MOODYS.COM

5 SEPTEMBER 2016

NEWS & ANALYSIS Corporates 2 » Multiemployer Pension Benefit Cut Filings Are Credit Positive

for Sponsors » R.R. Donnelley's Spin Transaction Promises Improvement in

Leverage » European Satellite Operators Face Credit-Negative Delays from

Rocket Explosion » Ista's Voluntary Prepayments on Its Term Loan Are Credit

Positive » Hutchison 3G-Wind Merger Is Credit Positive » China Railway Construction Wins Kano, Nigeria Light Rail

Project, a Credit Positive

Banks 11 » US Banks' Improving Expense Efficiency Is Credit Positive » Swaps Margin Rule Is Credit Positive for US Global Investment

Banks » Banco Comafi's Planned Purchase of Deutsche Bank's Argentine

Subsidiary Is Credit Positive » Sparebanken Vest's Additional Tier 1 Bond Issue Is Credit

Positive » Nordic Banks Risk Losses as Norway's Oil Woes Mount with

Farstad's Second-Quarter Results » Hatton National Bank's Capital Increase Is Credit Positive » Creditor Banks Reject Hanjin Shipping's Self-Rescue Plan, a

Credit Positive

Insurers 24 » US Response to Insurer Withdrawals from Affordable Care Act

Exchanges Poses Credit-Negative Threat

Sovereigns 26 » Ruling on Ireland's Taxation of Apple Could Threaten Its

Successful Foreign Direct Investment Strategy » Spain's Political Deadlock Could Lead to Early Elections,

Increasing Fiscal and Economic Risks » Egypt's Long-Awaited Approval of Value-Added Tax Is Credit

Positive » Uganda Grants Long-Delayed Oil Production Licences, a Credit

Positive » Ethiopia Signs Hydropower Export Deal with Tanzania, a Credit

Positive » Zimbabwe's Foreign Donor Support Weakens after Police

Suppress Protesters » Sierra Leone Graft Arrests Are Credit Positive » Korea's Net International Investment Position Reduces External

Vulnerabilities » India's Deficit in April-July Points to Large Investment Spending

Cuts Later, a Credit Negative

RECENTLY IN CREDIT OUTLOOK

» Articles in Last Monday’s Credit Outlook 42 » Go to Last Monday’s Credit Outlook

The next issue of Moody’s Credit Outlook will be Monday 12 September.

NEWS & ANALYSIS Credit implications of current events

2 MOODY’S CREDIT OUTLOOK 5 SEPTEMBER 2016

Corporates

Multiemployer Pension Benefit Cut Filings Are Credit Positive for Sponsors Last Wednesday, the New York State Teamsters Conference Pension and Retirement Fund (NY Conference) submitted an application to the US Treasury to cut benefits by 28%. Besides having a severe effect upon retirees, if approved, the application would save NY Conference’s sponsors $1.6 billion, a credit positive. This is the eighth plan to file for a benefit cut since October 2015, reflecting the ongoing stress to multiemployer pension plan (MEPP) sponsors and federal backstops alike. If further plans receive approvals for benefit cuts and/or the US government infuses $101 billion of cash into the Pension Benefits Guarantee Corporation (PBGC), it would be credit positive for plan sponsors.

The NY Conference’s application, if approved, means a lower contingent call on future funding for its sponsors. NY Conference’s largest contributor in 2015 was United Parcel Service, Inc. (Aa3 negative), which contributed $86 million of $135 million total contributions. The remaining contributions came from small and midsize enterprises or large corporates with few Teamster employees.

Despite NY Conference’s dire financial position, ($5.9 billion in liabilities and only $1.4 billion in assets as of 31 December 2015), approval of the cut is not guaranteed. The Treasury has denied two of seven previous applications, most notably Central State Southeast and Southwest area Pension Plans; the other five remain under adjudication. Despite the two previous denials, we expect that more applications for benefit reductions will be filed given overall funding problems for MEPPs. We estimate that the MEPP universe was collectively only 47% funded at the end of 2014. When 2015 data becomes available in October, we expect to see further deterioration in these funding levels because of falling discount rates and subpar asset performance.

These low funding levels negatively affect company cash flows and threaten the viability of the governmental agency tasked to insure the pension benefits of private-sector workers. The PBGC multiemployer fund disclosed $54 billion in liabilities and only $2 billion in assets as of 30 September 2015. These numbers are simply unworkable, and without an immediate 363%-552% increase in plan sponsor premiums, the PBGC forecasts that it will be insolvent in the next 10-20 years.

A PBGC insolvency would substantially reduce the current and future pensions of at least 500,000 retirees. In response to a request from Senate Committee on Finance Chairman Orrin Hatch, the Congressional Budget Office (CBO) issued a report on 2 August 2016 to analyze what policy options are available to improve the PBGC’s financial condition. The CBO’s report reiterates the impossible task that the PBGC faces if the status quo remains, but lays out nine different policy options to avoid a PBGC insolvency.

Of the nine options, the CBO concludes that only two basic strategies would allow the PBGC to remain solvent through 2036. Both options require massive infusions of cash into the PBGC, the only difference being the source. The CBO estimates that a $23-$51 billion increase in premiums from companies would allow the PBGC to operate until 2036, a credit negative for MEPP sponsors. The second option would be to provide federal funding to recapitalize PBGC and cover all multiemployer insurance claims. The CBO estimates that this strategy would cost the federal government $101 billion, which would be credit positive for plan sponsors because it would remove the contingent calls on cash resulting from higher premiums. The CBO made no recommendations in its report.

Wesley Smyth Vice President - Senior Accounting Analyst +1.212.553.2733 wesley.smyth@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 5 SEPTEMBER 2016

R.R. Donnelley’s Spin Transaction Promises Improvement in Leverage Last Wednesday, R.R. Donnelley & Sons Company (RRD, Ba3 developing) announced a conditional tender offer for $1 billion of its outstanding debt, bringing a major spinoff deal announced a year ago closer to completion. The transaction will be credit positive for the company, which will use equity from the spun-off companies to reduce debt while also reducing its proportionate pension, lease and dividend payment obligations.

In August 2015, RRD announced a tax-free spin of two separate, public companies: LSC Communications, a retail-oriented print services and office products company, and Donnelley Financial Solutions (DFS), a financial communications and data service company. Post-spin “Remain-co” RRD will continue as a small batch printing company also offering design, logistics and supply-chain management services.

All three companies will have less diversity and scale than today’s RRD, a credit negative for each. However, the transaction promises credit benefits for Remain-co RRD. The company will retain a portion of the spun-off companies’ equity and will later sell the positions, enhancing RRD’s debt-reduction ability.

Spinning off LSC and DFS will also shrink RRD’s proportionate pension and lease adjustments. After the spinoffs, pro forma for the estimated retained equity interest sales proceeds, RRD’s adjusted debt/EBITDA ratio will improve slightly to 3.8x from 4.0x as of 30 June 2016. If RRD maintains modest top-line growth and constant margins, and reduces debt with its free cash flow, its leverage will continue to improve during 2017-18.

Although management has not yet commented on post-spin dividend policies for any of the three companies, we expect RRD to disaggregate its $215 million annual dividend, since it is also disaggregating its operations and finances. Since RRD’s existing dividend would consume 80%-90% of the post-spin RRD’s available cash flow if left intact, we assume the company’s management would act to reduce it. If RRD allocated about 10% of its EBITDA toward dividends, as its competitor Quad/Graphics Inc. (Ba3 stable) does, it would be left with some $150-$200 million of free cash flow, which would allow its leverage to decrease towards 3x in 2018.

Bill Wolfe Senior Vice President +1.416.214.3847 bill.wolfe@moodys.com

NEWS & ANALYSIS Credit implications of current events

4 MOODY’S CREDIT OUTLOOK 5 SEPTEMBER 2016

European Satellite Operators Face Credit-Negative Delays from Rocket Explosion On Thursday, a SpaceX rocket blew up on a launch pad at Cape Canaveral, Florida, also destroying the satellite it would have carried into space on 3 September. There were no injuries. The incident is credit negative for Eutelsat Communications SA (Ba1 stable) because the now-destroyed satellite will result in lost revenue. Additionally, SpaceX’s flight schedule for 2016-17 will likely be delayed, forestalling the commercial launch of other satellites that SpaceX has been hired to carry into space. The delays would be credit negative for European satellite operators SES S.A. (Baa2 stable) and Inmarsat plc (Ba1 negative).

The destroyed satellite was the Israeli satellite communications company Spacecom’s (unrated) Amos-6, whose Ka-band broadband-focused payload had been leased to Eutelsat and Facebook to provide broadband service to Sub-Saharan Africa starting in early 2017.

Eutelsat estimates that the lost revenue from the project will be €5 million (0.3% of revenues) in fiscal 2017 (which ends 30 June 2017), €15 million in fiscal 2018 (1.0% of estimated revenues) and €25-€30 million in fiscal 2019. Eutelsat noted that cost savings arising from not operating the satellite would mitigate the incident’s effect on the company’s EBITDA margin. The event follows Eutelsat’s 29 July revised guidance of a 1%-3% revenue decline in fiscal 2017, versus an earlier forecast of a 4%-6% increase. Since the Florida incident, Eutelsat has confirmed its July guidance.

For SES and Inmarsat, the effects are less immediate but nonetheless negative because both companies have scheduled flights on SpaceX rockets this year and next. SES has plans to launch two satellites in fourth-quarter 2016 using SpaceX rockets, and another two in the second half of 2017. Inmarsat has scheduled launches with SpaceX of a satellite in the fourth-quarter of 2016 and one in the first half of 2017. The exhibit below shows SES’ and Inmarsat’s scheduled launches on SpaceX rockets this year and next.

SES’s and Inmarsat’s Satellite Scheduled Launches with SpaceX

Sources: SES, Inmarsat and SpaceX

As a result of Thursday’s explosion, both companies are likely to experience delays in their satellite expansion plans, particularly SES. Inmarsat has already made alternative arrangements with International Launch Services, diminishing the effect of any delays in SpaceX’s launch calendar.

Thursday’s explosion was similar to one that occurred in June 2015, after which SpaceX suspended its commercial satellite launches for nearly half a year. That suspension led to a delay in the launch of an SES satellite, and prompted SES to revise its guidance for 2015.

SES10

SES11

SES14SES16

I5 F4

Europasat

4Q2016 1H 2017 2H 2017

Inmarsat SES

Alejandro Nunez Vice President - Senior Analyst +44.20.7772.1389 alejandro.nunez@moodys.com

NEWS & ANALYSIS Credit implications of current events

5 MOODY’S CREDIT OUTLOOK 5 SEPTEMBER 2016

Ista’s Voluntary Prepayments on Its Term Loan Are Credit Positive Last Wednesday, Trionista TopCo GmbH (B1 stable), the intermediate holding company of Germany-based sub-metering services provider ista International GmbH, announced an €80 million voluntary prepayment, effective 7 September 2016, on its €1.3 billion senior secured term loan due April 2020 and issued by direct subsidiary Trionista HoldCo GmbH. This is ista’s third debt repayment on the term loan this year, following €60 million in January and €10 million in April. The voluntary repayment is credit positive for ista because it accelerates deleveraging and slightly improves interest coverage and free cash flow.

Pro forma for the €80 million prepayment, ista’s leverage ratio will decline by around 0.2x to a Moody’s-adjusted debt/EBITDA of 6.2x for the 12 months that ended 30 June 2016. All three prepayments, which total €150 million, account for a pro forma reduction in leverage by more than 0.4x this year. We now expect ista’s leverage to decline to around 6.0x by the end of March 2017, supported by the company’s solid earnings generation. This level would position ista’s leverage within our quantitative guidance for a B1 rating. Leverage at year-end 2016 may still exceed 6.0x if the company funds part of the debt repayment with a temporary drawing of its €150 million revolving credit facility, which was fully available as of 30 June 2016 (see Exhibit 1). The €150 million decrease in debt also reduces ista’s annual interest expenses by around €4.5 million.

EXHIBIT 1

Ista’s Debt and Moody’s-Adjusted Debt/EBITDA

Note: * Last 12 months data is partially based on Moody’s estimates. Source: Moody’s Financial Metrics, with estimates based on our forward view

The voluntary debt repayments reflect ista’s prudent financial policy to apply substantial parts of its excess cash to debt reduction. It also contrasts with ista’s direct German peer Techem Energy Metering Service GmbH & Co. KG (B1 positive). Although Techem has a smaller debt burden and stronger leverage metrics (its Moody’s-adjusted debt/EBITDA was 4.8x for the 12 months that ended 30 June 2016), it has had negative free cash flow since the fiscal year that ended March 2016 owing to increased dividend payments to its shareholder Macquarie. In contrast, ista has consistently generated positive free cash flow and made only small dividends. As a result, ista’s free cash flow metrics have outperformed Techem’s over the past three years, with adjusted free cash flow/debt of 2.9% in the 12 months that ended June 2016 versus Techem’s negative 6.6% (see Exhibit 2). Although ista’s free cash flow, €130 million cash balance and €150 million undrawn revolving credit facility as of 30 June 2016 can accommodate the €80 million repayment, further large extraordinary cash outflows this year risk harming the company’s liquidity, which we currently regard as solid.

9.0x

7.3x 6.9x 6.6x 6.4x

0x

2x

4x

6x

8x

10x

€ 0.0

€ 0.5

€ 1.0

€ 1.5

€ 2.0

€ 2.5

€ 3.0

2012 2013 2014 2015 LTM Jun-16* 2016E 2017E

€Bi

llion

s

Debt - left axis Debt/EBITDA - right axis

Goetz Grossmann Analyst +49.69.70730.728 goetz.grossmann@moodys.com

Karoline Metzger Associate Analyst +49.69.70730.912 karoline.metzger@moodys.com

NEWS & ANALYSIS Credit implications of current events

6 MOODY’S CREDIT OUTLOOK 5 SEPTEMBER 2016

EXHIBIT 2

Ista’s and Techem’s Moody’s-Adjusted Free Cash Flow and Ratio of Free Cash Flow to Debt

Notes: * Data for fiscal year ended 31 March. ** Data partially based on Moody’s estimates. Source: Moody’s Financial Metrics:

Essen, Germany-based ista is a leading global provider of energy services relating to sub-metering of heat and water consumption for multi-occupant housing units, energy cost allocation and billing services and adjacent services. In the 12 months that ended 30 June 2016, ista reported €826 million in revenues and EBITDA (as adjusted by the company) of €350 million. Ista is owned by funds managed by private-equity firm CVC Capital Partners Ltd., which acquired the company in 2013 after owning a minority stake since 2007.

2.7% 3.2% 3.0% 2.9%

-3.5%

-6.6%

1.8%

3.1% 3.3% 3.7%

2.2%2.9%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

-€ 100

-€ 80

-€ 60

-€ 40

-€ 20

€ 0

€ 20

€ 40

€ 60

€ 80

€ 100

2011 2012 2013 2014 2015 LTM Jun 2016**

€M

illio

ns

Techem FCF* ista FCF Techem FCF/Debt* ista FCF/Debt

NEWS & ANALYSIS Credit implications of current events

7 MOODY’S CREDIT OUTLOOK 5 SEPTEMBER 2016

Hutchison 3G-Wind Merger Is Credit Positive Last Thursday, the European Commission (EC) approved the proposed merger between CK Hutchison Holdings Limited’s (CKHH, A3 stable) Italian subsidiary, H3G (unrated), and Wind Telecomunicazioni S.p.A. (Wind, B2 positive), a subsidiary of VimpelCom Ltd (Ba3 stable). The merger is credit positive for both Wind and H3G because of the combined entity’s larger scale, and opportunities to achieve synergies and deleveraging. The companies expect the merger’s completion by the end of the year, once national regulatory approvals are obtained.

The merger was approved with the condition that the joint venture implements structural remedies designed to maintain mobile competition in Italy. These include the sale of spectrum frequency (see Exhibit 1) and several thousand radio access network (RAN)-sharing sites for rural areas, as well as the creation of a national roaming agreement (including 2G, 3G and 4G). The effective remedies will allow French operator Iliad (unrated) to enter Italy as the new fourth mobile operator.

EXHIBIT 1

Italy’s Spectrum Share after the Joint Venture Agreement

Sources: Company data and Moody’s Investors Service estimates

The combined entity will be the largest mobile operator in Italy with 31 million subscribers and roughly a 34% market share (see Exhibit 2) and the third-largest in terms of revenues, after Telecom Italia S.p.A. (Ba1 negative) and Vodafone Group Plc’s (Baa1 stable) subsidiary in Italy, Vodafone Italy (unrated).

EXHIBIT 2

Pro-Forma Telephony Market Share Estimates for Italy Following the Joint Venture’s Approval

Source: The Italian Communications Regulatory Authority as of March 2016

0

20

40

60

80

100

120

140

160

180

200

Telecom Italia Vodafone Italia Wind / H3G Iliad

Meg

aHer

tz

< 1.0 GHz 1.0 GHz to 2.1 GHz > 2.1 GHz

0%

10%

20%

30%

40%

50%

60%

Telecom Italia Wind/H3G Vodafone Fastweb Others

Fixed Broadband Mobile

Javier Gayol Associate Analyst +34.917.68.8243 javier.gayol@moodys.com

NEWS & ANALYSIS Credit implications of current events

8 MOODY’S CREDIT OUTLOOK 5 SEPTEMBER 2016

We expect that the Wind/H3G joint venture will accelerate investments on its fixed-line business, which only contributes around 28% of Wind’s total revenues, with a special focus on the enhancement of its network speed by accelerating fibre rollout, which will also be supported by the Enel Open Fibre project.

In addition, the combined entity will benefit from up-selling opportunities as well as realigning tariffs and new mobile services and cross selling through dual-play offering. Furthermore, the joint venture will bring some natural cost synergies and efficiencies, particularly in network and IT, customer operations and selling, general and administrative expenses. The companies expect to generate capex and opex synergies with a net present value in excess of €5 billion, net of integration costs. Annual run-rate cash synergies will amount to €700 million by the third year after merger completion.

Even though the divestment of assets for the merger will enable Iliad to offer competitive mobile services, we do not expect that Iliad will be disruptive over the next two to three years. Iliad does not have a fixed-line business to leverage on and prices are already low to accommodate a discounted offer. In addition, Iliad’s weaker spectrum portfolio (as shown in Exhibit 1) would limit its capacity to aggressively discount. This also means that 700MHz spectrum will be more strategic for Iliad, which will likely push spectrum prices higher.

Given that CKHH’s Italian assets are consolidated on a debt-free basis, plus €200 million cash from H3G, Wind/3 Italia’s leverage will decline to 4.5x on a pro-forma basis, according to our calculations (see Exhibit 3). The joint venture has the capacity to further reduce leverage as a result of CKHH’s and Vimpelcom’s sale of part of their Italian mobile assets over the next two to three years. The €450 million of proceeds from the sale of the spectrum frequencies would reduce the combined entity’s debt/EBITDA of around 0.2x. Tower sales’ related amounts have not been disclosed, but we expect more than 6,000 sites may be sold.

EXHIBIT 3

Wind/H3G’s Key Financial Indicators, € Millions Wind H3G Combined

Revenues € 4,304 € 1,825 € 6,129

EBITDA € 2,222 € 276 € 2,498

EBITDA Margin 52% 15% 41%

Capex € 780 € 446 € 1,226

EBITDA-Capex € 1,442 € -170 € 1,272

Business Model Fixed & Mobile Mobile Fixed & Mobile

Mobile Market Share 23% 10% 33%

Fixed Market Share 14% 0% 14%

Subscribers 24 million 10 million 34 million

Spectrum Ownership 31% sub 1GHz 24% over 1GHz

8% sub 1GHz 27% over 1GHz

31% sub 1GHz 37% over 1GHz

Debt/EBITDA (reported) 5.0x 0.0x 4.5x

Note: Spectrum ownership takes into account spectrum to be sold to Iliad.

Source: Company reports as of December 2015

Furthermore, Wind/3 Italia will benefit from additional wholesale revenues derived from the roaming agreement with Iliad. This additional source of revenues, jointly considered with its reinforced competitive positioning and its synergy potential, should allow further deleveraging, although achieving it will take time.

Wind’s B2 rating and positive outlook reflect the potential for an upgrade once the transaction is closed and the new entity’s business plan, capital structure and financial policy targets are more visible.

NEWS & ANALYSIS Credit implications of current events

9 MOODY’S CREDIT OUTLOOK 5 SEPTEMBER 2016

China Railway Construction Wins Kano, Nigeria Light Rail Project, a Credit Positive On 29 August, China Railway Construction Corp Ltd (CRCC, A3 negative) announced that it had won its RMB12.0 billion construction bid for the Light Rail Project in Nigeria’s capital city of Kano. Over the past five years, CRCC has acquired major inter-city rail mass transit, railway, bridge and terminal construction contracts in Nigeria, a key African market for CRCC, one of the world’s largest integrated construction companies, that mainly focuses on railway, highway, urban rail transit and housing construction. The LRT project will help the company strengthen its competitive position and gain more business in Nigeria, a credit positive.

The contract equals approximately 0.7% of CRCC’s total order backlog and 3.3% of its overseas order backlog as of 30 June 2016, and 2.0% of the company’s RMB604 billion revenue for the 12 months that ended 30 June 2016. The 74.3 kilometer LRT project will have a construction period of two years for each of Phase I and Phase II. The contract award is still subject to the final execution of the general contracting and subcontracting agreement.

We project CRCC’s revenue from its overseas operation will grow to about 7%-8% of total revenue over the next three years from about 5.5% in the first half of 2016, reflecting its efforts to penetrate overseas markets. CRCC’s revenue should grow low-single-digit percentages per year over the next 12-18 months, given its large order backlog of RMB1.83 trillion as of 30 June 2016, continued overseas expansion, and the likelihood that China’s solid infrastructure spending on railways, urban rail and roads will continue over the next two years. Additionally, we expect CRCC’s adjusted EBITDA margin to remain stable at 6.4% over the next 12-18 months, driven by its extended service offerings and continued cost controls.

CRCC will keep its investments in real estate and build-operate-transfer projects to manageable levels, limiting increases in debt over the next 12-18 months. We therefore expect CRCC’s adjusted debt/EBITDA to remain at around 4.5x-5.0x over the next 12-18 months.

Chenyi Lu Vice President - Senior Analyst +852.3758.1353 chenyi.lu@moodys.com

NEWS & ANALYSIS Credit implications of current events

10 MOODY’S CREDIT OUTLOOK 5 SEPTEMBER 2016

Banks

US Banks’ Improving Expense Efficiency Is Credit Positive Last Tuesday, the US Federal Deposit Insurance Corporation (FDIC) released its Quarterly Banking Profile for second-quarter 2016. A credit-positive highlight of the report was an improvement in the industry’s operating efficiency. The improvement was driven by significant management focus on reducing expenses and lower litigation costs at large banks.

Banks’ improved efficiency is an appropriate response to the industry’s ongoing revenue challenges, highlighted by protracted low interest rates. On a year-over-year basis, the FDIC reported that 30% of all institutions (commercial banks and savings institutions) reported a drop in expenses compared with the previous year, which is notable considering the industry’s rising compliance, cybersecurity and risk management demands.

The FDIC’s calculation of banks’ efficiency ratios takes their noninterest expenses, less amortization of intangible assets, as a percent of their net interest income plus noninterest income. As shown in Exhibit 1, for banks with assets of more than $1 billion, the ratio improved to 56.8% in the second quarter, or about 150 basis points over the year-ago level.

EXHIBIT 1

Efficiency Ratio for US FDIC-Insured Institutions with Assets Exceeding $1 Billion Banks’ improved efficiency shows that management expense initiatives have gained traction.

Source: US Federal Deposit Insurance Corporation

At the largest US banks, elevated regulatory and compliance expenses in recent years have largely offset concerted cost-cutting efforts. For example, although all banks have to contend with the cost of new technology initiatives such as cybersecurity and the development of digital banking channels, the largest banks also have heightened stress-testing requirements and, in some cases, the added expense of resolution planning.

Exhibit 2 shows that despite a 6% median headcount reduction from 2012 through the end of 2015 at 16 of the largest US banks, our measure1 of their median efficiency ratio was little changed, though it too moved in the right direction, dropping to 63% from 66% over the period depicted.

1 Our efficiency calculation incorporates our standard adjustments and differs from the FDIC’s measure since we do not subtract

the amortization of intangibles from noninterest expenses.

0%

10%

20%

30%

40%

50%

60%

70%

4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16

Allen Tischler Senior Vice President +1.212.553.4541 allen.tischler@moodys.com

NEWS & ANALYSIS Credit implications of current events

11 MOODY’S CREDIT OUTLOOK 5 SEPTEMBER 2016

EXHIBIT 2

Large US Banks’ Median Efficiency Ratio and Headcount Reduction, First-Quarter 2012 to Fourth-Quarter 2015 Headcount reductions have not been a panacea for large banks’ efficiency ratios.

Notes: The 16 firms included in the exhibit are Bank of America Corporation, BB&T Corporation, Capital One Financial Corporation, Citigroup, Inc.,

Comerica Incorporated, Fifth Third Bancorp, Huntington Bancshares Incorporated, JPMorgan Chase & Co., KeyCorp, M&T Bank Corporation, PNC Financial Services Group, Inc., Regions Financial Corporation, SunTrust Banks, Inc., U.S. Bancorp, Wells Fargo & Company and Zions Bancorporation.

For Bank of America, Citigroup and JPMorgan Chase, the efficiency ratio excludes debt-valuation adjustments. Sources: Regulatory FR Y-9C and Thrift Financial Report data, earnings releases and Moody’s Investors Service

The FDIC’s report noted that eight of the 10 largest banks reported declines in noninterest expenses in the second quarter of 2016 versus a year earlier. This trend, to the extent it continues, positions the banks to maintain their profitability even if the revenue environment remains challenged, as we expect. However, an increase in credit costs, which are currently low, remains another major threat to earnings growth.

0%

10%

20%

30%

40%

50%

60%

70%

-7%

-6%

-5%

-4%

-3%

-2%

-1%

0%

1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15

Median Headcount Reduction Since 1Q2012 - left axis Median Efficiency Ratio - right axis

NEWS & ANALYSIS Credit implications of current events

12 MOODY’S CREDIT OUTLOOK 5 SEPTEMBER 2016

Swaps Margin Rule Is Credit Positive for US Global Investment Banks Last Wednesday, the Commodity Futures Trading Commission (CFTC) and five US federal regulators2 mandated that US swap dealers implement the margin requirement for uncleared swap transactions set forth by global regulators, beginning 1 September. The margin requirements mandate bilateral exchange of initial and variation margin between covered entities3 and are credit positive for systemically important financial firms subject to the requirement. These firms include JPMorgan Chase & Co. (A3 stable), Bank of America Corporation (Baa1 stable), Citigroup Inc. (Baa1 stable), Morgan Stanley (A3 stable) and The Goldman Sachs Group, Inc. (A3 stable).

In early 2015, the Basel Committee on Banking Supervision and the International Organization of Securities Commissions established margin requirement standards for uncleared swaps, which are still a substantial part of total outstanding derivative trades among counterparties (see exhibit). The first compliance date starts 1 September 2016 for the largest4 derivatives dealers, as the US, European Union (EU) and international participants all agreed in early 2015. US regulators approved the final rules in October 2015, implementing the part of the Dodd-Frank Act aimed at enhancing regulation of over-the-counter derivatives in the US.

Gross Notional Outstanding by Cleared Status as of 17 August 2016, $ Trillions Interest Rate Swaps

Credit Swaps

Note: Gross notional outstanding is the total outstanding market-facing notional value of active swaps that are reported to the four swap data

repositories provisionally registered with the CFTC: Bloomberg SDR, CME Group SDR, DTCC Derivatives Repository, and ICE Trade Vault. Data is gross notional amount outstanding by asset class and cleared status, all products, tenors, and participant types. For cleared swaps, this

table reflects only one of the two sides of the swaps that results from the clearing process. Source: Commodities Futures Trading Commission

In June this year, the European Commission announced that the EU would delay the adoption of the margin rules for non-cleared derivatives, stating it needed more time to review the standards. The first implementation date is now set to mid-2017. The European Securities and Markets Authority and other European supervisory authorities raised concerns about the delay, arguing that it could cause fragmentation of the swaps market between the US and EU. Australian and Singapore regulators in August announced that they, too, would delay their implementation date.

2 Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, the Board of Governors of the Federal

Reserve System, the Farm Credit Administration and the Federal Housing Finance Agency. 3 Swap entities regulated by one of the US regulators and therefore subject to this final rule. 4 Entities with notional amount of non-centrally cleared derivatives exceeding $3.0 trillion.

$0 $100 $200 $300

Total

Cleared

Uncleared

$0 $2 $4

Total

Cleared

Uncleared

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

Ram Sri-Saravanapavaan Associate Analyst +1.212.553.4927 ram.saravanapavaan@moodys.com

NEWS & ANALYSIS Credit implications of current events

13 MOODY’S CREDIT OUTLOOK 5 SEPTEMBER 2016

The US, along with Canadian and Japanese regulators, stuck with the 1 September date. However, the CFTC extended the deadline for the custodian collateral requirements to 3 October 2016 to provide swap dealers some relief in establishing operationally viable custodian accounts to post initial margin.

The bifurcation of the implementation schedule among the global jurisdictions may create implementation and risk challenges in the global swap market, such as the renegotiation of a complex web of swap and custodian agreements and selective counterparty avoidance based on the collateralization requirements. This may create temporary competitive disadvantages for US banks that are subject to the strict collateral requirements while other global banks are not. This may cause regulatory arbitrage among parties and contractual mismatches. However, the new margin rule’s benefit of enhancing risk protections outweighs any short-term disadvantages for US dealer banks and swap participants.

The swaps margin rule as mandated by US regulators would benefit bank creditors by reducing counterparty risk at dealer banks. The rule is another step toward regulators’ objectives to limit interconnectedness, leverage and complexity in the financial system and to lower systemic risk in the event of a default by a major dealer or swap participant. Decreasing interconnectedness makes it easier to resolve a distressed bank without government support, one of the overarching goals of the Dodd-Frank legislation. In such a scenario, bank creditors could shoulder greater losses than in a supported resolution, but improving the creditworthiness of dealers and decreasing the risk of contagion is a more significant credit positive.

The swaps rule requires initial and variation margin on swaps among counterparties that the regulators deem to be swap dealers or counterparties with material swap exposure. The rule does not apply to swaps of financial institutions with $10 billion or less in total assets that enter into swaps for hedging purposes. Additionally, the rule does not apply to swaps entered into by commercial end users for purposes of hedging commercial risk.

The rule also provides for conservative safekeeping of the initial margin. A dealer bank that collects and posts the initial margin amount must place the collateral at one or more custodians that are not affiliated with either party, addressing the problem of recovering collateral from a defaulting counterparty, another credit positive.

NEWS & ANALYSIS Credit implications of current events

14 MOODY’S CREDIT OUTLOOK 5 SEPTEMBER 2016

Banco Comafi’s Planned Purchase of Deutsche Bank’s Argentine Subsidiary Is Credit Positive On 26 August, Banco Comafi S.A. (B3/B3 stable, b3) agreed to buy Deutsche Bank AG’s (A3/Baa2 stable, ba15) Argentine subsidiary Deutsche Bank S.A. (Argentina) (B1 review for downgrade) as part of Deutsche Bank’s scaling back of its global operations. The sale is credit positive for Comafi because it will strengthen the bank’s profitability and revenue diversification by giving it access to Deutsche Argentina’s significant fiduciary and depositary businesses.

However, it is credit negative for Deutsche Argentina’s creditors, who will lose the German parent company’s promise of support in times of stress once the transaction closes. As a result, we have placed Deutsche Argentina’s deposit ratings on review for downgrade. We expect to conclude the review upon the transaction’s close, at which point Deutsche Argentina’s rating will likely be lowered to the same level as Comafi’s. If Deutsche Argentina’s assets and liabilities are directly assumed by Comafi, as we expect, we will withdraw its rating.

Once regulators approve the transaction, which we expect in March 2017, Comafi will further consolidate its existing institutional business by developing deeper commercial relationships with Deutsche Argentina’s customers, which include several leading mutual funds and institutional investors. The acquisition will provide Comafi, currently Argentina’s 19th-largest lender, with potentially significant cross- selling opportunities.

The sale also will boost Comafi’s base of inexpensive demand deposits by 8% as it absorbs Deutsche Argentina’s ARS1 billion ($66 billion) of deposits. More expensive time deposits currently account for more than 56% of Comafi’s total deposits. Post acquisition, time deposits will fall to 51% of the bank’s total deposits, bringing it closer to the system average of 38% and reducing Comafi’s overall funding costs (see exhibit).

Comafi’s Dependence on Demand Deposits Will Decrease with Deutsche Bank S.A. (Argentina) Acquisition

Note: We expect the transaction’s approval in March 2017. Source: Argentina’s central bank and Moody’s Financial Metrics

Deutsche Argentina will provide Comafi with new and significant income sources that enhance its profitability. However, there is a significant risk that Comafi will lose Deutsche Argentina’s clients both before and after the transaction closes, which would reduce the value of Comafi’s purchase. To some extent,

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

and baseline credit assessment.

22% 25% 21%28%

11%12% 14%

13%

49%54% 56% 51%

13%5% 4% 3%

5% 4% 5% 5%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Jun-14 Jun-15 Jun-16 Mar-2017 Forecast

Demand Deposits Savings Accounts Time Deposits Government Deposits Other Deposits

Valeria Azconegui Vice President - Senior Analyst +54.11.5129.2611 valeria.azconegui@moodys.com

NEWS & ANALYSIS Credit implications of current events

15 MOODY’S CREDIT OUTLOOK 5 SEPTEMBER 2016

many of Deutsche Argentina’s clients did business with the bank because of its reputation and global expertise.

Deutsche Bank’s sale of its Argentine unit is part of its global rationalization to boost efficiency. The German bank announced late last year that it planned to exit 10 countries by 2018. Deutsche Bank will continue to serve certain clients in Argentina from global and regional hubs, providing M&A services and underwriting and advisory services to corporate and government debt issuers.

NEWS & ANALYSIS Credit implications of current events

16 MOODY’S CREDIT OUTLOOK 5 SEPTEMBER 2016

Sparebanken Vest’s Additional Tier 1 Bond Issue Is Credit Positive Last Tuesday, Sparebanken Vest (A1/A1 negative, baa16) issued NOK400 million of additional Tier 1 (AT1) bonds with a floating rate coupon equal to three-month NIBOR + 4.50%. We estimate that the AT1 issue will improve the bank’s Tier 1 capital ratio by approximately 60 basis points to around 15.8% from 15.2% reported in June 2016, enhancing the bank’s capitalisation buffers, a credit positive. The Norwegian regulator (FSA) has approved the issuance, and the bank will apply for its listing on the Nordic Alternative Bond Market.

As shown in the exhibit below, Sparebanken Vest bank has been increasing its capital base in recent quarters in anticipation of highter FSA requirements and recommendations, which include a common equity Tier 1 (CET1) ratio of at least 14.5% for Norwegian banks by the end of this year.

Sparebanken Vest’s Capital Position

Sources: Sparebanken Vest and Moody’s Investors Service estimate

Although this AT1 issue will not directly support the bank’s CET1 ratio, we expect that the bank will be able to meet its 14.5% target, up from 14.1% as of 30 June (which incorporated 80% of its first-half 2016 profit). This will be achieved mainly through its second-half accumulated profit and by containing its dividend distribution to around 50%, which falls at the lower end of the bank’s 2016 payout target of 50%-80% to its equity certificate holders.7

Sparebanken Vest’s lower oil-related exposure compared to some of its larger domestic peers has supported its solid financial performance in 2016, against weakening domestic growth. Persistently low oil prices and reduced oil-related investments have led Norwegian banks with higher exposures to the offshore service-vessel sector to increased nonperforming loans and credit losses, weighing on their financial performance.

Excluding non-recurring items, including a special NOK94 million of dividend income from its Visa shares, a one-off gain of NOK20 million from the sale of fixed assets and NOK55 million of restructuring costs, we estimate Sparebanken Vest’s net profits to have increased by a healthy 6% during the first-half of 2016 compared to the same period in 2015. The increase followed 7.3% year-on-year loan growth in June 2016, despite some pressure on the bank’s 1.49% June 2016 net interest margin, which declined from 1.59% in June 2015 amid lower interest rates in Norway.

6 The ratings shown in this report are the banks’ deposit rating, senior unsecured debt rating and baseline credit assessment. 7 Only 25% of the profit is allocated to the bank’s equity certificate holders, while the balance corresponds to the bank’s primary

owners/founders. In effect, a 50% dividend payout would mean distribution of only 12.5% of the net profit and 87.5% retained in the bank.

12.2%13.7% 13.8% 14.1% 14.3%

1.3%1.3% 1.3% 1.1% 1.7%

1.9%1.9% 1.8% 2.2%

2.2%15.3%16.9% 17.0% 17.4%

18.2%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Estimate

Common Equity Tier 1 Additional Tier 1 Supplementary Capital Total Capital Adequacy Ratio

Nondas Nicolaides Vice President - Senior Credit Officer +357.25.693.006 nondas.nicolaides@moodys.com

NEWS & ANALYSIS Credit implications of current events

17 MOODY’S CREDIT OUTLOOK 5 SEPTEMBER 2016

Contrary to peers that have more exposure to the petroleum sector, Sparebanken Vest’s impairments decreased during the first six months in 2016, amounting to NOK42 million from NOK77 million a year earlier, as problem loans marginally declined to NOK1.46 billion in June 2016 (or 1.1% of gross loans) from NOK1.47 billion in March 2016. As a result, the bank revised its loan write down expectation for full-year 2016 to NOK150-NOK200 million, from NOK250-NOK300 million previously.

Sparebanken Vest’s retail focus on Bergen and the Hordaland county supports its loan growth and performance. On 22 August, the Bergen Chamber of Commerce and Industry in Norway published the results of a regular survey of local companies, which were asked about the state of the local economy in the Bergen area within the Hordaland county. While 75% of the surveyed companies said the economic situation was in a crisis in April 2016, only 46% said it was in crisis in August. In addition, 90% of the companies believe there will be economic growth and stability next year, and 65% believe that the “worst” is over.

NEWS & ANALYSIS Credit implications of current events

18 MOODY’S CREDIT OUTLOOK 5 SEPTEMBER 2016

Nordic Banks Risk Losses as Norway’s Oil Woes Mount with Farstad’s Second-Quarter Results On Monday, Farstad Shipping ASA (unrated), one of Norway’s largest offshore supply vessel (OSV) operators, reported a second-quarter operating loss of NOK849 million. The company continues to deplete equity (NOK3.6 billion at 30 June, down from NOK6.1 billion a year before) and cash reserves (NOK1.1 billion, down from NOK1.7 billion), and has NOK2.0 billion in debt repayments by second quarter 2017, most of which is owed to Nordic banks.

As Farstad continues to lose money, bank lenders have already waived rights so Farstad could avoid default, illustrating the dire status of oil-related companies in Norway in light of low oil prices and reduced exploration investment, a credit negative for Nordic banks.

To stave off Farstad’s default, most of its bank creditors, including DNB Bank ASA (Aa2/Aa2 negative, a3), Danske Bank AS (A2/A2 stable, baa1) and Nordea Bank AB (Aa3/Aa3 stable, a3), agreed at the end of June to postpone all amortizations and suspend financial covenants until 1 October. That was not the first grace period banks have offered Farstad over the past 12 months. And, as the company continues to report heavy losses, the probability increases that creditor banks will need to accept principal losses on their exposures (see exhibit).

Rated Banks’ Exposures to Farstad at 31 December 2015, as a Percentage of Common Equity Tier 1 Capital

Notes: Farstad reported NOK1.3 billion of outstanding loans from Eksportfinans ASA (Ba3 stable) and NOK3.6 billion outstanding from Eksportkreditt

Norge AS (unrated), these loans are guaranteed by banks or The Norwegian Export Credit Guarantee Agency (GIEK, unrated). The exposures include guarantees where applicable.

Sources: Company reports

Norway’s OSV industry is grappling with a severe crisis as oil companies cut costs amid lower oil prices. With EBITDA dropping more than 40% over the last 12 months for listed Norwegian OSV companies, restructurings are a frequent occurrence. For example, in July the Norwegian OSV companies Solstad Offshore ASA (unrated) and Rem Offshore ASA (unrated) announced that they would merge as a step toward solving both companies’ financial troubles.

The turbulence in the oil-sector, where OSV companies are hit hardest, has contributed to Norwegian banks doubling loan losses compared to a year ago (0.34% of gross loans at the end of June 2016, compared to 0.17% a year earlier). At larger banks, losses have increased steeply: DNB, SpareBank 1 SR-Bank ASA (A1/A1 negative, baa2), and SpareBank 1 SMN (A1/A1 stable, baa1) aggregate loan losses increased 197% year on year.

0%1%2%3%4%5%6%7%8%9%10%

0.00.20.40.60.81.01.21.41.61.8

NO

K Bi

llion

s

Amount - left axis Percent of CET1 Capital - right axis

Aleksander Henskjold Associate Analyst +44.20.7772.1954 aleksander.henskjold@moodys.com

NEWS & ANALYSIS Credit implications of current events

19 MOODY’S CREDIT OUTLOOK 5 SEPTEMBER 2016

Despite increased loan losses, banks are better positioned than unsecured lenders and equity holders in the event of a principal reduction or default because their loans are mostly secured, with ships as collateral. However, we expect banks are reluctant to take possession of OSV ships because the current oversupply would make it difficult to realise the full collateral value in an asset sale.

We expect the OSV sector to remain challenged over the next two years, while the success of the industry’s debt restructurings will rely on improvements in the operating environment.

NEWS & ANALYSIS Credit implications of current events

20 MOODY’S CREDIT OUTLOOK 5 SEPTEMBER 2016

Hatton National Bank’s Capital Increase Is Credit Positive Last Wednesday, the Sri Lanka-based Hatton National Bank Ltd. (HNB, B1 negative, b18) announced its decision to issue approximately $50 million of common voting shares to the Asian Development Bank (ADB, Aaa stable), which will hold approximately 10% of HNB’s voting shares post issuance. The capital infusion will increase HNB’s capital buffer and support its credit growth strategy, a credit positive. We expect the transaction’s completion in the fourth quarter of this year, after receiving approval from the Colombo Stock Exchange and HNB’s shareholders.

We estimate that the capital raise will increase HNB’s Tier 1 capital ratio to 11.5% from 10.2% as of 30 June 2016. As Exhibit 1 shows, HNB will become one of the better capitalized banks in Sri Lanka, with a Tier 1 capital ratio comparable to the Commercial Bank of Ceylon (unrated) and higher than the ratios of Sampath Bank Plc ( B1 Negative, b1), Bank of Ceylon (B1 Negative, b1), and People’s Bank (unrated).

EXHIBIT 1

Hatton National Bank’s Pro Forma and Select Sri Lankan Banks’ Tier 1 Capital Ratios at 30 June 2016 HNB is set to become one of the better capitalized banks in Sri Lanka.

Note: *As of end-March 2016. Sources: The Banks and Moody’s Investors Service

The increase in the Tier 1 ratio will support HNB’s loan growth, which had increased 23% year on year as of 30 June. Exhibit 2 shows that the bank’s Tier 1 ratio had steadily declined with the pickup of loan growth from 2014 onward.

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

10.2%

1.3%

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

11%

12%

Sampath Bank Bank of Ceylon People's Bank* Hatton National Bank Commercial Bank of Ceylon

Tier 1 Ratio Pro-Forma Tier 1

Komaresan Subramanian Associate Analyst +65.6311.8329 komaresan.subramanian@moodys.com

NEWS & ANALYSIS Credit implications of current events

21 MOODY’S CREDIT OUTLOOK 5 SEPTEMBER 2016

EXHIBIT 2

Hatton National Bank’s Year-over-Year Loan Growth and Tier 1 Ratio HNB’s loan growth has been eroding its capital ratio.

Note: For our full-year 2016 forecast, we annualized loan growth and net income from the first half of 2016. Sources: The bank and Moody’s Investors Service

The issuance also increases HNB’s loss-absorption buffer. Its ratio of nonperforming loans to total shareholders’ equity and loan loss reserves will decrease to 12.5% after the capital raise from 13.4% at end-June 2016. This provides an additional buffer in the event of asset quality deterioration on the back of HNB’s rapid loan growth.

The tie-up with ADB, the first for a Sri Lankan bank, will likely further improve the maturity profile of HNB’s market borrowings by facilitating market access for longer-tenor funds. Separately in a transaction not related to the share issuance, the ADB had already provided a $100 million seven-year loan to HNB in 2015, and we expect that additional long-term funds could become available to HNB from international investors. HNB has increasingly relied on market funding because of rapid lending growth. Its market funds were 14.4% of its assets as of 30 June 2016, up from 10.6% as year-end 2014. Exhibit 3 shows that the structure of HNB’s borrowings nevertheless improved last year because of the 2015 ADB loan.

EXHIBIT 3

Hatton National Bank’s Market Funds Term Structure HNB’s market funds term structure had improved with the 2015 ADB Loan.

Sources: The Bank and Moody’s Investors Service

0%

3%

6%

9%

12%

15%

18%

21%

24%

27%

2012 2013 2014 2015 H1 2016 2016 F

Tier 1 Ratio Loan Growth

49%

25%

8%

11%

43%

64%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2014 2015

Less than 12 Months 1 - 3 Years Over 3 Years

NEWS & ANALYSIS Credit implications of current events

22 MOODY’S CREDIT OUTLOOK 5 SEPTEMBER 2016

Creditor Banks Reject Hanjin Shipping’s Self-Rescue Plan, a Credit Positive Last Tuesday, the creditor banks of Hanjin Shipping Co., Ltd. (unrated), led by Korea Development Bank (KDB, Aa2/Aa2 stable, ba29) announced that they had rejected the shipping company’s self-rescue plan and would cease providing further financial assistance to it. The creditor banks’ actions are credit positive because it will limit losses to their current exposures to Hanjin. However, the banks’ rejection prompted Hanjin, Korea’s largest container shipping company by asset size, to file for court receivership the next day, casting doubt on its solvency and viability.

According to the creditor banks, Hanjin would need at least KRW1 trillion in short-term liquidity to pay back maturing debt, cover arrears in payments to chartered ship owners, and fund its operations. However, the company submitted a rescue plan to raise only KRW500 billion ($446 million) through asset sales and financial aid from Korean Air Lines Co., Ltd. (unrated).

Had the banks accepted the restructuring plan, their exposure to Hanjin would have increased without any guarantee that the restructuring plan would succeed and allow Hanjin to repay its debts. Should the restructuring plan have failed, the banks would have borne higher losses than what we assess as a manageable sum at this point.

Instead, rejecting Hanjin’s restructuring plan will limit further losses to banks. Creditor banks’ exposure to Hanjin is KRW1.06 trillion ($923 million), or 11 basis points (bp) relative to their risk-weighted assets. The policy banks Export-Import Bank of Korea (Aa2 stable), KDB, and NongHyup Bank (A1/A1 stable, baa3) together hold around 77% of the Korean banking system’s total exposure to Hanjin. These three banks have all reclassified their Hanjin exposures as substandard, doubtful or as an estimated loss, and set aside more than 80% provisioning against these loans as of 30 June 2016. The potential additional loss of KRW147 billion ($128 million) in aggregate for the policy banks, which translates to 3 bp in the policy banks’ common equity Tier 1 (CET1) ratio, can be covered by the banks’ property collateral. Hanjin’s receivership will therefore have a minimal further effect on their profitability and capital ratios.

Hanjin’s receivership also has little effect on commercial creditor banks’ capital ratios. Kookmin Bank (A1/A1 stable, baa1), KEB Hana Bank (A1/A1 negative, baa1), Woori Bank (A2/A2 negative, baa3) and Busan Bank (A2/A2 negative, baa1) set aside close to 75% provisions against the company’s loans as of 30 June 2016, and the potential additional loss of KRW62 billion ($54 million) would translate to an insignificant 1 bp decline in the commercial banks’ CET1 ratios.

We also expect Hanjin’s failure would have a mild positive effect on the remaining shipping companies because it will reduce the sector’s excess capacity. Hanjin’s operations overlap with those of other shippers such as Hyundai Merchant Marine Co., Ltd. (unrated).

Korean shipping companies have been under financial pressure because the market for freight transportation has been depressed amid weak global economic growth and continued deliveries of new vessels. To deal with the risks to banks from the shipping industry, on 8 June, the Korean government announced a restructuring plan for the shipbuilding and shipping sectors, and plans to inject capital into public- policy banks.

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

credit assessment.

Hyun Hee Park Assistant Vice President - Analyst +852.3758.1514 hyunhee.park@moodys.com

NEWS & ANALYSIS Credit implications of current events

23 MOODY’S CREDIT OUTLOOK 5 SEPTEMBER 2016

Insurers

US Response to Insurer Withdrawals from Affordable Care Act Exchanges Poses Credit-Negative Threat Last Sunday, the Kaiser Family Foundation published a study that projects a marked decline in private health insurer participation in Affordable Care Act (ACA) public exchanges in 2017, reflecting private insurers’ growing retreat from the ACA marketplaces because of losses. Although we have said that the withdrawals reduce the earnings drag from these unprofitable products for individual insurers, any actions the US government takes to maintain the viability of the public exchanges would likely have negative credit implications for insurers.

A number of major carriers have announced big pullbacks from the public exchanges next year, including Aetna Inc. (Baa2 stable) in August, Humana Inc. (Baa3 review for upgrade) in July and UnitedHealth Group Incorporated (A3 negative) in April, and further exits are likely. If a sizable number of insurers stop offering individual policies on the exchanges, the ACA would be dealt a major setback and it is not clear what steps the Obama administration would take to salvage the individual commercial market.

The options include creating a government-run health insurer that would compete with private health insurers (i.e., the public-option originally proposed in the ACA); insurers not participating on the exchanges losing their eligibility to participate in government contracts (i.e., Medicare Advantage and Medicaid); and financial penalties. All would have negative consequences for insurers. One option that would not be as negative for insurers would be a solution at the state level. Governors have the option to ease eligibility requirements for Medicaid, which would provide coverage to some uninsured individuals.

We estimate that the private health insurance sector’s losses from ACA business exceeded $3 billion in 2014 (based on submissions to the ACA’s risk-corridor program), and the financial results of a majority of health insurers point to higher losses in 2015. The growing number of exits from these products reflects the poor performance of this business for many health insurers.

Additionally, we expect that larger health insurers’ pullback from the exchanges will prompt other health insurers to review their long-term strategies. Management teams at smaller insurers will ask how their firms can succeed when much larger carriers such as UnitedHealth, Aetna and Humana - which have substantial market shares, greater leverage in controlling medical costs, superior market data and larger capital bases - have concluded that the ACA business is unprofitable. We expect that smaller regional and other Blue Cross Blue Shield plans will decide to exit or limit their participation on the 2017 exchanges in the next few weeks, when they must make their final decisions.

The potential for additional insurer exits raises questions about the stability of the insured risk pool and overall sustainability of the public exchanges. The Kaiser study estimated that 31% of counties in the US will have only a single insurer participating on their public exchanges in 2017, up from 7% in 2016. Southern states and rural areas, where the number of participating insurers has typically been low, will be hit particularly hard. Exchange-enrollees in some urban counties will also see a reduction in insurer participation, perhaps down to a single marketplace insurer, which would affect as many as 1.7 million enrollees, or 15% of enrollees living in urban counties, up from 2% in 2016. Being the last carrier participating in counties that other insurers have abandoned as unprofitable increases the lone carrier’s share of that unprofitable business, including attracting a greater proportion of higher-risk individuals in search of coverage.

Pano Karambelas Vice President - Senior Credit Officer +1.212.553.1635 pano.karambelas@moodys.com

NEWS & ANALYSIS Credit implications of current events

24 MOODY’S CREDIT OUTLOOK 5 SEPTEMBER 2016

Insurers continuing to participate in the public exchanges in 2017 are taking steps to reduce their losses by shifting their plan offerings away from higher-cost preferred provider organizations in favor of lower-cost health maintenance organizations, or by narrowing the choice of doctors and hospitals. Insurers have also filed for or received substantial premium rate increases in an attempt to improve profitability. Longer term, however, these insurers will have to consider the likely effect of these large rate hikes on the risk profile of enrollees who remain on the exchanges. The continued rise in premiums and out-of-pocket costs will cause healthier individuals to opt out of the exchanges, leading to a riskier insured pool.

NEWS & ANALYSIS Credit implications of current events

25 MOODY’S CREDIT OUTLOOK 5 SEPTEMBER 2016

Sovereigns

Ruling on Ireland’s Taxation of Apple Could Threaten Its Successful Foreign Direct Investment Strategy On 30 August, the European Commission (EC) issued a ruling that Ireland (A3 positive) granted illegal tax benefits to Apple Inc (Aa1 stable). The EC ordered Ireland to recover unpaid taxes of up to €13 billion (or 4.8% of the country’s GDP), plus interest. Although such a large tax payment would be positive for Ireland’s public finances, we believe that the potential negative effect on large multinational corporations’ foreign direct investment (FDI) in Ireland might ultimately outweigh the fiscal benefit.

In principle, a tax payment of up to €13 billion would be beneficial for Ireland’s public finances: the amount is equal to around 4.8% of the country’s GDP and 25.6% of its total tax revenues of 2015. However, both Apple and Ireland are likely to contest the EC’s ruling, so these windfall tax revenues are uncertain. Experience indicates that such rulings can take years to finally resolve. In addition, the EC pointed out in its ruling that some of the taxable profits might lawfully accrue to other EU countries, potentially reducing the amount Ireland would receive.

Compared to the positive fiscal effect of the possible one-off tax proceeds, the tax ruling’s potential to diminish Ireland’s attractiveness to multinational corporations is likely to be a more relevant credit driver than a tax receipt windfall. Ireland’s competitive tax regime has always been a key magnet for FDI, although it is not the only one. Over many years, Ireland has been very successful in attracting foreign multinational corporations, in particular from the US and more recently from other jurisdictions also.

Ireland’s FDI stock amounted to 496% of GDP in 2015, making it the second-largest recipient of FDI flows in the EU after Luxembourg (Aaa stable). US companies account for around 37% of the stock, according to International Monetary Fund information. Multinational companies account for around 25% of gross value added in the economy. Around 20% of all private-sector workers are employed directly or indirectly by these companies (direct employment accounts for about 12%). Multinationals are also important taxpayers: according to the latest estimate by the Revenue Commissioners, the largest 10 corporate taxpayers accounted for 41% of all corporate tax revenues last year, most of which come from multination corporations.

Although the EC explicitly stated in its ruling that Ireland’s tax system and its low corporate tax rate of 12.5% are not “called into question,” and the Irish authorities last year closed the “stateless corporation” tax rule that Apple used, the dispute with the EC puts Ireland’s tax regime in the spotlight again. Companies need certainty over tax arrangements, both in prospect and retrospect, and the EU ruling creates uncertainty among Ireland’s current and potential foreign investors, a credit negative for the sovereign.

Given the importance and size of its multinational sector, Ireland is more exposed than most other sovereigns to changing global tax rules as well as changes in tax laws in the countries of origin, over which the Irish authorities would have very limited influence. Consequently, a reversal or end to Ireland’s success in attracting multinationals would have negative implications for the country’s growth model.

Kathrin Muehlbronner Senior Vice President +44.20.7772.1383 kathrin.muehlbronner@moodys.com

Eugeniu Croitor Associate Analyst +44.20.7772.1068 eugeniu.croitor@moodys.com

NEWS & ANALYSIS Credit implications of current events

26 MOODY’S CREDIT OUTLOOK 5 SEPTEMBER 2016

Spain’s Political Deadlock Could Lead to Early Elections, Increasing Fiscal and Economic Risks Last Friday, Spain’s (Baa2 stable) acting Prime Minister Mariano Rajoy failed to garner enough votes in parliament to form a minority government, prolonging Spain’s political impasse, a credit negative for the sovereign. The economic and fiscal costs stemming from the ongoing leadership vacuum are rising and we expect both weakening growth and continued fiscal underperformance heading into 2017.

The political impasse increases the risk of a December general election, which would be the third within a year, and further weakens the prospects for structural macroeconomic and fiscal reforms.

In last Friday’s confidence vote, Mr. Rajoy’s centre-right People’s Party (PP) was backed by the centrist Ciudadanos party, but fell six votes short of the simple majority required to form a government.10 Party leaders now have until 31 October to try and assemble a government. If they fail, parliament will be dissolved and another round of parliamentary elections will take place approximately 60 days later.

Spain’s political landscape has been fundamentally transformed by the rise of Ciudadanos and the left-wing Podemos party, which have broken the duopoly the PP and the Socialist Party (PSOE) held for decades. Elections in December 2015 and June 2016 each resulted in a highly fragmented parliament (see Exhibit 1), complicating coalition-building and ultimately preventing the formation of a majority government.

EXHIBIT 1

Composition of Spain’s Congress of Deputies June elections did not alter the Spanish parliament’s fundamental fragmentation.

Sources: Spanish Ministry of Interior and Moody’s Investors Service

We expect political uncertainty to continue. PSOE could yet abstain in a future vote of confidence and allow the formation of a minority PP-led government (most likely in coalition with Ciudadanos and some smaller regional parties), but a minority PP-led government would struggle to find enough legislative support to implement a wide-ranging reform programme. Alternatively, early elections could be called for the end of this year, leading to at least another four months of legislative gridlock. A worst-case but highly unlikely

10 In order to win the confidence vote with a simple majority, the PP needed the partial abstention of the opposition. The PP also

lost a prior round of voting on 31 August, which required an absolute majority to allow the formation of a government.

Sarah Carlson Senior Vice President +44.20.7772.1000 sarah.carlson@moodys.com

Mickaël Gondrand Associate Analyst +44.20.7772.1085 mickael.gondrand@moodys.com

NEWS & ANALYSIS Credit implications of current events

27 MOODY’S CREDIT OUTLOOK 5 SEPTEMBER 2016

outcome would be the formation of a parliamentary majority coalition that tries to roll back recently legislated reforms. All these scenarios would weigh on Spain’s reform prospects.

Spain’s economy has so far been resilient given the political deadlock, expanding by 3.4% year on year in real terms in the first quarter and 3.2% in the second quarter. Growth is benefiting from tailwinds provided by low oil prices, supportive financing conditions, and solid tourism, with the number of foreign tourists up 11.1% in the first seven months of this year.

Nevertheless, challenges to growth are rising, particularly on investment, except for private investment in the recovering property sector, which remains a bright spot. However, spending on public work contracts fell by a fifth in the first half of the year, partly because of the political deadlock, while the contribution of gross fixed capital formation to headline growth in the second quarter (0.8 percentage points) was the weakest since 2014 (see Exhibit 2). We expect economic growth to slow to a relatively healthy 2.9% rate for 2016 as a whole, but lowered our forecast for 2017 in the aftermath of the Brexit vote to 2.0%.

EXHIBIT 2

Contributions to Real GDP Change in Percentage Points Performance to date has been resilient, but headwinds to growth are rising.

Sources: Spain’s Central Statistical Office and Moody's Investors Service

The continued absence of a government undermines Spain’s ability to meet its fiscal targets and address the structural weaknesses of its public finances, including a lack of effective controls over regional government finances, healthcare expenditures and social security reform. The country has already been given a reprieve by the European Commission, with a two-year extension to 2018 to bring the budget shortfall below the EU deficit limit of 3% of GDP, but we expect that this year’s revised target of 4.6% of GDP will not be met. The EC’s recommended targets require that Spain undertake further fiscal measures with an estimated structural effect of 0.5% of GDP in both 2017 and 2018. However, not having a government in place raises the spectre of fiscal overruns in 2016 and failing to meet an October 15 deadline to present its 2017 budget to European authorities.

-6

-4

-2

0

2

4

6

I II III IV I II III IV I II III IV I II

2013 2014 2015 2016

Private Consumption Government Consumption Investment Net Exports Real GDP Growth, %

NEWS & ANALYSIS Credit implications of current events

28 MOODY’S CREDIT OUTLOOK 5 SEPTEMBER 2016

Egypt’s Long-Awaited Approval of Value-Added Tax Is Credit Positive On 28 August, Egypt’s (B3 stable) parliament approved the long-delayed value-added tax (VAT). Although the 13% VAT rate is lower than the government’s proposed 14% rate, and the list of exempted goods and services is 57 versus the proposed 52 items, the VAT is credit positive. The VAT forms an integral part of the government’s reform program over the coming three years and together with reforms to tax administration, will gradually increase Egypt’s low tax receipts and support its fiscal consolidation efforts. Implementation of VAT will also unlock external funding from multilateral sources such as the World Bank (Aaa stable) and the African Development Bank (Aaa stable).

The VAT takes effect 1 October and replaces the current 10% goods and services tax. The VAT’s lower 13% rate and the higher number of exempted goods and services will result in a revenue shortfall of EGP12 billion, equal to one third of the VAT revenue increase assumed in the current budget for fiscal 2017 (which ends 30 June 2017). However, some of the shortfall will be made up in fiscal 2018 when the VAT rate increases to 14%.

As a result, we expect the government to underperform its revenue and fiscal deficit targets. Our fiscal deficit forecast is 12% of GDP for fiscal 2017, compared to the government’s target of 9.9%. Our forecast takes into account potential slippages in revenue targets, reflecting both difficult implementation of revenue-raising measures and our GDP growth projection of 3.5% in fiscal 2017, which is lower than the official growth projection of 4.0%. In addition, along with widely discussed currency devaluation, introducing the VAT will exacerbate already high inflation. Egypt’s inflation rate increased to 14.8% year on year in June and was broadly unchanged in July.

Nevertheless, we think that VAT is an important step to increase Egypt’s tax revenues. As Exhibits 1 and 2 below show, Egypt has one of the lowest tax takes among its peers given the size of its economy and total government revenues, and it has a declining share of tax revenues over time. The three-percentage-point difference between the VAT’s 13% rate and the 10% goods and services tax will be the main source of additional revenues. Wider participation from Egypt’s large non-tax-paying informal sector and stiffened penalties against tax evasion will also add revenues.

EXHIBIT 1

Tax Revenues in Egypt and Peer Countries in 2015

Sources: National Ministries of Finance, Central Banks, Haver Analytics and Moody’s Investors Service

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

PakistanB3

EgyptB3

LebanonB2

JordanB1

GhanaB3

BosniaB3

TunisiaBa3

Tax Revenues as Percent of GDP Tax Revenues as Percent Total Revenues

Steffen Dyck Vice President - Senior Credit Officer +49.69.70730.942 steffen.dyck@moodys.com

Zahabia Saleem Gupta Associate Analyst +971.4.237.9549 zahabia.gupta@moodys.com

NEWS & ANALYSIS Credit implications of current events

29 MOODY’S CREDIT OUTLOOK 5 SEPTEMBER 2016

EXHIBIT 2

Tax Revenues In Egypt 2002-15

Sources: Egypt Ministry of Finance, Central Bank of Egypt and Haver Analytics

VAT will also unlock much needed external funding for Egypt. As grants and deposits from Gulf Cooperation Council member countries have slowed, funding from official donors such as the International Monetary Fund, World Bank and the African Development Bank is a crucial component to meet Egypt’s external funding gap. The disbursement of the first tranche of a $3 billion loan from the World Bank stalled because of delays in the VAT approval. The VAT introduction, along with reforms to the exchange rate regime, has been a cornerstone of recent negotiations with the IMF for a $12 billion loan. An approved IMF program will in turn encourage other bilateral and multilateral donors to engage with Egypt.

0%

10%

20%

30%

40%

50%

60%

70%

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Tax Revenues as Percent of GDP Tax Revenues as Percent Total Revenues

NEWS & ANALYSIS Credit implications of current events

30 MOODY’S CREDIT OUTLOOK 5 SEPTEMBER 2016

Uganda Grants Long-Delayed Oil Production Licences, a Credit Positive Last Tuesday, Uganda (B1 negative) granted oil production licences to UK-based Tullow Oil plc (B2 negative) and France-based TOTAL SA (Aa3 stable). The production licences open the door to the oil explorers’ investment in Uganda and eventual exploitation of the country’s estimated 1.3 billion barrels of recoverable oil reserves.

The government anticipates total oil-related investment of $8-12 billion over the next four years, or 32%-48% of 2016 GDP, providing a significant boost to 2017-21 growth even before oil production begins. The IMF estimates that growth will be between 2% and 4% higher than the baseline (non-oil) scenario during the investment phase, an important support for Uganda’s credit quality given that economic growth, a key credit strength, decelerated to an average of 5.4% during 2010-15 from 8% during 2004-09.

Despite the discovery of commercial oil reserves in Uganda almost a decade ago, these have yet to be exploited because of extended negotiations between the government and the oil exploration companies. The oil production licences now require Tullow Oil and Total to make final investment decisions within 18 months, marking a major step toward eventual exploitation of the country’s oil reserves. The government’s decision in July to commit to the construction of a pipeline to the coast via Tanzania, rather than Kenya as the government had considered, will provide an export route for the oil.

Government Oil Revenues as a Percent of Non-Oil Taxation and Non-Oil GDP Oil production will provide a revenue windfall for the government.

Note: Oil prices use constant 2012 dollars. Sources: Henstridge and Page and the Oxford Centre for the Analysis of Resource Rich Economiesr

The long-term health of the government’s finances will be much improved by the revenues generated by oil production. Uganda’s fiscal deficits have increased substantially in recent years because of rising infrastructure investment and declining support from international donors, which has constrained the government’s credit quality. Because oil production will not commence until 2019 at the earliest, the fiscal effect over the next three years will be negligible. However, revenue to the government could be substantial from 2019-20 onward, particularly once production peaks in a decade. Although accurate estimates are difficult to produce given the lack of transparency surrounding the terms of the agreement and the sensitivity of revenues to oil prices, the Oxford Centre for the Analysis of Resource-Rich Economies estimates they could amount to 3%-6% of non-oil GDP by 2030, depending on future oil prices, which concurs with the IMF’s similar research.

0%

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$75/bbl $100/bbl $120/bbl0%

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7%

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9%

10%

Percent of Non-oil Taxation - right axis Percent of Non-oil GDP - left axis

Rita Babihuga Assistant Vice President +44.20.7772.1718 rita.babihuga@moodys.com

Thaddeus Best Associate Analyst +44.20.7772.1088 thaddeus.best@moodys.com

NEWS & ANALYSIS Credit implications of current events

31 MOODY’S CREDIT OUTLOOK 5 SEPTEMBER 2016

The country also plans to refine some oil domestically, increasing added value for the hydrocarbons sector and generating an additional $4 million in investment for the development of a new refinery. The government is currently in talks with a consortium of companies led by South Korea’s SK Engineering and Construction Co. Ltd., with the successful bidder to provide 60% of the financing for the project.

Once completed, the refinery will process around 60,000 barrels a day and reduce Uganda’s dependence on imported fuel. Even assuming a steady increase in oil consumption over the next decade, the refinery’s oil production will more than adequately meet national demand, which currently amounts to around 22,000 barrels a day of refined petroleum imports. Once oil production comes online, domestically refined oil should lead to a permanent reduction in energy imports of around 4%-5% of GDP. Over the investment phase in the coming years, the current account deficit is likely to widen temporarily because of the capital goods imports required for oil production. However, inbound foreign direct investment will almost entirely finance the additional capital goods imports, which should decline after 2020 once the bulk of construction has been completed.

NEWS & ANALYSIS Credit implications of current events

32 MOODY’S CREDIT OUTLOOK 5 SEPTEMBER 2016

Ethiopia Signs Hydropower Export Deal with Tanzania, a Credit Positive On 28 August, Ethiopia (B1 stable) signed a deal to export 400 megawatts (MW) of hydropower electricity from the Grand Ethiopian Renaissance Dam to neighbouring Tanzania (unrated), adding to its existing power export agreements with Kenya, Sudan and Djibouti. The deal is credit positive for Ethiopia because electricity exports help address the country’s chronic shortage of international reserves and new revenues can be put toward repaying the $4.8 billion borrowed to construct the Grand Ethiopian Renaissance Dam.

Power exports generate foreign currency receipts for Ethiopia and will ameliorate its chronically low international reserves, which have been a persistent credit weakness for the sovereign. As of first-quarter 2016, reserve coverage stood at just 2.2 months of imports, which is below the level the International Monetary Fund’s recommended reserve coverage of three months. Ethiopia’s 195MW of electricity exports to Sudan and Djibouti earned $123 million in 2014 (roughly equal to 1.5% of total international reserves). However, the Ethiopian government estimates potential power export earnings at up to $2 billion a year once all its hydropower projects are completed.

Given the nation’s significant generation potential, the government’s long-term economic strategy is to establish itself as a major power hub for the East Africa region. In pursuit of this goal, the government borrowed heavily to fund the construction of several major hydropower projects, with the Grand Ethiopian Renaissance Dam the largest at 1,780 meters long and 145 meters high. Many of the other projects are now either completed or nearing completion. The next crucial phase of the government’s plan is to secure buyers for the new power. In addition to the deal with Tanzania, negotiations are ongoing to export 400MW to Rwanda, 500MW to Burundi, and 100MW to Yemen via Djibouti.

The Renaissance Dam is about 750 kilometres southwest of Addis Ababa, on the Blue Nile River. Its hydroelectric power plant has a projected capacity of 6,000MW and 15,692 gigawatts annual energy output once completed by 2017 at an estimated cost of $4.8 billion. The project is about 50% complete and will be the largest dam in Africa, substantially increasing Ethiopia’s power supply and strengthening its power export program. Total installed generation stood at 2300MW at the end of 2015, compared to 800MW in 2007. Ethiopian authorities expect generation will rise to 5200MW in 2017 once Grand Renaissance comes online.

Rita Babihuga Assistant Vice President +44.20.7772.1718 rita.babihugansanze@moodys.com

Thaddeus Best Associate Analyst +44.20.7772.1088 thaddeus.best@moodys.com

NEWS & ANALYSIS Credit implications of current events

33 MOODY’S CREDIT OUTLOOK 5 SEPTEMBER 2016

Zimbabwe’s Foreign Donor Support Weakens after Police Suppress Protesters On 26 August, police in Zimbabwe’s (unrated) capital of Harare deployed tear gas and water cannons to disperse opposition protests that had been authorized by the country’s High Court. The violence against demonstrators demanding free and fair elections in 2018 and better economic management, and the extent to which it has raised the ire of international donors, weakens Zimbabwe’s credit quality because it diminishes the likelihood of timely clearance of Zimbabwe’s arrears to the International Monetary Fund (IMF), the World Bank and the African Development Bank (ADB). The large arrears preclude the country’s access to new external financing from the three institutions on concessional terms.

Although 92-year-old President Robert Mugabe has imposed an authoritarian regime for 36 years, the wave and intensity of protests since July, triggered by delays on wage payments, and culminating on 26 August, has been rare. Several diplomatic missions in Harare, including those from Australia (Aaa stable), Canada (Aaa stable), the US (Aaa stable) and the European Union (EU, Aaa stable), condemned the violent suppression of the protests.

External debt arrears to the IMF, World Bank and ADB totalled $1.8 billion at the end of 2015, while total external debt arrears were $5.6 billion (39% of GDP). The government has made important strides toward resolving the arrears by adhering to an IMF Staff-Monitored Program that ended in March 2016, and by having prepared a strategy agreed to by donors for its clearance. However, donors’ concerns about the lack of adherence to human rights, freedom of speech and assembly, and respect for the rule of law have now resurfaced and are jeopardising the timely and comprehensive arrears clearance.

Further delays in arrears clearance will send a deeply negative signal to investors, which in turn will weaken the country’s precarious fiscal and external positions. Additionally, by raising already-high political risk, the action will further deter international investors amid severe dollar shortages. This has negative implications for the country’s economic strength and growth. It also significantly reduces the country’s ability to manage shocks, particularly the risk of a systemic bank run in a monetary regime where the Reserve Bank of Zimbabwe, the country’s central bank, cannot provide lender-of-last-resort support. A lack of social cohesion in the country will make it more challenging for the government to come up with credible measures that the donor community views as adequate for arrears clearance.

Withdrawal of support from key donors will also hamper any improvement in the country’s banks, which are enduring extreme cash shortages. As Exhibits 1 and 2 show, the banks’ cash/deposit ratio and balances in foreign accounts have declined significantly in the past two years.

EXHIBIT 1

Zimbabwean Banks’ Physical Cash and Ratio of Physical Cash to Demand Deposits

Source: Reserve Bank of Zimbabwe

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

$0

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14

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-14

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-14

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14

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14

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-14

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-14

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-16

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16

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-16

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16

$ M

illio

ns

Cash - left axis Notes and Coins in Banks/Demand Deposits - right axis

Zuzana Brixiova Vice President - Senior Analyst +44.20.7772.1628 zuzana.brixiova@moodys.com

Thaddeus Best Associate Analyst +44.20.7772.1088 thaddeus.best@moodys.com

Peter Mushangwe Associate Analyst +44.20.7772.5224 peter.mushangwe@moodys.com

NEWS & ANALYSIS Credit implications of current events

34 MOODY’S CREDIT OUTLOOK 5 SEPTEMBER 2016

EXHIBIT 2

Zimbabwean Banks’ Deposits at Foreign Banks

Source: Reserve Bank of Zimbabwe

In May, the Reserve Bank of Zimbabwe adopted emergency measures, including limits on ATM cash withdrawals to $300-$1,000 per week and restrictions on taking cash out of the country, but severe shortages have persisted. Moreover, some non-financial firms are struggling to make foreign payments for their production inputs, leading to reduced output. In June and July, cash shortages led the government to delay wage payments to a substantial portion of the civil service, including the army, which led to the initial protests in July.

$0

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14

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-14

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14

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-14

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14

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14

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14

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14

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-14

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15

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-15

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15

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15

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16

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16

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-16

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16

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-16

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16

$ M

illio

ns

NEWS & ANALYSIS Credit implications of current events

35 MOODY’S CREDIT OUTLOOK 5 SEPTEMBER 2016

Sierra Leone Graft Arrests Are Credit Positive Last Tuesday, Sierra Leone’s (unrated) Anti-Corruption Commission (ACC) arrested Momo Bockarie Foh, permanent secretary of the Ministry of Social Welfare, on corruption charges. Given Mr. Foh’s strong political connections, the charges reflect the government’s growing commitment to routing out graft and cronyism in public office, a credit positive. The country’s post-conflict Truth and Reconciliation Commission, which operated during 2002-04, cited endemic corruption as the one of the key drivers behind Sierra Leone’s descent into civil war in the 1990s, and controlling corruption is key for maintaining peace and stability.

Founded in 2000, the ACC was initially criticised for its ineffectiveness. In 2005, the ACC’s commissioner was removed amid a growing perception that the country’s attorney general was unwilling to prosecute corruption cases of high-profile individuals the ACC referred to him. However, the passage of the 2008 Anti-Corruption Act expanded the ACC’s powers and clarified its mission. Additionally, the ACC achieved an important degree of political independence by receiving the power to prosecute without the attorney general’s permission.

Since the 2008 reforms, the ACC has functioned more effectively, initiating more prosecutions and even successfully returning misappropriated funds to the public in some cases. Excluding the most recent arrest, the ACC’s achievements include several high-profile prosecutions of government ministers on corruption offenses, resulting in an improving score on Transparency International’s Corruption Perception Index. The ACC’s active stance contrasts with similar institutions in some other African countries that exist de jure, yet remain ineffectual in practice.

Mr. Foh’s arrest underscores the significant improvements that the authorities have made in tackling corruption in recent years, despite the economic setbacks from the Ebola crisis and the low strength of government institutions in the aftermath of conflict. The focus on this particularly high-profile ministry is especially important in the context of Sierra Leone’s weak public service delivery, which was the key challenge in containing the Ebola epidemic. Although corruption and embezzlement remain a challenge in Sierra Leone, the country has made marked improvements in Transparency International’s Corruption Perception Index. Between 2007 and 2015, Sierra Leone climbed 31 places in the index’s ranking (see Exhibit 1) and has lower perceived corruption than many regional peers (see Exhibit 2).

EXHIBIT 1

Corruption Perception Index Ranking for Sierra Leone A lower score is better.

Source: Transparency International

150

134

119

0

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2007 2011 2015

Zuzana Brixiova Vice President - Senior Analyst +44.20.7772.1628 zuzana.brixiova@moodys.com

Thaddeus Best Associate Analyst +44.20.7772.1088 thaddeus.best@moodys.com

NEWS & ANALYSIS Credit implications of current events

36 MOODY’S CREDIT OUTLOOK 5 SEPTEMBER 2016

EXHIBIT 2

Sierra Leone’s Corruption Perception Index Score, 2015 A smaller number means lower perceived corruption.

Source: Transparency International

A continued reduction in corruption will improve the effectiveness of the country’s institutions, leading to stronger fiscal management, better service delivery and a more attractive operating environment for investors. Improved governance will also increase confidence among the international donor community that transfers will be properly managed. Audits revealed that around one third of the Ebola funds internally allocated ($9.6 million) were unaccounted for. The general public’s lack of trust in government institutions was one of the key obstacles in effectively addressing the Ebola epidemic.

The ongoing corruption investigation is unlikely to have any adverse effect on political stability. In fact, the perception that the authorities are proactively tackling long-standing corruption issues is likely to improve popular support for the government.

0 5 10 15 20 25 30 35 40 45 50 55

Rwanda

Burkina Faso

Benin

Niger

Cote d'Ivoire

Mozambique

Sierra Leone

Gambia

Kenya

NEWS & ANALYSIS Credit implications of current events

37 MOODY’S CREDIT OUTLOOK 5 SEPTEMBER 2016

Korea’s Net International Investment Position Reduces External Vulnerabilities Last Tuesday, the Bank of Korea reported that the country’s net international investment position at the end of June had reached $234.1 billion, or 17% of 2015 GDP, a $103.7 billion increase from a year earlier and the highest level since the country began recording the statistic in 1994. This is credit positive for Korea (Aa2 stable) because it reflects a continued and significant strengthening of the country’s external payments position, which reduces the sovereign’s vulnerability to global financial market shocks and capital outflows.

The continued strengthening in Korea’s international investment position since 2011 reflects large and sustained current account surpluses, which we estimate at 6.9% of GDP in 2016. These surpluses shield the government, banking and corporate sectors from capital outflows, particularly during periods of heightened global financial market uncertainty and geopolitical risk that threaten to disrupt capital flows. Strengthened external buffers and reduced susceptibility to capital outflows provide the authorities with more monetary-policy flexibility to offset potential negative shocks.

However, the large current account surpluses and rapid increase in the international investment position also reflect weak consumption and subdued investment. This is reflected in the country’s more moderate GDP growth, which averaged 3.0% over the past five years, versus 5.7% in the decade preceding the global financial crisis. Nevertheless, Korea is now better insulated from the types of external funding market shocks that it experienced in 2008 and even more in 1997, when the country asked for support from the International Monetary Fund.

A fundamental development underlying the strengthening of Korea’s international investment position since the global financial crisis and a sudden stop in cross-border dollar credit following the September 2008 Lehman Brothers bankruptcy has been a reduction in Korean banks’ offshore borrowing. Before the Lehman crisis, Korea’s external balance sheet had deteriorated sharply. The increasing net liability balance of Korea’s international investment position during 2004-07 was largely driven by a run-up in external debt (see Exhibit 1).

EXHIBIT 1

Korea’s External Debt as a Percent of Foreign Exchange Reserves and Net International Investment Position

Source: Bank of Korea

As panic erupted during the global financial crisis, heightened risk aversion and a lack of dollar liquidity among Korean banks had particularly disruptive effects on the stability of Korea’s financial system and economy. The Bank of Korea was forced to tap into the US Federal Reserve’s $30 billion swap line in late 2008, which bolstered investor confidence and effectively halted the near sudden stop in funding to Korea’s heavily wholesale-funded banks.

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Long-Term External Debt - left axis Short-Term External Debt - left axis Net IIP Asset (Liability) - right axis

Shirin Mohammadi Associate Analyst +1.212.553.3256 shirin.mohammadi@moodys.com

Steffen Dyck Vice President - Senior Credit Officer +49.69.70730.942 steffen.dyck@moodys.com

NEWS & ANALYSIS Credit implications of current events

38 MOODY’S CREDIT OUTLOOK 5 SEPTEMBER 2016

The Bank of Korea’s implementation of macro-prudential measures since then, as well as improved risk management by Korean banks, are the reasons for the significant improvement in Korean banks’ funding and the containment of systemic risks. Korean banks reduced their total external debt to $174.8 billion in June 2016 from $220.8 billion in September 2008. Short-term external bank debt has declined by a larger margin to $74.8 billion in June 2016 from $159.3 billion in September 2008 (see Exhibit 2).

EXHIBIT 2

Korea’s Short-Term External Debt by Sector Macro-prudential measures have led to a significant reduction in banks’ short-term foreign-exchange exposures.

Source: Bank of Korea

In light of an easing in potentially destabilizing capital inflow pressures, the government in June 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 risks increasing short-term foreign-exchange borrowings, it will grant banks more flexibility in securing their foreign exchange liquidity needs, allowing them to better respond to potential future capital outflows.

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NEWS & ANALYSIS Credit implications of current events

39 MOODY’S CREDIT OUTLOOK 5 SEPTEMBER 2016

India’s Deficit in April-July Points to Large Investment Spending Cuts Later, a Credit Negative On Thursday, the Government of India (Baa3 positive) announced that its deficit in April-July 2016 equaled nearly 74% of the target for all of fiscal 2017 (which ends March 2017). We expect that the central government will meet its annual fiscal deficit target of 3.5% of GDP for fiscal 2017, but slippage at the beginning of the year implies that large and ad-hoc spending cuts, including cuts to much-needed investment spending, are necessary later in the year to achieve the target, a credit negative for the sovereign.

Adjustments late in the fiscal year will be particularly large, which undermines the effectiveness of the government’s fiscal policy since budget constraints rather than economic policy objectives drive late adjustments. In particular, late adjustments leave the implementation of public investment projects vulnerable to sudden freezes, which exacerbates economic volatility and hampers businesses’ visibility of the economic environment. The necessity for adjustments demonstrate the limits of India’s fiscal policy effectiveness and increases volatility in investment spending and GDP growth.

Fiscal deficits are usually higher in the first few months of the financial year owing to lumpy expenditure outlays and revenue intakes. However, as a proportion of the aggregate annual target, the deficit for the first four months of fiscal 2017 is the largest since 2008 (see exhibit).

Percentage of Annual Fiscal Deficit Target in April-July and Actual Fiscal Slippage from Target Large deficits at the beginning of the fiscal year are often followed by ad-hoc spending cuts to meet budget targets and reduce fiscal slippage.

Note: Positive number means actual fiscal deficits are wider than budget estimates. Sources: India’s Controller General of Accounts, Indian Union Budget and Moody’s Investors Service

This year, the government has repeatedly asserted its commitment to meeting its deficit target of 3.5% of GDP and will likely achieve its goal. But larger-than-usual slippage in the first four months of the fiscal year, large current spending commitments in the remainder of the year, more moderate GDP growth than assumed in the budget and a tighter target than last year (which was 3.9% of GDP) imply that the target will be achieved through large and ad-hoc cuts in investment or asset sales late in the fiscal year.

During the remainder of the fiscal year, large increases in public sector wages, following the recommendation of the Seventh Pay Commission, will boost current spending leaving little room for current expenditure restraint. Moreover, the government has pledged to prioritize spending on the rural economy, infrastructure and social sectors. With elections in the large, politically important states of Punjab and Uttar Pradesh looming in early 2017, it is likely that the government will follow through on these spending commitments.

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Percent of Full-year Fiscal Deficit in First 4 Months - left axisActual Fiscal Deficit - Original Budgeted Estimates, Percent of GDP - right axis

Amelia Tan Associate Analyst +65 6398 8323 amelia.tan@moodys.com

William Foster Vice President - Senior Credit Officer +1.212.553.4741 william.foster@moodys.com

Marie Diron Senior Vice President +65.6398.8310 marie.diron@moodys.com

NEWS & ANALYSIS Credit implications of current events

40 MOODY’S CREDIT OUTLOOK 5 SEPTEMBER 2016

From the revenue side, moderate growth in nominal GDP will likely constrain revenue increases. In the quarter that ended in June, nominal GDP grew by 10.4% year over year and we forecast nominal GDP growth of 10% for fiscal 2017, which will weigh on revenues because it is lower than the 11.0% nominal GDP growth assumed in the budget.

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41 MOODY’S CREDIT OUTLOOK 5 SEPTEMBER 2016

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Sovereigns 8 » Colombia's Peace Agreement with FARC Ends a 52-year

Credit- Negative Conflict

Sub-sovereigns 9 » Toronto and Ottawa Will Benefit from Canada's Transit

Infrastructure Stimulus » China's Intra-Governmental Fiscal Reform Will Reduce

Regional and Local Government Deficits

US Public Finance 14 » Alaska's Natural Gas Pipeline Hits Setback, a Credit Negative

for the State and Its Local Governments » Private University Graduate Students' Ability to Unionize Is

Credit Negative

Securitization 17 » Fannie Mae and Freddie Mac Risk-Sharing Transactions Will

Benefit from New Refi Programs for Underwater Homeowners

MOODYS.COM

Report: 191919

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EDITORS PRODUCTION ASSOCIATE Elisa Herr and Jay Sherman Wing Chan