MOODYS.COM

14 AUGUST 2014

NEWS & ANALYSIS Corporates 2 » Chiquita Would Benefit from Cutrale Group and Safra Group’s

Takeover Bid

» A More Restrictive Arms Export Policy Would Be Credit Negative for German Defense Companies

» PLDT’s Investment in Rocket Internet Is Credit Negative

Infrastructure 6 » Delayed Nuclear Construction Schedule Is Credit Negative for

SCANA and Santee Cooper

Banks 7 » Italy’s Third Recession Since 2008 Is Credit Negative for

Italian Banks

» LBBW’s Sale of Structured Credit Portfolio Is Credit Positive

» South Africa’s Bail-in of African Bank Is Negative for Bondholders and Depositors

Sovereigns 12 » Ebola Outbreak Threatens to Inflict Broad Economic

Ramifications in West Africa

US Public Finance 14 » Closure of Atlantic City, New Jersey’s Second-Largest Taxpayer

Is Credit Negative

» New Jersey Authorization of Infrastructure Loans Benefits State’s Water and Sewer Utilities

» Michigan School District Financial Emergency Underscores Persistent Fiscal Pressure in Sector

CREDIT IN DEPTH US Investment Banks 19

Morgan Stanley and Goldman Sachs: business mix, profitability and risk controls separate the two US investment banks. Only two large traditional US investment banks survived the 2008 financial crisis, and each has responded differently to the regulatory and market challenges they face in the aftermath. We judge Goldman the better credit risk, but on 24 July we changed Morgan Stanley’s ratings outlook to positive.

RECENTLY IN CREDIT OUTLOOK

» Articles in Last Monday’s Credit Outlook 22 » Go to Last Monday’s Credit Outlook

NEWS & ANALYSIS Credit implications of current events

2 MOODY’S CREDIT OUTLOOK 14 AUGUST 2014

Corporates

Chiquita Would Benefit from Cutrale Group and Safra Group’s Takeover Bid On Monday, Chiquita Brands International, Inc. (B2 developing) said that it had received an unsolicited offer from Cutrale Group and Safra Group to acquire the common stock of Chiquita for $13 a share. The offer, which is a 29% premium to Chiquita’s closing share price on 8 August, is credit positive for the company because it would trigger repayment of its outstanding notes, whereas the fate of its debt under Chiquita’s planned merger with Fyffes Plc (unrated) is unclear.

Cutrale and Safra’s all-cash offer is subject to shareholder approval pending review and a recommendation from Chiquita’s board of directors. The proposed buyout would also necessitate termination of the pending merger agreement with Dublin, Ireland-based Fyffes.

Relative to the merger agreement with Fyffes, we view the alternative offer from Cutrale and Safra more favorably from a credit perspective because a change in control would trigger bondholder put options on Chiquita’s $425 million senior secured notes due 2021 and $200 million convertible senior notes due 2016. As part of their offer, the acquiring companies intend to provide any additional capital required if Chiquita bondholders exercise the change-of-control put option that would result in repayment. Management at Cutrale and Safra believe they can complete the buyout before the end of the year, which is the same time frame that Chiquita has stated for the Fyffes merger.

Our outlook on Chiquita’s ratings remains unchanged at developing because the company now has the additional option of accepting the Cutrale-Safra buyout versus entering into a merger with Fyffes. The developing outlook continues to reflect the uncertainty surrounding the post-transaction pro forma credit metrics in either scenario, including the company’s capital structure and management’s views on achievable synergies.

Brian Silver Assistant Vice President-Analyst +1.212.553.1663 brian.silver@moodys.com

Andrew MacDonald Associate Analyst +1.212.553. 4152 andrew.macdonald@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 14 AUGUST 2014

A More Restrictive Arms Export Policy Would Be Credit Negative for German Defense Companies On 7 August, Rheinmetall AG (Ba1 stable) announced that the German government had withdrawn a permit for the company to supply a combat simulation center to Russia as part of a more than €100 million contract, prompting the company to lower by €20 million its 2014 earnings forecast. More restrictive export policies would be credit negative for German defense exporters such as Rheinmetall and Heckler & Koch GmbH (Caa2 negative) because they would reduce these companies’ earnings and cash flow.

We interpret the German government’s withdrawal of the export permit as an indication of a shift in its approach and position in the Ukraine political crisis. However, the withdrawal of an existing contract also highlights the internal pressure on the German government to adopt a more cautious stance in its foreign policy and arms exports relative to some of its Western allies. The withdrawal covered an existing contract rather than a future contract, thereby going above and beyond the sanction rules adopted by the European Union. The French government is not expected to cancel the delivery of the first of two Mistral Warships to Russia.

The German government’s action comes amid shrinking local defense budgets that have prompted Rheinmetall and Heckler & Koch to increase their international presence. In 2013, Rheinmetall opened new international sales offices, including one in Saudi Arabia, and established a joint venture with project developer Ferrostaal to improve international efforts in defense as well as infrastructure projects. Around 40% of Rheinmetall’s 2013 defense revenues were from business outside of Europe, and orders from abroad are increasing, with 75% of all 2013 orders coming from outside Europe. For the first half of this year, 50% of orders were from non-European customers. Over the past few years, Heckler & Koch has also gradually increased its business with the US and certain non-NATO countries such as those in the Middle East.

In Germany, there has been extensive political discussion and reluctance to sell arms to countries with questionable human rights records and those that are not members of NATO. The restriction of arms sales was a key campaigning issue in Germany’s recent elections, including that of Frank-Walter Steinmeier, who is now Germany’s foreign minister. The debate has been further fueled in recent months by growing conflicts in the Middle East and Ukraine, allegations of bribery by German defense export companies and investigations into claims that German weapons have been found in war-torn countries. On Tuesday, Mr. Steinmeier said the German government would now consider sending military assistance to the Iraqi government. This represents a clear change from the German government’s previous stance on Monday that, in line with its foreign policy, it does not send arms to conflict zones. It remains to be seen whether the government’s greater willingness to provide military assistance in Iraq will influence the debate about a more restrictive export arms policy.

Rheinmetall is better positioned within its rating to sustain more restrictive export policies than Heckler & Koch, whose negative rating outlook reflects the company’s weak liquidity profile and cash flow generation that is barely sufficient to accommodate annual interest payments. Meanwhile, Rheinmetall benefits from improved diversification, with its improving automotive business supporting the company’s earnings. However, Rheinmetall’s leverage, which we expect will be around 4.0x normalized debt/EBITDA by 2014, remains high for a company of this type with a Ba1 rating. Earnings pressure from more restrictive arms policies would challenge the company’s ability to deleverage to the 3.5x ratio we forecast the company to reach by 2015, in line with our rating guidance.

Jeanine Arnold Vice President-Senior Analyst + 49.69.70730.789 jeanine.arnold@moodys.com

NEWS & ANALYSIS Credit implications of current events

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PLDT’s Investment in Rocket Internet Is Credit Negative Last Thursday, Philippine Long Distance Telephone Company (PLDT, Baa2 stable) said that it would pay €333 million (PHP19.5 billion) for a 10% stake in Germany’s Rocket Internet AG (unrated) and will jointly develop mobile and online payment technologies and services for the Philippines and other emerging markets. The investment is credit negative for PLDT because it will increase leverage and expose the company to the competitive Internet business. The deal also signals PLDT’s appetite to invest in peripheral businesses.

PLDT plans to fund the investment with cash and new debt. As a result, we expect the company’s adjusted debt/EBITDA to increase to 1.9x-2.0x by December 2014 from approximately 1.8x for the 12 months that ended June 2014 and 1.6x as of December 2013. We estimate that PLDT will be able to finance the majority of the investment with its excess cash. The company had PHP43 billion in cash and cash equivalents as of June 2014, which is approximately PHP10 billion more than its historical levels.

However, PLDT secured the excess cash by increasing its total debt by PHP19 billion to PHP123 billion during the first half of this year, which is a major reason for the increased leverage as of June 2014. We expect that the company will further increase its total debt to PHP130-135 billion by December 2014 to maintain its cash and cash equivalents of more than PHP30 billion.

As shown in the exhibit below, we expect PLDT to generate cash flow from operations (CFO) of PHP70-75 billion in 2014. However, its free cash flow (CFO minus capex and dividend payments) is likely to be moderate, given its high level of capex and its likely maintenance of a 100% dividend payout ratio. As a result, PLDT’s major investments will require debt financing or the sale of assets.

Components of PLDT’s Change in Cash over 2014 Investment will require debt financing, given high capex and dividends

Source: Moody’s Investors Service

Beacon Electric Asset Holding Inc (unrated), of which PLDT owns about 50% indirectly, agreed to sell a 5% stake in Manila Electric Company (Meralco, unrated) in June 2014. PLDT will receive about 50% of the total cash proceeds of approximately PHP13.2 billion from this transaction (mostly in 2015), which should help improve its cash position.

At the same time, the joint development with Rocket of mobile payment solutions should allow PLDT to expand its revenue in the mobile payment business, helping to offset declines in revenue from voice and

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Yoshio Takahashi Assistant Vice President-Analyst +852.3758.1535 yoshio.takahashi@moodys.com

Maisam Hasnain Associate Analyst +852.3758.1420 maisam.hasnain@moodys.com

NEWS & ANALYSIS Credit implications of current events

5 MOODY’S CREDIT OUTLOOK 14 AUGUST 2014

short message services. However, generating stable returns from investments in the fast-changing and competitive Internet market is challenging.

The investment in Rocket also shows that PLDT’s investment appetite remains strong. Although the size of the Rocket investment is moderate at about 5% of PLDT’s total assets and 15% of total equity, based on its balance sheet as of June 2014, PLDT’s acquisition activity has increased over the past several years. The company invested about PHP20 billion in Meralco in 2009 and acquired Digital Telecommunications Philippines, Inc. (Digitel, unrated) in 2011 for about PHP70 billion via a share swap.

Meralco is an electricity distributor with telecommunications assets such as towers, poles and a fiber-optic network. Although a major PLDT objective was to secure access to these assets, the acquisition was non-core. Meanwhile, Digitel was the Philippines’ third-largest cellular operator at the time that PLDT acquired it and since then PLDT’s market position and spectrum holdings have increased. However, its leverage increased significantly to 1.6x in 2012 from 1.2x in 2010 owing largely to the consolidation of approximately $500 million of Digitel debt.

NEWS & ANALYSIS Credit implications of current events

6 MOODY’S CREDIT OUTLOOK 14 AUGUST 2014

Infrastructure

Delayed Nuclear Construction Schedule Is Credit Negative for SCANA and Santee Cooper On Monday, SCANA Corporation (Baa3 stable) announced another delay to the construction of its new nuclear generating plants at the VC Summer facility in Jenkinsville, South Carolina. SCANA now expects VC Summer Unit 2 to be “substantially complete” in the first half of 2019, roughly three years later than the original target date of April 2016, while it expects Unit 3 to be completed in the first half of 2020.

These delays are credit negative for SCANA, its primary subsidiary South Carolina Electric & Gas Company (SCE&G, Baa2 stable) and South Carolina Public Service Authority (Santee Cooper, A1 stable), which currently owns 45% of VC Summer units 2 and 3, because it will likely increase the cost to complete the already expensive project, inflate customers’ electricity bills and, for SCE&G, raise regulatory intervention risk – all of which could reduce future cash flow coverage of rising debt levels.

So far, project delays have had little effect on the original cost estimate of $10 billion for the two units. However, the nature of these most recent delays (i.e., the prolonged placement of a critical path structural component of the reactor facility) and unknown cost effect raises the probability of abandonment, which could result in some stranded costs and hurt the company’s financial profile. However, we think SCANA and Santee Cooper are too far along to abandon the project, although the possibility of abandoning Unit 3 (albeit still remote) has modestly increased with this latest delay.

The delay increases SCANA’s risk profile in several ways. The most important is the prospect for rising regulatory risks over customers’ tolerance to absorb new nuclear-related costs in an environment of low natural gas prices and when the timing to recover new expenses will fall outside of the credit friendly Base Load Review Act, a legislative act that provides transparent and prescriptive cost recovery provisions for new nuclear unit costs.

The delays also increase the risk of a significant change in SCANA’s and Santee Cooper’s financial strategy owing to a domino effect on the schedule. And, SCANA may be in a weakened position to litigate contractor disputes given the strategic importance of this project, which risks additional cost pressures and could erode its relationship with regulators if the delays result in costs that the South Carolina Public Service Commission deems are imprudent.

From a financial perspective, the cost overruns risk SCANA having to revise its capital structure or dividend policy outside of current expectations, which adds a degree of uncertainty. Today, SCANA’s financing plans are designed to achieve a ratio of cash from operations pre-working capital (CFO pre-WC) to debt in the mid to high teens through 2018. In the past, we have stated that a CFO pre-WC/debt below 17% or material cost overruns could prompt us to downgrade SCANA and SCE&G.

As a public power electric utility with rate-setting autonomy, Santee Cooper is insulated from regulatory approval risks for cost recovery. However, the utility shares in the construction risk and potential rate pressure with SCANA. Santee Cooper has mitigated some of the early rate pressure through a restructuring of its debt to more closely align it with a recently approved 50-year Central Electric Power Cooperative wholesale agreement. Santee Cooper also has in its forecast a contingency that incorporates $600 million of additional costs, a credit positive.

Susana Vivares Vice President-Senior Analyst +1.212.553.4694 susana.vivares@moodys.com

Dan Aschenbach Senior Vice President +1.212.553.0880 daniel.aschenbach@moodys.com

NEWS & ANALYSIS Credit implications of current events

7 MOODY’S CREDIT OUTLOOK 14 AUGUST 2014

Banks

Italy’s Third Recession Since 2008 Is Credit Negative for Italian Banks On 6 August, the Italian Statistical Institute published preliminary data on Italy’s second-quarter GDP growth that showed the country had entered its third recession since 2008. The Italian economy contracted 0.2% in the second quarter from the first quarter, following a 0.1% contraction in first-quarter 2014 from fourth-quarter 2013. A recession is credit negative for Italian banks, which were significantly weakened by the two previous recessions.

On Monday, we revised our GDP growth assumptions for 2014 and 2015 and now forecast that Italy’s GDP will be in a range of contracting by 0.5% and growing by 0.5% this year, and growing 0.5%-1.5% next year. Previously, we had forecast GDP growth of 0%-1% this year, and 1%-2% next year. Between 2008 and 2013, Italy’s GDP contracted by 7.6%, versus contractions of 6.6% for Spain and 0.6% for the UK. Germany’s economy grew by 3.1% (see Exhibit 1).

EXHIBIT 1

GDP Growth of Main European Countries, Index = 100 at 2008

Source: Moody’s Investors Service

Given Italian banks’ already weakened state, the emergence of even a mild recession risks further weakening their credit strength and may result in banks needing additional capital injections following the €11 billion capital hikes that banks completed earlier this year ahead of the European Central Bank’s comprehensive assessment. Should this renewed recession continue in coming quarters, it would delay a stabilisation in the level of nonperforming loans, which we currently expect to occur in 2015, to at least 2016.

Raising capital would be particularly challenging for banks that are undergoing significant restructuring, such as Banca Monte dei Paschi di Siena S.p.A. (B1 negative, E/caa21), which reported problem loans of 20.8% as of June 2014, and Banca Carige S.p.A. (Caa1 negative, E/caa3), which reported problem loans of 15.4% as of June 2014. Capital raises will also be challenging for banks that are currently under administration by the Bank of Italy, such as Banca delle Marche S.p.A. (unrated).

1 The bank ratings shown in this report are the bank’s deposit rating, its standalone bank financial strength rating/baseline credit

assessment and the corresponding rating outlooks.

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London +44.20.7772.5454

NEWS & ANALYSIS Credit implications of current events

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Another recession will also make it more difficult for banks to improve their pre-provision profitability, and could thwart their efforts to reduce loan-loss charges, a goal that many banks have aimed to complete over the next two years.

The GDP contraction of the past few years has also led to severe asset quality deterioration, with problem loans2 accounting for 12.3% of Italian banks’ gross loans in 2013, up from 4.5% in 2008 and among the highest levels in Europe (see Exhibit 2).

EXHIBIT 2

Problem Loans as a Percent of Gross Loans in Select European Countries, 2008-13

Sources: Italy: Bank of Italy and Moody’s Investors Service adjustments; France: Moody’s Financial Metrics; Germany: Moody’s Financial Metrics; Portugal: Bank of Portugal; Spain: Bank of Spain and Moody’s estimates; UK: Moody’s Financial Metrics

2 Problem loans in Italy include nonperforming loans, watchlist, restructured and past-due. We adjust these numbers and only

incorporate 30% of the watchlist category as an estimate of those loans more than 90 days past due.

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Italy France Germany Portugal Spain UK

Problem Loans (Reported) Repossesed Real Estate Assets Performing Refinanced Loans

NEWS & ANALYSIS Credit implications of current events

9 MOODY’S CREDIT OUTLOOK 14 AUGUST 2014

LBBW’s Sale of Structured Credit Portfolio Is Credit Positive On 6 August, Landesbank Baden-Wuerttemberg (LBBW, A2 negative, D+/baa3 stable) announced that it had sold a €4.7 billion structured credit portfolio to international investors for an undisclosed sum. The sale of the legacy structured credit portfolio is credit positive for LBBW because it significantly reduces the annual guarantee fee that LBBW paid to Land of Baden-Wuerttemberg (Aaa stable), and strengthens the bank’s internal capital-generation capacity.

LBBW in 2008 established a €95 billion credit investment portfolio that included €29 billion of securitisations. In 2009, the Baden-Wuerttemberg granted LBBW a €12.7 billion second-loss guarantee to protect against risk related to €15 billion of securitisations in the credit investment portfolio, and provided a second-loss guarantee on a €9 billion loan that LBBW provided Sealink Funding, a special-purpose entity that invested in asset-backed securitisations. By year-end 2013, the guaranteed exposures on the securitisations and loan shrank to €12.8 billion, while the remaining guarantee totalled €10.4 billion.

With the sale, LBBW will reduce the guaranteed structured credit portfolio to zero; an unguaranteed credit investment portfolio of less than €5 billion remains. The loan provided to Sealink, reduced to €6.5 billion at year-end 2013, remains fully guaranteed, of which €5.0 billion is through the second-loss guarantee provided by Baden-Wuerttemberg and a first-loss guarantee granted by the Free State of Saxony (unrated).

LBBW will significantly reduce its guarantee fee as result of the disposal. During the past five years, LBBW’s annual earnings were materially burdened by the fee it paid for the guarantee. Costs totalled €305 million per year for the full €12.7 billion guarantee. With the remaining guarantee falling to €5.0 billion, we estimate that annual guarantee costs will fall to around €120 million, based on the assumption that the guarantee fee for the securitisation portfolio is comparable with the guarantee fee for the Sealink loan. However, the full effect of this benefit will only become effective in 2015. As a point of comparison, LBBW reported a net profit of €337 million for 2013. The exhibit below compares the bank’s annual pre-tax profits and net income against the costs for both guarantees, which equalled 64% of LBBW’s 2013 pre-tax profit of €471 million.

LBBW’s Pre-Tax Profit, Guarantee Expenses and Net Income Since 2010

Sources: LBBW and Moody’s Banking Financial Metrics

The profitability improvement arising from the sale will allow LBBW to increase its risk-based capital ratios by 10 basis points per year, assuming risk-weighted assets of €88 billion as of first-quarter 2014. LBBW reported solid capital metrics at 31 March 2014, which will further benefit from the improved ability to

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Johannes Binder Associate Analyst +49.69.70730.756 johannes.binder@moodys.com

Alexander Hendricks, CFA Associate Managing Director +49.69.70730.779 alexander.hendricks@moodys.com

NEWS & ANALYSIS Credit implications of current events

10 MOODY’S CREDIT OUTLOOK 14 AUGUST 2014

generate profits and make the bank’s metrics more comparable with banks that do not rely on capital relief measures such as the bank’s second-loss guarantee. The bank’s transitional Basel III common equity Tier 1 (CET1) ratio was 14.0% and its fully phased-in CET1 ratio was 12.9% as of March 2014, and the sale of the portfolio puts the bank in a better position to grow its capital ratios.

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11 MOODY’S CREDIT OUTLOOK 14 AUGUST 2014

South Africa’s Bail-in of African Bank Is Negative for Bondholders and Depositors On Sunday, the South African Reserve Bank (SARB) placed African Bank Limited (Caa2 review for downgrade, E/ca3) under curatorship. The SARB’s action came after African Bank’s parent company, African Bank Investment Limited, reported significantly higher loan-loss provisions in May and August 2014, which limited the bank’s access to interbank borrowing and local debt capital markets. As part of the bank’s restructuring, the SARB also announced that senior bondholders and wholesale depositors will sustain an outright 10% loss, with subordinated debtholders likely to face higher losses. These developments are credit negative for South African banks’ wholesale depositors and senior bondholders because they demonstrate regulators’ willingness to impose losses upon them.

Following African Bank Investment Limited’s trading statement on 6 August and the subsequent collapse of its share price, the SARB intervened on 10 August and placed the bank under curatorship. According to the SARB’s announcement, the bank will be resolved into a “good bank” and a “bad book,” with depositors and senior bondholders transferred to the good bank. Retail deposits will be transferred at full value to the good bank, while wholesale deposits and senior debt will be transferred at 90% of face value, implying a 10% loss for related creditors.

Subordinated debtholders will likely sustain higher losses, and, as per the restructuring plan, they will be placed with the bad book. The good bank will also be strengthened with ZAR10 billion ($939 million) of new capital, underwritten by a consortium of South African banks and the state-owned Public Investment Corporation.

The authorities’ decision to include a bail-in as part of the restructuring plan is negative for wholesale depositors and senior bondholders. And, because the SARB’s action comes before the adoption of an official resolution framework, it signals a clear shift in policy and the regulator’s willingness to impose losses on banks’ subordinated bondholders, senior bondholders and wholesale depositors. The inclusion of burden-sharing with unsecured creditors as a means of reducing the public cost of bank resolution shifts the balance of risk for banks’ senior unsecured and wholesale depositor creditors to the downside. For subordinated debt instruments, we had already considered that the authorities were unlikely to extend systemic support in case of financial distress, and their response to African Bank reinforces this view.

There are currently five South African banks whose deposit and senior debt ratings benefit from our assumptions of a high probability of systemic support, leading to one notch of systemic support uplift. Those banks are Standard Bank of South Africa (A3 negative, C-/baa1 stable), ABSA Bank Limited (A3 negative, C-/baa1 stable), FirstRand Bank Limited (A3 negative, C-/baa1 stable), Nedbank Limited (A3 negative, C-/baa1 stable) and Capitec Bank Limited (Baa3 stable, D+/ba1 stable).

3 The bank ratings shown in this report are the bank’s local currency deposit ratings, its standalone bank financial strength

rating/baseline credit assessment and the corresponding rating outlooks.

Constantinos Kypreos Vice President-Senior Credit Officer +357.25.693.009 constantinos.kypreos@moodys.com

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Sovereigns

Ebola Outbreak Threatens to Inflict Broad Economic Ramifications in West Africa On Friday, the World Health Organization declared that the Ebola epidemic is “a public health emergency of international concern,” just as a number of west African sovereigns have declared states of emergency as the death toll in the region surpasses 1,000. Beyond the tragic loss of life, west Africa’s worst-ever outbreak of Ebola threatens to have significant economic and fiscal ramifications for a number of sovereigns in the region.

On Friday, Nigeria (Ba3 stable) became the latest country to declare a state of emergency after the second death from 10 confirmed cases, and following similar declarations from Liberia (unrated) and Sierra Leone (unrated) in late July. This past weekend, Ghana’s (B2 negative) health ministry issued a “red alert” following the discovery of suspected cases of Ebola within the eastern region of the country.

Critical commercial and transport disruptions that we expect will last for at least the next month will exact an economic toll in Guinea (unrated), Liberia and Sierra Leone, with the majority of border crossings in all three countries either closed or only allowing limited public and commercial traffic. Public schools are closed, and many non-essential government personnel are on mandatory leaves of absence to prevent the spread of the disease. The US Centers for Disease Control late last month advised against all non-essential travel to the three countries. West African regional air carrier ASKY Airlines (unrated) and Nigeria’s Arik Air (unrated) have indefinitely suspended flights to Liberia’s and Sierra Leone’s main airports, as have international carriers such as Emirates (unrated) and British Airways Plc (Ba3 stable).

The outbreak risks having a direct financial effect on government budgets via increased health expenditures that could be significant, and an indirect effect arising from an Ebola-induced economic slowdown on government revenue generation in a region where budgets are already hindered by low tax collection.

Last week, Liberia Minister of Finance Amara Konneh indicated that Ebola-related expenses in the second quarter cost $12 million (equivalent to 2% of the government’s annual budget or 0.6% of GDP), which will inevitably increase in line with the epidemic’s escalation in the third quarter. Guinea and Sierra Leone, already running budget deficits in excess of 3% of GDP (or closer to 8% for Sierra Leone if we exclude international donor grants) are also likely to see their budget positions deteriorate amid higher healthcare spending. This is despite pledges for assistance exceeding $300 million for the three countries from the World Bank, African Development Bank (Aaa stable), World Health Organisation and neighbouring west Africa sovereigns.

The level of potential disruption was evidenced by one contractor calling a force majeure in the past month that resulted in ArcelorMittal (Ba1 negative) having to halt phase two of its iron ore mining development in Liberia. Mr. Konneh suggested Liberia’s projected GDP growth for this year would need to be revised down from the current forecast of 5.9% owing to Ebola-related disruptions. An initial assessment by the World Bank and International Monetary Fund in June predicted that GDP growth in Guinea will fall a full percentage point to 3.5% in 2014 as a result of the epidemic.

Meanwhile, Sierra Leone’s economic growth would decelerate from the 16% growth rate recorded in 2013 if mining sector production is affected by Ebola. African Minerals (unrated), the largest private sector employer in Sierra Leone and largest contributor to GDP in 2013, and London Mining (unrated) have

Matt Robinson Vice President-Senior Credit Officer +44.20.7772.5635 matt.robinson@moodys.com

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imposed restrictions on non-essential travel and introduced employee health screening measures to protect production facilities.

Although Enermech (unrated) announced that it was withdrawing staff from Nigeria, and Tullow Oil plc (Ba2 stable) announced that it was doing the same at its operations in Liberia, most west African mining operations are far removed from areas affected by Ebola. This, along with national and global efforts to contain the virus, suggests that at this stage the disease’s effect on the mining industry is likely to be temporary.

However, if a significant outbreak emerges in the Nigerian capital of Lagos, Africa’s most populous city, the consequences for the west African oil and gas industry would be considerable. Nigeria is the largest oil producer on the continent, with international companies such as Exxon Mobil Corporation (Aaa stable), Chevron Corporation (Aa1 stable), Royal Dutch Shell Plc (Aa1 stable), ENI S.p.A. (A3 stable) and Total S.A. (Aa1 negative) operating there. A major outbreak would impair the indigenous workforce and likely prompt international oil companies to evacuate their expatriate personnel, resulting in significantly curtailed oil production. With Nigeria as the world’s 12th-largest oil producer and oil accounting for more than 85% of exports and roughly two thirds of Nigeria’s fiscal revenues, any material decline in production would quickly translate into economic and fiscal deterioration.

NEWS & ANALYSIS Credit implications of current events

14 MOODY’S CREDIT OUTLOOK 14 AUGUST 2014

US Public Finance

Closure of Atlantic City, New Jersey’s Second-Largest Taxpayer Is Credit Negative On Tuesday, one of Atlantic City, New Jersey’s (Ba1 negative) largest taxpayers, Revel Atlantic City, LLC, announced its plans to close. The latest in a string of credit negatives for the struggling city, this closure will result in the loss of the city’s second-largest property taxpayer and increase its already high unemployment rate. Additionally, the lack of bids through Revel’s bankruptcy process suggests that even at a very low price, casino operators are finding it difficult to operate profitably in Atlantic City. We expect the closure to have a minimal effect on the state of New Jersey (A1 negative).

Revel, which will pay approximately $19 million of property taxes this year, or 7.5% of the city’s total revenues, is one of many closures announced over the past year. The Atlantic Club closed in December 2013, and Trump Plaza and Showboat have announced plans to close this summer, further eroding the city’s taxable base. These four casino closures constitute $1.9 billion of assessed valuation, or 17% of the city’s 2014 total taxable values.

Closing Revel, which employs 3,100 people, will also weigh on the city’s already high unemployment rate of 13.1% as of June 2014, which is more than double both the state’s 6.4% unemployment rate and the US unemployment rate of 6.3% for the same period. In total, the combined casino closures in the past year are likely to reduce employment in the city by approximately 7,000.

Although the string of recent closings may initially benefit the remaining casinos in Atlantic City, that benefit may be short lived given that the number of gaming venues in the broader Mid-Atlantic region is growing. For this reason, we expect that gaming revenue will continue to drop in the Atlantic City market (see Exhibit 1). Moreover, the financial challenges facing many of the remaining casino operators in Atlantic City limit their ability to make investments that would help them compete against regional peers.

Atlantic City, New Jersey’s Annual Casino Revenues

Source: New Jersey Gaming Commission

On top of the competitive issues that will continue to challenge Atlantic City, casino gaming throughout the US, including Atlantic City, is experiencing a decline in revenues. We attribute this trend largely to an uneven economic recovery that has hurt consumers in middle and lower socio-economic brackets. This includes middle age consumers grappling with under-employment, funding college education for their

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2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

$ Bi

llion

s

Vito Galluccio Analyst +1.212.553.2738 vito.galluccio@moodys.com

Baye Larsen Vice President-Senior Analyst +1.212.553.0818 baye.larsen@moodys.com

Peggy Holloway Senior Vice President +1.212.553.4542 margaret.holloway@moodys.com

NEWS & ANALYSIS Credit implications of current events

15 MOODY’S CREDIT OUTLOOK 14 AUGUST 2014

children, and caring for aging parents, and who have both less time and lower disposable income available for gaming.

Revel’s closure will have minimal direct effect on the state’s revenues or economic recovery. The 3,100 jobs eliminated at Revel equals less than 0.1% of the state’s total employment base. However, continued downsizing in the Atlantic City gaming and tourism market risks negatively affecting the state’s already-slow job recovery.

New Jersey’s primary revenue generated from casinos is an 8% tax on their gross gaming revenues after the casino pays out winnings to players. In addition, there are various state taxes on casino activities, including casino parking fees and a per-room per-day fee on casino hotel rooms. These taxes and fees have declined for the past five consecutive years and we estimate that they total $276 million, or just 0.9% of total state revenues.

Despite the relatively small size of the revenue stream, future casino closures and overall gaming weakness would challenge New Jersey’s budget balance. Although these revenues constitute a small portion of the budget, continued shortfalls have added to the state’s mid-year budget gaps. In the fiscal year ended 30 June, casino revenues were approximately $127 million below budget owing to the late implementation of online gaming, and so contributed nearly 10% of the state’s total $1.3 billion revenue shortfall in fiscal 2014.

NEWS & ANALYSIS Credit implications of current events

16 MOODY’S CREDIT OUTLOOK 14 AUGUST 2014

New Jersey Authorization of Infrastructure Loans Benefits State’s Water and Sewer Utilities

Last Friday, New Jersey Governor Chris Christie authorized $1.3 billion in low- and no-interest loans to water and sewer utilities in New Jersey through the New Jersey Department of Environmental Protection (DEP) and the New Jersey Environmental Infrastructure Trust (NJEIT, Aaa stable). The authorization, which was well beyond the few-hundred-million-dollar allocations of past years, is credit positive for municipal utilities in the state, including the Passaic Valley Sewerage Commission (A2 negative) and Passaic Valley Water Commission (A1). Other beneficiaries are cities and counties with general-obligation-guaranteed water or sewer debt, including the City of Jersey City (A2 positive), Ocean County (Aaa negative) and Middlesex County (Aa2 stable).

Low- and no-interest New Jersey Environmental Infrastructure Financing Program (NJEIFP) loans offer utilities a way to fund infrastructure at a low interest cost relative to bonds or bank loans. Depending on the loan program, loans from the NJEIFP have components that are interest-free (the portion funded by the DEP) and a direct pass-through from the NJEIT’s interest costs on its bonds. Long-term financing loans have for the past few years been 75%-funded by the DEP (fund loans) and 25%-funded by NJEIT bonds (trust loans), meaning that if the NJEIT’s bonds yield 4%, the net interest cost on its loans would be about 1%. In 2014, blended interest rates on NJEIFP base program loans ranged from 0.7% to 0.8%%, compared with average state and local borrowing rates4 of 4.2%. The trust also provides debt service savings by forgiving portions of borrowers’ principal and other features.

The impetus for the larger-than-usual loan authorization was the estimated $2.6 billion of damage the state’s water and sewer infrastructure sustained in 2012 from Superstorm Sandy. The storm damaged 400 water systems and 94 wastewater treatment plants in the state. The authorization encompasses about 235 loans written into state legislation earlier this year (see exhibit), most of which are dedicated to Sandy-related projects. Some utilities will also use NJEIT loans to bridge the delay in receiving Federal Emergency Management Agency (FEMA) reimbursements.

4 Bond Buyer Index of mixed-quality 20-year bonds.

Dan Seymour, CFA Analyst +1.212.553.4871 dan.seymour@moodys.com

Richard Kubanik Analyst +1.212.553.7823 richard.kubanik@moodys.com

NEWS & ANALYSIS Credit implications of current events

17 MOODY’S CREDIT OUTLOOK 14 AUGUST 2014

The Largest Recipients of $1.3 Billion of NJEIFP Allocations

Borrower Rating Allocation Allocation Relative to

Utility Revenues

Jersey City Municipal Utilities Authority

A2 positive (general obligation)

$148.4 million 1.3x

Middlesex County Utilities Authority

Aa3 (pool) $130.8 million 1.6x

Stony Brook Regional Sewerage Authority

Aa2 (pool) $62.6 million 4.1x

Bayshore Regional Sewer Authority

Unrated $42.8 million 3.1x

Milltown Borough A1 (general obligation) $42.4 million 3.5x

North Jersey District Water Supply Commission

Unrated $41.7 million n/a

City of Elizabeth Aa3 stable $35.4 1.6x

Pequannock Township Aa2 (general obligation) $34.6 million 5.8x

New Jersey-American Water Company, Inc.

A3 stable $31.5 million negligible

City of Newark Baa1 negative (general obligation)

$28.5 million 0.3x

Source: NJEIT and Moody’s Investors Service

The $1.3 billion allocation and the allocations for the recipients shown in the exhibit are the maximum total loan amounts, but the actual amount borrowed could be lower.

Greater NJEIFP loan availability reduces interest costs, which leads to stronger debt service coverage. For utilities using these loans to bridge gaps in FEMA reimbursements, the loans bolster liquidity until the reimbursements come through.

Many water and sewer utilities in New Jersey carry a general obligation guaranty from a parent city or county, so the benefit of this financing accrues to the parent in the form of reduced risk of the guaranty being called upon. Several regional utilities in the state are loan pools supported by municipal customers’ general obligation pledges; the beneficiaries in these cases are the general obligation guarantors.

The allocation does not weaken the credit quality of NJEIT’s revenue bonds, which will maintain strong credit quality owing to the size, diversity and strength of its loan pool.

NEWS & ANALYSIS Credit implications of current events

18 MOODY’S CREDIT OUTLOOK 14 AUGUST 2014

Michigan School District Financial Emergency Underscores Persistent Fiscal Pressure in Sector On Monday, Michigan (Aa2 positive) Governor Rick Snyder determined that a financial emergency exists in the Benton Harbor Area School District (BHASD, unrated) following an independent review team’s finding of an emergency on 1 August. The governor’s declaration is the latest example of credit negative trends for the Michigan school districts we rate, 50% of which we have downgraded since 2009.

BHASD can appeal the governor’s declaration, but absent that, it must choose one of four options: consent agreement, emergency manager, neutral evaluation process or a Chapter 9 bankruptcy. The first two options would be credit positive because they would involve increased state oversight to help stabilize financial operations and potentially stave off attempts to write down debt. The state currently has a consent agreement with the Pontiac City School District (PCSD, Caa2 negative) and emergency managers in three other districts.

BHASD has struggled with a general fund deficit since the fiscal year that ended 30 June 2007, making little, if any, headway in addressing an operational imbalance caused primarily by a cumulative 32% decline in enrollment. Enrollment decline is the key driver behind the district’s financial deterioration, since Michigan school funding is based on a per-pupil formula established by the state. BHASD’s audited financial statements for fiscal 2013 show a deficit general fund balance of $15.5 million, or 51% of revenue. The district estimates it closed fiscal 2014 with a $14.7 million deficit, equal to 46% of revenue (see exhibit).

Benton Harbor Area School District’s General Fund Balance

Source: Benton Harbor Area School District audited financial statements and report of the financial review team:

In 2010, the Michigan Department of Education granted BHASD a six-year time frame to eliminate its cumulative deficit under a deficit elimination plan. Since then, a slight improvement in the negative position is due solely to the closure and sale of district facilities in fiscal 2012 and $2 million emergency state loans each in September 2012 and December 2013.

The state education department initiated a preliminary financial review of BHASD in December 2011 and found evidence of probable financial stress. Yet, the department indicated that the district’s facility sales, together with other actions, precluded the need for a financial review team assessment. After the 2011 review, the district’s fiscal stress escalated as operations remained imbalanced by $1.3 million in fiscal 2013. Improvement in the deficit in fiscal 2013 was entirely the result of the first of the two emergency loans. In

-$18

-$16

-$14

-$12

-$10

-$8

-$6

-$4

-$2

$0

2007 2008 2009 2010 2011 2012 2013 2014 Estimate

$ M

illio

ns

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

Michelle Chalker Associate Analyst +1.312.706.9973 michelle.chalker@moodys.com

NEWS & ANALYSIS Credit implications of current events

19 MOODY’S CREDIT OUTLOOK 14 AUGUST 2014

March 2014, the state education department initiated a second preliminary financial review that ultimately led to this month’s declaration of a financial emergency.

Governor Snyder also declared a financial emergency for the Pontiac district after several years of fiscal decline. PCSD first recorded a general fund deficit balance at the close of the fiscal year that ended 30 June 2009, and the deficit grew to 87% of revenue as of fiscal 2013. In May 2013, the district defaulted on debt as very tight cash flow margins drove it to divert available cash to payroll and other core operating expenses. The consent agreement, signed in August 2013, outlines various requirements for the district, including the submission of monthly budget reports to the state treasurer. Although significant pressure remains on PCSD, additional state oversight has improved operational management and likely assisted in the district receiving a $10 million emergency loan in April 2014.

CREDIT IN DEPTH Detailed analysis of an important topic

20 MOODY’S CREDIT OUTLOOK 14 AUGUST 2014

Morgan Stanley and Goldman Sachs: Business Mix, Profitability and Risk Controls Separate the Two US Investment Banks

This is an excerpt from a 19-page report that can be found here.

Only two large traditional US investment banks – The Goldman Sachs Group, Inc. (Baa1 stable) and Morgan Stanley (Baa2 positive) – survived the 2008 financial crisis, and each has responded differently to the regulatory and market challenges they face in the aftermath. We judge Goldman the better credit risk: its debt rating has been a notch above Morgan Stanley’s since the financial crisis. But on 24 July we changed Morgan Stanley’s ratings outlook to positive, reflecting the progress the firm continues to make in strengthening its profitability, particularly within its non-capital markets businesses, and in reducing the risk of its capital markets business.

Our positive outlook for Morgan Stanley reflects fundamental business transformation and financial improvements. These positive trends are the fruit of the firm’s multi-year transformation, which sought to significantly expand its wealth management business, enhance its risk management and controls and reduce its reliance on capital markets activities. At the same time, the firm has maintained its strong risk-based capital position and liquidity profile. The positive outlook reflects the potential that should these trends continue, Morgan Stanley’s ratings could be upgraded, which would eliminate the rating difference between it and Goldman Sachs.

Goldman’s higher ratings reflect stronger and more stable performance despite its greater reliance on the capital markets; the bank’s more limited legacy and restructuring costs highlight its strong control and risk functions. By contrast with Morgan Stanley, Goldman Sachs adopted a more gradualist approach, remaining more reliant on capital markets activities and refining its existing businesses to comply with the new regulatory and operating environment, rather than significantly changing its business mix. Notwithstanding the challenging capital markets environment, Goldman has produced stronger and more consistent earnings than Morgan Stanley over the past several years. We believe this reflects Goldman’s stronger capital markets franchise, its independent, empowered control and risk functions and its more limited legacy and restructuring costs. The difference in the standalone financial strength of the two firms is reflected in their baseline credit assessments (BCAs): Morgan Stanley has a BCA of baa3, while Goldman has a BCA of baa1.

Both firms still command a significant market share and maintain top rankings on capital markets league tables, but Morgan Stanley’s profitability has lagged and is more volatile. Despite a major makeover of its capital markets business, Morgan Stanley’s fixed income, currencies and commodities businesses continue to consume significant capital, and remain a drag on the firm’s profitability. Goldman is not immune to such challenges, but has been more successful in earning its cost of equity.5 Despite limited diversification outside of its capital markets operations, Goldman generates relatively stable earnings that are superior to most other global investment banks.

To improve its baseline credit assessment and close the ratings gap with Goldman, Morgan Stanley must generate more consistent and less volatile earnings without incremental risk-taking. Our positive ratings outlook for Morgan Stanley reflects the progress it has made thus far. But firm-wide profitability remains below management targets and we believe absent higher returns the firm will face growing pressure to

5 This is based on our estimate of the firms’ cost of equity using a capital asset pricing model. Although estimated cost of equity

varies by firm, in this report we assume a range of 10%-12% for the industry.

David Fanger Senior Vice President +1.212.553.4342 david.fanger@moodys.com

Anna Sherbakova Analyst +1.212.553.7946 anna.sherbakova@moodys.com

CREDIT IN DEPTH Detailed analysis of an important topic

21 MOODY’S CREDIT OUTLOOK 14 AUGUST 2014

increase risk-taking or undertake more a significant restructuring. A critical component of stronger firm-wide profitability for Morgan Stanley is strengthening the returns of its fixed income business despite significant headwinds that are affecting the entire industry and will make achieving this goal a challenge. To be successful without adding more risk, Morgan Stanley will need to ensure that it sustains its comprehensive post-financial crisis improvements in risk governance, management and internal control processes and that they are consistently adhered to throughout the firm. Goldman’s stronger franchise and risk-management performance are driven by sustained investment in people, processes and technology.

Continued heavy reliance on short-term wholesale funding makes confidence sensitivity an important ongoing challenge. The wholesale funding of both firms is down relative to levels before the global financial crisis. Nonetheless, both firms still rely heavily on short-term secured funding which, together with large trading exposures, leaves them vulnerable to a loss of counterparty or funder confidence. Although both firms are increasing deposit funding, the expansion of Morgan Stanley’s wealth management business has resulted in more substantial growth in relationship-based core deposits. If deployed prudently, the increased deposits at Morgan Stanley could reduce the firm’s vulnerability to confidence sensitivity. Morgan Stanley’s strategic alliance with Bank of Tokyo-Mitsubishi UFJ (MUFG) also helps mitigate the risk posed by the confidence sensitivity of its funding profile by providing a potential source of alternative liquidity. The potential for support from MUFG provides a one-notch uplift to Morgan Stanley’s ratings and is reflected in Morgan Stanley’s adjusted BCA of baa2.

Comparison of Goldman Sachs’ and Morgan Stanley’s Key Credit Characteristics

Strategic Position

Goldman: Gradualist approach to refining compliance of existing business with new regulation. Business model remains largely intact and returns are satisfactory as firm adapts to changing environment.

Morgan Stanley: More aggressive approach; significant reduction in capital markets business, while expanding wealth management franchise. Still vulnerable to execution risk within fixed income, currencies and commodities, and plans to aggressively grow lending.

Profitability Goldman: Relatively low earnings volatility and solid returns on equity (albeit well below pre-crisis). Steep revenue decline from pre-crisis levels instigated by both a challenging capital markets environment and Volcker Rule restrictions. Firm has offset the effect of the decline by shrinking compensation expenses, partially offset by higher non-compensation expense.

Morgan Stanley: Higher earnings volatility and returns on equity remains modest, albeit gradually improving. Decline in capital markets revenues partially offset by expanding wealth management franchise, a key strategic shift in business mix for the firm. However, this has also pushed its expense base higher, along with litigation and integration costs.

Business Segment Performance

Goldman: Capital Markets’ return on equity is higher and less volatile. Investment Management has had more success in attracting net new assets outside of lower-margin liquidity products. Investing & Lending is more volatile than capital markets, but has higher returns on equity. However, limitations imposed by Volcker Rule could dampen returns in Investing & Lending.

Morgan Stanley: Capital Markets’ returns on equity lags Goldman, despite strong performance in equities and investment banking. Lower fixed income, currencies and commodities revenue yield highlights the challenges in that business. Wealth Management performance has improved significantly, although pre-tax margins still lag peers. Favorable market conditions have improved revenues in Investment Management since 2012; returns on equity and volatility levels are similar to Goldman’s when Investment Management and Investing & Lending (reported as two separate segments) are combined.

Confidence Sensitivity

Goldman: The firm still heavily relies on secured short-term wholesale funding, and an extended period without access to wholesale funding would shrink balance sheet enough to impair franchise value and earnings, notwithstanding robust liquidity profile. It is growing deposit funding, but will lag Morgan Stanley, leaving it potentially more vulnerable to a loss of confidence.

Morgan Stanley: Increase in deposits may help reduce confidence sensitivity, but wholesale funding reliance remains significant. Bank of Tokyo-Mitsubishi UFJ has signaled it is willing to aid the firm in a search for additional funding. This support and strategic alliance provides one notch of uplift to Morgan Stanley’s ratings.

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

22 MOODY’S CREDIT OUTLOOK 14 AUGUST 2014

NEWS & ANALYSIS Corporates » Gannett Stretches Leverage with Cars.com Purchase and

Publishing Spin-Off » Platform’s Deal to Buy Agriphar Unit Increases Its Leverage » Mexichem’s Gain of PVC Foothold in Europe Is Credit Positive » PDVSA Would Lose Key US Foothold with CITGO Sale, but

Improve CITGO’s Management » Delta Debtco Benefits from Discontinuation of Formula One

CEO’s Trial » Telefonica’s Acquisition of GVT Would Strengthen Its Market

Position in Brazil » Metro AG Sale of Vietnamese Operations Is Credit Positive » Voyage Care’s Change of Ownership Is Credit Positive » Looser Home-Purchase Rules in Foshan, China, Are Credit

Positive for Property Developers

Infrastructure » Mexico Plan Relieves PEMEX and CFE of up to 30% of Pension

Liabilities, a Credit Positive » UK Regulator Throws Cold Water on United Utilities’ and Bristol

Water’s Spending Plans, a Credit Negative

Banks » Less Margin for Error Has US Banks Running Uphill » US Rejection of Living Wills Makes Creditor Losses Less Likely for

Systemically Important US Banks

» US Department of Justice Subpoena for GM Financial Is Credit Negative

» Singapore’s New Liquidity Coverage Ratio Is Credit Positive for Largest Banks

» Singapore’s Proposed Basel III Leverage Ratio Guidelines Are Credit Positive

Sovereigns

» Italy’s Recession Adds Headwinds to Country’s Fiscal and Structural Reform

» Bangladesh Remittances Climb to a Record High, a Credit Positive for the Sovereign

Sub-Sovereigns » Mexican Energy Sector Reforms Are Credit Positive for Oil- and

Gas-Producing States

Rating Changes

Last week we upgraded Allison Transmission, Hellenic Telecommunications Organization, Southwest Airlines, USG, Interconexion Electrica, Beijing Enterprises Holdings Limited, Bank Negara Indonesia, Seguros Generales Suramericana, Seguros de Vida Suramericana, Sura Asset Management, and Athens (Greece) and downgraded Coso Geothermal Power Holdings, Deutsche Bank Mexico, and Oesterreichische Volksbanken, among other rating actions.

Research Highlights

Last week we published on Australian high-yield mining, US retailers, US building products, Moody’s Asian Liquidity Stress Index, US beverage industry, corporate credit quality, global mining, US merchant power outlook, electricity grids in Russia and Europe, Singapore power, Basel III implementation, UK banks, Taiwan banks, Australian banks, global investment banks, East African Community banks, US insurers, Bolivian banks, Morgan Stanley and Goldman Sachs, France, Peru, Cyprus, Greece, population and economic growth, Argentina, Vietnam, Canadian universities, Mexican states and municipalities, US money market reforms, Volkswagen’s auto ABS, and Asia-Pacific structured finance, among other reports.

MOODYS.COM

Report: 174325

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EDITORS PRODUCTION ASSOCIATE News & Analysis: Elisa Herr and Jay Sherman Sol Vivero