news & analysispg.jrj.com.cn/acc/res/cn_res/invest/2016/7/14/c90e...and 9% of as-reported...

MOODYS.COM

14 JULY 2016

NEWS & ANALYSIS Corporates 2 » Thomson Reuters’ Planned Divestiture of Its Intellectual

Property & Science Business Is Credit Positive » China Travel Service Will Benefit from Parent’s Merger with

China International Travel

Infrastructure 4 » US Ports Will Benefit from Federal Effort to Improve

Freight Mobility » Argentine Court Ruling Revoking Tariff Increase Is Credit

Negative for Gas Utilities » Kyushu Electric Faces Lower Earnings from Election of Anti-

Nuclear Candidate in Japan’s Kagoshima Prefecture

Banks 9 » Nykredit Realkredit’s Resolution Notes Increase Buffers for

Senior and Covered Bond Investors, a Credit Positive

Sovereigns 11 » Iraq’s IMF Deal Will Lower Fiscal and Balance-of-

Payments Challenges » Australian Government’s Slim Majority Will Challenge Its

Ability to Pass Fiscal Measures

US Public Finance 15 » US Municipal Borrowers to Benefit from Plunge in Bond Yields » Pennsylvania’s Unbalanced Budget Poses a Greater Risk than

Not Having One » Five New York Municipalities Receive Credit-Positive State

Grants for Downtown Revitalization » Court Ruling on Fort Worth Pension Contributions Is Positive

for It and Other Large Texas Local Governments

RECENTLY IN CREDIT OUTLOOK

» Articles in Last Monday’s Credit Outlook 23 » Go to Last Monday’s Credit Outlook

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

NEWS & ANALYSIS Credit implications of current events

2 MOODY’S CREDIT OUTLOOK 14 JULY 2016

Corporates

Thomson Reuters’ Planned Divestiture of Its Intellectual Property & Science Business Is Credit Positive On Monday, Thomson Reuters Corporation (Baa2 stable) said that it had agreed to sell its Intellectual Property & Science (IP&S) business to private-equity funds affiliated with Onex Corporation and Baring Private Equity Asia for $3.55 billion in cash. The planned divestiture is credit positive because Thomson Reuters plans to use the proceeds to repay debt.

Pending the requisite regulatory approvals, Thomson Reuters expects to close the sale in the next few months. IP&S is the smallest of the company’s four business units, accounting for roughly 8% of revenue and 9% of as-reported adjusted EBITDA for 2015, the most recent period for which IP&S was a reportable segment. Based on the company’s press release, we expect Thomson Reuters to use a portion of the net proceeds to repay outstanding commercial paper ($1.5 billion was outstanding as of 31 March 2016), resulting in estimated pro forma total debt/EBITDA, as adjusted by us, of 2.8x, down from about 3.0x for the 12 months that ended 31 March 2016.

IP&S has been challenged by lack of scale relative to larger players in the industry. Subscription revenue, which constitutes about 80% of the unit’s revenue, increased 3% in 2015 over the prior year. However, transaction revenue declined 4% owing to lower sales in the government and academia and intellectual property areas, which led to 1% organic revenue growth in 2015 (or a 1% decline including foreign currency exchange effects). IP&S’ EBITDA margin also declined 130 basis points to 31.3% last year, versus 32.4% in 2014.

The planned IP&S divestiture will allow Thomson Reuters to focus its resources on the three remaining segments: financial and risk; legal; and tax and accounting. The company is in the midst of a multi-year effort to lift organic revenue growth to the mid-single-digit range from a previous range of a 1% decline to a 1% increase.

Gregory A. Fraser, CFA Vice President - Senior Analyst +1.212.553.4385 [email protected]

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



China Travel Service Will Benefit from Parent’s Merger with China International Travel On Monday, China’s State-owned Assets Supervision and Administration Commission announced that it had approved the merger of China National Travel Service (HK) Group Corporation (CNTS, unrated) and China International Travel Service Group Corporation (CITS, unrated), and that CITS would be consolidated into CNTS as a wholly owned subsidiary. Beyond improving efficiencies, strengthening the combined entity’s competitive position and generating cost savings, the merger will be credit positive for CNTS subsidiary China Travel Service (Holdings) Hong Kong Ltd. (CTS, Baa3 negative) because CTS will benefit from CNTS’ strengthened capacity to support CTS.

The merged companies will become one of China’s largest travel service companies, with revenues of at least RMB52 billion and assets of at least RMB116 billion. CTS’ Baa3 issuer rating incorporates a two-notch uplift based on our expectation of strong support from CNTS. The combined group will have larger scale in terms of revenues and assets, and more stable earnings, enhancing CNTS’ ability to provide support.

CNTS in 2015 had revenues of RMB30.8 billion, adjusted EBITDA of RMB4.5 billion, adjusted debt of RMB28.7 billion, assets of RMB100.6 billion, and adjusted debt/EBITDA of 6.4x. CTS is CNTS’ core business.

CNTS is well positioned to receive strong support from the Government of China (Aa3 negative), in case of need, because it is 100% state-owned. CNTS is strategically important to the China travel services industry, providing travel-document services to residents in Hong Kong, Macau, and Taiwan. We expect this support to flow through to CTS via its parent.

CITS’ core operating entity, China International Travel Service Corporation Limited (unrated), mainly provides travel agency services, sells duty-free products in stores at airports and seaports and on flights, and develops and manages real estate at tourist resorts. It had 2015 revenues of RMB21.3 billion, reported EBITDA of RMB2.5 billion, reported net income of RMB1.7 billion, reported debt of RMB110 million, and assets of RMB15.7 billion.

Established in 1928, Hong Kong-based CTS focuses on travel services, real estate development, and logistics. The travel service segment provides travel agency services, and operates hotels and tourist attractions. Completion of the transaction requires the fulfilment of relevant conditions.

Chenyi Lu Vice President - Senior Analyst +852.3758.1353 [email protected]

Tina Xu Associate Analyst +852.3758.1431 [email protected]



Infrastructure

US Ports Will Benefit from Federal Effort to Improve Freight Mobility On 6 July, the US Department of Transportation (DOT) recommended 18 grants totaling $760 million under the Fostering Advancements in Shipping and Transportation for the Long-Term Achievement of National Efficiencies (FASTLANE) program. The grants are credit positive for US ports because they support freight mobility projects in 16 states, alleviating congestion at both the ports and the major freight land routes into which they feed. Less congestion increases operating efficiency and throughput rates for ports, saves time and reduces transport costs for shippers.

The $760 million will supplement $2.8 billion of public and private funds, and is the DOT’s first award under the FASTLANE program, which was created in late 2015 and is launching as another significant transportation finance program, the Transportation Infrastructure Finance and Innovation Act (TIFIA), scales down. Although TIFIA benefitted a select number of port-related projects, it was primarily oriented toward passenger rather than freight traffic. The Harbor Maintenance Trust Fund (HMT), the primary source of federal aid to ports, solely focuses on dredging harbors, although funding levels are scheduled to increase, which will allow ports to shift capital resources to critical landside projects (see exhibit).

Authorized US Federal Government Spending Programs for Ports

Note: Fiscal years end 30 September. Sources: US Department of Transportation and the Water Resources Development and Reform Act of 2014

Ports and freight land routes have been strained as the size of container ships doubled over the past two decades. Ports have responded by spending significantly to deepen waterways, upgrade terminal infrastructure and improve intermodal connectivity, all while the federal government provided little financial support. Reflecting the demand for financial support, the DOT received 212 FASTLANE grant applications requesting a total of $9.8 billion, more than 10x the available amount.

By focusing on freight mobility projects, the FASTLANE program targets one of the more critical aspects of port operations: throughput and congestion management. Ports typically focus investments “inside the fence,” such as on their terminals and intermodal systems. However, ports function as gateways for shippers, intermediate rather than final points in the movement of freight from both ends of the supply chain, and the fluidity of freight downstream of the port is equally important to shippers in selecting which port to use. Although shippers choose ports based on a variety of factors, chief considerations are cost, reliability of service and the extent to which the transit route facilitates a faster time-to-market. Severe congestion impedes all of these factors and can lead to the loss of cargo for all but the major hub ports with must-serve markets in Southern California and New York.

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Moses Kopmar Analyst +1.212.553.2846 [email protected]



As ship sizes continue to grow and carriers consolidate their services at fewer ports, concentrated volumes, or surges, will further challenge throughput. The proposed grants focus on the largest gateways and most active freight corridors. In the Northeast, congestion relief focuses on the Port Authority of New York and New Jersey (Aa3 stable), the largest and most frequently visited port on the East Coast. The Port Authority will receive $11 million for a railcar barge/float program across New York Harbor to reduce local truck trips. Other recipients include funds for terminal redevelopment projects at the Massachusetts Port Authority (Aa2 stable) and the Port of Portland (unrated) in Maine to promote service at these secondary ports to minimize interstate highway traffic.

In the Southeast, $165 million went to the $900 million Atlantic Gateway project to facilitate truck freight movement, resolve rail freight bottlenecks and construct new rail capacity along a North/South corridor, which will benefit the Virginia Port Authority (senior lien revenue bonds Aa3 stable). The Port of Savannah (unrated) in Georgia, the second-largest gateway on the East Coast, will receive $44 million to reconfigure its on-dock intermodal container transfer facilities. On the West Coast, $61 million of grants will focus on rail-line bottlenecks with three projects, including $45 million for a grade separation that supports rail access between Port of Seattle (intermediate lien revenue bonds A1 stable) terminals, intermodal facilities and the state highway system.



Argentine Court Ruling Revoking Tariff Increase Is Credit Negative for Gas Utilities Last Thursday, a federal court in Argentina issued a resolution revoking the provisional tariff increase approved in April by the country’s Ministry of Energy. The court’s action is credit negative for Argentina’s gas distribution and gas pipelines because it returns the gas tariff to its March value, an amount that is insufficient for gas utilities to cover their operational and network maintenance expenses. Affected companies include Camuzzi Gas Pampeana S.A. (B3 stable), Distribuidora de Gas Cuyana S.A. (B3 stable), Gas Natural BAN S.A. (B3 stable), MetroGas S.A. (B3 stable) and Transportadora de Gas del Sur S.A. (TGS, B3 stable).

The revocation of the tariff increase will delay the affected companies’ earnings recovery and reestablishes the uncertainty and unpredictability of a market framework that with the tariff increase had become more supportive of regulated utilities for the first time in more than a decade. Additionally, the disruption created by the ruling will likely delay a definitive tariff regime that we had expected to be in place in second- quarter 2017.

The company most affected will be MetroGas because it has the largest losses and highest leverage among the affected companies. MetroGas’ last-12-month operating losses as of March 2016 totaled ARS452 million, or 20% of its revenues, and its financial debt outstanding was ARS2.4 billion. Additionally, MetroGas has accumulated ARS1.4 billion of commercial debt owed to its gas suppliers because the company had insufficient internal cash generation under the previous tariff regime. Had the court not nullified the tariff increase, MetroGas would have reported positive operating income at year-end 2016 of approximately ARS1.5 billion and an operating margin of 15%. TGS would be less affected because unregulated revenues, unaffected by the adverse ruling, significantly contribute to the company’s cash flows, constituting more than 70% in the past year.

The April tariff increase would have begun to reverse the deficits that companies had produced until the first quarter of this year. Our original estimate under the now-revoked tariff regime was that the companies this year would have reported positive operating results and sufficient internal cash to fund operating expenses and maintenance capex without needing to curtail payments to their gas suppliers.

We expect the government to appeal the ruling, but if the country’s Supreme Court confirms the decision and the companies do not receive any cash relief, they will need to curtail payments to their gas suppliers to fund their other operating expenses as they did before the tariff increase. On Monday, the government announced a revision of the tariff scheme approved in April that basically limits the gas bill increase to consumers to 400% of the amount paid the previous year, in an effort to avoid the adverse effects of a fully canceled tariff increase. Because the resolution to limit the increase has not been published yet, it is unclear if the revised decision will affect the court ruling or the Supreme Court’s final decision on the matter.

Daniela Cuan Vice President - Senior Analyst +54.11.5129.2617 [email protected]



Kyushu Electric Faces Lower Earnings from Election of Anti-Nuclear Candidate in Japan’s Kagoshima Prefecture On Sunday, anti-nuclear candidate Satoshi Mitazono ousted incumbent Yuichiro Ito to become governor of Japan’s Kagoshima Prefecture after running on a campaign platform that included suspending the operations of Kyushu Electric Power Company, Incorporated’s (A3 negative) Sendai nuclear reactors, which resumed last year. The election result is credit negative for Kyushu Electric because if Mr. Mitazono is able to make good on his campaign promise it will drive up its operating costs and lower the company’s earnings.

Kyushu Electric’s Sendai 1 and 2 nuclear reactors are Japan’s only two nuclear reactors to resume operations under new safety requirements since the Fukushima nuclear accident in March 2011 prompted the government to shutter all of Japan’s nuclear reactors. They are scheduled for maintenance inspections in October (for Sendai 1) and December 2016 (for Sendai 2) that each will take about two and a half months to complete. We estimate that shutting down the two reactors will lower Kyushu Electric’s profits by about ¥10 billion ($100 million) per month because the company will rely on costlier thermal power plants to supplement energy supply. Mr. Mitazono has no legal authority to stop reactors that are already in operation, but once the reactors stop for inspections, we expect that Kyushu Electric will need his approval to restart them.

Kyushu Electric was able to restart Sendai 1 in August 2015 and Sendai 2 two months later, which resulted in Kyushu Electric’s earnings increasing by ¥73 billion in fiscal 2015, which ended 31 March 2016. Because the inspection is scheduled for late this year, the negative effect on earnings for fiscal 2016 will be limited should Mr. Mitazono disallow the reactors’ resumption. However, the effect will be material for fiscal 2017 if the two reactors do not resume operations. All else equal, Kyushu Electric could report an ordinary loss (see Exhibit 1).

EXHIBIT 1

Kyushu Electric Ordinary Profits (Losses) Arising from Sendai Shutdown

Notes: Fiscal years end 31 March of the following year. The company passes changes in fuel prices to customers with about a four-month time lag that benefited the company last year in a declining oil price environment. The company expects the opposite this year, projecting a loss of ¥45 billion from the time lag. Sources: The company and Moody’s Investors Service estimates

Kagoshima Prefecture has limited tax revenue sources and relies on central government transfers (see Exhibit 2). Several prefectural taxes levied on the Sendai nuclear plant have augmented the prefecture’s revenues (see Exhibit 3). Although Mr. Mitazono is pro-renewable energy, he appears to recognize that those alternatives cannot replace the power supply generated by the Sendai plant. As a result, we do not expect him to permanently halt the plant’s operations. However, negotiating with anti-nuclear activists who supported him through the election will take time, during which Kyushu Electric’s profits could decline, preventing the company from repairing its highly leveraged balance sheet in a timely fashion.

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EBIT - Interest Expense Restart of Sendai 1 and 2 Shutdown of Sendai 1 and 2 Time Lag

Kumiko Kakimoto Vice President - Senior Analyst +81.3.5408.4156 [email protected]

Mariko Semetko Vice President - Senior Analyst +81.3.5408.4209 [email protected]

Yukiko Asanuma Associate Analyst +81.3.5408.4215 [email protected]



EXHIBIT 2

Kagoshima Prefecture Local Tax Revenues as Percent of Total Revenue in Fiscal 2014

Source: Japan’s Ministry of Internal Affairs and Communications

EXHIBIT 3

Kagoshima Prefecture Revenues and Percent of Total Revenues from Sendai Nuclear Power Plants

Notes: Fiscal years end 31 March of the following year. Kagoshima Prefecture in June 2013 introduced a new levy that resulted in Kyushu Electric paying certain taxes for possessing nuclear reactors, even though the reactors were shut down. Source: Local Bond Association

We believe the election result in Kagoshima Prefecture signals a public backlash against nuclear power in some local areas. As a result, we expect ongoing uncertainty surrounding nuclear generation in Japan, including the risk of material litigation and associated delays in nuclear start-up and revenue generation.

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Total Tax Revenues - left axis Percent of Total Revenues from Nuclear Fuel Tax- right axis



Banks

Nykredit Realkredit’s Resolution Notes Increase Buffers for Senior and Covered Bond Investors, a Credit Positive Last Thursday, Denmark’s largest mortgage lender, Nykredit Realkredit A/S (Baa1 stable, baa11) issued €500 million of senior resolution notes following a similar sized issue in May. This type of senior unsecured security can be written down to absorb losses, ranking junior to unsubordinated debt if the entity were to enter resolution, and increases Nykredit Realkredit’s buffers in resolution, a credit positive for senior unsecured and covered bond investors.

In resolution, the notes may be written down permanently or converted into a subordinated instrument. Although the notes would be written down before the issuer’s senior unsecured debt, they rank senior to Tier 1 capital and Tier 2 capital. Contrary to the junior-senior securities developed in France, the principal loss-absorption feature is included as a contractual provision of these notes, reflecting that under Denmark’s implementation of the European Union’s Bank Recovery and Resolution Directive, the bail-in tool does not apply to mortgage institutions such as Nykredit Realkredit, but instead only to banks.

The contractual loss absorption feature aims to have the same effect as the general bail-in tool would for an institution to which bail-in applies. As a result, these notes can be used to fulfil Nykredit Realkredit’s 2% (of lending) legal debt buffer requirement. Together with the notes issued in May, Nykredit Realkredit now has covered about 32% of the requirement, which will be phased in toward 2020.

The Danish parliament adopted the debt buffer requirement for mortgage credit institutions in 2015 on top of ongoing increases in capital requirements. Denmark’s implementation of the European Union’s latest capital requirement directive has introduced a combined conservation, countercyclical and systemic buffer requirement that affects institutions’ current portfolios and their future lending. Any future deterioration in the credit quality of an institution’s loan portfolio would also increase risk-weighted assets and therefore capital requirements.

At the end of March 2016, Nykredit Realkredit reported a common equity Tier 1 ratio of 16.7%, a substantial increase from historical numbers, but still below the issuer’s 2019 target of 17.5%, which reflects the expected increased regulatory requirement. In February, Nykredit Realkredit said that it would complete an initial public offering to bridge part of the gap (see exhibit).

1 The ratings shown in this report are Nykredit Realkredit’s issuer rating and baseline credit assessment.

Swen Metzler Vice President - Senior Analyst +49.69.70730.762 [email protected]

John Hogan Assistant Vice President - Analyst +44.20.7772.5260 [email protected]

Maria del Mar Asensio Associate Analyst +44.20.7772.1078 [email protected]



Nykredit Realkredit’s Capital Buffers versus Target

Source: Nykredit Realkredit

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16.5% 16.7% 17.5%17.2%

20.1% 20.6%

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Sovereigns

Iraq’s IMF Deal Will Lower Fiscal and Balance-of-Payments Challenges Last Thursday, the International Monetary Fund’s (IMF) executive board approved a $5.34 billion, three-year Stand-By Arrangement with Iraq (unrated), which will be disbursed in 13 tranches over three years through June 2019. The agreement is credit positive for Iraq because it will improve liquidity at a time of heightened fiscal and balance-of-payments risks.

Iraq’s economy and government finances are suffering from the ongoing conflict with the Islamic State of Iraq and Syria (ISIS) and the steep drop in oil prices since mid-2014. The conflict has destroyed infrastructure, reduced economic activity in ISIS-occupied areas, and strained government resources, with expenditures now more heavily tilted toward military operations against ISIS. Meanwhile, lower oil prices have taken a toll on government revenues and the country’s external current account balance because oil accounts for more than 90% of total government revenues and almost 100% of goods exports.

The tight fiscal situation has also affected the government’s oil infrastructure development plans, which, in the absence of a recovery in oil prices, the country needs in order to increase oil receipts. The buildup of arrears to international oil companies led to subsequent downward revisions to investment budgets by about 50%, rendering the government’s 2020 production target of 6 million barrels per day (mbpd) less attainable. Oil production averaged 4.4 mbpd in the first five months of this year, while exports averaged only 3.3 mbpd (see Exhibit 1). Exports have not kept pace with production increases because of oil pipeline sabotage in the north.

EXHIBIT 1

Iraq’s Oil Exports Remain Flat Despite Increase in Production

Sources: Iraq Ministry of Oil and Haver Analytics

With oil prices staying lower for longer and near-term export volume increases unlikely, the Stand-By Arrangement is critical for lowering external liquidity pressures. The IMF projects Iraq’s large fiscal deficit will widen further this year to 15% of GDP from 14% in 2015 and the current account deficit will widen to 11% of GDP from 6.4% over the same period. The government has financed the fiscal deficit largely from domestic banks, but also from the accumulation of domestic arrears. To fund the balance-of-payments shortfall, the authorities primarily resorted to drawing on foreign exchange reserves.

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Shirin Mohammadi Associate Analyst +1.212.553.3256 [email protected]

Steffen Dyck Vice President - Senior Credit Officer +49.69.70730.942 [email protected]



In 2015, year-over-year net foreign direct investment inflows declined by 30% to $3.2 billion, and net portfolio inflows dropped by 86% to about $630 million. Net other investment outflows nearly doubled to about $8.5 billion. At the same time, the country registered a current account deficit of about $10.4 billion. The gap between the current account and the capital and financial account was largely filled by a drawdown of foreign exchange reserves, which fell by $10.5 billion in 2015 (see Exhibit 2). In the first five months of this year, foreign exchange reserves fell by a further $4.9 billion (see Exhibit 3).

EXHIBIT 2

Iraq’s Financial Account Net Flow Components

Note: Net errors and omissions (EO) is used to balance the current account (CA) and capital account (KA) with the financial account (FA). In principle, FA-CA-KA=0. If not (owing to several factors such as timing, valuation, data sources, etc., that can cause imbalances in the information recorded), countries use EO as a balancing item (FA-CA-KA-EO=0). Sources: Central Bank of Iraq, Haver Analytics and Moody’s Investors Service calculations

EXHIBIT 3

Iraq’s Foreign Exchange Reserves

Sources: Central Bank of Iraq, Haver Analytics and Moody’s Investors Service calculations

Access to the new IMF funding comes as the government seeks to postpone $800 million in annual debt repayments to the Paris Club of creditors until 2019, highlighting the severity and urgency of liquidity pressures.

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Australian Government’s Slim Majority Will Challenge Its Ability to Pass Fiscal Measures On Sunday, Australia’s (Aaa stable) incumbent Prime Minister Malcolm Turnbull claimed victory in the parliamentary election, with the latest results indicating that the coalition of the Liberal and National parties will govern with a weaker mandate than it has had over the past three years. A narrow win in the House of Representatives for the coalition, combined with the likelihood of a more splintered outcome in the Senate, is credit negative for the sovereign because it will challenge the government’s ability to implement measures aimed at curbing the budget deficit.

The results point to a small majority for the coalition government in the House of Representatives. As of Wednesday, the Liberal-National coalition held 76 seats and the Labor party had won 67 (see exhibit). Minor parties and independent representatives had five seats, while two were too close to call. A political party or coalition must win 76 seats to form a government.

Australia’s House of Representatives Composition Before and After the July Vote

Note: Outer ring is after July’s vote as of Wednesday evening (Australia time); inner ring is before the election. Source: Australian Electoral Commission

Successive Australian governments have reasserted their commitment to reducing the budget deficit, and we expect that the new government, when formed, will pledge similar objectives. The coalition previously proposed several measures aimed at reducing the budget deficit, including restricting tax advantages on superannuation contributions and restraining health, education and welfare spending. However, despite broad political consensus around the desirability of returning the budget balance to surplus, authorities have had difficulty implementing specific measures to achieve this.

The coalition’s now-narrower majority threatens to add to these challenges. Moderate nominal GDP growth as a result of lower corporate profits, following a decline in commodity prices, and muted wage growth will weigh on government revenues. Meanwhile, spending commitments on large budget items including health, education and social services limit the scope for reductions in overall expenditures. Without proactive measures to raise revenues or cut spending, Australia’s budget deficits will not narrow significantly and government debt will continue to rise. Additionally, all legislation must be approved by the Senate, where opinion is broadly split between the Liberal and National parties, Labor and a significant number of other parties and independents with varying agendas.

Robust real GDP growth will continue to bolster Australia’s credit quality. The positive effects of the weaker Australian dollar on services exports and the resilience of private consumption in an environment of stable unemployment and low interest rates will support real GDP growth of around 2.5% in coming years.

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Liberal/National Coalition Close Seat - Liberals/National Australian Labor Party Close Seat - Labor Party Others

Matthew Circosta Associate Analyst +65.6398.8324 [email protected]

Marie Diron Senior Vice President - Manager +65.6398.8310 [email protected]



Key determinants of Australia’s credit quality include whether authorities are able to effectively implement their fiscal objectives. House prices have risen rapidly and household debt has increased to high levels by historical and international standards. Developments in house prices and their effect on households’ spending and saving decisions will affect domestic growth, financial conditions and the health of banks, and will be important for the sovereign’s creditworthiness.



US Public Finance

US Municipal Borrowers to Benefit from Plunge in Bond Yields On 6 July, yields on long-term tax-exempt bonds hit an all-time low of 3.71% (see exhibit) amid the fallout from UK’s 23 June vote to leave the European Union and broader global economic anxiety. Short-term municipal note and variable rate yields also fell, although the effect was less pronounced and did not reach an all-time low. Lower yields on municipal notes and bonds are positive for state and local governments looking to plug cash-flow gaps by issuing short-term notes or to save money by refunding longer-term debt. It is also good news for issuers with upcoming new-money long-term debt issuances.

Bond Buyer Municipal Index Yield to Maturity The index measures yields on 40 long-term municipal bonds

Source: Bond Buyer

Longer-term tax-exempt bond yields at an all-time low is positive because it unlocks refunding opportunities for callable municipal bonds. Many issuers are saving a lot of money thanks to the sharp decline in yields. Issuers such as the states of Indiana (Aaa stable) and Michigan (Aa1 stable) along with the Pennsylvania Turnpike Commission (senior lien oil franchise tax revenue bonds Aa3 stable) have brought, or are in the process of bringing, refunding deals to market with estimated savings of upward of 20% of refunded par.

For issuers looking to fund capital projects with debt, low interest costs allow them to do so cheaply. According to the Bond Buyer, a 2042 maturity in a New York City Transitional Finance Authority (TFA, senior lien rated Aaa stable) issue, whose proceeds will finance part of New York City’s (Aa2 stable) capital plan, priced earlier this week at a yield of just 2.43%. By comparison, a 25-year TFA bond issued in 2011 priced at a yield of 4.7%. Similarly, the New York City Municipal Water Finance Authority (Aa1 stable) in an official statement said that its capital plan assumes long-term interest rates of approximately 5% on debt to be issued in 2016 and approximately 5.5% for debt to be issued in 2017. Current market levels provide for significant savings relative to those assumptions.

Although the drop in short-term note yields is more modest than the drop in long-term yields, it is also positive because it lowers the cost of funds for state and local governments to use tax anticipation notes and bond anticipation notes to bridge gaps in cash flows or begin construction projects with uncertain timetables.

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Dan Seymour, CFA Assistant Vice President - Analyst +1.212.553.4871 [email protected]



Coinciding as it does with the decisions by California (Aa3 stable) and Texas (Aaa stable) not to issue cash-flow notes this year (both once constituted the lion’s share of annual cash-flow note issuance), the drop in yields means issuers that do issue cash-flow notes, including the states of Oregon (Aa1 stable) and Colorado (Aa1 stable) and the cities of Los Angeles, California (Aa2 stable), and Philadelphia, Pennsylvania (A2 stable), will likely benefit from extremely low borrowing costs on their notes this year.



Pennsylvania’s Unbalanced Budget Poses a Greater Risk than Not Having One Last Monday, Pennsylvania (Aa3 negative) Governor Tom Wolf said that he would not veto the $31.5 billion budget that the legislature passed for fiscal 2017, which began 1 July, allowing it to become law. The passage of the budget is credit negative for the state because it appropriates money to spend without identifying how to pay for it. By passing a budget with a 5% spending increase without passing an associated package of revenue increases to fund it, Pennsylvania begins the fiscal year with what the governor estimates is a deficit of $1.2 billion.

An unbalanced budget in fiscal 2017 presents a greater risk to the state’s credit quality than did the lack of a budget for most of fiscal 2016. Working through the fiscal year without a budget in and of itself was not significantly credit negative for the state, but passing an unbalanced budget is. Indeed, the state not solving its budget gap head-on was always a greater risk than the budget impasse itself. Now facing a deficit, Pennsylvania officials will be tempted to roll deficits into long-term liabilities, namely by reverting to the state’s longstanding practice of underfunding its pension liabilities.

The state went nine months into fiscal 2016 without a full-year budget in place, a consequence of disagreements between the governor and the legislature over fundamental issues such as how to fund rising pension contributions, what tax rates should be, and how much to spend on public education. The state’s budget is structurally imbalanced by a magnitude of about $2 billion, as it ramps up pension contributions substantially amid a revenue growth rate of less than 4% (see exhibit).

Pennsylvania Projects Its Expenditures Will Grow Faster than Revenues

Source: Pennsylvania Independent Fiscal Office

Passing a structurally balanced budget, in which a state expects recurring revenues to be sufficient to pay for recurring spending, is a standard that most states strive to meet. When a state budget increases spending but does not show revenue growth to support that spending growth, the gap can be solved with further balancing actions, such as coming to agreement on revenue increases in a special legislative session. But when the difficult decisions cannot be reached, the gap can also be solved with credit-negative budget-balancing techniques such as deferring pension contributions, borrowing to fund spending growth or deferring other payments across the fiscal year.

In Pennsylvania, it is still possible that the legislature, having already passed the budget, will approve new revenues to pay for it in ongoing sessions this week. But if the legislature cannot agree on a way to structurally balance the budget and the state resorts to credit-negative budget-balancing techniques, this would be a more credit-negative development than the state’s chronically late budgets. Because the state drained its rainy-day fund years ago, it is approaching the point where it does not have significant available reserves to plug deficits.

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2015 Actual 2016 2017 2018 2019 2020 2021

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Ending Balance - right axis Revenues - left axis Expenditures - left axis

Dan Seymour Assistant Vice President - Analyst +1.212.553.4871 [email protected]



That said, having a budget in place is positive for public school districts, which, on average, get 40% of their revenues from state aid and will not have to scramble for cash the way they did last year. The budget is also positive, at least from a cash flow perspective, for community colleges, public universities and not-for-profit entities that receive state aid, all of which underwent a period of considerable uncertainty during last year’s budget impasse.



Five New York Municipalities Receive Credit-Positive State Grants for Downtown Revitalization On 6-7 July, New York (Aa1 stable) Governor Andrew Cuomo announced that the state would provide the municipalities of Plattsburgh (A2 negative), Geneva (A2 negative), Middletown (A1 no outlook), Westbury (Aa2 no outlook) and Elmira (Ba1 negative) with $10 million each for downtown revitalization. The grants are credit positive for these five municipalities, regardless of whether they use the funds for new projects or to offset the cost of projects already underway, either of which is permissible.

The grants are part of $100 million that the state will distribute equally to 10 municipalities statewide, one in each region. The state expects to announce the remaining five recipients shortly. The awards include $300,000 for a strategic planner to assist in drafting a strategic investment plan.

The grants provide significant investment in these small municipalities, which have limited tax-base growth or have below-average wealth levels, and stagnating populations (see Exhibit 1). The grant amounts are also significant relative to the municipalities’ fund balances (see Exhibit 2). Because the state is not restricting the grants to capital projects or new projects, the municipalities have the flexibility to use the funds for new initiatives or to offset the costs of projects that the municipalities were planning to fund from cash or additional debt issuance.

EXHIBIT 1

New York Grant Recipients’ Tax Base Contraction, Population Decline and Socio-Economic Profiles

Westbury Middletown Geneva Plattsburgh Elmira

Full Value $ Millions* $1,705 $1,227 $378 $927 $690

Five-Year Average Annual Growth in Full Value -4.80% -4.30% 1.50% 1.20% 2.20%

2010 Population 15,146 28,086 13,261 19,989 29,200

Percent Change in Population Since 1990 16.0% 16.3% -6.2% -6.0% -13.4%

2009 Per Capita Income as a Percent of US Median 123.1% 82.7% 76.5% 76.2% 63.7%

1989 Per Capita Income as a Percent of US Median 141.5% 93.8% 77.2% 81.9% 65.8%

Note: * Full Values for Plattsburgh, Middletown, and Geneva are from 2016, while full values for Westbury and Elmira are from 2015. Sources: US Census Bureau and Moody’s Investors Service

EXHIBIT 2

New York State Grants Relative to Municipalities’ Fund Balances

Note: Fund Balances for Westbury, Middletown and Geneva are from 2015, while fund balances for Plattsburgh and Elmira are from 2014. Sources: The municipalities’ audited financial statements

0%

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200%

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Westbury Village Middletown Geneva Plattsburgh Elmira

Valentina Gomez Analyst +1.212.553.4861 [email protected]

Vladimir Puchek Associate Analyst +1.212.553.3792 [email protected]



The grants are part of the state-developed Downtown Revitalization Initiative, which assists cities, towns and villages in transforming their downtown districts by formulating a strategic development plan, building on ongoing revitalization efforts and attracting additional investment. A key focus of the initiative is to attract the next generation of families to live and work in these neighborhoods. To that end, Plattsburgh, Geneva and Elmira plan to leverage the colleges in their respective communities. Middletown, located in Orange County, and Westbury, located on Long Island, benefit from their proximity to employment centers in New York City, New Jersey and Long Island, but both have experienced some tax-base declines.



Court Ruling on Fort Worth Pension Contributions Is Positive for It and Other Large Texas Local Governments On 1 July, a US federal appeals court ruled that the City of Fort Worth, Texas (Aa2 stable), did not violate the state constitution when it reduced pension benefits in 2012, a credit positive. The ruling upheld two previous lower-court rulings and allows the city’s pension reforms to continue as scheduled.

The court ruling may provide an avenue for other Texas local governments managing single-employer pension plans to reform costly plans. Yet, the amount of local control over pensions varies considerably. For some local plans, state statute guides benefit and contribution requirements, but in other cases, such as Fort Worth’s, local governments and local pension trustee boards have more control.

Fort Worth’s dispute centered on whether the state constitutional protection of local pensions locked in certain benefit formulas for the future service of current employees or alternatively allows for prospective benefit reductions. In 2012, the city adjusted future plan benefits including the average salary calculation and cost-of-living adjustment for current and future employees. The changes initially affected general employees and police officers, and in 2014 subsequently affected firefighters.

The city has noted the need to continue pension reforms as funding challenges remain. The city’s balance sheet is significantly more leveraged today than it was five years ago, primarily because of increasing pension liabilities (see exhibit). The city’s pension contribution rate has consistently fallen below actuarial requirements, which significantly contributes to the increasing liability. Furthermore, contributing at the actuarial-defined contribution level, which is not currently being met, would still be insufficient to cover the annual unfunded liability interest accrual.

Fort Worth, Texas’ Debt, Pension and Other Post-Employment Benefits Liability Unfunded pension liabilities are the main driver of increased leverage, a particular challenge for Fort Worth.

Note: * Figures are reported basis of unfunded liabilities. Revenues include general, debt service, and Crime Control and Prevention District tax collections. Sources: City of Fort Worth’s audited financial statements and Moody’s Investors Service

For the fiscal year that ended 30 September 2015, the city recognized pension expense of $80.8 million, or 10.6% of operating revenues, below the actuarial-defined contribution rate of $93.5 million, or 12.3% of operating revenues. The city’s contribution rate also fell well below our calculated “tread water” indicator of $133.2 million, which measures the annual government contribution required to prevent the reported net pension liability from growing, given attainment of assumed investment returns and other assumptions.

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Net Direct Debt Unfunded Pension Liabilities Other Postemployment Benefits Revenues

Andy Hobbs Assistant Vice President - Analyst +1.214.979.6844 [email protected]



Our fiscal 2015 adjusted net pension liability (ANPL) for the city, under our methodology for adjusting reported pension data, is $2.49 billion, above the reported unfunded actuarial accrued liability of $1.25 billion. When assuming the same level of contributions for pensions, the ANPL increases to roughly $3.26 billion for 2016. Under this calculation, the city’s ANPL would likely exceed 400% of its 2016 operating revenues.

The city’s pension task force continues to evaluate the plans’ funding progress in an effort to address the growing liability. The city also notes that in late 2017 it will be required under Texas House Bill 3310 to produce a plan to address the growing liability. We expect that the city will continue its efforts to address the plan’s funding challenge.

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


NEWS & ANALYSIS Corporates 2 » Newmont's Sale of Stake in Indonesian Mine Is

Credit Positive » Packaging Corporation of America's Acquisition of TimBar Is

Credit Positive » Honeywell's Planned Acquisition of Intelligrated Is

Credit Positive » WhiteWave Will Benefit from Its Acquisition by Danone » Danone's Acquisition of WhiteWave Is Credit Negative » Astaldi Resets Revolving Credit Facility Covenants, a

Credit Positive » Voith's Sale of KUKA Stake Is Credit Positive » Hutchison 3G Italy-Wind Merger Is More Likely with Iliad's

Entry as Italy's Fourth Mobile Operator, a Credit Positive » Hammerson Secures Ownership of Irish Shopping Centre, a

Credit Positive » Anhui Conch Terminates Asset Acquisition Agreement with

West China Cement, a Credit Negative for West China Cement

Infrastructure 14 » NatRural Completes Cable and Telco Assets Sales Near

Carrying Value, a Credit Positive » Regulators Approve Public Service of New Hampshire's

Divestiture of Generation Assets, a Credit Positive » Strengthening Environmental Regulation Is Credit Negative

for KEPCO and Subsidiaries

Banks 19 » US Banks Welcome Jump in Mortgage-Applications » Canadian Regulator's Increased Scrutiny of Residential

Mortgage Lending Is Credit Positive » UK Lowers Banks' Capital Buffer, a Credit Negative » Dutch Banks Will Pay for Alleged Derivative Product Mis-

selling, a Credit Negative » Austrian Banks Will Benefit from Government Plan to Reduce

Bank Levy » Norwegian Banks Will Benefit from Growing Seafood Exports » Ukraine Central Bank Tightens Banks' Credit Risk Supervision,

a Credit Positive » Completion of MKB Bank's Resolution Is Credit Positive » National Bank of Abu Dhabi and First Gulf Bank Proposed

Merger Is Credit Positive

Insurers 35 » Coface's Unexpected Spike in Loss Ratio Is Credit Negative » China's Revised Rules for Insurers’ Infrastructure Investments

Are Credit Negative

Money Market Funds 40 » UK Property Funds Suspend Redemptions, a Credit Negative

for Asset Managers and Insurers

Sovereigns 41 » Angola Suspends Program Talks with the IMF, a

Credit Negative » Sierra Leone Gains IMF Approval for $34 Million

Disbursement, a Credit Positive » Korea's Growth to Benefit from Strong Foreign Direct

Investment Commitments

Sub-sovereigns 47 » Carinthia Benefits from Austrian Legislation Paving Way for

Settlement with HETA Creditors

US Public Finance 48 » Kansas Tax Receipts Are Shy of Estimates Yet Again Amid

Modest National Revenue Growth » Mississippi Taps Rainy Day Fund Again, Narrowing Reserve

Position, a Credit Negative » Illinois Schools Benefit from Stopgap Budget; Pennsylvania

School Funding Remains Uncertain

MOODYS.COM

Report: 191078

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