Ratings

Standard & Poor's is an organization of professionals that provides analytical services and operates under the basic principles of:

• Independence
• Objectivity
• Credibility
• Disclosure

It operates with no government mandate and is independent of any investment banking firm, bank, or similar organization.

Standard & Poor's recognition as a rating agency ultimately depends on investors' willingness to accept its judgment. It is important that all users of its ratings understand how it arrives at the ratings, and regularly publishes ratings definitions and detailed reports on ratings criteria and methodology.

Standard & Poor's began rating the debt of corporate and government issuers more than 75 years ago. Since then, credit rating criteria and methodology have grown in sophistication and have kept pace with the introduction of new financial products. For example, Standard & Poor's was the first major rating agency to assess the credit quality of, and assign credit ratings to, the claims-paying ability of insurance companies (1971), financial guarantees (1971), mortgage-backed bonds (1975), mutual funds (1983), and asset-backed securities (1985).

A credit rating is Standard & Poor's opinion of the general creditworthiness of an obligor, or the creditworthiness of an obligor with respect to a particular debt security or other financial obligation, based on relevant risk factors. A rating does not constitute a recommendation to purchase, sell, or hold a particular security. In addition, a rating does not comment on the suitability of an investment for a particular investor.

Standard & Poor's credit ratings and symbols originally applied to debt securities. As described below, Standard & Poor's has developed credit ratings that may apply to an issuer's general creditworthiness or to a specific financial obligation. Standard & Poor's has historically maintained separate and well-established rating scales for preferred stock and short-term instruments. Over the years, these credit ratings have achieved wide investor acceptance as easily usable tools for differentiating credit quality, because a Standard & Poor's credit rating is judged by the market to be reliable and credible.

Long-term credit ratings are divided into several categories ranging from 'AAA', reflecting the strongest credit quality, to 'D', reflecting the lowest. Long-term 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.

A short-term credit rating is an assessment of the credit quality of an issuer with respect to an instrument considered short term in the relevant market. Short-term ratings range from 'A-1' for the highest-quality obligations to 'D' for the lowest. The 'A-1' rating may also be modified by a plus sign to distinguish the strongest credits in that category.

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. This opinion may reflect the creditworthiness of guarantors, insurers or other forms of credit enhancement on the obligation and takes into account statutory and regulatory preferences.

On a global basis, Standard & Poor's issue credit rating criteria have long identified the added country risk factors that give external debt a higher default probability than domestic obligations. In 1992, Standard & Poor's revised its criteria to define external versus domestic obligations by currency instead of by market of issuance. This led to the adoption of the local currency/foreign currency nomenclatures for issue credit ratings. As rating coverage expands to a growing range of emerging market countries, the analysis of political, economic, and monetary risk factors becomes even more important.

In 1994, Standard & Poor's initiated a symbol to be added to an issue credit rating when the instrument could have significant noncredit risk. The 'r' symbol is added to such instruments as mortgage interest-only strips, inverse floaters, and instruments that pay principal at maturity based on a nonfixed source, such as a currency or stock index. The symbol is intended to alert investors to noncredit risks and emphasizes that an issue credit rating only addresses the credit quality of the obligation.

In response to a need for rating evaluations on an issuer when there is no public debt outstanding, Standard & Poor's provides an issuer (also called counterparty) credit rating—an opinion of the obligor's overall capacity to meet its financial obligations. This opinion focuses on the obligor's capacity and willingness to meet its financial commitments as they come due. The opinion is not specific to any particular financial obligation, as it does not take into account the specific nature or provisions of any particular obligation. Issuer credit ratings do not take into account statutory or regulatory preferences nor do they take into account the creditworthiness of guarantors, insurers, or other forms of credit enhancement on an obligation. Counterparty ratings, corporate credit ratings, and sovereign credit ratings are all forms of issuer credit ratings.

Since a corporate credit rating provides an overall assessment of the creditworthiness of a company, it is used for a variety of financial and commercial purposes, such as to negotiate long-term leases or minimize the need for a letter of credit for vendors.

Standard & Poor's provides a rating only when there is adequate information available to form a credible opinion and only after applicable quantitative, qualitative, and legal analyses are performed. The analytical framework is divided into several categories to ensure salient qualitative and quantitative issues are considered. For example, with industrial companies, the qualitative categories are oriented to business analysis, such as the firm's competitiveness within its industry and the caliber of management; the quantitative relate to financial analysis.

The rating process is not limited to an examination of various financial measures. Proper assessment of credit quality for an industrial company includes a thorough review of business fundamentals, including industry prospects for growth and vulnerability to technological change, labor unrest, or regulatory actions. In the public finance sector, this involves an evaluation of the basic underlying economic strength of the public entity, as well as the effectiveness of the governing process to address problems. In financial institutions, the reputation of the bank or company may have an impact on the future financial performance and the ability of the institution to repay its obligations.

Standard & Poor's assembles a team of analysts with appropriate expertise to review information pertinent to the rating. A lead analyst is responsible for the conduct of the rating process. Several of the team members meet with management of the organization to review, in detail, key factors that have an impact on the rating, including operating and financial plans and management policies. The meeting also helps analysts develop the qualitative assessment so important in the rating decision.

(An exception to these procedures is made in the case of public information, or 'pi' ratings. A 'pi' credit rating is a local currency credit rating identified by the 'pi' subscript and based on an analysis of the obligor's published financial information, as well as additional information in the public domain. These ratings are reviewed annually based on a new year's financial statements, but may be reviewed on an interim basis if a major event that may affect an issuer's credit quality occurs. At present, 'pi' ratings are only provided on Standard & Poor's global scale.)

Following this review and discussion, a rating committee meeting is convened. At the meeting, the committee discusses the lead analyst's recommendation and the pertinent facts supporting the rating. Finally, the committee votes on the recommendation.

The issuer is subsequently notified of the rating and the major considerations supporting it. An issuer can appeal a rating prior to its publication, if new or meaningful additional information is to be presented by the issuer. Obviously, there is no guarantee that any new information will alter the rating committee's decision.

Once a final rating is assigned, it is disseminated to the public through the news media, except for ratings where the company has publication rights, such as traditional private placements. (Most 144A transactions are viewed as public deals.) In addition, if the rating is released to the media, the rating and rationale are published in CreditWeek or another Standard & Poor's publication.

All public ratings are monitored on an ongoing basis, including review of new financial or economic developments. It is typical to schedule annual review meetings with management, even in the absence of the issuance of new obligations. Surveillance also enables analysts to stay abreast of current developments, discuss potential problem areas, and be apprised of any changes in the issuer's plans.

As a result of the surveillance process, it is sometimes necessary to change a rating. When this occurs, the lead analyst undertakes a review, which may lead to a CreditWatch listing. This is followed by a comprehensive analysis, including, if applicable, a meeting with management, and a presentation to the rating committee. The rating committee evaluates the circumstances, arrives at a rating decision, notifies the issuer, and entertains an appeal, if one is made. After this process, the rating change or affirmation is announced.

It is common for companies to structure financing transactions to reflect rating criteria so they qualify for higher ratings. However, the actual structuring of a given issue is the function and responsibility of an issuer and its advisors. Standard & Poor's will react to a proposed financing, publish and interpret its criteria for a type of issue, and outline the rating implications for an issuer, underwriter, bond counsel, or financial advisor, but it does not function as an investment banker or financial advisor. Adoption of such a role ultimately would impair the objectivity and credibility that are vital to continued performance as an independent rating agency.

Standard & Poor's guidance also is sought on credit quality issues that might affect the rating opinion. For example, companies solicit a view on hybrid preferred stock, the sale of accounts receivable, or other innovative financing techniques before putting these into practice. Nor is it uncommon for debt issuers to undertake specific and sometimes significant actions for the sake of maintaining their ratings. For example, one large company faced a downgrade of its 'A-1' commercial paper rating owing to a growing component of short-term, floating-rate debt. To keep its rating, the company chose to restructure its debt maturity schedule in a way consistent with Standard & Poor's view of what was prudent.

(Recently, Standard & Poor's formalized its ratings evaluation role under the name Rating Evaluation Service (RES). Standard & Poor's will analyze the potential credit impact of alternative strategic initiatives, establish a definitive rating outcome for each, and share these with management. This service entails an engagement letter from the company with respect to a specific plan or multiple plans.)Many companies go one step further and incorporate specific rating objectives as corporate goals. Indeed, possessing an 'A' rating, or at least an investment-grade rating, affords companies a measure of flexibility and is worthwhile as part of an overall financial strategy. Beyond that, Standard & Poor's does not encourage companies to manage themselves with an eye toward a specific rating. The more appropriate approach is to operate for the good of the business as management sees it and to let the rating follow. Ironically, managing for a very high rating can sometimes be inconsistent with the company's ultimate best interests, if it means being overly conservative and foregoing opportunities.