iceland foods’ partial bond repayment is credit...
TRANSCRIPT
MOODYS.COM
8 JUNE 2017
NEWS & ANALYSIS Corporates 2 » Iceland Foods' Partial Bond Repayment Is Credit Positive » Evergrande's Second Round of Capital Raising Will Strengthen
Its Liquidity
Infrastructure 4 » Los Angeles Joins Western Energy Imbalance Market to Better
Integrate Renewables, a Credit Positive » Gwynt Y Mor Will Bear Some Costs for Cable Failures after UK
Regulator's Determination
Banks 6 » BanBajío's Share Offering Is Credit Positive » Intercorp Financial Services Solidifies Position in Annuities and
Life Insurance with Acquisition » Banco Mercantil Must Return Capital from Its Investment
Banking Subsidiary, a Credit Negative » For Qatari Banks, Sovereign’s Tensions with Fellow GCC
Countries Are Credit Negative » Abu Dhabi Banks’ Cost Control Initiative Is Credit Positive » Proposed Merger Plan Is Credit Positive for AmBank, but Less
So for RHB
Sovereigns 15 » Qatar's Credit Quality Would Decline If Tensions with Fellow
GCC Countries Persist » Mozambique’s Coral South Liquefied Natural Gas Project
Moves Forward, a Credit Positive » Bangladesh's Budget Projects Sizable Deficits Even with
Optimistic Revenue and Spending Assumptions
Sub-sovereigns 21 » China's Guidelines for Land Revenue Bonds Are Credit Positive
for Local Governments
US Public Finance 24 » Dallas and Houston Clear Major Pension Reform Milestones
RECENTLY IN CREDIT OUTLOOK
» Articles in Last Monday’s Credit Outlook 26 » Go to Last Monday’s Credit Outlook
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NEWS & ANALYSIS Credit implications of current events
2 MOODY’S CREDIT OUTLOOK 8 JUNE 2017
Corporates
Iceland Foods’ Partial Bond Repayment Is Credit Positive On Monday, UK food retailer Iceland VLNCo Limited (B2 stable) announced its intention to redeem up to £50 million of its senior secured floating rates notes due in 2020. The company expects the redemption to occur this month at a price of 100% plus accrued and unpaid interest.
The transaction is credit positive for Iceland Foods because the company’s pro forma Moody’s-adjusted leverage as of 24 March 2017 will decline to 5.5x from 5.7x. Additionally, the transaction reflects the company’s commitment to use excess cash to reduce its high indebtedness. Since completing its last refinancing in July 2014, we estimate that the company has bought back approximately £102 million of notes, or approximately 11% of total debt issued in par value (excluding notes purchased by management team). However, these transactions were made on the secondary markets at prices below par.
We caution that market conditions for UK food retailers will remain challenging owing to competition from large retailers and discounters, rising input costs and further increases in the UK national living wage. However, we estimate that the company’s rebranding strategy launched in March 2015 to stem the decline in like-for-like sales is now producing results. The company delivered positive like-for-like sales growth of 2% and EBITDA growth of 6% in its last fiscal year, which ended 24 March 2017.
We consider the company’s liquidity good, underpinned by a cash balance of £143 million as of 24 March 2017 pro forma for the £50 million note redemption, an undrawn revolving credit facility of £30 million and no mandatory debt amortization before 2019. We also assume that the company will maintain sufficient headroom under the draw-stop financial covenant applicable to its revolving credit facility and tested when drawn above a certain threshold.
Eric Kang, CFA Assistant Vice President - Analyst +44.20.7772.1965 [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 8 JUNE 2017
Evergrande’s Second Round of Capital Raising Will Strengthen Its Liquidity On 1 June, Hengda Real Estate Group Company Limited (unrated), the China Evergrande Group (B2 stable) subsidiary and holding company for most of its property projects in China, announced that it would raise RMB39.5 billion of new equity capital1 from 13 investors. Together with the first round of investment announced on 2 January 2017, total proceeds from its fundraising from investors will total RMB70 billion, or 23% of its cash on hand at year-end 2016.
The newly announced capital raise, if successful, would strengthen Evergrande’s current cash balances and provide the company funding beyond one year, a credit positive. We expect that the company’s liquidity strength, as measured by cash/short-term debt, will be above 1.2x-1.5x over the next 12-18 months, continuing the improvement at the end of December 2016. On 5 June 2017, we revised Evergrande’s rating outlook to stable from negative, reflecting its improved liquidity from strong contracted sales, active debt maturity management and our expectation that its credit metrics will continue to improve.
The company had cash on hand of RMB304 billion at year-end 2016. Its liquidity improved from year-end 2015, with cash/adjusted debt (including onshore perpetual securities, which we treat as debt) of 45% at year-end 2016, up from 43% at year-end 2015, and cash/short-term debt of 150% up from 103% over the same period.
We also expect that Evergrande’s adjusted debt leverage (as measured by revenue/adjusted debt) will improve to 55%-60% over the next 12-18 months from 32% in 2016, and its interest coverage ratio (as measured by adjusted EBIT/interest) will improve to 2.0x-2.5x from 1.4x over the same period. The improvement we expect in credit metrics will come from a combination of strong contracted sales, efficient cash collection and slower debt growth, in part because of the newly raised funds. In addition, our expectation of improved credit metrics is based on the company’s continued effort to improve gross profit margins by increasing its development of properties in China’s higher-tier cities and paying down its expensive onshore perpetual securities. The company paid down RMB56 billion between January and April 2017.
Evergrande delivered robust 63% year-on-year growth in contracted sales for the first four months of 2017, following robust 85% year-on-year growth to RMB373 billion in 2016. We expect the company to register around 20% cumulative average growth in contracted sales this year and in 2018. Contracted sales growth will ensure adequate cash inflow to cover the large amount of capital that Evergrande requires for construction, and will support its ability to refinance its maturing debts.
As part of the new capital raising, Evergrande is required to ensure that Hengda’s net profit does not fall below RMB24.3 billion in 2017, RMB30.8 billion in 2018 and RMB33.7 billion in 2019, and that at least 68% of the net profits are distributed as dividends over the same periods.
1 Although the newly raised funds are equity capital, Hengda has certain obligations regarding repurchase and compensation if
the company’s reorganization (namely its listing) is not completed by 31 January 2020.
Franco Leung Vice President - Senior Credit Officer +852.3758.1521 [email protected]
NEWS & ANALYSIS Credit implications of current events
4 MOODY’S CREDIT OUTLOOK 8 JUNE 2017
Infrastructure
Los Angeles Joins Western Energy Imbalance Market to Better Integrate Renewables, a Credit Positive On 1 June, the Los Angeles (California) Department of Water and Power (LADWP, Aa2 stable), the largest US municipal utility, signed an agreement with the California Independent System Operator Corp. (CAISO, A1 stable) to join the real-time Western Energy Imbalance Market (EIM) starting in April 2019. The credit-positive step will allow LADWP to better integrate its renewable energy into the Western market.
LADWP expects to better manage demand while lowering the cost of power supplied to its customer base. We expect that the evolving EIM will likely be used to better balance supply and demand in the service territories of the EIM participants, in real time when the electricity is used across a larger region to meet immediate power needs. The real-time market also allows participating systems to absorb the oversupply of renewable energy. According to the CAISO first-quarter 2017 report, the participating utilities have saved $173.7 million since the wholesale market began in November 2014.
An important factor in LADWP’s decision to join the EIM is to help meet its 2030 renewable energy standard of serving its retail load with 50% renewable energy. To arrive at that 50% level, more renewable energy will be derived from solar production, which will require significant balancing requirements because of the intermittency of production.
Initially reluctant to join, the region’s public power electric utilities have become more comfortable with participation. For example, City of Seattle (Washington) Electric Enterprise (Aa2 stable) and Sacramento (California) Municipal Utility District (Aa3 stable) are joining the EIM in April 2019, and Salt River Project Agricultural Improvement and Power District (Arizona) (Aa1 stable) expects to join in April 2020. Numerous investor-owned utilities already participate and others have plans to participate, including Powerex, a wholly owned subsidiary of British Columbia Hydro & Power Authority (Aaa stable) and Idaho Power Company (A3 stable).
LADWP serves more than 4 million customers and had 7,753 megawatts of installed net dependable capacity of generation in 2016, with all-time net energy for load peak demand at 6,396 megawatts on 16 September 2014. LADWP has ownership and control of a transmission network that accounts for about 25% of the state’s transmission grid. About 37% of its power supply energy and 12% of capacity is coal-fired generation. In 2016, LADWP provided its retail load with 25% of energy from renewable sources.
Dan Aschenbach Senior Vice President +1.212.553.0880 [email protected]
NEWS & ANALYSIS Credit implications of current events
5 MOODY’S CREDIT OUTLOOK 8 JUNE 2017
Gwynt Y Mor Will Bear Some Costs for Cable Failures after UK Regulator’s Determination On 31 May, the UK Office of Gas and Electricity Markets (Ofgem) determined that the first of two cable failure events was not an income-adjusting event, as defined in the offshore transmission licence held by Gwynt Y Mor OFTO PLC (GyM, A3 negative). Determination on the second event will be published “in due course,” according to Ofgem. GyM had claimed that both cable failure events were income- adjusting events.
Ofgem’s determination is credit negative for GyM because approximately £10.2 million of cost associated with repairing the cable will not be recoverable through the licence. GyM reported transmission receipts of approximately £25 million in the year to 31 March 2016. GyM has substantially drawn on its liquidity reserves to fund the cable repairs. Reserves will likely remain depleted for several years unless these repair costs are recovered through insurance or other commercial arrangements, including the cable manufacturer warranties.
In March 2015, one of GyM’s four export cables had an electrical fault that reduced GyM’s overall availability by 25%. The fault location was identified and 200 metres of the cable was successfully replaced. Availability was restored to 100% in July 2015 and this cable has not had any further issues since completion of the repairs. In September 2015, a fault was identified in another export cable, also reducing GyM’s overall availability by 25%. Winter weather made repair work somewhat slower than for the first cable failure, but availability has been fully restored. The outages led to periods of reduced availability, lower than the 98% licence target. GyM successfully claimed relief against revenue deductions from the unavailability under the Exceptional Event provision in the licence: of a cumulative 259 days of outages, Ofgem granted Exceptional Event relief for all but 30 days, resulting in a loss in revenue of approximately £1.4 million.
Total repair costs are approximately £24 million. GyM’s emergency reserve account, which was £5 million when the transaction closed in February 2015 and inflates with the retail price index, has been fully drawn. GyM has also drawn upon the majority of its debt service reserve account, which has a target balance of slightly less than £10 million. However, GyM also benefits from European Investment Bank project bond credit enhancement (PBCE), which is in the form of an unconditional and irrevocable revolving letter of credit. The PBCE is currently undrawn and GyM management forecasts having sufficient cash reserves without needing to draw upon the PBCE. The maximum amount available under the PBCE is 15% of the outstanding principal amount of the bonds and as of 31 March 2017 held approximately £48 million of additional liquidity available to GyM for debt service. Repayments of the PBCE are subordinate to bond debt service payments in the event of the PBCE being drawn in the future. Under the terms of the finance documents, both the emergency reserve account and debt service reserve account must be fully replenished before any subordinated debt payments or equity distributions are made.
GyM has submitted insurance claims for the cable failures and is also pursuing cost recovery through other commercial arrangements including the cable manufacturer warranties.
Adam Muckle Assistant Vice President - Analyst +44.20.7772.1969 [email protected]
NEWS & ANALYSIS Credit implications of current events
6 MOODY’S CREDIT OUTLOOK 8 JUNE 2017
Banks
BanBajío’s Share Offering Is Credit Positive Last Tuesday, Banco del Bajío, S.A. (BanBajío, Baa3 stable, ba12) published its primary and secondary share offering of up to about $490 million, or 25% of the bank’s ownership. The credit-positive offering will increase Mexico-based BanBajío’s capitalization, boost its transparency and market oversight, and improve corporate governance.
Following the primary offering, BanBajío’s capitalization, measured as the ratio of tangible common equity (TCE) to risk-weighted assets (RWAs), will increase by about 250 basis points to 15% from 12.4% as of March 2017. Higher capitalization supports the bank’s planned expansion, which will focus on its traditional target market of small and midsize regional companies. Management expects the bank’s loan book to grow 11%-13% over the next year.
Higher business volume at higher market interest rates will complement the bank’s multiyear efforts to lower funding and operating costs to boost profitability. Continued loan growth will also allow BanBajío to reduce its large concentrations of long-term loans to states and municipalities, which the bank took on during the 2009 financial crisis.
BanBajío’s listing, only the second one on the Mexican Stock Exchange so far this year, will require the bank to publish its financial reports quarterly and to hold a conference with investors, which will increase the company’s market oversight.
In addition, the bank’s corporate governance will improve with the appointment of a new independent board member, increasing the percentage of independent board members to 50% from about 40% currently. The new board member will replace the one appointed by Ion Investments, B.V. (unrated), a wholly owned subsidiary of Temasek Holdings (Private) Limited (Aaa stable), which is currently the bank’s second-largest shareholder. About 60% of the listing is a secondary offering, mainly for Ion Investments, whose current 12.97% ownership would fall to a little less than 3%.
The eighth-largest bank in Mexico, BanBajío is the largest commercial lender in the central Mexican region of Bajío. Economic growth in the Bajío has outpaced that of Mexico overall, driven by heavy manufacturing, specifically automotive investments. However, Bajío’s growth would be more affected than other regions if more extensive changes were to be made to the North American Free Trade Agreement, which risks negatively affecting BanBajío’s loan book. Because tail risks have risen, the bank’s higher capitalization is also positive because it boosts loss absorption.
2 The bank ratings shown in this report are the bank’s local deposit rating and baseline credit assessment.
Felipe Carvallo Vice President - Senior Analyst +52.55.1253.5738 [email protected]
NEWS & ANALYSIS Credit implications of current events
7 MOODY’S CREDIT OUTLOOK 8 JUNE 2017
Intercorp Financial Services Solidifies Position in Annuities and Life Insurance with Acquisition On 1 June, Intercorp Financial Services Inc. (IFS, unrated), a subsidiary of Intercorp Perú Ltd. (Intercorp, Ba2 stable), announced that it had reached an agreement to acquire up to 100% of the shares of Perú-based Seguros Sura S.A. (unrated) and Hipotecaria Sura Empresa Administradora Hipotecaria S.A. (unrated) from Colombia-based Sura Asset Management S.A. (Baa1 stable), and Perú-based Sura Asset Management Perú S.A. (unrated) and Grupo Wiese (unrated).
The transaction is credit positive for IFS and Intercorp because it will strengthen the holding group’s position in the annuities and individual life insurance market, consolidating its standing as one of Perú’s leading financial services companies. The purchase also will improve IFS’ revenue diversification, and specifically increase the contribution from the insurance business, a more stable source of fee-based revenue. At the same time, the transaction will improve IFS’ economies of scale in the annuities and life insurance businesses and generate cost synergies. In addition, IFS expects that it will be able to improve the return on the attributable invested insurance premiums.
The businesses being acquired, which equal nearly 10% of the holding group’s assets, are mainly focused on retirement annuities and individual life insurance. Once the transaction is approved by the Superintendency of Banking, Insurance and Private Pension Funds (which the company expects within the next 120 days), Interseguro Compañía de Seguros S.A. (unrated), a subsidiary of IFS, will absorb Seguros Sura, expecting to consolidate its leadership in the annuity market with a market share of 30%. Interseguro offers annuities, individual life insurance, disability insurance and survivor benefits, and mandatory traffic accident insurance.
The acquisition, which has an initial base price of $268 million, will most likely be financed with senior debt issued by IFS in the international market. IFS had assets of $15.8 billion and equity of $1.5 billion as of March 2017, and with no financial debt outstanding, the increase in leverage of roughly $270 million resulting from the transaction should be easily manageable.
In addition to Interseguro Companía de Seguros, S.A., IFS’ main subsidiaries are Banco Internacional del Perú-Interbank (Baa2/Baa2 stable, baa33) and Inteligo Group Corp. (unrated). Interbank is a full-service bank providing general banking services to retail and commercial customers, while Inteligo provides wealth management and brokerage services. Interbank will continue to account for around 75% of the group’s total assets and 60% of dividends following the acquisition.
3 The bank ratings shown in this report are the bank’s local deposit rating, senior unsecured debt rating and baseline credit
assessment.
Valeria Azconegui Vice President - Senior Analyst +54.11.5129.2611 [email protected]
NEWS & ANALYSIS Credit implications of current events
8 MOODY’S CREDIT OUTLOOK 8 JUNE 2017
Banco Mercantil Must Return Capital from Its Investment Banking Subsidiary, a Credit Negative Last Friday, Brazil’s central bank ordered Banco Mercantil do Brasil S.A. (BMB, Caa1 stable, caa11) to repay BRL150 million of capital that its investment banking subsidiary, Banco Mercantil de Investimentos S.A. (BMI), had received in 2016 from Codemig Participaçoes (unrated), the investment arm of Codemig, the development company of the Brazilian State of Minas Gerais. The return of the capital funds is credit negative because it will reduce income from the bank’s subsidiary and comes at a time when BMB’s profitability has been under pressure.
In 2016, BMI sold BRL191 million of ordinary and preference shares as it refocused its operations to provide investment banking products to small and midsize enterprises in Minas Gerais. Codemig Participaçoes purchased BRL150 million of the shares. After the capitalization, BMB was left with 36.2% of BMI’s total shares, including preference shares, but 51% of ordinary shares, and hence controlled the entity. Brazil’s central bank was in the process of ratifying the additional capitalization, but in the absence of third-party documentation required for its approval, the central bank ordered BMB to return Codemig’s contribution. BMI’s capital base will now be 50% lower and constrain its future operations. Consequently, potential fee and bridge loan income that could have come from a fully capitalized BMI will be significantly reduced. In 2016, BMI reported net income of BRL9 million, while BMB reported net income of BRL18.3 million. Codemig’s capitalization was held on BMI’s balance sheet and its return does not entail winding up its operations, which will continue on a reduced scale.
The return of capital comes as the high cost base of BMB’s extensive branch network challenges its profitability, and as we expect provisioning expenses, which already account for more than 90% of pre-provision income and expenses, to rise further (see Exhibit 1). The bank’s net income to tangible banking assets ratio was just 0.17% in 2016, down 74% versus 2015, when the bank benefited from a onetime tax windfall (the result of a tax rate change) that allowed it to monetize a larger share of deferred tax assets (see Exhibit 2). Were it not for the windfall, the bank would have reported losses, as it did the previous year.
EXHIBIT 1
Banco Mercantil do Brasil’s Provisioning Expense/Pre-Provision Income
Source: Banco Mercantil do Brasil
149%
136%
109%103%
90% 87%93% 91% 92%
0%
20%
40%
60%
80%
100%
120%
140%
160%
Dec-14 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16
Farooq Khan Analyst +55.11.3043.6087 [email protected]
NEWS & ANALYSIS Credit implications of current events
9 MOODY’S CREDIT OUTLOOK 8 JUNE 2017
EXHIBIT 2
Banco Mercantil do Brasil’s Net Income/Tangible Banking Assets
Source: Banco Mercantil do Brasil
Any recovery in the bank’s profitability will likely be constrained by low loan growth and reduced investment income from the lower Brazilian SELIC monetary policy rate, which has fallen by 400 basis points since October 2016 to 10.25% as part of the central bank’s monetary easing. The bank also faces risk as it transitions to a new business model. It remains unclear if the bank’s new focus of lending to pensioners will allow it to generate profits on a sustainable basis.
BMB’s consolidated capitalization ratios will not be affected because Codemig’s capital share in BMI was accounted for as a minority interest, which is not included in our measure of the ratio of tangible common equity to risk-weighted assets. The bank will hold an extraordinary general meeting to establish the exact timeline for the return of the capital.
-1.26%
-0.96%
-0.22%
0.14%
0.57% 0.62%
0.33%0.23% 0.17%
-1.5%
-1.0%
-0.5%
0.0%
0.5%
1.0%
Dec-14 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16
NEWS & ANALYSIS Credit implications of current events
10 MOODY’S CREDIT OUTLOOK 8 JUNE 2017
For Qatari Banks, Sovereign’s Tensions with Fellow GCC Countries Are Credit Negative On Monday, Gulf Cooperation Council (GCC) members4 Saudi Arabia (A1 stable), the United Arab Emirates (UAE, Aa2 stable) and Bahrain (Ba2 negative), and non-member Egypt (B3 stable) announced that they had severed diplomatic ties and cut transport links with Qatar (Aa3 stable).5 Should the rift between the GCC countries persist, it would be credit negative for Qatari banks, owing to their reliance on confidence sensitive foreign funding, which currently accounts for 35% of total liabilities.
We expect that Qatari banks’ funding costs will likely rise for debt securities (11% of foreign funding), and there is a risk of withdrawals from non-resident deposits (43% of foreign funding) and interbank facilities (46% of foreign funding) because a portion of these are sourced from the GCC. The liquidity squeeze could intensify in the event of further escalation of tensions, which could include restrictions on capital flows or change in investor sentiment. The rift, the worst since the creation of the GCC in 1981, could also be negative for regional economies, business confidence and credit growth opportunities for GCC banks if it persists.
The tensions with other GCC countries have come at a time when the reliance on the foreign funding has increased for Qatari banks. Over the past two years, deposits from the hydrocarbon-rich Qatari government and related-entity deposits into the local banks have declined because of the fall in oil prices. The decline in local deposits drove foreign funding to increase to 35% of total liabilities as of March 2017 versus 23% in 2014 (see Exhibit 1). Among the largest Qatari banks, Qatar National Bank’s (Aa3 stable, baa16) foreign funding accounts for 49% of its total liabilities, while The Commercial Bank’s (A2 negative, baa3) is 40% of its total liabilities and Qatar Islamic Bank’s (A1 stable, baa2) is 30%.
EXHIBIT 1
Qatar Banks’ Foreign Funding as a Percent Total Liabilities
Source: Qatar Central Bank
Against these risks as a result of higher reliance on foreign funding, Qatari banks’ had a healthy but declining stock of liquid assets of around 24% of total assets at the end of 2016 (see Exhibit 2). Qatari banks also started booking longer-term maturity deposits, which improved their asset-liability mismatch and helped them comply with the Qatar Central Bank’s new Basel III liquidity metrics. Additionally, we expect the Qatari government to support the banks if needed, as it did during the 2009-10 financial crisis to maintain 4 The GCC countries include Saudi Arabia, United Arab Emirates, Qatar, Kuwait, Bahrain and Oman. 5 Other countries that severed diplomatic ties with Qatar include Libya, Maldives, Mauritius and Yemen. 6 The bank ratings shown in this report are the banks’ deposit ratings and baseline credit assessments.
0%
5%
10%
15%
20%
25%
30%
35%
40%
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Mar-17
Nitish Bhojnagarwala Vice President - Senior Analyst +971.4.237.9563 [email protected]
Olivier Panis Vice President - Senior Credit Officer +971.4.237.9533 [email protected]
Corina Moustra Associate Analyst +357.2569.3003 [email protected]
NEWS & ANALYSIS Credit implications of current events
11 MOODY’S CREDIT OUTLOOK 8 JUNE 2017
investor/depositor confidence and financial stability when both equity and property prices were declining. We estimate Qatari government reserves at around 200% of GDP in 2016. Although not all of these assets are liquid, we expect that they would be mobilized and made available to support the banking system.
EXHIBIT 2
Qatar Banks’ Liquid Banking Assets to Tangible Banking Assets
Source: Qatari rated banks and Moody’s Investors Service
We expect that the GCC diplomatic crisis will have limited immediate effects for other GCC banking systems. We estimate that the overall exposure of the rest of the GCC banking systems to Qatari assets is less than 5%. However, any prolonged tensions in the Gulf would also negatively affect investments in other GCC countries, economic growth and the performance of regional companies.
0%
5%
10%
15%
20%
25%
30%
35%
2010 2011 2012 2013 2014 2015 2016
NEWS & ANALYSIS Credit implications of current events
12 MOODY’S CREDIT OUTLOOK 8 JUNE 2017
Abu Dhabi Banks’ Cost Control Initiative Is Credit Positive Last Tuesday, a report from the Statistics Centre of Abu Dhabi showed that Abu Dhabi banks reduced their number of employees by 917, or 6.8%, between first-quarter 2016 and first-quarter 2017, amid a weaker economic environment in the United Arab Emirates (UAE), and Abu Dhabi in particular. Fewer employees reduces banks’ costs, which is credit positive and helps mitigate softening top-line revenues, rising funding costs and provisioning expenses over the coming quarters.
Banking activity has gradually softened amid the economic slowdown and we estimate that lending growth will slow to 3%-5% this year from around 8% in 2015. We expect non-oil GDP growth in Abu Dhabi to slow to 1.9% this year, versus 8.6% in 2014, amid a 23% cut in government spending over the past two years in response to lower oil revenues.
The drop in Abu Dhabi bank employees, 767 of whom were cut in the first quarter of this year, reflects Abu Dhabi banks’ focus on stabilizing operating profits. Since oil prices collapsed in 2014, Abu Dhabi banks have gradually adapted their operations to a slower economy and more selective risk appetite. As a result, their operating expenses grew 3.3% year over year as of first-quarter 2017, versus an 8.9% compound annual growth rate (CAGR) during 2011-16. The decline in operating expenses was in line with banks’ moderating operating revenues, which grew 6.4% year over year as of first-quarter 2017, versus a 7.1% CAGR during 2011-16. The moderation of operating expenses allowed Abu Dhabi banks to maintain a broadly stable cost-to-income ratio, which averaged 33.5% as of first-quarter 2017, versus 33.6% over the past five years (see exhibit). The recent merger between National Bank of Abu Dhabi and First Gulf, which created First Abu Dhabi Bank (FAB, Aa3 stable, a37), also illustrates emirate banks’ current focus on cost efficiencies in the absence of rapid growth prospects.
Abu Dhabi Banks’ Efficiency Metrics
Note: *First-quarter 2017 growth is quarter-on-quarter factor metrics from First Abu Dhabi Bank, Abu Dhabi Commercial Bank, Abu Dhabi Islamic Bank and Union National Bank and accounts for the National Bank of Abu Dhabi-First Gulf Bank merger. Sources: The banks and Moody’s Investors Service
As of March 2017, banks with the best efficiency levels, as measured by cost-to-income ratios, were FAB at 30.2%, Union National Bank (UNB, A1 stable, baa3) at 30.9% and Abu Dhabi Commercial Bank (ADCB, A1 stable, baa3) at 34.4%, all lower than the UAE banking system average of around 36.8%. Abu Dhabi Islamic Bank (ADIB, A2 stable, ba1) had a cost-to-income ratio of 45.8% during the same period, down from 48.7% in 2014. 7 The bank ratings shown in this report are the bank’s deposit rating and baseline credit assessment
32.8% 33.5%34.8% 34.8%
33.5%
0%
2%
4%
6%
8%
10%
12%
14%
0%
5%
10%
15%
20%
25%
30%
35%
40%
2013 2014 2015 2016 Q1-2017*
Cost/Income - left axis Operating Expenses Growth - right axis Net Revenue Growth - right axis
Olivier Panis Vice President - Senior Credit Officer +971.4.237.9533 [email protected]
Badis Shubailat Associate Analyst +971.4.237.9505 [email protected]
NEWS & ANALYSIS Credit implications of current events
13 MOODY’S CREDIT OUTLOOK 8 JUNE 2017
We expect Abu Dhabi banks’ profitability to remain broadly stable over the next 12-18 months, with a return on assets of around 1.6% as efficiency gains and stable margins stemming from a potential US interest rate increase rise support modest pre-provision income growth. Rising loan yields will help mitigate an increasing cost of funding because Abu Dhabi banks have increased their reliance on more expensive market-based funding to 20.3% of funding as of first-quarter 2017 from 16.3% in 2013.
The modest growth in pre-provision income will also moderate the negative effect of provisioning costs that we expect will continue rising in line with problem loans in a weakening economy. In particular, job losses in banks and other corporates affected by the economic slowdown will challenge retail asset performance. Loan-loss provisions absorbed 27.7% of Abu Dhabi banks’ pre-provision income as of first-quarter 2017, versus 22.8% in first-quarter 2016. We also expect more consolidation between banks in Abu Dhabi and the UAE as shareholders continue prioritising the sustainability of banks’ profitability and return on capital.
NEWS & ANALYSIS Credit implications of current events
14 MOODY’S CREDIT OUTLOOK 8 JUNE 2017
Proposed Merger Plan Is Credit Positive for AmBank, but Less So for RHB Last Thursday, RHB Bank Berhad (RHB, A3/A3 stable, baa38), the parent company of RHB Banking Group, and AMMB Holdings Berhad (unrated), a holding company of AmBank Group, announced their 90-day exclusivity agreement to discuss a merger, pending regulatory approval. The banks indicated that the transaction would effectively be an all-share merger. The combination of the two midsize financial institutions would create Malaysia’s fourth-largest financial group by assets, with total consolidated assets of MYR368 billion ($86 billion), based on March 2017 financials.
The proposed merger is credit positive for AmBank (M) Berhad (Baa1/Baa1 stable, baa3), AmBank Group’s main operating bank, because its distribution, funding resources and systemic importance would benefit from being part of a larger Malaysian banking group. On a standalone credit basis, AmBank’s funding profile is weaker than that of RHB. AmBank has a materially smaller market share of domestic deposits and lower percentage of low-cost current and savings account deposits in its deposit mix than RHB. We expect the merged entity’s funding profile to be closer to that of RHB, and to gain from the larger scale of their combined and enhanced branch and customer network.
Potential benefits to RHB are discounted by its likely operating challenges to rationalize the organization structure and infrastructure of the newly merged entity. RHB’s integration of OSK Investment Bank Group (unrated) and other mergers involving Malaysian banks suggest significant challenges, with the realization of revenue and cost synergies occurring many years after integration. In this case, revenue benefits will likely materialize only after the merged entity incurs substantial restructuring expenses.
Furthermore, even as Malaysia’s fourth-largest financial group, we do not expect the merged entity to be in a significantly stronger strategic position relative to the top three Malaysian banking groups. Malayan Banking Berhad (Maybank, A3/A3 stable, a3) and CIMB Bank Berhad (A3/A3 stable, baa2) have entrenched corporate relationships, while Public Bank Berhad (A3 stable, a3) has a longstanding leadership position in retail lending.
However, the merger would still enhance the scale of RHB’s operations in Malaysia, and give it access to customer and product segments with which AmBank Group has stronger ties, such as the higher-yielding auto-finance segment, investment banking and general insurance. The combined total assets of both AmBank Group and RHB would increase RHB’s assets by 1.6x, and AmBank Group’s assets by 2.7x, based on 31 March 2017 figures. The merged entity would solidify its position as having among the largest branch networks in Malaysia, close to that of Maybank, which remains the country’s largest banking group in terms of banking assets, loans and deposits.
The merger will not significantly affect the two entities’ asset profile and capitalization. Based on our pro forma estimates, the gross impaired loan ratio of the merged entity was 2.2%, based on March 2017 financials, compared with 2.4% for RHB and 1.9% for AmBank Group.
On capital, we do not expect the proposed all-share transaction to result in significant goodwill that would negatively affect the capital position of the merged entity. At the end of March 2017, RHB reported a common equity Tier 1 ratio of 13.2%, while AmBank reported a ratio 11.6% for the consolidated AmBank Group.
8 The bank ratings shown in this report are the bank’s deposit rating, senior unsecured debt rating and baseline credit assessment.
Simon Chen, CFA Vice President - Senior Analyst +65.398.8305 [email protected]
Eugene Tarzimanov Vice President - Senior Credit Officer +65.6398.8329 [email protected]
NEWS & ANALYSIS Credit implications of current events
15 MOODY’S CREDIT OUTLOOK 8 JUNE 2017
Sovereigns
Qatar’s Credit Quality Would Decline If Tensions with Fellow GCC Countries Persist On Monday, eight mostly Arab countries, including Saudi Arabia (A1 stable) and the United Arab Emirates (UAE, Aa2 stable),9 announced that they had severed diplomatic ties with Qatar (Aa3 stable). In addition to severing diplomatic relations, Saudi Arabia, UAE and Bahrain (Ba2 negative), which, like Qatar, are all members of the Gulf Cooperation Council (GCC), as well as Egypt (B3 stable), which is not a GCC member, announced the suspension of air, land and sea transport, banned their citizens from visiting Qatar and gave Qatari nationals two weeks to leave their respective countries.
The move to isolate Qatar is unprecedented in the GCC’s history. Even though we do not expect disruptions to Qatar’s ability to export oil and gas via sea routes, imports might become costlier and tourism from the region will likely suffer. If the situation persists, it will negatively affect the sovereign’s credit strength, primarily through higher funding costs, the potential crystallization of contingent liabilities on the government’s balance sheet and a likely drain on foreign exchange reserves.
Given its geographical proximity to Saudi Arabia and the UAE, Qatar’s dependence on imports from those countries is sizable. In 2016, according to International Monetary Fund statistics, around 14% of Qatar’s total imports came from those two countries, with about 25% of all food and basic goods’ imports, as well as construction materials, such as those used in preparation for the 2022 FIFA World Cup. A prolonged disruption of trade links could require using potentially more costly alternatives, which in turn would increase inflationary pressures.
From an export perspective, the UAE is by far the largest recipient of Qatari exports, receiving about 5% of total exports, in addition to being a major transit hub for trade to other parts of the world. However, given that the majority of Qatar’s exports are hydrocarbon and predominantly natural gas, which is predominantly exported by sea to countries that did not take action Monday, we expect a limited effect on foreign-exchange inflows in the balance of payments and on government revenues. Even though the UAE announced that it will close its maritime area to Qatari vessels, tankers carrying Qatari gas will be able to use Iranian and Omani waters to reach the Indian Ocean.
The initial financial market reaction has been relatively manageable: yields on Qatar’s most recent 10-year international bond (issued June 2016) rose 20 basis points to 3.36% on Monday and narrowed slightly to 3.35% on Tuesday, and the Qatar Exchange Index decreased by a total 9.8% from its closing the previous week. But a prolonged or deepening rift between Qatar and its GCC neighbors would potentially have a more marked financial effect and increase funding costs for the sovereign and other Qatari entities.
An escalation could include restrictions on capital flows, which would be negative for Qatari banks’ liquidity and funding. Tighter domestic liquidity in 2016 drove banks to increase foreign funding, which correspondingly drove the increase in Qatar’s total external debt to about 150% of GDP in 2016, according to our estimates, up from around 111% in 2015. In a scenario of a rapid loss of confidence from international investors and depositors from other GCC countries, the government might have to step in to support domestic banks.
In such a scenario, Qatar’s government debt burden would likely rise beyond our current baseline projections of around 48% of GDP in 2017 and debt affordability metrics would weaken. Although Qatar has reasonably strong financial buffers – we estimate that total assets managed by the Qatar Investment
9 The other countries are Bahrain, Egypt, Libya, Maldives, Mauritius and Yemen.
Steffen Dyck Vice President - Senior Credit Officer +49.69.70730.942 [email protected]
Malgorzata Glowacka Associate Analyst +49.69.70730.938 [email protected]
NEWS & ANALYSIS Credit implications of current events
16 MOODY’S CREDIT OUTLOOK 8 JUNE 2017
Authority were almost 200% of GDP in 2016 – not all of these assets are liquid and external. Therefore, a pick-up in foreign investment outflows would drain foreign-exchange reserves from their current level of $34.8 billion and weaken Qatar’s external liquidity position.
NEWS & ANALYSIS Credit implications of current events
17 MOODY’S CREDIT OUTLOOK 8 JUNE 2017
Mozambique’s Coral South Liquefied Natural Gas Project Moves Forward, a Credit Positive On 1 June, a group including ENI S.p.A (Baa1 stable) and the Government of Mozambique (Caa3 negative) announced that it had reached a long-awaited investment decision for the Coral South liquefied natural gas (LNG) project. The $7 billion project, which ENI projects will start production in 2022, is credit positive because it will benefit the Mozambican economy. The production has already been contracted for 20 years of sale, and ENI expects that the project will have a capacity of 3.4 million tons per year.
Coral South LNG production will boost government revenues, exports, and thereby foreign exchange reserves, mitigating two key areas of credit weakness. Although the investment decision will not relieve the government of its near-term challenges in servicing debt, it does confirm Mozambique’s strong LNG potential. The country holds one of the largest natural gas reserves globally, which the US Energy Information Administration last year estimated at 100 trillion cubic feet.
Growth in Mozambique has been depressed in recent years because of lower commodity prices and a regional drought, as well as fiscal restraint. Nevertheless, the consortium’s investment decision in this climate means that the government managed to provide sufficient protection to investors for the final investment decision to occur. Although we expect economic growth to gradually recover over the next three to four years to near historical averages, the start of production and export for the Coral South LNG project, as well as other projects likely to come online, will drive a substantial increase in growth. The International Monetary Fund projects that Mozambique’s real GDP growth will reach nearly 15% in 2022 (see exhibit).
Mozambique’s Real GDP Growth Should Increase Rapidly Once LNG Production Begins
Sources: Mozambique government authorities, International Monetary Fund and Moody’s Investors Service
The Coral South LNG project will also drive sizable balance-of-payments flows in the coming years. Mozambique has had some of the highest levels of foreign direct investment as a share of GDP in the Moody’s-rated universe, averaging 21.5% of GDP during 2007-16, and the new project will only drive foreign direct investment higher. Although the majority of project-related external investments will be used to fund capital imports for the construction of the various components of the facility, we expect some capital flows to remain with Mozambique because of local content requirements, which will also support increased foreign-exchange reserves.
Once production begins in 2022, government revenues (derived through a 6% natural gas production tax) will increase, as will other related taxes. The government also reserves the right to be paid in kind with
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16%
2010 2011 2012 2013 2014 2015 2016 2017Forecast
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Actual Real GDP IMF Forecast
Lucie Villa Vice President - Senior Analyst +1.212.553.1990 [email protected]
David Kamran Associate Analyst +1.212.553.2109 [email protected]
NEWS & ANALYSIS Credit implications of current events
18 MOODY’S CREDIT OUTLOOK 8 JUNE 2017
natural gas in lieu of a regular tax payment. In addition to tax revenue, additional potential revenues may be derived from the state-owned Empresa Nacional de Hidrocarbonetos (unrated), which holds a minority stake in the project. This uplift in government revenues will offer a sizable support to government debt servicing capacity.
NEWS & ANALYSIS Credit implications of current events
19 MOODY’S CREDIT OUTLOOK 8 JUNE 2017
Bangladesh’s Budget Projects Sizable Deficits Even with Optimistic Revenue and Spending Assumptions Last Thursday, Bangladesh (Ba3 stable) Finance Minister Abul Mal Abdul Muhith announced a spending program of BDT4 trillion ($50 billion) that focuses on bolstering infrastructure investment in the budget for fiscal 2018 (ending 30 June 2018). Bangladeshi authorities expect stronger economic growth to increase tax revenues, which would help offset increased expenditures. Although more infrastructure investment would support growth, the budget assumptions on revenue and growth are optimistic, and yet projected deficits through fiscal 2020 remain sizable, a credit negative.
The government targets a fiscal 2018 budget deficit (excluding grants) of 5.0% of GDP, unchanged from the projected deficit for fiscal 2017 (see exhibit). The projected deficit is wider than the average 3.9% deficit over the past 10 years and our forecasted deficits for fiscal 2017 and 2018 of 4.6%-4.7% of GDP (excluding grants).
Bangladesh’s Central Government Budget Balance as a Percent of GDP
Note: Budget deficits including grants for 2017 and 2018 are our forecasts, whereas deficits excluding grants for 2017 and 2018 are government projections. Sources: Bangladesh Ministry of Finance and Moody’s Investors Service
The government’s expected deficit for fiscal 2018 factors in a 33.6% rise in tax revenues over the previous year, and a 37.1% increase in total development spending to 7.2% of GDP from 5.9% of GDP in fiscal 2017. However, these targets are unlikely to be fully met. Tax revenues have grown an average of 14% annually over the past five years. Revenue collection (excluding grants) in Bangladesh is among the lowest of similarly rated peers, at around only 10% of GDP in fiscal 2016, compared with the median of 28.5% of GDP for Ba-rated sovereigns. The government’s objective is to raise the revenue-to-GDP ratio (excluding grants) to 14% by fiscal 2020, driven by a series of projected future tax reforms.
Next month, the government intends to implement a new, mostly digital valued-added tax system that will harmonize tax rates and facilitate tax reporting and collection. The government has indicated that reforms to the direct tax code and customs regime will follow. But even if successfully implemented, a material pick-up in revenues is likely to lag policy implementation, and fiscal flexibility to spend on development needs is apt to remain limited over the next few years.
Moreover, the expected rise in fiscal 2018 tax revenues is based on projected real GDP growth of 7.4% year on year, which is higher than our 6.7% forecast and would be the fastest annual expansion in several decades. Therefore, we expect revenues to increase only incrementally to about 12.0% of GDP by fiscal
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2009 2010 2011 2012 2013 2014 2015 2016 2017 RevisedEstimate
2018 Budget
Budget Deficit Excluding Grants Budget Deficit Including Grants
Shirin Mohammadi Associate Analyst +1.212.553.3256 [email protected]
William Foster Vice President - Senior Credit Officer +1.212.553.4741 [email protected]
NEWS & ANALYSIS Credit implications of current events
20 MOODY’S CREDIT OUTLOOK 8 JUNE 2017
2018, falling short of the government’s target 13.0% because of slower-than-expected economic growth and collection of new value-added tax revenues.
On the expenditure side, we also see implementation risks to the government’s ambitious development spending targets. Bangladesh has consistently fallen short of its targets for capital spending under its annual development program (ADP) because of lengthy approval processes for procurements and supply constraints, which demonstrates a limited institutional capacity to spend effectively. Low institutional capacity continues to hamper Bangladesh’s policy credibility and effectiveness, which is a key limitation on the sovereign’s credit profile.
The latest budget targets a significant 38.5% increase in ADP expenditures to 6.9% of GDP in fiscal 2018, from a revised estimate of 5.7% of GDP in fiscal 2017 and 4.7% in fiscal 2016. If deployed effectively, greater ADP spending would strengthen Bangladesh's credit quality by addressing infrastructure constraints, augmenting growth and demonstrating improved policy effectiveness. However, the continued shortfall of ADP targets, which appears likely given the large targeted increase in spending absent significant improvements in institutional capacity to effectively manage projects, risks further weakening of policy credibility, a credit negative.
NEWS & ANALYSIS Credit implications of current events
21 MOODY’S CREDIT OUTLOOK 8 JUNE 2017
Sub-sovereigns
China’s Guidelines for Land Revenue Bonds Are Credit Positive for Local Governments On 1 June, China’s Ministry of Finance (MOF) and Ministry of Land and Resources (MOLR) jointly published Document 62, Pilot Guideline of Land Reserve Revenue Bond for Regional and Local Governments (RLGs). The guideline introduces land revenue bonds, which would be credit positive for RLGs. Land revenue bonds would deepen RLG finance and debt management reform, enhance the transparency of the local government bond market, and facilitate RLGs switching to direct bond issuance from local government financing vehicles (LGFVs) for land development projects, which include land acquisition, primary land development and land management.
The introduction of land revenue bonds will give local governments greater borrowing capacity to finance development projects by linking specific revenue streams from land sales to debt servicing. The land revenue bonds’ repayment sources would be land-sale-related income dedicated to the bonds, which accounted for around 21% of RLGs’ total revenue or 88% of RLGs’ fund revenue in 2016, as shown in Exhibit 1. RLG fund revenue is a separate booking category in Chinese fiscal accounting that is different from RLGs’ budgetary revenue. The fund revenue covers mainly revenues and expenditures of dedicated public project accounts like a land development fund and airport construction fund. Better debt service coverage based on the land sales will allow local governments to finance more land development projects through project specific land revenue bond issuance instead of general bonds.
EXHIBIT 1
Land-Sale-Related Revenue Accounts for the Largest Share of Regional and Local Governments’ Fund Revenue, 2010-16
Source: China’s Ministry of Finance
City or county level governments could request a land revenue bond quota based on specific land development projects from government finance bureaus of respective eligible upper-tier RLG bond issuers. The MOF has classified RLG bonds into General Purpose and Special Purpose bond categories. The new land revenue bonds are under the Special Purpose bond quota management. The issuance of Special Purpose bonds was RMB2.5 billion ($362 million) in 2016, almost 2.8x the issuance amount in 2015, when the RLG bond market officially began, as shown in Exhibit 2.
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Government Fund Revenue Percent from Land Sales - right axis
Amanda Du Vice President - Senior Analyst +86.21.2057.4016 [email protected]
Ivan Chung Associate Managing Director +852.3758.1399 [email protected]
NEWS & ANALYSIS Credit implications of current events
22 MOODY’S CREDIT OUTLOOK 8 JUNE 2017
EXHIBIT 2
Chinese Regional and Local Government Issuance of General Purpose and Special Purpose Bonds, 2015-17
Sources: Regional and Local Government Bond Prospectuses and Ministry of Finance
Considering the price volatility, regulatory risk and regional disparity in the domestic property market as shown in Exhibit 3, pricing differentiations of land revenue bonds will be larger than other RLG bonds.
EXHIBIT 3
Bond Repayment Sources and Housing Prices by Region, 2016
Note: We use local governments’ fund revenue for the land revenue bonds’ repayment sources and provincial capital cities’ housing price index for the price change in local property markets. Sources: Finance Bureau of local governments and National Bureau of Statistics
The guideline also aims to improve information transparency of RLG debt management by requiring counties and cities to disclose their land sales for the past three years and detailed land project information. Land revenue bond terms will be up to five years, which is aligned with the completion time of the linked projects. Prepayment and rollover are allowed if there is an early finish or delay. We expect the greater transparency will aid the development of the local government bond market.
The guideline is in line with previous policy documents and the government’s stance to prohibit pledging land for bank loans or LGFV financing, which are potential off-balance-sheet debt obligations for RLGs. Because about 80% of RLG bond issuance was used in the RLG debt-for-bond swap program in 2015 and 2016, RLGs did not raise much funding for public infrastructure spending. Instead, they still relied on LGFVs
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NEWS & ANALYSIS Credit implications of current events
23 MOODY’S CREDIT OUTLOOK 8 JUNE 2017
to raise debt for infrastructure projects, including land development projects in the past two years, as reflected in LGFVs’ rising onshore bond issuance, as shown in Exhibit 4.
EXHIBIT 4
Local Government Financing Vehicle Onshore Bond Issuance Rose, Even After the 2014 Launch of the Regional and Local Government Bond Issuance Program
Source: Wind
The land reserves revenue bonds provide an alternative funding channel, which is more transparent and directly supervised by the central government. It will help RLGs to clarify the limit of their development financing.
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NEWS & ANALYSIS Credit implications of current events
24 MOODY’S CREDIT OUTLOOK 8 JUNE 2017
US Public Finance
Dallas and Houston Clear Major Pension Reform Milestones On 31 May, Texas (Aaa stable) Governor Greg Abbott signed sweeping pension changes into law for the cities of Dallas (A1 negative) and Houston (Aa3 negative). Both cities depended on the state for approval of their reforms. The reforms are credit positive for the two cities because their pension liabilities will decline and ongoing pension funding will improve.
Pensions are a key credit challenge for both Dallas and Houston, and both cities have amassed substantial unfunded liabilities. In our most recent survey of pension obligations for the 50 largest US local governments, Dallas’ $7.6 billion adjusted net pension liability (ANPL) was 549% of its operating revenues as of its September 2015 financial reporting, the second highest of the group. Houston’s $10 billion ANPL as of its June 2015 financial snapshot was 414% of operating revenues, the fourth highest of the 50 local governments in our survey.
The reforms signed into law for Dallas will increase the city’s influence over the governance of its public safety plan, alter a number of benefit provisions for current and future public safety employees on a prospective basis, increase employees’ own contributions to 13.5% of payroll from either 8.5% or 4%, and suspend cost-of-living adjustments until the plan reaches a specified funding target.
A number of changes were also applied to the Deferred Retirement Option Plan (DROP) to prevent future lump sum withdrawals and to limit accruals on account balances. Subject to a minimum cost floor, Dallas will increase its annual contributions to 34.5% of “computation pay” from roughly 30.5%, plus a $13 million annual payment until 2024. Dallas’ public safety pension fund faces a severe funding shortfall over the next several decades and strained liquidity for at least the next several years, having had significant losses from investments in real estate and other alternative investments. Assets declined further in 2016 as many plan participants withdrew large lump sum accounts associated with DROP.
An updated actuarial valuation reflecting the approved changes to Dallas’ public safety pension fund is in progress but has not yet been published. We expect the plan’s accrued liabilities to fall based on the types of benefit changes enacted, but the relative strength of its revised contribution rate against plan funding remains uncertain.
We estimate that Houston’s ANPL across its three pension plans will fall by $3.5 billion (23%) from its benefit changes, reducing its overall balance sheet leverage from debt and pensions to 593% of operating revenues from 733% after accounting for a planned $1 billion pension obligation bond (see exhibit).
Tom Aaron Vice President - Senior Analyst +1.312.706.9967 [email protected]
NEWS & ANALYSIS Credit implications of current events
25 MOODY’S CREDIT OUTLOOK 8 JUNE 2017
Houston’s Net Direct Debt and Adjusted Net Pension Liability As Percent of Operating Revenues
Notes: All data reflect actual results except 2016 pro forma, which is a Moody’s Investors Service estimate. Sources: Houston, Texas’ comprehensive annual financial and pension plan reports, the city’s pension plan reform proposal summary, and Moody’s Investors Service
Including debt service on the new pension bond, Houston’s plan aims to keep its future pension costs at current levels, using a new “cost corridor” framework. These contributions will be closer to plan funding needs because of reduced liabilities.
The types of pension changes that the state approved for Dallas and Houston demonstrate significant legal flexibility in Texas to prospectively alter current employees’ benefits and change cost-of-living adjustments. This flexibility is comparatively favorable because such changes are not legally permissible in all states.
State reform approval makes significant progress, but pensions will nonetheless persist as a credit challenge for Dallas and Houston. Both cities remain exposed to future pension investment underperformance, and Dallas must incorporate a cost hike into its annual budget. Higher-than-expected unfunded liabilities in future years for either city could force greater contributions than currently expected, or further benefit adjustments that could prove politically difficult.
In Houston’s case, its firefighters have filed a legal challenge, arguing that certain provisions of the reform legislation are not permissible. Voters will also decide whether to approve the city’s planned pension bond issuance on 7 November. Houston’s reform legislation allows for certain deadline extensions on delivery of bond proceeds, but ultimately, voter rejection of the bonds would force the city’s police and general employee pension funds to rescind the benefit changes and unwind roughly 70% of the total liability reductions.
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2010 2011 2012 2013 2014 2015 2016 2016 Pro FormaReforms
Net Direct Debt Adjusted Net Pension Liability Pension Bond
RECENTLY IN CREDIT OUTLOOK Select any article below to go to last Monday’s Credit Outlook on moodys.com
26 MOODY’S CREDIT OUTLOOK 8 JUNE 2017
NEWS & ANALYSIS Corporates 2 » Praxair and Linde’s Merger Is Credit Positive for
Both Companies » First Data’s Planned Acquisition of CardConnect Is
Credit Negative » Worthington’s Acquisition of Amtrol Is Credit Positive » Tatneft’s Growing Exposure to Banking Is Credit Negative » Formosa Begins Steel Operations in Vietnam, a Credit
Positive » Tianjin Binhai New Area Construction’s Consent Solicitation
Is Credit Positive for Bondholders
Banks 8 » Banco Comafi’s Acquisition of Deutsche Bank’s Argentine
Subsidiary Is Credit Positive » Banco Macro’s Equity Sale Is Credit Positive » Barclays Sells Another Stake in Its African Business, a
Credit Positive » Montepaschi’s Restructuring and Recapitalization Are Credit
Positive for Senior Creditors, Negative for Junior Bondholders » Greek Banks’ Reduced Emergency Liquidity Assistance
Improves Their Profitability » Swedish Regulator Proposes Stricter Mortgage Amortisation
Requirement, a Credit Positive for Banks » Bulgarian Banks Will Benefit from Country’s Highest Credit
Growth Since 2009 » Saudi Banks’ Cash Balances with Central Bank Reach Three-
Year High, a Credit Positive » Nigerian Banks Will Benefit from Economic Improvement
Reflected in May Purchasing Managers Index » SMBC’s Acquisition of American Railcar Leasing Is
Credit Positive
Exchanges 23 » LSEG’s Acquisition of Citigroup’s Fixed-Income Index
Business Increases Leverage
Insurers 24 » Japan’s Industry-Wide Premium Rate Reduction Will Hurt
P&C Insurers’ Profitability
Sovereigns 26 » Bahamas’ Larger-than-Expected Deficit Significantly
Weakens Its Fiscal Position » Oman’s Weak Fiscal Performance, Despite Oil-Price
Recovery, Is Credit Negative » Philippines’ Passage of Tax Reform Is Credit Positive
MOODYS.COM
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Additional terms for Japan only: Moody's Japan K.K. (“MJKK”) is a wholly-owned credit rating agency subsidiary of Moody's Group Japan G.K., which is wholly-owned by Moody’s Overseas Holdings Inc., a wholly-owned subsidiary of MCO. Moody’s SF Japan K.K. (“MSFJ”) is a wholly-owned credit rating agency subsidiary of MJKK. MSFJ is not a Nationally Recognized Statistical Rating Organization (“NRSRO”). Therefore, credit ratings assigned by MSFJ are Non-NRSRO Credit Ratings. Non-NRSRO Credit Ratings are assigned by an entity that is not a NRSRO and, consequently, the rated obligation will not qualify for certain types of treatment under U.S. laws. MJKK and MSFJ are credit rating agencies registered with the Japan Financial Services Agency and their registration numbers are FSA Commissioner (Ratings) No. 2 and 3 respectively.
MJKK or MSFJ (as applicable) hereby disclose that most issuers of debt securities (including corporate and municipal bonds, debentures, notes and commercial paper) and preferred stock rated by MJKK or MSFJ (as applicable) have, prior to assignment of any rating, agreed to pay to MJKK or MSFJ (as applicable) for appraisal and rating services rendered by it fees ranging from JPY200,000 to approximately JPY350,000,000.
MJKK and MSFJ also maintain policies and procedures to address Japanese regulatory requirements.
EDITORS SENIOR PRODUCTION ASSOCIATE Elisa Herr and Jay Sherman Sol Vivero