Hi-Crush’s Acquisitions and Common Unit Offering Are...

MOODYS.COM

2 MARCH 2017

NEWS & ANALYSIS Corporates 2 » Hi-Crush's Acquisitions and Common Unit Offering Are

Credit Positive » Bharti's Acquisition of Telenor India Is Credit Positive

Banks 5 » Chile's New Consolidated Supervisory Body Is Credit Positive

for Banks » Proposed UK Bank Capital Changes Are Credit Negative » Cabot's Potential IPO Would Be Credit Positive » UniCredit's €13 Billion Capital Increase Restores Its

Creditworthiness » Strengthening Swedish Financial Regulator's Mandate Would

Be Credit Positive for Banks » Absa Bank Will Benefit from Separation Agreement with

Barclays Bank

Exchanges 13 » Lower Likelihood of London Stock Exchange-Deutsche Börse

Merger Is Credit Negative

Insurers 14 » Claims-Inflating Ogden Discount Rate Cut Is Credit Negative

for UK Motor Insurers and Reinsurers

Asset Managers 16 » China’s Potential Reforms for Fund Managers Are

Credit Negative

Sovereigns 18 » Germany’s Debt Reduction Accelerates with Third Consecutive

Fiscal Surplus » Korea’s Strong External Payments Position Provides Cushion

Against Shocks » Pakistan's Import Controls Signal Mounting External Pressures » Sri Lanka's Drought-Related Costs Add to Challenge of

Achieving Fiscal Targets

Securitization 26 » Germany's Public-Sector Pfandbriefe Benefit from

Government's Better-than-Expected Fiscal Surplus

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NEWS & ANALYSIS Credit implications of current events

2 MOODY’S CREDIT OUTLOOK 2 MARCH 2017

Corporates

Hi-Crush’s Acquisitions and Common Unit Offering Are Credit Positive Last Thursday, Hi-Crush Partners LP (Caa1 negative) announced two credit-positive acquisitions. Hi-Crush will acquire the Permian Basin Sand Company, LLC from a third party and it will acquire from its sponsor, the Whitehall facility, additional properties located near the Whitehall facility, and the remaining 2% additional interest in Hi-Crush Augusta LLC.

Hi-Crush also announced a primary public offering in which it expects to raise $360-$410 million. The proceeds of the public offering, along with up to $75 million of newly issued common units to the seller of Permian Basin Sand, will be used to fund the purchases. The total consideration for the two transactions is $415 million, not including the contingent earn-out associated with the acquisition of the Whitehall facility.

The acquisitions are credit positive because they position Hi-Crush to capitalize on the frac-sand demand recovery with more frac-sand reserves, expanded low-cost production capacity and a new presence in the Permian regional sand market. The Whitehall acquisition also simplifies Hi-Crush’s structure by consolidating all of the production assets from its sponsor into the limited partnership. The common unit offering is credit positive because it strengthens Hi-Crush’s balance sheet and preserves liquidity at a time when we expect end markets to remain unpredictable, despite what appears to be the beginning of a frac-sand industry recovery. Hi-Crush expects the acquisitions to close by the end of the first quarter.

Following the acquisitions, Hi-Crush will have 371 million tons of frac-sand reserves and 13.4 million tons of annual processing capacity, including a processing plant to be constructed at the Permian Basin Sand site. Hi-Crush will construct the on-site processing facility, which it expects will be operational by the fourth quarter of this year. The company estimates the cost of constructing the facility at $45-$50 million. Hi-Crush will have enough liquidity following the common unit offering to fund construction.

As of year-end 2016, Hi-Crush had approximately $72 million of liquidity. Hi-Crush also has an at-the-market equity program under which it can sell common units up to $50 million. We expect Hi-Crush’s cash flow to improve in 2017 as the frac-sand industry recovers. Hi-Crush reported growth in sand volume sales during the third and fourth quarters of 2016 after multiple quarters of declines. The sand price is also increasing. Hi-Crush has no meaningful debt maturities until its term loan matures in 2021. A revolving credit facility matures in 2019, but there are no borrowings drawn except for $8.6 million letters of credit.

At this time, Hi-Crush’s Caa1 rating and negative outlook are unchanged. If we gain confidence that the recovery in shipment volumes and prices are sustainable, we would revise the outlook to stable. Hi-Crush’s key metrics would need to improve considerably before we would consider a rating upgrade. Adjusted debt/EBITDA was more than 20.0x for 2016, and adjusted EBIT/interest was below zero.

Houston, Texas-based Hi-Crush is an integrated producer, transporter, marketer and distributor of high-quality monocrystalline sand, which is a specialized mineral used as a proppant to recover hydrocarbons from oil and natural gas wells. Hi-Crush owns, operates and develops sand reserves and related excavation, processing and distribution facilities. At year-end 2016, the company held approximately 235 million tons of proven recoverable reserves of frac sand meeting API specifications, had 7.57 million tons of annual processing capacity, owned or leased 4,200 railcars and owned 11 destination terminals (three of which are currently idle). In 2016, the company generated revenue of $204 million.

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.

Karen Nickerson Senior Vice President +1.212.553.4924 [email protected]

https://www.moodys.com/credit-ratings/Hi-Crush-Partners-LP-credit-rating-823633422




Bharti’s Acquisition of Telenor India Is Credit Positive Last Thursday, Bharti Airtel Ltd. (Baa3 stable) announced that it had entered into a definitive agreement with Telenor South Asia Investments Pte. Ltd. (unrated) to acquire Telenor (India) Communications Private Limited (Telenor India, unrated), a wholly owned subsidiary of Norway’s Telenor ASA (A3 stable). The acquisition is credit positive for Bharti, India’s largest integrated telecommunications operator by subscribers, because it will enhance the company’s spectrum holdings, revenues and customer base, bolstering its market position in India’s highly competitive mobile telecommunications market.

We do not expect Bharti to raise debt in order to finance the acquisition because the transaction is a non-cash deal. According to the agreement, Bharti will acquire Telenor India’s operations in seven circles (cellular mobile service areas), including the transfer of all assets (including spectrum) and customers. The transaction is subject to regulatory approvals and Bharti expects the deal to take 12 months to close. Bharti will take over Telenor India’s 43.4 megahertz spectrum, which can be shared and traded in the 1800 megahertz band across seven circles, along with the remaining 16 years on the spectrum’s license. This will bolster Bharti’s spectrum footprint, service offering and network coverage.

Following the acquisition, Bharti’s spectrum holdings will increase in seven circles, and its mobile services subscriber market share will increase by around two percentage points (based on December 2016 figures), both of which are credit positive. The spectrum gain will also better position the company for further growth in data services in densely populated circles. Pro forma for the acquisition, the company’s subscriber base in India would increase by approximately 44 million to 310 million for a total market share of around 26% (see exhibit), while its revenues would increase around 5% for the 12 months that ended 31 December 2016.

Indian Mobile Telecom Operators’ Subscriber Share, December 2016 Bharti’s subscribers share will increase to around 26% pro forma for the Telenor acquisition from 24%.

Source: Telecom Regulatory Authority of India, December 2016

Although Bharti will take over outstanding spectrum payments and other operational contracts, including tower leases, the net effect of these liabilities and acquired assets will not have a material effect on the company’s consolidated leverage. Bharti’s adjusted consolidated debt/EBITDA (including deferred spectrum liabilities) was 3.3x as of December 2016.

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24%

Quadrant

MTNL

Sistema

Telenor

Tata Teleservices

Reliance Jio

RCOM

Aircel

BSNL

Idea

Vodafone

Bharti

Annalisa Di Chiara Vice President - Senior Credit Officer +852.3758.1537 [email protected]

Carole Herve Associate Analyst +852.3758.1505 [email protected]

https://www.moodys.com/credit-ratings/Bharti-Airtel-Ltd-credit-rating-820304589

https://www.moodys.com/credit-ratings/Telenor-ASA-credit-rating-600018165

mailto:[email protected]



India’s mobile market remains intensely competitive following Reliance Jio Infocomm Limited’s (unrated) launch in September 2016, when it provided all services free of charge in its temporary promotional entry proposition. Although we believe Jio’s recently announced tariff plan (beginning 1 April 2017) will improve industry-wide average revenue per user as data subscribers and consumption continues to grow, we still expect intense price competition to persist over the next few quarters as incumbents such as Bharti, Vodafone India (unrated) and Idea Cellular (unrated) respond to protect their subscriber market shares.

As a result, we expect that Bharti’s profitability will remain challenged over the next few quarters. However, cash proceeds from monetization activities, including divestments in subsidiaries such as Bharti Infratel (unrated), will help reduce debt on an absolute and relative basis such that adjusted debt/EBITDA will trend toward 3.0x by June 2017, providing a cushion to absorb shocks in profitability.



Banks

Chile’s New Consolidated Supervisory Body Is Credit Positive for Banks Last Thursday, Chile’s Ministry of Finance created a new supervisory body, the Comisión para el Mercado Financiero (CMF), that will replace the existing securities and insurance supervisor (Superintendencia de Seguros y Valores) within 18 months. The CMF will eventually assume bank supervision responsibilities that the Superintendencia de Bancos e Instituciones Financieras carries out today. The creation of the new commission is credit positive for Chile’s banks and for the country’s broader financial system because it lays the groundwork for a more integrated and autonomous regulatory system.

The CMF will have a more independent corporate governance structure than existing regulatory bodies, which will enhance the reputation and authority of supervisors, in turn strengthening their ability to enforce regulations. The body will have a five-member board, but only the chair will be politically appointed, with a term that coincides with the Chilean president’s term. The remaining board members will be approved by congress, and their six-year tenures will not coincide with the political calendar. In addition, mechanisms will be put in place to prevent conflicts of interest, including post-employment restrictions for board members.

The creation of the new commission lays the groundwork for a significant increase in the regulator’s responsibilities once Chile’s new General Banking Law is approved and implemented. The law as proposed by a working group set up by the Ministry of Finance aims to establish clear guidelines that will allow the new regulator to intervene in failing banks more forcefully and in a more timely manner than is currently possible. These new regulatory powers will be positive for all creditors because they will help preserve the value of failing banks, foster the stability of the financial system and encourage lenders to adopt better risk management and corporate governance practices. The working group first submitted its proposal in November 2015, at which point we expected that the law would be approved during 2016. However, the process has been repeatedly delayed, and now we do not expect its approval until the new administration comes into power in early 2018.

Once the new banking law is in place, the CMF will assume responsibility for setting banks’ capital requirements, which is currently done by congress and is consequently difficult to modify as international norms evolve. Therefore, the establishment of this new supervisory body is a key step in Chile’s eventual adoption of Basel III guidelines and future changes to international banking regulations.

Felipe Carvallo Vice President - Senior Analyst +52.55.1253.5738 [email protected]



Proposed UK Bank Capital Changes Are Credit Negative Last Friday, the UK’s Prudential Regulation Authority (PRA) proposed a more flexible approach to determining Pillar 2A capital requirements for banks calculating risk-weighted assets (RWAs) according to the standardised approach. The PRA’s proposal aims to use Pillar 2A to reduce some of the variation between standardised risk weights and internal models outputs for similar risks, remove future duplication between IFRS 9 provisions for expected loss and the standardised approach, create incentives for smaller lenders to move away from higher risk mortgage lending and facilitate greater competition among UK banks.

We expect that the proposed changes will reduce the capital requirements for small banks and building societies, freeing up capital for further growth. However, in an already competitive market, with many smaller firms growing faster than the market, increased competition will negatively pressure margins and reduce profitability for all banks, a credit negative.

The proposal more closely aligns the RWAs calculated with the standardised approach and the internal ratings-based approach by allowing lenders the PRA deems adequately governed and well managed to benefit from lower Pillar 2A capital requirements if their loan portfolio is considered low risk. Disincentives would be created for higher-risk lending for which standardised risk weights are often equal to or lower than the upper band of the PRA’s internal ratings-based benchmarks. The PRA’s proposal follows the Competition Market Authority’s report recommending greater competition in the UK retail banking.

The proposal also seeks to address the potential for an effective double counting of expected loss that these firms may incur with the adoption of IFRS 9 on 1 January 2018, which would not have applied to lenders using the internal ratings-based approach.

We expect that the UK banks and building societies that we rate and which use the standardised approach will largely receive reduced Pillar 2A requirements under this proposal because of their focus on residential mortgages with limited high loan-to-value (LTV) exposures. These banks’ low-LTV and residential mortgage focus, as shown in Exhibit 1, means that they are likely to benefit from capital relief without significant incentives to change lending practices. However, all of these institutions have achieved material growth in their mortgage books over the past few years, targeting increases in volume to offset increasing margin pressure. We view negatively further incentives to foster growth for these firms through a relaxation of Pillar 2A capital requirements because doing so will weaken the affected banks’ stress capital resilience. Exhibit 2 shows banks’ reported common equity Tier1 capital ratios. We note that most of the affected banks we rate are already expanding their lending faster than the market, with annual growth of around 10% (excluding Yorkshire Building Society) in 2016, compared with 4% market growth.

Aleksander Henskjold Analyst +44.20.7772.1954 [email protected]

Daniel Forssen Associate Analyst +44.20.7772.1553 [email protected]



EXHIBIT 1

Banks’ Standardised Approach Average Mortgage Loan-to-Values The affected banks and building societies we rate have limited high LTV lending.

Note: Average LTV ratios for stock lending as reported by the banks. Data may reflect definitional differences. * Indicative threshold LTV where internal ratings-based risk-weights exceed standardised approach risk-weights. Sources: Company reports and Moody’s Investors Service

EXHIBIT 2

Banks’ Standardised Approach Common Equity Tier 1 Capital Ratios Banks’ CET1 capital requirements should benefit from Pillar 2A capital relief on their lower risk portfolios.

Note: 31 December 2016 data * Clydesdale Bank plc data is as of 30 September 2016 and Bank of Ireland (UK) data is as of year-end 2015. Source: Moody’s Banking Financial Metrics

We expect the PRA’s proposal to contribute to already-strong competition in the UK mortgage market, adding negative pressure to net interest margins, and negatively affecting the profitability of the banks we rate.

Affected firms are also likely to benefit from a lower minimum requirement for own funds and eligible liabilities (MREL) as a result of these proposals because of a reduction in the combined Pillar 1 and Pillar 2A capital requirements, reducing the loss-absorption capacity for creditors in the event of their failure. A subset of these firms, which have total assets in excess of £15-£25 billion, are likely to see the greatest MREL relief because they are subject to the strictest form of the requirements.

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Yorkshire Building Society Nottingham BuildingSociety

Clydesdale Bank plc Leeds Building Society Bank of Ireland (UK)

Average Loan-to-Value Indicative Threshold*

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Yorkshire Building Society Nottingham BuildingSociety

Clydesdale Bank plc* Leeds Building Society Bank of Ireland (UK)*



Cabot’s Potential IPO Would Be Credit Positive Last Thursday, Cabot Credit Management, the ultimate parent company of Cabot Financial Limited (Cabot, B2 stable), announced that its board of directors is assessing a potential initial public offering (IPO) of Cabot on the London Stock Exchange. Listing Cabot would be credit positive for bondholders because it creates an opportunity for the company to raise capital and deleverage. We also expect that a listing will reduce private-equity ownership and improve corporate governance and transparency.

A public listing would provide a venue for Cabot to raise capital at the time of the IPO, although we note that no announcements have been made about the use of proceeds or ownership divestments. It also provides access to equity capital markets, which we consider credit positive because it eases the company’s ability to raise equity when needed. Moreover, if equity is raised to pay down Cabot’s debt, it would reduce the company’s leverage and likely improve its marginal financing cost compared with some peers that are owned by private-equity funds. As of the end of June 2016, we calculate Cabot’s debt at 4.5x EBITDA, largely in line with peers (see exhibit).

Cabot’s Debt/EBITDA Cabot’s debt/EBITDA increased after its 2013 acquisition by J.C. Flowers.

Note: Gross debt and EBITDA calculations use Moody’s standard adjustments. Sources: Moody’s Financial Metrics

Currently, the US debt purchaser Encore Capital Group (unrated) holds 43% of the share capital of Cabot. Private-equity firm J.C. Flowers & Co. (unrated) holds a similar stake, while management owns the remainder. Because IPOs are frequently used by private-equity funds to exit their investment, we expect J.C. Flowers’ ownership and influence to decline, and to be eliminated over time.

Private-equity ownership is a source of risk for creditors because it often leads to a high degree of leverage, as with Cabot, whose interest expense was 71% of operating profit during the first nine months of 2016. Leverage often climbs as funds seek a higher return on investment by minimising their equity stakes with a corresponding high proportion of interest expense. Private-equity funds’ typical three- to five-year investment horizon is also a source of risk because that can lead to financial strategies that are suboptimal in the long-term, for example relating to exit strategy and timing.

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2013 2014 2015 June 2016

Cabot Asset-Weighted Average for Rated Peers

Aleksander Henskjold Analyst +44.20.7772.1954 [email protected]

Gorka Nunez Palacio Associate Analyst +44.20.7772.1645 [email protected]

https://www.moodys.com/credit-ratings/Cabot-Financial-Ltd-credit-rating-823211555



We expect that an IPO would improve Cabot’s board of directors’ independence, which would positively affect our assessment of Cabot’s corporate governance and reflect our expectation of a greater focus on the company’s long-term goals. Cabot’s board of directors currently has eight members, four of which are non-executive directors representing Encore and two non-executive directors representing J.C. Flowers. There is only one independent non-executive director.

Financial transparency and disclosures would likely benefit from Cabot becoming a publicly listed company because its statutory reporting requirements would be stricter than they are as a private company. If the IPO moves forward, we expect that Cabot will disclose targets for key metrics such as leverage, profitability and dividend payments, all of which would enhance the firm’s corporate governance as Cabot moves to comply with these commitments.

Cabot is the largest debt purchaser in the UK with 120-month estimated remaining loan collections of £2.1 billion at the end of September 2016. If the IPO succeeds, Cabot would be the second UK-based credit management company to go public since Arrow Global Group Plc’s (Ba3 stable) listing on the London Stock Exchange in October 2013.

https://www.moodys.com/credit-ratings/Arrow-Global-Group-PLC-credit-rating-824191808



UniCredit’s €13 Billion Capital Increase Restores Its Creditworthiness On Monday, UniCredit S.p.A. (Baa1 stable, ba11) announced that it had completed its €13 billion capital increase, which was fully subscribed. The credit-positive capital increase will allow UniCredit to restore its capital levels, which were adversely affected by large losses booked at year-end 2016, and maintain coupon payments, especially the Additional Tier 1 (AT1) coupon payment due on 10 March.

UniCredit’s capital increase will offset the negative effect on solvency of the €13.1 billion of large one-off charges booked in 2016. These charges included €8.1 billion of additional loan-loss provisions, which increased provisioning coverage of the bank’s problem loans but resulted in a net loss of €11.8 billion at year-end 2016. Following the loss, UniCredit reported a phased-in common equity Tier 1 (CET1) ratio of 8.15% at year-end 2016; this level compares with a capital requirement set by the European Central Bank (ECB) of 8.75%2 that UniCredit needs to maintain in 2017 to avoid limitations on its payments of coupons and dividends. The completion of the capital increase, which we expected but which was not a certainty, will lift UniCredit’s CET1 ratio to above 11% and give the bank more headroom to continue to make AT1 coupon payments.

The €13 billion capital increase is an important milestone of UniCredit’s 2017-19 strategic plan, which includes a large reduction in the stock of nonperforming loans. UniCredit is currently in the process of selling a sizable portion of its bad loans to Fortress Investment Group LLC and Pimco. UniCredit expects the sale to be completed in the second half of 2017 and will reduce the bank’s problem loan ratio (i.e., problem loans/gross loans) to less than 12%, versus 15.3%3 reported at year-end 2015. Despite this significant improvement, we expect UniCredit’s asset risk indicators to remain weak compared with most European peers, with its problem loan ratio still well above the 5.4% European Union average.

Unlike more troubled Italian banks, UniCredit was able to raise a large amount of capital from private sources without resorting to any kind of government support, and the completion of its capital increase signals a validation of its strategy by existing and new shareholders. Additionally, its improved credit quality should help ease pressures on Italy’s banking system, given UniCredit’s large size in the Italian market.

As part of its strategic plan, UniCredit also targets a €4.7 billion net profit for 2019 (equivalent to a 9% return on tangible equity versus a 4% return in 2015) and, underpinned by slightly higher revenues, cost cutting and a significant decline in the cost of credit. The targets will be challenging to achieve given the persistently weak operating conditions for Italian banks, with UniCredit’s domestic commercial banking and non-core activities still accounting for more than 30% of the group’s consolidated risk weighted assets.

1 The bank ratings shown in this report are the bank’s deposit rating and baseline credit assessment. 2 Pillar 1, Pillar 2 Requirement, Capital Conservation Buffer, and G-SIFI Buffer; in addition, UniCredit's Pillar 2 Guidance is 1.25%. 3 Excluding Pekao, which is being sold, UniCredit's 2015 problem loan ratio was 15.9% of gross loans.

London +44.20.7772.5454

https://www.moodys.com/credit-ratings/UniCredit-SpA-credit-rating-212250



Strengthening Swedish Financial Regulator’s Mandate Would Be Credit Positive for Banks Last Thursday, Sweden’s Ministry of Finance put forward a draft proposal to strengthen the Swedish Financial Supervisory Authority’s (SFSA) mandate to give it the authority to implement macro-prudential measures without parliamentary review. Strengthening the SFSA’s mandate would be credit positive for banks and give the authority the tools it needs to slow the high growth in household indebtedness, a key vulnerability for Swedish banks.

Comments on the draft are due by the end of April, clarifying if any changes need to be made. The Ministry of Finance expects the proposal to be implemented into law by February 2018. If the general intention of the proposal is intact, the process to implement new macro-prudential measures will be significantly quicker and at the discretion of the SFSA, needing only government approval. The proposal addresses the SFSA’s past struggle to implement the mortgage amortisation rule under its current mandate. The Administrative Court of Appeal in the city of Jönköping opined against the SFSA introducing an amortisation requirement, stating that its legal entitlement to introduce amortisation rules was doubtful. The court also voiced concerns regarding SFSA’s authority to introduce measures with such wide effect on individual households without a political process. Eventually, an amortisation requirement was introduced through legislation in June 2016. The same court will opine on the current proposal.

The regulator’s inability to slow Sweden’s fast pace of property price appreciation and household lending during the past decade illustrates the need for a regulatory framework more suitable to address risks associated with economic imbalances in a timely manner. The amortisation requirement has had limited effect on home prices and mortgage debt. Since its implementation, the trajectory of property prices has slowed to a yearly increase of 8% in 2016 from above 14% in 2015, according to data from Statistics Sweden, but household mortgage debt still grew at a pace of 7.7% in 2016, compared with 8.3% in 2015, which is higher than forecast real GDP growth of 3.4% in 2016 and 4.1% in 2015. In addition to the average debt-to-income ratio of 179% being among the top five of European countries, the share of households with a high disposable debt-to-income ratio has also increased over the past few years, and 10% of households with mortgages have a debt-to-income ratio of more than 600%.

The combination of property price appreciation, an increasing debt-to-income ratio and 75% of mortgages being variable rate results in increased downside risks. A reversal of property prices or an abrupt increase in interest rates would force borrowers to allocate a higher proportion of their disposable income to debt repayments. The consequence would be weakening consumer confidence and general economic activity, affecting small and midsize enterprises and commercial real estate, with increasing deterioration in banks’ asset quality.

The main point of the draft proposal states that a credit institution must be operated in such a way that the institution does not contribute to financial imbalances in the credit market. According to the Ministry of Finance, this would allow the SFSA to use a number of regulatory tools, including a debt-to-income cap, loan-to-value cap, distribution of interest rate maturities, size of loans denominated in foreign currency, and the size of debt payments that a borrower can afford with respect to income.

Niclas Boheman Assistant Vice President - Analyst +44.20.7772.1643 [email protected]



Absa Bank Will Benefit from Separation Agreement with Barclays Bank Last Thursday, Barclays Bank PLC (A1 negative, baa24) and Barclays Africa Group Limited (BAGL, unrated) announced the agreed terms of their separation, nearly a year after Barclays said that it would reduce its stake in BAGL to achieve accounting and regulatory deconsolidation. The terms of separation under the transitional services arrangements and specifically a £765 million (ZAR12.8 billion) payment will help fund BAGL’s required investments in technology, expertise and rebranding, benefitting BAGL and Absa Bank Limited (Baa2 negative, baa3), which is BAGL’s main operating subsidiary in South Africa.

Pending regulatory approvals, the transitional agreement and the payment eliminate the risk of a disorderly separation, which would have significantly challenged Absa’s operations. Nonetheless, implementation of the transitional agreements will be challenging.

Following the March 2016 announcement, there was a risk that Absa’s ability to leverage Barclay’s global banking knowledge, distribution network and technology to source cross-border business would diminish. Although Absa does not operate under the Barclays brand, we expect the bank to benefit from the transitional services arrangement that will allow BAGL to use the Barclays brand outside of South Africa for three years once Barclays’ stake is below 50%. This arrangement averts a sudden and sizable loss in Absa’s cross-border business with multinationals and corporates operating in sub-Saharan Africa, while allowing stronger relationships over the coming years. The transitional agreements eliminate the downside risk of a disorderly separation. Additionally, the receipt of certain services from Barclays on an arm’s length basis for up to three years once Barclays’ stake is below 50% will ensure business continuity and facilitate the development of further expertise in distribution networks, technology and risk management.

The agreed payment of £765 million, which Barclays expects will offset the capital and cash flow effect of separation expenses, amounts to around 18% of revenue or 81% of Absa’s profit for 2016. The largest payment by Barclays is in recognition of the investments that BAGL will require in technology, rebranding and other separation costs, with the £515 million (ZAR8.6 billion) equal to a little more than one year of BAGL’s ZAR7.4 billion information technology-related operating expenditures in 2016. The remaining amount is to terminate the existing service level agreement between Barclays and BAGL, relating to the rest of Africa operations, (£195 million or ZAR3.3 billion) and to cover other separation expenses (£55 million or ZAR900 million).

The challenges of the separation include its actual implementation and a possibility that Barclays’ payment may fall short of actual separation costs considering BAGL’s and Absa’s lack of experience in separation projects of this magnitude.

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

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

Nitish Bhojnagarwala Assistant Vice President - Analyst +971.4.237.9563 [email protected]

https://www.moodys.com/credit-ratings/Barclays-Bank-PLC-credit-rating-92500

http://www.barclaysafrica.com/barclaysafrica/News/Press-Statements/2017/Barclays-PLC-and-Barclays-Africa-Agree-Separation-Terms

https://www.moodys.com/credit-ratings/ABSA-Bank-Limited-credit-rating-600018177

https://www.moodys.com/credit-ratings/ABSA-Bank-Limited-credit-rating-600018177



Exchanges

Lower Likelihood of London Stock Exchange-Deutsche Börse Merger Is Credit Negative On Sunday, London Stock Exchange Group plc (LSEG, Baa1 positive) released a statement outlining the European Commission’s (EC) decision to request a full divestment of its 60% stake in Italian bond trading business MTS S.p.A. (unrated) in order to secure clearance for LSEG’s merger with Deutsche Börse (DB1, unrated). Given that LSEG has concluded it cannot commit to divest its stake in MTS, the EC is unlikely to provide clearance for the merger. Although our rating outlook is positive on LSEG on a standalone basis, a failure of the merger would be credit negative.

In January, LSEG proposed the sale of its French clearing business LCH.SA to support the EC’s clearance for the merger. During its Phase II review of the proposed merger, the EC highlighted concerns with this remedy because of the bond and repo trading feeds that MTS currently provides to LCH.SA. Although the merging entities proposed a remedy to address these concerns, the EC rejected the proposal and required a full divestment of LSEG’s majority stake in MTS to secure merger clearance. LSEG considered the EC’s request disproportionate and unlikely to be satisfactorily achieved considering LSEG’s dialogue with Italian authorities and MTS stakeholders. LSEG’s majority ownership in MTS is held locally in Italy through Borsa Italiana and a sale of MTS that separates the business from LSEG’s broader Italian business, which also includes Monte Titoli and CC&G, may have limited support by Italian authorities.

The merger now appears unlikely to gain EC approval. Although our current positive outlook on LSEG’s rating is supported by the positive operational developments in its business, a failure to consummate the merger suggests that bondholders would lose the potential benefit of synergies and a more diverse revenue base of the merged entity. Through DB1’s historically prudent leverage, the merged entity would likely have had relatively better financial fundamentals than the current LSEG business.

Since the merger announcement in March 2016, LSEG has been relatively less active in pursuing material acquisitions. Historically, the firm has engaged in a mix of debt- and equity-funded acquisitions that have led to interim spikes in leverage. Should the merger not proceed, LSEG could pursue other acquisitions, which may lead to higher leverage.

The combined entity would promote efficiency in European capital markets given the prospects for lower margin requirements arising from netted risk positions offset across the merged entity’s clearinghouses. It is also possible that the combined entity could bring greater efficiencies of scale to European capital markets, leading to lower transaction costs.

EC clearance is among a number of remaining hurdles needed for a successful completion of the merger. Although LSEG seeks to implement the merger, regulatory clearance from relevant regulators in each jurisdiction add hurdles, especially with the extra challenge arising with the UK’s planned withdrawal from the European Union.

Michael C. Eberhardt, CFA Vice President - Senior Credit Officer +44.20.7772.8611 [email protected]

Maxwell Price Associate Analyst +44.20.7772.1778 [email protected]

https://www.moodys.com/credit-ratings/London-Stock-Exchange-Group-plc-credit-rating-809227242



Insurers

Claims-Inflating Ogden Discount Rate Cut Is Credit Negative for UK Motor Insurers and Reinsurers On Monday, the UK’s Lord Chancellor Elizabeth Truss announced that the discount rate (known as the Ogden rate) that UK courts use to determine lump-sum payments awarded to claimants in significant bodily injury insurance cases, such as for serious brain or spinal injuries sustained in motor accidents, will decline by 325 basis points to minus 0.75%. The rate cut is credit negative for UK motor insurers and reinsurers, which will have a substantial one-off hit to operating profitability as existing claim reserves are increased. Furthermore, insurers face a material rise in future claims cost while the scope for future reserve releases, a material contributor to the sector’s earnings, is reduced.

The Ogden rate cut will have a material one-off adverse effect on UK motor insurers’ 2016 underwriting profits. Following the rate cut, insurers will need to revalue all the so-called large bodily claims reserves. If these reserves are insufficient, they will increase, reducing insurers’ earnings for the year. Insurance broker Willis Towers Watson estimates that a rate cut to minus 0.75% will result in a one-off sector-wide reserving charge of approximately £5.8 billion, which would not only affect primary UK motor insurers, but would also hit reinsurers that provide material quota share and excess of loss (XOL) protection to the primary market.

As illustrated in the exhibit, the effect of the rate cut on earnings will differ by insurer. Direct Line Insurance Group plc (Baa1(hybrid) stable) is the top personal motor insurer by premiums, with a material concentration in the UK motor market that accounted for 65% of ongoing operating profits for 2015. Direct Line historically used a discount rate of 1.5% to set reserves and disclosed that the move to a minus 0.75% rate will reduce its 2016 profit before tax by £215-£230 million, which equates to 42%-45% of 2015 profit before tax.

Ogden Rate Cut Effect on UK Insurers’ Profits

Notes: The percentage is based on 2015 pre-tax profits unless otherwise stated. Hastings is calculated on a pre-tax operation profit basis, before finance costs, depreciation and amortization. Ageas and Aviva are calculated on a post-tax profit basis. Sources: Company disclosures and Moody’s Investors Service

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Percent of Group Pre-tax Profit - left axis Amount - right axis

Helena Kingsley-Tomkins Assistant Vice President - Analyst +44.20.7772.1397 [email protected]

Charles Isselin-Pontet Associate Analyst +44.20.7772.5573 [email protected]

https://www.moodys.com/credit-ratings/Direct-Line-Insurance-Group-plc-credit-rating-823134660

https://www.moodys.com/credit-ratings/Direct-Line-Insurance-Group-plc-credit-rating-823134660



Aviva Plc (A2 positive) has the largest share of the UK personal and commercial motor markets combined by premiums. Although the company has some international operations and is well diversified on a product basis, it will nevertheless take an exception reserving charge of £385 million, which equals 36% of 2015 post-tax profit.

Similarly, Ageas SA/NV (Baa3 positive) is among the top three UK personal motor insurers and will also be affected by the rate cut. Ageas reduced its discount rate to 1% in the fourth quarter of 2016 in anticipation of the government’s announcement, which resulted in a €55 million reserving charge for 2016. In 2017, Ageas will take another €100 million reserving charge, which collectively equals around 20% of its 2016 insurance net result.

The Ogden rate cut could also reduce insurers’ future earnings if the market is unable to push through counterbalancing price increases. The lower Ogden rate will materially increase the present value of estimated future losses faced by severe bodily injury victims, pushing up the future cost to the insurers. Willis Towers Watson estimates an increase of £868 million a year at a minus 0.75% rate. Furthermore, the increase in prior-year claims reserves will likely reduce the scope for future reserve releases, a major earnings contributor.

https://www.moodys.com/credit-ratings/Aviva-Plc-credit-rating-600008562

https://www.moodys.com/credit-ratings/Ageas-SANV-credit-rating-600047377

https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1022120



Asset Managers

China’s Potential Reforms for Fund Managers Are Credit Negative On 22 February, the Chinese State Council’s Information Office confirmed that the People’s Bank of China will lead a group that includes the China Insurance Regulatory Commission, China Banking Regulatory Commission and China Securities Regulatory Commission in setting a new unified regulatory framework for China’s fast-growing RMB60 trillion asset management sector.5 The regulatory framework covers assets managed by banks, securities companies, fund companies, subsidiaries of fund companies and trust companies.

Although draft regulations are still under discussion and subject to change, the regulation’s current form would create additional compliance costs for fund managers operating in China, especially for those managing risky funds with high leverage and exposure to non-standard products. China’s fund managers would also face new regulatory restrictions that may lead their funds to underperform their benchmarks, another credit negative, because underperformance would slow growth of assets under management.

Although the net credit implications for fund managers are negative, we recognize that by fostering less risk with greater constraints, the potential reforms call for greater transparency, which would increase investor confidence in the investment funds and benefit the long-term growth of the sector. In addition, because we see the current opaqueness in the asset management sector as a key source of banking system risk, these draft reforms are credit positive for banks.6

Under the draft rules, fund managers would be required to set aside 10% of the fees from their clients’ assets as a capital reserve against potential risks. Funding the reserve would curb fund managers’ profitability, particularly pressuring smaller players, many of which are already struggling to survive.7 The draft rules also prohibit guaranteed returns, a measure that would limit the attractiveness of riskier funds that charge higher management fees. To date, retail investors’ interest in such products has been underpinned by the expectation of implicit guarantees from the financial institutions that distribute them.

The planned reform would also ban investments in non-standard products, mostly loans, and cap investment fund leverage8 at 140% of total net assets. These measures would reduce asset managers’ investment flexibility and hinder their income potential. Leveraged funds and those investing in illiquid assets may find it more difficult to justify their higher-than-average fees if their investment returns suffer as a result of the reform. Approximately 10% of Chinese bond funds would be affected by the proposed leverage limit (see exhibit).

5 See Chinese Investment Funds - Strong Growth to Continue, 29 June 2016. 6 See China’s Coordinated Approach to Regulating Investment Products Would Be Credit Positive for Banks, 27 February 2017. 7 Wind Information data show that 14% of Chinese fund companies earn less than $1 million. Because smaller fund companies

usually do not report data to Wind, this percentage is likely larger. 8 Leverage would be limited to 140% of their total assets for public funds and to 200% for private funds.

Vanessa Robert Vice President - Senior Credit Officer +33.1.53.30.10.23 [email protected]

Nino Siu Assistant Vice President - Analyst +852.3758.1667 [email protected]





Distribution of Chinese Bond Fund Leverage – Assets under Management/Net Asset Value Ten percent of Chinese bond funds have leverage greater than 140% of total assets.

Source: Wind Information Co.

Fund managers’ profitability would be further eroded by the cost of adapting their systems to comply with new regulatory disclosure requirements. Under the draft rules, fund managers would be obliged to register all investment products with the People’s Bank of China 10 days before launch, and to provide the regulator with monthly reports.

Over time, however, the draft rules should result in a safer asset management industry with more stable earnings and lower reputational risk. Beyond the costs, the draft rules aim to address possible causes of systemic financial risk and make the investment fund industry more stable. In the long run, fund managers should benefit from a safer sector and continue to generate strong margins with less volatility.

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Sovereigns

Germany’s Debt Reduction Accelerates with Third Consecutive Fiscal Surplus Last Thursday, DESTATIS, the German statistical office, reported a general government budget surplus of €23.7 billion (0.8% of GDP) in 2016, the third consecutive and largest surplus in absolute terms since 1991, the first year after East and West Germany’s reunification. The surplus is significantly higher than the German Stability Programme’s April 2016 forecast of 0.0% of GDP and our previous forecast of 0.4% of GDP.

The better-than-expected fiscal surplus is credit positive for the Government of Germany (Aaa stable) because it accelerates the rate at which general government debt declines, improving the sovereign’s credit quality. In addition, it reflects the government’s adherence to its target of balanced budgets, even outperforming them, and provides a buffer for a more expansionary fiscal policy.

For a second consecutive year, all sectors of government (central, state, local and social security funds) reported a surplus (see Exhibit 1). In 2016, the social security fund surplus was the largest contributor with €8.2 billion (0.3% of GDP), followed by a €7.7 billion (0.2% of GDP) surplus for the central government, €4.7 billion (0.2% of GDP) for state governments and €3.1 billion (0.1% of GDP) for local governments. The overall fiscal balance was 0.8% of GDP in 2016, supported by better-than-expected solid annual real GDP growth of 1.9%, the highest reading since 2011.

EXHIBIT 1

Germany’s Fiscal Surplus and Its Contributors

Sources: Haver Analytics, DESTATIS and Moody’s Investors Service

We expect fiscal surpluses to decrease moderately over the next three years as a result of a slightly more expansionary fiscal policy. We expect that future policies will probably include increased social spending and tax cuts against the backdrop of Germany’s elections on 24 September, as well as additional expenditures related to the refugee crisis. Nevertheless, we expect Germany to record surpluses of 0.4% in 2017 and in 2018.

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Michail Michailopoulos Associate Analyst +49.69.70730.740 [email protected]

Simon Griffin Vice President - Senior Analyst +49.69.70730.764 [email protected]

https://www.destatis.de/EN/PressServices/Press/pr/2017/02/PE17_063_813.html

https://www.moodys.com/credit-ratings/Germany-Government-of-credit-rating-333700



Although Germany’s general government debt-to-GDP ratio is declining, it is significantly higher than for many of its Aaa-rated peers. However, the gap between Germany’s debt-to-GDP ratio and the median of its Aaa-rated peers is narrowing (see Exhibit 2). In addition, Germany’s debt-to-GDP ratio has outperformed the euro area median since the end of 2013. Because of the better-than-expected fiscal outcome, we have revised down our debt-to-GDP forecast to 68.1% of GDP in 2016, 65.4% in 2017 and 63.0% in 2018.

EXHIBIT 2

Moody’s Forecast of German Debt-to-GDP Ratio We expect the debt-to-GDP ratio to decline toward the 60% Maastricht threshold.

Sources: Haver Analytics, Eurostat and Moody’s Investors Service

Germany’s fiscal surplus reflects an exceptional performance for its public finances, reaffirming the country’s track record of prudent fiscal policies and its adherence to balanced budgets and debt reduction. The surplus demonstrates that Germany’s various governmental sectors are acting together to reduce Germany’s general government debt burden. We forecast that the public debt-to-GDP ratio will be close to 60% (the Maastricht threshold) in 2019 and fall below 60% in 2020 under a baseline scenario that assumes average real GDP growth of 1.5% and average fiscal surpluses of 0.3% of GDP between 2017 and 2020. The decline will bring the debt-to-GDP ratio into line with European Commission requirements.

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Korea’s Strong External Payments Position Provides Cushion Against Shocks On 22 February, the Bank of Korea reported that the country’s net international investment position (IIP) was $278.5 billion at the end of 2016, a $74.0 billion increase from the year before and the highest level since the country began recording the statistic in 1994. It is also almost 20% of our estimate for nominal GDP. Korea’s (Aa2 stable) strengthening external payments position is credit positive because it reduces the sovereign’s vulnerability to global financial market shocks and capital outflows, which is particularly important given the country’s exposure to heightened geopolitical risk and rising global protectionism.

The continued strengthening in Korea’s IIP since 2011 reflects its large and sustained current account surpluses, as well as the strong rise in the financial account surplus. Despite an increase in the cost of energy imports and risks to export growth from a potential rise in protectionism, we expect Korea’s current account surplus to stay around 5.5%-6.0% of GDP in 2017-18. With financial account surpluses of a similar magnitude, Korea’s net IIP will continue to strengthen, which will shield the government, banking and corporate sectors from capital outflows, particularly during periods of heightened global financial market uncertainty and political risks that threaten to disrupt capital flows. Strong external buffers and reduced susceptibility to capital outflows provide the authorities with more monetary policy flexibility to offset potential negative shocks.

Last June, in light of a reduction in potentially destabilizing capital inflow pressures, the government announced revisions to its macro-prudential regulations, including raising the leverage cap on foreign-exchange forward positions to 40% of bank capital from 30% for local banks, and to 200% from 150% for foreign bank branches in Korea. Although this increased banks’ short-term external borrowings to $78.4 billion at the end of 2016 from $74.8 billion at the end of June, it has increased their flexibility in securing foreign exchange liquidity, allowing them to better respond to potential capital outflows.

Driving the further improvement in Korea’s net IIP was an increase in total external assets, which increased to $1.24 trillion at the end of 2016 from $1.14 trillion a year earlier. Reserve assets held by the Bank of Korea were the largest component of this side of the IIP balance sheet, and totaled $371.1 billion at the end of last year. The increase occurred despite the US dollar strengthening, which reduces the value of Korea’s euro- and Japanese yen-denominated portfolio investments, all else equal (and reduces the dollar value of such liabilities invested in Korea). Korea remains a net creditor in all three currencies.

At the same time, total external liabilities increased to $961.2 billion from $939.5 billion a year earlier, driven by an increase in portfolio equity investment in Korea. External debt of $380.9 billion (approximately 27.3% of GDP) and portfolio investment in equities of $384.2 billion constituted the bulk of external liabilities.

As the exhibit below shows, the direct investment position turned positive beginning in mid-2010, as Korean direct investment abroad outpaced foreign direct investment inflows. In addition, Korea’s net IIP has posted a small but growing net other investment asset position since the fourth quarter of 2013. Other investment asset growth has been predominantly driven by deposit-taking corporations’ growing external lending and deposits, whereas other investment liabilities have been moving sideways since 2008, driven by a reduction in banks’ external borrowings following the implementation of macro-prudential measures.

Shirin Mohammadi Associate Analyst +1.212.553.3256 [email protected]

Steffen Dyck Vice President - Senior Credit Officer +49.69.70730.942 [email protected]

http://www.bok.or.kr/down.search?file_path=/attach/eng/626/2017/02/1487662082968.pdf&file_name=International+Investment+Position%28End+of+2016%29.pdf

https://www.moodys.com/credit-ratings/Korea-Government-of-credit-rating-440230




Korea’s Net International Investment Position and Its Components

Note: Net IIP components are shown on net basis (assets minus liabilities); GDP is calculated on a four-quarter rolling basis and includes our estimate for fourth-quarter 2016. Sources: Bank of Korea and Moody’s Investors Service calculations

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Pakistan’s Import Controls Signal Mounting External Pressures Last Friday, the State Bank of Pakistan introduced a 100% cash margin requirement (foreign currency for the full purchase amount) on certain imported consumer goods including vehicles and home appliances. Through these measures, the Government of Pakistan (B3 stable) intends to partly offset the increase in capital goods imports under the China-Pakistan Economic Corridor (CPEC) infrastructure development project, which we expect will continue to widen the trade deficit as the project picks up. The controls on imports are credit negative for Pakistan because they signal policymakers’ limited tools to mitigate a persistent widening of the current account deficit.

The cash margin requirement on vehicles and appliances imports will likely curtail purchases of these items. However, such controls tend to be porous and some transactions will likely move to unofficial markets to avoid them. Moreover, the new requirements are unlikely to fully offset other factors that will weigh on the current account.

As a net oil importer, Pakistan benefited from lower global oil prices, but the uptick in prices last year combined with an increase in imported CPEC capital goods widened the trade and current account deficits (see exhibit). In 2016, goods imports increased by 5.9% from a year earlier, while exports declined by 4.1%. We expect the current account deficit to continue to widen in the foreseeable future, to 2.0% of GDP in 2018. The widening of the current account deficit will be driven by continued expansion of the trade deficit, subdued growth in remittance inflows from Gulf Cooperation Council (GCC) countries, and increased interest payments on external debt related in particular to CPEC projects, which are recorded as negative primary income in the current account.

Pakistan’s Current Account, Four Quarters Moving Sum, $ Billions

Sources: State Bank of Pakistan and Moody’s Investors Service calculations

Worker remittances from abroad have accounted for 32% of Pakistan’s current account receipts, on average, over the past five years, and around 6.5% of GDP. Therefore, they have provided critical support to Pakistan’s balance-of-payments stability in the past. However, total US dollar remittances shrank by 2.4% year on year in the second half of 2016, after expanding by 5.7% during the same period a year earlier. The decline is due primarily to slowing economic conditions in the GCC, where the prolonged period of low oil prices has prompted fiscal tightening. Around 64% of Pakistan’s total remittances come from GCC economies. Given our assumptions that oil prices will not increase significantly over the next two years, we expect that many of these countries will undergo lasting economic adjustments that weigh on employment trends and remittance outflows from the region.

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Shirin Mohammadi Associate Analyst +1.212.553.3256 [email protected]

William Foster Vice President - Senior Credit Officer +1.212.553.4741 [email protected]

http://www.sbp.org.pk/press/2017/Pr-24-Feb-17.pdf

https://www.moodys.com/credit-ratings/Pakistan-Government-of-credit-rating-600014774




At the same time, we expect external debt interest payments to rise as a result of the financial inflows that will accompany CPEC projects. The $45 billion China-funded investment deal to boost transportation and power generation infrastructure in Pakistan should gradually bolster Pakistan’s growth potential by reducing supply-side bottlenecks. However, in addition to foreign direct investment inflows, project capital expenditure and imports will also be financed through external loans. As a result, interest payments on such debt will contribute to a steady increase in income outflows, thereby exacerbating the current account deficit.

This expected increase in CPEC-related bilateral foreign currency debt could weigh on future foreign exchange reserves adequacy. Foreign exchange reserve buffers have increased nearly fourfold since the 2013 onset of Pakistan’s most recent International Monetary Fund (IMF) Extended Fund Facility program and they cover more than the full amount of external debt payments. However, they are still low in relation to current account payments. For example, Pakistan’s import coverage only recently edged up to just over four months in January – slightly above the three-month minimum adequate level, according to the IMF – from less than one-month coverage in late 2013. Moving forward, how Pakistani policymakers choose to handle such external balance of payment pressures related to CPEC will affect our assessment of the sovereign’s credit quality.



Sri Lanka’s Drought-Related Costs Add to Challenge of Achieving Fiscal Targets On Saturday, the Government of Sri Lanka (B1 negative) announced that it will continue to provide compensation to households affected by the country’s worst drought in 40 years. The government will provide LKR10,000 (or about $65.95) per acre of unusable, dried out rice paddies and compensation for other crops for a period of four months. The compensation is in addition to LKR82 million of drought-related spending so far. Although these measures provide affected families with income, they will increase government spending at a time when Sri Lanka’s fiscal strength is low. Therefore, Sri Lanka’s ambitious 2017 fiscal deficit target will be even more challenging to achieve, a credit negative.

Drought-related government spending will add to the challenge of containing public expenditures as specified under Sri Lanka’s current International Monetary Fund (IMF) Extended Fund Facility program. The government projects a 17.0% increase in overall spending this year, after a decline of 0.7% in 2016 and annual average increases of nearly 12.0% from 2010 to 2015. The increase in planned spending this year largely reflects higher growth-enhancing infrastructure outlays, leaving limited room to cut current expenditures.

No official information is available yet on the extent of the damage to crops, but if half the paddy acreage sown in 2015 is unusable, that would equal 1.5 million acres and the fiscal cost of the compensation would be 0.1%-0.2% of GDP, plus costs related to compensation for other crops. According to the Sri Lankan Ministry of Disaster Management and World Food Programme, only 35% of cultivable rice paddy land had been farmed as of the end of November, the lowest level in the last 30 years. Meanwhile, Sri Lanka’s major reservoirs were at only 29% of capacity as of the end of December, and hydropower availability was only 30% of total installed capacity.

The drought will weigh on GDP growth because of lower overall agricultural production. We expect the drought to weigh on economic activity in the first half of this year, with the summer monsoon rains providing some relief in the second half. Lower agricultural output will reduce exports, household income and consumption in affected areas, posing downside risks to GDP growth. We currently expect real GDP to increase by 5.0% in 2017, which is materially lower than the government’s forecast of 6.0%.

Weaker economic activity will weigh on government revenues. We currently forecast a fiscal deficit at 5.2%, which could be revised upward if the negative credit effect of the drought worsens or is not offset by other fiscal measures (see Exhibit 1). Under the IMF’s Extended Fund Facility program, the government targets a deficit of 4.6% of GDP in 2017.

William Foster Vice President - Senior Credit Officer +1.212.553.4741 [email protected]

Amelia Tan Associate Analyst +65.6398.8323 [email protected]

https://www.moodys.com/credit-ratings/Sri-Lanka-Government-of-credit-rating-600023158



EXHIBIT 1

Sri Lanka’s Fiscal Deficit and Real GDP Growth We expect Sri Lanka’s fiscal deficit to decline only modestly this year.

Sources: Haver Analytics and Moody’s Investors Service estimate and forecast

Moreover, lower agricultural exports and higher imports to substitute for the loss in domestic production will weigh on Sri Lanka’s current account deficit and foreign-exchange reserve buffers, a key constraint to Sri Lanka’s credit quality.

Sri Lanka, like many of its South Asian neighbors, is highly vulnerable to climate change because the magnitude and dispersion of seasonal monsoon rainfall influences agricultural sector growth and rural household consumption. Therefore, droughts can create economic and social costs for the sovereign. For Sri Lanka, the agricultural sector makes up about 9% of GDP and about 28% of the economy’s workforce (see Exhibit 2).

EXHIBIT 2

Sri Lanka’s 2015 GDP by Sector (Gross Value Added) Agriculture contributes nearly 10% of the economy’s GDP.

Source: Central Bank of Sri Lanka

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Securitization

Germany’s Public-Sector Pfandbriefe Benefit from Government’s Better-than-Expected Fiscal Surplus Last Thursday, DESTATIS, the German statistical office, announced that Germany had recorded a general government budget surplus of €23.7 billion in 2016. Last year’s budget surplus is the largest in absolute terms since 1991, the first year after East and West Germany’s reunification and the country’s third consecutive. The 2016 general government surplus accounts for 0.8% of GDP, which is higher than the German Stability Programme’s April 2016 breakeven forecast and our previous forecast of a 0.4% of GDP. The higher-than-expected budget surplus is credit positive for public-sector Pfandbriefe (covered bonds) because it supports the credit quality of German public-sector obligors.

Cover pools of German public-sector Pfandbriefe primarily consist of claims against public-sector obligors9 in the European Economic Area, Canada, Japan, Switzerland and the US, and German obligors that have either tax-10 or levy-raising power.11 The cover pool asset type that benefits from the higher-than-expected budget surplus are claims against German public-sector obligors. As of 30 September 2016, these obligors accounted for 65.7% of all cover pool assets on an aggregated basis, according to Association of German Pfandbrief Banks data (see Exhibit 1).

EXHIBIT 1

Aggregated Cover Pool Composition of Public-Sector Pfandbriefe as of 30 September 2016

Sources: Association of German Pfandbrief Banks and Moody’s Investors Service

9 This includes central governments, regional governments and local authorities. 10 A registered religious community, for example, is not a public-sector obligor but is an obligor that has tax-raising power. 11 A waste management company, for example, is typically not a public-sector obligor but is Pfandbrief cover-pool eligible if it has levy

raising power, even if does not benefit from a guarantee or other form of support from a regional government or local authority.

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€ 10.8 € 10.4 € 3.8 € 5.4 € 4.5 € 1.9 € 0.4 € 0.3

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Patrick Widmayer Vice President - Senior Analyst +49.69.70730.715 [email protected]

Martin Lenhard Vice President - Senior Credit Officer +49.69.70730.743 [email protected]



Although the majority of German cover pool assets benefit from the higher-than-expected general government budget surplus, individual public-sector Pfandbriefe benefit with varying degree. This is because cover pools backing Pfandbriefe are heterogeneous both in respect of the obligor type distribution within Germany and internationally. The three public-sector Pfandbrief programs of the 17 programs that we rate that will benefit most are those of UniCredit Bank AG (A2/Baa1 stable, baa212), Sparkasse KoelnBonn (Aa3/A2 stable, ba1) and SEB AG (A2 stable, baa3). These Pfandbriefe’s cover pools have the highest share of claims against German public-sector obligors (see Exhibit 2), according to Association of German Pfandbrief Banks data as of 30 September 2016. All three public-sector Pfandbrief programs are Aaa rated.

EXHIBIT 2

Share of German Public-Sector Obligors in Public-Sector Pfandbriefe as of 30 September 2016

Sources: Association of German Pfandbrief Banks and Moody’s Investors Service

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

credit assessment.

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https://www.moodys.com/credit-ratings/UniCredit-Bank-AG-credit-rating-96025

https://www.moodys.com/credit-ratings/Sparkasse-KoelnBonn-credit-rating-600016982

https://www.moodys.com/credit-ratings/SEB-AG-credit-rating-600022766

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


NEWS & ANALYSIS Corporates 2 » Restaurant Brands’ Acquisition of Popeyes Will

Increase Leverage » Boston Scientific Recalls Its Lotus Valve, a Credit Negative » SourceHOV’s Reverse IPO Merger with Novitex and

Quinpario Is Credit Positive » Brazil’s Votorantim Steel Deal with ArcelorMittal

Eases Leverage » China’s Curbs on Secondary Equity Offering Reduce Funding

Flexibility for Listed Companies » Alibaba’s Strategic Partnership with Bailian and Further

Expansion into Offline Retail Is Credit Positive » Singtel’s Latest Digital Marketing Acquisition Keeps

Leverage Elevated » Oil India and ONGC Will Benefit from Government Royalty

Claims Settlement » Parkway Life REIT’s Acquisition of Japanese Assets Enhances

Portfolio Quality, Extends Lease-Expiry Profile

Infrastructure 16 » Japanese Utility Kansai Electric’s Preliminary Nuclear Restart

Approval Is Credit Positive

Banks 18 » Desjardins’ Sale of Subsidiary’s Insurance and Brokerage

Operations Is Credit Positive » Brazilian Measure to Stimulate Mortgage Lending Is Credit

Positive for Banks » Royal Bank of Scotland May Not Need to Divest Williams &

Glyn, a Credit Positive » Germany’s Overvalued Real Estate Market Poses Risks for

Banks and RMBS

» Germany’s Deposit Protection Fund Reforms Make It More Viable, Benefitting Banks

» German Court’s Validation of Contract Cancellations Is Credit Positive for Building and Loan Associations

» BPCE’s Reduction of Its Domestic Branch Network Is Credit Positive

» Raiffeisen Schweiz's Mortgage Lending Grows as Margins Shrink, a Credit Negative

» Sweden’s MREL Framework Is Credit Positive » China’s Coordinated Approach to Regulating Investment

Products Would Be Credit Positive for Banks » SMBC and Resona Combining Subsidiary Banks in Japan’s

Kansai Region Would Be Credit Positive

Financial Market Infrastructure 36 » UK Proposals to Enhance Supervision of Financial Market

Infrastructure Companies Are Credit Positive

Sovereigns 37 » Hong Kong’s Budget Balances Economic Support with Fiscal

Prudence, a Credit Positive » Korea’s Rising Household Debt Poses Downside Risks to

Economic Growth

Sub-sovereigns 41 » German Laender’s Salary Pact with Public Employees Is

Credit Positive » Australian Universities to Benefit from Growing International

Student Enrollments

US Public Finance 44 » Kansas Governor Vetoes Tax Hike, a Credit Negative






































































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