MOODYS.COM

12 SEPTEMBER 2016

NEWS & ANALYSIS Corporates 2 » Hewlett-Packard’s Planned Spinoff of Software Business Is

Credit Negative » Danaher’s Planned Acquisition of Cepheid Is Credit Negative » EOG’s $2.5 Billion Acquisition Will Boost Exploration and

Production Acreage, a Credit Positive » General Electric’s Planned Acquisition of 3D Printing

Companies Is Credit Negative » Mexican Budget Cuts Are Credit Negative for PEMEX and

Construction Companies » Liberty Media’s Acquisition of Formula One Will Accelerate

Strategic Opportunities » Volkswagen’s Acquisition of Navistar Stake Is Credit Positive » Fresenius SE’s Offer to Acquire Quirónsalud Is Credit Negative » Altice N.V.’s Exchange Offer for SFR Minority Shareholders Is

Credit Positive » Schaeffler AG Will Benefit from Refinancing at

Holding Company » Ardagh’s Return of Capital to Shareholders Is Credit Negative » Knorr-Bremse’s Takeover of Haldex Would Be Credit Positive » Samsung Electronics’ Galaxy Note 7 Product Recall Is

Credit Negative » CNPC’s Listing of Its Financial Services Business Is

Credit Positive

Infrastructure 17 » Enbridge’s Merger with Spectra Energy Is Credit Positive » Lafayette Combined Utilities System’s Credit-Positive Rate

Hike Supports Capital Needs for New Generation

Banks 20 » Deficiencies in Wells Fargo’s Consumer Banking Sales Practices

Are Credit Negative » Italian Mutual Banks’ Implementation of ECB Opinion Would

Be Credit Positive » Declines in Greek Banks’ Nonperforming Loans and Operating

Expenses Are Credit Positive » Deposit Insurance Fee Increases Are Credit Negative for

Russian Banks » Jyske Bank’s Additional Tier 1 Capital Issue Mitigates

Share Buybacks

Insurers 29 » Hurricane Hermine Will Depress Property and Casualty

Insurers’ Third-Quarter Margins

» Colombia to Allow Auto Insurers to Audit Medical Claims, a Credit Positive

» China’s Tighter Life Insurance Product Regulations Are Credit Positive

Sovereigns 34 » Albania’s Step Toward European Union Membership Is

Credit Positive » Hong Kong Election Results Are Likely to Slow

Effective Policymaking

US Public Finance 38 » New Jersey Ends Credit-Negative Tax Reciprocity

with Pennsylvania

Covered Bonds 40 » Norway’s Proposed Tighter Mortgage Underwriting Standards

Are Credit Positive for Banks and Covered Bonds

RECENTLY IN CREDIT OUTLOOK

» Articles in the 5 September Credit Outlook 42 » Go to the 5 September 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 12 SEPTEMBER 2016

Corporates

Hewlett-Packard’s Planned Spinoff of Software Business Is Credit Negative Last Wednesday, Hewlett Packard Enterprise Company (HPE, Baa2 stable) said that it had agreed to spin off its non-core software assets to its shareholders and combine those assets with UK-based Micro Focus International plc (B1 review for downgrade) in a tax-free transaction valued at $8.8 billion. As part of the software spinoff, HPE will receive $2.5 billion in onshore cash from Micro Focus, although we expect a substantial portion of this cash to be earmarked for share repurchases.

The planned transaction, which HPE expects to close in the second or third quarter of 2017, is credit negative because the company will lose the benefit of diversification and the software business’ modest free cash flow, without a commensurate reduction in debt. After the spinoff, HPE’s revenue base will still be substantial, with about $30 billion in annual sales across a variety of market sectors, including servers, storage and networking businesses.

With $3.3 billion of revenue and $747 million of earnings before corporate cost allocations, the software segment is small and fairly distinct from the rest of HPE’s product offerings. The business, which grew primarily through acquisitions over the past 10 years, has had flat to declining revenue. Following the spinoff and the spinoff of its services business announced in May, we expect the composition of HPE’s business portfolio (servers, storage, networking and related financing) to stabilize.

Pro forma for the spinoff of the software and services businesses, we expect HPE’s adjusted debt/EBITDA to be 1.5x-1.7x at the end of the company’s fiscal year ending 31 October. For the same period, HPE’s free cash flow to adjusted debt will be in the mid-teens, or more than 25% when excluding onetime cash outflows related to the spinoffs.

HPE will maintain very strong liquidity, holding about $9 billion in cash and cash equivalents. Although most of its cash and free cash flow are offshore, the company would face only modest tax implications should it bring cash back to the US. HPE has additional liquidity in the form of a $4 billion revolving credit facility due in 2020 that the company uses as a backstop to a comparably sized commercial paper program, with same-day availability and ample room under financial covenants.

Richard J. Lane Senior Vice President +1.212.553.7863 richard.lane@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 12 SEPTEMBER 2016

Danaher’s Planned Acquisition of Cepheid Is Credit Negative Last Tuesday, Danaher Corporation (A2 stable) said that it had agreed to acquire molecular diagnostic company Cepheid (unrated) for about $4 billion. The planned acquisition, which Danaher expects to close around the end of 2016, is credit negative because the company will be paying a very high multiple and will fund the purchase entirely with debt.

Cepheid, which reported 2015 revenue of $538 million, has been increasing revenues at about 15% annually, but is barely profitable on an EBITDA basis. We estimate that Danaher will be paying about 8x revenue, signaling the strategic importance of Cepheid’s products and technology. By contrast, Danaher in 2015 paid about 4x revenue and about 20x reported EBITDA for its $13 billion acquisition of Pall Corporation, its most recent strategic investment.

Upon closing of the transaction, Danaher’s debt/EBITDA, as adjusted by us, will increase by one turn to about 3.3x. Although we expect little free cash flow from Cepheid in the first few years of Danaher’s ownership, Danaher’s annual free cash flow of about $2.3 billion will allow it to reduce debt relatively quickly. We expect that Danaher will restore its financial leverage within 18 months following the closing of the deal, provided there are no additional substantive acquisitions.

Our expectations for steady deleveraging are important because pro forma debt/EBITDA for this transaction is elevated for the A2 rating. When we changed our outlook on Danaher’s ratings to stable from negative in July, we had expected that Danaher would continue pursuing growth via acquisitions, but we did not expect the company to announce a deal this large so soon. Still, we believe that Danaher’s strong track record of successfully integrating acquisitions and its conservative financial policy (no share repurchases and targeting adjusted debt/EBITDA of below 2.5x) will support its credit quality.

Cepheid will enhance Danaher’s medical diagnostics franchise, which includes its Beckman-Coulter, Leica Biosystems and Radiometer businesses. Danaher’s medical diagnostics do not focus on molecular tests, which is Cepheid’s specialty. We believe that Danaher will leverage its existing distribution channels to increase Cepheid’s growth, improve the company’s operations and profitability, and enhance its research and development capabilities.

Jonathan Root, CFA Vice President - Senior Credit Officer +1.212.553.1672 jonathan.root@moodys.com

NEWS & ANALYSIS Credit implications of current events

4 MOODY’S CREDIT OUTLOOK 12 SEPTEMBER 2016

EOG’s $2.5 Billion Acquisition Will Boost Exploration and Production Acreage, a Credit Positive Last Tuesday, EOG Resources, Inc. (Baa1 stable) announced that it planned to buy Yates Petroleum Corporation (unrated), along with two smaller private companies, for $2.5 billion, most of it financed with EOG shares. The acquisition is credit positive for EOG, strengthening the exploration and production (E&P) company’s position in the Delaware Basin of West Texas and increasing its drilling inventory, despite some risk associated with integrating the privately held Yates and its mostly undeveloped acreage. The deal will have minimal effect on EOG’s leverage ratios.

The deal to buy Yates, plus Abo Petroleum (unrated), MYCO Industries (unrated) and certain related entities, will be 92% composed of EOG stock, valued at $2.3 billion. On top of that, EOG would pay $37 million of cash to buy Yates and pay down $114 million of Yates’ net debt at closing, probably in early October. EOG plans to begin drilling on the Yates acreage in late 2016 and add more rigs in 2017.

Historically, EOG has achieved most of its growth organically, rather than through acquisitions. Buying Yates and the smaller companies entails some integration risk for EOG. Yates’ largely undeveloped acreage adds some risk to EOG achieving reasonable returns on its drilling capital while oil prices are still weak. Still, the acquisition offers EOG the opportunity to ramp up production in the basin, given the largely adjacent acreage to existing leases and additional drilling inventory located in deeper horizons that EOG is acquiring, benefiting its overall E&P portfolio.

The Yates acreage will expand EOG’s portfolio in the Delaware and Powder River basins, boosting EOG’s acreage holdings by 78% in the Delaware and by 67% in the Powder River. EOG believes that Yates will add more than 1,700 drilling locations in both basins, generating at least a 30% rate of return, assuming oil prices of $40 a barrel.

Still, EOG is paying a high price for the additional production and proved developed reserves because Yates has a modest production and reserve profile. Yet, the 92% equity financing of the acquisition will leave EOG’s leverage profile virtually unchanged. And, although we believe that Yates has a higher operating cost structure than EOG, buying the Yates properties will have little effect on EOG’s overall costs since the new assets will only account for about 5% of EOG’s total production. The valuation of the transaction, based primarily on Yates’ acreage positions in the Delaware and Powder River Basins, looks reasonable compared with recent acreage transactions in the Permian Basin.

Gretchen French Vice President - Senior Credit Officer +1.212.553.3798 gretchen.french@moodys.com

Stephen Lee Associate Analyst +1.212.553.4757 stephen.lee@moodys.com

NEWS & ANALYSIS Credit implications of current events

5 MOODY’S CREDIT OUTLOOK 12 SEPTEMBER 2016

General Electric’s Planned Acquisition of 3D Printing Companies Is Credit Negative Last Tuesday, General Electric Company (A1 stable) said that it plans to acquire 3D printing (additive manufacturing) companies Arcam AB (unrated) and SLM Solutions Group AG (unrated) via public tender offers for a total price of $1.4 billion. Although strategically sound, the planned acquisitions are credit negative because the price is a high purchase multiple and will further reduce the company’s already-depleted cash balances.

The acquisitions are modest given GE’s more than $115 billion of annual revenue, but will consume about 14% of the company’s industrial cash and cash equivalents, and they come at a very rich price (10x revenue and about a 39% premium to the target copanies’ recent stock prices) when GE’s capital has already been thinning. Moreover, we do not expect the new business to generate meaningful returns for several years.

Additive manufacturing, which is commonly referred to as 3D printing, can create more complex parts (metal parts, in this case) at lower weights and faster speeds than is possible with conventional forging and/or casting. For example, GE was able to eliminate 845 parts using additive manufacturing for its forthcoming advanced turboprop engine. Over the next decade, the company envisions the need for 1,000 more additive machines. As a result, acquiring Arcam and SLM may simply represent an acceleration of GE’s procurement plans.

The acquisitions position GE to take a market-leading role in the commercial market for additive equipment, materials, services and software. The deals allow GE to add scale and important new technical capabilities to its own in-house efforts. GE has said that the acquisitions can eventually save the company $3-$5 billion, albeit likely over an extended time horizon.

Currently, the costs associated with additive manufacturing continue to outweigh those of traditional manufacturing, but with high-volume production, such as in GE’s wholly owned and jointly produced aircraft engine business, the company should be able to reap lucrative benefits over the long term.

We expect dramatic improvements in the speed, and ultimately the cost, at which parts are produced, along with enhanced design capabilities. For example, GE estimates that additive manufacturing could reduce the cost of a LEAP engine, which is used to power narrowbody airplanes, by $140,000 (or $650,000 for the much larger forthcoming GE9X engine), or about 1%-3% of an aircraft engine’s selling price.

However, GE has invested $1.5 billion to develop in-house additive manufacturing capabilities over the past seven years and the additional capital expenditures required to build out a viable commercial operation come at a time when GE’s heavy investment in the aviation business segment and other areas of the company are constraining its cash flows.

The target companies each generated about $70 million of revenue in the most recently reported 12-month period. We do not expect these businesses to contribute meaningfully to GE’s operating profit for some time. GE projects rapid growth for this still-developing manufacturing technology and about $400 million in operating profit by 2021 at a forecasted 20% margin level, which seems quite high. Although it appears that the moves diverge from the classic GE “build it, then service it” business model that has worked so well for the company for so many years (decades, in fact), GE views additive manufacturing as a dynamic new market that will expand as the industrial Internet-of-things really takes off. Opportunities for service revenues may well materialize from machine repairs and materials-as-a-service; they will be needed, in fact, to achieve the company’s targeted margins.

Russell Solomon Senior Vice President +1.212.553.4301 russell.solomon@moodys.com

NEWS & ANALYSIS Credit implications of current events

6 MOODY’S CREDIT OUTLOOK 12 SEPTEMBER 2016

Mexican Budget Cuts Are Credit Negative for PEMEX and Construction Companies On Thursday, Mexico’s finance ministry announced a proposed budget for 2017 that would include MXN240 billion ($12.7 billion) in spending cuts, well beyond previous cuts and implying significant reductions in public investment and spending. The reduced federal budget is credit negative for Petroleos Mexicanos (PEMEX, Baa3 negative), Mexico’s national oil company, whose annual budget will fall by about 21% to just under MXN391 billion.

Spending cuts will also hurt the heavy construction sector, weakening employment and consumer purchasing power and ultimately hit consumer-related sectors. Homebuilders will be less affected, however, because although the ministry in charge of federal housing subsidies is among the most affected, the government is still focused on reducing poverty, including supporting low-income housing.

According to the Mexican government, the reduced federal budget for 2017 reflects financial market volatility, the weak peso, declining exports to the US, slow growth of 2.0%-2.6%, and weak prices for Mexico’s oil exports. Mexico has been curbing federal spending in recent years, cutting the federal budget by MXN135 billion in 2015 and by MXN70 billion in 2016. The new cuts, equal to 1.5% of Mexico’s GDP, slash federal spending most heavily on energy, followed by education, communications, transportation, agriculture, health and urban development.

The new annual government outlay proposed in the budget would reduce PEMEX’s budget by MXN100 billion on top of the MXN100 billion of cuts that PEMEX had already committed to make this year. Because PEMEX devotes most of its budget to capital spending, the cuts will mostly affect its investments in exploration and production (E&P), even though PEMEX’s oil production has been falling consistently since 2004.

The proposed spending cuts will increase the annual decline in PEMEX’s oil production by well above the 5% that the earlier cuts had implied, as per our estimates. PEMEX’s reserve life, which fell to eight years in 2015 from 10 years in 2014, will also decline further. Meanwhile, the budget cuts endanger the company’s ability to enter into partnerships for deepwater E&P projects that the government will start to auction as soon as late 2016.

Heavy construction activity in 2017 will also remain subdued for a third year, having already worsened the credit profiles of Mexican construction companies such as Empresas ICA, S.A.B. de C.V. (Caa3 negative) and Abengoa Mexico S.A. de C.V. (C no outlook). Still, six public-private partnership construction projects in healthcare, communications and transportation will take in some MXN11.9 billion of private-sector investment, helping to soothe some of the sting of the reduced federal spending.

Residential construction in Mexico will remain among Mexico’s few bright spots in 2017, even with the new budget cuts. Mexico’s federal urban development ministry will face a 40% budget decrease in 2017, but the proposed budget still prioritizes poverty reduction, which we believe should include home-buying subsidies. Additionally, the 2016 housing subsidies budget of MXN9.6 billion is still well above the MXN6.3 billion average for 2010-13. Therefore, we expect that there is still room for cuts without greatly disrupting the homebuilding industry.

Homebuilders such as Corpovael S.A.B. de C.V. (B1 stable) and Servicios Corporativos Javer S.A.B. de C.V. (B2 stable), which rely heavily on federal subsidies, could be affected the most. However, both companies have proved they can quickly shift to unsubsidized houses if necessary. Recently, all rated homebuilders have focused on increasing middle-income houses in their product mix. Even companies such as Consorcio ARA, S.A.B. de C.V. (Ba2 stable), which relies less on subsidized products, have followed suit. The shift also comes amid an increased availability of mortgage loans from private banks, which usually involve larger amounts than loans from Infonavit and Fovissste, Mexico’s largest mortgage institutions. Since subsidies are

Sandra Beltran Assistant Vice President - Analyst +52.55.1253.5718 sandra.beltran@moodys.com

Alonso Sanchez Rosario Vice President - Senior Analyst +52.55.1253.5706 alonso.sanchezrosario@moodys.com

Nymia Almeida Vice President - Senior Credit Officer +52.55.1253.5707 nymia.almeida@moodys.com

NEWS & ANALYSIS Credit implications of current events

7 MOODY’S CREDIT OUTLOOK 12 SEPTEMBER 2016

only available to low-income homes buyers, the shift reduces the companies’ reliance on subsidized products.

But the budget cuts will strain companies with significant government contract work, including SixSigma Networks Mexico S.A. de C.V. (B2 negative), which recently signed a contract with the finance ministry. Any budget-related delays in payment for contract work would severely tighten liquidity for such companies.

Reduced public spending also will lead consumers to delay purchases of durable goods and shift spending to lower-priced food and beverages, leading packaged food producers to alter their pricing and product strategies.

NEWS & ANALYSIS Credit implications of current events

8 MOODY’S CREDIT OUTLOOK 12 SEPTEMBER 2016

Liberty Media’s Acquisition of Formula One Will Accelerate Strategic Opportunities Last Wednesday, Liberty Media Corporation (unrated) announced the $8 billion acquisition of Formula One’s holding company, Delta Topco Limited, parent of Alpha Topco Limited (B3 stable), from its current ownership group led by CVC Capital Partners. The transaction is credit positive for Alpha Topco because Liberty Media will help move the franchise toward digital and multiple platform content distribution.

Formula One has traditionally relied on three main sources of revenue: race promotion, broadcasting and advertising and sponsorship. US media conglomerate Liberty Media is a strong partner to support Formula One’s expansion of its digital presence, content distribution across multiple platforms and new revenue streams. After several years of decline in Formula One’s aggregate viewership numbers, Liberty Media’s ownership has the potential to broaden the audience across core markets and increase Formula One’s presence in the US market, where its popularity is less than in Europe.

The transaction confirms Formula One’s enterprise value at $8 billion, substantially above the company’s gross debt of $4.1 billion. Although the transaction confirms Formula One’s significant equity value, the debt will also be carried over as part of the transaction, meaning that we do not expect any change to the high 9x gross leverage level in 2016 (see exhibit). We also do not expect that the transaction will trigger a change of control under the first- and second-lien debt documentation.

Formula One’s Gross Leverage Will Remain High after Ownership Change

Note: Exhibit includes adjusted financial data and incorporates our standard adjustments. Sources: The company and Moody’s Financial Metrics

The management team around longstanding CEO Bernie Ecclestone, who has been crucial in developing the sport, will be complemented by new Chairman Chase Carey. The combination of a strategic partner for Formula One and a strengthened management team will help ensure a smooth management succession once Mr. Ecclestone decides to curtail his management responsibilities. In addition, the racing teams will be given the opportunity to invest, which could help further align the interests of the teams and Formula One.

Liberty Media expects to close the transaction in first-quarter 2017, subject to approvals from regulators, the governing body of Formula One, Fédération Internationale de l’Automobile, and Liberty Media stockholders. Existing Formula One shareholders could retain a significant stake in Liberty Media Group (to be renamed Formula One Group), the new holding company of Delta Topco Limited, of up to 65%, subject to Liberty Media’s additional fundraising efforts. In this case, existing shareholders would retain significant rights at Delta Topco Limited.

6.9x

9.0x

9.4x

9.0x

0x

1x

2x

3x

4x

5x

6x

7x

8x

9x

10x

2013 2014 2015 2016 Forecast

Tobias Wagner, CFA Vice President - Senior Analyst +44.20.7772.5308 tobias.wagner@moodys.com

NEWS & ANALYSIS Credit implications of current events

9 MOODY’S CREDIT OUTLOOK 12 SEPTEMBER 2016

Volkswagen’s Acquisition of Navistar Stake Is Credit Positive Last Tuesday, Volkswagen Aktiengesellschaft (VW, A3 negative) announced that it had formed a strategic alliance between its Volkswagen Truck & Bus (VW T&B) unit and Navistar International Corp. (B3 stable). As part of the alliance, Volkswagen will pay $256 million for a 16.6% stake in Navistar, enter into a strategic technology and supply agreement and establish a procurement joint venture. The companies expect to close transaction, which is subject to regulatory approval, by the end of 2016 or early 2017.

VW’s acquisition of a minority stake and the strategic alliance are credit positive for VW because they provide the company’s truck operation with the opportunity to significantly increase its engine and drivetrain volumes by providing engines and engine technology to Navistar. Additionally, there will be opportunities for cost synergies when Navistar and VW combine their sourcing volumes. VW’s investment for the 16.6% stake in Navistar involves a limited amount of cash outflow relative to VW’s automotive division’s reported net liquidity of €28.8 billion as of 30 June 2016.

Although VW currently has no plans to sell trucks in the US via Navistar’s broad dealer network, the agreement widens VW’s geographical footprint in the sizable US market via its minority interest in Navistar and the delivery of engine parts and technology. VW T&B predominantly operates in Europe and South America (see Exhibit 1), while Navistar generates 90% of its revenues in North America (see Exhibit 2).

EXHIBIT 1

Volkswagen Truck & Bus Sales by Region

Source: The company

EXHIBIT 2

Navistar Sales by Region

Source: The company

As part of the investment in Navistar, VW T&B will have representation on Navistar’s board of directors, and both companies will set up an alliance board composed of top-level representatives from both companies.

Navistar has been challenged with exceptionally high warranty costs associated with exhaust gas recirculation (EGR) engines that it manufactured during 2010-12, and expenses associated with switching from ERG-only emission technology to the selective catalytic reduction emission system as well as the erosion in market share that occurred as the company transitioned between the two technologies. However, Navistar has shown signs of progress in addressing these challenges. VW T&B’s engines and powertrain-related parts and technology could further support Navistar’s recovery.

Meanwhile, VW would gain a significant volume increase for its engines and powertrain parts business, resulting in cost savings and higher profitability. Still, even if the alliance is successful, the effect on VW’s consolidated financials will not be material enough to affect VW’s credit quality given that VW T&B in the first half of 2016 constituted around 11% of the overall company’s reported operating profit before special items.

North America1%

South America18%

Europe74%

Asia-Pacific7%

North America90%

South America5%

Other5%

Falk Frey Senior Vice President +49.69.70730.712 falk.frey@moodys.com

NEWS & ANALYSIS Credit implications of current events

10 MOODY’S CREDIT OUTLOOK 12 SEPTEMBER 2016

Fresenius SE’s Offer to Acquire Quirónsalud Is Credit Negative On Monday, Germany’s Fresenius SE & Co. KGaA (FSE, Baa3 stable) announced that it had offered €5.76 billion (on a debt and cash free basis) to acquire Spain’s largest private hospital operator, Quirónsalud, in a largely debt-financed deal. The transaction is credit negative for FSE because it will add approximately €5.4 billion of net debt to the company’s balance sheet and will lead to a deterioration of its credit metrics.

Pro forma for the closing of the acquisition, FSE’s 2015 debt/EBITDA would increase to around 4.5x from 3.3x before the acquisition. With this transaction, FSE will consume a fair amount of headroom under its Baa3 rating.

Our expectation of a temporary increase in leverage is largely mitigated by the quality of the business that FSE will acquire. Quirónsalud has strong market positions in Spain’s affluent regions, a well maintained asset base with well-regarded hospitals, good payor diversity and a strong track record of profitable growth. The Spanish hospital market offers good growth opportunities because of lower healthcare expenditures per capita than the European Union average; a low hospital and bed density; and a low average length of stay in hospitals because of a high level of outpatient care. Although Spain’s hospital market is different from Germany’s, we believe that FSE can add some value to Quirónsalud, while the latter can supply best practices to FSE’s domestic hospital business.

The multiple that FSE is paying for the acquisition is 12.0x-12.5x the 2016 estimate for EBITDA and 10.5x-11.0x the 2017 estimate for EBITDA. That level is comparable, if not lower, than multiples paid for similar assets in the recent past, and slightly lower than the multiple that FSE paid for Rhön Klinikum, a German private hospital operator, a few years back.

FSE should also be able to rapidly reduce leverage post integration as a result of strong cash flow generation and solid growth prospects at both FSE and Quirónsalud over the next 12-18 months. We expect pro forma debt/EBITDA to be 3.5x-4.0x in 2016 and 3.0x-3.5x in 2017. Excluding the contribution from Fresenius Medical Care (of which FSE owns 31% but fully consolidates into its accounts), we estimate that 2016 pro forma leverage would be 4.5x-5.0x, which is high for its current rating, but balanced by FSE’s valuable stake in Fresenius Medical Care. The exhibit below shows FSE’s revenue breakdown by business unit.

Fresenius SE & Co.’s 2015 Revenue by Business Segment

Ownership Revenues € Millions

EBIT € Millions

Fresenius SE & Co. KGaA Parent Company €27,626 €3,958

Fresenius Medical Care AG & Co. KGaA 31% €15,086 €2,097

Fresenius Kabi 100% €5,950 €1,189

Fresenius Helios 100% €5,578 €640

Fresenius Vamed 77% €1,118 €64

Note: The sum of the segment revenues and EBIT do not reconcile with the consolidated group revenues of FSE because of intra-group activities. Source: Fresenius SE & Co. KGaA

FSE is a global healthcare holding company that is 27%-owned by the Else-Kröner-Fresenius Foundation and whose major assets are investments in companies and inter-company financing arrangements. Fresenius Medical Care generates 50%-55% of group sales and EBIT. FSE’s other operations, which are majority or fully owned, include Fresenius Kabi, Fresenius Helios and Fresenius Vamed. Based on the trailing 12-month figures as of 30 June 2016, FSE had revenues of around €28 billion.

Stanislas Duquesnoy Vice President - Senior Credit Officer +49.69.70730.781 stanislas.duquesnoy@moodys.com

Taisiia Alieksieienko Associate Analyst +49.69.70730.707 taisiia.alieksieienko@moodys.com

NEWS & ANALYSIS Credit implications of current events

11 MOODY’S CREDIT OUTLOOK 12 SEPTEMBER 2016

Altice N.V.’s Exchange Offer for SFR Minority Shareholders Is Credit Positive Last Monday, Altice N.V. (unrated) filed a public exchange offer for the 22.25% of shares of SFR Group S.A. (B1 stable) that it does not already own. The offer values the minority interest at $2.6 billion. This equity transaction is credit positive for Altice Luxembourg S.A. (B1 negative), SFR’s intermediate holding company, because it will give Altice Luxembourg greater access to SFR’s cash flows and reduce dividend leakage to minority shareholders.

Altice Luxembourg is a Luxembourg-based holding company, through which subsidiaries Altice International S.a.r.l. (B1 negative) and SFR operate a multinational telecommunications and cable business. SFR, held indirectly through Altice France S.A. and Altice Bis S.a.r.l., operates mainly in France, while Altice International has a presence in the Dominican Republic, Israel, Western Europe and France’s overseas territories.

The transaction’s aim is to simplify Altice N.V.’s structure, fully aligning the interests of SFR’s shareholders and Altice N.V., increasing Altice N.V.’s organizational flexibility and access to SFR’s cash flows, and facilitating the sharing of skills and best practices among the entities. The goal is for Altice N.V. to become the only company to have its equity securities traded on a regulated market, reflecting the company’s expanding globalization, while improving its efficiency by eliminating multiple listings and minority interests.

The proposed exchange transaction is credit positive for Altice Luxembourg debtholders because it would give them greater access to SFR’s dividends, thereby reducing the leakage resulting from dividend payments to minority interests. Altice Luxembourg relies on dividends from SFR and other subsidiaries to meet its debt obligations. In the financial year that ended 31 December 2015, SFR paid $2.785 billion in dividends, $619 million of which went to non-Altice group minority interests.

The transaction’s positive effects outweigh the loss of benefit of having a publicly listed entity for valuation purposes. The transaction would not immediately change estimated pro forma Moody’s-adjusted leverage at Altice Luxembourg, which is presently close to 6.0x, a high level for its current rating and which leaves no headroom for debt-financed M&A activity.

The exchange offer is eight new Altice N.V. shares for five SFR shares, and is not subject to an ownership threshold. SFR’s independent directors approved the terms of the proposed transaction and unanimously recommended the transaction’s approval to SFR shareholders. The company expects to close the transaction in the fourth quarter of 2016, subject to approval by France’s Authorité des marchés financiers and the Netherlands Authority for the Financial Markets.

Colin Vittery Vice President - Senior Analyst +44.20.7772.1752 colin.vittery@moodys.com

NEWS & ANALYSIS Credit implications of current events

12 MOODY’S CREDIT OUTLOOK 12 SEPTEMBER 2016

Schaeffler AG Will Benefit from Refinancing at Holding Company Last Wednesday, Schaeffler Verwaltung Zwei GmbH (Ba1 stable), a holding entity with a 75% stake in Schaeffler AG (SAG, Baa3 stable) and a 36% stake in Continental AG (Baa1 stable), announced a plan to issue around €2.6 billion of secured notes. On Thursday, it increased the issue by €1 billion. The proposed bond issue by Schaeffler Verwaltung Zwei, which will be renamed to IHO Verwaltungs GmbH, (IHO-V) is credit positive for SAG because it will significantly improve its leverage and interest cover. As a result, we upgraded SAG’s rating to Baa3 from Ba2.

The deleveraging at SAG will happen because around €1.7 billion of the €3.6 billion to be raised by IHO-V will be used to fully repay a loan note held by SAG. SAG will use the €1.7 billion it will receive to reduce its own debt.

We calculate that SAG’s Moody’s-adjusted pro forma debt/EBITDA will decline to around 2.6x from 3.2x for the 12 months that ended June 2016. The pro forma calculation reflects SAG’s debt declining by the full value of the loan note (i.e., around €1.7 billion); an approximately €400 million pension underfunding increase between December 2015 and June 2016, primarily resulting from lower discount rates, which is part of our adjusted debt calculation; and some loss of EBITDA (roughly €70 million on a pro forma basis), given that SAG has received interest income of 4% per year for the loan note, which is included in our definition of EBITDA. Additionally, the substantial debt reduction will lead to a corresponding reduction of interest expense, materially improving interest cover. The exact amount will depend on which debt instruments SAG decides to repay.

The transaction is another step in SAG’s effort to reduce its debt load, which dates back to 2008, when the Schaeffler group undertook a debt-financed acquisition of a controlling stake in Continental, one of Europe’s leading auto suppliers. Since then, Schaeffler group has focused on debt reduction through free cash flow generation and via a two-part initial public offering in SAG in October 2015 (11% free float) and April 2016 (a 14% free float), using proceeds to repay debt at SAG as well as above SAG at holding entities. SAG still reported more than €5 billion of debt as of June 2016.

A complete elimination of the loan note between SAG and IHO-V also further delinks both entities. Earlier last week, IHO-V refinanced its credit facilities, which eliminated cross-default language between SAG and IHO-V. That cross-default fall-away prompted us last Wednesday to split the Schaeffler’s group rating into standalone ratings for SAG and for IHO-V, and the loan note elimination further supports that decision.

Germany-based SAG is a leading manufacturer of roller bearings and linear products primarily to the worldwide automotive industry. In 2015, SAG generated revenues of €13.2 billion.

Martin Fujerik Assistant Vice President - Analyst +49.69.70730.909 martin.fujerik@moodys.com

NEWS & ANALYSIS Credit implications of current events

13 MOODY’S CREDIT OUTLOOK 12 SEPTEMBER 2016

Ardagh’s Return of Capital to Shareholders Is Credit Negative Last Tuesday, Ireland’s Ardagh Packaging Group Ltd. (B2 stable), a leading global producer of glass and metal containers, announced its intention to issue $1.565 billion of new debt financing due in 2023, the net proceeds of which will fund the redemption of Ardagh’s existing 8.625% US-dollar denominated and 8.375% euro-denominated senior payment-in-kind (PIK) notes due in 2019.

The issuance of €270 million of additional new PIK toggle notes over and above the amount required to repay the existing PIK notes is credit negative because it will fund Ardagh’s latest shareholder distribution. The amount of the issuance was subsequently increased by $150 million with additional proceeds to be used reduce debt at the operating company level with no effect on leverage.

The dividend payment will increase Ardagh’s adjusted leverage to 7.4x pro forma for the new financing, thereby restoring leverage to the same level at 31 December 2015 after dipping temporarily to 7.2x at 30 June 2016. The delay in reducing leverage is a risk that comes at a time when the company is undergoing a major business integration of recently acquired assets from Ball Corporation and Rexam PLC, which is currently progressing to plan.

The shareholder payout is further evidence of a persistent aggressive financial policy that does not align with our expectations for the company. Those expectations are that Ardagh will refrain from funding further dividend payments until it achieves operational stability following the integration of the Ball and Rexam assets, and that it will use built-up cash from improving trading performance, realization of synergies and significantly lower capex requirements to gradually reduce debt and leverage.

Ardagh’s credit quality is negatively affected by its high level of adjusted leverage, which we now expect will remain above 7.0x through 2016 and into 2017, as well as the company’s exposure to a number of operating environment risks. Ardagh is vulnerable to raw material price volatility in its European business, where pass-through clauses in its contracts are less common than in the US. Growth in emerging markets is proving slower and more volatile than we expected owing mainly to the macroeconomic climate. There also is a risk of weakening operating margins in key mature markets because of competition.

Given Ardagh’s current weak positioning in the B2 category, further demonstrations of an aggressive financial policy through either debt-funded acquisitions or returns of capital to shareholders may result in a downgrade to either its rating or outlook.

Martin Chamberlain Vice President - Senior Analyst +44.20.7772.5213 martin.chamberlain@moodys.com

Simon West Associate Analyst +44.20.7772.5479 simon.west@moodys.com

NEWS & ANALYSIS Credit implications of current events

14 MOODY’S CREDIT OUTLOOK 12 SEPTEMBER 2016

Knorr-Bremse’s Takeover of Haldex Would Be Credit Positive Last Monday, Germany’s Knorr-Bremse AG (A2 stable) announced that it had made an offer to acquire Sweden’s Haldex (unrated), a manufacturer of brake and air suspension systems for heavy vehicles. The transaction would be credit positive for Knorr-Bremse because it would complement’s the company’s product range and can be financed from available cash on hand. The offer, which Haldex’s board of directors is evaluating, is subject to customary conditions and antitrust approval. Knorr-Bremse is the third company to place a bid for Haldex this summer.

Knorr-Bremse is offering SEK110 per share in cash for a total price of SEK4.9 billion (approximately €506 million). By comparison, Knorr-Bremse had cash and cash equivalents of €1.36 billion at year-end 2015. The offer is a 58.1% premium to the volume-weighted average price of SEK69.59 for Haldex’s shares during the six months before SAF-Holland GmbH (unrated) made an offer on 14 July bid for Haldex, and a 10% premium to ZF Friedrichshafen AG’s (Ba1 positive) offer of SEK100 per share made in August.

The bid from Knorr-Bremse is the third consecutively higher offer in six weeks. It is possible that Knorr-Bremse and ZF Friedrichshafen will raise their bids for Haldex because of the target’s strategic fit into each company’s existing products.

If Haldex accepts Knorr-Bremse’s bid, we expect that the transaction will not materially affect Knorr-Bremse’s leverage, which will remain at around a Moody’s-adjusted 0.5x debt/EBITDA for the next 12-18 months. We expect Knorr-Bremse’s Moody’s-adjusted EBITA margin to decrease to around 15.0% from around 15.7% over the next 12-18 months, excluding possible synergies.

Acquiring Haldex will allow Knorr-Bremse to broaden its product range and offer more comprehensive systems for heavy vehicles. This would add a complete product range for wheelends consisting of foundation drum brakes, slack adjusters, air disc brakes and brake actuators for worldwide applications to Knorr-Bremse’s products, which include advanced electronic chassis control, vehicle dynamics including steering and powertrain control systems. Haldex in 2015 generated approximately SEK4.78 billion in revenues and SEK464 million in reported EBITDA (€48 million).

Munich, Germany-based Knorr-Bremse is the world’s leading supplier of brake systems to the truck and railway industries, which account for the majority of revenues. The company had revenues of €5.8 billion in 2015, of which the company’s Rail Vehicle Systems division generated 57% and the company’s Commercial Vehicle Systems generated 43%. During 2015, 45% of revenues came from Europe, 24.5% from the Americas and 30.5% from the Asia-Pacific region. Knorr-Bremse is privately owned by the Thiele family. Landskrona, Sweden-based Haldex operates in 18 countries and generates about half of its sales in North America, one third in Europe and the remainder in Asia and South America.

Dirk Steinicke Associate Analyst +49.69.70730.949 dirk.steinicke@moodys.com

Oliver Giani Vice President - Senior Analyst +49.69.70730.722 oliver.giani@moodys.com

NEWS & ANALYSIS Credit implications of current events

15 MOODY’S CREDIT OUTLOOK 12 SEPTEMBER 2016

Samsung Electronics’ Galaxy Note 7 Product Recall Is Credit Negative On 2 September, Samsung Electronics Co. Ltd. (A1 stable) issued a product recall for its latest smartphone, the Galaxy Note 7, because of faulty batteries causing a relatively small number of handsets to spontaneously burst into flames.

Samsung launched the Galaxy Note 7 in mid-August and has shipped about 2.5 million units to more than 10 countries. Under terms of the recall, consumers who bought the device will be able to obtain a new one later this month, return their smartphones for a new Galaxy S7 model introduced earlier this year, or turn in the device for a full refund.

The company has acted aggressively to address the problem early in the product rollout, which will contain the cash cost of the recall to an amount that we estimate will be KRW1.0-KRW1.5 trillion ($900 million-$1.4 billion). The recall is likely to reverse improving profitability in Samsung’s IT and mobile communications (IM) segment (see exhibit) over the next one to two quarters. Since the introduction of the Galaxy 7 line of products this year, reported operating margins in the IM segment have improved to more than 16% as of second-quarter 2016 from about 10% in 2015. Samsung had been using its advantage in hardware technology to take market share from Apple Inc. (Aa1 stable).

Samsung’s IT and Mobile Communications Segment’s Operating Profit Margin

Source: Samsung Electronics Co. Ltd.

The recall would have a negative effect on the sales performance of the Galaxy Note 7 for the rest of 2016, particularly given Apple’s recent launch of its new iPhone 7 smartphone. In addition, Samsung could be required to increase marketing expenses to regain consumer confidence. Still, we expect the reported operating margin in its IM division to increase to 13%-14% for all of 2016, given the robust performance of its flagship model Galaxy S7 and improved cost structure.

The cash costs of the recall are insignificant relative to the company’s substantial earnings, free cash flow and liquid holdings. At 30 June 2016, Samsung had liquidity holdings of around KRW77.1 trillion, while total debt was only KRW12.2 trillion.

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

1Q15 2Q15 3Q15 4Q15 1Q16 2Q16

Joe Morrison, CFA Vice President - Senior Credit Officer +852.3758.1376 joe.morrison@moodys.com

Chris Wong, CFA Associate Analyst +852.3758.1531 chris.wong@moodys.com

NEWS & ANALYSIS Credit implications of current events

16 MOODY’S CREDIT OUTLOOK 12 SEPTEMBER 2016

CNPC’s Listing of Its Financial Services Business Is Credit Positive Last Tuesday, Jinan Diesel Engine Company Limited (JDE, unrated), a publicly listed subsidiary that is 60% indirectly owned by China National Petrochemical Corporation (CNPC, Aa3 negative), announced that its board had approved a plan to acquire 100% of CNPC Capital (unrated) from CNPC. JDE also said that it would issue up to RMB19 billion of new equity to a number of institutional investors to fund the asset acquisition, as well as inject capital into some financial services companies under CNPC Capital. CNPC Capital acts as CNPC’s platform to aggregate the company’s stakes in various financial services businesses, including banking, trust, insurance and leasing.

The transaction, which will allow CNPC to list the financial service businesses through JDE, is credit positive for CNPC because it will provide CNPC Capital with access to the capital markets, reducing CNPC’s need to support CNPC Capital. This will allow CNPC to focus its capital resources on core energy-related businesses, which are of high strategic importance to the Chinese government. Meanwhile, publicly listing CNPC Capital will help improve its transparency and corporate governance owing to increased disclosures to investors.

JDE will pay around RMB75 billion, of which RMB6 billion will be in cash and the rest in stakes in JDE. After the transaction, CNPC will own 77.35% of JDE. The transaction will likely increase CNPC’s total consolidated equity by as much as RMB19 billion. The amount roughly accounts for 0.8% of CNPC’s total reported equity of RMB2.398 trillion as of the end of 2015 and will marginally lower CNPC’s debt/capital ratio.

JDE plans to use around RMB13 billion to inject new capital into Bank of Kunlun (unrated), Kunlun Financial Leasing Co., Ltd (unrated) and Kunlun Trust Co., Ltd (unrated). This will help improve the capital adequacy ratios of these financial service units, which is also credit positive for CNPC.

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

Iris Liu Associate Analyst +852.3758.1532 iris.liu@moodys.com

NEWS & ANALYSIS Credit implications of current events

17 MOODY’S CREDIT OUTLOOK 12 SEPTEMBER 2016

Infrastructure

Enbridge’s Merger with Spectra Energy Is Credit Positive Last Tuesday, Enbridge Inc. (Baa2 negative) and Spectra Energy Corp. (guaranteed debt Baa2 stable) announced that they had agreed to merge in a transaction that assigned a $37 billion equity value to Spectra. The transaction is credit positive for Enbridge because, among other benefits, it will create the largest midstream company in North America and one of the world’s largest infrastructure companies, with pro forma net property plant and equipment of almost CAD100 billion as of 30 June 2016. However, our outlook on Enbridge remains negative based on its high leverage and the execution risk associated with the merger and the company’s capital program and deleveraging plans.

Both companies have extensive pipeline networks (mostly natural gas for Spectra and mostly liquids for Enbridge) in Canada and the US, and the combined entity will benefit from this diversity. As a combined entity, wider opportunities among oil and gas projects is a competitive advantage as the growth rate for pipeline infrastructure slows. Both companies have comparable low-risk business profiles, with assets that are mostly contracted or regulated and have little exposure to commodity prices or sales volumes.

The combined entity will have stronger financial metrics than Enbridge on its own, owing to Spectra’s lower leverage. As of June 2016, Enbridge’s debt/EBITDA was 7.2x, while Spectra’s was about 5.8x. On a combined last-12-months basis, their leverage was about 6.7x as of 30 June 2016. We had expected financial metrics at both companies to improve absent the proposed merger.

We expect the acquisition to be financed entirely with a share exchange, and since there are no cash elements there will be no meaningful incremental debt associated with the transaction, which helps support credit quality. This will also help reduce the execution risk associated with transaction financing.

Spectra’s secured capital program is favorable to Enbridge’s and supports faster deleveraging. Spectra expects to bring about CAD7 billion of capital into productive service, or about 70% of its total secured capital program, in 2017. This compares with about CAD6 billion of capital in service for Enbridge in 2017, or about 40% of its secured capital program, rising to CAD8.2 billion, or more than 50% of its secured capital program, in 2019. In addition, Enbridge’s Line 3 Replacement Program, which the company expects to complete in 2019, accounts for almost half (on a per-merger basis) of the company’s secured capital program over 2017-19, leading to concentrated project execution risk compared with Spectra’s more diversified portfolio of capital projects. Enbridge expects to drive annual synergies in excess of CAD500 million per year by the end of the decade, but the transaction is credit positive even without these substantial synergies.

The only negative aspect of the transaction is that Enbridge announced that upon the deal’s closing the company will increase its distributions to shareholders by 15% next year and amended its distribution guidance higher in the future. These measures reduce distribution coverage because more of its cash flow will be earmarked for dividends that Enbridge will be reluctant to cut.

Gavin MacFarlane Vice President - Senior Credit Officer +1.416.214.3864 gavin.macfarlane@moodys.com

NEWS & ANALYSIS Credit implications of current events

18 MOODY’S CREDIT OUTLOOK 12 SEPTEMBER 2016

Lafayette Combined Utilities System’s Credit-Positive Rate Hike Supports Capital Needs for New Generation Last Tuesday, the Lafayette City-Parish Council in Louisiana approved city-owned Lafayette Combined Utilities System’s (LUS, A1 stable) proposal to increase base rates by 9% over the next two fiscal years. The increase in base rates is credit positive because it will support the utility’s five-year, $232 million capital investment program, which includes the construction of gas-fired rapid internal combustion engines (RICE).

We understand that the approved rate increase will raise monthly charges by about $13 per month for the average household to $156.05 per month from $142.61. LUS’ historical financial performance is well-positioned in the A rating category, with fixed obligation charge coverage of 1.8x, a modest debt ratio of 31%, and three-year average liquidity of 215 days (see exhibit). The approved rate increase will fortify the utility’s position given that we expect debt levels to increase to finance a portion of the capital investment plan.

Lafayette Combined Utilities’ Financial Metrics Fixed-Obligation Charge Coverage1 Debt Ratio2 Liquidity in Days3

Notes: 1 Fixed obligation charge coverage is a Moody’s-calculated ratio that adjusts the traditional debt service coverage ratio for any debt-related payments made to a joint action agency for debt issued by that agency on behalf of the municipal utility and secured by a contract with the municipal utility.

2 Debt ratio is calculated as a ratio of gross debt less debt service fund, interest payable and debt service reserve funds divided by gross fixed plant assets, accumulated depreciation on plant and net working capital. Net working capital is defined as cash and investments plus receivables expected to be collected minus current liabilities unrelated to debt.

3 Liquidity calculated as days cash available is a ratio of available unrestricted cash and investments, eligible unused bank lines and capacity under commercial paper programs divided by the utility’s annual operating and maintenance expenses exclusive of depreciation and amortization expenses and then multiplied by 365 days.

Source: Lafayette Combined Utilities System and Moody’s Investors Service

LUS has the authority to enact a monthly fuel adjustment charge for fuel, purchased power and other costs without needing to obtain approval from the council, which provides financial stability. Since 2009, electric base rates have increased by 22% or more for all customer classes, with the electric base rate increasing by less than 10% in 2010, by 12.7% in 2011, and remaining flat thereafter.

We understand that a portion of the capital investment program will fund the construction of 8-10 megawatts of gas-fired RICE generation resources to fulfill incremental energy supply needs and to maintain stable costs and resource reliability. Following the completion of the RICE projects, we expect that the utility’s reliance on the Midwest ISO (MISO) wholesale power capacity market will decrease. Currently, LUS’ energy mix is 75% composed of energy from internally owned generation units and 25% from the MISO wholesale power market.

0.0x

0.5x

1.0x

1.5x

2.0x

2.5x

2011 2012 2013 2014 20150%

5%

10%

15%

20%

25%

30%

35%

40%

2011 2012 2013 2014 20150

50

100

150

200

250

300

2011 2012 2013 2014 2015

Gaurav Purohit Analyst +1.212.553.4381 gaurav.purohit@moodys.com

NEWS & ANALYSIS Credit implications of current events

19 MOODY’S CREDIT OUTLOOK 12 SEPTEMBER 2016

LUS is a combined electric, water and wastewater utility that serves the City of Lafayette, Louisiana. Although LUS manages the combined utility, the Lafayette Public Utilities Authority and the Lafayette City-Parish Council are LUS’ legislative governing bodies. About 80% of utility revenues are derived from the electric system.

NEWS & ANALYSIS Credit implications of current events

20 MOODY’S CREDIT OUTLOOK 12 SEPTEMBER 2016

Banks

Deficiencies in Wells Fargo’s Consumer Banking Sales Practices Are Credit Negative Last Thursday, Wells Fargo & Company’s (A2 stable) lead bank subsidiary agreed to pay $185 million to federal banking regulators and the Office of the Los Angeles, California, City Attorney to settle deficiencies identified by the government’s examination of Wells Fargo’s consumer banking sales practices. Although the incremental expense of the settlements is immaterial since Wells Fargo had fully accrued for them, the regulators’ revelations are highly disturbing; they highlight that Wells Fargo’s vaunted cross-selling capabilities were inflated, its incentive structure had led to pervasive inappropriate practices, and its retail banking sales process lacked adequate and effective oversight. As such, the implications of this announcement are credit negative.

The US Consumer Financial Protection Bureau (CFPB) and the US Office of the Comptroller of the Currency (OCC) each entered into consent orders with Wells Fargo tied to what the OCC labeled as “unsafe or unsound sales practices.” These practices resulted in the unauthorized opening of up to 2.1 million deposit or credit card accounts and emanated from employees’ desire to achieve their sales goals and generate additional compensation under Wells Fargo’s incentive plans. The sales also supported Wells Fargo’s cross-sell metrics, which measure the number of products sold to each of its retail banking households, a statistic that its management team often cited as a measure of its success.

Although the extent to which Wells Fargo’s cross-sell metrics were inflated by these practices was not disclosed, our estimates show that the artificial boost was modest. As of May 2016, Wells Fargo reported 6.27 products per retail banking household and roughly 21 million such households, for a total of nearly 132 million products held by those households.1 Assuming the 2.1 million unauthorized products identified by regulators were sold entirely to these retail banking households and were still reported as open in May, the cross-sell metric drops to 6.17, a modest reduction.

Nonetheless, the regulators’ findings are consequential for a bank such as Wells Fargo, which historically has had strong customer satisfaction scores and a reputation for sound risk management. In particular, the OCC noted that Wells Fargo lacked an enterprise-wide program to oversee its sales practices and a comprehensive process to monitor customer complaints. Additionally, regulators said that Wells Fargo failed to adequately test and monitor branch employee sales practices.

In addition to the $185 million in penalties, Wells Fargo has been refunding affected consumers for the total of all monthly maintenance fees, nonsufficient funds fees, overdraft charges and other fees they paid in connection with the establishment of the unauthorized accounts. These fees arose because in some instances Wells Fargo employees would fund the unauthorized accounts with an amount that was large enough to earn an incentive award, but the transfer of those funds came from consumers’ existing accounts and sometimes resulted in overdraft and other fees. Following a review by a third-party consulting firm, $2.6 million has already been refunded out of a total of $5 million that Wells Fargo has earmarked for customer remediation.

As is often the case with regulatory enforcement actions, we expect that Wells Fargo’s risk management and sales oversight program ultimately will be strengthened by these findings, particularly since regulators are requiring it to develop and implement a plan to correct the deficiencies they identified. Indeed, we believe the regulatory findings imply that Wells Fargo’s retail banking cross-sell model has reached its limits.

1 At its May 2016 investor day, Wells Fargo disclosed that it had 21 million retail checking households as of December 2015. We

assume little change in this figure between year-end 2015 and May 2016.

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

NEWS & ANALYSIS Credit implications of current events

21 MOODY’S CREDIT OUTLOOK 12 SEPTEMBER 2016

As such, we expect that Wells Fargo’s incentive plans will be better aligned with more realistic levels of customer demand going forward.

Although the extent to which Wells Fargo changes its sales practices and incentive structures is not yet clear, we believe that it will eventually result in a more durable sales and marketing model. Nonetheless, we do expect some immediate damage to Wells Fargo’s reputation from this embarrassing episode.

NEWS & ANALYSIS Credit implications of current events

22 MOODY’S CREDIT OUTLOOK 12 SEPTEMBER 2016

Italian Mutual Banks’ Implementation of ECB Opinion Would Be Credit Positive On 31 August, the European Central Bank opined on the Bank of Italy’s reforms of Italy’s mutual bank organization and oversight. The reform, which Italy’s parliament approved in February 2016, will place the 358 unrated banche di credito cooperativo (i.e., mutual banks) under the oversight of one or more banks and the group or groups will share cross-guarantee schemes. We believe that the Bank of Italy will adjust its reform implementation based on the ECB’s opinion, a credit positive for Italian mutual banks because it will increase their regulatory oversight and provide a framework and central manager for the mutual banks’ large stock of problem loans.

The leader institutions would have specific oversight functions, which we expect will improve governance along with the European Single Supervisory Mechanism, adding an additional layer of discipline. They would also facilitate plans to reduce the stock of problem loans for the mutual banks.

The ECB wrote that the central oversight institutions should approve loans granted by mutual banks that are too large for a single mutual bank, or would disproportionately expose the mutual banking group to a single borrower (the ECB has not defined thresholds); regulate the management and evaluation of problem loans; and manage the most severe class of problem loans, those to insolvent borrowers.

If three groups are formed, we see Iccrea Holding (unrated) leading a large nationwide group that would constitute Italy’s third-largest financial institution; Cassa Centrale Raiffeisen dell’Alto Adige (A3 negative, baa3/baa32) leading a group in the German-speaking province of Alto Adige; and Cassa Centrale Banca-Credito Cooperativo del Nord Est (Baa3 negative, baa3/baa3) leading a small national group. Alternatively, Iccrea Holding might lead all 358 mutual banks.

2 The ratings shown in this report are the banks’ deposit rating, baseline credit assessment and adjusted baseline credit

assessment.

London +44.20.7772.5454

NEWS & ANALYSIS Credit implications of current events

23 MOODY’S CREDIT OUTLOOK 12 SEPTEMBER 2016

Declines in Greek Banks’ Nonperforming Loans and Operating Expenses Are Credit Positive On 30-31 August, Greece’s four largest banks reported second-quarter 2016 results that in aggregate showed a decline in the formation of new nonperforming loans (NPLs) following a significant deceleration in the previous two quarters. This, together with banks’ reduced cost base, is credit positive, although loan-loss provisions continue to consume a large part of their pre-provision income. The banks that reported second-quarter 2016 results were National Bank of Greece S.A. (Caa3/Caa3 stable, caa33), Piraeus Bank S.A. (Caa3/Ca stable, caa3), Eurobank Ergasias S.A. (Caa3/Ca stable, caa3) and Alpha Bank AE (Caa3/Ca stable, caa3).

During second-quarter 2016, the banks’ accumulated NPLs 90 days past due decreased by around €375 million, with only Alpha Bank reporting a positive (but still decelerated) NPL formation of €110 million (see Exhibit 1). In addition, all four banks reported lower operating expenses in the period versus a year earlier as a result of significant cost-cutting measures, including job cuts. Lower NPLs and a smaller cost base will help the banks return to profitability following sizable losses over the past few years.

EXHIBIT 1

Four Greek Banks’ New Nonperforming Loan Formation

Note: Nonperforming loans are loans that are 90 days past due. Sources: Banks’ financial statements

Loan-loss provisions continued to consume around 88% of the banks’ pre-provision income as of June 2016, after having risen substantially in 2015 following a deterioration in the country’s economy. A further decline in NPLs will also reduce banks’ nonperforming exposures (NPEs),4 which were significantly higher than NPLs at an average 50% of gross loans as of June 2016. We expect the NPE ratio to improve with at least a one-year lag relative to the NPL ratio.

The four banks were able to reduce their NPL stock to €82.4 billion in June 2016 (or, on average, 36.3% of gross loans) from €84.9 billion in September 2015. Reducing the high stock of NPLs remains a key priority for Greek banks: starting this month, Greek banks must submit to the Bank of Greece the results of the actions they have taken to reduce NPLs against their respective targets, which envisage an average 40% reduction by the end of 2019. Assuming political stability in Greece, we expect that a material decrease in the banks’ NPLs will take at least three to four years given that the country’s frameworks for foreclosing collateral and selling NPLs still face significant challenges. 3 The bank ratings shown in this report are the bank’s deposit rating, senior unsecured rating and baseline credit assessment. 4 The European Banking Authority defines nonperforming exposures as both NPLs and other impaired/problem loans that are not

necessarily 90 days past due.

€ 520

€ 166

€ 483

€ 385

€ 214 € 235

€ -116

€ 80

€ 275

€ 42€ 106

€ -245

€ 110

€ -16

€ -281

€ -189

-€ 400

-€ 300

-€ 200

-€ 100

€ 0

€ 100

€ 200

€ 300

€ 400

€ 500

€ 600

Alpha Bank AE Eurobank Ergasias S.A. National Bank of Greece S.A. Piraeus Bank S.A.

September-15 December-15 March-16 June-16

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

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

NEWS & ANALYSIS Credit implications of current events

24 MOODY’S CREDIT OUTLOOK 12 SEPTEMBER 2016

The sale of loan portfolios (including both performing and nonperforming loans) will play a key role in alleviating the NPL burden on banks’ balance sheets. Foreign funds’ appetite to participate in such transactions depends the Greek government’s ability to conclude successfully the various reviews of its support programme by its official lenders in a timely manner. According to a study by the Hellenic Financial Stability Fund, managing NPLs remains a challenge for banks because there are serious judicial, tax, accounting and administrative obstacles to transferring and servicing NPLs.

The cost-saving measures that Greek banks began in 2014-15 included a significant reduction in the number of employees and branches, and this year expanded to include an increased emphasis on reducing general administrative expenses. As a result, the four banks’ average cost-to-income ratio fell to approximately 51% in June 2016 from 56% a year earlier (see Exhibit 2). These cost benefits, combined with the reduction in NPLs, will support banks’ overall profitability, which is gradually turning a corner such that we expect a marginally positive bottom line in 2016.

EXHIBIT 2

Four Greek Banks’ Second Quarter Cost-to-Income Ratio

Sources: Banks’ financial statements

49%

59%62%

55%

49% 48%

56%

53%

30%

35%

40%

45%

50%

55%

60%

65%

Alpha Bank AE Eurobank Ergasias S.A. National Bank of Greece S.A. Piraeus Bank S.A.

June-15 June-16

NEWS & ANALYSIS Credit implications of current events

25 MOODY’S CREDIT OUTLOOK 12 SEPTEMBER 2016

Deposit Insurance Fee Increases Are Credit Negative for Russian Banks Last Thursday, Central Bank of Russia (CBR) Deputy Chairman Mikhail Sukhov announced that the authorities plan to increase the so-called heightened additional deposit insurance fee in 2017 to 500% of the base fee, up from 200% currently. Mr. Sukhov added that the base insurance fee may also increase to the legislative maximum of 0.15% from 0.12% currently. The proposed increases are credit negative for Russian banks because the hikes will reduce profits.

The most prominent increase is the heightened additional fee, which applies to banks that attract individual deposits at interest rates 300 basis points above the market average retail deposit rate, and/or banks that received low scores from the regulator for their financial standing, risk management and internal controls. A three-basis-point rise in the base fee, which would apply to all banks, would be more easily absorbed by the sector. The new measure follows a series of insurance-fee increases introduced this year (see Exhibit 1), the most recent being an increase in the heightened additional fee to 300% starting on 1 October 2016 from the current level of 200%.

EXHIBIT 1

Russia’s Deposit Insurance Fees as a Percent of Banks’ Retail Deposit Base

Effective Second-Half 2015 to First-

Quarter 2016

Effective Second-

Quarter 2016

Effective Third-

Quarter 2016

Effective Fourth-

Quarter 2016

Maximum Allowed by

Existing Legislation

Base Fee1 0.10% 0.10% 0.12% 0.12% 0.15%

Base Fee + Additional Fee2 0.12% 0.15% 0.18% 0.18% 0.225%

Base Fee + Heightened Additional Fee3 0.25% 0.30% 0.36% 0.48% 0.90%

Notes: 1 Base fee applies to all banks collecting retail deposits.

2 Additional fee is payable on top of the base fee by banks that attract individual deposits at interest rates 200-300 basis points above the market average retail deposit rate. The additional fee is capped by law at 50% of the base fee.

3 Heightened additional fee is payable on top of the base fee by banks that attract individual deposits at interest rates 300 basis points above the market average retail deposit rate and/or banks with low scores from the regulator for their financial standing. The heightened additional fee is capped by law at 500% of the base fee.

Source: Russian Deposit Insurance Agency

The CBR discloses neither the names of banks that must pay the heightened additional insurance fee, nor the results of its individual bank assessments. The CBR only stated that 117 banks were paying the heightened additional fee in the second quarter of 2016, and that among those only 12 banks attracted retail deposits at high rates. The remaining 105 banks achieved low scores by the CBR. We expect that the presumably already-weak financial standing of at least that second category of banks will worsen with the heightened additional fee hike. Overall, as of mid-2016, there were approximately 550 licensed deposit-taking banks in Russia.

The regulator argues that since the Russian banking sector has returned to profitability this year, its earnings will be sufficient to absorb the increased charges. The CBR raised its profitability forecast for the sector to RUB700 billion for 2016 from a previous estimate of RUB500 billion because sector profits totaled RUB537 billion in the first seven months of this year. However, 60% of these profits came from Sberbank (Ba1/Ba1 negative, ba25), Russia’s largest bank and one of the banks solely paying the base deposit insurance fee. Profits at other Russian banks, including those exposed to the heightened additional fee, are much weaker.

5 The bank ratings shown in this report are the bank’s local currency deposit rating, senior unsecured debt rating and baseline

credit assessment.

Olga Ulyanova Vice President - Senior Analyst +7.495.228.6078 olga.ulyanova@moodys.com

NEWS & ANALYSIS Credit implications of current events

26 MOODY’S CREDIT OUTLOOK 12 SEPTEMBER 2016

We estimate that a further hike of the heightened additional insurance fee to the maximum level allowed by law will cost approximately RUB15 billion sector-wide.

The objective of the increase is to replenish Russia’s Deposit Insurance Agency’s (DIA) fund, which has been exhausted by massive insurance payouts to depositors in recent years as a result of numerous bank license withdrawals (see Exhibit 2).

EXHIBIT 2

Russia’s Deposit Insurance Agency Payouts and Number of Bank License Withdrawals

Sources: Russian Deposit Insurance Agency and Central Bank of Russia

The DIA earlier this year forecasted that banks’ insurance fee contributions to the deposit insurance fund will be around RUB100 billion for 2016, but DIA payouts in the first seven months of 2016 totaled RUB300 billion. This differential, and the insurance fund’s low reported balance at 1 July 2016 of RUB38.2 billion, prompted the DIA to impose higher deposit insurance charges for banks. However, since banks’ contributions lag well behind the DIA payouts, the DIA has relied on loans from the CBR. As of 1 July 2016, the DIA had used RUB372 billion of a RUB600 billion CBR facility approved for this purpose.

RUB 9RUB 27 RUB 14

RUB 104

RUB 202

RUB 369

RUB 297

26 17 19 30

7394

68

0

50

100

150

200

250

300

350

400

2010 2011 2012 2013 2014 2015 2016YTD

Payouts, RUB Billions Number of Bank License Withdrawals

NEWS & ANALYSIS Credit implications of current events

27 MOODY’S CREDIT OUTLOOK 12 SEPTEMBER 2016

Jyske Bank’s Additional Tier 1 Capital Issue Mitigates Share Buybacks Last Wednesday, Denmark’s Jyske Bank A/S (A3/Baa1 stable, baa16) issued approximately DKK1.5 billion of Additional Tier 1 (AT1) capital. The credit-positive issuance enhances Jyske Bank’s capitalisation buffers, offsetting the negative effect on the bank’s capital from share buybacks that it has executed since the third quarter of 2015 and plans to continue until the end of this year.

Jyske Bank has been focused on adjusting its capital structure since last year in anticipation of higher regulatory capital requirements. The bank targets a (fully loaded CRD IV) 14% common equity Tier 1 (CET1) ratio and a 17.5% total capital ratio, in line with an expected total capital requirement of 17%-17.5% starting in 2019.

As shown in the exhibit below, Jyske Bank’s latest reported CET1 was 15.8% and its total capital ratio was 17%. The newly issued AT1 bonds have a perpetual maturity and may be called by Jyske Bank in September 2021 at the earliest. Following the AT1 issuance, the bank’s hybrid Tier 1 and Tier 2 capital will total DKK3.6 billion, corresponding to 2% of the bank’s weighted risk exposure.

Jyske Bank’s Capital Position

Source: Jyske Bank

The AT1 issuance follows a capital-additive Tier 2 issuance of SEK1 billion in May, mitigating the share buybacks executed under the DKK750 million share buyback programme initiated in November 2015 which concluded in June, and under a new DKK1 billion programme launched on 1 July, which will run until 31 December 2016. Although the amount of capital raised through the AT1 and Tier 2 issues exceeds the share buybacks, the capital adjustments weaken Jyske Bank’s quality of capital because the loss-absorbing capacity of equity (i.e., shares), which takes the most junior position in subordination, is stronger.

With overall capital levels stable, Jyske Bank will depend on its profitability to generate capital for loan growth. Net profit for the first six months of 2016 declined to DKK1.2 billion from DKK1.4 billion a year earlier, reflecting reduced net interest income in Denmark’s ultra-low interest rate environment. The decline in net profit cancelled out a reduction in credit impairments to DKK67 million from DKK351 million that had been driven by net reversals. As per our measure of profitability, the bank’s net income/tangible assets declined to 0.44% in June from 0.51% a year earlier. The bank’s total loan book increased by 8.3% in the year to the end of June, primarily because of growth in the private customer segment as mortgage lending increased by 14.5%.

6 The ratings shown in this report are the banks’ deposit rating, senior unsecured debt rating and baseline credit assessment.

15.8% 16.1% 15.9% 15.8%

14.0%

16.9% 17.0% 16.7% 17.0% 17.5%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

Q3 2015 Q4 2015 Q1 2016 Q2 2016 Long-Term Target

CET1 Total Capital

Maria del Mar Asensio Associate Analyst +44.20.7772.1078 maria.asensio@moodys.com

NEWS & ANALYSIS Credit implications of current events

28 MOODY’S CREDIT OUTLOOK 12 SEPTEMBER 2016

Capital requirements under CRD IV for Danish banks will be gradually phased in such that we expect that the total capital requirement by 2019 will be 17.0%-17.5% (including the worst-case fully loaded countercyclical buffer). This includes an additional capital buffer requirement of 0.6%, which will increase to 1.5% in 2019, to which Jyske Bank is subject as a domestically systemically important financial institution.

NEWS & ANALYSIS Credit implications of current events

29 MOODY’S CREDIT OUTLOOK 12 SEPTEMBER 2016

Insurers

Hurricane Hermine Will Depress Property and Casualty Insurers’ Third- Quarter Margins On 2 September, Hurricane Hermine made landfall on Florida’s panhandle as a Category 1 storm. Hermine was the first hurricane to hit Florida since 2005. Initial damage estimates by catastrophe risk management firm Karen Clark & Company indicate that the storm caused about $500 million in insured losses and economic losses of about $1 billion. Although Hermine’s effect on the overall property and casualty (P&C) industry will be modest, regional carriers focusing on Florida and the Southeast could see a larger effect on their third-quarter 2016 earnings.

The storm should primarily generate homeowners’ and automobile claims in Florida, Georgia and the Carolinas. Karen Clark & Company’s industry loss estimate for Hermine reflects the storm’s relatively moderate winds, which limited significant structural damage to buildings. Instead, insured losses will include damages from falling trees or debris and minor damage to roofing and siding. Automobile losses will also include coverage for physical damage from flooding, primarily from Florida’s coastal storm surge. Homeowner policies do not typically cover storm surges, but disputes arise when the immediate cause of the loss (wind versus flood) is unclear. Commercial property insurers face modest exposure given Hermine’s moderate size, however, and they would be liable for losses from flooding, which is typically an optional commercial coverage with separate policy sub-limits.

Exhibit 1 lists the carriers with the 10 largest homeowners’ market share in Florida, and Exhibit 2 lists the 10 largest carriers in the four states that Hermine affected. The majority of claims from Hermine are likely to occur along coastal regions near the center of the storm’s path. The 10 largest homeowner insurers write approximately $7.5 billion of premiums in the four states, equal to 48% of the homeowners’ market.

EXHIBIT 1

Top 10 Homeowner Insurers in Florida, Georgia, North Carolina and South Carolina

Rank Insurance Group Insurance Financial

Strength Rating1 Direct Premiums Written $ Million Market Share

1 State Farm Unrated $2,237 14.3%

2 USAA Aaa stable $948 6.1%

3 Allstate Aa3 stable $920 5.9%

4 Universal P&C Insurance Unrated $794 5.1%

5 Nationwide Mututal A1 stable $537 3.4%

6 Citizens Property Insurance Unrated $504 3.2%

7 Liberty Mutual A2 stable $426 2.7%

8 Federated National Unrated $409 2.6%

9 Homeowners Choice P&C Insurance Unrated $362 2.3%

10 Travelers Aa2 stable $347 2.2%

Note: 1 Insurance financial strength rating of lead property and casualty insurer.

Sources: SNL Financial L.C. (Contains copyrighted and trade secret materials distributed under license from SNL, for recipient’s internal use only) and Moody’s Investors Service

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

Anthony Lucia Associate Analyst +1.212.553.3724 anthony.lucia@moodys.com

NEWS & ANALYSIS Credit implications of current events

30 MOODY’S CREDIT OUTLOOK 12 SEPTEMBER 2016

EXHIBIT 2

Top 10 Homeowner Insurers in Florida

Rank Insurance Group Insurance Financial

Strength Rating1 Direct Premiums Written $ Million Market Share

1 Universal P&C Insurance Unrated $741 8.5%

2 State Farm Unrated $614 7.0%

3 Citizens Property Insurance Unrated $504 5.7%

4 Federated National Unrated $408 4.7%

5 USAA Aaa stable $400 4.6%

6 Homeowners Choice P&C Insurance Unrated $362 4.1%

7 Heritage P&C Insurance Unrated $342 3.9%

8 United Insurance Unrated $277 3.2%

9 Florida Peninsula Insurance Unrated $262 3.0%

10 People's Trust Insurance Unrated $258 2.9%

Note: 1 Insurance financial strength rating of lead property and casualty insurer. Sources: SNL Financial L.C. (Contains copyrighted and trade secret materials distributed under license from SNL, for recipient’s internal use only) and Moody’s Investors Service

As detailed in Exhibit 1, State Farm Mutual Automobile Insurance Company (unrated), USAA Capital Corporation (Aa1 stable) and The Allstate Corporation (A3 stable) all have high market shares in the affected region. However, as large national carriers, these insurers have carefully monitored their coastal exposure and possess a diversified countrywide footprint and strong capital bases to withstand weather-related volatility. For more severe storms, these insurers generally have high quality reinsurance protection. We do not expect Hermine to affect our rated reinsurers.

To reduce their exposure to hurricane losses, many insurers cut back their presence in Florida after record storm losses in 2004 and 2005. As a result, a significant portion of the Florida homeowners’ market is served by smaller insurers with most of their business concentrated in Florida or the Southeast. Seven of the 10 insurers listed in Exhibit 2 write at least 90% of their business in Florida. Although Hermine is a relatively moderate event for US property insurers, it is a reminder of the significant potential exposure to hurricanes in Florida and the Southeast. According to Property Claim Services, a unit of VerRisk Analytics, the effect in today’s dollars of historical Florida storms, would be significant for primary carriers and reinsurers. For example, insured losses from Hurricane Andrew (1992) would be $24 billion, Hurricane Charley (2004) would be $9 billion, and Hurricane Wilma (2005) would be $12 billion.

NEWS & ANALYSIS Credit implications of current events

31 MOODY’S CREDIT OUTLOOK 12 SEPTEMBER 2016

Colombia to Allow Auto Insurers to Audit Medical Claims, a Credit Positive On 1 September, Colombia’s Health Ministry published a new resolution allowing auto insurers to audit expenses for medical services provided to accident victims in an effort to minimize fraud. The new regulation is credit positive for car insurers because it will help contain rising claims costs, which have contributed to mounting losses in this market segment in recent years.

The regulation applies specifically to insurance companies that offer obligatory automotive insurance (referred to locally by its Spanish acronym, SOAT). Under the new rule, medical institutions will inform SOAT insurers within 24 hours of an incident about all medical services provided. The information will be maintained in a centralized database that will be made available to all SOAT insurers. Additionally, insurers will be allowed to perform on-site audits at hospitals and clinics providing medical services to accident victims.

Claims costs for SOAT insurers increased at a compound annual growth rate of 18% between 2011 and 2015 (see Exhibit 1). According to FASECOLDA, a Colombian insurers’ association, roughly 10% of all claims were fraudulent in 2015, and the rapid rise in total claims prompted the government to launch an investigation into more than 50 medical service providers suspected of facilitating questionable claims. In the SOAT segment, total claims now consume about 80% of gross premiums, up from 61% in 2010. This has resulted in growing operating losses in the industry.

EXHIBIT 1

Colombian SOAT Providers’ Profit and Loss Evolution and Claims/Premiums, 2010-15

Source: FASECOLDA

Currently, there are 13 Colombian insurers that offer SOAT policies. Companies with the highest exposures are Aseguradora Mundial (unrated), Seguros del Estado (unrated), QBE Seguros (unrated), Previsora Seguros (unrated) and Seguros Generales Suramericana S.A. (financial strength Baa2 stable) (Exhibit 2).

61%

80%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

-250

-200

-150

-100

-50

0

50

100

2010 2011 2012 2013 2014 2015

COP

Billi

ons

Profit/Loss - left axis SOAT- Claims/Premiums - right axis

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

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

NEWS & ANALYSIS Credit implications of current events

32 MOODY’S CREDIT OUTLOOK 12 SEPTEMBER 2016

EXHIBIT 2

Colombia’s Top Five Insurers’ SOAT Insurance as a Percent Total Premiums

Source: Superintendencia Financiera de Colombia

The SOAT segment constitutes 16% of the country’s property and casualty insurance, and this new rule will give companies greater ability to manage difficult market conditions. SOAT premiums continue to be regulated by the government, preventing insurers from adequately pricing risks in this business segment. Rapid growth in motorcycle sales, which accounted for 46% of total insured vehicles in 2015 and were involved in 83% of accidents, have also contributed to the rise in claims costs. As a consequence of these challenges, some leading insurers have announced plans to exit the business to focus on other more profitable P&C products.

0%

10%

20%

30%

40%

50%

60%

70%

Mundial Estado QBE Seguros Previsora Suramericana

NEWS & ANALYSIS Credit implications of current events

33 MOODY’S CREDIT OUTLOOK 12 SEPTEMBER 2016

China’s Tighter Life Insurance Product Regulations Are Credit Positive Last Tuesday, the China Insurance Regulatory Commission (CIRC) announced that it would tighten life insurance product regulation, effective immediately. The credit-positive new measures for Chinese life insurers will steer the industry’s product mix away from its current focus on short-term savings products, for which many companies offer high yields and aggressive investment strategies. Additionally, increased sales of products with stronger protection elements and longer terms will improve insurers’ profitability.

The new measures include the following:

» A ban on new products that carry negative new business value

» A requirement that products with reserve discount rates below the minimum guarantee rate receive regulatory approval. The CIRC also is lowering the reserve discount rate cap of universal life products to 3.0% from 3.5%

» The imposition of a minimum sum assured ratio of 120%-160% on individual term life, endowment, whole life and care insurance

» Starting in 2017, a prohibition on the sale of whole life insurance, annuities and care insurance as short- and medium-term products,7 and expanding the existing restriction8 on short- and medium-term insurance products to include investment-linked products and variable annuities

» Limiting insurers’ sales of short- and medium-term products to 50% and 30% of their gross premiums by 2019 and 2021, respectively, and reiterating the target to limit such sales to below 2x of an insurer’s net asset by 2020

Larger insurers have already been selling more longer-term and regularly paying products with stronger protection elements. However, small and midsize insurers, which have been particularly aggressive in offering universal life products as a substitute for bank deposits through the bancassurance channel, will be challenged in adapting to the measures.

Universal life products have grown dramatically in recent months, with CIRC data showing that industry premiums from universal life products grew by 147.3% in the first half of 2016 and by 95.2% in 2015 from a year earlier, buoyed by the removal of a 2.5% guarantee rate cap9 in February 2015. These products generally have tenors of three to five years and can offer yields as high as 6%-8%. As price competition on these products intensifies, some insurers have invested heavily in high-risk assets such as listed equities and small-cap stocks, a strategy that exposes them to significant risk of negative spread in adverse market conditions, notably when combined with high surrender levels. Tightening the reserve discount rate will raise reserving requirements for universal life products, discouraging insurers from offering high yields on universal life products with low margins, and instead turning the focus to products that have good and sustainable profitability.

The banning of new products with negative new business value will directly restrict insurers’ ability to offer aggressive yields on a broad product set, and will lower their overall cost of liability. The resultant lower yield commitment should encourage insurers to be more flexible in de-risking their investment portfolios.

The imposition of a minimum sum assured ratio will ensure that insurers derive a meaningful portion of their profits from underwriting (mortality gains, morbidity gains and expense gains), which are largely independent from investment market volatility and tend to be relatively stable, as opposed to from investment spread gains.

7 These products are defined as those in which more than 60% of total policies issued have effective durations of less than five

years. 8 See Restrictions on Sales of Short- and Medium-Term Insurance Products Are Credit Positive for Chinese Life Insurers, 7 April

2016. 9 See Chinese Life Insurance Price Liberalization Is Credit Negative, 2 February 2015.

Kelvin Kwok Associate Analyst +852.3758.1516 kelvin.kwok@moodys.com

NEWS & ANALYSIS Credit implications of current events

34 MOODY’S CREDIT OUTLOOK 12 SEPTEMBER 2016

Sovereigns

Albania’s Step Toward European Union Membership Is Credit Positive Last Thursday, the European Union (EU) issued a statement recognizing the reform momentum in Albania (B1 stable), particularly the adoption of a contentious judicial reform package. This recognition increases the likelihood that formal EU membership negotiations will be opened in the coming months. EU membership would be credit positive for Albania because it would enhance existing trade links with the bloc, boost investment into Albania and allow access to the EU’s sizable structural funds, benefiting economic development. Additionally, the extra layer of oversight provided by the EU’s fiscal framework, including the Excessive Deficit Procedure, would improve the sustainability of Albania’s public finances, which have been historically volatile. The country’s fiscal deficit was consistently above 3% of GDP between 2006 and 2015.

The statement followed a stabilization and association council (SAC) meeting between Albania and the EU, and marks Albania’s notable progress toward fulfilling five key priorities for starting accession negotiations. A particularly important priority is reinforcing the de-politicization, efficiency and accountability of judicial institutions. SAC approval will also support further reform momentum in Albania’s challenging political environment.

The EU’s positive recognition reiterates its commitment to support the development of the region. Albania was given EU candidacy status in June 2014, but formal accession talks require the country to make progress in areas such as judicial reform, public administration, fighting corruption and protecting human rights. Last Thursday’s statement by the EU indicates that Albania has a chance to fulfill these goals ahead of the European Commission’s December 2016 summit. Swift progress is important given that Albanian parliamentary elections in June 2017 have the potential to slow reform momentum and delay the start of formal negotiations with the EU.

The EU’s statement will also support the Albanian government in sustaining reform progress amid significant domestic opposition. The challenging political environment led to the political opposition boycotting parliament during the second half of 2014 and, more recently, in early 2016, despite a December 2014 agreement for cooperation. For example, the country’s judicial reform bill suffered numerous delays over the 18 months of negotiations and was only adopted after EU and US representatives intervened.

Further EU integration will solidify improvements in Albania’s institutional environment, and boost competitiveness and foreign investment. The country has faced significant institutional challenges, exemplified by the continued mismatch between capital budgets and expenditure outflows, the buildup of significant government arrears of 4.8% of GDP in the run-up to 2013 elections, and the country’s weak scores in international surveys.

Worldwide Governance Indicators show that Albania’s government effectiveness, rule of law and control of corruption are still among the lowest in our rated universe, and bureaucratic hurdles in paying taxes, dealing with construction permits and enforcing contracts have resulted in a challenging business environment. Adopting the EU’s accumulated body of legislation will help to address many of these deficiencies through the development of agricultural and rural sectors and the harmonization of consumer protection with EU norms.

Evan Wohlmann Assistant Vice President - Analyst +44.20.7772.5567 evan.wohlmann@moodys.com

Vasil Nikolov Associate Analyst +44.20.7772.1533 vasil.nikolov@moodys.com

NEWS & ANALYSIS Credit implications of current events

35 MOODY’S CREDIT OUTLOOK 12 SEPTEMBER 2016

Albania’s Worldwide Governance Indicators, Percentile Rank in Moody’s Rated Universe

Sources: Worldwide Governance Indicators and Moody’s Investors Service

0

10

20

30

40

50

60

70

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Government Effectiveness Rule of Law Control of CorruptionRegulatory Quality Political Stability

NEWS & ANALYSIS Credit implications of current events

36 MOODY’S CREDIT OUTLOOK 12 SEPTEMBER 2016

Hong Kong Election Results Are Likely to Slow Effective Policymaking On 4 September, voters in Hong Kong (Aa1 negative) elected the members of its Legislative Council, the territory’s parliament. In contrast to opinion polls that suggested opposition parties would lose some ground, they won 29 seats10 in the 70-member assembly, two more than in the previous election. This includes 19 seats in the geographical constituencies that give the opposition power to block new legislation. With these results, filibustering, which has become increasingly common in the past two years, is likely to continue, a credit-negative development that will result in slow and less effective policymaking. Political tensions are unlikely to abate before next year’s election for Hong Kong’s next chief executive.

The opposition is divided into a number of parties, many with only a very small number of seats, ranging from long-established pan-democrats to more recent and, in some cases, more radical, so-called localist groups that were established after the “Umbrella Movement” or “Occupy Central Protest” in 2014 and which advocate greater autonomy from China in deciding political developments. The voter turnout rate hit a record high of 58.3%, exceeding the 53.1% in last Legislative Council election in 2012, giving credence to the elected representatives (see Exhibits 1 and 2).

EXHIBIT 1

Hong Kong Legislation Council Composition, 2012 versus 2016 Outer ring is 2016, inner ring is 2012.

Note: The number of seats of the opposition parties is either 29 or 30, depending on how one of the elected representatives is classified. Sources: 2016 Legislative Council Election website and Moody’s Investors Service

10 The number of seats of the opposition parties is either 29 or 30, depending on how one of the elected representatives is

classified.

27

43

29

41

Anti-establishment or Opposition Pro-establishment

Serena Wang Associate Analyst +65.6398.8334 serena.cc.wang@moodys.com

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

NEWS & ANALYSIS Credit implications of current events

37 MOODY’S CREDIT OUTLOOK 12 SEPTEMBER 2016

EXHIBIT 2

Hong Kong Election Voter Turnout Rate

Source: Hong Kong Legislative Council Election website

Although the opposition is more fragmented after this election, the anti-establishment parties are likely to be unified in voicing their disagreement to the government’s approach to Hong Kong’s relationship with China under the One Country, Two Systems policy. This opposition is likely to involve a continuation of the frequent filibustering that has characterized the legislature for the past two years. As a result, lawmaking will remain slow and less predictable since the filibustering stems from disagreements about a political vision of Hong Kong rather than specific issues related to economic, fiscal or financial policies.

In the past few years, there have been delays in passing legislation, including the approval of the 2016-17 budget, which was late by one month, and additional government spending for the Hong Kong-Zhuhai-Macao Bridge, which was stymied for almost one year. Under a more divided legislative council following this election, delays in getting legislation passed are likely to prevail.

Last Monday, the Hong Kong and Macao Affairs office of China’s State Council reiterated the responsibility of the new elected legislators to fulfill their duties based on Hong Kong’s Basic Law and the One Country, Two Systems policy. It stressed that any pro-independence claim would damage Hong Kong’s prosperity and stability.

In this environment, political friction is likely to continue and may intensify ahead of the chief executive election in March 2017. With 29 seats in the Legislative Council, the opposition has veto power over political reforms, including proposals to enact universal suffrage. In 2015, the Legislative Council rejected a universal suffrage proposal that was perceived to favor pro-Beijing candidates. Since then, the issue has remained on hold and no significant progress will happen before March 2017.

0%

10%

20%

30%

40%

50%

60%

2008 2012 2016

NEWS & ANALYSIS Credit implications of current events

38 MOODY’S CREDIT OUTLOOK 12 SEPTEMBER 2016

US Public Finance

New Jersey Ends Credit-Negative Tax Reciprocity with Pennsylvania On 2 September, New Jersey (A2 negative) Governor Chris Christie said that he would end the state’s 38-year-old tax reciprocity agreement with Pennsylvania (Aa3 stable). Effective 1 January 2017, interstate commuters will pay taxes where they work and live rather than only where they live. According to Pennsylvania’s analysis of US Census data, roughly 125,000 people commute from each state to the other for employment.

Terminating tax reciprocity is credit positive for New Jersey, which expects $180 million of additional income tax revenue (roughly 0.5% of general fund revenues) from applying its relatively high income tax rates to Pennsylvania residents working in New Jersey. These commuters currently pay relatively low income taxes only to their home state. Pennsylvania expects to collect only about $5 million less in net income taxes annually (gaining $199 million but losing $204 million), an immaterial amount in its $32 billion budget.

New Jersey’s move to end the longstanding tax agreement comes amid ongoing budget challenges brought on by the state’s slow economic recovery, optimistic revenue forecasting and rapidly growing pension obligations and contributions. New Jersey’s revenue growth since the recession has lagged the national average. According to Rockefeller Center data, New Jersey’s 2015 revenue was approximately 7% above the pre-recession peak, versus average state revenue growth of 20%. As a result, the state has had revenue shortfalls in four of the past six years, and in fiscal 2016 (which ended 30 June 2016), revenues were $735 million below the original budget. In addition, the state will rapidly ramp up its annual pension contributions, which have averaged only 23% of the actuarially required contributions over the past five years.

Under the reciprocity agreement, both states’ cross-state commuters file tax returns only in their home states, allowing Pennsylvania’s highest-earning commuters to pay the state’s flat 3.07% income tax rate instead of New Jersey’s progressive income tax rate at the top bracket of 8.97%, (see Exhibit 1). Conversely, the reciprocity agreement is advantageous for New Jersey residents who earn lower income in Pennsylvania. Instead of paying the flat 3.07% to Pennsylvania, they pay New Jersey’s lower marginal tax rate for taxable income under $35,000.

EXHIBIT 1

New Jersey’s Income Tax Brackets New Jersey’s progressive income tax rates (versus Pennsylvania’s flat 3.07% rate) benefit taxpayers with a marginal incomes below $35,000 and negatively affect those with marginal incomes above $35,000.

Taxable Income Marginal Tax Rate

$0 - $20,000 1.40%

$20,000 - $35,000 1.75%

$35,000 - $40,000 3.50%

$40,000 - $75,000 5.53%

$75,000 - $500,000 6.37%

Over $500,000 8.97%

Source: State of New Jersey

Dan Seymour, CFA Assistant Vice President - Analyst +1.212.553.4871 dan.seymour@moodys.com

Baye B. Larsen Vice President - Senior Credit Officer +1.212.553.0818 baye.larsen@moodys.com

NEWS & ANALYSIS Credit implications of current events

39 MOODY’S CREDIT OUTLOOK 12 SEPTEMBER 2016

Once reciprocity ends, Pennsylvania expects to lose taxes because its residents who work in New Jersey will first pay New Jersey income taxes, and get a credit against Pennsylvania income taxes. According to its analysis, Pennsylvania residents who commute to New Jersey have higher average wages ($62,874) than their counterparts who commute to Pennsylvania ($52,147). Therefore, Pennsylvania will lose more from its higher-income taxpayers who will pay New Jersey first than it will gain from lower-income taxpayers paying Pennsylvania first (see Exhibit 2).

EXHIBIT 2

Cross-State Commuters in New Jersey and Pennsylvania

New Jersey Residents Working in Pennsylvania Pennsylvania Residents Working in New Jersey

Number of Commuters 124,426 125,403

Average Wage $52,147 $62,874

Total Wages $6,488,464,490 $7,884,564,037

Sources: Commonwealth of Pennsylvania, based on US Census data

NEWS & ANALYSIS Credit implications of current events

40 MOODY’S CREDIT OUTLOOK 12 SEPTEMBER 2016

Covered Bonds

Norway’s Proposed Tighter Mortgage Underwriting Standards Are Credit Positive for Banks and Covered Bonds On 8 September, Norway’s Financial Supervisory Authority (FSA) published a proposal for tighter mortgage underwriting limits. The proposed regulation, made to the Ministry of Finance, includes a limit of 5x loan value to the borrower’s gross income; requiring loans to amortise down to a 60% loan-to-value (LTV) ratio, down from 70%; a maximum home-equity LTV of 60%, down from 70%; and the reduction or complete elimination of banks’ ability to deviate by 10% from the regulatory limits, including the 85% maximum LTV requirement.

The new measures would reduce borrowers’ ability to take on excessive debt amid still-increasing house prices, particularly in the urban areas concentrated around the capital city of Oslo. These more restrictive proposals are credit positive and would strengthen the credit quality of mortgage loans on banks’ balance sheets and in covered bond cover pools.

Norway has experienced strong house price growth since 2008 and the proposal for tighter regulations seeks to dampen excessive house price growth and credit expansion. Despite house price contraction in oil-reliant areas such as Stavanger, prices in Oslo remain on a strong upward trajectory and increased more than 12% per year to the end of June. During the same period, banks and mortgage companies’ residential mortgage lending grew nationally by around 6%, according to Statistics Norway. Although Norwegian banks and covered bonds performed strongly even after the decline in oil prices, a mortgage market cool down would reduce the risk of asset price bubbles and excessive lending to vulnerable households.

Norwegian House Prices, Household Debt and Income Growth Indexed to 100 at 2006

Note: * Household debt includes non-profit organisations serving households. Sources: Bank for International Settlements, Organization for Economic Co-operation and Development, Eurostat and Moody’s Investors Service

Capping the loan-to-income ratio limits the overall size of loan a borrower can take, regardless of affordability. In the present low interest rate environment, loan affordability is good, but large loans can easily become burdensome if interest rates rise. Lower LTV ratios decrease the loan’s probability of default and increase recoveries of loans that do default.

Increased amortization and limits on home-equity withdrawal reduce or constrain LTVs and limit potential payment shocks, benefiting mortgage loans’ credit quality. Currently, banks must factor amortisation into affordability testing, but a material proportion of loans are still interest-only. Interest-only loans can be

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Jane Soldera Vice President - Senior Credit Officer +44.20.7772.5318 jane.soldera@moodys.com

Carlos Suarez Duarte Vice President - Senior Analyst +44.20.7772.1061 carlos.suarezduarte@moodys.com

NEWS & ANALYSIS Credit implications of current events

41 MOODY’S CREDIT OUTLOOK 12 SEPTEMBER 2016

vulnerable in a falling house price environment. Unlike an amortising loan, an interest-only loan’s LTV only declines over time as a result of house price appreciation, resulting in a potentially lower equity buffer against declining house prices and leaving the borrower exposed if selling the property is the only method of repaying the loan at maturity. Similarly, restricting home-equity withdrawals limits increases in LTVs and discourages borrowers from taking on high debt burdens.

Removing or reducing banks’ ability to have up to 10% of loans breach the maximum 85% LTV requirement or other requirements would be prudent. The FSA considers the 10% limit substantial in light of debt and house price developments. If the government does not completely remove the 10% waiver from the regulations, the FSA suggests reducing it to 4%.

An advantage of having the regulator set underwriting restrictions is that it prevents competition from eroding prudent practices, while also allowing the rules to be changed when conditions warrant such changes. However, nationally applicable restrictions do not differentiate between Norway’s regions, and regional economic developments vary. The FSA emphasized that the tighter regulation may be temporary and could be lifted if market conditions changed, which would give banks the opportunity to recover some flexibility in their lending practices. Nevertheless, Norway’s underwriting standards and prudential regulation of mortgage loans are among the strongest in Europe, particularly the country’s conservative approach to LTVs and its affordability stress of five percentage points on loan interest rates.

RECENTLY IN CREDIT OUTLOOK Select any article below to go to the 5 September Credit Outlook on moodys.com

42 MOODY’S CREDIT OUTLOOK 12 SEPTEMBER 2016

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

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

in Leverage » European Satellite Operators Face Credit-Negative Delays

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

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

Project, a Credit Positive

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

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

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

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

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

Credit Positive

Insurers 24 » US Response to Insurer Withdrawals from Affordable Care

Act Exchanges Poses Credit-Negative Threat

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

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

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

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

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

Credit Positive » Zimbabwe's Foreign Donor Support Weakens after Police

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

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

Spending Cuts Later, a Credit Negative

MOODYS.COM

Report: 191993

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