MOODYS.COM

8 OCTOBER 2015

NEWS & ANALYSIS Corporates 2 » Pepsi Takes a $1.4 Billion Charge for Venezuela » Schaeffler’s Initial Public Offering Is Credit Positive » AngloGold Ashanti’s South African Wage Deal Brings

Production Certainty

Banks 6 » GM Moves Subvented Loans to GM Financial, Leaving Ally

Financial Without This Source of High-Quality Loans » Scottrade’s Cybersecurity Breach Is Credit Negative » BNDES’ Capitalization Improves as Loan Disbursements

Drop 25% » EBA Reports No Rise in European Bank Asset Encumbrance, but

Disparities by Country Persist » ESMA’s Mandatory CDS Clearing Regulations Are Credit

Positive for ICE, CME and LCH » UK’s Proposed Deadline for Sales Complaints Is Credit Positive

for Large Lenders » Banca Sella’s Capital Increase Is Credit Positive

Insurers 17 » Humana and Health Net Are Hardest Hit by Risk-Corridor

Program Shortfall

Asset Managers 19 » European Capital Markets Directive Poses Challenges to

Asset Managers

Sovereigns 21 » Agreement on Trans-Pacific Partnership Is Credit Positive for

the US » Portuguese Government’s Loss of Absolute Majority

Complicates Fiscal and Structural Reform

RECENTLY IN CREDIT OUTLOOK

» Articles in Last Monday’s Credit Outlook 25 » Go to Last Monday’s Credit Outlook

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NEWS & ANALYSIS Credit implications of current events

2 MOODY’S CREDIT OUTLOOK 8 OCTOBER 2015

Corporates

Pepsi Takes a $1.4 Billion Charge for Venezuela On Tuesday, PepsiCo. Inc. (A1 stable) said that it will take a $1.4 billion third-quarter accounting charge to deconsolidate its Venezuela operations from its results beginning in the fourth quarter of 2015. The charge is credit negative for Pepsi because it confirms that the company’s ability to recognize earnings or cash from its investments in Venezuela will be extremely limited for the foreseeable future.

Although we will adjust operating income for the onetime charge, we do not expect it to change Pepsi’s debt/EBITDA, which was around 2.9x as of 30 June 2015. The charge will decrease PepsiCo’s cash balances by $568 million, which is the amount of cash that is in Venezuela. The reduction will lower Pepsi’s retained cash flow/net debt by a little less than one percentage point – to about 23.0% from 23.9% as of 30 June 2015.

However, Pepsi’s liquidity will remain strong, with solid and predictable cash flow, large cash balances and about $7.5 billion in committed bank facilities. We expect Pepsi’s debt/EBITDA to approach 3x over the next 12-18 months from levels that were historically in the low-2x range, mostly because of its adoption of a more aggressive financial policy and growth challenges in its mature carbonated soft drink markets. The company’s scale, diversity and strong franchise will help offset some of its leverage creep, as will its strong innovation program, cost-cutting initiatives and good growth prospects in international markets and in its Frito-Lay North American snacks segment.

Based in Purchase, New York, Pepsi manufactures, markets and sells a variety of salty, convenient, sweet and grain-based snacks, carbonated and non-carbonated beverages, and food. It has 22 different product lines that each generate more than $1 billion in annual retail sales, including Pepsi, Diet Pepsi, Mountain Dew, Aquafina, Tropicana, Cheetos, Ruffles, Doritos, Fritos, Gatorade and Quaker. Revenue for the 12 months that ended June 2015 were approximately $65 billion.

Linda Montag Senior Vice President +1.212.553.1336 linda.montag@moodys.com

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

NEWS & ANALYSIS Credit implications of current events

3 MOODY’S CREDIT OUTLOOK 8 OCTOBER 2015

Schaeffler’s Initial Public Offering Is Credit Positive On Monday, Schaeffler AG (Ba3 review for upgrade), a German bearings producer mainly for the automotive industry, began placing its shares with domestic and international institutional investors as part of an initial public offering announced last month. Schaeffler intends to use the net proceeds to reduce debt, a credit positive because the company’s high leverage is a key credit constraint despite a solid business profile.

The company is initially placing 66 million new shares issued by Schaeffler AG and 9 million secondary shares held by Schaeffler Verwaltungs GmbH, a holding entity that currently owns a 15% stake in Schaeffler AG, at a price of €12-€14 a share. At the midpoint of that range, gross cash proceeds would amount to €975 million, or an approximately 11% free float. Excluding transaction costs, our adjusted pro forma debt/EBITDA for the Schaeffler group (which would include debt at both the operating and holding level) would improve to around 4.4x from around 4.6x for the 12 months to June 2015.

As part of this transaction, Schaeffler Verwaltungs GmbH reserves the right to sell another 24.4 million secondary shares. Additionally, upon the expiration of a six-month lockup period following the initial transaction, Schaeffler can sell additional secondary shares held by Schaeffler Verwaltungs GmbH up to targeted free float of 25%. Under such a scenario, the company would also use the proceeds to reduce debt.

The shares are common non-voting, but do provide dividends. That means that the founding Schaeffler family will continue to control 100% of the voting rights in Schaeffler AG through the holding entities. The company expects the first day of trading to occur after the initial placement on 9 October.

In addition to the placement, Schaeffler AG remains committed to repaying €1 billion of debt from operating cash flow until 2018. A moderate dividend policy, which is now set at 25%-35% of net income, supports further debt reduction from internal sources.

The placement is another step by the company to reduce its very high debt load, which dates back to 2008, when during the financial crisis and global recession Schaeffler undertook the debt-financed acquisition of a controlling stake in Continental AG (Baa1 stable), one of Europe’s leading auto suppliers. Currently, there is still around €10 billion of reported debt outstanding in the group.

Diana Beketova Associate Analyst +49.69.70730.920 diana.beketova@moodys.com

NEWS & ANALYSIS Credit implications of current events

4 MOODY’S CREDIT OUTLOOK 8 OCTOBER 2015

AngloGold Ashanti’s South African Wage Deal Brings Production Certainty Last Friday, AngloGold Ashanti Limited (AGA, Baa3 negative) announced that it had successfully negotiated a three-year wage deal with a majority of its employees in South Africa, a credit positive for the company. The acceptance of the offer by trade unions representing 59% of AGA’s workforce brings three years of wage certainty to 25% of its total production, averting a strike and a consequent production loss. We view the agreement as a win-win for AGA and its miners in ensuring job security in an economically advantageous and sustainable manner for both sides.

Given that the wage agreement was accepted by the National Union of Mineworkers, Solidarity and the United Association of South Africa, it constitutes majority employee acceptance by 59% of AGA’s unionised employees, and 66% of the workforce including non-unionised employees. Under the South African Labour Relations Act, an acceptance by a majority of employees constitutes an acceptance by all employees to whom the increases are subsequently extended.

AGA has the capacity under its current Baa3 rating credit metric parameters to absorb the wage increases, which we calculate to be around 7% higher than the current wage bill and which is above the prevailing 4.6% consumer price inflation level in South Africa (the exhibit below shows the credit effect). The main driver for this is the relief on AGA’s predominantly South African rand-denominated expenses, which have depreciated significantly against their US dollar revenue stream. The South African rand has depreciated by 18.68% against the US dollar year to date.

AngloGold Ashanti Pro Forma Credit Metrics with the Wage Increase AGA’s credit metrics remain well-positioned within its rating category after the wage increases.

Notes: CFO = cash flow from operations. Metrics are based on the wage agreement and an assumption of gold at $1,100 per ounce. Source: Moody’s Investors Service

AGA’s credit quality benefits because the wage agreement avoids a strike at its South African mines. Under our calculation, a month-long strike action at AGA’s South African mines would have cost it around $50 million of EBITDA, which is almost equivalent to the additional amount it will incur for the agreed increase on its entire 2016 wage bill. In our experience, South African mining companies and miners are worse off when strikes occur. Producers lose EBITDA with a production disruption, which often outweighs the cost of an increased annual wage bill.

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Debt/ EBITDA - left axis Maximum Debt/ EBITDA Baa3 Guidance - left axis

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Douglas Rowlings Analyst +971.4.237.9543 douglas.rowlings@moodys.com

NEWS & ANALYSIS Credit implications of current events

5 MOODY’S CREDIT OUTLOOK 8 OCTOBER 2015

We see a low likelihood of strike action at AGA’s mines by the Association of Mineworkers and Construction Union (AMCU), which represents 35% of AGA’s employees and rejected the wage offer. AMCU workers will meet on 11 October to decide whether to go on strike. Strike action by AMCU would be “unprotected” under the South African Labour Relations Act, meaning that AGA could legally dismiss employees taking part in the strike.

After the 2013 wage negotiations, AMCU threatened strike action, but never followed through given that it too would have been unprotected. The union challenged its unprotected status in the courts without success. Holding onto jobs remains the main priority for miners and their unions in a sector facing looming job cuts by mining companies looking to reduce costs and keep mines open. The gold mining sector, like many other South African mining sectors, is under pressure from electricity tariff increases and low metal prices, with gold around $1,147 per ounce.

The agreement marks a turning point in the stability of AGA’s South African mines in terms of keeping them open and miners employed on a sustainable economic basis. Gold production costs at AGA’s mines in South Africa are higher at $1,098 per ounce versus $844 per ounce elsewhere in the world because of the deep-level labour-intensive nature of the South African mines. The agreement also brings wage certainty to AGA’s cost base for its South African mines over the next three years.

NEWS & ANALYSIS Credit implications of current events

6 MOODY’S CREDIT OUTLOOK 8 OCTOBER 2015

Banks

GM Moves Subvented Loans to GM Financial, Leaving Ally Financial Without This Source of High-Quality Loans Last Thursday, General Motors Company (GM, Ba1 stable) announced plans to move almost all of its subvented loan business to General Motors Financial Company, Inc. (GMF, Ba1 stable). The move is credit positive for GMF because larger volumes of these loans will improve the credit quality of GMF’s overall portfolio. However, it is credit negative for Ally Financial Inc. (B1 positive), which will no longer originate GM subvented loans, because it will lose volumes that historically have exhibited solid performance.

Higher volumes of GM subvented loans will improve GMF’s portfolio credit quality as its asset mix shifts. We expect GMF’s subvented loan portfolio growth to be significant: based on Ally’s GM subvented loan originations over the past 18 months, GMF’s loan originations have the potential to grow by 15% or more. Ally originated $4.0 billion of GM subvented loans in 2014 and $1.2 billion in the first half of 2015. GMF originated $15.1 billion of loans for North America and international segments combined in 2014, and $8.4 billion for the first half of 2015.

Acquiring larger volumes of high-quality subvented loans will help balance a growing risk for GMF. Earlier this year, GMF became the exclusive underwriter of leases for GM. This accelerated lease origination volume as a percentage of loans and leases to 51% for the first half of 2015 from 29% in 2014 (see Exhibit 1). Leases are riskier than loans for GMF because of the company’s exposure to residual values. Focusing on leasing first was likely a strategic decision for GM and GMF since lease customers are commonly repeat customers and the term of the lease is fairly short.

EXHIBIT 1

General Motors Financial’s Consumer Auto Originations

Source: General Motors Financial Company

The loss of GM subvented loan volume is credit negative for Ally. Even though its GM subvented loan volumes have declined over time, these loans were still a meaningful portion of originations and a source of high credit quality loans for the company. Used vehicle loans, which carry a risk of higher losses than subvented loans, are likely to replace Ally’s loss of GM subvented loans. In the first half of 2015, GM subvented loans comprised 6% of Ally’s total consumer originations, versus 17% in 2011 (see Exhibit 2). Ally has diversified its revenue sources in the auto finance space by growing used vehicle lending, which has grown to 37% of originations in the first half this year from 22% in 2011. Mitigating the loss of GM subvented loans for Ally is non-subvented loans for new vehicles. Ally has grown non-subvented new loan volumes from GM and Chrysler vehicles, while also expanding with other nameplates.

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Consumer Loan Origination Consumer Lease Origination Lease Origination / Total - right axis

Jason Grohotolski Vice President - Senior Analyst +1.212.553.1067 jason.grohotolski@moodys.com

NEWS & ANALYSIS Credit implications of current events

7 MOODY’S CREDIT OUTLOOK 8 OCTOBER 2015

EXHIBIT 2

Ally Financial Consumer Auto Originations

Source: Ally Financial

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NEWS & ANALYSIS Credit implications of current events

8 MOODY’S CREDIT OUTLOOK 8 OCTOBER 2015

Scottrade’s Cybersecurity Breach Is Credit Negative Last Friday, Scottrade Financial Services, Inc. (Baa3 stable) announced that it had been the victim of an extensive cybersecurity breach that compromised client records. This is credit negative because it risks resulting in client losses and reputational damage that would make it more difficult and costly to attract new clients. There is also a risk that the breach will lead to increased costs associated with enhancing its risk management and control functions and in responding to potential litigation.

The privately held retail broker informed approximately 4.6 million clients that a system housing client names, addresses, social security numbers, email addresses and other sensitive data had been compromised by criminals over a period of several months between late 2013 and early 2014. The criminal activity was discovered by federal law enforcement officials, who informed Scottrade of the breach.

Scottrade believes client contact details were the focus of the breach, and that its trading platforms and client funds were not compromised. Nevertheless, the extent of the security breach (covering its entire client base at the time), and the fact that the company itself had not prevented or detected the intrusion, raise a number of questions. The company did not disclose further details of the system that was breached or the method the criminals used. However, Scottrade said the known intrusion point had been secured and a third-party expert had been consulted to advise the company on the matter. Scottrade also said that it has not seen any indication of fraudulent activity as a result of the breach.

Scottrade contacted clients who had accounts before February 2014 to inform them of the breach, and to offer them one year of free credit monitoring services. The cost of the credit monitoring services is likely to be immaterial. However, other adverse repercussions that arise from the breach could result in more significant damage to the company.

The retail brokerage sector is highly competitive, and it is relatively easy for clients to transfer their business from one broker to another. Any client losses stemming from the breach would reduce revenue and income. Additionally, reputational damage arising from the breach risks making it more difficult for Scottrade to attract new clients, with a consequent lost opportunity to grow revenue and income. This could make it necessary for the company to increase advertising spend and client incentives, which would pressure profit margins. The breach could also give rise to litigation and defense costs if clients allege they have suffered some form of consequential damages.

Scottrade has experienced a significant amount of transition in its management ranks and has been increasing its staffing in risk management and control functions. The data breach will likely result in the company placing even more emphasis on risk management and control, which is credit positive in terms of the potential to improve Scottrade’s control environment, but would increase the company’s cost base.

Donald Robertson Vice President - Senior Credit Officer +1.212.553.4762 donald.robertson@moodys.com

NEWS & ANALYSIS Credit implications of current events

9 MOODY’S CREDIT OUTLOOK 8 OCTOBER 2015

BNDES’ Capitalization Improves as Loan Disbursements Drop 25% Last Friday, Brazilian government development bank Banco Nac. Desenv. Economico e Social (BNDES, Baa3/Baa3 stable1) announced that loan disbursements between January and August 2015 fell 25% from a year earlier. This decline is credit positive for BNDES because it will help reduce risk-weighted asset growth, improving the bank’s capitalization.

The slowdown in loan origination is in large part the result of a fiscal adjustment implemented by the federal government in May 2015, which included a reduction in government funding for the bank. From 2009 to mid-2015, BNDES received roughly BRL386 billion in funds from the National Treasury, and this government funding allowed the bank to pursue a rapid pace of loan growth (see exhibit). Because government funding declined this year, BNDES has been forced to rely on the repayment of outstanding loans to fund more than 90% of new operations, compared with an average of 70% in previous years.

BNDES’ Lending Declines from Lower Credit Demand and Government Transfers

Sources: Banco Nac. Desenv. Economico e Social and Moody’s Investors Service.

Slower loan growth has already had a positive effect on BNDES’ capital position this year, with the bank’s total regulatory capital ratio rising 110 basis points to 16.99% as of June 2015. And, we expect the trend of declining credit growth to continue owing to loan consultations, an important indicator of future loan disbursements, falling 49% in the first eight months of 2015 from a year earlier. This will further boost BNDES’ capital buffers, providing an additional cushion over minimum regulatory capital levels.

The slowdown in lending is also aligned with BNDES’ renewed focus on helping to develop Brazil’s domestic capital market and on reducing its participation in project finance. In June 2015, the bank officially launched a program in partnership with the Brazilian Financial and Capital Markets Association (ANBIMA) to foster the issuance of debt instruments in the domestic market. The program allows borrowers to increase their access to credit lines at the country’s benchmark long-term interest rate (the TJLP, currently at 6.5%), which is lower than prevailing market rates (the SELIC, at 14.25%). Participants in the program are required to finance part of their financial needs by issuing debt domestically. BNDES estimates that companies that take advantage of this initiative will see a decline of up to 200 basis points in their total borrowing costs.

Although the BNDES-ANBIMA program offers a strong incentive for companies to tap the domestic market to raise funds, credit demand remains depressed as a result of Brazil’s weak economy and the decline in consumer and business confidence. In this environment, companies have put investment decisions on hold, which has also contributed to the decline in BNDES’ loan origination. This, combined with the decline in government funding, which limits its capacity to make new loans, reinforces our expectations that the development bank will continue to shrink its balance sheet in the coming years. 1 The bank ratings shown in this report are Banco Nac. Desenv. Economico e Social’s issuer rating and senior unsecured debt rating.

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Alexandre Albuquerque Assistant Vice President - Analyst +55.11.3043.7356 alexandre.albuquerque@moodys.com

NEWS & ANALYSIS Credit implications of current events

10 MOODY’S CREDIT OUTLOOK 8 OCTOBER 2015

EBA Reports No Rise in European Bank Asset Encumbrance, but Disparities by Country Persist Last Thursday, the European Banking Authority (EBA) reported that overall bank asset encumbrance levels had not significantly increased over the previous four years, although there remains widespread variation across both countries and individual banks. The broadly stable trend is credit positive for bank unsecured creditors, particularly given new requirements to post collateral against derivative transactions that will increase asset encumbrance.

Asset encumbrance occurs when banks pledge assets for the benefit of creditors to protect creditors against the risk of loss. High levels of asset encumbrance limit the amount of assets available to support unsecured creditors, which leads to higher losses for unsecured creditors in the event of a bank failure. Encumbrance can also restrict a bank’s ability to access unsecured funding.

Although overall encumbrance rates across the largest banks in the European Union averaged 27% of total bank assets (including collateral received from other banks) in March 2015, not all unencumbered assets can be used to generate funding. Loans tend to make up the majority of banks’ balance sheets, but banks generally can only use more marketable assets as collateral in secured funding transactions with other market participants. Central banks are an exception because they also accept some less liquid assets as collateral, having expanded the range of assets that can be delivered as collateral since 2008. When looking only at assets that can be used in central bank operations, or as collateral in repo or derivative transactions, the encumbrance ratio rises to 45%. However, this level remains in line with levels reported in an European Systemic Risk Board survey published in 2011.

The EBA also reported much more variation between banks in different countries, with averages ranging from 0% in Estonia to 44% in Denmark (see exhibit). Although the trend appears broadly stable in most countries, one noteworthy exception is the increase in Greek banks’ encumbrance to 44% of total assets in March 2015 from around 26% in December 2014, reflecting Greek banks’ increasing reliance on central bank liquidity this year.

Encumbered Bank Assets as a Percent of Total Bank Assets by Country, March 2015

Source: European Banking Authority

The report notes that relatively high levels of encumbrance are the result of the structure of funding markets in some countries, particularly those with large, established covered bond markets, such as Denmark and Sweden. High encumbrance levels are also driven by a high share of repo financing and derivative markets, or a high share of central bank funding. Banks in countries most affected by the global financial crisis reported the highest values of central bank encumbrance because they continue to rely on central bank funding.

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Simon Ainsworth Vice President - Senior Credit Officer +44.20.7772.5347 simon.ainsworth@moodys.com

NEWS & ANALYSIS Credit implications of current events

11 MOODY’S CREDIT OUTLOOK 8 OCTOBER 2015

There is also a wide dispersion in the encumbrance ratio among banks within countries, with 5% of banks across Europe reporting virtually no assets encumbered and the top 5% reporting encumbrance of greater than 60%. According to the EBA, some specialized mortgage institutions report encumbrance levels of greater than 90%. Although these high levels reflect the secured funding model for these banks, they also illustrate the limited recourse that any unsecured creditors would have to those banks’ assets in the case of failure.

NEWS & ANALYSIS Credit implications of current events

12 MOODY’S CREDIT OUTLOOK 8 OCTOBER 2015

ESMA’s Mandatory CDS Clearing Regulations Are Credit Positive for ICE, CME and LCH On Friday, the European Securities and Markets Authority (ESMA) issued its regulations for mandatory central clearing of select index credit default swaps (CDS).2 This mandate, which follows an August 2015 mandate for select over-the-counter (OTC) interest rate derivatives,3 has the potential to increase the volumes, and therefore revenues, of central counterparty clearinghouses (CCPs) clearing CDS in Europe, which would be credit positive for the large global CCPs. These CCPs include Intercontinental Exchange, Inc. (ICE, A2 stable), CME Group Inc. (Aa3 stable) and LCH.Clearnet Group (unrated), which is majority-owned by London Stock Exchange Group plc (Baa1 stable).

Global regulators are focusing on developing and enforcing rules for mandatory clearing and reporting as a key financial stability objective because it reduces counterparty exposure among banks and increases transparency in the financial system. Although certain index CDS are mandated for clearing in both the US (since 2013) and now in Europe, the CDS market is small compared with interest rate derivatives. According to the Bank for International Settlements, CDS had $16 trillion gross notional outstanding in December 2014,4 or 3% of the $630 trillion gross notional outstanding in the total OTC derivatives market, while interest rate derivatives were 80% of the total market. Additionally, index CDS account for less than $7 trillion gross notional outstanding, or 1% of the total OTC market (see Exhibit 1).

EXHIBIT 1

Composition of the Credit Default Swap Market by Product

Sources: Bank for International Settlements and Moody’s Investors Service estimates

We expect that the European clearing mandate will increase cleared volumes at the large global CCPs. Considering that both the US and Europe mandated similar index CDS products for clearing, and using the US as proxy (see Exhibit 2), the US clearing mandate drove a 27-percentage-point increase in the percent of cleared index CDS trades (right-hand column).

2 Credit default swaps are derivatives contracts designed to synthetically shift the risk of a credit event and are used by financial

institutions to hedge against the default of a bond or loan (i.e., as an insurance policy or to speculate about the credit risk of an entity). Multi-name CDS are contracts based on a basket of CDS or CDS indexes. Index CDS are determined by an official administrator such as Markit, as opposed to bespoke baskets.

3 See Europe’s Mandatory Clearing Rules for OTC Interest Rate Derivatives Are Credit Positive for Banks, 10 August 2015. 4 Data does not include compression or netting, which reduces notional outstanding.

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Katie Kolchin, CFA Vice President - Senior Analyst +1.212.553.6806 katie.kolchin@moodys.com

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

NEWS & ANALYSIS Credit implications of current events

13 MOODY’S CREDIT OUTLOOK 8 OCTOBER 2015

EXHIBIT 2

Index Credit Default Swap Average Daily Number of Trades

Cleared Un-cleared Total Percent Cleared

End of 2013 322 293 615 52%

Full-Year 2014 645 201 846 76%

Year-to-Date 2015 647 169 816 79%

Sources: International Swaps and Derivatives Association and Moody’s Investors Service estimates

Additionally, the Financial Stability Board indicates that although $6.7 trillion of CDS outstanding is clearable, only $2.4 trillion is currently centrally cleared, leaving a potential for $4.3 trillion to move to central clearing. The Financial Stability Board further notes that 40%-60% of all new CDS transactions in Europe can centrally clear.

This increase in volumes should lead to clearing revenue increases at the large global CCPs. CME and LCH have flagged this segment as a growth area, yet their presence is modest compared with ICE, the largest clearer of CDS. ICE’s CDS clearing business has already experienced consistent growth, with revenues increasing to just under $100 million in 2014 from around $60 million in 2012, after the US CDS clearing mandate became effective. ICE’s management expects more than $100 million in CDS clearing revenues for 2015.

Despite the potentially higher volumes, we do not expect an increase in the level of risk at these CCPs. The clearing mandates in both the US and Europe cover only index CDS products, which have greater liquidity, reliable pricing from a third-party operator and are more appropriate for clearing than bespoke products. Additionally, these CCPs are already experienced in clearing these products. The mandatory clearing rules will take effect gradually: large financial institutions in nine to 15 months, smaller financial institutions in 21 months, and non-financials in three years. For the first category of firms, enforcement should begin later next year.

NEWS & ANALYSIS Credit implications of current events

14 MOODY’S CREDIT OUTLOOK 8 OCTOBER 2015

UK’s Proposed Deadline for Sales Complaints Is Credit Positive for Large Lenders Last Friday, the UK Financial Conduct Authority (FCA) announced a consultation on the introduction of a deadline for customers to claim compensation for mis-sold payment protection insurance (PPI). The proposal also provides guidance for handling PPI complaints in which an unfair relationship might have arisen if the lender failed to disclose to the customer a commission of 50% or more of the premium amount. The proposal would give customers at least another three years to submit their complaints and will likely accelerate claims, forcing banks to increase provisions.

We consider the deadline and guidance to be credit positive for large UK banks because they would accelerate provisioning, thus reducing the downside risk arising from past conduct cost. The deadline does not eliminates the risk, but would force banks to set aside enough provisions to draw a line under the costliest conduct costs in UK banking. As the exhibit below shows, the deadline will be especially positive for banks most affected by this process, including Lloyds Bank plc (A1/A1 positive, baa15), Barclays Bank plc (A2/A2 stable, baa2), Royal Bank of Scotland N.V. (A3/A3 stable, ba1) and HSBC Bank Plc (Aa2/Aa2 stable, a3).

Payment Protection Insurance Provisions as a Proportion of Banks’ Net Revenue, for Banks with the Largest Provisions

Sources: Banks’ financial reports and Moody’s Investors Service calculations

Overall, PPI-related provisions accounted for approximately 56% of total conduct remediation and litigation charges among large UK banks between 2011 and June 2015, totalling £25.6 billion. Although the number of PPI complaints declined by 17% during the first half of 2015 versus the second half of 2014, we believe that the deadline proposal will encourage customers and claim-management companies to accelerate their complaints. However, a 38% reduction in the number of complaints upheld during the first half of 2015 reflects a decline in the proportion of valid complaints, which will progressively translate into lower redress costs.

The deadline will also include all the claims affected by the outcome of the Paragon-Plevin case, in which the Supreme Court determined that the non-disclosure of a commission above 50% of the premium constituted an unfair relationship. Therefore, clients will be entitled to claim back any commission paid in excess of 50% of the premium. Since the average PPI commission was approximately 67% for the 12 largest distributors between 2002 and 2006, according to the FCA, banks would have to pay some of that PPI premium back to customers, in addition to interest on this portion of the premium at an annual simple interest rate of 8%. As a result, banks will be in the position to calculate the potential amount of additional

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

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

NEWS & ANALYSIS Credit implications of current events

15 MOODY’S CREDIT OUTLOOK 8 OCTOBER 2015

provisions to set aside. It is not possible to calculate this amount using public data since a proportion of PPI claims have already been fully redressed.

We believe that over the next three years an acceleration of claims by customers and claim management companies will likely result in higher provisions. However, a deadline would establish a time frame for banks to set aside conduct remediation costs that they would have taken anyway. This will give bondholders more clarity about the downside risk to which they are exposed, and allow the banks to reduce the tail risk that having an open ended compliant time frame entails.

NEWS & ANALYSIS Credit implications of current events

16 MOODY’S CREDIT OUTLOOK 8 OCTOBER 2015

Banca Sella’s Capital Increase Is Credit Positive Last Monday, Banca Sella Holding’s (Banca Sella, Ba1 stable, ba36) Banca Sella S.p.A. (unrated) initiated a €120 million capital increase that it will complete by year-end. The capital increase is credit positive for Banca Sella because it will improve the bank’s regulatory capital by around 108 basis points at a consolidated level, bringing it closer to the Italian banking system’s average common equity Tier 1 ratio (CET1) of 11.8%. However, we note that the capital increase has not been underwritten, and as a result is subject to execution risk.

Banca Sella’s regulatory capital ratios have been historically lower than the system’s average. In recent years, Banca Sella regulatory ratios have improved significantly, mostly as a result of sales of non-strategic assets. In June 2015, the bank’s CET1 ratio under Basel III/Capital Requirement Regulation rules was 9.4%, 218 basis points higher than the 7.2% reported in December 2010 under Basel II rules (see exhibit below). According to our estimates, a successful €120 million capital increase will improve Banca Sella’s CET1 ratio by 108 basis points to 10.5% at a consolidated level, narrowing its gap with the system average of 11.8% as of December 2014.

Banca Sella’s Common Equity Tier 1 Ratio Will Improve with a Successful Capital Raise

Sources: Banca Sella Holding, Bank of Italy and Moody’s Investors Service

Banca Sella is unlisted, and the majority of its shares is held by the Sella family, which founded the bank in the late 1800s. This capital increase is the first material attempt by the bank to open-up its shareholder base beyond the founding family.

In the last two years, several Italian banks have raised capital in the market; these banks had a track record of similar transactions, or syndicates of investment banks guaranteed the capital increases. The lack of a track record and the lack of guarantees will pose additional execution challenges to Banca Sella.

6 The bank ratings shown in this report are Banca Sella Holding’s deposit rating and baseline credit assessment.

0%

2%

4%

6%

8%

10%

12%

2010 2011 2012 2013 2014 Jun-15

Banca Sella Capital Increase Italian System

London +44.20.7772.5454

NEWS & ANALYSIS Credit implications of current events

17 MOODY’S CREDIT OUTLOOK 8 OCTOBER 2015

Insurers

Humana and Health Net Are Hardest Hit by Risk-Corridor Program Shortfall On 1 October, the Centers for Medicare & Medicaid Services (CMS) announced that the risk-corridor program under the Affordable Care Act (ACA) would not pay health insurers the full $2.87 billion they are due for 2014. The program will have only $362 million available to fund this liability, which will be collected from profitable health insurers. As a result, insurers will be paid only 12.6% of the amount owed to them, assuming the CMS is successful in collecting the full $362 million it is due.

This development is credit negative, especially for Humana, Inc. (Baa3 review for upgrade) and Health Net, Inc. (Ba2 review for downgrade). In their 30 June 2015 10-Qs, Humana reported accruals for its 2014 ACA business of approximately $243 million and Health Net reported approximately $93 million. Both will now be forced to take a significant earnings hit.

Although the development is credit negative, it was not a total surprise and most other larger insurers have already accounted for some reduction in the risk-corridor payments. However, for smaller insurers, especially those without another significant line of business, such as the health cooperatives, which were recently established and funded by the ACA, we believe the unexpected magnitude of the reduction could be significant enough to force some of them out of business.

The risk-corridor program was established as a temporary program in the ACA for 2014-16 to stabilize premiums by having insurers share gains and losses on qualified plans sold under the ACA. The program mandates that insurers whose premiums exceed claims costs by a certain amount make payments to the government. Conversely, the federal government is supposed to reimburse insurers if their premiums fall short by a certain amount.

As written in the law, the risk-corridor program’s aim was to be revenue neutral with transfers from profitable insurers matching payments to insurers with losses. However, changes made to the law that allowed individuals to keep non-compliant ACA health plans resulted in higher-than-expected losses for insurers and undermined this premise. Late in 2014, the US Department of Health and Human Services issued a bulletin stating that if risk-corridor collections from insurers in a particular year were insufficient for the government to pay full risk-corridor payments due to insurers, the payments to insurers would be reduced pro rata to the extent of any shortfall.

CMS stated that the shortfall for 2014 could be paid to insurers in the future if more funds become available as a result of improved insurer profitability. However, based on financial reporting for the first six months of 2015, most insurers are losing money on this business and we believe there will be an additional shortfall in 2015. With the risk-corridor program expiring in 2016, sufficient time to generate enough money to fully compensate insurers is unlikely.

For insurers, there are two immediate issues: first, if they accrued for this payment in their 2014 financials, they will be forced to take an earnings hit for the shortfall. Second, if they factored collection of government risk-corridor payments into their 2015 and 2016 premiums, they are likely to have underpriced their insurance plans. With respect to the first issue, many insurers and auditors had become doubtful about the ability of CMS to make full payment under this program and, as a result, the risk-corridor payments were not reflected in their 2014 financial results. Humana and Health Net are exceptions.

Steve Zaharuk Senior Vice President +1.212.553.1634 stephen.zaharuk@moodys.com

NEWS & ANALYSIS Credit implications of current events

18 MOODY’S CREDIT OUTLOOK 8 OCTOBER 2015

There is no way to fix 2015 pricing at this point and we expect that some insurers will report adjustments in third-quarter results, reflecting the potential non-payment of the 2015 risk-corridor payments. Even for 2016 polices, it may also be too late for insurers to appeal to CMS to revise pricing because most premiums have been already approved by regulators and are being programed into the government website for the open enrollment period, which is set to begin on 1 November with the website scheduled to be available for preview in mid-October.

NEWS & ANALYSIS Credit implications of current events

19 MOODY’S CREDIT OUTLOOK 8 OCTOBER 2015

Asset Managers

European Capital Markets Directive Poses Challenges to Asset Managers On 28 September, the European Securities and Markets Authority (ESMA) published its final report under the Markets in Financial Instruments Directive (MIFID II), which sets out extensive technical standards governing the operation of European capital markets. The regulations aim to promote greater transparency and competition in the marketplace. Although investors will benefit from more competitive pricing and better execution, asset managers such as BlackRock, Inc. (A1 stable), FIL Limited (Baa1 positive), trading as Fidelity Worldwide Investment, and Schroders PLC (unrated) will face various reporting and disclosure requirements that raise compliance costs and risk reducing market liquidity, both of which would be credit negative.

Asset managers will incur direct costs from developing new trading procedures, and monitoring and collecting data to assess execution quality for clients to ensure they have the best execution possible. Specifically, investment firms must assess the factors of price and cost when executing orders from retail clients. This will require asset managers to pay for the necessary technological infrastructure and staffing.

MIFID II’s new pre- and post-trade transparency requirements also risk impairing market liquidity, limiting asset managers’ revenue potential by constraining the potential size of a fund. Because market makers will be required to reveal details of their transactions, they will likely become less willing to commit capital to facilitate clients’ trades to avoid the risk of other market participants trading against them. As market liquidity diminishes, asset managers would need to limit fund sizes and scale down their trading in order to trade in and out of positions quickly and efficiently.

The consequences would be especially problematic for bond fund managers. Bond market liquidity has declined substantially over the past several years,7 and so under MIFID II the new pre- and post-trade transparency requirements will be limited to the most liquid bonds. Liquidity will be measured on a bond-by-bond basis, rather than by a classification of bonds, and newly issued instruments will be deemed to be liquid or illiquid according to their issuance size for the first quarter (see exhibit below). Each bond’s liquidity will be reassessed at the end of every quarter, introducing new uncertainty for asset managers. The Investment Association, which represents UK asset managers, stated that ESMA’s measurement of liquidity is too unpredictable and makes it harder for fund managers to plan ahead on a long-term basis.

7 International Capital Market Association, November 2014.

Soo Shin Kobberstad Vice President - Senior Analyst +44.20.7772.5214 soo.kobberstad@moodys.com

Neal Epstein Vice President - Senior Credit Officer +1.212.553.3799 neal.epstein@moodys.com

Tiziano Oliva Associate Analyst +44.20.7772.8663 tiziano.oliva@moodys.com

NEWS & ANALYSIS Credit implications of current events

20 MOODY’S CREDIT OUTLOOK 8 OCTOBER 2015

MIFID II’s Factors to Determine a Bond’s Liquidity

Liquidity Assessment:

Instrument-by-Instrument Approach

Based on Quantitative Liquidity Criteria

Bonds Deemed Not Liquid at Issuance

Bond Type Average

Daily Turnover Average Daily

Number of Trades Percentage of

Days Traded Issuance Size

Sovereign Bond x x x < €1 billion

Other Public Bond x x x < €500 million

Convertible Bond x x x < €500 million

Covered Bond x x x < €500 million

Corporate Bond x x x < €500 million

Exchange Traded Certificates x x

Exchange Traded Notes x x

Source: European Securities and Markets Authority

Market participants will be required to make public the range of bid and offer prices and the depth of trading interest at those prices if a bond meets all of the following criteria: an average daily trade nominal amount of at least €100,000; a minimum average of two daily trades; and a minimum number of days traded equal to at least 80% of the trading sessions available.

The European Commission estimated that MIFID II would impose one-off compliance costs of €512-€732 million and ongoing annual costs of €312-€586 million across market participants. The UK government estimated that the UK will bear approximately 36% of this cost based on the UK’s share of Europe’s wholesale financial market, or €184-€264 million for one-off costs in 2015 and 2016, and €112-€211 million annually for ongoing costs starting in 2017. ESMA on 28 September submitted its final report to the European Commission, which has three months to decide whether to endorse the technical standards.

NEWS & ANALYSIS Credit implications of current events

21 MOODY’S CREDIT OUTLOOK 8 OCTOBER 2015

Sovereigns

Agreement on Trans-Pacific Partnership Is Credit Positive for the US On Monday, the trade ministers of 12 Pacific Rim countries, including the US (Aaa stable), announced that they had reached an agreement on the Trans-Pacific Partnership (TPP). The agreement, although not yet published in its entirety, will lower tariff barriers among the signatory countries for both merchandise and some services, and include standards for labor markets and intellectual property. By reducing barriers to trade in both goods and services for US exporters, the agreement is credit positive for the US.

The agreement still must be approved by the US Congress, and passage is uncertain. Congress has 90 days to examine and debate the agreement, although under fast-track authority the agreement cannot be amended. Final passage of the agreement, if it occurs, will not be until early next year at the earliest.

The TPP region is quite significant for US merchandise trade, accounting for about 45% of exports and 38% of imports (see Exhibit 1) in 2014. These proportions make the region the largest in both directions. On the import side, non-TPP Asia is of similar magnitude, consisting mainly of China (Aa3 stable).

EXHIBIT 1

US Imports and Exports, 2014 Countries in the Trans-Pacific Partnership form the largest region for US trade.

Imports of Goods: $2.35 Trillion

Source: Haver Analytics

Exports of Goods: $1.62 Trillion

Source:

Although the proportion of TPP countries in imports is smaller, the US runs a trade deficit with TPP countries since the value of imports is much larger than that of exports. In 2014, the deficit amounted to $157 billion (see Exhibit 2), compared with a deficit of $343 billion with China. Together, TPP and China account for more than two thirds of the total US trade deficit of $727 billion. The position vis-à-vis individual TPP countries varies, with the US running small surpluses with four of them but more substantial deficits with five of them. The largest trade deficit is with Japan (A1 stable), followed by Mexico (A3 stable) and Canada (Aaa stable). On the other hand, Australia (Aaa stable) is the country with which the US runs the largest surplus, although at $16 billion it is dwarfed by the countries where the US has deficits.

TPP38%

Asia (ex. TPP)34%

Europe21%

Latin America (ex. TPP)6%

Africa1%

TPP45%

Asia (ex. TPP)22%

Europe21%

Latin America (ex. TPP)10%

Africa2%

Steven Hess Senior Vice President +1 212.553.4741 steven.hess@moodys.com

NEWS & ANALYSIS Credit implications of current events

22 MOODY’S CREDIT OUTLOOK 8 OCTOBER 2015

EXHIBIT 2

US Trade Balance with Trans-Pacific Partnership Countries, 2014 The US runs a $157 billion trade deficit with the region.

Source: Haver Analytics

Although certain US industries may see marginally negative effects from the agreement, on balance we think that the effects on the US trade position will be positive. Industries negatively affected, although not substantially, could include automobiles and some pharmaceuticals. Japan is already an important manufacturer of automobiles in the US, so any increase in auto imports directly from Japan that TPP facilitates will likely be small. On the other hand, US auto exports to Japan could increase. For pharmaceuticals, the agreement reduces to five to eight years from 12 years the period that biologics can be sold without competition from generics. But we expect that this aspect of the agreement will be marginal for the overall industry.

US exporters of agricultural products and, probably most importantly, services, including financial services, are likely to be positively affected by the TPP. However, any positive or negative effects will materialize with a lag, so we do not expect an immediate effect on the trade balance. We do not have a schedule for the reduction of trade barriers, but typically they come into force in stages over a period of years.

Estimates of the TPP’s overall economic effect are not yet available because the agreement has not been made public. However, the economic effects will take time to develop. We expect that there will be a positive, although relatively small, effect on economic growth.

15.9113.81 7.04

3.98 0.52 0.28

-17.35

-24.85

-35.38

-53.83

-67.18

-0.16

-$70

-$60

-$50

-$40

-$30

-$20

-$10

$0

$10

$20

Australia Singapore Chile Peru Brunei NewZealand

Malaysia Vietnam Canada Mexico Japan TPP as aWhole

$ Bi

llion

s

NEWS & ANALYSIS Credit implications of current events

23 MOODY’S CREDIT OUTLOOK 8 OCTOBER 2015

Portuguese Government’s Loss of Absolute Majority Complicates Fiscal and Structural Reform On Sunday, Portugal’s (Ba1 stable) incumbent coalition government won the general election and will most likely form the next government. However, the centre-right coalition of the Partido Social Democrata and the Centro Democratico e Social – Partido Popular did not achieve an absolute majority, instead obtaining 36.8% of the votes versus the Socialist Party’s (PS) 32.4%. This will likely translate into 104 seats in parliament, short of the 116 seats needed for an absolute majority. Whereas we expect the re-election of the government to ensure a continued focus on fiscal consolidation, the loss of the previous absolute majority will complicate the implementation of further structural reforms.

Specifically, although the PS leader has opened the door to support the government on a case-by-case basis to ensure the country’s political stability, it is not clear if the government and the PS will be able to agree on reforms to the public-pension system, which the government had indicated it would pursue in 2016. Such a reform would be a significant and positive measure, both for its fiscal effect and as an indication that the Portuguese authorities remain committed to structural and permanent fiscal improvements.

A first test for the new government will be the presentation and approval of the 2016 budget. The government needs to present the broad outlines to the European Commission by 15 October and get the final budget approved in the Portuguese parliament before the end of the year. According to the Stability Program presented in April, the government targets a reduction in the general government deficit to 1.8% of GDP next year from 2.7% of GDP this year.

Although the government has been successful in materially reducing the budgetary shortfall (the underlying deficit fell to 4.4% of GDP in 2014 from 11.2% in 20108), we believe that the cyclical recovery of the Portuguese economy will not be strong enough to achieve the 2016 target of 1.8% and expect a deficit of 2.8% of GDP instead (see Exhibit 1). So far, the government has indicated its intention to eliminate the surcharge on the personal income tax in 2016 and will have to reverse part of the temporary public-sector wage cuts owing to adverse rulings by the country’s constitutional court. According to European Commission and International Monetary Fund estimates, these two measures alone would increase the budget deficit by 0.25 percentage points of GDP next year. The pension reform would offset these deficit-increasing measures, as will the lower interest burden on the public debt owing to the currently low interest rate environment.

8 The Portuguese Statistics Office recently revised Portugal’s headline deficit for 2014 to 7.2% of GDP from 4.4% of GDP to include

the one-off capital injection into Novo Banco that amounted to 2.8% of GDP. See our credit opinion on Portugal for more detail.

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

NEWS & ANALYSIS Credit implications of current events

24 MOODY’S CREDIT OUTLOOK 8 OCTOBER 2015

EXHIBIT 1

Portugal’s General Government Financial Balance and Debt as a Percent of GDP

Sources: Haver Analytics and Moody’s Investors Service forecasts

The country’s fiscal challenge – the public debt ratio has only just started to reverse trend and decline from its very high level of 128.7% of GDP in June 2015 – is complicated by Portugal’s subdued growth prospects. Real GDP growth during the first two quarters of this year was stable at 1.6% versus year-ago levels, in contrast to a 7% growth rate in Ireland and 2.9% in Spain (see Exhibit 2).

EXHIBIT 2

Portugal’s and Peers’ Real GDP Growth Real GDP at peak before global financial crisis indexed to 100 at time = 0.

Note: Time increments in quarters. Sources: Haver Analytics and Moody’s Investors Service

It remains to be seen whether the broad structural reforms that the Portuguese authorities implemented under the external support programme, including a new corporate insolvency regime, will produce higher economic growth rates. High leverage in the corporate sector and weakness in the banking sector, including high levels of nonperforming loans and weak earnings prospects, continue to weigh on Portugal’s economic outlook. We expect 1.7% GDP growth for 2015 and 1.8% growth for 2016.

-12%

-10%

-8%

-6%

-4%

-2%

0%

0%

20%

40%

60%

80%

100%

120%

140%

2010 2011 2012 2013 2014 2015F 2016F

Debt - left axis Financial Balance - right axis Financial Balance Excluding Novo Banco - right axis

85

90

95

100

105

110

t-7

t-6

t-5

t-4

t-3

t-2

t-1 t0 t+1

t+2

t+3

t+4

t+5

t+6

t+7

t+8

t+9

t+10

t+11

t+12

t+13

t+14

t+15

t+16

t+17

t+18

t+19

t+20

t+21

t+22

t+23

t+24

t+25

t+26

t+27

t+28

t+29

t+30

Portugal Spain Ireland Iceland

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

25 MOODY’S CREDIT OUTLOOK 8 OCTOBER 2015

NEWS & ANALYSIS Corporates 2

» Reynolds American's Planned Sale of Natural American Spirit Rights Is Credit Positive

» PBF Deal to Buy California Refinery Is Credit Positive

» Kraton's Takeover of Arizona Chemical Will Increase Leverage

» First Data's Planned IPO Will Reduce Leverage

» VeriFone's $200 Million Share Repurchase Program Is Credit Negative

» Affinion's Distressed Exchange Is Credit Positive for Remaining Debtholders

» Hapag-Lloyd's Planned IPO Is Credit Positive

» India's Natural Gas Price Cut Is Credit Negative for Upstream Players

» SOHO China's Tender Offer and Disposal of Joint Venture Project Are Credit Positive

» China's Vehicle-Purchase Tax Cut Will Benefit Domestic Automakers

Infrastructure 12

» AEP Casts Away Its Barge Business, a Credit Positive

Banks 13

» National Bank of Canada Equity Raise Strengthens Loss-Absorbing Capacity, a Credit Positive

» Transaero Edges Closer to Bankruptcy, a Credit Negative for Russian Banks

» Capital Injection Prepares Skandiabanken for Sweden-Focused Expansion, a Credit Positive

Insurers 17

» Genworth’s Sale of Life Insurance Block to Protective Is Credit Positive for Buyer and Seller

» China's Life Insurance Reform Is Credit Negative for Insurers

Sovereigns 21

» Results of Mexico’s Second Oil Auction Support Credit-Positive Energy Reform

» Iceland’s Payment from Hold-Out Creditors Is Credit Positive for Sovereign

US Public Finance 25

» Alaska Loses Indirect Benefits as Shell Ends Drilling and Exploration

Covered Bonds 26

» European Commission Proposes Credit-Positive Framework for Covered Bonds

RATINGS & RESEARCH Rating Changes 28

Last week, we downgraded First Quantum Minerals, B&G Foods, Concordia Healthcare, MEG Energy and Bank RSB 24, and upgraded IMS Health, Wyuna Water and China Guangfa Bank, among other rating actions.

Research Highlights 33

Last week, we wrote on Japanese steelmakers, Asian corporates, US telecom, Chinese automakers, US lodging and cruise, US homebuilders, US retailers, US diversified information technology, North American coal, European packaged food, Chinese property developers, Indonesian infrastructure, Volkswagen Bank and Volkswagen Financial Services, Turkish banks, Guyana & Venezuela, Great Britain electricity distribution, US municipal water and sewer utilities, French covered bonds, US single-family rental securitizations, Japan RMBS, VW auto ABS, Swedish covered bonds and Brazilian trade-receivables ABS, among other publications.

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EDITORS PRODUCTION ASSOCIATE News & Analysis: Jay Sherman and Elisa Herr Alisa Llorens