India (Republic of) (Unsolicited Ratings)

Issuer Credit Rating Ratings Rating Date Foreign Long Term Foreign Short Term Local Long Term Local Short Term BBBA-3 BBBA-3 30-Jan-2007 30-Jan-2007 30-Jan-2007 30-Jan-2007 Regulatory Identifiers EE EE EE EE 25-Apr-2012 Outlook NEGATIVE Last Credit Rating Action 25-Apr-2012 Outlook NEGATIVE

Transfer & Convertibility Assessment Ratings Rating Date Local Long Term BBB+ 30-Jan-2007 Regulatory Identifiers -Last Credit Rating Action

Credit Ratings Definitions & FAQs

Credit ratings are forward-looking opinions about credit risk. Standard & Poors credit ratings express the agencys opinion about the ability and willingness of an issuer, such as a corporation or state or city government, to meet its financial obligations in full and on time. Credit ratings can also speak to the credit quality of an individual debt issue, such as a corporate note, a municipal bond or a mortgage-backed security, and the relative likelihood that the issue may default. Ratings are provided by organizations such as Standard & Poors, commonly called credit rating agencies, which specialize in evaluating credit risk. Each agency applies its own methodology in measuring creditworthiness and uses a specific rating scale to publish its ratings opinions. Typically, ratings are expressed as letter grades that range, for example, from AAA to D to communicate the agencys opinion of relative level of credit risk. For more information view the detailed Ratings Definitions

What do the letter ratings mean?

Are Credit Ratings indicators of investment merit? Why do Credit Ratings change? Are Credit Ratings absolute measures of default probability?

What do the letter ratings mean? The general meaning of our credit rating opinions is summarized below. AAAExtremely strong capacity to meet financial commitments. Highest Rating. AAVery strong capacity to meet financial commitments. AStrong capacity to meet financial commitments, but somewhat susceptible to adverse economic conditions and changes in circumstances. BBBAdequate capacity to meet financial commitments, but more subject to adverse economic conditions. BBB-Considered lowest investment grade by market participants. BB+Considered highest speculative grade by market participants. BBLess vulnerable in the near-term but faces major ongoing uncertainties to adverse business, financial and economic conditions. BMore vulnerable to adverse business, financial and economic conditions but currently has the capacity to meet financial commitments. CCCCurrently vulnerable and dependent on favorable business, financial and economic conditions to meet financial commitments. CCCurrently highly vulnerable. CCurrently highly vulnerable obligations and other defined circumstances. DPayment default on financial commitments. Note: Ratings from AA to CCC may be modified by the addition of a plus (+) or minus (-) sign to show relative standing within the major rating categories. Specific ratings are also available from Standard & Poors Ratings Desk by emailing ratings_request@standardandpoors.com. top

Are Credit Ratings indicators of investment merit? While investors may use credit ratings in making investment decisions, Standard & Poor?s ratings are NOT indications of investment merit. In other words, the ratings are not buy, sell, or hold recommendations, or a measure of asset value. Nor are they intended to signal the suitability of an

investment. They speak to one aspect of an investment decisioncredit qualitywhich in some cases, may include our view of what investors can expect to recover in the event of default. In evaluating an investment, investors should consider, in addition to credit quality, the current make-up of their portfolios, their investment strategy and time horizon, their tolerance for risk, and an estimation of the security's relative value in comparison to other securities they might choose. By way of analogy, while reputation for dependability may be an important consideration in buying a car, it is not the sole criterion on which drivers normally base their purchase decisions. top

Why do Credit Ratings change? The reasons for ratings adjustments vary, and may be broadly related to overall shifts in the economy or business environment or more narrowly focused on circumstances affecting a specific industry, entity, or individual debt issue. In some cases, changes in the business climate can affect the credit risk of a wide array of issuers and securities. For instance, new competition or technology, beyond what might have been expected and factored into the ratings, may hurt a company's expected earnings performance, which could lead to one or more rating downgrades over time. Growing or shrinking debt burdens, hefty capital spending requirements, and regulatory changes may also trigger ratings changes. While some risk factors tend to affect all issuersan example would be growing inflation that affects interest rate levels and the cost of capitalother risk factors may pertain only to a narrow group of issuers and debt issues. For instance, the creditworthiness of a state or municipality may be impacted by population shifts or lower incomes of taxpayers, which reduce tax receipts and ability to repay debt. top

Are Credit Ratings absolute measures of default probability?

Since there are future events and developments that cannot be foreseen, the assignment of credit ratings is not an exact science. For this reason, Standard & Poors ratings opinions are not intended as guarantees of credit quality or as exact measures of the probability that a particular issuer or particular debt issue will default.

Instead, ratings express relative opinions about the creditworthiness of an issuer or credit quality of an individual debt issue, from strongest to weakest, within a universe of credit risk. The likelihood of default is the single most important factor in our assessment of creditworthiness.

For example, a corporate bond that is rated AA is viewed by Standard & Poors as having a higher credit quality than a corporate bond with a BBB rating. But the AA rating isnt a guarantee that it will not default, only that, in our opinion, it is less likely to default than the BBB bond.

General Criteria: Understanding Standard & Poor's Rating Definitions

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 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 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 companyspecific 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. 90 91, 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 speculativegrade corporate obligations reflect adjustments for the expected recovery following default. (See "Corporate Ratings Criteria 2008," pp. 91 92, 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 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 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 www.ratingsdirect.com and www.sandp.com.

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 oneyear 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. 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, 1981-2008

CC AA A AA + AA AA A+ A ABBB + BB B BB BBB + BB BB B+ B BC to C

1981

3.28

1982

0.3 3

0.6 8

2.8 6

7.0 4

2.2 2

2.33

7.41

21.4 3

1983

1.33

2.1 7

1.5 9

1.2 2

9.80

4.76

6.67

1984

1.4 0

1.6 4

1.4 9

2.1 3

3.51

7.69

25.0 0

1985

1.6 4

1.4 9

1.3 3

2.5 9

13.1 1

8.00

15.3 8

1986

0.7 8

0.7 8

1.8 2

1.1 8

1.1 2

4.6 5

12.1 6

16.6 7

23.0 8

1987

0.8 3

1.3 1

5.95

6.82

12.2 8

1988

2.3 3

1.9 8

4.50

9.80

20.3 7

1989

0.90

0.7 8

1.9 8

0.4 3

7.80

4.88

31.5 8

1990

0.76

1.10

2.7 8

3.0 6

4.4 6

4.8 7

12.2 6

22.5 8

31.2 5

1991

0.83

0.7 4

3.7 0

1.1 1

1.0 5

8.7 2

16.2 5

32.4 3

33.8 7

1992

0.7 2

14.9 3

20.8 3

30.1 9

1993

1.9 2

1.3 0

5.88

4.17

13.3 3

1994

0.4 5

0.8 6

1.8 3

6.58

3.23

16.6 7

1995

0.63

1.5 5

1.1 1

2.7 6

8.00

7.69

28.0 0

1996

0.8 6

0.6 5

0.5 5

2.3 3

3.74

3.92

4.17

1997

0.36

0.3 4

0.4 1

0.7 2

5.19

14.5 8

12.0 0

1998

0.5 4

0.70

1.2 9

1.0 6

0.7 2

2.5 7

7.47

9.46

42.8 6

1999

0.3 6

0.2 4

0.2 7

0.2 8

0.30

0.5 4

1.3 3

0.9 0

4.2 0

10.5 5

15.4 5

32.3 5

2000

0.2 4

0.5 6

0.2 6

0.88

0.8 0

2.2 9

5.6 0

10.6 6

11.5 0

34.1 2

2001

0.5 7

0.4 9

0.24

0.4 8

0.27

0.4 9

1.1 9

6.2 7

5.9 4

15.7 4

23.3 1

44.5 5

2002

1.11

0.6

1.31

1.5

1.7

4.6

3.6

9.63

19.5

44.1

2003

0.1 9

0.52

0.4 8

0.9 4

0.2 7

1.7 0

5.16

9.23

33.1 3

2004

0.2 3

0.6 4

0.7 6

0.4 6

2.68

2.82

15.1 1

2005

0.1 7

0.3 6

0.2 5

0.7 8

2.59

2.98

8.87

2006

0.3 6

0.4 8

0.5 4

0.78

1.58

13.0 8

2007

0.3 0

0.2 3

0.1 9

0.88

14.8 1

2008

0.4 3

0.4 0

0.3 1

0.2 1

0.5 8

0.18

0.5 9

0.71

1.1 4

0.6 3

0.6 3

2.9 7

3.29

7.02

26.5 3

Mean

0.0 2

0.0 3

0.0 5

0.0 6

0.0 8

0.16

0.2 8

0.28

0.6 8

0.8 9

1.5 3

2.4 4

7.28

9.97

22.6 7

Median

0.0 8

0.1 8

0.8 3

0.8 6

2.0 6

6.27

7.69

22.2 5

Minimu m

Maxim um

0.4 3

0.4 0

0.5 7

0.4 9

0.7 8

1.11

1.4 0

1.33

3.7 0

3.0 6

7.0 4

8.7 2

16.2 5

32.4 3

44.5 5

Standa rd Deviati on

0.0 8

0.1 0

0.1 4

0.1 3

0.2 0

0.32

0.3 6

0.43

0.9 6

0.8 4

1.8 3

2.0 2

4.51

7.82

11.9 3

Includes ratings of financial and non-financial corporate issuers. "" means zero.

Table 2

Standard & Poor's One-Year Global Structured Finance Default Rates By Refined Rating Category, 1978-2008

CC AA A AA + AA AA A+ A ABBB + BB B BB BBB + BB BBB+ B BC to C

1978

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

57.1 4

na

na

na

na

na

1989

na

na

na

na

na

1990

na

na

na

1991

na

na

1992

na

na

1993

6.25

na

1994

1.85

1995

0.4 3

0.9 8

0.95

52.6 3

1996

0.1 5

0.6 12.5 1 0

na

31.0 3

1997

20.6 9

1998

1.0 4

0.9 1

0.1 9

1.0 3

2.34

22.5 8

1999

0.7 7

0.39

1.54

19.3 5

2000

0.1 1

0.6 1

2.19

5.26

2001

0.0 5

0.1 2

2.22

0.86 0.83

0.5 0.91 5

2.0 2.69 3.27 26.8 0 7

2002

0.0 6

0.2 7

0.1 4

1.77

0.1 0.70 1.26 9

2.0 1.12 3

2.5 3.60 23.2 27.0 0 4 3

2003

0.1 9

0.0 3

0.1 6

0.20

0.6 0.50 0.75 0

0.8 1.43 4

3.2 1.64 5.15 32.5 8 8

2004

0.1 0.17 0.50 6

0.8 0.29 1

0.7 2.23 3.56 13.7 9 9

2005

0.0 0.06 0.15

0.1 0.45

0.3 1.34 2.53 16.0

2006

0.0 0.20 6

0.3 0.36 3

0.2 0.36 1.42 19.1 6 8

2007

0.0 4

0.0 3

0.0 7

0.0 8

0.1 0

0.2 1

0.48

0.4 1.27 5.07 7

1.6 1.53 1

0.6 1.55 1.47 24.1 8 1

2008

0.5 3

0.3 5

0.5 7

1.1 5

1.1 5

0.8 7

1.4 2

2.27

1.2 3.45 5.60 6

4.2 5.07 1

8.5 12.8 10.2 56.9 3 4 8 2

Mean

0.0 2

0.0 1

0.0 2

0.0 5

0.0 6

0.0 8

0.1 4

0.37

0.1 0.38 3.56 6

0.8 1.24 1

1.2 2.18 2.83 16.7 2 3

Median

0.6 1

0.2 1.55 6

17.6 3

Minimu m

Maxim um

0.5 3

0.3 5

0.5 7

1.1 5

1.1 5

1.0 4

1.4 2

2.27

1.2 3.45 57.1 6 4

4.2 12.5 1 0

8.5 12.8 23.2 56.9 3 4 4 2

Standa rd Deviati on

0.0 9

0.0 7

0.1 0

0.2 3

0.2 3

0.2 4

0.3 5

0.76

0.2 0.78 12.3 9 9

1.0 2.90 2

2.2 2.93 5.59 16.6 0 0

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.

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 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. 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 longterm 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 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. 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 sectorspecific 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 1933. U.S. unemployment peaked at 24.9% in 1933 and was above 20% from 1932 through 1935. U.S. industrial production declined by 47% and home building dropped by 80% from 1929 through 1932. 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 1935. Nominal GDP did not recover until 1940. 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%. '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)

Duration Name (interval or

Real GDP decline

Unemployment peak (%)

Stress Level Notes

months)

(%)

Panic of 1797

1797 1800

NA

NA

BB (U.S.)

Market disruptions caused by deflationary pressures from Britain.

Depression of 1807

1807 1814

NA

NA

BBB (U.S.)

The Embargo Act of 1807 suppressed shipping-related industries and led to increased smuggling in New England.

Panic of 1819

1819 1824

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 1837

1837 1843

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 1857

18 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 1873

65 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

18731896

NA

NA

AA (Britain)

The collapse of the Vienna Stock Exchange caused a depression that spread around the globe.

Panic of 1893

17 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 1907

13 months

(3)

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.)

18 months

(6.6)

11.7

A (U.S.)

A brief post-war recession involving high unemployment because of returning troops.

Post-World War I recession (U.K.)

14 months

(19.2)

NA

AA (U.K.)

Severe post-war recession spanning three years of sharply declining GDP.

Spanish Civil War

16 months

(31.3)

NA

> AAA (Spain)

Civil war in which the Second Spanish Republic was overthrown and replaced by the fascist Franco regime.

Great Depression (First Leg) (1929)

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.

Great Depression (Second Leg) (1937)

13 months

(3.4)

19

AAA (U.S.)

Second leg of Depression. Retightened monetary and fiscal policy after initial recovery.

World War II (France)

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.

World War II (Germany)

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.

1945

8 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.

1948

11 months

(3.4)

7.9

BBB (U.S.)

Inventory correction after postwar recovery.

1953

10 months

(1.8)

6.1

BB (U.S.)

Post-Korean War military build-up accompanied by tighter Fed policy to fight inflation.

1957

8 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 1957.

1960

10 months

(1.6)

7.1

BB (U.S.)

Monetary policy tightened to fight inflation and housing boom.

1970

11 months

(1.1)

6.1

BB (U.S.)

High interest rates were put in to fight inflation. A GM strike deepened the

recession.

1973 Oil Crisis

16 months

(3.1)

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.

1979 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.

Early 1980s recessions (1980)

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.

Early 1980s recessions (1982)

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.

Latin American Debt Crisis

19811982

NA

NA

A (Latin America); 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 Bubble (1989)

> 200 months

NA

NA

BBB (Japan); BB (global)

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 2009.

Early 1990s recession (U.S.)

8 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.

Early 1990s recession (U.K.)

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.

Early 1990s Nordic Banking Crisis (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.

1994 Mexican Economic Crisis

9 months

(15)

NA

AA (Mexico); 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 1997.

Thai Currency Crisis (19971998)

15 months

(12.5)

NA

AA (Thailand); BB (global)

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.

1998 Russian Financial Crisis

12 months

(9.1)

12.2

A/AA (Russia); BB (global)

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 Rubbledenominated bonds reached 200%. Inflation reached 84%.

Argentine Economic Crisis (19982002)

~48 months

(25)

21

AAA (Argentina); BB (global)

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.

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 1948. 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, 1957-2001

U.S.

Canada

U.K.

Germany

France

Italy

1957

1974-1975

1980-1982

1990-1992

2001

Sources: Cooper, R. "Beyond Shocks," Federal Reserve Bank of Boston (1998).

General Criteria: Understanding National Rating Scales

The rapid expansion of Standard & Poor's Ratings Services rating activities in the domestic financial markets of developing and transition economies has led Standard & Poor's to operate an increasing number of national rating scales in parallel with its global rating scale. Standard & Poor's national scale ratings provide an opinion of the relative creditworthiness of entities and specific financial obligations in a particular country. With the benefit of a link with Standard & Poor's global scale local currency ratings, national scale ratings help participants of domestic financial markets measure credit risk objectively, facilitating the pricing of financial obligations and the efficient allocation of capital. National scale ratings typically provide a finer demarcation of credit risk among local obligors than is possible with Standard & Poor's global scale, as the latter spans the full range of global credit quality and incorporates international comparative risk factors, including direct and indirect sovereign risk considerations. In turn, Standard & Poor's national scale ratings are not directly comparable to Standard & Poor's global scale ratings, and national scale ratings of different countries are not comparable to each

other. Therefore, rating definitions may vary from scale to scale, and unique symbols are used to highlight each rating scale.

Long And Diverse Experience

Compared with other local or international rating services, Standard & Poor's has the longest and most varied experience in developing and managing national rating scales. In addition, Standard & Poor's has developed a unique and rigorous methodology for managing national rating scales built upon: An assessment of credit risks in the market served by the national scale, Adjustable correlation guidelines between each national scale and Standard & Poor's global scale local currency ratings, and Extensive coordination and integration of the analytical process for assigning and reviewing ratings on the two scales. In addition to its extensive experience in managing national rating scales in more mature financial markets such as Canada, France and Sweden, Standard & Poor's currently provides national rating scales in eight emerging market economies: Argentina, Brazil, Kazakhstan, Mexico, Russia, Taiwan, Uruguay, and now, Ukraine. Operating procedures, policies, and criteria that have been developed and tested around the world are tailored to serve the needs of borrowers and lenders in each national market. Standard & Poor's is also working with existing and prospective affiliates that operate or are developing national scale rating services in Chile (Feller Rate), India (CRISIL), Indonesia (PEFINDO), Israel (Maalot), and several other emerging markets. As warranted by the development of local financial markets, Standard & Poor's will offer a growing number of national scale rating services to issuers, investors and intermediaries in emerging market economies. This article addresses the key methodological and communications issues posed by national rating scales: Under what circumstances are national scale ratings most valuable? What is the relationship between Standard & Poor's national rating scales and its global scale in terms of the consistency of criteria, the ranking of credit risk, and the degree of default risk? How does Standard & Poor's ensure the quality and consistency of ratings on multiple scales?

How are the differences between global and national scale ratings clearly communicated to users of Standard & Poor's credit rating services?

National Scale Credit Ratings Defined

Standard & Poor's national scale credit ratings provide a current opinion of an obligor's creditworthiness (that is, issuer, corporate, or counterparty credit ratings) or overall capacity to meet specific financial obligations (that is, issue credit ratings), relative to that of other entities and specific obligations in a given country. In contrast to Standard & Poor's global scale ratings, national scale rating opinions are based on a comparative credit risk analysis of active obligors, including the sovereign government, within one country, and exclude direct sovereign risks of a general or systemic nature. Each Standard & Poor's national scale is tailored to the market it serves based on a dynamic perspective on local credit risk conditions. Although national scale ratings emphasize relative credit risk in a domestic context, the scale is not designed to achieve a forced distribution of ratings. Instead, the distribution of national scale ratings can evolve over time with significant shifts in local economic conditions, reflecting a dynamic scale that encompasses the full range of potential creditworthiness of active local obligors. On the other hand, under particularly unfavorable domestic conditions, even the strongest entities in the country may not receive the highest rating classification on the national scale. However, should business and economic circumstances improve, the strongest entities in the country, including the sovereign, may aspire over time to the highest possible rating on the national scale. Given the focus on credit quality within a single country, national scale ratings are not comparable between countries. In most instances, national scale credit ratings only take the form of local currency credit risk opinions. However, foreign currency credit opinions are provided on a national scale basis in highly dollarized economies, and, in such cases, foreign and local currency national scale credit ratings are identical. National scale ratings are conveyed by symbols that distinguish them from Standard & Poor's global scale ratings, including the addition of a two-letter country prefix to Standard & Poor's wellknown letter-grade symbols, for example, 'uaAAA', 'uaAA+', 'uaAA', 'uaAA-', 'uaA+', 'uaA', 'uaA-', 'uaBBB+', and so on, for long-term national scale ratings in Ukraine.

Benefits Of National Rating Scales

National rating scales are of the most value where sovereign and other credit risks skew global scale ratings to low levels in the country and where local issuers and investors are predominant players on the domestic markets. Such a compression of ratings at lower levels is fairly common among the emerging market economies.

Added differentiation of credit risk Whether or not regulations dictate the use of national scale ratings, sovereign and country risk factors are important determinants of the market demand for a national rating scale. Sovereign risks (for example, direct constraints such as potential exchange controls) and country risks (for example, indirect effects from government policies affecting exchange rates, interest rates, taxation, regulations, infrastructure and labor markets) may compress the range of global scale ratings assigned to obligors in the country, reducing or even obscuring differences in credit standing that would otherwise be evident in the absence of these sovereign and country risks. For example, sovereign and country risk factors in Mexico result in a narrow range of global scale ratings, with many of global scale ratings compressed in the 'BB' and 'BBB' rating categories. While the potential impact of sovereign risk is a critical consideration for cross-border financing, direct sovereign risks of a general or systemic nature, which affect most national obligors to a similar degree, are of less importance to local participants in the national financial markets who find that national scale ratings are useful in providing the most precise ranking of relative credit risk available for obligors within their country. In addition to sovereign and country risk factors, the frequency distribution of credit risk (as measured by the number of observed global local currency ratings per each rating level for active obligors in the country) may be strongly influenced by other factors. Credit risk attributes that are common to many obligors in a given emerging economy such as limited size, lack of diversity, rapid expansion, or an unstable financial environment may limit the scope for higher ratings on the global scale, even in the absence of direct sovereign risk constraints. Such would be the case in Taiwan, where some two-thirds of rated obligors carry a 'BBB' category or lower global scale rating in spite of a sovereign local currency rating of 'AA+'. As a result, national rating scales offer enhanced differentiation of credit quality where the typical credit attributes of most of the active obligors tend to concentrate global scale ratings in the medium- to low-grade categories. Even though national scale ratings are meant to confer an opinion of relative credit risk within a domestic context, that is not to say that they are fully isolated from sovereign risk considerations and other international comparative risk factors. However, it is important to note that credit risk standards vary among national scales and these standards may change over time for a given national scale, if and when the country experiences a material change in sovereign risk and/or the frequency distribution of credit risk among debt issuers active on the local market. Helps develop local financial markets Demand for national scale ratings, whether initially fostered by regulation, sovereign risk, or other factors, typically endures over a long period. While national regulations often do initially play the role of catalyst in

the demand for national scale ratings, market forces eventually lead to an increasing focus on the quality of the credit opinions rendered, recognizing the intrinsic value of national scale ratings. Combining Standard & Poor's internationally established analytical processes with a national focus, Standard & Poor's national scale ratings: Help create more meaningful interest rate differences among obligations, Allow local and foreign investors to better allocate funds according to their risk-return preferences, and Help intermediaries more efficiently price and place debt instruments.

Key Characteristics Of National Rating Scales

Standard & Poor's national scale credit ratings have the following major attributes: The underlying methodology (for example, for corporates, financial institutions, local governments, and so on) employed is identical to the one used for global scale ratings. National rating scales exclude certain direct sovereign risks of a general or systemic nature, including the potential risk of foreign exchange controls. As a result, obligors and obligations with global scale ratings constrained by systemic, direct sovereign risk may have national scale ratings that are higher than the sovereign's rating on that scale, though such cases would necessarily be limited to countries where the sovereign's national scale (ns) rating is less than 'nsAAA'. National and global rating scales are broadly consistent in terms of the rank order (from highest to lowest credit quality) of ratings. National scale ratings are an expression of the relative creditworthiness of obligors and obligations in a particular country, and are based on a comparative analysis of that country's active obligors (this is in contrast to the all-encompassing international comparative context of global scale ratings). National rating scales are not static yardsticks of relative creditworthiness at a given point in time. Rather, they are meant to provide dynamic opinions of relative credit risk that encompass the full range of potential levels of creditworthiness of local obligors over the medium term.

Given the focus on relative creditworthiness, the strongest entities in the country, including the sovereign, often receive the highest possible rating on the national scale, provided the country is not experiencing an acute and widespread financial crisis that imperils the debt service capacity of even the strongest local debt issuers. While no obligors may be rated in the top classification of the national rating scale during periods of severe, nationwide financial stress or the early stages of economic development or transition, the dynamic quality of the national scale provides sufficient scope for potential upgrades and the use of the full rating spectrum--if warranted by improved business and economic circumstances.

While Standard & Poor's national scales are relative measures of credit risk within a given country, they do not seek to achieve any kind of a forced distribution of that country's obligors among the scale's rating classifications. Instead, as is the case with the global scale, the distribution of ratings on the national scale fluctuates with credit risk trends and the universe of active obligors. If economic and financial trends are favorable over an extended period, the percentage of ratings in higher categories may rise. Conversely, if unfavorable trends are experienced for a prolonged time, the proportion of ratings in lower categories may increase, as was the experience with Standard & Poor's Argentine national scale during the crisis beginning in 2001. However, changing economic fortunes may also expand or contract the number of issuers with access to the market, potentially offsetting the influence of upgrades and downgrades on the frequency distribution of credit ratings in the local market. For example, during an extended period of economic prosperity and monetary stability, more marginal debt issuers of limited size and credit standing may more readily tap domestic fixed-income markets, while market access may be restricted to only the largest and strongest local obligors during prolonged and severe economic downturns. Underlying default risk differs from that of global ratings The global scale and national rating scales usually imply substantial variations in the default probabilities associated with any particular rating category on the global and national scales. For example, the implicit default risk associated with a Standard & Poor's global scale rating of 'AA' is significantly lower than the risk inherent to a Taiwan national scale rating of 'twAA' by Standard & Poor's affiliate, Taiwan Ratings Corp., which, in turn, is lower than the default risk implied by an 'ruAA' rating on Standard & Poor's Russia national scale.

The difference in implicit default risk between Standard & Poor's global scale and any given national scale is a function of the degree of sovereign and country risks in the economy and, to a lesser extent, the distribution of credit risks among active obligors in the country. In order for the national scale to provide adequate differentiation in credit risks for obligors active in the local market, it follows that the higher the sovereign and country risks associated with the national economy, the higher the default risk that is embedded in the national scale. The same naturally holds true when the distribution of global scale ratings is concentrated among the lower rating categories. For example, a national scale serving an economy with medium sovereign risk and a predominance of low-grade, global scale ratings for active obligors (for example, Russia) would have lower global scale, local currency ratings corresponding to each category on the national scale than would be the case for a national scale serving an economy with low sovereign risk and a predominance of intermediate grade, global scale ratings for active obligors (for example, Taiwan). Examples of the relationship between global and national scale ratings are provided in the accompanying table.

Linking Each National Scale To The Global Scale

Standard & Poor's approach to national scales has emphasized the development of an operating framework linking each national scale with its global scale. The operating framework involves several key principles: Development of broad correlation guidelines between the rating categories of each national scale and the rating categories of Standard & Poor's global scale, Adjustment of correlation guidelines to any material change in sovereign risk or the frequency distribution of global local currency ratings to ensure that the national scale continues to provide adequate differentiation of credit risk among local obligors, and Coordinated analytical teams and rating committees that assign and review ratings on the two scales in each country. The operating framework and, in particular, the internal correlation guidelines have three major objectives: To ensure broad ranking consistency between the ratings on the two scales, while allowing the national scale the scope to provide meaningful differentiation of credit risk among obligors active in the local financial markets;

To anchor the national scale to Standard & Poor's global scale measure of default risk, so as to ensure prudent ratings and provide adequate forewarning of default risk; and

To allow Standard & Poor's analysts assigning national scale ratings to benefit from the broader comparative perspective embodied in Standard & Poor's global scale.

Selected Comparisons Of National And Global Scale Credit Ratings

Issuer

Global long-term local currency rating National scale rating

Russia

Russian Federation

BBB

ruAAA

Russian Railways

BB+

ruAA+

Lukoil

BB

ruAA

MMK

BB-

ruAA-

RAO UES

B+

ruA+

MGTS

BB-

ruAA-

VolgaTelecom

ruA-

Irkutskenergo

ruBBB+

Rosbank

B-

ruBBB-

Central Telecommunications

CCC+

ruBB+

OAO OMZ

CCC+

ruBB

International Bank of Saint-Petersburg CCC

ruB+

Yukos

ruD

Mexico

Grupo Bimbo S.A. de C.V.

BBB+

mxAAA

United Mexican States

mxAAA

Grupo Imsa S.A. de C.V.

BBB

mxAA+

Grupo Petrotemex S.A. de C.V.

BBB-

mxAA

Corporacion GEO

BB

mxA

Xignux S.A. de C.V.

BB-

mxBBB+

Vitro S.A.

mxBBB

Empresas Ica

B-

mxBB+

It is important to note that the methodology underlying Standard & Poor's national rating scales results in a nonlinear relationship between the global scale rating grade and its corresponding national scale rating grade(s) as one moves down the credit risk spectrum from high to low credit quality. That is, one cannot simply add a certain number of rating levels to a global scale local currency rating to determine the corresponding national scale rating. Rather, the degree of difference between the two rating scales in terms of the assigned letter-grade opinion generally increases as one moves up the rating scale towards the strongest credit rating assigned in the country. For example, an entity carrying a global scale local currency rating of 'BBB' in a medium-risk sovereign nation may well be rated as high as 'nsAA' or even 'nsAAA' on that country's national scale, underlining not only the higher degree of default risk embedded in the national scale but, most important, the inherent quality of national scales to provide greater differentiation in credit standing, particularly at the upper end of the rating spectrum. On the other hand, the rating gap is smaller, if it exists at all, at the bottom end of the rating spectrum, pointing to the ability of national scales to provide an adequate warning of the risk of default. Reflecting the increased scope for differentiation of credit risk, national scale ratings are more sensitive to changes in credit risk and, in turn, are likely to change more frequently and to a larger degree than global

scale ratings. That is, a given change in the business or financial profile may affect an issuer's national scale rating but not its global scale rating, or alternatively may translate into a revision of both ratings but one that is more pronounced on the national scale. However, the impact of changes in sovereign risk on national scale ratings is mitigated by corresponding adjustments to the correlation guidelines designed to safeguard the ability of the national scale to provide meaningful credit rating distinctions among local obligors.

Symbols And Definitions Highlight Differences

For many national rating agencies, the true nature of national rating scales is not fully understood or acknowledged, creating the potential for confusion among users of such credit rating services. Areas of misunderstanding chiefly bear upon the comparative frame of reference and the related issue of the degree of default risk implied by each rating classification. Within the Standard & Poor's network itself, the use of multiple national scales alongside the longstanding global rating scale requires clear and consistent means of communicating credit risk opinions on the two scales, as the same obligation or obligor may be rated on both the global scale and national scale. For example, a company's issue of local currency bonds may be assigned a global scale local currency rating and a separate and quite different national scale rating. Effective means of distinguishing such national scale ratings from global scale ratings are of critical importance due to the potentially large difference in implicit default risk between the two scales. Standard & Poor's has chosen to distinguish national and global scales from one another by means of a mixture of symbols, rating definitions and, on occasion, brand names. In more mature markets, Standard & Poor's has used unique symbols and brand names to convey national scale ratings, as in the case of the Nordic and ADEF scales used in Sweden and France, respectively. In contrast, in emerging markets Standard & Poor's uses its universally recognized letter-grade symbols with a country prefix, as is done in Mexico ('mx'), Argentina ('ra' for Republica de Argentina), Taiwan ('tw'), Brazil ('br'), Russia ('ru'), Kazakhstan ('kz') and now, Ukraine ('ua'). To reinforce the symbolic distinctions between the scales, Standard & Poor's has published rating definitions for each national scale. In the case of the national scales employed in emerging markets (for example, Mexico or Argentina), the rating definitions highlight the market served and the relative risk nature of the scale. In addition, the definitions emphasize that the rating opinions do not address certain direct sovereign risks, and in particular the potential risk of foreign exchange controls. Finally, for a number of national scales, Standard & Poor's retained or developed separate brand names associated with the national scale (for example, CaVal in Mexico, ADEF in France, and Nordic in Sweden).

General Criteria: Principles Of Credit Ratings

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, 2010.
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, 2007.
6.The analytic framework for structured finance securitization ratings includes five key areas:

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 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. 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 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 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 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. Chief Credit Officer, Corporates & Governments: Colleen Woodell, New York (1) 212-438-2118; colleen_woodell@standardandpoors.com Francis Parisi, PhD, New York (1) 212-438-2570; francis_parisi@standardandpoors.com Blaise Ganguin, Paris (33) 1-4420-6698; blaise_ganguin@standardandpoors.com Ian Thompson, Melbourne (61) 3-9631-2100; ian_thompson@standardandpoors.com Mark H Adelson, New York (1) 212-438-1075; mark_adelson@standardandpoors.com

Chief Credit Officer, Structured Finance:

Chief Credit Officer, EMEA:

Chief Credit Officer, Asia-Pacific:

Chief Credit Officer:

General Criteria: Timeliness of Payments: Grace Periods, Guarantees, And Use Of 'D' And 'SD' Ratings
1.This criteria article is a clarifying interpretation of certain provisions of Standard & Poor's Ratings

Service's global issue and issuer rating definitions. We will now apply a uniform five-business-day standard with respect to grace periods and the performance of guarantees relating to ratings of issues that have not been paid or of issuers that have failed to make payments as they come due. This article is related to our rating definitions and to our criteria articles "Principles Of Corporate And Government Ratings," published June 26, 2007, and "Principles-Based Rating Methodology For Global Structured Finance Securities," published May 29, 2007.

SCOPE OF THE CRITERIA

2.This criteria applies to all issue and issuer credit ratings assigned by Standard & Poor's except insurer

financial strength ratings and securities structured to allow for payment deferral. The scope includes securities structured with grace periods longer than five days.

IMPACT ON OUTSTANDING RATINGS

3.There is no immediate impact on outstanding ratings. In the future, the application of this criteria to

securities that have missed payments may result in quicker downgrades to the 'D' and 'SD' rating levels.

EFFECTIVE DATE AND TRANSITION

4.This criteria is effective immediately.

METHODOLOGY
5.In order to provide consistent application of the rating definitions, Standard & Poor's interprets "as they

come due" as payment no later than five business days after the due date for payment. This means that a rating of 'D' or 'SD' would apply even if an obligation has a grace period longer than five business days and we expect payment to be made more than five business days after the due date but before the expiration of the grace period. Where an obligation has no stated grace period, we treat it as having a five-business-day grace period for purposes of applying the long-term rating definitions. This means that we may not apply a rating of 'D' or 'SD' if an obligation with no grace period misses paying on its due date but we believe that payment will be made within five business days.
6.We also apply the five-business-day standard to cases where we apply a long-term rating to an

obligation based on the creditworthiness of a guarantor (or other support provider). This means that, in addition to all other provisions of current criteria, we would not apply the guarantor's rating to the subject obligation unless we believe the guarantee arrangement, viewed as a whole, embodies features (i.e., systems and facilities) that adequately support the guarantor's practical ability to fulfill its obligations under the guarantee within five business days of the primary obligation's due date. If investors are required to take collection action in order to receive payment, the obligor's failure to have funds available for collection within five business days of the obligation's due date will also be considered a default.
7.Given the fundamental differences between short- and long-term expectations in credit markets, we

would not impute a five-business day grace period to a short-term obligation that does not have a stated grace period. Accordingly, 'D' and 'SD' short-term ratings apply to issues and issuers if payment is not made on the date due for short-term obligations, unless we believe that payment will be made within the grace period. However, consistent with our approach on long-term ratings, a rating of 'D' or 'SD' would

apply even if a short-term obligation has a grace period longer than five business days and we expect payment to be made more than five business days after the due date but before the expiration of the grace period.

APPENDIX Excerpts From Standard & Poor's Rating Definitions

ISSUE CREDIT RATING DEFINITIONS
8.A Standard & Poor's issue credit rating is a forward-looking opinion about 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 reflects Standard & Poor's view of 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.
9.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. For example, in the U.S., that means obligations with an original maturity of no more than 365 daysincluding commercial paper. Short-term ratings are also used to indicate the creditworthiness of an obligor with respect to put features on longterm 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 *****
10.D: An obligation rated 'D' is in payment default. The 'D' rating category is used when payments on an

obligation, including a regulatory capital instrument, 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. ***** Short-Term Issue Credit Ratings

11.D: A short-term obligation rated 'D' is in payment default. The 'D' rating category is used when

payments on an obligation, including a regulatory capital instrument, 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 a similar action if payments on an obligation are jeopardized. ***** ISSUER CREDIT RATING DEFINITIONS
12.A Standard & Poor's issuer credit rating is a forward-looking opinion about 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.
13.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.
14.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 *****
15.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, excluding those that qualify as regulatory capital, 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. *****

Short-Term Issuer Credit Ratings *****

16.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, excluding those that qualify as regulatory capital, but it will continue to meet its payment obligations on other issues or classes of obligations in a timely manner. 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

RELATED CRITERIA AND RESEARCH

Principles Of Corporate And Government Ratings, June 26, 2007 Principles-Based Rating Methodology For Global Structured Finance Securities, May 29, 2007. Rating Sovereign-Guaranteed Debt, April 6, 2009 European Legal Criteria for Structured Finance Transactions, August 28, 2008 Overview Of Legal Criteria for U.S. Structured Finance Transactions, October 1, 2006 Guide To Legal Issues In Rating Australian Securitization, March 1, 2005 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. Chief Credit Officer, Corporates & Governments: Colleen Woodell, New York (1) 212-438-2118; colleen_woodell@standardandpoors.com Francis Parisi, PhD, New York (1) 212-438-2570;

Chief Credit Officer, Structured Finance:

francis_parisi@standardandpoors.com Chief Credit Officer, Asia-Pacific: Ian Thompson, Melbourne (61) 3-9631-2100; ian_thompson@standardandpoors.com Blaise Ganguin, Paris (33) 1-4420-6698; blaise_ganguin@standardandpoors.com

Chief Credit Officer, Europe, Middle East & Africa:

General Criteria: Rating Government-Related Entities: Methodology And Assumptions

Editor's Note: This criteria article was originally published on Dec. 9, 2010. We are republishing this article following our periodic review, completed on March 28, 2012. This article supersedes "Enhanced Methodology And Assumptions For Rating Government-Related Entities," published June 29, 2009; "Rating National Development Banks And Export Credit Institutions," published Aug. 24, 2006; "International Postal Entities: Influence of Government Support on Ratings," published Nov. 22, 2004; and "European Railways and State Support: Company Ratings Tend to Track Governments," published Oct. 12, 2001.)

1.Standard & Poor's Ratings Services is updating its methodology for rating government-related entities

(GREs). The main purpose of this update is to provide more detailed tables indicating rating outcomes. Since the updated rating outcome tables are fully consistent with those published June 29, 2009, this update does not represent any material change.

SCOPE OF THE CRITERIA

2.These criteria apply to the analysis of corporate and governmental issues and issuers globally. They do

not cover supra-nationals, which we rate according to a specific methodology.

SUMMARY OF CRITERIA UPDATE

3.GREs are enterprises potentially affected by extraordinary government intervention during periods of

stress. GREs are often partially or totally controlled by a government (or governments) and they contribute to implementing policies or delivering key services to the population. However, we have observed that some entities with little or no government ownership might also be considered as GREs, if we believe that they might benefit from extraordinary government support due to their systemic importance or their critical role as providers of crucial goods and services.
4.We consider governments' interventions as "extraordinary" when they are temporary, entity-specific,

and related to financial stress at the GRE or at the government level. In most cases, the intervention is likely to be in the form of extraordinary governmental support and in such cases the GRE's rating would likely be enhanced by its relationship with the government. Conversely, a government intervention could operate to redirect GRE resources to the government and weaken the GRE's credit quality.
5.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 burden. The government's rating, which speaks to the government's ability to support (or, in a negative scenario, its need to avail itself of the resources of) the GRE. Our opinion of the likelihood of sufficient and timely extraordinary government intervention in support of the GRE meeting its financial obligations, as derived from our assessment of the importance of the

GRE's role to the government, as well as the strength and durability of the links between the two.
6.Standard & Poor's distinguishes between government intervention that enables a timely repayment of a

GRE's debt and intervention that principally aims at supporting an entity's employment or operations but might not necessarily reduce the likelihood of default.
7.The potential for extraordinary government support is an important factor driving the creditworthiness of

all financial institutions. These criteria apply to certain financial institutions with a public policy role and/or where government ownership is strategic and long-term in nature. Criteria published in "External Support Key In Rating Private Sector Banks Worldwide," Feb. 27, 2007, and "How Systemic Importance Plays A Significant Role In Bank Ratings," July 3, 2007, continue to address the way extraordinary government support is incorporated into ratings on the majority of commercial financial institutions. While many characteristics of commercial financial institutions fit in with this broader approach to GREs, some types of government support in the banking sector call for a modified approach. Further criteria development is required before applying this broader GRE methodology to all financial institutions. Standard & Poor's expects to successively update its criteria on this subject.
8.This article supersedes "Enhanced Methodology And Assumptions For Rating Government-

Related Entities," published June 29, 2009.

9.We are updating this criteria article to replace tables 3-7 of the superseded article by tables 4-8 in this

article, providing more granularity regarding the rating outcomes. The tables in this article show the SACP and government ratings to the notch instead of by category.

IMPACT ON OUTSTANDING RATINGS

10.We expect no significant rating impact from this criteria update, as there is no material change in the

methodology but rather we are providing greater detail on certain existing elements.

EFFECTIVE DATE AND TRANSITION

11. The criteria described in this article are effective immediately.

METHODOLOGY AND ASSUMPTIONS Definition Of Extraordinary Government Intervention

12.We view extraordinary government intervention as either "discrete" or "temporary" (as opposed to

ongoing), entity-specific (as opposed to system-wide), and often related to financial stress at the GRE level. We view the potential for extraordinary government intervention as coming on top of "ongoing"

interactions. Extraordinary intervention may result in an enhancement of a GRE's rating if it is in the form of support. More rarely, government intervention may weaken a GRE's credit quality if it operates to redirect a GRE's resources to the government.
13.The line between what may be termed "extraordinary" and "ongoing" intervention is not always distinct.

However, "extraordinary" interventions usually occur in periods of 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. Examples of negative extraordinary intervention include special tax, dividend, asset- or cash-stripping, or other measures that the government may impose to divert GRE resources to the government, as the government's needs rise.
14.Standard & Poor's assesses the likelihood of timely and sufficient extraordinary support from the

government to the GRE on the basis of the GRE's capacity and willingness to meet its financial commitments as they come due. A government's perception of need for support may therefore be different from our definitional standard. More precisely, a default on non-deferrable subordinated debt, or a delay of payment for a short period of time, or a debt restructuring which we would consider to be distressed and below par, would typically be treated as a default according to Standard & Poor's ratings definitions, even though the government might have provided some form of support.

Stand-Alone Credit Profile (SACP) And Government Ratings

15.SACPs are determined according to our criteria published Oct. 1, 2010. Defined in our October criteria

article, the SACP identifies the downside for the GRE if the potential for extraordinary government support dissipates. It also provides the clearest view of the contingent liability the GRE poses for the government.
16.Government ratings are determined in accordance with "Methodology For Rating International

Local And Regional Governments," Sept. 20, 2010, "Sovereign Credit Ratings: A Primer," May 29, 2008, and "GO Debt," Oct. 12, 2006.

Assessment Of The Likelihood Of Extraordinary Government Support

17.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.

18.As a general rule, we believe that the higher the likelihood of sufficient and timely extraordinary

intervention, the closer the GRE's rating is likely to be to the government's rating. The lower the likelihood of intervention, 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 are based on our analysis, as described in the matrix below (table 1).

Assessing the importance of the GRE's role to the government

19.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 either because it implements a key national policy, provides an important public service, or because it affects the proper functioning of an important economic sector. Our qualitative assessment is 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.

20.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. We distinguish on a continuum between support from the government that mostly targets the continuation of the GRE's activities and/or the safeguard of employment, and support aimed at ensuring the full and timely payment of bondholders.
21.Standard & Poor's has observed that the importance of a particular GRE might vary over time,

triggering different reactions for 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 result might attain were the entity's troubles to occur in a more benign environment with the consequences of non-intervention 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 over time to reflect those considerations.
22.Standard & Poor's distinguishes four different levels when assessing the importance of the GRE to the

government: Critical Very important Important Limited importance.

23.The criteria for determination of the importance of the GRE's role are described in table 2 below.

Table 2

Assessing The Importance Of A GRE's Role To The Government

A default of the GRE would have a critical impact for the government, for one of the Critical 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.

-- 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.

Very important

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 for the local economy.

A default of the GRE would have an important but manageable impact for the Important 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:

* 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.

Limited importance

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.
24.Entities with less than limited importance to the government are not considered as GREs and are not

reflected in the above table. Assessing the strength and durability of the link between a GRE and the government
25.The strength and durability of the links between a GRE and the government can be estimated by

looking at the degree to which the government drives the GRE's strategy and its operations and by its level of supervision. Analytical considerations include the percentage of ownership of the GRE and/or other factors including the existence of a partial or ultimate government guarantee of the GRE's obligations and reputational risk to the government should the GRE default.
26.Our analysis of the links between a GRE and its government takes into consideration our opinion on

the government's general propensity to intervene in the GRE sector in a credit supportive and timely manner. In particular, we analyze the government's current willingness to support a particular GRE, supported by its policy, its track record of past interventions, its degree of involvement in the day-to-day operations of its GREs, but also the cultural and political aspects related to the government's intervention and its administrative capacity to provide timely support. Finally, we look at the spectrum of activities covered by the GRE sector as well as the potential constraints that might arise from a legal or regulatory framework such as the EU competition laws. In governments where we believe there is a high propensity to intervene, we generally assess that the link between the government and its GREs is stronger than for governments with what we view as a low propensity to support. If we doubt the willingness and/or capacity of the government to provide timely support for policy reasons, weak administrative capacity, or past practices, we would generally consider that the link between the government and its GRE is low, even if the GRE has a critical role.
27.Standard & Poor's distinguishes four different levels when assessing the strength of the link between

the GRE and the government:

Integral Very strong Strong Limited.

28.The levels are described in table 3 below.

Table 3

Assessing The Strength And Durability Of The Link Between The Government And A GRE

The GRE is essentially an arm of the government. It has a policy, supported by a track Integral record, of providing considerable and timely credit support in all circumstances

-- The government has a policy, supported by a track record, of providing 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.

Very strong

The government has a very strong and durable link with the GRE. It has a policy, supported by a track record, of providing very strong and timely credit support in most circumstances

-- The government is strong and stable shareholder. It has a policy or a track record of providing support to the GRE in most circumstances, and one or more of the conditions below are met:

* The government has a strong influence on the GRE's strategic 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.

* 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.

The government is an important shareholder of the GRE and/or has a policy, supported by a Strong track record, of providing strong credit support in certain circumstances

-- The government is an important--typically a majority--shareholder and has a policy and/or track record, of providing 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.

* A legal or regulatory framework partly constrains the government's ability to intervene (e.g. European Union competition laws).

-- 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 Limited capacity of providing very limited credit support

-- The government is a minority shareholder and does not interfere more than any other minority shareholder in the GRE's strategic decisions and operations.

-- 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.

* The government has very limited administrative and/or legal capacity to provide support to its GREs on a timely basis.

* The government has limited financial capacity to provide support to its GREs, for instance considering the size of total financial liabilities in the GRE sector.

Determining The GRE's Issuer Credit Rating

29.Once we have determined the likelihood of extraordinary government support based on our evaluation

of the GRE's role and link to the government and the above matrix, we establish the GRE's issuer credit rating through the combination of the likelihood of extraordinary support, the SACP, and the government's rating. We outline the combination of these factors and their effect on the GRE's rating in tables 4 to 8 below. These tables yield the GRE's issuer or senior credit rating based on its SACP (listed down the lefthand 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. The GRE's rating might vary by one notch up or down from the rating suggested in the tables in cases of a gradual transition in a GRE's role or link leading to a weakening of the likelihood of extraordinary government support over time. Where we assess extraordinary government support as highly likely and as the key rating driver
30.For GREs most closely tied to the government, 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 of the GRE tends to be close to, and move in tandem with, that of the government, as illustrated in tables 4 and 5 below.
31.We haven't included a table for the case where the likelihood of support is almost certain, as Standard

& Poor's would then generally equalize the rating of a GRE with that of the government.
Table 4

Determining A GRE's Issuer Credit Rating: Extremely High (EH) Likelihood Of Support

Government's local currency rating

SAC P

AA A

AA + AA AAA+ A A-

BBB +

BB B

BB B-

BB +

B B

BB B+ B B-

aaa

AA

AA aa+ A

AA+

AA aa A

AA+ AA

AA aaA

AA+ AA

AA-

a+

AA+ AA

AA

AA-

A+

AA+ AA

AA-

AA-

A+

a-

AA+ AA

AA-

A+

A-

bbb +

AA+ AA

AA-

A+

A-

A-

BBB +

AA+ AA bbb

AA-

A+

A-

BBB +

BBB +

BB B

AA+ AA bbb-

AA-

A+

A-

BBB +

BBB

BB B

BBB -

AA+ AA bb+

AA-

A+

A-

BBB +

BBB

BB B-

BBB -

BB +

AA bb

AA-

A+

A+

A-

BBB +

BBB

BB B-

BB+

BB

BB

AA bb-

AA-

A+

A+

A-

BBB +

BBB

BB B-

BB+

BB

BB BB -

AA b+

AA-

BBB +

BBB +

BBB

BBB -

BB+ BB

BB

BB B+ -

B+

AAb

A+

BBB +

BBB +

BBB

BBB -

BB+ BB

BB

BB B+ -

AAb-

BBB

BBB

BBB

BBB -

BB+ BB

BB

BB B+ -

B-

B-

BB ccc+ B-

BB B-

BB B-

BB B-

BBB -

BBB -

BBB -

BB+

BB

BB-

B+

B+

B-

B-

CCC +

BB+ BB+ BB+ BB+ BB+ ccc

BB+

BB+

BB

BB

BB-

B+

B+

B-

B-

CCC +

BB+ BB+ BB+ BB+ BB+ ccc-

BB+

BB+

BB

BB

BB-

B+

B+

B-

B-

CCC +

BBcc

BB-

BB-

BB-

BB-

BB-

BB-

B+

B+

B+

B-

CCC +

CCC +

CCC

SACP--Stand-alone credit profile.

32.In situations--which we expect to be rare--where a GRE's SACP is deteriorating to extremely weak

levels ('b' and lower), despite ongoing government support, 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.
33.For this reason, even in cases where the likelihood of timely extraordinary government support is, in

our view, extremely or very high, and hence the GRE's SACP may not be the primary driver in the determination of the GRE rating, we believe that it is important to take an approximate view on the SACP. This is because the SACP may help to 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.
Table 5

Determining A GRE's Issuer Credit Rating: Very High (VH) Likelihood Of Support

Government's local currency rating

SAC AA P A

AA + AA AAA+ A A-

BB B+

BB B

BB B-

BB + BB BBB+ B B-

AA aaa A

AA aa+ A

AA+

AA aa A

AA+

AA

aa-

AA+

AA+

AA

AA-

a+

AA

AA

AA

AA-

A+

AA

AA-

AA-

AA-

A+

a-

AA

AA-

A+

A+

A-

bbb +

AA-

AA-

A+

A-

A-

BBB +

A+ bbb

A+

A+

A-

BB B+

BBB +

BB B

bbb -

A-

A-

BB B+

BBB

BB B

BB B-

Abb+

A-

A-

A-

A-

BB B+

BB B+

BBB

BB B-

BB B-

BB +

BB bb B+

BB B+

BB B+

BB B+

BB B+

BB B+

BB B

BBB

BB B-

BB+ BB

BB

BB bbB+

BB B+

BB B

BB B

BB B

BB B

BB B

BBB -

BB B-

BB+ BB

BB-

BB-

BB b+ B+

BB B

BB B-

BB B-

BB B-

BB B-

BB B-

BBB -

BB +

BB

BB -

BB-

B+

B+

BB b B

BB B-

BB B-

BB B-

BB+

BB+

BB+

BB+

BB +

BB

BB -

BB-

B+

BB bB-

BB B-

BB+

BB+

BB

BB

BB

BB

BB

BB

BB -

B+

B-

B-

B-

ccc +

BB-

BB-

BB-

BB-

BB-

BB-

BB-

B+

B+

B+

B+

B+

B-

B-

B-

CC C+

B+ ccc

B+

B+

B+

B+

B+

B+

B+

B+

B+

B+

B-

CC C+

CC C+

CC C+

B+ ccc-

B+

B+

B+

B+

B+

B+

B+

B+

B+

B-

B-

CC C+

CC C+

CC C

B+ cc

B+

B+

B+

B+

B+

B+

B-

B-

CC C+

CC C+

CC C

CC C

CC C-

SACP--Stand-alone credit profile.

Where we view extraordinary government support as reasonably likely but not as the primary rating driver
34.For entities we view as benefiting from supportive government policies, possibly direct assistance, and

potentially extraordinary government intervention, but where the likelihood of the latter is lower, GRE ratings are usually more closely aligned with the GRE's SACP, as indicated in tables 6 to 8 below.
Table 6

Determining A GRE's Issuer Credit Rating: High (H) Likelihood Of Support

Government's local currency rating

SA CP

AA A

AA + AA AAA+ A A-

BB B+

BB B

BB BBB+ BB BBB+ B B-

AA aaa A

AA aa+ +

AA +

AA aa +

AA

AA

aa-

AA

AA

AA-

AA-

a+

AA-

AA-

AA-

A+

A+

AA-

A+

A+

A+

a-

AA-

A+

A+

A-

A-

bbb +

A+

A+

A-

BBB BBB + +

A bbb

A-

A-

A-

BBB BBB BBB +

bbb -

A-

A-

A-

A-

BBB BBB BBB BBB BBB BBB + + + -

BB bb+ B+

BB B+

BB B+

BB B+

BBB BBB BBB BBB BBB BB+ + -

BB+

BB bb B

BB B

BB B

BB B

BBB BBB BBB BBB BBB BB+ -

BB

BB

BB bbB-

BB B-

BB B-

BB B-

BBB BBB BBB BB+ -

BB+

BB+

BB

BB-

BB-

BB b+ +

BB +

BB +

BB +

BB+

BB+

BB+

BB+

BB

BB

BB-

BB-

B+

B+

BB

BB

BB

BB

BB

BB

BB

BB

BB

BB-

BB-

BB-

B+

b-

BB-

BB-

BB-

BB-

BB-

BB-

BB-

BB-

BB-

BB-

B+

B+

B-

B-

B-

ccc +

B+

B+

B+

B+

B+

B+

B+

B+

B+

B+

B-

B-

B-

CC C+

B ccc

B-

B-

B-

CC C+

CC C+

CC C+

Bccc-

B-

B-

B-

B-

B-

B-

B-

B-

B-

CC C+

CC C+

CC C+

CC C

CC C

CC C

Bcc

B-

B-

B-

CC C+

CC C+

CC C+

CC C+

CC C+

CC C+

CC C

CC C

CC C

CC C-

CC C-

CC

SACP--Stand-alone credit profile.

Table 7

Determining A GRE's Issuer Credit Rating: Moderately High (MH) Likelihood Of Support

Government's local currency rating

SA CP

AA A

AA + AA AAA+ A A-

BB B+

BB B

BB B-

BB + BB BBB+ B B-

aaa

AAA

aa+

AA+

AA+

aa

AA

AA

AA

aa-

AA

AA-

AA-

AA-

a+

AA-

AA-

A+

A+

A+

A+

A+

A+

a-

A+

A-

A-

A-

bbb +

A-

A-

A-

BBB BBB BBB + + +

Abbb

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 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-

BB-

BB-

b+

BB

BB

BB

BB

BB

BB

BB

BB

BB-

BB-

BB-

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-

ccc +

B-

B-

B-

CC C+

CC C+

CC C+

Bccc

B-

B-

B-

B-

B-

B-

B-

B-

B-

CC C+

CC C+

CC C+

CC C

CC C

CC C

CC ccc- C+

CC C+

CC C+

CC C+

CC C+

CC C+

CC C+

CC C+

CC C+

CC C+

CC C

CC C

CC C

CC C-

CC C-

CC C-

cc

CC

CC

CC

CC

CC

CC

CC

CC

CC

CC

CC

CC

CC

CC

CC

CC

C-

C-

C-

SACP--Stand-alone credit profile.

Table 8

Determining A GRE's Issuer Credit Rating: Moderate (M) Likelihood Of Support

Government's local currency rating

SA CP

AA A

AA + AA AAA+ A A-

BB B+

BB B

BB B-

BB + BB BBB+ B B-

aaa

AAA

aa+

AA+

AA+

aa

AA

AA

AA

aa-

AA-

AA-

AA-

AA-

a+

AA-

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 BBB -

bb+

BBB 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

BB

BB

BB

BB

BB

BB

BB

BB

BB-

BB-

BB-

BB-

b+

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-

ccc +

B-

B-

B-

B-

B-

B-

B-

B-

B-

B-

B-

B-

B-

CC C+

CC C+

CC C+

CC ccc C+

CC C+

CC C+

CC C+

CC C+

CC C+

CC C+

CC C+

CC C+

CC C+

CC C+

CC C+

CC C+

CC C

CC C

CC C

CC ccc- C

CC C

CC C

CC C

CC C

CC C

CC C

CC C

CC C

CC C

CC C

CC C

CC C

CC C-

CC C-

CC C-

CC cc C-

CC C-

CC C-

CC C-

CC C-

CC C-

CC C-

CC C-

CC C-

CC C-

CC

CC

CC

CC

CC

CC

SACP--Stand-alone credit profile.

Where we view that the likelihood of extraordinary government support is low

35.We may rate the GRE the same as its SACP where we believe that the likelihood of government

support is low, generally because the GRE's importance for the government is limited and the two entities are not closely linked. This is the case, for instance, for a GRE performing a function that other market participants could easily undertake and that the private sector usually operates in other countries, or where the government acts mostly as a regulator and its interventions have the primary objective of enhancing (or in some cases protecting) the functioning of the relevant industry segment, regardless of ownership.
36.The Appendix represents the same content as tables 4 to 8 above, but classified on the basis of the

government's rating.

Where a GRE has links to more than one government

37.In cases 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 single government, as well as the relationships among the different governments. If, in our view, one government has a prominent link with the GRE and would appear to be the more willing to support fully the GRE, even if the other governments don't, we would use that one government's local currency rating as a reference in tables 4 to 8. If support were to come from all governments for their respective share (for instance based on percentages of ownership), then we would use the lowest government rating as a reference in the tables 4 to 8. In cases where we are of the opinion that there would be "joint and several" support from all governments, the GRE's rating could be higher than reflected in the tables. Conversely, if we see a significant risk that asymmetries in interests or slow joint decision-making could weaken support to the GRE, this could bear on our assessment of the likelihood of support, bringing it down to "low." Application of currency considerations to tables 4 to 8
38.The GRE's local (and foreign) currency rating indicated in tables 4 to 8 would generally be capped at

the level of the sovereign foreign currency rating, unless either: The GRE benefits from at least an "extremely high" likelihood of sovereign support, or The GRE has an SACP above the sovereign's foreign currency rating.

39.In the first case, a GRE with "extremely high" likelihood of support, the GRE's local currency rating is

as shown in the table, and the GRE's foreign currency rating is capped at the sovereign foreign currency rating.
40.In the second case, the GRE's local currency rating is likely to be the SACP (stress-tested for country

risk) and the GRE's foreign currency rating will likely be the lower of the rating suggested by the SACP and the country transfer and convertibility (T&C) assessment, as further addressed in the sections below, "Extraordinary government intervention may impair a GRE rating" and "Rating a GRE above the rating on its government." As mentioned above, the tables address the situation of the majority of GREs having an SACP below the government's rating and whose final rating is likely to benefit from extraordinary government support. The cases of GREs with an SACP above the government's rating are, in our experience, more infrequent.

Other Considerations
Extraordinary government intervention may impair a GRE rating

41.While in most cases the likelihood of extraordinary government intervention enhances a GRE's rating

above its SACP, in a few instances government intervention is negative, potentially draining resources and keeping 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--where the SACP is above the rating of its government despite the ongoing negative intervention which is already captured in the SACP. In these situations, we could assign to the GRE a final rating 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 in a period in which the sovereign faces fiscal or external stress. In other cases, the risk of negative intervention would result in a lower SACP and final rating outcome. The risk of adverse intervention often increases when a government is in default or under financial pressure, therefore, it is relatively exceptional for a GRE to be rated above its related government, as explained below. Rating a GRE above the rating on its government
42.By assigning a GRE a rating that exceeds its government's foreign (or local) currency rating, Standard

& Poor's is expressing its view that the GRE's ability to service its debt is superior to that of the government and that, ultimately, if the government defaults on its foreign currency debt, there is a measurable likelihood that the GRE will not default. For this to happen, the first condition is that the GRE's SACP will exceed the government's foreign currency rating. The second condition is that the government's willingness and ability to impair the GRE's credit standing in periods of stress should be limited. The key considerations in these respects are: The GRE should be a fairly independent enterprise operating in a competitive environment. Government linkages should be limited. Government ownership, which should be materially less than 100%, is viewed in a parent/subsidiary context. If the parent (government) is under severe stress, it could demand increasing amounts of cash or other assets from the subsidiary. As a result, the GRE should demonstrate a significant ability to mitigate this type of governmentowner interference through, for example, nongovernment shareholder support, solid governance standards, financial resilience to interference, and a track record of a hands-off approach by the government. The GRE's rating should reflect its ability to mitigate the relevant country risks. To assess this, we would review the business and financial impacts of country risk and subjecting the GRE to significant

stress tests. (See "Corporate Ratings Criteria 2008," section "Country Risk.")
43.With regard to the last point, sovereign stress or default often creates very difficult business and

financial environments and situations. To maintain a rating above that of the relevant sovereign's foreign currency rating, an entity should be able to "pass" significant stress scenarios. Such scenarios normally involve sharp currency depreciation, higher inflation, economic contraction, and rising real and nominal interest rates as well as reductions in government support, higher required reserves and other taxes, increases in regulatory risk, and nonpayment of government obligations.
44.The GREs most likely to pass these scenarios are, in our experience, sound oil companies that play no

significant policy role and strong private-sector institutions in countries where we don't expect the relevant sovereign to act in ways that specifically diminish these entities' flexibility in a time of sovereign stress.
45.In those situations where a GRE's local currency rating exceeds the sovereign foreign currency rating

on the basis of the above conditions, Standard & Poor's practice is to cap the GRE's foreign currency rating by the sovereign's T&C assessment, as for any other non-sovereign entities. More information on the effect of the T&C assessments can be found in "Criteria For Determining Transfer And Convertibility Assessments," published May 18, 2009.
46.Financial institutions usually have neither local nor foreign currency ratings above the relevant

sovereign's foreign currency rating because of: The institutions' overall credit exposure to the general economy, the performance of which is highly correlated with sovereign creditworthiness. The threats of negative intervention--such as a deposit freeze--in a sovereign stress scenario. The institutions' direct exposure to sovereign risk due to their holdings of government bonds on their balance sheets. This exposure tends to increase in periods of stress. Government guarantees
47.Some GREs have outstanding obligations benefiting from timely, irrevocable, and unconditional

government guarantees. Standard & Poor's criteria for rating guaranteed debt are explained in "European Legal Criteria For Structured Finance Transactions," Aug. 28, 2008, and more specific indications on the application to sovereigns can be found in "Rating Sovereign-Guaranteed Debt,"

published April 6, 2009. For example, in light of pressures on the credit markets, a number of governments introduced in 2008 and 2009 guarantee programs through which financial institutions obtained sovereign guarantees for some or all of their debt obligations. We rate these guaranteed obligations on the basis of such criteria.
48.In cases where 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.
49.A few GREs benefit from statutory guarantees, whereby the government would be ultimately liable for

the GRE's obligations 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 consider that the existence of this statutory guarantee is one among other factors that might create an incentive for the government to provide timely support in accordance with our GRE methodology. More specifically, we 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 2. Rating GRE junior obligations
50.We have observed that governments may not necessarily support GREs in a manner that equally

benefits all security holders. Indeed, supporting the GRE's higher-ranking obligations may be to the detriment of lower-ranking, and specifically subordinated and/or deferrable, obligations, as contemplated by the terms of their respective issuances.
51.Therefore, as for any other entity, specific obligations issued by a GRE might be rated differently from

its issuer credit rating. We may rate hybrid capital or other subordinated obligations below the issuer credit rating or senior obligations if we anticipate that intervention could be less beneficial (and possibly negative) than for other obligations, in accordance with our hybrid capital criteria. (See "Hybrid Capital Handbook: September 2008 Edition," published Sept. 15, 2008.) Rating a GRE's subsidiaries
52.When rating a subsidiary of a GRE, we analyze the subsidiary's relationships both with its parent entity

and with the government. We have observed different results across the universe of rated entities.
53.Case 1: The subsidiary is essentially not a GRE. We rate the subsidiary primarily from a parent-

subsidiary perspective, taking as a reference the parent's SACP.

Government: 'AA' Parent's issuer credit rating: 'A' Parent's SACP: 'bbb+' Subsidiary's SACP: 'bbb-' Subsidiary's issuer credit rating: Typically between 'BBB-'and 'BBB+' *Determined in accordance with the applicable criteria for the sector.
54.Case 2: The subsidiary stands, vis--vis the government, in the moderate-to-low corner of the

GRE role-link matrix. We consider both GRE and parent-subsidiary approaches, but focus more on the latter.
55.We typically consider the rationale for extraordinary government support to be significantly weaker for

the subsidiary than for the parent. This could be for a variety of reasons, for example: the link is indirect, and so we see it as weaker; the subsidiary's role is of lower importance to the government; the subsidiary is operating in a different country and the government might be more reluctant to use domestic taxpayers' money to support non-domestic activities; or because of the possibility of group restructuring, divestments, or strategic revisions in a period of stress. In these situations, we would typically apply the principles of our parent-subsidiary criteria to rate these entities: We would consider the parent's willingness and capacity--as measured by its stand-alone credit profile--to support its subsidiary. (See section on "Nonrecourse debt of affiliates (scope of consolidation)" in "Corporate Ratings Criteria 2008," published April 15, 2008, and "Group Methodology for Financial Services Companies," published March 19, 2004.) Government: 'AA' Parent's issuer credit rating: 'A' Parent's SACP: 'bbb+' Subsidiary's SACP: 'bbb-' Subsidiary's issuer credit rating: Typically between 'BBB-' and 'A'

*Determined in accordance with the applicable criteria for the sector

56.In many cases this could result in the subsidiary's issuer credit rating not being higher than its parent's

as we would expect both any direct government support to the subsidiary to be recapturable by the parent and any indirect government support to the subsidiary to be directly capturable by the parent.
57.However, the subsidiary's issuer credit rating could exceed the parent's SACP to the extent that a

portion of extraordinary government support would benefit both parent and subsidiary (either because the support goes directly to the subsidiary or because it trickles down from government through the parent to, at least partially, the subsidiary).
58.Case 3: The subsidiary is a prominent government-related entity. In situations where despite its

subsidiary status the GRE discharges important policy or other functions, we consider both GRE and parent-subsidiary approaches but will likely place more weight on the former.
59.The subsidiary's issuer credit rating is not necessarily limited by that of its parent. Where a subsidiary's

issuer credit rating exceeds that of its parent, we will have likely concluded that despite the parent being under stress and potentially in default (inclusive of the support it could potentially have already received from the government), there is a reasonable likelihood that the subsidiary would not itself default.
60.In other cases, we may consider the subsidiary could itself qualify as a GRE, because of the

prominence of its role and/or links with the government. Some subsidiaries might even be more important to the government than their parent holding if they provide a crucial service to the population for instance. In that case, we would apply the GRE methodology explained in this article to rate the subsidiary. Finally, there might be cases where a subsidiary might benefit both from potential support from its parent as its investee and directly from the government as a GRE.

RELATED CRITERIA AND RESEARCH

Request for Comment: Bank Hybrid Capital Criteria: Methodology And Assumptions, Dec. 6, 2010 Request For Comment: Sovereign Government Rating Methodology And Assumptions, Nov. 26, 2010 Stand-Alone Credit Profiles: One Component Of A Rating, Oct. 1, 2010 Rating Sovereign-Guaranteed Debt, April 6, 2009

Criteria For Determining Transfer And Convertibility Assessments, May 18, 2009 Request For Comment: Enhanced Methodology For Rating Government-Related Entities And Assessing The Potential For Extraordinary Government Intervention, Jan. 23, 2009

Methodology And Assumptions: Rating International Local And Regional Governments, Jan. 5, 2009 Hybrid Capital Handbook: September 2008 Edition, Sept. 15, 2008 European Legal Criteria For Structured Finance Transactions, Aug. 28, 2008 Sovereign Credit Ratings: A Primer, May 29, 2008 Corporate Ratings Criteria 2008, April 15, 2008 How Systemic Importance Plays A Significant Role In Bank Ratings, July 3, 2007 Principles Of Corporate And Government Ratings, June 26, 2007 External Support Key In Rating Private Sector Banks Worldwide, Feb. 27, 2007. GO Debt, Oct. 12, 2006 Group Methodology for Financial Services Companies, March 19, 2004

APPENDIX Determining A GRE's Issuer Credit Rating: Tables Presented By Government Rating
61.Tables 9 to 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

MH

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-

AA-

a+

AAA

AA+

AA

AA-

AA-

AA-

A+

AAA

AA+

AA

AA-

A+

A+

a-

AAA

AA+

AA

AA-

A+

A-

bbb+

AAA

AA+

AA-

A+

A-

BBB+

bbb

AAA

AA+

A+

A-

BBB+

BBB

bbb-

AAA

AA+

A-

BBB+

BBB

BBB-

bb+

AAA

AA+

A-

BBB+

BBB

BBB-

BB+

bb

AAA

AA

BBB+

BBB

BBB-

BB+

BB

bb-

AAA

AA

BBB+

BBB-

BB+

BB

BB-

b+

AAA

AA

BBB+

BB+

BB

BB-

B+

AAA

AA-

BBB

BB

BB-

B+

b-

AAA

AA-

BBB-

BB-

B+

B-

ccc+

AAA

BBB-

BB-

B+

B-

CCC+

ccc

AAA

BB+

B+

B-

CCC+

CCC

ccc-

AAA

BB+

B+

B-

CCC+

CCC

CCC-

cc

AAA

BB-

B+

B-

CCC

CCC-

CC

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

MH

aa+

AA+

AA+

AA+

AA+

AA+

AA+

AA+

aa

AA+

AA+

AA+

AA

AA

AA

AA

aa-

AA+

AA+

AA+

AA

AA-

AA-

AA-

a+

AA+

AA

AA

AA-

AA-

A+

A+

AA+

AA

AA-

A+

A+

A+

a-

AA+

AA

AA-

A+

A-

bbb+

AA+

AA

AA-

A+

A-

BBB+

bbb

AA+

AA

A+

A-

BBB+

BBB

bbb-

AA+

AA

A-

BBB+

BBB

BBB-

bb+

AA+

AA

A-

BBB+

BBB

BBB-

BB+

bb

AA+

AA

BBB+

BBB

BBB-

BB+

BB

bb-

AA+

AA

BBB

BBB-

BB+

BB

BB-

b+

AA+

AA-

BBB

BB+

BB

BB-

B+

AA+

AA-

BBB-

BB

BB-

B+

b-

AA+

A+

BBB-

BB-

B+

B-

ccc+

AA+

BBB-

BB-

B+

B-

CCC+

ccc

AA+

BBB-

BB-

B-

CCC+

CCC

ccc-

AA+

BBB-

BB-

B-

CCC+

CCC

CCC-

cc

AA+

BB-

B+

B-

CCC

CCC-

CC

AC--Almost certain. EH--Extremely high. VH--Very high. H--High. MH--Moderately high. M--Moderate. L--Low.

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

MH

aa

AA

AA

AA

AA

AA

AA

AA

aa-

AA

AA

AA

AA-

AA-

AA-

AA-

a+

AA

AA

AA

AA-

A+

A+

A+

AA

AA-

AA-

A+

A+

a-

AA

AA-

A+

A+

A-

bbb+

AA

AA-

A+

A-

A-

BBB+

bbb

AA

AA-

A+

A-

BBB+

BBB

bbb-

AA

AA-

A-

BBB+

BBB

BBB-

bb+

AA

AA-

A-

BBB+

BBB

BBB-

BB+

bb

AA

A+

BBB+

BBB

BBB-

BB+

BB

bb-

AA

A+

BBB

BBB-

BB+

BB

BB-

b+

AA

BBB-

BB+

BB

BB-

B+

AA

BBB-

BB

BB-

B+

b-

AA

BB+

BB-

B+

B-

ccc+

AA

BBB-

BB-

B+

B-

CCC+

ccc

AA

BB+

B+

B-

CCC+

CCC

ccc-

AA

BB+

B+

B-

CCC+

CCC

CCC-

cc

AA

BB-

B+

B-

CCC

CCC-

CC

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

MH

aa-

AA-

AA-

AA-

AA-

AA-

AA-

AA-

a+

AA-

AA-

AA-

A+

A+

A+

A+

AA-

AA-

AA-

A+

a-

AA-

A+

A+

A-

A-

bbb+

AA-

A+

A-

A-

BBB+

bbb

AA-

A+

A-

BBB+

BBB+

BBB

bbb-

AA-

A+

A-

BBB+

BBB

BBB-

bb+

AA-

A+

A-

BBB+

BBB

BBB-

BB+

bb

AA-

A+

BBB+

BBB

BBB-

BB+

BB

bb-

AA-

A+

BBB

BBB-

BB+

BB

BB-

b+

AA-

BBB-

BB+

BB

BB-

B+

AA-

BBB-

BB

BB-

B+

b-

AA-

BB+

BB-

B+

B-

ccc+

AA-

BBB-

BB-

B+

B-

CCC+

ccc

AA-

BB+

B+

B-

CCC+

CCC

ccc-

AA-

BB+

B+

B-

CCC+

CCC

CCC-

cc

AA-

BB-

B+

B-

CCC

CCC-

CC

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

MH

a+

A+

A+

A+

A+

A+

A+

A+

A+

A+

A+

a-

A+

A-

A-

A-

bbb+

A+

A-

BBB+

BBB+

bbb

A+

A-

BBB+

BBB+

BBB

bbb-

A+

A-

BBB+

BBB

BBB

BBB-

bb+

A+

A-

BBB+

BBB

BBB-

BB+

bb

A+

BBB+

BBB

BBB-

BB+

BB

bb-

A+

BBB

BBB-

BB+

BB

BB-

b+

A+

BBB+

BBB-

BB+

BB

BB-

B+

A+

BBB+

BB+

BB

BB-

B+

b-

A+

BBB

BB

BB-

B+

B-

ccc+

A+

BBB-

BB-

B+

B-

CCC+

ccc

A+

BB+

B+

B-

CCC+

CCC

ccc-

A+

BB+

B+

B-

CCC+

CCC

CCC-

cc

A+

BB-

B+

CCC+

CCC

CCC-

CC

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

MH

a-

A-

A-

A-

A-

bbb+

A-

A-

A-

BBB+

BBB+

BBB+

bbb

A-

A-

A-

BBB+

BBB

BBB

bbb-

A-

A-

BBB+

BBB

BBB

BBB-

bb+

A-

BBB+

BBB

BBB-

BBB-

BB+

bb

A-

BBB+

BBB

BBB-

BB+

BB

bb-

A-

BBB

BBB-

BB+

BB

BB-

b+

BBB+

BBB-

BB+

BB

BB-

B+

BBB+

BB+

BB

BB-

B+

b-

BBB

BB

BB-

B+

B-

ccc+

BBB-

BB-

B+

B-

CCC+

ccc

BB+

B+

B-

CCC+

CCC

ccc-

BB+

B+

B-

CCC+

CCC

CCC-

cc

BB-

B+

CCC+

CCC

CCC-

CC

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

MH

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-

BBB-

bb+

A-

BBB+

BBB+

BBB

BBB-

BBB-

BB+

bb

A-

BBB+

BBB

BBB-

BB+

BB+

BB

bb-

A-

BBB+

BBB

BBB-

BB+

BB

BB-

b+

A-

BBB

BBB-

BB+

BB

BB-

B+

A-

BBB

BB+

BB

BB-

B+

b-

A-

BBB

BB

BB-

B+

B-

ccc+

A-

BBB-

BB-

B+

B-

CCC+

ccc

A-

BB+

B+

B-

CCC+

CCC

ccc-

A-

BB+

B+

B-

CCC+

CCC

CCC-

cc

A-

BB-

B+

CCC+

CCC

CCC-

CC

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

MH

bbb+

BBB+

BBB+

BBB+

BBB+

BBB+

BBB+

BBB+

bbb

BBB+

BBB+

BBB+

BBB

BBB

BBB

BBB

bbb-

BBB+

BBB

BBB

BBB

BBB-

BBB-

BBB-

bb+

BBB+

BBB

BBB

BBB

BBB-

BB+

BB+

bb

BBB+

BBB

BBB

BBB-

BB+

BB+

BB

bb-

BBB+

BBB

BBB-

BB+

BB

BB

BB-

b+

BBB+

BBB-

BBB-

BB+

BB

BB-

B+

BBB+

BBB-

BB+

BB

BB-

B+

b-

BBB+

BBB-

BB

BB-

B+

B-

ccc+

BBB+

BB+

B+

B+

B-

CCC+

ccc

BBB+

BB

B+

B-

CCC+

CCC

ccc-

BBB+

BB

B+

B-

CCC+

CCC

CCC-

cc

BBB+

B+

CCC+

CCC

CCC-

CC

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

MH

bbb

BBB

BBB

BBB

BBB

BBB

BBB

BBB

bbb-

BBB

BBB

BBB

BBB-

BBB-

BBB-

BBB-

bb+

BBB

BBB-

BBB-

BBB-

BB+

BB+

BB+

bb

BBB

BBB-

BBB-

BBB-

BB+

BB

BB

bb-

BBB

BBB-

BBB-

BB+

BB

BB

BB-

b+

BBB

BB+

BB+

BB

BB-

BB-

B+

BBB

BB+

BB+

BB

BB-

B+

b-

BBB

BB+

BB

BB-

B+

B-

ccc+

BBB

BB

B+

B+

B-

CCC+

ccc

BBB

BB

B+

B-

CCC+

CCC

ccc-

BBB

BB

B+

B-

CCC+

CCC

CCC-

cc

BBB

B+

CCC+

CCC

CCC-

CC

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

MH

bbb-

BBB-

BBB-

BBB-

BBB-

BBB-

BBB-

BBB-

bb+

BBB-

BBB-

BBB-

BB+

BB+

BB+

BB+

bb

BBB-

BB+

BB+

BB+

BB

BB

BB

bb-

BBB-

BB+

BB+

BB+

BB

BB-

BB-

b+

BBB-

BB

BB

BB

BB-

BB-

B+

BBB-

BB

BB

BB-

B+

B+

b-

BBB-

BB

BB

BB-

B+

B-

ccc+

BBB-

BB-

B+

B+

B-

CCC+

ccc

BBB-

BB-

B+

B-

CCC+

CCC

ccc-

BBB-

BB-

B+

B-

CCC+

CCC

CCC-

cc

BBB-

B+

B-

CCC+

CCC

CCC-

CC

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

MH

bb+

BB+

BB+

BB+

BB+

BB+

BB+

BB+

bb

BB+

BB

BB

BB

BB

BB

BB

bb-

BB+

BB

BB

BB

BB-

BB-

BB-

b+

BB+

BB

BB-

BB-

BB-

B+

B+

BB+

BB

BB-

BB-

B+

B+

b-

BB+

BB

BB-

B+

B-

ccc+

BB+

B+

B+

B-

B-

CCC+

ccc

BB+

B+

B+

B-

CCC+

CCC+

CCC

ccc-

BB+

B+

CCC+

CCC

CCC

CCC-

cc

BB+

B-

CCC

CCC-

CC

CC

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

MH

bb

BB

BB

BB

BB

BB

BB

BB

bb-

BB

BB-

BB-

BB-

BB-

BB-

BB-

b+

BB

BB-

BB-

BB-

B+

B+

B+

BB

BB-

BB-

BB-

B+

b-

BB

BB-

B+

B+

B-

ccc+

BB

B+

B+

B-

B-

CCC+

ccc

BB

B+

B-

CCC+

CCC+

CCC

ccc-

BB

B+

B-

CCC+

CCC

CCC

CCC-

cc

BB

CCC+

CCC

CCC-

CC

CC

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

MH

bb-

BB-

BB-

BB-

BB-

BB-

BB-

BB-

b+

BB-

B+

B+

B+

B+

B+

B+

BB-

B+

B+

B+

b-

BB-

B+

B-

B-

ccc+

BB-

B-

B-

B-

B-

CCC+

ccc

BB-

B-

B-

CCC+

CCC+

CCC

ccc-

BB-

B-

CCC+

CCC

CCC

CCC-

cc

BB-

B-

CCC+

CCC

CCC-

CC

CC

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

MH

b+

B+

B+

B+

B+

B+

B+

B+

B+

b-

B+

B-

B-

B-

B-

B-

ccc+

B+

B-

B-

B-

CCC+

CCC+

CCC+

ccc

B+

B-

CCC+

CCC+

CCC

CCC

CCC

ccc-

B+

B-

CCC+

CCC

CCC-

CCC-

CCC-

cc

B+

CCC+

CCC

CCC-

CC

CC

CC

SACP--Stand-alone credit profile. AC--Almost certain. EH--Extremely high. VH--Very high. H--High. MH-Moderately high. M--Moderate. L--Low.

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

MH

b-

B-

B-

B-

B-

B-

B-

ccc+

B-

B-

B-

CCC+

CCC+

CCC+

ccc

B-

CCC+

CCC+

CCC

CCC

CCC

ccc-

B-

CCC+

CCC

CCC-

CCC-

CCC-

cc

CCC+

CCC

CCC-

CC

CC

CC

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

MH

b-

B-

B-

B-

B-

B-

B-

B-

ccc+

B-

CCC+

CCC+

CCC+

CCC+

CCC+

CCC+

ccc

B-

CCC+

CCC+

CCC+

CCC

CCC

CCC

ccc-

B-

CCC+

CCC

CCC

CCC-

CCC-

CCC-

cc

B-

CCC

CCC-

CC

CC

CC

CC

SACP--Stand-alone credit profile. AC--Almost certain. EH--Extremely high. VH--Very high. H--High. MH-Moderately high. M--Moderate. L--Low.

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. Criteria Officer, EMEA Corporates: Emmanuel Dubois-Pelerin, Paris (33) 1-4420-6673; emmanuel_dubois-pelerin@standardandpoors.com Emmanuel Dubois-Pelerin, Paris (33) 1-4420-6673; emmanuel_dubois-pelerin@standardandpoors.com Arnaud DeToytot, Paris (33) 1-4420-6692; arnaud_detoytot@standardandpoors.com Laura A Kuffler-Macdonald, New York (1) 212-4382519; laura_kuffler_macdonald@standardandpoors.com Laura J Feinland Katz, CFA, New York (1) 212-4387893; laura_feinland_katz@standardandpoors.com Marie Cavanaugh, New York (1) 212-438-7343;

Primary Credit Analyst:

Secondary Credit Analysts:

marie_cavanaugh@standardandpoors.com Criteria Officer, Global Sovereigns: Alexandra Dimitrijevic, Paris (33) 1-4420-6663; alexandra_dimitrijevic@standardandpoors.com Rob E Richards, Frankfurt (49) 69-33-999-200; rob_richards@standardandpoors.com Rob Jones, London (44) 20-7176-7041; rob_jones@standardandpoors.com Colleen Woodell, New York (1) 212-438-2118; colleen_woodell@standardandpoors.com Hans Wright, London (44) 20 7176 7015; hans_wright@standardandpoors.com Terry E Chan, CFA, Melbourne (61) 3-9631-2174; terry_chan@standardandpoors.com

Criteria Officer, EMEA Corporates & Governments: Criteria Officer, EMEA Insurance:

Senior Credit Officer, Global Corporates & Governments: Criteria Officer, Global Financial Institutions: Criteria Officer, Asia-Pacific:

General Criteria: Methodology: Credit Stability Criteria

(Editor's Note: This article was originally published on May 3, 2010. We're republishing this article following our periodic review completed on Nov. 17, 2011. 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, 2007.

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 & Poors To Explicitly Recognize Credit Stability As An Important Rating Factor," published Oct. 15, 2008.

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 & Poors 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

BBB

BB

One year

AA

BB

CCC

Three years

BBB

BB

CCC

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 subpopulations 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.

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 & Poors Rating Definitions," published June 3, 2009).

RELATED CRITERIA AND RESEARCH

Big Changes in Standard & Poors Rating Criteria, Nov. 3, 2009 Understanding Standard & Poors 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. Analytics Policy Board: Mark H Adelson, Managing Director and Chief Credit Officer, New York (1) 212-438-1075; mark_adelson@standardandpoors.com

Gail I Hessol, Managing Director and Analytics Policy Board Analytical Manager, New York (1) 212-438-6606; gail_hessol@standardandpoors.com Structured Finance: Francis Parisi, PhD, Managing Director and Senior Credit Officer, New York (1) 212-438-2570; francis_parisi@standardandpoors.com Corporates and Governments: Colleen Woodell, Managing Director and Senior Credit Officer, New York (1) 212-438-2118; colleen_woodell@standardandpoors.com Blaise Ganguin, Paris (33) 1-4420-6698; blaise_ganguin@standardandpoors.com Ian Thompson, Melbourne (61) 3-9631-2100; ian_thompson@standardandpoors.com

Additional Contacts:

General Criteria: Rating Sovereign-Guaranteed Debt

Editor's Note: This criteria article was originally published on April 6, 2009. We're republishing this article, last published on Nov. 30, 2010, following our periodic review completed on Nov. 3, 2011. This article supersedes "Rating Sovereign-Guaranteed Debt," published Nov. 21, 2008.)

Criteria Principles
Standard & Poor's Ratings Services is refining its methodology for rating sovereign-guaranteed debt. These criteria are a specific methodology related to our fundamental rating principles, as described in

"Principles Of Corporate And Government Ratings," which we published on June 26, 2007, on RatingsDirect at www.ratingsdirect.com and on Standard & Poor's Web site at www.standardandpoors.com. This article supersedes "Rating Sovereign-Guaranteed Debt," which was published on Nov. 21, 2008; it and the articles listed in the "Related Articles" section at the end of this report can be found at the same locations. 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 in order to serve global markets better.

Criteria Update
Standard & Poor's is updating its criteria for rating sovereign-guaranteed debt to clarify three areas. The clarification focuses on commercial paper rating substitution, on the need for a trustee or other bondholder representative in situations where there is a limited period in which a creditor can make a claim, and on the weight placed on the contractual provisions in the guarantee documents. These are summarized below: The use of the sovereign rating as a substitution for the primary obligor's commercial paper, certificate of deposit, and other short-term program ratings is possible only if the guarantee provides for payment in accordance with normal market practice, in our view, which usually requires the sovereign to make the funds available on the day the obligations are due. Where the time frame during which a bondholder can call on the guarantor for payment is restricted, the issue documents normally will designate a trustee or other bondholder representative to ensure that the claim is submitted within the authorized period. The sovereign rating substitution provided by these criteria rests heavily on the mechanisms in the documents supporting timely payment, not on assessments of potential extraordinary government intervention that affect the ratings of government-related entities and financial institutions generally.

Rating Implications
We expect few if any rating changes.

Criteria Methodology
A guarantee is a form of credit enhancement whereby the evaluation of the creditworthiness of the primary obligor is shifted to that of the guarantor and the terms of the guarantee. Standard & Poor's guarantee criteria identify the circumstances under which a guarantor could be excused from making a payment necessary for servicing the obligations of the guaranteed securities and take those circumstances into account in the rating. Timely payment is a key component of a guarantee. Standard & Poor's considers obligations to be in default if not paid when due under the terms of the issuance. Debt supported by a sovereign guarantee that does not, in Standard & Poor's view, adequately address timeliness is unlikely to receive the same rating as the sovereign. Standard & Poor's normally will rate an obligation based on the creditworthiness of the sovereign guarantor if the following apply: The guarantee is one of payment and not of collection. The guarantee documentation makes clear that the creditor is able to call on the guarantor for payment upon a default by the primary obligor, without the need for the creditor first to commence legal action against the primary obligor for payment. If the time frame during which a bondholder can call on the guarantor for payment is restricted, the issue documents normally will designate a trustee or other bondholder representative to facilitate the submission of the claim within the designated period. The sovereign guarantor agrees to service the guaranteed obligations on the dates on which payments are due. With regard to a sovereign guarantee, "timely" pertains to payment during the grace period or within five business days of the due date. However, in the case of commercial paper, certificate of deposit, and other short-term programs for which timely payment is essential, rating substitution will be possible only if the issuer, dealer, paying agent, or another party is required to notify the sovereign guarantor of any shortfall with sufficient time for the sovereign to make a payment on the date it is due. This will usually require the sovereign to commit to paying on the same day and without a need for a claim by creditors.

The guarantor's right to terminate or amend the guarantee is appropriately restricted and, in particular, cannot be triggered by the primary obligor making any changes to the terms or failing to pay the guarantee fee.

The guarantee is unconditional, irrespective of value, genuineness, validity, or enforceability of the guaranteed obligations. The guarantor waives any other circumstance or condition that might release it from its obligations. The guarantor also waives the right of set-off and counterclaim. The guarantee includes few, if any, conditions that need to be satisfiedor steps that need to be takenbefore the creditor is permitted to draw on the guarantee, other than a failure of the primary obligor to make its required payment. Where the guarantee provides for conditions or the guarantor retains certain defenses or rights of setoff, Standard & Poor's will evaluate the effect of such attributes on a case-by-case basis.

Standard & Poor's criteria anticipate that these provisions will be addressed either by statutory instrument (a law, a regulation, an executive order) or an explicit reference in the guarantee or issuance documentation as opposed to verbal representations. With regard to the latter, assessments of potential extraordinary government intervention are not part of these criteria, but are central to Standard & Poor's criteria for rating government-related entities (see "Rating Government-Related Entities: A Primer," published on RatingsDirect on June 14, 2006). Recovery criteria can be applied to financial institution obligations benefiting from a sovereign guarantee that may not be paid within the grace period (or five days). Financial institution debt supported by guarantees that meet all of Standard & Poor's guarantee criteria, but fall short of the timeliness provisions, will be rated based on our recovery criteria. Ratings will not be aligned with those of the government providing the guarantee unless our guarantee criteria are met. Instead, we will apply our recovery rating methodology to rate the issue above the primary obligor's credit rating and assign a recovery rating. However, the recovery criteria will not be applied to issuers or obligations covered by guarantees that contain no time provisions (as is often the case with statutory guarantees) or only pertain to payment post-liquidation or post-restructuring. Issuers or obligations with guarantees that contain no specific time commitments are rated in accordance with the government-related entities criteria cited earlier.

With regard to the financial-sector guarantee programs of highly rated sovereigns that suggest full payment is highly likely, despite it not meeting the timeliness expectations, our highest recovery rating (1+) could be assigned. Generally, recovery methodology has been applied to speculative-grade debt, but we have used it for U.S. utility first mortgage bonds in the investment-grade range. Assuming that a '1+' recovery rating is assigned, the issue rating will receive an uplift from the primary obligor's rating according to the following schedule: If the rating on the entity is BB+ or lower, three notches. If the rating is in the 'BBB' category, two notches. If the rating is in the 'A' category, one notch. Ratings in the 'AA' category will receive no uplift.

However, in no instances will the guaranteed obligation be rated the same as the sovereign if the guarantee does not fulfill the timeliness and other provisions of the sovereign guarantee criteria. Thus, the enhancement from recovery considerations can bring the guaranteed rating to at most one notch below the sovereign rating. Short-term obligationssuch as commercial paper or certificates of deposit, where a strict notion of timeliness is critical to investorswould not receive any ratings benefit from recovery analysis if the guarantee does not adequately address the timeliness of payment.

Frequently Asked Questions

How does the application of Standard & Poor's guarantee criteria differ for sovereign and nonsovereign guarantees? There are two key differences, and they are related to sovereign intent in extending a guarantee and to potential lack of effective legal redress against a sovereign. First, certain elements of the guarantee criteria focus on limiting the circumstances in which the guarantor may be released from its guarantee obligations. However, when a sovereign extends a guarantee, it is usually doing so to further some public policy purpose. With regard to the recently introduced financial-sector guarantees, the sovereign guarantors are providing these guarantees to boost confidence in domestic financial systems. Accordingly, we believe the sovereign governments are not likely to try to avoid meeting guarantee claims, which could weaken confidence in the same manner as confidence could be weakened if the sovereign were to try to alter the terms of its own direct debt obligations. The sovereign guarantees are not undertaken to generate income, as often could be the case for arms-length guarantors. Rather, the guarantees are a method for promoting the orderly operation of financial markets considered crucial to the economy.

Second, because enforcing a claim against a sovereign could be difficult, analysis of sovereign creditworthinesseither directly or as a guarantorrelies less on legal characteristics and more on willingness issues than is the case for nonsovereign issuers (see "Sovereign Credit Ratings: A Primer," published on RatingsDirect on May 29, 2008). Sovereigns make laws and can change laws. However, as noted above, where the intent of sovereign guarantees is to support public policy goals, we believe that a sovereign would view reduction or elimination of its guarantee obligations as a last resort. For information on Standard & Poor's guarantee criteria, please see "Legal Criteria For U.S. Structured Finance Transactions," published on Nov. 25, 2006, on RatingsDirect. What type of information will Standard & Poor's request from the sovereign providing the guarantee to evaluate whether the guarantee can be used as a rating substitution? Standard & Poor's evaluates the guarantee framework within its analysis of the sovereign commitment. Our analysis focuses on: Do the guarantees create sovereign contingent liabilities that, if exercised, are tantamount to sovereign debt? If, under some circumstances, we view the sovereign liabilities created by exercising the guarantees as lower priority, it is unlikely that we will assign the obligations the same rating assigned to the sovereign. Are there any circumstances (such as fraud or any other action taken by the primary obligor) under which the government might not have to service an exercised guarantee? In addition, any appreciable likelihood that a future government might take steps to alter material provisions of the guarantees would be a negative rating factor. How long will it take for the government to service an exercised guarantee, and under what circumstances might this time frame vary? Is there a formal grace period? If so, how is it determined? Are there provisions to facilitate the payment of the commercial paper and other short-term program obligations on the due date? How often was the government called upon to service an explicit guarantee obligation during the last decade, and what was the method? How were the guarantee obligations triggered, and how much time elapsed before the government paid? Was interest paid over this time period? How is the guarantee under consideration similar, and how is it different?

Might the government restrict payments in the event that the debt holder has tax arrears or owes the government funds for any reason? If the entity benefiting from the guarantee is paying a guarantee fee and stops paying the fee sometime in the future, is the government's guarantee obligation affected?

Are there any guarantee terms or provisions that vary depending on ownership of the primary obligor, residency of the creditor (local versus foreign), or whether the primary obligor's business is largely domestic or with nonresidents? Any difference in treatment could result in the sovereign rating not being assigned to the guaranteed obligation.

What if the guarantee is extended for only a limited period of time? Neither the guarantee criteria nor recovery analysis will be applied to any issue maturing beyond the term of the guarantee; the rating assigned to the issuance will be based on that of the primary obligor. Does the assignment of recovery ratings to some sovereign-guaranteed investment-grade obligations mean that Standard & Poor's will now assign recovery ratings to a wider variety of investment-grade obligations? No, the application of recovery criteria to sovereign-guaranteed financial sector obligations is based on the strategic importance of the public policy initiatives that led to the establishment of the guarantees and our views regarding the very high likelihood that the sovereign will pay within the timeframe suggested by our recovery analysis. Sovereign-guaranteed issues by entities outside the financial institution sector that do not meet the guarantee criteria will be considered separately, normally in accordance with the government-related entities criteria. What distinguishes between when these guarantee criteria are applied and when the governmentrelated entities criteria are applied? These guarantee criteria are applied when ratings substitution is possible based on the provisions of the documents. Where there is no guarantee, a partial or conditional guarantee, a guarantee in which timeliness is not addressed, or prior experience or expectations that raise questions about the government's commitment to honoring its obligations as stated, the government-related entity criteria may apply. There may be ratings equalization with the sovereign under the government-related entity criteria, but it would be based on the government's record of extraordinary intervention, the government's current view of the likelihood of extraordinary intervention, and our assessment of how the potential for extraordinary intervention may evolve in the future.

Do we expect the financial institution guarantees to have a ratings impact on the sovereign governments? In and of themselves, the guarantees have not led to any sovereign rating changes and are unlikely to do so. A sovereign rating incorporates the contingent liability stemming from the financial sector through estimates of potential problematic assets in a stress scenario. As our forecast of potential problematic assets rises, the contingent liability grows, and the likelihood of a negative sovereign rating or outlook change increases. From the standpoint of the guarantees, this would correlate with expectations of a rising number of guarantees being exercised but not with the extension of the guarantees. The financial sector has long been considered a sovereign contingent liability because solvency andto a lesser extentliquidity problems that lead to sovereign support can impair a sovereign's credit standing. The impetus to assist banks is strong when there is a systemic crisis because banking system soundness is essential to macroeconomic stability, effective demand management, and sustained economic growth. The Sovereign Group's analysis of the current market turmoil is focusing on probable financial sector recapitalization costs and likely economic impacts, particularly the costs of fiscal stimulus packages.

Related Publications
"Principles Of Corporate And Government Ratings," June 26, 2007. "Rating Sovereign-Guaranteed Debt," Nov. 21, 2008. "Rating Government-Related Entities: A Primer," June 14, 2006. "Request For Comment: Enhanced Methodology For Rating Government-Related Entities And Assessing The Potential For Extraordinary Government Intervention," Jan. 23, 2009. "Recovery Analytics Update: Enhanced Recovery Scale and Issue Ratings Framework," May 30, 2007. "Sovereign Credit Ratings: A Primer," May 29, 2008. "Legal Criteria For U.S. Structured Finance Transactions," Nov. 25, 2006. Primary Credit Analysts: Marie Cavanaugh, New York (1) 212-438-7343; marie_cavanaugh@standardandpoors.com Hans Wright, New York;

hans_wright@standardandpoors.com Secondary Credit Analysts: Scott Bugie, Paris (33)1-4420-6680; scott_bugie@standardandpoors.com Colleen Woodell, New York (1) 212-438-2118; colleen_woodell@standardandpoors.com

ARCHIVE | Criteria | Governments | Sovereigns: Sovereign Credit Ratings: A Primer

(Editor's Note: This article has been superseded by "Sovereign Government Rating Methodology And Assumptions," published June 30, 2011.)

Criteria Update
Sovereign credit ratings reflect Standard & Poor's Ratings Services' opinions on the future ability and willingness of sovereign governments to service their debt obligations to the nonofficial sector in full and

on time. Ratings coverage continues to expand, with the 119th sovereign rating recently assigned to Aruba (see "Sovereign Ratings And Country T&C Assessments," updated regularly and available on RatingsDirect, the real-time Web-based source for Standard & Poor's credit ratings, research, and risk analysis, at www.ratingsdirect.com). This criteria article replaces an earlier article of the same name, which was published on Oct 19, 2006. There are no major changes in analytical approach, but subsidiary changes reflect: Greater focus on the change in general government debt, as a supplement to the reported fiscal balance analysis; Added attention to inflationary pressures, as they show the potential to emerge as a more important credit factor than has been the case in recent years; Updated data and examples; and Some reorganization, including moving background and definitional matters to an appendix. No rating changes occurred as a result of this criteria update. This criteria article focuses on sovereign ratings as forward-looking estimates of default probability. Standard & Poor's introduced sovereign recovery ratings in June 2007. As a result, issue ratings on most speculative-grade sovereigns ('BB+' and below) now include recovery prospects to some degree. These are not addressed in this article. For information on sovereign recovery ratings and issue ratings that incorporate recovery, please see "Introduction Of Sovereign Recovery Ratings," RatingsDirect, June 14, 2007).

Rating Basics
Standard & Poor's appraisal of each sovereign's overall creditworthiness focuses on political and economic risks and is both quantitative and qualitative. The quantitative aspects of the analysis incorporate a number of measures of economic performance, although judging the integrity of the data is a more qualitative matter. The analysis is also qualitative due to the importance of political and policy developments and because Standard & Poor's ratings indicate future debt-service capacity. Much of the analysis focuses on the appropriateness of the policy mix, because inconsistencies tend to leave a country vulnerable to shocks that can change the exchange rate and fortunes abruptly. Willingness to pay is a qualitative issue that distinguishes sovereigns from most other types of issuers. Partly because creditors have only limited legal redress, a government can (and sometimes does) default

selectively on its obligations even when it possesses the financial capacity for timely debt service. In practice, of course, political and economic risks are related. A government that is unwilling to repay debt is usually pursuing economic policies that weaken its ability to do so. Willingness to pay, therefore, encompasses the range of economic and political factors influencing government policy. A sovereign local currency rating reflects Standard & Poor's opinion of the sovereign's willingness and ability to service debt issued and payable in the currency the sovereign (or its central bank) supplies. A Standard & Poor's sovereign foreign currency rating reflects its opinion of the sovereign's willingness and ability to service debt issued in currencies of foreign jurisdictions. Where a sovereign is a member of a monetary union, and has ceded monetary and exchange-rate flexibility to a common central bank, or uses the currency of another sovereign, local and foreign currency ratings are equalized. More information on local and foreign currency rating distinctions can be found below in the section entitled, "Local And Foreign Currency Rating Distinctions." While the same political and economic factors affect a government's ability and willingness to honor local and foreign currency debt, they do so in varying degrees. A sovereign government's ability and willingness to service local currency debt are supported by its taxation powers and its ability to control the domestic monetary and financial systems, which give it potentially unlimited access to local currency resources. To service foreign currency debt, however, the sovereign must secure foreign exchange, usually by purchasing it in the currency markets. This can be a binding constraint, as reflected in the much higher frequency of sovereign foreign than local currency debt defaults. The primary focus of Standard & Poor's local currency credit analysis is on a government's economic strategy, particularly its fiscal and monetary policies, as well as on its plans for privatization, other microeconomic reforms, and additional factors likely to support or erode incentives for timely debt service. When assessing the default risk on foreign currency debt, Standard & Poor's places more weight upon the impact of these same factors on the balance of payments and external liquidity, and upon the magnitude and characteristics of the external debt burden. Key economic and political risks that Standard & Poor's considers when rating sovereign debt include: Political institutions and trends in the country and their impact on the effectiveness and transparency of the policy environment, as well as public security and geopolitical concerns; Economic structure and growth prospects;

General government revenue flexibility and expenditure pressures, general government deficits and the size of the debt burden, and contingent liabilities posed by the financial system and public-sector enterprises;

Monetary flexibility; and External liquidity and trends in public- and private-sector liabilities to nonresidents.

The first four factors directly affect the ability and willingness of governments to ensure timely local currency debt service. Since fiscal and monetary policies ultimately influence a country's external balance sheet, they also affect the ability and willingness of governments to service foreign currency debtwhich is also affected by the fifth factor above. Balance-of-payments constraints are often among the most binding.

Ratings Methodology Profile

Standard & Poor's divides the analytical framework for sovereigns into nine categories (see table 1). As part of the committee process that Standard & Poor's uses to assign credit ratings, each sovereign is ranked on a scale of one (the best) to six for each of the nine analytical categories. There is no exact formula for combining the scores to determine ratings. The analytical variables are interrelated and the weights are not fixed, either across sovereigns or over time. In most cases, how the committee views one category depends upon other categories and trends as much as upon the absolute level of many measures. For example, 4% real GDP growth would be viewed as high for Germany but fairly low for China, given their different stages of development. Similarly, Turkey's improved, but still heavy, debt burden weighs on its speculative-grade rating, while some higher-rated sovereigns in Western Europe that manage comparable or higher debt burdens have less risk due to their wealthier and more-diversified economies and the flexibility afforded them by being able to borrow long term in local currency domestic markets at reasonable market rates.
Table 1

The charts in this article illustrate data commonly reviewed by rating committees, but other data series are also examined. There are no perfect measures across the rating scale, and the analytical focus varies depending upon the level of development, political and economic challenges, and other factors. Measurement difficulties also sometimes necessitate a more qualitative approach. Political risk The first of the nine analytical categories in the sovereign ratings methodology profile (see table 1) is political risk, which encompasses institutions as well as systems and processes. The stability, predictability, and transparency of a country's political institutions are important considerations in analyzing the parameters for economic policymaking, including how quickly policy shortcomings are identified and addressed. While a democratic tradition is usually supportive of the openness and accountability that preclude political shocks, the most important factors are probably an independent judiciary and a civil society, particularly a free press. Standard & Poor's examines the degree to which politics is adversarial and the frequency of changes in government, as well as any public security concerns. Relations with neighboring countries are considered, with an eye toward potential external security risk. National security is a concern when military threats place a significant burden on fiscal policy, reduce the flow of potential investment, or put the balance of payments under stress. A strong political risk ranking for most EU sovereigns reflects the broad public backing for their open political frameworks, in which popular participation is high, the process of succession is clear, and the conduct of government is transparent and responsive to changing situations. Well-established institutions provide transparency and predictability, particularly with regard to property rights, in a relatively efficient manner. At the weaker end of the scale, political institutions may have a short track record and/or be considerably less open and effective. Political decision-making processes may be highly concentrated, or a significant portion of the population may be marginalized. There may be internal divisions along racial or economic lines, some geopolitical risk, or public-security concerns. Political and external shocks are more likely to disrupt economic policy than at higher rankings. Kenya, for example, has a weak political risk score because its democratic process is flawed by political, social, and cultural divisions that contribute to election-related turmoil, which was especially severe following the December 2007 election. While political factors are at the core of sovereign risk analysis, in some cases, as seen in Russia, significant improvements in fiscal and external performance lead to higher sovereign ratings than political factors suggest. In such instances, sovereign risk tends to be lower than the country risk factors affecting nonsovereign ratings. (See "Russia: The Gap Between Improving Sovereign Risk And Deteriorating Country Risk Is Increasing," RatingsDirect, Feb. 14, 2005.)

Economic structure and prospects The second and third of the nine sovereign criteria categories are economic structure and growth. Due to its decentralized decision-making processes, a market economy with legally enforceable property rights tends to be less prone to policy error and more respectful of the interests of creditors than one where the public sector dominates. Market reform in the transition economies of Central and Eastern Europe has brought the economic-structure scores of Slovenia and the Czech Republic close to those of Western European sovereigns with well-entrenched market economies. Rankings in this category are highly correlated with per-capita GDP (see chart 1), with lower scores assigned to sovereigns having relatively narrow economies, weak or less-developed financial systems, and wide income disparities. Lower rankings may also reflect highly leveraged or undeveloped private sectors, structural impediments to growth, and large and relatively inefficient public sectors. For countries undertaking substantial economic reforms, the sequencing of the various measures may be the key to their effectiveness. While there have been successful variations, the most common starting point is the reduction of fiscal imbalances in order to strengthen macroeconomic stability. This is generally followed by measures to improve labor market flexibility, strengthen the domestic financial sector, and open trade and services globally. Past economic crises, particularly in Asia in the late 1990s, suggest capital account liberalization best takes place not only after current-account liberalization, but as part of coordinated policies addressing both macroeconomic and financial-sector weaknesses.
Chart 1

A government in a country with a growing standard of living and an income distribution regarded as broadly equitable can support public-sector debt and withstand unexpected economic and political shocks more readily than a government in a country with a poor or stagnant economy. Standard & Poor's weighs the benefits of economic expansion most highly when governments take advantage of favorable conditions to adopt policies that bolster the environment for sustainable economic growth and reduce the risks associated with eventual slowdowns. The ratings speak to risk fundamentals and are not raised during recovery periods or lowered in downturns. High trend growth, seen in China and a handful of other countries, provides considerably more policy flexibility and a superior economic prospects ranking than Standard & Poor's ascribes to sovereigns for which economic growth prospects will remain comparatively weak until fiscal imbalances or structural constraints on competitiveness are addressed. Chart 2 illustrates how growth prospects are generally greatest in the middle of the rating range, where many sovereigns are actively engaged in reform and tend to be attracting a fair amount of foreign investment. At top ratings, the advanced level of development usually precludes high trend growth. At the lower end of the rating range, growth is likely to be more variable and constrained by structural impediments. Note, too, that chart 2 illustrates just 2008. In its analysis of growth prospects, Standard & Poor's examines historical economic trends and forecasts based upon scrutiny of how fundamentals affecting investment and competitiveness have evolved.
Chart 2

Fiscal flexibility The next three categories in Standard & Poor's sovereign ratings methodology profile address fiscal flexibility, as measured by: An examination of general government revenue, expenditure, and balance performance and of the appropriateness of the fiscal stance in light of monetary and external factors; Debt and interest burden trends, taking into account debt characteristics such as currency and maturity; and Off-budget and contingent liabilities.

Scores in the first fiscal category are a function not only of surpluses and deficits, but also of revenue and expenditure flexibility, the effectiveness of expenditure programs, and the appropriateness of the policy mix. A surplus or a low deficit usually does not provide much fiscal flexibility if the tax base is narrow, infrastructure needs are acute, the debt burden is high, the financial sector has systemic problems, or monetary policy is unduly expansionary. Conversely, a high deficit may be appropriate when countercyclical measures are needed (and the debt burden is not high) or when economic growth necessitates significant infrastructure investment. Successful fiscal policies help build an environment conducive to sustainable economic growth. Sovereigns with fixed or heavily managed exchange-rate regimes or large external imbalances usually have to rely more on fiscal measures in influencing domestic

demand. Thus, the analysis depends as much on the appropriateness of the economic policy mix as on specific surplus or deficit performance. Much of the fiscal analysis focuses on the general government, which is the aggregate of the national, regional, and local governments (including social security and excluding intergovernmental transactions). This is the measure that usually best captures the economic impact of the fiscal policy stance and is most closely aligned with issues relating to macroeconomic stability and sustained economic growth. General government also tends to be the most useful comparator because the division of revenue-raising authority and expenditure responsibility differs. For example, in some countries, such as France, revenue collection and spending is highly centralized, while in others, such as Canada, provincial and local governments account for a much higher proportion of the provision of public services. To compare central governments would be misleading; it would suggest that indebtedness was lower and flexibility much greater in a country that was decentralized, when in fact that would depend more upon the public's demand for (and willingness to fund) public services and the nature of intergovernmental fiscal arrangements. Also, in countries where noncommercial off-budget and quasi-fiscal activities are extensive, the general government may not be broad enough and it may be appropriate to focus on a more expansive measure of the public sector. With regard to revenue flexibility, the least distortionary and most growth-friendly tax system that also addresses equity concerns typically has a broad tax base and low tax rates. Sovereigns with strong scores in the first fiscal category can adjust tax bases and rates without serious constitutional, political, or administrative difficulties. Effective expenditure programs provide the public services demanded by the population and the infrastructure and education levels needed to underpin sustainable economic growth, all within the confines of tax and fee resources and affordable financing. Arrears are quantified, and deficits can be reconciled to trends in debt. A high score may be assigned, despite significant financing needs, if astute investment in public infrastructure and in an educated workforce underpins sustainable prosperity. Lower scores are given where government money is not spent as effectively because of constitutional rigidities, political pressures, or corruption, and where revenue flexibility is constrained by already-high taxes or tax-collection difficulties. Fiscal policy may be insufficiently tight in light of monetary and external pressures. The environment is less conducive to sustainable economic growth and more suggestive of potential debt-servicing difficulties. India's sizable deficits and limited revenue and expenditure flexibility give it a weak score in this category.

As chart 3 illustrates, deficits tend to be highest in the speculative-grade categories. In some cases, deficits may not be as high as expected at the lower rating levels, with the fiscal flexibility score affected more by quasi-fiscal activities, lack of transparency, and limited revenue, expenditure, and borrowing flexibility.
Chart 3

The change in general government debt as a percent of GDP is another measure rating committees consider, in part as a check on the surplus/deficit figure. After adjusting for noncash items, debt forgiveness/restructuring, privatization proceeds, and the use of cash balances, the increase in the stock of debt should approximate the deficit. Where it does notbecause of exchange-rate movements, recognition of skeletons, or other factorsgreater weight may be placed on this measure because it is likely that the deficit has been understated (or surplus overstated) in the past. The reported deficit may also suffer from being targeted, as political and other attention to the headline deficit may create strong incentives to move some programs or functions to public-sector enterprises. Most important, prior to past sovereign defaults, the change in debt has been a better indicator of the impending crisis than the deficit. In fact, in some cases, the headline deficit improved while the change in debt rose sharply. As one would expect, the data shown in chart 4 approximately reflect the balances shown in chart 3. Deficits and borrowings are lower than might be expected in the 'BBB' and 'BB' categories, in part reflecting the

predominance in these rating ranges of commodity producers benefiting from continued high prices in 2008.
Chart 4

Pension obligations represent a fiscal pressure of growing significance for countries with rapidly aging populations. Standard & Poor's believes that the credit ratings of some highly rated sovereigns could begin to come under downward pressure in the medium term if there are insufficient fiscal adjustments and structural reforms to counter the financial problems of aging societies (see "What A Change A Year Makes: Standard & Poor's 2007 Global Graying Progress Report," RatingsDirect, Sept. 19, 2007). In analyzing the debt and interest burden, Standard & Poor's recognizes that taxation and monetary powers unique to sovereigns, as well as domestic capital market characteristics, can permit governments to manage widely varying debt levels. Thus, ratings tend to be less correlated with debt burdens than with some other economic measures. A sovereign with an unblemished track record of honoring debt obligations and a strong domestic capital market providing long-term and fairly low-cost market-based financing may receive a better score in this category than sovereigns with lower debt-to-GDP ratios but higher and more-variable debt-servicing burdens. Conversely, low debt burdens may reflect financing challenges and high interest costs, or in some cases recent debt relief, rather than fiscal flexibility. Chart 5 shows net general government debt as a percent of GDP, which is unusually low in the 'AA' category because of the inclusion of a number of Gulf states that are benefiting from significant petroleum-driven

fiscal and external surpluses. The strengthening balance sheets have led to upgrades, but not to the extent the data alone might imply because of the relative lack of economic diversity, political risks, and shortcomings in transparency.
Chart 5

Off-budget and contingent liabilities can be important rating considerations, with attention focused on the size and health of nonfinancial public sector enterprises (NFPEs) and the robustness of the financial sector. NFPEs pose a risk to a sovereign because they generally are formed to further public policies and can suffer from weak profitability and low (or virtually nonexistent) equity bases, which leave them vulnerable to adverse economic circumstances. While theory suggests that NFPEs may be required due to market imperfections, in practice many exist for legacy reasons, because of natural monopolies, or to collect and expend funds that promote public policies without the rigor of budgetary scrutiny. If such activities are sizable, the usefulness of general government statistics as an indicator of fiscal performance and position and the role of the government in the economy is diminished. The indebtedness of unprofitable or poorly capitalized NFPEs is a useful starting point in measuring contingent liabilities, but profitable NFPEs also may suffer in difficult political or economic circumstances or be required to perform additional public services. Thus, Standard & Poor's tends to view large public sectors with caution and incorporates in its contingent liability estimate all NFPE debt that may require sovereign support in a period of stress. Particular note is taken of enterprises that benefit from subsidies and capital injections,

enjoy a monopoly position, have access to preferential funding, price their products to further budgetary objectives, or pay higher-than-commercial prices to suppliers. The financial sector is a contingent liability because liquidity and solvency problems that lead to sovereign support can impair a sovereign's credit standing. The impetus to assist banks is strong when there is a systemic crisis, since banking-system soundness is essential to macroeconomic stability, effective demand management, and sustained economic growth. The sovereign local and foreign currency ratings on the Republic of Kazakhstan were lowered in 2007 because of the escalating costs of supporting the country's banking sector, which had aggressively borrowed offshore. Standard & Poor's financial sector analysts regularly examine global financial sector risk (see "S&P's Banking Industry Country Risk Assessments: Global Annual Roundup," RatingsDirect, Aug. 9, 2007), and their assessments of the potential for a systemic crisis are a crucial input in this category of sovereign analysis. While historically the sources of systemic risk have tended to be related to rapid credit growth, a weakening economy, and rising nonperforming loans, off-balance-sheet activities are emerging as a new source of concern. Publicsector banks may weigh heavily in the off-budget and contingent liability category when they engage in various quasi-fiscal activities (e.g., directed lending, subsidized lending, bank rescue operations, or exchange-rate guarantees) that are not provided for in the government's budget. Monetary flexibility Monetary flexibility, the seventh risk category in the sovereign ratings methodology profile, can be an important indicator of sovereign credit trends. The appropriateness and effectiveness of monetary policy is analyzed in the context of a sovereign's other economic policies and the depth of the country's financial sector and capital markets. Where the exchange rate is pegged or managed, monetary policy is tied to the monetary policy pursued by the sovereign or central bank of the country (or countries) to which the currency is linked. The analysis will focus on the benefits and costs of this link and the monetary policy thus imposed. Chart 6 shows more inflation at lower rating categories. Persistent global imbalances, in combination with commodity price and fiscal pressures, are pointing to higher levels of inflation across the spectrum than has been the case for much of the past decade. Monetary management may be increasingly challenging, with more sources of inflation outside the domestic economy and liquidity progressively a function of global factors.
Chart 6

In evaluating monetary flexibility, Standard & Poor's considers: Price behavior over economic cycles and relative to trading partners; The market orientation of monetary policy tools and the degree to which their effectiveness is facilitated by a transparent, well-developed, and well-regulated financial sector and debt market; The extent to which indexation (of wages or other economic factors) and dollarization (foreign currency share of loans, deposits, or currency in circulation) are reflective of intermittent bouts of inflation and limit the reach of monetary tools; Institutional factors, such as the resources and operational independence of the central bank; and The compatibility of the fiscal stance and the exchange-rate regime with monetary policy goals. Inflation targeting increasingly has become the monetary policy of choice, although the focus may evolve as credit market turmoil sharpens debates on financial-sector risks, the role of asset prices, and other issues. In countries where rising inflation is tamed by administrative and fiscal measures such as limiting exports, lowering controlled prices, or reducing indirect taxes, the policy measures likely are addressing the symptoms rather than the problem. Countries with significant dependence upon foreign currency

borrowing may be tempted to rely unduly on raising domestic interest rates because the impact of higher domestic interest rates on investment and growth is limited and the appreciating currency reduces the debt service burden. However, this may attract more capital and increase inflationary pressures. In such situations, tightening fiscal policy may be the more appropriate policy choice. Sterilizing capital inflows by selling or repoing monetary authority holdings of government securities or issuing central bank securities is another approach, albeit potentially more costly in that it may reduce monetary flexibility and raise quasi-fiscal pressures. The European Central Bank's strong monetary flexibility score reflects Europe's low inflation, with monetary flexibility bolstered by transparent and well-developed capital markets. Toward the other end of the monetary flexibility spectrum is Russia, whose monetary score is constrained by a weak financial sector, relatively shallow capital markets, and continued double-digit inflation. In other cases, monetary flexibility is limited by fiscal imbalances. The most damaging situation usually arises when a government seeks central bank financing, as was the case recently in Pakistan. However, deficits tend to raise interest rates even when funded in the markets, particularly if the debt burden is high and the markets are shallow. In conjunction with enhancing monetary flexibility and the effectiveness of monetary tools, the depth and breadth of a country's capital markets can act as an important discipline. A sovereign has fewer incentives to default on local currency obligations when they are held by a broad cross section of domestic investors rather than concentrated in the hands of local banks. For this reason, the establishment of defined-contribution pension programs (e.g., as in Chile) may help to bolster a sovereign's credit standing by creating an influential new class of bondholders. The experiences of many highly rated sovereigns indicate that, even when public debt is high, creditworthiness can be sustained over long periods when policymakers are responsive to constituencies with vested interests in safeguarding the internal value of money and financial contracts. External finances The last two risk categories in the sovereign ratings methodology profile are external liquidity and the external balance sheet. Standard & Poor's balance-of-payments analysis focuses upon the impact of macroeconomic and microeconomic policies on the external sector, and on the external sector's structural characteristics. Because a sovereign generally levies taxes and fees in local currency and must buy foreign exchange in currency markets or from the central bank, external analysis focuses on the economy's ability to generate foreign exchange. This is assessed in relation to the economy's foreign exchange needs and the cushion provided by reserves. Where public- and private-sector obligations to nonresidents are substantial, there is greater exposure to movements in exchange rates, interest rates,

foreign investor sentiment, and other offshore factors. Monetary union membership may stem the impact of the exchange rate, but the other influences remain sources of vulnerability. A key quantitative measure in this criteria category is gross external financing needs (current account payments plus short-term liabilities to nonresidents, including nonresident bank deposits, by remaining maturity) as a percent of current account receipts (CAR) plus usable foreign exchange reserves. The explanatory capacity of this ratio is strong in the middle of the rating range, with lower needs relative to resources being a positive. The ratio tends to be high for the most creditworthy sovereigns because of the importance of short-term debt, although analytically this debt usually does not present the risk that it might further down the rating scale. Conversely, the ratio tends to be low for the least creditworthy sovereigns because of their heavy reliance on concessional debt, which is rarely short term. Thus, the quantitative measure shown in chart 7 is current account balance as a percentage of CAR, which is an important component of the key external liquidity measure. (As described in the fiscal section, the high surplus in the 'AA' category is skewed by the presence of several Gulf petroleum exporters.) However, the size of a country's current account deficit, which reflects the excess of investment over savings, may not by itself be an important rating consideration. Where investment boosts competitiveness and is likely to generate higher foreign exchange earnings, the risk of future external financing pressures is reduced. Conversely, where the deficit is driven by imports of consumption goods or investment in domestically-focused industries, the risks are higher. An important factor mitigating the risk of high external financing needs is foreign direct investment (FDI). FDI funding of the current account deficit poses less risk than portfolio equity, which can reverse quickly, or debt, which must be serviced even if current account earnings lag. FDI creates a more flexible liability because dividends are usually not paid unless profits are generated.
Chart 7

Usable foreign exchange reserves, which include only those reserves available for foreign exchange operations and repayment of external debt, usually act as a financial buffer during periods of balance-ofpayments stress. High reserves provide insurance against various potential shocks, and, in so doing, usually lower sovereign borrowing rates. But a high reserve policy has costs. One is the cost associated with low returns on the reserves. Related to this is the cost of sterilization, with the debt sold to absorb some or all of the local currency liquidity created by the accumulation of reserves likely costing more than the reserves earn. Still another is revaluation pressure, which could eventually cause further strain on central-bank profitability (or cause losses). Reserves deposited with domestic banks, pledged as security, related to reserve requirements on resident foreign currency deposits, or sold forward in the exchange markets are not included in usable reserves. In addition, for sovereigns that have adopted a currency board or have a long-standing fixed peg with another currency, some adjustment is made for the fact that a portion of reserves may be needed to underpin confidence in the exchange-rate link. Whether a given level of CAR plus reserves is, or is not, adequate is judged not only in relation to gross external financing needs, but also to the government's policy mix. Reserve policies are usually driven by the benefits of reserves in crisis mitigation versus the costs of holding them. Countries with a freely floating exchange rate and deep foreign exchange markets usually need reserves less, which is why conventional measures do not work as well at the high end of the rating scale. High reserves might also be accumulated to support export growth by restraining nominal currency

appreciation. This usually introduces economic distortions in the tradable versus nontradable sectors. As reserves grow excessive, they may contribute to global imbalances and in turn spur protectionist responses. On the domestic side, very high reserves may contribute to excessive credit growth and asset bubbles. Sterilization usually cannot fully offset the expansionary impact of inflows. In some cases, monetary authorities may avoid some of the costs of sterilization by turning to higher reserve requirements, but this transfers the costs to the banking system or taxes inward investment, which reduces market liquidity. The U.S. maintains very low reserves. It can do so because the U.S. dollar generally has floated against other currencies since 1971. The dollar's status as a key currency financing global trade and investment also reduces the need for gold and foreign exchange (see "Despite Pressures, The U.S. Dollar Remains The Key International Currency," RatingsDirect, Oct. 15, 2007). Most other high-investmentgrade sovereigns with floating currencies and little foreign currency debt also hold relatively modest reserves. Other sovereigns, such as some of the 10 that joined the EU on May 1, 2004, have large external financing gaps, but the credit risk these gaps pose is mitigated by heavy offsetting FDI inflows and by the fact that the probability of an exchange-rate shock will diminish as these sovereigns move closer to European Economic and Monetary Union membership. International liquidity is more critical at lower rating levels when a significant portion of debt is denominated in or linked to foreign currencies, or when significant amounts of local currency debt are held by cross-border investors. Fiscal setbacks and other economic or political shocks can impair financial market access. Standard & Poor's scrutinizes each country's external balance sheet, which shows residents' assets and liabilities (in both foreign and local currency) vis--vis the rest of the world alongside an analysis of its balance-of-payments flows. While the main focus is on trends in the external debt position, shifts in the international investment position, which is the broadest measure of a country's external financial situation, can also be a source of pressure. To measure the magnitude of the net external debt burden, Standard & Poor's compares it to CAR (proceeds from exports of goods and services along with investment income and transfers received from nonresidents), as shown in chart 8. For a number of sovereigns at the highest rating levels (e.g., the U.S.), most, if not all, external public-sector debt is local-currency denominated and less burdensome in most reasonable scenarios.
Chart 8

Private sector, and particularly financial sector, debt is examined because it can pressure reserves and, in some cases, ultimately become a liability of the government, as was the case in several Asian countries in 1997-1998. External debt also is evaluated in terms of its maturity profile, currency composition, and sensitivity to changing interest rates. Along with new borrowings, these factors influence the size of future interest and amortization payments, as well as pressures emanating from short-term debt. Debt contracted on concessional bilateral terms can, to some extent, offset a large public-sector external debt burden. While private flows to emerging markets afford great benefits, sharp and sudden variations in these flows can cause great distress. High proportions of foreign-currency-denominated and short-term debt magnify a country's vulnerability to changes in investor sentiment. Funding from the International Monetary Fund and other multilateral official sources can be a mitigating factor, but the availability of official resources may be limited in relation to the funds deployed by banks and cross-border investors. Other sources of protection for macroeconomic performance are robust domestic sources of finance, a sound financial sector that minimizes the risk of capital flight, and productive FDI. Capital account liberalization is generally viewed positively in the context of sensible economic policies, an appropriate monetary/exchange regime, and a sound financial system.

Local And Foreign Currency Rating Distinctions

Any divergence between a sovereign's local and foreign currency ratings reflects the distinctive credit risks of each type of debt. One might ask why, if sovereigns have such extensive powers within their own bordersincluding the ability to print moneysovereign local currency ratings are not all 'AAA'. The reason is that while the ability to print local currency gives the sovereign, and the sovereign alone, tremendous flexibility, heavy reliance upon such an expansionary monetary stance may bring the risk of hyperinflation and of more serious political and economic damage than would a rescheduling of local currency debt. In such instances, sovereigns may opt to reschedule their local currency obligations. Based upon both empirical evidence and an evaluation of relative degrees of flexibility and incentives, Standard & Poor's tends to rate a sovereign's local currency debt from zero to three notches above the sovereign's foreign currency debt rating. (For a more extensive discussion of this topic, see "Sovereign Foreign and Local Currency Rating Differentials," RatingsDirect, Oct. 19, 2005.) The overriding factor in determining the distinction between sovereign local and foreign currency ratings is monetary flexibility. If a sovereign has joined a monetary union and ceded monetary authority to a central bank that it does not control or if a sovereign has adopted the currency of another sovereign, its local and foreign currency obligations are rated the same. Geopolitical risk factors also can result in a small difference between local and foreign currency ratings, as can weak political institutions, protracted large fiscal imbalances, and difficulties in policy implementation. The dominant factor for those sovereigns with wider differences between local and foreign currency ratings is a developed domestic capital market providing long-term local currency financing at a fairly low market-determined cost. This is a key factor in allowing a sovereign to continue to service local currency debt, even as it defaults on foreign currency obligations. The existence of a local currency domestic capital market can, to some extent, offset political and fiscal concerns that might otherwise constrain the rating. There tends to be no gap between local and foreign currency ratings where: A sovereign is a member of a monetary union (including EU sovereigns expected to join the Eurozone in the near to medium term); A sovereign has adopted the currency of another sovereign; A sovereign has a long-standing fixed peg or high usage of another currency domestically; or A sovereign's rating is constrained predominantly by political or fiscal risks that may ultimately limit policy options (e.g., China and India).

A one-notch gap is common for: Sovereigns with currency boards; Some EU sovereigns where membership in the Eurozone is uncertain or likely to be far in the future; Sovereigns with a long-standing fixed peg or significant usage of another currency domestically; and Sovereigns where the rating is constrained by fiscal or political concerns (e.g., Russia and Turkey). Two- and three-notch currency-based rating gaps are assigned to sovereigns in countries with more developed or developing local capital markets that provide long-term local currency financing, and where the availability of financing is not primarily a result of capital controls on residents. Dollar-linked, local-currency-payable debt represents a special case in which the rating is usually equalized with the sovereign foreign currency rating. Dollar-linked debt makes debt service, and thus the fiscal accounts, vulnerable to changes in the exchange rate. The flexibility that underpins higher local currency ratings is diminished. In a crisis (when the exchange rate tends to depreciate), the cost of servicing dollar-linked, local-currency-payable debt rises dramatically in proportion to the cost of servicing local currency debt. Moreover, history has shown this debt to pressure foreign exchange reserves in the same way as foreign currency debt, with debtholders taking the local currency they have just been paid and exchanging it for foreign currency. Similar considerations may constrain ratings on local currency debt issued in the global capital markets.

Rating Changes
Standard & Poor's rated just a dozen sovereign issuers in 1980all at the 'AAA' level. Rating downgrades were relatively rare over the remainder of that decade and, when they occurred, were usually of modest dimensions. Today, the sovereign sector is far more heterogeneous. The 118 sovereigns Standard & Poor's monitors currently carry ratings between 'AAA' and 'CCC+'. Given this range of credit quality, rating changes occur more frequently. Sovereign ratings measure future debt-service capacity, and rating committees therefore consider trends and possible developments, including potential political and economic shocks, in gauging credit risk. A government's medium-term plan is scrutinized alongside independent forecasts. Standard & Poor's then examines the interaction between public-sector finances, external debt, and other variables such as expected real export growth, asset quality and other trends affecting the local banking system, and

potential changes in local and overseas interest rates. Standard & Poor's incorporates risks arising over economic, political, and commodity cycles in its ratings. Rating changes occur whenever new information significantly alters Standard & Poor's view of likely future developments. A strong policy response that identifies and addresses sources of instability is key to maintaining credit quality in the face of negative shocks or trends. Whether the problem is a weak banking sector, excessively leveraged corporates, inflexible exchange-rate regimes, or high fiscal imbalances, a robust policy response is crucial for strengthening both the economic environment and sovereign creditworthiness.

Sovereign Ratings Compared To Nonsovereign Ratings

Sovereign ratings address the credit risk of national governments but not the aggregate of the specific risks involved in doing business within or from a particular country. Thus, sovereign ratings are not country ratings, and do not speak specifically to exchange-rate or regulatory risk or to any of a host of country characteristics that affect the operating and financial environment of a nonsovereign entity. However, sovereign ratings and country risk are highly correlated. Sovereigns with the highest ratings (the least sovereign risk) tend to be in countries with the least country risk, as evidenced by stable political systems, well-developed legal frameworks, and market-oriented economies. Accordingly, a rating assigned to a nonsovereign entity is, most frequently, the same as or lower than that assigned to the sovereign in the main country of domicile. However, Standard & Poor's has no sovereign ceilings, and nonsovereign ratings may be higher when the nonsovereign entity has stronger credit characteristics than the sovereign and when the risk of the sovereign limiting access to foreign exchange needed for debt service is less than the risk of sovereign default. Examples of such cases include: A financially strong issuer located in a country where the risks of the sovereign restricting the convertibility of its currency and the transfer of foreign currency to nonresidents for debt servicing are relatively low; An issuer with a significant percent of assets and business offshore; and An issuer with a very supportive offshore parent.

Similarly, an issue benefiting from specific structural enhancements can be rated above the sovereign. The risk of restrictions on access to foreign exchange needed for debt service is reflected in transfer and

convertibility (T&C) assessments, which are available for each of the 118 countries for which Standard & Poor's has a sovereign rating. Sovereign default and transition studies (see "Default, Transition, And Recovery: Sovereign Defaults And Rating Transition Data: 2007 Update," RatingsDirect, Feb. 29, 2008) indicate that Standard & Poor's sovereign default experience is in line with reference rates proposed under Basel II guidelines. There have been no sovereign defaults at rating levels of 'BBB+' and higher, while sovereign and privatesector default rates are broadly comparable at rating levels of 'BBB' and lower. Comparative statistics are affected by the small number of rated sovereign defaults, but Standard & Poor's expects sovereign default probabilities to be closer to private-sector ratios over time as the number of sovereign observations increases, something one would expect given the same rating definitions. Table 2 shows cumulative average default rates for sovereign and private-sector issuers over one-, three-, and five-year intervals by initial rating category.
Table 2

Sovereign And Corporate Default Rate Comparison

One-year

Three-year

Five-year

(% of rated issuers) Sovereign

Private sector Sovereign

Private sector Sovereign

Private sector

AAA

0.0

0.0

0.0

0.1

0.0

0.3

AA

0.0

0.0

0.0

0.1

0.0

0.3

0.0

0.1

0.0

0.3

0.0

0.6

BBB

0.0

0.2

1.8

1.1

4.7

2.4

BB

0.9

1.0

4.5

5.2

7.8

9.3

1.7

4.6

7.3

14.7

14.3

21.1

CCC/CC

38.9

25.6

52.9

39

52.9

44.5

Note: Implied senior debt ratings through 1995; issuer credit ratings thereafter. Sovereign foreign currency ratings cover 1975-2007; private sector local currency ratings cover 1981-2007.

Historical Default Trends

Defaults on sovereign foreign currency bonds occurred repeatedly, and on a substantial scale, throughout the 19th century and as recently as the 1940s. Sovereign bond default rates fell to low levels only in the decades after World War II (see chart 9), when cross-border sovereign bond issuance also was minimal. Defaults on bank loans, the main vehicle for financing governments in the 1970s and 1980s, peaked in the early 1990s and have since fallen, while bond defaults have turned up again.
Chart 9

Past sovereign defaults reflect a variety of factors, including wars, revolutions, lax fiscal and monetary polices, and external economic shocks. Today, tenuous fiscal discipline, debt-management pressures, structural inefficiencies constraining productivity, rising inflation, external imbalances, and contingent liabilities arising from off-budget activities and weak banking systems are among the significant economic policy challenges facing many sovereigns.

Appendix: Sovereign Default Definitions And Emergence From Default

Table 3 highlights Standard & Poor's definition of sovereign default, which includes a sovereign's failure to service its debt as payments come due and distressed debt exchanges (even when no payment is missed). Emergence from default also can be a complicated issue for sovereigns. Sovereign debt restructurings are often undertaken through exchange offers that rarely close the books on the restructured debt. For a number of reasons, ranging from difficulty in contacting all debtholders to holdouts seeking payment in accordance with original terms, participation in sovereign distressed debt exchanges usually does not reach 100%. This stands in sharp contrast to corporate debt restructurings in the U.S. and in many other jurisdictions, where all obligations are addressed in bankruptcy reorganization. A corporate reorganizing outside of bankruptcy must continue payments on the holdouts' debt or face the prospect of an involuntary bankruptcy filing.
Table 3

Less common among sovereign defaults is the repudiation of debt, which most often follows a revolutionary change of regime (as occurred in the Soviet Union in 1917, China in 1949, and Cuba in 1960). Standard & Poor's takes no position on the propriety of government debt defaults, repudiations, and the like. Nor does Standard & Poor's take a position on the course of negotiations (or the absence thereof) between creditors and the government about working out debt that is repudiated, or on the parameters of any settlements between creditors and governments that may occur. Instead, Standard & Poor's ratings are an opinion of the probability of default on a forward-looking basis. Historical defaults are analyzed to the extent they may affect the likelihood of the sovereign defaulting in the future. In general, Standard & Poor's sovereign ratings apply only to debt that the present government acknowledges as its own. If there is no resolution of a default through the courts or by the parties

involved, Standard & Poor's eventually removes the default ratings based upon the diminished prospects for resolution and the lack of relevance of the default ratings in the context of the market. (For more information on emergence from default when a significant amount of debt has not been restructured, see "Argentina Emerges From Default, Although Some Debt Issues Are Still Rated 'D'," RatingsDirect, June 1, 2005.) For example, Standard & Poor's has no rating on direct and guaranteed debt of the government of China issued prior to the founding of the People's Republic of China in 1949 because Standard & Poor's first rated China in 1992, long after the repudiation of pre-1949 debt by the new government. The default is included in Standard & Poor's sovereign default survey, which covers defaults by rated and unrated issuers (see "Sovereign Defaults At 26-Year Low, To Show Little Change in 2007," RatingsDirect, Sept. 18, 2006). These criteria represent the specific application of fundamental principles that define credit risk and ratings opinions. Their use is determined by the issuer-specific or issue-specific facts, as well as Standard & Poor's assessment of the credit and, if applicable, structural risks for a given issuer or issue rating. Methodology and assumptions change from time to time as a result of market and economic conditions, issue-specific or issuer-specific factors, or new empirical evidence that would affect our credit judgment. Primary Credit Analysts: David T Beers, London (44) 20-7176-7101; david_beers@standardandpoors.com Marie Cavanaugh, New York (1) 212-438-7343; marie_cavanaugh@standardandpoors.com

ARCHIVE | Criteria | Corporates | General: Principles Of Corporate And Government Ratings

Publication date: 26-Jun-2007 00:00:00 EST

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Table of Contents Issuer Credit RatingsRating Specific Instruments(Editor's Note: This

criteria article is no longer current. It has been superseded by the article titled "Principles Of Credit Ratings," published Feb. 16, 2011.) Standard & Poor's Ratings Services corporate, government, financial institution, and insurer (C&G) credit ratings may be broadly split between those assigned to obligors (debt issuers) and obligations (issues). The Issuer Credit Rating (ICR) is a current opinion on an issuer's overall capacity and willingness to pay its financial obligations on a timely basis. It primarily indicates the likelihood of default. Standard & Poor's Ratings Services also assigns credit ratings to specific issues. Issue credit ratings may reflect a blend of default risk and recovery prospects in the event of default. The issue credit rating 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 that could affect ultimate payment in the event of default, such as collateral security and subordination.

Issuer Credit Ratings

For C&G ratings, Standard & Poor's Ratings Services employs fundamental credit analysis, supplemented by quantitative models, as appropriate, in accordance with its methodology and criteria. The analysis follows a systematic framework, called the Rating Methodology Profile (RAMP) tailored to the type of obligor. Business risk and financial risk are the main elements of corporate and financial institution analysis. Credit ratings are often identified with financial analysis, especially ratios. But it is critical to realize that ratings analysis starts with the assessment of the business and competitive profile of the company or the economic and political profile of the government. Business risk When assessing business risk, the analysis commonly includes country risk, industry characteristics, competitive position, cost efficiency, and profitability relative to peers. Industry characteristics typically

encompass growth prospects, volatility, and technological change, as well as the degree and nature of competition. The economic environment is especially important for bank credit quality. Regulatory structure affects utilities, insurance companies, banks, and other sectors. A company's product/service diversity, especially any risk concentration of a financial institution, is considered. While any particular profile category can be the overriding rating consideration, the industry risk assessment can be a key factor in determining the credit rating to which any participant in the industry can aspire. Broadly speaking, the lower the industry risk, the higher the potential credit rating on companies in that sector will be. An organization's strategy, operational effectiveness, and financial risk tolerance will shape its competitiveness in the marketplace and the strength of its financial profile. Risk management is an increasingly important analytical factor in the financial services sector. Credit, market, and trading risks are assessed. Standard & Poor's Ratings Services attaches great importance to management's philosophies and policies concerning financial risk. Financial risk Financial analysis begins with an evaluation of the firm's accounting principles employed, particularly any unusual practices or underlying assumption. Key financial indicators generally fall into the following categories: profitability, leverage, cash flow adequacy, liquidity, and financial flexibility. For financial institutions and insurers, critical factors are asset quality, reserves for losses, asset/liability management, and capital adequacy. The specific ratios analyzed vary by industry and may include profit margins, return on investment, debt/capital, debt/cash flow, and debt service coverage. Cash flow analysis and liquidity assume heightened significance for firms with speculative-grade ratings ('BB+' and lower). Trends over time and peer comparisons are evaluated. Off-balance sheet items, such as leases and pension liabilities, are considered. Where appropriate, Standard & Poor's Ratings Services may adjust reported financial statements to arrive at a more faithful representation of credit measures and to improve comparability. Standard & Poor's Ratings Services makes extensive use of risk-adjusted asset quality indicators and risk-adjusted capital analysis to compare financial institutions in different countries. Standard & Poor's Ratings Services employs proprietary quantitative models to measure the capital adequacy of insurance companies, including firms that insure U.S. municipal bonds and other obligations. An earnings adequacy model also may be applied to insurance companies. At its core, it is a risk-

adjusted analysis of a company's earnings stream, reflecting the insurer's underwriting risks and investment income. Analysis of liquidity and reserve adequacy are also modeled. 'Pi' ratings assigned to insurance companies may be substantially determined by quantitative models that evaluate publicly available financial data. Combining business and financial risk RAMP categories may be scored, but there is no precise recipe for combining the scores to produce ratings. The analytical variables are interrelated and the weights are not fixed. A company's business-risk profile determines the level of financial risk appropriate for any rating category. A well-positioned firm can tolerate greater financial risk, for a given rating, than a poorly positioned organization. Two firms with identical financial metrics may be rated very differently to the extent their business challenges and prospects differ. Government credit ratings For sovereign governments, the key determinants of credit quality are political and economic risk. Economic risk addresses a government's ability to repay obligations on time. Political risk addresses the sovereign's willingness to repay, a qualitative factor that distinguishes sovereigns from most other issuers. Political risk encompasses the stability and legitimacy of political institutions. At the regional and local government level, the analysis includes the supportiveness and predictability of the public sector system and the matching of revenue to service responsibilities. The foundation of government creditworthiness is the economic base. The economic structure, demographics, wealth, and economic growth prospects play a key role in credit analysis. Budgetary performance is a central component of financial analysis. Special attention is paid to revenue forecasting, expenditure control, long-term capital planning, debt management, and contingency plans. The debt burden relative to the economic and population base, as well as the government's debt structure and funding sources are considered. Off-balance sheet obligations are recognized. Quantitative elements are captured in a number of ratios that can be compared to those of peers. For sovereigns, financial analysis includes fiscal and monetary flexibility. The financial sector may be viewed as a significant contingent liability for a sovereign government. External liquidity is also analyzed.

Similar to the rating process in the private sector, analytical judgment, rather than a formulaic approach, is employed to weigh the individual RAMP categories and reach a rating decision.

Rating Specific Instruments

The ICR, which indicates the obligor's default risk, is generally the starting point when rating individual C&G issues. The issue's credit rating may also take account of ultimate recovery in the event of default. For the same obligor, secured debt is often rated higher than unsecured debt, and subordinated debt is typically rated below senior debt. Debt of a holding company may be rated below debt of its operating subsidiary. Recovery expectations dictate whether an obligation is rated above, below, or the same as the ICR. Standard & Poor's Ratings Services is in the process of expanding its recovery analysis for speculativegrade issuers, in response to the market's increased interest in post-default recovery. As a result, a growing number of issues will be rated 1-3 designations (notches) above and below the ICR. Certain obligations, including municipal revenue bonds, are serviced from a dedicated source, such as water and sewer charges and road tolls. Analysis of these instruments is generally project-specific and focuses on revenue generation relative to debt service, facility maintenance, and other requirements, often cushioned by reserve funds. Primary Credit Analyst: Gail I Hessol, New York (1) 212-438-6606; gail_hessol@standardandpoors.com Scott Bugie, Paris (33) 1-4420-6680; scott_bugie@standardandpoors.com Marie Cavanaugh, New York (1) 212-438-7343; marie_cavanaugh@standardandpoors.com Solomon B Samson, New York (1) 212-438-7653; sol_samson@standardandpoors.com

Secondary Credit Analysts:

Criteria | Governments | Sovereigns: Sovereign Government Rating Methodology And Assumptions

Publication date: 30-Jun-2011 09:15:02 EST

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Table of Contents I. SCOPE II. SUMMARYIII. CHANGES FROM RFCIV. EFFECT ON OUTSTANDING RATINGSV. EFFECTIVE DATE AND TRANSITION VI. METHODOLOGYA. Standard & Poor's Sovereign Rating CalibrationsB. Determining A Sovereign Foreign-currency RatingC. Assessing The Five Main Sovereign Rating Factors 1. Political Score2. Economic Score 3. External Score4. Fiscal Score5. Monetary Score D. Determining A Sovereign Local-Currency RatingVII. APPENDICESAppendix A. Glossary Of Key Indicators And Data SourcesAppendix B. Application Of Standard & Poor's Ratings Definitions To Sovereigns Emerging From DefaultAppendix C. Example Of Application Of The Methodology For A Sovereign Receiving Official FundingRELATED CRITERIA AND RESEARCH(Editor's Note: This criteria article was originally published

on June 30, 2011. We are republishing this article following our periodic review, completed on March 29, 2012. This article should be read in conjunction with the addendum "Sovereign Government Ratings Methodology Addendum For Sovereigns With Limited External Data," published Nov. 7, 2011.)
1.This sovereign criteria update follows the publication of "Request for Comment: Sovereign

Government Rating Methodology and Assumptions," on Nov. 26, 2010. This update provides additional clarity by introducing a finer calibration of the five major rating factors that form the foundation of a sovereign analysis and by articulating how these factors combine to derive a sovereign's issuer credit ratings. It also aims to incorporate the information derived from the 2008-2009 global recession, particularly regarding the potential effect of financial sector difficulties on governments' fiscal profiles. Specific considerations on the credit analysis of sovereigns in monetary unions are also covered. (See the related CreditMatters TV segment, "S&P's Updated Sovereign Ratings Methodology Aims To Provide A Clear Reflection Of The Fiscal Climate," dated June 30, 2011.)
2.The "Principles Of Credit Ratings," published Feb. 16, 2011, form the basis of these criteria. This

article replaces Standard & Poor's methodology addressed in "Sovereign Credit Ratings: A Primer," published May 29, 2008.

I. SCOPE
3.This methodology applies to ratings on all sovereign governments (also known as central governments).

4.All references to sovereign ratings in this article pertain to a sovereign's ability and willingness to service

financial obligations to nonofficial, in other words commercial, creditors. A sovereign's issuer credit rating does not reflect its ability and willingness to service other types of obligations listed below. Obligations to other governments (such as Paris Club debt) or intergovernmental debt. Obligations to supranationals, such as the International Monetary Fund (IMF) or the World Bank. Obligations to honor a guarantee that does not meet our criteria for sovereign guaranteed debt (see "Rating Sovereign-Guaranteed Debt," published April 6, 2009). Obligations issued by public sector enterprises, government-related entities or local and regional governments. However, the methodology takes into account the potential effect that these obligations may have on a sovereign's ability to service its commercial financial obligations.
5.Moreover, this article does not address post-default recovery prospects and their effect on specific issue

ratings. A separate criteria article "Introduction Of Sovereign Recovery Ratings," published June 14, 2007, covers these topics.
6.In this article, "rating" refers to an issuer credit rating, if not otherwise qualified.

II. SUMMARY
7.The sovereign rating methodology ("criteria" and "methodology" are used interchangeably herein)

addresses the factors that affect a sovereign government's willingness and ability to service its debt on time and in full. The analysis focuses on a sovereign's performance over past economic and political cycles, as well as factors that indicate greater or lesser fiscal and monetary flexibility over the course of future economic cycles.
8. The five key factors that form the foundation of our sovereign credit analysis are:

Institutional effectiveness and political risks, reflected in the political score. Economic structure and growth prospects, reflected in the economic score.

External liquidity and international investment position, reflected in the external score. Fiscal performance and flexibility, as well as debt burden, reflected in the fiscal score. Monetary flexibility, reflected in the monetary score.

9.Our sovereign rating analysis involves several steps, which the chart below summarizes.

10.The first step is to assign a score to each of the five key factors on a six-point numerical scale from '1'

(the strongest) to '6' (the weakest). Each score is based on a series of quantitative factors and qualitative considerations described in subpart VI.C below. The criteria then combine the political and economic scores to form a sovereign's "political and economic profile," and the external, fiscal, and monetary scores to form its "flexibility and performance profile." Those two profiles combine to determine the sovereign foreign-currency rating, after factoring in exceptional adjustments when applicable (see subpart VI.B).

11.A sovereign local-currency rating is determined by applying zero to two notches of uplift from the

foreign-currency rating following our methodology outlined in subpart VI.D. Sovereign local-currency ratings can be higher than sovereign foreign-currency ratings because local-currency creditworthiness may be supported by the unique powers that sovereigns possess within their own borders, including issuance of the local currency and regulatory control of the domestic financial system. When a sovereign is a member of a monetary union, and thus cedes monetary and exchange-rate policy to a common central bank, or when it uses the currency of another sovereign, the local-currency rating is equal to the foreign-currency rating.

III. CHANGES FROM RFC

12.On Nov. 26, 2010, Standard & Poor's published "Request for Comment: Sovereign Government

Rating Methodology and Assumptions." Market participants who responded were generally positive about the increased transparency and clarity of the criteria. Some of them provided comments about parts of the text that could be further clarified or specified, or possible different weighting of certain factors. Those comments led to the following main changes between these criteria and the proposal presented in the request for comment: The political score puts more emphasis on factors such as risks of political instability, the effect of social and economic factors and the potential effect of international organizations on national policy setting. The economic, external and fiscal scores are further clarified by changes in presentation and a better specification of the adjustment factors. The assessment of contingent liabilities related to the financial sector provides a more comprehensive measure of credit risks, market risks, and operational risks by using the "Bank Capital Methodology And Assumptions" published on Dec. 6, 2010. The effect of financing from another government, the IMF, or a multilateral lender such as the World Bank or a similar institution (also called 'official funding' in the rest of this article) on the rating of the recipient of such programs is further developed. The monetary score puts less emphasis on the exchange rate regime and provides more details to assess the development of the financial system and the capital market. Factors leading to an uplift of the local-currency rating from the foreigncurrency rating put more emphasis on monetary flexibility.

IV. EFFECT ON OUTSTANDING RATINGS

13.We expect few changes to existing foreign-currency sovereign ratings from the updated criteria. On the

other hand, we expect the revised criteria to lead to more numerous changes to local-currency ratings. Where gaps between foreign- and local-currency sovereign ratings exist, the rating differential should narrow in about half of the cases, most often with the sovereign local-currency ratings being lowered by one or two notches. The lowering of some sovereign local-currency ratings could affect our ratings on other issuers, such as government-related entities (GREs).

V. EFFECTIVE DATE AND TRANSITION

14.The criteria described in this article are effective immediately. We intend to complete our review of all

issuers affected with the next six months.

VI. METHODOLOGY A. Standard & Poor's Sovereign Rating Calibrations

15.The overall calibration of the sovereign ratings criteria is based on our analysis of the history of

sovereign defaults, the effect of the 2008-2009 financial and economic crisis on sovereign creditworthiness, and what we view to be the credit strength of sovereign governments compared with other types of issuers. History of sovereign defaults
16.The review of the history of sovereign defaults uses the following main sources:

Standard & Poor's "Sovereign Defaults at 26-Year Low, To Show Little Change in 2007," published Sept. 18, 2006, which looks at the default history of rated and unrated sovereigns since 1824.

"Sovereign Defaults And Rating Transition Data: 2010 Update," published Feb. 23, 2011, which covers the performance of Standard & Poor's sovereign ratings, both in terms of transition and default, over the period 1975 to 2010.

The data that Carmen Reinhart and Kenneth Rogoff gathered in their book "This Time Is Different," covering over 250 sovereign external default episodes over the period 1800-2009 and at least 68 cases of default on domestic debt. However, the book's definition of default is broader than our own.

17.The sources above show that, since the beginning of the 19th century, most sovereign defaults have

occurred because a defaulting government's past policies left it ill prepared to face an unexpected turn of events (in other words, a shock). War, regime change, other forms of political instability and sharp deterioration in terms of trade are examples of shocks. Some defaults also followed governments' decision to abandon the gold standard, under which they backed their paper currencies with gold at fixed conversion rates. Following a shock, when a government's previous fiscal or monetary policies left it little room for maneuver, or when economic policy did not support sustained economic growth then investors' perceptions tended to change quickly. This, in turn, raised financing costs and, in some cases, left a government with default as the preferred policy response. Effect of the 2008-2009 global recession
18.The recent global recession has not triggered a wave of sovereign defaults, though this chapter in

economic history is not over yet. However, the number of downgrades of sovereigns rated by Standard & Poor's, especially those in Europe, rose sharply in the past couple of years. The 2008-2009 global recession was the first synchronized recession since the establishment of the European Monetary Union (EMU). Our scoring calibration reflects the importance of a sovereign's external and fiscal performance inside a monetary union relative to the rest of the zone. Those sovereigns more reliant on funding sourced outside their national boundaries, and those that have experienced unexpected deterioration in their borrowing requirements or their growth prospects, have witnessed a sharp rise in their funding costs relative to those of other EMU members. Credit strength of sovereigns relative to other types of issuers
19.Central governments have unique powers, such as the ability to raise taxes, set laws, and control the

supply of money, which generally make them more creditworthy than other issuers with less authority. Consequently, although Standard & Poor's sovereign ratings span the entire rating scale, there is a greater proportion of sovereign ratings at the higher end of the scale compared with Standard & Poor's ratings in other sectors. Almost 15% of our sovereign foreign-currency ratings stood at the 'AAA' level at year-end 2010 and 11% in the 'AA' category, compared with about 1% and 8%, respectively, for corporate issuers. As of the date of this article, Standard & Poor's rates 126 sovereign governments. The global sovereign universe is over 200 governments when taking into account the 192 member states of the U.N. and other states and territories outside the U.N. If Standard & Poor's rated all sovereign governments, we believe that the proportion of ratings in the lower categories would likely rise.
20.Standard & Poor's elaborates and calibrates its sovereign rating criteria based on the above

observations and on its general framework for the idealized behavior of its credit ratings over time through economic cycles. Three articles outline our framework:

"Understanding Standard & Poor's Rating Definitions," published June 3, 2009; "Credit Stability Criteria," published May 3, 2010; and "The Time Dimension Of Standard & Poor's Credit Ratings," published Sept. 22, 2010.

21.We believe that the calibration of sovereign ratings in table 2 in subpart VI.B below achieves increased

comparability with other Standard & Poor's ratings across different sectors.

B. Determining A Sovereign Foreign-currency Rating

22.Standard & Poor's analysis of a sovereign's creditworthiness starts with its assessment and scoring of

five key rating factors (see table 1).

23.Each factor receives a score, using a six-point numerical scale from '1' (the strongest) to '6' (the

weakest). A series of quantitative factors and qualitative considerations, described in subpart VI.C below, form the basis for assigning the scores. The criteria then combine those five scores to form a sovereign's "political and economic profile," and its "flexibility and performance profile" as described below. The political and economic profile. The political and economic profile reflects our view of the resilience of a country's economy, the strength and stability of the government's institutions, and the effectiveness of its policy-making. It is the average of the political score (see section VI.C.1) and the economic score (see section VI.C.2). The flexibility and performance profile. The flexibility and performance profile reflects our view of the sustainability of a government's fiscal balance and debt burden, in light of the country's external position, as well as the government's fiscal and monetary flexibility. It is the

average of the external score (see section VI.C.3), the fiscal score (see section VI.C.4), and the monetary score (see section VI.C.5).
24.Those two profiles are then used in table 2 below to determine an indicative rating level.

25.We expect that our sovereign foreign-currency rating would in most cases fall within one notch of the

indicative rating level, based on the sovereign's positioning relative to peers. For example, for a sovereign we view as having a "moderately strong" political and economic profile and a "very strong" flexibility and performance profile, we would most likely assign a rating within one notch of 'AA-'.
26.A sovereign foreign-currency rating might differ by more than one notch compared with the indicative

rating level if it meets one or more of the exceptional characteristics listed below in paragraphs 27 to 33. If a sovereign combines several of the exceptional factors, its foreign-currency rating would be adjusted by the cumulative effect of those adjustments. Those exceptional adjustments are based on a forwardlooking analysis. They are important because certain components of credit risk can at times dominate overall creditworthiness even if the other factors remain stable.

27.Extremely weak external liquidity. A sovereign receives a foreign-currency rating below the

indicative rating level when the country's external liquidity is at, or we expect it to deteriorate to, levels that are substantially worse than the benchmark for the weakest levels of external liquidity, as defined in table 5. For instance, the rating would be one notch lower if the external score is '6' and we expect the ratio of gross external financing needs as a percentage of current account receipts and usable foreign exchange reserves to reach more than about 1.5x the level commensurate with the benchmark for the weakest external liquidity in table 5. The rating would be two notches lower if we expect them to reach more than twice that level.
28.Extremely weak fiscal situation. Similarly, a sovereign receives a foreign-currency rating below the

indicative rating level when its fiscal performance or its debt burden presents characteristics that are significantly worse than the benchmark for the weakest levels as defined in tables 6 and 7. For instance, the rating would be one notch lower if the debt score is '6' based on the sovereign's debt level as defined in table 7 and contingent liabilities are 'moderate' in accordance with table 8. The rating would be three notches lower if the debt score is '6', but the sovereign's debt burden is 1.5 times the level commensurate with a '6' score in table 7, and, in addition, contingent liabilities are 'very high' in accordance with table 8.
29.Exceptionally large net general government asset position. A sovereign receives a foreign-

currency rating one notch above the indicative rating level when it has exceptionally large liquid assets compared to peers at the same rating level (typically accounting for more than 100% of GDP), providing the government with an exceptional buffer during periods of economic or financial shocks.
30.Very high political risk and high debt burden. A sovereign with a political score of '6' cannot be

rated higher than 'BB+,' or 'B+' if the political score of '6' is combined with a debt score of '5' or '6' (see table 7), regardless of any potential upward adjustment for a large net asset position (see paragraph 29). The track record of sovereign defaults suggests that governance and political risks are among the main drivers of the poor economic policies that lead to default, which is why the political score receives this particular weight.
31.Rescheduling risk. When a government is likely to engage in a debt rescheduling that qualifies as a

distressed exchange, the sovereign's rating would be determined in accordance with the criteria "Rating Implications Of Exchange Offers And Similar Restructurings," published May, 12 2009.
32.High security risk. In cases of imminent or rapidly rising risk of war, a sovereign rating could differ

from the indicative rating level, depending on the conflict's expected magnitude and effect on the sovereign's credit characteristics. History provides several examples of defaults, such as the former

Yugoslavia, linked to a sovereign government ceasing to exist following a war. In the other cases when the risk of conflict is long-standing but not imminent, such as in the Gulf states, it affects the sovereign rating through an adjustment to the political score (see subsection VI.C.1.d)).
33.Severe natural catastrophes. The occurrence of a rare, but highly severe, natural catastrophe could

lead to a material deviation from the indicative rating level depending on the extent of damage and the effect on the country's fundamentals. An example is the financial costs for Grenada, linked to damage from Hurricane Ivan (we estimate these costs at close to 200% of the country's 2004 GDP), which, in our view, acted as the main trigger event for Grenada's ensuing default from its pre-hurricane rating level of 'BB-.' However, more generally, when a country is constantly exposed to natural disasters or adverse weather conditions, such as in the Caribbean region, this vulnerability affects our analysis of its economic structure, the potential volatility of its economic output, and the government's readiness to respond to those events. For more information, see "Assessing The Impact Of Natural Disasters On Sovereign Credit Ratings," published June 14, 2010.
34.A sovereign that becomes unable to attract credit at a sustainable interest rate may receive lower-cost

financing from another sovereign, the IMF, the World Bank or similar institutions, also called official funding. Participation in this type of program addresses part of the recipient's funding needs for a defined period of time and often entails conditions for continued access, such as the implementation of economic reforms or domestic fiscal consolidation. Where the program may facilitate reforms and the official funding is likely to remain in place to cover the recipient's borrowing requirements, it could break the downward trend in the recipient's credit quality. In other cases, participation in these programs may not prove successful and thus may not positively affect the recipient's creditworthiness. The effect of this official funding on the recipient's rating is reflected in three of the five key rating factors: the political score (see subsection VI.C.1.e)), the external score (see subsection VI.C.3.e)) and the fiscal score (see paragraph 96 and table 7), and not as an exceptional adjustment factor. Appendix C illustrates the application of this approach by an example.

C. Assessing The Five Main Sovereign Rating Factors

35.The analysis of each of the key five factors embodies a combination of quantitative and qualitative

elements. Some factors, such as the robustness of political institutions, are primarily qualitative, while others, such as the economy, debt, and external liquidity use mostly quantitative indicators.

1. Political Score

36.The political score assesses how a government's institutions and policymaking affect a sovereign's

credit fundamentals by delivering sustainable public finances, promoting balanced economic growth, and responding to economic or political shocks.
37.The political score captures the factors listed below, which are uncorrelated with any particular political

system: The effectiveness, stability, and predictability of the sovereign's policymaking and political institutions (primary factor). The transparency and accountability of institutions, data, and processes, as well as the coverage and reliability of statistical information (secondary factor). The government's payment culture (potential adjustment factor). External security risks (potential adjustment factor). The potential effect of external organizations on policy setting (potential adjustment factor).
38.Table 3 shows the interplay of the factors listed in paragraph 37. The primary factor for determining the

political score is the effectiveness, stability, and predictability of the sovereign's policymaking and political institutions. The secondary factor provides additional information on the transparency and accountability and acts as a qualifier to the primary factor in determining the initial political score (see table 3). The table contains the characteristics generally expected at different levels for the political score, although a government might exhibit a majority but not all of them. Finally, a sovereign's political score may be better or worse than the initial score based on the last three factors, payment culture, security risks, and effect of external organizations, as explained in table 3.

39.The assessment of these factors relies mostly on our qualitative analysis, which may be

complemented by external sources such as: The World Bank's "Doing Business" reports.

The World Bank's "Worldwide Governance Indicators," which measure six broad dimensions of governance (voice and accountability, governance effectiveness, rule of law, regulatory quality, control of corruption, and political stability and absence of violence).

The United Nations Development Programme's "Human Development Indicators", with a particular focus on the "human development index." Transparency International's "Corruption Perception Index." IMF and World Bank Reports on the Observance of Standards and Codes.

a) Effectiveness, stability, and predictability of policymaking and political institutions

40.The criteria analyze the effectiveness, stability, and predictability of policymaking and institutions

based on: The track record of a sovereign in managing past political, economic, and financial crises; maintaining prudent policy-making in good times; and delivering balanced economic growth. A sovereign's ability and willingness to implement reforms to address fiscal challenges, such as health care or pensions, to ensure sustainable public finances over the long term. The predictability in the overall policy framework and developments that may affect policy responses to future crisis or lead to significant policy shifts. Actual or potential challenges to political institutions, possibly involving domestic conflict, from popular demands for increased political or economic participation, or from significant challenges to the legitimacy of institutions on ethnic, religious, or political grounds.
41.Effective policymaking and stable political institutions enable governments to address proactively

periods of economic distress and to take measures to correct imbalances. This helps to sustain long-term growth prospects and limits the risk of sharp deterioration of a sovereign's creditworthiness. Stable and well-established institutions generally ensure a certain degree of predictability in the general direction of policymaking, even when political power shifts between competing parties and policy details change as a result. Conversely, succession risks, high concentration of power, and potential or actual challenges to political institutions are factors that can pose risks to institutional stability, and in turn lead to substantial policy shifts and affect the continuity of key credit characteristics. The analysis of the risk from challenges

to political institutions is based on the history of internal political conflicts, including extra-constitutional changes of government. b) Transparency and accountability of institutions, data, and processes
42.The accountability and transparency of institutions, data, and processes are based on the analysis of

the following: The existence of checks and balances between institutions. The perceived level of corruption in the country, which correlates strongly to the accountability of the institutions. The unbiased enforcement of contracts and respect for the rule of law (especially in the area of property rights), which correlates closely to respect for creditors' and investors' interests. The independence of statistical offices and the media, as well as the history of data revisions or data gaps, as measures of the transparency and reliability of the information.
43.The last point includes an assessment of the quality and consistency of the relevant data, which

include national income accounts, fiscal accounts, monetary surveys, public enterprise accounts, the balance of payments, and the international investment position. These data are based on estimated values and are not always measured with precision. Thus, where there is a history of significant data revisions, poor forecasting, or data gaps and inconsistencies (either from one source or between sources), the criteria call for interpreting the data in light of these discrepancies as reflected in table 3.
44.The transparency and accountability of institutions bear directly on sovereign creditworthiness because

they reinforce the stability and predictability both of political institutions and the political framework. They do this even though they may not reinforce the stability of a ruling political class or party. In addition, transparent and accountable institutions, processes, and data are important because they enhance the reliability and accuracy of information, and help make known in a timely manner any significant shifts in a country's policymaking or the occurrence of risks relevant to sovereign credit risk. c) A government's debt payment culture
45.The first potential adjustment to the initial political score relates to debt payment culture. Willingness to

default is an important consideration when analyzing a sovereign's creditworthiness, partly because creditors have only limited legal redress. As a result, a sovereign can, and sometimes does, default on its obligations even when it possesses the financial capability for timely debt service. Therefore, the analysis

aims to assess to what degree policymakers likely are willing to prioritize debt service to avoid default in difficult situations.
46.The overall political score cannot be better than '6' in cases where we believe that a government's debt

payment culture represents a credit risk. For this to happen, a government would typically present one or more of the following characteristics: Arrears on bilateral official debt, which is debt owed to other governments and government-owned entities. A public discourse that questions the legitimacy of debt contracted by a previous administration (so-called "odious debt"). No material policy change since the last default on commercial debt.

47.Academic studies suggest the relevance of the last characteristic mentioned just above. In their 2003

article "Debt Intolerance," Reinhart, Rogoff, and Savastano find that countries can graduate from being serial defaulters, although the path to "graduation" is long. Defaults weaken political institutions because the ensuing economic decline discredits the policies that led to default and raises the population's mistrust. This greater public mistrust may make forming a consensus on economic policy more difficult and thus may prompt further defaults in the future. The evidence that the study presents also suggests that the first default may be much more costly than later ones, hence the idea that, with each successive default, serial defaulters have less of a reputation to lose. d) External security risks
48.The second potential adjustment to the initial political score relates to geopolitical and external security

risks, including war or threats of war stemming from conflicts or strained relations with neighboring countries. When there is a long-standing risk of war within the country's territory, but we do not foresee that this risk will likely materialize in the next three to five years, the political score would be one to two categories worse than the initial score. However, when these risks are imminent or rapidly rising, it would affect the sovereign's political risk and the overall rating to a greater extent, depending on what the magnitude and effect of the conflict would be on the sovereign's economic and political situation (see exceptional adjustment factors in paragraph 32). National security is a rating concern because military threats may place a large burden on fiscal policy, reduce the flow of potential investment, or put the balance of payments under stress. It may also lead to economic sanctions. e) Effect of external organizations on policy making

49.At times, membership in supranational organizations can affect policy setting. Membership in military

alliances, political unions, monetary unions, and trading blocks, for example, brings with it not only benefits but obligations as well. This issue is most evident when a sovereign seeks exceptional official funding, for example from the IMF or the European Union. Such funding often provides much needed financing, either for balance of payment support (see subsection VI.C.3.e) or for budgetary support (see paragraph 96) for short- to medium-term tenors, but it also entails conditions for that support to be disbursed over time.
50.When participation in a supranational program--either in the guise of conditions for membership or

conditions for exceptional financial assistance--gives greater predictability and effectiveness of policymaking, then a sovereign's political score would be one category better. Conversely, if a sovereign's commitment to external organizations is not credible with investors or its domestic population such that policy outcomes or access to funding is more uncertain, then a sovereign's political score would be one category worse.

2. Economic Score
51.The history of sovereign defaults suggests that a wealthy, diversified, resilient, market-oriented, and

adaptable economic structure, coupled with a track record of sustained economic growth, provides a sovereign government with a strong revenue base, enhances its fiscal and monetary policy flexibility, and ultimately boosts its debt-bearing capacity. We observe that market-oriented economies tend to produce higher wealth levels because these economies enable more efficient allocation of resources to promote sustainable, long-term economic growth.
52.The following three factors are the key drivers of a sovereign's economic score:

Income levels. Growth prospects. Economic diversity and volatility.

53.The combination of those three factors determines a sovereign economic score as presented in table

4. The criteria derive an initial score based on a country's income level, as measured by its GDP per capita (see subsection VI.C.2.a). Then the initial score receives a positive or negative adjustment by up to two categories, based on the economy's growth prospects (see subsection VI.C.2.b), as well as its potential concentration or volatility (see subsection VI.C.2.c).

a) Income levels
54.GDP per capita is Standard & Poor's most prominent measure of income levels. With higher GDP per

capita, a country has a broader potential tax and funding base upon which to draw, a factor that generally supports creditworthiness. The determination of the economic score uses the latest GDP per capita from national statistics, converted to U.S. dollars. In cases where a country's GDP per capita fluctuates around the border between two score categories (see table 4), then the score is based on a moving threeyear average of GDP per capita.

55.A sovereign's economic score would be one category better or worse than the initial score, if the GDP

per capita in U.S. dollars was not an adequate reflection of a country's income level due to, respectively, a significant currency under- or over-valuation. A currency might be significantly undervalued, for instance, when a country with a non-market determined exchange rate runs sustained current account surpluses and holds sizeable usable reserves (covering consistently more than 12 months current account payments). Conversely, a currency might be significantly overvalued, for instance, when a country with capital controls runs consistent current account deficits. b) Economic growth prospects
56.A sovereign's economic score is one category worse or better than the initial score when its growth

prospects are well above or below those of peers in the same GDP per capita category. The key measure of economic growth is real per capita GDP trend growth.
57.The term "trend growth" refers to estimates of the rate at which GDP grows sustainably over an

extended period, in other words without creating inflationary pressure, asset bubbles, or other economic dislocations. Such estimates are generally derived from empirical observations based on the recent past and longer-term historical trends, and they attempt to look through the fluctuations of an economic cycle, smoothing for peaks and troughs in output during the period being analyzed. Our analysis focuses on per capita GDP growth in order to normalize for growth driven more by changes in population than productivity.
58.In order to form the trend growth measure used in table 4, the criteria use the average growth in a

country's real per capita GDP over a 10-year period, which generally covers at least one economic cycle (including both a period of economic expansion and a period of contraction). More specifically, the real per capita GDP trend growth is the average of six years historical data, our current year estimate and three-year forecasts. The latest historical year, current year estimate, and forecasts are weighted 100%, while previous years are assigned a lower weight in order to avoid a cliff effect when an exceptional year drops out of the 10-year average. The source for historical data is national statistics. Our estimate and forecasts result from analysis of the government forecasts, projections from the IMF and other sources, as well as identification of the main factors that could lead to a change in future growth compared to the historical trend. The trend growth calculation is adjusted for one-off items such as changes in the statistical base or a one-off sizable investment.
59.In order to derive the median growth rate in real per capita GDP for a group of peer countries used in

table 4, the criteria use Standard & Poor's and IMF data for almost all rated and unrated countries. We derive one median growth rate for countries with an initial economic score of '1' or '2' (GDP per capita

above US$ 25,000), one for countries with an initial economic score of '3' or '4' (GDP per capita between US$ 5,000 and 25,000), and one for countries with an initial economic score of '5' or '6' (GDP per capita below US$ 5,000). We have observed that countries in those combined categories have relatively comparable growth levels and that statistics for narrower peer categories are less meaningful.
60.A sovereign's economic score would be one category worse than the initial score, when GDP growth

seems to be fueled mostly by a rapid increase in banking sector domestic claims on the private sector, combined with a sustained growth in inflation-adjusted asset prices, indicating vulnerability to a potential credit-fueled asset bubble. We measure this factor along the lines of the BICRA methodology (see "Request for Comment: Methodology For Determining Banking Industry Country Risk Assessments," published May 13, 2010). c) Economic diversity and volatility
61.Finally, a sovereign exposed to significant economic concentration and volatility compared with its

peers receives an economic score that is one category worse than the initial score. More precisely, a sovereign's economic score would be one category worse if it carried significant exposure to a single cyclical industry (typically accounting for more than about 20% of GDP), or if its economic activity were vulnerable due to constant exposure to natural disasters or adverse weather conditions. However, the score would not receive an adjustment if the country had an initial economic score of '5' or '6' or if it displayed very large net general government liquid assets (typically above 50% of GDP) that can be used to mitigate the effect of this volatility. Economic concentration and volatility are important because a narrowly based economic structure tends to be correlated with greater variation in growth than is typical of a more diversified economy. Pronounced economic cycles tend to test economic policy flexibility more harshly and impair the government's balance sheet more significantly than shallow economic cycles.

3. External Score
62.The external score reflects a country's ability to generate receipts from abroad necessary to meet its

public- and private-sector obligations to nonresidents. It refers to the transactions and positions of all residents (public- and private-sector entities) versus those of nonresidents because it is the totality of these transactions that affects the exchange rates of a country's currency.
63.Three factors drive a country's external score:

The status of a sovereign's currency in international transactions.

The country's external liquidity, which provides an indication of the economy's ability to generate the foreign exchange necessary to meet its public- and private-sector obligations to nonresidents.

The country's external indebtedness, which shows residents' assets and liabilities (in both foreign and local currency) relative to the rest of the world.

a) Currency status in international transactions

64.The first step in the assessment of the external score relates to the degree to which a sovereign's

currency is used in international transactions. The criteria assign a better external liquidity score to sovereigns that control a "reserve currency" or an "actively traded currency." These sovereigns have a common attribute: Their currencies are used (widely for reserve currencies) in financial transactions outside their own borders, which means that they may be less vulnerable to shifts in investors' portfolios of debt holdings than are other countries. The international use of these currencies in turn stems from (i) the credibility of the countries' policies and institutions, (ii) the strength of their financial systems, (iii) the countries' large and open capital markets, with market-determined interest and foreign exchange rates, and (iv) the use of their currencies as units of account in global capital markets. These characteristics may push the external debt of these sovereigns to relatively high levels. But this does not present the same degree of risks as for countries with non-actively traded currencies, because these sovereigns' policy settings can more readily preserve foreign investor confidence. The criteria differentiate between sovereigns with reserve currencies and those with actively traded currencies as follows.
65.Sovereigns with a reserve currency. A sovereign in this category benefits from a currency that

accounts for more than 3% of the world's total allocated foreign exchange reserves based on the IMF's report "Currency Composition of Official Foreign Exchange Reserves," and the sovereign's global economic and political influence supports this official demand. Demand for the debt of sovereigns that control reserve currencies tends to rise in periods of economic stress (this is the so-called "flight to quality"). At the time of writing these criteria, this category of sovereigns includes the U.S., the U.K., Japan, France, and Germany. The latter two, the largest members of the eurozone, benefit, in our view, from the reserve currency status of the euro. Given that they account individually for more than 20% of the zone's GDP, it is unlikely that the ECB's monetary stance would be at odds with their economic fundamentals for a long time, as was the case with some of the smaller EMU members that suffered large lending bubbles.
66.Sovereigns with an actively traded currency. A sovereign in this category benefits from a currency

that accounts for more than 1% of global foreign exchange market turnover, based on the Bank for

International Settlement (BIS) report "Triennial Central Bank Survey," and which is not a reserve currency as defined above. At the time of writing these criteria, this category includes Australia, Switzerland, Canada, Hong Kong, Sweden, New Zealand, Korea, Singapore, Norway, and Mexico. In addition, all eurozone countries are included, with the exception of France and Germany, which are included in the previous category. This list may vary over time.
67.For countries with a reserve currency or an actively traded currency, the analysis focuses on a

measure of external indebtedness, defined as the ratio of narrow net external debt to current account receipts, as explained in paragraph 73 and reflected in table 5. The more flexible monetary position of these countries allows less reserve accumulation and permits higher short-term debt levels compared to the sovereigns with less monetary flexibility, making quantitative comparison based on an external liquidity ratio (described in paragraph 69) less meaningful.
68.For the other countries, the criteria combine the assessment of a sovereign's international investment

position with the analysis of its external liquidity to derive its initial external score (see table 5). b) External liquidity
69.The key measure of a country's external liquidity is the ratio of "gross external financing needs" to the

sum of current account receipts plus usable official foreign exchange reserves (see the glossary in Appendix A).
70.The "gross external financing needs" in table 5 is the average of the current-year estimate and

forecasts for the next two to three years. Standard & Poor's forecasts a country's gross external financing needs first by reviewing the country's historical balance of payments and international investment position, the official government and the central bank's own forecasts (when available), and those of independent economists and the IMF. In addition, Standard & Poor's independently estimates a sovereign's gross external financing needs based on information about the country's expected imports, the terms of trade, and external debt structure. When compositional data on the tenors of private sector external debt are not available, Standard & Poor's makes estimates based on observations of the international investment positions of other countries at similar stages of development when this information is available. In cases where one-off items (i.e., items unlikely to repeat in the next three to five years) distort the period average, then the score is based on the level of future external liquidity adjusted for the one-off items.
71.Usable foreign exchange reserves represent the sum of liquid claims in foreign currency on

nonresidents under the control of the central bank and gold holdings. The calculation of usable foreign

exchange reserves is explained in Appendix A. For most sovereigns, usable foreign exchange reserves serve as a financial buffer during periods of balance-of-payments stress. However, sovereigns with freely floating exchange rates and deep foreign exchange markets typically hold a low level of reserves. Their central banks are usually not called upon to be last-resort sellers of foreign exchange, and a single external borrower having trouble rolling over its debt does not threaten the foreign exchange regime. c) External indebtedness
72.Standard & Poor's key measure of a country's external indebtedness is the ratio of "narrow net external

debt" to current account receipts (see the glossary in Appendix A).

73.The term "narrow" in the description of net external debt refers to a more restricted measure than

some widely used international definitions of net external debt. The calculation of "narrow net external debt" subtracts from gross external indebtedness only the most liquid external assets from the public sector and the financial sector (see Appendix A for more details on this calculation). The criteria use this special definition for two reasons. First, financial sector assets are generally more liquid than those of the non-financial private sector. Second, most financial institutions manage external assets and liabilities, which is not the case for many non-financial private sector entities, some of which may be primarily holders of assets, and others primarily holders of liabilities. In a downside scenario, private sector entities may transfer their assets in the domestic financial system to foreign accounts.
74.A sovereign's external score equals the initial score derived from table 5, adjusted by up to two

categories based on the net effect of the positive and negative qualitative factors listed in the table. The paragraphs following the table provide a detailed explanation for each adjustment factor.

d) Adjustments for the trend and funding composition of the balance of payments

75.Either of the following two conditions improves a sovereign's external score by one category as shown

in table 5: The sovereign controls an actively traded currency and displays a current account surplus on average over the last historical year, the current year, and the next two forecast years. The country has significant and liquid non-financial private sector external assets and income-earning net direct investment. This is as reflected by a net international investment position that is more favorable than the narrow net external debt position by more than 100% of CAR.
76.One of the following conditions weakens a sovereign's external score by one category as shown in

table 5: The sovereign has an actively traded currency and displays a high current account deficit (consistently over 10% of CAR), likely indicating a structural problem (competitiveness or overleveraged domestic economy, or both), or its external short-term debt generally exceeds 100% of CAR. There is a risk of marked deterioration in the country's external financing, based on our qualitative assessment of the following factors: (i) a sudden reduction in the availability of official funding due to non compliance with the program's conditions (for countries reliant on an IMF or similar program); (ii) a sudden reduction of cross-border interbank lines resulting from perceptions of increasing stress in the financial sector; (iii) a sudden loss of non-resident deposits, due to the importance of non-resident deposits in relation to the size, concentration and vulnerabilities of the national banking system. This sudden loss might result from a wide-spread change in regulatory environment or country-specific developments hurting the country's reputation as a stable international financial center. This risk is further exacerbated if these non-resident deposits are on-lent onshore; (iv) a sudden shift in foreign direct investments or portfolio equity investments, especially in countries where the net external liability

position is substantially worse than the narrow net external debt position (by over 100% of CAR). The country is exposed to significant volatility in terms of trade (see Appendix A) due to a narrow or concentrated export base (including commodity-exporting countries), as measured for instance by a standard deviation of the change in terms of trade that exceeds 10%, unless the country has a large net external asset position (over 50% of CAR) to compensate for this volatility. The country's low external debt or low external financing needs reflect debt constraints such as lack of market access, recent debt rescheduling (improving the amortization profile), debt forgiveness, or other similar characteristics, all of which suggest external vulnerabilities despite the seemingly strong ratios. Or the country has arrears on the official external debt. The country's balance of payments has significant stock-flow mismatches or other gaps/inconsistencies between the balance of payments and the international investment position. e) Specific considerations for members of currency or monetary unions
77.Each sovereign that belongs to a currency or monetary union receives an external score based on its

individual external performance, using table 5 and depending on the currency of the union. This is because the external liquidity and balance sheet situations of members of a currency union may vary greatly, even though they all share a common currency and common capital markets. Where a currency union member displays a sizable and sustained current account deficit, no exchange rate pressures are likely to ensue, since exchange rate movements are more likely to be a function of the political and economic characteristics of the union as a whole. However, a member's large and sustained current account deficit may be a sign of poor competitiveness or an overleveraged domestic economy, or both. The loss of competitiveness is unlikely to be eased through exchange rate adjustments and improvements may require an extended period of slow growth, possibly with deflationary implications. Conversely, current account surpluses could be a sign of strong competitiveness and underpin a strong external creditor position. f) Effect of official funding
78.A sovereign's participation in an official program, such as IMF programs, may affect the evolution of its

external performance. Successful IMF programs may result in breaking a downward trend or in a gradual improvement in a country's external performance, which would be reflected through the forecasts used to

assign the external score in table 5. IMF and other official programs are normally sought by sovereigns in countries with external funding pressures. Governments often decide to seek programs as a form of political cover for difficult economic policy decisions or as a way to address temporary or potential spikes in the cost of external financing. The credit-supportive aspects of a program that provides funds include low cost external funding, the adoption of policies likely to address sources of stress and improve fundamentals, and various forms of technical assistance. However, program implementation is not always successful, because it is usually a challenge in a tough political and economic environment. In some cases, sovereign defaults occur subsequently.

4. Fiscal Score
79.The fiscal score reflects the sustainability of a sovereign's deficits and debt burden. This measure

considers fiscal flexibility, long-term fiscal trends and vulnerabilities, debt structure and funding access, and potential risks arising from contingent liabilities.
80.Given the many dimensions that this score captures, the analysis is divided into two segments, "fiscal

performance and flexibility" and "debt burden" which are scored separately. The overall score for this rating factor is the average from the two segments. a) Fiscal performance and flexibility
81.To determine a sovereign's fiscal performance and flexibility score, these criteria first derive an initial

score based on the prospective change in nominal general government debt calculated as a percentage of GDP (see paragraph 82). Then the initial score receives a positive or negative adjustment by up to two categories, based on the factors listed in the table below. Those factors relate to a government's fiscal flexibility and vulnerabilities, as well as long-term trends (see paragraphs 85 to 88).

Fiscal performance
82.The key measure of a government's fiscal performance is the change in general government debt

stock during the year expressed as a percentage of GDP in that year. We believe that the former is a better indicator of fiscal performance rather than the reported deficit. The deficit is sometimes affected by political and other considerations, possibly creating strong incentives to move expenditures off budget. The calculation of this ratio is explained in Appendix A.
83.The change in general government debt used in table 6 is the average of the current-year estimate and

forecasts for the next three years. Our current-year estimate and forecasts are established first by reviewing the government's own projections, as well as those of external institutions such as the IMF, and

then by making adjustments, when necessary to reflect the effect of economic growth prospects (see section VI.C.2) or the occurrence of contingent risks. In cases where the period average is distorted by one-off items that are unlikely to recur in the next three to five years, the score is based on the level of change in general government debt adjusted for the one-off items.
84.The criteria focus on measures at the general government level, which is the aggregate of the national,

regional, and local governments, including social security and eliminating intergovernmental transactions. This measure better captures the economic effect of the fiscal policy stance and is most closely aligned with issues relating to macroeconomic stability and economic growth. In addition, general government measures are the most useful comparator because the division of revenue-raising authority and expenditure responsibility differs between countries, while all tiers of government ultimately rely on the same population to pay taxes. In addition a sovereign generally has the strongest influence over the distribution of public sector responsibilities between different tiers of government. Fiscal flexibility, long-term fiscal trends and vulnerabilities
85.Fiscal flexibility provides governments with the "room to maneuver" to mitigate the effect of economic

downturns or other shocks and to restore its fiscal balance. Conversely, government finances can also be subject to vulnerabilities or long-term fiscal challenges and trends that are likely to hurt their fiscal performance. The assessment of a sovereign's revenue and expenditure flexibility, vulnerabilities and long-term trends is primarily qualitative.
86.One of the following conditions improves a sovereign's fiscal performance and flexibility score by one

category as shown in table 6: The government is able and willing to raise revenues through increases in tax rates, in tax coverage, or through asset sales in the near term. Revenue flexibility is a qualitative assessment based on the government's policy or track-record, but also taking into account the potential constitutional, political, or administrative difficulties, as well as potential economic or social consequences of such measures. The government is able and willing to reduce general government expenditures in the near term despite the economic, social or political effect. Expenditure flexibility can be determined by looking at the level and trend of public sector wages and entitlement expenditures (pensions and health care), its mix of operating and capital

expenditures, and the government's track-record and policy with regard to implementing expenditure cuts when needed. The general government has liquid assets available to mitigate the effect of economic cycles on its fiscal performance.
87.One of the following conditions weakens a sovereign's fiscal performance and flexibility score by one

category as shown in table 6: The government's revenue base is volatile, stemming, for example, from a high reliance on real estate turnover taxes or royalties on the extractive industries (generally above 25% of revenues). The government has limited ability to increase tax revenues for instance due to a large shadow economy or low tax collection rates, making an increase in tax rates ineffective. The country has a significant shortfall in basic services to the population and infrastructure, which is likely to result in spending pressure for a long period of time, as reflected, for instance, by a "medium" or "low" UNDP human development index.
88.Age-related expenditures. Demographic change and population aging will be, and in some cases

already are, major challenges for public finances in many countries. Sovereigns are facing a decline in the working-age population and rising outlays for age-related spending items such as pensions and health care. While these burdens are in many cases substantial, they generally peak in a horizon of 10 to 20 years, and they are gradually increasing, rather than suddenly changing (see "Global Aging 2010: An Irreversible Truth," published Oct. 7, 2010). Consequently, in some cases, these potential drivers of future fiscal imbalances are far enough in the future to give governments sufficient time to take steps to remedy them. When this is not the case, age-related budgetary pressures are included in the assessment of a government's fiscal flexibility and long-term trends, and in our budgetary projections (see table 6 above). b) Debt burden
89.The debt burden score reflects the sustainability of a sovereign's prospective debt level. Factors

underpinning a sovereign's debt burden score are: its debt level; the cost of debt relative to revenue growth; and debt structure and funding access. This score also reflects risks arising from contingent liabilities with the potential to become government debt if they were to materialize.

90.The combination of those factors determines a sovereign's debt burden score as presented in table 7.

The criteria derive an initial score from two key measures of the general government debt level and cost of debt (see table 7). Then, the initial score receives a positive adjustment by up to one category or a negative adjustment by as many as three categories, based on our analysis of the government's debt structure, funding access and contingent liabilities.

Debt level and cost of debt

91.The analysis of a sovereign's debt level focuses on the following two measures:

General government interest expenditures as a percentage of general government revenues; and Net general government debt as a percentage of GDP.

92.The calculation of net general government debt (as defined in Appendix A) is generally more restrictive

than national measures of net general government debt, as it deducts from the general government debt only the most liquid assets. For instance, the following assets are not deducted: (i) international monetary reserves held by the central bank, which are typically held for balance of payment purposes and not for budgetary support; (ii) loans to or investments in majority-government-owned companies; and (iii) assets for which liquidity might be impaired in a sovereign stress scenario.
93.A sovereign's debt burden is assessed relative to its other credit characteristics, as explained in

subparts VI.A and VI.B, rather than as an absolute trigger at a given rating level. Governments can afford varying debt levels, depending on their other credit characteristics. In particular, the debt level that a government can sustain is affected by its monetary and fiscal flexibility, domestic capital market characteristics and by the credibility that it has established in past periods of stress. A sovereign with an unblemished track record of honoring debt obligations, a growing economy, and a strong domestic capital market providing fairly low-cost market-based financing may sustain a higher debt burden than a sovereign with lower debt-to-GDP ratios but higher and more variable debt-servicing burdens. Conversely, low debt burdens may reflect a lack of financing options and high interest costs, or, in some cases, debt restructurings, rather than fiscal flexibility. Some governments with relatively low debt to GDP levels have defaulted. Access to funding and debt structure
94.For sovereigns in a fiscal debtor position, the debt score is one category worse than the initial score if

at least two of the four conditions below apply: The central government debt has significant exposure to exchange rate movements and refinancing risk and, on average, more than 40% of the debt denominated in foreign currency or the average maturity is typically less than three years. Non-residents hold consistently more than 60% of the central government commercial debt. The debt service is vulnerable due to an amortization profile that varies by more than 5% of GDP one year to the next or due to possible acceleration from puts or rating triggers. The resident banking sector balance sheet has a large share of central government debt (above 20%), indicating a limited capacity of the national banking sector to lend more to the central government, without possibly crowding out private sector borrowing.

95.These measures help to assess a government's sensitivity to an increase in its refinancing costs and

refinancing risk. They are based on data at the central government level rather than general government. This is because sovereign ratings address the ability of the central government to repay its own direct financial obligations, and not those of other public sector entities or local and regional governments included in the scope of general government data.
96.When bilateral or multilateral official creditors are or are expected to become an important component

of a government's creditor base, the access to this official funding usually depends on the ability of the government to satisfy the conditions they impose. If the government is likely to satisfy those conditions and the official financing is likely to remain in place to cover the government's borrowing requirements and refinancing needs, the debt score is positively adjusted (see table 7). Contingent liabilities
97.Contingent liabilities refer to obligations that have the potential to become government debt or more

broadly affect a government's credit standing, if they were to materialize. Some of these liabilities may be difficult to identify and measure, but they can generally be grouped in three broad categories: Contingent liabilities related to the financial sector (public and private bank and non-bank financial institutions); Contingent liabilities related to nonfinancial public sector enterprises (NFPEs); and Guarantees and other off-budget and contingent liabilities.

98.In table 8, contingent liabilities related to the financial sector are assessed by estimating a country's

banking sector's potential recapitalization needs in a stress scenario. This assessment does not include, however, the broader fiscal cost for a sovereign that would derive from the economic downturn normally associated with a banking crisis and, more specifically, from the loss of tax revenues. Previous episodes of systemic banking crisis indicate that these costs may be significantly larger for a sovereign than the direct recapitalization cost, although to degrees that could vary widely.
99.As a result, the categories of contingent liabilities presented in table 8 below, ranging from "limited" to

"very high," should be interpreted as relative measures of risks. They provide only an indicative range of the potential direct costs that could arise for a sovereign from its contingent liabilities, as opposed to the broader fiscal effect. This is why this estimate of contingent liabilities is used as a qualifier when assessing a government's debt burden in table 7, and not as a measure that could simply be added to the government's existing debt level.

100.Contingent liabilities related to the financial sector. The largest of these contingent liabilities is the

risk posed by a systemic crisis in the financial sector. Contingent liabilities related to the financial sector are assessed by estimating the potential recapitalization needs in case of a systemic banking crisis in an 'A' stress scenario. Such scenario, defined in "Understanding Standard & Poors Ratings Definitions," published on June 3, 2009, corresponds to a GDP decline by as much as 6%, an unemployment rise up to 15%, and the stock market drop by up to 60%. This assessment involves several steps.
101.The first step consists in estimating the potential unexpected losses that a country's banking sector

would incur over a three-year period under such stress scenario. This calculation uses the risk-adjusted capital (RAC) framework explained in "Bank Capital Methodology And Assumptions" published Dec. 6, 2010. The calculation of the RAC losses consist of estimating a bank's total risk-weighted assets by multiplying its main risk exposures by the relevant risk weights, stated as a percentage. Risk weights adjust the exposures to reflect our view of their relative degree of risk. This means, the greater the risk we see, the higher the risk weight we apply. The main exposure categories in our computation are credit risk, market risk, and operational risk. The relevant risk weights are based on the country's BICRA score, as these risks vary by jurisdiction (see "Request for Comment: Methodology For Determining Banking Industry Country Risk Assessments," published May 13, 2010). This measure is calculated by using Standard & Poor's data on rated banks and by extrapolating the estimated losses to the aggregated banking sector. For countries with no or a very limited number of rated banks that are not representative of the banking industry, we use central bank data to build a simplified balance sheet for the aggregated banking sector and we apply risk-weighting similar to those of countries that have the most comparable banking sector.

102.The second step entails calculating the potential recapitalization needs for the banking sector under

such stress scenario. This calculation is the difference between a banking system's aggregate total adjusted capital and the sum of (a) the above-defined RAC losses and (b) the capital needed in order to reconstitute a minimum capital base for the domestic banking sector. We have fixed this minimum riskadjusted capital at 7% of risk-weighted assets, which corresponds to the minimum regulatory Common Equity Tier 1 capital under Basel III (unless the national requirements differ significantly from that level).
103.Some non-bank financial institutions (such as finance companies, securities dealers, or insurance

companies) and public-sector financial enterprises (such as national development banks, export credit agencies, or housing institutions), which may not be included in the above calculation, may affect sovereign credit standing when they are of material size. In the absence of comparable statistics for those sectors, the estimate of contingent liabilities for those entities is done on an individual basis using an analytical framework similar to that described above in paragraph 100.
104.Contingent liabilities related to non-financial public sector enterprises (NFPE). NFPEs can pose

a risk to a sovereign because they are generally formed to further public policies and can suffer from weak profitability and narrow equity bases, which may leave them vulnerable to adverse economic circumstances. NFPEs include most government-related entities (GREs) that are outside the financial sector. These are enterprises, partially or totally under government control, that we believe are likely to be affected by extraordinary government intervention during periods of stress. (see " Rating GovernmentRelated Entities: Methodology And Assumptions," published Dec. 9, 2010).
105.The assessment of contingent liabilities related to NFPEs applies a loss estimate under a significant

downside scenario to NFPE borrowings from nonresidents (either multilaterals, financial corporations or in the international bond markets) and NFPE domestic market bond issuance, along the lines of paragraph 100. (NFPEs' borrowing from the banking system is excluded to avoid double counting.) The borrowing from domestic financial institutions is already included in the previous estimate of contingent liabilities related to the financial sector. This assessment focuses on the largest NFPEs (typically those with debt of more than about 1% of GDP). It excludes the debt of enterprises that have a stand-alone credit profile (SACP) in investment grade (for details on SACPs, see "Stand-Alone Credit Profiles: One Component Of A Rating," published Oct. 1, 2010), or for which we assess a 'low' or 'moderate' likelihood of support under on our GRE methodology.
106.Guarantees and other off-budget and contingent liabilities. Contingent liabilities include other

types of risks including guarantees, when relevant in our view, such as:

The estimated potential loss on formal or implicit sovereign guarantees that are not already accounted for in the above categories. Quasi-fiscal or other off-budget operations, such as, for example, extra-budgetary funds, securitizations, and public-private partnerships.

5. Monetary Score
107.A sovereign's monetary score reflects the extent to which its monetary authority can support

sustainable economic growth and attenuate major economic or financial shocks, thereby supporting sovereign creditworthiness. Monetary policy is a particularly important stabilization tool for sovereigns facing economic and financial shocks. Accordingly, it could be a significant factor in slowing or preventing a deterioration of sovereign creditworthiness in times of stress.
108.A sovereign's monetary score results from the analysis of the following elements:

The sovereign's ability to use monetary policy to address domestic economic stresses particularly through its control of money supply and domestic liquidity conditions.

The credibility of monetary policy, as measured by inflation trends. The effectiveness of mechanisms for transmitting the effect of monetary policy decisions to the real economy, largely a function of the depth and diversification of the domestic financial system and capital markets.

109.On one end of the continuum, a score of '1' corresponds to a sovereign with extensive monetary

flexibility where the monetary authority is able to lower interest rates effectively or even expand its balance sheet significantly, and therefore ease tight liquidity conditions without stoking inflationary pressures. This flexibility exists only for monetary authorities with high perceived policy credibility in countries with deep and diversified credit and capital markets. This type of extensive monetary flexibility provides important benefits to contain financial crises and their implications for sovereign creditworthiness.
110.On the other end of the spectrum, a score of '6' corresponds to a sovereign without meaningful

monetary flexibility. Examples include sovereigns using the currency of another, sovereigns that apply extensive foreign exchange controls affecting the current account, and countries with persistent high inflation. A sovereign with these constraining features either has very limited or no flexibility to affect domestic economic conditions, including liquidity, or has a poor track record in meeting monetary

objectives. Where a sovereign does not have an independent monetary policy, monetary conditions are mostly determined by factors outside the control of the domestic monetary authorities and therefore cannot provide any meaningful buffer against domestic financial stress.
111.Table 9 below presents the characteristics expected for each score category between 1 and 5 for this

factor. A sovereign's initial score is derived from the majority of the sub-factors a), b), c) at a given level. When there is no majority, it is based the average score of those sub-factors. The initial score can be adjusted by one or two categories down based on the adjustment factors listed in the table.

a) A sovereign's ability to use monetary policy and the exchange rate regime
112.A sovereign can use monetary policy to address imbalances or shocks in the domestic economy only

when it controls the dominant currency used for domestic economic and financial transactions. The exchange rate regime influences the ability of the monetary authorities to conduct monetary policies effectively, as monetary objectives may conflict with objectives to sustain a certain exchange rate level. The more rigid the exchange rate regime, the more likely this disconnect impeding the conduct of monetary policy. b) Credibility of the monetary policy and inflation trends
113.Effective monetary policy requires credible institutions conducting it. While "credibility" cannot be

objectively measured, there are certain factors that generally make a central bank more credible and therefore effective in its conduct of monetary policies. Operational independence is important for effective policy formulation and implementation. Independence of central banks is itself not a measurable variable, but it usually goes hand in hand with institutional settings such as the nomination of members of the monetary policy board for defined terms, the protection of board members from political interference, and

the independence of central banks' budgets within the confines of applicable public sector guidelines. The length of the period of independence is relevant, as reversing independent monetary policy conduct may become harder the more entrenched its status has become.
114.Effective monetary policy is another important foundation for confidence in monetary authorities.

Confidence is crucial in a period of stress because it enables policymakers to resort temporarily to unconventional tools to counter the effect of economic shocks (for example, implementing quantitative easing without triggering sharp increases in interest rates). Monetary authorities with weak track records rarely have this flexibility.
115.A chief measure of effectiveness of monetary policy is low and stable inflation, which is the primary

objective of modern monetary policy. Low and stable inflation is also an important foundation for confidence in local currencies as a store of value and for the development of the financial sector. Consequently, sovereigns where persistently high consumer price inflation prevails receive the weakest score (see adjustment factors in table 9). On the other hand, for sovereigns with the highest level of monetary flexibility, inflation is expected to remain well contained (defined as averaging between 0% and 3% per year). e) Monetary policy effectiveness and development level of financial system and capital markets
116.A financial system and capital markets are necessary to transmit monetary policy decisions to the real

economy, because monetary policy tools, such as policy interest rates, reserve requirements or open market operations, work by influencing the funding costs and conditions that households and businesses face. This influence is often weak when the financial sector is in its early stages of development, when lending conditions are set by administrative means, or the use of foreign currency is prevalent. By contrast, a developed capital market allows for open market operations and a financial system in which local-currency transactions facilitate a central bank's conduct of monetary policy.
117.Financial system and capital market developments can be assessed by evaluating the following

factors: A government's ability to issue, at market-determined rates, long-term fixed-rate nominal local-currency bonds, which provides an indication of the confidence in a market's long-term liquidity. Better scores are associated with a higher proportion of local-currency fixed-rated bonds with a long maturity.

The existence of an active money market and corporate bond market, and a developed banking system. The availability of multiple sources of financing, both through capital markets and the banking system, reduces the risks of a funding squeeze when one funding channel faces difficulties.

The share of bank intermediation in local currency, because monetary policy tools are more effective if a country actively uses its local currency for domestic economic and financial transactions.

d) Case of sovereigns in a monetary union

118.The monetary score for sovereigns in monetary unions result from a two-step process. The first step

assigns an initial score to reflect our view of the effectiveness of the monetary policy of the union as a whole, based on the characteristics in table 9. The second step weakens this initial score by one category, reflecting the lower flexibility that members of a monetary union generally have relative to sovereigns with their own central banks. The central bank of the monetary union applies its monetary flexibility to the intended benefit of the zone as a whole and not of individual member states. The score would be worse by two categories rather than one where the economy of a sovereign in a monetary union is unsynchronized with the zone at large and displays prolonged price and wage trends diverging strongly from the union average. In other words, the union's monetary policy stance would be detrimental to a particular sovereign's creditworthiness.
119.In the case of a sovereign that leaves a monetary union, the monetary score would be based on the

characteristics outlined in table 9.

D. Determining A Sovereign Local-Currency Rating

120.A sovereign's local-currency debt may be rated above its foreign-currency rating. Historically, we have

observed lower default rates on local-currency debt than on foreign-currency debt. Any divergence between sovereign local and foreign-currency ratings reflects the distinctive credit risks of each debt type.
121.One might ask why sovereign local-currency ratings are not all rated 'AAA' given sovereigns'

extensive powers within their own borders, including the ability to print money. While the ability to print local currency gives the sovereign tremendous flexibility, heavy reliance on such an expansionary monetary stance may fuel the risk of very high inflation or even hyperinflation, which may cause more serious political and economic damage than rescheduling of local-currency debt. In such instances, sovereigns may opt to default on their local-currency obligations.

122.The sovereign local-currency rating is between zero and two notches above the sovereign foreign-

currency rating based on the following factors. Independent monetary policy: A government has greater capacity to pay its local-currency debt than its foreign-currency debt only if it can manage its local currency independently. Absent exchange controls, it can do this if it can set interest rates without regard to the currency's external value. Depth of the local currency capital markets. A sovereign has greater ability to conduct monetary policy the deeper its capital markets and the broader its ancillary markets, including active secondary market trading. An important incentive in continuing to service local currencydebt, when not servicing foreign-currency debt, is that the localcurrency debt may be a significant portion of the assets of local pension funds, banks, and other private-sector entities, which represent not only voters, but also important elements of the local economy. Political and fiscal flexibility. If political or fiscal concerns are the dominant constraint on the rating, the sovereign is less likely to have sufficient flexibility to accord a higher priority to servicing local-currency obligations.
123.The combination of those factors and effect on a sovereign's local-currency rating is outlined in table

10 below.

124.Issue-specific considerations. There are two cases when our rating on a local-currency debt

instrument might differ from the sovereign local-currency rating: When a government issues a local currency-payable debt instrument, for which debt service is linked to another currency. This issue receives the same rating as that on the sovereign's foreign-currency debt because, in a stress scenario, we expect this debt type to behave much like foreign-currency debt, with debt holders exchanging the local-currency debt service proceeds into foreign currency. A typical example of this kind of instrument was the dollar-indexed "tesobonos" that the Mexican government issued in its domestic market in the 1990s.

When a government issues local-currency debt in the global capital markets and the debt documentation states that the obligations rank pari passu with foreign-currency obligations. This issue receives the same rating as that on the sovereign's foreign-currency debt.

125.The approach does not reverse, however, for foreign-currency-denominated debt issued in domestic

markets. Such debt always receives a foreign-currency rating to such debt. Foreign-currency debt issuance generally diminishes the buffer that a domestic capital market can provide against economic and political shocks. We observe that such issuance often indicates domestic investors' lack of confidence in the local currency.

VII. APPENDICES Appendix A. Glossary Of Key Indicators And Data Sources

126.This section contains short definitions of the key economic terms used in tables 3 through 10. Most of

these measures are published twice a year in "Sovereign Risk Indicators," as well as in annual reports on individual sovereigns.
127.Standard & Poor's draws its data for its analyses from both national and supranational sources. The

data are found in the national income accounts, fiscal accounts, monetary survey, balance of payments, and international investment position compiled by national sources such as the national statistical agency, the central bank, the ministry of finance, or other key line ministries. Supranational sources most commonly include Eurostat, central banks of monetary unions, and the International Financial Statistics of the IMF.
Table 11

Glossary Of Key Indicators In Standard & Poor's Sovereign Rating Methodology

Terms

Definitions

Economic And Monetary Scores Key Indicators

GDP per capita (USD)

Total US dollar market value of goods and services produced by resident factors of production, divided by population.

Real GDP per capita (%

Percent change in constant-price per capita GDP.

change)

Consumer price index (% Average percent change in index of prices of a representative set of consumer change) goods bought by a typical household on a regular basis.

Domestic claims (% change)

Percent change in outstanding resident depository institution claims (at year end) on the resident private sector and nonfinancial public sector enterprises (NFPEs). May include claims by resident non-depository institutions, where these institutions are of systemic importance.

Monetary base

The monetary base consists of local currency in circulation plus the monetary authority's local currency liabilities to other depository corporations. The latter normally consists of these depository institutions deposits at the central bank plus central bank securities that can be used in satisfying reserve requirements, though there are national differences in definitions.

External Score Key Indicators

Current Account Receipts (CAR)

= Proceeds from exports of goods and services + factor income earned by residents from nonresidents + official and private transfers to residents from nonresidents.

In which:

Factor income = compensation of employees + investment income earned by residents from nonresidents

Gross external financing needs (% of CAR plus usable reserves)

= Gross external financing needs/ (CAR + usable reserves) .

In which :

Gross external financing needs = current account payments + plus short-term external debt at the end of the prior year + non-resident deposits at the end of the prior year + long term external debt maturing within the year).

In our projections of gross external financing needs, we make in adjustment in cases where we expect a shift in the portfolio of investments due to weakening

economic fundamentals or changes to the regimes for taxes or capital repatriation.

Narrow net external debt/CAR (%)

= Narrow net external debt/CAR

In which :

Narrow net external debt = stock of foreign and local currency public and private sector borrowings from nonresidents - liquid external assets

In which:

Liquid external assets =

official foreign exchange reserves

+ other liquid assets of the public sector held by non-residents

+ resident financial sector loans to, deposits with, or investments in nonresident entities.

The calculation of the narrow net external debt may exclude the external debt of foreign banks that do not have domestic financial assets, when material.

Reserves

Reserves are monetary authority liquid claims in foreign currency (including gold) on nonresidents.

Foreign exchange usable = foreign exchange reserves - items not readily available for foreign exchange reserves operations and repayment of external debt

In which :

Items not readily available for foreign exchange operations and repayment of external debt =

reserves pledged as security for any loan, including gold repos (unless the loan is

due within a year)

+ mark-to-market losses on reserves sold forward

+ reserves deposited in domestic financial institutions, including offshore branches

+ required reserves on resident foreign currency deposits. (Required reserves on nonresident deposits are included in reserves because the nonresident deposits are included in the short-term external debt measure in the calculation.).

+ monetary base for sovereigns that have adopted a currency board or have a longstanding fixed peg with another currency (because the reserve coverage of the base is critical to maintaining confidence in the exchange-rate link).

Current account balance/CAR (%)

= current account balance/CAR

In which:

Current account balance = exports of goods and services - imports of the same + net factor income + official and private net transfers, as a percentage of current account receipts.

Net foreign direct investment (FDI)/GDP (%)

= (direct investment by nonresidents - residents' direct investment abroad)/GDP

Net FDI in the tradable sector = net FDI - investments in the non-tradable sector

Net external liabilities/CAR (%)

= net external liabilities/CAR

In which:

Net external liabilities = (total external debt + stock of direct and portfolio equity investment from abroad) - (total external assets)

In which:

Total external assets = official reserves + other public sector assets held by nonresidents + resident financial institutions' assets held by nonresidents + resident non-financial sector assets held by nonresidents + the stock of direct and portfolio equity investment placed abroad.

Terms of trade

= exports price/imports price

In other words, it means what quantity of imports can be purchased through the sale of a fixed quantity of exports.

Fiscal Score Key Indicators

General government

Aggregate of the national, regional, and local government sectors, including social security and other defined benefit public sector pension systems, and excluding intergovernmental transactions.

Change in general government debt as a percentage of GDP

= (General government debt at year-end - general government debt at prior yearend)/Annual GDP

For the calculation of the change in gross general government debt, the following items are adjusted:

- Changes in cash reserves/deposits are deducted for governments that pre-fund deficits or that issue debt for the purpose of market presence rather than budget funding.

- Changes in debt that are due to debt relief or debt restructuring are deducted.

- Large shifts in exchange rates that are not expected to be repeated

- Quasi-fiscal activities that represent debt-like obligations are added (e.g., leases, project financing operations).

Net general government

=(Gross general government debt - general government financial assets)/GDP

debt/GDP (%)

Gross general government debt includes the debt of government's asset management companies used for the resolution of banks or other private sector bail-outs

General government financial assets

General government financial assets =

general government deposits in financial institutions (unless the deposits are a source of support to the recipient institution)

+ minority arms-length holdings of incorporated enterprises that are widely-traded

+ balances in defined-benefit pension plans or social security funds (or stabilization or other freely available funds) that are held in bank deposits, widely-traded securities, or other liquid forms.

Defined-benefit pension fund balances invested in government debt are usually excluded from gross debt if the government controls the fund, and thus are not included in assets.

Gross general government debt/GDP (%)

= Gross debt incurred by national, regional, and local governments/GDP

Internal holdings, including social security and defined benefit public sector pension fund investments in government debt, are netted out.

General government interest/general government revenues(%)

Interest payments on general government debt/general government revenues

Central government debt service / central government revenues (%)

interest + principal repayment on central government debt/central government revenues

Appendix B. Application Of Standard & Poor's Ratings Definitions To Sovereigns Emerging From Default
128.A sovereign that undertakes a debt rescheduling qualifying as a distressed exchange under our

criteria would receive a 'SD' rating (see "Rating Implications Of Exchange Offers And Similar Restructurings," published May 12, 2009). However, emergence from default also can be a complicated analytical issue for a sovereign. Sovereigns often undertake debt restructurings through exchange offers that, we find, rarely close the books on the restructured debt. For a number of reasons, ranging from difficulty in contacting all debt holders to holdouts seeking payment in accordance with original terms, we have observed that participation in sovereign distressed debt exchanges usually does not reach 100%. This stands in contrast with corporate debt restructurings in the U.S. and in many other jurisdictions, where all obligations are typically addressed in bankruptcy reorganization. A corporate reorganizing outside of bankruptcy generally must continue payments on the holdouts' debt or face the prospect of an involuntary bankruptcy filing.
129.Less common among sovereign defaults is the repudiation of debt, which most often follows a

revolutionary change of regime (as occurred in the Soviet Union in 1917, China in 1949, and Cuba in 1960). Standard & Poor's takes no position on the propriety of government debt defaults, repudiations, and the like. Nor do we take a position on the course of negotiations (or the absence thereof) between creditors and the government about working out debt that is repudiated, or on the parameters of any settlements between creditors and governments that could occur. Instead, Standard & Poor's places the defaulted obligations in "selected default" but its issuer credit rating reflects its current opinion of the creditworthiness of a sovereign government on a forward-looking basis. Historical defaults inform our view to the extent that they suggest how political and economic risks could affect sovereign decision-making in the future.
130.In general, Standard & Poor's sovereign ratings apply only to debt that the present government

acknowledges as its own. If there is no resolution of a default through the courts or by the parties involved, Standard & Poor's eventually withdraws the default ratings based on the diminished prospects for resolution and the lack of relevance of the default ratings in the context of the market. For example, Standard & Poor's has no rating on direct and guaranteed debt of the government of China issued prior to the founding of the People's Republic of China in 1949 because we first rated China in 1992, long after the new government repudiated pre-1949 debt.

Appendix C. Example Of Application Of The Methodology For A Sovereign Receiving Official Funding

131.Paragraph 34 explains that the effect of this official funding on the recipient government's rating is

reflected in three of the five key rating factors: the political score (see subsection VI.C.1.e)), the external score (see subsection VI.C.3.e)) and the fiscal score (see paragraph 96 and table 7). The purpose of this appendix is to illustrate this approach through an example. The example below illustrates a case of fiscal support program, aiming to cover a government's refinancing needs (as opposed to a case of balance of payment support aiming to address a country's external funding pressures).
132.Sovereign X has a relatively wealthy but slowly growing economy (leading to an economic score of

'3'). It displays very large external imbalances (leading to an external score of '6'), large fiscal deficits and a very high debt burden (leading to a fiscal score of '6'), and little monetary flexibility but only modest inflationary risk (leading to a monetary score of '4'). Sovereign X is faced with a sharp rise in its funding costs and finds it difficult to refinance its debt at a sustainable cost. In this context, it benefits from a lower-cost loan from an international public institution that covers its refinancing needs over the next three years. Continuous access to this loan entails conditions, such as sovereign X committing to implementing a series of economic reforms and fiscal consolidation measures. The effect of this support program on sovereign A's rating could follow different scenarios: Scenario 1. We believe that this program improves the predictability and effectiveness of X's policy making. It positively affects its political score which is assessed at '3' based on table 3. At the same time, we estimate that A is likely to meet the conditions attached to the loan, which covers its refinancing needs over the next two to three years. As a result, its debt score is '5' based on table 7. External liquidity is unlikely to improve sufficiently to affect the external score of '6.' In this case, sovereign X's indicative rating level appears as 'bb' in table 2 (before any exceptional adjustment factor). Scenario 2. We believe that sovereign X's commitment to this program is not credible to the investors or the population, such that policy outcomes or access to funding becomes more uncertain. This is reflected in the political score of '4' based on table 3, while the debt score is '6' based on table 7. External liquidity is unlikely to improve sufficiently to affect the external score of '6'. In this case, X's indicative rating level appears as 'b' in table 2 (before any exceptional adjustment factor).

RELATED CRITERIA AND RESEARCH

Sovereign Government Ratings Methodology Addendum For Sovereigns With Limited External Data, Nov. 7, 2011 Sovereign Defaults and Rating Transition 2010 Update, Feb. 23, 2011 Principles Of Credit Ratings, Feb. 16, 2011 Rating Government-Related Entities: Methodology And Assumptions, Dec. 9, 2010 Bank Capital Methodology And Assumptions, Dec. 6, 2010 Request for Comment: Sovereign Government Rating Methodology and Assumptions, Nov. 26, 2010 Global Aging 2010: An Irreversible Truth, Oct. 7, 2010 Stand-Alone Credit Profiles: One Component Of A Rating, Oct. 1, 2010 The Time Dimension Of Standard & Poor's Credit Ratings, Sept. 22, 2010 Assessing The Impact Of Natural Disasters On Sovereign Credit Ratings, June 14, 2010 Request for Comment: Methodology For Determining Banking Industry Country Risk Assessments, May 13, 2010 Credit Stability Criteria, May 3, 2010 Understanding Standard & Poor's Rating Definitions, June 3, 2009 Rating Implications Of Exchange Offers And Similar Restructurings, May 12, 2009 Rating Sovereign-Guaranteed Debt, April 6, 2009 Sovereign Credit Ratings: A Primer, May 29, 2008 Introduction Of Sovereign Recovery Ratings, June 14, 2007 Sovereign Defaults at 26-Year Low, To Show Little Change in 2007, Sept. 18, 2006 Methodology: Banking Industry Country Risk Assessments, June 6, 2006 Sovereign Foreign And Local Currency Rating Differentials, Oct. 19, 2005

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. Primary Credit Analyst: Alexandra Dimitrijevic, Paris (33) 1-4420-6663; alexandra_dimitrijevic@standardandpoors.com David T Beers, London (44) 20-7176-7101; david_beers@standardandpoors.com John Chambers, CFA, New York (1) 212-438-7344; john_chambers@standardandpoors.com Moritz Kraemer, Frankfurt (49) 69-33-99-9249; moritz_kraemer@standardandpoors.com Criteria Officers: Alexandra Dimitrijevic, Paris (33) 1-4420-6663; alexandra_dimitrijevic@standardandpoors.com Colleen Woodell, New York (1) 212-438-2118; colleen_woodell@standardandpoors.com Additional Contacts: Marie Cavanaugh, New York (1) 212-438-7343; marie_cavanaugh@standardandpoors.com Olga Kalinina, CFA, New York (1) 212-438-7350; olga_kalinina@standardandpoors.com KimEng Tan, Singapore (65) 6239-6350; kimeng_tan@standardandpoors.com Christian Esters, CFA, Frankfurt (49) 69-33-999-242; christian_esters@standardandpoors.com Kai Stukenbrock, Frankfurt (49) 69-33-999-247; kai_stukenbrock@standardandpoors.com Frank Gill, London (44) 20-7176-7129;

Secondary Credit Analysts:

frank_gill@standardandpoors.com Ivan Morozov, London (44) 20-7176-7159; ivan_morozov@standardandpoors.com

ARCHIVE | Criteria | Corporates | Recovery: Recovery Analytics Update: Enhanced Recovery Scale And Issue Ratings Framework
Publication date: 30-May-2007 13:25:55 EST

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Table of Contents Recovery Rating DefinitionRecovery And Issue Rating ProcessJurisdiction-Specific Adjustments For Recovery And Issue RatingsRecovery Analytics For Investment-Grade IssuersImplications For Preferred Stock And Other Equity HybridsImplications For Collateralized Debt Obligations (CDOs)Standard & Poor's Ratings Services released

on May 30, 2007, the enhanced recovery rating scale and issue rating framework for speculative-grade recovery and issue ratings. These enhancements were previewed and commented on by the market, as discussed in our articles published on Oct. 4, 2006, "Request for Comment: Expanding Recovery Rating Coverage And Enhancing Issue Ratings"; Dec. 6, 2006, "Request for Comment: Introduction Of Sovereign Recovery Ratings", and April 10, 2007, "Recovery Analytics Update: Expanding Recovery Rating Coverage and Enhancing Issue Ratings." We expect to roll out revisions for speculative-grade industrial and financial service issuers with existing recovery ratings on secured debt instruments to the market on June 7. This part of the rollout covers rated secured debt on speculative-grade issuers in the U.S., Canada, Europe, Australia, and South Africa. As indicated in the earlier articles, the changed ratings we will announce are due to the recalibration, or rebasing, of our recovery scale and issue-level ratings based on recovery. We will follow on June 12 with the introduction of our recovery ratings on speculative-grade sovereign issuers, along with a sovereign criteria article. Therefore, the revised recovery rating scale will not take effect until the June revisions have been announced. We expect to introduce our recovery ratings for speculative-grade unsecured debt issues, for issuers in the jurisdictions listed above, in the fourth quarter of 2007. Other jurisdictions will be added by year-end 2007, continuing into 2008 as we complete relevant insolvency regime and restructuring practice research on a country-by-country basis. Our expanded recovery analytics initiative is in response to the market's broad acceptance of our 2,000plus recovery ratings on secured debt in effect today and the increasing focus on post-default recovery prospects. Our initiative also helps answer the demand for greater clarity and specificity with respect to recovery prospects on different debt instruments of all types of issuers globally.

The market is clearly interested in disaggregating the components of credit risk. By providing a default indicator (an issuer credit rating) and a recovery indicator (a recovery rating) and combining both to arrive at the issue rating, our intent is to enhance ratings transparency, provide market participants the opportunity to deconstruct the risks of default and loss as components of the rating, and facilitate prevailing valuation and risk management disciplines in use in the credit markets. As we noted in our earlier publications, the introduction of this new methodology represents a meaningful transition in the ratings product. The enhanced recovery and issue rating framework is shown below in table 1.
Table 1

Revised Recovery Ratings, Ranges, And Issue Ratings

Speculative-grade issuers

Recovery rating Description of recovery

Recovery range (%) Issue rating notches*

1+

Highest expectation, full recovery

100

+3

Very high recovery

90-100

+2

Substantial recovery

70-90

+1

Meaningful recovery

50-70

Average recovery

30-50

Modest recovery

10-30

-1

Negligible recovery

0-10

-2

*Indicates issue rating "notches" relative to Standard & Poor's issuer credit rating.

Recovery Rating Definition

Recovery ratings focus solely on expected recovery in the event of a payment default of a specific issue and use a numerical scale that runs from '1+' to '6'. The recovery rating is not linked to, or limited by, the

issuer credit rating or any other rating and provides a specific opinion about the expected recovery prospects. Standard & Poor's recovery rating analysis for non-sovereigns generally compares the nominal value expected to be received at the end of the workout period or bankruptcy to exposure at default, the latter defined as principal plus accrued and unpaid interest at the point of default. For sovereigns, political considerations and difficulties in obtaining and enforcing judgments create the possibility of protracted workout periods. Given the potential for significant accumulation of past-due interest in some sovereign defaults, and the prevalence of maturity extensions in sovereign workouts, we express the expected recovery rate for sovereign issuers in terms of net present value (NPV). The approach for sovereigns is equivalent to discounting both the remaining scheduled payments under the original debt instrument and the recovery given default at a post-restructuring discount rate. Standard & Poor's recovery ratings, although informed by historical data (including our proprietary LossStats? database for the U.S.) showing average recovery experience, are based on a fundamental issuer- and instrument-specific, scenario-based recovery analysis.

Recovery And Issue Rating Process

Once we have extended recovery rating coverage to a given sector and debt type, generally all new debt instruments issued by speculative-grade entities will be assigned recovery ratings as part of the assignment of their issue ratings. The analysis of these two elements--the likelihood of default, already incorporated in the issuer credit rating, and the expected recovery rate--are the integral components of the issue credit rating. We will, therefore, assign the issue rating based on the issuer credit rating as adjusted, if appropriate, per the recovery rating and the guidelines shown in table 1. This process will be applied for debt across the capital structure once the roll-out is complete, i.e., secured, unsecured, and subordinated debt will be rated based on the issuer credit rating and recovery rating. We will continue to place primary emphasis for the issue rating on the likelihood of default, and the instrument rating will be higher, lower, or equal to the issuer credit rating based on the specific issue's recovery expectations relative to the long-term average recovery rate for unsecured debt, rather than based on relative position in insolvency. We have "re-based" the issue rating around a central recovery tendency of approximately 50%. Therefore, issues with recovery rates significantly above 50% (i.e., with an expected recovery rate of 70% or above) will be rated higher than the issuer credit rating, and those significantly below 50% (expected recovery rate of 30% or below) will be rated below the issuer credit rating.

Recovery ratings will not be applied to securitizations, including corporate securitizations, or to covered bonds, all of which will continue to be rated based on asset-specific criteria.

Jurisdiction-Specific Adjustments For Recovery And Issue Ratings

The distinctive characteristics of particular jurisdictions' insolvency regimes have a significant effect on the amounts ultimately recovered by both secured and unsecured creditors, the time to recover such amounts, and the overall predictability of the process. In addition, for most jurisdictions outside the U.S., there is very little reliable historical default and recovery data available to verify in practice the predictability of insolvency proceedings and actual recovery rates. To consistently incorporate this legal analysis in our recovery and issue ratings consistently, we are reviewing all significant jurisdictions to assess how insolvency proceedings in practice affect post-default recovery prospects. We have reviewed 12 systems so far and expect to analyze and classify a total of about 40 before year-end. The general concept is to cap both the recovery and issue ratings in countries where we expect the recovery process and actual recovery rates to be negatively affected by weak insolvency regimes. Further guidance on our approach to classifying insolvency regimes and related recovery and issue rating guidelines will be included as part of the roll-out for industrial and financial service recovery ratings.

Recovery Analytics For Investment-Grade Issuers

For investment-grade issuers (those rated 'BBB-' or higher), it is more difficult to predict a path to default and, therefore, to perform a scenario-based, firm- and instrument-specific recovery analysis. We believe some markets have less interest in such analysis, given the lower likelihood of default. We expect to assign recovery ratings on selected investment-grade issuers with secured debt obligations, as we have for some time on utility first-mortgage bonds. Otherwise, we would assess instrument recovery based on class-level recovery assumptions and incorporate these in the issue rating. For example, subordinated debt of investment-grade issuers will generally continue to be rated one notch lower than the issuer credit rating. Very well-secured debt could be rated higher than the issuer credit rating. For example, firstmortgage bonds of investment-grade utilities can be rated up to two notches above the issuer credit rating.

Implications For Preferred Stock And Other Equity Hybrids

Once we have rolled out recovery ratings on unsecured and subordinated debt (expected by fourth quarter 2007), speculative-grade preferred stock and equity hybrids will be rated based on instrumentspecific recovery prospects. However, we expect few rating changes based on this shift. We expect most

such instruments of speculative-grade issuers to receive a recovery rating of '6' on the revised scale (0% to 10% recovery after a default), which implies being rated two notches below the issuer credit rating for purposes of reflecting ultimate recovery prospects, similar to the two-notch cut these instruments have historically received for subordination. Currently, we also reflect heightened payment risk represented by deferral features in rating equity hybrids. Therefore, in addition to adjusting the issue rating on equity hybrids to account for ultimate recovery prospects, we would also make further adjustments to reflect deferral features. Our current convention is to rate such instruments at least one additional notch lower to account for the deferral risk. For example, a preferred stock with a recovery rating of '6' would typically be rated three notches below the issuer credit rating: two notches for negligible ultimate recovery prospects, and one notch for the deferral feature. When we have heightened concerns that the issuer may defer--whether because of the exercise of its right to defer optionally, the breaching of a mandatory deferral trigger, or the exercise of the prerogatives of a regulator--we increase the gap between the issuer credit rating and the issue rating, and we do not impose any arbitrary limit on the size of the gap. (See "Criteria: Assigning Ratings To Hybrid Capital Issues," published March 28, 2006.)

Implications For Collateralized Debt Obligations (CDOs)

The enhancements described above do not have a significant effect on CDO analytical methodology or on CDO ratings. Under our current CDO methodology, we consider the default probability to be driven by the issuer rating for industrial, financial, and sovereign debt. The recovery expectations are asset-specific, based on the seniority and security of the asset. In an Oct. 17, 2006, article titled "CDO Spotlight: Using Standard & Poor's Recovery Ratings in Cash Flow CDOs," we highlighted that CDO managers have an option to incorporate our recovery ratings as the source of recovery estimates for CDO purposes. We expect to release a separate commentary updating guidelines on the use of recovery ratings in cash flow CDOs. Click here to see other articles discussing Standard & Poor's expanded recovery ratings scale and issuer ratings framework. Click on this link to go to the Special Report Archive. Primary Credit Analysts: Laura Feinland Katz, New York (1) 212-438-7893; laura_feinland_katz@standardandpoors.com William H Chew, New York (1) 212-438-7981;

bill_chew@standardandpoors.com Secondary Credit Analysts: Blaise Ganguin, Paris (33) 1-4420-6698; blaise_ganguin@standardandpoors.com David Gillmor, London (44) 20-7176-3673; david_gillmor@standardandpoors.com Christopher H Legge, Melbourne (61) 3-9631-2093; chris_legge@standardandpoors.com Additional Contact: Terry Chan, Melbourne (61) 3-9631-2174; terry_chan@standardandpoors.com

ARCHIVE | Criteria | Governments | Request for Comment: Enhanced Methodology For Rating Government-Related Entities And Assessing The Potential For Extraordinary Government Intervention
Publication date: 23-Jan-2009 10:54:55 EST

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Table of Contents Proposal Summary Ratings ImpactResponse DeadlineUpdated Methodology Where Extraordinary Government Support Is Viewed As Highly Likely And Is The Key Rating DriverWhere Extraordinary Government Support Is Viewed As Reasonably Likely And Is Not The Primary Rating DriverCases Of Private Systemically Important Enterprises That May Benefit From Extraordinary Government InterventionRelated Research(Editor's Note: This article has been superseded by

"Enhanced Methodology And Assumptions For Rating Government-Related Entities," published June 29, 2009.) Government-related entities (GREs) are enterprises potentially affected by government intervention during periods of stress. Most of the time, GREs are partially or totally controlled by a government and they contribute to implementing policies or delivering key services to the population. Standard & Poor's Ratings Services has, over the years, issued criteria for rating such entities and, in particular, for taking into account any support of the GRE from the relevant government. We have observed that the relationships between GREs and their respective governments have become ever more complex. Accordingly, Standard & Poor's is now requesting comment on the proposal described herein (Proposal). If implemented, the Proposal would (i) introduce a more granular approach in our GRE ratings to capture this increased complexity, (ii) update our approach as to how GRE ratings can be affected by the possibility of "extraordinary" government intervention during periods of stress, and (iii) apply this methodology to entities not traditionally considered GREs, where there is the potential for timely extraordinary government intervention. In the rest of this report, "rating" refers to the issuer credit rating if not otherwise qualified. The elements of the Proposal are found in "Updated Methodology," below.

This request for comment 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. The criteria discussed in this request for comment are based on "Principles Of Corporate And Government Ratings," published June 26, 2007, on RatingsDirect at www.ratingsdirect.com and Standard & Poor's Web site at www.standardandpoors.com. The Proposal, if implemented, would replace Standard & Poor's methodology for rating GREs addressed in "Rating Government-Related Entities: A Primer," published June 14, 2006, on RatingsDirect.

Proposal Summary
GREs are enterprises potentially affected by government intervention during periods of economic or financial stress. In most cases, the intervention is likely to be in the form of extraordinary governmental support and in such cases the GRE's rating would likely be enhanced by its relationship with the government. Conversely, a government intervention could operate to redirect GRE resources to the government and weaken the GRE's credit quality. We consider governments' interventions as "extraordinary" when they are point-in-time, entity-specific, and related to financial stress at the GRE level. GREs are generally in the public sector and controlled by a government (or governments) through majority ownership. However, we have observed that some companies with little or no government ownership might also benefit from extraordinary government support due to their systemic importance or their critical role as providers of crucial goods and services. This would appear more likely in countries whose governments tend to be interventionist. Standard & Poor's incorporates in its ratings its opinion of the likelihood of a government taking timely extraordinary measures that could affect the credit risk of the entity during periods of economic or financial stress. Standard & Poor's analysis takes into account a variety of political and economic factors in arriving at its view of the likelihood of government intervention, particularly where the stand-alone credit characteristics of the GRE change rapidly and the history of government intervention is mixed. We propose to maintain most of our current methodology, but to introduce certain clarifications designed to achieve a more granular analysis of the range of GREs across sectors and regions. We expect this approach should provide more transparency in our rating approach. The most significant changes proposed are:

Placing less emphasis on the "binary" categorization of GREs as either "public policy" or "commercial" entities in favor of an approach whereby our assessment of the potential for extraordinary government intervention is based on (i) the importance of the GRE's role, and (ii) the strength and durability of its link with the government.

Providing more specific guidance as to how to arrive at the GRE's rating from the stand-alone credit profile and the government's rating, and further emphasizing the importance of the GRE's stand-alone credit profile and its evolution.

Using the foregoing approach to assess the potential for extraordinary government intervention for entities that have not traditionally been considered GREs (because they are privately owned and have no public mission), but that might, because of their systemic importance, receive timely extraordinary government support.

In addition to the merits of the Proposal, we request comment on the following questions: Do you believe that the stand-alone credit profile of a GRE and our analysis of each component of our rating approach should be communicated to the market in most circumstances? What reservations do you have with such communication? Do you agree with the proposed notching guidelines discussed in "Updated Methodology" below? Do you agree they result in a more transparent rating approach? What reservations have you with the proposed notching guidelines? Do you agree that Standard & Poor's should view a GRE as any entity for which government support is highly likely during periods of economic or financial stress, regardless of its ownership? What reservations do you have with such approach?

Ratings Impact
Standard & Poor's does not expect the Proposal, if implemented, to significantly affect current ratings although minor changes may result.

Response Deadline

We encourage market participants to submit comments on the Proposal and the above questions by Feb. 27, 2009, to CriteriaComments@standardandpoors.com. Interested parties may also directly contact any of the individuals listed as authors of this article.

Updated Methodology
Below is an extract of the proposed updated methodology for rating GREs and assessing the potential for extraordinary government intervention in respect of systemically important private-sector enterprises comparable with that received by a government-controlled GRE. Rating basics 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 quality and the government's rating. The stand-alone credit profile represents the GRE's credit quality in the absence of extraordinary support or burden and the government's rating speaks to the government's ability and willingness to support (or, in a negative scenario, its need to avail itself of the resources of) the GRE. The placement of the rating between these two inclusive bounds indicates our opinion of the likelihood of sufficient and timely government intervention in support of the GRE's meeting its financial obligations. Definition of stand-alone credit profile An entity's stand-alone credit profile reflects Standard & Poor's opinion of an entity's creditworthiness, before taking into account the potential for extraordinary government intervention. Regular "ongoing interactions" with the government are generally incorporated in an issuer's stand-alone credit profile, along with related day-to-day benefits or burdens and/or system-wide regulatory frameworks. "Ongoing interaction" may include, for example, recurrent operating or capital subsidies, access to preferential funding, monopoly powers, favorable government contracts, and sympathetic regulatory regimes, but also price ceilings, risky project mandates, and directives to provide loss-making goods and services. On the financial side, stand-alone credit profile encompasses dividend policies, equity issuance flexibility, the tax regime, and existing guarantees or lines of credit. For financial institutions, "ongoing interaction" includes system-wide features designed to support access to liquidity and support market confidence, such as the provision of liquidity lines, a "discount window," securities repurchase, and other similar facilities made available by the central bank or the government to all financial institutions in a given banking system. Definition of extraordinary government intervention

We view extraordinary government intervention as intervention which is point-in-time (as opposed to ongoing), entity-specific (as opposed to system-wide) and often related to financial stress at the GRE level. Potential for extraordinary government intervention comes on top of the "ongoing" interactions described above and is not included in a GRE's stand-alone credit profile. It may result in an enhancement of a GRE's rating if it is in the form of support, or, more rarely, it may weaken a GRE's credit quality if government intervention could operate to redirect a GRE's resources to the government. General framework for assessing the likelihood of extraordinary government support Standard & Poor's evaluates the relationships between GREs and governments, while recognizing that they are sometimes unclear and that extraordinary government intervention is not always predictable. As a general rule, we believe that the higher the likelihood of sufficient and timely extraordinary intervention, the closer the GRE's rating is likely to be to the government's rating. The lower the likelihood of intervention, the closer the GRE's rating is likely to be to the GRE's stand-alone credit profile. Standard & Poor's views on the likelihood of extraordinary government support affecting the credit rating of a GRE are summarized below.

Relationship Between The Likelihood Of Extraordinary Government Support And A GRE's Credit Rating

Likelihood Of Extraordinary Support

Rating approach

Extremely high

Equalize

Very high

Government -1 or -2 *

High

Stand-alone + 3*

Moderately high

Stand-alone + 2

Moderate

Stand-alone + 1

Low

Stand-alone

*Although a majority of our GRE ratings fall in the above framework, the criteria allows for notching down from the government's rating by three notches or more and notching up from the stand-alone credit profile by four notches or more, under certain circumstances described below.

Guidelines for assessing the likelihood of extraordinary government support However, to provide more specific guidelines, Standard & Poor's has developed an approach focused on two parameters (which are not necessarily equally weighted): 1. Importance of GRE's role. Standard & Poor's analyzes the potential importance of the GRE to the government, either because the GRE implements a key national policy, provides an important public service, or because it affects the proper functioning of an important economic sector. The importance of a GRE can be estimated by evaluating the consequences should the GRE interrupt its operations or fail to pay its obligations. Standard & Poor's distinguishes four different levels when assessing the importance of the GRE to the government: critical, very important, important, and limited importance. 2. Strength and durability of links between the GRE and the government. An analysis of the strength and the durability of the links between the GRE and the government can be estimated by the degree to which the government drives the GRE's strategy and its operations and by its level of supervision. Analytical considerations include ownership of the GRE and/or other factors including a government guarantee of the GRE's obligations or reputational risk to the government should the GRE default. 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. Though not prescriptive, the matrix below suggests how a rating approach can be derived from the combination of these two factors. As explained below, the GRE's rating can be influenced by other considerations. Of course, the parameters can evolve as the GRE's role and its links to the government also evolve.

As we observe more instances of GREs being bailed-out (or not), we will likely modify the matrix to reflect such instances. The "two parameter" approach is flexible; factors that could cause Standard & Poor's to modify the application of the parameters include the propensity of the government to intervene, the circumstances giving rise to the GRE's situation, and the relative distance between the GRE's stand-alone credit profile and the government's rating. The government's propensity to intervene. We analyze the government's policy and track record of past interventions, its degree of involvement in the day-to-day operations of its GREs, its administrative capacity to provide timely support, but also the spectrum of activities covered by the GRE sector as well as the potential constraints that might arise from a regulatory framework such as the EU competition laws. In respect of governments with what we view as a high propensity to intervene, a GRE's rating could reflect a stronger likelihood of government support than outlined in the above matrix. Conversely, for governments with what we view as a low propensity to support, we may view the likelihood of extraordinary government intervention as being weaker than suggested in the matrix. If we doubt the willingness and/or capacity of the government to provide timely support either for policy reasons or because of weak administrative capacity we would likely align the GRE's rating more closely to its standalone credit profile, even if it has a critical role. The circumstances in which a GRE comes under stress. Standard & Poor's has observed that governments might have a different reaction to the distress of a particular GRE depending on the circumstances of and reasons for the distress, and the consequences of the GRE's default. For instance,

in periods of fragile market confidence, the failure of a relatively small bank may have systemic repercussions. Such repercussions could prompt the government to provide extraordinary support-despite the entity's limited importance. In our view, a different result might attain were the entity's troubles to occur in a more benign environment with the consequences of non-intervention less severe. The relative distance between a GRE's stand-alone credit profile and the government's rating. For a GRE having a stand-alone credit profile close to the government's rating, extraordinary government support appears generally less likely than would be the case for a GRE that has a weaker stand-alone credit profile and that may require future intervention. The weight we give for rating purposes to the distance between a GRE's stand-alone credit profile and the government's rating will likely rest on our opinion of the likelihood of extraordinary government intervention. Examples are given in the sections below. Standard & Poor's analysis of GREs is, as suggested by the foregoing, highly qualitative as opposed to being primarily based on a scoring approach. As noted previously, the GRE's rating might occasionally be affected by considerations not encapsulated by the matrix.

Where Extraordinary Government Support Is Viewed As Highly Likely And Is The Key Rating Driver
For GREs most closely tied to the government, 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 of the GRE tends to be close to, and move in tandem with, that of the government. GREs viewed as closely tied to the government include those whom the government asserts that it will support in all circumstances with such assertion being underpinned by a pattern of support. Other factors establishing linkage are, in our view, the critical or very important role of the GRE to the government, and a strong link to the government with no near-term privatization plans. We observe that most GREs in this category have full or strong and stable government ownership or have a special public status. Cases of equalization The proximity of the GRE's rating to the government rating (or their equalization) is a function of the above factors. Generally, Standard & Poor's would likely equalize the rating of a GRE with that of the government only in cases when we view the entity's role as critical for the government (critical role in the implementation of a key social or economic national policy, or in the provision of an important public service that could not be readily undertaken by a private entity) and when it is, in our view, closely integrated with the government. Both the GRE's role and its link with the government are considered from

a future rather than a historical perspective. The ratings of certain government-owned development agencies, export credit institutions, strategic petroleum reserves, national health care or social security funding agencies, national housing agencies, some owners of key national infrastructure (e.g. rail), government treasury corporations or funding authorities have been equalized with their respective governments. Cases of notching down by one or two notches In general, we might rate a GRE one or two notches lower than the government's rating to indicate our opinion of the importance of the GRE's role (e.g. increasing competitive activities, gradual reduction of the public policy mandate, political debates on the entity's role going forward, activity operated by the private sector in other countries) or of the durability of the GRE's link with the government (e.g. privatization considered in the medium to long term, external regulatory constraints on the government's ability to provide support, government's willingness to gradually promote more independent management). The ratings of certain local public transportation authorities, government-owned providers of essential utility services (water, power grids), providers of important public infrastructure (prisons, social housing, schools), and financial institutions with a public mission illustrate this approach. Cases of notching down by three notches or more We might notch down a GRE's rating by three or more notches from the government's rating if we perceive a transition toward a different operating model, such as privatization. This could result from circumstances where we would balance the medium-term prospects of a privatization and the fact that the transition period before the removal of government support is expected to give time for a material strengthening of the stand-alone credit profile of the GRE. A wider rating differential may also reflect cases where the government has a poor track record of supporting the GRE's sector, or cases where a sharp deterioration in the GRE's stand-alone credit profile could signal lower-than-expected government support. There are no typical examples for these sorts of case as they tend to be infrequent and reflect transitory situations. In cases where the likelihood of timely extraordinary government support is, in our view, extremely or very high, the GRE stand-alone credit profile may not be the primary driver in the determination of the GRE rating, but we may take nevertheless an approximate view on such stand-alone credit profile to identify the possible timing and extent of support. An appreciable deterioration could signal, in our view, diminishing government support which we may decide to reflect in a lower GRE rating. Furthermore, the GRE's stand-alone credit profile may help us gauge the government's contingent liability.

Where Extraordinary Government Support Is Viewed As Reasonably Likely And Is Not The Primary Rating Driver

For entities we view as benefiting from supportive government policies, possibly direct assistance, and potentially extraordinary government intervention, but where the likelihood of the latter is lower, GRE ratings may more closely be aligned with the GRE's stand-alone credit profile. As indicated above, the stand-alone credit profile does include the effect of ongoing government support or burdens imposed. We view this category as including government-owned companies operating essentially as profit-seeking enterprises in a competitive environment possibly affected by an extraordinary government intervention either because of their special link to the government or because of their systemic importance. This approach also applies to certain systemically important private entities under exceptional periods of individual stress as explained in the section below. Generally, Standard & Poor's determines the number of notches added to the stand-alone credit profile (usually one to three notches, occasionally more) based on a combination of the importance of the GRE's role and/or the strength of its link to the government. Cases of notching up by two or more notches In our view, a GRE operating in a competitive environment might be rated two or more notches above its stand-alone credit profile if it benefits from strong links with the government and if it serves a secondary public policy role that might prompt government intervention in case of need. Another trigger for government intervention might be a GRE's strategic role due to its monopoly position or its delivery of crucial goods or services to the population. We have observed that a GRE often has strong links with a government when the latter has a stable majority ownership and is involved in directing and/or approving the GRE's strategic and business plans. In our opinion, the existence of a partial payment guarantee or strong political involvement could imply a tighter link to the government that is "publicly associated" with the GRE and therefore a greater incentive to support. Examples of this are a number of government-owned systemically important commercial banks, postal services, national oil or energy producers, rail services, and electricity distributors. Cases of notching up by one notch We have observed that some privately owned entities, or entities with small or changing government ownership, might benefit from a moderate likelihood of extraordinary government intervention because of their strategic or systemic importance. We have observed that this is particularly the case for entities located in interventionist countries where governments are most likely to extend support to enterprises operating in the commercial sector. In such cases, we may consider it appropriate to rate a GRE one

notch above its stand-alone credit profile. In our opinion, this would also be the case for GREs with large and stable government ownership, but whose activity could easily be undertaken by other market participants. Examples include certain important private-sector commercial banks or utilities in interventionist countries, some government-owned real estate development entities, and local housing companies. Cases where the GRE's rating is aligned with its stand-alone credit profile We consider that a GRE's rating would be closely aligned with its stand-alone credit profile generally if its importance for the government is limited and if the two entities are not closely linked. For instance, we may rate the GRE the same as its stand-alone credit profile in cases where the government acts mostly as a regulator and its interventions have the primary objective of enhancing (or in some cases protecting) the functioning of the relevant industry segment (regardless of ownership). We may also rate the GRE the same as its stand-alone credit profile in the case of a GRE that performs an activity that could be easily undertaken by other market participants and is usually operated by the private sector in other countries. Examples include certain entities with a minority ownership by the government and operating in competitive sectors especially in countries where government interventions are subject to restrictive national or international regulation (e.g. EU competition laws), such as airports, telecom companies, and some gas and electricity utilities. Impact on notching of the distance between the GRE's stand-alone credit profile and the government's ratings When, in our view, the likelihood of government extraordinary support is moderate, the distance between a GRE's stand-alone credit profile and the government's rating may, in some cases, result in a greater notching up. Thus, if a GRE with a stand-alone credit profile of 'B' is domiciled in a country with a 'BB' sovereign foreign currency rating and a similar GRE is domiciled in a 'AAA' sovereign, there may be reasons (likely related to the sovereign's ability to provide timely support) to rate the GRE in the 'AAA' sovereign marginally higher even if the links to the respective governments and importance of the respective roles are similar. By contrast, if a GRE has a stand-alone credit profile of 'AA' and the relevant sovereign has a 'AAA' rating, the probability in our view, that the government will need to provide the GRE with extraordinary support is less likely than would be the case for a GRE with a weaker ('B') stand-alone profile. Accordingly, the likelihood of extraordinary government support could be reflected by additional notches of uplift in the case of the weaker GRE.

Exceptional cases where a notching approach would not apply The notching approach described above applies in most situations. However, Standard & Poor's may diverge from these guidelines if we believe that it would enable us to better reflect a GRE's overall creditworthiness. We believe this could occur mostly in two circumstances: when the stand-alone credit profile of the GRE is distant from the government's rating in cases where there is at least a moderate degree of likelihood of support, and in cases where there is a rapid deterioration of the GRE's stand-alone credit profile. Cases of large ratings difference and high or moderately high likelihood of support. We have observed circumstances where the GRE's stand-alone credit profile is several rating categories below the government's rating (e.g. a 'B' stand-alone with a 'AA' government), and, at the same time, we believe that the likelihood of extraordinary government support is high but insufficient to tie the GRE's ratings to that of the government. In these situations, we may believe that the GRE's creditworthiness would be best reflected by a low investment-grade or high speculative-grade rating, depending on our overall assessment on the potential for future government support. In the same situation (e.g. a 'B' stand-alone with a 'AA' government), what would appear to be a very high likelihood of government support could lead us to rate the entity one or two notches below the government's rating, while a moderate likelihood of support could lead us to rate the GRE one or two notches above its stand-alone credit profile. Cases of a sharp fall in a GRE's stand-alone credit profile. We have observed situations where a sharp deterioration in an entity's stand-alone credit profile (e.g. in confidence-sensitive industries) may happen so precipitously that the government has not had time to provide the necessary support. In these situations, we view that it may be illusory to try to determine the fluctuations in the GRE's stand-alone profile in such a brief period; more important to the determination of the GRE's rating is our opinion on the likelihood of sufficient and timely extraordinary government intervention, overriding the outcome indicated in the above matrix. The 2007-2008 liquidity crisis provides a number of examples of financial institutions whose stand-alone credit profile deteriorated rapidly despite the system-wide measures the authorities introduced to stabilize the banking system. In such cases, downgrades were limited by our expectation of extraordinary government support that we factored into the rating on the basis of evidence of the government's willingness to intervene under the current circumstances. One such example was a midsize bank in the U.K. (Northern Rock), whose rating was maintained at 'A-/A-1', despite its stand-alone credit profile falling into the speculative-grade category as a result of severe liquidity stress. Northern Rock's rating reflected increasing likelihood that the U.K. authorities would provide the necessary extraordinary support given the

implications that "non-intervention" would have had for the U.K. banking system in a difficult market environment.

Cases Of Private Systemically Important Enterprises That May Benefit From Extraordinary Government Intervention
Experience suggests that some private-sector enterprises might benefit from extraordinary government intervention because of their systemic importance in cases where the government may be willing and able to provide direct support to the failing enterprise. Most of the observed cases have been for systemically important financial institutions, but the principle could apply to large insurance companies or important employers, for instance, the automobile industry. Compared with government-owned GREs, we consider that the potential for extraordinary government support to these private-sector entities is less certain and highly dependent on the circumstances under which the entity's financial distress occurs. As these entities often appear not to have an established privileged link with the government and don't have a public mission (as traditionally viewed, at least), the government's willingness to support them is, in our view, more dependent on a series of factors such as the reasons why the entity went into distress, the political situation of the government at the time of stress, and the possible contagion effect in case of non-intervention. Furthermore, we have observed in several instances that certain governments tend to favor a market answer when a private enterprise is in difficulties and that their support may occur at the last moment, be limited in time, and be associated with conditions of structural changes at the company level. Finally, the case of the loan package by the U.S. government to the U.S. automakers appears to illustrate that government support might not necessarily reduce the likelihood of default for the company as the government might be more focused on protecting employment than investors. As a result of this unpredictability, we do not usually factor into the rating of systemically important private-sector companies the potential for extraordinary government support by a specific uplift at all times. In particular, when a private-sector company has a very strong credit profile (at the higher end of the investment-grade category), we consider that the likelihood of extraordinary government support is less material to its overall credit profile. Instead, as an entity's financial profile starts deteriorating and as we get a clearer factual picture of the government's attitude and willingness to support, we will take a view of the potential for extraordinary government intervention. Ratings, accordingly, may incorporate additional support as the stand-alone credit profile deteriorates. Where this happens, the GRE rating may remain in appropriate cases at low

investment grade or high speculative grade, depending on the strength of the above mentioned factors and the level of the government's rating. For example, since September 2007 the support provided by governments in the U.K., Belgium, The Netherlands, Germany, and the U.S., which in some cases resulted in partial or full nationalization, prevented an abrupt rating deterioration for issuers such as Northern Rock, Bradford & Bingley, RBS, Fortis Bank Nederland, Dexia, and AIG. Similar support was also provided to numerous unrated entities in other countries, such as Austria, Portugal, and Denmark.

Related Research
"How Systemic Importance Plays A Significant Role In Bank Ratings," published July 3, 2007. "External Support Key In Rating Private Sector Banks Worldwide," published Feb. 27, 2007. "Principles Of Corporate And Government Ratings," published June 26, 2007. "Rating Government-Related Entities: A Primer," published June 14, 2006. The above articles are available to subscribers of RatingsDirect, the real-time Web-based source for Standard & Poor's credit ratings, research, and risk analysis, at www.ratingsdirect.com. These criteria represent the specific application of fundamental principles that define credit risk and ratings opinions. Their use is determined by the issuer-specific or issue-specific facts, as well as Standard & Poor's assessment of the credit and, if applicable, structural risks for a given issuer or issue rating. Methodology and assumptions change from time to time as a result of market and economic conditions, issue-specific or issuer-specific factors, or new empirical evidence that would affect our credit judgment. Primary Credit Analyst: Alexandra Dimitrijevic, Paris (33) 1-4420-6663; alexandra_dimitrijevic@standardandpoors.com Emmanuel Dubois-Pelerin, Paris (33) 1-4420-6673; emmanuel_dubois-pelerin@standardandpoors.com Arnaud De Toytot, Paris (33) 1-4420-6692; arnaud_detoytot@standardandpoors.com

Secondary Credit Analysts:

Laura Feinland Katz, New York (1) 212-438-7893; laura_feinland_katz@standardandpoors.com Additional Contacts: Marie Cavanaugh, New York (1) 212-438-7343; marie_cavanaugh@standardandpoors.com Terry Chan, Melbourne (61) 3-9631-2174; terry_chan@standardandpoors.com Agnes De Petigny, Paris (33) 1-4420-6670; agnes_depetigny@standardandpoors.com Rob Jones, London (44) 20-7176-7041; rob_jones@standardandpoors.com Moritz Kraemer, Frankfurt (49) 69-33-99-9249; moritz_kraemer@standardandpoors.com Curtis Moulton, New York (1) 212-438-2064; curt_moulton@standardandpoors.com Elena Okorotchenko, Singapore (65) 6239-6375; elena_okorotchenko@standardandpoors.com Greg Pau, Toronto (1) 416-507-2518; greg_pau@standardandpoors.com Robert E Richards, Frankfurt (49) 69-33-999-200; rob_richards@standardandpoors.com Victoria Wagner, New York (1) 212-438-7406; victoria_wagner@standardandpoors.com Colleen Woodell, New York (1) 212-438-2118; colleen_woodell@standardandpoors.com Takamasa Yamaoka, Tokyo (81) 3-4550-8719; takamasa_yamaoka@standardandpoors.com

ARCHIVE | General Criteria: Rating Government-Related Entities: A Primer

Publication date: 14-Jun-2006 09:29:25 EST

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Table of Contents Criteria Evolution And OverviewStand-Alone Ratings Incorporate Ongoing Government InfluenceExtraordinary Government Influence Could Enhance Or Impair A Rating On A GREDistinguishing Between Public-Policy-Based And Commercial GREsGovernment GuaranteesRating A GRE Above The Rating On Its GovernmentForeign Currency ConsiderationsSummary(Editor's Note: This article has been

superseded by "Enhanced Methodology And Assumptions For Rating Government-Related Entities," published on June 29, 2009.) Government-related entities (GREs) are enterprises potentially affected by extraordinary government intervention in an economic or financial stress scenario. In most cases, the intervention is in the form of support, and the GRE rating is enhanced by the government relationship. Conversely, government intervention could redirect GRE resources to the government and weaken GRE credit quality. Most GREs are in the public sector and controlled by a government (or governments) through majority ownership. However, some GREs have little or no government ownership and are GREs because of their monopoly positions or their roles as systemically important financial institutions, as providers of other crucial goods and services, or as critical employers. A government's actions affect all entities domiciled in its jurisdiction, in some cases directly by methods such as regulation and licensing and in other cases more broadly through the impact of fiscal, monetary, and other economic policies. Sovereign and country risks play a role in most ratings because of the power of governments to shape the operational and financial environments in which corporations, financial institutions, and other entities operate. The impact of sovereign and country risk is an important part of the criteria Standard & Poor's Ratings Services uses to rate all issuers as well as specific obligations. In addition, supranationals are affected by government policiesbut in a fundamentally different manner that involves several or many sovereigns. The subject of this criteria piece is the narrower set of institutions that are either in the public sector (of one country) or in the private sector but could be affected by special government influence in a stress scenario, usually because of their economic importance.

This criteria article replaces "Revised Rating Methodology for Government-Supported Entities," which was published on RatingsDirect on June 5, 2001. The main differences include: The three categories of GREs have been combined into two: publicpolicy-based institutions and commercial (or potentially commercial) institutions. The notching guidelines have been relaxed so there is greater scope for the rating on the GRE to be further from the stand-alone or government rating, though it continues to be bounded by these two ratings. Specific consideration of systemically important private-sector financial institutions in interventionist countries is included. A new section has been added on rating GREs above the related government and above the sovereign. Foreign currency considerations are explicitly addressed.

No rating changes are anticipated as a result of this criteria update.

Criteria Evolution And Overview

Governments rely on market mechanisms more often now than they did in the past. In numerous countries, privatization is on the agenda, but even where it is not, many policymakers are showing a growing tendency to expose government-owned institutions to market discipline. At the same time, in some instances, important private-sector institutions that face operational and financial difficulties continue to benefit from various forms of extraordinary government support. Standard & Poor's methodology for rating GREs has evolved in line with these trends. Whereas 25 years ago, ratings on public-sector enterprises were most often aligned with the ratings on their ownergovernments, Standard & Poor's analytical approach increasingly focuses on the stand-alone credit quality of the GRE and determining the durability of the entity's links with the government. The advantage of this approach is that it is analytically rigorous, forcing consideration not only of the operational and financial aspects of the entity but also the evolution of the relationship with the government. If government support for an entity wanes, signs of government ambiguity emerge, or the government's ability to support diminishes, the rating may be adjusted to rest more heavily on the institution's own debt-servicing capabilities. If the government adopts a privatization program or a more active competition policy (such as recommended by the European Union; EU), a similar adjustment will occur, taking into account the specifics of the affected institutions. Therefore, abrupt changes in ratings are minimized.

Standard & Poor's analysis of the likelihood of extraordinary government influence begins by classifying the GRE on the basis of its public-policy role and integration into the government's operations and finances. All GREs are rated on the basis of a combination of stand-alone credit quality, which includes all ongoing government support, and the likelihood of extraordinary support. For institutions most closely tied to the government, the significant probability that the government will extend timely extraordinary support in a stress scenario tends to be the crucial factor, and the rating on the entity is linked to that on the government. A rating on a closely tied institution generally differs from that on the government by no more than two rating categories. Conversely, all private-sector GREsas well as public-sector GREs that benefit from supportive government policies and possibly direct assistance but are capable of functioning in a commercial environmenthave ratings more closely aligned with their stand-alone credit quality. As with more closely tied institutions, the stand-alone rating includes ongoing government support. The potential for extraordinary assistance in a stress scenario might enhance the rating on such an institution, usually by no more than one or two rating categories. Among the private-sector GREs in this category are systemically important financial institutions in countries where the likelihood of the government providing direct support to a failing institution or facilitating a merger with a stronger institution boosts credit quality. In the case of healthy private-sector banks with no special role in the national economy, the rating enhancement usually does not exceed one notch.

Stand-Alone Ratings Incorporate Ongoing Government Influence

The first analytical step is the determination of the GRE's stand-alone credit quality. A stand-alone rating reflects the GRE's strategies, performance, and prospects, including whatever government support or intervention the GRE typically receives in the normal course of business. However, it excludes credit for any extraordinary government assistance or influence that might be expected in the event of a crisis. This exercise is done in accordance with the criteria Standard & Poor's has established for the specific type of institution or project being analyzed. The financial institution, utility, oil company, housing project, or other criteria employed are the same as the criteria used for a similar private-sector institution that does not benefit from the potential for extraordinary government support or intervention. Because the stand-alone rating includes any long-standing government involvement in the GRE's operations or finances as well as consideration of how government influence is evolving, the term "standalone" has, at times, caused some confusion. The stand-alone rating focuses on the status-quo environment, including material government influence. Crucially, it is forward-looking in including potential changes in that environment.

Ongoing government influence included in a stand-alone credit rating embraces, in addition to subsidies and capital injections, access to preferential funding, a monopoly position, favorable contracts, and sympathetic regulatory regimes. These are difficult-to-measure forms of support that enhance both operational and financial performance. On the negative side, price ceilings, risky investment-project mandates, and directives to provide loss-generating goods and services constitute forms of government intervention that adversely affect operational and financial performance. The stand-alone rating provides the clearest view of the contingent liability the GRE poses for the government, aside from economic efficiency considerations. The stand-alone rating identifies the downside, or credit cliff, for the GRE if the potential for extraordinary government support were to dissipate. A key assumption made in determining the stand-alone rating is that the government will not specifically intervene to maintain the solvency or liquidity of the GRE; in other words, the government will not bail out the enterprise in a crisis. Particularly where privatization or reduced government involvement is on the agenda, Standard & Poor's makes assumptions as to what changes in the entity's capital structure and business focus are likely to occur. This results in a stand-alone rating that is forward-looking and necessarily subjective but that is nonetheless useful in managing the issuer's rating transition to a possible eventual privatization. The analytical process also includes comparisons with similar institutions, both locally and globally.

Extraordinary Government Influence Could Enhance Or Impair A Rating On A GRE

The stand-alone rating on the GRE and the rating on the government form the inclusive bounds between which the rating on the GRE lies. Following the determination of the stand-alone rating, consideration is given to extraordinary government influence. Although in most cases, the likelihood of government support enhances the GRE rating, in some cases, government intervention is a negative, potentially draining resources and keeping financial flexibility below what it would be on a stand-alone basis. In assessing the credit implications of government ownership or the government relationship, Standard & Poor's generally classifies GREs in one of two broad categories: Public-policy-based institutions, which play a central role in meeting political and economic objectives and have credit standings more closely associated with those of their governments. Commercial (or potentially commercial) enterprises, which play a lesser or no public policy role and have credit standings more closely connected to the stand-alone ratings on the GREs.

The purpose of this categorization is to clarify Standard & Poor's thinking about the relationship between the government and the entity concerned. It recognizes a range of relationships that imply varying degrees of government intervention, with different degrees of certainty. Standard & Poor's task is to evaluate the potential government influence and factor it into the rating on the GRE in a coherent and consistent manner. The strongest form of government influence usually implies alignment of the ratings on the GRE and the government. In most cases, this will mean that the rating on the entity exceeds the stand-alone rating, but for some well-capitalized and well-run institutions, the rating could be below the stand-alone rating. In the latter case, the GRE rating could be seen as being constrained by the government, but of course the relatively strong operational and financial characteristics are themselves the result of government decisions, at least if the GRE is in the public sector. For policy-based institutions, depending on conclusions about the government's willingness and ability to provide timely support (or take resources), the rating tends to be within two rating categories of the government rating. For more commercial GREs benefiting from a supportive government, the issuer rating would generally be within one or two rating categories of the stand-alone rating on the entity. In the case of healthy private-sector bank GREs with no special role in the national economy, the enhancement over the stand-alone rating usually does not exceed one notch. However, in a situation where the standalone rating on the GRE and the rating on the government are far apart or where one of these ratings or the relationship between the GRE and the government is changing, the GRE rating could vary by more than these guidelines.

Distinguishing Between Public-Policy-Based And Commercial GREs

Distinguishing between public-policy-based and more commercially oriented entities can be quite difficult. Most GREs benefit from supportive government policies and potentially benefit from extraordinary assistance, so they in fact lie on a continuum between these two categorizations. Given the growing tendency of governments to privatize and pursue market-oriented policies, Standard & Poor's tends to put entities on the policy/commercial dividing line in the commercial category. For public-policy-based institutions, government influence tends to be a matter of both policy and law, with the latter expressed, in part, through timely or ultimate guarantees (see section below for discussion of guarantees). Commercially oriented entities generally do not benefit from any guarantee and may be in the private sector. Extraordinary government support is possible but less likely than for policy-based institutions. However, government interest and influence might affect the business risks faced by commercial GREs. Public-policy-based GREs

Even when government control is assessed as very strong, support is often less than totally certain, and a rating differential between the government and the GRE might be appropriate. Extraordinary government support is not simply a matter of a positive attitude and supportive disposition. Standard & Poor's must be convinced that the government could and would intervene to avoid default by the enterprise. The degree of likely support could be constrained by the number of GREs and the government's limited capacity to provide support. The degree of notching that is appropriate to consider in individual cases will reflect the stand-alone assessment of the GRE (which, in and of itself, might be indicative of government support), the rating on the government, and Standard & Poor's assessment of the robustness of government support. Rating distinctions of up to two categories are most common. A rating distinction within a single category of that on the government is generally appropriate when the enterprise benefits from an ultimate (non-timely) guarantee, the government is rated in the 'AA' or 'AAA' categories, the government's relationship with the entity is regarded as stable, the GRE has moderately strong stand-alone creditworthiness, or the number of GREs is relatively small. A larger rating distinction addresses situations where there is no statutory guarantee, there are many government-related entities with ambiguous or diminishing public policy roles (which, in aggregate, pose a significant contingent financial risk to the government), or the risk of privatization of the rated entity is deemed to be rising. Among the specific issues Standard & Poor's considers in assessing the degree of notching for potential extraordinary government influence (within the bounds set by the stand-alone rating on the GRE and the rating on the government) are the following: The government's track record of extraordinary support for GREs. If untested, what are the government's policies on support, does it have the means, and what mechanisms are in place for diagnosing and responding to financial distress in a timely fashion? The government's track record of burdening GREs with higher taxes and dividends or other means to boost government resources during a period of increasing political or economic stress. The specific GRE's economic and political importance as well as its ranking in terms of order of importance to the government versus other GREs and its public policy role compared with similar entities in other jurisdictions. The essentiality of the service the specific GRE provides and the likelihood of other (particularly private sector) entities providing the same products or services.

The likelihood of access to the debt markets by the government or related entities being compromised in the event of a particular GRE defaulting as well as the importance of continued, unimpeded access to debt markets for the government. The government's policy and track record regarding privatization, including the government's history of assuming liabilities or re-capitalizing companies upon privatization. These issues are not always clear-cut and will be weighed within the context of the direction of government policy and the underlying credit strength of the enterprise itself in reaching a final rating conclusion. For some emerging-market governments, support could be more questionable when the legal system and governance is weak and when there are a number of entities relying on such support. In these instances, the GRE rating might be driven more by the inherent credit attributes of the GRE itself. When the government plays a large role in the economy, its support could be diluted, and the ratings on GREs can rest largely on their stand-alone credit quality, whereby the same GRE in a leaner public sector might benefit from more support. Notwithstanding the current government policy, the ultimate rating decision takes into consideration the time horizon of privatization risk, the likelihood of a reversal in current policy, and the stand-alone rating. Within Europe, the impact of EU competition policy on state ownership and support is a factor that might pressure governments to change policy and pursue privatizationor to at least limit government support. When is a GRE rating aligned with that on the government? The rating on a GRE is generally aligned with that on the owner-government when the entity is a government ministry or when the entity either is the source of substantial budgetary revenue, has a constitutionally or legally mandated place in the machinery of government that is difficult to change, and engages in activities that cannot readily be undertaken on a commercial basis. Alignment does not result solely from the entity's policy role or importance but rather from its place in the processes of government. Among the entities in this category are deposit insurance agencies, strategic petroleum reserves, and a number of development banks and export credit institutions. In some cases, the potential for government intervention limits the rating. A government-owned oil company, for example, might have higher standalone credit quality than the final rating indicates because the final rating includes the government's tendency to increase taxes and dividends, to require the GRE to provide subsidies, or to restrict the GRE's flexibility in some other way in a period of fiscal or external stress. Commercial GREs

Commercial GREs include an array of government-owned enterprises with lesser or no defined public policy mission as well as private-sector institutions that could be affected by extraordinary government influence. Among private-sector GREs are systemically important financial institutions in countries with interventionist or supportive governments. Commercial GREs are generally rated within one or two categories of their stand-alone ratings. In the case of healthy private-sector bank GREs with no special role in the national economy, the enhancement over the stand-alone rating usually does not exceed one notch. Rating enhancement based on the potential for extraordinary government support reflects situations where government support is possible but is less certain than for a policy-based institution. It also applies to situations where the government could act in an increasingly supportive manner during a crisis and, as such, reduce the business risks faced by the GRE. In some cases, government officials assert support and pledge to assure avoidance of default, but Standard & Poor's may constrain the notching because of doubts about institutional stability, administrative processes, or the ability to diagnose and promptly respond to financial distress. Standard & Poor's might believe that an upcoming possible privatization or an existing partial privatization contradicts the logic of support or erodes the identity of interest between the government and the enterprise. There is also the situation of considerable ambiguity, where the government has a track record of avoiding default by its enterprises, but its official or stated position is one of nonsupport. Ambiguities of this kind generally lead to an analytical approach that puts less weight on the government relationship and more on the enterprise's own credit attributes. With these caveats, Standard & Poor's broadly considers the same issues reviewed in connection with policy-based institutions in considering the degree of notching. The comparators are other commercial GREs. Potential extraordinary government support could rise as the stand-alone assessment falls Standard & Poor's application of criteria guidelines is dynamic, so a given institution could transition between the policy and commercial classifications and in or out of the GRE category altogether. Evidence leading to greater or lesser confidence in extraordinary government support could vary over time. In particular, the evidence for government support might increase as the financial condition of a corporate or a financial institution (or of an entire financial system) deteriorates. Ratings may accordingly incorporate additional support as the stand-alone assessment deteriorates, braking a slide in ratings that would otherwise occur. Where this happens, the GRE rating may deviate from the normal notching guidelines. For example, during the late 1990s and early years of the current decade, the ratings on several troubled private-sector Japanese banks remained in investment grade because of the substantial measures that the Japanese government took to support the sector. Certain banks might have failed without that government intervention. At the depth of the crisis, the ratings uplift exceeded two rating categories for

some banking groups. Over the last few years, the stand-alone creditworthiness of Japanese banks has rebounded, and the notching has returned to the norm.

Government Guarantees
Some GREs have outstanding obligations benefiting from timely, unconditional government guarantees. These guaranteed obligations are most often rated the same as the government. However, the issuer credit rating will not necessarily be the same, despite the level of support indicated by the guarantee. To determine an issuer credit rating (and thus the rating assigned to nonguaranteed financial obligations), the entity is classified as policy-based or commercial, and the appropriate approach indicated above is employed. Ultimate guarantees generally require the guarantor to meet obligations in fullbut only after the resources of the guaranteed entity are exhausted. Issuer ratings for GREs enjoying an ultimate, rather than a timely, guarantee are also rated in accordance with the methodology outlined above. As already suggested, these entities are generally placed in the policy-based category of GREs. When a government guarantee carries conditionsor when the guarantee obligation is timely and ranks equally with the government's own obligations, but administrative and other problems hamper timely servicethe guaranteed issuer or issue is rated in accordance with the GRE criteria rather than receiving the government rating. A private-sector entity generally cannot discriminate between obligations with the same ranking, but in the public sector, lags in payments on guarantees do occur, and they rarely result in creditors accelerating other obligations or seeking legal redress.

Rating A GRE Above The Rating On Its Government

A GRE may be rated above its government if the stand-alone rating on the GRE exceeds the rating on the government and the government is not expected in a stress scenario to take actions that impair the GRE's credit standing. Rating a GRE above the government under which it operates is not common. The key considerations are: The GRE should be a commercial enterprise operating in a competitive environment. Government linkages, including contracts and liquidity held in government securities, should be minimal. Government control/ownership, which should be materially less than 100% and unlikely to increase, is viewed in a parent/subsidiary context. If the parent (government) is under severe stress, it could demand increasing amounts of cash from the subsidiary (partly

government owned-entity). As a result, the GRE should demonstrate significant ability to mitigate this type of government-owner interference through methods such as nongovernment shareholder support, solid governance standards, financial resilience to interference, and a track record of a hands-off approach by the government. The proposed GRE rating should incorporate standard country risk analysis, which includes a review of the business and financial impact of country risk and subjects the GRE to significant stress tests, particularly for rating above the sovereign foreign currency rating. The entity must have the ability to mitigate relevant country risks. Generally, regulated utilities are judged least likely to have such characteristics, and exporters or entities with off-shore operations are most likely. Rating above the sovereign Expanding on the last bullet point above, aside from a GRE that is essentially an arm of the government, it is highly unlikely that the potential for extraordinary sovereign support can bring a the local currency rating on the GRE above the foreign currency rating on the sovereign. For sovereign support to provide such enhancement, Standard & Poor's must feel comfortable that the sovereign will provide support even as it fails to meet its own foreign currency obligations. More commonly, the rating on the GRE exceeds the sovereign foreign currency rating only if the stress-tested, stand-alone GRE rating exceeds the sovereign foreign currency rating. Stress tests normally involve sharp currency depreciation, higher inflation, economic contraction, and rising real and nominal interest rates as well as reductions in government support, higher required reserves and other taxes, increases in regulatory risk, and nonpayment of government obligations. When Standard & Poor's rates an issuer or specific obligation above a sovereign, it is expressing its view that willingness and ability to service debt is superior to that of the sovereign and, ultimately, that if there is a sovereign default, there is a measurable probability that the issuer or issue will not default. Sovereign stress/default often creates very difficult situations, and rating entities above the sovereign requires consideration of stress scenarios. Among GREs, commercial entities with strong operating and financial characteristics, geographically diversified business, and modest holdings of government debt are the best candidates, particularly where the sovereign itself tends not to be very interventionist. Financial institutions are usually not rated above the sovereign foreign currency rating

Financial institutions usually have neither local nor foreign currency ratings above the foreign currency rating on the sovereign because of: The bank's overall credit exposure to the general economy, the performance of which is likely correlated with sovereign creditworthiness. The threats of negative interventionsuch as a deposit freezein a sovereign stress scenario. However, a sovereign stress scenario could be considerably less grim for a monetary union member in that depreciation is likely to be less harsh and inflation less severe, suggesting greater scope for rating above the sovereign. Government-owned banks are least likely to be rated above the sovereign. Banks are typically among the most harshly affected by a sovereign default or distress scenario, and government-owned banks frequently are affected more than private-sector ones.

Foreign Currency Considerations

The criteria outlined so far focus on the methodology for assigning local currency issuer credit ratings. Foreign currency considerations introduce several dichotomies: If the related government is not a sovereign, the foreign currency rating on the GRE is the lower of its local currency rating and the transfer and convertibility (T&C) assessment for the country of domicile. The T&C assessment is the rating associated with the probability of the sovereign restricting nonsovereign access to foreign exchange needed for debt service. If the related government is the sovereign and the GRE is a policybased institution, the foreign currency rating on the GRE is either the local currency rating on the GRE or the sovereign foreign currency rating, whichever is lower. The latter constraint is not the T&C assessment because a sovereign can interfere with policy-based entities it owns or supports in a variety of ways without resorting to T&C restrictions. T&C restrictions are normally designed for nonsovereigns. A local currency GRE rating that is based on the potential for extraordinary sovereign support and exceeds the foreign currency rating on the sovereign (but never the local currency rating on the sovereign) addresses just the GRE's capacity for meeting local

currency debt-servicing requirements. The reason that the sovereign local currency definition applies here is because policy-based institutions are in large part agents of the government. If the related government is the sovereign and the GRE is a commercially oriented institution, the foreign currency rating on the GRE normally is the local currency rating or the T&C assessment for the country of domicile, whichever is lower. The GRE local currency rating can exceed the sovereign foreign rating only if the GRE's standalone assessment exceeds the sovereign foreign currency rating and the potential for negative intervention is viewed as low. The best candidates among GREs are sound oil companies playing no policy role and strong private-sector institutions, where the sovereign is not expected to act in ways that specifically diminish these GREs' flexibility in a time of sovereign stress. Rating definition differences can complicate discussions of sovereign support and intervention. Although a nonsovereign local currency rating speaks to willingness and ability to service financial obligations, regardless of currency and absent restrictions on access to foreign exchange needed to service the obligations, a sovereign local currency rating speaks to willingness and ability to service only local currency financial obligations. Sovereigns (or their central banks) generally control access to foreign exchange, and as a result, the notion of a sovereign restricting its own access is redundant. Restrictions on such access have been the most common way for sovereigns to interfere with nonsovereigns in an external crisis, though the reliance on such measures is diminishing. Sovereign local currency ratings are higher than foreign currency ratings (in many instances) because of the unique power of sovereigns to create local currency and thus meet all local currency obligations. A variety of considerations sometimes prevent sovereigns from doing so, though sovereign local currency defaults are infrequent and rather nuanced. In each of the last 25 years, sovereign foreign currency defaults have exceeded local currency defaults by more than 5x. This is compelling evidence supporting higher sovereign local currency ratings and, by extension, higher local currency ratings for GREs that are essentially arms of the government. Such marked differentials do not exist for nonsovereigns because of their inability in many circumstances to distinguish among equally ranking obligations, aside from the situation where the sovereign restricts access to foreign currency.

Summary

Broadly categorizing GREs in accordance with the nature and stability of the relationship with the government enhances the predictive power of GRE credit ratings. This approach addresses the variations in the nature of the relationships between governments and GREs while recognizing the ongoing evolution of these relationships. Relationships between GREs and governments are often unclear or seemingly contradictory. Some governments have a clear track record of supporting certain entities, even though the stated policy is one of nonsupport. Some governments treat their enterprises badly, refusing price increases or imposing unprofitable tasks. This sometimes implies acute credit risks, while at other times it reflects and deepens the government's moral obligation to the entity. Governments often deal with GREs arbitrarily, precisely because they are likely recipients of extraordinary government assistance and do not necessarily need strong financial profiles to continue to trade and access financial markets. The task of Standard & Poor's is to evaluate the relationship, while recognizing that extraordinary government support/intervention is not a black-and-white issue. Primary Credit Analysts: Marie Cavanaugh, New York (1) 212-438-7343; marie_cavanaugh@standardandpoors.com Scott Bugie, Paris (33) 1-4420-6680; scott_bugie@standardandpoors.com Alexandra Dimitrijevic, Paris (33) 1-4420-6663; alexandra_dimitrijevic@standardandpoors.com Secondary Credit Analysts: Laura Feinland Katz, New York (1) 212-438-7893; laura_feinland_katz@standardandpoors.com Blaise Ganguin, Paris (33) 1-4420-6698; blaise_ganguin@standardandpoors.com Ian Thompson, Melbourne (61) 3-9631-2100; ian_thompson@standardandpoors.com

ARCHIVE | Criteria | Structured Finance | CDOs: CDO Spotlight: Quantitative Modeling Approach To Rating Index CPDO Structures
Publication date: 22-Mar-2007 00:00:00 EST

Table of Contents Section 1: Background To CPDOs.Where Did They Come From?Rational Behind The CPDO StructureWorked Example Of A CPDO StructureSection 2: CPDO Rating MethodologyTechnical Modeling CriteriaDetailed Description Of The CPDO AlgorithmStep IStep IIStep IIIBibliographyRelated Articles(Editor's Note: This article is no longer

current. It has been superseded by " Principles Of Credit Ratings," published Feb. 16, 2011.) Unlike a traditional synthetic CDO, Standard & Poor's Ratings Services' approach to rating index CPDOs (constant proportion debt obligations) involves the modeling of multiple risk factors, including marketspread risk, credit risk, and interest rate risk. In developing our rating approach, we had to overcome the challenge of conducting a detailed analysis of all these risk factors. The approach we take analyses these risk factors in a Monte Carlo framework, which allows the risks to be looked at not in isolation but as a suite. In this document, we present our quantitative modeling framework and criteria for rating index CPDO structures--but not managed CPDOs--and provide detailed technical criteria of our modeling approach. This methodology will be included in the modeling tool CPDO Evaluator (for index trades), the beta version of which was released today. By way of background, we first describe the rationale behind and the mechanics of the CPDO structure. Section 1 updates and supercedes "CDO Spotlight: CPDOs Have Arrived In Global Derivatives Market," published on Nov. 1, 2006. In addition to providing a short introduction on CPDOs, we include here formulae for calculating the inputs to our criteria and provide a working example showing how these inputs interact.

Section 1: Background To CPDOs.Where Did They Come From?

The structured credit markets have in recent years come up with innovative structures to offer enhanced yield and return to its investors. A feature of the credit derivatives markets in particular has been the development of spread- and market value-based structures in the rating space, and CPDO structures are the newest arrivals in this area. Given the tight spread environment, high returns are achieved via rulebased leveraged credit strategies.

The CPDO structure is a variation of the credit constant proportion principal insurance (CPPI) structure. CPDO transactions address some of the specific limitations of rating the CPPI structure, while retaining the overall investment strategy. CPPI has been around in different forms and in different markets since the 1980s, and since that time has been applied to repackage a variety of risks, including interest rate risk, and commodity and real estate indices. One of the attractions of CPPI to investors is that it is not a correlation product and it typically guarantees the return of principal. As with most structures in the CDO market, it was quickly replicated and improved upon, resulting in CPDOs, which have proven popular with investors because they pay a stated coupon at high ratings. We began to look at these structures from a principal and interest rating basis in 2005. The asset side of a CPDO structure consists of two subportfolios: a cash component, called the "risk free" cash account, and a synthetic component, the so-called risky exposure. The cash from the rated liabilities--i.e., the issued notes--is used to fund the cash account. At the same time, the issuer enters into a credit default swap (CDS) referencing indices of corporate names, which is the risky exposure. The mechanics of a CPDO structure involve the concept of "leverage", which, at its simplest, is the ratio of this risky exposure to the amount of the rated liabilities. The worked example in this article shows how leverage changes over time as both the size of the risky exposure increases or decreases according to how well it's performing and the amount of the liabilities decreases as they are paid down. To understand how CPDO structures were arrived at, it is important to review the basic credit CPPI structure, and in particular its limitations. The leverage strategy in CPPI trades Credit CPPI structures seek to maximize returns while providing full or partial principal protection. They do this by dynamically re-allocating the composition of the underlying portfolio between risky exposures and risk-free assets, based on fixed rules aimed at providing a minimum acceptable return. The subportfolio of risky exposures provides upside potential, while a constant reference to a "bond floor" provides a notional put option on that same risky subportfolio guarantees a lowest acceptable return (principal protection). In general, the mechanism of dynamically adjusting the portfolio's composition means that: As the portfolio value increases, more of the portfolio is shifted to the risky exposure, boosting returns.

As the portfolio value decreases, more of the portfolio is shifted to the "risk free" subportfolio, providing principal protection.

This strategy provides the investor with two general outcomes: first that the strategy doesn't perform and the investment principal is returned and second that the strategy performs and the investor gets the resulting returns produced. In both these outcomes, principal is protected.

Rational Behind The CPDO Structure

The CPDO structure is a variant of the credit CPPI structure, with the main differences between the two being the lack of principal protection and the leverage mechanism. The CPDO leverage mechanism is the inverse of the CPPI one. A key difference, though, is the CPDO structure's added ability to recover from negative performance, albeit at the cost of providing the same "guaranteed" principal on the investment as CPPI structures provide. The CPDO leverage mechanism Similar to other structured products, a CPDO funds itself through the issuance of long-term debt paying timely coupon and principal on the notes. The proceeds of the notes are invested in a cash account that is typically "risk free" and accrues at a LIBOR rate. The promised coupon is a spread above LIBOR. The CPDO takes leveraged exposure to a synthetic portfolio. This risky exposure ensures there is enough spread to meet the promised liabilities and also to cover for fees, expenses, and potential losses that the transaction will absorb. These losses are credit losses (defaults in the reference portfolio) or mark-tomarket losses, which are linked to the fair market value of the CDS contract. While in a CPPI structure negative performance leads to a reduction in notional exposure to the risky asset until the bond floor is hit, in CPDO structures this would lead to an increase in the notional exposure (subject to a maximum leverage cap). This intuitively allows any negative performance to be cured by increasing the income from the risky asset to rebuild the portfolio's net asset value (NAV). The modeling exercise quantifies how much the spreads from the risky assets compensate for losses and cover the coupons and principal on the liabilities. Assets and liabilities of a CPDO In every time step, a CPDO structure compares the target bond price, which is the present value of the remaining coupon and principal of the note, and the current NAV of the portfolio, which incorporates the cash account, the market value of the synthetic portfolio.

The mark-to-market of the risky portfolio is calculated as the difference between the contracted spread on the CDS contract (through which protection is sold on the index) and the then-current market spread. The mismatch between the target bond price and the NAV is called the "shortfall":

The shortfall dictates the volume of risky protection sold at any point in time (see chart 1). In some structures, the PV (liabilities) is adjusted by a factor. The adjustment factor is a cushion typically attached to the notional, expressed as a percentage of that notional.

The performance of a CPDO can be characterized by three states: "cash-in," "cash-out," and failure to redeem par at term. In the first case, should the target bond price and the NAV be equal, the transaction will cash in, namely, the risky exposure will be reduced to zero. From that point onward, the NAV is invested at the risk-free rate, with coupons and fees being paid until maturity. The arranger can also define the structure to cash in when the transaction is able to pay the coupon and principal for a shorter maturity than the maturity of the issued debt (e.g., five years instead of 10 years). A cash out occurs when the transaction suffers substantial losses and the NAV drops below a threshold, for example, 10%

of the notional of the issued debt. In this case the CPDO would unwind and the investor would receive the remaining proceeds. It is possible that neither an early cash-in nor a cash-out during the life of the CPDO note will occur. In this state, the structure's inflows would have funded all coupon payments to term and been sufficient enough to avert a cash-out, but would not be sufficient to pay back par. The CPDO note would fail on its obligations. The ratio of the shortfall and the risky income, adjusted with a gearing factor, is called the target notional. (Some structures implement a flat gearing factor, some use a time-dependent gearing factor.) The target notional determines the leverage, the exposure to the risky assets. The ratio is meant to quantify how big the current shortfall is when compared with the cash flow expected from the risky assets. If the absolute difference between the index notional and the target notional is greater than a certain threshold, rebalancing takes place and the index notional is reset to the target notional.

Chart 2 depicts a scenario for the declining present value of the liabilities and the portfolio NAV stream. When the two paths cross in year 5, the transaction cashes in.

Underlying reference portfolio The structure takes leveraged exposure to a risky asset by selling protection on indices or individual names. To date, all the CPDO transactions that have been rated involve investment-grade "on-the-run"

corporate indices as the underlying risky assets, typically Dow Jones CDX and iTraxx Europe. There have been a number of reasons for this. In particular, the composition of the indices rolls on a six-month basis to the most liquid investment-grade names, meaning that the default risk to which the transaction is exposed is limited to the six-month "straight-to-default" risk on investment-grade corporates. Furthermore, as the indices reflect the most liquid names traded in the investment-grade space, it minimizes the bidask spread taken by the structure on the six-month roll or on any rebalancing date. The Dow Jones CDX and iTraxx Europe indices both consist of 125 corporate names, selected on a most-liquid basis. The average rating on the indices varies between 'A-' and 'BBB+'. Every six months, the index rolls into a new index in which speculative-grade names are replaced with investment-grade names. The choice of "on-the-run" index versus "off-the-run" ensures that credit risk is limited to a sixmonth window. When the index rolls, protection is bought on the off-the-run index. New protection is sold on the current on-the-run index. Since 2005, spreads on the on-the-run Dow Jones CDX and iTraxx Europe indices have been very tight (see chart 3). As explained below, the mechanics of the CPDO structure rely on spread income to overcompensate for defaults.

Drivers of CPDO performance The performance of a CPDO is driven by factors that affect the NAV, namely, credit losses, changes in credit spreads, bid-offer changes, and interest rate changes. Of these factors, credit losses and changes

in spreads are the first-order drivers of performance, with liquidity and interest rates being of less overall importance. The simplest of the drivers to observe is the effect of credit losses. Defaults on names in the indices lead to a reduction in the NAV. When the assets are leveraged, the reductions in NAV are higher. This multiplier effect can be shown in a simple example. In a 250-name unleveraged portfolio, one default with 40% recovery will lead to a 0.24% decrease in NAV, calculated as (1-0.4)/250. On a portfolio leveraged 15 times, however, the effect of one default is 0.24%*15 = 3.6%. The default risk in the investment-grade indices is limited to six-month exposures to investment-grade names, so a large portion of this default risk is eliminated. Not all the risk is mitigated, though, and consequently the NAV can be negatively affected by defaults. The other primary variable is the credit spread effect. The effect of spreads is twofold: as spreads widen/tighten there is the initial negative/positive mark-to-market effect on the NAV. However, there is also an income effect: as spreads widen/tighten, and the structure re-contracts at the new rate, the leveraged return will also increase/decrease. Each of these two effects works against the other. Aggregating their impact over time and quantifying the overcompensation of default losses determines the net performance of the structure. To elaborate, if the spreads are initially relatively high and then there is tightening, the initial effect will be a mark-to-market gain as the structure is contracted at a rate that is higher than the new market rate. This would increase the NAV. However, this also means that the relative level of income that the structure now earns will decrease once the lower spreads feed into new contracts. Whether or not this affects the probability that the structure will pay timely interest and ultimate principal depends on what level of defaults (if any) the portfolio has experienced or will experience and how much spread income overcompensates these losses. Intuitively, a period of spread tightening implies that the market expects lower default risk, so situations where low spread levels and low default levels are experienced can be benign on the structure. The effect of the other driversbid-offer changes and interest rate changestends to be less than that of losses and spreads. Liquidity, as reflected in the form of the bid-offer spread, is stressed to ensure that a decrease in market liquidity is presumed throughout the life of the transaction. However, a change in spread is magnified by both leverage and duration. The effect of changes in liquidity is magnified only by the leverage, so overall it has a lesser effect.

Interest rates also tend to be a secondary driver of portfolio performance. The effect of interest rates is seen primarily in the calculation of the present value of future coupons plus par, i.e., the cash-in position. However, in our rating analysis we stress the structures with high and low interest rates to gauge the sensitivity of the portfolio to changes in interest rates.

Worked Example Of A CPDO Structure

In this section, we describe the mechanics of a CPDO transaction referencing a portfolio consisting of the five-year Dow Jones CDX and iTraxx Europe indices. The transaction takes exposure in these indices with an initial leverage of 15, i.e., the protection sold is 15 times larger than the notional of the notes issued. These and other assumed features of the CPDO are shown in table 1 and chart 4

In what follows, we discuss the mechanics of the asset and the liability side of the CPDO. The results are presented in table 2.

Asset side On the closing date, $100 million issuance proceeds (minus any upfront fee, which is zero in this example) is placed into the risk-free cash account accruing interest at 3.5% (three-month LIBOR). The NAV is the sum of the mark-to-market on the risky CDS portfolio and the current value of the cash account. At any trading day, the mark-to-market of the risky CDS portfolio is defined as the cost of

entering an offsetting CDS portfolio. If the difference between the contracted spread and the simulated spread is positive, there is a mark-to-market gain, otherwise, there is a mark-to-market loss. The discount rates of the risky cash flows are derived using an interest rate model. Because the assets held are risky assets, the discount factor is the risk-free rate plus a risk premium (i.e., a risky discount factor). As the term structure in credit spreads is flat, the cost of the offsetting CDS is zero. Liability side The present value of the liabilities--the notes issued--is the sum of all the coupons and the final principal redemption amount, discounted at the appropriate discount factor derived from the interest rate term structure. Leverage On time step 0, the shortfall, which is the difference between the present value of the liabilities and the NAV, is $16.6 million and the leverage is 15. We assume a zero cushion. Over subsequent time steps, the current NAV increases, the shortfall decreases, and hence the leverage goes down. In year 9, the structure cashes in, when the present value of the liabilities equals the current NAV. A plot of the two NAV streams is represented in chart 5. Chart 6 shows the declining leverage function. As shown in table 2 and chart 5, the transaction cashes in at year 9.

Section 2: CPDO Rating Methodology

In this section we provide the key steps in our rating methodology and follow this with a more formal algorithm in the technical section "Technical Modeling Criteria." The CPDO structure's NAV dictates the probability of receiving timely interest and ultimate principal. In assigning ratings, we are addressing the probability of receiving interest throughout the life of the transaction and principal at maturity. The ability for the NAV to go below par and having a cash-out point at the standard 10% of notional means that the transaction can pay coupons in a wide range of scenarios as interest coupons are a direct deduction from the NAV. While this means that the transaction can withstand some negative performance without defaulting on payments, it does not imply that it is fully immune from a significant decrease in NAV. The probability of the structure being able to pay timely interest and principal may change, leading to a downward revision to the rating. This is similar to any synthetic CDO structure. As outlined above, the main variables driving NAV are credit defaults and spreads on the underlying reference assets, the depth of liquidity in the CDS market, and the interest rate. In analyzing a CPDO structure, we run numerous sensitivity scenarios on each of these variables to understand the net effect of changes on the NAV, and therefore the rating. These sensitivity analyses are performed on each variable in isolation as well as in combination with the other variables. The size of the impact of each variable and the timing of the imposition of the stress in the transaction are central in determining the "suite" of stresses used to arrive at a base case scenario for rating these structures. Stressing credit risk

The starting point or first layer of stress added to the structure is to size for credit defaults, which is consistent with our existing CDO criteria. To determine the credit default exposure in the transaction, we assess the indices' six-month exposure to investment-grade names. In sizing the risk, we capture this sixmonth jump-to-default risk over 20 periods. Another aspect of credit risk in this structure is the transition risk below 'BBB-', i.e., speculative grade. Upon a transition below 'BBB-', the affected name is removed from the indices at the next roll date and we would expect a mark-to-market loss as a direct result of this downgrade. As we model default risk but not rating transition risk and the spread modeling is based on the average index spread, mark-tomarket changes due to rating changes are not directly captured in the modeling. To account for this risk, we use stressed default curves. The model generates on average 6.8 defaults over the life of the transaction (however, the tail-end of this distribution has much higher number of defaults). Stressing credit spread and other risks The net effect of changes in spread is not as clear as for credit losses. To assess the impact of spread changes on losses, we consider both the short-term and long-term effects of spread movements. While an increase in spreads will lead to a short-term decrease in NAV, this can be compensated for by the increased income received over the life of the transaction if the maturity of the liability is longer than that of the assets. The opposite applies for spread tightening. We also stress for bid-offer spreads on each roll of the index to account for liquidity risks and simulate an interest rate term structure to ensure the robustness of the transaction structure to changes in interest rates. Applying stresses in scenario analyses To stress the transaction, we combine the stressed level of defaults with different spread scenarios, which can be categorized as high, low, high-low, or low-high. The default distribution due to the shape of the amended default curve should be relatively evenly spread through the transaction. The severest scenario that we apply occurs where the stressed level of defaults is applied and spreads are suppressed in the short term, with a drift toward the higher long-term mean over the remainder of the transaction. In this scenario, the NAV is reduced through credit losses. However, as spreads are not correlated with defaults there isn't a corresponding increase in spread levels contributing to rebuild the NAV.

Technical Modeling Criteria

We use a Monte Carlo framework to model CPDO structures. The model tests whether cash flows can meet the timely payment of coupon and principal. This allows us to calculate the number of paths in which a cash in or cash out has occurred. A failed path is a path in which a cash-out event occurred or coupon and principal cannot be paid in full. The number of failed paths is then compared with the default probability by rating and tenor for CDO liabilities. The key risk factors--such as market spreads, defaults, and interest rates--are stochastically simulated and used as inputs in the cash flow model. The approach we take relates particularly to transactions referencing five-year Dow Jones iTraxx and CDX Europe indices but attempts to show generalizations to other CPDO structures. Interest rates Interest rates affect both the asset and liability sides of the CPDO structure. Receipt and payment of cash on the assets and liabilities, respectively, must be discounted over the term of the CPDO note. Therefore, at every time t we must calculate the time t value of payments that occur after this time. We describe this as the "long" interest rate process. The "short" interest rate process is for calculating interest accrued in the cash deposit account and the size of the coupon that is paid on the issued debt.

Credit spreads We assume that the credit spread for a maturity M on the underlying portfolio follows a Black-Karasinki model with parameters:

Defaults Credit losses on the underlying portfolio of the CPDO arrive at the default times modeled in the Gaussian copula framework. Refer to "CDO Evaluator Version 3.0: Technical Document" (see "Related Articles") for a description of the methodology employed here. To accommodate the indices' distinct six-month rollover feature and the fact that we are not modeling rating transitions, we generated a new default curve up until 10 years, matching the longest tenure of CPDO trade. The default curve is generated by applying the probability of default between years 1 and 2 in our original asset default table for each year, so, as a result, the new default curve is linear (see table 3 below).

Asset correlation The correlation to be used between corporate obligations is given in table 4 from CDO Evaluator.

Recovery rate We use a stochastic recovery model for a CPDO structure referencing Dow Jones iTraxx and CDX Europe in its risky portfolio. Recovery rates are assumed to follow a beta distribution (see "CDO Evaluator Version 3.0: Technical Document").

Detailed Description Of The CPDO Algorithm

Step I of the CPDO algorithm is to define the present values of the liability and asset streams. Step II is to compute the portfolio's NAV from the sum of portfolio's mark-to-market, CDS coupon receipts, and cash account balances. Step III involves computing the optimal leverage of the CPDO structure using the NAV, liability, and asset streams and then rebalancing the portfolio. Subject to rebalancing, the algorithm proceeds anew. There are four important recursive variables that affect the mechanics of the CPDO: spreads, portfolio NAV, the present value of the liabilities, and leverage. They interact with each other, e.g., spreads determine NAV, which in turn affects the shortfall, and finally this affects the leverage. The leverage strategy determines the new size of the risky exposure in the following time step and a new iteration starts. Given the complexity of the algorithm and the continuous interaction between the asset side and the liability side in a CPDO structure, chart 7 shows a full Monte Carlo scenario.

Step I

Step II

The cash account is the variable that tracks in each time step the amount of cash in the structure. On the issue date, the proceeds from the note issuance minus upfront fees are placed on deposit accruing interest at the reference rate, e.g., the risk-free three-month LIBOR rate.

The cash account will be credited with: Interest accruing at a rate equal to the simulated reference rate; Credit premiums from the index portfolio; and Any profit from adjustments to the index portfolio's notional (mark-tomarket gains on any roll/rebalancing date). The cash account will be debited by: Any loss arising as a result of credit events in the index portfolio; Any loss from adjustments to the index portfolio's notional (mark-tomarket losses on any roll/rebalancing date); The amount of any fees. The fee structure incorporates an upfront fee (if applied), a running/operational fee (if applied), and a strategy/leverage fee (if applied); and Coupon payments on interest payment date.

The following formulae formalize the mechanics described above:

Step III

The iteration repeats itself and in each path the model records (i) a cash-out trigger during the life of the CPDO note, or (ii) a failed path if timely coupon and principal cannot be paid at CPDO note term. For a collection of these Monte Carlo iterations, Standard & Poor's CPDO model will output a frequency of the non-cash-in paths. This frequency has to be commensurate with the default probability of a CDO liability

(see "CDO Evaluator Version 3.0: Technical Document") with the same rating as the issued debt and with a tenor that reflects appropriately the timing and size of paid coupon/principal. Sriram Rajan also contributed to this report.

Bibliography
Standard & Poor's, CDO Evaluator Version 3.0: Technical Document", (2005). Samaresh Priyadarshi, working paper, "Bond and Option Valuation in the HJM Framework", (2000). John Hull and Alan White (1990), "Pricing Interest-Rate-Derivative Securities", Review of Financial Studies, vol3, no 4, pp 573-592.

Related Articles
"CDO Evaluator Version 3.0: Technical Document" (published on Dec. 16, 2005). "CDO Spotlight: CPPI Jostling To Become Structured Credit Market's Next Big Thing" (published on Feb. 2, 2006). "CDO Spotlight: Criteria For Rating Market Value CDO Transactions" (published Sept. 15, 2005). "CDO Spotlight: Approach To Rating Leveraged Super Senior CDO Notes" (published Aug. 22, 2005). "CDO Spotlight: Counterparty Risk In Structured Finance Transactions" (published March 7, 2005). All related articles are available on RatingsDirect, the real-time Web-based source for Standard & Poor's credit ratings, research, and risk analysis, at www.ratingsdirect.com.

General Criteria: Request For Comment: Management And Governance Credit Factors
Publication date: 12-Mar-2012 13:39:32 EST

View Analyst Contact Information

Table of Contents PROPOSAL SUMMARYSCOPE OF THE PROPOSED CRITERIASPECIFIC QUESTIONS FOR WHICH WE ARE SEEKING A RESPONSEIMPACT ON OUTSTANDING RATINGSRESPONSE DEADLINEMETHODOLOGYThe Components Of Management Analysis And Related MetricsDetermining The Management And Governance ScoreStrategic PositioningRisk Management/Financial ManagementOrganizational EffectivenessGovernanceFrequently Asked QuestionsAPPENDIXESAppendix 1: Proposed Use Of Management Metrics In Determining The Management And Governance Score-Corporate RatingsAppendix 2: Proposed Use of Management Metrics in Determining the Management and Governance ScoreInsurance RatingsRELATED CRITERIA AND RESEARCH(Editor's Note: On April

12, 2012, Standard & Poor's Ratings Services extended the deadline for responses to this request for comment to May 1, 2012.)
1.Standard & Poor's Ratings Services is requesting comments on its proposal to revise its criteria for

evaluating enterprises' management and governance. If adopted, these proposed criteria would update and partially supersede the article "2008 Corporate Criteria: Analytical Methodology," published April 15, 2008, and supersede the article "Management And Corporate Strategy Of Insurers: Methodology And Assumptions," published Jan. 20, 2011.
2.This article is related to "Principles Of Credit Ratings," published on Feb. 16, 2011.

PROPOSAL SUMMARY
3.Standard & Poor's is proposing to update its criteria for evaluating management and governance, which

is a component of our assessment of an enterprise's creditworthiness.

4.The term "management and governance" encompasses the broad range of oversight and direction

conducted by an enterprise's owners, board representatives, executives, and functional managers. Their strategic competence, operational effectiveness, and ability to manage risks shape an enterprise's competitiveness in the marketplace and the strength of its "business risk profile" (as our criteria define the term). If an enterprise has the ability to manage important strategic and operating risks, then its management plays a positive role in determining its operational success. Alternatively, weak

management with a flawed operating strategy or an inability to execute its business plan effectively is likely to substantially weaken an enterprise's business risk profile.
5.The analysis of management and governance is arguably one of the most qualitative aspects of our

rating methodology. These criteria bring enhanced transparency to our ratings by articulating how we score this category of analysis. This qualitative analysis typifies characteristics and elements of management and governance that are most pertinent to credit analysis.

SCOPE OF THE PROPOSED CRITERIA

6.These proposed criteria apply to corporate ratings and insurance ratings.

SPECIFIC QUESTIONS FOR WHICH WE ARE SEEKING A RESPONSE

7.Specifically, Standard & Poor's is seeking responses to the following questions:

How well do the proposed criteria handle the assessment of the strategic positioning, risk management/financial management, and organizational effectiveness components?

How well do the proposed criteria handle the assessment of the governance component? Do you believe that any of the risks receive too much or too little weight in the proposed criteria? Do you have any different views on how to arrive at the overall management and governance score? Do you have any different views on how to score any individual subfactor?

IMPACT ON OUTSTANDING RATINGS

8.We do not expect any significant rating changes as a result of these proposed criteria because they

bring enhanced transparency rather than substantive change to our scoring of management and governance.

RESPONSE DEADLINE
9.We encourage market participants to submit written comments only on the proposed criteria by April 12,

2012. Please send your comments to CriteriaComments@standardandpoors.com. Once the comment period is over, we will review the comments and publish the criteria.

METHODOLOGY

The Components Of Management Analysis And Related Metrics

10.The proposed analysis of management and governance consists of a review of:

Strategic positioning, Risk management/financial management, Organizational effectiveness, and Governance.

11.Under the proposed criteria, the assessments of the first three components can either positively or

negatively influence the overall management and governance score, or can have no net effect. The assessment of the fourth component, governance, can be either neutral or can negatively influence the overall management and governance score; it cannot positively influence the score.
12.To arrive at the overall management and governance score under the proposed criteria, we apply

metrics for evaluating the subfactors within the strategic positioning, risk management/ financial management, and organizational effectiveness components. An enterprise is scored as positive, neutral, or negative for each subfactor. The enterprise's overall score for management and governance is based on a collective review of these outcomes, adjusted by our assessment of the governance subfactors.

Determining The Management And Governance Score

13.The proposal is to score management and governance as (1) strong, (2) satisfactory, (3) fair, or (4)

weak for the evaluation of corporate and insurance enterprises. These scores are determined by aggregating the assessments of the appropriate subfactors for strategic positioning, risk management/financial management, and operational effectiveness for each sector and then applying the seven subfactors for governance. In total, there are 17 subfactors used to evaluate management and governance. Each practice uses the subfactors that are relevant to their sector. Appendix 1 describes the proposed scoring methodology and the relevant subfactors for corporate enterprises. Appendix 2 describes the proposed scoring methodology and the relevant subfactors for insurance enterprises. Table 1 explains the proposed scoring for each of the subfactors for strategic positioning, risk management/financial management, and operational effectiveness. Table 2 explains the proposed scoring for each of the subfactors for governance.
14.This is an evidence-based analysis. An enterprise receives a neutral score for any strategic

positioning, risk management/financial management, organizational effectiveness, or governance subfactor for which there is insufficient evidence to assign either a positive or negative score. However,

some subfactors may receive a negative score if an enterprise has a track record of failing to disclose key management and governance information.
15.From time to time issuers may change their strategic direction, risk appetite, execution capabilities,

governance, senior management, and/or board membership. This may be due to shareholder/stakeholder initiatives, regulatory pressure, or changes in focus at the management or board level. Such changes necessarily require the reevaluation of all relevant subfactor scores. Evidence of these changes would be reflected in the relevant subfactor score(s).
Table 1

Summary Of Proposed Scoring Rules For Strategic Positioning, Risk Management/Financial Management, And Organizational Effectiveness Subfactors*

Subfactors used to evaluate strategic positioning

Positive

Neutral

Negative

1. Strategic planning process (see paragraphs 17-18)

Evidence of strategic plans that contain specific financial and operational goals with clear measures of achieving those goals.

Evidence of strategic plans, but some aspects lack depth or specific financial/operational goals. Measures to achieve goals are unclear.

There is very limited evidence that strategic plans exist, or plans are superficial.

2. Consistency of strategy with organizational capabilities and marketplace conditions (see paragraphs 19-21)

Strategy is nearly always consistent with the organizations capabilities, taking into account marketplace conditions. A track record of marketplace leadership and effective innovation exists.

Strategy is generally consistent with the organizations capabilities, taking into account marketplace conditions.

Strategy is inconsistent with the organizations capabilities or marketplace conditions. Abrupt or frequent changes in strategy, unexpected acquisitions, divestitures, or restructurings have occurred.

3. Ability to track, adjust, and control execution of

Management has been able to convert almost all

Management has been able to convert most but usually

Management is often unable to convert

strategy (see paragraphs 22-23)

of its strategic decisions into constructive action. Management has a track record of achieving its financial and operational goals and is successful relative to peers.

not all of its strategic decisions into constructive action. Management has a track record of achieving most but usually not all of its financial and operational goals.

strategic decisions into constructive action. Management often fails to achieve its financial and operational goals.

Subfactors used to evaluate risk management/financial management

Positive

Neutral

Negative

4. Comprehensiveness of risk management standards and tolerances (see paragraphs 27-28)

Management has successfully instituted comprehensive policies that effectively identify, monitor, select, and mitigate key risks and has articulated tolerances to key stakeholders.

Management has a basic set of standards and tolerances in place, but may not have fully developed risk management capabilities.

Management has no or few defined standards and tolerances and little risk management capability.

5. Standards for operational performance (see paragraphs 29-30)

Management has set rigorous and ambitious, but reasonable standards for operational performance.

Management has set standards for operational performance that are achievable and similar to industry norms.

Management does not have the wherewithal, discipline, or management commitment to achieve set standards, or it has low standards.

6. Comprehensiveness of financial standards and risk tolerances (see paragraphs 31-32)

Management has a comprehensive and sophisticated set of financial standards and risk tolerances in place.

Management has a basic set of financial standards and risk tolerances in place.

Management has no or few defined financial standards and risk tolerances.

7. Risk Tolerances (see paragraphs 33-34)

Management articulates and maintains conservative risk tolerances (relative to

Management maintains moderately conservative risk tolerances.

Management maintains aggressive risk tolerances.

Standard & Poors published criteria).

Subfactors used to evaluate organizational effectiveness

Positive

Neutral

Negative

8. Managements (see paragraphs 36-37)

Management has experience, and a track record of success in operating all of its major lines of business.

Management has sufficient expertise and experience in operating its major lines of business. Managements track record of success in carrying out its plans is comparable to peers.

Management lacks the expertise and experience to fully understand and control many of its businesses. The enterprise often deviates significantly from its plans.

expertise and experience considerable expertise,

9. Management depth and breadth (see paragraphs 38-39)

Management has good its major lines of business, and can withstand loss of key personnel without significant disruption to operations or cash flows in each of its significant business units.

Management depth or breadth The enterprise relies on one or a small number of managers. The loss of key personnel would seriously affect the organizations operations. loss of key personnel would be expected to only temporarily affect the organizations operations or cash flows.

depth and breadth across is limited in some areas. The

10. Managements operational effectiveness (see paragraphs 40-41)

Management has a demonstrated history of not incurring operational surprises that affect earnings or cash flow.

Operational surprises cash flow.

Operational surprises earnings or cash flow.

occasionally affect earnings or regularly affect

*Please see the Appendixes to determine which subfactors are relevant for each sector.

Table 2

Summary Of Proposed Scoring Rules For Governance Subfactors

Neutral

Negative

1. Board independence from management (see paragraph 44)

The board maintains sufficient independence from management to provide effective oversight final decision-making authority with respect to key enterprise risks, compensation, and/or conflicts of interest.

The board manifests a lack of independence from management and scrutiny of key enterprise risks, compensation, and/or unmanaged conflicts of interest.

of management. The board retains control as the provides insufficient oversight and

2. Entrepreneurial or controlling ownership (see paragraph 45)

Where ownership is concentrated, management and the board of directors have professional/independent members who are stakeholders, including minority interests. The influence of the controlling shareholder is offset by risk-aware professional management and a board of directors that effectively serves the interests of all stakeholders.

Controlling ownership negatively influences corporate decision-making to promote the interests of the other stakeholders.

capably engaged in risk oversight on behalf of all controlling owners above those of

3. Management culture (see paragraph 46)

Management is responsive to all stakeholders' interests, appropriately balances those interests, and acknowledges that the board of directors is the ultimate decision-making authority.

Managements own interests (or those of a narrow group of stakeholders) are its primary concern, where dissent in the executive suite is generally not tolerated, or where management proves incapable of managing conflicts of interest arising between different stakeholder groups. Excessive management turnover can be an indicator of a governance deficiency in management culture. Alternatively, management dominates the board of directors, as demonstrated by the control exercised by the chair or CEO, or as evidenced by compensation and incentive programs that promote outsize risk taking.

4. Regulatory, tax, or legal infractions (see paragraph

The enterprise generally remains free of regulatory, tax, or legal infractions and has

The enterprise has a history of regulatory, tax, or legal infractions beyond an isolated episode or outside

47)

stable relationships with regulatory authorities.

industry norms which represent significant risk to the enterprise.

5. Communication of messages (see paragraph 48)

The enterprise generally communicates consistent messages to all constituencies.

The enterprise communicates conflicting information to different stakeholders on significant issues.

6. Internal controls (see paragraphs 49-50)

The enterprises internal control environment is not viewed as deficient.

The enterprises internal control environment is viewed as deficient based on available evidence, such as restatements or delays in filings.

7. Financial reporting and transparency (see paragraphs 51-52)

Accounting choices are usually reflective of the economics of the business.

The enterprises financial statements obfuscate the true intent or the economic drivers of key transactions, or the financial statements are insufficient to allow users of the financial statements to understand the intent and the economic drivers.

Strategic Positioning
16.The proposed analysis of an enterprise's strategic positioning consists of three subfactors: (i) the

strategic planning process, (ii) the consistency of the strategy with organizational capabilities and marketplace conditions, and (iii) the management team's ability to track, adjust, and control execution of strategy. The effectiveness of the strategic planning process determines how well an organization's financial and operational goals are articulated. In turn, the organizations that have put in place strategies that are consistent with their capabilities and marketplace realities tend to perform better over time than their peers that have strategies that are inconsistent with their capabilities. Finally, strategies can only be effective if management can monitor and adjust execution to stay aligned with them. Strategic planning process
17.An effective strategic planning process is critical to developing a formal and well-articulated strategy.

This component includes evidence of a strategic planning process, the specificity of the plans, and the comprehensiveness of business units covered when scoring this subfactor. The key indicator of the success of the strategic planning process is the result. A solid planning process ordinarily leads to a written strategic plan that includes projections, specific financial and operational goals, and clear measures for achieving the goals. Insights into an enterprise's strategic planning can be garnered by inquiring about the frequency of strategic planning sessions and their nature.

18.An enterprise receives a positive score for its strategic planning process if there is evidence of a

written strategic plan that has specific financial and operational goals for all major business units and contains specific measures for achieving those goals. An enterprise with a positive score typically will have a methodology for producing estimates, forecasts, and projections that is transparent, and it will have well-supported assumptions underlying the plan. An enterprise receives a negative score if there is limited evidence that a strategic plan for many of its major business units exists, or if it develops a superficial strategic plan that lacks specific financial and operational goals for many of its major business units. Enterprises with some evidence of written plans, but which may lack depth, such as a lack of some specific financial and operational goals for their major business units, are scored as neutral. An enterprise also may be scored neutral if the measures for achieving goals are unclear. Consistency of strategy with organizational capabilities and marketplace conditions
19.Enterprises with strategies that are consistent with their capabilities, taking into account marketplace

conditions, tend to perform better than enterprises with strategies that are inconsistent with their capabilities or that have a history of strategy volatility. When assessing the consistency of an enterprise's strategy with its organizational capabilities and marketplace conditions, we compare management's planning assumptions with those of peer enterprises and with our own forecasts. A track record of abrupt or frequent changes in business strategy or unexpected acquisitions, divestitures, or restructurings indicates a higher level of business risk. The criteria are dynamic and allow for evolution of standards, expectations, and availability of information. For example, as financial regulators expand compensation disclosure requirements, the additional insight can help to identify the correlation between actual incentives and stated strategic intent.
20.An enterprise receives a negative score for the consistency of its strategy with its organizational

capabilities and marketplace realities if it has implausible, very aggressive, or overly optimistic strategies and projections that reflect weak internal planning capabilities or an insufficient grasp of challenges (or opportunities), especially if management fails to consider factors on which peer enterprises are focusing. For example, an enterprise receives a negative score if projections for revenue or earnings growth are significantly higher than results of the recent past or relative to forecasts of peers, unless there are identified factors that support them such as a favorably-viewed acquisition or growth from a new business line. An enterprise with strategies that are generally consistent with its capabilities and that is cognizant of marketplace conditions, but is unlikely to display market leadership or notable innovation typically receives a neutral score. An enterprise receives a positive score if it possesses the minimal attributes for neutral but has a track record of market leadership and effective innovation (i.e., being among the first in its sector to respond to changes in market conditions successfully).

21.In addition, an enterprise generally receives a negative score for strategic consistency if it exhibits

abrupt or frequent changes in business strategy or unexpected acquisitions, divestitures, or restructurings. However, although almost all mergers involve risk, well-executed acquisitions can make strategic sense and benefit enterprises. Acquisitions are evaluated with respect to: Strategic fit (e.g., vertical or horizontal), Diversification objectives, Market-share gains, Availability of excess cash resources and cost synergies, and Valuation considerations (cash flow multiples, internal rate of return, and earnings accretion). An enterprise will not receive a negative score if the acquisition (i) is consistent with the organization's capabilities, (ii) is appropriately valued and has potential for profitable growth, and (iii) displays strong prospects for successful integration based on either the enterprise's track record or statements regarding specific measures it will take to achieve a successful integration. Ability to track, adjust, and control execution of strategy
22.The ultimate purpose of planning is to track, adjust, and control the execution of the enterprise's

strategy. This subfactor is a forward-looking evaluation of an enterprise's strategy. The criteria focus on whether an enterprise's strategy can be converted into constructive actions that lead to successful financial and operational performance. For example, management's systems for communicating its plans to lower management are part of the scoring of this subfactor. Looking at how the enterprise implements its strategy, plans, and policies helps shape a view of management's consistency and credibility. It also helps in assessing performance versus plans. For example, determining why results meet or fail to meet expectations is important. After all, meeting or exceeding projections could be the result of good fortune rather than management's capabilities.
23.An enterprise receives a positive score for its ability to convert strategy into constructive actions that

lead to successful financial and operational performance. In addition, the management team has a track record of achieving its financial and operational goals and is successful relative to peers. Objective appraisals of business units and disciplined approaches to dealing with underperformance (divestiture, restructuring, or discontinuing businesses are among the options in such cases) are favorable factors. Conversely, an enterprise that is often unable to convert strategy into constructive actions receives a negative score. Such an enterprise has a track record of frequently not achieving its financial and operational goals. Management's approach and plans for poorly performing business units or those that

no longer fit with the enterprise's strategy are also an area for inquiry. An enterprise that does not have a credible strategy for approaching poorly performing units receives a negative score. Also, the score is negative if the enterprise has insufficient or ineffective communication of strategic planning with lower levels of management based on the way it implements its strategy, plans, and policies. An enterprise receives a score of neutral if it has achieved most, but usually not all, of the major goals that it defined in its recent strategic planning. The management team of such an enterprise is usually, but not invariably, expected to convert strategy into constructive actions.

Risk Management/Financial Management

24.Risk management/financial management refers to the management of risk which is not covered

elsewhere in criteria applicable for that enterprise type: For corporate enterprises, risk management refers to risk other than financial policy; financial policy is covered by other corporate criteria; and For insurance enterprises, it refers to financial management; other risk is covered by criteria assessing enterprise risk management for insurers.
25.Under the proposal, a corporate enterprise's risk management includes the subfactors:

Comprehensiveness of risk management standards and tolerances, and The standards for operational performance.

Assessing the sophistication and comprehensiveness of an enterprise's risk management is important because of the prospective impact of these policies on the enterprise's financial profile.
26.Under the proposal, an insurer's financial management includes the following subfactors:

Comprehensiveness of financial standards and risk tolerances, The standards for operational performance, and Management's risk tolerances.

Assessing management's risk tolerance, prudence, and sophistication has always been a critical part of rating decisions. A view of management's philosophies and policies involving financial risk--and the degree of perceived conservatism or aggressiveness of these policies--is important because of the

prospective impact of these policies on the firm's financial profile. Our review of financial management considers: Financial risk appetite, Capital structure, Liquidity policies, Investment policies, Derivatives usage, and Hedging practices and the use of other risk mitigants.

Comprehensiveness of risk management standards and tolerances

27.Corporate enterprises with a deliberate, consistent, well-articulated, well-resourced, and integrated

approach that effectively identifies, selects, and prudently mitigates risks are more likely to build long-term credit strength compared with enterprises with a casual, opportunistic, or reactive approach. Business managers may demonstrate proficiency by institutionalizing comprehensive policies that recognize the complex interdependencies of the risks their businesses face, the trade-off between risk and reward, and the interplay between business and financial risk. Questions regarding this issue include: Does the corporate regularly identify and assess the impact of critical strategic risks? Has the corporate determined limits for acceptable levels of risk, and if so, how are they enforced? Does the corporate hold accountable specific individuals for oversight of the most critical risks the enterprise faces, and if so, what are the rewards (consequences) for success (failure)? Does the corporate employ an effective risk-based approach to strategic decisions? Has the corporate effectively communicated to employees, owners, and other key stakeholders its tolerance for risk and commensurate expectations for earnings volatility?
28.This subfactor addresses the comprehensiveness of corporate risk management standards and

tolerances as opposed to the degree of aggressiveness or conservatism of those standards and risk tolerances. A corporate that has both comprehensive and sophisticated standards and tolerances receives a positive score. Such a corporate has successfully instituted comprehensive policies that effectively identify, monitor, select, and mitigate key risks and has articulated tolerances to key

stakeholders. Corporates that have no or few defined standards and risk tolerances receive negative scores. The score is neutral if a corporate has basic standards and risk tolerances, or standards and risk tolerances that are not comprehensive across most significant business lines. Such a corporate may not have fully developed risk management capabilities. Standards for operational performance
29.An enterprise's financial goals for operational performance are distinct from its strategic goals. Even

enterprises that set financial goals, such as for earnings and sales, might not have the wherewithal, discipline, or management commitment to achieve the objectives they have set. These goals should be viewed in the context of an issuer's past record and the financial dynamics affecting the business.
30.An enterprise receives a positive score if it sets rigorous and ambitious, but reasonable standards for

operational performance. Operational surprises rarely interfere with the enterprise's strategy. An enterprise receives a neutral score if it sets standards for operational performance that are achievable and similar to industry norms. An enterprise receives a negative score if, in our opinion, it either (i) sets low standards or (ii) does not have the wherewithal, discipline, or management commitment to achieve the standards that it sets. Comprehensiveness of financial standards and risk tolerances
31.Some insurers have not given serious thought to the balance between the risks that they take and their

financial resources to absorb adverse outcomes of those risks. Others have reached firm conclusions about the matter. This limits the comprehensiveness of management's financial standards. For many insurers, a simplistic standard--such as a debt service coverage ratio or a leverage ratio, in either case based on reported figures with no adjustment--is the only focal point of such policy considerations. By contrast, more sophisticated managements have thoughtful and more comprehensive policies that recognize the complex interdependencies of the risks their insurance enterprises face, the trade-off between risk and reward, and the interplay between business and financial risk. Questions regarding this issue include: Has the insurer determined limits for acceptable levels of risk? Are these guidelines detailed or general? Do the guidelines apply to many areas of the operation or just a few?

32.This subfactor addresses our analysis of the comprehensiveness of an insurer's financial standards

and risk tolerances as opposed to the degree of aggressiveness or conservatism of those standards and risk tolerances. An insurer that has both comprehensive and sophisticated financial standards and risk

tolerances receives a positive score. Such an insurer has predetermined limits for all significant risks and detailed guidelines for effective operational management of the business. Insurers that have no or few defined financial standards and risk tolerances receive negative scores. The score is neutral if an insurer has basic standards and risk tolerances, or standards and risk tolerances that are not comprehensive across most significant business lines. Risk tolerances
33.An insurer's management's risk tolerances are compared to Standard & Poor's published criteria to

assess the aggressiveness or conservatism of a company's financial policies. See the articles in the "Related Criteria And Research" section for additional information on the benchmarks used for ratings analyses. Specific practices--such as risk tolerances for macroeconomic stress and catastrophic risk--can be telling about management's financial risk tolerance. Other indicators of risk tolerance include levels of leverage, debt service coverage, investment risk, liquidity, asset-liability mismatches, and over/under utilization of hedging. The risk tolerance evaluation addresses: What are management's specific financial risk limits? What are the amounts and types of capital in the capital structure and what is the level of leverage employed? What is the amount and quality of liquidity available relative to the firm's needs in periods of stress? What are the quality and allocation of invested assets and measures of capital adequacy?
34.Responses to these questions help to reveal how conservative or aggressive management is. An

insurance enterprise receives a positive score for risk tolerance if it articulates and maintains conservative risk tolerances relative to Standard & Poor's published benchmarks found in our sector-specific criteria. An insurance enterprise receives a neutral score if it articulates and maintains moderately conservative risk tolerances or has some specific risk tolerances that could impair its financial performance during a period of moderate stress. An insurance enterprise may also receive a neutral score if it maintains some risk tolerances that are aggressive, but are mitigated by other factors so as not to be harmful to the insurance enterprise's overall risk profile. An insurance enterprise that maintains aggressive risk tolerances or that has few defined risk tolerances receives a negative score.

Organizational Effectiveness
35.Under this proposal, the analysis of an enterprise's organizational effectiveness includes three

subfactors: management's ability to execute plans, management's depth and breadth, and management's

operational effectiveness. Organizations that have track records of successfully executing their plans without relying on a small number of managers and that do not have histories of operational surprises will generally be able to better manage their risks than other organizations. The analysis of organizational effectiveness is based on the answers to such questions as: How has an enterprise performed compared with the expectations that its management provided? Does management have good depth across its most significant businesses, or does it rely on one or a few managers? Does the enterprise have a history of unusual events or operational surprises, in particular those that materially affect earnings and cash flow? Management's expertise and experience
36.Management's expertise and experience in operating each line of business is an important determinant

of an enterprise's success. Management's expertise should be evaluated in the context of its ability to grasp and react to market conditions, financial conditions, and competitive challenges. Organizational structure and management's breadth of experience should support the strategy to execute plans and produce the desired results in order to be scored positive. Determining whether management has considerable expertise in operating its lines of business or lacks the ability to fully understand and control its business helps to differentiate a stronger management from a weaker one. The evaluation of management's expertise and experience is also based on its track record of implementing constructive actions. An important consideration is what could cause performance to deviate from management's stated expectations. Forecasting is more difficult in some industries than others, and unforeseen factors outside of management's control can upset the best-laid plans. An acknowledgement of risks and an understanding of how various factors could affect earnings and cash flow reflects favorably on management's credibility.
37.An enterprise receives a positive score for management's expertise and experience if it has

demonstrated expertise in operating all major lines of business based on its ability to grasp and successfully react to changing market conditions, as reflected in the enterprise's track record and in comparison to peers. Such an enterprise has a track record of success in continuously and dependably executing its plans, excluding any events that, in our opinion, are unforeseeable. Alternatively, an enterprise receives a negative score if management lacks the expertise and experience to fully understand and control its business. Such an enterprise has a track record of often deviating significantly from plans. The score is also negative if the enterprise does not acknowledge its risks or does not

demonstrate an understanding of significant factors that could affect its cash flows and earnings. An enterprise that demonstrates either unexceptional expertise in operating its lines of business or a basic understanding of the significant risks in specific lines of business will be scored as neutral. Such an enterprise usually has a track record of success in carrying out its plans, excluding any events that, in our opinion, are unforeseeable. Management depth and breadth
38.The depth and breadth of management influence an enterprise's operational effectiveness.

Organizations that rely on one or a few managers, which is known as key man risk, face the potential for significant disruption to operations upon the loss of key personnel.
39.An enterprise that has a management team with good depth and breadth across all significant

business units receives a positive score. Such an enterprise can absorb the loss of senior managers without significantly disrupting operations or cash flows in each of its significant business units. An enterprise receives a neutral score if management depth or breadth is limited, although the loss of a few key managers would not be expected to meaningfully affect the organization's overall cash flows or earnings. If one or a small number of individual managers are critical to the success of an enterprise's operations, the score for this subfactor is negative. For example, if the loss of one or a few key managers could disrupt a significant operation that would meaningfully affect the organization's overall cash flows or earnings, the score is negative. Management's operational effectiveness
40.A history of unusual events or operational surprises, in particular those that materially affect earnings

and cash flow, may cast doubt on management's ability to operate its business effectively going forward. This operational volatility can negatively affect an organization's overall risk profile.
41.An enterprise receives a negative score if unusual events or operational surprises regularly affect

earnings or cash flow while an enterprise receives a positive score if it has a history of not incurring such surprises. An enterprise receives a neutral score if it reports unusual transactions or events that affect financial performance only occasionally.

Governance
42.The proposed analysis of governance covers a number of risk factors relating to how an enterprise is

managed; its relationship with shareholders/stakeholders, creditors, and others; and how its internal procedures, policies, and practices can create or mitigate risk. Strong governance (such as the presence of an active, independent board) does not, by itself, enhance creditworthiness. Good governance

practices cannot overcome a weak business or financial risk profile, though they would generally help to protect an already strong business.
43.The outcome of governance analysis does not, in itself, raise the overall management and governance

score. The impact of governance analysis is either neutral or negative. For example, an enterprise receives a neutral score for board independence from management where a small proportion of the board's members are enterprise insiders and where overall board skills are sufficient to provide proactive oversight of management's activities. Conversely, this subfactor is scored as negative if board composition includes several management insiders to the point where the board can no longer maintain its independence from management and exercise appropriate oversight over risk taking, compensation, and/or conflicts of interest. A negative result can arise from a variety of perceived shortcomings or potential problems that are considered significant either individually or in combination. Any governance deficiency could translate into greater perceived overall risk and will lead to a score of no higher than fair. Any individual governance deficiency or combination of governance deficiencies that are considered severe will lead to a score of weak. A governance deficiency is severe when any negative governance subfactor alone or in combination with another or other subfactors impairs the ability of the enterprise to execute strategy or manage its risks. Board independence from management
44.A key governance issue is the board of directors' independence from management as evidenced by

the sufficiency of their scrutiny of management. Assessing independence entails looking beyond affiliations that inform formal notions of director autonomy. This subfactor is scored as neutral if the board maintains sufficient independence from management to provide appropriate oversight of key enterprise risks, compensation, and/or conflicts of interest. In such cases, the board is supportive of management but retains control as the final decision-making authority for high-level matters. In contrast, this subfactor is scored as negative if the board manifests a lack of independence from management or provides insufficient oversight and scrutiny of management. Evidence of this could include strategies or compensation programs that promote outsize risk taking or that tolerate unmanaged conflicts of interest and/or inadequate succession planning for senior management. Entrepreneurial or controlling ownership
45.Entrepreneurial or family-bound ownership and control of management can be another governance

deficiency. However, this is not a deficiency (i.e., it has a neutral impact) if, although ownership is concentrated, management and the board of directors have professional/independent members who are capably engaged in risk oversight on behalf of all stakeholders, including minority interests. For enterprises with those characteristics, the influence of the controlling shareholder/stakeholder is offset by

risk-aware professional management and a board of directors that effectively serves the interests of all stakeholders. In rare cases, a board lacking any independent representation can receive a neutral evaluation if it has a proven track record of discharging its fiduciary responsibilities on behalf of all stakeholders. Ownership structure is a governance deficiency if controlling ownership negatively influences corporate decision-making to promote the interests of the controlling owners above those of other stakeholders. Management culture
46.Management culture can be a governance deficiency for any enterprise. The impact is neutral if

management is responsive to all stakeholders' interests, appropriately balances those interests, and acknowledges that the board of directors is the ultimate decision-making authority. Management culture is a governance deficiency and gets a negative subfactor score where management's own interests are its primary concern, where dissent in the executive suite is generally not tolerated, where management is responsive only to a narrow group of stakeholders, or where management proves incapable of managing conflicts of interest arising between different stakeholder groups. Excessive management turnover can be an indicator of a governance deficiency in management culture. Management culture is also a governance deficiency where management dominates the board of directors as indicated by the control exercised by the Chair, CEO, or other key executives, unless that is offset by clear evidence that the board prevails against such pressure in exercise of its oversight responsibilities. For example, by ensuring that management incentives and compensation programs do not promote outsized risk taking. Regulatory, tax, or legal infractions
47.A history of regulatory, tax, or legal infractions beyond an isolated episode or outside industry norms is

a governance deficiency. This is a neutral factor for an enterprise that avoids them and has a history of stable relationships with regulatory authorities. On the other hand, this is negative for enterprises that have frequent infractions or confrontations with outside parties, including regulatory authorities, which represent significant risk to the enterprise as evidenced by a history of material losses or an adverse impact on the enterprise's reputation. Communication of messages
48.The communication of conflicting messages to different constituencies is a governance deficiency. An

enterprise that generally communicates consistent messages to all constituencies receives a neutral score for messaging. Where there is evidence that an enterprise communicates conflicting information to different stakeholders on significant issues, it receives a negative score. Internal controls

49.The score for this subfactor is negative if there is evidence of material deficiencies in the internal

control systems based on an enterprise's reporting on internal controls or other evidence such as restatements or delays in filings. However, an enterprise will receive a score of neutral for this subfactor if there is evidence that the potential deficiency has been remedied or is rendered immaterial. The score for this subfactor is neutral if there are no observed material deficiencies in the internal control system.
50.An example of a material deficiency that would produce a negative score is when an enterprise

discloses material weaknesses from inadequate information system controls over key processes as part of its report on the design and operating effectiveness of its internal controls (e.g., pursuant to SarbanesOxley Section 404 in the U.S.), and it affects the validity and accuracy of financial data. Financial reporting and transparency
51.Financial statements and related disclosures are the primary source of information regarding an

enterprise's current and earlier period financial condition and performance. This analysis starts with a review of accounting principles applied (in particular, any unusual practices) and the underlying assumptions used. The analysis of disclosures--such as detailed schedules of reserves, contingent liabilities, and ranges of assumptions used--can provide a better understanding of an enterprise's risks. The purpose is to determine whether the ratios and statistics derived from the financial statements can serve as meaningful measures of an enterprise's performance and position relative to both its peer group and the larger universe of corporate issuers.
52.The score for the financial reporting and transparency subfactor is neutral if an enterprise's accounting

practices and transparency are at least adequate. When alternatives are available, the enterprise's accounting choices are usually reflective of the economics of the business. Enterprises that have weak accounting practices or that lack financial transparency receive negative scores. For example, a negative score may be warranted if an enterprise's financial statements obfuscate the true intent or the economic drivers of key transactions, or the financial statements are insufficient to allow users of the financial statements to understand the intent and the economic drivers. Another example is if an enterprise's financial statements require an unusually large number of analytical adjustments (compared with peers) because of the enterprise's specific accounting policy choices. Further, financial reporting has a negative impact if disclosures are contradictory to information provided to investors through other means (e.g., investor presentations) or if the frequency of financial reporting is less timely when compared to peers.

Frequently Asked Questions

53.Question 1: Where there is a lack of information for any subfactor in management and strategy or

governance, how is that subfactor scored?

54.This is an evidence-based analysis. If there is no information to indicate that a subfactor should be

scored as either positive or negative, the subfactor is scored as neutral.

55.Question 2: What is the overall score for management and governance where there is no one

governance subfactor that is potentially harmful to an enterprise's risk profile, but in aggregate two or more subfactors are potentially harmful to the enterprise's risk profile?
56.Management and governance is scored as weak if a group of subfactors is viewed as potentially

harmful to the enterprise's risk profile. As an example, an enterprise's management culture could be scored as negative, which apart from other characteristics may lead management and governance to be scored as fair. However, if the subfactor of internal controls is also scored as weak and the combination of these two governance deficiencies is potentially harmful to the enterprise's risk profile, then management and governance is scored as weak. Of course, any one subfactor could be sufficiently harmful to the enterprise's risk profile, such that management and governance is scored as weak.
57.Question 3: How does a change in senior management affect the scoring of individual subfactors?

58.Evidence of a change in any subfactor due to a change in management is reflected in the subfactor

score. To the extent an issuer changes senior management, board composition, strategic direction, risk appetite, or execution capabilities, the relevant subfactor scores may change based on updated information.
59.Question 4: How do you determine that there is insufficient board oversight of management in order to

score the subfactor, board independence from management, as negative?

60.Board of director processes and directors' interactions with management are largely hidden from view,

so the evidence for a negative assessment will be indirect and circumstantial. Circumstances that could indicate a lack of board independence from management are numerous. Some indicators of this governance deficiency are based on board members having another relationship with the enterprise or because they have been co-opted by management. Examples of affiliations of board members with the enterprise include enterprise, or subsidiary executives; individuals associated with firms that provide professional services to the enterprise; and individuals associated with enterprises that have substantial interconnecting relationships. Most boards will have some members that are either insiders or are affiliated with the enterprise in another capacity, but a board with a preponderance of such members is likely to receive a negative score for this subfactor, absent evidence of appropriate oversight of key enterprise risks. Conversely, short tenures combined with high turnover may also be evidence of a lack of board independence. When these conditions combine with evidence of strategies or compensation

programs that promote outsize risk taking, that tolerate unmanaged conflicts of interest, or where there is inadequate succession planning, this constitutes evidence of insufficient board oversight of management. The critical element of independent mindedness--or the lack of it--which is the highway to a negative assessment, will be evidenced by a number of facts and circumstances like these.
61.Question 5: What are examples of where the subfactor, regulatory, tax, or legal infractions, would be

scored as negative?
62.A negative score would result if, due to management's actions or failure to act, an enterprise's

relationship with a regulator eroded to the point where it affected the enterprise's ability to conduct business and led to failures to maintain its competitive profile. For example, a relationship of mutual trust and respect between issuer and regulator is an important consideration for many utilities which require regulatory consent regarding pricing and, in turn, their ability to service their debt obligations. Where tax is avoided in a legitimate and lawful way the enterprise would receive a neutral score, but if that shaded into tax evasion a negative score would result. Similarly, while many rated issuers have to cope with lawsuits of various kinds that they can choose to litigate or settle without necessarily attracting a negative evaluation, the deliberate or negligent breaking of law, in areas as varied as product defects to criminal sanctions against commercial bribery, will be visited with a negative score. A negative score of this subfactor, among other things, reflects the cost to the enterprise and distraction for management that accompanies these events.
63.Question 6: What are some of the conditions that could lead to a positive score for the subfactor,

comprehensiveness of risk management standards and tolerances?

64.Enterprises with a true enterprise-wide approach to ERM appreciate the importance of going beyond

only quantifiable risks or even top 10 risks. They increasingly understand the importance of emerging risks. Generally, enterprises that score positively for this element exhibit an active management of risks with ongoing risk reviews and the assessment of high-impact/high-probability risks. These enterprises employ a risk-based approach to strategic decisions and can demonstrate success. Such enterprises have effectively communicated to employees, owners, and other key stakeholders their tolerance for risk.

APPENDIXES Appendix 1: Proposed Use Of Management Metrics In Determining The Management And Governance Score--Corporate Ratings
65.The proposed scoring methodology for corporate entities utilizes the following subfactors:

Strategic positioning

 Risk management Organizational effectiveness Governance

Strategic planning process Consistency of strategy with organizational capabilities and marketplace conditions Ability to track, adjust, and control execution of strategy

Comprehensiveness of risk management standards and tolerances Standards for operational performance

Management's expertise and experience Management depth and breadth Management's operational effectiveness

Board independence from management Entrepreneurial or controlling ownership Management culture Regulatory, tax, or legal infractions Communication of messages Internal controls Financial reporting and transparency

66.Table 3 describes the proposed scoring methodology for corporate entities.

Table 3

Proposed Scoring Of Management And Governance--Corporate Entities

Score

Related subfactors

1. Strong

At least five of the eight strategic positioning, risk management, and organizational effectiveness subfactor scores are positive, and none are negative. No negative scores for governance.

2.

At least three of the eight strategic positioning, risk management, and organizational

Satisfactory

effectiveness subfactor scores are positive, and none are negative. No negative scores for governance.

3. Fair

At least three of the eight strategic positioning, risk management, and organizational effectiveness subfactor scores are positive or neutral. Any negative score for a governance subfactor limits the score to fair.

4. Weak

Five or more of the eight strategic positioning, risk management, and organizational effectiveness subfactor scores are negative or key aspects of management are potentially harmful to the companys risk profile. If there are deficiencies in governance that are considered severe, management and governance is scored weak.

67.As depicted in table 3, one or more negative subfactor scores will constrain the overall management

and governance score to no higher than fair, regardless of the actual tally of subfactor scores. A score of negative for any subfactor indicates that there is a material deficiency in the management of a company. If a specific subfactor or group of subfactors is viewed as potentially harmful to the company's risk profile, management and governance will be scored as weak. For example, management and governance will be scored as weak if a company's management has a history of experiencing unusual items that regularly affect its financial performance to the point of being harmful to the company's risk profile. Management and governance will be scored no higher than fair if one or more governance subfactors are scored as negative, and scored weak if there are deficiencies in governance that are considered severe.

Appendix 2: Proposed Use of Management Metrics in Determining the Management and Governance ScoreInsurance Ratings
68.The proposed scoring methodology for insurance entities utilizes the following subfactors:

Strategic positioning Financial management Comprehensiveness of financial standards and risk tolerances Standards for operational performance Risk tolerance Strategic planning process Consistency of strategy with organizational capabilities and marketplace conditions Ability to track, adjust, and control execution of strategy

Organizational effectiveness Governance Board independence from management Entrepreneurial or controlling ownership Management culture Regulatory, tax, or legal infractions Communication of messages Internal controls Financial reporting and transparency Management's expertise and experience Management depth and breadth Management's operational effectiveness

69.Table 4 describes the scoring methodology for insurance entities.

Table 4

Proposed Scoring Of Management and Governance--Insurance Entities

Score

Related subfactors

1. Strong

At least seven of the nine strategic positioning, financial management, and organizational effectiveness subfactor scores are positive, and none are negative. No negative scores for governance.

2. Satisfactory

At least three of the nine strategic positioning, financial management, and organizational effectiveness subfactor scores are positive, and none are negative. Or one subfactor score, other than risk tolerances, is negative and at least four are positive. No negative scores for governance.

3. Fair

Other combinations not covered by other descriptors. Any negative score for a governance subfactor limits the score to fair.

4. Weak

Five or more of the nine strategic positioning, financial management, and organizational effectiveness subfactor scores are negative or key aspects of management are potentially

harmful to the enterprises risk profile. If there are deficiencies in governance that are considered severe, management and governance is scored weak.
70.As depicted in table 4, one or more negative governance subfactor scores will constrain the overall

management and governance score to no higher than fair, regardless of the actual tally of subfactor scores. However, a satisfactory score can result if one management subfactor, other than risk tolerances, is scored as negative--balanced by at least four other positive assessments and no negative scores for governance. If a specific subfactor or group of subfactors is viewed as potentially harmful to the company's risk profile, management and governance will be scored as weak. For example, management and governance will be scored as weak if a company's management has a history of experiencing unusual items that regularly affect its financial performance to the point of being harmful to the company's risk profile. Management and governance will be scored no higher than fair if one or more governance subfactors are scored as negative, and scored weak if there are deficiencies in governance that are considered severe.

RELATED CRITERIA AND RESEARCH

Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, May 27, 2009 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Watch the related CreditMatters TV segment titled, "What Prompted Standard & Poors Proposed Criteria For Management And Governance For Corporate Ratings?," dated April 9, 2012. These proposed 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 affects our credit judgment. Global Corporates & Governments: Colleen Woodell, Senior Credit Officer, New York (1) 212-4382118; colleen_woodell@standardandpoors.com Mark Puccia, New York (1) 212-438-7233; mark_puccia@standardandpoors.com

Primary Credit Analyst:

Secondary Contacts:

Steven J Dreyer, Washington D.C. (1) 202-383-2487; steven_dreyer@standardandpoors.com Laurence Hazell, New York (1) 212-438-1864; laurence_hazell@standardandpoors.com Mark Mettrick, CFA, Toronto (1) 416-507-2584; mark_mettrick@standardandpoors.com James Parchment, New York (1) 212-438-4445; james_parchment@standardandpoors.com Peter Kernan, London (44) 20-7176-3618; peter_kernan@standardandpoors.com Emmanuel Dubois-Pelerin, Paris (33) 1-4420-6673; emmanuel_dubois-pelerin@standardandpoors.com Rodney A Clark, FSA, New York (1) 212-438-7245; rodney_clark@standardandpoors.com

Criteria | Corporates | General: Methodology: Short-Term/Long-Term Ratings Linkage Criteria For Corporate And Sovereign Issuers
Publication date: 15-May-2012 09:21:17 EST

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Table of Contents SUMMARY OF CRITERIASCOPE OF THE CRITERIASUMMARY OF COMMENTS RECEIVEDIMPACT ON OUTSTANDING RATINGSEFFECTIVE DATE AND TRANSITIONMETHODOLOGYCorporate RatingsSovereign RatingsGroup RatingsGREsOtherRELATED CRITERIA AND RESEARCH1.Standard &

Poor's Ratings Services is publishing its methodology to link short-term and long-term ratings for corporate and sovereign issuers. This article is related to our criteria article "Principles Of Credit Ratings", which we published on Feb. 16, 2011.

SUMMARY OF CRITERIA
2.The methodology establishes a linkage of short-term and long-term ratings for corporate issuers through

the use of liquidity descriptors as described in "Liquidity Descriptors For Global Corporate Issuers," published Sept. 28, 2011. The methodology also clarifies the link between short-term and long-term ratings for sovereigns. Corporate entities assessed as having "less than adequate" or "weak" liquidity, as our criteria describe the terms, are not rated investment grade (see "Liquidity Descriptors for Global Corporate Issuers," published Sept. 28, 2011). For corporate entities, the evaluation of issuer liquidity determines short-term ratings. For sovereigns, the short-term rating is derived uniquely from the issuer's long-term rating.

SCOPE OF THE CRITERIA

3.This methodology applies to short-term corporate and sovereign issuer and issue credit ratings. It does

not apply to project finance ratings, because of the contractual cash management protections in place for those credits, nor to issuers with characteristics of finance companies, such as equipment leasing companies and captive finance companies. This methodology also applies to government related enterprises (GREs) where the rating is equalized with that of a sovereign government and applies to GREs that operate in the corporate sector. For GREs operating in the financial, insurance, and public finance sectors, the linkage between the long-term and the short-term rating is the one applicable in these sectors (see "Holding Company Analysis," published June 11, 2009, and "Methodology For Mapping Short- And Long-Term Issuer Credit Ratings For Banks," published May 4, 2010).

SUMMARY OF COMMENTS RECEIVED

4.On Feb. 24, 2012, Standard & Poor's published "Request For Comment: Short-Term/Long-Term

Ratings Linkage Criteria For Corporate And Sovereign Issuers". We received no comments on this criteria proposal.

IMPACT ON OUTSTANDING RATINGS

5.We expect less than 1% of corporate short-term ratings to change upon implementation. All changes

would be within one rating category.

6.We expect short-term ratings to rise to 'A-2' from 'A-3' for sovereigns with a 'BBB' long-term rating and

to 'B' from 'C' for sovereigns with a 'B-' long-term rating. As a consequence, the short-term ratings on nonsovereigns that are currently capped at the sovereign short-term rating level or equalized with it (as might be the case for certain GREs or guaranteed obligations) will also rise.

EFFECTIVE DATE AND TRANSITION

7.These criteria are effective immediately. We intend to complete our review of all affected ratings within

the next month.

METHODOLOGY Corporate Ratings

8.Liquidity is an important component of financial risk across the entire rating spectrum. Unlike most other

rating factors within an issuer's risk profile, a lack of liquidity could precipitate the default of an otherwise healthy entity. Accordingly, liquidity is an independent characteristic of a company, measured on an absolute basis. The combination of the long-term rating and the liquidity assessment produce the shortterm rating results in Table 1.

Sovereign Ratings
9.The analytical approach to assigning long-term ratings for sovereigns includes an analysis of the

country's balance of payments and the cost of external financing, the sovereign's own domestic funding profile, and the potential benefits deriving from the status of its currency in international transactions and its monetary flexibility (see "Sovereign Government Rating Methodology And Assumptions," published June 30, 2011). For this reason, we use the same long- and short-term ratings relationships for sovereigns. The combination of the long-term rating and the equivalent of the "strong" or "adequate" liquidity column in Table 1 produce the short-term rating for a sovereign.
Table 1

Short-Term/Long-Term Ratings Linkage

Long-Term Rating

Exceptional Liquidity

Strong Or Adequate Liquidity

Less-Than-Adequate Liquidity

Weak Liquidity

AAA

A-1+

A-1+

N/A

N/A

AA+/AA/AA-

A-1+

A-1+

N/A

N/A

A+

A-1+

A-1

N/A

N/A

A-1

A-1

N/A

N/A

A-

A-1

A-2

N/A

N/A

BBB+

A-2

A-2

N/A

N/A

BBB

A-2

A-2

N/A

N/A

BBB-

A-3

A-3

N/A

N/A

BB+

A-3

N/A

BB/BB-/ B+/B

N/A

B-

CCC+ and below

SD/D

N/A--Not applicable.

Group Ratings
10.The liquidity assessment includes the potential for extraordinary support. This means that for entities

that are highly strategic or core to their group, the group's liquidity assessment is used. For investmentgrade rated entities that are strategically important to their group, the liquidity assessment is the higher of

"adequate" liquidity or the issuer's liquidity descriptor based on its stand-alone credit profile (SACP). For non-investment-grade rated entities that are strategically important to their group, the liquidity assessment is the higher of the group's liquidity descriptor or the issuer's liquidity descriptor based on its SACP. For entities that are moderately strategic or non-strategic to their groups, the issuer's liquidity is based on its SACP. In order for an entity with a non-investment-grade SACP to be rated investment grade on its shortterm or long-term obligations based on group support, the entity's liquidity descriptor must be at least "adequate" when including the potential for extraordinary support.

GREs
11.For GREs operating in the corporate sector, the liquidity assessment includes the potential for

extraordinary liquidity support. As is the case with group support, in order for a GRE with a noninvestment-grade SACP to be rated investment grade on its short-term or long-term obligations, the entity's liquidity descriptor must be at least "adequate" when including the potential for extraordinary support. As a result, for investment grade ratings, the issuer's liquidity descriptor is the higher of "adequate" liquidity or the issuer's liquidity descriptor based on its SACP. Similarly, for entities rated from 'B' to 'BB+', the issuer's liquidity descriptor is the higher of "less than adequate" liquidity or the issuer's liquidity descriptor based on its SACP. When a long-term rating on a GRE is equalized with that of its related government, the short-term rating on the GRE is also equalized with the short-term rating on the government.

Other
12.Regardless of our liquidity assessment, ratings on a non-sovereign can be higher than those on the

sovereign only if that entity meets the criteria to be rated above the sovereign (see "Methodology: Criteria For Determining Transfer And Convertibility Assessments," published May 18, 2009, and "Nonsovereign Ratings That Exceed EMU Sovereign Ratings: Methodology And Assumptions," published June 14, 2011).
13.For an issue, issuer, or short-term program of issues that benefits from a guaranty that meets the

necessary conditions for credit substitution under Standard & Poor's criteria, the guarantor's short-term rating is used.

RELATED CRITERIA AND RESEARCH

Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 Rating Government-Related Entities: Methodology And Assumptions, Dec. 9, 2010

Methodology For Mapping Short- And Long-Term Issuer Credit Ratings For Banks, May 4, 2010 Holding Company Analysis, June 11, 2009 Corporate Criteria--Parent/Subsidiary Links; General Principles; Subsidiaries/Joint Ventures/Nonrecourse Projects; Finance Subsidiaries; Rating Link to Parent, Oct. 28, 2004

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. Criteria Officers: Mark Puccia, New York (1) 212-438-7233; mark_puccia@standardandpoors.com Alexandra Dimitrijevic, Paris (33) 1-4420-6663; alexandra_dimitrijevic@standardandpoors.com Colleen Woodell, New York (1) 212-438-2118; colleen_woodell@standardandpoors.com

General Criteria: Criteria Update: Joint-Support Criteria Refined

Publication date: 03-Feb-2006 14:22:57 EST

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Table of Contents SummaryJoint Probability Of Default CalculationEntities To Which The Criteria Are ApplicableLegal And Structural ConsiderationsImplementation(Editor's Note: We are republishing this

article (last published on May 19, 2011) following our periodic review completed on April 8, 2012. This article, originally published on Feb. 3, 2006, has been amended and partially superseded by "General Criteria: Joint-Support Criteria Update", published April 22, 2009.) Standard & Poor's Ratings Services has refined its criteria for rating jointly supported obligations, when each obligor is fully responsible for the entire obligation. In this situation, a default on the obligation would occur only if both obligors default. Common examples of joint support include a primary obligor plus a guarantor or a primary obligor and a letter-of-credit (LOC) provider. The risk that both obligors will default is less than the risk that either one will. As a result, the obligation may be rated higher than the rating on the stronger obligor (supporter). Standard & Poor's introduced the application of probability theory to jointly supported obligations more than 10 years ago. The fundamental concept is now widely accepted by market participants. Our compilation of extensive data on speculative-grade default risk during the past decadeespecially our indepth analysis of default risk correlationhas prompted the criteria refinements. This research also underpins CDO Evaluator Version 3.0, Standard & Poor's proprietary modeling tool for CDOs, which was released on Dec. 19, 2005.

Summary
The revised criteria contain the following key elements: The rating for the jointly supported obligation will be derived from one of three reference tables, one each for obligor pairs that have high, medium, and low default correlation (see charts 1, 2, and 3). Under Standard & Poor's old criteria, a single table was used for all eligible obligors. The new tables were generated with a more sophisticated

calculation of the joint default probability, including explicit default correlation assumptions. Obligations of very highly correlated entities remain ineligible for credit enhancement. Application of the criteria is extended to speculative-grade entities. Previously, the criteria were applicable only to investment-grade obligors. The joint-support criteria will not be used to rate issues or issuers that receive less-formal support, such as the benefits enjoyed by many government-owned enterprises. In other words, these issues will continue to be rated no higher than the rating on the government or parent company providing support. On Nov. 2, 2005, Standard & Poor's published "Request for Comment: Refinements To Joint Support Criteria Proposed," which is available on RatingsDirect. We thank market participants who sent us comments, and we are encouraged by the positive response. The new criteria are largely the same as those in the November proposal. It should be noted, however, that the underlying probabilities of default (displayed in table 1) were slightly modified to maintain consistency with those in CDO Evaluator. As a result, charts 1, 2, and 3 differ somewhat from those in the November proposal.

Joint Probability Of Default Calculation

The joint probability of default (PD) is calculated as follows:

For the rating on each obligor, the corresponding 10-year cumulative PD (displayed in table 1) is used. After the joint PD is calculated, the number is converted back into the closest corresponding rating for the 10-year time horizon. The underlying PDs associated with each rating are consistent with those used by Standard & Poor's for rating CDOs. The following example is illustrative. If a French bank rated 'A+' (PD of 1.458%) guarantees an obligation of an American manufacturing company rated 'BB+' (PD of 13.179%), and the assumed default correlation is 15%, the jointly supported rating would be 'AA' (joint PD of 0.800%).
Table 1

Correspondence Between Ratings And Probabilities Of Default

Rating

Probability of default (%)

AAA

0.362

AA+

0.536

AA

0.872

AA-

1.13

A+

1.458

1.782

A-

2.479

BBB+

3.842

BBB

5.876

BBB-

10.637

BB+

13.179

BB

18.258

BB-

24.197

B+

30.565

38.145

B-

48.559

CCC+

65.517

CCC

75.853

CCC-

88.268

Under the old joint-support criteria, the joint PD was calculated simply by multiplying the stronger obligor's PD (different PDs were used in 1995) by 0.5 to crudely reflect potential default correlation. This is comparable with assuming the weaker obligor is rated 'B-' and that default risk of the two obligors is completely independent. The revised, more refined approach reflects our analysis of empirical default correlations. Under the new criteria, default correlations of 25%, 20%, or 15% are explicitly assumed based on the obligors' characteristics, as shown in table 2.
Table 2

Default Correlation Guidelines

Default Correlation (%) Characteristics

Too high

No benefit (1) Affiliated companies, (2) government and its owned/supported entities, (3) economically codependent entities, (4) both obligors in the same country, and its sovereign government is rated speculative grade*

High

25 Both obligors share two of the following: same industry, same region, speculative grade*

Medium

20 Both obligors share one of the following: same industry, same region, speculative grade*

Low

15 Obligors are in different industries and regions, and at least one is investment grade*

*When rating a jointly supported foreign currency issue, the foreign currency ratings on the obligors and sovereign are relevant, but the result is constrained by the transfer and convertibility limit.

In lieu of a single table for all eligible obligors, as under the old criteria (table 3), three different reference tables (charts 1, 2, and 3) for different degrees of correlation are now employed. To facilitate implementation, relatively simple guidelines are used to determine which table is appropriate. The main factors are whether the obligors are in the same industry, in the same region, or speculative grade. The relevance of these intuitive criteria is supported by Standard & Poor's default correlation research. Most eligible jointly supported issues are expected to fall in the medium or low correlation categories. In the U.S., a region will generally be defined as a state. Outside the U.S., a region will generally be defined as a country. However, we will also make case-specific analytical conclusions about correlation when appropriate. To date, joint-support criteria have typically been applied to transactions involving a bank and either a U.S. corporate or a U.S. public finance entity. When assessing geographic correlation, a large bank, with a globally diverse business profile, will not be treated as in any particular U.S. state. In other words, a major bank with its home office in New York would not be considered in the same region as a New York State municipality. On the other hand, smaller banks with significant geographic concentrations in one to three states may be considered to be in the same region as entities from any of those states. As sovereign default risk moves through the rating spectrum, default correlation for entities within the country, regardless of industry, typically rises and falls geometrically. The default correlation guidelines take this phenomenon into account, with some smoothing of the ups and downs. No credit enhancement for joint support will be permitted when both obligors are in the same country with a sovereign government rated 'BB+' or lower, and the benefit caps shown below will be used to reduce the credit cliff. When both obligors are in the same country and its government is rated:
Table 3

'AA-' or higher, there is no benefit cap. In the 'A' category, there is a three-notch benefit cap. In the 'BBB' category, there is a one-notch benefit cap. 'BB+' or lower, there is no joint-support benefit.

Old Criteria For Jointly Supported Obligations

AAA AA+ AA

AA-

A+

A-

BBB+ BBB

BBB-

AAA

AAA

AAA AAA AAA AAA AAA AAA AAA

AAA

AAA

AA+

AAA

AAA AAA AAA AAA AAA AAA AAA

AAA

AAA

AA

AAA

AAA AAA AAA AAA AAA AAA AA+

AA+

AA+

AA-

AAA

AAA AAA AA+

AA+

AA+

AA+

AA+

AA+

AA

A+

AAA

AAA AAA AA+

AA+

AA+

AA+

AA

AA

AA-

AAA

AAA AAA AA+

AA+

AA

AA

AA-

AA-

A+

A-

AAA

AAA AAA AA+

AA+

AA

AA-

A+

A+

BBB+ AAA

AAA AA+

AA+

AA

AA-

A+

A-

BBB

AAA

AAA AA+

AA+

AA

AA-

A+

A-

BBB+

BBB-

AAA

AAA AA+

AA

AA-

A+

A-

BBB+ BBB

The colors in charts 1, 2, and 3 illustrate a comparison of the new criteria to Standard & Poor's old criteria. Yellow indicates that the new rating is lower, light blue indicates that the new rating is one notch higher, dark blue indicates that the new rating is more than one notch higher, and white indicates no rating change.

Entities To Which The Criteria Are Applicable

The main application of the joint-support criteria to date has been for LOC-backed issues. Nearly 400 such issues are currently rated based on Standard & Poor's joint-support criteria. The LOC-backed issues are split between those for which the primary obligor is a U.S. public finance (tax-exempt) entity and those with a U.S. corporate primary obligor. Banks providing the LOCs range from local U.S. commercial banks to large multinational institutions based in a number of countries. Virtually all transactions to which the criteria are applied include at least one financial institution obligor. Under the new criteria, Standard & Poor's will continue to exclude very highly correlated entitiessuch as affiliated companiesfrom any joint-support benefit. Obligations insured by the monoline bond insurers will remain ineligible for joint-support credit enhancement (above the rating on the insurer), reflecting the significant correlation between the insurer and its portfolio of insured obligations. The joint-support approach remains inappropriate for U.S. public finance double-barreled bonds, which are backed by economically codependent payment sources (e.g., a general obligation pledge and revenue from water and sewer charges). Nor should it be applied to obligations of government-owned or -supported enterprises when the joint obligors are the issuer and its government owner/supporter. Government-supported entities (GSEs) When rating a GSE and its obligations, Standard & Poor's has long recognized the benefits afforded to them, originating from the supporting government (see "Revised Rating Methodology for GovernmentSupported Entities," published on RatingsDirect on June 5, 2001). Based on government support, GSEs are often rated above their stand-alone credit quality, sometimes as high as the government providing support, even in the absence of an explicit guarantee. Standard & Poor's does not plan to apply a probabilistic approach to GSE ratings. After appropriately elevating the ratings on the GSE to account for support, it would be double counting to raise the rating further, above the rating on the government, in an attempt to incorporate the GSE's independent ability to continue paying its obligations when the government is in default. The more likely scenarios are that they will both default or the GSE will default and the government will not. Although default risk might not be identical, there is clearly a very high degree of default correlation between a government and a GSE that is owned by and depends on meaningful support from it. Under the new joint-support criteria, the high correlation category assumes default correlation of only 25%, well below the default correlation of a GSE and its government benefactor. Short-term and dual ratings

Jointly supported short-term obligations will remain eligible for credit enhancement. This is accomplished by converting the indicated long-term rating into the corresponding short-term rating. A substantial number of LOC-backed issues have a short-term put or demand feature. Every seven days, the interest rate is reset and investors may demand repayment. Standard & Poor's assigns a dual rating (e.g., 'AA/A1+') to these instruments. Standard & Poor's will continue to apply its current criteria with the new reference tables, as explained below. Corporate obligors Using the long-term rating on each obligor, the final long-term rating is found in the appropriate (low, medium, or high correlation) joint-support reference table. Then, based on this long-term rating, the final short-term rating is generally determined by the standard long/short correlation table. When there is a choice, the more conservative option is usually employed, but the jointly supported short-term rating will never be lower than the actual short-term rating on the stronger obligor. For example, a Japanese bank rated 'A-' provides an LOC for an issue of a U.S. manufacturing company rated 'B+'. The low correlation joint-support reference table shows that the long-term rating would be 'A', which, in turn, conservatively corresponds to a short-term rating of 'A-2'. Thus, the jointly supported issue would be rated 'A/A-2'. The long-term rating on the primary obligor fully reflects its liability for the obligation, including the possible put. U.S. public finance obligors Technically, both the LOC provider and the primary obligor are obligated to meet both the scheduled long-term payments and the put option. However, Standard & Poor's has concluded that U.S. public finance obligors, even those with high investment-grade ratings, do not have the capacity to meet the sudden put. Accordingly, we recognize joint support for the long-term component but not for the shortterm rating. The short-term rating on the LOC provider is assigned to the short-term portion of the obligation. Third obligor When there are three obligors, each fully responsible for the obligation (such as a primary obligor, an LOC provider, and a confirming LOC provider), the joint-support criteria will now be applied to the best two out of three. We will use the joint-support criteria reference table (high, medium, or low correlation) for the two obligors that produce the highest rating, which will often be the two most highly rated obligors. Here is an example: The primary obligor is a health care entity rated 'BBB-', an LOC is provided by a bank rated 'BBB+', and a confirming LOC is provided by a bank rated 'AA-'. The primary obligor and LOC provider are both in the U.S. state of Georgia; the confirming LOC provider is in Germany. We would use the medium correlation table for the two banks (same industry, different regions, and both investment

grade), resulting in a rating of 'AA+'. If the health care firm is upgraded a notch to 'BBB', a 'AAA' rating could be achieved by combining the primary obligor with the confirming LOC provider in the low correlation reference table (different region and industry). Under our old joint-support criteria, the primary obligor was disregarded.

Legal And Structural Considerations

Both the new and old joint-support criteria are only applicable when the obligation is legal, valid, and enforceable against both (or all three) obligors. Any preference payment or clawback risk must be addressed in the structure of the transaction. Analysts will exercise judgment to determine whether the joint-support criteria should be applied if the obligation is unusual or unpredictable, such as a GIC.

Implementation
To ensure transparency of Standard & Poor's public ratings, the joint-support approach will only be applied when both obligors have a public long-term and, if relevant, short-term rating unless the jointsupport criteria affect only one element of a complex transaction. Standard & Poor's plans to enhance its published reports on LOC-backed issues. A notation will be added when joint-support criteria are applied. (Responses to the request for comment indicated the importance of this disclosure.) If the rating on a supporting obligor is placed on CreditWatch, Standard & Poor's will either place the rating on the jointly supported issue on CreditWatch or state publicly that the latter rating will be unaffected by the obligor's rating review. Analytics Policy Board: Gail I Hessol, Managing Director and Senior Credit Officer, New York (1) 212-4386606; gail_hessol@standardandpoors.com Laura J Feinland Katz, CFA, Managing Director and Chief Credit Officer (Latin America), New York (1) 212-438-7893; laura_feinland_katz@standardandpoors.com Takamasa Yamaoka, Director and Credit Officer (Asia Pacific), Tokyo (81) 3-45508719; takamasa_yamaoka@standardandpoors.com Public Finance: Jeffrey Previdi, Director, New York (1) 212-438-1796;

jeff_previdi@standardandpoors.com Debra Boyd, Associate Director, San Francisco (1) 415-371-5098; debra_boyd@standardandpoors.com Structured Finance: Christine T Scaperdas, Director and Analytical Manager, New York (1) 212-4387330; christine_scaperdas@standardandpoors.com Kai Gilkes, Managing Director, London (44) 20-7176-3727; kai_gilkes@standardandpoors.com

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