MOODYS.COM

8 MAY 2017

NEWS & ANALYSIS Corporates 2 » Restaurant Brands’ Plan to Redeem Preferred Stock Will

Increase Leverage

» Scotts’ Sale of International Businesses Bolsters Plan to Cultivate Hydroponics, a Credit Positive

» Heineken’s Acquisition of Remaining Stake in Lagunitas Is Credit Negative

» IOI’s Stronger Commitment to Sustainable Palm Oil Production Is Credit Positive

» CNPC and CNOOC Will Benefit from China’s Value-Added Tax Cut for Natural Gas Imports

Infrastructure 8 » PREPA Receives Approval of Fiscal Plan and Extends

Restructuring Pact, Credit Positives for Utility

Banks 9 » Peru Cuts Reserve Requirements for Banks, a Credit Positive

» Sparebanken Vest’s Reduced Expectation for Credit Losses Is Credit Positive

» RGS Bank Will Benefit from Integration into Bank Otkritie Group

» Georgian Banks Will Benefit from Increased Tourism

» Kuwaiti Banks’ Participation in Development Projects Supports Profitability

Exchanges 18

» LSEG Faces Risks from European Commission’s Options for Clearing Euro-Denominated Derivatives

Insurers 19 » For US Health Insurers, American Health Care Act Would Be

Credit Positive

» Puerto Rico’s Debt Restructuring Filing Is Credit Positive for Financial Guarantors

» Record First-Quarter Catastrophe Losses Hit US P&C Insurers

» Intact’s Acquisition of OneBeacon Is Credit Negative

Sovereigns 27 » Macao’s Gaming Recovery Boosts Economic Prospects,

Strengthens Fiscal and External Buffers

US Public Finance 30 » Many Ohio Local Governments Pass Credit-Positive Tax Increases

CREDIT IN DEPTH

Puerto Rico 32

The US oversight board created to resolve Puerto Rico’s fiscal crisis filed a District Court petition in San Juan to restructure the territory’s $13 billion of constitutionally protected general obligation debt. Together with likely future filings related to affiliated government borrowers, this action should help establish an orderly framework to address competing creditor claims and those of pensioners, leading to higher overall bondholder recoveries.

RECENTLY IN CREDIT OUTLOOK

» Articles in Last Thursday’s Credit Outlook 34

» Go to Last Thursday’s Credit Outlook

Click here for Weekly Market Outlook, our sister publication containing Moody’s Analytics’ review of market activity, financial predictions, and the dates of upcoming economic releases.

NEWS & ANALYSIS Credit implications of current events

2 MOODY’S CREDIT OUTLOOK 8 MAY 2017

Corporates

Restaurant Brands’ Plan to Redeem Preferred Stock Will Increase Leverage Last Wednesday, 1011778 B.C. Unlimited Liability Company (B1 stable), the owner of Burger King, Tim Hortons, and Popeyes, and the wholly owned subsidiary of Restaurant Brands International Inc. (RBI), said that it is raising $1.75 billion in debt to partially fund the redemption of all or a portion of RBI’s high coupon preferred stock. The announcement is credit negative because it will increase the company’s leverage.

RBI plans to redeem all or a portion of its preferred stock, which it can start purchasing in December 2017. The price would be 109.9% of par value, accrued and unpaid dividends and unpaid make-whole dividends, or approximately $3.3 billion.

1011778 B.C.’s debt/EBITDA would exceed 6.0x for the 12 months that ended December 2016, pro forma for the proposed transaction and a full year of its $1.8 billion acquisition of Popeyes Louisiana Kitchen, announced in February this year. After the announcement of the Popeyes acquisition, we changed 1011778 B.C.’s rating outlook to stable from positive because of the related increase in leverage.

Although 6.0x debt/EBITDA is above our quantitative downgrade guidance of leverage sustained above 5.5x, we expect that debt reduction over the next 12-18 months over and above required amortization along with improved earnings will reduce leverage to a level more commensurate with its current rating or below 5.5x. As a result, we affirmed the ratings of 1011778 B.C. with a stable outlook. Longer term, the company will benefit from the larger scale that Popeyes brings, along with greater revenue diversification of its brands and product offerings, and potential growth in new markets.

1011778 B.C. owns, operates and franchises more than 15,700 Burger King hamburger quick-service restaurants, more than 4,600 Tim Hortons restaurants and more than 2,700 Popeyes restaurants. Annual revenue is around $4.4 billion, although systemwide sales exceed $27 billion. 3G Restaurant Brands Holdings LP owns approximately 43% of the combined voting power of RBI and is affiliated with private investment firm 3G Capital Partners, Ltd.

William Fahy Vice President - Senior Credit Officer +1.212.553.1687 william.fahy@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 8 MAY 2017

Scotts’ Sale of International Businesses Bolsters Plan to Cultivate Hydroponics, a Credit Positive Last Tuesday, The Scotts Miracle-Gro Company (Ba2 stable) said that it will sell its international businesses in Europe and Australia to Exponent Private Equity LLP for $250 million. The sale is credit positive for Scotts, a Marysville, Ohio-based lawn-care company, because it plans to reinvest the majority of its proceeds in high-growth, high-margin businesses, such as hydroponics.

The deal, which Scotts expects to close in the first half of the quarter ending 30 September 2017, will slightly increase leverage to 3.6x debt/EBITDA from 3.5x. But, by investing its proceeds in hydroponics, Scotts will also improve its overall EBIT margins by more than 125 basis points to 17%, excluding the effects of any potential acquisitions. The businesses that Scotts is selling are mature, with EBIT margins of around 5%. Scotts’ hydroponics business, by contrast, has strong top-line growth and margins in the teens.

Sales in the hydroponics segment grew in the low teens over the past few quarters. We expect the hydroponics business’ positive trends to continue, bolstered by the ongoing legalization of medical and recreational marijuana in the US. Although marijuana remains an illegal substance under US federal law, some 26 US states have legalized some form of its use. Hydroponics, a method of cultivating plants without soil, is favored by many marijuana growers.

The sale is part of Scotts’ Project Focus, the company’s largest strategic review since the 1990s, when it merged with Miracle-Gro. As part of the review, the company has jettisoned several non-core assets, including spinning off its majority stake in its lawn-care business to TruGreen in 2016. At the same time, it has made numerous acquisitions in hydroponics, which now accounts for 5%-10% of revenue. After the deal closes, Scotts will have operations in North America, Central America, South America, Israel, China and Japan.

Kevin Cassidy Vice President - Senior Credit Officer +1.212.553.1676 kevin.cassidy@moodys.com

NEWS & ANALYSIS Credit implications of current events

4 MOODY’S CREDIT OUTLOOK 8 MAY 2017

Heineken’s Acquisition of Remaining Stake in Lagunitas Is Credit Negative Last Thursday, Heineken N.V. (Baa1 stable) announced that it had acquired the 50% stake in US craft beer manufacturer Lagunitas (unrated) that it did not already own for an undisclosed price. The acquisition is credit negative because it will adversely affect Heineken’s credit metrics, which are already stretched for its rating and have limited scope to absorb any potential deterioration in the company’s operating performance.

Despite the lack of financial details for the transaction, we expect the acquisition to result in an approximately 0.15x deterioration in Heineken’s Moody’s-adjusted debt/EBITDA, which at December 2016 was 3.6x, already above the 3.5x quantitative guideline to maintain its Baa1 rating. We were already expecting an approximately 0.6x deterioration in Heineken’s financial leverage during 2017 because of two pending acquisitions: Kirin Holdings Company, Limited’s (A3 negative) operations in Brazil, which Heineken announced in February and which have a €1.02 billion enterprise value, and the Punch Tavern (unrated) acquisition announced in December 2016 for a total consideration of €1.49 billion, including assumed debt. Both deals await approvals by regulators.

We also note that Heineken’s gross leverage is inflated by its use of a notional cash pooling used to optimize cash needs and surpluses within the group, which increases company leverage by around 0.3x, because since June 2016 debit and credit balances related to cash pooling are reported on a gross basis.

We expect Heineken to pay a high EBITDA multiple for the stake in Lagunitas, which is the fifth-largest craft beer manufacturer in the US. In recent months we have observed a number of brewing asset transactions with multiples in the mid to high teens, and the strong growth of craft beers in the US demands some premium. In 2015, when Heineken acquired its first 50% in Lagunitas, the company spent €543 million in total for acquisitions of associates and joint ventures, of which, we assume, Lagunitas was a large component.

We expect the three transactions to result in almost €3.0 billion of additional debt. We expect Heineken to partially compensate for this over the next 12-18 months with ongoing profit growth and sound free cash flow generation, which during 2016, after dividend payments as per our definition, was €821 million. During 2016, Heineken reported sound organic growth, with like-for-like profit up 9.9% before exceptional items and amortisation of acquisition-related intangible assets. Despite organic volume growth slowing to 0.6% in the first quarter of 2017, albeit, in a seasonally weak quarter for the company, we expect the company to deliver free cash flow in 2017 similar to that of last year.

In addition, the company remains committed to maintaining a net debt/EBITDA ratio before exceptional items and amortisation of acquisition-related intangible assets of less than 2.5x (it was 2.3x as of December 2016), with any deviation to be only temporary. This commitment provides some indication of Heineken’s intention to reduce leverage after these acquisitions. Therefore, although we expect adjusted financial leverage at December 2017 to be slightly above the 3.5x guidance for its Baa1 rating, we do not expect it to affect the rating.

The Lagunitas acquisition is a good strategic fit for Heineken in light of its premium positioning and the strong momentum for craft beer in the US market. According to the US brewers association, craft beers composed 21% of the US beer market and grew at 10% in value terms during 2016 (12.3% of volume and 6.2% growth in volume terms). According to Heineken, Lagunitas during 2016 outperformed the beer category and is the market leader in the India Pale Ale segment, the fastest-growing sub-segment within craft. And, the brand’s export to some European countries and Mexico benefit from Heineken’s distribution scale.

Paolo Leschiutta Vice President - Senior Credit Officer +39.02.9148.1140 paolo.leschiutta@moodys.com

NEWS & ANALYSIS Credit implications of current events

5 MOODY’S CREDIT OUTLOOK 8 MAY 2017

IOI’s Stronger Commitment to Sustainable Palm Oil Production Is Credit Positive On 28 April, IOI Corporation Berhad (Baa2 negative) published a quarterly update on its progress to implement its sustainable palm oil policy (SPOP), which it launched in August 2016. IOI said that it is adding new commitments to the original action plan, including independent third-party verification of its progress toward SPOP implementation, and more stringent peatland management practices in its Indonesian plantations aligned with the Palm Oil Innovation Group’s standards, an initiative that strives to adopt sustainably responsible palm oil production practices globally. The environmental activist organization Greenpeace also acknowledged IOI’s progress in implementing SPOP standards.

IOI’s increased transparency and commitment to sustainable palm oil production is credit positive and will strengthen the company’s existing off-take relationships within its specialty oils and fats downstream segment. More sustainable palm oil practices will also allow IOI to re-establish relationships with customers that terminated contracts with IOI after it was suspended from the Roundtable for Sustainable Palm Oil (RSPO) over environmental lapses.

We expect IOI’s downstream revenues to grow 5%-10% over the next 12-18 months, helped by rising sales volume from its specialty oils and fats sub-segment following the company’s renewed commitment to sustainable practices (see exhibit). IOI’s specialty oils and fats business segment is a global leading producer of fractionated oils and blends, which have strong demand in processed-food applications, particularly in North America and Europe, where palm oil-based products require the RSPO-certification.

IOI’s Downstream Sales Will Improve on Stronger Sales Volume in Specialty Oils and Fats

Note: Fiscal years end 30 June. Sources: Company data and Moody’s Investors Service estimates

Compliance with RSPO principles and criteria is an important differentiating factor for palm-oil producers, providing a competitive advantage and profitability enhancement in the industry. RSPO-compliant palm oil producers are well positioned for growth, particularly in Europe and North America, because certified crude palm oil and its derivatives are increasingly required by leading global food and household product companies.

IOI introduced SPOP after RSPO suspended its certification of IOI’s palm oil value chain in April 2016. The main reason for the suspension was a complaint filed by environmental organization Aidenvironment, criticizing IOI’s clearing of peatlands in Kalimantan, Indonesia. RSPO lifted the suspension on all of IOI’s palm oil products in August 2016 because it was satisfied with the company’s actions to address deforestation. Both sides have agreed on an action plan, with RSPO’s board monitoring IOI’s implementation of sustainable palm oil practices in the company’s value chain over the 12-month period ending July 2017.

0

100,000

200,000

300,000

400,000

500,000

600,000

700,000

800,000

900,000

0

2

4

6

8

10

12

14

16

FY2012 FY2013 FY2014 FY2015 FY2016 FY2017 Estimate FY2018 Estimate

Met

ric T

onne

s

MYR

Bill

ions

Upstream Sales - left axis Downstream Sales - left axis Specialty Oils and Fats Sales Volume - right axis

Diana Beketova, CFA Associate Analyst +65.6398.3724 diana.beketova@moodys.com

Jacintha Poh Vice President - Senior Analyst +65.6398.8320 jacintha.poh@moodys.com

NEWS & ANALYSIS Credit implications of current events

6 MOODY’S CREDIT OUTLOOK 8 MAY 2017

CNPC and CNOOC Will Benefit from China’s Value-Added Tax Cut for Natural Gas Imports On Thursday, China’s Ministry of Finance said that it will reduce the value-added tax (VAT) rate on imported natural gas to 11% from 13%, effective 1 July. The reduction is credit positive for China National Petroleum Corporation (CNPC, Aa3 negative) and China National Offshore Oil Corporation (CNOOC, Aa3 negative), the country’s largest natural gas importers and whose combined imports we estimate accounted for more than 90% of China’s total natural gas imports in 2016. The lower VAT rate should stimulate consumption and consequently increase their revenues, reinforcing their importance to China’s energy supply and policies.

The companies pass the VAT to end-users such as power generators, chemical plants and transportation users, and these end-users will likely use more natural gas because of its lower cost. For example, power generators will likely increase their use of natural gas as fuel versus coal if there is a cost advantage.

Natural gas accounts for a large and increasing proportion of the two companies’ revenues. The natural gas and pipeline segment of PetroChina (unrated), CNPC’s key unlisted subsidiary, accounted for around 15.3% of PetroChina’s total revenue in 2016. CNOOC’s natural gas and power generation segment accounted for around 13.7% of the company’s total revenue in 2015. (CNOOC has not yet reported its 2016 results.) Additionally, the lower natural gas tax will reduce fuel costs for CNOOC’s large gas-fired power generation business, which generated around 21.5 billion kilowatt hours of electricity in 2016.

Increased demand for natural gas will also reinforce CNPC’s and CNOOC’s strategic importance to the Chinese government given the country’s increased reliance on imported gas and its efforts to increase consumption of clean energy sources. In 2016, imported gas accounted for 35% of China’s total natural gas consumption, more than double the 2010 level of 15.8%, while domestic gas production increased by only 1.5%, according to China’s National Development and Reform Commission (NDRC).

China’s energy policy aims to increase natural gas consumption. However, consumption growth during 2010-15 failed to reach the government’s goal in its 12th five-year plan because of the relatively high cost of gas relative to other energy sources, as well as an insufficient network of connectivity and storage facilities. The government aimed to increase the proportion of natural gas in China’s total energy mix to 7.5% by the end of 2015, but only reached 5.9%.

The 13th five-year plan (2016-20) calls for the proportion to reach 8.3%-10% by the end of 2020. We estimate natural gas consumption must increase at least 10% per year to meet the lower end of this target. Achieving this consumption growth goal will be challenging: apparent natural gas consumption increased by 6.6% in 2016, more than double the approximately 3% in 2015, according to the NDRC (see exhibit). The increased growth rate primarily was due to the decline in the natural gas price since 2015, which stimulated demand. Indeed, PetroChina’s average selling price of natural gas dropped by around 20% in 2016 from its average selling price in 2015.

Kai Hu Senior Vice President +86.21.2057.4012 kai.hu@moodys.com

NEWS & ANALYSIS Credit implications of current events

7 MOODY’S CREDIT OUTLOOK 8 MAY 2017

China’s Natural Gas Consumption and Consumption Growth Rate

Sources: BP Statistics Review 2016 and China’s National Development and Reform Commission

0%

5%

10%

15%

20%

25%

0

50

100

150

200

250

2011 2012 2013 2014 2015 2016

Billi

on C

ubic

Met

ers

Consumption - left axis Growth Rate - right axis

NEWS & ANALYSIS Credit implications of current events

8 MOODY’S CREDIT OUTLOOK 8 MAY 2017

Infrastructure

PREPA Receives Approval of Fiscal Plan and Extends Restructuring Pact, Credit Positives for Utility On 28 April, the Financial Oversight and Management Board for Puerto Rico, set up under the Puerto Rico Oversight, Management and Economic Stabilization Act (PROMESA), approved the Puerto Rico Electric Power Authority’s (PREPA, Caa3 negative) fiscal plan, subject to certain requirements, including submission of a detailed implementation plan within 30 days. On the same day, PREPA and its bondholders announced that a restructuring support agreement (RSA) had been amended and extended to 1 September 2017. Both events are credit positive, indicating movement toward a consensual restructuring of PREPA’s approximately $9.0 billion of debt that began more than a year ago under the RSA. The alternative would have been a municipal-style bankruptcy, like what Puerto Rico (Caa3 negative) has just done. Although Puerto Rico’s action benefits its creditors overall, a similar action by PREPA risked eroding bondholder value.

As part of the amendment to extend the RSA, the parties included a revised term sheet that appears to track many of the terms of the original RSA, but with greater detail. For example, the RSA still calls for bondholders to exchange their bonds for new securitization bonds at an exchange ratio of 85%. The securitization bonds would be issued by a special-purpose vehicle (SPV) that is separate from PREPA and would be repaid via a surcharge of 3.1 cents per kilowatt-hour on ratepayers’ bills to cover debt service on the securitization bonds.

The length of periods of principal deferral and capitalization of interest would be preserved at five years. Bondholders would have the option to accept their new securitization bonds one of two ways: either in the form of current interest bonds that defer principal for five years, but pay current interest at a rate of 4.75%; or as capital appreciation bonds that defer principal and interest for five years at a higher rate of 5.50%. The latest RSA extends the maturity of the securitization bonds to 2047 from 2043. The revised RSA term sheet also drops the requirement for an investment-grade rating on the new securitization bonds, although it commits PREPA and the SPV to using their best efforts to secure the highest rating possible. Additionally, the RSA commits PREPA to restructuring financial debt using Title VI of PROMESA, which allows for the implementation of PREPA’s proposed restructuring as part of a pre-existing voluntary agreement.

PREPA’s next debt service payment of about $400 million, including principal and interest, is due on 1 July 2017. We understand that PREPA does not have the internal liquidity to make this payment on its own and will need to rely on liquidity from its bondholders. This is something that PREPA bondholders have done in the past to meet debt service payments. The revised RSA provides for liquidity to make the July 2017 payment by allowing PREPA to issue new bonds (relending bonds) to existing bondholders.

PREPA’s fiscal plan approved by the Oversight Board calls for, among other things, an improvement of the power grid in Puerto Rico through public/private partnership agreements and the privatization of energy generation. This aims to foster fuel diversification and cost reduction, which are key to achieving PREPA’s long-term financial health and fiscal stability.

These latest developments suggest that PREPA and its creditors are on a different path from that of Puerto Rico and its creditors. On 3 May, the Oversight Board in US District Court petitioned for relief for Puerto Rico under Title III of PROMESA, which provides for a process more akin to a municipal bankruptcy.

As for PREPA, the RSA extension and the approval of the fiscal plan support efforts to move toward an organized restructuring and suggest that PREPA is getting closer to a final definitive restructuring with its creditors. That said, there is still uncertainty regarding the final execution of PREPA’s complex restructuring, as well as its ultimate recovery.

Richard E. Donner Vice President - Senior Credit Officer +1.212.553.7226 richard.donner@moodys.com

NEWS & ANALYSIS Credit implications of current events

9 MOODY’S CREDIT OUTLOOK 8 MAY 2017

Banks

Peru Cuts Reserve Requirements for Banks, a Credit Positive On 30 April, the Central Bank of Perú reduced reserve requirements for banks to 44% of total deposits from 46%, both for the local currency, the sol, and US dollars, in an effort to foster lending growth. The lower regulatory requirement is credit positive for Peruvian banks because it will expand their capacity to pursue new lending opportunities by freeing roughly PEN4.1 billion ($1.3 billion), stimulating lending at a time when both consumer and corporate loan growth has been slowing.

Soft economic activity has caused loan growth to slow to a 3.2% annual pace in the 12 months that ended in March 2017 from 11.9% in the year-earlier period. At the same time, economic growth has continued to slow, with GDP expanding at an annualized pace of just 0.7% in February, down sharply from a robust 4.8% in January. Consequently, we expect that real GDP growth for the year will fall to 3.7% from 4.0% in 2016. Nevertheless, we expect that reconstruction efforts in the coming months following recent El Niño floods will drive a pick-up in credit demand.

The lower reserve requirement will have the greatest effect on high-yielding local currency consumer lending because local currency deposits are scarcer than those in foreign currencies. A change in regulations implemented by central bank in late 2014 that sought to discourage dollar-denominated lending has led banks to focus on originating corporate, mortgage and auto loans in soles as opposed to the previous practice of originating mostly in US dollars. This has helped to reduce currency mismatches at the borrower level and resulted in a sustained decline in the dollarization of banks’ loan portfolios.

At the same time, however, the dollarization of the deposit base has remained stubbornly high as confidence in the sol remains relatively weak despite the central bank’s strong track record of controlling inflation. Consequently, the dollar loan-to-deposit ratio was just 72% at year-end 2016, while the local-currency ratio was a high 155%. The shortage of local currency funding reflected by the high loan-to-deposit ratio has forced banks to rely on currency swaps from the central bank to meet demand for local currency loans.

By freeing up additional sol-denominated funds, the reduction in the local currency reserve requirement should encourage more high-yielding local-currency lending and thereby help preserve banks’ high net interest margins, which climbed to 5.7% at the end of 2016 from 5.3% a year earlier (see Exhibits 1 and 2), despite slowing loan growth. At the same time, although liquid assets may fall slightly from current levels of approximately 29% of tangible banking assets, they should remain more than sufficient in light of Peruvian banks’ relatively limited reliance on market funding.

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

NEWS & ANALYSIS Credit implications of current events

10 MOODY’S CREDIT OUTLOOK 8 MAY 2017

EXHIBIT 1

Peru’s Lower Reserve Requirements Will Further Stimulate Local Currency Lending

Sources: Peru’s Superintendency of Banks, Insurance Companies and Pension Funds (SBS) and Moody’s Financial Metrics Banking

EXHIBIT 2

Peruvian Banks Profitability Profile

Sources: Peru’s Superintendency of Banks, Insurance Companies and Pension Funds and Moody’s Financial Metrics Banking

99%107% 106%

112%

0%

20%

40%

60%

80%

100%

120%

140%

160%

2013 2014 2015 2016

Loan to Deposits Loan to Deposits - Local Currency Loan to Deposits - Foreign Currency

1.9% 1.8% 2.0% 2.0%

5.8%5.6%

5.3%5.7%

0%

1%

2%

3%

4%

5%

6%

2013 2014 2015 2016

Net Income/Tangible Assets Net Interest Margin

NEWS & ANALYSIS Credit implications of current events

11 MOODY’S CREDIT OUTLOOK 8 MAY 2017

Sparebanken Vest’s Reduced Expectation for Credit Losses Is Credit Positive Last Wednesday, Norway’s Sparebanken Vest (A1/A1 stable, baa11) announced that it had significantly revised downward its expected credit losses for full-year 2017. The lower expected loan impairments are credit positive because they will support the bank’s earnings and profitability metrics.

As part of the bank’s first-quarter 2017 results, it announced that it had reduced its projections for loan impairments for full-year 2017 to NOK150-NOK175 million from the NOK200-NOK250 million it estimated as part of its fourth-quarter 2016 results. This was mainly driven by the good underlying quality of the bank’s lending portfolio and improving economic conditions in Sparebanken Vest’s regional markets in Western Norway.

Lower credit losses will support the bank’s bottom line and compensate for the negative pressure on its net interest margin. The bank’s ratio of net interest income to average assets fell to 1.47% in March 2017 from 1.51% a year earlier. Nonetheless, Sparebanken Vest’s net interest margin improved by four basis points between fourth-quarter 2016 and first-quarter 2017 owing to a 16-basis-point improvement in lending margins in the retail sector during first-quarter 2017.

The bank reported an annualised credit loss ratio (loan impairments over gross loans) of a low 0.08% in first-quarter 2017, while we estimate that the revised credit loss projections imply that it could rise to 0.12% by year-end. This ratio is significantly lower than that of similarly rated local peers with materially higher oil-related exposure, which have been negatively affected by the slump in oil prices in recent years. As shown in the exhibit below, Sparebanken Vest’s loans in default and other potential bad debts amounted to around 0.96% of gross loans in March 2017, down from 0.99% a year earlier.

Sparebanken Vest’s Defaults and Other Potential Bad Debts

Source: Sparebanken Vest

Sparebanken Vest’s retail focus in the city of Bergen and the county of Hordaland in Western Norway supports its loan growth and performance. We note that businesses in Western Norway reported a slight increase in investments in first-quarter 2017, while the expectation index shows that optimism hit its highest level in three years. Such credit conditions will likely raise the bank’s loan growth this year after a relatively subdued 2016, in which loan growth was 5.6%. As of March 2017, outstanding loans grew 6.5% from a year earlier.

1 The ratings shown in this report are Sparebanken Vest’s deposit rating, senior unsecured debt rating and baseline credit assessment.

220 247 238 223 247

1,267 1,215 1,241 1,218 1,274

0.99% 0.96% 0.96%0.92%

0.96%

0.0%

0.1%

0.2%

0.3%

0.4%

0.5%

0.6%

0.7%

0.8%

0.9%

1.0%

0

200

400

600

800

1,000

1,200

1,400

Q1 2016 Q2 2016 Q3 2016 Q4 2016 Q1 2017

NO

K M

illio

ns

Retail Bad Loans - left axis Corporate Bad Loans - left axis Deafaults and Bad Debts to Gross Loans - right axis

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

NEWS & ANALYSIS Credit implications of current events

12 MOODY’S CREDIT OUTLOOK 8 MAY 2017

The bank’s profitability metrics in 2017 will also benefit from its increasing focus on internet-based banking services, as well as a containment of operating expenses following the implementation of a restructuring plan in 2016. As a result, the bank’s first-quarter operating expenses fell to NOK355 million from NOK370 million a year earlier, and its cost-to-income ratio dropped to 44.3% in March 2017 from 52.1% in March 2016.

The improving performance measures and reduced credit loss projections should help the bank meet its long-term return on equity target of 11% in 2017, versus a reported 10.6% as of March 2017. Stronger profitability and enhanced asset quality will improve Sparebanken Vest’s credit quality and has the potential to exert upward rating pressure over the next 12-18 months.

NEWS & ANALYSIS Credit implications of current events

13 MOODY’S CREDIT OUTLOOK 8 MAY 2017

RGS Bank Will Benefit from Integration into Bank Otkritie Group On Friday, a representative of the Russian Federal Anti-Monopoly Service told Russian business daily Vedomosti that Otkritie Holding (unrated), the parent company of Bank Otkritie Financial Corporation PJSC (Ba3/Ba3 negative, b12), had filed a request to the Federal Anti-Monopoly Service to approve its acquisition of a 75% stake in RGS Bank (B2 stable, b2). The prospect of an acquisition by Otkritie Holding is credit positive for RGS Bank because RGS Bank would become affiliated with Bank Otkritie, which is included in the Central Bank of Russia’s list of systemically important institutions. We factor the possibility of government support into our credit analysis of Bank Otkritie and rate the bank higher than we otherwise would.

Acquiring RGS Bank would have a limited effect on Bank Otkritie’s financial standing, given the target’s relatively small size, which equals approximately 5% of Bank Otkritie’s assets (see exhibit).

RGS Bank’s Size Relative to Bank Otkritie as of 31 December 2016

Sources: The banks’ IFRS reports

However, the ultimate credit effect for all the parties involved will depend on the deal structure, which has not yet been announced. In particular, if Bank Otkritie is involved in a wider acquisition that includes insurance company Rosgosstrakh (RGS, unrated), it risks triggering a review of the bank’s ratings.3 RGS is Russia’s largest insurance company and has recently become loss-making, largely because of severe losses from the obligatory motor insurance business. RGS’ RUB33.3 billion ($498 million) net loss in 2016 equaled a significant 14% of Bank Otkritie’s year-end 2016 equity.

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

3 See Bank Otkritie Financial Corporation PJSC: Otkritie Holding’s Acquisitions May Trigger Review of Bank Otkritie Ratings If Bank Is Involved in the Deal Financing, 26 December 2016.

5%

1%

7%

11%

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

11%

12%

Total Assets Net Loans Equity Pre-Provision Income

Svetlana Pavlova Assistant Vice President - Analyst +7.495.228.60.52 svetlana.pavlova@moodys.com

Petr Paklin Assistant Vice President - Analyst +7.495.228.60.51 petr.paklin@moodys.com

NEWS & ANALYSIS Credit implications of current events

14 MOODY’S CREDIT OUTLOOK 8 MAY 2017

Georgian Banks Will Benefit from Increased Tourism Last Monday, Georgia’s National Tourism Administration published data that showed international tourist arrivals rose 11% for the first four months of 2017, versus a year earlier. The increase in tourist arrivals is positive for Georgian banks because it will enhance the repayment capacity of borrowers in the tourism industry, support economic growth and promote employment. Higher foreign-currency inflows will also support the exchange rate of the local currency, the lari, and moderate currency-induced credit risk in banks’ loan portfolios.

In the first four months of 2017, 1.8 million tourists visited Georgia, up from 1.6 million in the same period of 2016 (see Exhibit 1). Georgia has seen double-digit growth in arrivals from Armenia and Russia as tourism to neighbouring Turkey has dropped. Arrivals from Iran more than doubled during the same period following the reinstatement of visa-free travel to Georgia for Iranian citizens in 2016.

EXHIBIT 1

Total Tourist Arrivals in Georgia and Top 10 Countries by Arrivals Country January to April 2017 January to April 2016 Year-on-Year Growth

Azerbaijan 481,374 459,038 5%

Armenia 383,676 334,811 15%

Turkey 329,894 390,523 -16%

Russia 272,119 219,186 24%

Iran 65,861 20,125 227%

Ukraine 48,707 40,529 20%

Israel 18,559 11,124 67%

India 16,443 6,858 140%

Kazakhstan 10,349 8,763 18%

Germany 9,940 6,940 43%

Total Arrivals 1,776,719 1,599,850 11%

Source: Georgian National Tourism Administration

The strong growth in tourism will positively affect banks’ asset quality because it will support the hospitality and related sectors and lead to job creation. In 2016, tourism directly accounted for 7.1% of Georgia’s GDP, up from 6.7% in 2015. Also, according to the World Travel and Tourism Council, the overall contribution of tourism to the Georgian economy for 2016 was 27% of GDP and accounted for 23% of employment. Although Georgian banks’ direct exposure to hotels and restaurants is low at around 7% of their corporate loan book, we think that the tourism sector’s effect on banks’ loan books, given its overall importance to the economy, is substantially higher.

Increased tourism will lead to higher foreign currency inflows, which support the lari’s exchange rate against major currencies and, in turn, will moderate banks’ currency-induced credit risk. Travellers’ currency inflows were $2.2 billion in 2016 and made up 65% of service exports. Banks in Georgia are exposed to increased credit risk when currency movements adversely affect borrowers’ repayment capacity. The lari fell by 10% last year against the US dollar, together with the currencies of major trade partners, but has appreciated by 8% this year, supporting the repayment capacity of individuals and businesses that borrowed in US dollars but have income in lari. Around two thirds of loans in Georgia are denominated in a foreign currency, while 70% of aggregate mortgage loans and 46% of small business loans of JSC Bank of Georgia (Ba3 stable,

Marina Hadjitsangari Associate Analyst +357.25.693.034 marina.hadjitsangari@moodys.com

Alexios Philippides Assistant Vice President - Analyst +357.25.693.031 alexios.philippides@moodys.com

NEWS & ANALYSIS Credit implications of current events

15 MOODY’S CREDIT OUTLOOK 8 MAY 2017

ba34) and JSC TBC Bank (Ba3 stable, ba3) were denominated in dollars at year-end 2016 and made to borrowers with no dollar income (see Exhibit 2).

EXHIBIT 2

Currency-Induced Credit Risk in Rated Georgian Banks’ Loan Portfolio Loan book breakdown in currencies and incomes at year-end 2016.

Sources: JSC TBC Bank, BGEO Group PLC and Moody’s Investors Service

More tourism will also drive foreign direct investment (FDI) inflows toward the tourism sector and provide new lending opportunities for banks. FDI, although volatile, has been trending upward in recent years, with year-on-year FDI inflows up by 5% in dollar terms in 2016 and 75% higher compared with 2013 levels. Over the next few years, we expect net FDI levels to remain high at 9%-10% of GDP, owing to the continued development of new projects, particularly in infrastructure.

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

25%

41%

34%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Mortgages Consumer SME & Micro Corporate Total

USD Loans to Borrowers with USD Income USD Loans to Borrowers without USD Income Local & Other Currency Loans

NEWS & ANALYSIS Credit implications of current events

16 MOODY’S CREDIT OUTLOOK 8 MAY 2017

Kuwaiti Banks’ Participation in Development Projects Supports Profitability Last Tuesday, National Bank of Kuwait S.A.K.P (NBK, Aa3 negative, a35) published a report showing that KWD1.4 billion (around $4.6 billion) worth of development projects were awarded in Kuwait during the first quarter of 2017. This robust project activity is credit positive for Kuwaiti banks because it creates new business opportunities and supports their profitability. Additionally, participating in such projects will help diversify Kuwait’s oil-dependent economy and, by extension, banks’ balance sheets.

The amount of projects awarded during first-quarter 2017 exceeded the previous two quarters, during which contract award volume averaged KWD750 million per quarter. The strong project activity this year alleviates, at least for now, the risk that a more challenging political environment jeopardizes projects and thus curbs our growth expectations for banks.

Following the dissolution of the parliament in October 2016, new elections in November resulted in government opposition groups winning 24 out of 50 seats in Kuwait. Bureaucratic hurdles including disagreements between the government and parliament remain the main risk against project implementation. According to NBK, Kuwait could award another KWD6.2 billion in contracts by year-end.

Strong project activity will drive corporate credit demand and fee income for banks from non-cash business, such as contract guarantees and letters of credit. We expect credit growth of 6%-7% this year, mainly driven by corporates. The Kuwaiti government has maintained capital spending even as oil prices remain low. Already-awarded projects under the government’s $115 billion 2015-19 National Development Plan are gradually entering the implementation phase and will drive growth in the non-oil economy and new business for banks. Conventional Kuwaiti banks posted an aggregate 14% year-on-year increase in net profits in first-quarter 2017, driven by net interest and fee income growth (see exhibit).

Kuwaiti Banks’ Profits Rose in First-Quarter 2017

Notes: * Pre-provision income is operating profit before provisions and impairments. Figures are aggregates for Al Ahli Bank of Kuwait K.S.C.P., Burgan Bank K.P.S.C., Gulf Bank K.S.C.P and NBK. Sources: The banks

NBK is especially well-placed to benefit from increased project activity because it is the largest bank in Kuwait with around 35% market share by assets. The bank’s equity size allows it to exploit larger credit opportunities compared with its domestic conventional peers, Al Ahli Bank of Kuwait K.S.C.P. (A2 stable, baa3), Burgan Bank K.P.S.C. (A3 stable, ba2), Commercial Bank of Kuwait K.P.S.C. (A3 stable, ba1) and Gulf Bank K.S.C.P (A3 stable, ba1). Additionally, NBK in the past has acted as lead-financier for the majority of

5 The bank ratings shown in this report are the banks’ deposit ratings and baseline credit assessment.

234

4%, Y-o-Y Growth

201

8%, Y-o-Y Growth

111

14%, Y-o-Y Growth

58

3%, Y-o-Y Growth

0

50

100

150

200

250

300

Q1 2016 Q1 2017

KWD

Mill

ion

Net Interest Income Pre-Provision Income* Net Profit Net Fee and Commission Income

243

60

217

127

Alexios Philippides Assistant Vice President - Analyst +357.25.693.031 alexios.philippides@moodys.com

Stelios Kyprou Associate Analyst +357.25.693.002 stelios.kyprou@moodys.com

NEWS & ANALYSIS Credit implications of current events

17 MOODY’S CREDIT OUTLOOK 8 MAY 2017

public contracts awarded to foreign companies. The bank’s net income in first-quarter 2017 grew by a strong 8% from a year earlier.

Successful implementation of the large number of infrastructure, power, oil, healthcare and housing projects under the government’s development plan will help diversify Kuwait’s oil-dependent economy. We estimate that hydrocarbon income contributed around 65% of total government revenue and accounted for 40% of GDP in 2016. Greater economic diversification will help banks diversify their highly concentrated loan books and reduce the GDP volatility that is now heavily influenced by the price of oil. High single-name concentrations are typical for banks operating in the Gulf Cooperation Council, and we estimate that, on average, Kuwaiti banks’ top 20 corporate exposures exceed 150% of their aggregate Tier 1 capital.

NEWS & ANALYSIS Credit implications of current events

18 MOODY’S CREDIT OUTLOOK 8 MAY 2017

Exchanges

LSEG Faces Risks from European Commission’s Options for Clearing Euro-Denominated Derivatives Last Thursday, the European Commission (EC) proposed three options for its forthcoming impact assessment for the clearing of euro-denominated derivatives. The aim of the assessment is to further enhance the European Union’s (EU) regulatory framework for central counterparty clearinghouses (CCPs) in the event of failure, and provide a toolkit for future resolution authorities. These enhancements will be reflected in the pending legislative proposal on CCP recovery and resolution. Although enhancements to authorities’ toolkit may improve their ability to recover a CCP in distress, certain options under consideration may fragment margin pools such that the cost of clearing of derivatives in the EU and UK would increase for market participants. Increased cost would be credit negative for London-based CCPs such as LCH.Clearnet Group (unrated), which is majority-owned by the London Stock Exchange Group plc (LSEG, Baa1 positive), and its participants.

The first option is to grant existing third country CCPs equivalence. Currently, there are 15 countries and 28 CCPs outside the EU that are already recognized as equivalent. This number will increase with the UK’s withdrawal from the EU in 2019. This option is credit neutral for London-based CCPs such as LCH.Clearnet.

The second option would require enhanced supervisory powers for the European Securities and Markets Authority (ESMA) for all third country CCPs. Given ESMA’s involvement as a member of the supervisory college overseeing LCH, we believe the benefit of further governance and supervision would be minimal while adding costs to LCH in terms of satisfying compliance and supervision by ESMA. Such added cost would weigh on LSEG’s profitability.

The third option, which would have the greatest effect on LCH, would require relocation of all clearing of euro-denominated derivatives above a threshold to be cleared within the EU. Given that as much as 75% of all euro-denominated interest rate derivatives clear through UK-based CCPs, such a requirement would fragment existing margin pools at LCH, provided the present offsets of cross-currency transactions are not maintained cross-border. Such an exercise would likely lead to increased costs and loss of revenue for LCH.

As example, a euro-denominated swap cleared at LCH in London may lose the benefit of its offset of margin from a Danish kroner-denominated swap as the euro-denominated swap shifts to being cleared in the EU from the UK by the same clearing member. According to Clarus Financial Technology and in comments to the UK parliament, industry estimates suggest such fragmentation could cost the industry $77 billion in additional margin. In such a case, the cost of clearing derivatives in the UK and EU would increase, negatively affecting revenues and profitability for London-based CCPs. This added cost would be shared by participants and thus have knock-on effects on the cost of credit for those members clearing derivatives in London.

Relocation would create added operational challenges for LCH and its clearing members. Although LCH may be able to shift the clearing of euro-denominated derivatives to its Paris-based CCP, LCH.Clearnet SA, the operational demands of doing so would add costs for LCH and its clearing members. For LCH, the cost of this transition would entail enhancing operational infrastructure to support a larger clearing operation in the EU. Some euro-denominated clearing might also migrate to US-based CCPs provided amounts cleared remain below a threshold. Members may have to establish local clearing entities and hire local staff to support the clearing and even trading of these derivatives. The shift of personnel for clearing members could involve a costly relocation of thousands of personnel to the EU from London. In addition to cost, such a shift would likely introduce operational risk for market participants.

Michael C. Eberhardt, CFA Vice President - Senior Credit Officer +44.20.7772.8611 michael.eberhardt@moodys.com

Maxwell Price Associate Analyst +44.20.7772.1778 maxwell.price@moodys.com

NEWS & ANALYSIS Credit implications of current events

19 MOODY’S CREDIT OUTLOOK 8 MAY 2017

Insurers

For US Health Insurers, American Health Care Act Would Be Credit Positive Last Thursday, an amended version of the American Health Care Act of 2017 (AHCA) narrowly passed the US House of Representatives. The US Senate will next take up the AHCA and will likely make significant changes. With that caveat, and just focusing on the credit effects of the bill, the House bill would be credit positive for health insurers.

For insurers, although there are significant challenges to projecting the AHCA enrollee pool, such as estimating the participation of low income, older age individuals, the amended AHCA should provide a better risk pool than the Affordable Care Act (ACA). Specifically, the legislation provides incentives for younger and healthier people to enroll and moves the most costly patients into federally funded high-risk pools. In addition, the bill removes the health insurance fee on insurers, which raised costs for customers. The amended AHCA also repeals the individual mandate: anyone buying coverage who has not been continuously covered would pay a 30% premium penalty in that year.

AHCA effect on individual market. The health insurance industry has lost billions of dollars on the ACA exchanges since 2014. AHCA seeks to address these issues. We estimate that the total losses were more than $3 billion through 2015. We believe losses trended lower in 2016 because of higher premiums, revised plan designs and insurers’ more selective participation in the exchanges. We also believe that 2017 should be even closer to breakeven since insurers have continued to pull out of the exchanges and create more restrictive plans. The cause of these losses are lower enrollment and less healthy individuals than originally anticipated. The US Department of Health and Human Services (HHS) has estimated that year-end 2016 enrollment on the ACA exchanges was 10 million, while 10.7 million were not enrolled despite 84% being eligible for subsidies. Young, healthy individuals have not enrolled in large numbers because of cost, thereby skewing the risk pool.

The ACA required that older people not be charged more than three times the amount of younger people. Pre-ACA, the band had averaged 5 to 1. The AHCA removes the cross subsidization feature of the ACA, resulting in premiums more aligned with actuarial costs (that is, lower costs for younger people, higher ones for older ones).

With the AHCA, young people will be able to buy lower-cost plans and still qualify for a tax credit. Starting in 2020, states under AHCA will be able to apply for a waiver that lets them amend the standard health benefits package, which could result in more economical and less comprehensive plans. Furthermore, the bill restores the cost band between young and old to 5-to-1, which should also help lower the cost of plans for young people (a benefit to the risk pool), while making insurance more costly for older people. There will be a continuous coverage requirement that should incentivize all ages to maintain coverage. For those who maintain coverage, the cost will not reflect any pre-existing conditions. Those who enroll after getting sick will face higher costs, at least for a specified time period, usually the plan year. Overall, these changes should help create a more balanced risk pool and help improve the profitability of the individual market. Finally, the establishment of high-risk pools will take some of the most costly members out of the individual market.

AHCA effect on Medicaid. The AHCA’s credit effect on Medicaid insurers is more ambiguous. Funding for Medicaid will be converted to a per capita or block grant mechanism in 2020 from the current open-ended federal cost-sharing arrangement, which will limit federal spending on the program and likely put more burden on the states. In addition, AHCA will reduce the current enhanced federal cost share on the Medicaid expansion population to the same lower level as all other Medicaid groups. The ACA created Medicaid expansion, which opened Medicaid eligibility to childless adults and increased the qualifying threshold to

Dean S. Ungar, CFA Vice President - Senior Analyst +1.212.553.6968 dean.ungar@moodys.com

NEWS & ANALYSIS Credit implications of current events

20 MOODY’S CREDIT OUTLOOK 8 MAY 2017

138% of the federal poverty level. This has increased Medicaid enrollment by approximately 11 million in the 31 states in which it was adopted.

The Congressional Budget Office (CBO), which will release an updated analysis soon, originally estimated that the AHCA would reduce Medicaid enrollment by 14 million compared with ACA, which would be credit negative for the Medicaid-focused insurers such as Centene Corporation (Ba2 negative), WellCare Health Plans, Inc. (Ba2 stable) and Molina Healthcare, Inc. (Ba3 negative). However, more fiscal pressure on the states could incentivize them to further move to managed care Medicaid, which could potentially offset insurers’ loss of members.

In the exhibit below, we compare key features of each plan.

American Health Care Act versus the Affordable Care Act

ACA AHCA Credit Effect

+ or -

Individual Mandate Yes No -

Old/Young Premium Ratio 3:1 5:1 ++

Actuarial Value Requirements 60% minimum, but insurer also must offer 70% and 80% coverage plans

Can offer coverage option below 60%, no requirement to offer 70% or 80% coverage plans.

+++

Essential Health Benefits Only policies on an exchange including 10 essential health benefits qualify for subsidies

States could obtain waivers to reduce or change the essential health benefit package

+

High-Risk Individuals Enrolled in ACA exchanges or Medicaid

1) Establish Federally Funded Invisible risk pool. 2) Insure people with pre-existing conditions if they maintain continuous coverage.

+++

Assisting Lower Income Individuals

Subsidies to reduce premiums - varies with income. Also expanded Medicaid eligibility

Refundable tax-credit tied to age

++

Health Savings Account Limited Expanded None

Expanded Eligibility for Medicaid

Yes Extended until 2020, then Federal funding reduced

--

Federal Medicaid Financing Shares costs with the states. Pays half for traditional Medicaid and 90% of Medicaid expansion costs

Per capita grants or block grants +

Sources: Introducing the American Health Care Act, House Republican Document, Budget Reconciliation Recommendations relating to Repeal and Replace of the Patient Protection and the Affordable Care Act, Congressional Budget Cost Estimate, American Health Care Act, 13 March 2017, Healthcare.gov, and H.R. 1628 – American Health Care Act of 2017.

NEWS & ANALYSIS Credit implications of current events

21 MOODY’S CREDIT OUTLOOK 8 MAY 2017

Puerto Rico’s Debt Restructuring Filing Is Credit Positive for Financial Guarantors Last Wednesday, the Financial Oversight and Management Board of Puerto Rico filed a US District Court petition in San Juan to restructure Puerto Rico’s (Caa3 negative) $13 billion of general obligation debt. Effectively a bankruptcy filing, the restructuring petition for Puerto Rico is credit positive for financial guaranty insurers because it should provide an orderly framework to address competing creditor claims, leading to higher overall bondholder recoveries, and, by extension, lower loss claims on insured exposures of the financial guarantors.

Puerto Rico’s decision to restructure its debt under Title III of the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA), which was signed into law on 30 June 2016, provides a “bankruptcy-like” process for the adjustment of its debts. The Title III proceeding is likely to eventually incorporate other securities issued by Puerto Rico’s debt-issuing entities, resulting in what will be a lengthy and extremely complex restructuring process. However, we view this as preferable to a potentially disorderly and chaotic process involving proliferating lawsuits among competing creditors.

Financial guaranty insurers including Assured Guaranty Municipal Corp. (AGM, financial strength A2 stable), Assured Guaranty Corp. (AGC, financial strength A3 stable) and National Public Finance Guarantee Corporation (financial strength A3 negative) are exposed to a wide range of debt issued by Puerto Rico and its instrumentalities. As of 31 March 2017, Assured Guaranty Ltd. (Baa2 stable), the holding company for AGM and AGC, had approximately $4.9 billion in consolidated net par exposure to Puerto Rico’s issuers within three of its insurance subsidiaries, while National had approximately $4.1 billion of gross par exposure to Puerto Rico (including accreted interest on capital appreciation bonds) at year-end 2016. As a percentage of qualified statutory capital, these exposures range from 63% at AGM to 117% at National (see exhibit).

Financial Guarantors’ Puerto Rico Par Exposure as a Percent of Qualified Statutory Capital

Notes: AGM and AGC exposures are net par outstanding as of 31 March 2017; National’s exposure is gross par outstanding as of 31 December 2016. National’s exposure includes accreted interest on capital appreciation bonds. Sources: The companies

We believe that prospective Puerto Rico-related losses remain manageable within the context of the guarantors’ capital and core earnings power. We expect AGM’s capital to be only modestly affected under a wide range of loss scenarios, while AGC and National could have more significant capital deterioration in the event that higher-than-expected loss severity results from the restructuring process.

Importantly for the guarantors, much of their exposure is to Puerto Rico’s general obligation bonds and senior lien bonds issued by Puerto Rico Sales Tax Financing Corporation (Caa3 negative), which both benefit from strong legal protections. Other exposures are to bonds issued by the Puerto Rico Electric Power Authority (Caa3 negative), which has a restructuring support agreement with creditors in place and is likely

63% 66%

117%

49%

63%

80%

0%

20%

40%

60%

80%

100%

120%

140%

AGM AGC National

Puerto Rico Puerto Rico, Excluding PREPA

James Eck Vice President - Senior Credit Officer +1.212.553.4438 james.eck@moodys.com

Molly Joyce Associate Analyst +1.212.553.4476 molly.joyce@moodys.com

NEWS & ANALYSIS Credit implications of current events

22 MOODY’S CREDIT OUTLOOK 8 MAY 2017

to complete its restructuring on a consensual basis under Title VI of PROMESA without impairment to the financial guarantors. These exposures were 75% of National’s total exposure to Puerto Rico, 55% of AGM’s and 26% of AGC’s.

However, the inability of Puerto Rico and its creditors to reach a consensual debt restructuring outside of court creates significant uncertainty for bondholders. Foremost is Puerto Rico’s need to restructure $49 billion of pension liabilities. Since Puerto Rico’s three primary government pension plans expect to run out of assets by year-end 2017, Puerto Rico’s government will need to provide benefit payments from its general revenues. These obligations are a wildcard in the debt restructuring process and could have a significant effect on bondholder recoveries and ultimate loss claims for the guarantors.

NEWS & ANALYSIS Credit implications of current events

23 MOODY’S CREDIT OUTLOOK 8 MAY 2017

Record First-Quarter Catastrophe Losses Hit US P&C Insurers Over the past week, many US property and casualty (P&C) insurers including Liberty Mutual Group Inc. (Baa2 stable), The Allstate Corporation (A3 stable) and American International Group, Inc. (AIG, Baa1 stable) reported record or near-record catastrophe losses for the first quarter of 2017. This is credit negative because it has eroded earnings for the quarter, while catastrophe losses remain one of the biggest risks to insurance companies’ earnings and capital.

The losses were the result of tornados, hail and other storms in Texas and the Midwest, and are unusual this year because first-quarter catastrophe losses tend to be low compared with other quarters, and may portend higher non-hurricane storm losses for the remainder of the year. High-frequency, low-severity storms such as tornados, hail and winter storms can have a significant effect on catastrophe results in aggregate. For example, losses related to such events comprised most US P&C insurers’ catastrophe results in 2011, which was the fifth-highest year for US P&C catastrophe losses since 1989. Elevated storm losses, if sustained for the remainder of 2017, pose a significant risk for insurers’ 2017 net income.

Among our rated insurers, catastrophe losses were 74% higher than the previous five-year average (see Exhibit 1) and 18% higher than first-quarter 2016 levels, which were already at a 10-year record high, according to the Property Claims Services unit of Verisk Insurance Solutions. Although some insurers’ first-quarter 2017 net income took a hit because of high catastrophe losses, other insurers performed well despite elevated catastrophes owing to higher investment income and recovering auto results, which have struggled in recent quarters.

EXHIBIT 1

US Property and Casualty Insurers’ First-Quarter Catastrophe Losses

Note: Data include Moody’s-rated insurers that had reported first-quarter 2017 catastrophe losses as of 5 May 2017.

Sources: Company reports and SNL Financial LLC. Contains copyrighted and trade secret materials distributed under license from SNL. For recipient’s internal use only.

Several large US P&C issuers including Liberty Mutual, The Travelers Companies, Inc. (A2 stable), The Hanover Insurance Group Inc. (Baa3 stable) and Horace Mann Educators Corporation (Baa3 positive) reported significant declines in net income in the first quarter as a result of high catastrophe losses (see Exhibit 2). Meanwhile, other insurers, including AIG, Allstate, The Chubb Corporation (A3 stable) and The Hartford Financial Services Group, Inc. (Baa2 stable), reported higher net income despite higher catastrophe losses, reflecting higher investment income, improved personal and commercial auto results, lower expenses and better underlying underwriting profitability. We expect that reinsurers also reported somewhat elevated catastrophe losses for the quarter, although the effects could be muted given that most events will fall below contract retentions.

$0.0

$0.5

$1.0

$1.5

$2.0

$2.5

$3.0

2012Q1 2013Q1 2014Q1 2015Q1 2016Q1 2017Q1

$ Bi

llion

s

Catastrophe Losses 5-Year First Quarter Average, 2012-16

Jasper Cooper Vice President - Senior Analyst +1.212.553.1366 jasper.cooper@moodys.com

NEWS & ANALYSIS Credit implications of current events

24 MOODY’S CREDIT OUTLOOK 8 MAY 2017

EXHIBIT 2

US Property and Casualty Insurers’ Net Income and Catastrophe Losses Catastrophe Losses $ Millions Net Income $ Millions

Company First-Quarter

2017 Five-Year

Average Percent Change

First-Quarter 2017

First-Quarter 2016

Percent Change

AIG (P&C Only) $228 $153 49% $1,148 $933 23%

Alleghany 5 3 46% 149 155 -3%

Allstate 777 464 67% 695 246 183%

AFG 7 8 -10% 155 104 49%

Assurant 1 6 -89% 144 220 -35%

Chubb 164 66 149% 1,093 439 149%

Cincinnati Financial 117 64 83% 201 188 7%

CNA Financial 24 27 -10% 260 66 294%

Hanover 84 43 97% 45 78 -42%

Hartford 98 52 88% 378 323 17%

Horace Mann 11 5 109% 15 25 -39%

Infinity P&C 2 0 292% 11 8 38%

Kemper 64 17 269% (0) (2) -86%

Liberty Mutual 639 386 66% 351 403 -13%

OneBeacon 2 3 -48% 33 47 -30%

Progressive 94 37 157% 430 259 66%

Selective 12 16 -23% 50 37 36%

Travelers 226 117 93% 617 691 -11%

W. R. Berkley 14 11 36% 125 120 4%

Total $2,569 $1,478 74% $5,900 $4,340 36%

Note: Catastrophe losses are as reported. Some may be on a pre-tax basis, while others are after-tax. Sources: Company reports and SNL Financial LLC. Contains copyrighted and trade secret materials distributed under license from SNL. For recipient’s internal use only.

NEWS & ANALYSIS Credit implications of current events

25 MOODY’S CREDIT OUTLOOK 8 MAY 2017

Intact’s Acquisition of OneBeacon Is Credit Negative Last Tuesday, Canada’s Intact Financial Corporation (Baa1 stable) announced that it had entered into a definitive agreement to acquire US-based specialty lines insurer OneBeacon Insurance Group, Ltd., parent of OneBeacon US Holdings Ltd. (Baa3 review for upgrade), for $1.7 billion. The acquisition is credit negative for Intact because it involves heightened execution risk given that OneBeacon is outside Intact’s home market and carries high product risk associated with expanding into US specialty lines.

Intact plans to fund the acquisition with a combination of cash, debt and newly issued preferred and common equity. The companies expect the transaction to close in the fourth quarter of 2017, subject to shareholder and regulatory approvals. On a pro forma basis, we expect Intact’s financial leverage (defined as total adjusted debt divided by total capital) to rise above 35% post-closing, returning to normal levels of just over 30% within 24 months. The company has suspended its share repurchase program to preserve capital. We changed our outlook on Intact’s ratings to stable from positive to reflect execution and higher product risk with the acquisition. We expect that Intact will sustain its profitability and reduce its acquisition-related leverage to historical levels of less than 35% over the next 12-18 months.

Intact, Canada’s largest insurer, has strengthened its domestic franchise in both personal and commercial private insurance markets through a series of acquisitions of Canadian companies that have been highly effective. It is now the largest private-sector provider of property and casualty (P&C) insurance in six of Canada’s 10 provinces, and has grown its national market share to 17% as of the end of 2016. Intact has a solid acquisition track record in Canada, extracting significant value through acquiring and integrating local companies. OneBeacon is Intact’s first sizable acquisition outside Canada, and comes with higher execution and operational risks.

Following the closing of the transaction, we expect OneBeacon to continue managing its operations under a separate brand from Intact. The OneBeacon acquisition will add diversification to Intact’s revenue sources in terms of geography and product. On a pro forma basis, OneBeacon will constitute 20% of Intact’s net written premiums post-acquisition. California and New York will now become larger sources of premiums than most Canadian provinces.

OneBeacon will add product and reserving risk to Intact’s business profile. OneBeacon’s products are low- to moderate-hazard products in long-tail specialty casualty lines such as general liability and workers’ compensation. In Canada, workers’ compensation is provided by provincial government programs. On a pro forma basis, the proportion of Intact’s net written premium in specialty lines will increase to 17% from 6% (see Exhibit 1).

Jason Mercer, CFA Assistant Vice President - Analyst +1.416.214.3632 jason.mercer@moodys.com

NEWS & ANALYSIS Credit implications of current events

26 MOODY’S CREDIT OUTLOOK 8 MAY 2017

EXHIBIT 1

Intact’s Pro Forma Net Written Premium Mix Before and After the OneBeacon Acquisition Intact’s product mix will shift to more long-tail casualty business.

Note: Premiums converted USD/CAD at 0.75, based on 2016 net written premiums. Sources: The companies and Moody’s Investors Service

US specialty lines have longer-dated liabilities that carry higher product and reserving risk relative to Intact’s existing products. Intact has a consistent track record of positive reserve development, whereas OneBeacon has experienced significant reserve volatility over the past five years (see Exhibit 2). Given prior reserve volatility in OneBeacon’s business, Intact has purchased reinsurance protection to mitigate any adverse development on OneBeacon’s existing reserves. Under that transaction, a major reinsurer will assume 80% of any negative development in excess of $74 million to a maximum of $250 million with respect to OneBeacon’s claims liabilities as of 31 December 2016. Intact’s use of adverse development reinsurance and management retention programs will offer downside protection.

EXHIBIT 2

OneBeacon’s and Intact’s Adverse (Favorable) Reserve Development OneBeacon’s reserve development has been more volatile than Intact’s.

Sources: The companies and Moody’s Investors Service

One Beacon has low catastrophe risk given its specialty focus, while Intact has high gross exposure to natural catastrophes that it mitigates through the use of high-quality reinsurers.

Personal Auto46%

Personal Property25%

Commercial Auto11%

Commercial Property12%

Casualty6%

Intact

Personal Property27%

Casualty73%

One Beacon

Personal Auto39%

Personal Property25%

Commercial Auto9%

Commercial Property10%

Casualty17%

Combined

-0.6%

0.0%

9.2%

-0.2%

1.3%

-5.8%-5.1% -4.9% -4.9% -5.0%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

2012 2013 2014 2015 2016

OneBeacon Intact

NEWS & ANALYSIS Credit implications of current events

27 MOODY’S CREDIT OUTLOOK 8 MAY 2017

Sovereigns

Macao’s Gaming Recovery Boosts Economic Prospects, Strengthens Fiscal and External Buffers Last Monday, the Macao Gaming Inspection and Coordination Bureau reported that gross gaming revenue in April grew 16.3% from a year ago to MOP20.2 billion ($2.52 billion). Given that gaming accounts for about 50% of GDP and directly contributes around 80% of government revenues, the sector’s marked recovery provides a significant boost to Macao’s (Aa3 negative) GDP growth and budget. It also underscores the credit-positive effectiveness of diversification policies aimed at ensuring more stable and sustainable growth in GDP and public finances.

The effects of China’s increased scrutiny on corruption on Macao’s gaming and tourism sector are easing. Gross gaming revenues have been increasing on an annual basis since August 2016, boosted by the opening of two new casinos late last year and a recovery in tourism from China. Reports indicate that tourism arrivals continued to rise strongly during the May Labour Day holiday period. Because of the recovery in gaming, we expect real GDP growth of 2.5% in 2017, following a sharp recession during 2014-16 (see Exhibit 1).

EXHIBIT 1

Annual Percent Change of Macao’s Gross Gaming Revenue and Real GDP

Sources: Macao’s Gaming Inspection and Coordination Bureau, Statistics and Census Service and Moody’s Investors Service

Macao’s policy initiatives based around economic diversification in non-gaming activities aim to reduce the economy’s vulnerability to future shocks in the sector. The government’s plan includes shifts in the following areas: to mass-market gaming from high-end VIP gaming; to non-gaming tourism from gaming tourism; and to financial services from tourism. The successful implementation of these plans would help boost the shock absorption capacity of Macao’s economy.

Nascent signs of credit-positive economic diversification are evident in the increase in per-capita spending on non-gaming activities such as shopping, accommodation and food and beverage (see Exhibit 2). The increasing number of overnight visitor arrivals relative to same-day visitors supports higher overall visitor spending. Overnight visitor arrivals rose 12.1% in first-quarter 2017 versus a year earlier, while day trips fell 0.2% over the same period.

-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

60%

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

2018Forecast

Gross Gaming Revenues Real GDP

YTD through April

Matthew Circosta Analyst +65.6398.8324 matthew.circosta@moodys.com

NEWS & ANALYSIS Credit implications of current events

28 MOODY’S CREDIT OUTLOOK 8 MAY 2017

EXHIBIT 2

Percentage-Point Contribution to Macao’s Annual Growth in Visitors’ Per Capita Spending, Excluding Gaming Expenses

Sources: Macao’s Statistics and Census Service and Moody’s Investors Service

The share of mass-market gaming revenues increased in 2016 to around 47% of all gaming revenues from about 27% five years earlier. The development of a new ferry terminal in Macao and high-speed rail lines in China provide greater opportunities for Macao to increase tourism arrivals and boost mass-market gaming.

The development of financial services, such as financial leasing and wealth management, is occurring from a low base (see Exhibit 3). Macao’s low tax rate, common language and legal system with Chinese and Portuguese-speaking countries, and strong infrastructure investment in nearby Mainland provinces offer significant opportunities for Macao to expand its finance and insurance industry.

EXHIBIT 3

Macao’s Exports of Finance and Insurance Services as a Percent of GDP

Sources: Macao’s Statistics and Census Service and Moody’s Investors Service

Macao’s financial strength provides the government with the means to support the economy through a transition. Fiscal reserves were around MOP471 billion (around $59 billion) as of February, equal to nearly six years’ worth of 2016 public expenditures. Stronger gaming activity will bolster tax revenue receipts and the government’s ability to maintain large fiscal surpluses of around 6% of GDP in coming years, further boosting the sovereign’s stock of financial assets.

-25%

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

30%Shopping Accommodation Food and Beverage Outbound Transport and Other Total

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

2009 2010 2011 2012 2013 2014 2015 2016

NEWS & ANALYSIS Credit implications of current events

29 MOODY’S CREDIT OUTLOOK 8 MAY 2017

External buffers will also continue to grow, providing Macao significant capacity to withstand negative economic shocks. We expect the current account surplus to remain large at around 30% of GDP in 2017 and 2018, versus an estimated 27% in 2016, driven by increased tourist arrivals and higher per capita spending.

NEWS & ANALYSIS Credit implications of current events

30 MOODY’S CREDIT OUTLOOK 8 MAY 2017

US Public Finance

Many Ohio Local Governments Pass Credit-Positive Tax Increases Last Tuesday, voters in 21 rated Ohio cities and school districts passed new or increased levies that will provide credit-positive revenue increases, while voters in 11 municipalities rejected similar ballot measures and face the possibility of heightened operating challenges, especially those with more limited financial reserves.

Among the cities whose voters approved new or increased levies, Eastlake (Baa2 stable) and Springfield (A2 negative) particularly benefitted. Both cities have reported considerable liquidity declines in recent years and the increased revenue has the potential to expand financial reserves. Eastlake voters approved a permanent 4.5 mill increase in local property taxes, while Springfield voters raised the local income tax to 2.4% from 2.0% for 5½ years (see Exhibit 1).

EXHIBIT 1

Outcome of Ohio Cities’ 2 May Vote on Tax Increases City or Village Rating Type Unofficial Result

Bedford A1 no outlook 0.75% income tax Passed

Brookville A1 no outlook 7.5 mill property tax* Defeated

Brunswick Aa2 no outlook 0.65% income tax Passed

Eastlake Baa2 stable 4.5 mill property tax Passed

Heath Aa2 no outlook 0.5% income tax Passed

Macedonia Aa3 no outlook 0.5% income tax Passed

Marietta A2 no outlook 0.5% income tax Defeated

Napoleon Aa3 no outlook 0.3% income tax Defeated

Reynoldsburg Aa2 no outlook 1% income tax Passed

Springfield A2 negative 0.4% income tax Passed

Troy Aa1 no outlook 0.25% income tax Defeated

Note: * Included a 2.5 mill property tax for roads and a 5.0 mill property tax for police. Sources: Ohio Secretary of State, the respective county board of elections and Moody’s Investors Service

With 81% support, voters in Bedford (A1 no outlook) approved an income tax hike to 3.00% from 2.25%. Although Bedford’s financial position is currently strong, with a fund balance in 2015 equal to 54% of revenue, the recent loss of major employers reduced income tax collections. Income taxes fell nearly 20% in 2015 and the city projected looming budget gaps without new revenue.

Tax increase efforts failed in the rated cities of Brookville (A1 no outlook), Marietta (A2 no outlook), Napoleon (Aa3 no outlook) and Troy (Aa1 no outlook). Although all four cities have adequate reserves, the negative result is most significant in Marietta, where the general fund balance declined to 16% of revenue in 2015 from 22% in 2011.

Among school districts, the financially struggling Cardinal Local School District (B1 negative) passed its first tax increase since 1992 (see Exhibit 2), after 11 failed attempts to do so. We expect that the district’s new 5.5 mill property tax, which does not sunset, will generate nearly $1.7 million in new annual revenue for a district that nearly depleted its liquidity in fiscal 2016 (which ended on 30 June 2016).

Matthew Butler Vice President - Senior Analyst +1.312.706.9970 matthew.butler@moodys.com

Natalie Claes Associate Analyst +1.312.706.9973 natalie.claes@moodys.com

NEWS & ANALYSIS Credit implications of current events

31 MOODY’S CREDIT OUTLOOK 8 MAY 2017

EXHIBIT 2

Outcome of Ohio School Districts’ 2 May Vote on Tax Increases School District Rating Type Unofficial Result

Aurora City School District Aa2 no outlook 5.9 mill property tax Passed

Beavercreek City School District Aa1 no outlook 6 mill property tax Defeated

Bellaire Local School District A3 no outlook 2.5 mill property tax Passed

Brecksville-Broadview Heights City School District Aa2 no outlook 5.99 mill property tax Passed

Cardinal Local School District B1 negative 5.5 mill property tax Passed

Chagrin Falls Exempted Village School District Aa1 no outlook 5.5 mill property tax Passed

Liberty-Union-Thurston Local School District Aa3 no outlook 3.5 mill property tax Defeated

Lisbon Exempted Village School District A2 no outlook 1% income tax Defeated

Madison Local School District (Lake County) Baa1 no outlook 4.99 mill property tax Passed

Northridge Local School District A2 no outlook 0.75% income tax Defeated

Oak Hills Local School District Aa2 no outlook 4.82 mill property tax Passed

Pickerington Local School District Aa2 no outlook 3 mill property tax Defeated

Ravenna City School District Baa1 negative 2.9 mill property tax Passed

Riverside Local School District (Lake County) A1 no outlook 4.9 mill property tax Passed

Rocky River City School District Aa2 no outlook 0.5 mill property tax Passed

Shaker Heights City School District Aaa no outlook 1.25 mill property tax Passed

Tuslaw Local School District A1 stable 7.3 mill property tax Defeated

Twinsburg City School District Aa2 no outlook 6.9 mill property tax Passed

Waterloo Local School District A3 no outlook 8.25 mill property tax Defeated

Wooster City School District Aa2 no outlook 1.75 mill property tax Passed

Wyoming City School District Aa2 no outlook 9.5 mill property tax Passed Sources: Ohio Secretary of State, the respective county board of elections and Moody’s Investors Service

Passage of a new property tax in the Ravenna City School District (Baa1 negative) followed a slew of recent failures and deferral of facility maintenance. Although the district significantly cut costs and recorded a sizable surplus in fiscal 2016 (which ended 30 June 2016) that stabilized reserves, voters had rejected six requests for a new levy since 2013, including tax increases dedicated to financing much-needed capital improvements. The district’s new levy, which we estimate will generate $900,000 annually and is in place for five years, will reduce the need to further defer maintenance.

Rejections by voters in the Lisbon Exempted Village School District (A2 no outlook) and Waterloo Local School District (A3 no outlook) mark the second consecutive defeat for new taxes in both districts, both of which had attempted to pass property tax levies in November 2016. The districts’ reserves provide varying levels of protection against the likelihood of continued revenue challenges. As of fiscal 2016, Lisbon’s general fund balance was a healthy 24% of revenue, while Waterloo’s was a narrower 16% of revenue.

NEWS & ANALYSIS Credit implications of current events

32 MOODY’S CREDIT OUTLOOK 8 MAY 2017

Credit In Depth

US Board Starts Judicial Process to Restructure Puerto Rico’s General Obligation Debt Last Wednesday, the federal oversight board created to resolve Puerto Rico’s (Caa3 negative) fiscal crisis filed a US District Court petition in San Juan to restructure the territory’s $13 billion of constitutionally protected general obligation debt. “Puerto Rico’s crisis has reached a breaking point,” the oversight board said in its filing. Together with likely future filings related to affiliated government borrowers, this action should help establish an orderly framework to address competing creditor claims and those of pensioners, leading to higher overall bondholder recoveries.

A stay on Puerto Rico debt litigation expired on 2 May. Since then, bondholders filed new suits and dormant suits became active, raising the prospect of disorderly court battles dragging on as the territory’s fiscal, economic and quality-of-life challenges worsen. To avoid this outcome, the oversight board chose a bankruptcy-like process authorized by Title III of the Puerto Rico Oversight, Management and Economic Stabilization Act (PROMESA), the 2016 federal law that created the oversight board.

Even if the Title III process is more orderly than the alternative, it is unlikely to be quick or easy. Puerto Rico’s Title III proceeding may eventually incorporate more than $51 billion of debt and about 20 other security types, which would make it larger than Detroit, Michigan’s (B2 stable) $8.5 billion municipal debt restructuring. Additionally, it may take longer than Detroit’s 17-month process. Puerto Rico’s restructuring will unfold in the untested legal context of PROMESA and pose legal issues that may take even more time to resolve than a large city restructuring under Chapter 9 of the US Bankruptcy Code.

The court will have to weigh numerous competing claims on Puerto Rico’s resources. Pension participants will assert rights to promised retirement benefits at the expense of bondholders with a higher legal claim on revenues. Holders of the biggest Puerto Rico debt components – general obligation and sales-tax securities – will emphasize their bonds’ relative legal strengths, in a bid for improved recovery rates. Under Article VI of Puerto Rico’s constitution, the government is mandated to pay general obligation bond debt service before all other expenses.

Suits filed in recent months, despite the litigation stay under PROMESA, lay out some of the arguments that the court will likely hear. In the Lex Claims case, general obligation bondholders contend that Puerto Rico violated PROMESA, as well as other commonwealth and federal laws, by defaulting on general obligation debt while continuing to pay on bonds issued by the Puerto Rico Sales Tax Financing Corp. (COFINA, Caa3 negative).6

Pension participants, in a separate lawsuit, take issue with pension funding cuts outlined in the oversight board’s certified fiscal plan.7 One reason the board cited for initiating the Title III proceeding is the “need to restructure $49 billion of pension liabilities [in a judicial proceeding] because Congress did not authorize pension restructurings” in PROMESA's Title VI provisions for out-of-court debt restructurings. Puerto Rico’s three primary government pension plans are projected to run out of assets between July and December, leaving the government to provide benefits from general revenue.

6 Lex Claims, LLC, et al., Plaintiffs, v. Alejandro Garcia-Padilla, et al., Defendants; US District Court for the District of Puerto Rico, Civil Case No. 16-2374.

7 This refers to a suit brought by a large union on behalf of its members: Servidores Publicos Unidos, Council 95 of the American Federation of State, County and Municipal Employees; Sandra Pacheco Santiago; Carlos Reyes Castro; and Miguel Ortiz Ramos, Plaintiffs, v. The Financial Oversight and Management Board for Puerto Rico, the Commonwealth of Puerto Rico, and Ricardo Antonio Rossello Nevares, in his capacity as governor of the Commonwealth of Puerto Rico; US District Court for the District of Puerto Rico, Civil Case No. 17-01483-FAB.

Ted Hampton Vice President - Senior Credit Officer +1.212.553.2741 ted.hampton@moodys.com

NEWS & ANALYSIS Credit implications of current events

33 MOODY’S CREDIT OUTLOOK 8 MAY 2017

The oversight board, meanwhile, has increasingly come under fire for the fiscal plan it certified, which requires severe bondholder concessions during the nine-year period that the plan covers.8 Some of the criticism leveled at the board was in a suit that Ambac Assurance Corporation, a bond insurer with exposure to senior COFINA bonds and half a dozen other Puerto Rico security types, filed just after the stay expired. Ambac asserted that Puerto Rico’s government and the oversight board had violated PROMESA as well as other statutory and constitutional provisions by ignoring legal protections for bondholders.9

Some portions of the government’s total debt, which amounts to about $74 billion, may never be incorporated in Title III proceedings. These include the almost $9 billion of bonds issued by the Puerto Rico Electric Power Authority (PREPA, Caa3 negative) and the nearly $4 billion of Puerto Rico Aqueduct and Sewer Authority (PRASA, Caa3 negative) debt. PREPA has a restructuring support agreement with creditors that has been repeatedly extended and now runs to 1 September 2017. These utilities may be able to negotiate debt exchanges with creditors without help from a judge, under PROMESA’s Title VI.

Puerto Rico’s government began defaulting on debt in August 2015, when it missed a payment on bonds issued by the Puerto Rico Public Finance Corporation. The initial default came a few weeks after the then-governor, Alejandro García Padilla, declared that Puerto Rico could no longer afford to pay creditors while maintaining essential services. Within a year, the Puerto Rico Infrastructure Financing Authority’s bonds backed by rum taxes (C negative), the Government Development Bank for Puerto Rico (C negative) and the government’s general obligation had all defaulted (see exhibit).

Puerto Rico Rated Debt with Default Status and Outstanding Amounts

Debt Type Rating Status

Outstanding Amount $ Billions

General Obligation and Guaranteed Caa3 negative Defaulted 1 July 2016 $18.06

Puerto Rico Electric Power Authority* Caa3 negative Not in Default $8.96

Puerto Rico Aqueduct & Sewer Authority (PRASA) Senior Debt* Caa3 negative Not in Default $3.89

Puerto Rico Sales Tax Financing Corporation (Senior) Caa3 negative Not in Default $7.58

Puerto Rico Sales Tax Financing Corporation (Subordinate) Ca negative Not in Default $9.72

Puerto Rico Municipal Finance Agency Ca negative Not in Default $0.62

Puerto Rico Industrial Development Company Ca negative Depleting Reserves $0.16

Puerto Rico Highways and Transportation Authority **1968 Resolution Ca negative Not in Default $0.82

University of Puerto Rico Ca negative Depleting Reserves $0.50

Puerto Rico Employees Retirement System C negative Depleting Reserves $3.16

Puerto Rico Convention Center District Authority C negative Depleting Reserves $0.39

Highways and Transportation Authority** 1998 Resolution C negative Defaulted 1 July 2016 $3.50

Infrastructure Financing Authority (Rum Tax Bonds) C negative Defaulted 1 Jan 2016 $1.78

Government Development Bank for Puerto Rico C negative Defaulted 1 May 2016 $4.13

Puerto Rico Public Finance Corporation (Lease Debt) C negative Defaulted 1 Aug 2015 $1.20 Notes: * Not currently expected to be included in a Title III proceeding; the expected recovery rate ranges for ratings shown are 65%-80% for Caa3, 35%-65% for Ca and less than 35% for C.** The authority’s 1968 resolution debt is rated a notch higher than the similarly secured 1998 resolution debt because it benefits from pledged toll revenues that are not available under Puerto Rico’s constitution to pay general obligation debt service. Sources: Moody’s Investors Service

8 Any restructuring approved under Title III must be “consistent with the applicable fiscal plan,” according to PROMESA Sect. 314 (b)(7). 9 Ambac Assurance Corporation, Plaintiff, against Commonwealth of Puerto Rico, Ricardo Rossello Nevares, Raul Maldonado, Jose

Ivan Marrero Rosado, Gerardo Jose Portela Franco, Jose B. Carrion III, Andrew G. Biggs, Carlos M. Garcia, Arthur J. Gonzalez, Ana J. Matosantos, David A. Skeel Jr., Elias Sanchez, John Does 1-12 and Financial Oversight and Management Board for Puerto Rico, Defendants; US District Court for the District of Puerto Rico, Civil No. 17-cv-1567.

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

34 MOODY’S CREDIT OUTLOOK 8 MAY 2017

NEWS & ANALYSIS Corporates 2 » For Aeroporti di Roma, Alitalia's Filing for Extraordinary

Administration Is Credit Negative

Infrastructure 3 » NGPL's $400 Million Equity Infusion and Debt Repayment

Are Credit Positive

Banks 4 » Ocwen's Mortgage Servicing Rights Sale and Equity

Investment by New Residential Are Credit Positive » Mexico's Banks Benefit from Increased Remittances

» Russian Auto Lenders Benefit from Increased Demand

Asset Managers 10 » Invesco's Acquisition of Source Has Credit-Positive

Strategic Benefits

Sovereigns 13 » Greek Pact with Creditors Raises Likelihood of Official-Sector

Debt Relief, a Credit Positive for Private-Sector Debt

» South Korea's Geopolitical Risk Broadens with Escalating North Korea-US Tensions

MOODYS.COM

Report: 195519

© 2017 Moody’s Corporation, Moody’s Investors Service, Inc., Moody’s Analytics, Inc. and/or their licensors and affiliates (collectively, “MOODY’S”). All rights reserved.

CREDIT RATINGS ISSUED BY MOODY'S INVESTORS SERVICE, INC. AND ITS RATINGS AFFILIATES (“MIS”) ARE MOODY’S CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES, AND MOODY’S PUBLICATIONS MAY INCLUDE MOODY’S CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES. MOODY’S DEFINES CREDIT RISK AS THE RISK THAT AN ENTITY MAY NOT MEET ITS CONTRACTUAL, FINANCIAL OBLIGATIONS AS THEY COME DUE AND ANY ESTIMATED FINANCIAL LOSS IN THE EVENT OF DEFAULT. CREDIT RATINGS DO NOT ADDRESS ANY OTHER RISK, INCLUDING BUT NOT LIMITED TO: LIQUIDITY RISK, MARKET VALUE RISK, OR PRICE VOLATILITY. CREDIT RATINGS AND MOODY’S OPINIONS INCLUDED IN MOODY’S PUBLICATIONS ARE NOT STATEMENTS OF CURRENT OR HISTORICAL FACT. MOODY’S PUBLICATIONS MAY ALSO INCLUDE QUANTITATIVE MODEL-BASED ESTIMATES OF CREDIT RISK AND RELATED OPINIONS OR COMMENTARY PUBLISHED BY MOODY’S ANALYTICS, INC. CREDIT RATINGS AND MOODY’S PUBLICATIONS DO NOT CONSTITUTE OR PROVIDE INVESTMENT OR FINANCIAL ADVICE, AND CREDIT RATINGS AND MOODY’S PUBLICATIONS ARE NOT AND DO NOT PROVIDE RECOMMENDATIONS TO PURCHASE, SELL, OR HOLD PARTICULAR SECURITIES. NEITHER CREDIT RATINGS NOR MOODY’S PUBLICATIONS COMMENT ON THE SUITABILITY OF AN INVESTMENT FOR ANY PARTICULAR INVESTOR. MOODY’S ISSUES ITS CREDIT RATINGS AND PUBLISHES MOODY’S PUBLICATIONS WITH THE EXPECTATION AND UNDERSTANDING THAT EACH INVESTOR WILL, WITH DUE CARE, MAKE ITS OWN STUDY AND EVALUATION OF EACH SECURITY THAT IS UNDER CONSIDERATION FOR PURCHASE, HOLDING, OR SALE.

MOODY’S CREDIT RATINGS AND MOODY’S PUBLICATIONS ARE NOT INTENDED FOR USE BY RETAIL INVESTORS AND IT WOULD BE RECKLESS AND INAPPROPRIATE FOR RETAIL INVESTORS TO USE MOODY’S CREDIT RATINGS OR MOODY’S PUBLICATIONS WHEN MAKING AN INVESTMENT DECISION. IF IN DOUBT YOU SHOULD CONTACT YOUR FINANCIAL OR OTHER PROFESSIONAL ADVISER.

ALL INFORMATION CONTAINED HEREIN IS PROTECTED BY LAW, INCLUDING BUT NOT LIMITED TO, COPYRIGHT LAW, AND NONE OF SUCH INFORMATION MAY BE COPIED OR OTHERWISE REPRODUCED, REPACKAGED, FURTHER TRANSMITTED, TRANSFERRED, DISSEMINATED, REDISTRIBUTED OR RESOLD, OR STORED FOR SUBSEQUENT USE FOR ANY SUCH PURPOSE, IN WHOLE OR IN PART, IN ANY FORM OR MANNER OR BY ANY MEANS WHATSOEVER, BY ANY PERSON WITHOUT MOODY’S PRIOR WRITTEN CONSENT.

All information contained herein is obtained by MOODY’S from sources believed by it to be accurate and reliable. Because of the possibility of human or mechanical error as well as other factors, however, all information contained herein is provided “AS IS” without warranty of any kind. MOODY'S adopts all necessary measures so that the information it uses in assigning a credit rating is of sufficient quality and from sources MOODY'S considers to be reliable including, when appropriate, independent third-party sources. However, MOODY’S is not an auditor and cannot in every instance independently verify or validate information received in the rating process or in preparing the Moody’s publications.

To the extent permitted by law, MOODY’S and its directors, officers, employees, agents, representatives, licensors and suppliers disclaim liability to any person or entity for any indirect, special, consequential, or incidental losses or damages whatsoever arising from or in connection with the information contained herein or the use of or inability to use any such information, even if MOODY’S or any of its directors, officers, employees, agents, representatives, licensors or suppliers is advised in advance of the possibility of such losses or damages, including but not limited to: (a) any loss of present or prospective profits or (b) any loss or damage arising where the relevant financial instrument is not the subject of a particular credit rating assigned by MOODY’S.

To the extent permitted by law, MOODY’S and its directors, officers, employees, agents, representatives, licensors and suppliers disclaim liability for any direct or compensatory losses or damages caused to any person or entity, including but not limited to by any negligence (but excluding fraud, willful misconduct or any other type of liability that, for the avoidance of doubt, by law cannot be excluded) on the part of, or any contingency within or beyond the control of, MOODY’S or any of its directors, officers, employees, agents, representatives, licensors or suppliers, arising from or in connection with the information contained herein or the use of or inability to use any such information.

NO WARRANTY, EXPRESS OR IMPLIED, AS TO THE ACCURACY, TIMELINESS, COMPLETENESS, MERCHANTABILITY OR FITNESS FOR ANY PARTICULAR PURPOSE OF ANY SUCH RATING OR OTHER OPINION OR INFORMATION IS GIVEN OR MADE BY MOODY’S IN ANY FORM OR MANNER WHATSOEVER.

Moody’s Investors Service, Inc., a wholly-owned credit rating agency subsidiary of Moody’s Corporation (“MCO”), hereby discloses that most issuers of debt securities (including corporate and municipal bonds, debentures, notes and commercial paper) and preferred stock rated by Moody’s Investors Service, Inc. have, prior to assignment of any rating, agreed to pay to Moody’s Investors Service, Inc. for appraisal and rating services rendered by it fees ranging from $1,500 to approximately $2,500,000. MCO and MIS also maintain policies and procedures to address the independence of MIS’s ratings and rating processes. Information regarding certain affiliations that may exist between directors of MCO and rated entities, and between entities who hold ratings from MIS and have also publicly reported to the SEC an ownership interest in MCO of more than 5%, is posted annually at www.moodys.com under the heading “Investor Relations — Corporate Governance — Director and Shareholder Affiliation Policy.”

Additional terms for Australia only: Any publication into Australia of this document is pursuant to the Australian Financial Services License of MOODY’S affiliate, Moody’s Investors Service Pty Limited ABN 61 003 399 657AFSL 336969 and/or Moody’s Analytics Australia Pty Ltd ABN 94 105 136 972 AFSL 383569 (as applicable). This document is intended to be provided only to “wholesale clients” within the meaning of section 761G of the Corporations Act 2001. By continuing to access this document from within Australia, you represent to MOODY’S that you are, or are accessing the document as a representative of, a “wholesale client” and that neither you nor the entity you represent will directly or indirectly disseminate this document or its contents to “retail clients” within the meaning of section 761G of the Corporations Act 2001. MOODY’S credit rating is an opinion as to the creditworthiness of a debt obligation of the issuer, not on the equity securities of the issuer or any form of security that is available to retail investors. It would be reckless and inappropriate for retail investors to use MOODY’S credit ratings or publications when making an investment decision. If in doubt you should contact your financial or other professional adviser.

Additional terms for Japan only: Moody's Japan K.K. (“MJKK”) is a wholly-owned credit rating agency subsidiary of Moody's Group Japan G.K., which is wholly-owned by Moody’s Overseas Holdings Inc., a wholly-owned subsidiary of MCO. Moody’s SF Japan K.K. (“MSFJ”) is a wholly-owned credit rating agency subsidiary of MJKK. MSFJ is not a Nationally Recognized Statistical Rating Organization (“NRSRO”). Therefore, credit ratings assigned by MSFJ are Non-NRSRO Credit Ratings. Non-NRSRO Credit Ratings are assigned by an entity that is not a NRSRO and, consequently, the rated obligation will not qualify for certain types of treatment under U.S. laws. MJKK and MSFJ are credit rating agencies registered with the Japan Financial Services Agency and their registration numbers are FSA Commissioner (Ratings) No. 2 and 3 respectively.

MJKK or MSFJ (as applicable) hereby disclose that most issuers of debt securities (including corporate and municipal bonds, debentures, notes and commercial paper) and preferred stock rated by MJKK or MSFJ (as applicable) have, prior to assignment of any rating, agreed to pay to MJKK or MSFJ (as applicable) for appraisal and rating services rendered by it fees ranging from JPY200,000 to approximately JPY350,000,000.

MJKK and MSFJ also maintain policies and procedures to address Japanese regulatory requirements.

EDITORS SENIOR PRODUCTION ASSOCIATE Jay Sherman and Elisa Herr David Dombrovskis