Moody's Credit Outlook - 3 August 2015

MOODYS.COM

3 AUGUST 2015

NEWS & ANALYSIS Corporates 2 Honeywells Planned Acquisition of Melrose Industries Elster

Unit Is Credit Positive A UPS Acquisition of Coyote Logistics Would Be

Credit Negative Delphis Planned Acquisition of HellermannTyton Is

Credit Negative A Wabtec Acquisition of Faiveley Transport Would Be

Credit Positive Brazil Demand for Fine Payment Heightens Threat to

Votorantim Cimentos Liquidity Solvays Acquisition of Cytec Is Credit Negative for Both GKNs Acquisition of Fokker Technologies Is Credit Positive Falling Copper Prices and Zambian Power Reductions Tarnish

FQMs Credit Metrics Baidus Greater Investment in Online-to-Offline Business Is

Credit Negative

Infrastructure 14 SSEs Acquisition of Gas Assets Improves Internal Sources

of Supply ENGIE Clinches Credit-Positive Nuclear Contribution Reduction

and Reactor Extension

Banks 18 Ally Financial Will Benefit from Ally Banks Ability to Fund

Riskier Loans Banco PSA and Santander (Brasil) Car Loan Partnership Is

Credit Positive Guatemalas Weakening Economic Confidence Is Credit

Negative for Banks

Insurers 24 Sirius Groups Sale to China Minsheng Investment Corp. Is

Credit Negative Argentinas New Civil and Commercial Code Has Mixed

Implications for Insurers

Sovereigns 27 Ireland Reports Strong First-Quarter Growth, a Credit Positive Slovenias Privatisation Strategy Builds Momentum, a

Credit Positive

US Public Finance 31 Michigan Supreme Court Affirms State Pension Reforms, Credit

Positive for the State Glendale, Arizona, Renegotiates Smaller Subsidy to Pro Hockey

Team, a Credit Positive

RATINGS & RESEARCH Rating Changes 35

Last week we downgraded Advanced Micro Devices and Teva Pharmaceutical Industries, and upgraded Michigan, Southeast Housing and 26 US subprime RMBS, among other rating actions.

Research Highlights 38

Last week we published on US homebuilders, Asian corporates, European alcoholic beverage manufacturers, US chemicals, North American covenant quality, Japanese corporate liquidity, UK retail, US corporate defaults, Latin American telecommunications, US nuclear power generators, Bolivian banks, Lebanese banks, Austrian banks, Gazprombank, The Bank of New York Mellon and State Street Corp, Vietnamese banks, Eurasian sovereigns, Sri Lanka, Dominican Republic, Cyprus, Nicaragua, L&Q Group, SANRAL, Prague, Spanish regions, Michigan public universities, US variable-rate demand bonds, Japanese ABS and RMBS, UK RMBS and Finnish covered bonds, among other reports.

RECENTLY IN CREDIT OUTLOOK

Articles in Last Thursdays Credit Outlook 44 Go to Last Thursdays Credit Outlook

NEWS & ANALYSIS Credit implications of current events

2 MOODYS CREDIT OUTLOOK 3 AUGUST 2015

Corporates

Honeywells Planned Acquisition of Melrose Industries Elster Unit Is Credit Positive Last Tuesday, Honeywell International Inc. (A2 stable) said that it had agreed to acquire the Elster Group unit of Melrose Industries plc (unrated) for $5.1 billion. The planned acquisition is credit positive because it will enhance Honeywells environmental and combustion control and process solutions offerings, which should lead to revenue and margin expansion.

Honeywell expects to close the transaction in the first quarter of 2016 and will fund the purchase with overseas cash and some new debt issued by one or more of its US subsidiaries. The 12.6x 2015 EBITDA purchase multiple is on the lower end of the range of recent, cross-industry M&A transactions.

Elsters leadership in the natural gas sector and its footholds in electricity and water, together with Honeywells focus on driving cost efficiencies, leveraging research and development and reducing time to market for new products, will help the company realize its expected financial returns. Honeywell estimates that cost synergies from the deal will total around $150 million, or 8% of Elsters annual revenue, which will help it achieve a targeted return on investment of at least 10% by the fifth year after the deals completion. Honeywell excludes revenue synergies when calculating financial returns.

Funding the majority of the purchase price with cash will limit pressure on Honeywells credit metrics. Pro forma for the acquisition as of 30 June 2015, we estimate that debt/EBITDA will be 2.0x, versus 1.8x pre-transaction, while EBITA/interest will be 13.0x, versus 14.4x pre-transaction. We also estimate that Honeywells EBITDA margin will be 18.1%, versus 17.9% pre-transaction, while free cash flow/debt will be 15.0%, versus 16.9% pre-transaction. Our pro forma estimates assume no cost synergies and debt funding of 40% of the purchase price.

We expect pro forma metrics to remain well within the indicative parameters we have articulated for the assigned ratings (i.e., debt/EBITDA of less than 2.5x and EBITA/interest of more than 7x). With offshore cash and short-term investments likely to exceed $9 billion by the end of 2015, Honeywell maintains a significant amount of dry powder for funding additional acquisitions while maintaining its credit metrics at levels supportive of its A2 rating.

Jonathan Root, CFA Vice President - Senior Credit Officer +1.212.553.1672 [email protected]

This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on www.moodys.com for the most updated credit rating action information and rating history.



A UPS Acquisition of Coyote Logistics Would Be Credit Negative Last Friday, United Parcel Service, Inc. (Aa3 negative) said that it had agreed to acquire Coyote Logistics, LLC (B2 stable) for $1.8 billion, including assumed debt. The planned transaction is credit negative because UPS is paying a high multiple for the synergies it expects to realize.

The acquisition of Coyote, which UPS expects to close by the end of August, is mainly an attempt to reduce costs. Coyote provides truckload freight brokerage services across the continental US. The company is an important service provider to UPS, which increasingly relies on it when package demand surges, such as during the year-end holiday period. Truckload freight brokerage is a low-margin business and requires significant scale to produce meaningful earnings and free cash flow, notwithstanding minimal capital needs. Bringing Coyote in-house will allow UPS to capture the profit it currently pays as a customer.

The acquisition will also provide UPS with the opportunity to reduce empty miles across its line-haul fleet by leveraging Coyotes technology and database to find loads for return trips that today do not contribute any revenue. Doing so will increase the utilization of UPS tractors and trailers, contributing to top-line growth and operating profit given limited additional expense. UPS also expects that the combination of Coyotes technology and UPS logistics infrastructure will contribute incremental growth by deepening relationships with existing customers.

But 18x trailing EBITDA is a high multiple to pay for these benefits, some of which the company could have realized without acquiring Coyote. That said, even though we expect the entire purchase to be funded with debt, the modest size of the transaction will not burden UPS credit metrics. Pro forma for the acquisition as of 31 March 2015, we estimate that debt/EBITDA will be 4.0x, versus 3.9x pre-transaction, while EBIT/interest will be 7.0x, versus 7.3x pre-transaction. We also estimate that UPS EBITDA margin will decline by up to 0.4 percentage points from 12.4% pre-transaction. These pro forma measures assume no cost or revenue synergies. If the transaction yields $150 million in cost synergies (the high end of UPS expectations), these credit metrics would barely change.

UPS credit metrics are weak relative to other issuers rated Aa3. Over $14 billion of incremental adjusted debt related to the companys participation in multi-employer pension plans (MEPPs) is a large component of its pro forma total adjusted debt of $37 billion. This adjustment increases debt/EBITDA by more than 1.5 turns, which remains somewhat elevated for the Aa3 rating if the MEPP adjustment is excluded. Our negative outlook on UPS ratings reflects the potential for us to downgrade the senior unsecured rating should credit metrics not strengthen to levels that better support the Aa3 rating following the 2015 holiday season.

Jonathan Root, CFA Vice President - Senior Credit Officer +1.212.553.1672 [email protected]



Delphis Planned Acquisition of HellermannTyton Is Credit Negative Last Thursday, Delphi Automotive PLC (Baa3 positive), the parent of Delphi Corporation (Baa3 positive), said that it had made a binding offer to acquire HellermannTyton Group PLC (Ba2 review for upgrade) for $1.85 billion, which includes the assumption of debt. Although strategically sound, the deal is credit negative for Delphi because it will weaken its leverage and interest coverage metrics. Following the announcement, we put HellermannTytons ratings on review for upgrade.

We expect that adjusted debt/EBITDA, pro forma for the acquisition, will rise to about 2.00x from 1.59x for the last-12-month period ended 30 June. We also expect pro forma EBITA/interest to decline to about 8x from about 10x for the last-12-month period. The company is well-positioned to return debt/EBITDA to less than 2x thanks to gross business bookings of $24 billion at year-end 2014, increasing electrical content in passenger cars and managements expectations of about $50 million in annual synergies from the HellermannTyton acquisition. In addition, we expect the company to pursue shareholder return policies consistent with managements intention of maintaining strong, investment-grade credit ratings.

The planned transaction, which Delphi expects to close in the fourth quarter of 2015, will modestly enhance profit margins and bolster the ability of its electrical/electronic architecture segment to increase passenger vehicle content. We estimate that the companys EBITA margin, including our standard adjustments, will approach 14% on a pro forma basis, improving from about 13% for the 12 months ended 30 June 2015.

Liquidity will remain strong. As of 30 June 2105, Delphis cash balances totaled about $1.2 billion, which included proceeds from the divestment of the thermal business announced in February 2015. Although cash balances will fall by about half pro forma for the acquisition, seasonal working capital inflows in the fourth quarter should support cash balances, with full-year 2015 free cash flow generation of about $1.1 billion.

HellermannTytons $720 million revenue base is modest compared with Delphis electrical/electronic architecture segments $8.3 billion in annual revenue. As connectivity, infotainment and other electronic content in passenger vehicles increase, it will require additional electrical connections, which will support growth in this part of Delphis business.

Delphi has continued to improve profitability after its 2012 acquisition of FCI Groups motorized vehicles division. As such, we believe the integration risks around the acquisition of HellermannTyton are low. However, any softening in global passenger vehicle demand would delay the pace of leverage reduction.

Timothy Harrod Vice President - Senior Credit Officer +1.212.553.4488 [email protected]



A Wabtec Acquisition of Faiveley Transport Would Be Credit Positive Last Monday, Westinghouse Air Brake Technologies Corp. (Wabtec, Baa3 stable) said that it had agreed to acquire Faiveley Transport S.A. (unrated) for about $1.8 billion, including assumed debt. Despite our expectation of an uptick in leverage and a dilutive effect on margins, the planned acquisition is credit positive because it will significantly enhance Wabtecs position in key non-US markets and expand its product and service offerings. After the announcement of the deal, we affirmed Wabtecs Baa3 rating and maintained a stable outlook.

Faiveley is the second-largest provider of equipment and services in the European passenger rail transit market. The acquisition will strengthen Wabtecs presence in other regions, notably Asia-Pacific. Although Wabtec derives about 50% of its revenues from non-US markets, its market share remains relatively low in most of those regions, despite an acquisitive growth strategy.

Wabtec plans to fund the acquisition with available cash, existing credit facilities and potentially other debt financing, as well as by issuing convertible preferred stock. Pro forma for the acquisition, we estimate that debt/EBITDA for the 12 months ended 31 March 2015 would be 2.3x, up from only 0.9x on a standalone basis. Benefiting from at least $400 million in annual free cash flow, Wabtec should be able to reduce leverage to about 1.5x at the end of 2016.

The transaction will also have a dilutive effect on margins, because margins tend to be lower in the transit market versus the freight rail market. We estimate that Wabtecs EBITA margin, pro forma for the acquisition, will decline by about 200 basis points to around 16% for the 12 months ended 31 March 2015. Faiveley reported an operating margin of 8.6% for the fiscal year ended 31 March 2015, lower than the 11.2% margin in Wabtecs transit segment in 2014. Under Faiveleys three-year strategic plan for fiscal 2016-18, the company was targeting an increase in its operating margin to 11%-12%, a margin expansion of 240-340 basis points.

The planned transaction poses integration risks because it would be Wabtecs largest acquisition to date and most of Faiveleys operations are outside the US. Still, we believe that Wabtec will be able to integrate Faiveley successfully, given managements track record of integrating newly acquired, albeit significantly smaller, companies.

Rene Lipsch Vice President - Senior Analyst +1.212.553.1908 [email protected]



Brazil Demand for Fine Payment Heightens Threat to Votorantim Cimentos Liquidity Last Wednesday, Brazils Council for Economic Defence (CADE), the countrys antitrust authority, ruled that the companies implicated in a cement price-fixing and cartel case have 30 days to pay BRL3.1 billion ($931 million) in fines from 2014, including BRL1.5 billion from Votorantim Cimentos S.A. (Baa3 stable). The demand is credit negative for Votorantim Cimentos because it threatens the companys liquidity.

CADEs demand for payment was widely expected and ends the appeal process at the antitrust authority. CADE also gave the cement companies involved in the cartel case a year to reduce their installed concrete and cement capacity through asset sales, which was part of their punishment. All of the fined companies will likely see restricted access to public financing and tax benefits until they divest some assets.

In May 2014, CADE fined Votorantim Cimentos and a number of other Brazilian cement producers for price-fixing and cartel formation. Votorantim Cimentos, Brazils only rated cement company with roughly a 36% share of the domestic market, has long denied involvement in cartel practices, and will appeal the sanctions. The legal appeals process will almost certainly delay compliance, taking years to make its way through three levels of Brazils federal courts, including the highest. A final decision could eventually reduce or throw out the penalty, or allow installment payments. But if upheld in whole or in part, the sanctions would strain Votorantim Cimentos liquidity and likely damage its reputation.

CADEs non-monetary penalty demands that the companies named in its ruling divest their ready-mix concrete assets equal to 20% of total installed capacity wherever they have more than one plant within a 50-kilometer radius. The companies may sell these assets either individually or as a group to any company not named in the suit. CADE is also requiring that the penalized companies sell their minority interests in cement and ready-mix concrete companies in Brazil.

Votorantim Cimentos today could afford the BRL1.5 billion fine and the loss of capacity equaling less than 5% of its annual EBITDA, but the full payment would take a considerable chunk out of its BRL2.4 billion-plus cash balance. In an extreme liquidity situation, Votorantim Cimentos, the worlds eighth-largest cement producer, could tap its revolving credit facility, which has more than BRL2.1 billion available. Votorantim Cimentos has a comfortable amortization schedule with an average debt maturity of 9.2 years and funding mix mainly concentrated in bonds (50% of total reported debt) and debentures (29% of total reported debt), giving the company the means to pay the fines if necessary.

Any payments or divestments would also add to the stress that capital spending already places on Votorantim Cimentos liquidity. The company plans to invest around BRL5 billion in 2015-17 to raise its production capacity in Brazil to 37 million tons by the end of 2017, bringing its total worldwide capacity close to 60 million tons.

Marcos Schmidt Vice President - Senior Analyst +55.11.3043.7310 [email protected]



Solvays Acquisition of Cytec Is Credit Negative for Both Last Wednesday, Solvay SA (Baa2 negative) announced that it had agreed to acquire Cytec Industries Inc. (Baa2 review for downgrade) for $6.4 billion, including a total cash consideration of $5.5 billion. The acquisition is credit negative for Solvay because it will significantly increase its debt and put renewed pressure on its leverage metrics. The deal is also credit negative for Cytec because there is no indication what Solvay will do with Cytecs debt. Following the announcement, we changed Solvays outlook to negative, and put Cytecs ratings on review for downgrade.

Despite the sizable equity component in the permanent financing structure that Solvay intends to put in place to term out the initial bridge financing, including a 1.5 billion rights issue and the issuance of hybrid notes, we estimate that Moodys-adjusted debt/EBITDA will rise to just under 4x immediately following the closing of the transaction from 3.5x at the end of June 2015 (see exhibit).

Solvays Financial Metrics

Note: Forecasts for 2015 are pro forma for the merger taking effect on 1 January 2015. Sources: Moodys Financial Metrics and Moodys Investors Service forecasts

Additionally, the integration of this large and fully priced acquisition entails some significant risk. The transactions price tag equals 14.7x Cytecs 2015 consensus EBITDA (based on analysts mean estimate published by FactSet), a valuation clearly above the average of around 10x EBITDA recorded in the specialty chemical sector in recent years, notwithstanding that the price reflects Cytecs above-average growth prospects and robust average EBITDA margin of around 18% (on a Moodys-adjusted basis) over the past three years.

Although the rights issue that Solvay has planned has received the full support of its main 30% shareholder, Solvac (unrated), the timely implementation of the refinancing of the acquisition bridge financing in the equity and debt capital markets is subject to future market conditions.

The deal is also credit negative for Cytec because it creates uncertainty regarding whether the companys outstanding bonds will be assumed, guaranteed or refinanced by Solvay. If Solvay decides not to provide support for Cytecs bonds and Cytec does not continue to issue separate consolidated financial statements, it would be detrimental to Cytecs bondholders.

Despite the credit-negative aspects, the deal makes strategic sense, enhancing Solvays business risk profile and growth prospects. Cytec will also help Solvay to further diversify its end-market and geographical exposure: based on 2014 figures, North America will account for 26% of group sales, versus 23% pre-merger. Solvay will gain leading positions in fast-growing markets such as composites materials for aircraft and automobiles, and in phosphine-based separation chemicals used by the mining industry. It will have

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Francois Lauras Vice President - Senior Credit Officer +44.20.7772.5397 [email protected]

Joseph Princiotta Vice President - Senior Analyst +1.212.553.6823 [email protected]



access to Cytecs strong technology platform and long-established and close relationships with key customers such as The Boeing Company (A2 stable) and Airbus Group SE (A2 stable).

Given Cytecs financial track record, the acquisition should be accretive to Solvays EBITDA margin and boost its future cash flow. In addition, management targets annual synergies of more than 100 million within the three next years, which we view as achievable given the potential cost savings and cross-selling opportunities between Cytec and Solvays existing specialty polymers and advanced formulations businesses.

In addition, Solvay is likely to accelerate the transformation of its portfolio post-acquisition, and sell some of its more mature businesses, such as Acetow or Polyamide. This would further support Solvays deleveraging effort and the recovery in its financial metrics, including returning debt/EBITDA toward 3x by 2017.

The transaction has been unanimously recommended by Cytecs board of directors, and although the transaction is subject to customary regulatory and shareholder approvals, the companies expect to complete it by fourth-quarter 2015.



GKNs Acquisition of Fokker Technologies Is Credit Positive Last Tuesday, UK-based GKN Holdings plc (Baa3 stable) announced that it would acquire Netherland-based aerostructures specialist Fokker Technologies (unrated) for 636 million (451 million), including the refinancing of approximately 135 million of external net debt as of year-end 2014. The Fokker acquisition is credit positive for GKN because it will enhance its product offering and allow it to strengthen its competitive position.

Around 45% of the deals funding will be raised from equity, with debt composing the rest. As a result, GKNs credit metrics will only slightly weaken when the transaction closes, with Moodys-adjusted debt/EBITDA rising to 3.3x from 3.1x as of year-end 2014. When we factor in Fokkers approximately 50 million of debt-like obligations (including a $21 million settlement of US sanction violations) that GKN will assume, the transaction values Fokker at 501 million, or 9.3x Fokkers 2014 EBITDA.

Fokker generated 758 million (544 million) of revenues and 76 million (55 million) of EBITDA in 2014. The company specializes in empennage, fuselage and movable wing parts. It benefits from leading advanced composite and electrical technologies and holds strong positions in electrical wiring design and manufacturing systems.

The transaction, which the companies expect to close in October, would mark GKNs first major acquisition since 2012, when it acquired Volvo Aero, the aerospace division of Sweden-based AB Volvo (Baa2 stable) for 633 million. GKNs cautious approach toward external growth and its commitment to an investment-grade rating explains why management decided to fund both transactions with a mix of debt and equity.

Acquiring Fokker will strengthen GKNs aerospace division by giving GKN access to Fokkers complementary technology, broadening its product offering and increasing its order book. Pro forma for the transaction, the companys auto-related activities will generate 55% of group sales post-Fokker, versus 59% pre-Fokker, while aerospace will constitute 35%, versus 30% pre-Fokker.

We expect the transaction to be moderately margin dilutive given Fokkers slightly lower profitability in EBITA margin terms (approximately 0.3 percentage points down from the 8.5% reported in 2014 after integration cost). We expect a strengthening of GKNs key credit metrics starting in 2016 as the company applies free cash flow to debt reduction, supported by some initial synergies from the combination with Fokker, which company management estimates will be around 23 million.

GKN acts as a finance, investment and holding company of GKN plc, an international engineering group with operations in 33 countries. In 2014, GKN reported revenues of 7.0 billion, or 7.5 billion including GKNs pro rata share in joint ventures.

Oliver Giani Vice President - Senior Analyst +49.69.70730.722 [email protected]



Falling Copper Prices and Zambian Power Reductions Tarnish FQMs Credit Metrics On Friday, copper closed at $2.36 per pound, $0.98 lower than its 52-week high of $3.24 per pound on 8 August 2014, driven by decreasing demand from China, the worlds largest copper consumer. Falling copper prices are credit negative for First Quantum Minerals Ltd. (FQM, B1 negative) because they lower revenues at a time when FQM faces mounting financial pressure as its Zambian mines suffer power reductions and the companys Cobre Panama project consumes cash.

To date, FQM has had no challenges in selling product despite global supply-demand trends weighing on the prices it receives. International Copper Study Group estimates that Chinas consumption, which constitutes approximately 40% of global demand, fell 5% in the four months ended April 2015 versus a year earlier. We expect this trend to continue owing to Chinas falling GDP growth and a deterioration in consumer sentiment as demand for end products using copper decreases. At the same time, there has been a sustained increase in copper inventories since the beginning of the year as a result of global mine production increasing by around 3% (see exhibit). This has added further pressure on copper prices.

London Metals Exchange Copper Warehouse Inventories

Source: London Metals Exchange

Compounding FQMs challenges is that Zambian power utility Zesco Ltd. (unrated) has implemented power cuts following reduced generation capacity at its hydroelectric plant. Zambia is enduring one of its worst droughts on record and although the country is adding power generation capacity early next year, the country faces a power shortage over the next eight months. Such a shortage would reduce production rates at FQMs two Zambian copper mines, Kansanshi and Sentinal, a project that had been ramping up production, and reduce flow rates at Kansanshis new smelter facility. These mines together generate nearly half of FQMs total cash flow, which will be negatively affected by lower production available for sale.

The path for FQM to restore credit metrics back to rating guidance levels looks less clear. Lower copper prices, the $600 million that the company will spend this year on its $6.4 billion Cobre Panama copper project and production reductions at the Zambian mines will weaken credit metrics. This will be driven by lower EBITDA generation, continued negative free cash flow and rising debt levels. Metrics for the 12 months ended 30 June 2015 will likely breach our indicative parameters for a B1 rating: debt/EBITDA below 4.5x and EBIT/interest above 2.0x. Currently, FQMs debt/EBITDA is 4.4x and EBIT/interest is 1.8x.

FQMs liquidity remains strong following a recent renegotiation of bank loan covenants, which still offer sufficient headroom against reported metrics and a lower copper price. Further supporting FQMs liquidity is a $1.1 billion equity capital raise in May that the company used to reduce its draw-down on its bank facilities. However, any uplift to credit metrics from these factors is temporary: any availability on the bank facilities is likely to be used up by the remaining portion of the $1 billion of capex for this year, driving debt

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Douglas Rowlings Analyst +971.4.237.9543 [email protected]



higher. We recognise that FQM can defer some of its capex spend into next year, but it will eventually be spent. The effect from delaying capex is unlikely to change the effect of declining free cash flow and rising debt because we see little relief in sight for copper prices. Forecast refined copper production will exceed usage next year, keeping prices low.



Baidus Greater Investment in Online-to-Offline Business Is Credit Negative Last Tuesday, Baidu Inc. (A3 positive) CFO Jennifer Li said during the companys second-quarter earnings call that the Chinese search engines selling, general and administration (SG&A) expenses in the second half of 2015 will increase by 80%-90% from the first half, mainly to support growth in Baidus online-to-offline (O2O) service. This significant increase in expenses is credit negative because it will reduce the companys EBITDA and weaken its debt/EBITDA ratio.

The increase will come on top of a 65% increase in SG&A in the first half of this year to RMB6.8 billion, versus the year-earlier level of RMB4.2 billion (see exhibit).

Baidus SG&A and SG&A as a Percentage of Sales Baidu to increase SG&A to promote its online-to-offline services.

Sources: Baidu quarterly financial statements and Moodys Investors Service estimates

In particular, Baidu plans to spend RMB20 billion over the next three years to attract consumers to Baidu Nuomi, its O2O local e-commerce platform. O2O refers to Internet companies driving consumers who access their online platforms to brick-and-mortar merchants and service providers with which Internet companies have partnered.

Baidu reported RMB40.5 billion of gross merchandise value for its O2O services in second-quarter 2015, which includes Chinese group buying site Baidu Nuomi, online travel agency Qunar and Baidu Takeout Delivery. Gross merchandise value grew 109% in second-quarter 2015 from a year earlier.

Notwithstanding this growth, Baidu Nuomi and Baidu Takeout Delivery are in the early stages of growth and do not yet contribute materially to revenue. Baidu offers subsidies and promotions to its users to facilitate transactions to seed the market and educate users about O2O services, but it will take time for these initiatives to produce meaningful earnings.

Baidus heavy investment to develop a user base for O2O has weakened its credit profile. Based on Baidus current investment plan, we expect the companys debt/EBITDA to increase to 2.4x at year-end 2015 from 1.6x at year-end 2014, and for its EBITDA margin to decline to 25% for full-year 2015 from 39% over 2014.

Baidus net cash position remains strong. Cash and short-term investments totaled RMB75 billion as of 30 June. This amount, together with its strong and stable cash flows from its core search business, should be sufficient to cover its investment needs and its recently announced $1 billion share repurchase program.

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Anthony Lee, CFA Associate Analyst +852.3758.1305 [email protected]

Lina Choi, CFA Vice President - Senior Analyst +852.3758.1369 [email protected]



In addition, Baidu has indicated that it has invited financial and strategic investors to co-invest in its takeout delivery business to help fund growth. Reducing its investment outlay by attracting more investors would be credit positive and could increase the companys rating upgrade potential.



Infrastructure

SSEs Acquisition of Gas Assets Improves Internal Sources of Supply On Wednesday, SSE plc (A3 negative) announced that it will acquire a 20% non-operating stake in Totals Laggan-Tomore and Eradour-Glenlivet fields, off the Shetland Islands, for 565 million (around $880 million). SSE also plans to invest 350 million through 2018 (including 170 million in the current year) to complete the development. The acquisition is a significant increase in both the volume and quality of SSEs internal sources of supply, a credit positive.

The acquisition increases SSEs gas reserves to more than 6 billion therms (100 million barrels of oil equivalent or mmboe). The company reported reserves of 2.2 billion therms at 31 March 2015, implying that the Total assets have added around 3.8 billion therms (65 mmboe).

When the new fields reach peak production in 2016, SSE expects that its share of output will be 1 million therms per day. This is a near doubling of the 1.1 million therms/day average production in the fiscal year ended March 2015, and will account for a significant portion of gas and electricity (which in the UK market is closely linked to gas) it supplies to customers. In fiscal 2015, SSE supplied 1.542 billion therms of gas to residential and business customers in Great Britain. It also supplied 39.9 terawatt-hours of electricity, which we estimate equals a further 700 million therms of demand.

The Total assets significantly increase SSEs internal sources of supply. They also increase the quality of SSEs hedge on gas prices. SSE has historically had little gas production of its own. Instead, it has relied on coal-fired generation, where profits are positively correlated with gas prices because revenues are set by Great Britains gas-driven electricity market, an approximate hedge on its gas exposure. However, coal output declined significantly in fiscal 2015 and is unlikely to recover. SSEs renewable output provides a better proxy for gas, but remains small. The addition of the Total gas assets provides a significant and direct source of supply, as shown in the exhibit below.

SSEs Internal Supplies as a Percent of Sales to Customers in Great Britain

Note: Both supply and production assume gas is converted to electricity at 52% efficiency. Sources: SSE, Ofgem Consolidated Segmental Statements and Moodys Investors Service estimates

Owning gas assets or fixed-cost electricity generation is important if prices paid by customers do not immediately reflect changes in Great Britains gas prices, which could lead to volatility in energy suppliers cash flows. In recent years, retail prices have adjusted more quickly than in the past, which may reduce the

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Graham W. Taylor Vice President - Senior Analyst +44.20.7772.5206 [email protected]

Neil Griffiths-Lambeth Associate Managing Director +44.20.7772.5543 [email protected]



need for this internal supply. However, SSE is less hedged than its peers and this acquisition increases its alignment with the market average, a credit positive.

The upfront costs of the 565 million purchase will increase SSEs net debt from 8.3 billion (on a Moodys-adjusted basis) at 31 March 2015, and the effect on credit metrics in the year to March 2016 is likely to be modestly negative. In subsequent years we expect the acquisition to have a neutral or positive effect on credit metrics, given capital allowances. In SSEs first-quarter results on 23 July, management reiterated its intention to spend 5.5 billion on capex and acquisitions (net of disposals) between now and 2018. The 350 million of planned development expenditure falls within this plan, although it suggests a significant change in the balance of the spending: the 170 million to be invested in the new fields this year compares with just 21 million of gas production capex in the year to March 2015.



ENGIE Clinches Credit-Positive Nuclear Contribution Reduction and Reactor Extension Last Wednesday, global energy utility ENGIE SA (formerly GDF SUEZ, A1 negative) negotiated a reduction in the nuclear contribution (levy) it pays to the Belgian government as part of a wider deal that also prolongs by 10 years the lifespan of two of its Belgian nuclear reactors. The agreement, which requires Belgian parliamentary approval, is credit positive for ENGIE because it reduces the financial burden of Belgiums nuclear contribution and extends the earnings stream generated by ENGIEs Doel 1 and Doel 2 reactors.

Under the agreement, ENGIE will pay the Belgian government 200 million in 2015 and 130 million in 2016 (which excludes ENGIEs contribution for the Tihange 1 nuclear reactor) and a royalty of 20 million per year starting in 2016. This compares with a total contribution of 397 million in 2014. Doel 1 and Doel 2 each had been due to reach the end of their operational lives in 2015. ENGIE intends to invest 700 million in the two plants as a result of the extension.

ENGIEs annual nuclear contribution for Doel 3, Doel 4, Tihange 2 and Tihange 3 will total 200 million in 2015 and 130 million in 2016. Starting in 2017, ENGIEs contribution will be set at 40% of the profit that the four nuclear power plants generate, taking into account variations in costs, production volumes and electricity prices. In addition, ENGIE will pay starting in 2016 a 20 million annual royalty linked to the extension of the Doel 1 and Doel 2 plants into Belgiums energy transition fund. The fund was created in June 2015 to finance research into new energy production and storage technologies as part of the countrys preparation for the phase-out of nuclear power. ENGIE also has agreed to pay the Belgian state 100 million in 2015 and 20 million in 2016 to settle a longstanding legal dispute.

An existing agreement for the life extension of the Tihange 1 reactor, which also comprises a profit-sharing mechanism with the Belgian government, remains unchanged. Tihange 1 is jointly owned by ENGIE and Electricite de France (A1 negative).

We estimate that if the reduced payments agreed to for 2016 had been in effect last year, ENGIEs ratio of funds from operations (FFO) to net debt would have been 50 basis points higher at 21.4%. We calculate that the closure of both Doel 1 and 2 would have reduced ENGIEs monthly EBITDA by more than 20 million, excluding the effect of drawing rights.

The agreement suggests that the Belgian government, which intends to phase out nuclear power by 2025, sees a continued role for nuclear generation in providing Belgiums energy supply between now and then. Belgium relies on nuclear power for around half of its energy needs, and ENGIE is the countrys biggest clean power generator with 4.1 gigawatts of net nuclear capacity, (net of third-party capacity and drawing rights) spread across seven reactors (see exhibit below).

Paul Marty Vice President - Senior Credit Officer +44.20.7772.1036 [email protected]



ENGIEs Nuclear Net Capacity in Belgium

Note: Data is net of third-party capacity and gross of drawing rights. Source: ENGIE

ENGIE faces separate challenges related to its nuclear fleet in Belgium. Its Doel 3 and Tihange 2 reactors are both currently closed subject to technical inspection by the Belgian regulator. In February 2015, the company estimated that when running, the two plants generated a monthly EBITDA of 40 million. The company expects the reactors to resume operations on 1 November, subject to the Belgian regulators authorization.

Doel 1 (433 MW)9%

Doel 2 (433 MW)9%

Doel 3 (905 MW)18%

Doel 4 (935 MW)18%

Tihange 1 (481 MW)9%





Banks

Ally Financial Will Benefit from Ally Banks Ability to Fund Riskier Loans Last Tuesday, Ally Financial Inc. (B1 positive) announced that it had received regulatory approval from the Federal Deposit Insurance Corporation to fund loans with FICO scores of 620-659 within Ally Bank, lifting a restriction that had been in place since its inception. The lifting of this restriction is credit positive for Ally Financial because it provides another funding option with a significantly lower cost of funds than long-term unsecured debt as the company expands its presence in riskier nonprime auto lending.

Using idle deposits to fund higher-yielding 620-659 FICO loans will improve Ally Financials net interest margins. Ally Financials annualized cost of funds for the second quarter of 2015 for long-term senior unsecured debt was 4.98%, while Ally Banks cost of deposits was 1.16%, a significant difference. Capital Auto Receivables Asset Trust 2015-2, a recent Ally Financial securitization with a 633 weighted average FICO score, had an initial weighted average coupon of 1.50%-1.75%, depending on actual prepayments, which shows that deposit funding cost is lower even than the cost of secured debt.

Adding deposits from Ally Bank as a funding source for these loans provides Ally Financial with another funding option. If the securitization markets become unreliable in a stressed environment, nonprime loans would more likely become even more illiquid compared with prime loans. Having bank deposits available to fund nonprime loans puts Ally Financial in a better position to manage its funding availability across various economic and capital market scenarios.

Ally Financial is in the midst of a shift in originations as General Motors Financial Company, Inc. (Ba1 stable) has taken most of the General Motors subvented loan and lease originations and a small portion of wholesale financing. Against that backdrop, Ally Financial has focused on increasing originations with new dealer relationships beyond its historical General Motors and Chrysler ties (see Exhibits 1 and 2). Lending spans across the credit spectrum, including 620-659 FICO loans and lower. Although we do not expect it, Ally Financials ability to fund the 620-659 FICO loans with deposits gives the company greater flexibility to grow the proportion of these riskier loans in its portfolio. If Ally Financial were to accelerate nonprime originations, it would be a credit negative development.

EXHIBIT 1

Ally Financials Auto Loan Originations by Dealer

Source: Ally Financial

66% 63%63%

60% 52% 45%

15%17%

16%

18% 20% 24%

19%

20%20%

22% 28%32%

$9.2

$10.9 $11.8

$9.0 $9.8

$10.8

$0

$2

$4

$6

$8

$10

$12

$14

1Q 14 2Q 14 3Q 14 4Q 14 1Q 15 2Q 15

$ Bi

llion

s

GM Chrysler Other Dealers

Jason Grohotolski Vice President - Senior Analyst +1.212.553.1067 [email protected]



EXHIBIT 2

Ally Financials Auto Loan Originations by Dealer

Second-Quarter 2015 $ Billions

Second-Quarter 2014 $ Billions

Year-over Year Change

Other Dealers $ 3.4 $ 2.2 58%

Chrysler 2.5 1.9 37%

GM Non Subvented 4.1 3.3 22%

GM Subvented (Loan and Lease) 0.8 3.6 -78%

Total $ 10.8 $ 10.9 -1%

Source: Ally Financial



Banco PSA and Santander (Brasil) Car Loan Partnership Is Credit Positive Last Friday, Banco Psa Finance Brasil S.A. (Banco PSA, Ba2 stable, ba31) and Banco Santander (Brasil) S.A. (Baa2 negative, baa2) announced that they would form a partnership to offer car loans to individuals and inventory financing to authorized car dealers under the PSA brand, pending regulatory approval. The agreement is credit positive for both banks because it will strengthen Banco PSAs funding profile and help Santander (Brasil) gain market share and strengthen its asset quality.

Banco PSAs current funding structure is highly concentrated: deposits from other financial institutions comprised almost three quarters of its funding base in 2014, and the 10 largest investors held more than 90% of deposits. Under the new partnership, Santander (Brasil) will provide Banco PSA with more stable funding at longer tenors, helping to reduce Banco PSAs overall funding costs and strengthening its liquidity.

Santander (Brasil) will benefit from the transaction because it will gain exposure to Banco PSAs portfolio of relatively low-risk auto loans. Banco PSAs focus on new car financing has allowed it to maintain superior asset quality, with a nonperforming loan ratio of 2.58% in 2014, which will likely improve the quality of Santander (Brasil)s mixed portfolio of new and used car financing.

The agreement will also allow Santander (Brasil) to increase its presence in the countrys vehicle finance market. The banks combined auto finance operation will be 40% larger than the existing portfolio at Santander (Brasil). In December 2014, Santander (Brasil) had 3% of the market, while Banco PSA had 1.2%. In addition, the partnership will enable Santander (Brasil) to offer financial services, such as auto insurance, to customers through Banco PSAs distribution network of authorized dealers.

The agreement calls for Santander (Brasil) to acquire 50% of Banco PSAs equity through a wholly owned financial subsidiary, with the final acquisition price depending on Banco PSAs book value on the date the deal closes. As of 31 December 2014, Banco PSAs reported equity was BRL454 million ($171 million), while Santander (Brasil)s net worth was BRL57.3 billion ($21.6 billion). Last year, the parent companies of Santander (Brasil) and Banco PSA pursued similar agreements in 10 European countries, which shows their commitment to building strong car finance franchises in all of their core markets.

Gaining access to additional low-cost funding will alleviate pressure on Banco PSAs performance from Brazils tightening monetary policy and weakening auto sector (see exhibit). The slump in car production and sales in Brazil that began in 2013 persists this year, with the first six months of 2015 showing a year-over-year decline of 18% in car production and a 21% decline in sales. Brazils association of car manufacturers, Associao Nacional dos Fabricantes de Veculos Automotores, projects that sales will fall 17.8% for the entire year, while production will decline 20.6%. In 2014, captive vehicle lenders managed to maintain the pace of loan origination based on their close ties with car manufactures, which allowed them to make special offers that included interest subvention, offering 0% interest rate deals, and grace periods on first loan payments. These competitive advantages, combined with the infusion of additional resources, will help the banks partnership to perform well despite continued weakness in Brazils car market.

1 The bank ratings shown in this report are the banks deposit ratings and baseline credit assessments.

Alexandre Albuquerque Assistant Vice President - Analyst +55.11.3043.7356 [email protected]



Brazil Vehicle Sales Auto sales have been declining since 2013, reducing Banco PSAs loan book by 13% last year.

Source: Associao Nacional dos Fabricantes de Veculos Automotores

Under the agreement, Santander (Brasil) will also acquire 100% of Banco PSAs leasing subsidiary PSA Finance Arrendamento Mercantil S.A. (unrated) and 50% of its insurance brokerage company PSA Corretora de Seguros e Servios Ltda (unrated). Both would be acquired through Santander (Brasil) subsidiaries. The banks did not disclose how Santander (Brasil) will finance the transaction.

2.9

3.2

3.6 3.63.8 3.8

3.5

3.2

1.5

2.0

2.5

3.0

3.5

4.0

2008 2009 2010 2011 2012 2013 2014 Jun-15

Mill

ions



Guatemalas Weakening Economic Confidence Is Credit Negative for Banks Last Tuesday, Guatemalas central bank reported that the countrys Economic Activity Confidence Index2 in July 2015 fell to its lowest level since 2009 (see exhibit below), capping a sharp decline over the past three months amid increased political turmoil. This decline in confidence is credit negative for Guatemalan banks because it raises the risk that economic growth will weaken amid a more uncertain investment climate and lead to a slowdown in household and corporate income growth.

Guatemalas Economic Activity Confidence Index

Source: Guatemala central bank

The index fell to 28.68 from 57.82 at the end of the first quarter, triggered by a series of corruption scandals that have come to light since April and which have entangled several high-level politicians, including Roxana Baldetti, the countrys former vice president, and Julio Surez, the governor of the central bank.

A decline in the creditworthiness of individuals and corporates triggered by the decline in confidence would lead to higher nonperforming loans (NPLs), which were a very low 1.45% as of June 2015. Guatemalas tense political climate will continue to weigh on the economy through the end of the year, owing to presidential elections scheduled to take place in September, and a new president not taking office until January.

These economic and political headwinds come at a time when banks have been expanding their loan books at a rapid pace, which compounds asset quality risks. Loan growth has averaged 14% over the past three years, or a high 1.8x nominal GDP growth. Additionally, credit expansion has targeted the riskier consumer segment, which constituted a relatively large 28% of total loans as of June 2015, and has accounted for about one third of total nominal growth since year-end 2012.

This means that banks with larger consumer loan exposures would initially see the greatest effect from a downturn in job creation and real wage gains. These banks include Banco de los Trabajadores (Ba3 stable, b13), Banco de Desarrollo Rural (unrated), Banco de America Central (its Panama-based parent BAC International Bank, Inc. is rated Baa3 stable, baa3) and, to a lesser extent, Banco Agromercantil de Guatemala (unrated). If a prolonged economic slowdown driven by lower investment materializes, the asset quality of banks that focus on commercial loans would also be affected because reduced cash flow would lead to a deterioration in companies financial positions.

2 The index gauges a survey of analysts related to business confidence, investment climate and expectations for economic growth. 3 The bank ratings shown in this report are the banks deposit ratings, senior unsecured debt ratings (where available) and baseline

credit assessments.

05

10152025303540455055606570758085

Oct

-09

Jan-

10

Apr-

10

Jul-

10

Oct

-10

Jan-

11

Apr-

11

Jul-

11

Oct

-11

Jan-

12

Apr-

12

Jul-

12

Oct

-12

Jan-

13

Apr-

13

Jul-

13

Oct

-13

Jan-

14

Apr-

14

Jul-

14

Oct

-14

Jan-

15

Apr-

15

Jul-

15

Georges Hatcherian Analyst +52.55.1555.5301 [email protected]

Vicente Gomez Associate Analyst +52.55.1555.5304 [email protected]



A rapid deterioration in asset quality would increase loan-loss provisions, reducing Guatemalan banks return on average assets, which averaged a strong 2% over the past three years, according to the Central American Monetary Council. Should this cause a decline in banks capitalization, it may put strain on their already low capital metrics. The banking systems ratio of core capital to total average assets was 6.8% as of November 2014, well below the 7.7% average for Central America.



Insurers

Sirius Groups Sale to China Minsheng Investment Corp. Is Credit Negative Last Monday, White Mountains Insurance Group Ltd. (WTM, unrated), the ultimate parent of Sirius International Group, Ltd. (Baa3 stable), announced that it had signed a definitive agreement to sell 100% of its ownership stake in Sirius and its immediate parent to CM International Holding PTE Ltd., the Singapore-based investment arm of China Minsheng Investment Corp., Ltd. (CMI, unrated). The planned sale to CMI is credit negative because it exposes Sirius to new risks and uncertainties given CMIs limited operating history and lack of meaningful expertise in the reinsurance industry. Additionally, the lack of visibility into CMIs influence over Sirius strategy, including the risk of it adopting a more aggressive investment and underwriting approach, is credit negative. WTMs credit quality is unaffected by the sale.

Sirius is a long-established, medium-scale reinsurer, with approximately $2 billion of capital, and 2014 gross written premiums of approximately $1.1 billion. An important part of its franchise is its longstanding, local relationships with a large number of cedents across multiple countries.

Although Sirius granular portfolio and strong client relationships allow it to defend its position in a challenging reinsurance market, it lacks the resources and scale to compete effectively against larger reinsurers. Ownership by CMI, a Shanghai-domiciled investment company focused on investing in financial services and industrial businesses, could help Sirius increase its presence in Asia, a market with attractive potential.

Sirius has indicated that CMI intends to maintain Sirius current investment and underwriting approach and risk tolerance levels, but it is not clear whether Sirius will maintain this position over time, given the different path that some of its peers have followed. For example, Fosun International Limited (Ba3 stable), another Chinese investment holding company, has purchased a number of insurance companies over the past three years and has adopted an insurance plus investment strategy that involves taking more investment risk onto the insurers balance sheet to generate higher returns.

In Sirius case, such a strategy would increase its overall risk given its exposure to catastrophes that could require the liquidation of substantial assets to pay claims. Large exposures to higher risk, illiquid or concentrated assets would increase the possibility of having to sell them at a substantial discount. Sirius reported a net after-tax loss for a 1-in-250-year modeled event for its largest catastrophe zone (Southeast US) of about 19% of consolidated GAAP equity. Among reinsurers that report such data publicly, the industry median for similar losses is 15% of consolidated GAAP equity.

With the sale, Sirius loses its affiliation with WTM, an established, insurance-focused holding company with deep industry expertise, and joins a newly formed group with limited insurance expertise and a limited track record, notwithstanding CMIs substantial undeployed financial resources. Our expectation that Sirius management team will remain in place mitigates this risk.

The transaction is credit neutral for WTM and its remaining subsidiaries, taking into consideration WTMs potential uses of proceeds, which we believe include a combination of returning capital to shareholders, new acquisitions, retaining capital at the holding company and capital contributions to OneBeacon U.S. Holdings, Inc. (Baa3 stable) or other subsidiaries. Pro forma for the sale of Sirius, we estimate that WTMs financial leverage will decline to approximately 7% from 18% currently. Conversely, depending on the ultimate use of the proceeds, selling Sirius could reduce ongoing sources of cash flow to WTM, leaving OneBeacon as its principal dividend-paying subsidiary.

Brandan Holmes Vice President - Senior Analyst +1.212.553.6897 [email protected]

Alan Murray Senior Vice President +1.212.553.7787 [email protected]



Argentinas New Civil and Commercial Code Has Mixed Implications for Insurers Effective 1 August, Argentinas new Civil and Commercial Code took effect, triggering changes that affect insurers. Although some aspects of the code are credit positive for all insurers, other aspects are credit negative for non-contractual liability and life and annuity insurers, while still others are credit positive for public transportation insurers and contractual liability insurers.

The new code ends the application to insurers of a three-year statute of limitation for consumers, which is credit positive for all insurance companies. The three-year limitation was outlined in Argentinas previous consumer protection law, which superseded laws specific to certain sectors such as insurance to the favor of the consumer. The current code makes clear that the three-year statute of limitation clause is not applicable to insurers, reinforcing the one-year statute of limitation period specified in Argentinas insurance law. The reduction of the limitation period to one year will reduce claims against insurers, a credit positive given that the narrower time frame to file a claim will likely result in fewer losses for insurers.

Heretofore, policyholders deductibles, mostly in public transportation coverages, have occasionally been contested by injured third parties, at times resulting in insurers being obligated to fund the policy deductible, even in the absence of a contractual obligation to do so and contrary to international best practices. However, under the new law, a third party cannot pursue claims against an insurer beyond the terms and conditions of the policy, thereby reducing claims. Exhibit 1 shows Argentine public transportation insurers that benefit from the change.

EXHIBIT 1

Market Share of Public Transportation Insurers Company Market Share

Proteccin Mutual de Seguros 36%

Mutual Rivadavia de Seguros 25%

Escudo Seguros 19%

Metropol Sociedad de Seguros Mutuos 9%

Argos Mutual de Seguros 9%

Garanta Mutual de Seguros 2%

Source: Moodys Investors Service, based on information published by Argentinas Superintendencia de Seguros de la Nacin

The new code establishes a unified expiration period of three years for non-contractual and contractual liability, versus the previous legal framework of two years for non-contractual liability and 10 years for contractual liability. This change is credit negative for insurers offering non-contractual liability coverage, such as third-party liability for corporations or construction firms, because it extends by one year the expiration period, increasing the time claims can be made. On the other hand, the change will benefit contractual liability insurers, such as professional liability insurers, because it shortens the expiration period by seven years, decreasing the time claims can be made. Exhibit 2 shows the top five Argentine professional liability insurers that will benefit from this change.

Diego Nemirovsky Vice President - Senior Credit Officer +54.11.5129.2627 [email protected]



EXHIBIT 2

Market Share of Professional Liability Insurers Company Market Share

SMG Compaia Argentina de Seguros 25%

Noble Aseguradora de Responsabilidad Profesional 15%

Seguros Mdicos 14%

Federacion Patronal 13%

TPC Compaia de Seguros 9%


The new law allows any debtor to cancel any contract denominated in a foreign currency at the equivalent amount in local currency (bank deposits are excluded). This is credit negative for life and annuity insurers because they could honor a foreign currency obligation in local currency at the official exchange rate, which often overvalues the Argentine peso, thereby discouraging the demand for these products. Exhibit 3 shows the top five Argentine individual life and annuity insurers.

EXHIBIT 3

Market Shares of Argentinas Individual Life and Individual Annuity Insurers Individual Life Insurers Individual Annuity Insurers

Company Market Share

Company Market Share

Prudential Seguros 17%

San Cristbal Seguro de Retiro 34%

Zurich International Life 14%

La Segunda Seguros de Retiro 25%

HSBC Seguros de Vida 13%

Binaria Seguros de Retiro 17%

Liderar Ca. de Seguros 8%

Orgenes Seguros de Retiro 8%

Metlife Seguros 6%

HSBC Seguros de Retiro 6%


The new code also establishes additional obligations for different parties to buy certain insurance policies, such as comprehensive insurance coverage for commercial property owners and landlords condominiums, or liability coverage for educational institutions against any damage suffered or caused by underage students. These business segments which have historically been under-developed owing to a lack of demand will benefit from increased demand.



Sovereigns

Ireland Reports Strong First-Quarter Growth, a Credit Positive Last Thursday, Ireland (Baa1 stable) published its national accounts data for first-quarter 2015, which showed that real GDP had risen by 1.7% from fourth-quarter 2014 levels and by 6.5% from first-quarter 2014. The growth, which exceeded the rest of the euro area, is credit positive because it means a more rapid reduction of the governments still-elevated debt ratio than we had expected and significantly shrinks Irelands budget deficit. The first-quarter results have prompted us to revise upward our real GDP growth forecast to 4.2% for 2015, versus our earlier forecast of 3.8%, and reduce our public debt ratio forecast, which we now expect will decline to below 100% of GDP next year.

Irelands real GDP growth continues to surprise on the upside, with the recovery driven predominantly by a 4.5% contribution from domestic demand and 2% from net exports (see Exhibit 1). Exports of goods and services grew by 14.3% versus a year earlier, following an already strong increase of 12% in 2014.4 Private consumption expanded by 3.8% from a year earlier, after growing just 2% in all of 2014. Capital investment was also strong, growing by 4% in the quarter, after already strong growth of 14.3% in 2014.5 In addition to the strong first-quarter numbers, Irelands Central Statistics Office revised upward its GDP data for 2014, now estimating growth was 5.2% last year, versus an earlier estimate of 4.8%.

EXHIBIT 1

Contribution of Domestic and External Demand to Irelands Real GDP Growth

Sources: Irelands Central Statistics Office and Moodys Investors Service

We expect that Irelands strong growth will continue, although perhaps not at levels comparable to the first quarter. Private consumption growth will continue to benefit from strong employment growth, real wage increases and very high consumer confidence. Additionally, households will likely benefit from tax cuts in 2016. Exports will continue to benefit from economic recoveries in the UK and US, and the competitive exchange rate against these two key trading partners. Sound export prospects and domestic demand will support the investment recovery and construction investment will benefit from strong foreign interest in commercial real estate and strengthening residential investment. 4 Imports also are increasing rapidly, given the strength of domestic demand and the relatively high import content of Irelands

exports, so the net trade contribution to growth is small. 5 The data on capital investment and imports have to be treated with caution owing to the first-time inclusion of the large aircraft

leasing industry in national accounts and balance-of-payments data. However, higher investment and imports effectively cancel each other out in the overall GDP data.

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

2010Q1

2010Q2

2010Q3

2010Q4

2011Q1

2011Q2

2011Q3

2011Q4

2012Q1

2012Q2

2012Q3

2012Q4

2013Q1

2013Q2

2013Q3

2013Q4

2014Q1

2014Q2

2014Q3

2014Q4

2015Q1

Domestic Demand External Demand Real GDP Growth

Kathrin Muehlbronner Senior Vice President +44.20.7772.1383 [email protected]



The strong growth will translate into a very rapid reduction in Irelands budget deficit. The data on budget execution up to June show significantly stronger tax revenues than the government budgeted (see Exhibit 2), while expenditures have remained below budget. We expect that the government will exceed its target of reducing the general government budget deficit to 2.7% of GDP from 4% in 2014 and more than 8% in 2012. We currently expect a deficit of 2.3%, although it could be even lower.

EXHIBIT 2

Irelands Cumulative Tax Revenue Outperformance Against Budget

Sources: Ireland Ministry of Finance, Haver Analytics and Moodys Investors Service

These strong GDP growth numbers also facilitate a faster reduction in Irelands high public debt ratio than we had previously expected. We forecast the debt/GDP ratio to decline to 102.5% of GDP by the end of this year, and to drop below the 100% mark next year, lower than our expectations of just a few months ago (see Exhibit 3) and down sharply from Irelands debt ratio peak of around 120% of GDP in 2012.

EXHIBIT 3

Irelands General Government Debt to GDP Ratio

Note: Our debt forecasts do not include any privatisation receipts from the state holdings in Allied Irish Banks and Bank of Ireland, whose value the government estimates at around 10% of GDP. Sources: Ireland Central Statistics Office, Haver Analytics and Moodys Investors Service

0 100 200 300 400 500 600 700 800 900

1,000 1,100 1,200 1,300

January February March April May June July August September October November December

M

illio

ns

2014 2015

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

110%

120%

130%

2010 2011 2012 2013 2014 2015F 2016F 2017F



Slovenias Privatisation Strategy Builds Momentum, a Credit Positive Last Wednesday, the supervisory board of Slovenian Sovereign Holding (SSH), Slovenias (Baa3 stable) asset management and privatisation agency, approved the privatisation of Elan, a sporting goods manufacturer. The approval is credit positive for the sovereign because the government will use proceeds from the sale for debt reduction and it indicates that the governments privatisation strategy has built momentum over the past few months. In addition to reducing government debt, the privatisations are an important step in Slovenia addressing governance problems in some of the countrys state-owned companies.

Elans privatisation is Slovenias sixth of 15 companies on the governments initial list for state asset sales (see exhibit). The government first put this list together in 2013, but until only recently these sales had been hindered by a lack of political consensus about the privatisation programme in general. Since then, the Slovenian parliament has revised its strategy for managing 91 state-owned enterprises, adopting a plan in mid-July 2015 under which the government classified 46 of the 91 companies as portfolio investments and thus eligible for sale. Complementing the governments divestment programme is the sale of distressed assets through the Bank Asset Management Corporation, whose mandate the government recently extended by five years to 2022 to avoid selling off assets at fire-sale prices.

The First 15 Slovenian Companies Slated for Privatisation Company Business Status

Aerodrom Ljubljana Airport operator Complete

Fotona Laser products Complete

Helios Industrial coatings producer Complete

ito Slovenias biggest food producer Sale and purchase agreement signed in April 2015

NKBM Financial services Sale and purchase agreement signed in June 2015

Elan Sports equipment SSH supervisory board granted conditional consent for sale

Cinkarna Celje Chemicals Advanced

Adria Airways Airline Invitations for expressions of interest

Telekom Slovenije Telecoms Sale stalled because of changes to buyers offer

Aero Celje Chemicals In bankruptcy

Terme Olimia Spa operator Not started

Gospodarsko razstavie Ljubljana fair and event manager Not started

Paloma Paper and tissue producer Not started

Unior Tooling and tourism Not started

Adria Airways Tehnika Aircraft maintenance Not started

Sources: Slovenian Sovereign Holding and Slovenia Ministry of Finance

Elan is being sold to Merrill Lynch International and Wiltan Enterprises Limited. The sale is subject to some non-financial commitments by the buyers, including the preservation of Slovenian as the language of communication with employees and the honouring of existing collective bargaining agreements and other social deals struck with the employees or the workers council.

According to the European Commission, the Slovenian government is the countrys largest employer, asset manager and corporate debtor, employing one fifth of all workers in non-financial corporates, and holds about one third of the countrys corporate assets. In its latest Macroeconomic Imbalances report, the European Commission cited high state involvement in the economy as being a drag on the economy.

Sarah Carlson Senior Vice President +44.20.7772.5348 [email protected]

Stefan Triendl Associate Analyst +44.20.7772.5560 [email protected]



The government will use the funds raised through the privatisation programme to reduce the debt stock, complementing the governments fiscal consolidation efforts. The debt stock was 80.9% of GDP at the end of 2014 and we expect it to peak at around 82% of GDP this year and slowly decline thereafter. We do not include asset sales in our forecasts, but any privatisation proceeds will prompt us to revise debt forecasts downward.



US Public Finance

Michigan Supreme Court Affirms State Pension Reforms, Credit Positive for the State Last Wednesday, the Michigan Supreme Court ruled in favor of the State of Michigans (Aa1 stable) pension reforms, which took effect in April 2012. The courts ruling is credit positive for Michigan because it preserves a requirement that employees participating in the State Employees Retirement System (SERS) defined-benefit plan contribute toward their pensions along with the state. The ruling also prevents the states pension fund from having to draw down assets to refund accumulated employee contributions.

The state passed Public Act 264 in 2011, which took effect in April 2012 and gave current employees a choice between contributing 4% of their salaries going forward, and enrolling in a defined contribution plan for future years of service. Before April 2012, state employees were not required to contribute toward their pensions, meaning the only contributions into the plan came from the state.

A coalition of employee labor groups filed a lawsuit claiming the states reforms violated the state constitution. Michigans constitution provides the Civil Service Commission with the authority to oversee public employee rates of compensation and conditions of employment. The labor groups claimed that the state legislature usurped the commissions authority when it required state employees to begin contributing to their pensions. A lower court and a state appellate court both sided with the labor groups, and declared the states reforms unconstitutional. However, the Michigan Supreme Court disagreed, finding that the commission does not have the authority to repeal or revise legislation, and that pension benefits do not fall under the commissions constitutional purview.

Had the state not prevailed, the pension fund would have had to refund accumulated employee contributions, which the state estimates now total $134 million. The state would have to make up this loss over time as it amortized the plans unfunded liability.

An adverse ruling also would have removed a key source of annual pension funding that the state would have to assume going forward, an amount we estimate totaled more than $40 million in both 2013 and 2014. Although these employee contributions are relatively small compared with the states annual operating budget of more than $25 billion, they have recently helped bolster annual plan funding relative to the annual required contribution (ARC) determined by plan actuaries (see exhibit).

Tom Aaron Assistant Vice President - Analyst +1.312.706.9967 [email protected]



State and Employee Contributions to Michigans SERS Pension Plan Versus the Annual Required Contribution

Note: We estimate the employee contributions associated with 4% of payroll requirement based on covered payroll for each year and the effective date of the reforms. The exhibit excludes employee contributions for purchased service credit. Annual required contribution includes employee requirement 2012-14. Sources: Michigan State Employees Retirement System Comprehensive Annual Financial Report and Moodys Investors Service

Michigans state employee pensions are somewhat unique compared with other states and local governments because the state eliminated defined benefit pensions for new state employees long ago. Rather than participating in SERS, employees hired after March 1997 receive retirement benefits through a defined contribution plan. Thus, the states 2012 reforms requiring employee contributions affected only employees who were already working for the state and participating in SERS by March 1997.

$0

$100

$200

$300

$400

$500

$600

$700

$800

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

$ M

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State Employee Annual Required Contributions



Glendale, Arizona, Renegotiates Smaller Subsidy to Pro Hockey Team, a Credit Positive Last Friday, the Glendale, Arizona (A3 positive), city council voted to amend its arena management agreement with the owners of the National Hockey Leagues Arizona Coyotes. The amended agreement is credit positive because it reduces the citys costs related to professional sports enterprises.

The term of the arena agreement was shortened significantly to 30 June 2017 from 2028 and the annual management fee payable by Glendale was reduced to $6.5 million from $15 million. Net short-term savings to the city will be approximately $3.6 million annually through the fiscal year ending 30 June 2017 because the Coyotes ownership will now collect approximately $5 million annually from ticket surcharges and parking fees from arena events that were previously paid to the city.

The city councils actions also rescinded the full cancellation of the arena management agreement that was approved on 10 June 2015, but was halted by a restraining order from the Maricopa County Superior Court. The amended agreement removes litigation risk to the city because the owners of the Coyotes, IceArizona Manager Co. LLC, a subsidiary of Renaissance Sports and Entertainment, will no longer pursue a civil suit for $200 million of damages that stemmed from the citys attempt to cancel the arena agreement.

The city was obligated to pay the teams owners $225 million under the 2013 original agreement, or $15 million annually for 15 years, to manage the city-owned and financed Gila River Arena. Amending the agreement reduces the citys net costs of the Coyotes to 2.9% of budgeted operating revenues for fiscal 2016 from 4.4% under the original agreement (see exhibit).

Glendales Costs and Revenues under Arena Agreement

Source: Glendale, Arizona

Glendale currently does not have an arena management contract after fiscal 2017 and will have to hire for arena management services, either with the Coyotes or another third party, but the expected cost of those services will be less onerous than the prior $15 million annual fee and will align with the reported competitive market rate of $6.5 million. The Coyotes may opt to relocate after the arena agreement ends following the 2016-17 season, although the teams owners and the city publicly indicated that they want the team to remain in Glendale.

The citys long-term costs related to the Coyotes include debt service on approximately $133 million of long-term debt outstanding until 2033. The debt-financed construction of the arena is secured by the citys general excise taxes, a key operating resource. Glendale expects to appropriate annual transfers from its general fund or seek other measures to offset more than $39 million of internal transfers that the city

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-$16-$14-$12-$10-$8-$6-$4-$2$0$2$4$6$8

Original Agreement Amended Agreement

$ M

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Fiscal Year 2016

Arena Management Fee & Capital Contribution Shared Arena Revenues with Coyotes Net Costs to Glendale

Pat Liberatore Analyst +1.415.274.1709 [email protected]



previously made to its general fund from its environmental enterprises; these transfers supported subsidies of $25 million annually that the city owed the National Hockey League in fiscal 2011 and 2012, when the league temporarily managed the arena and the Coyotes before the team secured a long-term owner.

RATING CHANGES Significant rating actions taken the week ending 31 July 2015


Corporates

Advanced Micro Devices, Inc. Downgrade 21 Apr 15 28 Jul 15

Corporate Family Rating B3 Caa1

Outlook Negative Negative

The downgrade reflects our expectation that the company will face ongoing operating losses over the next year and negative free cash flow. It also reflects ongoing revenue declines and operating losses in its PC-related business (microprocessors and graphics chips) that will more than offset the expected profitability in the companys embedded and semi-custom chip business.

Gardner Denver, Inc. Outlook Change 9 Jul 13 29 Jul 15

Corporate Family Rating B2 B2

Outlook Stable Negative

The outlook change reflects our concerns about Gardner Denvers significant exposure to upstream energy (estimated at about 25% of sales) and our expectations that lower volumes and pricing pressure in these markets will lead to a material weakening of credit metrics over the next 12 to 18 months.

Italcementi S.p.A. Review for Upgrade 31 Jul 14 29 Jul 15

Corporate Family Rating Ba3 Ba3

Outlook Positive Review for Upgrade

The review for upgrade follows the announcement that HeidelbergCement will acquire the 45% interest in Italcementi owned by Italimobiliari and will make a tender offer to acquire the companys remaining public shares. The review will consider the potential for the companys credit profile to be strengthened as part of the larger and less financially leveraged HeidelbergCement Group.

Peugeot S.A. Outlook Change 19 Feb 15 30 Jul 15

Corporate Family Rating Ba3 Ba3

Outlook Stable Positive

The outlook change reflects the companys successful progress on its turnaround strategy, which, together with favorable market conditions, has supported better margins in the first six months of 2015.



Teva Pharmaceutical Industries Ltd Downgrade 21 Apr 15 27 Jul 15

Long-Term Issuer Rating A3 Baa1

Outlook Negative Review for Downgrade

The downgrade reflects Tevas demonstration of more aggressive financial policies and its willingness to tolerate a level of leverage that no longer supports the A3 rating. We expect that pro forma debt to EBITDA (before synergies) will rise to approximately 4.6x from 2.0x currently.

Financial Institutions

Actions Taken on StanCorp Group Review for Upgrade 27 Jul 15

We placed on review for upgrade the senior debt ratings of StanCorp Financial Group, Inc. at Baa2. The placement on review follows Meiji Yasuda Life Insurance Companys announcement of its proposed acquisition of all outstanding stock of StanCorp for about $5 billion in cash in a transaction expected to close by end of the first quarter of 2016. We note that the acquirer is a higher rated company and expect that Meiji Yasuda will provide support to StanCorps creditors to protect the $5 billion investment.

OJSC Bank of Baku Outlook Change 12 Dec 13 30 Jul 15

Long-Term Bank Deposits B1 B1

Outlook Stable Negative

The outlook change reflects increased pressure on OJSC Bank of Bakus asset quality and profitability, driven by the weakening of its borrowers creditworthiness on the back of unhedged foreign currency risk, accelerated inflation and elevated cost of funds.



US Public Finance

Michigan (State Of) Upgrade 25 Mar 14 24 Jul 15

GO Bonds Aa2 Aa1

Revenue Bonds Aa3 Aa2

Outlook Positive Stable

The upgrade reflects improvement in the states financial position, particularly growth in the states rainy day fund, bolstered by a strong tax revenue trend and a robust growth rate in the economy that has featured an improvement in the auto sector.

Southeast Housing, LLC Upgrade 1 Aug 14 27 Jul 15

Revenue Bonds Ba3 Ba2

Outlook Stable Stable

The upgrade reflects improved financial performance following debt restructuring and mitigation of litigation risk over property taxes. It also reflects our projections for solid financial performance, full occupancy, including a substantial number of units rented to non-active military service members, and an increase in the basic allowance for housing for 2015.

Structured Finance

26 Tranches from Eight Subprime RMBS Transactions Upgraded We upgraded the ratings of 26 tranches from eight subprime RMBS transactions backed by subprime mortgage loans, affecting $1.05 billion. The upgrades reflect the recent performance of the underlying pools and our updated loss expectations on the pools. The upgrades also account for the build-up in credit enhancement owing to the sequential pay structure, non-amortizing subordinate bonds and availability of excess spread.

RESEARCH HIGHLIGHTS Notable research published the week ending 31 July 2015


Corporates

US Homebuilders Outlook Is Positive on Improving Job Market, Limited Supply of Homes Our outlook on the US homebuilding industry remains positive. Employment in the US continues to grow, with about three million jobs created in the last year alone. This improvement, alongside pent-up demand and low housing supply, should support solid growth for US homebuilders through 2015 and 2016. Asian Corporates Can Expect Ongoing Negative Credit Trends The credit trend for Asia Pacific (including Japan and Australia) corporates remained negative in Q2 2015. Although there were more positive rating actions than negative ones, 21 of the 29 positive actions were driven by sovereign rating actions or other changes unrelated to the issuers standalone credit profiles. Excluding such actions, the number of positive rating actions as a result of changes in the standalone credit profiles of the corporate entities totaled just eight, only about half that of negative rating actions. European Alcoholic Beverage Manufacturers: Regulation Will Curb Profitability Growth in India Despite Growing Economy and Increased Consumption Indias alcoholic beverage market has strong long-term potential for European producers, supported by strong economic growth prospects, rising disposable incomes and an increasing social acceptance of alcohol consumption. We expect beer volume growth of 8.8% a year in 2015-18, albeit from a low base, and spirits segment volume growth to moderate to around 3.7% a year, more in line with the global average. US Chemicals: Refinancing Risk is Rising for Select High-Yield Chemical Companies About one fifth of our B-rated chemicals portfolio has about $5 billion of debt maturing in 2017 and 2018. Most were initially rated in the last few

Moody's Credit Outlook - 3 August 2015

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