MOODYS.COM

1 MAY 2017

NEWS & ANALYSIS Corporates 2 » PPG Industries' New, Higher AkzoNobel Buyout Bid Is

Credit Negative

» Becton’s Bard Deal Will Double Its Gross Debt » Qualcomm’s Royalty Dispute with Apple Is Credit Negative

» Odebrecht Engenharia e Construcao Benefits from Closure of Odebrecht Ambiental Sale

Infrastructure 7 » EDB's Participation in Brazil's Electricity Transmission Expansion

Is Credit Positive

Banks 9

» For Fannie Mae and Freddie Mac, Tax Reform Is Credit Negative » Financial CHOICE Act Passage Would Be Credit Negative for

US Banks

» Alawwal Bank Would Benefit from a Merger with Saudi British Bank

Insurers 14 » Ameriprise's Acquisition of Investment Professionals Is

Credit Positive

» Accelerating Car Thefts in Mexico Threaten Auto Insurers’ Profitability

Sub-sovereigns 17 » Moscow’s Increased Capital Spending Is Credit Negative

US Public Finance 19 » States Raise Gas Taxes to Address Infrastructure Needs, a

Credit Positive

» South Carolina Enacts Measures to Improve Pension Funding, a Credit Positive

Securitization 23 » Austrian Regulator's New Macro-prudential Tools Would Be

Credit Positive for Banks and Covered Bonds

RECENTLY IN CREDIT OUTLOOK

» Articles in Last Thursday’s Credit Outlook 24

» Go to Last Thursday’s Credit Outlook

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NEWS & ANALYSIS Credit implications of current events

2 MOODY’S CREDIT OUTLOOK 1 MAY 2017

Corporates

PPG Industries’ New, Higher AkzoNobel Buyout Bid Is Credit Negative Last Monday, PPG Industries Inc. (A3 negative) made a third offer to buy AkzoNobel N.V. (Baa1 stable), raising its bid to €26.9 billion, or €96.75 per share, a 17% increase from its first proposal in March.

PPG’s new offer, which the company would likely finance mostly with debt, is credit negative for the chemical company and shows its willingness to pursue large acquisitions at the expense of its credit quality. The higher bid is a premium of more than 50% above AkzoNobel’s pre-announcement closing price of €64.00 on 8 March 2017. The offer reiterates PPG’s expectation for annual run-rate synergies and makes new commitments regarding AkzoNobel’s stakeholders.

The strategic benefits of combining the two companies are clear, particularly amid broader consolidation in the coatings industry. The combination of two similar businesses should generate meaningful operating synergies, which PPG estimates at an annual run-rate of $750 million, based on public information. The combined entity could raise further significant proceeds if regulators demand divestitures of coatings businesses or AkzoNobel’s Specialty Chemicals Business. PPG should also generate significant cash before completing the transaction, and have enough free cash flow to reduce its debt over the following 18-24 months, a key period of deleveraging for major M&A deals.

Even so, PPG’s continued aggressive pursuit of AkzoNobel would likely weaken PPG’s credit quality. PPG’s adjusted financial leverage would rise significantly: its debt/EBITDA ratio for the 12 months through 31 March 2017 would increase to more than 4x on a pro forma basis from about 2x today. Regulatory-driven divestitures, discretionary divestitures, deal-related synergies, and cash generated before the transaction’s closing would likely reduce pro forma leverage by at least one turn, however.

Moreover, the offer reflects PPG’s public statements that signal a willingness to sacrifice its A rating to complete this deal. We revised PPG’s outlook to negative in March after the first AkzoNobel offer and reiterated our view after the second. While prospective financing details have not been released and the company is publicly committed to a “solid investment-grade rating,” it is likely that leverage will remain meaningfully above current levels for an extended period.

Chemical companies with high credit quality are increasingly sacrificing their A-level ratings to pursue larger M&A transactions.1 Most of the chemicals industry is growing slowly today, and the highest-rated companies do not sacrifice much in the way of financing costs even if their ratings drop by a notch or two. The latest, highest offer for AkzoNobel would not cost PPG its investment-grade status, but the high cost of the deal and a likely increase in financing costs make the acquisition credit negative for the would-be buyer.

1 See Chemicals – North America: Stress Highest for Strong Investment-Grade and Weak Speculative-Grade Companies, 30 March 2017.

Benjamin Nelson Vice President - Senior Credit Officer +1.212.553.2981 benjamin.nelson@moodys.com

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 1 MAY 2017

Becton’s Bard Deal Will Double Its Gross Debt On 23 April, medical device maker Becton, Dickinson and Company (Baa2 review for downgrade) said that it had signed a definitive agreement to acquire C.R. Bard, Inc. (Baa1 review for downgrade) for approximately $25.7 billion, including Bard’s existing debt. The transaction, which Becton plans to fund with a combination of equity, debt and excess cash, is credit negative because it will double the company’s gross debt. Following the acquisition's announcement, we placed Becton’s ratings on review for downgrade and said that its unsecured debt rating will likely fall to Ba1 with a stable outlook. We also placed Bard’s ratings on review for downgrade.

Bard manufactures a diverse group of mostly low-tech vascular, urology, oncology and surgical products that hospitals use. It will increase Becton’s sales by approximately 30% in product lines in which it will have leading positions. However, the deal will increase Becton’s pro forma leverage to about 5.2x, which is higher than what we typically see in healthcare merger deals. It also comes at a time when we expected Becton to continue to deleverage following its $12.2 billion acquisition of CareFusion in March 2015.

Becton achieved its unadjusted debt/EBITDA target of about 3.0x debt/EBITDA (about 3.4x-3.5x on a Moody’s-adjusted basis) within two years of closing the CareFusion transaction (see exhibit). But when Becton announced the CareFusion deal, it articulated a long-term unadjusted debt/EBITDA target of below 2.5x (or below a Moody’s-adjusted 3.0x). With the Bard transaction, the company will not achieve this leverage level for several years.

Becton’s Leverage Will Rise and Deleveraging Will Take Longer

Sources: Company filings and Moody’s Investors Service estimates

Becton said that it expects to achieve leverage of 3.0x (about 3.4x-3.5x Moody’s adjusted) within three years of closing the Bard deal. That compares with a two-year deleveraging period after closing the CareFusion acquisition. Although we expect that Becton will limit its share buybacks over the next three years to reach its deleveraging goal, the longer the deleveraging period, the more likely it is that Becton will encounter setbacks that impede its progress.

After the Bard deal closes, Becton will have to make additional payouts related to Bard’s pelvic mesh litigation at a time when its cash levels will be limited because it is using cash to fund the transaction. Although Bard has made progress in settling known claims, the outcome of future mesh claims is uncertain. Multidistrict litigation covering all federal product claims filed against Bard’s inferior vena cava filters, which were used to treat patients at high risk of pulmonary embolisms, also creates uncertainty.

The deal also marks a notable shift in Becton’s financial policies and attitude toward debt. After years of not making any debt-financed acquisitions, Becton has now embarked on two transformative transactions in

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Diana Lee Vice President - Senior Credit Officer +1.212.553.4747 diana.lee@moodys.com

NEWS & ANALYSIS Credit implications of current events

4 MOODY’S CREDIT OUTLOOK 1 MAY 2017

less than three years. Before CareFusion, almost all of Becton’s acquisitions over the past 20 years were well under $300 million.

Bard has a strong presence in hospitals, providing well-known, largely disposable products in urology, oncology, surgery and vascular treatment. However, unlike CareFusion, which provided strategic benefits focused on medication management, Bard will primarily take Becton outside of its current product segments. This, along with its increased tolerance for debt, raises some risk regarding the likelihood of possible future acquisitions.

We expect that Bard’s vascular segment will emerge as an important contributor to Becton’s top-line growth in the next few years. Bard’s Lutonix product, which treats peripheral vascular disease, offers a high-tech platform with good growth potential. Because it is outside of both Bard’s and Becton’s low-tech product lines, Lutonix also provides greater diversification. But the technology adds regulatory, adoption and product liability risk. Additionally, it may signal Becton’s potential interest in adding other high-tech vascular products to its mix.

NEWS & ANALYSIS Credit implications of current events

5 MOODY’S CREDIT OUTLOOK 1 MAY 2017

Qualcomm’s Royalty Dispute with Apple Is Credit Negative On Friday, Qualcomm Incorporated (A1 review for downgrade) announced that Apple Inc. (Aa1 stable) is withholding payments to its contract manufacturers for the royalties those contract manufacturers owe to Qualcomm under their licenses with Qualcomm, and that it will continue withholding payments until its dispute with Qualcomm is resolved. The withheld payments are credit negative for Qualcomm because the absence of royalty payments related to iPhone and cellular-enabled iPad sales in the current fiscal quarter will reduce Qualcomm’s quarterly revenue by about $500 million, or 9%, as compared to our most recent expectations, which had included some iPhone-related royalty revenue.

Qualcomm’s royalty revenue, on average, generates 85% pre-tax margins, so the absence of iPhone-related payments will reduce Qualcomm’s pre-tax profit by about $425 million. Qualcomm has developed technology deemed essential to cellular communications, and it collects royalties from nearly every smartphone sold worldwide (nearly 1.6 billion smartphones in 2016). For the fiscal year that ended September 2016, Qualcomm’s licensing business generated 75% of total segment profit, excluding unallocated corporate expenses.

Apple sued Qualcomm in January, claiming that the royalties were excessive, and now will withhold payments until the legal battle is resolved. Qualcomm countersued on 10 April, accusing Apple of harming its business and breaching deals between the two companies. At this point, the duration of the dispute is uncertain, but the lack of iPhone royalty payments equates to an implied $1.7 billion of annualized royalty pretax earnings.

Qualcomm maintains strong liquidity, with nearly $29 billion of cash and liquid investments as of March 2017, $2.1 billion of which it held domestically. Qualcomm targets a minimum of domestic cash of $2-$4 billion and a similar amount of offshore cash. The company currently maintains a $5 billion US commercial paper program under which Qualcomm reported $2.0 billion of borrowings at the end of March 2017. The program is supported by a $5 billion committed bank facility, of which $530 million matures in February 2020 and $4.47 billion matures in November 2021.

Qualcomm’s A1 rating remains on review for downgrade following its October 2016 agreement to acquire NXP Semiconductors N.V. (Ba2 review for upgrade), parent of NXP B.V. (Ba1 review for upgrade), for $47 billion. Subject to regulatory review, the companies expect that transaction to close by the end of this year. Qualcomm plans to finance the deal with offshore cash balances and approximately $11 billion in debt financing, which it has already obtained in the form of bridge financing.

Following consummation of NXP acquisition, Qualcomm plans to reduce leverage with offshore cash flow, the bulk of which is generated by Qualcomm’s chip business (21% of Qualcomm’s segment profit) and cash flow from the internationally based NXP. Neither of these cash flows are affected by the dispute with Apple.

Richard J. Lane Senior Vice President +1.212.553.7863 richard.lane@moodys.com

NEWS & ANALYSIS Credit implications of current events

6 MOODY’S CREDIT OUTLOOK 1 MAY 2017

Odebrecht Engenharia e Construcao Benefits from Closure of Odebrecht Ambiental Sale Last Tuesday, Odebrecht Engenharia e Construcao S.A. (OEC, Caa2 negative) parent Odebrecht S.A. (unrated) said that it had closed a BRL2.75 billion ($878 million) sale of its 70% interest in Odebrecht Ambiental (unrated) to Brookfield Business Partners LP (unrated). The sale, which the company announced in October 2016, is credit positive for OEC, whose parent will receive BRL1.9 billion in net proceeds up front, and as much as BRL345 million in gross payments over the next three years, depending on growth. The proceeds reduce the necessity of intercompany loans from OEC to Odebrecht and increase the likelihood that Odebrecht will have the resources to repay $450 million in intercompany loans that it owes OEC.

Odebrecht said that it would use the money to reinforce its own liquidity and that of its operating subsidiaries at a time of slow construction activity and weak cash conversion, rather than using the sale proceeds to repay around BRL1.5 billion related to restructured bank debt at its Odebrecht Agroindustrial (unrated) subsidiary.

OEC, which had $10.5 billion in net revenues for the 12 months through September 2016, is Latin America’s largest engineering and construction company. Still, it faces considerable business risk and its $17 billion backlog is shrinking. In the meantime, OEC must keep spending much of its cash amid delays in collecting receivables, a lower book-to-bill ratio and fewer cash advances from clients. During the fourth quarter of 2016, OEC spent around $250 million in cash, further reducing its liquidity to $1.3 billion as of year-end 2016, compared with roughly double that amount a year earlier.

Intercompany loans from OEC to parent Odebrecht have only accelerated OEC’s liquidity consumption. OEC in December 2016 had only enough cash available to cover about 38% of total debt outstanding (per unaudited reports), including our standard adjustments and off-balance-debt guarantees, compared with 66% a year earlier. The company still has a comfortable debt amortization schedule, with an average tenor of 32 years and with main debt maturities starting in 2025. However, OEC’s cash cushion is gradually deteriorating.

By comparison, parent Odebrecht in June 2016 reported consolidated cash availability of around BRL17.5 billion and about BRL23.8 billion in short-term debt maturities. But Odebrecht Agroindustrial concluded its debt restructuring in the third quarter of 2016, which reduced Odebrecht’s consolidated short-term debt by BRL5.7 billion.

The sale of Odebrecht Ambiental offers further relief to Odebrecht, taking it about one third of the way toward the BRL12 billion asset sale plan it announced in April 2016, which it targets completing by June 2017. Odebrecht Ambiental has been its largest divestiture so far under this effort.

Marcos Schmidt Vice President - Senior Analyst +55.11.3043.7310 marcos.schmidt@moodys.com

NEWS & ANALYSIS Credit implications of current events

7 MOODY’S CREDIT OUTLOOK 1 MAY 2017

Infrastructure

EDB’s Participation in Brazil’s Electricity Transmission Expansion Is Credit Positive On Monday, EDP – Energias do Brasil (EDB, Ba2 stable) won four of 35 lots of power transmission licenses auctioned by Brazil’s National Electric Energy Agency as part of a national development program aimed at boosting growth through private infrastructure. EDB’s lots comprise 1,184 kilometers of new transmission lines involving BRL3.7 billion ($1.2 billion) of regulatory investments through 2022, including one developed in partnership with Centrais Eletricas de Santa Catarina S.A. (B1 negative). These new concessions are credit positive for EDB because they provide the company with greater and more stable cash flow generation owing to the regulated contracts’ 30-year terms.

The contracts involve the construction, operation and maintenance of transmission lines and substations in five different Brazilian states that aim to improve the national interconnected system’s reliability. The action allows EDB to advance its strategy to grow its transmission business, and follows the company in October 2016 winning a 113-kilometer transmission project in the State of Espírito Santo, which will require approximately BRL116 million of investments through 2019. The exhibit below shows EDB’s recent concessions.

Summary of EDP – Energias do Brasil’s Concessions

Lot # Winning Bid, BRL Millions

Discount to Asking Price

Investments, BRL Millions Location

Length in Kilometers Consortium

7 66.3 36.5% 495 Maranhao 121 EDB 100%

11 30.2 4.9% 160 Maranhao 203 EDB 100%

18 205.2 47.5% 1,820 São Paulo and Minas Gerais 375 EDB 100%

21 171.8 35.0% 1,265 Santa Catarina & Rio Grande do Sul

485 EDB 90%; Celesc 10%

TOTAL 473.5 40.2% 3,740 1,184

Sources: EDP – Energias do Brasil and Brazil’s National Electric Energy Agency

EDB’s bids implied an average discount of 40.2% to the asking prices, which is fairly close to the second-most aggressive bidders. The four concessions will equal BRL473 million of incremental annual revenues for EDB. Transmission companies have stable and predictable regulated revenues indexed to inflation and subject to review every five years. These revenues derive from sector fees paid by generators, distributors and merchant consumers for access to transmission lines, regardless of the volume of power carried through the lines.

According to the company, the expected internal rates of return for the four projects will be 12%-14%, which considers an up to 52-month completion schedule, along with savings on capital expenditures, synergies to its existing business, tax incentives and access to subsidized loans for the financing structure. These returns seem achievable if there is no significant deviation from these assumptions. Although the company will use experienced construction firms and suppliers, EDB is not completely insulated from construction risks, such as cost overruns or schedule delays because of rights-of-way and environmental permits.

EDB expects to finance these projects using a combination of equity (20%-30%) and long-term debt (70%-80%), which includes primarily subsidized funding from BNDES Finame and BNDES Social, along with market-based financings from the BNDES Finem and infrastructure debentures. EDB’s leverage as measured by net debt/EBITDA was 1.5x for 2016, and will likely peak to around 2.5x on a pro forma basis during the construction phase before stabilizing at around 2.1x with a 20% EBITDA improvement once the lines are

Cristiane Spercel Vice President - Senior Analyst +55.11.3043.7333 cristiane.spercel@moodys.com

NEWS & ANALYSIS Credit implications of current events

8 MOODY’S CREDIT OUTLOOK 1 MAY 2017

fully operational by 2022. The company’s senior unsecured debentures have embedded in them a maintenance financial covenant of net debt/EBITDA of below 3.5x, which provides some cushion to accommodate deviations.

São Paulo, Brazil-based EDB is a holding company controlled by EDP - Energias de Portugal, S.A. (Baa3 stable), with activities in generation, distribution and commercialization of electricity. In 2016, EDB reported consolidated net revenues of BRL8.9 billion and EBITDA of BRL2.3 billion, 65% of which was derived from its power generation business, 34% from power distribution and 1% from commercialization of energy and other operating and management services.

NEWS & ANALYSIS Credit implications of current events

9 MOODY’S CREDIT OUTLOOK 1 MAY 2017

Banks

For Fannie Mae and Freddie Mac, Tax Reform Is Credit Negative Last Wednesday, the Trump Administration proposed a sharp decrease in corporate tax rates as part of its tax reform proposal. A lower corporate tax rate is credit negative for Fannie Mae and Freddie Mac (the GSEs, both Aaa stable) since it would have to impair their deferred tax asset (DTA) and require the companies to draw capital from the US Treasury reducing their available amount. Fannie Mae would have to write down its DTA by $15.6 billion and Freddie Mac by $5.7 billion if the corporate tax rate is reduced to 15% from the current statutory amount of 35%.

The GSEs would have to take the DTA charge in the quarter that the tax rules are changed, decimating their capital and requiring them to utilize a portion of their capital-call agreement with the US Treasury to replenish their capital. Although the GSEs do not have the financial resources to absorb multibillion losses on their own, Fannie Mae and Freddie Mac have a substantial amount of capital that can be “called” from the US Treasury.

Fannie Mae’s earnings are approximately $3 billion per quarter and Freddie Mac’s are approximately $2 billion per quarter. In addition, the GSEs hold only $600 million of capital and cannot by the terms of their agreement with the Treasury department build capital above this limit so a multibillion loss would result in negative capital.

The ability to request capital from the Treasury is a result of the senior preferred stock purchase agreement (PSPA) with the Treasury in which Fannie Mae has access to $117.6 billion (originally $200 billion) in senior preferred capital and Freddie Mac has access $140.5 billion (originally $200 billion). Under the agreements, the Treasury will contribute capital to Fannie Mae or Freddie Mac should their regulator, the Federal Housing Finance Agency (FHFA), determine that either GSEs’ net worth is negative. Additionally, the GSEs cannot build capital on their own given the requirement that they pay any excess earnings to the Treasury over their permitted capital base.

The PSPA declines dollar for dollar by any draw. Therefore, if Fannie Mae had to draw $12.0 billion2 and Freddie Mac had to draw $3.1 billion3 from the Treasury, Fannie Mae’s PSPA access would decline to $105.6 billion (i.e., $117.6 billion less $12.0 billion) and Freddie Mac’s would decline to $137.4 billion, (i.e., $140.5 billion less $3.1 billion), which would still leave Fannie Mae’s and Freddie Mac’s capital are at historically high levels (see exhibit).

Fannie Mae and Freddie Mac Capital as a Percent of Total Assets Adjusted for the PSPA

Sources: Fannie Mae and Freddie Mac annual reports

2 A $15.6 billion deferred tax asset impairment less earnings of $3 billion less capital of $600 million. 3 A $5.7 billion deferred tax asset impairment less earnings of $2 billion less capital of $600 million.

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Brian Harris Senior Vice President +1.212.553.4705 brian.harris@moodys.com

NEWS & ANALYSIS Credit implications of current events

10 MOODY’S CREDIT OUTLOOK 1 MAY 2017

Financial CHOICE Act Passage Would Be Credit Negative for US Banks Last Wednesday, the US House of Representatives’ Financial Services Committee held a hearing on the Financial CHOICE Act of 2017, which was introduced on 19 April and aims to provide banks relief from various provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act enacted in 2010. The proposed legislation envisions a broad reduction in regulatory and supervisory requirements that would be negative for banks’ creditworthiness, increasing the potential asset risk in the banking system and the likelihood of a disorderly unwinding of a failed systemically important bank.

Increased likelihood of a disorderly bank resolution. Among the CHOICE Act’s most notable provisions is the repeal of Title II of Dodd-Frank, including the orderly liquidation authority (OLA) to resolve highly interconnected, systemically important banks. Although the bill calls for a new section of the bankruptcy code to accommodate the failure of large, complex financial institutions, we believe that dismantling the OLA increases the likelihood of a disorderly wind-down of a failed systemically important bank with greater losses to creditors. Additionally, although the aim of repealing Title II is to end “too big to fail,” without the enactment of a credible replacement bank resolution framework, the actual effect could be the opposite.

A credible operational resolution regime (ORR) to replace OLA would require provisions specifically intended to facilitate the orderly resolution of failed banks and would provide clarity around the effect of a bank failure on its depositors and other creditors, its branches and affiliates. The intent of OLA is to resolve failed banks as going concerns, preserving bank franchise value so as to limit losses to bank creditors and counterparties. If, under the new legislation, failed banks are liquidated instead of being resolved as going concerns, loss rates suffered by creditors would increase.

A disorderly resolution would also have greater repercussions for the broader financial markets and the economy. This suggests that although the intent of eliminating OLA may be to reduce the likelihood of future bank bailouts, absent an ORR we believe that the likelihood of a US government bailout of a systemically important US bank could actually increase.

A return to greater risk-taking, only partly offset by improved profitability prospects. The CHOICE Act would also ease restrictions on risk-taking by eliminating the Volcker Rule and rolling back the supervisory function of the US Consumer Financial Protection Bureau (CFPB), limiting it instead to the enforcement of specific consumer protection laws. Eliminating the Volcker Rule restrictions on proprietary trading could reverse the decline in banks’ trading inventories and private equity and hedge fund investments since the financial crisis. That decline in trading inventories has contributed to a decline in risk measures such as value at risk. How far inventories rebound and proprietary trading pick up will take time to become evident, but increased risk seems likely. Changes to the CFPB could also add risk by lifting the regulatory scrutiny that has caused banks to scale back or eliminate some riskier consumer lending products (such as payday advances).

The CHOICE Act also imposes a variety of restrictions and requirements on US banking regulators that could erode the robustness of US banking regulation. More generally, weakened supervision and oversight create the potential for increased asset risk in the banking system. From a credit risk standpoint, the resulting uptick in credit costs and tail risks from increased risk-taking would outweigh the potential boost to bank profitability from reduced compliance expenses and new revenue opportunities.

Less robust capital supervision and stress-testing. The CHOICE Act calls for a reduction in the frequency of regulatory stress testing, and an exemption from enhanced US Federal Reserve supervision, including stress-testing, for banks with a Basel III supplementary leverage ratio of at least 10%. These measures would undermine the post-crisis Dodd-Frank Act Stress Test (DFAST) and Comprehensive Capital Analysis and Review (CCAR) regimes, which have driven both an increase in capital ratios and a more conservative approach to capital management.

David Fanger Senior Vice President +1.212.553.4342 david.fanger.@moodys.com

Ana Arsov Associate Managing Director +1.212.553.3763 ana.arsov@moodys.com

NEWS & ANALYSIS Credit implications of current events

11 MOODY’S CREDIT OUTLOOK 1 MAY 2017

We believe that DFAST and CCAR have been successful tools in reducing the risk of bank failures, not only improving capital and placing beneficial restrictions on shareholder distributions but, more importantly, stimulating vast improvements in banks’ internal risk management and capital planning processes. The DFAST and CCAR results are a useful, independent and public tool to analyze banks’ stress capital resilience over time. The public disclosures from these exercises are an important data point for creditors, the market and our own stress-testing analysis, and provide a strong incentive for bank management teams to closely manage and fully resource their stress-testing and capital-planning processes.

NEWS & ANALYSIS Credit implications of current events

12 MOODY’S CREDIT OUTLOOK 1 MAY 2017

Alawwal Bank Would Benefit from a Merger with Saudi British Bank Last Tuesday, Alawwal Bank’s (A3 stable, baa24) board announced that it had begun exploring a merger with HSBC-affiliated Saudi British Bank (SABB, A1 stable, a3). Despite integration challenges, we would consider the merger credit positive for Alawwal because it would strengthen and diversify the bank’s business, supporting its profitability and overall credit profile. However, the consolidation would be credit neutral for SABB. While the combined entity will benefit from potential economies of scale and increased lending opportunities in a slowing economic environment, these benefits would be mitigated by the absorption of Alawwal’s loan portfolio, whose problem loans were 2.6% of total loans at year-end 2016, versus SABB’s 1.6% ratio.

If successfully completed, the transaction would create the third-largest bank in Saudi Arabia, with approximately SAR291 billion in total assets for an estimated pro forma 13.1% market share as of year-end 2016 (see Exhibit 1). Pending required approvals from relevant authorities and the banks’ respective shareholders, the merger would occur against Saudi Arabia’s backdrop of low, albeit stabilizing, oil prices; a slowdown in economic growth driving rising asset risks; and subdued credit growth (credit to private sector was up only 0.3% year-on-year as of February 2017).

EXHIBIT 1

Largest Saudi Banks by Asset Size as of Year-end 2016

Sources: Saudi Arabia Monetary Agency and Moody’s Investors Service

We expect Alawwal to benefit from greater access to SABB’s larger and more established retail franchise, which Alawwal is currently developing from a small base. This will likely support profitability by securing a larger proportion of low-cost retail banking deposits that will reduce funding costs and help the bank expand into higher margin retail banking offerings. Indeed, as of December 2016, SABB’s share of low-cost current and savings accounts deposits accounted for around 63.8% of its customer deposits, in line with the Saudi system average, while Alawwal’s demand deposit base was 37.7% of customer deposits during the same period (see Exhibit 2). Additionally, provided the merged entity remains affiliated with global bank HSBC, which has supported SABB’s credit quality in recent years in terms of risk practices, product development and through technical and operational integration, Alawwal would also benefit. ABN AMRO (now RBS Netherlands N.V.) has a 40% stake in Alawwal and has been trying to sell its stake in the bank for many years.

4 The bank ratings shown in this report are the bank’s deposit rating and baseline credit assessment.

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Olivier Panis Vice President - Senior Credit Officer +971.4.237.9533 olivier.panis@moodys.com

Christos Theofilou Assistant Vice President - Analyst +357.256.93.3004 christos.theofilou@moodys.com

Badis Shubailat Associate Analyst +971.4.237.9505 badis.shubailat@moodys.com

NEWS & ANALYSIS Credit implications of current events

13 MOODY’S CREDIT OUTLOOK 1 MAY 2017

EXHIBIT 2

Retail Deposit Bases of Alawwal Bank and SABB

Note: CASA = Current and savings accounts. Source: Moody’s Investors Service

Alawwal would also benefit from SABB’s stronger standalone credit quality and from SABB’s higher probability of government support given its systemic importance (8.5% asset market share as of December 2016), complexity and financial interconnectedness (with a large derivative notional value).

We believe that the consolidation would be credit neutral for SABB, because it will absorb Alawaal’s higher proportion of problem loans. At the same time, a successful integration will lead to revenue synergies in the form of pricing optimisation, cross-selling opportunities, and cost synergies originating from economies of scale and branch consolidation. It would also lead to increased lending opportunities by leveraging on each institution’s relative strengths. For example, Alawwal has strong mortgage financing operations, a key growth area for the Kingdom. Alawwal’s residential mortgages stood at SAR10.8 billion as of year-end 2016, compared to SAR10.3 billion for SABB.

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SABB CASA/Total Customer Deposits - left axis Alawwal CASA/Total Customer Deposits - left axisSABB Cost of Funds - right axis Alawwal Cost of Funds - right axis

NEWS & ANALYSIS Credit implications of current events

14 MOODY’S CREDIT OUTLOOK 1 MAY 2017

Insurers

Ameriprise’s Acquisition of Investment Professionals Is Credit Positive Last Monday, Ameriprise Financial, Inc. (A3 stable) announced that it will buy independent broker-dealer Investment Professionals, Inc. (IPI, unrated) for an undisclosed amount, subject to regulatory approval. The transaction is credit positive for Ameriprise because the acquisition expands its financial advisor channel and leverages Ameriprise’s larger product platform, marketing support and technology solutions to improve advisor productivity.

The transaction will not affect Ameriprise’s financial leverage, which was approximately 35% debt/capital at year-end 2016, because we expect the funds to come from cash on hand. Additionally, the purchase price is modest relative to Ameriprise’s financial resources.

IPI is a San Antonio, Texas-based, privately held investment and insurance brokerage firm specializing in the delivery of investment services to individuals and financial institutions. The company focuses on community banks and credit unions, which will expand Ameriprise’s presence in these markets. IPI’s average revenue per advisor is approximately $300,000, which is materially below Ameriprise’s average productivity of more than $500,000 per advisor. However, IPI’s relationships and focus on financial institutions, coupled with Ameriprise’s depth in financial planning and technology capabilities, should lead to greater revenues and agent productivity.

With total assets of more than $8 billion at year-end 2016, IPI operates via more than 140 financial institutions in 29 states. However, this is modest compared with Ameriprise’s Advice and Wealth Management (AWM) segment’s $479 billion of client assets. AWM is the largest of Ameriprise’s segments, contributing 43% of pretax operating earnings for full year 2016 and 41% for the first quarter of 2017 (see exhibit).

Ameriprise 2016 Pre-tax Operating Earnings by Segment

Source: Ameriprise Financial, Inc.

Ameriprise actively recruits experienced financial advisors and targets adding 300-400 recruits each year. The IPI acquisition would incrementally add approximately 200 financial advisors to Ameriprise’s typical recruiting plans.

The IPI acquisition is the second bulk acquisition for Ameriprise’s AWM segment following its April 2015 purchase of the retail assets of independent broker-dealer JHS Capital Advisors. The JHS transaction was somewhat smaller, involving approximately 150 financial advisors and $4.1 billion in assets.

Advice & Wealth Management43%

Asset Management29%

Annuities16%

Protection12%

Shachar Gonen Vice President - Senior Analyst +1.212.553.3711 shachar.gonen@moodys.com

NEWS & ANALYSIS Credit implications of current events

15 MOODY’S CREDIT OUTLOOK 1 MAY 2017

Accelerating Car Thefts in Mexico Threaten Auto Insurers’ Profitability Last Tuesday, the Mexican Insurance Association announced that car thefts rose 21% in March from a year earlier, the fastest increase in 12 years, while the recovery rate of stolen cars fell to 37% from 45% over the same period (see Exhibit 1). If this trend continues at the pace recorded in March, we estimate that rising claims will lift the auto-insurance industry’s loss ratio (claims/earned premiums) and erode insurers’ profitability, a credit negative.

EXHIBIT 1

Mexico’s Rate of Auto Thefts and Recoveries

Source: Mexican Insurance Association

Car thefts consistently decreased between 2012 and 2015, and the recent climb poses a significant threat to the sector’s already-modest profitability. In 2016, auto insurers’ combined ratio (claims plus general expenses/earned premiums) rose to 99%, and if thefts continue to climb, this ratio could be well above 100% in 2017, indicating general underwriting losses.

Auto insurance constitutes more than half of total general non-life insurance business in Mexico, and 11 of the 35 firms writing car insurance policies are monoline insurers. Gross auto premiums have been growing at a pace of 10% annually over the past five years, and business volumes jumped 20% in 2016, supported by a 19% rise in new cars sales. Competition among car insurers will lead many to choose to absorb losses and keep market share rather than raise prices. To mitigate losses, insurers might increase deductibles and apply different prices based on each state’s automobile theft rates.

Among Mexico’s 10 largest insurers, Quálitas Compañía de Seguros, S.A. de C.V. (unrated), ABA Seguros, S.A. de C.V. (urnated) and HDI Seguros, S.A. de C.V. (unrated) are the most vulnerable because they specialize almost exclusively in car insurance, which generates on average 85% of their premiums. As Exhibit 2 shows, HDI Seguros is in the weakest position to absorb additional losses given that its combined ratio for the auto segment was already 102% in 2016, indicating that underwriting losses will likely continue this year. Conversely, Quálitas, whose combined ratio was 95% in 2016, and ABA Seguros, whose combined ratio was 90%, are better able to absorb the effect of higher theft-related losses. Insurers with a more diversified product base, lower combined ratios and pricing power will be less affected.

-15%-10%-5%0%5%

10%15%20%25%30%35%40%45%50%55%

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Recovery Rate of Stolen cars Annual Car Theft Growth Rate

Francisco Uriostegui Analyst +52.55.1253.5728 francisco.uriostegui@moodys.com

Jose Angel Montano Vice President - Senior Analyst +52.55.1253.5722 joseangel.montano@moodys.com

NEWS & ANALYSIS Credit implications of current events

16 MOODY’S CREDIT OUTLOOK 1 MAY 2017

EXHIBIT 2

Mexico’s Top 10 Auto Insurers, 2016 Statistics

Company’s Auto Insurance Gross

Premiums as Percent of Industry’s Auto

Insurance Gross Premiums

Auto Insurance Premiums as

Percent of Company’s Total

Premiums Combined Ratio

for Auto Insurance

Quálitas Compañía de Seguros, S.A. de C.V. 31.5% 100% 95%

Grupo Nacional Provincial, S.A.B. 12.7% 21% 107%

AXA Seguros, S.A. de C.V. 10.9% 28% 102%

ABA Seguros, S.A. de C.V. 6.8% 84% 90%

Seguros Banorte, S.A. de C.V., Grupo Financiero Banorte 5.5% 27% 91%

HDI Seguros, S.A. de C.V. 4.9% 86% 102%

Mapfre Tepeyac, S.A. 4.8% 31% 115%

Seguros Inbursa, S.A., Grupo Financiero Inbursa 4.8% 23% 83%

Seguros BBVA Bancomer, S.A. de C.V., Grupo Financiero BBVA Bancomer

4.2% 16% 94%

Zurich, Compañía de Seguros, S.A. 3.1% 41% 105%

Source: Moody’s Investors Service, based on Mexico’s insurance regulator data

NEWS & ANALYSIS Credit implications of current events

17 MOODY’S CREDIT OUTLOOK 1 MAY 2017

Sub-sovereigns

Moscow’s Increased Capital Spending Is Credit Negative Last Wednesday, the City of Moscow’s (Ba1 stable) Duma (parliament) approved changes to the city’s budget that include a larger investment programme and, in turn, increase the budget deficit to a three-year high of 17% of total revenues from 12% initially budgeted for 2017. The deficit increase is credit negative for Moscow because its liquidity will deteriorate.

Despite the fact that actual deficits have historically been significantly lower than budgeted, the city’s deficit will grow this year (see Exhibit 1). The budgetary changes reflect a new capital investment programme to finance the renovation of a significant amount of residential housing in Moscow. According to the programme, the city will build new apartments for the inhabitants of low-cost houses that were developed during the early 1960s. The city expects that this programme will be approved, adding to an existing investment programme that is already 16% higher than 2016 levels. The higher expenditures reflect the city’s planned infrastructure developments, particularly ahead of presidential and mayoral elections in 2018.

EXHIBIT 1

Moscow’s Deficit and Capital Expenditures

Note: The 2017 actual deficit as a percent of own-source revenues is our current forecast. The investment program as a percent of own-source revenues is based on budgeted numbers. Sources: Russian Federal Treasury and Moody’s Investors Service calculations and forecasts

The lower actual financial deficit will be the result of the city’s regular overestimation of expenses and conservative revenue forecasts. Additionally, the new housing renovation programme is still in the early stage and its cost may change or its implementation time frame may be extended.

As Exhibit 2 shows, the higher deficit will reduce liquidity, although liquidity will be higher than budgeted (over 10% of operating revenues) because of a lower-than-budgeted deficit. Moscow does not plan new borrowings to cover higher capital expenditures this year and will finance its deficit via existing liquidity. The large investment programme will increase Moscow’s debt, but we expect that the city’s liquidity and expenditure flexibility will contain its debt burden below 10% of operating revenues during the next three years.

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

35%

40%

2014 2015 2016 2017 Forecast

Budgeted Deficit as a Percent of Own-Source Revenues Actual Deficit as a Percent of Own-Source RevenuesInvestment Programme as a Percent of Own-Source Revenues

Vladlen Kuznetsov Vice President - Senior Analyst +7.495.228.6060 vladlen.kuznetsov@moodys.com

NEWS & ANALYSIS Credit implications of current events

18 MOODY’S CREDIT OUTLOOK 1 MAY 2017

EXHIBIT 2

Moscow’s Liquid Assets and Debt Burden as a Percent of Own-Source Revenue

Note: The 2017 net direct and indirect debt as a percent of own-source revenue is our forecast. The liquidity data for 2017 is based on Moscow’s budget. The 2016 liquidity data is our estimate. Sources: Russian Federal Treasury, Russian Ministry of Finance and Moody’s Investors Service calculations and forecasts

0%

4%

8%

12%

16%

20%

24%

2013 2014 2015 2016 2017 Forecast

Liquid Assets Net Direct and Indirect Debt

NEWS & ANALYSIS Credit implications of current events

19 MOODY’S CREDIT OUTLOOK 1 MAY 2017

US Public Finance

States Raise Gas Taxes to Address Infrastructure Needs, a Credit Positive On Friday, California (Aa3 stable) enacted a gas and vehicle fee increase that will direct $5 billion annually toward its roughly $57 billion backlog of transportation deferred maintenance. On Thursday, Indiana (Aaa stable) increased transportation-related fees and began a multi-year increase in the state’s gas tax that when fully phased in it expects will boost road and bridge funding by $1 billion per year. And on Wednesday, Tennessee (Aaa stable) raised its gas tax and other transportation-related fees, expecting to raise $350 million annually to address its $10 billion transportation project backlog. These states’ actions address investment needs that are critical to preserving and expanding their economies and are credit positive.

Increasingly, states are moving to close the gap created by flat federal spending on transportation, mounting needs, more fuel efficient vehicles and the erosion of per-gallon gas taxes amid inflation (see exhibit). Last November, New Jersey (A3 stable) increased its gas tax, which will raise $1.2 billion for transportation. On 22 April, Montana’s (Aa1 stable) legislature passed a bill increasing the gas tax and sent it to the state’s governor.

Twenty Four State Legislatures Increased Gas Taxes to Address Infrastructure Needs, 2013-17

Sources: National Conference of State Legislatures and Moody’s Investors Service

Tennessee’s transportation package identifies 962 projects to be funded by the increased gas tax and other transportation-related fees, with revenues split between the state ($250 million) and local governments ($100 million). The legislation also authorizes local governments to ask voters to levy a surcharge to fund

Julius Vizner Assistant Vice President - Analyst +1.212.553.0334 julius.vizner@moodys.com

NEWS & ANALYSIS Credit implications of current events

20 MOODY’S CREDIT OUTLOOK 1 MAY 2017

transit, which addresses the strong economic growth in some Tennessee cities. In keeping with its historical approach to transportation funding, Tennessee does not expect to issue any debt to pay for its roads and bridges.

Indiana expects that its increased gas tax and other transportation-related fees will generate $347 million in fiscal 2018, which ends 30 June 2018. By 2024, Indiana expects new revenues to bring in $1 billion, which is the additional funding it needs each year just to maintain road and bridges in their current condition. Indiana also passed legislation that facilitates the tolling of its interstate highways, although tolling would still require federal approval. We expect that tolls will be used more and more to fund the growing backlog of infrastructure needs in the US.

Infrastructure and logistics are core competitive advantages for both Tennessee and Indiana because of their geographic proximity to most US consumers and large manufacturing sectors. Shipping company FedEx’s global hub is in Memphis, Tennessee and its competitor UPS’ global hub in Louisville, Kentucky shares a metro area with southern Indiana.

NEWS & ANALYSIS Credit implications of current events

21 MOODY’S CREDIT OUTLOOK 1 MAY 2017

South Carolina Enacts Measures to Improve Pension Funding, a Credit Positive Last Tuesday, South Carolina (Aaa stable) Governor Henry McMaster signed legislation that raises government and employee contributions to the South Carolina Retirement System (SCRS) and the Police Officers Retirement System (PORS). In addition to the direct increases in contribution rates, the legislation will gradually adopt actuarial assumptions that reduce the deferral of costs and investment risk-taking, such as shorter amortization periods and a lower assumed rate of investment return. The legislation is credit positive, despite the resulting fiscal pressure, for all participating governments in the two systems, which include the state, local governments, the state university system and public hospitals, because it will slow the growth of unfunded pension liabilities.

Weak state and local government contributions to SCRS and PORS have been a driving factor behind continually rising unfunded liabilities for more than a decade. State statute sets contribution rates relative to payroll for all participating governments, but those rates have historically fallen far short of plan funding needs. Today, the state’s Moody’s-adjusted net pension liability of $22.6 billion equals 177% of the state’s revenues, which compares negatively with the national median of 85% of revenue for all US states.

The reform legislation begins to address the annual funding shortfalls by increasing state and local government contributions to the SCRS plans by 2% of payroll in fiscal 2018 (which ends 30 June 2018) and increase another 1% of payroll each year thereafter until fiscal 2023. Additionally, the legislation allows for the South Carolina Public Employee Benefit Authority Board to increase the employer contribution rates further if the scheduled contributions are insufficient to meet the revised amortization period, which is scheduled to decrease to 20 years from 30 years between fiscal 2018 and fiscal 2028 (see exhibit).

Required Employer Contribution as Percent of Covered Payroll to South Carolina Retirement Systems

Sources: SCRS comprehensive financial reports and South Carolina house bill 3726

Escalating contribution rates will create negative operating pressure for participating employers. Additional state aid may help mitigate the increase in fiscal 2018. The state senate recently approved a $145 million general fund appropriation in fiscal 2018 to help mitigate the increased pension costs for state agencies and local governments. If the state’s final budget includes this appropriation, it would offset half of the cost increase in fiscal 2018.

South Carolina’s local governments face a challenging revenue-raising environment. They are limited in how much revenue they can raise through property taxes by Act 388, which sets a maximum operating millage increase based on CPI increases and population growth. However, local governments can rely on their generally strong expenditure flexibility to absorb forthcoming pension cost increases.

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

22%

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027

South Carolina Retirement System Police Officers Retirement System

Evan Hess Associate Analyst +1.212.533.3910 evan.hess@moodys.com

Thomas Aaron Vice President - Senior Analyst +1.312.706.9967 thomas.aaron@moodys.com

NEWS & ANALYSIS Credit implications of current events

22 MOODY’S CREDIT OUTLOOK 1 MAY 2017

Among local governments, school districts will be the most challenged to comply with the new contribution requirements. School districts are limited in their revenue-raising ability owing to their high level of dependency on state aid, which is calculated based on a state funding formula. School enrollment limits districts’ ability to cut expenditures, another limitation on their operating flexibility.

The state’s colleges and universities will face modest budgetary pressure during a time of slower revenue growth as universities seek to limit tuition increases. But most universities have the capacity to absorb the increased employer contributions. Additionally, the reform will allow for the gradual reduction of debt-like liabilities introduced by the defined benefit plans.

Not-for-profit health systems will also be challenged by increased funding requirements, but they can generally absorb the higher costs. Hospitals can reduce capital expenditures or cut costs in other areas to free up cash flow to make higher pension contributions.

NEWS & ANALYSIS Credit implications of current events

23 MOODY’S CREDIT OUTLOOK 1 MAY 2017

Securitization

Austrian Regulator’s New Macro-prudential Tools Would Be Credit Positive for Banks and Covered Bonds On 21 April, Austria’s Ministry of Finance introduced a law to parliament aimed at strengthening the Austrian Financial Market Authority’s (FMA) mandate to give it the authority to implement macro-prudential tools. Strengthening the FMA’s mandate would be credit positive for Austrian banks and covered bonds because it would help maintain prudent underwriting standards, thereby safeguarding the credit quality of the cover pools backing covered bonds. If implemented, the law will help reduce systemic risks because it will enable Austrian authorities to react quickly if signs emerge that mortgage lending or property prices are overheating.

The proposed law would give the FMA a wide range of tools, including binding limits for loan-to-value ratios, debt-to-borrower income ratios and debt-service-to-income ratios. Additionally, the FMA would be allowed to require interest rate stress tests in a bank’s underwriting and set minimum loan amortization rates. The FMA would also have the ability to adjust the tools by restricting their application to particular regions of Austria, different property types or loan products (including commercial properties). Policy measures would apply only to newly originated mortgage loans, not retrospectively to existing outstanding mortgages.

Such measures will reduce the risk of excessive risk-taking on Austrian banks’ balance sheets if they are applied proactively ahead of cycle peaks in property markets. In addition, the measures could reduce the risk of property markets overheating. By addressing risks during the cycle rather than setting static underwriting standards, the regulator ensures broad access to loans when markets are healthy, while containing systemic risk when they are not.

The proposed law would enable Austrian authorities to react quickly if signs emerge that mortgage lending or property prices are overheating. According to the central bank, Austria’s average residential property prices overall are 4.9% above the level indicated by the central bank’s fundamental price model, while in Vienna, the capital city, they are 18.6% above the indicated level. A further risk stems from Austrian households’ exposure to interest rate increases given that mortgages are typically variable rate.

Starting in 2014, low interest rates drove up the growth rate of domestic mortgage lending to around 4.0% from 0.5%-2.0% starting in mid-2010. Despite this recent rise, we believe that the nationwide housing market is not overheating to a point where it poses a risk to macroeconomic stability. Austria is less susceptible to macroeconomic shocks from mortgage lending because its owner-occupation rate is 56%, versus the European Union average of 70%. Furthermore, outstanding mortgage debt is smaller relative to GDP, household income and banks’ capital than, for example, in Nordic countries, which have also experienced strong property price growth in recent years. Austria’s low owner-occupation rate also means that a fall in house prices is less likely to have a significant effect on households’ consumption behavior and hence economic growth.

Austria joins a number of other European countries, including Germany and Nordic countries, to use macro-prudential tools to combat the negative effects of low interest rates, growing household debt and reduced affordability of home ownership. A particular benefit of setting underwriting limits through macro-prudential policy measures is that it prevents competition from weakening lending standards, and allows authorities to adjust the limits in response to changing market conditions.

Alexander Zeidler Vice President - Senior Credit Officer +44.20.7772.8713 alexander.zeidler@moodys.com

Michael Rohr Vice President - Senior Credit Officer +49.69.70730.901 michael.rohr@moodys.com

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

24 MOODY’S CREDIT OUTLOOK 1 MAY 2017

NEWS & ANALYSIS Corporates 2 » US Television Broadcasters Will Benefit from Reinstatement

of UHF Discount

» Sinclair’s Acquisition of Bonten Media Group Is Credit Positive

» JAB Holding Would Benefit from Jimmy Choo Sale

» Schaeffler’s Prepayment of Its 2021 Bond Is Credit Positive

Banks 6 » Mexico’s Investigation Into Bond Market Manipulation Is

Credit Negative for Financial Institutions » Peruvian Banks’ Loan Delinquencies Hit 12-Year High

Insurers 9 » Great-West Life Assurance’s Job Cuts Are Credit Positive

Sovereigns 10 » Malta’s Surprise 2016 Budget Surplus Is Credit Positive

US Public Finance 12 » Ohio Teacher Pension System Suspends Benefit Cost

Adjustments, a Credit Positive for Schools

Securitization 14 » Ocwen and Related RMBS Face Credit-Negative Effects from

Regulatory Actions

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