MOODYS.COM

9 FEBRUARY 2017

NEWS & ANALYSIS Corporates 2 » Andrade Gutierrez Engenharia Will Benefit from New

Construction Projects in Argentina » Grupo Antolin’s Sale of Its Seating and Metal Business to Lear Is

Credit Positive

Banks 5 » Mexico’s Consumer Confidence Plunges, a Credit Negative

for Banks » Russia’s Proposal to Tighten Requirements for Consumer

Lenders Is Credit Positive » Raiffeisen Schweiz Abandons Planned Relaxation of Mortgage

Lending Criteria, a Credit Positive » Japanese Banks Would Be Hurt by Toshiba’s Issuance of

Preferred Shares

Insurers 12 » Validus’ Acquisition of ADM’s Crop Risk Services Is

Credit Positive » Old Mutual’s Redemption of Perpetual Preferred Securities Is

Credit Positive

Clearing Agencies 15 » DTCC’s Disposition of Non-Core Businesses Is Credit Positive

Asset Managers 16 » US Regulators’ Review of Fiduciary Rule Suggests Intent, but

Has No Immediate Effect

Sovereigns 17 » Greece Faces Negative Effects from IMF-ESM Creditor Discord

US Public Finance 19 » Boston’s Growth Will Lead to Surge in Property Tax Revenue, a

Credit Positive

RECENTLY IN CREDIT OUTLOOK

» Articles in Last Monday’s Credit Outlook 21 » Go to Last Monday’s Credit Outlook

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NEWS & ANALYSIS Credit implications of current events

2 MOODY’S CREDIT OUTLOOK 9 FEBRUARY 2017

Corporates

Andrade Gutierrez Engenharia Will Benefit from New Construction Projects in Argentina On Monday, Brazilian engineering and construction (E&C) company Andrade Gutierrez Engenharia S.A. (AGE, Caa2 negative) announced two new construction projects that will add BRL480 million ($153 million) to its backlog. The new projects are credit positive for AGE, demonstrating a further step in the firm’s resumption of normal operations after a May 2016 Brazilian federal court accepted the company’s settlement over corruption allegations.

AGE’s role in the construction and assembly of a coking plant and a fuel gas treatment plant for Axion Energy (unrated) in Argentina will bring AGE’s total project backlog to about BRL20.5 billion from about BRL16.8 billion as of September 2016. The additions help slow what has been a sharp drop in backlog additions in recent years (see exhibit).

AGE’s Project Backlog, 2012-16

Notes: Currency conversion: $1 = BRL3.14. Third-quarter 2016 figures are pro forma, including all new projects since the end of that quarter. Source: The company

The new contracts in Argentina reinforce a trend that began in December, when AGE, Brazil’s second-largest E&C firm, added to its project backlog for the first time since the May court decision. In December, AGE announced that it had signed a BRL3.1 billion transmission line contract with Equatorial Energia (unrated), followed by a smaller BRL50 million contract with Votorantim Metais (unrated) at the end of January 2017.

The new contracts reinforce AGE’s strategy of pursuing foreign and private contracts. Although the Argentine projects, AGE’s first in that country since 2013, increase its total backlog only modestly, they mark its first new contracts outside Brazil since the court decision. AGE will take charge of 80% of the new projects, teaming up with a local partner for the remainder.

BRL 30.5BRL 33.7

BRL 30.0BRL 25.2

BRL 16.8

BRL 3.7

BRL 0

BRL 5

BRL 10

BRL 15

BRL 20

BRL 25

BRL 30

BRL 35

BRL 40

2012 2013 2014 2015 Q3 2016

BRL

Billi

ons

Backlog Backlog Additions

Marcos Schmidt Vice President - Senior Analyst +55.11.3043.7310 marcos.schmidt@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 9 FEBRUARY 2017

Getting new projects on its backlog is crucial to stabilizing AGE’s revenues, which were about BRL4.4 billion for the 12 months through 30 September 2016. However, slower execution of infrastructure projects in Latin America amid commodity price weakness and fiscal consolidation efforts in several countries has reduced the availability of public funding to the sector and adversely affected AGE. At the same time, AGE and its Brazilian E&C peers are dealing with investors’ aversion to risk amid corruption investigations in Brazil. AGE’s revenue contracted 35.4% to BRL4.4 billion during the 12 months through 30 September 2016 because of the drop in financing availability, project cancellations and delays in collecting receivables.

As of September 2016, AGE’s BRL16.8 billion project backlog included 43 projects, 18% of which were in its home market. The diversified backlog includes hydropower, basic infrastructure, industrial and civil construction, and oil and gas projects. AGE had BRL1.0 billion in cash and total gross adjusted debt of BRL3.7 billion, including off-balance debt guarantees and contingency liabilities. The improvement in its backlog promises higher revenues and earnings in future quarters.

AGE in May 2016 settled corruption allegations connected to the Lava Jato scandal, which has badly shaken Brazil’s corporate, financial and political sectors for roughly two years, and involved accusations that numerous large companies in Brazil had engaged in bribery or other corrupt practices related to business contracts. Since the settlement, AGE has focused on strengthening its franchise and improving day-to-day operations under new, stricter compliance. The company has already secured some other significant partnerships with private clients in the transportation and energy segments, making new business opportunities more likely once E&C market fundamentals improve.

NEWS & ANALYSIS Credit implications of current events

4 MOODY’S CREDIT OUTLOOK 9 FEBRUARY 2017

Grupo Antolin’s Sale of Its Seating and Metal Business to Lear Is Credit Positive On Monday, Spanish auto-parts maker Grupo Antolin-Irausa, S.A. (Ba3 stable) announced that it had reached an agreement to sell its seating and metal business to Lear Corporation (Baa3 stable) for €286 million (implying an enterprise value/EBITDA multiple of around 5.2x). This transaction is credit positive for Grupo Antolin because it improves liquidity and flexibility, although it has no effect on the company’s ratings.

We estimate that the seating and metal business contributed around €360 million of revenue and €55 million of EBITDA (10% of the company-reported total). The disposal means that Grupo Antolin’s overall size will decrease and that the group’s average margin will decrease. Seating, along with lighting and doors, tends to have above-average margins (14%-16%, according to company reports), compared with 5%-6% for cockpits and 11%-12% for overheads. We estimate that the negative effect on group margins will be 20-30 basis points.

Grupo Antolin said that it will not use the disposal proceeds for debt reduction and we do not expect that the company will increase shareholder remuneration because of this transaction. Instead, the company plans to use the cash to pre-fund its existing capital expenditure program, which will support the company’s overall liquidity as well as its future funding, a credit positive.

However, there will be a small increase in leverage: we estimate that the disposal will increase leverage (as measured by Moody’s-adjusted debt/EBITDA) by around 0.3x to 3.5x-4.0x over the next two years from 3.0x-3.5x. Although this is a slightly higher range than we previously expected, we still forecast that leverage will remain comfortably within our quantitative guidance of below 4.0x for a Ba3 rating.

Even after its 2015 acquisition of Magna’s interiors business, Grupo Antolin’s seating business has been small compared with its other product lines, and overall the company was a niche player compared with global leaders such as Faurecia SA (Ba2 stable) and Lear. Therefore, we believe that the disposal makes strategic sense and allows Grupo Antolin to focus on its main offerings of cockpits, overheads and doors, all segments in which the company is a top-three player.

Scott Phillips Vice President - Senior Analyst +49.69.70730.718 scott.phillips@moodys.com

NEWS & ANALYSIS Credit implications of current events

5 MOODY’S CREDIT OUTLOOK 9 FEBRUARY 2017

Banks

Mexico’s Consumer Confidence Plunges, a Credit Negative for Banks Last Friday, Mexico’s National Institute of Statistics and Geography reported that the country’s consumer confidence index had plunged 15 points in January from the December 2016 level to its lowest level since 2001 and 23 points lower than in January 2016 (see Exhibit 1). The significant decline in consumer confidence is credit negative for Mexican banks because it provides a leading indicator that asset risks of consumer loans will increase and consequently reduce bank profits in 2017. Lower consumer confidence points to likely lower income for individuals because it reflects a perceived deterioration of households’ economic situation over the past 12 months and weakening expectations for the next 12 months.

EXHIBIT 1

Mexico’s Consumer Confidence Index Plunged in January (January 2008 = 100)

Sources: Mexico’s National Institute of Statistics and Geography and Banco de México

Among the largest banks, Banco Nacional de México, S.A. (Citibanamex A3/A3 negative, baa21) and BBVA Bancomer, S.A. (A3/A3 negative, baa2) will be most affected by the decline in consumer confidence because unsecured consumer loan books constitute 32% of Citibanamex’s total portfolio and 25% of Bancomer’s. Also exposed will be HSBC México, S.A. (Baa2/Baa2 stable, ba3), which posted the fastest consumer loan growth in 2016 and is among Mexico’s largest lenders, Banco Azteca, S.A. (Ba1 stable, ba3), BanCoppel, S.A. (unrated) and Banco Ahorro Famsa, S.A. (unrated), which focus on lending to low-income borrowers.

Mexican consumers are increasingly concerned about rising inflation, driven by the peso’s depreciation, a sharp rise in gasoline prices in January and tension about possible talks to renegotiate the country’s trade relationship with the US. Inflation has squeezed household income and, along with slowing economic growth, will hurt the repayment capacity of existing borrowers, especially in the low- and middle-income segments. At the same time, Mexico’s monetary authorities have hiked the benchmark policy rate 250 basis points over the past 12 months, which will dampen credit demand this year.

1 The bank ratings shown in this report are the banks’ deposit rating, senior unsecured rating (where available) and baseline credit

assessment.

0

10

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Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16 Jan-17

Georges Hatcherian Analyst +52.55.1555.5301 georges.hatcherian@moodys.com

Felipe Carvallo Vice President - Senior Analyst +52.55.1253.5738 felipe.carvallo@moodys.com

Vicente Gomez Associate Analyst +52.55.1555.5304 vicente.gomez@moodys.com

NEWS & ANALYSIS Credit implications of current events

6 MOODY’S CREDIT OUTLOOK 9 FEBRUARY 2017

Disappointing economic growth over the past two years has not prevented banks from seeking the higher spreads that consumer lending offers. Banks have expanded their consumer loan books at high multiples of about twice nominal GDP growth, reaching 12.4% in 2016 and 11.7% the year before, which will expose banks to deterioration as loan books begin to season.

Although the banking system’s nonperforming consumer loan ratio was a still-manageable 4.2% as of year-end 2016, bank earnings in 2017 could be reduced by further increases in credit costs related to deterioration in consumer financing. In fact, almost 8% of consumer loans were written off during 2016, leading to high credit costs that drained nearly 50% of core earnings. Consumer loans constitute an outsize 80% of total loan-loss provisions, despite being only about one fifth of the system’s gross loans. High credit costs bring Mexican banks’ return on assets down to Latin American averages, despite lenders’ ample net interest margins (see Exhibit 2).

EXHIBIT 2

High Credit Costs Are Eroding Mexican Banks’ Ample Net Interest Margins Annualized data for the first nine months of 2016.

Notes: *Brazil data for the first half of 2016. **Colombia data excludes Banco de Bogotá’s extraordinary gain related to a corporate restructuring. Sources: Moody’s Banking Financial Metrics, Chile’s Superintendencia de Bancos e Instituciones Financieras, Superintendencia Financiera de Colombia, Mexico’s Comisión Nacional Bancaria y de Valores and Peru’s Superintendencia de Banca, Seguros y AFP

We expect consumer delinquencies in 2017 to gradually increase as consumer confidence becomes further impaired by the ongoing uncertainties related to US trade and immigration policies. In particular, any decline in the inflow of remittances to Mexico will undermine the quality of low-end consumer credit.

0.0%

0.5%

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3.0%

3.5%

4.0%

4.5%

5.0%

5.5%

6.0%

Brazil* Chile Colombia** Mexico Peru

Net Interest Margin Net Income to Tangible Banking Assets

NEWS & ANALYSIS Credit implications of current events

7 MOODY’S CREDIT OUTLOOK 9 FEBRUARY 2017

Russia’s Proposal to Tighten Requirements for Consumer Lenders Is Credit Positive Last Friday, the Central Bank of Russia (CBR) published its proposed amendments to risk weights for high-yielding unsecured consumer loans, which will apply to loans issued after 1 March 2017. The proposed changes are credit positive for Russian consumer lenders because they will prevent the institutions from extending high-risk, high-yielding loans to financially weak borrowers by requiring banks to set aside substantial capital against those types of loans.

The newly proposed changes will most affect specialised consumer lenders because their lending rates are generally higher than those quoted by universal players. These lenders include Home Credit & Finance Bank (B2 stable, b22), Tinkoff Bank (B2/B2 positive, b2), Cetelem Bank (unrated), Vostochny Express Bank (Caa1/Caa1 negative, caa1) and CB Renaissance Credit LLC (B3/B3 stable, b3).

The risk weights are part of banks’ capital adequacy computation, and higher risk weights require banks to maintain larger capital buffers. Under the proposal, the CBR would increase the risk weights of loans bearing a full cost of loan3 of more than 20% per year, with loans having a full cost of 30%-35% per year subject to risk weights of 300%. Loans having a full cost of 35% per year and higher would be subject to risk weights of 600%. Currently, loans having a full cost of 45%-60% per year are subject to a 300% risk weight, while those above 60% are subject to a 600% risk weight. Exhibit 1 compares the current and proposed risk-weight requirements.

EXHIBIT 1

Central Bank of Russia’s Risk Weights for Consumer Loans Loan Category by Full Cost of Loan, as Defined by the CBR Current Risk Weights Proposed Risk Weights

Less than 20% 100% 100%

20% - 25% 100% 110%

25% - 30% 110% 140%

30% - 35% 110% 300%

35% - 45% 140% 600%

45% - 60% 300% 600%

Greater than 60% 600% 600%

Source: Central Bank of Russia

Through the full-cost cap mechanism, coupled with the imposition of progressively increasing risk weights for loans with high full cost, the CBR aims to curb excessive risk-taking by banks involved in consumer lending (see Exhibit 2). Such limitations were particularly effective during the 2015-16 banking crisis in Russia, when borrowers’ weakened financial standing triggered a spike in borrower defaults.

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

assessment. 3 Full cost of a loan is computed by banks based on a CBR-developed formula that depends on the loan interest rate, nature of

additional payments linked to the loan, payment schedule and other factors. Typically, the higher the full cost of a consumer loan, the riskier the loan in terms of the product type and/or the financial standing of the borrower. The full cost of a loan issued by any consumer lender in a given quarter must be no more than one third higher than the market average full cost of loans of this type published by the CBR in the preceding quarter.

Olga Ulyanova Vice President - Senior Analyst +7.495.228.60.78 olga.ulyanova@moodys.com

NEWS & ANALYSIS Credit implications of current events

8 MOODY’S CREDIT OUTLOOK 9 FEBRUARY 2017

EXHIBIT 2

Russian Market Average Full Cost of Select Consumer Loans

Note: POS = Point of Sale. Source: Central Bank of Russia

During the crisis, the CBR consistently tightened regulatory requirements in consumer lending, resulting in the aggregate stock of Russian banks’ consumer loans declining following a boom in 2012-14 (see Exhibit 3). In 2016, after a period of severe credit losses, consumer lenders gradually returned to breakeven profitability and intensified their new lending. However, the CBR apparently wants to revamp the regulatory landscape to completely remove any incentives for banks to enter the riskiest customer segments.

EXHIBIT 3

Russian Banks’ Consumer Loans Outstanding and Nonperforming, 2012-16

Note: We define nonperforming loans in this exhibit as those overdue by more than 90 days. Source: Central Bank of Russia

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4Q2014 1Q2015 2Q2015 3Q2015 4Q2015 1Q2016 2Q2016 3Q2016

POS-Loans for Less than 1 Year, up to RUB30 thousand POS-Loans for Less than 1 Year, RUB30-100 thousandCash Loans for Less than 1 Year, up to RUB30 thousand Cash Loans for Less than 1 Year, RUB30-100 thousand

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Banks' Consumer Loans Outstanding - left axis 90+ Overdue Consumer Loans - right axis

NEWS & ANALYSIS Credit implications of current events

9 MOODY’S CREDIT OUTLOOK 9 FEBRUARY 2017

Raiffeisen Schweiz Abandons Planned Relaxation of Mortgage Lending Criteria, a Credit Positive On Sunday, Swiss bank Raiffeisen Schweiz Genossenschaft (Aa2/A2 stable, a24) confirmed that it had abandoned plans to relax mortgage-lending criteria after the Swiss Financial Market Supervisory Authority and the Swiss National Bank (SNB) raised concerns about renewed momentum behind already-elevated house prices in Switzerland. The decision not to loosen lending criteria is credit positive for Raiffeisen Schweiz because it reduces the potential for further loan book expansion at the cost of taking on higher risk.

Over the past years, growth at Raiffeisen Group (unrated), for which Raiffeisen Schweiz is the central organization, has considerably outpaced the Swiss mortgage market. Curbing the bank’s lending appetite will allow its lending book to mature, particularly given that mortgage lending constituted 76% of its total assets as of the first half of 2016. Had Raiffeisen Schweiz gone ahead with its plan, other lenders likely would have followed suit, spurring greater demand for property and driving prices higher.

Raiffeisen Group initially announced plans to offer loans with relaxed limits on affordability assessments relating to interest rate hikes. This included applying a less conservative downside scenario that only considered a rise of mortgage lending rates5 to 3%, rather than the Swiss banking industry’s 5% standard. This would have meant providing easier access to mortgages for clients with lower income, while risking defaults on loan repayments if interest rates rise again.

Over the past 10 years, Raiffeisen Group has rapidly grown its mortgage book with a compound annual growth rate of 6.4% during 2007-16, versus the 4.1% market average, and increased its market share to 17% from 14% in 2006 (see exhibit). Given its less seasoned loan book and above-average growth amid elevated property prices, further market expansion by relaxing credit standards would have challenged the bank’s asset risk and standalone credit profiles.

Raiffeisen Group’s Mortgage Book Growth Has Outpaced the Swiss Average

Note: *Year-end 2016 forecast based on November 2016 data. Source: Swiss National Bank

4 The bank ratings shown in this report are Raiffeisen Schweiz’s deposit rating, senior unsecured debt rating and baseline credit

assessment. 5 Defined by the SNB as the imputed interest rate and used for calculation of affordability assessments.

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Switzerland Mortgage Loan Growth - left axis Raiffeisen Mortgage Loan Growth - left axisRaiffeisen Market Share - right axis

Andrea Wehmeier Vice President - Senior Analyst +49.69.70730.782 andrea.wehmeier@moodys.com

Mark C. Jenkinson Associate Analyst +49.69.70730.756 mark.jenkinson@moodys.com

NEWS & ANALYSIS Credit implications of current events

10 MOODY’S CREDIT OUTLOOK 9 FEBRUARY 2017

According to the SNB, it is critical that banks maintain risk exposures related to interest rate risks and the housing market at sustainable levels in order for the Swiss financial system to maintain its stability. However, the low-yield environment creates strong incentives for increased lending (accompanied by potentially higher interest rate risks) and a relaxation of lending criteria in order to meet profitability goals.

Raiffeisen Schweiz’s decision to abandon its plan is particularly significant given its large market share and the threat of further increases in Swiss house prices. House prices have risen nationally to elevated levels, posing a potential risk to the stability of the financial system. Only recently has real estate price growth begun to decelerate owing to a combination of stricter regulatory oversight and weaker economic growth. We expect prices to softly plateau. Raiffeisen Schweiz’s decision also illustrates the regulatory scrutiny banks are under, particularly against the backdrop of our estimate that real economic growth will be just under 2% during 2017-18.

NEWS & ANALYSIS Credit implications of current events

11 MOODY’S CREDIT OUTLOOK 9 FEBRUARY 2017

Japanese Banks Would Be Hurt by Toshiba’s Issuance of Preferred Shares On Sunday, The Japan Times reported that Toshiba Corporation (Caa1 review for downgrade) is considering issuance of ¥300 billion of preferred shares convertible into approximately 19.5% of the common shares of its profitable memory chip company, which it plans to spin off by 31 March 2017. The transaction, which Toshiba would not confirm, would be credit negative for Sumitomo Mitsui Financial Group, Inc. (SMFG, A1 stable), Mizuho Financial Group, Inc. (A1 stable) and Sumitomo Mitsui Trust Bank, Limited (SMTB, A1/A1 stable, a36) because it would dilute Toshiba’s ownership stake in the memory chip company upon the conversion of the preferred stock into the memory chip company common stock.

In the event of default, the dilution would diminish the potential recovery rate for creditors led by the three banks because the memory chip company will be one of the most valuable assets remaining at Toshiba. As of the end of March 2016, the three banks together funded ¥491 billion of Toshiba’s ¥1.5 trillion in borrowings (¥183.4 billion from Mizuho, ¥176.8 billion from SMFG and ¥131.0 billion from SMTB). The three banks had additional exposures through undrawn lending commitments totaling ¥405 billion as of the end of March 2016, but they have not disclosed the amount of their individual exposures.

Under the bank loan agreement that covers the majority of Toshiba’s ¥1.2 trillion total borrowings as of the end of September 2016, the banks can request that Toshiba provide collateral or guaranties. The dilution of Toshiba’s stake in the memory chip company would reduce the potential collateral value of the stake. This follows the ¥648 billion sale of Toshiba’s medical unit in the fiscal year that ended March 2016, and the transaction would further shrink the pool of assets available for creditors to claim as collateral.

The memory chip business is a key component of Toshiba’s Electronic Devices & Components segment, which contributed ¥78.3 billion, or 81%, of Toshiba’s operating income in the six months that ended September 2016. The proposed transaction suggests a valuation of approximately ¥1.5 trillion, based on the ¥300 billion price for approximately 20% of the memory chip company stock, which is much higher than Toshiba’s ¥1 trillion equity market capitalization as of 8 February.

The proposed capital raise by Toshiba follows its December announcement that it would book an impairment loss of up to “several billion dollars” on its US nuclear business. The Japan Times reported that the losses could reach ¥700 billion, with Toshiba facing the risk of reporting greater liabilities than assets when it posts its business results for the fiscal year ending 31 March 2017.

6 The bank ratings shown in this report are Sumitomo Mitsui Trust Bank’s deposit rating, senior unsecured debt rating and baseline

credit assessment.

Shunsaku Sato Vice President - Senior Credit Officer +81.3.5208.4159 shunsaku.sato@moodys.com

NEWS & ANALYSIS Credit implications of current events

12 MOODY’S CREDIT OUTLOOK 9 FEBRUARY 2017

Insurers

Validus’ Acquisition of ADM’s Crop Risk Services Is Credit Positive On Friday, Validus Holdings, Ltd. (Baa1 stable) provided additional details regarding its announced acquisition of Archer-Daniels-Midland-Company’s (ADM, A2 stable) Crop Risk Services (CRS) unit for a net purchase price of $117.5 million using cash on hand. The deal includes a seven-year marketing service agreement between Validus and ADM (extendible to 10 years at Validus’ option), which will allow Validus and CRS to enhance their market reach as they provide insurance and related services to ADM’s farm customer relationships. The acquisition is credit positive for Validus because it advances the company’s strategy of reducing its concentration in catastrophe reinsurance by growing its US specialty lines. Validus expects to acquire CRS in the second quarter of 2017, subject to regulatory approval.

CRS is a managing general agent that sells and underwrites primary crop insurance products to farmers and controls a portfolio of crop insurance policies. Crop insurance is a historically profitable business, with manageable earnings volatility and a low correlation to Validus’ catastrophe reinsurance business, the firm’s largest earner (60%-70% of profits) and its greatest source of earnings and capital volatility.

The new business will fall under Validus’ specialty insurance segment as a subsidiary of its Western World Insurance Group (unrated). With the acquisition, Validus’ gross premiums from its insurance segment will surpass its reinsurance segment’s premiums for the first time. Pro forma 2016 insurance segment premiums were about 53% of Validus’ total premiums, compared with the segment’s actual 43% share in 2016 (see exhibit).

Validus Expands Its Primary Specialty Insurance Segment with CRS Acquisition

Note: Insurance includes facultative reinsurance and direct insurance. Source: The company

43%53%

57%

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

NEWS & ANALYSIS Credit implications of current events

13 MOODY’S CREDIT OUTLOOK 9 FEBRUARY 2017

Validus, a midsize Bermuda-based property-casualty insurer and reinsurer, has a solid catastrophe reinsurance franchise that drives the firm’s earnings. In recent years, however, Validus has increased the size of its existing specialty insurance platform to offset the cyclical and structural headwinds in the catastrophe reinsurance market that are lowering Validus’ returns closer to its cost of capital. Its Talbot segment (acquired in 2007), the 11th-largest syndicate at Lloyd’s of London, drives 20%-30% of the group’s underwriting income, providing meaningful diversification. We believe that Validus’ acquisition of specialty insurer Western World in 2014 (which will be CRS’ parent following completion of the acquisition) helps hedge some of the reinsurance market disruption.

CRS is one of only 16 insurers that can cede losses on crops and livestock to the US government through the federal multi-peril crop insurance (MPCI) program. CRS is the ninth-largest insurer participating in the MPCI program. Historically, CRS’ business has been profitable with occasional bouts of volatility. The company uses advanced proprietary technology, including data and analytics to underwrite business and drones to manage risks and customer claims.

Although the crop business significantly improves Validus’ revenue mix, the acquisition will only incrementally diversify the company’s earnings. And, despite the fact that CRS’ exposure to losses from natural perils including freezes, hail, flood, wind, drought and insects has low correlation to Validus’ natural catastrophe risk, these losses can nonetheless erase earnings. In 2012, crop insurers including CRS incurred large losses from severe droughts across multiple US states, and earnings were weak, but have improved since then.

NEWS & ANALYSIS Credit implications of current events

14 MOODY’S CREDIT OUTLOOK 9 FEBRUARY 2017

Old Mutual’s Redemption of Perpetual Preferred Securities Is Credit Positive On 1 February, Anglo-South African insurer Old Mutual Plc (Baa3 negative) announced that it will purchase or redeem all £273 million of its £350 million perpetual preferred callable securities at 6.38% that are still outstanding. These securities were cancelled upon settlement on 3 February. The securities’ redemption is credit positive because it will reduce Old Mutual’s debt leverage, while affirming management’s stated intention to materially reduce holding company debt before returning excess capital to shareholders.

The redemption will absorb excess holding company cash built up from divestments. Between December 2016 and January 2017, Old Mutual raised approximately £480 million of gross proceeds through a partial sale of its stake in OM Asset Management plc (OMAM, Baa2 stable) and the disposal of Old Mutual Wealth Life Assurance Limited’s (OMW, insurance financial strength A2 negative) Italian operation. These disposals are in line with the company’s plan to separate its four key underlying businesses by the end of 2018.

Based on Old Mutual’s first-half 2016 results, we estimate that total leverage (total debt divided by total capital) will decrease by approximately one percentage point to 10.6% from 11.6% owing to the redemption of the preferred securities. The securities are treated as Tier 1 capital for Solvency II purposes, and their redemption will lead to some deterioration in Old Mutual’s Solvency II ratio. However, the decline will be partly offset by a reduction in required capital as a result of the sale of OMW’s Italian operation. Additionally, we expect that the capitalisation of Old Mutual’s underlying operating entities is more meaningful from a credit perspective. This is unaffected by the redemption of Tier 1 preferred securities at the group level.

After the redemption, Old Mutual will have £950 million of subordinated debt remaining at the holding company. Redemption of the subordinated debt, which is considered Tier 2 capital for Solvency II purposes, would have been incrementally more credit positive because we consider Tier 2 capital to be of lower quality capital than Tier 1 preferred securities. Even so, Old Mutual’s decision to use excess liquidity to fund the redemption of the preferred securities underlines its intention to materially reduce holding company debt ahead of capital returns to shareholders. Although management has previously stated that it would prioritise debt repayment over capital returns to shareholders, we expected it to face investor pressure to put more emphasis on investor returns.

Brandan Holmes Vice President - Senior Analyst +44.20.7772.1605 brandan.holmes@moodys.com

NEWS & ANALYSIS Credit implications of current events

15 MOODY’S CREDIT OUTLOOK 9 FEBRUARY 2017

Clearing Agencies

DTCC’s Disposition of Non-Core Businesses Is Credit Positive Last Monday, The Depository Trust & Clearing Corporation (DTCC, Aa3 stable) announced the sale of Avox Limited (unrated) and Clarient Global LLC (unrated) to Thomson Reuters Corporation (Baa2 stable) for an undisclosed amount. The sale is credit positive for DTCC because the disposition will remove two non-core and relatively less creditworthy entities from its corporate structure.

DTCC is a holding company for systemically important clearing agencies that form the backbone of the US capital markets infrastructure. These clearing agencies include The Depository Trust Company (P-1, clearing counterparty rating Aaa stable), the National Securities Clearing Corporation (P-1, clearing counterparty rating Aaa stable), as well as the Fixed Income Clearing Corporation’s (P-1) Government Securities Division (clearing counterparty rating Aaa stable) and Mortgage-Backed Securities Division (clearing counterparty rating Aaa stable).

DTCC’s strong creditworthiness is derived almost entirely from the financial soundness and stability of its clearing agencies. Nevertheless, 35%-40% of its revenue is contributed by a variety of non-core activities in ancillary functions such as data management and information services.

Avox is a UK-based supplier of legal entity data on financial entities globally that helps facilitate its clients’ decision-making and regulatory reporting. Clarient was founded by DTCC together with a number of its clearing agencies’ members. Clarient acts as a central hub for investment managers, hedge funds and corporations to upload, securely store, maintain and permission use of certain client information to assist with regulatory compliance.

Although there is generally little risk in Avox’s and Clarient’s activities, they operate in increasingly competitive sectors. Consequently, their business needs may necessitate increased financial investment and more management attention. Their sale ensures that DTCC avoids having to spend such resources and can focus more on investing in its core businesses.

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

NEWS & ANALYSIS Credit implications of current events

16 MOODY’S CREDIT OUTLOOK 9 FEBRUARY 2017

Asset Managers

US Regulators’ Review of Fiduciary Rule Suggests Intent, but Has No Immediate Effect Last Friday, US President Donald Trump issued a presidential memorandum asking the US Department of Labor (DOL) to review its fiduciary rule to determine whether it may “adversely affect the ability of Americans to gain access to retirement information and financial advice.” The Trump administration’s order in and of itself does nothing to change the regulation, but it does raise questions both about the rule’s fate and the possibility of an eventual repeal, which would benefit life insurers, broker-dealers and asset managers by reducing litigation risk and incremental costs of compliance.

An Obama-era regulation scheduled to take effect in April, the rule has increased the number and types of entities considered fiduciaries and requires that providers that charge for advice on retirement investments put their clients’ best interests first by requiring increased disclosures on fees and conflicts of interests. It also includes a contract-based warranty by financial institutions adhering to the standards of the regulation that exposes firms to the threat of litigation when violated.

Regardless of the fate of this latest iteration of the fiduciary rule, it has already had an effect on the retirement savings industry. Throughout 2016, broker-dealers have launched various system and process changes, along with extensive training and customer communications, in order to comply by the April deadline. We expect that our issuers will continue to incur the incremental costs necessary to comply with the regulation until Congress or the DOL take more definitive action that provides certainty for companies.

The Trump administration has other avenues that it can take to weaken the rule, including not defending the various court challenges the rule faces, or introducing legislation to allow the US Securities and Exchange Commission (SEC) to promulgate a uniform fiduciary standard that applies to all financial advice. Any changes to the regulation that arise from the Trump administration’s reevaluation during the review period would be subject to the official notice and comment rulemaking process – a process that can take a long time and create even more uncertainty.

Because the fiduciary rule became effective in June 2016, the April deadline reflects the applicability of the main provisions of the final rule. Many companies have completed or are in the process of making the operational changes required for compliance. The SEC recently issued guidance and streamlined filings for asset managers to introduce mutual fund share classes that comply with the rule. Life insurers have also made preparations to comply by April. Pricing for investment products and variable and fixed-indexed annuities has been revised; platforms have been changed and appropriate disclosures devised; and agents and call centers have been trained. Some companies switched to the new fee-based products in January.

Rokhaya Cisse, CFA Analyst +1.212.553.3870 rokhaya.cisse@moodys.com

Laura Bazer Vice President - Senior Credit Officer +1.212.553.7919 laura.bazer@moodys.com

Fadi Abdel Massih Analyst +1.212.553.0441 fadi.massih@moodys.com

NEWS & ANALYSIS Credit implications of current events

17 MOODY’S CREDIT OUTLOOK 9 FEBRUARY 2017

Sovereigns

Greece Faces Negative Effects from IMF-ESM Creditor Discord On Monday, the International Monetary Fund’s (IMF) board of directors concluded its latest evaluation of Greece’s (Caa3 stable) economic and financial situation and prospects, reiterating its previous stance that “further relief may well be required to restore debt sustainability.” This differs from European creditors’ position that Greece’s debt is sustainable, provided that Greece sticks to the external support programme in full. The IMF’s determination that Greece’s debt is unsustainable means the IMF cannot provide financial resources to Greece’s current (and third) external support programme. The impasse between the IMF and the euro area member states that are Greece’s main creditors is credit negative for the sovereign because it raises the likelihood of one or more unfavourable outcomes.

The programme, which totals €86 billion, thus remains entirely funded by Greece’s European creditors via the European Stability Mechanism (ESM, Aa1 stable). The European creditors also have a more optimistic view of Greece’s fiscal and macro prospects than the IMF, including that Greece will be able to maintain primary surpluses of 3.5% of GDP for the coming years. The IMF, meanwhile, believes Greece can achieve a primary surplus of only 1.5% per year.

The impasse has a number of risks for Greece. First, it puts pressure on the Greek government to deliver more measures than it had originally envisaged to conclude the second review of its ESM programme. Measures that await implementation include labour market reforms, a reduction of the tax-free threshold and a resolution framework for nonperforming loans.

Although we expect that the Greek government will implement the required measures, the risk of early elections is increasing given the rising political cost to the government and its slim majority in the parliament. The biggest disagreement remains on labour market reforms such as collective dismissals and collective bargaining. Early elections might bring a new and more reform-minded conservative government, but Greece’s economy would be hit again by prolonged uncertainty, after having just started to record positive growth (see Exhibit 1).

EXHIBIT 1

Greece’s Real GDP Growth, Year-on-Year Percentage-Point Change

Sources: Haver Analytics, ELSTAT and Moody’s Investors Service

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-15

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-16

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16

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16

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

Michail Michailopoulos Associate Analyst +49.69.70730.740 michail.michailopoulos@moodys.com

NEWS & ANALYSIS Credit implications of current events

18 MOODY’S CREDIT OUTLOOK 9 FEBRUARY 2017

Another negative is the short time frame within which to conclude the second review, which raises the risk of default on upcoming maturities. We do not expect a default because it is not in European creditors’ interest. Instead, it is more likely that a political compromise will be found, allowing the European creditors to provide bridge financing to the Greek government, similar to what happened in 2015.

However, the time frame for Greece to legislate the required measures and close the second review before the start of key European elections is narrowing. Greece has large upcoming maturities in July 2017, with €2.3 billion owed to private-sector bondholders and €3.9 billion to the European Central Bank. The government also has smaller maturities of €1.6 billion in April (see Exhibit 2). Greece will be highly challenged to meet these redemptions without completion of the programme’s second review and without the ESM’s disbursement by the summer.

EXHIBIT 2

Greece’s Monthly Amortisation Payments in 2017, € Billions

Sources: Greece’s Public Debt Management Agency and Moody’s Investors Service

The impasse also increases the risk that Greece’s programme will have to be renegotiated after Germany’s elections in September, given that the IMF is unlikely to change its view. The German government in particular has made the IMF’s financial participation a condition for the third support package, with the German finance minister recently pointing to the need to renegotiate the ESM support package if the IMF did not come on board. Such a scenario would be highly negative for Greece in our view, because the economy would likely be hit by another period of uncertainty and loss of confidence, making Greece’s fiscal targets more difficult to achieve.

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ECB New GGBs Old GGBs Holdouts BoG loans EIB loans Securitisation IMF loans Private sector

NEWS & ANALYSIS Credit implications of current events

19 MOODY’S CREDIT OUTLOOK 9 FEBRUARY 2017

US Public Finance

Boston’s Growth Will Lead to Surge in Property Tax Revenue, a Credit Positive Last Thursday, the Massachusetts Division of Local Services reported that new growth for the City of Boston (Aaa stable) for fiscal 2017 (which ends 30 June 2017) reflected an unprecedented $4.3 billion growth in taxable valuation, an 88% increase over 2016 valuation growth. The growth, which reflects new construction projects throughout the city, is credit positive for Boston, allowing it to generate higher property tax revenue.

Proposition 2½, the Massachusetts tax levy limit, allows a municipality to increase the levy up to 2.5% annually. Above and beyond the 2.5% is an additional increase to the levy that is permitted based on the valuation of new construction subject to taxation for the first time. This valuation is defined as “new growth,” and when added to the 2.5% increase, equals the total allowable increase in the tax levy for the year. Boston’s 2017 new growth value spiked to $4.3 billion versus $2.3 million in 2016, which translates to a 57% increase in the new growth tax levy to $74.7 million from $47.5 million in 2016 (see exhibit).

Boston’s Annual New Growth Valuation and Tax Levy New growth in 2017 resulted in an 88% increase in valuation and 57% increase in the tax levy.

Source: Massachusetts Department of Revenue’s Division of Local Services

Property taxes generally constitute 68% of the city’s annual revenues and stronger new growth provides greater operating ability to meet expenditures. If a municipality does not generate new growth, property taxes and the tax levy growth would be constrained by the 2.5% annual levy limit and make it a challenge to balance annual revenues with annual expenditure growth.

In Boston, the new growth tax levy has exceeded the 2.5% allowable levy increase in 21 of the past 34 years. In fiscal 2016, the allowable 2.5% levy increase was $46.7 million and the new growth levy increase was $47.5 million. The strong levy growth in recent years has resulted in an annual increase in the total tax levy of 5%-6% (2014-17), compared with 4%-5% in years coming out of the recession (2010-13). Residential development comprises 60% of the $4.3 billion new growth in 2017. Major construction projects that were completed include commercial developments in the Seaport District, Longwood Medical Area and the New Balance Athletics Inc. headquarters in Brighton Landing.

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New Growth Valuation - left axis New Growth Levy - right axis

Nicholas Lehman Assistant Vice President - Analyst +1.617.535.7694 nicholas.lehman@moodys.com

NEWS & ANALYSIS Credit implications of current events

20 MOODY’S CREDIT OUTLOOK 9 FEBRUARY 2017

Boston had 23% of the $18.2 billion in total new growth across all Massachusetts municipalities. The strong contribution reflects Boston’s significant economic development initiatives in recent years and its importance to the regional economy. Additionally, the 2017 total new growth for all cities and towns constitutes the fifth consecutive year of improving new growth and is just below pre-recession levels that peaked in 2007, indicating that most of the state is experiencing modest new development, mostly in the residential sector.

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

21 MOODY’S CREDIT OUTLOOK 9 FEBRUARY 2017

NEWS & ANALYSIS Corporates 2 » Entercom's Plan to Merge with CBS Radio Is Credit Positive » Multiemployer Pension Plan Benefit Cut Sets Credit-Positive

Precedent for Other US Pension Plans » ONEOK Buyout of Subsidiary Is Credit Positive for Parent,

Credit Negative for Subsidiary » Tempur Sealy's Termination of Mattress Firm Supply Pact Is

Credit Negative » For Teva Pharmaceutical, Copaxone Patent Ruling Is Another

Credit Negative » Keysight's Planned Acquisition of IXIA Is Credit Negative » Bouygues' Agreement with Cellnex Is Credit Positive » IHS Netherlands Holdco's Share Transaction with MTN Is

Credit Positive » MTN Increases Its Stake in IHS Holding, a Credit Positive » Steinhoff and Mattress Firm to Benefit from Termination of

Tempur Sealy Contract » LVMH's Partnership with Marcolin Is Credit Negative

for Safilo » Reckitt Benckiser’s Proposed $17 Billion Acquisition of Mead

Johnson Is Credit Negative » ONGC's Planned $11.5 Billion Investment in Andhra Pradesh

Is Credit Negative

Infrastructure 18 » Stipulation Agreement Approval Would Be Credit Positive for

Dayton Power & Light and Its Parent

Banks 20 » Large Purchase of Mortgage Servicing Rights Is Credit

Negative for Subservicer Nationstar » Brazil's Banks Would Benefit from Proposed Covered

Bond Regulation » Credit Mutuel Arkea Increases Own Funds with Tier 2

Securities Issuance, a Credit Positive » Russian Banks Benefit from Their Retail Asset Managers'

Larger Business Volumes » Ukraine's Capital Injections Will Benefit Two State-

Owned Banks » Lebanese Banks' Use of Exceptional Gains to Bolster Their

Balance Sheets Is Credit Positive » Egyptian Government-Owned Banks Elevate Asset Risks with

Sharp SME Loan Growth » Sustained Cedi Depreciation Is Credit Negative for

Ghana's Banks » Sumitomo Mitsui Trust's Reorganization of Its Asset

Management Operations Is Credit Positive

Exchanges 32 » Nasdaq's eSpeed Write-down Is Credit Negative

Sovereigns 33 » Mexico's Fiscal Accounts Deteriorate amid Economic

Headwinds, a Credit Negative » Ghana's $1.6 Billion of Previously Undisclosed Fiscal Arrears

Implies a Higher Debt Burden

Sub-sovereigns 37 » UK Universities' EU Undergraduate Student Applications

Decline, a Credit Negative » Most German Laender Reach Balanced Budgets Ahead of

Schedule, a Credit Positive

US Public Finance 41 » Kansas' Revenue Forecasts Are Improving, a Credit Positive » New Mexico Cuts School Funding a Second Time in Fiscal

Year, a Credit Negative

Securitization 45 » Court Ruling in Lending Club Case Is Positive for Marketplace

Lending ABS

MOODYS.COM

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