next decade is far outweighed by the amount of revenue foregone through the extension of lower tax rates for those with incomes below $400,000, the indexation of the alternative minimum tax, and other measures.
The Congressional Budget Office (CBO) estimates that the net increase in budget deficits from the fiscal package when compared to its baseline scenario (which assumes taxes on all income levels would increase) is about $4 trillion over the coming decade, excluding higher interest costs on the resultant higher debt. Based on that estimate, our preliminary calculation shows that the ratio of government debt to GDP would peak at about 80% in 2014 and then remain in the upper 70% range through 2022. Stabilization at this level would leave the government less able to deal with future pressures from entitlement spending or from unforeseen shocks. Thus, further measures that bring about a downward debt trajectory will likely be needed to support the government’s creditworthiness.
The macroeconomic effects of the package are positive, since it averts the recession that would likely have occurred had personal income taxes gone up for all income levels. However, the increase in the Social Security payroll tax to 6.2% of income from 4.2%, which became effective on 1 January, will constrain growth in the coming quarters. Furthermore, expenditure cuts that may be decided in the coming months could also affect the rate of GDP growth this year. Overall, therefore, the recent package mitigates part of the fiscal drag on the economy associated with the fiscal cliff but does not eliminate it.
Despite reaching the statutory debt limit at the end of the year, the Treasury has indicated that extraordinary measures may be sufficient to maintain normal expenditures for approximately two months. Nonetheless, the debt limit will have to be raised in February or early March. At the same time, the fiscal package passed at the beginning of the year delayed the implementation of spending cuts mandated by the Budget Control Act of 2011 for two months. Therefore, it seems likely that new measures addressing the expenditure side of the budget will be negotiated at around the time the debt limit needs to be raised.
Although we believe the debt limit will be raised and that the risk of default on Treasury bonds is extremely low, this confluence of events adds uncertainty to the outcome of negotiations. Further revenue measures may also form part of any future fiscal package. The debt trajectory resulting from this process will determine whether the final result is positive or negative for the creditworthiness of the US government.
Steven Hess Senior Vice President +1.212.553.4741 [email protected]
NEWS & ANALYSIS Credit implications of current events
25 MOODY’S CREDIT OUTLOOK 10 JANUARY 2013
Czech Sovereign Beats Its 2012 Fiscal Target, a Credit Positive
On 3 January, the Czech Republic (A1 stable) Finance Ministry released preliminary estimates for the 2012 central government deficit on a cash accounting basis pointing to a deficit of CZK101 billion (€4 billion, 2.6% of 2012 GDP), better than the government’s target of CZK105 billion despite a very challenging macroeconomic environment. The credit positive result highlights the authorities’ commitment to maintaining fiscal rectitude, a key credit strength that underpins the sovereign’s solid fiscal policy credibility.
Total budget revenue grew 3.8% during the year to CZK1 trillion, missing the budget target by 3.5%. As a result of lower revenues, the government cut expenditures 3.4% versus the budget, more than offsetting the revenue loss given that fiscal spending is larger than income. The proactive policy response has become an important element of the sovereign’s fiscal framework, and has led to lower funding costs and a favorable market perception that make the Czech Republic (along with Poland) a regional safe haven in Central and Eastern Europe.
Still, the overall general government deficit, which includes local government balances and is reported to Eurostat on an accrual accounting basis, will be wider than the central government result. We estimate that the 2012 general government deficit will come to 5% of GDP on an accrual basis, including the one-off effect of the deal to compensate churches for property confiscated during communist rule.15 The underlying fiscal outcome, excluding the deal with the churches, should come to approximately negative 3.5% of GDP for 2012, while we forecast a narrowing of the fiscal imbalance to negative 3.2% of GDP in 2013.
The absence of fiscal slippage in 2012 is notable given that the economy contracted by 1.3% according to our estimates, following sluggish growth of 1.9% in 2011. The macroeconomic outlook for 2013 is more supportive of the fiscal tightening program than that of 2012 since we expect the recession will end and output will expand by 0.4%.
Nevertheless, the sovereign faces a continuing risk of political instability, which has hampered the government’s policy agenda. Prime Minister Petr Necas’ government has narrowly survived seven confidence votes in parliament since taking office in July 2010. Parliamentary support for Mr. Necas’ administration in the 200-seat legislature has narrowed to 98 votes from the original 118, decreasing the government’s ability to enact measures and reforms to support policy implementation.
A collapse of the government would likely result in some transition costs arising from stop-and-go policies, but is unlikely to result in a material loss of creditworthiness for the sovereign. The current government has achieved significant fiscal consolidation and sought to enhance economic performance through competitiveness-boosting reforms. Future governments will face the challenge of continuing these enhancements or risk longer-term stagnation that could negatively affect the sovereign’s credit.
15 Please see Czech Government Approves Amended 2013 Budget: Deficit Target Remains 2.9% of GDP, 25 November 2012,
and Czech Republic Annual Credit Analysis Report, 19 July 2012.
Jaime Reusche Assistant Vice President - Analyst +1.212.553.0358 [email protected]
NEWS & ANALYSIS Credit implications of current events
26 MOODY’S CREDIT OUTLOOK 10 JANUARY 2013
Slovakia’s 2012 Fiscal Outcome Makes Final Consolidation Push a Challenge
On 2 January, the Slovakia (A2 negative) Finance Ministry released preliminary estimates for the 2012 central government deficit on a cash accounting basis. The initial budget guidance points to significant slippage, a credit negative that will make it more challenging for Slovakia to reach its goal of bringing the general government deficit below 3% this year. The preliminary estimates indicate a budget shortfall that’s more than 5% of our estimated 2012 GDP, against the administration’s general government deficit target of 4.62% of GDP.
The wider central government deficit reflects a shortfall in revenues, which only reached 86.8% of the budgeted amount. Tax revenues, which make up the majority of the state’s income, decreased by nearly 3% in 2012 compared with 2011 and fell short of the €9.23 billion (12.7% of 2012 GDP) target by €764.3 million. Expenditures grew by 2.4% year on year, reaching €15.64 billion, but were below the full-year target of €17.30 billion.
Revenues underperformed in 2012 despite relatively robust economic growth. We estimate GDP expanded by 2.5% last year, driven by strong performance in the car-manufacturing industry, an export-oriented sector that generates comparatively low levels of revenue for the government. Nevertheless, we expect growth to slow to 1.9% in 2013 owing to sluggish economic activity in Slovakia’s European exports markets, which we expect to further depress government revenues. With unemployment reaching an eight-year high, we forecast private consumption will remain anemic and unlikely to pick up the slack. Flagging economic growth will increase the challenge of meeting 2013’s 3% deficit target.
While the preliminary numbers refer to the cash operations of the central government, the Finance Ministry does not expect adverse developments in local government finances and therefore does not anticipate that regions will add to the state budget deficit. In 2011, local governments posted a balanced budget and the social security accounts posted a positive balance of 0.4% of GDP. Moreover, the overall general government figures that determine the official outcome reported to Eurostat are calculated on an accrual basis and will be released by the end of first-quarter 2013. Based on European Union fund flows, the accrual basis result for 2012 is likely to be more favorable than what was reported on a cash basis.
Our A2 rating contemplated a scenario of fiscal slippage, and therefore this slippage will not in itself point to future rating deterioration. The development nonetheless highlights the risks to the government balance sheet, which has deteriorated since the beginning of the financial crisis as debt ratios have steadily climbed, reaching more than 50% of GDP in 2012 versus 28% of GDP in 2008.
The economic environment will therefore make it all the more challenging for the Slovakian government to consolidate the fiscal accounts by the nearly two percentage points it now needs to achieve the European Union’s prudential limit of 3% of GDP by the end of this year. The administration may also find it harder to find new sources of revenue this year, having already raised taxes on companies and wealthy individuals, and increased a special levy on banks. Finance Minister Peter Kazimir has indicated that the administration would wait on new economic forecasts in the spring to make any adjustments to the this year’s budget.
Jaime Reusche Assistant Vice President - Analyst +1.212.553.0358 [email protected]
Rebecca Karnovitz Associate Analyst +1.212.553.1054 [email protected]
NEWS & ANALYSIS Credit implications of current events
27 MOODY’S CREDIT OUTLOOK 10 JANUARY 2013
Myanmar Secures More Financial Assistance from Japan
On 3 January, Japan’s (Aa3 stable) Finance Minister Taro Aso pledged ¥50 billion ($573 million) of fresh loans to Myanmar’s infrastructure sector, in particular for the Thilawa project, where a port and industrial park are being set up just outside of the capital city of Yangon. The loans will also support projects related to power and rural development. The loans are credit positive for Myanmar, and will help boost its structural growth.
Mr. Aso also confirmed that Japan’s new administration, led by Prime Minister Shinzo Abe (elected in late December), would honor the prior administration’s commitment to forgive a substantial portion of its total debt claims on Myanmar (unrated).16 The announcement confirms that debt forgiveness will begin this year, possibly as early as this month, which will substantially reduce Myanmar’s external arrears and moderate its external debt burden, also credit positive.
Mr. Aso’s meeting with Myanmar’s President Thein Sen last week in Naypyitaw marks Japan’s first diplomatic visit overseas since the Abe-led Liberal Democratic Party was elected. His confirmation that it will waive part of Myanmar’s debt and the resolution of arrears improves Myanmar’s debt profile and paves the way for fresh funding, particularly for the infrastructure sector. The International Monetary Fund (IMF) estimates Myanmar’s external debt at $11.8 billion (22.8% of GDP) in fiscal 2012 (1 April to 31 March). Japan is Myanmar’s largest external creditor, providing $5.7 billion. It will now forgive much of its debt that is in arrears and aims to ultimately waive more than half of its bilateral total debt.
Although Myanmar’s debt is not large by emerging market standards, Myanmar’s repayment capacity has been very limited, as reflected by its significant arrears, which totaled $5.4 billion in fiscal 2011 and which the IMF estimates at $5.5 billion in fiscal 2012, of which at least $4 billion is owed to Japan.
Japan’s actions support other credit positive events in Myanmar over the past year. Since its emergence from 50 years of semi-autarkic economic policies with the election of a new government in 2010 (the military-backed Union Solidarity and Development Party), a host of reforms have been implemented, including abandoning a currency peg and the passage of a new foreign investment law17 to liberalize the investment regime.
Myanmar now has renewed diplomatic efforts and the resumption of financial assistance,18 which bodes well for continued foreign investor interest in the country, already reflected by the quadrupling of foreign direct investment flows since fiscal 2008 to $2.9 billion in fiscal 2012 and Myanmar’s rising strategic and economic significance in the Southeast Asian region.
16 See Sanction Removal, Debt Forgiveness and Reform Progress Are Credit Positive for Myanmar, 30 April 2012. 17 See Myanmar's Passage of Foreign Investment Law Is Credit Positive, 5 November 2012. 18 See Myanmar Moves Toward Rejoining International Financial System, a Credit Positive, 6 August 2012.
Anushka Shah Analyst +65.6398.3710 [email protected]
Tom Byrne Senior Vice President +65.6398.8310 [email protected]
NEWS & ANALYSIS Credit implications of current events
28 MOODY’S CREDIT OUTLOOK 10 JANUARY 2013
Covered Bonds
Dexia Municipal Agency Restructuring Is Credit Positive for French Covered Bonds
On 28 December, the European Commission approved Dexia Municipal Agency’s (Dexia MA, unrated) restructuring, completing a 15-month process during which French authorities provided multiple credit-positive support mechanisms for the performance of Dexia’s French covered bonds (Aa2). The authorities’ actions are in turn supportive of all French law-based covered bonds.
The authorities’ efforts will enable Dexia MA to be transferred to a new state-backed owner with minimal disruption and to continue as a viable platform for covered bonds, a credit positive. To support this outcome, the authorities also arranged for temporary guarantees of the sponsor bank, Dexia Credit Local (Baa2 negative; E/ Ca stable),19 during the restructuring process. The range of measures used by the authorities showed their flexible approach, which improved their chance of success. We believe their support indicates their view of the French covered bond product’s importance, and that support may be provided to other programmes, if required.
Covered bond programme to be transferred to a state-owned bank. Dexia MA will be transferred to a new sponsor bank, owned predominantly by French public entities and temporarily named Nouvel Etablissement de Credit (NEC). NEC intends to continue the programme by refinancing new asset acquisitions and will replace Dexia Credit Local in its role as sponsor bank.
Guarantee provided to ensure stability in the first phase of restructuring. Temporary guarantees were initially put in place to ensure the programme’s stability. This gave the authorities time to consider their options and negotiate European Union approval. The key measure was a temporary refinancing guarantee by France, Belgium and Luxembourg for an initial amount of €45 billion, later extended to €55 billion, for Dexia SA (unrated), the parent bank and Dexia Credit Local. Although not directly applicable to covered bonds, the guarantee preserved the sponsor bank’s financial stability during the restructuring process and allowed it perform its obligations under the covered bonds.
Variety of measures illustrated flexible approach. The authorities’ range of different measures – the transfer of the programme and the use of temporary guarantees – shows their willingness to be flexible in supporting covered bond programmes. The guarantees effectively stabilised the situation once Dexia came under stress, while the transfer mechanism provided a long-term solution, though one that needed time to implement. A flexible approach to resolving complex situations such as Dexia’s gives the best prospect of a resolution that will be satisfactory from a political, market and investor perspective.
19 The ratings shown are Dexia Credit’s deposit rating, its standalone bank financial strength rating/baseline credit assessment
and the corresponding rating outlooks.
Hadrien Rogier Analyst +44.20.7772.8765 [email protected]
Jane Soldera Vice President - Senior Credit Officer +44.20.7772.5318 [email protected]
NEWS & ANALYSIS Credit implications of current events
29 MOODY’S CREDIT OUTLOOK 10 JANUARY 2013
Accounting
US FASB Proposal on Financial Asset Impairment Will Lead to More Timely Recognition
The US Financial Accounting Standards Board (FASB) published an exposure draft on 20 December pertaining to the recognition of impairment losses for financial assets such as loans and fixed-income securities on financial institutions’ balance sheets. The proposed model would require firms to recognize impairment losses on a timelier basis than current rules, which would more closely align financial statements with the economics of lending and investing. However, the proposal differs from the one currently favored by the International Accounting Standards Board (IASB), hindering global accounting convergence.
The impairment model proposed in the exposure draft is referred to as the “Current Expected Credit Loss Model” (CECL). It would require firms to record a credit impairment allowance for their current estimate of expected lifetime credit losses on their portfolio of financial assets at each reporting date. The estimate of expected credit losses should reflect management’s current estimate of the contractual cash flows that the entity does not expect to collect, reflecting changes in the credit risk of assets held by the entity, changes in historical loss experience for those assets, changes in conditions since the previous reporting date, and changes in reasonable and supportable forecasts about the future.
Under the CECL Model, the balance sheet would reflect the current estimate of expected lifetime credit losses at the reporting date and the income statement would reflect the effects of credit deterioration (or improvement) during the reporting period. Credit losses are an expected part of all lending and fixed-income investment activity and we believe that accelerated recognition of credit losses better aligns balance sheets with the true financial picture of the lender/investor.
The proposed model differs from the current incurred-loss approach under US GAAP, under which assets are written down only when there is evidence that there will be a credit loss. For loans, such evidence would be a specific event pertaining to an individual credit or the deterioration of a macroeconomic factor that is likely to lead to defaults across a portfolio of loans. The current approach does not permit the recognition of credit losses until such evidence becomes apparent, which has been criticized for creating a lag in the recognition of losses and producing overstated income.
The downside of the simpler CECL model is that loss recognition will be required on day one after acquisition or origination of loans or other debt securities, which results in the counterintuitive result that carrying values of financial assets will be less than purchase price immediately after acquisition. Despite this concern, we still believe that the proposal is an improvement over current rules.
The CECL model differs from the IASB proposal and is negative for convergence. The FASB proposed model is another area where its and the IASB’s efforts to converge global accounting standards seem to be falling short. In December 2011, the boards had tentatively agreed to a “three bucket” approach for measuring impairment of financial assets. Under that approach, the first bucket would include assets with insignificant deterioration in credit since origination or purchase, on which losses that the entity expects to occur within the next 12 months will need to be recognized; the second (assets evaluated collectively) and third (assets evaluated individually) buckets would include assets for which the entity determined that there has been more than insignificant deterioration of credit quality since the initial recognition, on which lifetime expected losses would need to be recognized.
Wallace Enman Vice President - Senior Credit Officer +1.212.553.4321 [email protected]
NEWS & ANALYSIS Credit implications of current events
30 MOODY’S CREDIT OUTLOOK 10 JANUARY 2013
While the IASB remains focused on the three-bucket model, FASB outreach to constituents indicated that a model that included two different measurement methods and the transfer of assets between buckets would lead to confusion among investors. The revised CECL model eliminates the “transfer-notion” and puts forth a single measurement model.
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