Standard & Poor’s Rating Process

David Gillmor
European Head of Leveraged Analytics

2nd December 2015

Permission to reprint or distribute any content from this presentation requires the prior written approval of
Standard & Poor’s. Copyright © 2015 by Standard & Poor’s Financial Services LLC. All rights reserved.
Understanding Credit Ratings
Standard & Poor’s Rating Scales
International rating scales Ratings are actively monitored
Long-term Short-term*
AAA Outlook
AA+
AA A-1+
• How the rating can change in
AA-
the near to medium term
A+ – 6 months-1 years for non-IG
Investment
grade A A-1 – <2 years for IG
A-
• 1-in-3 chance of alternative
BBB+ A-2
scenario materializing
BBB
BBB- A-3 • Positive’, ’Negative’, ’Stable’
BB+
or ’Developing’
BB Credit Watch
BB- B • Possible near-term change
B+
– <90 days
B
Non-investment B- • 1-in-2 chance of alternative
grade (high yield) CCC+ scenario materializing
CCC C • Most likely event driven
CCC-
• ’Positive’, ’Negative’, or
CC
’Developing’
SD
D D
*Depends on liquidity assessment

3
Historical Inverse Correlation Between Rating Levels and
Defaults
Global Corporate Average Cumulative Default Rates, 1981 - 2012 (%)
—Time horizon (years)—
Rating Y1 Y2 Y3 Y4 Y5 Y6 Y7 Y8 Y9 Y10 Y11 Y12 Y13 Y14 Y15
AAA 0.00 0.03 0.14 0.25 0.36 0.5 0.5 0.6 0.7 0.8 0.8 0.8 0.9 0.9 1.0
AA 0.02 0.04 0.09 0.24 0.39 0.5 0.7 0.8 0.9 1.0 1.1 1.2 1.3 1.4 1.5
A 0.07 0.18 0.28 0.43 0.59 0.8 1.0 1.2 1.4 1.7 1.9 2.1 2.2 2.3 2.5
BBB+ 0.14 0.40 0.70 1.00 1.3 1.7 2.0 2.3 2.6 3.0 3.3 3.5 3.8 4.2 4.7
BBB 0.20 0.52 0.81 1.3 1.7 2.2 2.6 3.0 3.5 3.9 4.4 4.9 5.3 5.4 5.7
BBB- 0.35 1.1 1.9 2.9 3.8 4.7 5.5 6.2 6.8 7.5 8.1 8.7 9.3 10.1 10.7
BB+ 0.47 1.3 2.5 3.6 4.7 5.9 6.9 7.7 8.6 9.6 10.3 11.0 11.6 12.1 13.0
BB 0.71 2.2 4.3 6.2 8.1 9.6 11.0 12.2 13.2 14.0 14.9 15.6 16.0 16.3 16.6
BB- 1.2 3.7 6.2 8.6 10.8 12.9 14.7 16.4 17.9 19.2 20.2 20.9 21.8 22.5 23.3
B+ 2.4 6.5 10.4 13.9 16.5 18.5 20.4 22.0 23.5 25.0 26.2 27.1 28.0 28.8 29.5
B 5.1 11.2 16.0 19.5 22.0 24.4 26.0 27.0 28.0 28.9 29.7 30.4 31.1 31.7 32.5
B- 8.2 15.8 21.3 25.1 28.0 29.9 31.6 32.6 33.2 33.7 34.4 35.0 35.4 35.8 36.3
CCC/C 26.9 35.9 41.2 44.2 46.6 47.7 48.7 49.4 50.4 51.1 51.8 52.6 53.5 54.3 54.3

Investment grade 0.1 0.3 0.5 0.8 1.1 1.4 1.7 1.9 2.2 2.5 2.7 2.9 3.1 3.3 3.5
Speculative grade 4.1 8.1 11.5 14.2 16.4 18.3 19.9 21.2 22.4 23.5 24.4 25.2 25.9 26.5 27.1
All rated 1.6 3.1 4.4 5.5 6.5 7.3 8.0 8.6 9.1 9.6 10.1 10.5 10.8 11.1 11.5
Sources: Standard & Poor's Global Fixed Income Research and Standard & Poor's CreditPro®.

• Lower rating implies higher risk of default

• However, investment grade ratings have never been risk free
• Defaults are cyclical, these are just averages through the cycle

4
Corporate Credit Rating
Methodology
Framework

6
Business Risk Profile
Assessment
Corporate Industry And Country Risk Assessment (CICRA)

“The combined assessment for country risk and industry risk”

Determining The CICRA

-- Country risk assessment--

1 3 4 6
2 5
Industry risk assessment (Very low (Intermediat (Moderately (Very high
(Low risk) (High risk)
risk) e risk) high risk) risk)

1 (Very low risk) 1 1 1 2 4 5

2 (Low risk) 2 2 2 3 4 5

3 (Intermediate risk) 3 3 3 3 4 6

4 (Moderately high risk) 4 4 4 4 5 6

5 (High risk) 5 5 5 5 5 6

6 (Very high risk) 6 6 6 6 6 6

8
Competitive Position Business Risk
Profile
Financial Risk
Profile
Anchor Modifiers
Group
methodology

Competitive Advantage

Preliminary
Scale, Scope & Competitive
Diversity Position
Assessment

Operating Efficiency Profitability can Competitive

strengthen or weaken Position
the competitive position
Assessment
Absolute Profitability

Profitability

Volatility Of Profitability

9
Determining The Business Risk Profile Business Risk
Profile
Financial Risk
Profile
Anchor Modifiers
Group
methodology

Determining The Business Risk Profile Assessment

-- CICRA--

Competitive position
1 2 3 4 5 6
assessment

1 1 1 1 2 3 5

2 1 2 2 3 4 5

3 2 3 3 3 4 6

4 3 4 4 4 5 6

5 4 5 5 5 5 6

6 5 6 6 6 6 6

*A small number of companies with a CICRA of ‘5’ may be assigned a business risk profile of ‘2’ if certain conditions are
met

10
Distribution Of Business Risk Profiles In EMEA*

3% 7%

19%
16%

29% 26%

Excellent (1) Strong (2) Satisfactory (3) Fair (4) Weak (5) Vulnerable (6)

Source: "European Corporate Rating Scores By Industry Sector As Of Jan. 22, 2014”, published on RatingsDirect on Jan. 22, 2014 *As of January 22, 2014

11
Financial Risk Profile
Assessment
Cash Flow/Leverage (CFL) Business Risk
Profile
Financial Risk
Profile
Anchor Modifiers
Group
methodology

Step 1:
Apply weights to ratios Core payback ratios
Over, typically, 5-year (FFO/debt; Debt/EBITDA)
time horizon

Step 2:
Compare core ratios Preliminary CFL Supplemental ratios + Step 3:
to appropriate volatility
assessment additional industry credit Determine importance
table benchmarks of supplemental ratios
ratios

Step 4:
Derive adjusted CFL
Adjusted CFL assessment score if supplemental
ratios indicate a
different conclusion

Step 5: “Highly Volatile” may

Based on a volatility “Volatile” may modify
adjustment, determine
modify 2 categories
1 category down
the final CFL score down

Final CFL assessment

13
Benchmark Ratio Tables Business Risk
Profile
Financial Risk
Profile
Anchor Modifiers
Group
methodology

Three benchmark tables provide ranges for various cash flow/leverage assessments

CICRA assessment and KCFs determine which table to apply

– Low volatility; generally applied to entities with a CICRA of ‘1’ (except those with competitive position of ‘5’ or ‘6’)
– Medial volatility; used under certain circumstances for entities with a CICRA of ‘1’ or ‘2’
– Standard volatility; CICRA ‘2’ or worse

Cash Flow Leverage Analysis Ratios -- Standard Volatility

-- Core ratios-- -- Supplementary coverage ratios-- -- Supplementary payback ratios--

FFO /
FFO / Debt / cash EBITDA / interest CFO / FOCF / DCF /
debt (%) EBITDA (x) interest (x) debt (%) debt (%) debt (%)
(x)

Minimal 60+ Less than 1.5 More than 13 More than 15 More than 50 40+ 25+

Modest 45 – 60 1.5 – 2 9 – 13 10 – 15 35 – 50 25 – 40 15 – 25

Intermediate 30 – 45 2–3 6–9 6 – 10 25 – 35 15 – 25 10 – 15

Significant 20 – 30 3–4 4–6 3–6 15 – 25 10 – 15 5 – 10

Aggressive 12 – 20 4–5 2–4 2–3 10 – 15 5 – 10 2–5

Highly
14 Less than 12 5+ Less than 2 Less than 2 Less than 10 Less than 5 Less than 2
Leveraged
Distribution Of Financial Risk Profiles In EMEA*

4%

9%
30%

19%

18% 20%

Minimal (1) Modest (2) Intermediate (3)

Significant (4) Aggressive (5) Highly leveraged (6)
Source: "European Corporate Rating Scores By Industry Sector As Of Jan. 22, 2014”, published on RatingsDirect on Jan. 22, 2014 *As of January 22, 2014

15
Anchor
Anchor Business Risk
Profile
Financial Risk
Profile
Anchor Modifiers
Group
methodology

Combining The Business And Financial Risk Profiles To Determine The Anchor

-- Financial risk profile --

3 6
1 2 4 5
-- Business risk profile -- (intermediat (highly
(minimal) (modest) (significant) (aggressive)
e) leveraged)

1 (excellent) aaa/aa+ aa a+/a a- bbb bbb-/bb+

2 (strong) aa/aa- a+/a a-/bbb+ bbb bb+ bb

3 (satisfactory) a/a- bbb+ bbb/bbb- bbb-/bb+ bb b+

4 (fair) bbb/bbb- bbb- bb+ bb bb- b

5 (weak) bb+ bb+ bb bb- b+ b/b-

6 (vulnerable) bb- bb- bb-/b+ b+ b b-

When two anchor outcomes are listed for a given combination of business risk profile assessment and
financial risk profile assessment, the anchor will be based on the:
– Comparative strength of its business risk profile if the financial risk profile is ‘4’ or stronger
(i.e. 1-4)
– Comparative strength of its financial risk profile if its financial risk profile is ‘5-6’
17
Distribution Of Anchor Outcomes In EMEA*

2%

11%
38%

24%

24%

AAA AA A BBB BB B

Source: "European Corporate Rating Scores By Industry Sector As Of Jan. 22, 2014”, published on RatingsDirect on Jan. 22, 2014 *As of January 22, 2014

18
Modifiers
Modifiers Business Risk
Profile
Financial Risk
Profile
Anchor Modifiers
Group
methodology

20
Modifiers – Liquidity And M&G Business Risk
Profile
Financial Risk
Profile
Anchor Modifiers
Group
methodology

Liquidity
– Minor revisions and clarifications
– Analysis continues to focus on:
 Monetary flows--the sources and uses of cash--that are the key indicators of a
company's liquidity cushion;
 The potential for a company to breach covenant tests related to declines in
EBITDA; and
 The company’s ability to:
o Absorb high-impact, low-probability events;
o The nature of the company's bank relationships;
o Its standing in credit markets; and
o How prudent (or not) we believe its financial risk management to be
Management and governance
– Measures an enterprise’s ability to manage important strategic and operating
risks
21
Impact Of Modifiers Business Risk
Profile
Financial Risk
Profile
Anchor Modifiers
Group
methodology

Modifier Step 2: Impact Of Remaining Modifiers On The Anchor

--Anchor range--

Factor/ranking ‘a-’ and higher ‘bbb+’ to ‘bbb-’ ‘bb+’ to ‘bb-’ ‘b+’ and lower

Liquidity
+1 notch if FP is positive,
1. Exceptional 0 notches 0 notches 0 notches
neutral, FS-4 or FS-51
+1 notch if FP is positive,
2. Strong 0 notches 0 notches 0 notches
neutral, FS-4 or FS-51
3. Adequate 0 notches 0 notches 0 notches 0 notches

4. Less than adequate2 N/A N/A - 1 notch3 0 notches

5. Weak N/A N/A N/A ‘b-’ cap on SACP

Management and Governance

1. Strong 0 notches 0 notches 0, +1 notches4 0, +1 notches4

2. Satisfactory 0 notches 0 notches 0 notches 0 notches

3. Fair - 1 notches 0 notches 0 notches 0 notches

4. Weak - 2 or more notches5 - 2 or more notches5 - 1 or more notches5 - 1 or more notches5

1Additional notch applies only if we expect liquidity to remain exceptional or strong.
2SACP is capped at ‘bb+.’
3If issuer SACP is ‘bb+’ due to cap, there is no further notching.
4This adjustment is one notch if we have not already captured benefits of strong management and governance in the analysis of the issuer’s competitive position.
5Number of notches depends upon the degree of negative effect to the enterprise’s risk profile.

22
Application Of Modifiers In EMEA*

400
350
300
250
200
150
100
50
0
AAA AA A BBB BB B
*As of January 22, 2014
Anchor Final rating
Source: "European Corporate Rating Scores By Industry Sector As Of Jan. 22, 2014”, published on RatingsDirect on Jan. 22, 2014

23
Insolvency Process &
Jurisdictional Considerations
Overview
Ranking a Jurisdiction

Ability to
access assets Ability to take
within and retain
corporate security
group

Ability to
Ability to
enforce/achieve
commence and
control the
Overall realisations
Ranking within
insolvency
reasonable
process
timescale

25
Insolvency Overview – S&P’s Jurisdictional Framework
S&P’s framework for assessing “creditor friendliness”
• Security
• Proven effective in protecting creditor rights?

• Creditor participation/influence
• Can creditors influence the process in a manner commensurate with their relative position in the
capital structure and their reasonable prospects for recovery?

• Distribution of value/certainty of priorities

• Are distributions to creditors done in a fair and equitable manner?

• Time to resolution
• Expected time between insolvency and ultimate resolution (may include prospects for
monetizing noncash distributions)
• General expectations should be 2 years or less

See: Criteria|Corporates|Recovery: Update: Jurisdiction-Specific

Adjustments To Recovery And Issue Ratings, published June
20, 2008

26
 Publicly Ranked Jurisdictions
Countries are classified into three categories, placing the most
creditor-friendly insolvency regimes in Group A and the least
creditor-friendly environments in Group C.
Creditor friendly Creditor Unfriendly

27
Jurisdiction-Specific Adjustments to Recovery And Issue
Ratings

• Multi-jurisdictional issues lead us to factor in increased insolvency

costs and delays
• Geographic spread of a company's assets, debt, and revenues

28
European Recoveries by Seniority

• First Lien Debt recoveries remain strong at 76%

• Second Lien Debt recoveries remain very similar to Mezzanine recoveries
• 71% of Second Lien and 87% of Mezzanine facilities with binary recoveries
(either 100% or 0%)
• Interim Recoveries remain a major risk factor given that they make up the
majority of our data set

29
Secured Bond Recoveries – First Indications

• First Lien Bank Debt recoveries outperform Secured Bond

recoveries
• Impact of covenant-lite transactions on credit quality remains
unknown at this early stage in Europe
• Lower recoveries for secured bondholders when there is a super
senior RCF in the capital structure

30
Case Analysis: A.T.U.
Auto-Teile Unger Handels Gmbh
ATU Rating Development
Thank You

David Gillmor
European Head of Leveraged Analytics
44-20-7176 3673
email@standardandpoors.com

Permission to reprint or distribute any content from this presentation requires the prior written approval of
Standard & Poor’s. Copyright © 2015 by Standard & Poor’s Financial Services LLC. All rights reserved.
Appendices
Key Attributes Of Standard & Poor’s Credit Ratings

“S&P credit ratings are designed primarily to provide relative rankings among issuers
and obligations; the ratings are not measures of absolute default probability”

Rank ordering of creditworthiness among issuers and obligations

• Forward opinions about the creditworthiness of issuers and obligations
• Relative ranking; higher ratings are judged by us to be more creditworthy and should:
- Default less frequently
- Withstand successively more stressful economic environments that we view as less likely to occur
• Absolute stress levels is part of how we try to achieve comparability of ratings
- Used to calibrate criteria across sectors and over time

Ratings are not measures of absolute default probability

• We recognize that observed default rates for all rating categories rise and fall as the economic
environment changes
• Each economic cycle is unique and produces different default rates across sectors and
regions
• We do observe long-term default frequencies to inform future changes to criteria and analytics

35
S&P Default Events

Bankruptcy filings
Failure to pay
• Principal or interest
Distressed exchange offers
• No legal default
• Exchange offers and buybacks
• Two conditions need to be met:
1. The offer implies the investor will receive less value than the promise of the
original securities
2. The offer is distressed rather than purely opportunistic
- Investors accept less than the original promise because of the risk that the issuer
will not fulfill its original obligations
- If rating is ‘B-’ or lower, then the exchange is ordinarily viewed as distressed
- Can include secondary market repurchases below par, if the company is
advertising itself as the buyer

Debt standstill agreements and writedowns also default

36
Defaults Are Cyclical, Beware Of Long-Term Averages

37
Ratings Transition Continues to Exhibit Consistency

Average Global Corporate One-Year Corporate Transition Rates, 1981-2012 (%)

Rating at the end of the year
Global Corporate
AAA AA A BBB BB B CCC/CC D NR
AAA 87.2 8.7 0.5 0.1 0.1 0.0 0.1 0.0 3.4
beginning of the year

AA 0.5 86.3 8.4 0.6 0.1 0.1 0.0 0.0 4.1

Rating at the

A 0.0 1.9 87.3 5.5 0.4 0.2 0.0 0.1 4.7

BBB 0.0 0.1 3.5 85.1 3.9 0.6 0.1 0.2 6.4
BB 0.0 0.0 0.2 5.2 76.1 7.2 0.7 0.9 9.7
B 0.0 0.0 0.1 0.2 5.4 73.8 4.4 4.3 11.7
CCC/CC 0.0 0.0 0.2 0.2 0.7 13.7 43.9 26.9 14.4

• Investment-grade-rated issuers tend to exhibit greater credit stability as measured by the frequency of rating
transition
• Higher ratings have been consistently more stable than lower ratings

38
European Default Rates – Expected At 5.2% By March 2015
• Trailing 12-month speculative-grade default
rate was 5.9% to Dec. 31, 2013 (6.7% in Q3-
2013)
- 42 EU-31 entities defaulted on €24.3 billion of
debt
- 11 entities defaulted in Q4-2013 on €4.9 billion
of debt

• Basecase default forecast 5.2% to March

2015 (versus five-year average of 7.4%)
- Downside forecast 6.7%
- Largely driven by a rise in our private credit
estimates portfolio and serial defaulters

• Favorable debt and interest rate

environment
- Helped rated companies to bolster their liquidity
positions by terming out debt maturities and
refinancing bank debt
39
Competitive Position Group Profile Business Risk
Profile
Financial Risk
Profile
Anchor Modifiers
Group
methodology

“…we determine a company’s preliminary competitive position assessment by ascribing a specific

weight to each component”

Competitive Position Group Profiles (CPGPs) And Category Weightings

-- %--

Service Product Commodit National

Capital or Commodit
and focus/ y focus/ industries
Component asset y focus/
product scale scale and
focus cost driven
focus driven driven utilities

1. Competitive advantage 45 35 30 15 10 60

2. Scale, scope, and diversity 30 50 30 35 55 20

3. Operating efficiency 25 15 40 50 35 20

Total 100 100 100 100 100 100

Weighted-average assessment 1.0-5.0 1.0-5.0 1.0-5.0 1.0-5.0 1.0-5.0 1.0-5.0

40
Modifiers – Diversification Business Risk
Profile
Financial Risk
Profile
Anchor Modifiers
Group
methodology

Diversification/portfolio effect
– Identifies the benefits of diversification across business lines (conglomerates)
– Minimum (usually) of three business lines, smallest >10% of EBITDA (or FOCF) and largest <50%
– Assessment impacted by our view of correlation between segments

Assessing Diversification/ Portfolio Effect

-- Number of business lines --

Degree of correlation of business lines 3 4 5 or more

High Neutral Neutral Neutral

Medium Neutral Moderately diversified Moderately diversified

Low Moderately diversified Significantly diversified Significantly diversified

Assessing Diversification/ Portfolio Effect

-- Business risk profile --
1 2 3 4 5 6
Diversification/ portfolio effect
(excellent) (strong) (satisfactory) (fair) (weak) (vulnerable)

1 (significant diversification) +2 notches +2 notches +2 notches +1 notch +1 notch 0 notches

2 (moderate diversification) +1 notch +1 notch +1 notch +1 notch 0 notches 0 notches

3 (neutral) 0 notches 0 notches 0 notches 0 notches 0 notches 0 notches

41
Modifiers – Capital Structure Business Risk
Profile
Financial Risk
Profile
Anchor Modifiers
Group
methodology

Capital structure
– Assesses risks in a company’s capital structure that may not show up in our
standard ratio analysis
– An analysis of four subfactors
 Currency risk associated with debt (tier 1)
 Debt maturity profile (tier 1)
 Interest rate risk associated with debt (tier 2)
 Investments (can modify preliminary capital structure assessment)
Final Capital Structure Assessment

-- Investment subfactor assessment --

Preliminary capital structure assessment Neutral Positive Very positive

Neutral Neutral Positive Very positive

Negative Negative Neutral Positive

Very negative Very negative Negative Negative

42
Modifiers – Financial Policy Business Risk
Profile
Financial Risk
Profile
Anchor Modifiers
Group
methodology

Refines the view of a company’s risks beyond the conclusions arising from the
standard assumptions in the cash flow/leverage assessment
– Assumptions do not always reflect or entirely capture the short-to-medium term event
risks or longer-term risks stemming from a company’s financial policy
Analysis depends on the nature of the company’s controlling shareholder(s)
– For companies not owned by financial sponsors, we assess:
1. Management’s financial discipline
 Determines whether unforeseen actions by management to increase,
maintain, or reduce financial risk are likely to occur during the next two to
three years
2. The company’s financial policy framework
 Assess the comprehensiveness, transparency, and sustainability of the entity’s
financial policies
 Assessed as supportive or non-supportive
“The influence management is likely to exert on an entity’s financial risk profile beyond what is
implied by recent credit ratios and cash flow and leverage forecasts”

43
Modifiers – Financial Policy Business Risk
Profile
Financial Risk
Profile
Anchor Modifiers
Group
methodology

For companies that are owned =>40% by a financial sponsor (or a

group of three or less), we assess the influence of financial sponsor
ownership
– Range from “FS4” to “FS6 (minus)”
 Depending on how aggressive we assume the sponsor will be
 FS5 and FS4 are expected to be used only in rare instances
– Generally financial sponsor-owned issuers will receive an assessment of
“FS6” or “FS6 (minus)”
 Leads to a financial risk profile of ‘6/Highly Leveraged’ under the criteria

44
Impact Of Modifiers Business Risk
Profile
Financial Risk
Profile
Anchor Modifiers
Group
methodology

Modifier Step 2: Impact Of Remaining Modifiers On The Anchor

--Anchor range--

Factor/ranking ‘a-’ and higher ‘bbb+’ to ‘bbb-’ ‘bb+’ to ‘bb-’ ‘b+’ and lower

Capital structure

1. Very positive +2 notches +2 notches +2 notches +2 notches

2. Positive +1 notch +1 notch +1 notch +1 notch

3. Neutral 0 notches 0 notches 0 notches 0 notches

4. Negative - 1 notch - 1 notch - 1 notch - 1 notch

5. Very negative - 2 or more notches - 2 or more notches - 2 or more notches - 2 or more notches

Financial policy (FP)

+1 notch if liquidity is at +1 notch if liquidity is at

+1 notch if M&G is at least +1 notch if M&G is at least
1. Positive least adequate and M&G is least adequate and M&G is
satisfactory satisfactory
at least satisfactory at least satisfactory

2. Neutral 0 notches 0 notches 0 notches 0 notches

3. Negative - 1 to - 3 notches1 - 1 to - 3 notches1 - 1 to - 2 notches1 - 1 notch

4. FS-4, FS-5, FS-6, FS-6 (minus) N/A N/A N/A N/A

1Number of notches depends on potential incremental leverage.

45
Comparable Ratings Analysis Business Risk
Profile
Financial Risk
Profile
Anchor Modifiers
Group
methodology

• Last step in determining a stand-alone credit profile on a company

• An holistic review of a company’s stand-alone credit risk profile

– Evaluates an issuer’s credit characteristics in aggregate
– Based on positive and negative nuances and reflects the need to ‘fine-tune’ ratings outcomes
– A positive or negative assessment is therefore likely to be common rather than exceptional
• A company's rating may be changed by one notch in either direction in this
comparable ratings analysis
– Assessed as neutral, positive, or negative
• Examples that can lead to an adjustment (up or down) include:
– A company being strong/weak within its business risk and/or financial risk profile (or metrics)
– Contingent risk exposures
– Short operating track record
– Unusual funding structures
– Entities in transition
– Industry or macroeconomic trends

46
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