U.S. Public Finance Ratings Criteria: General Criteria and Cross-Sector

Transcription

1 U.S. Public Finance Ratings Criteria: General Criteria and Cross-Sector

2 Visit spratings.com/uspublicfinance for additional criteria-related materials.

3 To Our Readers S&P Global Ratings is pleased to present the 2016 edition of U.S. Public Finance Ratings Criteria General Criteria and Cross-Sector. The criteria in this book were in effect as of July 11, From time to time we may revise or withdraw criteria or publish new criteria, and we encourage market participants to visit our websites for the most current information. Changes and updates to our criteria will be published on our public website at spglobal.com, and on S&P Global Ratings RatingsDirect on the Global Credit Portal (subscription-based). Our goal is to provide greater insight to market participants about our ratings criteria, and we hope you will find the information useful. Sincerely, Tina Morris Managing Director General Manager Head of U.S. Public Finance S&P Global Ratings

4 Table of Contents The criteria in this book were in effect as of July 11, From time to time we may revise or withdraw criteria or publish new criteria, and we encourage market participants to visit our websites for the most current information. Changes and updates to our criteria will be published on our public website at spglobal.com, and on S&P Global Ratings RatingsDirect on the Global Credit Portal (subscription-based). General Criteria (Applies to all sectors) Bond Insurance And Credit Ratings, Aug. 24, 2009 Credit Stability Criteria, May 3, 2010 Criteria For Assigning CCC+, CCC, CCC-, And CC Ratings, Oct. 1, 2012 Rating Implications Of Exchange Offers And Similar Restructurings, Update, May 13, 2009 Rating Government-Related Entities: Methodology And Assumptions, March 25, 2015 Principles For Rating Debt Issues Based On Imputed Promises, Dec. 19, 2014 Methodology: Industry Risk, November 19, 2013 Methodology And Assumptions For Rating Jointly Supported Financial Obligations, May 23, 2016 Post-Default Ratings Methodology: When Does S&P Global Raise A Rating From D Or SD?, March 23, 2015 Principles of Credit Ratings, Feb. 16, 2011 Rating Definitions, Understanding, June 3, 2009 Ratings Above The Sovereign: Corporate And Government Ratings Methodology And Assumptions, Nov. 19, 2013 Stand-Alone Credit Profiles: One Component Of A Rating, Oct. 1, 2010 Stressed Reinvestment Rate Assumptions For Fixed-Rate U.S. Debt Obligations, May 20, 2013 Timeliness Of Payments: Grace Periods, Guarantees, And Use Of D And SD Ratings, Oct. 24, 2013 Use Of C And D Issue Credit Ratings For Hybrid Capital And Payment-In-Kind Instruments, Oct. 24, 2013 Use of CreditWatch And Outlooks, Sept. 14, 2009

5 Cross-Sector (Applies to multiple sectors) Appropriation-Backed Obligations, June 13, 2007 Assessing Construction Risk, June 22, 2007 Assigning Issue Credit Ratings Of Operating Entities, May 20, 2015 Bond Anticipation Note Rating Methodology, Aug. 31, 2011 Commercial Paper, VRDO, And Self-Liquidity, July 3, 2007 Contingent Liquidity Risks, March 5, 2012 Covenant And Payment Provisions In U.S. Public Finance Revenue Obligations, Nov. 29, 2011 Derivative Agreement Criteria, June 24, 2013 Escrowed Collateral, Nov. 30, 2012 Investment Guidelines, June 25, 2007 Long-Term Municipal Pools, March 19, 2012 Obligations With Multiple Revenue Streams, Nov. 29, 2011 Pension Fund Credit Enhancement And Related Guarantee Programs, Sept. 25, 2006 Public Pension Funds, June 27, 2007 Short-Term Debt, June 15, 2007 State Credit Enhancement Programs, Nov. 13, 2008 Temporary Investments In Transaction Accounts, May 31, 2012 Copyright 2016 by S&P Global Financial Services LLC. All rights reserved. STANDARD & POOR S, S&P and RATINGSDIRECT are registered trademarks of Standard & Poor s Financial Services LLC.

6 General Criteria

7 General Criteria: Methodology: The Interaction Of Bond Insurance And Credit Ratings Corporate Criteria Officer, EMEA: Emmanuel Dubois-Pelerin, Paris (33) ; Senior Credit Officer, Latin America: Laura J Feinland Katz, CFA, New York (1) ; laura_feinland_katz@standardandpoors.com Table Of Contents SCOPE OF THE CRITERIA SUMMARY OF CRITERIA UPDATE IMPACT ON OUTSTANDING RATINGS EFFECTIVE DATE AND TRANSITION METHODOLOGY Frequently Asked Questions RELATED RESEARCH AUGUST 24,

8 General Criteria: Methodology: The Interaction Of Bond Insurance And Credit Ratings (Editor's Note: We originally published this criteria article on Aug. 24, We're republishing it following our periodic review completed on March 13, As a result of our review, we updated the author contact information.) Note: This article supersedes the following previously published criteria articles: Credit FAQ: The Interaction Of Bond Insurance And Credit Ratings, Dec. 19, Credit FAQ: The Interaction Of Bond Insurance And Credit Ratings Structured Finance Update, Feb. 26, Credit FAQ: Underlying Corporate Ratings Of Insured Debt Remain Strongly Investment Grade, March 11, Credit FAQ: Increased Focus On Credit Quality Of Project Finance Issues After Ratings Changes To Monolines, April 24, Standard & Poor's Ratings Services is publishing this article to help market participants better understand its methodology regarding the interaction of bond insurance and credit ratings. This article is related to our criteria articles "Principles Of Corporate And Government Ratings," which we published on June 26, 2007 and "Principles-Based Rating Methodology For Global Structured Finance Securities," which we published on May 29, SCOPE OF THE CRITERIA 2. Standard & Poor's is publishing this criteria article to summarize and clarify its methodology for rating issues that have credit enhancement in the form of bond insurance. These criteria apply to all sectors. SUMMARY OF CRITERIA UPDATE 3. This article supersedes the following articles: Credit FAQ: The Interaction Of Bond Insurance And Credit Ratings, Dec. 19, Credit FAQ: The Interaction Of Bond Insurance And Credit Ratings Structured Finance Update, Feb. 26, Credit FAQ: Underlying Corporate Ratings Of Insured Debt Remain Strongly Investment Grade, March 11, Credit FAQ: Increased Focus On Credit Quality Of Project Finance Issues After Ratings Changes To Monolines, April 24, The main differences compared with the aforementioned articles are: This criteria article consolidates the previously published criteria to provide increased transparency; however, there are no methodological changes from previous criteria. We have added the section "What consequences does a bond insurer downgrade have on an obligation that does not have a SPUR?," paragraphs AUGUST 24,

9 General Criteria: Methodology: The Interaction Of Bond Insurance And Credit Ratings IMPACT ON OUTSTANDING RATINGS 5. We do not expect any rating changes as a result of this criteria update, since our methodology has not changed. EFFECTIVE DATE AND TRANSITION 6. These criteria are effective immediately. METHODOLOGY 7. In general, the rating on an issue that has credit enhancement in the form of bond insurance will be the higher of the rating on the insurance company providing the enhancement, and, if rated, that of the underlying obligation. Standard & Poor's provides, upon request, a Standard & Poor's underlying rating (SPUR), which addresses the creditworthiness of the underlying entity or obligation (i.e., without considering the potential credit enhancement from bond insurance). Frequently Asked Questions What is bond insurance? 8. Bond insurance is a financial commitment by a bond insurance company to make the scheduled principal and interest payments on a bond if the obligor does not. Insurance on a new issue is typically obtained by the issuer with the expectation that the interest rate on the insured bonds will be lower than if they were not insured. Bondholders can also obtain insurance in the secondary market. What is credit enhancement? 9. Credit enhancement generally refers to a financial instrument or structural feature of a transaction that enables the obligation to be rated higher than the creditworthiness of the obligor (or underlying assets). Letters of credit, reserve accounts, overcollateralization, and bond insurance are all viewed as forms of credit enhancement. Credit enhancement generally operates to absorb all or a portion of credit losses in a transaction, thereby increasing protection for the holders of rated "credit-enhanced" securities. What is an issue rating? 10. A Standard & Poor's issue credit rating is a current opinion of the creditworthiness of an obligor with respect to a specific financial obligation, a specific class of financial obligations, or a specific financial program. It takes into consideration the creditworthiness of guarantors, insurers, or other forms of credit enhancement on the obligation. What is a SPUR? 11. A SPUR expresses our opinion of the stand-alone creditworthiness of the obligation, the stand-alone capacity to pay debt service on an insured debt issue in accordance with its terms, without taking into account the enhancement that may reduce default risk. Upon request of the issuer, Standard & Poor's will publish a SPUR on an insured bond issue. A SPUR is the same as an issue rating, simply without enhancement. The SPUR is assigned and surveilled in the same manner as an unenhanced issue rating. Making more SPURs publicly available is one of several steps Standard & AUGUST 24,

10 General Criteria: Methodology: The Interaction Of Bond Insurance And Credit Ratings Poor's is taking to provide greater transparency. What are the interactions between these ratings? 12. When we have assigned a SPUR, the issue credit rating on a fully insured bond issue is the higher of the bond insurance provider's rating or the SPUR. For example, an issue, with a SPUR of 'BBB+', would be rated 'A' based on the support of an 'A' rated bond insurer. If the bond insurer's rating was lowered to 'A-', then the issue rating would also be lowered to 'A-'. But if the bond insurer's rating was lowered to, say, 'BBB-', while the SPUR remained 'BBB+', then the issue would be lowered only to 'BBB+', because the underlying creditworthiness of the obligor or obligation is higher than the bond insurer's. Note that the SPUR remains in place regardless of what happens to the bond insurer's rating and is subject to surveillance by Standard & Poor's. If the bond insurer's rating and the SPUR are the same, the issue outlook or CreditWatch status is assigned based on our assessment of the possible outcomes for the issue rating. For example, a stable outlook on the SPUR and a developing outlook on the bond insurer would result, if both are rated the same, in a positive outlook on the issue. When are SPURs withdrawn? 13. Like other ratings, if we no longer receive adequate information to maintain surveillance on the underlying obligation, Standard & Poor's withdraws the SPUR. In such a case, our practice is to rate the issue based solely on the bond insurance--at the then current rating of the bond insurer, except as noted below, in the section "What consequences does a bond insurer downgrade have on an obligation that does not have a SPUR?" What are the consequences of a bond insurer downgrade on an obligation that has a confidential SPUR? 14. In the event that we lower the rating on a bond insurer to a level below the confidential SPUR on a corporate or government obligation, then, Standard & Poor's will likely suspend or withdraw the issue rating, unless the issuer requests the SPUR to be made public, in which case paragraph 12, "What are the interactions between these ratings?," would apply. The rating is withdrawn or suspended because it no longer reflects our opinion of the issue's credit quality. 15. Historically, Standard & Poor's public SPURs were not requested for most fully bond insured structured finance issues. However, typically we maintain a SPUR on the obligation for purposes of determining capital charges for the bond insurer. We generally do not publish these SPURs unless specifically requested to do so by the issuer or the bond insurer. However, if the bond insurer's rating falls below the level of the SPUR, Standard & Poor's practice has been to lower the structured finance issue rating to the level of the SPUR. What consequences does a bond insurer downgrade have on an obligation that does not have a SPUR? 16. The answer to this question depends on Standard & Poor's general assessment of credit quality within a given sector. The issue rating on a transaction without a SPUR will reflect that of the relevant bond insurer, until the bond insurer's rating declines below a given level whereby we no longer regard the bond insurer rating as reflective of credit quality of the obligation. At this point, the issue rating would be suspended or withdrawn. 17. For example, in the case of public finance, we generally suspend or withdraw ratings on bond insured transactions that do not have a SPUR if the relevant bond insurer's rating is lowered below 'BBB-'. This is because we generally AUGUST 24,

11 General Criteria: Methodology: The Interaction Of Bond Insurance And Credit Ratings assess credit quality as 'BBB-' or higher for the underlying entities/obligations in this sector. However, in the case of other sectors, including structured finance, we generally suspend or withdraw ratings on bond insured transactions that do not have a SPUR if the relevant bond insurer's rating is lowered below 'B+'. This is because we expect there may be many transactions in these sectors with underlying creditworthiness below 'BBB-'. Does the lowering of the insured rating have any impact on the SPUR? 18. In most cases, the SPUR and the bond-insured issue rating operate independently of each other. That said, there may be some effect on the SPUR as a result of the downgrade of a bond insurer in cases where the downgrade may have adverse credit consequences for the underlying entity and/or transaction, for example, by triggering a risk premium payable on the entity hitting certain performance covenants. Standard & Poor's will assess the potential effect of a bond insurer downgrade on an entity's SPUR depending on relevant provisions in the issue's documentation. RELATED RESEARCH Credit FAQ: The Interaction Of Bond Insurance And Credit Ratings, Dec. 19, 2007 Credit FAQ: The Interaction Of Bond Insurance And Credit Ratings Structured Finance Update, Feb. 26, 2008 Credit FAQ: Underlying Corporate Ratings Of Insured Debt Remain Strongly Investment Grade, March 11, 2008 Credit FAQ: Increased Focus On Credit Quality Of Project Finance Issues After Ratings Changes To Monolines, April 24, 2008 Principles Of Corporate And Government Ratings, June 26, 2007 Principles-Based Rating Methodology For Global Structured Finance Securities, May 29, 2007 These criteria represent the specific application of fundamental principles that define credit risk and ratings opinions. Their use is determined by issuer- or issue-specific attributes as well as Standard & Poor's Ratings Services' assessment of the credit and, if applicable, structural risks for a given issuer or issue rating. Methodology and assumptions may change from time to time as a result of market and economic conditions, issuer- or issue-specific factors, or new empirical evidence that would affect our credit judgment. AUGUST 24,

12 Copyright 2015 Standard & Poor's Financial Services LLC, a part of McGraw Hill Financial. All rights reserved. No content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor's Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an "as is" basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT'S FUNCTIONING WILL BE UNINTERRUPTED, OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages. Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P's opinions, analyses, and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw, or suspend such acknowledgement at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal, or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof. S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain nonpublic information received in connection with each analytical process. S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, (free of charge), and and (subscription) and (subscription) and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at AUGUST 24,

13 General Criteria: Methodology: Credit Stability Criteria Primary Credit Analysts: Ian D Thompson, Melbourne (44) ; ian.thompson@standardandpoors.com Lucy A Collett, New York (1) ; lucy.collett@standardandpoors.com Secondary Contacts: Lapo Guadagnuolo, London (44) ; lapo.guadagnuolo@standardandpoors.com Felix E Herrera, CFA, New York (1) ; felix.herrera@standardandpoors.com Table Of Contents SCOPE OF THE CRITERIA SUMMARY OF CRITERIA UPDATE EFFECTIVE DATE AND TRANSITION METHODOLOGY Defining An Unusually Large Decline In Credit Quality Why Did Standard & Poor's Adopt This Approach? RELATED CRITERIA AND RESEARCH MAY 3,

14 General Criteria: Methodology: Credit Stability Criteria (Editor's Note: We originally published this criteria article on May 3, We\rquote ve republished it following our periodic review completed on Nov. 10, As a result of our review, we updated the author contact information. This article supersedes "Standard & Poor's To Explicitly Recognize Credit Stability As An Important Rating Factor," published Oct. 15, 2008.) 1. Standard & Poor's Ratings Services is clarifying its criteria for recognizing credit stability as an important rating factor. We are publishing this article to help market participants better understand how credit stability is incorporated in our ratings. This article is related to "Principles Of Corporate And Government Ratings," which we published on June 26, 2007, and "Principles-Based Rating Methodology For Global Structured Finance Securities," which we published on May 29, SCOPE OF THE CRITERIA 2. These criteria apply to credit ratings on all types of issuers and issues. SUMMARY OF CRITERIA UPDATE 3. Standard & Poor's incorporates credit stability as an important factor in our rating opinions. When assigning and monitoring ratings, we consider whether we believe an issuer or security has a high likelihood of experiencing unusually large adverse changes in credit quality under conditions of moderate stress. In such cases, we would assign the issuer or security a lower rating than we would have otherwise. 4. This update clarifies the meaning of "moderate stress," as used in these criteria, and supersedes "Standard & Poor s To Explicitly Recognize Credit Stability As An Important Rating Factor," published Oct. 15, EFFECTIVE DATE AND TRANSITION 5. These criteria are effective immediately for all new and outstanding ratings. METHODOLOGY 6. When assigning and monitoring ratings, we consider whether we believe an issuer or security has a high likelihood of experiencing unusually large adverse changes in credit quality under conditions of moderate stress (for example, recessions of moderate severity, such as the U.S. recession of 1982 and the U.K. recession in the early 1990s or appropriate sector-specific stress scenarios). To promote rating comparability, we use hypothetical stress scenarios as benchmarks for calibrating our criteria across different sectors and over time (see "Understanding Standard & Poor s MAY 3,

15 General Criteria: Methodology: Credit Stability Criteria Rating Definitions," published June 3, 2009). Each scenario broadly corresponds to one of the rating categories 'AAA' through 'B'. The scenario for a particular category reflects the level of stress that issuers or obligations rated in that category should, in our view, be able to withstand without defaulting. The 'BBB' stress scenario connotes moderate stress. Defining An Unusually Large Decline In Credit Quality 7. The table shows the maximum projected deterioration under moderate stress conditions that we would associate with each rating level for time horizons of one year and three years. For example, we would not assign a rating of 'AA' where we believe the rating would likely fall below 'A' within one year under moderate stress conditions. Maximum Projected Deterioration Associated With Rating Levels For One-Year And Three-Year Horizons Under Moderate Stress Conditions AAA AA A BBB BB B One year AA A BB B CCC D Three years BBB BB B CCC D D 8. These credit-quality transitions do not reflect our view of the expected degree of deterioration that rated issuers or securities could experience over the specified time horizons. Nor do they reflect the typical historical levels of deterioration among rated issuers and securities. In fact, instances of credit deterioration of this magnitude and speed have been relatively uncommon. These criteria do not imply that we believe that issuers or securities should become--or are likely to become--less stable. 9. Rather, the values in the table express a theoretical outer bound for the projected credit deterioration of any given issuer or security under specific, hypothetical stress scenarios. Actual experience likely will vary from the hypothetical scenarios, so the universe of rated issuers and securities (as well as sub-populations of the full universe) likely will display actual degrees of deterioration greater than or less than those indicated in the table. For example, we would naturally expect relatively little credit deterioration during benign market conditions or during conditions of only mild or modest stress, which we view as the 'B' and 'BB' stress scenario, respectively. Conversely, issuers and securities could suffer greater degrees of credit deterioration during periods of severe (AA scenario) or extreme (AAA scenario) stress. In addition, specific business segments--such as housing, energy, retail, and transportation--could experience different degrees of stress over any given period. 10. We do not intend this approach to result in rating upgrades in sectors that have historically displayed above-average credit stability. Instead, we intend the framework to function as a limiting factor on the ratings assigned to credits that we believe are vulnerable to exceptionally high instability. 11. The primary focus of the stability consideration is intended to be ordinary business risk rather than special types of risk, such as changes in laws, fraud, or corporate acquisitions. 12. The methodology is asymmetric in that it focuses solely on credit deterioration rather than on credit improvement. There are two reasons for this approach. First, investors and creditors have expressed greater concern about deterioration than improvement. Second is the essential downside/upside asymmetry of the basic credit proposition. MAY 3,

16 General Criteria: Methodology: Credit Stability Criteria Why Did Standard & Poor's Adopt This Approach? 13. We incorporate credit stability in our ratings in light of the high degree of credit volatility displayed by certain derivative securities in recent years. By explicitly recognizing stability as a factor in our ratings, we intend to align their meanings more closely with our perception of investors' desires and expectations. 14. Responses to our July 16, 2008, Request For Comment on this subject reinforce our belief that investors generally prefer high ratings to be more stable than low ratings. High ratings should connote high stability. 15. As a general matter, our ratings express our opinion of the creditworthiness of issuers and specific securities. However, the notion of creditworthiness has sometimes been interpreted differently in various market segments. In particular, certain areas of the structured finance segment have favored a narrow interpretation, essentially meaning "likelihood of default" without regard to other factors. We have moved beyond the narrow interpretation in favor of one that we believe is more practical and useful for market participants. As a result, although our view on likelihood of default remains a focus of our ratings, it is not our only consideration (see "Understanding Standard & Poor s Rating Definitions," published June 3, 2009). RELATED CRITERIA AND RESEARCH Big Changes in Standard & Poor s Rating Criteria, Nov. 3, 2009 Understanding Standard & Poor s Rating Definitions, June 3, 2009 Standard & Poor's Reaffirms Its Commitment To The Goal Of Comparable Ratings Across Sectors And Outlines Related Actions, May 6, 2008 These criteria represent the specific application of fundamental principles that define credit risk and ratings opinions. Their use is determined by issuer- or issue-specific attributes as well as Standard & Poor's Ratings Services' assessment of the credit and, if applicable, structural risks for a given issuer or issue rating. Methodology and assumptions may change from time to time as a result of market and economic conditions, issuer- or issue-specific factors, or new empirical evidence that would affect our credit judgment. MAY 3,

17 Copyright 2015 Standard & Poor's Financial Services LLC, a part of McGraw Hill Financial. All rights reserved. No content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor's Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an "as is" basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT'S FUNCTIONING WILL BE UNINTERRUPTED, OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages. Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P's opinions, analyses, and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw, or suspend such acknowledgement at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal, or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof. S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain nonpublic information received in connection with each analytical process. S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, (free of charge), and and (subscription) and (subscription) and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at MAY 3,

18 General Criteria: Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings Primary Credit Analysts: Philip A Baggaley, CFA, New York (1) ; philip.baggaley@standardandpoors.com Sol B Samson, New York (1) ; sol_samson@standardandpoors.com Criteria Officers: Mark Puccia, Corporate & Governments, New York (1) ; mark_puccia@standardandpoors.com Joseph F Sheridan, Structured Finance, New York (1) ; joseph_sheridan@standardandpoors.com Secondary Contacts: Emmanuel Dubois-Pelerin, Paris (33) ; emmanuel_dubois-pelerin@standardandpoors.com Luciano D Gremone, Buenos Aires (54) ; luciano_gremone@standardandpoors.com Fabienne Michaux, Melbourne (61) ; fabienne_michaux@standardandpoors.com Felix E Herrera, CFA, New York (1) ; felix_herrera@standardandpoors.com Table Of Contents SUMMARY OF THE CRITERIA SCOPE OF THE CRITERIA IMPACT ON OUTSTANDING RATINGS EFFECTIVE DATE AND TRANSITION METHODOLOGY Criteria For 'CCC' Category Ratings Criteria For 'CC' Category Ratings Primary Differentiating Factor--Likelihood Of Default OCTOBER 1,

19 Table Of Contents (cont.) Frequently Asked Questions RELATED CRITERIA AND RESEARCH OCTOBER 1,

20 General Criteria: Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings (Editor's Note: We originally published this criteria article on Oct. 1, We're republishing it following our periodic review completed on Sep. 5, 2014.) 1. Standard & Poor's Ratings Services is updating its criteria for assigning 'CCC+', 'CCC', 'CCC-', and 'CC' ratings. This article is related to our criteria article "Principles Of Credit Ratings", which we published on Feb. 16, SUMMARY OF THE CRITERIA 2. The article updates our criteria for assigning 'CCC+', 'CCC', 'CCC-', and 'CC' ratings. We associate each rating level with a distinct scenario or set of scenarios. The criteria supersede the article "How Standard & Poor s Uses Its 'CCC' Rating," published Dec. 12, SCOPE OF THE CRITERIA 3. This methodology applies to issuer credit ratings and issue ratings. However, corporate and government issue ratings may be notched up or down from the issuer credit rating based on post-default recovery considerations, or relative position in the event of bankruptcy, and such notching adjustments are outside the scope of this criteria. Please refer to the following criteria: "Hybrid Capital Handbook: September 2008 Edition," published Sept. 15, 2008, "Bank Hybrid Capital Methodology And Assumptions," published Nov. 1, 2011, and "Criteria Guidelines For Recovery Ratings On Global Industrial Issuers' Speculative-Grade Debt," published Aug. 10, IMPACT ON OUTSTANDING RATINGS 4. We expect a limited number of rating changes with most rating changes to occur within the 'CCC' category. We expect a minimal number of ratings to move to the 'CCC' category from the 'B' category. EFFECTIVE DATE AND TRANSITION 5. These criteria are effective immediately for all new and outstanding issuer and issue ratings. We intend to complete our review of issuers and issues affected within the next six months. METHODOLOGY 6. The criteria are designed to provide clarity for assigning 'CCC+', 'CCC', 'CCC-', and 'CC' ratings. The number of ratings at these levels has grown substantially in recent years as a result of the financial crisis and subsequent recession. In OCTOBER 1,

21 General Criteria: Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings addition, in certain sectors, such as corporate ratings, the increased use of these ratings reflects greater investor acceptance of more speculative credits. In order to provide additional clarity for assigning these ratings, we associate each rating level with a distinct scenario or set of scenarios (see "Understanding Standard & Poor's Ratings Definitions," published June 3, 2009). These criteria have priority over other sector specific criteria when assigning these ratings to issues and issuers. Criteria For 'CCC' Category Ratings 7. Standard & Poor's defines the 'CCC' issue credit rating as follows: "An obligation rated 'CCC' is currently vulnerable to nonpayment, and is dependent upon favorable business, financial, and economic conditions for the obligor to meet its financial commitment on the obligation. In the event of adverse business, financial, or economic conditions, the obligor is not likely to have the capacity to meet its financial commitment on the obligation." 8. As a general rule, issuers and issues that face at least a one-in-two likelihood of default will be rated in the 'CCC' category. The 'CCC' category may also be appropriate--even at a lower likelihood of default threshold of approximately one-in-three--if we expect a default within the next 12 months. Criteria For 'CC' Category Ratings 9. Standard & Poor's defines the 'CC' issue credit rating as follows: "An obligation rated 'CC' is currently highly vulnerable to nonpayment." 10. We rate an issuer or issue 'CC' when we expect default to be a virtual certainty, regardless of the time to default. We use the 'CC' rating when, for example: An entity has announced that it will miss its next interest or principal payment, but is still current on these payments. An entity has announced its intention to file a bankruptcy petition or take similar action and payments on an obligation are jeopardized, but the entity has not yet entered into receivership protection. An entity has announced its intention to undertake an exchange offer or similar restructuring that we classify as distressed, but has not yet completed the transaction (see "Rating Implications Of Exchange Offers And Similar Restructurings, Update," published May 12, 2009). We expect the default of an issue to be a virtual certainty based on either: the specific default scenarios that are envisioned over the next 12 months, or the expectation of default even under the most optimistic collateral performance scenario over a longer period of time. 11. In addition, we assign a 'cc' SACP (stand-alone credit profile) to an issuer when we expect default to be a virtual certainty, unless it receives extraordinary support from a parent or government. Primary Differentiating Factor--Likelihood Of Default 12. In our view, likelihood of default is the centerpiece of creditworthiness. That means likelihood of default--encompassing both capacity and willingness to pay--is the single most important factor in our assessment of OCTOBER 1,

22 General Criteria: Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings the creditworthiness of an issuer or an obligation. Therefore, consistent with our goal of achieving a rank ordering of creditworthiness, higher ratings on issuers and obligations reflect our expectation that the rated issuer or obligation should default less frequently than issuers and obligations with lower ratings, all other things being equal. 13. More specifically, the degree of financial stress on the issuer or issue and the time frame for anticipated default are primary factors in our assessment of the likelihood of default for issuers and issues rated in the 'CCC' and 'CC' categories. 14. For corporate and government issuers, the time frame to anticipated default is generally the dominant factor when assigning a plus (+) or minus (-) sign modifier to show relative standing within the 'CCC' rating category. This is because, as a corporate and government issuer approaches an anticipated default date the likelihood of a favorable change in business, financial, or economic conditions that would be sufficient to avoid a default generally declines and the level of certainty that the issuer will default generally increases. In order to provide greater clarity about the usage of ratings ranging from 'CCC+' to 'CCC-' (and from 'ccc+' to 'ccc-' SACPs for issuers, unless they receive extraordinary support from a parent or government), the following are scenarios that would generally be associated with each rating level: 'CCC+': The issuer is currently vulnerable and is dependent upon favorable business, financial, and economic conditions to meet its financial commitments. The issuer's financial commitments appear to be unsustainable in the long term, although the issuer may not face a near term (within 12 months) credit or payment crisis. 'CCC': It is likely that the issuer will default without an unforeseen positive development. In contrast to the 'CCC+' rating, specific default scenarios are envisioned over the next 12 months. These scenarios include, but are not limited to, a near-term liquidity crisis, violation of financial covenants, or an issuer is likely to consider a distressed exchange offer or redemption in the next 12 months. 'CCC-': A default, distressed exchange, or redemption appears to be inevitable within six months, absent unanticipated significantly favorable changes in the issuer's circumstances. 15. Similarly, for structured finance issues, the 'CCC' category is used if the payment of principal or interest when due is dependent upon favorable business, financial, or economic conditions. The degree of financial stress is generally the dominant factor and the time frame for anticipated default is generally a secondary consideration when assigning a plus (+) or minus (-) sign modifier to the 'CCC' rating. Expected collateral performance and the level of available enhancement (credit and/or cash flow) are generally the primary factors in our assessment of the degree of financial stress and likelihood of default. Time frame for anticipated default is generally a secondary consideration because structured finance issuers are typically special purpose entities, which by definition have limited ability to raise additional capital or pursue strategic alternatives that could improve their business or financial conditions irrespective of the time horizon. Frequently Asked Questions Q1: What scenarios are associated with corporate issuers for 'CCC+' and 'CCC' ratings? 16. A: Corporate issuers rated 'CCC+' typically have a combination of "vulnerable" business risk and a "highly leveraged" financial profile, but a specific default scenario is not yet envisioned. However, in some cases very high leverage could place an issuer with a "weak" business profile in this rating (as our criteria define the terms). The issuer's leverage is OCTOBER 1,

23 General Criteria: Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings "unsustainable". (For example, debt is a very high multiple of EBITDA and a successful refinancing is unlikely, absent financial improvement.) 17. When specific default scenarios are envisioned over the next 12 months, the corporate issuer is rated 'CCC'. (For example: the issuer has breached covenants, unless we have reason to think creditors will waive their remedies or the related facilities are of limited size; the issuer's operating cash is dwindling; or a large maturity or other liquidity crisis for the issuer looms.) Q2: What are the most common factors that lead to upgrades out of the 'CCC' category for issuers? 18. A: Generally, 'CCC' rated companies often default without a material positive development, such as a change to their capital structure or business model, as the definition of this category suggests. But we have observed that many struggling companies can and do endeavor to make such positive developments materialize. If this occurs, some may subsequently be upgraded to reflect the improved situation--but a good percentage of these slip back into distress and ultimately default. Upgrades out of the 'CCC' category can be due to the following reasons: Improved business, financial, or economic conditions; Purchase by a stronger entity; Refinancing; Debt repayment; Waiver and amendment of covenants; Market factors, e.g., higher commodity prices; and Asset sales. Q3: What about cases, like banks and insurance, where the holding company's issuer credit rating is typically derived by notching down from the Group Credit Profile (GCP)? 19. A: Typically, an insurance holding company is rated one to three notches below the GCP of its operating subsidiaries to reflect structural subordination. So for operating companies rated in the 'B' category or lower, standard notching could imply a holding company rating in the 'CCC' or 'CC' categories. However, in some cases the holding company may have no liabilities of significance that could lead to default. In those cases, if the holding company does not meet the criteria in paragraphs 7-14 for the 'CCC' or 'CC' ratings, its issuer credit rating would generally be no lower than 'B-', even though this might result in compression between the operating company and holding company ratings. 20. We do not expect such an issue to arise for banks where the maximum notching down of the holding company rating is one from the GCP. RELATED CRITERIA AND RESEARCH Bank Hybrid Capital Methodology And Assumptions, Nov. 1, 2011 Principles Of Credit Ratings, Feb. 16, 2011 Criteria Guidelines For Recovery Ratings On Global Industrial Issuers' Speculative-Grade Debt, Aug. 10, 2009 Understanding Standard & Poor's Ratings Definitions, June 3, 2009 Rating Implications Of Exchange Offers And Similar Restructurings, Update, May 12, 2009 Hybrid Capital Handbook: September 2008 Edition, Sept. 15, OCTOBER 1,

24 General Criteria: Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings These criteria represent the specific application of fundamental principles that define credit risk and ratings opinions. Their use is determined by issuer- or issue-specific attributes as well as Standard & Poor's Ratings Services' assessment of the credit and, if applicable, structural risks for a given issuer or issue rating. Methodology and assumptions may change from time to time as a result of market and economic conditions, issuer- or issue-specific factors, or new empirical evidence that would affect our credit judgment. OCTOBER 1,

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26 General Criteria: Rating Implications Of Exchange Offers And Similar Restructurings, Update Primary Credit Analysts: Emmanuel Dubois-Pelerin, Paris (33) ; Mark Puccia, New York (1) ; Secondary Credit Analyst: Laura J Feinland Katz, CFA, New York (1) ; laura_feinland_katz@standardandpoors.com Table Of Contents Frequently Asked Questions MAY 12,

27 General Criteria: Rating Implications Of Exchange Offers And Similar Restructurings, Update (Editor's Note: We originally published this criteria article on May 12, We are republishing this article following our periodic review completed on March 27, As a result of our review, we updated the author contact information. This article supersedes the article titled, "Corporate Default Risk With A Twist," published July 5, In addition, this article has been partially superseded by "Use Of 'C' And 'D' Issue Credit Ratings For Hybrid Capital And Payment-In-Kind Instruments," published Oct. 24, 2013, and by "Post-Default Ratings Methodology: When Does Standard & Poor's Raise A Rating From 'D' Or 'SD'?" published March 23, Specifically, the latter article fully supersedes the last paragraph of the answer to question 5 and the entire answer to question 11 in this criteria article.) Entities in distress often restructure their obligations, offering less than the original promise. There recently has been a great deal of such activity, taking the form of exchange offers and buybacks. The alternative of a potential conventional default, in which the investor or counterparty stands to fare even worse, motivates (at least partially) their acceptance of such an offer. Standard & Poor's Ratings Services treats such offers and buybacks analytically as de facto restructuring--and, accordingly, as equivalent to a default on the part of the issuer. To consider an exchange offer as tantamount to default, we look for two conditions to be met: The offer, in our view, implies the investor will receive less value than the promise of the original securities; and The offer, in our view, is distressed, rather than purely opportunistic. Upon completion of an exchange we view to be distressed, we lower our ratings on the affected issues to 'D', and the issuer credit rating is reduced to 'SD' (selective default), assuming the issuer continues to honor its other obligations. This is the case even though the investors, technically, may accept the offer voluntarily and no legal default occurs. Subsequently, we raise the rating to again focus on conventional default risk. This applies even in the case of an extended de facto restructuring--such as a proposed series of auctions to buy back distressed debt. Our approach to such transactions pertains equally to the restructuring of any financial obligation of the entity--debt security, loan, or derivatives contract. This article updates and supersedes Distressed Exchange Offers: Tantamount To Default, published Nov. 2, 2001, and Rating Implications Of Exchange Offers And Similar Restructurings, published Jan. 28, 2009, on RatingsDirect. In particular, questions 9-12 have been added, and we have tried to better clarify some of the original answers. Compared with the Nov. 2, 2001 article, we have widened the scope to include: Methodology for considering whether the renegotiation of a derivative contract is equivalent to a distressed exchange and, therefore, tantamount to default for the issuer rating and, if the derivative is a rated obligation, a default for the issue-level rating; Specific discussion on how we apply the methodology to equity hybrid instruments, such as preferred stock; Specific discussion on how we apply the methodology to structured finance transactions; and Additional discussion on when we consider an exchange or tender offer as "distressed," including reference to the MAY 12,

28 General Criteria: Rating Implications Of Exchange Offers And Similar Restructurings, Update current rating of the issuer and/or instrument. Compared with the Jan. 28, 2009 article, we have added a number of clarifications, and also clarified the approach we take to determine recovery ratings on debt issues subject to distressed exchange offers, in that recovery ratings (and related issue rating notching implications) will not focus on the selective default transaction; rather, they will continue to focus on post-conventional default recovery (see question No. 5, below). The criteria discussed in this article reflect our principle-based methodology, as discussed in Principles Of Corporate And Government Ratings, published June 26, 2007, and Principles-Based Rating Methodology For Global Structured Finance Securities, published May 29, 2007, on RatingsDirect. This article is part of a broad series of measures announced last year to enhance our governance, analytics, dissemination of information, and investor education initiatives. These initiatives are aimed at augmenting our independence, strengthening the rating process, and increasing our transparency to better serve the global markets. (See also Rating Policies And Procedures: Distress And Default," published March 5, 2001, on RatingsDirect.) This article also partially supersedes the article, Credit FAQ:How the Expansion Of The C Rating Definition Affects Its use For Hybrid Capital and Payment-In-Kind Instruments, published Aug. 1, 2008, on RatingsDirect. Frequently Asked Questions 1. How do you determine whether an offer is distressed or opportunistic? We distinguish between distressed offers and those that are merely opportunistic. In a distressed exchange, holders accept less than the original promise because of the risk that the issuer will fulfill its original obligations. By way of contrast, an entity that is a strong credit may offer to exchange bonds for below par where changes in market interest rates, other technicalities, or market developments have caused its bonds to trade at a discount. Such an offer is opportunistic, and would have no rating implications (other than the resulting beneficial impact on future financial profile.) For an exchange offer to be viewed as distressed, we must decide that, apart from the offer, there is a realistic possibility of a conventional default (i.e., the company could file for bankruptcy, become insolvent, or fall into payment default) on the instrument subject to the exchange, over the near to medium term. Alternatively, exchange offers for which we believe the issuer does not face insolvency or bankruptcy in the near to medium term if the offer is not accepted are viewed as opportunistic exchanges, not distressed exchanges. The extant issuer credit ratings, as well as rating outlooks or CreditWatch listings, can often serve as proxies for that assessment.. For example, we consider the following guidelines, in addition to other information: If the issuer credit rating is 'B-' or lower, the exchange would ordinarily be viewed as distressed and, hence, as a de facto restructuring. If the issuer credit rating is 'BB-' or higher, the exchange would ordinarily not be characterized as a de facto restructuring. If the issuer credit rating is 'B+' or 'B', market prices or other cues would be used to make the call. MAY 12,

29 General Criteria: Rating Implications Of Exchange Offers And Similar Restructurings, Update Trading prices of the securities under offer and/or the offering prices can also provide some insight about the characterization of the exchange offer and other buyback activity. Investors, or counterparties--whatever their trading strategies--would be assessing the likelihood of receiving the originally promised amount and comparing the offer to what they expect to receive if a conventional default occurs. An exchange offer conducted several quarters in advance of maturities, where investors are asked to extend the tenor, with compensation in the form of amendment fees or increased interest rates, would be considered proactive treasury management, rather than a de facto restructuring. 2. Aren't such offers and similar restructuring positive for the company's credit quality? Indeed, upon completion of a distressed offer, the entity ordinarily will benefit financially, helping it to avoid a conventional insolvency and reduce risk going forward. This may ultimately lead to higher ratings than before the offer was announced. However, this positive change would be the result of restructuring the obligation (i.e., not meeting its financial obligations in accordance with its terms). In our view, it is analogous to a bankruptcy--a process that also benefits an entity by relieving it of the financial burdens that it undertook previously. Accordingly, our ratings take into account this failure to pay in accordance with the terms of the obligation, and any subsequent benefit would be reflected only afterwards. 3. Exchange offers are sometimes referred to as "coercive." Is this the same as a "distressed offer"? No. An offer may be deemed coercive, if, for example, the entity employs tactics that pit holders of one series against holders of another series, or imperils holdouts with the threat of stripping covenants once 51% of the bonds are bought in. But from a credit perspective, the coercive aspect of an offer is largely irrelevant. While it may reflect on management style and financial policy, incorporating coercive tactics into an offer would not cause us to view that offer as a de facto restructuring, just as the absence of such tactics would not prevent an offer from being characterized as a distressed offer. Whether coercive tactics are involved or not, exchange offers are entirely voluntary: Investors can elect not to participate. However, the voluntary acceptance of an offer at a distressed value implies a perception of a significant risk the original obligation may not be fulfilled. The entity's offer acknowledges this reality. Holders may be very pleased with an offer that is above market prices, especially if they account for the investment on a mark-to-market basis. Moreover, holders that bought their securities at distressed prices may be elated to turn a quick profit. In fact, holders often are the ones to initiate such transactions. But such considerations do not detract from the credit perspective: The obligation is not being fulfilled as originally promised. 4. What constitutes "less than the original promise"? Investors may receive less value than the promise of the original securities, if one or more of the following happens without adequate offsetting compensation: The combination of any cash amount and principal amount of new securities offered is less than the original par amount; The interest rate is lower than the original yield; MAY 12,

30 General Criteria: Rating Implications Of Exchange Offers And Similar Restructurings, Update The new securities' maturities extend beyond the original; The timing of payments is slowed (e.g., zero-coupon from quarterly paying, or bullet from amortizing); or The ranking is altered to more junior. Even a small discrepancy between the offer and the original promise may be deemed a de facto restructuring. However, if an offer is so close to the original promise that it is hard to discern any shortfall, we would not characterize that as a default. It does not matter if the entity is offering cash, securities, or common equity, as long as the market value of the offer can reasonably be shown to equate to the accreted value of the original securities (par and any accrued interest). 5. What specific rating actions do you take in the case of a distressed transaction? The consummation of a distressed exchange offer or analogous transaction is viewed as a de facto restructuring with respect to the security involved, resulting in a 'D' rating on that security, even if only a portion of it is subject to the exchange. The issuer credit rating is downgraded to 'SD' (selective default) to reflect the de facto restructuring on some of its obligations. We lower the issuer rating to 'SD' rather than 'D' if the entity continues to honor all its other obligations, and there is no conventional default or broad de facto restructuring, as there would be in the case of a bankruptcy. For sovereigns, once the distressed exchange offer has been confirmed (albeit with a future effective date), we also lower the issuer rating to 'SD' and the affected issue rating to 'D'. Once a distressed offer is announced or otherwise anticipated, we lower the issuer and issue ratings to reflect the risk of the expected de facto restructuring. The issuer credit rating is generally lowered to 'CC' and ordinarily carries a negative rating outlook. The issue that is subject to the exchange offer is cut to 'CC'. Recovery ratings--and related notching implications--do not focus on the selective default transaction; rather, they continue to focus on post-conventional default recovery. If the offer is rejected and there is no expectation of another offer being made, the issuer and issue ratings will ordinarily be restored to their previous levels (unless credit quality has evolved in the meantime for other reasons, including the increased risk of additional distressed exchange offers). After an exchange offer is completed, the entity is no longer in default--similar to an entity that has exited from bankruptcy. The 'SD' issuer credit rating is no longer applicable--and we change it as expeditiously as possible (that is, once we complete a forward-looking review that takes into account whatever benefits were realized from the restructuring, as well as any other interim developments). If the exchange offer applies to only part of an issue--either because the offer was limited or because some holders declined it--we could raise the rating on the portion of the original securities that remain outstanding, if the issuer continues full debt service as originally contracted. The rating could also remain at 'D' if payments are not made on time and in full on that portion. 6. How do you treat loan modifications? Similar to exchange offers for bonds, if a bank loan is rescheduled such that the lender receives less value than the original value of the loan--for example, if tenor is extended without appropriate compensation (e.g., an amendment fee or increased interest rate), or interest or principal is reduced, we may consider it a de facto restructuring. However, MAY 12,

31 General Criteria: Rating Implications Of Exchange Offers And Similar Restructurings, Update the extension of bank loan maturities for a bilateral bank loan (between a bank and its customer, as opposed to a syndicated loan) considered in the normal course of business (rather than an extension for a distressed issuer) would not be considered a de facto restructuring. Sometimes it is difficult to discern the nature of the changes. Apart from the credit risk of the borrower (i.e., whether it viewed as distressed by virtue of low ratings), the context and timing of an extension may offer insights. Accordingly, whether we consider them de facto restructurings depends on the circumstances. 7. How do you treat secondary market repurchases below par? We make an exception for open-market purchases; however, this exception applies only in a limited fashion. When the market is liquid, so that an issuer's market repurchases can be anonymous, we view that as if any other investor were buying the securities. By contrast, when a company faces its investors through direct or indirect interaction--including advertising itself as a buyer--we treat such repurchases as a debt restructuring. Typically, repurchases of significant percentages of an issue indicate that the issuer is playing at least a behind-the-scene role. 8. What if a shareholder or one of its affiliates, launches the offer, rather than the company itself? A related party offering at clearly less than par would be seen in the same light as if the entity itself made the same offer. The fact that the loan remains outstanding--held by the affiliate--is irrelevant, because the investors participating in the transaction received less than the original promise. (This situation is obviously distinct from restructuring a loan originally extended by the shareholders, which would be viewed as the equivalent of infusion of equity.) 9. How does a selective default affect ratings on the entity's affiliates--including parent companies and subsidiaries? Ordinarily, ratings indicating default apply strictly to the legal entity involved. That applies to de facto restructurings as well. However, we extend that to affiliates that guarantee the issues which are subject to the restructuring. If the obligation was guaranteed by a third party, there would be no implications for that other entity, inasmuch as the guarantee is not invoked. 10. Does the amount of debt restructured matter? Yes and no. The amount of "par" that gets restructured does not directly matter, because even very small amounts may be deemed a default, just as if a company misses a minimal amount of payment due. However, if the transaction involves only a trivial amount, we would not characterize that as a restructuring. Consider that in such instances any impact on the company's risk profile is de minimus (even though we do not otherwise attempt to gauge the extent to which a de facto restructuring will succeed in relieving the risk of a conventional default.) 11. What about restructurings that are not effected in a single transactions, but rather involve multiple separate transactions over several weeks or months? How do you deal with such situations? We have recently seen a number of cases, especially on bank loans, where the issuer intends to conduct periodic auctions to repurchase some of its debt over several weeks or several quarters. We downgrade to 'D'/'SD' on completion of the first repurchase. Subsequently--as early as the next business day--we would raise the corporate MAY 12,

32 General Criteria: Rating Implications Of Exchange Offers And Similar Restructurings, Update rating so that it reflects the risk of a conventional default--i.e., not focusing on the ongoing restructuring associated with the buyback. (In some cases, this rating will be higher than the original rating, given the debt reduction resulting from the buybacks. However, any issues subject to the buyback remain at 'D' until the termination of the restructuring that pertains to them. 12. How do you treat standstill agreements? Unless the standstill provides for appropriate compensation with respect to the obligations that will be deferred, we will typically lower the issuer's credit rating to 'D' (or 'SD' if some obligations would not be subject to the standstill). Similarly, we would lower the issue ratings to 'D' for those obligations subject to the stand-still agreement. In particular, we do not wait until a payment is first missed on an obligation but would typically lower the issuer's credit rating to 'D'/'SD' (and affected issue ratings to 'D') upon agreement with lenders on the standstill or any like formalization of the default. The ratings in such cases will remain 'D' or 'SD' until the obligations are subsequently restructured. 13. What about the entity's other rated obligations? A distressed exchange offer for specific securities may have no direct bearing on the entity's other securities and/or loans, so the ratings on these may not be immediately affected. (Whereas issue ratings typically are anchored by the issuer rating--i.e., they reflect a combination of the issuer's credit rating and the issue-specific recovery prospects--we make an exception in the case of selective default situations, such as de facto restructurings.) However, as mentioned earlier, in the aftermath of an exchange offer, the entity may be in a better financial position than before--and that could potentially benefit all its rated obligations. Accordingly, these issue ratings could be placed on CreditWatch with positive (or developing) implications when an exchange offer is announced. The listing would be based on the likelihood that post-completion default risk or recovery prospects, or both, would have improved enough to warrant an upgrade on the issue. Such a CreditWatch listing would be resolved once we know the offer will be consummated as proposed and can assess its implications for ongoing credit quality. An opportunistic offer rarely affects our ratings on the issuer's other obligations. 14. How do you apply this methodology to ratings of equity hybrid instruments? Hybrids typically incorporate features other than fixed obligations such as deferral and/or conversion provisions. An exchange offer on an equity hybrid instrument may reflect the possibility that, absent the exchange offer taking place, the issuer would exercise the coupon deferral option--in accordance with the terms of the instrument.) In such instances, the hybrid's rating would go to 'C', rather than the 'D' rating used for nonhybrids. Since deferral on a hybrid in accordance with its terms (outside of the offer scenario) would result in a rating of 'C', a distressed exchange offer should not result in a lower rating. Similarly, the issuer rating would not be affected--just as deferral on hybrid instruments in accordance with terms does not automatically lead to a change in the issuer rating. 15. What about exchange offers for unrated obligations? Where we determine that a rated issuer's offer in reference to unrated financial contracts constitutes a distressed exchange, the issuer credit rating will be lowered to 'SD'. Such offers in reference to unrated financial obligations may include: bank loan modifications (see question No. 6), offers in reference to the commutation of credit default swaps, or offers in reference to the restructuring of other derivatives. We review these offers using the same factors we review MAY 12,

33 General Criteria: Rating Implications Of Exchange Offers And Similar Restructurings, Update for rated obligations, in order to determine whether we consider such exchanges distressed, resulting in an issuer rating of 'SD'. Exchange offers for unrated obligations that are not considered financial obligations or do not provide credit enhancement for financial obligations, such as commutation offers on traditional insurance policy claims or a settlement offer for a commercial dispute, would not be considered a distressed exchange offer for the purpose of these criteria. We also do not consider modifications to pension plans, other retirement benefit plans, other labor obligations, or operating leases a default event for the purpose of these criteria. 16. How do you apply this methodology to structured finance ratings? Many issuers of structured finance obligations are incorporated with a very limited purpose; thus, we refer to them as special purpose vehicles (SPVs) or special purpose corporations (SPCs). We generally do not assign issuer credit ratings to these entities, so the 'SD' treatment would not be relevant. The most frequent request reviewed by our Structured Finance group does not typically concern a distressed exchange of notes, but rather an amendment of existing debt document terms and conditions. The most frequent type of amendment, in this context, concerns credit derivative swap amendments, such that the floating-rate payer (the protection buyer--most typically a swap broker-dealer counterparty) agrees to a higher or more remote threshold amount or attachment point in exchange for paying a far lower insurance premium or fixed-rate swap payment leg. The impact of such an amendment is often to lower the coupon on a note issued by the trust or special purpose vehicle that has entered into the credit default swap as a seller of protection. In contrast with a distressed exchange offer, these amendments for swaps and notes typically reference vehicles that currently have 'AAA' or other investment-grade ratings. Thus, such amendment requests are not typically being made to avoid a payment default or insolvency of the SPV. Nevertheless, the same principles will apply as described in the previous paragraphs, with the proviso that we will publish supporting information that details the amendment request and rationale for the rating decision. When we believe an amendment was not requested in order to avoid an issue payment default or an SPV insolvency or bankruptcy if the offer was not accepted, we will view the amendment as opportunistic and not distressed, and we would not lower the rating to 'D'. Recently, we have also seen proposals for exchange offers involving traditional securitization structures, such as student loan asset-backed securities. To date, such offers have been opportunistic and, therefore, would not affect outstanding ratings. However, if we believe the issuer would face insolvency, bankruptcy, or imminent payment default if the exchange or amendment were not executed, then we would view it as commensurate with a distressed exchange and lower the issue rating to 'D' before raising it to a level that reflects the then-current credit quality. MAY 12,

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35 General Criteria: Rating Government-Related Entities: Methodology And Assumptions Primary Credit Analyst: Tommy J Trask, EMEA Corporate Ratings, Dubai (971) ; tommy.trask@standardandpoors.com Criteria Officer: Laura J Feinland Katz, CFA, New York (1) ; laura.feinland.katz@standardandpoors.com Other Contacts, EMEA: Arnaud DeToytot, Financial Institutions Ratings, Paris (33) ; arnaud.detoytot@standardandpoors.com Boris Kopeykin, International Public Finance Ratings, Moscow (7) ; boris.kopeykin@standardandpoors.com Peter Kernan, Criteria Officer, EMEA Corporate Ratings, London (44) ; peter.kernan@standardandpoors.com Michelle M Brennan, Criteria Officer, EMEA Financial Services Ratings, London (44) ; michelle.brennan@standardandpoors.com Emmanuel Dubois-Pelerin, Global Criteria Officer, Financial Services, Paris (33) ; emmanuel.dubois-pelerin@standardandpoors.com Other Contacts, Asia/Pacific: Takamasa Yamaoka, Criteria Officer, Asia/Pacific Ratings, Tokyo (81) ; takamasa.yamaoka@standardandpoors.com Other Contacts, Americas: Laura A Kuffler-Macdonald, U.S. Public Finance Ratings, New York (1) ; laura.kuffler.macdonald@standardandpoors.com Lisa M Schineller, PhD, Sovereign Ratings, New York (1) ; lisa.schineller@standardandpoors.com Olga I Kalinina, CFA, Criteria Officer, Sovereign and International Public Finance, New York (1) ; olga.kalinina@standardandpoors.com Lucy A Collett, Chief Credit Officer, Americas, New York (1) ; lucy.collett@standardandpoors.com MARCH 25,

36 Table Of Contents SCOPE OF THE PROPOSAL SUMMARY IMPACT ON OUTSTANDING RATINGS EFFECTIVE DATE AND TRANSITION METHODOLOGY Definition Of "Government-Related Entity" Definition Of "Extraordinary Government Support" Or "Negative Intervention" Stand-Alone Credit Profiles (SACPs) And Government Ratings Assessment Of The Likelihood Of Extraordinary Government Support Determining The GRE's Issuer Credit Rating Other Considerations GREs: Rating Obligations Rating GRE Subsidiaries APPENDICES Appendix 1: Excerpt From Group Rating Methodology Appendix 2: Determining A GRE's Issuer Credit Rating: Tables Presented By Government Rating Appendix 3: Key Changes From The Previous Methodology RELATED CRITERIA AND RESEARCH MARCH 25,

37 General Criteria: Rating Government-Related Entities: Methodology And Assumptions (Editor's Note: This article fully supersedes the article "Rating Government-Related Entities," published Dec. 9, 2010, except in those markets that require prior notification to, or registration by, the local regulator.) 1. Standard & Poor's Ratings Services is publishing an update to its criteria for rating government-related entities (GREs). This update follows our "Request For Comment: Rating Government-Related Entities: Methodology And Assumptions," published Nov. 25, 2014 (RFC). The update provides greater transparency and consistency for our rating methodology for GREs. The main changes clarify and enhance certain parts of the criteria. For a summary of the changes relative to the RFC, see "RFC Process Summary: Standard & Poor's Summarizes The Request For Comment Process For Government-Related Entity Criteria," published March 25, See Appendix 3 for an overview of the changes from the previous methodology. This article is related to our criteria article "Principles Of Credit Ratings," which we published on Feb. 16, SCOPE OF THE PROPOSAL 2. These criteria apply to the analysis of corporate (including project finance), financial institution, insurance, and public sector issues and issuers globally for entities that we define as government-related entities, per paragraphs 10 and 11 of these criteria, and for debt issues that may be expected to receive differentiated degrees of extraordinary government support, per the section "GREs: Rating Obligations," below. Throughout these criteria, unless otherwise stated, "GRE" refers to an entity or to a specific debt obligation. These GRE criteria apply to financial institutions that we consider to be government-related entities, which are those with a public policy role and/or where government ownership is strategic and long-term in nature. 3. On the other hand, the criteria, "Banks: Rating Methodology And Assumptions," published Nov. 9, 2011, describes our approach to factor in our view of potential extraordinary government support into the issuer credit rating (ICR) on systemically important commercial financial institutions. These GRE criteria do not apply to multilateral lending institutions, which we rate according to "Multilateral Lending Institutions And Other Supranational Institutions Ratings Methodology," published Nov. 26, 2012, nor to potential extraordinary support from one government to another, which we consider according to sector criteria. SUMMARY 4. We consider an entity to be a GRE, for the purposes of these criteria, if (i) we believe the entity could, if under stress, benefit from extraordinary government support, which could enhance the entity's capacity and willingness to meet its financial commitments as they come due, or (ii) we believe an entity controlled by a government could be subject to negative extraordinary government intervention if the government is under stress. In other words, government control MARCH 25,

38 General Criteria: Rating Government-Related Entities: Methodology And Assumptions is not required for us to consider an entity a GRE for cases of potential government support. However, government control is required for us to consider an entity a GRE for cases of potential negative government intervention. By "government," we refer to sovereigns, U.S. states, and local and regional governments (LRGs) globally. 5. We consider government support, or negative intervention, as "extraordinary" when it is temporary, entity-specific, and often related to financial stress at the GRE or at the government level. In our experience to date, the determination in most cases is for support, in which case the GRE's rating may be enhanced by its relationship with the government. Conversely, instead of providing extraordinary support to a GRE, a government may intervene to redirect GRE resources to the government and weaken the GRE's credit quality. 6. Standard & Poor's general analytical approach to rating GREs is to consider their credit quality as falling between the inclusive bounds formed by the GRE's stand-alone credit profile (SACP) and the government's rating. The GRE rating is based on an analysis of the following elements: The GRE's SACP, which represents the GRE's credit quality in the absence of extraordinary support or intervention; The government's local currency ICR, which reflects the government's ability to support (or, in a negative scenario, its need to avail itself of the resources of) the GRE; and Our opinion of the likelihood of sufficient and timely extraordinary government intervention in support of the GRE's meeting its financial obligations, as derived from our assessment of the importance of the GRE's role to the government (assessed as summarized in table 2, "Assessing The Importance Of A GRE's Role To The Government") as well as the link between the two (assessed as summarized in table 3, "Assessing The Strength And Durability Of The Link Between The Government And A GRE"). The link and role assessments combined form our overall likelihood of extraordinary government support assessment, per table 1, "Role-Link Matrix For Assessing The Likelihood Of Extraordinary Government Support." 7. We combine the elements listed above--(i) the GRE's SACP, (ii) the government rating, and (iii) the likelihood of extraordinary government support, using tables 4 through 8--to arrive at the potential rating on the GRE, subject to considerations such as constraints for sovereign risk or currency risk. Standard & Poor's distinguishes between government support that enables a timely repayment of a GRE's debt and intervention that principally aims to support an entity's employment or operations but might not necessarily reduce the likelihood of default, and therefore does not qualify for rating uplift in these criteria. IMPACT ON OUTSTANDING RATINGS 8. We expect minimal rating impact from this criteria update. EFFECTIVE DATE AND TRANSITION 9. These criteria are effective immediately, except in markets that require prior notification to, or registration by, the local regulator. In these markets, the criteria will become effective when so notified by Standard & Poor's or registered by the regulator. MARCH 25,

39 General Criteria: Rating Government-Related Entities: Methodology And Assumptions METHODOLOGY Definition Of "Government-Related Entity" 10. We consider an entity to be a GRE, for the purposes of these criteria, if (i) we believe the entity could, if under stress, benefit from extraordinary government support that could enhance the entity's capacity and willingness to meet its financial commitments as they come due, or (ii) we believe any entity controlled by a government could be subject to negative extraordinary government intervention if the government is under stress. In other words, government control is not required for us to consider an entity a GRE for cases of potential government support. However, government control is required for us to consider an entity a GRE for cases of potential negative government intervention. 11. Government ownership or control is not required for us to classify an entity as a GRE, albeit that we would generally expect the absence of a government ownership interest to reduce the economic incentive of the government to support a GRE compared with a government-owned GRE. 12. We may classify as a non-gre an entity we previously considered a GRE (and therefore move the entity out of scope for the purposes of these criteria) once we no longer expect the entity to potentially benefit from extraordinary government support, as long as we also do not expect the entity to potentially be subject to extraordinary negative government intervention, as the latter could reduce the entity's capacity and willingness to meet its financial commitments as they come due. 13. We may transition an entity out of GRE status when the following two conditions are met: We assess the likelihood of extraordinary government support as "low," and We believe the risk of extraordinary negative government intervention is remote. 14. Similarly, we may also newly classify an entity as a GRE once we believe the provisions in paragraph 10 apply. Definition Of "Extraordinary Government Support" Or "Negative Intervention" 15. We consider government support, or negative intervention, as "extraordinary" when it is temporary, entity-specific, and often related to financial stress at the GRE or at the government level. In our experience to date, we have seen more cases of government support than of negative intervention. In cases of potential support, the GRE's rating may be enhanced by its relationship with the government. Conversely, instead of providing extraordinary support to a GRE, a government may intervene to redirect GRE resources to the government and weaken the GRE's credit quality. 16. The line between what we term "extraordinary" and "ongoing" support (or negative intervention) is not always distinct. However, "extraordinary" support usually occur in periods of a GRE's stress and take the form of liquidity injections, loans from the government or through government-owned banks, recapitalizations, or arrangement of a solvency rescue package directly from the government or through other market participants. If the GRE accounts for a substantial share of government revenues, "support" may mean the government takes less and leaves more to the GRE for its own investment and debt-service needs. Conversely, examples of negative extraordinary intervention include MARCH 25,

40 General Criteria: Rating Government-Related Entities: Methodology And Assumptions special tax, dividend, asset- or cash-stripping, support to or merger with stressed entities, or other measures that the government may impose to divert GRE resources to the government, as the government's needs rise. 17. Standard & Poor's assesses the likelihood of timely and sufficient extraordinary support from the government to the GRE in the context of how this support affects the GRE's capacity and willingness to meet its financial commitments as they come due. A government's perception of need for support (e.g., amount, tenor, and timeliness) may therefore be different from our definitional standard. For instance, we treat a delay of payment on a long-term obligation as a default, unless we expect payment within the earlier of the stated grace period or 30 calendar days (or if there is no stated grace period, within five business days), and we treat a debt restructuring that we would consider to be distressed and below par as a default. (For more details on our methodology with respect to timeliness of payments and distressed restructurings, see "Timeliness Of Payments: Grace Periods, Guarantees, And Use Of 'D' And 'SD' Ratings," published Oct. 24, 2013, and "General Criteria: Rating Implications Of Exchange Offers And Similar Restructurings, Update," published May 12, 2009.) Defaults could occur according to our criteria even though the government might have provided some form of support. Stand-Alone Credit Profiles (SACPs) And Government Ratings 18. SACPs are determined according to our criteria, "Stand-Alone Credit Profiles: One Component Of A Rating," published Oct. 1, 2010, and the related sector criteria for the type of entity. As defined in our SACP criteria, it is an "opinion of an issuer's creditworthiness in the absence of extraordinary support or burden." The SACP identifies the downside for the GRE's creditworthiness if the potential for extraordinary government support dissipates. The SACP reflects ongoing government support, however. An SACP exceeding the government's ICR identifies an "upside" to the ICR in the absence of negative intervention risk and provided other conditions listed in the section, "Rating a GRE above the rating on its government," below, are met. 19. We determine an SACP for all GREs on which the rating is not equalized with that of the supporting government in order to rate these GREs. Even when we believe the likelihood of timely extraordinary government support is "extremely high" or "very high," and hence the GRE's SACP may not be the primary driver in the determination of the GRE rating, we believe it is important to determine the SACP because the SACP may help identify the possible timing and extent of a need for support. Furthermore, the GRE's SACP may help us gauge the government's contingent liability. 20. Similarly, we often, but not always, determine an SACP when our view of the likelihood of extraordinary government support is "almost certain." We may choose not to determine an SACP only if the following three conditions are met: (i) the likelihood of timely extraordinary government support is, in our view, "almost certain," (ii) we do not believe this likelihood of government support is subject to transition risk, and (iii) the entity, in our view, is a non-severable arm of the government or executes strategic government policies. Examples of the types of entities we consider as "executing strategic government policies," for the purpose of this paragraph, include entities responsible for strategic oil stockpiling or entities with a critical policy role such as a deposit insurance agency. Similarly, government guarantees for 100% of debt obligations may help us in our determination of point (iii), particularly if such guarantees meet our definition of timeliness of payment, but such guarantees are not required for us to reach such a determination. MARCH 25,

41 General Criteria: Rating Government-Related Entities: Methodology And Assumptions 21. For other types of GREs with "almost certain" likelihood of support, such as a corporate entity or a financial institution (for example, a government-owned oil company or government-owned municipal lender), we believe it is important to determine an SACP or an estimate of the SACP. These entities are more subject to transition risk in government support, and a significant deterioration in the SACP--not accompanied by a comparable deterioration in the government's ICR--can be one signal of such a transition. Note: We may also determine an SACP for the purpose of applying the section below, titled "Rating GRE debt obligations," for rating hybrid capital instruments, for example. 22. Government ratings are determined in accordance with "Methodology For Rating Non-U.S. Local And Regional Governments," published June 30, 2014, "Sovereign Rating Methodology," Dec. 23, 2014, "U.S. Local Governments General Obligation Ratings: Methodology And Assumptions," Sept. 12, 2013, and "U.S. State Ratings Methodology," Jan. 3, In some cases, Standard & Poor's may not have a public rating on a GRE's related government. If we have sufficient information to determine a confidential rating on the government and the likelihood of government support, we will use that rating and determination in applying tables 4 through 8 to determine the GRE's rating. If we do not have sufficient information to determine a confidential rating on the government, we will determine the government's approximate creditworthiness to apply the constraints in the section below titled, "Rating a GRE above the rating on its government." Then, we would not apply the GRE tables 4 through 8, but instead rate the GRE at its SACP level, including ongoing government support subject to the constraints in that section. In other words, if we do not have sufficient information to determine a rating on the government, we would not factor in potential extraordinary support from that government in the rating on the GRE, but we may constrain the GRE's rating because of our view of potential negative intervention from the government. Assessment Of The Likelihood Of Extraordinary Government Support 24. Standard & Poor's evaluates the relationships between GREs and governments while observing that they are sometimes unclear and that extraordinary government intervention is not always predictable. 25. As a general principle, we believe that the higher the likelihood of sufficient and timely extraordinary support, the closer the GRE's creditworthiness is likely to be to the government's creditworthiness. The lower the likelihood of support, the closer the GRE's rating is likely to be to the GRE's SACP. To provide more specific guidelines, Standard & Poor's has developed a matrix approach designed to focus on two parameters: the importance of the GRE's role to the government, and the link between the GRE and the government, which are defined in the section below (tables 2 and 3). Combined, these two factors help to assess the likelihood of extraordinary government support. The factors are not necessarily equally weighted but the specific combination is based on our analysis, as described in the matrix below (table 1). MARCH 25,

42 General Criteria: Rating Government-Related Entities: Methodology And Assumptions Table We assess both the link and the role in a prospective manner based not only on currently observable facts but also on our expectation. A prospective assessment is particularly crucial when the link or role is changing, or is expected to change, rapidly following a certain event, including but not limited to change in the government regime, change in the party(ies) in power, change in the government's general strategy with the public sector, a catastrophe in the area where the GRE is relevant, or discovery of any credit issues at the GRE. 27. Standard & Poor's analyzes the importance of the GRE's role to the government by assessing the severity of the effect that a default of the GRE would have for the government or the local economy. A GRE may be important to the government because it implements a key national policy or provides an important public service, or because it affects the proper functioning of an important economic sector. Our qualitative assessment may be supported by quantitative indicators that vary depending on the nature of the GRE's activity and may include, for instance, the number of employees, the GRE's revenues as a percentage of the country's GDP, its share in national exports, its share in the production of energy for the country, or its share in national deposits for a bank. 28. While assessing the importance of a GRE's role, we focus on the potential consequences deriving from the absence of government intervention, or more precisely, the implications that a default of the GRE would have for the government MARCH 25,

43 General Criteria: Rating Government-Related Entities: Methodology And Assumptions and/or the local economy. We distinguish on a continuum between support from the government that mostly targets the continuation of the GRE's activities and/or the safeguarding of employment and that does not result in rating uplift under these criteria, and support aimed at ensuring the full and timely payment of bondholders. In our view, historically, defaults of financial institution GREs have been more disruptive to the economy than defaults of corporate GREs. 29. Standard & Poor's has observed that the importance of the role for a particular GRE might vary over time, triggering different reactions from a government depending on the circumstances and the consequences of the GRE's default. For instance, in periods of fragile market confidence, the failure of a relatively small public bank may have systemic repercussions. Such repercussions would increase the importance of the GRE for a certain period and could prompt the government to provide extraordinary support. In our view, a different outcome might result if the entity's troubles were to occur in a more benign environment and the consequences of non-intervention were less severe. More generally, we usually try to assess a hypothetical stress scenario for a particular GRE and the government's potential response in this situation. Accordingly, our opinion of the importance of a particular GRE may evolve to reflect those considerations. 30. Standard & Poor's distinguishes four different levels when assessing the importance of the GRE's role to the government for the purpose of determining potential extraordinary support from the government: Critical, Very important, Important, and Limited importance. 31. The criteria for determination of the importance of the GRE's role for determining potential extraordinary support from the government are described in table 2 below. Table 2 Assessing The Importance Of A GRE's Role To The Government Critical A default of the GRE would have a critical impact for the government, for one of the following reasons: -- The GRE operates essentially on behalf of the government and its main purpose is to provide a key public service that could not be readily undertaken by a private entity and that would be likely conducted by the government itself if the GRE did not exist. Very important Important -- The GRE is among the most important GREs in the country/region and it plays a central role in meeting key economic, social, or political objectives of the government or in the implementation of a key national or regional policy. A default of the GRE would have a major impact for the government, for one of the following reasons: -- The GRE operates essentially as an independent not-for-profit entity and it plays a very important role in meeting key economic, social, or political objectives of the government or in the implementation of a key national or regional policy. -- The GRE operates essentially as a profit-seeking enterprise in a competitive environment, and its default/credit stress would lead to a disruption of its activities and have a significant systemic impact on the local economy. A default of the GRE would have an important but manageable impact for the government, for one of the following reasons: -- The GRE operates essentially as an independent not-for-profit entity, which participates in the provision of a public service as its primary role, and this individual role is important for the government. -- The GRE operates essentially as a profit-seeking enterprise in a competitive environment, and its credit standing is important for the government because one or more of the conditions below are met: MARCH 25,

44 General Criteria: Rating Government-Related Entities: Methodology And Assumptions Table 2 Assessing The Importance Of A GRE's Role To The Government (cont.) Limited importance * It provides essential infrastructure, goods, or services to the population. * Part of its activities relates to an important public policy role. * Its default/credit stress would lead to a disruption of its activities and could have an important impact on a sector of the economy. A default of the GRE would have a limited impact for the government, for one of the following reasons: -- The GRE operates essentially as an independent not-for-profit entity that participates in the provision of a public service as its primary role, but the individual importance of the entity to the government is relatively minor. -- The GRE is a profit-seeking enterprise in a competitive environment, whose activity is relatively important for the government, but one or more of the conditions below are met: * It is one among many GREs and/or its activity could easily be undertaken by a private sector entity or another larger GRE if it ceased to exist. * The government is primarily interested by the GRE's operations and/or employment and not so much by its credit standing. 32. Entities with less than "limited importance" to the government are not considered GREs and are not reflected in table 2 above. Assessing the strength and durability of the link between a GRE and the government 33. We assess the strength and durability of the link between a GRE and the government primarily by analyzing the degree to which the government determines the GRE's strategy and operations and its level of supervision. Analytical considerations include the percentage of ownership of the GRE, the existence of a partial or ultimate government guarantee of the GRE's obligations, statements of support (particularly if they are made publicly), and/or reputational risk to the government if the GRE defaults according to our definitions. 34. In particular, we analyze the government's willingness to support a particular GRE as demonstrated by the government's policy, track record of past interventions, involvement in the day-to-day operations of its GREs, as well as the cultural and political aspects related to the government's intervention and its administrative capacity to provide timely support. Finally, we assess potential constraints to government support that might arise from a legal or regulatory framework. 35. Our analysis of the link between a GRE and its government also takes into consideration our opinion of the government's general propensity to support the GRE sector in a credit-supportive and timely manner. By "GRE sector," we mean all the GREs related to a single government, across all industries. We may classify a government's general propensity to support the GRE sector as "doubtful" if any of the following conditions apply: If we doubt the government's willingness to provide full and timely support for policy reasons, weak administrative capacity, or past practices; If we have doubts about the government's capacity to support its GREs' debt (as opposed to the government's capacity to pay its own debt), considering the size of total liabilities in the GRE sector and/or the creditworthiness of the GREs in question. For sovereign governments, we assess the capacity to support the GRE sector through a combination of our rating on the government, and our assessment of its "contingent liability." We would typically determine that support is "doubtful" when our sovereign foreign currency rating is 'BB+' or lower and our "contingent liability" assessment (according to our sovereign rating methodology), is "high" or "very high." The reason is that such a combination suggests that the capacity to support is weaker than indicated by the MARCH 25,

45 General Criteria: Rating Government-Related Entities: Methodology And Assumptions government's rating. In certain cases, we could also classify support as "doubtful" for sovereigns rated 'BBB-' or higher because of a perceived lack of willingness to support the GRE sector, or because of "very high" contingent liabilities. For LRGs, we may classify overall likelihood to support the GRE sector as "doubtful" in the context of our view of government capacity and willingness to support and our view of the contingent liabilities; or If we otherwise perceive a lack of willingness to support the GRE sector. 36. When we assess government support for the GRE sector as "doubtful," we would assess the link for all GREs related to that government as "limited," even for GREs with a "critical" role, with certain exceptions described below. 37. The "doubtful" assessment would apply to all GREs related to the respective government unless, based on available evidence, we believe the government would support some GREs prioritized ahead of others, and the GREs in question account for a small share of total GRE sector contingent liabilities and government debt. 38. If we consider the correlation between the GRE's SACP and the government's rating to be high (or very high), for instance when a GRE (such as a national oil company) or a group of GREs in the same industry account for more than 50% (or 75%) of government revenue, we typically limit the overall likelihood of extraordinary government support assessment per table 1 to "moderately high" (50%) or "moderate" (75%), respectively. 39. These limits reflect the fact that creditworthiness of the GRE and the government is highly intertwined and the government is unlikely to be in a position to provide extraordinary support to the GRE in a stress scenario because the stress is likely to affect both the GRE and the government. These limits may not apply to governments that hold very large external liquid assets (more than 50% of GDP) that are uncorrelated to the creditworthiness of the GRE and the local economy and that reduce correlation between the GRE and the government. 40. Standard & Poor's distinguishes four different levels when assessing the strength of the link between the GRE and the government: Integral, Very strong, Strong, and Limited. 41. The levels are described in table 3 below. Table 3 Assessing The Strength And Durability Of The Link Between The Government And A GRE Integral The GRE is essentially an arm of, and/or very tightly controlled by, the government, and/or there is a legal framework in place that provides for explicit government support for the GRE. In addition, the government has a policy, supported by a track record, of providing considerable and timely credit support in all circumstances. -- The government has a policy, supported by a track record, of providing timely support to the GRE in all circumstances, AND: * The GRE has a special public status or is a government agency and can be considered as an extension of the government. * OR: The government fully owns the GRE and acts more as a manager than a shareholder. It drives the GRE's strategy, determines key budgetary decisions, and maintains a very tight degree of control to ensure the implementation of the GRE's policy role. We expect none of these factors to change in the long term. -- AND: The government has clear and robust processes and procedures in place that enables effective governance, monitoring and control over the GRE. It has the administrative capacity and mechanisms for responding to the GREs financial distress in a timely manner. MARCH 25,

46 General Criteria: Rating Government-Related Entities: Methodology And Assumptions Table 3 Assessing The Strength And Durability Of The Link Between The Government And A GRE Very strong Strong Limited (cont.) The government has a very strong and durable link with the GRE, and/or there is a legal framework in place that provides for explicit government support for the GRE. In addition, the government has a policy, supported by a track record, of providing very strong and timely credit support in most circumstances. -- The government has a policy or a track record of providing very strong and timely credit support to the GRE in most circumstances, and one or more of the conditions below are met: * The government is a strong and stable shareholder and has a strong influence on the GRE's strategy and business plans. Privatization is not contemplated in the medium term; * The GRE benefits from a form of ultimate, statutory, or long-term guarantee from the government, implying a tighter link with the government and incentive to support; or * A considerable deterioration in the GRE's creditworthiness would significantly affect the government's reputation, as the latter is publicly associated with the GRE through strong political involvement and a high degree of control. -- AND: The government has processes and procedures in place that enables effective governance, monitoring and control over the GRE. It has the administrative capacity and mechanisms for responding to the GREs financial distress in a timely manner. The government is an important shareholder of the GRE and has a policy and/or track record of providing strong credit support in certain circumstances, or in case the government is not an important shareholder, it has already supported the GRE and stated its intention to continue to do so. -- The government is an important--typically a controlling--shareholder and has a policy and/or track record of providing strong credit support to the GRE in certain circumstances, but one or more of the conditions below are met: * The GRE has a clear corporate governance set-up with an independent management that makes autonomous business decisions; * Privatization might be contemplated in the next three to five years and/or the government's involvement with the GRE is changing and rather unpredictable; or * A legal or regulatory framework partly constrains the government's ability to intervene. -- OR: The government is not a structural or important shareholder of the GRE but it has already taken some extraordinary actions--typically resulting in capital injections--and it has stated its intention to continue to do so on a temporary and exceptional basis (e.g., systemic financial crisis). The government has limited interference with the GRE and has a policy, track record, and/or capacity for providing very limited credit support, or has or is expected to negatively intervene in the GRE. -- The government is not a shareholder or is a minority shareholder and does not interfere more than any other minority shareholder in the GRE's strategic decisions and operations. -- OR: The government is an important shareholder, but one or more of the conditions below are met: * Privatization is ongoing or contemplated within the next two years and we expect this to lead to a significant reduction in the government's ownership; * The government is not willing to provide support to its GREs on a timely basis, as reflected in its policy and/or track record of not interfering in the management of its GREs, and, in some cases, a track record of adverse/negative intervention leading to a weakening of the GRE's profile; or * The government has very limited administrative and/or legal capacity to provide support to its GREs on a timely basis. -- OR: We have doubts about the government's capacity or willingness to support its GREs, for instance considering the size of contingent liabilities in the GRE sector. 42. Where table 3 refers to "track record" of government support, this can be with respect to the specific GRE or for other GREs that operate in a similar industry. Determining The GRE's Issuer Credit Rating 43. Once we have determined the likelihood of extraordinary government support (table 1) based on our evaluation of the GRE's role (table 2) and link (table 3) to the government, we establish the GRE's issuer credit rating (or equivalent, such MARCH 25,

47 General Criteria: Rating Government-Related Entities: Methodology And Assumptions as senior unsecured rating or general obligation rating) based on the combination of the likelihood of extraordinary government support, the SACP, and the government's local currency rating (see tables 4 through 8). These tables yield the GRE's issuer credit rating based on its SACP (listed down the left-hand side of the table), the government's local currency rating (listed across the top of the table), and our assessment of the likelihood of extraordinary government support. Ratings in the 'CCC' or 'CC' rating categories do not appear as outcomes in the tables; we only assign issuer credit ratings for GREs in these rating categories based on "Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings," published Oct. 1, Such criteria would apply if, for example, after factoring in potential extraordinary government support, we viewed a GRE's obligations as currently vulnerable to nonpayment and if the obligor were dependent on favorable business, financial, and economic conditions to meet its commitments on its obligations. 44. The GRE's rating might vary by one notch up or down from the rating suggested in the tables (or from the rating suggested for GREs not rated according to the tables, such as those with "almost certain" likelihood of extraordinary government support, which may be one notch down, or "low" likelihood, which may be one notch up; see paragraph 45 or 49) when a gradual transition in a GRE's role or link leads to a weakening or strengthening of the likelihood of extraordinary government support over time. When we assess the likelihood of extraordinary government support as "almost certain" 45. We have not included a table for cases when the likelihood of support is "almost certain" because Standard & Poor's would then equalize the rating on a GRE with that on the government, unless we applied the potential one-notch downward adjustment described in the previous paragraph. When we assess the likelihood of extraordinary government support as highly likely (i.e., "extremely high" or "very high") and as the key rating driver 46. For GREs most closely tied to the government in terms of role and link, our opinion that the government will likely extend timely extraordinary support during periods of economic or financial stress is generally a significant credit factor. In such circumstances, the rating on the GRE tends to be close to, and move in tandem with, that on the government (see tables 4 and 5 below). Table 4 Determining A GRE's Issuer Credit Rating: Extremely High (EH) Likelihood Of Support --Government's local currency rating-- SACP AAA AA+ AA AA- A+ A A- BBB+ BBB BBB- BB+ BB BB- B+ B B- aaa AAA aa+ AAA AA+ aa AAA AA+ AA aa- AAA AA+ AA AAa+ AA+ AA AA AA- A+ a AA+ AA AA- AA- A+ A a- AA+ AA AA- A+ A A A- bbb+ AA+ AA AA- A+ A A- A- BBB+ bbb AA+ AA AA- A+ A A- BBB+ BBB+ BBB bbb- AA+ AA AA- A+ A A- BBB+ BBB BBB BBBbb+ AA+ AA AA- A+ A A- BBB+ BBB BBB- BBB- BB+ bb AA AA- A+ A+ A A- BBB+ BBB BBB- BB+ BB BB MARCH 25,

48 General Criteria: Rating Government-Related Entities: Methodology And Assumptions Table 4 Determining A GRE's Issuer Credit Rating: Extremely High (EH) Likelihood Of Support (cont.) bb- AA AA- A+ A+ A A- BBB+ BBB BBB- BB+ BB BB- BBb+ AA AA- A A BBB+ BBB+ BBB BBB- BB+ BB BB BB- B+ B+ b AA- A+ A A BBB+ BBB+ BBB BBB- BB+ BB BB BB- B+ B B b- AA- A A A BBB BBB BBB BBB- BB+ BB BB BB- B+ B B- B- ccc+ BBB- BBB- BBB- BBB- BBB- BBB- BBB- BB+ BB BB- B+ B+ B B- B- * ccc BB+ BB+ BB+ BB+ BB+ BB+ BB+ BB BB BB- B+ B+ B B- B- * ccc- BB+ BB+ BB+ BB+ BB+ BB+ BB+ BB BB BB- B+ B+ B B- B- * cc BB- BB- BB- BB- BB- BB- BB- B+ B+ B+ B B B- * * * *These combinations may suggest an issuer credit rating in the 'CCC' or weaker rating categories. As per paragraph 43, we only assign issuer credit ratings for GREs in these rating categories based on "Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings," published Oct. 1, SACP--Stand-alone credit profile. 47. When a GRE's SACP has a rapidly widening gap relative to the related government rating or is deteriorating to extremely weak levels ('b' or lower), we believe this could signal diminishing government support. Generally, these situations would trigger our reevaluation of a GRE's importance to and link with the government. If the GRE's SACP has deteriorated more than three notches within six months, or more than six notches in 12 months, to 'b' or lower, and the government has no credible and timely plan of action to support the GRE, we take this as evidence that support is diminishing. In such cases, the link (per table 3) would be capped at "limited" and the overall likelihood of support (per table 1) at "moderate." We may no longer apply these caps to the link and likelihood of support once we have evidence that the government has contributed support or support is forthcoming, sufficient for us to raise the SACP back at least one notch after the deterioration described in this paragraph has occurred. Table 5 Determining A GRE's Issuer Credit Rating: Very High (VH) Likelihood Of Support --Government's local currency rating-- SACP AAA AA+ AA AA- A+ A A- BBB+ BBB BBB- BB+ BB BB- B+ B B- aaa AAA aa+ AAA AA+ aa AAA AA+ AA aa- AA+ AA+ AA AAa+ AA AA AA AA- A+ a AA AA- AA- AA- A+ A a- AA AA- A+ A+ A A A- bbb+ AA- AA- A+ A A A- A- BBB+ bbb A+ A+ A+ A A A- BBB+ BBB+ BBB bbb- A A A A A- A- BBB+ BBB BBB BBBbb+ A- A- A- A- A- BBB+ BBB+ BBB BBB- BBB- BB+ bb BBB+ BBB+ BBB+ BBB+ BBB+ BBB+ BBB BBB BBB- BB+ BB BB bb- BBB+ BBB+ BBB BBB BBB BBB BBB BBB- BBB- BB+ BB BB- BBb+ BBB+ BBB BBB- BBB- BBB- BBB- BBB- BBB- BB+ BB BB- BB- B+ B+ b BBB BBB- BBB- BBB- BB+ BB+ BB+ BB+ BB+ BB BB- BB- B+ B B b- BBB- BBB- BB+ BB+ BB BB BB BB BB BB BB- B+ B B- B- B- ccc+ BB- BB- BB- BB- BB- BB- BB- B+ B+ B+ B+ B+ B- B- B- * MARCH 25,

49 General Criteria: Rating Government-Related Entities: Methodology And Assumptions Table 5 Determining A GRE's Issuer Credit Rating: Very High (VH) Likelihood Of Support (cont.) ccc B+ B+ B+ B+ B+ B+ B+ B+ B+ B+ B+ B B- * * * ccc- B+ B+ B+ B+ B+ B+ B+ B+ B+ B+ B B- B- * * * cc B+ B+ B+ B+ B+ B+ B+ B B B- B- * * * * * *These combinations may suggest an issuer credit rating in the 'CCC' or weaker rating categories. As per paragraph 43, we only assign issuer credit ratings for GREs in these rating categories based on "Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings," published Oct. 1, SACP--Stand-alone credit profile. When we assess the likelihood of extraordinary government support as reasonably likely (i.e., "high," "moderately high," or "moderate") but not as the primary rating driver 48. For entities we view as benefiting from supportive government policies, possibly direct assistance, and potentially extraordinary government support, but where the likelihood of the latter is lower, GRE ratings are usually more closely aligned with the GRE's SACP (see tables 6 to 8 below). Table 6 Determining A GRE's Issuer Credit Rating: High (H) Likelihood Of Support --Government's local currency rating-- SACP AAA AA+ AA AA- A+ A A- BBB+ BBB BBB- BB+ BB BB- B+ B B- aaa AAA aa+ AA+ AA+ aa AA+ AA AA aa- AA AA AA- AAa+ AA- AA- AA- A+ A+ a AA- A+ A+ A+ A A a- AA- A+ A+ A A A- A- bbb+ A+ A+ A A A A- BBB+ BBB+ bbb A A A A- A- A- BBB+ BBB BBB bbb- A- A- A- A- BBB+ BBB+ BBB+ BBB BBB- BBBbb+ BBB+ BBB+ BBB+ BBB+ BBB+ BBB BBB BBB BBB- BB+ BB+ bb BBB BBB BBB BBB BBB BBB BBB- BBB- BBB- BB+ BB BB bb- BBB- BBB- BBB- BBB- BBB- BBB- BBB- BB+ BB+ BB+ BB BB- BBb+ BB+ BB+ BB+ BB+ BB+ BB+ BB+ BB+ BB BB BB- BB- B+ B+ b BB BB BB BB BB BB BB BB BB BB- BB- BB- B+ B B b- BB- BB- BB- BB- BB- BB- BB- BB- BB- BB- B+ B+ B B- B- B- ccc+ B+ B+ B+ B+ B+ B+ B+ B+ B+ B+ B B B- B- B- * ccc B B B B B B B B B B B- B- B- * * * ccc- B- B- B- B- B- B- B- B- B- B- * * * * * * cc B- B- B- B- * * * * * * * * * * * * *These combinations may suggest an issuer credit rating in the 'CCC' or weaker rating categories. As per paragraph 43, we only assign issuer credit ratings for GREs in these rating categories based on "Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings," published Oct. 1, SACP--Stand-alone credit profile. MARCH 25,

50 General Criteria: Rating Government-Related Entities: Methodology And Assumptions Table 7 Determining A GRE's Issuer Credit Rating: Moderately High (MH) Likelihood Of Support --Government's local currency rating-- SACP AAA AA+ AA AA- A+ A A- BBB+ BBB BBB- BB+ BB BB- B+ B B- aaa AAA aa+ AA+ AA+ aa AA AA AA aa- AA AA- AA- AAa+ AA- AA- A+ A+ A+ a A+ A+ A+ A A A a- A+ A A A A- A- A- bbb+ A A A- A- A- BBB+ BBB+ BBB+ bbb A- A- A- BBB+ BBB+ BBB+ BBB BBB BBB bbb- BBB+ BBB+ BBB+ BBB+ BBB BBB BBB BBB- BBB- BBBbb+ BBB BBB BBB BBB BBB BBB- BBB- BBB- BB+ BB+ BB+ bb BBB- BBB- BBB- BBB- BBB- BBB- BB+ BB+ BB+ BB BB BB bb- BB+ BB+ BB+ BB+ BB+ BB+ BB+ BB BB BB BB- BB- BBb+ BB BB BB BB BB BB BB BB BB- BB- BB- B+ B+ B+ b BB- BB- BB- BB- BB- BB- BB- BB- BB- B+ B+ B+ B B B b- B+ B+ B+ B+ B+ B+ B+ B+ B+ B+ B B B B- B- B- ccc+ B B B B B B B B B B B- B- B- * * * ccc B- B- B- B- B- B- B- B- B- B- * * * * * * ccc- * * * * * * * * * * * * * * * * cc * * * * * * * * * * * * * * * * *These combinations may suggest an issuer credit rating in the 'CCC' or weaker rating categories. As per paragraph 43, we only assign issuer credit ratings for GREs in these rating categories based on "Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings," published Oct. 1, SACP--Stand-alone credit profile. Table 8 Determining A GRE's Issuer Credit Rating: Moderate (M) Likelihood Of Support --Government's local currency rating-- SACP AAA AA+ AA AA- A+ A A- BBB+ BBB BBB- BB+ BB BB- B+ B B- aaa AAA aa+ AA+ AA+ aa AA AA AA aa- AA- AA- AA- AAa+ AA- A+ A+ A+ A+ a A+ A+ A A A A a- A A A A- A- A- A- bbb+ A- A- A- A- BBB+ BBB+ BBB+ BBB+ bbb BBB+ BBB+ BBB+ BBB+ BBB+ BBB BBB BBB BBB bbb- BBB BBB BBB BBB BBB BBB BBB- BBB- BBB- BBBbb+ BBB- BBB- BBB- BBB- BBB- BBB- BBB- BB+ BB+ BB+ BB+ bb BB+ BB+ BB+ BB+ BB+ BB+ BB+ BB+ BB BB BB BB MARCH 25,

51 General Criteria: Rating Government-Related Entities: Methodology And Assumptions Table 8 Determining A GRE's Issuer Credit Rating: Moderate (M) Likelihood Of Support (cont.) bb- BB BB BB BB BB BB BB BB BB BB- BB- BB- BBb+ BB- BB- BB- BB- BB- BB- BB- BB- BB- BB- B+ B+ B+ B+ b B+ B+ B+ B+ B+ B+ B+ B+ B+ B+ B+ B B B B b- B B B B B B B B B B B B B- B- B- B- ccc+ B- B- B- B- B- B- B- B- B- B- B- B- B- * * * ccc * * * * * * * * * * * * * * * * ccc- * * * * * * * * * * * * * * * * cc * * * * * * * * * * * * * * * * *These combinations may suggest an issuer credit rating in the 'CCC' or weaker rating categories. As per paragraph 43, we only assign issuer credit ratings for GREs in these rating categories based on "Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings," published Oct. 1, SACP--Stand-alone credit profile. When we assess the likelihood of extraordinary government support as "low" 49. We typically rate the GRE the same as its SACP when we believe the likelihood of government support is "low" because the GRE's importance to the government is limited and the two entities are not closely linked. This would be the case, for instance, for a GRE performing a function that other market participants could easily undertake and that the private sector usually operates, or when the government acts mostly as a regulator and its interventions are primarily to enhance (or in some cases protect) the functioning of the relevant industry segment, regardless of ownership. 50. The tables in Appendix 2 comprise the same content as tables 4 through 8 above but classified on the basis of the government's rating. Tables 4 through 8 are the operative versions of the tables. When a GRE has links to more than one government 51. When a GRE is related to two or more governments (for instance, through a split ownership), Standard & Poor's analyzes both the nature of the link between the GRE and each government as well as the relationships among the different governments. If, in our view, one government has a prominent link with the GRE and appears to be willing to support fully the GRE, even if the other governments do not, we would use that one government's local currency rating as a reference in tables 4 through 8. If support were to come from all governments for their respective shares (for instance, based on percentages of ownership), we would use the lowest government rating as a reference in the tables. 52. When we are of the opinion that "joint and several" support exists from all governments, we would use the highest government rating as a reference in tables 4 through 8. However, if we see a significant risk of differences in interests or slow joint decision-making (for example, a large number of governments are involved) that could weaken support to the GRE, this could bear on our assessment of the likelihood of support, and the GRE's rating could be lower than what is reflected in the tables. We also assess the materiality of the obligations in relation to the financial capacity and willingness of the strongest guarantor(s) to cover such obligations in full and on time, if required to support a GRE. 53. Note: When a transaction is guaranteed by two or three rated governments, and when the contractual terms of each guarantee meet our criteria for credit substitution, and our view is that correlation of the creditworthiness among the guaranteeing governments is not too high, we would apply our joint-support methodology (see "Joint-Support Criteria Update," published April 22, 2009) to determine the issue credit rating. The application of this methodology may result MARCH 25,

52 General Criteria: Rating Government-Related Entities: Methodology And Assumptions in an issue credit rating that is higher than that on either of the two highest-rated guaranteeing governments. Application of currency considerations to tables 4 through The GRE's local (and foreign) currency rating indicated in tables 4 through 8 would generally be capped at the level of the sovereign foreign currency rating, unless either: The GRE benefits from an "extremely high" or "almost certain" likelihood of sovereign support, or The GRE has an SACP above the sovereign's foreign currency rating. 55. In the first case described above, a GRE with "almost certain" likelihood of sovereign support would have both its local and foreign currency ratings equalized with the respective sovereign ratings. In the case of "extremely high" likelihood of support, the GRE's local currency rating would be as shown in the tables, and the GRE's foreign currency rating would be capped at the sovereign foreign currency rating. 56. In the second case described above, the GRE's local currency rating would be at the level of its SACP, subject to constraints for: (i) stress testing for a rating above the sovereign foreign currency rating, as per "Ratings Above The Sovereign--Corporate And Government Ratings: Methodology And Assumptions," published Nov. 19, 2013, and (ii) potential negative government intervention. The GRE's foreign currency rating would be the lower of the GRE's local currency rating or the country transfer and convertibility (T&C) assessment. See also the sections below, "Extraordinary government intervention may constrain a GRE rating" and "Rating a GRE above the rating on its government." GREs with a rating above the government's rating are, in our experience, relatively infrequent. Other Considerations Extraordinary government intervention may constrain a GRE rating 57. In most cases, the likelihood of extraordinary government support enhances a GRE's rating, leading us to rate the GRE at or above its SACP. But in a few instances, government intervention is negative, potentially draining resources and reducing financial flexibility below what it would be on a stand-alone basis. This could be the case for GREs (government-owned oil companies, for example) whose SACPs are above the rating on their related government despite the ongoing negative intervention, which is already captured in the SACP. In these situations, we could rate the GRE below its SACP to reflect our expectation of extraordinary negative intervention from the government, for instance through a tendency to increase taxes and dividends, to require the GRE to provide subsidies, or to restrict the GRE's flexibility in some other way when the sovereign faces fiscal or external stress. The risk of adverse intervention often increases when a government is in default or under financial pressure. Therefore, it is unusual for a GRE to be rated above its related government, as explained below. Rating a GRE above the rating on its government 58. By rating a GRE above its related government, Standard & Poor's is expressing its view that the GRE's ability and willingness to service its debt is superior to that of the government and that, ultimately, if the government defaults, there is a measurable likelihood that the GRE would not default. 59. For governments rated 'B-' or higher, the following three conditions must be met for any GRE to have a rating above that of its respective government: MARCH 25,

53 General Criteria: Rating Government-Related Entities: Methodology And Assumptions The GRE must be protected from extraordinary negative government intervention, as described in paragraph 57. The likelihood of extraordinary negative intervention should be relatively low: We should be confident that the government's willingness and ability to impair the GRE's creditworthiness in periods of stress should be limited. We also should believe the GRE can mitigate potential government interference, for example, through one or more of the following: non-government shareholder support, solid governance standards, financial resilience to interference, or a track record of a hands-off approach by the government, including in periods of stress. Therefore, if we believe there is a meaningful risk of extraordinary negative government intervention, we would not rate the GRE higher than the related government. The SACP, which includes ongoing positive and negative intervention, must exceed the government's rating. When a GRE rating exceeds that of its related government, the GRE rating will be no higher than its SACP. Sector-specific criteria generally indicate adjustments to be made with respect to ongoing support from the government when the entity is significantly reliant on such support and when its SACP exceeds the rating on the government. These adjustments could include caps above the related government rating or additional stressed assumptions in determination of the final SACP to reflect the ongoing link to the creditworthiness of the related government. In the absence of such sector-specific guidelines, we may further adjust the SACP to reduce a portion of the benefits of "ongoing support" (such as government appropriations, subsidies, ongoing funding, etc.) and factor in ongoing negative intervention from the related government. The GRE rating would be capped by that of the related government if we expect the GRE to default when the related government defaults. For all sectors globally, we will not rate a GRE more than three notches above the related government rating if we view the GRE as dependent on ongoing support from the government. Per our "Ratings Above The Sovereign--Corporate And Government Ratings," published Nov. 19, 2013, in the section on GRE ratings, most sovereign-related GREs would have a maximum differential of two notches above the related sovereign foreign currency rating (as explained in paragraphs 60 through 62 of that criteria). The link is not "integral" or "very strong." 60. When the related government's rating is in the 'CCC' category or lower, including 'SD' (selective default) and 'D', the GRE's rating reflects its SACP as may be adjusted downward for negative intervention risk, or as per "Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings," published Oct. 1, For GREs whose related government is a sovereign and that meet the three conditions in paragraph 59, to further determine whether the GRE can be rated above the sovereign (and if so, by how many notches), we apply "Ratings Above The Sovereign--Corporate And Government Ratings," section E, "Government-Related Entities (GREs)" (paragraphs 60 through 62). 62. For GREs whose related government is an LRG that is itself rated above the sovereign, the GRE could be rated above the sovereign without a stress test per se, solely based on support of an LRG, as long as our stress test for rating the LRG above the sovereign incorporates all aspects of both ongoing and extraordinary support for the GRE in such a stress scenario, including funding cost, subsidies, etc. 63. For GREs whose related government is an LRG that is not rated above the sovereign, and the rating on the LRG is between 'B-' and 'A+', inclusive, we review a stress scenario as part of our process to consider a GRE rating above the rating on the respective LRG. This stress scenario uses the SACP as the starting point. The stress scenario is intended to test for resilience to government default and would include assumptions about the following aspects: Regional economic decline and the related effect on the GRE--The region experiences a deep recession, and MARCH 25,

54 General Criteria: Rating Government-Related Entities: Methodology And Assumptions regional economic output declines by approximately 6% to 10% in one year. The assumption is that the regional economic decline, if the region defaults, would mirror that of the sovereign if it defaults. Stress on securities of the related regional government held in liquidity reserves--we assume that the obligor would default and that recovery in a default would be as per assumptions used for LRGs in our collateralized debt obligation criteria. Stress on securities of other regionally based entities held in liquidity reserves--depending on the GRE's relation to the related government, we would assume that the obligor's rating would be subject to downward transition or default, with a related effect on the market value of such securities (in the case of entities highly correlated with the LRG, we would assume they would also be in default, and recovery would be as per the paragraph above). Negative extraordinary intervention--for example, we may assume that the region imposes a special tax equivalent to 10% of the entities' incomes. Effect of ongoing support in the SACP--For example, we may assume that any income derived from the owner is halved. 64. In case a specific, clearly defined government default scenario can be determined, and this does not encompass a regional macroeconomic decline, we would not apply the above stress scenario, and instead, we would apply the case-specific scenario as the relevant stress. 65. When the related LRG is rated above 'A+', no formal stress test is required, but we must have the view, as per paragraph 58, that there is a measurable likelihood that the entity would not default if the government defaulted. If the related LRG is rated 'CCC+' or below, we expect the current stressed conditions to represent both our base-case and the expected default scenarios, and we generally would not perform a stress test for GREs rated up to 'B-'. Project financings 66. In assessing a project's linkages to the government, we consider the strength and durability of the link between the government and the project GRE (see table 3), and we may also analyze any statements of support from the government, any contractual commitment that provides timely, extraordinary intervention to support a project's debt issue in periods of stress, or any strong precedent of government support for financial obligations of projects that operate in an essential segment of the economy and are systemically important to a country. We would apply any GRE uplift to the project SACP and, if present, the subordinated SACP (see "Project Finance Framework Methodology," published Sept. 16, 2014, paragraphs 27 and 28). Any GRE uplift above a project SACP is typically rare given the nature of project financings. For example, governments that award a concession or contract using a project finance structure often do so to shift the risks of constructing and operating a critical infrastructure or social asset to a private enterprise. As such, the government's incentives are typically limited to satisfying its obligations embedded in the concession or contract it awards. Liquidity assessment for corporate GREs 67. We assess liquidity at the SACP level, which would include ongoing support but not extraordinary support. As outlined in "Stand-Alone Credit Profiles: One Component Of A Rating," published Oct. 1, 2010, the determination of an SACP incorporates direct support already committed and the influence of ongoing interactions or influence from the government, parent, or affiliate. In the case of GREs, the support can be channeled through government-owned or -controlled banks or agencies and would typically include ongoing certain and timely cash contributions or access to funding provided to a GRE from a government or another GRE, or government-directed funding from MARCH 25,

55 General Criteria: Rating Government-Related Entities: Methodology And Assumptions government-owned or -controlled banks or agencies. To be included under our liquidity assessment at the SACP level, such ongoing liquidity or funding support would need to be certain and timely and be demonstrated by a track record and government policy, or an agreed and established process and ongoing interactions by the government and government-owned or -controlled funding bank(s) or agencies to provide such liquidity or access to funding as required. The short-term rating on a GRE would, however, be based on a liquidity descriptor that has been adjusted for extraordinary support (see paragraph 13 of "Methodology For Linking Short-Term And Long-Term Ratings For Corporate, Insurance, And Sovereign Issuers," published May 7, 2013). GREs: Rating Obligations Government guarantees 68. Some GREs' obligations have timely, irrevocable, and unconditional government guarantees. Standard & Poor's criteria for rating guaranteed obligations are explained in "Guarantee Criteria--Structured Finance," published May 7, 2013, and more specific indications on the application to guarantees given by sovereigns can be found in "Rating Sovereign-Guaranteed Debt," published April 6, If the sovereign or other relevant governmental unit does not guarantee a particular issuance or GRE according to the above criteria, we use our GRE methodology to determine the relevant rating assigned to such obligations or issuer. 70. Certain GREs or their obligations benefit from statutory guarantees, whereby the government would be ultimately liable for all of the GRE's obligations or the specific obligation if the entity ceased to exist. In many cases, the defining characteristic of such guarantees is that they do not promise timely payment and thus do not generally require the guarantor to meet the obligations on their respective payment dates but only after the resources of the guaranteed entity are exhausted (a process that could take some time). In those cases, we would account for the existence of this statutory guarantee as one factor among others that might create an incentive for the government to provide timely support in accordance with our GRE methodology for determining the GRE's ICR or senior debt rating. More specifically, we would view this as one of the elements that could lead us to assess the link between the GRE and its related government as "very strong," as described in table 4. In addition, if there is a legal or contractual basis for support of a specific obligation that is different from that which forms the basis of the ICR, we may rate such obligation based on government support specific to the obligation. We would expect the application to be narrow because we rate to timely support, and the guarantees considered under this paragraph may not meet this requirement. Similarly, if the existence of a guarantee means there is a legal or contractual basis for government support of a subordinated instrument that mitigates risks associated with post-default recovery or position in bankruptcy, we may rate such obligations based on government support specific to the obligation. 71. In rare cases, when a GRE is transitioning from one of the top support categories ("almost certain" or "extremely high") to a lower support category, the supporting government may publicly state support for existing ("grandfathered") debt while not stating such support for debt issued after a certain date. If we are confident of such support based on evidence or statements from the government, we may rate such supported debt issues higher than the ICR (or senior debt rating) on the GRE by applying tables 2 and 3 (role and link) and 4 through 8 of the GRE criteria separately to the grandfathered debt issues. MARCH 25,

56 General Criteria: Rating Government-Related Entities: Methodology And Assumptions Rating GRE debt obligations 72. As for any other entity, we might rate specific obligations issued by a GRE differently from its ICR, depending on our view of default risk of the obligation and the payment priority or expected recovery on the instrument in the case of obligor default. We generally rate such obligations, including hybrid capital and other subordinated debt, in line with the relevant sector criteria. For ratings on GRE debt obligations in the 'CCC' category, we also apply "Criteria for Assigning CCC+, CCC, CCC-, And CC Ratings," published Oct. 1, 2012, as further explained in "Credit FAQ: Applying Criteria For Assigning CCC+, CCC, CCC-, And CC Ratings To Subordinated and Hybrid Capital Instruments," published July 16, For hybrid capital instruments issued by a GRE for which we determine the SACP using bank or other financial institution methodology, we apply "Bank Hybrid Capital And Nondeferrable Subordinated Debt Methodology And Assumptions," published Jan. 29, 2015 (paragraph 79), or "Hybrid Capital Handbook: September 2008 Edition" (page 51, "Rating The Issue: Government Support"), published Sept. 15, 2008, as applicable. When the GRE's SACP is determined using corporate or insurance methodology, we apply page 51, "Rating The Issue: Government Support" in the "Hybrid Capital Handbook." 74. For nondeferrable subordinated debt instruments, we also generally rate according to the sector criteria used to determine the SACP of the GRE, which specifies how we notch down such instrument ratings from the ICR or the SACP (for banks, see "Bank Hybrid Capital And Nondeferrable Subordinated Debt Methodology And Assumptions," published Jan. 29, 2015, paragraphs 97 through 105; for insurance companies, see "Insurers: Rating Methodology," published May 7, 2013, section E, "Assigning Issue Ratings To Instruments Other Than Equity Hybrids"; for corporate entities, see "2008 Corporate Criteria: Rating Each Issue," published April 15, 2008). See also paragraph 70, above, for treatment of subordinated instruments that benefit from statutory guarantees from a government. 75. For countries and sectors where we apply recovery ratings, such as for corporate entities and certain types of financial institutions, with ICRs of 'BB+' or below (in certain jurisdictions), we apply our recovery and related issue credit rating criteria to GREs that meet all of the following characteristics: The GRE is in a country where we have performed insolvency regime analysis and where we assign recovery ratings; The likelihood of support to the GRE is not one of the top two categories, i.e., not "almost certain" nor "extremely high." This is because for these, we assume the government would heavily influence the debt restructuring, rather than assuming a restructuring under the local insolvency regime; and We need to have concluded that the GRE would be subject to the local insolvency regime in case of a default, and that recovery outcomes would be equally predictable as those for private-sector corporates. 76. Similarly, for sectors in which we apply recovery ratings and where an issue is backed by a government guarantee that provides for ultimate recovery rather than for timely payment, we factor in the amount of the guarantee in line with our recovery methodology, "Criteria Guidelines For Recovery Ratings On Global Industrials Issuers' Speculative-Grade Debt," published Aug. 10, For rated issues of corporate GREs with issuer credit ratings of 'BB+' or weaker, on which we do not apply our recovery rating methodology (because of the support category or because we reached an analytical or legal conclusion that the issuer would not be subject to the local insolvency regime), we apply the issue credit rating criteria in "2008 Corporate Criteria: Rating Each Issue," published April 15, This means we do not MARCH 25,

57 General Criteria: Rating Government-Related Entities: Methodology And Assumptions notch up for well-secured debt, but we may notch down for junior/subordinated GRE debt, the latter using either the hybrid capital criteria or the same guidelines we use for jurisdictions where we do not apply recovery ratings. 77. For transactions backed by non-debt payments from a GRE, such as a transaction backed by lease payments, we will perform a transaction-specific analysis of the likelihood of government support to such obligations of the GRE. We align such likelihood of support or payment with either (i) the SACP on the GRE (if we do not expect extraordinary government support for the transaction backed by non-debt payments), or (ii) with the ICR or senior debt rating on the GRE if we do expect the same level of extraordinary government support for the transaction backed by non-debt payments. In addition, we may assess the likelihood of payment at a level between the SACP and the ICR or senior debt rating on the GRE. Rating GRE Subsidiaries 78. When rating a subsidiary of a GRE, we analyze the subsidiary's relationships both with its group and with the government. We apply our "Group Rating Methodology," published Nov. 19, 2013 (in particular, paragraphs 46 through 48, 208 through 210, and table 2; see Appendix 1 to this document for a copy of those paragraphs and table 2), for entities in scope for the methodology, including corporate entities, financial institutions, and insurance entities. 79. We may choose to rate based solely on potential extraordinary government support for the subsidiary, and not consider the group credit profile (GCP), as long as we believe the government would mitigate the effects of potential negative extraordinary intervention from the group, and as long as any potential ongoing negative intervention from the group is considered as part of the entity's SACP. 80. In certain limited cases for a "core" subsidiary, we may apply tables 4 through 8 by using the unsupported group credit profile in place of the subsidiary's SACP. This would be only when both of the following conditions apply: We believe both group and government support can apply; and We believe that (i) the group has the willingness and capacity, equivalent to its unsupported group credit profile, to support classes of debt of subsidiaries that carry statements of government support (albeit short of a guarantee meeting our criteria for a rating substitution), as opposed to merely relying on the government to service such classes of debt, and (ii) the government will support the obligations in line with our GRE analysis, despite the availability of group support. 81. In such cases, no SACP is required for the subsidiary. 82. For a subsidiary of a GRE that is out of scope for the group rating methodology, we assess whether government support would likely accrue to rated members of the group as follows: If we believe the government is likely to extend such extraordinary support directly to that subsidiary (bypassing the parent), we would add any rating uplift for such support to the SACP of that subsidiary in determining the ICR. If we believe the government is likely to extend such extraordinary support indirectly, via the parent or group, to the subsidiary, we would use the parent's ICR (which would include uplift, if any, for such support) as the reference point in determining the ICR for that subsidiary. Therefore, the rating on the subsidiary would likely be between the subsidiary's SACP and the parent's ICR, depending on the degree of support expected from the parent. MARCH 25,

58 General Criteria: Rating Government-Related Entities: Methodology And Assumptions If we believe the government is unlikely to extend such extraordinary support to the subsidiary, we would consider the parent's willingness and capacity to support its subsidiary as measured by the parent's SACP. Therefore, the rating on the subsidiary would likely be between the subsidiary SACP and the parent SACP (or potentially higher, if the subsidiary SACP is above the parent SACP), depending on the degree of support expected from the parent. APPENDICES Appendix 1: Excerpt From Group Rating Methodology 83. For reference, the following are excerpts from the criteria "Group Rating Methodology," published Nov. 19, 2013, that relate to GREs (paragraphs 46 through 48, table 2, and paragraphs 208 through 210). 46. In some instances, the potential for extraordinary government support (beyond that already factored into the SACP or unsupported GCP) is a component of the ICRs on certain group members or the GCPs (see the GRE criteria, published March 25, 2015, and the bank criteria, published Nov. 9, 2011), reflecting the GRE status of an entity or the systemic importance of a bank. In determining the supported GCP by using the government support tables in the GRE criteria or bank criteria, we use the unsupported GCP in place of the SACP. 47. In this case, the criteria assess whether such government support, driven by GRE status or systemic importance, would likely accrue to all members of the group (for members of a group where the ultimate parent is a GRE, see table 2 [below]). 48. To determine the ICR for a particular group subsidiary, where the assessment indicates that the government: Is likely to extend such extraordinary support directly to that subsidiary (bypassing the group), any rating uplift for such support is added to the SACP of that subsidiary in determining the ICR. If the subsidiary has core or highly strategic group status or "almost certain" GRE status, then the rating outcome is based on the group support or GRE support. Is likely to extend such extraordinary support indirectly, via the group, to the subsidiary, the supported GCP (which would include uplift, if any, for such support) is the reference point in determining the ICR for that subsidiary because the group is still responsible for the flow of support. The same approach applies if government support is likely for a subsidiary within a subgroup via the head entity of that subgroup; i.e., the supported GCP for the subgroup is the reference point for determining the ICR for the subsidiary. Is unlikely to extend such support, the criteria use the unsupported GCP in determining the ICR for that subsidiary. Table 2 (from "Group Rating Methodology") Rating Government-Related Entities--Likelihood Of Government Support Versus Group Support SACP or GCP levels If the subsidiary is likely to benefit directly from extraordinary government support If the subsidiary is likely to get extraordinary government support indirectly through the group If the government is unlikely to support the subsidiary either directly or indirectly SACP is lower than an unsupported GCP ICR = Higher of the SACP + uplift for potential government support, or SACP + uplift for group status uplift (subject to a cap at the level of the GCP unless the subsidiary is insulated). ICR = SACP + uplift for group status uplift. If the group status is "strategically important" or lower, the ICR is capped at one notch below the GCP. ICR = SACP + uplift for group status (with reference to the unsupported GCP). MARCH 25,

59 General Criteria: Rating Government-Related Entities: Methodology And Assumptions Table 2 (from "Group Rating Methodology") Rating Government-Related Entities--Likelihood Of Government Support Versus Group Support (cont.) SACP is higher than or equal to an unsupported GCP ICR = SACP + uplift for potential government support (subject to a cap at the level of the GCP unless the subsidiary is insulated). ICR = SACP + uplift for group status (with reference to the GCP). If the group status is "strategically important" or lower, the ICR is capped at one notch below the GCP (unless the subsidiary's SACP>= the GCP). If the SACP>= the GCP, the ICR is capped at the level of the GCP (unless the subsidiary is insulated). ICR = SACP, subject to a cap at the level of the GCP (unless the subsidiary is insulated) If subsidiaries classified as GREs are owned by the government via a holding or asset management company but we believe that "control" over a GRE's strategy and cash flow rests ultimately with the relevant government, or a representative thereof, we will typically analyze the GRE using our government-related-entity criteria (see paragraphs 48 and 67) As an example, we are likely to rate a regulated utility that is classified as a GRE and is owned by a holding company, whose sole purpose is acting as the legal owner on behalf of the government and that does not carry out its own business activities, using our criteria for rating government-related entities Other GRE subsidiaries are rated as per paragraph 29 and the section, "Extraordinary government support in the GCP" of these criteria, and the section "Rating GRE Subsidiaries" in the GRE criteria. While, per these criteria, the final ICR is the highest of the three potential long-term ICRs resulting from group support, government support, or credit-substitution guarantee methodologies, the GRE criteria also provide for the case where we may choose to rate based solely on potential extraordinary government support for the subsidiary, and not consider the group credit profile, subject to certain conditions (in paragraph 79 of the GRE criteria). Appendix 2: Determining A GRE's Issuer Credit Rating: Tables Presented By Government Rating 84. Tables 9 through 24 below indicate what would be the GRE's issuer or senior credit rating based on its SACP (listed down the left-hand side of the table), our assessment of the likelihood of extraordinary government support (listed across the top of the table), and the government's local currency rating. Table 9 Determining A GRE's Issuer Credit Rating: Government With A Local Currency Rating Of 'AAA' --Likelihood of extraordinary government support-- SACP AC EH VH H MH M L aaa AAA AAA AAA AAA AAA AAA AAA aa+ AAA AAA AAA AA+ AA+ AA+ AA+ aa AAA AAA AAA AA+ AA AA AA aa- AAA AAA AA+ AA AA AA- AAa+ AAA AA+ AA AA- AA- AA- A+ a AAA AA+ AA AA- A+ A+ A a- AAA AA+ AA AA- A+ A A- bbb+ AAA AA+ AA- A+ A A- BBB+ bbb AAA AA+ A+ A A- BBB+ BBB MARCH 25,

60 General Criteria: Rating Government-Related Entities: Methodology And Assumptions Table 9 Determining A GRE's Issuer Credit Rating: Government With A Local Currency Rating Of 'AAA' (cont.) bbb- AAA AA+ A A- BBB+ BBB BBBbb+ AAA AA+ A- BBB+ BBB BBB- BB+ bb AAA AA BBB+ BBB BBB- BB+ BB bb- AAA AA BBB+ BBB- BB+ BB BBb+ AAA AA BBB+ BB+ BB BB- B+ b AAA AA- BBB BB BB- B+ B b- AAA AA- BBB- BB- B+ B B- ccc+ AAA BBB- BB- B+ B B- * ccc AAA BB+ B+ B B- * * ccc- AAA BB+ B+ B- * * * cc AAA BB- B+ B- * * * *These combinations may suggest an issuer credit rating in the 'CCC' or weaker rating categories. As per paragraph 43, we only assign issuer credit ratings for GREs in these rating categories based on "Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings," published Oct. 1, SACP--Stand-alone credit profile. AC--Almost certain. EH--Extremely high. VH--Very high. H--High. MH--Moderately high. M--Moderate. L--Low. Table 10 Determining A GRE's Issuer Credit Rating: Government With A Local Currency Rating Of 'AA+' --Likelihood of extraordinary government support-- SACP AC EH VH H MH M L aa+ AA+ AA+ AA+ AA+ AA+ AA+ AA+ aa AA+ AA+ AA+ AA AA AA AA aa- AA+ AA+ AA+ AA AA- AA- AAa+ AA+ AA AA AA- AA- A+ A+ a AA+ AA AA- A+ A+ A+ A a- AA+ AA AA- A+ A A A- bbb+ AA+ AA AA- A+ A A- BBB+ bbb AA+ AA A+ A A- BBB+ BBB bbb- AA+ AA A A- BBB+ BBB BBBbb+ AA+ AA A- BBB+ BBB BBB- BB+ bb AA+ AA- BBB+ BBB BBB- BB+ BB bb- AA+ AA- BBB+ BBB- BB+ BB BBb+ AA+ AA- BBB BB+ BB BB- B+ b AA+ A+ BBB- BB BB- B+ B b- AA+ A BBB- BB- B+ B B- ccc+ AA+ BBB- BB- B+ B B- * ccc AA+ BB+ B+ B B- * * ccc- AA+ BB+ B+ B- * * * cc AA+ BB- B+ B- * * * *These combinations may suggest an issuer credit rating in the 'CCC' or weaker rating categories. As per paragraph 43, we only assign issuer credit ratings for GREs in these rating categories based on "Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings," published Oct. 1, SACP--Stand-alone credit profile. AC--Almost certain. EH--Extremely high. VH--Very high. H--High. MH--Moderately high. M--Moderate. L--Low. MARCH 25,

61 General Criteria: Rating Government-Related Entities: Methodology And Assumptions Table 11 Determining A GRE's Issuer Credit Rating: Government With A Local Currency Rating Of 'AA' --Likelihood of extraordinary government support-- SACP AC EH VH H MH M L aa AA AA AA AA AA AA AA aa- AA AA AA AA- AA- AA- AAa+ AA AA AA AA- A+ A+ A+ a AA AA- AA- A+ A+ A A a- AA AA- A+ A+ A A A- bbb+ AA AA- A+ A A- A- BBB+ bbb AA AA- A+ A A- BBB+ BBB bbb- AA AA- A A- BBB+ BBB BBBbb+ AA AA- A- BBB+ BBB BBB- BB+ bb AA A+ BBB+ BBB BBB- BB+ BB bb- AA A+ BBB BBB- BB+ BB BBb+ AA A BBB- BB+ BB BB- B+ b AA A BBB- BB BB- B+ B b- AA A BB+ BB- B+ B B- ccc+ AA BBB- BB- B+ B B- * ccc AA BB+ B+ B B- * * ccc- AA BB+ B+ B- * * * cc AA BB- B+ B- * * * *These combinations may suggest an issuer credit rating in the 'CCC' or weaker rating categories. As per paragraph 43, we only assign issuer credit ratings for GREs in these rating categories based on "Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings," published Oct. 1, SACP--Stand-alone credit profile. AC--Almost certain. EH--Extremely high. VH--Very high. H--High. MH--Moderately high. M--Moderate. L--Low. Table 12 Determining A GRE's Issuer Credit Rating: Government With A Local Currency Rating Of 'AA-' --Likelihood of extraordinary government support-- SACP AC EH VH H MH M L aa- AA- AA- AA- AA- AA- AA- AAa+ AA- AA- AA- A+ A+ A+ A+ a AA- AA- AA- A+ A A A a- AA- A+ A+ A A A- A- bbb+ AA- A+ A A A- A- BBB+ bbb AA- A+ A A- BBB+ BBB+ BBB bbb- AA- A+ A A- BBB+ BBB BBBbb+ AA- A+ A- BBB+ BBB BBB- BB+ bb AA- A+ BBB+ BBB BBB- BB+ BB bb- AA- A+ BBB BBB- BB+ BB BBb+ AA- A BBB- BB+ BB BB- B+ b AA- A BBB- BB BB- B+ B b- AA- A BB+ BB- B+ B B- MARCH 25,

62 General Criteria: Rating Government-Related Entities: Methodology And Assumptions Table 12 Determining A GRE's Issuer Credit Rating: Government With A Local Currency Rating Of 'AA-' (cont.) ccc+ AA- BBB- BB- B+ B B- * ccc AA- BB+ B+ B B- * * ccc- AA- BB+ B+ B- * * * cc AA- BB- B+ B- * * * *These combinations may suggest an issuer credit rating in the 'CCC' or weaker rating categories. As per paragraph 43, we only assign issuer credit ratings for GREs in these rating categories based on "Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings," published Oct. 1, SACP--Stand-alone credit profile. AC--Almost certain. EH--Extremely high. VH--Very high. H--High. MH--Moderately high. M--Moderate. L--Low. Table 13 Determining A GRE's Issuer Credit Rating: Government With A Local Currency Rating Of 'A+' --Likelihood of extraordinary government support-- SACP AC EH VH H MH M L a+ A+ A+ A+ A+ A+ A+ A+ a A+ A+ A+ A A A A a- A+ A A A A- A- A- bbb+ A+ A A A A- BBB+ BBB+ bbb A+ A A A- BBB+ BBB+ BBB bbb- A+ A A- BBB+ BBB BBB BBBbb+ A+ A A- BBB+ BBB BBB- BB+ bb A+ A BBB+ BBB BBB- BB+ BB bb- A+ A BBB BBB- BB+ BB BBb+ A+ BBB+ BBB- BB+ BB BB- B+ b A+ BBB+ BB+ BB BB- B+ B b- A+ BBB BB BB- B+ B B- ccc+ A+ BBB- BB- B+ B B- * ccc A+ BB+ B+ B B- * * ccc- A+ BB+ B+ B- * * * cc A+ BB- B+ * * * * *These combinations may suggest an issuer credit rating in the 'CCC' or weaker rating categories. As per paragraph 43, we only assign issuer credit ratings for GREs in these rating categories based on "Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings," published Oct. 1, SACP--Stand-alone credit profile. AC--Almost certain. EH--Extremely high. VH--Very high. H--High. MH--Moderately high. M--Moderate. L--Low. Table 14 Determining A GRE's Issuer Credit Rating: Government With A Local Currency Rating Of 'A' --Likelihood of extraordinary government support-- SACP AC EH VH H MH M L a A A A A A A A a- A A A A- A- A- A- bbb+ A A- A- A- BBB+ BBB+ BBB+ bbb A A- A- A- BBB+ BBB BBB bbb- A A- A- BBB+ BBB BBB BBB- MARCH 25,

63 General Criteria: Rating Government-Related Entities: Methodology And Assumptions Table 14 Determining A GRE's Issuer Credit Rating: Government With A Local Currency Rating Of 'A' (cont.) bb+ A A- BBB+ BBB BBB- BBB- BB+ bb A A- BBB+ BBB BBB- BB+ BB bb- A A- BBB BBB- BB+ BB BBb+ A BBB+ BBB- BB+ BB BB- B+ b A BBB+ BB+ BB BB- B+ B b- A BBB BB BB- B+ B B- ccc+ A BBB- BB- B+ B B- * ccc A BB+ B+ B B- * * ccc- A BB+ B+ B- * * * cc A BB- B+ * * * * *These combinations may suggest an issuer credit rating in the 'CCC' or weaker rating categories. As per paragraph 43, we only assign issuer credit ratings for GREs in these rating categories based on "Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings," published Oct. 1, SACP--Stand-alone credit profile. AC--Almost certain. EH--Extremely high. VH--Very high. H--High. MH--Moderately high. M--Moderate. L--Low. Table 15 Determining A GRE's Issuer Credit Rating: Government With A Local Currency Rating Of 'A-' --Likelihood of extraordinary government support-- SACP AC EH VH H MH M L a- A- A- A- A- A- A- A- bbb+ A- A- A- BBB+ BBB+ BBB+ BBB+ bbb A- BBB+ BBB+ BBB+ BBB BBB BBB bbb- A- BBB+ BBB+ BBB+ BBB BBB- BBBbb+ A- BBB+ BBB+ BBB BBB- BBB- BB+ bb A- BBB+ BBB BBB- BB+ BB+ BB bb- A- BBB+ BBB BBB- BB+ BB BBb+ A- BBB BBB- BB+ BB BB- B+ b A- BBB BB+ BB BB- B+ B b- A- BBB BB BB- B+ B B- ccc+ A- BBB- BB- B+ B B- * ccc A- BB+ B+ B B- * * ccc- A- BB+ B+ B- * * * cc A- BB- B+ * * * * *These combinations may suggest an issuer credit rating in the 'CCC' or weaker rating categories. As per paragraph 43, we only assign issuer credit ratings for GREs in these rating categories based on "Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings," published Oct. 1, SACP--Stand-alone credit profile. AC--Almost certain. EH--Extremely high. VH--Very high. H--High. MH--Moderately high. M--Moderate. L--Low. Table 16 Determining A GRE's Issuer Credit Rating: Government With A Local Currency Rating Of 'BBB+' --Likelihood of extraordinary government support-- SACP AC EH VH H MH M L bbb+ BBB+ BBB+ BBB+ BBB+ BBB+ BBB+ BBB+ MARCH 25,

64 General Criteria: Rating Government-Related Entities: Methodology And Assumptions Table 16 Determining A GRE's Issuer Credit Rating: Government With A Local Currency Rating Of 'BBB+' (cont.) bbb BBB+ BBB+ BBB+ BBB BBB BBB BBB bbb- BBB+ BBB BBB BBB BBB- BBB- BBBbb+ BBB+ BBB BBB BBB BBB- BB+ BB+ bb BBB+ BBB BBB BBB- BB+ BB+ BB bb- BBB+ BBB BBB- BB+ BB BB BBb+ BBB+ BBB- BBB- BB+ BB BB- B+ b BBB+ BBB- BB+ BB BB- B+ B b- BBB+ BBB- BB BB- B+ B B- ccc+ BBB+ BB+ B+ B+ B B- * ccc BBB+ BB B+ B B- * * ccc- BBB+ BB B+ B- * * * cc BBB+ B+ B * * * * *These combinations may suggest an issuer credit rating in the 'CCC' or weaker rating categories. As per paragraph 43, we only assign issuer credit ratings for GREs in these rating categories based on "Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings," published Oct. 1, SACP--Stand-alone credit profile. AC--Almost certain. EH--Extremely high. VH--Very high. H--High. MH--Moderately high. M--Moderate. L--Low. Table 17 Determining A GRE's Issuer Credit Rating: Government With A Local Currency Rating Of 'BBB' --Likelihood of extraordinary government support-- SACP AC EH VH H MH M L bbb BBB BBB BBB BBB BBB BBB BBB bbb- BBB BBB BBB BBB- BBB- BBB- BBBbb+ BBB BBB- BBB- BBB- BB+ BB+ BB+ bb BBB BBB- BBB- BBB- BB+ BB BB bb- BBB BBB- BBB- BB+ BB BB BBb+ BBB BB+ BB+ BB BB- BB- B+ b BBB BB+ BB+ BB BB- B+ B b- BBB BB+ BB BB- B+ B B- ccc+ BBB BB B+ B+ B B- * ccc BBB BB B+ B B- * * ccc- BBB BB B+ B- * * * cc BBB B+ B * * * * *These combinations may suggest an issuer credit rating in the 'CCC' or weaker rating categories. As per paragraph 43, we only assign issuer credit ratings for GREs in these rating categories based on "Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings," published Oct. 1, SACP--Stand-alone credit profile. AC--Almost certain. EH--Extremely high. VH--Very high. H--High. MH--Moderately high. M--Moderate. L--Low. Table 18 Determining A GRE's Issuer Credit Rating: Government With A Local Currency Rating Of 'BBB-' --Likelihood of extraordinary government support-- SACP AC EH VH H MH M L bbb- BBB- BBB- BBB- BBB- BBB- BBB- BBB- MARCH 25,

65 General Criteria: Rating Government-Related Entities: Methodology And Assumptions Table 18 Determining A GRE's Issuer Credit Rating: Government With A Local Currency Rating Of 'BBB-' (cont.) bb+ BBB- BBB- BBB- BB+ BB+ BB+ BB+ bb BBB- BB+ BB+ BB+ BB BB BB bb- BBB- BB+ BB+ BB+ BB BB- BBb+ BBB- BB BB BB BB- BB- B+ b BBB- BB BB BB- B+ B+ B b- BBB- BB BB BB- B+ B B- ccc+ BBB- BB- B+ B+ B B- * ccc BBB- BB- B+ B B- * * ccc- BBB- BB- B+ B- * * * cc BBB- B+ B- * * * * *These combinations may suggest an issuer credit rating in the 'CCC' or weaker rating categories. As per paragraph 43, we only assign issuer credit ratings for GREs in these rating categories based on "Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings," published Oct. 1, SACP--Stand-alone credit profile. AC--Almost certain. EH--Extremely high. VH--Very high. H--High. MH--Moderately high. M--Moderate. L--Low. Table 19 Determining A GRE's Issuer Credit Rating: Government With A Local Currency Rating Of 'BB+' --Likelihood of extraordinary government support-- SACP AC EH VH H MH M L bb+ BB+ BB+ BB+ BB+ BB+ BB+ BB+ bb BB+ BB BB BB BB BB BB bb- BB+ BB BB BB BB- BB- BBb+ BB+ BB BB- BB- BB- B+ B+ b BB+ BB BB- BB- B+ B+ B b- BB+ BB BB- B+ B B B- ccc+ BB+ B+ B+ B B- B- * ccc BB+ B+ B+ B- * * * ccc- BB+ B+ B * * * * cc BB+ B B- * * * * *These combinations may suggest an issuer credit rating in the 'CCC' or weaker rating categories. As per paragraph 43, we only assign issuer credit ratings for GREs in these rating categories based on "Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings," published Oct. 1, SACP--Stand-alone credit profile. AC--Almost certain. EH--Extremely high. VH--Very high. H--High. MH--Moderately high. M--Moderate. L--Low. Table 20 Determining A GRE's Issuer Credit Rating: Government With A Local Currency Rating Of 'BB' --Likelihood of extraordinary government support-- SACP AC EH VH H MH M L bb BB BB BB BB BB BB BB bb- BB BB- BB- BB- BB- BB- BBb+ BB BB- BB- BB- B+ B+ B+ b BB BB- BB- BB- B+ B B b- BB BB- B+ B+ B B B- MARCH 25,

66 General Criteria: Rating Government-Related Entities: Methodology And Assumptions Table 20 Determining A GRE's Issuer Credit Rating: Government With A Local Currency Rating Of 'BB' (cont.) ccc+ BB B+ B+ B B- B- * ccc BB B+ B B- * * * ccc- BB B+ B- * * * * cc BB B * * * * * *These combinations may suggest an issuer credit rating in the 'CCC' or weaker rating categories. As per paragraph 43, we only assign issuer credit ratings for GREs in these rating categories based on "Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings," published Oct. 1, SACP--Stand-alone credit profile. AC--Almost certain. EH--Extremely high. VH--Very high. H--High. MH--Moderately high. M--Moderate. L--Low. Table 21 Determining A GRE's Issuer Credit Rating: Government With A Local Currency Rating Of 'BB-' --Likelihood of extraordinary government support-- SACP AC EH VH H MH M L bb- BB- BB- BB- BB- BB- BB- BBb+ BB- B+ B+ B+ B+ B+ B+ b BB- B+ B+ B+ B B B b- BB- B+ B B B B- B- ccc+ BB- B B- B- B- B- * ccc BB- B B- B- * * * ccc- BB- B B- * * * * cc BB- B- * * * * * *These combinations may suggest an issuer credit rating in the 'CCC' or weaker rating categories. As per paragraph 43, we only assign issuer credit ratings for GREs in these rating categories based on "Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings," published Oct. 1, SACP--Stand-alone credit profile. AC--Almost certain. EH--Extremely high. VH--Very high. H--High. MH--Moderately high. M--Moderate. L--Low. Table 22 Determining A GRE's Issuer Credit Rating: Government With A Local Currency Rating Of 'B+' --Likelihood of extraordinary government support-- SACP AC EH VH H MH M L b+ B+ B+ B+ B+ B+ B+ B+ b B+ B B B B B B b- B+ B B- B- B- B- B- ccc+ B+ B- B- B- * * * ccc B+ B- * * * * * ccc- B+ B- * * * * * cc B+ * * * * * * *These combinations may suggest an issuer credit rating in the 'CCC' or weaker rating categories. As per paragraph 43, we only assign issuer credit ratings for GREs in these rating categories based on "Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings," published Oct. 1, SACP--Stand-alone credit profile. AC--Almost certain. EH--Extremely high. VH--Very high. H--High. MH--Moderately high. M--Moderate. L--Low. MARCH 25,

67 General Criteria: Rating Government-Related Entities: Methodology And Assumptions Table 23 Determining A GRE's Issuer Credit Rating: Government With A Local Currency Rating Of 'B' --Likelihood of extraordinary government support-- SACP AC EH VH H MH M L b B B B B B B B b- B B- B- B- B- B- B- ccc+ B B- B- B- * * * ccc B B- * * * * * ccc- B B- * * * * * cc B * * * * * * *These combinations may suggest an issuer credit rating in the 'CCC' or weaker rating categories. As per paragraph 43, we only assign issuer credit ratings for GREs in these rating categories based on "Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings," published Oct. 1, SACP--Stand-alone credit profile. AC--Almost certain. EH--Extremely high. VH--Very high. H--High. MH--Moderately high. M--Moderate. L--Low. Table 24 Determining A GRE's Issuer Credit Rating: Government With A Local Currency Rating Of 'B-' --Likelihood of extraordinary government support-- SACP AC EH VH H MH M L b- B- B- B- B- B- B- B- ccc+ B- * * * * * * ccc B- * * * * * * ccc- B- * * * * * * cc B- * * * * * * *These combinations may suggest an issuer credit rating in the 'CCC' or weaker rating categories. As per paragraph 43, we only assign issuer credit ratings for GREs in these rating categories based on "Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings," published Oct. 1, SACP--Stand-alone credit profile. AC--Almost certain. EH--Extremely high. VH--Very high. H--High. MH--Moderately high. M--Moderate. L--Low. Appendix 3: Key Changes From The Previous Methodology 85. These criteria fully supersede "Rating Government-Related Entities: Methodology And Assumptions," published Dec. 9, The main changes clarify and enhance certain parts of the criteria. In particular: We updated our definition of a GRE. We clarified that a GRE can be (i) any entity that we believe could benefit from extraordinary government support (regardless of whether such entity is controlled by a government), or (ii) entities controlled by a government that we believe could be subject to negative extraordinary government intervention (see paragraph 10). We clarified when we will, or will not, determine an SACP for a GRE that, in our view, benefits from "almost certain" likelihood of support (as defined in our criteria). In most cases, we will determine an SACP for such GREs because the SACP is important for us to monitor transition risk for government support. However, we may not determine an SACP when we do not believe the likelihood of government support is subject to transition risk and when the entity is, in our view, a non-severable arm of the government or executes strategic government policies (see paragraph 20). We clarified that we will not notch up a rating on a GRE above its SACP for potential extraordinary government MARCH 25,

68 General Criteria: Rating Government-Related Entities: Methodology And Assumptions support unless we have a rating (public or confidential) on the related government and sufficient information to determine the "role" and "link" (as defined in our criteria) of the GRE to its government (see paragraph 23). We provided additional guidance on when we may determine that the government's overall likelihood of support for the GRE sector is "doubtful," which would in turn lead to the link, as per table 3, between the GRE and the related government being "limited" (see paragraphs 35 and 36). We capped the "likelihood of extraordinary government support," per table 1, at "moderately high" or "moderate," respectively, if we determine a "high" or "very high" correlation between the GRE's SACP and the rating on the related government (see paragraphs 38 and 39). We provided more detailed guidance on when and how we will limit rating uplift to GREs in cases of a rapidly deteriorating SACP (see paragraph 47). We provided more detail on how we determine whether a GRE, when the related government is a local or regional government (LRG), can be rated above the rating on the related government, including use of a formal "pass/fail" stress test. We also set a cap (three notches above the related government rating) if we view the GRE as dependent on ongoing support from the government. For GREs with a sovereign related government, we clarified that the GRE section of "Ratings Above The Sovereign--Corporate And Government Ratings: Methodology And Assumptions," published Nov. 19, 2013, applies (see paragraphs 57 through 65). We clarified that we may apply GRE criteria to the ratings on debt issues (issue credit ratings) as well as to ratings on issuers (ICRs), including the use of sector-specific criteria to differentiate degrees of government support among a GRE's issue credit ratings (i.e., when to notch up or down; paragraphs 68 through 77). We clarified that our group rating methodology applies to all GREs that are in scope for such methodology (corporate, financial institutions, and insurance sector entities, and some U.S. public finance entities; see paragraphs 78 through 82). We made no changes to the GRE rating tables (tables 4 through 8, and 9 through 24 in Appendix 2), except that we removed 'CCC' and 'CC' category ratings from the results in the tables. Instead, we would apply our methodology, "Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings," published Oct. 1, 2012, to determine a GRE rating in those rating categories. For GRE instrument ratings in the 'CCC' or 'CC' categories, also see "Credit FAQ: Criteria For Assigning CCC+, CCC, CCC-, And CC Ratings To Subordinated And Hybrid Capital Instruments," published July 16, RELATED CRITERIA AND RESEARCH Related Criteria Bank Hybrid Capital And Nondeferrable Subordinated Debt Methodology And Assumptions, Jan. 29, 2015 Sovereign Rating Methodology, Dec. 23, 2014 Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Dec. 16, 2014 Methodology And Assumptions For Assessing Portfolios Of International Public Sector And Other Debt Obligations Backing Covered Bonds And Structured Finance Securities, Dec. 9, 2014 Project Finance Framework Methodology, Sept. 16, 2014 Methodology For Rating Non-U.S. Local And Regional Governments, June 30, 2014 Ratings Above The Sovereign--Corporate And Government Ratings: Methodology And Assumptions, Nov. 19, 2013 Corporate Methodology, Nov. 19, 2013 Group Rating Methodology, Nov. 19, 2013 Timeliness Of Payments: Grace Periods, Guarantees, And Use Of 'D' And 'SD' Ratings, Oct. 24, 2013 U.S. Local Governments General Obligation Ratings: Methodology And Assumptions, Sept. 12, 2013 Guarantee Criteria--Structured Finance, May 7, MARCH 25,

69 General Criteria: Rating Government-Related Entities: Methodology And Assumptions Methodology For Linking Short-Term And Long-Term Ratings For Corporate, Insurance, And Sovereign Issuers, May 7, 2013 Insurers: Rating Methodology, May 7, 2013 Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings, Oct. 1, 2012 CDOs And Pooled TOBs Backed By U.S. Municipal Debt: Methodology And Assumptions, April 3, 2012 Banks: Rating Methodology And Assumptions, Nov. 9, 2011 Principles Of Credit Ratings, Feb. 16, 2011 U.S. State Ratings Methodology, Jan. 3, 2011 Stand-Alone Credit Profiles: One Component Of A Rating, Oct. 1, 2010 Criteria Guidelines For Recovery Ratings On Global Industrials Issuers' Speculative-Grade Debt, Aug. 10, 2009 General Criteria: Rating Implications Of Exchange Offers And Similar Restructurings, Update, May 12, 2009 Joint-Support Criteria Update, April 22, 2009 Rating Sovereign-Guaranteed Debt, April 6, Corporate Criteria: Rating Each Issue, April 15, 2008 Partially superseded criteria Multilateral Lending Institutions And Other Supranational Institutions Ratings Methodology, Nov. 26, 2012 Related research Credit FAQ: Applying "Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings" To Subordinated And Hybrid Capital Instruments, July 16, 2014 (Watch the related CreditMatters TV segment titled, "Standard & Poor s Updates Its Criteria For Rating Government-Related Entities," dated March 25, 2015.) These criteria represent the specific application of fundamental principles that define credit risk and ratings opinions. Their use is determined by issuer- or issue-specific attributes as well as Standard & Poor's Ratings Services' assessment of the credit and, if applicable, structural risks for a given issuer or issue rating. Methodology and assumptions may change from time to time as a result of market and economic conditions, issuer- or issue-specific factors, or new empirical evidence that would affect our credit judgment. Under Standard & Poor's policies, only a Rating Committee can determine a Credit Rating Action (including a Credit Rating change, affirmation or withdrawal, Rating Outlook change, or CreditWatch action). This commentary and its subject matter have not been the subject of Rating Committee action and should not be interpreted as a change to, or affirmation of, a Credit Rating or Rating Outlook. MARCH 25,

70 Copyright 2015 Standard & Poor's Financial Services LLC, a part of McGraw Hill Financial. All rights reserved. No content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor's Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an "as is" basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT'S FUNCTIONING WILL BE UNINTERRUPTED, OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages. Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P's opinions, analyses, and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw, or suspend such acknowledgement at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal, or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof. S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain nonpublic information received in connection with each analytical process. S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, (free of charge), and and (subscription) and (subscription) and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at MARCH 25,

71 General Criteria: Principles For Rating Debt Issues Based On Imputed Promises Primary Contact: Laura J Feinland Katz, CFA, Criteria Officer, New York (1) ; laura.feinland.katz@standardandpoors.com Secondary Contact: Adrian D Techeira, Criteria Officer, Structured Finance, New York (1) ; adrian.techeira@standardandpoors.com Chief Criteria Officer, Structured Finance: Felix E Herrera, CFA, New York (1) ; felix.herrera@standardandpoors.com Chief Criteria Officer, Americas: Lucy A Collett, New York (1) ; lucy.collett@standardandpoors.com Chief Criteria Officer, EMEA: Lapo Guadagnuolo, London (44) ; lapo.guadagnuolo@standardandpoors.com Chief Criteria Officer, Asia-Pacific: Peter J Eastham, Melbourne (61) ; peter.eastham@standardandpoors.com Chief Criteria Officer, Global: Ian D Thompson, Melbourne (44) ; ian.thompson@standardandpoors.com Table Of Contents SCOPE OF THE CRITERIA SUMMARY OF THE CRITERIA IMPACT ON OUTSTANDING RATINGS EFFECTIVE DATE AND TRANSITION METHODOLOGY DECEMBER 19,

72 Table Of Contents (cont.) A. Attributes Of A Ratable Promise B. Conditions For Assigning A Rating C. Using Imputed Promises To Rate Debt Instruments D. The Effects Of Breaching A Ratable Promise APPENDIX Frequently Asked Questions RELATED CRITERIA AND RESEARCH DECEMBER 19,

73 General Criteria: Principles For Rating Debt Issues Based On Imputed Promises (Editor's Note: This article fully supersedes "Principles For Rating Debt Issues Based On Imputed Promises," published Oct. 24, 2013, and is related to "Principles Of Credit Ratings," published Feb. 16, 2011.) 1. Standard & Poor's Ratings Services is updating its principles for rating securities that do not have plainly stated promises with respect to repayment of principal, interest, or both within a specific time period. The principles provide guidance regarding debt instruments that Standard & Poor's will and will not rate and how we will arrive at those rating decisions when the terms of an instrument, in our opinion, are not credit-based or measurable. The main changes in these criteria update and clarify certain parts of the criteria through the inclusion of the "Frequently Asked Questions" section in the Appendix. This article fully supersedes "Principles For Rating Debt Issues Based on Imputed Promises," published Oct. 24, 2013, on RatingsDirect. 2. These criteria clarify that Standard & Poor's does not merely rate to the terms of a transaction. Rather, in order to rate a transaction, we require a "ratable promise," which is, in our view, a promise that is both credit-based and measurable. Where a ratable promise does not exist, we will impute such a promise, add a qualifying subscript, or not rate the transaction. In this way, we expect our ratings to continue to provide market participants with meaningful, credit-based opinions. These principles also represent a continuation of our initiative to enhance ratings comparability among structured finance, corporate, financial services, and government instruments by providing globally consistent principles for "imputing" a promise to form the basis of the rating, when needed. 3. The criteria clarify the types of market, or non-credit risks, that would cause Standard & Poor's to add a subscript to a rating or not assign a rating. These criteria provide general principles for rating debt issues based on imputed promises and are complemented by sector-specific criteria as needed, such as "Use of C And D Issue Credit Ratings For Hybrid Capital And Payment-In-Kind Instruments," published Oct. 24, This article is related to "Principles Of Credit Ratings," published Feb. 16, SCOPE OF THE CRITERIA 4. These criteria apply to all issue credit ratings globally. This includes ratings on instruments that corporate and government entities and structured finance vehicles issue. These criteria do not apply to issuer credit ratings or insurer financial strength ratings. SUMMARY OF THE CRITERIA 5. The criteria provide principles for determining whether a rating may be assigned, based on whether the principal and interest components of an instrument individually contain promises that are credit-based and measurable. By "credit-based," we mean that the likelihood of payment must be primarily linked to an obligor's willingness and ability DECEMBER 19,

74 General Criteria: Principles For Rating Debt Issues Based On Imputed Promises to pay. By "measurable," we generally mean that the promise to pay relates to a specific amount due on a specific date. Because our issue credit ratings are primarily an assessment of relative default risk, defining what constitutes a default is critical. Where terms of an instrument do not define a default event, or where we deem that the promise stated in the terms of the instrument is not credit-based and measurable, or the promise carves out credit risk, we will do one of three things: Impute a promise that we consider credit-based and measurable, and use this promise as the basis for assigning a rating; Add a qualifying subscript ('p', denoting that the rating addresses only the repayment of principal and not any payments of interest); or Not rate the instrument. 6. Where promises in instruments are meaningless, illusory, difficult to measure, or contain qualifications, the criteria explain how we may impute a ratable promise--that is a promise on which to base the rating. To impute individual promises for payment of principal and interest, the criteria explain how we apply the terms of an instrument along with those of the underlying asset or assets. The criteria also describe how the imputed promise addresses payment deferrals and interest shortfalls, payment accelerations, puts and calls, and payment qualifications based on the terms and nature of the instrument. 7. Generally, when an instrument breaches the rated promise--whether based on an imputed promise or the instrument's terms--the rating will fall to 'D', absent de-minimis exceptions with regard to the duration and amount of the breach. In addition, when a deferral occurs where deferred amounts are permitted by the terms of the instrument, and we believe virtual certainty exists that repayment of such deferrals will not be made in full at or before maturity, the rating would be lowered to 'D'. Where the issue rating is lowered to 'D' based on an imputed promise, the issuer rating would not necessarily fall all the way to 'D' or 'SD' (selective default). For example, we typically would not lower a company's issuer credit rating to 'D' or 'SD' upon a failure to make a dividend payment on a non-cumulative preferred stock issue, even though the issue rating would fall to 'D'. DECEMBER 19,

75 General Criteria: Principles For Rating Debt Issues Based On Imputed Promises IMPACT ON OUTSTANDING RATINGS 8. We do not expect the update of the criteria to lead to any rating changes. DECEMBER 19,

76 General Criteria: Principles For Rating Debt Issues Based On Imputed Promises EFFECTIVE DATE AND TRANSITION 9. These criteria are effective immediately. METHODOLOGY A. Attributes Of A Ratable Promise 10. First, a ratable promise must primarily depend on some credit-based element to link the likelihood of repayment to an obligor's willingness and ability to pay. In other words, the investor's likelihood of receiving payment is based on the likelihood of an obligor honoring a promise to pay principal and interest, or the likelihood of a securitization vehicle having sufficient cash flow to honor a promise to pay. Examples of non-credit-based elements include instruments where the investor's payment largely depends on commodity or equity price risk. In other words, if principal varies due to equity price movements, this is not a change related to the ability and willingness of the obligor to pay, and is considered non-credit-based, unless there is a floor in the principal repayment amount where such floor is equal to the original par amount. 11. When the likelihood of receiving a payment is linked to non-credit events, the instrument may transform a non-credit type of risk into a credit risk. An instrument that, in our view, effects such a transformation satisfies the credit-based element condition and, accordingly, has a ratable promise under the criteria. For example, we will continue to rate catastrophe bonds, where our rating methodology focuses on sizing the likelihood that a specified event occurs that would cause non-payment of principal in full, and where non-payment results in a 'D' rating on the instrument. On the other hand, where the payment amount of principal is linked to non-credit events, those securities would not qualify as having a sufficient credit-based element under these criteria. For example, if a bank issues a note where the amount of principal an investor receives varies with the value of an equity index, such as the S&P 500, we would not rate the instrument, unless it is "principal protected," i.e., has a floor on the principal amount equal to the par amount. On the other hand, we would rate a market-value instrument, such as a market-value collateralized debt obligation (CDO). In this case, we rate to a fixed amount of principal due, which does not vary with any index. The rating addresses the likelihood of the investor receiving a fixed amount, based on our assessment of the worst observed historical price declines for the supporting assets. 12. Second, a ratable promise must be measurable. Otherwise, no way exists to determine whether the promise has been broken. For example, a specific amount due on a specified maturity date is measurable. On the other hand, the promise to pay for residual instruments--the debtholder receives all remaining cash flows once other obligations have been paid--is not measurable because one cannot determine whether the promise was honored by observing the amount paid. The ratable promise should be one that is not considered illusory (i.e., misleading). 13. A standard fixed-rate instrument satisfies the conditions for a ratable promise because it contains a plainly stated promise to pay specified amounts at specified times. The actual terms describe the promise, which Standard & Poor's bases its rating on, even though other provisions in the instrument might blur the meaning of timeliness, loss, or other DECEMBER 19,

77 General Criteria: Principles For Rating Debt Issues Based On Imputed Promises elements. For example, the rating reflects the likelihood of repayment on the specified date, or within our imputed grace period (see paragraph 51), even though the instrument might provide for a longer grace period. Likewise, an investor may receive the right to compensation for the missed payment in the form of a higher, penalty rate of interest, though that does not negate that an event of non-payment has occurred. 14. To meet the "measurable" standard, the promise can either be expressed as a specified nominal amount or rate, paid on a certain date, or it can be linked to a variable index, subject to certain limitations. The promise to pay interest can also be based on a rate that is periodically determined by an independent third party according to an established market-based process, such as the promised interest rates in auction-rate securities and some variable-rate demand obligations. When a promise is linked to a variable index, the variable index must meet certain minimum standards, regardless of whether it relates to the promise to pay principal or interest: The index must have an established track record (generally, a minimum of 10 years); The index must be readily accessible, such as posted on a public website; The index must be independent, for example, calculated by a third party independent of the issuer; and The index must be calculated in a transparent, consistent, and verifiable manner. 15. For principal, only inflation, inflation-related (such as a minimum wage index), or currency indices are acceptable. When principal is linked to other types of market indices (such as an equity index, commodity index, fixed-income [bond price] index, CDS index, etc.), a rating will only be assigned if principal is "protected." That is if the issuer or transaction guarantees that principal, equivalent to the original par value, will be repaid in full by the maturity date. Under our criteria, protected principal means that the par amount of principal is protected at all times during the life of the instrument, i.e., repaid at least at par value. For interest, the minimum standards listed above apply to traditional floating-rate interest references (such as interbank rates, inflation, inflation related, and currency). The minimum standards for the variable index for interest (per paragraph 14) do not apply where we are rating an instrument using the subscript 'p'. We will use the subscript 'p' where the interest rate is tied to other types of market indices (such as equity index, commodity index, fixed-income [bond price] index, CDS index, etc.). We may also use the subscript 'p' where most of the promised investment return is linked to one of these market indices, even if such return is not called interest (see paragraph 29). B. Conditions For Assigning A Rating 16. When the principal and interest components of an instrument satisfy both conditions (credit-based and measurable) for assigning a rating, we will assign a rating without subscripts reflecting the credit risk contained in both components. A single, standard rating will be assigned even if principal and interest have substantially different risk levels. This may occur, for example, due to differences in timing or credit risk profiles. In these cases, sector-specific criteria, usually reflecting a weak-link approach, would determine the rating. 17. For some instruments, the principal component may contain a ratable promise, but not the interest component, and vice versa. When the principal, but not the interest, component of an instrument satisfies the two conditions for a ratable promise, the criteria adds a 'p' subscript to the rating to distinguish the instrument from those that contain ratable promises for both principal and interest. An example is a senior note issued by a 'A' rated obligor with an DECEMBER 19,

78 General Criteria: Principles For Rating Debt Issues Based On Imputed Promises interest rate that varies based on the value of a commodity or equity index. The criteria consider precious metals, such as gold and silver, to be commodities rather than currencies. Such a note would be rated 'Ap', denoting that the interest component does not sufficiently satisfy the credit-based element condition. 18. The ratings on instruments with payments that fluctuate based on a floating interest rate index (such as LIBOR), inflation (or an inflation related index), or currency exchange rates would not have subscripts because interest rate, inflation, and currency risk are viewed as ordinary risks in the fixed-income landscape. For example, our ratings do not address the potential losses an investor could incur if the currency in which the instrument is denominated depreciates relative to the investor's home market currency. 19. Under these criteria, Standard & Poor's will not rate an instrument when the principal component does not satisfy both of the necessary conditions, even if the interest component does. 20. For structured finance interest-only (IO) securities, we rate based on the referenced notional principal balance (see "Global Methodology For Rating Interest-Only Securities," published April 15, 2010). We impute a credit-based promise in order to rate these securities, as stated in that criteria: "ratings on new IO securities will be based on both the IO's payment priority as well as the rating that we attribute to the credit quality of the underlying assets on which the IO's notional amount is based." C. Using Imputed Promises To Rate Debt Instruments 21. Some instruments have less traditional promises, for which Standard & Poor's can often impute a ratable promise. Such promises typically represent illusory or qualified promises. Noncumulative preferred stock and pass-through securities both contain illusory promises, in that the promise to pay is meaningless, or difficult to measure. Neither embodies a ratable promise in its actual terms. However, it is possible to impute a ratable promise to both preferred stock and to pass-through securities in most cases. 22. A qualified promise is a promise that changes if one or more specific events occur; for example, the terms in an instrument allow for shortfalls or late payments under specific circumstances. The inclusion of qualifications may make a promise difficult to measure. Multiple qualifications compound the challenge. In the extreme, broadly stated qualifications may make a promise illusory. As with illusory promises, when the presence of qualifications renders an instrument's actual terms unratable, it is often possible to impute a ratable promise. 23. The deficiencies in certain less traditional promises require Standard & Poor's to impute a promise with the necessary attributes to assign a rating. An imputed promise may embody deferral features and provide for various caps on what might otherwise seem to be straightforward basis for calculating interest. Once the instrument fails to honor the imputed promise, however, we would generally lower the issue rating to 'D'. 24. Another key difference between an imputed promise and the actual terms of an instrument relates to the impact that a breach of the promise would have on the issuer rating. An issuer's breach of an actual promise to pay on a rated instrument constitutes a default, and as a result, Standard & Poor's would lower its rating on the issuer to 'D' or 'SD'. However, if an issuer were to breach an imputed promise, we would lower the issue rating to 'D', but the issuer rating DECEMBER 19,

79 General Criteria: Principles For Rating Debt Issues Based On Imputed Promises would not necessarily fall all the way to 'D' or 'SD'. For example, the lowering of an issue credit rating assigned to a hybrid capital instrument to 'D', such as upon a failure to make a dividend payment on non-cumulative preferred stock, does not in and of itself result in a lowering of the issuer credit rating 'SD' if the non-payment is in accordance with the instrument's terms and conditions, or if the instrument is classified as regulatory capital for a prudentially regulated issuer. 1. Interest 25. If the terms of an instrument indicate a specific rate (with or without qualifications), our imputed promise for the instrument typically uses the stated rate. If the instrument omits a specific rate, the imputed promise uses a rate based on the underlying assets. 26. An imputed promise of interest generally bases the amount due on the outstanding face amount (i.e., unamortized par amount) and the imputed interest rate. 27. The imputed timing of the interest payment is either the dates associated with the rated obligation, or if none are stated, the payment dates associated with the underlying assets. 28. If the instrument specifies a higher coupon payment upon the occurrence of certain events, the imputed promise usually considers the potential step-up in coupon as part of the ratable promise. Examples could include higher interest rates resulting from failed remarketings, deferred payments, or credit deterioration. 29. An instrument may contain provisions by which investors may receive additional amounts over and above the stated coupon. Such payments may come in the way of special distributions, fees, or other supplemental payments. Generally, the rated promise does not consider the likelihood that these additional payments will be made unless the coupon payment itself is de minimis or illusory. If the stated coupon (or the effective yield, when there is no stated coupon) is de minimis or illusory and the additional payments are both credit-based and measurable, then we would generally include the additional payments in the rated promise, and a single, standard rating would apply (see paragraph 16). However, if the stated coupon is de minimis or illusory but the additional payments are not credit-based or not measurable, we would either not assign a rating, or we would assign a rating that indicates the interest is not rated, as in 'XXp'. When there is no stated coupon and the additional payments are not credit-based or not measurable, the instrument would generally receive the 'p' subscript unless we make a case-specific determination that the effective yield of the credit-based and measurable component of the promise to pay is not de minimis. To be clear, we do not consider a traditional market-base rate as de minimis, such as an instrument linked to LIBOR flat. However, the base rate must meet the minimum standards set out in paragraph 14. In general, to evaluate whether a promised coupon payment is de minimis, we would consider factors including: Whether the promised coupon exceeds the relevant sovereign government borrowing rate at the time of issuance for an instrument with the same tenor and currency of the rated issue; and On a judgmental basis, whether the promised coupon constitutes only a small fraction of the overall return offered, above the return of original invested principal, for the instrument. 2. Principal 30. If the terms of an instrument specify a final maturity date, as well as an earlier, projected principal repayment schedule--sometimes referred to as the expected maturity date or the target amortization schedule--the imputed DECEMBER 19,

80 General Criteria: Principles For Rating Debt Issues Based On Imputed Promises promise is principal due at final maturity (or "legal maturity date") in cash. Although more typically found in securitizations, this treatment applies to all rated instruments with such features, including project finance instruments and traditional corporate bonds. If the terms of a securitization do not specify a final maturity (such as those for certain pass-through securitizations), the imputed promise is to pay principal by the latest original maturity of the underlying assets, plus a period to allow for liquidation of the collateral, if needed. In the cases of non-securitizations with terms that do not specify a final maturity (for example, perpetual bonds or preferred stock), the imputed promise is that the instrument will maintain its rank in the capital structure (such as senior or subordinated) and will pay principal in full at a specified call date, an optional refinancing date, or the time of liquidation. 3. Temporary interest deferrals and payment delays 31. The manner in which an imputed promise allows for temporary deferrals depends on our view of the cause for the deferral and whether the missed payment can be repaid by maturity. 32. Instruments that capitalize interest from issuance. Examples of instruments that capitalize interest beginning at issuance include zero-coupon bonds and accrual or accretion bonds that accrue interest from inception. Such instruments capitalize interest from inception for reasons other than credit stress. For these instruments, the ratable promise is identical to the actual terms--the deferral feature (from inception) would not affect the rating. However, once the deferral period ends and the instrument begins paying interest in cash, any subsequent deferral (even in accordance with terms) is evaluated as below. 33. Instruments that lack deferral provisions, or the deferral is expressed as a "temporary shock absorber."pass-through certificates are an example of instruments that lack specific provisions for deferral, even though deferrals or interest shortfalls may occur and be repaid prior to maturity. Examples of instruments that provide for deferral as a temporary shock absorber include payment-in-kind (PIK) notes, PIK toggle notes, subordinate tranches of CDOs, and cumulative preferred stock. These instruments defer or capitalize interest at times of stress. However, payments are not foregone. Rather the cash flow timing is delayed. Temporary shock absorbers may also include instruments with temporary write-downs to principal, as long as the terms of the instrument allow for full reinstatement of the principal along with reinstatement, deferral, or capitalization of the related interest shortfall (i.e., the interest that would have accrued on the portion of principal subject to the temporary write-down). 34. For all instruments similar to those above, sector-specific criteria or analyses will typically provide more detail as to how, and whether, we will consider a deferred payment as leading to a lower rating or a default. This sector-specific approach is necessary to appropriately capture differing amounts of credit and non-credit factors that could lead to a deferral and differing instrument terms across asset classes and jurisdictions. 35. In addition, for all sectors and asset classes, when we believe virtual certainty exists that repayment of deferred amounts due under the terms of the documentation will not be made in full at or before maturity--whether because of the asset composition, structural mechanics of the transaction, or other factors--this certainty overrides any imputed allowed deferral periods. At the time of, or following, a deferral event, when, in our view, such virtual certainty exists, the rating would be lowered to 'D'. For purposes of this paragraph, amounts due under the terms of the documentation include principal, interest, interest step-up, and compounding of deferred interest at the rate set in the documentation. 36. Instruments with a deferral expressed as a "permanent shock absorber."these include many hybrid capital instruments, including contingent-convertible bonds and non-cumulative preferred stock. As opposed to temporary shock absorbers, when instruments with permanent shock absorbers defer interest, write down principal, or convert to equity, unpaid amounts are not repaid in the future. As a result, investors suffer a permanent loss. DECEMBER 19,

81 General Criteria: Principles For Rating Debt Issues Based On Imputed Promises 37. In the case of permanent shock absorbers, although the terms of the instrument may permit non-payment of interest, conversion to equity, or write-down of principal, the terms of the imputed promise are to pay cash on a timely basis. Therefore, use of this type of permanent shock absorber would constitute a breach of the imputed promise. For example, a write-down of principal, in accordance with the terms of a bank hybrid security, would result in a 'D' rating. Similarly, the conversion of a debt instrument into common equity as a result of a credit-related trigger, in accordance with the terms of the instrument, would result in a 'D' rating unless the current market value of the shares received upon conversion was equal to or exceeded the original principal amount. 38. However, the exercise of an equity conversion feature in an instrument that includes one does not constitute a breach of the ratable promise if the conversion does not occur as a result of credit stress. 4. Acceleration or early amortization 39. For non-securitization instruments, such as corporate bonds, acceleration (where all principal amounts become immediately due and payable) is typically due to an event of default, and the expectation of additional ongoing payments may not exist. The purpose of the acceleration is to position creditors to better enforce their claims in bankruptcy or other restructuring proceedings. Although the triggering event may have been a covenant default rather than a payment default, once payments are accelerated, the imputed promise is breached unless accelerated amounts are paid per the terms of the acceleration clause. 40. For securitization instruments, our criteria call for different treatment of payment accelerations that result from events of default or other early amortization events. In a tranched securitization, the acceleration alters the payment waterfall for senior creditors while payments continue. To the extent that a structured finance security is not credit tranched (e.g., a repackaged security), we follow the methodology used to rate the underlying securities. 41. For securitizations, the lack of immediate payment of principal in full following such an event would not be a breach of the ratable promise. In these cases, the criteria focus on the fact that the acceleration could result in a higher likelihood of full payment of obligated amounts in a shorter period of time relative to the original promise. Therefore, the ratable promise for principal remains principal due at original final maturity. 42. With regard to interest for securitizations with a tranched structure--when the purpose of the change in the transaction waterfall is to divert all cash flow to senior noteholders--the ratable promise after the credit stress event follows the sector-specific approach for addressing interest shortfalls and payment delays. 5. Puts and calls 43. When an instrument specifies the ability for investors to demand principal repayment before maturity (with a corresponding obligation of the issuer to honor it) or when an instrument allows the issuer to call the obligation at an earlier date, the specified promise to pay under these events (if it exists) should meet the conditions necessary to assign a rating. If it does not, then the instrument as a whole does not contain a ratable promise. 44. For an instrument with a call option, when the obligation requires full repayment of the outstanding par amount upon the exercise of the call, a payment of less than 100% of the related par amount results in the breach of the ratable promise. 45. However, the criteria would not consider a call at less than par a breach of the ratable promise in certain infrequent DECEMBER 19,

82 General Criteria: Principles For Rating Debt Issues Based On Imputed Promises circumstances. If, in the view of Standard & Poor's, the call option price is below par, but: a) is not credit-risk sensitive, b) is reflected in the price of the security, and c) there is a high level of transparency and a low likelihood that the call provisions could be misunderstood when the securities are sold, we would not necessarily consider exercise of the call as a breach of the ratable promise. For example, a zero-coupon note with an annual call provision at accreted value, where such accreted value provides for payment of the original invested amount plus a return in line with the original effective yield of the instrument, would not represent a breach of the imputed promise. On the other hand, an instrument with a call provision at present value of the instrument, based on then current market yields, would not be ratable. (See also "Methodology For Rating Structured Finance Securities With Call Provisions At Less Than Par," published May 14, 2009.) 46. For an instrument with a put option, the ratable promise is equivalent to the stated promise. An issuer's failure to honor the put would constitute a breach of the promise. However, when instruments contain provisions that allow investors to indicate their desire to put back an obligation, but do not obligate the issuer to honor the desire, an issuer's decision not to repay the amount does not represent a breach of the imputed (rated) promise. 6. Treatment of other qualifications 47. In general, an instrument's imputed promise incorporates most non-credit-related qualifications that are in the instrument's actual terms. Examples of what we consider non-credit-related qualifications include allowances for lower payments due to activated military reservists (Servicemembers Civil Relief Act provisions); lower payments due to lost interest from prepayments; qualifications that cap a promise to pay interest at the lower of an interest index (such as LIBOR) plus a spread or the weighted-average coupon (WAC) of the underlying assets; and allowances for lower payments due to negative amortization. Lower payments resulting solely from these factors, if the terms of the instrument permitted them, would not represent a breach of the imputed promise and would not cause the rating to fall to 'D'. 48. By contrast, lower payments resulting from credit-related qualifications that reflect credit deterioration would likely be a breach of the imputed promise. Examples include non-payments on certain U.S. public finance appropriation obligations because of a decision not to appropriate funds. 49. Where a securitization instrument's interest obligation is constrained by referencing the WAC of the underlying assets in the pool, a severe deterioration in the WAC resulting from credit events (such as loan modifications) would be a breach of the imputed promise. Subsequent sector-specific criteria for U.S. RMBS would determine how we define "severe deterioration in the WAC" (see "Request for Comment: Criteria Structured Finance Request for Comment: Methodology For Incorporating Loan Modifications And Extraordinary Expenses Into U.S. RMBS Ratings," published Dec. 3, 2014). D. The Effects Of Breaching A Ratable Promise 50. Generally, when an instrument breaches a ratable promise--whether based on an imputed promise or the instrument's terms--the rating on the instrument would be lowered to 'D'. However, there are two exceptions, one relating to grace periods and one relating to de-minimis shortfalls. DECEMBER 19,

83 General Criteria: Principles For Rating Debt Issues Based On Imputed Promises Grace periods 51. In accordance with our criteria "Methodology: Timeliness Of Payments: Grace Periods, Guarantees, And Use Of 'D' And 'SD' Ratings," the long-term rating on a past due security may not be lowered to 'D' if we expect full payment will be made within the earlier of the stated grace period or 30 calendar days after the due date. If there is no stated grace period, or a stated grace period of one to five business days, we impute a promise of timely payment to mean no later than five business days after the due date for payment. For short-term ratings, 'D' is used when payments on a financial obligation are not made on the date due even if the applicable grace period has not expired, unless Standard & Poor's believes that such payments will be made during such grace period. However, any stated grace period longer than five business days will be treated as five business days (see "Methodology: Timeliness Of Payments: Grace Periods, Guarantees, And Use Of 'D' And 'SD' Ratings," published Oct. 24, 2013). De-minimis shortfalls 52. De-minimis shortfalls of the amount due will not have a rating impact, regardless of whether we expect recovery of the shortfall amount, where such shortfalls do not exceed 1 basis point of original principal on a cumulative basis. APPENDIX Frequently Asked Questions Step-Ups And Step-Downs 53. What are the key implications of the imputed promises criteria for transactions with "step-up" or "step-down" coupons? For step-up coupons, the imputed promise usually includes the step-up rate (i.e., a failure to pay the step-up would be considered a default [see paragraph 28]). However, if the step-up differential is subordinated in priority of payment, we do not consider the differential to be part of the imputed promise unless (1) the initial coupon is de minimis, or (2) the failure to pay such step-up leads to an event of default (EOD). If either condition is met, the imputed promise would also incorporate the subordinated step-up differential, in which case the rating on the instrument would reflect our credit opinion of the subordinated step-up. Consider these examples: A corporate security has terms that require a step-up of 100 basis points (bps) in the interest rate in case of credit deterioration, for example if debt to EBITDA worsens significantly, to a certain defined level, from the ratio at origination. Such a step-up is part of the ratable promise--in other words, if the step-up is triggered and the issuer fails to pay the new rate (including the step-up) on time and in full, we would lower the note rating to 'D'. A collateralized mortgage-backed security (CMBS) transaction has terms that require a step-up of 100 bps on the interest rate payable on all classes in the event that the underlying loans are not refinanced by a specific date. The step-up differential is paid sequentially but is subordinated to both the base interest (i.e., "pre-step-up" amounts) and principal. If there is no event of default associated with a failure to pay such a step-up, we do not include the step-up in the ratable promise, i.e., the failure to pay the step-up would not result in a rating of 'D'. In such cases, we treat such a step-up as a "bonus" payment (as long as the pre-step-up rate is not de minimis) and accordingly is not part of the ratable promise. A residential mortgage-backed security (RMBS) has terms that require a "subordinated" step-up of 100 bps on all classes in case any "early amortization event" occurs. As in the first example, such a step-up is subordinated in that it would be paid (sequentially) only if there is sufficient cash flow in the waterfall after the pre-step-up rates are paid DECEMBER 19,

84 General Criteria: Principles For Rating Debt Issues Based On Imputed Promises to all classes. However, in this example, the failure to pay the stepped-up interest rate is an EOD. The presence of the EOD signals that such a step-up is not simply a "bonus" payment: It is a required payment to compensate investors for increased risk in the transaction. In this case, we would lower the instrument rating to 'D' if a trigger event occurs that results in the stepped-up interest rate and such additional interest is not paid on time and in full according to the terms of the notes. Therefore, our ratings on each class would reflect the likelihood that stepped-up interest payments are made. 54. For step-down coupons, if they are a result of credit deterioration, we usually consider the step-down equivalent to a default. However, if the step-down coupons are a result of credit improvement, they have no effect on the rating. Consider these examples: A corporate note has the provision that if debt to EBITDA improves to a certain level above the level at origination, the rate on the note will decline by 200 bps. Such a provision rewards the issuer for credit improvement via a lower interest rate. Therefore, payments made at the lower rate, in accordance with the terms, would have no effect on the rating (although a significant enough improvement in debt measures, among other factors, may result in an improved issuer credit rating). A bank note has the provision that if capital ratios deteriorate below a certain level, the rate on the note will decline by 200 bps. Such a provision is a type of step-down coupon as a result of credit deterioration: It provides relief to a distressed issuer. If the provision were triggered and payments were made at the lower rate, we would lower the rating on the note to 'D', despite the note terms. We consider such a step-down as akin to a distressed exchange, which, similarly, is a default under our criteria. 55. An issuer rated 'A' issues a principal-protected, equity-linked medium-term note (MTN) that pays a de-minimis stated coupon. But, the interest rate steps up to a rate that is not de minimis after a specific period of time. Is the promise to pay interest ratable? Yes, as long as the weighted-average yield of the credit-based and measurable component of the promise to pay interest is not de minimis (i.e., in most cases, higher than yield on sovereign securities with an equivalent tenor). For example, say the interest rate is.25 bps for year 1 (plus a variable return based on the S&P 500 Index) and steps up to a fixed rate of 5% for years 2 through 10. In this case, the rating on the instrument would be 'A' because the weighted average of the promised fixed rates is clearly not de minimis. On the other hand, the promise would not be ratable if the weighted-average yield of the credit-based and measurable component of the promise were de minimis. As another example, say the interest rate is.25 bps for years 1 through 9 (plus a variable return based on the S&P 500 Index) and steps up to a fixed rate of 5% for the final interest payment in year 10. In this case, the rating on the instrument would be 'Ap' (i.e., if, at the time we initially assigned the rating, we concluded that the weighted-average rate of interest was de minimis [see paragraph 29]). Convertible Debt 56. How do you treat convertible debt under the imputed promises criteria? Convertible debt is generally ratable. In the case of mandatory convertible securities, we rate them based on the credit-based and measurable promise that exists until the time of conversion, at which point we would withdraw the rating. In the case of convertibles that do not have mandatory conversion features, we can rate them if the investor holds the conversion option. The conversion feature by itself has no effect on the rating, although if such an instrument has deferral or subordination features, such features may affect our issue rating, as per the relevant sector criteria. If the conversion is at the issuer's option (as to whether the instrument converts to shares, and the timing of such conversion), and if the value of principal once converted into shares varies with the equity price, paragraph 11 would apply and the instrument would not be ratable, "if the payment amount of principal is linked to non-credit events, those securities would not qualify as having a sufficient credit-based element under these criteria." If the instrument converts to shares based on credit deterioration (i.e., such as a DECEMBER 19,

85 General Criteria: Principles For Rating Debt Issues Based On Imputed Promises deterioration in a bank capital ratio), the instrument would be ratable, but the rating would reflect our view of the likelihood of such an event (and the rating would be lowered to 'D' upon conversion), per related criteria for the sector. (The relevant sector criteria referenced in this FAQ includes "Bank Hybrid Capital And Nondeferrable Subordinated Debt Methodology And Assumptions," published Sept. 18, 2014, and "Hybrid Capital Handbook," published Sept. 15, 2008). Replacement Index 57. How do you consider a replacement index? For example, an 'A' rated issuer issues a five-year MTN that pays interest based on a spread to EURIBOR. However, if the index becomes unavailable, the MTN interest rate will be determined by the bank, in good faith, based on relevant market practice. Is the promise to pay interest measurable? Yes. The ratable promise would be based on the interest index (EURIBOR), regardless of any alternative interest rate determination method, because we generally expect EURIBOR to be available. However, if we believed that EURIBOR may not be available, we would assign a rating of 'Ap', or not rate the instrument, because the alternative method for determining interest is not measurable (see paragraph 14). Failure To Pay Interest (Effect On Ratings With 'p' Subscripts) 58. Let's take a principal-protected, equity-linked note rated 'Ap', where the 'p' subscript is added because the promise to pay interest varies with equity prices and, therefore, such promise does not contain enough credit-based content for us to rate it. Furthermore, the terms in the instrument clearly state that a failure to pay interest is an EOD. Would the rating on the instrument fall to 'D' if interest is not paid on time and in full? No. Because the rating does not address interest, a failure to pay interest would not, by itself, result in a 'D' rating on the instrument. However, if such a failure leads to the acceleration of principal repayment, and the principal is not paid in accordance with the requirements of the acceleration provision, we would lower the rating on the instrument to 'D' (see paragraph 39 in reference to acceleration provisions). 59. Let's take a principal-protected, commodity-linked, repackaged ("repack") security, where the 'p' subscript is added to the rating because the promise to pay interest varies with commodity prices and, therefore, such promise does not have enough credit-based content for us to rate it. Furthermore, the terms in the instrument clearly state that a failure to pay interest is an EOD that would automatically lead to a liquidation of all assets and a wind-up of the repack issuer. Consequently, if a failure to pay interest occurred and the liquidation proceeds were insufficient, the repack securities would default. Is the promise to pay principal ratable? Yes, if the credit source supporting payments of interest is rated; no, if the credit source supporting payments of interest is not rated. 60. The EOD and the automatic unwind provision link the ability to pay principal to the ability to pay interest. Accordingly, if a default on the promise to pay interest could also result in a default on the promise to pay principal, the promise to pay principal would be weak-linked to the lower of (1) the credit source supporting repayment of principal, or (2) the credit source supporting interest payments. For example, if the likelihood of receiving both principal and interest is 'AA+' because they are paid from the same credit source and have the same credit risk, the rating on the instrument would be 'AA+p'. However, if the likelihood of receiving principal is 'AA+' but the likelihood of receiving interest is 'A' (because the promise to pay interest reflects a different credit risk profile), the rating on the instrument would be 'Ap'. We would add the 'p' subscript to the instrument rating because the promise to pay interest is commodity-linked and does not have enough credit-based content for us to rate it otherwise (see paragraphs 16 and 17). DECEMBER 19,

86 General Criteria: Principles For Rating Debt Issues Based On Imputed Promises Bonus/Supplemental Payments; De-Minimis Interest 61. A corporation rated 'AA-' is about to issue a 10-year convertible bond (convertible at the option of the investor) that promises to pay an interest rate of 1.25% but no additional amounts. The yield on the government's ('AAA') 10-year bonds is 2.60%. Is the fact that the interest rate is below the government yield a factor under this criteria?no. Because the corporate bond did not promise any bonus/supplemental/additional amounts, the government bond yield is not relevant. The government bond yield would be relevant only when additional amounts are promised. In those cases, the criteria call for applying a de minimis test to the promised interest rate. The de minimis test considers factors including the sovereign government borrowing rate (see paragraphs 25, for when there is no bonus payment, and 29, for when there is a bonus payment). 62. A repack issuer issues a $10 million, principal-protected note that matures in 10 years. The note is priced at par and backed by a $10 million, zero-coupon, sovereign bond (issued by a sovereign rated 'AA+') that also matures in 10 years, and by the residual tranche of a prime RMBS transaction. The repack note has no stated coupon, but it does promise to pay "supplemental amounts" based on cash flows from the underlying RMBS tranche. Is the repack security is ratable? If so, would the rating have a 'p' subscript? Yes, the repack security is ratable, and would have a 'p' subscript added. Because the instrument does not promise any interest and the additional amounts are not credit-based (they come from a residual tranche), the assigned rating would be 'AA+p'. Residuals 63. Do you rate residuals, i.e., securities whose payout is variable and determined according to residual cash flows in a given transaction? No. Under the imputed promises criteria, such promises are not measurable, therefore the instrument would not be ratable. RELATED CRITERIA AND RESEARCH Related Criteria Request for Comment: Methodology For Incorporating Loan Modifications And Extraordinary Expenses Into U.S. RMBS Ratings, Dec. 3, 2014 Bank Hybrid Capital And Nondeferrable Subordinated Debt Methodology And Assumptions, Sept. 18, 2014 Rating Natural Peril Catastrophe Bonds: Methodology And Assumptions, Dec. 18, 2013 Use Of C And D Issue Credit Ratings For Hybrid Capital And Payment-in-Kind instruments, Oct. 24, 2013 Timeliness Of Payments: Grace Periods, Guarantees, And Use Of 'D' And 'SD' Ratings, Oct. 24, 2013 Methodology For Assessing The Impact Of Interest Shortfalls On U.S. RMBS, March 28, 2012 Global Methodology For Rating Interest-Only Securities, April 15, 2010 Methodology For Rating Structured Finance Securities With Call Provisions At Less Than Par, May 14, 2009 Rating Implications Of Exchange Offers And Similar Restructurings, Update, May 12, 2009 Hybrid Capital Handbook, Sept. 15, 2008 Rating U.S. CMBS In The Face Of Interest Shortfalls, Feb. 23, 2006 Related Research Standard & Poor s Ratings Definitions, Nov. 20, 2014 The authors wish to thank James Wiemken for his contributions to the previous version of these criteria. These criteria represent the specific application of fundamental principles that define credit risk and ratings opinions. Their use is determined by issuer- or issue-specific attributes as well as Standard & Poor's Ratings Services' assessment DECEMBER 19,

87 General Criteria: Principles For Rating Debt Issues Based On Imputed Promises of the credit and, if applicable, structural risks for a given issuer or issue rating. Methodology and assumptions may change from time to time as a result of market and economic conditions, issuer- or issue-specific factors, or new empirical evidence that would affect our credit judgment. DECEMBER 19,

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89 General Criteria: Methodology: Industry Risk Primary Credit Analysts: David N Bodek, New York (1) ; david.bodek@standardandpoors.com Michael F Scerbo, New York (1) ; michael.scerbo@standardandpoors.com Criteria Offcier: Mark Puccia, New York (1) ; mark.puccia@standardandpoors.com Olga I Kalinina, CFA, New York (1) ; olga.kalinina@standardandpoors.com Table Of Contents SCOPE OF THE CRITERIA SUMMARY OF THE CRITERIA IMPACT ON OUTSTANDING RATINGS EFFECTIVE DATE AND TRANSITION METHODOLOGY A. Cyclicality B. Competitive Risk And Growth RELATED CRITERIA AND RESEARCH APPENDIX I APPENDIX II APPENDIX III NOVEMBER 19,

90 General Criteria: Methodology: Industry Risk (Editor's Note: We originally published this criteria article on Nov. 19, We're republishing this article following our periodic review completed on Oct. 16, As a result of our review, we updated the author contact information. On March 28, 2014, we updated data in tables 5 and 6 concerning the unregulated power and gas sector.) 1. Standard & Poor's Ratings Services is updating its methodology for measuring and calibrating global industry risk. The criteria will help market participants better understand our revised approach to evaluating industry risk for nonfinancial corporate entities and U.S. public finance and international public finance enterprises. The criteria supersede the industry risk segments of: "2008 Corporate Criteria: Analytical Methodology," published April 15, 2008, "Public And Nonprofit Social Housing Providers: Methodology And Assumptions," published July 11, 2012, and "Bond Insurance Rating Methodology And Assumptions," published Aug. 25, The criteria constitute specific methodologies and assumptions under "Principles Of Credit Ratings," published Feb. 16, SCOPE OF THE CRITERIA 3. The criteria apply to global corporate ratings (see "Corporate Methodology," published Nov. 19, 2013). The corporate criteria framework incorporates an entity-level industry risk assessment as one of the three anchor assessments--together with the country risk assessment and a competitive position assessment--that we would use to derive the business risk profile assessment for the rated corporate entity. 4. We expect these criteria to apply to other sectors in the future upon publication of sector-specific criteria that describe the use of the industry risk assessment for that sector. SUMMARY OF THE CRITERIA 5. Our industry risk criteria enhance the comparability and transparency of ratings across sectors by comparing and scoring interindustry risk. The methodology addresses the major industry risk factors that entities face. 6. The criteria use two factors for calculating a global industry risk assessment: Cyclicality, and Competitive risk and growth. 7. Each of the two factors receives an assessment from 1 (very low risk) to 6 (very high risk). The combination of these assessments determines the global industry risk assessment, which uses the same 1 to 6 scale (see table 1). 8. We calibrate an industry's cyclicality assessment (see section A) using the hypothetical stress scenarios in "Understanding Standard & Poor's Rating Definitions," published June 3, 2009, which we use to enhance ratings comparability. NOVEMBER 19,

91 General Criteria: Methodology: Industry Risk 9. The analysis of a sector's overall competitive risk and growth environment (see section B) addresses on an industry-aggregate level the: Effectiveness of industry barriers to entry; Level and trend of industry profit margins; Risk of secular change and substitution of products, services, and technologies; and Risk in growth trends. 10. The risks within different subsectors of an industry are captured within the analysis of a firm's competitive position. IMPACT ON OUTSTANDING RATINGS 11. We do not expect these criteria, in and of themselves, to result in any rating changes. EFFECTIVE DATE AND TRANSITION 12. These criteria are immediately effective upon publication. METHODOLOGY 13. The industry risk criteria consider two factors in the calculation of a global industry risk assessment: Cyclicality, and Competitive risk and growth. 14. We assess each factor according to the following scale: very low risk (1), low risk (2), intermediate risk (3), moderately high risk (4), high risk (5), and very high risk (6). These assessments are based on a series of quantitative and qualitative considerations. Combined, they determine the global industry risk assessment (see table 1). 15. The criteria weight competitive risk and growth more heavily than cyclicality because competitive risk and growth is a prospective analysis, and the cyclicality assessment is based on historical data. Table 1 Determining A Global Industry Risk Assessment --Competitive risk and growth assessment-- Very low risk Low risk Intermediate risk Moderately high risk High risk Very high risk Cyclicality assessment Very low risk Low risk Intermediate risk Moderately high risk High risk Very high risk NOVEMBER 19,

92 General Criteria: Methodology: Industry Risk A. Cyclicality 16. Cyclicality is the first factor in the global industry risk assessment under the criteria and has two subfactors: cyclicality of industry revenue and cyclicality of industry profitability. 17. We generally consider the more cyclical an industry's level of profits, the more this factor will contribute to credit risk for the entities operating in that industry. However, the overall effect of cyclicality on an industry's risk profile may be mitigated or exacerbated by an industry's competitive risk and growth environment. 18. The criteria assign a heavier weighting to an industry's profitability cyclicality assessment than to its revenue cyclicality assessment to calculate the industry cyclical risk assessment. The reason for this is the importance of an entity maintaining adequate profitability to service its cash flow needs, including its working capital and debt service requirements. Although a company's level and volatility of cash flows are often a better measure of its credit strength than its profitability, we have used the cyclicality of an industry's level of profits in the criteria as a proxy for cash flows due to the lack of globally consistent and comparable data. Profitability measures also exclude distortions to industry cyclicality measurements that working capital movements (that are not reflective of credit risk) would have on cash flow measurements. 19. We calibrate the cyclicality assessments with stress scenarios to enhance ratings comparability across sectors and time. As part of our calibration, we calculated the peak-to-trough changes in U.S. sector revenues during the first leg of the Great Depression (from August 1929 to March 1933). In the second phase of the cyclicality calibration, we focused on analyzing industry revenue and EBITDA margin performance in recessions from 1950 to 2010 in the U.S. and from 1987 to 2010 in other major economies. The cyclicality assessments are calibrated against 'BBB' and 'BB' stresses/recessions during this time period (see Appendix IV of "Understanding Standard & Poor's Rating Definitions," published June 3, 2009). To calibrate the cyclicality component of these criteria, we performed a peak-to-trough analysis of industry revenues and profitability in these recessionary periods. 20. We consider cyclicality calibration as a key component of these criteria because of the importance of cyclicality in determining an industry's and entity's level of credit risk. Historical research demonstrates that industries vary significantly in their degree of revenue and profitability cyclicality (see Appendix I). Table 2 shows the methodology we use to determine the rank ordering of the degree of cyclicality between industries, and Appendix I provides a compendium of our rank ordering of industry revenue and profitability cyclicality. 21. The criteria divide the cyclical peak-to-trough declines in revenue and profitability into ranges and assign each an assessment, from 1 to 6. The categories are: very low risk (1), low risk (2), intermediate risk (3), moderately high risk (4), high risk (5), and very high risk (6). 22. The statistical technique we used to establish the buckets in table 2 is based on a k-means clustering methodology (see Appendix II for an explanation). NOVEMBER 19,

93 General Criteria: Methodology: Industry Risk Table 2 Determining An Industry's Cyclical Risk Assessment Industry revenues either increase or decline by up to 4% during a cyclical downturn Industry revenues decline between 4% and up to 8% during a cyclical downturn Industry revenues decline between 8% and up to 13% during a cyclical downturn Industry revenues decline between 13% and up to 20% during a cyclical downturn Industry revenues decline between 20% and up to 32% during a cyclical downturn Industry revenues decline by more than 32% during a cyclical downturn Profitability ratio either increases or declines by up to 3% during a cyclical downturn Profitability ratio declines between 3% and up to 7% during a cyclical downturn Profitability ratio declines between 7% and up to 12% during a cyclical downturn Profitability ratio declines between 12% and up to 24% during a cyclical downturn Profitability ratio declines between 24% and up to 72% during a cyclical downturn Profitability ratio declines more than 72% during a cyclical downturn Sectors with higher cyclicality of profitability include mineral-based, metals, and building products industries (see Appendix I). This is because demand for their products comes, to a great extent, from industries that produce discretionary consumer and capital goods, which also tend to demonstrate greater cyclicality than many other sectors. 24. Overbuilding of production capacity in an industry will create more competitive and earnings pressure, especially in NOVEMBER 19,

94 General Criteria: Methodology: Industry Risk the event of a cyclical downturn in demand. 25. Companies operating in cyclical industries need to be able to reduce their cost bases in a downturn as revenues decline. Therefore, industry risk is greater for cyclical industries with high fixed costs, such as the auto industry. B. Competitive Risk And Growth 26. The second factor under the criteria is competitive risk and growth. The criteria assess four subfactors as low, medium, or high risk (see table 3). These subfactors are: Effectiveness of barriers to entry; Level and trend of industry profit margins; Risk of secular change and substitution of products, services, and technologies; and Risk in growth trends. 27. The criteria then combine these subfactor assessments to produce a competitive risk and growth assessment, from 1 to 6 (see table 4). Table 3 Assessing The Competitive Risk And Growth Subfactors Subfactor Low risk Medium risk High risk a) Effectiveness of barriers to entry (see paragraph 28) b) Level and trend of industry profit margins (see paragraphs 29 and 30) c) Risk of secular change and substitution of products, services, and technologies (see paragraph 31) d) Risk in growth trends (see paragraph 32) Barriers to entry are high and are effective in limiting competitive entrants. Industry participants demonstrate stable or increasing operating profit margins. No discernible substitution risk from outside the industry. Established industry where sales are rising over the medium term at a rate equal to or faster than nominal GDP growth. Barriers to entry are limited but partially effective in excluding competitive entrants. Operating margins are under moderate competitive pressure. Limited likelihood of substitution risk from outside the industry. Established industry where sales are rising between 1% and the rate of nominal GDP growth over the medium term, given that nominal GDP growth is greater than 1%. Table 4 Determining The Industry Competitive Risk And Growth Assessment Competitive risk and growth assessments Combination of assessments from table 3 1. Very low risk All of the subfactors are low risk. 2. Low risk Three of the subfactors are low risk, and one subfactor is medium risk. Barriers to entry are either very low or nonexistent. Material prospective or actual pressure on operating margins. Alternatively, margins may be increasing unsustainably and creating the risk of a collapse in industry profitability. High risk of prospective or actual substitution from outside the industry. Established industry where sales are either rising by less than 1%, or are declining, over the medium term. This category also includes start-up industries, which may be high growth, with unproven growth records. 3. Intermediate risk (i) Three subfactors are medium risk and one is medium or low risk; (ii) Two subfactors are medium risk and two are low risk; or (iii) One subfactor is high risk, and the other three are any combination of low and/or medium risk.* 4. Moderately high risk Two of the subfactors are assessed as high risk, and the other two are medium or low risk. 5. High risk Three of the subfactors are high risk, and one is medium or low risk. NOVEMBER 19,

95 General Criteria: Methodology: Industry Risk Table 4 Determining The Industry Competitive Risk And Growth Assessment (cont.) 6. Very high risk All four of the subfactors are high risk. *If either barriers to entry or substitution risk is assessed as high risk, competitive risk and growth is assigned an assessment of '4' (moderately high risk). 1. Competitive risk and growth subfactors a) Effectiveness of barriers to entry 28. Industries that benefit from meaningful barriers to entry generally have materially lower competitive risk than those that have low or no barriers. Barriers to entry include: Government-related factors such as regulation, licensing, approvals, tariffs, taxation, and government industry ownership and controls. These elements may lower competition and stabilize EBITDA and cash flows. In some instances, governments may grant monopolies or oligopolies in industries such as regulated utilities, telecommunications, and airlines. Patents, research capabilities, and scientific and technological know-how. These can create substantial competitive advantage for a period of time for established entities, as well as barriers against would-be entrants, in industries such as pharmaceuticals, biotechnology, high technology, specialty chemicals, and aerospace. Capital intensity. Industries that require large capital outlays, especially those with a long-term return horizon, present a major obstacle for entities attempting to break in because their access to debt and equity financing is often weaker than that of industry incumbents. Industries where these characteristics are present include regulated utilities, steel, autos, and aerospace. Industry structure that creates cost advantages for incumbents. For example, transportation and distribution infrastructure and vertical integration of production can make it difficult for challengers to establish themselves profitably. Industries where these characteristics are present include forest products, integrated oil, and mining. Industry consolidation and concentration. This can lead to limited competition and greater size and efficiency for incumbents, including oligopolistic and monopolistic market positions in such sectors as steel, chemicals, branded consumer products, and patented/branded pharmaceuticals. Brand power, such as established profitable brands that make it difficult and costly for entrants to build competitive brands and gain customer recognition. Industries where strong brands can provide a real advantage include luxury and big box retail, autos, consumer technology, and consumer staples. b) Level and trend of industry profit margins 29. This subfactor evaluates the effect that an industry's competitive conditions, operating dynamics, and cost structure and volatility have on margins--as opposed to the economic cyclicality of profit margins. The criteria evaluate both the level and trends of an industry's margins. The methodology does not specifically measure and assess competitive and operating risk and cost elements affecting industry operating margins because these are already captured in the cost side of an industry's profit margin. 30. Some major industry competitive and operating cost considerations that we view as affecting industry operating margins include: Level of competition in an industry, including the basis for/nature of its competition Production input costs and related volatility (such as energy, raw material, and component prices) Asset and commodity price bubble-and-bust risk Labor costs and practices risk NOVEMBER 19,

96 General Criteria: Methodology: Industry Risk Customer and supplier concentrations and pricing power Asset quality costs, including property, plant, and equipment upkeep in capital-intensive industries Natural and manmade catastrophic event risk. Manmade catastrophes include nuclear, chemical plant, and oil drilling accidents, and associated costs. Technological change in an industry and related costs and risk dynamics Legal risks and costs Government regulation, taxation, and ownership policies c) Risk of secular changes and substitution of products, services, and technologies 31. This section of the criteria covers secular changes in an industry that can affect its internal competitive and risk profile. In addition, competition from other industries or from an innovative company within the industry providing alternative technologies or products can have a negative impact on industry revenues, margins, cash flows, and credit quality. This form of substitution or competition can, in extreme cases, shutter an entire industry. d) Risk in growth trends 32. A healthy growth outlook for a well-established industry can be a key positive factor in the industry's risk profile. Conversely, a long-term trend of, or prospects for, declining revenues is a major industry risk. Very rapid industry growth can also be a major generator of risk when an industry is young, growing from a low revenue base, or uses new technology or a business model with unproven long-term commercial viability. RELATED CRITERIA AND RESEARCH Corporate Methodology, Nov. 19, 2013 Public And Nonprofit Social Housing Providers: Methodology And Assumptions, July 11, 2012 Principles Of Credit Ratings, Feb. 16, 2011 Understanding Standard & Poor's Rating Definitions, June 3, 2009 APPENDIX I 33. We based our global peak-to-trough (PTT) change analysis for industry EBITDA margins and revenues on Compustat data for major recessions ('BBB' and 'BB' stress) mapped to specific industry sectors (see tables 5 and 6). The Compustat data cover the U.S. and other major economies, including Canada, the eurozone, the U.K., and Australia. The tables do not include data on China because its economy experienced no recessions for the period that Compustat data were available. Empty cells in the table represent recessionary periods before sector data were available. Compustat's non-u.s. industry data go back to 1987, versus its U.S. data, which go back to the 1950s, 1960s, or 1970s for many industries. Because of this, the only major recessionary period ('BBB' stress) we analyzed for industries outside the U.S. was the downturn. Computing industry revenues and profitability margins in a recession 34. In calculating an industry's sales, we determine the group of companies that report sales data for every year of a particular recession in each industry. We use this group of companies to compute the average sales (after applying a deflationary multiplier to account for inflation) for each year of that recession. NOVEMBER 19,

97 General Criteria: Methodology: Industry Risk 35. For the profitability margin, we use the ratio of EBITDA to sales margins for each year in the data set. To compute these profitability margins, we first selected the universe of companies in a given year and industry in which sales and EBITDA are reported. The profitability margin for that year equals the sum of all companies' EBITDA divided by the sum of all companies' sales. Calculating industry peak-to-trough declines 36. For purposes of calculating the industry PTT change in sales and profitability, we begin by taking the relevant data for the year before recession. For most industries, we calculate the PTT decline from the year before the recession to the year the recession ends. However, some industries will lag the economic cycle. For these industries, we include any decreases in sales and profitability in the year after the end of the economic downturn in the PTT calculation. 37. We measure an industry's PTT sales and profitability declines by determining the average percentage decline for each 'BBB' and 'BB' stress recession since 1950 on which Compustat has data. For a given recession, we determine the maximum percentage decline in sales and profitability margin throughout the period but set this PTT decline to 0% if the profitability margin strictly increases throughout the period. Table 5 EBITDA Margin PTT Declines (%) --PTT decline by recession-- Industry Transportation cyclical Average PTT decline (59.1) (42.3) (93.4) (41.7) Auto OEM (38.0) (18.1) (22.8) (4.6) (34.1) (49.5) (79.5) (39.9) (27.9) (65.4) Metals and mining downstream Metals and mining upstream Homebuilders and developers Oil and gas refining and marketing Forest and paper products (30.8) 0.0 (7.0) (13.2) (25.2) (24.0) (56.3) (52.4) (27.3) (71.4) (30.0) (9.9) (29.9) (7.0) (16.1) (8.6) (64.3) (40.3) (37.7) (55.8) (26.0) 0.0 (2.4) (52.9) (34.8) (36.6) 0.0 (55.4) (22.1) (5.9) (15.9) (2.8) (30.3) (25.7) (36.8) (20.3) (11.3) (50.0) (19.6) (3.8) (9.5) (20.0) (23.8) (13.4) (41.5) (33.8) (18.1) (12.4) Building materials (16.1) 0.0 (15.7) (18.4) (18.6) (7.0) (32.1) (30.6) (7.3) (15.5) Oil and gas integrated, exploration and production Agribusiness and commodity foods (15.5) (6.2) (17.4) (2.9) (4.4) (19.0) (27.5) (22.2) (12.2) (27.4) (15.3) (4.5) (7.6) (4.2) (12.5) (1.0) (25.4) (31.4) 0.0 (50.9) Leisure and sports (14.9) (16.2) (9.8) (28.7) (30.4) (15.7) (14.1) (8.4) 0.0 (10.6) Commodity chemicals (14.8) (7.2) (9.9) (10.2) (15.8) (7.5) (16.4) (27.5) (27.4) (11.0) Auto suppliers (13.5) (6.5) (6.2) (12.5) (17.9) (20.2) (11.9) (10.0) (18.8) (17.5) Aerospace and defense (12.9) (7.2) (16.4) (25.6) (11.7) (12.1) (13.1) (6.3) (9.6) (13.9) NOVEMBER 19,

98 General Criteria: Methodology: Industry Risk Table 5 EBITDA Margin PTT Declines (%) (cont.) Technology hardware and semiconductors (12.8) (8.0) (2.4) (3.3) (12.0) (4.9) (7.7) (18.7) (42.3) (16.3) Specialty chemicals (11.5) 0.0 (9.3) (12.6) (11.1) (21.2) (19.0) 0.0 (14.0) (15.9) Capital goods (11.1) (13.1) 0.0 (17.7) (8.4) (3.1) (20.3) (5.5) (10.3) (21.8) Engineering and construction Real estate investment trusts (REITs) Railroads and package express Business and consumer services (10.9) (12.0) (7.5) (10.6) (29.8) (12.5) (6.5) 0.0 (16.6) (2.5) (10.8) (15.4) (33.3) (2.9) (9.1) (3.9) 0.0 (10.6) (8.6) (8.3) (14.8) (10.2) (50.0) (9.2) 0.0 (6.6) (9.6) (10.7) (1.9) 0.0 (4.0) Midstream energy (10.0) 0.0 (4.8) (12.0) (12.2) (13.2) (19.2) (9.5) (8.8) Technology software and services (9.4) (13.3) 0.0 (4.4) (28.8) (24.6) (3.1) (10.5) Consumer durables (9.9) (1.0) (7.9) (10.7) (12.1) (18.4) (7.3) (2.3) (11.6) (18.1) Containers and packaging Media and entertainment Oil and gas drilling, equipment and services Retail and restaurants (8.8) 0.0 (0.8) (8.9) (15.9) (6.3) (24.2) (10.6) (6.3) (6.5) (8.1) (17.4) (19.4) (7.2) (8.0) (6.3) (7.5) (6.9) (7.7) 0.0 (5.8) (8.5) (21.6) (0.4) (4.6) (5.6) (13.5) (9.0) (7.1) (1.9) (6.2) (9.5) (9.0) (13.1) (7.1) (9.9) (1.1) (5.6) Health care services (6.2) (5.7) (16.6) (1.6) (6.8) (2.5) (3.8) Transportation infrastructure Environmental services (6.1) (6.1) (6.0) (4.9) (10.9) (6.7) 0.0 (8.4) (1.3) (9.9) Regulated utilities (5.3) (5.3) (11.2) (16.6) (8.4) (1.9) 0.0 (4.3) Unregulated power and gas N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A Pharmaceuticals (4.0) 0.0 (5.4) (3.1) (9.0) (7.4) (3.7) (1.7) (3.5) (1.8) Transportation leasing Telecommunications and cable Health care equipment Branded nondurables (3.7) (8.2) (7.6) (3.9) (4.7) (3.8) 0.0 (5.2) (3.3) (5.3) (2.6) (0.4) (5.1) (3.3) (8.5) (11.1) (3.4) (4.5) (1.8) (3.2) (2.6) (4.6) (9.8) (0.3) (3.6) (2.2) (5.4) Note: Empty cells in the table refer to recessionary periods before sector data were available. N/A--Not applicable, historical data is not representative. NOVEMBER 19,

99 General Criteria: Methodology: Industry Risk Table 6 Revenue PTT Declines (%) --PTT decline by recession-- Industry Homebuilders and developers Metals and mining downstream Average PTT decline (20.1) 0.0 (31.1) (26.4) (18.8) 0.0 (44.5) (17.4) (16.1) (21.1) (8.1) (6.1) (16.0) (24.2) (24.2) (6.5) (34.3) Auto OEM (16.5) (10.3) (24.0) (5.8) (16.9) (15.7) (30.0) (8.2) (6.9) (30.7) Midstream energy (15.3) (0.4) (3.4) 0.0 (2.6) (12.1) (59.3) (29.2) Metals and mining upstream Oil and gas refining and marketing Transportation cyclical (12.6) (1.4) (27.4) (1.3) (8.2) (7.3) (25.9) (15.5) (5.7) (20.6) (11.7) (15.2) (18.0) (2.4) 0.0 (2.1) (11.5) (15.4) (9.5) (31.4) (10.7) (0.2) (14.7) (17.3) Auto suppliers (9.5) (10.4) (8.1) (6.7) (5.4) (6.1) (20.3) (5.2) (4.9) (18.9) Building materials (8.0) (1.8) (6.3) (2.2) 0.0 (8.4) (23.6) (11.5) (1.5) (16.9) Oil and gas integrated, exploration and production Oil and gas drilling, equipment and services (7.9) (0.2) (7.3) (0.7) (12.0) (14.2) (3.9) (33.2) (7.7) (1.0) (17.7) (9.7) (10.2) (9.4) (21.5) Capital goods (7.7) (7.0) (9.1) (0.2) 0.0 (1.4) (14.7) (10.0) (5.3) (21.8) Transportation leasing Real estate investment trusts (REITs) Commodity chemicals Railroads and package express (7.7) (17.5) (23.5) (0.9) (5.0) (3.0) (6.3) (12.6) (7.4) 0.0 (11.7) (8.8) (11.5) 0.0 (12.1) (7.3) (1.6) (6.8) 0.0 (4.8) (2.1) (2.4) (13.1) (12.1) (22.9) (6.6) (2.5) (3.7) (13.5) Regulated utilities (6.1) (6.1) (42.6) (6.2) Unregulated power and gas Technology software and services Forest and paper products N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A (5.9) (17.8) 0.0 (2.3) (11.9) (9.0) (11.8) (5.6) (2.6) (8.8) (16.1) (9.3) (2.5) (11.4) Consumer durables (7.4) (8.1) (5.6) 0.0 (3.7) (7.8) (15.3) (2.0) (5.9) (18.5) Engineering and construction Business and consumer services Aerospace and defense (4.8) (12.6) (4.7) (4.5) (8.1) (0.6) (12.3) (4.4) 0.0 (23.0) (2.6) (3.0) 0.0 (2.1) (9.3) (4.4) (4.1) (4.5) 0.0 (15.3) (0.4) (2.9) (8.2) 0.0 (4.0) NOVEMBER 19,

100 General Criteria: Methodology: Industry Risk Table 6 Revenue PTT Declines (%) (cont.) Technology hardware and semiconductors (4.4) (1.0) (1.5) (19.4) (17.6) Specialty chemicals (3.8) (4.2) (9.7) (2.0) (0.3) (18.3) Agribusiness and commodity foods Containers and packaging Telecommunications and cable Environmental services (3.7) (10.8) (5.1) (6.9) (3.3) (6.7) (3.5) (0.4) (1.2) (1.9) 0.0 (1.7) (20.2) 0.0 (1.1) (5.0) (3.0) (0.9) (0.6) (5.6) (5.0) (2.3) 0.0 (1.5) (0.9) 0.0 (6.9) (4.5) Leisure and sports (1.6) (3.1) 0.0 (2.8) (0.8) (7.3) Branded nondurables Health care equipment Media and entertainment Retail and restaurants Transportation infrastructure (1.1) (1.4) 0.0 (4.4) (3.8) (0.8) (5.3) (1.5) (0.6) 0.0 (0.4) 0.0 (1.8) (3.3) (0.6) (0.5) (1.4) (3.4) (0.4) (0.4) Pharmaceuticals (0.2) (1.2) (0.4) Health care services Note: Empty cells in the table refer to recessionary periods before sector data were available. N/A--Not applicable, historical data is not representative. APPENDIX II Technique used to establish the cyclical scoring ranges in table To establish the cyclical scoring ranges in table 2, we used a statistical technique known as k-means clustering. This is a method of cluster analysis that partitions data observations into k clusters (referred to as groups or buckets), maximizing the distance between cluster means, and by which each observation belongs to the cluster with the nearest mean. In this case, k, the number of scoring groups, is six. 39. The criteria use the k-means clustering technique for both the historical sector revenue and EBITDA margin PTT data. However, because the EBITDA margin PTT assessments were positively skewed, a log transform methodology was first applied to control the influence of more extreme PTT assessments on the resulting ranges. A log transform was not applied to the revenue PTT data, which were much less skewed. APPENDIX III 40. The public finance sectors and their associated industry corollaries are: Not-for-profit health systems, not-for-profit hospitals, and not-for-profit mental health: Health care services industry NOVEMBER 19,

101 General Criteria: Methodology: Industry Risk Airports, transit systems, toll roads, parking, and ports: Transportation infrastructure industry State housing finance agencies and public authorities, and senior living: REIT industry Solid waste: Environmental services industry Public power utilities, electric cooperative utilities, and water and sewer utilities: Regulated utilities industry 41. These criteria represent the specific application of fundamental principles that define credit risk and ratings opinions. Their use is determined by issuer- or issue-specific attributes as well as Standard & Poor's Ratings Services' assessment of the credit and, if applicable, structural risks for a given issuer or issue rating. Methodology and assumptions may change from time to time as a result of market and economic conditions, issuer- or issue-specific factors, or new empirical evidence that would affect our credit judgment. NOVEMBER 19,

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103 General Criteria: Methodology And Assumptions For Rating Jointly Supported Financial Obligations Primary Credit Analysts: Ekaterina Z Curry, New York (1) ; ekaterina.curry@spglobal.com Mikiyon W Alexander, New York (1) ; mikiyon.alexander@spglobal.com Lead Analytical Manager: Philip A Galgano, New York (1) ; philip.galgano@spglobal.com Criteria Officer, U.S. Public Finance: Liz E Sweeney, Annapolis (1) ; liz.sweeney@spglobal.com Senior Criteria Officer, Structured Finance: Joseph F Sheridan, New York (1) ; joseph.sheridan@spglobal.com Chief Credit Officer, Structured Finance: Felix E Herrera, CFA, New York (1) ; felix.herrera@spglobal.com Senior Criteria Officer: Herve-Pierre P Flammier, Paris (33) ; herve-pierre.flammier@spglobal.com Chief Credit Officer, Global: John A Scowcroft, New York (212) ; john.scowcroft@spglobal.com Table Of Contents SCOPE OF THE CRITERIA SUMMARY OF THE CRITERIA EFFECTIVE DATE IMPACT ON OUTSTANDING RATINGS METHODOLOGY MAY 23,

104 Table Of Contents (cont.) A. The Amount Of Potential Rating Uplift B. Determining The Applicable Correlation Level C. Variable-Rate Demand Obligations (VRDOs) D. Short-Term Ratings E. Rating Above The Sovereign APPENDICES Appendix 1: Examples of the Possible Impact of Sovereign-Related Rating Constraints On Ratings Assigned To Jointly Supported Financial Obligations Appendix 2: General Rules Used To Construct The Tables RELATED CRITERIA AND RESEARCH MAY 23,

105 General Criteria: Methodology And Assumptions For Rating Jointly Supported Financial Obligations 1. S&P Global Ratings is publishing its methodology and assumptions for rating jointly supported financial obligations. Under these criteria, we may rate an obligation jointly supported by two or more supporting parties at a rating higher than that of either party, if in our view they are not too highly correlated. The criteria publication follows our request for comment "Request for Comment: Methodology And Assumptions For Rating Jointly Supported Financial Obligations," published Aug. 26, These criteria fully supersede: "Joint-Support Criteria Update," published April 22, 2009, "Municipal Applications For Joint-Support Criteria," published June 25, 2007, and "Criteria Update: Joint-Support Criteria Refined," published Feb. 3, These criteria are related to our criteria articles "Principles of Credit Ratings," published Feb. 16, 2011, "Methodology: Credit Stability Criteria," published May 3, 2010, and "Understanding Standard & Poor's Rating Definitions," published June 3, SCOPE OF THE CRITERIA 3. The methodology applies to all financial obligations where two or more supporting parties are contractually committed to irrevocably provide full and timely payments on the obligation, and each party has a public long-term rating. For short-term ratings (e.g., liquidity support providers are considered supporting parties under the criteria only if the liquidity facility was irrevocable), the methodology applies to the obligation with a short-term rating. One of the two supporting parties (sources of full and timely payments) may also be an issuance (e.g., asset-backed security) with a public rating that has the same contractual payment terms as the jointly supported obligation. Common examples of joint support include a primary obligor and a guarantor or a primary obligor and a letter of credit (LOC) provider. 4. Very highly correlated entities--such as affiliated companies--are excluded from receiving any joint-support benefit. Obligations insured by monoline bond insurers, which often provide guarantees such as credit wraps, are ineligible for joint-support credit enhancement, reflecting the significant correlation between the insurer and its portfolio of insured obligations. In addition, the following are ineligible for the joint-support approach: U.S. public finance "double-barreled" bonds (e.g., a general obligation pledge and revenue from water and sewer charges), those that are backed by economically co-dependent payment (e.g. state credit enhancement programs) sources, and obligations of government-owned or related enterprises when the joint obligors are the issuer and its government owner/supporter. 5. We typically will not apply the joint-support methodology to obligations supported by a confirming LOC from a Federal Home Loan Bank (FHLB) and a fronting LOC from an FHLB member bank, given their very high level of correlation. The level of correlation between an FHLB and a member bank, in our view, is generally too high. 6. To enhance the transparency of our public ratings, we will apply the joint-support approach only when both obligors have a public long-term rating and, if relevant, short-term rating. MAY 23,

106 General Criteria: Methodology And Assumptions For Rating Jointly Supported Financial Obligations SUMMARY OF THE CRITERIA 7. Under the criteria, a jointly supported obligation rating is based on: The ratings on the two sources of the obligation's full and timely payment; The degree of credit risk correlation between the ratings on the two sources of repayment; and The impact of sovereign-related risk on the jointly supported obligation. 8. The amount of potential rating uplift above the higher-rated source of repayment is based on the rating on each of the two sources of repayment (supporting parties), the proximity of the rating on the lower-rated supporting party to that of the higher-rated supporting party, and whether we consider the level of credit risk correlation between the two supporting parties to be high, medium, or low. If, in our view, the supporting parties are both in the same region and in the same industry, then we will assign a correlation assessment of "high," if we believe that they are in the same region or same industries (but not both), then correlation would be "medium," and if we believe that the supporting parties are not in the same region and not in same industries, then correlation would be "low." The maximum potential joint-support rating outcomes for obligations with rated support parties that we view as having low, medium, and high correlation are summarized in tables 1, 2, and 3, respectively. The potential uplift above the higher-rated supporting party is zero to three notches where the correlation is considered low, zero to two notches where the correlation is considered medium, and zero to one notch where the correlation is considered high. 9. The rating on a jointly supported obligation may be constrained by sovereign related risk. If both applicable supporting parties are domiciled in the same country, the rating assigned to the jointly supported obligation may be capped based on the sensitivity of each supporting party to country risk. When the joint-supporting parties are not domiciled in the same country, sovereign-related risk will not be a constraining factor beyond that already factored into the individual ratings of each supporting party, unless we believe that the two countries are more economically co-dependent than the correlation framework suggests. 10. As noted in paragraph 4, S&P Global Ratings will exclude very highly correlated entities--such as affiliated companies--from any joint-support benefit. EFFECTIVE DATE 11. The criteria are effective immediately, except in markets that require prior notification to, and/or registration by, the local regulator. In these markets, the criteria will become effective when notified by S&P Global Ratings and/or registered by the regulator. We intend to complete our review of potentially affected ratings within six months of the effective date. IMPACT ON OUTSTANDING RATINGS 12. We currently rate about 2,000 jointly supported obligations. Upon application of the criteria, we expect approximately 80% of jointly supported obligations would be downgraded by one to three notches. The majority of the expected MAY 23,

107 General Criteria: Methodology And Assumptions For Rating Jointly Supported Financial Obligations downgrades would be confined to one notch and approximately one-third of the ratings are expected to be lowered by two to three notches. METHODOLOGY 13. We define a jointly supported obligation as a financial obligation that is fully supported by two or more parties. In such cases, a default on the obligation would occur only if both the primary supporting party (i.e., the first source of payments) and the backup supporting party default. The rating on such obligations may be above the higher-rated party if we believe that all of the following conditions have been met. Both supporting parties are contractually committed to irrevocably provide for full and timely payments on the jointly supported obligation, and legal risk, timing risk and liquidity risk (as explained in the next three bullets below) have each been sufficiently mitigated: Legal risk: Assuming one of the supporting parties is the subject of insolvency proceedings, the risk that its payments will be clawed back, Timing risk: Assuming one of the supporting parties defaults on a payment, the risk that there would not be sufficient time for the other supporting party to make timely payments, and Liquidity risk: Assuming a support provider defaults or becomes insolvent, the risk that the obligation would be accelerated or redeemed early and, if possible, the risk that the other supporting party would be incapable of honoring the obligation's potential unscheduled repayment; The rating differential between the supporting parties is not beyond the thresholds outlined herein (see The Amount Of Potential Rating Uplift section below); and The parties are not assessed as very highly correlated (see paragraph 4). 14. A rating on the jointly supported obligation that is above the rating on the higher-rated party reflects our view that the obligation's default risk is lower than the risk of either of the supporting parties defaulting. 15. Where a financial obligation is fully supported by three or more parties (such as the issuer, a fronting LOC provider, and a confirming LOC provider), the rating on the obligation is based on the application of these criteria to the two parties that would result in the highest rating outcome. A. The Amount Of Potential Rating Uplift 16. Under the criteria, we consider that the lower the correlation among the supporting parties and the closer their assigned ratings, the more likely it is that at least one of the parties and, therefore, the jointly supported obligation, will be able to withstand an economic stress that is more onerous than indicated by our rating on the higher-rated party. In addition, the criteria reflects our view that ratings 'BB+' or below are more volatile than higher ratings and that ratings volatility diminishes the benefit of lower correlation. 17. The amount of potential rating uplift above the higher-rated source of repayment is based on the rating on each of the two supporting parties, the proximity of the rating on the lower-rated supporting party to that of the higher-rated supporting party, and whether we consider the level of credit risk correlation between the two supporting parties to be high, medium, or low. Tables 1, 2, and 3 show the potential rating outcomes under the criteria (see Appendix 2 for the MAY 23,

108 General Criteria: Methodology And Assumptions For Rating Jointly Supported Financial Obligations general rules that were used in constructing the tables). Table 1 Maximum Potential Joint-Support Rating Outcomes--Low Correlation Rating outcomes AAA AA+ AA AA- A+ A A- BBB+ BBB BBB- BB+ BB BB- B+ B B- AAA AA+ AA AA- A+ A A- BBB+ BBB BBB- BB+ BB BB- B+ B B- AAA AAA AAA AAA AAA AAA AAA AAA AAA AAA AAA AAA AAA AAA AAA AAA AAA AAA AAA AAA AA+ AA+ AA+ AA+ AA+ AA+ AA+ AA+ AA+ AA+ AA+ AA+ AAA AAA AAA AAA AA+ AA+ AA AA AA AA AA AA AA AA AA AA AAA AAA AAA AAA AA+ AA+ AA AA- AA- AA- AA- AA- AA- AA- AA- AA- AAA AA+ AA+ AA+ AA+ AA+ AA AA- A+ A+ A+ A+ A+ A+ A+ A+ AAA AA+ AA+ AA+ AA+ AA AA AA- A+ A A A A A A A AAA AA+ AA AA AA AA AA- AA- A+ A A- A- A- A- A- A- AAA AA+ AA AA- AA- AA- AA- A+ A A- BBB+ BBB+ BBB+ BBB+ BBB+ BBB+ AAA AA+ AA AA- A+ A+ A+ A A- BBB+ BBB BBB BBB BBB BBB BBB AAA AA+ AA AA- A+ A A A- BBB+ BBB BBB- BBB- BBB- BBB- BBB- BBB- AAA AA+ AA AA- A+ A A- BBB+ BBB BBB- BB+ BB+ BB+ BB+ BB+ BB+ AAA AA+ AA AA- A+ A A- BBB+ BBB BBB- BB+ BB+ BB+ BB BB BB AAA AA+ AA AA- A+ A A- BBB+ BBB BBB- BB+ BB+ BB+ BB BB- BB- AAA AA+ AA AA- A+ A A- BBB+ BBB BBB- BB+ BB BB BB BB- B+ AAA AA+ AA AA- A+ A A- BBB+ BBB BBB- BB+ BB BB- BB- BB- B+ AAA AA+ AA AA- A+ A A- BBB+ BBB BBB- BB+ BB BB- B+ B+ B Note: If one or both parties is rated 'CCC+' or below, the joint support rating is the same as the rating on the higher-rated party, as described in paragraph MAY 23,

109 General Criteria: Methodology And Assumptions For Rating Jointly Supported Financial Obligations Table 2 Maximum Potential Joint-Support Rating Outcomes--Medium Correlation Rating outcomes AAA AA+ AA AA- A+ A A- BBB+ BBB BBB- AAA AAA AAA AAA AAA AAA AAA AAA AAA AAA AAA AAA AAA AA+ AA+ AA+ AA+ AA+ AA+ AA+ AAA AAA AAA AA+ AA+ AA AA AA AA AA AAA AA+ AA+ AA+ AA+ AA AA- AA- AA- AA- AAA AA+ AA+ AA+ AA AA AA- A+ A+ A+ AAA AA+ AA AA AA AA- AA- A+ A A AAA AA+ AA AA- AA- AA- A+ A+ A A- AAA AA+ AA AA- A+ A+ A+ A A A- AAA AA+ AA AA- A+ A A A A- BBB+ AAA AA+ AA AA- A+ A A- A- BBB+ BBB AAA AA+ AA AA- A+ A A- BBB+ BBB BBB- Note: If one or both parties are rated 'BB+' or below, the joint-support rating is the same as the rating on the higher-rated party, as described in paragraph 18. Table 3 Maximum Potential Joint-Support Rating Outcomes--High Correlation Rating outcomes AAA AA+ AA AA- A+ A A- BBB+ BBB BBB- AAA AAA AAA AAA AAA AAA AAA AAA AAA AAA AAA AA+ AA+ AA+ AA+ AA+ AA+ AA+ AA+ AA+ AAA AA+ AA+ AA+ AA AA AA AA AA AA AAA AA+ AA+ AA AA AA- AA- AA- AA- AA- AAA AA+ AA AA AA- AA- A+ A+ A+ A+ AAA AA+ AA AA- AA- A+ A+ A A A AAA AA+ AA AA- A+ A+ A A A- A- AAA AA+ AA AA- A+ A A A- A- BBB+ AAA AA+ AA AA- A+ A A- A- BBB+ BBB+ AAA AA+ AA AA- A+ A A- BBB+ BBB+ BBB AAA AA+ AA AA- A+ A A- BBB+ BBB BBB- Note: If one or both parties are rated 'BB+' or below, then the joint-support rating is the same as the rating on the higher-rated party, as described in paragraph A minimum rating on the lower-rated party is necessary for the obligation to achieve any joint-support rating uplift. The minimum rating on the lower-rated party reflects our credit stability criteria by more fully recognizing that if the lower-rated party were to default, the rating on the obligation would be lowered to that of the non-defaulting party. The joint-support rating will be the same as the rating on the higher-rated party if: MAY 23,

110 General Criteria: Methodology And Assumptions For Rating Jointly Supported Financial Obligations One or both of the supporting parties is rated in the 'CCC' category or below and table 1 (low correlation) applies; or One or both of the supporting parties is rated in the 'BB' category or below and table 2 or 3 (medium or high correlation) applies. 19. Where we believe correlation among the supporting parties is low, the rating on the jointly supported obligation would be the same as the rating on the higher-rated party unless the ratings on the parties were within three notches. The ratings on the supporting parties would have to be closer for obligations in which we believe correlation is moderate or high. B. Determining The Applicable Correlation Level 20. The level of correlation is generally based on whether we consider the supporting parties are in the same region and same industry. If the supporting parties are both in the same region and in the same industry, then we will assign a correlation assessment of "high," if they are in the same region or same industries (but not both), then correlation would be "medium," and, if the supporting parties are not in the same region and not in same industries, then correlation would be "low." For transactions where the supporting parties are based in different countries, we would usually consider each country as a separate region, except if we view the two countries as "highly correlated," in which case the two countries would be considered one region (see paragraph 22 below). However, for transactions where both supporting parties are based in the U.S., a region would generally be defined as a state, except: Where both supporting parties are financial institutions, we would deem them to be in the same region. If a large, U.S.-domiciled financial institution with a globally diverse business profile is a supporting party and the other U.S.-domiciled supporting party is not a financial institution, the financial institution will not be treated as being in any particular state (e.g., a major bank with its home office in New York City would not be considered in the same region as a New York state municipality). This contrasts with how the criteria treat smaller financial institutions with significant geographic concentrations/exposures in one to three states; in those cases, we would consider the financial institution to be in the same region as supporting parties from any of those states. We may consider two supporting parties to be in the same region if they have significant overlap in their state concentrations. For example, a U.S. public finance entity (e.g., a non-profit regional hospital network) that operates primarily in one or more states would be considered to be in the same region as a U.S.-based corporation with a regional business profile concentrated in one or more of the same states. 21. Where a supporting party is a subsidiary or branch of a multinational entity, to select the appropriate correlation table the region will be the country of the parent, if the supporting party's rating is based primarily on the parent's creditworthiness. Otherwise, the country where the branch (or subsidiaries) is domiciled will be the region applied. In either case, the supporting party's country of domicile will determine a ratings cap based on sovereign related risk (see paragraphs 28 and 29). 22. We may consider two countries highly correlated, and therefore in the same region, based on analytical judgement. For example, we make such a determination if we conclude that credit conditions in a given country are highly affected by event risk in a second country. 23. To determine whether two corporate or financial services support providers are in the same industry we use the "Corporate Industry Concentration Categories" (table 9) from "Methodology And Assumptions For Market Value MAY 23,

111 General Criteria: Methodology And Assumptions For Rating Jointly Supported Financial Obligations Securities," published Sept. 17, Under these criteria, all public finance entities are considered to be in the same industry. Similarly, structured finance securities will generally be deemed to be in the same industry and different from the industry of all other obligors that are not special purpose vehicles, except as described in paragraph Our correlation assessment may be higher, thereby resulting in lower joint-support rating outcomes, after applying our analytical judgement that the parties are more economically co-dependent than the correlation framework suggests (see paragraphs 16-23), for example multi-state health care systems or transportation authorities. Furthermore, our opinion of correlation regarding a specific jointly supported obligation could change, if, for example, we believe that a supporting party's profile has fundamentally changed. If one of the supporting parties is a structured finance issue, we would consider the structured finance issue's correlation with the industry of the other supporting party, and may consider the two supporting parties to be in the same industry when applying these criteria. For example, a covered bond issued by a bank is considered to be in the same industry as a supporting party that is another bank. Similarly, an auto dealer floorplan asset-backed security is considered to be in the same industry as an auto manufacturer. Further, if one of the supporting parties is a structured finance issue, we would consider whether its relationship with the other support provider would preclude any uplift above the higher rated supporting party. For example, if the other supporting party's rating is also a weak-link in the analysis of the structured finance issue, the two supporting parties would be considered very highly correlated. C. Variable-Rate Demand Obligations (VRDOs) 25. A VRDO is a variable-rate bond with an embedded put option, which gives investors the right to demand full principal repayment before maturity, together with accrued interest, if the investor gives the required notice--typically one week-- to the designated administrator. VRDOs carry dual ratings (e.g., 'A/A-1'), since the put option typically creates a potential short-term obligation. 26. For jointly supported VRDOs, only the long-term rating can be rated above the higher-rated supporting party unless both supporting parties have short-term ratings and are contractually committed to irrevocably provide for full and timely payments when the put option is exercised. D. Short-Term Ratings 27. Where both supporting parties have public long-and short-term ratings and are contractually committed to irrevocably provide for a short-term obligation's full and timely payments, such obligation's short-term rating derived from these supporting parties under these criteria is assigned first by determining the jointly supported long-term rating and then by looking up the corresponding short-term rating in the "Strong or adequate liquidity" column in table 1 of "Methodology For Linking Short-Term And Long-Term Ratings For Corporate, Insurance, And Sovereign Issuers," published May 7, 2013, for purposes of these criteria, even for public finance entities. This will only apply if the short-term rating assigned to the obligation would be no lower than the short-term rating on the supporting party with the highest public short-term rating. MAY 23,

112 General Criteria: Methodology And Assumptions For Rating Jointly Supported Financial Obligations E. Rating Above The Sovereign 28. Sovereign-related risk may also constrain the maximum potential rating assigned to the jointly supported obligation. If both applicable supporting parties are domiciled in the same country, we will apply the maximum differential above the sovereign foreign currency rating per our rating above the sovereign (RAS) criteria. If both supporting parties are in sectors that have moderate sensitivity to country risk, we will apply the maximum rating differential in table 2 in the RAS criteria applicable to an issue with moderate country risk sensitivity (usually a four-notch cap above the sovereign). In all other cases where both supporting parties are in the same country, we will apply the maximum rating differential in table 2 in the RAS criteria applicable to an issue with high sensitivity to country risk (usually a two-notch cap above the sovereign), provided that the cap will not be lower than the highest-rated supporting party. This includes obligations where the sovereign is one of the supporting parties. For supporting parties that are structured finance assets, we will determine their sector-specific sensitivity to country risk as outlined in our criteria "Methodology And Assumptions For Ratings Above The Sovereign--Single-Jurisdiction Structured Finance," published May 29, If the joint-supporting parties are not domiciled in the same country, the sovereign-related risk will not be a constraining factor beyond that already factored into the individual ratings on each supporting party, unless we believe that the two countries are more economically co-dependent than the correlation framework suggests. Per paragraph 22, we may make such determination based on analytical judgement, and therefore apply the maximum differential above the sovereign foreign currency rating on the more highly rated sovereign, considering sensitivity to country risk as stated above. For example, if the two supporting parties were banks from two different countries we consider highly correlated, where the sovereign foreign currency ratings on those two countries are 'BBB' and 'BBB+', then the maximum potential rating on the jointly supported obligation would be 'A', that is, two notches above 'BBB+' (see examples in Appendix 1). APPENDICES Appendix 1: Examples of the Possible Impact of Sovereign-Related Rating Constraints On Ratings Assigned To Jointly Supported Financial Obligations 30. The following table is used to determine the maximum rating differential between the sovereign foreign currency rating and the issuer (foreign and local currency) rating (see table 2 in our RAS criteria). This table is applied to jointly supported obligations where both supporting parties are domiciled in the same country. Table 4 Determining The Maximum Rating Differential Between Our Ratings On The Sovereign Foreign Currency And The Issuer (Foreign And Local Currency) Country risk sensitivity* For sovereign ratings 'B' or higher, the maximum differential above the sovereign rating High Two notches 'B+' For sovereign ratings of 'B-' to 'D' or 'SD', the maximum non-sovereign rating MAY 23,

113 General Criteria: Methodology And Assumptions For Rating Jointly Supported Financial Obligations Table 4 Determining The Maximum Rating Differential Between Our Ratings On The Sovereign Foreign Currency And The Issuer (Foreign And Local Currency) (cont.) Country risk sensitivity* For sovereign ratings 'B' or higher, the maximum differential above the sovereign rating Moderate Four notches 'BB' For sovereign ratings of 'B-' to 'D' or 'SD', the maximum non-sovereign rating Note: For entities with more than 70% exposure to a single country with "significant" adverse currency redenomination risk, the maximum rating is 'B'. "Significant" adverse currency redenomination risk applies when we assess a 1-in-3 or greater likelihood that a country will exit its currency regime, such as leaving a monetary union, and when we expect the redenomination to have a negative credit effect.*per table 1. We apply analytical judgment in making the final determination about the rating differential, on a case-by-case basis, up to the maximum (see paragraph 50). Limits on the maximum differential may also apply for a given country and sector; for example, certain local and regional governments have moderate sensitivity to country risk, but can be rated only up to 3 notches above the sovereign, subject to certain additional requirements, per paragraph 52. These paragraphs refer to "Ratings Above the Sovereign Corporate And Government Ratings: Methodology And Assumptions," published Nov. 19, As noted in paragraphs 28 and 29, the rating assigned to a jointly supported financial obligation may also be constrained by the rating on the applicable sovereign. The following are examples of potential outcomes when applying these criteria where both supporting parties are domiciled in the same country. Table 5 Examples Of The Sovereign Risks' Impact On Ratings Assigned To Jointly Supported Financial Obligations Applied to jointly supported obligations where both supporting parties are in the same country Example 1 Example 2 Example 3 Rating on support provider Support provider 1 (A) A+ BBB A- Support provider 2 (B) A A A- Higher rated support provider (C = higher of A and B) A+ A A- Applicable correlation table Medium correlation (table 2) Medium correlation (table 2) Low correlation (table 1) Joint-supported rating before RAS cap (D) AA A AA- Sovereign rating A- A- A- Country risk sensitivity: Support provider 1 Support provider 2 Maximum rating based on country risk sensitivity for: Moderate sensitivity (maximum four notches above sovereign) Moderate sensitivity (maximum four notches above sovereign) High sensitivity (maximum two notches above sovereign) Moderate sensitivity (maximum four notches above sovereign) Support provider 1 (E) AA A+ A+ Support provider 2 (F) AA AA A+ Lower of maximum based on country risk sensitivity RAS cap (G = lower of E and F) (H = higher of C and G) AA A+ A+ AA A+ A+ High sensitivity (maximum two notches above sovereign) High sensitivity (maximum two notches above sovereign) MAY 23,

114 General Criteria: Methodology And Assumptions For Rating Jointly Supported Financial Obligations Table 5 Examples Of The Sovereign Risks' Impact On Ratings Assigned To Jointly Supported Financial Obligations (cont.) Applied to jointly supported obligations where both supporting parties are in the same country Joint-supported rating after RAS cap adjustment * (I = lower of D and H) Example 1 Example 2 Example 3 AA A A+ *The lower of the rating outcome based on the criteria outlined in paragraphs 8-11; and the RAS cap on the jointly supported obligation rating. The RAS cap is the higher of the highest rated support provider; the lowest maximum rating for each support provider based on the applicable RAS criteria. RAS--Rating above the sovereign. Appendix 2: General Rules Used To Construct The Tables 32. We applied the following rules in paragraphs 33 through 36 in constructing the tables for "low" correlation. 33. If both parties are rated 'BBB-' or higher, the joint-support rating is four notches above the lower-rated party, subject to: A three-notch cap (maximum rating) above the higher-rated party; A floor (minimum rating) of the rating on the higher-rated party; The downgrade of any of the two obligors cannot lead to a more severe downgrade on the joint-supported obligation; and To assign a 'AAA' rating to the obligation, either both parties must be rated at least 'AA-' or one of the parties must be rated 'AAA'. 34. If one party (not both parties) is rated 'BB+' or below, then the joint-support rating is the same as the rating on the higher-rated party. 35. If both parties are rated 'BB+' or below, then the joint-support rating is two notches above the lower-rated party, subject to: A cap of 'BB+'; and A floor of the rating on the higher-rated party. 36. The joint-support rating is the same as the rating on the higher-rated party if one or both of the parties is rated in the 'CCC' category or below. 37. We applied the following rules in paragraphs 38 and 39 in constructing the table for "medium" correlation. 38. If both parties are rated 'BBB-' or higher, the joint-support rating is three notches above the lower-rated party, subject to: A two-notch cap above the higher-rated party; A floor of the rating on the higher-rated party; The downgrade of any of the two obligors cannot lead to a more severe downgrade on the joint-supported obligation; and Both parties must be rated at least 'AA' for us to assign a 'AAA' rating to the obligation. MAY 23,

115 General Criteria: Methodology And Assumptions For Rating Jointly Supported Financial Obligations 39. If one or both parties is rated 'BB+' or below, then the joint-support rating is the same as the rating on the higher-rated party. 40. We applied the following rules in paragraphs 41 and 42 in constructing the table for "high" correlation. 41. If both parties are rated 'BBB-' or higher, the joint-support rating is two notches above the lower-rated party, subject to: A one-notch cap above the higher-rated party, A floor of the rating on the higher-rate party, and Joint-support criteria cannot be used to achieve a 'AAA' rating if neither party is rated 'AAA'. 42. If one or both parties is rated 'BB+' or below, then the joint-support rating is the same as the rating on the higher-rated party. RELATED CRITERIA AND RESEARCH Methodology And Assumptions For Ratings Above The Sovereign--Single-Jurisdiction Structured Finance, May 29, 2015 Methodology and Assumptions For Analyzing Letter Of Credit-Supported Debt, Feb. 20, 2015 Ratings Above the Sovereign Corporate And Government Ratings: Methodology And Assumptions, Nov. 19, 2013 Methodology And Assumptions For Market Value Securities, Sept. 17, 2013 Counterparty Risk Framework Methodology And Assumptions, June 25, 2013 Methodology For Linking Short-Term And Long-Term Ratings For Corporate, Insurance, And Sovereign Issuers, May 7, 2013 Principles of Credit Ratings, Feb. 16, 2011 Methodology: Credit Stability Criteria, May 3, 2010 Understanding Standard & Poor's Rating Definitions, June 3, 2009 The following articles are fully superseded by these criteria: Joint-Support Criteria Update, April 22, 2009 Municipal Applications For Joint-Support Criteria, June 25, 2007 Criteria Update: Joint-Support Criteria Refined, Feb. 3, 2006 These criteria represent the specific application of fundamental principles that define credit risk and ratings opinions. Their use is determined by issuer- or issue-specific attributes as well as S&P Global Ratings' assessment of the credit and, if applicable, structural risks for a given issuer or issue rating. Methodology and assumptions may change from time to time as a result of market and economic conditions, issuer- or issue-specific factors, or new empirical evidence that would affect our credit judgment. MAY 23,

116 Copyright 2016 by Standard & Poor's Financial Services LLC. All rights reserved. No content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor's Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an "as is" basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT'S FUNCTIONING WILL BE UNINTERRUPTED, OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages. Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P's opinions, analyses, and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw, or suspend such acknowledgement at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal, or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof. S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain nonpublic information received in connection with each analytical process. S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, (free of charge), and and (subscription) and (subscription) and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at STANDARD & POOR'S, S&P and RATINGSDIRECT are registered trademarks of Standard & Poor's Financial Services LLC. MAY 23,

117 General Criteria: Post-Default Ratings Methodology: When Does Standard & Poor's Raise A Rating From 'D' Or 'SD'? Primary Contact: Takamasa Yamaoka, Tokyo (81) ; takamasa.yamaoka@standardandpoors.com Secondary Contact: Emmanuel Dubois-Pelerin, Paris (33) ; emmanuel.dubois-pelerin@standardandpoors.com Chief Credit Officer, Global: Ian D Thompson, Melbourne (61) ; ian.thompson@standardandpoors.com Chief Credit Officer, Americas: Lucy A Collett, New York (1) ; lucy.collett@standardandpoors.com Chief Credit Officer, EMEA: Lapo Guadagnuolo, London (44) ; lapo.guadagnuolo@standardandpoors.com Chief Credit Officer, Asia-Pacific: Peter J Eastham, Melbourne (61) ; peter.eastham@standardandpoors.com Criteria Officer, Emerging Markets: Laura J Feinland Katz, CFA, New York (1) ; laura.feinland.katz@standardandpoors.com Senior Criteria Officer, Structured Finance: Felix E Herrera, CFA, New York (1) ; felix.herrera@standardandpoors.com Global Criteria Officer, Corporates: Mark Puccia, New York (1) ; mark.puccia@standardandpoors.com Global Criteria Officer, Sovereigns and International Public Finance: Olga I Kalinina, CFA, New York (1) ; olga.kalinina@standardandpoors.com Criteria Officer, European Financial Services: Michelle M Brennan, London (44) ; michelle.brennan@standardandpoors.com MARCH 23,

118 Table Of Contents SCOPE OF THE CRITERIA SUMMARY OF THE CRITERIA IMPACT ON OUTSTANDING RATINGS EFFECTIVE DATE AND TRANSITION METHODOLOGY A. After A Filing For Bankruptcy Proceedings B. After A Failure Of Payment Under A Contractual Promise C. Breach Of An Imputed Promise (Contractual Deferral Or Contractual Payment Omission) D. A Principal Write-Down Has Occurred E. After A Distressed Debt Restructuring RELATED CRITERIA AND RESEARCH GLOSSARY OF TERMS MARCH 23,

119 General Criteria: Post-Default Ratings Methodology: When Does Standard & Poor's Raise A Rating From 'D' Or 'SD'? 1. Standard & Poor's Ratings Services is clarifying its criteria as to what conditions must be met to raise an issue credit rating from 'D', or an issuer credit rating from 'D' or 'SD' (selective default). These criteria partially supersede the Frequently Asked Questions section of "General Criteria: Rating Implications Of Exchange Offers And Similar Restructurings, Update," published on May 12, 2009, by superseding the last paragraph of the answer to question 5 (in reference to specific rating actions on distressed transactions) and the entire answer to question 11 (in reference to restructurings not effected in a single transaction). SCOPE OF THE CRITERIA 2. These criteria apply globally to all issue credit ratings, issuer credit ratings, and insurer financial strength ratings, including global and national scale credit ratings. When this article uses the term "ICR", the relevant criteria apply to both issuer credit ratings (ICRs) and insurer financial strength ratings. 3. These criteria do not address the following topics, which are covered by separate criteria, or by Standard & Poor's rating policies: The circumstances under which we lower an issue credit rating to 'D', or an ICR to 'D' or 'SD'; The circumstances under which we withdraw a rating; or How we determine the specific level of a rating when we raise it from 'D' or 'SD'. SUMMARY OF THE CRITERIA 4. Generally, after we lower a rating to 'D' or 'SD', the rationale and the timing of any upgrade involve consideration of: the nature of the event that caused the downgrade to 'D' or 'SD', and whether the event was resolved. The weight on each factor varies depending on the nature of the situation. Furthermore, any upgrade from 'D' or 'SD' would not occur on the same day as the downgrade to 'D' or 'SD'. IMPACT ON OUTSTANDING RATINGS 5. We expect these criteria to result in upgrades only in the U.S. residential mortgage-backed securities (RMBS) sector, where up to 1% of existing ratings, or up to 2% of current 'D' ratings, may be upgraded from 'D'. We don't expect any rating impact in other sectors. MARCH 23,

120 General Criteria: Post-Default Ratings Methodology: When Does Standard & Poor's Raise A Rating From 'D' Or 'SD'? EFFECTIVE DATE AND TRANSITION 6. These criteria are effective immediately for all new and outstanding issue credit ratings and ICRs, except in markets that require prior notification to, or registration by, the local regulator. In these markets, the criteria will become effective when so notified by Standard & Poor's or registered by the regulator. We intend to complete our review of all affected ratings within the next six months. METHODOLOGY 7. These criteria categorize 'D' or 'SD' ratings into five distinct types of causal events (see each of sections A to E below, as well as the Glossary Of Terms at the end of this article). For each event, specific conditions must be met to raise a 'D' or 'SD' rating (for example, to the 'CCC' category or higher) to reflect our forward-looking opinion on the post-default creditworthiness of an issue or issuer, as the case may be, assuming the rating has not already been withdrawn. If the situation pertains to more than one of the types of events described in sections A to E, all conditions specified in the relevant sections must be met to raise a 'D' or 'SD' rating. To be clear, an upgrade from 'D' or 'SD' does not presuppose that the likelihood of another default is low. For instance, our forward-looking opinion may lead us to determine that a rating should be raised only to the 'CCC' category, which denotes a relatively high likelihood of default. However, this is not meant to suggest that we have a rating cap at the 'CCC' category for companies emerging from a default. Additionally, we will not raise a rating from 'D' or 'SD' if we believe a further default is virtually certain. 8. In addition, to enhance the clarity of communications, we do not raise a rating from 'D' or 'SD' on the same day we lowered it to 'D' or 'SD'. This is in addition to any other condition mentioned below. A. After A Filing For Bankruptcy Proceedings Issuer credit ratings (ICRs) 9. If the ICR was lowered to 'D' as a result of bankruptcy proceedings (see Glossary), we will not raise the rating from 'D' until the issuer emerges from such bankruptcy proceedings, typically following the bankruptcy court's approval of the reorganization or similar plan. Issue credit ratings 10. Similarly, we will not raise an issue credit rating that was lowered to 'D' because of bankruptcy proceedings until the issuer emerges from such bankruptcy proceedings, except where the obligation has been restructured and is expected to be serviced during the proceedings. Under such circumstances the issue credit rating may be raised to reflect our forward-looking view of the likelihood that the obligation would be paid in accordance with its new terms. 11. Neither an ICR nor an issue credit rating will be raised from 'D' or 'SD' after the issuer becomes subject to bankruptcy proceedings if the bankruptcy is in the form of a liquidation. MARCH 23,

121 General Criteria: Post-Default Ratings Methodology: When Does Standard & Poor's Raise A Rating From 'D' Or 'SD'? B. After A Failure Of Payment Under A Contractual Promise Issue credit ratings and ICRs 12. If we lowered an issue credit rating to 'D', or an ICR to 'D' or 'SD', to reflect a failure of payment under a contractual promise, the rating will not be raised from 'D' or 'SD' until payments resume (see Glossary) in accordance with the original terms. This applies unless the terms are amended and have become legally effective, in which case we would raise the rating from 'D' or 'SD' when the term amendments become legally effective, unless we believe a default under the amended terms is virtually certain. ICRs--Specific situation 13. For sovereign and some other issuers, typically those that are not subject to bankruptcy, even if the defaulted obligations have not been discharged by a court or formally restructured or renegotiated by the parties involved, the ICR may be raised from 'SD' or 'D' if, based on the passage of time, we expect no further resolution to occur and we believe a revised rating better reflects our forward-looking opinion on the creditworthiness of the entity. This approach applies to the following types of issuers. Sovereign issuers Nonsovereign entities that are not subject to bankruptcy, including, but not limited to, many local and regional governments (LRGs), government-related entities (GREs), multilateral lending institutions and other supranationals, and central banks 14. This approach also applies in rare circumstances where entities may be subject to bankruptcy provisions but we assess that such proceedings are highly unlikely to occur, such as: LRGs and GREs that can become subject to bankruptcy, only if we become confident that a bankruptcy is very unlikely to be filed Companies that are subject to bankruptcy, only if we become confident that a bankruptcy is very unlikely to be filed. We expect such cases to be rare, and likely limited to emerging markets where companies are not subject to involuntary bankruptcy filings, or where we believe creditors would not have practical access to legal remedies such as bankruptcy proceedings. 15. To be clear, even where the ICR is raised from 'SD' or 'D' based on the considerations described in the previous two paragraphs, we will not raise our issue credit ratings on the defaulted obligations, as described in paragraph 12, until payments have resumed or the terms are amended and have become legally effective within any necessary process. C. Breach Of An Imputed Promise (Contractual Deferral Or Contractual Payment Omission) Issue credit ratings 16. When an issue credit rating is lowered to 'D' to reflect the breach of an imputed, rather than a contractual, promise (for example, a payment was deferred or omitted in accordance with the terms and conditions of the obligation--- see "Principles For Rating Debt Issues Based On Imputed Promises," published Dec. 19, 2014), we will not raise the issue credit rating on the obligation from 'D' until payments resume in accordance with the initial imputed promise. MARCH 23,

122 General Criteria: Post-Default Ratings Methodology: When Does Standard & Poor's Raise A Rating From 'D' Or 'SD'? ICRs 17. Of note, under Standard & Poor's ratings definitions, the lowering of an issue credit rating to 'D' as a result of the breach of an imputed, but not contractual, promise does not necessarily lead to a lowering of the associated ICR to 'D' or 'SD'. D. A Principal Write-Down Has Occurred Issue credit ratings 18. When an issue credit rating is lowered to 'D' to reflect a principal write-down that occurred in accordance with the terms and conditions of the obligation or the statutory powers or legal framework applicable to the obligation, the below requirements must be satisfied in order to raise the rating (see paragraphs 19 and 20, as well as the table below). 19. For temporary write-downs, the issue credit rating may be raised if: The principal has been written back up to initial par; and If the terms and conditions of the obligation contemplate compensation for the temporary lower par and interest forgone during the period when par was below initial par, such compensation has been paid to creditors in accordance with these terms and conditions. 20. For permanent and partial write-downs: For hybrid capital issues of corporate and government issuers, the issue credit rating may be raised after payment has resumed. With respect to corporates and governments, an upgrade after a principal write-down can occur. Our forward-looking view in this case would reflect the likelihood that the lower par amount and associated interest will be paid. For example, when the principal amount of a bank's hybrid capital instrument is partially written down because of a failure to meet a certain regulatory capital ratio while the obligation still has a very long residual life, such as 60 years, any new rating after 'D' reflects the likelihood of payment going forward based on the written-down principal amount throughout the remaining 60 years. However, securitizations (structured finance transactions) will usually not be upgraded from 'D' after a permanent and partial write-down. Such a write-down of the principal on securitizations usually means the transaction has permanently exhausted cash-flow coverage from the securitized assets to fully support the issuance. Therefore it would be unusual to raise the rating from 'D'. Conditions For Raising 'D' Issue Credit Ratings After Principal Write-Downs Conditions for upgrade from 'D'* Nature of write-down Payment resumption Write-up back to initial par Compensation payment Temporary, with compensation payment clause Temporary, without compensation payment clause No Yes Yes No Yes N/A Permanent, partial, hybrids Yes N/A N/A Permanent, partial, structured finance The rating will usually not be raised from 'D'. The rating will usually not be raised from 'D'. The rating will usually not be raised from 'D'. Permanent, full N/A N/A N/A *When multiple conditions apply, all conditions need to be concurrently met for an upgrade from 'D'. Compensation payment in this table refers to payment required as compensation for the temporary, lower par having reduced interest during the write-down period. The rating is typically withdrawn for full, permanent write-downs. N/A--Not applicable. MARCH 23,

123 General Criteria: Post-Default Ratings Methodology: When Does Standard & Poor's Raise A Rating From 'D' Or 'SD'? ICRs 21. Of note, the lowering of an issue credit rating to 'D' owing to a principal write-down in accordance with an obligation's terms and conditions does not necessarily lead to a lowering of the associated ICR to 'D' or 'SD' under Standard & Poor's ratings definitions. E. After A Distressed Debt Restructuring 22. In this criteria article, we use the term "restructuring" broadly, as defined in the Glossary. Exchanges can be either full or partial (see paragraph 25), and repurchases can be effected in either a single transaction or multiple transactions (see paragraph 26). Issue credit ratings 23. In the case of a single repurchase, the issue credit rating on any remaining portion will not be raised from 'D' until the next business day after the downgrade to 'D' (see paragraph 26 for multiple repurchases). In the case of a term amendment, we will not raise from 'D' our issue credit rating before the next business day after the downgrade to 'D', and the revised rating reflects the amended terms of the obligation. ICRs 24. Unless paragraph 25 applies, if we lowered an ICR to 'D' or 'SD' as a result of a restructuring (whether an exchange, a repurchase, or a term amendment), the earliest the rating could be raised from 'D' or 'SD' will be the next business day after the downgrade to 'D' or 'SD'. (For the criteria for lowering the ICR to 'D' or 'SD' upon a distressed debt restructuring, see "Rating Implications Of Exchange Offers And Similar Restructurings, Update," published May 12, 2009.) Partial exchanges 25. If we lowered an ICR to 'D' or 'SD' owing to an exchange, we will raise the ICR from 'SD' or 'D'--even if full and timely payment has not been made on the original securities that have not been exchanged--if: The circumstances fall under one of the four situations described in paragraphs 13 and 14; and We consider, given the acceptance rate level, that (i) no further resolution of the default will likely occur, and (ii) the near-term ability of holdout creditors to materially complicate the issuer's financing ability is limited. Multiple repurchases 26. If we lowered our issue credit rating on an obligation to 'D' as a result of a repurchase and we expect additional repurchases to occur in separate transactions over the course of several weeks or months, the rating remains at 'D' until we become confident that the likelihood of further repurchases is remote. By contrast, even in such a case, the ICR can be raised as early as one business day after the downgrade to 'D' or 'SD' without regard to ongoing repurchases on the obligation to reflect our forward-looking opinion on the creditworthiness of the entity. RELATED CRITERIA AND RESEARCH MARCH 23,

124 General Criteria: Post-Default Ratings Methodology: When Does Standard & Poor's Raise A Rating From 'D' Or 'SD'? Related Criteria Principles For Rating Debt Issues Based On Imputed Promises, Dec. 19, 2014 Methodology: Use Of 'C' And 'D' Issue Credit Ratings For Hybrid Capital And Payment-In-Kind Instruments, Oct. 24, 2013 Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings, Oct. 1, 2012 Rating Implications Of Exchange Offers And Similar Restructurings, Update, May 12, 2009 GLOSSARY OF TERMS Bankruptcy Encompasses insolvency and similar legal proceedings. Exchange Outstanding obligations are entirely or partly replaced with new obligations. Obligation Includes not only legal obligations but also imputed promises in some issues such as preferred stocks that we rate based on an imputed promise (see "Principles For Rating Debt Issues Based On Imputed Promises," published on Dec. 19, 2014, for details). Payment resumption Debt service has fully resumed according to the terms of the obligation (including new terms, if the terms were amended). Where the obligation is cumulative and, therefore, the issuer is obliged to settle missed payments, resumption of payments includes the settlement of any arrearages, any penalties, and any interest owed on deferred interest. Repurchase The outstanding obligation is repurchased in the market, typically only in part. Restructuring Any debt restructuring--typically an exchange, a repurchase, or a term amendment--that we view as distressed according to "Rating Implications Of Exchange Offers And Similar Restructurings, Update," published May 12, Term amendment The terms of the outstanding obligation are amended, including, but not limited to, principal amount, interest rate, deferability, maturity, seniority, and/or currency denomination. Term amendment here is the narrow meaning of "restructuring" as used in the credit derivative world. These criteria represent the specific application of fundamental principles that define credit risk and ratings opinions. Their use is determined by issuer- or issue-specific attributes as well as Standard & Poor's Ratings Services' assessment of the credit and, if applicable, structural risks for a given issuer or issue rating. Methodology and assumptions may change from time to time as a result of market and economic conditions, issuer- or issue-specific factors, or new empirical evidence that would affect our credit judgment. MARCH 23,

125 Copyright 2015 Standard & Poor's Financial Services LLC, a part of McGraw Hill Financial. All rights reserved. No content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor's Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an "as is" basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT'S FUNCTIONING WILL BE UNINTERRUPTED, OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages. Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P's opinions, analyses, and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw, or suspend such acknowledgement at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal, or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof. S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain nonpublic information received in connection with each analytical process. S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, (free of charge), and and (subscription) and (subscription) and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at MARCH 23,

126 General Criteria: Principles Of Credit Ratings Chief Credit Officer, Corporates & Governments: Lucy A Collett, New York (1) ; lucy.collett@standardandpoors.com Chief Credit Officer, Structured Finance: Felix E Herrera, CFA, New York (1) ; felix.herrera@standardandpoors.com Chief Credit Officer, EMEA: Lapo Guadagnuolo, London (44) ; lapo.guadagnuolo@standardandpoors.com Chief Credit Officer: Ian D Thompson, Melbourne (44) ; ian.thompson@standardandpoors.com Table Of Contents SCOPE OF THE CRITERIA SUMMARY OF CRITERIA UPDATE IMPACT ON OUTSTANDING RATINGS EFFECTIVE DATE AND TRANSITION FUNDAMENTAL PRINCIPLES OF STRUCTURED FINANCE RATINGS AND CRITERIA FUNDAMENTAL PRINCIPLES OF CORPORATE AND GOVERNMENT RATINGS AND CRITERIA RELATED CRITERIA AND RESEARCH FEBRUARY 16,

127 General Criteria: Principles Of Credit Ratings (Editor's Note: This criteria article was originally published on Feb. 16, We are republishing this article following our periodic review completed on Dec. 22, As a result of our review, we updated the author contact information. This article fully supersedes (but does not make substantive changes to) "Principles of Corporate And Government Ratings," published June 26, 2007, and "Principles-Based Rating Methodology For Global Structured Finance Securities," published May 29, It also supersedes "Structured Investment Vehicle Criteria," published March 13, 2002, "Corporate Securitizations: The Role of Risk Capital in Aligning Stakeholder Interests," published Sept. 18, 2003, and "CDO Spotlight: Quantitative Modeling Approach To Rating Index CPDO Structures," published March 22, 2007.) 1. Standard & Poor's Ratings Services uses a principles-based approach for assigning and monitoring ratings globally. These broad principles apply generally to ratings of all types of corporates, governments, securitization structures, and asset classes. However, for certain types of issuers, issues, asset classes, markets, and regions, Standard & Poor's complements these principles with specific methodologies and assumptions. 2. Readers should read this article in conjunction with "Understanding Standard & Poor's Rating Definitions," published June 3, 2009, and "Methodology: Credit Stability Criteria," published May 3, Standard & Poor's assigns credit ratings to both issuers and issues, and strives to maintain comparability of ratings across sectors and over time. That is, Standard & Poor's intends for each rating symbol to connote the same general level of creditworthiness for issuers and issues in different sectors and at different times. Enhancing comparability requires calibrating the criteria for determining ratings. Standard & Poor's calibrates criteria through various means including measuring default behavior across sectors and over time, applying common approaches to risk analysis, and using a common set of macroeconomic scenarios associated with the different rating levels. The scenario associated with the 'AAA' rating level is one of extreme macroeconomic stress--on par with the Great Depression of the 1930s. The scenarios associated with the lower rating levels are successively less stressful. Credits rated in each category are intended to be able to withstand the associated level of macroeconomic stress without defaulting (although we might significantly lower the ratings on those credits as economic stresses increase). SCOPE OF THE CRITERIA 4. These criteria apply to ratings of all issuers and issues rated by Standard & Poor's. SUMMARY OF CRITERIA UPDATE 5. This article fully supersedes (but does not make substantive changes to) "Principles of Corporate And Government Ratings," published June 26, 2007, and "Principles-Based Rating Methodology For Global Structured Finance Securities," published May 29, The analytic framework for structured finance securitization ratings includes five key areas: FEBRUARY 16,

128 General Criteria: Principles Of Credit Ratings Credit quality of the securitized assets; Legal and regulatory risks; Payment structure and cash flow mechanics; Operational and administrative risks; and Counterparty risk. 7. The analytic framework for corporate and government ratings includes three key areas: Creditworthiness before external support; External support; and Analysis of specific instruments. IMPACT ON OUTSTANDING RATINGS 8. This criteria update does not cause changes to any outstanding ratings. EFFECTIVE DATE AND TRANSITION 9. These criteria are effective immediately for all new and outstanding ratings. FUNDAMENTAL PRINCIPLES OF STRUCTURED FINANCE RATINGS AND CRITERIA Credit Quality Of The Securitized Assets 10. In most securitization transactions, the first key step in analyzing the credit quality of the securitized assets is determining the amount of credit support necessary, in our opinion, to maintain a rating at the 'AAA' level. That determination is equivalent to estimating the amount of losses that the assets would suffer under conditions of extreme stress. The estimation can include reference to historical studies of the subject asset class or, when such studies are not available and as we deem appropriate, comparison or benchmarking relative to asset classes for which such studies do exist. 11. For some asset classes, the estimation may proceed in stages: We might separately estimate asset default frequencies and loss severities under extreme stress conditions and then combine those components to form the overall loss estimate. Similarly, for some asset classes, the estimation may use generalizations based on historical studies, such as the notion that losses under extreme stress conditions can be estimated as a multiple of expected losses, with the multiple potentially varying for different asset classes. 12. For some asset classes, Standard & Poor's defines an archetypical asset pool and uses it as a comparison benchmark for gauging the estimated losses under extreme stress for pools underlying actual transactions in such asset classes. In some cases, the maximum rating for the highest rated security may be below 'AAA' based on our assessment of factors such as country risk, or transfer and convertibility risk, and we would adjust the analysis accordingly. 13. In many securitization transactions, a key step in analyzing the credit quality of the securitized assets is estimating the FEBRUARY 16,

129 General Criteria: Principles Of Credit Ratings level of expected losses. The level of expected losses generally corresponds to the amount of credit enhancement associated with the 'B' rating level. Estimation of expected losses generally uses the recent performance of similar assets as a guide. The estimation may include adjustments based on our assessment of current trends, as well as evolving market practices. 14. Interpolation is one of the methods we may use when we analyze the amount of credit enhancement associated with the rating levels between 'AAA' and 'B' for transactions in certain asset classes. For other asset classes, we create specific benchmarks, such as coverage multiples or simulated default rates, within a mathematical simulation model. 15. Our view on the credit quality of a pool of assets may change over time. The performance of the pool may diverge from expectations and that divergence may reveal credit strengths or weakness that were not previously apparent. Through our surveillance processes, we reassess the credit quality of the pool based on certain information regarding the observed performance and other factors we deem relevant. Legal And Regulatory Risks 16. Standard & Poor's assessment of legal and regulatory risks focuses primarily on the degree to which a securitization structure isolates the securitized assets from the bankruptcy or insolvency risk of entities that participate in the transaction. Typically, our analysis focuses on the entity or entities that originated and owned the assets before the securitization, although the creditworthiness of other entities also may be relevant. A true sale of the subject assets from the originator/seller to a special purpose entity (SPE) is one method commonly used by an arranger seeking to achieve asset isolation in a securitization. From a legal perspective, a true sale is generally understood to result in the assets ceasing to be part of the seller's bankruptcy or insolvency estate. There may also be other legal mechanisms, apart from true sale, that may achieve analogous comfort. SPEs are entities that typically are used in a securitization transaction to "house" the assets that will back the payment obligations usually represented by the securities issued by the SPE. In the context of our analysis, Standard & Poor's forms an opinion about the insolvency remoteness of an SPE based on our evaluation of the specific facts and circumstances that we view as applicable to a particular transaction. Among other things, the analysis considers whether the separate legal identity of the SPE would be respected by bankruptcy courts or bodies charged with similar functions. In addition, we assess the presence of features intended to minimize the likelihood that the SPE itself becomes the subject of bankruptcy. Payment Structure And Cash Flow Mechanics 17. The rating analysis for structured finance typically includes an analysis of payment structure and cash flow mechanics. This portion of the analysis may involve both assessing the documentation for a security and testing the cash flows using quantitative models. In both cases, the objective is to assess whether the cash flow from the securitized assets would be sufficient, at the applicable rating levels, to make timely payments of interest and ultimate payment of principal to the related securities, after taking account of available credit enhancement and allowing for transaction expenses, such as servicing and trustee fees. The analysis may encompass diverse features of the payment structure and cash flow mechanics, ranging from the basic payment priorities inherent in a deal (i.e., the subordination hierarchy of tranches) to the impact of performance covenants (i.e., so-called "triggers") that may operate as switches that materially change the distribution priorities if they are breached. Finally, for securities that embody support facilities from third parties, such as insurance policies, guarantees, bank credit and liquidity facilities, and derivatives instruments, the analysis focuses on the payment mechanics for those obligations. FEBRUARY 16,

130 General Criteria: Principles Of Credit Ratings Operational And Administrative Risks 18. The analysis of operational and administrative risks is another part of the structured finance rating analysis. This part of the analysis focuses on key transaction parties to determine whether they are capable of managing a securitization over its life. Key transaction parties may include a transaction's servicer or manager, the asset manager of a collateralized debt obligation (CDO), the trustee, the paying agent, and any other transaction party; herein we collectively refer to these parties as servicers. 19. In securitizations involving many asset classes, the analysis focuses on evaluating a servicer's or manager's ability to perform its duties, such as receiving timely payments, pursuing collection efforts on delinquent assets, foreclosing on and liquidating collateral, tracking cash receipts and disbursements, and providing timely and accurate investor reports. For transactions that involve revenue-producing assets (e.g., commercial property), the analysis may include, as we deem appropriate, assessment of certain incremental risks associated with managing the assets. For actively managed portfolios, the analysis considers the asset manager's capabilities and past performance as an asset manager. 20. The analysis of operational and administrative risks generally considers the possibility that a servicer may become unable or unwilling to perform its duties during the life of the transaction. In that vein, the analysis may consider both the potential for hiring a substitute or successor servicer and any arrangements that provide for a designated backup servicer. That portion of the analysis would typically consider the sufficiency of the servicing fee to attract a substitute, the seniority of the fee in the payment priorities, and the availability of substitute servicers. Counterparty Risk 21. The fifth part of the rating analysis is the analysis of counterparty risk. That analysis focuses on third-party obligations to either hold assets (including cash) or make financial payments that may affect the creditworthiness of structured finance instruments. Examples of counterparty risks include exposures to institutions that maintain key accounts and exposures to the providers of derivative contracts such as interest rate swaps and currency swaps. The counterparty risk analysis considers both the type of dependency and the rating of the counterparty for each counterparty relationship in a transaction. FUNDAMENTAL PRINCIPLES OF CORPORATE AND GOVERNMENT RATINGS AND CRITERIA Creditworthiness Before External Support 22. The most important step in analyzing the creditworthiness of a corporate or governmental obligor is gauging the resources available to it for fulfilling its commitments relative to the size and timing of those commitments. Assessing an obligor's resources for fulfilling its financial commitments is primarily a forward-looking exercise. It may entail estimating or projecting future income and cash flows. It may include consideration of economic conditions, the regulatory environment, and economic projections and forecasts. For business entities, future income and cash flows may come primarily from ongoing operations or investments. For governmental entities, income and cash flows may come primarily from taxes. In some cases, other resources, including liquid assets or, in the case of a sovereign obligor, the ability to print currency, may be relevant. 23. The assessment of resources considers both the expected level of future income and cash flows and their potential FEBRUARY 16,

131 General Criteria: Principles Of Credit Ratings variability. For all types of obligors, the assessment includes both qualitative and quantitative factors. 24. The quantitative side of the analysis focuses primarily on financial analysis and may include an evaluation of an obligor's accounting principles and practices. 25. For business entities, key financial indicators generally include profitability, leverage, cash flow adequacy, liquidity, and financial flexibility. For financial institutions and insurers, other critical factors may include asset quality, reserves for losses, asset-liability management, and capital adequacy. Off-balance sheet items, such as securitizations, derivative exposures, leases, and pension liabilities, may also be part of the quantitative analysis. Cash flow analysis and liquidity assume heightened significance for firms with speculative-grade ratings ('BB+' and lower). 26. For governmental entities, the quantitative factors we assess are different from the factors we assess for business entities; they generally include both economic factors and budgetary and financial performance, as well as additional items for sovereign obligors. The economic side of the analysis typically encompasses demographics, wealth, and growth prospects. The budgetary and financial side generally includes budget reserves, external liquidity, and structural budget performance. For sovereign obligors, additional quantitative factors that may, in our view, be relevant to our analysis include fiscal policy flexibility, monetary policy flexibility, international investment position, and contingent liabilities associated with potential support for the financial sector. 27. Trends over time and peer comparisons may be part of the quantitative analysis for both business and governmental entities. 28. On the qualitative side, the analysis of business entities focuses on various factors, including: country risk, industry characteristics, and entity-specific factors. We intend for our analysis of the country risk factor to capture our assessment of the financial and operating environment that applies broadly to businesses in a particular country, including a country's physical, legal, and financial infrastructure. Historically, this assessment has often operated to constrain the ratings of business entities in countries that have high country risk. 29. Industry characteristics typically encompass growth prospects, volatility, and technological change, as well as the degree and nature of competition. Broadly speaking, the lower the industry risk, the higher the potential credit rating for an obligor in that sector. The analysis also considers certain entity-specific factors that we believe can distinguish an individual obligor from its peers. These may include diversification of the obligor's products and services as well as risk concentrations, particularly for a financial institution. Obligor-specific factors also may include operational effectiveness, overall competitive position, strategy, governance, financial policies, risk management practices, and risk tolerance. 30. Qualitative factors for governmental entities are somewhat different from the factors for business entities. Our analysis may encompass political risks, including the effectiveness and predictability of policymaking and institutions and the transparency of processes and data and the accountability of institutions. In addition, for sovereign obligors, consideration of political risks may include an assessment of the potential for war, revolution, or other security-related events to affect creditworthiness. Other qualitative considerations that may be part of an analysis of a governmental obligor include revenue forecasting, expenditure control, long-term capital planning, debt management, and contingency planning. Finally, the assessment of a governmental obligor focuses on the potential that the obligor FEBRUARY 16,

132 General Criteria: Principles Of Credit Ratings might default even when it has the resources to meet its financial commitments. External Support 31. In addition to our assessment of an obligor's stand-alone creditworthiness, Standard & Poor's analysis considers the likelihood and potential amount of external support (or influence) that could enhance (or diminish) the obligor's creditworthiness. When an obligor's creditors have the benefit of contractual support, such as a guarantee from a higher-rated guarantor, the analysis may assign the guarantor's rating to the supported issue or issuer. However, this occurs only when the guarantee satisfies stringent conditions and guarantees full and timely payment of the underlying obligation. 32. Apart from formal guarantees, the analysis considers the potential for other support from affiliated business entities, governments, and multilateral institutions. For affiliated business entities, the analysis considers both the degree of strategic importance of subsidiaries or affiliates to determine the likelihood and degree of support by a stronger parent and - the parent's capacity to provide such support. 33. For governmental support, the analysis considers the potential for various forms of support. For example, the analysis considers potential support for government-related entities (GREs), such as certain public utilities, transportation systems, and financial companies. The analysis of a GRE considers the role that the entity plays and the nature of its links to its government. A similar line of analysis applies to the potential for extraordinary government support to banks that, in our view, have systemic importance in a national economy. In the case of a sovereign obligor, the analysis considers the potential for support from multilateral institutions (e.g., the International Monetary Fund [IMF]). 34. The assessment of potential external support generally does not include the benefits that an obligor receives merely by being part of a system or framework. We consider those benefits in the assessment of industry characteristics or otherwise in the analysis of stand-alone creditworthiness. For example, the stand-alone analysis of a bank includes consideration of benefits that we believe it may receive from supervision within its regulatory framework and from access to low-cost borrowings from its central bank. Likewise, the analysis of governments (e.g., a school district) may include an evaluation of system support provided by a higher level entity (e.g., a city or state). 35. In some cases, external support can have a negative influence on an entity's creditworthiness. For example, this can happen when a weaker parent company drains cash flows or assets from a stronger subsidiary through dividends or in other ways. Similarly, a sovereign government can be a negative factor for a company's creditworthiness if it intervenes by withdrawing resources or limiting the company's financial flexibility. Notching And Analysis Of Specific Instruments 36. The analysis of specific instruments includes consideration of priorities within an obligor's capital structure and the potential effects of collateral and recovery estimates in the event of the obligor's default. The analysis may apply notching to instruments that rank above or below their obligor's senior, unsecured debt. For example, subordinated debt would generally receive a rating below the senior debt rating. Conversely, secured debt may receive a rating above the unsecured debt rating. 37. Notching also applies to the structural subordination of debt issued by operating subsidiaries or holding companies that are part of an enterprise viewed as a single economic entity. For example, the debt of a holding company may be FEBRUARY 16,

133 General Criteria: Principles Of Credit Ratings rated lower than the debt of its subsidiaries that have the enterprise's assets and cash flows. We extend the notching approach to analyzing the creditworthiness of instruments involving payment priority. For example, we would generally rate preferred stock and so-called hybrid capital instruments lower than senior debt to indicate that payment could be deferred. RELATED CRITERIA AND RESEARCH Methodology: Credit Stability Criteria, May 3, 2010 Understanding Standard & Poor's Rating Definitions, June 3, 2009 Principles Of Corporate And Government Ratings, June 26, 2007 Principles-Based Rating Methodology For Global Structured Finance Securities, May 29, 2007 These criteria represent the specific application of fundamental principles that define credit risk and ratings opinions. Their use is determined by issuer- or issue-specific attributes as well as Standard & Poor's Ratings Services' assessment of the credit and, if applicable, structural risks for a given issuer or issue rating. Methodology and assumptions may change from time to time as a result of market and economic conditions, issuer- or issue-specific factors, or new empirical evidence that would affect our credit judgment. FEBRUARY 16,

134 Copyright 2015 Standard & Poor's Financial Services LLC, a part of McGraw Hill Financial. All rights reserved. No content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor's Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an "as is" basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT'S FUNCTIONING WILL BE UNINTERRUPTED, OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages. Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P's opinions, analyses, and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw, or suspend such acknowledgement at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal, or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof. S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain nonpublic information received in connection with each analytical process. S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, (free of charge), and and (subscription) and (subscription) and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at FEBRUARY 16,

135 General Criteria: Understanding Standard & Poor's Rating Definitions Chief Credit Officer: Ian D Thompson, Melbourne (44) ; ian.thompson@standardandpoors.com Chief Credit Officer, Americas: Lucy A Collett, New York (1) ; lucy.collett@standardandpoors.com Chief Credit Officer, EMEA: Lapo Guadagnuolo, London (44) ; lapo.guadagnuolo@standardandpoors.com Chief Credit Officer, Structured Finance: Felix E Herrera, CFA, New York (1) ; felix.herrera@standardandpoors.com Table Of Contents Key Attributes Of Standard & Poor's Credit Ratings Measuring Ratings Performance Conclusion Notes Appendix I Appendix II Appendix III Appendix IV Appendix V JUNE 3,

136 General Criteria: Understanding Standard & Poor's Rating Definitions (Editor's Note: This article contains excerpts from Standard & Poor's Ratings Definitions, which we periodically update. Therefore, please see the current version of the Ratings Definitions for the up-to-date definitions. We originally published this criteria article on June 3, We're republishing it following our periodic review completed March 3, As a result of our review, we updated the author contact information.) Standard & Poor's is committed to taking action to help restore confidence in ratings. As one example, over the past year, we have launched a number of initiatives designed to foster greater transparency in our analytics and processes. These initiatives have included publishing "what-if" scenario analyses discussing factors that could cause ratings to change, more explicit discussions of the assumptions we used in forming our opinions, and changes we have made to our rating criteria for several asset classes resulting from macroeconomic developments and ongoing performance data. By providing more information and data about ratings, we can help market participants better understand how we develop our ratings and - whether they agree or disagree with our assessment - act accordingly. This article is designed to help market participants better understand what Standard & Poor's credit ratings mean. Although the official definitions appear outwardly to be very simple, they embody multiple factors that compose the overall assessment of creditworthiness. Standard & Poor's has striven to maintain comparability of ratings across sectors. This has been done by relating all ratings to common default behavior and measurement and by common approaches to risk analysis. In the spirit of promoting greater transparency, Standard & Poor's is now articulating a set of economic stress scenarios enumerated in Appendix IV, which we intend to use as benchmarks for enhancing the consistency and comparability of ratings across sectors and over time. Each scenario describes particular conditions of economic stress, which we associate with a particular rating level, as described in the appendix. Credits rated in each category are intended to be able to withstand particular conditions of economic stress without defaulting (though they might be downgraded significantly JUNE 3,

137 General Criteria: Understanding Standard & Poor's Rating Definitions as economic stresses increase). This publication intends to promote greater understanding of ratings and help investors attribute clearer meanings to different rating categories. Key Attributes Of Standard & Poor's Credit Ratings Rank ordering of creditworthiness Standard & Poor's credit ratings express forward-looking opinions about the creditworthiness of issuers and obligations (see Appendix I for a description of "issuer" and "issue" ratings). More specifically, Standard & Poor's credit ratings express a relative ranking of creditworthiness. Issuers and obligations with higher ratings are judged by us to be more creditworthy than issuers and obligations with lower credit ratings. (See Appendix III for a relevant excerpt from the rating definitions.) Creditworthiness is a multi-faceted phenomenon. Although there is no "formula" for combining the various facets, our credit ratings attempt to condense their combined effects into rating symbols along a simple, one-dimensional scale. Indeed, as discussed below, the relative importance of the various factors may change in different situations. The term creditworthiness refers to the question of whether a bond or other financial instrument will be paid according to its contractual terms. At first blush, the idea of creditworthiness seems entirely straightforward. However, delving beneath the outward simplicity reveals the true multi-dimensional nature. Primary factor -- likelihood of default In our view, likelihood of default is the centerpiece of creditworthiness. That means likelihood of default--encompassing both capacity and willingness to pay--is the single most important factor in our assessment of the creditworthiness of an issuer or an obligation. Therefore, consistent with our goal of achieving a rank ordering of creditworthiness, higher ratings on issuers and obligations reflect our expectation that the rated issuer or obligation should default less frequently than issuers and obligations with lower ratings, all other things being equal. Although we emphasize the rank ordering of default likelihood, we do not view the rating categories solely in relative terms. We associate each successively higher rating category with the ability to withstand successively more stressful economic environments, which we view as less likely to occur. We associate issuers and obligations rated in the highest categories with the ability to withstand extreme or severe stress in absolute terms without defaulting. Conversely, we associate issuers and obligations rated in lower categories with vulnerability to mild or modest stress. (See Appendix IV for stress scenarios by rating level that we intend to use in promoting ratings comparability. Appendix V contains a listing of historical examples of stress conditions, including the magnitude of stress that we associate with each.) Looking to absolute stress levels is part of how we try to achieve comparability of ratings across different types of securities, different times, different currencies, and different regions. That is, we strive to make our rating symbols correspond to the same approximate level of creditworthiness wherever they appear. Thus, when we use a given rating symbol, we intend to connote roughly the same level of creditworthiness to the widely disparate issuers on a global JUNE 3,

138 General Criteria: Understanding Standard & Poor's Rating Definitions basis, such as a Canadian mining company, a Japanese financial institution, a Wisconsin school district, a British mortgage-backed security, or a sovereign nation. We intend to use the hypothetical stress scenarios described in Appendix IV as benchmarks for calibrating our criteria across different sectors and over time. The scenarios will not become part of the rating definitions. Nor will they be the sole or primary drivers of our criteria. However, they will be an important tool for calibrating our criteria to help maintain comparability across sectors and over time. That is, we will consider the stress scenarios in the process of associating both qualitative and quantitative factors with different rating categories. For example, for corporate credits we will consider the stress scenarios (along with everything else that we now consider) in assessing the levels of leverage and profitability that we associate with credits in different rating categories. Likewise, for structured finance issues, we will consider the stress scenarios in assessing the levels of credit support that we associate with the different rating categories. The scenarios represent hypothetical stress conditions corresponding to each rating category. The scenario for a particular category would reflect a level of stress that credits rated in that category should, in our view, be able to withstand without defaulting (though they might be downgraded to levels near default). Significantly, the scenarios do not supplant consideration of sector-specific and company-specific risk factors in our criteria or in assigning individual ratings. Rather, they apply in addition to such factors. We do not expect that adopting the stress scenarios, in itself, will cause a significant number of rating changes in the near term. That is, although rating changes are occurring as we update our criteria over time, we do not expect that adopting the stress scenarios, in and of itself, will cause additional changes or changes of greater magnitude. Still, we do not attach specific probabilities to particular types of potential economic environments. Therefore, we do not ascribe a specific "default probability" to each rating category. On the contrary, we recognize that the observed default rates for all rating categories rise and fall as the economic environment progresses through periods of expansion and contraction (see note 1). Moreover, any given economic cycle generally does not produce the same degree of stress in all sectors and regions. Accordingly, only over the very long term (e.g., covering multiple economic cycles), would we expect to be able to observe whether similarly rated issuers from different market segments actually experience similar long-term default frequencies. These observations inform future changes to our criteria and analytics. Secondary credit factors Beyond likelihood of default, there are other factors that may be relevant. For example, one such factor is the payment priority of an obligation following default. Our ratings reflect the impact of payment priority in a very visible way: When a corporation issues both senior and subordinated debt, we usually assign a lower rating to the subordinate debt. For most issuers, the likelihood of default is exactly the same for both senior and subordinated debt because both default at the same time when an issuer goes into bankruptcy. A further example is the "structural subordination" of a holding company's debt to the debt of its operating subsidiaries. (See "Corporate Ratings Criteria 2008," pp , available on RatingsDirect. Under Criteria, select Corporates, Criteria Books.) Another secondary factor is the projected recovery that an investor would expect to receive if an obligation defaults. For example, our ratings on certain financial institution obligations and on speculative-grade corporate obligations JUNE 3,

139 General Criteria: Understanding Standard & Poor's Rating Definitions reflect adjustments for the expected recovery following default. (See "Corporate Ratings Criteria 2008," pp , and "Well Secured Debt: Notching Up," published March 23, 2004.) (See note 2.) A third secondary factor is credit stability. Some types of issuers and obligations are prone to displaying a period of gradual decay before they default. Others may be more vulnerable to sudden deterioration or default. In essence, some types of credits tend to give a warning before they default, while others do not. In addition, the likelihood of default for some types of credits may suddenly change because of changes in key aspects of the economic or business environment. For other credits, the likelihood of default may be less sensitive to changing conditions. Both kinds of differences are described by the term "credit stability." Differing degrees of stability constitute differences in creditworthiness (see "Standard & Poor's To Explicitly Recognize Credit Stability As An Important Rating Factor," published Oct. 15, 2008). Creditworthiness is complex and while there is no formula for combining the different factors into an overall assessment, the criteria does provide a guide in considering these factors. Payment priority and recovery apply more often in the context of rating specific obligations than in rating issuers. Also, payment priority and recovery have increasing significance as likelihood of default increases (i.e., at lower rating levels). In contrast, credit stability has increasing significance as likelihood of default decreases (i.e., at higher rating levels). In addition, the relative importance of the several factors may wax or wane with changes in market conditions and the economic environment. The rating criteria for different types of credits details the specifics of how payment priority, recovery, and stability factor into our analysis. Standard & Poor's credit ratings are forward-looking. That is, they express opinions about the future. Indeed, the issue that they address -- credit quality -- is at its core future-oriented. Ratings at the lower end of the rating scale reflect our view as to the rated entity's vulnerability to cyclical fluctuations and, accordingly, generally address shorter time horizons and may reflect specific economic forecasts and projections. Conversely, ratings at the higher end of the rating scale generally address longer time horizons and are usually less reflective of forecasts or projections of what is likely to occur in the near term. Instead, they reflect greater emphasis of our view as to what might occur in unlikely (or highly unlikely) future scenarios. Given the movement in economic and credit cycles, we expect ratings to change over time as the creditworthiness of rated issuers and obligations rises and falls. To address the inherent variability of creditworthiness, we maintain surveillance on our ratings. Our approach to changes in creditworthiness is to take prompt rating actions when we believe, based on our surveillance, that an upgrade, downgrade, or an affirmation is appropriate. Along with the ratings themselves, we strive to explain the basis for our analysis by publishing a clear rationale for the ratings we issue. In many cases, we not only describe our reason for assigning a particular rating, but also discuss future developments that could cause us to change it. Measuring Ratings Performance As noted earlier, the key objective of Standard & Poor's ratings is rank ordering the relative creditworthiness of issuers and obligations. Accordingly, a key measure that we use for assessing the performance of our ratings is how well they JUNE 3,

140 General Criteria: Understanding Standard & Poor's Rating Definitions have rank-ordered observed default frequencies during a given test period (usually one year). That is, when our ratings perform as intended, securities with higher ratings should display lower observed default frequencies than securities with lower ratings during a given test period. Our performance studies have shown mostly strong rank ordering of default frequencies within each major segment of the fixed-income market (e.g., corporate bonds, structured finance, public finance, etc.). However, as noted above, economic cycles do not produce the same degree of stress in all geographic regions and in all market segments at any point in time. Accordingly, although we strive for comparability in our ratings, we expect to observe less consistency in rank ordering of observed default frequencies among regions and market segments. Only over very long periods - covering multiple economic cycles - would we expect to be able to observe whether similarly rated credits from different market segments actually experience similar long-term default frequencies. Small sample sizes also sometimes affect measurements of actual default frequencies. Comparisons of default rates between sub-sectors that contain small numbers of credits can be distorted by small sample sizes and by idiosyncratic factors. Beyond the primary measure of rank ordering, we secondarily consider whether ratings have effectively incorporated other aspects of creditworthiness. In that vein, we examine whether the observed default rate for each rating category during a given test period is higher or lower than has been historically observed during past periods of similar economic and financial conditions. We examine rating transitions and sudden defaults to consider the degree to which ratings have captured credit stability. Likewise, we examine recoveries following default to assess whether their impact has been captured. However, the secondary measurements do not figure into the ultimate measurement of ratings performance, which remains focused on an assessment of rank ordering. Conclusion Standard & Poor's ratings express forward-looking opinions about relative creditworthiness of issuers and obligations. Creditworthiness is a multi-dimensional phenomenon. We view likelihood of default as the single most important dimension of creditworthiness. We place the greatest emphasis on rank ordering default likelihood in applying our rating definitions, in developing rating criteria, and in rating specific issuers and obligations. In addition, we place secondary emphasis on absolute likelihoods of default as part of how we strive for comparability of ratings. In an indirect way, our consideration of absolute default likelihood can be viewed as associating "stress tests" or "scenarios" of varying severity with the different rating categories. We do not expect to observe constant default frequencies over time; we expect observed default frequencies for all rating categories to rise and fall with changes in economic conditions. Beyond likelihood of default, we also consider secondary dimensions of creditworthiness: payment priority, recovery, and credit stability. Those can become critical elements of how we apply our rating definitions in developing criteria for particular situations. However, when we conduct studies to measure the performance of our ratings, we return to the touchstone of relative JUNE 3,

141 General Criteria: Understanding Standard & Poor's Rating Definitions ranking of observed default frequency. We may measure and report on absolute default frequencies or on secondary factors, but our primary emphasis for performance measurement always remains the relative ranking of default frequency during any given study period. Notes (1) We generally apply longer time horizons for our analysis of issuers/issues at higher rating levels. Even so, this does not fully neutralize the effect of economic cycles. (See Appendix II for illustrations of how actual default rates vary over time.) (2) Although, as set forth in our published criteria, recoveries can be a factor in some of our ratings, our credit ratings are not intended to be indicators of expected loss. Appendix I Issuer ratings, issue ratings, and other rating products Some of Standard & Poor's ratings relate to issuers and others relate to specific issues or obligations. Definitions for both are included in Appendix III. Briefly, an issuer credit rating addresses an issuer's overall capacity and willingness to meet its financial obligations. More specifically, an issuer rating usually refers to the issuer's ability and willingness to meet senior, unsecured obligations. Issuer ratings of related entities, such as ratings of a holding company and its primary operating subsidiary, may reflect the structural subordination of the holding company to the operating company debt, generally producing a lower rating for the holding company. In contrast, an issue rating relates to a specific financial obligation, a specific class of financial obligations, or a specific financial program (including ratings on medium-term note programs and commercial paper programs). The rating on a specific issue may reflect positive or negative adjustments relative to the issuer's rating for (i) the presence of collateral, (ii) explicit subordination, or (iii) any other factors that affect the payment priority, expected recovery, or credit stability of the specific issue. In addition, Standard & Poor's produces a number of specialized rating products such as (i) recovery ratings, (ii) principal stability ratings for money market funds, (iii) bond fund credit quality ratings, and (iv) national scale ratings. Descriptions of those ratings products are available on and Appendix II Variability of default rates over time Performance studies of credit ratings provide various statistics about the default rates of issuers (or issues) in different rating categories. Some readers of those studies focus intently on the average one-year default rate for each rating category and largely ignore the annual variation around the average. Another misuse of these statistics is to assume that historical average default rates represent the "probability of default" of debt in a particular rating category. JUNE 3,

142 General Criteria: Understanding Standard & Poor's Rating Definitions However, as shown in Tables 1 and 2, default rates can vary significantly from one year to the next and the observed rate for any given year can vary significantly from the average. The highest observed default rates have sometimes been very high above the average levels. In short, historical default statistics should not be used to impute specific prospective default rates to specific issuers or obligations based on their ratings, particularly over short time periods or in relation to limited segments of the rated universe. Table 1 Standard & Poor's One-Year Global Corporate Default Rates By Refined Rating Category, AAA AA+ AA AA- A+ A A- BBB+ BBB BBB- BB+ BB BB- B+ B B- CCC to C Mean Median Minimum Maximum Standard Deviation Includes ratings of financial and non-financial corporate issuers. " " means zero. JUNE 3,

143 General Criteria: Understanding Standard & Poor's Rating Definitions Table 2 Standard & Poor's One-Year Global Structured Finance Default Rates By Refined Rating Category, AAA AA+ AA AA- A+ A A- BBB+ BBB BBB- BB+ BB BB- B+ B B na na na na na na na na na na na na na na na 1979 na na na na na na na na na na na na na na 1980 na na na na na na na na na na na na na na 1981 na na na na na na na na na na na na na na 1982 na na na na na na na na na na na na na na 1983 na na na na na na na na na na na na na 1984 na na na na na na na na na na na 1985 na na na na na na na na na 1986 na na na na na na na na na na 1987 na na na na na na na na 1988 na na na na na na 1989 na na na na na 1990 na na na 1991 na na 1992 na na na na Mean Median Minimum Maximum Standard Deviation AAA' ratings from the same transaction are treated as a single rating in the calculation of this table. "na" means no data available from which to calculate a default rate. " " means zero. CCC to C JUNE 3,

144 General Criteria: Understanding Standard & Poor's Rating Definitions Appendix III Excerpts from Standard & Poor's ratings definitions Issuer credit rating definitions A Standard & Poor's issuer credit rating is a current opinion of an obligor's overall financial capacity (its creditworthiness) to pay its financial obligations. This opinion focuses on the obligor's capacity and willingness to meet its financial commitments as they come due. It does not apply to any specific financial obligation, as it does not take into account the nature of and provisions of the obligation, its standing in bankruptcy or liquidation, statutory preferences, or the legality and enforceability of the obligation. In addition, it does not take into account the creditworthiness of the guarantors, insurers, or other forms of credit enhancement on the obligation. The issuer credit rating is not a statement of fact or recommendation to purchase, sell, or hold a financial obligation issued by an obligor or make any investment decisions. Nor does it comment on market price or suitability for a particular investor. Counterparty credit ratings, ratings assigned under the Corporate Credit Rating Service (formerly called the Credit Assessment Service), and sovereign credit ratings are all forms of issuer credit ratings. Issuer credit ratings are based on current information furnished by obligors or obtained by Standard & Poor's from other sources it considers reliable. Standard & Poor's does not perform an audit in connection with any issuer credit rating and may, on occasion, rely on unaudited financial information. Issuer credit ratings may be changed, suspended, or withdrawn as a result of changes in, or unavailability of, such information, or based on other circumstances. Issuer credit ratings can be either long term or short term. Short-term issuer credit ratings reflect the obligor's creditworthiness over a short-term time horizon. Long-term issuer credit ratings AAA: An obligor rated 'AAA' has extremely strong capacity to meet its financial commitments. 'AAA' is the highest issuer credit rating assigned by Standard & Poor's. AA: An obligor rated 'AA' has very strong capacity to meet its financial commitments. It differs from the highest-rated obligors only to a small degree. A: An obligor rated 'A' has strong capacity to meet its financial commitments but is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than obligors in higher-rated categories. BBB: An obligor rated 'BBB' has adequate capacity to meet its financial commitments. However, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity of the obligor to meet its financial commitments. BB, B, CCC, and CC: Obligors rated 'BB', 'B', 'CCC', and 'CC' are regarded as having significant speculative characteristics. 'BB' indicates the least degree of speculation and 'CC' the highest. While such obligors will likely have some quality and protective characteristics, these may be outweighed by large uncertainties or major exposures to adverse conditions. BB: An obligor rated 'BB' is less vulnerable in the near term than other lower-rated obligors. However, it faces major JUNE 3,

145 General Criteria: Understanding Standard & Poor's Rating Definitions ongoing uncertainties and exposure to adverse business, financial, or economic conditions, which could lead to the obligor's inadequate capacity to meet its financial commitments. B: An obligor rated 'B' is more vulnerable than the obligors rated 'BB', but the obligor currently has the capacity to meet its financial commitments. Adverse business, financial, or economic conditions will likely impair the obligor's capacity or willingness to meet its financial commitments. CCC: An obligor rated 'CCC' is currently vulnerable, and is dependent upon favorable business, financial, and economic conditions to meet its financial commitments. CC: An obligor rated 'CC' is currently highly vulnerable. R: An obligor rated 'R' is under regulatory supervision owing to its financial condition. During the pendency of the regulatory supervision, the regulators may have the power to favor one class of obligations over others or pay some obligations and not others. Please see Standard & Poor's issue credit ratings for a more detailed description of the effects of regulatory supervision on specific issues or classes of obligations. SD and D: An obligor rated 'SD' (selective default) or 'D' has failed to pay one or more of its financial obligations (rated or unrated) when it came due. A 'D' rating is assigned when Standard & Poor's believes that the default will be a general default and that the obligor will fail to pay all or substantially all of its obligations as they come due. An 'SD' rating is assigned when Standard & Poor's believes that the obligor has selectively defaulted on a specific issue or class of obligations but it will continue to meet its payment obligations on other issues or classes of obligations in a timely manner. A selective default includes the completion of a distressed exchange offer, whereby one or more financial obligation is either repurchased for an amount of cash or replaced by other instruments having a total value that is less than par. Please see Standard & Poor's issue credit ratings for a more detailed description of the effects of a default on specific issues or classes of obligations. Issue credit rating definitions A Standard & Poor's issue credit rating is a current opinion of the creditworthiness of an obligor with respect to a specific financial obligation, a specific class of financial obligations, or a specific financial program (including ratings on medium-term note programs and commercial paper programs). It takes into consideration the creditworthiness of guarantors, insurers, or other forms of credit enhancement on the obligation and takes into account the currency in which the obligation is denominated. The opinion evaluates the obligor's capacity and willingness to meet its financial commitments as they come due, and may assess terms, such as collateral security and subordination, which could affect ultimate payment in the event of default. The issue credit rating is not a statement of fact or recommendation to purchase, sell, or hold a financial obligation or make any investment decisions. Nor is it a comment regarding an issue's market price or suitability for a particular investor. Issue credit ratings are based on current information furnished by the obligors or obtained by Standard & Poor's from other sources it considers reliable. Standard & Poor's does not perform an audit in connection with any credit rating and may, on occasion, rely on unaudited financial information. Credit ratings may be changed, suspended, or withdrawn as a result of changes in, or unavailability of, such information, or based on other circumstances. JUNE 3,

146 General Criteria: Understanding Standard & Poor's Rating Definitions Issue credit ratings can be either long term or short term. Short-term ratings are generally assigned to those obligations considered short-term in the relevant market. In the U.S., for example, that means obligations with an original maturity of no more than 365 days--including commercial paper. Short-term ratings are also used to indicate the creditworthiness of an obligor with respect to put features on long-term obligations. The result is a dual rating, in which the short-term rating addresses the put feature, in addition to the usual long-term rating. Medium-term notes are assigned long-term ratings. Long-term issue credit ratings Issue credit ratings are based, in varying degrees, on the following considerations: Likelihood of payment--capacity and willingness of the obligor to meet its financial commitment on an obligation in accordance with the terms of the obligation; Nature of and provisions of the obligation; Protection afforded by, and relative position of, the obligation in the event of bankruptcy, reorganization, or other arrangement under the laws of bankruptcy and other laws affecting creditors' rights. Issue ratings are an assessment of default risk, but may incorporate an assessment of relative seniority or ultimate recovery in the event of default. Junior obligations are typically rated lower than senior obligations, to reflect the lower priority in bankruptcy, as noted above. (Such differentiation may apply when an entity has both senior and subordinated obligations, secured and unsecured obligations, or operating company and holding company obligations.) AAA: An obligation rated 'AAA' has the highest rating assigned by Standard & Poor's. The obligor's capacity to meet its financial commitment on the obligation is extremely strong. AA: An obligation rated 'AA' differs from the highest-rated obligations only to a small degree. The obligor's capacity to meet its financial commitment on the obligation is very strong. A: An obligation rated 'A' is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than obligations in higher-rated categories. However, the obligor's capacity to meet its financial commitment on the obligation is still strong. BBB: An obligation rated 'BBB' exhibits adequate protection parameters. However, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity of the obligor to meet its financial commitment on the obligation. BB, B, CCC, CC, and C: Obligations rated 'BB', 'B', 'CCC', 'CC', and 'C' are regarded as having significant speculative characteristics. 'BB' indicates the least degree of speculation and 'C' the highest. While such obligations will likely have some quality and protective characteristics, these may be outweighed by large uncertainties or major exposures to adverse conditions. BB: An obligation rated 'BB' is less vulnerable to nonpayment than other speculative issues. However, it faces major ongoing uncertainties or exposure to adverse business, financial, or economic conditions, which could lead to the obligor's inadequate capacity to meet its financial commitment on the obligation. B: An obligation rated 'B' is more vulnerable to nonpayment than obligations rated 'BB', but the obligor currently has JUNE 3,

147 General Criteria: Understanding Standard & Poor's Rating Definitions the capacity to meet its financial commitment on the obligation. Adverse business, financial, or economic conditions will likely impair the obligor's capacity or willingness to meet its financial commitment on the obligation. CCC: An obligation rated 'CCC' is currently vulnerable to nonpayment, and is dependent upon favorable business, financial, and economic conditions for the obligor to meet its financial commitment on the obligation. In the event of adverse business, financial, or economic conditions, the obligor is not likely to have the capacity to meet its financial commitment on the obligation. CC: An obligation rated 'CC' is currently highly vulnerable to nonpayment. C: A 'C' rating is assigned to obligations that are currently highly vulnerable to nonpayment, obligations that have payment arrearages allowed by the terms of the documents, or obligations of an issuer that is the subject of a bankruptcy petition or similar action which have not experienced a payment default. Among others, the 'C' rating may be assigned to subordinated debt, preferred stock or other obligations on which cash payments have been suspended in accordance with the instrument's terms or when preferred stock is the subject of a distressed exchange offer, whereby some or all of the issue is either repurchased for an amount of cash or replaced by other instruments having a total value that is less than par. D: An obligation rated 'D' is in payment default. The 'D' rating category is used when payments on an obligation are not made on the date due even if the applicable grace period has not expired, unless Standard & Poor's believes that such payments will be made during such grace period. The 'D' rating also will be used upon the filing of a bankruptcy petition or the taking of similar action if payments on an obligation are jeopardized. An obligation's rating is lowered to 'D' upon completion of a distressed exchange offer, whereby some or all of the issue is either repurchased for an amount of cash or replaced by other instruments having a total value that is less than par. Appendix IV Stress scenario examples for promoting ratings comparability This appendix contains hypothetical stress scenarios that we will use for promoting ratings comparability. We will use the scenarios as benchmarks for calibrating our criteria across different sectors and over time. The scenarios will not become part of the rating definitions. Nor will they become the sole or primary drivers of our criteria. However, they will be an important tool for calibrating our criteria to help maintain comparability across sectors and over time. Each scenario broadly corresponds to one of the rating categories 'AAA' through 'B'. The scenario for a particular rating category reflects a level of stress that issuers or obligations rated in that category should, in our view, be able to withstand without defaulting. That does not mean that rated credits would not be expected to suffer downgrades. On the contrary, we believe that the occurrence of stress conditions that might be characterized as "substantial," "severe," or "extreme" likely would produce large numbers of downgrades of rated issuers and obligations. The scenarios do not represent a guarantee that rated entities will not default in those or similar scenarios. The scenarios presume a starting point of "benign conditions" and a fairly rapid path of deterioration in economic conditions. Starting conditions that are less favorable would require proportionally more adverse scenarios. JUNE 3,

148 General Criteria: Understanding Standard & Poor's Rating Definitions Accordingly, the scenarios are not part of the rating definitions, which apply universally in all economic environments. For example, for an issuer to attain a rating of 'AAA' it must have "extremely strong" capacity to meet its financial commitments under the actual conditions at the time of consideration. If the starting conditions are adverse, then the credit must have the capacity to withstand further deterioration of "extreme" magnitude. Moreover, each of the scenarios below reflects only a single example of stress at a given level. Naturally, a given measure of stress potentially could result from a nearly infinite combination of factors contributing to the intensity and duration of the episode. In fact, some real-world occurrences may include successive shocks (the Great Depression was an example). The stress scenarios generally contemplate issuers or obligations from countries with highly developed economies (i.e., the U.S., Japan, Australia, etc.). Even among developed economies, however, the scenarios may require adjustments for structural differences in specific countries, such as above-average unemployment rates even during periods of economic expansion. For example, the average unemployment rate for EU countries tends to be about three percentage points higher than that of the U.S. Likewise, for developing economies even greater adjustments would be appropriate because such economies may experience pronounced swings in GDP and unemployment at fairly frequent intervals. Moreover, criteria for rating credits above sovereign rating levels in developing economies should reflect scenarios in which the sovereign itself defaults. Therefore, although the scenarios below are the ones that we will use as our main benchmarks for enhancing comparability of ratings across sectors, market participants should not interpret them as the only scenarios we may consider. On the contrary, market participants should understand that the scenarios may be adjusted depending on economic conditions (as described two paragraphs above) or depending on geographic and sector-specific factors, as applicable. Apart from the notion of general economic stress, issuers and obligations, particularly those at the lower rating levels ('BB' and 'B'), may be vulnerable to default even during benign conditions because of sector-specific or issuer-specific characteristics and events. Accordingly, the inclusion of stress scenarios corresponding to the lower rating levels should not be interpreted as an indication that there should not be defaults of lower-rated issuers and obligations in the absence of stress conditions. 'AAA' stress scenario. An issuer or obligation rated 'AAA' should be able to withstand an extreme level of stress and still meet its financial obligations. A historical example of such a scenario is the Great Depression in the U.S. In that episode, real GDP for the U.S. declined by 26.5% from 1929 through U.S. unemployment peaked at 24.9% in 1933 and was above 20% from 1932 through U.S. industrial production declined by 47% and home building dropped by 80% from 1929 through The stock market dropped by 85% from September 1929 to July 1932 (as measured by the Dow Jones Industrial Average). The U.S. experienced deflation of roughly 25%. Real GDP did not recover to its 1929 level until Nominal GDP did not recover until We consider conditions such as these to reflect extreme stress. The 'AAA' stress scenario envisions a widespread collapse of consumer confidence. The financial system suffers major dislocations. Economic decline propagates around the globe. 'AA' stress scenario. An issuer or obligation rated 'AA' should be able to withstand a severe level of stress and still meet its financial obligations. Such a scenario could include GDP declines of up to 15%, unemployment levels of up to 20%, and stock market declines of up to 70%. JUNE 3,

149 General Criteria: Understanding Standard & Poor's Rating Definitions 'A' stress scenario. An issuer or obligation rated 'A' should be able to withstand a substantial level of stress and still meet its financial obligations. In such a scenario, GDP could decline by as much as 6% and unemployment could reach up to 15%. The stock market could drop by up to 60%. 'BBB' stress scenario. An issuer or obligation rated 'BBB' should be able to withstand a moderate level of stress and still meet its financial obligations. A GDP decline of as much as 3% and unemployment at 10% would be reflective of a moderate stress scenario. A drop in the stock market by up to 50% would similarly indicate moderate stress. 'BB' stress scenario. An issuer or obligation rated 'BB' should be able to withstand a modest level of stress and still meet its financial obligations. For example, GDP might decline by as much as 1% and unemployment might reach 8%. The stock market could drop by up to 25%. 'B' stress scenario. An issuer or obligation rated 'B' should be able to withstand a mild level of stress and still meet its financial obligations. Scenarios in which GDP is flat or declines by as much as 0.5% and unemployment is in the area of 6% or less could be viewed as mild stress scenarios. A flat stock market or a drop by up to 10% would be another indicator of such a scenario. Appendix V Historical stress examples Table 3 Selected Recessions And Financial Crises And Standard & Poor's View Of Corresponding Stress Levels (U.S. unless otherwise noted) Name Duration (interval or months) Real GDP decline (%) Unemployment peak (%) Stress Level Notes Panic of NA NA BB (U.S.) Market disruptions caused by deflationary pressures from Britain. Depression of NA NA BBB (U.S.) The Embargo Act of 1807 suppressed shipping-related industries and led to increased smuggling in New England. Panic of NA NA A (U.S.) This was the first major financial crisis in the U.S. There was significant unemployment and declines in both manufacturing and agriculture. Panic of NA NA AA (U.S.) Bursting of a speculative bubble and loss of confidence in paper money led to a five-year depression. About 40% of U.S. banks closed. Banks stopped paying in gold and silver coinage. Some consider this to be a depression comparable in scope and severity to the Great Depression. Panic of months NA NA AAA (U.S.) Every U.S. railroad bond defaulted. More than 5,000 businesses failed during the first year. Bank failures were widespread. The full impact of this recession did not dissipate until after the Civil War. Poor s Manual was first published in the immediate wake of this recession. Panic of months NA NA BBB (U.S.) The start of the Long Depression in Europe caused the bursting of the post-civil War speculative bubble in the U.S. Long Depression NA NA AA (Britain) The collapse of the Vienna Stock Exchange caused a depression that spread around the globe. JUNE 3,

150 General Criteria: Understanding Standard & Poor's Rating Definitions Table 3 Selected Recessions And Financial Crises And Standard & Poor's View Of Corresponding Stress Levels (cont.) Panic of months (2.6) 18.4 AA (U.S.) This event involved the failure of more than 15,000 companies and 500 banks. Overbuilding of railroads was one of the key causes. A major protest march by unemployed workers--known as Coxey's Army--occurred during this event. Panic of months (3) 8 A (U.S.) A failed attempt to corner the copper market started a chain of bank failures, including the collapse of Knickerbocker Trust Co. Intervention by J.P. Morgan may have helped to dampen the intensity of the event. Post-World War I recession (U.S.) Post-World War I recession (U.K.) Spanish Civil War Great Depression (First Leg) (1929) Great Depression (Second Leg) (1937) World War II (France) World War II (Germany) 18 months (6.6) 11.7 A (U.S.) A brief post-war recession involving high unemployment because of returning troops. 14 months (19.2) NA AA (U.K.) Severe post-war recession spanning three years of sharply declining GDP. 16 months (31.3) NA >AAA (Spain) Civil war in which the Second Spanish Republic was overthrown and replaced by the fascist Franco regime. 43 months (26.5) 24.9 AAA (U.S.) Probably the worst depression in U.S. history, involving very high unemployment and sharp declines in GDP and industrial production. The event was accompanied by the "Dust Bowl" ecological disaster in the High Plains region. 13 months (3.4) 19 AAA (U.S.) Second leg of Depression. Retightened monetary and fiscal policy after initial recovery. 24 months (41.4) NA >AAA (France) Global military conflict that involved most of the world's nations, including Britain, Japan, France, Germany, Italy, the Soviet Union, and the U.S. 16 months (73.6) NA >AAA (Germany) Global military conflict that involved most of the world's nations, including Britain, Japan, France, Germany, Italy, the Soviet Union, and the U.S months (12.8) 3.9 BB (U.S.) Drop in military spending after WWII. Return of soldiers looking for work. A brief but sharp recession months (3.4) 7.9 BBB (U.S.) Inventory correction after postwar recovery months (1.8) 6.1 BB (U.S.) Post-Korean War military build-up accompanied by tighter Fed policy to fight inflation months (2.7) 7.5 BBB (U.S.) This recession extended to many developed countries. U.S. auto sales dropped 31% in 1958 relative to months (1.6) 7.1 BB (U.S.) Monetary policy tightened to fight inflation and housing boom months (1.1) 6.1 BB (U.S.) High interest rates were put in to fight inflation. A GM strike deepened the recession Oil Crisis 16 months (3.1) 9 BBB (U.S.) OPEC countries initiated an oil embargo against the U.S. in reaction to U.S. support for Israel during the Yom Kippur War. The oil embargo combined with high government spending on the Vietnam War resulted in a sharp stock market decline and an extended period of stagflation (i.e., high unemployment and high inflation at the same time) in the U.S Oil Crisis (U.K.) 11 months (5.9) 11.9 BBB/A (U.K.) Recession triggered by reduced public sector spending and monetary policies designed to reduce inflation. JUNE 3,

151 General Criteria: Understanding Standard & Poor's Rating Definitions Table 3 Selected Recessions And Financial Crises And Standard & Poor's View Of Corresponding Stress Levels (cont.) Early 1980s recessions (1980) Early 1980s recessions (1982) Latin American Debt Crisis Japanese Bubble (1989) Early 1990s recession (U.S.) Early 1990s recession (U.K.) Early 1990s Nordic Banking Crisis (Sweden) 1994 Mexican Economic Crisis Thai Currency Crisis ( ) 1998 Russian Financial Crisis Argentine Economic Crisis ( ) 6 months (2.2) 7.8 BB (U.S.) Oil prices rose sharply in the wake of the 1979 Iranian Revolution and the new Iranian regime's oil export policies. Credit controls imposed by the Carter Administration suppressed consumer spending. 16 months (2.9) 10.8 BBB (U.S.) Attempting to control inflation, the Fed's tight monetary policy produced another recession. The focus on inflation was a remnant of the previous decade's high inflation driven by oil prices. 1981#1982 NA NA A (Latin America); BB (global) >200 months NA NA BBB (Japan); BB (global) Latin American countries borrowed heavily in the 1960s and 1970s to finance industrialization and infrastructure. Large fiscal and external imbalances led to sharply weaker local currencies, raising the burden of servicing foreign currency debt. Japanese real estate and stock prices rose sharply from 1986 through 1989 and then started a slow but lengthy process of decline that continues through months (1.3) 6.9 BB (U.S.) Although this recession was modest in overall terms, it had stronger effects on the West Coast of the U.S., where it coincided with the bursting of a regional real estate bubble. 6 months (2.6) 10.7 BBB (U.K.) A short but somewhat severe recession. Britain faced both a fiscal deficit and a current account deficit. These amplified pressures on the European exchange rate mechanism through which the British pound was tied to the Deutsche Mark. The recession also was tied to banking sector problems in both the U.S. and Sweden. 13 months (5.6) 8.3 BBB (Sweden) Bursting of a real estate bubble caused a credit crunch and deleveraging in Nordic countries. The impact was most pronounced in Sweden. 9 months (15) NA AA (Mexico); BB (global) 15 months (12.5) NA AA (Thailand); BB (global) 12 months (9.1) 12.2 A/AA (Russia); BB (global) ~48 months (25) 21 AAA (Argentina); BB (global) Years of deficit spending, current account deficits, and unprecedented political uncertainty led to capital flight. This undermined the fixed exchange rate, produced devaluation of the peso, and led to high inflation, a banking crisis, and a recession. A $20 billion loan from the U.S. in early 1995 helped resolve the crisis. Mexico repaid the loan in Many years of rapid growth and expansion of bank lending resulted in inflated asset values and a growing current account deficit. Resulting devaluation of Thai Baht triggered a regional financial crisis across the emerging markets of East Asia. The worst macro effects were concentrated in Thailand, Indonesia, Malaysia, and South Korea. This event was triggered by falling commodity prices, in the wake of the 1997 Asian Financial Crisis, which exacerbated Russia's mushrooming fiscal pressures. The Russian stock market declined 75% from January to August. Yields on Rubble-denominated bonds reached 200%. Inflation reached 84%. The Argentine peso was pegged to the U.S. dollar. The strength of the U.S. dollar, low commodity prices for Argentine exports, and loose fiscal policy undermined the country s ability to grow, leading to a severe recession and capital flight. In late 2001, the government undertook a distressed debt exchange, devalued the currency, and subsequently imposed a broad moratorium on sovereign debt repayment. JUNE 3,

152 General Criteria: Understanding Standard & Poor's Rating Definitions Table 3 Selected Recessions And Financial Crises And Standard & Poor's View Of Corresponding Stress Levels (cont.) 2001 Recession 8 months (0.3) 6.2 BB (U.S.) Corporate accounting scandals and the bursting of the tech bubble contributed to a modest recession. U.S. recessions are included from the National Bureau of Economic Research canon after 1945; before 1945 only a selective list. Based on annual GDP and unemployment data before NA--Not available. Sources: National Bureau of Economic Research; U.S. Dept. of Commerce, Bureau of Economic Analysis; U.S. Dept. of Labor, Bureau of Labor Statistics; Romer, C., Remeasuring Business Cycles, Journal of Economic History, vol. 54 (Sept. 1994); Barro, J.R. et al., "Macroeconomic Crises Since 1870," Working Paper 13940, National Bureau of Economic Research, April 2008; Bloomberg. International cycles Business cycles have sometimes been coincident around the world, while others have affected only one country or region. Most recent cycles have affected both the U.S. and Europe, although there have been exceptions. Table 4 reveals how recent cycles have affected several major countries at the same time. Table 4 Downturns in Real GDP, U.S. Canada U.K. Germany France Italy 1957 X X X X X X X X X X X X X X X X X X 2001 X Sources: Cooper, R. "Beyond Shocks," Federal Reserve Bank of Boston (1998). JUNE 3,

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154 General Criteria: Ratings Above The Sovereign--Corporate And Government Ratings: Methodology And Assumptions Primary Contact: Laura J Feinland Katz, CFA, Criteria Officer, Emerging Markets, New York (1) ; laura.feinland.katz@standardandpoors.com Corporate Ratings: Elena Anankina, CFA, Moscow (7) ; elena.anankina@standardandpoors.com Mehul P Sukkawala, CFA, Singapore (65) ; mehul.sukkawala@standardandpoors.com Peter Kernan, Criteria Officer, London (44) ; peter.kernan@standardandpoors.com Financial Institutions Ratings: Arnaud DeToytot, Paris (33) ; arnaud.detoytot@standardandpoors.com Michelle M Brennan, Criteria Officer, London (44) ; michelle.brennan@standardandpoors.com Insurance Ratings: Rob C Jones, London (44) ; rob.jones@standardandpoors.com Rodney A Clark, FSA, New York (1) ; rodney.clark@standardandpoors.com Emmanuel Dubois-Pelerin, Criteria Officer, Global Financial Services, Paris (33) ; emmanuel.dubois-pelerin@standardandpoors.com Taos D Fudji, Milan (39) ; taos.fudji@standardandpoors.com Public Finance Ratings: Cathy L Daicoff, Criteria Officer, U.S. Public Finance, New York (1) ; cathy.daicoff@standardandpoors.com Olga I Kalinina, CFA, Criteria Officer, Sovereigns And International Public Finance, New York (1) ; olga.kalinina@standardandpoors.com Structured Finance Ratings: Nancy G Chu, Criteria Officer, RMBS--Americas, New York (1) ; nancy.chu@standardandpoors.com Chief Credit Officers: NOVEMBER 19,

155 Lucy A Collett, Americas, New York (1) ; lucy.collett@standardandpoors.com Lapo Guadagnuolo, EMEA, London (44) ; lapo.guadagnuolo@standardandpoors.com Fabienne Michaux, Asia-Pacific, Melbourne (61) ; fabienne.michaux@standardandpoors.com Ian D Thompson, London (44) ; ian.thompson@standardandpoors.com Table Of Contents SCOPE OF THE CRITERIA SUMMARY OF THE CRITERIA EFFECTIVE DATE IMPACT ON OUTSTANDING RATINGS METHODOLOGY A. Criteria Calibration B. Ratings Above The Sovereign: The Pass/Fail Stress Test C. Ratings Above The Sovereign: The Maximum Rating Differential Between Nonsovereign Entity Ratings And The Related Sovereign Rating D. Determining The Final Rating Differential From The Sovereign Rating E. Government-Related Entities (GREs) F. Other Situations G. Transfer & Convertibility Assessment APPENDIX I APPENDIX II: Data And Additional Details For "Sovereign Default Scenarios": Basis For Stress Test For Ratings Above The Sovereign APPENDIX III: Changes Compared To Previous Criteria RELATED CRITERIA AND RESEARCH NOVEMBER 19,

156 General Criteria: Ratings Above The Sovereign--Corporate And Government Ratings: Methodology And Assumptions (Editor's Note: This article was updated on Nov. 20, 2013, for minor formatting changes and to incorporate a correction to table 2. These changes did not affect the substance of the criteria. We are republishing this article following our periodic review, completed on Oct. 30, In addition, we are adding a clarifying example to table 3, scenario B, regarding the local currency devaluation assumption.) 1. Standard & Poor's Ratings Services is updating its methodology for considering in what cases we will rate nonsovereign entities at a higher rating level than the sovereign, with respect to corporate ratings (including on project finance, financial institutions, and insurance companies) and local and regional government ratings (including public-sector enterprises). The criteria combine the following aspects: The potential to rate entities above the sovereign, if we believe the entity would not default in the stress scenario likely to accompany a sovereign default. A framework that indicates by how many notches an entity rating can exceed the sovereign rating, depending primarily on the sensitivity of the entity's sector to country risk: up to 2 notches in case of 'high sensitivity' to country risk, and up to 4 notches in case of 'moderate sensitivity' to country risk; and Rating caps for foreign currency ratings, related to transfer and convertibility (T&C) risk, unless there are mitigating factors for T&C risk. 2. The criteria update follows our request for comment, "Request For Comment: Ratings Above The Sovereign--Corporate And Government Ratings," published April 12, These criteria constitute a global framework that supersedes "Nonsovereign Ratings That Exceed EMU Sovereign Ratings: Methodology And Assumptions" ("EMU criteria"), published June 14, 2011, with respect to corporate and nonsovereign government ratings. A related criteria request for comment with respect to structured finance ratings, "Request For Comment: Methodology And Assumptions For Ratings Above the Sovereign--Single Jurisdiction Structured Finance," was published Oct. 14, The criteria also supersede, in part, the sections in several criteria articles that refer to ratings above the sovereign, such as "Criteria For Determining Transfer And Convertibility Assessments," published May 18, 2009 (the sections "Ratings Above The Sovereign's" and "Ratings Above The T&C Assessment"); see "Related Criteria And Research" at the end of this article. 3. These criteria bring additional clarity and comparability to our global approach for considering nonsovereign ratings above that of the sovereign, with respect to corporate and government ratings. A related criteria article, "Country Risk Assessment Methodology And Assumptions," published Nov. 19, 2013, introduces a new benchmark, the country risk assessment. This ranking (on a 1 to 6 scale) of identified country risks is one aspect of certain sector-specific criteria we use to determine the ratings of identified entities, such as corporate ratings. Country risk addresses the broad range of economic, institutional, financial market, and legal risks that arise from doing business with or in a specific country, and can affect a nonsovereign entity's credit quality regardless of where it lies on the rating spectrum. NOVEMBER 19,

157 General Criteria: Ratings Above The Sovereign--Corporate And Government Ratings: Methodology And Assumptions 4. Standard & Poor's view is that not all ratings need to be constrained at the level of the sovereign rating. Evidence from the past 20 years of sovereign crises and defaults (see Appendix II) supports two key notions that are reaffirmed in our criteria: (1) A sovereign default does not imply that every entity in the country will default, but (2) The economic stress that historically accompanies a sovereign default would be considered severe and would lead to a significant increase in nonsovereign defaults. 5. In this updated global framework for ratings above the sovereign, we are aligning our treatment of developed and developing markets. In doing so, we are introducing a few key changes from the EMU criteria. We believe many unique country risk considerations in the European Economic and Monetary Union (EMU) remain valid. But, we now believe certain sectors' sensitivity to country risk is higher than we previously thought, particularly for entities in countries that are part of a monetary union, such as Greece, Portugal, Spain, and Ireland. In addition, we have observed a greater degree of tail risk--that is, low-probability but high-severity event risk (such as the risk of a monetary union exit, which, in our view, reached significant levels in Greece, or the imposition of a deposit freeze and capital controls, which occurred in Cyprus)--when a country is experiencing severe economic stress or upon a sovereign default. 6. Therefore, we do not distinguish between EMU and non-emu member countries with respect to the application of a formal sovereign default stress scenario and the maximum differentiation of notches relative to the respective sovereign rating. 7. The criteria constitute specific methodologies and assumptions under "Principles Of Credit Ratings," published Feb. 16, SCOPE OF THE CRITERIA 8. The criteria apply to global scale ratings for corporates (including project finance issue ratings); financial institutions; insurance companies; state, local, and regional governments (including public finance issue ratings), inclusive of government-related entities (GREs) and public sector enterprises (both sovereign and local-government-related). Public finance single- and multifamily housing bonds and municipal pools are not within the scope of these criteria; they are covered by the related criteria for structured finance, which was proposed in a separate request for comment (see "Request For Comment: Methodology And Assumptions For Ratings Above the Sovereign--Single Jurisdiction Structured Finance," Oct. 14, 2013). SUMMARY OF THE CRITERIA 9. An entity can be rated above the sovereign foreign currency rating if, in our view, there is an appreciable likelihood that it would not default if the sovereign were to default. For entities where the sovereign is rated 'A+' or lower, we apply a simulated sovereign stress scenario. Entities that "pass" such a stress test (or, for sovereigns rated 'AA-' and higher, entities that have characteristics that can mitigate a sovereign stress scenario and whose creditworthiness does not depend on direct linkages to the sovereign) can be rated up to 2 or up to 4 notches above the sovereign foreign currency rating, depending on whether we view their sector's sensitivity to country risk as 'high' or 'moderate', NOVEMBER 19,

158 General Criteria: Ratings Above The Sovereign--Corporate And Government Ratings: Methodology And Assumptions respectively. Additional specifics of these steps are explained below. 10. We first determine the entity's potential rating, which we compare with the sovereign foreign currency rating on the country (or countries) where the entity has material exposure(s). By "potential" rating, we mean the rating that we would assign according to the relevant criteria for the entity, such as corporate rating criteria, bank rating criteria, etc., prior to considering any sovereign stress scenario. The potential rating incorporates our view of the entity's exposure to the broad set of relevant country risks. The sovereign rating does not act as a "ceiling" for ratings. However, when rating an entity above the sovereign foreign currency rating, Standard & Poor's is expressing its view that the entity has sufficient creditworthiness to withstand a sovereign default. In other words, an entity rated above the sovereign should have the ability to service its debt superior to that of the sovereign, and ultimately, if there is a sovereign foreign currency default, there should be an appreciable likelihood that the issuer will not default as a result of the scenario accompanying the sovereign default. 11. Therefore, for an entity to be rated above the respective sovereign foreign currency rating, we will apply a hypothetical sovereign foreign currency default stress scenario (stress test). This stress test is applied with respect to the country (or countries) where the entity has material concentration(s) of exposure and where the potential rating would exceed the foreign currency rating on the sovereign. The general nature of a sovereign default stress scenario as well as sector-specific assumptions are described later, in the section titled "Ratings Above The Sovereign: The Pass/Fail Stress Test." 12. When we are considering a rating above the sovereign local currency rating, even if the latter equals the foreign currency rating, the entity should be able to pass an appropriately more stressful scenario associated with both a sovereign foreign and a local currency default. The main difference between the sovereign foreign and local currency default scenarios is the incremental adverse effect that a default on sovereign local currency securities would have on the liquidity and investment positions of entities holding those securities. 13. For entities that pass the stress test described in the "Methodology" section titled "Ratings Above The Sovereign: The Pass/Fail Stress Test," the criteria allow a rating differential of up to four notches above the referenced sovereign foreign currency rating, with additional rating elevation possible in case of structural enhancements or external support. The maximum number of notches above the referenced sovereign foreign currency rating depends on the entity's relative sensitivity to country risk, as specified in tables 1 and 2. The referenced sovereign foreign currency rating for a single-jurisdiction entity is the entity's country of domicile; for a multijurisdiction entity, it may be the domicile or derived using a blended approach. The domicile is generally used for financial institutions, insurance, and local governments, and a blended (weighted average) approach is usually used for corporates, as explained in paragraphs The purpose of this framework is also to anticipate low-probability but high-severity event risks associated with sovereign distress and default scenarios, which are not specifically captured by the stress test. These types of events could include a deposit freeze, currency redenomination, or geopolitical risks. We evaluate external credit support (such as from a foreign-domiciled entity), under the relevant criteria, such as "Group Rating Methodology," published Nov. 19, 2013, or "Assessing Bank Branch Creditworthiness," published Oct. 14, 2013, for implicit parent support; or our guarantee criteria, such as "Guarantee Criteria--Structured Finance," published May 7, Based on these NOVEMBER 19,

159 General Criteria: Ratings Above The Sovereign--Corporate And Government Ratings: Methodology And Assumptions criteria relating to external credit support, we could rate an entity above the maximum rating differential specified by this criteria article. 15. Table 1 lists the relative degree of sensitivity to country risk by sector. 16. The final step in the criteria applies to non-sovereign foreign currency ratings only. It is to consider whether the rating is constrained by the T&C assessment. A country's T&C assessment reflects Standard & Poor's view of the likelihood of a sovereign's restricting nonsovereign access to foreign exchange needed to satisfy the nonsovereign's debt-service obligations. (See "Methodology: Criteria For Determining Transfer And Convertibility Assessments," published May 18, 2009.) 17. Foreign currency ratings on nonsovereign entities are generally the lower of the local currency rating on the issuer or the T&C assessment. However, the rating may exceed the T&C assessment, depending on the entity's expected resilience to a T&C event and exposure to a given jurisdiction. (See paragraphs for further details, including reference to caps where exposure is 50% or higher to a given jurisdiction, and stress tests for T&C events where exposure is 25% or greater to a given jurisdiction.) 18. The T&C-related stress test and caps apply only to foreign currency ratings; local currency ratings are guided by the application of these criteria, but are not constrained by T&C risk. NOVEMBER 19,

160 General Criteria: Ratings Above The Sovereign--Corporate And Government Ratings: Methodology And Assumptions 19. Note 1: In addition to the steps in this chart, we may evaluate group support, or structural aspects, in order to consider whether a rating can exceed the sovereign. See paragraphs 42 and Note 2: In a country rated 'AA-' or above, Step 3 is not required ("Apply stress test for Ratings Above the Sovereign"), although as per paragraph 38, we review considerations to be rated above the sovereign from a qualitative perspective. NOVEMBER 19,

161 General Criteria: Ratings Above The Sovereign--Corporate And Government Ratings: Methodology And Assumptions Table 1 Determining A Non-Sovereign Entity's Sensitivity To Country Risk Moderate sensitivity examples Industries not listed in the high sensitivity section are generally considered moderate sensitivity, as per paragraph 48. Below are some examples of moderate sensitivity industries: Non-life insurers (property/casualty, reinsurance, non-savings-based health insurers) Financial market infrastructure companies (such as exchanges, transaction processors (for credit card payments), except clearinghouses) Telecommunications, cable companies Exporting natural-resource producers Exporting cyclical companies (steel, chemicals, autos, cement, and capital goods) Staple consumer product manufacturers, including beverages Food retailers Pharmaceutical companies High sensitivity examples* Life insurers, life re-insurers, savings-based health insurers, composite insurers with a majority of life liabilities, insurers with business closely correlated with economic cycles Financial institutions Financial clearinghouses Real estate sector: homebuilders, real estate investment trusts, property developers, real estate management companies, construction companies Non-exporting natural-resource producers Non-exporting cyclical companies (steel, chemicals, autos, cement and capital goods) Domestic investment holding companies Deregulated power generation and supply companies Regulated utility network infrastructure (investor-owned and not-for-profit) Transport infrastructure companies Local and regional governments** Public finance enterprise sectors: health care, higher education, housing, and not-for-profits** *Government-related entities (GREs), regardless of their industry sector, typically are considered to have high sensitivity to country risk, with certain exceptions. See paragraphs for specific considerations for GREs. **Certain local and regional governments, and certain related enterprise sectors, may have moderate sensitivity to country risk. The requirements are described in paragraph 45. Note: On a country-by-country basis, we may change industry sensitivity classifications. Any such changes are governed by paragraphs 44-45, and listed in Appendix I, as may be updated and republished in the future. Table 2 Determining The Maximum Rating Differential Between The Sovereign Foreign Currency Rating And The Issuer (Foreign And Local Currency) Rating Country risk sensitivity* For sovereign ratings B or higher, the maximum differential above the sovereign rating High 2 notches B+ Moderate 4 notches BB For sovereign ratings of B- to D or SD, the maximum non-sovereign rating *Per table 1. We apply analytical judgment in making the final determination about the rating differential, on a case-by-case basis, up to the maximum (see paragraph 50). Limits on the maximum differential may also apply for a given country and sector; for example, certain local and regional governments have moderate sensitivity to country risk, but can be rated only up to 3 notches above the sovereign, subject to certain additional requirements, per paragraph 52. Note: For entities with more than 70% exposure to a single country with significant adverse currency redenomination risk, the maximum rating is B. Significant adverse currency redenomination risk applies when we assess a 1-in-3 or greater likelihood that a country will exit its currency regime, such as leaving a monetary union, and when we expect the redenomination to have a negative credit effect. NOVEMBER 19,

162 General Criteria: Ratings Above The Sovereign--Corporate And Government Ratings: Methodology And Assumptions EFFECTIVE DATE 20. These criteria are effective immediately on the date of publication. We intend to complete our review of potentially affected ratings within the next six months. IMPACT ON OUTSTANDING RATINGS 21. We expect somewhat fewer rating changes as a result of the application of these criteria than we expected at the time we published the request for comment. We expect up to 25 financial groups to be affected within financial services ratings, up to 15 entities to be affected within corporate and project finance ratings, and no impact for local and regional governments and their related public-sector enterprises. The impact for corporate ratings will be predominantly upgrades, mostly with respect to local currency ratings; the impact for financial services will be a mix of upgrades and downgrades, the latter for entities which do not pass the stress test for ratings to exceed the sovereign foreign currency rating. METHODOLOGY A. Criteria Calibration 22. In "Understanding Standard & Poor's Rating Definitions," published June 3, 2009, Standard & Poor's described selected financial crises and defined them in terms of the stress associated with a given rating level. The crises associated with sovereign default or distress were among the highest severity: Argentina in 2001 ('AAA' stress scenario), Mexico in 1994 ('AA' stress scenario), Thailand in 1997 ('AA' stress scenario), and Russia in 1998 ('A'/'AA' stress scenarios). The recent crisis in Greece exhibited macroeconomic volatility associated with an 'AA' stress scenario. These stress levels informed our stress test for ratings above the sovereign. The macroeconomic stress for this stress test is similar to that used in our definition of an 'AA' stress scenario, as we have typically observed such severity in a sovereign default and distress case. For example, the real GDP declines in the cases listed above were as follows (cumulative declines cited, unless a single year is given): Argentina, 25% ( ); Mexico, 15% ( ); Thailand, 12.5% ( ); Russia, 9.1% (1998); Greece, 7.1% in 2011, followed by 6.8% in 2012, with a cumulative decline over 20% expected between (For more details on the observed data, please see Appendix II and "Understanding Standard & Poor's Rating Definitions," published June 3, 2009.) 23. There is a high correlation between corporate default rates and sovereign crises and macroeconomic volatility, as our emerging-market default study supports (see "2012 Emerging Markets Corporate Default Study And Rating Transitions: The Region's Default Rate Exceeds The Global Rate For The Fourth Time In History," published March 27, 2013). According to this study, global emerging-market speculative-grade default rates peaked in 2002 at 16% after the Argentina sovereign crisis and heightened macroeconomic volatility in Brazil. This peak default rate was significantly higher than the record speculative-grade global corporate default rate of 11% in The other significant peak in emerging-market speculative-grade default rates was 8% in 1998 related to the Russian and Asian NOVEMBER 19,

163 General Criteria: Ratings Above The Sovereign--Corporate And Government Ratings: Methodology And Assumptions macroeconomic crises. 24. For developed markets, our global default studies also demonstrate significant correlation of defaults with weak points in business cycles and banking crises. The 1991 peak default rate referred to above occurred after a mild recession in the U.S., a severe but short recession in the U.K., and the Nordic banking crisis. Other developed-market speculative-grade default peaks were the U.S., at 10.6% in 2001 (the U.S. recession) and 11.4% in 2009 (the global banking crisis and recession); and Europe, at 12.3% in 2002 (due in part to the bursting of the technology/internet bubble and failures of a large number of telecom start-ups). (Sources: "2012 Annual Global Corporate Default Study," published March 18, 2013, and "Understanding Standard & Poor's Rating Definitions," published June 3, 2009.) 25. For calibration of sensitivity to country risk by industry ('moderate' vs. 'high' sensitivity), we considered sensitivity to economic cycles, as measured by the historical cyclical peak-to-trough decline in profitability and revenues, as described in "Methodology: Industry Risk," published Nov. 19, 2013, Appendix 1; our historical observations of transitions to higher regulatory risk or other types of heightened negative government influence, for industries such as utilities and transport infrastructure, during sovereign stress scenarios; our historical observations of the sensitivity to economic trends and sovereign stress scenarios for financial institutions (see Appendix II for nonperforming loan data); and, for insurers, the tendency to concentrate investments in domestic government and other domestic securities, and the relative size of investments versus capital. 26. When calibrating the thresholds of the maximum rating differential above the sovereign rating (2 and 4 notches, respectively, for 'high' and 'moderate' sensitivity industries), we considered the severity of defaults resulting from observed high-severity events (such as the combination of a deposit freeze, currency devaluation, and price controls in the Argentina stress event of 2001/2002; the bank deposit freeze and capital controls in Cyprus in March 2013); and the expected severity of defaults if a member country were to leave the eurozone, as indicated by the rising risk we saw for such an event in the case of Greece (see "Credit FAQ: What Are The Potential Rating Effects If A Country Exits A Monetary Union?" published Oct. 4, 2012). We impose rating caps because all entities would be affected by such high-severity events; we divide such caps into two categories, recognizing that entities with 'moderate' sensitivity to country risk have a better ability to mitigate the impact of country and sovereign risk. 27. Other studies, such as "This Time Is Different" (Reinhart, Carmen M., and Rogoff, Kenneth S., 2009), also point to the link between corporate defaults and banking crises (see figure 16.1, page 252). The authors indicate that although countries may "graduate" from certain types of crises, such as serial defaults on sovereign debt or hyperinflation episodes, developed and emerging economies alike remain subject to banking and financial crises. B. Ratings Above The Sovereign: The Pass/Fail Stress Test 28. We first determine the entity's potential rating, which we then compare with the sovereign foreign currency rating on the country (or countries) where the entity has material exposure(s). By "potential" rating, we mean the rating that we would assign according to the relevant criteria for the entity, such as corporate rating criteria, bank rating criteria, etc., prior to applying a stress test for ratings above the sovereign. The potential rating incorporates our view of the entity's exposure to the broad set of relevant country risks. The sovereign rating does not act as a "ceiling" for nonsovereign NOVEMBER 19,

164 General Criteria: Ratings Above The Sovereign--Corporate And Government Ratings: Methodology And Assumptions ratings. However, in rating an entity above the sovereign foreign currency rating, Standard & Poor's is expressing its view that the entity's willingness and ability to service debt is superior to that of the sovereign, and that, ultimately, if a sovereign foreign currency default occurs, there should be an appreciable likelihood that the issuer will not default as a result of the scenario accompanying the sovereign default. 29. Therefore, for an entity to be rated above the relevant sovereign foreign currency rating, the entity should be able to pass a hypothetical sovereign foreign currency default stress test. We consider this stress test for multijurisdictional entities (or groups of entities) with material exposure to countries whose sovereign foreign currency rating is lower than the potential credit rating on the entity. At a minimum, we apply the stress test to the foreign currency rating on the sovereign to which the entity has the largest material, single-country exposure and whose foreign currency rating is lower than the potential credit rating on the entity. The reason we apply the stress test to the largest material single-country exposure is that usually, if an entity passes the stress test for countries where it has large exposures, it will also pass the test for countries where it is less exposed. In the case of unrated sovereigns, we will apply the stress test based on our view of sovereign creditworthiness. 30. On a case-specific basis, we may apply the stress test to more than one country, if we consider the entity to have material exposure to two or more countries. When applying the stress test to more than one country at a time, we might assume the stress affects two or more countries at the same time if we consider economic correlation among the countries to be significant. Should an entity fail the stress test, we would cap the rating at the foreign currency rating on the lowest-rated country for which it failed the test. If we determine that the issuer has no material single-country exposure to a country whose sovereign is rated lower than the potential rating, we may not apply a stress test. 31. We generally consider exposure to be material when it represents approximately 25% or more of an entity's total exposure, (as measured per the metrics in paragraph 43) taking into account our views of current and expected exposures. We also apply the sovereign stress on exposures below 25% with regard to the country of domicile if we believe a company could fail the sovereign stress test. We list examples of how we apply the stress test below. Example 1: Issuer domiciled in a highly rated sovereign (rated 'AA+'), with material (30%) exposure to a lower-rated sovereign: An issuer has a potential rating of 'BBB' and 60% exposure to the country of domicile, which has a sovereign foreign currency rating of 'AA+'; 30% exposure to Country A (sovereign foreign currency 'BB'), and 10% exposure to Country B (sovereign foreign currency 'B'). For the issuer to have a credit rating of 'BBB', it would need to pass a sovereign foreign currency default scenario test for Country A. If it failed the test, the credit rating would be capped at 'BB'. Example 2: Issuer domiciled in a highly rated sovereign (rated 'AAA'), with material exposures to two lower-rated sovereigns (35% and 25%): An issuer has a potential rating of 'BBB' and 40% exposure to the country of domicile (sovereign foreign currency 'AAA'), 35% exposure to Country A (sovereign foreign currency 'BB'), and 25% exposure to Country B (sovereign foreign currency 'B'). For the issuer to have a credit rating of 'BBB', it would need to pass a sovereign foreign currency default scenario test for Country A. If it failed the test, the rating would be capped at 'BB'. If, on a case-specific basis, we thought the entity would be particularly vulnerable to a sovereign default in Country B, we might also apply a discrete stress test to the exposure to Country B (and failing the test for Country B would lead to a rating cap of 'B'). If we considered correlation to be significant between Country A and Country B, we might perform an aggregated stress test for hypothetical sovereign defaults in both countries at the same time. Example 3: Issuer domiciled in a low-rated sovereign (rated 'B-'), with a majority (95%) of exposure to higher-rated NOVEMBER 19,

165 General Criteria: Ratings Above The Sovereign--Corporate And Government Ratings: Methodology And Assumptions sovereigns: An issuer has a potential rating of 'BBB-' and 5% exposure to the country of domicile (sovereign foreign currency 'B-'), 50% exposure to Country A (sovereign foreign currency 'BBB'), and 45% to Country B (sovereign foreign currency 'BB'). For the entity to be rated 'BBB-', it would need to pass a sovereign foreign currency default scenario test for Country B. If the issuer failed the test, the rating would be capped at 'BB'. In this case, the exposure to the country of domicile is not material enough to run a stress test for that country. As we note in paragraph 63, ratings are not constrained by the sovereign rating of the country of domicile when exposure is under 10%. Example 4: Issuer domiciled in a 'BBB' rated sovereign, with significant exposure to higher-rated sovereigns: An issuer has a potential rating of 'A-' and 50% exposure to the country of domicile (sovereign foreign currency 'BBB'), 30% exposure to Country A (sovereign foreign currency 'A-') and 20% exposure to Country B (sovereign foreign currency 'AA+'). For the entity to be rated 'A-', it would need to pass a sovereign foreign currency default scenario test for the country of domicile. Example 5: Issuer domiciled in a 'BBB' rated sovereign, with diversified exposures to lower-rated sovereigns: An issuer has a potential rating of 'BBB' and 50% exposure to the country of domicile (sovereign foreign currency 'BBB'), 20% exposure to Country A (sovereign foreign currency 'BB'), 15% exposure to Country B (sovereign foreign currency 'B+'), 10% exposure to Country C (sovereign foreign currency 'B'), and 5% exposure to Country D (sovereign foreign currency 'B-'). For the entity to be rated 'BBB', we would run a stress test on Country A, even though the exposure is under 25%, if we thought the entity might fail the stress test with respect to that country. We may also run a stress test on Country A if we expected exposure to increase to over 25% in the next few years. Alternatively, if we thought Country A and Country B were highly correlated, we may run a stress test on the combined exposure to Country A and Country B. 32. Where a financial institution or insurance company has exposure in excess of about 50% concentrated in its country of domicile, we generally consider it highly likely that the entity would fail a stress test associated with a sovereign foreign currency default. As a result, we would not undertake the stress test unless we saw strong idiosyncratic reasons that could potentially cause the entity to pass the test. Such factors may include exceptionally high levels of capital and liquidity, a predominantly local currency exposure (with matched tenors for assets and liabilities), or the strong possibility of effective external support (in accordance with paragraph 42). 33. The general nature of these sovereign default stress tests is described in table 3. The criteria apply one of three sovereign default scenarios--scenario A, B, or C-- depending on our assessment of the currency regime of the country. The relevant sector-level criteria may indicate more detailed assumptions to be used for these stress tests. The main effects of the stress scenario on liquidity would be reduced revenues and earnings resulting from the severe macroeconomic stress, a haircut to holdings of domestic marketable securities, a sharp increase in funding costs for floating-rate or short-term debt because of the assumed interest rate shock, and lack of capital market access for refinancing. In countries where we also assume a currency shock (see table 3, scenario B), the potential effect would be incremental. The foreign currency rating may also be constrained by the T&C assessment for the country of domicile or the T&C assessment for the countries of material exposure, as described further in paragraphs Passing the stress test means the entity likely would not be in default. Therefore, the relevant liquidity measure should indicate that debt-service coverage would be positive, and, where relevant, the capitalization measure would be positive and meet regulatory minimums, as follows (after applying the stresses in table 3): Corporates: Liquidity (the ratio of sources to uses over a one-year stress scenario,) is greater than 1, as defined in "Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers," published Nov. 19, For NOVEMBER 19,

166 General Criteria: Ratings Above The Sovereign--Corporate And Government Ratings: Methodology And Assumptions certain asset-based companies, such as real estate investment trusts and investment holding companies, we also apply a capitalization test: the loan-to-value ratio should remain below 0.8 to pass the stress test. Financial institutions: (1) Liquidity, as defined in the relevant criteria (such as "Banks: Rating Methodology And Assumptions," published Nov. 9, 2011: Section H, "Funding And Liquidity," subsection 2, "Liquidity"), remains sufficient; (2) equity is greater than 0; and (3) available regulatory capital is positive--either the institution meets regulatory minimum capital requirements, or Standard & Poor's expects regulatory forbearance in order not to close down the institution, nor introduce restrictions that would be classified by Standard & Poor's as a default. Insurance companies/groups of companies: The liquidity ratio (as defined in "Insurers: Rating Methodology," published May 7, 2013 (section D2, "Liquidity," part 4, "An insurer's liquidity ratio") is greater than 100%; available regulatory capital is positive; and regulatory intervention is unlikely. Public finance: Liquidity is sufficient to meet debt service. (For further details on the relevant liquidity measures, see the relevant section for the sector criteria, such as "Assessing Liquidity" in "Methodology For Rating International Local And Regional Governments," published Sept. 20, 2010; "Liquidity" (paragraph 46) in "U.S. State Ratings Methodology," published Jan. 3, 2011; and Section H, "Liquidity Score" in "U.S. Local Governments General Obligation Ratings: Methodology And Assumptions," published Sept. 12, 2013). 35. Very infrequently, an issuer might pass the stress test only because we assume the issuer will execute a well-documented risk-mitigation plan that would alleviate the default risk associated with the stress. That plan must be credible and approved by the issuer's board of directors, and the issuer must have clear incentives (that outweigh any drawbacks) to execute such a plan and be able and willing to do so under the stress scenario. For example, for insurers, the risk-mitigation plan might include the sharing of resulting investment losses with life insurance policyholders under policies that have discretionary participation features (sometimes known as "with-profit policies"). 36. For cases when we are considering rating an entity above the sovereign local currency rating, the entity should be able to pass an appropriately more stressful scenario associated with both a sovereign foreign and local currency default. The difference between the sovereign foreign and local currency default scenarios is the incremental adverse effect that a default on sovereign local currency securities would have on the liquidity and investment positions of entities holding those securities. 37. We have observed that, regardless of the initial sovereign rating, sovereign defaults over the past two decades have tended to share similar characteristics. As a result, we set out three "standing" theoretical sovereign default scenarios (see table 3) rather than having country-specific scenarios. We could supplement these scenarios with more specific ones, once the scenario is more predictable, where the sovereign is rated 'B' or 'B-', as explained in paragraph For entities we are considering rating above a sovereign that has a foreign currency rating of 'AA-' or higher, the stress test for a sovereign default scenario would generally not be required, given the very low likelihood of a potential sovereign default scenario for such a highly rated sovereign. Nevertheless, we will review, from a qualitative perspective, why the entity or sector would (or would not) be expected to default at a time when the sovereign is defaulting, based on the entity's or sector's expected resilience to a severe stress scenario and limited direct links to the sovereign. For example, we expect entities rated above the sovereign to have the following characteristics: The ability to maintain stronger credit characteristics than the sovereign in a stress scenario. For example, the entity would have a lack of dependence on contracts, revenues, subsidies, or guarantees from the central or federal government or its related entities, and limited exposure to domestic government and private-sector securities in the NOVEMBER 19,

167 General Criteria: Ratings Above The Sovereign--Corporate And Government Ratings: Methodology And Assumptions investment portfolio; and The ability to limit the risk of negative sovereign intervention. 39. Specifically for local or regional governments or public-sector enterprises (health care, higher education, housing, or other not-for-profit sectors), they must meet the following three conditions to qualify for a rating above the sovereign (in addition to passing the pass/fail test, if the sovereign foreign currency rating is 'A+' or below): The ability to maintain stronger credit characteristics than the sovereign in a stress scenario, such as having a predominantly locally derived revenue base (i.e., a lack of dependence on central government revenues, subsidies, or other government transfers); An institutional framework that is predictable and limits the risk of negative sovereign intervention, such as revenue and expenditure autonomy supported by both constitutional and statutory provisions; and The ability to mitigate negative intervention from the sovereign because the entity has high financial flexibility and independent treasury management. 40. When the sovereign rating is 'B' or lower, the specific default scenario might be more predictable. If the sovereign rating is 'B' or 'B-', we might develop a country-specific default scenario to determine whether we could rate entities above the sovereign. For sovereign ratings of 'CCC+' and below, we expect the current stressed conditions to represent both our base case and the expected default scenario, and we generally will not perform a stress test for entity ratings up to 'B-' (unless the transfer and convertibility assessment were also 'CCC+' or below). Where the sovereign rating is 'CCC+' or below, we would still perform a stress test for entity ratings that could exceed 'B-'. Table 3 Sovereign Default Scenario Stress Tests Scenario A: Economic stress, no currency devaluation Country scope This scenario would apply for eurozone member countries, countries with a fixed and permanent tie to another currency (e.g., Panama), and other countries with international reserve currencies (the U.S., Japan). The sovereign foreign and local currency ratings will be the same for these countries. GDP Unemployment Interest rates Sovereign securities, and local and regional government securities Commodity price shock Private-sector debt securities The country experiences a deep recession. GDP declines by approximately 6% to 10% in one year. Unemployment increases by 20% to 30%, subject to a minimum assumed unemployment rate of 15%. Doubling of local nominal interest rates, subject to a minimum of at least the historical peak interest rate for that country, over a relevant time horizon, plus "flight to quality" or, where available, assumptions calibrated to a severe level of economic stress: we expect the rationing of credit to the highest-rated domestic issuers. Short-term securities (less than one year), 65% of face value (haircut = 35%); long-term securities (one year or longer), 40% of face value (haircut = 60%). Note: These haircuts applied to bonds/securities and for sovereign debt would also be applied to loans. For long-term loans to the central government, 60% of face value (haircut = 40%). For loans to local and regional governments, see Banking and insurance sector-specific assumptions, below. For countries where commodities account for a significant percentage of exports or GDP, apply a severe commodity price drop, which is applied to the country related stress test for commodity producers (e.g., drops to the historical low three-month average price observed over the last severe industry downturn, adjusted for global inflation and/or structural changes in the market ). The following haircuts apply to all bonds/securities and to loans that are held for liquidity purposes (trading/investment portfolios). For the impact on loan portfolios, see Banking and insurance sector-specific assumptions, below. Bank senior debt drops to 40% of face value (haircut = 60%) NOVEMBER 19,

168 General Criteria: Ratings Above The Sovereign--Corporate And Government Ratings: Methodology And Assumptions Table 3 Sovereign Default Scenario Stress Tests (cont.) Bank deposits Equity: listed, liquid securities Bank short-term (less than one year) senior debt, certificates of deposit drop to 65% of face value (haircut = 35%) Corporate senior debt: 60% haircut to face value, for liquidity test; 30% haircut to face value, for capital test Bank/corporate junior debt (equity hybrids): 100% haircut (0% of face value) Covered bonds drop to 40% of face value for the liquidity stress test, and for the capital stress test, drop to 70% of face value, where the cover pool is RMBS, CMBS, or ABS; drop to 40% of face value where the cover pool is public sector assets, for both the liquidity and capital tests RMBS, CMBS, and ABS: For the liquidity stress test, we assume a 100% haircut (0% of face value) due to a very illiquid market in general, and in particular at a time of sovereign stress. For the capital stress test, we assume a 30% haircut to face value. We assume a 10% haircut, unless mitigated by deposit insurance or use of systemically important banks Price falls to 30% of carrying value recorded as of the previous fiscal year-end reporting date; in case of a substantial observed price decline from recent peak values or since the year-end reporting date, we may modify this assumption on a case-by-case basis Property price decline For issuers with a combined portfolio of residential and commercial property, we assume a 50% price decline since the last fiscal year-end reporting date, with adjustments depending on our view of the point at which the real estate cycle for that country is. In case of (i) a substantial observed price decline from recent peak values or since the year-end reporting date, or (ii) a country with a property asset bubble where a 50% assumption may be insufficiently prudent, we may modify this assumption on a case-by-case basis. Other securities or investments Other For funds, we haircut in line with the type of holding (government versus private-sector debt securities, or equity); for other types of securities or investments (private equity, other illiquid holdings), we assume a 100% haircut (0% of face value) We assume no access to domestic or external capital markets. No access to external bank financing, including cross-border swaps, except for committed lines in which we do not expect "material adverse change" clauses or similar triggers in case of a sovereign default scenario. Tariffs for utilities are frozen. Commodity exporters face increased export duties. For issuers rated BB+ or lower, we assume domestic bank financing is available for rollovers of existing short-term domestic bank lines only. For issuers rated BBB- and higher, we assume domestic bank financing is available for rollovers of existing short-term domestic bank lines and refinancing of medium-term domestic bank loans. Sector-specific assumptions Stress test duration Banking and insurance sector-specific assumptions All of the factors above are stressed for at least one year in our projections. Regarding the effect on balance-sheet measures (financial institutions, insurance), the stress test is performed on a pro forma basis with respect to the latest available reporting date. Regarding liquidity measures where the related sovereign is rated BB+ or lower, we stress the entity or transaction (for project finance) for the first projection year; where the relevant sovereign is rated BBB-' or above, we stress the entity or transaction for the second projection year. Banking and insurance: Nonperforming loans increase to the higher of 20% or twice the current level (average for consumer and commercial loans). Loss given default (LGD) is 70% for unsecured loans, 50% for secured loans (e.g., mortgages). If a very substantial deterioration in asset quality has already occurred, we may modify these assumptions on a case-by-case basis. Banking: Pre-provision profits are subject to a haircut of 30% for those arising from the country of stress, and 10% for all other post-provision profits. Insurance: Pre-stress profits are subject to a haircut of 30% for those arising from the country of stress, and 10% for all other post-provision profits. Regional and local governments: If loan exposures to domestic regional and local governments are substantial, we may assume additional sector-specific nonperforming loan rates or add a haircut. Domestic deposit run-off: we assume 15% run-off of retail deposits, 25% of wholesale deposits, and 20% of all deposits where the mix is undisclosed. Outflows are halved where we expect the bank would benefit from a flight to quality. At a minimum, we would expect such a bank to have an SACP at least 2 notches above the average bank SACP in the system. See paragraph 84 for assumptions for cross-border funding. NOVEMBER 19,

169 General Criteria: Ratings Above The Sovereign--Corporate And Government Ratings: Methodology And Assumptions Table 3 Sovereign Default Scenario Stress Tests (cont.) Insurance sector-specific assumptions Corporate, project finance, and government/municipal enterprise sector-specific assumptions Public finance-specific assumptions, regional and local governments Scenario B: Economic stress with currency devaluation The central bank remains available (for domestic banks) only as a source of local currency liquidity (against eligible collateral). If the central bank is a supranational institution rated higher than the respective sovereign, where there is a realistic prospect of access, we may assume limited access to foreign currency liquidity. In countries where the central bank is a supranational institution, such as the European Central Bank, and rated higher than the respective sovereign, the liquidity stress test takes into account the expected access to central bank repo facilities, with the haircuts applied by the central bank. We apply a 35% policy lapse assumption; for credit insurance, we apply an increase in the loss ratio by 150% (2.5x). Haircut to liquidity held in local banks and government securities (value decline as specified above), interest rate shock to funding costs for floating-rate or short-term debt, risk to domestic lines of credit, GDP-related decline in domestic demand. For the latter, we may use sector-specific assumptions for a given industry, although case-specific assumptions may apply. For corporate ratings, we may alternatively use the following guidance for EBITDA declines assumed for purposes of the stress test, depending on the industry s country risk sensitivity: MODERATE sensitivity, 15%-20% EBITDA decline HIGH sensitivity, 30% EBITDA decline Haircut to liquidity held in local banks and government securities (as specified above); drop in income tax revenues related to GDP and unemployment assumptions; drop in property tax revenues related to property price-decline assumptions General assumptions Scenario B would apply for all countries that do not fall within sovereign default scenario A or C. This scenario would include, for example, developed-market countries that are not members of a monetary union and do not have a reserve currency (such as New Zealand), and most emerging-market countries. This scenario includes all the stresses in Scenario A and adds a currency stress. Because the sovereign foreign and local currency ratings may be different, there are related differentiated stresses. Local currency devaluation Inflation Sovereign foreign currency securities Sovereign local currency securities For the stress test for ratings above the sovereign local currency rating, or where the sovereign local currency and foreign currency ratings are the same Scenario C: Significant risk of exiting a monetary union General assumptions Note: For any variable not listed below, the stresses are identical to the assumptions in Scenario A, including: GDP, unemployment, interest rates, market-value haircuts (except for sovereign local currency securities), and access to refinancing, as well as Corporate & government-specific assumptions. Local currency loses 50% of its value versus the hard currency benchmark (i.e., U.S. dollar for Latin America, Asia/Pacific; euro for Eastern Europe). By 50% loss of value versus the hard currency benchmark, we mean if the exchange rate is currently 10 local currency units per 1 hard currency unit, the stressed exchange rate would be 20 local currency units per 1 hard currency unit. General: Entity- or transaction-specific effect for currency mismatch (assets versus liabilities) and/or related un-hedged debt-service costs For corporates, add currency depreciation effect on revenues, imported raw material costs, and capital expenditure costs Assume a doubling of inflation, subject to a minimum of at least the historical peak in inflation rates for that country over a relevant time horizon Assume market value drops to 40% of face value Short term, valued at 75% of face value for two-notch differential, 70% of face value for one-notch differential. Long term, valued at 60% of face value for a two-notch differential, 50% of face value for a one-notch differential. Assume market value drops to 30% of face value for all securities Country with a 50% or greater likelihood of transitioning out of a monetary union or other fixed tie to another currency; assumptions are similar to Scenario B, plus deposit freeze and redenomination of liabilities into new local currency (at an assumed government-mandated conversion rate that is 50% of the market foreign exchange rate) NOVEMBER 19,

170 General Criteria: Ratings Above The Sovereign--Corporate And Government Ratings: Methodology And Assumptions C. Ratings Above The Sovereign: The Maximum Rating Differential Between Nonsovereign Entity Ratings And The Related Sovereign Rating 41. For entities that pass the relevant stress test described in table 3, the criteria allow a rating differential of up to 4 notches above the referenced sovereign foreign currency rating. The latter is either that of the country where the entity is domiciled or, for nonfinancial corporate entities operating in multiple jurisdictions, is determined by a weighted average of the sovereign ratings on countries where the entity has material exposures. The maximum number of notches above the referenced sovereign foreign currency rating depends on the entity's relative sensitivity to country risk. The purpose of this framework is to anticipate the risk of low-probability but high-severity events associated with sovereign distress and default scenarios that are not captured by the stress test. These types of events could include a deposit freeze, currency redenomination, or geopolitical risks. 42. We evaluate external credit support (for example, from a foreign-domiciled entity), such as implicit parent support or a guarantee, under the relevant criteria, and we could rate an entity above the maximum rating differential specified by this criteria. In the case of implicit support, such support would need to be, in our view, resilient to a sovereign default scenario, which would weigh on incentives for the parent to extend support in the first place, and we analyze the support according to the relevant criteria (see "Group Rating Methodology," published Nov. 19, 2013). 43. We apply the methodology in paragraphs to determine an entity's relative degree of sensitivity to country risk. If an entity has exposure to a number of sectors or countries, the criteria will gauge exposures using the following measures: Corporate ratings--ebitda or revenues or other volume-based measures, as appropriate. For example, for the purposes of this calculation, we apply a "weak-link" approach to exporters. If assets are based in a high-risk country, and cannot be relocated elsewhere, we test exposure to the high-risk country, even if the products are exported to a low-risk country. Similarly, if exports are made to a high-risk country and cannot be easily redirected elsewhere, but we will measure exposure to the high-risk country, even if assets are based in a low-risk country; Banks and other balance-sheet-intensive financial institutions--the adjusted exposure used in risk-adjusted capital analysis (see "Bank Capital Methodology And Assumptions," published Dec. 6, 2010), or where not available, the geographic breakdown of a bank's loan book (including off-balance-sheet items); Clearinghouses and asset managers--revenues; Insurance companies--general account investments (an insurer's investment portfolio, which excludes investments of policies where the policyholder carries default risk); and Local and regional governments--revenues. 44. Our classification of the sensitivity of a corporate and government issuer to country risk, based on historical sensitivity of sectors and asset types to economic volatility, and to potential changes in the legal and regulatory environment during sovereign stress and default, generally breaks down as outlined in paragraphs We assess this sensitivity to country risk in two categories: 'high' or 'moderate.' However, on a country-specific basis, we might determine that a sector usually considered to have 'moderate' sensitivity instead has 'high' sensitivity, or conversely, that a sector usually considered to have "high" sensitivity instead has "moderate" sensitivity, based on historical data and our prospective view. For example, we classify the telecommunications and cable industry as having 'moderate' sensitivity to country risk. If country-specific historical data and our prospective view of an entity in that sector support our view NOVEMBER 19,

171 General Criteria: Ratings Above The Sovereign--Corporate And Government Ratings: Methodology And Assumptions that that industry may be more sensitive to country risk in a particular country, we might change the country risk classification to 'high.' We list any country-specific, sector-specific determinations for sensitivity in Appendix I, or in the future, as a published update to Appendix I. 45. In order to make the unusual determination to move an industry from 'high' to 'moderate,' we would need to expect country-specific characteristics that shelter that industry from macroeconomic and country risk and from the direct impact of sovereign default, and we would need to expect such characteristics would continue to be present even if the sovereign transitioned to greater degrees of stress in the future. In the unusual case where this country-specific determination has been made for local and regional governments (i.e., moving from 'high' to 'moderate' sensitivity), and potentially for certain of their related enterprise sectors, there are additional requirements and restrictions on the maximum rating differential between the sovereign and entity rating, as per paragraph 52. In order to make a determination of 'moderate' sensitivity, governments, in our view, would need country-specific characteristics which shelter them from macroeconomic and country risk and from the direct impact of a sovereign default, in addition to the factors mentioned in paragraph 39. High sensitivity 46. We qualify the following sectors and asset types as having 'high' sensitivity to country risk, which means they are highly sensitive to a combination of economic volatility and potential changes in the legal and regulatory environments. Government-related entities, regardless of their industry sector, typically are considered to have 'high' sensitivity to country risk, with certain exceptions. See paragraphs for specific considerations for GREs. Life insurers, life reinsurers, savings-based health insurers, and composite insurers with a majority of life liabilities, because their business is heavily influenced by the pace of wealth accumulation in a country and because a significant share of assets tend to be invested in domestic government debt and domestic bank deposits. To relieve resulting stress on life insurers, some past sovereign defaults have led some governments to mandate changes in insurance contract terms that would prompt us to consider the affected insurers to be in default; Insurers with businesses closely correlated with economic cycles, such as mortgage insurers and trade credit insurers; Financial institutions, as they often hold domestic government debt, including for liquidity purposes, and because their businesses are affected by domestic economic trends. Financial institutions are typically exposed to fiscal policies and are subject to domestic regulation; Financial clearinghouses; Real estate sector companies--homebuilders, real estate investment trusts, property developers, real estate management companies, and other construction companies because of the high impact of economic cycles on their business volumes and cash flows; Deregulated power generation and supply companies; Regulated utility network infrastructure companies (including both investor-owned and not-for-profit entities); Transport infrastructure companies, given their exposure to both economic conditions and potential changes in regulatory frameworks; Non-exporting natural-resource producers, given the fiscal and political risks we believe they face; Non-exporting cyclical companies that produce steel, chemicals, autos, cement, and capital goods, given our view of their extreme sensitivity to their domestic economy; Domestic investment holding companies, given their exposure to equity markets in a sovereign stress scenario; Local and regional governments, as we typically view their revenue base as closely correlated with domestic NOVEMBER 19,

172 General Criteria: Ratings Above The Sovereign--Corporate And Government Ratings: Methodology And Assumptions economic conditions (subject to paragraph 45); and Public finance enterprise sectors--health care, higher education, housing, and other not-for-profit issuers, given their links with domestic economic conditions and/or links with their respective central, state, local, or regional governments (subject to paragraph 45). Moderate sensitivity 47. For example, we qualify the following sectors and asset types as having 'moderate' sensitivity to country risk (with the exception of most government-related entities, as noted in paragraph 46): Financial market infrastructure companies (such as exchanges and transaction processors {for credit card payments}), except clearinghouses; Non-life insurers (property/casualty, non-life reinsurance, non-savings-based health insurers and composite insurers and reinsurers with a majority of non-life liabilities); Telecommunications and cable companies; Exporting natural resource producers and cyclical companies that are primarily exporters (steel, chemicals, autos, cement and capital goods). Although demand for their products might not be tied to domestic conditions, exporters are still exposed to the direct and indirect sovereign intervention of their country of domicile (e.g., export duties, export quotas, obligations to repatriate export proceeds and convert them to local currency, etc.); Staple consumer product manufacturers, including beverages; Food retailers; Pharmaceutical companies 48. Any other industry not listed as 'high sensitivity,' per paragraph 46, will generally be considered as "moderate sensitivity." The examples listed above are summarized in table 1. D. Determining The Final Rating Differential From The Sovereign Rating 49. The final rating differential between the issuer rating (or equivalent) and the relevant sovereign foreign currency rating can be up to the maximum differential, for sovereign ratings of 'B' or higher, or result from the application of the rating cap, for sovereign ratings of 'B-' or lower, determined using table 2. To apply table 2, we would have first determined: a) the potential rating for the entity, according to the relevant criteria; b) the sensitivity of the entity to country risk, using the guidance in table 1; and c) the relevant sovereign rating (domicile or weighted average by exposure; see paragraph 55). 50. It is important to note that entities passing the test would not always be rated up to the caps or maximum rating differentials indicated in table 2. We apply analytical judgment when making the final determination about the rating differential, up to the cap. For example, let's say we are analyzing a telecommunications company with a potential rating of 4 notches above the sovereign foreign currency rating, based on its stand-alone credit characteristics and its being in a 'moderate' sensitivity industry. We may decide to rate the entity only one or two notches above the sovereign, due to substantial business volumes with government entities, or due to a track record of government restrictions on its pricing flexibility. 51. When we apply recovery ratings or other structural aspects to our issue rating analysis, the final issue rating might exceed the rating determined using table 2 to reflect such structural characteristics. In such cases, we would allow NOVEMBER 19,

173 General Criteria: Ratings Above The Sovereign--Corporate And Government Ratings: Methodology And Assumptions issue rating elevation above the sovereign foreign currency rating if we expected the enhancements to still apply in the case of the sovereign default scenario. 52. In the unusual, country-specific case where local and regional governments have been classified, per paragraph 45, as having 'moderate' sensitivity, the maximum rating differential between the sovereign foreign currency rating and issuer (or issue) rating is capped at 3 notches. If any government-related entities associated with such governments are classified as having 'moderate' sensitivity, they are subject to the same maximum rating differential of 3 notches above the sovereign foreign currency rating. The reason for this differentiated approach for governments is that even local and regional governments with 'moderate' sensitivity are more linked to central government influence than other 'moderate' sensitivity industries. In addition, we would apply an increased severity stress test in order for a given entity or debt rating to reach this maximum 3-notch gap, in line with an 'extreme' level of economic stress (which we define as a 'AAA' stress scenario in "Understanding Standard & Poor s Rating Definitions," published June 3, 2009), rather than merely a 'severe' level of economic stress (which we define as a 'AA' stress scenario). Such a stress test would be applied regardless of the current sovereign rating. 53. Our matrix in table 2 links sovereign ratings and an entity's country risk sensitivity because sovereign credit quality weighs to varying degrees on all entities in the jurisdiction. We believe that the closer the sovereign is to distress (rated 'B-' or below), the more predictable is its actual default scenario. We factor this in by applying absolute rating-level caps in place of a specified rating differential if the sovereign rating is 'B-' or below. 54. The differential above the sovereign rating applies only if the entity has passed the stress test (or subject to related qualitative analysis), as described in the section "Ratings Above The Sovereign: The Pass/Fail Stress Test," for being rated above the sovereign. This is, therefore, less likely if sensitivity to country risk is high. 55. For purposes of applying table 2, the "relevant" sovereign rating we use to determine the maximum rating differential is usually that on the country of domicile. For multijurisdictional entities, the relevant sovereign rating is: a) for financial institutions and insurance companies, the country of domicile (because of the critical role of regulations and funding); b) for corporates (industrials and utilities), a weighted average computed according to the sovereign ratings of countries where the company has material exposures, subject to the conditions in the following two paragraphs. In the case of unrated sovereigns, we apply the maximum rating differentials and maximum rating levels in table 2 based on our view of sovereign creditworthiness. 56. For the weighted-average measure, we generally consider all countries that account for 25% or more of the issuer's exposure, but we apply judgment where relevant. For example, if a corporate entity had 10% exposure to each of 10 'B' rated sovereigns, we would likely consider the relevant sovereign rating to be 'B' despite the fact that no single country accounted for 25% or more exposure. Alternatively, if a corporate entity had 5% exposure to each of 20 sovereigns ranging from 'B' to 'AAA', we might estimate a weighted average (unless we use the country of domicile, as mentioned above). Where we expect projected exposures to be significantly different from historical ones, we would use the projected exposures. 57. For corporates, the country of domicile may still be relevant. We may use the country of domicile as the reference point in some cases--for instance, for globally diversified multinational companies operating in a large number of NOVEMBER 19,

174 General Criteria: Ratings Above The Sovereign--Corporate And Government Ratings: Methodology And Assumptions countries, if we believe there is no material exposure to a single country. Alternatively, the weighted average may be raised by one notch if all of the following conditions are met: The company's head office is located in a country with a sovereign rating higher than the preliminary weighted average of the sovereign ratings corresponding to its material exposures; No country, with a sovereign rating equal to or lower than the preliminary weighted average of the sovereign ratings, represents or is expected to represent more than 20% of revenues, EBITDA, or fixed assets, or other appropriate financial measures; and The company is primarily funded at the holding company level, or through a finance subsidiary located in a country with a stronger sovereign rating than the holding company, or if any local funding could be very rapidly substituted at the holding company level. 58. Similar to the preceding paragraph, for corporates, the weighted average sovereign rating used to apply table 2 may be lowered by one notch if either of the following conditions are met: The company's head office is located in a country with a sovereign rating lower than the preliminary weighted average of the sovereign ratings corresponding to its material exposures; or The company is primarily funded at the holding level, or through a finance subsidiary located in a country with a weaker sovereign rating than the weighted average. Short-lived sovereign defaults of a technical nature 59. If we lowered a sovereign rating to 'SD' (selective default) because of a default event that we expect to be short-lived and technical in nature, or if we lowered the sovereign rating to the 'CCC' category or to 'CC' in anticipation of such an event, nonsovereign entities might not be affected directly in terms of rating caps. In such a scenario, the reference point for nonsovereign ratings, for purposes of applying table 2, would be the expected post-default sovereign rating, or the upper end of the range of the expected post-default sovereign rating, as indicated in conjunction with the related sovereign rating action. E. Government-Related Entities (GREs) 60. GREs are typically more subject to country risk, and negative sovereign intervention risk, than private-sector entities, since they usually have direct links to governments. When considering whether to rate a GRE above the sovereign, we consider the provisions of these "Ratings Above the Sovereign" criteria ("RAS criteria") as well as our criteria for GREs, "Rating Government-Related Entities: Methodology And Assumptions," published Dec. 9, 2010 ("GRE criteria"). The GRE criteria (in paragraphs 42-44) set the general conditions for rating a GRE above the sovereign. The RAS criteria set the maximum rating differential over the sovereign rating, as well as the specifics for the stress test we run to assign ratings above the sovereign. The special provisions for GRE ratings depend on whether the GRE is related to a sovereign government or to a local or regional government. The following special conditions apply with respect to sovereign-related GREs and local and regional government-related GREs. Note: the provisions below with respect to "maximum rating differential" address the maximum rating differential between the GRE rating and the sovereign foreign currency rating, for cases where the sovereign is rated 'B' or higher. Where the sovereign is rated 'B-' or lower, we apply the provisions of table 2 with respect to the maximum nonsovereign rating, according to the GRE's sensitivity classification. NOVEMBER 19,

175 General Criteria: Ratings Above The Sovereign--Corporate And Government Ratings: Methodology And Assumptions 61. The RAS criteria apply to sovereign-related GREs, with the following special conditions: Industry sensitivity: For the purposes of applying table 2, we classify the GRE's sensitivity as 'high' unless it meets both of the following conditions: a) its "link" (as determined according to the GRE criteria) is 'limited,' and b) the industry sensitivity for the GRE's sector is 'moderate,' either due to the industry classification per table 1 or Appendix I. Maximum rating differential: For the purposes of applying table 2, the maximum rating differential will generally correspond to the sensitivity determination in item 1, above. However, for domestic utilities (defined as those with 70% or greater exposure to a single jurisdiction), the maximum differential is 1 notch. For purposes of clarity, if the GRE's government support category is 'almost certain' or 'extremely high,' no stress test is needed to align the GRE's ratings with the sovereign foreign and local currency ratings (for those in the 'almost certain' category) or with the rating outcome of table 4 of the GRE criteria ('extremely high'). 62. The RAS criteria apply to local and regional government-related GREs, with the following special conditions: Industry sensitivity: The industry sensitivity follows that of the GRE's sector, either per table 1 or Appendix I, with the following proviso: the GRE sensitivity can be 'moderate' as long as either the link with the government is 'limited,' or the related government's sensitivity is 'moderate.' Maximum rating differential: For the purposes of applying Table 2, the maximum rating differential will generally correspond to the sensitivity determined in item 1, above. For domestic utilities, the maximum differential is 1 notch, unless the related local or regional government itself is 2 notches above the sovereign, in which case the utility can be rated up to 2 notches above the sovereign. If the related government itself is 3 notches above the sovereign (as per Appendix I), the utility can be rated 3 notches above the sovereign if the application of the GRE criteria supports that conclusion. F. Other Situations 63. Guarantees: The maximum rating differentials vis-à-vis the sovereign do not apply where financial obligations are guaranteed by a counterparty rated higher than the primary obligor's sovereign, where the guarantor is located outside the jurisdiction, and where the guarantee meets our rating substitution criteria (see "Guarantee Criteria--Structured Finance," published May 7, 2013). 64. Implicit parent/group support: When the issuer in question is a subsidiary, we apply our "Group Rating Methodology," published Nov.19, 2013, to determine whether the entity can be rated above the sovereign, and by how much, depending on our view of the likelihood of receiving group support during a potential future sovereign stress event. 65. Issuers or transactions with under 10% exposure to the jurisdiction of domicile: These are not capped by table 2, based on their jurisdiction of domicile. However, where such entities have significant, concentrated exposures outside their jurisdiction of domicile, we may apply caps relevant to those exposures. For example, if a financial institution is domiciled in a country where it has only 5% exposure, but it has over 25% exposure to another, single country rated below the potential rating of the entity, then we still perform a stress test associated with a sovereign default scenario in such (nondomicile) country, and we may apply rating caps relative to such exposure. G. Transfer & Convertibility Assessment 66. The final step in applying these criteria (to foreign currency ratings only) is to consider whether the rating is NOVEMBER 19,

176 General Criteria: Ratings Above The Sovereign--Corporate And Government Ratings: Methodology And Assumptions constrained by the T&C assessment. This assessment reflects Standard & Poor's view of the likelihood of a sovereign's restricting nonsovereign access to foreign exchange needed to satisfy the nonsovereign entity's debt-service obligations. Local currency ratings are not constrained by the T&C assessment. 67. The paragraphs below specify certain tests to consider ratings above the T&C assessment. However, with respect to the country of domicile, we also analyze legal, regulatory, and other qualitative considerations. These considerations might lead in turn to rating constraints on the T&C assessment for the country of domicile, regardless of the entity's exposure to that country. 68. For sovereign ratings or T&C assessments of 'B' or higher, foreign currency ratings on any entity that derives 90% or more of its exposure from a single jurisdiction will generally be capped at the T&C assessment for that jurisdiction. However, if the entity is a nonfinancial corporate entity, it could have a foreign currency rating up to one notch above the T&C assessment, if it meets all of the following conditions (for cases where we might consider more than one notch above the T&C assessment, see other mitigating factors in the following paragraph): Derives its revenues principally from exports; Has established off-shore accounts to capture export sales; Has strong incentives to continue paying foreign debt through a sovereign stress scenario, judged by the degree of integration in the global trading system and capital markets (that is, geographical diversification of its customer base, foreign debt and/or equity registrations, and a track record in previous economic crises, if relevant); Passes our T&C stress test (in addition to meeting the standard stress test for rating above the sovereign; see the "Rating Above the Sovereign: The Pass/Fail Stress Test" section), meaning we think the entity could still service debt if a) we assume only 25% of export revenues would be available for foreign debt service, due to export repatriation requirements; b) the remaining 75% of export revenue, and any other domestic-source cash flow and assets, will not be available to service foreign currency debt; and c) we assume restricted access to foreign exchange available for imported raw materials, and imported capital goods. 69. Structural mitigants for T&C risk, which could lead to a rating more than 1 notch above the T&C assessment, include political risk insurance, third-party guarantees, or a project finance transaction with structural mechanisms that mitigate T&C risk by segregating foreign currency receivables into offshore accounts. Also, for nonfinancial corporates, per our "Group Rating Methodology" (Methodology section IX: "Corporate Groups"), we can consider implicit support from a foreign parent in certain cases, to support 1 notch above the T&C assessment (if the entity is "core" to the parent, and if the sovereign rating or T&C assessment is 'B-' or lower). 70. When the sovereign foreign currency rating, or T&C assessment, is 'B-' or lower, we may alternatively decide there is a country-specific T&C scenario, similar to paragraph 40 for the sovereign stress scenario. Such a scenario may conclude, for example, that there would be harsher T&C restrictions (i.e., no export revenues permitted to be kept offshore for debt service), or potentially less harsh restrictions, such as specific exemptions for certain industries. 71. For entities with less than 90% exposure to a single jurisdiction, we apply the framework indicated in table 4 to determine whether an entity could be rated above the T&C assessment of that jurisdiction, and if so, by up to how many notches. For entities with exposure between 25% and 90% to a single jurisdiction, we require a stress test for a T&C event. For this stress test, we make the assumption that domestic-source cash flow and assets will not be available to service foreign currency debt, nor pay for imports of raw materials or capital goods. However, for NOVEMBER 19,

177 General Criteria: Ratings Above The Sovereign--Corporate And Government Ratings: Methodology And Assumptions exporters, we assume 25% of stressed export revenues remain available in hard currency for debt service, and 10% of export revenues remain available to pay imports of raw materials or capital goods. Table 4 Determining The Rating Effect Of The Transfer & Convertibility Assessment Exposure to jurisdiction Stress test for T&C event? >90%, Sells domestically >90%, Exporters 70%-90% 50%-70% 25%-50% <25% No Yes Yes Yes Yes No Rating cap T&C Up to 1 notch above T&C, if pass stress test; cap at T&C if fail stress test Up to 1 notch above T&C, if pass stress test; cap at T&C if fail stress test Note: In this table, all references to stress tests refer to the stress test for a T&C event. Up to 2 notches above T&C, if pass stress test; cap at T&C if fail stress test No cap if pass stress test; cap at T&C if fail stress test 72. Therefore, as long as the entity would not default on foreign currency financial obligations during the single-country T&C stress test (or exporter T&C stress test, where relevant), the entity's foreign currency rating can be: Up to one notch above the T&C assessment of that jurisdiction for non-exporters with 70% to 90% of exposure derived from the jurisdiction or exporters with over 90% exposure; Up to two notches above the T&C assessment of that jurisdiction (50% to 70% of exposure); or No limit relative to the T&C assessment (below 50% exposure). 73. The T&C test applies only to foreign currency ratings; local currency ratings are not constrained by T&C. On the other hand, local currency ratings do reflect relevant country risks, with the exception of T&C. Foreign currency issuer credit ratings on domestic non-sovereign entities are generally the lower of a) the issuer local currency rating or b) the T&C assessment, unless the rating can exceed the T&C assessment as per the previous paragraph. None APPENDIX I 74. In reference to table 1 and paragraphs 44 and 45, we have classified the following sectors for the listed countries as having 'moderate,' instead of 'high,' sensitivity: State and local governments, United States. 75. Rationale: The following characteristics distinguish U.S. state and local governments from the U.S. federal government, and also demonstrate autonomy and relative stability of revenues, even under stressed conditions. Exceptionally strong and predictable legal framework governing autonomy; long track record of decentralized institutional framework protection. Responsibility for the delivery of a wide range of services and the authority to levy taxes sufficient to finance their provision remains the states' under the Tenth Amendment to the constitution. The federal system in the U.S. empowers states as sovereign entities. Local entities are governed by state laws. States' rights and their powers were established from the bottom up, creating a unique, distant relationship between the federal government and state/local forms of government. There is no history of direct negative intervention by the federal government to state and local government entities in the U.S. Exceptionally strong autonomy of decision-making/revenue collection/spending adjustments. The arrangement of U.S. fiscal federalism encourages fiscal discipline by having state and local governments largely NOVEMBER 19,

178 General Criteria: Ratings Above The Sovereign--Corporate And Government Ratings: Methodology And Assumptions internalize the costs of discretionary fiscal decisions. This discipline is well-embedded and evidenced by fiscal policies such as the requirement to have balanced budgets. Relatively low leverage of U.S. state and local governments. The debt structure for state and local governments provides for significant strength during a stress scenario. Debt is generally amortizing, and nearly all of the ratings in U.S. public finance are issue ratings, which reflect specific security structures, pledged/dedicated revenues, legal provisions that provide priority of payment to bondholders on a first-dollar basis, and frequently have a built-in stress scenario (priority, coverage and limits on leverage). Strong credit performance over time. U.S. public finance ratings have endured an 'AAA' stress scenario with relatively strong credit performance: one default at the state level during the Great Depression and very few defaults at the local level over time. Very high flexibility of revenues and expenditures. State governments have autonomy over their tax structure, including tax base composition, rate setting, and collection. Local governments in the U.S. derive a majority of their revenues (generally between 60%-70%) from local property taxes. Property tax revenues have two defining features that help create stability for local governments: 1) real estate declines are not immediately reflected in property values due to the lag in property revaluations; and 2) the flexibility of local governments to compensate for declining value with autonomy in rate or levy setting. Limited reliance on direct federal funding. Direct funding from the federal government represents only about 4% of total local government revenues, much of which represents funds designated for capital spending. While states have a higher reliance on federal funding, the primary area of fiscal integration with the federal government is Medicaid, which is a voluntary program. 76. Despite the characteristics above, U.S. state and local governments are limited to three notches above the sovereign. An individual government would need to demonstrate resilience to an 'extreme' stress test in order to qualify for more than two notches above the sovereign. Higher-education, independent schools, United States. 77. Rationale: Universities in the U.S. have demonstrated a proven ability to withstand declining revenue sources, variability in endowment values, changing demographics, and various competitive pressures over a range of economic cycles. Universities in the U.S. are autonomous entities and have operated without any direct negative government intervention and retain full authority to implement adjustments necessary to respond to changing economic climates. These institutions operate separately from the state or federal government. However, public universities (those associated with, or funded by, state or city governments) are limited to 3 notches above the sovereign, the same as the related government; an individual university would need to demonstrate resilience to an 'extreme' stress test in order to qualify for more than two notches above the sovereign. 78. Private universities and independent schools are treated the same as other 'moderate sensitivity' industries; they can qualify for up to 4 notches above the sovereign. Not-for-profits, United States. 79. Rationale: U.S. not-for-profits are considered to have 'moderate' sensitivity due to typically robust endowment levels and a demonstrated ability to perform through various economic cycles. However, an individual not-for-profit would need to demonstrate resilience to an 'extreme' stress test in order to qualify for more than 2 'notches' above the sovereign. 80. Standard & Poor's may periodically update this Appendix with additional country-specific sector reclassifications. NOVEMBER 19,

179 General Criteria: Ratings Above The Sovereign--Corporate And Government Ratings: Methodology And Assumptions APPENDIX II: Data And Additional Details For "Sovereign Default Scenarios": Basis For Stress Test For Ratings Above The Sovereign GDP peak-to-trough decline 81. See "Understanding Standard & Poor's Rating Definitions," published June 3, 2009, Appendix 4. In the 'AA' stress scenario, we indicate a GDP decline of up to 15%, and in the 'A' stress scenario, we indicate a GDP decline of up to 6%. In the article cited above, and in the more recent case of Greece, we also observed GDP declines as follows for select sovereign stress events: Mexico, 1994: 15%; Thailand, 1997: 12.5%; Russia, 1998: 9.1%; and Greece, 2011: 7.1% 82. We chose a 6%-10% one-year GDP decline for the sovereign stress test in the criteria for rating above the sovereign--worse than the 'A' stress scenario, but not up to the maximum indicated in the 'AA' stress scenario. Currency movements (all sectors) 83. Our scenario calls for a 50% loss of value vis-à-vis the relevant benchmark currency (US$/euro). That severity is more harsh than the 30%-40% movements observed in September and October 2008, yet less than the 70%-plus movements observed during sovereign crises during which a currency came off a fixed exchange rate. Historical examples of a 30%-40% loss in value. Brazil, The Brazilian real lost 33% of its value against the dollar. Mexico, The Mexican peso lost 30% of its value against the dollar. Brazil, 2002, after the Argentine default and amid fears about policy prospects under a potential Lula government--the Brazilian real lost 41% of its value against the dollar. Historical examples of a 50% loss in value. Mexico, The "Tequila" crisis. Historical examples of a 70%-plus loss in value. Argentina crisis, The peso lost 71% of its value against the dollar, off a fixed exchange rate. Indonesia, The rupiah lost 76% of its value. Russia, The ruble lost 74% of its value. Access to cross-border funding (all sectors). 84. Our scenario indicates that entities would have no access to new cross-border funding, from either foreign banks or capital markets (and for banks, from wholesale deposits) for one year. Maturing short-term or long-term loan facilities or bond issues would need to be repaid out of cash flow, other forms of liquidity, or domestic sources of financing. The exception would be bank lines for which we do not expect "material adverse change" clauses or similar triggers in case of a sovereign default scenario. The rationale for this is that nondomestic sources of financing dry up quickly in a sovereign crisis. NOVEMBER 19,

180 General Criteria: Ratings Above The Sovereign--Corporate And Government Ratings: Methodology And Assumptions Access to domestic funding (all sectors). 85. Our scenario assumes no access to domestic capital markets. In reference to bank funding, we expect a doubling of local nominal interest rates. For speculative-grade issuers, we assume domestic bank financing will be available for rollovers of existing short-term domestic bank lines only. For investment-grade issuers, we assume domestic bank financing would be available for maturing long-term bank debt. The rationale for this is that we expect domestic interest rates to rise sharply during a sovereign default crisis. We also expect credit availability to be curtailed in line with liquidity/funding issues at domestic banks. Value of liquidity position/assets invested in local government bonds, local banks, and domestic corporates. 86. We assume a haircut of 60% of par on the value of foreign currency government securities. This change from our proposal in the request for comment (where we assumed a 70% haircut) followed comments noting that the severity of the Greece and Argentina loss-given-default results were atypical for sovereign defaults. We reexamined data from studies such as the IMF working paper by Sturzenegger and Zettelmeyer, "Haircuts: Estimating Investor Losses in Sovereign Debt Restructurings, ," published in July In this study, haircuts were found to be significant, albeit most were not as severe as our original 70% haircut assumption (Russia at about 60%, Ukraine 40%, Pakistan 30%, Ecuador 60%, Argentina 70%, and Uruguay 30%). The haircut assumption we use remains quite significant, recognizing the likely severe market discount in case entities need to sell domestic debt securities to cover immediate liquidity needs. 87. For countries where the sovereign foreign and local currency ratings differ by two notches, scenario B calls for a haircut of 40% to par on the value of long-term local currency government securities, and a haircut of 50% to par for a 1-notch differential between the sovereign foreign currency and local currency ratings. Short-term (maturing in less than one year) local currency government securities are assumed to hold greater valuations. We assume a haircut of 25% of par for a 2-notch differential, and 30% of par for a 1-notch differential. 88. Our assumptions for non-sovereign security haircuts are as follows: Bank senior debt and debt of local and regional governments are treated similarly to sovereign government foreign currency bond assumptions because banks generally trade in line with the sovereign and are assumed to have a high default correlation with the sovereign; Corporate senior debt is assumed to get a 60% haircut to face value, for purposes of the liquidity test, which is in line with assumptions we use in our market value (MV) criteria (see: "Methodology And Assumptions For Market Value Securities," published Sept. 17, 2013). On the other hand, we assume a 30% haircut to face value, for the purpose of our capital test, in order to better align with our nonperforming loan assumptions for banks (20% NPLs, with loss given default (LGD) of 70% for unsecured loans and 50% for secured loans). Securitizations (RMBS, CMBS, and ABS) are assumed to have no liquidity in a sovereign stress scenario; the haircut for purpose of our liquidity test is assumed to be 100%. This is similar to the assumptions we use in our MV criteria for these asset classes. On the other hand, we assume a 30% haircut to face value, for the purpose of our capital test, reflecting the fact that the higher-rated securitizations in a given country tend to be rated well above the sovereign, indicating that we expect significant resilience of these asset classes to a sovereign default scenario. Covered bonds are assumed to have similar haircuts to bank and sovereign securities for our liquidity test (40% haircut to par), and similar to assumptions for the cover pool assets for the purpose of our capital test (60% haircut to par for local and regional government securities, 30% haircut to par for RMBS/CMBS/ABS securities). NOVEMBER 19,

181 General Criteria: Ratings Above The Sovereign--Corporate And Government Ratings: Methodology And Assumptions Price controls 89. We expect a utility rate/price freeze for one year. The rationale for this is that price controls are common during severe currency depreciations and in times of economic stress. Examples of this are Argentina's long-term price freeze or price controls for electric and gas utilities; Indonesia's utility rate freezes in the crisis; Venezuela's price controls on utility tariffs and basic foodstuffs; and Mexico's price controls during the 1994 "Tequila" crisis (bread and utility tariffs). Nonperforming loans 90. We expect NPLs to rise to at least 20% of total loans. According to the "World Bank Database of Banking Crises" ( 30% was the typical peak reached in the Asian crisis of (Malaysia, 30%; Korea, 35%; and Thailand, 33%; although Indonesia reached 70%). Other data points: Argentina, 20% (2002); Uruguay, 25% (2002); Brazil, 15% (1999); Costa Rica, 32% (1996); Mexico, 18.9% (1995). According to World Bank data for Greece, NPLs to total gross loans reached 11.5% in 2011, and we estimate that NPLs in Greece reached 20%-25% by the end of Deposit run-off 91. We assume domestic banks would experience a significant deposit run-off in the period leading up to, during, or following a sovereign default event, as follows: 15% of retail deposits and 25% of wholesale domestic deposits (cross-border wholesale deposit run-off should be 100%, i.e., time deposits are not renewed at maturity ). The basis for this assumption is observed deposit outflows in sovereign stress scenarios, including: Uruguay reached 33% deposit run-off in 2002; Argentina reached 18% in 2001 prior to the deposit freeze; and Greece reached 37% peak-to-trough run-off (December 2009 to June 2012). APPENDIX III: Changes Compared To Previous Criteria 92. The main changes with respect to EMU criteria are: We changed certain classifications for industry sensitivity to country risk, such as eliminating the 'low sensitivity' classification; considering property/casualty insurance companies to have moderate' sensitivity, compared with 'high' sensitivity in the EMU criteria; and bringing regional and local governments and public finance enterprises into the framework as sectors that generally have 'high' country risk sensitivity. We also allowed for country-specific industry determinations, such as moving from 'high' to 'moderate,' or from 'moderate' to 'high,' on a country-specific basis (such determinations appear in Appendix I) The stress test for rating a nonsovereign entity above the related sovereign is new as an explicit requirement, even for EMU-based entities. At the same time, the criteria include a wider rating differential between a nonsovereign entity and the related sovereign for 'moderate' and 'high' sensitivities. For nonfinancial corporate ratings, we have broadened the definition of country exposure. We consider the relevant measure for a particular industry or sector, which can be EBITDA, revenues, or other volume-based measures, as appropriate. Also for corporate ratings, we now generally determine the referenced sovereign foreign currency rating for entities operating in multiple jurisdictions using a weighted average of the sovereign foreign currency ratings on the countries where the entity has material exposures; however, there are certain situations where the domicile is the reference. NOVEMBER 19,

182 General Criteria: Ratings Above The Sovereign--Corporate And Government Ratings: Methodology And Assumptions 93. For entities outside the EMU, the main changes from the previous criteria are the following: For entities that pass the stress test, we introduced more specificity for the maximum rating differential from the sovereign, depending on the industry's sensitivity to country risk. We could rate an entity up to 2 notches above the sovereign if the entity is in an industry we consider to have "high" sensitivity to country risk, or up to 4 notches if we consider the industry to have "moderate" sensitivity to country risk. We introduced more specificity regarding assumptions for an explicit stress test for rating a nonsovereign above the sovereign for sovereigns rated 'A+' and below (see table 3). For insurance companies, there is an increased focus on the risks associated with a sovereign foreign currency default scenario and the insurer rating differential versus the sovereign foreign currency rating, compared with our current criteria, which focuses on the rating differential versus the sovereign local currency rating. We believe that although most insurers have local currency-denominated investments and policy obligations, the insurers would still be significantly affected by the economic stress that may accompany a sovereign foreign currency default. For example, we would expect a significant market-value loss in the domestic bond, equity, and real estate portfolios, a significant drop in new business volumes, and for the life insurance sector, a hike in policy lapses. In addition, since we assume no access to capital markets, insurers dependent on capital market access would experience a significant decline in credit availability. We also added more specificity to our criteria for potential ratings above the T&C assessment. Entities with 50% or more domestic-source revenues, including exporters that produce exports from a local asset base, may be able to have a foreign currency rating above the T&C assessment subject to certain stress tests and rating caps. Exporters that produce exports from a local asset base may have a foreign currency rating one notch above the T&C assessment even with 90% exposure to a single country, subject to constraints detailed in the T&C section. RELATED CRITERIA AND RESEARCH Country Risk Assessment Methodology And Assumptions, Nov. 19, 2013 Group Rating Methodology, Nov. 19, 2013 Corporate Methodology, Nov. 19, 2013 How Standard & Poor's Intends To Finalize--And Apply--Its Ratings Above The Sovereign Corporate And Government Criteria, Nov. 15, 2013 Standard & Poor's Ratings Definitions, Oct. 24, 2013 Request For Comment: Methodology And Assumptions For Ratings Above The Sovereign--Single Jurisdiction Structured Finance, Oct. 14, 2013 Assessing Bank Branch Creditworthiness, Oct. 14, 2013 Methodology And Assumptions For Market Value Securities, Sept. 17, 2013 Update On Proposed Criteria For Ratings Above The Sovereign For Corporate And Government Entities, Aug. 19, 2013 Guarantee Criteria--Structured Finance, May 7, 2013 Principles Of Credit Ratings, Feb. 16, 2011 Stand-Alone Credit Profiles: One Component Of A Rating, Oct. 1, 2010 Understanding Standard & Poor's Rating Definitions, June 3, 2009 Criteria fully superseded: Criteria Update: Factoring Country Risk Into Insurer Financial Strength Ratings, Feb. 11, NOVEMBER 19,

183 General Criteria: Ratings Above The Sovereign--Corporate And Government Ratings: Methodology And Assumptions Criteria partly superseded: Insurers: Rating Methodology, May 7, 2013 (Section D3 "Rating An Insurer Above The Sovereign Rating," paragraphs ) U.S. Local Governments General Obligation Ratings: Methodology And Assumptions, Sept. 12, 2013 (paragraph 13 is updated to refer to these criteria, in place of the related request for comment, "Methodology And Assumptions: Request For Comment: Ratings Above The Sovereign--Corporate And Government Ratings," April 12, 2013) Banks: Rating Methodology And Assumptions, Nov. 9, 2011 (Section C, "Rating Banks Above The Sovereign," paragraphs ) U.S. State Ratings Methodology, Jan. 3, 2011 (Section A, 2, "Relationship to sovereign rating," paragraph 19, is updated to refer to the requirements of these criteria) Nonsovereign Ratings That Exceed EMU Sovereign Ratings: Methodology And Assumptions," June 14, 2011 (all sections are superseded, with respect to corporate and government ratings) Rating Government-Related Entities: Methodology And Assumptions, Dec. 9, 2010 ("Rating a GRE above the rating on its government", paragraphs 42 and 43 are partially superseded, with respect to Table 3, Sovereign Default Scenario Stress Tests, and by paragraphs 60-62, Government Related Entities; paragraph 45, with respect to the cap for the T&C assessment.) Methodology: Rating A Regional Or Local Government Higher Than Its Sovereign, Sept. 9, 2009 (paragraph 13 is updated to refer to the requirements of these criteria, with respect to the ratings differential between a local and regional government rating and the rating of its respective sovereign; paragraph 15 is updated to refer to table 3 of this article with respect to specific characteristics of our sovereign stress scenario analysis for a LRG to be rated above the sovereign) Criteria For Determining Transfer and Convertibility Assessments, May 18, 2009 (the sections "Ratings Above The Sovereign's" and "Ratings Above the T&C Assessment" are superseded, with respected to corporate and government ratings) 94. These criteria represent the specific application of fundamental principles that define credit risk and ratings opinions. Their use is determined by issuer- or issue-specific attributes as well as Standard & Poor's Ratings Services' assessment of the credit and, if applicable, structural risks for a given issuer or issue rating. Methodology and assumptions may change from time to time as a result of market and economic conditions, issuer- or issue-specific factors, or new empirical evidence that would affect our credit judgment. NOVEMBER 19,

184 Copyright 2015 Standard & Poor's Financial Services LLC, a part of McGraw Hill Financial. All rights reserved. No content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor's Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an "as is" basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT'S FUNCTIONING WILL BE UNINTERRUPTED, OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages. Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P's opinions, analyses, and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw, or suspend such acknowledgement at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal, or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof. S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain nonpublic information received in connection with each analytical process. S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, (free of charge), and and (subscription) and (subscription) and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at NOVEMBER 19,

185 General Criteria: Stand-Alone Credit Profiles: One Component Of A Rating Criteria Officer, EMEA Corporates: Emmanuel Dubois-Pelerin, Paris (33) ; emmanuel.dubois-pelerin@standardandpoors.com Table Of Contents SCOPE OF THE CRITERIA SUMMARY OF CRITERIA UPDATE IMPACT ON OUTSTANDING RATINGS EFFECTIVE DATE AND TRANSITION METHODOLOGY Definition Of Stand-Alone Credit Profile (SACP) The SACP Includes Ongoing Interaction/Influence The SACP Does Not Include Potential Extraordinary Intervention RELATED CRITERIA AND RESEARCH OCTOBER 1,

186 General Criteria: Stand-Alone Credit Profiles: One Component Of A Rating (Editor's Note: On Aug. 11, 2015, we updated the criteria references in this article. We originally published this criteria article on Oct. 1, We republished this article following our periodic review completed on Aug. 11, As a result of our review, we updated the author contact information.) 1. This article comments on Standard & Poor's Ratings Services' stand-alone credit profiles (SACPs). 2. SACPs refer to Standard & Poor's opinion of an issue's or issuer's creditworthiness, in the absence of extraordinary intervention from its parent or affiliate or related government, and are but one component of a rating. We use lowercase symbols, for example 'aaa', or 'aa', to designate SACPs, and may modify this symbol with a "+" or "-" sign, depending on the specificity of the relevant analysis. SACPs do not have outlooks and are not placed on CreditWatch. We do not consider SACPs to be ratings, in contrast to SPURs (Standard & Poor's underlying ratings), which reflect an issuer's credit quality without enhancement. 3. We are publishing this article to help market participants better understand our approach to reviewing the components of ratings when other entities, including governments and parents, influence credit quality. This article is related to our criteria article "Principles Of Credit Ratings," published on Feb. 16, SCOPE OF THE CRITERIA 4. These criteria apply to the analysis of corporate and governmental issues and issuers globally. Please refer to specific criteria for further description of how Standard & Poor's uses the SACP in its analysis. SUMMARY OF CRITERIA UPDATE 5. This article defines the SACP, as a rating component and not as a rating in itself, and reviews the symbology for the SACP. 6. This definition supersedes all other SACP definitions in criteria articles. IMPACT ON OUTSTANDING RATINGS 7. We do not expect any rating changes as a result of these new criteria. OCTOBER 1,

187 General Criteria: Stand-Alone Credit Profiles: One Component Of A Rating EFFECTIVE DATE AND TRANSITION 8. These criteria are effective immediately. METHODOLOGY Definition Of Stand-Alone Credit Profile (SACP) 9. The SACP is not a rating, but a component of the issue rating or issuer credit rating (ICR). We do not assign outlooks to SACPs or place them on CreditWatch. 10. Standard & Poor's may assign an SACP as a component of a rating to provide information on an issuer's creditworthiness. The SACP is Standard & Poor's opinion of an issuer's creditworthiness in the absence of extraordinary support or burden. It incorporates direct support already committed and the influence of ongoing interactions with the issuer's group and/or government. However, the SACP differs from the ICR in that it does not include potential future extraordinary support from a group or government, during a period of credit stress for the issuer, except if that support is systemwide. Neither does the SACP include the potential for the owner or government under a stress to extract assets, capital, or liquidity from the issuer. 11. We assign the SACP at the issuer level. It is not generally applied to specific obligations, except in some cases when an issuer does not have an ICR. But the SACP can directly influence ratings on deferrable instruments (hybrids). While we use the ICR as the starting point for rating nondeferrable debt, we use the SACP as the basis for rating hybrids when we believe that the potential for extraordinary support does not fully extend to them or that extraordinary interference may even target them specifically. 12. We conceive SACPs as existing on a scale ranging from 'aaa' to 'd', which parallels the ICR rating scale, 'AAA' to 'D'. We use 'd' or 'sd' SACPs for issuers with 'D' or 'SD' ICRs respectively. Standard & Poor's uses lowercase letters for SACPs to indicate their status as a component of a rating rather than as a rating. While we attempt to refine the SACP and utilize "+" and "-" to graduate the scale in the same way we do for ICRs, in some cases we may use category-only scoring. Text accompanying the SACP will discuss whether the score is a category or is refined. 13. We recognize it is not always possible to assign an SACP, particularly when the issuer's operations and finances are closely intertwined with the related group or governmental entity's position. The SACP Includes Ongoing Interaction/Influence 14. The determination of an SACP includes ongoing interaction or influence, whether beneficial (positive), neutral, or burdensome (negative). We also include extraordinary support when we believe it has been committed. Ongoing interaction or influence from governments includes interaction with an entire sector on a continuous basis. We consider that groups, including owners and affiliates, influence the SACP when there are regular interactions with the OCTOBER 1,

188 General Criteria: Stand-Alone Credit Profiles: One Component Of A Rating issuer. Table 1 presents examples of influences that we would include in determining the SACP. Table 1 Positive And Negative Influences Examples of positive influence on SACP Recurrent operating or capital subsidies Access to preferential funding Availability of centralized group liquidity resources Conferring monopoly powers Favorable government contracts Supportive regulation Dividend policies, equity issuance flexibility or restriction Applicable tax regime Existing guarantees or lines of credit Use of a group brand Provision of services (property, investment, payroll, shares sales force, etc.) Committed capital or liquidity injection Support of financial system Examples of negative influence on SACP Price ceilings Risky project mandates Directives to provide loss-making goods and services Double leverage, high shareholder-distribution policies Aggressive financial expectations from owners Unfavorable regulatory, tax, or legal regime The SACP Does Not Include Potential Extraordinary Intervention 15. We include potential future extraordinary intervention in the ICR determination, but not in the SACP. 16. We consider interventions as "extraordinary" when they are issuer-specific, related to the issuer's financial stress, and nonrecurrent in nature. Such intervention could be in the form of support to the issuer from groups or governments or interference with the issuer from groups or governments--for example to protect such groups' or governments' own credit quality--that weaken an issuer. 17. Based on our assessment of the relationship between the issuer and its government or group, we form an opinion on the likelihood of timely and sufficient extraordinary intervention in support of the issuer meeting its financial obligations. While support can take many forms, common types include capital and liquidity injections or risk relief (table 2). 18. In our analysis, we specify the potential sources of future extraordinary external intervention. The relevant parent may or may not be the ultimate parent, particularly when intermediate holding companies may exist between the issuer and the relevant parent; government intervention with an issuer may come from national or local public authorities; and an ICR may be influenced by several parents (in the case of non-fully owned subsidiaries), affiliates, and/or governments. 19. If we expect an issue or issuer to receive extraordinary support in the very near term to prevent it from defaulting, we will assign an SACP of 'cc'. OCTOBER 1,

189 General Criteria: Stand-Alone Credit Profiles: One Component Of A Rating Table 2 Extraordinary Intervention Examples of potential extraordinary support Discrete liquidity support that governments, parents, or affiliates provide to specific entities Loans from the parent or government, or through affiliates or government-owned banks Recapitalizations with common equity or hybrid instruments Arrangement of a solvency rescue package directly from the government or through other market participants One-off transfers of risk from an issuer to a governmental entity, its parent or an affiliate to alleviate future stress Targeted increase in some form of ongoing support to a specific entity beyond promised or planned levels Examples of potential extraordinary interference Special taxes Special shareholder distributions Asset- or cash-stripping the issuer at the behest of the group or government to service other obligations of the group or government RELATED CRITERIA AND RESEARCH Rating Government-Related Entities: Methodology And Assumptions, March 25, 2015 Group Rating Methodology, Nov. 19, 2013 Corporate Methodology, Nov. 19, 2013 Banks: Rating Methodology And Assumptions, Nov. 9, 2011 Rating Implications Of Exchange Offers And Similar Restructurings, Update, May 12, 2009 Methodology: Hybrid Capital Issue Features: Update On Dividend Stoppers, Look-Backs, And Pushers, Feb. 9, 2010 Assumptions: Clarification Of The Equity Content Categories Used For Bank And Insurance Hybrid Instruments With Restricted Ability To Defer Payments, Feb. 9, 2010 These criteria represent the specific application of fundamental principles that define credit risk and ratings opinions. Their use is determined by issuer- or issue-specific attributes as well as Standard & Poor's Ratings Services' assessment of the credit and, if applicable, structural risks for a given issuer or issue rating. Methodology and assumptions may change from time to time as a result of market and economic conditions, issuer- or issue-specific factors, or new empirical evidence that would affect our credit judgment. OCTOBER 1,

190 Copyright 2015 Standard & Poor's Financial Services LLC, a part of McGraw Hill Financial. All rights reserved. No content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor's Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an "as is" basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT'S FUNCTIONING WILL BE UNINTERRUPTED, OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages. Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P's opinions, analyses, and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw, or suspend such acknowledgement at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal, or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof. S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain nonpublic information received in connection with each analytical process. S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, (free of charge), and and (subscription) and (subscription) and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at OCTOBER 1,

191 Stressed Reinvestment Rate Assumptions For Fixed-Rate U.S. Debt Obligations, May 20, 2013 General Criteria: Methodology For Revisions To Standard & Poor's Stressed Reinvestment Rate Assumptions For Fixed-Rate U.S. Debt Obligations Primary Credit Analysts: Karen M Fitzgerald, CFA, New York (1) ; karen.fitzgerald@standardandpoors.com Mikiyon W Alexander, New York (1) ; mikiyon.alexander@standardandpoors.com Table Of Contents SCOPE OF THE CRITERIA SUMMARY OF THE CRITERIA IMPACT ON OUTSTANDING RATINGS EFFECTIVE DATE AND TRANSITION METHODOLOGY A. Analytical Approach B. Frequency Of Updates To The Reinvestment Rate Assumptions RELATED CRITERIA AND RESEARCH MAY 20,

192 General Criteria: Methodology For Revisions To Standard & Poor's Stressed Reinvestment Rate Assumptions For Fixed-Rate U.S. Debt Obligations (Editor's Note: We originally published this criteria article on May 20, We're republishing this article following our periodic review completed on April 20, As a result of our review, we updated the author contact information. This criteria article supersedes "Revised Minimum Reinvestment Rate Assumptions For Fixed-Rate U.S. Structured Finance And Municipal Housing Bonds," published June 7, 2010, and partially supersedes "Revised Methodology For Certain Federal Government-Enhanced Housing Transactions," published May 12, This article is related to "Standard & Poor's Revises Its Stressed Reinvestment Rate Assumptions For Fixed-Rate U.S. Debt Obligations," published May 20, 2013.) 1. Standard & Poor's Ratings Services is republishing its methodology for revising reinvestment interest rates for fixed-rate bonds where the investment income on reinvested periodic cash flow contributes toward debt service coverage. This most often applies to U.S. structured finance and U.S. municipal housing bonds. This article is related to our criteria article "Principles Of Credit Ratings," published Feb 16, 2011, and to "Standard & Poor's Revises Its Stressed Reinvestment Rate Assumptions For Fixed-Rate U.S. Debt Obligations," published May 20, SCOPE OF THE CRITERIA 2. These criteria apply to fixed-rate U.S. structured finance and municipal housing bonds, as well as any other obligations, that rely on income generated from reinvesting periodic cash flows to meet debt service payments and do not have a guaranteed investment contract (GIC) or other investment vehicle with a stated interest rate in place. SUMMARY OF THE CRITERIA 3. Standard & Poor's uses stressed reinvestment rate assumptions to determine the amount of reinvestment income it should use in its cash flow analysis of a transaction where there is no other stated interest rate, such as in the case of a GIC. We derive these stressed reinvestment rate assumptions by analyzing three-month U.S. Treasury bill yields and federal funds rates, as well as the relationship between the two. 4. This article supersedes "Revised Minimum Reinvestment Rate Assumptions For Fixed-Rate U.S. Structured Finance And Municipal Housing Bonds," published June 7, 2010, and partially supersedes "Revised Methodology For Certain Federal Government-Enhanced Housing Transactions," published May 12, IMPACT ON OUTSTANDING RATINGS 5. These criteria do not affect any outstanding ratings on U.S. structured finance or U.S. municipal housing bonds. MAY 20,

193 General Criteria: Methodology For Revisions To Standard & Poor's Stressed Reinvestment Rate Assumptions For Fixed-Rate U.S. Debt Obligations EFFECTIVE DATE AND TRANSITION 6. These criteria are effective immediately for all new and outstanding fixed-rate U.S. securities. METHODOLOGY A. Analytical Approach 7. Our criteria for stressed reinvestment rates reflect the expected short-term rates that we derive from analyzing three-month U.S. Treasury bill yields and overnight federal funds rates, as well as the relationship between the two. Under our analysis, we apply a bivariate autoregressive (AR) model of appropriate order to these data series, and then use the fitted model to estimate interest rate paths over the next six years. ("Appropriate order" refers to the order of the best-fitting model. An AR model reflects the number of lags on which the current value depends. An AR(1) means the value at time t depends on the value at time t-1; AR(2) means the value at time t depends on the value at time t-1 and at t-2, etc.) We also apply a univariate AR model to the spread between the three-month U.S. Treasury bill yields and the overnight federal funds rates. 8. The analysis to determine these rates also considers the Federal Reserve Board's policies and the economic forecasts from Standard & Poor's and other leading econometrics firms, as available. In deriving the assumed stressed reinvestment rates, in some cases we may discount these economic forecasts by as much as 75%. While the forecasts reflect an expected scenario, the assumed reinvestment rates apply to securities rated as high as 'AAA' and the discount to the forecasts reflects a stressed interest rate scenario. B. Frequency Of Updates To The Reinvestment Rate Assumptions 9. Standard & Poor's will review the reinvestment rate assumptions derived from this methodology at least annually--as part of its periodic criteria reviews--and upon any market event that may materially change interest rates relative to the then-current reinvestment rate assumptions. RELATED CRITERIA AND RESEARCH Standard & Poor's Revises Its Stressed Reinvestment Rate Assumptions For Fixed-Rate U.S. Debt Obligations, May 20, 2013 IHS Global Insight's U.S. Economic Outlook, April 15, 2013 U.S. Economic Forecast: House Cleaning, March 20, 2013 Counterparty Risk Framework Methodology And Assumptions, Nov. 29, 2012 These criteria represent the specific application of fundamental principles that define credit risk and ratings opinions. Their use is determined by issuer- or issue-specific attributes as well as Standard & Poor's Ratings Services' assessment of the credit and, if applicable, structural risks for a given issuer or issue rating. Methodology and assumptions may change from time to time as a result of market and economic conditions, issuer- or issue-specific factors, or new MAY 20,

194 General Criteria: Methodology For Revisions To Standard & Poor's Stressed Reinvestment Rate Assumptions For Fixed-Rate U.S. Debt Obligations empirical evidence that would affect our credit judgment. MAY 20,

195 Copyright 2015 Standard & Poor's Financial Services LLC, a part of McGraw Hill Financial. All rights reserved. No content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor's Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an "as is" basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT'S FUNCTIONING WILL BE UNINTERRUPTED, OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages. Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P's opinions, analyses, and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw, or suspend such acknowledgement at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal, or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof. S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain nonpublic information received in connection with each analytical process. S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, (free of charge), and and (subscription) and (subscription) and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at MAY 20,

196 General Criteria: Methodology: Timeliness Of Payments: Grace Periods, Guarantees, And Use Of 'D' And 'SD' Ratings Criteria Officer, Emerging Markets: Laura J Feinland Katz, CFA, New York (1) ; laura.feinland.katz@standardandpoors.com Chief Credit Officer, Americas: Lucy A Collett, New York (1) ; lucy.collett@standardandpoors.com Chief Credit Officer, Global: Ian D Thompson, London (44) ; ian.thompson@standardandpoors.com Table Of Contents SUMMARY OF THE CRITERIA SCOPE OF THE CRITERIA IMPACT ON OUTSTANDING RATINGS EFFECTIVE DATE AND TRANSITION METHODOLOGY RELATED QUESTIONS Hypothetical Scenarios RELATED CRITERIA AND RESEARCH OCTOBER 24,

197 General Criteria: Methodology: Timeliness Of Payments: Grace Periods, Guarantees, And Use Of 'D' And 'SD' Ratings (Editor's Note: We originally published this criteria article on Oct. 24, We're republishing this article following our periodic review completed on Dec. 18, 2014.) 1. Standard & Poor's Ratings Services is revising its methodology for timeliness of payments, including our interpretation of "as payments come due," for the purpose of our issue and issuer credit ratings definitions. This revision more closely aligns the treatment of grace periods with market practice and with the practicality of timely payment for guaranteed issues. For long-term financial obligations with stated grace periods greater than five business days, we will apply the 'D' or 'SD' rating if we expect payment will not be made within the earlier of the stated grace period or 30 calendar days after the due date, in place of our previous standard of "up to five business days." 2. This article fully supersedes "Timeliness Of Payments; Grace Periods, Guarantees, And Use Of D And SD Ratings," published Dec. 23, 2010, and partially supersedes "General Criteria: Guarantee Default: Assessing The Impact On The Guarantor's Issuer Credit Rating," published May 11, 2012, and "General Criteria: Rating Sovereign-Guaranteed Debt," published April 6, It is related to "Standard & Poor s Ratings Definitions," published Oct. 24, 2013, "Principles For Rating Debt Issues Based On Imputed Promises," published Oct. 24, 2013, and "Principles Of Credit Ratings," published Feb. 16, SUMMARY OF THE CRITERIA 3. Standard & Poor's is updating its criteria for timeliness of payments for issuers and issues with stated grace periods longer than five business days. 4. The amendment clarifies that when a long-term obligation has a stated grace period greater than five business days, a rating of 'D' or 'SD' may not apply if we expect payment to be made within the earlier of the stated grace period or 30 calendar days. This change, from our previous standard of a maximum of five business days, is intended to be i) more in line with current market practice, ii) more in line with the practical mechanics of transfers and payments within stated grace periods for some guarantees, and iii) aligned with the new criteria, "Principles For Rating Debt Issues Based On Imputed Promises." 5. For long-term obligations that have no stated grace period, or a stated grace period of up to five business days, the criteria retain the current treatment; we treat the obligation as having an imputed five-business-day grace period. 6. For short-term obligations, the criteria retain the current treatment. When there is no stated grace period, we do not impute any grace period. When there is a stated grace period, we interpret "as they come due" as payment within the earlier of the stated grace period or five business days after the due date for payment. OCTOBER 24,

198 General Criteria: Methodology: Timeliness Of Payments: Grace Periods, Guarantees, And Use Of 'D' And 'SD' Ratings SCOPE OF THE CRITERIA This criteria apply to all issue and issuer credit ratings assigned by Standard & Poor's except insurer financial strength ratings (for the latter, see "Standard & Poor s Ratings Definitions," published Oct. 24, 2013). For securities structured to allow for payment deferral, see "Principles For Rating Debt Issues Based On Imputed Promises," published Oct. 24, 2013, and "General Criteria: Methodology: Use Of 'C' And 'D' Issue Credit Ratings For Hybrid Capital And Payment-In-Kind Instruments," published Oct. 24, IMPACT ON OUTSTANDING RATINGS 8. There is no impact on outstanding ratings. EFFECTIVE DATE AND TRANSITION 9. The criteria are effective immediately. METHODOLOGY 10. In order to provide consistent application of our long-term rating definitions, we interpret "as payments come due" as follows: If there is no stated grace period, or a stated grace period of one to five business days, timely payment means no later than five business days after the due date for payment; and If there is a stated grace period of more than five business days, timely payment means no later than the earlier of the stated grace period or 30 calendar days. 11. This means that for long-term issue or issuer credit ratings: We would assign a rating of 'D' or 'SD' if a payment is missed on its due date and we do not believe payment will be made in the relevant (stated or imputed) grace period. We would not apply a rating of 'D' or 'SD' if a payment is missed on its due date but we believe that payment will be made within five business days. We would not apply a rating of 'D' or 'SD' if an obligation has a stated grace period greater than five business days and a payment is missed on its due date, but we believe that payment will be made within the earlier of the stated grace period or 30 calendar days. We would apply a rating of 'D' or 'SD' if an obligation has a stated grace period greater than 30 calendar days and we expect payment to be made more than 30 calendar days after the due date but before the expiration of the stated grace period. 12. The rationale for imputing a maximum 30-day grace period is to balance typical market practice for the use of grace periods, with a desire to maintain a reasonable standard beyond which we believe investors would not consider payments as timely, regardless of the stated grace period. OCTOBER 24,

199 General Criteria: Methodology: Timeliness Of Payments: Grace Periods, Guarantees, And Use Of 'D' And 'SD' Ratings 13. We also apply the same timeliness of payments standard to cases where we apply a long-term rating to an obligation based on the creditworthiness of a guarantor (or other support provider). 14. This means that, in addition to all other provisions of current criteria, we would not apply the guarantor's rating to the obligation unless we believe the guarantee arrangement, viewed as a whole and including any collective actions, embodies features (i.e., systems and facilities) that adequately support the guarantor's practical ability to fulfill its obligations under the guarantee. For a guaranteed obligation with a stated grace period longer than five business days, we would consider timely payment to be the earlier of the primary obligation's stated grace period or 30 calendar days after the primary obligation's due date. When a guaranteed obligation has no stated grace period or a stated grace period of less than five business days, we would impute a five-business-day grace period. 15. For short-term ratings, 'D' and 'SD' is used when payments on a financial obligation are not made on the due date even if the applicable stated grace period has not expired, unless Standard & Poor's believes that such payments will be made during the stated grace period. However, any stated grace period longer than five business days will be treated as five business days. 16. The reason for different timeliness standards between short-term and long-term ratings is the fundamental differences between short- and long-term expectations in credit markets. There are very different market needs and expectations regarding timely payment. Traditional short-term instruments, such as commercial paper or short-term government securities, are commonly used as investments matched to an investor's short-term liquidity needs. Making payment on the due date, or at most within a few business days of the due date (regardless of whether there is a longer stated grace period), is critical. RELATED QUESTIONS What if there is a non-credit administrative error that delays payment a few days beyond the maximum "timeliness of payments" standards? 17. A: Standard & Poor's will apply reasonable judgment in such cases. For example, if payment is originally made on a timely basis, but paid into the wrong account due to what Standard & Poor's believes is an administrative error on the part of the issuer, payment agent, or trustee, we may not lower the rating to 'D' as long as we believe the error will be corrected within a few business days. What if there is a non-credit extraordinary event that delays payment a few days beyond the maximum "timeliness of payments" standards? 18. A: Standard & Poor's will apply reasonable judgment in such cases. For example, if due to a natural catastrophe or other "force majeure" event, an issuer cannot access payment systems for a few days beyond the original payment date or grace period end, we may not lower the rating to 'D' as long as we believe payment can be made within a few business days. What if the issuer makes the payment to the trustee on a timely basis, but a judicial action interferes with full and timely payment being made to the investor? 19. A: Standard & Poor's interpretation of meeting financial commitments "as they come due" is that investors are paid on a full and timely basis. If a judicial action interferes in the timely payment flows from the issuer to the investors, the OCTOBER 24,

200 General Criteria: Methodology: Timeliness Of Payments: Grace Periods, Guarantees, And Use Of 'D' And 'SD' Ratings rating will be lowered to 'D'. Examples of such actions include a successful litigation by one class of investors that results in a redirection or sharing of payments between different classes of investors. When such action results in payment not being made on a full and timely basis to one or more class of investors according to the terms of the documents, the rating will be lowered to 'D'. On the other hand, if payment doesn't reach an investor due to judicial action against that investor, such as a freezing of investor assets, such action would not affect the issuer or issue rating. What if a short-term rating has a grace period of three business days? 20. A: Standard & Poor's does not impute any grace period for short-term ratings. If a payment is not made on the due date, the rating will be lowered to 'D' unless there is a stated grace period and we believe the payment will be made within the stated grace period up to a maximum of five business days. Therefore, a short-term rating would not be lowered to 'D' if we believed the payment would be made within the stated grace period of three business days. What if a short-term rating has a grace period of nine business days? 21. A short-term rating would be lowered to 'D' if we believed the payment would be made within the stated grace period of nine business days but past the five business-day maximum. If payment of a financial obligation is not made on the due date, when are ratings lowered to 'D'? 22. A: Standard & Poor's would lower its ratings to 'D' as soon as a payment is missed and we believe the issuer will not make the payment within the applicable grace period. For the majority of actions, this would be the day after the original missed payment (T+1 day) because there is a high standard of evidence that a payment could be forthcoming during a grace period. In practice, grace period payments are the exception. In the rarer cases where a payment is missed but we believe would be paid within the applicable grace period, we would consider placing the ratings on CreditWatch negative to reflect any residual uncertainty or risk that the payment may not eventually be made within the grace period. Finally, if a stated grace period is longer than 30 days, our ratings are lowered to 'D' as soon as we believe the payment would not be made within our maximum imputed grace period of 30 calendar days. Again, for the majority of actions under this scenario this would be the day after the original due date, because payments are rarely subsequently made and we'd additionally have to believe they'd be made before the expiry of the longer stated grace period. What if Standard & Poor's initially expects payment will be made within a 30-day-grace period, but subsequently no longer believes payment will be made within 30 calendar days? 23. A: Initially, following a missed payment that we expect will be made within the grace period, and within 30 calendar days, we may place the rating on CreditWatch with negative implications. Once we come to believe that payment will not be made within the earlier of the stated grace period or 30 calendar days, we would lower the issue rating to 'D' and the issuer credit rating to 'SD'. Hypothetical Scenarios The following timeline and table illustrate our approach to calling an instrument in default depending on hypothetical scenarios for grace periods and expected payment dates. OCTOBER 24,

201 General Criteria: Methodology: Timeliness Of Payments: Grace Periods, Guarantees, And Use Of 'D' And 'SD' Ratings How We Determine Whether A Past-Due Obligation Is Rated D --Timeline-- March 1 (Monday) Due date March 3 (Wednesday) March 8 (Monday) March 9 (Tuesday) March 31 (Wednesday) A, B C (i) C (ii) D (i) D (ii) Five business days after due date Six business days after due date 30 calendar days after due date --For payment due date of March 1-- April 15 (Thursday) 45 calendar days after due date Case Standard & Poor s expected payment date Stated grace period --Is there a default on:-- Long-term debt? Short-term debt? Explanation A March 3 None No Yes For long-term debt, we allow a five-day grace period if none is stated. For short-term debt, we consider one day late as default, if there is no stated grace period. B March 3 Three business days C (i) March 8 10 calendar days C (ii) March 9 10 calendar days D (i) March calendar days D (ii) April calendar days No No We expect payment within five business days, and within the stated grace period No No We expect payment within five business days after due date, and within the stated grace period. March 8, in this example, is five business days after the due date. No Yes We expect payment within the stated grace period, and within 30 calendar days after the due date, but after five business days. Therefore, as early as March 2 (the date after the missed payment), we would lower the short-term rating to D, though the long-term rating would not fall to D. No Yes For long-term debt, we allow up to a 30-calendar-day grace period, where terms provide for a longer grace period. For short-term debt, we do not allow beyond five business days. Yes Yes In this case, we expect payment 45 days after the due date. Although this is within the stated grace period, we consider it a default, since payment is expected after 30 calendar days (long-term debt) and five business days (short-term debt). We would lower the shortand long-term ratings to D as soon as March 2 (the date after the missed payment). RELATED CRITERIA AND RESEARCH Standard & Poor s Ratings Definitions, Oct. 24, 2013 Principles For Rating Debt Issues Based On Imputed Promises, Oct. 24, 2013 Use Of C And D Issue Credit Ratings For Hybrid Capital And Payment-In-Kind Instruments, Oct. 24, 2013 General Criteria: Guarantee Default: Assessing The Impact On The Guarantor's Issuer Credit Rating, May 11, 2012 General Criteria: Rating Sovereign-Guaranteed Debt, April 6, 2009 These criteria represent the specific application of fundamental principles that define credit risk and ratings opinions. OCTOBER 24,

202 General Criteria: Methodology: Timeliness Of Payments: Grace Periods, Guarantees, And Use Of 'D' And 'SD' Ratings Their use is determined by issuer- or issue-specific attributes as well as Standard & Poor's Ratings Services' assessment of the credit and, if applicable, structural risks for a given issuer or issue rating. Methodology and assumptions may change from time to time as a result of market and economic conditions, issuer- or issue-specific factors, or new empirical evidence that would affect our credit judgment. OCTOBER 24,

203 Copyright 2015 Standard & Poor's Financial Services LLC, a part of McGraw Hill Financial. All rights reserved. No content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor's Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an "as is" basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT'S FUNCTIONING WILL BE UNINTERRUPTED, OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages. Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P's opinions, analyses, and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw, or suspend such acknowledgement at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal, or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof. S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain nonpublic information received in connection with each analytical process. S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, (free of charge), and and (subscription) and (subscription) and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at OCTOBER 24,

204 General Criteria: Methodology: Use Of 'C' And 'D' Issue Credit Ratings For Hybrid Capital And Payment-In-Kind Instruments Primary Credit Analyst: Michelle M Brennan, Criteria Officer, European Financial Services, London (44) ; michelle.brennan@standardandpoors.com Secondary Contacts: Laura J Feinland Katz, CFA, Criteria Officer, New York (1) ; laura.feinland.katz@standardandpoors.com Emmanuel Dubois-Pelerin, Global Criteria Officer, Financial Services, Paris (33) ; emmanuel.dubois-pelerin@standardandpoors.com Mark Puccia, Global Criteria Officer, Corporates, New York (1) ; mark.puccia@standardandpoors.com Takamasa Yamaoka, Japan/Korea Regional Criteria Officer, Tokyo (81) ; takamasa.yamaoka@standardandpoors.com Chief Credit Officer, Americas: Lucy A Collett, New York (1) ; lucy.collett@standardandpoors.com Table Of Contents SCOPE OF THE CRITERIA SUMMARY OF THE CRITERIA EFFECTIVE DATE IMPACT ON OUTSTANDING RATINGS METHODOLOGY OCTOBER 24,

205 Table Of Contents (cont.) Permanent Shock Absorbers: Hybrid Capital Instruments That Allow For Non-Cumulative Deferrals, Write-Down Provisions, Or Debt/Equity Conversions Temporary Shock Absorbers: Hybrid Capital Instruments That Allow For Cumulative Non-Compounding Deferrals Temporary Shock Absorbers: Payment-In-Kind (PIK) Instruments Debt Obligations With Deferrable Principal Repayment Dates (Other Than Hybrid Capital Instruments) Impact On The ICR Of A 'D' Issue Credit Rating On A Hybrid Capital Instrument Exchange Offers And Similar Restructurings On Hybrid Capital Instruments Glossary Related Criteria And Research OCTOBER 24,

206 General Criteria: Methodology: Use Of 'C' And 'D' Issue Credit Ratings For Hybrid Capital And Payment-In-Kind Instruments (Editor's Note: We originally published this criteria article on Oct. 24, We're republishing it following our periodic review completed on Oct. 16, In addition to the superseded articles listed in paragraph 2, this article partially supersedes the section headed, 'Preferred stock,' in the article titled, "2008 Corporate Criteria: Rating Each Issue," published on April 15, Paragraph 18 in this article has been partly superseded by "Bank Hybrid Capital And Nondeferrable Subordinated Debt Methodology And Assumptions," published on Sept. 18, 2014, which clarifies that notching by at least three notches applies to deferrable hybrid capital instruments because notching for some nondeferrable bank hybrid capital instruments could be two notches down at those rating and stand-alone credit profile levels.) 1. On Oct. 24, 2013, Standard & Poor's Ratings Services published its criteria, "Principles For Rating Debt Issues Based On Imputed Promises" (Imputed Promises Criteria). Among other provisions, the criteria indicate that we assign the 'D' long-term issue credit rating and no longer the 'C' rating to issues on which cash coupon payments have been deferred, eliminated, or, in some cases, paid in kind, as permitted under the terms of the issue, or in certain cases of principal writedown. This criteria article provides additional guidance for determining when we will apply the 'D' rating to such instruments. 2. This article supersedes "How The Expansion Of The C Rating Definition Affects Its Use For Hybrid Capital And Payment In-Kind Instruments," published Aug. 1, It also partially supersedes "Rating Implications Of Exchange Offers And Similar Restructurings, Update," published May 12, 2009, by superseding the references to use of the 'C' issue credit rating in the answer to question 14 of that article. It also partially supersedes "Bank Hybrid Capital Methodology And Assumptions," published Nov. 1, 2011, by superseding the references to use of the 'C' issue credit rating in table 2, and partially supersedes "Hybrid Capital Handbook," published Sept. 15, 2008, by superseding the references to use of the 'C' issue credit rating in the section titled, "Rating The Issue: Default And Distress." SCOPE OF THE CRITERIA 3. These criteria apply to the issue credit ratings we assign to payment-in-kind (PIK) instruments issued by entities. These criteria also apply to hybrid capital instruments, such as preferred stock, deferrable subordinated notes, "kikin" (a form of deferrable subordinated debt capital unique to Japanese mutual life insurers), trust preferred securities, and other instruments with deferrable coupon or deferrable principal repayment dates, rated under our criteria for corporate (including project finance), governments (including international public finance, U.S. public finance, multilateral lending institutions, and sovereigns), financial institutions, and insurance issuers. This article does not apply to issuer credit ratings (ICRs). 4. Hybrid capital generally refers to an instrument that has characteristics of both debt and equity. Standard & Poor's considers an instrument as a hybrid capital instrument if, and only if, without causing a legal default or liquidation of OCTOBER 24,

207 General Criteria: Methodology: Use Of 'C' And 'D' Issue Credit Ratings For Hybrid Capital And Payment-In-Kind Instruments the issuer, it can absorb losses via either nonpayment of the coupon or a write-down of principal, or can convert into common equity or another hybrid capital instrument. SUMMARY OF THE CRITERIA 5. The issue credit ratings on hybrid capital instruments, or on any debt instrument with a coupon deferral or cancellation feature or principal write-down or deferral feature, are generally lowered to 'D' when payments are deferred or reduced on a permanent basis according to terms of the instrument. This includes: deferral of interest or dividends on a non-cumulative instrument (where missed coupons are not repaid in the future); write-down of principal; or conversion to common equity due to a credit event. In these criteria, "coupon" refers to periodic distributions, regardless of how they are described under the terms and conditions of the instrument (including such descriptions as "coupons," "interest," or "dividends"). 6. The issue credit ratings on hybrid capital instruments with cumulative deferral provisions (such as cumulative preferred stock), or economically equivalent structures that also allow temporary coupon deferral without interest on deferred interest, will be lowered to 'D' upon deferral. The exception is if we expect that the deferral period a) will be short term, typically one year or less, and b) will be in accordance with the terms of the instrument. 7. For instruments that may make payment in kind, or economically equivalent structures (such as capitalized interest options), paying in kind does not in and of itself result in a rating change to 'C' or 'D'. However, we may still lower the issue credit ratings due to issuer credit deterioration, as reflected in a lower issuer credit rating or stand-alone credit profile. 8. The lowering of an issue credit rating assigned to a hybrid capital instrument to 'D' does not result in a lowering of the ICR to 'SD' nor 'D' if the payment default is in accordance with the instrument's terms and conditions, or if the instrument forms part of regulatory capital for a prudentially regulated issuer. EFFECTIVE DATE 9. These criteria are effective immediately. We intend to complete our review of relevant ratings within the next six months. IMPACT ON OUTSTANDING RATINGS 10. Standard & Poor's expects to lower to 'D' the issue credit ratings on almost all hybrid capital instruments currently rated 'C'. (Hybrid capital instruments include preferred stock, preference shares, and subordinated debt with deferral features, issued by corporations, financial institutions, and insurers.) Approximately 80 hybrid capital instruments are currently rated 'C' because they are deferring payments as their terms permit, or are currently subject to a distressed exchange. Those hybrid capital instruments we rate 'C' due to notching for subordination, but that are not currently deferring coupons, remain rated 'C'. OCTOBER 24,

208 General Criteria: Methodology: Use Of 'C' And 'D' Issue Credit Ratings For Hybrid Capital And Payment-In-Kind Instruments METHODOLOGY Permanent Shock Absorbers: Hybrid Capital Instruments That Allow For Non-Cumulative Deferrals, Write-Down Provisions, Or Debt/Equity Conversions 11. Even when the terms of an instrument permit nonpayment of interest, conversion to common equity, or write-down or deferral of principal in such a way that this constitutes a "permanent shock absorber" under our criteria, the occurrence of any of these is a breach of the terms of the imputed promise we impute to rate the instrument (which is to pay cash on the originally scheduled due date). In such a case, the instrument is rated 'D'. For more on our definition and rating criteria for permanent shock absorbers, see Imputed Promises Criteria, paragraphs Therefore, a write-down of principal, even if in accordance with the terms of a hybrid capital instrument, results in a 'D' rating if it causes a permanent diminished payment. Also, the conversion of a debt instrument into common equity due to a credit related trigger, even if in accordance with the terms of the instrument, results in a 'D' rating unless the current market value of the shares received upon conversion equals or exceeds the original principal amount. We lower the issue credit rating to 'D' if any portion of distribution payments or principal is deferred or reduced on a permanent basis even if this is according to the terms of the instrument, or if an instrument is subject to a distressed exchange. 13. For a hybrid capital instrument that has a provision for a temporary, instead of permanent, write-down of principal, if -as we expect will almost always be the case--the use of such a provision results in a permanent diminished interest payment we lower the rating to 'D'. Temporary Shock Absorbers: Hybrid Capital Instruments That Allow For Cumulative Non-Compounding Deferrals 14. For hybrid capital instruments with cumulative deferral features (such as cumulative preferred stock), or economically equivalent structures that allow temporary interest deferral without interest on deferred interest, we impute a ratable promise of repayment of the deferred amount within one year of the deferral date, and we lower an instrument's issue credit rating to 'D' unless we expect (a) repayment to occur within one year and in accordance with terms (including any penalty interest, for example) and (b) the next year of coupons to be honored in full and on scheduled dates. (For the criteria on instruments that allow temporary interest deferral with interest on deferred interest, see section on payment-in-kind instruments, paragraph 19.) For more on our definition and rating criteria for temporary shock absorbers, see Imputed Promises Criteria, paragraphs As a result, in practice, we expect to generally lower issue credit ratings to 'D' upon deferral since, in our experience, arrears are settled, if at all, sufficiently late as to turn the future interest promise into an illusory one. 16. If, however, we make a case-specific analysis that the deferral period will be short term, typically one year or less, within which we expect all arrears to be settled, then the issue credit rating is not 'D' and reflects our opinion of the risk OCTOBER 24,

209 General Criteria: Methodology: Use Of 'C' And 'D' Issue Credit Ratings For Hybrid Capital And Payment-In-Kind Instruments of the coupons not being reinstated within this time period. In these cases, we derive the issue credit rating by applying "Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings," published Oct. 1, 2012, if the conditions in paragraphs are met; and otherwise, by applying our general hybrid capital criteria. 17. For a hybrid capital instrument that is current on coupons, paragraphs 11 to 15 above do not affect our criteria for "notching" its issue credit rating. Notching refers to the number of notches that an issue is rated below the ICR or stand-alone credit profile (SACP), based on our analysis of the nonpayment risk and/or subordination features associated with the instrument. In line with existing criteria, all deferrable instruments are rated at least one notch below the ICR or SACP because of their deferral risk. If deferral becomes an increasingly likely prospect on a hybrid but not on senior debt, the gap between the ICR or SACP and the issue credit rating on a hybrid capital instrument widens to reflect the heightened risk of deferral. 18. The 'C' issue credit rating is assigned to hybrid capital instruments (and other subordinated instruments) only to reflect subordination, notably for all issuers with an ICR of 'CCC-' or lower, or for all banks with an SACP of 'ccc' or lower, since we notch at least three notches down for a hybrid capital instrument at these rating and SACP levels. Temporary Shock Absorbers: Payment-In-Kind (PIK) Instruments 19. For instruments with PIK features or economically equivalent structures (such as capitalized interest options) that allow interest to be met with a non-cash payment, a PIK event is a breach of the imputed promise only if we have virtual certainty that repayment will not occur by the maturity date. Absent this virtual certainty, however, we may lower PIK instrument ratings on the occurrence of such an event due to issuer credit deterioration, as reflected in a lower issuer credit rating. The rationale for this treatment is that such instruments are generally expected to repay both principal and interest, along with the payment-in-kind or capitalized interest, in line with the likelihood the issuer will repay its other financial obligations. 20. These criteria align our rating approaches on traditional PIK and PIK toggle instruments. 21. A PIK feature does not cause an instrument to be rated lower than the issuer credit rating of the issuer. However, notching for subordination or recovery will apply. Debt Obligations With Deferrable Principal Repayment Dates (Other Than Hybrid Capital Instruments) 22. As indicated in "Principles For Rating Debt Issues Based On Imputed Promises," if the terms of an instrument specify a final maturity date, as well as an earlier, projected principal repayment schedule--sometimes referred to as the expected maturity date or the target amortization schedule--the imputed promise is principal due at final maturity (or "legal maturity date"). Examples of such instruments include leveraged loans with cash sweep features that provide for projected repayment earlier than scheduled payment. 23. For a debt obligation with a scheduled principal repayment date that has a deferral feature, used, for example, as a temporary shock absorber in the case of debt service shortfalls, the issue credit rating is not moved to 'D' if the deferral OCTOBER 24,

210 General Criteria: Methodology: Use Of 'C' And 'D' Issue Credit Ratings For Hybrid Capital And Payment-In-Kind Instruments of principal is for one year or less and the debt instrument maturity is maintained within its final maturity under the terms of an instrument. If we expect a principal repayment to be delayed for more than one year past a scheduled but deferrable repayment date, we would lower the issue credit rating to 'D' to reflect the sustained loss absorption. Impact On The ICR Of A 'D' Issue Credit Rating On A Hybrid Capital Instrument 24. The lowering of a hybrid capital instrument rating to 'D' does not result in a lowering of the ICR to 'SD' nor 'D' if the payment default is in accordance with the instrument's terms and conditions, or if the instrument forms part of regulatory capital for a prudentially regulated issuer. Exchange Offers And Similar Restructurings On Hybrid Capital Instruments 25. An exchange offer or similar restructuring on a hybrid capital instrument (see "Rating Implications Of Exchange Offers And Similar Restructurings, Update," published May 12, 2009, for the definition of an exchange offer or similar restructuring) may reflect the possibility that, absent the exchange offer taking place, the issuer would exercise the coupon deferral or a loss absorption feature in accordance with the terms of the instrument. In such instances, we would lower the instrument's issue credit rating to 'C' on announcement of the offer and to 'D' on completion of the offer. The impact on the ICR is as discussed in paragraph 24 above. Glossary 26. PIK debt: These obligations are typically issued by corporate entities with ICRs of 'BB+' and lower. PIK debt can pay interest in cash or in kind in certain circumstances. PIK means that the investor, in lieu of cash, receives more of the same note, or that the note's principal is increased. There are several forms of PIK debt. In their simplest form, PIK notes pay interest in kind from the outset, and for the life of the instrument. Some PIK debt initially requires cash interest payments, but gives the issuer the option of paying in kind later. In other cases, payments are initially PIK, but then must be made in cash after a prespecified period. 27. Toggle notes: These notes are a specific form of PIK debt designed to facilitate switching back and forth between cash payments and PIK distributions, at the issuer's discretion. The issuer increases remuneration for those periods when the PIK option is utilized. Related Criteria And Research Principles For Rating Debt Issues Based On Imputed Promises, Oct. 24, 2013 Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings, Oct. 1, 2012 Bank Hybrid Capital Methodology And Assumptions, Nov. 1, 2011 Rating Implications Of Exchange Offers And Similar Restructurings, Update, May 12, 2009 Hybrid Capital Handbook: September 2008 Edition, Sept. 15, OCTOBER 24,

211 Copyright 2015 Standard & Poor's Financial Services LLC, a part of McGraw Hill Financial. All rights reserved. No content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor's Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an "as is" basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT'S FUNCTIONING WILL BE UNINTERRUPTED, OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages. Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P's opinions, analyses, and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw, or suspend such acknowledgement at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal, or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof. S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain nonpublic information received in connection with each analytical process. S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, (free of charge), and and (subscription) and (subscription) and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at OCTOBER 24,

212 General Criteria: Use Of CreditWatch And Outlooks Primary Credit Analyst: Mark Puccia, New York (1) ; Criteria Officer, Emerging Markets: Laura J Feinland Katz, CFA, New York (1) ; laura_feinland_katz@standardandpoors.com Chief Credit Officer, EMEA: Lapo Guadagnuolo, London (44) ; lapo.guadagnuolo@standardandpoors.com Chief Credit Officer, Americas: Lucy A Collett, New York (1) ; lucy.collett@standardandpoors.com Chief Credit Officer, Structured Finance: Felix E Herrera, CFA, New York (1) ; felix.herrera@standardandpoors.com Table Of Contents Background CreditWatch Outlooks Communications Policy For CreditWatch And Outlook Listings Frequently Asked Questions Related Criteria And Research SEPTEMBER 14,

213 General Criteria: Use Of CreditWatch And Outlooks (Editor's Note: We republished this article on April 10, 2015, to add a question to the Frequently Asked Questions section. We originally published this criteria article on Sept. 14, We republished this article following our periodic review completed on April 6, This article updates and supersedes "Credit Policy Update: Criteria On Use Of CreditWatch And Outlooks Clarified," published Sept. 30, 2005, and supersedes "Acquisition Risk And Its Effect On Ratings," published Sept. 11, 2006.) Background Standard & Poor's Ratings Services uses CreditWatch and ratings outlooks to indicate its view regarding the degree of likelihood of a rating change and, in most cases, the probable direction of that change. CreditWatch highlights the potential direction of a short- or long-term rating. It focuses on identifiable events and short-term trends that may cause ratings to be placed under special surveillance by Standard & Poor's. These may include mergers, recapitalizations, voter referendums, regulatory action, performance deterioration of securitized assets, or anticipated operating developments. Ratings may be placed on CreditWatch when such an event or a deviation from an expected trend occurs and we believe that additional information is necessary to evaluate the current rating or when there is, in our opinion, a material change in the performance of securitized assets and the magnitude of the rating impact has not been fully determined. A CreditWatch listing, however, does not mean a rating change is inevitable, and when appropriate, a range of potential alternative ratings that we believe could result will be shown. CreditWatch is not intended to include all ratings under review, and rating changes may occur without the ratings having first appeared on CreditWatch. The "positive" CreditWatch designation means that a rating may be raised; "negative" CreditWatch means a rating may be lowered; and "developing" CreditWatch means that a rating may be raised, lowered, or affirmed. (See Ratings Definitions) A Standard & Poor's rating outlook indicates our view regarding the potential direction of a long-term credit rating over the intermediate term (typically six months to two years). In determining a rating outlook, consideration is given to any changes we see in the economic and/or fundamental business/financial conditions. An outlook is not necessarily a precursor of a rating change or future CreditWatch action. Positive means that a rating may be raised. Negative means that a rating may be lowered. Stable means that a rating is not likely to change. Developing means a rating may be raised or lowered. N.M. means not meaningful. Rating outlooks (other than stable) and CreditWatch are used in a changing credit situation when, in our view, a rating change is not certain. Although many rating changes are preceded by a non-stable outlook or a CreditWatch SEPTEMBER 14,

214 General Criteria: Use Of CreditWatch And Outlooks placement, changes can and should occur even when the outlook is stable or the rating is not on CreditWatch but when an abrupt change in the creditworthiness can be assessed immediately. Standard & Poor's priority is always to get the rating appropriate as quickly as possible, even if a rating change is not signaled in advance because of unanticipated circumstances. Standard & Poor's credit ratings express forward-looking opinions about the creditworthiness of issuers and obligations. More specifically, Standard & Poor's credit ratings express a relative ranking of creditworthiness. The primary factor in Standard & Poor's analysis of creditworthiness is likelihood of default, although payment priority, potential recovery following default, and credit stability are factors that can also play a role in Standard & Poor's assessment of credit risk. Credit ratings incorporate an assessment of future events to the extent they can be anticipated. However, Standard & Poor's also recognizes the potential for future performance to differ from initial expectations. Outlooks and CreditWatch listings address this possibility by focusing on the scenarios that, in our opinion, could result in a rating change. CreditWatch Ratings may be placed on CreditWatch under three sets of circumstances: 1) When, in our view, an event or deviation from an expected trend has occurred or is expected and when additional information is necessary to take a rating action. 2) When we believe there has been a material change in the performance of an issue or issuer, but the magnitude of the rating impact has not been fully determined, and Standard & Poor's believes that a rating change is likely in the short term. 3) A change in criteria has been adopted that necessitates a review of an entire sector or multiple transactions and Standard & Poor's believes that rating changes are likely in the short term. For example, under Circumstance 1, an issuer typically is placed under such surveillance as the result of a merger, recapitalization, or unanticipated operating development. Such rating reviews are completed as soon as Standard & Poor's has received the necessary information and completed its analysis normally within 90 days unless the outcome of a specific event is pending. Under Circumstance 2, a group of transactions may be placed under such surveillance as the result of identified performance deterioration until we complete our analysis of the magnitude of the rating impact, normally within 90 days. In Circumstance 3, a group of transactions may be placed under such surveillance as the result of being affected by a change in criteria. In situations where ratings remain on CreditWatch for more than 90 days (e.g., for mergers and acquisitions) or when material events or deviations from trends occur, Standard & Poor's will generally publish interim updates to identify its most current assessment of the situation. In situations where ratings are placed on CreditWatch due to performance deterioration of securitized assets or due to a change in criteria, and the analysis of the ratings impact is expected to exceed 90 days, Standard & Poor's will generally publish an expected timeframe to complete its assessment of the situation. Standard & Poor's uses CreditWatch when it believes that the likelihood of rating action within the next 90 days is substantial. Standard & Poor's will place a rating on CreditWatch if we determine that there is at least a one-in-two likelihood of a rating change within 90 days. From time to time, there may be events or issues that present such significant uncertainty to the creditworthiness of an issue or issuer that a rating is placed on CreditWatch without the need to assess this threshold of potential change. SEPTEMBER 14,

215 Cross-Sector

216 Criteria Governments U.S. Public Finance: Appropriation-Backed Obligations Primary Credit Analyst: Lisa R Schroeer, Charlottesville (1) ; lisa.schroeer@standardandpoors.com Secondary Contact: Horacio G Aldrete-Sanchez, Dallas (1) ; horacio.aldrete@standardandpoors.com Table Of Contents Government Obligor's General Creditworthiness Appropriation And Term Features Nontax-Supported Leases Frequently Asked Questions JUNE 13,

217 Criteria Governments U.S. Public Finance: Appropriation-Backed Obligations (Editor's Note: We originally published this criteria article on June 13, We republished this article following our periodic review completed on April 1, As a result of our review, we updated the author contact information. We added a section entitled "Frequently Asked Questions" on Aug. 10, 2015.) 1. Appropriation-backed obligations come in various forms; the most prevalent are lease revenue bonds, certificates of participation, and service contract bonds. Municipal appropriation-backed obligations frequently are used to avoid constitutional or other legal restrictions on the use of GO debt. Appropriation-backed obligations may also be the most expedient and flexible financing method for many governments. For these obligations, timely payment of principal and interest depends on annual appropriations by the issuer. Because lease or service contract payments are not binding on future legislatures or councils, appropriation-backed obligations are generally not considered "debt" under issuers' technical and legal definitions. As a result of the appropriation risk those appropriation-backed obligations that meet Standard & Poor's Ratings Services criteria are rated typically one notch off the GO ratings, as a reflection that appropriation-backed obligations are not legally debt and do not bear the same legal protections as GO bonds. 2. However, analytically, these instruments are considered obligations of the entity and are fully reflected in the debt statement and ratios. As a result, failure to make an appropriation will result in a downgrade of both the appropriation-backed obligation and the general obligation of the entity, as a reflection of the willingness of an entity to make good on its obligations. 3. Standard & Poor's does not consider the essentiality of a particular project in the evaluation of an appropriation-backed obligation. Instead, the willingness to pay for that project is a part of the analysis performed in the assessment of the general creditworthiness of the issuing government. Additionally, the necessity of a security interest being granted in the leased property is not required. A security interest is a common feature in which the governmental obligor grants the lessor, or the trustee, as assignee of the lessor--title or a first lien on the leased property for the life of the bonds. In the event the government obligor chooses to exercise its right of nonappropriation, the lessor, or its assignee, has the right to take possession of the leased asset. For many projects, even if a security interest is granted, it is questionable as to whether the lessor or its assignee can effectively take possession of the projects, as in the case of a prison, a government center, a school or any other facility that serves the basic functions of that government. Government Obligor's General Creditworthiness 4. The government obligor's general creditworthiness evaluation is based on traditional GO analysis, and includes factors such as: Overall debt structure and burden; Economic and tax-base factors; Financial flexibility, performance, and position; and Administrative and management factors. JUNE 13,

218 Criteria Governments U.S. Public Finance: Appropriation-Backed Obligations 5. If the government obligor were a utility district, university, hospital, or other not-for-profit entity, the relevant rating criteria used in assessing credit quality for those types of entities would be applied. Appropriation And Term Features 6. For master leases or service contracts, where numerous operating departments may be involved, a centralized appropriations process helps to ensure the timely payment of obligations. 7. The following appropriation features are considered when evaluating the transaction's structure: The useful life of the financed property or project matches or exceeds the term of the contract. The term of the contract matches the term of the bond issue or certificates of participation, avoiding exposure on renegotiation; if state law prohibits long-term appropriation-backed obligations, term renewal should be automatic. The lease or contract payments represent installments toward an equity buildup in the financed property. At the end of the financing term, ownership of the asset should transfer to the government obligor automatically or for a nominal fee. The government obligor agrees to request appropriations for lease or contract payments in its annual budget. 8. The government obligor unconditionally agrees to make rental or purchase option payments as agreed. Such payments typically should not be subject to counterclaim or offset because of a disagreement over any aspect of the transaction. A clear statement that "notwithstanding any other provisions to the contrary, appropriation-backed obligation rental payments are triple-net not subject to counterclaim or offset" is preferable and is generally included in the contract. However, language that indicates that those payments are absolute and unconditional and cannot be reduced for any reason is allowable. A triple net appropriation-backed obligation is one that designates the government obligor as a tenant being solely responsible for all of the costs relating to the asset being leased. The costs could include any upgrades, utilities, repairs, taxes or insurance requirements. 9. For California lessees, while the lessee covenants to appropriate lease payments, those payments are subject to abatement in the event the leased property is not available for use. As such, Standard & Poor's generally requires, as it does with all abatement and non-date certain appropriation-backed obligations, both a review of the construction risk associated with the project and the presence of business interruption insurance. Underlying revenues in support of appropriation-backed securities 10. In certain circumstances, a government may legally pledge specific tax revenues to meet its appropriation-backed obligation payment. If the pledged revenues are not available for any purpose other than those consistent with the appropriation project, such as economic development or a convention center, the appropriation risk is significantly mitigated and the rating assignment will be determined by the credit characteristics of the pledged revenue source, not the appropriation risk. Maintenance and insurance 11. The government obligor typically agrees to maintain the financed property in good repair and to insure it against loss or damage in an amount at least equal to the purchase option value or replacement cost, whether or not repair and replacement are mandated by the agreement. If the payments are subject to abatement in the event the property is JUNE 13,

219 Criteria Governments U.S. Public Finance: Appropriation-Backed Obligations damaged, destroyed, or taken under a provision of eminent domain, the government obligor, in most instances, should maintain business interruption insurance for at least 24 months. Where applicable, special hazard insurance coverage is required unless the financed facility passes Standard & Poor's natural hazard test. 12. Self-insurance for property damage risks is permitted. 13. In general, adequate reserve levels should be maintained and reviewed annually by an independent consultant or professional risk manager and notification given to the trustee that reserve levels are adequate Self-insurance is typically not an acceptable alternative to commercial coverage for earthquake risk when the government obligor's obligation is limited only to self-insurance reserves and does not extend to the municipality's general resources. Debt-service reserve fund 14. A debt service reserve equal to maximum semiannual debt service or three months' advanced (and unconditional) funding of debt service, or an equivalent combination of reserves and advance funding, may be beneficial on leases and service contracts that provide for abatement for lost use of property owing to damage or destruction, or to those instruments where late budget passage risk exists. A debt service reserve may not be required if there is sufficient time between the start of the obligor's fiscal year and the lease or service contract payments and debt service payment dates, once again allowing for the possibility of late budget adoption. Lessor features and bankruptcy risk 15. Most appropriation-backed obligation transactions rated by Standard & Poor's are between a governmental obligor and a non-profit public benefit corporation, as lessor, which has been established specifically for the purposes of the lease transaction. These lessors, typically, are filers under Chapter 9 of the U.S. bankruptcy code and are considered bankruptcy remote. Alternative arrangements include: For lessors not judged to be bankruptcy remote, there should generally be a sale and absolute assignment by the lessor of lease rental payments to the trustee, thereby ensuring timely payment to the bondholders if the lessor becomes insolvent. The assignment should typically be accompanied by a legal opinion stating that as a result of the assignment, bankruptcy of the lessor would not cause the lease and lease payments to be considered property of the lessor's estate. The automatic stay provisions of the bankruptcy code should not apply and therefore would not cause an interruption of rental payments to the bond trustee. Insolvency-proofing the lessor is an alternative approach. The lessor should be set up as a single-purpose entity (SPE) that is prohibited from engaging in any business--other than owning the rated project--and from incurring additional debt, unless it is rated at least as high as the Standard & Poor's rated lease-secured debt. Furthermore, the SPE may not typically sell the project except to another entity that meets these criteria unless Standard & Poor's rates the entity's senior debt at least as high as the lease obligation. These provisions should appear in the lessor's partnership agreement or articles of incorporation and in the trust indenture. Construction risk 16. Construction risk is present in virtually all public finance transactions, but it typically introduces credit risk only in those transactions where debt service payment is contingent on project completion and/or acceptance. In those states where such a risk is present, Standard & Poor's will perform a construction review for all issues where completion of the project, that is securing the lease payments, is required prior to the commencement of rental payments supported by appropriated funds. For further clarification refer to Public Finance Criteria: Assessing Construction Risk in Public Finance. JUNE 13,

220 Criteria Governments U.S. Public Finance: Appropriation-Backed Obligations Special considerations for vendor leases 17. Vendor equipment and developer office leases receive further scrutiny in the rating process because the municipal lessee is not the party primarily responsible for the sale of securities. It is often the vendors and/or developers that have a greater interest in the actual debt financing. Therefore, Standard & Poor's generally assesses the following areas in determining appropriation risk: Government support: Are the appropriate high-level governmental officials supportive of the lease project, the lease provisions, and the sale of securities? Essentiality: Is the vendor equipment or developer lease essential? Making the case that essentiality is high for developer-owned office leases is also more difficult because the government usually has no eventual equity interest in the facility. Ownership of the building being leased normally resides with the developer after the government makes all of its lease payments. Therefore, the incentive to make lease payments in later years is not enhanced by the expectation of eventual ownership. Triple-net lease: Despite vendor involvement or developer ownership, the lease must be triple-net, without the right of offset. Bankruptcy: An absolute assignment of rental payments from the private third-party lessor to the trustee is required. Nontax-Supported Leases Higher education leases 18. Colleges and universities frequently use leases as a means of financing capital improvements and equipment such as computers, telecommunications equipment, and research facilities. Historically, capital leases were the most used form of leasing for institutions of higher education. From a rating perspective, many of these capital leases are no different than other bonded, long-term debt. An institution wishes to finance an academic or research building over a long period of time, but may be subject to state debt restrictions, which prohibit the issuance of GO debt. For public universities, because of these debt limitations, capital leases are often subject to annual renewal or reappropriation of debt service. However, public universities often issue capital leases that are not subject to appropriation. Typically, this instance occurs when a university wishes to involve outside developers, or affiliation foundations. 19. Capital leases' payment of debt service can be subject to annual appropriation, or it can be a continuing and unconditional obligation without the option of termination. The rating assigned by Standard & Poor's depends on the underlying security; if a lease for a public university is subject to annual appropriation of debt service, the rating analysis follows the criteria established for other municipal entities such as states and local governments. Therefore, in most instances, a lease supported by legally available funds of a university will be rated one notch from the general obligation equivalent rating. There is one caveat, of course, which is that the lease rating is still a function of the underlying nature of the lease pledge and the obligor's general credit quality. If the underlying security on an appropriation lease is not legally available funds, or the broadest possible pledge, such as a general revenue pledge, then Standard & Poor's might notch it further than leases for state and local government entities. 20. For instance, consider an appropriation lease for a parking system. If the revenues that actually secure the lease are only parking revenues, a fairly narrow revenue stream, the rating would likely be notched lower than that on a general revenue appropriation lease. For a capital lease to be rated on par with a general obligation equivalent rating, it should JUNE 13,

221 Criteria Governments U.S. Public Finance: Appropriation-Backed Obligations be continuing and unconditional, not subject to annual renewal or appropriation, and secured by the broadest possible pledge of revenues. Most capital leases for private colleges and universities reflect an unsecured general obligation. Most private college bond ratings also reflect an unsecured general obligation pledge. Unlike health care institutions, which historically have placed a lien on gross revenues, private colleges and universities typically do not. Therefore, a capital lease, which is an unsecured corporate pledge, can be rated on par with other unsecured debt of the institution. Health care leases 21. In the not-for-profit health care sector leases are a fairly common means of financing for major equipment, such as radiology machines, telephone systems, and computers. From time to time they are used to lease additional space for physicians' offices, research facilities, or back-office functions. These leases are usually operating leases although capital leases do occur from time to time. Capital leases are rare but are incorporated in the long-term debt structure of the organization. If a capital lease for a health care system is subject to annual appropriation of debt service, the rating analysis follows the criteria established for other municipal entities, such as states and local governments. Transportation leases 22. Generally speaking, leases are not used as a financing vehicle in the transportation sector. In the very rare instance when an airport issues lease bonds, where debt service is subject to appropriation risk, but not abatement risk, the rating analysis follows the criteria established for other municipal entities, such as states and local governments. Frequently Asked Questions The criteria states that appropriation-backed obligations "are rated typically one notch off the GO ratings". Does that mean that Standard & Poor's never rates appropriation-backed obligations more than one notch below the GO rating? 23. While Standard & Poor's typically rates appropriation-backed obligations one notch below the GO debt rating of an obligor, under certain circumstance, obligations could be rated more than one notch below the GO rating. See the following question for additional information. How does Standard & Poor's evaluate appropriation-backed obligations which have risk characteristics that are different from those typically found in appropriation-backed obligations, such as lack of municipal ownership of the project, lack of municipal responsibility for maintenance, or insurance coverage purchased by a private entity? 24. In cases where we view appropriation and lease terms as nonstandard, we use analytic judgment to determine our view of the project, its economic risks, and the structural elements of the transaction, including ownership and responsibility for maintenance or insurance. Under certain circumstances, obligations could be rated more than one notch below the GO rating. 25. If we view the project as having a weak relationship to the government or elevated economic risk, we could apply additional notches below the GO rating beyond the typical one notch referenced in the criteria. For projects we view as particularly risky, especially where we feel the incentive for the municipality to appropriate for the project may be lessened, a noninvestment-grade rating may be considered. 26. In our view, a well-maintained and insured property increases the obligor's incentive to appropriate for the project. Where the obligor is not responsible for repair, maintenance, or insurance of the property, including where a third JUNE 13,

222 Criteria Governments U.S. Public Finance: Appropriation-Backed Obligations party is operating and insuring the property, and we thus have less confidence in the incentive to maintain and insure the property adequately, we may apply an additional notch below the GO rating, or multiple notches in extreme cases. JUNE 13,

223 Copyright 2015 Standard & Poor's Financial Services LLC, a part of McGraw Hill Financial. All rights reserved. No content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor's Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an "as is" basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT'S FUNCTIONING WILL BE UNINTERRUPTED, OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages. Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P's opinions, analyses, and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw, or suspend such acknowledgement at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal, or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof. S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain nonpublic information received in connection with each analytical process. S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, (free of charge), and and (subscription) and (subscription) and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at JUNE 13,

224 Criteria Governments U.S. Public Finance: Public Finance Criteria: Assessing Construction Risk Primary Credit Analyst: Horacio G Aldrete-Sanchez, Dallas (1) ; horacio.aldrete@standardandpoors.com Secondary Contacts: Laura A Kuffler-Macdonald, New York (1) ; laura.kuffler.macdonald@standardandpoors.com Mikiyon W Alexander, New York (1) ; mikiyon.alexander@standardandpoors.com Table Of Contents Construction And Vendor Experience Construction Funds Management Construction Schedule And Budget Cash Flow Considerations And Capitalized Interest Calculations Covering Construction Risk With Credit Enhancements Turnkey Contracts As Credit Enhancements JUNE 22,

225 Criteria Governments U.S. Public Finance: Public Finance Criteria: Assessing Construction Risk (Editor's Note: We originally published this criteria article on June 22, We\rquote ve republished it following our periodic review completed on Oct. 21, As a result of our review, we updated the author contact information. The following replaces criteria published on Oct. 12, 2006.) Construction risk is present in virtually all public finance transactions, but it typically introduces credit risk only in those transactions where debt service payment is contingent on project completion and/or acceptance. Standard & Poor's Ratings Services addresses construction risk directly in the rating, either through an evaluation of the construction process or, with credit support such as letters of credit during the construction period. The depth of the evaluation of the construction process will vary by project; earthquake analysis is unchanged. For example, the analysis performed on a school building will be less than that performed on an off-campus student housing project. Standard & Poor's will adopt a continuum of risk approach to assessing construction risk. If there is strong public support for a project, and the projects are not complex, the construction analysis will typically focus on the following issues: Project essentiality; Experience with similar projects; Contractor's experience with the issuer/obligor; Project schedule and cost structure; Construction contingencies in the project budget; Duration of capitalized interest; Insurance coverage during construction, including whether coverage is sufficient to cover full redemption of bonds in the event of damage or destruction; and Full permitting and site approvals. The level of construction risk the project entails will then be evaluated, and if determined to be minimal, a rating will be assigned, based on the obligor's creditworthiness. Generally, if the level of construction risks exceeds the normal threshold of most municipal projects, further analysis typically will be undertaken, which would generally reflect the criteria used within Standard & Poor's project finance group, and may include the use of an outside construction consultant. Where no municipal entity agrees to pay debt service upon completion, and where the project must be completed in order for debt service to be paid, the project ratings will involve a full analysis of the risks of construction. These risks are typically three-fold: Timely completion; Project performance--whether the project will be built as anticipated or perform as expected; and Project cost. JUNE 22,

226 Criteria Governments U.S. Public Finance: Public Finance Criteria: Assessing Construction Risk Each layer of risk can affect whether the project will produce the cash flow necessary to pay debt service, generate sufficient demand as built, and whether unanticipated costs will result in inability to pay debt service. These projects generally are likely to include many federal leases, public-private partnerships, affordable multifamily housing and non-recourse projects. Standard & Poor's has used this approach for construction risk analysis for many years and has developed levels of construction risk based on comparable projects. If construction risk is determined to be appropriately low, a rating based on the obligor's creditworthiness may, all other things being equal, be assigned. If the level of construction risk is excessive, further analysis generally will be undertaken along the lines of the complex project criteria and might could include the use of a outside construction consultant. Even where a complex project analysis may not ultimately be appropriate for certain projects, Standard & Poor's may retain a construction consultant to advise on particular issues. The scope of the consultancy typically encompasses the following principle areas of inquiry: Review of plans and construction documents; Evaluation of the likelihood that the contractor will perform based on historical performance on similar projects; Hard cost budget and construction schedule evaluation whether costs allocated for the project seem reasonable, whether there is adequate contingency, and whether the construction time frame is aggressive; Project location, special situations (wetlands, weather); Construction schedule; Whether construction is set in a union/nonunion environment; Names of borrower, architect, general contractor, or construction manager; and Review of drawings or plans for the proposed building. A complex project's rating rests, in part, on the dependability of its design, construction, and operation. Should the project fail to achieve timely completion or perform as designed, it will not be able to make its scheduled payments. Standard & Poor's criteria may require the report of an "independent engineer" as an aid to identifying and summarizing construction and other project risks, and certifying that notwithstanding those risks, the project will nevertheless be able to operate in the manner designed, and to generate sufficient cash flow to enable it to make its scheduled debt service payments. For complex projects, construction risk may be divided into its preconstruction and postconstruction facets. The former consists of: Engineering and design; Site plans and permits; Construction; and Testing and commissioning. Though a project's design may attempt to limit construction difficulties, its construction program may nevertheless adversely affect the project. Limited contractor and vendor experience with the technology can put a project at risk, as can a weak security and warranty package. A construction management plan that fails to adequately control construction fund disbursement can result in cash leakage. Designs requiring complicated sequencing of construction JUNE 22,

227 Criteria Governments U.S. Public Finance: Public Finance Criteria: Assessing Construction Risk activities may also present delay and cost risks. Construction relying on commercially proven technology and experienced contractors typically can mitigate much of the construction risk attributed to design. Construction And Vendor Experience For complex projects, in most cases, Standard & Poor's reviews the performance record of equipment vendors and general contractors in building comparable predecessor projects. Generally, higher-rated projects tend to feature vendors and contractors having broad experience building comparable projects and demonstrated records of meeting schedules. In addition, the better contractors likely will have demonstrated a pattern of meeting budgets and avoiding liquidated damage payments or other penalties. If project sponsors elect to use a fixed-price, turnkey construction contract, Standard & Poor's typically verifies that the owners, developers and others have had favorable experience with the proposed contractor. While Standard & Poor's does not identify specific vendors or contractors as appropriate for construction, it generally does examine the experience of contractors and vendors in building comparable facilities, as well as overall performance records. Standard & Poor's also considers the ongoing and future business interests of the contractor and key vendors. Experience has shown that business interests of contractors, vendors, and sponsors typically contribute as much influence as legal obligations in ensuring on time and under budget construction projects. Construction Funds Management Managing construction fund disbursements frequently provides a mechanism to maintain leverage over the sponsor developer and contractors and thus helps to minimize construction risk in higher-rated projects. Active management by the lender or lenders or their representatives may also achieve this objective. Loan documents typically give lenders the right to closely monitor construction progress and release funds only for work that the lender's engineering and construction expert has approved as being complete. On projects seeking to raise capital from a broader investor base, either through private placement or public debt issues, management of construction funds becomes more difficult because individual investors have no real capacity to oversee construction draws. For such projects, however, third-party trustees, acting in a fiduciary capacity, will generally manage disbursement of funds to protect debt holders' interest in the project. In general, the higher rated transactions will provide the following controls over construction funds: Retention of all debt-financed funds in a segregated account by a trustee experienced in management of project construction, preferably an experienced bank or other lender for these projects; Control over all disbursements from this account to the project with disbursements made only for work certified as complete by an independent project engineer and/or mortgage servicer retained by the construction trustee solely for approving disbursements and monitoring the completion of construction of the project on time and on budget; and Right to suspend or halt disbursements when the trustee, acting in consultation with the independent project engineer, concludes that construction progress is materially at risk because of outside events, such as reversals or revocations of necessary regulatory approvals, or changes in law or cost outside the levels anticipated by the budget JUNE 22,

228 Criteria Governments U.S. Public Finance: Public Finance Criteria: Assessing Construction Risk and schedule or failure to perform by contractors; and the authority to approve all change orders; And the authority to approve all change orders. In order for the trustee to fund construction draws out of the construction fund, in most instances, the following should be in place: An application and certification for payment (AIA Document G702) must should been completed and received by trustee certifying that construction is in accordance with the plans for the project. The loan must be in balance an amount necessary to complete project should be on hand or available - remaining uses must equal sources. There should be no events of default under indenture, mortgage, ground lease or any other operating agreements. The owner and trustee should receive lien waivers from the contractor and major subcontractors prior to funding draws. The trustee should receive title insurance bring-downs (i.e. there should be no mechanic's liens on the project) prior to funding draws. Any credit enhancements relied upon in the initial rating should continue to be in place (e.g. LOC or rated completion guarantee). The construction consultant and/or mortgage servicer, if used, should approve the construction draws. The trustee should withhold an applicable amount of retainage (between 5-10% as decided in beginning of transaction). The trustee should receive certificate of occupancy and certification as to completion of project and satisfaction of punch list items prior to final release of funds from project fund. Construction Schedule And Budget Standard & Poor's assessment of construction risk typically includes a determination of whether the contractor can achieve the proposed construction schedule and budget without costly delays or quality problems. Standard & Poor's expects that the independent engineer will have reviewed detailed budgets and construction schedules and will have opined as to their feasibility. Reports without defensible conclusions about schedules and budgets can raise concerns. Higher-rated projects likely will have contractors and equipment vendors who have consistently provided services on time. Budgets typically should include contingencies to cover unexpected construction events (not merely uncosted items) during construction. In addition, Standard & Poor's generally assesses the extent to which engineering and design are complete, with equipment procured when construction begins; investment-grade projects tend to have completed these tasks earlier than noninvestment-grade projects. Standard & Poor's analyzes the independent engineer's conclusions on the adequacy of contingencies for schedule and budget, and related assumptions. Standard & Poor's also evaluates performance requirements and incentives for project contractors along with the financial and technical capacity of the contractors. Projects that require construction monitoring by an expert third party, such as an independent engineer, enhance construction surveillance with this oversight mechanism. JUNE 22,

229 Criteria Governments U.S. Public Finance: Public Finance Criteria: Assessing Construction Risk Cash Flow Considerations And Capitalized Interest Calculations For financings that are cash-flow dependent, such as mortgage revenue bonds for multifamily finance, sufficient funds must be available to pay debt service during the construction period. Project capitalization should demonstrate sufficient amounts of capitalized interest to ensure bondholders will be paid in full and on time during construction. These considerations vary according to bond structure and use of credit enhancements, among other things. In situations where bond proceeds are used to fund construction and there is no construction period credit enhancement, Standard & Poor's generally will analyze the following: Earnings during the construction period. Like other transactions, in which funds are held in escrow during development, Standard & Poor's will stress the effect of investment earnings on coverage levels. Standard & Poor's analysis involves a comparison of construction fund investment earnings and the mortgage note interest rate. If the construction fund investment rate is lower than the mortgage interest rate, then cash flows should assume that all monies should remain in the construction fund account until the latest date they can be drawn under the bond documents (late draw). If the mortgage rate is lower than the construction fund rate, then it should be assumed that all funds are drawn day one and the mortgagor is making mortgage payments. On a case-by-case basis, income may be shown during the construction period, Length of construction period. Standard & Poor's will assume a delay in reaching construction completion, as well as lease-up and stabilization. Delays will vary depending on Standard & Poor's analysis of construction risk, including the opinion of an independent construction consultant in some instances. For low risk projects, a six-month delay might be sufficient, whereas for moderate risk projects, one year might be in order. High-risk construction may call for delays of 18 months or longer. Rental income. Standard & Poor's will examine case-by-case whether rental income exists during construction. An example of where rental income could be shown would be in low risk construction situations, such as military housing transactions, where units are on line at the outset of the transaction and demand is extremely deep. In any event, Standard & Poor's will assume maximum occupancy of 95%. Occupancy assumptions could be lower if the market analysis cannot substantiate 95%. Trending of income and expenses. If rental income is present in a particular transaction, no trending of income and expenses will be taken into account, except on a case-by-case basis. Debt service coverage. Coverage of debt should always be at least 1x for investment grade ratings. Standard & Poor's will determine case by case what the coverage level should be depending on analysis of construction risk and the rating on the bonds. Shortfalls in bond cash flows can be covered by equity contributions or other paid-in cash at closing, letters of credit (LOCs), available funds under an HFA parity program and other rated credit enhancements. Covering Construction Risk With Credit Enhancements When construction risk is moderate to high, credit enhancement during the construction and lease-up phase may be needed for investment grade ratings. This is often the practice in single-asset affordable housing transactions. Credit enhancements are typically in the form of a LOC from a bank rated as high as the bonds, or Freddie Mac, Fannie Mae, GNMA, FHA insurance or guarantees. JUNE 22,

230 Criteria Governments U.S. Public Finance: Public Finance Criteria: Assessing Construction Risk LOCs The LOC should remain in place until the project achieves stabilization at full occupancy at a predetermined debt service coverage ratio for at least one year. Once the project achieves stabilization, the LOC may be released. The rating during the credit enhancement period will be limited by the rating of the credit enhancer. The LOC amount should cover bond principal amount and interest to a specified completion date. The trust indenture should have a mandatory draw on the LOC and a corresponding mandatory redemption of the bonds from LOC proceeds in the event that the project does not reach completion and lease-up at specified debt service coverage by the specified completion date. Please see, "Public Finance Criteria: LOC-Backed Municipal Debt" for a full description of Standard & Poor's criteria relating to letters of credit. Freddie Mac, Fannie Mae, GNMA guarantees/fha insurance Please see, "Public Finance Criteria: Ginnie Mae, Fannie Mae And Freddie Mac Multifamily Securities," and "Public Finance Criteria: FHA Insured Mortgages" for a full description of rating criteria. Construction risk is typically fully mitigated by the insurance and guarantees; however, transaction documents must accurately reflect the mechanics of the program, cash flow considerations and capitalized interest calculations must be incorporated into the analysis, and Standard & Poor's assumes a "worst case" receipt of guarantee and insurance proceeds. Turnkey Contracts As Credit Enhancements Sponsors often use "turnkey" ("soup-to-nuts") contracts on major projects as a means of shifting construction risk away from equity and lenders. In a turnkey contract, the builder promises to deliver the project complete on a certain day, and takes all responsibility for design, engineering, procurement, construction, and testing. All the project owner has to do is pay the contract costs, and "get the keys" to a fully functioning project at the end of the process. In appropriate circumstances, turnkey contracts can shift risk to the extent that they may be viewed as an indirect type of credit enhancement by providing for timely and full completion on pain of damage or penalty payments, on which the project might be able to rely for debt service. Nevertheless, prompt payment of liquidated damages is more a desideratum than a reality. Turnkey or other construction contracts cannot eliminate all risk. Some risk generally remains, such as force majeure and change-of-law events, which by definition, cannot be controlled by the vendor and contractor. JUNE 22,

231 Copyright 2015 Standard & Poor's Financial Services LLC, a part of McGraw Hill Financial. All rights reserved. No content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor's Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an "as is" basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT'S FUNCTIONING WILL BE UNINTERRUPTED, OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages. Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P's opinions, analyses, and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw, or suspend such acknowledgement at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal, or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof. S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain nonpublic information received in connection with each analytical process. S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, (free of charge), and and (subscription) and (subscription) and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at JUNE 22,

232 Criteria Governments U.S. Public Finance: Assigning Issue Credit Ratings Of Operating Entities Criteria Officer and Primary Credit Analyst: Liz E Sweeney, New York (1) ; liz.sweeney@standardandpoors.com Chief Credit Officer, Corporate & Government Ratings: Lucy A Collett, New York (1) ; lucy.collett@standardandpoors.com Table Of Contents I. SCOPE OF THE CRITERIA II. SUMMARY OF THE CRITERIA III. IMPACT ON OUTSTANDING RATINGS IV. EFFECTIVE DATE AND TRANSITION V. METHODOLOGY VI. APPENDIX EXAMPLES OF PLEDGES VII. RELATED CRITERIA AND RESEARCH MAY 20,

233 Criteria Governments U.S. Public Finance: Assigning Issue Credit Ratings Of Operating Entities 1. Standard & Poor's Ratings Services is publishing these criteria to provide additional transparency related to the assignment of issue credit ratings on U.S. public finance debt instruments of operating entities, including the assignment of issue credit ratings at the level of the issuer credit rating (ICR); and on subordinated obligations of these entities. These criteria relate to our criteria article "Principles Of Credit Ratings", published Feb. 16, These criteria supersede the section of the criteria article "Wholesale Utilities", published May 24, 2005, entitled "Senior and Subordinate Lien". These criteria also supersede paragraph 29 of "Methodology: Definitions And Related Analytic Practices For Covenant And Payment Provisions In U.S. Public Finance Revenue Obligations", with respect to issue credit ratings in the scope of these criteria. I. SCOPE OF THE CRITERIA 2. These criteria apply to long-term issue credit ratings ("issue credit ratings") on obligations issued for U.S. public finance operating entities, such as utilities, local governments, and universities ("operating entities"). The criteria do not apply to rating sales tax, single-family and multifamily mortgage-backed, appropriation debt, and other issue-specific obligations, which are rated with various issue-specific criteria (see paragraph 14 for examples). II. SUMMARY OF THE CRITERIA 3. For operating entities, determination of an issue credit rating starts with our view of the general creditworthiness of the obligor, which may be expressed as an issuer credit rating (ICR), followed by analysis of the legal structure and covenants of the debt instrument. 4. To obligations (a) benefiting from pledged revenues that we consider central to the entity's purpose (see examples in the Appendix) and (b) the covenants of which, in our view, support creditor security at the senior debt level, we generally assign an issue credit rating at the same level as the ICR. In some cases, sector-specific criteria may provide additional guidance on legal considerations that may impact the issue credit rating. 5. To obligations for which either or both of conditions (a) or (b) in the previous paragraph is not met, we generally assign an issue credit rating that is one or more notches below the ICR. 6. Unless conditions in the next paragraph are met, subordinated debt of operating entities that have an ICR of 'BBB-' or higher, are typically rated one notch lower ("rating differential") than the ICR. The rating differential for entities with ICRs of 'BB+' or lower may be up to two notches. The determination of a one- or two-notch differential is primarily based on the amount of debt outstanding on liens senior to it. 7. The rating differentials described in paragraph 6 do not hold, and subordinated debt is rated at the ICR level if it MAY 20,

234 Criteria Governments U.S. Public Finance: Assigning Issue Credit Ratings Of Operating Entities benefits from sufficient additional security, such as a pledge of another revenue stream not pledged to senior-lien holders, certain situations where the senior lien is closed, and where certain springing-lien provisions are present. 8. Mortgage liens and other liens on assets will generally not result in a rating higher than the ICR. U.S. public finance ratings do not incorporate post-default recovery prospects (for example, in bankruptcy). Similarly, we generally will not notch an issue up from its ICR when the senior lien is closed, because the ICR already incorporates the ability to pay all obligations, including senior and subordinate liens. III. IMPACT ON OUTSTANDING RATINGS 9. We estimate that a very small percentage of U.S. public finance ratings -- fewer than 50 ratings out of several thousand -- will change as a result of the application of these criteria, mostly by one notch. IV. EFFECTIVE DATE AND TRANSITION 10. These criteria are effective immediately and apply to all new and outstanding ratings within scope. We intend to complete our review of issuers affected within the next 12 months. V. METHODOLOGY A. Relationship of issue ratings to ICRs 11. The majority of published U.S. public finance ratings are issue credit ratings, which apply to a specific debt obligation, while a minority of published U.S. public finance ratings are ICRs, which address the general creditworthiness of the obligor. In some cases, the same obligor may have both issue credit ratings and a public ICR, but this is not typical. As we explain below, the issue credit rating may be equal to, or differ from, our view of general creditworthiness of the issuer, which we interchangeably refer to as the ICR in this article. 12. Issue credit ratings are generally arrived at through one of two methods, depending on the debt and issuer type: Application of criteria to an operating entity, where the entity's general creditworthiness (which may be expressed by an ICR) is the starting point for the issue credit rating analysis, or Application of issue-specific criteria, which apply to obligations where there is not an operating entity whose general creditworthiness is central to the issue credit rating evaluation. 13. Examples of criteria applying to operating entities are "Local Government GO Ratings Methodology And Assumptions", "U.S. Not-For-Profit Acute-Care Stand-Alone Hospitals", and "Electric And Gas Utility Ratings". Ratings determined under these examples are in scope of these criteria. 14. Examples of issue-specific U.S. public finance criteria are "Special Tax Bonds", "Rating Methodology And Assumptions For Affordable Multifamily Housing Bonds", and "Appropriation-Backed Obligations". Ratings determined under these examples are in not scope of these criteria. 15. We assign certain issue credit ratings by first determining the general creditworthiness of the obligor, which may be MAY 20,

235 Criteria Governments U.S. Public Finance: Assigning Issue Credit Ratings Of Operating Entities expressed as an issuer credit rating (ICR), then applying issue-specific criteria to determine the relationship between the general creditworthiness of the operating entity and the issue credit rating. For example, in applying "Appropriation-Backed Obligations", the starting point is the application of the relevant operating entity criteria, such as "U.S. State Ratings Methodology", to determine the general creditworthiness of the obligor, after which the appropriation criteria is applied to determine the issue credit rating. In this example, the application of "U.S. State Ratings Methodology" criteria to determine the general creditworthiness of the state is in scope of these criteria, while the application of "Appropriation-Backed Obligations" criteria to determine the issue credit rating is not. 16. For operating entities, the starting point of the analysis is the general creditworthiness of the obligor. In applying criteria to operating entities, we determine whether the two rating types ICR and issue credit rating - differ from each other. When the issue credit rating differs from the ICR, we will generally note the factors that cause a rating differential between the two rating types. For the remainder of this article, we use references to 'ICR' or 'general creditworthiness' interchangeably. The sector criteria for a given type of operating entity may not specifically reference an ICR and we may not publish ICRs for each entity. 17. If a U.S. public finance obligor provides (a) a security pledge of revenues that fund activities we consider central to its purpose, and (b) debt covenants which, in our view, support creditor security at the senior debt level, we generally equalize the issue credit rating of obligations which benefit from these strengths with the ICR. Sector-specific criteria within public finance may outline additional legal structure and debt covenant assessments. We also discuss these considerations in "Methodology: Definitions And Related Analytical Practices For Covenant And Payment Provisions In U.S. Public Finance Revenue Obligations", published Nov. 29, To meet condition (a) in the previous paragraph, pledged revenues of operating entities must fund activities that are central to the entity's core business and are typically, but do not have to be, the majority of the entity's revenue stream. Examples by sector of security pledges that we consider central enough to qualify for an issue credit rating at the same level as the ICR are provided in the Appendix. 19. If condition (a) or (b) in paragraph 17 is not met, for example if pledged revenue is narrow or not central, typically because the obligor has pledged measurable portions of its revenue to other debt instruments, bondholders do not benefit from the full credit strength that the ICR reflects. In this case, we typically assign an issue credit rating one or more notches below the ICR. The number of notches below the ICR depends on the amount of revenue and debt that is not part of the rated debt pledge. 20. Mortgage liens and other liens on assets generally do not support issue credit ratings higher than the ICR. U.S. public finance ratings do not incorporate an opinion about postdefault recovery prospects (for example, in bankruptcy) on an issuer basis due to the paucity of cases from which to generate such projections, and the unpredictability associated with postdefault municipal experience. 21. Issue credit ratings will generally only be higher than the ICR with some form of enhancement, such as a letter of credit, bond insurance, guarantee of a third party, or access to collateral or revenues of a party outside the rated entity (such as support from an endowment fund not consolidated with the entity). MAY 20,

236 Criteria Governments U.S. Public Finance: Assigning Issue Credit Ratings Of Operating Entities B. Subordinated debt and notching 22. While we do not project postdefault possibilities in our analysis, several classes of creditors may have access and some of them may have a prioritized access - to a single pledged revenue stream. This section addresses issue credit ratings on obligations which have an inferior lien on the same revenue stream as other obligations; we call the former "subordinated debt" and the latter "senior debt". 23. Given the differences in priority of access, and unless conditions in paragraphs are met, for obligors whose ICR is 'BBB-' or higher, we typically rate subordinated debt (whether it has a second, third or even more subordinated lien) one notch below the ICR. 24. For issuers with ICRs that are 'BB+' or lower, unless conditions in paragraphs are met, we typically rate subordinated debt two notches below the ICR. In some cases, the differential can be one notch. The determination of a one- or two-notch differential is primarily based on the amount of debt outstanding on each lien. A relatively large amount of senior-lien debt would more likely result in a two- notch differential, while a smaller senior-lien debt amount would more likely result in a one-notch differential. If such notching result in a subordinate rating in the 'CCC' category or below, the subordinate rating will be governed by our view of its risks under "Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings", and may not follow the same pattern of notching for higher-rated subordinate obligations. 25. Situations where we may rate subordinated obligations at the same level as senior obligations include: Subordinate obligation holders are granted additional security such as a pledge of another revenue stream not pledged to senior-lien holders, if we believe such additional security improves the subordinate-lien holder's position sufficiently; or Senior liens that are closed, that is, no additional debt will be issued under the senior lien, and we consider the amount of debt outstanding under the senior lien as minimal. 26. In rare cases, a subordinated obligation may have "springing" provisions, which elevate it to the senior-lien level upon attainment of certain thresholds, such as a specified debt service coverage level. We treat such springing-lien obligation as a subordinated obligation and rate it in accordance with paragraphs until we believe the conditions for elevating its lien to senior will be imminently met, at which time we will equalize its rating with that on senior-lien obligations, unless the conditions in paragraph 27 are met. 27. Where the springing-lien provision elevates the subordinate obligation to the senior lien upon an event of default, we believe the benefits of senior-lien status over subordinate obligations are no longer present, and we equalize the rating of the subordinate- and senior-lien obligations, assuming there are no other distinguishing features such as described in paragraphs 19 and 25. VI. APPENDIX EXAMPLES OF PLEDGES 28. Examples of pledges that we consider central enough to equalize the issue credit ratings with the ICR follow. The examples are for illustrative purposes and are not intended to be exhaustive. Sector-specific criteria may provide additional guidance on debt covenants and the treatment of specific pledges: Higher education: unlimited student fees; general obligation of the university; available funds. MAY 20,

237 Criteria Governments U.S. Public Finance: Assigning Issue Credit Ratings Of Operating Entities Health care: patient revenues (gross or net); patient receivables; general obligation of a parent with full control of subsidiaries and unlimited ability to upstream revenue from subsidiaries. Utilities, transportation, and other infrastructure: system net revenues. Local, state, and other governmental entities: unlimited property taxes; limited property taxes (subject to "Standard & Poor's Refines Its Limited-Tax GO Debt Criteria"). Housing authorities and enterprises: general obligation of the entity; net revenues of the enterprise. VII. RELATED CRITERIA AND RESEARCH Related Criteria Principles Of Credit Ratings, Feb. 16, 2011 Methodology: Definitions And Related Analytical Practices For Covenant And Payment Provisions In U.S. Public Finance Revenue Obligations, Nov. 29, 2011 Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings, Oct. 1, 2012 Wholesale Utilities, May 24, 2005 Standard & Poor's Refines Its Limited-Tax GO Debt Criteria, Jan. 10, 2002 These criteria represent the specific application of fundamental principles that define credit risk and ratings opinions. Their use is determined by issuer- or issue-specific attributes as well as Standard & Poor's Ratings Services' assessment of the credit and, if applicable, structural risks for a given issuer or issue rating. Methodology and assumptions may change from time to time as a result of market and economic conditions, issuer- or issue-specific factors, or new empirical evidence that would affect our credit judgment. Additional Contacts: Laura A Kuffler-Macdonald, New York (1) ; laura.kuffler.macdonald@standardandpoors.com Matthew T Reining, San Francisco (1) ; matthew.reining@standardandpoors.com David N Bodek, New York (1) ; david.bodek@standardandpoors.com Martin D Arrick, New York (1) ; martin.arrick@standardandpoors.com Karen M Fitzgerald, CFA, New York (1) ; karen.fitzgerald@standardandpoors.com MAY 20,

238 Copyright 2015 Standard & Poor's Financial Services LLC, a part of McGraw Hill Financial. All rights reserved. No content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor's Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an "as is" basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT'S FUNCTIONING WILL BE UNINTERRUPTED, OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages. Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P's opinions, analyses, and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw, or suspend such acknowledgement at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal, or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof. S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain nonpublic information received in connection with each analytical process. S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, (free of charge), and and (subscription) and (subscription) and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at MAY 20,

239 Criteria Governments U.S. Public Finance: Bond Anticipation Note Rating Methodology Primary Credit Analyst: Gabriel J Petek, CFA, San Francisco (1) ; gabriel.petek@standardandpoors.com Secondary Contact: Jeffrey J Previdi, New York (1) ; jeff_previdi@standardandpoors.com Chief Credit Officer, Corporates and Governments: Colleen Woodell, New York (1) ; colleen_woodell@standardandpoors.com Criteria Officer, U.S. Public Finance: James M Wiemken, London ; james_wiemken@standardandpoors.com Table Of Contents SCOPE OF THE CRITERIA SUMMARY OF CRITERIA UPDATE CHANGES FROM RFC IMPACT ON OUTSTANDING RATINGS EFFECTIVE DATE AND TRANSITION METHODOLOGY I. Overall Framework for BAN Analysis II. The Long-Term Rating Component III. The Market Risk Profile IV. Analysis Of Market Risk Profile Factors AUGUST 31,

240 Table Of Contents (cont.) APPENDIX: Comments Received Following The RFC Publication RELATED CRITERIA AND RESEARCH AUGUST 31,

241 Criteria Governments U.S. Public Finance: Bond Anticipation Note Rating Methodology (Editor's Note: We originally published this criteria article on Aug. 31, We're republishing this article following our periodic review completed on Aug. 14, 2014.) 1. Standard & Poor's Ratings Services is refining and adapting its methodology for rating bond anticipation notes (BANs). We are publishing this article to help market participants better understand our approach to reviewing bond anticipation notes. This article is related to the criteria article "Principles Of Credit Ratings," published on Feb. 16, These criteria amend and supersede portions of "USPF Criteria: Short-Term Debt," published June 15, BANs are a type of debt generally structured to rely primarily on the proceeds of future bond or note sales for repayment of the BANs at maturity. Market access is integral to the credit quality of BANs given the central role an obligor's ability to sell debt in the capital markets plays in its ability to repay BANs. Periodic disruptions in the capital markets including episodes of illiquidity in some short-term debt markets could frustrate refinancing. 3. Reflecting the potential unpredictability of shifts in market preferences, the revised criteria do not presume that obligors will always have market access to issue takeout debt at the time of BAN maturity. SCOPE OF THE CRITERIA 4. These criteria are applicable to all BANS issued by U.S. public finance obligors including cities, school districts, states, airports, hospitals, universities, and various other state and local government and municipal enterprise entities (see box, "Application Of Municipal Short-Term Note Ratings Definitions"). Issues with maturities of more than 36 months will generally receive long-term ratings. BAN issue ratings--be they short- or long-term--will reflect the analytic factors described in this article if they are structured to be repaid from the proceeds of a future bond issue. Upon request, BAN issues with maturities of 13 to 36 months may receive a long-term rating if a repayment source other than future issuance is pledged and if we project that the obligor is likely to have funds on hand (other than those derived from the issuance of takeout debt) to retire the obligation at maturity. 5. BANs may be backed by a specific pledge of revenue, a general obligation pledge, or a best-efforts pledge to issue debt AUGUST 31,

242 Criteria Governments U.S. Public Finance: Bond Anticipation Note Rating Methodology in the future and to use the proceeds to retire the BANs. Regardless of the specific security pledged, the rating criteria presented in this article are applicable to obligations in which the retirement in part depends upon the obligor issuing its planned takeout debt prior to the BAN reaching maturity. In the somewhat uncommon instance where a BAN structure includes interest payments prior to maturity, such payments are typically inconsequential relative to the payment of principal and interest due at final maturity. If material payments are due prior to the final BAN maturity, the BAN rating criteria incorporate the relevant elements of the general obligation or short-term debt (for cash flow notes) criteria as appropriate. SUMMARY OF CRITERIA UPDATE 6. BANs are debt instruments that provide a source of interim financing, usually for capital projects. BAN debt service is commonly structured with a bullet maturity and is typically repaid with the proceeds of a new bond or note issue. Under the revised criteria, Standard & Poor's rates BANs based on a combination of the obligor's long-term rating on the type of debt intended to be used to retire the BANs and an analysis of the market risk profile of the obligor. In assigning BAN ratings, market risk is scored 'low', 'neutral', or 'high' based on our evaluation of the legal authority for takeout debt and the degree of information availability. Whether the BAN is secured by specific proceeds (other than future proceeds) and whether the obligor has a high concentration of variable rate debt exposure can improve (in the case of a specific pledge) or worsen (in the case of high variable rate debt exposure) the resulting rating relative to that implied by the other fundamental factors, as set forth in our criteria. Table 1 details how specific note ratings result from specific combinations of our assessment of the long-term credit quality of the takeout financing and the market risk profile. CHANGES FROM RFC 7. On Dec. 20, 2010, Standard & Poor's published "Request for Comment: Methodology For Rating Bond Anticipation Notes." Several market participants submitted responses addressed to the criteria comments mailbox. The comments addressed a wide range of issues that sometimes extended beyond the questions posed in the RFC. 8. Some adjustments to the methodology occurred following a review of the comments. The main changes between the final criteria and the criteria presented in the Request for Comment include the following: Rating outcomes in Table 1 at the 'AAA', 'AA+', and 'A-' levels were adjusted. Whether a general obligation pledge secures the BANs was added as a positive adjustment factor, but the fact that remarketing risk could also impact the long term rating was emphasized, and The market familiarity and continuing disclosure scores were combined and addressed more broadly through the information availability score. IMPACT ON OUTSTANDING RATINGS 9. Standard & Poor's currently maintains ratings on approximately 250 BAN issues. The Request for Comment (RFC) estimated that approximately one-third of existing BAN ratings could be subject to downward revisions, most to 'SP-1' AUGUST 31,

243 Criteria Governments U.S. Public Finance: Bond Anticipation Note Rating Methodology from 'SP-1+'. Reflecting certain modifications to the criteria in light of comments received during the RFC period, the number of BANs subject to downward revision should now be less than one third, although the majority of rating changes should still be to 'SP-1' from 'SP-1+'. EFFECTIVE DATE AND TRANSITION 10. These criteria are effective immediately for all new and outstanding BAN issues. Reviews of all outstanding BAN transactions will occur within the next six months. METHODOLOGY 11. Standard & Poor's Ratings Services rates bond anticipation notes (BANs) of governmental entities (including governments and municipal enterprises) and nonprofit organizations (including colleges, universities, and hospitals). 12. BANs are debt instruments that provide a source of interim financing, usually for capital projects. BAN debt service is commonly structured with a bullet maturity and is typically repaid with the proceeds of a new bond or note issue. In addition to the obligor's long-term rating on the type of debt intended to finance the takeout of the BANs, the rating criteria for BANs reflects the security pledged to repay the notes, and the obligor's projected ability to issue the takeout debt. The analytic emphasis rests more heavily on an obligor's long-term credit quality and on the projected ability of the obligor to issue the takeout financing. BAN rating criteria recognize that the long-term rating reflects much, but not all, of the potential credit risk of a note dependent on future market access for timely retirement. Historically, there have been instances in which obligors unable to make their BAN payments as they came due continued to pay similarly secured long-term debt. Obligors expected to have the ability to consistently fund the repayment of existing debt as it matures from the proceeds of newly issued debt are viewed as having market access. 13. Not all issuers with the same long-term rating enjoy the same market access. It is possible for debt of an obligor with which the market is very familiar to benefit from greater market liquidity and easier market access than that of a relatively unknown obligor with a higher long-term rating. Obligors whose ability to sell debt that is highly sensitive to investor confidence risk losing market access which could jeopardize BAN retirement if a loss of confidence occurred prior to BAN maturity. This concept is the market risk associated with a particular obligor and its BAN issue(s). I. Overall Framework for BAN Analysis 14. The criteria result in BAN ratings based on a combination of the obligor's long-term rating on the type of debt intended to be used to retire the BANs and an analysis of the market risk profile of the obligor. Market risk may be 'low', 'neutral', or 'high' based on the evaluation of the legal authority for takeout debt and the information availability for a given obligor. Table 1 details how specific note ratings result from specific combinations of the assessment of the long-term credit quality of the takeout financing and the market risk profile. AUGUST 31,

244 Criteria Governments U.S. Public Finance: Bond Anticipation Note Rating Methodology 15. The BAN rating derived from the long-term rating on the takeout debt and the market risk profile may differ from the BAN rating assigned for several reasons. For obligors at any long-term rating level, an 'SP-3' rating is assigned if the obligor lacks clear legal authority to issue the debt retiring the BANs, if the security for this debt is not legally specified. If additional tax base or revenue growth will be necessary for the obligor to issue the takeout debt and the obligor lacks tax- or rate-raising flexibility, an 'SP-3' rating will be assigned. 16. Although obligors with long-term ratings of 'AAA' and 'AA+' generally have market access and credit profiles consistent with the 'SP-1+' note rating, the converse also applies. Obligors incurring substantial remarketing risk should also expect this risk to be evaluated as part of the analysis on the long-term rating. Accordingly, if a note rating on a 'AAA'- or 'AA+'-rated obligor should be lower than 'SP-1+' that would likely suggest that the long-term rating should be lowered. II. The Long-Term Rating Component 17. The long-term rating on an obligor's intended takeout debt serves as the starting point for our short-term analysis. Even if the BANs themselves have a security different from that assigned to the takeout debt, the long-term rating AUGUST 31,

245 Criteria Governments U.S. Public Finance: Bond Anticipation Note Rating Methodology applied in Table 1 is the rating associated with the security on the takeout debt. For example, if the BANs are secured by a junior lien on the net revenues of a municipal water utility, but the utility has committed to retire the BANs with senior lien bonds, the long-term rating on the utility's senior lien debt drives the evaluation. Similarly, if a school district's BANs are not secured by a state credit enhancement program but the takeout bonds will be so secured, the long-term rating will typically reflect the rating associated with the state credit enhancement program. Standard & Poor's will assign a BAN rating only when there is a long-term rating on the type of debt intended to serve as the takeout financing. III. The Market Risk Profile 18. As stated in paragraph 15, an obligor's market risk profile may be 'low', 'neutral', or 'high.' Two factors form the starting point for the market risk profile: legal authority for takeout debt and information availability. Each is scored individually as 'strong', 'adequate', or 'weak'. Table 2 shows how assessments of these factors lead to different market risk profile outcomes. 19. As Table 2 also details, certain other factors may positively or negatively impact the market risk profile score over and above that implied by the scores for legal authority for takeout debt and information availability. The market risk profile score will improve by one if the BANs are backed by a governmental entity's pledge of its general obligation or all of its operating revenues (either net or gross). The market risk profile score will worsen by one if the rating on the debt intended to retire the BANs is 'AA-', 'A-', or 'BBB-' and is on CreditWatch with negative implications or has a negative outlook. Finally, the market risk profile score will worsen by one if the obligor's debt position presents a high level of exposure to confidence-sensitive debt. AUGUST 31,

246 Criteria Governments U.S. Public Finance: Bond Anticipation Note Rating Methodology 20. High market confidence exposure exists when more than 50% of the obligor's total debt portfolio is subject to optional tender or relies on remarketing proceeds within 30 days of proposed BAN maturity. The market risk profile score will not worsen in situations in which the obligor has only one outstanding debt issue to lessen the likelihood of penalizing lowly leveraged credits. 21. For municipal enterprise obligors, the calculation includes any debt backed by the same revenue stream that the obligor intends to leverage as the source of repayment for the takeout bonds. Senior and subordinate debt regardless of the lien pledged to retire the BANs is included, as is any tax-secured debt issued by the enterprise for which the enterprise is the obligor. IV. Analysis Of Market Risk Profile Factors A. Legal authority for takeout debt 22. Legal authority for takeout debt is scored as weak, adequate, or strong. The governing board's legal representation (in its BAN resolution or other legal documentation) is the primary source of information regarding an obligor's plans to issue takeout debt. Because the specific provisions associated with leases and other debt subject to annual appropriation can vary considerably (potentially resulting in non-investment grade takeout financings), prior issuance of appropriation debt and the availability of legal documents for review improve clarity regarding the specific nature of the appropriation takeout and also affect our score when appropriation debt is the intended takeout. 23. 'Weak', 'adequate', and 'strong' legal authority are generally characterized as follows: 24. 'Weak': Legal authority is scored 'weak' if obligors require improved fundamental credit factors (i.e., tax base or revenue growth) in order to comply with a debt limitation threshold or additional bonds test (ABT). Any circumstance in which additional voter approval is required is scored as 'weak'. Instances in which the takeout debt is subject to annual appropriation, the issuer has not previously issued such debt and no draft lease or similar agreement is available are also scored as 'weak'. 25. 'Adequate': Legal authority is scored 'adequate' if such authority is present with no need for voter authorization but the practical ability to issue takeout debt is conditional on other factors (e.g., compliance with debt limitation threshold or additional bonds test). If additional administrative or legal preconditions need to be met prior to issuance of takeout debt, contingency plans such as the ability to issue rollover BANs should exist. 'Adequate' includes instances in which the takeout debt is subject to annual appropriation and the issuer has either previously issued such debt or has a draft lease or similar agreement available for review, but not both. 26. 'Strong': Legal authority to issue takeout debt is scored 'strong' if such authority exists with no material preconditions, and the risk of other limitations on the obligor's ability to incur the takeout debt are remote. Authority to issue takeout debt will be scored 'strong' even if there is a legal requirement of formal approval by the governing body at the time of issuance, provided this action is deemed routine. Obligors whose debt issuance authority is subject to an ABT, but have operating metrics indicating that the ABT is unlikely to present a practical limitation may also receive a score of 'strong'. For instances where the takeout debt is subject to annual appropriation, the legal authority is considered 'strong' if the issuer has previously issued such debt and has a draft lease or similar agreement available for review. B. Information availability 27. Empirical research suggests that municipal market inefficiencies result in part from information asymmetries and a lack of transparency. Additional information allows investors to make informed decisions and may influence their AUGUST 31,

247 Criteria Governments U.S. Public Finance: Bond Anticipation Note Rating Methodology behavior, particularly in constrained market environments. In addition to credit ratings, ongoing disclosure and recent market issuance are two ways that investors gain additional information on issuers. Accordingly, the information availability score considers whether the obligor has issued debt during the past five years and whether the obligor regularly provides ongoing disclosure to the market (either through 15c2-12 filings, other similar filings, or through a public website). For the purposes of debt issuance, LOC debt is excluded. 'Weak' information availability exists when neither the issuance or disclosure tests are met, 'adequate' information availability exists when only one of the two tests are met, and 'strong' information availability exists when both of the tests are met. APPENDIX: Comments Received Following The RFC Publication 28. On Dec. 20, 2010, Standard & Poor's published "Request for Comment: Methodology For Rating Bond Anticipation Notes." Several market participants submitted responses addressed to the criteria comments mailbox. The comments addressed a wide range of issues that sometimes extended beyond the questions posed in the RFC. 29. On the first question, regarding the "Analysis of Market Risk Profile" factors, most participants generally agreed that the factors identified were relevant, although several commented that certain factors should be given more weight and others less, and several commented that the security on the BANs should receive greater consideration. 30. On the second question, regarding the "Market liquidity of obligor's debt", many market participants agreed with the concept, but questioned the specific measures used and overall level of precision possible. 31. On the third and fourth questions, regarding confidence-sensitive debt, several market participants preferred a focus on overall leverage burdens. Some also disagreed with the idea of including LOC-backed debt and LOC-backed commercial paper in the calculation. 32. On the fifth question, regarding BANs repaid by lease appropriation debt, certain participants agreed with the need for additional understanding regarding possible provisions, others did not see a sufficient reason to consider whether they had issued appropriation debt before, while most did not comment on this issue. RELATED CRITERIA AND RESEARCH Podcast titled, "Standard & Poor s Revised Criteria For Bond Anticipation Notes," Aug. 31, 2011 USPF Criteria: Short-Term Debt, June 15, 2007 USPF Criteria: Commercial Paper, VRDO, And Self-Liquidity, July 3, 2007 USPF Criteria: GO Debt, Oct. 12, 2006 USPF Criteria: Appropriation-Backed Obligations, June 13, 2007 Criteria: Methodology And Assumptions: Approach To Evaluating Letter Of Credit-Supported Debt, July 6, 2009 These criteria represent the specific application of fundamental principles that define credit risk and ratings opinions. Their use is determined by issuer- or issue-specific attributes as well as Standard & Poor's Ratings Services' assessment of the credit and, if applicable, structural risks for a given issuer or issue rating. Methodology and assumptions may change from time to time as a result of market and economic conditions, issuer- or issue-specific factors, or new empirical evidence that would affect our credit judgment. AUGUST 31,

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249 Criteria Governments U.S. Public Finance: Commercial Paper, VRDO, And Self-Liquidity Primary Credit Analyst: Gabriel J Petek, CFA, San Francisco (1) ; gabriel.petek@standardandpoors.com Secondary Credit Analysts: Colleen Woodell, New York (1) ; colleen_woodell@standardandpoors.com Mary Peloquin-Dodd, New York (1) ; mary_peloquin-dodd@standardandpoors.com Gary R Arne, New York (1) ; gary_arne@standardandpoors.com Table Of Contents Extendible Commercial Paper Extendible CP Extension Period Backup Policies Issuers Can Provide Self-Liquidity Self-Liquidity For Commercial Paper And Variable Rate Demand Obligations (VRDOs) Asset-To-Debt Coverage Requirements What Are Available Assets? JULY 3,

250 Criteria Governments U.S. Public Finance: Commercial Paper, VRDO, And Self-Liquidity (Editor's Note: This criteria article originally was published July 3, We're republishing this article following our periodic review completed on Oct. 2, 2013.) Standard & Poor's Ratings Services Public Finance department rates the commercial paper (CP) programs and variable rate demand obligations (VRDOs) of governmental entities and nonprofit organizations (including colleges, universities, and hospitals). CP program ratings can be based on the issuer's creditworthiness or a third-party credit facility. Issuers in all sectors are increasingly issuing VRDOs and other types of variable rate debt, such as auction rate and index bonds. These issuers seek to lower their borrowing costs as they encounter a significant difference between short- and long-term tax-exempt interest rates. Also, the efficient pricing of derivative products by broker-dealers, such as interest rate swaps, has also impacted issuer's willingness to enter the short-term debt markets. Interest rate swaps in particular can potentially lock in interest rate savings to issuers that choose to synthetically fix interest rates on VRDOs. Issuers can also use swaps to lower fixed debt service costs by converting fixed rate debt into variable rate debt. Standard & Poor's typically rates the tender obligations on VRDOs based on third-party liquidity facilities, such as LOCs and standby bond purchase agreements (SBPAs), although some highly capitalized issuers are increasing issuing "unenhanced" VRDOs, where tender obligations on the debt are supported by the issuer's own liquidity sources. Issuers have the option of using their own assets to provide liquidity support as a substitute for traditional liquidity facilities both for CP programs or VRDO tender obligations. An issuer may also choose to use its own liquid assets in combination with liquidity facilities to provide support for liquidity demands. An issuer's assets and other forms of liquidity must be sufficient, liquid and creditworthy enough to meet all payment obligations on time and in full. For VRDOs, self-liquidity must involve at least 100% backup of outstanding principal and interest through a combination of the issuer's assets or credit facilities. Sources to back unenhanced CP programs do not have to account for 100% of CP authorized since ratings reflect the issuer's ongoing ability to provide funds to meet maturing CP. Also, the issuer does not have to provide sources that are rated equivalent to the CP rating. This is not the case, however, with VRDOs. The distinguishing factor between unenhanced CP and VRDOs is the issuer's control over the timing of payment events. CP programs have predictable maturity schedules, whereas VRDOs are subject to tenders at the option of the bondholders at any time. The unpredictable nature of VRDO tenders necessitates a more conservative approach towards the quality and sufficiency of liquidity reserves for VRDOs. Therefore, short-term ratings on VRDOs will reflect the lowest-rated liquidity sources backing the tender obligation. Issuers that elect to issue unenhanced CP or VRDOs and back these obligations with their own liquid assets rather than a credit facility provided by a rated entity, must undergo a formal Liquidity Assessment review by Standard & Poor's (see Self Liquidity). JULY 3,

251 Criteria Governments U.S. Public Finance: Commercial Paper, VRDO, And Self-Liquidity Extendible Commercial Paper Extendible commercial paper is almost identical to traditional commercial paper, with one major difference: the issuer can choose to extend the maturity date of the CP beyond the initial maturity date of one to 270 days from issuance. Extendible CP allow an issuer to cover the liquidity risk of a failed or potential failed remarketing of its paper and avoid default by exercising its option to extend the maturity date, thus precluding a need for liquidity. Extendible CP is rated the same as traditional CP. The rating does not address the likelihood of extension only payment in accordance with terms. An extension does not constitute a default of the paper. Extendible CP Extension Period Standard & Poor's does not have specific extension period requirements for rating extendible CP. The extension period for each individual extendible CP financing will vary on a case-by-case basis. The question is: how much time does an issuer need to arrange financing to retire extendible CP. The amount of time required will depend, in large part, upon the overall credit strength of the issuer with a track record of market access. A higher-rated issuer is less likely to be denied access to the CP market than a lower rated entity. Since the vast majority of traditional CP issuers and likely ECN issuers in public finance are major market players (such as states, major counties, cities, universities, hospitals, utilities and housing agencies) and rated at least 'A', denial of market access is remote. At the time of the ECP issuance, borrowers should have taken all needed steps to put long-term financing in place, in order to ensure a smooth take out of the CP at the end of the extension period. Partially enhanced CP programs Issuers may provide partial enhancement of CP programs by providing a credit facility for payment of CP principal only. In most partially enhanced structures, the issuer pledges to cover interest only and repay the enhancer bank for CP principal draws. If the issuer has secured a bank facility as partial credit replacement, and is pledging its own credit for interest only, Standard & Poor's will rate the CP based on a weak-link approach, using the lower of the bank's short-term rating or the issuer's short-term rating equivalent. The reason for this is due to the fact that both principal and interest of CP must be paid upon maturity and neither the bank nor the issuer is obligated to pay both components. If, however, the issuer is pledging its own credit support as a secondary source of payment for CP principal, Standard & Poor's can rate the CP program based on the issuer's short-term rating equivalent, irrespective of the credit bank's rating because the issuer is ultimately obligated to repay both principal and interest upon CP maturity. If a partially enhanced CP program rating is ultimately based on the bank's short-term rating, all conditions of the LOC backed CP criteria discussed above will apply. If the CP program rating is to be based on the issuer's short-term rating equivalent, all conditions of the unenhanced CP criteria should be met as described above. Additionally, if the issuer is serving as a source of payment for CP principal, Standard & Poor's will determine whether the credit facility and bond documents meet its criteria for "confirming" LOCs (see "Confirmation LOC Rating Criteria" section of "Public Finance Criteria: LOC-Backed Municipal Debt"). Evaluation of an issuer's commercial paper (CP) reflects Standard & Poor's opinion of the issuer's fundamental credit JULY 3,

252 Criteria Governments U.S. Public Finance: Commercial Paper, VRDO, And Self-Liquidity quality. The analytical approach is virtually identical to the one followed in assigning a long-term credit rating, and there is a strong link between the short-term and long-term rating systems. Indeed, the time horizon for CP ratings is not a function of the typical 30-day life of a commercial paper note, the 270-day maximum maturity for the most common type of commercial paper in the U.S., or even the one- to three-year tenor typically used to determine which instrument gets a short-term rating in the first place. To achieve an 'A-1+' CP rating, the obligor's credit quality should be at least the equivalent of an 'AA-' long-term rating. Similarly, for CP to be rated 'A-1', the long-term credit rating would need to be at least 'A-'. When an obligor has multiple lien positions, Standard & Poor's will look to the long-term rating on the intended takeout financing to evaluate the correlation between the short- and long-term ratings. For example, if an obligor issues subordinate lien CP but intends to ultimately retire the CP using senior lien debt, it is the long-term rating on the senior lien debt that will determine the short-term rating. (See chart, "Correlation Of CP Ratings With Long-Term Credit Ratings".) Conversely, knowing the long-term rating will not fully determine a CP rating, considering the overlap in rating categories. However, the range of possibilities is always narrow. To the extent that one of two CP ratings might be assigned at a given level of long-term credit quality (e.g., if the long-term rating is 'A'), overall strength of the credit within the rating category is the main consideration. For example, a marginal 'A' category credit likely would have its commercial paper rated 'A-2', whereas a stronger 'A' category will likely receive an 'A-1'. Backup Policies Standard & Poor's deems it prudent for obligors that issue commercial paper to make arrangements in advance for alternative sources of liquidity. This alternative, backup liquidity protects an obligor from defaulting if they are unable to roll over their maturing paper with new notes, because of a shrinking overall CP market or investor concerns about the obligor that might make CP investors reluctant to extend additional credit to the obligor. Many developments affecting a single obligor or group of obligors--including bad economic conditions, a lawsuit, management changes, a rating change--could make commercial-paper investors flee the credit. Given the size of the CP market, backup facilities could not be relied on with a high degree of confidence in the event of widespread disruption. A general disruption of CP markets could be a highly volatile scenario, under which most bank lines would represent unreliable claims on whatever cash would be made available through the banking system to support the market. Standard & Poor's neither anticipates that such a scenario is likely to develop, nor assumes that it never will. The norm for public finance obligors is 1.0x coverage of outstanding CP with excess liquid assets or bank facilities in an amount that equals all such paper outstanding providing the backup support. Under some exceptional circumstances, Standard & Poor's will assign a strong short-term rating with coverage of less-than 1.0x, if the obligor has a long-term rating of 'AA-' or higher, and can demonstrate through some combination of their own resources or alternative bank facilities, that they will always have the capacity to cover all CP as it matures, including in the event of a call on the liquid assets of the obligor. In these cases, it is possible that Standard & Poor's will assign a strong short-term rating with coverage levels in the range of, but no lower than, 50%-to-75% of CP outstanding as long as JULY 3,

253 Criteria Governments U.S. Public Finance: Commercial Paper, VRDO, And Self-Liquidity they have 1.0x coverage of all maturing CP. Determinants in the acceptable level of coverage of CP are the planned use of CP proceeds and intended takeout financing. Standard & Poor's will generally look for relatively higher coverage ratios if the purpose of the CP issue is to finance operations and to manage intra-year cash flows. Higher coverage levels will also be expected when the issuer intends to retire the CP with its own cash. Coverage can be lower when the obligor intends to issue long-term debt to retire outstanding CP. Available cash or marketable securities are ideal to provide backup, although it will likely be necessary to "haircut" their apparent value to account for potential fluctuation in value. Marketability of liquid assets is also critical. The vast majority of commercial paper issuers rely on bank facilities (lines of credit) for alternative liquidity. This high standard for back-up liquidity has provided a sense of security to the commercial-paper market--even though backup facilities are far from a guarantee that liquidity will, in the end, be available. For example, an obligor could be denied funds if its banks invoked "material adverse change" clauses. Alternatively, an obligor with insufficient liquidity might draw down its credit line to fund other cash needs, leaving less-than-full coverage of paper outstanding, or issue paper beyond the expiration date of its lines. Obligors rated 'A-1+' can provide 50%-75% coverage of CP outstanding, once again, if the issuer can demonstrate they always have the capacity to cover CP as it matures. In practice, this may be hard to demonstrate on an ongoing basis, especially for an issuer that is an active user of commercial paper and with numerous maturity dates. The exact amount is determined by the issuer's overall credit strength and its access to capital markets. Current credit quality is an important consideration in two respects. It indicates: The different likelihood of the issuer's ever losing access to funding in the commercial-paper market; and The timeframe presumed necessary to arrange funding should the obligor lose access. A higher-rated entity is less likely to encounter financial reverses of significance and--in the event of a general contraction of the commercial-paper market--the higher-rated credit would be less likely to lose investors. In fact, higher-rated obligors could actually be net beneficiaries of a flight to quality. JULY 3,

254 Criteria Governments U.S. Public Finance: Commercial Paper, VRDO, And Self-Liquidity Issuers Can Provide Self-Liquidity Creditworthy municipalities and nongovernmental organizations with good liquidity and a strong investment management function can use their own assets to provide liquidity support for commercial paper (CP) programs and variable rate demand obligations (VRDO) Rather than relying on external dedicated bank facilities, these issuers demonstrate they have both sufficient fixed income investments and the policies and procedures necessary to cover either outstanding commercial paper or variable rate demand obligations. The rating process involves an assessment of the quality and sufficiency of investments that would be used to cover the variable rate debt or commercial paper and the issuer's demonstration that they have adequate policies and procedures in place to act as a bank facility would under the same circumstances. Therefore an issuer should demonstrate that it could liquidate sufficient investments and cash when necessary under the bond documents in order to meet either a remarketing failure of commercial paper or an optional put for variable rate demand obligations. Standard & Poor's Ratings Services will evaluate an organization or municipality's fixed income investments that can be used to support short-term ratings if the issuer's assets are sufficient, liquid, and creditworthy to meet all debt obligations on a full and timely basis. Because the ability to access sufficient moneys when necessary is not related to bank performance, commercial paper ratings and any short-term ratings assigned to variable rate demand bonds, are thus tied to the issuer's long-term credit rating, rather than to external bank liquidity support. (See chart, "Correlation Of CP Ratings With Long-Term Credit Ratings). JULY 3,

255 Criteria Governments U.S. Public Finance: Commercial Paper, VRDO, And Self-Liquidity Self-Liquidity For Commercial Paper And Variable Rate Demand Obligations (VRDOs) Commercial paper ratings are a function of market access and long term credit quality, the rating on the commercial paper reflects the market access ability of the issuer to either take out the financing with long-term paper or new commercial paper notes. In general, commercial paper is more predictable and flexible than variable rate demand obligations, because it is the issuer who decides on the maturity of the commercial paper. Therefore, while there is remarketing risk, the issuer itself manages the remarketing risk. On the day that remarketing proceeds must be settled, however, the issuer will still need to have sufficient, liquid funds on hand to cover any potential remarketing failure. Standard & Poor's looks for an issuer to have on hand sufficient liquid resources, in any combination of revolving credit agreements or liquid fixed income investments available, to cover the amount of the commercial paper outstanding, as well as the ability to cover up to 270 days of interest. Please refer to the commercial paper criteria for more detail on requirements. Because the investments may be called on to meet market events, such as a failed CP rollover or a VRDO tender, using these investments should not impair an issuer's ability to meet ongoing operating expenses. Therefore issuers who provide self-liquidity should generally have a high level of liquidity available for debt and operations. While an 'A' category issuer could provide self liquidity for CP and variable rate demand obligations, most issuers who will be able to provide self liquidity will likely be rated in the 'AA' category or 'AAA'. Standard & Poor's will evaluate an issuer's ability to provide self-liquidity through an assessment of investment management policies and practices, and (2) an analysis of the fixed income portfolio. Some institutions, such as heavily endowed colleges and universities may be able to demonstrate overwhelming coverage of commercial paper or VRDOs with treasury securities and cash alone. If their portfolios are sufficiently large, or the amount of debt being covered is very small, the analysis of the fixed income portfolio is narrower in scope. However, even in cases where the entire portfolio does not need to be evaluated, Standard & Poor's still evaluates the capacity of management to provide self liquidity and still asks for a liquidity procedures letter to indicate that the cash and high quality fixed income securities can be available when needed and to identify the steps that the institution will take to meet its obligations. Standard & Poor's expects issuers to demonstrate their capacity and willingness to make short-term debt payments by submitting a detailed written liquidation plan. The procedures letter should conform to the timing in the legal documents such as when the institution or municipality receives notice that there is a shortfall and when the funds are due to the paying agent or tender agent. The letter should also identify the individuals who are responsible for taking these steps. In an evaluation of management's capacity, Standard & Poor's asks the institutions themselves and not their financial advisors or underwriters to prepare the procedures letter. Additional documentation such as operating cash flows and investment balances available for operations throughout the year may be necessary, depending on the nature of cash flow for the issuers. Ultimately, Standard & Poor's will evaluate whether the issuer's long and short-term credit quality is sufficiently robust to withstand a call on its assets pledged for liquidity purposes. JULY 3,

256 Criteria Governments U.S. Public Finance: Commercial Paper, VRDO, And Self-Liquidity An issuer may also choose to use a combination of its own assets and third-party liquidity (for example, a bank liquidity facility) to provide liquidity support. Strong lines that more closely resemble standby bond purchase agreements may be used to reduce the amount of available assets to cover maturing CP or VRDOs and still allow the issuer to pledge its own self-liquidity. In cases where a strong line is being used to substitute for self-liquidity, Standard & Poor's will evaluate the strength of the line. Weak lines, which include looser events of termination, have historically been used to cover commercial paper programs, and because of the predictable nature of commercial paper, Standard & Poor's accepts weak external liquidity facilities as a source of backup for maturing commercial paper if they are dedicated to the program. Variable rate demand bonds, however, carry an element of unpredictability because investors can choose to put their bonds. In these cases, weak lines might not be an acceptable substitute for self-liquidity and the presence of the line may not reduce the issuer's liquidity on a dollar per dollar basis. Standard & Poor's will evaluate lines if requested to do so, and strong lines that more closely resemble standby bond purchase agreements, even if they are not part of the bond transaction, may be used to reduce an issuer's self liquidity. Asset-To-Debt Coverage Requirements An issuer must ensure, on an ongoing basis, that its available assets (whether they are cash and fixed income investments or dedicated liquidity facilities) are sufficient, safe, and liquid enough to meet at least 100% of maturing CP or the full amount of a potential VRDO tender. The 100% requirement provides a minimum of 1.0x coverage of debt by available assets and assumes assets are available in the event of a failed remarketing or optional tender. In cases where a combination of an issuer's own assets and bank liquidity facilities (provided they are strong enough to provide support for the program) provide liquidity support, the minimum coverage requirement remains 1.0x. When evaluating fixed income investments in a portfolio, Standard & Poor's uses different coverage levels of different types of investments to take into account the nature of the specific assets available and the speed with which the assets can be liquidated without significant market losses. An issuer providing self-liquidity must indicate its willingness to sell assets in a down market and incur a potential loss if Standard & Poor's is to be comfortable with their ability to provide self-liquidity. When an issuer chooses to use its own assets, the amount of assets necessary to cover maturing CP or a potential VRDO tender depends upon the asset's credit quality, volatility, and weighted average maturity. Generally, the lower the credit quality of the fixed income security, the longer the weighted average maturity, and the greater the volatility and market risk of the assets, then the higher the coverage requirement such as 1.50 for investment grade corporate notes becomes. Logically, the reverse holds true. As the asset's weighted average maturity and market risk declines and credit quality increases, the lower the asset coverage requirement. Generally, Standard & Poor's will discount U.S. Treasury debt obligations and highly rated money market funds at a ratio of 1:10 and will apply higher discount ratios of 1:20 and above for all other securities. The discount ratio is also a function of how frequently an issuer plans to have assets valued in the market. While monthly valuations for high quality assets such as U.S. Treasuries may be adequate, daily or weekly valuations are JULY 3,

257 Criteria Governments U.S. Public Finance: Commercial Paper, VRDO, And Self-Liquidity recommended for assets that have greater volatility due to poor credit quality and longer maturity. Market valuation periods greater than weekly will lead to larger discount factors for most assets. Standard & Poor's also needs to understand the actions an issuer will take if the valuation falls short of expected level. Once collateral levels and valuation periods are determined, including these requirements in the legal debt documents will be viewed positively in the assignment of ratings. What Are Available Assets? Available assets are defined as cash and fixed-income investments that are not needed to meet daily operating needs. Should an issuer need to liquidate its assets to cover a failed commercial paper rollover or VRDO tender, the reduction in the issuer's liquidity position should not impair the issuer's ongoing ability to meet its daily cash flow needs, including the payment of long-term debt obligations. In short, the liquidation and use of investments should not result in a liquidity crisis for the institution or municipality. Therefore, assets available for liquidity support must be above and beyond the assets needed to meet its daily ongoing obligations. Issuers should not have to delay the payment of obligations in the event of asset liquidation to meet tenders. In light of the cyclical nature of many portfolios Standard & Poor's analysis will start at the historically lowest asset point during the year to determine the level of excess liquidity available to the obligor (Since many obligors do not have "excess" liquidity, only a select group of highly creditworthy, and liquid, obligors are able to use their own assets to support their variable-rate debt. What types of assets are eligible for liquidity support? The bulk of the assets intended for liquidity-supported programs include investment-grade fixed-income securities that are highly liquid and have a low-market-risk profile. Examples are highly rated short-term securities (securities rated 'A-1+' or 'A-1' that mature in one year or less) or long-term paper of equivalent credit quality such as U.S. governments and agencies, 'AAA', 'AA', or 'A' Standard & Poor's rated fixed-income securities. Longer-maturing assets (one year or greater) are eligible for inclusion, but coverage requirements will be higher. Equities will not be counted toward liquidity requirements. All securities should be marked-to-market frequently (at least monthly) and depending on price volatility daily valuations may be recommended. Monthly surveillance asset reports (see Exhibit A) to be submitted to Standard & Poor's will include the market and par values of each security, the security identifier (CUSIP number), and the security's rating, if applicable. In addition to the types of assets eligible to be used for liquidity support, an issuer must ensure that it has the legal authority to use its own assets for liquidity support. In some cases, state constitutions or state and local statutes may not permit an issuer to use its own assets for liquidity support. Standard & Poor's may require a legal opinion if necessary from the appropriate counsel--whether it is bond counsel, a state attorney general, or other legal representative--as to an issuer's legal authority to use its own assets for liquidity support. The "Suggested Documentation" box outlines the information issuers submit to initiate a portfolio evaluation for a liquidity assessment. If Standard & Poor's has already evaluated their investment portfolio, no further action is required. Issuers that have complex investment portfolios may be referred to Standard & Poor's Fund Services Group for liquidity evaluation and ongoing surveillance requirements indicated in Exhibit A. However, the liquidity review and surveillance requirements are substantially the same and issuers must be prepared to discuss plans for the portfolio's ongoing management and surveillance. JULY 3,

258 Criteria Governments U.S. Public Finance: Commercial Paper, VRDO, And Self-Liquidity Asset management and documentation requirements The ability of an issuer's investment management team to liquidate assets or raise cash on a same day basis (if necessary) are key factors in the evaluation of an issuer's ability to provide its own liquidity support. Very specific written liquidation procedures are required and should detail: Persons responsible for executing the asset liquidation; The sequence of steps that must be undertaken by all parties to effect liquidation (including any third parties such as the tender or paying agents acting on the issuer's behalf); If particular investments, such as fedwire securities, are custodied securities must be liquidated by a certain time to qualify for same day monies, these deadlines should be identified in the liquidation procedures letter; The timing of notifications to the appropriate parties to ensure that sufficient funds are available to pay CP and VRDO investors on a same-day basis, if necessary. The liquidation procedures must mirror timing requirements specified in CP resolutions and VRDO trust indentures for full and timely payment of debt service. The chain of events to liquidate assets will be evaluated. The evaluation starts with a bond trustee's receipt of a tender notice from a bondholder or the stop issuance order executed by the CP issuing and paying agent to an issuer's broker-dealer. The chain of events ends with the deposit of liquidated assets in immediately available funds, with the tender or paying agent to pay the purchase price of tendered bonds or maturing CP. The investment management team will be evaluated based on its documented procedures to provide the required funds by the end of the day that the trade is initiated. This liquidation letter (see sample) should be updated annually and should be prepared by the institution or municipality rather than by a financial advisor or underwriter. Capable monitoring, frequency of portfolio valuation and oversight are vital to a successful program. An obligor's success or failure in providing self-liquidity depends on their ability and willingness to take on these proactive roles. Liquidation letter Each issuer of unenhanced VRDOs will be asked to provide a letter from its management addressed to Standard & Poor's describing its liquidation procedures in detail with the major players named and their roles defined. The procedures described by the letter must indicate a strong likelihood of same-day liquidation. The acceptability of the obligor's proposed liquidation mechanics, especially with regard to timing, will be based on Standard & Poor's follow-up investigation into the procedures described by the letter. The chain of events starting with the bond trustee's sell order to the obligor's broker-dealer account representative and ending with the deposit of liquidation proceeds in immediately available funds with the tender or paying agent to pay the purchase price of tendered bonds will be scrutinized for its ability to generate the required cash by the end of the day that the trade is initiated. Among the factors that will be considered in analyzing the obligor's proposed liquidation procedures are the number of steps and parties in the liquidation process, a reasonable time frame in which to accomplish the liquidation, the experience level of the parties involved, whether the party holding the securities has direct access to FedWire, and the FedWire closing time. The credibility of the obligor's management on the issue of its ability to liquidate its available assets within the timing requirements of the VRDO structure is extremely important. Management's experience in managing and liquidating its JULY 3,

259 Criteria Governments U.S. Public Finance: Commercial Paper, VRDO, And Self-Liquidity assets will be considered in Standard & Poor's evaluation of the obligor's proposed liquidation procedures. JULY 3,

260 Criteria Governments U.S. Public Finance: Commercial Paper, VRDO, And Self-Liquidity JULY 3,

261 Criteria Governments U.S. Public Finance: Commercial Paper, VRDO, And Self-Liquidity JULY 3,

262 Criteria Governments U.S. Public Finance: Commercial Paper, VRDO, And Self-Liquidity JULY 3,

263 Criteria Governments U.S. Public Finance: Commercial Paper, VRDO, And Self-Liquidity JULY 3,

264 Copyright 2015 Standard & Poor's Financial Services LLC, a part of McGraw Hill Financial. All rights reserved. No content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor's Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an "as is" basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT'S FUNCTIONING WILL BE UNINTERRUPTED, OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages. Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P's opinions, analyses, and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw, or suspend such acknowledgement at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal, or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof. S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain nonpublic information received in connection with each analytical process. S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, (free of charge), and and (subscription) and (subscription) and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at JULY 3,

265 Criteria Governments U.S. Public Finance: Contingent Liquidity Risks In U.S. Public Finance Instruments: Methodology And Assumptions Primary Credit Analyst: David N Bodek, New York (1) ; david.bodek@standardandpoors.com Table Of Contents I. SCOPE OF THE CRITERIA II. SUMMARY OF CRITERIA UPDATE III. IMPACT ON OUTSTANDING RATINGS IV. EFFECTIVE DATE AND TRANSITION V. METHODOLOGY A. Ratings-Related Triggers B. Other Triggers C. Meeting Contingent Claims D. The Problem With Generalizing Contract Provisions E. Opportunity For Further Management Assessment VI. RELATED CRITERIA AND RESEARCH MARCH 5,

266 Criteria Governments U.S. Public Finance: Contingent Liquidity Risks In U.S. Public Finance Instruments: Methodology And Assumptions (Editor's Note: We originally published this criteria article on March 5, We're republishing this article following our periodic review completed on March 16, As a result of our review, we updated the author contact information.) 1. Standard & Poor's Ratings Services is clarifying its methodology and assumptions for evaluating contingent liquidity risk present in financial instruments of U.S. public finance obligors. We are publishing this article to help market participants better understand our approach to evaluating these risks when assigning U.S. public finance ratings. This article is related to our criteria article "Principles Of Credit Ratings", which we published on Feb. 16, The criteria supersede "Debt Derivative Profile Scores", published March 27, U.S. public finance obligors face potential heightened liquidity risk from financial instruments with payment provisions that change upon the occurrence of certain events. These "triggers" can result in the acceleration of debt payment provisions. They can also heighten liquidity needs for obligors if the provisions permit investors to tender debt following prescribed events. In addition to debt instruments, triggers are also present in derivatives, such as swaps, and other financial instruments where termination or similar events can lead to near-term settlements of all amounts due based on market or specified conditions. Other examples of instruments with triggers include letters of credit, extendable products, variable-rate demand bonds, direct purchase obligations, and revolving credit agreements. From a ratings perspective, the contract provisions and the obligor's current performance relative to those conditions will dictate the extent to which potential payment events resulting from these triggers are included in the liquidity assessment of rated entities. No distinction is made between triggers that automatically result in these potential claims and those that give investors rights to demand such amounts. This article clarifies the treatment of these potential obligations in the rating process for long-term ratings, regardless of whether these instruments are held as debt or investments. I. SCOPE OF THE CRITERIA 3. These criteria apply to all U.S. public finance issue and issuer credit ratings. II. SUMMARY OF CRITERIA UPDATE 4. Provisions in some financial instruments create potential additional claims on the liquidity of U.S. public finance obligors upon the occurrence of events or conditions specified in the instrument's terms. If these conditions are already present or if stress equivalent to that necessary to cause a two-notch downgrade of an obligor's rating would create such conditions, the liquidity analysis in sector-specific criteria includes these potential obligations as an actual claim or use of liquidity. Accordingly, this could weaken our assessment of the obligor's liquidity. In addition, the management assessment in sector-specific criteria considers the extent to which management understands these risks MARCH 5,

267 Criteria Governments U.S. Public Finance: Contingent Liquidity Risks In U.S. Public Finance Instruments: Methodology And Assumptions and has plans or policies to mitigate them. III. IMPACT ON OUTSTANDING RATINGS 5. We do not expect changes in existing ratings to result from the clarification of this methodology. IV. EFFECTIVE DATE AND TRANSITION 6. These criteria are effective immediately for all new and outstanding public finance transactions. V. METHODOLOGY A. Ratings-Related Triggers 7. Many triggers found in financial instruments relate to ratings on the obligor and other contract counterparties. Similar to the approach taken in "Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers" (Feb. 28, 2011), this methodology includes the potential exposure under the instrument as an actual claim on liquidity if a two-notch downgrade of either the obligor or its counterparty would result in a breach of the trigger. Absent explicit written changes to the terms of the instrument in advance of a demand for payment, this assumption will hold even if the obligor receives its lender's or counterparty's assurances that it will not avail itself of termination or acceleration rights under the instrument. Amounts due to public finance obligors from such triggers, however, are not included as potential liquidity sources until the obligor has exercised its rights to receive such funds and receives them. B. Other Triggers 8. In addition to ratings-based triggers, there may be other contract provisions with potential liquidity risks. They could be tied to many events, such as legal findings, operational developments, or ratio tests measuring liquidity, financial performance, or leverage. Accordingly, it is impossible to specify a unique threshold for every conceivable item, although sector-specific criteria may provide greater detail. To approach different risks in a consistent manner, the criteria consider the likelihood that any additional contingent risks will be realized relative to the likelihood of the two-notch downgrade referenced for rating triggers. The criteria include any resulting claims on liquidity in the liquidity analysis if the likelihood of breaching any other individual trigger is equal to or greater than the likelihood of the two-notch downgrade, even if the event itself does not result in a two-notch downgrade. C. Meeting Contingent Claims 9. Obligors often address such potential claims in three primary ways through: the use of internal liquidity, the use of pre-established liquidity lines, and access to the capital markets. In cases where internal liquidity or line availability is reduced as a result of these claims, sector-specific criteria for liquidity detail the manner in which ratings may be MARCH 5,

268 Criteria Governments U.S. Public Finance: Contingent Liquidity Risks In U.S. Public Finance Instruments: Methodology And Assumptions affected. An issuer planning on using market access to meet contingency claims faces the risk that market conditions might not be favorable at the required time. A longer time period between the triggering event and the date when the obligor must pay the resulting claim provides some protection against potential market disruptions. Because suddenness is frequently an attribute of contingent claims and because capital market access requires some planning and coordination, the criteria usually assume no ability to fund claims through capital market access within 180 days. 10. Some factors could necessitate extending the 180-day threshold, including: A rapid deterioration of the credit in question, An already noninvestment-grade rating, Additional potentially difficult actions required before an issuance could occur, such as passage of a difficult budget, rate or fee adjustments, or completion of adequate disclosure where audit completion is significantly delayed, or Widespread market disruptions or closures that are expected to continue. 11. Conversely, the criteria allow for the assumption that some obligors may be able to gain market access in less than 180 days. Assuming that none of the conditions in the previous paragraph exist, obligor characteristics that may lead to this assumption are: Characteristics consistent with a market risk profile score of 'low' as calculated in "Bond Anticipation Note Rating Methodology", published Aug. 31, 2011 (the BAN criteria) or, A long-term credit rating in one of the highest two categories, no recent history of late budget adoption, and characteristics consistent with at least a neutral market risk profile score as defined in the BAN criteria. D. The Problem With Generalizing Contract Provisions 12. It is important to realize that the effect of contract provisions on ratings may differ considerably among public finance sectors. First, because different sectors often have differing levels of liquidity, some sectors or issuers may be less able to mitigate contingent liquidity risks through internal liquidity alone. A greater reliance on market access or committed lines could result for these entities. Second, because internal liquidity, rating levels, and other factors can change over time, contract provisions that originally did not add to liquidity stress could do so at a later date. These dependent and dynamic effects render the concept of a "generally risky" provision or a "generally safe" provision less meaningful. E. Opportunity For Further Management Assessment 13. Although the methodology outlined incorporates contingent liquidity risk through the standard liquidity framework of sector-specific criteria, the existence of such provisions also creates the opportunity to better understand management as part of the sector-specific criteria's management assessment. Specifically, the assessment of debt management is informed by an obligor's understanding of the risks management faces from contingent liquidity provisions, the reasons behind management's choice in accepting them, and the extent of plans to mitigate these risks. MARCH 5,

269 Criteria Governments U.S. Public Finance: Contingent Liquidity Risks In U.S. Public Finance Instruments: Methodology And Assumptions VI. RELATED CRITERIA AND RESEARCH Airport Revenue Bonds, June 13, 2007 Applying Key Rating Factors To U.S. Cooperative Utilities, Nov. 21, 2007 Bond Anticipation Note Rating Methodology, Aug. 31, 2011 Charter Schools, June 14, 2007 Debt Derivative Profile Scores, March 27, 2006 Electric Utility Ratings, June 15, 2007 GO Debt, Oct. 12, 2006 Higher Education, June 19, 2007 Housing Finance Agencies, June 14, 2007 Human Service Providers, June 13, 2007 Non-Traditional Not-For-Profits, June 14, 2007 Not-For-Profit Health Care, June 14, 2007 Senior Living, June 18, 2007 Solid Waste System Financings, June 15, 2007 State Ratings Methodology, Jan. 3, 2011 Standard & Poor s Revises Criteria For Rating Water, Sewer, And Drainage Utility Revenue Bonds, Sept. 15, 2008 U.S. Public Housing Authority Issuer Credit Rating, Nov. 13, 2007 Methodology And Assumptions: Rating Unlimited Property Tax Basic Infrastructure Districts, March 17, 2009 These criteria represent the specific application of fundamental principles that define credit risk and ratings opinions. Their use is determined by issuer- or issue-specific attributes as well as Standard & Poor's Ratings Services' assessment of the credit and, if applicable, structural risks for a given issuer or issue rating. Methodology and assumptions may change from time to time as a result of market and economic conditions, issuer- or issue-specific factors, or new empirical evidence that would affect our credit judgment. MARCH 5,

270 Copyright 2015 Standard & Poor's Financial Services LLC, a part of McGraw Hill Financial. All rights reserved. No content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor's Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an "as is" basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT'S FUNCTIONING WILL BE UNINTERRUPTED, OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages. Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P's opinions, analyses, and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw, or suspend such acknowledgement at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal, or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof. S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain nonpublic information received in connection with each analytical process. S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, (free of charge), and and (subscription) and (subscription) and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at MARCH 5,

271 Criteria Governments U.S. Public Finance: Methodology: Definitions And Related Analytic Practices For Covenant And Payment Provisions In U.S. Public Finance Revenue Obligations Criteria Office and Primary Credit Analyst, U.S. Public Finance and International Public Finance: James M Wiemken, New York (1) ; james.wiemken@standardandpoors.com Secondary Credit Analyst: Laura A Kuffler-Macdonald, New York (1) ; laura_kuffler_macdonald@standardandpoors.com Table Of Contents I. SCOPE OF THE CRITERIA II. SUMMARY OF CRITERIA UPDATE III. IMPACT ON OUTSTANDING RATINGS IV. EFFECTIVE DATE AND TRANSITION V. METHODOLOGY A. Covenant And Payment Provision Definitions And Descriptions B. Analytic Practices Associated With The Above Provisions C. Calculation Of Debt Service And Fixed-Charge Coverage D. Analytic Practices Associated With The Above Provisions E. Covenant Violations NOVEMBER 29,

272 Table Of Contents (cont.) RELATED CRITERIA AND RESEARCH NOVEMBER 29,

273 Criteria Governments U.S. Public Finance: Methodology: Definitions And Related Analytic Practices For Covenant And Payment Provisions In U.S. Public Finance Revenue Obligations (Editor's Note: This article, originally published Nov. 29, 2011, has been partially superseded by "Assigning Issue Credit Ratings Of Operating Entities", published May 20, 2015.) 1. Standard & Poor's Ratings Services is publishing the covenant and payment provisions considered in analyzing revenue bonds across U.S. public finance. This article is related to our criteria article Principles of Credit Ratings, which we published on Feb. 16, I. SCOPE OF THE CRITERIA 2. These criteria apply to issue ratings on U.S. public finance revenue obligations. II. SUMMARY OF CRITERIA UPDATE 3. Standard & Poor's is publishing standard definitions, descriptions, and related analytical practices associated with covenant and payment provisions referenced in its U.S. public finance criteria for analyzing revenue obligations. Bond covenants can affect our forward-looking view of a credit's underlying cash flows and leverage characteristics. Ratings on revenue bonds thus reflect our views on the combination of the strength of the underlying cash flows and relevant document provisions. III. IMPACT ON OUTSTANDING RATINGS 4. We do not anticipate any rating changes as a consequence of these criteria. IV. EFFECTIVE DATE AND TRANSITION 5. These criteria are effective immediately for all ratings on U.S. public finance revenue obligations. V. METHODOLOGY 6. Payment provisions and covenants are widely used in U.S. public finance revenue obligation transactions to set forth the specifics of a given issue and to provide certain protections to the investor given the often limited nature of the pledged revenue. Revenue obligations are typically payable only from a defined revenue stream, but covenant provisions may require an obligor to adjust rates, set aside reserves, or constrain future debt issuance. This article NOVEMBER 29,

274 Criteria Governments U.S. Public Finance: Methodology: Definitions And Related Analytic Practices For Covenant And Payment Provisions In U.S. Public Finance Revenue Obligations provides standard definitions of certain terms as they are used in our other U.S. public finance criteria and discusses issues that arise in relation to these terms. A. Covenant And Payment Provision Definitions And Descriptions 7. The indenture, bond resolution, or other related transaction documents typically specify the various provisions and covenants discussed below. 1. Security: 8. A section titled or referencing "security" specifies the payment source pledged to pay debt service. Generally, if a revenue stream backing a debt instrument is insufficient to make payments on that obligation, security holders may not collect against any other revenue of the obligor. As such, our analysis of revenue obligations focuses on the cash flows associated with the revenues pledged. 2. Flow of funds 9. The flow of funds provisions govern the receipt, deposit, and application of pledged revenues. A typical, but not necessarily a comprehensive list of accounts often specified in the flow of funds includes: 10. a) Revenue fund. This fund typically holds revenues of the obligor collected upon receipt by the obligor or trustee; revenues in this fund are generally held until distributed to other accounts as dictated by the flow of funds. 11. b) Operations and maintenance fund. Monies deposited in this fund are used to meet the expenses associated with operating and maintaining the related enterprise. 12. c) Debt service or bond fund. Monies deposited in this fund are for the payment of principal and interest. Transaction documents may provide for the debt service fund to have separate subaccounts for the payment of principal and interest, or for the payment of junior- and senior-lien debt. Alternatively, there may be separate debt service funds for principal and interest and junior- or senior-lien debt. 13. d) Debt service reserve fund (DSRF). Monies placed in reserve in this fund support debt service in the event that pledged revenues are insufficient to pay debt service in full. Bond provisions may or may not require replenishment of a debt service reserve once drawn upon. A DSRF may be funded at issuance from bond proceeds in an amount equal to average annual debt service, maximum annual debt service, or some other specified level and is usually restricted by tax law. Alternatively, a DSRF may be funded from operations over time, or bond provisions may provide for a "springing reserve" when financial performance deteriorates below a certain level. 14. e) Renewal and replacement fund (or capital projects fund). Money deposited in such funds is typically intended to cover anticipated capital expenses of the related enterprise. Although they may be available for liquidity, these funds have a limited role in the credit analysis. 15. f) Surplus fund. After all other deposits into accounts specified in the flow of funds provisions have been made, transaction documents may provide for a surplus fund to capture residual revenues. 3. Rate covenant 16. The rate covenant requires the obligor to set rates and charges at levels that either are or are expected to be sufficient to cover debt service and operating expenses by a margin specified in the legal documents. NOVEMBER 29,

275 Criteria Governments U.S. Public Finance: Methodology: Definitions And Related Analytic Practices For Covenant And Payment Provisions In U.S. Public Finance Revenue Obligations 4. Additional bonds test (ABT) 17. The ABT specifies the conditions necessary for the obligor to issue additional parity or senior-lien debt. Typically, the test requires that historical or projected revenues available for debt service exceed projected annual debt service requirements for both existing and proposed bonds by a specified ratio. B. Analytic Practices Associated With The Above Provisions 1. Gross vs. net revenue pledges 18. Flow of funds provisions that direct the payment of debt service before operations and maintenance represent what is commonly known as a gross revenue pledge, while those that specify the payment of debt service after operations and maintenance represent a net revenue pledge. Although payment of debt service with a gross revenue pledge represents a prior claim on revenues from an ordinal perspective, ratings assigned do not reflect the payment order. Revenues diverted for debt service could effectively shut down the entity if operations and maintenance went unpaid for more than a short time. Such an event could risk operations, including revenue collections, and the ability to continue to produce revenues for debt service. 2. Recognition of the DSRF as a credit strength 19. Although sector-specific criteria will define the rating impact associated with different transaction provisions, in general a springing DSRF does not represent a credit strength because such requirements place additional liquidity stress on the entity producing the revenues at the exact time that financial performance is declining. Also, the rating on the DSRF assets or provider should be investment-grade to warrant the recognition of the additional liquidity provided by this fund for an investment-grade rating. Typically, DSRFs provide only liquidity rather than full credit protection because they provide only temporary rather than sustained protection against stresses. As such, rating differentials resulting from the presence of DSRFs in most cases are limited. For public finance housing issues and other issues where reserve funds are the primary expected source for payment, ratings implications will follow those detailed in our counterparty criteria ("Counterparty And Supporting Obligations Methodology And Assumptions", Dec. 6, 2010). 3. Open vs. closed flow of funds 20. Provisions that allow for transfers outside the flow of funds (including transfers outside of the entity generating the revenues) represent what is commonly known as an "open" flow of funds, while an inability to make such transfers represents a "closed" flow of funds. Sector-specific criteria address situations where the existence of an open or closed flow of funds may affect the credit rating. 4. Conservative vs. prospective rate covenants and ABTs 21. Conservative rate covenants use only actual recent historic revenues in the calculation or include only those revenues that would have been generated by a rate increase already approved. Prospective rate covenants are perceived as weaker because they allow for adjustments for anticipated growth, revenues from planned projects that are not yet operational, or rate increases not yet approved and are generally perceived as weaker. Similarly, rate covenants incorporating existing liquidity in addition to available revenues to determine sufficiency suffer a relative weakness because they do not ensure that recurring revenues will meet recurring expenditures. Although sector-specific criteria will detail the manner in which different rate covenant levels may affect ratings, rate covenants generally play a larger role in determining credit quality when expected performance is near the levels specified by the rate covenant. In these NOVEMBER 29,

276 Criteria Governments U.S. Public Finance: Methodology: Definitions And Related Analytic Practices For Covenant And Payment Provisions In U.S. Public Finance Revenue Obligations cases, the rate covenant creates a potential floor for coverage that can affect our forward-looking view of actual performance. 22. As with the rate covenant, a conservative ABT uses only actual recent historic revenues in the calculation or in addition only those that would have been generated by a rate increase already approved. Weaker prospective ABTs allow for adjustments for anticipated growth or rate increases not yet approved. C. Calculation Of Debt Service And Fixed-Charge Coverage 1. Net revenues available for debt service (NRAFDS) 23. The numerator for coverage calculations begins with a consideration of all pledged revenues. As detailed in paragraph, when all or the vast majority of an enterprise's revenues are pledged for debt service, coverage is determined using revenues available after operating expenses regardless of whether the security provides for a gross or net revenue pledge. To take a more forward-looking view of revenues available, the analysis considers not only all available revenues but also differentiates those that are likely to be regularly recurring from those that are more one-time in nature. Investment earnings and tap fees are two examples of revenues that may be more volatile and less recurring. When considering net revenues, the calculation uses annual values and adds back noncash expenses such as depreciation and amortization to recognize cash availability. For historical debt service coverage references, the criteria use NRAFDS in the year in which the relevant debt service was paid. For current and future debt service coverage ratios, sector-specific criteria may call for forward projections of NRAFDS in the year in which related debt service is to be paid, where possible. Otherwise, the criteria use NRAFDS for the last available year when calculating debt service coverage for current and future years. 24. Accordingly, net revenues available for debt service is defined as: total operating revenues - total operating expenses + nonoperating income nonoperating expenses + depreciation and other noncash expenses + interest expense on debt. 25. When calculating fixed-charge coverage, the NRAFDS also includes all debt-related contractual obligations of the obligor, because the calculation treats these items as obligations to be covered by NRAFDS instead of operating expenses. 2. Debt service 26. Principal and interest included in debt service calculations generally consist of the regularly scheduled principal and interest coming due annually. The calculation excludes bond anticipation note maturities and bullet payments funded from sinking funds where funds are already set aside. Coverage calculations do not include prepayments of debt. Calculations of fixed-charge coverage include all debt and other debt-related contractual obligations of the obligor due that year. This includes fixed contractual obligations under operating leases or "take or pay" type relationships that, although not technically considered debt, are obligations nonetheless and are often associated with capital financing. Operational contractual obligations, including those for pensions and benefits, are not included. NOVEMBER 29,

277 Criteria Governments U.S. Public Finance: Methodology: Definitions And Related Analytic Practices For Covenant And Payment Provisions In U.S. Public Finance Revenue Obligations 3. Debt service coverage formulae 27. Sector-specific criteria use various coverage ratios that rely on the definitions of NRAFDS and debt service above. The ratios are defined as follows: Total annual debt service coverage for a given year = NRAFDS/debt service for that year plus capital lease payments due during that period. Average annual debt service coverage = the average of total annual debt service coverage over all years that debt remains outstanding. Maximum annual debt service coverage = NRAFDS/the largest annual debt service payment coming due between the current date and the final maturity of all debt paid by the specified revenues. Senior-lien debt service coverage for a given year = NRAFDS/total senior-lien debt service for that year. Subordinate-lien debt service coverage for a given year = NRAFDS/total subordinate-lien debt service for that year + all debt service on prior lien debt coming due in that year. D. Analytic Practices Associated With The Above Provisions 1. Use of coverage ratios 28. The debt amortization profile, revenue and expenditure volatility, and degree of revenue flexibility will affect whether the analysis focuses more on current and pending annual debt service coverage, rather than on average annual debt service coverage or maximum annual debt service coverage. Current and pending annual debt service coverage is most useful with a level amortization profile and stable revenue and expenditure patterns. When the difference between current and maximum annual debt service is significant, the difference between current and maximum annual debt service coverage can reveal the extent to which NRAFDS must grow before the year that maximum annual debt service occurs. Average annual debt service may be a better measure of the ongoing debt service burden when current debt service costs are below ongoing expectations due to a lumpy amortization schedule or other factors. Accordingly, average annual debt service coverage adds value in these contexts. Although the current debt service calculation uses actual interest expense, the analysis of future potential volatility also considers the degree to which interest-rate increases on variable-rate debt could alter existing coverage levels. 2. Senior vs. subordinate debt ratings 29. Senior and subordinate debt issues may or may not receive different ratings depending on the circumstances. While sector-specific criteria will provide greater detail as to when senior and subordinate issue may be rated equally, common reasons for equal ratings on senior and subordinate issues may include: When little debt remains on either the senior or subordinate debt level and no plans for further debt exist at this level (as may be the case with a closed lien), When very high coverage of overall debt service at both levels leads to no expected difference in both liens' debt servicing ability during a stressful period, and When particularly strong subordinate-lien legal provisions exist. NOVEMBER 29,

278 Criteria Governments U.S. Public Finance: Methodology: Definitions And Related Analytic Practices For Covenant And Payment Provisions In U.S. Public Finance Revenue Obligations E. Covenant Violations 30. When issuers fail to meet covenants specified in bond documents, bondholders can receive additional rights, often after a specified cure period. If such failures are included in the events of default, a technical default may result. Assuming that payment defaults have not occurred, technical defaults do not automatically lead to ratings being lowered to 'D'. However, covenant violations can often have rating impacts, regardless of whether they result in technical default. For enterprises, the inability to perform in accordance with legal covenants may indicate difficulties in managing the enterprise to acceptable levels. For special-tax revenue bonds, it may indicate previously unexpected revenue volatility. Moreover, investors may be allowed to accelerate or put debt back to the issuer upon such an event, thus increasing liquidity stress. Although some investors may choose not to exercise these rights for various reasons, our analysis assumes that investors exercise their rights in such stressful conditions. RELATED CRITERIA AND RESEARCH Principles of Credit Ratings, Feb. 16, 2011 Methodology: Rating Approach To Obligations With Multiple Revenue Streams, Nov. 29, 2011 These criteria represent the specific application of fundamental principles that define credit risk and ratings opinions. Their use is determined by issuer- or issue-specific attributes as well as Standard & Poor's Ratings Services' assessment of the credit and, if applicable, structural risks for a given issuer or issue rating. Methodology and assumptions may change from time to time as a result of market and economic conditions, issuer- or issue-specific factors, or new empirical evidence that would affect our credit judgment. NOVEMBER 29,

279 Copyright 2015 Standard & Poor's Financial Services LLC, a part of McGraw Hill Financial. All rights reserved. No content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor's Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an "as is" basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT'S FUNCTIONING WILL BE UNINTERRUPTED, OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages. Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P's opinions, analyses, and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw, or suspend such acknowledgement at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal, or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof. S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain nonpublic information received in connection with each analytical process. S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, (free of charge), and and (subscription) and (subscription) and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at NOVEMBER 29,

280 Criteria Structured Finance General: Global Derivative Agreement Criteria U.S. Structured Finance Ratings, Criteria Officer: Felix E Herrera, CFA, New York (1) ; felix.herrera@standardandpoors.com Asia-Pacific, Chief Credit Officer: Peter J Eastham, Melbourne (61) ; peter.eastham@standardandpoors.com EMEA, Chief Credit Officer: Lapo Guadagnuolo, London (44) ; lapo.guadagnuolo@standardandpoors.com EMEA Structured Finance Ratings, Criteria Officer: Herve-Pierre P Flammier, Paris (33) ; herve-pierre.flammier@standardandpoors.com Claire K Robert, Paris (33) ; claire.robert@standardandpoors.com Table Of Contents SCOPE OF THE CRITERIA SUMMARY OF THE CRITERIA IMPACT ON OUTSTANDING RATINGS EFFECTIVE DATE AND TRANSITION METHODOLOGY Criteria Overview The ISDA Master Agreement The Collateral Support Documents Derivative-Independent Approach APPENDICES JUNE 24,

281 Table Of Contents (cont.) Appendix 1: Hypothetical Schedule To The 1992 ISDA Master Agreement Reflecting An Example Of The Application Of Standard & Poor's Derivative Agreement Criteria Appendix 2: Hypothetical ISDA Credit Support Annex Reflecting An Example Of The Application Of Standard & Poor's Replacement Options As Described In "Counterparty Risk Framework Methodology And Assumptions," published Nov. 29, 2012 EXHIBIT I: Standard & Poor's Eligible Collateral And Valuation Percentages EXHIBIT II: Tables A And B For Use In Calculating The Standard & Poor's Credit Support Amount RELATED CRITERIA AND RESEARCH Related Criteria Related Research JUNE 24,

282 Criteria Structured Finance General: Global Derivative Agreement Criteria (Editor's Note: We originally published this criteria article on June 24, We're republishing this article following our periodic review completed on May 28, As a result of our review, we updated the author contact information. This criteria article supersedes "Standard & Poor's Accepts Tax Event As a Termination Event in Structured Finance Swaps," published Sept. 17, 2003, "Global Synthetic Securities Criteria: Swap Agreement Criteria," published June 1, 1999, and "ISDA Swap Agreement Primer," published July 22, It partially supersedes the article titled, "Criteria For Rating Synthetic CDO Transactions: Legal Analysis And Surveillance," published on Sept. 1, 2004.) 1. Standard & Poor's Ratings Services is updating its global derivative agreement criteria. This update supersedes "Standard & Poor's Accepts Tax Event As a Termination Event in Structured Finance Swaps," published Sept. 17, 2003, "Global Synthetic Securities Criteria: Swap Agreement Criteria," published June 1, 1999, and "ISDA Swap Agreement Primer," published July 22, The criteria update addresses the counterparty risk principle described in "Principles Of Credit Ratings," published Feb. 16, SCOPE OF THE CRITERIA 2. These criteria apply globally to our analysis of derivative agreements in new and existing structured finance transactions, including covered bonds. The criteria also apply to highly-leveraged project finance transactions, highly-leveraged public finance transactions that possess structured finance characteristics (e.g., stand-alone singleand multifamily housing bonds, and tender option bonds), catastrophe bonds, gas prepay financings, and equipment trust certificates. For project finance, public finance, and corporate issuers that we view as possessing substantially more financial and operating flexibility, we would use these criteria as a starting point in our analysis of their derivative agreements, and make adjustments to reflect our assessment of the issuers' respective credit and liquidity profiles, including access to other assets and/or funding streams. 3. The criteria do not apply if we believe an issuer has the financial resources to absorb the loss of its derivative cash flows, pay senior early termination costs, and post collateral to the counterparty without experiencing a downgrade of its obligations. SUMMARY OF THE CRITERIA 4. These criteria identify provisions in derivatives agreements that may introduce uncertainties in the amount and timing of an issuer's derivative cash flows. Many of the identified provisions could result in an issuer's unexpected loss of a hedge and/or an obligation to make an early termination payment, primarily due to nonmonetary and cross-default risks. The criteria also identify provisions that potentially expose an issuer to unanticipated costs and to the risk of becoming undercollateralized. 5. While providing a general methodology for reviewing derivative agreements, this methodology update specifically includes criteria for reviewing both the 1992 and 2002 ISDA Master Agreements, as well as the 1994 and 1995 ISDA JUNE 24,

283 Criteria Structured Finance General: Global Derivative Agreement Criteria Credit Support Annexes (New York Law and English Law, respectively). The update also includes criteria for risks unique to total return swaps and covered bonds. IMPACT ON OUTSTANDING RATINGS 6. These criteria update, consolidate, and restate the existing criteria. We do not expect this criteria update to affect any outstanding ratings. EFFECTIVE DATE AND TRANSITION 7. The updated criteria are effective immediately and apply to all new and outstanding ratings within scope. METHODOLOGY Criteria Overview 8. Derivatives are an integral part of many securitizations and certain other types of financial transactions. They are important because they transform cash flows into amounts that are due to investors under the terms of the securities they hold. Consequently, the issuer, usually a bankruptcy-remote special-purpose entity (SPE) (or an equivalent) with a limited cash flow stream, cannot risk an early termination of the derivative agreement. 9. The objective of these criteria is to identify provisions in derivatives agreements that may introduce uncertainties in the amount and timing of an issuer's derivative cash flows. In general, the criteria reflect the following assumptions: The issuer, typically a bankruptcy-remote SPE, does not have the financial resources to fund additional payments to or absorb reduced payments from a derivative counterparty without experiencing a cash flow shortfall on or a downgrade of its rated obligations (see paragraphs 15-20, 23-61, and 70-71). The issuer does not have an incentive to terminate the derivative agreement absent an underlying collateral or counterparty default, and then only if it is in the best interests of or at the direction of the holders of the rated obligations (see paragraph 22). If the derivative counterparty terminates the derivative agreement early, the issuer could become liable for early termination costs (or "derivative break costs"), which could result in cash flow shortfalls on or a downgrade of the issuer's rated obligations (see paragraphs 15-16, 62-66, and 73). The issuer does not have the financial resources to both maintain the ratings on its obligations and post collateral to a counterparty (see paragraphs 76-89). 10. Following from these assumptions, the terms of any derivative documentation incorporated into a transaction structure are an important rating consideration in assessing an issuer's ability to make payments to securities holders in full and on time. If an SPE issuer has the financial resources to absorb the loss of the derivative cash flows, but cannot pay senior derivative break costs without experiencing a downgrade of its obligations, then paragraph 90 (Derivative-independent approach) applies. JUNE 24,

284 Criteria Structured Finance General: Global Derivative Agreement Criteria 11. The transaction parties may choose to document their derivative contracts under an International Swaps and Derivatives Association Inc. (ISDA) agreement or other equivalent written agreement. These criteria refer to provisions in the commonly used 1992 ISDA Master Agreement (Multicurrency-Cross Border) for convenience only. In addition to the 1992 ISDA Master Agreement, the criteria address key differences between the 1992 and 2002 ISDA Master Agreements to the extent relevant to our analysis of derivative agreements. For ease of use, we capitalize the ISDA terms used herein. If a derivative contract is not based on ISDA forms, then additional criteria may apply to the extent there are other risks. 12. Throughout the article we refer to the issuer as "bankruptcy-remote," meaning bankruptcy-remote based on our criteria (see "Asset Isolation And Special-Purpose Entity Criteria Structured Finance," published May 7, 2013). 13. For illustrative purposes only, appendices 1 and 2 set out an example of a Schedule to the ISDA 1992 Master Agreement and a Credit Support Annex (CSA) governed by New York law, respectively. They are one example of how these derivative agreement criteria may be applied in the context of a hypothetical transaction that issued notes with an 'AAA' rating, and assume the hypothetical parties have chosen to document the replacement options described in "Counterparty Risk Framework Methodology And Assumptions," published Nov. 29, The appendices do not constitute criteria and transaction participants should not interpret them as recommendations or advice on how they should document and/or structure their transactions. The ISDA Master Agreement Section 2 of the ISDA Master Agreement Obligations 14. Section 2 sets out the general terms and conditions under which the parties make payments. Netting 15. Netting of Payments [Section 2(c)]. The ISDA Master Agreement allows for the party that owes the larger derivative payment to make a net payment to the other party if the amounts due from both parties are payable (i) on the same date and (ii) in the same currency. If the parties enter into and document multiple Transactions (or Confirmations) under the same ISDA Master Agreement and Schedule, then only payments made within the same Transaction are netted unless the parties affirmatively elect, in the 1992 ISDA Master Agreement, that "2(c)(ii) will not apply" or, in the 2002 ISDA Master Agreement, that "Multiple Transaction Netting applies." 16. According to these criteria, netting across multiple Transactions is not a risk factor if all of the Transactions relate to the same credit risk and collateral pool. However, when an issuer can issue multiple classes of securities (secured by the same collateral pool) that do not all share the same credit rating or multiple series of securities, each of which may be secured by different collateral pools that are not cross-collateralized (a multiple-use issuer), netting payments across different Transactions (or Confirmations) with different credit profiles may result in payment shortfalls to a more highly rated class or to a series backed by a different collateral pool. In addition, if the derivative counterparty has the right to terminate the agreement because the issuer had defaulted on any of the related Transactions, issuer shortfalls also may result from either the loss of a hedge or early termination costs. Therefore, we look for separate derivative agreements (including separate ISDA Schedules) for the different credit profiles unless netting across different series or classes will not apply, section 1(c) ("Single Agreement") of the ISDA Master Agreement will not apply, and the risks related to loss of a hedge and early termination costs are fully mitigated. Alternatively, our ratings analysis could reflect cross-default JUNE 24,

285 Criteria Structured Finance General: Global Derivative Agreement Criteria risk (see "Assessing Credit Quality By The Weakest Link," published Feb. 13, 2012). Total Return Swaps And Cross-Default Risk From The Referenced Assets In most transactions involving a total return swap, the counterparty contractually assumes the default, insolvency, and market value risk of specific issuer assets (the "TRS reference assets"). Typically, the issuer and counterparty agree that cash flows from the TRS reference assets will be passed through to the counterparty and that the counterparty will pay the issuer even if some or all of those assets default during the term of the agreement. Furthermore, the parties usually intend that the ratings on the issuer's obligations reflect only the counterparty's rating and, where applicable, the credit quality of any non-trs reference assets. Our ratings on the issuer's obligations will reflect only the counterparty's rating and, where applicable, the non-trs assets' credit quality if we believe cross-default risk from the TRS reference assets has been mitigated. For example, transaction parties have addressed the cross-default risk as follows: Section 2(c) did not apply to issuer and counterparty payments (which disabled netting within a single Transaction) and Section 5(a)(i) [Failure to Pay or Deliver] did not apply to the issuer; or The issuer was obligated to make payments to the counterparty only to the extent of the TRS reference asset cash flows received. Taxation 17. Deduction or withholding for tax [Section 2(d)]. Section 2(d) requires a party to make all derivative payments without deducting or withholding any taxes unless required by law (in which case the derivative payer is obliged only to make payments that are net of taxes). However, a party is required to gross-up its derivative payments if an Indemnifiable Tax is imposed on the payments. 18. When withholding taxes are imposed on an issuer's payments, the issuer's potential tax burden is a risk factor because, if the withholding tax is an Indemnifiable Tax, the issuer would be obligated to gross-up payments. At the same time, when withholding taxes are imposed on payments the issuer receives, the issuer would receive payments net of taxes unless the withholding tax is an Indemnifiable Tax. In either case, a SPE issuer that is burdened by the tax may be rendered less capable of paying all of its rated liabilities. 19. Whenever funds are to be transferred across a jurisdictional border, there is a risk that the tax authority in the payer's jurisdiction will require that a part of the amount be withheld and remitted to it as a tax. These criteria consider whether withholding taxes may be imposed on the cash flows to be received or paid by the issuer. In our view, withholding tax risk is mitigated if the counterparty accepts derivative payments from the issuer that are net of tax and pays to the issuer amounts that are grossed-up for tax. If the counterparty and the issuer are of the view that no withholding tax applies and they choose to make the "no withholding tax" payer representation in Part 2(a) of the ISDA Schedule, then our analysis assumes that withholding tax risk is mitigated. If the parties do not document either approach in the derivative agreement and Standard & Poor's is not otherwise comfortable that there is no withholding tax risk (e.g., payments are among parties in the same jurisdiction), we may request legal comfort from the issuer or counterparty that no withholding tax applies under current applicable law. JUNE 24,

286 Criteria Structured Finance General: Global Derivative Agreement Criteria 20. Payment of stamp tax [Section 4(e)]. Similar to withholding tax, we may seek additional legal comfort that neither party has to pay a stamp duty or other documentary tax to execute or perform on the derivative agreement. If the issuer must pay or indemnify a duty or tax, it must demonstrate its ability to meet the expense. Section 5 of the ISDA Master Agreement Events of Default and Termination Events 21. Our analysis of Events of Default and Termination Events considers how the applicable events affect an issuer's available cash flows. 22. Issuer's right to terminate. As a general principle, we assume that the issuer does not exercise any right to terminate a derivative unless doing so is at the security holders' direction or in their best interests. Therefore, the criteria would not typically consider an issuer's right to terminate a derivative agreement as potentially conflicting with the ratings on that issuer's obligations. However, when made applicable to the counterparty, we consider the following sections as providing both an option for the issuer to terminate if the counterparty fails to perform and an incentive for the counterparty to perform: a Failure to Pay or Deliver (Section 5(a)(i)); Bankruptcy (Section 5(a)(vii)); and, if the counterparty is credit-supported (e.g., by a CSA or guarantor) and such support is a credit factor in our ratings analysis, Credit Support Default (Section 5(a)(iii)). 23. Counterparty's right to terminate.an Event of Default or a Termination Event that gives a counterparty the right to terminate or suspend a derivative agreement may result in a cash flow shortfall on or a downgrade of an issuer's rated obligations (i) if the issuer does not have the financial resources to fully absorb the risk that the derivative agreement addresses or (ii) if the issuer needs to redirect cash flows intended for the rated noteholders to pay derivative break costs to a counterparty for whom the derivative agreement has a net positive value (i.e., an "in-the-money" counterparty). 24. Where a rated obligation could be downgraded if the issuer loses the hedge or other financial support that a derivative agreement provides, the Events of Default and Termination Events usually should not give rise to the counterparty's right to terminate or suspend the agreement unless, in our view: The issuer would have failed to pay the senior-most tranche of rated debt to which the derivative agreement relates even if the counterparty did not terminate or suspend the agreement; The likelihood of the event occurring is commensurate with the rating we assign to the issuer's rated obligations (for an example, please see paragraph 41); or The event would be precipitated by a change in law. 25. Any "Specified Entity" that the transaction parties identify in relation to the issuer for Events of Default will be an additional credit factor in our analysis (e.g., analyzed based on the weak-link approach) unless we believe the Specified Entity's credit profile (i.e., its credit rating and performance) is and will be the same as the transaction's credit profile for the transaction's life. JUNE 24,

287 Criteria Structured Finance General: Global Derivative Agreement Criteria Counterparty's Right To Terminate In Legislation-Enabled Covered Bond Jurisdictions In some jurisdictions (e.g., Germany and Luxembourg), a bank, rather than a SPE, issues legislation-enabled covered bonds, and that bank separates the assets (sometimes including derivative agreements) from its books by identifying them in a cover register. In these cases, the bank signs the derivative agreement with the counterparty. Our methodology for rating covered bonds assumes recourse to the cover pool and, consequently, that the derivative agreement will continue even if the issuing bank fails to pay, becomes insolvent, or if any other event occurs with respect to the issuing bank. Therefore, when a bank issues legislation-enabled covered bonds, the derivative agreement usually clarifies that the Events of Default and Termination Events that give rise to a counterparty's right to terminate or suspend the agreement apply to the cover pool instead of the issuing bank. Or, the transaction parties agree that no Event of Default or Termination Event will give rise to the counterparty's right to terminate/suspend the derivative agreement. In addition, in instances where the covered bonds are issued by a vehicle separate from the bank but our ratings analysis relies on the governing jurisdiction's general legal framework for covered bond issuances rather than on the issuing vehicle's bankruptcy remoteness, we would generally expect that the vehicle's bankruptcy would not give rise to the counterparty's right to terminate/suspend the derivative agreement. Events of default 26. Failure to Pay or Deliver [Section 5(a)(i)]. This section refers to a party's failure to make payments or deliveries when due under a Confirmation. A Failure to Pay or Deliver does not become an Event of Default unless the non-defaulting Party has provided a default notice and the grace period has elapsed without cure by the Defaulting Party. 27. In our opinion, application of section 5(a)(i) to the issuer is consistent with these criteria if scheduled derivative payments (i.e., excluding early termination costs) from the issuer to the counterparty are prioritized in the issuer's payment waterfall so that they are consistent with the rating assigned to the senior-most tranche that benefits from the derivative agreement. Furthermore, an early termination payment payable to the counterparty as a result of an issuer's "Failure to Pay or Deliver" also is consistent with these criteria if its priority in the payment waterfall is equal to or higher than the senior-most tranche that benefits from the derivative agreement. However, if there are rated tranches that are more senior and do not benefit from the same Confirmation, any potential early termination costs payable to the counterparty should be junior to those tranches. 28. Breach of Agreement [Section 5(a)(ii)]. This section refers to a party's failure to comply with or perform any of its obligations (other than a Failure to Pay or Deliver) under the agreement. A breach of agreement does not become an Event of Default unless the non-defaulting Party has provided notice of the breach and 30 business days have elapsed since the notice date without cure by the Defaulting Party; however, the breach does immediately become a Potential Event of Default. Section 2(a)(iii) permits the non-defaulting Party to suspend contractual performance either until the Defaulting Party cures the Potential Event of Default or the non-defaulting Party terminates the agreement after the Potential Event of Default ages into an Event of Default. 29. In our opinion, application of Section 5(a)(ii) to the issuer is a risk factor unless it is limited to financial (as distinguished from administrative) obligations that can be measured in the cash flow analysis of the issuer's rated obligations. The issuer is usually an SPE that depends on third parties to perform its administrative functions. The criteria assume the counterparty is comfortable with the third parties' capabilities before it enters into the agreement. JUNE 24,

288 Criteria Structured Finance General: Global Derivative Agreement Criteria 30. Credit Support Default [Section 5(a)(iii)]. This section relates to parties with credit-supported derivative obligations (e.g., their obligations are guaranteed or they may be required to post collateral) and generally provides that a party's failure to comply with the terms in any Credit Support Document or its premature loss of credit support would be an Event of Default. 31. In our opinion, application of Section 5(a)(iii) to the issuer is a risk factor, particularly if a Credit Support Document is identified in regard to the issuer. We believe that parts of Section 5(a)(iii) are equivalent to, among other things, Breach of Agreement [Section 5(a)(ii)]. However, if a CSA or Deed requires the counterparty to post or transfer collateral, it is consistent with these criteria for Section 5(a)(iii)(1) alone to apply to the issuer and only if that subsection is limited to the issuer's obligations under the CSA or Deed to return excess collateral, or to pay an Interest Amount or a Distribution Amount. In any event, the definition of Credit Support Documents typically should not include security or other transaction documents (e.g., a trust indenture or a pooling and servicing agreement) in regard to the issuer. 32. We look for a guarantor who enhances a counterparty's creditworthiness for purposes of the ratings on an issuer's obligations to be specified as a Credit Support Provider, and for the guarantee to be specified as a Credit Support Document, in both cases, in regard to the counterparty. 33. Misrepresentation [Section 5(a)(iv)]. Under Section 5(a)(iv), a party may declare an Event of Default if any representation made by the other party or its Credit Support Provider proves to be materially incorrect or misleading. 34. In our opinion, application of Section 5(a)(iv) to the issuer is a risk factor. Similar to the analysis of Breach of Agreement [Section 5(a)(ii)], the criteria assume the counterparty is comfortable with the accuracy of the information reflected in the issuer's representations before it enters into the Transaction. In limited circumstances, Section 5(a)(iv) has applied solely with regard to the issuer's capacity to enter into the derivative agreement and to the agreement's validity if we believe those issues are fully addressed in a legal opinion the issuer has provided. 35. Default Under Specified Transaction [Section 5(a)(v)]. This provision allows a party to declare an Event of Default if its counterparty (or the counterparty's Credit Support Provider or Specified Entity) defaults on, or repudiates, a Specified Transaction. A "Specified Transaction" is any additional derivative agreement between the issuer and counterparty that is not covered by the same ISDA schedule. 36. In our view, Section 5(a)(v) is analogous to a cross-default provision, which is a risk factor if a transaction with a specific credit profile could be affected by a transaction with a different credit profile (see paragraph 16). Alternatively, our ratings analysis could reflect cross-default risk. 37. Cross Default [Section 5(a)(vi)]. This provision allows a party to declare an Event of Default if its counterparty defaults on borrowed money in an amount exceeding a specified Threshold Amount. Furthermore, this is the only Event of Default that does not apply to the parties unless they explicitly make it applicable. If this section applies to a party, then a default by that party's Credit Support Provider (typically, a guarantor) or Specified Entity also could cause an Event of Default. Our approach for Section 5(a)(vi) is the same as our approach for Section 5(a)(v) [Specified Transaction] (see paragraph 36). 38. Bankruptcy [Section 5(a)(vii)]. Section 5(a)(vii) provides that a party may declare an Event of Default if its counterparty (or the counterparty's Credit Support Provider or Specified Entity) becomes insolvent or bankrupt. In terms of whether this section is a risk factor, it is consistent with these criteria if the transaction parties have structured the issuer to be bankruptcy-remote or if the issuer's bankruptcy risk is otherwise reflected in the assigned rating(s). However, we believe subsection (2) could introduce cross-default risk if an SPE issuer has subordinated obligations (including fees JUNE 24,

289 Criteria Structured Finance General: Global Derivative Agreement Criteria and other unrated liabilities) that are secured by the same collateral pool or multiple series of securities that are secured by different collateral pools. 39. Subsection (2) applies to a party that "is unable to pay its debts or fails or admits in writing its inability generally to pay its debts as they become due." In our view, the subsection could apply if the issuer fails to make payments on a subordinated obligation (or an obligation related to a different series), even if it continues to pay its higher-rated, more senior obligations (or all obligations related to a given series). We believe the potential for subsection (2) to become a cross-default risk can be mitigated, for example by deleting subsection (2). 40. Merger Without Assumption [Section 5(a)(viii)]. This provision permits a party to declare an Event of Default if the other party merges with (or transfers substantially all of its assets to) another organization and the resulting entity (or transferee) fails to assume that "other" party's obligations under the agreement or any Credit Support Document to which it or its predecessor was a party. The provision also permits a party to declare an Event of Default if the other party's Credit Support Provider (for example, a guarantor) merges with (or transfers substantially all of its assets to) another entity and the resulting entity (or transferee) fails to assume such Credit Support Provider's obligations under any credit support document to which it or its predecessor was a party. 41. In our view, Section 5(a)(viii) is a risk factor unless the transaction parties have structured the issuer to be bankruptcy-remote so that the transaction documents include restrictions on the issuer's ability to merge and transfer assets. 42. Table 1 shows applications of Events of Default that are usually consistent with these criteria when we believe that a counterparty's termination or suspension of a derivative agreement could result in a cash flow shortfall or a downgrade of the issuer's rated obligations. We do not consider the list exhaustive and we would review bespoke events based on the principles in paragraph 24. Table 1 Applicability Of Events Of Default In The 2002 And 1992 ISDA Master Agreements Section 5(a) -- Events of Default Applicable to the issuer Applicable to the counterparty 5(a)(i) -- Failure to Pay or Deliver Yes Yes 5(a)(ii) -- Breach of Agreement No Yes 5(a)(iii) -- Credit Support Default No* Yes 5(a)(iv) -- Misrepresentation No Yes 5(a)(v) -- Default Under Specified Transaction No Yes 5(a)(vi) -- Cross Default No Yes 5(a)(vii) -- Bankruptcy Yes Yes 5(a)(viii) -- Merger Without Assumption Yes Yes *May apply to the issuer if Credit Support Default is limited to the issuer's obligations under a CSA or Deed to return excess collateral or to pay an Interest Amount or a Distribution Amount. May apply if the issuer is bankruptcy-remote. CSA--Credit support annex. Termination events 43. Illegality [Section 5(b)(i)]. This provision refers to any change in law that occurs after a derivative agreement is executed, where, as a result of the change, it becomes unlawful for a party (the "Affected Party") or its Credit Support Provider to comply with any material provision in the agreement or a related Credit Support Document (for example, a CSA or guarantee). Both parties have the right to terminate Affected Transactions. 44. Our ratings do not address the likelihood of changes in law that were not contemplated at the time the ratings were JUNE 24,

290 Criteria Structured Finance General: Global Derivative Agreement Criteria assigned (or change in law risk). As a result, if changes in law are not being contemplated at the time the ratings are being assigned, it is consistent with our ratings approach for either the issuer or the counterparty, or both, to have the right to terminate the derivative agreement. We may adjust our ratings as a result of such termination, depending on the potential impact. 45. Tax Event [Section 5(b)(ii)]. This provision generally refers to any change in withholding tax law that occurs after a derivative agreement is executed, where, as a result of the change, a party (the "Affected Party") will likely be required to gross-up or receive net derivative payments under section 2(d) of the ISDA Master Agreement. The Affected Party has the right to terminate Affected Transactions. 46. Our ratings do not address change in law risk. As a result, if changes in withholding tax law are not being contemplated at the time the ratings are being assigned, it is consistent with our ratings approach for either the issuer or the counterparty, or both, to be the Affected Party and have the right to terminate the derivative agreement. Some transaction parties go further by narrowing the definition of a Tax Event so that it excludes "(x) any action taken by a taxing authority, or brought in a court of competent jurisdiction " By inference, the narrower Tax Event definition is also consistent with these criteria. Force Majeure Event ISDA Master Agreement [Section 5(b)(ii)] This section refers to a "force majeure or act of state" that prevents a party (the "Affected Party") or its specified Office from performing under the derivative agreement even after it has used reasonable efforts to do so, but only if the event is beyond its control. The provision also applies to a party's Credit Support Provider when a force majeure or act of state prevents it from performing under a Credit Support Document. If a Force Majeure Event continues on a payment/delivery date, then the payment/delivery otherwise due from the Affected Party on that date is deferred until the earlier of (i) the first business day after the Waiting Period (eight business days) ends and (ii) the first business day on which the Force Majeure Event ends. If the Force Majeure Event continues even after the Waiting Period expires, then either party may terminate Affected Transactions. Our ratings do not address the likelihood of a force majeure event occurring. The 2002 ISDA Master Agreement does not specifically define "force majeure," but it is consistent with these criteria for the issuer or the counterparty, or both, to have the right to terminate the Affected Transactions because we believe that section 5(b)(ii) adequately restricts the counterparty's right to terminate the derivative agreement. 47. Tax Event Upon Merger [Section 5(b)(iii)]. This provision refers to a party (the "Burdened Party") that is required under a Transaction to gross-up or receive a reduced payment as a result of a withholding tax that was imposed because one of the parties to the derivative agreement (the "Affected Party") merged with (or transferred substantially all of its assets to) another entity. The Burdened Party has the right to terminate Affected Transactions. However, when the Burdened Party is the Affected Party, Section 6(b)(ii) restricts the Burdened Party's ability to terminate the agreement: As a condition to designating an Early Termination Date, Section 6(b)(ii) requires the Affected Party to use "all reasonable efforts" to transfer the Agreement within 20 days of giving notice of the Tax Event Upon Merger to the non-affected Party; then, if a transfer has not been consummated within 30 days of the notice date, the Affected Party may designate an Early Termination Date. 48. If the transaction parties have structured the issuer to be bankruptcy-remote so that the transaction documents include restrictions on the issuer's ability to merge and transfer assets, it is consistent with these criteria for the counterparty to JUNE 24,

291 Criteria Structured Finance General: Global Derivative Agreement Criteria be capable of terminating Affected Transactions when the issuer is the Affected Party. It is also consistent with our criteria for the counterparty to have the right to terminate the Affected Transactions if it is the Affected Party because, in that case, we believe Section 6(b)(ii) adequately restricts its right to terminate the derivative agreement. Some derivative agreements go further by fully restricting the counterparty's ability to terminate if it is the Affected Party. By inference, this more restrictive approach is also consistent with these criteria. 49. Credit Event Upon Merger [Section 5(b)(iv)]. This provision refers to a party (the "Affected Party") or its Credit Support Provider that merges with or transfers substantially all of its assets to another entity and, as a result of that merger/asset transfer, the successor/transferee entity's creditworthiness is materially weaker than that of the original party. Furthermore, this is the only Termination Event in the ISDA Master Agreement that does not apply to the parties unless the parties explicitly make it applicable. The non-affected Party has the right to terminate Affected Transactions. 50. In our view, Section 5(b)(iv) is a risk factor unless the transaction parties have structured the issuer to be bankruptcy-remote so that the transaction documents include restrictions on the issuer's ability to merge and transfer assets. If the issuer is bankruptcy-remote, then it is consistent with these criteria for either party, or both parties, to be the Affected Party. 51. Additional Termination Events [Section 5(b)(v)]. Generally, Additional Termination Events are bespoke events that the parties explicitly agree should supplement the list of Termination Events that are included in the ISDA Master Agreement. Within the context of a securitization, the parties usually negotiate these events to mitigate counterparty and/or structural risk for one or both of the parties to the agreement. The non-affected Party has the right to terminate the Affected Transactions. 52. We review the Additional Termination Events based on the principles in paragraph 24 and within the context of the transaction. At a minimum, we look for the derivative agreement to specify the Affected Party for each event. Below, we set out examples showing how transaction parties have addressed early termination risk related to a few common Additional Termination Events. 53. Amendment of Transaction Documents. Derivative counterparties may look for an Additional Termination Event to occur if the issuer amends the transaction documents (for example, an indenture or a pooling and servicing agreement) without the derivative counterparty's prior written consent. 54. If the issuer is the Affected Party, we analyze whether the parties have mitigated the early termination risk. For example, it is consistent with these criteria if: The transaction parties demonstrate that the Additional Termination Event would occur only where the transaction documents require the issuer to have obtained the counterparty's consent, or The terms of each relevant operative document (or a document that the issuer's administrative agent would consult during the ordinary course of amendment procedures) explicitly require the counterparty's consent as a condition of being amended. 55. Enforcement of Transaction Document. In some circumstances, counterparties look for an Additional Termination Event to occur if an event of default occurs in one or more security documents (e.g., an indenture or a security trust deed). 56. If the issuer is the Affected Party, then we analyze each event of default in the relevant transaction document for JUNE 24,

292 Criteria Structured Finance General: Global Derivative Agreement Criteria consistency with paragraph 24 unless the document permits only a majority (or more) of the issuer's rated security holders to declare an event of default and the counterparty is unable to terminate the derivative agreement until the event of default can no longer be rescinded. 57. "Clean-up Call" Termination. Counterparties may expect an Additional Termination Event to occur if the servicer (or other party) exercises a right to purchase all remaining collateral from the issuer after the collateral pool balance has significantly amortized (typically 90% or 95%). 58. If the issuer is the Affected Party, we believe early termination costs are mitigated if, for example, the collateral purchase price includes all derivative break costs that could be payable by the issuer, if costs due from the issuer to the derivative counterparty are not payable until a distribution date that occurs after the rated obligations have been redeemed in full, or if derivative break costs are payable only to the extent the issuer has received such costs from the underlying borrowers. 59. Table 2 shows applications of Termination Events that are usually consistent with these criteria when we believe that a counterparty's termination or suspension of a derivative agreement could result in a cash flow shortfall or a downgrade of the issuer's rated obligations. We do not consider the list exhaustive and we would review bespoke events based on the principles in paragraph 24. Table 2 Right To Terminate For Termination Events In The 2002 And 1992 ISDA Master Agreements Section 5(b) -- Termination Events Issuer's right to terminate Counterparty's right to terminate 5(b)(i) -- Illegality Yes Yes* 5(b)(ii) -- Force Majeure Event (1992 ISDA: Not Applicable) Yes Yes 5(b)(iii) -- Tax Event (1992 ISDA: 5(b)(ii)) Yes Yes* 5(b)(iv) -- Tax Event Upon Merger (1992 ISDA: 5(b)(iii)) Yes Yes 5(b)(v) -- Credit Event Upon Merger (1992 ISDA: 5(b)(iv)) 5(b)(vi) -- Additional Termination Event (1992 ISDA: 5(b)(v)) Yes Transaction-specific Yes Transaction-specific *The counterparty's right to terminate is restricted if changes in the relevant laws are being contemplated at the time of issuance. The counterparty's right to terminate is restricted unless the issuer is bankruptcy-remote. Section 6 of the ISDA Master Agreement Early Termination 60. Automatic Early Termination [Section 6(a)]. When the parties explicitly apply this election, the derivative agreement will automatically terminate if specific events related to the Defaulting Party's bankruptcy or insolvency occur. 61. If Automatic Early Termination applies and the counterparty is supported by a guarantee, the counterparty's insolvency or bankruptcy would result in an automatic early termination of the derivative contract even if the guarantor is still performing, potentially resulting in the issuer's loss of a hedge and its potential liability for derivative break costs. We consider the early termination risk mitigated if, for example, Automatic Early Termination does not apply to the counterparty. 62. Payments on Early Termination [Section 6(e)]. Under the 1992 ISDA Master Agreement, early termination payments may be measured in two ways: Market Quotation or Loss. Market Quotation applies either by the parties' explicit election or when the parties have not elected a payment measure. Under the 2002 ISDA Master Agreement, early JUNE 24,

293 Criteria Structured Finance General: Global Derivative Agreement Criteria termination payments are determined using only the "Close-out Amount." 63. The early termination of a derivative agreement may reduce the cash flows available for an issuer's rated obligations if the issuer is required to pay derivative break costs. When the cash flows from a derivative counterparty support the ratings on an issuer's obligations, we believe any potential derivative break costs are mitigated as follows: If our rating on a supported security is based on the weak-link approach, by applying paragraphs and (paragraphs also apply). For the avoidance of doubt, the criteria are indifferent to whether derivative break costs payable to a counterparty in a weak-link structure are senior or subordinated even if the counterparty is the Defaulting Party. If our rating on a supported security is based on our counterparty risk criteria, by, for example, subordinating the derivative break costs (see paragraph 111 in "Counterparty Risk Framework Methodology And Assumptions," published Nov. 29, 2012) and applying these criteria through paragraph 89. If our rating on a supported security is not capped at the counterparty rating and the parties have structured the transaction to terminate with no loss if the counterparty defaults (i.e., a "terminating structure"), by, for example, electing that the Settlement Amount (or Close-out Amount) be zero and applying these criteria through paragraph 89. Alternatively, if the transaction parties have subordinated a counterparty's claim by way of a "flip clause" (i.e., the counterparty's claims to derivative break costs are senior except if it defaults) or have elected that only the non-defaulting Party is entitled to derivative break costs (i.e., First Method applies), we believe potential derivative break costs are mitigated if cash flows to the rated securities would not be adversely affected by the counterparty's bankruptcy filing (see "Standard & Poor's Comments On The Potential Impact Of The U.S. Bankruptcy Court Decision On Swap Termination Payments," published Feb. 9, 2010), in addition to applying these criteria through paragraph Set-off [Section 6(e)]. Like payment netting, Set-off is a payment offset provision, except it applies only when an early termination payment is due. It permits the early termination payment payer to partially or fully satisfy its payment obligation by offsetting the amount payable against a receivable due from the other party, even if the receivable is unrelated to the derivative agreement. 65. When the issuer and the counterparty have more than one contractual relationship and the counterparty is capable of setting-off the early termination payment against amounts the issuer owes under the other contracts, we believe the issuer is exposed to Set-off risk either if it is a multiple-use issuer or if the amounts due to the counterparty under the other contracts are subordinated (see paragraph 16 for an analogous discussion of netting payments across multiple Transactions). In our opinion, this Set-off risk is mitigated if both parties waive Set-off rights (e.g., by deleting the last sentence in the first paragraph of Section 6(e)). 66. However, if the issuer waives Set-off rights, it is potentially without recourse to posted collateral since the right to Set-off gives the issuer the right to apply the collateral in discharge of derivative break costs that the counterparty has not paid. Therefore, we look for the issuer to retain Set-off rights when the ratings analysis depends on a covenant that requires the counterparty to post collateral. For example, transaction parties have balanced addressing Set-off risk to the issuer and Set-off rights for the issuer by generally waiving Set-Off rights except as they relate to paragraph 8(a) of the New York CSA or the Credit Support Deed (the criterion in this paragraph does not apply to a U.K. CSA because, unlike a New York CSA or a Credit Support Deed, full ownership transfers for delivered collateral). JUNE 24,

294 Criteria Structured Finance General: Global Derivative Agreement Criteria Set-off ISDA Master Agreement [Sections 6(e) and (f)] Sections 6(e) and 6(f) of the 2002 ISDA Master Agreement restrict Set-off so that only the non-defaulting Party or non-affected Party, as applicable, has the option to apply it. Accordingly, these sections are consistent with the criteria, and we believe it is redundant for the Counterparty to waive the Set-Off provision. Other sections in the ISDA Master Agreement and other issues 67. Transfer [Section 7]. This provision prevents the parties from transferring their rights and obligations under the derivative agreement without first obtaining the other party's written consent. 68. When analyzing transfers/assignments, we look to see if the derivative documentation and the rating on the replacement counterparty are consistent with these and other applicable criteria (e.g., the counterparty risk criteria). Furthermore, we analyze whether the assignment would result in any potential tax burden on the issuer (see paragraphs 17-20). As a general matter, the transaction parties should provide prior notification of the assignment to Standard & Poor's. 69. Amendments [Section 9(b)]. This section clarifies that acknowledgements from both parties are required in order for amendments, modifications, or waivers to become binding. As a general matter, transaction parties should provide prior notification of the amendment to Standard & Poor's. 70. Multibranch Parties [Section 10(c)]. When the Schedule specifies that a party is a Multibranch Party, that party has the option to make and receive payments or deliveries through any Office listed in the Schedule. 71. For each Office listed, we look to see if the parties have mitigated potential adverse effects to the issuer (for example, tax withholdings and business day conventions that may affect cash flow timing). 72. Non-petition. In keeping with our Asset Isolation and Special Purpose Entity Criteria, the derivative agreement should restrict the counterparty from petitioning the issuer into a bankruptcy or insolvency proceeding for one year (or if longer, the applicable preference period) and a day after the rated securities are paid in full. Furthermore, the restriction should survive the derivative agreement's termination unless the agreement is not scheduled to terminate until the rated liabilities have been repaid. 73. Limited Recourse. Because the counterparty usually signs only the derivative agreement and none of the issuer's other transaction documents, the issuer's priority of payments may not be legally binding on the counterparty. For the waterfall to become binding on the counterparty, the counterparty usually acknowledges and agrees that the issuer's obligations are limited-recourse obligations, payable only in accordance with the waterfall and other terms of the transaction document with the issuer waterfall. Furthermore, the counterparty agrees that to the extent the issuer is unable to satisfy all of the counterparty's claims under the derivative agreement, the remaining claims against the issuer are extinguished. The provision should survive the derivative agreement's termination unless the agreement is not scheduled to terminate until the rated liabilities have been repaid. The Collateral Support Documents 74. The collateral support documents address the following issues, among others: collateral posting frequency, the circumstances under which collateral is to be delivered, eligible collateral types, minimum collateral amounts, volatility JUNE 24,

295 Criteria Structured Finance General: Global Derivative Agreement Criteria buffers, collateral haircuts (i.e., Valuation Percentages), and custodian accounts. 75. Collateral support documents may include the 1994 ISDA Credit Support Annex (Security Interest New York Law), the 1995 ISDA Credit Support Annex (Transfer English Law), the 1995 ISDA Credit Support Deed (Security Interest English Law), or similar documentation. For convenience only, these criteria mostly refer to provisions in the commonly used 1994 ISDA Credit Support Annex and 1995 ISDA Credit Support Annex (the New York CSA and the U.K. CSA, respectively). 76. When our ratings on an issuer's obligations are based on the weak-link approach, we look for the derivative agreement to reflect the criteria in paragraphs 77 ("Specifying the Collateral Posting Party"), 87 ("Interest Amount"), and 89 ("Expenses") if the parties agree to a collateral support document. However, if the counterparty risk criteria apply or if the transaction is a terminating structure, we look for the derivative agreement to reflect the criteria in paragraphs Specifying the Collateral Posting Party [New York CSA 1(b); U.K. CSA 10 ("Transferee," "Transferor")] These criteria assume that most structured finance issuers will not have the financial resources to both maintain the ratings on their obligations and post collateral to a counterparty. In those cases, the risk that the issuer becomes undercollateralized because it may be required to post collateral is mitigated by asymmetrical collateral posting whereby only the counterparty is obliged to post collateral. Credit support documents typically clarify that all references to the Pledgor/Chargor/Transferor refer to the counterparty only, and all references to the Secured Party/Transferee refer to the issuer only. 78. Mark-to-market calculations. The counterparty usually is responsible for calculating the mark-to-market value of the derivative and the posted collateral. However, we look for the issuer to have the right to appoint a calculation agent if the counterparty defaults on an obligation. 79. Delivery Amount [New York CSA 3(a), 13(b)(i)(A); U.K. CSA 2(a), 11(b)(i)(A)]. In our opinion, when the counterparty is automatically required to transfer the Delivery Amount to the issuer (i.e., the issuer is not required to demand the Delivery Amount), this mitigates the risk of an operational oversight by the issuer's third-party administrators. 80. Return Amount [New York CSA 3(b), 13(b)(i)(B); U.K. CSA 2(b), 11(b)(i)(B)]. We also believe that the risk of an operational oversight by the issuer's third-party administrators is mitigated when the counterparty is required to demand the Return Amount from the issuer. 81. Definition of "Credit Support Amount." The transaction-specific definition of Credit Support Amount (including any subdefinitions), in its entirety, should be consistent with the collateral required amount(s) for the transaction (e.g., see paragraph 94 of "Counterparty Risk Framework Methodology And Assumptions," published Nov. 29, 2012). 82. Exposure [New York CSA 12; U.K. CSA 10]. If an issuer has multiple Transactions (i.e., Confirmations) under the same ISDA Schedule and they are related to differently rated classes or multiple series of securities that are not cross-collateralized (e.g., because it is a segregated program or multiple-use issuer), then Exposures across the different credit profiles should not be netted unless the assigned ratings reflect the cross-default risk (see paragraph 16). 83. Definition of "Value." The transaction-specific definition of Value should be consistent with the value that is given to posted collateral, according to the applicable criteria governing collateral values. This usually would include defining the Valuation Percentage for each security that the counterparty can post/transfer as collateral to be consistent with the applicable market value advance rate, which usually would be further discounted to the extent collateral can be posted in currencies other than that of the counterparty's payment obligation (e.g., see paragraphs of JUNE 24,

296 Criteria Structured Finance General: Global Derivative Agreement Criteria "Counterparty Risk Framework Methodology And Assumptions," published Nov. 29, 2012). 84. Minimum Transfer Amount [New York CSA 13(b)(iv)(C); U.K. CSA 11(b)(iii)(C)]. In theory, the issuer always should be holding Posted Credit Support in an amount equal to the Credit Support Amount when the counterparty becomes obligated to post/transfer collateral. However, transaction parties establish Minimum Transfer Amounts to minimize the administrative burden and costs of relatively de minimus collateral transfers. For most structured finance transactions, we do not consider the undercollateralization risk to the issuer as material if the counterparty's (Pledgor/Chargor/Transferor) Minimum Transfer Amount is $100,000 or less (or the Base Currency equivalent, rounded up to the nearest thousand). For covered bond transactions, the Minimum Transfer Amount may be somewhat higher since the criteria additionally account for, among other factors, market volumes and jurisdiction. In any event, the issuer's (Secured Party/Transferee) Minimum Transfer Amount should not be lower than the amounts that apply to the counterparty. 85. Rounding [New York CSA 13(b)(iv)(D), U.K. CSA 11(b)(iii)(D)]. The key issue is the direction of any rounding: the issuer (Secured Party/Transferee) is not at incremental risk of becoming undercollateralized relative to the Credit Support Amount when the Delivery Amount is rounded up and the Return Amount is rounded down (e.g., by / /$10,000). 86. Secured Party's Rights and Remedies [New York CSA 8(a), 13(d); U.K. CSA 6]. In the New York CSA, the issuer's right to apply collateral in discharge of a counterparty's obligation to pay derivative break costs after an Additional Termination Event has occurred is conditioned upon the event's designation as a Specified Condition for the counterparty. Accordingly, where our counterparty risk criteria or criteria for terminating structures apply, Specified Conditions for the counterparty should include Additional Termination Events that address those criteria (e.g., see paragraph 81 of "Counterparty Risk Framework Methodology And Assumptions," published Nov. 29, 2012). The concept of Specified Condition doesn't exist in the U.K. CSA, so the issuer/transferee has recourse to the Credit Support Balance only if an Event of Default that applies to the counterparty/transferor has occurred. We believe the issuer would have rights to the Credit Support Balance after an Additional Termination Event that addresses our counterparty risk criteria or criteria for terminating structures if, for example, either Paragraph 6 was amended to include those Additional Termination Events or those events instead were defined as Events of Default under section 5(a) of the ISDA Master Agreement. 87. Interest Amount [New York CSA 6(d)(ii), 13(h); U.K. CSA 5(c)(ii), 11(f)]. The issuer must demonstrate that it is capable of or insulated from paying any interest rate specified for cash collateral. A specified interest rate effectively obligates the issuer to guarantee the counterparty a specific rate of return on cash collateral, regardless of the rate actually earned. In many transactions, the issuer is insulated from the potential exposure because no interest rate is specified as applying for cash collateral. In others, the issuer's obligation to transfer the interest amount is limited to the amount it earns and receives and, to the extent that any portion of the interest amount is not transferred (e.g., because it would result in a counterparty Delivery Amount), only the amounts that the issuer earns and receives are added to Posted Credit Support or the Credit Support Balance, as the case may be. 88. Events of Default [New York CSA 7]. In our opinion, application of paragraph 7(iii) to the issuer is a risk factor because it is equivalent to a Breach of Agreement (for a rationale, see paragraphs 24 and 25). The criterion in this paragraph does not directly apply to the terms in a U.K. CSA. (Unlike a New York CSA or a Credit Support Deed, a U.K. CSA is a Confirmation. As such, the ISDA Master Agreement's Events of Default (e.g., Sections 5(a)(i) [Failure to Pay or Deliver] and 5(a)(ii) [Breach of Agreement]) apply directly to the parties' performance obligations in the U.K. CSA (please see paragraphs for criteria that apply to Events of Default in the ISDA Master Agreement).) 89. Expenses [New York CSA 10; U.K. CSA 8]. The issuer must demonstrate that it is capable of or insulated from paying all costs and expenses related to the transfer and maintenance of the posted collateral. JUNE 24,

297 Criteria Structured Finance General: Global Derivative Agreement Criteria Derivative-Independent Approach 90. In some structures, our ratings on an issuer's obligations are not linked to the counterparty's rating because counterparty cash flows are not a factor in our credit analysis. In these circumstances, the analysis of the derivative agreement's terms are significantly more flexible (e.g., when the counterparty has the right to terminate the contract) because the counterparty's performance does not support the assigned issue ratings. However, we analyze the derivative agreement's terms to see the potential effect on the issuer's ability to pay its rated obligations. When we have arrived at all of the conclusions below, in our view, the terms in a derivative agreement would not adversely affect the issuer's ability to pay its rated obligations: The issuer would not realize any deterioration in its ability to pay the rated obligations because of derivative payments (excluding derivative break costs) the issuer might owe to the counterparty under rating-specific stress scenarios; The issuer would not realize any credit deterioration in its ability to pay its rated obligations even if it were to become liable for potential derivative break costs because the effect of those costs has been mitigated; If the counterparty were to become insolvent, the issuer's cash flows would not be adversely affected by the counterparty's bankruptcy filing (see "Standard & Poor's Comments On The Potential Impact Of The U.S. Bankruptcy Court Decision On Swap Termination Payments," published Feb. 9, 2010); and The criteria in the following paragraphs have been applied: 69 (Amendments), 72 (Non-Petition), 73 (Limited recourse), and, if there is a CSA, 77 (Specifying the Collateral Posting Party), 87 (Interest Amount), and 89 (Expenses). APPENDICES Appendix 1: Hypothetical Schedule To The 1992 ISDA Master Agreement Reflecting An Example Of The Application Of Standard & Poor's Derivative Agreement Criteria Note: This appendix is for illustrative purposes only; it does not constitute criteria and is not to be interpreted as recommendations and/or advice on how transaction participants should document and/or structure their transactions. SCHEDULE to the 1992 ISDA Master Agreement, dated as of [ ] between [Counterparty] ("Party A") and [Issuer] ("Party B") Part 1. Termination Provisions (a)"specified Entity" means in relation to Party A for the purpose of: Section 5(a)(v),... Not applicable... Section 5(a)(vi),... Not applicable... Section 5(a)(vii),... Not applicable... Section 5(b)(iv),... Not applicable... JUNE 24,

298 Criteria Structured Finance General: Global Derivative Agreement Criteria And, in relation to Party B for the purpose of: Section 5(a)(v),... Not applicable... Section 5(a)(vi),... Not applicable... Section 5(a)(vii),... Not applicable... Section 5(b)(iv),... Not applicable... (b)"specified Transaction" will have the meaning specified in Section 14 of this Agreement. (c)application of Events of Default. The provisions of Section 5(a) of this Agreement will apply to Party A and Party B as follows: Application Of Events Of Default Section 5(a) Party A Party B (i)"failure to Pay or Deliver" Applicable. Applicable. (ii) "Breach of Agreement" Applicable. Not Applicable. (iii) "Credit Support Default" Applicable. Applicable (but only to the extent described below in Part 1(d)(i)). (iv) "Misrepresentation" Applicable. Not Applicable. (v) "Default Under Specified Transaction" Applicable. Not Applicable. (vi) "Cross Default" Applicable. Not Applicable. (vii) "Bankruptcy" Applicable. Applicable (subject to the limitations described below in Part 1(d)(ii)). (viii) "Merger Without Assumption" Applicable. Applicable. (d)(i)section 5(a)(iii) shall apply to Party B solely with respect to Party B's obligations under Paragraph 3(b) of the Credit Support Annex. (ii)notwithstanding anything to the contrary in Section 5(a)(vii), clause (2) shall not apply to Party B. (e)application of Termination Events. The provisions of Section 5(b) of this Agreement will apply to Party A and Party B as follows: Application Of Termination Events Section 5(b) Party A Party B (i)"illegality" Applicable. Applicable. (ii) "Tax Event" Applicable. Applicable. (iii) "Tax Event Upon Merger" Applicable (as modified by Part 1(g) below). Applicable. (iv) "Credit Event Upon Merger" Applicable. Applicable. The statement above that a Termination Event will apply to a specific party means that upon the occurrence of such Termination Event, if such specific party is the Affected Party with respect to a Tax Event, the Burdened Party with respect to a Tax Event Upon Merger (except as noted below) or the non-affected Party with respect to a Credit Event Upon Merger, as the case may be, such specific party shall have the right to designate an Early Termination Date in accordance with Section 6 of this Agreement; conversely, the statement above that such an event will not apply to a specific party means that such party shall not have such right; provided, however, with respect to "Illegality" the statement that such event will apply to a specific party means that upon the occurrence of such Termination Event with respect to such party, either party shall have the right to designate an Early Termination Date in accordance with JUNE 24,

299 Criteria Structured Finance General: Global Derivative Agreement Criteria Section 6 of this Agreement. (f)section 5(b)(ii) is amended such that the words "(x) any action taken by a taxing authority, or brought in a court of competent jurisdiction, on or after the date on which a Transaction is entered into (regardless of whether such action is taken or brought with respect to a party to this Agreement) or (y)" shall be deleted. (g)notwithstanding Section 5(b)(iii), Party A shall not be entitled to designate an Early Termination Date by reason of a Tax Event Upon Merger in respect of which it is the Affected Party. (h)payments on Early Termination. For the purpose of Section 6(e) of this Agreement: (i)"market Quotation" will apply. (ii)"second Method" will apply. (i)"termination Currency"means [ ]. (j)the "Automatic Early Termination" provision of Section 6(a) of this Agreement will not apply to Party A or Party B. (k)additional Termination Events. Additional Termination Events will apply. The following shall constitute Additional Termination Events: (i)following an S&P Collateralization Event, each Relevant Entity has failed to take action that satisfies Part 5(e)(i) hereof. In such event, Party A shall be the sole Affected Party and each Transaction shall be an Affected Transaction. (ii)[select EITHER OPTION A OR OPTION B] [OPTION A: Following an S&P Replacement Event, each Relevant Entity has failed to (x) assign its rights and obligations under this Agreement to an Eligible Replacement in accordance with the terms hereof or (y) procure an Eligible Guarantee of Party A's obligations hereunder by a guarantor that satisfies the Hedge Counterparty Ratings Requirement, in either case, within the time period specified in Part 5(e)(ii) hereof. In such event, Party A shall be the sole Affected Party and each Transaction shall be an Affected Transaction.] [OPTION B: Following an S&P Replacement Event, (A) each Relevant Entity has failed to (x) assign its rights and obligations under this Agreement to an Eligible Replacement in accordance with the terms hereof or (y) procure an Eligible Guarantee of Party A's obligations hereunder by a guarantor that satisfies the Hedge Counterparty Ratings Requirement, in either case, within the time period specified in Part 5(e)(ii) and (B) Party A has received an offer from an Eligible Replacement to assume Party A's rights and obligations under this Agreement and such offer is capable of becoming legally binding upon acceptance. In such event, Party A shall be the sole Affected Party and each Transaction shall be an Affected Transaction.]* (*Note: Option B is consistent with the maximum potential rating on the supported security only if Section 5(a)(ii)("Breach of Agreement") applies to Party A. Also, please see Part 5(e)(ii).) Part 2. Tax Representations (a)payer Representations. For the purpose of Section 3(e) of this Agreement, Party A and Party B will make the following representation: It is not required by any applicable law, as modified by the practice of any relevant governmental revenue authority, of any Relevant Jurisdiction to make any deduction or withholding for or on account of any Tax from any payment (other JUNE 24,

300 Criteria Structured Finance General: Global Derivative Agreement Criteria than interest under Section 2(e), 6(d)(ii) or 6(e) of this Agreement) to be made by it to the other party under this Agreement. In making this representation, it may rely on (i) the accuracy of any representations made by the other party pursuant to Section 3(f) of this Agreement, (ii) the satisfaction of the agreement contained in Section 4(a)(i) or 4(a)(iii) of this Agreement and the accuracy and effectiveness of any document provided by the other party pursuant to Section 4(a)(i) or 4(a)(iii) of this Agreement and (iii) the satisfaction of the agreement of the other party contained in Section 4(d) of this Agreement, provided that it shall not be a breach of this representation where reliance is placed on sub-clause (ii) and the other party does not deliver a form or document under Section 4(a)(iii) by reason of material prejudice to its legal or commercial position. (b)[payee Representations. For the purpose of Section 3(f) of this Agreement, [Party A represents that it is a [ ] and Party B make no representations.] Part 3. Agreement to Deliver Documents For the purpose of Section 4(a)(i) and (ii) of this Agreement, each party agrees to deliver the following documents, as applicable: (a)tax forms, documents or certificates to be delivered are: [ ] (b)other documents to be delivered are: [ ] Part 4. Miscellaneous (a)address for Notices. For the purpose of Section 12(a) of this Agreement: Address for notices or communications to Party A: With respect to a Transaction, to the address specified in the relevant Confirmation. With respect to any notice for purposes of Section 5 or Section 6 to: [ ] Address for notices or communications to Party B: [ ] (b)process Agent. For the purpose of Section 13(c) of this Agreement: Party A appoints as its Process Agent: Not applicable. Party B appoints as its Process Agent: Not applicable. (c)offices. The provision of Section 10(a) will apply to this Agreement. (d)multibranch Party. For the purpose of Section 10(c) of this Agreement:- Party A is [not] a Multibranch Party [and for the purposes of this Agreement may only act through its [ ] Office]. Party B is not a Multibranch Party. (e)calculation Agent. The Calculation Agent is Party A; provided, however, that if an Event of Default shall have occurred with respect to which Party A is the Defaulting Party, Party B shall have the right to appoint as Calculation Agent a financial institution which would qualify as a Reference Market-maker, reasonably acceptable to Party A, the cost for which shall be borne by Party A. (f)credit Support Document. Details of any Credit Support Document: in relation to Party A... the Credit Support Annex dated the date hereof (the "Credit Support Annex") and JUNE 24,

301 Criteria Structured Finance General: Global Derivative Agreement Criteria duly executed and delivered by Party A and Party B [and the Eligible Guarantee]. in relation to Party B... Not applicable. (g)credit Support Provider. Credit Support Provider means: in relation to Party A... Not applicable. in relation to Party B... Not applicable. (h)governing Law. This Agreement will be governed by and construed in accordance with [New York] Law (without reference to choice of law doctrine). (i)netting of Payments. Section 2(c)(ii) of this Agreement will [not] apply to all Transactions. (j)right of Set-off. Except as provided in Paragraph 8(a) of the Credit Support Annex, Set-off will not apply. (k)"affiliate" will have the meaning specified in Section 14 of this Agreement, provided that Party B shall be deemed to have no Affiliates for all purposes herein. (l)amendment. Notwithstanding any provision to the contrary in this Agreement, no amendment of either this Agreement or any Transaction under this Agreement shall be permitted by either party unless each Rating Agency has been provided with at least five (5) days prior written notice of the same. (m)expenses. Party B shall not be liable for and shall be precluded from paying any out-of-pocket expenses required under Section 11 of this Agreement and incurred by Party A related to the enforcement and protection of Party A's rights under this Agreement. (n)tax Provisions. (i)gross Up. Section 2(d)(i)(4) shall not apply to Party B as X, and Section 2(d)(ii) shall not apply to Party B as Y, in each case such that Party B shall not be required to pay any additional amounts referred to therein. (ii)section 2(d)(i)(4) is amended by: (x) deleting the words "However, X will not be required to pay any additional amount to Y to the extent that it would not be required to be paid but for:", and (y) deleting subsections (A) and (B). (iii) Section 4(e) will apply to Party A and will not apply to Party B. (iv)indemnifiable Tax. The definition of "Indemnifiable Tax" in Section 14 is hereby deleted and replaced with the following: "Indemnifiable Tax" means, in relation to payments by Party A, any Tax and, in relation to payments by Party B, no Tax." Part 5. Other Provisions (a)isda Definitions. Reference is hereby made to the [2006] ISDA Definitions (the "ISDA Definitions"), as published by the International Swaps and Derivatives Association, Inc., which shall be incorporated by reference into this Agreement. Any terms used and not otherwise defined herein that are contained in the ISDA Definitions shall have the meaning set forth therein. JUNE 24,

302 Criteria Structured Finance General: Global Derivative Agreement Criteria (b)acknowledgement of Assignment. Party A hereby acknowledges and consents to Party B's assignment to the [Trustee], for the benefit of the secured parties under the [Relevant Credit Document], of Party B's rights hereunder, including the right to enforce Party A's obligations hereunder. (c)no Petition; Limited Recourse. Party A hereby agrees that it shall not until a period of one year (or if longer, the applicable preference period) and one day after all liabilities of Party B under the [Relevant Credit Document] have been indefeasibly paid in full institute against, or join any other person in instituting against Party B any bankruptcy, reorganization, arrangement, insolvency, moratorium or liquidation proceedings or other proceedings under U.S. federal or state or other bankruptcy or similar laws. This provision shall survive termination of this Agreement. Party A acknowledges and agrees that, notwithstanding any provision in this Agreement to the contrary, the obligations of Party B hereunder are limited recourse obligations of Party B, payable solely from the [Relevant Collateral] and the proceeds thereof, in accordance with the priority of payments and other terms of the [Relevant Credit Document] and that Party A will not have any recourse to any of the directors, officers, agents, employees, shareholders or affiliates of Party B with respect to any claims, losses, damages, liabilities, indemnities or other obligations in connection with any transactions contemplated hereby. In the event that the [Relevant Collateral] and the proceeds thereof, should be insufficient to satisfy all claims outstanding and following the realization of the [Relevant Collateral] and the proceeds thereof, any claims against or obligations of Party B under this Agreement or any other confirmation thereunder still outstanding shall be extinguished and thereafter not revive. This provision will survive the termination of this Agreement. (d)transfers by Party A (i) Section 7 of this Agreement shall not apply to Party A and, subject to Section 6(b)(ii) (provided that to the extent Party A makes a transfer pursuant to Section 6(b)(ii) it will provide a prior written notice to each Rating Agency of such transfer) and Part 5(d)(ii) below, Party A may not transfer (whether by way of security or otherwise) any interest or obligation in or under this Agreement without the prior written consent of Party B. (ii) Party A may (at its own cost) transfer its rights and obligations with respect to this Agreement to any other entity (a "Transferee") that is an Eligible Replacement through a novation or other assignment and assumption agreement or similar agreement in form and substance reasonably satisfactory to Party B; provided that (A) as of the date of such transfer the Transferee will not be required to withhold or deduct on account of a Tax from any payments under this Agreement unless the Transferee will be required to make payments of additional amounts pursuant to Section 2(d)(i)(4) of this Agreement in respect of such Tax, (B) a Termination Event or Event of Default does not occur under this Agreement as a result of such transfer, (C) the agreement that replaces this Agreement as a result of such transfer contains (x) identical terms (except for the name, address and, subject to clause (A), jurisdiction of the Transferee) as this Agreement or (y) terms that are in all material respects no less beneficial for Party B than the terms of this Agreement, as determined by Party B, and (D) Party A has provided prior written notice to each Rating Agency of such transfer. Following such transfer, all references to Party A shall be deemed to be references to the Transferee. (iii) Except as specified otherwise in the documentation evidencing a transfer, a transfer of all the obligations of Party A made in compliance with this Part 5(d) will constitute an acceptance and assumption of such obligations (and any related interests so transferred) by the Transferee, a novation of the transferee in place of Party A with respect to such obligations (and any related interests so transferred), and a release and discharge by Party B of Party A from, and an JUNE 24,

303 Criteria Structured Finance General: Global Derivative Agreement Criteria agreement by Party B not to make any claim for payment, liability, or otherwise against Party A with respect to, such obligations from and after the effective date of the transfer. (e)downgrades of Party A (i)s&p Collateralization Events. If an S&P Collateralization Event has occurred with respect to each Relevant Entity, Party A shall notify the Trustee and Standard & Poor's and shall at its sole expense post Collateral for the benefit of Party B in the amount and on the terms then applicable under the Credit Support Annex. (ii)s&p Replacement Events. If an S&P Replacement Event has occurred and is continuing with respect to each Relevant Entity, Party A shall notify the Trustee and Standard & Poor's and shall, at its sole cost, use commercially reasonable efforts to [(x) in the case of any S&P Replacement Event other than an S&P Replacement Option 4 Replacement Event, within 60 calendar days, or (y) in the case of an S&P Replacement Option 4 Replacement Event, within 30 calendar days][as soon as reasonably practicable*], either (1) assign its rights and obligations under this Agreement to an Eligible Replacement in accordance with the terms hereof or (2) procure an Eligible Guarantee of Party A's obligations hereunder by a guarantor that satisfies the Hedge Counterparty Ratings Requirement. (*Note: As soon as reasonably practicable" is consistent with the maximum potential rating on the supported security only if Section 5(a)(ii)("Breach of Agreement") applies to Party A and the parties select Option B (in Part 1(k)(ii).) (f)counterparty Replacement Option Election: As of the Effective Date, S&P Replacement Option [1][2][3][4] is in effect. On any Local Business Day following the Effective Date but prior to the occurrence of (x) an Event of Default with respect to which Party A is the Defaulting Party or (y) an Additional Termination Event with respect to which Party A is the Affected Party, Party A may designate a different S&P Replacement Option as effective by providing written notice of such change to Party B, the [Trustee], the Valuation Agent and S&P. Any such change to the S&P Replacement Option shall become effective one (1) Local Business Day following delivery of the notice described in the immediately preceding sentence. Notwithstanding the foregoing, Party A may not designate an S&P Replacement Option if an S&P Replacement Event shall occur as a result of giving effect to such designation. (g)certain Definitions "Eligible Guarantee" means an unconditional and irrevocable guarantee that is consistent with S&P criteria* and is provided by a guarantor as principal debtor rather than surety and is directly enforceable by Party B, where either (A) such guarantee provides that, in the event that any of such guarantor's payments to Party B are subject to withholding for Tax, such guarantor is required to pay such additional amount as is necessary to ensure that the net amount actually received by Party B (free and clear of any withholding tax) will equal the full amount Party B would have received had no such withholding been required, or (B) in the event that any payment under such guarantee is made net of deduction or withholding for Tax, Party A is required, under Section 2(a)(i), to make such additional payment as is necessary to ensure that the net amount actually received by Party B from the guarantor will equal the full amount Party B would have received had no such deduction or withholding been required. (*Note: See "Guarantee Criteria -Structured Finance," May 7, 2013.) "Eligible Replacement" means an entity that could lawfully perform the obligations owing to Party B under this Transaction and (i) that satisfies the Hedge Counterparty Ratings Requirement, or (ii) whose present and future obligations owing to Party B are guaranteed pursuant to an Eligible Guarantee provided by a guarantor that satisfies the Hedge Counterparty Ratings Requirement. "Hedge Counterparty Ratings Requirement"is satisfied by a Relevant Entity at any time if such entity has ratings from S&P such that no S&P Replacement Event shall occur with respect to such entity. JUNE 24,

304 Criteria Structured Finance General: Global Derivative Agreement Criteria "Rating Agency" means each of S&P and [ ]. "Relevant Entities" means Party A and any guarantor under an Eligible Guarantee in respect of all of Party A's present and future obligations under this Agreement. "Relevant Notes" means any notes or certificates issued in connection with the underlying transaction in connection with which this Transaction has been entered into. "S&P" means Standard and Poor's Ratings Services, a Standard & Poor's Financial Services LLC business, or any successor thereto. "S&P Collateralization Event" means an S&P Replacement Option 1 Collateralization Event, an S&P Replacement Option 2 Collateralization Event or an S&P Replacement Option 3 Replacement Event. "S&P Replacement Event" means: (A)On any S&P Replacement Option 1 Effective Date, an S&P Replacement Option 1 Replacement Event, or (B)On any S&P Replacement Option 2 Effective Date, an S&P Replacement Option 2 Replacement Event, or (C)On any S&P Replacement Option 3 Effective Date, an S&P Replacement Option 3 Replacement Event, or (D)On any S&P Replacement Option 4 Effective Date, an S&P Replacement Option 4 Replacement Event. "S&P Replacement Option" means "S&P Replacement Option 1", "S&P Replacement Option 2", "S&P Replacement Option 3" or "S&P Replacement Option 4". "S&P Replacement Option 1 Collateralization Event" is deemed to occur with respect to a Relevant Entity at any time if such Relevant Entity does not have (x) a long-term rating from S&P of at least "A" and a short-term rating from S&P of at least "A-1" or (y) if such Relevant Entity does not have a short-term rating from S&P of at least "A-1", a long-term rating from S&P of at least "A+". "S&P Replacement Option 1 Effective Date" means each day on which (i) any Relevant Notes are outstanding and rated by S&P and (ii) S&P Replacement Option 1 is in effect as of the Effective Date or following written notice of such election by Party A in accordance with the terms hereof. "S&P Replacement Option 1 Replacement Event" is deemed to occur with respect to a Relevant Entity at any time the long-term rating of such Relevant Entity from S&P is withdrawn, suspended or downgraded below "BBB+". "S&P Replacement Option 2 Collateralization Event" is deemed to occur with respect to a Relevant Entity at any time if such Relevant Entity does not have (x) a long-term rating from S&P of at least "A" and a short-term rating from S&P of at least "A-1" or (y) if such Relevant Entity does not have a short-term rating from S&P of at least "A-1", a long-term rating from S&P of at least "A+". "S&P Replacement Option 2 Effective Date" means each day on which (i) any Relevant Notes are outstanding and rated by S&P and (ii) S&P Replacement Option 2 is in effect as of the Effective Date or following written notice of such election by Party A in accordance with the terms hereof. "S&P Replacement Option 2 Replacement Event" is deemed to occur with respect to a Relevant Entity at any time the long-term rating of such Relevant Entity from S&P is withdrawn, suspended or downgraded below "A-". "S&P Replacement Option 3 Effective Date" means each day on which (i) any Relevant Notes are outstanding and rated by S&P and (ii) S&P Replacement Option 3 is in effect as of the Effective Date or following written notice of such election by Party A in accordance with the terms hereof. JUNE 24,

305 Criteria Structured Finance General: Global Derivative Agreement Criteria "S&P Replacement Option 3 Replacement Event" is deemed to occur with respect to a Relevant Entity at any time such Relevant Entity does not have (x) a long-term rating from S&P of at least "A" and a short-term rating from S&P of at least "A-1" or (y) if such Relevant Entity does not have a short-term rating from S&P of at least "A-1", a long-term rating from S&P of at least "A+". "S&P Replacement Option 4 Effective Date" means each day on which (i) any Relevant Notes are outstanding and rated by S&P and (ii) S&P Replacement Option 4 is in effect as of the Effective Date or following written notice of such election by Party A in accordance with the terms hereof. "S&P Replacement Option 4 Replacement Event" is deemed to occur with respect to a Relevant Entity at any time the long-term rating of such Relevant Entity from S&P is withdrawn, suspended or downgraded below "A+". IN WITNESS WHEREOF the parties have executed this Schedule on the respective dates specified below with effect from the date specified on the first page of this Agreement. [COUNTERPARTY] [ISSUER] Appendix 2: Hypothetical ISDA Credit Support Annex Reflecting An Example Of The Application Of Standard & Poor's Replacement Options As Described In "Counterparty Risk Framework Methodology And Assumptions," published Nov. 29, 2012 Note: This appendix is for illustrative purposes only; it does not constitute criteria and is not to be interpreted as recommendations and/or advice on how transaction participants should document and/or structure their transactions. Elections and Variables to the ISDA Credit Support Annex between [Counterparty] ("Party A") and [Issuer] ("Party B"), dated as of [ ] Paragraph 13. (a)security Interest for "Obligations". The term "Obligations" as used in this Annex includes no additional obligations with respect to Party A or Party B. (b)credit Support Obligations. (i)"delivery Amount" has the meaning specified in Paragraph 3(a), except that: (A)the words "upon a demand made by the Secured Party on or promptly following a Valuation Date" shall be deleted and replaced with the words "not later than the close of business on each Valuation Date"; (B)the sentence beginning "Unless otherwise specified in Paragraph 13" and ending "(ii) the Value as of that Valuation Date of all Posted Credit Support held by the Secured Party." shall be deleted in its entirety and replaced with the following: "The "Delivery Amount" applicable to the Pledgor for any Valuation Date will equal [the greater of]: (1)the amount by which (a) the S&P Credit Support Amount for such Valuation Date exceeds (b) the Value, as of such Valuation Date, of all Posted Credit Support held by the Secured Party; and JUNE 24,

306 Criteria Structured Finance General: Global Derivative Agreement Criteria (2)[methodology for other rating agency]; and (C)notwithstanding Paragraph 4(b), but subject to Paragraphs 4(a) and 5, if, on any Valuation Date, the Delivery Amount equals or exceeds the Pledgor's Minimum Transfer Amount, the Pledgor will Transfer to the Secured Party sufficient Eligible Credit Support to ensure that, immediately following such transfer, the Delivery Amount shall be zero. (ii)"return Amount" has the meaning specified in Paragraph 3(b), except that: (A)the sentence beginning "Unless otherwise specified in Paragraph 13" and ending "(ii) the Credit Support Amount." shall be deleted in its entirety and replaced with the following: "The "Return Amount" applicable to the Secured Party for any Valuation Date will equal [the lesser of]: (1)the amount by which (a) the Value, as of such Valuation Date, of all Posted Credit Support held by the Secured Party exceeds (b) the S&P Credit Support Amount for such Valuation Date; and (2)[methodology for other rating agency]; and (B)in no event shall the Secured Party be required to Transfer any Posted Credit Support under Paragraph 3(b) if, immediately following such Transfer, the Delivery Amount would be greater than zero. (iii)eligible Collateral. Exhibit I hereto lists the types of assets that will qualify as "Eligible Collateral" for purposes of calculating Value. (iv)threshold. (A)"Independent Amount" means with respect to Party A: Not Applicable. "Independent Amount" means with respect to Party B: Not Applicable. (B)"S&P Threshold" means with respect to Party A: Infinity; provided, however, that the S&P Threshold with respect to Party A shall be zero if an S&P Collateralization Event has occurred and been continuing with respect to each Relevant Entity (i) for at least 10 Local Business Days or (ii) since the date of this Annex. "S&P Threshold" means with respect to Party B: Infinity. "Minimum Transfer Amount" means $100,000 with respect to each of Party A and Party B. (C)Rounding. The Delivery Amount will be rounded up and the Return Amount will be rounded down to the nearest integral multiple of $10,000, respectively. (c)valuation and Timing. (i)"valuation Agent" means Party A; provided, however, that if an Event of Default shall have occurred with respect to which Party A is the Defaulting Party, Party B shall have the right to designate as Valuation Agent an independent party, reasonably acceptable to Party A, the cost for which shall be borne by Party A. JUNE 24,

307 Criteria Structured Finance General: Global Derivative Agreement Criteria (ii)"valuation Date" means the [first] Local Business Day in each week during which an S&P Collateralization Event has occurred and is continuing. (iii)"valuation Time" means: [ ] the close of business in the city of the Valuation Agent on the Valuation Date or date of calculation, as applicable; [ ] the close of business on the Local Business Day before the Valuation Date or date of calculation, as applicable; provided that the calculations of Value and Exposure will be made as of approximately the same time on the same date. (iv) If an S&P Collateralization Event has occurred and is continuing and Party A is the Valuation Agent, then, in addition to its obligations pursuant to Paragraph 4(c), Party A shall promptly notify Standard & Poor's of its calculations of Value and Exposure. "Notification Time" means [ ] [p.m.], New York time, on a Local Business Day. (d)conditions Precedent and Secured Party's Rights and Remedies. Each Additional Termination Event shall constitute a "Specified Condition". (e)substitution. (i)"substitution Date" means [_]. (ii)consent. The Pledgor is required to obtain the Secured Party's consent for any substitution pursuant to Paragraph 4(d). (f)dispute Resolution. (i)"resolution Time" means [ ] [p.m.], New York time, on the Local Business Day following the date on which a notice is given that gives rise to a dispute under Paragraph 5. (ii)alternative. The provisions of Paragraph 5 will apply. (g)holding and Using Posted Collateral. (i)eligibility to Hold Posted Collateral; Custodians. Party B (or its Custodian) will hold Posted Collateral, as applicable, pursuant to Paragraph 6(b). Party B hereby covenants and agrees that it will cause all Posted Collateral received from Party A to be held in one or more segregated trust accounts (each, a "Collateral Account") maintained with a domestic office of a commercial bank, trust company or financial institution organized under the laws of the United States (or any state or a political subdivision thereof) having (x) a long-term debt or deposit rating of at least A+ from S&P or (y) a long-term debt or deposit rating of at least A and a short-term debt or deposit rating of at least A-1 from S&P (a "Qualified Institution"). If at any time the entity holding Posted Collateral no longer has credit ratings sufficient to qualify as a Qualified Institution, then Party B shall, within 60 days, cause the Posted Collateral to be moved to a Qualified Institution and provide notice of such change to the Pledgor and the Rating Agency. (ii)use of Posted Collateral. The provisions of Paragraph 6(c) will not apply to Party B. JUNE 24,

308 Criteria Structured Finance General: Global Derivative Agreement Criteria (h)distributions and Interest Amount. (i)the "Interest Rate", with respect to Eligible Collateral in the form of USD Cash, for any day, will be the rate that Party B actually earns and receives on the relevant Posted Collateral. (ii)the "Transfer of Interest Amount" will be made within [_] Local Business Days after the last Local Business Day of each calendar month; provided that Party B shall not be obligated to transfer to Party A any Interest Amount in excess of the amount of interest that Party B actually earns and receives on the relevant Posted Collateral. (iii)alternative Interest Amount. The provisions of Paragraph 6(d)(ii) will apply. (iv)the definition of "Posted Collateral" in Paragraph 12 is hereby amended by inserting the words "received by Party B and" after the words "Interest Amount or portion thereof". (i)additional Representations. None. (j)other Eligible Support and Other Posted Support. Not Applicable. (k)demands and Notices. All demands, specifications and notices made by a party to this Annex will be made to the following: [ ] (l)addresses for Transfers. [ ] (m)other Provisions. (i)paragraph 1(b) of this Annex is amended by deleting it and restating it in full as follows: (b)"secured Party and Pledgor." All references in this Annex to the "Secured Party" mean Party B, and all references in this Annex to the "Pledgor" mean Party A." (ii)paragraph 2 of this Annex is amended by deleting the first sentence thereof and restating that sentence in full as follows: "Party A, as the Pledgor, hereby pledges to Party B, as the Secured Party, as security for the Pledgor's Obligations, and grants to the Secured Party a first priority continuing security interest in, lien on and right of Set-off against all Posted Collateral Transferred to or received by the Secured Party hereunder." (iii)only Party A makes the representations contained in Paragraph 9 of this Annex. (iv)notwithstanding anything to the contrary in Paragraph 10(a) of this Annex, the Pledgor will be responsible for all transfer and other taxes and other costs involved in the maintenance of and any Transfer of Eligible Collateral. (v)paragraph 12 of this Annex is amended by deleting the definitions of "Pledgor", "Secured Party" and "Value" and replacing them with the following: JUNE 24,

309 Criteria Structured Finance General: Global Derivative Agreement Criteria "Pledgor" means Party A. "Secured Party" means Party B. "Value", for any Valuation Date or other date for which Value is calculated and subject to Paragraph 5 in the case of a dispute, will be calculated as follows: for Cash, the [U.S. dollar] value thereof, and for each item of Eligible Collateral (except for Cash), an amount in [U.S. dollars] equal to in the case of any calculation relating to the S&P Credit Support Amount, the product of (A) either (I) the bid price for such security quoted on such day by a principal market-maker for such security selected in good faith by the Valuation Agent or (II) the most recent publicly available bid price for such security as reported by a quotation service or in a medium selected in good faith and in a commercially reasonable manner by the Valuation Agent and (B) the applicable S&P Valuation Percentage listed for such security in Exhibit I hereto. For the avoidance of doubt, if an S&P Collateralization Event has occurred, any Posted Collateral that consists of an item not specified in Exhibit I shall for purposes of the S&P Credit Support Amount be assigned a Value of zero (0)." (vi)paragraph 12 is hereby further amended by adding the following definitions (each in the correct alphabetical order): "S&P" means Standard & Poor's Ratings Services, a Standard & Poor's Financial Services LLC business, or any successor to the rating business of such entity. "S&P Collateralization Event" means an S&P Replacement Option 1 Collateralization Event, an S&P Replacement Option 2 Collateralization Event or an S&P Replacement Option 3 Replacement Event. "S&P Credit Support Amount" means, for any Valuation Date, the excess, if any, of: (I) (A)for any Valuation Date that is an S&P Replacement Option 1 Effective Date, the S&P Replacement Option 1 Credit Support Amount, or (B)for any Valuation Date that is an S&P Replacement Option 2 Effective Date, the S&P Replacement Option 2 Credit Support Amount, or (C)for any Valuation Date that is an S&P Replacement Option 3 Effective Date, the S&P Replacement Option 3 Credit Support Amount, or (D)for any other Valuation Date, zero, over (II) the S&P Threshold for Party A for such Valuation Date. "S&P Replacement Event" means: (A)on any S&P Replacement Option 1 Effective Date, an S&P Replacement Option 1 Replacement Event, or (B)on any S&P Replacement Option 2 Effective Date, an S&P Replacement Option 2 Replacement Event, or (C)on any S&P Replacement Option 3 Effective Date, an S&P Replacement Option 3 Replacement Event, or (D)on any S&P Replacement Option 4 Effective Date, an S&P Replacement Option 4 Replacement Event. "S&P Replacement Option 1 Collateralization Event" is deemed to occur with respect to a Relevant Entity at any time if such Relevant Entity does not have (x) a long-term rating from S&P of at least "A" and a short-term rating from S&P of at least "A-1" or (y) if such Relevant Entity does not have a short-term rating from S&P of at least "A-1", a long-term rating from S&P of at least "A+". JUNE 24,

310 Criteria Structured Finance General: Global Derivative Agreement Criteria "S&P Replacement Option 1 Credit Support Amount" means for any Valuation Date on which an S&P Replacement Option 1 Collateralization Event has occurred and is continuing, the greater of (I) the sum of (a) the Secured Party's Exposure for all Transactions and (b) the aggregate of the S&P Replacement Option 1 Volatility Buffer Amounts for each Transaction, and (II) 0. "S&P Replacement Option 1 Effective Date" means each day on which (i) any Relevant Notes are outstanding and rated by S&P and (ii) S&P Replacement Option 1 is in effect as of the Effective Date or following written notice of such election by Party A in accordance with the terms hereof. "S&P Replacement Option 1 Replacement Event" is deemed to occur with respect to a Relevant Entity at any time the long-term rating of such Relevant Entity from S&P is withdrawn, suspended or downgraded below "BBB+". "S&P Replacement Option 1 Volatility Buffer Amount" means, with respect to any Transaction, the product of the applicable S&P Volatility Buffer set forth in Table A of Exhibit II and the Notional Amount for such Transaction as determined on the first day of the Calculation Period which includes such Valuation Date. "S&P Replacement Option 2 Collateralization Event" is deemed to occur with respect to a Relevant Entity at any time if such Relevant Entity does not have (x) a long-term rating from S&P of at least "A" and a short-term rating from S&P of at least "A-1" or (y) if such Relevant Entity does not have a short-term rating from S&P of at least "A-1", a long-term rating from S&P of at least "A+". "S&P Replacement Option 2 Credit Support Amount" means: (I)for any Valuation Date on which an S&P Replacement Option 2 Collateralization Event has occurred and is continuing but no S&P Replacement Option 2 Replacement Event has occurred and been continuing for 10 Local Business Days, the greater of (I) the product of (a) the Secured Party's Exposure for all Transactions and (b) 1.25, and (II) 0; or (II)for any Valuation Date on which an S&P Replacement Option 2 Replacement Event has occurred and is continuing for at least 10 Local Business Days, the greater of: (x) the greater of (I) the product of (a) the Secured Party's Exposure for all Transactions and (b) 1.30, and (II) 0, and (y) the greater of (I) the sum of (a) the Secured Party's Exposure for all Transactions and (b) the aggregate of the S&P Replacement Option 2 Volatility Buffer Amounts for each Transaction, and (II) 0. "S&P Replacement Option 2 Effective Date" means each day on which (i) any Relevant Notes are outstanding and rated by S&P and (ii) S&P Replacement Option 2 is in effect as of the Effective Date or following written notice of such election by Party A in accordance with the terms hereof. "S&P Replacement Option 2 Replacement Event" is deemed to occur with respect to a Relevant Entity at any time the long-term rating of such Relevant Entity from S&P is withdrawn, suspended or downgraded below "A-". "S&P Replacement Option 2 Volatility Buffer Amount" means, with respect to any Transaction, the product of the applicable S&P Volatility Buffer set forth in Table B of Exhibit II and the Notional Amount for such Transaction as determined on the first day of the Calculation Period which includes such Valuation Date. "S&P Replacement Option 3 Credit Support Amount" means for any Valuation Date on which an S&P Replacement Option 3 Replacement Event has occurred and is continuing, the greater of (I) the product of (a) the Secured Party's Exposure for all Transactions and (b) 1.25, and (II) 0. JUNE 24,

311 Criteria Structured Finance General: Global Derivative Agreement Criteria "S&P Replacement Option 3 Effective Date" means each day on which (i) any Relevant Notes are outstanding and rated by S&P and (ii) S&P Replacement Option 3 is in effect as of the Effective Date or following written notice of such election by Party A in accordance with the terms hereof. "S&P Replacement Option 3 Replacement Event" is deemed to occur with respect to a Relevant Entity at any time such Relevant Entity does not have (x) a long-term rating from S&P of at least "A" and a short-term rating from S&P of at least "A-1" or (y) if such Relevant Entity does not have a short-term rating from S&P of at least "A-1", a long-term rating from S&P of at least "A+". "S&P Replacement Option 4 Effective Date" means each day on which (i) any Relevant Notes are outstanding and rated by S&P and (ii) S&P Replacement Option 4 is in effect as of the Effective Date or following written notice of such election by Party A in accordance with the terms hereof. "S&P Replacement Option 4 Replacement Event" is deemed to occur with respect to a Relevant Entity at any time the long-term rating of such Relevant Entity from S&P is withdrawn, suspended or downgraded below "A+". (vii) Paragraph 7(iii) of this Annex shall not apply to Party B. (n)[reserved] Accepted and agreed: [ ] [ ] EXHIBIT I: Standard & Poor's Eligible Collateral And Valuation Percentages Standard & Poor's Eligible Collateral And Valuation Percentages Eligible Collateral Cash (i.e., U.S. dollar-denominated cash) 100 Fixed-rate, coupon-bearing Treasury securities having a remaining maturity on such date of not more than one year Fixed-rate, coupon-bearing Treasury securities having a remaining maturity on such date of more than one year but not more than three years Fixed-rate, coupon-bearing Treasury securities having a remaining maturity on such date of more than three years but not more than five years Fixed-rate, coupon-bearing Treasury securities having a remaining maturity on such date of more than five years but not more than seven years Fixed-rate, coupon-bearing Treasury securities having a remaining maturity on such date of more than seven years but not more than 10 years Fixed-rate, coupon-bearing Treasury securities having a remaining maturity on such date of more than 10 years but not more than 15 years Fixed-rate, coupon-bearing Treasury securities having a remaining maturity on such date of more than 15 years but not more than 20 years Fixed-rate, coupon-bearing Treasury securities having a remaining maturity on such date of more than 20 years Standard & Poor's Valuation Percentage 100/97* 100/91* 100/89.5* 100/88* 100/86.5* 100/85* 100/83.5* 100/82* Note: The listed valuation percentage will be lower if the eligible collateral is not in the same currency as the counterparty's payment obligation. *With respect to Standard & Poor's, the government security will have the first listed valuation percentage if it is rated the same as or higher than the relevant notes; otherwise such government security will have the second listed valuation percentage. JUNE 24,

312 Criteria Structured Finance General: Global Derivative Agreement Criteria EXHIBIT II: Tables A And B For Use In Calculating The Standard & Poor's Credit Support Amount Table A Replacement Option 1 Volatility Buffer By Currency Risk Group (% Of Notional) For Securities Rated 'AAA' Interest rate swaps (%) Cross-currency swaps (%) Swap tenor weighted average life (years) Fixed to floating Floating to floating Fixed to floating Fixed to fixed Floating to floating Currency risk group 1 volatility buffers Up to three Greater than three and less than or equal to five Greater than five and less than or equal to 10 Greater than 10 and less than or equal to Greater than Currency risk group 2 volatility buffers Up to three Greater than three and less than or equal to five Greater than five and less than or equal to 10 Greater than 10 and less than or equal to Greater than Currency risk group 3 volatility buffers Up to three Greater than three and less than or equal to five Greater than five and less than or equal to 10 Greater than 10 and less than or equal to Greater than Table B Replacement Option 2 Volatility Buffer By Currency Risk Group (% Of Notional) For Securities Rated 'AAA' Interest rate swaps (%) Cross currency swaps (%) Swap tenor weighted average life (years) Fixed to floating Floating to floating Fixed to floating Fixed to fixed Floating to floating Currency risk group 1 volatility buffers Up to three Greater than three and less than or equal to five Greater than five and less than or equal to JUNE 24,

313 Criteria Structured Finance General: Global Derivative Agreement Criteria Table B Replacement Option 2 Volatility Buffer By Currency Risk Group (% Of Notional) For Securities Rated 'AAA' (cont.) Greater than 10 and less than or equal to Greater than Currency risk group 2 volatility buffers Up to three Greater than three and less than or equal to five Greater than five and less than or equal to 10 Greater than 10 and less than or equal to Greater than Currency risk group 3 volatility buffers Up to three Greater than three and less than or equal to five Greater than five and less than or equal to 10 Greater than 10 and less than or equal to Greater than RELATED CRITERIA AND RESEARCH Related Criteria Asset Isolation And Special-Purpose Entity Criteria--Structured Finance, May 7, 2013 Counterparty Risk Framework Methodology And Assumptions, Nov. 29, 2012 Covered Bonds Counterparty And Supporting Obligations Methodology And Assumptions, May 31, 2012 Contingent Liquidity Risks In U.S. Public Finance Instruments: Methodology And Assumptions, March 5, 2012 Principles Of Credit Ratings, Feb. 16, 2011 Related Research Standard & Poor's Comments On The Potential Impact Of The U.S. Bankruptcy Court Decision On Swap Termination Payments, Feb. 9, 2010 These criteria represent the specific application of fundamental principles that define credit risk and ratings opinions. Their use is determined by issuer- or issue-specific attributes as well as Standard & Poor's Ratings Services' assessment of the credit and, if applicable, structural risks for a given issuer or issue rating. Methodology and assumptions may change from time to time as a result of market and economic conditions, issuer- or issue-specific factors, or new empirical evidence that would affect our credit judgment. JUNE 24,

314 Copyright 2015 Standard & Poor's Financial Services LLC, a part of McGraw Hill Financial. All rights reserved. No content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor's Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an "as is" basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT'S FUNCTIONING WILL BE UNINTERRUPTED, OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages. Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P's opinions, analyses, and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw, or suspend such acknowledgement at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal, or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof. S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain nonpublic information received in connection with each analytical process. S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, (free of charge), and and (subscription) and (subscription) and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at JUNE 24,

315 General Criteria: Methodology And Assumptions: Assigning Ratings To Bonds In The U.S. Based On Escrowed Collateral Primary Credit Analysts: Adrian D Techeira, New York (1) ; adrian.techeira@standardandpoors.com Ryan Butler, New York (1) ; ryan_butler@standardandpoors.com Secondary Contact: Jeffrey J Previdi, New York (1) ; jeff_previdi@standardandpoors.com Chief Criteria Officer, Global Corporates & Governments: Colleen Woodell, New York (1) ; colleen_woodell@standardandpoors.com Senior Criteria Officer, Global Structured Finance: Felix E Herrera, CFA, New York (1) ; felix_herrera@standardandpoors.com Table Of Contents SCOPE OF THE CRITERIA SUMMARY OF THE CRITERIA IMPACT ON OUTSTANDING RATINGS EFFECTIVE DATE AND TRANSITION METHODOLOGY AND ASSUMPTIONS Overview CREDIT CONSIDERATIONS Analysis Of The Defeasance Collateral Analysis Of The Defeased Bond's Terms NOVEMBER 30,

316 Table Of Contents (cont.) Collateral Sufficiency EXPOSURE TO THE ESCROW AGENT OTHER CONSIDERATIONS ADMINISTRATOR CONSIDERATIONS APPENDIX Legal And Economic Defeasances RELATED CRITERIA AND RESEARCH NOVEMBER 30,

317 General Criteria: Methodology And Assumptions: Assigning Ratings To Bonds In The U.S. Based On Escrowed Collateral (Editor's Note: We originally published this crtieria article on Nov. 30, We're republishing it following our periodic review completed on Dec. 4, This article supersedes "Methodology And Assumptions: Assigning Ratings To Bonds In The U.S. Based On Escrowed Collateral," published on May 31, 2012.) 1. Standard & Poor's Ratings Services is refining and adapting its methodology and assumptions for rating defeased bonds in the U.S. We are publishing this article to help market participants better understand our approach to reviewing these transactions. This article relates to "Principles Of Credit Ratings," published Feb. 16, SCOPE OF THE CRITERIA 2. The criteria apply to all new and outstanding defeased bonds rated in the U.S. based on the credit quality of escrowed collateral. Additional sector-specific criteria supplement our approach for rating defeased commercial mortgage-backed securities (CMBS) (see "Standard & Poor s Defeasance Criteria For U.S. CMBS Transactions," published April 4, 2003). 3. In addition, this article applies to the analyses of escrow periods within bond issues where the collateral supporting repayment of the bonds comprise escrowed collateral during an escrow period. SUMMARY OF THE CRITERIA 4. Based on these criteria, the rating assigned to a defeased bond will reflect the escrowed collateral's credit quality if, in our opinion: The collateral type satisfies "Global Investment Criteria For Temporary Investments In Transaction Accounts," published May 31, 2012; There is enough collateral cash flows to make timely payments on the defeased bond until it is fully repaid, even after applying our cash flow stresses; and There are no operational or legal issues that could disrupt or reduce the collateral cash flows. 5. These criteria for rating defeased bonds in the U.S. are being updated to: Expand the scope of defeased bond issues that are eligible for ratings to include those backed by most types of defeasance collateral, regardless of the collateral's repayment source; Provide examples of the collateral characteristics and defeased bond terms that are analyzed; Explicitly reflect that demand deposit state and local government series securities (demand deposit SLGS), which are often escrowed as collateral in tax-exempt financings, carry extension or rollover risk; Incorporate our methodologies for assessing temporary investments and counterparty risk to our analysis of NOVEMBER 30,

318 General Criteria: Methodology And Assumptions: Assigning Ratings To Bonds In The U.S. Based On Escrowed Collateral counterparty exposure to the escrow agent; Clarify how defeased bonds that contain an embedded investor put option are analyzed; and Include our approach for reviewing forward purchase contracts (FPCs). 6. This article supersedes "Updated Defeasance Criteria For U.S. CMBS Transactions," published Aug. 16, 2011, "Defeasance" and "Forward Purchase Contracts And 'AAA' Defeased Bonds," both published June 26, 2007, and "Defeasance Of Corporate Bonds May Be Gaining Popularity," published July 25, IMPACT ON OUTSTANDING RATINGS 7. We will be reviewing our ratings on defeased bond transactions during the next six months and revising the ratings on transactions that are affected by these updated criteria. A notable change from previous criteria is our methodology for assessing the counterparty risk of the escrow agent when the defeased collateral includes cash holdings (see the section, "Exposure To The Escrow Agent"). Going forward, the ratings on new defeased bonds will be based on an assessment of the counterparty risk associated with the escrow agent as well as an assessment of the defeased collateral held by the escrow agent. For rated defeased bonds outstanding on the date of publication of this criteria, we will apply a different approach. For such bonds, we will not consider exposure to the escrow agent if the amount of cash comprising defeased collateral is minimal (generally less than $2,000). We believe this approach would avoid the unintended consequence of ratings migration in cases where Standard & Poor's does not see a significant deterioration in credit quality. EFFECTIVE DATE AND TRANSITION 8. The criteria outlined in this article are effective immediately. METHODOLOGY AND ASSUMPTIONS Overview 9. An existing bond issue is defeased or refunded when enough collateral often funded by new debt has been set aside to make all future payments on the existing bond issue. Typically, the collateral is deposited into an escrow account and the escrow agent applies the collateral cash flows as bond payments come due. 10. Bond issues are eligible for ratings based on the defeasance collateral's credit quality when the collateral type is consistent with the obligations described in "Credit quality" ( 13), the collateral amount is sufficient in view of the bond payment terms ( 22), and the transaction parties' bankruptcy risks are not credit factors ( 27-31). We also analyze the defeasance structure for operational and other issues that could disrupt or reduce the available cash flows ( 25-26, 31-33). 11. When bonds are being legally defeased, the collateral's cash flows are substituted for the borrower's payments ( 36). Therefore, the defeased bond rating cannot be higher than the rating on the collateral. When bonds are being NOVEMBER 30,

319 General Criteria: Methodology And Assumptions: Assigning Ratings To Bonds In The U.S. Based On Escrowed Collateral economically defeased, the defeased bonds are fully supported by each of the collateral and the borrower ( 38). Consequently, if bonds are being economically defeased, the ratings can be based on the higher of the ratings on the borrower and the collateral. Regardless of whether bonds are being legally or economically defeased, the defeased bond rating will be capped by a transaction party's creditworthiness if that party's bankruptcy can disrupt the collateral cash flows ( 27). (See the Appendix for a discussion on how legal and economic defeasances differ.) CREDIT CONSIDERATIONS Analysis Of The Defeasance Collateral 12. The likelihood of defeased bond repayment depends, in part, on the supporting collateral's characteristics. Therefore, these criteria consider all collateral characteristics that could affect the likelihood of the defeased bond being repaid. The collateral characteristics include credit quality, prepayment potential, extendibility, and interest-rate variability. Credit quality 13. Ratings will be assigned to defeased bond issues if, among other things, the collateral comprises cash holdings and/or investments that satisfy 16, 20-22, and of "Global Investment Criteria For Temporary Investments In Transaction Accounts," published May 31, The rating assigned to a defeased bond may reflect additional methodologies if the investment guidelines in the escrow agreement do not limit to one the number of credit sources that are ultimately responsible for repaying the bonds. Prepayment potential 15. Where the collateral can prepay for any reason (including by way of acceleration, redemption, or mandatory tender), the cash flows will be analyzed as if the collateral will prepay or be called on the first possible date. This approach is taken because a loss of yield, which may result in cash flow shortfalls, could occur if an issuer of collateral unexpectedly calls its debt or if any type of asset-backed security that comprises the collateral prepays faster than expected. Extendibility 16. If the defeasance collateral has payment dates that can be extended, our cash flow analysis assumes the extension option will be exercised. For example, demand deposit SLGS are U.S. Treasury-issued one-day certificates of indebtedness that automatically roll over until a demand for payment is made. Borrowers in tax-exempt financings often use these securities to collateralize defeased municipal debt because SLGS generally provide cash flows at yields that do not exceed Internal Revenue Service arbitrage limits. According to governing regulations, the U.S. Treasury will roll over demand deposit SLGS into certificates of indebtedness maturing in 90 days when the secretary of the Treasury has determined that the U.S. debt ceiling has been reached. For analytical purposes, we assume that the U.S. debt ceiling will be reached and each one-day certificate could roll over into a 90-day certificate on any given day. Interest-rate variability 17. To the extent the collateral includes variable-rate securities, the cash flows are analyzed as if the minimum collateral interest rate (which may be 0%) will be payable during periods when collateral rates have not yet been determined. NOVEMBER 30,

320 General Criteria: Methodology And Assumptions: Assigning Ratings To Bonds In The U.S. Based On Escrowed Collateral This approach stresses the cash flows for shortfalls that could result from interest rate reset risk related to the collateral. However, the stress is not applied if the same interest index and reset dates are used to calculate interest due on both the defeasance collateral and the defeased bond issue. Analysis Of The Defeased Bond's Terms 18. The criteria contemplate a review of the payment terms in the escrow agreement to determine if they are consistent with those of the bond being defeased because inconsistencies may result in late payments or payment shortfalls. Examples of payment terms include variable interest rates and investor put option rights. Variable interest rates 19. All escrow liabilities must be capped, including variable interest-rate bonds, and the liabilities are stressed at the cap amounts. For example, with regard to variable-rate bonds, interest is stressed at the maximum rate defined in the defeased bond instrument during periods for which interest rates have not yet been determined. Investor put option rights 20. For a defeased bond with investor put option rights (or a "demand" feature), we assume the investors are owed payments on the first possible put option payment date in the defeasance period and each put option exercise date thereafter. This includes bonds requiring several days' or weeks' notice of put option exercise because the investors may have exercised the put option before the defeasance period began. However, if the tender or remarketing agent provides actual payment due dates and amounts for previously exercised puts, then those dates are reflected in our analysis. 21. When bonds are being legally defeased, operational issues are also considered, such as whether the put process is reflected in the escrow agreement and whether key parties (e.g., the party who receives put notices) are contractually retained during the defeasance period. When there is a third-party liquidity provider supporting payment of put option exercises, our methodology for reviewing liquidity facilities will be applied (see "Bank Liquidity Facilities," published June 22, 2007, and "Methodology And Assumptions: Approach To Evaluating Letter Of Credit-Supported Debt," published July 6, 2009). The cash flow impact of liquidity provider fees and liquidity facility draws (full and partial) on the defeasance structure will also be analyzed by referring to the liquidity facility's repayment terms. Collateral Sufficiency 22. A cash flow verification report, provided by an independent certified public accounting or cash flow verification firm (with a certified public accountant's attestation), is reviewed for defeasance collateral sufficiency. The criteria regard collateral as being sufficient when, based on our stresses ( 15-20, 23-24), the cash flow projections show that enough collateral cash flows will be available on each escrow liability payment date to pay all liabilities, including any fees that are payable from the collateral, and interest, principal, and redemption premium due. The cash flows should also be sufficient to cover potential lags in payments, such as those from a guarantor (see "Timeliness of Payments: Grace Periods, Guarantees, And Use of D And SD Ratings," published Dec. 23, 2010). 23. When analyzing cash flow sufficiency, our analysis does not reflect any income from collateral that will not have been NOVEMBER 30,

321 General Criteria: Methodology And Assumptions: Assigning Ratings To Bonds In The U.S. Based On Escrowed Collateral deposited as of the escrow closing date. Therefore, potential reinvestment earnings are not considered. Further, if collateral needs to be liquidated for making payments, then our market value criteria are applied (see "Request For Comment: Methodology And Assumptions For Market Value Securities," published Aug. 31, 2010). Investing cash flows 24. In some defeasance structures, the transaction documents include instructions for the escrow agent to invest the cash flows until the dates they are expected to be applied. These include collateral cash flows that, based on our stresses, will be needed to make payments on the defeased bond. Any investments should address our criteria for credit quality and extendibility (see 13, 14, and 16) and mature before the date needed for payment, according to the most-recent verified cash flow report. Additional criteria apply if the cash flows are invested pursuant to the terms in an FPC (see the Forward Purchase Contracts box below). NOVEMBER 30,

322 General Criteria: Methodology And Assumptions: Assigning Ratings To Bonds In The U.S. Based On Escrowed Collateral EXPOSURE TO THE ESCROW AGENT 25. The defeasance collateral should be maintained with the corporate trust department of a federal- or state-chartered depository institution. In addition, if cash is not held in a FDIC-insured account at or below the insured limit, the criteria establish the minimum escrow agent rating based on (i) the rating on the defeased bond and (ii) the exposure period to the escrow agent (see the table, as well as "Global Investment Criteria For Temporary Investments In Transaction Accounts" and "Counterparty Risk Framework Methodology And Assumptions," both published May 31, 2012). When a minimum rating applies to the escrow agent and the defeasance period is longer than 60 calendar days, a replacement covenant also applies. However, if we believe an escrow agent's failure to perform is not likely to cause a direct disruption of payments on the rated security (e.g., certain defeased loans in CMBS transactions), then our bank accounts criteria apply (see "Counterparty Risk Framework Methodology And Assumptions," published May 31, 2012). 26. Further, if cash is held in a FDIC-insured account at or below the insured limit, then the applicable minimum escrow agent rating applies to the rating on the FDIC, but a replacement covenant does not apply. If the escrow structure does not meet these criteria, then the rating on the defeased bond will be no higher than the rating on the escrow agent unless we receive legal comfort that applicable laws and regulations isolate the defeasance collateral and cash flows from the insolvency risk of the escrow agent (see table). Minimum Escrow Agent Ratings Exposure period Minimum escrow agent rating for 'AAA' and 'AA+' defeased bonds Minimum escrow agent rating for 'AA' and 'AA-' defeased bonds Up to one year* A A- BBB+ Longer than one year* One notch below the rating on the defeased bond One notch below the rating on the defeased bond Minimum escrow agent rating for 'A+' defeased bonds One notch below the rating on the defeased bond *If the defeasance period is longer than 60 calendar days, the minimum escrow agent rating is consistent with the above-indicated transaction rating only if the escrow agent agrees to, within 60 calendar days of a downgrade below the minimum escrow agent rating and at its own expense, replace itself with a new escrow agent satisfying the minimum escrow agent rating. Escrow agents that only have short-term ratings are treated as having the following corresponding long-term issuer credit ratings: 'A-1+' corresponds to 'AA-', 'A-1' corresponds to 'A' for financial institutions and 'A-' for all other entities, 'A-2' corresponds to 'BBB', and 'A-3' corresponds to 'BBB-'. OTHER CONSIDERATIONS Bankruptcy risk 27. The rating on a defeased bond issue usually is intended to reflect the creditworthiness of the supporting collateral. Accordingly, the criteria consider the defeasance collateral's isolation from the transaction parties' bankruptcy risks. If a transaction party's bankruptcy can disrupt the collateral cash flows, then the defeased bond rating will be capped by that party's creditworthiness. 28. The relevant transaction parties may include any party listed in "Automatic stay risk" ( 29-30). Regardless of how the defeasance is structured and whether it is legal or economic (see the Appendix), our bankruptcy review focuses on two primary risks: automatic stay risk and preference risk. NOVEMBER 30,

323 General Criteria: Methodology And Assumptions: Assigning Ratings To Bonds In The U.S. Based On Escrowed Collateral Automatic stay risk 29. The consequences of an automatic stay on the collateral and collateral cash flows could include a delay of payments to the bondholders. If a transaction party is eligible to become a debtor under the U.S. Bankruptcy Code (the Code) and is not bankruptcy-remote, then a given transaction's facts and circumstances should support the conclusion (upon our request, in the form of a legal opinion) that a court would not consider the collateral and collateral cash flows to be (i) in the case of a transaction party that is a not a Chapter 9 filer, the property of that party's bankruptcy estate under Code Section 541 or subject to an automatic stay under Code Section 362(a), or (ii) in the case of a transaction party that is a Chapter 9 filer, the property of the municipal debtor or subject to an automatic stay under either Code Sections 362(a) or 922. If a transaction party is not eligible to become a debtor under the Code but may become insolvent under another regime, similar comfort under the applicable insolvency regime will typically be requested. 30. Depending on a given transaction's facts and circumstances, automatic stay risk may exist with regard to: A party depositing collateral into an escrow account; A party responsible for topping-up cash flow shortfalls. For purposes of analyzing automatic stay risk only, we assume that an economic defeasance has occurred unless we have received a legal defeasance opinion to the effect that the lien securing repayment of an existing bond issue has been released; or A party being entitled to receive excess cash flows or collateral that remains after the defeased debt has been repaid in full. Preference risk 31. If a transaction party is not bankruptcy-remote or a Chapter 9 filer under the Code, then a given transaction's facts and circumstances should support the conclusion (upon our request, in the form of a legal opinion) that a court would not consider the transfers of assets to the escrow account to be subject to recapture as voidable preferences under Section 547(b) of the Code or other applicable insolvency regime. By way of example, preference risk may be mitigated if the collateral was purchased from the proceeds of a refunding bond issue. Other legal considerations 32. In addition to the aforementioned legal considerations, the escrow agreement must address the following provisions, largely concerning the collateral: The collateral is irrevocably deposited with the escrow agent; The collateral is free and clear of all claims and liens; The collateral, cash flows, and accounts are pledged to, or for the benefit of, the defeasance bondholders; The collateral and cash flows are segregated from other assets held by the escrow agent; and The escrow agent is prohibited from asserting any claim on the collateral for the nonpayment of fees where those fees are not paid from the collateral. ADMINISTRATOR CONSIDERATIONS 33. Administrator risk exists largely because, in addition to collateral performance, full and timely payments depend on the escrow agent performing according to the terms in the escrow agreement and any FPC. Consequently, the escrow agent should not be capable of resigning for any reason (including nonpayment of fees that are paid from a source that is not the collateral) or being removed from duty without a successor in place. NOVEMBER 30,

324 General Criteria: Methodology And Assumptions: Assigning Ratings To Bonds In The U.S. Based On Escrowed Collateral 34. Other elements of administrator risk are also analyzed to see if they are mitigated. For example: If the defeased bonds are to be repaid on an early redemption date, the escrow agreement should direct the escrow agent to provide a redemption notice that is consistent with the requirements in the indenture (or other governing legal document); and If the collateral requires demand as a precondition for payment from the collateral issuer (e.g., demand deposit SLGS), there should be explicit instructions directing the escrow agent to make timely demand for payment (consistent with the related payment date assumptions in the last verified cash flow report) in accordance with the related collateral's terms. APPENDIX Legal And Economic Defeasances 35. In general, there are two approaches for defeasing a bond issue: legal and economic. A legal defeasance occurs when the lien securing repayment of an existing bond issue is released because the bond is "deemed" to have been paid in full according to the terms in an indenture (or equivalent debt instrument). The release occurs even though the bondholders have not actually been repaid in full. 36. In legally defeased structures, payments from the borrower are discontinued when all indenture preconditions for discharge of the original lien are met. Bondholders receive uninterrupted payments until they are repaid in full because the collateral cash flows are substituted for the borrower's payments. When a legal defeasance occurs, the borrower is not legally responsible for any collateral cash flow shortfalls. 37. An economic or "in-substance" defeasance is similar to a legal defeasance in that a borrower dedicates enough assets to pay off the defeased bond. However, unlike a legally defeased bond, an economically defeased bond is not deemed to be paid either because the borrower has not satisfied all of the preconditions in the indenture or only an actual repayment of the bond can release the indenture's lien. 38. With economic defeasances, the collateral becomes the primary bond repayment source but the borrower is legally responsible for funding any collateral cash flow shortfalls, effectively becoming a guarantor of the collateral. Despite this, state and local government entities may treat economically defeased bonds as being repaid in full for accounting and financial reporting purposes, depending on the escrowed collateral type. 39. When rating a bond issue in the U.S. based on the defeasance collateral's support, the ratings methodology in this article will be applied regardless of whether the bond is being legally or economically defeased. RELATED CRITERIA AND RESEARCH Counterparty Risk Framework Methodology And Assumptions, published May 31, Global Investment Criteria For Temporary Investments In Transaction Accounts, published May 31, U.S. Government Support In Structured Finance And Public Finance Ratings, published Sept. 19, Principles Of Credit Ratings, published Feb. 16, NOVEMBER 30,

325 General Criteria: Methodology And Assumptions: Assigning Ratings To Bonds In The U.S. Based On Escrowed Collateral Timeliness of Payments: Grace Periods, Guarantees, And Use of D And SD Ratings, published Dec. 23, Methodology And Assumptions: Approach To Evaluating Letter Of Credit-Supported Debt, published July 6, Bank Liquidity Facilities, published June 22, Legal Criteria For U.S. Structured Finance Transactions: Securitizations By SPE Transferors And Non-Code Transferors, published Oct. 1, These criteria represent the specific application of fundamental principles that define credit risk and ratings opinions. Their use is determined by issuer- or issue-specific attributes as well as Standard & Poor's Ratings Services' assessment of the credit and, if applicable, structural risks for a given issuer or issue rating. Methodology and assumptions may change from time to time as a result of market and economic conditions, issuer- or issue-specific factors, or new empirical evidence that would affect our credit judgment. NOVEMBER 30,

326 Copyright 2015 Standard & Poor's Financial Services LLC, a part of McGraw Hill Financial. All rights reserved. No content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor's Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an "as is" basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT'S FUNCTIONING WILL BE UNINTERRUPTED, OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages. Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P's opinions, analyses, and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw, or suspend such acknowledgement at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal, or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof. S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain nonpublic information received in connection with each analytical process. S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, (free of charge), and and (subscription) and (subscription) and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at NOVEMBER 30,

327 Criteria Governments U.S. Public Finance: Investment Guidelines Primary Credit Analyst: Jeffrey J Previdi, New York (1) ; jeff.previdi@standardandpoors.com Secondary Credit Analyst: Colleen Woodell, New York (1) ; colleen_woodell@standardandpoors.com Table Of Contents 'Prudent Practice' Derivatives Pools and Mutual Funds Review and Oversight Eligible Investment Criteria for 'AAA' Rated Structured Transactions JUNE 25,

328 Criteria Governments U.S. Public Finance: Investment Guidelines (Editor's Note: This criteria article has been partially superseded by "Global Investment Criteria For Temporary Investments In Transaction Accounts," published May 31, Specifically, the section headed, "Eligible Investment Criteria For 'AAA' Rated Structured Transactions" is superceded. This criteria article was originally published on June 25, We're republishing this article following our periodic review completed on Nov. 6, Updated secondary contact: Liz E Sweeney, New York (1) , liz.sweeney@standardandpoors.com.) With regard to the investment of issuers' operating funds, no formal rating requirements exist, as finance officers tend to invest conservatively, based on internal policies or state-legislated restrictions that emphasize the safety of principal and liquidity over the desire for higher yields. In the event that losses were to occur, most governments and enterprises have the financial capacity to take budget balancing actions to reduce the pressures derived from lost investment earnings. Certain issuers, such as in the housing sector, have limited revenue raising flexibility and therefore the credit quality of investments takes on greater importance. Standard & Poor's Ratings Services belief in the traditional conservatism of municipal investment practices is grounded in experience and has been confirmed in discussions with issuers on investment policy as participation in exotic and more volatile derivative securities has climbed. That is good news, because with the proliferation of new investment structures, which change dramatically by the day, it would be virtually impossible to regulate investment requirements to keep up with the changing environment. Standard & Poor's rating analysis particularly for short-term notes and commercial paper is based on the presumption that funds are invested with the preservation of capital as the issuer's highest priority. The level of risk able to be tolerated is also a function of the issuer's level of liquidity and overall financial strength. The following investment guidelines are "common sense" investing policies that Standard & Poor's believes are followed by the vast majority of rated public finance issuers; they might be called "normal prudent practice." If Standard & Poor's identifies issuers whose practices diverge from these guidelines, it would not automatically warrant a lower rating, but it would prompt further questioning and analysis of that issuer's cash flow and liquidity needs. Regular borrowers of short-term, seasonal cash flow notes have greater needs for liquidity and safety of principal because of the large debt service exposure that occurs at maturity of the notes; for these reasons, the guidelines presented here for investing operating funds take on more importance for such issuers, and investment practices that veer from them could be cause for rating concern. Nonoperating funds, such as endowments and pension funds, can be invested long term while ensuring that assets and liabilities are maturity matched. The following guidelines are suggested for investing general operating funds. Operating funds, as defined by Standard & Poor's, are those needed to pay recurring expenses, such as payroll, maintenance, debt service, and other expenses needed to provide normal essential services during the fiscal year. Issuers that deviate from these guidelines will be examined individually to determine the effect, if any, their investment practices have on their credit ratings. JUNE 25,

329 Criteria Governments U.S. Public Finance: Investment Guidelines 'Prudent Practice' Standard & Poor's general operating fund investment guidelines are based on what it considers "normal, prudent" investment practices with regard to maturity and liquidity, leverage, and credit quality. Average maturity and liquidity The weighted average maturity of the operating fund, as well as the maturity of individual securities in the fund, is typically limited to one year, or as needed for the issuer's normal disbursement patterns. Operating funds should be invested in liquid securities to meet withdrawals related to operating expenses, debt service, note payments, and so forth. Principal protection and liquidity are typically the primary goals of an operating fund and investment return a secondary goal. If the operating funds are invested in county or state investment pools, the weighted average maturity of the county or state pool is typically one year or less. Leverage Borrowing through reverse repurchase agreements and other types of leveraged investments is typically limited and reflective of the risk profile of the issuer.. If reverse repos are used for enhancing yield on the portfolio, the money borrowed is invested in securities of a high credit quality and match the term of the reverse repos. Issuers that use reverse repos need to have the sophistication and skills in place to hedge collateral call and interest rate risks associated with reverse repos. Credit quality An entity's operating fund investments meet the minimum credit quality standards permitted by statute, or its own investment policy. Investments can include deposits in local financial institutions that are FDIC insured, commercial paper issued by investment-grade corporations and financial institutions, bankers' acceptances, and U.S. treasury or government agency securities. Derivatives For the purposes of these guidelines, derivative investments can be described as those whose yield or market value does not follow the normal swings of interest rates. They include but are not limited to such items as structured notes issued by agencies and corporations, "inverse floaters," leveraged variable-rate debt, and interest-only or principal-only CMOs. These securities are volatile and can result in dramatically different market values if liquidated before maturity. Significant investment positions in risky derivatives, could be viewed negatively, depending on the proportion of derivatives to total investments and the liquidity needs of the issuer. These derivatives are extremely sensitive to interest rate changes and are highly susceptible to liquidity risks. JUNE 25,

330 Criteria Governments U.S. Public Finance: Investment Guidelines Pools and Mutual Funds The same guidelines regarding average maturity and liquidity, leverage, credit quality, and derivatives are generally followed for operating fund investments in externally managed investment pools. Exceptions can be made depending on the amount of nonoperating and surplus funds invested in the pool. Standard & Poor's may review the pool investments, and the historical and projected cash flows of the pool. While Standard & Poor's does not require investment funds to be rated by Standard & Poor's in order to evaluate an issuer's credit quality, a public rating on the investment fund provides transparency as well as the initial and ongoing information that may be asked for as part of an investment review. Review and Oversight Issuers should be aware of statutory investment requirements and may want to supplement statutory guidelines with a written investment policy tailored to that entity's situation. The policies can address credit quality, maturity, market valuation frequency, leverage, and derivative-type investments. Officials should be aware of such policies, and periodic reporting of compliance and performance is prudent practice. As part of Standard & Poor's analysis, we may request a discussion of the investment practices and how they follow written or otherwise adopted policies. In general, the longer the maturity or duration of permitted investments and the less liquid the securities the more frequent the need for "mark to market" valuations of operating fund investments. Eligible Investment Criteria for 'AAA' Rated Structured Transactions The most widespread criteria used for investment in the secondary market relate to the category called "eligible investments." Eligible investments are those securities that the trust of a structured finance transaction purchases for the management of its cash flow. Fortunately, it is also the most stable category, rarely changing over time. At the same time, it is important to note that one qualifying investment, the debt obligations of the Student Loan Marketing Association (SLMA or Sallie Mae), will no longer qualify as an eligible investment after Sept. 30, The enactment of the Student Loan Marketing Association Reorganization Act will result in the gradual dissolution of Sallie Mae's GSE (government-sponsored enterprise) status, which allows Sallie Mae limited access to U.S. Treasury funds. The final dissolution date is Sept. 30, If additional Sallie Mae debt is issued, the debt must mature before that date. Sallie Mae debt obligations will continue to qualify as eligible investments for rated structured transactions until Sept. 30, Eligible investments are typically used to temporarily house (usually 30 days or less) the cash flows related to a transaction in low-risk, short-term investments. Eligible investments may also be used for certain reserve or cash collateral accounts, where maturities may extend beyond the next payment date. In instances where the investments may be invested for up to 90 days or longer, the eligibility of investments may be further evaluated, as indicated below. Generally speaking, the following eligible investments should not have maturities in excess of one year. Any use other JUNE 25,

331 Criteria Governments U.S. Public Finance: Investment Guidelines than contemplated above may not be appropriate for structured finance transactions. Investment requirements for escrow accounts for refunded bonds are marked with an asterisk. Any security used for defeasance provides for the timely payment of principal and interest and callable or prepayable prior to maturity or earlier redemption of the rated debt (see "Public Finance Criteria: Defeasance"). The following investments are eligible for 'AAA' rated transactions: (1*) Certain obligations of, or obligations guaranteed as to principal and interest by, the U.S. government or any agency or instrumentality thereof, when these obligations are backed by the full faith and credit of the United States. As Standard & Poor's does not explicitly rate all such obligations, the obligation must be limited to those instruments that have a predetermined fixed dollar amount of principal due at maturity that cannot vary or change. If it is rated, the obligation should not have an 'r' suffix attached to its rating. For non-defeasance investments, interest may either be fixed or variable. If the investments may be liquidated prior to their maturity or are being relied on to meet a certain yield, additional restrictions are necessary. Interest should be tied to a single interest rate index plus a single fixed spread (if any) and should move proportionately with that index. These investments include but are not limited to: U.S. Treasury obligations (all direct or fully guaranteed obligations); Farmers Home Administration Certificates of Beneficial Ownership; General Services Administration participation certificates; U.S. Maritime Administration guaranteed Title XI financing; Small Business Administration guaranteed participation certificates and guaranteed pool certificates; GNMA guaranteed MBS and participation certificates (defeasances only); U.S. Department of Housing and Urban Development local authority bonds; and Washington Metropolitan Area Transit Authority guaranteed transit bonds. (2) Federal Housing Administration debentures. (3*) Certain obligations of government-sponsored agencies that are not backed by the full faith and credit of the United States. As Standard & Poor's does not explicitly rate all these obligations, they must be limited to instruments that have a predetermined fixed dollar amount of principal due at maturity that cannot vary. If it is rated, the obligation should not have an 'r' suffix attached to its rating. For non-defeasance investments, interest may either be fixed or variable. If the investments may be liquidated prior to their maturity, or are being relied on to meet a certain yield, additional restrictions are necessary. Interest should be tied to a single interest rate index plus a single fixed spread (if any) and move proportionately with that index. These investments are limited to: Federal Home Loan Mortgage Corp. (FHLMC) debt obligations; Farm Credit System (formerly Federal Land Banks, Federal Intermediate Credit Banks, and Banks for Cooperatives) consolidated system-wide bonds and notes; Federal Home Loan Banks (FHL Banks) consolidated debt obligations; Federal National Mortgage Association (FNMA) debt obligations; Student Loan Marketing Association (SLMA) debt obligations; Financing Corp. (FICO) debt obligations; and Resolution Funding Corp. (REFCORP) debt obligations. JUNE 25,

332 Criteria Governments U.S. Public Finance: Investment Guidelines (4) Certain federal funds, unsecured certificates of deposit, time deposits, banker's acceptances, and repurchase agreements having maturities of not more than 365 days, of any bank, the short-term debt obligations of which are rated 'A-1+' by Standard & Poor's. In addition, the instrument should not have an 'r' suffix attached to its rating and its terms should have a predetermined fixed dollar amount of principal due at maturity that cannot vary or change. Interest may either be fixed or variable. If the investments may be liquidated prior to their maturity or are being relied on to meet a certain yield, additional restrictions are necessary. Interest should be tied to a single interest rate index plus a single fixed spread (if any) and should move proportionately with that index. (5) Certain deposits that are fully insured by the Federal Deposit Insurance Corp. (FDIC). The deposit's repayment terms have a predetermined fixed dollar amount of principal due at maturity that cannot vary or change. If rated, the deposit should not have an 'r' suffix attached to its rating. Interest may either be fixed or variable. If the investments may be liquidated prior to their maturity or are being relied on to meet a certain yield, additional restrictions are necessary. Interest should be tied to a single interest rate index plus a single fixed spread (if any) and should move proportionately with that index. (6) Certain debt obligations maturing in 365 days or less that are rated 'AA-' or higher by Standard & Poor's. The debt should not have an 'r' suffix attached to its rating and by its terms have a predetermined fixed dollar amount of principal due at maturity that cannot vary or change. Interest can be either fixed or variable. If the investments may be liquidated prior to their maturity or are being relied on to meet a certain yield, additional restrictions are necessary. Interest should be tied to a single interest rate index plus a single fixed spread (if any) and should move proportionately with that index. (7) Certain commercial paper rated 'A-1+' by Standard & Poor's and maturing in 365 days or less. The commercial paper should not have an 'r' suffix attached to its rating and by its terms have a predetermined fixed dollar amount of principal due at maturity that cannot vary or change. Interest may either be fixed or variable. If the investments may be liquidated prior to their maturity or are being relied on to meet a certain yield, additional restrictions are necessary. Interest should be tied to a single interest rate index plus a single fixed spread (if any) and should move proportionately with that index. (8) Investments in certain short-term debt of issuers rated 'A-1' by Standard & Poor's may be permitted with certain restrictions. The total amount of debt from 'A-1' issuers must be limited to the investment of monthly principal and interest payments (assuming fully amortizing collateral). The total amount of 'A-1' investments should not represent more than 20% of the rated issue's outstanding principal amount and each investment should not mature beyond 30 days. Investments in 'A-1' rated securities are not eligible for reserve accounts, cash collateral accounts, or other forms of credit enhancement in 'AAA' rated issues. In addition, none of the investments may have an 'r' suffix attached to its rating. The terms of the debt should have a predetermined fixed dollar amount of principal due at maturity that cannot vary. Interest may either be fixed or variable. If the investments may be liquidated prior to their maturity or are being relied on to meet a certain yield, additional restrictions are necessary. Interest should be tied to a single interest rate index plus a single fixed spread (if any) and should move proportionately with that index. Short-term debt includes commercial paper, federal funds, repurchase agreements, unsecured certificates of deposit, time deposits, and banker's acceptances. JUNE 25,

333 Criteria Governments U.S. Public Finance: Investment Guidelines (9) Investment in money market funds rated 'AAAm' or 'AAAm-G' by Standard & Poor's. (10*) Stripped securities: principal-only strips and interest-only strips of noncallable obligations issued by the U.S. Treasury, and REFCORP securities stripped by the Federal Reserve Bank of New York. (11) Any security not included in this list may be approved by Standard & Poor's after a review of the specific terms of the security and its appropriateness for the issue being rated. In addition to the permitted investments listed above, guaranteed investment contracts are also eligible investments subject to certain terms and conditions (see "Public Finance Criteria: Review of Investment Agreements for Municipal Revenue Bond Financings" and "Public Finance Criteria: Joint Support to Investment Agreements"). JUNE 25,

334 Copyright 2015 Standard & Poor's Financial Services LLC, a part of McGraw Hill Financial. All rights reserved. No content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor's Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an "as is" basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT'S FUNCTIONING WILL BE UNINTERRUPTED, OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages. Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P's opinions, analyses, and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw, or suspend such acknowledgement at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal, or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof. S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain nonpublic information received in connection with each analytical process. S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, (free of charge), and and (subscription) and (subscription) and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at JUNE 25,

335 Criteria Governments U.S. Public Finance: U.S. Public Finance Long-Term Municipal Pools: Methodology And Assumptions Primary Credit Analyst: James M Breeding, Dallas (1) ; james.breeding@standardandpoors.com Secondary Credit Analysts: Scott D Garrigan, Chicago (1) ; scott_garrigan@standardandpoors.com John A Sugden, New York (1) ; john_sugden@standardandpoors.com Criteria Officer, U.S. Public Finance And International Public Finance: James M Wiemken, London ; james_wiemken@standardandpoors.com Table Of Contents I. SCOPE OF THE CRITERIA II. SUMMARY OF THE CRITERIA III. CHANGES FROM THE REQUEST FOR COMMENT IV. IMPACT ON OUTSTANDING RATINGS V. EFFECTIVE DATE AND TRANSITION VI. METHODOLOGY A. Overall Framework For Rating Municipal Pool Programs B. Enterprise Risk Score C. Financial Risk Score MARCH 19,

336 Table Of Contents (cont.) VII. APPENDIX A: Example Application Of Default And Recovery Parameters To Program Cash Flows VIII. APPENDIX B: Example Of The Largest Obligor Test For A 'AAA' Rated Municipal Pool Program IX. APPENDIX C: Comments Received Following The RFC Publication X. RELATED CRITERIA AND RESEARCH MARCH 19,

337 Criteria Governments U.S. Public Finance: U.S. Public Finance Long-Term Municipal Pools: Methodology And Assumptions (Editor's Note: We originally published this criteria article on March 19, We're republishing this article following our periodic review completed on March 20, 2015.) 1. Standard & Poor's Ratings Services is refining its methodology and assumptions for rating U.S. public finance issues and issuers backed by long-term municipal pools. These criteria fully supersede "Long-Term Municipal Pools", published Oct. 19, This article is related to our criteria article "Principles Of Credit Ratings," published Feb. 16, Long-term municipal pool programs (hereafter referenced as municipal pool programs) vary in structure, funding, and purpose. Examples of municipal pool programs range from government-supported state revolving funds and bond bank programs to more localized private sector-related economic development programs and pool programs that enjoy only a tangential relationship with a quasigovernmental organization. Most programs operate only in a single state. 4. The criteria reference criteria for bond insurers and municipal and corporate collateralized debt obligations (CDOs), reflecting the similarities in structure and purpose. The use of the other criteria reflects a desire to further illustrate comparability across sectors. Accordingly, readers should also reference the following articles: "CDOs And Pooled TOBs Backed By U.S. Municipal Debt: Methodology And Assumptions", published March 13, 2012 (the Muni CDO criteria), "Bond Insurance Rating Methodology And Assumptions", published Aug. 25, 2011 (the bond insurance criteria), and "Update To Global Methodologies And Assumptions For Corporate Cash Flow And Synthetic CDOs", published Sept. 17, 2009 (the corporate CDO criteria). 5. While the criteria reference these similarities, they also recognize that the public purpose nature of municipal pool programs affect credit quality. Public-sector objectives of funding infrastructure improvements and recycling this money in a sustainable manner can result in different risk-taking behavior relative to the goals of maximizing yield return or profit. The methodology therefore uses a public finance enterprise framework to assess both enterprise and financial risk, consistent with other types of municipal enterprises. I. SCOPE OF THE CRITERIA 6. These criteria apply to ratings on U.S. public finance transactions backed by long-term municipal pool programs. MARCH 19,

338 Criteria Governments U.S. Public Finance: U.S. Public Finance Long-Term Municipal Pools: Methodology And Assumptions II. SUMMARY OF THE CRITERIA 7. The criteria apply to ratings on transactions backed by municipal pool programs using an overall framework that considers the enterprise risk and financial risk scores characterizing a program. The chart below summarizes this framework. Industry risk, market position, and geographic concentration of the area served determine the enterprise risk score. Loss coverage carries the most weight in the financial risk score, with operating performance and financial policies and practices playing a lesser role. The CDO evaluator methodology detailed in the Muni CDO criteria is the starting point for the loss coverage score. For state-sponsored municipal pools with management powers to influence better local performance, the criteria apply the recovery levels presented in table 12 of the bond insurance criteria. The largest obligor test may further worsen the loss coverage score. 8. Absent overriding factors, the final rating outcome for a municipal pool program will be within one notch of the indicative rating resulting from the combination of the financial and enterprise risk scores shown in table 1. To receive a 'AAA' rating, a municipal pool program should also pass the leverage test presented in paragraph MARCH 19,

339 Criteria Governments U.S. Public Finance: U.S. Public Finance Long-Term Municipal Pools: Methodology And Assumptions MARCH 19,

340 Criteria Governments U.S. Public Finance: U.S. Public Finance Long-Term Municipal Pools: Methodology And Assumptions III. CHANGES FROM THE REQUEST FOR COMMENT 9. On Dec. 1, 2011, Standard & Poor's published "Request For Comment: U.S. Public Finance Long-Term Municipal Pools: Methodology And Assumptions". Several market participants submitted responses addressed to the criteria comments mailbox. Following a review of these responses, we clarified the largest obligor test and leverage test portions of the methodology and made a small change to the scoring ranges for operating performance in table 8. IV. IMPACT ON OUTSTANDING RATINGS 10. Standard & Poor's currently maintains ratings on debt associated with 88 different state-specific municipal pool programs. This includes multiple liens within certain programs. Preliminary testing suggests that: The ratings on about 83% of the programs will likely not change. These unaffected programs predominantly constitute state revolving funds and many state bond banks. The ratings on about 13% of the programs could decline by as much as one rating category (up to three notches). The ratings on about 4% of the programs could decline by more than one rating category. V. EFFECTIVE DATE AND TRANSITION 11. These criteria are effective immediately for all new and outstanding municipal pool ratings. A review of all outstanding ratings will occur within six months from the date of publication. VI. METHODOLOGY A. Overall Framework For Rating Municipal Pool Programs 12. The criteria result in ratings for transactions backed by municipal pool programs based on an overall framework that considers both the enterprise risk and the financial risk scores of a program. The enterprise risk score results from the assessment of industry risk, market position, and geographic concentration. The financial risk score results from the assessment of loss coverage, operating performance, and financial policies and practices. The final rating results from the combination of the enterprise risk and financial risk scores, as shown in table 1. Absent overriding factors, the final issue or issuer rating will fall within one notch of the indicative rating outcomes shown, with one-notch deviations resulting from the presence of significantly favorable or unfavorable credit features. Table 1 Determining The Indicative Rating Outcome For The Municipal Pool Program Enterprise Risk Score Financial Risk Score 1 Extremely Strong 2 Very Strong 3 Strong 4 Adequate 5 Vulnerable 6 Highly Vulnerable 1 Extremely Strong aaa aa+ aa- a bbb bb 2 Very Strong aa+ aa a+ a- bbb- bb- 3 Strong aa- a+ a bbb+ bb+ b+ MARCH 19,

341 Criteria Governments U.S. Public Finance: U.S. Public Finance Long-Term Municipal Pools: Methodology And Assumptions Table 1 Determining The Indicative Rating Outcome For The Municipal Pool Program (cont.) 4 Adequate a+ a a- bbb bb b 5 Vulnerable bbb+ bbb bbb- bb+ b+ b- 6 Highly Vulnerable bbb- bb bb- b+ b- ccc Absent overriding factors, the final rating outcome for the municipal pool program will be within one notch of the indicative rating resulting from the combination of the financial and enterprise risk scores shown above. To receive a AAA rating, a municipal pool program must also pass the leverage test specified in the bond insurance criteria. A terminating municipal pool program that maintained all other credit fundamentals could maintain a rating equal to the lowest-rated pool participant if no other factors besides loss coverage suggested a lower rating (see paragraph 13). 13. The final rating assigned could further differ from table 1 in four instances. First, where a municipal pool program is winding down, the rating could remain as high as the lowest-rated participant in the pool if no other factors apart from the loss coverage score deteriorated to a point suggesting a lower rating. This reflects the diminished value of the CDO evaluator analysis as the number of loan participants drops below 10. Second, if an issue would otherwise qualify for a 'AAA' rating, the transaction should also pass a leverage test consistent with that presented in paragraph 15. Third, the final rating could move up by a maximum of one notch over the indicative rating due to significantly favorable credit features. These include the municipal pool program being able to withstand a stressed default level in excess of 1.5x the level determined by the CDO Evaluator, or a history of exceptionally low loan delinquencies (0%) for the past five years. Finally, the rating could move lower by a maximum of one notch for significantly unfavorable credit features. These include the likelihood for significant additional parity debt to be issued without a commensurate increase in collateralization levels, such that the current loss coverage score is likely unsustainable, or a multiyear history of high (more than 6%) recurring loan delinquency rates. These positive and negative credit features could potentially be offsetting. 14. While Standard & Poor's CDO evaluator model is a valuable tool for assessing a municipal pool programs' loss coverage, no single model can capture the full range of possibilities, relationships, and evolution that can occur during times of stress. Consequently, the criteria supplement our analysis with a leverage test that serves as an independent constraint on the amount of exposure a 'AAA' rated program can have relative to its available reserves and program revenues. This test addresses both event risk and model risk that might be present. The test is restricted to 'AAA' programs because of the view that the possibility of stress associated with either model error or event risk is remote and not captured by the 'AAA' stress in the model. Moreover, limiting leverage is consistent with 'AAA' credit stability (see "Methodology: Credit Stability Criteria", published May 3, 2010). 15. Paragraph 38 of the bond insurance criteria details the maximum leverage level. For these criteria, leverage is defined as the ratio of total debt service payable to revenues and reserves available for repayment, or total loan revenue receivable plus pledged reserves, divided by total bond debt service payable. The criteria limit the rating on a pool program exceeding the maximum leverage consistent with a 'AAA' rating to no higher than 'AA+', with the actual level determined by the application of the remainder of the criteria. B. Enterprise Risk Score 16. To calculate the enterprise risk score, the criteria first score industry risk and market position. Scores for each range from '1' (the strongest) to '6' (the weakest). Second, these two scores combine to form the initial enterprise risk score as MARCH 19,

342 Criteria Governments U.S. Public Finance: U.S. Public Finance Long-Term Municipal Pools: Methodology And Assumptions detailed in table 4. Finally, the outcome of this initial score may then move up (worsen) if the pool program predominantly serves only one metropolitan area. 1. Industry risk 17. The criteria assess industry risk using the methodology detailed in paragraphs 110 and 111 and table 21 of the bond insurance criteria. Primary sub-factors for scoring industry risk are: Cyclicality and volatility of operating revenues, Competitive and growth environment, Industry operating and cost structure and risk, Capital, funding, and liquidity characteristics, and Governmental/legal and regulatory environment. 18. Table 2 details typical municipal pool program characteristics associated with the industry risk categories. Currently, overall industry risk for government and not-for-profit municipal pool programs equates to an industry risk score of '2' (low risk). These programs generally enjoy favorable government and regulatory environments and solid, if unspectacular, growth potential. Loss potential has historically remained low, with programs emphasizing tax-backed and essential-service credits experiencing smaller losses and less volatility than programs incorporating more corporate, nonprofit, or land-based risk in their loan portfolios. Questions about continued government support for recipient programs and a sometimes commodity-like pricing environment for those without government subsidies limit these positive elements. Table 2 Municipal Pool Industry Risk Sub-factors* Risk factor U.S. municipal pools Cyclicality and volatility of operating earnings Competitive and growth environment Industry operating and cost structure and risk Capital, funding, and liquidity characteristics Governmental/legal and regulatory environment Overall industry risk score Low risk Intermediate risk Very low risk Intermediate risk Very low risk Low risk (2) *See paragraphs 18 and With respect to the industry risk sub-factors, the maturity and historically modest cyclicality associated with the U.S. public finance debt market results in a low risk assessment. Overall, competition and the threat of substitute products or services for the U.S. public finance market is an intermediate risk. Letters of credit and bond insurers represent substitute products in the municipal market but can be cyclical depending on banking-sector issues, bank capacity, and competition. Municipal pool programs have a very low-risk cost structure with both low operating costs and labor costs, given their modest staffing and infrastructure needs. Competitive new programs often prove difficult to initiate without government support or other capital in addition to an existing portfolio of loans. U.S. municipal pool programs principally focused on the general obligation (GO) and municipal utility sectors face a very low risk for a major loss. Governmental, legal, and regulatory conditions pose very low risk to the programs, apart from ongoing funding, which is captured in the assessment of funding and liquidity characteristics. MARCH 19,

343 Criteria Governments U.S. Public Finance: U.S. Public Finance Long-Term Municipal Pools: Methodology And Assumptions 2. Market position 20. The market position score reflects the level of government support received and the presence of significant challenges that could affect demand. Programs that enjoy regular capital infusions from multiple layers of government and which are established through legislative action receive the highest score. Programs that lack legislative authorization, have no formal direct link to governments, and receive no public funding are scored lower. Programs facing equity withdrawals from their sponsoring entity receive a lower score, and programs facing challenges that will likely harm future demand significantly will receive the lowest score. Examples of such challenges could include government investigation into the program's legitimacy or other legal standing, program mismanagement or program deterioration. Table 3 details the scoring methodology for market position. Table 3 Market Position 1 (Extremely strong) Ongoing support comes from several levels of government (federal, state, local, etc.) leading to growing equity positions; establishment of the program exists in statute and a governmental entity manages the program. 2 (Very strong) Ongoing support comes from one level of government and exists in the form of direct equity contributions or explicit statutory authority to support debt service if needed. Establishment of the program exists in statute and a governmental entity manages the program. All funds remain within the organization rather than being transferred to the government for other purposes. 3 (Strong) A governmental entity manages the program, but little government funding support has occurred and no further infusions are expected. State or local statutes establish the program, but no explicit statutory authority for the government to support debt service exists. Provisions or precedents exist for dividends or other transfers outside the organization. 4 (Adequate) A governmental entity manages a program not established by government statute, or a quasigovernmental entity manages the program, regardless of its method of establishment. 5 (Less vulnerable) 6 (More vulnerable) A private entity manages the program, with no formal relationship to governmental entities and no public investment. The program faces significant legal or reputational challenges apart from competing programs that we believe will harm future demand in a significant way. 3. Combining industry risk and market position with geographic concentrations 21. The industry risk and market position scores combine to form the initial enterprise risk scores in table 4. Because a program's geographic concentration can further limit demand, programs that target only one metropolitan area receive a one-notch negative adjustment. Table 4 Deriving The Enterprise Risk Score Market position score Industry risk score Very low Low Intermediate High Very high Extremely high The final enterprise risk score equals the score resulting from the combination of the market position score and industry risk score, adjusted up (worsened) one notch if the program predominantly serves one metropolitan area. MARCH 19,

344 Criteria Governments U.S. Public Finance: U.S. Public Finance Long-Term Municipal Pools: Methodology And Assumptions C. Financial Risk Score 22. To calculate the financial risk score, the criteria first assess loss coverage, which plays the dominant role in the score. Second, the criteria score operating performance and financial policies and practices and calculate the average of these two scores. Finally, the level of this average may move the overall financial risk score one notch away from the loss coverage score, as detailed in table 5. The criteria average the operating performance and financial policies and practices scores with equal weight, and decimal outcomes are rounded to the nearest whole number. Table 5 Determining The Overall Financial Risk Score If the average of the operating performance and financial policies scores is: 1 or 2 (Strong) 3 or 4 (Adequate) 5 or 6 (Weak) The overall financial risk score equals The loss coverage score minus one The loss coverage score The loss coverage score plus one 1. Loss Coverage Score 23. The criteria measure loss coverage at the program or parity indenture level by determining the highest rating attainable given the program's loan portfolio, overcollateralization, and cash flow pattern. The loss coverage score equals the score associated with the highest rating category attainable under the CDO evaluator test, adjusted for performance against the largest obligor test as per table 6. Table 6 Determining The Loss Coverage Score Score 1 (Extremely strong) AAA 2 (Very strong) AA 3 (Strong) A 4 (Adequate) BBB 5 (Vulnerable) BB 6 (Highly vulnerable) B (or lower) Highest rating category attainable using the CDO Evaluator, cash flow analysis, and largest obligor test* The loss coverage score equals the score associated with the highest rating category achievable based on the CDO Evaluator test, adjusted up one notch (worsened) if the program scores least favorable on the largest obligor test. * See paragraphs a) CDO evaluator and cash flow application 24. To determine relative default rates given the credit quality of an underlying loan portfolio, the criteria use Standard & Poor's CDO Evaluator and assumptions as detailed in the Muni CDO criteria. Relevant assumptions and references from the Muni CDO criteria include: Use of the same methodology for assigning obligor exposures based on security type as described in paragraphs 15-17, Use of the same underlying municipal industry classifications as those detailed in Appendix A, and Use of the CDO Evaluator modeling parameters described in paragraphs Following the determination of the scenario default rate (SDR), the criteria also use assumptions from the Muni CDO criteria to determine recoveries. Where underlying loans have different recovery rates, the criteria use a weighted MARCH 19,

345 Criteria Governments U.S. Public Finance: U.S. Public Finance Long-Term Municipal Pools: Methodology And Assumptions average recovery rate based on loan balances outstanding. Relevant assumptions include: Use of the same recovery groupings described in table 1 of the Muni CDO criteria, and Use of the same recovery rate parameters described in table 3 of the Muni CDO criteria. 26. However, for state-sponsored programs that have powers to influence local borrower behavior, the criteria use the higher recovery rates specified in table 12 of the bond insurance criteria. Examples of such influence include program involvement of a regulatory or oversight authority, state intercept provisions, or other measures to compel or remedy borrower nonpayments without court action. 27. State-sponsored programs also often have large reserve balances pledged to cover losses. The criteria recognize the full amount of reserve balances invested in guaranteed investment contracts meeting our counterparty criteria (see "Counterparty And Supporting Obligations Methodology And Assumptions", published Dec. 6, 2010) and reserve balances in other instruments meeting eligible investments criteria (see "Investment Guidelines", published June 25, 2007). Otherwise, the criteria include reserve balances as assets in the CDO evaluator and receive related reductions in value. 28. The criteria then apply these default (SDR) and recovery assumptions to program cash flows to determine whether the municipal pool program has sufficient loss coverage at a given rating level from surplus revenues or reserves. The criteria assume that losses begin over a consecutive four-year period, with 25% of the losses occurring each year. Recovery timing parameters are those detailed in table 2 of the Muni CDO criteria. In order to receive a score commensurate with the rating level detailed in table 6, a program should have sufficient loss coverage across the entire amortization of related debt. See the Appendix A for an example of the application of these assumptions to program cash flows. b) The largest obligor test 29. While the CDO evaluator addresses the question of reserves and surplus relative to a severe, wide-scale stress environment, the largest obligor test addresses credit stability in the context of occasional, large discrete defaults by individual obligors. Large exposures to a small number of defaulting issuers could threaten a pool program's viability. 30. For this reason, Standard & Poor's standardizes largest obligor metrics calculated for exposures to individual issuers or issues. The approach reflects the possibility that, even in a benign credit environment, a small number of issuers or issues could suffer large discrete losses for idiosyncratic reasons. The methodology measures the possible default of a minimum number of the largest obligor exposures within the loan portfolio, factoring in the underlying assets' credit quality, against available reserves and repayment surplus. The largest obligor test reflects the expectation that the severity of the loss will be great, differentiated by the recovery characteristics of the obligor's sector. 31. Table 1 in the corporate CDO criteria specifies different combinations of the number of exposures that must be covered to pass the largest obligor test, depending on the desired tranche or issue rating. The municipal pool criteria use the set of thresholds in table 1 commensurate with the initial loss coverage score as determined by paragraphs 24 through 28 above. For example, a program receiving a '1' score under the CDO Evaluator test would use the 'AAA' tranche thresholds detailed in table 1 of the corporate CDO criteria. The total amount of this exposure expressed as a percentage of total loans outstanding represents a second default rate that the program should withstand using the MARCH 19,

346 Criteria Governments U.S. Public Finance: U.S. Public Finance Long-Term Municipal Pools: Methodology And Assumptions cash flow analysis detailed in paragraph 28. This test also uses lower assumed recovery rates as detailed in table 14 of the bond insurance criteria. To achieve a "favorable" score, the municipal pool program should have a sufficient combination of reserves and surplus revenues to cover the losses resulting from these assumptions. Otherwise, the resulting score is "least favorable" and the loss coverage score will be adjusted by When a municipal pool program has more than one debt instrument from the same obligor, the criteria aggregate such debts as a single obligor for this analysis if those instruments have the same rating and the same security. When the issue ratings are different, only those exposures that are rated within the largest obligor analysis parameters will be aggregated. For example, assume the loan portfolio holds two rated issues from the same obligor, one with a 'AA-' rating and another with a 'A+' rating. When aggregating exposures for assets rated below 'AAA', both issues would be aggregated. However, when aggregating exposures for issuers rated below 'AA-', the 'AA-' rated instrument would not be included because under this analysis, only obligor issues up to the 'A+' rating are aggregated. See Appendix B for an example of the application of the largest obligor test. c) Credit estimates for the CDO evaluator test 33. The use of CDO Evaluator requires credit estimates for each individual borrower in the program. Standard & Poor's public issuer credit ratings or issue ratings secured by the same pledge of the borrower will serve this purpose if these exist. If such ratings do not exist, we will use available information in our assignment of a credit estimate to each borrower. Where no information exists for a borrower, the criteria establish guidelines for assigning credit estimates according to the nature of the security, as specified in table 7. The credit estimate represents the highest rating we would assign absent information. Lower estimates could result depending on credit-specific concerns. Table 7 Maximum Credit Estimate Levels Absent Additional Information Type of loan security Tax-backed general obligation pledges, water-sewer revenues, sales, income, or gas tax pledges, public universities, and Federal Housing Administration housing financings Tax-backed general fund or appropriation pledges, obligations backed by public power, solid waste, gas utility, airport, or other transportation revenues, state agency single family housing financings, housing finance agency financings, and public housing authority financings Other special tax pledges, including special assessment and tax increment revenues. Local agency single-family financings All other municipal financings Nonmunicipal obligations Credit Estimate bbb bbbbb b ccc 2. Operating Performance 34. Operating performance consists of two measures: the number of nonperforming loans as a percentage of total loans and the percentage of payments more than five days late in the past 12 months. These measures address the degree to which a program is proactive in its management of more-challenging loans. Because these factors are meant to assess repayment management rather than loan quality, both factors are measured at the organizational level to provide a broader view. A nonperforming loan is defined as a loan more than 90 days late in payment. A loan more than five days late is included in our second calculation even if the delay is not an event of default under the loan agreement. The criteria measure both statistics as a percentage of the total number of loans outstanding, rather than as a percentage of the total loan par amount outstanding, again due to the focus on management performance instead of MARCH 19,

347 Criteria Governments U.S. Public Finance: U.S. Public Finance Long-Term Municipal Pools: Methodology And Assumptions payment impact. Table 8 details the scoring for these measures. By definition, the nonperforming loans score cannot be lower (better) than the late payments score. Table 8 Scoring For Nonperforming Loans As A Percentage Of The Total And Percentage Of Loans More Than Five Days Late In The Past 12 Months* Score Threshold range 1 (Extremely low) 0% 2 (Very low) 0%-2% 3 (Low) 2%-4% 4 (Moderate) 4%-6% 5 (High) 6%-10% 6 (Very high) Greater than 10% Except for 0%, an outcome occurring exactly at the threshold for two scores will receive the worse score. For example, nonperforming loans of exactly 2% would receive a score of 3. *See paragraphs 34 and The average of the nonperforming loans score and the late payments score represents the operating performance score. Any fractional number result is rounded up to the next whole number. 3. Financial Policies And Practices 36. Financial policies and practices considered include those governing loan origination, loan monitoring, default remedies, long-term planning, and investment policies. Such policies may exist at a program or organizational level. When different policies for different programs exist, the criteria consider the policies associated with the rated program. Tables 9-13 detail the attributes of each component associated with scores of one, three, and five. A pool program does not need to display all of the attributes associated with a given score but should display a preponderance of attributes. A score of two results from a roughly equal mix of attributes in the one and three categories, while a score of four results from a roughly equal mix of attributes in the three and five categories. The final financial policies score results from the average of the five component scores, with each component receiving equal weight. Final averages are rounded to the nearest whole number to determine the score. However, regardless of this average, a score of six would result from program management not maintaining any clear written policies or internal procedures to monitor financial or investment performance, with an inability to demonstrate a clear understanding of long-term program goals or demand. Table 9 Loan Origination Policies* 1 (Strong) Formal guidelines exist for loan application approval that include credit considerations. Management performs credit reviews for all new loan applications. Application approvals reflect strong adherence to established guidelines. 3 (Adequate) Guidelines exist for loan application approvals, but such guidelines are less formal and detailed and may lack credit considerations. Some credit reviews of loan applicants take place, but not all applicants receive such reviews. When approving loan applications, management considers established guidelines but has discretion with regard to their use. 5 (Weak) Program management discretion rather than established guidelines or reviews drive loan application approval. *See paragraph 36 Table 10 Loan Monitoring Policies* 1 (Strong) Management requires program participants to submit annual audited statements, and program staff reviews all program participants' financial condition at least annually. MARCH 19,

348 Criteria Governments U.S. Public Finance: U.S. Public Finance Long-Term Municipal Pools: Methodology And Assumptions Table 10 Loan Monitoring Policies* (cont.) 3 (Adequate) Management requires all borrowers to submit financial information at least biennially but less than annually or management requires only certain participants to submit financial information annually. Program staff reviews all program participants financial condition at least biennially but less than annually, or program staff reviews only certain participants' financial condition annually. 5 (Weak) Management does not require program participants to submit financial information following the loan application process, and management does not conduct any financial reviews of program participants. *See paragraph 36 Table 11 Default And Delinquency Policies* 1 (Strong) Management has formal policies to address loan payment delinquencies on a timely basis to limit the risk to program debt service. Borrowers make loan payments more than 10 days prior to program bond debt service payments. 3 (Adequate) Management has plans for addressing payment delinquencies, but they lack a formal, timely, or specific nature. Borrowers make loan payments between five and 10 days prior to program debt service payments. 5 (Weak) No policies or practices exist to address payment delinquencies. Borrowers make loan payments less than five days prior to program debt service payments. *See paragraph 36 Table 12 Long-term Planning* 1 (Strong) Management prioritizes future loan demand based on a specific set of criteria. Management has regular and ongoing communications with relevant parties to maintain a current view of future loan demand, and updates a long-term funding plan at least annually. Plan updates include the consideration of program credit impacts associated with potential future participants. 3 (Adequate) Management prioritizes projects only based on consistency with the program s stated or statutory goals. No formal criteria exist for ranking projects in order of priority. management updates long term plans or demand studies no more often than biennially. Management considers the credit implications associated with potential borrowers only at the time of financing or loan approval. 5 (Weak) Management does not engage in formal long term planning, routinely approves projects with little consideration for long term impacts, and has not updated a demand study in the last five years. *See paragraph 36 Table 13 Investment Policies* 1 (Strong) Program management has its own investment policy over and above requirements specified by state statues. The policy addresses credit risk, reinvestment procedures, and liquidity risk and liquidation procedures. The policy requires program management to address instances where asset movements deviate from policy guidelines. Program management reviews investment performance and compliance with the policy at least quarterly. 3 (Adequate) Program management has its own investment policy, but the policy contains little detail above those specified by state statutes. The policy addresses credit risk and reinvestment, but do not address liquidation procedures. The policy does not require program management to address instances where asset movements deviate from policy guidelines. Program management reviews investment performance and compliance with the policy less than quarterly but at least annually. 5 (Weak) Program management does not have its own investment policy and instead looks only to comply with state statutes. Program management reviews investment performance and compliance less than annually. *See paragraph 36 VII. APPENDIX A: Example Application Of Default And Recovery Parameters To Program Cash Flows 37. The example below uses assumed loan repayments from pool borrowers totaling $1 million each year, a 'AAA' scenario default rate of 20% (as determined by the CDO Evaluator), and a recovery rate of 85% for a 'AAA' rated pool. Defaults in the example begin in year one, with 25% of the defaults beginning each year for four years. Recoveries of MARCH 19,

349 Criteria Governments U.S. Public Finance: U.S. Public Finance Long-Term Municipal Pools: Methodology And Assumptions initially defaulted amounts occur four years after the default, with recoveries recognized at the scheduled payment date thereafter. Thus, the current effective recovery rate represents 85% of the default rate four years ago. 38. To calculate net revenues received each year, the example subtracts defaulted payments from scheduled annual loan payments and adds back recovered payments from prior periods. Defaulted payments result from multiplying the scheduled annual loan payments by the net current default rate. Recovered payments from prior periods represent 85% of the defaulted payments for each year in which defaults commenced, lagged by four years. In each year, net revenues received must be sufficient to cover debt service due, or available reserves must cover the shortfall. If reserves do not cover the shortfall, the program does not receive the loss coverage score associated with that rating level ('AAA' in this case). Table 14 Application Of Default And Recovery Parameters To Program Cash Flows* Period Annual Scheduled Loan Payments ($) Annual Default Rate (%) Current Effective Recovery Rate (%) Net Current Default Rate (%) Defaulted Payments ($) Recovered Payments from Prior Periods ($) Net Revenues Received ($) ,000, , , ,000, , , ,000, , , ,000, , , ,000, ,500 42, , ,000, ,000 85, , ,000, , ,500 1,055, ,000, , ,000 1,140, ,000, , ,875 1,103, ,000, ,000 97,750 1,067, ,000, ,000 61,625 1,031, ,000, , , ,000, , , ,000, , ,000 *See paragraphs 37 and 38. VIII. APPENDIX B: Example Of The Largest Obligor Test For A 'AAA' Rated Municipal Pool Program 39. As in the criteria for rating corporate CDOs and municipal CDOs, the criteria for rating long-term municipal pools assess whether the rated program is projected to withstand the defaults of a minimum number of the largest obligor exposures within the portfolio. If a pool scored a '1' in the CDO Evaluator test, suggesting it could withstand stresses at a 'AAA' level, the largest obligor test would apply the thresholds consistent with a 'AAA' tranche rating as detailed in table 1 of the corporate CDO criteria. Per that table, a pool rated 'AAA' is generally expected to have collateralization levels sufficient to withstand resulting losses from the default of the greater of these seven scenarios: The two largest exposures rated between 'AAA' and 'CCC-'; MARCH 19,

350 Criteria Governments U.S. Public Finance: U.S. Public Finance Long-Term Municipal Pools: Methodology And Assumptions The three largest exposures rated between 'AA+' and 'CCC-'; The four largest exposures rated between 'A+' and 'CCC-'; The six largest exposures rated between 'BBB+' and 'CCC-'; The eight largest exposures rated between 'BB+' and 'CCC-'; The 10 largest exposures rated between 'B+' and 'CCC-'; and The 12 largest exposures rated between 'CCC+' and 'CCC- 40. The data for table 15 represent a mock pool consisting of 30 loans to 30 separate borrowers, with $200 million of loan outstanding and collateralized with $20 million of pledged reserves. Also, in this case, the security for each loan is either a GO or water and sewer revenue pledge, so the assumed recovery rate equals 60% (see table 14 of the bond insurance criteria). Table 15 Sample Loan Portfolio Borrower Public Rating or Credit Estimate Loan Amount Outstanding ($) Gross Default ($) 1 AAA 10,000,000 2 AAA 10,000,000 20,000,000 3 AA+ 8,000,000 4 AA+ 8,000,000 5 AA+ 8,000,000 24,000,000 6 A+ 8,000,000 7 A+ 8,000,000 8 A+ 8,000,000 9 A+ 8,000,000 32,000, BBB+ 8,000, BBB+ 8,000, BBB+ 8,000, BBB+ 8,000, BBB+ 8,000, BBB+ 8,000,000 48,000, bbb 6,000, bbb 5,000, bbb 5,000, bbb 5,000, bbb 5,000, bbb 5,000, bbb 5,000, bbb 5,000, bbb 5,000, bbb 5,000, bbb 5,000, bbb 5,000, bbb 5,000, bbb 5,000, bbb 5,000,000 MARCH 19,

351 Criteria Governments U.S. Public Finance: U.S. Public Finance Long-Term Municipal Pools: Methodology And Assumptions 41. Table 16 shows the results for each of the seven scenarios outlined in paragraph 39. The largest of the seven scenarios results in a gross loss of $48 million. In this example, $48 million of gross defaults represents 24% of the loans payable. This 24% default level would be stressed against the cash flows as detailed in paragraph 28 using a 60% recovery rate. If the program fails to pass this test, then the result would be "least favorable" and a +1 adjustment made to the loss coverage score. Table 16 Largest Obligor Test Results Gross Defaults ($) 2 largest AAA 20,000,000 3 largest below AAA 24,000,000 4 largest below AA- 32,000,000 6 largest below A- 48,000,000 8 largest below BBB largest below BB largest below B- 0 IX. APPENDIX C: Comments Received Following The RFC Publication 42. On Dec. 1, 2011, Standard & Poor's published "Request For Comment: U.S. Public Finance Long-Term Municipal Pools: Methodology And Assumptions". Several market participants submitted responses. The comments addressed the questions for which we were seeking responses. 43. On the first question regarding agreement with the overall proposed framework for rating U.S. public finance municipal pools, the majority of comments reflected a desire for additional clarity in the criteria. 44. On the second question regarding views on the proposal to adopt the changes detailed in the CDO RFC as the measure for loss coverage, some respondents raised questions regarding the use of the same assumed default rates for corporate and municipal obligations. 45. On the third question regarding views on the supplemental tests, some responses sought additional clarity on the application of these tests. 46. On the fourth question regarding the relevance of measures above and beyond the loss coverage score, the comments suggested that the inclusion of these measures was beneficial but that the levels of the measures were too stringent. 47. Additional comments concerned the clarity of the criteria, particularly around the industry risk score. X. RELATED CRITERIA AND RESEARCH Request For Comment: U.S. Public Finance Long-Term Municipal Pools: Methodology And Assumptions, Dec. 1, 2011 CDOs And Pooled TOBs Backed By U.S. Municipal Debt: Methodology And Assumptions, March 13, MARCH 19,

352 Criteria Governments U.S. Public Finance: U.S. Public Finance Long-Term Municipal Pools: Methodology And Assumptions Update To Global Methodologies And Assumptions For Corporate Cash Flow And Synthetic CDOs, Sept. 17, 2009 Bond Insurance Rating Methodology And Assumptions, Aug. 25, 2011 Long-Term Municipal Pools, Oct. 19, 2006 Investment Guidelines, June 25, 2007 Counterparty And Supporting Obligations Methodology And Assumptions, Dec. 6, 2010 These criteria represent the specific application of fundamental principles that define credit risk and ratings opinions. Their use is determined by issuer- or issue-specific attributes as well as Standard & Poor's Ratings Services' assessment of the credit and, if applicable, structural risks for a given issuer or issue rating. Methodology and assumptions may change from time to time as a result of market and economic conditions, issuer- or issue-specific factors, or new empirical evidence that would affect our credit judgment. MARCH 19,

353 Copyright 2015 Standard & Poor's Financial Services LLC, a part of McGraw Hill Financial. All rights reserved. No content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor's Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an "as is" basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT'S FUNCTIONING WILL BE UNINTERRUPTED, OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages. Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P's opinions, analyses, and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw, or suspend such acknowledgement at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal, or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof. S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain nonpublic information received in connection with each analytical process. S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, (free of charge), and and (subscription) and (subscription) and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at MARCH 19,

354 Criteria Governments U.S. Public Finance: Methodology: Rating Approach To Obligations With Multiple Revenue Streams Criteria Officer and Primary Credit Analyst, U.S. Public Finance and International Public Finance: James M Wiemken, New York (44) ; james.wiemken@standardandpoors.com Table Of Contents I. SCOPE OF THE CRITERIA II. SUMMARY OF CRITERIA UPDATE III. IMPACT ON OUTSTANDING RATINGS IV. EFFECTIVE DATE AND TRANSITION V. METHODOLOGY RELATED CRITERIA AND RESEARCH NOVEMBER 29,

355 Criteria Governments U.S. Public Finance: Methodology: Rating Approach To Obligations With Multiple Revenue Streams (Editor's Note: This criteria article was originally published on Nov. 29, We're republishing this article following our periodic review completed on Nov. 30, 2014.) 1. Standard & Poor's Ratings Services is publishing its methodology for rating U.S. public finance obligations backed by pledges of multiple revenue streams. This article is related to our criteria article "Principles of Credit Ratings", which we published on Feb. 16, I. SCOPE OF THE CRITERIA 2. These criteria apply to issue ratings on U.S. public finance obligations. II. SUMMARY OF CRITERIA UPDATE 3. The rating approach for structures containing separate multiple revenue streams as the source of payments depends on whether they come from the same obligor and whether the individual revenue streams independently provide full coverage of debt service. Multiple revenue streams of the same obligor that do not individually provide full coverage of debt service receive a rating based on the volatility of the combined revenues taken as a whole. When multiple revenue streams of the same obligor do individually provide full coverage of debt service, the rating reflects the credit quality of the revenue stream having the highest credit quality. When multiple revenue streams from different obligors individually provide full coverage of debt service, our joint support criteria dictate the rating. III. IMPACT ON OUTSTANDING RATINGS 4. We do not anticipate any rating changes as a consequence of these criteria. IV. EFFECTIVE DATE AND TRANSITION 5. These criteria are effective immediately for all ratings on U.S. public finance revenue obligations. V. METHODOLOGY 6. The rating approach for structures containing separate multiple revenue streams as the source of payments depends on the correlation between revenue streams and the degree to which individual revenue streams provide full coverage of debt service. Different revenue streams pledged by the same obligor do not allow for the application of joint criteria because of the assumed high correlation of the revenue streams (see "Joint Support Criteria Update," published April NOVEMBER 29,

356 Criteria Governments U.S. Public Finance: Methodology: Rating Approach To Obligations With Multiple Revenue Streams 22, 2009). When the same obligor pledges several revenue streams and the combination of these revenues is likely necessary to pay debt service, the analysis considers the volatility of the revenue stream as a whole and the ability to cover debt service. When an obligor pledges multiple revenue streams where each is assumed capable of covering debt service (often one stream is the intended payment source and the other is provided as additional enhancement as with a double-barreled bond), the rating reflects our assessment of the pledged revenue stream with the higher credit quality if we believe that the additional revenue stream can be accessed in a timely manner. 7. When different obligors pledge multiple revenue streams on a several basis and each revenue stream will be necessary to pay debt service or each revenue stream pays only a portion of debt service, the rating reflects our assessment of the credit quality of the pledged revenue stream with the weakest credit quality, assuming it is necessary for debt service payment. Sector-specific criteria may specify other possibilities due to step-up provisions or other sources of financial flexibility. 8. Finally, when different obligors pledge multiple revenue streams and each revenue stream is capable of covering full debt service, the rating reflects the application of our joint criteria if the obligors are sufficiently uncorrelated. In most instances, however, public finance obligors are highly related; in these cases our rating reflects our assessment of the credit quality of the pledged revenue stream with the highest credit quality, again dependent on our expectation that the additional source can be accessed in a timely manner. Our view of the timeliness of financial assistance from this additional security could change over time, depending on the transaction specifics. RELATED CRITERIA AND RESEARCH Principles of Credit Ratings,Feb. 16, 2011 Joint Support Criteria Update, April 22, 2009 Methodology: Definitions And Related Analytic Practices For Covenant And Payment Provisions In U.S. Public Finance Revenue Obligations, Nov. 29, 2011 These criteria represent the specific application of fundamental principles that define credit risk and ratings opinions. Their use is determined by issuer- or issue-specific attributes as well as Standard & Poor's Ratings Services' assessment of the credit and, if applicable, structural risks for a given issuer or issue rating. Methodology and assumptions may change from time to time as a result of market and economic conditions, issuer- or issue-specific factors, or new empirical evidence that would affect our credit judgment. NOVEMBER 29,

357 Copyright 2015 Standard & Poor's Financial Services LLC, a part of McGraw Hill Financial. All rights reserved. No content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor's Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an "as is" basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT'S FUNCTIONING WILL BE UNINTERRUPTED, OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages. Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P's opinions, analyses, and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw, or suspend such acknowledgement at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal, or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof. S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain nonpublic information received in connection with each analytical process. S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, (free of charge), and and (subscription) and (subscription) and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at NOVEMBER 29,

358 Criteria Governments U.S. Public Finance: Pension Fund Credit Enhancement And Related Guarantee Programs Primary Credit Analysts: David G Hitchcock, New York (1) ; david.hitchcock@standardandpoors.com Robin L Prunty, New York (1) ; robin.prunty@standardandpoors.com Table Of Contents Pension Fund Guarantees Rating Analysis Assessing Creditworthiness SEPTEMBER 25,

359 Criteria Governments U.S. Public Finance: Pension Fund Credit Enhancement And Related Guarantee Programs (Editor's Note: This criteria article originally was published Sept. 25, We're republishing this article following our periodic review completed on Jan, 12, As a result of our review, we updated the author contact information.) Standard & Poor's Ratings Services, upon request, will assign ratings to issues secured by public pension fund credit enhancement programs. Even though some enhancement programs are relatively short-term in nature, or signify a fraction of a pension fund's accumulated assets, Standard & Poor's analytical approach for public pension fund credit enhancement program issue ratings focuses on the long-term credit quality of the fund's sponsor, along with the pension fund's independence, management, and operating performance. In other words, a pension fund's credit enhancement program is not viewed in a vacuum: extraordinary asset and cash flow coverage of credit enhancement program obligations does not automatically translate into superior credit quality. Nonetheless, credit enhancement programs remain an important credit consideration and will be analyzed in the context of how the program fits within the pension fund's overall management and operating profile. Pension Fund Guarantees Credit enhancement programs and related guarantees pertain to the extension of a pension fund's creditworthiness to debt instruments of other entities through letters of credit (LOCs), guarantee agreements, liquidity agreements for commercial paper (CP) or other short-term instruments, or liquidity agreements to honor optional "put" provisions on variable-rate debt. In one respect, the extension of pension fund guarantees is similar to the investment risk undertaken by a pension fund in its normal course of business, in that pension fund assets are placed at a level of risk in return for current or future compensation for undertaking the risk of lending or promising to advance assets. However, it is important to note that the extension of pension guarantees leverages existing assets, in addition to the normal investment risk associated with the direct ownership of financial securities. In the extreme case of a securities market price decline, losses on owned investments by a pension fund could be aggravated by requirements to honor guarantees or other financial commitments extended by the pension fund, increasing the potential for losses of fund assets and reducing the ability of the pension fund to honor its standing obligations for benefit payments to retirees. Rating Analysis In order to rate a credit enhancement program issue, the pension fund itself is first assigned a public issuer credit SEPTEMBER 25,

360 Criteria Governments U.S. Public Finance: Pension Fund Credit Enhancement And Related Guarantee Programs rating. For credit enhancement programs, areas of analysis include a review of: Legal authorization for the extension of pension guarantees (statutory, constitutional, or via permitted investment guidelines); Legal priority of pension fund guarantees relative to the fund's obligation to pay pension benefits; Enforceability of pension fund guarantees; Legally permissible guarantees or extension of fund credit, including direct debt guarantees, CP, LOCs, liquidity agreements, and guaranteed investment contracts; Maximum permitted program exposure amount relative to the pension fund's: percentage of total invested assets; percentage of normal annual net cash flow (income and contributions minus required annual pension benefit payments); and percentage of annual pension benefit payments; Types of guarantees that may be undertaken or incurred by a pension fund, by generic industry credit risk (e.g., municipal debt guarantees, corporate debt guarantees, small business loans, currency risk or interest-rate risk, etc.); Risk concentration limits or guidelines, as they relate to industry or single-issuer guarantee risk; Maturity or liquidity risk to the pension fund, depending on the nature and proposed types of instruments to be guaranteed; The legally available highly liquid asset portfolio and its composition in terms of credit quality, volatility, and weighted average maturity; and The management, monitoring, and oversight procedures for the legally available highly liquid assets. Asset liquidation plan For pension fund credit enhancement programs that require immediate access to liquid assets, a detailed asset liquidation plan will be reviewed (see Standard & Poor's self liquidity criteria). The ability of a fund's asset management team to liquidate assets on a same day basis (if necessary) is a key factor in the evaluation of a pension fund credit enhancement program. Very specific written liquidation procedures are required and should detail: Persons responsible (including alternates) for executing the asset liquidation; The sequence of steps that must be undertaken by all parties to effect liquidation; and The timing of notifications to the appropriate parties to ensure that sufficient funds are available to pay program obligations on a same-day basis, if necessary. Assessing Creditworthiness The strengths associated with any specific extension of a public pension fund's creditworthiness will be a function of the specific terms included in the guarantee or LOC agreement. As with any debt instrument that may contain credit enhancement from an outside party, the credit rating value of a guarantee may be weakened or rendered unratable if there are conditions or provisions that would allow the guarantee to be terminated, unenforceable, or dishonored. An analysis of the pension fund's financial risk management and operating principles will be undertaken to check that execution of the credit enhancement program will ensure policy compliance. In general, laws, statutes, or formal policies limiting the extension of pension fund creditworthiness reduce the potential risk to pension assets and required sponsor fund contributions to maintain the solvency of the pension fund for the short- and long-term. The absence of formal plans to manage, monitor, and limit or control the extension of pension fund credit will impact the assessment SEPTEMBER 25,

361 Criteria Governments U.S. Public Finance: Pension Fund Credit Enhancement And Related Guarantee Programs of the pension fund. Finally, in addition to limits on the extension of pension fund credit, the risks associated with the projects or debts to be guaranteed will be analyzed for their impact on the safety of pension fund assets. In situations where the parameters for the extension of pension fund credit are very broad, concerns over potential increased risk could translate into lower pension fund ratings, and, under certain circumstances, into added credit stress for the sponsor governments. SEPTEMBER 25,

362 Copyright 2015 Standard & Poor's Financial Services LLC, a part of McGraw Hill Financial. All rights reserved. No content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor's Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an "as is" basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT'S FUNCTIONING WILL BE UNINTERRUPTED, OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages. Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P's opinions, analyses, and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw, or suspend such acknowledgement at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal, or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof. S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain nonpublic information received in connection with each analytical process. S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, (free of charge), and and (subscription) and (subscription) and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at SEPTEMBER 25,

363 Criteria Governments U.S. Public Finance: Public Pension Funds Primary Credit Analyst: Robin L Prunty, New York (1) ; robin.prunty@standardandpoors.com Secondary Credit Analyst: Colin A MacNaught, Boston (1) ; colin_macnaught@standardandpoors.com Table Of Contents Background Rating Methodology Sponsor Credit Quality Pension Fund Independence Pension Fund Management Pension Fund Operating And Financial Considerations JUNE 27,

364 Criteria Governments U.S. Public Finance: Public Pension Funds (Editor's Note: We originally published this criteria article on June 27, We're republishing it following our periodic review completed on April 1, As a result of our review, we updated the author contact information.) Standard & Poor's Ratings Services has enhanced its public pension fund rating criteria to incorporate an evaluation of a public pension fund's issuer credit rating, including reviewing the underlying characteristics that comprise the fund's sponsor credit quality, independence, management controls, and operating and financial performance. An additional, though separate, credit consideration includes the pension fund's credit enhancement or related guarantee program. (See "Public Finance Criteria: Pension Fund Credit Enhancement And Related Guarantee Programs".) Background Public pension funds are vehicles for accumulating financial assets to advance-fund employee retirement defined benefits that have been earned by, and promised to public employees as part of their compensation. Employee retirement defined benefit obligations represent the long-term liabilities promised by the pension fund's sponsor. Generally, both the sponsor and the employee, through regular contributions, share pension benefit funding. Typical employee defined pension benefits include monthly stipends based on a formula, including years of service and final salary. Public pension fund asset management mainly focuses on increasing accumulated assets through investment income and appreciation. However, pension funds may also engage in alternative means of revenue generation, such as credit enhancement programs, which generate fee income through the extension of the fund's guarantee of debt instruments of other entities. Standard & Poor's views public pension funds as entities that are intrinsically linked to their respective government sponsor in terms of contribution support and benefit obligation modifications. Standard & Poor's criteria does not de-link pension fund rating factors from those of its sponsor. Rating Methodology Specifically, under Standard & Poor's enhanced public pension fund criteria, the creditworthiness of a public pension fund is a function of performance in the following basic analytical areas: Sponsor credit quality; Pension fund independence; Pension fund management; and Pension fund operating and financial performance. JUNE 27,

365 Criteria Governments U.S. Public Finance: Public Pension Funds Sponsor Credit Quality Although public pension funds are generally legally separate financial entities, their strength and solvency are a function of the willingness and ability of sponsor governments to ensure that the defined benefits are provided through the timely payment of required contributions, and the maintenance of an adequate funding level. Moreover, public pension fund employee benefit liabilities are tied to, and are negotiated and determined by the government sponsor. One of the items evaluated in the context of a pension fund rating is whether a government views pension benefits as a means to achieve labor settlement, since those costs may have no substantial immediate effect on the sponsor's annual budgets or taxes. Standard & Poor's views well-funded public pension funds as having the ability to withstand a short- to mid-term disruption in sponsor contributions, or enhancements of employee benefits due to the long-term nature of employee retirement benefit obligation accruals and disbursements, as well as the large share of income derived by returns on existing investments. Yet, even though a well-funded pension fund can likely continue to make benefit payments in the short- to mid-term, a prolonged reduction or absence of sponsor contribution payments and/or enhanced benefit liabilities will affect the fund's long-term operating and financial performance. Due to these fundamental relationships between sponsor and fund, including the ability of government sponsors to recover from periods of financial weakness, Standard & Poor's analytical approach to public pension fund ratings limits the upward rating spread between the sponsor and pension fund to one full rating category (three notches). In other words, if a government sponsor's general credit rating were 'A', then the highest potential rating that the corresponding pension fund could earn would be 'AA'. Conversely, it is possible that a pension fund may be viewed as less creditworthy than its sponsor if Standard & Poor's considers the fund's remaining basic analytical areas to be deficient. Analytical evaluation Standard & Poor's analytical approach to public pension fund ratings begins with determining the government sponsor's general creditworthiness, which includes examining the sponsor's pension contribution history. In evaluating the sponsor's creditworthiness, that is, its ability to continue to make pension contributions in the context of its other financial obligations and commitments, consideration will be given to the strength and priority of required contributions relative to other financial obligations of the government sponsor. Standard & Poor's will determine if the sponsor's pension contributions are discretionary or constitutionally protected, or, if there is a legal priority for pension contributions relative to other financial commitments. Standard & Poor's will also examine the sponsor's funding objectives, along with the sponsor's willingness and ability to cure funding deficits. Moreover, Standard & Poor's will calculate how significant the pension funding requirements and liabilities are relative to the sponsor's operating budget. Public pension funds are typically single-employer defined benefit plans, or multiple-employer (agent or cost-sharing) defined benefit plans sponsored by state or local governments. In multiple-employer plans, the pension fund receives contributions from a number of governments and their employees. A government that is the sole sponsor for the public pension fund may provide several separate plans for different classes or types of employees. Funding levels and requirements may vary, so it would not be accurate to assume one plan's creditworthiness could serve as a proxy for another plan funded by the same sponsor. JUNE 27,

366 Criteria Governments U.S. Public Finance: Public Pension Funds Multiple-employer pension plans may or may not include state funding participation. To assess the creditworthiness of the government sponsor where there is no state participation, a portfolio analysis of the credit characteristics of the local government participants is necessary. Where a multiple-employer plan includes both state and local government employees and funding requirements, such as a cost-sharing plan, the state's credit rating will be significantly weighted under a multiple-employer cost-sharing program, the state is typically the largest employer and contributor, therefore making the plan substantially dependent on the state's creditworthiness for its ongoing solvency. For multiple-employer teachers' retirement systems, with or without state-required funding of contributions, the state's general credit rating may still be viewed as a proxy for the underlying creditworthiness of the governmental sponsors, since states traditionally provide substantial funding resources to local school districts for educational expenses, and teachers' salaries and other compensation are usually the largest component of school district spending. The ability of the public pension fund to exceed the sponsor's general credit rating by up to one full rating category will hinge on the strength of the fund's three remaining basic analytical areas. Pension Fund Independence Standard & Poor's considers independence as being an essential factor in deciding whether the pension fund's credit rating can exceed that of its sponsor. The assessment of independence is largely qualitative in nature and includes a thorough documentation analysis and a meeting with fund officials. Issues to consider include: Are pension board directors appointed independently, with staggered terms, or do they serve at the pleasure of the government sponsor? Are operating and/or investment decisions vested solely in the management of the pension fund, or are they influenced or determined by the government sponsor's representatives? Are contribution rates determined independently, based on actuarial needs, or are they merely a function of the sponsor's annual budget process, subject to the sponsor's financial condition on a year-to-year basis? Can pension assets be reclaimed or diverted by, and to, the government sponsor for other uses? How can actuarial assumptions used to determine pension-funding levels be influenced or revised? Despite the inherent connection between pension fund and sponsor, the degree to which a pension fund can demonstrate that its managerial structure and operations are independent of sponsor control and influence is a credit factor. Although the sponsor typically sets the retirement benefits promised to employees, many pension funds are designed to retain significant autonomy in direct management and operating areas. In general, credit strength will be accorded to a pension fund where it can be verified that the fund can operate independently of its sponsor in the following areas: Legal authority: the basis for the establishment, organization, and operation of the pension fund; Management: the basis for election or appointment of those charged with responsibility for pension fund administration; Policy making authority: investment guidelines, asset allocation, and risk management, and, overall control of asset portfolio; Operating and financial performance: the basis for establishing funding objectives, performance goals, and financial JUNE 27,

367 Criteria Governments U.S. Public Finance: Public Pension Funds targets; and Determination of funding requirements and actuarial assumptions. Pension Fund Management A key factor of Standard & Poor's public pension fund rating process is assessing the execution of the fund's management in the context of the fund's independence, and operating and financial performance. An assessment of fund management is derived from understanding managerial techniques; funding objectives, investment objectives, and risk aversion strategies, document analysis comprises the balance. Although management has little control over the ability of the sponsor to make contributions or employee retirement benefit modifications, managing its operations and finances in a prudent manner are factors over which the fund can exert significant influence. It is important to note that the assessments of pension fund management and independence go hand in hand. Standard & Poor's public pension fund management assessment guidelines borrow heavily from its existing life insurance and fund rating criteria, and seek to determine whether a pension fund is maintaining transparent and thoroughly planned managerial and risk acceptance policies, while simultaneously generating sufficient returns to fund its current and future benefit obligations. Areas of focus for a review of management includes the pension fund's: Organization; Operational effectiveness; and Financial risk management. Organization Standard & Poor's considers strong organization as being essential to effectively managing a public pension fund, and the fund's management experience must support the operational strategy to produce the desired results of maximizing asset growth and income, within the specified risk tolerance. When analyzing organization, Standard & Poor's will, for instance, determine whether the fund maintains transparent operating principles and controls, as well, as a sound organizational structure. Issues to consider include: How old is the fund and how is the fund organized? What are management's goals and how are strategies developed? How large is the pension fund in terms of staff and function, and what is the role of the board of directors and government sponsor(s)? How involved is the board of directors in the management of the pension fund, including a discussion of committees such as audit and finances committees; Are written policies and procedures communicated to fund staff and signed by staff annually (i.e. a Code of Ethics)? Do investment managers possess a proven track record, what is that track record, and how closely are they monitored? What type of internal audit controls does the fund adhere to? Operational effectiveness Operational effectiveness involves assessing a pension fund's ability to execute chosen funding and operating JUNE 27,

368 Criteria Governments U.S. Public Finance: Public Pension Funds objectives and follow through with actual performance. Standard & Poor's also evaluates management's expertise and understanding in terms of operating the fund and managing investments. An assessment of the adequacy of audit and control systems is essential. Standard & Poor's must evaluate whether the strategies and objectives management has chosen are consistent with the fund's capabilities and principles. Furthermore, public pension funds often employ private financial firms to assist with investments and operations, and a review of the policies and strategies governing these relationships is imperative. Issues to consider include: What are the fund's specific operating and financial goals or targets, and how has the fund performed compared with these goals? Does management maintain any form of operating and/or strategic forecasts that are tied to future retiree benefit payments or other anticipated liabilities? Does management maintain any form of contingency planning? Financial risk management A major component of the review of a pension fund's financial risk management is the investment decision-making process, as asset quality and investment performance are integral to a fund's operations and solvency. Numerous investment decisions are made frequently for invested funds, and Standard & Poor's examines how these decisions are made and who is responsible for executing them. Evaluating financial risk acceptance allows Standard & Poor's to understand management's views on financial goals, asset structure, and board oversight. Standard & Poor's analysis begins with a comprehensive review of the pension fund's permitted investment guidelines, asset allocation strategy, and risk management policies. The ultimate responsibility for any pension fund typically lies with its board of directors or trustees, and board members are usually elected and/or appointed to oversee the fund's investments and management. Boards entrust staff and investment managers with handling the fund's day-to-day affairs, and policies are typically established that delineate management's tolerance for risk. Boards must establish effective procedures for reviewing and enforcing these policies. Standard & Poor's expects public pension funds to maintain detailed policies documenting the amount, type, and quality of information used in making investment, asset allocation, and risk management decisions. This includes the size, breadth of understanding, and capabilities of the credit and risk research staff, as well as access to current economic data and analysis. Once investment and risk management strategies are understood, Standard & Poor's reviews the pension fund's allocation of assets among investments such as fixed income, domestic and international equities, real estate, and other invested assets. The assets are evaluated for credit quality and diversification. Asset concentrations by type and maturity, credit quality, industry, geographic location, and within single issuers are evaluated. The pension fund's asset allocation is also examined to determine liquidity in relation to its liabilities. Standard & Poor's reviews the portfolio's liquidity because the fund may need to liquidate assets quickly to pay liabilities such as capital calls, guarantees, or credit enhancement programs. Issues to consider include: Is there a defined risk management process in place to ensure that assets are managed within their objectives and established risk parameters? Does the fund have predetermined limits for acceptable levels of risk, and are these guidelines detailed or general? What policies are in place for investments or trading by investment managers and how are they monitored? JUNE 27,

369 Criteria Governments U.S. Public Finance: Public Pension Funds Public Pension Fund Evaluation: Fund Management Strong Adequate Weak Management maintains a clear and comprehensive set of operating and funding principles, objectives, and strategies. Board is independent, highly qualified, and willing to exercise proactive judgment. Organizational structure fits principles, objectives, and strategies. Audit and control systems are extensive and transparent. Management has considerable expertise, depth, and breadth, and is engaged in, and has demonstrated an ability to exercise strong control over its operations. Strategies and objectives chosen are consistent with the fund s capabilities and principles. Maintains very conservative operating and financial targets. A set of comprehensive investment, asset allocation, and risk acceptance policies and standards are formally in place. Investment, asset allocation, and risk acceptance policies are closely and consistently adhered to. Fund consistently performs well against objectives/strategies/targets. Management generally follows a basic set of principles, objectives, and strategies. Board is independent. Organizational structure does not fully foster principles, objectives, and strategies. Audit and control systems are average. Management lacks expertise, depth, and breadth, but maintains good control over its operations. Strategies and objectives include some contradictions with the fund s capabilities and principles. Achievement of some objectives appears unlikely. Has no commitment to maintaining conservative operating and financial targets. A set of comprehensive investment, asset allocation, and risk acceptance policies and standards are formally in place. Investment, asset allocation, and risk acceptance policies are often, but not always, adhered to. Fund usually performs well against objectives/strategies/targets. Management does not maintain or follow a basic set of principles, objectives, and strategies. Board is not independent and/or is not involved. Organizational structure impedes implementation of principles, objectives, and strategies. Audit and control systems are weak and/or are ignored. Management lacks ability to understand and control its operations. Strategies and objectives include many contradictions with the fund s capabilities and principles, and many goals appear unattainable. Disregards any reasonable standards for operating and financial targets. Has no defined set of investment, asset allocation, and risk acceptance policies and standards in place. Investment, asset allocation, and risk acceptance policies are not adhered to. Fund often misses objectives/strategies/targets. Pension Fund Operating And Financial Considerations Obligations and expenditures Pension fund liabilities are derived from the retiree benefits incurred as a result of sponsor government compensation agreements with employees and plan structure obligations. Among these are: Monthly stipends based on plan formula; Disability entitlements; and Death benefits. An important focus of this area will be on the process of how benefits are revised and whether there are built-in factors that could cause future pension benefits to increase substantially. Examples are pension benefit increases or accelerations that could increase or accelerate payments of pension benefits, such as early retirement legislation, or changes in the method of calculation of eligible compensation as the basis for pension payments. In addition, Standard & Poor's will need to assess the history of retiree benefit enhancements or other changes, and how any modifications were compensated for in terms of funding. Other areas to be reviewed are the vesting rights of employees, as well as obligations for termination payments by the plan when an employee withdraws from the plan or government employment. Furthermore, Standard & Poor's will JUNE 27,

370 Criteria Governments U.S. Public Finance: Public Pension Funds closely examine the pension fund's actuarial assumptions, including funding method, asset valuation smoothing assumptions, mortality, and inflation. Analytical questions include: Is participation optional, allowing for competing plans and possible withdrawal of participants' and sponsors' contributions and shares of assets into other pension plans? Under what conditions can employee termination withdrawals occur and what has been the historical experience? If non-vested, do employees have rights to their contributions alone, or are they also entitled to benefits with respect of employer contributions made on their behalf? If termination payments are made to the employees, do sponsor contributions remain in the plan or revert to the sponsor? Has there been a change in actuaries and/or have any significant actuarial assumptions been altered? Operating and financial performance measurements Standard & Poor's employs trend analysis to assess public pension fund operating and financial performance. Depending on the metric, the trend analysis timeframe can range from three to ten years, and the analysis will determine the underlying factors behind positive or negative changes. Standard & Poor's will conduct its trend analysis in the context of the pension fund's various management factors, which include funding objectives and financial risk acceptance. Standard & Poor's begins its operating and financial performance trend assessment by analyzing the pension fund's funding ratios. Specifically, Standard & Poor's will look at the pension fund's unfunded actuarial accrued liability (UAAL) and the funded ratio. Pension Fund Unfunded Actuarial Accrued Liability And Funded Ratio A pension fund s unfunded actuarial accrued liability (UAAL) and funded ratio are tied to the fund s actuarial value of assets (AVA) and actuarial accrued liability (AAL). The UAAL is established by subtracting the fund s AVA from the fund s AAL. When the difference is a positive number, it means that the AVA is not sufficient to cover the AAL. Conversely, when the difference is a negative number, it means that the AVA exceeds the AAL. The funded ratio is derived by dividing the fund s AVA by the AAL, and is important in quantifying the adequacy of the pension fund s accumulated assets. Overall, the higher the funded ratio, the more likely that accumulated assets will be able to support annual benefit obligations. Generally, Standard & Poor's will favorably view a pension fund with a funded ratio trend that is stable or increasing. Although funded ratios that are 100% or higher are viewed most favorably, Standard & Poor's understands that keeping a pension system at or near full funding is a very difficult balancing act and may not be desirable. For example, very strong funding levels can result in greater pressure to increase benefit levels. Further, in actuarially funded pension systems, full funding results in downward pressure on the contribution rate and, in some cases, outright contribution holidays. Benefit enhancements and/or contribution holidays have the potential to pressure the pension fund's operations and funding status in the event of an adverse investment environment. Standard & Poor's will consider the fund to be of weaker quality when there is consistently below average funded ratios or where the pension system is closer to pay-as-you-go status (no accumulated assets, with benefits funded as an annual expense). Standard & Poor's analyzes the pension fund's current and historical investment returns compared with benchmark return targets that have been imputed into actuarial assumptions. Accordingly, a thorough evaluation of the assumed discount rate, including the discount rate's level of conservativeness and actual rate of return, will be conducted. Investment losses can result in the substantial weakening of the fund's asset portfolio, potentially resulting in JUNE 27,

371 Criteria Governments U.S. Public Finance: Public Pension Funds decreased liquidity, reduced flexibility in terms of covering pension payments, and increased dependence on the government sponsor for higher contributions. In analyzing investment income and performance, focus will be placed on how much investment income derives from actual cash payments (such as interest, dividends, and rental income) as opposed to investment income generated from capital appreciation. Standard & Poor's evaluates various performance metrics in order to assess operating efficiency and asset maximization. Standard & Poor's employs performance ratios such as return on assets, return on net assets, and total margin. These metrics are useful in providing insight as to how effectively the pension fund is able to augment its operating income and leverage its asset base. Standard & Poor's also uses a service delivery efficiency ratio that looks at what percentage of total annual pension fund expenses are specifically for retirement benefits. Consistently maintaining a very high service delivery ratio (one that approaches 100%) over time is a credit strength. Conversely, in cases where administrative or other expenses consistently comprise a larger share of operating expenses, or where there is tremendous fluctuation in service delivery requirements, suggest credit weakness. Standard & Poor's conducts a historical analysis of the makeup of the fund's balance sheet and income statement. Specifically, Standard & Poor's will seek to understand and annually compare the composition and movement of the fund's assets and liabilities in relation to their respective total bases. Finally, Standard & Poor's assesses the pension fund in relation to the government sponsor in order to determine how material the pension fund's operations and liabilities are to the sponsor. Standard & Poor's will look at the sponsor's annual pension contribution relative to its own budget, which will reveal the level of financial resources needed to regularly support the pension fund, and is analogous to a debt service carrying charge calculation regularly conducted for general debt credit analysis. A calculation of the UAAL relative to the sponsor's operating budget will be an important indicator as to the significance and rate of change of the unfunded liability. Similarly, the unfunded pension liability will be analyzed in terms of UAAL per capita (using the government sponsor's population) and UAAL as a share of per capita income (using the per capita income of the government sponsor's population). Although pension fund liabilities are not generally considered to be "hard" debt, they are considered to be debt-like in nature, and it is useful to make pension fund burden comparisons that are similar in nature to general credit debt burden ratios. JUNE 27,

372 Criteria Governments U.S. Public Finance: Public Pension Funds JUNE 27,

373 Copyright 2015 Standard & Poor's Financial Services LLC, a part of McGraw Hill Financial. All rights reserved. No content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor's Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an "as is" basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT'S FUNCTIONING WILL BE UNINTERRUPTED, OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages. Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P's opinions, analyses, and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw, or suspend such acknowledgement at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal, or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof. S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain nonpublic information received in connection with each analytical process. S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, (free of charge), and and (subscription) and (subscription) and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at JUNE 27,

374 Criteria Governments U.S. Public Finance: Short-Term Debt Primary Credit Analyst: Gabriel J Petek, CFA, San Francisco (1) ; gabriel.petek@standardandpoors.com Secondary Credit Analyst: Robert Williams, San Francisco ; robert_williams@standardandpoors.com Table Of Contents Note Ratings TRANs, TANs and RANs Structural Analysis Liquidity Analysis Cash Flow Note Pools Pool Structure Bond Anticipation Notes JUNE 15,

375 Criteria Governments U.S. Public Finance: Short-Term Debt (Editor's Note: This criteria article originally was published on June 15, We're republishing this article following our periodic review completed on Jan. 12, This article replaces criteria published on May 16, This article has been partially superceded by Bond Anticipation Note Rating Methodology, published Aug. 31, 2011.) Note Ratings Short-term debt instruments rated by Standard & Poor's Ratings Services include cash flow notes such as tax and revenue anticipation notes (TRANs), bond anticipation notes (BANs) and cash flow note pools. Note ratings differ from bond ratings in that many long-term credit risks are mitigated by the comparatively short repayment period. Conversely, liquidity factors that enhance note security may not allay long-term credit concerns or provide additional comfort regarding the issuer's ability to pay its debt obligations over the long-term. A strong liquidity position is a primary determinant in the assignment of a cash flow note rating. There is no exact debt service coverage benchmark that determines a specific rating. Financial and cash management and the quality of the pledged revenue stream, which includes the reliability of the pledged revenue source, are additional factors considered when determining a note rating. Moreover, the quality of financial reports--including audits, issuer constructed historic and projected monthly cash flow statements, and budget projections are additional credit factors. Municipal note issues are divided into two major categories requiring different rating approaches: cash flow notes and bond anticipation notes (BANs). Cash flow notes are generally referred to as tax anticipation notes (TANs), revenue anticipation notes (RANs) or tax and revenue anticipation notes (TRANs). TRANs, TANs and RANs State and local governments typically issue cash flow notes to address a mismatch between the receipt of revenues and disbursements for ongoing operations. Many issuers receive major revenues unevenly during a fiscal year, while operating expenditures typically follow a level monthly pattern. For example, a school district may receive the bulk of its annual property taxes in June; however, it needs to make salary and benefit expenditures evenly each month. The district may issue cash flow notes to bridge the gap between receipts and disbursements during the period when cash balances are insufficient. The ratings on cash flow notes--trans, TANs, and RANs--rely on: The security pledged to retire the notes; The notes' legal structure; The issuer's historical and projected liquidity position, as reflected by its cash management and budgetary practices; The reliability of the issuer's primary revenue sources; and The issuer's overall fiscal health. JUNE 15,

376 Criteria Governments U.S. Public Finance: Short-Term Debt Structural Analysis Security The specific security pledged to retire cash flow notes plays a role in the assignment of a note rating. State and local statutes governing short-term debt issuance and the resolution authorizing issuance of a particular note usually define the security. The security may range from a single tax or general fund revenue pledge, to a full faith and credit GO pledge. Broad unlimited-tax GO pledges are viewed most favorably since all of the issuer's resources are pledged to note repayment. While the pledge of a specific narrow revenue source may be viewed less favorably than a combination of revenue sources, the analysis hinges on the quality and consistency of the revenue in question. In most cases, a narrow but generally reliable single tax pledge can achieve the same rating as a broader full faith and credit GO pledge. Flow of funds-segregation of pledged revenues The monthly flow of funds takes on added importance for cash flow notes because of the potential strain on resources required on one maturity date to repay a note. The issuer must ensure that sufficient resources are available to make the note payment at maturity. The segregation of pledged revenues in separate note repayment accounts prior to note maturity reduces the likelihood that weak budget and financial performance will interfere with full and timely payment of debt service. However, sufficient resources to pay debt service at note maturity--after all expenditures are made--is most critical in the assignment of a high investment-grade note rating. Pledged revenues typically are segregated by an issuer in its own accounts. In some cases, pledged revenues may be segregated in accounts in the custody of a third party. Accounts held by a third party do not necessarily strengthen a note issue's structure, especially if funding of the account depends on the issuer's timely transfer of funds to the third party. If the issuer does not have sufficient funds to transfer, the third party will not have adequate resources for note repayment. Standard & Poor's does not consider debt service segregation structures as substitutes for the sound liquidity and financial positions of issuers. Standard & Poor's considers debt repayment capacity to be enhanced only marginally by the early segregation of pledged revenues. However, the early prepayment and segregation of pledged revenues for note repayment can be an indication of the cash flow strength of an issuer and, in that respect, may affect a note rating. Fiscal and paying agent requirements Issuers sometimes use fiscal agents and paying agents to hold and invest funds or to hold securities pledged and segregated for debt service of TRANs. The fiscal agents and paying agents are introduced into a TRAN structure to provide comfort to investors that pledged funds and securities segregated for note repayment are not subject to potential investment risk, even in the event of insolvency of the issuer. Standard & Poor's does not view the segregation of pledged funds and/or securities with a paying or fiscal agent as enhancement of a TRAN rating, provision of additional security, or protection from investment losses because funds JUNE 15,

377 Criteria Governments U.S. Public Finance: Short-Term Debt segregated for TRAN debt service repayment and held by a fiscal or paying agent continue to be general funds of the issuer. Thus, Standard & Poor's does not consider the use of a paying agent or fiscal agent to be a mitigating factor that reduces credit risk for a TRAN issue in the event of an issuer's investment losses or even its insolvency. Liquidity Analysis Cash flow statement analysis The credibility and reliability of cash flow projections, which forecast the amount and timing of the receipt of resources pledged to note repayment, are critical to the assignment of a note rating. Cash flow statements, together with the underlying assumptions upon which the projections are based, provide a foundation for analysis of the reliability and quality of the revenue stream available to pay note debt service. Standard & Poor's analyzes both historic and projected monthly cash flows in the context of the issuer's operating budget, financial statements, cash management practices, pledged revenue segregation, and against prior forecasts. Standard & Poor's analyzes cash flow projections for prior fiscal years, which outline changes in receipt and disbursement patterns over time (see tables 1a and 1b for an example of a monthly cash flow statement). The trend of cash flow borrowing is also important if increases exceed the rate of budget growth, as it may signal deterioration in overall liquidity or a growing structural imbalance. The sensitivity of the pledged revenue stream to adverse external events over time is evaluated. A note with a property tax pledge usually has a more stable revenue stream than one secured by sales or income taxes. Revenues derived from other governmental entities, such as state aid funding, could exhibit historical volatility, especially in the face of an adverse budget climate, that could make timing and amount of future receipts uncertain. To the extent issuers are reliant on external funding sources with some historical volatility, other revenue sources or cash reserves could serve as mediating factors if those revenues are pledged to debt repayment. Cash flow projections that are in line with historical projections provide comfort regarding the reliability of an issuer's cash flow projections. Cash flow results that differ significantly from prior-year projections may be an indication of historically volatile revenues or inconsistent management forecasting abilities and can raise questions about the issuer's ability to manage its cash and, therefore, pay note debt service fully and in a timely manner. The basis for Standard & Poor's analysis of an issuer's ability to forecast its cash flows reliably will be the issuer's own historic accuracy, when available. For statements of monthly operating cash flows, Standard & Poor's will conduct variance analyses of current fiscal cash flow projections submitted in the prior year against actual year-to-date and projected current year-end cash flow performance. This "actual-versus-projected" performance will then be compared to the most recent fiscal year projected cash flows currently being submitted in conjunction with TRAN rating requests for the ensuing fiscal year. For issuers with projected coverage of less than 1.25x at maturity, a detailed analysis and explanation of the reliability of projected cash flows will be important. Moreover, scrutiny will be applied to issuers who present cash flows that project higher than 1.25x coverage but whose coverage falls to less than 1.25x if actual historic variance is applied to the projected fiscal cash flows. In these cases, Standard & Poor's, in the ratings process, will conduct a thorough review of what caused the variance between projected and actual cash flows and debt service coverage levels. JUNE 15,

378 Criteria Governments U.S. Public Finance: Short-Term Debt While this analysis of variance is an important starting point for the rating process, variance and coverage levels alone will not dictate the rating. The actual underlying causes of changing patterns in the monthly cash flows and year-end cash balances is always a central feature to the rating process. In some cases, one-time events that cause a variance in cash flows may not reflect potential future risk or a lack of management foresight, whereas in other cases, such variances may either reflect volatile revenues in general, or problems with forecasting or financial management overall. Table 1 Sample Projected Cash Flow Fiscal July-December General fund ($000) July August September October November December Beginning balances ($) 25,647 30,360 21,661 14,260 12,529 5,270 Receipts property taxes , ,676 Other taxes , Licenses/permits 1,854 3,549 4,517 4,376 3,027 3,536 Interest income , ,504 Intergovernmental 17,853 11,343 11,245 16,157 10,649 14,613 Other revenue 20,7991 4,724 3,870 4,748 2,604 2,880 Note proceeds 35, Total 76,289 20,111 21,954 27,948 17,763 60,162 Disbursements General government 5,921 2,895 3,192 3,324 2,305 2,780 Public safety 14,957 6,298 6,267 6,579 6,673 6,604 Health & sanitation 14,879 8,296 8,973 9,316 5,534 6,444 Human services 16,724 10,285 10,000 9,503 9,826 9,300 Education Other expenses 18, Note repayment ,905 Total 71,576 28,810 29,354 29,679 25,021 43,838 Ending balance 30,360 21,661 14,261 12,529 5,271 21,5942 Available resources Special revenue funds 7,653 8,120 8,530 7,742 8,760 9,120 Ending balance including special revenue funds 38,013 29,781 22,791 20,271 14,031 30,7143 Includes accrued monies. Monthly general fund ending balance covers December segregation 2.2x and May segregation 1.6x Monthly ending balance including special revenue funds covers December segregation 2.7x and May segregation 2.1x. Table 2 Sample Projected Cash Flow Fiscal January-June General fund ($000) January February March April May June Total Beginning balances ($) 21,595 15,766 6,777 6,399 36,595 11,976 25,647 Receipts property taxes , ,604 85,519 Other taxes ,016 1, ,056 12,070 Licenses/permits 4,214 3,473 3,618 4,056 3,626 1,179 41,025 Interest income , ,569 7,532 JUNE 15,

379 Criteria Governments U.S. Public Finance: Short-Term Debt Table 2 Sample Projected Cash Flow Fiscal January-June (cont.) Intergovernmental 11,679 8,673 13,391 11,265 13,332 5, ,316 Other revenue 2,214 3,569 2,410 2,598 2, ,183 Note proceeds ,000 Total 18,685 16,642 24,997 55,628 19,659 19, ,645 Disbursements General government 2,514 2,672 2,861 2,673 2,854 1,473 35,464 Public safety 6,848 6,325 6,531 6,356 6,727 1,823 81,988 Health and sanitation 5,050 6,517 5,596 5,950 5, ,005 Human services 9,427 9,474 9,628 9,701 9,549 1, ,346 Education ,680 Other expenses ,537 Note repayment , ,952 Total 24,514 25,631 25,375 25,432 44,278 5, ,972 Ending balance 15,766 6,777 6,399 36,595 11, , ,319 Available resources Special revenue funds 8,871 7,954 7,320 8,516 9,416 10,987 10,987 Ending balance including special revenue funds 24,637 14,731 13,719 45,111 21, ,306 37,306 Includes accrued monies. Monthly general fund ending balance covers December segregation 2.2x and May segregation 1.6x. Monthly ending balance including special revenue funds covers December segregation 2.7x and May segregation 2.1x. Calculating debt service coverage Standard & Poor's begins the analysis of debt service coverage by measuring debt service due against available cash balances at month's end, after normal operating expenditures are made and without the inclusion of proceeds from additional note borrowings. For debt repayment or early segregation of pledged revenues during the first days of the month, coverage will be measured against the prior month's ending balance. Revenues received early in the month will be considered when detail is available and substantiated. When monies are due late in the month, coverage is measured against the current month's ending balance. Alternative liquidity Alternative liquidity refers to unrestricted cash and liquid investments that may not be legally pledged toward TRAN repayment, but are available to be temporarily used--or borrowed through interfund borrowing and repaid to the fund--for that purpose at the discretion of the issuer. In the case of a GO TRAN pledge, all resources of an issuer are available to repay the note. However, when the pledge is more restricted--such as California TRANs, which are secured by current year general fund monies--alternative liquidity can provide comfort to noteholders if an unforeseen event occurs that could affect TRAN repayment. Such events could include delays in the receipt of state aid or an unexpected increase in operating expenditures. The utilization of alternative liquidity to pay TRAN debt service, however, is extremely rare. Generally, sources of alternative liquidity considered assessible by Standard & Poor's include any funds not subject to legal or other restrictions and not expected to be needed for any other purpose prior to TRAN maturity. Standard & Poor's requires documentation from the TRAN issuer expressly stating the sources of alternative liquidity and the JUNE 15,

380 Criteria Governments U.S. Public Finance: Short-Term Debt amounts that are expected to be available at TRAN maturity or segregation dates to make up any deficiency in the note repayment account. Typical sources of alternative liquidity include operating funds accumulated in a reserve fund to finance future capital projects or deposit of proceeds from an asset sale or other unrestricted one-time revenues into a reserve fund for unspecified future uses. Sources of alternative liquidity not considered by Standard & Poor's as available include bond or other debt proceeds and monies held in trust or in a fiduciary capacity. While legal under certain circumstances, Standard & Poor's does not view reliance on these sources of funds for alternate liquidity as enhancing short-term credit quality. It is important to emphasize that alternative liquidity sources are not a substitute for very strong financial and liquidity fundamentals. Alternative liquidity will rarely, if ever, impact a TRAN rating in cases where the issuer has poor credit fundamentals. Lower-rated TRANs--'SP-2' and 'SP-3'--have fundamental credit weaknesses that generally cannot be offset with alternative liquidity. For example, a TRAN issuer that expects to incur a general fund operating deficit and which does not have sufficient year-end general fund cash reserves to fully compensate for its expected deficit generally cannot strengthen its TRAN rating with alternative liquidity to reach an 'SP-1' or 'SP-1+' rating. Cash Flow Note Pools Multiple-issuer TRAN pools are most often structured as several obligations of various participants--meaning that each participant is responsible for only its own debt service payments. Standard & Poor's bases a TRAN pool rating on either an overcollateralization or weak-link approach. Under the weak-link approach, the TRAN pool rating is equivalent to the creditworthiness of the weakest issuer in the pool--the so-called "weak link." Under the overcollateralization approach, the TRAN pool rating is assigned according to a blended approach of individual issuer quality and common debt service reserve provisions that overcollateralize the total borrowing. In addition, note pool ratings include analysis of a pool's structural and legal strengths, and liquidity facilities, such as state and county guarantees and intercepts that provide for repayment of note debt service. TRAN pool ratings also may be enhanced through liquidity facilities--such as irrevocable bank letters of credit--and bond insurance that unconditionally transfers the credit risk to a higher-rated entity. Weak-link approach The weak-link approach assesses each participant's ability to repay its share of the TRAN pool financing. Each participant is evaluated and assigned a TRAN rating as if it were issuing TRANs on a stand-alone basis and not as a member of a pooled financing. Because full and timely debt service repayment is reflected in the rating, this approach results in TRAN pool ratings that are only as strong as the creditworthiness of the weakest participant regardless of the relative size of that issuer's participation in the financing. Where all participants are strong enough to be rated at least 'SP-1' individually, the pool rating assigned is 'SP-1'. In another example, where one pool participant is rated 'SP-1', and the rest of the participants are rated 'SP-1+', the rating assigned to the pool would be 'SP-1'. The 'SP-1' rating based on the creditworthiness of the weakest issuer would be assigned regardless of the magnitude of borrowing by the weakest participant. JUNE 15,

381 Criteria Governments U.S. Public Finance: Short-Term Debt Overcollateralization approach The overcollateralization approach allows issuers to achieve strong TRAN pool ratings even if a wide disparity of credit quality exists among the participants, including, in some cases, noninvestment-grade issuers. This approach also allows TRAN pools comprising very small issuers to achieve higher ratings through structural enhancement. A common debt service reserve that overcollateralizes the total borrowing results in higher ratings without issuer reliance on a third party to guarantee 100% of principal and interest payments. Cash reserves, a surety bond, or other forms of financial guarantee provide the extra security reflected in the higher rating. While each participant's obligation to repay only its share of the total borrowing remains unchanged, all reserves must be available for note payment on shortfalls from any participant. Standard & Poor's determines the common debt service reserve level necessary to address the principal portion of a pool that would be rated lower than the desired pool rating. The establishment of the reserve level begins with analysis of the pool's underlying credit quality. The pool participants are segregated into four credit quality categories correlating to 'SP-1+', 'SP-1', 'SP-2', and 'SP-3'. The availability of statutory protections, intergovernmental aid distributions, and institutionalized financial practices will determine the depth of analysis on the individual pool participants. Many pools require a full cash flow analysis of each participant. Standard & Poor's identifies those pool participants rated lower the desired rating on the entire pool. Please refer to Standard & Poor's criteria for rating TANs and TRANs for detail on the analysis of the individual cash flows. Once that principal portion is determined, the reserve level needed to overcollateralize to the desired rating level is established according to standard requirements. Reserve levels for 'SP-1+' rated pools have ranged between 8%-20%, reflecting the underlying credit quality of the participants or other structural enhancements. Table 3 TRAN Pool Reserve Requirements (%) Pool rating Participant rating SP-2 SP-1 SP-1+ SP SP SP JUNE 15,

382 Criteria Governments U.S. Public Finance: Short-Term Debt Pool Structure As with stand-alone cash flow note ratings, Standard & Poor's evaluates the legal security, the lien position, and the flow of funds, including the segregation of pledged revenues into separate debt service repayment accounts for each participant. In addition, for cash flow note pool ratings, Standard & Poor's confirms that all participants are required to make full repayment of principal and interest prior to the maturity date of the note pool itself. In the case of note pools, it is important that segregated pledged revenues are held in accounts under the custody of a third party. Similar to stand-alone cash flow note ratings, when repayment accounts are held with a third party paying or fiscal agent, Standard & Poor's also confirms that the legal documents insulate the issue from paying agent or fiscal agent risk. All investments, including Guaranteed Investment Contracts, are restricted to maturities that mature no later than the maturity date of the TRANs. A common approach to investing note proceeds and repayment amounts is to place the money in a guaranteed investment contract--or GIC. These instruments offer the investor a guaranteed return on the amount invested at a time certain. Please refer to Standard & Poor's investment guidelines for information on permitted investments. Bond Anticipation Notes Bond anticipation notes (BANs) are generally used as an interim financing vehicle for capital projects. BAN debt service is typically repaid with bond proceeds, which requires the issuer to access the capital markets. Standard & Poor's assumes that most investment-grade issuers have access to the public credit markets to sell bonds to retire BANs and the BAN ratings reflect that assumption. Borderline investment-grade credits or those on CreditWatch or JUNE 15,