MOODYS.COM

5 MAY 2016

NEWS & ANALYSIS Corporates 2 » Collapse of Merger Gives Baker Hughes $3.5 Billion in Cash at

Halliburton's Expense » International Paper's Acquisition of Weyerhaeuser's Pulp Assets

Is Credit Positive for Both » CommScope's PIK Note Repayment Is Credit Positive » The Navigator Company Slashes Interest Expense with New

Financing, a Credit Positive » Evergrande's Increased Stake in Shengjing Bank Is

Credit Negative » Korea's SK Telecom and KT Corporation Win Spectrum at

Auction, a Credit Positive for Both

Infrastructure 9 » Energy Future Holdings' New Reorganization Plan Is Credit

Positive for Texas Competitive Electric » Energias do Brasil's BRL1.5 Billion Capitalization Is Credit

Positive for It and Its Subsidiaries » Australian Airports Face Credit-Negative Airline Capacity Cuts

Pressuring Revenue

Banks 13 » Italy's New Framework on Nonperforming Loan Foreclosures Is

Credit Positive for Banks and SME Securitisations » Details of European Commission's State Aid Approval for HSH

Nordbank Present Credit-Negative Challenges

Sovereigns 16 » US Cruise Ships Set Sail for Cuba, a Credit Positive for the

Sovereign » IMF Program Will Ease Sri Lanka's Liquidity Pressures, but Not

Its Fiscal Challenges

RECENTLY IN CREDIT OUTLOOK

» Articles in Last Monday’s Credit Outlook 19 » Go to Last Monday’s Credit Outlook

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NEWS & ANALYSIS Credit implications of current events

2 MOODY’S CREDIT OUTLOOK 5 MAY 2016

Corporates

Collapse of Merger Gives Baker Hughes $3.5 Billion in Cash at Halliburton’s Expense On Monday, Halliburton Company (A2 review for downgrade) and Baker Hughes Incorporated (A2 review for downgrade) formally called off their proposal to merge, which would have fortified Halliburton’s position as the second-largest global oilfield services (OFS) company.

The deal’s collapse under antitrust concerns is credit negative for Halliburton and credit positive for Baker Hughes, requiring Halliburton to pay Baker Hughes a $3.5 billion termination fee by 4 May, according to the terms of their $35 billion merger agreement. The deal would have created a more formidable rival to industry leader Schlumberger Ltd. (A1 stable).

The $3.5 billion termination fee is a big silver lining for Baker Hughes, which, like Halliburton, has faced tremendous strain from the ongoing oil-price downturn. The two companies agreed to merge in November 2014, early in what has turned out to be a deep and lengthy downturn in global oil prices. Under the deal, either party had the option to terminate the transaction if it failed to obtain the required antitrust approvals by the end of 2015 (a date later extended to 30 April 2016), thereby compelling Halliburton to pay Baker Hughes the $3.5 billion fee.

Since November 2014, however, the US rig count, which is the main proxy for US OFS activity, has fallen by about 80%. Demand for OFS activities worldwide will likely fall by more than 30% in 2016, and by 40%-50% in North America. Baker Hughes’ revenue fell by 35% in 2015, including a 50% decline in North America, and its EBITDA more than halved to $2 billion from $5.5 billion in 2014. Halliburton’s 2015 revenue fell 42%, and its North American businesses operated near breakeven levels of profitability, reducing its EBITDA significantly.

For Baker Hughes, the payment does not offset the severe fundamental weakness in the OFS industry, which is straining both companies’ competitive positions, cash flow and ability to cut costs. These issues, along with heightened leverage, will be the focus of the continuing reviews for downgrade that we initiated in October 2015 and will conclude during the second quarter.

Still, the termination fee offers a timely benefit to Baker Hughes, which plans to reduce debt using $1 billion of the after-tax fee proceeds, and $1.5 billion to buy back shares. Baker Hughes has good liquidity with $2.2 billion of cash and a $2.5 billion revolving credit facility maturing in September 2016, which we soon expect to be extended. The revolver backs a $2.5 billion commercial paper program. Baker Hughes had no borrowings under its revolver nor an outstanding commercial paper balance as of 31 March 2016.

Halliburton also has strong liquidity, with a significant cash balance bolstered by a $7.5 billion debt offering in November, an unused $3.0 billion revolving credit facility and positive free cash flow. We believe the company is poised for a strong rebound in cash flow and profitability once industry conditions improve, attracting increased upstream capital spending.

Still, the termination fee places an immediate cash cost on Halliburton, the financing of which will contribute to weakening its net debt/EBITDA ratio to about 3.3x, adjusted for $2.5 billion of mandatorily redeemable debt, from 1.7x on a net debt basis in 2015, including our standard adjustments.

Terry Marshall Senior Vice President +1.416.214.3863

Terry Marshall Senior Vice President +1.416.214.3863 terry.marshall@moodys.com

Andrew Brooks Vice President - Senior Analyst +1.212.553.1065 andrew.brooks@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 5 MAY 2016

International Paper’s Acquisition of Weyerhaeuser’s Pulp Assets Is Credit Positive for Both On Monday, International Paper Company (Baa2 stable) announced that it had signed a definitive agreement to acquire Weyerhaeuser Company’s (Baa2 stable) cellulose fibers business for about $2.2 billion. The deal is credit positive for both companies. Pending customary closing conditions and regulatory approvals, the companies expect the deal to close in the second half of this year.

The addition of Weyerhaeuser’s high-quality pulp mills will make International Paper the largest producer of fluff pulp in the world, generating cost synergies while only modestly increasing its leverage. At the same time, the cash proceeds that Weyerhaeuser receives will allow it to significantly reduce leverage following its recent acquisition of Plum Creek Timber Company.

The deal further diversifies International Paper’s leading global packaging and paper business by creating a leading global fluff pulp business that focuses on producing the absorbent material used in diapers. The business will have about a 40% market share, based on global production capacity, assuming a Hart-Scott-Rodino antitrust review does not force International Paper to divest some mills to gain US regulatory approval. The addition of Weyerhaeuser’s higher value-added pulp products will allow International Paper to offer a broader portfolio of products to a larger customer base. We expect International Paper’s stable market-leading packaging business to still generate about 70% of its EBITDA and to temper the growth of the very cyclical market pulp business.

International Paper will also gain immediate synergies by folding Weyerhaeuser’s five pulp mills into its existing mill system. The proximity of the acquired mills to International Paper’s existing four pulp facilities in the US South should allow the company to easily achieve its stated synergy target of $175 million by optimizing its mill system and realizing freight and other cost synergies.

International Paper plans to fund the purchase with $2.2 billion of incremental debt. The company’s 2015 pro forma adjusted debt/EBITDA ratio (including our standard adjustments for pensions and operating leases) as of 31 December will increase slightly to 3.4x from 3.2x. We expect that International Paper’s leverage metric will drop below 3x within two years of closing because the company will focus its cash flow generation to reduce debt. Management has a good track record of levering up for acquisitions (it acquired Weyerhaeuser’s packaging business in 2008 and packaging company Temple-Inland in 2012) and then bringing leverage back down to its stated target of below 3x relatively quickly.

International Paper’s liquidity is strong, with $1 billion of cash, full availability under a $1.5 billion committed revolver maturing August 2019, the absence of significant near-term debt maturities and our estimate of about $750 million of free cash flow over the next year. International Paper’s Baa2 senior unsecured rating and stable outlook remain unchanged.

The transaction is also credit positive for Weyerhaeuser. The cash proceeds from the sale of its cellulose fibers business will allow Weyerhaeuser to significantly reduce its adjusted leverage toward 3.5x in the next 12-18 months. Weyerhaeuser’s 2015 adjusted debt/EBITDA is 4.9x, pro forma for the February 2016 acquisition of Plum Creek Timber Co., a $2.5 billion 18-month bank term loan put in place to fund the company’s share repurchase authorization and $440 million of proceeds received from the April 2016 joint venture transaction. Weyerhaeuser plans additional asset sales, including its liquid packaging assets, newsprint and publishing papers joint venture and non-strategic timberlands.

Memphis, Tennessee-based International Paper is the largest global producer of packaging products and uncoated freesheet paper. Federal Way, Washington-based Weyerhaeuser is a timber real estate investment trust with about 13 million acres of company-owned and leased commercial forestland in 19 US states and Uruguay.

Ed Sustar Senior Vice President +1.416.214.3628 ed.sustar@moodys.com

NEWS & ANALYSIS Credit implications of current events

4 MOODY’S CREDIT OUTLOOK 5 MAY 2016

CommScope’s PIK Note Repayment Is Credit Positive Last Thursday, CommScope Holding Company, Inc. (B1 positive) said that it had planned to pay down ahead of schedule $300 million of payment-in-kind (PIK) notes due in 2020. The move is credit positive because it will result in $20 million of annual interest cost savings and demonstrates the company’s long-term commitment to repaying debt and improving its credit quality.

We estimate that paying down the PIK notes will lower CommScope’s adjusted debt/EBITDA to 5.2x from 5.5x as of the last 12 months that ended 31 March 2016, pro forma for the acquisitions of TE Connectivity’s Broadband Network Solutions business in August 2015 and Airvana in October 2015, the elimination of onetime costs and certain cost synergies. CommScope’s leverage is approximately 6.6x when excluding the add-backs of onetime costs and synergies. Given the cyclicality of the business, volatility in carrier spending and international economic headwinds, CommScope’s decision to pay down debt is an important step toward improving the company’s credit quality and ratings. We expect that CommScope will continue focusing on paying down debt with internally generated cash and that its leverage will trend toward 4.5x over the next 18 months.

The wireless network technology provider also announced results for the first quarter of 2016 that were better than expected despite international macroeconomic headwinds and a negative year-over-year foreign exchange effect of 2%. The Mobility business segment’s pro forma sales declined 14% from a year earlier and the Connectivity Solutions business segment’s revenues declined 4% because of lower international carrier spending. However, the declines were partially offset by strong demand in North America. Operating margins improved to 18% as the integration of the Broadband Network Solutions business progressed, cost savings initiatives were realized and its sales contributed to a higher margin product mix. We expect full-year 2016 revenues to be nearly flat on a pro forma basis.

Matthew B. Jones Vice President - Senior Analyst +1.212.553.3779 matthew.b.jones@moodys.com

NEWS & ANALYSIS Credit implications of current events

5 MOODY’S CREDIT OUTLOOK 5 MAY 2016

The Navigator Company Slashes Interest Expense with New Financing, a Credit Positive Last Thursday, Portugal-based office paper producer The Navigator Company (formerly Portucel, Ba2 stable), announced the early repayment of the remaining €150 million of its senior 5.375% notes due in 2020. The Navigator Company expects to fund repayment of notes on 13 May with new financing arrangements now being finalized that the company expects will be a lot more favourable than the conditions for the original notes. The refinancing is credit positive for The Navigator Company because it contributes to the company more than halving its interest expenses through various refinancing exercises since September 2015, also benefitting interest cover and cash flows.

Already in September 2015, the company took advantage of competitive loan pricing offered by two of its domestic banks and redeemed €200 million of its fixed 5.375% senior notes due in 2020, funded by the issuance of a new floating rate bond loan and indexed to an interest rate based on six-month Euribor plus a 1.9% margin due in 2023. The company also renegotiated and extended the maturity of a €125 million commercial paper programme on more favourable market terms than the existing programme. To mitigate the company’s increased interest rate exposure, it put in place a series of interest rate swaps that resulted in 69% of its borrowing being effectively on a fixed-rate basis.

Following the completion of the upcoming financing transactions that include the redemption of the outstanding €150 million notes, The Navigator Company estimates additional total savings of €16 million over the next four years, net of the redemption premium, and a reduced average cost of its total borrowings of less than 2% compared with 4.2% before the September 2015 refinancing.

Also on Thursday, the company reported a 3% decline in first-quarter EBITDA versus the fourth quarter, reflecting the seasonally weaker first quarter. However, EBITDA improved 15% compared with first-quarter 2015 as a result of a 7% reduction in the industry’s uncoated wood free capacity at the end of 2015. This led to higher operating rates, while successful paper price increases, a reduction in exports and a redirection of the company’s uncoated wood free sales to Europe increased 3% and added to positive year-over-year EBITDA growth. However, a 10% decline in global bleached eucalyptus kraft (BEK) pulp prices in US dollar terms since the start of the year, on the back of fewer purchases from Chinese buyers, partly offset the year-over-year improvement in EBITDA.

The Navigator Company is a leading producer of premium and branded office paper and BEK market pulp and has operations in energy and tissue, with 2015 revenues of €1.6 billion. The company has two integrated paper mills, a pulp mill, a recently acquired tissue operation in Portugal, a pellet mill project in the US, and a forestry project in Mozambique. The Navigator Company is listed on the Lisbon stock exchange and had a market capitalization of €2.76 billion as of December 2015.

Matthias Volkmer Vice President - Senior Credit Officer +49.69.70730.758 matthias.volkmer@moodys.com

Florian Zimmermann Associate Analyst +49.69.70730.971 florian.zimmermann@moodys.com

NEWS & ANALYSIS Credit implications of current events

6 MOODY’S CREDIT OUTLOOK 5 MAY 2016

Evergrande’s Increased Stake in Shengjing Bank Is Credit Negative Last Thursday, Evergrande Real Estate Group Limited (B2 negative) announced that it had acquired an additional equity stake in Shengjing Bank for around RMB10 billion, bringing its ownership share to about 27.24% as of 31 March 2016 from 5.59% as of February.

The investment, which we believe is financial rather than strategic, is credit negative because it raises Evergrande’s financial and investment risk and undermines the company’s effort to limit its debt growth. However, Evergrande has sufficient cash reserves to fund its investment in Shengjing Bank and the effect on its liquidity will be manageable. The investment in Shengjing equals approximately 6% of Evergrande’s cash on hand of RMB164 billion at year-end 2015.

The transaction has little strategic value because Evergrande is unlikely to exercise management control over Shengjing Bank in the near term, and there are no apparent synergies between Evergrande’s property development operations and Shengjing Bank’s banking business. Evergrande also already has multiple strong onshore banking relationships to support its existing projects.

Evergrande’s pursuit of debt-funded expansion to support its business growth has raised debt leverage as measured by adjusted revenue/debt, which dropped significantly to 36% in 2015 from 53% in 2014. The series of investments and acquisitions announced this year will consume some of Evergrande’s cash on hand, which will constrain its ability to limit further debt growth. We expect that the company will continue to pursue debt-funded acquisitions and hence revenue/debt will remain weak. But we also expect the ratio to trend above 40% over the next 12 months, as the company continues to generate strong cash inflows from property sales and has an abundant cash balance to support its business growth. Contracted sales of RMB65.7 billion in the first quarter of 2016, up 115% from the same period in 2015, will support Evergrande’s liquidity.

Evergrande’s increased bank stake follows a number of investments in non-property businesses in recent years, including in insurance, consumer goods and healthcare services. The company expects these non-property investments to diversify the business and help drive its growth.

Evergrande is one of the largest residential developers in China. At 31 December 2015, its land bank totaled 156 million square meters in gross floor area across 162 Chinese cities.

Franco Leung Vice President - Senior Credit Officer +852.3758.1521 franco.leung@moodys.com

Lisa Tao Associate Analyst +852.3758.1307 lisa.tao@moodys.com

NEWS & ANALYSIS Credit implications of current events

7 MOODY’S CREDIT OUTLOOK 5 MAY 2016

Korea’s SK Telecom and KT Corporation Win Spectrum at Auction, a Credit Positive for Both On Monday, Korea’s Ministry of Science, ICT and Future Planning (MSIP) released the results of spectrum auctions held in April. SK Telecom Co. Ltd (SKT, A3 stable) won the auction for two bandwidth blocks in the 2.6-gigahertz band for KRW1.28 trillion, and KT Corporation (KT, Baa1 stable) won the auction for the 1.8-gigahertz bandwidth block for KRW451 billion. The companies’ spectrum block wins are credit positive because they secured the necessary spectrum bandwidths at reasonable prices. Although adjusted leverage will slightly increase for both companies, they can accommodate the increase within their existing ratings and outlooks.

The prices were modest and there was no excessive competition. Even the band that most interested operators, the 2.1-gigahertz block, was sold at the minimum price. This could be due to the fact that the renewal of the three operators’ existing 2.1-gigahertz blocks later this year will be based on the result of the April auction, making the operators conservative in their bidding to avoid paying excessively high prices at renewal.

On a per megahertz per five-year basis, SKT paid on average KRW10.6 billion, which is lower than its two main competitors, and also lower than the KRW19.2 billion lowest price paid at the 2013 auction and the KRW24.9 billion at the 2011 auction, as shown in the exhibit.

Korean Spectrum Results

Blocks Spectrum (Frequency) Bandwidth

(Megahertz) Period of

Use in Years

Minimum Bid KRW

Billions Winner

Final Price KRW

Billions

Final Price/MHz

per Five Years KRW

Billions

A 700 megahertz 40 10 762 Not Sold Not

Available Not

Available

B 1.8 gigahertz 20 10 451 KT 451 11.3

C 2.1 gigahertz 20 5 382 LGU+ 382 19.1

D 2.6 gigahertz 40 10 655 SKT 950 10.6

E 2.6 gigahertz 20 10 328 SKT 328

Total 140 2,578 2,111

Source: Korea’s Ministry of Science, ICT and Future Planning

We expect that SKT and KT will fund the 25% upfront payments from their existing cash holdings. For the remaining 75%, we expect the companies to fund the annual payments from their operating cash flows, which total around KRW4 trillion each year for each company, since the payout will be over the 10-year life of the spectrum licenses.

On an adjusted debt basis, since we treat deferred spectrum obligations as debt, we estimate that SKT’s leverage will increase to around 2.1x this year, versus 1.8x in 2015, declining to around 2.0x in 2017. The increase in SKT’s adjusted leverage in 2016 will temporarily pressure the company’s A3 rating, given that our quantitative guidance for an A3 rating is 2.0x, but we expect the ratio to decline in 2017. Moreover, the actual cash effect will be fairly limited: we estimate that without the deferred payment debt adjustment, SKT’s leverage would be around 1.9x in 2016 and 1.8x in 2017.

For KT, a similar adjustment in deferred spectrum obligations will increase the company’s adjusted debt/EBITDA to around 2.1x this year and next, versus 2.0x in 2015. Likewise, we estimate that without the adjustment, KT’s leverage would remain around 2.0x this year and in 2017, solidly positioning the company for its Baa1 rating.

Gloria Tsuen, CFA Vice President - Senior Analyst +852.3758.1583 gloria.tsuen@moodys.com

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

NEWS & ANALYSIS Credit implications of current events

8 MOODY’S CREDIT OUTLOOK 5 MAY 2016

With the new spectrum allocation, there are also capital expenditure commitments that the operators have made with the government. However, these commitments (mainly base station construction) are spread over the life of the spectrum licenses, and can for the most part be absorbed within the operators’ annual capex budgets. We therefore do not expect incremental debt burdens.

Both SKT and KT reported first-quarter results last week. SKT’s revenue was down 0.3% year on year to KRW4.2 trillion, and reported EBITDA rose 1.7% to KRW1.15 trillion. KT’s revenue was up 2.2% year on year to KRW5.5 trillion, and reported EBITDA rose 5.3% to KRW1.22 trillion. Both companies’ reported net debt was largely stable at around KRW6 trillion each.

NEWS & ANALYSIS Credit implications of current events

9 MOODY’S CREDIT OUTLOOK 5 MAY 2016

Infrastructure

Energy Future Holdings’ New Reorganization Plan Is Credit Positive for Texas Competitive Electric On 1 May, Energy Future Holdings Corp (EFH, unrated) filed a new reorganization plan and accompanying disclosure statements with the US Bankruptcy Court for the District of Delaware. The new plan, filed almost exactly two years after the original 29 April 2014 bankruptcy filing, aims to separate EFH’s unregulated businesses at Texas Competitive Electric Holdings Company LLC (TCEH, unrated) from its regulated transmission and distribution utility operations at Oncor Electric Delivery Company LLC (Baa1 positive). Oncor is not a participant in any of the lengthy bankruptcy proceedings, but its intermediate parent, Energy Future Intermediate Holdings (EFIH, unrated), and parent holding company, EFH, are debtors in the proceedings.

If all goes according to schedule, the new plan would be credit positive for TCEH because the company would emerge from bankruptcy with some certainty, a $1.0 billion step-up in its tax basis, and more corporate freedom to pursue alternative strategic plans without the oversight of a bankruptcy judge. The confirmation hearings are targeted for 1 August, implying a final emergence from bankruptcy within the calendar year.

TCEH makes it clear in the new plan that it is ready to move forward, without waiting for EFH and EFIH to complete their restructuring plans. TCEH is asking the court to separate the confirmation hearing schedules because EFH and EFIH are struggling to attain Public Utility Commission of Texas (PUCT) regulatory approvals, which would be needed if Oncor experiences a change of control.

But PUCT’s approval has been hung up on the complexity associated with the EFH and EFIH preferred restructuring plan for Oncor. In that plan, EFH and EFIH would sell Oncor to a consortium led by Hunt Consolidated (unrated), which would put Oncor into a real estate investment trust (REIT). Along those lines, the new plan explicitly withdraws a request to make a REIT structure a condition to consummate bankruptcy emergence.

We think the REIT structure will bring a heightened level of regulatory contentiousness to Oncor’s future regulatory proceedings, a credit negative. But we also expect the PUCT approval to be delayed because of the sizable debt load sitting on top of Oncor, at EFH and EFIH. As the only income-producing subsidiary of EFH and EFIH, both the PUCT and Oncor’s customers realize it is Oncor that will be servicing that debt. Looking back to the original leveraged buyout plan in 2007, we cannot help but notice that Oncor was never expected to shoulder any of the original incremental debt used to finance the acquisition, so we expect some ring-fence-type provisions to remain whenever a bankruptcy emergence becomes effective.

Jim Hempstead Associate Managing Director +1.212.553.4318 james.hempstead@moodys.com

NEWS & ANALYSIS Credit implications of current events

10 MOODY’S CREDIT OUTLOOK 5 MAY 2016

Energias do Brasil’s BRL1.5 Billion Capitalization Is Credit Positive for It and Its Subsidiaries On Monday, EDP - Energias do Brasil SA (EDB, Ba3/A2.br negative) announced that it will increase its capital by BRL1.5 billion. EDB’s major shareholder, EDP - Energias de Portugal SA (Baa3 stable), which holds 51% of EDB’s common equity, has committed to subscribe to 51% of the capital raise and has indicated that it intends to subscribe to the remaining shares that may eventually become available.

The agreement is credit positive for EDB and its subsidiaries. EDB’s capital structure will improve (capitalization is around 25% of the company’s consolidated debt) and its borrowing costs will decline. And, the increased capitalization will reduce the pressure EDB exerts on its subsidiaries, mainly the two distribution utilities Bandeirante Energia SA (Ba2/Aa2.br negative) and Espírito Santo Centrais Elétricas - ESCELSA (Ba2/Aa2.br negative), to upstream dividends.

EDB will likely use part of the capital proceeds to accelerate the payment of more expensive debt at the holding company level, reduce financial expenses and strengthen its capital structure. Assuming that EDB uses 50%, or BRL750 million, of the capitalization increase to reduce debt, annual consolidated cash from operations (CFO) will increase by BRL120 million, or 12% of the company’s 2015 CFO, assuming a 16% annual interest rate.

Both Bandeirante and Escelsa will likely post weaker cash flows in 2016 and potentially in 2017 owing to the combination of lower tariffs as a result of periodic tariff reviews and lower volume sales because of Brazil’s economic recession. The regulator ANEEL reduced Bandeirante’s electricity tariffs in October 2015 and Escelsa’s tariff review is schedule for August 2016. The expected receipt of regulatory assets will partly compensate the negative effect of lower volume sales and lower tariffs.

São Paulo, Brazil-based EDB is a holding company with activities in generation, distribution and the trading of electricity. In 2015, EDB’s power distribution business accounted for 41% of consolidated EBITDA, while the power generation business was 56% and the trading of energy made up the remaining 3%.

Bandeirante and Escelsa distributed in aggregate 25,713 gigawatt hours in 2015, or approximately 5.3% of the electricity consumed in the Brazilian electricity integrated system. The generation business consisted of 2,704 megawatts of installed capacity at year-end 2015, which accounted for approximately 1.8% of the country’s electricity installed capacity. EDB reported 2015 consolidated net revenues of BRL9.8 billion, which does not include BRL317 million of construction revenues, and a net profit of BRL1.4 billion.

Jose Soares Vice President - Senior Credit Officer +55.11.3043.7339 jose.soares@moodys.com

NEWS & ANALYSIS Credit implications of current events

11 MOODY’S CREDIT OUTLOOK 5 MAY 2016

Australian Airports Face Credit-Negative Airline Capacity Cuts Pressuring Revenue On Monday, Virgin Australia Holdings Limited (B2 review for downgrade) announced that it will cut capacity (as measured by the number of available seats kilometers) by 5.1% in the June 2016 quarter, which follows a similar announcement by Qantas Airways Ltd. (Baa3 stable) in recent weeks. The capacity reductions are credit negative for Australian airports and will negatively pressure passenger numbers and revenue. Virgin and Qantas are the largest Australian airlines, accounting for around 98% of the domestic market, and passenger-linked revenue is typically more than 75% of Australian airport earnings, comprising aeronautical charges, retail and parking revenue.

The airlines’ decisions highlight the softness in the economy, which is a key driver of demand for travel. Both airlines have cited weaker consumer demand and sentiment as well as ongoing challenges in the resources and mining sector as reasons behind their decisions to reduce capacity.

Although neither airline provided a breakdown of cuts by route, we believe airports in service areas more exposed to the weakening economy and with lower earnings contribution from international passengers will be most affected. In particular, we believe Perth Airport Pty Ltd. (Baa2 stable) will likely be worst affected, given the continued decline in demand for mining-related travel and the effect of the slowdown on consumer sentiment in Western Australia.

In contrast, we expect airports that generate more of their earnings from inbound international passengers – such as Sydney Airport Finance Company Pty Ltd. (Baa2 stable), Australia Pacific Airports (Melbourne) Pty Ltd. (A3 stable) and Brisbane Airport Corporation Pty Limited (Baa2 stable) – will be less affected. These airports continue to benefit from solid inbound tourist growth.

Considering that earnings per international passenger are materially higher than domestic passengers in these airports, the increase in international passenger earnings would outweigh weaker domestic passenger activities. We expect the growth rate in international passengers to remain in the low-single-digit percentage range over the next 12 months, moderating from the mid- to high-single-digit growth recorded during 2015.

Seat capacity is a key driver of domestic passenger numbers (see exhibit). Additional seat supply creates competitive tension over airfares and provides more options for leisure travelers. Between 2012 and 2013, domestic passenger traffic grew rapidly as Australian airlines competed for market share and added capacity. Therefore, we believe the reduction in airline seat capacity will dampen growth opportunities in the domestic market.

Year-over-Year Change in Australian Airlines’ Seat Capacity and Domestic Passenger Volumes

Source: Australian Bureau of Infrastructure, Transport and Regional Economics

-9%

-6%

-3%

0%

3%

6%

9%

12%

15%Number of Passengers Number of Seats

Spencer Ng Vice President - Senior Analyst +61.2.9270.8191 spencer.ng@moodys.com

Kendrew Fung Associate Analyst +61.2.9270.8181 kendrew.fung@moodys.com

NEWS & ANALYSIS Credit implications of current events

12 MOODY’S CREDIT OUTLOOK 5 MAY 2016

Australian airports have the flexibility to manage the effect of weaker revenue on their credit quality by either deferring capital expansions or decreasing the proportion of essential capital works that are debt funded. Other than Brisbane Airport, which is in the process of developing its second runway, these airports’ capital works are predominantly modular in nature and can be more readily deferred in response to changes in passenger trends.

Finally, an unexpected change in Australian airlines’ approach toward capacity management and the resumption of strategies that prioritizes market share over yield – as they did in early part of this decade – could also reduce the negative effects on Australian airports.

NEWS & ANALYSIS Credit implications of current events

13 MOODY’S CREDIT OUTLOOK 5 MAY 2016

Banks

Italy’s New Framework on Nonperforming Loan Foreclosures Is Credit Positive for Banks and SME Securitisations Last Friday, the Italian government approved a series of measures aimed at expediting foreclosures on nonperforming loans (NPLs) to corporate and small and midsize enterprises (SMEs). The government estimates that it will take less than a year to collect collateral under the new framework, as opposed to six to eight years currently. The quicker collateral collection is credit positive for Italian banks and SME securitisations because faster foreclosures will reduce the very high stock of problem loans and will increase the recovery value of NPLs.

Furthermore, faster procedures for collecting collateral will accelerate the recovery for SME securitisations, improving their recoveries and cash flows. However, the measures have yet to be tested, and the expected reduction seems slightly optimistic to us. However, according to the Bank of Italy, a two-year reduction for collecting collateral to four to six years from six to eight years would still significantly reduce the NPL stock over two years or so.

There are three main changes included in the government decree:

» There will be a new type of loan contract that will allow banks to sell borrowers’ real estate collateral even if they are under insolvency proceedings. Banks currently have to wait for the completion of a lengthy insolvency process before repossessing collateral

» Banks and borrowers can renegotiate existing loan agreements so that this new provision applies to outstanding loans

» Bankruptcy hearings can be done remotely via the Internet. Currently, banks’ representatives and their lawyers have to attend these meetings in person, which contributes to long delays.

As the exhibit below shows, Italian banks’ stock of NPLs, which mostly comprises loans to SMEs, is among the highest in Europe, equalling 16.7% of all loans as of June 2015. Italy’s NPL ratio compares with a 5.6% ratio in the European Union, 7.1% for Spain and 4.3% for France. NPLs were mostly generated a few years ago, and the time necessary to foreclose prevents banks from off-loading these non-interest-bearing assets from their balance sheets.

Italian Banks’ Nonperforming Loan Ratio Is Well above Those of Most Other European Union Nations

Source: European Banking Authority’s Transparency Exercise data as of June 2015

0%

3%

6%

9%

12%

15%

18%

21%

London +44.20.7772.5454

NEWS & ANALYSIS Credit implications of current events

14 MOODY’S CREDIT OUTLOOK 5 MAY 2016

The lengthy foreclosure process has also made it more difficult for Italy’s banks to sell NPLs in the secondary markets because investors value loans by discounting future cash flows. A faster foreclosure process will increase NPL prices. Overall, with a lower stock of NPLs, banks will reduce their carrying and servicing costs, which will free up capital for new loans and improve banks’ profitability.

The decree does not tackle the issue of inefficiency of some courts, and we expect the foreclosure process to remain long, especially in some areas of Italy. According to the Ministry of Justice, despite having the same legal framework throughout Italy, it takes two years in some areas in the north of Italy to repossess collateral, and up to eight years in some areas in the south.

NEWS & ANALYSIS Credit implications of current events

15 MOODY’S CREDIT OUTLOOK 5 MAY 2016

Details of European Commission’s State Aid Approval for HSH Nordbank Present Credit-Negative Challenges On Monday, the European Commission (EC) issued its formal state aid approval for Germany’s largest ship lender, HSH Nordbank AG (HSH, Baa3/Baa3 developing, b31). Although the details on the bank’s restructuring and subsequent privatisation process are broadly in line with earlier indications, HSH’s own announcement on the same day mentions a substantial €260 million one-off payment that the EC requires to ensure that the approval is based on “state-aid neutral” terms. In addition, HSH specified the deadline for its privatisation as February 2018, which is earlier than expected.

The one-off payment and earlier-than-expected privatisation are credit negative for HSH. The one-off payment will weigh on HSH’s 2015 income statement and capital resources, and the early date for the bank’s privatisation implies limited time for the troubled lender to demonstrate that the fruits of its restructuring will eventually stabilise its franchise and risk profile, which will be vital for HSH’s privatisation to be successful. The EC’s final approval formalises its 19 October 2015 statement that gave the green light for an increase to €10 billion of a second-loss asset guaranty from HSH’s state owners that HSH had prematurely reduced to €7 billion in September 2011.

The news has some credit-positive elements. The EC’s formal approval ends a three-year period of state-aid investigations that had added legal uncertainty to HSH’s multiple challenges of managing its outsize exposure to the shipping sector, high nonperforming loans and substantial market risk from its US dollar-based lending. In addition, the approval allows the bank to go ahead with important restructuring measures, in particular the creation of a new holding company and offloading most of €8.2 billion of risky assets to that holding company and selling the remainder on the market. We expect that these asset sales will halve HSH’s nonperforming loans.

However, HSH’s announcement included cost items that were not mentioned when the bank first indicated an agreement with the EC over state aid last October. The €260 million one-off payment compares with a modest €110 million pre-tax profit that HSH reported for the nine months to September 2015 and is equivalent to almost 0.7 percentage points of HSH’s regulatory capital ratios, based on the bank’s €38.4 billion risk-weighted assets as of September. However, we understand that HSH’s indication in March that it will achieve a common equity Tier1 ratio of at least 12.0% as of December 2015 already includes the one-off payment.

The €260 million is largely meant to cover premium obligations on the €10 billion asset guaranty that HSH had initially indicated were no longer required from 2016 onward. We now understand that €210 million of the €260 million will compensate the new holding company for the equivalent of guaranty premiums that it must pay starting this year, until HSH is privatised in 2018. This effectively moves to the fore a burden that we had expected HSH would no longer have to pay. In addition, the payment entails HSH’s coverage of €50 million operating costs at the holding company.

When HSH reported its September 2015 results, the bank summarised the pre-agreed deal with the EC as one that will strengthen its profitability and risk profile. Upon closer inspection of the newly disclosed details, however, the terms of the decision highlight how serious the European antitrust authorities are about disallowing any relief from previously imposed compensation measures.

1 The bank ratings shown in this report are HSH’s deposit rating, senior unsecured rating and baseline credit assessment.

Katharina Barten Senior Vice President +49.69.70730.765 katharina.barten@moodys.com

NEWS & ANALYSIS Credit implications of current events

16 MOODY’S CREDIT OUTLOOK 5 MAY 2016

Sovereigns

US Cruise Ships Set Sail for Cuba, a Credit Positive for the Sovereign Last Sunday, the first US cruise ship in more than a half century left Port Miami in Florida for Cuba (Caa2 positive). This followed the modification of a decades-old Cuban policy that prohibited those born in Cuba (including Cuban-born Americans) from arriving on the island by sea via commercial vessels, a crucial step for US cruise lines to begin service to and dock in Cuba.2 Cuba’s rapid ability to adjust laws to expand channels for US visitor arrivals reflects the government’s commitment to adopting policy changes that both deliver an economic benefit to the island nation (through increased US visitor arrivals) and support increased rapprochement with the US, a credit positive.

Sunday’s historic departure followed the Cuban government’s series of rapid policy changes in March and April to increase visitor arrivals from the US. First, in March, Carnival Corporation (Baa1 stable), the largest worldwide cruise line, became the first US cruise company to receive permission from the Cuban government to dock in Cuba. However, Cuban law prohibiting people born in Cuba from entering by sea created a conundrum for Carnival. In place since the late 1960s, the law was motivated by fears that commercial vessels (including cruise ships) could be used by individuals who wanted to enter Cuba and undermine the government, and also by Cubans to flee the island.3 To comply with the Cuban law, Carnival initially refused to sell tickets for US-Cuba cruise service to Cuban-born travelers.

Carnival’s work-around met major public backlash, including a class-action lawsuit brought by two Cuban-born individuals, alleging that Carnival’s policy discriminated against Cubans by denying them tickets. Carnival then reversed course, requesting that the Cuban government modify existing law so that Cuban-born passengers could book tickets, which would give them the same access to Cuba by sea as they have by air. On 22 April, the Cuban authorities lifted the longstanding ban on arrival by cruise ships of Cuban-born individuals.

Hospitality and tourism remain a key industry for Cuba as a generator of jobs, foreign exchange and economic activity. An estimated 3.5 million visitors arrived in 2015, a 17.4% increase from 2014. We expect 3.9 million visitors to arrive in 2016, an 11% increase over last year, underpinned primarily by increased visitor arrivals from the US.

The increase in travelers arriving in Cuba via cruise ship from the US will significantly increase visitor arrivals without putting a strain on Cuba’s limited hotel capacity. Although the number and quality of hotel rooms has been expanding, Cuba’s tourism infrastructure is currently unable to sustain rapid growth. Nevertheless, the Cuban authorities’ quick action (upon learning of the problem) to allow for the visit of Cuban-born passengers reflects their commitment to adopting policy changes that support increased rapprochement with the US and overall economic activity in Cuba, a credit positive trend for the island nation.

2 The cruises were initially made possible by a relaxation of legal requirements for US travelers to visit Cuba. Because US tourist travel

to Cuba is still prohibited, the cruises are structured to comply with US Office of Foreign Assets Control requirements for “people to people” exchanges. Passengers may, however, undertake a self-directed schedule if they comply with other travel authorizations under Cuban sanctions.

3 There is no restriction on Cuban-born individuals arriving by air.

Jaime Reusche Vice President - Senior Analyst +1.212.553.0358 jaime.reusche@moodys.com

Anna Snyder Associate Analyst +1.212.553.4037 anna.snyder@moodys.com

NEWS & ANALYSIS Credit implications of current events

17 MOODY’S CREDIT OUTLOOK 5 MAY 2016

IMF Program Will Ease Sri Lanka’s Liquidity Pressures, but Not Its Fiscal Challenges Last Friday, the International Monetary Fund (IMF) and Government of Sri Lanka (B1 stable) announced a staff-level agreement on a $1.5 billion three-year Extended Fund Facility program. The IMF financial assistance program aims to provide liquidity and support Sri Lanka’s foreign-exchange reserves and government credit metrics. The IMF program will have a credit-positive effect on liquidity, but will only marginally affect government credit metrics, unless fiscal policy implementation is much smoother than we expect. The IMF agreement comes as Sri Lanka’s sovereign credit quality is increasingly under pressure from its large fiscal deficits, high debt levels, poor debt affordability and low foreign exchange reserves.

The IMF program has three potential benefits for Sri Lanka’s external financing profile. First, program disbursements, together with $650 million of forthcoming multilateral and bilateral loans, according to the IMF, will increase liquidity. Foreign exchange reserves have fallen to low levels relative to external debt repayments and net import payments. In the fourth-quarter of 2015, short-term external debt totalled 103.7% of foreign exchange reserves. Meanwhile, Sri Lanka’s current account deficit was 2.4% of GDP in 2015, only partly covered by foreign direct investment inflows, which also weighs on reserves. Program funding will likely reverse the decline in foreign exchange reserves and reduce Sri Lanka’s vulnerability to a sudden stop in capital inflows.

Second, the IMF financing will be at more favourable terms than Sri Lanka can get through the market. In 2015, interest payments on government debt absorbed 35% of Sri Lanka’s government revenues. As a result, the government’s fiscal metrics are very sensitive to effective interest rates. The interest rate charged on the IMF’s Extended Fund Facility programs is the Special Drawing Rights lending rate, currently 0.05% plus 100 basis points, versus the 11.75% yield on the government’s three-year notes auctioned in April.

Third, the agreement may help restore market access. The government will still rely on market financing to cover large financing needs, which the IMF estimates at 28.7% of GDP this year. Moreover, evidence of macroeconomic policy reforms, particularly regarding fiscal policy, would likely support more stable private external inflows, such as foreign direct investment. Reforms of the tax structure, collection and administration will be bolstered by the IMF’s technical assistance and credibility. On the day of the agreement announcement, the government confirmed some tax increases, including raising the value-added tax (VAT) rate to 15% and a broadening of the VAT base starting on 2 May.

However, we expect bumps in the sovereign’s fiscal consolidation path because of difficulties in implementing robust revenue raising measures. We forecast a further increase in the government’s debt burden and debt/GDP ratio this year and next, leaving Sri Lanka vulnerable to a shift in financing conditions (see exhibit). The budget deficit widened markedly last year to 7.4% of GDP, compared with 4.4% targeted in the budget. At 76% of GDP, government debt was high compared with similarly rated sovereigns.

Atsi Sheth Associate Managing Director +65.6398.3727 atsi.sheth@moodys.com

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

Amelia Tan Associate Analyst +65.6398.8323 amelia.tan@moodys.com

NEWS & ANALYSIS Credit implications of current events

18 MOODY’S CREDIT OUTLOOK 5 MAY 2016

Sri Lanka’s Government Debt/GDP Ratio

Sources: Central Bank of Sri Lanka and Moody’s Investors Service

The IMF mission chief mentioned a targeted deficit at 3.5% of GDP in 2020. According to our estimates, Sri Lanka’s narrowest deficit since 1998 was 5.4% of GDP in 2013. With slower growth in the next few years, and signs of financial stress for some state-owned enterprises, achieving significant fiscal consolidation will be challenging.

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2010 2011 2012 2013 2014 2015 2016 (F)

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

19 MOODY’S CREDIT OUTLOOK 5 MAY 2016

NEWS & ANALYSIS Corporates 2 » Apple Boosts Shareholder Payouts, a Credit Negative » AbbVie Delays Deleveraging to Buy Stemcentrx » Anheuser-Busch InBev Sale of SAB European Assets Dampens

Negative Credit Effect of SABMiller Acquisition » Verisk’s Healthcare Sale Is Credit Positive » Brown-Forman’s Acquisition of BenRiach Whisky Brands Is

Credit Negative » Avery Dennison’s Purchase of Mactac’s European Business Is

Credit Positive » Sanofi’s Offer to Acquire Medivation in All-Cash Deal Is

Credit Negative » Fortescue Metals’ Note Redemption Is Credit Positive

Infrastructure 11 » EPM’s Resumption of Operations at Guatape Power Plant Is

Credit Positive

Banks 13 » FASB’s New Expected Credit Loss Model Aligns with the

Economics of Lending and Investing » US Regulators’ Proposed Funding Rule Would Enhance Bank

Liquidity » General Motors Financial’s Possible Breach of Capital

Support Ratio Is Credit Negative

» Mexican Government’s Guarantee on Loans to Cities and States Is Credit Positive for Banks

» RBS Delays Williams & Glyn’s Divestment, Adding to Costs, a Credit Negative

» Bankinter’s Placement of Additional Tier 1 Securities Is Credit Positive

Exchanges 21 » European Central Counterparty Stress Test Shows Resilience

to Market Shocks, a Credit Positive

Sovereigns 23 » Delays in Concluding Greece’s Bailout Program Review Are

Credit Negative » UK’s Suspension of Aid to Mozambique Is Credit Negative for

the African Sovereign

Sub-sovereigns 25 » Increase in Russian Government Budget Loans to Regions Is

Credit Positive

US Public Finance 27 » Illinois’ Stopgap Higher Education Funding Bill Is Credit

Positive, but Funding Challenges Persist » Strike at San Francisco Community College Signals Credit-

Negative Resistance to Budget Cuts

MOODYS.COM

Report: 189608

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