Moody s approach to rating subsovereigns DANIEL MAZIBUKO, ASSOCIATE ANALYST

Moody s approach to rating subsovereigns DANIEL MAZIBUKO, ASSOCIATE ANALYST 14 JULY 2016

Agenda 1. RLGs Global presence 2. Moody s approach to rating government-related issuers (GRIs) 3. Moody s approach to rating regional & local governments (RLGs) 4. Lessons learnt from African issuers active in the bond market 2

1 RLGs Global Presence 3

Global Presence» 47 analysts/associates» Staff located in 13 offices world-wide to serve our clients and the market» 16 different nationalities speaking 17+ languages Toronto London Madrid Frankfurt Prague Milan Moscow Beijing Tokyo Mexico City Buenos Aires Johannesburg Sydney 4

Rating Universe: A Wide Array of Public Entities Two Big Families: RLGs, GRIs Housing Associations Utilities Provinces Regions Transportation Specialised Lenders Regional and Local Governments (RLGs) Water Governmentrelated Issuers (GRIs) Financial Institutions Cities States Healthcare Higher Education Not for Profit 5

RLG Ratings Universe by Geography Credits Spread Over 39 Countries» Strong presence in Canada and Africa Australia and Asia South America Mexico, W.Europe & CEE/CIS» Issuer ratings dominant vs. debt Western Europe ratings, capital mkt activity limited in many countries North America» National Scale Ratings widely used in Eastern Europe Mexico, CEE/CIS, South Africa and Turkey» Africa coverage is limited to South Africa 6

South African Rated Sub-Sovereigns (As at 11 May 2016) OUTLOOK GLOBAL SCALE NATIONAL SCALE RATING METROPOLITAN MUNICIPALITIES City of Cape Town Negative Baa2/P-2 Aaa.za/P1-za [1] Ekurhuleni Metro Negative Baa2/P-2 Aaa.za/P-1.za [1] Johannesburg Negative Baa2/P-2 Aa1.za/P-1.za [1] Nelson Mandela Metro Negative Baa2 Aa1.za City of Tshwane Negative Ba1/NP A1.za/ P-1.za Mangaung Negative Ba1/NP A1.za/P-1.za LOCAL MUNICIPALITIES Rustenburg Negative Ba1 A1.za Mbombela Negative Ba1 A2.za KwaDukuza Negative Ba2 A3.za Bergrivier Stable Ba3/NP Baa2.za/P-1.za Breede Valley Negative Ba1/NP A2.za/P-1.za DISTRICT MUNICIPALITIES Amathole District Negative Ba1 A2.za UMgungundlovu District Stable Ba3 Baa2.za GOVERNMENT RELATED ISSUERS (GRI S) City Power Johannesburg Negative Baa2 Aa1.za East Rand Water Care Company (ERWAT) Negative Baa3 Aa3.za South African National Roads (SANRAL) Negative Baa3/P-3 Aa3.za/P-1.za Notes: [1] Issuer and debt ratings. 7

2 Moody s approach to rating government-related issuers (GRIs) 8

What is a Government-Related Issuer (GRI)? 1 An entity with full or partial government ownership or control or a public policy mandate from the national or local government 2 Minimum 20% government ownership level 3 Sub Sovereign Group rates around 80 GRIs, in view of the close link with the relevant state/sub-national government 9

Joint Default Analysis (JDA) framework Under the Joint-Default Analysis (JDA) framework, Moody s ratings express: 1 The standalone credit risk profile of the GRI: Baseline Credit Assessment (BCA) 2 The intervention of the supporter government to prevent a default by the GRI (i.e. Extraordinary support) 3 The degree of financial/economic linkage between the issuer and its supporting government (i.e. Default dependence) 10

Joint Default Analysis (JDA) Framework Continued Baseline Credit Assessment The intrinsic or stand-alone risk of the GRI, in essence a bail-out risk rating» Benchmark to peers if available; incorporates recurring/predictable subsidies and transfers from the supporting government» Includes ordinary support from the government as well as relevant government-related risks such as loss of special charter, monopoly status, or punitive taxation» Published on a scale of aaa to c (where aaa corresponds to the lowest credit risk) 11

Joint Default Analysis (JDA) Framework Continued Extraordinary Support» Probability that a government owner would provide financial support, or other contractual protections» Major analytical factors Existence of guarantees Ownership level Barriers to support Government intervention Political linkages Economic importance of GRI» It can be either low (0-30%), moderate (31-50%), strong (51-70%), high (71-90%), very high (91-100%) 12

Joint Default Analysis (JDA) Framework Continued Default Dependence» Reflects the tendency of a GRI and its supporting government to be jointly susceptible to adverse circumstances that simultaneously move them closer to default» Scorecard-based analysis, to ensure international consistency» Major analytical factors Operational and financial linkages Reliance on overlapping revenue base Exposure to common credit risks» It can be either low (30%), moderate (50%), high (70%), very high (90%) 13

Joint Default Analysis (JDA) Framework Continued Analytical approach for GRIs Without a BCA Characteristics of such GRIs without a BCA, which are rated solely on support include: A very close and enduring alignment of interests and objectives Generally government agencies or entities wholly government-owned Very limited strategic or operational autonomy Standalone financial performance and metrics are essentially meaningless The GRI s default would substantially damage the governments own credit standing 14

3 Moody s approach to rating Regional & local governments (RLGs) 15

RLGs: The Approach 1 RLGs are enduringly linked to their respective sovereign. The sovereign s credit quality will to some extent anchor the credit quality of the RLG 2 As we move down the rating scale, we observe that credit risks for RLGs tend to align closer to sovereign credit risk, hence rating compression with the sovereign 3 Sovereign and sub-sovereign entities are more likely to be affected by similar external factors, or event risk. 16

RLGs: BCA and Extraordinary Support F1. Economic Fundamentals F2. Institutional Framework F3. Financial performance & Debt profile F4. Governance & Management Operating Environment (typically reflected in Sovereign bond rating) Assessment of idiosyncratic risk Assessment of systemic risk Baseline Credit Assessment RLG Rating Extraordinary Support Range 17

Assessing Idiosyncratic Risk Institutional Framework Financial performance & Debt profile Economic Fundamentals Governance & Management 18

Assessing Idiosyncratic Risk Why it matters Economic Fundamentals (20%)» An RLG's ability to service its debt depends on, among other factors, the sufficiency and reliability of its future revenues.» Relative economic performance will likely impact an RLG s ability to generate own-source revenues and its dependence on fiscal transfers. How it s measured in the scorecard» Regional GDP per capita as a percentage of national GDP per capita» Economic volatility is assessed by evaluating an RLG s economic diversity 19

Assessing Idiosyncratic Risk Continued Why it matters Institutional Framework (20%)» The institutional framework determines intergovernmental relations and shapes RLG powers and responsibilities.» It addresses the way in which these responsibilities and powers may be altered, whether by a higher tier entity or by the RLG itself. How it s measured in the scorecard» We gauge predictability, stability and responsiveness by assessing whether and how RLG powers and responsibilities may be altered in response to changing circumstances.» We gauge financial flexibility by evaluating own-source revenue flexibility and the RLG sector's spending flexibility 20

Assessing Idiosyncratic Risk Continued Why it matters Financial Performance & Debt Profile (30%)» Financial performance is the product of accumulated decisions of policy makers regarding an RLG s revenue structure and expenditure base» The government's debt profile includes the amount of debt, the burden it poses, its structure and composition» How it s measured in the scorecard» Ratio of gross operating balance to operating revenue» Ratio of interest payments to operating revenue» Cash and liquidity management» Debt burden & debt structure 21

Assessing Idiosyncratic Risk Continued Why it matters Governance and Management (30%)» Our assessment of a government's credit standing includes an assessment of the quality of financial decision-making.» How it s measured in the scorecard» Risk controls and financial management practices.» Investment and debt management policies and practices» Transparency and disclosure practices 22

Extraordinary Support assumptions 1 Extraordinary support is the likelihood that a higher-tier government would aid an RLG in the event that it faced acute liquidity stress 2 Support could take different forms, for example, a one-time cash infusion or any action facilitating negotiations with lenders that enhances access to interim financing for the RLG. 3 Extraordinary support is classified into five ranges: low (0% - 30%), moderate (31% - 50%), strong (51% - 70%), high (71% - 90%) and very high (91% - 100%). 23

4 Lessons learnt from African issuers active in the bond market (Cape Town, Johannesburg, Ekurhuleni and City of Tshwane) 24

Municipalities are Governed by Strong Legislations National Government Plays Key Oversight Role» Since 1994, the local government system in South Africa has been restructured and transformed in an effort to improve the coverage and quality of public service» In year 2000 the new demarcation process was completed and three spheres of municipalities were created» In 2003 the new Municipal Financial Management Act was implemented to govern and manage municipal operations» In 2004 the city of Johannesburg issued the first municipal bond and others follow later 25

Municipal Bond issuances have substantially increased 4 metros (CT, JHB, Ekurhuleni and Tshwane) have entered the debt capital market since 2004, registering a total of ZAR32 billion ($2.7 billion) DMTN program by 30 June 2015. These metros plan to spend $7.8 billion on capital investments in 2016-18 which represents a 23% increase from 2012-15, borrowing will contribute 30% of the total Cumulative Bond Issuance (US$ Million) Source: Moody s calculations on issuers financials 26

US$ million Bond issuances add to diversification of funding sources The number of investors participating in the municipal bonds has increased 51% of the metros total debt is financed through bond issuances City of Johannesburg successfully redeemed ZAR2.6 billion ($236 million) through the sinking fund investment from 2010 to 2015 Total Debt as at 30 June 2015 1600 Bonds Other loans Total Debt 1400 1200 1000 800 600 400 200 Source: 0 Moody s calculations on issuers financials Ekurhuleni Cape Town Johannesburg Tshwane Metro 27

US$ million Substantial increase in fixed assets for metros Four Metros budgeted to continue tapping debt capital market to diversify funding sources Access to funding has improved for South African municipalities in particular at metro level 3,000 New borrowings Capital Revenues Own funds Capital Expenditures 2,500 2,000 1,500 1,000 500 0 Source: Moody s calculations on issuers financials and Budget 2012 2013 2014 2015 2016F 2017F 2018F 28

Percentage (%) Moderate debt levels despite increase in capital investments Net Direct and Indirect Debt/Operating Revenue 60.0 Cape Town Johannesburg City of Tshwane Ekurhuleni Metro 50.0 40.0 30.0 20.0 10.0 0.0 2012 2013 2014 2015 2016F 2017F 2018F Source: Moody s calculations on issuers financials and budget 29

Analytical Team South Africa Daniel Mazibuko Associate Analyst Tel. + 27.011.217.5481 daniel.mazibuko@moodys.com Sebastien Hay VP / Senior Credit officer Team Leader Tel. +34.91.768.8222 sebastien.hay@moodys.com Mauro Crisafulli Associate Managing Director Tel. +39.02.91481.105 mauro.crisafulli@moodys.com 31

2016 Moody s Corporation, Moody s Investors Service, Inc., Moody s Analytics, Inc. and/or their licensors and affiliates (collectively, MOODY S ). All rights reserved. CREDIT RATINGS ISSUED BY MOODY'S INVESTORS SERVICE, INC. AND ITS RATINGS AFFILIATES ( MIS ) ARE MOODY S CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES, AND CREDIT RATINGS AND RESEARCH PUBLICATIONS PUBLISHED BY MOODY S ( MOODY S PUBLICATIONS ) MAY INCLUDE MOODY S CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES. MOODY S DEFINES CREDIT RISK AS THE RISK THAT AN ENTITY MAY NOT MEET ITS CONTRACTUAL, FINANCIAL OBLIGATIONS AS THEY COME DUE AND ANY ESTIMATED FINANCIAL LOSS IN THE EVENT OF DEFAULT. CREDIT RATINGS DO NOT ADDRESS ANY OTHER RISK, INCLUDING BUT NOT LIMITED TO: LIQUIDITY RISK, MARKET VALUE RISK, OR PRICE VOLATILITY. CREDIT RATINGS AND MOODY S OPINIONS INCLUDED IN MOODY S PUBLICATIONS ARE NOT STATEMENTS OF CURRENT OR HISTORICAL FACT. MOODY S PUBLICATIONS MAY ALSO INCLUDE QUANTITATIVE MODEL-BASED ESTIMATES OF CREDIT RISK AND RELATED OPINIONS OR COMMENTARY PUBLISHED BY MOODY S ANALYTICS, INC. CREDIT RATINGS AND MOODY S PUBLICATIONS DO NOT CONSTITUTE OR PROVIDE INVESTMENT OR FINANCIAL ADVICE, AND CREDIT RATINGS AND MOODY S PUBLICATIONS ARE NOT AND DO NOT PROVIDE RECOMMENDATIONS TO PURCHASE, SELL, OR HOLD PARTICULAR SECURITIES. NEITHER CREDIT RATINGS NOR MOODY S PUBLICATIONS COMMENT ON THE SUITABILITY OF AN INVESTMENT FOR ANY PARTICULAR INVESTOR. MOODY S ISSUES ITS CREDIT RATINGS AND PUBLISHES MOODY S PUBLICATIONS WITH THE EXPECTATION AND UNDERSTANDING THAT EACH INVESTOR WILL, WITH DUE CARE, MAKE ITS OWN STUDY AND EVALUATION OF EACH SECURITY THAT IS UNDER CONSIDERATION FOR PURCHASE, HOLDING, OR SALE. MOODY S CREDIT RATINGS AND MOODY S PUBLICATIONS ARE NOT INTENDED FOR USE BY RETAIL INVESTORS AND IT WOULD BE RECKLESS AND INAPPROPRIATE FOR RETAIL INVESTORS TO USE MOODY S CREDIT RATINGS OR MOODY S PUBLICATIONS WHEN MAKING AN INVESTMENT DECISION. IF IN DOUBT YOU SHOULD CONTACT YOUR FINANCIAL OR OTHER PROFESSIONAL ADVISER. ALL INFORMATION CONTAINED HEREIN IS PROTECTED BY LAW, INCLUDING BUT NOT LIMITED TO, COPYRIGHT LAW, AND NONE OF SUCH INFORMATION MAY BE COPIED OR OTHERWISE REPRODUCED, REPACKAGED, FURTHER TRANSMITTED, TRANSFERRED, DISSEMINATED, REDISTRIBUTED OR RESOLD, OR STORED FOR SUBSEQUENT USE FOR ANY SUCH PURPOSE, IN WHOLE OR IN PART, IN ANY FORM OR MANNER OR BY ANY MEANS WHATSOEVER, BY ANY PERSON WITHOUT MOODY S PRIOR WRITTEN CONSENT. All information contained herein is obtained by MOODY S from sources believed by it to be accurate and reliable. Because of the possibility of human or mechanical error as well as other factors, however, all information contained herein is provided AS IS without warranty of any kind. MOODY'S adopts all necessary measures so that the information it uses in assigning a credit rating is of sufficient quality and from sources MOODY'S considers to be reliable including, when appropriate, independent third-party sources. However, MOODY S is not an auditor and cannot in every instance independently verify or validate information received in the rating process or in preparing the Moody s Publications. To the extent permitted by law, MOODY S and its directors, officers, employees, agents, representatives, licensors and suppliers disclaim liability to any person or entity for any indirect, special, consequential, or incidental losses or damages whatsoever arising from or in connection with the information contained herein or the use of or inability to use any such information, even if MOODY S or any of its directors, officers, employees, agents, representatives, licensors or suppliers is advised in advance of the possibility of such losses or damages, including but not limited to: (a) any loss of present or prospective profits or (b) any loss or damage arising where the relevant financial instrument is not the subject of a particular credit rating assigned by MOODY S. To the extent permitted by law, MOODY S and its directors, officers, employees, agents, representatives, licensors and suppliers disclaim liability for any direct or compensatory losses or damages caused to any person or entity, including but not limited to by any negligence (but excluding fraud, willful misconduct or any other type of liability that, for the avoidance of doubt, by law cannot be excluded) on the part of, or any contingency within or beyond the control of, MOODY S or any of its directors, officers, employees, agents, representatives, licensors or suppliers, arising from or in connection with the information contained herein or the use of or inability to use any such information. NO WARRANTY, EXPRESS OR IMPLIED, AS TO THE ACCURACY, TIMELINESS, COMPLETENESS, MERCHANTABILITY OR FITNESS FOR ANY PARTICULAR PURPOSE OF ANY SUCH RATING OR OTHER OPINION OR INFORMATION IS GIVEN OR MADE BY MOODY S IN ANY FORM OR MANNER WHATSOEVER. Moody s Investors Service, Inc., a wholly-owned credit rating agency subsidiary of Moody s Corporation ( MCO ), hereby discloses that most issuers of debt securities (including corporate and municipal bonds, debentures, notes and commercial paper) and preferred stock rated by Moody s Investors Service, Inc. have, prior to assignment of any rating, agreed to pay to Moody s Investors Service, Inc. for appraisal and rating services rendered by it fees ranging from $1,500 to approximately $2,500,000. MCO and MIS also maintain policies and procedures to address the independence of MIS s ratings and rating processes. Information regarding certain affiliations that may exist between directors of MCO and rated entities, and between entities who hold ratings from MIS and have also publicly reported to the SEC an ownership interest in MCO of more than 5%, is posted annually at www.moodys.com under the heading Investor Relations Corporate Governance Director and Shareholder Affiliation Policy. Additional terms for Australia only: Any publication into Australia of this document is pursuant to the Australian Financial Services License of MOODY S affiliate, Moody s Investors Service Pty Limited ABN 61 003 399 657AFSL 336969 and/or Moody s Analytics Australia Pty Ltd ABN 94 105 136 972 AFSL 383569 (as applicable). This document is intended to be provided only to wholesale clients within the meaning of section 761G of the Corporations Act 2001. By continuing to access this document from within Australia, you represent to MOODY S that you are, or are accessing the document as a representative of, a wholesale client and that neither you nor the entity you represent will directly or indirectly disseminate this document or its contents to retail clients within the meaning of section 761G of the Corporations Act 2001. MOODY S credit rating is an opinion as to the creditworthiness of a debt obligation of the issuer, not on the equity securities of the issuer or any form of security that is available to retail investors. It would be reckless and inappropriate for retail investors to use MOODY S credit ratings or publications when making an investment decision. If in doubt you should contact your financial or other professional adviser. Additional terms for Japan only: Moody's Japan K.K. ( MJKK ) is a wholly-owned credit rating agency subsidiary of Moody's Group Japan G.K., which is wholly-owned by Moody s Overseas Holdings Inc., a wholly-owned subsidiary of MCO. Moody s SF Japan K.K. ( MSFJ ) is a wholly-owned credit rating agency subsidiary of MJKK. MSFJ is not a Nationally Recognized Statistical Rating Organization ( NRSRO ). Therefore, credit ratings assigned by MSFJ are Non-NRSRO Credit Ratings. Non-NRSRO Credit Ratings are assigned by an entity that is not a NRSRO and, consequently, the rated obligation will not qualify for certain types of treatment under U.S. laws. MJKK and MSFJ are credit rating agencies registered with the Japan Financial Services Agency and their registration numbers are FSA Commissioner (Ratings) No. 2 and 3 respectively. MJKK or MSFJ (as applicable) hereby disclose that most issuers of debt securities (including corporate and municipal bonds, debentures, notes and commercial paper) and preferred stock rated by MJKK or MSFJ (as applicable) have, prior to assignment of any rating, agreed to pay to MJKK or MSFJ (as applicable) for appraisal and rating services rendered by it fees ranging from JPY200,000 to approximately JPY350,000,000. MJKK and MSFJ also maintain policies and procedures to address Japanese regulatory requirements. 32